S-1/A 1 ds1a.htm FORM S-1 AMENDMENT NO. 4 Form S-1 Amendment No. 4
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As filed with the Securities and Exchange Commission on March 1, 2011

Registration No. 333-167184

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 4

to

Form S-1

REGISTRATION STATEMENT

Under

The Securities Act of 1933

 

 

TRIPWIRE, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   7372   91-1826027

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

 

101 SW Main Street, Suite 1500

Portland, Oregon 97204

(503) 276-7500

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

 

James B. Johnson

President and Chief Executive Officer

Tripwire, Inc.

101 SW Main Street, Suite 1500

Portland, Oregon 97204

(503) 276-7500

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

Roy W. Tucker, Esq.

David S. Matheson, Esq.

Perkins Coie LLP

1120 NW Couch Street, Tenth Floor

Portland, Oregon 97209-4128

(503) 727-2000

 

Patrick J. Schultheis, Esq.

Nathaniel P. Gallon, Esq.

Wilson Sonsini Goodrich & Rosati

Professional Corporation

701 Fifth Avenue, Suite 5100

Seattle, Washington 98104

(206) 883-2500

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨    Accelerated filer  ¨   Non-accelerated filer  x   Smaller reporting company  ¨

(Do not check if a smaller reporting company)

 

 

The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 


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The information in this prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and we and the selling stockholders are not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED MARCH 1, 2011

Preliminary Prospectus

shares                                                                          

LOGO

 

 

Common Stock

 

 

This is the initial public offering of shares of common stock of Tripwire, Inc. Prior to this offering, there has been no public market for our common stock. We are offering              shares, and the selling stockholders identified in this prospectus are offering              shares of our common stock. We will not receive any proceeds from the sale of shares of common stock by the selling stockholders. The initial public offering price is expected to be between $             and $             per share.

We have applied to list our common stock on the Nasdaq Global Market under the symbol “TPWR.”

Investing in our common stock involves a high degree of risk. Please read “Risk Factors” beginning on page 10.

 

         Per Share                  Total          

Initial public offering price

   $                    $                

Underwriting discounts and commissions

   $                    $                

Proceeds to Tripwire, Inc., before expenses

   $                    $                

Proceeds to selling stockholders, before expenses

   $                    $                

To the extent the underwriters sell more than              shares of common stock, we and the selling stockholders have granted the underwriters an option to purchase up to              additional shares of common stock, at the initial public offering price less the underwriting discounts and commissions, to cover any over-allotments. The underwriters may exercise this option at any time within 30 days of the date of this prospectus.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares of common stock to purchasers on             , 2011.

 

J.P. Morgan   Stifel Nicolaus Weisel

 

 

 

Needham & Company, LLC   RBC Capital Markets

                    , 2011


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TABLE OF CONTENTS

 

     Page  

Prospectus Summary

     1   

Risk Factors

     10   

Special Note Regarding Forward-Looking Statements and Industry Data

     32   

Use of Proceeds

     33   

Dividend Policy

     33   

Capitalization

     34   

Dilution

     36   

Selected Consolidated Financial Data

     38   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     42   

Business

     72   

Management

     93   

Executive Compensation

     99   

Description of the 2010 Incentive Plan

     110   

Certain Relationships and Related Party Transactions

     113   

Principal and Selling Stockholders

     115   

Description of Capital Stock

     118   

Shares Eligible for Future Sale

     122   

Material U.S. Federal Income and Estate Tax Consequences to Non-U.S. Holders

     124   

Underwriting

     127   

Legal Matters

     131   

Experts

     131   

Where You Can Find More Information

     131   

Index to Consolidated Financial Statements

     F-1   

 

 

You should rely only on the information contained in this prospectus or in any free writing prospectus prepared by or on behalf of us and delivered or made available to you. Neither we, the selling stockholders nor the underwriters have authorized anyone to provide you with information that is different from that contained in this prospectus or any such free writing prospectus. We and the selling stockholders are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

No action is being taken in any jurisdiction outside the United States to permit a public offering of our common stock or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in a jurisdiction outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to that jurisdiction.

Until                     , 2011, all dealers that buy, sell or trade in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotment or subscriptions.


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PROSPECTUS SUMMARY

The following summary highlights information contained elsewhere in this prospectus. It does not contain all of the information you should consider before investing in our common stock. You should also read the more detailed information set out in this prospectus, including our financial statements and related notes and the discussion of risks of investing in our common stock set forth in the section entitled “Risk Factors.”

Tripwire, Inc.

Tripwire is a leading provider of IT security and compliance automation software solutions that help protect physical, virtual and cloud IT infrastructure, prove compliance and prevent outages for enterprises, service providers and government agencies worldwide. Our software intelligently identifies on a real-time basis security threats and compliance breaches, often otherwise undetected for months, by tracking high volumes of changes and events across an organization’s IT infrastructure, automatically analyzing this data to identify security threats and compliance breaches, and helping remediate these issues. Our software provides a cost-effective alternative to more narrowly focused “point” solutions that typically require manual and resource-intensive efforts to keep pace with growing security and compliance requirements. Our customers span a broad range of industries, including retail and hospitality, financial services, energy, media and communications, transportation and government and defense. Our customers include organizations such as AXA Financial, bwin Interactive Entertainment AG, Federal National Mortgage Association (Fannie Mae), Federal Express Corporation, PepsiCo and The Walt Disney Company. These customers are among our top 30 active accounts based on cumulative sales to the customer since our inception. As of December 31, 2010, we had sold our products and services to over 5,700 customers in 94 countries worldwide, including 46% of the Fortune 500, 27 of 30 U.S. federal government executive branch agencies, and many other domestic and foreign governments.

Our Tripwire VIA software suite, which integrates our Tripwire Enterprise and Tripwire Log Center product families, facilitates continuous protection against security threats and ongoing compliance with regulatory requirements. Our flagship product, Tripwire Enterprise, helps organizations achieve and maintain a secure and compliant IT infrastructure by immediately detecting, assessing and reporting file and configuration changes. Tripwire Log Center, our log and security event management solution, helps organizations detect security breaches and compliance violations by performing real-time correlation analysis on high volumes of disparate log and security data and efficiently stores the data for reporting and compliance purposes. We believe we offer one of the largest IT policy libraries, addressing over 250 regulations, standards and best practices that can be applied to more than 150 different technology platforms with tests that assess and substantiate over 89,000 IT compliance requirements.

IT infrastructure is critical to almost every function within enterprises, service providers and government agencies. Security threats to IT infrastructure continue to increase in number and severity, and evolve with greater sophistication in parallel to the growing complexity of IT infrastructure. Threats come from cyber-criminals, foreign governments, malicious internal users and inadvertent internal errors. These attacks and errors can cause significant economic loss, impairment of critical infrastructure, the loss of valuable data and reputational damage. Current trends that move digital assets and data to virtual and cloud environments increase the difficulty of securing IT infrastructure. Governments, businesses and industry organizations have responded with a growing number of laws, regulations and policies, many of which impose burdensome compliance requirements on companies and, in particular, their IT personnel. Audit failures or findings of non-compliance can lead to significant fines or an inability to engage in core business activities. As IT infrastructures become more complex, distributed and dynamic, maintaining security and compliance is increasingly challenging and expensive.

 

 

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We believe that the need for IT security and compliance automation solutions presents a significant and growing market opportunity. In December 2010, International Data Corporation (IDC), an independent technology research firm, estimated that worldwide revenue for the security and vulnerability management (SVM) market, our primary target market, exceeded $2.9 billion in 2009 and is projected to grow to nearly $5.2 billion in 2014, representing a compound annual growth rate of 12.4% from 2009. In addition, we believe that our products address certain needs of the change and configuration management software market and the software segment of the governance, risk and compliance (GRC) infrastructure market. We also believe that our opportunities with enterprises, service providers and government agencies will be enhanced by the growing adoption of virtualization, the emergence of cloud computing and other technology trends that increase demand for broad and integrated IT infrastructure protection and automation, and by regulatory trends requiring more transparency and information in order to prove compliance.

We have had seven consecutive years of revenue growth and positive operating cash flows. For the year ended December 31, 2010, we recorded operating income of $6.4 million and generated $10.3 million of cash from our operating activities. For 2008, 2009 and 2010, we generated revenue of $62.4 million, $74.0 million and $86.2 million, respectively, of which approximately 29%, 24% and 26%, respectively, was generated from customers outside of the United States. For the same periods, our Adjusted EBITDA was $5.3 million, $10.0 million and $8.9 million, respectively. For a discussion of Adjusted EBITDA, which is a non-GAAP financial measure, and a reconciliation of net income to Adjusted EBITDA, please read note 3 to the tables included in “Selected Consolidated Financial Data.”

Organizations Continue to Face Significant Security and Compliance Challenges

The approaches organizations use to address the complex security risks of IT infrastructure and growing compliance requirements have significant limitations and present organizations with challenges, including:

 

   

Attacks and Breaches Can Go Undetected for Months. Many organizations are exposed to unknown threats because they lack the ability and personnel to collect and evaluate threat, event and change information. Even when all the data can be collected, there is often too much of it for an organization to effectively and timely analyze and interpret using existing point solutions and manual methods.

 

   

Existing Approaches to Security and Compliance Automation are Not Cost-Effective. Approaches using available point solutions are slow, relatively ineffective and labor-intensive. The time and effort required to audit an organization’s IT infrastructure, separate real threats from non-threatening changes, and remediate identified problems can impose substantial burdens on IT personnel and infrastructure and can result in high recurring costs. Some organizations engage expensive outside service providers and IT consultants to address these challenges.

 

   

Applying Regulations and Compliance Policies to IT Infrastructure Requires Expertise. The translation of regulations into actionable IT procedures and rules is costly, complex and time consuming, and significant expertise is required to understand these regulations, standards and policies and their impact on the IT infrastructure.

 

   

Achieving and Maintaining Compliance is Difficult. The solutions used by organizations to achieve compliance generally offer relatively limited functionality and fail to address continuous compliance requirements. This may result in continued security breaches, compliance violations and fines despite an organization’s belief that it is compliant.

 

 

 

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Our Solution

We have designed our products and services to provide a broad, integrated and automated solution that helps enterprises, service providers and government agencies meet the challenges of making IT infrastructure secure and compliant. Our Tripwire VIA software suite provides visibility across the IT infrastructure, intelligently identifies security threats and compliance breaches, and automates security and compliance processes to reduce risk and cost. The Tripwire VIA software suite helps customers cost-effectively reduce the security breach-to-detection time gap and address the issue of siloed data residing in disparate security and systems management tools.

Our solution addresses organizations’ IT security and compliance challenges by enabling them to:

 

   

Intelligently Identify Threats and Changes that Matter Most in a Timely Manner. Our solution continuously analyzes relationships among large amounts of data from disparate IT systems to significantly reduce the time between breach and discovery. Our solution uses numerous methods to automatically distinguish between “good” and “bad” changes or events and identify real threats.

 

   

Cost-effectively Address Key IT Security and Compliance Needs by Providing an Integrated Solution. We enable our customers to use fewer solutions and services and eliminate significant manual efforts to achieve compliance in a cost-effective manner. We provide an integrated solution that identifies and helps correct security vulnerabilities and non-compliant configurations, speeds the investigation of security incidents, and reduces the costs associated with demonstrating compliance.

 

   

Accelerate Implementation of IT Compliance Processes through an Extensive Security and Compliance Policy Library. We believe we offer one of the largest IT policy libraries, addressing over 250 regulations, standards and best practices that can be applied to more than 150 different technology platforms and with tests that assess and substantiate over 89,000 IT compliance requirements.

 

   

Achieve and Maintain Continuous Compliance through Real-time Technology. Our solution immediately detects threats and vulnerabilities in the IT infrastructure, assesses compliance with known standards and best practices and proactively helps customers achieve and maintain a known and trusted state. Our real-time technology is event-based and provides continuous visibility into security and compliance as changes occur.

 

   

Implement Enterprise-class Technology that is Easy-to-use, Scalable and Flexible. We design our solution to serve organizations of all sizes, including large, global organizations that have complex, dynamic, geographically-dispersed and heterogeneous IT infrastructures, as well as those that rely heavily on cloud-based and virtual infrastructures. Our solution is downloadable and designed to simplify installation and implementation by IT personnel.

Our Growth Strategy

Our objective is to be the leading provider of enterprise-class IT security and compliance automation software solutions. Key elements of our strategy to achieve this objective include:

 

   

Continue to Innovate and Expand Our Product Offerings. We intend to add new product functionality, expand our library of compliance policies, and enhance our solutions to provide additional virtualization-related functionality and support cloud computing environments.

 

   

Grow Our Customer Base. We plan to pursue new customers in industry verticals where we have significant expertise, as well as in new verticals where growing security threats and regulatory requirements create demand for our solutions.

 

   

Increase Sales to Our Existing Customer Base. We believe we have a significant opportunity to increase our sales to existing customers by automating compliance of more of their IT systems,

 

 

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pursuing product upgrades and sales of new offerings, and targeting additional business units and broad enterprise deployments within these customers’ organizations.

 

   

Strengthen and Expand Our International Presence. We plan to selectively target geographic regions where the number and scope of security risks and compliance regulations continue to increase. We intend to rely primarily on channel partners to expand our international presence.

 

   

Increase Sales to Governments. We plan to increase our sales to U.S. and foreign public sector organizations by continuing to build additional functionality into our products and invest in certifications necessary to do business with some government agencies.

 

   

Selectively Pursue Acquisitions. We plan to selectively pursue acquisitions of businesses and technologies that complement our integrated IT security and compliance automation offerings.

Risk Factors

Our business is subject to numerous risks, which are described in the “Risk Factors” section of this prospectus, beginning on page 10.

Corporate Information

Tripwire, Inc. was incorporated in Delaware in September 1997. Our principal executive offices are located at 101 SW Main Street, Suite 1500, Portland, Oregon 97204, and our telephone number is (503) 276-7500. Our website address is www.tripwire.com. Information contained on, or that can be accessed through, our website does not constitute part of this prospectus.

In this prospectus, unless indicated otherwise, references to “Tripwire,” “the company,” “we,” “us” and “our” refer to Tripwire, Inc. and its subsidiaries.

“Tripwire,” “ChangeIQ,” “Tripwire VIA” and the Tripwire logo are trademarks of Tripwire. Other trademarks and trade names referred to in this prospectus are the property of their respective owners.

 

 

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The Offering

 

Common stock offered by us

                shares

Common stock offered by selling stockholders

                shares

Over-allotment option

   We and the selling stockholders have granted the underwriters an option to purchase up to an additional              shares of common stock to cover any over-allotments. The underwriters may exercise this option at any time within 30 days of the date of this prospectus.

Common stock to be outstanding after this offering

                shares

Use of proceeds

   We plan to use the net proceeds from this offering for general corporate purposes, including working capital. We may also use a portion of our net proceeds to acquire or make investments in complimentary products, technologies or businesses. We will not receive any of the proceeds from the sale of shares of common stock by the selling stockholders. Please read “Use of Proceeds.”

Proposed Nasdaq Global Market symbol

   “TPWR”

Risk Factors

   Please read “Risk Factors” beginning on page 10 of this prospectus and the other information in this prospectus for a discussion of the risks you should consider before deciding to invest.

The number of shares outstanding after this offering is based on 53,036,260 shares of our common stock outstanding as of February 24, 2011 after giving effect to the conversion of our convertible preferred stock into an aggregate of 36,484,920 shares of our common stock and, unless otherwise indicated, excludes as of that date:

 

   

356,112 shares of common stock available for issuance under our 2010 Stock Option/Stock Issuance Plan (which the Board adopted on November 11, 2010 to replace the 2000 Stock Option/Stock Issuance Plan that expired by its terms on November 8, 2010), which shares, to the extent they remain available for issuance, will cease to be available for issuance under our 2010 Stock Option/Stock Issuance Plan and become available for issuance under our 2010 Incentive Plan effective upon the closing of this offering;

 

   

16,120,957 shares of common stock issuable upon exercise of outstanding stock options at a weighted- average exercise price of $0.96 per share granted under our 2010 Stock Option/Stock Issuance Plan or our 2000 Stock Option/Stock Issuance Plan (including shares we expect to be sold in this offering by certain selling stockholders upon the exercise of vested stock options prior to the closing of this offering), which shares, to the extent such stock options expire unexercised prior to this offering will again become available for issuance under our 2010 Stock Option/Stock Issuance Plan, and to the extent such stock options expire unexercised following this offering, will again become available for issuance under our 2010 Incentive Plan;

 

   

200,000 shares of common stock issuable upon exercise of outstanding stock options at an exercise price of $0.50 per share granted outside of our equity compensation plans as a charitable donation;

 

   

4,340,250 shares of common stock, subject to increase on an annual basis, reserved for issuance under our 2010 Incentive Plan, which will become effective upon the closing of this offering; and

 

 

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308,559 shares of common stock issuable upon exercise of outstanding warrants at a weighted-average exercise price of $2.07 per share, giving effect to the conversion of warrants to purchase shares of our preferred stock into warrants to purchase shares of our common stock, which conversion will occur prior to the closing of this offering.

Unless otherwise indicated, all information in this prospectus reflects or assumes the following:

 

   

a             -for-            reverse split of our common stock and preferred stock to be effected prior to the effectiveness of the registration statement of which this prospectus forms a part;

 

   

the conversion of all outstanding shares of our convertible preferred stock into an aggregate of 36,484,920 shares of our common stock effective immediately prior to the closing of this offering;

 

   

the conversion of all outstanding warrants to purchase shares of our convertible preferred stock into warrants to purchase an aggregate of 108,559 shares of our common stock prior to the closing of this offering;

 

   

no exercise by the underwriters of their over-allotment option;

 

   

no exercise of stock options or warrants outstanding as of February 24, 2011; and

 

   

the filing of our amended and restated certificate of incorporation in connection with the closing of this offering.

 

 

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Summary Consolidated Financial Data

The following tables summarize consolidated financial data for the periods indicated. We have derived the following consolidated statement of operations data for the years ended December 31, 2008, 2009 and 2010 from our audited consolidated financial statements included elsewhere in this prospectus. You should read this information together with our consolidated financial statements and related notes and the information under “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained elsewhere in this prospectus. Our historical results are not necessarily indicative of our results to be expected in any future period.

 

 

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Consolidated Statements of Operations

 

     Years Ended December 31,  
     2008     2009     2010  
                    
     (in thousands, except per share
data)
 

Revenue:

      

Software licenses

   $ 32,480      $ 37,289      $ 40,312   

Maintenance and professional services

     29,899        36,717        45,922   
                        

Total revenue

     62,379        74,006        86,234   

Cost of revenue:

      

Software licenses

     172        109        82   

Maintenance and professional services

     6,917        7,991        10,945   
                        

Total cost of revenue (1)

     7,089        8,100        11,027   
                        

Gross profit

     55,290        65,906        75,207   

Operating expenses:

      

Research and development (1)

     12,618        12,550        14,037   

Sales and marketing (1)

     32,391        39,130        45,995   

General and administrative (1)

     6,062        5,627        8,796   
                        

Total operating expenses

     51,071        57,307        68,828   
                        

Income from operations

     4,219        8,599        6,379   

Other income, net

     307        7        133   
                        

Income before income taxes

     4,526        8,606        6,512   

Income tax benefit (expense)

     1,330        10,977        (2,495
                        

Net income

     5,856        19,583        4,017   

Accretion and allocation to participating preferred stock

     (4,197     (13,868     (2,800
                        

Net income attributable to common stockholders

   $ 1,659      $ 5,715      $ 1,217   
                        

Net income per common share—basic

   $ 0.11      $ 0.39      $ 0.08   
                        

Net income per common share—diluted

   $ 0.11      $ 0.32      $ 0.05   
                        

Shares used in computation of net income per common share:

      

Basic

     14,516        14,762        15,862   

Diluted

     14,963        18,119        24,733   

Pro forma net income per common share (unaudited): (2)

      

Basic

       $ 0.08   
            

Diluted

       $ 0.07   
            

Shares used in computation of pro forma net income per common share (unaudited): (2)

      

Basic

         52,347   

Diluted

         61,218   

Other data:

      

Adjusted EBITDA (3)

   $ 5,277      $ 9,991      $ 8,939   
                        

 

 

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Consolidated Balance Sheet Data

 

     As of December 31, 2010  
     Actual      Pro Forma (2)      Pro Forma as
Adjusted (4)
 
     (unaudited)  
     (in thousands)  

Cash and cash equivalents

   $ 39,011       $ 39,011       $     

Working capital (5)

     31,748         31,748      

Total assets

     82,645         82,645      

Deferred revenue (current and non-current)

     33,516         33,516      

Long-term debt

     —           —        

Total stockholders’ equity

     39,708         39,708      

 

(1) Includes stock-based compensation as follows:

 

     Year Ended December 31,  
         2008              2009              2010      

Cost of revenue

   $ 8       $ 13       $ 44   

Research and development

     15         30         95   

Sales and marketing

     58         72         239   

General and administrative

     73         36         338   
                          

Total stock-based compensation

   $ 154       $ 151       $ 716   
                          

 

(2) Reflects on a pro forma basis the conversion of all outstanding shares of our convertible preferred stock as of December 31, 2010 into 36,484,920 shares of our common stock immediately prior to the closing of this offering.
(3) We define Adjusted EBITDA as net income plus other income (expense), net, income tax expense (benefit), depreciation and amortization, and stock-based compensation expense. Adjusted EBITDA is a financial measure that is not calculated in accordance with generally accepted accounting principles (GAAP). Adjusted EBITDA should not be considered as an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate Adjusted EBITDA in the same manner as we do. For additional information about our use of Adjusted EBITDA, please read note 3 to the tables included in “Selected Consolidated Financial Data” in this prospectus.
(4) Reflects on a pro forma basis the conversion described in note 2 above and, on an adjusted basis, the receipt by us of the estimated net proceeds from the sale of              shares of common stock by us in this offering at an assumed initial public offering price of $             per share (the midpoint of the range listed on the cover page of this prospectus), after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.
(5) Working capital represents current assets minus current liabilities.

 

 

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RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this prospectus before purchasing our common stock. Any of these risks could harm our business, operating results, financial condition and prospects. In addition, the trading price of our common stock could decline and you may lose some or all of your investment. Please read “Special Note Regarding Forward-Looking Statements and Industry Data.”

Risks Related to Our Business and Industry

In recent periods our revenue has depended upon sales of our Tripwire Enterprise product family, and a decrease in sales, or in the growth rate of sales, of this product would harm our business.

Sales of our Tripwire Enterprise product family and related maintenance and professional services generated approximately 90% and 86% of our revenue in 2009 and 2010, respectively, and we expect that we will continue to depend substantially on revenue from sales of Tripwire Enterprise for the foreseeable future. Demand for Tripwire Enterprise is affected by a number of factors, many of which are beyond our control, including the timing of development and release of new products by us and our competitors, technological change and other risks described in this section. Key factors that have fostered demand for our Tripwire Enterprise products and services and that we consider to be key factors for our future growth include increasing security threats to, and breaches of, IT systems and related data and increasing volumes of, and obligations under, laws, regulations and policies applicable to market segments in which many of our customers operate for which IT systems are required to demonstrate compliance. Any decrease in the level or magnitude of such threats, breaches or legal or regulatory actions and compliance requirements, including any changes in laws or regulations that simplify, consolidate or eliminate legal or regulatory compliance requirements, or any decrease in the pace of such increases, could lead to a decrease in demand for our Tripwire Enterprise products. This could require us to change our focus from obtaining customers requiring compliance software to gaining market share primarily through the sale of our products to customers that already have competing products in place. Any decrease in the sales or growth rate of sales of our Tripwire Enterprise products for these or any other reasons could be contrary to our analysts’ or investors’ expectations, and would result in harm to our business, operating results and financial condition, and a decline in our stock price.

If our Tripwire Log Center product and VIA software suite do not achieve broad market acceptance or perform to market expectations, our revenue growth may be limited and our business may be harmed.

In January 2010, we formally launched our Tripwire Log Center product for log and security event management, which, together with our Tripwire Enterprise product, constitutes our Tripwire VIA software suite. We are devoting significant effort and resources in further developing and marketing Tripwire Log Center and our Tripwire VIA software suite. We plan additional releases to enhance the value of our VIA software suite, which are subject to development risks and potential delays. If Tripwire Log Center and our VIA software suite do not achieve broad market acceptance and their sales are limited, our business will continue to depend primarily on sales of our Tripwire Enterprise product in the near-term, limiting our total revenue growth. In addition, if Tripwire Log Center or our VIA software suite do not perform to market expectations, our brand and reputation could be harmed.

We face intense competition in our markets, especially from larger, better-known companies, and we may lack sufficient financial or other resources to maintain or improve our competitive position.

The market for IT security and compliance software products is rapidly evolving and intensely competitive, and we expect competition to increase in the future. A significant number of companies have developed, or are developing, products and increased functionalities that currently, or are expected to, compete with some or all of our products and services. For example, competitors are increasingly including compliance functionality within their solutions. Our recent entry into the log and security event management market with our Tripwire Log Center product has expanded the number of companies with which we compete and increased our profile in our markets, which may result in greater or more targeted competition against us.

 

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We currently face competition in several broad categories, including file integrity monitoring, policy compliance, log management and security event management. Within these categories, we compete with suppliers such as ArcSight (a division of Hewlett Packard (HP)), IBM, McAfee (a division of Intel), RSA (the security division of EMC Corporation), BMC Software and Symantec, that offer broad product offerings covering these and other categories, as well as with smaller vendors such as LogLogic and Q1 Labs, that focus on specific functionalities by offering point solutions. Many of our historical competitors have been acquired by larger, publicly-traded companies trying to expand their solution suites, resulting in more direct competition from HP, Intel, BMC Software, EMC Corporation and its majority-owned, publicly-held subsidiary, VMware. We may not compete successfully against our current or future competitors, many of which have:

 

   

significantly greater financial, technical, research and development and other resources;

 

   

greater brand recognition, domestically and internationally;

 

   

more customers and closer or broader relationships with customers, including with large enterprises, the federal government or foreign governments; and

 

   

broader product lines and sales channels.

Competition may intensify as our existing competitors enter into business combinations or alliances and established companies in other market segments enter into our markets. In addition, competitors may introduce products that are more competitively priced, have greater performance or functionality or incorporate technological advances that we have not yet developed or implemented. Our existing and prospective customers may develop their own solutions, purchase competitive products, or engage third-party providers rather than purchase our products or services. Increased competition may reduce our market share, impair our growth prospects, require us to lower pricing for our products and services or otherwise harm our business and operating results.

We may not compete effectively with companies that integrate functionality or bundle products similar to ours with other product offerings.

Several large, integrated software companies and hardware vendors that sell software products that our customers and potential customers have broadly adopted may have a substantial advantage when they market and sell products to these customers that perform functions substantially similar to our products. Competitors that offer a large array of security or software products may be able to offer products or functionality similar to ours at a more attractive price than we can by integrating or bundling them with their other product offerings. The trend toward consolidation in our industry increases the likelihood of competition based on integration or bundling. Customers may also increasingly seek to consolidate their enterprise-level software purchases with a small number of larger vendors that purport to satisfy a broad range of their requirements. If we are unable to sufficiently differentiate our products from the integrated or bundled products of our competitors, such as by offering enhanced functionality, performance or value, demand for our products may decline, which would harm our business, operating results and financial condition.

If we fail to effectively implement and manage changes in our pricing structure our revenue and growth

prospects could be harmed.

Demand for our products and services is sensitive to price, especially in times of economic slowdown and corporate conservatism. We have in the past and from time to time may continue to make changes to our pricing structure for our products in order to remain competitive. For example, in January 2011, we revised our pricing structure for Tripwire Enterprise and, for Tripwire Log Center, we began using node-based pricing rather than events-per-second pricing. Any decrease in price may not be offset by increased volume and any increase in price may cause a decrease in volume, either of which could negatively affect our revenue, gross profit and overall profitability.

 

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Although we were profitable in 2008, 2009 and 2010, we had a net loss in 2007 and we may not be profitable in the future.

Because the market for our products and services is rapidly evolving, it is difficult for us to predict our operating results and the ultimate size of the markets for our products and services. We expect our operating expenses to increase over the next several years as we hire additional sales and marketing personnel, expand our channel sales program and develop our technology and new products. In addition, as a public company, we will incur significant legal, accounting and other expenses that we do not incur as a private company. If our revenue does not increase sufficiently to offset increases in our operating expenses, we may not continue to be profitable and may suffer a net loss, as we did in 2007. Even if we do maintain profitability, we may be unable to increase profitability on a consistent basis, which may result in a decline in our common stock price.

Our revenue and growth can be difficult to accurately forecast and, if sales are less than expected, we may be unable to adjust our expense levels to avoid harm to our operating results.

Our sales cycle can be lengthy and often covers several months, particularly for larger transactions. Many customers evaluate our software at multiple levels within an organization, which often have different requirements and considerations that go beyond the functionality of our products and the quality and scope of our services, such as internal projections of business growth, capital budgets and anticipated costs. As a result, we devote substantial time and effort and incur significant upfront expense in our sales efforts without any assurance that our efforts will result in a customer purchase. Therefore, it often is difficult to predict when, or even if, we will make a sale with a potential customer. This difficulty may grow to the extent the size of our potential sales or the complexity of our solutions increases, which may lead to more intensive customer evaluations or may affect the accuracy of our historical forecasting methods. We have limited experience with selling our recently-introduced Tripwire Log Center product and our VIA software suite. The additions of the Tripwire Log Center and our Tripwire VIA software suite to our product offerings may increase the sales cycle and otherwise adversely affect our ability to forecast our sales accurately.

Additionally, we make investment decisions and budget our expense levels based primarily on sales forecasts. Because a substantial portion of our expenses are relatively fixed in the short term, our operating results will be harmed if revenue falls below our expectations in a particular quarter, which could cause the price of our common stock to decline significantly.

Reliance on a concentration of sales at the end of the quarter could cause our revenue to fall below expected levels, resulting in a decline in our stock price.

Due largely to our focus on enterprise customers, historically we have often generated a substantial portion of a quarter’s license revenue during the last few weeks or days of the quarter. As the proportion of our total sales from larger transactions has grown and may continue to grow, so has the impact that such larger sales can have on our quarterly results. If expected revenue at the end of any given quarter is delayed until a subsequent quarter for any reason, including the failure of anticipated purchases to materialize, our revenue and results of operations for that quarter could fall below our expectations or those of securities analysts and investors, resulting in a decline in our stock price.

Our quarterly revenue and operating results have fluctuated in the past and may fluctuate and be difficult to predict in the future, and such fluctuations could adversely affect our stock price.

Our quarterly revenue and operating results have fluctuated significantly in the past and we believe they may continue to do so. As a result, you should not rely on the results of any one quarter or fiscal period as an indication of future performance and period-to-period comparisons of our revenue and operating results may not be meaningful.

 

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Our quarterly operating results may fluctuate as a result of a variety of factors, including, among others, those described elsewhere in this section and those listed below, many of which are outside of our control:

 

   

the timing and amount of customer and channel partner sales, particularly of large transactions;

 

   

our ability to retain existing customers, increase sales to existing customers and attract new customers;

 

   

our ability to retain and expand our network of channel partners, and to sell our products and services through these channel partners;

 

   

the timing and implementation of our growth strategy, including product improvements and new product introductions;

 

   

any pricing changes to our products or services;

 

   

actions by our competitors, including product introductions, pricing and other competitive factors;

 

   

the level of demand for our products and services;

 

   

changes in the level (or perceived level) of security threats to or breaches of IT systems or the pace of new regulations for which IT systems are required to demonstrate compliance;

 

   

the mix of our direct and indirect sales and of the products and services we sell;

 

   

the historical seasonality of our operating results, with quarterly sales generally weakest for the first fiscal quarter and then increasing through the remaining three quarters;

 

   

the amount and timing of operating expenses and capital expenditures related to the expansion of our operations and infrastructure;

 

   

the timing of revenue and expenses related to the development or acquisition of technologies, products or businesses;

 

   

potential goodwill and intangible asset impairment charges and amortization associated with any acquired businesses;

 

   

potential foreign exchange gains and losses related to expenses and sales denominated in foreign currencies;

 

   

the outcome of any legal proceedings or claims;

 

   

insolvency or credit difficulties confronting our customers, affecting their ability to pay for our products and services; and

 

   

general economic, industry and market conditions that impact expenditures for IT security and compliance software in the United States and other countries where we sell our products and services.

Fluctuations in our quarterly operating results could result in decreases in our stock price.

Failure to effectively expand and manage our sales operations and train our sales personnel could harm our ability to maintain and grow our customer base, achieve broader market acceptance of our products and services and enter new markets successfully.

Maintaining and increasing our customer base, achieving broader market acceptance of our products and services and successfully entering new markets will depend on our ability to effectively expand and manage our sales operations and train our sales personnel. To obtain new customers and sales, we rely on our inside and field direct sales forces and, to a lesser extent, channel partners such as resellers and system integrators. We have significantly expanded our direct sales force in recent years and plan to continue to do so domestically and internationally. In addition to training new sales personnel generally, we are continuing to train our entire sales force to effectively sell our recently-introduced Tripwire Log Center product and VIA software suite. Our ability

 

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to achieve significant growth in revenue in the future, including growth from sales of new products, will depend in part on our success in recruiting, training and retaining sufficient numbers of direct sales personnel, and on the productivity of those personnel. Recent and planned personnel additions may not become as productive as we would like. Failure to expand and manage our sales operations effectively or in a cost-effective manner could harm our business, operating results and financial condition.

If we fail to maintain, further develop and manage our distribution channels, our revenue and growth prospects could be harmed, particularly in the United States public sector and international markets.

We derive a significant portion of our revenue from sales of our products and related services through channel partners, such as resellers and systems integrators. Resellers are an important source of sales for us in the United States public sector, as government agencies often rely on resellers to meet IT needs. A significant percentage of our sales to United States government agencies are made through two particular resellers. We also use resellers to augment our internal resources elsewhere, primarily in international markets. We expect that channel sales will represent a growing portion of our future revenue as we seek to expand our United States and international sales. The loss of any important channel partners, and our potential inability to promptly replace them could harm our business, operating results and financial condition. Our channel partners may cease marketing our products and services at any time and may do so with limited or no notice and with little or no penalty. We plan to continue to expand the number of our channel partners domestically and internationally. We may be unable to recruit additional channel partners and successfully and cost-effectively expand our distribution channel. Failure to successfully expand our distribution channel could harm our business and growth prospects, particularly in the United States public sector and international markets.

Our agreements with our channel partners generally are non-exclusive and many of our channel partners have established relationships with our competitors. If our channel partners do not effectively market and sell our products and services, if they put greater emphasis on their own products and services or those of our competitors, or if they fail to meet the needs of our customers, our ability to grow our business and sell our products and services may be harmed, particularly in the United States public sector and international markets. Similarly, any reduction or delay in our channel partners’ sales of our products and services or conflicts between channel sales and our direct sales and marketing activities could harm our business, operating results and financial condition. In addition, changes in the proportion of our revenue attributable to channel sales, which are more likely than direct sales to present collection concerns at the time of contract execution and product delivery, may cause our operating results to fluctuate from period to period.

We may be unsuccessful in our efforts to expand our international operations and sales.

In 2008, 2009 and 2010, we derived approximately 29%, 24% and 26%, respectively, of our revenue from sales to customers outside the United States. We are seeking to expand our international sales and operations as part of our growth strategy. In certain international markets we have little or no operating experience, and the competitive environment in our existing markets may differ significantly from that in these new markets. Local companies or other competitors may have a substantial advantage because of their greater understanding of the local markets and brands that are more established locally. In addition, operating in international markets requires significant management attention and financial resources. The investment and additional resources required to establish, develop and maintain operations in other countries may not produce desired levels of revenue and profitability. As a result, we may not be successful in entering or competing in new markets, gaining customer acceptance there or operating profitably on a sustained basis. If we are unable to successfully expand our sales and operations internationally, it could harm our business, operating results and financial condition.

 

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International sales and operations subject us to additional risks that can harm our business and operating results.

In addition to risks described elsewhere in this section, our international sales and operations may subject us to a variety of risks, including:

 

   

difficulties and costs of staffing, developing and managing foreign operations as a result of distance, language and cultural differences;

 

   

increased management, travel, infrastructure and legal compliance costs associated with having multiple international operations;

 

   

differing regulatory requirements, and U.S. or foreign tariffs, export or import restrictions, trade barriers and other regulatory or contractual limitations on our ability to sell, distribute or develop our products in certain foreign markets, including restrictions on the use, import or export of encryption technologies, which could delay or prevent the sale or use of our products in some jurisdictions;

 

   

restrictions on foreign ownership and business licensing and certification requirements;

 

   

shorter payable and longer receivable cycles and difficulties in enforcing contracts and collecting accounts receivable, especially in emerging markets;

 

   

the need to localize our products, services and licensing programs for international customers, including translation into foreign languages and adaptation for local practices and regulatory requirements;

 

   

different employee/employer relationships and the existence of workers’ councils and labor unions in some jurisdictions;

 

   

fluctuations in currency exchange rates;

 

   

dependence on certain third parties to increase customer acquisition and sales, including dependence on channel partners with which we may not have extensive experience;

 

   

increased financial accounting and reporting burdens and complexities;

 

   

reduced protection for intellectual property rights, including reduced protection from software piracy, in some countries;

 

   

local political and economic conditions, including any instability caused by war and terrorism or the threat of war and terrorism; and

 

   

overlapping of different tax regimes, and potentially adverse tax consequences, including the complexities of foreign value added or other tax systems and restrictions on the repatriation of earnings and the investment of funds.

Any of these risks could harm our international operations and reduce our international sales, adversely affecting our business, operating results, financial condition and growth prospects.

We generate a significant portion of our revenue from sales to government entities, which pose a number of challenges and risks.

In 2008, 2009 and 2010, we derived approximately 15%, 17% and 21%, respectively, of our license and professional services revenue from sales directly and indirectly to departments and agencies of the United States federal government. We also derive revenue from sales to departments and agencies of other domestic and foreign governments. Our growth strategy includes seeking to increase sales to U.S. and other domestic and foreign government entities. Sales into government entities are subject to a number of challenges and risks, including, among others, generally longer sales cycles and related upfront time and cost without the assurance of purchases, and more complicated contracting requirements than with commercial sales. In addition, funding

 

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freezes, reductions or delays may adversely affect public sector demand for our products and services or timely payment of invoices. Government demand may also be reduced due to changes in government programs. Government entities may have contractual or other legal rights to terminate contracts with our distributors and resellers for convenience or due to a default, and any such termination may harm our business and operating results.

Most of our sales to the United States federal government have been made indirectly through our distribution channel. We must comply with laws and regulations relating to the formation, administration and performance of United States government contracts, which affect how we and our channel partners do business in connection with United States federal agencies and may impose added costs on our business. In addition, governments also routinely investigate and audit government contractors’ administrative processes. Failure to comply with applicable laws, regulations and requirements, including non-compliance in the past, or any unfavorable audit, could lead to penalties, civil or criminal liability, claims for damages from our channel partners, termination of contracts and suspension from government contracting. Any such penalties, liability, disruption or limitation in our ability to do business with the United States government could harm our business, operating results and financial condition.

In addition, the United States government may require that certain products it purchases be manufactured in the United States and other higher-cost manufacturing locations. For example, some contracts with United States government agencies require that at least 50% of the components of each of our products be of United States origin. Consequently, our ability to optimize our software development by conducting it outside of the United States may be limited. Some of our competitors do not rely on contracts with the United States government to the same degree as we do and may develop software off-shore. If we are unable to develop software as cost-effectively as our competitors, our ability to compete for our non-government customers may be reduced and our customer sales may decline.

If we are unable to continue to offer high quality maintenance and professional services and maintain strong customer relationships, our sales, renewals of maintenance contracts and operating results could be harmed.

We offer our customers assistance in installing, customizing, maintaining or managing the functions of our software products. Our maintenance and professional services provide us an opportunity to introduce existing customers to our new products or product enhancements and to expand the use of a particular product to a customer’s other operating or geographic divisions. As a result, if we are unable, directly or through our channel partners, to provide effective and high-quality maintenance and professional services and help our customers quickly resolve any post-deployment issues, our ability to expand our business with existing customers and our reputation with potential customers could be harmed.

We sell each of our products pursuant to a perpetual license, which is typically sold with a one year maintenance contract. Our customers have no obligation to renew their maintenance contract after the expiration of the initial period, and the percentage of contracts renewed during a given period may decline as a result of a number of factors, including customers’ level of satisfaction with our services or our products, the prices of our products relative to competitive products, or reductions in our customers’ spending levels. If our customers do not renew their maintenance arrangements or if they renew them on less favorable terms, our revenue may decline and our operating results may be harmed.

We rely significantly on revenue from maintenance contracts which may decline, and because we recognize revenue from maintenance contracts over the term of the relevant service period, downturns in sales are not immediately reflected in full in our operating results.

Our maintenance revenue accounted for 37%, 40% and 42% of our total revenue for 2008, 2009 and 2010, respectively. Sales of maintenance contracts may decline or fluctuate as a result of a number of factors, including

 

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customers’ level of satisfaction with our products and services, the prices of our products and services, the prices of products and services offered by our competitors or reductions in our customers’ spending levels. If our sales of maintenance contracts decline, our revenue and revenue growth may decline and our business will suffer. In addition, we recognize service revenue monthly over the term of the relevant service period, which is typically one year. As a result, much of the revenue we report each quarter is the recognition of deferred revenue from maintenance contracts entered into during previous quarters. Consequently, a decline in maintenance contracts in any one quarter will not be fully reflected in revenue in that quarter, but will negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in sales of our maintenance support is not reflected in full in our results of operations until future periods. GAAP revenue recognition requirements for service revenue also makes it difficult for us to rapidly increase our revenue through additional maintenance support sales in any period, as revenue from maintenance contracts must be recognized over the applicable service period.

We have experienced significant growth in recent years, which has increased demands upon our management, systems, operational, financial and other resources, and our inability to successfully manage or accommodate this or any future growth could harm our business.

We have experienced significant growth in recent years and we seek to continue to expand our operations. Our growth has increased the complexity of our business and placed significantly increased demands on our management, personnel, operations, systems, processes, financial resources and our internal control and reporting functions and any future growth will continue to do so. Growth in recent years has included, among other things:

 

   

our becoming a multiple-product company through the formal introduction in January 2010 of our Tripwire Log Center product and Tripwire VIA software suite;

 

   

expansion of our international operations;

 

   

significant increases in the numbers of our customers and employees, including the recent hiring of several members of our management team; and

 

   

use of research and development contractors, including in foreign markets.

We may be unable to manage our expanding operations effectively, successfully integrate new members of our management team and employees, achieve planned growth on a timely or profitable basis or cost-effectively scale our systems to accommodate any growth. Any inability to manage our growth effectively could adversely affect our revenue and profitability, the quality of our products and services, the timeliness and effectiveness of our product development efforts and our ability to retain key personnel. These factors could harm our business, operating results and financial conditions.

The loss of key personnel or an inability to attract and retain additional key personnel may harm our business and impair our ability to grow.

We depend on the service and performance of our senior management team and other key personnel, including experienced sales personnel that have developed close relationships with existing customers. The loss of any of these individuals may significantly delay or prevent the achievement of our business objectives or result in customer losses. Our success will depend upon our ability to identify, attract and retain highly skilled technical, managerial, finance, sales and other personnel. We face intense competition for qualified individuals from numerous software and other technology companies. There is a limited pool of such qualified individuals in Portland, Oregon, where our primary operations are based, and it may be difficult to hire such individuals in, or recruit them to Portland. We may devote significant time and expense to attract and retain qualified personnel, and we may lose employees to our competitors or other companies before we realize the benefit of our investment in recruiting and training them. We may be unable to attract and retain suitably qualified individuals who are capable of meeting our growing technical, operational and managerial requirements, on a timely basis or

 

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at all, and we may be required to pay increased compensation in order to do so. If we are unable to attract and retain the qualified personnel we need to succeed, our business would be harmed.

Real or perceived errors, failures or bugs in our products could harm our reputation, business and operating results.

Because we offer complex products, undetected errors, failures or bugs may exist or occur, especially when products are first introduced, such as our Tripwire Log Center product and our Tripwire VIA software suite, or when new versions are released, as with our Tripwire Enterprise product. Our products are often installed and used in large-scale computing environments with different operating systems, system management software and equipment and networking configurations, which may cause errors or failures in our products or may expose undetected errors, failures or bugs in our products. Despite our testing, we may not identify all errors, failures or bugs in new products or releases until after commencement of commercial sales or installation. In the past, we have discovered software errors, failures, and bugs in some of our product offerings after their introduction.

Real or perceived errors, failures or bugs in our products, including our Tripwire Log Center product and new versions or releases of our Tripwire Enterprise product, could result in negative publicity, loss of or delay in market acceptance of our products, loss of competitive position, or claims by customers for losses sustained by them. Many of our customers use our products in applications that are critical to their businesses, and our products routinely process large amounts of data, including sensitive and personally-identifiable information. Accordingly, our customers may have a greater sensitivity to real or perceived defects in our products than to defects in other, less critical, software products. They also use our products to minimize security vulnerabilities and to demonstrate compliance with laws, regulations and industry standards. Noncompliance could result, for example, if we were to incorrectly map requirements of an applicable regulation or standard to our compliance policy library and related product features. In such an event, we may be required, or may choose, for customer relations or other reasons, to expend additional resources in order to help correct the problem. Helping to alleviate any of these problems could require significant expenditures of capital and other resources and could cause interruptions, delays or cessation of our product licensing, which could harm our business, operating results and financial condition. Noncompliance or a breach could also damage our reputation. Our product liability insurance may not be adequate to cover related claims. In addition, provisions in our customer, reseller and license agreements that limit our exposure to liabilities arising from such claims may not fully protect us against such claims and related liabilities and costs. Defending a lawsuit, regardless of its merit, could be costly and distract management from running our business.

Perceived failure of our solutions to provide expected results may result in negative publicity and harm our business and operating results.

Our customers use our products and services in a wide variety of IT systems and application environments in order to help to reduce security vulnerabilities and to demonstrate compliance. Despite our efforts to make clear in our marketing materials and customer agreements the capabilities and limitations of our products, some customers may view the deployment of our products in their IT infrastructure as a guarantee that there will be no security breach or policy non-compliance event. As a result, the occurrence of a high profile security breach, or a failure by one of our customers to pass a regulatory compliance IT audit could result in public and customer perception that our products are not effective, even if the occurrence is unrelated to the use of our products or services or if the failure is the result of actions or inactions on the part of the customer. If our software products are not used correctly or as intended, inaccurate results may be produced. Our customers may incorrectly implement or use our products. For example, our products permit a customer to identify and select the applicable compliance policies and features that are relevant for its security needs. Failure by the customer to properly identify and select the applicable policies and features could lead to unexpected results. The incorrect or improper use of our software solutions and the actual or perceived failure of our solutions to provide expected results may result in negative publicity and harm to our business and operating results.

 

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If we fail to develop and maintain our brand cost-effectively, or if we are unable to successfully extend our brand into other markets, our business, operating results and financial condition could be harmed.

We believe that developing and maintaining awareness and integrity of our brand in a cost-effective manner are important to achieving widespread acceptance of our existing and future products and services and are important elements in attracting new customers. We believe that the importance of brand recognition will increase as competition in our market further intensifies and as we seek to enter new markets. Successful promotion of our brand will depend upon the effectiveness of our marketing efforts and on our ability to provide reliable and useful products and services at competitive prices. While we believe that our Tripwire Enterprise product has strong brand recognition in the file integrity monitoring and configuration management markets, extension of our brand to new products and markets—including our Tripwire Log Center product and our Tripwire VIA software suite—may dilute this brand. We rely significantly on marketing to build our sales pipeline. Brand promotion activities, including current or new marketing initiatives we may undertake in the future, may be expensive and not yield any increased revenue or sufficient revenue to offset the expenses. We also rely on our customer base in a variety of ways, including to give us feedback on our products and services and to help validate our products and services to the market. If we fail to promote, maintain and expand our brand successfully or to maintain loyalty among our customers, or if we incur substantial expenses in an unsuccessful attempt to promote, maintain and expand our brand, we may fail to attract new customers or retain our existing customers and our business, operating results and financial condition could be harmed.

If our internal IT infrastructure is compromised by security breaches, public perception of our brand and business may be harmed.

Because we provide IT security and compliance products and services, we may be a more attractive target for attacks by computer hackers. We manage and store proprietary information and sensitive or confidential data relating to our business. If an actual or perceived breach of network security occurs in our internal systems it could expose us to a risk of unauthorized use or disclosure of such information. In addition, any such actual or perceived breach could harm the market perception of our products and services and could lead some customers to return products, to reduce or delay future purchases or use competitive products. In addition, such a security breach could impair our ability to operate our business, including our ability to provide maintenance and professional services to our customers. Any or all of these events could cause our business and operating results.

We are exposed to fluctuations in currency exchange rates, which could harm our ability to expand into international markets and our financial condition and operating results.

Our sales contracts are primarily denominated in U.S. dollars. A strengthening of the U.S. dollar could increase the real cost of our products and services to our customers outside of the United States, which could result in reduced sales of our products and services to these customers and hinder our ability to expand internationally. In addition, certain of our revenue is generated, and certain of our operating expenses are incurred, in foreign currencies and are subject to fluctuations due to changes in foreign currency exchange rates, which could affect our operating results. We do not currently hedge currency exposures, but we may do so in the future. If any attempts by us to hedge against these risks are unsuccessful, our financial condition and operating results could be harmed.

If we are unable to enhance existing products or develop or acquire new products that respond to technological advances, rapidly changing regulatory and customer requirements or evolving industry standards, or to obtain required certifications, our long-term revenue growth will be harmed.

The markets for our products and services are characterized by rapid technological advances, changes in regulatory and customer requirements, changes in protocols and evolving industry standards. Our long-term growth depends in part on our ability to enhance and improve our existing products and services and to develop or acquire new products that respond to these changes and demands, including those created by virtualization,

 

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cloud computing and other technology trends. The success of any enhancement or new product depends on a number of factors, including its timely completion, commercial launch and market acceptance. We may not introduce new or enhanced products in a timely or cost-effective manner and may not generate significant revenue from product expansions and improvements. We may not expand our compliance policy library as new regulatory or industry standards are introduced or existing standards are modified. Maintaining adequate research and development resources, such as quality personnel and development technology, is essential to meet market demands for new and improved products. Our failure to maintain adequate research and development resources or to compete effectively with the research and development programs of our competitors would present an advantage to such competitors. If we are unable to develop or acquire enhancements to, and new features for, our existing products or acceptable new products that keep pace with rapid technological developments and customer and market requirements, our products may become obsolete or less competitive, which would harm our business, operating results and financial condition.

In addition, we must obtain certain certifications for some products and sales. We must meet specific technological certifications to sell our products to governmental entities. Also, each new whole release of our products must be certified by the Center for Internet Security (CIS) if we cover CIS policies in the release, which may be desired by existing and potential customers. Our failure to obtain required certifications could limit our sales to governmental entities or reduce demand for our products, which could harm our business and operating results.

We have limited experience with acquiring or investing in other technologies, products or businesses and any future acquisitions or investments may be unsuccessful.

Our growth strategy includes our potential acquisition of, or making investments in, complementary technologies, products or businesses, although no acquisitions or investments are currently pending or planned. We have had little experience negotiating or completing acquisitions or investments or managing the integration of acquisitions. Accordingly, we may be unable to successfully complete or integrate any such transactions we may pursue, and our failure to do so could harm our business, operating results and financial condition. The success of any future acquisitions or investments will depend upon our ability to identify, negotiate, complete and integrate these transactions and, if necessary, to obtain satisfactory debt or equity financing to fund them. Any acquisitions or investments we undertake will involve numerous risks, which may include any of the following:

 

   

disruption of our ongoing business, including diversion of management’s attention during negotiation of the transaction and during post-transaction integration;

 

   

costs, delays and difficulties of integrating any acquired company’s operations, products, technologies and personnel into our existing operations and organization;

 

   

difficulties in maintaining uniform and applicable standards, controls, procedures and policies;

 

   

adverse impact on earnings as a result of amortizing the acquired company’s intangible assets or impairment charges related to write-downs of goodwill related to acquisition;

 

   

issuances of equity securities or the incurrence of debt to pay for acquisitions or investments, which may be dilutive to existing stockholders or increase our financial leverage and interest expense;

 

   

potential loss of customers or key employees;

 

   

impact on our operating results or financial condition due to the timing of the acquisition or investment or failure to meet operating expectations for acquired businesses or investments;

 

   

assumption of unknown liabilities of the acquired company or becoming subject to adverse tax consequences; and

 

   

the entry into geographic or business markets in which we have little or no prior experience.

 

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Any acquisitions of or investments in technologies, products or businesses may not generate sufficient revenue to offset the associated costs of the acquisition or may result in other adverse effects that would harm our business, operating results and financial condition.

We rely on software licensed from other parties. Defects in such software or the loss of these licenses could harm our business, increase our costs and delay sales of affected products.

We use software licensed from unaffiliated third parties in certain of our products, including for our search capacity in our Tripwire Log Center product, and may license additional third-party software in the future. Any errors or defects in this third-party software could result in errors that could harm our brand and business. In addition, licensed software may not continue to be available on commercially reasonable terms, or at all. While we believe that there are currently adequate replacements for the third-party software we presently use, the loss of our right to use any of this software could result in delays in producing or delivering affected products until equivalent technology is identified, licensed or otherwise procured and integrated. Our business would be disrupted if any software we license from others or functional equivalents of this software were either no longer available to us or no longer offered to us on commercially reasonable terms. In either case, we would be required either to attempt to redesign our products to function with software available from other parties or to develop these components ourselves, which would result in increased costs and could result in delays in product sales and the release of new product offerings. Alternatively, we might be forced to limit the features available in affected products. Any of these results could harm our business, operating results and financial condition.

Failure to retain the services of our supplemental product development resources could harm our ability to timely and cost-effectively release new products and our revenue and operating results.

Our success depends on our ability to enhance current products and to develop new products timely and cost effectively. We currently supplement our research and development capabilities with non-employee contractors in Vietnam, Mexico and Colorado. If we are unable to maintain our relationship with these or other contractors, or if they are unable or unwilling to provide services to us, we may be required to develop our products in an alternative and less efficient and cost-effective manner and our product release schedules may be delayed while we hire software developers or find alternative contract development resources. This could harm our business and operating results.

If customers demand that our products be provided via a “software-as-a-service” business model, our business could be harmed.

Software-as-a-service (SaaS) is a model of software deployment where a software provider typically licenses an application to customers for use as a service on demand through web browser technologies. A SaaS business model can require a vendor to adapt its applications for SaaS deployment, to undertake substantial capital investments and to hire additional related sales and support resources and personnel. If we were to provide our products via a SaaS deployment, we would need to undertake these investments to implement this alternative business model. In addition, we may need to apply different revenue recognition policies. Even if we undertook these investments, we may be unsuccessful in implementing a SaaS business model. These factors could harm our business, operating results and financial condition.

We will incur increased costs and demands upon management as a result of being a public company, which will harm our operating results.

As we have prepared to become, and following our becoming, a public company, we have incurred, and will continue to incur, significant legal, accounting and other expenses that we did not incur previously, including costs associated with public company reporting requirements following this offering. We also will incur increased costs associated with corporate governance requirements, including requirements under Section 404 and other provisions of the Sarbanes-Oxley Act, as well as rules implemented by the Securities and Exchange

 

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Commission (SEC), and the Nasdaq Stock Market LLC (Nasdaq). Compliance with these laws and rules also will increase the demands upon our management team. We also expect that, as a public company, it will be more expensive for us to obtain director and officer liability insurance. The increased cost of being a public company will adversely affect our operating results.

If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investor views of us.

Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort requiring frequent re-evaluation. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. We are in the process of documenting, reviewing and improving our internal controls and procedures for compliance with Section 404 of the Sarbanes-Oxley Act of 2002, which requires annual management assessment of the effectiveness of our internal control over financial reporting and a report by our independent registered public accounting firm addressing this assessment. Both we and our independent registered public accounting firm will be testing our internal controls in connection with the audit of our financial statements for the year ending December 31, 2012 and, as part of that testing, identifying areas for further attention and improvement.

Implementing any appropriate changes to our internal controls may distract our officers and employees and entail significant time and costs to modify our existing processes. If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could lead to our need to restate financial results or otherwise harm our business, operating results, investor perceptions or stock price.

Accounting rules governing revenue recognition for software products and services are complex and may change.

The accounting rules governing software revenue recognition are complex and have been subject to authoritative interpretations that only provide for recognition of software revenue at the beginning of the license period in specific circumstances. For example, the bundling of products and services may require deferral of revenue recognition until vendor-specific objective evidence (VSOE) of fair value exists for all elements included in the bundled package or, if earlier, the completion of delivery of all the elements in the package, including any included services. We have established VSOE of the fair value of maintenance for our recently-introduced Tripwire Log Center product and Tripwire VIA software suite, and we use the residual method to recognize license revenue for these products. We may experience trends that result in an inability to establish VSOE for the undelivered elements in an arrangement. As a result of this and any new or revised revenue recognition standards or interpretations, our ability to meet near-term revenue expectations could be harmed.

If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our operating results could fall below expectations of securities analysts and investors, resulting in a decline in our stock price.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in financial statements and accompanying notes. We base our estimates on our experience and on assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our operating results may be harmed if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our operating results to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price. Significant assumptions

 

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and estimates used in preparing our financial statements include those related to revenue recognition, the allowance for doubtful accounts, goodwill and intangible assets, stock-based compensation and accounting for income taxes.

Some of our products contain “open source” software, and any failure to comply with the terms of one or more of these open source licenses could harm our business.

Some of our products are distributed with software licensed by its authors or other third parties under “open source” licenses. Some of these licenses contain requirements that we make available source code for modifications or derivative works we create based upon the open source software, and that we license these modifications or derivative works under the terms of a particular open source license or other license granting third parties certain rights of further use. If we combine our proprietary software with open source software in a certain manner, we could, under provisions of the open source licenses, be required to release the source code of our proprietary software. In addition to risks related to license requirements, usage of open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or controls on origin of the software. We have established processes to help alleviate these risks, and we plan to implement the use of software tools to review our source code for potential inclusion of open source software. However, we cannot be sure that any open source software has been, or will be, submitted for approval prior to use, if any, in our products or that any such software tools will be effective. We also rely upon third-party, non-employee contractors to perform certain development services on our behalf, and cannot be certain that such contractors will comply with our review process or not incorporate software code made available under open source licenses into our proprietary code base. In addition, open source license terms may be ambiguous. If we were found to have inappropriately used open source software, we may be required to re-engineer affected products, release proprietary source code, discontinue the sale of our products if re-engineering could not be accomplished on a timely basis, or take other remedial action that may divert resources from our development efforts, any of which could harm our business, operating results and financial condition.

We may be unable to adequately protect our intellectual property rights, which could harm our business.

We regard our patents, trademarks, copyrights, trade secrets, proprietary technology and similar intellectual property as important to our success, and we rely on patent, trademark and copyright law, trade secret protection and confidentiality agreements with our employees, customers and others to protect our proprietary rights. There is no guarantee that such parties will abide by the terms of such agreements or that we will be able to adequately enforce our rights, in part because we rely on “click-wrap” and “shrink-wrap” licenses in some instances. We may not be able to discover or determine the extent of any infringement or misappropriation of our intellectual property or proprietary rights, or unauthorized use of our proprietary software and technology. The protection of our intellectual property may require the expenditure of significant financial and managerial resources. Any of our patents, copyrights, trademarks or other intellectual property rights may be challenged by others or invalidated through administrative process or litigation. Our issued patents may not provide us with any competitive advantages or may be challenged by third parties, and our patent applications may never be granted. In addition, the process of obtaining patent protection is expensive and time-consuming, and we may not be able to prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. Even if issued, there can be no assurance that these patents will adequately protect our intellectual property, as the legal standards relating to the validity, enforceability and scope of protection of patent and other intellectual property rights are uncertain. Effective intellectual property protection may not be available in every country in which we offer our products and services. The laws of some foreign countries may not be as protective of intellectual property rights as those in the United States, and mechanisms for enforcement of intellectual property rights may be inadequate. Accordingly, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property. We also cannot be certain that others will not independently develop or otherwise acquire equivalent or superior technology or intellectual property rights. We might be required to spend significant resources to monitor and protect our intellectual property rights. We may initiate

 

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claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel, which may harm our business, operating results and financial condition.

Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.

In order to protect our proprietary technology, processes and methods, we rely in part on agreements containing confidentiality provisions with our resellers, employees, consultants, advisors and others. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover trade secrets and proprietary information, and in these cases we would not be able to assert any trade secret rights against those parties. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could harm our competitive business position.

We may be accused of infringing intellectual property rights of third parties.

Third parties also may claim that we infringe their proprietary rights. Companies in the software, networking and technology industries, including some of our current and potential competitors, own large numbers of patents, copyrights, trademarks and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. In addition, many of these companies have the capability to dedicate substantially greater resources to enforce their intellectual property rights, initial legal proceedings and to defend claims that may be brought against them. Litigation may involve patent holding companies or other adverse patent owners who have no relevant product revenue and against whom our actual and potential patents may provide little or no deterrence.

We have been subject to, and expect to continue to be subject to, notices that claim we have infringed or misappropriated third-party intellectual property rights, and we expect that we may be subject to claims and legal proceedings regarding alleged infringement by us of the intellectual property rights of third parties. To the extent we gain greater visibility, we face a higher risk of being the subject of intellectual property infringement claims, which is not uncommon for companies offering software and related services in general and security and vulnerability management technology in particular. Such claims, whether or not meritorious, may result in the expenditure of significant financial and managerial resources, injunctions against us or the payment of damages. We may need to obtain licenses from third parties who allege that we have infringed their rights, but such licenses may not be available on terms acceptable to us or at all, or we may be required to develop alternative non-infringing technology or rebrand certain products or features, which could require significant effort and expense. If we cannot license or develop technology for any infringing aspect of our business, we would be forced to limit or stop sales of one or more of our products or product features or, in the case of trademark disputes, rebrand certain product offerings, and we may be unable to compete effectively. Our exposure to risks associated with the use of intellectual property may be increased as a result of acquisitions, as we have a lower level of visibility into the development process with respect to acquired technology or the care taken to safeguard against infringement risks. Third parties may make infringement and similar or related claims after we have acquired technology that had not been asserted prior to our acquisition. Any of these results would harm our business, operating results and financial condition. These risks have been amplified by the increase in third parties whose sole or primary business is to assert such claims.

Indemnity provisions in various agreements potentially expose us to substantial liability for intellectual property infringement and other losses.

Our agreements with customers and channel partners include indemnification provisions under which we agree to indemnify them for losses suffered or incurred as a result of claims of intellectual property infringement

 

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and, in some cases, for other damages, such as damages caused by us to property or persons. For customers who purchase perpetual licenses, the terms of these indemnity provisions are perpetual. In other agreements, the indemnity provision may survive termination of the agreement. Large indemnity payments could harm our business, operating results and financial condition.

Governmental export or import or other controls could subject us to liability or limit our ability to compete in foreign markets.

Our products incorporate encryption technology and may be exported outside the United States only if we obtain an export license or qualify for an export license exception. Compliance with applicable regulatory requirements regarding the export of our products, including with respect to new releases of our products, may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export of our products to some countries altogether. Any new export or import restrictions, new legislation or shifting approaches in the enforcement or scope of existing regulations, or in the countries or affecting the persons or technologies targeted by such regulations, could result in decreased use of our products by existing customers with international operations, declining adoption of our products by new customers with international operations and decreased revenue. If we fail to comply with export and import regulations, we may be denied export privileges, be subjected to fines or other penalties and our products may be denied entry into other countries. If our channel partners fail to comply with these regulations, we may be adversely affected through reputational harm and penalties.

In addition, United States export control laws and economic sanctions prohibit the shipment of certain products to United States embargoed or sanctioned countries, governments and persons. Even though we take precautions to prevent our products from being shipped to U.S.-sanctioned targets, our products could be shipped to those targets inadvertently or by our channel partners, despite such precautions. Any such shipment could result in government investigations and penalties or reputational harm.

Conducting business in countries with a history of corruption and transactions with foreign governments increase the risks associated with our international activities.

As we operate and sell products and services internationally and seek to expand our international presence, we are subject to the United States Foreign Corrupt Practices Act (FCPA), and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by United States and other business entities for the purpose of obtaining or retaining business. As we operate and seek to expand internationally, we may have operations, deal with and make sales to governmental customers in, countries known to experience corruption, particularly certain emerging countries. Our activities in these countries may create the risk of unauthorized payments or offers of payments by one of our employees, sales agents or channel partners that could be in violation of various laws, including the FCPA, even though these parties are not always subject to our control. Violations of the FCPA may result in severe criminal or civil sanctions, including suspension from United States government contracting, and we may be subject to other liabilities, which could harm our reputation, business, operating results and financial condition.

Debt covenants may restrict our business.

We have a credit facility that we may use from time to time for working capital purposes. As of December 31, 2010, we had no outstanding indebtedness under the facility. Our existing credit facility contains restrictive covenants and we may enter into other credit facilities that contain similar or more extensive restrictive covenants. The covenants under our existing credit facility limit our ability to, among other things:

 

   

incur additional indebtedness or guarantee indebtedness of others;

 

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create additional liens on our assets;

 

   

pay dividends and make other distributions on our capital stock;

 

   

make acquisitions or investments, enter into mergers or sell our assets; or

 

   

engage in any business unrelated to our current business.

Our credit facility also contains various financial covenants. Covenants in any current or future credit facilities could harm our business by limiting our operations or our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities that may be beneficial to our business and stockholders.

Our failure to generate sufficient capital or raise additional capital to expand our operations and invest in new products and services could reduce our ability to compete and harm our business.

We expect that our existing cash and cash equivalents, together with our net proceeds from this offering, will be sufficient to meet our cash needs for at least the next twelve months. In the future, we may need to raise additional funds, and we may be unable to obtain additional debt or equity financing on favorable terms, if at all. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership interests and our common stock price could decline. If we obtain debt financing, the holders of debt would have priority over the holders of our common stock and we may be required to accept terms that restrict our operational or financial flexibility, including our ability to take certain actions that otherwise would be in the interests of the stockholders, any of which could harm our business, operating results and financial condition. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things:

 

   

develop or enhance our products and services;

 

   

continue to expand our sales and marketing and research and development organizations;

 

   

acquire complementary technologies, products or businesses;

 

   

expand operations in the United States or internationally;

 

   

hire, train and retain employees; or

 

   

respond to competitive pressures or unanticipated working capital requirements.

Our failure to do any of these things could harm our business, financial condition and results of operations.

Changes in our provision for income taxes or adverse outcomes resulting from examination of our income tax returns could harm our financial condition and operating results.

Our provision for income taxes is subject to volatility and could be adversely affected by:

 

   

our earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates;

 

   

changes in the valuation of our deferred tax assets and liabilities;

 

   

expiration of or lapses in research and development tax credit laws;

 

   

transfer pricing adjustments;

 

   

tax effects of nondeductible compensation;

 

   

changes in accounting principles; or

 

   

changes in tax laws and regulations, including possible changes to U.S. taxation of earnings of our foreign subsidiary, and the deductibility of expenses attributable to foreign income, or the foreign tax credit rules.

In addition, we are subject to potential examination of our income tax returns by the U.S. Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these

 

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examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from any of these potential examinations will not harm our operating results or financial condition.

Forecasting our estimated annual effective tax rate is complex and subject to uncertainty, and there may be material differences between our forecasted and actual tax rates.

Forecasts of our income tax position and effective tax rate are complex and subject to uncertainty because our income tax position for each year combines the effects of a mix of profits earned and losses incurred by us in various tax jurisdictions with a broad range of income tax rates, as well as changes in the valuation of deferred tax assets and liabilities, the impact of various accounting rules and changes to these rules and tax laws, the results of examinations by various tax authorities, and the impact of any acquisition, business combination or other reorganization or financing transaction. To forecast our global tax rate, we estimate our pre-tax profits and losses by jurisdiction and forecast our tax expense by jurisdiction. If the mix of profits and losses, our ability to use tax credits, or effective tax rates by jurisdiction are different than those estimated, our actual tax rate could be materially different than forecasted, which could harm our operating results or financial condition.

As an international corporation, we conduct our business in many countries and are subject to taxation in various jurisdictions. The taxation of our business is subject to the application of multiple and sometimes conflicting tax laws and regulations as well as multinational tax conventions. Our effective tax rate depends upon the geographic distribution of our worldwide earnings or losses, the tax regulations in each geographic region, the availability of tax credits and carryforwards, and the effectiveness of our tax planning strategies. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, and the evolution of regulations and court rulings. Consequently, taxing authorities may impose tax assessments or judgments against us that could increase our tax liability and our effective income tax rate.

In addition, if tax authorities challenge the relative mix of our U.S. and international income, our future effective income tax rates could increase. While we regularly assess the likelihood of adverse outcomes from such examinations and the adequacy of our provision for income taxes, such provision may not be sufficient and a determination by a tax authority may harm our operating results and financial condition.

Our ability to utilize our net operating losses to offset future taxable income may be subject to certain limitations.

As of December 31, 2010, we had net operating losses of $15.9 million that were potentially eligible to offset future taxable income. In general, under Section 382 of the Internal Revenue Code of 1986, as amended (the Internal Revenue Code), a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change net operating losses to offset future taxable income. Our existing net operating losses may be subject to limitations arising from previous ownership changes, and if we undergo an ownership change in connection with or after this offering, our ability to utilize net operating losses could be further limited by Section 382 of the Internal Revenue Code. We have not yet determined the amount of the cumulative change in our ownership resulting from this offering. In addition, transactions in our stock that may not be within our control could result in an ownership change under Section 382 of the Internal Revenue Code and may impose a limitation on the utilization of our net operating losses in the future. If our use of our net operating losses is limited and we are profitable, our related ability to reduce our tax liability likewise will be limited.

Prolonged economic uncertainties or downturns could harm our business.

Economic downturns, particularly in the United States, where we generate the majority of our revenue, could harm our business, operating results and financial condition. The recent global economic downturn and financial crisis made it more difficult for our customers and potential customers to forecast and plan business

 

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activities, and obtain credit. We believe this resulted in some customers and potential customers decreasing their IT spending, foregoing or deferring purchases of our products and services and increasing their negotiations for additional discounts from us. We derive a significant portion of our revenue from customers in the retail, financial services and communications industries. A substantial downturn in these industries in particular may result in lower or slower sales of our products and services.

Our business is subject to the risks of earthquakes, volcanic eruptions, fire, power outages, telecommunications and network failures, floods and other catastrophic events, and to interruption by manmade problems such as terrorism.

A significant natural disaster, such as an earthquake, volcanic eruption, fire or a flood, medical epidemic or pandemic, or a significant power outage or IT system or telecommunications failure could harm our business, operating results and financial condition. Our corporate headquarters and principal operating office is located in Portland, Oregon, a region subject to seismic and volcanic activity. Any such natural disaster or other event could hinder our operations and ability to develop and sell products and services, which could lead to decreased revenue, increased expenses and customer losses. In addition, acts of terrorism could cause disruptions in our business or the business of our channel partners and customers or the economy as a whole. We currently do not have a business continuity plan in place.

Risks Related to this Offering and Ownership of Our Common Stock

Our stock price may be volatile or may decline and you could lose some or all of your investment.

The trading prices of the securities of technology companies have been highly volatile. The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including those described above under “Risks Related to Our Business and Industry” (such as fluctuations in our operating results or announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, capital commitments or other developments) and the following:

 

   

any financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;

 

   

failure of securities analysts to initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow us or our failure to meet these estimates or the expectations of investors;

 

   

ratings changes by any securities analysts who follow us;

 

   

changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular; and

 

   

price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole.

In addition, the stock markets have experienced significant price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from our business and harm our business, operating results and financial condition.

A significant portion of our total outstanding shares may be sold into the public market in the near future. If substantial sales of shares of our common stock are sold into the public market, the price of our common stock could decline.

The price of our common stock could decline if there are substantial sales of our common stock into the public market, particularly sales by our directors, officers and significant stockholders, or if there is a large

 

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number of shares of our common stock available for sale or the perception in the market that the holders of a large number of our shares intend to sell their shares. Immediately after this offering, we will have outstanding approximately              shares of our common stock, based on the number of shares outstanding as of                     , 2011. This includes the shares that we and the selling stockholders are selling in this offering, which may be resold in the public market immediately. Of the remaining shares outstanding immediately after this offering,              or approximately     %, are currently restricted as a result of contractual agreements with the underwriters or securities law restrictions but may be sold in the near future as set forth below.

 

Date Available for Sale into Public Market

  

Number of Shares and % of Total Outstanding

Immediately upon completion of this offering

  

180 days after the date of this prospectus

  

In addition, as of February 24, 2011, there were 16,579,516 shares of our common stock subject to outstanding stock options and warrants that will become eligible for sale in the public market to the extent permitted by any applicable vesting requirements, contractual agreements with the underwriters or securities law restrictions. After this offering, the holders of an aggregate of approximately 47,712,369 shares of our common stock will have rights, subject to certain conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. We also intend to register under the Securities Act of 1933 shares of common stock that we have issued and may issue under our employee equity incentive plans. Once we register these shares, they may be sold freely into the public market upon issuance, subject to existing contractual restrictions. The lead underwriters for this offering may, in their sole discretion, permit our directors, officers and stockholders who are subject to the 180-day contractual lock-up to sell shares prior to the expiration of the lock-up agreements. The 180-day period is subject to extension in some circumstances.

If securities or industry analysts do not publish or cease publishing research or reports about us, our business or our market, or if they adversely change their recommendations regarding our stock, our stock price and trading volume could decline.

The trading market for our common stock is influenced by the research and reports that industry or securities analysts publish about us, our business, our market or our competitors. If any of the analysts who cover us or may cover us in the future change their recommendation regarding our stock adversely, or provide more favorable relative recommendations about our competitors, our stock price would likely decline. If any analyst who covers us or may cover us in the future were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

No public market for our common stock currently exists and an active trading market may not develop or be sustained following this offering and the market price may decline below the initial public offering price.

Prior to this offering, there has been no public market for our common stock. The initial public offering price for our common stock will be determined through negotiations between the underwriters and us and may vary from the market price of our common stock following this offering. If you purchase shares of our common stock in this offering, you may be unable to resell those shares at or above the initial public offering price. An active or liquid trading market may not develop following this offering or, if developed, may not be sustained. The lack of an active market may impair your ability to sell your shares at the time you wish or at a price that you consider reasonable. The lack of an active market may also reduce the trading price of our shares. In addition, an inactive market may impair our ability to raise capital by selling shares or increase dilution to existing stockholders if we do so and may also impair our ability to acquire other companies or technologies by using our shares as consideration.

 

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Concentration of ownership among our existing executive officers and directors and their affiliates may prevent new investors from influencing significant corporate decisions.

Immediately after this offering, our executive officers and directors and their respective affiliates will beneficially own, in the aggregate, approximately     % of our outstanding common stock. As a result, these stockholders will be able to exercise a significant level of control over all matters requiring stockholder approval, including the election of directors, amendment of our certificate of incorporation and approval of significant corporate transactions. This control could have the effect of delaying or preventing a change of control of our company or changes in management and will make the approval of certain transactions difficult or impossible without the support of these stockholders. Please read “Principal and Selling Stockholders” for additional detail about the shareholdings of these persons.

Because our initial public offering price is substantially higher than net tangible book value per share of our outstanding common stock, new investors will incur immediate and substantial dilution.

The initial public offering price of $             per share (based on the midpoint of the assumed price range for this offering) is substantially higher than the pro forma net tangible book value per share of our common stock immediately following this offering. Based on this initial offering price, you will experience immediate and substantial dilution of approximately $             per share, the difference between the price you pay for our common stock and its net tangible book value after completion of the offering. In addition, investors purchasing common stock in this offering will own only approximately     % of our shares outstanding after the offering even though they will have contributed     % of the total consideration received by us in connection with our sales of common stock. To the extent outstanding options to purchase common stock are exercised, there will be further dilution to investors in the offering.

We have broad discretion in the use of the net proceeds from this offering and may not use them effectively.

We cannot specify with certainty the particular uses of the net proceeds that we will receive from this offering. Our management will have broad discretion in the application of the net proceeds, including for working capital, possible acquisitions and other general corporate purposes, and we may spend or invest these proceeds in a way with which our stockholders disagree. The failure by our management to apply these funds effectively could harm our business, operating results and financial condition. Pending their use, we may invest the net proceeds from this offering in a manner that does not produce income or that loses value.

Anti-takeover provisions contained in our certificate of incorporation and by-laws, as well as provisions of Delaware law, could impair a takeover attempt.

We are a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an “interested stockholder” for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our certificate of incorporation and by-laws that will be in effect immediately following the completion of this offering contain provisions that may make the acquisition of us more difficult without the approval of our board of directors, including the following:

 

   

our board of directors will be classified into three classes of directors with staggered three-year terms;

 

   

our stockholders will only be able to take action at a meeting of stockholders and not by written consent;

 

   

only our chairman of the board, our chief executive officer or president or a majority of our board of directors will be authorized to call a special meeting of stockholders;

 

   

vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders;

 

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directors may be removed from office only for cause;

 

   

our certificate of incorporation will authorize undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and

 

   

advance notice procedures will apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders.

These provisions, alone or together, could delay hostile takeovers and changes in control or changes in our management. Any provision of our restated certificate of incorporation or by-laws or of Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

We may issue additional shares of our common stock or other securities without your approval, which would dilute your ownership interests and may depress the market price of our common stock.

Subject to the rules of Nasdaq, we may issue additional shares of our common stock, and other equity securities of equal or senior rank, without stockholder approval in a number of circumstances.

The issuance by us of additional shares of our common stock or other equity securities of equal or senior rank will have the following effects:

 

   

our existing stockholders’ proportionate ownership interest in us will decrease;

 

   

the amount of cash available for dividends payable on our common stock may decrease;

 

   

the relative voting strength of each previously outstanding share may be diluted; and

 

   

the market price of our common stock may decline.

We do not intend to pay dividends on our common stock.

We have never declared or paid any dividends on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

This prospectus contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in the sections of this prospectus entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and “Compensation Discussion and Analysis.” Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth and market opportunities and the effects of competition. Forward-looking statements include all statements that are not historical facts and generally may be identified by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “seeks,” “should,” “would” or similar expressions and the negatives of those terms.

Forward-looking statements contained in this prospectus reflect our views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance or achievements. Readers are cautioned not to place undue reliance on these forward-looking statements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, among others, those factors described in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

All forward-looking statements included in this prospectus are based on information available to us on the date of this prospectus. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

This prospectus contains various estimates related to our industry, including market size and growth rates. These estimates have been included in studies published or produced by market researchers and other firms, including International Data Corporation (IDC) and INPUT. These estimates have been produced by industry analysts and consultants based on trends to date, their knowledge of technologies and markets and customer research, but these estimates are forecasts only and are subject to inherent uncertainty. Although we believe these sources are reliable, we have not independently verified the information.

 

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USE OF PROCEEDS

We estimate that our net proceeds from the sale of the common stock that we are offering will be approximately $             million, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us and assuming an initial public offering price of $             per share (the midpoint of the range listed on the cover page of this prospectus). A $1.00 increase (decrease) in the assumed initial public offering price would increase (decrease) the net proceeds to us from this offering by $             million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any proceeds from the sale of shares of common stock by the selling stockholders.

The principal purposes of this offering are to create a public market for our common stock, obtain additional capital and facilitate our future access to the public equity markets. We intend to use the net proceeds that we receive in this offering for general corporate purposes, including working capital. If appropriate opportunities arise, we may use a portion of our net proceeds from this offering to acquire or invest in products, technologies or businesses that are complementary to our own. We currently have no plans, proposals or arrangements with respect to any specific acquisition or investment.

We cannot specify with certainty the particular uses of our net proceeds from this offering. Accordingly, our management will have broad discretion in using our net proceeds from this offering. Pending use of our net proceeds from this offering, we intend to invest the net proceeds in short-term, investment-grade, interest-bearing instruments.

DIVIDEND POLICY

We have never paid dividends on our common stock and we intend to retain all available funds and any future earnings to fund the development and growth of our business. We therefore do not anticipate paying any dividends on our common stock in the foreseeable future. Any future determinations to pay dividends on our common stock would depend upon our operating results, our financial condition and liquidity requirements, restrictions that may be imposed by applicable law or our contracts, and any other factors that our board of directors may consider relevant.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of December 31, 2010:

 

   

on an actual basis;

 

   

on a pro forma basis to give effect to the conversion of all outstanding shares of our convertible preferred stock into an aggregate of 36,484,920 shares of our common stock effective immediately prior to the closing of this offering; and

 

   

on a pro forma as adjusted basis to give effect to (1) the issuance and sale by us of              shares of common stock in this offering, and our receipt of our net proceeds from the sale of such shares at an assumed initial public offering price of $             per share (the midpoint of the range listed on the cover page of this prospectus), after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, (2) the conversion of all outstanding shares of our convertible preferred stock into common stock immediately prior to the closing of this offering and (3) the amendment and restatement of our certificate of incorporation immediately prior to the closing of this offering.

The information below is illustrative only. Our cash and cash equivalents and capitalization following this offering will depend upon the actual initial public offering price and other terms of this offering determined at pricing. You should read this table in conjunction with the sections entitled “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of December 31, 2010  
     Actual     Pro Forma     Pro Forma
as Adjusted
 
     (unaudited)  
     (in thousands)  

Cash and cash equivalents

   $ 39,011      $ 39,011      $                
                        

Long-term obligations, including current portion (excluding deferred revenue)

   $ 436      $ 436      $     

Stockholders’ equity:

      

Convertible preferred stock, $0.001 par value: 37,367 shares authorized, 35,836 shares issued and outstanding, actual; 37,367 shares authorized, no shares issued or outstanding, pro forma; 10,000 shares authorized, no shares issued or outstanding, pro forma as adjusted

     36        —       

Common stock, $0.001 par value, 70,000 shares authorized, 16,522 shares issued and outstanding, actual; 70,000 shares authorized, 53,007 shares issued and outstanding, pro forma; 125,000 shares authorized,                  shares issued and outstanding, pro forma as adjusted

     17        53     

Additional paid-in capital

     61,470        61,470     

Additional paid-in capital—warrants

     222        222     

Accumulated deficit

     (22,037     (22,037  
                        

Total stockholders’ equity

     39,708        39,708     
                        

Total capitalization

   $ 79,155      $ 79,155      $     
                        

The number of shares in the table above excludes, as of December 31, 2010:

 

   

391,208 shares of common stock available for issuance under our 2010 Stock Option/Stock Issuance Plan. These shares, to the extent they remain available for issuance, will cease to be available for issuance under our 2010 Stock Option/Stock Issuance Plan and become available for issuance under our 2010 Incentive Plan effective upon the closing of this offering;

 

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16,115,545 shares of common stock issuable upon exercise of outstanding stock options at a weighted average exercise price of $0.96 per share granted under our 2010 Stock Option/Stock Issuance Plan or our 2000 Stock Option/Stock Issuance Plan (including shares we expect to be sold in this offering by certain selling stockholders upon the exercise of vested stock options prior to the closing of this offering), which shares, to the extent such stock options expire unexercised prior to this offering will again become available for issuance under our 2010 Stock Option/Stock Issuance Plan, and to the extent such options expire unexercised following this offering, will again become available for issuance under our 2010 Incentive Plan;

 

   

200,000 shares of common stock issuable upon exercise of outstanding stock options at an exercise price of $0.50 per share granted outside of our equity compensation plans as a charitable donation;

 

   

4,340,250 shares of common stock, subject to increase on an annual basis, reserved for issuance under our 2010 Incentive Plan, which will become effective upon the closing of this offering; and

 

   

308,559 shares of common stock issuable upon exercise of outstanding warrants at a weighted-average exercise price of $2.07 per share, giving effect to the conversion of warrants to purchase shares of our preferred stock, into warrants to purchase shares of our common stock, which conversion will occur prior to the closing of this offering.

 

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DILUTION

If you invest in our common stock, you will experience dilution to the extent of the difference between the initial public offering price per share of our common stock in this offering and the pro forma, as adjusted net tangible book value per share of our common stock immediately after this offering.

As of December 31, 2010, our net tangible book value was $37.3 million, or $2.26 per share of common stock. Our pro forma net tangible book value as of December 31, 2010 was $37.3 million, or $0.70 per share of common stock. Pro forma net tangible book value per share represents total tangible assets less total liabilities, divided by the number of shares of common stock outstanding after giving effect to the conversion of all outstanding shares of our convertible preferred stock into an aggregate of 36,484,920 shares of our common stock effective immediately prior to the closing of this offering. After giving further effect to the issuance and sale by us of              shares of our common stock in this offering at an assumed initial public offering price of $             per share (the midpoint of the estimated price range set forth on the cover page of this prospectus), and after deducting the underwriting discounts and commissions and our estimated offering expenses payable by us, our pro forma, as adjusted net tangible book value as of December 31, 2010 would have been $             million, or $             per share. This represents an immediate increase in net tangible book value of $             per share to our existing stockholders and an immediate dilution of $              per share to our new investors purchasing shares of common stock in this offering.

The following table illustrates this dilution on a per share basis:

 

Assumed initial public offering price

   $                    $                

Pro forma net tangible book value per share as of December 31, 2010

     

Increase per share attributable to sale of shares of our common stock in this offering

     

Pro forma, as adjusted net tangible book value per share immediately after this offering

     
                 

Dilution per share to new investors

   $         $     
                 

The following table sets forth as of December 31, 2010, on the pro forma as adjusted basis described above, the difference between the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by existing stockholders, and the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by investors purchasing shares in this offering, based on an assumed initial public offering price of $            per share and before deducting underwriting discounts and commissions and estimated offering expenses payable by us:

 

     Total Shares     Total Consideration     Average Price
Per Share
 
     Number      Percent     Amount      Percent    

Existing stockholders

     53,006,576                        $ 57,519,992                        $ 1.09   

New investors

            

Total

                       $                         
                                    

If the underwriters exercise their over-allotment option in full, the number of shares purchased by the new investors will be increased to            , or approximately     % of the total number of shares of our common stock outstanding after this offering. A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) total consideration paid by new stockholders by $             million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

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The tables and calculations above are based on 53,006,576 shares of common stock issued and outstanding as of December 31, 2010, and exclude, as of that date:

 

   

391,208 shares of common stock available for issuance under our 2010 Stock Option/Stock Issuance Plan. These shares, to the extent they remain available for issuance, will cease to be available for issuance under our 2010 Stock Option/Stock Issuance Plan and become available for issuance under our 2010 Incentive Plan effective upon the closing of this offering;

 

   

16,115,545 shares of common stock reserved for issuance upon exercise of outstanding stock options at a weighted average price of $0.58 per share granted under our 2010 Stock Option/Stock Issuance Plan or our 2000 Stock Option/Stock Issuance Plan (including shares we expect to be sold in this offering by certain selling stockholders upon the exercise of vested stock options prior to the closing of this offering), which shares, to the extent such stock options expire unexercised prior to this offering will again become available for issuance under our 2010 Stock Option/Stock Issuance Plan, and to the extent such stock options expire unexercised following this offering, will again become available for issuance under our 2010 Incentive Plan;

 

   

200,000 shares of common stock issuable upon exercise of outstanding stock options at an exercise price of $0.50 per share granted outside of our equity compensation plans as a charitable donation;

 

   

4,340,250 shares of common stock, subject to increase on an annual basis, reserved for issuance under our 2010 Incentive Plan, which will become effective upon the closing of this offering; and

 

   

308,559 shares of common stock issuable upon exercise of outstanding warrants at a weighted-average exercise price of $2.07 per share, giving effect to the conversion of warrants to purchase shares of our preferred stock into warrants to purchase shares of our common stock, which conversion will occur prior to the closing of this offering.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

We have derived the following consolidated statement of operations data for 2008, 2009 and 2010 and consolidated balance sheet data as of December 31, 2009 and 2010 from our audited consolidated financial statements included elsewhere in this prospectus. We have derived the following consolidated statement of operations data for 2006 and 2007 and consolidated balance sheet data as of December 31, 2006 and 2007 from our audited consolidated financial statements not included in this prospectus. You should read the consolidated financial data set forth below in conjunction with our consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our historical results are not necessarily indicative of our results to be expected in any future period.

 

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    Year Ended December 31,  
    2006     2007     2008     2009     2010  

Consolidated Statements of Operations Data:

         

Revenue:

         

Software license fees

  $ 20,740      $ 25,976      $ 32,480      $ 37,289      $ 40,312   

Maintenance and professional services

    20,485        23,207        29,899        36,717        45,922   
                                       

Total revenue

    41,225        49,183        62,379        74,006        86,234   

Cost of revenue:

         

Software license fees

    111        167        172        109        82   

Maintenance and professional services

    5,867        5,857        6,917        7,991        10,945   
                                       

Total cost of revenue (1)

    5,978        6,024        7,089        8,100        11,027   
                                       

Gross profit

    35,247        43,159        55,290        65,906        75,207   

Operating expenses:

         

Research and development (1)

    7,536        9,868        12,618        12,550        14,037   

Sales and marketing (1)

    20,802        28,640        32,391        39,130        45,995   

General and administrative (1)

    4,193        5,016        6,062        5,627        8,796   
                                       

Total operating expenses

    32,531        43,524        51,071        57,307        68,828   
                                       

Income (loss) from operations

    2,716        (365     4,219        8,599        6,379   

Other income, net

    358        493        307        7        133   
                                       

Income (loss) before income taxes

    3,074        128        4,526        8,606        6,512   

Income tax benefit (expense)

    (108     (147     1,330        10,977        (2,495
                                       

Net income (loss)

    2,966        (19     5,856        19,583        4,017   

Accretion and allocation to participating preferred stock

    (2,277     (485     (4,197     (13,868     (2,800
                                       

Net income (loss) attributable to common shareholders

  $ 689      $ (504   $ 1,659      $ 5,715      $ 1,217   
                                       

Net income (loss) per common share—basic

  $ 0.05      $ (0.03   $ 0.11      $ 0.39      $ 0.08   
                                       

Net income (loss) per common share—diluted

  $ 0.05      $ (0.03   $ 0.11      $ 0.32      $ 0.05   
                                       

Shares used in computation of net income (loss) per common share:

         

Basic

    13,775        14,434        14,516        14,762        15,862   

Diluted

    14,120        14,434        14,963        18,119        24,733   

Pro forma net income (loss) per common share (unaudited): (2)

         

Basic

            0.08   
               

Diluted

            0.07   
               

Shares used in computation of pro forma net income (loss) per common share
(unaudited): (2)

         

Basic

            52,347   

Diluted

            61,218   

Other Data (unaudited):

         

Adjusted EBITDA (3)

  $ 3,354      $ 513      $ 5,277      $ 9,991      $ 8,939   
                                       

 

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    December 31,  
    2006     2007     2008     2009     2010  

Consolidated Balance Sheet Data:

         

Cash and cash equivalents

  $ 10,152      $ 11,017      $ 21,204      $ 31,986      $ 39,011   

Working capital (4)

    6,422        6,932        11,974        20,518        31,748   

Total assets

    22,588        27,120        41,947        70,252        82,645   

Deferred revenue (current and non-current)

    11,298        14,149        20,800        26,765        33,516   

Long-term debt

    225        225        —          —          —     

Convertible redeemable preferred stock (5)

    53,270        53,755        52,905        —          —     

Total stockholders’ equity (deficit) (5)

    (46,224     (46,524     (40,527     33,084        39,708   

 

 

(1) Includes stock-based compensation expense as follows:

 

     December 31,  
     2006      2007      2008      2009      2010  

Cost of revenue

   $ 5       $ 6       $ 8       $ 13       $ 44   

Research and development

     12         7         15         30         95   

Sales and marketing

     45         56         58         72         239   

General and administrative

     65         74         73         36         338   
                                            

Total stock-based compensation

   $ 127       $ 143       $ 154       $ 151       $ 716   
                                            

 

(2) Reflects on a pro forma basis the conversion of all outstanding shares of our convertible preferred stock as of December 31, 2010 into 36,484,920 shares of our common stock immediately prior to the closing of this offering.

 

(3) We define Adjusted EBITDA as net income plus other income (expense), net, income tax expense (benefit), depreciation and amortization, and stock-based compensation expense. Adjusted EBITDA is a financial measure that is not calculated in accordance with GAAP. The table below provides a reconciliation of this non-GAAP financial measure to the most directly comparable financial measure calculated and presented in accordance with GAAP. Adjusted EBITDA should not be considered as an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate Adjusted EBITDA in the same manner as we do.

Our management believes that Adjusted EBITDA is a more indicative measure than GAAP financial measures of our core operating performance (the performance of our operations that are directly related to the development, licensing and sale of IT security and compliance automation software and related services) because it eliminates items that either are not part of our core operations, such as investment gains and losses and net interest expense, or do not require cash outlays, such as stock-based compensation. Adjusted EBITDA also excludes depreciation and amortization expense, which is based on a company’s estimate of the useful life of tangible and intangible assets. These estimates can vary relative to the actual performance and actual value of the asset itself, are based on historical costs and may not be indicative of current or future capital expenditures. Adjusted EBITDA assists management in: planning, including the preparation of our annual operating budget; allocating resources to enhance the financial performance of our business; evaluating the effectiveness of our business strategies; and certain communications with our board of directors about our financial performance.

 

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We believe Adjusted EBITDA is useful to investors in evaluating our operating performance for the following reasons:

 

   

Adjusted EBITDA is widely used by investors to measure a company’s operating performance without regard to items such as those described above, which can vary substantially from company to company and from period to period depending upon the company’s financing and accounting methods, the book value of the company’s assets, the company’s capital structure, the methods by which the company’s assets were acquired and the timing and amount of stock-based awards; and

 

   

securities analysts frequently use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of companies.

Although Adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results of operations as reported under GAAP. Some of these limitations are that Adjusted EBITDA does not reflect: our cash expenditures or future requirements for capital expenditures or other contractual commitments; changes in, or cash requirements for, our working capital needs; interest expense or interest income; or cash requirements for income taxes. In addition, other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

The following table presents a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, for each of the periods indicated.

 

    Year Ended December 31,  
        2006             2007             2008             2009             2010      
    (in thousands)  

Reconciliation of Adjusted EBITDA to Net Income

         

Net income (loss)

  $ 2,966      $ (19   $ 5,856      $ 19,583      $ 4,017   

Other income, net

    (358     (493     (307     (7     (133

Income tax expense (benefit)

    108        147        (1,330     (10,977     2,495   

Depreciation

    511        735        904        1,091        1,426   

Amortization

    —          —          —          150        418   

Stock-based compensation expense

    127        143        154        151        716   
                                       

Adjusted EBITDA

  $ 3,354      $ 513      $ 5,277      $ 9,991      $ 8,939   
                                       

 

(4) Working capital represents current assets minus current liabilities.

 

(5) The redemption provision for our outstanding shares of convertible preferred stock expired in June 2009. Upon this expiration, we reclassified $53.8 million in related par value and additional paid-in capital to stockholders’ equity.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited and unaudited consolidated financial statements and related notes included elsewhere in this prospectus. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results may differ materially from those contained in or implied by any forward-looking statements. Please read “Special Note Regarding Forward-Looking Statements and Industry Data.” Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly in “Risk Factors.”

Overview

We are a leading provider of IT security and compliance automation software solutions that help protect physical, virtual and cloud IT infrastructure, prove compliance and prevent outages for enterprises, service providers and government agencies. Our software intelligently identifies on a real-time basis security threats and compliance breaches, often otherwise undetected for months, by tracking high volumes of changes and events across an organization’s IT infrastructure, automatically analyzing this data to identify security threats and compliance breaches, and helping remediate these issues. As of December 31, 2010, we had sold our products and services to over 5,700 customers in 94 countries worldwide, including 46% of the Fortune 500, 27 of 30 U.S. federal government executive branch agencies, and many other domestic and foreign governments.

We were founded in 1997 and launched our initial product, Tripwire for Servers, in 1998, and our current flagship product, Tripwire Enterprise, in 2004. In January 2010, we formally launched Tripwire Log Center, which is based on technology we acquired in August 2009. Substantially all of our revenue through 2009 has been generated from sales of our Tripwire Enterprise and Tripwire for Servers products and related maintenance and professional services. In 2010, revenue for Tripwire Enterprise, Tripwire for Servers and Tripwire Log Center accounted for 86%, 9% and 5%, respectively, of our total revenue. Our future operating results will be affected by, among other things, the extent to which our Tripwire Log Center gains market acceptance.

In 2008, 2009 and 2010, we derived approximately 29%, 24% and 26%, respectively, of our revenue from sales to customers outside the United States. As part of our growth strategy, we are seeking to expand our international sales and operations, in part due to opportunities provided in global markets where the scope of compliance regulations continues to increase. In 2008, 2009 and 2010, we derived approximately 15%, 17% and 21%, respectively, of our license and professional services revenue from sales directly and indirectly to departments and agencies of the United States federal government. Our growth strategy also includes efforts to expand our sales to the public sector. Our future operating results will be affected by, among other things, our success in expanding our international sales and our sales to the public sector.

We have had seven consecutive years of revenue growth and positive operating cash flows. Our revenue has grown from $41.2 million in 2006 to $86.2 million in 2010. For 2008, 2009 and 2010, our operating income was $4.2 million, $8.6 million and $6.4 million, respectively, and our operating cash flow for the same periods was $12.1 million, $15.2 million, and $10.3 million, respectively. The operating margin for 2010 was 7.4% of revenue, compared to operating margins of 6.8% and 11.6% in 2008 and 2009, respectively. The decrease in operating margin primarily reflects an increased cost structure as we have invested in sales and marketing initiatives designed to increase revenue in future periods. Additionally, we have invested in our administrative functions to support the growth of our business and prepare for our becoming a public company.

We initially funded our operations through convertible preferred stock financings that raised a total of $55.1 million through June 2003. Subsequently we have funded our operations primarily through cash from operations. As of December 31, 2010, we had cash and cash equivalents of $39.0 million, accounts receivable of $19.4

 

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million, $33.5 million in deferred revenue, primarily related to maintenance contracts, and an aggregate of $9.0 million in accounts payable and accrued liabilities. We currently have no debt.

Key Components of Results of Operations

Our sales transactions typically include a perpetual software license and a contract for first-year maintenance which is renewable annually at the customer’s option. Maintenance includes unspecified software updates and upgrades and access to customer support. At the customer’s request, we also provide professional services for installation, remote management, implementation and training. We sell our products and services primarily through our direct sales force. To a lesser extent we also use resellers and systems integrators, particularly in sales to government agencies and international customers. Our sales cycle can be lengthy and often covers several months, particularly for larger transactions. Our customers’ initial orders are often followed by one or more additional orders as our solutions are deployed onto additional IT infrastructure elements and into other business units within the customer’s organization.

We recognize revenue pursuant to Accounting Standards Codification (ASC) Topic 985-605 regarding software revenue recognition, which specifies that software license revenue may be recognized upon product delivery provided that certain requirements are met, including establishment of vendor-specific objective evidence of fair value (VSOE), for each undelivered element of multiple element customer contracts.

Software Licenses

We price our software licenses for our Tripwire Enterprise and Tripwire for Servers products based on a number of factors, including the type and number of devices that our customers intend to monitor using our software. Tripwire Log Center product licenses are priced based primarily on specified levels of IT infrastructure activity. Software licenses are invoiced at the time of delivery. As a result of the increase in the number of larger orders, we expect that our revenue may become more volatile as the timing of delivery of licenses for these larger orders near the end of a reporting period may cause a significant variance in revenue from quarter to quarter.

Maintenance and Professional Services

Maintenance Contracts. Maintenance contracts provide rights to unspecified software product updates and upgrades, maintenance releases and patches, if and when released, and Internet and telephone access to support personnel and content during the term of the maintenance contract. For new product sales, maintenance contract terms begin upon receipt of the product. Maintenance revenue is generated both from the one-year maintenance contracts that are purchased with software licenses and from maintenance contract renewals. Maintenance contracts are generally sold on an annual term, invoiced in advance and recorded as deferred revenue that is recognized ratably over the duration of the agreed upon service period. To the extent our customer base expands, we expect maintenance revenue to continue to grow . Our maintenance renewal rate was approximately 90% in 2008, 2009 and 2010 .

Professional Services. Although most of our customers are able to install our software unassisted and are often able to resolve technical issues without the need to contact our support representatives, we offer professional services for those customers desiring expert assistance.

We offer the following professional services designed to help our customers maximize the value they receive from our products:

 

   

basic services, consisting of installation and configuration services to help customers quickly implement the core capabilities of our products;

 

   

advanced services, including project management, integration, and custom policy development to accommodate unique situations or special needs; and

 

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training, including instructor-led public and onsite training to prepare our customers to install, configure, operate, and maintain their Tripwire products.

Basic services engagements, which represent the majority of our professional services revenue, generally last no longer than ten days. Professional services are generally priced on a time-and-materials basis and invoiced and recognized as the work is performed.

In 2009, we formally introduced two managed services offerings, remote implementation and on-going operational services, for our customers that choose to have our staff manage their Tripwire software deployment. Revenue for remote implementation services is recognized as the services are performed. On-going operational services are generally invoiced on an annual basis and recognized ratably over the term of service.

Cost of Revenue

Cost of software license revenue consists of third-party royalties and payments to a fulfillment provider for delivery of our products to the small percentage of customers that request physical delivery. Since our products are primarily delivered via the Internet, we do not incur significant product delivery costs.

Cost of maintenance and professional services revenue consists primarily of salaries and benefits for support and services personnel, cost of services provided by subcontractors for professional services, travel and other out-of-pocket expenses, facilities costs and other direct and allocated overhead. We allocate overhead costs for general expenses such as office supplies, computer supplies, utilities, rent, and depreciation for furniture and equipment to functional departments based on the relative headcount of the respective departments. While we expect that cost of revenue will grow in absolute dollars consistent with expected growth in revenue, we expect gross profit as a percentage of revenue to remain relatively consistent for the foreseeable future.

Operating Expenses

Research and Development Expenses. Research and development expenses consist primarily of salaries and benefits for employees and costs of contract personnel engaged in the development of new products, the enhancement of existing products and quality assurance activities and, to a lesser extent, facilities costs and other direct and allocated overhead. To date, we have not capitalized any of our software development costs because the timing of the commercial release of our products has substantially coincided with the attainment of technological feasibility. We expect that research and development expenses will increase in absolute dollars as we continue to invest in research and development activities to develop new products and expand the functionality of our existing products. These expenses will increase as a percentage of revenue in the near term as we invest in development of our VIA software suite. Additionally, we expect that increased valuations for our common stock resulting from our initial public offering will result in increased stock-based compensation expense. In future years, we do not expect the rate of increases in research and development to exceed expected rates of increases in future revenue, and as such, we believe that research and development expenses will decrease as a percentage of revenue.

Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries, commissions and benefits for sales and marketing employees and consultants; travel and related out-of-pocket expenses; expenses for marketing programs, such as trade shows and user conferences, lead-generation programs, marketing materials and corporate communications; and facilities costs and other direct and allocated overhead. Commissions on sales of software licenses and initial and renewal maintenance agreements are typically earned and expensed when revenue recognition for the respective revenue elements commences and for professional services when the service is accepted and the customer is invoiced. Commission rates for sales employees are based on annual quotas, and when quotas are exceeded, commission rates accelerate. We intend to hire additional sales and marketing personnel, initiate additional marketing programs and build additional relationships with resellers, system integrators and other channel partners on a global basis. Additionally, we expect increased stock-based compensation expense in future periods. Accordingly, we expect that our sales and marketing expenses will continue to increase for the foreseeable future in absolute dollars. We expect sales and marketing

 

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expense to remain relatively stable in the near term, as a percentage of revenue. As we leverage our sales and marketing personnel and our distribution partnerships in future years, we expect our sales and marketing expense to decrease as a percentage of total revenue.

General and Administrative Expenses. General and administrative expenses consist primarily of salaries and benefits for certain members of the management team, finance, information systems and human resources personnel and consultants; accounting and legal fees, insurance costs, bad debt expense and other direct and allocated overhead. We have incurred and expect to incur significant costs related to our initial public offering. Following the closing of this offering, certain costs will increase, including, among other things, those for SEC reporting compliance, investor relations, directors’ compensation and indemnity insurance. Additionally, we expect increased stock-based compensation expense. As a result, general and administrative expenses are expected to increase both in absolute dollars and as a percentage of revenue compared to historical levels.

Other Income (Expense), Net

Other income (expense), net consists of interest earned on our cash and cash equivalents and foreign currency transaction gains and losses, net of any interest accrued on borrowed funds. Our interest income varies in each reporting period depending on our average cash balances during the period and the current level of interest rates. Similarly, our foreign currency transaction gains and losses will also vary depending upon the volume of transactions denominated in foreign currency and movements in underlying exchange rates.

Provision for Income Taxes

We are subject to income tax in U.S. and foreign jurisdictions and account for income taxes using the asset and liability method. Under this approach, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We have historically maintained a valuation allowance against deferred tax assets; however, in 2008 and 2009, we reversed substantially all of the valuation allowance against deferred tax assets as our historical operating results and forecasted financial performance indicated that our deferred tax assets were more likely than not to be realized.

 

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Results of Operations

The following table presents selected items in our consolidated statements of operations for 2008, 2009 and 2010.

 

     Year Ended
December 31,
 
     2008      2009      2010  
                      
     (dollars in thousands)  

Revenue:

        

Software licenses

   $ 32,480       $ 37,289       $ 40,312   

Maintenance and professional services

     29,899         36,717         45,922   
                          

Total revenue

     62,379         74,006         86,234   

Cost of revenue (1)

     7,089         8,100         11,027   
                          

Gross profit

     55,290         65,906         75,207   

Operating expenses:

        

Research and development (1)

     12,618         12,550         14,037   

Sales and marketing (1)

     32,391         39,130         45,995   

General and administrative (1)

     6,062         5,627         8,796   
                          

Operating income

     4,219         8,599         6,379   

Other income, net

     307         7         133   

Income tax benefit (expense)

     1,330         10,977         (2,495
                          

Net income

   $ 5,856       $ 19,583       $ 4,017   
                          

 

(1)    Includes stock-based compensation expense as follows:

        

Cost of revenue

   $ 8       $ 13       $ 44   

Research and development

     15         30         95   

Sales and marketing

     58         72         239   

General and administrative

     73         36         338   
                          

Total stock compensation

   $ 154       $ 151       $ 716   
                          

Comparison of Years Ended December 31, 2009 and 2010

Revenue in 2010 reflects a 17% increase compared to revenue for 2009, primarily attributable to successful execution of our growth strategy. Our operating margin for 2010 was 7.4% of revenue, compared to an operating margin of 11.6% of revenue for 2009. In 2010 we invested more significantly in sales and marketing initiatives to support growth in revenue in future periods. Additionally, we have invested in our administrative functions to support the growth of our business and prepare for our being a public company.

Revenue

 

     Year ended December 31,  
     2009     2010     Change  
     Amount      Percentage
of Revenue
    Amount      Percentage
of Revenue
    $      %  
Revenue                

(dollars in thousands)

               

Software licenses

   $ 37,289         50.4   $ 40,312         46.7   $ 3,023         8.1

Maintenance and professional services

     36,717         49.6        45,922         53.3        9,205         25.1   
                                                   

Total revenue

   $ 74,006         100.0   $ 86,234         100.0   $ 12,228         16.5
                                             

 

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Revenue was $86.2 million in 2010, compared to $74.0 million in 2009, an increase of $12.2 million, or 17%.

Software license revenue was $40.3 million in 2010, compared to $37.3 million in 2009, an increase of $3.0 million, or 8%. The increase in software license revenue was primarily attributable to a $2.9 million, or 48%, increase in international license revenue in 2010 compared to 2009. Software license revenue in 2010 also benefited from $3.5 million in revenue from the formal introduction of our Tripwire Log Center product.

Maintenance and professional services revenue was $45.9 million in 2010 compared to $36.7 million in 2009, an increase of $9.2 million, or 25%. The following table presents detail of our maintenance and professional services revenue:

 

     Year ended December 31,  
     2009     2010     Change  
     Amount      Percentage of
total Revenue
    Amount      Percentage of
total Revenue
    $      %  
Revenue                

(dollars in thousands)

               

Maintenance

   $ 29,765         40.2   $ 36,312         42.1   $ 6,547         22.0

Professional services

     6,952         9.4        9,610         11.1        2,658         38.2   
                                                   
   $ 36,717         49.6   $ 45,922         53.3   $ 9,205         25.1
                                             

The $6.5 million, or 22%, increase in maintenance contract revenue resulted from a larger installed base due to sales of licenses to new customers and renewals of maintenance contracts. The $2.7 million, or 38%, increase in professional services revenue primarily reflects an increase in sales to customers that increased demand for professional services and our introduction of managed services offerings and two large professional service engagements in Europe.

Cost of Revenue and Gross Profit

 

     Year ended December 31,  
     2009     2010     Change  
     Amount      Percentage
of Revenue
    Amount      Percentage
of Revenue
    $     %  
Cost of Revenue and Gross Profit               

(dollars in thousands)

              

Software licenses

   $ 109         0.1   $ 82         0.1   $ (27     (24.8 )% 

Maintenance and professional services

     7,991         10.8        10,945         12.7        2,954        37.0   
                                                  

Total cost of revenue

   $ 8,100         10.9   $ 11,027         12.8   $ 2,927        36.1
                                            

Gross profit

   $ 65,906         89.1   $ 75,207         87.2   $ 9,301        14.1
                                            

Gross profit was $75.2 million in 2010, compared to $65.9 million in 2009, an increase of $9.3 million, or 14%. Gross profit as a percentage of revenue decreased to 87.2% in 2010 compared to 89.1% in 2009. The decrease in gross profit as a percentage of revenue was primarily related to a $3.0 million, or 37%, increase in cost of revenue for maintenance and professional services. Cost of revenue for maintenance and professional services increased primarily due to:

 

   

an increase of $1.5 million in payroll, travel and other headcount-related costs resulting from a 47% increase in headcount to support our growing installed base;

 

   

an increase of $1.0 million in contracted support technicians and related travel costs driven primarily by two large professional service engagements in Europe; and

 

   

growth in our business.

Additionally, in 2010, we recorded a $0.4 million increase in non-cash amortization of purchased intangibles related to the acquisition in August 2009 of technology upon which the Tripwire Log Center product is based.

 

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Operating Expenses

 

     Year ended December 31,  
     2009     2010     Change  
     Amount      Percentage
of Revenue
    Amount      Percentage
of Revenue
    $      %  
Operating Expenses                

(dollars in thousands)

               

Research and development

   $ 12,550         17.0   $ 14,037         16.3   $ 1,487         11.8

Sales and marketing

     39,130         52.9        45,995         53.3        6,865         17.5   

General and administrative

     5,627         7.6        8,796         10.2        3,169         56.3   
                                                   

Total operating expenses

   $ 57,307         77.4   $ 68,828         79.8   $ 11,521         20.1
                                             

Research and Development. Research and development expenses were $14.0 million in 2010, compared to $12.6 million in 2009, an increase of $1.5 million, or 12%. The increase was primarily due to a $1.0 million increase in payroll expenses due to a 25% increase in headcount to support Tripwire Log Center and other product development and a $0.2 million increase in depreciation.

Sales and Marketing. Sales and marketing expenses were $46.0 million in 2010 compared to $39.1 million in 2009, an increase of $6.9 million, or 18%. The increase was primarily due to costs incurred to support revenue growth initiatives, including a $5.7 million increase in payroll, recruiting and travel expenses attributable to a 24% increase in headcount, comprised primarily of personnel hired to support international sales initiatives. Marketing expenses increased by $1.2 million to support international and domestic sales initiatives.

General and Administrative. General and administrative expenses were $8.8 million in 2010 compared to $5.6 million in 2009, an increase of $3.2 million, or 56%. The increase was primarily due to increased costs to support the growth of our business, including a $2.1 million increase in payroll, recruiting and travel costs. During 2009 we benefited from a reduction in bad debt expense related to the collection of previously reserved receivables. As a result, in 2009 we had negative bad debt expense, and our 2010 bad debt expense increased by $0.5 million in comparison to the prior year.

Income Taxes

 

     Year ended December 31,  
     2009        2010  

Effective Tax Rate

     (127.9 )%         38.3

Impact of reversal of valuation allowance

     170.7        0.2
                   

Effective Tax Rate excluding impact of reversal of valuation allowance

     42.8        38.5
                   

Our income tax expense in 2010 was $2.5 million compared to an income tax benefit of $11.0 million in 2009. In 2009, the benefit for income taxes was impacted by the net reversal of approximately $12.3 million of our valuation allowance on deferred tax assets. The effective tax rate for 2010 was 38.3%, compared to (127.9%) in 2009. Exclusive of the impact on the effective tax rate of the net reversal of the valuation allowance, the 2009 effective tax rate of 42.8% was slightly higher than the effective tax rate in 2010 due to the impact of a non-deductible permanent book-to-tax difference related to forgiveness of a portion of an intercompany loan to our Japanese subsidiary in 2009.

 

 

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Comparison of Years Ended December 31, 2008 and 2009

Revenue

 

     Year Ended December 31,  
     2008     2009     Change  
     Amount      Percentage
of Revenue
    Amount      Percentage
of Revenue
    $      %  
Revenue                
(dollars in thousands)                

Software licenses

   $ 32,480         52.1   $ 37,289         50.4   $ 4,809         14.8

Maintenance and professional services

     29,899         47.9        36,717         49.6        6,818         22.8   
                                                   

Total revenue

   $ 62,379         100.0   $ 74,006         100.0   $ 11,627         18.6
                                             

Revenue was $74.0 million for 2009, compared to $62.4 million for 2008, an increase of $11.6 million, or 19%.

Software license revenue was $37.3 million for 2009, compared to $32.5 million for 2008, an increase of $4.8 million, or 15%. A $6.7 million, or 27%, increase in license revenue from customers in the Americas, substantially all in the U.S. and Canada, was partially offset by a decrease in international revenue of $1.9 million, or 23%. In 2008, our international sales benefited from a significant sale to a foreign government agency.

Maintenance and professional services revenue was $36.7 million for 2009, compared to $29.9 million for 2008, an increase of $6.8 million, or 23%. The following table presents detail of our maintenance and professional services revenue:

 

     Year Ended December 31,  
     2008     2009     Change  
     Amount      Percentage
of Revenue
    Amount      Percentage
of Revenue
    $     %  
Revenue               
(dollars in thousands)               

Maintenance

   $ 22,926         36.7   $ 29,765         40.2   $ 6,839        29.8

Professional services

     6,973         11.2        6,952         9.4        (21     (0.3
                                                  
   $ 29,899         47.9   $ 36,717         49.6   $ 6,818        22.8
                                            

The $6.8 million, or 30%, increase in maintenance contract revenue resulted from a larger installed base and renewals of maintenance contracts. Despite a 15% growth in software license revenue in 2009 compared to 2008, professional services revenue remained flat primarily because customers that purchased licenses in 2009 required less deployment support than those that purchased licenses in 2008.

 

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Cost of Revenue and Gross Profit

 

     Year Ended December 31,  
     2008     2009     Change  
     Amount      Percentage
of Revenue
    Amount      Percentage
of Revenue
    $     %  
Cost of Revenue and Gross Profit               

(dollars in thousands)

              

Software licenses

   $ 172         0.3   $ 109         0.1   $ (63     (36.6 )% 

Maintenance and professional services

     6,917         11.1        7,991         10.8        1,074        15.5   
                                                  

Total cost of revenue

   $ 7,089         11.4   $ 8,100         10.9   $ 1,011        14.3
                                            

Gross profit

   $ 55,290         88.6   $ 65,906         89.1   $ 10,616        19.2
                                            

Gross profit was $65.9 million for 2009, compared to $55.3 million for 2008, an increase of $10.6 million, or 19%. The increase in gross profit was due principally to higher sales volumes, as gross profit as a percentage of revenue remained relatively stable. Cost of revenue for maintenance and professional services increased by $1.1 million, primarily due to increased payroll and related charges resulting from a 22% increase in headcount necessary to support the growth of our business.

Operating Expenses

 

     Year Ended December 31,  
     2008     2009     Change  
     Amount      Percentage
of Revenue
    Amount      Percentage
of Revenue
    $     %  
Operating Expenses               

(dollars in thousands)

              

Research and development

   $ 12,618         20.2   $ 12,550         17.0   $ (68     (0.5 )% 

Sales and marketing

     32,391         51.9        39,130         52.9        6,739        20.8   

General and administrative

     6,062         9.7        5,627         7.6        (435     (7.2
                                                  

Total operating expenses

   $ 51,071         81.9   $ 57,307         77.4   $ 6,236        12.2
                                            

Research and Development Expense. Research and development expenses remained relatively stable at $12.6 million for both 2009 and 2008. An increase of $0.5 million in payroll and related costs was substantially offset by reduced costs for offshore contract personnel as a result of a favorable contract renegotiation with a major sub-contractor. Research and development expense decreased as a percentage of revenue for 2009 compared to 2008, reflecting operating leverage and improved efficiencies in our research and development organization.

Sales and Marketing Expense. Sales and marketing expenses were $39.1 million for 2009, compared to $32.4 million for 2008, an increase of $6.7 million, or 21%. The increase was primarily due to a $2.0 million increase in commission costs resulting from higher revenue and favorable achievement against sales targets and a $2.0 million increase in marketing costs to support international and domestic sales initiatives. The increase also included a $1.6 million increase in payroll and related charges resulting from a 14% increase in headcount and an additional $0.6 million in contract personnel expenses to support business requirements while minimizing headcount increases.

General and Administrative Expense. General and administrative expenses were $5.6 million for 2009, compared to $6.1 million for 2008, a decrease of $0.4 million, or 7%. The decrease was primarily due to a $1.1 million change in bad debt expense as items that were previously reserved were collected in 2009. This decrease

 

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was partially offset by an increase of $0.3 million in legal and accounting fees, primarily due to our acquisition of the technology upon which our Tripwire Log Center product is based, and a $0.3 million increase in contract employee expense.

Other Income, Net

 

     Year Ended December 31,  
     2008     2009     Change  
     Amount     Amount     $     %  
Other Income         
(dollars in thousands)         

Interest income

   $ 341      $ 87      $ (254     (74.5 )% 

Interest expense

     —          (4     (4     n/a   

Other income (expense), net

     (34     (76     (42     123.5   
                                
   $ 307      $ 7      $ (300     (97.7 )% 
                          

Other income decreased by $0.3 million for 2009 compared to 2008 primarily due to decreased investment income as a result of a significant decline in market interest rates.

Income Taxes

Our income tax benefit for 2009 was $11.0 million, an increase of $9.7 million compared to an income tax benefit of $1.3 million for 2008. Despite an increase of $4.1 million in income before income taxes, in the third quarter of 2009 we recorded a benefit for income taxes comprised of a net reversal of approximately $12.3 million of our valuation allowance on deferred tax assets which resulted in a significant benefit from income taxes in 2009, partially offset by income tax expense of $1.3 million. We reversed substantially all of the valuation allowance against deferred tax assets in 2009 as our historical operating results and forecast financial performance indicated that our deferred tax assets were more likely than not to be realized.

We adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, included in ASC Subtopic 740-10, Income Taxes—Overall, as of January 1, 2009. Prior to adoption, we recognized the effect of income tax positions only if such positions were probable of being sustained. In accordance with the interpretation, we now recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. There was no impact of adopting this interpretation on our consolidated financial statements.

 

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Selected Quarterly Results of Operations

The following table sets forth unaudited quarterly consolidated statements of operations data for 2009 and 2010. We derived this information from our unaudited consolidated financial statements, which we prepared on the same basis as our audited consolidated financial statements contained in this prospectus. In our opinion, these unaudited statements include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair statement of that information when read in conjunction with the consolidated financial statements and related notes included elsewhere in this prospectus. The operating results for any quarter should not be considered indicative of results for any future period.

 

    Three Months Ended  
    Mar. 31,
2009
    Jun. 30,
2009
    Sep. 30,
2009
    Dec. 31,
2009
    Mar. 31,
2010
    Jun. 30,
2010
    Sep. 30,
2010
    Dec. 31,
2010
 
    (unaudited)  
    (in thousands, except for per share data)  

Consolidated Statements of Operations:

               

Revenue:

               

Software licenses

  $ 7,378      $ 8,202      $ 10,384      $ 11,325      $ 8,283      $ 9,978      $ 10,954      $ 11,097   

Maintenance and professional services

    8,156        8,718        9,625        10,218        10,356        11,468        11,945        12,153   
                                                               

Total revenue

    15,534        16,920        20,009        21,543        18,639        21,446        22,899        23,250   

Cost of revenue:

               

Software licenses

    22        30        22        35        19        18        24        21   

Maintenance and professional services

    1,910        1,858        1,950        2,273        2,542        2,776        2,843        2,784   
                                                               

Total cost of revenue (1)

    1,932        1,888        1,972        2,308        2,561        2,794        2,867        2,805   
                                                               

Gross profit

    13,602        15,032        18,037        19,235        16,078        18,652        20,032        20,445   

Operating expenses:

               

Research and development (1)

    3,291        3,142        3,051        3,066        3,475        3,625        3,374        3,563   

Sales and marketing (1)

    8,367        8,895        9,402        12,466        11,199        11,597        11,102        12,097   

General and administrative (1)

    1,181        1,211        1,567        1,668        2,076        2,153        2,121        2,446   
                                                               

Total operating expenses

    12,839        13,248        14,020        17,200        16,750        17,375        16,597        18,106   
                                                               

Income (loss) from operations

    763        1,784        4,017        2,035        (672     1,277        3,435        2,339   

Other income (expense), net

    21        53        (21     (46     (3     4        152        (20
                                                               

Income (loss) before income taxes

    784        1,837        3,996        1,989        (675     1,281        3,587        2,319   

Income tax benefit (expense) (2)

    (205     (446     11,711        (83     388        (514     (1,423     (946
                                                               

Net income (loss)

    579        1,391        15,707        1,906        (287     767        2,164        1,373   

Accretion and allocation to participating preferred stock

    (410     (986     (11,124     (1,348     —          (535     (1,499     (948
                                                               

Net income (loss) attributable to common shareholders

  $ 169      $ 405      $ 4,583      $ 558      $ (287   $ 232      $ 665      $ 425   
                                                               

Net income (loss) per common share—basic

  $ 0.01      $ 0.03      $ 0.31      $ 0.04      $ (0.02   $ 0.01      $ 0.04      $ 0.03   
                                                               

Net income (loss) per common share—diluted

  $ 0.01      $ 0.03      $ 0.26      $ 0.02      $ (0.02   $ 0.01      $ 0.03      $ 0.02   
                                                               

Other Data:

               

Adjusted EBITDA (3)

  $ 1,068      $ 2,097      $ 4,312      $ 2,514      $ (172   $ 1,919      $ 4,092      $ 3,100   
                                                               

 

(1) Includes stock-based compensation expense as follows:

               

Cost of revenue

  $ 3      $ 3      $ 4      $ 3      $ 4      $ 8      $ 16      $ 16   

Research and development

    4        8        7        11        10        24        30        31   

Sales and marketing

    14        18        20        20        36        56        72        75   

General and administrative

    11        10        8        7        20        115        102        101   
                                                               

Total stock-based compensation expense

  $ 32      $ 39      $ 39      $ 41      $ 70      $ 203      $ 220      $ 223   
                                                               

 

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(2) During the three months ended September 30, 2009, we reversed a net $12.3 million of our allowance on deferred tax assets, as we determined the deferred tax assets were more likely than not to be realized. The benefit for income taxes from the reversal of the allowance was partially offset by $0.6 million in quarterly income tax expense.
(3) We define Adjusted EBITDA as net income plus other income (expense), net, income tax expense (benefit), depreciation and amortization, and stock-based compensation expense. Adjusted EBITDA is a financial measure that is not calculated in accordance with GAAP. Adjusted EBITDA should not be considered as an alternative to net income, operating income, or any other measure of financial performance calculated and presented in accordance with GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate Adjusted EBITDA in the same manner as we do. The following table presents a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, for each of the periods indicated. For additional information about our use of Adjusted EBITDA, please read note 3 to the tables included in “Selected Consolidated Financial Data” in this prospectus.

 

    Three Months Ended  
    Mar. 31,
2009
    Jun. 30,
2009
    Sep. 30,
2009
    Dec. 31,
2009
    Mar. 31,
2010
    Jun. 30,
2010
    Sep. 30,
2010
    Dec. 31,
2010
 
    (unaudited)  
    (in thousands, except for per share data)  

Reconciliation of Adjusted EBITDA to Net Income (Loss)

               

Net income (loss)

  $ 579      $ 1,391      $ 15,707      $ 1,906      $ (287   $ 767      $ 2,164      $ 1,373   

Other (income) expense, net

    (21     (53     21        46        3        (4     (152     20   

Income tax expense (benefit)

    205        446        (11,711     83        (388     514        1,423        946   

Depreciation

    273        274        256        288        325        335        333        433   

Amortization

    —          —          —          150        105        104        104        105   

Stock-based compensation expense

    32        39        39        41        70        203        220        223   
                                                               

Adjusted EBITDA

  $ 1,068      $ 2,097      $ 4,312      $ 2,514      $ (172   $ 1,919      $ 4,092      $ 3,100   
                                                               

 

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The following table sets forth our historical results, for the periods indicated, as a percentage of our revenue.

 

    Three Months Ended  
    Mar. 31,
2009
    Jun. 30,
2009
    Sep. 30,
2009
    Dec. 31,
2009
    Mar. 31,
2010
    June 30,
2010
    Sep. 30,
2010
    Dec. 31,
2010
 
    (unaudited)        

Consolidated Statements of Operations:

               

Revenue:

               

Software licenses

    47.5     48.5     51.9     52.6     44.4     46.5     47.8     47.7

Maintenance and professional services

    52.5        51.5        48.1        47.4        55.6        53.5        52.2        52.3   
                                                               

Total revenue

    100.0        100.0        100.0        100.0        100.0        100.0        100.0        100.0   

Cost of Revenue:

               

Software licenses

    0.1        0.2        0.1        0.2        0.1        0.1        0.1        0.1   

Maintenance and professional services

    12.3        11.0        9.7        10.6        13.6        12.9        12.4        12.0   
                                                               

Total cost of revenue

    12.4        11.2        9.9        10.7        13.7        13.0        12.5        12.1   
                                                               

Gross profit

    87.6        88.8        90.1        89.3        86.3        87.0        87.5        87.9   

Operating expenses:

               

Research and development

    21.2        18.6        15.2        14.2        18.6        16.9        14.7        15.3   

Sales and marketing

    53.9        52.6        47.0        57.9        60.1        54.1        48.5        52.0   

General and administrative

    7.6        7.2        7.8        7.7        11.1        10.0        9.3        10.5   
                                                               

Total operating expenses

    82.7        78.3        70.1        79.8        89.9        81.0        72.5        77.9   
                                                               

Income (loss) from operations

    4.9        10.5        20.1        9.4        (3.6     6.0        15.0        10.1   

Other income (expense), net

    0.1        0.3        (0.1     (0.2     0.0        0.0        0.7        (0.1
                                                               

Income (loss) before income taxes

    5.0        10.9        20.0        9.2        (3.6     6.0        15.7        10.0   

Income tax benefit (expense)

    (1.3     (2.6     58.5        (0.4     2.1        (2.4     (6.2     (4.1
                                                               

Net income (loss)

    3.7        8.2        78.5        8.8        (1.5     3.6        9.5        5.9   

Accretion and allocation to participating preferred stock

    (2.6     (5.8     (55.6     (6.3     0.0        (2.5     (6.5     (4.1
                                                               

Net income (loss) attributable to common shareholders

    1.1     2.4     22.9     2.6     (1.5 )%      1.1     2.9     1.8
                                                               

Other Data:

               

Adjusted EBITDA

    6.9     12.4     21.6     11.7     (0.9 )%      8.9     17.9     13.3
                                                               

On an annual basis, we have historically generated our lowest quarterly revenue amounts in the first quarter and our highest quarterly revenue amounts in the fourth quarter of each year. Many of our customers do not finalize their budgets for spending on our products until after the first quarter of a given year and often spend the largest portion of their budgets in the fourth quarter. Seasonal purchasing patterns of international customers and the U.S. government can also materially impact our quarter to quarter operating results. Additionally, our sales and marketing expenses may be weighted heavily in the fourth quarter of a year as accelerated commission rates on sales that exceed annual quotas, if applicable, tend to occur in the final quarter of a year.

Our revenue within a particular quarter is often significantly affected by the unpredictable procurement patterns of our prospective customers. Many of our prospective customers do not finalize their purchasing decisions until the last few weeks or days of a quarter. As a result, we have historically generated the majority of our software license revenue in the final month of each quarter. We expect these purchasing patterns to continue in the future. Therefore, a delay in even one large order beyond the end of the quarter could materially reduce our anticipated revenue for a quarter. Because many of our expenses must be incurred before we expect to generate revenue, delayed orders could negatively impact our results of operations for the period.

 

 

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Liquidity and Capital Resources

Our sources of liquidity and capital resources as of December 31, 2010 consisted of $39.0 million of cash and cash equivalents and $25.0 million unused availability under our revolving bank credit agreement. As of December 31, 2010, we were in compliance with all covenants under our revolving bank credit agreement, and there was no principal amount outstanding under the credit facility.

We initially funded our operations through convertible preferred stock financings that raised a total of $55.1 million through June 2003. Subsequently, we have funded our operations primarily through cash from operations. Historically, our principal uses of cash have consisted of payroll and other operating expenses and purchases of property and equipment to support our growth. In 2009, we acquired certain technology, upon which our Tripwire Log Center product is based, for $2.9 million paid primarily in cash.

Our credit facility in the amount of $25.0 million matures on October 21, 2013. Amounts outstanding under the facility accrue interest at a per annum rate equal to, at the Company’s election, a “base rate” plus an applicable margin or a LIBOR rate plus an applicable margin. The base rate is defined in the revolving bank credit agreement as the greater of the lender’s prime rate, the overnight federal funds rate plus 50 basis points, or the daily LIBOR rate plus 200 basis points. The applicable margin is dependent upon a leverage ratio calculated on the basis of quarter-end borrowings and adjusted EBITDA. At December 31, 2010, the applicable interest rates were 3.25% for base rate loans or a range 1.26%-1.96% for LIBOR rate loans, depending on the loan term. The credit facility is secured by a lien on substantially all of our assets and is subject to customary covenants for facilities of this type, including covenants limiting debt incurrence, liens, investments, asset sales and mergers. The revolving credit facility also includes financial covenants requiring a borrowing base ratio (as defined in the agreement) of 1.5 to 1.0 and a rolling four-quarter adjusted EBITDA exceeding $5.0 million, and increasing by $1.0 million each quarter thereafter until reaching a requirement of $8.0 million for the 12 months ended June 30, 2011 and each quarter thereafter.

The following table shows our cash flows from operating activities, investing activities and financing activities for the stated periods:

 

     Year Ended December 31,  
     2008     2009     2010  
        
     (in thousands)  

Cash provided by operating activities

   $ 12,141      $ 15,229      $ 10,255   

Cash used in investing activities

     (2,022     (4,482     (2,869

Cash provided by (used in) financing activities

     68        35        (361
                        

Cash generated

   $ 10,187      $ 10,782      $ 7,025   
                        

Operating Activities

Our operating activities have provided our primary source of funding since 2005. The primary sources of operating cash flows are net income (losses) adjusted for non-cash items, primarily depreciation and amortization and deferred tax adjustments, and from advance payments on maintenance contracts. Our collection of receivables for software licenses and advance payments of maintenance contracts has generally exceeded our investment in working capital assets in a given period.

Future cash flow from operations will depend primarily on our profitability and changes in working capital items, including deferred revenue, accounts receivable and the timing of payment of tax liabilities.

 

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Cash flow from operating activities in 2010 totaled $10.3 million. Cash totaling $8.5 million was primarily provided by net income of $4.0 million and $4.4 million in net non-cash items, primarily $1.8 million in depreciation and amortization, $0.7 million of non-cash charges related to stock compensation and $1.8 million in adjustments to net deferred tax assets. Changes in net working capital generated $1.8 million, primarily from a $6.8 million increase in deferred revenue from advance payments on maintenance contracts. This source of cash was offset by an increase of $1.8 million in accounts receivable resulting from higher revenue, a decrease of $2.6 million in current liabilities primarily related to the payment of management’s variable compensation and sales commissions for 2009, and an increase of $0.4 million in other current assets due to payments of prepaid expenses.

Cash flow from operating activities in 2009 totaled $15.2 million. Cash totaling $8.8 million was provided by net income of $19.6 million, offset by $10.8 million in net non-cash items. Non-cash items were comprised primarily of $11.8 million in non-cash adjustments to deferred tax assets resulting from reversal of a portion of the valuation allowance maintained against deferred tax assets based on improved profitability, partially offset by $1.2 million in depreciation and amortization charges. Changes in net working capital provided cash in-flows totaling $6.5 million, primarily resulting from a $6.0 million increase in deferred revenue and increases in other items partially offset by an increase of $1.8 million in accounts receivable associated with the growth in our revenue.

Cash flow from operating activities in 2008 totaled $12.1 million primarily from net income of $5.9 million and changes in net working capital. Changes in net working capital provided cash in-flows totaling $6.3 million, primarily resulting from a $6.7 million increase in deferred revenue and increases in other items partially offset by an increase of $2.1 million in accounts receivable associated with the growth in our revenue.

Investing Activities

Cash used in investing activities is primarily comprised of capital expenditures associated with information systems and facilities and fixtures required to support our business activities and employee base. Net cash used in investing activities was $2.0 million, $4.5 million and $2.9 million in 2008, 2009 and 2010, respectively. In addition to the capital expenditures described above, in 2009 we purchased certain technology upon which our Tripwire Log Center product is based for $2.9 million, paid primarily in cash. We expect our capital expenditures to slightly increase to support expansion of our customer base and revenue.

Financing Activities

As cash flow from operations has been sufficient to sustain our business in the past three years, there were no significant cash flows from financing activities in 2008 and 2009. In 2010, warrants and stock options were exercised, generating cash in-flows of $1.9 million. We expect stock option exercise activity to increase subsequent to this offering. As stock options are exercised in the future, we will experience additional cash in-flows. We also paid costs related to our proposed public offering totaling $2.3 million during 2010.

Other Factors Affecting Liquidity and Capital Resources

We believe that our cash and cash equivalents and cash flow from operations together with the cash proceeds from this offering will be sufficient to meet our anticipated cash needs, including cash requirements for working capital, capital expenditures and various contractual obligations, for at least the next 12 months. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these sources are insufficient to satisfy our cash requirements, we may seek additional sources of funding, including borrowing on our Credit Agreement or issuance of debt securities or additional equity securities. The sale of any such securities could result in additional dilution to our stockholders. The incurrence of indebtedness would result in debt service obligations and could result in operating and financial covenants that could restrict our operations. In

 

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addition, there can be no assurance that any additional financing will be available on acceptable terms, if at all. We anticipate that, from time to time, we may evaluate acquisitions of complementary businesses, technologies or assets. However, there are no current plans, proposals or arrangements with respect to any specific acquisition.

Off-Balance Sheet Arrangements

As of December 31, 2010, we had no off-balance sheet arrangements.

Contractual Obligations and Commitments

We lease our administrative offices in Portland, Oregon under a non-cancelable operating lease agreement that expires in April 2014. During the third quarter of 2010, we expanded our corporate offices and, accordingly, will incur an increase of approximately $0.3 million in annual lease payments which is reflected in the table below. We also lease sales offices in Europe and Asia under non-cancelable operating lease agreements with terms expiring through 2011. We opened a Singapore office in December 2010, which requires annual lease payments totaling approximately $0.1 million reflected in the table below.

The following table is a summary of our contractual obligations as of December 31, 2010:

 

     Payments Due by Period  
     Total      2011      2012 to
2013
     2014 to
2015
     More than
5 years
 
     (in thousands)  

Operating leases

   $ 5,004       $ 1,774       $ 2,781       $ 449             —   
                                            

Critical Accounting Policies, Significant Judgments and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenue and expenses during the reporting period. We base our estimates and judgments on our historical experience, knowledge of current conditions and our beliefs regarding likely occurrences in the future, given available information. Estimates are used for, but are not limited to, revenue recognition, determination of fair value of stock awards, valuation of goodwill and intangible assets acquired in business combinations, impairment of goodwill and other intangible assets, amortization of intangible assets, accounting for uncertainties in income taxes, contingencies and litigation and allowances for doubtful accounts. Actual results may differ from those estimates, and any differences may be material to our financial statements. Further, if we apply different factors, or change the method by which we apply the various factors that are used, in making our critical estimates and judgments, our reported operating results and financial condition could be materially affected. This information should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus.

Revenue Recognition and Deferred Revenue

We recognize revenue according to the provisions of the FASB guidance on software revenue recognition. Accordingly, we exercise judgment and use estimates in connection with the determination of the amount of software licenses and maintenance and professional service revenue to be recognized in each accounting period. We derive revenue primarily from two sources: (i) sales of software licenses, and (ii) maintenance contracts. Additionally, a small portion of our revenue is earned from providing professional services.

 

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Software license revenue is recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable, collection is probable and VSOE of the fair value of undelivered elements exists. As substantially all of our software licenses are sold in multiple-element arrangements that include either maintenance or both maintenance and professional services, we use the residual method to determine the amount of license revenue to be recognized. Under the residual method, consideration is allocated to undelivered elements based upon VSOE of the fair value of those elements, with the residual of the arrangement fee allocated to and recognized as license revenue. We have established VSOE of the fair value of maintenance based on the contractually stated maintenance renewal rates, provided such rates are substantive. These demonstrate a consistent relationship of pricing maintenance as a percentage of the license fee. VSOE of the fair value of professional services is established based on daily rates when sold on a stand-alone basis.

Software licenses revenue is generally recognized upon the delivery of the software if all revenue recognition criteria are met. Estimated sales returns and allowances are recorded upon shipment of the product. We generally accept returns within 90 days of original sale. To date, we have not experienced significant sales returns.

We sell a portion of our products and services through a limited number of distributors and resellers. Distributor agreements may offer expanded rights of return, including stock rotation rights, price protection, etc., beyond our normal agreements and as such we recognize revenue upon sale from the distributor to the end user in these arrangements.

Revenue allocated to maintenance contracts, which gives the subscriber the rights to obtain unspecified updates and enhancements, on a when and if available basis, is generally paid in advance and is recognized ratably over the term of the service.

Deferred revenue generally consists of amounts received or receivable from customers for maintenance for which the earnings process is incomplete.

Professional services generally consist of installation and training services and are not essential to the functionality of the software. Revenue allocated to professional services is recognized as the services are performed.

Stock-Based Compensation

We have a 2000 Stock Option/Stock Issuance Plan (2000 Plan) and a 2010 Stock Option/Stock Issuance Plan (2010 Plan) (which the Board adopted on November 11, 2010 to replace the 2000 Stock Option/Stock Issuance Plan that expired by its terms on November 8, 2010) which provide for the granting of stock options to employees, directors and consultants within the meaning of Section 422 of the Internal Revenue Code and nonstatutory stock options. We have reserved a total of 798,667 shares of our common stock for issuance under the 2010 Plan. At February 24, 2011, we had approximately 356,112 shares of common stock available for issuance under the 2010 Plan. Stock options under the 2000 Plan and the 2010 Plan generally vest over a four-year period and expire in 10 years. We currently use authorized and unissued shares to satisfy stock option exercises. Upon termination of service all unvested stock options are forfeited and option holders must exercise vested stock options generally within three months or they are forfeited.

On May 7, 2010, the board of directors adopted our 2010 Incentive Plan, which will become effective upon closing of this offering. The board has authorized 4,340,250 shares of common stock for issuance under the 2010 Incentive Plan. In addition, any shares that are available for issuance under the 2010 Plan or that are subject to outstanding awards under the 2000 Plan and the 2010 Plan as of the effective date of the 2010 Incentive Plan that cease to be subject to these awards (other than from exercise or settlement of the awards in shares) will automatically become available for issuance under the 2010 Incentive Plan, up to an aggregate maximum of 17,125,102 shares. The board may increase the authorized shares each January starting in 2011 pursuant to an evergreen provision by adding an amount equal to the least of (i) 4,875,000 shares, (ii) 5% of our outstanding common stock as of the end of our immediately preceding fiscal year, and (iii) a lesser amount determined by the board.

 

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We apply FASB ASC Topic 718, Compensation—Stock Compensation, in accounting for stock options granted, modified or canceled after January 1, 2006 to employees under the Plans, which requires that the fair value of stock-based compensation be expensed over the vesting period. The fair value of each stock option is estimated on the date of grant using the Black-Scholes option pricing model. Since our shares are not currently publicly traded and as a result there is a lack of consistent historical experience on which to base the assumptions, the simplified method is used to estimate the expected term of the stock option and expected volatility is computed based on the average historical volatility of similar entities with publicly traded shares. The risk free rate for the expected term of the stock option is based on the U.S. Treasury yield curve in effect at the time of grant.

Valuation of Common Stock

The following table summarizes by grant date the number of shares of our common stock subject to stock options granted since January 1, 2008, and the associated per share exercise price. As discussed below, we have determined for each grant that the exercise price equaled or exceeded the fair value per share of our common stock as of the date of the grant.

 

Grant Date

   Options Granted      Exercise Price Per Share      Fair Value Per Share  

2008

        

April 23

     1,318,721       $ 0.60       $ 0.34   

June 18

     122,500       $ 0.60       $ 0.34   

July 24

     33,100       $ 0.60       $ 0.34   

October 1

     162,100       $ 0.65       $ 0.44   

October 28

     128,500       $ 0.65       $ 0.44   

December 10 (1)

     39,100       $ 0.65         —     

2009

        

April 15

     1,312,065       $ 0.65       $ 0.44   

June 17

     16,500       $ 0.65       $ 0.44   

July 23

     253,980       $ 0.65       $ 0.44   

September 23

     227,600       $ 0.70       $ 0.60   

October 30 (1)

     52,000       $ 0.70         —     

December 16

     65,500       $ 0.80       $ 0.60   

2010

        

March 31

     1,357,900       $ 1.98       $ 1.98   

April 21

     84,000       $ 2.09       $ 2.09   

May 7

     936,999       $ 2.09       $ 2.09   

May 25

     93,215       $ 2.08       $ 2.08   

May 26

     20,000       $ 2.08       $ 2.08   

June 25

     685,247       $ 2.08       $ 1.96   

July 22

     481,999       $ 2.08       $ 1.95   

September 21

     97,545       $ 2.08       $ 2.06   

December 15

     441,000       $ 2.08       $ 2.08   

2011

        

February 24

     81,000       $ 2.30       $ 2.30   

 

(1) For these stock option grants, the board of directors did not determine a specific fair value per share but concluded that the fair value per share was less than the exercise price.

Since December 2005, we have obtained valuation analyses prepared by an independent third-party valuation firm to assist us in determining the fair market value of our common stock. In obtaining third-party valuations of our common stock, our management provided the third-party valuation firm with information about our performance, markets and prospects, which the valuation firm used, along with other information, to perform its valuation calculations. These valuations were reviewed by management and provided to our board of directors. In determining the fair market value of our common stock up to December 31, 2009, when we revised our approach of obtaining semi-annual valuations and began obtaining third-party valuations for each option grant, our board of directors considered these valuation reports together with subsequent market conditions,

 

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company performance and any significant events or developments related to us. After December 31, 2009, the board considered the common stock valuation provided by the third-party valuation firm for a specific grant, and took into account certain significant transactions between stockholders that involved our common stock. We have also used these third-party valuations for purposes of determining the Black-Scholes fair value of our stock option awards and related stock-based compensation expense. Because the board of directors had concerns about consistency and internal fairness among employees receiving stock options, the exercise price for stock options granted after the December 2005 initiation of the third-party valuation process took the exercise price of previous grants into consideration as well as the fair market value determined by the valuation firm, resulting in stock options granted through 2009 and in June and July 2010 having an exercise price higher than the fair market value per share on their date of grant, as determined by the valuation firm.

The third-party valuations described below used the “Income Approach” and the “Market Approach” (each discussed below) to calculate a total equity value from which the estimated fair market value of our common stock was derived. We prepared financial forecasts used in the computation of our equity value for both the Income Approach and the Market Approach. The financial forecasts were based on a number of assumptions, including, assumptions regarding revenue growth rates and expenses, that took into account our past experience and future expectations.

Under the Income Approach, estimated future returns are discounted to present value at an appropriate rate of return for the investment, where the discount reflects the degree of risk associated with the future returns and returns available from alternative investments. Higher risk leads to a higher discount rate, which produces a lower value for the investment. Under the Income Approach, discrete cash flows were determined over several years, and estimated in a residual period. The analysis was based on a number of assumptions, including:

 

   

our expected sales growth, cost of sales, operating expenses, depreciation expense, required working capital, capital expenditures and other income for the current and future years, which assumptions were based on management’s estimates as of the effective date of the valuation;

 

   

a discount rate, which was applied to the forecasted discrete period cash flows; and

 

   

a capitalization rate, which was used to capitalize the forecasted residual cash flows projected beyond the discrete period.

The valuations applied two valuation methods under the Market Approach, the Public Company method and the Merger and Acquisition, or M&A, Transactions method.

The Public Company method determines total equity value of a company by applying valuation multiples derived from publicly-traded companies that are similar to the company being valued. When choosing the guideline companies for the Public Company method, a peer group of comparable publicly-traded companies in the computer programming, data processing and other computer services industries that provide software for security or integrity purposes were identified. As part of the Market Approach—M&A Transactions method, mergers and acquisitions involving companies in the computer programming, data processing and other computer services industry with similar size and products were analyzed.

One or more of the following total equity multiples and market value of invested capital multiples were used in the Public Company and M&A Transactions methods because they are considered to provide meaningful indications of value:

 

   

Total Equity Multiples. Total Equity Value to: projected earnings for the following fiscal year, determined as of the valuation date based on our estimates, and pre-tax income, net income and gross cash flow for the latest twelve months prior to the valuation date; and

 

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Market Value of Invested Capital Multiples. Market Value of Invested Capital to: revenue, earnings before interest, taxes, depreciation and amortization, or EBITDA, earnings before interest and taxes, or EBIT, for the latest twelve months prior to the valuation date, and projected revenue and projected EBITDA each for the following fiscal year, determined as of the valuation date based on our estimates.

The specific multiples used in each valuation are listed in the discussion of grants made on each date below.

Under the Public Company method, these valuation multiples were adjusted to account for growth, size and unique risks that would influence the financial data of the guideline companies. Each adjusted valuation multiple was then applied to the relevant financial measure to produce an indication of value, either equity value or total capital value depending on the multiple used, and necessary adjustments for converting capital values to equity values were made. The total equity values for the various valuation multiples were then weighted, a control premium applied and any non-operating assets added to the value to arrive at a reconciled total equity value under the Public Company method.

Under the M&A Transactions method, certain discounts were applied to the multiples to account for transactions that include additional investment value to strategic and publicly-traded buyers and unique risks related to the subject company. Each adjusted valuation multiple was then applied to our adjusted earnings or cash flows to produce an indication of total equity value. The total equity values for the various valuation multiples were then weighted, based on the number of transactions, comparability of the companies, and quality of the data included in the valuation multiple to arrive at a reconciled total equity value under the M&A Transactions method. More weight was assigned to the revenue multiple than to the other multiples, because this multiple is believed to provide a more consistent value in each period and reflects the values seen in the market. While merger and acquisition data provides valuable information, the data also has certain limitations, including that: the financial data cannot be independently verified; it is sometimes unclear whether reported results conform to United States generally accepted accounting principles; different data sources use varying definitions of “earnings” and “cash flow;” and, in the case of small-to-medium sized transactions, the deal price may include payments related to employment agreements and be affected by the type of consideration paid.

After total equity value was calculated based on the Income Approach and Market Approach, the total equity value determined under each approach was weighted to reach a reconciled total equity value.

The valuations used methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the AICPA Practice Guide. As disclosed in the notes to our Consolidated Financial Statements included elsewhere in this prospectus, we have issued and outstanding Series A, Series B, Series C, Series C-1 and Series D preferred stock, stock options and warrants over which to allocate the total value of equity. Consistent with the AICPA Practice Guide, the value of each share of preferred and common stock can then be inferred by analyzing various option-pricing methodologies.

Under the option-pricing methodology used by the third-party valuation firm, the equity value was allocated to the preferred stock, common stock, warrants and stock options using the Black-Scholes model. To determine the Black-Scholes assumptions, the time to a liquidity event is estimated, the risk-free rate is determined (typically based on the rate available on a government security whose term matches the assumed time to liquidity) and the volatility assumption is determined. For a private company, volatility is based on the historical stock performance for comparable public companies.

April 23, June 18 and July 24, 2008

The stock options granted on these dates had an exercise price of $0.60 per share. Our board of directors determined this price taking into account the third-party valuation of our common stock performed as of December 31, 2007, which estimated that the fair value of our common stock at that time was $0.34 per share. To establish the exercise price, our board adjusted this number upward to increase the exercise price over the

 

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exercise price of the most recent prior grants by an amount roughly proportionate to the increase in the fair market value of the common stock from the previous third party valuation. In the December 2007 valuation, under the Income Approach, a discount rate of 19.8% and a capitalization rate of 12.3% were applied. Under the Market Approach-Public Company method, adjusted multiples of total equity to projected earnings, pre-tax income, net income and gross cash flow of 11.31, 27.81, 40.71 and 40.01, respectively, were applied. Adjusted multiples of market value of invested capital to revenue, EBITDA and EBIT of 2.08, 41.12 and 32.01, respectively, were also applied. Under the Market Approach—M&A Transactions method, adjusted multiples of total equity value to revenue, pre-tax income, net income and gross cash flow of 1.75, 14.18, 20.04 and 10.89, respectively, were applied. As part of its application of the Market Approach — M&A Transactions method for determining total equity value, the December 31, 2007 valuation separately considered the acquisition of Embarcadero Technologies Inc. by a private equity firm in June 2007. Embarcadero was a business of similar nature and size to us, and had been used as a guideline company in previous appraisals. In evaluating the Embarcadero M&A transaction, an adjusted multiple of total equity value to gross cash flow of 20.79 was applied. Adjusted multiples of market value of invested capital to revenue, EBITDA and EBIT of 3.19, 22.45 and 32.01, respectively, were also applied.

In the December 2007 valuation, the various valuation approaches were given the following weight: Income Approach 55%, Market Approach—Public Company 25%, Market Approach—M&A Transactions 10% and Market Approach—Embarcadero Technologies Acquisition 10%. The Income Approach was given significant weight because it represented the amount a prudent investor would pay for our expected future cash flows based on the then current market rates of return and our specific risks. The Market Approach—Public Company method was given some weight because it represented the value investors were then paying for reasonably similar public companies that represented alternative investment opportunities. The Market Approach—M&A Transactions method was given little weight because the limited available data was determined to be a less reliable source of value. After arriving at a total equity value, a portion of that equity value was allocated to our common stock. Next, the valuation applied a minority discount of 10%, to account for the lack of control in a minority ownership interest, and a marketability discount of 30%, to account for the lack of liquidity found in a public market. Finally, the dilutive impact of outstanding options and warrants that were “in the money” were taken into consideration in arriving at the final fair market value per share.

For purposes of the June 2008 and July 2008 stock option grants, our board of directors determined that there had been no significant change in our business or industry that would warrant a higher valuation than the fair value of our common stock determined in April 2008, and continued to grant stock options with an exercise price significantly higher than the fair value as reflected in the December 31, 2007 valuation.

October 1, October 28 and December 10, 2008

The stock options granted on these dates had an exercise price of $0.65 per share. For the grant on October 1, 2008, our board of directors determined this price taking into account the third-party valuation of our common stock performed as of June 30, 2008, which estimated that the fair value of our common stock at that time was $0.44 per share. To establish the exercise price, our board of directors adjusted this number upward to increase the exercise price over the exercise price of the most recent prior grants by an amount roughly proportionate to the increase in the fair market value of the common stock from the previous third party valuation. In the June 2008 valuation, under the Income Approach, a discount rate of 18.8% and a capitalization rate of 11.3% were applied. Under the Market Approach-Public Company method, an adjusted multiple of total equity to projected earnings of 17.67 was applied. Adjusted multiples of market value of invested capital to revenue, projected revenue and projected EBITDA of 1.52, 1.42 and 6.10, respectively, were also applied. Under the Market Approach—M&A Transactions method, an adjusted multiple of total equity value to gross cash flow of 11.79 was applied. Adjusted multiples of market value of invested capital to revenue, EBITDA and EBIT of 2.59, 12.70 and 18.39, respectively, were also applied. In evaluating the Embarcadero M&A transaction, an adjusted multiple of total equity value to gross cash flow of 23.60 was applied. Adjusted multiples of market value of invested capital to revenue, EBITDA and EBIT of 3.24, 25.47 and 36.31, respectively, were also applied.

 

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In the June 2008 valuation, the various valuation approaches were given the following weight: Income Approach 55%, Market Approach—Publicly Traded Companies 25%, Market Approach—M&A Transactions 15% and Market Approach—Embarcadero Technologies Acquisition 5%. The total equity value was then allocated to the preferred stock, common stock, warrants and stock options using the option-pricing methodology and a marketability discount of 28.3% was applied. The allocation of more than a majority of the weight to the Income Approach reflects an assumption that the potential for a liquidity event was more than several years away. The fair market value increased, however, primarily as a result of the increase in our revenue.

For purposes of the stock option grants made on October 28, 2008 and the stock option grants made on December 10, 2008 (on which latter date the board of directors did not specify fair market value but determined that the fair market value was no greater than $0.65 per share), our board of directors did not identify any significant change in our business or industry that would warrant a higher valuation than the fair value of our common stock as of June 30, 2008, and continued to grant stock options with an exercise price significantly higher than the fair value as reflected in the June 30, 2008 valuation.

April 15, June 17 and July 23, 2009

The stock options granted on these dates had an exercise price of $0.65 per share. Our board of directors determined this price taking into account the third-party valuation of our common stock performed as of December 31, 2008, which estimated that the fair value of our common stock at that time was $0.44 per share, approximately equal to the valuation as of June 30, 2008. In the December 2008 valuation, under the Income Approach, a discount rate of 16.7% and a capitalization rate of 10.2% were applied. Under the Market Approach-Public Company method, multiples of total equity to projected earnings and gross cash flow of 14.67 and 23.48, respectively, were applied. Adjusted multiples of market value of invested capital to revenue, projected revenue and projected EBITDA of 1.84, 1.62 and 12.23, respectively, were also applied. Under the Market Approach—M&A Transactions method, an adjusted multiple of total equity value to gross cash flow of 11.19 was applied. Adjusted multiples of market value of invested capital to revenue, EBITDA and EBIT of 2.55, 13.42 and 17.79, respectively, were also applied. In addition to considering the Embarcadero acquisition referenced in prior valuations, the December 31, 2008 third-party valuation also considered the November 2008 acquisition of Secure Computing Corp. by McAfee, Inc. Secure Computing Corp. operated a business similar to our business and had been used as a guideline company in previous valuations of our company. In evaluating the specified M&A transactions, an adjusted multiple of total equity value to gross cash flow of 24.09 wa