-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QBPWtcy9++PUyGjwMgdxjVeGqAl5UczQspTZx6neLZHoX+IalQJwBOZWR9oXskPc TzX2NcLzOuwnVpOhimHfIQ== 0000950144-99-000731.txt : 19990201 0000950144-99-000731.hdr.sgml : 19990201 ACCESSION NUMBER: 0000950144-99-000731 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 19990129 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ISS GROUP INC CENTRAL INDEX KEY: 0001053148 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 582362189 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-71471 FILM NUMBER: 99517281 BUSINESS ADDRESS: STREET 1: 6600 PEACHTREE DUNWOODY RD STREET 2: BLDG 300 SUITE 500 CITY: ATLANTA STATE: GA ZIP: 30328 BUSINESS PHONE: 6784436000 S-1 1 ISS GROUP, INC. 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 29, 1999. REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ---------------------- ISS GROUP, INC. (Exact name of registrant as specified in its charter) DELAWARE 7372 58-2362189 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation or organization) Classification Code Number) Identification Number)
6600 PEACHTREE-DUNWOODY ROAD 300 EMBASSY ROW, SUITE 500 ATLANTA, GEORGIA 30328 (678) 443-6000 (Address, including zip code, and telephone number, including area code, of the registrant's principal executive offices) ---------------------- THOMAS E. NOONAN CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER ISS GROUP, INC. 6600 PEACHTREE-DUNWOODY ROAD 300 EMBASSY ROW, SUITE 500 ATLANTA, GEORGIA 30328 TELEPHONE: (678) 443-6000 FACSIMILE: (678) 443-6477 (Name, address, including zip code, and telephone number, including area code, of agent for service) COPIES TO: CARMELO M. GORDIAN, P.C. KEITH F. HIGGINS, ESQ. S. MICHAEL DUNN, P.C. CHRISTOPHER J. AUSTIN, ESQ. BROBECK, PHLEGER & HARRISON LLP ROPES & GRAY 301 CONGRESS AVENUE, SUITE 1200 ONE INTERNATIONAL PLACE AUSTIN, TEXAS 78701 BOSTON, MASSACHUSETTS 02110 TELEPHONE: (512) 477-5495 TELEPHONE: (617) 951-7000 FACSIMILE: (512) 477-5813 FACSIMILE: (617) 951-7050
---------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. 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, as amended, 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, please 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, 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, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] --------------- If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] CALCULATION OF REGISTRATION FEE
- ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- PROPOSED MAXIMUM PROPOSED MAXIMUM TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE AMOUNT OF SECURITIES TO BE REGISTERED BE REGISTERED (1) PER SHARE(2)(3) OFFERING PRICE(2) REGISTRATION FEE - ------------------------------------------------------------------------------------------------------------------------------- Common Stock, $0.001 par value............. 2,760,000 shares $60.44 $166,814,400 $46,375 - ------------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------------
(1) Includes 375,000 shares that the Underwriters have the option to purchase to cover over-allotments, if any. (2) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(a). (3) A portion of the shares to be registered represents shares that are to be offered outside the United States but that may be resold from time to time in the United States. Such shares are not being registered for the purposes of sales outside the United States. 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 THAT SPECIFICALLY STATES THAT THIS REGISTRANT STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SUCH SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED WITH SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PRELIMINARY PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. SUBJECT TO COMPLETION. DATED JANUARY 29, 1999. 2,400,000 Shares (ISS Logo) ISS GROUP, INC. Common Stock ---------------------- This is an offering of shares of common stock of ISS Group, Inc. This prospectus relates to an offering of 1,920,000 shares in the United States. In addition, 480,000 shares are being offered outside the United States in an international offering. ISS Group is offering 1,200,000 shares to be sold in the offering. The selling stockholders identified in this prospectus are offering an additional 1,200,000 shares. ISS Group will not receive any of the proceeds from the sale of the shares sold by the selling stockholders. The common stock is traded on the Nasdaq National Market under the symbol "ISSX". On January 28, 1999, the last reported sale price for our common stock on the Nasdaq National Market was $62.94 per share. See "Risk Factors" beginning on page 3 to read about certain factors you should consider before buying shares of the common stock. ---------------------- NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ----------------------
Per Share Total --------- ----- Initial public offering price............................... $ $ Underwriting discount....................................... $ $ Proceeds, before expenses, to ISS Group..................... $ $ Proceeds to the selling stockholders........................ $ $
The U.S. underwriters may, under certain circumstances, purchase up to an additional 288,000 shares from ISS Group and the selling stockholders at the initial public offering price less the underwriting discount. The international underwriters may similarly purchase up to an aggregate of an additional 72,000 shares. ---------------------- The underwriters expect to deliver the shares against payment in New York, New York on , 1999. GOLDMAN, SACHS & CO. DAIN RAUSCHER WESSELS A DIVISION OF DAIN RAUSCHER INCORPORATED WARBURG DILLON READ LLC BANCBOSTON ROBERTSON STEPHENS ---------------------- Prospectus dated , 1999. 3 ---------------------- TABLE OF CONTENTS
Page ---- Prospectus Summary...................... 1 Risk Factors............................ 3 Use of Proceeds......................... 12 Price Range of Common Stock............. 12 Dividend Policy......................... 12 Capitalization.......................... 13 Dilution................................ 14 Selected Consolidated Financial Data.... 15 Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 16 Business................................ 24 Management.............................. 43 Certain Transactions.................... 52 Principal and Selling Stockholders...... 54 Description of Securities............... 56 Shares Eligible for Future Sale......... 60 Validity of Common Stock................ 62 Experts................................. 62 Additional Information.................. 62 Index to Consolidated Financial Statements............................ F-1 Underwriting............................ U-1
4 [Inside Front Cover of Prospectus] Picture headed "Adaptive Network Security Process" depicts a large circle with three arrows linked together to form the circle. One arrow states the term "monitor", the second arrow states the term "detect" and the third arrow states the term "respond". In the center of this circle is the phrase "Enterprise Security Policy". In the upper right hand section of the graphic outside of the "monitor" section of the circle are the terms "Applications", "Databases", "Operating Systems" and "Networks". In the lower right hand section of the graphic outside of the "detect" section of the circle are the terms "Policy Violations", "Vulnerabilities" and "Threats". In the left hand section of the graphic outside of the "respond" section of the circle are the terms "Alarms", "Corrective Action", "Active Response" and "Actionable Information". At the lower far right hand corner of the graphic is the ISS logo and the terms "ISS Internet Security Systems." Our trademarks include Database Scanner, Firewall Scanner, Internet Scanner, Internet Security Systems, ISS, RealSecure, RealSecure Agents, RealSecure Engine, RealSecure Manager, SAFEsuite, SAFEsuite Decisions, System Scanner, Web Security Scanner and the ISS logo. All other trademarks or trade names referred to in this Prospectus are the property of their respective owners. 5 PROSPECTUS SUMMARY You should read the following summary together with the more detailed information and consolidated financial statements and related notes appearing elsewhere in this prospectus. Unless otherwise indicated, all information in this prospectus, including share and per share information, assumes neither the exercise of stock options after December 31, 1998 nor the exercise of the underwriters' over-allotment option. ISS GROUP, INC. We are a leading provider of network security monitoring, detection and response solutions that protect the security and integrity of enterprise information systems. Our SAFEsuite family of products protects distributed computing environments, such as internal corporate networks, inter-company networks and the Internet, from attacks, misuse and security policy violations. Our innovative Adaptive Network Security approach uses continuous security risk monitoring and response to develop and enforce an active network security policy. We also offer professional services that enable us to deliver comprehensive solutions to our customers. The proliferation and growth of corporate intranets and the growth of electronic commerce have dramatically increased the use and openness of computer networks. Their accessibility and the relative anonymity of users make these systems, and the integrity of the information that is stored on them, vulnerable to security threats. As a result, security breaches of corporate networks have been increasing in recent years. According to the annual Information Week/PricewaterhouseCoopers LLP 1998 Global Information Security Survey of information technology managers and professionals, 59% of those surveyed who are associated with sites selling products or services on the Web reported at least one security breach in the past year. In a separate PricewaterhouseCoopers LLP 1998 survey of chief executive officers, 84% cited security concerns as a barrier to deployment of information technology initiatives. Because of the complexity of vulnerabilities in open systems and the pervasiveness of the threats to such systems, many organizations seek out a trusted security advisor to assist them in developing effective security policies and managing their information risks. We pioneered the technology for vulnerability and threat detection and we believe that we have the most comprehensive vulnerability and threat database in existence. Over 3,000 organizations worldwide, including firms in the Global 2000, U.S. and international government agencies and major universities, have licensed our products. Twenty-one of the 25 largest commercial banks in the United States, as ranked by Fortune Magazine, also have licensed our products. Our principal executive offices are located at 6600 Peachtree-Dunwoody Road, 300 Embassy Row, Suite 500, Atlanta, Georgia 30328, and our telephone number is (678) 443-6000. Our address on the World Wide Web is "www.iss.net". This prospectus does not incorporate by reference the information on our Web site. 1 6 THE OFFERING The following information assumes that the underwriters do not exercise their options to purchase additional shares in the offering from us or the selling stockholders. This information is based on shares of common stock outstanding as of December 31, 1998, and excludes 2,379,670 shares of common stock issuable upon the exercise of stock options outstanding as of December 31, 1998. Common stock offered by ISS Group......................... 1,200,000 shares Common stock offered by selling stockholders.............. 1,200,000 shares Common stock to be outstanding after the offering......... 18,512,462 shares Nasdaq National Market symbol............................. ISSX Use of proceeds........................................... For general corporate purposes, including working capital and possible acquisitions. See "Use of Proceeds".
SUMMARY CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
APRIL 19, 1994 (INCEPTION) THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, ------------------------------------- 1994 1995 1996 1997 1998 -------------- ------- ------- ------- ------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues........................................... $ 38 $ 257 $ 4,462 $13,467 $35,929 Operating income (loss)............................ 20 (140) (1,205) (4,147) (6,406) Net income (loss).................................. 20 (140) (1,131) (3,919) (4,102) Basic and diluted net loss per share............... $ -- $ (0.03) $ (0.14) $ (0.50) $ (0.28) Weighted average shares used in basic and diluted net loss per share calculation................... 4,586 5,001 7,916 7,907 14,883
DECEMBER 31, 1998 --------------------------- ACTUAL AS ADJUSTED(1) ---------- -------------- CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents................................... $52,632 $123,972 Working capital............................................. 54,389 125,729 Total assets................................................ 78,021 149,361 Stockholders' equity........................................ 66,315 137,655
- --------------- (1) As adjusted to reflect the application of the net proceeds from the sale of the common stock in this offering at an assumed public offering price of $62.94 per share and after deducting the underwriting discount and estimated offering expenses. See "Use of Proceeds". 2 7 RISK FACTORS You should carefully consider the risks described below before you decide to buy our common stock. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties may also adversely impair our business operations. If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment. This prospectus contains forward-looking statements based on our current expectations, assumptions, estimates and projections about ISS and our industry. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those anticipated in such forward-looking statements as a result of certain factors, as more fully described in this section and elsewhere in this prospectus. We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. WE ARE A YOUNG COMPANY THAT HAS NEVER BEEN PROFITABLE We were incorporated in April 1994 and have never achieved profitability. Although our losses have narrowed recently, we cannot be certain that we will become profitable in the future. Even if we become profitable at some point in the future, we cannot be certain that we can sustain such profitability. You should be aware that we have only a limited operating history upon which to evaluate our business and prospects. In deciding to purchase our shares, you must consider the risks, expenses and difficulties frequently encountered by companies that are, like us, in their early stage of development and that depend upon new and rapidly evolving markets. In order to address these risks, we must, among other things: - - respond to competitive developments; - - continue to upgrade and expand our product and services offerings; and - - continue to attract, retain and motivate our employees. We cannot be certain that we will successfully address these risks. OUR FUTURE OPERATING RESULTS WILL FLUCTUATE SIGNIFICANTLY As a result of our limited operating history, we cannot predict our future revenues and operating results. However, we do expect our future revenues and operating results to fluctuate due to a combination of factors, including: - - the growth of private Internet-based networks (often referred to as intranets); - - the extent to which the public perceives that unauthorized access to and use of online information is a threat to network security; - - the volume and timing of orders, including seasonal trends in customer purchasing; - - our ability to develop new and enhanced products and expand our professional services; - - the growth in the acceptance of, and activity on, the Internet and the World Wide Web, particularly by corporate, institutional and government users; - - customer budgets which may limit their ability to purchase our products; - - foreign currency exchange rates that affect our international operations; - - the mix of distribution channels through which we sell our products; - - product and price competition in our markets; and - - general economic conditions, both domestically and in our foreign markets. We increasingly focus our efforts on sales of enterprise-wide security solutions, which consist of our entire product suite and related professional services, rather than on 3 8 the sale of component products. As a result, we expect that each sale may require additional time and effort from our sales staff. In addition, the revenues associated with particular sales vary significantly depending on the number of products licensed by a customer, the number of devices used by the customer and the customer's relative need for our professional services. Large individual sales, or even small delays in customer orders, can cause significant variation in our license revenues and results of operations for a particular period. The timing of large orders is usually difficult to predict and, like many software companies, our customers typically license most of our products in the last month of a quarter. Our future operating expenses are expected to increase in future periods as we intend to: - - expand our domestic and international sales and marketing operations; - - increase our investments in product development and our proprietary threat and vulnerability database; - - expand our professional services capabilities; - - seek acquisition candidates that will enhance our products and market share; and - - improve our internal operating and financial systems. We cannot predict our operating expenses based on our past results. Instead, we establish our spending levels based in large part on our expected future revenues. As a result, if our actual revenues in any future period fall below our expectations, our operating results likely will be adversely affected because very few of our expenses vary with our revenues. Because of the factors listed above, we believe that our quarterly and annual revenues, expenses and operating results likely will vary significantly in the future. Accordingly, period-to-period comparisons of our results of operations are not necessarily meaningful, and investors in our common stock should not rely upon them as indications of our future performance. For these and other reasons, our operating results may fall below market analysts' expectations, which, in turn, could cause the market price of our common stock to decline, and perhaps decline significantly. WE FACE INTENSE COMPETITION IN OUR MARKET The market for network security monitoring, detection and response solutions is intensely competitive, and we expect competition to increase in the future. We cannot guarantee that we will compete successfully against our current or potential competitors, especially those with significantly greater financial resources or brand name recognition. Our chief competitors generally fall within one of four categories: - - internal information technology departments of our customers and the consulting firms that assist them in formulating security systems; - - relatively smaller software companies offering relatively limited applications for network and Internet security; - - large companies, including Axent Technologies, Cisco Systems and Network Associates, that sell competitive products, as well as other large software companies that have the technical capability and resources to develop competitive products; and - - software or hardware companies that could integrate features that are similar to our products into their own products. Mergers or consolidations among these competitors, or acquisitions of small competitors by larger companies, would make such combined entities more formidable competitors to us. In the last 18 months, both Cisco Systems and Network Associates have acquired privately-held companies with products competitive to ours. Large companies may have advantages over us because of their longer operating histories, greater name recognition, larger customer bases or greater financial, technical and marketing resources. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. They can also devote 4 9 greater resources to the promotion and sale of their products than we can. In addition, these companies have reduced, and could continue to reduce, the price of their security monitoring, detection and response products, which increases pricing pressures within our market. In addition, large companies with broad product offerings, such as Network Associates, have bundled their security products with their other products, and we expect them to continue to do so in the future, which makes it more difficult for us to compete with them. These companies may develop security monitoring, detection and response products that are better than our current or future products and this may render our products obsolete. Several companies currently sell software products (such as encryption, firewall, operating system security and virus detection software) that our customers and potential customers have broadly adopted. Some of these companies sell products which perform the same functions as some of our products. In addition, vendors of operating system software or networking hardware may enhance their products to include the same kinds of functions that our products currently provide. The widespread inclusion of comparable features to our software in operating system software or networking hardware could render our products obsolete, particularly if such features are of a high quality. Even if security functions integrated into operating system software or networking hardware are more limited than those of our software, a significant number of customers may accept more limited functionality to avoid purchasing additional software. For the above reasons, we may not be able to compete successfully against our current and future competitors. Increased competition may result in price reductions, reduced gross margins and loss of market share, any one of which could materially and adversely affect our business, operating results and financial condition. See "Business -- Competition" for detailed information about our competition. WE FACE RAPID TECHNOLOGICAL CHANGE IN OUR INDUSTRY AND FREQUENT INTRODUCTIONS OF NEW PRODUCTS Rapid changes in technology pose significant risks to us. We do not control nor can we influence the forces behind these changes, which include: - - the extent to which businesses and others seek to establish more secure networks; - - the extent to which hackers and others seek to compromise secure systems; - - evolving computer hardware and software standards; - - changing customer requirements; and - - frequent introductions of new products and product enhancements. To remain successful, we must continue to change, adapt and improve our products in response to these and other changes in technology. Our future success hinges on our ability to both continue to enhance our current line of products and professional services and to introduce new products that address and respond to innovations in computer hacking, computer technology and customer requirements. We cannot be sure that we will successfully develop and market new products that do this. Any failure by us to timely develop and introduce new products, to enhance our current products or to expand our professional services capabilities in response to these changes could adversely affect our business, operating results and financial condition. Our products involve very complex technology, and as a consequence, major new products and product enhancements require a long time to develop and test before going to market. Because this amount of time is difficult to estimate, we have had to delay the scheduled introduction of new and enhanced products in the past and may have to delay the introduction of new products and product enhancements in the future. The techniques computer hackers use to gain unauthorized access to or to sabotage networks and intranets are constantly evolving and increasingly sophisticated. 5 10 Furthermore, because new hacking techniques are usually not recognized until used against one or more targets, we are unable to anticipate most new hacking techniques. To the extent that new hacking techniques harm our customers' computer systems or businesses, affected customers may believe that our products are ineffective, which may cause them or prospective customers to reduce or avoid purchases of our products. In such event, we may lose customer goodwill, which could adversely affect our business. WE MUST EFFECTIVELY MANAGE OUR RAPID GROWTH Our business has grown rapidly in the last three years, with total revenues increasing from $4.5 million in 1996 to $35.9 million in 1998. During this period, our workforce has also rapidly expanded, increasing from seven employees in January 1996 to 328 in December 1998. This growth has strained, and if continued, will further strain our management resources and systems. We intend to continue to expand both our business and workforce for the foreseeable future to pursue existing and potential market opportunities. However, if the market for our solutions fails to grow or grows more slowly than we currently anticipate, our business, operating results and financial condition would be materially and adversely affected. In addition, our ability to manage future growth will require us to continually improve our financial and management controls, reporting systems and procedures, to implement new systems as necessary and to expand, train and manage our employees. We cannot assure investors in our common stock that we will be able to manage successfully any future expansion. Our inability to do so would materially and adversely affect our business, operating results and financial condition. RISKS ASSOCIATED WITH OUR GLOBAL OPERATIONS We have derived approximately 21% and 19% of our total revenues from sales to customers outside of North America in 1997 and 1998, respectively. The expansion of our international operations includes the maintenance of sales offices in dispersed locations throughout the world, including throughout Europe and the Asia/Pacific and Latin America regions. Our international presence and expansion exposes us to risks not present in our U.S. operations, such as: - - the difficulty in managing an organization spread over various countries located across the world; - - unexpected changes in regulatory requirements in countries where we do business; - - excess taxation due to overlapping tax structures; - - fluctuations in foreign currency exchange rates, which may be aggravated in European markets by the recent introduction of the Euro currency; - - import and export licensing requirements; - - trade restrictions; - - changes in tariff and freight rates; and - - depressed regional and economic conditions, such as those currently affecting many regions in Asian markets. Despite these risks, we believe that we must continue to expand our operations in international markets to support our growth. To this end, we intend to establish additional foreign sales operations, expand our existing offices, hire additional personnel, expand our international sales channels and customize our products for local markets. If we fail to execute this strategy, our international sales growth will be limited, which, in turn, could materially and adversely affect our business, operating results and financial condition. To date, we have primarily denominated our revenues from international operations in United States dollars; however, we will increasingly denominate sales in local foreign currencies in the future. An increase in the 6 11 value of the United States dollar relative to foreign currencies would make our products more expensive and, therefore, potentially less competitive in foreign markets. In addition, even if we successfully expand our international operations, we may not be able to maintain or increase international market demand for our products. WE INCREASINGLY RELY ON INDIRECT DISTRIBUTION CHANNELS Although our direct sales have accounted for a majority of our revenues in 1998, we expect to continue to license a significant percentage of our products to end users through indirect distribution channels in the future. Our indirect distribution channel partners include: - - original equipment manufacturers that bundle our products with products that they sell to their customers; - - managed service providers, such as telecommunications companies and Internet service providers, that host networking and Internet operations for business customers; and - - consultants and systems integrators that incorporate our products into customized solutions that they have implemented for their customers. We have established our relationships with many of our channel partners only within the last three years. We cannot predict whether our channel partners will continue to market and sell our products successfully. We have little or no control over the manner in which our channel partners sell our products or integrate our products with their own products or solutions. In addition, many of our channel partners also market and sell our competitors' products. While no one channel partner accounted for more than 10% of our consolidated revenues in 1998, a loss of several of our major channel partners without replacement would adversely affect our business, operating results and financial condition. Our future performance will also depend, in part, on our ability to attract new channel partners to market and support our products effectively, especially in new markets. We cannot assure you that revenue from channel partners that accounted for significant revenues in past periods will continue or, if continued, will reach or exceed past performance levels. In addition, we often depend upon our channel partners to install and support our products for end users. If our channel partners fail to provide adequate installation and support, end users of our products could cease using, or improperly implement and operate, our products. Such a failure could substantially increase our customer support costs and materially and adversely affect our business, operating results and financial condition. POTENTIAL FUTURE ACQUISITIONS OR INVESTMENTS As part of our growth strategy, we have acquired, and may continue to acquire or make investments in, companies with products, technologies or professional services capabilities complementary to our solutions. In acquiring companies in the future, we could encounter difficulties in assimilating their personnel and operations into our company. These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. These difficulties could also include accounting requirements, such as amortization of goodwill or in-process research and development expense. We cannot be certain that we will successfully overcome these risks with respect to any future acquisitions or that we will not encounter other problems in connection with our prior or any future acquisitions. In addition, any future acquisitions may require us to incur debt or issue equity securities. The issuance of equity securities could dilute the investment of our existing stockholders. WE DEPEND ON OUR KEY PERSONNEL We rely, and will continue to rely, on our senior executive officers and other key management personnel, especially Thomas E. Noonan (our Chairman of the Board, President and Chief Executive Officer) and Christopher Klaus (our founder and Chief Technology Officer). We do not have an 7 12 employment agreement with either Mr. Noonan or Mr. Klaus. A departure by either of these individuals or any of our other key employees could significantly diminish our level of management, technical, marketing and sales expertise and we would need to find replacements who have these skills. We believe that hiring replacements for key personnel, if necessary, will be difficult. Our future success also depends on our continuing ability to attract and retain highly qualified engineers, managers and sales and professional services personnel. The competition for employees at all levels of the software industry, especially those with experience in the relatively new discipline of security software, is increasingly intense. If we do not succeed in attracting new employees or retaining and motivating our current employees, our business could suffer significantly. WE DEPEND ON OUR INTELLECTUAL PROPERTY RIGHTS AND USE LICENSED TECHNOLOGY We rely primarily on copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. We also believe that the technological and creative skills of our personnel, new product developments, frequent product enhancements, our name recognition, our professional services capabilities and delivery of reliable product maintenance are essential to establishing and maintaining our technology leadership position. We cannot assure you that our competitors will not independently develop technologies that are similar to ours. We seek to protect our software, documentation and other written materials under the trade secret and copyright laws, which afford only limited protection. We have also submitted two United States patent applications. Patents may not issue from these applications or, if issued, may not provide any meaningful competitive advantages to us. We generally license our products to end users in a machine-readable format. However, certain customers have required us to place the source code for our products in an escrow account with a third-party software escrow agent. Under these escrow arrangements, our insolvency or our failure to perform our obligations under certain license and maintenance agreements could cause the release of our source code to such customers. Such an event could significantly compromise our ability to protect the use of our software by our competitors or potential competitors. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult. While we cannot determine the extent to which piracy of our software products occurs, we expect software piracy to be a persistent problem. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States and many foreign countries do not enforce these laws as diligently as U.S. government agencies and private parties. We are not aware that any of our products infringes the proprietary rights of others, but it is conceivable that our current or future products may infringe the proprietary rights of others. In fact, in July 1998 Network Associates, which is one of our competitors, filed a lawsuit against us alleging that our RealSecure product violates a patent claim for intrusion detection technology held by Network Associates. We believe that the lawsuit is without merit and are vigorously defending against Network Associates' claims. However, should Network Associates prevail in the suit, it could materially and adversely affect our business, operating results and financial condition. We expect the number of intellectual property infringement lawsuits against software companies to increase. Any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements may not be made available on terms acceptable to us, which could materially and adversely affect 8 13 our business, operating results and financial condition. WE LACK CERTAIN TRADEMARK PROTECTION We currently cannot obtain trademark protection on the name "Internet Security Systems" due to its general use in a variety of security-related applications. We have in the past asserted and intend to continue to assert our rights to the name "Internet Security Systems". In addition, we have in the past taken and will continue to take action against any use of that name in a manner that may create confusion for our products in our current or future markets. However, we may not be successful in these efforts, which could have a material adverse effect upon our business, operating results and financial condition. WE FACE POTENTIAL PRODUCT LIABILITY EXPOSURE AND PRODUCT DEFECTS Many organizations use our products for critical functions of monitoring and enhancing network security. As a result, we risk product liability and related claims for our products if they do not adequately perform this function. In our licensing agreements, we typically seek to limit our liability for special, consequential or incidental damages, but these provisions may not in all cases be enforceable under applicable laws. In addition, we currently have $2.0 million of product liability insurance coverage that, subject to customary exclusions, covers claims resulting from failure of our products or services to perform their intended function or to serve their intended purpose. A product liability claim, to the extent not covered by our insurance, could materially and adversely affect our business, operating results and financial condition. Complex software products such as ours may contain undetected "bugs" that, despite our testing, are discovered only after installation and use by our customers. The occurrence of these bugs could result in adverse publicity, loss of or delay in market acceptance or claims by customers against us, any of which could have a material adverse effect upon our business, operating results and financial condition. Customers who deploy or use our products improperly or incompletely may experience temporary disruptions to their computer networking systems, which could damage our relationship with them and our reputation. Our current products may not be error-free and it is extremely doubtful that our future products will be error-free. Furthermore, computers are manufactured in a variety of different configurations with different operating systems (such as Windows, Unix, Macintosh and OS/2) and embedded software. As a result, it is very difficult to comprehensively test our software products for programming or compatibility errors. Errors in the performance of our products, whether due to our design or their compatibility with products of other companies, could hinder the acceptance of our products, which, in turn, would impair our business, operating results and financial condition. See "Business -- Products" and "-- Product Development". HACKERS MAY TARGET US As a producer of leading security software, we may represent an attractive target for hacker attacks. Should hackers infiltrate our internal network system and obtain sensitive data and information, or create bugs or viruses in an attempt to sabotage the functionality of our products, we may receive negative publicity, or incur direct damage to our systems or liability to our customers. We cannot guarantee our ability to respond to such attacks in a timely or effective manner and any failure to do so could materially and adversely affect our business, operating results and financial condition. GOVERNMENT MAY REGULATE OUR TECHNOLOGY EXPORTS Governments, including the United States government, from time to time have imposed controls, export license requirements and restrictions on the export of certain technology, especially encryption technology. Certain of our products incorporate advanced encryption technology and, as a consequence, we have been required to modify the relative sophistication of the 9 14 encryption technology used in these products in order to license them to customers in certain foreign markets. Our inability to export our domestic version of these products to such customers may reduce our competitiveness in such markets, which may adversely affect our sales. Moreover, any further expansion of export regulations would further restrict our ability to export our products, which may materially and adversely affect our business, operating results and financial condition. YEAR 2000 RISKS Many currently installed computer systems and software products accept only two-digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, computer systems and software used by many companies and governmental agencies may need to be upgraded to comply with such "Year 2000" requirements. Noncompliant computer systems or software may cause system failure or result in miscalculations that will cause disruptions of normal business activities. Although we have designed all of the products that we currently offer to be Year 2000 compliant, we cannot assure you that our products contain all necessary date code changes, or that, in the year 2000, our products will be compatible with third-party software that may be integrated or used in conjunction with our products. See "Management's Discussion and Analysis -- Year 2000". LIMITED PRIOR MARKET FOR OUR COMMON STOCK AND POSSIBLE VOLATILITY OF OUR STOCK PRICE Our common stock has only been publicly traded since our initial public offering on March 24, 1998. We cannot guarantee to purchasers of our shares that the market price of our common stock will be maintained after the offering or that the volume of trading in our shares will increase. The risks detailed in this Prospectus may significantly adversely affect the market price of our common stock after the offering by the risks detailed in this prospectus. In particular, the stock prices for many high technology companies, especially those that base their businesses on the Internet, recently have experienced wide fluctuations and extreme volatility which have often been unrelated to the operating performance of such companies. Such fluctuations have adversely affected and may in the future adversely affect the market price of our common stock. Furthermore, following periods of volatility in the market price of a company's securities, securities class action claims frequently are brought against the subject company. To the extent that the market price of our shares falls dramatically in any period of time, stockholders likely will bring claims, with or without merit, against us. Such litigation would be very expensive to defend and would divert management attention and resources regardless of outcome. ANTI-TAKEOVER PROVISIONS Our certificate of incorporation and bylaws contain the following provisions that may deter a takeover, including one on terms that many of our stockholders might consider favorable: - - authority of our board of directors to issue common stock and preferred stock and to determine the price, rights (including voting rights), preferences, privileges and restrictions of each series of preferred stock, without any vote or action by our stockholders; - - the existence of large amounts of authorized but unissued common stock and preferred stock; - - staggered, three-year terms for our board of directors; - - supermajority voting requirements to effect certain amendments to our certificate of incorporation and bylaws; - - limitations on who may call special meetings of stockholders; - - prohibition of stockholder action by written consent; and - - advance notice requirements for board of directors nominations and for stockholder proposals. 10 15 The rights and preferences of any series of preferred stock could include a preference over the common stock on the distribution of our assets upon a liquidation or sale of our company, preferential dividends, redemption rights, the right to elect one or more directors and other voting rights. The rights of the holders of any series of preferred stock that may be issued in the future may adversely affect the rights of the holders of the common stock . We have no current plans to issue preferred stock. In addition, certain provisions of Delaware law and our stock option plan may also discourage, delay or prevent a change in control of our company or unsolicited acquisition proposals. SHARES ELIGIBLE FOR FUTURE SALE AND REGISTRATION RIGHTS If our stockholders sell substantial amounts of common stock (including shares issued upon the exercise of outstanding stock options) in the public market following this offering, the market price of our common stock could fall. Such sales also could make it more difficult for us to sell equity or equity- related securities in the future at a time and price that we deem appropriate. Upon completion of this offering, we will have outstanding 18,512,462 shares of common stock (assuming no exercises of options after the date of this prospectus). Of these shares, the 3,450,000 shares sold in our initial public offering in March 1998, the 2,400,000 shares being offered hereby and 5,165,872 shares that have been sold pursuant to Rule 144 under the Securities Act of 1933, as amended, or that are eligible under paragraph (k) of that rule are freely tradeable. This leaves 7,496,590 shares eligible for sale in the public market as follows:
NUMBER OF SHARES DATE - ---------------- ---- 514,192............ At various times after the date of this prospectus pursuant to Rule 144 6,982,398............ At various times after 90 days from the date of this prospectus pursuant to Rule 144
In addition, we have registered for resale the 3,000,000 shares of our common stock reserved for issuance under our Restated 1995 Stock Incentive Plan, as well as 100,000 shares of common stock that were subject to options granted pursuant to written compensation agreements separate from the plan. As of December 31, 1998, options to purchase 244,643 shares of our common stock were outstanding and will be eligible for sale in the public market from time to time subject to vesting and, in the case of certain options, the expiration of 90-day lock-up agreements with the underwriters of this offering. These stock options generally have exercise prices significantly below the current price of our common stock. The possible sale of a significant number of these shares may cause the price of our common stock to fall. Certain stockholders, representing approximately 7,189,177 shares of common stock may have the right, subject to certain conditions, to include their shares in certain registration statements relating to our securities. By exercising their registration rights and causing a large number of shares to be registered and sold in the public market, these holders may cause the price of common stock to fall. In addition, any demand by holders of registration rights to include shares of common stock held by them in a registration initiated by us could adversely affect our ability to raise needed capital. See "Management -- Our Stock Option Plan", "Principal and Selling Stockholders", "Description of Securities -- Registration Rights", "Shares Eligible for Future Sale" and "Underwriting". BROAD DISCRETION IN USE OF PROCEEDS We have not yet decided how we will use the proceeds from this offering. Therefore, our management will retain broad discretion to allocate the net proceeds from this offering to uses with which our stockholders may not agree. We cannot assure you that any use of proceeds can or will yield a significant return. See "Use of Proceeds". 11 16 USE OF PROCEEDS Based on an assumed public offering price of $62.94 per share, we estimate that the net proceeds from our sale of shares of common stock in this offering will be approximately $71.3 million (approximately $91.1 million if the underwriters exercise their over-allotment option in full), after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any proceeds from the sale of common stock by the selling stockholders. We currently intend to use the net proceeds of this offering for working capital and general corporate purposes, including financing accounts receivable and funding capital expenditures made in the ordinary course of our business. We also may use a portion of the proceeds to fund possible acquisitions of businesses, products and technologies that are complementary to ours. Although we have no current agreements with respect to such transactions, we from time to time evaluate such acquisition opportunities and may engage in negotiations with respect to them. Pending such uses, we will invest the net proceeds from this offering in government securities and other short-term, investment-grade, interest-bearing instruments. PRICE RANGE OF COMMON STOCK The common stock has been quoted on the Nasdaq National Market under the symbol "ISSX" since our initial public offering on March 24, 1998. Prior to that offering there had been no public market for the common stock. The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock as reported on the Nasdaq National Market:
1998: HIGH LOW - ----- ------ ------ First Quarter (from March 24, 1998)..................... $41.50 $37.00 Second Quarter.......................................... 56.63 31.63 Third Quarter........................................... 50.50 25.38 Fourth Quarter.......................................... 60.63 17.00
On January 28, 1999, the last reported sale price of the common stock on the Nasdaq National Market was $62.94 per share. As of December 31, 1998, there were 201 holders of record of the common stock. DIVIDEND POLICY We have never declared or paid any cash dividends on our capital stock other than a $10,000 dividend paid in each of 1994 and 1995, and we do not intend to pay any cash dividends on our common stock in the foreseeable future. 12 17 CAPITALIZATION The table below sets forth our capitalization as of December 31, 1998 on an actual basis, and as adjusted to reflect our sale of 1,200,000 shares of common stock in the offering at an assumed public offering price of $62.94 per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us. This table should be read in conjunction with our consolidated financial statements and the other financial information included in this prospectus.
DECEMBER 31, 1998 --------------------- ACTUAL AS ADJUSTED ------- ----------- (IN THOUSANDS) Stockholders' equity: Preferred Stock, $0.001 par value, 20,000,000 shares authorized and none issued, actual and as adjusted..... $ -- $ -- Common Stock, $0.001 par value, 50,000,000 shares authorized; 17,292,087 shares issued and outstanding; 18,492,087 shares issued and outstanding as adjusted (1).................................................... 17 18 Additional paid-in capital................................ 76,110 147,449 Deferred compensation..................................... (662) (662) Cumulative adjustment for currency revaluation............ 142 142 Accumulated deficit....................................... (9,292) (9,292) ------- -------- Total stockholders' equity........................ 66,315 137,655 ------- -------- Total capitalization.............................. $66,315 $137,655 ======= ========
- --------------- (1) Excludes 2,379,670 shares of common stock issuable upon exercise of options outstanding as of December 31, 1998, with exercise prices ranging from $0.15 to $48.12 per share and with a weighted average exercise price of $10.98 per share. See "Management -- Our Stock Option Plan" and Note 5 of Notes to Consolidated Financial Statements. 13 18 DILUTION Our net tangible book value as of December 31, 1998 was $58.5 million, or $3.38 per share of common stock. Net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of our common stock outstanding. After giving effect to the sale of the 1,200,000 shares of common stock offered by us in this offering at an assumed public offering price of $62.94 per share and the application of the estimated net proceeds, our net tangible book value as of December 31, 1998 would have been $129.9 million, or $7.02 per share of common stock. This represents an immediate increase in the net tangible book value of $3.64 per share to our existing stockholders and an immediate dilution in the net tangible book value of $55.92 per share to new investors of common stock in this offering. The following table illustrates this per share dilution: Assumed public offering price per share..................... $62.94 ------ Net tangible book value per share as of December 31, 1998................................................... $3.38 Increase per share attributable to new investors.......... 3.64 ----- Net tangible book value per share after this offering....... 7.02 ------ Dilution per share to new investors......................... $55.92 ======
14 19 SELECTED CONSOLIDATED FINANCIAL DATA The financial data set forth below for each of the three years in the period ended December 31, 1998, and as of December 31, 1997 and 1998, has been derived from the audited consolidated financial statements appearing elsewhere in this prospectus and should be read in conjunction therewith. The financial data for the periods from inception (April 19, 1994) through December 31, 1994, for the year ended December 31, 1995, and as of December 31, 1994, 1995 and 1996, has been derived from audited financial statements not included in this prospectus. Historical results are not necessarily indicative of the results that may be expected in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations".
APRIL 19, 1994 (INCEPTION) THROUGH DECEMBER 31, YEAR ENDED DECEMBER 31, --------------- ------------------------------------------- 1994 1995 1996 1997 1998 --------------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues: Perpetual licenses............................. $ 38 $ 246 $ 4,233 $10,936 $25,936 Subscriptions.................................. -- -- 219 2,465 7,406 Professional services.......................... -- 11 10 66 2,587 ------ ------- ------- ------- ------- 38 257 4,462 13,467 35,929 Costs and expenses: Cost of revenues............................... -- 4 18 676 4,831 Research and development....................... 5 97 1,225 3,434 9,321 Charges for in-process research and development.................................. -- -- -- -- 802 Sales and marketing............................ 11 252 3,768 11,731 22,762 General and administrative..................... 2 44 656 1,773 4,389 Amortization................................... -- -- -- -- 230 ------ ------- ------- ------- ------- 18 397 5,667 17,614 42,335 ------ ------- ------- ------- ------- Operating income (loss).......................... 20 (140) (1,205) (4,147) (6,406) Interest income, net............................. -- -- 74 228 2,366 ------ ------- ------- ------- ------- Income (loss) before income taxes................ 20 (140) (1,131) (3,919) (4,040) Provision for income taxes....................... -- -- -- -- 62 ------ ------- ------- ------- ------- Net income (loss)................................ $ 20 $ (140) $(1,131) $(3,919) $(4,102) ------ ------- ------- ------- ------- Basic and diluted net loss per share(1).......... $ -- $ (0.03) $ (0.14) $ (0.50) $ (0.28) ====== ======= ======= ======= ======= Weighted average shares used in basic and diluted net loss per share calculation(2).............. 4,586 5,001 7,916 7,907 14,883 ====== ======= ======= ======= ======= Unaudited pro forma net loss per share(1)........ $ (0.29) $ (0.25) ======= ======= Unaudited weighted average shares used in unaudited pro forma net loss per share calculation(2)................................. 13,644 16,189 ======= =======
DECEMBER 31, --------------------------------------------------------------- 1994 1995 1996 1997 1998 ---- ------- ------- ------- ------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents........................ $ 9 $ 6 $ 2,007 $ 3,929 $52,632 Working capital (working capital deficit)........ 10 (26) 2,298 2,272 54,389 Total assets..................................... 10 176 4,380 9,866 78,021 Long-term debt, net of current portion........... -- -- 140 70 -- Redeemable, convertible preferred stock.......... -- -- 3,614 8,878 -- Stockholders' equity (deficit)................... 10 (7) (1,160) (5,058) 66,315
- --------------- (1) Computed on the basis described in Note 1 of Notes to Consolidated Financial Statements. (2) See Note 1 of Notes to Consolidated Financial Statements for the determination of shares used in computing basic and diluted net income per share. 15 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under "Risk Factors" and elsewhere in this prospectus. OVERVIEW We are the leading provider of network security monitoring, detection and response software that protects the security and integrity of enterprise information systems according to market share reports by the Aberdeen Group, Gartner Group and The Yankee Group. Our SAFEsuite family of products protects distributed computing environments, such as internal corporate networks, inter-company networks and the Internet, from attacks, misuse and security policy violations. Our business is focused on maintaining the latest security threat and vulnerability checks within our existing products, creating new products and providing technical and professional services that are consistent with our goal of providing enterprise solutions to address network security. We generate a substantial portion of our revenues from our SAFEsuite family of products in the form of perpetual licenses and subscriptions. We recognize perpetual license revenues upon delivery of software or, if the customer has evaluation software, delivery of the software key and issuance of the related license, assuming that no significant vendor obligations or customer acceptance rights exist. Where payment terms are extended over periods greater than 12 months, revenue is recognized as such amounts are billable. Annual renewable maintenance is a separate component of each perpetual license agreement with revenue recognized ratably over the maintenance term. Subscription revenues include maintenance and term licenses. Term licenses allow customers to use the product and receive maintenance coverage for a specified period, generally 12 months. We recognize revenues from each subscription agreement ratably over the subscription term. In 1998, training and implementation services represented an increasing portion of our revenues. These professional services, which typically are billed on a time-and-materials basis, assist in the successful deployment of our products within customer networks, the development of customers' security policies and the assessment of security policy decisions. We recognize professional services revenues as such services are performed. We believe that each of our current products and products in development, together with maintenance and professional services, will represent important sources of revenue in the future. Generally, we base our prices on the number of devices or engines being managed by the customer, scaled to provide discounts for either larger systems or the simultaneous license of several SAFEsuite products. We offer annual maintenance for a separate fee. Our customers virtually always purchase maintenance when they initially license a product. Maintenance fees generally equal 20% of the perpetual license fee. Maintenance packages typically include telephone support, product updates, access to our security advisory notices and error corrections. We recommend that our customers renew their maintenance contracts and, to date, most customers have done so. Because of the dynamic nature of vulnerabilities and threats to computer networks, we expect that a substantial majority of our customers will continue to renew their maintenance contracts. We sell our products and services primarily through our direct sales force and telephone sales operations, and we also sell through indirect sales channels, including resellers, security consultants, Internet service 16 21 providers, and other providers of network management services. We generate less revenue per license from indirect channels than direct sales, as we typically sell our products to channel partners at a 25% to 50% discount from list price. In addition, we have entered into several contracts with original equipment manufacturers, or OEMs, in 1998 that contemplate the incorporation of our products into their product offerings. We expect this OEM channel to be an additional important source of revenue for us in the future. We expense research and development costs as incurred. Although we have not capitalized any internal development costs under Statement of Financial Accounting Standards No. 86, we have capitalized core and developed technology assets in connection with two acquisitions that we completed in 1998. The primary assets acquired in these acquisitions were security assessment technologies for Windows NT, Unix and databases. While we expect the expansion of our product offerings to originate primarily from internal development, our strategy includes acquiring products and technologies that fit within our product strategy and that potentially accelerate the timing of the commercial introduction of such products and technologies as integrated components of our enterprise network security solutions. Our business has grown rapidly in the last three years, with total revenues increasing from $4.5 million in 1996 to $35.9 million in 1998. However, we have experienced net losses in each of these years and, as of December 31, 1998, had an accumulated deficit of $9.3 million. These losses resulted from significant costs incurred in the development and sale of our products and professional services. During this period, we went from seven employees at January 1, 1996 to 328 employees at December 31, 1998. We expect to expand our domestic and international sales and marketing operations, increase investment in product development and our proprietary threat and vulnerability database, seek acquisition candidates that will enhance our products and market share, and improve our internal operating and financial infrastructure in support of our strategic goals and objectives. All of these initiatives will increase operating expenses. As a result, while operating losses have narrowed over the course of 1998, we cannot be certain that we will become profitable in the future. Even if we become profitable in the future, we cannot be certain that we can sustain such profitability. Due to our fast growth over the past several years in an emerging market, period-to-period comparisons of our operating results are not meaningful. Although we recently have experienced significant revenue growth, we cannot assume that we can sustain such growth and, therefore, investors should not rely on our past growth as a predictor of future performance. Rather, our prospects must be considered in light of the risks and difficulties frequently encountered by companies in new and rapidly evolving markets. There can be no assurance that we will be successful in addressing such risks and difficulties. See "Risk Factors -- We Are a Young Company That Has Never Been Profitable", "-- Our Future Operating Results Will Fluctuate Significantly" and "-- We Must Effectively Manage Our Rapid Growth". 17 22 RESULTS OF OPERATIONS The following table sets forth our consolidated historical operating information, as a percentage of total revenues, for the periods indicated.
YEAR ENDED DECEMBER 31, ------------------------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: 1996 1997 1998 - ------------------------------------------ ----- ----- ----- Revenues: Perpetual licenses........................................ 94.9% 81.2% 72.2% Subscriptions............................................. 4.9 18.3 20.6 Professional services..................................... 0.2 0.5 7.2 ----- ----- ----- 100.0 100.0 100.0 Costs and expenses: Cost of revenues.......................................... 0.4 5.0 13.5 Research and development.................................. 27.5 25.5 25.9 Charges for in-process research and development........... -- -- 2.2 Sales and marketing....................................... 84.4 87.1 63.4 General and administrative................................ 14.7 13.2 12.2 Amortization.............................................. -- -- 0.6 ----- ----- ----- 127.0 130.8 117.8 ----- ----- ----- Operating loss.............................................. (27.0)% (30.8)% (17.8)% ===== ===== =====
REVENUES Our revenues increased from $4.5 million in 1996, to $13.5 million in 1997 and to $35.9 million in 1998. Revenues from perpetual licenses increased during these periods from $4.2 million in 1996, to $10.9 million in 1997 and to $25.9 million in 1998. Historically, we have generated most of our revenues from perpetual licenses, but perpetual license revenues have decreased as a percentage of total revenues from 95% in 1996, to 81% in 1997 and to 72% in 1998. Subscription revenues have increased substantially during these periods, from $219,000 in 1996, to $2.5 million in 1997 and to $7.4 million in 1998, representing 5%, 18% and 21%, respectively, of total revenues. We continue to diversify our mix of sales within the SAFEsuite family of products, especially due to the significant increases in the sale of licenses for RealSecure, our intrusion detection product. As a result, sales of licenses for our initial product, Internet Scanner, continued to grow in absolute dollars but decreased as a percentage of license revenues from 93% in 1996, to 57% in 1998, and to less than 45% of license revenues in the fourth quarter of 1998. With the continued introduction of new product offerings, both from internal development and acquisitions consummated in 1998, we expect this trend to continue. A key initiative in 1998 was to address the demand from customers for implementation, training and consulting services. As a result, professional services revenues increased from less than 1% of revenues in each of 1996 and 1997 to 7% of total revenues in 1998. Professional services revenues increased principally in the latter half of 1998 and comprised 12% of our total revenues in the fourth quarter of 1998. On a geographic basis, we derived the majority of our revenues from sales to customers within North America. However, international operations continue to contribute significantly to revenues. Sales to customers outside of North America represented 19% of our total revenues in 1998 compared with 21% in 1997 and 4% in 1996. No customer represented more than 10% of total revenues in any of these periods. COSTS AND EXPENSES COST OF REVENUES Cost of revenues includes packaging and distribution costs for our software licenses. Since we use the Internet to distribute product updates and keys necessary to 18 23 activate a customer's software, this is a minor cost. Cost of revenues also includes costs associated with a technical support group that provides assistance to maintenance customers. Finally, the category includes the costs we incur to provide professional services to customers. During the first half of 1998, we built up our professional services management team who then developed a billable consulting staff over the balance of the year. The growth in professional services has caused gross margin, represented by total revenues less cost of revenues expressed as a percentage of total revenues, to trend downward from 99% and 95% in 1996 and 1997, respectively, to 87% in 1998. We expect gross margin to settle at a few percentage points below the 1998 level. RESEARCH AND DEVELOPMENT Research and development expenses consist of salary and related costs of research and development personnel, including costs for employee benefits and depreciation of related computer equipment. Research and development expenses include costs associated with maintaining the "X-Force", a team composed of security experts dedicated to understanding new vulnerabilities and real-time threats and attacks and developing solutions to address these security issues. We continue to increase research and development expenditures because we regard primary research and product development as a requirement for retaining our leadership position in the market. We also increased the number of our development personnel as we expanded our suite of products, upgraded our existing products with enhanced functionality and began development efforts in connection with OEM arrangements that were executed in the last half of 1998 but for which no revenues have yet been generated. Accordingly, research and development expenses increased in absolute dollars from $1.2 million in 1996, to $3.4 million in 1997 and to $9.3 million in 1998. These costs remained at a relatively constant percentage of revenues, although we anticipate that this percentage will trend downward in future periods. We have reflected a charge of $802,000 in our 1998 statement of operations for identified in-process research and development in connection with our October 1998 acquisitions of two companies engaged in Windows NT, Unix and database security assessment technologies. The charge was based on a valuation of products under development using estimated future cash flows, reduced for the core technology component of such products and the percentage of product development remaining at the time of the acquisition. SALES AND MARKETING Sales and marketing expenses consist of salaries, travel expenses, commissions, advertising, maintenance of our Web site, trade show expenses, personnel recruiting costs and costs of marketing materials. Sales and marketing expenses were $3.8 million in 1996, $11.7 million in 1997 and $22.8 million in 1998. Sales and marketing expenses increased during these periods primarily from a significant increase in the number of regional United States sales locations and personnel, increased commissions commensurate with increased direct sales revenues and expanded international operations in Europe and the Asia/Pacific region. Sales and marketing expenses were 84% and 87% of our total revenues in 1996 and 1997, respectively, but decreased to 63% of revenues in 1998. This decrease occurred because we had employed a larger proportion of our sales force for a sufficient period of time to enable them to achieve greater levels of productivity. If we are able to maintain low rates of attrition within our sales force, we expect this trend to continue. GENERAL AND ADMINISTRATIVE General and administrative expenses of $656,000 in 1996, $1.8 million in 1997 and $4.4 million in 1998, represented approximately 15%, 13% and 12%, respectively, of our total revenues. General and administrative expenses consist of personnel-related costs for executive, administrative, finance and human resources, information systems and other support services and legal, accounting and other 19 24 professional services fees. During 1998, we upgraded our internal financial reporting and information systems, and we expect to continue to expend resources to enhance our management's ability to obtain and analyze information about our domestic and international operations. In addition, we incurred approximately $720,000 of amortization of deferred compensation in 1998, the majority of which is recorded in the general and administrative category. This charge is related to the valuation of stock options to employees and directors granted around the time of our initial public offering of our common stock in March 1998. INCOME TAXES No provision for federal or state income taxes has been recorded because we have experienced cumulative net losses since inception. We recorded a minor amount of income tax expense in 1998 related to our European operations. At December 31, 1998, we had net operating loss carryforwards of approximately $13.6 million for federal tax purposes which will expire, if not utilized, in 2011 through 2018. These carryforwards include $7.7 million related to exercises of stock options for which the income tax benefit, if realized, would increase additional paid-in-capital. We also had approximately $800,000 of net operating loss carryforwards related to certain foreign operations which will expire, if not utilized, in 2002 and 2003. We have not recognized any benefit from the future use of loss carryforwards for these periods or any other periods since inception because management's evaluation of all the available evidence in assessing realizability of the tax benefits of such loss carryforwards indicates that the underlying assumptions of future profitable operations contain risks that do not provide sufficient assurance to recognize such benefits currently. 20 25 QUARTERLY RESULTS OF OPERATIONS The following tables set forth certain unaudited consolidated quarterly statement of operations data for the eight quarters ended December 31, 1998, as well as such data expressed as a percentage of our total revenues for the periods indicated. This data has been derived from unaudited consolidated financial statements that, in our opinion, include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of such information when read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this prospectus. The operating results for any quarter are not necessarily indicative of results for any future period.
QUARTER ENDED ----------------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, 1997 1997 1997 1997 1998 1998 1998 1998 --------- --------- ---------- --------- --------- --------- ---------- --------- (IN THOUSANDS) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues: Perpetual licenses...... $1,872 $2,150 $ 2,767 $ 4,147 $ 4,875 $ 5,559 $ 6,596 $ 8,906 Subscriptions........... 349 513 691 912 1,169 1,487 2,152 2,598 Professional services... 4 8 15 39 29 285 682 1,591 --------- --------- ---------- --------- --------- --------- ---------- --------- 2,225 2,671 3,473 5,098 6,073 7,331 9,430 13,095 Costs and expenses: Cost of revenues........ 87 137 176 276 513 892 1,559 1,867 Research and development........... 493 569 895 1,477 1,636 1,832 2,541 3,312 Charge for in-process research and development........... -- -- -- -- -- -- -- 802 Sales and marketing..... 1,754 2,342 3,051 4,584 4,648 5,431 5,632 7,051 General and administrative........ 320 301 443 709 981 1,100 1,046 1,262 Amortization............ -- -- -- -- -- -- -- 230 --------- --------- ---------- --------- --------- --------- ---------- --------- 2,654 3,349 4,565 7,046 7,778 9,255 10,778 14,524 --------- --------- ---------- --------- --------- --------- ---------- --------- Operating loss............ (429) (678) (1,092) (1,948) (1,705) (1924) (1,348) (1,429) Interest income, net...... 35 68 66 59 66 841 765 694 --------- --------- ---------- --------- --------- --------- ---------- --------- Loss before income taxes................. (394) (610) (1,026) (1,889) (1,639) (1,083) (583) (735) Provision for income taxes................. -- -- -- -- -- -- -- 62 --------- --------- ---------- --------- --------- --------- ---------- --------- Net loss.................. $ (394) $ (610) $(1,026) $(1,889) $(1,639) $(1,083) $ (583) $ (797) ========= ========= ========== ========= ========= ========= ========== =========
QUARTER ENDED ----------------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, 1997 1997 1997 1997 1998 1998 1998 1998 --------- --------- ---------- --------- --------- --------- ---------- --------- AS A PERCENTAGE OF TOTAL REVENUES: Revenues: Perpetual licenses...... 84.1% 80.5% 79.7% 81.3% 80.3% 75.8% 70.0% 68.0% Subscriptions........... 15.7 19.2 19.9 17.9 19.2 20.3 22.8 19.8 Professional services... 0.2 0.3 0.4 0.8 0.5 3.9 7.2 12.2 --------- --------- ---------- --------- --------- --------- ---------- --------- 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Costs and expenses: Cost of revenues........ 3.9 5.1 5.1 5.4 8.5 12.2 16.5 14.3 Research and development........... 22.2 21.3 25.8 29.0 26.9 25.0 27.0 25.3 Charge for in-process research and development........... -- -- -- -- -- -- -- 6.1 Sales and marketing..... 78.8 87.7 87.8 89.9 76.5 74.1 59.7 53.8 General and administrative........ 14.4 11.3 12.7 13.9 16.2 15.0 11.1 9.6 Amortization............ -- -- -- -- -- -- -- 1.8 --------- --------- ---------- --------- --------- --------- ---------- --------- 119.3 125.4 131.4 138.2 128.1 126.2 114.3 110.9 Operating loss............ (19.3) (25.4) (31.4) (38.2) (28.1) (26.2) (14.3) (10.9) Net loss.................. (17.7)% (22.8)% (29.5)% (37.1)% (27.0)% (14.8)% (6.2)% (6.1)% ========= ========= ========== ========= ========= ========= ========== =========
21 26 As a result of our limited operating history, we are unable to predict our future revenues and operating results. See "Risk Factors -- Our Future Operating Results Will Fluctuate Significantly". LIQUIDITY AND CAPITAL RESOURCES We have financed our operations to date primarily through sales of our equity securities. The net proceeds of $61.5 million from our March 1998 initial public offering were the primary source of cash provided by financing activities in 1998. In February 1996 and February 1997, we received aggregate net proceeds of $8.9 million from the sale of our preferred stock, all of which automatically converted into common stock when we completed our initial public offering. Net cash used in operations of approximately $4.3 million in 1998 included $4.1 million of net loss. This loss, however, included $3.8 million of non-cash expense for depreciation of equipment, amortization of acquisition related intangibles and deferred compensation, and a charge for the write-off of acquired in-process research and development. The other use of cash in operations was working capital associated with our growth. An increase in accounts receivable of $8.1 million was only partially offset by an increase in deferred revenues of $4.5 million. Growth in annual maintenance contracts, the upfront billing of multi-year maintenance arrangements with certain customers and an increase in term licenses increased the deferred revenues balance. Our primary investing activity of 1998 was our acquisition of March Information Systems Limited and the technology assets of DbSecure. The $5.2 million cash component of these acquisitions included cash consideration and direct transaction costs. We also invested in equipment totaling $3.6 million in 1998 as we provided existing and new personnel with the computer hardware and software necessary to perform their job functions. This included engineering lab equipment, expanded information systems and a telephone switch installed in connection with our relocation to our new headquarters facilities. We expect a similar level of equipment investment in 1999, assuming continued growth in our number of employees. At December 31, 1998, we had $52.6 million of cash and cash equivalents, consisting primarily of money market accounts and short-term, commercial paper carrying the highest investment grade rating. We believe that these investments, together with the proceeds from this offering, will be sufficient to fund any operating losses and capital expenditures and meet our working capital needs for the foreseeable future. We currently intend to use the net proceeds of this offering for general corporate purposes, including possible acquisitions of or investments in businesses, products and technologies that are complementary to ours. Although we have not identified any specific businesses, products or technologies that we intend to acquire or invest in, and there are not any current agreements or negotiations with respect to any such transactions, from time to time we evaluate such opportunities. Pending such uses, we will invest the net proceeds in government securities and other short-term, investment-grade, interest-bearing instruments. YEAR 2000 We have reviewed our products and believe that they are designed to properly function through and beyond the year 2000. Furthermore, we only support the current and most recent prior version of our products. While we have conducted tests of our software and have informed our customers that our products are Year 2000 compliant, we cannot guarantee that our products, particularly when they incorporate third-party software, will contain all date code changes necessary to ensure Year 2000 compliance. In addition, we use several internal management and other information systems in the operation of our business. Since we have experienced most of our growth in systems and personnel since January 1, 1997, purchases and upgrades of systems have occurred principally during 1997 and 1998. Internal systems for financial, human resources and sales reporting, as well as 22 27 telephone, voice mail and other office support systems, have all been purchased during 1998 and are reflected either on the balance sheet as capital purchases or expensed under our standard policy. We used our best efforts to ensure that these new systems are Year 2000 compliant. We are in the process of contacting providers of various tools used in our product development process and the providers of desktop systems (primarily Microsoft) to determine that these recognized systems, such as Windows NT and Windows 95/98, will be Year 2000 compliant with appropriate fixes. We do not depend on any suppliers or manufacturers whose failure to be Year 2000 compliant would have any significant impact on our financial condition or results of operations. We expect to complete our Year 2000 project for these remaining items by the middle of 1999. We do not expect to expend any significant funds to correct Year 2000 issues. Any minor expenses will be funded through cash provided by operations. Based on available information, we do not believe we have any material exposure to significant business interruptions as a result of Year 2000 compliance issues, or that the cost of remedial actions will have a material adverse effect on our business, financial condition or results of operations. Accordingly, we have not adopted any formal contingency plan in the event we do not achieve Year 2000 compliance. 23 28 BUSINESS OVERVIEW We are the leading provider of monitoring, detection and response software that protects the security and integrity of enterprise information systems, according to market share reports by Aberdeen Group, Gartner Group and the Yankee Group. Our SAFEsuite family of products is designed to enforce "best practice" information risk management automatically across distributed computing environments. Our products use an innovative Adaptive Network Security, or ANS, approach that entails continuous security risk monitoring, detection and response to develop and enforce an active network security policy. In addition, we offer professional services which enable us to deliver comprehensive network and Internet security solutions to our customers. We pioneered the technology for vulnerability and threat detection through a dedicated security research and development team and we believe that we have the most comprehensive vulnerability and threat database in existence. We have licensed our network security solutions to over 3,000 organizations worldwide, including firms in the Global 2000, U.S. and international government agencies, and major universities. Twenty-one of the 25 largest commercial banks in the United States, as ranked by Fortune, have licensed our products. We also have established strategic relationships with industry leaders, including Check Point, GTE, IBM, MCI WorldCom, Microsoft and Nortel, to enable worldwide distribution of our core monitoring technology. INDUSTRY BACKGROUND Network computing has evolved from client/server-based local area networks to distributed computing environments based on the integration of inter-company wide area networks via the Internet. The proliferation and growth of corporate intranets and the increasing importance of electronic commerce have dramatically increased the openness of computer networks, with the Internet becoming a widely accepted platform for many business-to-business and direct-to-customer transactions. International Data Corporation ("IDC") estimates that the number of Internet users will grow from 97 million in 1998 to 320 million in 2002, and that the value of electronic commerce transactions will grow from $32 billion to $426 billion over the same period. Additionally, IDC estimates that the number of devices accessing the Web will increase from 120 million in 1998 to 515 million in 2002. To capitalize on these trends, organizations are increasingly connecting their enterprise networks to the Internet to facilitate and support strategic business objectives, including: - - electronic data interchange (EDI); - - supply chain systems integration; - - Web-based access to account information and delivery schedules; and - - secure messaging and online purchases and payments. With the increased use of the Internet by businesses and consumers, organizations increasingly network their key systems in order to reduce costs and increase revenues. For example, businesses can implement supply chain management applications through standards enabled by the Internet. To optimize the supply chain, businesses use the Internet to provide suppliers with access to sensitive internal information, such as engineering designs, product development plans, raw material inventories and product schedules. Organizations also strengthen their ties with customers through "corporate Internet portals" that provide comprehensive information for purchasing products, checking order status and managing customer billings. This increased level of access provided by open systems carries with it the risk of unauthorized access to and use of sensitive information or malicious disruptions of important information-exchange systems. THE NEED FOR NETWORK SECURITY Although open computing environments have many business advantages, their accessibility and the relative anonymity of users make these systems, and the integrity 24 29 of the information that is stored on them, vulnerable to security threats. Open systems present inviting opportunities for computer hackers, curious or disgruntled employees, contractors and competitors to compromise or destroy sensitive information within the system or to otherwise disrupt the normal operation of the system. In addition, open computing environments are complex and typically involve a variety of hardware, operating systems and applications supplied by a multitude of vendors, making these networks difficult to manage, monitor and protect from unauthorized access. Each new addition of operating system software, applications or hardware products to the distributed computing environment may introduce a vast number of new vulnerabilities and security risks. To adequately secure a network, information technology, or IT, managers must have the resources to not only correctly configure the security measures in each system, but also to understand the risks created by any change to existing systems on the network. This situation is made worse by the limited supply of personnel knowledgeable in information security issues. Executives must understand and manage the risks involved when integrating their systems with the systems of suppliers and customers to achieve strategic objectives. According to the annual Information Week/PricewaterhouseCoopers LLP 1998 Global Information Security Survey of IT managers and professionals, 59% of those surveyed who are associated with sites selling products or services on the Web reported at least one security breach in the past year. In addition, sites integrated with supply-chain network or enterprise resource planning applications reported security violations 10% more often than sites without such applications. In a separate PricewaterhouseCoopers 1998 survey of chief executive officers, 84% cited security concerns as a barrier to deployment of IT initiatives. Despite the convenience and the compelling economic incentives for the use of Internet-protocol networks, they cannot reach their full potential as a platform for global communication and commerce until organizations can implement an effective platform to manage information risk. Historically, organizations have responded to perceived security threats by implementing passive point tools, such as encryption, firewall, authentication and other technologies designed to protect individual components of their internal networks from unauthorized use or outside attacks. These technologies address some security concerns, but are often ineffective because: - - encryption protects information during transmission; however, it does not typically protect information at either the source or the destination; - - a firewall, which controls the flow of data between an internal network and outside networks or the Internet, is necessary for rudimentary access control, but must be regularly reconfigured to accommodate new business applications, users and business partners on the network. Thus, firewalls can be left vulnerable to hackers and others seeking to compromise network integrity and fail to protect against improper use by authorized users; - - operating system security mechanisms, such as user authentication, passwords and multi-level access rights, can prevent unauthorized access by internal and external users. However, deployment issues such as easily guessed passwords or default accounts left on newly installed devices diminish the effectiveness of these measures. Passive point tools do not address the fundamental issue that the inherent utility of open systems is itself the source of their vulnerability. This conflict between the benefits of open systems and the risks of their unauthorized use or disruption has not been widely recognized or addressed by passive security tools. Many organizations have developed security policies that define the appropriate use of network resources, establish the proper configuration of network services, operating systems and applications and describe the actions to be taken if there is an attack on the network. These security policies 25 30 attempt to define the organization's acceptable level of risk. Organizations, however, have not had the systems to automatically enforce and implement such policies across their entire IT infrastructure. Without such systems, the dynamic nature of enterprise networks causes the organization's actual security practice to diverge from the stated security policy, potentially exposing the organization to additional unanticipated risks. To be effective, passive point tools need to be coordinated through enterprise-wide systems that automatically evaluate and eliminate the vulnerabilities and threats. Direct observation of vulnerabilities and threats can allow an organization to define and automatically enforce an integrated, enterprise-wide information risk management process that can be managed centrally and implemented on a distributed basis. Any security solution must be: - - easy to use by both management and the organization's existing IT personnel; - - compatible with existing security technologies as well as be flexible enough to incorporate new technologies; and - - able to provide a comprehensive and accurate picture of security issues across the organization's entire distributed network such that the managers of the system trust the objectivity of the security system in monitoring, detecting and responding to vulnerabilities and threats. THE ISS SOLUTION Our dynamic, process-driven Adaptive Network Security approach to enterprise-wide information risk management relies on the principles of monitoring, detection and response to the ever-changing vulnerabilities in and threats to the hardware products, operating systems and applications that comprise every network system. We designed our SAFEsuite family of products to enable an organization to centrally define and manage an information risk policy for its existing network system infrastructure, including all Internet protocol-enabled devices. Our solutions provide the ability to visualize, measure and analyze real-time security vulnerabilities and control threats across the entire enterprise computing infrastructure, keeping the organization's IT personnel informed of changing risk conditions and automatically making adjustments as necessary. Through custom policies or by using our "best practice" templates, our customers can minimize security risks without closing off their networks to the benefits of open computing environments and the Internet. Our solutions reach beyond the traditional approaches to network security in the following respects: ADAPTIVE NETWORK SECURITY ANS is a proactive, risk management-based approach to enterprise security that links security practice and security policy through a continuous improvement process. ANS achieves this objective through four critical processes: - - continuously monitoring network, system and user activity and configuring devices, systems and applications on the network; - - detecting security risks in network traffic and within systems; - - responding to security threats to minimize risks; and - - analyzing and reporting dynamic risk conditions and response actions and updating security policies. COMPREHENSIVE ENTERPRISE SECURITY SOLUTION We combine ANS principles with our extensive knowledge of network, system and application vulnerabilities and threats to provide scalable security solutions. Our SAFEsuite family of products provides a comprehensive network and system security framework. In addition, we sell our products individually as solutions for a particular function. We also offer a broad range of professional services to assist in the development and enforcement of an effective security policy and to facilitate the deployment and use of our software. Our solutions are interoperable with a broad range of platforms and complement the products of leading security and network management vendors. 26 31 They provide a single point of management and control for an enterprise-wide security policy. In this manner, our SAFEsuite family of products serves as a critical enhancement to traditional passive point tools, such as encryption, firewalls and authentication. We have designed our products to be easily installed, configured, managed and updated by a system administrator through an intuitive graphical user interface without interrupting or affecting network operation. The software automatically identifies systems and activities that do not comply with a customer's policies, and provides a critical feedback mechanism for adjusting the security levels of networked systems based upon its findings. Our products generate easy-to-understand reports ranging from executive-level trend analysis to detailed step-by-step instructions for eliminating security risks. THE X-FORCE Because there are few IT professionals specifically trained in network and system security issues, we have assembled a senior research and development team composed of security experts who are dedicated to understanding new vulnerabilities and real-time threats and attacks, and developing solutions to address these security issues. The team is known in the industry as the "X- Force" and represents one of our competitive advantages. Because of the collective knowledge and experience of the members of the X-Force, we believe that they comprise one of the largest and most sophisticated groups of IT security experts currently researching vulnerability and threat science. Organizations such as CERT (Computer Emergency Response Team), the FBI and leading technology companies routinely consult the X-Force on network security issues. Through the X-Force, we maintain a proprietary and comprehensive knowledge base of computer exploits and attack methods, including what we believe is the most extensive publicly-available collection of Windows NT vulnerabilities and threats in existence. To respond to an ever-changing risk profile, the X-Force continually updates this knowledge base with the latest network vulnerability information, which aids in the design of new products and product enhancements. STRATEGY Our objective is to be the leading provider of information risk management systems that, through our ANS approach, proactively protect the integrity and security of enterprise-wide information systems from vulnerabilities, misuse, attacks and other information risks. We focus on developing innovative and automated software solutions to provide customers with a comprehensive framework for protecting their networks and systems by monitoring for vulnerabilities and real-time threats. Our solutions allow customers to enforce "best practice" network and system security policies. Key elements of our strategy include: CONTINUE OUR LEADERSHIP POSITION IN SECURITY TECHNOLOGY We intend to maintain and enhance our technological leadership in the enterprise security market by hiring additional network and Internet security experts, broadening our proprietary knowledge base, continuing to invest in product development and product enhancements and acquiring innovative companies and technologies that complement our solutions. By remaining independent of other providers of system software, applications and hardware and by solidifying our position as a best-of-breed provider of monitoring, detection and response software, we believe that customers and potential customers will view us as the firm of choice for establishing and maintaining effective security practices and policies. EXPAND DOMESTIC SALES CHANNELS We intend to increase the distribution and visibility of our products by expanding our regional direct sales program and increasing our market coverage through the establishment of additional indirect channels with key managed service providers, Internet service providers, systems integrators, resellers, OEMs and other channel partners. We believe that a multi-channel sales approach will build customer awareness of 27 32 the need for our products and enable us to more rapidly build market share across a wide variety of industries. ENHANCE AND PROMOTE PROFESSIONAL SERVICES CAPABILITIES We are establishing long-term relationships with our customers by serving as a "trusted advisor" in addressing network security issues. To continue to fulfill this responsibility to our customers, we are expanding our professional services capabilities. These capabilities will allow us to provide our customers with additional security system design, planning, installation, testing and consulting services to assist in developing and maintaining effective information risk management solutions. By providing professional services, we also can heighten customer awareness about network security issues, which creates opportunities for us to sell new products or product enhancements to our existing customers. EXPAND INTERNATIONAL OPERATIONS We plan to continue to aggressively expand our international operations to address the rapid global adoption of distributed computing environments. Many foreign countries do not have laws recognizing network intrusion or misuse as a crime or the resources to enforce such laws if they do exist. As a consequence, we believe that organizations in such countries will have greater need for effective security solutions. We currently maintain international offices in Australia, Belgium, Brazil, Canada, England, France, Germany, Japan and Mexico and plan to expand in those regions where businesses, governments and other institutional users are using distributed networks and the Internet for their mission-critical needs. BROADEN ANS CATEGORY AWARENESS We intend to increase and broaden awareness of the need for ANS and our information risk management solutions. In 1998, we led the formation of the Adaptive Network Security Alliance, or ANSA, as a means to offer Adaptive Network Security to support a wide range of network management and security products. In addition, by increasing our level of public relations, educational events, seminars, advertising, direct marketing and trade show participation, we intend to increase the public's recognition of the risks and dangers associated with the adoption of open computing systems and commerce initiatives, as well as the ability to manage such risks through an effective ANS-based solution. PRODUCT ARCHITECTURE The SAFEsuite family of products delivers our ANS approach to network security through a flexible architecture designed to be integrated with existing security and network system infrastructures. Our SAFEsuite products enhance the effectiveness of passive point tools by monitoring them for threats and vulnerabilities and responding with actions that align customers' security practices with their security policies. SAFEsuite complements network and security management frameworks by providing information required for informed decisions to minimize security risks while maintaining the desired level of network functionality. Thus, our products provide a risk management-based approach to security with scalable deployment of best-of-breed products and integrated enterprise-wide implementations. 28 33 The following depicts the SAFEsuite product architecture: [SAFESUITE PRODUCT ARCHITECTURE LOGO] Picture headed "SAFEsuite Architecture" depicts a rectangle segmented into 12 parts: One segment spans the top of the top of the rectangle and is titled "Information Risk Management". Immediately below that segment is another segment spanning the top of the rectangle entitled "SAFEsuite Decisions" and includes that product's square logo. Immediately below that segment are two segments of half the length of the rectangle. The left segment is entitled "Vulnerability Management" and the right segment is entitled "Threat Management". Below the Vulnerability Management segment are three segments, entitled (from left to right) "Internet Scanner", "Database Scanner" and "System Scanner", each with a circular product logo. Below the "Threat Management" segment are two segments (on a level even with the three segments below "Vulnerability Management") entitled "RealSecure Engine" and "RealSecure Agent", both with a circular product logo. Below these five segments is a segment spanning the length of the rectangle entitled "Security Knowledge Base". Below that segment is another segment spanning the width of the rectangle with 4 rectangular "X-Force" logos. Along the right edge of the rectangle is a segment entitled "Professional Services" with the words "Implementation" "Consulting" "Training" and "Advisory Service" underneath the title. The SAFEsuite policy management interface lets customers choose among "best practice" templates or policies that establish the acceptable level of risk appropriate for their networks. Our individual products then automatically verify compliance with the chosen policy in terms of actual system configuration and network activity. Graphical reports describe the deviations from the established policy, including the measures required to reduce the risk. This product architecture allows all the SAFEsuite technologies to connect directly into common standards, providing comprehensive security reports for the entire enterprise. To ensure communication confidentiality between individual SAFEsuite components and to prevent their misuse, SAFEsuite uses RSA encryption algorithms, which have become de facto encryption standards. The SAFEsuite Security Knowledge Base, a database containing information about the devices and security risks on a customer's network, utilizes an open database connectivity, or ODBC, interface and allows customers to select their preferred database such as Informix, Microsoft SQL Server, Oracle, Sybase or any ODBC-compliant database for data storage. The various SAFEsuite products consolidate security data, enabling users to quickly determine their risk profiles and respond. In addition, SAFEsuite products provide automated decision support by assessing priorities and providing a graphical representation of important security risk data sets. This feature allows key decision-makers to prioritize their program strategies for effective deployment of resources to minimize security risks. Each SAFEsuite product can be deployed as a stand-alone, best-of-breed solution to meet the needs of the local administrator or departmental user. Through support for remote, multi-level management consoles and the SAFEsuite Security Knowledge Base, enterprise-level users can analyze security risk conditions for the entire network. The SAFEsuite Security Knowledge Base allows the customer to address both vulnerabilities 29 34 and threats, thereby minimizing network security risk and associated costs. SAFEsuite's frequent updates integrate the latest identified security vulnerabilities and threats into the operations of an existing product installation. PRODUCTS The following table lists our current offering of SAFEsuite products, and includes a brief description of each product's functionality and current list prices (dollar amounts are for the indicated scope of use, with prices discounted for larger networks):
INTRODUCTION DESCRIPTION SCOPE U.S. LIST PRICE DATE - ---------------------------------------------------------------------------------------------------------- NETWORK SECURITY VULNERABILITY DETECTION, ANALYSIS AND REPORTING - ---------------------------------------------------------------------------------------------------------- Internet Scanner Comprehensive security 50 devices $ 3,495 October 1992 assessment for all 1000 devices 19,945 devices on an enterprise 3000 devices 39,500 network - ---------------------------------------------------------------------------------------------------------- INTERNAL SYSTEM SECURITY VULNERABILITY DETECTION, ANALYSIS AND REPORTING - ---------------------------------------------------------------------------------------------------------- System Scanner -- Internal security 50 computers $ 1,950 December 1998 assessment desktop version for desktop operating 400 computers 11,950 systems 1000 computers 25,500 - ---------------------------------------------------------------------------------------------------------- System Scanner -- Internal security 5 computers $ 3,250 January 1997 assessment server version for server operating 30 computers 17,500 systems 100 computers 50,000 - ---------------------------------------------------------------------------------------------------------- DATABASE SECURITY VULNERABILITY DETECTION, ANALYSIS AND RESPONSE - ---------------------------------------------------------------------------------------------------------- Database Scanner Comprehensive security 5 servers $ 4,475 December 1998 assessment for SQL 10 servers 8,500 databases 50 servers 41,250 - ---------------------------------------------------------------------------------------------------------- NETWORK SECURITY THREAT AND MISUSE DETECTION, ANALYSIS AND RESPONSE - ---------------------------------------------------------------------------------------------------------- RealSecure Engine Real-time attack 1 engine $ 8,995 December 1996 recognition, misuse detection and 10 engines 69,900 response for network 25 engines 149,900 traffic - ---------------------------------------------------------------------------------------------------------- INTERNAL SYSTEM SECURITY THREAT AND MISUSE DETECTION, ANALYSIS AND RESPONSE - ---------------------------------------------------------------------------------------------------------- RealSecure Agent Real-time attack 5 computers $ 3,750 December 1998 recognition, misuse detection and 25 computers 15,000 response for activities 100 computers 50,000 within systems - ---------------------------------------------------------------------------------------------------------- ENTERPRISE INFORMATION RISK MANAGEMENT - ---------------------------------------------------------------------------------------------------------- SAFEsuite Decisions Decision support system Small enterprise $ 25,000 December 1998 for information risk Medium enterprise 100,000 management Large enterprise 250,000 - ----------------------------------------------------------------------------------------------------------
30 35 INTERNET SCANNER Internet Scanner quickly finds and fixes security holes through automated and comprehensive network security vulnerability detection and analysis. Internet Scanner scans and detects vulnerabilities, prioritizes security risks and generates an array of meaningful reports ranging from executive-level trend analysis to detailed step-by-step instructions for eliminating security risks. Internet Scanner initiates a scan from a workstation placed inside or outside a corporate firewall. These scans measure the actual implementation of an organization's security policies. Scans may be as simple as determining the basic computing services available on the network or as comprehensive as a thorough testing using Internet Scanner's vulnerability database -- the most comprehensive in the industry. Internet Scanner's intranet module methodically examines intranet servers, routers, operating systems and key applications for potential violations in security policy. The firewall module works through the network to find firewalls and provide an accurate assessment of their configuration and degree of protection. Finally, the Web security module locates intranet, extranet and Internet Web servers, checking them for possible misconfigurations and security weaknesses. After completing their scans, the Internet Scanner modules return lists of discovered vulnerabilities and prepare in-depth reports to assist administrators with follow-up and review. SYSTEM SCANNER System Scanner serves as a security assessment system that helps manage security risks through comprehensive detection and analysis of operating system, application and user-controlled security weaknesses. System Scanner identifies potential security risks by comparing security policy with actual host computer configurations. Potential vulnerabilities include missing security patches, dictionary-crackable passwords, inappropriate user privileges, incorrect file system access rights, unsecure service configurations and suspicious log activity that might indicate an intrusion. System Scanner stores scanned operating system configurations, placing an electronic "fingerprint" on individual hosts. Routine reviews of these records help identify damaged or maliciously altered systems before they become a security or performance liability. Furthermore, System Scanner helps restore suspicious or damaged Unix systems, generating automated fix scripts for file ownerships and permissions. System Scanner augments its automated policy compliance testing with a database of over 600 vendor patches and other system enhancements. This powerful built-in knowledge base quickly pinpoints high risk activity, such as password sniffing, remote access programs or unauthorized dial-up modems and remote control software. System Scanner returns a list of discovered vulnerabilities and prepares in-depth reports to assist administrators with follow-up and review. DATABASE SCANNER Database Scanner provides security risk assessment for database management systems. Database Scanner allows a user to establish a database security policy, audit a database and present a database's security risks and exposures in easy-to-read reports. Most database security violations occur not because databases have inherently weak security, but rather because systems are not set up correctly and security policies are not established and enforced. Even in a properly configured system, settings can be changed -- either accidentally or maliciously -- leaving sensitive information at risk. Database Scanner develops, implements and maintains appropriate database system security strategies, policies and procedures. It examines database systems for adherence to accepted operational standards for account creation, access control, account suspensions and renewals along with software upgrades, patches and hot fixes. The security risks in internal applications utilizing database management systems can be measured and managed with Database Scanner. The easy to read reports provide detailed graphical analysis with recommended fixes and promote effective communication of security 31 36 risks across departments and levels of management. REALSECURE RealSecure is an integrated network- and host-based intrusion detection and response system. RealSecure's around-the-clock surveillance extends unobtrusively across the enterprise, allowing administrators to automatically monitor network traffic and host logs, detect and respond to suspicious activity and intercept and respond to internal or external host and network abuse before system security is compromised. RealSecure's multi-point management architecture allows for rapid enterprise-wide deployment and operation across geographic and organizational boundaries in both Unix and Windows NT environments. RealSecure's innovative Manager-Engine-Agent architecture provides flexible deployments to meet the requirements of diverse corporate networks. REALSECURE ENGINE. The RealSecure Engine runs on dedicated workstations to provide network intrusion detection and response. Each RealSecure Engine monitors the packet traffic on a specific network segment for attack signatures -- telltale evidence that an intrusion attempt is taking place. Recognition occurs in real time and triggers user-definable alarms and responses as soon as the attack is detected. RealSecure utilizes our Digital FingerPrinting technology to recognize a large number of attack patterns on high-speed networks. Additionally, our Adaptive Filtering Algorithm tunes the packet filter rules in response to network load, allowing the engine to effectively function during bursts in network traffic. When a RealSecure Engine detects an attack or misuse, it transmits an alarm to the RealSecure Manager or a third-party network management console for administrative follow-up and review. In addition, RealSecure responds immediately by terminating the connection, sending email or pager alerts, recording the session, reconfiguring select firewalls or taking other user-definable actions. REALSECURE AGENT. RealSecure Agent is a host-based complement to RealSecure Engine. RealSecure Agent analyzes host logs to recognize attacks, determine whether an attack was successful and provide other forensic information not available in real time. Based on what is discovered, RealSecure Agent reacts to prevent further incursions by terminating user processes and suspending user accounts. It also logs events, sends, alarms and emails and executes user-defined actions. Each RealSecure Agent installs on a workstation or host, thoroughly examining that system's logs for telltale patterns of network misuse and breaches of security. Like RealSecure Engine, RealSecure Agent sends an alarm to the RealSecure Manager or third-party network management console when it detects evidence of improper usage. Based on what it discovers, RealSecure Agent also automatically reconfigures RealSecure Engines and select firewalls to prevent future incursions. SAFESUITE DECISIONS SAFEsuite Decisions is the initial product in our new SAFEsuite Enterprise family of enterprise security management solutions. SAFEsuite Decisions delivers continuous security improvement across the enterprise from a single application. SAFEsuite Decisions leverages the value of our SAFEsuite products to provide an adaptive enterprise network security system for ongoing, active information risk management. SAFEsuite Decisions integrates critical security data generated by our Internet Scanner, System Scanner, RealSecure and third-party firewalls, into a closed, automated feedback loop. This information is condensed into a comprehensive reporting system, enabling timely, focused and informed decisions for effective information risk management. SAFEsuite Decisions enables managers and administrators to take immediate action to protect online resources. SAFEsuite Decisions facilitates efficient management of enterprise security risk and maximizes the security of large-scale networking and Internet-based commerce. 32 37 PROFESSIONAL SERVICES We enhance the value of our products by offering professional consulting services to assure customers' success in the use of our products. We have network security professionals ready to assist customers with their particular security policy development and enforcement needs. Our professional services can range from providing network security resources for overburdened IT departments to conducting investigations of serious breaches in security. Our professional services offerings include: - - Quick Assist -- Customer assistance for determining a client's risk condition and development of an Adaptive Network Security business case; - - JumpStart -- High-value, customized on-the-job training and quick-start implementation programs; - - Incident Response & Post-Attack Support -- Data recovery and business resumption planning services, investigation and forensics, litigation and expert witness support; - - Triage -- High-impact, rapid turnaround network emergency support services including vulnerability assessment and corrective action support; - - Security Architecture Design & Engineering -- Adaptive Network Security architecture and design services; - - Enterprise Threat & Vulnerability Battle Planning -- Logical, systematic approach for project and budget planning, acquisition and technology strategy and security program development and implementation; and - - Network Operations Support -- On-site and remote network monitoring and response, coupled with standard network security operations services. We complement our service offerings with a full range of training and certification programs. Our Certified User courses are available at our education center in Atlanta, Georgia, and at approved training centers around the world. These classes address planning, installation and basic operation of our products in a hands-on, interactive environment. For more advanced needs, our ISS Certified Engineer training courses cover advanced topics specific to each SAFEsuite or SAFEsuite Enterprise product. Our training goes beyond simple "how to" exercises. Upon completion of instructor-led discussions and exercises, students respond to actual, on-the-job scenarios. These simulations allow students to apply their new skills to real-world situations, reinforcing both basic and advanced skills. Our training courses encompass the complete life cycle of our SAFEsuite products, from installation and operations to advanced troubleshooting. PRODUCT PRICING We use a range of fee structures to license our products, depending on the type of product and the intended use. We license our vulnerability detection products, Internet Scanner, System Scanner and Database Scanner, based on the number of devices being scanned. The pricing scheme is scalable, providing low entry points for departmental users without limiting our revenue potential from customers with large networks. Pricing for our threat detection products, RealSecure Engine and RealSecure Agent, is based on the number of engines deployed on the network. Thus, licensing fees for our products are ultimately determined by the size of the customer's network, as size dictates the number of devices to be scanned or the number of engines to be deployed. In addition to license fees, customers virtually always purchase maintenance agreements in conjunction with their initial purchase of a software license, with annual maintenance fees typically equal to 20% of the product's license fee. Maintenance agreements include annually renewable telephone support, product updates, access to our X-Force Security Alerts and error corrections. Our continuing research into new security risks and resulting product updates provide significant ongoing value. As a result, a substantial majority of our customers renew their maintenance agreements. Customers who use our products to provide IT consulting services have license agreements that are 33 38 based on a revenue sharing model. We have historically sold fully-paid perpetual licenses with a renewable annual maintenance fee and, more recently, have licensed our products on a subscription basis (which includes maintenance) for one or two year periods and are exploring other alternatives for customers desiring longer term arrangements or multi-year commitments. PRODUCT DEVELOPMENT We developed our SAFEsuite products to operate in heterogeneous computing environments. Products are compatible with other vendors' products across a broad range of platforms, including HP-UX, IBM AIX, Linux, SGI IRIX, SunOS, Sun Solaris, Windows 95/98 and Windows NT. We have incorporated a modular design in our products to permit plug-and-play capabilities, although customers often use our professional services or our strategic partners to install and configure products for use in larger or more complex network systems. We employ a two-pronged product development strategy to achieve our goal of providing the most comprehensive security coverage within the monitoring, detection and response market. First, we continue to develop best-of-breed security products to address particular network configurations. Such new products, and our existing products like Internet Scanner, System Scanner and RealSecure, are updated approximately every four to six months to add new features, improve functionality and incorporate timely responses to vulnerabilities and threats that have been added to our vulnerability and threat database. These updates are usually provided as part of separate maintenance agreements sold with the product license. Second, to complement our existing products and provide more comprehensive network security coverage, we are expanding our existing SAFEsuite products by developing additional enterprise-level products that incorporate ANS principles. These products will allow customers to protect their networks by continuously measuring and analyzing the status of their network's security, and by monitoring and controlling the security risks in real time across the enterprise network. These SAFEsuite enterprise products are interoperable with our existing products, allowing modular implementation. Expenses for product development were $1.2 million, $3.4 million and $9.3 million in 1996, 1997 and 1998, respectively. All product development activities are conducted at our principal offices in Atlanta, and at our research and development facilities in Mountain View, California and Reading, England, where, as of December 31, 1998, an aggregate of 108 personnel were employed in product development teams. In addition, our personnel include members of the Computer Security Institute, Forum for Incident Response and Security Technicians (FIRST), Georgia Tech Industrial Partners Association, Georgia Tech Information Security Center and the International Computer Security Association (ICSA), enabling us to actively participate in the development of industry standards in the emerging market for network and Internet security systems and products. CUSTOMERS As of December 31, 1998, we had licensed versions of our SAFEsuite family of products to over 3,000 customers. No customer accounted for more than 10% of our consolidated revenues in 1996, 1997 or 1998. Our target customers include both public and private sector organizations that utilize Internet protocol-enabled information systems to facilitate mission-critical processes in their operations. Our customers represent a broad spectrum of organizations within diverse sectors, including financial services, technology, telecommunications, government and information technology services. 34 39 The following is a list of certain of our customers that have purchased licenses and services from us with an aggregate price of at least $15,000 and which we believe are representative of our overall customer base: FINANCIAL SERVICES IT SERVICES GOVERNMENT Charles Schwab EDS NASA First Union KPMG Peat Marwick Salt River Project KeyCorp Perot Systems U.S. Department of the Merrill Lynch PricewaterhouseCoopers Air Force PNC Bank SAIC U.S. Department of the SITA Army TELECOMMUNICATIONS U.S. Department of America Online TECHNOLOGY Defense Bell Atlantic Hewlett-Packard U.S. State Department BellSouth IBM GTE Internetworking Intel OTHER NETCOM On-Line Lucent Technologies Lockheed Martin Communications Microsoft Merck Nippon Telephone & NCR REI Telegraph Siemens VeriSign Xerox
SALES AND MARKETING SALES ORGANIZATION Our sales organization is divided regionally among the Americas, Europe and the Asia/Pacific region. In the Americas, we market our products primarily through our direct sales organization augmented by our indirect channels, including security consultants, resellers, OEMs and systems consulting and integration firms. The direct sales organization for the Americas consists of regionally-based sales representatives and sales engineers and a tele-sales organization located in Atlanta. As of December 31, 1998, we maintained sales offices in the Atlanta, Austin, Boston, Chicago, Cincinnati, Dallas, Denver, Los Angeles, Minneapolis, Monterrey (Mexico), New York, Palo Alto, Philadelphia, Portland, San Francisco, Sao Paulo (Brazil), Seattle, Toronto (Canada) and Washington, D.C. metropolitan areas. A dedicated group of professionals in our Atlanta headquarters covers Latin America. As of December 31, 1998, we employed 92 people in the Americas direct sales and professional services organization. The regionally-based direct sales representatives focus on opportunities where we believe we can realize more than $200,000 in revenues per year. In Europe and the Asia/Pacific region, substantially all of our sales occur through authorized resellers. Internationally, we have established regional sales offices in Brussels, London, Munich, Paris, Reading (England), Stuttgart, Sydney and Tokyo. Personnel in these offices are responsible for market development, including managing our relationships with resellers, assisting them in winning and supporting key customer accounts and acting as a liaison between the end user and our marketing and product development organizations. As of December 31, 1998, 50 employees were located in our European and Asia/Pacific regional offices. We expect to continue to expand our field organization into additional countries in these regions. SECURITY PARTNERS PROGRAM We have established a Security Partners Program to train and organize security consulting practices, Internet service providers, systems integrators and resellers to match our products with their own complementary products and services. By reselling SAFEsuite products, Security Partners provide additional value for specific market and industry segments, while maintaining our ongoing commitment to quality software and guaranteed customer 35 40 satisfaction. We have established three different levels of partnership opportunities: - - PREMIER PARTNERS. Premier Partners are value-added resellers and systems integrators with focused security practices. Many Premier Partners are experienced in the sales and implementation of leading firewall technology, as well as authentication and encryption technologies. These partners leverage their expertise with our vulnerability assessment and intrusion detection products. Premier Partners receive direct distribution of our products, sales training, financial incentives, access to our Web site for placing orders and partner-only communications, including a link to the ISS Partner Web site. - - AUTHORIZED PARTNERS. Authorized Partners generally consist of organizations that provide security-focused consulting services, but elect not to commit to the minimum annual purchase commitments and entry fees applicable to Premier Partners. Authorized Partners may purchase products directly from us and may access our Web site to place orders and receive partner-only communications. - - REGISTERED PARTNERS. Unlike Premier Partners and Authorized Partners, Registered Partners are not required to maintain an ISS Certified Engineer on their staffs. Registered Partners receive partner-only communications and may purchase products directly from us, including through our online Web order system. ADAPTIVE NETWORK SECURITY ALLIANCE In 1998, we formed the Adaptive Network Security Alliance, or ANSA, as a means to offer Adaptive Network Security to support a wide range of network management and security products. ANSA currently has 53 members, including leading security software vendors. ANSA delivers the flexibility of best- of-breed products, enhanced enterprise security, accelerated implementation of enterprise management and security solutions and additional value for existing products and services. ANSA provides Adaptive Network Security modules for firewalls, virtual private networks (VPNs), antivirus/malicious code software, public key infrastructure (PKI) and enterprise systems management products. Through ANSA, we, together with our technology partners, deliver self-correcting security and management systems that provide maximum value for organizations with limited IT security resources. ANSA provides functionality in the following four key areas: - - ACTIVE RESPONSE. Security breaches require rapid response to identify and stop threats before they place critical online assets at risk. Through ANSA, firewalls, routers, switches, virtual private networks and other technologies are reconfigured automatically and in real time to break off the attack and prevent future penetrations. - - LOCK DOWN. Improper configurations can make any technology vulnerable to attack and misuse. We work with ANSA partners to develop customized templates that enable the secure configuration of network devices. With this "lock down" functionality, customers can be assured that the ANSA partner's product will function as designed and will be securely configured. - - DECISION SUPPORT. Effective security decision-making and planning requires timely analysis of enormous amounts of data across disparate systems and network devices. ANSA enables fast and informed enterprise-wide security decisions by collecting, integrating and analyzing data from security and network infrastructure products of ANSA partners. Resulting high value information is routed to network and systems management consoles for immediate action. - - ADAPTIVE NETWORK SECURITY MANAGEMENT. ANSA integrates Adaptive Network Security management with enterprise system management platforms. This integration simplifies the enforcement and implementation of security policies across the enterprise leveraging existing IT resources. ANSA is an open initiative and membership is offered free of charge to vendors providing security, and enterprise and network infrastructure products and 36 41 services with a commitment to interoperability. MARKETING PROGRAMS We conduct a number of marketing programs to support the sale and distribution of our products. These programs are designed to inform existing and potential end-user customers, OEMs and resellers about the capabilities and benefits of our products. Marketing activities include: - - press relations and education; - - publication of technical and educational articles in industry journals and our on-line magazine, ISS Alert; - - participation in industry tradeshows; - - product/technology conferences and seminars; - - competitive analysis; - - sales training; - - advertising and development and distribution of marketing literature; and - - maintenance of our Web site. A key element of our marketing strategy is to establish our products and our ANS model as the leading approach for enterprise-wide security management. We have implemented a multi-faceted program to leverage the use of our SAFEsuite product family and increase its acceptance through relationships with various channel partners: - - STRATEGIC RESELLERS. Although we have numerous resellers, certain of these relationships have generated significant leverage for us in targeted markets. Our strategic resellers, which include EDS, IBM, Lucent, Siemens and Softbank, provide broad awareness of our brand through enhanced marketing activity, access to large sales forces, competitive control points and access to larger strategic customer opportunities. - - CONSULTANTS. The use of our products by security consultants not only generates revenue from the license sold to the consultant, but also provides us with leads to potential end users with a concern for network security. Consultants who have generated substantial leads for our sales organization include Andersen Consulting, Arthur Andersen, Deloitte Touche Tohmatsu International, Ernst & Young, IBM, KPMG Peat Marwick, PricewaterhouseCoopers and SAIC Global Integrity. - - MANAGED SERVICE PROVIDERS AND INTERNET SERVICE PROVIDERS. We license our products to certain managed service providers and Internet service providers to be used as part of their value-added services for their customers, With our products, Internet service providers can offer their users perimeter vulnerability scanning and assessment, and intrusion detection for Web services and applications that typically reside outside the firewalled perimeter. We license our products to GTE, Intermedia Communications (Digex), IRE, MCI Worldcom and PSINet and other Internet service providers for these purposes and receive a percentage of the value-added revenue stream. - - OEMS. A number of vendors of security products, including Check Point, Entrust, Lucent, NCR, Nortel and ODS Networks, have signed OEM agreements with us. These agreements enable OEMs to incorporate our products into their own product offerings to enhance their security features and functionality. We receive royalties from OEM vendors and increased acceptance of our products under these arrangements, which, in turn, promotes sales of our other products to the OEM's customers. We typically enter into written agreements with our strategic resellers, consultants, managed service providers, Internet service providers and OEMs. These agreements generally do not provide for firm dollar commitments from the strategic parties, but are intended to establish the basis upon which the parties will work together to achieve mutually beneficial objectives. 37 42 ADVISORY BOARD We established an Advisory Board in February 1998 to further our sales and recruiting efforts. Members of the Advisory Board currently consist of the following: SAM NUNN. Mr. Nunn has been a partner in the Atlanta law firm of King & Spalding since January 1997. Previously, he served in the United States Senate for four terms starting in 1972. Mr. Nunn is a director of The Coca-Cola Company, General Electric Company, National Service Industries, Scientific-Atlanta, Texaco and Total System Services. He also serves as Chairman of the Board of the Center for Strategic and International Studies (CSIS), a Washington, D.C. think tank. JOHN P. IMLAY, JR. Mr. Imlay is Chairman of Imlay Investments, and serves on the board of directors of the Atlanta Falcons, Gartner Group, Metromedia International Group, and several other organizations. He was Chairman of Dun & Bradstreet Software Services from March 1990 until November 1996. Prior to that, Mr. Imlay served as Chairman and Chief Executive Officer of Management Science America, a company that was acquired by Dun & Bradstreet Software Services. The Advisory Board members advise us on long-term strategic growth, including strategies for selling to key industries, recruitment of board members and other key personnel, and trends in national and international policy influencing our products and services. We also anticipate that Advisory Board members will provide high visibility for us at industry events and will play key roles in leading customer user groups to support our growth and industry prominence. Members of the Advisory Board meet individually or as a group with our management from time to time and are compensated through issuances of common stock or options to acquire common stock. CUSTOMER SERVICE AND SUPPORT We provide ongoing product support services under license agreements. Maintenance contracts are typically sold to customers for a one-year term at the time of the initial product license and may be renewed for additional periods. Under our maintenance agreements with our customers, we provide, without additional charge, telephone support, documentation and software updates and error corrections. Customers that do not renew their maintenance agreements but wish to obtain product updates and new version releases are generally required to purchase such items from us at market prices. In general, major new product releases come out annually, minor updates come out every four to six months and new vulnerability and threat checks come out every two to four weeks. Customers with current maintenance agreements may download product updates from our Web site. We believe that providing a high level of customer service and technical support is necessary to achieve rapid product implementation which, in turn, is essential to customer satisfaction and continued license sales and revenue growth. Accordingly, we are committed to continued recruiting and maintenance of a high-quality technical support team. We provide telephone support to customers who purchase maintenance agreements along with their product license. A team of dedicated engineers trained to answer questions on the installation and usage of the SAFEsuite products provides telephone support from 8:00 a.m. to 6:00 p.m., Eastern time, Monday through Friday, from our corporate office in Atlanta. We provide telephone support 24 hours a day, seven days a week through a call-back procedure to certain customers who pay an additional fee for the service. In the United States and internationally, our resellers provide telephone support to their customers with technical assistance from us. COMPETITION The market for network security monitoring, detection and response solutions 38 43 is intensely competitive, and we expect competition to increase in the future. We believe that the principal competitive factors affecting the market for network security products include security effectiveness, manageability, technical features, performance, ease of use, price, scope of product offerings, professional services capabilities, distribution relationships and customer service and support. Although we believe that our solutions generally compete favorably with respect to such factors, there can be no assurance that we can maintain our competitive position against current and potential competitors, especially those with significantly greater financial, marketing, service, support, technical and other competitive resources. Our chief competitors generally fall within one of four categories: - - internal IT departments of our customers and the consulting firms that assist them in formulating security systems; - - relatively smaller software companies offering relatively limited applications for network and Internet security; - - large companies, including Axent Technologies, Cisco Systems and Network Associates, that sell competitive products, as well as other large software companies that have the technical capability and resources to develop competitive products; and - - software or hardware companies that could integrate features that are similar to our products into their own products. Due to a lack of appreciation of the complexity involved in the development of automated systems to establish and maintain comprehensive and effective security within a distributed computing environment, potential customers often rely on their IT departments to internally formulate security systems or retain consultants to undertake such a project. However, because experts in security issues are in extremely short supply, such in-house solutions typically fail to provide a comprehensive and sophisticated approach to security, are not designed to adapt to changing security risks and are extremely expensive to develop. As IT departments learn of our products and their relative cost, we believe that these departments will be less inclined to independently develop systems with functionalities similar to our products. In addition, a number of smaller companies currently market or have under development software applications to provide network and Internet security. We believe that, to date, none of these companies offers products that are as robust in features or as comprehensive in scope as the SAFEsuite family of products. Although it is likely that the product development efforts of these companies will eventually enable them to offer a line of products to compete with our current product line, we intend to continue to dedicate significant resources for product development and recruiting in order to expand our product capabilities ahead of these competitors. Notwithstanding, we expect additional competition from these established competitors and from other emerging companies. Mergers or consolidations among our competitors, or acquisitions of small competitors by larger companies, would make such combined entities more formidable competitors to us. In the last 18 months, both Cisco Systems and Network Associates have acquired privately-held companies with products competitive to ours. Although we believe that Cisco Systems and Network Associates will continue to integrate these security products with their other product offerings, we believe that our products will compete favorably based on our product and platform functionality and Adaptive Network Security approach. Notwithstanding, large companies may have advantages over us because of their longer operating histories, greater name recognition, larger customer bases or greater financial, technical and marketing resources. We believe that the entry of larger, more established companies into our market will require them to undertake operations that are currently not within their core areas of expertise, thus exposing them to significant uncertainties in the product development process. In addition, if larger companies were to enter our market, they could have a greater ability to adapt more quickly to new or emerging technologies and 39 44 changes in customer requirements. They also could devote greater resources to the promotion and sale of their products than we can. In addition, these companies have reduced, and could continue to reduce, the price of their security monitoring, detection and response products, which increases pricing pressures within our market. In addition, large companies with broad product offerings, such as Network Associates, have bundled their security products with their other products, and we expect them to continue to do so in the future, which makes it more difficult for us to compete with them. These companies may develop security monitoring, detection and response products that are better than our current or future products and this may render our products obsolete. Several companies currently sell software products (such as encryption, firewall, operating system security and virus detection software) that our customers and potential customers have broadly adopted. Some of these companies sell products which perform the same functions as some of our products. In addition, vendors of operating system software or networking hardware may enhance their products to include the same kinds of functions that our products currently provide. The widespread inclusion in operating system software or networking hardware of features comparable to our software could render our products obsolete, particularly if such features are of a high quality. Even if security functions integrated into operating system software or networking hardware are more limited than those of our software, a significant number of customers may accept more limited functionality to avoid purchasing additional software. For the above reasons, we may not be able to compete successfully against our current and future competitors. Increased competition may result in price reductions, reduced gross margins and loss of market share, any one of which could materially and adversely affect our business, operating results and financial condition. PROPRIETARY RIGHTS AND TRADEMARK ISSUES We rely primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. Furthermore, we believe that factors such as the technological and creative skills of our personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are essential to establishing and maintaining a technology leadership position. We seek to protect our software, documentation and other written materials under the trade secret and copyright laws, which afford only limited protection. We also have submitted two United States patent applications. There can be no assurance that any patents will issue from these applications or, if issued, that any such patent would provide meaningful competitive advantages to us. We generally license our SAFEsuite products to end users in object code (machine-readable) format. Certain customers have required us to maintain a source-code escrow account with a third-party software escrow agent, and a failure by us to perform our obligations under any of the related license and maintenance agreements, or our insolvency, could conceivably cause the release of our product source code to such customers. The standard form agreement allows the end user to use our SAFEsuite products solely on the end user's computer equipment for the end user's internal purposes, and the end user is generally prohibited from sublicensing or transferring the products. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult, and while we are unable to determine the extent to which piracy of our software products exists, software piracy can be expected to be a persistent problem. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. There can be no assurance that our competitors will not independently develop similar technologies. 40 45 We are not aware that any of our products infringes the proprietary rights of others, but it is possible that our current or future products may infringe proprietary rights of others. In fact, in July 1998, Network Associates, which is one of our competitors, filed a lawsuit against us alleging that our RealSecure product violates a patent claim for intrusion detection technology held by Network Associates. Although we believe that the lawsuit is without merit and are vigorously defending against Network Associates' claims, should Network Associates prevail in the suit, it could result in us having to pay significant damages and cease the licensing of our RealSecure product. Such a result would materially and adversely affect our business, operating results and financial condition. It is conceivable that other third parties, in addition to Network Associates, could claim infringement by us with respect to our current or future products. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could have a material adverse effect upon our business, operating results and financial condition. The name "Internet Security Systems" is not currently subject to trademark registration in the United States, and may not be a name for which a trademark is registrable due to its general use in a variety of security-related applications. Although we have in the past asserted and intend to continue to assert our rights with respect to the name "Internet Security Systems" and we have taken and will take action against any use of such name in a manner that may create confusion with our products in relevant markets, there can be no assurance that we will be successful in such efforts, which could have a material adverse effect upon our business, operating results and financial condition. EMPLOYEES As of December 31, 1998, we had 328 employees, of whom 108 were engaged in product research and development, 103 were engaged in sales, 16 were engaged in customer service and support, 46 were engaged in professional services, 35 were engaged in marketing and business development and 20 were engaged in administrative functions. We believe that we have good relations with our employees. FACILITIES Our Atlanta headquarters and research and development facilities consist of approximately 72,000 square feet of office space occupied pursuant to a lease and a sublease expiring in June 2002, which provide for minimum annual lease obligations of approximately $1,240,000. We also lease office space in Mountain View, California, New York City, Washington, D.C., Brussels, London, Paris, Reading (England), Stuttgart and Tokyo, as well as small executive suites in several United States cities. We believe that our existing facilities are adequate for our current needs and that additional space will be available as needed. LEGAL PROCEEDINGS On June 25, 1998, Network Associates filed a lawsuit against us in the U. S. District Court for the Northern District of California (the "Court") which alleges that our RealSecure product infringes a patent claim for intrusion detection technology held by Network Associates. Network Associates claims that this alleged infringement is deliberate and willful and is seeking treble damages in an unspecified amount and attorneys' fees, in addition to an injunction prohibiting the alleged infringement. The Court conditionally dismissed the original complaint based on the parties' representation to the Court that they would attempt to reach a settlement. However, on January 13, 1999, Network Associates notified the Court that no settlement had been 41 46 reached and requested that the Court place the case on the Court's calendar. On January 25, 1999, we filed our answer to the complaint with the Court. In our answer, we asserted several affirmative defenses and made counterclaims against Network Associates for unfair competition and antitrust violations under federal and state laws. We believe that Network Associates' lawsuit is without merit and we will continue to vigorously defend against it. However, should Network Associates prevail in the suit, it could materially and adversely affect our business, operating results and financial condition. Except as noted above, we are not a party to any material legal proceedings. 42 47 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS Set forth below is certain information concerning our directors and executive officers.
NAME AGE POSITION(S) - --------------------------------------------------- ------- ----------------------------------------------------------- Thomas E. Noonan................................... 38 President, Chief Executive Officer and Chairman of the Board of Directors Christopher W. Klaus............................... 25 Chief Technology Officer, Secretary and Director Richard Macchia.................................... 47 Vice President and Chief Financial Officer H. Keith Cooley.................................... 45 Vice President (Engineering) M. Thomas McNeight................................. 54 Vice President (Americas Sales) Alex Bogaerts...................................... 49 Vice President (Europe) Lin Ja Hong........................................ 40 Vice President (Asia/Pacific) Richard S. Bodman.................................. 60 Director Robert E. Davoli................................... 50 Director Kevin J. O'Connor.................................. 37 Director David N. Strohm.................................... 50 Director
MR. NOONAN has served as our President and as a director since August 1995, and as our Chief Executive Officer and Chairman of the Board of Directors since November 1996. Prior to joining our company, Mr. Noonan served as Vice President, Sales and Business Development with TSI International, an electronic commerce company then owned by Warburg Pincus and Dun & Bradstreet, from October 1994 until August 1995. From November 1989 until October 1994, Mr. Noonan held high-level sales and marketing positions at Dun & Bradstreet Software, a developer of enterprise business software. Prior to 1989, Mr. Noonan co-founded Actuation Electronics, a motion control company for precision applications, and founded Leapfrog Technologies, an object-oriented software development tools company for networked applications. Mr. Noonan holds a B.S. in mechanical engineering from the Georgia Institute of Technology and a C.S.S. in business administration and management from Harvard University. MR. KLAUS founded ISS in April 1994 and served as our President until August 1995 and as our Chief Executive Officer until November 1996. Mr. Klaus continues to serve as our Chief Technology Officer and as a director. Prior to founding our company, Mr. Klaus developed a shareware version of Internet Scanner while attending the Georgia Institute of Technology. MR. MACCHIA has been our Vice President and Chief Financial Officer since December 1997. From December 1989 until December 1997, Mr. Macchia was employed by First Financial Management Corporation as its Executive Vice President (Finance), and by First Data Corporation as its Senior Vice President (Finance) following its merger with First Financial Management Corporation. Mr. Macchia received a B.B.A. in accounting from the University of Notre Dame. MR. COOLEY has served as our Vice President (Engineering) since January 1996. Mr. Cooley has over 20 years of executive-level experience in software development and customer support, most recently as a founding partner for Value Sourcing Group, an Atlanta-based management consultancy specializing in information technology, from 1995 to 1996. Prior to that, Mr. Cooley was employed by Dun & Bradstreet Software for over 16 years where he held various management and executive-level positions in marketing, development and support, and ended his tenure as Chief Information Officer. Mr. Cooley holds a B.S. in industrial engineering from the Georgia Institute of Technology. MR. MCNEIGHT has served as our Vice President (Americas Sales) since August 1996. Prior to joining our company, Mr. McNeight was employed for more than 20 years in various sales, sales management and 43 48 executive management positions with technology and service companies, having most recently been a principal in The Complex Sale, a strategic sales consulting and training firm, from December 1995 to August 1996. In 1995, Mr. McNeight was Senior Vice President, Americas Operations, for TSW International, Inc., a supplier of plant performance and maintenance management software. Additionally, Mr. McNeight was Chief Executive Officer of Aurum Software Inc., a provider of sales, marketing and customer service software that was subsequently acquired by Baan Company, from 1993 to 1994 and, prior to that, spent 13 years at Dun & Bradstreet, ending his tenure there as Executive Vice President for the Americas. Mr. McNeight serves on the board of directors of Firstwave Technologies, Inc. Mr. McNeight has a B.S. in chemistry from Oklahoma State University and an M.S. in management information sciences from Texas Christian University. MR. BOGAERTS joined us as our Vice President (Europe) in February 1996. Before joining us, Mr. Bogaerts was an independent technology consultant from September 1995 to February 1996, and prior to that held sales, marketing and strategic marketing, and general management positions with Dun & Bradstreet Software from 1992 to September 1995, and with Ethica N.V., an enterprise IT management and consulting firm, from 1989 to 1992. Mr. Bogaerts received a degree in applied economics and management sciences from the University of Leuven, Belgium, and an M.B.A. through a joint program of the University of Leuven, the University of Chicago and Cornell University Business Schools. MR. LIN has served as our Vice President (Asia/Pacific) since January 1997 and manages the Company's Asia/Pacific operations from the Company's office in Tokyo. Mr. Lin has over 20 years of sales and marketing experience in the Asia/Pacific software market. From 1984 to December 1996, he held a number of sales, marketing and development positions with Dun & Bradstreet Technology Asia (formerly known as Ashisuto KK), most recently as its Vice President and General Manager of Sales and Operations. Mr. Lin holds a B.A. in business administration from Aoyama Gakuin University in Tokyo. MR. BODMAN joined our Board in July 1997. Since May 1996, Mr. Bodman has served as the Managing General Partner of AT&T Ventures, LLC, which manages numerous venture capital investments. Before joining AT&T Ventures, LLC, Mr. Bodman served AT&T Corporation in various senior management positions. Mr. Bodman serves on the board of directors of several public companies, including Tyco International, Inc., LIN Television, Inc., NHP, Inc., Reed Elsevier plc. and Young & Rubicam, and several private companies. Mr. Bodman holds a B.S. in engineering from Princeton University and an M.S. in industrial management from the Massachusetts Institute of Technology. MR. DAVOLI has been a director since February 1996. Mr. Davoli has been a general partner of or an advisor to Sigma Partners, a venture capital firm, since January 1995. Mr. Davoli was President and Chief Executive Officer of Epoch Systems, Inc., a client/server storage management provider, from February 1993 to September 1994. From May 1986 through June 1992, Mr. Davoli was the President and Chief Executive Officer of SQL Solutions, a relational database management systems consulting and tools company that he founded and sold to Sybase, Inc. in January 1990. Mr. Davoli serves as a director of several privately held companies. Mr. Davoli received a B.A. in history from Ricker College. MR. O'CONNOR has served as a director since October 1995. Mr. O'Connor has been the Chief Executive Officer and Chairman of DoubleClick Inc., a provider of Internet advertising services, since January 1996. From September 1994 to December 1995, Mr. O'Connor served as Director of Research for Digital Communications Associates, a data communications company (now Attachmate Corporation), and from April 1992 to September 1994, as its Chief Technical Officer and Vice President, Research. From its inception in May 1983 until its sale in April 1992, Mr. O'Connor served as Vice President, Research of Intercomputer Communications 44 49 Corp., a software development company. Mr. O'Connor received his B.S. in electrical engineering from the University of Michigan. MR. STROHM has served as a director since January 1996. Since 1980, Mr. Strohm has been an employee of Greylock Management Corporation, a venture capital group and has been a general partner of several venture capital funds affiliated with Greylock. Mr. Strohm currently serves as a director of DoubleClick, Banyan Systems, Inc., an enterprise networking software company, and Legato Systems, Inc., a data storage management software company. Mr. Strohm received his B.A. from Dartmouth College and his M.B.A. from Harvard Business School. CLASSES OF DIRECTORS Our charter and bylaws provide that the size of the board shall be determined by resolution of the board. The board is currently composed of six members. Each director holds office until their next election at an annual meeting of stockholders or until his or her successor is duly elected and qualified. Our charter and bylaws also provide that, beginning with our 1999 annual meeting of stockholders, the board will be divided into three classes serving staggered three-year terms as follows:
CLASS CURRENT DIRECTORS NEXT ELECTION - ----- ----------------- ------------- I Messrs. Bodman 1999 Annual and O'Connor Meeting II Messrs. Noonan 2000 Annual and Strohm Meeting III Messrs. Davoli 2001 Annual and Klaus Meeting
BOARD COMMITTEES The board established an audit committee in January 1998. The members of the audit committee are Messrs. Bodman, Davoli and Noonan. The audit committee reviews, acts on and reports to the board with respect to various auditing and accounting matters, including the selection of the auditors, the scope of the annual audits, fees to be paid to the auditors, the performance of the independent auditors and our accounting practices. The board established a compensation committee in February 1996 and re-authorized it in January 1998. The members of the compensation committee are Messrs. Davoli, O'Connor and Strohm. The compensation committee determines the salaries and incentive compensation of our officers and provides recommendations for the salaries and incentive compensation of our other employees. The compensation committee also administers our various incentive compensation, stock and benefit plans. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The board established a compensation committee in February 1996. During 1997, Messrs. Davoli, O'Connor and Strohm served as members of the compensation committee. None of these individuals has served at any time as one of our officers or employees. Prior to the establishment of the compensation committee, all decisions relating to executive compensation were made by the board. For a description of the transactions between us and members of the compensation committee and entities affiliated with such members, see "Certain Transactions". None of our executive officers serve as a member of the board of directors or compensation committee of any entity which has one or more executive officers serving as a member of the board or compensation committee. COMPENSATION OF DIRECTORS Except for grants of stock options, directors generally do not receive compensation for services rendered as a director. We also do not pay compensation for committee participation or special assignments of the board. We reimburse each director for all out-of-pocket expenses incurred in attending meetings of the board and committees thereof. Non-employee board members receive option grants at periodic intervals under the automatic option grant program of our stock option plan and also are eligible to receive discretionary option grants under the discretionary option grant program of such plan. See "-- Our Stock Option Plan". 45 50 On December 8, 1997, we granted to each of Messrs. Bodman, Davoli, O'Connor and Strohm an option to purchase 20,000 shares of common stock at an exercise price of $7.00 per share. These options are immediately exercisable for all of the option shares. However, the shares purchasable upon exercise of the options are unvested, and subject to repurchase at the option exercise price paid per share, upon an early termination of the optionee's board service. The shares subject to each option grant will vest as to 25% of the option shares upon the optionee's completion of each year of board service after the grant date. These options expire 10 years from the grant date, subject to earlier termination following the cessation of the optionee's board service. These options will immediately vest in the event of either certain changes in the ownership or control of our company (except upon assumption of such options by the successor), or the death or disability of the optionee while serving as a board member. INDEMNIFICATION The bylaws provide for indemnification of directors and officers to the fullest extent permitted by Delaware law, except if limited by contract. We have indemnification agreements with all of our directors and have purchased directors' and officers' liability insurance. In addition, our charter limits the personal liability of board members to our company or our stockholders for breaches of the directors' fiduciary duties to the fullest extent permitted by Delaware law. See "Description of Securities -- Certain Anti-Takeover, Limited Liability and Indemnification Provisions". EMPLOYMENT CONTRACTS AND CHANGE IN CONTROL ARRANGEMENTS Our officers serve at the discretion of the board. We do not presently have an employment contract in effect with any of our executive officers. The compensation committee, as plan administrator of our stock option plan, has the authority to accelerate vesting of the shares of common stock subject to outstanding options held by the chief executive officer and our other executive officers or any unvested shares actually held by those individuals under our stock option plan, in the event that we are acquired by merger, consolidation or asset sale or there is a change in control effected by a successful tender or exchange offer for more than 50% of our outstanding voting securities or a change in the majority of the board as a result of one or more contested elections for board membership. Alternatively, the compensation committee may condition such accelerated vesting upon the individual's position with us being replaced with a lesser position or the termination of the individual's service within a designated period following the acquisition or takeover. In addition, we have agreements with certain management members regarding acceleration of option vesting in the event of the consummation of a transaction that results in a change of control. 46 51 EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE. The following table provides certain summary information concerning the compensation earned by our chief executive officer and certain other executive officers (collectively, the "Named Officers") whose salary and bonus exceeded $100,000 for services rendered in all capacities to us and our subsidiaries during 1997 and 1998. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ANNUAL COMPENSATION --------------------- -------------------- SECURITIES UNDERLYING NAME AND PRINCIPAL POSITION(S) YEAR SALARY BONUS OPTIONS - -------------------------------------------------- ---- -------- ------- --------------------- Thomas E. Noonan.................................. 1998 $185,486 $95,000 120,000 President, Chief Executive Officer and Chairman 1997 130,000 60,000 -- of the Board Alex Bogaerts..................................... 1998 100,000 104,401 -- Vice President (Europe) 1997 89,000(1) 76,000(1) 25,000 Lin Ja Hong....................................... 1998 110,000 62,642 15,000 Vice President (Asia/Pacific) 1997 110,000 43,890 27,500 Richard Macchia................................... 1998 135,000 35,320 -- Vice President and Chief Financial Officer 1997 1,688(2) -- -- M. Thomas McNeight................................ 1998 125,000 240,874 -- Vice President (Americas Sales) 1997 125,000 91,300 --
- --------------- (1) Mr. Bogaerts' compensation, other than options, was paid to a consulting company owned by Mr. Bogaerts. (2) Mr. Macchia joined our company in December 1997. OPTION GRANTS IN LAST YEAR. The following table provides certain information concerning stock options granted to each of the Named Officers during 1998. No stock appreciation rights were granted to these individuals during 1998. OPTION GRANTS IN 1998
% OF TOTAL POTENTIAL REALIZABLE VALUE AT NUMBER OF OPTIONS ASSUMED ANNUAL RATES OF SECURITIES GRANTED EXERCISE MARKET STOCK PRICE APPRECIATION FOR UNDERLYING TO PRICE PRICE OPTION TERM(1) OPTIONS EMPLOYEES PER PER EXPIRATION ----------------------------- NAME GRANTED IN 1998 SHARE SHARE DATE 5% 10% - --------------------------- ----------- ---------- -------- ------ ---------- ------------- ------------- Thomas E. Noonan........... 20,000(2) 2.1% $22.00 $20.00 3/13/2003 $ 121,564 $ 268,624 100,000(3) 10.4 20.00 20.00 3/13/2008 1,257,789 3,187,485 Alex Bogaerts.............. -- -- -- -- -- -- -- Lin Ja Hong................ 15,000(4) 1.6 20.00 20.00 3/13/2008 188,668 478,123 Richard Macchia............ -- -- -- -- -- -- -- M. Thomas McNeight......... -- -- -- -- -- -- --
- --------------- (1) Future value assumes appreciation in the market value of the common stock of 5% and 10% per year over the ten-year option period as mandated by the rules and regulations of the Securities and Exchange Commission and does not represent the our estimate or projection of the future value of the common stock. The actual value realized may be greater than or less than the potential realizable values set forth in the table. (2) The option is immediately exercisable with respect to 5,000 shares and becomes exercisable for an additional 5,000 shares on January 1 of each of 1999, 2000 and 2001. The option shares are initially unvested and subject to repurchase by us. Our repurchase right shall lapse with respect to, and Mr. Noonan shall vest in all of the option shares on March 12, 2003, provided that Mr. Noonan remains in our service through such date. In addition, our repurchase right lapses on an accelerated basis based upon achievement of prescribed revenue levels. Based upon 1988 revenues, 5,000 additional shares vested on December 31, 1998. (3) The option is exercisable in its entirety on March 12, 2004, subject to acceleration based upon achievement of prescribed revenue levels. Based upon our 1998 revenues, 25,000 shares became exercisable on December 31, 1998. 47 52 (4) The shares underlying these options vest 25% per year over a four-year period and are subject to repurchase by us at the exercise price should Mr. Lin cease his employment with us prior to full vesting. If we are acquired by merger, consolidation or asset sale, the option shares will accelerate in full unless the successor assumes these options. In the event that the successor assumes these options, if within 12 months following the acquisition, Mr. Lin's position is reduced to a lesser position or Mr. Lin's employment is involuntarily terminated, the option shares will accelerate in part so that the next annual installment of option shares scheduled to vest will immediately vest in full and, to the extent Mr. Lin continues in our service, each installment of option shares scheduled to vest thereafter will vest on each subsequent anniversary of the acceleration date. Each option expires on the earlier of ten years from the date of grant or termination of Mr. Lin's employment with us. All options were granted at fair market value as determined by the board on the date of grant. AGGREGATE OPTION EXERCISES IN 1998 AND YEAR-END OPTION VALUES. The following table provides certain information concerning option exercises and option holdings for the fiscal year ended December 31, 1998 with respect to each of the Named Officers. AGGREGATE 1998 OPTION EXERCISES AND YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS ACQUIRED OPTIONS AT DECEMBER 31, 1998 AT DECEMBER 31, 1998(1) ON VALUE ---------------------------- --------------------------- NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - --------------------- -------- --------- ----------- ------------- ----------- ------------- Thomas E. Noonan..... -- $ -- 35,000(2) 85,000(2) $1,205,000 $2,955,000 Alex Bogaerts........ 16,250 519,969 28,750(3) -- 1,568,500 -- Lin Ja Hong.......... -- -- 27,500(3) 15,000 1,448,000 525,000 Richard Macchia...... -- -- 125,000(3) -- 6,000,000 -- M. Thomas McNeight... 100,000 2,742,356 135,000(3) -- 7,404,750 --
- --------------- (1) Value determined by subtracting the exercise price from the closing price per share of the common stock on the Nasdaq National Market on December 31, 1998 ($55.00 per share). (2) Mr. Noonan's options vest as described in footnotes (2) and (3) to the table captioned "Option Grants in 1998". (3) The shares purchasable upon exercise of these options are subject to repurchase by us at the exercise price upon the optionee's termination of employment prior to vesting in the shares. Our repurchase right lapses with respect to, and the optionee vests in, 25% of the option shares upon the optionee's completion of each year of service. As of December 31, 1998, the number of exercisable vested option shares for each named officer was as follows: Mr. Bogaerts -- no shares; Mr. Lin -- 6,875 shares; Mr. Macchia -- 31,250 shares; Mr. McNeight -- 17,500 shares. OUR STOCK OPTION PLAN The board of directors of Internet Security Systems, Inc. first adopted the Restated 1995 Stock Incentive Plan on September 6, 1995, and its stockholders approved this stock option plan on January 31, 1996. On December 8, 1997, we assumed this stock option plan and all outstanding options thereunder and converted such options on a share-for-share basis into options to purchase shares of our common stock. As of December 31, 1998, we had reserved 3,000,000 shares of common stock for issuance under our stock option plan. We will automatically increase this share reserve on the first trading day of each calendar year beginning with 1999 by an amount equal to three percent of the number of shares of common stock outstanding on the last trading day of the immediately preceding calendar year. Accordingly, on January 4, 1999, 518,762 additional shares of common stock were reserved for issuance under our stock option plan. No single participant in our stock option plan may receive option grants or direct stock issuances for more than 300,000 shares per calendar year. Our stock option plan has three separate components: - - the discretionary option grant program, which allows the plan administrator to grant options to purchase shares of common stock to eligible individuals at an exercise price equal to, greater than or less than their fair market value on the grant date; - - the stock issuance program, which allows the plan administrator to issue shares of 48 53 common stock directly to eligible individuals for a price equal to, greater than or less than their fair market value at the time of issuance, or as a bonus for services rendered; and - - the automatic option grant program, which automatically grants options to purchase shares of common stock at an exercise price equal to 100% of the fair market value of such shares on the grant date at periodic intervals to eligible non-employee board members. The compensation committee of the board administers the discretionary option grant program and the stock issuance program. The compensation committee, as current plan administrator, has complete discretion to determine: - - which eligible individuals are to receive option grants or stock issuances; - - the time or times when such option grants or stock issuances are to be made; - - the number of shares subject to each such grant or issuance; - - the status of any granted option as either an incentive stock option or a non-statutory stock option under the federal tax laws; - - the vesting schedule to be in effect for the option grant or stock issuance; and - - the maximum term for which any granted option is to remain outstanding. The administration of the automatic option grant program is self-executing in accordance with its express provisions. The exercise price for the shares of common stock subject to option grants made under our stock option plan may be paid in cash or in shares of common stock (held for the requisite period necessary to avoid a charge to our earnings for financial reporting purposes) valued at fair market value on the exercise date. The option may also be exercised through a same-day sale program without any cash outlay by the optionee. In addition, the plan administrator may provide financial assistance to optionees in the exercise of outstanding options by allowing optionees to deliver a full-recourse, interest-bearing promissory note in payment of the exercise price and any associated withholding taxes incurred in connection with such exercise. During the 90-day period following the date of this prospectus, optionees exercising options under our stock option plan will be required to enter into lock-up agreements with the representatives of the underwriters. If we are acquired by merger, consolidation or asset sale, each outstanding option under the discretionary option grant program which is not to be assumed by our successor will automatically become fully exercisable, and all unvested shares under the stock issuance program will immediately vest, except to the extent our repurchase rights with respect to those shares are to be assigned to our successor. In the event an outstanding option is assumed and our repurchase rights are assigned to our successor, and within 12 months following the merger, consolidation or asset sale, either the optionee is offered a lesser position compared to the position held by the optionee prior to the acquisition or the optionee's service is terminated, either involuntarily or through resignation as a result of being offered a lesser position, then the option will accelerate in part so that it will become immediately exercisable with respect to the next annual installment of option shares scheduled to vest. The plan administrator also has the authority under the discretionary option grant and stock issuance programs to grant options and to structure repurchase rights so that the shares subject to those options or repurchase rights will automatically vest in the event the individual is offered a lesser position or the individual's service is terminated, whether involuntarily or through a resignation as a result of being offered a lesser position, within a specified period (not to exceed 12 months) following a change in control effected by a successful tender offer for more than 50% of the outstanding voting stock or by proxy contest for the election of directors. The plan administrator also has the discretion to provide for the automatic acceleration of outstanding options and the lapse of any outstanding repurchase rights 49 54 upon certain changes in the ownership or control. In February 1998, we entered into an Amended and Restated Agreement Regarding Acceleration of Vesting of Future Optionees with Greylock Equity Limited Partnership ("Greylock"), Sigma Associates III, L.P., Sigma Investors III, L.P. and Sigma Partners III, L.P. (collectively, the "Sigma Entities"), AT&T Venture Fund II, L.P. and Venture Fund I, L.P. (collectively, the "AT&T Entities") and Kleiner, Perkins, Caufield & Byers VIII, KPCB Information Sciences Zaibatsu Fund II and KPCB Java Fund (collectively, the "KPCB Entities") which provides that, in all option grants made after the date of the agreement, we will provide that no more than the greater of (i) 50% of the unvested shares issued pursuant to such grant or (ii) the options which would be vested in such optionee's next vesting installment may become immediately vested in the event that (x) we sell, convey or otherwise dispose of all or substantially all of our property or business, or merge into or effect a reorganization with any corporation (other than a wholly-owned subsidiary corporation) in which our stockholders immediately prior to the transaction possess less than 50% of the voting power of the surviving entity (or its parent), and (y) the optionee is not offered a position with the surviving entity which (I) offers compensation equivalent to or greater than that provided to the optionee by us immediately prior to the change in control, and (II) offers duties and responsibilities comparable to those associated with the position held by the optionee with us immediately prior to the change in control such that the duties and responsibilities of the optionee with the surviving entity are not materially diminished from those of the optionee at our company. The discretionary option grant program authorizes the issuance of stock appreciation rights, which provide their holders with the election, subject to the plan administrator's approval, to surrender their outstanding options for an appreciation distribution from us equal to the excess of the fair market value of the vested shares of common stock subject to the surrendered option over the aggregate exercise price payable for such shares. In addition, the plan administrator has the authority to grant to certain officers and directors limited stock appreciation rights which, upon a hostile take-over (as defined in our stock option plan), generally provide the holders with the automatic right to surrender his or her outstanding options for an appreciation distribution from us equal to the excess of the tender price paid in the hostile take-over for the vested shares subject to the surrendered options over the aggregate exercise price payable for such shares. Such appreciation distribution may be made in cash or in shares of common stock. The plan administrator also has the authority to effect the cancellation of outstanding options under the discretionary option grant program with the consent of the affected option holders in return for the grant of new options for the same or different number of option shares with an exercise price per share based upon the fair market value of the common stock on the new grant date. Under the automatic option grant program, each individual who first joins the board as a non-employee director will receive an option to purchase 20,000 shares of common stock on the date he or she is first elected or appointed to the board, provided he or she has not otherwise been in our prior employ. In addition, at each annual stockholders meeting each individual who is to continue to serve as a non-employee board member after the meeting will receive an additional option to purchase 2,500 shares of common stock. Each automatic grant will have a term of 10 years, subject to earlier termination following the optionee's cessation of board service. Each automatic option will be immediately exercisable; however, any shares purchased upon exercise of the option will be subject to repurchase by us should the optionee's service as a non-employee board member cease prior to vesting in the shares. An initial 20,000-share grant will vest in four equal successive annual installments over an optionee's period of board service. However, the shares subject to each initial automatic 50 55 grant will immediately vest upon certain changes in the ownership or control of our company or upon the death or disability of the optionee while serving as a board member. Each additional 2,500-share grant will vest immediately. The board may amend or modify our stock option plan at any time. Our stock option plan will terminate on the earliest of September 6, 2005, the date on which all available shares have been issued as vested shares or the termination of all outstanding options in connection with certain changes in the ownership or control. 51 56 CERTAIN TRANSACTIONS SALE OF SERIES A PREFERRED STOCK In February 1996, we sold an aggregate of 3,650,000 shares of our Series A preferred stock for $1.00 per share in a private placement exempt from registration under Section 4(2) of the Securities Act of 1933. The purchasers of the Series A preferred stock included, among others, Greylock and the Sigma Entities. The Series A preferred stock automatically converted into common stock on a one-for-one basis upon the completion of our initial public offering. Concurrently with the closing of the financing, David N. Strohm, an employee of Greylock and the general partner of several venture capital funds associated with Greylock, and Robert E. Davoli, a general partner of the Sigma Entities, joined the board. In connection with the sale of the Series A preferred stock, we entered into an agreement with Greylock and Sigma Partners concerning certain of the shares of the common stock sold by the underwriters of the initial public offering of the common stock to persons designated by us ("Directed Shares"). This agreement required us to use our best efforts to cause Greylock and the Sigma Entities to receive up to 100,000 Directed Shares at the initial public offering price. Pursuant to this right, Greylock and the Sigma Entities purchased 36,488 and 27,674 Directed Shares, respectively, in our initial public offering. Also in connection with the 1996 Series A preferred stock financing, we: - - entered into an Agreement Regarding Acceleration of Vesting of Future Optionees with Greylock and the Sigma Entities, which was later amended and restated to make certain technical clarifications; - - entered into a Rights Agreement, which was amended and restated in connection with the sale of our Series B preferred stock; and - - repurchased 100,000 shares of common stock from Christopher W. Klaus, a founder, officer and director of the Company, for $15,000. SALE OF SERIES B PREFERRED STOCK In February 1997, we sold an aggregate of 2,086,957 shares of our Series B preferred stock for $2.53 per share in a private placement exempt from registration under Section 4(2) of the Securities Act of 1933. The purchasers of the Series B preferred stock included, among others, Greylock, the Sigma Entities, the AT&T Entities and the KPCB Entities. The Series B preferred stock automatically converted into common stock on a one-for-one basis upon the closing of our initial public offering. Richard S. Bodman, the managing general partner of the AT&T Entities, joined our board in July 1997. In connection with the sale of the Series B preferred stock, we entered into an agreement with the AT&T Entities and Kleiner, Perkins, Caufield & Byers ("KPCB") concerning Directed Shares. This agreement required us to use our best efforts to cause the AT&T Entities and KPCB to receive up to 100,000 Directed Shares at the initial public offering price. Pursuant to this right, the AT&T Entities and KPCB purchased 15,141 and 19,789 Directed Shares, respectively in our initial public offering. In connection with the sale of the Series B preferred stock, we also entered into an Agreement Regarding Acceleration of Vesting of Future Optionees with the AT&T Entities and the KPCB Entities, which was later amended and restated to make certain technical clarifications. We also entered into an Amended and Restated Rights Agreement. Pursuant to this agreement, purchasers of the Series A preferred stock and Series B preferred stock have the right, subject to certain conditions and limitations, to require us to file a registration statement, including, if requested, a shelf registration statement, under the Securities Act of 1933 in order to register all or part of their shares of common stock. In certain circumstances, we may defer such registrations, and the underwriters have the right, subject to certain limitations, to limit the number of shares included in such registrations. In the event that we propose to register any of our securities under the 52 57 Securities Act of 1933, either for our account or for the account of other security holders, the purchasers of the Series A preferred stock and Series B preferred stock and certain holders of the common stock, including Christopher W. Klaus, Thomas E. Noonan and Kevin J. O'Connor, are entitled to include their shares of common stock in such registration, subject to marketing and other limitations. Generally, we are required to bear all expenses associated with such registrations. AMENDED AND RESTATED AGREEMENT REGARDING ACCELERATION OF FUTURE OPTIONEES In February 1998, we entered into an Amended and Restated Agreement Regarding Acceleration of Vesting of Future Optionees with Greylock, the Sigma Entities, the AT&T Entities and the KPCB Entities which restricts the acceleration of vesting of shares subject to options in certain situations. For a more detailed description of this agreement, see "Management -- Our Stock Option Plan". FUTURE TRANSACTIONS All future transactions, including loans, between us and our officers, directors, principal stockholders and their affiliates, will be approved by a majority of the board, including a majority of the independent and disinterested outside directors on the board, and will continue to be on terms no less favorable to us than could be obtained from unaffiliated third parties. 53 58 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information regarding beneficial ownership of the common stock as of January 28, 1999 adjusted to reflect the sale of shares offered hereby for - - each person who is known by us to own beneficially more than five percent of the common stock; - - each Named Officer; - - each director; - - each selling stockholder; and - - all current executive officers and directors as a group. Unless otherwise indicated, the address for the following stockholders is c/o ISS Group, Inc., 6600 Peachtree-Dunwoody Road, 300 Embassy Row, Suite 500, Atlanta, Georgia 30328.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED BEFORE THE OWNED AFTER THE OFFERING NUMBER OFFERING(1)(2) ------------------------ OF SHARES ----------------------- BENEFICIAL OWNER NUMBER PERCENTAGE OFFERED NUMBER PERCENTAGE - ----------------------------------- ----------- ---------- --------- ---------- ---------- Christopher W. Klaus............... 3,915,276 22.6% 800,000 3,115,276 16.8% Ark Asset Management Co., Inc.(3).. 2,740,000 15.8 -- 2,740,000 14.8 Thomas E. Noonan(4)................ 1,621,070 9.3 140,000 1,481,070 8.0 Greylock Equity Limited Partnership(5)................... 885,991 5.1 -- 885,991 4.8 Alex Bogaerts(6)................... 42,600 * 3,000 39,600 * Lin Ja Hong(7)..................... 31,250 * 2,500 28,750 * Rich Macchia(8).................... 125,600 * 12,500 112,500 * M. Thomas McNeight(9).............. 135,000 * 17,000 118,000 * Richard S. Bodman(10).............. 281,638 1.6 -- 281,638 1.5 Robert E. Davoli(11)............... 841,762 4.9 -- 841,762 4.5 Kevin J. O'Connor(12).............. 473,980 2.7 70,000 403,980 2.2 David N. Strohm(5)................. 885,991 5.1 -- 885,991 4.8 Nancy Blair(13).................... 157,500 * 20,000 137,500 * H. Keith Cooley(14)................ 130,000 * 30,000 100,000 * Glenn M. McGonnigle(15)............ 166,590 * 60,000 106,590 * Charles Meyers(16)................. 90,000 * 20,000 70,000 Patrick J.D. Taylor(17)............ 59,500 * 25,000 34,500 * All directors and officers as a group (11 persons)(18)........... 8,484,167 47.5 1,075,000 7,409,167 38.9
- --------------- * Indicates less than 1%. (1) Assumes no exercise of the underwriters' over-allotment option. (2) Beneficial ownership is calculated in accordance with the rules of the Securities and Exchange Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to options held by that person that are currently exercisable or become exercisable within 60 days following January 28, 1999, are deemed outstanding. However, such shares are not deemed outstanding for the purpose of computing the percentage ownership of any other person. Unless otherwise indicated in the footnotes to this table, the persons and entities named in the table have sole voting and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable. (3) Based solely on information provided by Ark Asset Management Co., Inc. on its Schedule 13G filed December 9, 1998 with the Securities and Exchange Commission. The address for Ark Asset Management Co., Inc. is 125 Broad Street, New York, New York 10004. 54 59 (4) Includes 168,822 shares held in family trusts and options immediately exercisable for 35,000 shares of common stock. (5) Includes 83,760 shares of common stock held by Mr. Strohm and 802,231 shares held by Greylock Equity Limited Partnership. The general partner of Greylock Equity Limited Partnership is Greylock Equity GP Limited Partnership. Mr. Strohm, a director of our company, is a general partner of Greylock Equity GP Limited Partnership. Mr. Strohm disclaims beneficial ownership of the shares held by Greylock Equity Limited Partnership except to the extent of his pecuniary interest therein arising from his general partnership interest in Greylock Equity GP Limited Partnership. The address of Greylock Equity Limited Partnership and Mr. Strohm is c/o Greylock Equity Limited Partnership, 755 Page Mill Road, Building A, Palo Alto, California 94304. (6) Includes options immediately exercisable for 28,750 shares of common stock. (7) Includes options immediately exercisable for 31,250 shares of common stock. (8) Includes option immediately exercisable for 125,000 shares of common stock. (9) Includes options immediately exercisable for 135,000 shares of common stock. (10) Includes 66 shares of common stock and options immediately exercisable for 20,000 shares of common stock held by Mr. Bodman and 261,572 shares held by AT&T Venture Fund II, L.P. The general partner of AT&T Venture Fund II, L.P. is Venture Management LLC. Mr. Bodman is a managing member of Venture Management LLC. Mr. Bodman disclaims beneficial ownership of the shares held by AT&T Venture Fund II, L.P. except to the extent of his pecuniary interest therein from his management interest in Venture Management LLC. Mr. Bodman's address is c/o AT&T Ventures, L.L.C., Two Wisconsin Circle, Chevy Chase, Maryland 20815. (11) Includes 49,340 shares of common stock and options immediately exercisable for 20,000 shares of common stock held by Mr. Davoli, 125,472 shares held by Sigma Associates III, L.P., 10,175 shares held by Sigma Investors III, L.P. and 636,775 shares held by Sigma Partners III, L.P. Mr. Davoli, a director of our company, is also a general partner of Sigma Management III, L.P., which is the general partner of Sigma Associates III, L.P., Sigma Investors III, L.P. and Sigma Partners III, L.P. Mr. Davoli disclaims beneficial ownership of the shares held by Sigma Associates III, L.P., Sigma Investors III, L.P. and Sigma Partners III, L.P. except to the extent of his pecuniary interest therein from his general partnership interest in Sigma Management III, L.P. The address of Mr. Davoli and the Sigma Entities is 20 Custom House Street, Suite 830, Boston, Massachusetts 02110. (12) Includes options immediately exercisable for 20,000 shares of common stock. In addition to the number of shares shown as offered for sale in the table, Mr. O'Connor has granted the underwriters the right to purchase up to an additional 20,000 shares pursuant to the underwriters' over-allotment option. Mr. O'Connor's address is c/o DoubleClick Inc., 41 Madison Avenue, New York, New York 10010. (13) Includes options immediately exercisable for 157,500 shares of common stock. (14) Includes options immediately exercisable for 130,000 shares of common stock. (15) Includes options immediately exercisable for 85,500 shares of common stock. In addition to the number of shares shown as offered for sale in the table, Mr. McGonnigle has granted the underwriters the right to purchase up to an additional 10,000 shares pursuant to the underwriters' over-allotment option. (16) Includes options immediately exercisable for 90,000 shares common stock. (17) Includes options immediately exercisable for 14,500 shares of common stock. (18) Includes options immediately exercisable for 545,000 shares of common stock. 55 60 DESCRIPTION OF SECURITIES AUTHORIZED AND OUTSTANDING CAPITAL STOCK Our authorized capital stock consists of 50,000,000 shares of common stock, par value $0.001 per share, and 20,000,000 shares of preferred stock, par value $0.001 per share. Upon consummation of this offering, no shares of preferred stock and 18,512,462 shares of common stock (18,842,462 shares if the underwriters' over-allotment option is exercised in full) will be outstanding. The following summary is qualified in its entirety by reference to our charter and bylaws, copies of which are filed as exhibits to the registration statement of which this prospectus is a part. COMMON STOCK As of December 31, 1998, there were 17,292,087 shares of common stock outstanding that were held by 201 stockholders of record. The holders of common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Subject to preferences that may be applicable to any outstanding preferred stock, the holders of common stock are entitled to receive ratably such dividends, if any, as may be declared from time to time by the board out of funds legally available therefor. In the event of liquidation, dissolution or winding up, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock, if any, then outstanding. The common stock has no preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and nonassessable, and the shares of common stock to be issued upon completion of this offering will be fully paid and nonassessable. PREFERRED STOCK The board has the authority to issue the preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series, without further vote or action by the stockholders. The issuance of preferred stock may have the effect of delaying, deferring or preventing a change in control of our company without further action by the stockholders and may adversely affect the voting and other rights of the holders of common stock. The issuance of preferred stock with voting and conversion rights may adversely affect the voting power of the holders of common stock, including the loss of voting control to others. At present, we have no plans to issue any shares of preferred stock. STOCK OPTIONS As of December 31, 1998, options to purchase a total of 2,379,670 shares of common stock were outstanding. The total number of shares of common stock that may be subject to the granting of options under our stock option plan shall be equal to 3,000,000 shares plus the number of shares with respect to options previously granted under our stock option plan that terminate without being exercised, expire, are forfeited or canceled, and the number of shares of common stock that are surrendered in payment of any options or any tax withholding requirements. In addition, on the first trading date of each year, the share reserve will be increased by an amount equal to three percent of the total number of shares of common stock outstanding on the last trading day of the immediately preceding calendar year. Pursuant to this automatic increase provision, on January 4, 1999 an additional 518,762 shares of common stock were reserved for issuance under our stock option plan. See "Management -- Our Stock Option Plan" and "Shares Eligible for Future Sale". On May 21, 1998, we filed a registration statement with the Securities and Exchange Commission pursuant to which we registered 56 61 the 3,000,000 shares of common stock issued or issuable at that time upon the exercise of options granted under our stock option plan. Such registration statement became immediately effective upon filing. We have outstanding a large number of stock options to purchase common stock with exercise prices significantly below the current market price of the common stock. The possible sale of a significant number of such shares by the holders thereof may have an adverse effect on the price of the common stock. CERTAIN ANTI-TAKEOVER, LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW We are subject to the provisions of Section 203 of the Delaware General Corporation Law, as amended from time to time. Subject to certain exceptions, Section 203 prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the interested stockholder attained such status with the approval of the board of directors or unless the business combination is approved in a prescribed manner. A "business combination" includes mergers, assets sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, 15% or more of the corporation's voting stock. The statute could prohibit or delay the accomplishment of mergers or other takeover or change in control attempts with respect to us and, accordingly, may discourage attempts to acquire our company. CHARTER AND BYLAW PROVISIONS Our charter and bylaws include provisions that may have the effect of discouraging, delaying or preventing a change in control or an unsolicited acquisition proposal that a stockholder might consider favorable, including a proposal that might result in the payment of a premium over the market price for the shares held by stockholders. These provisions are summarized in the following paragraphs. CLASSIFIED BOARD OF DIRECTORS. Our charter and bylaws provide for the board to be divided into three classes of directors serving staggered, three-year terms. The classification of the board has the effect of requiring at least two annual stockholder meetings, instead of one, to replace a majority of board members. SUPERMAJORITY VOTING. Our charter requires that holders of at least 66 2/3% of our company's combined voting power approve certain amendments to the charter unless such amendments are approved by a majority of the directors not affiliated or associated with any person holding (or which has announced an intention to acquire) 26% or more of the voting power of our outstanding capital stock. Either a majority of the board or holders of a majority of voting stock may amend the bylaws, but certain amendments approved by stockholders require the approval of at least 66 2/3% of our combined voting power unless such amendments are approved by a majority of the directors not affiliated or associated with any person holding (or which has announced an intention to acquire) 26% or more of the voting power of our outstanding capital stock. AUTHORIZED BUT UNISSUED OR UNDESIGNATED CAPITAL STOCK. Our charter authorizes 50,000,000 shares of common stock and 20,000,000 shares of preferred stock. No preferred stock will be designated upon consummation of this offering. After this offering, 18,512,462 shares of common stock will be outstanding (18,842,462 shares if the underwriters' over-allotment option is exercised in full). The authorized but unissued (and in the case of preferred stock, undesignated) stock may be issued by the board in one or more transactions. In this regard, our charter grants the board broad power to establish the rights and preferences of authorized and unissued preferred stock. The issuance of shares of preferred stock pursuant to the board's authority described 57 62 above could decrease the amount of earnings and assets available for distribution to holders of common stock and adversely affect the rights and powers, including voting rights, of such holders and may have the effect of delaying, deferring or preventing a change in control. The board does not currently intend to seek stockholder approval prior to any issuance of preferred stock, unless otherwise required by law. SPECIAL MEETINGS OF STOCKHOLDERS. Our bylaws provide that special meetings of our stockholders may be called only by our board, chairman or President. NO STOCKHOLDER ACTION BY WRITTEN CONSENT. Our charter and bylaws provide that an action required or permitted to be taken at any annual or special meeting of the stockholders may only be taken at a duly called annual or special meeting of stockholders. This provision prevents stockholders from initiating or effecting any action by written consent, and thereby taking actions opposed by the board. NOTICE PROCEDURES. Our bylaws establish advance notice procedures with regard to all stockholder proposals to be brought before meetings of our stockholders, including proposals relating to the nomination of candidates for election as directors, the removal of directors and amendments to our charter or bylaws. These procedures require notice of such stockholder proposals to be given timely and in writing to our corporate secretary prior to the meeting. Generally, to be timely, notice must be received by our corporate secretary not less than 120 days prior to the meeting. The notice must contain certain information specified in our bylaws. OTHER ANTI-TAKEOVER PROVISIONS. See "Management -- Our Stock Option Plan" for a discussion of certain provisions of our stock option plan which may have the effect of discouraging, delaying or preventing a change in control or unsolicited acquisition proposals. LIMITATION OF DIRECTOR LIABILITY. Our charter limits the liability of directors (in their capacity as directors but not in their capacity as officers) to our company or our stockholders to the fullest extent permitted by Delaware law. Specifically, directors will not be personally liable for monetary damages for breach of a director's fiduciary duty as a director, except for liability: - - for any breach of the director's duty of loyalty to our company or our stockholders; - - for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; - - under Section 174 of the Delaware General Corporation Law, which relates to unlawful payments of dividends or unlawful stock repurchases or redemptions; or - - for any transaction from which the director derived an improper personal benefit. INDEMNIFICATION ARRANGEMENTS. Our bylaws provide that our directors and officers shall be indemnified and provide for the advancement to them of expenses in connection with actual or threatened proceedings and claims arising out of their status as such to the fullest extent permitted by the Delaware General Corporation Law. We have entered into indemnification agreements with each of our directors and executive officers that will provide them with rights to indemnification and expense advancement to the fullest extent permitted under the Delaware General Corporation Law. REGISTRATION RIGHTS Pursuant to the terms of the Amended and Restated Rights Agreement between our company and certain existing stockholders, the holders of 2,222,761 shares of common stock have the right, subject to certain conditions and limitations, to require us to file a registration statement, including, if requested, a shelf registration statement, under the Securities Act of 1933 in order to register all or part of such stockholders' shares of common stock. We may in certain circumstances defer such registrations, and the underwriters have the right, subject to certain limitations, to limit the number of 58 63 shares included in such registrations. In the event that we propose to register any of our securities under the Securities Act of 1933, either for our own account or for the account of other security holders, certain stockholders holding 7,189,177 shares of common stock are entitled to include their shares of common stock in such registration, subject to marketing and other limitations. Generally, we are required to bear the expense of all such registrations. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the common stock is SunTrust Bank, Atlanta, located in Atlanta, Georgia. 59 64 SHARES ELIGIBLE FOR FUTURE SALE Upon the closing of the offering, we will have an aggregate of 18,512,462 shares of common stock outstanding, assuming no exercise of the underwriters' over-allotment option and no exercise of outstanding options to purchase common stock after December 31, 1998. Of these shares, the 3,450,000 shares sold in our IPO in March 1998, the 2,400,000 shares being offered hereby and 5,165,872 shares that have been sold in accordance with Rule 144 are freely tradeable. Of the remaining outstanding shares of common stock, (i) approximately 6,982,398 shares are subject to 90-day lock-up agreements, approximately 6,851,580 of which are also "restricted securities" as that term is defined under Rule 144, and (ii) approximately 514,192 shares are "restricted securities", as that term is defined under Rule 144, and not subject to lock-up agreements. The 6,982,398 shares that are subject to 90-day lock-up agreements will be eligible for immediate sale in the public market without restriction on their expiration except that the 6,941,308 shares which are also held by our "affiliates" may only be sold in compliance with the volume and other limitations of Rule 144. In general, under Rule 144, a person (or persons whose shares are aggregated), including an affiliate, who has beneficially owned shares for at least one year is entitled to sell, within any three-month period commencing 90 days after the date of this prospectus, a number of shares that does not exceed the greater of 1% of the then outstanding shares of common stock (approximately 185,125 shares immediately after the offering) or the average weekly trading volume in the common stock during the four calendar weeks preceding the date on which notice of such sale is filed, subject to certain restrictions. In addition, a person who is not deemed to have been an affiliate of us at any time during the 90 days preceding a sale and who has beneficially owned the shares proposed to be sold for at least two years would be entitled to sell such shares under Rule 144(k) without regard to the share volume limitations described above. To the extent that shares were acquired from an affiliate of us, such affiliates' holding period for the purpose of effecting a sale under Rule 144 commences on the date of transfer from the affiliate. On May 21, 1998, we filed a registration statement with the Commission pursuant to which it registered the 3,000,000 shares of common stock issued or issuable upon the exercise of options granted or that may be granted in the future under our stock option plan, as well as 100,000 shares of common stock that were subject to options granted pursuant to written compensation agreements separate from our stock option plan. Such registration statement became immediately effective upon filing. At December 31, 1998, options to purchase 2,379,670 shares were issued and outstanding under our stock option plan and options to purchase 60,000 shares were issued and outstanding outside of our stock option plan, all of which shares will be eligible for sale in the public market from time to time, subject to vesting and, in the case of certain of such options, the expiration of lock-up agreements. These stock options generally have exercise prices significantly below the current market price of the common stock. The possible sale of a significant number of such shares by the holders thereof may have an adverse affect on the price of the common stock. The market price of the common stock after the offering may be significantly affected by the risks detailed in this prospectus, including, but not limited to, those set forth under the caption "Risk Factors". In particular, the stock prices for many high technology companies, especially those that base their respective businesses on the Internet, recently have experienced wide fluctuations and extreme volatility which have often been unrelated to the operating performance of such companies. Such fluctuations have adversely affected and may in the future adversely affect the market price of the common stock. Furthermore, following periods of volatility in the market price of a company's securities, securities class action 60 65 claims frequently are brought against the subject company. To the extent that the market price of the common stock falls dramatically in any period of time, there is a high likelihood that claims, with or without merit, will be brought against us. Such litigation would be very expensive to defend and would divert management attention and resources regardless of outcome. 61 66 VALIDITY OF COMMON STOCK The validity of the common stock offered hereby will be passed upon for ISS by Brobeck, Phleger & Harrison LLP, Austin, Texas, U.S. counsel to ISS. Certain legal matters in connection with the offering will be passed upon for the underwriters by Ropes & Gray, Boston, Massachusetts, U.S. counsel for the underwriters. EXPERTS ISS GROUP, INC. The consolidated financial statements and schedule audited by Ernst & Young LLP have been included in reliance on their report given on their authority as experts in accounting and auditing. MARCH INFORMATION SYSTEMS LIMITED The financial statements audited by Ernst & Young have been included in reliance on their report given on their authority as experts in accounting and auditing. ADDITIONAL INFORMATION We have filed with the Securities and Exchange Commission a registration statement on Form S-1 (including the exhibits and schedules thereto) under the Securities Act of 1933 with respect to the shares to be sold in the offering. This prospectus does not contain all of the information set forth in the registration statement. For further information with respect to us and the shares to be sold in the offering, reference is made to the registration statement. Statements contained in this prospectus as to the contents of any contract, agreement or other document referred to are not necessarily complete, and in each instance reference is made to the copy of such contract, agreement or other document filed as an exhibit to the registration statement, each such statement being qualified in all respects by such reference. In addition, we file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission. You may read and copy all or any portion of the registration statement or any reports, statements or other information we file at the Securities and Exchange Commission's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can request copies of these documents, upon payment of a duplicating fee, by writing to the Securities and Exchange Commission. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of the public reference rooms. Our filings with the Securities and Exchange Commission, including the registration statement of which this prospectus is a part, are also available to you on the Securities and Exchange Commission's Internet site (http://www.sec.gov). In addition, reports, proxy statements and other information concerning our company may be inspected at the National Association of Securities Dealers, Inc. at 1735 K Street, N.W., Washington, D.C. 20006. 62 67 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ISS GROUP, INC. Report of Independent Auditors.............................. F-2 Consolidated Balance Sheets as of December 31, 1997 and 1998...................................................... F-3 Consolidated Statements of Operations for the Years Ended December 31, 1996, 1997 and 1998.......................... F-4 Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended December 31, 1996, 1997 and 1998...... F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1997 and 1998.......................... F-6 Notes to Consolidated Financial Statements.................. F-7 MARCH INFORMATION SYSTEMS LIMITED Report of Independent Auditors.............................. F-18 Consolidated Balance Sheets as of March 31, 1997 and 1998 and September 30, 1998 (unaudited)........................ F-19 Consolidated Statements of Operations for the Years Ended March 31, 1997 and 1998 and the Six Months Ended September 30, 1997 and 1998 (unaudited)............................. F-20 Consolidated Statements of Shareholders' Equity for the Years Ended March 31, 1997 and 1998 and the Six Months Ended September 30, 1998 (unaudited)...................... F-21 Consolidated Statements of Cash Flows for the Years Ended March 31, 1997 and 1998 and the Six Months Ended September 30, 1997 and 1998 (unaudited)............................. F-22 Notes to Consolidated Financial Statements.................. F-23 Unaudited Pro Forma Consolidated Statement of Operations.... F-30
F-1 68 REPORT OF INDEPENDENT AUDITORS Board of Directors ISS Group, Inc. We have audited the accompanying consolidated balance sheets of ISS Group, Inc. as of December 31, 1997 and 1998, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ISS Group, Inc. at December 31, 1997 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP January 15, 1999 F-2 69 ISS GROUP, INC. CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ------------------------ 1997 1998 ---------- ----------- ASSETS Current assets: Cash and cash equivalents................................. $3,929,000 $52,632,000 Accounts receivable, less allowance for doubtful accounts of $255,000 and $287,000, respectively................. 4,038,000 12,586,000 Prepaid expenses and other current assets................. 281,000 743,000 ---------- ----------- Total current assets.............................. 8,248,000 65,961,000 Property and equipment: Computer equipment........................................ 1,688,000 4,370,000 Office furniture and equipment............................ 268,000 1,027,000 Leasehold improvements.................................... 15,000 275,000 ---------- ----------- 1,971,000 5,672,000 Less accumulated depreciation............................. 402,000 1,655,000 ---------- ----------- 1,569,000 4,017,000 Goodwill, less accumulated amortization of $77,000.......... -- 3,094,000 Other intangible assets, less accumulated amortization of $154,000.................................................. -- 4,692,000 Other assets................................................ 49,000 257,000 ---------- ----------- Total assets......................................... $9,866,000 $78,021,000 ========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable.......................................... $2,002,000 $ 692,000 Accrued expenses.......................................... 1,798,000 4,202,000 Deferred revenues......................................... 2,106,000 6,678,000 Current portion of long-term debt......................... 70,000 -- ---------- ----------- Total current liabilities............................ 5,976,000 11,572,000 Long-term debt.............................................. 70,000 -- Other liabilities........................................... -- 134,000 Commitments and contingencies Redeemable, Convertible Preferred Stock (5,737,000 shares authorized): Series A; $.001 par value; 3,650,000 and 0 shares issued and outstanding, respectively (liquidation preference $1 per share).......................................... 3,621,000 -- Series B; $.001 par value; 2,087,000 and 0 shares issued and outstanding, respectively (liquidation preference $2.53 per share)....................................... 5,257,000 -- Stockholders' equity (deficit): Preferred stock; $.001 par value; 20,000,000 shares authorized, none issued or outstanding Common stock, $.001 par value, 50,000,000 shares authorized, 7,921,000 and 17,292,000 shares issued and outstanding, respectively.............................. 8,000 17,000 Additional paid-in capital................................ 695,000 76,110,000 Deferred compensation..................................... (571,000) (662,000) Cumulative adjustment for currency revaluation............ -- 142,000 Accumulated deficit....................................... (5,190,000) (9,292,000) ---------- ----------- Total stockholders' equity (deficit)................. (5,058,000) 66,315,000 ---------- ----------- Total liabilities and stockholders' equity (deficit)........................................... $9,866,000 $78,021,000 ========== ===========
See accompanying notes. F-3 70 ISS GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, --------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Revenues: Perpetual licenses................................ $ 4,233,000 $10,936,000 $25,936,000 Subscriptions..................................... 219,000 2,465,000 7,406,000 Professional services............................. 10,000 66,000 2,587,000 ----------- ----------- ----------- 4,462,000 13,467,000 35,929,000 Costs and expenses: Cost of revenues.................................. 18,000 676,000 4,831,000 Research and development.......................... 1,225,000 3,434,000 9,321,000 Charge for in-process research and development.... -- -- 802,000 Sales and marketing............................... 3,768,000 11,731,000 22,762,000 General and administrative........................ 656,000 1,773,000 4,389,000 Amortization...................................... -- -- 230,000 ----------- ----------- ----------- 5,667,000 17,614,000 42,335,000 ----------- ----------- ----------- Operating loss...................................... (1,205,000) (4,147,000) (6,406,000) Interest income..................................... 77,000 245,000 2,382,000 Interest expense.................................... (3,000) (17,000) (16,000) ----------- ----------- ----------- Loss before income taxes............................ (1,131,000) (3,919,000) (4,040,000) Provision for income taxes.......................... -- -- 62,000 =========== =========== =========== Net loss............................................ $(1,131,000) $(3,919,000) $(4,102,000) =========== =========== =========== Basic and diluted net loss per share of Common Stock............................................. $ (0.14) $ (0.50) $ (0.28) =========== =========== =========== Weighted average number of shares used in calculating basic and diluted net loss per share of Common Stock................................... 7,916,000 7,907,000 14,883,000 =========== =========== =========== Unaudited pro forma net loss per share of Common Stock............................................. $ (0.29) $ (0.25) =========== =========== Unaudited weighted average number of shares used in calculating unaudited pro forma net loss per share of Common Stock................................... 13,644,000 16,189,000 =========== ===========
See accompanying notes. F-4 71 ISS GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
ACCUMULATED RETAINED COMMON STOCK ADDITIONAL OTHER EARNINGS -------------------- PAID-IN DEFERRED COMPREHENSIVE (ACCUMULATED SHARES AMOUNT CAPITAL COMPENSATION INCOME DEFICIT) ---------- ------- ----------- ------------ -------------- ------------- Balance at December 31, 1995............... 8,002,000 $8,000 $ 125,000 $ -- $ -- $ (140,000) Comprehensive income (loss) Net loss............................... -- -- -- -- -- (1,131,000) Repurchase of Common Stock from founder................................ (100,000) -- (15,000) -- -- -- Accretion related to Redeemable, Convertible Preferred Stock............ -- -- (7,000) -- -- -- ---------- ------- ----------- --------- -------- ----------- Balance at December 31, 1996............... 7,902,000 8,000 103,000 -- -- -- Comprehensive income (loss) Net loss............................... -- -- -- -- -- (3,919,000) Accretion related to Redeemable, Convertible Preferred Stock............ -- -- (11,000) -- -- -- Deferred compensation related to stock options................................ -- -- 571,000 (571,000) -- -- Issuance of Common Stock................. 19,000 -- 32,000 -- -- -- ---------- ------- ----------- --------- -------- ----------- Balance at December 31, 1997............... 7,921,000 8,000 695,000 (571,000) -- (5,190,000) Comprehensive income (loss) Net loss............................... -- -- -- -- -- (4,102,000) Translation adjustment................. -- -- -- -- 142,000 -- -- -- -- -- -- -- Issuance of Common Stock: Initial public offering................ 3,070,000 3,000 61,528,000 -- -- -- Conversion of Redeemable, Convertible Preferred Stock in connection with the initial public offering.......... 5,737,000 6,000 8,872,000 -- -- -- Acquisitions........................... 158,000 -- 3,901,000 -- -- -- Exercise of stock options.............. 405,000 -- 292,000 -- -- -- Issuance to consultant................. 1,000 -- 11,000 -- -- -- Deferred compensation related to stock options................................ -- -- 811,000 (811,000) -- -- Amortization of deferred compensation in connection with stock options.......... -- -- -- 720,000 -- -- ---------- ------- ----------- --------- -------- ----------- Balance at December 31, 1998............... 17,292,000 $17,000 $76,110,000 $(662,000) $142,000 $(9,292,000) ========== ======= =========== ========= ======== =========== TOTAL STOCKHOLDERS' COMPREHENSIVE EQUITY INCOME (DEFICIT) ------------- -------------- Balance at December 31, 1995............... -- $ (7,000) Comprehensive income (loss) Net loss............................... $(1,131,000) (1,131,000) =========== Repurchase of Common Stock from founder................................ -- (15,000) Accretion related to Redeemable, Convertible Preferred Stock............ -- (7,000) ----------- Balance at December 31, 1996............... (1,160,000) Comprehensive income (loss) Net loss............................... $(3,919,000) (3,919,000) =========== Accretion related to Redeemable, Convertible Preferred Stock............ -- (11,000) Deferred compensation related to stock options................................ -- -- Issuance of Common Stock................. -- 32,000 ----------- Balance at December 31, 1997............... -- (5,058,000) Comprehensive income (loss) Net loss............................... $(4,102,000) (4,102,000) Translation adjustment................. 142,000 142,000 ----------- $(3,960,000) -- =========== Issuance of Common Stock: Initial public offering................ -- 61,531,000 Conversion of Redeemable, Convertible Preferred Stock in connection with the initial public offering.......... -- 8,878,000 Acquisitions........................... -- 3,901,000 Exercise of stock options.............. -- 292,000 Issuance to consultant................. -- 11,000 Deferred compensation related to stock options................................ -- -- Amortization of deferred compensation in connection with stock options.......... 720,000 ----------- Balance at December 31, 1998............... $66,315,000 ===========
See accompanying notes. F-5 72 ISS GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, --------------------------------------- 1996 1997 1998 ----------- ----------- ----------- OPERATING ACTIVITIES Net loss............................................ $(1,131,000) $(3,919,000) $(4,102,000) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation................................... 66,000 334,000 1,253,000 Amortization of goodwill and intangibles....... -- -- 231,000 Charge for in-process research and development.................................. -- -- 802,000 Amortization of deferred compensation.......... -- -- 720,000 Other non-cash expense......................... -- 31,000 118,000 Changes in assets and liabilities, excluding the effects of acquisitions: Accounts receivable....................... (1,802,000) (2,089,000) (8,107,000) Prepaid expenses and other assets......... (146,000) (179,000) (501,000) Accounts payable and accrued expenses..... 955,000 2,728,000 776,000 Deferred revenues......................... 607,000 1,462,000 4,461,000 ----------- ----------- ----------- Net cash used in operating activities..... (1,451,000) (1,632,000) (4,349,000) ----------- ----------- ----------- INVESTING ACTIVITIES Acquisitions, net of cash acquired.................. -- -- (5,206,000) Purchases of property and equipment................. (320,000) (1,630,000) (3,567,000) ----------- ----------- ----------- Net cash used in investing activities............... (320,000) (1,630,000) (8,773,000) ----------- ----------- ----------- FINANCING ACTIVITIES Proceeds from (payments on) long-term debt.......... 210,000 (70,000) (140,000) Net proceeds from Redeemable, Convertible Preferred Stock issuances................................... 3,607,000 5,253,000 -- Payments on notes payable to shareholder............ (30,000) -- -- Net proceeds from initial public offering........... -- -- 61,531,000 Other Common Stock activities....................... (15,000) 1,000 292,000 ----------- ----------- ----------- Net cash provided by financing activities........... 3,772,000 5,184,000 61,683,000 ----------- ----------- ----------- Foreign currency impact on cash..................... -- -- 142,000 Net increase in cash and cash equivalents........... 2,001,000 1,922,000 48,703,000 Cash and cash equivalents at beginning of year...... 6,000 2,007,000 3,929,000 ----------- ----------- ----------- Cash and cash equivalents at end of year............ $ 2,007,000 $ 3,929,000 $52,632,000 =========== =========== =========== SUPPLEMENTAL CASH FLOW DISCLOSURE Interest paid....................................... $ 1,000 $ 17,000 $ 16,000 =========== =========== ===========
See accompanying notes. F-6 73 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 1. SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION AND DESCRIPTION OF BUSINESS The consolidated financial statements include the accounts of ISS Group, Inc. and its subsidiaries ("ISS"). All significant intercompany investment accounts and transactions have been eliminated in consolidation. On March 27, 1998, ISS completed an initial public offering ("IPO") of its Common Stock. A total of 3,450,000 shares were sold at $22 per share, including 450,000 shares sold pursuant to the underwriters over-allotment option and 380,000 sold by certain selling stockholders. ISS did not receive any of the proceeds from the sale of shares by the selling stockholders. The net proceeds to ISS were approximately $61,531,000 and certain of such proceeds have been used for general corporate purposes. ISS's shares are traded on the Nasdaq National Market under the ticker symbol "ISSX". ISS Group, Inc. was incorporated in the State of Delaware on December 8, 1997 to be a holding company for Internet Security Systems, Inc., a Georgia company incorporated on April 19, 1994, to design, market, and sell computer network security assessment software. In addition, ISS has various other subsidiaries in Europe and the Asia/Pacific region with primary marketing and sales responsibilities for ISS's products and services in their respective markets. The financial statements of foreign subsidiaries have been translated into United States dollars in accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 52 Foreign Currency Translation. Revenues from international customers, except in Japan, were denominated in U.S. dollars. Revenues from Japanese customers and international expenditures were denominated in the respective local currencies and translated using the average exchange rates for the year. The effect on the statements of operations related to transaction gains and losses is insignificant for all years presented. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. ISS's business is focused on maintaining the latest security threat and vulnerability checks within existing products and creating new products and services that are consistent with ISS's goal of providing an adaptive solution approach to enterprise network security. This approach entails continuous security risk monitoring and response to develop an active and informed network security policy. REVENUE RECOGNITION ISS recognizes its perpetual license revenues upon (i) delivery of software or, if the customer has evaluation software, delivery of the software key, and (ii) issuance of the related license, assuming no significant vendor obligations or customer acceptance rights exist. For perpetual license agreements when payment terms extend over periods greater than twelve months, revenue is recognized as such amounts are billable. In October 1997, the AICPA issued Statement of Position ("SOP") No. 97-2, Software Revenue Recognition, which ISS adopted, effective January 1, 1997. Such adoption had no effect on ISS's methods of recognizing revenue from license and maintenance activities. Prior to 1997, ISS's revenue recognition policy was in accordance with the preceding authoritative guidance provided by SOP No. 91-1, Software Revenue Recognition. F-7 74 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Subscriptions revenues include maintenance and term licenses. Annual renewable maintenance is a separate component of perpetual license agreements with revenue recognized ratably over the maintenance contract term. Term licenses allow customer use of the product and maintenance for a specified period, generally 12 months, for which revenues are also recognized ratably over the contract term. Professional services revenues are recognized as such services are performed. COST OF REVENUES Cost of revenues include amounts related to ISS's technical support group who provide assistance to customers with maintenance agreements and the costs related to ISS's professional services. CASH AND CASH EQUIVALENTS Cash equivalents include all highly liquid investments with a maturity of three months or less when purchased. Such amounts are stated at cost, which approximates market value. CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially subject ISS to significant concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. ISS maintains cash and cash equivalents in short-term money market accounts with two financial institutions and short-term, investment grade commercial paper. ISS's sales are primarily to companies located in the United States, Europe and the Asia/Pacific region. ISS performs periodic credit evaluations of its customers' financial condition and does not require collateral. Accounts receivable are due principally from large U.S. companies under stated contract terms. ISS provides for estimated credit losses, which have not been significant to date, as required. PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method for financial reporting purposes over the estimated useful lives of the assets (primarily three years). F-8 75 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) GOODWILL AND INTANGIBLES The major classes of intangible assets, including goodwill (excess of cost over acquired net assets), at December 31, 1998 are as follows:
LIFE ---- Goodwill.................................................... 10 $3,171,000 less accumulated amortization............................... (77,000) ---------- $3,094,000 ========== Core technology............................................. 8 $3,853,000 Developed technology........................................ 5 778,000 Work force.................................................. 6 215,000 ---------- 4,846,000 less accumulated amortization............................... (154,000) ---------- $4,692,000 ==========
Goodwill and other intangible assets are amortized using the straight-line method for the period indicated. They are reviewed for impairment whenever events indicate that their carrying amounts may not be recoverable. In such reviews, undiscounted cash flows associated with these assets are compared with their carrying values to determine if a write-down to fair value is required. RESEARCH AND DEVELOPMENT COSTS Research and development costs are charged to expense as incurred. ISS has not capitalized any such development costs under SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, because the cost incurred between the attainment of technological feasibility for the various software products through the date when such products are made available for general release to customers has been insignificant. INCOME TAXES ISS uses the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. ADVERTISING COSTS ISS incurred $485,000, $572,000 and $486,000 of advertising costs for the years ended December 31, 1996, 1997 and 1998, respectively, which are expensed as incurred and are included in sales and marketing expense in the statements of operations. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts F-9 76 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) reported in the financial statements and accompanying notes. Actual results may differ from those estimates, and such differences may be material to the consolidated financial statements. STOCK-BASED COMPENSATION ISS generally grants stock options for a fixed number of shares to certain employees with an exercise price equal to the fair value of the shares at the date of grant. ISS accounts for stock option grants in accordance with Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, recognizes compensation expense only if the fair value of the underlying Common Stock exceeds the exercise price of the stock option on the date of grant. In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation, which provides an alternative to APB Opinion No. 25 in accounting for stock-based compensation issued to employees. As permitted by SFAS No. 123, ISS continues to account for stock-based compensation in accordance with APB Opinion No. 25 and has elected the pro forma disclosure alternative of SFAS No. 123 (see Note 5). LOSS PER SHARE Basic and diluted historical net loss per share (see Note 9) was computed by dividing net loss plus accretion of the Series A and Series B Redeemable, Convertible Preferred Stock by the weighted average number of shares of Common Stock. Common Stock equivalents were antidilutive and therefore were not included in the computation of weighted average shares used in computing diluted loss per share. Also, ISS has no Common Stock equivalents due to "cheap stock" as defined in Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 98. Unaudited pro forma net loss per share was computed by dividing net loss by the unaudited weighted average number of shares of Common Stock outstanding plus the assumed conversion of the Redeemable, Convertible Preferred Stock into 5,737,000 shares of Common Stock as of the later of (i) January 1, 1997 or (ii) the date of issuance of such preferred stock, instead of March 27, 1998 when such shares of preferred stock automatically converted into Common Stock. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements for periods beginning after December 15, 1997. The Statement requires that business segment financial information be reported in the financial statements utilizing the management approach. The management approach is defined as the manner in which management organizes the segments within the enterprise for making operating decisions and assessing performance. Since ISS is organized as, and operates in, a single business segment that provides products, technical support and consulting and training services as components of its enterprise solution for network security, this Statement did not have an impact on financial reporting for the year ended December 31, 1998. ISS adopted SFAS No. 130, Reporting Comprehensive Income, on January 1, 1998. ISS reported comprehensive income in its statement of changes in stockholders' equity (deficit). The F-10 77 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) adoption of SFAS No. 130 resulted in revised and additional disclosures but had no effect on the financial position, results of operations, or liquidity of ISS. RECLASSIFICATIONS Certain reclassifications were made to the prior years' financial statements to conform with the 1998 presentation. 2. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the balance sheets for cash and cash equivalents, accounts receivable and accounts payable approximate their fair values. The carrying amounts reported in the balance sheet at December 31, 1997 for long-term debt approximated its fair values as the interest rate related to such debt was variable and commensurate with the credit worthiness of ISS. 3. BUSINESS COMBINATION AND ASSET ACQUISITION In October 1998, ISS acquired March Information Systems Limited ("March"), a United Kingdom-based developer of Windows NT and Unix-based security assessment technologies. Also in October 1998, ISS acquired the technology assets of DbSecure, Inc., a developer of database security risk assessment software. ISS issued 158,000 shares of ISS Common Stock and paid $5,206,000 in cash, net of cash acquired, and direct transaction costs for these acquisitions. Both of these acquisitions have been accounted for as purchases and their results have been included in the results of ISS's operations from the effective dates of acquisition. Substantially all of the aggregate consideration of $9,144,000 was allocated to identified intangibles, including core and developed technologies, in-process research and development, work force and goodwill (see Note 1). The valuations of core and developed technologies and in-process research and development were based on the present value of estimated future cash flows over the lesser of: (i) five years or (ii) the period in which the product is expected to be integrated into an existing ISS product. The resulting values were reviewed for reasonableness based on the time and cost spent on the effort, the complexity of the development effort and, in the case of in-process development projects, the stage to which it had progressed. For in-process research and development, the valuation was reduced for the core technology component of such product and the percentage of product development remaining at the acquisition date. The resulting in-process research and development amount of $802,000 is reflected as a charge in the 1998 statement of operations. F-11 78 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 3. BUSINESS COMBINATION AND ASSET ACQUISITION (CONTINUED) The following table summarizes pro forma unaudited results of operations as if the acquisition of March was concluded on January 1, 1997. The effect of the DbSecure acquisition is not included as its impact was immaterial. The adjustments to the historical data reflect the reduction of interest income in connection with the cash portion of the purchase price and amortization of goodwill and intangibles. This unaudited pro forma financial information is not necessarily indicative of what the combined operations would have been if ISS had control of such combined businesses for the periods presented.
1997 1998 ----------- ----------- Revenues.................................................... $15,513,000 $37,735,000 Operating loss.............................................. (4,901,000) (6,838,000) Net loss.................................................... (4,946,000) (4,828,000) Per share: Basic and diluted net loss................................ $ (0.62) $ (0.32) Pro forma net loss........................................ $ (0.36) $ (0.30)
4. REDEEMABLE, CONVERTIBLE PREFERRED STOCK Redeemable, Convertible Preferred Stock consisted of the following:
GROSS NET SERIES DATE OF ISSUANCE PROCEEDS PROCEEDS SHARES ISSUED - ------ ----------------- ---------- ---------- -------------- A February 2, 1996 $3,650,000 $3,607,000 3,650,000 B February 14, 1997 5,280,000 5,253,000 2,087,000 ---------- ---------- --------- $8,930,000 $8,860,000 5,737,000 ========== ========== =========
Accretion related to the Series A and Series B Redeemable, Convertible Preferred Stock was recorded over the respective redemption period by charges against additional paid-in capital with corresponding increases to the carrying value of the Series A and Series B Redeemable, Convertible Preferred Stock. Such increases aggregated $7,000 and $11,000 for the years ended December 31, 1996 and 1997, respectively, and were immaterial in 1998. All of the outstanding shares of Redeemable, Convertible Preferred Stock were automatically converted into an aggregate of 5,737,000 shares of Common Stock on March 27, 1998 in connection with the IPO. 5. STOCK OPTION PLANS ISS's Incentive Stock Plan (the "Plan") provides for the granting of qualified or nonqualified options to purchase shares of ISS's Common Stock. Under the Plan, there are 3,000,000 shares reserved for future issuances, which increases automatically on the first trading day of each year, beginning with 1999, by an amount equal to 3% of the number of shares of Common Stock outstanding on the last trading day of the immediately preceding year. Certain options granted under the Plan prior to the IPO are immediately exercisable, subject to a right of repurchase by ISS at the original exercise price for all unvested shares. Options granted subsequent to the IPO are generally exercisable as vesting occurs. Vesting is generally in equal annual installments over four years, measured from the date of the grant. F-12 79 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 5. STOCK OPTION PLANS (CONTINUED) During the quarters ended December 31, 1997 and March 31, 1998, deferred compensation of $571,000 and $811,000, respectively, was recorded for options granted with an exercise price less than the fair value of the Common Stock on the date of grant. The deferred compensation was determined by comparing the exercise price of stock options issued in December 1997 to the estimated price range for the IPO as set forth in the initial filing on January 20, 1998 of ISS's Registration Statement on Form S-1. The fair value of ISS's Common Stock in January and February 1998 was based on the final estimated price range contained in ISS's pre-effective amendment to its Registration Statement filed in March 1998. The amounts are being charged to operations proportionately over the four-year vesting period of the related stock options. Amortization of deferred compensation for the year ended December 31, 1998 was $720,000. All other options were issued at fair market value on the date of grant. On December 8, 1997, the Board of Directors granted to each of the four non-employee directors a nonstatutory option to purchase up to 20,000 shares of Common Stock outside the Plan, on the same terms as if those options had been granted under the 1995 Plan. ISS reserved 80,000 shares of Common Stock for issuance under these options. A summary of ISS's stock option activity is as follows:
1997 1998 --------------------- --------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE NUMBER EXERCISE NUMBER EXERCISE OF SHARES PRICE OF SHARES PRICE ---------- -------- ---------- -------- Outstanding at beginning of year................. 810,000 $0.16 1,888,000 $ 2.71 Granted........................................ 1,103,000 4.54 961,000 22.78 Exercised...................................... (7,000) 0.15 (405,000) 0.72 Canceled....................................... (18,000) 0.50 (64,000) 9.32 ---------- ---------- Outstanding at end of year....................... 1,888,000 2.71 2,380,000 10.98 ========== ========== Exercisable at end of year....................... 1,888,000 2.71 1,585,000 3.85 ========== ========== Weighted average fair value of options granted during the year................................ $ 2.34 $ 12.77 ========== ==========
The following table summarizes information about stock options outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS FULLY ---------------------------- VESTED AND EXERCISABLE NUMBER OF WEIGHTED -------------------------- OPTIONS AVERAGE NUMBER WEIGHTED OUTSTANDING AT REMAINING EXERCISABLE AVERAGE RANGE OF DECEMBER 31, CONTRACTUAL AT DECEMBER 31, EXERCISE EXERCISE PRICES 1998 LIFE 1998 PRICE - --------------- -------------- ----------- --------------- -------- $0.15-0.60................................. 695,000 7.7 years 289,000 $0.26 $1.00-7.00................................. 741,000 8.9 years 185,000 5.99 $8.00-20.00................................ 612,000 9.2 years -- -- $21.00-30.00............................... 181,000 9.8 years -- -- $31.00-50.00............................... 150,000 9.7 years -- --
ISS has reserved 2,379,000 shares of ISS common stock for the future exercise of stock options at December 31, 1998. F-13 80 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 5. STOCK OPTION PLANS (CONTINUED) Pro forma information regarding net income and net income per share is required by SFAS No. 123, which also requires that the information be determined as if ISS had accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method prescribed by that Statement. The fair value for options granted was estimated at the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used for 1997 and 1998, respectively: risk-free interest rates of 6.28% and 5.27%; no dividend yield; a .60 volatility factor; and an expected life of the options of 4 and 5 years, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because employee stock options have characteristics different from those of traded options, and because the changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the option is amortized to expense over the options' vesting period. The following pro forma information adjusts net loss for the years ended December 31, 1997 and 1998 for the impact of SFAS No. 123:
YEAR ENDED DECEMBER 31, ------------------------- 1997 1998 ----------- ----------- Pro forma net loss....................................... $(3,975,000) $(6,126,000) =========== =========== Pro forma net loss per share............................. $ (0.29) $ (0.38) =========== ===========
6. COMMITMENTS AND CONTINGENT LIABILITIES ISS has noncancellable operating leases for facilities that expire at various dates through July 2002. Future minimum payments under noncancellable operating leases with initial terms of one year or more consisted of the following at December 31, 1998:
OPERATING LEASES ---------- 1999........................................................ $1,855,000 2000........................................................ 1,693,000 2001........................................................ 1,513,000 2002........................................................ 683,000 ---------- Total minimum lease payments...................... $5,744,000 ==========
Rent expense was approximately $105,000, $401,000 and $1,200,000 for the years ended December 31, 1996, 1997, and 1998, respectively. In July 1998, Network Associates, Inc. ("Network Associates"), a competitor of ISS, filed a patent infringement suit against ISS in the Federal District Court for the Northern District of California. The suit alleges that ISS's product, RealSecure, violates certain patent claims issued for Network Associates' intrusion detection technology. ISS believes the lawsuit is without merit F-14 81 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 6. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) and intends to defend against it vigorously. However, there can be no assurance that the lawsuit will not have or result in a material adverse effect on ISS's business, operating results or financial condition. 7. INCOME TAXES A reconciliation of the provision for income taxes to the statutory federal income tax rate is as follows:
YEAR ENDED DECEMBER 31, ------------------------------------- 1996 1997 1998 --------- ----------- ----------- Statutory rate at 34%, applied to pretax loss......... $(384,000) $(1,332,000) $(1,440,000) State income taxes, net of federal income tax benefit............................................. (45,000) (157,000) (160,000) Intangibles........................................... -- -- 345,000 Research and development tax credit................... (28,000) (159,000) (384,000) Foreign operations.................................... 100,000 -- 62,000 Other................................................. 46,000 (26,000) 42,000 Change in valuation allowance......................... 311,000 1,674,000 1,597,000 --------- ----------- ----------- $ -- $ -- $ 62,000 ========= =========== ===========
The provision for income taxes for the year ended December 31, 1998 consisted of $62,000 of current income taxes related to some of ISS's foreign operations. Deferred income taxes reflect the net income tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of ISS's net deferred income tax assets are as follows:
DECEMBER 31, -------------------------- 1997 1998 ----------- ------------ Deferred income tax liabilities: Core technology............................................. $ -- $ (494,000) ----------- ------------ Total deferred income tax liabilities....................... -- (494,000) ----------- ------------ Deferred income tax assets: Depreciation.............................................. 69,000 72,000 Accrued liabilities....................................... 143,000 410,000 Allowance for doubtful accounts........................... 97,000 109,000 Deferred compensation..................................... -- 274,000 Net operating loss carryforwards.......................... 1,573,000 5,178,000 Research and development tax credit carryforwards......... 187,000 571,000 ----------- ------------ Total deferred income tax assets.................. 2,069,000 6,120,000 Less deferred income tax asset valuation allowance.......... (2,069,000) (6,120,000) ----------- ------------ Net deferred income tax assets.............................. $ -- $ -- =========== ============
For financial reporting purposes, a valuation allowance has been recognized to reduce the net deferred income tax assets to zero. ISS has not recognized the benefit from the future use of such loss carryforwards because management's evaluation of all the available evidence in F-15 82 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 7. INCOME TAXES (CONTINUED) assessing the realizability of the tax benefits of such loss carryforwards and other deferred income tax benefits indicates that the underlying assumptions of future profitable operations contain risks that do not provide sufficient assurance to recognize such tax benefits currently. ISS has approximately $13,600,000 of net operating loss carryforwards for federal income tax purposes that expire in varying amounts between 2011 and 2018. These carryforwards include approximately $7,700,000 related to exercises of stock options in 1998 for which the income tax benefit, if realized, would increase additional paid-in capital. ISS also has approximately $800,000 of net operating loss carryforwards related to its foreign operations which expire between 2002 and 2003. Additionally, ISS has approximately $571,000 of research and development tax credit carryforwards which expire between 2011 and 2014. 8. EMPLOYEE BENEFIT PLANS ISS sponsors a 401(k) plan that covers substantially all employees over 21 years of age. ISS may make contributions to the plan at its discretion, but has made no contributions to the plan through December 31, 1998. 9. LOSS PER SHARE The following table sets forth the computation of basic, diluted and pro forma (unaudited) net loss per share:
YEAR ENDED DECEMBER 31, --------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Numerator: Net loss.......................................... $(1,131,000) $(3,919,000) $(4,102,000) Accretion of Series A and Series B Redeemable, Convertible Preferred Stock.................... (7,000) (11,000) -- ----------- ----------- ----------- $(1,138,000) $(3,930,000) $(4,102,000) =========== =========== =========== Denominator: Denominator for basic and diluted net loss per share -- weighted average shares............... 7,916,000 7,907,000 14,883,000 Redeemable, Convertible Preferred Stock........... -- 5,737,000 1,306,000 ----------- ----------- ----------- Weighted average shares for pro forma net loss per share.......................................... 7,916,000 13,644,000 16,189,000 =========== =========== =========== Basic net loss per share............................ $ (0.14) $ (0.50) $ (0.28) =========== =========== =========== Diluted net loss per share.......................... $ (0.14) $ (0.50) $ (0.28) =========== =========== =========== Pro forma net loss per share (unaudited)............ $ (0.29) $ (0.25) =========== ===========
Stock options aggregating 1,888,000 and 2,379,000 at December 31, 1997 and 1998, respectively, are not included in the above calculations as they are antidilutive. 10. EXPORT SALES Export sales from the United States to the Europe and Asia/Pacific region represented approximately 10% and 3%, respectively, of total revenues for the year ended December 31, 1997 F-16 83 ISS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 10. EXPORT SALES (CONTINUED) and 12% and 0%, respectively, of total revenues for the year ended December 31, 1998. Export sales were not significant for the year ended December 31, 1996. Revenues generated from ISS's foreign operations located in the Europe and Asia/Pacific region totaled approximately 0% and 8%, respectively, and 2% and 5%, respectively, of total revenues for the years ended December 31, 1997 and 1998, respectively. ISS had no revenue generating foreign operations prior to 1997. 11. QUARTERLY FINANCIAL RESULTS (UNAUDITED) Summarized quarterly results for the two years ended December 31, 1997 and 1998 are as follows (in thousands, except per share data):
FIRST SECOND THIRD FOURTH ------- ------- ------- ------- 1997 by quarter: Revenues..................................... $ 2,225 $ 2,671 $ 3,473 $ 5,098 Operating loss............................... (429) (678) (1,092) (1,948) Net loss..................................... (394) (610) (1,026) (1,889) Loss per share(1): Basic and diluted............................ (0.05) (0.08) (0.13) (0.24) Pro forma (unaudited)........................ (0.03) (0.05) (0.08) (0.14) 1998 by quarter: Revenues..................................... 6,073 7,331 9,430 13,095 Operating loss............................... (1,705) (1,924) (1,348) (1,429) Net loss..................................... (1,639) (1,083) (583) (797) Loss per share(1): Basic and diluted............................ (0.19) (0.06) (0.03) (0.05) Pro forma (unaudited)........................ (0.12) -- -- --
- --------------- (1) Because of the method used in calculating per share data, the quarterly per share data will not add to the per share data as computed for the year. F-17 84 REPORT OF ERNST & YOUNG, INDEPENDENT AUDITORS To the Board of Directors and Shareholders March Information Systems Limited We have audited the accompanying consolidated balance sheets of March Information Systems Limited as of March 31, 1997 and 1998 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended March 31, 1998, which have been prepared in accordance with accounting principles generally accepted in the United States and are expressed in U.S. Dollars. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with UK auditing standards, which do not differ materially from auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of March Information Systems Limited at March 31, 1997 and 1998 and the results of its operations and its cash flows for the each of the two years in the period ended March 31, 1998, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young Reading, England October 16, 1998 F-18 85 MARCH INFORMATION SYSTEMS LIMITED CONSOLIDATED BALANCE SHEETS
MARCH 31, ------------------- SEPTEMBER 30, 1997 1998 1998 -------- -------- ------------- (UNAUDITED) ASSETS Current Assets Cash and cash equivalents.............................. $ 4,494 $ 16,900 $ 38,683 Accounts receivable.................................... 533,080 538,851 441,074 Other receivables...................................... 32,433 25,724 81,089 Prepaid expenses....................................... 26,545 20,800 49,765 Other current assets................................... 15,434 15,742 26,105 -------- -------- -------- Total current assets......................... 611,986 618,017 636,716 Investments (Note 2)................................... 821 837 -- Equipment and fixtures: Computer equipment................................ 176,594 220,985 243,701 Office furniture and equipment.................... 36,244 38,469 39,039 Motor vehicles.................................... 312,857 230,541 243,216 -------- -------- -------- 525,695 489,995 525,956 Less accumulated depreciation..................... 327,295 356,635 391,792 -------- -------- -------- 198,400 133,360 134,164 Deferred income taxes (Note 4)......................... 12,256 12,704 12,704 -------- -------- -------- Total Assets................................. $823,463 $764,918 $783,584 ======== ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Accounts payable....................................... $ 1,478 $ 42,763 $ 44,084 Accrued expenses and other liabilities................. 68,457 51,747 91,516 Deferred revenue....................................... 92,227 84,301 111,370 Taxes and social security payable...................... 180,387 98,011 103,193 Notes payable to Directors............................. 52,544 90,428 -- Current portion of capital lease obligations........... 63,378 25,713 20,802 -------- -------- -------- Total current liabilities.................... 458,471 392,963 370,965 Capital lease obligation (Note 3)...................... 31,191 6,097 12,710 Minority interest...................................... 161 -- -- Commitments (Note 7) Shareholders' Equity Ordinary shares: $1 par value, 50,000 shares authorized; 9,600 issued and outstanding at March 31, 1997, 9,700 shares at March 31,1998 and 9,800 shares at September 30, 1998................................ 14,654 14,821 14,988 Retained earnings...................................... 292,128 317,305 345,180 Cumulative translation adjustment...................... 26,858 33,732 39,741 -------- -------- -------- Total shareholders' equity................... 333,640 365,858 399,909 -------- -------- -------- Total Liabilities and Shareholders' Equity... $823,463 $764,918 $783,584 ======== ======== ========
F-19 86 MARCH INFORMATION SYSTEMS LIMITED CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED SIX MONTHS ENDED MARCH 31, SEPTEMBER 30, ----------------------- --------------------- 1997 1998 1997 1998 ---------- ---------- -------- ---------- (UNAUDITED) Revenues: Consulting............................... $1,294,573 $1,224,339 $566,991 $ 663,205 Licenses................................. 267,568 690,764 275,582 461,247 Maintenance and other.................... 73,909 131,265 65,231 74,323 ---------- ---------- -------- ---------- 1,636,050 2,046,368 907,804 1,198,775 Research and development................... 460,027 697,808 367,380 405,083 Marketing, general and administrative...... 1,176,375 1,193,958 519,050 695,334 Depreciation and amortization.............. 110,216 99,304 55,029 39,293 ---------- ---------- -------- ---------- 1,746,618 1,991,070 941,459 1,139,710 Operating (loss) profit.................... (110,568) 55,298 (33,655) 59,065 Equity share of losses of affiliated company.................................. 3,263 -- -- -- Interest expense........................... (29,253) (12,861) (6,518) (6,921) Interest income............................ 1,680 3,103 1,995 714 Other income............................... -- 330 8,402 727 ---------- ---------- -------- ---------- Income (loss) before taxation and minority interests................................ (134,878) 45,870 (29,776) 53,585 Minority interest.......................... 692 -- -- -- Income tax benefit (expense)............... 26,677 (20,693) -- (25,710) ---------- ---------- -------- ---------- Net (loss) income.......................... $ (107,509) $ 25,177 $(29,776) $ 27,875 ========== ========== ======== ==========
See accompanying Notes to the Consolidated Financial Statements. F-20 87 MARCH INFORMATION SYSTEMS LIMITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
CUMULATIVE COMMON RETAINED TRANSLATION STOCK EARNINGS ADJUSTMENT TOTAL ------- -------- ----------- -------- Balance at March 31, 1996 (unaudited)............... $14,654 $399,637 $20,267 $434,558 Net loss............................................ -- (107,509) -- (107,509) Cumulative translation adjustment................... -- -- 6,591 6,591 ------- -------- ------- -------- Balance at March 31, 1997........................... 14,654 292,128 26,858 333,640 Net income.......................................... -- 25,177 -- 25,177 Cumulative translation adjustment................... -- -- 6,874 6,874 Issuance of ordinary stock for bonuses to employees......................................... 167 -- -- 167 ------- -------- ------- -------- Balance at March 31, 1998........................... 14,821 317,305 33,732 365,858 Net income (unaudited).............................. -- 27,875 -- 28,042 Cumulative translation adjustment (unaudited)....... -- -- 6,009 6,009 Issuance of ordinary stock for bonuses to employees (unaudited)....................................... 167 -- -- 167 ------- -------- ------- -------- Balance at September 30, 1998 (unaudited)........... $14,988 $345,180 $39,741 $399,909 ======= ======== ======= ========
See accompanying Notes to the Consolidated Financial Statements F-21 88 MARCH INFORMATION SYSTEMS LIMITED CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED SIX MONTHS ENDED MARCH SEPTEMBER 30, ------------------- -------------------------- 1997 1998 1997 1998 --------- ------- ----------- ----------- (UNAUDITED) (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES Net (loss) income......................... $(107,509) $25,177 $ (29,776) $ 27,875 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation............................ 110,216 99,304 55,029 39,293 Minority interest....................... 692 -- -- -- Loss on disposal of assets.............. 6,107 12,354 7,926 7,953 Changes in operating assets and liabilities: Accounts receivable.................. (59,188) 4,719 160,112 102,894 Other receivable..................... (23,401) 7,210 6,915 (53,496) Prepaid expenses..................... (13,036) 6,149 (8,360) (27,881) Other current assets................. 714 -- -- (9,856) Accounts payable..................... (159) 40,450 39,022 670 Accrued expenses and other liabilities........................ 70,140 18,406 27,189 (51,336) Deferred revenue..................... 30,478 (9,567) (19,845) 25,122 Taxes and social security payable.... 28,839 (84,279) (147,501) 3,629 Deferred income taxes................ (5,259) (448) -- -- --------- ------- --------- -------- Net cash provided by operating activities.............................. 38,634 119,475 90,711 64,867 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of equipment and fixtures....... (87,164) (44,026) (5,003) (18,917) Loss from Joint Venture................... -- -- -- 827 --------- ------- --------- -------- Net cash used in investing activities..... (87,164) (44,026) (5,003) (18,090) CASH FLOWS FROM FINANCING ACTIVITIES Payments on capital lease obligations..... (35,355) (63,374) (36,852) (25,993) Minority interest......................... (1,537) (161) (160) -- Dividends paid............................ (41,050) -- -- -- Issuance of ordinary stock for bonus...... -- 167 167 167 --------- ------- --------- -------- Net cash used in financing activities..... (77,942) (63,368) (36,845) (25,826) --------- ------- --------- -------- Net (decrease) increase in cash and cash equivalents............................. (126,472) 12,081 48,863 20,951 Cash and cash equivalents at the beginning of the year............................. 124,544 4,494 4,494 16,900 Translation adjustment.................... 6,422 325 (596) 832 --------- ------- --------- -------- Cash and cash equivalents at the end of the year................................ $ 4,494 $16,900 $ 52,761 $ 38,683 ========= ======= ========= ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid............................. $ 13,850 $12,368 $ 5,866 $ 8,182 ========= ======= ========= ======== Income taxes paid......................... $ 56,455 $ -- $ 20,047 $ -- ========= ======= ========= ======== SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES Equipment and fixtures acquired under capital leases.......................... $ -- $ -- $ -- $ 27,190 ========= ======= ========= ========
See accompanying Notes to the Consolidated Financial Statements F-22 89 MARCH INFORMATION SYSTEMS LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS March Information Systems ("March" or the "Company") was incorporated in England in 1990 with the name March Systems Consultancy Limited with the objective of providing computer consultancy services in systems administration, application development and systems integration. The Company's name was changed in February 1997 to March Information Systems reflecting the refocus of the company as a supplier of specialist security software rather than as a consultancy company. The company was acquired in October 1998 by ISS Group, Inc. as further explained in Note 7. The Company provides security software and services to customers using computers running UNIX and Windows NT operating systems with the objective of helping those customers improve the security of and reduce the threats to critical corporate data held on these computers. BASIS OF PRESENTATION These financial statements do not comprise the statutory accounts of the Company within the meaning of Section 240 of the Companies Act 1985, as amended (the "Companies Act"). The Company's statutory accounts, which are its primary financial statements, are prepared in accordance with the Companies Act and are presented in British pounds. Statutory accounts for the year ended March 31, 1997 and March 31, 1998 have been prepared and the auditors have given unqualified audit reports thereon. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and have been prepared in U.S. dollars. These consolidated financial statements have been translated from the functional currency (British pounds) to U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52 -"Foreign Currency Translation". Under this Statement assets and liabilities are translated at year end rates and income and expenses are translated at average rates. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Investments in 50% or less owned companies and joint ventures over which the Company has the ability to exercise significant influence are accounted for using the equity method. REVENUE RECOGNITION The Company recognizes its license revenue upon (i) delivery of software or, if the customer has evaluation software, delivery of the software key, and (ii) issuance of the related license, assuming no significant vendor obligations or customer acceptance rights exist. In October 1997, the AICPA issued Statement of Position ("SOP") No. 97-2, Software Revenue Recognition, which the Company adopted, effective April 1, 1997. Such adoption had no effect on the Company's revenue recognition policies related to its licensee and maintenance activities. Prior to 1997, the Company's revenue recognition policy was in accordance with the preceding authoritative guidance provided by SOP No. 91-1, Software Revenue Recognition. Annual renewable maintenance is a separate component of each contract, and is recognized ratably over the contract term. Professional services revenues are recognized as such services are performed. F-23 90 MARCH INFORMATION SYSTEMS LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) EQUIPMENT AND FIXTURES Depreciation is provided so as to write down the cost of property and equipment to their estimated residual value over their expected useful lives which is typically 3-4 years. The principal annual depreciation rates and methods of calculation are as follows: Computer and telecom equipment.............................. 3 years straight line Furniture and fittings...................................... 3 years straight line Motor vehicles.............................................. 4 years straight line
INCOME TAXES Income taxes are accounted for in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under the asset and liability method of Statement No. 109, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to carryforward losses and differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred income tax assets are recorded at their likely realizable amount. FOREIGN CURRENCY TRANSLATION Although the Company's functional currency is the British pound, some transactions are made in different currencies. Foreign currency transactions are converted into local currency at the rate of exchange prevailing at the date of the transaction. Exchange gains or losses arising from transactions denominated in a currency other than the functional currency of the entity involved are included in other expenses. USE OF ESTIMATES The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain estimates used by management are particularly susceptible to significant changes, such as the recoverability and amortization periods of intangible assets. Management believes that as of March 31, 1997 and 1998 and September 30, 1998, the estimates used are adequate based on the information currently available. INTERIM FINANCIAL INFORMATION The financial information at September 30, 1998 and for the six months ended September 30, 1997 and 1998 is unaudited but included all adjustments (consisting of normal recurring adjustments) which the Company considers necessary for a fair presentation of the financial position at such date and the operating results and cash flows for those periods. Results of the September 30, 1998 period are not necessarily indicative of the results for the entire year. F-24 91 MARCH INFORMATION SYSTEMS LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts for the Company's financial instruments, including cash, accounts receivable, accounts payable, accrued expenses and long-term debt approximate fair values. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Therefore, the estimates are not necessarily indicative of the amounts which could be realized or would be paid in a current market exchange. The effect of using different market assumptions and/or estimation methodologies may be material to the estimated fair value amount. CASH AND CASH EQUIVALENTS The Company considers investments in highly liquid instruments purchased with an original maturity of 90 days or less to be cash equivalents. Such amounts are stated at cost which approximates market value. CONCENTRATION OF CREDIT RISK The Company performs ongoing credit evaluations of its customers' financial condition and, generally, does not require collateral on accounts receivable. When required, the Company maintains allowances for credit losses and such losses have been within management's expectations. The Company's services are provided to customers mainly throughout Europe and United States. There was no allowance for doubtful accounts established for the periods presented and write-offs of accounts receivable have not been significant. The Company had one customer that accounted for approximately 49% of total revenues for the year ended March 31, 1997 and 45% for the six months ended September 30, 1997 and two customers that accounted for approximately 33% and 41% of total revenues for the year ended March 31, 1998 and 29% and 42% of total revenues for the six months ended September 30, 1998, respectively. PENSION PLAN The Company sponsors a defined contribution pension plan. The pension charge represents the amounts payable by the Company to the fund. Employees are eligible to join the plan after three months of employment. The Company matches the employees contribution up to a maximum 5% of the employees salary. If an employee belongs to a pension fund outside of the company and does not elect to join the pension fund maintained by March, then the Company will contribute to the outside fund at a rate of 5% or match what the employee contributes, whichever is lower. Contributions for the year ended March 31, 1997 and 1998 and the six months ending September 30, 1997 and 1998 were $45,030, $47,247, $23,733 and $22,588, respectively. RESEARCH AND DEVELOPMENT Research and development costs are charged to expense as incurred. The Company has not capitalized any such development costs under SFAS No. 86, Accounting for the Costs of Computer Software to be sold, leased, or otherwise marketed, because the costs incurred by the company between the attainment of technological feasibility for the related software product through the date when the product is available for general release to customers is insignificant. F-25 92 MARCH INFORMATION SYSTEMS LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) ADVERTISING Costs related to advertising are expensed as incurred. Advertising expense was $4,879, $4,031 $1,051 and $7,589 for the years ended March 31, 1997 and 1998 and the six months ended September 30, 1997 and 1998, respectively. NEW ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income". This Statement requires that changes in comprehensive income be shown in a financial statement that is displayed with the same prominence as other financial statements. The Statement will be effective for annual periods beginning after December 15, 1997 and the Company will adopt its provisions in fiscal 1998. Reclassification for earlier periods is required for comparative purposes. The Company is currently evaluating the impact this Statement will have on its financial statements, however, because the Statement requires only additional disclosure, the Company does not expect the statement to have a material impact on its financial position or results of operations. In June 1997, the FASB issued SFAS No 131, "Disclosure about Segments of an Enterprise and Related Information," which changes the way public companies report information about operating segments. SFAS No. 131, which is based on the management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenue. The Statement will be effective for annual periods beginning after December 15, 1997 and the Company will adopt its provisions in fiscal 1998. The Company does not expect the Statement to have a material impact on its financial position or results of operations. YEAR 2000 (UNAUDITED) The Company has determined that its current computer systems are Year 2000 compliant and would function properly with respect to dates in the Year 2000 and beyond. The Company has not noted any Year 2000 issues with its products; however, the Company has not performed a significant amount of testing with respect to its products. The Company has yet to initiate discussions with all of its third-party relationships to ensure that those parties have appropriate plans in place to correct all of their year 2000 issues. While the Company believes its planning efforts are adequate to address its Year 2000 concerns, there can be no assurance that the systems and products of other companies on which the Company's operations rely will be converted on a timely basis and will not have a material adverse effect on the Company's results of operations. The cost of the Year 2000 initiatives is not expected to be material to the Company's consolidated results of operations or financial position. 2. BUSINESS COMBINATIONS The Company incorporated a wholly-owned subsidiary in Belgium, March Systems Consultancy BVBA, in January 1993 to exploit the market for temporary computer specialists in Belgium and Western Europe. March Systems Consultancy BVBA was dissolved in December 1997 as the UK company continued to focus on software development. F-26 93 MARCH INFORMATION SYSTEMS LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 2. BUSINESS COMBINATIONS (CONTINUED) Also in 1993, the Company acquired a 50% interest in another company, Westmount UK Limited, supplying UNIX based I-CASE software and professional services. Westmount UK ceased trading in December 1997. 3. COMMITMENTS OPERATING LEASES The Company leases two separate office spaces under non-cancelable operating leases. One lease is month to month and the other expires on September 30, 1999. The Company also leases cars and computer equipment under a non-cancelable lease arrangements. Required future minimum lease payments under both operating and capital leases as of March 31, 1998 are as follows:
OPERATING CAPITAL LEASES LEASES --------- -------- Years ending December 31: 1999...................................................... $31,817 $ 32,226 2000...................................................... 15,908 3,190 ------- -------- Total minimum payments required................... $47,725 35,416 ======= Present value of future lease payments.................... 31,810 Less current portion...................................... (25,713) -------- Noncurrent portion........................................ $ 6,097 ========
Rent expense was $42,152, $43,629, $16,424 and $22,744 for the fiscal years ending March 31, 1997 and March 31, 1998, and the six months ending September 30, 1997 and September 30, 1998, respectively. Equipment and fixtures financed under a capital lease were $277,639, $158,365 and $85,592 at March 31, 1997, March 31, 1998 and September 30, 1998, respectively. Accumulated amortization related to the leased assets were $139,910, $98,466 and $37,528 at March 31, 1997, March 31, 1998 and September 30, 1998, respectively. Amortization related to capital leases are included in depreciation expense. 4. INCOME TAX The deferred tax asset reflects the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets are as follows:
YEAR ENDED MARCH 31, ----------------- 1997 1998 ------- ------- Book over tax depreciation.................................. $11,468 $10,945 Other....................................................... 788 1,759 ======= ======= Total deferred tax asset.......................... $12,256 $12,704 ======= =======
F-27 94 MARCH INFORMATION SYSTEMS LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 4. INCOME TAX (CONTINUED) Significant components of the benefit (provision) for income taxes attributable to operations are as follows:
YEAR ENDED MARCH 31, ------------------ 1997 1998 ------- -------- Current..................................................... $21,418 $(20,811) Deferred.................................................... 5,259 118 ======= ======== $26,677 $(20,693) ======= ========
A reconciliation of the statutory income tax rate to the Company's effective income tax rate is as follows:
YEAR ENDED MARCH 31, ------------------ 1997 1998 ------- -------- Income tax at statutory rates............................... $32,370 $ (9,564) Income not taxable.......................................... -- 3,276 Non deductible expenses..................................... (6,239) (12,210) Other....................................................... 809 (152) Change in rate for deferred accounts........................ (263) (2,043) ======= ======== $26,677 $(20,693) ======= ======== 19.8% 45.4% ======= ========
5. RELATED PARTIES The directors of the Company have made short term loans to assist in the funding of the Company during temporary cash flow shortages. At March 31, 1997 and March 31, 1998 the total of the loans were approximately $52,544 and $90,428, respectively. There were no balances outstanding at September 30, 1998. There were no specific payment terms attached to the notes. The balances are included in accrued expenses and other liabilities on the balance sheet. Subsequent to year end, the balance of the notes were paid. 6. SEGMENT REPORTING Revenue by geographic area is as follows:
YEAR ENDED SIX MONTHS ENDED MARCH 31, SEPTEMBER 30, ----------------------- ------------------------- 1997 1998 1997 1998 ---------- ---------- ----------- ----------- (UNAUDITED) (UNAUDITED) United Kingdom customers................ $1,553,784 $1,473,022 $691,533 $ 691,287 Continental Europe customers............ 62,754 118,691 57,866 240,123 United States of America................ -- 358,461 147,386 41,610 Rest of the world....................... 19,512 96,194 11,019 225,755 ========== ========== ======== ========== Total revenue................. $1,636,050 $2,046,368 $907,804 $1,198,775 ========== ========== ======== ==========
F-28 95 MARCH INFORMATION SYSTEMS LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 7. SUBSEQUENT EVENTS On October 6, 1998, the Company was purchased by ISS Group, Inc. for $4.75 million plus 120,000 shares of ISS Group, Inc.'s common stock. The acquisition will be accounted for as a purchase. ISS Group is a US based company currently being traded on the NASDAQ stock exchange. Upon acquisition, the Company's name was changed to ISS Group Ltd. F-29 96 ISS GROUP, INC. ACQUISITION OF MARCH INFORMATION SYSTEMS UNAUDITED PRO FORMA FINANCIAL DATA On October 6, 1998, ISS acquired privately held March Information Systems Limited ("March Systems"), a United Kingdom-based developer of Windows NT and Unix-based security assessment technologies. Under the terms of the agreement, ISS Group, Inc. ("ISS" or "Company") acquired all of the outstanding stock of March Systems in exchange for $4.75 million in cash and 120,000 shares of ISS Group common stock. The ISS shares were valued at the closing price of ISS common stock on October 6, 1998 of $24 per share, as quoted on the NASDAQ National Market System. In addition, there were transaction costs of approximately $265,000, principally for legal and accounting professional services and stock transfer taxes. The transaction has been accounted for using the purchase method of accounting and the results of March Systems will be included in future results of ISS from October 6, 1998, the closing date of the transaction. The Unaudited Pro Forma Consolidated Statement of Operations set forth below for the year ended December 31, 1998 gives effect to the acquisition as if it occurred on January 1, 1998. It has been derived from the ISS historical consolidated statement of operations for the year ended December 31, 1998 and from the March Systems unaudited consolidated statement of operations for the nine-month period ended September 30, 1998. The Pro Forma Consolidated Financial Statements do not purport to be indicative of the results of operations or financial position which would have actually been reported if the acquisition had been consummated on the date indicated, or which may be reported in the future. F-30 97 UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 1998
MARCH INFORMATION PRO FORMA SYSTEMS ACQUISITION ISS GROUP ISS GROUP LIMITED ADJUSTMENTS PRO FORMA ----------- ----------- ----------- ----------- Revenues: Perpetual licenses................. $25,936,000 $1,029,000 $ -- $26,965,000 Subscriptions...................... 7,406,000 109,000 7,515,000 Professional services.............. 2,587,000 668,000 3,255,000 ----------- ---------- --------- ----------- 35,929,000 1,806,000 37,735,000 ----------- ---------- --------- ----------- Costs and expenses:.................. -- Cost of revenues................... 4,831,000 584,000 5,415,000 Research and development........... 9,321,000 387,000 9,708,000 Charge for in-process research and development..................... 802,000 802,000 Sales and marketing................ 22,762,000 585,000 23,347,000 Amortization....................... 230,000 -- 607,000(1) 837,000 General and administrative......... 4,389,000 75,000 4,464,000 ----------- ---------- --------- ----------- 42,335,000 1,631,000 607,000 44,573,000 ----------- ---------- --------- Operating income (loss).............. (6,406,000) 175,000 (607,000) (6,838,000) Interest income (expense), net....... 2,366,000 (31,000) (196,000)(2) 2,139,000 ----------- ---------- --------- ----------- Income (loss) before income taxes.... (4,040,000) 144,000 (803,000) (4,699,000) Provision for income taxes........... 62,000 67,000 129,000 ----------- ---------- --------- ----------- Net income (loss).................... $(4,102,000) $ 77,000 $(803,000) (4,828,000) =========== ========== ========= =========== Basic and diluted net loss per share of Common Stock.................... $ (0.28) $ (0.32) =========== =========== Weighted average number of shares used in calculating basic and diluted net loss per share of Common Stock....................... 14,883,000 120,000 15,003,000 =========== ========= =========== Unaudited pro forma net loss per share of Common Stock (see note 3)................................. $ (0.25) $ (0.30) =========== =========== Unaudited weighted average number of shares used in calculating pro forma net loss per share of Common Stock (see note 3)................. 16,189,000 120,000 16,309,000 =========== ========= ===========
See accompanying notes to unaudited pro forma consolidated financial statements for explanation of pro forma acquisition adjustments. F-31 98 ISS GROUP, INC. ACQUISITION OF MARCH INFORMATION SYSTEMS NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION (1) ALLOCATION OF PURCHASE PRICE AND RELATED AMORTIZATION The purchase price was allocated first to tangible net assets, then to identified intangible assets with any remaining unallocated purchase price attributed to goodwill. The fair value of tangible assets approximated their historical book values at September 30, 1998. The identified intangible assets, along with their estimated lives for amortization, are as follows:
LIFE ---- Professional work force..................................... $ 215,000 6 Core technology software.................................... 3,099,000 8 Developed software.......................................... 380,000 5 In process research and development software................ 705,000 Goodwill.................................................... 3,096,000 10
The value assigned to in-process research and development software, in accordance with generally accepted accounting principles, was written off at the time of the acquisition and is reflected in the ISS consolidated financial results for the year ended December 31, 1998. (2) INTEREST INCOME In connection with the payment of $5,015,000 in cash in conjunction with the acquisition, including transaction costs, interest income was reduced for the nine months ended September 30, 1998 using the 5.2% interest rate earned on such funds. (3) PRO FORMA LOSS PER SHARE The Pro Forma basic and diluted historical net loss per share use the historical amounts for ISS Group, Inc adjusted by the impact of the March Systems acquisition. This impact includes March Systems historical net income for the periods, the impact of purchase accounting adjustments and the shares of Common Stock issued in connection with the acquisition. Additionally, these pro forma consolidated statements of operation reflect adjustments to the pro forma net loss per share amounts reflected in the ISS historical consolidated statements of operations. The per share amounts were computed for the historical ISS statements by dividing its net losses by the number of shares of common Stock outstanding plus the conversion of the 3,650,000 shares of Series A and 2,087,000 shares of Series B Redeemable, Convertible Preferred Stock into 5,737,000 share of Common Stock which occurred upon consummation of ISS's initial public offering in March 1998. These pro forma financial statements adjust such net loss and weighted average share amounts for March Systems historical net income for the period, the impact of purchase accounting adjustments and the shares of Common Stock issued in connection with the acquisition. F-32 99 UNDERWRITING ISS, the selling stockholders and the underwriters for the U.S. offering (the "U.S. Underwriters") named below have entered into an underwriting agreement with respect to the shares being offered in the United States. Subject to certain conditions, each U.S. Underwriter has severally agreed to purchase the number of shares indicated in the following table. Goldman, Sachs & Co., Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Warburg Dillon Read LLC, a subsidiary of UBS AG, and BancBoston Robertson Stephens Inc. are the representatives of the U.S. Underwriters.
Number of Underwriters Shares ------------ --------- Goldman, Sachs & Co......................................... Dain Rauscher Wessels....................................... Warburg Dillon Read LLC, a subsidiary of UBS AG............. BancBoston Robertson Stephens Inc........................... --------- Total............................................. 1,920,000 =========
---------------------- If the U.S. Underwriters sell more shares than the total number set forth in the table above, the U.S. Underwriters have an option to buy up to an additional 264,000 shares from ISS and an option to buy an additional 24,000 shares from the selling stockholders to cover such sales. They may exercise that option for 30 days. If any shares are purchased pursuant to this option, the U.S. Underwriters will severally purchase shares in approximately the same proportion as set forth in the table above. The following tables show the per share and total underwriting discounts and commissions to be paid to the U.S. Underwriters by ISS and the selling stockholders. Such amounts are shown assuming both no exercise and full exercise of the U.S. Underwriters' option to purchase additional shares.
Paid by the Company ------------------------------- No Full Exercise Exercise ----------- ------------- Per Share............ $ $ Total................ $ $
Paid by the Selling Stockholders ------------------------------- No Full Exercise Exercise ----------- ------------- Per Share............ $ $ Total................ $ $
Shares sold by the Underwriters to the public will initially be offered at the initial public offering price set forth on the cover of this Prospectus. Any shares sold by the Underwriters to securities dealers may be sold at a discount of up to $ per share from the initial public offering price. Any such securities dealers may resell any shares purchased from the U.S. Underwriters to certain other brokers or dealers at a discount of up to $ per share from the initial public offering price. If all the shares are not sold at the initial offering price, the representatives may change the offering price and the other selling terms. ISS and the selling stockholders have entered into underwriting agreements with the Underwriters for the sale of shares outside of the United States. The terms and conditions of both offerings are the same and the sale of shares in both Offerings are conditioned on each other. Goldman Sachs International, Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Warburg Dillon Read, a division of UBS AG, and BancBoston Robertson Stephens Inc. are representatives of the Underwriters for the international offering outside of the United States (the "International Underwriters"). ISS and the selling stockholders have granted the International Underwriters similar options to U-1 100 purchase up to an aggregate of an additional 72,000 shares. The Underwriters for both of the Offerings have entered into an agreement in which they agree to restrictions on where and to whom they and any dealer purchasing from them may offer shares as a part of the distribution of the shares. The Underwriters also have agreed that they may sell shares among each of the underwriting groups. ISS and the selling stockholders have agreed with the Underwriters not to dispose of or hedge any of their common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus continuing through the date 90 days after the date of this prospectus, except with the prior written consent of the representatives. This agreement does not apply to any existing employee benefit plans. See "Shares Available for Future Sale" for a discussion of certain transfer restrictions. The common stock will be quoted on the Nasdaq National Market under the symbol "ISSX". In connection with the Offerings, the Underwriters may purchase and sell shares of common stock in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the Underwriters of a greater number of shares than they are required to purchase in the Offerings. Stabilizing transactions consist of certain bids or purchases made for the purpose of preventing or retarding a decline in the market price of the common stock while the Offerings are in progress. The Underwriters also may impose a penalty bid. This occurs when a particular Underwriter repays to the Underwriters a portion of the underwriting discount received by it because the representatives have repurchased shares sold by or for the account of such Underwriter in stabilizing or short covering transactions. These activities by the Underwriters may stabilize, maintain or otherwise affect the market price of the common stock. As a result, the price of the common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the Underwriters at any time. These transactions may be effected on the Nasdaq National Market, in the over-the-counter market or otherwise. ISS estimates that the total expenses of the Offerings, excluding underwriting discounts and commissions, will be approximately $ . ISS and the selling stockholders have agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act of 1933. This prospectus may be used by the Underwriters and other dealers in connection with offers and sales of the shares, including sales of shares initially sold by the Underwriters in the Offerings being made outside of the United States, to persons located in the United States. U-2 101 [Inside Back Cover of Prospectus] Picture headed "SAFEsuite Architecture" depicts a rectangle segmented into 12 parts: One segment spans the top of the top of the rectangle and is titled "Information Risk Management". Immediately below that segment is another segment spanning the top of the rectangle entitled "SAFEsuite Decisions" and includes that product's square logo. Immediately below that segment are two segments of half the length of the rectangle. The left segment is entitled "Vulnerability Management" and the right segment is entitled "Threat Management". Below the Vulnerability Management segment are three segments, entitled (from left to right) "Internet Scanner", "Database Scanner" and "System Scanner", each with a circular product logo. Below the "Threat Management" segment are two segments (on a level even with the three segments below "Vulnerability Management") entitled "RealSecure Engine" and "RealSecure Agent", both with a circular product logo. Below these five segments is a segment spanning the length of the rectangle entitled "Security Knowledge Base". Below that segment is another segment spanning the width of the rectangle with 4 rectangular "X-Force" logos. Along the right edge of the rectangle is a segment entitled "Professional Services" with the words "Implementation" "Consulting" "Training" and "Advisory Service" underneath the title. 102 - ---------------------------------------------------------- - ---------------------------------------------------------- No dealer, salesperson or other person is authorized to give you any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell or to buy only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date. ---------------------- TABLE OF CONTENTS
Page ---- Prospectus Summary...................... 1 Risk Factors............................ 3 Use of Proceeds......................... 12 Price Range of Common Stock............. 12 Dividend Policy......................... 12 Capitalization.......................... 13 Dilution................................ 14 Selected Consolidated Financial Data.... 15 Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 16 Business................................ 24 Management.............................. 43 Certain Transactions.................... 52 Principal and Selling Stockholders...... 54 Description of Securities............... 56 Shares Eligible for Future Sale......... 60 Validity of Common Stock................ 62 Experts................................. 62 Additional Information.................. 62 Index to Consolidated Financial Statements............................ F-1 Underwriting............................ U-1
- ---------------------------------------------------------- - ---------------------------------------------------------- - ---------------------------------------------------------- - ---------------------------------------------------------- 2,400,000 Shares ISS GROUP, INC. Common Stock ---------------------- (ISS LOGO) ---------------------- GOLDMAN, SACHS & CO. DAIN RAUSCHER WESSELS A DIVISION OF DAIN RAUSCHER INCORPORATED WARBURG DILLON READ LLC BANCBOSTON ROBERTSON STEPHENS Representatives of the Underwriters - ---------------------------------------------------------- - ---------------------------------------------------------- 103 PART II INFORMATION NOT REQUIRED IN PROSPECTUS All capitalized terms used and not defined in Part II of this registration statement shall have the meaning assigned to them in the prospectus which forms a part of this registration statement. ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by the registrant connection with the sale of common stock being registered. All amounts are estimates, except the SEC registration fee and the NASD filing fee. SEC Registration fee........................................ $ 46,375 NASD fee.................................................... 17,182 Nasdaq National Market listing fee.......................... 17,500 Printing and engraving expenses............................. 200,000 Legal fees and expenses..................................... 150,000 Accounting fees and expenses................................ 120,000 Blue sky fees and expenses.................................. 5,000 Transfer agent fees......................................... 10,000 Miscellaneous............................................... 33,943 -------- Total............................................. $600,000 ========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS Subsection (a) of Section 145 of the Delaware General Corporation Law empowers a corporation to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that he is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. Subsection (b) of Section 145 empowers a corporation to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by right of the corporation to procure a judgment in its favor by reason of the fact that such person acted in any of the capacities set forth above, against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, except that no indemnification may be made in respect to any claim issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. II-1 104 Section 145 further provides that to the extent a director or officer of a corporation has been successful on the merits or otherwise in the defense of any such action, suit or proceeding referred to in subsections (a) and (b) of Section 145 or in the defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith; that the indemnification provided for by Section 145 shall not be deemed exclusive of any other rights which the indemnified party may be entitled; that indemnification provided by Section 145 shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of such person's heirs, executors and administrators; and empowers the corporation to purchase and maintain insurance on behalf of a director or officer of the corporation against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the corporation would have the power to indemnify him against such liabilities under Section 145. Section 102(b)(7) of the Delaware General Corporation Law provides that a certificate of incorporation may contain a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of the director (i) for any breach of the director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law or (iv) for any transaction from which the director derived an improper personal benefit. Article Eleventh of the registrant's charter provides that, to the fullest extent permitted by the Delaware General Corporation Law as the same exists or as it may hereafter be amended, no director of the registrant shall be personally liable to the registrant or its stockholders for monetary damages for breach of fiduciary duty as a director. Section 6.1 of the registrant's bylaws further provides that the registrant shall, to the maximum extent and in the manner permitted by the Delaware General Corporation Law indemnify each of its directors and officers against expenses (including attorneys' fees), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding, arising by reason of the fact that such person is or was an agent of the registrant. The registrant has entered into indemnification agreements with each of its directors and executive officers that provide for indemnification and expense advancement to the fullest extent permitted under the Delaware General Corporation Law. The registrant has purchased officers' and directors' liability insurance. The registrant has agreed to indemnify certain directors and officers against certain liabilities, including liabilities under the Securities Act of 1933 (the "Securities Act"), pursuant to Section 7 of the Amended and Restated Rights Agreement. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES Within the last three years, the registrant has sold the following securities or engaged in the following transactions in private placements exempt from registration under the Securities Act pursuant to Section 4(2) thereof: (1) On September 6, 1995, Internet Security Systems, Inc. ("Oldco") sold 1,293,475 shares of its common stock, par value $1.00 per share ("Oldco Common Stock") to Kevin J. O'Connor for $50,000. II-2 105 (2) On December 29, 1995, Oldco issued 1,959,770 shares of Oldco Common Stock to Thomas E. Noonan and 162,890 shares of Oldco Common Stock to Glenn McGonnigle in consideration for their employment with Oldco. (3) On February 2 and 21, 1996, Oldco sold an aggregate of 3,650,000 shares of its Series A Preferred Stock, par value $1.00 per share, for an aggregate of $3,650,000 to Greylock Equity Limited Partnership, Sigma Associates III, L,P., Sigma Investors III, L.P., Sigma Partners III, L.P. and John P. Imlay, Jr., which shares automatically converted into an aggregate of 3,650,000 shares of common stock upon closing of the registrant's Initial Public Offering on March 27, 1998. Also in connection with the sale of Oldco's Series A Preferred Stock, Oldco repurchased 100,000 shares of Oldco Common Stock from Christopher W. Klaus for $15,000. (4) On February 14, 1997, Oldco sold an aggregate of 2,086,957 shares of its Series B Preferred Stock, par value $1.00 per share, for an aggregate of $5,280,001 to Greylock Equity Limited Partnership, Sigma Associates III, L.P., Sigma Investors III, L.P., Sigma Partners III, L.P., John P. Imlay, Jr., Kleiner Perkins Caufield & Byers VIII, KPCB Information Sciences Zaibatsu Fund II, KPCB Java Fund, AT&T Venture Fund II, L.P. and Venture Fund I, L.P., which shares automatically converted into 2,086,457 Shares of common stock upon closing of the registrant's initial public offering on March 27, 1998. (5) On July 26, 1997, Oldco issued an aggregate of 12,500 shares of common stock to an executive recruiter in partial consideration for services rendered. (6) In December 1997, the registrant, Oldco and the shareholders of Oldco entered into an exchange agreement whereby (i) each share of Oldco Common Stock was exchanged for one share of the registrant's common stock, (ii) each share of Oldco's Series A Preferred Stock was exchanged for one share of the registrant's Series A Preferred Stock and (iii) each share of Oldco's Series B Preferred Stock was exchanged for one share of the registrant's Series B Preferred Stock. (7) On February 24, 1998, the registrant issued an aggregate of 1,000 shares of common stock to an executive recruiter in partial consideration for services rendered. (8) In this period, holders of options issued under our stock option plan exercised options to purchase 412,000 shares of common stock for approximately $293,000. (9) The registrant has from time to time granted stock options to employees. The following table sets forth certain information regarding such grants:
NUMBER OF RANGE OF SHARES EXERCISE PRICES --------- --------------- April 19, 1994 (inception) through December 31, 1995................................................. -- $ -- January 1, 1996 through December 31, 1996.............. 810,350 0.15 - 0.60 January 1, 1997 through December 31, 1997.............. 1,023,000 0.60 - 7.00 January 1, 1998 through December 31, 1998.............. 964,535 8.00 - 48.125
The above securities were offered and sold by the registrant in reliance upon exemptions for registration pursuant to either (i) Section 4(2) of the Securities Act, as transactions not involving any public offering, or (ii) Rule 701 under the Securities Act. No underwriters were involved in connections with the sales of securities referred to in this Item 15. II-3 106 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Exhibits: 1.1 -- Form of U.S. Underwriting Agreement. 3.1* -- Certificate of Incorporation. 3.2* -- Bylaws. 4.1* -- Specimen common stock certificate. 4.2* -- See Exhibits 3.1 and 3.2 for provisions of the Certificate of Incorporation and Bylaws of the registrant defining the rights of holders of common stock of the registrant. +5.1 -- Opinion of Brobeck, Phleger & Harrison LLP. 10.1* -- 1995 Stock Incentive Plan. 10.2* -- Internet Security Systems, Inc. Amended and Restated Rights Agreement. 10.3* -- Stock Exchange Agreement dated December 9, 1997. 10.4* -- Amended and Restated Agreement Regarding Acceleration of Vesting of Future Optionees. 10.5* -- Forms of Non-Employee Director Compensation Agreement, Notice of Stock Option Grant and Stock Option Agreement. 10.6* -- Sublease for Atlanta facilities. 10.7* -- Form of Indemnification Agreement for directors and certain officers. 10.8* -- Series B Preferred Stock Purchase Agreement. 10.9 -- Sublease for additional Atlanta facilities. 21.1 -- Subsidiaries of registrant. 23.1 -- Consent of Ernst & Young LLP. 23.2 -- Consent of Ernst & Young. 23.3 -- Consent of Brobeck, Phleger & Harrison LLP (included in the opinion filed as Exhibit 5.1). 24.1 -- Power of attorney pursuant to which amendments to this registration statement may be filed (included on the signature page in Part 11 hereof). 27.1 -- Financial Data Schedule (for SEC use only).
- --------------- * Incorporated by reference to the registrant's registration statement on Form S-1, Registration No. 333-44529. + To be filed by amendment. (b) Financial Statement Schedules The following financial statement schedule of the registrant is included in Part II of the registration statement: Report of Ernst & Young LLP, Independent Auditors Schedule II -- Valuation and Qualifying Accounts Except for the financial statement schedule listed above, the financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission (the "Commission")are either not required under the related instructions or are inapplicable and have therefore been omitted. ITEM 17. UNDERTAKINGS The registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreements certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the Delaware General II-4 107 Corporation Law, the charter or the bylaws of the registrant, the underwriting agreement, or otherwise, the registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer, or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered hereunder, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424 (b) (1) or (4) or 497 (h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 108 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Atlanta, State of Georgia, on this 29th day of January, 1999. ISS GROUP, INC. By: /s/ THOMAS E. NOONAN ----------------------------------- Thomas E. Noonan Chairman, President and Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each individual whose signature appears below constitutes and appoints Thomas E. Noonan, Richard Macchia and Jon Ver Steeg and each of them, his true and lawful attorney-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Registration Statement, and to sign any registration statement for the same offering covered by this Registration Statement that is to be effective upon filing pursuant to Rule 462(b) promulgated under the Securities Act of 1933, and all post-effective amendments thereto, and to file the same, with all exhibits thereto and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in fact and agents, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated:
NAME TITLE DATE ---- ----- ---- /s/ THOMAS E. NOONAN Chairman, President and January 29, 1999 - ----------------------------------------------------- Chief Executive Thomas E. Noonan (Principal Executive Officer) /s/ CHRISTOPHER W. KLAUS Chief Technical Officer, January 29, 1999 - ----------------------------------------------------- Secretary and Director Christopher W. Klaus /s/ RICHARD MACCHIA Vice President and Chief January 29, 1999 - ----------------------------------------------------- Financial Officer Richard Macchia (Principal Financial and Accounting Officer) /s/ RICHARD S. BODMAN Director January 29, 1999 - ----------------------------------------------------- Richard S. Bodman /s/ ROBERT E. DAVOLI Director January 29, 1999 - ----------------------------------------------------- Robert E. Davoli /s/ KEVIN J. O'CONNOR Director January 29, 1999 - ----------------------------------------------------- Kevin J. O'Connor /s/ DAVID N. STROHM Director January 29, 1999 - ----------------------------------------------------- David N. Strohm
II-6 109 REPORT OF INDEPENDENT AUDITORS We have audited the consolidated financial statements of ISS Group, Inc. as of December 31, 1997 and 1998, and for each of the three years in the period ended December 31, 1998, and have issued our report thereon dated January 15, 1999 (included elsewhere in this Registration Statement). Our audits also included the financial statement schedule listed in Item 16(b) of this Registration Statement. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Atlanta, Georgia January 15, 1999 II-7 110 SCHEDULE II [UPDATE] VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT BEGINNING OF BALANCE AT YEAR PROVISION WRITEOFFS END OF YEAR ------------- --------- --------- ------------ 1996 Allowance for Doubtful Accounts......... $ -- $ 86,000 $ (7,000) $ 79,000 ======== ======== ========= ======== 1997 Allowance for Doubtful Accounts......... $ 79,000 $195,000 $ (19,000) $255,000 ======== ======== ========= ======== 1998 Allowance for Doubtful Accounts......... $255,000 $135,000 $(103,000) $287,000 ======== ======== ========= ========
EX-1.1 2 FORM OF UNDERWRITING AGREEMENT 1 DRAFT OF 1/28/99 EXHIBIT 1.1 ISS GROUP, INC. COMMON STOCK (PAR VALUE $0.001 PER SHARE) ---------------------------- UNDERWRITING AGREEMENT (U.S. VERSION) ---------------------------- February __, 1999 Goldman, Sachs & Co., Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Warburg Dillon Read LLC, a subsidiary of UBS AG and BancBoston Robertson Stephens Inc. As representatives of the several Underwriters named in Schedule I hereto, c/o Goldman, Sachs & Co. 85 Broad Street New York, New York 10004 Ladies and Gentlemen: ISS Group, Inc., a Delaware corporation (the "Company"), proposes, subject to the terms and conditions stated herein, to issue and sell to the Underwriters named in Schedule I hereto (the "Underwriters") an aggregate of _________ shares and, at the election of the Underwriters, up to _______ additional shares of Common Stock (par value $0.001 per share) ("Stock") of the Company and the stockholders of the Company named in Schedule II hereto (the "Selling Stockholders") propose, subject to the terms and conditions stated herein, to sell to the Underwriters an aggregate of _______ shares and, at the election of the Underwriters, up to an additional ______ shares of Stock. The aggregate of _________ shares to be sold by the Company and the Selling Stockholders is herein called the "Firm Shares" and the aggregate of _______ additional shares to be sold by the Company and the Selling Stockholders is herein called the "Optional Shares." The Firm Shares and the Optional Shares that the Underwriters elect to purchase pursuant to Section 2 hereof are herein collectively called the "Shares." It is understood and agreed to by all parties that the Company and the Selling Stockholders are concurrently entering into an agreement (the "International Underwriting Agreement") providing for the sale by the Company and the Selling Stockholders of up to a total of ....... shares of Stock (the "International Shares"), including the overallotment option thereunder, through arrangements with certain underwriters outside the United States (the "International Underwriters"), for whom Goldman Sachs International, Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Warburg Dillon Read, a division of UBS AG and BancBoston Robertson Stephens Inc. are acting as lead managers. 2 Anything herein or therein to the contrary notwithstanding, the respective closings under this Agreement and the International Underwriting Agreement are hereby expressly made conditional on one another. The Underwriters hereunder and the International Underwriters are simultaneously entering into an Agreement between U.S. and International Underwriting Syndicates (the "Agreement between Syndicates") which provides, among other things, for the transfer of shares of Stock between the two syndicates. Two forms of prospectus are to be used in connection with the offering and sale of shares of Stock contemplated by the foregoing, one relating to the Shares hereunder and the other relating to the International Shares. The latter form of prospectus will be identical to the former except for certain substitute pages as included in the registration statement and amendments thereto as mentioned below. Except as used in Sections 2, 3, 4, 9 and 11 herein, and except as the context may otherwise require, references hereinafter to the Shares shall include all the shares of Stock which may be sold pursuant to either this Agreement or the International Underwriting Agreement, and references herein to any prospectus whether in preliminary or final form, and whether as amended or supplemented, shall include both the U.S. and the international versions thereof. 1. (a) The Company and Internet Security Systems, Inc., a Georgia corporation and the Company's wholly-owned subsidiary ("ISS"), jointly and severally represent and warrant to, and agree with, each of the Underwriters that: (i) A registration statement on Form S-1 (File No. _________) (the "Initial Registration Statement") in respect of the Shares has been filed with the Securities and Exchange Commission (the "Commission"); the Initial Registration Statement and any post effective amendment thereto, each in the form heretofore delivered to you, and, excluding exhibits thereto, to you for each of the other Underwriters, have been declared effective by the Commission in such form; other than a registration statement, if any, increasing the size of the offering (a "Rule 462(b) Registration Statement"), filed pursuant to Rule 462(b) under the Securities Act of 1933, as amended (the "Act"), which became effective upon filing, no other document with respect to the Initial Registration Statement has heretofore been filed with the Commission; no stop order suspending the effectiveness of the Initial Registration Statement, any post-effective amendment thereto or the Rule 462(b) Registration Statement, if any, has been issued and no proceeding for that purpose has been initiated or threatened by the Commission (any preliminary prospectus included in the Initial Registration Statement or filed with the Commission pursuant to Rule 424(a) of the rules and regulations of the Commission under the Act, is hereinafter called a "Preliminary Prospectus"; the various parts of the Initial Registration Statement, including all exhibits thereto and including the information contained in the form of final prospectus filed with the Commission pursuant to Rule 424(b) under the Act in accordance with Section 5(a) hereof and deemed by virtue of Rule 430A under the Act to be part of the Initial Registration Statement at the time it was declared effective or such parts of the Rule 462(b) Registration Statement, if any, became or hereafter becomes effective, each as amended at the time such part of the registration statement became effective, is hereinafter collectively called the "Registration Statement"; and such final prospectus, in the form first filed pursuant to Rule 424(b) under the Act, is hereinafter called the "Prospectus"; (ii) No order preventing or suspending the use of any Preliminary Prospectus has been issued by the Commission, and each Preliminary Prospectus, at the time of filing thereof, conformed in all material respects to the requirements of the Act and the rules and regulations of the Commission thereunder, and did not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements -2- 3 therein, in the light of the circumstances under which they were made, not misleading; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by an Underwriter through Goldman, Sachs & Co. expressly for use therein or by a Selling Stockholder expressly for use in the preparation of the answers therein to Items 7 and 11(m) of Form S-1; (iii) The Registration Statement conforms, and the Prospectus and any further amendments or supplements to the Registration Statement or the Prospectus will conform, in all material respects to the requirements of the Act and the rules and regulations of the Commission thereunder and do not and will not, as of the applicable effective date as to the Registration Statement and any amendment thereto, and as of the applicable filing date as to the Prospectus and any amendment or supplement thereto, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by an Underwriter through Goldman, Sachs & Co. expressly for use therein or by a Selling Stockholder expressly for use in the preparation of the answers therein to Items 7 and 11(m) of Form S-1; (iv) Neither the Company nor any of its subsidiaries has sustained since the date of the latest audited financial statements included in the Prospectus any material loss or interference with its business from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, otherwise than as set forth or contemplated in the Prospectus; and, since the respective dates as of which information is given in the Registration Statement and the Prospectus, there has not been any change in the capital stock (other than pursuant to the grant or exercise of options described in the Prospectus) or long-term debt of the Company or any of its subsidiaries or any material adverse change, or any development that is reasonably likely to result in a material adverse change, in or affecting the general affairs, management, financial position, stockholders' equity or results of operations of the Company and its subsidiaries, otherwise than as set forth or contemplated in the Prospectus; (v) The Company and its subsidiaries have good and marketable title in fee simple to all real property and good and marketable title to all personal property owned by them, in each case free and clear of all liens, encumbrances and defects except such as are described in the Prospectus or such as are not material to the Company and its subsidiaries; and any real property and buildings held under lease by the Company and its subsidiaries are held by them under valid, subsisting and enforceable leases with such exceptions as are not material to the Company and its subsidiaries; (vi) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the State of Delaware, with power and authority (corporate and other) to own its properties and conduct its business as described in the Prospectus, and has been duly qualified as a foreign corporation for the transaction of business and is in good standing under the laws of each other jurisdiction in which it owns or leases properties or conducts any business so as to require such qualification, or is subject to no material liability or disability by reason of the failure to be so qualified in any such jurisdiction; and each -3- 4 subsidiary of the Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation; (vii) The Company has an authorized capitalization as set forth in the Prospectus, and all of the issued shares of capital stock of the Company have been duly and validly authorized and issued, are fully paid and non-assessable and conform to the description of the Stock contained in the Prospectus; and all of the issued shares of capital stock of each subsidiary of the Company have been duly and validly authorized and issued, are fully paid and non-assessable and (except for directors' qualifying shares) are owned directly or indirectly by the Company, free and clear of all liens, encumbrances, equities or claims; (viii) The unissued Shares to be issued and sold by the Company to the Underwriters hereunder and under the International Underwriting Agreement have been duly and validly authorized and, when issued and delivered against payment therefor as provided herein, will be duly and validly issued and fully paid and non-assessable and will conform to the description of the Stock contained in the Prospectus; (ix) The issue and sale of the Shares to be sold by the Company hereunder and under the International Underwriting Agreement and the compliance by the Company with all of the provisions of this Agreement and the International Underwriting Agreement and the consummation of the transactions herein and therein contemplated will not conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, any indenture, mortgage, deed of trust, loan agreement or other agreement or instrument to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries is bound or to which any of the property or assets of the Company or any of its subsidiaries is subject, other than breaches or defaults that are not, individually or in the aggregate, reasonably likely to have a material adverse effect on the Company and its subsidiaries considered as one enterprise, nor will such action result in any violation of the provisions of the Certificate of Incorporation or By-laws of the Company or any statute or any order, rule or regulation of any court or governmental agency or body having jurisdiction over the Company or any of its subsidiaries or any of their properties; and no consent, approval, authorization, order, registration or qualification of or with any such court or governmental agency or body is required for the issue and sale of the Shares or the consummation by the Company of the transactions contemplated by this Agreement and the International Underwriting Agreement, except the registration under the Act of the Shares and such consents, approvals, authorizations, registrations or qualifications as may be required under state or foreign securities or Blue Sky laws in connection with the purchase and distribution of the Shares by the Underwriters and the International Underwriters; (x) Neither the Company nor any of its subsidiaries is in violation of its Certificate of Incorporation or By-laws or in default in the performance or observance of any material obligation, agreement, covenant or condition contained in any indenture, mortgage, deed of trust, loan agreement, lease or other agreement or instrument to which it is a party or by which it or any of its properties may be bound; (xi) The statements set forth in the Prospectus under the caption "Description of Capital Stock", insofar as they purport to constitute a summary of the terms of the Stock, under the caption "Certain U.S. Tax Considerations Applicable to Non-U.S. Holders of the Common -4- 5 Stock", and under the caption "Underwriting", insofar as they purport to describe the provisions of the laws and documents referred to therein, are accurate, complete and fair; (xii) Other than as set forth in the Prospectus, there are no legal or governmental proceedings pending to which the Company or any of its subsidiaries is a party or of which any property of the Company or any of its subsidiaries is the subject which, if determined adversely to the Company or any of its subsidiaries, would individually or in the aggregate have a material adverse effect on the current or future consolidated financial position, stockholders' equity or results of operations of the Company and its subsidiaries; and, to the Company's knowledge, no such proceedings are threatened or contemplated by governmental authorities or threatened by others; (xiii) Other than as set forth in the Prospectus, the Company and its subsidiaries own or have the right to use pursuant to license, sublicense, agreement, or permission all patents, patent applications, trademarks, service marks, trade names, copyrights, trade secrets, confidential information, proprietary rights and processes ("Intellectual Property") necessary for the operation of the business of the Company and its subsidiaries as presently conducted and as presently proposed to be conducted as described in the Prospectus and have taken all steps reasonably necessary to secure assignments of such Intellectual Property from its employees and contractors; none of the technology employed by the Company or its subsidiaries has been obtained or is being used by the Company or its subsidiaries in violation of any contractual or fiduciary obligation binding on the Company, its subsidiaries or any of their respective directors or executive officers or, to the Company's knowledge, any of their respective employees or consultants; and the Company and its subsidiaries have taken and will maintain reasonable measures to prevent the unauthorized dissemination or publication of its confidential information. To the Company's knowledge, neither the Company nor any of its subsidiaries have interfered with, infringed upon, misappropriated, or otherwise come into conflict with any Intellectual Property rights of third parties, and there has never been any charge, complaint, claim, demand, or notice alleging any such interference, infringement, misappropriation, or violation (including any claim that the Company or any of its subsidiaries must license or refrain from using any intellectual property rights of any third party) which, if the subject of any unfavorable decision, ruling or finding would, individually or in the aggregate, have a material adverse effect on the current or future consolidated financial position, stockholders' equity or results of operations of the Company and its subsidiaries; (xiv) The Company is not and, after giving effect to the offering and sale of the Shares, will not be an "investment company" or an entity "controlled" by an "investment company", as such terms are defined in the Investment Company Act of 1940, as amended (the "Investment Company Act"); (xv) Neither the Company nor any of its affiliates does business with the government of Cuba or with any person or affiliate located in Cuba within the meaning of Section 517.075, Florida Statutes; (xvi) To the Company's knowledge, Ernst & Young LLP, who have certified certain financial statements of the Company and its subsidiaries, are independent public accountants as required by the Act and the rules and regulations of the Commission thereunder; -5- 6 (xvii) The Company has reviewed its operations and that of its subsidiaries and any third parties with which the Company or any of its subsidiaries has a material relationship to evaluate the extent to which the business or operations of the Company or any of its subsidiaries will be affected by the Year 2000 Problem. As a result of such review, the Company has no reason to believe, and does not believe, that the Year 2000 Problem will have a material adverse effect on the general affairs, management, the current or future consolidated financial position, business prospects, stockholders' equity or results of operations of the Company and its subsidiaries or result in any material loss or interference with the Company's business or operations. The "Year 2000 Problem" as used herein means any significant risk that computer hardware or software used in the receipt, transmission, processing, manipulation, storage, retrieval, retransmission or other utilization of data or in the operation of mechanical or electrical systems of any kind will not, in the case of dates or time periods occurring after December 31, 1999, function at least as effectively as in the case of dates or time periods occurring prior to January 1, 2000; and (xviii) The Company has filed all reports it has been required to file under the Securities Exchange Act of 1934, as amended, and the rules and regulations of the Commission thereunder (the "Exchange Act"); such reports when filed conformed in all material respects to the requirements of the Exchange Act; and none of such reports contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein to make the statements therein, in light of the circumstances under which they were made, not misleading. (b) Each of the Selling Stockholders severally represents and warrants to, and agrees with, each of the Underwriters and the Company that: (i) All consents, approvals, authorizations and orders necessary for the execution and delivery by such Selling Stockholder of this Agreement, the International Underwriting Agreement and the Power of Attorney and the Custody Agreement hereinafter referred to, and for the sale and delivery of the Shares to be sold by such Selling Stockholder hereunder and under the International Underwriting Agreement, have been obtained; and such Selling Stockholder has full right, power and authority to enter into this Agreement, the International Underwriting Agreement, the Power of Attorney and the Custody Agreement and to sell, assign, transfer and deliver the Shares to be sold by such Selling Stockholder hereunder and under the International Underwriting Agreement; (ii) The sale of the Shares to be sold by such Selling Stockholder hereunder and under the International Underwriting Agreement and the compliance by such Selling Stockholder with all of the provisions of this Agreement, the International Underwriting Agreement, the Power of Attorney and the Custody Agreement and the consummation of the transactions herein and therein contemplated will not conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, any statute, indenture, mortgage, deed of trust, loan agreement or other agreement or instrument to which such Selling Stockholder is a party or by which such Selling Stockholder is bound or to which any of the property or assets of such Selling Stockholder is subject, nor will such action result in any violation of the provisions of any statute or any order, rule or regulation of any court or governmental agency or body having jurisdiction over such Selling Stockholder or the property of such Selling Stockholder; (iii) Such Selling Stockholder has, and immediately prior to each Time of Delivery (as defined in Section 4 hereof) such Selling Stockholder will have, good and valid title to the -6- 7 Shares to be sold by such Selling Stockholder hereunder and under the International Underwriting Agreement, free and clear of all liens, encumbrances, equities or claims; and, upon delivery of such Shares and payment therefor pursuant hereto and thereto, good and valid title to such Shares, free and clear of all liens, encumbrances, equities or claims, will pass to the several Underwriters and the International Underwriters, as the case may be; (iv) During the period beginning from the date hereof and continuing to and including the date 90 days after the date of the Prospectus, such Selling Stockholder will not, without your prior written consent (A) offer, sell, contract to sell or otherwise dispose of, except as provided hereunder or under the International Underwriting Agreement, any securities of the Company that are substantially similar to the Shares, including but not limited to any securities that are convertible into or exchangeable for, or that represent the right to receive, Stock or any such substantially similar securities (other than pursuant to employee stock option plans existing on, or upon the conversion or exchange of convertible or exchangeable securities outstanding as of, the date of this Agreement) or (B) not to engage directly or indirectly in any transaction the likely result of which would involve a transaction prohibited by subclause (A) of this clause (iv); provided, that notwithstanding the foregoing, (x) if such Selling Stockholder is an individual, he or she may transfer shares of Stock either during his or her lifetime or on death by gift, will or intestacy to his or her immediate family or to a trust the beneficiaries of which are exclusively such Selling Stockholder and/or members of his or her immediate family; and (y) if such Selling Stockholder is a trust, the trust may transfer shares of Stock to any beneficiary of such trust as of the date of this Agreement or to the estate of any such beneficiary, and any beneficiary who is an individual may transfer any such shares of Stock by gift, will or intestacy to his or her members of his or her immediate family, provided, however, that in any such described in clauses (x) and/or (y), it shall be a condition to the transfer that the transferee execute an agreement stating that the transferee is receiving and holding the shares of Stock so transferred subject to the provisions of this Section (1)(b)(iv), and there shall be no further transfer of such shares of Stock except in accordance with the provisions of this Section 1(b)(b)(iv), and that for the purposes of the foregoing, "immediate family" shall mean spouse, lineal descendant, father, mother, brother or sister of the transferor; (v) Such Selling Stockholder has not taken and will not take, directly or indirectly, any action which is designed to or which has constituted or which might reasonably be expected to cause or result in stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares; (vi) To the extent that any statements or omissions made in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto are made in reliance upon and in conformity with written information furnished to the Company by such Selling Stockholder expressly for use therein, such Preliminary Prospectus and the Registration Statement did, and the Prospectus and any further amendments or supplements to the Registration Statement and the Prospectus, when they become effective or are filed with the Commission, as the case may be, will conform in all material respects to the requirements of the Act and the rules and regulations of the Commission thereunder and will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading; (vii) In order to document the Underwriters' compliance with the reporting and withholding provisions of the Tax Equity and Fiscal Responsibility Act of 1982 with respect to the -7- 8 transactions herein contemplated, such Selling Stockholder will deliver to you prior to or at the First Time of Delivery (as hereinafter defined) a properly completed and executed United States Treasury Department Form W-9 (or other applicable form or statement specified by Treasury Department regulations in lieu thereof); (viii) Certificates in negotiable form representing all of the Shares to be sold by such Selling Stockholder hereunder and under the International Underwriting Agreement have been placed in custody under a Custody Agreement, in the form heretofore furnished to you (the "Custody Agreement"), duly executed and delivered by such Selling Stockholder to ISS Group, Inc., as custodian (the "Custodian"), and such Selling Stockholder has duly executed and delivered a Power of Attorney, in the form heretofore furnished to you (the "Power of Attorney"), appointing the persons indicated in Schedule II hereto, and each of them, as such Selling Stockholder's attorneys-in-fact (the "Attorneys-in-Fact") with authority to execute and deliver this Agreement and the International Underwriting Agreement on behalf of such Selling Stockholder, to determine the purchase price to be paid by the Underwriters and the International Underwriters to the Selling Stockholders as provided in Section 2 hereof, to authorize the delivery of the Shares to be sold by such Selling Stockholder hereunder and otherwise to act on behalf of such Selling Stockholder in connection with the transactions contemplated by this Agreement, the International Underwriting Agreement and the Custody Agreement; and (ix) The Shares represented by the certificates held in custody for such Selling Stockholder under the Custody Agreement, as a result of the obligations of such Selling Stockholder under this Agreement, are subject to the interests of the Underwriters hereunder and the International Underwriters under the International Underwriting Agreement; the arrangements made by such Selling Stockholder for such custody, and the appointment by such Selling Stockholder of the Attorneys-in-Fact by the Power of Attorney, are to that extent irrevocable; the obligations of the Selling Stockholders hereunder shall not be terminated by operation of law, whether by the death or incapacity of any individual Selling Stockholder or, in the case of an estate or trust, by the death or incapacity of any executor or trustee or the termination of such estate or trust, or in the case of a partnership or corporation, by the dissolution of such partnership or corporation, or by the occurrence of any other event; if any individual Selling Stockholder or any such executor or trustee should die or become incapacitated, or if any such estate or trust should be terminated, or if any such partnership or corporation should be dissolved, or if any other such event should occur, before the delivery of the Shares hereunder, certificates representing the Shares shall be delivered by or on behalf of the Selling Stockholders in accordance with the terms and conditions of this Agreement, of the International Underwriting Agreement and of the Custody Agreements; and actions taken by the Attorneys-in-Fact pursuant to the Powers of Attorney shall be as valid as if such death, incapacity, termination, dissolution or other event had not occurred, regardless of whether or not the Custodian, the Attorneys-in-Fact, or any of them, shall have received notice of such death, incapacity, termination, dissolution or other event. 2. Subject to the terms and conditions herein set forth, (a) the Company and each of the Selling Stockholders agree, severally and not jointly, to sell to each of the Underwriters, and each of the Underwriters agrees, severally and not jointly, to purchase from the Company and each of the Selling Stockholders, at a purchase price per share of $_____, the number of Firm Shares (to be adjusted by you so as to eliminate fractional shares) determined by multiplying the aggregate number of Firm Shares to be sold by the Company and each of the Selling Stockholders as set forth opposite their -8- 9 respective names in Schedule II hereto by a fraction, the numerator of which is the aggregate number of Firm Shares to be purchased by such Underwriter as set forth opposite the name of such Underwriter in Schedule I hereto and the denominator of which is the aggregate number of Firm Shares to be purchased by all of the Underwriters from the Company and all of the Selling Stockholders hereunder and (b) in the event and to the extent that the Underwriters shall exercise the election to purchase Optional Shares as provided below, the Company agrees to issue and sell and each of the Selling Stockholders agrees to sell to each of the Underwriters, and each of the Underwriters agrees, severally and not jointly, to purchase from the Company and each of the Selling Stockholders, at the purchase price per share set forth in clause (a) of this Section 2, that portion of the number of Optional Shares as to which such election shall have been exercised (to be adjusted by you so as to eliminate fractional shares) determined by multiplying such number of Optional Shares by a fraction, the numerator of which is the maximum number of Optional Shares which such Underwriter is entitled to purchase as set forth opposite the name of such Underwriter in Schedule I hereto and the denominator of which is the maximum number of Optional Shares that all of the Underwriters are entitled to purchase hereunder. The Company and the Selling Stockholders, as and to the extent indicated in Schedule II hereto, hereby grant, severally and not jointly, to the Underwriters the right to purchase at their election up to _______ Optional Shares, at the purchase price per share set forth in the paragraph above, for the sole purpose of covering overallotments in the sale of the Firm Shares. Any such election to purchase Optional Shares shall be made in proportion to the maximum number of Optional Shares to be sold by the Company and each Selling Stockholder as set forth in Schedule II hereto initially with respect to the Optional Shares to be sold by the Company and then among the Selling Stockholders in proportion to the maximum number of Optional Shares to be sold by each Selling Stockholder as set forth in Schedule II hereto. Any such election to purchase Optional Shares may be exercised only by written notice from you to the Company and the Attorneys-in-Fact, given within a period of 30 calendar days after the date of this Agreement and setting forth the aggregate number of Optional Shares to be purchased and the date on which such Optional Shares are to be delivered, as determined by you but in no event earlier than the First Time of Delivery (as defined in Section 4 hereof) or, unless you and the Company and the Attorneys-in-Fact otherwise agree in writing, earlier than two or later than ten business days after the date of such notice. 3. Upon the authorization by you of the release of the Firm Shares, the several Underwriters propose to offer the Firm Shares for sale upon the terms and conditions set forth in the Prospectus. 4. (a) The Shares to be purchased by each Underwriter hereunder, in definitive form, and in such authorized denominations and registered in such names as Goldman, Sachs & Co. may request upon at least forty-eight hours' prior notice to the Company and the Selling Stockholders shall be delivered by or on behalf of the Company and the Selling Stockholders to Goldman, Sachs & Co., through the facilities of the Depository Trust Company ("DTC"), for the account of such Underwriter, against payment by or on behalf of such Underwriter of the purchase price therefor by wire transfer to an account designated by the Company and each Selling Stockholder in Federal (same day) funds. The Company and each Selling Stockholder will cause the certificates representing the Shares to be made available for checking and packaging at least twenty-four hours prior to the Time of Delivery (as defined below) with respect thereto at the office of DTC or its designated custodian (the "Designated Office"). The time and date of such delivery and payment shall be, with respect to the Firm Shares, 9:30 a.m., New York City time, on ________, 1999 or such other time and date as Goldman, Sachs & Co., the Company may agree upon in writing, and, with respect to the Optional Shares, 9:30 a.m., -9- 10 New York time, on the date specified by Goldman, Sachs & Co. in the written notice given by Goldman, Sachs & Co. of the Underwriters' election to purchase such Optional Shares, or such other time and date as Goldman, Sachs & Co., the Company and the Selling Stockholders may agree upon in writing. Such time and date for delivery of the Firm Shares is herein called the "First Time of Delivery", such time and date for delivery of the Optional Shares, if not the First Time of Delivery, is herein called the "Second Time of Delivery", and each such time and date for delivery is herein called a "Time of Delivery". (b) The documents to be delivered at each Time of Delivery by or on behalf of the parties hereto pursuant to Section 7 hereof, including the cross receipt for the Shares and any additional documents requested by the Underwriters pursuant to Section 7(i) hereof, will be delivered at the offices of Brobeck, Phleger & Harrison, LLP, 1633 Broadway, New York, New York 10019 (the "Closing Location"), and the Shares will be delivered at the Designated Office, all at such Time of Delivery. A meeting will be held at the Closing Location at 3:00 p.m., New York City time, on the New York Business Day next preceding such Time of Delivery, at which meeting the final drafts of the documents to be delivered pursuant to the preceding sentence will be available for review by the parties hereto. For the purposes of this Section 4, "New York Business Day" shall mean each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which banking institutions in New York are generally authorized or obligated by law or executive order to close. 5. The Company and ISS jointly and severally agree with each of the Underwriters: (a) To prepare the Prospectus in a form approved by you and to file such Prospectus pursuant to Rule 424(b) under the Act not later than the Commission's close of business on the second business day following the execution and delivery of this Agreement, or, if applicable, such earlier time as may be required by Rule 430A(a)(3) under the Act; to make no further amendment or any supplement to the Registration Statement or Prospectus which shall be disapproved by you promptly after reasonable notice thereof; to advise you, promptly after it receives notice thereof, of the time when any amendment to the Registration Statement has been filed or becomes effective or any supplement to the Prospectus or any amended Prospectus has been filed and to furnish you with copies thereof; to advise you, promptly after it receives notice thereof, of the issuance by the Commission of any stop order or of any order preventing or suspending the use of any Preliminary Prospectus or prospectus, of the suspension of the qualification of the Shares for offering or sale in any jurisdiction, of the initiation or threatening of any proceeding for any such purpose, or of any request by the Commission for the amending or supplementing of the Registration Statement or Prospectus or for additional information; and, in the event of the issuance of any stop order or of any order preventing or suspending the use of any Preliminary Prospectus or prospectus or suspending any such qualification, promptly to use its best efforts to obtain the withdrawal of such order; (b) Promptly from time to time to take such action as you may reasonably request to qualify the Shares for offering and sale under the securities laws of such jurisdictions as you may request and to comply with such laws so as to permit the continuance of sales and dealings therein in such jurisdictions for as long as may be necessary to complete the distribution of the Shares, provided that in connection therewith the Company shall not be required to qualify as a foreign corporation or to file a general consent to service of process in any jurisdiction; (c) Prior to 10:00 a.m., New York City time on the New York Business Day next succeeding the date of this Agreement and from time to time, to furnish the Underwriters with copies of the Prospectus in New York City in such quantities as you may reasonably request, and, if the -10- 11 delivery of a prospectus is required at any time prior to the expiration of nine months after the time of issue of the Prospectus in connection with the offering or sale of the Shares and if at such time any event shall have occurred as a result of which the Prospectus as then amended or supplemented would include an untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made when such Prospectus is delivered, not misleading, or, if for any other reason it shall be necessary during such period to amend or supplement the Prospectus in order to comply with the Act, to notify you and upon your request to prepare and furnish without charge to each Underwriter and to any dealer in securities as many copies as you may from time to time reasonably request of an amended Prospectus or a supplement to the Prospectus which will correct such statement or omission or effect such compliance, and in case any Underwriter is required to deliver a prospectus in connection with sales of any of the Shares at any time nine months or more after the time of issue of the Prospectus, upon your request but at the expense of such Underwriter, to prepare and deliver to such Underwriter as many copies as you may request of an amended or supplemented Prospectus complying with Section 10(a)(3) of the Act; (d) To make generally available to the Company's security holders as soon as practicable, but in any event not later than eighteen months after the effective date of the Registration Statement (as defined in Rule 158(c) under the Act), an earnings statement of the Company and its subsidiaries (which need not be audited) complying with Section 11(a) of the Act and the rules and regulations thereunder (including, at the option of the Company, Rule 158); (e) During the period beginning from the date hereof and continuing to and including the date 90 days after the date of the Prospectus, not to (i) offer, sell, contract to sell or otherwise dispose of, except as provided hereunder and under the International Underwriting Agreement, any securities of the Company that are substantially similar to the Shares, including but not limited to any securities that are convertible into or exchangeable for, or that represent the right to receive, Stock or any such substantially similar securities (other than pursuant to employee stock option plans existing on, or upon the conversion or exchange of convertible or exchangeable securities outstanding as of, the date of this Agreement) or (ii) engage directly or indirectly in any transaction the likely result of which would involve a transaction prohibited by clause (i) of this section 5(e), without your prior written consent; (f) To furnish to the Company's stockholders as soon as practicable after the end of each fiscal year an annual report (including a balance sheet and statements of income, stockholders' equity and cash flows of the Company and its consolidated subsidiaries certified by independent public accountants); (g) During a period of five years from the effective date of the Registration Statement, to furnish to you copies of all reports or other communications (financial or other) furnished to the Company's stockholders, and to deliver to you (i) as soon as they are available, copies of any reports and financial statements furnished to or filed with the Commission or any national securities exchange on which any class of securities of the Company is listed; and (ii) such additional information concerning the business and financial condition of the Company as you may from time to time reasonably request (such financial statements to be on a consolidated basis to the extent the accounts of the Company and its subsidiaries are consolidated in reports furnished to its stockholders generally or to the Commission); -11- 12 (h) To use the net proceeds received by the Company from the sale of the Shares pursuant to this Agreement and the International Underwriting Agreement in the manner specified in the Prospectus under the caption "Use of Proceeds"; (i) To use its best efforts to list for quotation the Shares on the National Association of Securities Dealers Automated Quotations National Market System ("NASDAQ"); and (j) If the Company elects to rely upon Rule 462(b), the Company shall file a Rule 462(b) Registration Statement with the Commission in compliance with Rule 462(b) by 10:00 P.M., Washington, D.C. time, on the date of this Agreement, and the Company shall at the time of filing either pay to the Commission the filing fee for the Rule 462(b) Registration Statement or give irrevocable instructions for the payments of such fee pursuant to Rule 111(b) under the Act. 6. The Company and each of the Selling Stockholders covenant and agree with one another and with the several Underwriters that (a) the Company will pay or cause to be paid the following: (i) the fees, disbursements and expenses of the Company's counsel and accountants in connection with the registration of the Shares under the Act and all other expenses in connection with the preparation, printing and filing of the Registration Statement, any Preliminary Prospectus and the Prospectus and amendments and supplements thereto and the mailing and delivering of copies thereof to the Underwriters and dealers; (ii) the cost of printing or producing any Agreement among Underwriters, this Agreement, the International Underwriting Agreement, the Agreement between Syndicates, the Selling Agreements, the Blue Sky Memorandum, closing documents (including any compilations thereof) and any other documents in connection with the offering, purchase, sale and delivery of the Shares; (iii) all expenses in connection with the qualification of the Shares for offering and sale under state securities laws as provided in Section 5(b) hereof, including the fees and disbursements of counsel for the Underwriters in connection with such qualification and in connection with the Blue Sky survey (iv) all fees and expenses in connection with listing the Shares on the NASDAQ; (iv) the filing fees incident to, and up to $5,000 of the fees and disbursements of counsel for the Underwriters in connection with, securing any required review by the National Association of Securities Dealers, Inc. of the terms of the sale of the Shares; (v) the cost of preparing stock certificates; (vi) the costs and charges of any transfer agent or registrar; and (vii) all other costs and expenses incident to the performance of its obligations hereunder which are not otherwise specifically provided for in this Section; and (b) such Selling Stockholder will pay or cause to be paid all costs and expenses incident to the performance of such Selling Stockholder's obligations hereunder which are not otherwise specifically provided for in this Section, including (i) any fees and expenses of counsel for such Selling Stockholder, (ii) the Selling Stockholder's pro rata share of fees and expenses of the Attorneys-in-Fact and the Custodian, and (iii) all expenses and taxes incident to the sale and delivery of the Shares to be sold by such Selling Stockholders to the Underwriters hereunder. In connection with clause (b) (iii) of the preceding sentence, Goldman, Sachs & Co. agrees to pay New York State stock transfer tax, and the Selling Stockholders agree to reimburse Goldman, Sachs & Co. for associated carrying costs if such tax payment is not rebated on the day of payment and for any portion of such tax payment not rebated. It is understood, however, that the Company shall bear, and the Selling Stockholders shall not be required to pay or to reimburse the Company for, the cost of any other matters not directly relating to the sale and purchase of the Shares pursuant to this Agreement, and that, except as provided in this Section, and Sections 8 and 11 hereof, the Underwriters will pay all of their own costs and expenses, including the fees of their counsel, stock transfer taxes on resale of any of the Shares by them, and any advertising expenses connected with any offers they may make. -12- 13 7. The obligations of the Underwriters hereunder, as to the Shares to be delivered at each Time of Delivery, shall be subject, in their discretion, to the condition that all representations and warranties and other statements of the Company and of the Selling Stockholders herein are, at and as of such Time of Delivery, true and correct, the condition that the Company and the Selling Stockholders shall have performed all of its and their obligations hereunder theretofore to be performed, and the following additional conditions: (a) The Prospectus shall have been filed with the Commission pursuant to Rule 424(b) within the applicable time period prescribed for such filing by the rules and regulations under the Act and in accordance with Section 5(a) hereof; if the Company has elected to rely upon Rule 462(b), the Rule 462(b) Registration Statement shall have become effective by 10:00 p.m., Washington, D.C. time, on the date of this Agreement; no stop order suspending the effectiveness of the Registration Statement or any part thereof shall have been issued and no proceeding for that purpose shall have been initiated or threatened by the Commission; and all requests for additional information on the part of the Commission shall have been complied with to your reasonable satisfaction; (b) Ropes & Gray, counsel for the Underwriters, shall have furnished to you such opinion or opinions (a draft of such opinion is attached as Annex II(a) hereto), dated such Time of Delivery, with respect to the matters covered in paragraphs (i), (ii), (vi), (x) and (xiii) of subsection (c) below as well as such other related matters as you may reasonably request, and such counsel shall have received such papers and information as they may reasonably request to enable them to pass upon such matters; (c) Brobeck, Phleger & Harrison LLP, counsel for the Company, shall have furnished to you their written opinion (a draft of such opinion is attached as Annex II(B) hereto), dated such Time of Delivery, in form and substance satisfactory to you, to the effect that: (i) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the State of Delaware, with power and authority (corporate and other) to own its properties and conduct its business as described in the Registration Statement and Prospectus; (ii) The Company has an authorized capitalization as set forth in the Prospectus, and all of the issued shares of capital stock of the Company (including the Shares being delivered at such Time of Delivery) have been duly and validly authorized and issued and are fully paid and non-assessable; and the Shares conform in all material respects to the description of the Stock contained in the Registration Statement and Prospectus; (iii) Each of the Company and ISS has been duly qualified as a foreign corporation for the transaction of business and is in good standing under the laws of the State of Georgia (as to the Company only) and each other jurisdiction in which it owns or leases properties or to such counsel's knowledge conducts any business so as to require such qualification, except where the failure to be so qualified or in good standing would not have a material adverse effect on the Company and its subsidiaries considered as one enterprise, or is subject to no material liability or disability by reason of failure to be so qualified in any such jurisdiction (such counsel being entitled to rely in respect of the opinion in this clause upon opinions of local counsel and in respect of matters of fact upon certificates of officers of the Company, -13- 14 provided that such counsel shall state that they believe that both you and they are justified in relying upon such opinions and certificates); (iv) Each subsidiary of the Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation; and all of the issued shares of capital stock of each such subsidiary have been duly and validly authorized and issued, are fully paid and non-assessable, and (except for directors' qualifying shares and except as otherwise set forth in the Prospectus) are owned directly or indirectly by the Company, free and clear of all liens, encumbrances, equities or claims (such counsel being entitled to rely in respect of the opinion in this clause upon opinions of local counsel and in respect to matters of fact upon certificates of officers of the Company or its subsidiaries, provided that such counsel shall state that they believe that both you and they are justified in relying upon such opinions and certificates); (v) To the best of such counsel's knowledge and other than as set forth in the Prospectus, there are no legal or governmental proceedings pending to which the Company or any of its subsidiaries is a party or of which any property of the Company or any of its subsidiaries is the subject that is required to be described in the Registration Statement or Prospectus and is not so described and, to such counsel's knowledge, no such proceedings are threatened or contemplated by governmental authorities or threatened by others; (vi) This Agreement and the International Underwriting Agreement have been duly authorized, executed and delivered by the Company; (vii) The issue and sale of the Shares being delivered at such Time of Delivery to be sold by the Company and the compliance by the Company with all of the provisions of this Agreement and the International Underwriting Agreement and the consummation of the transactions herein contemplated will not conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, any indenture, mortgage, deed of trust, loan agreement or other agreement or instrument which is filed as an exhibit to, or referred to, in the Registration Statement (in giving the opinion in this clause counsel may attach to such opinion a list of the foregoing agreements and instruments), nor will such action result in any violation of the provisions of the Certificate of Incorporation or By-laws of the Company or any statute or any order, rule or regulation known to such counsel of any court or governmental agency or body having jurisdiction over the Company or any of its subsidiaries or any of their properties (other than the clearance of the underwriting arrangements with the NASD, Blue Sky or state securities laws matters in connection with the purchase and distribution of the Shares by the Underwriters); (viii) No consent, approval, authorization, order, registration or qualification of or with any such court or governmental agency or body is required for the issue and sale of the Shares or the consummation by the Company of the transactions contemplated by this Agreement and the International Underwriting Agreement, except the registration under the Act of the Shares, and such consents, approvals, authorizations, registrations or qualifications as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Shares by the -14- 15 Underwriters and the International Underwriters (as to which counsel need express no opinion); (ix) Neither the Company nor any of its subsidiaries is in violation of its Certificate of Incorporation or By-laws or in default in the performance or observance of any material obligation, agreement, covenant or condition contained in any indenture, mortgage, deed of trust, loan agreement, lease or other agreement or instrument which is filed as an exhibit to, or referred to, in the Registration Statement (in giving the opinion in this clause counsel may attach to such opinion a list of the foregoing agreements and instruments); (x) The statements set forth in the Prospectus under the caption "Description of Capital Stock", insofar as they purport to constitute a summary of the terms of the Stock, under the caption "Certain U.S. Tax Considerations Applicable to Non-U.S. Holders of the Common Stock" and under the caption "Underwriting", insofar as they purport to describe the provisions of the laws and documents referred to therein, are accurate, complete and fair; (xi) The Company is not an "investment company" or required to be registered as an investment company under the Investment Company Act; (xii) No holders of outstanding options under the 1995 Restated Stock Incentive Plan (the "Plan") have the right to acquire any shares of capital stock of ISS as a result of the assumption by the Company of the outstanding options issued pursuant to the Plan and all other obligations under the Plan in connection with the transactions contemplated by the Stock Exchange Agreement dated as of December 8, 1997 by and among the Company and the shareholders of ISS. In addition, the Company has consummated the assumption of such options and obligations in accordance with all of the terms and conditions of the Plan, and the Company has obtained all required consents, approvals and authorizations for such assumption; and (xiii) The Registration Statement and the Prospectus and any further amendments and supplements thereto made by the Company prior to such Time of Delivery (other than the financial statements and related schedules therein, as to which such counsel need express no opinion), when filed and at the time the Registration Statement was declared effective, complied as to form in all material respects with the requirements of the Act and the rules and regulations thereunder; although they do not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Registration Statement or the Prospectus, except for those referred to in the opinion in subsection (x) of this section 7(c), they have no reason to believe that, as of its effective date, the Registration Statement or any further amendment thereto made by the Company prior to such Time of Delivery (other than the financial statements and related schedules therein, as to which such counsel need express no opinion) contained an untrue statement of a -15- 16 material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading or that, as of its date, the Prospectus or any further amendment or supplement thereto made by the Company prior such Time of Delivery (other than the financial statements and related schedules therein, as to which such counsel need express no opinion) contained an untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading or that, as of such Time of Delivery, either the Registration Statement or the Prospectus or any further amendment or supplement thereto made by the Company prior to such Time of Delivery (other than the financial statements and related schedules therein, as to which such counsel need express no opinion) contains an untrue statement of a material fact or omits to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; and they do not know of any amendment to the Registration Statement required to be filed or of any contracts or other documents of a character required to be filed as an exhibit to the Registration Statement or required to be described in the Registration Statement or the Prospectus which are not filed or described as required; (d) Each of King & Spalding and Nagashimi & Ohno, counsel to the Company, shall have furnished to you their written opinion, dated such time of delivery, in form and substance satisfactory to you, with respect to the matters set forth in clauses (iv), (v), and (ix) of the foregoing paragraph (c), relating to Internet Security Systems, Inc., a Georgia corporation and Internet Security Systems KK, a Japanese corporation, respectively; (e) The respective counsel for each of the Selling Stockholders, as indicated in Schedule II hereto, each shall have furnished to you their written opinion with respect to each of the Selling Stockholders for whom they are acting as counsel, dated such Time of Delivery, in form and substance satisfactory to you, to the effect that: (i) A Power-of-Attorney and a Custody Agreement dated as of the date of this Agreement have been duly executed and delivered by such Selling Stockholder and constitute valid and binding agreements of such Selling Stockholder in accordance with their terms; (ii) This Agreement and the International Underwriting Agreement have been duly executed and delivered by or on behalf of such Selling Stockholder; and the sale of the Shares to be sold by such Selling Stockholder hereunder and thereunder and the compliance by such Selling Stockholder with all of the provisions of this Agreement and the International Underwriting Agreement, the Power-of-Attorney and the Custody Agreement and the consummation of the transactions herein and therein contemplated will not conflict with or result in a breach or violation of any terms or provisions of, or constitute a default under, any statute, indenture, mortgage, deed of trust, loan agreement or other agreement or instrument known to such counsel to which such Selling Stockholder is a party or by which such Selling Stockholder is bound or to which any of the property or assets of such Selling Stockholder is subject, nor will such action result in any violation of the provisions of any order, rule or regulation known to such counsel of any court or governmental agency or body having jurisdiction over such Selling Stockholder or the property of such Selling Stockholder; (iii) No consent, approval, authorization or order of any court or governmental agency or body is required for the consummation of the transactions contemplated by this Agreement and the International Underwriting Agreement in connection with the Shares to be sold by such Selling Stockholder hereunder or thereunder, except such as have -16- 17 been obtained under the Act and such as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of such Shares by the Underwriters or the International Underwriters; (iv) Immediately prior to any Time of Delivery, such Selling Stockholder had good and valid title to the Shares to be sold at such Time of Delivery by such Selling Stockholder under this Agreement and the International Underwriting Agreement, free and clear of all liens, encumbrances, equities or claims, and full right, power and authority to sell, assign, transfer and deliver the Shares to be sold by such Selling Stockholder hereunder and thereunder; and (v) Assuming that the Underwriters purchase the Shares to be sold by each Selling Stockholder for value, in good faith and without notice of any adverse claim within the meaning of the Uniform Commercial Code, upon delivery and payment for the Shares to be sold by each Selling Stockholder, the Underwriters will receive valid title to such Shares, free and clear of all liens, encumbrances, equities or claims. In rendering the opinion in paragraph (iv), such counsel may rely upon a certificate of such Selling Stockholder in respect of matters of fact as to ownership of, and liens, encumbrances, equities or claims on, the Shares sold by such Selling Stockholder, provided that such counsel shall state that they believe that both you and they are justified in relying upon such certificate and that an original of such certificate is delivered to you; (f) On the date of the Prospectus at a time prior to the execution of this Agreement, at 9:30 a.m., New York City time, on the effective date of any post-effective amendment to the Registration Statement filed subsequent to the date of this Agreement and also at each Time of Delivery, Ernst & Young LLP shall have furnished to you a letter or letters, dated the respective dates of delivery thereof, in form and substance satisfactory to you, to the effect set forth in Annex I hereto; (g)(i) Neither the Company nor any of its subsidiaries shall have sustained since the date of the latest audited financial statements included in the Prospectus any loss or interference with its business from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, otherwise than as set forth or contemplated in the Prospectus, and (ii) since the respective dates as of which information is given in the Prospectus there shall not have been any change in the capital stock or long-term debt of the Company or any of its subsidiaries or any change, or any development involving a prospective change, in or affecting the general affairs, management, financial position, stockholders' equity or results of operations of the Company and its subsidiaries, otherwise than as set forth or contemplated in the Prospectus, the effect of which, in any such case described in Clause (i) or (ii), is in the judgment of the Representatives so material and adverse as to make it impracticable or inadvisable to proceed with the public offering or the delivery of the Shares being delivered at such Time of Delivery on the terms and in the manner contemplated in the Prospectus; (h) On or after the date hereof (i) no downgrading shall have occurred in the rating, if any, accorded the Company's debt securities by any "nationally recognized statistical rating organization", as that term is defined by the Commission for purposes of Rule 436(g)(2) under the Act, and (ii) no such organization shall have publicly announced that it has under surveillance or review, with possible negative implications, its rating of any of the Company's debt securities; -17- 18 (i) On or after the date hereof there shall not have occurred any of the following: (i) a suspension or material limitation in trading in securities generally on the New York Stock Exchange or on NASDAQ; (ii) a suspension or material limitation in trading in the Company's securities on NASDAQ; (iii) a general moratorium on commercial banking activities declared by either Federal or New York State authorities; or (iv) the outbreak or escalation of hostilities involving the United States or the declaration by the United States of a national emergency or war, if the effect of any such event specified in this Clause (iv) in the judgment of the Representatives makes it impracticable or inadvisable to proceed with the public offering or the delivery of the Shares being delivered at such Time of Delivery on the terms and in the manner contemplated in the Prospectus; (j) The Shares to be sold at such Time of Delivery shall have been duly listed for quotation on NASDAQ; (k) The Company has obtained and delivered to the Underwriters executed copies of agreements from stockholders of the Company holding in the aggregate in excess of 95% of the shares outstanding on the date of this Agreement, substantially to the effect set forth in Subsection 1(b)(iv) hereof in form and substance satisfactory to you; (l) The Company shall have complied with the provisions of Section 5(c) hereof with respect to the furnishing of prospectuses on the New York Business Day next succeeding the date of this Agreement; and (m) The Company and the Selling Stockholders shall have furnished or caused to be furnished to you at such Time of Delivery certificates of officers of the Company and of the Selling Stockholders, respectively, satisfactory to you as to the accuracy of the representations and warranties of the Company and of the Selling Stockholders, respectively, herein at and as of such Time of Delivery, as to the performance by the Company and the Selling Stockholders of all of their respective obligations hereunder to be performed at or prior to such Time of Delivery, and as to such other matters as you may reasonably request, and the Company shall have furnished or caused to be furnished certificates as to the matters set forth in subsections (a) and (f) of this Section. 8. (a) The Company and ISS, jointly and severally, will indemnify and hold harmless each Underwriter against any losses, claims, damages or liabilities, joint or several, to which such Underwriter may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in any Preliminary Prospectus, the Registration Statement or the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse each Underwriter for any legal or other expenses reasonably incurred by such Underwriter in connection with investigating or defending any such action or claim as such expenses are incurred; provided, however, that the Company and ISS shall not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in any Preliminary Prospectus, the Registration Statement or the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished to the Company by any Underwriter through Goldman, Sachs & Co. expressly for use therein. (b) Each of the Selling Stockholders will indemnify and hold harmless each Underwriter against any losses, claims, damages or liabilities, joint or several, to which such Underwriter may become subject, under the Act or otherwise, insofar as such losses, claims, damages -18- 19 or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in any Preliminary Prospectus, the Registration Statement or the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse each Underwriter for any legal or other expenses reasonably incurred by such Underwriter in connection with investigating or defending any such action or claim as such expenses are incurred; provided, however, that such Selling Stockholder shall not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in any preliminary Prospectus, the Registration Statement or the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished by any Underwriter through Goldman, Sachs & Co. expressly for use therein; provided, further, that the liability of a Selling Stockholder pursuant to this subsection (b) shall not exceed the product of the number of Shares sold by such Selling Stockholder and the initial public offering price of the Shares as set forth in the Prospectus. (c) Each Underwriter will indemnify and hold harmless the Company and each Selling Stockholder against any losses, claims, damages or liabilities to which the Company or such Selling Stockholder may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in any Preliminary Prospectus, the Registration Statement or the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in any Preliminary Prospectus, the Registration Statement or the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished to the Company by such Underwriter through Goldman, Sachs & Co. expressly for use therein; and will reimburse the Company and each Selling Stockholder for any legal or other expenses reasonably incurred by the Company or such Selling Stockholder in connection with investigating or defending any such action or claim as such expenses are incurred. (d) Promptly after receipt by an indemnified party under subsection (a), (b) or (c) above of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against the indemnifying party under such subsection, notify the indemnifying party in writing of the commencement thereof; but the omission so to notify the indemnifying party shall not relieve it from any liability which it may have to any indemnified party otherwise than under such subsection. In case any such action shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party (who shall not, except with the consent of the indemnified party, be counsel to the indemnifying party), and, after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be liable to such indemnified party under such subsection for any legal expenses of other counsel or any other expenses, in each case subsequently incurred by such indemnified party, in connection with the defense thereof other than reasonable costs of investigation. No indemnifying party shall, without the written consent of the indemnified party, effect the settlement or compromise of, or consent to the entry of any judgment with respect to, any pending -19- 20 or threatened action or claim in respect of which indemnification or contribution may be sought hereunder (whether or not the indemnified party is an actual or potential party to such action or claim) unless such settlement, compromise or judgment (i) includes an unconditional release of the indemnified party from all liability arising out of such action or claim and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act, by or on behalf of any indemnified party. (e) If the indemnification provided for in this Section 8 is unavailable to or insufficient to hold harmless an indemnified party under subsection (a), (b) or (c) above in respect of any losses, claims, damages or liabilities (or actions in respect thereof) referred to therein, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect the relative benefits received by the Company and the Selling Stockholders on the one hand and the Underwriters on the other from the offering of the Shares. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law or if the indemnified party failed to give the notice required under subsection (d) above, then each indemnifying party shall contribute to such amount paid or payable by such indemnified party in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the Company and the Selling Stockholders on the one hand and the Underwriters on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Company and the Selling Stockholders on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total net proceeds from the offering (before deducting expenses) received by the Company and the Selling Stockholders bear to the total underwriting discounts and commissions received by the Underwriters, in each case as set forth in the table on the cover page of the Prospectus. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or the Selling Stockholders on the one hand or the Underwriters on the other and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company, each of the Selling Stockholders and the Underwriters agree that it would not be just and equitable if contributions pursuant to this subsection (e) were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above in this subsection (e). The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions in respect thereof) referred to above in this subsection (e) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this subsection (e), no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Shares underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages which such Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations in this subsection (e) to contribute are several in proportion to their respective underwriting obligations and not joint. -20- 21 (f) The obligations of the Company, ISS and the Selling Stockholders under this Section 8 shall be in addition to any liability which the Company and the respective Selling Stockholders may otherwise have and shall extend, upon the same terms and conditions, to each person, if any, who controls any Underwriter within the meaning of the Act; and the obligations of the Underwriters under this Section 8 shall be in addition to any liability which the respective Underwriters may otherwise have and shall extend, upon the same terms and conditions, to each officer and director of the Company (including any person who, with his or her consent, is named in the Registration Statement as about to become a director of the Company) and to each person, if any, who controls the Company within the meaning of the Act. 9. (a) If any Underwriter shall default in its obligation to purchase the Shares which it has agreed to purchase hereunder at a Time of Delivery, you may in your discretion arrange for you or another party or other parties to purchase such Shares on the terms contained herein. If within thirty-six hours after such default by any Underwriter you do not arrange for the purchase of such Shares, then the Company and the Selling Stockholders shall be entitled to a further period of thirty-six hours within which to procure another party or other parties satisfactory to you to purchase such Shares on such terms. In the event that, within the respective prescribed periods, you notify the Company and the Selling Stockholders that you have so arranged for the purchase of such Shares, or the Company and the Selling Stockholders notify you that they have so arranged for the purchase of such Shares, you or the Company shall have the right to postpone such Time of Delivery for a period of not more than seven days, in order to effect whatever changes may thereby be made necessary in the Registration Statement or the Prospectus, or in any other documents or arrangements, and the Company agrees to file promptly any amendments to the Registration Statement or the Prospectus which in your reasonable opinion may thereby be made necessary. The term "Underwriter" as used in this Agreement shall include any person substituted under this Section with like effect as if such person had originally been a party to this Agreement with respect to such Shares. (b) If, after giving effect to any arrangements for the purchase of the Shares of a defaulting Underwriter or Underwriters by you and the Company and the Selling Stockholders as provided in subsection (a) above, the aggregate number of such Shares which remains unpurchased does not exceed one-eleventh of the aggregate number of all the Shares to be purchased at such Time of Delivery, then the Company and the Selling Stockholders shall have the right to require each non-defaulting Underwriter to purchase the number of Shares which such Underwriter agreed to purchase hereunder at such Time of Delivery and, in addition, to require each non-defaulting Underwriter to purchase its pro rata share (based on the number of Shares which such Underwriter agreed to purchase hereunder) of the Shares of such defaulting Underwriter or Underwriters for which such arrangements have not been made; but nothing herein shall relieve a defaulting Underwriter from liability for its default. (c) If, after giving effect to any arrangements for the purchase of the Shares of a defaulting Underwriter or Underwriters by you and the Company and the Selling Stockholders as provided in subsection (a) above, the aggregate number of such Shares which remains unpurchased exceeds one-eleventh of the aggregate number of all the Shares to be purchased at such Time of Delivery, or if the Company and the Selling Stockholders shall not exercise the right described in subsection (b) above to require non-defaulting -21- 22 Underwriters to purchase Shares of a defaulting Underwriter or Underwriters, then this Agreement or, with respect to the Second Time of Delivery, the obligations of the Underwriters to purchase and of the Company and the Selling Stockholders to sell the Optional Shares, shall thereupon terminate, without liability on the part of any non-defaulting Underwriter or the Company or the Selling Stockholders, except for the expenses to be borne by the Company and the Selling Stockholders and the Underwriters as provided in Section 6 hereof and the indemnity and contribution agreements in Section 8 hereof; but nothing herein shall relieve a defaulting Underwriter from liability for its default. 10. The respective indemnities, agreements, representations, warranties and other statements of the Company and the Selling Stockholders and the several Underwriters, as set forth in this Agreement or made by or on behalf of them, respectively, pursuant to this Agreement, shall remain in full force and effect, regardless of any investigation (or any statement as to the results thereof) made by or on behalf of any Underwriter or any controlling person of any Underwriter, or the Company or the Selling Stockholders, or any officer or director or controlling person of the Company or any controlling person of any Selling Stockholder, and shall survive delivery of and payment for the Shares. 11. If this Agreement shall be terminated pursuant to Section 9 hereof, neither the Company, nor ISS nor the Selling Stockholders shall then be under any liability to any Underwriter except as provided in Sections 6 and 8 hereof; but, if for any other reason any Shares are not delivered by or on behalf of the Company and the Selling Stockholders as provided herein, the Company and each of the Selling Stockholders pro rata (based on the number of Shares to be sold by the Company and such Selling Stockholder hereunder) will reimburse the Underwriters through you for all out-of-pocket expenses approved in writing by you, including fees and disbursements of counsel, reasonably incurred by the Underwriters in making preparations for the purchase, sale and delivery of the Shares not so delivered, but the Company, ISS and the Selling Stockholders shall then be under no further liability to any Underwriter in respect of the Shares not so delivered except as provided in Sections 6 and 8 hereof. 12. In all dealings hereunder, you shall act on behalf of each of the Underwriters, and the parties hereto shall be entitled to act and rely upon any statement, request, notice or agreement on behalf of any Underwriter made or given by you jointly or by Goldman, Sachs & Co. on behalf of you as the representatives; and in all dealings with any Selling Stockholder hereunder, you and the Company shall be entitled to act and rely upon any statement, request, notice or agreement on behalf of such Selling Stockholder made or given by any or all of the Attorneys-in-Fact for such Selling Stockholder. All statements, requests, notices and agreements hereunder shall be in writing, and if to the Underwriters shall be delivered or sent by mail, telex or facsimile transmission to you as the representatives in care of Goldman, Sachs & Co., 85 Broad Street, New York, New York 10004, Attention: Registration Department; and if to any Selling Stockholders shall be delivered or sent by mail, telex or facsimile transmission to counsel for such Selling Stockholder at its address set forth in Schedule II hereto; and if to the Company shall be delivered or sent by mail, telex or facsimile transmission to the address of the Company set forth in the Registration Statement, Attention: Secretary; provided, however, that any notice to an Underwriter pursuant to Section 8(c) hereof shall be delivered or sent by mail, telex or facsimile transmission to such Underwriter at its address set forth in its Underwriters' Questionnaire, or telex constituting such Questionnaire, which address will be supplied to the Company by you upon request. Any such statements, requests, notices or agreements shall take effect upon receipt thereof. 13. This Agreement shall be binding upon, and inure solely to the benefit of, the Underwriters, the Company and the Selling Stockholders and, to the extent provided in Sections 8 and 10 hereof, the officers and directors of the Company and each person who controls the Company, any Selling -22- 23 Stockholder or any Underwriter, and their respective heirs, executors, administrators, successors and assigns, and no other person shall acquire or have any right under or by virtue of this Agreement. No purchaser of any of the Shares from any Underwriter shall be deemed a successor or assign by reason merely of such purchase. 14. Time shall be of the essence of this Agreement. As used herein, the term "business day" shall mean any day when the Commission's office in Washington, D.C. is open for business. 15. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. 16. This Agreement may be executed by any one or more of the parties hereto in any number of counterparts, each of which shall be deemed to be an original, but all such counterparts shall together constitute one and the same instrument. If the foregoing is in accordance with your understanding, please sign and return to us eight counterparts hereof, and upon the acceptance hereof by you, on behalf of each of the Underwriters, this letter and such acceptance hereof shall constitute a binding agreement among each of the Underwriters, the Company and each of the Selling Stockholders. It is understood that your acceptance of this letter on behalf of each of the Underwriters is pursuant to the authority set forth in a form of Agreement among Underwriters, the form of which shall be submitted to the Company and -23- 24 the Selling Stockholders for examination upon request, but without warranty on your part as to the authority of the signers thereof. Very truly yours, ISS Group, Inc. By: ------------------------------------------ Name: Title: Internet Security Systems, Inc. By: ------------------------------------------ Name: Title: Christopher W. Klaus Thomas E. Noonan Kevin J. O'Connor Alex Bogaerts Lin Ja Hong Richard Macchia M. Thomas McNeight H. Keith Cooley Glenn M. McGonnigle Nancy Blair Charles Meyers Patrick J.D. Taylor By: .......................................... Name: Title: As Attorney-in-Fact acting on behalf of each of the Selling Stockholders named in Schedule II to this Agreement. Accepted as of the date hereof: Goldman, Sachs & Co. Dain Rauscher Wessels, a division of Dain Rauscher Incorporated Warburg Dillon Read LLC, a subsidiary of UBS AG BancBoston Robertson Stephens Inc. By: ...................................... (Goldman, Sachs & Co.) On behalf of each of the Underwriters 25 SCHEDULE I -25- 26 SCHEDULE II -26- 27 ANNEX I Pursuant to Section 7(d) of the Underwriting Agreement, the accountants shall furnish letters to the Underwriters to the effect that: (i) They are independent certified public accountants with respect to the Company and its subsidiaries within the meaning of the Act and the applicable published rules and regulations thereunder; (ii) In their opinion, the financial statements and any supplementary financial information and schedules (and, if applicable, financial forecasts and/or pro forma financial information) examined by them and included in the Prospectus or the Registration Statement comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations thereunder; and, if applicable, they have made a review in accordance with standards established by the American Institute of Certified Public Accountants of the unaudited consolidated interim financial statements, selected financial data, pro forma financial information, financial forecasts and/or condensed financial statements derived from audited financial statements of the Company for the periods specified in such letter, as indicated in their reports thereon, copies of which have been furnished to the representatives of the Underwriters (the "Representatives" and are attached hereto; (iii) They have made a review in accordance with standards established by the American Institute of Certified Public Accountants of the unaudited condensed consolidated statements of income, consolidated balance sheets and consolidated statements of cash flows included in the Prospectus as indicated in their reports thereon copies of which are attached hereto and on the basis of specified procedures including inquiries of officials of the Company who have responsibility for financial and accounting matters regarding whether the unaudited condensed consolidated financial statements referred to in paragraph (vi)(A)(i) below comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations, nothing came to their attention that caused them to believe that the unaudited condensed consolidated financial statements do not comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations; (iv) They have compared the information in the Prospectus under selected captions with the disclosure requirements of Regulation S-K and on the basis of limited procedures specified in such letter nothing came to their attention as a result of the foregoing procedures that caused them to believe that this information does not conform in all material respects with the disclosure requirements of Items 301, 302, 402 and 503(d), respectively, of Regulation S-K; (vi) On the basis of limited procedures, not constituting an examination in accordance with generally accepted auditing standards, consisting of a reading of the unaudited financial statements and other information referred to below, a reading of the latest available interim financial statements of the Company and its subsidiaries, inspection of the minute books of the Company and its subsidiaries since the date of the latest audited financial statements included in the Prospectus, inquiries of officials of the Company and its subsidiaries responsible for 28 financial and accounting matters and such other inquiries and procedures as may be specified in such letter, nothing came to their attention that caused them to believe that: (A) (i) the unaudited consolidated statements of income, consolidated balance sheets and consolidated statements of cash flows included in the Prospectus do not comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations, or (ii) any material modifications should be made to the unaudited condensed consolidated statements of income, consolidated balance sheets and consolidated statements of cash flows included in the Prospectus for them to be in conformity with generally accepted accounting principles; (B) any other unaudited income statement data and balance sheet items included in the Prospectus do not agree with the corresponding items in the unaudited consolidated financial statements from which such data and items were derived, and any such unaudited data and items were not determined on a basis substantially consistent with the basis for the corresponding amounts in the audited consolidated financial statements included in the Prospectus; (C) the unaudited financial statements which were not included in the Prospectus but from which were derived any unaudited condensed financial statements referred to in Clause (A) and any unaudited income statement data and balance sheet items included in the Prospectus and referred to in Clause (B) were not determined on a basis substantially consistent with the basis for the audited consolidated financial statements included in the Prospectus; (D) any unaudited pro forma consolidated condensed financial statements included in the Prospectus do not comply as to form in all material respects with the applicable accounting requirements of the Act and the published rules and regulations thereunder or the pro forma adjustments have not been properly applied to the historical amounts in the compilation of those statements; (E) as of a specified date not more than five days prior to the date of such letter, there have been any changes in the consolidated capital stock (other than issuances of capital stock upon exercise of options and stock appreciation rights, upon earn-outs of performance shares and upon conversions of convertible securities, in each case which were outstanding on the date of the latest financial statements included in the Prospectus) or any increase in the consolidated long-term debt of the Company and its subsidiaries, or any decreases in consolidated net current assets or stockholders' equity or other items specified by the Representatives, or any increases in any items specified by the Representatives, in each case as compared with amounts shown in the latest balance sheet included in the Prospectus, except in each case for changes, increases or decreases which the Prospectus discloses have occurred or may occur or which are described in such letter; and (F) for the period from the date of the latest financial statements included in the Prospectus to the specified date referred to in Clause (E) there were any decreases in consolidated net revenues or operating profit or the total or per share amounts of consolidated net income or other items specified by the Representatives, or any increases in any items specified by the Representatives, in each case as compared with the 29 comparable period of the preceding year and with any other period of corresponding length specified by the Representatives, except in each case for decreases or increases which the Prospectus discloses have occurred or may occur or which are described in such letter; and (vii) In addition to the examination referred to in their report(s) included in the Prospectus and the limited procedures, inspection of minute books, inquiries and other procedures referred to in paragraphs (iii) and (vi) above, they have carried out certain specified procedures, not constituting an examination in accordance with generally accepted auditing standards, with respect to certain amounts, percentages and financial information specified by the Representatives, which are derived from the general accounting records of the Company and its subsidiaries, which appear in the Prospectus, or in Part II of, or in exhibits and schedules to, the Registration Statement specified by the Representatives, and have compared certain of such amounts, percentages and financial information with the accounting records of the Company and its subsidiaries and have found them to be in agreement. EX-10.9 3 SUBLEASE FOR ADDITIONAL ATLANTA FACILITIES 1 EXHIBIT 10.9 Lease EMBASSY ROW 600 6600 PEACHTREE DUNWOODY ROAD BUILDING 600, SUITE 600 ATLANTA, GEORGIA 30328 Between INTERNET SECURITY SYSTEMS, INC. (ISS) (Tenant) and CARRAMERICA REALTY CORPORATION (Landlord) 2 LEASE THIS LEASE (the "Lease") is made as of ________, 19 _______ between CARRAMERICA REALTY CORPORATION, a Maryland corporation (the "Landlord") and the Tenant as named in the Schedule below. The term "Project" means the building (the "Building") known as "Embassy Row 600" and the land (the "Land") located at 6600 Peachtree Dunwoody Road, Atlanta, Georgia 30328. "Premises" means that part of the Project leased to Tenant described in the Schedule and outlined on Appendix A. The following schedule (the "Schedule") is an integral part of this Lease. Terms defined in this Schedule shall have the same meaning throughout the Lease. SCHEDULE 1. TENANT: Internet Security Systems, Inc. (ISS), a Georgia corporation 2. PREMISES: 6600 Peachtree Dunwoody Road, Building 600, Suite 600, Atlanta, Georgia 30328 3. RENTABLE SQUARE FEET OF THE PREMISES: 24,481 (See Special Stipulations #1 - Phased Occupancy) PHASE 1 OF THE PREMISES: 12,240 rentable square feet on Floor 6. PHASE 2 OF THE PREMISES: 6,120 rentable square feet on Floor 6. PHASE 3 OF THE PREMISES: 6,121 rentable square feet on Floor 6. 4. TENANT'S PROPORTIONATE SHARE: 16.08% (based upon a total of 152,246 rentable square feet in the Building) 5. SECURITY DEPOSIT: $42,535.74 6. TENANT'S REAL ESTATE BROKER FOR THIS LEASE: Cushman & Wakefield of Georgia, Inc. 7. LANDLORD'S REAL ESTATE BROKER FOR THIS LEASE: N/A 8. TENANT IMPROVEMENTS, IF ANY: See the Tenant Improvement Agreement attached hereto as Appendix C. 9. COMMENCEMENT DATE: The COMMENCEMENT DATE FOR PHASE 1 OF THE PREMISES is to occur on January 1, 1999 or the Completion Date (as defined in Appendix C) with respect to Phase 1 of the Premises. Landlord and Tenant shall execute a Commencement Date Confirmation substantially in the form of Appendix E promptly following the Commencement Date for Phase 1 of the Premises. The COMMENCEMENT DATE FOR PHASE 2 OF THE PREMISES is to occur on April 1, 1999. Landlord and Tenant shall execute a Commencement Date Confirmation substantially in the form of Appendix E promptly following the Commencement Date for Phase 2 of the Premises. The COMMENCEMENT DATE FOR PHASE 3 OF THE PREMISES is to occur on June 1, 1999. Landlord and Tenant shall execute a Commencement Date Confirmation substantially in the form of Appendix E promptly following the Commencement Date for Phase 2 of the Premises. 10. TERMINATION DATE/TERM: June 30, 2002 11. GUARANTOR: N/A 12. BASE YEAR: 1999 2 3 13. BASE RENT:
Per Sq. Ft. Annual Monthly Period Base Rent Base Rent Base Rent ------ --------- --------- --------- 1/1/99 - 3/30/99 $20.85 $255,204.00 $21.267.00 4/1/99 - 5/31/99 $20.85 $382,806.00 $31,900.50 6/1/99 - 12/31/99 $20.85 $510,428.88 $42,535.74 1/1/00 - 12/31/00 $21.50 $526,341.48 $43,861.79 1/1/01 - 12/31/01 $22.00 $538,581.96 $44,881.83 1/1/02 - 6/30/02 $22.50 $550,822.56 $45,901.88
1. LEASE AGREEMENT. On the terms stated in this Lease, Landlord leases the Premises to Tenant, and Tenant leases the Premises from Landlord, for the Term beginning on the Commencement Date and ending on the Termination Date unless extended or sooner terminated pursuant to this Lease. 2. RENT. A. Types of Rent. Tenant shall pay the following Rent in the form of a check to Landlord at the following address: CARRAMERICA REALTY CORPORATION, T/A EMBASSY ROW P.O. Box 198184 Atlanta, GA 30384-8184 or by wire transfer as follows: NationsBank, N.A. (South) ABA Number 061-00-0052 Account Number 3255807945 or in such other manner as Landlord may notify Tenant: (1) Base Rent in monthly installments in advance, the first monthly installment payable concurrently with the execution of this Lease and thereafter on or before the first day of each month of the Term in the amount set forth on the Schedule. (2) Operating Cost Share Rent in an amount equal to the Tenant's Proportionate Share of the excess of Operating Costs for the applicable fiscal year of the Lease (the "Excess Operating Costs") over the Operating Costs for the Base Year (the "Base Operating Costs"), paid monthly in advance in an estimated amount. Definitions of Operating Costs and Tenant's Proportionate Share, and the method for billing and payment of Operating Cost Share Rent are set forth in Sections 2B, 2C and 2D. (3) Tax Share Rent in an amount equal to the Tenant's Proportionate Share of the excess of Taxes for the applicable fiscal year of this Lease (the "Excess Taxes") over the Taxes for the Base Year (the "Base Taxes"), paid monthly in advance in an estimated amount. A definition of Taxes and the method for billing and payment of Tax Share Rent are set forth in Sections 2B, 2C and 2D. (4) Additional Rent in the amount of all costs, expenses, liabilities, and amounts which Tenant is required to pay under this Lease, excluding Base Rent, Operating Cost Share Rent, and Tax Share Rent, but including any interest for late payment of any item of Rent. 3 4 (5) Rent as used in this Lease means Base Rent, Operating Cost Share Rent, Tax Share Rent and Additional Rent. Tenant's agreement to pay Rent is an independent covenant, with no right of setoff, deduction or counterclaim of any kind. B. Payment of Operating Cost Share Rent and Tax Share Rent. (1) Payment of Estimated Operating Cost Share Rent and Tax Share Rent. Landlord shall estimate the Operating Costs and Taxes of the Project by April 1 of each fiscal year, or as soon as reasonably possible thereafter. Landlord may revise these estimates whenever it obtains more accurate information, such as the final real estate tax assessment or tax rate for the Project. Within ten (10) days after receiving the original or revised estimate from Landlord setting forth (a) an estimate of Operating Costs for a particular fiscal year, (b) the Base Operating Costs, and (c) the resulting estimate of Excess Operating Costs for such fiscal year, Tenant shall pay Landlord one-twelfth (1/12th) of Tenant's Proportionate Share of the estimated Excess Operating Costs, multiplied by the number of months that have elapsed in the applicable fiscal year to the date of such payment including the current month, minus payments previously made by Tenant for the months elapsed. On the first day of each month thereafter, Tenant shall pay Landlord one-twelfth (1/12th) of Tenant's Proportionate Share of this estimate, until a new estimate becomes applicable. Within ten (10) days after receiving the original or revised estimate from Landlord setting forth (a) an estimate of Taxes for a particular fiscal year, (b) the Base Taxes, and (c) the resulting estimate of Excess Taxes for such fiscal year, Tenant shall pay Landlord one-twelfth (1/12th) of Tenant's Proportionate Share of the estimated Excess Taxes, multiplied by the number of months that have elapsed in the applicable fiscal year to the date of such payment including the current month, minus payments previously made by Tenant for the months elapsed. On the first day of each month thereafter, Tenant shall pay Landlord one-twelfth (1/12th) of Tenant's Proportionate Share of this estimate, until a new estimate becomes applicable. (2) Correction of Operating Cost Share Rent. Landlord shall deliver to Tenant a report for the previous fiscal year (the "Operating Cost Report") by April 1 of each year, or as soon as reasonably possible thereafter, setting forth (a) the actual Operating Costs incurred, (b) the Base Operating Costs, (c) the amount of Operating Cost Share Rent due from Tenant, and (d) the amount of Operating Cost Share Rent paid by Tenant. Within twenty (20) days after such delivery, Tenant shall pay to Landlord the amount due minus the amount paid. If the amount paid exceeds the amount due, Landlord shall apply the excess to Tenant's payments of Operating Cost Share Rent next coming due. (3) Correction of Tax Share Rent. Landlord shall deliver to Tenant a report for the previous fiscal year (the "Tax Report") by April 1 of each year, or as soon as reasonably possible thereafter, setting forth (a) the actual Taxes, (b) the Base Taxes, (c) the amount of Tax Share Rent due from Tenant, and (d) the amount of Tax Share Rent paid by Tenant. Within twenty (20) days after such delivery, Tenant shall pay to Landlord the amount due from Tenant minus the amount paid by Tenant. If the amount paid exceeds the amount due, Landlord shall apply the excess to Tenant's payments of Tax Share Rent next coming due. C. Definitions. (1) Included Operating Costs. "Operating Costs" means any expenses, costs and disbursements of any kind other than Taxes, paid or incurred by Landlord in connection with the management, maintenance, operation, insurance, repair and other related activities in connection with any part of the Project and of the personal property, fixtures, machinery, equipment, systems and apparatus used in connection therewith, including the cost of providing those services required to be furnished by Landlord under this Lease. Operating Costs shall also include the costs of any capital improvements which are intended to reduce Operating Costs or improve safety, and those made to keep the Project in compliance with governmental requirements applicable from time to time (collectively, "Included Capital 4 5 Items"); provided, that the costs of any Included Capital Item shall be amortized by Landlord, together with an amount equal to interest at the Prime Rate plus one and one-half percent (1.5%) per annum, over the estimated useful life of such item and such amortized costs are only included in Operating Costs for that portion of the useful life of the Included Capital Item which falls within the Term. If the Project is not fully occupied during any portion of any fiscal year, Landlord may adjust (an "Equitable Adjustment") Operating Costs to equal what would have been incurred by Landlord had the Project been fully occupied. This Equitable Adjustment shall apply only to Operating Costs which are variable and therefore increase as occupancy of the Project increases. Landlord may incorporate the Equitable Adjustment in its estimates of Operating Costs. If Landlord does not furnish any particular service whose cost would have constituted an Operating Cost to a tenant other than Tenant who has undertaken to perform such service itself, Operating Costs shall be increased by the amount which Landlord would have incurred if it had furnished the service to such tenant. (2) Excluded Operating Costs. Operating Costs shall not include: (a) costs of alterations of tenant premises; (b) costs of capital improvements other than Included Capital Items; (c) interest and principal payments on mortgages or any other debt costs, or rental payments on any ground lease of the Project; (d) real estate brokers' leasing commissions; (e) legal fees, space planner fees and advertising expenses incurred with regard to leasing the Building or portions thereof; (f) any cost or expenditure for which Landlord is reimbursed, by insurance proceeds or otherwise, except by Operating Cost Share Rent; (g) the cost of any service furnished to any office tenant of the Project which Landlord does not make available to Tenant; (h) depreciation (except on any Included Capital Items); (i) franchise or income taxes imposed upon Landlord, except to the extent imposed in lieu of all or any part of Taxes; (j) costs of correcting defects in construction of the Building (as opposed to the cost of normal repair, maintenance and replacement expected with the construction materials and equipment installed in the Building in light of their specifications); (k) legal and auditing fees which are for the benefit of Landlord such as collecting delinquent rents, preparing tax returns and other financial statements, and audits other than those incurred in connection with the preparation of reports required pursuant to Section 2B above; (l) the wages of any employee for services not related directly to the management, maintenance, operation and repair of the Building; and 5 6 (m) fines, penalties and interest. (3) Taxes. "Taxes" means any and all taxes, assessments and charges of any kind, general or special, ordinary or extraordinary, levied against the Project, which Landlord shall pay or become obligated to pay in connection with the ownership, leasing, renting, management, use, occupancy, control or operation of the Project or of the personal property, fixtures, machinery, equipment, systems and apparatus used in connection therewith. Taxes shall include real estate taxes, personal property taxes, sewer rents, water rents, special or general assessments, transit taxes, ad valorem taxes, and any tax levied on the rents hereunder or the interest of Landlord under this Lease (the "Rent Tax"). Taxes shall also include all fees and other costs and expenses paid by Landlord in reviewing any tax and in seeking a refund or reduction of any Taxes, whether or not the Landlord is ultimately successful. For any year, the amount to be included in Taxes (a) from taxes or assessments payable in installments, shall be the amount of the installments (with any interest) due and payable during such year, and (b) from all other Taxes, shall at Landlord's election be the amount accrued, assessed, or otherwise imposed for such year or the amount due and payable in such year. Any refund or other adjustment to any Taxes by the taxing authority, shall apply during the year in which the adjustment is made. Taxes shall not include any net income (except Rent Tax), capital, stock, succession, transfer, franchise, gift, estate or inheritance tax, except to the extent that such tax shall be imposed in lieu of any portion of Taxes. (4) Lease Year. "Lease Year" means each consecutive twelve-month period beginning with the Commencement Date, except that if the Commencement Date is not the first day of a calendar month, then the first Lease Year shall be the period from the Commencement Date through the final day of the twelve months after the first day of the following month, and each subsequent Lease Year shall be the twelve months following the prior Lease Year. (5) Fiscal Year. "Fiscal Year" means the calendar year, except that the first fiscal year and the last fiscal year of the Term may be a partial calendar year. D. Computation of Base Rent and Rent Adjustments. (1) Prorations. If this Lease begins on a day other than the first day of a month, the Base Rent, Operating Cost Share Rent and Tax Share Rent shall be prorated for such partial month based on the actual number of days in such month. If this Lease begins on a day other than the first day, or ends on a day other than the last day, of the fiscal year, Operating Cost Share Rent and Tax Share Rent shall be prorated for the applicable fiscal year. (2) Default Interest. Any sum due from Tenant to Landlord not paid when due shall bear interest from the date due until paid at eighteen percent (18%) per annum. (3) Rent Adjustments. The square footage of the Premises and the Building set forth in the Schedule are conclusively deemed to be the actual square footage thereof, without regard to any subsequent remeasurement of the Premises or the Building. If any Operating Cost paid in one fiscal year relates to more than one fiscal year, Landlord may proportionately allocate such Operating Cost among the related fiscal years. (4) Books and Records. Landlord shall maintain books and records reflecting the Operating Costs and Taxes in accordance with sound accounting and management practices. Tenant and its certified public accountant shall have the right to inspect Landlord's records at Landlord's office upon at least seventy-two (72) hours' prior notice during normal business hours during the ninety (90) days following the respective delivery of the Operating Cost Report or the Tax Report. The results of any such inspection shall be kept strictly confidential by Tenant and its agents, and Tenant and its certified public accountant must agree, in their contract for such services, to such confidentiality restrictions and shall specifically agree that the results shall not be made available to any other tenant of 6 7 the Building. Unless Tenant sends to Landlord any written exception to either such report within said ninety (90) day period, such report shall be deemed final and accepted by Tenant. Tenant shall pay the amount shown on both reports in the manner prescribed in this Lease, whether or not Tenant takes any such written exception, without any prejudice to such exception. If Tenant makes a timely exception, Landlord shall cause its independent certified public accountant to issue a final and conclusive resolution of Tenant's exception. Tenant shall pay the cost of such certification unless Landlord's original determination of annual Operating Costs or Taxes overstated the amounts thereof by more than five percent (5%). (5) Miscellaneous. So long as Tenant is in default of any obligation under this Lease, Tenant shall not be entitled to any refund of any amount from Landlord. If this Lease is terminated for any reason prior to the annual determination of Operating Cost Share Rent or Tax Share Rent, either party shall pay the full amount due to the other within fifteen (15) days after Landlord's notice to Tenant of the amount when it is determined. Landlord may commingle any payments made with respect to Operating Cost Share Rent or Tax Share Rent, without payment of interest. 3. PREPARATION AND CONDITION OF PREMISES; POSSESSION AND SURRENDER OF PREMISES. A. Condition of Premises. Except to the extent of the Tenant Improvements item on the Schedule, Landlord is leasing the Premises to Tenant "as is", without any obligation to alter, remodel, improve, repair or decorate any part of the Premises. Landlord shall cause the Premises to be completed in accordance with the Tenant Improvement Agreement attached as Appendix C. B. Tenant's Possession. Tenant's taking possession of any portion of the Premises shall be conclusive evidence that the Premises was in good order, repair and condition. If Landlord authorizes Tenant to take possession of any part of the Premises prior to the Commencement Date for purposes of doing business, all terms of this Lease shall apply to such pre-Term possession, including Base Rent at the rate set forth for the First Lease Year in the Schedule prorated for any partial month. C. Maintenance. Throughout the Term, Tenant shall maintain the Premises in their condition as of the Completion Date, loss or damage caused by the elements, ordinary wear, and fire and other casualty excepted, and at the termination of this Lease, or Tenant's right to possession, Tenant shall return the Premises to Landlord in broom-clean condition. To the extent Tenant fails to perform either obligation, Landlord may, but need not, restore the Premises to such condition and Tenant shall pay the cost thereof. 4. PROJECT SERVICES. Landlord shall furnish services as follows: A. Heating and Air Conditioning. During the normal business hours of 8:00 a.m. to 6:00 p.m., Monday through Friday, and 8:00 a.m. to 1:00 p.m. on Saturday, Landlord shall furnish heating and air conditioning to provide a comfortable temperature, in Landlord's judgment, for normal business operations, except to the extent Tenant installs equipment which adversely affects the temperature maintained by the air conditioning system. If Tenant installs such equipment, Landlord may install supplementary air conditioning units in the Premises, and Tenant shall pay to Landlord upon demand as Additional Rent the cost of installation, operation and maintenance thereof. Landlord shall furnish heating and air conditioning after business hours if Tenant provides Landlord reasonable prior notice, and pays Landlord all then current charges for such additional heating or air conditioning. B. Elevators. Landlord shall provide passenger elevator service during normal business hours to Tenant in common with Landlord and all other tenants. Landlord shall provide limited passenger service at other times, except in case of 7 8 an emergency. Landlord shall provide freight elevator service at reasonable hours at Tenant's request, subject to scheduling by the Landlord and payment for the service by Tenant. C. Electricity. Landlord shall provide sufficient electricity to operate normal office lighting and equipment. Tenant shall not install or operate in the Premises any electrically operated equipment or other machinery, other than business machines and equipment normally employed for general office use which do not require high electricity consumption for operation, without obtaining the prior written consent of Landlord. If any or all of Tenant's equipment requires electricity consumption in excess of that which is necessary to operate normal office equipment, such consumption (including consumption for computer or telephone rooms and special HVAC equipment) shall be submetered by Landlord at Tenant's expense, and Tenant shall reimburse Landlord as Additional Rent for the cost of its submetered consumption based upon Landlord's average cost of electricity. Such Additional Rent shall be in addition to Tenant's obligations pursuant to Section 2A(2) to pay its Proportionate Share of Operating Costs. D. Water. Landlord shall furnish hot and cold tap water for drinking and toilet purposes. Tenant shall pay Landlord for water furnished for any other purpose as Additional Rent at rates fixed by Landlord. Tenant shall not permit water to be wasted. E. Janitorial Service. Landlord shall furnish janitorial service as generally provided to other tenants in the Building. F. Interruption of Services. If any of the Building equipment or machinery ceases to function properly for any cause Landlord shall use reasonable diligence to repair the same promptly. Landlord's inability to furnish, to any extent, the Project services set forth in this Section 4, or any cessation thereof resulting from any causes, including any entry for repairs pursuant to this Lease, and any renovation, redecoration or rehabilitation of any area of the Building shall not render Landlord liable for damages to either person or property or for interruption or loss to Tenant's business, nor be construed as an eviction of Tenant, nor work an abatement of any portion of Rent, nor relieve Tenant from fulfillment of any covenant or agreement hereof. However, in the event that an interruption of the Project services set forth in this Section 4 causes the Premises to be untenantable for a period of at least three (3) business days, monthly Rent shall be thereafter abated proportionately. G. Services Standard. During the Term, Landlord will use reasonable efforts to cause the Building to be operated and managed in accordance with the standards of other similar class A, multi-tenant office buildings (using a so-called basket approach, and not by reference to any one specific office building) now located within the central perimeter submarket of Atlanta, Georgia (bounded on the west by Roswell Road and I-285, on the east by Chamblee Dunwoody Road and I-285, on the north by Northridge Road, and on the south by the Glenridge Connector; the "Geographic Area"), provided that Landlord shall not be obligated to incur capital expenditures not reimbursable as Operating Costs under this Lease in order to comply with such agreement, and provided further that nothing contained in this sentence is intended to or shall be construed to require Landlord to provide any services other than those expressly set forth in this Lease, and provided further, electrical, heat, air conditioning and janitorial service shall be deemed to satisfy the requirements set forth in this sentence if such services satisfy the applicable standards set forth in this Lease. 5. ALTERATIONS AND REPAIRS. A. Landlord's Consent and Conditions. Tenant shall not make any improvements or alterations to the Premises (the "Work") without in each instance submitting plans and specifications for the Work to Landlord and obtaining Landlord's prior written consent unless (a) the cost thereof is less than $25,000.00, (b) such Work does not impact the base structural components or systems of the Building, (c) such Work will not impact any other tenant's premises, and (d) such Work is not visible from outside the Premises. Tenant shall pay Landlord's standard charge of $500.00 for review of the plans and all other items submitted by Tenant. Landlord will be deemed to be acting reasonably in withholding its consent for any Work which (a) impacts the base structural components or systems of the Building, (b) impacts any other tenant's premises, or (c) is visible from outside the Premises. 8 9 Tenant shall pay for the cost of all Work. All Work shall become the property of Landlord upon its installation, except for Tenant's trade fixtures and for items which Landlord requires Tenant to remove at Tenant's cost at the termination of the Lease pursuant to Section 3E. The following requirements shall apply to all Work: (1) Prior to commencement, Tenant shall furnish to Landlord building permits, certificates of insurance satisfactory to Landlord, and, at Landlord's request, security for payment of all costs. (2) Tenant shall perform all Work so as to maintain peace and harmony among other contractors serving the Project and shall avoid interference with other work to be performed or services to be rendered in the Project. (3) The Work shall be performed in a good and workmanlike manner, meeting the standard for construction and quality of materials in the Building, and shall comply with all insurance requirements and all applicable governmental laws, ordinances and regulations ("Governmental Requirements"). (4) Tenant shall perform all Work so as to minimize or prevent disruption to other tenants, and Tenant shall comply with all reasonable requests of Landlord in response to complaints from other tenants. (5) Tenant shall perform all Work in compliance with Landlord's "Policies, Rules and Procedures for Construction Projects" in effect at the time the Work is performed. (6) Tenant shall permit Landlord to supervise all Work. Landlord may charge a supervisory fee not to exceed five percent (5%) of labor, material, and all other costs of the Work, if Landlord's employees or contractors perform the Work. (7) Upon completion, Tenant shall furnish Landlord with contractor's affidavits and full and final statutory waivers of liens, as-built plans and specifications, and receipted bills covering all labor and materials, and all other close-out documentation required in Landlord's "Policies, Rules and Procedures for Construction Projects". B. Damage to Systems. If any part of the mechanical, electrical or other systems in the Premises shall be damaged, Tenant shall promptly notify Landlord, and Landlord shall repair such damage. Landlord may also at any reasonable time make any repairs or alterations which Landlord deems necessary for the safety or protection of the Project, or which Landlord is required to make by any court or pursuant to any Governmental Requirement. Tenant shall at its expense make all other repairs necessary to keep the Premises, and Tenant's fixtures and personal property, in good order, condition and repair; to the extent Tenant fails to do so, Landlord may make such repairs itself. The cost of any repairs made by Landlord on account of Tenant's default, or on account of the misuse or neglect by Tenant or its invitees, contractors or agents anywhere in the Project, shall become Additional Rent payable by Tenant on demand. C. No Liens. Tenant has no authority to cause or permit any lien or encumbrance of any kind to affect Landlord's interest in the Project; any such lien or encumbrance shall attach to Tenant's interest only. If any mechanic's lien shall be filed or claim of lien made for work or materials furnished to Tenant, then Tenant shall at its expense within ten (10) days thereafter either discharge or contest the lien or claim. If Tenant contests the lien or claim, then Tenant shall (i) within such ten (10) day period, provide Landlord adequate security for the lien or claim, (ii) contest the lien or claim in good faith by appropriate proceedings that operate to stay its enforcement, and (iii) pay promptly any final adverse judgment entered in any such proceeding. If Tenant does not comply with these requirements, Landlord may discharge the lien or claim, and the amount paid, as well as attorney's fees and other expenses incurred by Landlord, shall become Additional Rent payable by Tenant on demand. 9 10 D. Ownership of Improvements. All Work as defined in this Section 5, partitions, hardware, equipment, machinery and all other improvements and all fixtures except trade fixtures, constructed in the Premises by either Landlord or Tenant, (i) shall become Landlord's property upon installation without compensation to Tenant, unless Landlord consents otherwise in writing, and (ii) shall at Landlord's option either (a) be surrendered to Landlord with the Premises at the termination of the Lease or of Tenant's right to possession, or (b) be removed in accordance with Subsection 5E below (unless Landlord at the time it gives its consent to the performance of such construction expressly waives in writing the right to require such removal). E. Removal at Termination. Upon the termination of this Lease or Tenant's right of possession Tenant shall remove from the Project its trade fixtures, furniture, moveable equipment and other personal property, any improvements which Landlord elects shall be removed by Tenant pursuant to Section 5D, and any improvements to any portion of the Project other than the Premises. Tenant shall repair all damage caused by the installation or removal of any of the foregoing items. If Tenant does not timely remove such property, then Tenant shall be conclusively presumed to have, at Landlord's election (i) conveyed such property to Landlord without compensation or (ii) abandoned such property, and Landlord may dispose of or store any part thereof in any manner at Tenant's sole cost, without waiving Landlord's right to claim from Tenant all expenses arising out of Tenant's failure to remove the property, and without liability to Tenant or any other person. Landlord shall have no duty to be a bailee of any such personal property. If Landlord elects abandonment, Tenant shall pay to Landlord, upon demand, any expenses incurred for disposition. 6. USE OF PREMISES. Tenant shall use the Premises only for general office purposes. Tenant shall not allow any use of the Premises which will negatively affect the cost of coverage of Landlord's insurance on the Project. Tenant shall not allow any inflammable or explosive liquids or materials to be kept on the Premises. Tenant shall not allow any use of the Premises which would cause the value or utility of any part of the Premises to diminish or would interfere with any other Tenant or with the operation of the Project by Landlord. Tenant shall not permit any nuisance or waste upon the Premises, or allow any offensive noise or odor in or around the Premises. If any governmental authority shall deem the Premises to be a "place of public accommodation" under the Americans with Disabilities Act or any other comparable law as a result of Tenant's use, Tenant shall either modify its use to cause such authority to rescind its designation or be responsible for any alterations, structural or otherwise, required to be made to the Building or the Premises under such laws. 7. GOVERNMENTAL REQUIREMENTS AND BUILDING RULES. Tenant shall comply with all Governmental Requirements applying to its use of the Premises. Tenant shall also comply with all reasonable rules established for the Project from time to time by Landlord. The present rules and regulations are contained in Appendix B. Failure by another tenant to comply with the rules or failure by Landlord to enforce them shall not relieve Tenant of its obligation to comply with the rules or make Landlord responsible to Tenant in any way. Landlord shall use reasonable efforts to apply the rules and regulations uniformly with respect to Tenant and tenants in the Building under leases containing rules and regulations similar to this Lease. In the event of alterations and repairs performed by Tenant, Tenant shall comply with the provisions of Section 5 of this Lease and also Landlord's "Policies, Rules and Regulations for Construction Projects". 8. WAIVER OF CLAIMS; INDEMNIFICATION; INSURANCE. A. Waiver of Claims. To the extent permitted by law, Tenant waives any claims it may have against Landlord or its officers, directors, employees or agents for business interruption or damage to property sustained by Tenant as the result of any act or omission of Landlord. To the extent permitted by law, Landlord waives any claims it may have against Tenant or its officers, directors, employees or agents for loss of rents (other than Rent) or damage to property sustained by Landlord as the result of any act or omission of Tenant. 10 11 B. Indemnification. Tenant shall indemnify, defend and hold harmless Landlord and its officers, directors, employees and agents against any claim by any third party for injury to any person or damage to or loss of any property occurring in the Project and arising from the use of the Premises (unless caused by the willful misconduct or gross negligence of Landlord) or from any other act or omission or negligence of Tenant or any of Tenant's employees or agents. Tenant's obligations under this section shall survive the termination of this Lease. Landlord shall indemnify, defend and hold harmless Tenant and its officers, directors, employees and agents against any claim by any third party for injury to any person or damage to or loss of any property occurring in the Project and arising from any other act or omission or negligence of Landlord or any of Landlord's employees or agents. Landlord's obligations under this section shall survive the termination of this Lease. C. Tenant's Insurance. Tenant shall maintain insurance as follows, with such other terms, coverages and insurers, as Landlord shall reasonably require from time to time: (1) Commercial General Liability Insurance, with (a) Contractual Liability including the indemnification provisions contained in this Lease, (b) a severability of interest endorsement, (c) limits of not less than One Million Dollars ($1,000,000) combined single limit per occurrence and not less than Two Million Dollars ($2,000,000) in the aggregate for bodily injury, sickness or death, and property damage, and umbrella coverage of not less than Three Million Dollars ($3,000,000). (2) Property Insurance against "All Risks" of physical loss covering the replacement cost of all improvements, fixtures and personal property. Tenant waives all rights of subrogation, and Tenant's property insurance shall include a waiver of subrogation in favor of Landlord. (3) Workers' compensation or similar insurance in form and amounts required by law, and Employer's Liability with not less than the following limits: Each Accident $500,000 Disease--Policy Limit $500,000 Disease--Each Employee $500,000
Such insurance shall contain a waiver of subrogation provision in favor of Landlord and its agents. Tenant's insurance shall be primary and not contributory to that carried by Landlord, its agents, or mortgagee. Landlord, and if any, Landlord's building manager or agent and ground lessor shall be named as additional insureds as respects to insurance required of the Tenant in Section 8C(1). The company or companies writing any insurance which Tenant is required to maintain under this Lease, as well as the form of such insurance, shall at all times be subject to Landlord's approval, and any such company shall be licensed to do business in the state in which the Building is located. Such insurance companies shall have a A.M. Best rating of A VI or better. Tenant shall cause any contractor of Tenant performing work on the Premises to maintain insurance as follows, with such other terms, coverages and insurers, as Landlord shall reasonably require from time to time: (1) Commercial General Liability Insurance, including contractor's liability coverage, contractual liability coverage, completed operations coverage, broad form property damage endorsement, and contractor's protective liability coverage, to afford protection with limits, for each occurrence, of not less than One Million Dollars ($1,000,000) with respect to personal injury, death or property damage. (2) Workers' compensation or similar insurance in form and amounts required by law, and Employer's Liability with not less than the following limits: 11 12 Each Accident $500,000 Disease--Policy Limit $500,000 Disease--Each Employee $500,000
Such insurance shall contain a waiver of subrogation provision in favor of Landlord and its agents. Tenant's contractor's insurance shall be primary and not contributory to that carried by Tenant, Landlord, their agents or mortgagees. Tenant and Landlord, and if any, Landlord's building manager or agent, mortgagee or ground lessor shall be named as additional insured on Tenant's contractor's insurance policies. D. Insurance Certificates. Tenant shall deliver to Landlord certificates evidencing all required insurance no later than five (5) days prior to the Commencement Date and each renewal date. Each certificate will provide for thirty (30) days prior written notice of cancellation to Landlord and Tenant. E. Landlord's Insurance. Landlord shall maintain "All-Risk" property insurance at replacement cost, including loss of rents, on the Building, and Commercial General Liability insurance policies covering the common areas of the Building, each with such terms, coverages and conditions as are normally carried by reasonably prudent owners of properties similar to the Project. With respect to property insurance, Landlord and Tenant mutually waive all rights of subrogation, and the respective "All-Risk" coverage property insurance policies carried by Landlord and Tenant shall contain enforceable waiver of subrogation endorsements. 9. FIRE AND OTHER CASUALTY. A. Termination. If a fire or other casualty causes substantial damage to the Building or the Premises, Landlord shall engage a registered architect to certify within one (1) month of the casualty to both Landlord and Tenant the amount of time needed to restore the Building and the Premises to tenantability, using standard working methods. If the time needed exceeds nine (9) months from the date of damage occurrence, or two (2) months therefrom if the restoration would begin during the last nine (9) months of the Lease, then in the case of the Premises, either Landlord or Tenant may terminate this Lease, and in the case of the Building, Landlord may terminate this Lease, by notice to the other party within ten (10) days after the notifying party's receipt of the architect's certificate. The termination shall be effective thirty (30) days from the date of the notice and Rent shall be paid by Tenant to that date, with an abatement for any portion of the Premises which has been untenantable after the casualty. B. Restoration. If a casualty causes damage to the Building or the Premises but this Lease is not terminated for any reason, then subject to the rights of any mortgagees or ground lessors, Landlord shall obtain the applicable insurance proceeds and diligently restore the Building and the Premises subject to current Governmental Requirements. Tenant shall replace its damaged improvements, personal property and fixtures. Rent shall be abated on a per diem basis during the restoration for any portion of the Premises which is untenantable, except to the extent that Tenant's negligence caused the casualty. 10. EMINENT DOMAIN. If a part of the Project is taken by eminent domain or deed in lieu thereof which is so substantial that the Premises cannot reasonably be used by Tenant for the operation of its business, then either party may terminate this Lease effective as of the date of the taking. If any substantial portion of the Project is taken without affecting the Premises, then Landlord may terminate this Lease as of the date of such taking. Rent shall abate from the date of the taking in proportion to any part of the Premises taken. The entire award for a taking of any kind shall be paid to Landlord, and Tenant shall have no right to share in the award. All obligations accrued to the date of the taking shall be performed by the party liable to perform said obligations, as set forth herein. 12 13 11. RIGHTS RESERVED TO LANDLORD. Landlord may exercise at any time any of the following rights respecting the operation of the Project without liability to the Tenant of any kind: A. Name. To change the name or street address of the Building or the suite number(s) of the Premises. B. Signs. To install and maintain any signs on the exterior and in the interior of the Building, and to approve at its sole discretion, prior to installation, any of Tenant's signs in the Premises visible from the common areas or the exterior of the Building. C. Window Treatments. To approve, at its discretion, prior to installation, any shades, blinds, ventilators or window treatments of any kind, as well as any lighting within the Premises that may be visible from the exterior of the Building or any interior common area. D. Keys. To retain and use at any time passkeys to enter the Premises or any door within the Premises. Tenant shall not alter or add any lock or bolt. E. Access. To have access to inspect the Premises, and to perform its obligations, or make repairs, alterations, additions or improvements, as permitted by this Lease. F. Preparation for Reoccupancy. Intentionally Omitted. G. Heavy Articles. To approve the weight, size, placement and time and manner of movement within the Building of any safe, central filing system or other heavy article of Tenant's property. Tenant shall move its property entirely at its own risk. H. Show Premises. To show the Premises to prospective purchasers, tenants, brokers, lenders, investors, rating agencies or others at any reasonable time, provided that Landlord gives prior notice to Tenant and does not materially interfere with Tenant's use of the Premises. I. Relocation of Tenant. Intentionally Omitted. J. Use of Lockbox. To designate a lockbox collection agent for collections of amounts due Landlord. In that case, the date of payment of Rent or other sums shall be the date of the agent's receipt of such payment or the date of actual collection if payment is made in the form of a negotiable instrument thereafter dishonored upon presentment. However, Landlord may reject any payment for all purposes as of the date of receipt or actual collection by mailing to Tenant within 21 days after such receipt or collection a check equal to the amount sent by Tenant. K. Repairs and Alterations. To make repairs or alterations to the Project and in doing so transport any required material through the Premises, to close entrances, doors, corridors, elevators and other facilities in the Project, to open any ceiling in the Premises, or to temporarily suspend services or use of common areas in the Building. Landlord may perform any such repairs or alterations during ordinary business hours so long as such work does not materially interfere with Tenant's business, except that Tenant may require any Work in the Premises to be done after business hours if Tenant pays Landlord for overtime and any other expenses incurred. Landlord may do or permit any work on any nearby building, land, street, alley or way. L. Landlord's Agents. If Tenant is in default under this Lease, possession of Tenant's funds or negotiation of Tenant's negotiable instrument by any of Landlord's agents shall not waive any breach by Tenant or any remedies of Landlord under this Lease. 13 14 M. Building Services. To install, use and maintain through the Premises, pipes, conduits, wires and ducts serving the Building, provided that such installation, use and maintenance does not unreasonably interfere with Tenant's use of the Premises. N. Other Actions. To take any other action which Landlord deems reasonable in connection with the operation, maintenance or preservation of the Building. 12. TENANT'S DEFAULT. Any of the following shall constitute a default by Tenant: A. Rent Default. Tenant fails to pay any Rent when due, and in the case of only the first two (2) such failures in any 12 consecutive months, such failure continues for five (5) days from the date of Landlord's notice; B. Assignment/Sublease or Hazardous Substances Default. Tenant defaults in its obligations under Section 17 Assignment and Sublease or Section 28 Hazardous Substances; C. Other Performance Default. Tenant fails to perform any other obligation to Landlord under this Lease, and, in the case of only the first failure during the Term of this Lease with respect to a particular provision, this failure continues for ten (10) days after written notice from Landlord, except that if Tenant begins to cure its failure within the ten (10) day period but cannot reasonably complete its cure within such period, then, so long as Tenant continues to diligently attempt to cure its failure, the ten (10) day period shall be extended to sixty (60) days, or such lesser period as is reasonably necessary to complete the cure; D. Credit Default. One of the following credit defaults occurs: (1) Tenant commences any proceeding under any law relating to bankruptcy, insolvency, reorganization or relief of debts, or seeks appointment of a receiver, trustee, custodian or other similar official for the Tenant or for any substantial part of its property, or any such proceeding is commenced against Tenant and either remains undismissed for a period of thirty days or results in the entry of an order for relief against Tenant which is not fully stayed within seven days after entry; (2) Tenant becomes insolvent or bankrupt, does not generally pay its debts as they become due, or admits in writing its inability to pay its debts, or makes a general assignment for the benefit of creditors; (3) Any third party obtains a levy or attachment under process of law against Tenant's leasehold interest. E. Vacation or Abandonment Default. Tenant vacates or abandons the Premises and any Rent is past due. 13. LANDLORD REMEDIES. A. Termination of Lease or Possession. If Tenant defaults, Landlord may elect by notice to Tenant either to terminate this Lease or to terminate Tenant's possession of the Premises without terminating this Lease. In either case, Tenant shall immediately vacate the Premises and deliver possession to Landlord, and Landlord may repossess the Premises and may, at Tenant's sole cost, remove any of Tenant's signs and any of its other property, without relinquishing its right to receive Rent or any other right against Tenant. Tenant shall remain liable for the payment of all Rent accruing after any writ of possession as to the Premises is issued to Landlord. B. Lease Termination Damages. If Landlord terminates the Lease, Tenant shall pay to Landlord all Rent due on or before the date of termination, plus Landlord's reasonable estimate of the aggregate Rent that would have been payable from the date of termination through the Termination Date, reduced by the rental value of the Premises calculated as of the date of 14 15 termination for the same period, taking into account anticipated vacancy prior to reletting, reletting expenses and market concessions, both discounted to present value at the rate of five percent (5%) per annum. If Landlord shall relet any part of the Premises for any part of such period before such present value amount shall have been paid by Tenant or finally determined by a court, then the amount of Rent payable pursuant to such reletting (taking into account vacancy prior to reletting and any reletting expenses or concessions) shall be deemed to be the reasonable rental value for that portion of the Premises relet during the period of the reletting. C. Possession Termination Damages. If Landlord terminates Tenant's right to possession without terminating the Lease and Landlord takes possession of the Premises itself, Landlord may relet any part of the Premises for such Rent, for such time, and upon such terms as Landlord in its sole discretion shall determine, without any obligation to do so prior to renting other vacant areas in the Building. Any proceeds from reletting the Premises shall first be applied to the expenses of reletting, including redecoration, repair, alteration, advertising, brokerage, legal, and other reasonably necessary expenses. If the reletting proceeds after payment of expenses are insufficient to pay the full amount of Rent under this Lease, Tenant shall pay such deficiency to Landlord monthly upon demand as it becomes due. Any excess proceeds shall be retained by Landlord. D. Landlord's Remedies Cumulative. All of Landlord's remedies under this Lease shall be in addition to all other remedies Landlord may have at law or in equity. Waiver by Landlord of any breach of any obligation by Tenant shall be effective only if it is in writing, and shall not be deemed a waiver of any other breach, or any subsequent breach of the same obligation. Landlord's acceptance of payment by Tenant shall not constitute a waiver of any breach by Tenant, and if the acceptance occurs after Landlord's notice to Tenant, or termination of the Lease or of Tenant's right to possession, the acceptance shall not affect such notice or termination. Acceptance of payment by Landlord after commencement of a legal proceeding or final judgment shall not affect such proceeding or judgment. Landlord may advance such monies and take such other actions for Tenant's account as reasonably may be required to cure or mitigate any default by Tenant. Tenant shall immediately reimburse Landlord for any such advance, and such sums shall bear interest at the default interest rate until paid. E. WAIVER OF TRIAL BY JURY. EACH PARTY WAIVES TRIAL BY JURY IN THE EVENT OF ANY LEGAL PROCEEDING BROUGHT BY THE OTHER IN CONNECTION WITH THIS LEASE. EACH PARTY SHALL BRING ANY ACTION AGAINST THE OTHER IN CONNECTION WITH THIS LEASE IN A FEDERAL OR STATE COURT LOCATED IN GEORGIA, CONSENTS TO THE JURISDICTION OF SUCH COURTS, AND WAIVES ANY RIGHT TO HAVE ANY PROCEEDING TRANSFERRED FROM SUCH COURTS ON THE GROUND OF IMPROPER VENUE OR INCONVENIENT FORUM. F. Litigation Costs. In any judgment where a party is proven to be in breach of this Lease Agreement, the losing party shall pay the prevailing party's reasonable attorneys' fees and other costs in enforcing this Lease, whether in litigation or arbitration. 14. SURRENDER. Upon termination of this Lease or Tenant's right to possession, Tenant shall return the Premises to Landlord in good order and condition, ordinary wear and casualty damage excepted. If Landlord requires Tenant to remove any alterations, then Tenant shall remove the alterations in a good and workmanlike manner and restore the Premises to its condition prior to their installation. 15. HOLDOVER. Tenant shall have no right to holdover possession of the Premises after the expiration or termination of this Lease without Landlord's prior written consent, which consent may be withheld in Landlord's sole and absolute discretion. If Tenant retains possession of any part of the Premises after the Term, Tenant shall become a month-to-month tenant for the entire Premises upon all of the terms of this Lease as might be applicable to such month-to-month tenancy, except that Tenant shall pay all of Base Rent, Operating Cost Share Rent and Tax Share Rent at one hundred and fifty percent (150%) of the rate in effect immediately prior to such holdover, computed on a monthly basis for each full or partial month Tenant remains in possession. Tenant shall also pay Landlord all of Landlord's direct damages resulting from Tenant's holdover. No acceptance of Rent or other payments by Landlord under these holdover provisions shall operate as a waiver of Landlord's right to regain possession or any other of Landlord's remedies. See Special Stipulations 6. 15 16 16. SUBORDINATION TO GROUND LEASES AND MORTGAGES. A. Subordination and Non-Disturbance. This Lease shall be subordinate to any present or future ground lease or mortgage respecting the Project, and any amendments to such ground lease or mortgage, at the election of the ground lessor or mortgagee as the case may be, effected by notice to Tenant in the manner provided in this Lease. The subordination shall be effective upon such notice, but at the request of Landlord or ground lessor or mortgagee, Tenant shall within ten (10) days of the request, execute and deliver to the requesting party any reasonable documents provided to evidence the subordination. Any mortgagee has the right, at its option, to subordinate its mortgage to the terms of this Lease, without notice to, nor the consent of, Tenant. At any time that the project is made subject to any ground lease or mortgage, Landlord shall use reasonable efforts to cause the mortgagee or ground lessor to deliver to Tenant a non-disturbance agreement reasonably acceptable to Tenant, providing that so long as Tenant is not in default under this Lease after the expiration of any applicable notice and cure periods, Tenant may remain in possession of the Premises under the terms of this Lease, even if the ground lessor should terminate the ground lease or if the mortgagee or its successor should acquire Landlord's title to the Project. B. Termination of Ground Lease or Foreclosure of Mortgage. If any ground lease is terminated or mortgage foreclosed or deed in lieu of foreclosure given and the ground lessor, mortgagee, or purchaser at a foreclosure sale shall thereby become the owner of the Project, Tenant shall attorn to such ground lessor or mortgagee or purchaser without any deduction or setoff by Tenant, and this Lease shall continue in effect as a direct lease between Tenant and such ground lessor, mortgagee or purchaser. The ground lessor or mortgagee or purchaser shall be liable as Landlord only during the time such ground lessor or mortgagee or purchaser is the owner of the Project. At the request of Landlord, ground lessor or mortgagee, Tenant shall execute and deliver within ten (10) days of the request any document furnished by the requesting party to evidence Tenant's agreement to attorn. C. Security Deposit. Any ground lessor or mortgagee shall be responsible for the return of any security deposit by Tenant only to the extent the security deposit is received by such ground lessor or mortgagee. D. Notice and Right to Cure. The Project is subject to any ground lease and mortgage identified with name and address of ground lessor or mortgagee in Appendix D to this Lease (as the same may be amended from time to time by written notice to Tenant). Tenant agrees to send by registered or certified mail to any ground lessor or mortgagee identified either in such Appendix or in any later notice from Landlord to Tenant a copy of any notice of default sent by Tenant to Landlord. If Landlord fails to cure such default within the required time period under this Lease, but ground lessor or mortgagee begins to cure within ten (10) days after such period and proceeds diligently to complete such cure, then ground lessor or mortgagee shall have such additional time as is necessary to complete such cure, including any time necessary to obtain possession if possession is necessary to cure, and Tenant shall not begin to enforce its remedies so long as the cure is being diligently pursued. E. Definitions. As used in this Section 16, "mortgage" shall include "deed of trust" and/or "trust deed" and "mortgagee" shall include "beneficiary" and/or "trustee", "mortgagee" shall include the mortgagee of any ground lessee, and "ground lessor", "mortgagee", and "purchaser at a foreclosure sale" shall include, in each case, all of its successors and assigns, however remote. 17. ASSIGNMENT AND SUBLEASE. A. In General. Tenant shall not, without the prior consent of Landlord in each case, (i) make or allow any assignment or transfer, by operation of law or otherwise, of any part of Tenant's interest in this Lease, (ii) grant or allow any lien or encumbrance, by operation of law or otherwise, upon any part of Tenant's interest in this Lease, (iii) sublet any part of the Premises, or (iv) permit anyone other than Tenant and its employees to occupy any part of the Premises. Tenant shall remain primarily liable for all of its obligations under this Lease, notwithstanding any assignment or transfer. No consent granted by Landlord shall be deemed to be a consent to any subsequent assignment or transfer, lien or encumbrance, sublease or occupancy. Tenant shall pay all of Landlord's attorneys' fees and other expenses incurred in connection with any consent requested by Tenant or in reviewing any proposed assignment or subletting. Any assignment or transfer, grant of lien or encumbrance, or sublease or occupancy without Landlord's prior written consent shall be void. If Tenant shall assign this Lease or sublet the Premises in its 16 17 entirety any rights of Tenant to renew this Lease, extend the Term or to lease additional space in the Project shall be extinguished thereby and will not be transferred to the assignee or subtenant, all such rights being personal to the Tenant named herein. B. Landlord's Consent. Landlord will not unreasonably withhold its consent to any proposed assignment or subletting. It shall be reasonable for Landlord to withhold its consent to any assignment or sublease if (i) Tenant is in default under this Lease, (ii) during the initial ninety (90) days of Tenant's effort to market the Premises for sublease, the proposed assignee or sublessee is a tenant in the Project or an affiliate of such a tenant or a party that Landlord has identified as a prospective tenant in the Project, (iii) the nature of business, and character of the proposed assignee or subtenant are not reasonably satisfactory to Landlord, (iv) in the reasonable judgment of Landlord the purpose for which the assignee or subtenant intends to use the Premises (or a portion thereof) is not in keeping with Landlord's standards for the Building or are in violation of the terms of this Lease or any other leases in the Project, (v) the proposed assignee or subtenant is a government entity. The foregoing shall not exclude any other reasonable basis for Landlord to withhold its consent. C. Procedure. Tenant shall notify Landlord of any proposed assignment or sublease at least thirty (30) days prior to its proposed effective date. The notice shall include the name and address of the proposed assignee or subtenant, its corporate affiliates in the case of a corporation and its partners in a case of a partnership, an execution copy of the proposed assignment or sublease, and sufficient information to permit Landlord to determine the financial responsibility and character of the proposed assignee or subtenant. As a condition to any effective assignment of this Lease, the assignee shall execute and deliver in form satisfactory to Landlord at least fifteen (15) days prior to the effective date of the assignment, an assumption of all of the obligations of Tenant under this Lease. As a condition to any effective sublease, subtenant shall execute and deliver in form satisfactory to Landlord at least fifteen (15) days prior to the effective date of the sublease, an agreement to comply with all of Tenant's obligations under this Lease, and at Landlord's option, an agreement (except for the economic obligations which subtenant will undertake directly to Tenant) to attorn to Landlord under the terms of the sublease in the event this Lease terminates before the sublease expires. D. Change of Management or Ownership. (1) Any transfer of the direct or indirect power to affect the management or policies of Tenant or direct or indirect change in 25% or more of the ownership interest in Tenant (any of the foregoing in this Subsection D being herein sometimes referred to as an "Ownership Transfer") shall constitute an assignment of this Lease. Notwithstanding the foregoing in this Subsection D to the contrary if Tenant shall be a corporation whose stock is publicly traded on a nationally recognized securities exchange (including the NASDAQ over-the-counter market), then, except with respect to an Ownership Transfer in connection with the merger or consolidation of Tenant and except with respect to an Ownership Transfer in connection with the sale of all or substantially all of the assets of Tenant, any Ownership Transfer shall not be deemed to be an assignment of this Lease. In any event, any Ownership Transfer in connection with the merger or consolidation of Tenant or in connection with the sale of all or substantially all of the assets of Tenant shall constitute an assignment of this Lease. (2) Notwithstanding the foregoing, if no default on the part of Tenant has occurred and is continuing, Tenant may assign this Lease to an entity into which Tenant is merged or consolidated or to an entity to which substantially all of Tenant's assets are transferred, without first obtaining Landlord's written consent, if Tenant notifies Landlord prior to the proposed transaction, providing information satisfactory to Landlord in order to determine the net worth both of the successor entity and of Tenant immediately prior to such assignment, and showing the net worth of the successor to be at least equal to the net worth of Tenant. E. Excess Payments. If Tenant shall assign this Lease or sublet any part of the Premises to any entity that is not an Affiliate of Tenant for consideration in excess of the pro-rata portion of Rent applicable to the space subject to the assignment or sublet, then Tenant shall pay to Landlord as Additional Rent 50% of any such excess (net of Tenant's Transfer Costs, as defined below) immediately upon receipt. "Tenant's Transfer Costs" means the outstanding balance from time to time of the sum of the following items: (1) the cost of any additional tenant improvements required for the assignment of this Lease or the subleasing of such portion of the Premises paid by Tenant; (2) reasonable leasing commissions paid by Tenant in connection with the assignment or sublease to the transferee, not to exceed the amount of such commissions customarily payable with respect to 17 18 the leasing of office space in the Geographic Area; (3) rent abatements and other reasonable concessions granted by Tenant in connection with such assignment or sublease; and (4) reasonable marketing expenses paid directly by Tenant to assign this Lease or sublease the space (to the extent not included in a brokerage commission paid by Tenant). F. Recapture. Landlord may, by giving written notice to Tenant within ten (10) business days after receipt of Tenant's notice of assignment or subletting, terminate this Lease with respect to the space described in Tenant's notice, as of the effective date of the proposed assignment or sublease and all obligations under this Lease as to such space shall expire except as to any obligations that expressly survive any termination of this Lease. 18. CONVEYANCE BY LANDLORD. If Landlord shall at any time transfer its interest in the Project or this Lease, Landlord shall be released of any obligations occurring after such transfer, except the obligation to return to Tenant any security deposit not delivered to its transferee, and Tenant shall look solely to Landlord's successors for performance of such obligations. This Lease shall not be affected by any such transfer. 19. ESTOPPEL CERTIFICATE. Each party shall, within ten (10) days of receiving a request from the other party, execute, acknowledge in recordable form, and deliver to the other party or its designee a certificate stating, subject to a specific statement of any applicable exceptions, that the Lease as amended to date is in full force and effect, that the Tenant is paying Rent and other charges on a current basis, and that to the best of the knowledge of the certifying party, the other party has committed no uncured defaults and has no offsets or claims. The certifying party may also be required to state the date of commencement of payment of Rent, the Commencement Date, the Termination Date, the Base Rent, the current Operating Cost Share Rent and Tax Share Rent estimates, the status of any improvements required to be completed by Landlord, the amount of any security deposit, and such other matters as may be reasonably requested. Failure to deliver such statement within the time required shall be conclusive evidence against the non-certifying party that this Lease, with any amendments identified by the requesting party, is in full force and effect, that there are no uncured defaults by the requesting party, that not more than one month's Rent has been paid in advance, that the non-certifying party has not paid any security deposit, and that the non-certifying party has no claims or offsets against the requesting party. 20. SECURITY DEPOSIT. Tenant shall deposit with Landlord on the date of this Lease, security for the performance of all of its obligations in the amount set forth on the Schedule. If Tenant defaults under this Lease, Landlord may use any part of the Security Deposit to make any defaulted payment, to pay for Landlord's cure of any defaulted obligation, or to compensate Landlord for any loss or damage resulting from any default. To the extent any portion of the deposit is used, Tenant shall within five (5) days after demand from Landlord restore the deposit to its full amount. Landlord may keep the Security Deposit in its general funds and shall not be required to pay interest to Tenant on the deposit amount. If Tenant shall perform all of its obligations under this Lease and return the Premises to Landlord at the end of the Term, Landlord shall return all of the remaining Security Deposit to Tenant within thirty (30) days after the end of the Term. The Security Deposit shall not serve as an advance payment of Rent or a measure of Landlord's damages for any default under this Lease. If Landlord transfers its interest in the Project or this Lease, Landlord may transfer the Security Deposit to its transferee. Upon such transfer, Landlord shall have no further obligation to return the Security Deposit to Tenant, and Tenant's right to the return of the Security Deposit shall apply solely against Landlord's transferee. 21. FORCE MAJEURE. Landlord shall not be in default under this Lease to the extent Landlord is unable to perform any of its obligations on account of any strike or labor problem, energy shortage, governmental pre-emption or prescription, national emergency, or any other cause of any kind beyond the reasonable control of Landlord ("Force Majeure"). 22. TENANT'S PERSONAL PROPERTY AND FIXTURES. In addition to any statutory lien, Tenant hereby grants to Landlord a lien against and a security interest in all of Tenant's personal property and fixtures now or hereafter located within the Premises as security for performance of all of Tenant's obligations under this Lease. Tenant may replace such personal property and fixtures with items of equal or better quality, but shall not otherwise remove them from the Premises without the consent of Landlord until all of the obligations of Tenant under this Lease have been performed. This Lease constitutes a security agreement creating a security interest in such property in favor of Landlord, subject only to the liens of existing 18 19 creditors, and Landlord may at any time file this Lease as a financing statement under the Uniform Commercial Code of the state in which the Project is located. Alternatively, if requested to do so by Landlord, Tenant shall execute and deliver to Landlord within ten (10) days of such request a Form UCC-1 Financing Statement wherein Landlord is the secured party and Tenant is the Debtor. 23. NOTICES. All notices, consents, approvals and similar communications to be given by one party to the other under this Lease, shall be given in writing, mailed or personally delivered as follows: A. Landlord. To Landlord as follows: CARRAMERICA REALTY CORPORATION 1600 Parkwood Circle, Suite 150 Atlanta, Georgia 30339 Attn: Market Officer with a copy to: CarrAmerica Realty Corporation 1850 K Street, Suite 500 Washington, D.C. 20006 Attn: Lease Administration or to such other person at such other address as Landlord may designate by notice to Tenant. B. Tenant. To Tenant as follows: Internet Security Systems, Inc. 6600 Peachtree Dunwoody Road Building 600, Suite 600 Atlanta, Georgia 30328 or to such other person at such other address as Tenant may designate by notice to Landlord. Mailed notices shall be sent by United States certified or registered mail, or by a reputable national overnight courier service, postage prepaid. Mailed notices shall be deemed to have been given on the earlier of actual delivery or three (3) business days after posting in the United States mail in the case of registered or certified mail, and one business day in the case of overnight courier. 24. QUIET POSSESSION. So long as Tenant shall perform all of its obligations under this Lease, Tenant shall enjoy peaceful and quiet possession of the Premises against any party claiming through the Landlord. 25. REAL ESTATE BROKER. Tenant represents to Landlord that Tenant has not dealt with any real estate broker with respect to this Lease except for any broker(s) listed in the Schedule, and no other broker is in any way entitled to any broker's fee or other payment in connection with this Lease. Tenant shall indemnify and defend Landlord against any claims by any other broker or third party for any payment of any kind in connection with this Lease. 26. MISCELLANEOUS. A. Successors and Assigns. Subject to the limits on Tenant's assignment contained in Section 17, the provisions of this Lease shall be binding upon and inure to the benefit of all successors and assigns of Landlord and Tenant. 19 20 B. Date Payments Are Due. Except for payments to be made by Tenant under this Lease which are due upon demand or are due in advance (such as Base Rent). Tenant shall pay to Landlord any amount for which Landlord renders a statement of account within ten days of Tenant's receipt of Landlord's statement. C. Meaning of "Landlord", "Re-Entry, "including" and "Affiliate". The term "Landlord" means only the owner of the Project and the lessor's interest in this Lease from time to time. The words "re-entry" and "re-enter" are not restricted to their technical legal meaning. The words "including" and similar words shall mean "without limitation." The word "affiliate" shall mean a person or entity controlling, controlled by or under common control with the applicable entity. "Control" shall mean the power directly or indirectly, by contract or otherwise, to direct the management and policies of the applicable entity. D. Time of the Essence. Time is of the essence of each provision of this Lease. E. No Option. This document shall not be effective for any purpose until it has been executed and delivered by both parties; execution and delivery by one party shall not create any option or other right in the other party. F. Severability. The unenforceability of any provision of this Lease shall not affect any other provision. G. Governing Law. This Lease shall be governed in all respects by the laws of the state in which the Project is located, without regard to the principles of conflicts of laws. H. Lease Modification. Tenant agrees to modify this Lease in any way requested by a mortgagee which does not cause increased expense to Tenant or otherwise materially adversely affect Tenant's interests under this Lease. I. No Oral Modification. No modification of this Lease shall be effective unless it is a written modification signed by both parties. J. Landlord's Right to Cure. If Landlord breaches any of its obligations under this Lease, Tenant shall notify Landlord in writing and shall take no action respecting such breach so long as Landlord promptly begins to cure the breach and diligently pursues such cure to its completion. Landlord may cure any default by Tenant; any expenses incurred shall become Additional Rent due from Tenant on demand by Landlord. K. Captions. The captions used in this Lease shall have no effect on the construction of this Lease. L. Authority. Landlord and Tenant each represents to the other that it has full power and authority to execute and perform this Lease. M. Landlord's Enforcement of Remedies. Landlord may enforce any of its remedies under this Lease either in its own name or through an agent. N. Entire Agreement. This Lease, together with all Appendices, constitutes the entire agreement between the parties. No representations or agreements of any kind have been made by either party which are not contained in this Lease. O. Landlord's Title. Landlord's title shall always be paramount to the interest of the Tenant, and nothing in this Lease shall empower Tenant to do anything which might in any way impair Landlord's title. P. Light and Air Rights. Landlord does not grant in this Lease any rights to light and air in connection with Project. Landlord reserves to itself, the Land, the Building below the improved floor of each floor of the Premises, the Building above the ceiling of each floor of the Premises, the exterior of the Premises and the areas on the same floor outside the Premises, along with the areas within the Premises required for the installation and repair of utility lines and other items required to serve other tenants of the Building. 20 21 Q. Singular and Plural. Wherever appropriate in this Lease, a singular term shall be construed to mean the plural where necessary, and a plural term the singular. For example, if at any time two parties shall constitute Landlord or Tenant, then the relevant term shall refer to both parties together. R. No Recording by Tenant. Tenant shall not record in any public records any memorandum or any portion of this Lease. S. Exclusivity. Landlord does not grant to Tenant in this Lease any exclusive right except the right to occupy its Premises. T. No Construction Against Drafting Party. The rule of construction that ambiguities are resolved against the drafting party shall not apply to this Lease. U. Survival. All obligations of Landlord and Tenant under this Lease shall survive the termination of this Lease. V. Rent Not Based on Income. No rent or other payment in respect of the Premises shall be based in any way upon net income or profits from the Premises. Tenant may not enter into or permit any sublease or license or other agreement in connection with the Premises which provides for a rental or other payment based on net income or profit. W. Building Manager and Service Providers. Landlord may perform any of its obligations under this Lease through its employees or third parties hired by the Landlord. X. Late Charge and Interest on Late Payments. Without limiting the provisions of Section 12A, if Tenant fails to pay any installment of Rent or other charge to be paid by Tenant pursuant to this Lease within five (5) business days after the same becomes due and payable, then Tenant shall pay a late charge equal to the greater of five percent (5%) of the amount of such payment or $250. In addition, interest shall be paid by Tenant to Landlord on any late payments of Rent from the date due until paid at the rate provided in Section 2D(2). Such late charge and interest shall constitute Additional Rent due and payable by Tenant to Landlord upon the date of payment of the delinquent payment referenced above. Y. Tenant's Financial Statements. Within ten (10) days after Landlord's written request therefor, Tenant shall deliver to Landlord the current audited annual and quarterly financial statements of Tenant, and annual audited financial statements of the two (2) years prior to the current year's financial statements, each with an option of a certified public accountant and including a balance sheet and profit and loss statement, all prepared in accordance with generally accepted accounting principles consistently applied. 27. UNRELATED BUSINESS INCOME. If Landlord is advised by its counsel at any time that any part of the payments by Tenant to Landlord under this Lease may be characterized as unrelated business income under the United States Internal Revenue Code and its regulations, then Tenant shall enter into any amendment proposed by Landlord to avoid such income, so long as the amendment does not require Tenant to make more payments or accept fewer services from Landlord, than this Lease provides. 28. HAZARDOUS SUBSTANCES. Tenant shall not cause or permit any Hazardous Substances to be brought upon, produced, stored, used, discharged or disposed of in or near the Project unless Landlord has consented to such storage or use in its sole discretion. "Hazardous Substances" include those hazardous substances described in the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. Section 9601 et seq., the Resource Conservation and Recovery Act, as amended, 42 U.S.C. Section 6901 et seq., any other applicable federal, state or local law, and the regulations adopted under these laws. If any lender or governmental agency shall require testing for Hazardous Substances in the Premises, Tenant shall pay for such testing. 29. EXCULPATION. Landlord shall have no personal liability under this Lease; its liability shall be limited to its interest in the Project, and shall not extend to any other property or assets of the Landlord. In no event shall any officer, 21 22 director, employee, agent, shareholder, partner, member or beneficiary of Landlord be personally liable for any of Landlord's obligations hereunder. IN WITNESS WHEREOF, the parties hereto have executed this Lease. LANDLORD: CarrAmerica Realty Corporation, a Maryland corporation By: ---------------------------------------- Print Name: -------------------------------- Print Title: -------------------------------- Date: ------------------------------------- TENANT: Internet Security Systems, Inc., a Georgia corporation By: ---------------------------------------- Print Name: -------------------------------- Print Title: -------------------------------- Date: ------------------------------------- [CORPORATE SEAL] 22 23 APPENDIX A PLAN OF THE PREMISES Appendix A 1 24 APPENDIX B RULES AND REGULATIONS 1. Tenant shall not place anything, or allow anything to be placed near the glass of any window, door, partition or wall which may, in Landlord's judgment, appear unsightly from outside of the Project. 2. The Project directory shall be available to Tenant solely to display names and their location in the Project, which display shall be as directed by Landlord. 3. The sidewalks, halls, passages, exits, entrances, elevators and stairways shall not be obstructed by Tenant or used by Tenant for any purposes other than for ingress to and egress from the Premises. Tenant shall lend its full cooperation to keep such areas free from all obstruction and in a clean and sightly condition and shall move all supplies, furniture and equipment as soon as received directly to the Premises and move all such items and waste being taken from the Premises (other than waste customarily removed by employees of the Building) directly to the shipping platform at or about the time arranged for removal therefrom. The halls, passages, exits, entrances, elevators, stairways, balconies and roof are not for the use of the general public and Landlord shall, in all cases, retain the right to control and prevent access thereto by all persons whose presence in the judgment of Landlord, reasonably exercised, shall be prejudicial to the safety, character, reputation and interests of the Project. Neither Tenant nor any employee or invitee of Tenant shall go upon the roof of the Project. 4. The toilet rooms, urinals, wash bowls and other apparatuses shall not be used for any purposes other than that for which they were constructed, and no foreign substance of any kind whatsoever shall be thrown therein, and to the extent caused by Tenant or its employees or invitees, the expense of any breakage, stoppage or damage resulting from the violation of this rule shall be borne by Tenant. 5. Tenant shall not cause any unnecessary janitorial labor or services by reason of Tenant's carelessness or indifference in the preservation of good order and cleanliness. 6. Tenant shall not install or operate any refrigerating, heating or air conditioning apparatus, or carry on any mechanical business without the prior written consent of Landlord; use the Premises for housing, lodging or sleeping purposes; or permit preparation or warming of food in the Premises (warming of coffee and individual meals with employees and guests excepted). Tenant shall not occupy or use the Premises or permit the Premises to be occupied or used for any purpose, act or thing which is in violation of any Governmental Requirement or which may be dangerous to persons or property. 7. Tenant shall not bring upon, use or keep in the Premises or the Project any kerosene, gasoline or inflammable or combustible fluid or material, or any other articles deemed hazardous to persons or property, or use any method of heating or air conditioning other than that supplied by Landlord. 8. Landlord shall have sole power to direct electricians as to where and how telephone and other wires are to be introduced. No boring or cutting for wires is to be allowed without the consent of Landlord. The location of telephones, call boxes and other office equipment affixed to the Premises shall be subject to the approval of Landlord. 9. No additional locks shall be placed upon any doors, windows or transoms in or to the Premises without the prior written consent of Landlord. Tenant shall not change existing locks or the mechanism thereof. Upon termination of the lease, Tenant shall deliver to Landlord all keys and passes for offices, rooms, parking lot and toilet rooms which shall have been furnished Tenant. In the event of the loss of keys so furnished, Tenant shall pay Landlord therefor. Tenant shall not make, or cause to be made, any such keys and shall order all such keys solely from Landlord and shall pay Landlord for any keys in addition to the two sets of keys originally furnished by Landlord for each lock. Appendix B 1 25 10. Tenant shall not install linoleum, tile, carpet or other floor covering so that the same shall be affixed to the floor of the Premises in any manner except as approved by Landlord. 11. No furniture, packages, supplies, equipment or merchandise will be received in the Project or carried up or down in the freight elevator, except between such hours and in such freight elevator as shall be designated by Landlord. Tenant shall not take or permit to be taken in or out of other entrances of the Building, or take or permit on other elevators, any item normally taken in or out through the trucking concourse or service doors or in or on freight elevators. 12. Tenant shall cause all doors to the Premises to be closed and securely locked and shall turn off all utilities, lights and machines before leaving the Project at the end of the day. 13. Without the prior written consent of Landlord, Tenant shall not use the name of the Project or any picture of the Project in connection with, or in promoting or advertising the business of, Tenant, except Tenant may use the address of the Project as the address of its business. 14. Tenant shall cooperate fully with Landlord to assure the most effective operation of the Premises' or the Project's heating and air conditioning, and shall refrain from attempting to adjust any controls, other than room thermostats installed for Tenant's use. Tenant shall keep corridor doors closed. 15. Tenant assumes full responsibility for protecting the Premises from theft, robbery and pilferage, which may arise from a cause other than Landlord's negligence, which includes keeping doors locked and other means of entry to the Premises closed and secured. 16. Peddlers, solicitors and beggars shall be reported to the office of the Project or as Landlord otherwise requests. 17. Tenant shall not advertise the business, profession or activities of Tenant conducted in the Project in any manner which violates the letter or spirit of any code of ethics adopted by any recognized association or organization pertaining to such business, profession or activities. 18. No bicycle or other vehicle and no animals or pets shall be allowed in the Premises, halls, freight docks, or any other parts of the Building except that blind persons may be accompanied by "seeing eye" dogs. Tenant shall not make or permit any noise, vibration or odor to emanate from the Premises, or do anything therein tending to create, or maintain, a nuisance, or do any act tending to injure the reputation of the Building. 19. Tenant acknowledges that Building security problems may occur which may require the employment of extreme security measures in the day-to-day operation of the Project. Accordingly: (a) Landlord may, at any time, or from time to time, or for regularly scheduled time periods, as deemed advisable by Landlord and/or its agents, in their sole discretion, require that persons entering or leaving the Project or the Property identify themselves to watchmen or other employees designated by Landlord, by registration, identification or otherwise. (b) Tenant agrees that it and its employees will cooperate fully with Project employees in the implementation of any and all security procedures. (c) Such security measures shall be the sole responsibility of Landlord, and Tenant shall have no liability for any action taken by Landlord in connection therewith, it being understood that Landlord is not required to provide any security procedures and shall have no liability for such security procedures or the lack thereof. Appendix B 2 26 20. Tenant shall not do or permit the manufacture, sale, purchase, use or gift of any fermented, intoxicating or alcoholic beverages without obtaining written consent of Landlord. 21. Tenant shall not disturb the quiet enjoyment of any other tenant. 22. Tenant shall not provide any janitorial services or cleaning without Landlord's written consent and then only subject to supervision of Landlord and at Tenant's sole responsibility and by janitor or cleaning contractor or employees at all times satisfactory to Landlord. 23. Landlord may retain a pass key to the Premises and be allowed admittance thereto at all times to enable its representatives to examine the Premises from time to time and to exhibit the same and Landlord may place and keep on the windows and doors of the Premises at any time signs advertising the Premises for Rent. 24. No equipment, mechanical ventilators, awnings, special shades or other forms of window covering shall be permitted either inside or outside the windows of the Premises without the prior written consent of Landlord, and then only at the expense and risk of Tenant, and they shall be of such shape, color, material, quality, design and make as may be approved by Landlord. 25. Tenant shall not during the term of this Lease canvas or solicit other tenants of the Building for any purpose. 26. Tenant shall not install or operate any phonograph, musical or sound- producing instrument or device, radio receiver or transmitter, TV receiver or transmitter, or similar device in the Building, nor install or operate any antenna, aerial, wires or other equipment inside or outside the Building, nor operate any electrical device from which may emanate electrical waves which may interfere with or impair radio or television broadcasting or reception from or in the Building or elsewhere, without in each instance the prior written approval of Landlord. The use thereof, if permitted, shall be subject to control by Landlord to the end that others shall not be disturbed. 27. Tenant shall promptly remove all rubbish and waste from the Premises. 28. Tenant shall not exhibit, sell or offer for sale, Rent or exchange in the Premises or at the Project any article, thing or service, except those ordinarily embraced within the use of the Premises specified in Section 6 of this Lease, without the prior written consent of Landlord. 29. Tenant shall list all furniture, equipment and similar articles Tenant desires to remove from the Premises or the Building and deliver a copy of such list to Landlord and procure a removal permit from the Office of the Building authorizing Building employees to permit such articles to be removed. 30. Tenant shall not overload any floors in the Premises or any public corridors or elevators in the Building. 31. Tenant shall not do any painting in the Premises, or mark, paint, cut or drill into, drive nails or screws into, or in any way deface any part of the Premises or the Building, outside or inside, without the prior written consent of Landlord. 32. Whenever Landlord's consent, approval or satisfaction is required under these Rules, then unless otherwise stated, any such consent, approval or satisfaction must be obtained in advance, such consent or approval may be granted or withheld in Landlord's sole discretion, and Landlord's satisfaction shall be determined in its sole judgment. 33 Tenant and its employees shall cooperate in all fire drills conducted by Landlord in the Building. Appendix B 3 27 APPENDIX C TENANT IMPROVEMENT AGREEMENT 1. INITIAL IMPROVEMENTS. Landlord shall cause to be performed the improvements (the "Initial Improvements") in the Premises in accordance with plans and specifications approved by Tenant and Landlord (the "Plans"), which Plans shall be initialed by Landlord and Tenant and attached hereto by November 20, 1998 or the Commencement Date of this Lease shall be January 1, 1999 and all conditions set forth in Paragraph 4. below shall be null and void. The Initial Improvements shall be performed at the Tenant's cost, subject to the Landlord's Contribution (hereinafter defined). Landlord shall cause the Plans to be prepared, at Tenant's cost, by a registered professional architect. Tenant hereby agrees that the Plans for the Initial Improvements shall comply with all applicable Governmental Requirements. Landlord's approval of any of the Plans (or any modifications or changes thereto) shall not impose upon Landlord or its agents or representatives any obligation with respect to the design of the Initial Improvements or the compliance of such Initial Improvements or the Plans with applicable Governmental Requirements. Landlord shall select a contractor to perform the construction of the Initial Improvements. Landlord shall use commercially reasonable efforts to cause the Initial Improvements to be substantially completed, except for minor "Punch List" items, on or before the Commencement Date specified in the Schedule to the Lease, subject to Tenant Delay (as defined in Section 4 hereof) and Force Majeure. Landlord, or an agent of Landlord, shall provide project management services in connection with the construction of the Initial Improvements and the Change Orders (hereinafter defined). Such project management services shall be performed, at Tenant's cost, for a fee of five percent (5%) of all costs related to the preparation of the Plans and the construction of the Initial Improvements and the Change Orders. 2. CHANGE ORDERS. If, prior to the Commencement Date, Tenant shall require improvements or changes (individually or collectively, "Change Orders") to the Premises in addition to, revision of or substitution for the Initial Improvements, Tenant shall deliver to Landlord for its approval plans and specifications for such Change Orders. If Landlord does not approve of the plans for Change Orders, Landlord shall advise Tenant of the revisions required. Tenant shall revise and redeliver the plans and specifications to Landlord within five (5) business days of Landlord's advice or Tenant shall be deemed to have abandoned its request for such Change Orders. Tenant shall pay for all preparations and revisions of plans and specifications, and the construction of all Change Orders, subject to Landlord's Contribution. 3. LANDLORD'S CONTRIBUTION. Landlord shall contribute an amount up to $146,886.00 ("Landlord's Contribution") toward the costs incurred for the Initial Improvements and Change Orders. Landlord has no obligation to pay for costs of the Initial Improvements or Change Orders in excess of Landlord's Contribution. If the cost of the Initial Improvements and/or Change Orders exceeds the Landlord's Contribution, Tenant shall pay such overage to Landlord prior to commencement of construction of the Initial Improvements and/or Change Orders. If Landlord's Contribution exceeds the cost of the Initial Improvements and Change Orders, then Landlord shall credit such excess against the monthly installments of Base Rent first due and payable after the Commencement Date. 4. COMMENCEMENT DATE DELAY. Commencement Date shall be delayed until the Initial Improvements have been substantially completed (the "Completion Date"), except to the extent that the delay shall be caused by any one or more of the following (a "Tenant Delay"): (a) Tenant's request for Change Orders whether or not any such Change Orders are actually performed; or (b) Contractor's performance of any Change Orders; or Appendix C 1 28 (c) Tenant's request for materials, finishes or installations requiring unusually long lead times; or (d) Tenant's delay in reviewing, revising or approving plans and specifications beyond the periods set forth herein; or (e) Tenant's delay in providing information critical to the normal progression of the project. Tenant shall provide such information as soon as reasonably possible, but in no event longer than one week after receipt of such request for information from the Landlord; or (f) Tenant's delay in making payments to Landlord for costs of the Initial Improvements and/or Change Orders in excess of the Landlord's Contribution; or (g) Any other act or omission by Tenant, its agents, contractors or persons employed by any of such persons. If the Commencement Date is delayed for any reason, then Landlord shall cause Landlord's Architect to certify the date on which the Initial Improvements would have been completed but for such Tenant Delay, or were in fact completed without any Tenant Delay. Notwithstanding anything herein to the contrary, the only Commencement Date which is subject to delays shall be the Phase I Commencement Date. Phase II and Phase III Commencement Dates shall commence without being subject to the conditions of this paragraph 4. 5. ACCESS BY TENANT PRIOR TO COMMENCEMENT OF TERM. Landlord at its discretion may permit Tenant and its agents to enter the Premises prior to the Commencement Date to prepare the Premises for Tenant's use and occupancy. Any such permission shall constitute a license only, conditioned upon Tenant's: (a) working in harmony with Landlord and Landlord's agents, contractors, workmen, mechanics and suppliers and with other tenants and occupants of the Building; (b) obtaining in advance Landlord's approval of the contractors proposed to be used by Tenant and depositing with Landlord in advance of any work (i) security satisfactory to Landlord for the completion thereof, and (ii) the contractor's affidavit for the proposed work and the waivers of lien from the contractor and all subcontractors and suppliers of material; and (c) furnishing Landlord with such insurance as Landlord may require against liabilities which may arise out of such entry. Landlord shall have the right to withdraw such license for any reason upon twenty-four (24) hours' written notice to Tenant. Landlord shall not be liable in any way for any injury, loss or damage which may occur to any of Tenant's property or installations in the Premises prior to the Commencement Date. Tenant shall protect, defend, indemnify and save harmless Landlord from all liabilities, costs, damages, fees and expenses arising out of the activities of Tenant or its agents, contractors, suppliers or workmen in the Premises or the Building. Any entry and occupation permitted under this Section shall be governed by Section 5 and all other terms of the Lease. 6. MISCELLANEOUS. Terms used in this Appendix C shall have the meanings assigned to them in the Lease. The terms of this Appendix C are subject to the terms of the Lease. Appendix C 2 29 APPENDIX D MORTGAGES CURRENTLY AFFECTING THE PROJECT NONE Appendix D 1 30 APPENDIX E COMMENCEMENT DATE CONFIRMATION Landlord: CarrAmerica Realty Corporation, a Georgia corporation Tenant: ____________________, a _____________ This Commencement Date Confirmation is made by Landlord and Tenant pursuant to that certain Lease dated as of _________, 199__ (the "Lease") for certain premises known as Suite ____ in the building commonly known as [PROPERTY NAME] (the "Premises"). This Confirmation is made pursuant to Item 9 of the Schedule to the Lease. 1. Lease Commencement Date, Termination Date. Landlord and Tenant hereby agree that the Commencement Date of the Lease is _____________, 199__, and the Termination Date of the Lease is __________________, ________. 2. Acceptance of Premises. Tenant has inspected the Premises and affirms that the Premises is acceptable in all respects in its current "as is" condition. 3. Incorporation. This Confirmation is incorporated into the Lease, and forms an integral part thereof. This Confirmation shall be construed and interpreted in accordance with the terms of the Lease for all purposes. TENANT: a -------------------------, ------------------------ By: ------------------------------------------------- Name: ----------------------------------------------- Title: ---------------------------------------------- LANDLORD: CarrAmerica Realty Corporation, a Georgia corporation By: -------------------------------------------------- Name ------------------------------------------------- Title: ----------------------------------------------- Appendix E 1 31 APPENDIX F SPECIAL STIPULATIONS 1. EARLY OCCUPANCY. Tenant may begin its move into the Premises in December, 1998; provided Tenant does not interfere with any construction. During December, 1998, Tenant shall be liable for all Terms set forth in this Lease except Rent. 2. PHASED OCCUPANCY. Landlord and Tenant agree in good faith that Tenant's use of the Premises during the Phased Occupancy shall approximately meet the square footage amounts reflected in Paragraph 3 of the Schedule. 3. PARKING. Notwithstanding anything to the contrary set forth herein, parking shall be on-site, adequately lit and free of charge. A. As used herein, the term "Parking Spaces" shall mean 86 parking spaces in the initial Premises located in the Building such Parking Spaces to be located on the Land associated with the Building, all of which shall be non-designated spaces. Tenant and its agents, employees, contractors, invitees and licensees may not use additional parking spaces without the prior written consent of Landlord. Tenant and its agents, employees, contractors, invitees or licensees shall not interfere with the rights of Landlord or others entitled to similar use of the parking facilities. If Tenant's use is in excess of the allotted Parking Spaces, then such use shall be an immediate event of default and Landlord may use all of its rights and remedies under the Lease including its right to immediately terminate this Lease. B. All parking facilities furnished by Landlord shall be subject to the reasonable and control and management of Landlord, who may, from time to time, establish, modify and enforce reasonable rules and regulations with respect thereto, provided that there shall be no charge to Tenant or its employees or invitees for use of the Parking Spaces during the Term, except in connection with Operating Costs (including exterior lighting) and except for the reasonable cost of any access cards. Landlord further reserves the right to change or reconfigure the parking facilities and designate the parking spaces therein, to construct or repair any portion thereof, and to restrict or eliminate the use of any parking areas and do such other acts in and to such areas as Landlord deems necessary or desirable without such actions being deemed an eviction of Tenant or a disturbance of Tenant's use of the Premises and without Landlord being deemed in default hereunder; provided, however, the number of Parking Spaces as set forth in Section (a) above shall be maintained throughout the Term. C. If parking spaces are not assigned pursuant to the terms of this Lease, Landlord reserves the right at any time to assign parking spaces, and Tenant shall thereafter be responsible to insure that its employees park in the designated areas. Landlord shall not be liable for any damage of any nature to, or any theft of vehicles, or contents thereof, in or about such parking facility. 4. SIGNAGE. It is expressly understood and agreed that Tenant shall have the right to install signage at the Project, upon and subject to the terms and conditions set forth in this Special Stipulation 1 below. A. Monument Signage Rights. Landlord shall procure and install a monument type sign (the "Monument Sign") on the Land for the non-exclusive use of Tenant, in a location to be decided by Landlord. Tenant shall have the right to procure, and Landlord shall install and maintain, all at Tenant's sole cost and expense, Tenant's lettering/sign on the Monument Sign (the "Tenant's Monument Signage"), upon and subject to the following terms and conditions. (a) All costs and expenses in connection with the procurement, installation, insuring, maintenance and removal of Tenant's Monument Signage shall be the responsibility of Tenant; (b) Tenant's Monument Signage shall comply with all Legal Requirements and Tenant and Landlord, at Tenant's cost shall obtain any required consents or permits from any applicable Governmental Authority; Appendix F 1 32 (c) Tenant's Monument Signage shall be located on the Monument Sign in the area approved by Landlord, which approval shall not be unreasonably withheld, and the exact manner of installation, design, size, color, lettering, location and illumination of the Monument Sign and Tenant's Monument Signage shall be subject to the prior written approval of Landlord (such approval not to be unreasonably withheld). Without limiting the generality of the foregoing, the Monument Sign and Tenant's Monument Signage shall not adversely affect or conflict with in any way the Embassy Row entrances or Embassy Row development identification(s); (d) Tenant shall have the right to maintain Tenant's Monument Signage on the Monument Sign only for so long as this Lease remains in full force and effect, and Tenant and/or its Affiliates are collectively leasing 20,000 or more rentable square feet in the Building and subleasing 40,000 or more rentable square feet in the Project. In addition to the foregoing conditions, the rights granted to Tenant in this subsection A are personal to the Tenant named herein and may not be transferred to any assignee or subtenant that is not an Affiliate of Tenant unless Landlord otherwise agrees in writing to permit the assignment of such signage rights to the permitted assignee of the Lease or any permitted sublessee. Landlord covenants that it will not unreasonably withhold its consent to such assignment of the signage rights; provided, however, if the assignee or sublessee is a Governmental entity, Landlord may withhold its consent in its sole, arbitrary and absolute discretion. Tenant shall, at its sole cost and expense, promptly remove the Tenant's Monument Signage and repair any damage to the Monument Sign, the Building, the Land and/or any other portion of the Project caused by or resulting from such removal if the above conditions do not continue to be satisfied. In the event Tenant fails to so remove such Tenant's Monument Signage or repair such damage, Landlord may remove same and made such repairs at Tenant's cost and Tenant shall pay Landlord on demand as additional Rent the cost of such removal and repairs. The Monument Sign shall remain the property of Landlord upon the expiration or earlier termination of this Lease. B. Georgia 400 Monument Sign. In the event that the Metropolitan Atlanta Rapid Transit authority ("MARTA") grants to Landlord a written easement in recordable form (the "MARTA Easement") to install, maintain, repair, replace and use a monument type sign on the real property owned by MARTA that is adjacent to land owned by Landlord and to Georgia Highway 400 (the "MARTA Monument Sign"), then, subject to the provisions of the MARTA Easement, Tenant shall have the right to procure, and the Landlord shall install and maintain, all at Tenant's sole cost and expense, Tenant's lettering/sign on the MARTA Monument Sign (the "Tenant's MARTA Monument Signage"), upon and subject to the following terms and conditions: (a) Tenant rights under this subsection B are not exclusive. The area of coverage of Tenant's MARTA Monument Signage on the MARTA Monument Sign shall not exceed 50% of the total area available for signage on the MARTA Monument Sign as determined by Landlord in its reasonable discretion. Landlord agrees that the position of Tenant's MARTA Monument Signage on the MARTA Monument Sign shall be on the lower half portion of the MARTA Monument Sign. If during the Term of this Lease, Landlord executes a Lease with another Tenant for premises containing at least 48,000 square feet, then upon Landlord's written notice, Tenant's signage rights hereunder shall be reduced from 50% to 25% and the position of Tenant's signage shall generally be on the middle to lower half portion of such sign. All costs and expenses in connection with the procurement, installation, insuring, maintenance and removal of Tenant's MARTA Monument Signage shall be the responsibility of Tenant; (b) Tenant's MARTA Monument Signage shall comply with the provisions of the MARTA Easement and with all Legal Requirements, and Tenant and Landlord, at Tenant's cost,- shall obtain any required consents or permits from any applicable governmental Authority; (c) Tenant's MARTA Monument Signage shall be located on the MARTA Monument Sign in the area approved by Landlord, which approval shall not be unreasonably withheld, and the exact manner of installation, design, size, color, lettering, location and illumination of the MARTA Monument Sign and Tenant's MARTA Monument Signage shall be subject to the prior written approval of Landlord (such approval shall not be unreasonably withheld). Landlord agrees that the position of Tenant's MARTA Monument Signage on the MARTA Monument Sign shall generally be on the middle to lower half portion of the MARTA Monument Sign. Notwithstanding the foregoing, it shall be deemed reasonable for Landlord to withhold Appendix F 2 33 its approval if Tenant's plans do not comply with the provisions of, or otherwise breach the provisions of, the MARTA Easement; (d) Tenant shall have the right to maintain Tenant's MARTA Monument Signage on the MARTA Monument Sign only for so long as (i) the MARTA Easement remains in effect, (ii) this Lease remains in full force and effect, and (iii) Tenant and/or its Affiliates are leasing 20,000 or more rentable square feet in the Building and subleasing 40,000 or more rentable square feet in the Project. In addition to the foregoing conditions, the rights granted to Tenant in this subsection B are personal to the Tenant named herein and may not be transferred to any assignee or subtenant that is not an Affiliate of Tenant unless Landlord otherwise agrees in writing to permit the assignment of such signage rights to the permitted assignee of the Lease or any permitted sublessee. Landlord covenants that it will not unreasonably withhold its consent to such assignment of the signage rights; provided, however, if the assignee or sublessee is a Governmental Entity, Landlord may withhold its consent in its sole, arbitrary and absolute discretion. Tenant shall, at its sole cost and expense, promptly remove the Tenant's MARTA Monument Signage and repair any damage to the MARTA Monument Sign, MARTA'S land and/or any other portion of the Project caused by or resulting from such removal if the above conditions do not continue to be satisfied. In the event Tenant fails to so remove such Tenant's MARTA Monument Signage or repair such damage, Landlord may remove same and made such repairs at Tenant's cost and Tenant shall pay Landlord on demand as additional Rent the cost of such removal and repairs. The MARTA Monument Sign shall remain the property of Landlord upon the expiration or earlier termination of this Lease. 5. LANDLORD FEES. Notwithstanding anything herein to the contrary, Landlord shall not charge Tenant a supervisory fee for installation of phone or data cabling which are contracted between Tenant and third party vendors. 6. LEASE EXTENSION. Tenant shall have a one-time right to extend the Lease Term for an additional ninety (90) days ("Extension Period") provided it gives Landlord written notice at least ninety (90) days prior to the expiration of the Original Term. For the Extension Period, all terms and conditions as set forth in this Lease shall apply except the monthly Rent due shall be equal to one hundred and fifteen percent (115%) of the prevailing monthly Rent being paid in the last year of this original Lease Agreement. Appendix F 3 34 TABLE OF CONTENTS
Page ---- 1. LEASE AGREEMENT 3 2. RENT 3 A. Types of Rent 3 (1) Base Rent 3 (2) Operating Cost Share Rent 3 (3) Tax Share Rent 3 (4) Additional Rent 3 (5) Rent 4 B. Payment of Operating Cost Share Rent and Tax Share Rent 4 (1) Payment of Estimated Operating Cost Share Rent and Tax Share Rent 4 (2) Correction of Operating Cost Share Rent 4 (3) Correction of Tax Share Rent 4 C. Definitions 4 (1) Included Operating Costs 4 (2) Excluded Operating Costs 5 (3) Taxes 6 (4) Lease Year 6 (5) Fiscal Year 6 D. Computation of Base Rent and Rent Adjustments 6 (1) Prorations. 6 (2) Default Interest. 6 (3) Rent Adjustments. 6 (4) Books and Records. 6 (5) Miscellaneous. 7 3. PREPARATION AND CONDITION OF PREMISES POSSESSION AND SURRENDER OF PREMISES 7 A. Condition of Premises. 7 B. Tenant's Possession. 7 C. Maintenance. 7 4. PROJECT SERVICES 7 A. Heating and Air Conditioning 7 B. Elevators 7 C. Electricity 8 D. Water 8 E. Janitorial Service 8 F. Interruption of Services 8 5. ALTERATIONS AND REPAIRS 8 A. Landlord's Consent and Conditions. 8 B. Damage to Systems. 9 C. No Liens. 9 D. Ownership of Improvements. 10 E. Removal at Termination. 10 6. USE OF PREMISES 10 7. GOVERNMENTAL REQUIREMENTS AND BUILDING RULES. 10
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Page ---- 8. WAIVER OF CLAIMS; INDEMNIFICATION; INSURANCE. 10 A. Waiver of Claims. 10 B. Indemnification. 11 C. Tenant's Insurance. 11 D. Insurance Certificates. 12 E. Landlord's Insurance. 12 9. FIRE AND OTHER CASUALTY 12 A. Termination. 12 B. Restoration. 12 10. EMINENT DOMAIN. 12 11. RIGHTS RESERVED TO LANDLORD. 13 A. Name 13 B. Signs. 13 C. Window Treatments. 13 D. Keys 13 E. Access 13 F. Preparation for Reoccupancy 13 G. Heavy Articles 13 H. Show Premises 13 I. Relocation of Tenant 13 J. Use of Lockbox 13 K. Repairs and Alterations 13 L. Landlord's Agents 13 M. Building Services. 14 N. Other Actions. 14 12. TENANT'S DEFAULT. 14 A. Rent Default. 14 B. Assignment/Sublease or Hazardous Substances Default. 14 C. Other Performance Default. 14 D. Credit Default. 14 E. Vacation or Abandonment Default. 14 13. LANDLORD REMEDIES 14 A. Termination of Lease or Possession. 14 B. Lease Termination Damages. 14 C. Possession Termination Damages. 15 D. Landlord's Remedies Cumulative. 15 E. WAIVER OF TRIAL BY JURY. 15 F. Litigation Costs. 15 14. SURRENDER. 15 15. HOLDOVER. 15 16. SUBORDINATION TO GROUND LEASES AND MORTGAGES 16 A. Subordination 16
36 TABLE OF CONTENTS
Page ---- B. Termination of Ground Lease or Foreclosure of Mortgage 16 C. Security Deposit 16 D. Notice and Right to Cure 16 E. Definitions. 16 17. ASSIGNMENT AND SUBLEASE. 16 A. In General. 16 B. Landlord's Consent. 17 C. Procedure. 17 D. Change of Management or Ownership. 17 E. Excess Payments. 17 F. Recapture. 18 18. CONVEYANCE BY LANDLORD 18 19. ESTOPPEL CERTIFICATE 18 20. SECURITY DEPOSIT 18 21. FORCE MAJEURE 18 22. TENANT'S PERSONAL PROPERTY AND FIXTURES 18 23. NOTICES 19 A. Landlord. 19 B. Tenant. 19 24. QUIET POSSESSION 19 25. REAL ESTATE BROKER 19 26. MISCELLANEOUS 19 A. Successors and Assigns. 19 B. Date Payments Are Due. 20 C. Meaning of "Landlord", "Re-Entry, "including" and "Affiliate". 20 D. Time of the Essence. 20 E. No Option. 20 F. Severability. 20 G. Governing Law. 20 H. Lease Modification. 20 I. No Oral Modification. 20 J. Landlord's Right to Cure. 20 K. Captions. 20 L. Authority. 20 M. Landlord's Enforcement of Remedies. 20 N. Entire Agreement. 20 O. Landlord's Title. 20 P. Light and Air Rights. 20 Q. Singular and Plural. 21 R. No Recording by Tenant. 21 S. Exclusivity. 21
37 TABLE OF CONTENTS
Page ---- T. No Construction Against Drafting Party. 21 U. Survival. 21 V. Rent Not Based on Income. 21 W. Building Manager and Service Providers. 21 X. Late Charge and Interest on Late Payments. 21 Y. Tenant's Financial Statements 21 27. UNRELATED BUSINESS INCOME 21 28. HAZARDOUS SUBSTANCES 21 29. EXCULPATION 22
APPENDIX A - PLAN OF THE PREMISES APPENDIX B - RULES AND REGULATIONS APPENDIX C - TENANT IMPROVEMENT AGREEMENT APPENDIX D - MORTGAGES CURRENTLY AFFECTING THE PROJECT APPENDIX E - COMMENCEMENT DATE CONFIRMATION APPENDIX F - SPECIAL STIPULATIONS EX-21.1 4 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21.1 Subsidiaries of the Registrant. 1. Internet Security Systems, Inc. (Georgia). 2. Internet Security Systems K.K. (Japan). 3. ISS Group Ltd. (United Kingdon). 4. ISS Investments Holding, Inc. (Delaware). EX-23.1 5 CONSENT OF ERNST & YOUNG, LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our reports dated January 15, 1999 in the Registration Statement (Form S-1) and related Prospectus of ISS Group, Inc. dated January 29, 1999. /s/ Ernst & Young LLP Atlanta, Georgia January 29, 1999 EX-23.2 6 CONSENT OF ERNST & YOUNG, LLP 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our report dated October 16, 1998, in the Registration Statement (Form S-1 No. 333-00000) and related Prospectus of ISS Group, Inc's for the registration of 2,400,000 shares of its common stock. /s/ Ernst & Young Reading, England January 29, 1999 EX-27.1 7 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS OF ISS GROUP, INC. FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 52,632 0 12,586 287 0 65,961 5,672 1,655 78,021 11,572 0 0 0 17 66,298 78,021 0 35,929 0 42,335 0 0 16 (4,040) 62 (4,102) 0 0 0 (4,102) (.28) (.28)
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