-----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, SchpvUtmho0V2ajHN6UkQA2m+BwGAZPpqxZP3sV8JIQVbLr70Ngme3GNrJPiYgCd Q+H3194JvZNFaQwtuRkedw== 0001032210-01-500577.txt : 20010516 0001032210-01-500577.hdr.sgml : 20010516 ACCESSION NUMBER: 0001032210-01-500577 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WATCHGUARD TECHNOLOGIES INC CENTRAL INDEX KEY: 0001062019 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 911712427 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26819 FILM NUMBER: 1635552 BUSINESS ADDRESS: STREET 1: 505 FIFTH AVENUE SOUTH SUITE 500 CITY: SEATTLE STATE: WA ZIP: 98104 BUSINESS PHONE: 2065218340 MAIL ADDRESS: STREET 1: 505 FIFTH AVENUE SOUTH SUITE 500 CITY: SEATTLE STATE: WA ZIP: 98104 10-Q 1 d10q.txt FORM 10-Q FOR THE QUARTERLY PERIOD ENDED 3/31/01 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the quarterly period ended Commission File Number March 31, 2001 000-26819 - -------------- --------- WATCHGUARD TECHNOLOGIES, INC. ----------------------------- (Exact Name of Registrant as Specified in Its Charter) Delaware 91-1712427 - ------------------------------- ------------------------------------ (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 505 Fifth Ave. South, Suite 500 ------------------------------- Seattle WA 98104-3892 --------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (206) 521-8340 -------------- Not Applicable -------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes X No --- --- 26,852,011 shares of WatchGuard common stock were outstanding as of May 7, 2001. Page 1 WATCHGUARD TECHNOLOGIES, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2001 TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS....................................................................... 3 - Consolidated Balance Sheets as of March 31, 2001 and December 31, 2000.................. 3 - Consolidated Statements of Operations for the three months ended March 31, 2001 and 2000 4 - Consolidated Statements of Cash Flows for the three months ended March 31, 2001 and 2000 5 - Notes to Consolidated Financial Statements.............................................. 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...... 9 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................. 26 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.................................................. 28 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................................................... 28
Page 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS WATCHGUARD TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS --------------------------- (In thousands, except share data) March 31, December 31, 2001 2000 ----------------- ----------------- (unaudited) ASSETS Current assets: Cash and cash equivalents....................................................... $ 18,878 $ 13,837 Securities available for sale................................................... 95,946 101,278 Trade accounts receivable, net.................................................. 12,330 15,271 Inventories..................................................................... 6,110 7,026 Prepaid expenses and other receivables.......................................... 3,544 3,178 ----------------- ----------------- Total current assets........................................................... 136,808 140,590 Property and equipment, net...................................................... 7,448 7,341 Goodwill......................................................................... 32,111 33,947 Other intangibles and other assets............................................... 13,170 14,052 ----------------- ----------------- Total assets..................................................................... $189,537 $195,930 ================= ================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable................................................................ $ 4,698 $ 7,256 Accrued expenses................................................................ 3,808 4,395 Deferred revenue................................................................ 12,855 11,874 ----------------- ----------------- Total current liabilities........................................................ 21,361 23,525 Stockholders' equity: Preferred stock, $0.001 par value: Authorized shares: 10,000,000 No shares issued and outstanding.............................................. -- -- Common stock, $0.001 par value: Authorized shares: 80,000,000 Shares issued and outstanding: 26,776,367 at March 31, 2001 and 26,287,072 at December 31, 2000............................................ 27 26 Additional paid-in capital...................................................... 232,034 230,591 Deferred stock-based compensation............................................... (8,070) (12,387) Accumulated other comprehensive gain (loss)..................................... 268 (222) Accumulated deficit............................................................. (56,083) (45,603) ----------------- ----------------- Total stockholders' equity....................................................... 168,176 172,405 ----------------- ----------------- Total liabilities and stockholders' equity....................................... $189,537 $195,930 ================= =================
- ----------------------------- See accompanying notes. Page 3 WATCHGUARD TECHNOLOGIES, INC. ----------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------- (In thousands, except per share data) (unaudited)
Three Months Ended March 31, --------------------------------------- 2001 2000 ----------------- ----------------- Revenues: Product............................................................. $ 13,284 $ 8,494 Service............................................................. 3,818 1,308 ----------------- ----------------- Total revenues................................................... 17,102 9,802 Cost of revenues: Product............................................................. 5,267 3,091 Service............................................................. 1,376 432 ----------------- ----------------- Total cost of revenues........................................... 6,643 3,523 ----------------- ----------------- Gross margin......................................................... 10,459 6,279 Operating expenses: Sales and marketing (1)............................................. 8,171 5,559 Research and development (2)........................................ 5,271 2,521 General and administrative (3)...................................... 1,870 1,154 Stock-based compensation............................................ 4,520 236 Amortization of goodwill, purchased technology and other intangible assets acquired...................................... 2,724 368 ----------------- ----------------- Total operating expenses......................................... 22,556 9,838 ----------------- ----------------- Operating loss....................................................... (12,097) (3,559) Interest income, net................................................. 1,701 863 ----------------- ----------------- Loss before income taxes............................................. (10,396) (2,696) ----------------- ----------------- Provision for income taxes........................................... 84 - ----------------- ----------------- Net loss............................................................. $ (10,480) $ (2,696) ================= ================= Basic and diluted net loss per share................................. $ (0.40) $ (0.13) ================= ================= Shares used in calculation of basic and diluted net loss per share.................................................. 26,348 21,243 ================= =================
- ------------------------ (1) Sales and marketing expenses exclude amortization of stock-based compensation of $12,000 and $51,000 for the three months ended March 31, 2001 and 2000, respectively. (2) Research and development expenses exclude amortization of stock-based compensation of $4,441,000 and $164,000 for the three months ended March 31, 2001 and 2000, respectively. (3) General and administrative expenses exclude amortization of stock-based compensation of $67,000 and $21,000 for the three months ended March 31, 2001 and 2000, respectively. See accompanying notes. Page 4 WATCHGUARD TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (In thousands) (unaudited)
Three Months Ended March 31, -------------------------------------------- 2001 2000 ------------------- ------------------- OPERATING ACTIVITIES: Net loss........................................................................ $(10,480) $ (2,696) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization of property and equipment....................... 514 246 Amortization of goodwill and other intangible assets.......................... 2,724 368 Amortization of stock-based compensation...................................... 4,520 236 Provision for sales returns and allowances.................................... 1,252 209 Provision for bad debt expense................................................ 276 102 Changes in operating assets and liabilities: (Increase) decrease in trade accounts receivable............................ 1,413 (2,895) (Increase) decrease in inventories.......................................... 916 (1,378) (Increase) in prepaid expenses and other receivables........................ (366) (1,001) (Increase) in goodwill, intangibles and other assets........................ (6) (13) Increase (decrease) in accounts payable and accrued expenses................ (3,145) 2,041 Increase in deferred revenue................................................ 981 1,259 ------------------- ------------------- NET CASH USED IN OPERATING ACTIVITIES (1,401) (3,522) INVESTING ACTIVITIES: Purchases of equipment and furniture............................................ (621) (403) Proceeds from sales and maturities of marketable securities..................... 70,524 2,000 Purchases of marketable securities.............................................. (64,702) (40,872) ------------------- ------------------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES.............................. 5,201 (39,275) FINANCING ACTIVITIES: Principal repayments on line of credit and notes payable........................ -- (383) Proceeds from the sale of common stock, net of expenses......................... -- 90,437 Proceeds from the exercise of common stock options and warrants, and the sale of common stock through the employee stock purchase plan.................... 1,241 1,122 ------------------- ------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES........................................ 1,241 91,176 ------------------- ------------------- NET INCREASE IN CASH AND CASH EQUIVALENTS....................................... 5,041 48,379 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD................................. 13,837 1,903 ------------------- ------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD....................................... $ 18,878 $ 50,282 =================== ===================
- ------------------------- See accompanying notes. Page 5 WATCHGUARD TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION Description of Business WatchGuard Technologies, Inc. is a provider of Internet security solutions designed to protect enterprises that use the Internet for electronic commerce and secure communications. Interim Financial Information The accompanying unaudited financial statements of WatchGuard, which include the December 31, 2000 balance sheet that was derived from audited financial statements, have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the unaudited financial statements include all adjustments, consisting of normal recurring accruals, necessary for a fair presentation. Operating results for the three-month period ended March 31, 2001 are not necessarily indicative of the results that may be expected for future quarters or for the year ended December 31, 2001. The financial statements should be read in conjunction with the financial statements and related notes for the year ended December 31, 2000 included in WatchGuard's annual report on Form 10-K, filed with the Securities and Exchange Commission (SEC) on March 28, 2001. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition WatchGuard recognizes revenue in accordance with accounting standards for software companies, including Statement of Position (SOP) 97-2, "Software Revenue Recognition," as amended by SOP 98-9, and related interpretations, including Technical Practice Aids. In December 1999, the SEC issued Staff Accounting Bulletin (SAB) 101, "Revenue Recognition in Financial Statements". SAB 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. The SEC continues to issue further guidance with respect to adoption of specific issues addressed by SAB 101. WatchGuard believes its current revenue recognition policies and practices are consistent with the current accounting standards and guidance in SAB 101. WatchGuard generates revenues through sales of its Firebox products, including related software licenses, and subscriptions for its LiveSecurity Service, which includes threat responses, software updates and maintenance. Software license revenues are generated from licensing the rights to use WatchGuard's products directly to end-users, from sublicense fees from resellers, distributors and from sales of its products to Internet service providers (ISPs) and other managed service providers that utilize WatchGuard's products to provide managed security services to their customers. Revenues from software license agreements are generally recognized upon delivery of software if persuasive evidence of an arrangement exists, collection is probable, the fee is fixed or determinable, and vendor-specific objective evidence exists to allocate the total fee to undelivered elements of the arrangement. WatchGuard's payment terms typically range from 30 to 60 days. A limited number of WatchGuard's distributors have unlimited stock return and rotation rights. Revenues from these distribution arrangements are not recognized until a sale to their customer occurs. Vendor-specific objective evidence is typically based on the price charged when an element is sold separately or, if an element is not sold separately, on the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. WatchGuard uses the residual method, as defined in SOP 98-9, to allocate revenue to delivered elements once it has established vendor-specific objective evidence for all undelivered elements. Under the residual method, any discount in the arrangement is allocated to the delivered element. WatchGuard provides for return rights and pricing protection rights for some of its customers. The return rights included in these customer agreements are generally limited to a percentage of purchases by these customers for the previous quarter. The pricing protection rights in these agreements are generally limited to 60 to 90 days after notification of a price change. Revenues are reduced by the provision for estimated returns and allowances at the time the sale is made. The reserves are reviewed and revised as needed. Revenues from LiveSecurity subscriptions are recognized ratably over the term of the contract, typically one year. Page 6 Principles of Consolidation The consolidated financial statements include the accounts of WatchGuard and its wholly owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. Comprehensive Loss WatchGuard's investments consist of corporate and government debt securities, are considered available-for-sale, and are stated at fair value, with unrealized gains and losses included as a component of stockholders' equity. During the first quarters of 2001 and 2000, there were no material realized gains or losses on securities available-for-sale. All such investments mature within two years, with the weighted average life of the investment portfolio being approximately one year. The following table sets forth the components of comprehensive loss (in thousands): Three Months Ended March 31, --------------------------------------------- 2001 2000 ------------------- ------------------- Net loss............................................................... $(10,480) $(2,696) Unrealized gain (loss) on investments.................................. 490 (235) ------------------- ------------------- Comprehensive loss..................................................... $ (9,990) $(2,931) =================== ===================
Reclassifications Certain prior-period items have been reclassified to conform to the current-period presentation. NOTE 3 - BALANCE SHEET ACCOUNT DETAIL (in thousands) Trade Accounts Receivable, Net Trade accounts receivable, net consisted of the following: March 31, December 31, 2001 2000 ------------------- ------------------- Trade accounts receivable..................................... $14,575 $16,869 Reserve for returns and allowances............................ (1,466) (965) Allowance for uncollectible accounts.......................... (779) (633) ------------------- ------------------- $12,330 $15,271 =================== ===================
Inventories Inventories consisted of the following: March 31, December 31, 2001 2000 ------------------- ------------------- Finished goods................................................ $4,633 $4,077 Components.................................................... 2,056 3,394 ------------------- ------------------- 6,689 7,471 Inventory reserves............................................ (579) (445) ------------------- ------------------- $6,110 $7,026 =================== ===================
Page 7 NOTE 4 - INTERNATIONAL REVENUES WatchGuard licenses and markets its Internet security products and services throughout the world and operates in a single industry segment. While certain expenses for sales and marketing activities are incurred in various geographical regions, substantially all of WatchGuard's assets are located, and the majority of its operating expenses are incurred, at its corporate headquarters. Revenue information by geographic region is as follows (in thousands):
Three Months Ended March 31, -------------------------------------------- 2001 2000 ------------------- ------------------- United States............................................................. $ 7,434 $4,533 Rest of World............................................................. 9,668 5,269 ------------------- ------------------- Total..................................................................... $17,102 $9,802 =================== ===================
NOTE 5 - SUBSEQUENT EVENTS In April 2001, WatchGuard announced a restructuring plan designed to streamline operations and reduce costs, in response to a recent decrease in demand for its products and services. This restructuring plan includes a reduction in its workforce and a consolidation of excess facilities, in addition to other cost-saving strategies. As a result of this restructuring, WatchGuard expects to incur a one-time charge of approximately $1.5 to $2.0 million during the second quarter of 2001. Page 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of WatchGuard's results of operations and financial condition. The discussion should be read in conjunction with the financial statements and the notes to the financial statements. References to "we," "our" and "us" in this quarterly report refer to WatchGuard Technologies, Inc. Forward-Looking Statements Our disclosure and analysis in this quarterly report on Form 10-Q contain forward-looking statements, which provide our current expectations or forecasts of future events. We use words such as "anticipates," "believes," "expects," "future" and "intends," and similar expressions, to identify forward-looking statements, but the absence of these words does not mean that the statement is not forward-looking. Forward-looking statements include statements about our plans, objectives, expectations and intentions and other statements that are not historical facts. They are subject to known and unknown risks and uncertainties and inaccurate assumptions that could cause our actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward- looking statements for many reasons, including the risks described under "Factors Affecting Our Operating Results, Our Business and Our Stock Price." You should not unduly rely on these forward-looking statements, which apply only as of the date of this quarterly report. We undertake no obligation to update any forward-looking statements to reflect new information, circumstances or events after the date of this report. Overview WatchGuard is a leading provider of Internet security solutions designed to protect enterprises that use the Internet for electronic commerce and secure communications. Our award-winning products and services include firewalls for access control, virtual private networks, or VPNs, for secure communications and our new ServerLock products for server content and application security. Our core market includes small- to medium-sized enterprises, or SMEs, large Internet-distributed enterprises, or IDEs, with ultra-high-speed connections supporting VPNs between the IDEs and their geographically dispersed branch offices and telecommuters, small and home offices, or SOHOs, with broadband connections, and telecommuters. Our recent acquisition of Qiave Technologies Corporation allowed us to expand our product line with a software-based solution designed to protect server content and applications from unauthorized and unintentional access and manipulation. Our innovative subscription-based LiveSecurity Service delivers threat responses, software updates, expert editorials, support flashes and virus alerts over the Internet, which enables enterprises to protect their data and communications in a continuously changing environment, with minimal effort. Since our inception, we have invested heavily in the development of our products and services and financed our operations as follows: . In September 1996, we introduced our initial Firebox security appliance and began selling our products both domestically and internationally. . In 1997, we significantly expanded our worldwide sales and marketing efforts. . In 1998, we launched our managed security offering for Internet service providers and other managed service providers and introduced our second- generation security appliance, which added significant functionality to our existing product lines. . In February 1999, we launched the broadcast portion of our LiveSecurity Service. . In July 1999, we raised net proceeds of $40.7 million in the initial public offering of our common stock. . In October 1999, we acquired BeadleNet, LLC, a developer of Internet security solutions for SOHOs. Page 9 . In January 2000, we announced the introduction of our security solutions for SOHOs and telecommuters, which we began shipping in the first quarter of 2000. . In February 2000, we raised net proceeds of $90.4 million in a follow-on public offering of our common stock. . In October 2000, we acquired Qiave, a developer of digital information security systems, which allowed us to expand our product line with ServerLock, which protects server content and applications against unauthorized or unintentional changes. . In February 2001, we announced the introduction of our ServerLock products, which we began shipping in the first quarter of 2001. . In May 2001, we introduced a higher performance third-generation security appliance targeted at the larger enterprise and the large internet-distributed enterprise markets. Sources of Revenues and Revenue Recognition Policy We generate revenues through . sales of products and service subscriptions indirectly through our distribution network at a discount from list price; . sales of products and service subscriptions directly and, from time to time, indirectly through our distributors, to our service provider customers at volume pricing rates; and . sales of service subscription renewals directly to our end-users. Product revenues include the perpetual software license fees for our Firebox System and the sale of our security appliance as part of our security solutions; the sales of software options, such as VPN; the sales of our network operations center, or NOC, security suite software license and our security appliance as part of LiveSecurity for MSS; and the sales of our new ServerLock products. Service revenues include the annual fee for our LiveSecurity Service, which is sold as part of our security solution, and for LiveSecurity subscription renewals from our enterprise customers and end-users. These services provide access to our LiveSecurity Service for product updates, security threat responses, general security information and technical support. These services also provide our service provider customers access to the LiveSecurity Service and the ability to manage and update a specific number of their customers' security appliances. We recognize revenues only when a contract or agreement has been executed, delivery has occurred, the fee is fixed and determinable and we believe collection is probable. While we generally recognize product revenues upon shipment, we defer revenues on product sales for two of our major distributors until these distributors have sold the product to their customers. Service subscription revenues are recognized ratably on a monthly basis, generally over periods ranging between one and two years. Page 10 Results of Operations The following table provides financial data for the periods indicated as a percentage of total revenues: Three Months Ended March 31, ---------------------------------------- 2001 2000 ----------------- ----------------- Revenues: Product.................................................................... 77.7 % 86.7 % Service.................................................................... 22.3 13.3 ----------------- ----------------- Total revenues.......................................................... 100.0 100.0 Cost of revenues: Product.................................................................... 30.8 31.5 Service.................................................................... 8.0 4.4 ----------------- ----------------- Total cost of revenues.................................................. 38.8 35.9 ----------------- ----------------- Gross margin................................................................ 61.2 64.1 Operating expenses: Sales and marketing........................................................ 47.8 56.7 Research and development................................................... 30.8 25.7 General and administrative................................................. 10.9 11.8 Stock-based compensation................................................... 26.5 2.4 Amortization of goodwill, purchased technology and other intangible assets acquired............................................. 15.9 3.8 ----------------- ----------------- Total operating expenses................................................ 131.9 100.4 ----------------- ----------------- Operating loss.............................................................. (70.7) (36.3) Interest income, net........................................................ 9.9 8.8 ----------------- ----------------- Loss before income taxes.................................................... (60.8) (27.5) Provision for income taxes.................................................. 0.5 0.0 ----------------- ----------------- Net loss.................................................................... (61.3)% (27.5)% ================= =================
Beginning in the fourth quarter of 2000 and continuing through the first quarter of 2001, we saw a general downturn in the global economy, which has affected the demand for our products and services. We generated revenues of $17.1 million in the first quarter of 2001, an increase of 74% from $9.8 million in revenues for the first quarter of 2000 and a decrease of 14% from $19.9 million in revenues for the fourth quarter of 2000. Our net loss for the first quarter of 2001 was ($10.5 million), or ($0.40) per share, compared to a net loss of ($2.7 million), or ($0.13) per share, for the first quarter of 2000. Our net loss was adversely affected by amortization of intangibles and deferred stock-based compensation primarily related to our purchase of Qiave in October 2000 as well as a reduction in revenues for the first quarter of 2001 as compared to the fourth quarter of 2000. The decrease in revenues between the fourth quarter of 2000 and the first quarter of 2001 and the resulting operating loss for the three month period ended March 31, 2001 is a result of the current economic slowdown, which has caused a deferral or decrease in capital spending for information technology products. On April 4, 2001, we announced a restructuring plan designed to streamline operations and reduce costs and better align our infrastructure to near-term reduced revenue volumes. We have streamlined WatchGuard's operations to focus on our core business of firewalls, VPNs and server security for business customers. As part of this reorganization, we have exited the consumer business which includes various OEM agreements and reduced our staff by approximately 50 people, or 16% of our workforce. We have also consolidated our development and product marketing activities into product-specific areas to better focus on our business customers. We believe that the staff reduction, which impacted all functional areas of the company, will allow us to reduce our break-even point to drive improved profitability. We will continue to invest in the research and Page 11 development efforts necessary to ensure we maintain our leadership position in providing enterprises with Internet security and VPN solutions that are easy to install and manage. Three Months Ended March 31, 2001 and 2000 Revenues Total revenues, which consist of product revenues and service revenues, increased from $9.8 million in the three months ended March 31, 2000 to $17.1 million in the three months ended March 31, 2001, an increase of 74%. The increase in total revenues was primarily due to increases in sales volume caused by increased distribution in the European, Asia/Pacific and North American markets. Total international revenues represented approximately 54% of total revenues in the three months ended March 31, 2000 and 57% in the three months ended March 31, 2001. In the first quarter of 2000, no one customer accounted for more than 10% of total revenues. However, in the first quarter of 2001, worldwide revenues from one of our distributors, Ingram Micro, Inc., were $2.4 million, or 14% of total revenues. Product revenues include: (1) perpetual software license fees for our Firebox System and the sale of our security appliance as part of our security solutions; (2) sales of software options, such as VPN; (3) sales of our NOC, security suite software license and our security appliance as part of LiveSecurity for MSS; and (4) sales from our new ServerLock product line, which is based on technology acquired in conjunction with our purchase of Qiave. Product revenues increased from $8.5 million in the three months ended March 31, 2000 to $13.3 million in the three months ended March 31, 2001, an increase of 56%. Our sales volume and growth rate of product revenues was lower than expected in the first quarter 2001 as compared to the prior quarter, but lower sales and growth was somewhat offset by increased service revenues and a broader subscription base. As a result, product revenues as a percentage of total revenues decreased from 87% in the three months ended March 31, 2000 to 78% in the three months ended March 31, 2001. Given the current economic uncertainty and slowdown in capital spending, it is difficult to predict revenue levels in future quarters, which may be more variable than usual. Service revenues include the annual fee for our LiveSecurity broadcast service, which is sold as part of the Firebox System and LiveSecurity for MSS. Service revenues increased from $1.3 million in the three months ended March 31, 2000 to $3.8 million in the three months ended March 31, 2001, an increase of 192%. As a percentage of total revenues, service revenues increased from 13% in the three months ended March 31, 2000 to 22% in the three months ended March 31, 2001, which reflects an increased base of customers renewing their LiveSecurity service subscriptions, and a reduced growth rate for product sales. We have established a returns and allowances reserve to address the return rights and pricing protection rights of some of our customers. The provision for sales returns and allowances was $209,000, or 2% of total revenues before returns and allowances, in the three months ended March 31, 2000 and $1.3 million, or 7% of total revenues, before returns and allowances, in the three months ended March 31, 2001. The increase in the provision as a percentage of total revenues reflects the expected return rates of current products that may originate from the introduction of new products we are introducing during the second quarter of 2001. We expect to continue to introduce new products each year, which may impact our reserve for sales returns and allowances. Cost of Revenues and Gross Margin Total cost of revenues, which includes product and service costs, increased from $3.5 million in the three months ended March 31, 2000 to $6.6 million in the three months ended March 31, 2001, an increase of 89%. As a percentage of total revenues, cost of revenues increased from 36% in the three months ended March 31, 2000 to 39% in the three months ended March 31, 2001. Gross margins are impacted by various factors, including the volume discount level contained in our channel partner agreements, the cost of our Firebox appliances, the mix of product and service sales, which may include hardware and software products and service subscriptions or both, the cost of royalties associated with our products, and the costs of our technical support organization and LiveSecurity Service. Cost of product revenues, which includes the cost of manufacturing our security appliance, product packaging and third-party product licensing fees, increased from $3.1 million in the three months ended March 31, 2000 to $5.3 million in the three months ended March 31, 2001, an increase of 70%. The increase was primarily due to greater sales volume. As a percentage of total revenues, cost of product revenues decreased from 32% in the three months ended March 31, 2000 to 31% in the three months ended March 31, 2001. Cost of product revenues as a percentage of total product revenues increased from Page 12 36% in the three months ended March 31, 2000 to 39% in the three months ended March 31, 2001. The increase in cost of product revenues as a percentage of product revenues primarily reflects lower sales volume and a change in product mix, in which the sales volume of some of our lower-margin products increased on a relative basis from the first quarter of 2000 as compared to the first quarter of 2001. We expect product mix changes which will result from the addition of software products such as ServerLock, to have a positive impact on gross margins. Cost savings and product mix changes that improve gross margins, however, may be offset in the short term by heightened price competition. In addition, we recently introduced several new products and plan to introduce additional new products in the future. In the near term, we expect our gross margins to be approximately 60% as we introduce our new products and liquidate inventories related to older products. We expect gross margins to gradually improve during the latter half of 2001 as a result of increased revenues generated from sales of higher-margin software products and expected reductions in manufacturing costs. Cost of service revenues, which includes the costs of our technical support organization and costs associated with our LiveSecurity Service, increased from $432,000 in the three months ended March 31, 2000 to $1.4 million in the three months ended March 31, 2001, an increase of 219%. As a percentage of total revenues, cost of service revenues increased from 4% in the three months ended March 31, 2000 to 8% in three months ended March 31, 2001. As a percentage of total service revenues, cost of service revenues increased from 33% in the first quarter of 2000 to 36% in the first quarter of 2001. This increase reflects an investment in our customer support organization to assist the growing number of customers who are implementing VPNs in a more complex environment, as well as a broader customer base. We expect service costs to continue to increase in total dollar amount as our user base expands. In the longer term, as revenues from LiveSecurity subscriptions increase and account for a greater percentage of total revenues, we expect our service margins to increase. Operating Expenses Sales and Marketing. Sales and marketing expenses include salaries, commissions and employee-related expenses and certain variable marketing expenses, including distributor promotional costs, public relations costs, marketing collateral and trade show expenses. Total sales and marketing expenses increased from $5.6 million in the three months ended March 31, 2000 to $8.1 million in the three months ended March 31, 2001, an increase of 47%. As a percentage of total revenues, sales and marketing expenses decreased from 57% in the three months ended March 31, 2000 to 48% in the three months ended March 31, 2001. The dollar increase in sales and marketing expenses was primarily due to recruiting and supporting a greater number of current and prospective resellers and distributors and, to a lesser extent, to increased efforts to establish brand recognition of our products and services. Specifically, major components of the increase included . an increase in salaries, commissions, recruiting and related expenses from $2.1 million to $2.9 million; . an increase in variable marketing costs from $2.3 million to $2.7 million; and . an increase in travel, annual sales conferences and related expenses from $859,000 to $1.7 million. The decrease in sales and marketing expenses as a percentage of total revenues reflects both increased productivity of and efficiencies in managing our indirect channel network and realization of our previous investments to expand distribution, capture market share and establish brand recognition of our products. We will continue to invest in sales and marketing programs designed to increase distribution. Because we expect our sales and marketing expenses, as well as the other expenses we describe below, to increase at a slower rate than revenues, we expect to see a gradual reduction over time in each of these types of expenses as a percentage of total revenues. Research and Development. Research and development expenses include salaries, noncapitalized equipment and software tools, depreciation from capital equipment and software, nonrecurring costs associated with our security appliance prototypes and payments to designers and contractors. Research and development expenses increased from $2.5 million in the three months ended March 31, 2000 to $5.3 million in the three months ended March 31, 2001, an increase of 109%. As a percentage of total revenues, research and development expenses increased from 26% in the three months ended March 31, 2000 to 31% in the three months ended March 31, 2001. The increase in research and development expenses reflects the growth of our research and development organization to expand and enhance our Firebox System and Live Security for MSS product lines, including our SOHO and ServerLock products, and our efforts to respond to new and emerging worldwide Internet security threats through our LiveSecurity Service. Specifically, major components of the increase included Page 13 . an increase in payroll and related expenses from $1.7 million to $3.4 million, a portion of which is related to the acquisition of Qiave and resulting costs of development personnel within our ServerLock products organization; and . an increase in consulting and security appliance prototype engineering costs from $243,000 to $696,000, reflecting increased expenses for enhancements of our existing products and costs related to future expansion of our product offerings in 2001. We will continue to increase our research and development expenses in total dollar amounts to enhance and expand our current product offerings, develop new products and enhance our rapid response team, which analyzes and addresses Internet security threats, and our advisory council, which provides continuing education and editorials on Internet security. General and Administrative. General and administrative expenses include costs of executive, human resource, finance and administrative support functions, provision for uncollectible accounts and legal and accounting professional services. General and administrative expenses increased from $1.2 million in the three months ended March 31, 2000 to $1.9 million in the three months ended March 31, 2001, an increase of 62%. As a percentage of total revenues, general and administrative expenses decreased from 12% in the three months ended March 31, 2000 to 11% in the three months ended March 31, 2001. The dollar increase in general and administrative expenses reflects the expansion of our infrastructure to manage the growth of our operations and costs associated with being a public company, an increase in payroll and related expenses and increases in other general and administrative areas such as bad debt. Specifically, major components of the increase included . an increase in payroll and related expenses from $517,000 to $884,000; and . an increase in bad debt expense from $102,000 to $276,000. As a percent of total revenues, bad debt expenses increased from 1.0% in the three months ended March 31, 2000 to 1.6% in the three months ended March 31, 2001, reflecting both an increase in risk associated with a broader customer base and the uncertain economy. Stock-based Compensation. Stock-based compensation arises from amortization of previously deferred stock-based compensation over the vesting periods of the common stock subject to repurchase and stock options. Stock-based compensation expense was $236,000 in the three months ended March 31, 2000 and $4.5 million in the three months ended March 31, 2001. The allocation of the stock-based compensation expense associated with the functional operating expense categories of sales and marketing, research and development, and general and administrative was $51,000, $164,000 and $21,000 in the three months ended March 31, 2000 and $12,000, $4.4 million, and $67,000 in the three months ended March 31, 2001. Deferred stock-based compensation is recorded as a component of stockholders' equity as the difference between the exercise price of options and the fair value of our common stock on the date of grant, and for the value of common stock subject to repurchase that we issued in connection with our 1999 acquisition of BeadleNet and our October 2000 acquisition of Qiave. We recorded $19.3 million of deferred stock-based compensation in 2000 in connection with the Qiave acquisition, which included charges related to the issuance of common stock subject to repurchase and the assumption of unvested Qiave employee stock options outstanding at the time of the merger. We recorded $912,000 of deferred stock-based compensation in 1999, which included charges related to the BeadleNet acquisition. Amortization of goodwill, purchased technology and other intangible assets acquired. Amortization of goodwill, purchased technology and other intangibles consists of the amortization of goodwill and other intangibles related to our acquisitions of BeadleNet in 1999 and Qiave in 2000. The intangible assets recorded in connection with the above acquisitions, including goodwill and purchased technology, are being amortized on a straight-line basis over useful lives ranging from two to five years. We recorded amortization charges related to these assets of $368,000 in the three months ended March 31, 2000, and $2.7 million in the three months ended March 31, 2001. The increase in amortization in 2001 resulted primarily from recording amortization of intangibles associated with our acquisition of Qiave in October 2000. Interest Income (Expense) Interest income is generated from the investment of proceeds from the sale of common stock in our initial public offering in 1999 and our public offering in February 2000. Interest income increased from $911,000 in the three months ended March 31, 2000 to $1.8 million in the three months ended March 31, 2001. This increase resulted primarily from the full quarter's investment of the proceeds of our public offering in 2000, in addition to the investment of the proceeds from our initial public Page 14 offering. Interest income was offset slightly by interest expense of $48,000 for the three months ended March 31, 2000 and $73,000 for the three months ended March 31, 2001. Income Taxes Income tax expense of $84,000 for the three months ended March 31, 2001 primarily relates to our provision for foreign income taxes associated with our international operations. We have experienced losses since inception, resulting in a net operating loss carryforward position for federal income tax purposes of approximately $135.5 million as of March 31, 2001. These carryforwards, if not utilized, will begin to expire in 2011, and may be subject to limitations under Section 382 of the Internal Revenue Code. Quarterly Results of Operations The following tables provide our unaudited results of operations both in dollar amounts and expressed as a percentage of total revenues for each quarter in the five-quarter period ended March 31, 2001. In our opinion, this unaudited information has been prepared on the same basis as our audited consolidated financial statements. This information includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information for the quarters presented, when read in conjunction with our consolidated financial statements and the notes to the consolidated financial statements. The results of operations for any quarter are not necessarily indicative of our future results. Three Months Ended ------------------------------------------------------------------------- Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, 2001 2000 2000 2000 2000 ---------- ---------- ----------- ----------- ---------- (In thousands) Consolidated Statement of Operations Data: Revenues: Product........................................... $ 13,284 $ 16,734 $ 14,782 $ 12,000 $ 8,494 Service........................................... 3,818 3,192 2,453 1,740 1,308 ---------- ---------- ----------- ----------- ---------- Total revenues................................... 17,102 19,926 17,235 13,740 9,802 Cost of revenues: Product........................................... 5,267 6,137 5,363 4,341 3,091 Service........................................... 1,376 1,174 824 557 432 ---------- ---------- ----------- ----------- ---------- Total cost of revenues........................... 6,643 7,311 6,187 4,898 3,523 ---------- ---------- ----------- ----------- ---------- Gross margin....................................... 10,459 12,615 11,048 8,842 6,279 Operating expenses: Sales and marketing............................... 8,171 6,838 5,849 5,967 5,559 Research and development.......................... 5,271 4,704 3,413 3,262 2,521 General and administrative........................ 1,870 1,895 1,703 1,249 1,154 Stock-based compensation.......................... 4,520 7,750 193 228 236 Acquired in-process technology and amortization of goodwill, purchased technology and other intangible assets acquired............. 2,724 7,123 368 368 368 ---------- ---------- ----------- ----------- ---------- Total operating expenses......................... 22,556 28,310 11,526 11,074 9,838 ---------- ---------- ----------- ----------- ---------- Operating loss..................................... (12,097) (15,695) (478) (2,232) (3,559) Interest income, net............................... 1,701 1,986 1,812 1,854 863 ---------- ---------- ----------- ----------- ---------- Income (loss) before income taxes.................. (10,396) (13,709) 1,334 (378) (2,696) Provision for income taxes......................... 84 215 -- -- -- ---------- ---------- ----------- ----------- ---------- Net income (loss).................................. $(10,480) $(13,924) $ 1,334 $ (378) $(2,696) ========== ========== =========== ============ ==========
Page 15 Three Months Ended --------------------------------------------------------------------------- Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, 2001 2000 2000 2000 2000 ------------ ------------ ------------ ------------ ----------- Consolidated Statement of Operations Data: Revenues: Product........................................... 77.7 % 84.0 % 85.8 % 87.3 % 86.7 % Service........................................... 22.3 16.0 14.2 12.7 13.3 ------------ ------------ ------------ ------------ ----------- Total revenues................................... 100.0 100.0 100.0 100.0 100.0 Cost of revenues: Product........................................... 30.8 30.8 31.1 31.6 31.5 Service........................................... 8.0 5.9 4.8 4.1 4.4 ------------ ------------ ------------ ------------ ----------- Total cost of revenues........................... 38.8 36.7 35.9 35.6 35.9 ------------ ------------ ------------ ------------ ----------- Gross margin....................................... 61.2 63.3 64.1 64.4 64.1 Operating expenses: Sales and marketing............................... 47.8 34.3 33.9 43.4 56.7 Research and development.......................... 30.8 23.6 19.8 23.7 25.7 General and administrative........................ 10.9 9.5 9.9 9.1 11.8 Stock-based compensation.......................... 26.5 38.9 1.1 1.7 2.4 Acquired in-process technology and amortization of goodwill, purchased technology and other intangible assets acquired........ 15.9 35.7 2.1 2.7 3.8 ------------ ------------ ------------ ------------ ----------- Total operating expenses......................... 131.9 142.1 66.9 80.6 100.4 ------------ ------------ ------------ ------------ ----------- Operating loss..................................... (70.7) (78.8) (2.8) (16.2) (36.3) Interest income, net............................... 9.9 10.0 10.5 13.5 8.8 ------------ ------------ ------------ ------------ ----------- Income (loss) before income taxes.................. (60.8) (68.8) 7.7 (2.8) (27.5) Provision for income taxes......................... 0.5 1.1 0.0 0.0 0.0 ------------ ------------ ------------ ------------ ----------- Net income (loss).................................. (61.3)% (69.9)% 7.7 % (2.8)% (27.5)% ============ ============ ============ ============ ===========
As discussed above, we believe that global economic challenges and a deceleration in corporate information technology spending have deferred the demand for our products and services. Like most companies in the technology sector, we experienced a downturn in revenues during the quarter. Revenues of $17.1 million for the first quarter of 2001 were significantly lower than revenues of $19.9 million which were recorded for the previous quarter. Both revenues and our quarterly operating results were negatively impacted by the economic slowdown worldwide and an overall reduction in capital spending. Revenue levels in future quarters are difficult to predict given the current business climate, however, and may be more variable than usual. We have, in general, maintained our product gross margins over the past year as we gained efficiencies in the production of our security appliances and introduced product options with higher gross margins. However, gross margins in first quarter of 2001 and the fourth quarter of 2000 were negatively impacted by lower sales volumes and our sales product mix, in which lower-margin products comprised a greater percentage of overall revenues. In addition, competitive selling pressures in future quarters could adversely impact on our gross margins. Finally, we have continued to make significant investments in our customer support organization, leading to an overall increase in the cost of service revenues. While these investments had a negative short-term impact on our gross margins during recent quarters, we believe they are required to meet the needs of our expanding customer base, and that service margins will improve as our LiveSecurity subscription base expands. We also have continued to make large investments in our sales and marketing organization, as reflected in the increased expenditure levels during the first quarter of 2001 and the fourth quarter of 2000. In addition, our first-quarter expenses included significant charges associated with our annual sales and partner conferences. Other significant increases in operating expenses during these two quarters, including research and development, stock-based compensation, and the amortization of Page 16 intangibles, were primarily related to our acquisition of Qiave in October 2000. While our operating expenses, excluding amortization of goodwill, intangibles and stock-based compensation, have continued to increase over time in dollar amounts, these expenses continued to decrease as a percentage of total revenues until the fourth quarter of 2000. Increased operating expenses as a percentage of total revenues during the first quarter of 2001, compared to previous quarters, resulted from the decrease in revenues discussed above. In light of the current economic slowdown and the uncertainty of market conditions, we have implemented programs to increase efficiencies and reduce costs within all areas of our organization, in an effort to better align our expenses with near-term revenue projections. These programs include the reduction in workforce discussed earlier, as well as a consolidation of excess facilities and related fixed asset charges. Our quarterly operating results have fluctuated significantly in the past and will probably continue to fluctuate. Liquidity and Capital Resources We have financed our operations primarily through proceeds from private placements of preferred stock and, more recently, proceeds from our initial public offering in July 1999 and our follow-on public offering in February 2000. To date, net proceeds from our private placements and public offerings have totaled approximately $144.0 million. Through the first quarter of 2001, we had a working capital revolving line of credit with a bank, secured by our accounts receivable. The line of credit provided for borrowings not greater than $5.0 million or the amount of the borrowing base. As of March 31, 2001, we had no borrowings on this line of credit. However, our borrowing limit of $5.0 million as of March 31, 2001 was reduced by a $3.0 million unconditional letter of credit we issued to our landlord in September 2000 in conjunction with our building lease for our corporate headquarters. Currently, our letter of credit is collateralized by investments with our bank. We have chosen not to renew our line of credit, which expired in April 2001. As of March 31, 2001, we had $114.8 million in cash, cash equivalents and securities available for sale, invested primarily in high-quality money market accounts and marketable securities. We believe that the market risk arising from our holdings of these financial instruments is not material. Our working capital as of March 31, 2001 was $115.4 million. Operating activities Our operating activities resulted in net cash outflows of $3.5 million in the three months ended March 31, 2000 and $1.4 million in the three months ended March 31, 2001. The operating cash outflows during these periods resulted primarily from significant investments in sales and marketing and research and development, all of which led to operating losses. Cash used in operating activities was net of noncash charges totaling $1.2 million for the three months ended March 31, 2000 and $9.3 million for the three months ended March 31, 2001. These noncash charges were primarily associated with the amortization of goodwill and other intangibles, depreciation and amortization of capital assets, provisions for bad debts and sales returns and allowances, and compensation charges resulting from the issuance of stock options and common stock subject to repurchase by WatchGuard. Cash utilized by working capital components for operating activities was $2.0 million for the three months ended March 31, 2000 and $207,000 for the three months ended March 31, 2001. In the three-month period ended March 31, 2001, there were large fluctuations within some major working capital components, as described below: (a) Receivables decreased from $15.3 million at December 31, 2000 to $12.3 million at March 31, 2001, reflecting the decrease in revenues from $19.9 million for the three months ended December 31, 2000 to $17.1 million for the three months ended March 31, 2001. Days sales outstanding, or DSOs, were 69 days at December 31, 2000 and 65 days at March 31, 2001, as calculated on a quarterly basis. DSOs are impacted by the payment terms contained in our customer contracts, linearity in revenues in any particular quarter and the amount of deferred revenue contained in the receivable balance that has not been recognized as revenue. The decrease in DSOs for the first quarter of 2001 as compared to the fourth quarter of 2000 primarily reflects changes in our customer sales mix during the first quarter. Based on the current sales mix, the resulting timing differences arising from varying payment terms in our customer agreements, the linearity of revenues in any particular quarter and the growth of deferred revenue, we expect our DSOs to generally range from 55 days to 70 days. (b) Sales reserves for returns and allowance reserves were $965,000 at December 31, 2000 and $1.5 million at March 31, 2001, reflecting our estimate of returns and allowances associated with the return rights and price protection rights of some of our customers. We increased the sales reserve during the first quarter of 2001 to reflect the Page 17 potential for increased returns and pricing adjustments associated with new products introduced in May 2001 and products we expect to introduce which would follow in subsequent months. The reserve will continue to fluctuate from time to time depending on the timing of product introductions and pricing program changes. (c) Inventories decreased from $7.0 million at December 31, 2000 to $6.1 million at March 31, 2001. While inventory levels at March 31, 2001 were higher than we anticipated, due to lower-than-expected revenues, the overall decrease in inventory reflects planned changes in inventory levels and a slowdown in manufacturing in preparation for our new product introductions. We maintain a reserve for inventory obsolescence and will continue to analyze the adequacy of our reserves on a periodic basis. (d) Accounts payable and accrued expenses decreased from $11.7 million at December 31, 2000 to $8.5 million at March 31, 2001. This decrease resulted primarily from the timing of inventory purchases and other expenditures during the fourth quarter of 2000 as compared to the first quarter of 2001. (e) Deferred revenue increased from $11.9 million at December 31, 2000 to $12.9 million at March 31, 2001, an increase of 8%. This increase reflects the deferral of revenue from bundled LiveSecurity subscriptions included in new product revenues and renewals of LiveSecurity subscriptions. Investing activities Cash used in investing activities was $39.3 million in the three months ended March 31, 2000 and cash provided by investing activities was $5.2 million in the three months ended March 31, 2001. These activities primarily relate to short-term investing activity of the proceeds received from our public offerings, and capital expenditures for equipment and furniture. Financing activities Cash provided by financing activities totaled $91.2 million in the three months ended March 31, 2000 and $1.2 million in the three months ended March 31, 2001. We received $90.4 million in proceeds from a public offering in the first quarter of 2000. We received cash in both periods from the exercise of employee stock options and the purchase of common stock through our employee stock purchase plan. We believe that existing cash and securities balances will be sufficient to meet our anticipated cash needs for working capital, capital expenditures and potential acquisitions or technology investments for at least the next 12 months. However, if the underlying assumed levels of spending for the potential acquisition of or investment in complementary businesses or technologies prove to be inaccurate, we may need to seek additional funding before that time through public or private financings or other arrangements. Page 18 Unaudited Pro Forma Operating Results Our management reviews our operating results on a pro forma basis in making operating decisions, and we believe pro forma results provide additional meaningful information. The following table provides our pro forma results for the three-month periods ended March 31, 2000 and 2001. Three months ended March 31, ------------------------------- 2001 2000 ----------- ----------- Net loss................................................ $(10,480) $(2,696) Adjustments to reconcile net loss in the financial statements to pro forma net loss: Stock-based compensation........................... 4,520 236 Amortization of goodwill, purchased technology and other intangibles................................. 2,724 368 ----------- ----------- Pro forma net loss...................................... $ (3,236) $(2,092) ----------- ----------- Pro forma basic and diluted net loss per share: $ (0.12) $ (0.10) =========== =========== Shares used in calculating pro forma basic and diluted net loss per share:................................. 26,348 21,243 =========== ===========
- ------------------- Pro forma information is presented for informational purposes only and is not prepared in accordance with generally accepted accounting principles. Pro forma results . exclude the amortization of goodwill, purchased technology and other intangibles arising from WatchGuard's acquisition of BeadleNet in October 1999 and Qiave in October 2000; and . exclude noncash stock-based compensation expenses originating from employee stock options granted at less than fair value, stock options granted to consultants and certain restricted common stock and common stock subject to repurchase issued in connection with the BeadleNet and Qiave acquisitions. FACTORS AFFECTING OUR OPERATING RESULTS, OUR BUSINESS AND OUR STOCK PRICE In addition to the other information contained in this quarterly report, you should carefully read and consider the following risk factors. If any of these risks actually occur, our business, financial condition or operating results could be harmed and the trading price of our common stock could decline. We have incurred losses in the past and may not achieve or sustain consistent profitability, which could result in a decline in the value of our common stock. Since inception through the first quarter of 2001, we incurred net losses and experienced negative cash flows from operations in each quarter, except for the third quarter of 2000. As of March 31, 2001, we had an accumulated deficit of approximately $56.1 million. Although our revenues have increased each year since we began operations, we do not believe that the historical percentage growth rate of our revenues will be sustainable as our revenue base increases and we may not achieve or sustain profitability in future periods. Moreover, we currently expect to increase our operating expenses significantly in connection with . expanding into new geographic markets; . expanding into new product markets; . continuing to develop our technology; . hiring additional personnel; Page 19 . upgrading our information and internal control systems; and . integrating acquisitions of businesses, products and technologies and pursuing additional strategic acquisitions. If we are unable to achieve or sustain profitability in future quarters, the trading price of our common stock could decline. Our operating results fluctuate and could fall below expectations of securities analysts and investors, resulting in a decline in our stock price. Our quarterly and yearly operating results have varied widely in the past and will probably continue to fluctuate. For this reason, we believe that period-to-period comparisons of our operating results may not be meaningful. In addition, our limited operating history makes predicting our future performance difficult. In the fourth quarter of 2000 and the first quarter of 2001, our operating results fell below the expectations of securities analysts and investors and our operating results for a future quarter or year may again fail to meet market expectations. This could result in a decline in our stock price. Beginning in the fourth quarter of 2000 and continuing through the first quarter of 2001, we saw a general economic downturn in the U.S. economy, and more recently, the worldwide economy, which has affected the demand for our products and services. We do not know how long this economic downturn will last or how severe it will become. We also cannot predict the extent and timing, if any, of the impact of the economic downturn in the United States on economies in other countries and geographic regions in which we conduct business. To the extent that this downturn continues or spreads to other geographic regions, the Internet security industry and demand for our products and services are likely to be adversely affected and could result in a decline in our stock price. We base our spending levels for product development, sales and marketing and other operating expenses largely on our expected future revenues. Because our expenses are largely fixed for a particular quarter or year, we may be unable to adjust our spending in time to compensate for any unexpected quarterly or annual shortfall in revenues. A failure to so adjust our spending in time also could cause operating results to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price. Because many potential customers remain unaware of the need for Internet security or may perceive it as costly and difficult to implement, our products and services may not achieve market acceptance. We believe that many potential customers, particularly SMEs, SOHOs and telecommuters, are not fully aware of the need for Internet security products and services. Historically, only enterprises having substantial resources have developed or purchased Internet security solutions. Also, there is a perception that Internet security is costly and difficult to implement. We will therefore not succeed unless the market understands the need for Internet security and we can convince our potential customers of our ability to provide this security in a cost-effective and administratively feasible manner. Although we have spent, and will continue to spend, considerable resources educating potential customers about the need for Internet security and the benefits of our products and services, our efforts may be unsuccessful. If potential customers do not accept our Firebox and ServerLock products and related LiveSecurity services, our business will not succeed. We currently expect all future revenues to be generated through sales of our Firebox and ServerLock products and related LiveSecurity services, including subscription fees, and we cannot succeed if the market does not accept these products and services. Our success depends on our ability and the ability of our distribution network, which includes distributors, value-added resellers and ISPs and other managed service providers, to obtain and retain customers. Some of our Firebox and ServerLock products and related LiveSecurity services, however, are relatively new and unproven. The broadcast portion of our LiveSecurity solution has been available only since February 1999, our Firebox products for SOHOs and telecommuters have been available only since February 2000 and our ServerLock products were launched under the WatchGuard brand only in February 2001. To receive our LiveSecurity Service, enterprises will be required to pay an annual subscription fee, either to us or, if they obtain the LiveSecurity Service through one of our channel partners, to the channel partner. We are not aware of any other Internet security product that allows enterprises to keep their security solution current by receiving software updates and comprehensive security information over the Internet. Enterprises may be unwilling to pay a subscription fee to keep their Internet security up to date. Because our LiveSecurity Service is relatively new, we cannot accurately predict the rate at which our customers will renew their annual subscriptions. In addition, most businesses implementing security services have traditionally managed their own Internet security rather than using the services of third- party service providers. As a result, our products and services and the outsourcing of Internet security to third parties may not achieve significant market acceptance. Page 20 Seasonality and concentration of revenues at the end of the quarter could cause our revenues to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price. The growth rate of our domestic and international sales has been and may continue to be lower in the summer months, when businesses often defer purchasing decisions. Also, as a result of customer buying patterns and the efforts of our sales force to meet or exceed quarterly and year-end quotas, historically we have earned a substantial portion of a quarter's revenues during its last month and, more recently, in the latter half of the last month. If expected revenues at the end of any quarter are delayed, our revenues for that quarter could fall below the expectations of securities analysts and investors, resulting in a decline in our stock price. The integration of Qiave and any future acquisitions may be costly, difficult and disruptive. In October 2000, we acquired Qiave Technologies Corporation, a privately held provider of digital information security products. As part of our business strategy, we may acquire other companies, products or technologies. The Qiave acquisition, and any future acquisitions, will subject us to numerous operational and financial risks and difficulties, including . loss of key personnel; . difficulties in assimilating the acquired company's technologies, products, personnel and operations; . disruption of our ongoing business and diversion of management attention; . assumption of known and unknown liabilities, higher-than-expected acquisition and integration costs and charges against earnings; . potentially dilutive issuances of equity securities; and . inability of our sales force, consultants and development staff to adapt to new product lines. We may be unable to successfully integrate Qiave or any future acquisition. In addition, we may not gain any substantial benefit from the Qiave acquisition or from any businesses, products or technologies that we acquire in the future, notwithstanding the significant expenditure of time and financial, personnel and other resources. If our third-party channel partners fail to perform, our ability to sell our products and services will be limited. We sell most of our products and services through our distribution network, and we expect our success to continue to depend in large part on their performance. Our channel partners have the ability to sell products and services that are competitive with ours, to devote more resources to those competitive products or to cease selling our products and services altogether. In the first quarter of 2001, two channel partners, Ingram Micro and Tech Data, together accounted for 23% of our revenues. The loss of one of these distributors, a reduction in their sales or a loss or reduction in sales involving one or more other channel partners, particularly if the reduction results in increased sales of competitive products, could harm our business. Page 21 If we are unable to compete successfully in the highly competitive market for Internet security products and services, our business will fail. The market for Internet security products is intensely competitive and we expect competition to intensify in the future. An increase in competitive pressures in our market or our failure to compete effectively may result in pricing reductions, reduced gross margins and loss of market share. Currently, the primary competitors in our industry include Cisco Systems, Inc., Check Point Software Technologies Ltd., Nokia Corporation and SonicWALL Inc. Other competitors offering security products include hardware and software vendors such as Netscreen Technologies Inc., Lucent Technologies, Inc. and Network Associates, Inc., operating system vendors such as Microsoft Corporation, Novell, Inc. and Sun Microsystems, Inc. and a number of smaller companies. Many of our competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, marketing and other resources than we do. In addition, our current and potential competitors may establish cooperative relationships among themselves or with third parties that may further enhance their resources. As a result, they may be able to adapt more quickly to new technologies and customer needs, devote greater resources to the promotion or sale of their products and services, initiate or withstand substantial price competition, take advantage of acquisition or other opportunities more readily or develop and expand their product and service offerings more quickly. In addition, our competitors may bundle products competitive with ours with other products that they may sell to our current or potential customers. These customers may accept these bundled products rather than separately purchasing our products. Product returns or retroactive price adjustments could exceed our allowances, which could adversely affect our operating results. We provide some of our channel partners with product return rights for stock rotation. We also provide some of our channel partners with price protection rights for their inventories, which they may exercise if we lower our prices for those products. We may experience significant returns and price adjustments for which we may not have adequate allowances. The short life cycles of our products and the difficulty of predicting future sales increase the risk that new product introductions or price reductions by us or our competitors could result in significant product returns or price adjustments. In September 1998, for example, when we introduced the Firebox II security appliance, we experienced an increase in returns of previous products and product versions. Provisions for returns and allowances for the years ended December 31, 1998, 1999, and 2000, were $1.7 million, $1.1 million and $1.9 million, or 13%, 5% and 3% of total revenues before returns and allowances. The provision for returns and allowances was $209,000 or 2% of total revenues before returns and allowances for the three month period ended March 31, 2000 and $1.3 million, or 7% of total revenues before returns and allowances, for the three months ended March 31, 2001. While we increased our provision for returns and allowances during the first quarter of 2001 to reflect the potential for increased returns and pricing adjustments associated with new products introduced in May 2001 and products we expect to introduce which would follow in subsequent months, the provision may still be inadequate. Failure to address strain on our resources caused by our rapid growth will result in our inability to effectively manage our business. Our current systems, management and resources will be inadequate if we continue to grow. Our business has grown rapidly in size and complexity. This rapid expansion has placed significant strain on our administrative, operational and financial resources and has resulted in ever-increasing responsibilities for our management personnel. We will be unable to effectively manage our business if we are unable to timely and successfully alleviate the strain on our resources caused by our rapid growth. We may be unable to adequately expand our operational systems to accommodate growth, which could harm our ability to deliver our products and services. Our operational systems have not been tested at the customer volumes that may be required in the future. We may encounter performance difficulties when operating with a substantially greater number of customers. In implementing our LiveSecurity products and services, we have experienced periodic interruptions affecting all or a portion of our systems, and we believe that interruptions will continue to occur from time to time. These interruptions could harm our ability to deliver our products and services. An inability to add software and hardware or to develop and upgrade existing technology or operational systems to handle increased traffic may cause unanticipated system disruptions, slower response times and poor customer service, including problems filling customer orders. Page 22 Rapid changes in technology and industry standards could render our products and services unmarketable or obsolete, and we may be unable to introduce new products and services timely and successfully. To succeed, we must continually change and improve our products in response to rapid technological developments and changes in operating systems, Internet access and communications, application and networking software, computer and communications hardware, programming tools, computer language technology and hacker techniques. We may be unable to successfully and timely develop these new products and services or achieve and maintain market acceptance. The development of new, technologically advanced products and services is a complex and uncertain process requiring great innovation and the ability to anticipate technological and market trends. Because Internet security technology is complex, it can require long development and testing periods. Releasing new products and services prematurely may result in quality problems, and releasing them late may result in loss of customer confidence and market share. In the past, we have on occasion experienced delays in the scheduled introduction of new and enhanced products and services, and we may experience delays in the future. When we do introduce new or enhanced products and services, we may be unable to manage the transition from the older products and services to minimize disruption in customer ordering patterns, avoid excessive inventories of older products and deliver enough new products and services to meet customer demand. We may be required to defend lawsuits or pay damages in connection with the alleged or actual failure of our products and services. Because our products and services provide and monitor Internet security and may protect valuable information, we may face claims for product liability, tort or breach of warranty relating to our products and services. Anyone who circumvents our security measures could misappropriate the confidential information or other property of end-users using our products and services or interrupt their operations. If that happens, affected end-users or channel partners may sue us. In addition, we may face liability for breaches caused by faulty installation and implementation of our products by end-users or channel partners. Although we attempt to reduce the risk of losses from claims through contractual warranty disclaimers and liability limitations, these provisions may be unenforceable. Some courts, for example, have found contractual limitations of liability in standard software licenses to be unenforceable because the licensee does not sign them. Defending a suit, regardless of its merit, could be costly and could divert management attention. Although we currently maintain business liability insurance, this coverage may be inadequate or may be unavailable in the future on acceptable terms, if at all. A breach of security could harm public perception of our products and services. We will not succeed unless the marketplace is confident that we provide effective Internet security protection. Even networks protected by our software products may be vulnerable to electronic break-ins and computer viruses. If an actual or perceived breach of Internet security occurs in an end-user's systems, regardless of whether the breach is attributable to us, the market perception of the efficacy of our products and services could be harmed. This could cause us or our channel partners to lose current and potential customers or cause us to lose potential channel partners. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. If we are unable to prevent attacks on our internal network system by computer hackers, public perception of our products and services will be harmed. Because we provide Internet security, we are a significant target of computer hackers. We have experienced attacks by computer hackers in the past and expect attacks to continue. If attacks on our internal network system are successful, public perception of our products and services will be harmed. We may be unable to adequately protect our operational systems from damage, failure or interruption, which could harm our reputation and our ability to attract and retain customers. Our operations, customer service, reputation and ability to attract and retain customers depend on the uninterrupted operation of our operational systems. Although we utilize limited off-site backup facilities and take other precautions to prevent damage, failure or interruption of our systems, our precautions may be inadequate. Any damage, failure or interruption of our computer or communications systems could lead to service interruptions, delays, loss of data and inability to accept and fill customer orders and provide customers with the LiveSecurity Service. Page 23 We may be unable to deliver our products and services if we cannot continue to license third-party technology that is important for the functionality of our products. Our success will depend in part on our continued ability to license technology that is important for the functionality of our products. A significant interruption in the supply of a third-party technology could delay our development and sales until we can find, license and integrate equivalent technology. This could damage our brand and result in loss of current and potential customers. Although we believe that we could find other sources for the technology we license, alternative technologies may be unavailable on acceptable terms, if at all. We depend on our third-party licensors to deliver reliable, high-quality products, develop new products on a timely and cost- effective basis and respond to evolving technology and changes in industry standards. We also depend on the continued compatibility of our third-party software with future versions of our products. We may be unable to deliver our products and services if component manufacturers fail to supply component parts with acceptable quantity, quality and cost. We obtain the component parts for our hardware from a variety of manufacturers. While our component vendors have produced parts for us in acceptable quantities and with acceptable quality and cost in the past, they may be unable to do so in the future. Companies in the electronics industry regularly experience lower-than-required component allocations, and the industry is subject to frequent component shortfalls. Although we believe that we could find additional or replacement sources for our hardware components, our operations could be disrupted if we have to add or switch to a replacement vendor or if our component supply is interrupted for an extended period. This could result in loss of customer orders and revenue. We may need additional capital and our ability to secure additional funding is uncertain. Our future revenues may be insufficient to support the expenses of our operations and the expansion of our business. We may therefore need additional equity or debt capital. We may seek additional funding through . public or private equity financings, which could result in significant dilution to stockholders; . public or private debt financings; and . capital lease transactions. We believe that existing cash and cash equivalent balances will be sufficient to meet our capital required for at least the next 12 months. Our capital requirements will depend on several factors, however, including . the rate of market acceptance of our products and services; . our ability to expand our customer base; . the growth of our sales and marketing capabilities; and . the cost of any acquisitions we may complete. Financing may be unavailable to us when needed or on acceptable terms. We may be unable to adequately protect our proprietary rights, which may limit our ability to compete effectively. Despite our efforts to protect our proprietary rights, unauthorized parties may misappropriate or infringe on our trade secrets, copyrights, trademarks, service marks and similar proprietary rights. We face additional risk when conducting business in countries that have poorly developed or inadequately enforced intellectual property laws. While we are unable to determine the extent to which piracy of our software products exists, we expect piracy to be a continuing concern, particularly in international markets and as a result of the growing use of the Internet. If we fail to obtain and maintain patent protection for our technology, we may be unable to compete effectively. We have 12 patents pending, but our patent applications may not result in issued patents. Even if we secure a patent, the patent may not provide meaningful protection. In addition, we rely on unpatented proprietary technology. Because this proprietary technology does not have patent protection, we may be unable to meaningfully protect this technology from unauthorized use or misappropriation by a third party. In addition, our competitors may independently develop similar or superior technologies or duplicate any unpatented technologies that we have developed, which could significantly reduce the value of our proprietary technology or threaten our market position. Page 24 Intellectual property claims and litigation could subject us to significant liability for damages and invalidation of our proprietary rights. In the future, we may have to resort to litigation to protect our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Any litigation, regardless of its success, would probably be costly and require significant time and attention of our key management and technical personnel. Litigation could also force us to . stop or delay selling, incorporating or using products that incorporate the challenged intellectual property; . pay damages; . enter into licensing or royalty agreements, which may be unavailable on acceptable terms; or . redesign products or services that incorporate infringing technology. Although we have not been sued for intellectual property infringement, we may face infringement claims from third parties in the future. The software industry has seen frequent litigation over intellectual property rights, and we expect that participants in the Internet security industry will be increasingly subject to infringement claims as the number of products, services and competitors grows and functionality of products and services overlaps. Undetected product errors or defects could result in loss of revenues, delayed market acceptance and claims against us. Our products and services may contain undetected errors or defects, especially when first released. Despite extensive testing, some errors are discovered only after a product has been installed and used by customers. Any errors discovered after commercial release could result in loss of revenues or claims against us or our channel partners. Governmental controls over the export or import of encryption technology could cause us to lose sales. Any additional governmental regulation of imports or exports or failure to obtain required export approval of our encryption technologies could adversely affect our international and domestic sales. The United States and various other countries have imposed controls, export license requirements and restrictions on the import or export of some technologies, especially encryption technology. In addition, from time to time governmental agencies have proposed additional regulation of encryption technology, such as requiring the escrow and governmental recovery of private encryption keys. Additional regulation of encryption technology could delay or prevent the acceptance and use of encryption products and public networks for secure communications. This, in turn, could result in decreased demand for our products and services. In addition, some foreign competitors are subject to less stringent controls on exporting their encryption technologies. As a result, they may be able to compete more effectively than we can in the U.S. and international Internet security markets. If we do not retain our key employees, our ability to execute our business strategy will be impaired. Our future success will depend largely on the efforts and abilities of our senior management and our key development, technical, operations, information systems, customer support and sales and marketing personnel, and on our ability to retain them. These employees are not obligated to continue their employment with us and may leave us at any time. If we do not expand our international operations and successfully overcome the risks inherent in international business activities, the growth of our business will be limited. Our ability to grow will depend in part on the expansion of our international sales and operations, which are expected to continue to account for a significant portion of our revenues. Sales to customers outside of the United States accounted for approximately 35% of our revenues in 1998, 50% in 1999, 55% in 2000 and 57% in the first three months of 2001. The failure of our channel partners to sell our products internationally would limit our ability to increase our revenues. In addition, our international sales are subject to the risks inherent in international business activities, including . cost of customizing products for foreign countries; . export and import restrictions, such as those affecting encryption commodities and software; . difficulties in acquiring and authenticating customer information; . reduced protection of intellectual property rights and increased liability exposure; and Page 25 . regional economic and political conditions. Our international sales currently are U.S. dollar-denominated. As a result, an increase in the value of the U.S. dollar relative to foreign currencies has made and may continue to make our products less competitive in international markets. Our stock price is volatile. The trading price of our common stock could be subject to fluctuations for a number of reasons, including . actual or anticipated variations in quarterly or annual operating results; . changes in analysts' earnings projections or recommendations; . failure to meet analysts' revenue or earnings projections; . our inability to successfully implement our business strategy; . changes in business conditions affecting our customers, our competitors and us; and . changes in accounting standards that adversely affect our revenues and earnings. In recent years, moreover, the stock market in general and the market for Internet-related technology companies in particular have experienced extreme price and volume fluctuations, often unrelated to the operating performance of the affected companies. Our common stock has experienced, and is likely to continue to experience, these fluctuations in price, regardless of our performance. Changes in or interpretations of accounting rules may adversely impact future and past results of operations. We prepare our financial statements in conformity with accounting principles generally accepted in the United States. These principles have changed frequently and are subject to ongoing change and interpretation by the Financial Accounting Standards Board, the Securities and Exchange Commission and other agencies and organizations. A change in generally accepted accounting principles could significantly affect our reported results of operations or the reporting of transactions completed before a change is announced, which could require us to restate our prior published financial statements. Accounting standards that impact the technology and software sectors in which we operate and that are currently under review include . rules relating to revenue recognition, including rules affecting the recognition of revenue from the sale of software or related services; . rules relating to the classification of costs related to marketing programs, which may impact sales discounts, cost of sales or marketing expenses; and . accounting for stock-based compensation for employees and nonemployees. Any changes to these accounting principles or the way they are interpreted or applied could significantly affect our reported financial results or the way in which we conduct business. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk We do not hold derivative financial instruments or derivative equity securities in our investment portfolio. Our cash equivalents and debt securities available for sale consist of high-quality securities, as specified in our investment policy guidelines. Our policy limits the amount of credit exposure to any one issue or issuer to a maximum of 20% of the total portfolio or $5 million per issuer, with the exception of treasury securities and money market funds, which are exempt from this size limitation. Our policy limits all investments to those that mature in two years or less, and our investments have an average maturity of one year or less. These securities are subject to interest-rate risk and will decrease in value if interest rates increase. The fair value of our investment portfolio or related income would not be significantly impacted by a 100-basis-point increase or decrease in interest rates, due primarily to the short-term nature of most of our investment portfolio. Page 26 Foreign Currency Risk All of our sales and the majority of our expenses are currently denominated in U.S. dollars. As a result, we have not experienced significant foreign exchange gains and losses. While we conducted some transactions in foreign currencies during the first quarter of 2001 and expect to continue to do so in the future, we do not anticipate that foreign exchange gains or losses will be material to WatchGuard. Although we have not engaged in foreign currency hedging to date, we may do so in the future. Page 27 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (d) Use of Proceeds --------------- On February 15, 2000 our registration statement on Form S-1 for our public offering, file number 333-95049, became effective. The offering terminated as a result of all of the shares offered being sold. After accounting for approximately $5.3 million in underwriting discounts and commissions and $600,000 in other expenses, we received proceeds of approximately $90.4 million. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits -------- 3.1 Restated Certificate of Incorporation of WatchGuard Technologies, Inc. (incorporated by reference to Exhibit 3.1 to WatchGuard's Registration Statement on Form S-1 (file number 333-78813), filed July 30, 1999). 3.2 Restated Bylaws of WatchGuard Technologies, Inc. (incorporated by reference to Exhibit 3.2 to WatchGuard's Registration Statement on Form S-1 (file number 333-78813), filed July 30, 1999). 10.1 2000 Stock Option Plan, as amended January 9, 2001. (b) Reports on Form 8-K ------------------- No reports on Form 8-K were filed during the quarter ended March 31, 2001. Page 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. May 15, 2001 WATCHGUARD TECHNOLOGIES, INC By: /s/ Michael E. McConnell --------------------------------- Michael E. McConnell Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) Page 29 EX-10.1 2 dex101.txt AMENDED 2000 STOCK OPTION PLAN EXHIBIT 10.1 WATCHGUARD TECHNOLOGIES, INC. 2000 STOCK OPTION PLAN (Amended January 9, 2001) SECTION 1. PURPOSE The purpose of this WatchGuard Technologies, Inc. 2000 Stock Option Plan (the "Plan") is to enhance the long-term stockholder value of WatchGuard Technologies, Inc., a Delaware corporation (the "Company"), by offering opportunities to selected Employees, consultants, agents, advisors and independent contractors of the Company and its Subsidiaries (as defined in Section 2 below) to participate in the Company's growth and success, and to encourage them to remain in the service of the Company and its Subsidiaries and to acquire and maintain stock ownership in the Company. SECTION 2. DEFINITIONS For purposes of the Plan, the following terms shall be defined as set forth below: 2.1 Board "Board" means the Board of Directors of the Company. 2.2 Cause "Cause" means willful misconduct with respect to, or that is harmful to, the Company or any of its affiliates including, without limitation, dishonesty, fraud, unauthorized use or disclosure of confidential information or trade secrets or other misconduct (including, without limitation, conviction for a felony), in each case as reasonably determined by the Plan Administrator. 2.3 Code "Code" means the Internal Revenue Code of 1986, as amended from time to time. 2.4 Common Stock "Common Stock" means the common stock, par value $.01 per share, of the Company. 2.5 Corporate Transaction "Corporate Transaction" means either of the following events: (a) Consummation of any merger or consolidation of the Company with or into another corporation; or (b) Consummation of any sale, lease, exchange or other transfer in one transaction or a series of related transactions of all or substantially all of the Company's assets or outstanding securities, other than a transfer of the Company's assets or securities to a majority-owned Subsidiary Corporation. 2.6 Disability As used in the Plan, the term "Disability" refers to a mental or physical impairment of the Participant which is expected to result in death or which has lasted or is expected to last for a continuous period of 12 months or more and which causes the Participant to be unable, in the opinion of the Company, to perform his or her duties for the Company and to be engaged in any substantial gainful activity. 2.7 Early Retirement "Early Retirement" means retirement as that term is defined by the Plan Administrator from time to time for purposes of the Plan. 2.8 Employee "Employee" means any common law employee of the Company or any Subsidiary, other than employees who are officers or directors of the Company or any Subsidiary. 2.9 Exchange Act "Exchange Act" means the Securities Exchange Act of 1934, as amended. 2.10 Good Reason "Good Reason" means the occurrence of any of the following events or conditions and the failure of a Successor Corporation to cure such event or condition within 30 days after receipt of written notice from the Participant: (a) a change in the Holder's status, title, position or responsibilities (including reporting responsibilities) that, in the Holder's reasonable judgment, represents a substantial reduction in the status, title, position or responsibilities as in effect immediately prior thereto; the assignment to the Holder of any duties or responsibilities that, in the Holder's reasonable judgment, are inconsistent with such status, title, position or responsibilities; or any removal of the Holder from or failure to reappoint or reelect the Holder to any of such positions, except in connection with the termination of the Holder's employment for Cause, for Disability or as a result of his or her death, or by the Holder other than for Good Reason; (b) a reduction in the Holder's annual base salary; (c) the Successor Corporation's requiring the Holder (without the Holder's consent) to be based at any place outside a 35-mile radius of his or her place of employment prior to a Corporate Transaction, except for reasonably required travel on the Successor Corporation's business that is not materially greater than such travel requirements prior to the Corporate Transaction; 2 (d) the Successor Corporation's failure to (i) continue in effect any material compensation or benefit plan (or the substantial equivalent thereof) in which the Holder was participating at the time of a Corporate Transaction, including, but not limited to, the Plan, or (ii) provide the Holder with compensation and benefits at least equal (in terms of benefit levels and/or reward opportunities) to those provided for under each employee benefit plan, program and practice as in effect immediately prior to the Corporate Transaction (or as in effect following the Corporate Transaction, if greater); (e) any material breach by the Successor Corporation of its obligations to the Holder under the Plan or any substantially equivalent plan of the Successor Corporation; or (f) any purported termination of the Holder's employment or service for Cause by the Company that does not comply with the terms of the Plan. 2.11 Grant Date "Grant Date" means the date on which the Plan Administrator completes the corporate action relating to the grant of an Option and all conditions precedent to the grant have been satisfied, provided that conditions to the exercisability or vesting of Options shall not defer the Grant Date. 2.12 Holder "Holder" means the Participant to whom an Option is granted or the personal representative of a Holder who has died. 2.13 Nonqualified Stock Option "Nonqualified Stock Option" means an option to purchase Common Stock granted under the Plan. All such Nonqualified Stock Options are not intended to qualify as "incentive stock options" as that term is defined by Section 422 of the Code. 2.14 Option "Option" means the right to purchase Common Stock granted under the Plan. 2.15 Participant "Participant" means an individual who is a Holder of an Option or, as the context may require, any employee of the Company or a Subsidiary who has been designated by the Plan Administrator as eligible to participate in the Plan. 2.16 Plan Administrator "Plan Administrator" means the Board or any committee of the Board designated to administer the Plan under Section 3.1 of the Plan. 3 2.17 Related Party Transaction "Related Party Transaction" means (a) a merger of the Company in which the holders of shares of Common Stock immediately prior to the merger hold at least a majority of the shares of Common Stock in the surviving corporation immediately after the merger, (b) a mere reincorporation of the Company or (c) a transaction undertaken for the sole purpose of creating a holding company. 2.18 Retirement "Retirement" means retirement as of the individual's normal retirement date under the Company's 401(k) plan or other similar plan applicable to salaried employees, unless otherwise defined by the Plan Administrator from time to time for purposes of the Plan. 2.19 Securities Act "Securities Act" means the Securities Act of 1933, as amended. 2.20 Subsidiary "Subsidiary," except as expressly provided otherwise, means any entity that is directly or indirectly controlled by the Company or in which the Company has a significant ownership interest, as determined by the Plan Administrator. 2.21 Successor Corporation "Successor Corporation" has the meaning given such term in Section 11.3.1. SECTION 3. ADMINISTRATION 3.1 Plan Administrator The Plan shall be administered by the Board and/or a committee or committees (which term includes subcommittees) appointed by, and consisting of two or more members of, the Board (a "Plan Administrator"). If and so long as the Common Stock is registered under Section 12(b) or 12(g) of the Exchange Act, the Board shall consider in selecting the members of any committee acting as Plan Administrator, with respect to any persons subject or likely to become subject to Section 16 of the Exchange Act, the provisions regarding "nonemployee directors" as contemplated by Rule 16b-3 under the Exchange Act. The Board may delegate the responsibility for administering the Plan with respect to designated classes of eligible persons to different committees consisting of one or more members of the Board, subject to such limitations as the Board deems appropriate. Committee members shall serve for such term as the Board may determine, subject to removal by the Board at any time. 3.2 Administration and Interpretation by the Plan Administrator Except for the terms and conditions explicitly set forth in the Plan, the Plan Administrator shall have exclusive authority, in its discretion, to determine all matters relating to Options under the Plan, including the selection of individuals to be granted Options, the number of shares of Common 4 Stock subject to an Option, all terms, conditions, restrictions and limitations, if any, of an Option and the terms of any instrument that evidences the Option. The Plan Administrator shall also have exclusive authority to interpret the Plan and may from time to time adopt, and change, rules and regulations of general application for the Plan's administration. The Plan Administrator's interpretation of the Plan and its rules and regulations, and all actions taken and determinations made by the Plan Administrator pursuant to the Plan, shall be conclusive and binding on all parties involved or affected. The Plan Administrator may delegate administrative duties to such of the Company's officers as it so determines. SECTION 4. STOCK SUBJECT TO THE PLAN 4.1 Authorized Number of Shares Subject to adjustment from time to time as provided in Section 11.1, the number of shares of Common Stock that shall be available for issuance under the Plan shall be 8,000,000/1/. Shares issued under the Plan shall be drawn from authorized and unissued shares or shares now held or subsequently acquired by the Company as treasury shares. 4.2 Reuse of Shares Any shares of Common Stock that have been made subject to an Option that cease to be subject to the Option (other than by reason of exercise or payment of the Option to the extent it is exercised for or settled in shares), including, without limitation, in connection with the cancellation of an Option and the grant of a replacement Option, shall again be available for issuance in connection with future grants of Options under the Plan. SECTION 5. ELIGIBILITY Options may be granted under the Plan to those Employees, consultants, agents, advisors and independent contractors of the Company and its Subsidiaries as the Plan Administrator from time to time selects. SECTION 6. OPTIONS 6.1 Form and Grant of Options The Plan Administrator shall have the authority, in its sole discretion, to determine the Options to be made under the Plan. 6.2 Acquired Company Options Notwithstanding anything in the Plan to the contrary, the Plan Administrator may grant Options under the Plan in substitution for awards issued under other plans, or assume under the Plan awards issued under other plans, if the other plans are or were plans of other entities ("Acquired Entities") (or the parent of the Acquired Entity) and the new Option is substituted, or - --------------- /1/ On January 9, 2001, the Board of Directors approved the amendment of this Section 4.1 to provide for an increase in the number of shares that shall be available for issuance under the Plan from 3,000,000 to 8,000,000. 5 the old award is assumed, by reason of a merger, consolidation, acquisition of property or of stock, reorganization or liquidation (the "Acquisition Transaction"). In the event that a written agreement pursuant to which the Acquisition Transaction is completed is approved by the Board and said agreement sets forth the terms and conditions of the substitution for or assumption of outstanding awards of the Acquired Entity, said terms and conditions shall be deemed to be the action of the Plan Administrator without any further action by the Plan Administrator, except as may be required for compliance with Rule 16b-3 under the Exchange Act, and the persons holding such Options shall be deemed to be Participants and Holders. 6.3 Option Exercise Price The exercise price for shares purchased under an Option shall be as determined by the Plan Administrator. 6.4 Term of Options The term of each Option shall be as established by the Plan Administrator or, if not so established, shall be 10 years from the Grant Date. 6.5 Exercise of Options The Plan Administrator shall establish and set forth in each instrument that evidences an Option the time at which or the installments in which the Option shall become exercisable, which provisions may be waived or modified by the Plan Administrator at any time. If not so established in the instrument evidencing the Option, the Option will become exercisable according to the following schedule, which may be waived or modified by the Plan Administrator at any time:
Period of Optionee's Continuous Employment or Service With the Company or Its Subsidiaries Percent of Total Option From the Grant Date That Is Exercisable - --------------------------------------------------- ----------------------- After 12 months 25% Each additional month thereafter 2.0833% After 4 years 100%
To the extent that the right to purchase shares has accrued thereunder, an Option may be exercised from time to time by written notice to the Company, in accordance with procedures established by the Plan Administrator, setting forth the number of shares with respect to which the Option is being exercised and accompanied by payment in full as described in Section 6.6 of the Plan. The Plan Administrator may determine that an Option may not be exercised as to less than a reasonable number of shares at any one time. 6.6 Payment of Exercise Price The exercise price for shares purchased under an Option shall be paid in full to the Company by delivery of consideration equal to the product of the Option exercise price and the number of shares purchased. Such consideration must be paid in cash or by check or, unless the 6 Plan Administrator in its sole discretion determines otherwise, either at the time the Option is granted or at any time before it is exercised, in any combination of (a) cash or check; (b) tendering (either actually or, if and so long as the Common Stock is registered under Section 12(b) or 12(g) of the Exchange Act, by attestation) shares of Common Stock already owned by the Participant for at least six months (or any shorter period necessary to avoid a charge to the Company's earnings for financial reporting purposes) having a Fair Market Value on the day prior to the exercise date equal to the aggregate Option exercise price; (c) if and so long as the Common Stock is registered under Section 12(b) or 12(g) of the Exchange Act, delivery of a properly executed exercise notice, together with irrevocable instructions, to (i) a brokerage firm designated by the Company to deliver promptly to the Company the aggregate amount of sale or loan proceeds to pay the Option exercise price and any withholding tax obligations that may arise in connection with the exercise and (ii) the Company to deliver the certificates for such purchased shares directly to such brokerage firm, all in accordance with the regulations of the Federal Reserve Board; or (d) such other consideration as the Plan Administrator may permit. In addition, to assist a Participant (including a Participant who is an officer or a director of the Company) in acquiring shares of Common Stock pursuant to an Option granted under the Plan, the Plan Administrator, in its sole discretion, may authorize, either at the Grant Date or at any time before the acquisition of Common Stock pursuant to the Option, (i) the payment by a Participant of a full-recourse promissory note, (ii) the payment by the Participant of the purchase price, if any, of the Common Stock in installments, or (iii) the guarantee by the Company of a loan obtained by the Participant from a third party. Subject to the foregoing, the Plan Administrator shall in its sole discretion specify the terms of any loans, installment payments or loan guarantees, including the interest rate and terms of and security for repayment. 6.7 Post-Termination Exercises The Plan Administrator shall establish and set forth in each instrument that evidences an Option whether the Option will continue to be exercisable, and the terms and conditions of such exercise, if a Holder ceases to be employed by, or to provide services to, the Company or its Subsidiaries, which provisions may be waived or modified by the Plan Administrator at any time. If not so established in the instrument evidencing the Option, the Option will be exercisable according to the following terms and conditions, which may be waived or modified by the Plan Administrator at any time. In case of termination of the Holder's employment or services other than by reason of death or Cause, the Option shall be exercisable, to the extent of the number of shares purchasable by the Holder at the date of such termination, only: (a) within one year if the termination of the Holder's employment or services are coincident with Retirement, Early Retirement at the Company's request or Disability or (b) within three months after the date the Holder ceases to be an employee, director, officer, consultant, agent, advisor or independent contractor of the Company or a Subsidiary if termination of the Holder's employment or services is for any reason other than Retirement, Early Retirement at the Company's request or Disability, but in no event later than the remaining term of the Option. Any Option exercisable at the time of the Holder's death may be 7 exercised, to the extent of the number of shares purchasable by the Holder at the date of the Holder's death, by the personal representative of the Holder's estate entitled thereto at any time or from time to time within one year after the date of death, but in no event later than the remaining term of the Option. In case of termination of the Holder's employment or services for Cause, the Option shall automatically terminate upon first notification to the Holder of such termination, unless the Plan Administrator determines otherwise. If a Holder's employment or services with the Company are suspended pending an investigation of whether the Holder shall be terminated for Cause, all the Holder's rights under any Option likewise shall be suspended during the period of investigation. A transfer of employment or services between or among the Company and its Subsidiaries shall not be considered a termination of employment or services. Unless the Plan Administrator determines otherwise, a leave of absence approved in accordance with Company procedures shall not be considered a termination of employment or services. SECTION 7. ASSIGNABILITY Except as may be provided in a stock option agreement, Options granted under the Plan and any interest therein may not be assigned, pledged or transferred by the Holder and may not be made subject to attachment or similar proceedings other than by will or by the applicable laws of descent and distribution, and during the Holder's lifetime, such Options may be exercised only by the Holder. Notwithstanding the foregoing, the Plan Administrator, in its sole discretion, may permit such assignment, transfer and exercisability and may permit a Holder to designate a beneficiary who may exercise the Option or receive compensation under the Option after the Holder's death; provided, however, that any Option so assigned or transferred shall be subject to all the same terms and conditions contained in the instrument evidencing the Option. SECTION 8. ADJUSTMENTS 8.1 Adjustment of Shares In the event that, at any time or from time to time, a stock dividend, stock split, spin-off, combination or exchange of shares, recapitalization, merger, consolidation, distribution to stockholders other than a normal cash dividend, or other change in the Company's corporate or capital structure results in (a) the outstanding shares, or any securities exchanged therefor or received in their place, being exchanged for a different number or class of securities of the Company or of any other corporation or (b) new, different or additional securities of the Company or of any other corporation being received by the holders of shares of Common Stock of the Company, then the Plan Administrator shall make proportional adjustments as it shall deem appropriate in the circumstances in (i) the maximum number and kind of securities subject to the Plan as set forth in Section 4.1, and (ii) the number and kind of securities that are subject to any outstanding Option and the per share price of such securities, without any change in the aggregate price to be paid therefor. The determination by the Plan Administrator as to the terms of any of the foregoing adjustments shall be conclusive and binding. Notwithstanding the foregoing, a dissolution or liquidation of the Company or a Corporate Transaction shall not be governed by this Section 8.1 but shall be governed by Sections 8.2 and 8.3, respectively. 8 8.2 Dissolution or Liquidation In the event of the proposed dissolution or liquidation of the Company, the Plan Administrator shall notify each Participant as soon as practicable prior to the effective date of such proposed transaction. The Plan Administrator in its discretion may permit a Participant to exercise an Option until 10 days prior to such transaction with respect to all vested and exercisable shares of Common Stock covered thereby and with respect to such number of unvested shares as the Plan Administrator shall determine. In addition, the Plan Administrator may provide that any forfeiture provision or Company repurchase option applicable to any Option shall lapse as to such number of shares as the Plan Administrator shall determine, contingent upon the occurrence of the proposed dissolution or liquidation at the time and in the manner contemplated. To the extent an Option has not been previously exercised, the Option shall terminate automatically immediately prior to the consummation of the proposed action. To the extent a forfeiture provision applicable to a Stock Option has not been waived by the Plan Administrator, the Stock Option shall be forfeited automatically immediately prior to the consummation of the proposed action. 8.3 Corporate Transaction 8.3.1 Options In the event of a Corporate Transaction, except as otherwise provided in the instrument evidencing the Option, each outstanding Option shall be assumed or continued or an equivalent option or right substituted by the surviving corporation, the successor corporation or its parent corporation, as applicable (the "Successor Corporation"). In the event that the Successor Corporation refuses to assume, continue or substitute for the Option, the Participant shall fully vest in and have the right to exercise the Option as to all of the shares of Common Stock subject thereto, including shares as to which the Option would not otherwise be vested or exercisable. If an Option shall become fully vested and exercisable in lieu of assumption or substitution in the event of a Corporate Transaction, the Plan Administrator shall notify the Participant in writing or electronically that the Option shall be fully vested and exercisable for a specified time period after the date of such notice, and the Option shall terminate upon the expiration of such period, in each case conditioned on the consummation of the Corporate Transaction. For purposes of this Section 8.3.1, the Option shall be considered assumed if, following the Corporate Transaction, the option or right confers the right to purchase or receive, for each share of Common Stock subject to the Option, immediately prior to the Corporate Transaction, the consideration (whether stock, cash, or other securities or property) received in the merger or sale of assets by holders of Common Stock for each share held on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding shares); provided, however, that if such consideration received in the Corporate Transaction is not solely common stock of the Successor Corporation, the Plan Administrator may, with the consent of the Successor Corporation, provide for the consideration to be received upon the exercise of the Option, for each share of Common Stock subject thereto, to be solely common stock of the Successor Corporation equal in fair market value to the per share consideration received by holders of Common Stock in the Corporate Transaction. All Options shall terminate and cease to remain outstanding immediately following the consummation of the Corporate Transaction, except to the extent assumed by the Successor Corporation. 9 8.3.2 Acceleration Upon Termination of Employment Except as may be provided in the instrument evidencing the Option, any Options that are assumed or replaced in the Corporate Transaction, other than a Related Party Transaction, and do not otherwise accelerate at that time shall be accelerated in the event the Holder's employment or services should subsequently terminate within two years following such Corporate Transaction, unless such employment or services are terminated by the Successor Corporation for Cause or by the Holder voluntarily without Good Reason. 8.4 Further Adjustment of Options Without limiting the preceding Sections 8.2 and 8.3 of the Plan, the Plan Administrator shall have the discretion, exercisable at any time before a sale, merger, consolidation, reorganization, liquidation or change in control of the Company, as defined by the Plan Administrator, to take such further action as it determines to be necessary or advisable, and fair and equitable to Participants, with respect to Options. Such authorized action may include (but shall not be limited to) establishing, amending or waiving the type, terms, conditions or duration of, or restrictions on, Options so as to provide for earlier, later, extended or additional time for exercise, payment or settlement or lifting restrictions, differing methods for calculating payments or settlements, alternate forms and amounts of payments and settlements and other modifications, and the Plan Administrator may take such actions with respect to all Participants, to certain categories of Participants or only to individual Participants. The Plan Administrator may take such actions before or after granting Options to which the action relates and before or after any public announcement with respect to such sale, merger, consolidation, reorganization, liquidation or change in control that is the reason for such action. 8.5 Limitations The grant of Options will in no way affect the Company's right to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets. SECTION 9. WITHHOLDING OF TAXES The Company may require the Participant to pay to the Company the amount of any withholding taxes that the Company is required to withhold with respect to the grant, vesting or exercise of any Option. Subject to the Plan and applicable law, the Plan Administrator may, in its sole discretion, permit the Participant to satisfy withholding obligations, in whole or in part, (a) by paying cash, (b) by electing to have the Company withhold shares of Common Stock (up to the minimum required federal tax withholding rate) or (c) by transferring to the Company shares of Common Stock (already owned by the Participant for such period necessary to avoid a charge to the Company's earnings for financial reporting purposes), in such amounts as are equivalent to the Fair Market Value of the withholding obligation. The Company shall have the right to withhold from any Option or any shares of Common Stock issuable pursuant to an Option (up to the minimum required federal tax withholding rate) or from any cash amounts otherwise due or to become due from the Company to the Participant an amount equal to such taxes. The Company may also deduct from any Option any other amounts due from the Participant to the Company or a Subsidiary. 10 SECTION 10. AMENDMENT AND TERMINATION OF PLAN 10.1 Amendment of Plan The Plan may be amended by the stockholders of the Company. The Board may also amend the Plan in such respects as it shall deem advisable. 10.2 Termination of Plan The Board may suspend or terminate the Plan at any time. Unless sooner terminated as provided herein, the Plan shall terminate on the tenth anniversary of the date of the Plan's adoption. 10.3 Consent of Holder The amendment or termination of the Plan or the amendment of an outstanding Option shall not, without the consent of the Holder of any Option under the Plan, impair or diminish any rights or obligations under any Option theretofore granted under the Plan. SECTION 11. GENERAL 11.1 Notification The Plan Administrator shall promptly notify a Participant of an Option, and a written grant shall promptly be executed and delivered by or on behalf of the Company that shall contain such terms, conditions, limitations and restrictions as the Plan Administrator shall deem advisable and that are not inconsistent with the Plan. 11.2 Continued Employment or Services; Rights in Options Neither the Plan, participation in the Plan as a Participant nor any action of the Plan Administrator taken under the Plan shall be construed as giving any Participant or employee of the Company any right to be retained in the employ of the Company or a Subsidiary or limit the Company's or a Subsidiary's right to terminate the employment or services of the Participant at any time, with or without Cause. 11.3 Registration; Certificates for Shares The Company shall be under no obligation to any Participant to register for offering or resale under the Securities Act or register or qualify under state securities laws, any shares of Common Stock, security or interest in a security paid or issued under, or created by, the Plan, or to continue in effect any such registrations or qualifications if made. The Company may issue certificates for shares with such legends and subject to such restrictions on transfer and stop- transfer instructions as counsel for the Company deems necessary or desirable for compliance by the Company with federal and state securities laws. To the extent that the Plan or any instrument evidencing an Option provides for issuance of stock certificates to reflect the issuance of shares of Common Stock, the issuance may be effected on a noncertificated basis, to the extent not prohibited by applicable law or the applicable rules of any stock exchange. 11 11.4 No Rights as a Stockholder No Option or Stock Option denominated in units shall entitle the Holder to any dividend, voting or other right of a stockholder unless and until the date of issuance under the Plan of the shares that are the subject of such Options. 11.5 Compliance With Laws and Regulations Notwithstanding anything in the Plan to the contrary, the Plan Administrator, in its sole discretion, may bifurcate the Plan so as to restrict, limit or condition the use of any provision of the Plan to Participants who become officers or directors subject to Section 16 of the Exchange Act without so restricting, limiting or conditioning the Plan with respect to other Participants. 11.6 Participants in Foreign Countries The Plan Administrator shall have the authority to adopt such modifications, procedures and subplans as may be necessary or desirable to comply with provisions of the laws of foreign countries in which the Company or its Subsidiaries may operate to assure the viability of the benefits from Options granted to Participants employed in such countries and to meet the objectives of the Plan. 11.7 No Trust or Fund The Plan is intended to constitute an "unfunded" plan. Nothing contained herein shall require the Company to segregate any monies or other property, or shares of Common Stock, or to create any trusts, or to make any special deposits for any immediate or deferred amounts payable to any Participant, and no Participant shall have any rights that are greater than those of a general unsecured creditor of the Company. 11.8 Severability If any provision of the Plan or any Option is determined to be invalid, illegal or unenforceable in any jurisdiction, or as to any person, or would disqualify the Plan or any Option under any law deemed applicable by the Plan Administrator, such provision shall be construed or deemed amended to conform to applicable laws, or, if it cannot be so construed or deemed amended without, in the Plan Administrator's determination, materially altering the intent of the Plan or the Option, such provision shall be stricken as to such jurisdiction, person or Option, and the remainder of the Plan and any such Option shall remain in full force and effect. 11.9 Choice of Law The Plan and all determinations made and actions taken pursuant hereto, to the extent not otherwise governed by the laws of the United States, shall be governed by the laws of the State of Washington without giving effect to principles of conflicts of laws. SECTION 12. EFFECTIVE DATE The Plan's effective date is the date on which it is adopted by the Board. Adopted by the Board of Directors on July 17, 2000. Amended by the Board on January 9, 2001. 12 PLAN ADOPTION AND AMENDMENTS/ADJUSTMENTS SUMMARY PAGE
Date of Board Action Action Section/Effect of Amendment 7/17/00 Initial Plan Adoption ------------- 1/9/01 Amendment Section 4.1 - increase in aggregate maximum number of shares from 3,000,000 shares to 8,000,000 shares of common stock
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