sv1za
As filed with the Securities
and Exchange Commission on February 28, 2007
Registration
No. 333-138199
UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 6
TO
FORM S-1
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
SOURCEFIRE, INC.
(Exact name of registrant as
specified in its charter)
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Delaware
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7372
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52-2289365
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(State or Other Jurisdiction
of
Incorporation or Organization)
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(Primary Standard Industrial
Classification Code Number)
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(IRS Employer
Identification No.)
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9770 Patuxent Woods Drive
Columbia, Maryland 21046
(410) 290-1616
(Address, including zip code,
and telephone number, including area code, of registrant’s
principal executive offices)
E. Wayne Jackson, III
Chief Executive Officer
Sourcefire, Inc.
9770 Patuxent Woods Drive
Columbia, Maryland 21046
(410) 290-1616
(Name, address, including zip
code, and telephone number, including area code, of agent for
service)
Copies to:
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Thomas J.
Knox, Esq.
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Marc D.
Jaffe, Esq.
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Jeffrey S.
Marcus, Esq.
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Rachel W.
Sheridan, Esq.
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Morrison & Foerster
LLP
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Latham & Watkins
LLP
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1650 Tysons Blvd,
Suite 300
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885 Third Avenue,
Suite 1000
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McLean, VA 22102
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New York, NY 10022
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(703) 760-7700
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(212)
906-1200
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Approximate date of commencement of proposed sale to the
public: As soon as practicable after this
Registration Statement becomes effective.
If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to
Rule 415 under the Securities Act of 1933 check the
following box. o
If this Form is filed to register additional securities for an
offering pursuant to Rule 462(b) under the Securities Act,
check the following box and list the Securities Act registration
statement number of the earlier effective registration statement
for the same
offering. o _
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If this Form is a post-effective amendment filed pursuant to
Rule 462(c) under the Securities Act, check the following
box and list the Securities Act registration statement number of
the earlier effective registration statement for the same
offering. o
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If this Form is a post-effective amendment filed pursuant to
Rule 462(d) under the Securities Act, check the following
box and list the Securities Act registration statement number of
the earlier effective registration statement for the same
offering. o _
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The Registrant hereby amends this registration statement on
such date or dates as may be necessary to delay its effective
date until the Registrant shall file a further amendment which
specifically states that this registration statement shall
thereafter become effective in accordance with Section 8(a)
of the Securities Act of 1933, or until the registration
statement shall become effective on such date as the Commission,
acting pursuant to said Section 8(a), may determine.
The
information contained in this prospectus is not complete and may
be changed. We may not sell these securities until the
registration statement filed with the Securities and Exchange
Commission is effective. This prospectus is not an offer to sell
these securities and we are not soliciting offers to buy these
securities in any state where the offer or sale is not
permitted.
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PROSPECTUS
(Subject to Completion)
Issued
February 28, 2007
5,770,000 Shares
COMMON STOCK
Sourcefire, Inc. is offering 5,320,000 shares of its
common stock and the selling stockholders are offering
450,000 shares. We will not receive any proceeds from the
sale of shares by the selling stockholders. This is our initial
public offering and no public market exists for our shares. We
anticipate that the initial public offering price will be
between $12.00 and $14.00 per share.
We have applied to list our common stock for quotation on
the Nasdaq Global Market under the symbol
“FIRE.”
Investing in our common
stock involves risks. See “Risk Factors”
beginning on page 9.
PRICE
$
A SHARE
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Underwriting
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Discounts and
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Proceeds to
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Proceeds to
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Price to Public
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Commissions
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Sourcefire
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Selling Stockholders
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Per share
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$
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$
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$
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$
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Total
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$
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$
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$
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$
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We have granted the underwriters the right to purchase up to an
additional 865,500 shares of common stock to cover
over-allotments.
The Securities and Exchange Commission and state securities
regulators have not approved or disapproved these securities, or
determined if this prospectus is truthful or complete. Any
representation to the contrary is a criminal offense.
Morgan Stanley & Co. Incorporated expects to
deliver the shares of common stock to purchasers
on ,
2007.
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MORGAN
STANLEY |
LEHMAN
BROTHERS |
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UBS
INVESTMENT BANK |
JEFFERIES &
COMPANY |
,
2007
TABLE OF
CONTENTS
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Page
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75
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95
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97
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100
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102
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109
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109
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109
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F-1
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You should rely only on the information contained in this
prospectus. We have not authorized anyone to provide you with
information different from that contained in this prospectus. We
are offering to sell, and seeking offers to buy, shares of
common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is
accurate only as of the date of this prospectus, regardless of
the time of delivery of this prospectus or of any sale of shares
of common stock.
Until and
including ,
2007, 25 days after the commencement of this offering, all
dealers that buy, sell or trade shares of our common stock,
whether or not participating in this offering, may be required
to deliver a prospectus. This delivery requirement is in
addition to the dealers’ obligation to deliver a prospectus
when acting as underwriters and with respect to their unsold
allotments or subscriptions.
For investors outside the United
States. Neither we nor any of the underwriters
have done anything that would permit this offering or possession
or distribution of this prospectus in any jurisdiction where
action for that purpose is required, other than in the United
States. You are required to inform yourselves about, and to
observe any restrictions relating to, this offering and the
distribution of this prospectus.
PROSPECTUS
SUMMARY
This summary highlights selected information contained
elsewhere in this prospectus and does not contain all of the
information you should consider in making your investment
decision. You should read the following summary together with
all of the more detailed information regarding us and our common
stock being sold in the offering, including our financial
statements and the related notes, appearing elsewhere in this
prospectus. Unless we state otherwise, “Sourcefire,”
the “Company,” “we,” “us,” and
“our” refer to Sourcefire, Inc., a Delaware
corporation, and its subsidiaries, taken as a whole.
SOURCEFIRE,
INC.
Overview
We are a leading provider of intelligence driven, open source
network security solutions that enable our customers to protect
their computer networks in an effective, efficient and highly
automated manner. We sell our security solutions to a diverse
customer base that includes more than 25 of the Fortune
100 companies and over half of the 30 largest
U.S. government agencies. We also manage one of the
security industry’s leading open source initiatives, Snort.
Our family of network security products forms a comprehensive
Discover, Determine and Defend, or 3D, approach to network
security. Using this approach, our technology can automatically:
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Discover potential threats and points of vulnerability;
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Determine the potential impact of those observations to the
network; and
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Defend the network through proactive enforcement of security
policy.
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Our Sourcefire 3D approach is comprised of three key components:
RNA. At the heart of the Sourcefire 3D
security solution is Real-time Network Awareness, or RNA, our
network intelligence product that provides persistent visibility
into the composition, behavior, topology (the relationship of
network components) and risk profile of the network. This
information provides a platform for the Defense Center’s
automated decision-making and network policy compliance
enforcement. The ability to continuously discover
characteristics and vulnerabilities of any computing device, or
endpoint, communicating on a network (such as a computer,
printer or server), or endpoint intelligence, along with the
ability to observe how those endpoints communicate with each
other, or network intelligence, enables our Intrusion Prevention
products to more precisely identify and block threatening
traffic and to more efficiently classify threatening
and/or
suspicious behavior than products lacking network intelligence.
Intrusion Sensors. The Intrusion
Sensors utilize open source
Snort®
and our proprietary technology to monitor network traffic. These
sensors compare observed traffic to a set of “Rules”,
or a set of anomalous network traffic characteristics, which can
be indicative of malicious activity. Once the Intrusion Sensors
match a Rule to the observed traffic, they block malicious
traffic
and/or send
an alert to the Defense Center for further analysis,
prioritization and possible action.
Defense Center. The Defense Center
aggregates, correlates and prioritizes network security events
from RNA Sensors and Intrusion Sensors to synthesize multipoint
event correlation and policy compliance analysis. The Defense
Center’s policy and response subsystems are designed to
leverage existing IT infrastructure such as firewalls, routers,
trouble ticketing and patch management systems for virtually any
task, including alerting, blocking and initiating corrective
measures.
The traffic inspection engine used in our intrusion prevention
products is the open source technology called Snort. Martin
Roesch, our founder and Chief Technology Officer, created Snort
in 1998. Our employees, including Mr. Roesch, have authored
all major components of Snort, and we maintain control over the
Snort project, including the principal Snort community forum,
Snort.org. Snort, which has become a de facto industry standard,
has been downloaded over 3 million times. We believe that a
majority of the Fortune 100 companies and all of the
30 largest U.S. government agencies use Snort
technology to monitor network traffic and that Snort is the most
widely
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deployed intrusion prevention technology worldwide. The
ubiquitous nature of the Snort user community represents a
significant opportunity to sell our proprietary products to
customers that require a complete enterprise solution.
For the year ended December 31, 2006, we generated
approximately 81% of our revenue from customers in the U.S. and
19% from international customers. We increased our revenue from
$32.9 million in 2005 to $44.9 million in 2006,
representing a growth rate of 37%.
Our
Industry
We believe, based on our review of various industry sources,
that the network security industry was estimated to be a
$18.4 billion market in 2006 and is projected to grow to
$26.9 billion in 2009, representing a compound annual
growth rate of over 13%. Our addressable markets include
intrusion prevention, vulnerability management and unified
threat management, which were collectively projected to total
$2.9 billion in 2006 and are expected to grow at a compound
annual growth rate in excess of 21% to $5.2 billion in
2009, according to industry sources we reviewed. We expect that
this growth should continue as organizations seek solutions to
various growing and evolving security challenges, including:
Greater Sophistication, Severity and Frequency of Network
Attacks. The growing use of the Internet as a
business tool has required organizations to increase the number
of access points to their networks, which has made vast amounts
of critical information more vulnerable to attack. Theft of
sensitive information for financial gain motivates network
attackers, who derive profit through identity theft, credit card
fraud, money laundering, extortion, intellectual property theft
and other illegal means. These profit-motivated attackers, in
contrast to the hobbyist hackers of the past, are employing much
more sophisticated tools and techniques to generate profits for
themselves and their well-organized and well-financed sponsors.
Increasing Risks from Unknown
Vulnerabilities. Unknown vulnerabilities in
computer software that are discovered by network attackers
before they are discovered by security and software vendors
represent a tremendous risk. These uncorrected flaws can leave
networks largely defenseless and open to exploitation. According
to Computer Emergency Response Team Coordination Center, or
CERT-CC,
data as of October 2006, the trends in the rate of vulnerability
disclosure are particularly alarming, with approximately 3,780
disclosed in 2004 and more than 5,990 disclosed in 2005,
representing a growth rate of approximately 58%.
Potential Degradation of Network
Performance. Many security products degrade
network performance and are, therefore, disfavored by network
administrators who generally prioritize network performance over
incremental gains in network security. For example, the use of
active scanners that probe networks for vulnerabilities often
meets heavy resistance from administrators concerned about
excessive network “noise,” clogged firewall logs and
disruption of network assets that are critical to business
operations.
Diverse Demands on Security
Administrators. The proliferation of targeted
security solutions such as firewalls, intrusion prevention
systems, URL filters, spam filters and anti-spyware solutions,
while critical to enhancing network security, create significant
administrative burdens on personnel who must manage numerous
disparate technologies that are seldom integrated and often
difficult to use. Most network security products require manual,
labor intensive incident response and investigation by security
administrators, especially when “false positive”
results are generated.
Heightened Government
Regulation. Rapidly growing government
regulation is forcing compliance with increased requirements for
network security, which has escalated demand for security
solutions that meet both compliance requirements and reduce the
burdens of compliance, reporting and enforcement. Examples of
these laws include The Health Insurance Portability and
Accountability Act of 1996, or HIPAA, The Financial Services
Modernization Act of 1999, commonly known as the
Gramm-Leach-Bliley Act, The Sarbanes-Oxley Act of 2002 and The
Federal Information Security Management Act.
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Our
Competitive Strengths
We believe that our leading market position results from several
key competitive strengths, including:
Real-Time Approach to Network
Security. Our solution is designed to support
a continuum of network security functions that span pre-attack
hardening of assets, high fidelity attack identification and
disruption and real-time compromise detection and incident
response. In addition, our ability to confidently classify and
prioritize threats in network traffic and determine the
composition, behavior and relationships of network devices, or
endpoints, allows us to reliably automate what are otherwise
manual, time-intensive processes.
Comprehensive Network Intelligence. Our
innovative network security solution incorporates RNA, which
provides persistent visibility into the composition, behavior,
topology and risk profile of the network and serves as a
platform for automated decision-making and network security
policy enforcement. RNA performs passive, or non-disruptive,
network discovery. This enables real-time compositional
cataloging of network assets, including their configuration,
thereby significantly increasing the network intelligence
available to IT and security administrators. By integrating this
contextual understanding of the network’s components and
situational awareness of network events, our solution is
effective across a broad range of security domains, especially
in the area of threat identification and impact assessment.
The Snort Community. The Snort user
community, with over 100,000 registered users and over
3 million downloads to date, has enabled us to establish a
market footprint unlike any other in the industry. We believe
the Snort open source community provides us with significant
benefits, including a broad threat awareness network,
significant research and development leverage, and a large pool
of security experts that are skilled in the use of our
technology. We believe that Snort’s broad acceptance makes
us one of the most trusted sources of intrusion prevention and
related security solutions.
Leading-Edge Performance. Our solutions
have the ability to process multiple gigabits of traffic with
latency as low as 100 microseconds. Our intrusion prevention
technology incorporates advanced traffic processing
functionality, including packet acquisition, protocol
normalization and target-based traffic inspection, which yields
increased inspection precision and efficiency and enables more
granular inspection of network traffic. The Defense Center
supports event loads as high as 1,300 events per second, which
we believe meets or exceeds the requirements of the most
demanding enterprise customers.
Significant Security Expertise. We have
a highly knowledgeable management team with extensive network
security industry experience gained from past service in leading
enterprises and government organizations including Symantec,
McAfee, the Department of Defense and the National Security
Agency. Our founder and CTO, Martin Roesch, invented Snort and
our core RNA technology and is widely regarded as a network
security visionary. Our senior management team
averages 16 years of experience in the networking and
security industries. In addition, our Vulnerability Research
Team, or VRT, is comprised of highly experienced security
experts who research new vulnerabilities and create innovative
methods for preventing attempts to exploit them.
Broad Industry Recognition. We have
received numerous industry awards and certifications, including
recognition as a “leader” in the network intrusion
prevention systems market, supporting our position as one of a
select few companies that best combines “completeness of
vision” with “ability to execute.” RNA is one of
only five network security products to receive the NSS Gold
award, which is awarded by The NSS Group only to those products
that are distinguished in terms of advanced or unique features,
and which offer outstanding value. In addition, our technology
has achieved Common Criteria Evaluation Assurance Level 2,
or EAL2, which is an international evaluation standard for
information technology security products sanctioned by, among
others, the International Standards Organization, the National
Security Agency and the National Institute for Standards and
Technology.
3
Our
Growth Strategy
We intend to become the preeminent provider of network security
solutions on a global basis. The key elements of our growth
strategy include:
Continue to Develop Innovative Network Security
Technology. We will continue to invest
significantly in internal development and product enhancements
and to hire additional network security experts to broaden our
proprietary knowledge base. We believe our platform is capable
of expanding into new markets such as unified threat management,
security management and compliance and network management.
Grow our Customer Base. With over
3 million downloads of Snort and over 100,000 registered
users, we believe Snort is the most ubiquitous network intrusion
detection and prevention technology. We seek to monetize the
Snort installed base by targeting enterprises that implement
Snort but have not yet purchased any of the components of our
Sourcefire 3D security solution. We will continue to target
large enterprises and government agencies that require advanced
security technology and high levels of network availability and
performance in sectors including finance, technology,
healthcare, manufacturing and defense.
Further Penetrate our Existing Customer
Base. As of December 31, 2006, over
1,300 customers have purchased our Intrusion Sensors and Defense
Center products. We intend to sell additional Intrusion Sensors
to existing customers and expand our footprint in the networks
of our customers to include branch offices, remote locations and
data centers. In addition, we believe we have a significant
opportunity to up-sell our higher margin RNA product to existing
customers because of the significant incremental benefit that
increased network intelligence can bring to their security
systems.
Expand our OEM Alliances and Distribution
Relationships. As part of our ongoing effort
to expand our OEM alliances, we recently entered into a
relationship with Nokia whereby Nokia Enterprise Solutions will
market to its enterprise customers network security solutions
that utilize our proprietary software and technology. In
addition, we seek to expand our strategic reseller agreements
and increasingly use this channel to generate additional inbound
customer prospects. We also intend to utilize our relationships
with managed security service providers such as Verizon,
VeriSign and Symantec, to derive incremental revenue. In 2006,
we generated approximately 11% of our revenue from governmental
organizations and, in the future, we believe we will generate an
increasing amount of revenue from government suppliers such as
Lockheed Martin, Northrop Grumman and Immix Technology.
Strengthen Our International
Presence. We believe the network security
needs of many enterprises located outside of the United States
are not being adequately served and represent a significant
potential market opportunity. In 2006, we generated only
approximately 19% of our revenue from international customers.
We are expanding our sales in international markets by adding
distribution relationships and expanding our direct sales force,
with plans in the next year to double the number of personnel in
Europe and to hire a country manager for Japan.
Selectively Pursue Acquisitions of Complementary
Businesses and Technologies. To accelerate
our expected growth, enhance the capabilities of our existing
products and broaden our product and service offerings, we
intend to selectively pursue acquisitions of businesses,
technologies and products that could complement our existing
operations.
Certain
Risk Factors
Investing in our common stock involves substantial risk. You
should carefully consider all the information in this prospectus
prior to investing in our common stock. These risks and
uncertainties include, but are not limited to, the following:
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As we have had operating losses since our inception and we
expect operating expenses to increase in the foreseeable future,
we may never reach or maintain profitability.
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We face intense competition in our market, especially from
larger, better-known companies, and we may lack sufficient
financial or other resources to maintain or improve our
competitive position.
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New competitors could emerge or our customers or distributors
could internally develop alternatives to our products and either
development could impair our sales.
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Our quarterly operating results are likely to vary significantly
and be unpredictable, in part because of the purchasing and
budget practices of our customers, which could cause the trading
price of our stock to decline.
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The market for network security products is rapidly evolving and
the complex technology incorporated in our products makes them
difficult to develop. If we do not accurately predict, prepare
for and respond to technological and market developments and
changing customer needs, our competitive position and prospects
will be harmed.
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Claims that our products infringe the proprietary rights of
others could harm our business and cause us to incur significant
costs.
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Our
Corporate Information
We were incorporated as a Delaware corporation in December 2001.
Our principal executive office is located at 9770 Patuxent Woods
Drive, Columbia, Maryland 21046. Our telephone number at that
location is
(410) 290-1616.
Our website address is www.sourcefire.com. We
also operate www.snort.org. These are textual
references only. We do not incorporate the information on, or
accessible through, any of our websites into this prospectus,
and you should not consider any information on, or that can be
accessed through, our websites as part of this prospectus.
5
THE
OFFERING
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Common stock offered by Sourcefire |
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5,320,000 shares |
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Common stock offered by the selling stockholders
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450,000 shares
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Over-allotment option to be offered by Sourcefire
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865,500 shares |
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Common stock to be outstanding after this offering
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23,113,892 shares |
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Use of proceeds |
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We intend to use the net proceeds from this offering for working
capital and other general corporate purposes. We may also use a
portion of the net proceeds to repay our equipment facility or
acquire other businesses, products or technologies. However, we
do not have agreements or commitments for any specific
repayments or acquisitions at this time. We will not receive any
proceeds from the sale of common stock by the selling
stockholders. See “Use of Proceeds.” |
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Proposed Nasdaq Global Market symbol
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“FIRE” |
The number of shares to be outstanding after this offering is
based on 17,793,892 shares outstanding as of
December 31, 2006, and excludes:
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3,199,903 shares that may be issued upon the exercise of
options outstanding as of December 31, 2006 under our stock
option plan;
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36,944 shares that may be issued upon the exercise of
warrants outstanding as of December 31, 2006;
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181,934 shares that were reserved for issuance pursuant to
our stock option plan as of December 31, 2006; and
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27,709 shares that are subject to repurchase by us.
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Unless we specifically state otherwise, all information in this
prospectus reflects or assumes:
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an initial public offering price of $13.00;
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a 1-to-1.624
reverse split of our common stock, which was effected on
February 22, 2007;
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the conversion of all outstanding shares of our preferred stock
into shares of our common stock immediately prior to the
completion of this offering pursuant to a written consent
executed by the holders of the requisite number of shares of
each class of our preferred stock to voluntarily convert their
shares of our preferred stock into shares of our common
stock; and
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the underwriters’ over-allotment option to purchase up to
an additional 865,500 shares of common stock is not
exercised.
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6
SUMMARY
CONSOLIDATED FINANCIAL DATA
The table below summarizes our consolidated financial
information for the periods indicated and has been derived from
our audited consolidated financial statements. You should read
the following information together with the more detailed
information contained in “Selected Consolidated Financial
Data,” “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and our
consolidated financial statements and the accompanying notes
appearing elsewhere in this prospectus.
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Year ended December 31,
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2003
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2004
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2005
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2006
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(in thousands, except share, per share and other operating
data)
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Consolidated statement of
operations data:
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Revenue:
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Products
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$
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8,153
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$
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12,738
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$
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23,589
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$
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30,219
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Services
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1,328
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3,955
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9,290
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14,707
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Total revenue
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9,481
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16,693
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32,879
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44,926
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Cost of revenue:
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Products
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2,570
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4,533
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6,610
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8,440
|
|
Services
|
|
|
436
|
|
|
|
872
|
|
|
|
1,453
|
|
|
|
2,632
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
3,006
|
|
|
|
5,405
|
|
|
|
8,063
|
|
|
|
11,072
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
6,475
|
|
|
|
11,288
|
|
|
|
24,816
|
|
|
|
33,854
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
3,751
|
|
|
|
5,706
|
|
|
|
6,831
|
|
|
|
8,612
|
|
Sales and marketing
|
|
|
9,002
|
|
|
|
12,585
|
|
|
|
17,135
|
|
|
|
20,652
|
|
General and administrative
|
|
|
2,141
|
|
|
|
2,905
|
|
|
|
5,120
|
|
|
|
5,017
|
|
Depreciation and amortization
|
|
|
441
|
|
|
|
752
|
|
|
|
1,103
|
|
|
|
1,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
15,335
|
|
|
|
21,948
|
|
|
|
30,189
|
|
|
|
35,511
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(8,860
|
)
|
|
|
(10,660
|
)
|
|
|
(5,373
|
)
|
|
|
(1,657
|
)
|
Other income (expense), net
|
|
|
16
|
|
|
|
164
|
|
|
|
(85
|
)
|
|
|
792
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes
|
|
|
(8,844
|
)
|
|
|
(10,496
|
)
|
|
|
(5,458
|
)
|
|
|
(865
|
)
|
Income tax expense
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(67
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(8,844
|
)
|
|
|
(10,496
|
)
|
|
|
(5,458
|
)
|
|
|
(932
|
)
|
Accretion of preferred stock
|
|
|
(1,262
|
)
|
|
|
(2,451
|
)
|
|
|
(2,668
|
)
|
|
|
(3,819
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders
|
|
$
|
(10,106
|
)
|
|
$
|
(12,947
|
)
|
|
$
|
(8,126
|
)
|
|
$
|
(4,751
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(4.69
|
)
|
|
$
|
(4.97
|
)
|
|
$
|
(2.54
|
)
|
|
$
|
(1.40
|
)
|
Pro forma
(unaudited)(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(0.06
|
)
|
Shares used in per common share
calculations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
2,156,725
|
|
|
|
2,602,743
|
|
|
|
3,200,318
|
|
|
|
3,389,527
|
|
Pro forma
(unaudited)(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,885,981
|
|
Other operating data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of sales in excess of
$500,000
|
|
|
2
|
|
|
|
5
|
|
|
|
9
|
|
|
|
14
|
|
Number of new 3D customers
|
|
|
161
|
|
|
|
136
|
|
|
|
149
|
|
|
|
273
|
|
Cumulative number of Fortune
100 3D customers at end of period
|
|
|
10
|
|
|
|
17
|
|
|
|
24
|
|
|
|
26
|
|
Number of full-time employees at
end of period
|
|
|
84
|
|
|
|
107
|
|
|
|
135
|
|
|
|
182
|
|
(footnotes on following page)
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
Pro forma
|
|
|
|
Actual
|
|
|
Pro
forma(2)
|
|
|
As
Adjusted(3)
|
|
|
|
(unaudited)
|
|
|
|
(in thousands)
|
|
|
Consolidated balance sheet
data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
13,029
|
|
|
$
|
13,029
|
|
|
$
|
74,898
|
|
Held-to-maturity
investments
|
|
|
13,293
|
|
|
|
13,293
|
|
|
|
13,293
|
|
Total assets
|
|
|
49,952
|
|
|
|
49,952
|
|
|
|
111,821
|
|
Long-term debt
|
|
|
1,312
|
|
|
|
1,312
|
|
|
|
1,312
|
|
Total liabilities
|
|
|
22,104
|
|
|
|
22,104
|
|
|
|
22,104
|
|
Total convertible preferred stock
|
|
|
66,747
|
|
|
|
—
|
|
|
|
—
|
|
Total stockholders’ equity
(deficit)
|
|
|
(38,899
|
)
|
|
|
27,848
|
|
|
|
89,717
|
|
|
|
|
(1)
|
|
Pro forma to give effect to the
conversion of all outstanding shares of our preferred stock into
shares of our common stock immediately prior to the completion
of this offering.
|
(2)
|
|
The pro forma balance sheet data
reflect the conversion of all outstanding shares of our
preferred stock into shares of our common stock immediately
prior to the completion of this offering.
|
|
|
|
(3)
|
|
The pro forma as adjusted balance
sheet data reflect the conversion of all outstanding shares of
our preferred stock into shares of our common stock immediately
prior to the completion of this offering and our receipt of
estimated net proceeds of $61.9 million from our sale of
5,320,000 shares of common stock that we are offering at an
assumed public offering price of $13.00 per share, after
deducting estimated underwriting discounts and commissions and
estimated offering expenses payable by us.
|
8
RISK
FACTORS
Investing in our common stock involves a high degree of risk.
You should carefully consider the following risks and all other
information contained in this prospectus, including our
consolidated financial statements and the related notes, before
investing in our common stock. The risks and uncertainties
described below are not the only ones we face. Additional risks
and uncertainties that we are unaware of, or that we currently
believe are not material, also may become important factors that
affect us. If any of the following risks materialize, our
business, financial condition or results of operations could be
materially harmed. In that case, the trading price of our common
stock could decline, and you may lose some or all of your
investment.
Risks
Related to Our Business
We have had operating losses since our inception and we
expect operating expenses to increase in the foreseeable future
and we may never reach or maintain profitability.
We have incurred operating losses each year since our inception
in 2001. Our net loss was approximately $10.5 million for
the year ended December 31, 2004, $5.5 million for the
year ended December 31, 2005 and $0.9 million for the
year ended December 31, 2006. Our accumulated deficit as of
December 31, 2006 is approximately $38.9 million.
Becoming profitable will depend in large part on our ability to
generate and sustain increased revenue levels in future periods.
Although our revenue has generally been increasing and our
losses have generally been decreasing when compared to prior
periods, you should not assume that we will become profitable in
the near future or at any other time. We may never achieve
profitability and, even if we do, we may not be able to maintain
or increase our level of profitability. We expect that our
operating expenses will continue to increase in the foreseeable
future as we seek to expand our customer base, increase our
sales and marketing efforts, continue to invest in research and
development of our technologies and product enhancements and
incur significant new costs associated with becoming a public
company. These efforts may be more costly than we expect and we
may not be able to increase our revenue enough to offset our
higher operating expenses. In addition, if our new products and
product enhancements fail to achieve adequate market acceptance,
our revenue will suffer. If we cannot increase our revenue at a
greater rate than our expenses, we will not become and remain
profitable.
We face intense competition in our market, especially from
larger, better-known companies, and we may lack sufficient
financial or other resources to maintain or improve our
competitive position.
The market for network security monitoring, detection,
prevention and response solutions is intensely competitive, and
we expect competition to increase in the future. We may not
compete successfully against our current or potential
competitors, especially those with significantly greater
financial resources or brand name recognition. Our chief
competitors include large software companies, software or
hardware network infrastructure companies, smaller software
companies offering relatively limited applications for network
and Internet security monitoring, detection, prevention or
response and small and large companies offering point solutions
that compete with components of our product offerings.
Mergers or consolidations among these competitors, or
acquisitions of our competitors by large companies, present
heightened competitive challenges to our business. For example,
Symantec Corporation, Cisco Systems, Inc., McAfee, Inc., 3Com
Corporation and Juniper Networks, Inc. have acquired during the
past several years smaller companies, which have intrusion
detection or prevention technologies and Internet Security
Systems, Inc. has recently been acquired by IBM. These
acquisitions will make these combined entities potentially more
formidable competitors to us if such products and offerings are
effectively integrated. Large companies may have advantages over
us because of their longer operating histories, greater brand
name recognition, larger customer bases or greater financial,
technical and marketing resources. As a result, they may be able
to adapt more quickly to new or emerging technologies and
changes in customer requirements. They also have greater
resources to devote to the promotion and sale of their products
than we have. In addition, these companies have reduced and
could continue to reduce, the price of their security
monitoring, detection, prevention and response products and
managed security services, which intensifies pricing pressures
within our market.
Several companies currently sell software products (such as
encryption, firewall, operating system security and virus
detection software) that our customers and potential customers
have broadly adopted. Some of these
9
companies sell products that perform the same functions as some
of our products. In addition, the vendors of operating system
software or networking hardware may enhance their products to
include functions similar to those that our products currently
provide. The widespread inclusion of comparable features to our
software in operating system software or networking hardware
could render our products less competitive or obsolete,
particularly if such features are of a high quality. Even if
security functions integrated into operating system software or
networking hardware are more limited than those of our products,
a significant number of customers may accept more limited
functionality to avoid purchasing additional products such as
ours.
One of the characteristics of open source software is that
anyone can offer new software products for free under an open
source licensing model in order to gain rapid and widespread
market acceptance. Such competition can develop without the
degree of overhead and lead time required by traditional
technology companies. It is possible for new competitors with
greater resources than ours to develop their own open source
security solutions, potentially reducing the demand for our
solutions. We may not be able to compete successfully against
current and future competitors. Competitive pressure
and/or the
availability of open source software may result in price
reductions, reduced revenue, reduced operating margins and loss
of market share, any one of which could seriously harm our
business.
New competitors could emerge or our customers or
distributors could internally develop alternatives to our
products and either development could impair our sales.
We may face competition from emerging companies as well as
established companies who have not previously entered the market
for network security products. Established companies may not
only develop their own network intrusion detection and
prevention products, but they may also acquire or establish
product integration, distribution or other cooperative
relationships with our current competitors. Moreover, our large
corporate customers and potential customers could develop
network security software internally, which would reduce our
potential revenue. New competitors or alliances among
competitors may emerge and rapidly acquire significant market
share due to factors such as greater brand name recognition, a
larger installed customer base and significantly greater
financial, technical, marketing and other resources and
experience. For example, one of our competitors, Internet
Security Systems, Inc., has recently been acquired by IBM and
the combined company, if successfully integrated, could become a
formidable competitor to us. In addition, the acquisition could
result in a loss of our current sales to IBM if IBM were to
discontinue reselling our products and services. If these new
competitors are successful, we would lose market share and our
revenue would likely decline.
Our quarterly operating results are likely to vary
significantly and be unpredictable, in part because of the
purchasing and budget practices of our customers, which could
cause the trading price of our stock to decline.
Our operating results have historically varied significantly
from period to period, and we expect that they will continue to
do so as a result of a number of factors, most of which are
outside of our control, including:
|
|
|
|
•
|
the budgeting cycles, internal approval requirements and funding
available to our existing and prospective customers for the
purchase of network security products;
|
|
|
•
|
the timing, size and contract terms of orders received, which
have historically been highest in the fourth quarter
(representing more than one-third of our total revenue in recent
years), but may fluctuate seasonally in different ways;
|
|
|
•
|
the level of perceived threats to network security, which may
fluctuate from period to period;
|
|
|
•
|
the level of demand for products sold by original equipment
manufacturers, or OEMs, resellers and distributors that
incorporate and resell our technologies;
|
|
|
•
|
the market acceptance of open-source software solutions;
|
|
|
•
|
the announcement or introduction of new product offerings by us
or our competitors, and the levels of anticipation and market
acceptance of those products;
|
|
|
•
|
price competition;
|
|
|
•
|
general economic conditions, both domestically and in our
foreign markets;
|
10
|
|
|
|
•
|
the product mix of our sales; and
|
|
|
•
|
the timing of revenue recognition for our sales.
|
In particular, the network security technology procurement
practices of many of our customers have had a measurable
influence on the historical variability of our operating
performance. Our prospective customers usually exercise great
care and invest substantial time in their network security
technology purchasing decisions. Many of our customers have
historically finalized purchase decisions in the last weeks or
days of a quarter. A delay in even one large order beyond the
end of a particular quarter can substantially diminish our
anticipated revenue for that quarter. In addition, many of our
expenses must be incurred before we generate revenue. As a
result, the negative impact on our operating results would
increase if our revenue fails to meet expectations in any period.
The cumulative effect of these factors will likely result in
larger fluctuations and unpredictability in our quarterly
operating results than in the operating results of many other
software and technology companies. This variability and
unpredictability could result in our failing to meet the revenue
or operating results expectations of securities industry
analysts or investors for any period. If we fail to meet or
exceed such expectations for these or any other reasons, the
market price of our shares could fall substantially and we could
face costly securities class action suits. Therefore, you should
not rely on our operating results in any quarter as being
indicative of our operating results for any future period, nor
should you rely on other expectations, predictions or
projections of our future revenue or other aspects of our
results of operations.
The market for network security products is rapidly
evolving and the complex technology incorporated in our products
makes them difficult to develop. If we do not accurately
predict, prepare for and respond promptly to technological and
market developments and changing customer needs, our competitive
position and prospects will be harmed.
The market for network security products is relatively new and
is expected to continue to evolve rapidly. Moreover, many
customers operate in markets characterized by rapidly changing
technologies and business plans, which require them to add
numerous network access points and adapt increasingly complex
enterprise networks, incorporating a variety of hardware,
software applications, operating systems and networking
protocols. In addition, computer hackers and others who try to
attack networks employ increasingly sophisticated new techniques
to gain access to and attack systems and networks. Customers
look to our products to continue to protect their networks
against these threats in this increasingly complex environment
without sacrificing network efficiency or causing significant
network downtime. The software in our products is especially
complex because it needs to effectively identify and respond to
new and increasingly sophisticated methods of attack, while not
impeding the high network performance demanded by our customers.
Although the market expects speedy introduction of software to
respond to new threats, the development of these products is
difficult and the timetable for commercial release of new
products is uncertain. Therefore, we may in the future
experience delays in the introduction of new products or new
versions, modifications or enhancements of existing products. If
we do not quickly respond to the rapidly changing and rigorous
needs of our customers by developing and introducing on a timely
basis new and effective products, upgrades and services that can
respond adequately to new security threats, our competitive
position and business prospects will be harmed.
If our new products and product enhancements do not
achieve sufficient market acceptance, our results of operations
and competitive position will suffer.
We spend substantial amounts of time and money to research and
develop new products and enhanced versions of Snort, the Defense
Center and our Intrusion Sensors and RNA products to incorporate
additional features, improved functionality or other
enhancements in order to meet our customers’ rapidly
evolving demands for network security in our highly competitive
industry. When we develop a new product or an advanced version
of an existing product, we typically expend significant money
and effort upfront to market, promote and sell the new offering.
Therefore, when we develop and introduce new or enhanced
products, they must achieve high levels of market acceptance in
order to justify the amount of our investment in developing and
bringing the products to market.
11
Our new products or enhancements could fail to attain sufficient
market acceptance for many reasons, including:
|
|
|
|
•
|
delays in introducing new, enhanced or modified products;
|
|
|
•
|
defects, errors or failures in any of our products;
|
|
|
•
|
inability to operate effectively with the networks of our
prospective customers;
|
|
|
•
|
inability to protect against new types of attacks or techniques
used by hackers;
|
|
|
•
|
negative publicity about the performance or effectiveness of our
intrusion prevention or other network security products;
|
|
|
•
|
reluctance of customers to purchase products based on open
source software; and
|
|
|
•
|
disruptions or delays in the availability and delivery of our
products, which problems are more likely due to our
just-in-time
manufacturing and inventory practices.
|
If our new products or enhancements (including, but not limited
to, version 4.0 of RNA, which we plan to introduce in the next
several months) do not achieve adequate acceptance in the
market, our competitive position will be impaired, our revenue
will be diminished and the effect on our operating results may
be particularly acute because of the significant research,
development, marketing, sales and other expenses we incurred in
connection with the new product.
If existing customers do not make subsequent purchases
from us or if our relationships with our largest customers are
impaired, our revenue could decline.
In 2004, 2005 and 2006, existing customers that purchased
additional products and services from us, whether for new
locations or additional technology to protect existing networks
and locations, generated a majority of our total revenue for
each respective period. Part of our growth strategy is to sell
additional products to our existing customers and, in
particular, to up-sell our RNA products to customers that
previously bought our Intrusion Sensor products. We may not be
effective in executing this or any other aspect of our growth
strategy. Our revenue could decline if our current customers do
not continue to purchase additional products from us. In
addition, as we deploy new versions of our existing Snort,
Intrusion Sensors and RNA products or introduce new products,
our current customers may not require the functionality of these
products and may not purchase them.
We also depend on our installed customer base for future service
revenue from annual maintenance fees. Our maintenance and
support agreements typically have durations of one year.
Approximately 82% of our customers renewed their maintenance and
support agreements upon expiration in the year ended
December 31, 2006. No single customer contributed greater
than 10% of our recurring maintenance and support revenues in
2005 or in 2006. If customers choose not to continue their
maintenance service, our revenue may decline.
If we cannot attract sufficient government agency
customers, our revenue and competitive position will
suffer.
Contracts with the U.S. federal and state and other
national and state government agencies accounted for 17% of our
total revenue for the year ended December 31, 2004, 16% for
the year ended December 31, 2005 and 11% for the year ended
December 31, 2006. We lost many government agency customers
when a foreign company tried unsuccessfully to acquire us in
late 2005 and early 2006. Since then, we have been attempting to
regain government customers, which subjects us to a number of
risks, including:
|
|
|
|
•
|
Procurement. Contracting with public sector
customers is highly competitive and can be expensive and
time-consuming, often requiring that we incur significant
upfront time and expense without any assurance that we will win
a contract;
|
|
|
|
|
•
|
Budgetary Constraints and Cycles. Demand and
payment for our products and services are impacted by public
sector budgetary cycles and funding availability, with funding
reductions or delays adversely impacting public sector demand
for our products, including delays caused by continuing
resolutions or other temporary funding arrangements resulting
from the current congressional transition;
|
12
|
|
|
|
•
|
Modification or Cancellation of
Contracts. Public sector customers often have
contractual or other legal rights to terminate current contracts
for convenience or due to a default. If a contract is cancelled
for convenience, which can occur if the customer’s product
needs change, we may only be able to collect for products and
services delivered prior to termination. If a contract is
cancelled because of default, we may only be able to collect for
products and alternative products and services delivered to the
customer;
|
|
|
|
|
•
|
Governmental Audits. National governments and
other state and local agencies routinely investigate and audit
government contractors’ administrative processes. They may
audit our performance and pricing and review our compliance with
applicable rules and regulations. If they find that we
improperly allocated costs, they may require us to refund those
costs or may refuse to pay us for outstanding balances related
to the improper allocation. An unfavorable audit could result in
a reduction of revenue, and may result in civil or criminal
liability if the audit uncovers improper or illegal activities.
|
|
|
•
|
Replacing Existing Products. After we
announced in October 2005 that we had agreed to be acquired by a
foreign company, many government agencies were unwilling to buy
products from us and instead purchased and installed products
sold by our competitors. The proposed acquisition was terminated
in April 2006 following objections from the Committee on Foreign
Investment in the United States. Since that time, we have been
attempting to retain government agency customers. Many
government agencies, however, already have installed network
security products of our competitors. It can be very difficult
to convince government agencies or other prospective customers
to replace their existing network security solutions with our
products, even if we can demonstrate the superiority of our
products.
|
We are subject to risks of operating internationally that
could impair our ability to grow our revenue abroad.
We market and sell our software in North America, South America,
Europe, Asia and Australia and we plan to establish additional
sales presence in these and other parts of the world. Therefore,
we are subject to risks associated with having worldwide
operations. Sales to customers located outside of the United
States accounted for approximately 18% of our total revenue in
the year ended December 31, 2004, approximately 18% of our
total revenue in the year ended December 31, 2005 and
approximately 19% of our total revenue in the year ended
December 31, 2006. The expansion of our existing operations
and entry into additional worldwide markets will require
significant management attention and financial resources. We are
also subject to a number of risks customary for international
operations, including:
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economic or political instability in foreign markets;
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greater difficulty in accounts receivable collection and longer
collection periods;
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unexpected changes in regulatory requirements;
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difficulties and costs of staffing and managing foreign
operations;
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import and export controls;
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the uncertainty of protection for intellectual property rights
in some countries;
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costs of compliance with foreign laws and laws applicable to
companies doing business in foreign jurisdictions;
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management communication and integration problems resulting from
cultural differences and geographic dispersion;
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multiple and possibly overlapping tax structures; and
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foreign currency exchange rate fluctuations.
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To date, a substantial portion of our sales have been
denominated in U.S. dollars, and we have not used risk
management techniques or “hedged” the risks associated
with fluctuations in foreign currency exchange rates. In the
future, if we do not engage in hedging transactions, our results
of operations will be subject to losses from fluctuations in
foreign currency exchange rates.
13
In the future, we may not be able to secure financing
necessary to operate and grow our business as planned.
We expect that the net proceeds from this offering together with
current cash, cash equivalents, borrowings under our credit
facility and short-term investments should be sufficient to meet
our anticipated cash needs for working capital and capital
expenditures for at least the next 24 months. However, our
business and operations may consume resources faster than we
anticipate. In the future, we may need to raise additional funds
to expand our sales and marketing and research and development
efforts or to make acquisitions. Additional financing may not be
available on favorable terms, if at all. If adequate funds are
not available on acceptable terms, we may be unable to fund the
expansion of our sales and marketing and research and
development efforts or take advantage of acquisition or other
opportunities, which could seriously harm our business and
operating results. If we issue debt, the debt holders would have
rights senior to common stockholders to make claims on our
assets and the terms of any debt could restrict our operations,
including our ability to pay dividends on our common stock.
Furthermore, if we issue additional equity securities,
stockholders will experience dilution, and the new equity
securities could have rights senior to those of our common stock.
Our inability to acquire and integrate other businesses,
products or technologies could seriously harm our competitive
position.
In order to remain competitive, we intend to acquire additional
businesses, products or technologies. If we identify an
appropriate acquisition candidate, we may not be successful in
negotiating the terms of the acquisition, financing the
acquisition, or effectively integrating the acquired business,
product or technology into our existing business and operations.
Any acquisitions we are able to complete may not be accretive to
earnings. Further, completing a potential acquisition and
integrating an acquired business will significantly divert
management time and resources.
If other parties claim commercial ownership rights to
Snort, our reputation, customer relations and results of
operations could be harmed.
While we created a majority of the current Snort code base, a
portion of the current Snort code was created by the combined
efforts of the Company and the open source software community
and a portion was created solely by the open source community.
We believe that the portions of the Snort code base created by
anyone other than by us are required to be licensed by us
pursuant to the GNU General Public License, or GPL, which is how
we currently license Snort. There is a risk, however, that a
third party could claim some ownership rights in Snort, and
attempt to prevent us from commercially licensing Snort in the
future (rather than pursuant to the GPL as it is currently
licensed) and claim a right to licensing royalties. Any such
claim, regardless of its merit or outcome, could be costly to
defend, harm our reputation and customer relations and result in
our having to pay substantial compensation to the party claiming
ownership.
Our products contain third party open source software, and
failure to comply with the terms of the underlying open source
software licenses could restrict our ability to sell our
products.
Our products are distributed with software programs licensed to
us by third party authors under “open source”
licenses, which may include the GPL, the GNU Lesser Public
License, or LGPL, the BSD License and the Apache License. These
open source software programs include, without limitation,
Snort®,
Linux, Apache, Openssl, Etheral, IPTables, Tcpdump and Tripwire.
These third party open source programs are typically licensed to
us for a minimal fee or no fee at all, and the underlying
license agreements generally require us to make available to the
open source user community the source code for such programs, as
well as the source code for any modifications or derivative
works we create based on these third party open source software
programs. With the exception of Snort, we have not created any
modifications or derivative works to any other open source
software programs referenced above. We regularly release updates
and upgrades to the Snort software program under the terms and
conditions of the GNU GPL version 2. Included with our
software and/or appliances are copies of the relevant source
code and licenses for the open source programs. Alternatively,
we include instructions to users on how to obtain copies of the
relevant open source code and licenses. Additionally, if we
combine our proprietary software with third party open source
software in a certain manner, we could, under the terms of
certain of these open source license agreements, be required to
release the source code of our proprietary software. This could
also allow our competitors to create similar products, which
would result in a loss of our product sales. We do not provide
end users a copy of the source
14
code to our proprietary software because we believe that the
manner in which our proprietary software is aligned with the
relevant open source programs does not create a modification or
derivative work of that open source program requiring the
distribution of our proprietary source code. Our ability to
commercialize our products by incorporating third party open
source software may be restricted because, among other reasons:
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the terms of open source license agreements may be unclear and
subject to varying interpretations, which could result in
unforeseen obligations regarding our proprietary products;
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it may be difficult to determine the developers of open source
software and whether such licensed software infringes another
party’s intellectual property rights;
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competitors will have greater access to information by obtaining
these open source products, which may help them develop
competitive products; and
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open source software potentially increases customer support
costs because licensees can modify the software and potentially
introduce errors.
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The software program Linux is included in our products and is
licensed under the GPL. The GPL is the subject of litigation in
the case of The SCO Group, Inc. v. International Business
Machines Corp., pending in the United States District Court for
the District of Utah. It is possible that the court could rule
that the GPL is not enforceable in such litigation. Any ruling
by the court that the GPL is not enforceable could have the
effect of limiting or preventing us from using Linux as
currently implemented.
Efforts to assert intellectual property ownership rights
in our products could impact our standing in the open source
community which could limit our product innovation
capabilities.
When we undertake actions to protect and maintain ownership and
control over our proprietary intellectual property, including
patents, copyrights and trademark rights, our standing in the
open source community could be diminished which could result in
a limitation on our ability to continue to rely on this
community as a resource to identify and defend against new
viruses, threats and techniques to attack secure networks,
explore new ideas and concepts and further our research and
development efforts.
Our proprietary rights may be difficult to enforce, which
could enable others to copy or use aspects of our products
without compensating us.
We rely primarily on copyright, trademark, patent and trade
secrets laws, confidentiality procedures and contractual
provisions to protect our proprietary rights. As of the date
hereof, we had 25 patent applications pending for examination in
the U.S. and foreign jurisdictions. We also hold numerous
registered United States and foreign trademarks and have a
number of trademark applications pending in the United States
and in foreign jurisdictions. Valid patents may not be issued
from pending applications, and the claims allowed on any patents
may not be sufficiently broad to protect our technology or
products. Any issued patents may be challenged, invalidated or
circumvented, and any rights granted under these patents may not
actually provide adequate protection or competitive advantages
to us. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our products
or to obtain and use information that we regard as proprietary.
Policing unauthorized use of our technologies or products is
difficult. Our products incorporate open source Snort software,
which is readily available to the public. In addition, the laws
of some foreign countries do not protect our proprietary rights
to as great an extent as do the laws of the United States, and
many foreign countries do not enforce these laws as diligently
as U.S. government agencies and private parties. It is
possible that we may have to resort to litigation to enforce and
protect our copyrights, trademarks, patents and trade secrets,
which litigation could be costly and a diversion of management
resources. If we are unable to protect our proprietary rights to
the totality of the features in our software and products
(including aspects of our software and products protected other
than by patent rights), we may find ourselves at a competitive
disadvantage to others who need not incur the additional
expense, time and effort required to create the innovative
products that have enabled us to be successful to date.
In limited instances we have agreed to place, and in the future
may place, source code for our software in escrow, other than
the Snort source code which is publicly available. In most
cases, the source code may be made available to certain of our
customers and OEM partners in the event that we file for
bankruptcy or materially fail to support our products. This may
increase the likelihood of misappropriation or other misuse of
our software. We
15
have agreed to source code escrow arrangements in the past only
rarely and usually only in connection with prospective customers
considering a significant purchase of our products and services.
Claims that our products infringe the proprietary rights
of others could harm our business and cause us to incur
significant costs.
Technology products such as ours, which interact with multiple
components of complex networks, are increasingly subject to
infringement claims as the functionality of products in
different industry segments overlaps. In particular, our RNA
technology is a new technology for which we have yet be issued a
patent. It is possible that other companies have patents with
respect to technology similar to our technology, including RNA.
Ten of our 25 pending patent applications relate to our
RNA technology and were filed in 2003, 2004 and 2005. If
others filed patent applications before us, which contain
allowable claims within the scope of our RNA technology, then we
may be found to infringe on such patents, if and when they are
issued. We are aware of at least one company that has filed an
application for a patent that, on its face, contains claims that
may be construed to be within the scope of the same broad
technology area as our RNA technology. That company,
PredatorWatch, has filed suit against us for misappropriation
and incorporation in our RNA technology of its proprietary
rights (see discussion in next risk factor). PredatorWatch has
separately notified us that it believes that our
RNA technology is covered by claims in a pending patent
application filed by PredatorWatch. Unless and until the
U.S. Patent and Trademark Office, or PTO, issues a patent
to an applicant, there can be no way to assess a potential
patentee’s right to exclude. Depending on the timing and
substance of these patents and patent applications, our
products, including our RNA technology, may infringe the
proprietary rights of others, and we may be subject to
litigation with respect to any alleged infringement. The
application of patent law to the software industry is
particularly uncertain as the PTO has only recently begun to
issue software patents in large numbers and there is a backlog
of software related patent applications pending claiming
inventions whose priority dates may pre-date development of our
own proprietary software. Additionally, in our customer
contracts we typically agree to indemnify our customers if they
incur losses resulting from a third party claim that their use
of our products infringes upon the intellectual property rights
of a third party. Any potential intellectual property claims
against us, with or without merit, could:
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be very expensive and time consuming to defend;
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require us to indemnify our customers for losses resulting from
such claims;
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cause us to cease making, licensing or using software or
products that incorporate the challenged intellectual property;
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cause product shipment and installation delays;
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require us to redesign our products, which may not be feasible;
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divert management’s attention and resources; or
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require us to enter into royalty or licensing agreements in
order to obtain the right to use a necessary product or
component.
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Royalty or licensing agreements, if required, may not be
available on acceptable terms, if at all. A successful claim of
infringement against us and our failure or inability to license
the infringed or similar technology could prevent us from
distributing our products and cause us to incur great expense
and delay in developing non-infringing products.
We have been sued by a company claiming that we
misappropriated and incorporated its proprietary rights into our
3D product line and our defense of these claims is costly,
diverts the attention of our management and may be
unsuccessful.
On April 25, 2006, we were served with a complaint filed by
PredatorWatch (now named NetClarity) in the Superior Court for
Suffolk County, Massachusetts. The plaintiff alleges that we,
Martin F. Roesch, our Chief Technology Officer, and Inflection
Point Associates, L.P., the general partner of one of our
stockholders, Inflection Point Ventures, L.P.
(i) misappropriated and incorporated the plaintiff’s
trade secrets; (ii) breached an oral agreement of
confidentiality; (iii) breached a covenant of good faith
and fair dealing owed to the plaintiff;
16
(iv) were unjustly enriched; (v) misrepresented
certain material facts to the plaintiff, upon which the
plaintiff relied to its detriment; and (vi) engaged in
unfair and deceptive acts in violation of Massachusetts state
law. The plaintiff has sought to recover amounts to be
ascertained and established, as well as double and treble
damages and attorney’s fees.
Litigation is subject to inherent uncertainties, especially in
cases like this where sophisticated factual issues must be
assessed and complex technical issues must be resolved. In
addition, these types of cases involve issues of law that are
evolving, presenting further uncertainty. Our defense of this
litigation, regardless of the merits of the complaint, has been,
and will likely continue to be, time consuming, extremely costly
and a diversion of time and attention for our technical and
management personnel. Through December 31, 2006, we have
spent approximately $198,000 in legal fees and expenses on this
litigation and expect to incur substantial additional expenses
even if we ultimately prevail. Publicity related to this
litigation could likely have a negative impact on our sales of
our 3D product line and a negative impact on the price of our
common stock. Sales of our 3D product line amounted to
$21.7 million and $26.9 million for 2005 and 2006,
respectively, or 66% and 60% of our total sales for 2005 and
2006, respectively.
A failure to prevail in the litigation could result in one or
more of the following:
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our paying substantial monetary damages, which could be tripled
if any misappropriation is found to have been willful, and which
may include paying an ongoing significant royalty to
PredatorWatch or compensation for lost profits to PredatorWatch;
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our paying substantial punitive damages;
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our having to provide an accounting of all revenue received from
selling our 3D product line in its current form;
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the issuance of a preliminary or permanent injunction requiring
us to stop selling our 3D product line in its current form;
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our having to redesign our 3D product line, which could be
costly and time-consuming and could substantially delay our 3D
product line shipments, assuming that a redesign is feasible;
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our having to reimburse PredatorWatch for some or all of its
attorneys’ fees and costs, which would be substantial;
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our having to obtain from PredatorWatch a license to use its
technology, which might not be available on reasonable terms, if
at all; or
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our having to indemnify our customers against any losses they
may incur due to the alleged infringement.
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Additionally, PredatorWatch has separately notified us that they
believe that our RNA technology and 3D security solutions are
covered by claims contained in a pending patent application.
This pending patent application has not issued as a patent, but
in the event it does issue, PredatorWatch could file an
additional complaint to include a patent infringement claim
against us.
If we are enjoined from selling our 3D product line in its
current form, we may be required to redesign our 3D product line
to avoid infringing on the intellectual property rights of
others. If we are unable to efficiently redesign commercially
acceptable products, our sales will decline substantially. This
litigation is at an early stage, so we cannot predict its course
or its costs to us. We do, however, expect to continue to incur
significant costs in defending against this litigation and these
costs could increase substantially if this litigation approaches
or enters a trial phase. It is possible that these costs could
substantially exceed our expectations in future periods. For a
more detailed description of this litigation, please see
“Business — Legal Proceedings.”
We rely on software licensed from other parties, the loss
of which could increase our costs and delay software
shipments.
We utilize various types of software licensed from unaffiliated
third parties. For example, we license database software from
MySQL that we use in our Intrusion Sensors, our RNA Sensors and
our Defense Centers. Our
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Agreement with MySQL permits us to distribute MySQL software on
our products to our customers worldwide until December 31,
2010. We amended our MySQL agreement on December 29, 2006
to give us the unlimited right to distribute MySQL software in
exchange for a one-time lump-sum payment. We believe that the
MySQL agreement is material to our business because we have
spent a significant amount of development resources to allow the
MySQL software to function in our products. If we were forced to
find replacement database software for our products, we would be
required to expend resources to implement a replacement database
in our products, and there would be no guarantee that we would
be able to procure the replacement on the same or similar
commercial terms.
In addition to MySQL, we rely on other open source software,
such as the Linux operating system, the Apache web server and
OpenSSL, a secure socket layer implementation. These open source
programs are licensed to us under various open source licenses.
For example, Linux is licensed under the GNU General Public
License, while Apache and OpenSSL are licensed under other forms
of open source license agreements. If we could no longer rely on
these open source programs, the functionality of our products
would be impaired and, we would be required to expend
significant resources to find suitable alternatives.
Our business would be disrupted if any of the software we
license from others or functional equivalents of this software
were either no longer available to us or no longer offered to us
on commercially reasonable terms. In either case, we would be
required to either redesign our products to function with
software available from other parties or develop these
components ourselves, which would result in increased costs and
could result in delays in our product shipments and the release
of new product offerings. Furthermore, we might be forced to
limit the features available in our current or future products.
If we fail to maintain or renegotiate any of these software
licenses, we could face significant delays and diversion of
resources in attempting to license and integrate a functional
equivalent of the software.
Defects, errors or vulnerabilities in our software
products would harm our reputation and divert resources.
Because our products are complex, they may contain defects,
errors or vulnerabilities that are not detected until after our
commercial release and installation by our customers. We may not
be able to correct any errors or defects or address
vulnerabilities promptly, or at all. Any defects, errors or
vulnerabilities in our products could result in:
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expenditure of significant financial and product development
resources in efforts to analyze, correct, eliminate or
work-around errors or defects or to address and eliminate
vulnerabilities;
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loss of existing or potential customers;
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delayed or lost revenue;
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delay or failure to attain market acceptance;
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increased service, warranty, product replacement and product
liability insurance costs; and
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negative publicity, which will harm our reputation.
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In addition, because our products and services provide and
monitor network security and may protect valuable information,
we could face claims for product liability, tort or breach of
warranty. Anyone who circumvents our security measures could
misappropriate the confidential information or other valuable
property of customers using our products, or interrupt their
operations. If that happens, affected customers or others may
sue us. In addition, we may face liability for breaches of our
product warranties, product failures or damages caused by faulty
installation of our products. Provisions in our contracts
relating to warranty disclaimers and liability limitations may
be unenforceable. Some courts, for example, have found
contractual limitations of liability in standard computer and
software contracts to be unenforceable in some circumstances.
Defending a lawsuit, regardless of its merit, could be costly
and divert management attention. Our business liability
insurance coverage may be inadequate or future coverage may be
unavailable on acceptable terms or at all.
Our networks, products and services are vulnerable to, and
may be targeted by, hackers.
Like other companies, our websites, networks, information
systems, products and services may be targets for sabotage,
disruption or misappropriation by hackers. As a leading network
security solutions company, we are a
18
high profile target and our networks, products and services may
have vulnerabilities that may be targeted by hackers. Although
we believe we have sufficient controls in place to prevent
disruption and misappropriation, and to respond to such
situations, we expect these efforts by hackers to continue. If
these efforts are successful, our operations, reputation and
sales could be adversely affected.
We utilize a
just-in-time
contract manufacturing and inventory process, which increases
our vulnerability to supply disruption.
Our ability to meet our customers’ demand for certain of
our products depends upon obtaining adequate hardware platforms
on a timely basis, which must be integrated with our software.
We purchase hardware platforms through our contract
manufacturers from a limited number of suppliers on a
just-in-time
basis. In addition, these suppliers may extend lead times, limit
the supply to our manufacturers or increase prices due to
capacity constraints or other factors. Although we work closely
with our manufacturers and suppliers to avoid shortages, we may
encounter these problems in the future. Our results of
operations would be adversely affected if we were unable to
obtain adequate supplies of hardware platforms in a timely
manner or if there were significant increases in the costs of
hardware platforms or problems with the quality of those
hardware platforms.
We depend on a single source to manufacture our enterprise
class intrusion sensor product; if that sole source were to fail
to satisfy our requirements, our sales revenue would decline and
our reputation would be harmed.
We rely on one manufacturer, Bivio Networks, to build the
hardware platform for two models of our intrusion sensor
products that are used by our enterprise class customers. These
enterprise class intrusion sensor products are purchased
directly by customers for their internal use and are also
utilized by third party managed security service providers to
provide services to their customers. Revenue resulting from
sales of these enterprise class intrusion sensor products
accounted for approximately 3.8% of our product revenue in the
year ended December 31, 2005 and approximately 21% of our
product revenue in the year ended December 31, 2006. The
unexpected termination of our relationship with Bivio Networks
would be disruptive to our business and our reputation which
could result in a decline in our revenue as well as shipment
delays and possible increased costs as we seek and implement
production with an alternate manufacturer.
Our inability to hire and retain key personnel would slow
our growth.
Our business is dependent on our ability to hire, retain and
motivate highly qualified personnel, including senior
management, sales and technical professionals. In particular, we
intend to expand the size of our direct sales force domestically
and internationally and to hire additional customer support and
professional services personnel. However, competition for
qualified services personnel is intense, and if we are unable to
attract, train or retain the number of highly qualified sales
and services personnel that our business needs, our reputation,
customer satisfaction and potential revenue growth could be
seriously harmed. To the extent we hire personnel from
competitors, we may be subject to allegations that they have
been improperly solicited or divulged proprietary or other
confidential information.
Our future success will depend to a significant extent on the
continued services of Martin Roesch, our founder and Chief
Technology Officer, and E. Wayne Jackson, III, our Chief
Executive Officer. The loss of the services of either of these
or other individuals could adversely affect our business and
could divert other senior management time in searching for their
replacements.
We depend on resellers and distributors for our sales; if
they fail to perform as expected, our revenue will
suffer.
Part of our business strategy involves entering into additional
agreements with resellers and distributors that permit them to
resell our products and service offerings. Revenue resulting
from our resellers and distributors accounted for approximately
46% of our total revenue in the year ended December 31,
2004, approximately 48% of our total revenue in the year ended
December 31, 2005 and approximately 49% of our total
revenue in the year ended December 31, 2006. For the year
ended December 31, 2005 and for the year ended
December 31, 2006, no single reseller, distributor,
customer or OEM accounted for more than ten percent of our total
revenue. There is a risk that our pace of entering into such
agreements may slow, or that our existing agreements may not
produce as much business as we anticipate. There is also a risk
that some or all of our resellers or distributors may be
acquired,
19
may change their business models or may go out of business, any
of which could have an adverse effect on our business. For
example, IBM, our current reseller, recently completed its
acquisition of Internet Security Systems, Inc., one of our
competitors. Sales of our products to IBM or where IBM helped
influence the sales process as a percentage of our total revenue
were 3.1% and 1.2% for the year ended December 31, 2006 and
the year ended December 31, 2005, respectively. While we
have received oral assurances from IBM that it does not expect
any material change to our reseller relationship solely on
account of its acquisition of Internet Security Systems, Inc.,
we cannot currently anticipate how our relationship with IBM may
change. IBM may decide to discontinue reselling our products and
services.
If we do not continue to establish and effectively manage
our OEM relationships, our revenue could decline.
Our ability to sell our network security software products in
new markets and to increase our share of existing markets will
be impaired if we fail to expand our indirect distribution
channels. Our sales strategy involves the establishment of
multiple distribution channels domestically and internationally
through strategic resellers, system integrators and OEMs. We
have alliances with OEMs such as IBM and Nokia and we cannot
predict the extent to which these companies will be successful
in marketing or selling our software. These agreements could be
terminated on short notice and they do not prevent our OEMs,
systems integrators, strategic resellers or other distributors
from selling the network security software of other companies,
including our competitors. IBM and Nokia or any other OEM,
system integrator, strategic reseller or distributor could give
higher priority to other companies’ software or to their
own software than they give to ours, which could cause our
revenue to decline. Additionally, IBM recently completed its
acquisition of Internet Security Systems, Inc., one of our
competitors. Our ability to sell our network security software
products through IBM as a reseller or have our product sales
influenced by them as a partner could be materially diminished.
Our inability to effectively manage our expected headcount
growth and expansion and our additional obligations as a public
company could seriously harm our ability to effectively run our
business.
Our historical growth has placed, and our intended future growth
is likely to continue to place, a significant strain on our
management, financial, personnel and other resources. We will
likely not continue to grow at our historical pace due to limits
on our resources. We have grown from 84 employees at
December 31, 2003 to 182 employees at December 31,
2006. Since January 1, 2005, we have opened additional
sales offices and have significantly expanded our operations.
This rapid growth has strained our facilities and required us to
lease additional space at our headquarters. In several recent
quarters, we have not been able to hire sufficient personnel to
keep pace with our growth. In addition to managing our expected
growth, we will have substantial additional obligations and
costs as a result of being a public company. These obligations
include investor relations, preparing and filing periodic SEC
reports, developing and maintaining internal controls over
financial reporting and disclosure controls, compliance with
corporate governance rules, Regulation FD and other requirements
imposed on public companies by the SEC and the Nasdaq Global
Market. Fulfilling these additional obligations will make it
more difficult to operate a growing company. Any failure to
effectively manage growth or fulfill our obligations as a public
company could seriously harm our ability to respond to
customers, the quality of our software and services and our
operating results. To effectively manage growth and operate a
public company, we will need to implement additional management
information systems, improve our operating, administrative,
financial and accounting systems and controls, train new
employees and maintain close coordination among our executive,
engineering, accounting, finance, marketing, sales and
operations organizations.
Risks
Related to Your Investment
The price of our common stock may be subject to wide
fluctuations and may trade below the initial public offering
price.
Before this offering, there has not been a public market for our
common stock. The initial public offering price of our common
stock will be determined by negotiations between us and
representatives of the underwriters, based on numerous factors,
including those that we discuss under “Underwriters.”
This price may not be indicative of the market price of our
common stock after this offering. We cannot assure you that an
active public market for our common stock will develop or be
sustained after this offering. The market price of our common
stock also could be
20
subject to significant fluctuations. As a result, you may not be
able to sell your shares of our common stock quickly or at
prices equal to or greater than the price you paid in this
offering.
Among the factors that could affect our common stock price are
the risks described in this “Risk Factors” section and
other factors, including:
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•
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quarterly variations in our operating results compared to market
expectations;
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•
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changes in expectations as to our future financial performance,
including financial estimates or reports by securities analysts;
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•
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changes in market valuations of similar companies;
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•
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liquidity and activity in the market for our common stock;
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•
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actual or expected sales of our common stock by our stockholders;
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•
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strategic moves by us or our competitors, such as acquisitions
or restructurings;
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•
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general market conditions; and
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•
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domestic and international economic, legal and regulatory
factors unrelated to our performance.
|
Stock markets in general have experienced extreme volatility
that has often been unrelated to the operating performance of a
particular company. These broad market fluctuations may
adversely affect the trading price of our common stock,
regardless of our operating performance.
Sales of substantial amounts of our common stock in the
public markets, or the perception that they might occur, could
reduce the price that our common stock might otherwise attain
and may dilute your voting power and your ownership interest in
us.
After the completion of this offering, we will have 23,113,892
outstanding shares of common stock (23,979,392 shares of
common stock if the underwriters exercise in full their option
to purchase additional shares). This number is comprised of all
the shares of our common stock that we are selling in this
offering, which may be resold immediately in the public market.
Subject to certain exceptions described under the caption
“Underwriters,” we and all of our directors and
executive officers and certain of our stockholders and option
holders have agreed not to offer, sell or agree to sell,
directly or indirectly, any shares of common stock without the
permission of the underwriters for a period of 180 days
from the date of this prospectus. When this period expires we
and our
locked-up
stockholders will be able to sell our shares in the public
market. Sales of a substantial number of such shares upon
expiration, or early release, of the
lock-up (or
the perception that such sales may occur) could cause our share
price to fall.
Sales of substantial amounts of our common stock in the public
market following our initial public offering, or the perception
that such sales could occur, could adversely affect the market
price of our common stock and may make it more difficult for you
to sell your common stock at a time and price that you deem
appropriate.
We also may issue our shares of common stock from time to time
as consideration for future acquisitions and investments. If any
such acquisition or investment is significant, the number of
shares that we may issue may in turn be significant. In
addition, we may also grant registration rights covering those
shares in connection with any such acquisitions and investments.
Investors purchasing common stock in this offering will
experience immediate and substantial dilution.
The assumed initial public offering price of our common stock is
substantially higher than the net tangible book value per
outstanding share of our common stock immediately after this
offering. As a result, you will pay a price per share that
substantially exceeds the book value of our tangible assets
after subtracting our liabilities. Purchasers of our common
stock in this offering will incur immediate and substantial
dilution of $9.12 per share in the net tangible book value
of our common stock from the assumed initial public offering
price of $13.00 per share, which is the mid-point of the
estimated range set forth on the cover of this prospectus. If
the underwriters exercise in
21
full their option to purchase additional shares, there will be
dilution of $8.82 per share in the net tangible book value
of our common stock, assuming the same public offering price.
As a result of becoming a public company, we will be
obligated to develop and maintain proper and effective internal
controls over financial reporting and will be subject to other
requirements that will be burdensome and costly. We may not
complete our analysis of our internal controls over financial
reporting in a timely manner, or these internal controls may not
be determined to be effective, which may adversely affect
investor confidence in our company and, as a result, the value
of our common stock.
We will be required, pursuant to Section 404 of the
Sarbanes-Oxley Act of 2002 (Section 404), to furnish a
report by management on, among other things, the effectiveness
of our internal control over financial reporting for the first
fiscal year beginning after the effective date of this offering.
This assessment will need to include disclosure of any material
weaknesses identified by our management in our internal control
over financial reporting, as well as a statement that our
auditors have issued an attestation report on our
management’s assessment of our internal controls.
We are just beginning the costly and challenging process of
compiling the system and processing documentation before we
perform the evaluation needed to comply with Section 404.
We may not be able to complete our evaluation, testing and any
required remediation in a timely fashion. During the evaluation
and testing process, if we identify one or more material
weaknesses in our internal control over financial reporting, we
will be unable to assert that our internal control is effective.
If we are unable to assert that our internal control over
financial reporting is effective, or if our auditors are unable
to attest that our management’s report is fairly stated or
they are unable to express an opinion on the effectiveness of
our internal control, we could lose investor confidence in the
accuracy and completeness of our financial reports, which would
have a material adverse effect on the price of our common stock.
Failure to comply with the new rules might make it more
difficult for us to obtain certain types of insurance, including
director and officer liability insurance, and we might be forced
to accept reduced policy limits and coverage
and/or incur
substantially higher costs to obtain the same or similar
coverage. The impact of these events could also make it more
difficult for us to attract and retain qualified persons to
serve on our board of directors, on committees of our board of
directors, or as executive officers.
In addition, as a public company, we will incur significant
additional legal, accounting and other expenses that we did not
incur as a private company, and our administrative staff will be
required to perform additional tasks. For example, in
anticipation of becoming a public company, we will need to
create or revise the roles and duties of our board committees,
adopt disclosure controls and procedures, retain a transfer
agent, adopt an insider trading policy and bear all of the
internal and external costs of preparing and distributing
periodic public reports in compliance with our obligations under
the securities laws. In addition, changing laws, regulations and
standards relating to corporate governance and public
disclosure, and related regulations implemented by the
Securities and Exchange Commission and the Nasdaq Global Market,
are creating uncertainty for public companies, increasing legal
and financial compliance costs and making some activities more
time consuming. These laws, regulations and standards are
subject to varying interpretations, in many cases due to their
lack of specificity, and, as a result, their application in
practice may evolve over time as new guidance is provided by
regulatory and governing bodies. We intend to invest resources
to comply with evolving laws, regulations and standards, and
this investment may result in increased general and
administrative expenses and a diversion of management’s
time and attention from revenue-generating activities to
compliance activities. If our efforts to comply with new laws,
regulations and standards differ from the activities intended by
regulatory or governing bodies due to ambiguities related to
practice, regulatory authorities may initiate legal proceedings
against us and our business may be harmed.
22
Anti-takeover provisions in our charter documents and
under Delaware law could make an acquisition of us, which may be
beneficial to our stockholders, more difficult and may prevent
attempts by our stockholders to replace or remove our current
management.
We intend to amend and restate our certificate of incorporation
and bylaws, both of which will become effective upon the
completion of this offering, to add provisions that may delay or
prevent an acquisition of us or a change in our management.
These provisions include a classified board of directors, a
prohibition on actions by written consent of our stockholders,
and the ability of our board of directors to issue preferred
stock without stockholder approval. In addition, because we are
incorporated in Delaware, we are governed by the provisions of
Section 203 of the Delaware General Corporation Law, which
prohibits stockholders owning in excess of 15% of our
outstanding voting stock from merging or combining with us.
Although we believe these provisions collectively provide for an
opportunity to receive higher bids by requiring potential
acquirors to negotiate with our board of directors, they would
apply even if the offer may be considered beneficial by some
stockholders. In addition, these provisions may frustrate or
prevent attempts by our stockholders to replace or remove our
current management by making it more difficult for stockholders
to replace members of our board of directors, which is
responsible for appointing the members of our management.
23
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains both historical and forward-looking
statements. All statements other than statements of historical
fact are, or may be deemed to be, forward-looking statements.
For example, statements concerning projections, predictions,
expectations, estimates or forecasts and statements that
describe our objectives, plans or goals are or may be
forward-looking statements. These forward-looking statements
reflect management’s current expectations concerning future
results and events and generally can be identified by use of
expressions such as “may,” “will,”
“should,” “could,” “would,”
“predict,” “potential,”
“continue,” “expect,”
“anticipate,” “future,” “intend,”
“plan,” “foresee,” “believe,”
“estimate,” and similar expressions, as well as
statements in future tense. These forward-looking statements
include, but are not limited to, the following:
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expected growth in the markets for network security products;
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•
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our plans to continue to invest in and develop innovative
technology and products for our existing markets and other
network security markets;
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•
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the timing of expected introductions of new or enhanced products;
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•
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our expectation of growth in our customer base and increasing
sales to existing customers;
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•
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our plans to increase revenue through more relationships with
original equipment manufacturers, resellers, distributors,
government suppliers and co-marketers;
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•
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our plans to grow international sales;
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•
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our plans to acquire and integrate new businesses and
technologies;
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•
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our plans to hire more network security experts and broaden our
knowledge base; and
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•
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our plans to hire additional sales personnel and the additional
revenue we expect them to generate.
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The forward-looking statements included in this prospectus are
made only as of the date of this prospectus. We expressly
disclaim any intent or obligation to update any forward-looking
statements to reflect subsequent events or circumstances.
Forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause our actual
results, performance or achievements to be different from any
future results, performance and achievements expressed or
implied by these statements. These risks and uncertainties
include, but are not limited to, the following:
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the market for network security products is rapidly evolving and
the complex technology incorporated in our products makes them
difficult to develop, and if we do not accurately predict,
prepare for and respond promptly to technological and market
developments and changing customer needs, our competitive
position and prospects will be harmed;
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•
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defects, errors or vulnerabilities in our software products
would harm our reputation and divert resources;
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•
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in the future, we may not be able to secure financing necessary
to operate and grow our business as planned;
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•
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claims that our products infringe the proprietary rights of
others could harm our business and cause us to incur significant
costs;
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•
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we face intense competition in our market, especially from
larger, better-known companies, and we may lack sufficient
financial or other resources to maintain or improve our
competitive position;
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•
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new competitors could emerge or our customers or distributors
could internally develop alternatives to our products and either
development could impair our sales;
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•
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if our new products and product enhancements do not achieve
sufficient market acceptance, our results of operations and
competitive position will suffer;
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•
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if existing customers do not make subsequent purchases from us
or if our relationships with our largest customers are impaired,
our revenue could decline;
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24
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•
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if we cannot attract sufficient government agency customers, our
revenue and competitive position will suffer;
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•
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if we do not continue to establish and effectively manage our
OEM relationships, our revenue could decline;
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•
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we are subject to risks of operating internationally that could
impair our ability to grow our revenue abroad;
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•
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our inability to acquire and integrate other businesses,
products or technologies could seriously harm our competitive
position;
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•
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our inability to hire and retain key personnel would slow our
growth; and
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our inability to effectively manage our headcount growth and
expansion could seriously harm our ability to effectively run
our business.
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We operate in an industry in which it is difficult to obtain
precise industry and market information. Although we have
obtained some industry data from outside sources that we believe
to be reliable, in certain cases we have based certain
statements contained in this prospectus regarding our industry
and our position in the industry on our estimates concerning,
among other things, our customers and competitors. These
estimates are based on our experience in the industry,
conversations with our principal suppliers and customers and our
own investigations of market conditions. The statistical data
contained in this prospectus regarding the network security
software industry are our statements, which are based on data we
obtained from industry sources.
SOURCEFIRE®,
SNORT®,
the Sourcefire logo, the Snort and Pig logo, SECURITY FOR THE
REAL
WORLDtm,
SOURCEFIRE DEFENSE
CENTERtm,
SOURCEFIRE
3Dtm,
RNAtm
and certain other trademarks and logos are trademarks or
registered trademarks of Sourcefire, Inc. in the United States
and other countries. This prospectus also refers to the products
or services of other companies by the trademarks and trade names
used and owned by those companies.
25
USE OF
PROCEEDS
Assuming an initial public offering price of $13.00 per
share, we estimate that we will receive net proceeds from this
offering of approximately $61.9 million, after deducting
underwriting discounts and commissions and other estimated
expenses of $2.5 million payable by us. If the
underwriters’ option to purchase additional shares in this
offering is exercised in full we estimate that our net proceeds
will be approximately $72.3 million. We will not receive
any proceeds from the sale of shares of our common stock by the
selling stockholders, one of which is our Chief Executive
Officer. See “Principal and Selling Stockholders” for
more information.
We intend to use the net proceeds to us from this offering for
working capital and other general corporate purposes, including
financing our growth, developing new products and funding
capital expenditures. We may seek to finance our growth by, for
example, expanding our direct sales force in international
markets and by hiring additional personnel beyond our current
plans to bring products to market sooner. Some possible capital
expenditures include, without limitation, (i) procuring and
installing an enterprise resource planning system,
(ii) purchasing additional development and testing
equipment for our security lab and (iii) acquiring
additional security-related technology for further development.
In addition, we may choose to repay the equipment line portion
of our credit facility with Silicon Valley Bank or expand our
current business through acquisitions of other businesses,
products or technologies. However, we do not have agreements or
commitments for any specific repayments nor do we have any
plans, proposals or arrangements with respect to any specific
acquisitions at this time. As of December 31, 2006, the
outstanding balance under the equipment line portion of our
Silicon Valley Bank credit facility was $1,312,000, bearing
interest at annual rates from 6.5%, fixed, to 8.75%, variable
based on prime plus 0.5% at December 31, 2006, and maturing
between February 2007 and December 2009. The
outstanding balance, if any, under the working capital portion
of the credit facility must be repaid on
March 28, 2007. The proceeds of the
equipment line portion of the credit facility were used for
furniture, leasehold improvements, personal computers and
equipment for our network security lab.
Pending any use, as described above, we plan to invest the net
proceeds in short-term, interest-bearing investment grade
securities.
A $1.00 increase (decrease) in the assumed initial public
offering price of $13.00 per share would increase
(decrease) the net proceeds to us from this offering by $4.9
million, assuming the number of shares offered by us, as set
forth on the cover page of this prospectus, remains the same and
after deducting the estimated underwriting discounts and
commissions and estimated expenses payable by us.
DIVIDEND
POLICY
We intend to retain all future earnings, if any, for use in the
operation of our business and to fund future growth. We have
never declared or paid any dividend on our capital stock and do
not anticipate paying any dividends for the foreseeable future
and the loan and security agreement governing our working
capital line of credit restricts our ability to pay dividends or
other distributions on our capital stock. The decision whether
to pay dividends will be made by our board of directors in light
of conditions then existing, including factors such as our
results of operations, financial condition and requirements,
business conditions and covenants under any applicable
contractual arrangements.
26
CAPITALIZATION
The following table sets forth our cash and cash equivalents and
our capitalization (including long-term debt) as of
December 31, 2006:
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•
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on a pro forma basis, giving effect to the conversion of all of
the outstanding shares of our preferred stock into
14,302,128 shares of our common stock immediately prior to
the completion of this offering pursuant to a written consent
executed by the holders of the requisite number of shares of
each class of our preferred stock to voluntarily convert their
shares of our preferred stock into shares of our common
stock; and
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•
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on a pro forma as adjusted basis, giving effect to the
conversion of all of the outstanding shares of our preferred
stock into 14,302,128 shares of our common stock
immediately prior to the completion of this offering and our
sale of 5,320,000 shares of common stock in this offering,
assuming an initial public offering price of $13.00, the
midpoint of the estimated price range set forth on the cover of
this prospectus, after deducting the estimated underwriting
discounts and commissions and estimated offering expenses
payable by us.
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The numbers of shares of common stock shown as issued and
outstanding exclude:
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3,199,093 shares that may be issued upon the exercise of
options outstanding as of December 31, 2006;
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•
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36,944 shares that may be issued upon the exercise of
warrants outstanding as of December 31, 2006;
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•
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181,934 shares that are reserved for issuance pursuant to
our stock option plan as of December 31, 2006; and
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•
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27,709 shares that are subject to repurchase by us.
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You should read this table in conjunction with the consolidated
financial statements and the related notes,
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations,” and “Description
of Capital Stock” included elsewhere in this prospectus.
27
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As of December 31, 2006
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Pro forma
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Actual
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Pro forma
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As Adjusted
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(unaudited)
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(dollars in thousands)
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Cash and cash equivalents
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$
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13,029
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$
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13,029
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$
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74,898
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Long-term debt, including current
portion
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$
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1,312
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$
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1,312
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$
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1,312
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Series A Convertible
Preferred Stock, par value $.001 per share:
2,495,410 shares authorized, 2,475,410 shares issued
and outstanding, actual; no shares authorized, no shares issued
and outstanding, pro forma and pro forma as adjusted
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10,308
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—
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—
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Series B Convertible
Preferred Stock, par value $.001 per share:
7,132,205 shares authorized, 7,132,205 shares issued
and outstanding, actual; no shares authorized, no shares issued
and outstanding, pro forma and pro forma as adjusted
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14,265
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—
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—
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Series C Convertible
Preferred Stock, par value $.001 per share:
5,404,043 shares authorized, 5,404,043 shares issued
and outstanding, actual; no shares authorized, no shares issued
and outstanding, pro forma and pro forma as adjusted
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18,270
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—
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—
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Series D Convertible
Preferred Stock, par value $.001 per share:
3,264,449 shares authorized, 3,264,449 shares issued
and outstanding, actual; no shares authorized, no shares issued
and outstanding, pro forma and pro forma as adjusted
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23,879
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—
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—
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Warrants to purchase Series A
Convertible Preferred Stock
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25
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—
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—
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Total convertible preferred stock
and warrants
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66,747
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—
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—
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Stockholders’ equity
(deficit):
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Common Stock, par value
$.001 per share: 36,500,000 authorized, 3,491,764 issued
and outstanding, actual; 36,500,000 shares authorized,
17,793,892 shares issued and outstanding, pro forma;
240,000,000 shares authorized, 23,113,892 shares
issued and outstanding, pro forma as adjusted
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3
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18
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23
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Preferred Stock, par value
$.001 per share: no shares authorized, no shares issued and
outstanding, actual and pro forma; 20,000,000 shares
authorized, no shares issued and outstanding, pro forma as
adjusted
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—
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—
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—
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Unearned compensation
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—
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—
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Additional paid-in capital
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—
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66,732
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|
128,596
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Accumulated deficit
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(38,902
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)
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|
(38,902
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)
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(38,902
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)
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Total stockholders’ equity
(deficit)
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(38,899
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)
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27,848
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89,717
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Total capitalization (including
long-term debt)
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$
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29,160
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|
$
|
29,160
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$
|
91,029
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28
DILUTION
Dilution is the amount by which the offering price paid by the
purchasers of the common stock sold in the offering exceeds the
net tangible book value per share of common stock after the
offering. Net tangible book value per share is determined at any
date by subtracting our total liabilities from the total book
value of our tangible assets and dividing the difference by the
number of shares of common stock deemed to be outstanding at
that date.
Our pro forma net tangible book value as of December 31,
2006 was $27.8 million, or $1.57 per share, which gives
effect to the conversion of all outstanding shares of our
preferred stock into 14,302,128 shares of our common stock
immediately prior to the completion of this offering. After
giving effect to the receipt and our intended use of
approximately $61.9 million of estimated net proceeds from
our sale of 5,320,000 shares of common stock in this
offering at an assumed offering price of $13.00 per share, our
pro forma as adjusted net tangible book value as of
December 31, 2006 would have been approximately
$89.7 million, or $3.88 per share. This represents an
immediate increase in pro forma net tangible book value of $2.31
per share to existing stockholders and an immediate dilution of
$9.12 per share to new investors purchasing shares of common
stock in the offering. The following table illustrates this
substantial and immediate per share dilution to new investors:
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Assumed initial public offering
price per share
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$
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13.00
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Pro forma net tangible book
value per share before this offering
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$
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1.57
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Increase per share attributable to
investors in this offering
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2.31
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As adjusted pro forma net tangible
book value per share after this offering
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3.88
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Dilution per share to new investors
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$
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9.12
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A $1.00 increase (decrease) in the assumed initial public
offering price of $13.00 per share, which is the midpoint of the
range listed on the cover page of this prospectus, would
increase (decrease) the as adjusted pro forma net tangible book
value per share after this offering by $0.22 and the dilution
per share to new investors in this offering by $0.22, assuming
the number of shares offered by us, as set forth on the cover
page of this prospectus, remains the same and after deducting
underwriting discounts and commissions and estimated offering
expenses payable by us.
The following table summarizes on an as adjusted pro forma basis
as of December 31, 2006.
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•
|
the total number of shares of common stock purchased from us by
our existing stockholders and by new investors purchasing shares
in this offering;
|
|
|
|
|
•
|
the total consideration paid to us by our existing stockholders
and by new investors purchasing shares in this offering,
assuming an initial public offering price of $13.00 per
share (before deducting the estimated underwriting discounts and
commissions and estimated offering expenses payable by us in
connection with this offering); and
|
|
|
|
|
•
|
the average price per share paid by existing stockholders and by
new investors purchasing shares in this offering:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares purchased
|
|
|
Total consideration
|
|
|
Average price
|
|
|
|
Number
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
per share
|
|
|
Existing stockholders
|
|
|
17,793,892
|
|
|
|
77
|
%
|
|
$
|
56,878,184
|
|
|
|
45
|
%
|
|
$
|
3.20
|
|
Investors in the offering
|
|
|
5,320,000
|
|
|
|
23
|
|
|
|
69,160,000
|
|
|
|
55
|
|
|
|
13.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
23,113,892
|
|
|
|
100
|
%
|
|
$
|
126,038,184
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The tables and calculations above assume no exercise of:
|
|
|
|
•
|
stock options outstanding as of December 31, 2006 to
purchase 3,199,903 shares of common stock at a weighted average
exercise price of $2.95 per share; or
|
|
|
|
|
•
|
the underwriters’ over-allotment option.
|
To the extent any of these options are exercised, there will be
further dilution to new investors.
29
SELECTED
CONSOLIDATED FINANCIAL DATA
The consolidated statement of operations data for the five years
ended December 31, 2006 and the consolidated balance sheet
data as of December 31, 2002, 2003, 2004, 2005 and 2006
have been derived from our audited consolidated financial
statements. The selected consolidated financial data set forth
below should be read in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations” set forth below and our consolidated financial
statements and related notes included elsewhere in this
prospectus. The historical results are not necessarily
indicative of the results to be expected in any future period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31,
|
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
|
(in thousands, except share, per share and other operating
data)
|
|
|
Consolidated statement of
operations data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
$
|
1,704
|
|
|
$
|
8,153
|
|
|
$
|
12,738
|
|
|
$
|
23,589
|
|
|
$
|
30,219
|
|
Services
|
|
|
197
|
|
|
|
1,328
|
|
|
|
3,955
|
|
|
|
9,290
|
|
|
|
14,707
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
1,901
|
|
|
|
9,481
|
|
|
|
16,693
|
|
|
|
32,879
|
|
|
|
44,926
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
448
|
|
|
|
2,570
|
|
|
|
4,533
|
|
|
|
6,610
|
|
|
|
8,440
|
|
Services
|
|
|
155
|
|
|
|
436
|
|
|
|
872
|
|
|
|
1,453
|
|
|
|
2,632
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
603
|
|
|
|
3,006
|
|
|
|
5,405
|
|
|
|
8,063
|
|
|
|
11,072
|
|
Gross profit
|
|
|
1,298
|
|
|
|
6,475
|
|
|
|
11,288
|
|
|
|
24,816
|
|
|
|
33,854
|
|
Operating expenses
Research and development
|
|
|
1,261
|
|
|
|
3,751
|
|
|
|
5,706
|
|
|
|
6,831
|
|
|
|
8,612
|
|
Sales and marketing
|
|
|
3,179
|
|
|
|
9,002
|
|
|
|
12,585
|
|
|
|
17,135
|
|
|
|
20,652
|
|
General and administrative
|
|
|
1,234
|
|
|
|
2,141
|
|
|
|
2,905
|
|
|
|
5,120
|
|
|
|
5,017
|
|
Depreciation and amortization
|
|
|
153
|
|
|
|
441
|
|
|
|
752
|
|
|
|
1,103
|
|
|
|
1,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
5,827
|
|
|
|
15,335
|
|
|
|
21,948
|
|
|
|
30,189
|
|
|
|
35,511
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(4,529
|
)
|
|
|
(8,860
|
)
|
|
|
(10,660
|
)
|
|
|
(5,373
|
)
|
|
|
(1,657
|
)
|
Other income (expense), net
|
|
|
22
|
|
|
|
16
|
|
|
|
164
|
|
|
|
(85
|
)
|
|
|
792
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes
|
|
|
(4,507
|
)
|
|
|
(8,844
|
)
|
|
|
(10,496
|
)
|
|
|
(5,458
|
)
|
|
|
(865
|
)
|
Income tax expense
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(67
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(4,507
|
)
|
|
|
(8,844
|
)
|
|
|
(10,496
|
)
|
|
|
(5,458
|
)
|
|
|
(932
|
)
|
Accretion of preferred stock
|
|
|
(356
|
)
|
|
|
(1,262
|
)
|
|
|
(2,451
|
)
|
|
|
(2,668
|
)
|
|
|
(3,819
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders
|
|
$
|
(4,863
|
)
|
|
$
|
(10,106
|
)
|
|
$
|
(12,947
|
)
|
|
$
|
(8,126
|
)
|
|
$
|
(4,751
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(2.61
|
)
|
|
$
|
(4.69
|
)
|
|
$
|
(4.97
|
)
|
|
$
|
(2.54
|
)
|
|
$
|
(1.40
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma
(unaudited)(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(0.06
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in per common share
calculations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
1,865,663
|
|
|
|
2,156,725
|
|
|
|
2,602,743
|
|
|
|
3,200,318
|
|
|
|
3,389,527
|
|
Pro forma
(unaudited)(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,885,981
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other operating data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of sales in excess of
$500,000
|
|
|
1
|
|
|
|
2
|
|
|
|
5
|
|
|
|
9
|
|
|
|
14
|
|
Number of new 3D customers
|
|
|
|
|
|
|
161
|
|
|
|
136
|
|
|
|
149
|
|
|
|
273
|
|
Cumulative number of Fortune 100 3D
customers at end of period
|
|
|
3
|
|
|
|
10
|
|
|
|
17
|
|
|
|
24
|
|
|
|
26
|
|
Number of full-time employees at
end of period
|
|
|
46
|
|
|
|
84
|
|
|
|
107
|
|
|
|
135
|
|
|
|
182
|
|
(footnotes on following
page)
30
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2006
|
|
|
Consolidated balance sheet
data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
2,991
|
|
|
$
|
5,315
|
|
|
$
|
3,563
|
|
|
$
|
1,106
|
|
|
$
|
13,029
|
|
|
|
|
|
Held-to-maturity
investments
|
|
|
—
|
|
|
|
—
|
|
|
|
5,751
|
|
|
|
2,005
|
|
|
|
13,293
|
|
|
|
|
|
Total assets
|
|
|
4,928
|
|
|
|
10,316
|
|
|
|
20,016
|
|
|
|
21,250
|
|
|
|
49,952
|
|
|
|
|
|
Long-term debt
|
|
|
580
|
|
|
|
345
|
|
|
|
461
|
|
|
|
990
|
|
|
|
1,312
|
|
|
|
|
|
Total liabilities
|
|
|
2,031
|
|
|
|
5,166
|
|
|
|
10,177
|
|
|
|
16,340
|
|
|
|
22,104
|
|
|
|
|
|
Total convertible preferred stock
|
|
|
7,716
|
|
|
|
19,958
|
|
|
|
37,339
|
|
|
|
40,007
|
|
|
|
66,747
|
|
|
|
|
|
Total stockholders’ equity
(deficit)
|
|
|
(4,819
|
)
|
|
|
(14,808
|
)
|
|
|
(27,500
|
)
|
|
|
(35,097
|
)
|
|
|
(38,899
|
)
|
|
|
|
|
Dividends declared per share
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
(1)
|
|
On a pro forma basis, giving effect
to the conversion of all of the outstanding shares of our
preferred stock into shares of our common stock immediately
prior to the completion of this offering.
|
31
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial
condition and results of operations should be read in
conjunction with our consolidated financial statements and
related notes that appear elsewhere in this prospectus. In
addition to historical consolidated financial information, the
following discussion contains forward-looking statements that
reflect our plans, estimates and beliefs. Our actual results
could differ materially from those discussed in the
forward-looking statements. Factors that could cause or
contribute to these differences include those discussed below
and elsewhere in this prospectus, particularly in “Risk
Factors.”
Overview
Sourcefire is a leading provider of intelligence driven, open
source network security solutions that enable our customers to
protect their computer networks in an effective, efficient and
highly automated manner. We apply a comprehensive Discover,
Determine and Defend, or 3D, approach to network security
through which we: 1) discover potential threats and
vulnerabilities, 2) determine the potential impact of those
observations to the network and 3) defend the network
through aggressive enforcement of security policies. We sell our
security solutions to a diverse customer base that includes over
25 of the Fortune 100 companies and over half of the 30
largest U.S. government agencies. We also manage one of the
security industry’s leading open source initiatives, Snort.
Our Sourcefire 3D approach is comprised of three key components:
RNA. At the heart of the Sourcefire 3D
security solution is Real-time Network Awareness, or RNA, our
network intelligence product that provides persistent visibility
into the composition, behavior, topology (the relationship of
network components) and risk profile of the network. This
information provides a platform for the Defense Center’s
automated decision-making and network policy compliance
enforcement. The ability to continuously discover
characteristics and vulnerabilities of any computing device
communicating on a network such as a computer, printer or
server, or endpoint intelligence, enables our Intrusion
Prevention products to more precisely identify and block
threatening traffic and to more efficiently classify threatening
and/or
suspicious behavior than products lacking network intelligence.
Intrusion Sensors. The Intrusion Sensors
utilize open source
Snort®
and our proprietary technology to monitor network
traffic. These sensors compare observed traffic to a set of
“Rules”, or a set of network traffic characteristics,
which can be indicative of malicious activity. Once the
Intrusion Sensors match a Rule to the observed traffic, they
block malicious traffic
and/or send
an alert to the Defense Center for further analysis,
prioritization and possible action.
Defense Center. The Defense Center aggregates,
correlates and prioritizes network security events from RNA
Sensors and Intrusion Sensors to synthesize multipoint event
correlation and policy compliance analysis. The Defense
Center’s policy and response subsystems are designed to
leverage existing IT infrastructure such as firewalls, routers,
trouble ticketing, and patch management systems for virtually
any task, including alerting, blocking and initiating corrective
measures.
Historical
Development of our Business
We were organized as a Delaware corporation and began operations
in January 2001, and we sold our first commercial product, a
Sourcefire Intrusion Sensor, in the summer of 2001. In 2002, we
released the first version of the Defense Center product, closed
our first round of institutional financing, raising
approximately $7.5 million from the sale of Series A
convertible preferred stock, and hired senior executives
including our CEO, COO, VP of Sales and VP of Business
Development. In 2003, we closed our second round of
institutional financing, raising $11 million from the sale
of Series B convertible preferred stock, released our RNA
product and hired our CFO and VP of Engineering. In 2004, we
completed our third round of institutional financing, raising
$15 million from the sale of Series C convertible
preferred stock, exceeded 100 total employees, hired our chief
marketing officer and introduced the Sourcefire 3D suite of
products. In 2005, we leased approximately 40,000 square
feet of office space
32
for our corporate headquarters including a 4,000 square
foot
state-of-the-art
security lab, received NSS gold certification for our intrusion
detection product and released our enterprise class intrusion
sensor product.
In October 2005 we entered into a definitive merger agreement to
be acquired by Check Point Software Technologies Ltd., an
Israeli company, for $225.0 million. As a result of the
merger announcement and during the period following the
announcement, our U.S. government business was curtailed as
certain government agencies apparently became unwilling to buy
products from a company being acquired by a foreign entity and
instead purchased and installed products sold by our
competitors. In April 2006, the proposed acquisition was
mutually terminated in response to objections from the Committee
on Foreign Investment in the United States. Our business,
including our business with the U.S. government, continued
to grow following the termination. We believe that, other than
the curtailment of government business described above, the
announcement, pendency and termination of the merger have not
had a material adverse effect on our business or plans for this
offering.
In 2006, we closed our fourth round of institutional financing,
raising $23 million from the sale of Series D
convertible preferred stock, and achieved our first quarter of
cash flow positive results.
Key
Financial Metrics and Trends
Pricing
and Discounts
We maintain a standard price list for all our products and we
have not changed our list pricing during the past. Additionally,
we have a corporate policy that governs the level of discounting
our sales organization may offer on our products based on
factors such as transaction size, volume of products, federal or
state programs, reseller or distributor involvement and the
level of technical support commitment. Our total product revenue
and the resulting cost of revenue and gross profit percentage
are directly affected by our ability to manage our product
pricing policy. Although we have not experienced pressure to
reduce our prices, competition is increasing and, in the future,
we may be forced to reduce our prices to remain competitive.
Revenue
We currently derive revenue from product sales and services.
Product revenue is principally derived from the sale of our
network security solutions. Our network security solutions
include a perpetual software license bundled with a third-party
hardware platform. Services revenue is principally derived from
technical support and professional services. We typically sell
technical support to complement our network security solutions.
Technical support entitles a customer to product updates, new
Rules releases and both telephone and web assistance for using
our products. Our professional services revenue includes
optional
on-site
network security deployment consulting, and classroom and online
training for managing a network security solution.
Product sales are typically recognized as revenue at shipment of
the product to the customer, whether sold directly or through
resellers. For sales made through distributors and original
equipment manufacturers, or OEMs, we do not recognize revenue
until we receive the monthly sales report which indicates the
sell-through volume to end user customers. Revenue from services
is recognized when the services are performed. For technical
support services, revenue is recognized ratably over the term of
the support arrangement, which is usually a
12-month
agreement providing for payment in advance and automatic
renewals.
We sell our network security solutions globally. However, over
80% of our revenue for 2006 was generated by sales to
U.S.-based
customers. We expect that our revenue from customers based
outside of the United States will increase in amount and as a
percentage of total revenue as we execute our strategy to
strengthen our international presence. We also expect that our
revenue from sales through OEMs and distributors will increase
in amount and as a percentage of total revenue as we execute our
strategy to expand such relationships. We manage our operations
on a consolidated basis for purposes of assessing performance
and making operating decisions. Accordingly, our business does
not have reportable segments.
Revenue from product sales has been highly seasonal, with more
than one-third of our total product revenue in recent fiscal
years generated in the fourth quarter. The timing of our
year-end shipments could materially affect our fourth quarter
product revenue in any fiscal year and sequential quarterly
comparisons. Revenue from our government customers has
occasionally been influenced by the September 30th fiscal
year-end of the U.S. federal
33
government, which has historically resulted in our revenue from
government customers being highest in the third quarter.
Although we do not expect these general seasonal patterns to
change substantially in the future, our revenue within a
particular quarter is often affected significantly by the
unpredictable procurement patterns of our customers. Our
prospective customers usually spend a long time evaluating and
making purchase decisions for network security solutions.
Historically, many of our customers have not finalized their
purchasing decisions until the final weeks or days of a quarter.
We expect these purchasing patterns to continue in the future.
Therefore, a delay in even one large order beyond the end of the
quarter could materially reduce our anticipated revenue for a
quarter. Because many of our expenses must be incurred before we
expect to generate revenue, delayed orders could negatively
impact our results of operations for the period and cause us to
fail to meet the financial performance expectations of
securities industry research analysts or investors.
On April 20, 2006, we received a complaint filed by
PredatorWatch, Inc. in Suffolk County, Massachusetts, alleging,
among other things, that we misappropriated and incorporated the
plaintiff’s trade secrets and confidential information into
our RNA technology. The plaintiff has sought to recover amounts
to be ascertained and established, as well as double and treble
damages and attorneys’ fees. While this litigation is at an
early stage and we cannot reliably estimate the amount, if any,
that the Plaintiff could recover, the potential range of
remedies available to the Plaintiff, if successful, could
include royalties on past and future sales of RNA and/or a
permanent injunction prohibiting us from selling any products
containing RNA technology.
Cost
of Revenue
Cost of product revenue includes the cost of the hardware
platform bundled into our network security solution, royalties
for third-party software included in our network security
solution, materials and labor that go into the quality assurance
of our products, logistics, warranty, shipping and handling
costs and, in the limited instance where we lease our network
security solutions to our customers, depreciation and
amortization. For both the year ended December 31, 2006 and
the year ended December 31, 2005, cost of product revenue
was 28% of total product revenue. Hardware costs, which are our
most significant cost items, generally have not fluctuated
materially as a percentage of revenue in recent years because
competition among hardware platform suppliers has remained
strong and, therefore, our hardware cost has remained
consistent. Because of the competition among hardware suppliers
and our outsourcing of the manufacture of our products to four
separate domestic contract manufacturers, we currently have no
reason to expect that our cost of product revenue as a
percentage of total product revenue will change significantly in
the foreseeable future due to hardware pricing increases.
However, hardware or other costs of manufacturing may increase
in the future. We incur labor and associated overhead expenses,
such as occupancy costs and fringe benefits costs, as part of
managing the manufacturing process. These costs are included as
a component of our cost of product revenue, but they have not
been material.
Cost of service revenue includes the direct labor costs of
professionals and outside consultants engaged to furnish those
services, as well as their travel and associated direct material
costs. Additionally, we include in cost of service revenue an
allocation of overhead expenses such as occupancy costs, fringe
benefits and supplies. For the years ended December 31,
2006 and 2005, cost of service revenue was 18% and 16% of total
service revenue, respectively, and, although we anticipate
incurring additional costs in the future for increased personnel
to support and service our growing customer base, we do not
expect the cost of service revenue as a percentage of service
revenue to change materially in the future.
Gross
Profit
Our gross profit is affected by a variety of factors, including
competition, the mix and average selling prices of our products,
our pricing policy, technical support and professional services,
new product introductions, the cost of hardware platforms, the
cost of labor to generate such revenue and the mix of
distribution channels through which our products are sold.
Although we have not had to reduce the prices of our products or
vary our pricing policy in recent years, our gross profit would
be adversely affected by price declines if we are unable to
reduce costs on existing products and to continue to introduce
new products with higher margins. Currently, product sales
typically have a lower gross profit as a percentage of revenue
than our services due to the cost of the hardware platform. Our
gross profit for any particular quarter could be adversely
affected if we do not complete sales of higher margin products
by the end of the quarter. As discussed above, many of our
customers do not finalize purchasing decisions
34
until the final weeks or days of a quarter, so a delay in even
one large order of a higher-margin product could reduce our
total gross profit percentage for that quarter. For both the
year ended December 31, 2006 and the year ended
December 31, 2005, gross profit was 75% of total revenue.
Based on current market conditions, we do not expect these
percentages to change significantly in the foreseeable future,
although unexpected pricing pressures or an increase in hardware
or other costs would cause our gross profit percentage to
decline.
Operating
Expenses
Research and Development. Research and
development expenses consist primarily of payroll, benefits and
related costs for our engineers, occupancy costs and other
overhead, costs for sophisticated components used in product and
prototype development and costs of test equipment used during
product development.
We have significantly expanded our research and development
capabilities and expect to continue to expand these capabilities
in the future. All of our research and development is performed
in the United States. We are committed to increasing the level
of innovative design and development of new products as we
strive to enhance our ability to serve our existing commercial
and federal government markets as well as new markets for
security solutions. To meet the changing requirements of our
customers, we will need to fund investments in several
development projects in parallel. Accordingly, we anticipate
that our research and development expenses will continue to
increase in absolute dollars for the foreseeable future, but
should decline moderately as a percentage of total revenue as we
expect to grow our sales more rapidly than our research and
development expenditures. For the years ended December 31,
2006 and 2005, research and development expense was
$8.6 million and $6.8 million, or 19% and 21% of total
revenue, respectively.
Sales and Marketing. Sales and marketing
expenses consist primarily of salaries, incentive compensation,
benefits and related costs for: sales and marketing personnel;
trade show, advertising, marketing and other brand-building
costs; marketing consultants and other professional services;
training, seminars and conferences; travel and related costs;
and occupancy and other overhead costs.
As we focus on increasing our market penetration, expanding
internationally and continuing to build brand awareness, we
anticipate that selling and marketing expenses will continue to
increase in absolute dollars, but decrease as a percentage of
our revenue, in the future.
For the years ended December 31, 2006 and 2005, sales and
marketing expense was $20.7 million and $17.1 million,
or 46% and 52% of total revenue, respectively.
General and Administrative. General and
administrative expenses consist primarily of: salaries,
incentive compensation, benefits and related costs for
executive, finance, information system and administrative
personnel; legal, accounting and tax preparation and advisory
fees; travel and related costs; information systems and
infrastructure costs; and occupancy and other overhead costs.
We expect our general and administrative expenses to increase
due to our preparations to become and to operate as a public
company, including costs associated with compliance with
Section 404 of the Sarbanes-Oxley Act, directors’ and
officers’ liability insurance, increased professional
services and a new investor relations function.
For the years ended December 31, 2006 and 2005, general and
administrative expense was $5.1 million and
$5.0 million or 11% and 16% of total revenue, respectively.
Stock-Based Compensation. Prior to
January 1, 2006, our stock-based compensation expense
consisted primarily of the amortization of unearned compensation
related to grants of restricted shares of our common stock to
certain officers and employees in 2002 and 2003, as well as the
modification of certain fixed stock option awards subsequent to
their grant date. Total stock-based compensation expenses
recorded in our statements of operations for 2003, 2004 and 2005
were $72,000, $177,000 and $470,000, respectively.
Effective January 1, 2006, the Company adopted the fair
value recognition provisions of the Financial Accounting
Standards Board’s SFAS No. 123(R),
“Share-Based Payment,” using the prospective
transition method, which requires the Company to apply its
provisions only to awards granted, modified, repurchased or
cancelled
35
after the effective date. Under this transition method,
stock-based compensation expense recognized beginning
January 1, 2006 is based on the grant date fair value of
stock awards granted or modified after January 1, 2006.
As a result of adopting SFAS No. 123(R) on
January 1, 2006, based on the estimated grant-date fair
value of employee stock options subsequently granted or
modified, the Company recognized aggregate stock-based
compensation expense of $703,000 for the year ended
December 31, 2006. The Company uses the Black-Scholes
option pricing model to estimate the calculated value of granted
stock options. The use of option valuation models requires the
input of highly subjective assumptions, including the expected
term and the expected stock price volatility.
The grant date fair value of options not yet recognized as
expense as of December 31, 2006 aggregated approximately
$3.4 million, net of estimated forfeitures, which will be
recognized over a weighted-average period of approximately four
years. We expect to record aggregate amortization of stock-based
compensation of approximately $1,251,000, $1,026,000, $791,000
and $321,000 during fiscal years 2007, 2008, 2009 and 2010,
respectively, from these outstanding awards, subject to
continued vesting.
Critical
Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United
States of America. The preparation of these consolidated
financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets,
liabilities, revenue, costs and expenses and related
disclosures. We evaluate our estimates and assumptions on an
ongoing basis. Our actual results may differ from these
estimates.
We believe that, of our significant accounting policies, which
are described in Note 2 to the notes to our consolidated
financial statements, the following accounting policies involve
a greater degree of judgment and complexity. Accordingly, we
believe that the following accounting policies are the most
critical to aid in fully understanding and evaluating our
consolidated financial condition and results of operations.
Revenue Recognition. We recognize
substantially all of our revenue in accordance with Statement of
Position
No. 97-2,
“Software Revenue Recognition,” or
SOP 97-2,
as amended by
SOP 98-4
and
SOP 98-9.
We establish persuasive evidence of an arrangement for each type
of revenue transaction based on:
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in the case of direct sales or indirect sales through some
resellers or distributors, either a signed contract with the end
user customer or a click-wrap contract embedded in the product,
whereby the end user customer agrees to our standard terms and
conditions,
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in the case of indirect sales through OEMs or some resellers or
distributors, a signed distribution contract with OEMs and other
resellers; or
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in the case of services, including support, training and other
professional services, through the execution of a separate
services arrangement.
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For each arrangement, we defer revenue recognition until all of
the following criteria have been met:
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persuasive evidence of an arrangement exists (e.g., a
signed contract);
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delivery of the product has occurred and there are no remaining
obligations or substantive customer acceptance provisions;
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the fee is fixed or determinable; and
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collection of the fee is probable.
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We allocate the total value of the arrangement among each
deliverable based on its fair value as determined by
vendor-specific objective evidence, such as standard product
discount levels, daily service rates and consistent support
level renewal pricing. If vendor-specific objective evidence of
fair value does not exist for each of the deliverables, all
revenue from the arrangement is further deferred until the
earlier of the point at which sufficient vendor-specific
objective evidence of fair value can be determined or all
elements of the arrangement have been delivered. However, if the
only undelivered elements are technical support
and/or
professional services, elements
36
for which we currently have established vendor specific
objective evidence of fair value, we recognize revenue for the
delivered elements using the residual method. Changes in
judgments and estimates about these assumptions could materially
impact the timing of revenue recognition.
Accounting for Stock-Based
Compensation. Prior to January 1, 2006,
we accounted for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion
No. 25, “Accounting for Stock Issued to
Employees,” or APB No. 25, and related
interpretations. Accordingly, compensation cost for stock
options generally was measured as the excess, if any, of the
estimated fair value of our common stock over the amount an
employee must pay to acquire the common stock on the date that
both the exercise price and the number of shares to be acquired
pursuant to the option are fixed. We had adopted the
disclosure-only provisions of SFAS No. 123,
“Accounting for Stock-Based Compensation,” and
SFAS No. 148, “Accounting for Stock-Based
Compensation — Transition and Disclosure,” which
was released in December 2002 as an amendment to
SFAS No. 123, and used the minimum value method of
valuing stock options as allowed for non-public companies.
In December 2004, the Financial Accounting Standards Board
issued SFAS No. 123(R), “Share-Based
Payment,” which revised SFAS No. 123 and
superseded APB No. 25. SFAS 123(R) focuses primarily
on transactions in which an entity obtains employee services in
exchange for share-based payments. Under SFAS 123(R), an
entity is generally required to measure the cost of employee
services received in exchange for an award of equity instruments
based on the grant date fair value of the award, with such cost
recognized over the applicable requisite service period. In
addition, SFAS 123(R) requires an entity to provide certain
disclosures in order to assist in understanding the nature of
share-based payment transactions and the effects of those
transactions on the financial statements. The provisions of
SFAS No. 123(R) are required to be applied as of the
beginning of the first interim or annual reporting period of the
entity’s first fiscal year that begins after
December 15, 2005.
Effective January 1, 2006, we adopted the fair value
recognition provisions of SFAS No. 123(R) using the
prospective transition method, which requires the Company to
apply the provisions of SFAS No. 123(R) only to awards
granted, modified, repurchased or cancelled after the effective
date. Under this transition method, stock-based compensation
expense recognized beginning January 1, 2006 is based on
the grant date fair value of stock awards granted or modified
after January 1, 2006. As the Company had used the minimum
value method for valuing its stock options under the disclosure
requirements of SFAS 123, all options granted prior to
January 1, 2006 continue to be accounted for under APB
No. 25.
In determining the grant date fair value of share-based
payments, we conducted contemporaneous valuations relying on the
guidance prescribed by the American Institute of Certified
Public Accountants in its practice aid, “Valuation of
Privately-Held-Company Equity Securities Issued as
Compensation,” or the Practice Aid. In each instance where
we made such a valuation determination, and as more fully
described below, we generally first determined a fair value of
the enterprise using one or both of the market approach or the
income approach. Once we determined an estimated fair value of
the enterprise, we then allocated that enterprise value to each
of our classes of stock based upon a consideration of those
classes’ relative economic and control rights, using a
methodology consistent with the Practice Aid, as discussed in
further detail below.
We did not obtain contemporaneous valuations by an unrelated
valuation specialist that we could rely on during the periods
outlined below. Instead, we relied on the experience of our
management team and our board of directors, which includes
several venture capitalists who have considerable experience in
the valuation of emerging companies and one member with
extensive experience as a chief financial officer of a publicly
traded company who joined our board in August 2006.
For the Period August 2005 through September
2005. We did not grant any share-based
payments during the period from August 2005 through September
2005. The primary reason for not granting any share-based
compensation during this period was because we believed that the
fair value of our enterprise was not easily determinable due to
our ongoing merger discussions with Check Point Software
Technologies Ltd., or Check Point.
October 2005. On October 5, 2005
our ongoing discussions with Check Point resulted in the signing
of a definitive merger agreement to be acquired for
approximately $225.0 million in cash. Later that month, we
granted an option to purchase 6,157 shares of our common
stock at an exercise price of $8.36 per share to one employee.
In connection with that grant, we determined that the fair value
of our common stock was also $8.36 per share and
37
therefore, in accordance with APB No. 25, did not record
any compensation expense since the award had no intrinsic value
on the measurement date. In concluding that $8.36 was the fair
value of our common stock, we followed the methodology outlined
above by first determining our enterprise value and then
allocating that value to each of our classes of stock. We
calculated an enterprise value of $225.0 million using the
market approach. We concluded that the market approach was the
most appropriate methodology at this time since it relied on
data generated by an actual market transaction. Immediately
prior to this grant, we executed a merger agreement with Check
Point, which proposed a definitive arm’s length transaction
between willing parties. We arrived at the $225.0 million
enterprise value using the aggregate consideration that Check
Point had agreed to pay for us. In addition to doing the
foregoing analysis, we also reviewed market data provided by our
investment advisors for comparable acquisition transactions that
had occurred in the previous several months to ascertain the
fairness of the Check Point offer.
In allocating the $225.0 million enterprise value to each
of our classes of stock, we used the current-value method since
we believed at the time of the valuation that a liquidity event
in the form of an acquisition was imminent. Using the
current-value method, we first allocated the proceeds to each of
our series of preferred stock based upon their respective
liquidation preferences and dividend rights. Specifically, we
allocated approximately $56.8 million in the aggregate to
our preferred stock, representing the liquidation preferences
plus all accrued but unpaid dividends. In accordance with our
Charter, we then allocated the remaining $168.2 million to
all equity securities assuming conversion of all securities into
shares of common stock. This resulted in a value of
approximately $8.85 per share of common stock. We then applied a
discount of approximately five percent to reflect the risk that
the proposed merger with Check Point would not be consummated,
and we arrived at fair value per common share of $8.36. We used
a five percent discount based upon advice received from our
financial advisors that such a discount was typical at similar
stages of similar transactions, as well as based on our own
opinions formed in negotiating the merger agreement with Check
Point.
For the Period November 2005 to March
2006. In January 2006 we granted options to
purchase a total of 171,489 shares of our common stock to
our employees at an exercise price of $8.36 per share. In
accordance with SFAS 123(R), we measured share-based
compensation expense with respect to these grants using the
Black-Scholes option pricing model using a per share fair value
of our common stock of $8.36 per share. In concluding that $8.36
was the fair value of our common stock, we followed the same
methodology used in October 2005 because we were still a party
to the proposed merger agreement with Check Point for which we
believed that consummation was imminent and therefore no
adjustment to the market approach previously used was warranted.
In late March 2006 we made a public announcement concerning the
withdrawal of our merger agreement with Check Point because we
could not obtain approval from the Department of Homeland
Security’s Committee on Foreign Investment in the United
States, or CFIUS.
April 2006. During April 2006, we
cancelled the 6,157 options previously granted in October 2005
as well as the options to purchase 159,175 shares of our
common stock we granted in January 2006, all at an exercise
price of $8.36 per share, and we reissued them at an exercise
price of $5.26 per share. Additionally, we granted new options
to employees to purchase an aggregate of 287,846 shares of
our common stock at $5.26 per share. In accordance with
SFAS 123(R), we measured the share-based compensation
expense with respect to these grants using the Black-Scholes
option pricing model using a per share fair value of our common
stock of $5.26 per share. In concluding that $5.26 was the fair
value of our common stock, we again followed the methodology
outlined above by first determining our enterprise value and
then allocating that value to each of our classes of stock.
In April 2006, we calculated an enterprise value of
$205.0 million using both a market approach and an income
approach. One fundamental factor that affected the enterprise
fair value calculated under both approaches, and resulted in an
enterprise value that was lower than the amount calculated
during the period from October 2005 through March 2006, was the
March 2006 withdrawal of our merger agreement from consideration
for approval by CFIUS. We considered valuations derived using
both approaches because we believed that neither approach, on
its own, would necessarily result in the best evidence of fair
value based on the status of our business. For example, we did
not believe that the market approach alone would be the most
appropriate methodology as a result of our inability to
consummate the Check Point transaction. Similarly, we believed
that relying solely on the income approach would not have
resulted in the best evidence of fair value because of the
inherent limitations of that approach in accounting for risk.
38
Under the market approach, we considered the merger agreement
with Check Point as one data point; however, we assigned less
probative value to that transaction in light of the termination
of that agreement due to the failure of the CFIUS approval
process. We also considered comparable recent acquisition
transactions that had occurred in the previous several months.
In deciding which companies and transactions were sufficiently
similar to us to result in a meaningful comparison, we looked to
the merger and acquisition market for security software
companies and specifically both public and private target
companies within that group that were similar to us in terms of
size (revenue and growth rates), industry, profitability (or net
loss experience), stage of development, enterprise valuations,
growth patterns, business model, and experience of the
management team. Examples of companies within this group, or the
Peer Group, included Abridean (acquired by nCipher), Cyberguard
(acquired by Secure Computing), Sygate (acquired by Symantec),
Omnipod (acquired by MessageLabs) LODOGA Security (acquired by
Transdigital), iDefense (acquired by Verisign), JP Mobile
(acquired by Good Technology) and GuardedBet (acquired by
Micromuse). We chose these companies because they best matched
the comparison criteria listed above without the need to make
further assumptions or adjustments to arrive at a meaningful
comparison.
In arriving at an enterprise fair value under this approach, we
placed significant emphasis on the enterprise value of companies
within the Peer Group expressed as a multiple of those
respective companies’ trailing revenues. We believe that
focusing on revenue multiples of trailing revenue was the best
evidence of fair value because the merger and acquisition market
for security software companies most commonly uses this approach
to measure valuation. Based on that assumption, in reviewing
companies within the Peer Group, we observed a range of revenue
multiples from 4.5 to 14.3 resulting in a mean revenue multiple
of 5.88. From this analysis and rounding to the nearest whole
number, we determined that an appropriate revenue multiple that
marketplace participants used to value companies within the Peer
Group was six times their 2005 revenues. Six times our 2005
revenues yielded an enterprise value of approximately
$197.0 million.
Under the income approach, we calculated our enterprise value
using the discounted cash flow method, which determines the
present value of the expected future economic benefit to an
equity holder by application of an appropriate discount rate.
Our EBITDA projections, working capital requirements and capital
expenditure requirements, all of which affect our cash flows,
were calculated through our fiscal year ending December 31,
2008. We did not use estimated cash flows for periods beyond our
fiscal year 2008 for two primary reasons. First, the projections
we used internally to manage our business included only detailed
results of our operations through our fiscal year ending
December 31, 2008. Second, the fact that we had limited and
variable historical data due to our establishment as an
enterprise in 2001 and our belief that the assumptions necessary
to determine cash flows from our business beyond 2008 were
highly speculative in nature and could have caused us to place
an inaccurate enterprise valuation on our business. To arrive at
a present value of these projected cash flows, we discounted
each year’s cash flows using a 20.8% weighted average cost
of capital. To these discounted cash flows we added the present
value of our estimated enterprise terminal value in early 2009.
Based on a review of comparable company market multiple data, we
determined this terminal value to be three times our estimated
2008 revenues, or $320.0 million. Taking into account the
discounted cash flows and this estimated terminal value, we
arrived at an enterprise value of $205.0 million. We used
this enterprise value to calculate the fair value of our common
stock since it did not differ materially from the estimated
enterprise value using the market approach.
In allocating the $205.0 million enterprise value to each
of our classes of stock, we again used the current-value method
since we still believed at the time that the most likely outcome
for our business was an acquisition transaction. We also
considered that if we had used the probability-weighted expected
return method of allocation, we believed the allocation results
would have been the same as those achieved using the
current-value method because in April 2006, we assigned a zero
probability to an IPO scenario. Accordingly, we allocated
approximately $57.8 million in the aggregate to our
preferred stock, representing the liquidation preferences plus
all accrued but unpaid dividends. We then allocated the
remaining $151.2 million, which included estimated option
exercise proceeds of $4.0 million, to all equity securities
assuming conversion of all securities into shares of common
stock. This resulted in a per share gross fair value of
approximately $8.25 per share of common stock. We then applied a
discount of fifteen percent (15%) to account for the lack of
marketability of our equity securities. In arriving at a fifteen
percent (15%) marketability discount, we considered the
following factors: our expectations of a ready market for our
securities in the future, the number, extent and terms of
existing contractual arrangements requiring us to purchase or
sell our securities, the restrictions on transferability of our
equity securities by our stockholders,
39
the existence of potential acquirors, the costs associated with
bringing equity securities to market, the risk and volatility of
our business, the size and timing of any projected dividends,
the difficulty in assigning a value to our equity interest and
the concentration of our ownership. In addition to the
marketability discount, we further discounted this value by
twenty-five percent (25%) to reflect the absence of any
strategic or synergistic benefits that would justify a valuation
premium for our common stockholders. Because our common
stockholders controlled significantly less than a 50% interest,
we considered that class a minority interest. In arriving at
this twenty-five percent (25%) discount, we considered the
following factors: the concentration of our ownership in
individual stockholders, the number of common stockholders and
the relative size of their holdings, the existence of potential
acquirors, the degree of influence a minority shareholder has,
patterns of historical liquidation of stockholders’
interests, how control is exercised and the average
change-of-control
premium realized in other comparable merger and acquisition
transactions. We relied on studies performed by merger and
acquisition data tracking service providers, such as Mergerstat
and Pratt’s Stats, to determine the appropriate
marketability and minority interest discounts. Applying both
discounts to the value of $8.25 per share yielded a fair value
of $5.26 per share. In determining that the result obtained
under this approach was the best evidence of our fair value, our
board also considered the negative impact that the withdrawal of
our Check Point merger agreement due to the CFIUS approval
process had on our business. Prior to entering into the merger
agreement, we had planned to generate both net income and
positive cash flow for 2006. As a result of the termination of
the merger agreement, we revised our 2006 operating plan
downward to reflect operational difficulties and uncertainties
associated with existing and potential government agency
customers, which had in some cases refrained from doing business
with us during the CFIUS review process. Although we had
increased our revenue and customer penetration substantially
over the previous few years, we still operated at a net loss and
had to use cash proceeds from private placements to fund our
operations. Thus, in April 2006, our board of directors
considered the foregoing analyses and concluded that $5.26 was
the best estimate of the fair value of our common stock for
purposes of granting options at that time.
For the Period May 2006 to September
2006. We did not grant any share-based
compensation to our employees during the period from May 2006
until September 2006, and thus recorded no expense with respect
to share-based compensation to our employees during that period.
October and November 2006. In October
2006 we granted options to purchase a total of
399,603 shares of our common stock to our employees at an
exercise price of $9.48 per share. In accordance with
SFAS 123(R), we measured share-based compensation expense
with respect to these grants using the Black-Scholes option
pricing model using a per share fair value of our common stock
of $9.48 per share. In concluding that $9.48 was the fair value
of our common stock, we again followed the methodology outlined
above by first determining our enterprise value and then
allocating that value to each of our classes of stock. In
addition to the allocation of the enterprise value to each of
our classes of stock, we also considered the impact of two
significant potential liquidity events: the successful
consummation of a public offering of our common stock, or the
IPO scenario, and the sale of the company in a merger or
acquisition transaction, or the M&A scenario. We took into
account the probability of each outcome in making our evaluation.
In October 2006, we calculated an enterprise value of
$226.0 million using a market approach, which we
corroborated using an income approach that considered discounted
cash flows. In conducting our analysis using the market
approach, we followed the same methodology that we used in
calculating fair value under that approach in April 2006, except
that we used a multiple of six times our revenues for the
trailing four quarters ended September 30, 2006 instead of
six times our 2005 revenues.
In allocating the $226.0 million enterprise value to each
of our classes of stock, we recognized that the methodology to
follow would differ from past periods because we faced the two
potential liquidity scenarios described above. In allocating the
enterprise value under the M&A scenario, we followed closely
the allocation methodology used in past periods whereby we first
allocated a portion of the enterprise fair value to our
preferred stock based upon its rights and preferences.
Accordingly, we allocated approximately $75.0 million in
the aggregate to our preferred stock based upon liquidation
preferences and accrued but unpaid dividends. We then allocated
the remaining $151.0 million to all equity securities
assuming conversion of all securities into shares of common
stock. This resulted in a per share value of approximately $7.55
per share of common stock.
40
In allocating the enterprise value under the IPO scenario, we
assumed that all of our preferred stock would automatically
convert to common stock based on the definition of a qualified
public offering contained in our Charter. Thus under the IPO
scenario allocation, we did not first allocate a portion of the
enterprise value to our preferred stock, but rather calculated
the value of approximately $11.42 per share assuming conversion
of all securities into shares of common stock.
Under this dual allocation approach, we then assigned a
probability to the M&A scenario and another probability to
the IPO scenario to arrive at a composite allocation. In October
2006, because of the relative uncertainty surrounding the
likelihood of an M&A scenario versus an IPO scenario, we
ascribed a 50% probability to the M&A scenario and 50%
probability to the IPO scenario, resulting in a fair value of
$9.48 per share. Thus, in mid-October 2006, our board of
directors considered the foregoing analyses and concluded that
$9.48 was the best estimate of the fair value of our common
stock for purposes of granting options at that time.
In November 2006 we granted options to purchase a total of
56,955 shares of our common stock to our employees at an
exercise price of $10.41 per share. In accordance with
SFAS 123(R), we measured share-based compensation expense
with respect to these grants using the Black-Scholes option
pricing model using a fair value of our common stock of $10.41
per share. In concluding that $10.41 was the fair value of our
common stock, we performed an analysis identical to the one we
performed in October 2006 using the same enterprise value of
$226.0 million. Because there was not a substantial
difference in our trailing four quarters of revenue as measured
in October and November, we determined that using an enterprise
value of $226.0 million for our analysis in both periods
was appropriate. The difference in the resultant valuation,
however, was in our assessment of an M&A scenario versus the
relative likelihood of an IPO scenario. In November 2006, we
determined that the IPO event scenario was more likely than it
had been in October because we had filed our initial
registration statement with the Securities and Exchange
Commission on October 25, 2006.
In allocating the $226.0 million enterprise value, we
followed the probability-weighted expected return method. Thus
we assigned a 75% probability to the $11.42 per share value
arrived under the IPO scenario and a 25% probability to the
$7.55 per share value arrived under the M&A scenario, given
our increased expectation of completing our initial public
offering. This probability-weighted expected return methodology
resulted in a per share fair value of our common stock of
$10.41. Thus, in November 2006, our board of directors
considered the foregoing analysis and concluded that $10.41 was
the best estimate of the fair value of our common stock for
purposes of granting options at that time.
December 2006. In December 2006 we
granted options to purchase a total of 38,484 shares of our
common stock to our employees at an exercise price of $11.34 per
share. In accordance with SFAS 123(R), we measured
share-based compensation expense with respect to these grants
using the Black-Scholes option pricing model using a per share
fair value of our common stock of $11.34 per share. In
concluding that $11.34 was a fair value of our common stock, we
followed an analysis similar to the ones that we performed in
October and November 2006.
We used an enterprise value of $250.0 million that we
determined based upon valuation discussions that we conducted
with our underwriters with respect to other recent technology
initial public offerings, and our perceptions of the
then-current market conditions. Additionally, in December 2006,
we determined that the IPO event scenario was just as likely as
it had been in November.
In allocating the $250.0 million enterprise value, we
followed the probability-weighted expected return method. Thus,
we assigned a 75% likelihood that the IPO scenario would occur
and a 25% likelihood that the M&A scenario would occur. In
allocating the enterprise value under the M&A scenario, we
followed closely the allocation methodology used in past periods
whereby we first allocated a portion of the enterprise fair
value to our preferred stock based upon its rights and
preferences. Accordingly, we allocated approximately
$79.0 million in the aggregate to our preferred stock based
upon liquidation preferences and accrued but unpaid dividends.
We then allocated the remaining $171.0 million to all
equity securities assuming conversion of all securities into
shares of common stock. Under the IPO scenario, we calculated
the fair value of approximately $12.26 per share assuming
conversion of all securities into shares of common stock. By
assigning a 25% probability to the $8.53 per share fair value
arrived under the M&A scenario and assigning a 75% probably
to the $11.34 per share fair value arrived under the IPO
scenario, this probability-weighted expected return methodology
resulted in a per share fair value of our common
41
stock of $11.34. Thus, in December 2006, our board of directors
considered the foregoing analysis and concluded that $11.34 was
the best estimate of the fair value of our common stock for
purposes of granting options at that time.
Based on an estimated offering price of $13.00, the intrinsic
value of the options outstanding at December 31, 2006 was
$32.2 million, of which $20.5 million related to
vested options and $11.7 million related to unvested
options.
As noted above, we use the Black-Scholes option pricing model to
estimate the calculated value of granted stock options. The use
of option valuation models requires the input of highly
subjective assumptions, including the expected term and the
expected stock price volatility. Additionally, the recognition
of expense requires the estimation of the number of options that
will ultimately vest and the number of options that will
ultimately be forfeited. Accordingly, the use of different
estimates and assumptions can have a significant impact on the
amount of stock-based compensation that is measured and
recognized.
Accounting for Income Taxes. Deferred taxes
are determined based on the difference between the financial
statement and tax basis of assets and liabilities using enacted
tax rates in effect in the years in which the differences are
expected to reverse. Valuation allowances are provided if, based
upon the weight of available evidence, it is more likely than
not that some or all of the deferred tax assets will not be
realized.
To date, for U.S. federal income tax purposes, we have
operated in a loss position. We have $28.1 million of net
operating loss carry-forwards as of December 31, 2006,
although the use of these net operating loss carry-forwards may
be significantly limited by changes in our ownership. As of
December 31, 2006, we recorded a full valuation allowance
against net deferred tax assets, including deferred tax assets
generated by net operating loss carry-forwards. These
carry-forwards will begin to expire in 2022. We expect that, to
the extent we have taxable income in years before their
expiration, these net operating loss carry-forwards will impact
our effective tax rate.
Warranty. We provide a one-year warranty
against defects in materials and workmanship and will either
repair the goods or provide replacement products at no charge to
the customer. We record estimated warranty costs, currently at
less than 1.0% of product revenue, based on historical
experience by product, at the time we recognize product revenue.
As the complexity of our products increases, we could experience
higher warranty claims relative to sales than we have previously
experienced, and we may need to increase these estimated
warranty reserves.
Bad Debt Reserve. We have historically used a
rate of 1.0% of outstanding accounts receivable to estimate our
reserve for bad debts based on analysis of past due balances and
historical experiences of write-offs. As we expand our business,
we expect our accounts receivable balance to grow. If our future
experience of actual write-offs for bad debts exceeds 1.0% of
our accounts receivable balance, we will have to increase our
reserve accordingly.
Inventory Valuation. We outsource our
manufacturing and our products are generally drop-shipped
directly to our customers by the manufacturers. Therefore, we
usually carry relatively little inventory. The inventory on our
balance sheet also includes products that we use for
demonstration purposes at customer locations. We value our
inventory at the lower of the actual cost of our inventory or
its current estimated market value. We write down inventory for
obsolescence or lack of marketability based upon condition of
the inventory and our view about future demand and market
conditions. Because of the seasonality of our product sales,
obsolescence of technology and product life cycles, we generally
write down inventory to net realizable value based on forecasted
product demand. Actual demand and market conditions may be lower
than those that we project and this difference could have a
material adverse effect on our gross profit if inventory
write-downs beyond those initially recorded become necessary.
42
Results
of Operations
The following table sets forth our results of operations for the
periods shown:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31,
|
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
|
(in thousands)
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
$
|
8,153
|
|
|
$
|
12,738
|
|
|
$
|
23,589
|
|
|
$
|
30,219
|
|
Services
|
|
|
1,328
|
|
|
|
3,955
|
|
|
|
9,290
|
|
|
|
14,707
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
9,481
|
|
|
|
16,693
|
|
|
|
32,879
|
|
|
|
44,926
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
2,570
|
|
|
|
4,533
|
|
|
|
6,610
|
|
|
|
8,440
|
|
Services
|
|
|
436
|
|
|
|
872
|
|
|
|
1,453
|
|
|
|
2,632
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
3,006
|
|
|
|
5,405
|
|
|
|
8,063
|
|
|
|
11,072
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
6,475
|
|
|
|
11,288
|
|
|
|
24,816
|
|
|
|
33,854
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
3,751
|
|
|
|
5,706
|
|
|
|
6,831
|
|
|
|
8,612
|
|
Sales and marketing
|
|
|
9,002
|
|
|
|
12,585
|
|
|
|
17,135
|
|
|
|
20,652
|
|
General and administrative
|
|
|
2,141
|
|
|
|
2,905
|
|
|
|
5,120
|
|
|
|
5,017
|
|
Depreciation and amortization
|
|
|
441
|
|
|
|
752
|
|
|
|
1,103
|
|
|
|
1,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
15,335
|
|
|
|
21,948
|
|
|
|
30,189
|
|
|
|
35,511
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(8,860
|
)
|
|
|
(10,660
|
)
|
|
|
(5,373
|
)
|
|
|
(1,657
|
)
|
Other income (expense), net
|
|
|
16
|
|
|
|
164
|
|
|
|
(85
|
)
|
|
|
792
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes
|
|
|
(8,844
|
)
|
|
|
(10,496
|
)
|
|
|
(5,458
|
)
|
|
|
(865
|
)
|
Income tax expense
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(67
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(8,844
|
)
|
|
$
|
(10,496
|
)
|
|
$
|
(5,458
|
)
|
|
$
|
(932
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43
The following table sets forth our results of operations as a
percentage of total revenue for the periods shown:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31,
|
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
|
(% of revenue)
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
86
|
%
|
|
|
76
|
%
|
|
|
72
|
%
|
|
|
67
|
%
|
Services
|
|
|
14
|
|
|
|
24
|
|
|
|
28
|
|
|
|
33
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
27
|
|
|
|
27
|
|
|
|
20
|
|
|
|
19
|
|
Services
|
|
|
5
|
|
|
|
5
|
|
|
|
5
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
32
|
|
|
|
32
|
|
|
|
25
|
|
|
|
25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
68
|
|
|
|
68
|
|
|
|
75
|
|
|
|
75
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
39
|
|
|
|
34
|
|
|
|
21
|
|
|
|
19
|
|
Sales and marketing
|
|
|
95
|
|
|
|
75
|
|
|
|
52
|
|
|
|
46
|
|
General and administrative
|
|
|
22
|
|
|
|
18
|
|
|
|
16
|
|
|
|
11
|
|
Depreciation and amortization
|
|
|
5
|
|
|
|
5
|
|
|
|
3
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
161
|
|
|
|
132
|
|
|
|
92
|
|
|
|
79
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(93
|
)
|
|
|
(64
|
)
|
|
|
(17
|
)
|
|
|
(4
|
)
|
Other income (expense), net
|
|
|
—
|
|
|
|
1
|
|
|
|
—
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes
|
|
|
(93
|
)
|
|
|
(63
|
)
|
|
|
(17
|
)
|
|
|
(2
|
)
|
Income tax expense
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(93
|
)%
|
|
|
(63
|
)%
|
|
|
(17
|
)%
|
|
|
(2
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comparison
of Years Ended December 31, 2006 and 2005
Revenue. Our total revenue increased 37% to
$44.9 million in the year ended December 31, 2006 from
$32.9 million in the year ended December 31, 2005.
Product revenue increased 28% to $30.2 million in the year
ended December 31, 2006 from $23.6 million in the year
ended December 31, 2005. We did not introduce any new
products during 2006 nor did we change the prices of our
products from 2005 to 2006. The increase in product revenue was
driven primarily by higher demand for our network security
solutions throughout both periods, specifically sales of our
enterprise class Intrusion Sensors which increased
$5.5 million during 2006. Our services revenue increased
58% to $14.7 million in the year ended December 31,
2006 from $9.3 million in the year ended December 31,
2005. The increase in service revenue resulted primarily from
support services being provided to a larger installed customer
base in the 2006 period.
Cost of Revenue. Our total cost of revenue
increased 36% to $11.1 million in the year ended
December 31, 2006, compared to $8.1 million in the
year ended December 31, 2005. Our product cost of revenue
increased 28% to $8.4 million in the year ended
December 31, 2006, compared to $6.6 million in the
year ended December 31, 2005. During these periods, we did
not experience a material increase in our cost per unit of
hardware platforms, which is the largest component of our
product cost of revenue. The increase in product cost of revenue
was driven primarily by higher volume demand for our network
security solutions for which we must procure and provide the
hardware platform to our customers. Our services cost of revenue
increased 81% to $2.6 million in the year ended
December 31, 2006, compared to $1.5 million in the
year ended December 31, 2005. Of this increase, $620,000
was attributable to our hiring of additional personnel to both
service our larger installed customer base
44
and to provide training and professional services to our
customers, and $190,000 was attributable to extending the
service contracts with the manufacturers for the hardware
platform included with our products for our installed base of
customers.
Gross Profit. Gross profit increased 36% to
$33.9 million in the year ended December 31, 2006,
from $24.8 million in the year ended December 31,
2005. Gross profit as a percentage of total revenue was 75% in
both the years ended December 31, 2006 and
December 31, 2005. This percentage did not vary between the
periods because our product mix, the selling prices of our
products and our hardware platform costs remained relatively
stable throughout both periods. The increase of
$9.1 million in gross profit was primarily due to an
increase in product sales and an increase in the number of
customers that contracted with us for support arrangements.
Research and Development. Research and
development expenses increased 26% to $8.6 million, or 19%
of total revenue, in the year ended December 31, 2006 from
$6.8 million, or 21% of total revenue, in the year ended
December 31, 2005. The increase in the amount of research
and development expenses was primarily due to an increase in
payroll and benefits of $1.8 million in the year ended
December 31, 2006, which resulted from adding personnel in
our research and development department to support the release
of updates and enhancements to RNA, Intrusion Sensor, and
Defense Center products. In addition, at the beginning of 2006,
we began product development work on a new release of the Snort
intrusion detection engine.
Sales and Marketing. Sales and marketing
expenses increased 21% to $20.7 million, or 46% of total
revenue, in the year ended December 31, 2006 from
$17.1 million, or 52% of total revenue, in the year ended
December 31, 2005. The increase in the amount of sales and
marketing expenses was primarily due to an increase of
$2.1 million in salaries and incentive compensation expense
for additional sales personnel, as well as an increase of
$0.4 million for stock compensation expense and
$0.3 million in advertising and promotion expenses in
support of our 3D marketing message for our network security
solutions.
General and Administrative. General and
administrative expenses decreased 2% to $5.0 million, or
11% of total revenue in the year ended December 31, 2006
from $5.1 million, or 16% of total revenue in the year
ended December 31, 2005. During 2006, payroll and benefits
increased $180,000 for personnel hired in our accounting,
information technology, human resources and legal departments,
stock compensation increased $280,000 for the adoption of
FAS 123R, and audit and tax consulting increased $110,000;
however, these increases were offset by a reduction of $620,000
in legal fees associated with the planned merger with Check
Point Software Technologies, Inc. that was negotiated in the
summer and autumn of 2005 and withdrawn in March 2006
Depreciation and Amortization. Depreciation
and amortization expenses increased 12% to $1.2 million in
the year ended December 31, 2006 from $1.1 million in
the year ended December 31, 2005. These expenses increased
principally because of additional personal computers purchased
for personnel hired during 2006.
Comparison
of Years Ended December 31, 2005 and 2004
Revenue. Our total revenue increased 97% to
$32.9 million in the year ended December 31, 2005 from
$16.7 million in the year ended December 31, 2004.
Product revenue increased 85% to $23.6 million in 2005 from
$12.7 million in 2004. The increase in product revenue was
primarily driven by increasingly strong demand for our
3D security solutions, particularly by Fortune
100 companies, of which we added seven as customers during
2005. During the fourth quarter of 2005 we introduced our
enterprise class Intrusion Sensors which resulted in $900,000 of
incremental sales over 2004. Additionally, the Company
experienced further demand for its RNA product during 2005
resulting in incremental sales of $2.3 million. We made no
material changes in the selling prices of our products in 2004
or 2005. Our services revenue increased 135% to
$9.3 million in 2005 from $4.0 million in 2004. The
$5.3 million increase resulted primarily from an additional
$4.4 million in revenue generated from support services
being provided to a larger installed customer base in 2005 than
in 2004, and a $880,000 increase in professional and training
services revenue resulting from our increase in the number of
training programs and the personnel to provide these services in
2005 over 2004. During 2005, we created the Sourcefire
Certification Program to provide training for network security
professionals.
Cost of Revenue. Our total cost of revenue
increased 49% to $8.1 million in the year ended
December 31, 2005 from $5.4 million in the year ended
December 31, 2004. Our product cost of revenue increased
46% to
45
$6.6 million in 2005, compared to $4.5 million in
2004. The increase in product cost of revenue was primarily
attributable to additional hardware platform costs for the
approximately 550 incremental units shipped in 2005 over the
amount shipped in 2004, as well as the shipment of our more
costly enterprise class intrusion sensors, which were introduced
in August 2005. Our cost for hardware platforms and
manufacturing did not change materially between 2004 and 2005.
Additionally our royalty cost of providing third party software
in our products increased by approximately $400,000. Our
services cost of revenue increased 67% to $1.5 million in
the 2005, compared to $872,000 in 2004. Of this increase,
approximately $310,000 was attributable to salaries, bonuses and
associated employee benefits and overhead costs for our hiring
of additional training and professional service personnel in
2005, with a further $270,000 attributable to travel, facilities
and consulting costs incurred in the provision of training and
services in 2005 over 2004.
Gross Profit. Our gross profit increased 120%
to $24.8 million in 2005, from $11.3 million in 2004.
Gross profit as a percentage of total revenue increased to 75%
in 2005 from 68% in 2004. This increase in gross profit, as a
percentage of total revenue, was principally due to a change in
product mix between the periods, with a larger percentage of
higher margin products being sold in 2005, and significant
growth in our customer support revenue of $4.5 million,
which did not require an equivalent incremental expense for
support personnel.
Research and Development. Research and
development expenses increased 20% to $6.8 million, or 21%
of total revenue, in the year ended December 31, 2005 from
$5.7 million, or 34% of total revenue, in the year ended
December 31, 2004. In 2005, we increased our research and
development staff to support the development of enhancements to
our 3D product line and the introduction of our enterprise class
intrusion sensor, which resulted in an approximate increase of
$500,000 in compensation and benefits for additional research
and development personnel. Additionally we submitted our
products to multiple independent security testing processes in
2005, which cost us an additional $420,000 in testing and
certification.
Sales and Marketing. Sales and marketing
expenses increased 36% to $17.1 million, or 52% of total
revenue, in the year ended December 31, 2005 from
$12.6 million, or 75% of total revenue, in the year ended
December 31, 2004. The reduction in the percentage of sales
and marketing costs to total revenue resulted primarily from an
increase in support revenue as well as an increase in sales
efficiency against higher sales quotas. The increase of
$4.5 million in 2005 resulted primarily from
$1.7 million in additional compensation and benefits for
personnel added to the sales force, $1.6 million in
additional incentive compensation earned on significantly higher
sales volume and an increase of $700,000 in marketing expenses
to support the company’s growth and product brand
recognition programs.
General and Administrative. General and
administrative expenses increased to $5.1 million, or 16%
of total revenue in the year ended December 31, 2005 from
$2.9 million, or 17% of total revenue in the year ended
December 31, 2004. The significant increase in 2005
resulted from $1.1 million in legal fees, including
$750,000 of one-time fees resulting from our planned acquisition
by Check Point Software Technologies, Ltd., and approximately
$900,000 in additional compensation and benefits for additional
general and administrative personnel.
Depreciation and Amortization. Depreciation
and amortization expenses increased 47% to $1.1 million in
the year ended December 31, 2005 from $752,000 in the year
ended December 31, 2004. These expenses increased
principally because of additional amortization of leasehold
improvements made to our principal place of business into which
we moved in April 2005.
Comparison
of Years Ended December 31, 2004 and 2003
Revenue. Our total revenue increased 76% to
$16.7 million in the year ended December 31, 2004,
from $9.5 million in the year ended December 31, 2003.
Product revenue increased 56% to $12.7 million in 2004 from
$8.2 million in 2003. The increase in product revenue in
2004 resulted primarily from an increase in demand for our
network security products, the first full year of sales for both
our RNA product, which was introduced in December 2003, and our
enterprise class Defense Center, which was introduced in
September 2003. Sales of RNA increased by $2.1 million and
incremental sales of the enterprise class Defense Center were
$550,000. Our services revenue increased 198% to
$4.0 million in 2004 from $1.3 million in 2003. The
increase in services revenue resulted
46
primarily from a $2.5 million increase in our support
services for our growing customer base as well as the first year
of professional training and service revenues of $160,000, which
programs were initiated in early 2004.
Cost of Revenue. Our total cost of revenue
increased to $5.4 million, or 32% of total revenue in 2004,
from $3.0 million, or 32% of total revenue, in 2003. Our
product cost of revenue increased 76% to $4.5 million in
2004, compared to $2.6 million in 2003. The increase in
product cost of revenue is primarily due to the increase in
product revenue of $4.5 million and the resulting increase
in our cost of hardware of $1.5 million. The cost of the
hardware platforms as a percentage of the selling price remained
relatively static at 29% and 27% for 2004 and 2003,
respectively. Our services cost of revenue increased 100% to
$872,000 in 2004 from $436,000 in 2003. This increase was
attributable to the addition in 2004 of personnel to perform
training services, which contributed $440,000 of additional
compensation, benefits and associated supplies and overhead
expenses.
Gross Profit. Gross profit increased to
$11.3 million in 2004 from $6.5 million in 2003. Gross
profit as a percentage of total revenue was 68% for both 2004
and 2003. The $4.8 million increase was achieved primarily
by increasing the volume of products sold while maintaining a
consistent hardware platform cost per unit relative to revenue
of 29% and 27% in 2004 and 2003, respectively.
Research and Development. Research and
development expenses increased 52% to $5.7 million, or 34%
of total revenue, in the year ended December 31, 2004 from
$3.8 million, or 40% of total revenue, in the year ended
December 31, 2003. The increase of $1.9 million
resulted primarily from the addition of hired personnel and
outside consultants to our research and development team to
support the development of our RNA product, which contributed an
increase of $1.4 million in compensation and benefits
expenses and $550,000 of consulting costs in 2004.
Sales and Marketing. Sales and marketing
expenses increased 40% to $12.6 million, or 75% of total
revenue, in the year ended December 31, 2004 from
$9.0 million, or 95% of total revenue in the year ended
December 31, 2003. The reduction in the percentage of sales
and marketing costs to total revenue resulted primarily from an
increase in support revenue as well as an increase in sales
efficiency against higher sales quotas. The increase of
$3.6 million in 2004 was primarily due to approximately
$1.3 million for salary and benefits for the addition of
personnel to the sales force, approximately $900,000 in
additional incentive compensation earned on significantly higher
sales volume and an increase of $800,000 in marketing expenses
to support the company’s growth and product brand
recognition.
General and Administrative. General and
administrative expenses increased to $2.9 million, or 17%
of total revenue, in the year ended December 31, 2004 from
$2.1 million, or 23% of total revenue in the year ended
December 31, 2003. The increase in 2004 resulted primarily
from additional personnel in finance and information technology,
which added approximately $600,000 of compensation and benefits
expenses.
Depreciation and Amortization. Depreciation
and amortization expenses increased 71% to $752,000 in the year
ended December 31, 2004 from $441,000 in the year ended
December 31, 2003. These expenses increased principally
because of an increase in purchases of testing equipment for our
research and development lab as well as personal computers for
additional personnel hired during 2004.
47
Quarterly
Results of Operations
You should read the following tables presenting our unaudited
quarterly results of operations in conjunction with the
consolidated financial statements and related notes contained
elsewhere in this prospectus. We have prepared the unaudited
information on the same basis as our audited consolidated
financial statements. You should also keep in mind, as you read
the following tables, that our operating results for any quarter
are not necessarily indicative of results for any future
quarters or for a full year.
The following table presents our unaudited quarterly results of
operations for the eight fiscal quarters ended December 31,
2006. This table includes all adjustments, consisting only of
normal recurring adjustments, that we consider necessary for
fair statement of our operating results for the quarters
presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
Sept. 30,
|
|
|
Dec. 31,
|
|
|
March 31,
|
|
|
June 30,
|
|
|
Sept. 30,
|
|
|
Dec. 31,
|
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
2006
|
|
|
2006
|
|
|
|
(unaudited)
|
|
|
|
(in thousands)
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
$
|
4,890
|
|
|
$
|
4,019
|
|
|
$
|
5,980
|
|
|
$
|
8,700
|
|
|
$
|
5,423
|
|
|
$
|
6,040
|
|
|
$
|
6,927
|
|
|
$
|
11,829
|
|
Services
|
|
|
1,862
|
|
|
|
2,076
|
|
|
|
2,397
|
|
|
|
2,955
|
|
|
|
3,109
|
|
|
|
3,495
|
|
|
|
3,940
|
|
|
|
4,163
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
6,752
|
|
|
|
6,095
|
|
|
|
8,377
|
|
|
|
11,655
|
|
|
|
8,532
|
|
|
|
9,535
|
|
|
|
10,867
|
|
|
|
15,992
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
1,375
|
|
|
|
1,082
|
|
|
|
1,772
|
|
|
|
2,381
|
|
|
|
1,397
|
|
|
|
1,721
|
|
|
|
1,813
|
|
|
|
3,509
|
|
Services
|
|
|
290
|
|
|
|
332
|
|
|
|
359
|
|
|
|
472
|
|
|
|
610
|
|
|
|
681
|
|
|
|
725
|
|
|
|
616
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
1,665
|
|
|
|
1,414
|
|
|
|
2,131
|
|
|
|
2,853
|
|
|
|
2,007
|
|
|
|
2,402
|
|
|
|
2,538
|
|
|
|
4,125
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
5,087
|
|
|
|
4,681
|
|
|
|
6,246
|
|
|
|
8,802
|
|
|
|
6,525
|
|
|
|
7,133
|
|
|
|
8,329
|
|
|
|
11,867
|
|
Operating expenses
|
|
|
6,547
|
|
|
|
6,466
|
|
|
|
8,021
|
|
|
|
9,155
|
|
|
|
8,440
|
|
|
|
8,485
|
|
|
|
8,420
|
|
|
|
10,166
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(1,460
|
)
|
|
|
(1,785
|
)
|
|
|
(1,775
|
)
|
|
|
(353
|
)
|
|
|
(1,915
|
)
|
|
|
(1,352
|
)
|
|
|
(91
|
)
|
|
|
1,701
|
|
Other income (expense)
|
|
|
(1
|
)
|
|
|
(10
|
)
|
|
|
(39
|
)
|
|
|
(35
|
)
|
|
|
(10
|
)
|
|
|
156
|
|
|
|
296
|
|
|
|
350
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before income taxes
|
|
|
(1,461
|
)
|
|
|
(1,795
|
)
|
|
|
(1,814
|
)
|
|
|
(388
|
)
|
|
|
(1,925
|
)
|
|
|
(1,196
|
)
|
|
|
205
|
|
|
|
2,051
|
|
Income tax expense
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(1,461
|
)
|
|
$
|
(1,795
|
)
|
|
$
|
(1,814
|
)
|
|
$
|
(388
|
)
|
|
$
|
(1,925
|
)
|
|
$
|
(1,196
|
)
|
|
$
|
205
|
|
|
$
|
1,984
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by
operations
|
|
|
680
|
|
|
|
(1,316
|
)
|
|
|
(2,086
|
)
|
|
|
(1,736
|
)
|
|
|
2,701
|
|
|
|
(1,205
|
)
|
|
|
416
|
|
|
|
156
|
|
48
The following table sets forth our results of operations as a
percentage of total revenue for the periods shown:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
Sept. 30,
|
|
|
Dec. 31,
|
|
|
March 31,
|
|
|
June 30,
|
|
|
Sept. 30,
|
|
|
Dec. 31,
|
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
2006
|
|
|
2006
|
|
|
|
(unaudited)
|
|
|
|
(% of revenue)
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
72
|
%
|
|
|
66
|
%
|
|
|
71
|
%
|
|
|
75
|
%
|
|
|
64
|
%
|
|
|
63
|
%
|
|
|
64
|
%
|
|
|
74
|
%
|
Services
|
|
|
28
|
|
|
|
34
|
|
|
|
29
|
|
|
|
25
|
|
|
|
36
|
|
|
|
37
|
|
|
|
36
|
|
|
|
26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
21
|
|
|
|
18
|
|
|
|
21
|
|
|
|
20
|
|
|
|
16
|
|
|
|
18
|
|
|
|
17
|
|
|
|
22
|
|
Services
|
|
|
4
|
|
|
|
5
|
|
|
|
4
|
|
|
|
4
|
|
|
|
7
|
|
|
|
7
|
|
|
|
7
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
25
|
|
|
|
23
|
|
|
|
25
|
|
|
|
24
|
|
|
|
23
|
|
|
|
25
|
|
|
|
24
|
|
|
|
26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
75
|
|
|
|
77
|
|
|
|
75
|
|
|
|
76
|
|
|
|
77
|
|
|
|
75
|
|
|
|
76
|
|
|
|
74
|
|
Operating expenses
|
|
|
97
|
|
|
|
106
|
|
|
|
96
|
|
|
|
79
|
|
|
|
99
|
|
|
|
89
|
|
|
|
77
|
|
|
|
64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(22
|
)
|
|
|
(29
|
)
|
|
|
(21
|
)
|
|
|
(3
|
)
|
|
|
(22
|
)
|
|
|
(14
|
)
|
|
|
(1
|
)
|
|
|
10
|
|
Other income (expense)
|
|
|
—
|
|
|
|
—
|
|
|
|
(1
|
)
|
|
|
—
|
|
|
|
(1
|
)
|
|
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1
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3
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2
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(Loss) income before income tax
expense
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(22
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)
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(29
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)
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(22
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)
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(3
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)
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(23
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)
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(13
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)
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2
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12
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Income tax expense
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—
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—
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—
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—
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—
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—
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—
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—
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Net (loss) income
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(22
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)%
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(29
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)%
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(22
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)%
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(3
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)%
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(23
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)%
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(13
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)%
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2
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%
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12
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%
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Seasonality
Our product revenue has tended to be seasonal. In our third
quarter, we have historically benefited from the Federal
government’s fiscal year end purchasing activity. This
increase has been partially offset, however, by European sales,
which have tended to decline significantly in the summer months
due to the practice by many Europeans of taking extended
vacation time and delaying capital purchase activities until
their return in the fall. We have historically generated a
significant portion of product revenue in the fourth quarter due
to the combination of increased activity in Europe coupled with
North American enterprise customers who often wait until the
fourth quarter to extract favorable pricing terms from their
vendors, including Sourcefire. The timing of these shipments
could materially affect our year-end product revenue. Currently,
we do not see any indication that these seasonal patterns will
change significantly in the foreseeable future.
Quarterly
Timing of Revenue
On a quarterly basis, we have usually generated the majority of
our product revenue in the final month of each quarter. We
believe this occurs for two reasons. First, many customers wait
until the end of the quarter to extract favorable pricing terms
from their vendors, including Sourcefire. Second, our sales
personnel, who have a strong incentive to meet quarterly sales
targets, have tended to increase their sales activity as the end
of a quarter nears, while their participation in sales
management review and planning activities are typically
scheduled at the beginning of a quarter.
Liquidity
and Capital Resources
At December 31, 2006 and December 31, 2005, our
principal sources of liquidity were cash and cash equivalents
totaling $13.0 million and $1.1 million, respectively,
held-to-maturity investments of $13.3 million and
49
$2.0 million, respectively, and accounts receivable of
$16.5 million and $12.9 million, respectively. We have
funded our growth primarily with proceeds from the issuance of
convertible preferred stock for aggregate net cash proceeds of
$56.5 million through December 31, 2006, occasional
borrowings under a working capital line of credit and cash
generated from operations.
We manufacture and distribute our products through contract
manufacturers and OEMs. We believe that this approach gives us
the advantages of relatively low capital investment and
significant flexibility in scheduling production and managing
inventory levels. By leasing our office facilities, we also
minimize the cash needed for expansion. Our capital spending is
generally limited to leasehold improvements, computers, office
furniture and product-specific test equipment. The majority of
our products are delivered to our customers directly from our
contract manufacturers. Accordingly, our contract manufacturers
are responsible for purchasing and stocking the components
required for the production of our products and they invoice us
when the finished goods are shipped.
Our product sales are, and are expected to continue to be,
highly seasonal. This seasonality typically results in a
significant amount of cash provided by our operating activities
during the first half of the year with lower to negative cash
flow during the second half of the year. We have cash reserves
and a working capital line of credit that can be utilized to
cover any short-term cash needs resulting from the seasonality
of our business.
Discussion
of Cash Flows
Net cash provided by our operating activities in 2006 was
$2.1 million compared to net cash used in our operating
activities in 2005, 2004 and 2003 of $4.5 million,
$9.8 million and $7.6 million, respectively.
The cash provided by our operations in 2006 resulted primarily
from an increase in deferred revenue of $3.5 million, an
increase in accounts payable and accrued expenses of
$1.6 million, and depreciation and amortization of
$1.3 million and stock based compensation of $806,000, both
of which are non-cash charges, offset by an increase in accounts
receivable of $3.6 million and a net loss of $932,000.
Deferred revenue increased primarily due to an increase of
$4.4 million in support services provided to customers. The
increase in accounts payable and accrued expenses resulted
primarily from additional legal costs associated with this
offering and additional contract manufacturing costs associated
with increased sales volume. The increase in accounts receivable
resulted primarily from our seasonally significant fourth
quarter product sales that are invoiced and recorded as revenue
but not collected as of the end of the calendar year.
The cash used in our operating activities in 2005 resulted
primarily from a net loss of $5.5 million and an increase
of $5.1 million in accounts receivable and
$1.1 million in inventory, offset by an increase in
deferred revenue of $5.0 million, and depreciation and
amortization of $1.1 million and stock-based compensation
of $470,000, both of which are non-cash charges. The increase in
accounts receivable resulted primarily from our seasonally
significant fourth quarter product sales that are invoiced and
recorded as revenue but not collected as of the end of the
calendar year, while the increase in inventory was primarily due
to the expansion of our number of evaluation, or demonstration,
products, especially the enterprise class intrusion sensors.
Deferred revenue increased primarily due to an increase of
$3.6 million for support services to customers, which are
usually paid for in advance but recorded as revenue ratably
throughout the term of the service contract.
The cash used in our operating activities in 2004 resulted
primarily from a net loss of $10.5 million and an increase
of $4.7 million in accounts receivable and $409,000 in
inventory, offset by an increase in deferred revenue of
$3.1 million, an increase in accounts payable and accrued
expenses of $1.7 million and depreciation and amortization
of $756,000 and stock-based compensation of $177,000, both of
which are non-cash charges. The increase in accounts receivable
resulted primarily from our seasonally significant fourth
quarter product sales that are invoiced and recorded as revenue
but not collected as of the end of the calendar year, while the
increase in inventory was primarily due to the expansion of our
number of evaluation, or demonstration, products. Deferred
revenue increased primarily due to an increase of
$2.4 million for support services to customers and $480,000
for products.
Historically, we have incurred significant losses, largely
attributable to our investment in internally funded research and
development and the rapid expansion of our sales force. Based on
our historical product development efforts, we launched our
first commercial products in November 2001. Since November 2001,
our revenue has
50
significantly increased, our investment in internally-funded
research and development has declined as a percentage of
revenue, but not for any subsequent period. We have not invested
significantly in property, plant and equipment, and we have
established an outsourced approach to manufacturing that
provides significant flexibility in both managing inventory
levels and financing our inventory. Our revenue has been highly
seasonal. This seasonality tends to result in the generation of
cash in the first quarter of the year, due to the collection of
accounts receivable from significant fourth quarter billings,
and the net use of cash during the remaining nine months of the
year. Given the recent success of our products and resulting
growth in revenue, we believe that the proceeds of this
offering, existing cash, cash equivalents, cash provided by
operating activities and funds available through our bank line
of credit will be sufficient to meet our working capital and
capital expenditure needs for at least the next 24 months.
Credit Facility. In March 2005, we renewed our
loan and security agreement with Silicon Valley Bank, under
which we increased our working capital line of credit with
Silicon Valley Bank so that we can borrow up to
$5.0 million. This agreement also provides for an
additional $1.0 million equipment facility for capital
expenditure financing and we obtained a supplemental
$1.0 million equipment facility in July 2006, for a total
of $2.0 million. Interest on the working capital line of
credit accrues at a variable rate of prime plus 0.5%. The line
expires on March 28, 2007, at which time all advances will
be immediately due and payable. We intend to renew this credit
facility for a minimum period of one year. As of
December 31, 2006, we had no amounts outstanding and
$4.8 million available under our working capital line of
credit. Any borrowings we may make under the working capital
line of credit would be secured by substantially all of our
assets, other than our intellectual property. We have issued a
$201,000 standby letter of credit which reduces the available
borrowings under the agreement by that amount. For the equipment
facility, we were allowed to request advances through
January 31, 2007. Each advance is collateralized into a
note payable at a fixed rate of 9.0% or prime plus 0.5% over a
term of 36 months. As of December 31, 2006, we had
$1,312,000 outstanding and $113,000 remaining available under
the equipment facility. The $113,000 remaining availability was
fully utilized as of January 31, 2007. The working capital line
of credit restricts our ability to:
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incur or guaranty additional indebtedness;
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create liens;
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enter into transactions with affiliates;
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make loans or investments;
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sell assets;
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•
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pay dividends or make distributions on, or repurchase, our
stock; or
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•
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consolidate or merge with other entities.
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In addition, we are required to maintain a monthly adjusted
quick ratio (unrestricted cash plus accounts receivable to
current liabilities, excluding deferred revenue, plus long-term
debt) of 1.5 to 1.0 and we must achieve a positive earnings
before interest, taxes, depreciation and amortization by the
calendar quarter ending March 31, 2007. These thresholds
are based on our stockholders’ equity, assuming conversion
of all of our convertible preferred stock into shares of common
stock. These operating and financial covenants may restrict our
ability to finance our operations, engage in business activities
or expand or pursue our business strategies. As of
December 31, 2006, we were in compliance with all covenants
under the credit facility. To the extent we are unable to
satisfy those covenants in the future, we will need to obtain
waivers to avoid being in default of the terms of either of our
credit facilities. In addition to a covenant default, other
events of default under our credit facilities include the filing
or entry of a tax lien, attachment of funds or material judgment
against us, or other uninsured loss of our material assets. If a
default occurs, the bank may require that we immediately repay
all amounts of principal and interest then outstanding. After
this offering, we expect that we will have sufficient resources
to fund any amounts which may become due under this credit
facility as a result of a default by us or otherwise. Any
amounts which we may be required to repay prior to a scheduled
repayment date, however, would reduce funds that we could
otherwise allocate to other opportunities that we consider
desirable.
Working
Capital and Capital Expenditure Needs
Except as disclosed in the Contractual Obligations table below,
we currently have no material cash commitments, except for
normal recurring trade payables, expense accruals and operating
leases, all of which we
51
anticipate funding through our existing working capital line of
credit, our available working capital and funds expected to be
provided by operating activities. In addition, we do not
currently anticipate significant investment in property, plant
and equipment, and we believe that our outsourced approach to
manufacturing provides us significant flexibility in both
managing inventory levels and financing our inventory. In the
event that our revenue plan does not meet our expectations, we
may eliminate or curtail expenditures to mitigate the impact on
our working capital. Our future capital requirements will depend
on many factors, including our rate of revenue growth, the
expansion of our marketing and sales activities, the timing and
extent of spending to support product development efforts, the
timing of introductions of new products and enhancements to
existing products, the acquisition of new capabilities or
technologies, and the continuing market acceptance of our
products and services. Moreover, to the extent that existing
cash, cash equivalents, cash from operations, cash from
short-term borrowing and the net proceeds from this offering are
insufficient to fund our future activities, we may need to raise
additional funds through public or private equity or debt
financing. In the years ended December 31, 2006 and 2005 we
spent $1.3 million and $2.2 million, respectively, on
capital equipment. Our capital expenditure budget for 2007
totals approximately $2.5 million, which is expected to
include approximately $400,000 for leasehold improvements,
$1.2 million for additional testing equipment for our
research and development lab, $600,000 for additional
network systems and $300,000 for personal computers for
additional personnel we anticipate hiring.
Although we are currently not a party to any agreement or letter
of intent with respect to potential investments in, or
acquisitions of, businesses, services or technologies, we may
enter into these types of arrangements in the future, which
could also require us to seek additional equity or debt
financing. Additional funds may not be available on terms
favorable to us or at all. We currently have no plans, proposals
or arrangements with respect to any specific acquisition.
Contractual
Obligations
Our principal commitments consist of obligations under our
equipment facility, leases for office space and minimum
contractual obligations for services. The following table
describes our commitments to settle contractual obligations in
cash as of December 31, 2006:
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Payments due by period
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Less than
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1-3
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3-5
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More than
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Total
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1 year
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years
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years
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5 years
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(in thousands)
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Equipment Line of Credit Facility
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$
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1,312
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$
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675
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$
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637
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$
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—
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$
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—
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Operating Leases
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5,511
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1,576
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2,604
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1,290
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|
41
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Purchase
Commitments(1)
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1,655
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1,388
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267
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—
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—
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(1)
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We entered into a purchase commitment with a hardware
manufacturing vendor with whom we have a current arrangement.
Under the terms of this commitment, we have agreed to purchase a
set quantity of new appliance inventory over an 18-month period.
The approximate value of the purchase commitment is $800,000 and
we expect to commence making payments under this commitment
beginning in April 2007 once the new appliance configuration is
accepted. Additionally, we have entered into a purchase
commitment with a vendor to license database software that is
used in our products. Under the terms of the commitment, we are
permitted to distribute the vendor’s software in our
products through December 31, 2010 in exchange for an up
front payment, plus annual maintenance fees. The approximate
aggregate value of the purchase commitment is $855,000, which
was paid in January 2007.
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As of December 31, 2006, our total contractual obligations
were $6.8 million or a net increase of $2.8 million
over the amount due at December 31, 2005, due to increased
borrowings under our equipment facility with Silicon Valley
Bank, our off-balance sheet arrangement with ePlus, and new
leases of office space.
Off-Balance
Sheet Arrangements
As of December 31, 2006, we had an off-balance sheet
arrangement with ePlus, a supplier and financier of computer
equipment and furniture. The arrangement provides financing that
does not meet the requirement of
52
generally accepted accounting principles for treatment as
capitalized equipment and furniture due to the short length of
the term of the financing versus the useful life of the
equipment and furniture. As of December 31, 2006 we had
utilized approximately $845,000 of this arrangement which has no
set expiration date, but can be terminated by either party
providing the other party notice of the intent to discontinue.
Recent
Accounting Pronouncement
On July 13, 2006, the FASB issued FIN 48,
“Accounting for Uncertainty in Income Taxes.”
FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in
accordance with FASB Statement No. 109, “Accounting
for Income Taxes.” FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected
to be taken in a tax return. FIN 48 also provides guidance
on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition.
FIN 48 is effective for fiscal years beginning after
December 15, 2006. An enterprise is required to disclose
the cumulative effect of the change on retained earnings in the
statement of financial position as of the date of adoption and
such disclosure is required only in the year of adoption. We are
currently evaluating the effect that FIN 48 will have on
our consolidated balance sheets, consolidated statements of
operations or consolidated statements of cash flows.
Quantitative
and Qualitative Disclosures about Market Risk
Foreign
Currency Risk
Nearly all of our revenue is derived from transactions
denominated in U.S. dollars, even though we maintain sales
and business operations in foreign countries. As such, we have
exposure to adverse changes in exchange rates associated with
operating expenses of our foreign operations, but we believe
this exposure to be immaterial at this time. As we grow our
international operations, our exposure to foreign currency risk
could become more significant.
Interest
Rate Sensitivity
We had unrestricted cash, cash equivalents and held-to-maturity
investments totaling $26.3 million at December 31,
2006. The unrestricted cash and cash equivalents are held for
working capital purposes while investments, made in accordance
with our low-risk investment policy, take advantage of higher
interest income yields. In accordance with our investment
policy, we do not enter into investments for trading or
speculative purposes. Some of the securities in which we invest,
however, may be subject to market risk. This means that a change
in prevailing interest rates may cause the principal amount of
the investment to fluctuate. To minimize this risk in the
future, we intend to maintain our portfolio of cash equivalents
and long-term investments in a variety of securities, including
commercial paper, money market funds, debt securities and
certificates of deposit. Due to the nature of these investments,
we believe that we do not have any material exposure to changes
in the fair value of our investment portfolio as a result of
changes in interest rates.
Our exposure to market risk also relates to the increase or
decrease in the amount of interest expense we must pay on our
outstanding debt instruments, primarily certain borrowings under
our bank working capital line of credit and equipment facility.
Any advances under the working capital line of credit and
certain advances under our equipment facility bear a variable
rate of interest determined as a function of the prime rate at
the time of the borrowing and is adjusted monthly based on
changes in the prime rate. Other advances under our equipment
facility bear interest at a fixed rate of interest. At
December 31, 2006, there were no amounts outstanding under
our working capital line of credit and $1,312,000 outstanding
under the equipment facility. The interest rates paid on this
balance at December 31, 2006 were: a fixed rate of 6.5% on
$18,000; a fixed rate of 7.0% on $458,000; and a variable rate
of 8.75% on $836,000.
53
BUSINESS
Overview
We are a leading provider of intelligence driven, open source
network security solutions that enable our customers to protect
their computer networks in an effective, efficient and
highly-automated manner. We sell our security solutions to a
diverse customer base that includes over 25 of the Fortune
100 companies and over half of the 30 largest
U.S. government agencies. We also manage one of the
security industry’s leading open source initiatives, Snort.
Our family of network security products forms a comprehensive
Discover, Determine and Defend, or 3D, approach to network
security. Using this approach, our technology can automatically:
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Discover potential threats and points of vulnerability through
use of our Intrusion Sensors coupled with our Real-time Network
Awareness, or RNA, Sensors;
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Determine the potential impact of those observations to the
network by aggregating threat and network intelligence,
including potential attacks and points of vulnerabilities at the
Defense Center; and
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Defend the network through proactive enforcement of security
policy, substantially reducing the need for manual investigation
and intervention by information technology, or IT,
administrators.
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At the heart of the Sourcefire 3D security solution is RNA, our
network intelligence product that provides persistent visibility
into the composition, behavior, topology (the relationship of
network components) and risk profile of the network. This
information provides a platform for automated decision-making
and network policy compliance enforcement. The ability to
continuously discover characteristics and vulnerabilities of any
computing device, or endpoint, communicating on a network (such
as a computer, printer or server) or endpoint intelligence,
along with the ability to observe how those endpoints
communicate with each other, or network intelligence, enables
our Intrusion Prevention products to more precisely identify and
block threatening traffic and to more efficiently classify
threatening
and/or
suspicious behavior than products lacking network intelligence.
Using a broad range of analysis, reporting and automated
response capabilities, the Defense Center aggregates, correlates
and prioritizes network security events from RNA Sensors and
Intrusion Sensors to synthesize multipoint event correlation and
policy compliance analysis. The Defense Center’s policy and
response subsystems are designed to leverage existing IT
infrastructure such as firewalls, routers, trouble ticketing and
patch management systems for virtually any task, including
alerting, blocking and initiating corrective measures.
The traffic inspection engine used in our intrusion prevention
products is the open source technology called
Snort®.
Martin Roesch, our founder and Chief Technology Officer, created
Snort in 1998, and assigned his rights in Snort to us when we
were formed. Our employees, including Mr. Roesch, have
authored all major components of
54
Snort, and we maintain control over the Snort project, including
the principal Snort community forum, Snort.org. Snort, which has
become a de facto industry standard, has been downloaded over
3 million times. We believe that a majority of the Fortune
100 companies and all of the 30 largest
U.S. government agencies use Snort technology to monitor
network traffic and that Snort is the most widely deployed
intrusion prevention technology worldwide. The ubiquitous nature
of the Snort user community represents a significant opportunity
to sell our proprietary products to customers that require a
complete enterprise solution.
For the years ended December 31, 2005 and 2006, we
generated approximately 82% and 81% of our revenue from
customers in the United States and 18% and 19% from customers
outside of the United States respectively. We have expanded our
international and indirect distribution channels and, in the
future, we expect to increase sales outside of the United States
and to source additional customer prospects and generate an
increasing portion of product revenue through alliances with
original equipment manufacturers, or OEMs, such as Nokia Inc. We
increased our revenue from $32.9 million in 2005 to
$44.9 million in 2006, representing a growth rate of 37%.
For the year ended December 31, 2006, product revenue
represented 67% of our total revenue and services revenue
represented 33% of our total revenue.
Our
Industry
We believe, based on our review of various industry sources,
that the network security industry was estimated to be a
$18.4 billion market in 2006 and is projected to grow to
$26.9 billion in 2009, representing a compound annual
growth rate of over 13%. Our addressable markets include
intrusion prevention, vulnerability management and unified
threat management, which were collectively projected to total
$2.9 billion in 2006 and are expected to grow at a compound
annual growth rate in excess of 21% to $5.2 billion in
2009, according to industry sources we reviewed. We expect
growth should continue as organizations seek solutions to
various growing and evolving security challenges, including:
Greater Sophistication, Severity and Frequency of Network
Attacks. The growing use of the Internet as a
business tool has required organizations to increase the number
of access points to their networks, which has made vast amounts
of critical information more vulnerable to attack. Theft of
sensitive information for financial gain motivates network
attackers, who derive profit through identity theft, credit card
fraud, money laundering, extortion, intellectual property theft
and other illegal means. These profit-motivated attackers, in
contrast to the hobbyist hackers of the past, are employing much
more sophisticated tools and techniques to generate profits for
themselves and their well-organized and well-financed sponsors.
Their attacks are increasingly difficult to detect and their
tools often establish footholds on compromised network assets
with little or no discernable effect, facilitating future access
to the assets and the networks on which they reside.
Increasing Risks from Unknown
Vulnerabilities. Vulnerabilities in computer
software that are discovered by network attackers before they
are discovered by security and software vendors represent a
tremendous risk. These uncorrected flaws can leave networks
largely defenseless and open to exploitation. According to
CERT-CC data
as of October 2006, the trends in the rate of vulnerability
disclosure are particularly alarming, with approximately 3,780
disclosed in 2004 and more than 5,990 disclosed in 2005. During
2006, Microsoft alone issued 49 patches designated as
‘critical’ for its various software products. Many
vulnerabilities have existed since the original release of the
affected software products — some dating back to the
1990s — but were not corrected until recently.
Potential Degradation of Network
Performance. Many security products degrade
network performance and are, therefore, disfavored by network
administrators who generally prioritize network performance over
incremental gains in network security. For example, the use of
active scanners that probe networks for vulnerabilities often
meet heavy resistance from administrators concerned about
excessive network “noise,” clogged firewall logs, and
disruption of network assets that are critical to business
operations.
Diverse Demands on Security
Administrators. The proliferation of targeted
security solutions such as firewalls, intrusion prevention
systems, URL filters, spam filters and anti-spyware solutions,
while critical to enhancing network security, create significant
administrative burdens on personnel who must manage numerous
disparate technologies that are seldom integrated and often
difficult to use. Most network security products require manual,
labor intensive incident response and investigation by security
administrators, especially when “false
55
positive” results are generated. Compounding these resource
constraint issues, many organizations are increasingly
challenged by the loss of key personnel as the demand for
security experts has risen dramatically in traditional corporate
settings, government agencies and the growing number of
start-up
security companies.
Heightened Government
Regulation. Rapidly growing government
regulation is forcing compliance with increased requirements for
network security, which has escalated demand for security
solutions that both meet compliance requirements and reduce the
burden of compliance reporting and enforcement. Examples of
these laws include
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The Health Insurance Portability and Accountability Act of 1996,
or HIPAA, and its related rules, which establish requirements
for safeguards to protect the confidentiality, integrity and
availability of electronic protected health information.
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•
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The Financial Services Modernization Act of 1999, commonly known
as the Gramm-Leach-Bliley Act, which includes provisions to
protect consumers’ personal financial information held by
financial institutions.
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The Sarbanes-Oxley Act of 2002, which mandates that public
companies demonstrate due diligence in the disclosure of
financial information and maintain internal controls and
procedures for the communication, storage and protection of such
data.
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The Federal Information Security Management Act, which requires
federal agencies, including contractors and other organizations
that work with the agencies, to develop, document and implement
an agency-wide information security program.
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Our
Competitive Strengths
We are a leading provider of intelligence driven, open source
network security solutions that enable our customers to protect
their computer networks in an effective, efficient and highly
automated manner. We apply the Sourcefire 3D security
solution — Discover, Determine, Defend — to
network security through our comprehensive family of products,
which consists of our RNA, Intrusion Sensors and the Defense
Center products. Our competitive strengths include:
Real-Time Approach to Network
Security. Our approach to network security
enables our customers to secure their networks by providing
real-time defense against both known and unknown threats. Our
solution is designed to support a continuum of network security
functions that span pre-attack hardening of assets, high
fidelity attack identification and disruption and real-time
compromise detection and incident response. In addition, our
ability to confidently classify and prioritize threats in
network traffic and determine the composition, behavior and
relationships of network devices, or endpoints, allows us to
reliably automate what are otherwise manual, time-intensive
processes. For example, our Intrusion Sensor may trigger an
alert upon identifying a Microsoft Windows-specific threat. The
Defense Center would collect this alert, or security event, and
classify and prioritize the event based upon a number of factors
including, whether any other Intrusion Sensor generated the same
alert, whether the network endpoints are vulnerable to that
specific attack (based on intelligence collected by RNA Sensors
and whether the threat is against a high-priority target (e.g.,
an
e-commerce
server). The response to any given security event is predicated
upon this automated, real-time intelligent analysis and could
range from no action (as in the case where the Defense Center
has determined that the network or the individual asset is not
vulnerable to the observed threat) to blocking the threat in
real time, dynamically modifying firewall policy,
and/or
launching configuration management software to correct a
vulnerability condition.
Comprehensive Network Intelligence. Our
innovative network security solution incorporates RNA, which
provides persistent visibility into the composition, behavior,
topology and risk profile of the network and serves as a
platform for automated decision-making and network security
policy enforcement. RNA performs passive, or non-disruptive,
network discovery. This enables network behavior analysis and
real-time compositional cataloging of network assets, including
their configuration, thereby significantly increasing the
network intelligence available to IT and security
administrators. By integrating this contextual understanding of
the network’s components and situational awareness of
network events, our solution is effective across a broad range
of security domains, especially in the area of threat
identification and impact assessment. In the intrusion
prevention and vulnerability
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management markets, we believe that our solution’s ability
to gather this network intelligence has made our products
difficult to evade, easy to tune or calibrate, and efficient, in
terms of network performance as measured by aggregate throughput
and latency reduction.
The Snort Community. The Snort user
community, with over 100,000 registered users and over
3 million downloads to date, has enabled us to establish a
market footprint unlike any other in the industry. We believe
that a majority of the Fortune 100 companies and all of the
top 30 U.S. government agencies (as measured by total
annual budgets) use Snort technology to monitor network traffic
and that Snort is the most widely deployed intrusion prevention
technology worldwide. We believe the Snort open source community
provides us with significant benefits, including a broad threat
awareness network, significant research and development
leverage, and a large pool of security experts that are skilled
in the use of our technology. The Snort user community enables
us to cost-effectively test new algorithms and concepts on a
vast number of diverse networks and significantly expedites the
process of product innovation. We believe that Snort’s
broad acceptance makes us one of the most trusted sources of
intrusion prevention and related security solutions.
Leading-Edge Performance. Our solutions
are built to maintain high performance across the network while
also providing high levels of network security. Specifically,
our solutions have the ability to process multiple gigabits of
traffic with latency as low as 100 microseconds. Our intrusion
prevention technology incorporates advanced traffic processing
functionality, including packet acquisition, protocol
normalization and target-based traffic inspection, which yields
increased inspection precision and efficiency and enables more
granular inspection of network traffic. The Defense Center
supports event loads as high as 1,300 events per second, which
we believe meets or exceeds the requirements of the most
demanding enterprise customers.
Significant Security Expertise. We have
a highly knowledgeable management team with extensive network
security industry experience gained from past service in leading
enterprises and government organizations including Symantec,
McAfee, the Department of Defense and the National Security
Agency. Our founder and CTO, Martin Roesch, invented Snort and
the core RNA technology and is widely regarded as a network
security visionary. In addition, our senior management team
averages 16 years of experience in the networking and
security industries. Our employees have authored all major
components of the Snort source code and maintain the Snort
project. In addition, our Vulnerability Research Team, or VRT,
is comprised of highly experienced security experts who research
new vulnerabilities and create innovative methods for preventing
attempts to exploit them. By combining the strengths of our VRT
with the tremendous breadth of the Snort community, we believe
our aggregate industry knowledge places us at the leading edge
of the network security industry.
Broad Industry Recognition. We have
received numerous industry awards and certifications including
recognition as a “leader” in the network intrusion
prevention systems market, supporting our position as one of a
select few companies that best combines “completeness of
vision” with “ability to execute.” RNA is one of
only five network security products to receive the NSS Gold
award, which is awarded by The NSS Group only to those products
that are distinguished in terms of advanced or unique features,
and which offer outstanding value. In addition, our technology
has achieved Common Criteria Evaluation Assurance Level 2,
or EAL2, which is an international evaluation standard for
information technology security products sanctioned by, among
others, the International Standards Organization, the National
Security Agency and the National Institute for Standards and
Technology.
Our
Growth Strategy
We intend to become the preeminent provider of network security
solutions on a global basis. The key elements of our growth
strategy include:
Continue to Develop Innovative Network Security
Technology. We intend to maintain and enhance
our technological leadership position in network security. We
will continue to invest significantly in internal development
and product enhancements and to hire additional network security
experts to broaden our proprietary knowledge base. We believe
our platform is capable of expanding into new markets such as
unified threat management, security management, network behavior
analysis and compliance and network management and, over time,
we expect to penetrate these markets with innovative products
and technologies.
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Grow Our Customer Base. We have a
substantial opportunity to grow our customer base as our
products become more widely adopted. With over 3 million
downloads of Snort and over 100,000 registered users, we believe
Snort is the most ubiquitous network intrusion detection and
prevention technology and represents a significant customer
conversion and up-sell opportunity for Sourcefire. We seek to
monetize the Snort installed base by targeting enterprises that
implement Snort but have not yet purchased any of the components
of our Sourcefire 3D security solution. We will continue to
target large enterprises and government agencies that require
advanced security technology and high levels of network
availability and performance in sectors including finance,
technology, healthcare, manufacturing and defense. Furthermore,
we may attempt to create new customer conversion and up-sell
opportunities by releasing select future product developments
and enhancements under an open source licensing scheme, similar
to the up-sell opportunities for our current products created by
releasing Snort under the GNU General Public License.
Further Penetrate Our Existing Customer
Base. We believe our strong customer
relationships provide us the opportunity to sell additional
quantities of existing products and up-sell new products.
Through December 31, 2006, over 1,300 customers have
purchased our Intrusion Sensors and Defense Center products. We
intend to sell additional Intrusion Sensors to existing
customers and expand our footprint in the networks of our
customers to include branch offices, remote locations and data
centers. In addition, we believe we have a significant
opportunity to up-sell our higher margin RNA product to existing
customers because of the significant incremental benefit that
increased network intelligence can bring to their security
systems.
Expand Our OEM Alliances and Distribution
Relationships. We believe we have a
significant opportunity to drive revenue growth through our OEM
and distribution relationships. As part of our ongoing effort to
expand our OEM alliances, we recently entered into a
relationship with Nokia, Inc. whereby Nokia Enterprise Solutions
will market to its enterprise customers network security
solutions that utilize our proprietary software and technology.
In addition, we seek to expand our strategic reseller agreements
and increasingly use this channel to generate additional inbound
customer prospects. For example, we have reseller agreements
with True North Solutions, which has been acquired by American
Systems Corporation, and Pentura Limited, a UK information
technology security company, through which we expect to derive
additional revenue growth in the future. We also intend to
utilize our relationships with managed security service
providers such as Verizon, VeriSign and Symantec, to derive
incremental revenue. In 2006, we generated approximately 11% of
our revenue from governmental organizations and, in the future,
we believe we will generate an increasing amount of revenue from
government suppliers such as Lockheed Martin, Northrop Grumman
and Immix Technology, who resell our products to government
agencies. In addition, we believe we have a significant
opportunity to drive revenue growth by expanding our
relationships with other network security vendors. For example,
Crossbeam Systems, Inc. currently offers the Sourcefire 3D
security solution as a blade, or server component, in its
unified threat management appliance.
Strengthen Our International
Presence. We believe the network security
needs of many enterprises located outside of North America are
not being adequately served and represent a significant
potential market opportunity. In 2006, we generated
approximately 19% of our revenue from international customers.
We have distribution agreements with several resellers having
significant foreign presence, through which we now offer the
Sourcefire 3D security solution. We are expanding our sales in
international markets by adding distribution relationships and
expanding our direct sales force, with plans in the next year to
double the number of personnel in Europe and to hire a country
manager for Japan. We believe that the addition of more sales
personnel will lead to increased international sales.
Selectively Pursue Acquisitions of Complementary
Businesses and Technologies. To accelerate
our expected growth, enhance the capabilities of our existing
products and broaden our product and service offerings, we
intend to selectively pursue acquisitions of businesses,
technologies and products that could complement our existing
operations. We continually seek to enhance and expand the
functionality of our offerings and in the future we may pursue
acquisitions that will enable us to better satisfy our
customers’ rigorous and evolving network security needs. We
currently have no plans, proposals or arrangements with respect
to any specific acquisition.
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Products
Our key products consist of RNA Sensors, Intrusion Sensors and
the Defense Center. When deployed in a customer’s network,
these three products work together to produce an automated,
unified intrusion prevention solution. The RNA Sensors and the
Intrusion Sensors report network information and intelligence
back to the central management center, known as the Defense
Center. The Defense Center then aggregates, contextualizes,
analyzes, prioritizes and acts on the event information
generated by the RNA Sensors and the Intrusion Sensors. By
aggregating the events from these sources, the Defense Center is
designed to offer a comprehensive view of security events on a
customer’s network and can identify suspicious activity
that is undetectable through traditional intrusion
detection/prevention products. While our customers can purchase
and use the Intrusion Sensors without necessarily purchasing the
Defense Center (as in the case where the customer is using a
different kind of management console or where the customer can
manage the sensor directly), a customer deploying an Intrusion
Sensor without a corresponding Defense Center loses a
significant amount of capability available when the products are
used together.
Our approach to network security enables our customers to secure
their networks by providing real-time defense against both known
and unknown threats. For example, our Intrusion Sensor may
trigger an alert upon identifying a Microsoft Windows-specific
threat. The Defense Center would collect this alert, or security
event, and classify and prioritize the event based upon a number
of factors, including whether any other Intrusion Sensor
generated the same alert, whether the network endpoints are
vulnerable to that specific attack (based on intelligence
collected by an RNA sensor) and whether the threat is against a
high-priority target (e.g., an
e-commerce
server). The response to any given security event is predicated
upon this automated, real-time intelligent analysis and could
range from no action (as in the case where the Defense Center
has determined that the network or the individual asset is not
vulnerable to the observed threat) to blocking the threat in
real time, dynamically modifying firewall policy,
and/or
launching configuration management software to correct a
vulnerability condition.
Our products are generally sold as dedicated hardware appliances
that are pre-configured with our proprietary network security
technology, along with open source software, including Snort. By
offering our products as turn-key solutions, our customers
benefit from:
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Ease of Installation and Interoperability. RNA
and the Intrusion Sensors can be shipped to various locations,
plugged in by any network or systems administrator and
configured remotely, usually in less than 30 minutes, and are
easy to install across geographically dispersed organizations.
In addition, our products are typically interoperable with the
diverse range of IT infrastructures used by our customers.
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Ease of Management and Maintenance. Because
our appliances are pre-configured with our proprietary
technology, open source software, a secure operating system and
a self-maintaining database, each appliance can be managed and
maintained from a central console.
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High Degree of Performance and
Scalability. Our products exhibit high levels of
performance in network environments with line speeds of up to
eight gigabits per second with latency as low as 100
microseconds, ideal for latency-sensitive services such as voice
over internet protocol. Additionally, depending upon the volume
of network traffic, the Defense Center can support up to 120 RNA
Sensors
and/or
Intrusion Sensors, making the Sourcefire 3D security solution
scalable for the most demanding customer environments. By way of
comparison, a network that would require 120 RNA sensors would
be one that is of significant size and complexity, and would be
consistent with a network used by our largest customers.
Additionally, multiple Defense Centers may be deployed on a
single network.
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In addition, RNA can be separately licensed as a standalone
software solution for installation on a qualified Linux
distribution environment (e.g., Red Hat Enterprise Linux).
We charge our customers a one-time, up-front fee for each of our
appliances, which includes a perpetual license to use our
proprietary technology installed on that appliance. We license
the standalone software version of RNA based upon the number of
nodes, or devices, on the network segment monitored by the
software. We also charge our customers for annual maintenance
and support, which includes the right to receive our VRT
certified Rules and updates to the vulnerability database. The
ability to receive
up-to-date
Rules and vulnerabilities is critical to the successful
performance of the Sourcefire 3D security solution. Of the
customer maintenance and support revenues up for renewal in the
year ended December 31, 2006, we renewed approximately 82%
of this value. Such services are typically paid for in advance,
and recognized ratably as revenue over the period of the
agreement.
As of December 31, 2006, the list prices of our Intrusion
Sensors ranged from $3,995 to $119,500; the list prices for our
RNA Sensors ranged from $1,195 to $11,995; the list prices for
our RNA nodes ranged from $3 to $30; and the list prices for our
Defense Center ranged from $16,995 to $41,995. Pricing for our
products varies based on performance capabilities.
Real-Time
Network Awareness, or RNA
RNA, available either as a software product or as an appliance,
was invented to solve a very basic problem with traditional
network security technologies: they have limited knowledge about
the networks that they are defending. Even at the most basic
level, firewalls, intrusion detection and prevention systems,
patch management systems, vulnerability management systems and
IT compliance solutions have limited knowledge about the assets
and network they are protecting at any given point in time.
Correspondingly, most of these enterprise network security
technologies operate with little real-time information about
composition, behavior or change within the network environment.
As a result, these technologies are often blind to obvious
critical security events and are unable to respond without human
intervention.
As illustrated below, traditional intrusion prevention and
detection technologies provide little automation and require IT
professionals to manually perform event analysis and response.
By incorporating network intelligence, the Sourcefire 3D
security solution increases the amount of automated response to
actionable and dismissible events, and reduces the number of
security events requiring human analysis and response.
RNA Sensors are deployed at strategic points on the network to
provide visibility into traffic passing that point. If RNA can
observe the traffic of devices in the network, it can determine
the operating system of those devices, the network, transport
and application layer protocols (including tunneled protocols
and protocols on non-standard ports) they are using, and the
services and clients employed by those devices. Once RNA has
gathered this information it can determine the topology of the
network and the vulnerability state of any individual device.
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In addition to determining network behavior and device
composition, RNA, coupled with the Defense Center, is capable of
identifying potentially threatening or abnormal traffic that
would be undetectable through traditional detection techniques
and intrusion prevention products. RNA and the Defense Center
accomplish this by collecting, aggregating and analyzing traffic
‘flow’ information. These flow records contain a wide
variety of information about the observed network traffic, and
anomalies in these flow records can be indicative of malicious
or abnormal activity. The Defense Center uses this information
to build models of ‘normal’ network traffic behavior.
Divergence from traffic norms, especially when correlated with
other network events, enables the Defense Center to identify and
trigger responses to threats posed by unknown vulnerabilities,
newly released exploits, worms, stealth scans, distributed
denial of service and other attacks.
While RNA was originally invented to accumulate intelligence
about the network environment and behavior, it has a number of
other applications. For example, RNA can (i) inform network
access control about device changes that are not compliant with
network policy or user roles; (ii) drive real-time patch
management by informing those systems of the presence and
composition of network end-points; and (iii) inform
vulnerability management systems of new hosts and their
composition, enabling surgical scanning of those devices on a
basis consistent with network security policy. Beyond network
security, RNA is also proving to be beneficial in purely
administrative tasks. For example, IT administrators use RNA
inventory information to assist in asset and license management
functions.
RNA 4.0, which we intend to release in the next several months,
will allow customers to define and set compliance policies for
endpoints, subnetworks or networks with the click of a mouse.
Once defined, any change outside of policy would result in
immediate notification followed by an array of possible
corrective actions, including the sending of an alert,
redirection of the asset into a ‘sandbox’ or
quarantined network, blocking some or all traffic to or from the
asset, and corrective measures such as patch and configuration
management. RNA 4.0 will also include a sophisticated compliance
dashboard that will allow administrators to monitor and report
on compliance in real-time.
Intrusion
Sensors
Intrusion Sensor appliances include proprietary Sourcefire
components and open source Snort technology. They monitor
network traffic and compare observed traffic to a set of Rules,
or a set of network traffic characteristics, indicative of
malicious activity. These Rules are created by our Vulnerability
Research Team and are updated two to three times per month,
depending on the rate that new vulnerabilities
and/or
exploits are discovered and disclosed. Once the Intrusion
Sensors match a Rule to the observed traffic, they send an alert
to the Defense Center for further analysis and prioritization.
The Intrusion Sensors can be used either as an intrusion
prevention system, configured as an “in-line”
solution, or as an intrusion detection system, passively
monitoring traffic and providing alerts. The in-line
configuration allows IT administrators to proactively and
automatically protect their networks by, for example, blocking
sessions containing malicious traffic. We offer several
different models of Intrusion Sensors depending on the network
traffic volume and inspection performance desired.
Defense
Center
The Defense Center enables the central management of critical
network security functions, including event monitoring, event
correlation and prioritization, policy definition and
enforcement, forensic analysis, network behavior analysis,
trends analysis, management reporting, and system administration.
The Defense Center can also accept data from legacy Snort
sensors, which are sensors built by a customer who has
downloaded the open source Snort engine from www.snort.org.
The Defense Center, with its intuitive and
easy-to-navigate
web-based user interface, includes an integrated high
performance database capable of correlating and analyzing events
received from RNA Sensors, the Intrusion Sensors
and/or
Intrusion Agents in real-time to determine the:
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relevance of an event to a specific network asset;
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potential impact an event will have on the network
asset; and
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criticality of an event based on the business sensitivity of the
targeted network.
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Automated event prioritization allows IT administrators to focus
their time and resources on real security events that represent
the most critical threats based upon the customer’s actual,
point-in-time
network exposures and threats.
Designed to scale to virtually any size deployment, from remote
site to global enterprise, the Defense Center’s data
management solution is capable of handling extremely high event
loads while also preserving those events for both high-level
security trends analysis and in-depth forensic analysis down to
the individual packet level. The forensic analysis interface
features customizable workflows that enable users to tailor the
graphical user interface to fit the way they prefer to monitor
their networks and investigate and analyze security events. In
addition, users can easily create standard or customized reports
in PDF, HTML and CSV formats that can be automatically emailed
for easy distribution.
The Defense Center also excels as an administrative platform. A
flexible scheduling subsystem allows the automation of tasks
including system backup, report generation, software update
downloading, policy update downloading and the application of
intrusion prevention policies. The Defense Center also supports
high-availability deployment for management redundancy and
dynamic load balancing of our Intrusion Sensors where required.
Services
Maintenance and Support. We offer our
customers ongoing product support services for both hardware and
software. These maintenance programs are typically sold to
customers for a one-year term at the time of the initial product
sale and typically automatically renew for successive one-year
periods. As part of our maintenance and support, we provide
telephone and web-based support, documentation and software
updates, error corrections and Rules and vulnerability updates.
Additionally, we provide expedited replacement for any defective
hardware under warranty.
The ability to receive an accurate and
up-to-date
set of Rules with which our sensors inspect network traffic is a
part of our maintenance and support program. Because the
sophistication and methods of attacks are constantly changing,
our Vulnerability Research Team, or VRT, is continually
crafting, refining and updating our set of Rules so that, when
deployed, Intrusion Sensors can detect the most recently
discovered vulnerabilities and exploits in addition to existing
vulnerabilities and exploits. We typically release new and
updated Rules two to three times per month; however, that rate
can increase or decrease depending on the rate that new
vulnerabilities and exploits are discovered and disclosed. Of
the customer maintenance and support revenues up for renewal in
the year ended December 31, 2006, we renewed approximately
82% of this value.
We make available all updates, upgrades, patches and new Rules
to our customers through our web site. Our maintenance and
support team is located at our corporate headquarters in
Columbia, Maryland.
Professional Services and Training. Our
technical consultants assist our customers in the configuration
of our appliances and software. These fee-based services,
provided by our technical consultants, include providing advice
on optimal sensor deployment strategies within the
customer’s network, customization, or tuning of, Rules and
configuration of appliances for the particular characteristics
of the customer’s network. Additionally, we provide our
customers with fee-based, hands-on training classes on subjects
such as sensor deployment, Rule creation, tuning and
configuration and security assessment. Our professional services
and training are sold directly to our customers as well as
indirectly through our resellers and can be delivered by our
personnel or authorized training and service partners.
Technology
The Sourcefire 3D security solution provides our customers with
a unified intrusion, vulnerability management and compliance
enforcement capability. By combining the intelligence gathered
by RNA and the Intrusion Sensor, along with the central
management of the Defense Center, our customers can better
prepare for, defend and remediate attacks on their networks.
Real-time Network Awareness. RNA acquires
intelligence about the network passively; that is, it listens to
network traffic to determine the key characteristics of the
devices on the network. For example, by watching the
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creation and termination of a transmission control protocol, or
TCP, connection, RNA can determine, among other things, the
operating systems and versions running on the devices
communicating with each other, as well the identity of those
devices, or their IP addresses. Active network discovery, by
contrast, works by sending out probative traffic in order to
stimulate a response from accessible devices. It then interprets
the responses so that it can draw conclusions about those
devices. Because active scanners rely on a “pinging”
model of stimulus and response, they are “noisy,” have
the potential to disrupt or degrade overall network performance,
and sometimes disturb the potentially sensitive assets that they
seek to interrogate. RNA’s passive network discovery
methods do not generate traffic on the network and are designed
not to disrupt or degrade network performance.
Once RNA has established a host profile for a specific device,
it will update that profile dynamically as it observes traffic
to or from that device. The types of information that could be
updated include routing changes, new services, new protocols on
existing service ports, OS vendor or version changes, changed
hop count to the device, and changed vendor and version data of
services.
In addition to determining network and device composition, RNA,
coupled with the Defense Center, is capable of identifying
traffic anomalies. RNA and the Defense Center accomplish this by
collecting, aggregating and analyzing traffic flow information.
These flow records can contain a wide variety of information
about the observed network traffic, including a timestamp for
the flow start and finish time, the number of bytes and packets
observed in the flow, their sequence, the flow’s source and
destination IP addresses, source and destination port numbers,
IP protocol, the application layer protocol and, in the case of
TCP flows, all TCP flags observed over the life of the flow. The
Defense Center leverages this information to build models of
‘normal’ network traffic behavior. Divergence from
traffic norms, especially when correlated with other network
events, can enable critical protection against threats posed by
unknown vulnerabilities, newly released exploits,
“zero-learning” worm detection, stealth scans, and
fine-grained distributed denial of service attacks, as well as
network system malfunctions and misconfigurations.
Defense Center. The Defense Center is a high
performance management system suited for large, complex and
distributed enterprise networks. It simplifies the complicated
issues usually associated with intrusion detection and
prevention deployments by incorporating policy management, data
aggregation, correlation, analysis and reporting into a single
centralized solution that enables our customers to take
advantage of a distributed sensor infrastructure. The Defense
Center is delivered with a built-in high performance database
capable of handling millions of events and supporting in-depth
forensic analysis for identification of both discrete
occurrences and long-term security trends. Packaged as a
complete, preconfigured system and including an intuitive,
efficient interface, the Defense Center is easy to install and
easy to use on a daily basis.
The Defense Center also allows IT administrators to build
customized policies that combine threat, network and
vulnerability management, so that IT administrators can define
responses in advance to anomalous observations, including any
combination of alerting, blocking or correcting the non-normal
condition. Examples include alerting via email, Simple Network
Management Protocol, or SNMP, traps or SYSLOG events, blocking
by dynamically modifying router, firewall, switch, or IPS
policies, and correcting via interaction with trouble ticketing,
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patch management, or configuration management systems. For
maximum flexibility, the Defense Center provides a fully
documented remediation application programming interface, or
API, that allows the creation of customized responses with
third-party technologies.
We also separately license a visualization module to the Defense
Center that provides our customers a real-time map of their
network using the intelligence gathered by RNA. This
visualization module provides a unique, intuitive graphical
interface for IT professionals to manage their network assets
and enforce policy compliance.
Intrusion Sensors. The Intrusion Sensors are
sold as turn-key networking appliances that are composed of
highly optimized proprietary Sourcefire components and open
source Snort technology. The Intrusion Sensor’s threat
detection algorithms are governed by a rules-based language that
combines the benefits of signature, protocol and anomaly-based
inspection methods. The highly flexible Snort rules language
also allows administrators to write their own custom rules or to
tailor existing rules to their specific networking environment.
Once the Intrusion Sensor matches observed traffic with one of
the many Rules deployed on the Intrusion Sensor, an alert is
generated and sent to the Defense Center for additional analysis
and prioritization.
Awards and Certifications. We have received
numerous industry awards and certifications, including:
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Gartner Magic Quadrant. We were recognized by
Gartner, Inc. as being a “Leader” in the Network
Intrusion Prevention System Appliances category.
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NSS Gold Award. Our product is one of only
five network security products to be awarded the NSS Gold award.
NSS is a world leader in benchmarking and independent product
evaluations, and the NSS Gold Award is awarded only to those
products that are distinguished in terms of advanced or unique
features, and which offer outstanding value.
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EAL2. Common Criteria Evaluation Assurance
Level 2 is an international evaluation standard for
information technology security products sanctioned by, among
others, the International Standards Organization, the National
Security Agency and the National Institute for Standards and
Technology.
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National Security Agency Systems and Network Attack
Center. We have met the classified testing
standards of the National Security Agency Systems and Network
Attack Center, which are required in order to sell security
products to certain agencies of the U.S. Government.
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DISA FAO STIG. We have met the classified
testing standards of the Defense Information Security Agency,
Finance and Accounting Office — Security Technical
Implementation Guide, which are required in order to sell
security products to certain agencies of the U.S. Government.
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FIPS 140-2. Federal Information Processing
Standard 140-2 is a standard that describes US Federal
government requirements that IT products should meet for
Sensitive, but Unclassified, or SBU, use. The standard was
published by the National Institute of Standards and Technology
(NIST). FIPS 140-2 evaluation is required for sale of products
implementing cryptography to the Federal Government. In
addition, the financial community increasingly specifies FIPS
140-2 as a procurement requirement and is beginning to embrace
it.
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•
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NEBS. Network Equipment-Building System
requirements are used by service providers to qualify equipment
that will provide a high level of reliability and safety to
their network. These requirements are designed to ensure that
products are safe and do not interfere with the reliable
operation of a network. NEBS compliance is a critical issue to
service providers evaluating the suitability of products for use
in their networks.
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•
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OSEC. Open Security Evaluation Criteria is a
framework for evaluating the security functionality of networked
products. OSEC defines a core set of tests for any networked
security product, and then adds tests for security and
performance to each product space, such as network intrusion
detection systems. OSEC criteria are open to view and critique,
and are formulated with input from vendors, end-users, and many
representatives from the security community that actively work
in the product spaces for which criteria have been developed.
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64
Customers
We provide products and services to a variety of end users
worldwide, including some of the world’s largest banks,
defense contractors, hospitals, IT companies and retailers, as
well as U.S. and other national, state and local government
agencies. We view our primary customers as enterprise, service
provider and risk management enterprises, but we have also
developed products and services for the consumer and small
office market. Our enterprise market customers generally have
annual revenue exceeding $500 million.
In 2003, Northrop Grumman, a federal government reseller,
accounted for 15% of our revenues. In 2004, Immix Technologies,
a federal government reseller, accounted for 10% of our
revenues. In 2005 and 2006, no customer accounted for over 10%
of our revenues. If we failed to retain either Northrop Grumman
or Immix Technologies as a reseller customer, we believe that we
would find another federal government reseller through which we
could sell our products. Our customers represent a broad
spectrum of organizations within diverse sectors, including
financial services, technology, telecommunications and
government and information technology services.
For the years ended December 31, 2005 and 2006, we
generated approximately 82% and 81% of our revenue from
customers in the United States and approximately 18% and 19%
from customers outside of the United States, respectively.
Sales and
Marketing
We market and sell our appliances, software and services
directly to our customers through our direct sales organization
and indirectly through our resellers, distributors and original
equipment manufacturers.
Sales. As of December 31, 2006, our sales
organization was comprised of approximately 75 full-time
individuals organized into two groups: North America and
International. We maintain sales offices in Columbia, Maryland;
Vienna, Virginia; Livonia, Michigan; and Reading, United
Kingdom. As of December 31, 2006, our international sales
force was made up of 17 individuals, and our North America sales
force was made up of 58 individuals divided into three
geographic regions: East, West and Federal. Our sales personnel
are responsible for market development, including managing our
relationships with resellers, assisting resellers in winning and
supporting key customer accounts and acting as liaisons between
the end customers and our marketing and product development
organizations. We expect to continue to expand our International
direct sales group in Europe, the Middle East, Asia/Pacific and
Latin America. We are expanding our sales in international
markets by adding distribution relationships and expanding our
direct sales force, with plans in the next year to double the
number of personnel in Europe and to hire a country manager for
Japan.
Each sales organization is supported by experienced sales
engineers who are responsible for providing pre-sales technical
support and technical training for the sales team and for our
resellers and distributors. All of our sales personnel are
responsible for lead
follow-up
and account management. Our sales personnel have quota
requirements and are compensated with a combination of base
salary and earned commissions.
Our indirect sales channel, comprised primarily of resellers and
distributors, is supported by our dedicated sales force with
broad experience in selling network security products to
resellers. We maintain a broad network of value-added resellers
throughout the United States and Canada, and distributors in
Europe, Latin America and Asia/Pacific. Our arrangements with
our resellers are non-exclusive, territory-specific, and
generally cover all of our products and services and provide for
appropriate discounts based on a variety of factors including
volume purchases. These agreements are generally terminable at
will by either party by providing the other party at least
90 days written notice. Our arrangements with distributors
also are non-exclusive and territory-specific and provide
distributors with discounts based upon the annual volume of
their orders. We provide our resellers and distributors with
marketing assistance, technical training and support.
Strategic Relationships. We have established
commercial relationships with networking and security companies
to provide alternative distribution channels for our products.
We executed an OEM agreement with Nokia Inc. on July 14,
2006 under which Nokia is permitted to incorporate our RNA and
Intrusion Sensor technology into Nokia Enterprise Solutions
hardware platform for direct
65
and indirect sales to its enterprise customers. In addition,
Nokia has the ability to resell the Defense Center. This
agreement expires on July 14, 2009. We have no other
relationship with Nokia, other than this OEM agreement and there
exists no material dependencies on Nokia.
Marketing. Our marketing activity consists
primarily of product marketing, product management and sales
support programs. Marketing also includes advertising, our Web
site, trade shows, direct marketing and public relations. Our
marketing program is designed to build the Sourcefire and Snort
brands, increase customer awareness, generate leads and
communicate our product advantages. We also use our marketing
program to support the sale of our products through new channels
and to new markets. We have eight full-time employees in our
marketing department.
Research
and Development
Our research and development efforts are focused primarily on
improving and enhancing our existing network security products
as well as developing new features and functionality. We
communicate with our customers and the open source community
when considering product improvements and enhancements, and we
regularly release new versions of our products incorporating
these improvements and enhancements.
Vulnerability Research Team. Our Vulnerability
Research Team is a group of leading edge network security
experts working to proactively discover, assess and respond to
the latest trends in network threats and security
vulnerabilities. By gathering and analyzing this information,
our Vulnerability Research Team creates and updates Snort Rules
and security tools that are designed to identify, characterize
and defeat attacks.
This team comprises eight full time employees and operates from
our corporate headquarters in Columbia, Maryland. Our
Vulnerability Research Team participates in extensive
collaboration with hundreds of network security professionals in
the open source Snort community to learn of new vulnerabilities
and exploits. The Vulnerability Research Team also coordinates
and shares information with other security authorities such as
The SANS Institute, CERT-CC (Computer Emergency Response Team),
iDefense (Verisign), SecurityFocus (Bugtraq; Symantec) and
Common Vulnerabilities and Exposures (Mitre). Because of the
knowledge and experience of our personnel comprising the
Vulnerability Research Team, as well as its extensive
coordination with the open source community, we believe that we
have access to one of the largest and most sophisticated groups
of IT security experts researching vulnerability and threats on
a real-time basis.
As of December 31, 2006, we had approximately 55 employees
dedicated to research and development. Our research and
development expense was $5.7 million, $6.8 million and
$8.6 million for the years ended December 31, 2004,
2005 and 2006, respectively.
Manufacturing
and Suppliers
We rely primarily on contract equipment manufacturers to
assemble, integrate and test our appliances and to ship those
appliances to our customers. We typically hold little inventory,
relying instead on a
just-in-time
manufacturing philosophy. We rely on four primary integrators.
We have contracted with Avnet, Inc., a leading distributor of
enterprise network and computer equipment, to manufacture all of
our appliances built on IBM hardware. Avnet is our sole supplier
of IBM-based hardware appliances. We have also contracted with
Patriot Technologies, Inc. and Intelligent Decisions Inc., or
IDI, to assemble, integrate and test all our product offerings
operating on an Intel platform. Our agreement with Patriot
expires on December 12, 2007, and will automatically renew
for successive one year periods unless either we or Patriot
notify the other of an intent not to renew at least 90 days
prior to expiration. We entered into a conditional purchase
commitment with Patriot pursuant to which we have agreed to
purchase a set quantity of new appliance inventory over an
18-month period provided that the new appliance meets certain
specifications on or before November 15, 2006. The
approximate value of the purchase commitment is $800,000. Our
agreement with IDI expires on January 31, 2008 and will
automatically renew unless either party notifies the other party
of its intent not to renew at least 30 days prior to the
end of the term. Finally, we have contracted with Bivio
Networks, Inc. to manufacture select high performance models of
our appliances. Bivio is our sole supplier of these high
performance models, such as our IS3800 and IS5800, which are the
highest priced Intrusion Sensors that we offer. Our agreement
with Bivio expires on February 10, 2008. All of these
agreements are
66
non-exclusive. We would be faced with the burden, cost and delay
of having to qualify and contract with a new supplier if any of
these agreements terminate or expire for any reason.
Intellectual
Property
To protect our intellectual property, both domestically and
abroad, we rely primarily on patent, trademark, copyright and
trade secret laws. As of the date hereof we had 25 patent
applications pending for examination in the U.S. and foreign
jurisdictions. We currently hold no issued patents. The claims
for which we have sought patent protection relate to methods and
systems we have developed for intrusion detection and prevention
used in our RNA, Intrusion Sensor and Defense Center products.
In addition, we utilize contractual provisions, such as
non-disclosure and non-compete agreements, as well as
confidentiality procedures to strengthen our protection.
Despite our efforts to protect our intellectual property,
unauthorized parties may attempt to copy aspects of our products
or obtain and use information that we regard as proprietary.
While we cannot determine the extent to which piracy of our
software products occurs, we expect software piracy to be a
persistent problem. In addition, the laws of some foreign
countries do not protect our proprietary rights to as great an
extent as do the laws of the United States and many foreign
countries do not enforce these laws as diligently as
U.S. government agencies and private parties.
Seasonality
Our business is subject to seasonal fluctuations. For a
discussion of seasonality affecting our business, see
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations —
Seasonality.”
Competition
The market for network security monitoring, detection,
prevention and response solutions is intensely competitive and
we expect competition to increase in the future. Our chief
competitors generally fall within the following categories:
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•
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large companies, including Symantec Corporation, Cisco Systems,
Inc., Internet Security Systems, Inc. (which has recently been
acquired by IBM), Juniper Networks, Inc., 3Com Corporation,
Check Point Software Technologies, LTD and McAfee, Inc., that
sell competitive products and offerings, as well as other large
software companies that have the technical capability and
resources to develop competitive products;
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•
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software or hardware network infrastructure companies, including
Cisco Systems, Inc., 3Com Corporation and Juniper Networks,
Inc., that could integrate features that are similar to our
products into their own products;
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•
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smaller software companies offering relatively limited
applications for network and Internet security monitoring,
detection, prevention or response; and
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•
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small and large companies offering point solutions that compete
with components of our product offerings.
|
Mergers or consolidations among these competitors, or
acquisitions of our competitors by large companies, present
competitive challenges to our business. For example, Symantec
Corporation, Cisco Systems, Inc., McAfee, Inc., 3Com Corporation
and Juniper Networks, Inc. have acquired during the past several
years smaller companies, which have intrusion detection or
prevention technologies and Internet Security Systems, Inc. has
recently been acquired by IBM. These acquisitions will make
these combined entities potentially more formidable competitors
to us if such products and offerings are effectively integrated.
Large companies may have advantages over us because of their
longer operating histories, greater brand name recognition,
larger customer bases or greater financial, technical and
marketing resources. As a result, they may be able to adapt more
quickly to new or emerging technologies and changes in customer
requirements. They also have greater resources to devote to the
promotion and sale of their products than us. In addition, these
companies have reduced and could continue to reduce, the price
of their security monitoring, detection, prevention and response
products and managed security services, which intensifies
pricing pressures within our market.
Several companies currently sell software products (such as
encryption, firewall, operating system security and virus
detection software) that our customers and potential customers
have broadly adopted. Some of these
67
companies sell products that perform the same functions as some
of our products. In addition, the vendors of operating system
software or networking hardware may enhance their products to
include functions similar to those that our products currently
provide.
We believe that the principal competitive factors affecting the
market for information security solutions include security
effectiveness, manageability, technical features, performance,
ease of use, price, scope of product offerings, professional
services capabilities, distribution relationships and customer
service and support. We believe that our solutions generally
compete favorably with respect to such factors.
Properties
Our principal executive offices are located in Columbia,
Maryland. We also lease sales offices in Vienna, Virginia;
Livonia, Michigan; and Wokingham, United Kingdom. Our lease in
Columbia, Maryland expires on May 31, 2010; our lease in
Vienna, Virginia expires on January 31, 2012; our lease in
Livonia, Michigan expires on August 31, 2008; and our lease
in Wokingham, United Kingdom expires on January 24, 2012.
We believe that our facilities are generally suitable to meet
our needs for the foreseeable future; however, we will continue
to seek additional space as needed to satisfy our growth.
Employees
As of December 31, 2006, we had 182 employees, of whom 55
were engaged in product research and development, 84 were
engaged in sales and marketing, 11 were engaged in customer
service and support, 7 were engaged in professional services and
25 were engaged in administrative functions. Our current
employees are not represented by a labor union and are not the
subject of a collective bargaining agreement. We believe that we
have good relations with our employees.
Legal
Proceedings
On April 25, 2006, we were served with a complaint filed by
PredatorWatch, Inc. (a.k.a. NetClarity) in the Superior Court of
Suffolk County, Massachusetts. The plaintiff alleges that we and
Martin F. Roesch, our Chief Technology Officer, together with
Inflection Point Associates, L.P., the general partner of one of
our stockholders, Inflection Point Ventures, L.P.:
(i) misappropriated its trade secrets; (ii) breached
an oral agreement of confidentiality; (iii) breached a
covenant of good faith and fair dealing owed to the plaintiff;
(iv) were unjustly enriched; (v) misrepresented
certain material facts to the plaintiff upon which the plaintiff
relied to its detriment; and (vi) engaged in unfair and
deceptive acts in violation of Massachusetts state law. The
plaintiff has sought to recover amounts to be ascertained and
established, as well as double and treble damages and
attorneys’ fees.
On May 22, 2006, we answered the plaintiff’s complaint
and denied each and every count contained in the
plaintiff’s complaint. As of December 31, 2006, the
parties are in the process of conducting discovery and no trial
date has been set. The court has scheduled a hearing on our
motion for summary judgment in mid-April 2007. We have not
recorded any reserve in our financial statements for potential
liability for legal fees in connection with this suit. We intend
vigorously to defend against the plaintiff’s case.
Additionally, PredatorWatch has separately notified us that it
believes that our RNA technology and 3D security solution are
covered by claims contained in its pending patent application.
This pending patent application has not issued as a patent, but
in the event it does issue, PredatorWatch could file an
additional complaint to include a patent infringement claim
against us.
From time to time, we may be involved in other disputes or
litigation relating to claims arising out of our operations.
However, we are not currently a party to any other material
legal proceedings.
68
MANAGEMENT
Directors
and Executive Officers
The following table sets forth information concerning our
directors, executive officers and other key members of our
management team as of December 31, 2006:
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Name
|
|
Age
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|
|
Position
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E. Wayne Jackson, III
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45
|
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Chief Executive Officer and
Chairman of the Board of Directors
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Martin F. Roesch
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37
|
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Chief Technology Officer and
Director
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Thomas M. McDonough
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|
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52
|
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President and Chief Operating
Officer
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Todd P. Headley
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44
|
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Chief Financial Officer and
Treasurer
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Michele M. Perry-Boucher
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45
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Chief Marketing Officer
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Joseph M. Boyle
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40
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General Counsel and Secretary
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Thomas D. Ashoff
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45
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Vice President of Engineering
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John T. Czupak
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44
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Vice President of International
Sales and Business Development
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John G. Negron
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43
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Vice President of North American
Sales
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Asheem
Chandna(2)(3)
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42
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Director
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Joseph R.
Chinnici(1)(3)(4)
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52
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Director
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Tim A.
Guleri(1)(2)
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41
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Director
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Steven R.
Polk(2)(3)
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59
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Director
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Arnold L.
Punaro(1)(5)
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60
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Director
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Harry R.
Weller(1)(2)
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37
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Director
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(1)
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Member of our audit committee.
|
(2)
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Member of our compensation
committee.
|
(3)
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Member of our nominating and
governance committee.
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(4)
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Mr. Chinnici also acts as our
lead outside director.
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(5)
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General Punaro joined our board of
directors in January 2007.
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Executive
Officers
E.
Wayne Jackson, III, Chief Executive Officer and Chairman of
the Board of Directors
E. Wayne Jackson, III joined us in May 2002 as our Chief
Executive Officer and a director. He was appointed Chairman of
our Board of Directors in October 2006. Before joining
Sourcefire, Mr. Jackson was a private investor from
September 2001 until May 2002. Prior to that, Mr. Jackson
co-founded Riverbed Technologies, Inc., a wireless
infrastructure company, served as its CEO from January 1999
until the sale of the company to Aether Systems Inc. for more
than $1.0 billion in March 2000 and continued as an
employee of Aether Systems as Managing Director of Aether
Capital until September 2001. Previously, Mr. Jackson built
an emerging technologies profit center for Noblestar Systems
Inc., a large systems integrator, and consulted to organizations
including General Electric, the World Bank and the Federal
Reserve. Mr. Jackson holds a B.B.A. in Finance from James
Madison University.
Martin
F. Roesch, Chief Technology Officer and Director
Martin F. Roesch founded Sourcefire in 2001 and served as our
President and Chief Technology Officer until September 2002,
since which time he has continued to serve as our Chief
Technology Officer. Mr. Roesch is responsible for our
technical direction and product development efforts.
Mr. Roesch, who has 16 years of industry experience in
network security and embedded systems engineering, is also the
author and lead developer of the Snort Intrusion Prevention and
Detection System that forms the foundation for the Sourcefire 3D
System. Over the past ten years, Mr. Roesch has developed
various network security tools and technologies, including
intrusion prevention and detection systems, honeypots, network
scanners and policy enforcement systems for organizations
69
such as GTE Internetworking and Stanford Telecommunications,
Inc. Mr. Roesch holds a B.S. in Electrical and Computer
Engineering from Clarkson University.
Thomas
M. McDonough, President and Chief Operating
Officer
Thomas M. McDonough joined us in September 2002 as our President
and Chief Operating Officer and is our executive officer in
charge of sales. Before joining Sourcefire, Mr. McDonough
was the Chief Executive Officer of Mountain Wave, Inc., an
information security company, from March 2002 until September
2002, which was acquired by Symantec Corporation in July 2002.
Prior to that, Mr. McDonough was Senior Vice President of
Worldwide Sales for Riverbed Technologies from February 2000
until March 2000, when it was acquired by Aether Systems. He
then served as the Senior Vice President of Worldwide Sales for
Aether Systems until March 2002. Previously, Mr. McDonough
spent six years with Axent Technologies, Inc. as Vice President
of North American Sales and Professional Services. That company
was acquired by Symantec Corporation in December 2000 for
$960 million. Mr. McDonough holds a B.A. in Economics
and an M.B.A. from the University of Notre Dame.
Todd
P. Headley, Chief Financial Officer and Treasurer
Todd P. Headley joined us in April 2003 and serves as our Chief
Financial Officer and Treasurer. Prior to joining Sourcefire,
Mr. Headley was CFO for BNX Corporation, a network access
management company, from September 2001 until April 2003. Prior
to BNX, Mr. Headley served as CFO for FBR Technology
Venture Partners, a Virginia-based venture capital firm, from
September 2000 until May 2001. Mr. Headley served as Chief
Financial Officer of Riverbed Technologies, a wireless
infrastructure company, from March 1999 until its acquisition by
Aether Systems in March 2000. Mr. Headley continued with
Aether Systems until June 2000, where he was engaged in various
business development and integration activities.
Mr. Headley also served as Controller at
POMS Corporation, a manufacturing supply chain execution
company, from February 1998 until February 1999 and as Vice
President and Controller of Roadshow International, Inc., a
supply chain execution company, from April 1992 until February
1998. Mr. Headley began his career at Arthur Andersen in
1985 as an auditor. Mr. Headley is a C.P.A. and holds a
B.S. in accounting from Virginia Polytechnic Institute and State
University.
Michele
M. Perry-Boucher, Chief Marketing Officer
Michele M. Perry-Boucher joined us in March 2004 and serves as
our Chief Marketing Officer. From September 2001 until joining
Sourcefire, Ms. Perry-Boucher operated her own strategic
marketing and business development consultancy, MPB Strategies,
which specialized in providing consulting and strategy services
to fast growing companies. Previously, Ms. Perry-Boucher
was Senior Vice President, Marketing at USinternetworking, Inc.
from July 1998 until June 2001. Additionally,
Ms. Perry-Boucher held senior marketing and management
positions at Versatility Inc. (acquired by Oracle Corporation)
from February 1997 to June 1998 and Software AG from January
1992 until January 1997. Ms. Perry-Boucher holds a B.S.
from the University of Pennsylvania (Wharton School) and an
M.B.A. from Harvard Business School.
Joseph
M. Boyle, General Counsel and Secretary
Joseph M. Boyle joined us in April 2006 and serves as our
General Counsel and Secretary. Prior to joining us,
Mr. Boyle was in private practice from February 2005 until
April 2006 where he focused on representing entrepreneurs,
start-ups,
emerging growth and technology companies. Mr. Boyle acted
as the Chief of Staff to the Director of the National Cyber
Security Division within the Department of Homeland
Security’s Information Assurance and Infrastructure
Protection Directorate from February 2004 to February 2005. From
September 2001 until February 2004, Mr. Boyle served as
general counsel to Riptech, Inc., an Alexandria, Virginia based
managed security service provider, which was acquired by
Symantec Corporation in August 2002. Prior to joining Riptech,
Mr. Boyle served from April 1998 until September 2001 as
general counsel to Cysive, Inc., a Reston, Virginia based IT
professional services firm. Prior to Cysive, Mr. Boyle was
in private practice focusing on private equity, mergers and
acquisitions and corporate securities. Mr. Boyle holds a
B.S. in Mechanical Engineering from the University of Detroit
and received his J.D. from the University of Michigan. He is
admitted to practice law in the Commonwealth of Virginia and the
District of Columbia.
70
Other Key
Members of Management
Thomas
D. Ashoff, Vice President of Engineering
Thomas D. Ashoff joined us in April 2003 as Vice President of
Engineering. Prior to joining Sourcefire, Mr. Ashoff worked
for Network Associates Inc. (now McAfee Inc.) in a number of
capacities from April 1998 until February 2003. At Network
Associates, Mr. Ashoff was Vice President, Strategic
Product Engineering in the Technology Research Division as well
as Vice President of Engineering for Network Associates’
PGP Security business unit. Mr. Ashoff joined Network
Associates in 1998 when it acquired Trusted Information Systems
(TIS). At TIS, Mr. Ashoff was the Senior Development
Manager for the Gauntlet Firewall and VPN products. Prior to
TIS, Mr. Ashoff developed software for GTE Spacenet/Contel
ASC from 1988 to June 1994. Mr. Ashoff also provided
consultancy services to the National Security Agency (NSA)
through HRB Singer, Inc. from 1985 until 1988 and was employed
by the NSA from 1982 until 1985. Mr. Ashoff holds a B.S. in
Computer Science from the University of Pittsburgh.
John
T. Czupak, Vice President of International Sales and Business
Development
John T. Czupak joined us in October 2002 and serves as our Vice
President of International Sales and Business Development.
Before joining us, Mr. Czupak was the Senior Vice President
of Worldwide Sales for Mountain Wave, Inc., an information
security company, from October 2001 until October 2002, which
was acquired by Symantec Corporation in July 2002. Prior to
joining Mountain Wave, Mr. Czupak was the Director of
International Operations for Riverbed Technologies from December
1999 until March 2000. He subsequently became the General
Manager, Europe, Middle East & Asia for Aether Systems,
Inc., after Aether acquired Riverbed Technologies in March 2000,
and served in that position until October 2001. Previously,
Mr. Czupak was with Axent Technologies, Inc., an Internet
security company, where he was Vice President of Asia,
Pacific & Latin America from August 1994 until December
1999. Mr. Czupak holds a B.S. in Marketing from Towson
State University and an M.B.A. from the University of Maryland.
John
G. Negron, Vice President of North American Sales
John G. Negron joined us in July 2002 and serves as Vice
President of North American Sales. Before joining us, from
December 2001 until May 2002, Mr. Negron was Vice President
of Sales and Marketing at mindShift Technologies, Inc.
Mr. Negron joined Riverbed Technologies in February 2000 as
Director of Sales and continued to serve in that capacity
following its acquisition by Aether Systems in March 2000, until
October 2001. He also served as Director of Sales for Aether
Systems’ Enterprise Vertical when Aether acquired Riverbed
in March 2000. From September 1994 until January 2000,
Mr. Negron was employed by Axent Technologies, an internet
security software company, where he directed the company’s
penetration into the public sector. Mr. Negron also held
multiple domestic and international sales management roles at
SunGard Data Systems Inc. from August 1985 until September 1991
which provided software and services in the disaster recovery
segment of the security industry. Mr. Negron holds a B.S.
from Bentley College.
Directors
Asheem
Chandna, Director
Asheem Chandna joined our board of directors in May 2003 and is
currently a partner with Greylock Partners, a venture capital
firm. Prior to joining Greylock in September 2003,
Mr. Chandna was with Check Point Software Technologies Ltd.
from April 1996 until December 2002 where he was Vice-President
of Business Development and Product Management. Prior to Check
Point, Mr. Chandna was Vice-President of Marketing with
CoroNet Systems from October 1994 to November 1995 and was with
Compuware Corporation from November 1995 to April 1996,
following Compuware’s acquisition of CoroNet. Previously,
Mr. Chandna held strategic marketing and product management
positions with SynOptics/Bay Networks from June 1991 to October
1994 and consulting positions with AT&T Bell Laboratories
from September 1988 to May 1991. Mr. Chandna currently
serves on the board of directors of several privately held
companies including Imperva Inc., Palo Alto Networks and
Securent, Inc.. He previously served on the board of directors
at CipherTrust, Inc. (acquired by Secure Computing Corporation),
NetBoost Inc. (acquired by Intel Corporation) and PortAuthority
Technologies (acquired by
71
Websense, Inc.). Mr. Chandna holds B.S. and M.S. degrees
in electrical and computer engineering from Case Western Reserve
University in Cleveland, Ohio.
Joseph
R. Chinnici, Director
Joseph R. Chinnici joined our board of directors in July 2006.
He was appointed our lead outside director in February 2007.
Mr. Chinnici has served as Senior Vice President, Finance
and Chief Financial Officer at Ciena Corporation since August
1997, and was previously Vice President, Finance and Chief
Financial Officer from May 1995 to August 1997.
Mr. Chinnici served previously as Controller since joining
Ciena in September 1994. From 1993 through 1994,
Mr. Chinnici served as a financial consultant for Halston
Borghese Inc. From 1977 to 1993, Mr. Chinnici held a
variety of accounting and finance assignments for Playtex
Apparel, Inc. (now a division of Sara Lee Corporation), ending
this period as Director of Operations Accounting and Financial
Analysis. Mr. Chinnici serves on the board of directors for
Brix Networks, Inc. He holds a B.S. degree in accounting from
Villanova University and an M.B.A. from Southern Illinois
University.
Tim A.
Guleri, Director
Tim A. Guleri joined our board of directors in June 2002 and is
currently a Managing Director with Sierra Ventures. Before
joining Sierra Ventures in February 2001, Mr. Guleri was
the Vice Chairman and Executive Vice President with Epiphany,
Inc. from March 2000 until February 2001; the Chairman, CEO and
Co-founder of Octane Software Inc. from September 1997 until
March 2000; Vice President of Field Operations, Product
Marketing with Scopus Technology Inc. from February 1992 until
February 1996 and was part of the information technology team
with LSI Logic Corporation from September 1989 until September
1991. He has been a director of: Octane Software from 1997 to
2000 (Sold to Epiphany in 2000); Net6, Inc. from March 2001 to
March 2004 (acquired by Citrix Systems, Inc. in 2004); Approva,
Inc. since April 2005; Spoke Software, Inc. since July 2002;
CodeGreen Networks, Inc. since March 2005; AIRMEDIA, Inc. since
April 2005; Steelbox Networks Inc. since 2006; and Everest, Inc.
since October 2003. Mr. Guleri holds a B.S. in Electrical
Engineering from Punjab Engineering College, India and an M.S.
in Engineering and Operational Research from Virginia Tech.
Lt.
Gen. Steven R. Polk (ret.), Director
Lt. Gen. Steven R. Polk joined our board of directors in August
2006. General Polk was the Inspector General of the Air Force,
Office of the Secretary of the Air Force, Washington, D.C., from
December 2003 until he retired on February 1, 2006. While
at the Air Force, General Polk oversaw Air Force inspection
policy, criminal investigations, counterintelligence operations,
intelligence oversight, complaints, and fraud, waste and abuse
programs and was also responsible for two field operating
agencies — the Air Force Inspection Agency and Air
Force Office of Special Investigations. Prior to this
assignment, he was Vice Commander, Pacific Air Forces from
March 2002 to November 2003 and Commander,
19th
Air Force, Air Education and Training Command from May 1999
to March 2002. Staff appointments included Director of
Operations at Headquarters Pacific Air Forces and Assistant
Chief of Staff for Operations at Headquarters Allied Air Forces
Northwestern Europe, NATO, as well as duty at Headquarters
U.S. Air Forces in Europe and Headquarters U.S. Air
Force. General Polk graduated and was commissioned from the
U.S. Air Force Academy in June 1968 with a B.S. in
aeronautical engineering. In 1974, he received an M.S. in
engineering from Arizona State University, Tempe and in 1988 he
received an M.A. in national security and strategic studies from
Naval War College, Newport, R.I.
Maj.
Gen. Arnold L. Punaro (ret.), Director
Maj. Gen. Arnold L. Punaro joined our board of directors in
January 2007 and is currently Executive Vice President,
Government Affairs, Communications and Support Operations and
General Manager of Washington Operations for Science
Applications International Corporation, or SAIC. He is also a
member of the Secretary of Defense Gates’ Defense Business
Board and is currently chairing the Statutory Commission on the
National Guard and Reserves. Prior to joining SAIC in 1997,
General Punaro worked for Senator Sam Nunn on national security
matters from 1973 to 1997. During that time, General Punaro
served as Senator Nunn’s director of national security
affairs and as staff director of the Senate Armed Services
Committee. General Punaro served as the director of the Marine
Corps Reserve from May 2001 until his retirement in October
2003. General Punaro also served as deputy
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commanding general, Marine Corps Combat Development Command
(Mobilization) from August 2000 until May 2001, and as the
commanding general of the 4th Marine Division headquartered
in New Orleans, Louisiana from 1997 to 2000. Prior to joining
SAIC, General Punaro served on active duty as an infantry
platoon commander in Vietnam where he was awarded the Bronze
Star for valor and the Purple Heart. As a reserve officer, he
has served in Operation Desert Shield in Saudi Arabia in
December 1990, Joint Task Force Provide Promise (Forward) in the
former Yugoslavia in December 1993, Operation Enduring Freedom
and Operation Iraqi Freedom in May 2003 and has served as both
the Headquarters Marine Corps Director of Reserve Affairs and as
the Special Assistant to the Commander, U.S. European
Command. General Punaro holds a B.S. from Spring Hill College in
Mobile, Alabama, an M.A. in journalism from the University of
Georgia and an M.A. in national security studies from Georgetown
University.
Harry
R. Weller, Director
Harry R. Weller joined our board of directors in February 2003.
Currently a Partner with New Enterprise Associates,
Mr. Weller joined New Enterprise Associates in January
2002. Prior to joining New Enterprise Associates,
Mr. Weller was a partner at FBR Technology Venture Partners
from 1997 until 2001, where he worked with
start-up
teams. Previously, Mr. Weller was with the Boston
Consulting Group in 1997 and Deloitte & Touche
Management Consulting from 1993 until 1996. At both firms, he
managed strategy and technology initiatives in the financial,
manufacturing and telecommunications industries. Mr. Weller
has served on the board of directors of Vonage, Inc. since
October 2003. Mr. Weller received a B.S. in Physics from
Duke University and an M.B.A. from Harvard University Graduate
School of Business.
Board of
Directors
Our board of directors has eight members and one vacancy, which
we intend to fill after completion of this offering. At each
annual meeting, our stockholders will re-elect, or elect
successors to, our directors. Our executive officers and key
employees serve at the discretion of our board of directors. The
following directors are independent as defined under The Nasdaq
Stock Market listing standards: Asheem Chandna, Joseph R.
Chinnici, Tim A. Guleri, Steven R. Polk,
Arnold L. Punaro and Harry R. Weller.
Pursuant to the Fourth Amended and Restated Stockholders’
Voting Agreement, dated as of May 24, 2006, the holders of
our Series A, B, C and D convertible preferred stock as
well as certain holders of our common stock have agreed to vote
their shares so as to elect to our board of directors: one
representative of the holders of our Series A convertible
preferred stock nominated by Sierra Ventures, which is currently
Mr. Guleri; one representative of the holders of our
Series B convertible preferred stock nominated by New
Enterprise Associates 10, which is currently
Mr. Weller; two representatives of the holders of our
common stock, which are currently Mr. Jackson and
Mr. Roesch; and one independent industry representative not
affiliated with or employed by us or any holders of our
preferred stock, which is currently Mr. Chandna. This
agreement will terminate upon the completion of this offering.
Mr. Weller has informed the board that he will not stand
for re-election when his term as director expires at our next
annual meeting of stockholders. Other directors may resign or
choose not to stand for re-election, which could adversely
affect the continuity of our board of directors.
After the completion of this offering, our board of directors
will consist of nine directors and will be divided into three
classes as follows:
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Class A will consist of Mr. Jackson, Mr. Chandna
and Mr. Weller, whose terms will expire at our annual
stockholders meeting to be held in 2007;
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Class B will consist of Mr. Roesch and
Mr. Guleri, whose terms will expire at our annual
stockholders meeting to be held in 2008; and
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Class C will consist of Mr. Chinnici, Mr. Punaro
and General Polk, whose terms will expire at our annual
stockholders meeting to be held in 2009.
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At each annual meeting of stockholders following the
establishment of the initial classes, the successors to
directors whose terms expire at that meeting will be elected to
service from the time of election and qualification
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until the third annual meeting following election. We anticipate
adding one additional Class B director to the board of
directors after the completion of this offering.
Board
Committees
The standing committees of our board of directors consist of an
audit committee, a compensation committee and a nominating and
governance committee.
Audit
Committee
Our audit committee consists of Joseph R. Chinnici, Tim A.
Guleri, Arnold L. Punaro and Harry R. Weller, each of whom is
independent, as defined under The Nasdaq Stock Market listing
standards. Mr. Chinnici serves as the chairman of our audit
committee. The audit committee reviews and recommends to our
board of directors internal accounting and financial controls
and accounting principles and auditing practices to be employed
in the preparation and review of our financial statements. In
addition, the audit committee has the authority to engage public
accountants to audit our annual financial statements and
determine the scope of the audit to be undertaken by such
accountants. The board of directors has determined that
Mr. Chinnici is an audit committee financial expert under
the SEC rule implementing Section 407 of the Sarbanes-Oxley
Act of 2002.
Compensation
Committee
Our compensation committee consists of Asheem Chandna, Tim A.
Guleri, Steven R. Polk and Harry R. Weller, each of whom is
independent, as defined under The Nasdaq Stock Market listing
standards. Mr. Guleri serves as the chairman of our
compensation committee. The compensation committee reviews and
recommends to our Chief Executive Officer and the board
policies, practices and procedures relating to the compensation
of managerial employees and the establishment and administration
of certain employee benefit plans for managerial employees. The
compensation committee has authority to administer our stock
incentive plan and advise and consult with our officers
regarding managerial personnel policies.
Nominating
and Governance Committee
Our nominating and governance committee consists of Asheem
Chandna, Joseph R. Chinnici and Steven R. Polk, each of whom is
independent, as defined under The Nasdaq Stock Market listing
standards. General Polk serves as the chairman of our nominating
and governance committee. The nominating and governance
committee assists the board of directors with its
responsibilities regarding, among other things, the
identification of individuals qualified to become directors; the
selection of the director nominees for the next annual meeting
of stockholders; the selection of director candidates to fill
any vacancies on the board of directors; reviewing and making
recommendations to the board with respect to management
succession planning; developing and recommending to the board
corporate governance principles; and overseeing an annual
evaluation of the board.
From time to time, the board may establish other committees to
facilitate the management of our business.
Compensation
Committee Interlocks and Insider Participation
None of our executive officers serves as a member of the board
of directors or compensation committee of any entity that has
one or more executive officers serving as our director or as a
member of our compensation committee.
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COMPENSATION
DISCUSSION AND ANALYSIS
Overview
This compensation discussion and analysis explains the material
elements of the compensation awarded to, earned by, or paid to
each of our executive officers who served as our named executive
officers during the last completed fiscal year.
Compensation
Program Objectives and Philosophy
The compensation committee of our board of directors currently
oversees the design and administration of our executive
compensation program. Our compensation committee’s primary
objectives in structuring and administering our executive
officer compensation program are to:
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attract, motivate and retain talented and dedicated executive
officers;
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tie annual and long-term cash and stock incentives to
achievement of measurable corporate, business unit and
individual performance objectives;
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reinforce business strategies and objectives for enhanced
stockholder value; and
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provide our executive officers with long-term incentives so we
can retain them and provide stability during our growth stage.
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To achieve these goals, our compensation committee intends to
implement and maintain compensation plans that tie a substantial
portion of executives’ overall compensation to key
strategic goals such as financial and operational performance,
as measured by metrics such as revenue, gross margins and net
income. Our compensation committee evaluates individual
executive performance with a goal of setting compensation at
levels the committee believes are comparable with those of
executives at other companies of similar size and stage of
growth, while taking into account our relative performance and
our own strategic goals.
The principal elements of our executive compensation program are
base salary, quarterly cash bonus awards, long-term equity
incentives in the form of restricted stock
and/or stock
options, other benefits and perquisites, post-termination
severance and acceleration of stock option vesting for certain
named executive officers upon termination
and/or a
change in control. Our other benefits and perquisites consist of
life and health insurance benefits and a qualified 401(k)
savings plan.
We view these components of compensation as related but
distinct. Although our compensation committee does review total
compensation, we do not believe that significant compensation
derived from one component of compensation should negate or
offset compensation from other components. We determine the
appropriate level for each compensation component based in part,
but not exclusively, on competitive benchmarking consistent with
our recruiting and retention goals, our view of internal equity
and consistency, and other considerations we deem relevant, such
as rewarding extraordinary performance.
Determination
of Compensation Awards
Our compensation committee currently intends to perform at least
annually a strategic review of our executive officers’
compensation to determine whether they provide adequate
incentives and motivation to our executive officers and whether
they adequately compensate our executive officers relative to
comparable officers in other similarly situated companies. Our
compensation committee’s most recent review occurred in
January 2007 when our compensation committee retained a
compensation consulting firm to assist it in evaluating our
compensation practices and to assist it in developing and
implementing our executive compensation program and philosophy.
With the assistance of the compensation consulting firm, our
compensation committee developed a competitive peer group and
performed an analysis of competitive performance and
compensation levels. We define our competitive market for
executive talent to be established publicly traded companies
with similar or comparable gross revenues, growth ratio, net
income and/or market capitalization and companies that have
consummated an initial public offering within the preceding
twelve months and who have comparable operating metrics. Our
compensation committee also met individually with members of our
senior management to learn about our business
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operations and strategy, key performance metrics and target
goals, and the labor and capital markets in which we compete,
and developed recommendations that were reviewed and approved by
our board of directors.
Our compensation committee meetings typically have included, for
all or a portion of each meeting, not only the committee members
but also our chief executive officer, our chief financial
officer and our general counsel. For compensation decisions,
including decisions regarding the grant of equity compensation,
relating to executive officers other than our chief executive
officer, our compensation committee typically considers
recommendations from our chief executive officer.
Benchmarking
of Base Compensation, Bonus and Equity Holdings
In January 2007, our board of directors (including our
compensation committee) approved the adjustment of executive
officers’ salaries to a level that is at or near the
60th percentile of salaries of executives with similar
roles at comparable public companies and to set their aggregate
share and option grants at a level that is at or near the 60th
percentile of executives in similar positions, contingent upon
the effectiveness of our registration statement. The comparable
public companies used by our board of directors in its analysis
include the following: ActivIdentity, Inc., Art Technology
Group, Inc., Blue Coat Systems, Inc., Chordiant Software, Inc.,
CommVault, Inc., Docucorp International, Inc., Double-Take
Software, Inc., Embarcadero Technologies, Inc, Entrust, Inc.,
FalconStor Software, Inc., Mobius Management Systems, Inc.,
Omniture, Inc., OPNET Technologies, Inc., Opsware Inc., Phoenix
Technologies Ltd, Quovadx, Inc., RightNow Technologies, Inc.,
Secure Computing Corporation, Sonicwall, Inc., Synchronoss
Technologies, Inc., Unica Corporation, VA Software Corporation
and VASCO Data Security International, Inc. Our compensation
committee believes that the 60th percentile for base salaries
and for aggregate share and option holdings is the minimum cash
and equity compensation level that will allow us to attract and
retain talented officers. Our compensation committee realizes
that using such a benchmark may not always be appropriate but
believes that it is appropriate at this point in the life cycle
of the company. In instances where an executive officer is
uniquely key to our success, our compensation committee may
provide compensation in excess of the benchmark percentile. Our
compensation committee’s judgments with regard to market
levels of base compensation and aggregate equity holdings were
based on the collective experiences of the members of our
compensation committee as well as the advice provided by a
compensation consultant. Our compensation committee also
compared our executive compensation with the executive
compensation at a number of recently public companies and a
number of established public companies, analyzing various
factors including revenues, growth rates, net income and
employee headcount. Our compensation committee chose revenues,
growth rate and net income as key financial objectives because
it believed that, as a “growth company,” we should
reward revenue growth, but only if that revenue growth is
achieved cost effectively. Thus, our compensation committee
considered the chosen metrics to be the best indicators of
financial success and stockholder value creation. Our
compensation committee’s choice of the 60th percentile as
our compensation benchmark reflected consideration of our
stockholders’ interests in paying what was necessary to
attract and retain key talent in a competitive market, while
conserving cash and equity as much as possible. We believe that,
given the industry in which we operate and the corporate culture
that we have created, our benchmark base compensation and equity
compensation levels should generally be sufficient to retain our
existing executive officers and to hire new executive officers
when and as required.
Base
Compensation
We provide our named executive officers and other executives
with base salaries that we believe enable us to hire and retain
individuals in a competitive environment and to reward
individual performance and contribution to our overall business
goals. We review base salaries for our named executive officers
annually in January and increases are based on our performance
and individual performance. We also take into account the base
compensation that is payable by companies that we believe to be
our competitors and by other public companies with which we
believe we generally compete for executives. The base salary of
our chief executive officer, Mr. Jackson, is reviewed and
recommended by our compensation committee and approved by our
full board of directors with Mr. Jackson abstaining, and
has been set at $275,000 for 2007, contingent on the completion
of this offering. Our compensation committee and our board
determined that this salary increase from $225,000 in 2006 would
provide a salary commensurate with Mr. Jackson’s
experience and would recognize his contributions to our growth
during the past four years. Additionally, our compensation
committee recommended, and our board approved, base salary
increases for Messrs. McDonough and Headley and
Ms. Perry-Boucher. Mr. McDonough’s annual base
salary in
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2006 was set at $200,000 and in 2007 is $225,000.
Mr. Headley’s annual base salary in 2006 was set at
$175,000 and in 2007 is $210,000. Ms. Perry-Boucher’s
annual base salary in 2006 was set at $185,000 and in 2007 is
$190,000. All of the foregoing increases are contingent on the
completion of this offering.
For 2006, the base salaries accounted for approximately 70% of
total compensation for our chief executive officer and 71% on
average for our other named executive officers.
Quarterly
Cash Bonus Awards
Our current quarterly cash bonus plan is designed to reward our
executive officers for exemplary service. Bonuses are determined
and paid on a quarterly basis, when executive bonus plans are
proposed to and approved by our compensation committee. We
designed this quarterly cash bonus plan to focus our management
on achieving key corporate financial objectives, to motivate
certain desirable individual behaviors and to reward substantial
achievement of our key corporate financial objectives and
individual goals. These quarterly bonus plans typically contain
between four and six objectives with a dollar value ascribed to
each objective so that the sum total equals the approved
quarterly bonus potential for each executive officer, according
to his or her compensation plan. Objectives include but are not
limited to: (i) revenue achievement; (ii) gross margin
achievement; (iii) EBITDA achievement; (iv) cash
collection goals; (v) project implementation plans;
(vi) product availability goals; (vii) hiring goals
and (viii) a variety of other department or
company-specific objectives. We believe that our bonus target
levels are moderately difficult to achieve and that our
executives must perform at a high level devoting their full time
and attention in order to earn their respective cash bonuses. At
the conclusion of each quarter, our chief executive officer and
chief financial officer provide our compensation committee with
a draft of the earned bonus figures for its review and approval.
Our performance goals are both quantitative and qualitative.
With respect to quantitative goals, no discretion may be
exercised because these goals are objective. With respect to
qualitative goals, a moderate amount of discretion may be
exercised because these goals are subjective. For instance,
qualitative goals include preparing product strategies and
supporting our engineering team in meeting its milestones. It is
necessary to exercise discretion in order to determine whether
such goals are met.
In January 2007, our compensation committee recommended, and our
board approved, new quarterly cash bonus award targets for our
executive officers that more closely follow our compensation
committee’s philosophy and objectives with respect to cash
bonuses. These changes in our quarterly cash bonus awards are
contingent upon the effectiveness of our registration statement.
For example, our quarterly cash bonus award targets now define
the maximum annual bonus as a percentage of the executive
officer’s current annual salary as agreed to with our
executive officers or, in the case of our chief executive
officer’s percentage, our compensation committee. The
percentages for 2007 are 55% for Mr. Jackson and 25%, 44%, 45%,
40% and 32% for Messrs. Roesch, McDonough, Headley and
Boyle and Ms. Perry-Boucher, respectively. In 2006, these
percentages were 44% for Mr. Jackson and 25%, 50%, 29%, 29% and
30% for Messrs. Roesch, McDonough, Headley and Boyle and
Ms. Perry-Boucher, respectively. We pay bonuses quarterly
with the maximum potential bonus in a given quarter equal to
one-quarter of the maximum annual bonus. We determined to pay
bonuses quarterly because our compensation committee is
attempting to maximize achievement of short-term operational
objectives. The individual performance objectives are determined
by the executive officer to whom the potential bonus recipient
reports or, in the case of our chief executive officer, by our
compensation committee, after taking input from the other
members of our board of directors. Mr. Jackson’s
future bonus opportunities might include such objectives as
developing our executive team, successfully integrating
acquisitions, or developing strategic opportunities. We
structure quarterly cash bonus awards so that they are taxable
to our executives at the time the awards become available to
them. We currently intend that all cash compensation paid will
be tax deductible by us as compensation expense.
For 2006, all quarterly cash bonuses paid to our chief executive
officer accounted for approximately 30% of his total
compensation. For our other named executive officers in 2006,
their quarterly cash bonuses, on average, accounted for
approximately 24% of their respective total compensation.
Equity
Compensation
We believe that for growth companies in the technology sector,
equity awards are a significant compensation-related motivator
in attracting and retaining executive-level employees. Our
compensation committee’s philosophy
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in this regard has historically been to allocate a greater
percentage of an employee’s total compensation to equity
compensation as he or she becomes more senior in our
organization.
Accordingly, we have provided our named executive officers and
other executives with long-term equity incentive awards that
incentivize those individuals to stay with us for long periods
of time, which in turn should provide us with greater stability
over such periods than we would experience without such awards.
While the majority of our long-term equity compensation awards
historically have also been in the form of non-qualified stock
options, we provided grants of restricted stock to Messrs.
Jackson and McDonough upon commencement of their employment with
us in 2002. For 2007 our compensation committee has decided to
use non-qualified stock options and restricted stock grants, in
each case subject to a vesting schedule, in combination in order
to provide us with additional flexibility. Stock options are
attractive because they provide a relatively straightforward
incentive for our executives, result in less immediate dilution
of existing shareholders’ interests and create a
disincentive to exercise vested options due to income tax
liabilities on the part of the option holder, thus extending the
term of employment. Our compensation committee also decided in
certain cases to make restricted stock awards to our executive
officers. We believe that restricted stock awards provide
additional incentive to our executives by providing them with
immediate stock ownership, which aligns their interests with
those of our stockholders. We believe that a restricted stock
award program may consume fewer shares than options in order to
achieve similar incentive levels because restricted shares are
immediately valuable to recipients, in contrast to stock
options, which may or may not ultimately result in realizable
value to recipients. Because of the lower share consumption rate
associated with our restricted stock award program, our use of
the program may lessen our equity overhang and reduce dilution
for our stockholders.
We account for equity compensation paid to our employees under
the rules of SFAS No. 123R, which requires us to
estimate and record compensation expense over the service period
of the award. All equity awards to our employees, including
executive officers, and to our directors have been granted and
reflected in our consolidated financial statements, based upon
the applicable accounting guidance, at fair market value on the
grant date in accordance with the valuation determined by our
board of directors. Generally, the granting of a non-qualified
stock option to our executive officers is not a taxable event to
those employees, provided, however, that the exercise of such
stock option would result in taxable income to the optionee
equal to the difference between the fair market value of the
stock on the exercise date and the exercise price paid for such
stock. Similarly, a restricted stock award subject to a vesting
requirement is also not taxable to our executive officers unless
such individual makes an election under section 83(b) of the
Internal Revenue Code of 1986, as amended. In the absence of a
section 83(b) election, the value of the restricted stock award
becomes taxable to the recipient as the restrictions lapse.
Prior to this offering, we have granted equity compensation to
our executive officers and other employees in the form of
non-qualified stock options under our 2002 Stock Incentive Plan.
Prior to the consummation of this offering, our board of
directors intends to supplement the 2002 Stock Incentive Plan
with the 2007 Stock Incentive Plan, which we refer to as the
2007 Plan. See “—Employee Benefit Plans” below
for additional information.
Generally, we grant long-term equity awards to our named
executive officers upon commencement of their employment, and
the terms of those awards are individually negotiated.
Additionally, from time to time, we have granted subsequent
long-term equity awards to our named executive officers based
upon a number of factors, including: rewarding executives for
superior performance, maintaining a sufficient number of
unvested long-term equity awards as a means to retain the
services of such executives, providing increased motivation to
such executives and ensuring that the total long-term equity
awards are competitive with those of other companies competing
for our named executive officers.
Restricted Stock. Over our history we have
made several grants of restricted stock to our executive
officers. In June 2002, in connection with the commencement of
his employment, we granted to Mr. Jackson a restricted
stock award equal to 559,729 shares of our common stock at
a price of $0.000541 per share. In December 2003, we granted to
Mr. Jackson 64,655 shares of restricted common stock
at a purchase price of $0.00162 per share. In November
2002, in connection with the commencement of his employment, we
granted to Mr. McDonough 312,192 shares of restricted
stock at a per share purchase price of $0.00162. In December
2003, we granted to Mr. McDonough 129,310 shares of
restricted stock at a per share purchase price of $0.00162. As
of December 31, 2006, all shares of restricted stock
granted to Messrs. Jackson and McDonough are fully vested
pursuant to the terms
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of their respective restricted stock agreements. We have also
granted restricted stock to certain of our directors. See
“—Summary of Director Compensation” below for
additional information.
Stock Options. Upon commencement of their
employment, we granted Messrs. Headley and Boyle and
Ms. Perry-Boucher non-qualified stock options to purchase
105,911, 123,152 and 123,152 shares of our common stock,
respectively, at exercise prices of $0.325, $5.26 and $1.14,
respectively. In December 2004, we granted Mr. Headley an
additional non-qualified stock option to purchase
24,630 shares of our common stock at an exercise price of
$1.62. In June of 2005, in connection with our merger agreement
with Check Point Software Technologies Ltd, we granted all of
our named executive officers additional grants of non-qualified
stock options in order to motivate those individuals to perform
all our obligations under that merger agreement. Accordingly,
Messrs. Jackson, McDonough, Roesch and Headley and
Ms. Perry-Boucher received non-qualified stock options to
purchase 98,522, 92,364, 61,576, 23,399 and 21,551 shares
of our common stock, respectively, each at an exercise price of
$2.03 per share.
In 2006, our compensation committee determined that our named
executive officers had a sufficient equity stake in us,
consisting of shares of common stock
and/or
existing options, to align their interests with ours and our
stockholders and consequently there were no grants in 2006 to
our named executive officers other than the grant to
Mr. Boyle of 123,152 non-qualified stock options at a price
of $5.26 per share in April 2006 at the commencement of his
employment.
In January 2007, in connection with its benchmarking of equity
holdings, our compensation committee recommended, and our board
of directors approved (subject to the effectiveness of our
registration statement), that we grant our named executive
officers additional long-term equity awards in order to
implement our compensation philosophy of setting aggregate share
and option holdings at a level that is at or near the
60th percentile of equity compensation for executives in
similar positions within our peer group. In determining the
amount of the long-term equity awards, our compensation
committee first developed a value range (in dollars) of the
equity compensation component that other similarly situated
executives within the 60th percentile of our peer group
received. For example, our compensation committee concluded
that, with respect to the position of chief executive officer
for companies within our peer group, the 60th percentile of
annual dollar value of the equity component of chief executive
officer compensation ranged from $350,000 to $450,000. Thus, our
compensation committee concluded and recommended, and our board
of directors approved, that the appropriate annual dollar value
of the long-term equity component of the compensation to be
provided to our chief executive officer should be $400,000.
Using the same methodology the compensation committee also
recommended, and our board approved, that we provide
Messrs. McDonough, Roesch, Headley and Boyle and
Ms. Perry-Boucher with long-term equity compensation of
$225,000, $65,000, $160,000, $25,000 and $85,000, respectively.
Furthermore, our compensation committee has determined that the
aggregate economic value of equity compensation payable to the
executive officers should be roughly one-half restricted stock
and one-half non-qualified stock options, although individual
cases may vary depending on the personal preferences, if any, of
the named executive officers. All of our non-qualified stock
options will be subject to a four year vesting schedule with
one-quarter vesting on the first anniversary of such grant and
the remainder vesting equally on a monthly basis over the next
three years. Our restricted stock awards will be subject to the
achievement of performance targets, which we intend to establish
when we grant such awards.
In determining the number of non-qualified stock options and/or
restricted stock to award our named executive officers in order
to convey the annual dollar value outlined above, our
compensation committee intends to determine the estimated fair
value for such awards on the grant date by performing a
Black-Scholes calculation using factors relevant to the company.
Using that estimated fair value, our compensation committee will
be able to ascertain the number of non-qualified stock options
and/or restricted stock grants to provide to our named executive
officers by dividing the dollar value of the long-term equity
component of the compensation for each named executive officer
by the estimated fair value of the applicable equity award.
For 2007, based on an assessment of the foregoing factors, the
compensation committee recommended, and our board of directors
approved, subject to the effectiveness of our registration
statement, that we grant our chief executive officer $300,000
worth of non-qualified stock options and $100,000 worth of
restricted stock. Similarly, our compensation committee
recommended that Mr. McDonough receive $56,250 worth of
non-qualified stock options and $168,750 worth of restricted
stock; that Mr. Roesch receive $65,000 worth of
non-qualified stock options; that Mr. Headley receive
$120,000 worth of non-qualified stock options and $40,000 worth
of restricted stock; that
79
Mr. Boyle receive $12,500 worth of non-qualified stock
options and $12,500 worth of restricted stock; and that
Ms. Perry-Boucher receive $42,500 worth of non-qualified
stock options and $42,500 worth of restricted stock.
For a discussion of the determination of the fair market value
of these grants, see “Management’s Discussion and
Analysis of Financial Condition and Results of
Operations — Critical Accounting Policies —
Stock-Based Compensation.”
Our stock options have a
10-year
contractual exercise term. In general, the option grants are
also subject to the following post-termination and change in
control provisions:
|
|
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|
|
Event
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|
Award vesting
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|
Exercise term
|
|
Termination by us for reason other
than death, total and permanent disability, voluntary
resignation or cause
|
|
Unvested terminate
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|
30 days following cessation
of employment, but in no event after the expiration date of such
options
|
Total and permanent disability or
death (prior to vesting of any options)
|
|
Immediate vesting of an amount
equal to total number of options granted, multiplied by 25%,
multiplied by a fraction equal to the number of days since the
vesting start date, divided by 365; remaining unvested terminate
|
|
6 months following cessation
of employment, but in no event after the expiration date of such
options
|
Voluntary resignation; termination
for cause; misconduct
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Vested and unvested terminate
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None
|
Change in control
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|
Vested and unvested terminate
unless provision is made in connection with the transaction
|
|
At least 20 days prior to
effective time of change in control
|
The vesting of certain of our named executive officers’
stock options is accelerated pursuant to the terms of their
stock option grant agreement in certain termination
and/or
change in control events. These terms are more fully described
below in “— Employment Agreements” and
“— Potential Payments upon Termination or Change
in Control.”
Executive
Benefits and Perquisites
In General. We provide the opportunity for our
named executive officers and other executives to receive certain
perquisites and general health and welfare benefits. We also
offer participation in our defined contribution 401(k) plan. We
do not match employee contributions under our 401(k) plan. We
provide these benefits to create additional incentives for our
executives and to remain competitive in the general marketplace
for executive talent.
Change in
Control and Severance Benefits
In General. We generally do not offer our
employees severance benefits or change of control provisions
within their option grant agreements unless specifically
authorized by our board of directors or our compensation
committee. We provide the opportunity for certain of our named
executive officers to receive additional compensation or
benefits under the severance and change in control provisions
contained in their employment agreements. We provide this
opportunity to attract and retain an appropriate caliber of
talent in key positions. Our severance and change in control
provisions for the named executive officers are summarized below
in “— Employment Agreements” and
“— Potential Payments Upon Termination or Change
in Control.” Our analysis indicates that our severance and
change in control provisions are consistent with the provisions
and benefit levels of other companies disclosing such provisions
as reported in public SEC filings. We believe our arrangements
are reasonable in light of the fact that severance benefits are
limited to six months, in the case of Messrs. Jackson,
McDonough and Roesch, and three months, in the case of
Messrs. Headley and Boyle, and no increase in severance
benefits would occur on a change in control.
80
Executive
Compensation
The following table shows information concerning the annual
compensation for services provided to us by our Chief Executive
Officer, our Chief Financial Officer and our four other most
highly compensated executive officers during 2006.
Summary
Compensation Table
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|
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|
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|
|
|
|
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|
Non-equity
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|
|
|
|
|
|
|
|
|
|
|
|
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|
incentive plan
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Total
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|
|
|
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|
Salary
|
|
|
Stock awards
|
|
|
compensation(1)
|
|
|
compensation
|
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|
|
|
Name and principal
position
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
|
|
|
E. Wayne Jackson, III
|
|
|
225,000
|
|
|
|
—
|
|
|
|
97,000
|
|
|
|
322,000
|
|
|
|
|
|
Chief Executive Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Todd P. Headley
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|
|
175,000
|
|
|
|
—
|
|
|
|
49,320
|
|
|
|
224,320
|
|
|
|
|
|
Chief Financial Officer and
Treasurer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Thomas M. McDonough
|
|
|
200,000
|
|
|
|
—
|
|
|
|
97,265
|
|
|
|
297,265
|
|
|
|
|
|
President and Chief Operating
Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Martin F. Roesch
|
|
|
200,000
|
|
|
|
—
|
|
|
|
50,895
|
|
|
|
250,895
|
|
|
|
|
|
Chief Technology Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Joseph M.
Boyle(2)
|
|
|
120,705
|
|
|
|
84,239
|
|
|
|
21,535
|
|
|
|
226,479
|
|
|
|
|
|
General Counsel and Secretary
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Michele M. Perry-Boucher
|
|
|
175,000
|
|
|
|
—
|
|
|
|
48,600
|
|
|
|
223,600
|
|
|
|
|
|
Chief Marketing Officer
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
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(1)
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The amounts in this column
represent total performance-based bonuses earned for services
rendered in 2006. These bonuses were based on our financial
performance and the executive officer’s performance against
his or her specified individual objectives.
|
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(2)
|
|
Mr. Boyle’s employment with us
began on April 24, 2006 at an annual salary of $175,000.
|
2006
Grants of Plan-Based Awards
The following table provides information with regard to
potential cash bonuses paid or payable in 2006 under our
performance-based, non-equity incentive plan, and with regard to
each stock option granted to each named executive officer during
2006.
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|
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|
|
|
|
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|
|
|
|
|
|
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated future payouts
|
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|
All other option
|
|
|
|
|
|
|
|
|
|
|
|
|
under non-equity incentive
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|
|
awards: number of
|
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|
Exercise or
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|
|
|
|
|
|
|
|
|
plan
awards(1)
|
|
|
securities underlying
|
|
|
base price of
|
|
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Grant date
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Threshold
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Target
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Maximum
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options
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option awards
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fair value of
|
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Name
|
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Grant date
|
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($)
|
|
|
($)
|
|
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($)
|
|
|
(#)
|
|
|
($/sh)
|
|
|
option awards
|
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|
E. Wayne Jackson, III
|
|
|
—
|
|
|
|
90,000
|
|
|
|
100,000
|
|
|
|
100,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Todd P. Headley
|
|
|
—
|
|
|
|
23,500
|
|
|
|
50,000
|
|
|
|
50,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Thomas M. McDonough
|
|
|
—
|
|
|
|
72,000
|
|
|
|
100,000
|
|
|
|
100,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Martin F. Roesch
|
|
|
—
|
|
|
|
29,000
|
|
|
|
52,000
|
|
|
|
52,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Joseph M. Boyle
|
|
|
4/27/06
|
|
|
|
9,500
|
|
|
|
37,500
|
|
|
|
37,500
|
|
|
|
123,152
|
|
|
|
5.26
|
|
|
$
|
470,480
|
|
Michele M. Perry-Boucher
|
|
|
—
|
|
|
|
25,250
|
|
|
|
52,500
|
|
|
|
52,500
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
(1)
|
|
In the table above, the
“Threshold” column represents the smallest total bonus
that would have been paid in 2006 to each named executive
officer if, in each quarter of 2006, we had achieved the minimum
corporate financial objectives required for the payment of any
bonus but the executive officer did not meet any of his or her
individual objectives. In the table above, the
“Target” column represents the amount payable if the
specified corporate financial and individual target objectives
were met in each quarter of 2006. The “Maximum” column
represents the largest total bonus that could have been paid to
each named executive officer if all corporate financial and
individual objectives were met in each quarter of 2006. The
actual bonus amount earned by each named executive officer in
2006 is shown in the “Summary Compensation Table”
above.
|
81
Employee
Benefits Plans
2002
Stock Incentive Plan
In January 2002, we adopted and our stockholders approved the
Sourcefire, Inc. 2002 Stock Incentive Plan, which we refer to as
the 2002 Plan.
As of December 31, 2006, there was an aggregate of
5,100,841 shares of common stock reserved for issuance
under the 2002 Plan, of which options to purchase
3,199,903 shares of common stock were outstanding,
1,093,596 shares of common stock were granted as restricted
stock awards and were outstanding, and 181,934 shares of
common stock remained available for future awards. Upon the
effective date of this offering, no further awards will be made
under the 2002 Plan and all shares remaining available for grant
will be transferred into the 2007 Plan discussed below.
The 2002 Plan allows for the grant of incentive stock options,
non-qualified stock options, restricted and unrestricted stock
awards, stock appreciation rights, phantom stock awards,
performance awards and other stock-based awards, which we
collectively refer to as awards. Our and our affiliates’
employees, officers, non-employee directors and consultants are
eligible to receive awards, except that incentive stock options
may be granted only to employees. Upon the effectiveness of our
2007 Stock Incentive Plan, as described below, we will cease to
make grants under the 2002 Plan.
Administration. The board of directors has
appointed our compensation committee as the administrator of the
2002 Plan. Subject to the terms of the 2002 Plan, our
compensation committee determines, among other things, the:
|
|
|
|
•
|
individuals eligible to receive an award;
|
|
|
•
|
number of shares of common stock covered by the awards, the
dates upon which such awards become exercisable and expire and
the dates on which any restrictions lapse;
|
|
|
•
|
form of award and the price and method of payment for each such
award;
|
|
|
•
|
vesting period; and
|
|
|
•
|
exercise price or purchase price of awards.
|
Incentive Stock Options. Incentive stock
options are intended to qualify as incentive stock options under
Section 422 of the Internal Revenue Code. Our compensation
committee determines the exercise price for an incentive stock
option, which may not be less than 100% of the fair market value
of the stock underlying the option determined on the date of
grant. However, incentive stock options granted to employees who
own, or are deemed to own, more than 10% of our voting stock,
must have an exercise price not less than 110% of the fair
market value of the shares underlying the option determined on
the date of grant. As of December 31, 2006, we have not
granted any incentive stock options.
Restricted Stock and Other Stock-Based
Awards. Stock appreciation rights and restricted
stock, phantom stock and other stock-based awards may be granted
on such terms as may be approved by our compensation committee.
Rights to acquire shares under a restricted stock or other
stock-based award may be transferable only to the extent
determined by our compensation committee.
Transfer of Awards. Except as otherwise
determined by our compensation committee, and in any event in
the case of an incentive stock option or a stock appreciation
right granted with respect to an incentive stock option, no
award shall be transferable otherwise than by will or the laws
of descent and distribution.
Change of Control of Company. In the event of
a change of control of our company, as such term is defined in
the 2002 Plan, outstanding awards will terminate upon the
effective time of such change of control unless provision is
made in connection with the transaction for the continuation,
assumption or substitution of such awards by the successor
entity. Our compensation committee shall also have the
discretion to accelerate outstanding options or terminate the
company’s repurchase rights with respect to restricted
stock awards and otherwise modify, amend or extend outstanding
awards.
82
2007
Stock Incentive Plan.
On February 22, 2007, we adopted the Sourcefire, Inc. 2007
Stock Incentive Plan, which we refer to as the 2007 Plan,
contingent on the effectiveness of this registration statement.
The number of shares of common stock that may be issued pursuant
to awards granted under the 2007 Plan initially shall be
3,142,452, which number will be increased annually on the first
day of each fiscal year, beginning in January 1, 2008 and
until January 1, 2017, to a number equal to 4.0% of the
outstanding shares of common stock of the company as of
December 31 of the immediately preceding year.
The 2007 Plan will allow for the grant of incentive stock
options, non-qualified stock options, restricted and
unrestricted stock awards, stock appreciation rights, dividend
equivalent rights and other stock-based awards, which we
collectively refer to as awards. Our and our affiliates’
employees, officers, non-employee directors and consultants are
eligible to receive awards, except that incentive stock options
may be granted only to employees.
Administration. The administrator of the 2007
Plan will be the compensation committee of our board of
directors. Subject to the terms of the 2007 Plan, our
compensation committee shall determine, among other things:
|
|
|
|
•
|
the individuals eligible to receive an award;
|
|
|
|
|
•
|
the number of shares of common stock covered by the award, the
dates upon which such awards become exercisable and expire and
the dates on which any restrictions lapse;
|
|
|
|
|
•
|
the form of award and the price and method of payment for each
such award;
|
|
|
|
|
•
|
the vesting period; and
|
|
|
|
|
•
|
the exercise price or purchase price of awards.
|
Incentive Stock Options. Incentive stock
options are intended to qualify as incentive stock options under
Section 422 of the Internal Revenue Code. Our compensation
committee determines the exercise price for an incentive stock
option, which may not be less than 100% of the fair market value
of the stock underlying the option determined on the date of
grant. However, incentive stock options granted to employees who
own, or are deemed to own, more than 10% of our voting stock,
must have an exercise price not less than 110% of the fair
market value of the shares underlying the option determined on
the date of grant.
Transfer of Awards. Incentive stock options
shall only be transferable by will or the laws of descent and
distribution. Other awards shall be transferable by will or the
laws of descent and distribution during the lifetime of the
grantee to the extent and in the manner authorized by our
compensation committee.
Change of Control of Company. In the event of
a change of control of our company or a corporate transaction,
as such terms are defined in the 2007 Plan, outstanding awards
will terminate upon the effective time of such change of control
or such corporate transaction unless provision is made in
connection with the transaction for the continuation, assumption
or substitution of such awards by the successor entity. Our
compensation committee shall also have the discretion to
accelerate outstanding options, terminate the company’s
repurchase rights with respect to restricted stock awards and
otherwise modify, amend or extend outstanding awards.
83
Outstanding
Equity Awards at December 31, 2006
The following table summarizes the number of securities
underlying outstanding 2002 Plan awards for each named executive
officer as of December 31, 2006. There are no outstanding
unvested shares of restricted stock held by our named executive
officers as of December 31, 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option awards
|
|
|
|
Number of
|
|
|
Number of
|
|
|
|
|
|
|
|
|
|
securities
|
|
|
securities
|
|
|
|
|
|
|
|
|
|
underlying
|
|
|
underlying
|
|
|
|
|
|
|
|
|
|
unexercised
|
|
|
unexercised
|
|
|
Option exercise
|
|
|
Option
|
|
|
|
options (#)
|
|
|
options (#)
|
|
|
price
|
|
|
expiration
|
|
Name
|
|
Exercisable
|
|
|
Unexercisable
|
|
|
($)
|
|
|
date
|
|
|
E. Wayne Jackson, III
|
|
|
36,945
|
|
|
|
61,576
|
(1)
|
|
|
2.03
|
|
|
|
6/24/15
|
|
Todd P. Headley
|
|
|
92,672
|
|
|
|
13,238
|
(2)
|
|
|
0.32
|
|
|
|
4/18/13
|
|
|
|
|
12,315
|
|
|
|
12,315
|
(3)
|
|
|
1.62
|
|
|
|
12/21/14
|
|
|
|
|
8,774
|
|
|
|
14,624
|
(1)
|
|
|
2.03
|
|
|
|
6/24/15
|
|
Thomas M. McDonough
|
|
|
34,636
|
|
|
|
57,727
|
(1)
|
|
|
2.03
|
|
|
|
6/24/15
|
|
Martin F. Roesch
|
|
|
23,091
|
|
|
|
38,485
|
(1)
|
|
|
2.03
|
|
|
|
6/24/15
|
|
Joseph M. Boyle
|
|
|
26,939
|
|
|
|
96,213
|
(4)
|
|
|
5.26
|
|
|
|
4/24/16
|
|
Michele M. Perry-Boucher
|
|
|
84,667
|
|
|
|
38,485
|
(5)
|
|
|
1.14
|
|
|
|
4/22/14
|
|
|
|
|
8,081
|
|
|
|
13,469
|
(1)
|
|
|
2.03
|
|
|
|
6/24/15
|
|
|
|
|
(1)
|
|
These options were granted pursuant
to our 2002 Stock Incentive Plan and vest 25% on the first
anniversary of June 24, 2005 and in equal monthly
installments of 2.083% over the subsequent three years. In
addition, these options accelerate and become fully vested if
there is a change in control and the holder’s employment is
terminated without cause within one year after the change in
control subsequent to the change in control.
|
|
(2)
|
|
These options were granted pursuant
to our 2002 Stock Incentive Plan and vest in equal quarterly
installments over four years, commencing on April 21, 2003.
In addition, these options accelerate and become fully vested if
there is a change in control and the holder’s employment is
terminated without cause (actual or constructive) subsequent to
the change in control.
|
|
(3)
|
|
These options were granted pursuant
to our 2002 Stock Incentive Plan and vest in equal quarterly
installments over four years, commencing on December 1,
2004. In addition, these options accelerate and become fully
vested if there is a change in control and the holder’s
employment is terminated without cause.
|
|
(4)
|
|
These options were granted pursuant
to our 2002 Stock Incentive Plan and vest as to 75% of the
options in equal quarterly installments over four years,
commencing on April 24, 2006. An additional 12.5% of the
options vested upon the filing of this Registration Statement on
Form S-1
on October 25, 2006 and an additional 12.5% of the options
will vest upon the first to occur of (i) the Snort OEM
license business unit successfully reaching agreement with its
third OEM customer and (ii) April 24, 2010. In
addition, with respect to the options that vest quarterly, the
lesser of (i) 50% of such options and (ii) the number
of such options that are unvested shall accelerate and become
fully vested if there is a change in control and the
holder’s employment is terminated without cause (actual or
constructive) subsequent to the change in control.
|
|
(5)
|
|
These options were granted pursuant
to our 2002 Stock Incentive Plan and vest in equal quarterly
installments over four years, commencing on April 22, 2004.
In addition, these options accelerate and become fully vested if
there is a change in control and the holder’s employment is
terminated without cause subsequent to the change in control.
|
84
Option
Exercises and Stock Vested
The following table provides information regarding exercises of
stock options and vesting of restricted stock held by each of
our named executive officers during 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option awards
|
|
|
|
|
|
|
|
|
|
Number of
|
|
|
|
|
|
Stock awards
|
|
|
|
shares
|
|
|
Value
|
|
|
Number of
|
|
|
Value
|
|
|
|
acquired on
|
|
|
realized on
|
|
|
shares
|
|
|
realized on
|
|
|
|
exercise
|
|
|
exercise
|
|
|
acquired on
|
|
|
vesting
|
|
Name
|
|
(#)
|
|
|
($)
|
|
|
vesting
|
|
|
($)
|
|
|
E. Wayne Jackson, III
|
|
|
—
|
|
|
|
—
|
|
|
|
21,568
|
(1)
|
|
|
155,798
|
|
Todd P. Headley
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Thomas M. McDonough
|
|
|
—
|
|
|
|
—
|
|
|
|
53,879
|
(2)
|
|
|
511,000
|
|
Martin F. Roesch
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Joseph M. Boyle
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Michele M. Perry-Boucher
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
(1)
|
|
These shares of restricted stock
were granted pursuant to our 2002 Stock Incentive Plan and
vested in equal quarterly installments over three years,
commencing on August 1, 2003.
|
|
(2)
|
|
These shares of restricted stock
were granted pursuant to our 2002 Stock Incentive Plan and
vested in full in October 2006.
|
Employment
Agreements
Employment
Agreement with E. Wayne Jackson III
We entered into an employment agreement with E. Wayne
Jackson III, our Chief Executive Officer, in August 2002,
effective as of May 6, 2002. The term of his employment
agreement is one year and may be renewed by a vote of our board
of directors for consecutive one-year periods. Under this
agreement, Mr. Jackson’s initial base salary was
$150,000 per annum, which is subject to annual increases in
the sole discretion of our board of directors.
Mr. Jackson’s current annual base salary, as approved
by our board of directors, is $225,000. Also, Mr. Jackson
is currently eligible to receive a cash bonus of up to
$100,000 per annum paid quarterly in the event that he and
Sourcefire achieve deliverables or reasonable goals approved by
Mr. Jackson and our board of directors or compensation
committee. Mr. Jackson is eligible to participate in any
and all plans providing general benefits to our employees,
subject to the provisions, rules and regulations applicable to
each such plan.
In June 2002, in connection with the commencement of his
employment, we granted Mr. Jackson 559,729 shares of
restricted stock at a per share purchase price of $0.000541.
This grant of restricted stock was subject to the terms and
conditions of a restricted stock agreement which, among other
things, provided us the unconditional right to repurchase a
certain percentage of this restricted stock at a per share
repurchase price to be determined by our board of directors in
the event we terminated Mr. Jackson’s employment for
cause or he terminated his employment without good reason, in
each case, within three years of date of the restricted stock
agreement. The percentage of the restricted stock that we could
repurchase under the restricted stock agreement began at 100%
and decreased by 8.33% every three months thereafter (being
reduced to 0% in June 2005). Correspondingly, we no longer have
any contractual rights under this restricted stock agreement to
repurchase any of Mr. Jackson’s shares of restricted
stock.
In December 2003, we granted Mr. Jackson 64,655 shares
of restricted stock at a per share purchase price of $0.00162.
This grant of restricted stock was subject to the terms and
conditions of a restricted stock grant agreement which, among
other things, provided us the unconditional right to repurchase
a certain percentage of this restricted stock at a per share
repurchase price of $0.325 in the event we terminated
Mr. Jackson’s employment for cause or he terminated
his employment without good reason, in each case, within three
years of date of the restricted stock agreement. The percentage
of the restricted stock that we could repurchase under the
restricted stock grant agreement began at 100% and decreased by
8.33% every three months thereafter (being reduced to 0% in
August 2006). Correspondingly, we no longer have any contractual
rights under this restricted stock agreement to repurchase any
of Mr. Jackson’s shares of restricted stock.
85
Mr. Jackson is also eligible to participate in our stock
incentive plan. In June 2005, we granted Mr. Jackson an
option to purchase 98,522 shares of our common stock at a
per share exercise price of $2.03, with one quarter of the
option vesting on the first anniversary of the vest start date
and the balance of the option vesting equally on a monthly basis
over the following three years. All vesting requirements with
respect to this June 2005 option would be removed if we
terminate Mr. Jackson’s employment without cause
within one year following a change of control (as defined in our
2002 Stock Incentive Plan).
Mr. Jackson’s employment agreement may be terminated,
with or without cause, by us or him at any time. If we terminate
the employment agreement for cause (as defined in the agreement)
or on account of death, or if Mr. Jackson terminates the
agreement for any reason other than for good reason (as defined
in the agreement), Mr. Jackson is entitled to no further
compensation or benefits other than those earned through the
date of termination. If we terminate the agreement for any
reason other than for cause or death, if we terminate the
agreement in the event Mr. Jackson becomes permanently
disabled (as defined in the agreement) or if Mr. Jackson
terminates the agreement for good reason (as defined in the
agreement), we will provide continued payment of base salary and
medical benefits for the six months following the termination of
employment, conditioned upon the execution by Mr. Jackson
of a release. In addition, our obligation to provide these
severance payments expires if Mr. Jackson secures
employment following a termination without cause or for good
reason. The terms and provisions of the assignment of
inventions, non-disclosure, non-solicitation, and
non-competition agreement, or NDA, entered into with
Mr. Jackson, shall survive the termination of
Mr. Jackson’s employment; provided, however, that if
Mr. Jackson is terminated without cause or resigns for good
reason, and agrees to waive his rights to the six months of
post-termination compensation described above, the
non-solicitation and the 12 month non-competition
provisions of the NDA shall terminate and be of no further force
or effect as of the date of termination.
Mr. Jackson’s employment agreement expires on
May 5, 2008 and may be renewed by our board of directors
for consecutive one-year terms.
Employment
Agreement with Thomas M. McDonough
We entered into an employment agreement with Thomas M.
McDonough, our President and Chief Operating Officer, in August
2002. The term of this employment agreement is one year and may
be renewed by our board of directors for consecutive one year
periods. Under this agreement, Mr. McDonough’s initial
base salary was $150,000 per annum, which is subject to
annual increases in the sole discretion of our board of
directors. Mr. McDonough’s current annual base salary,
as approved by our board of directors, is $200,000. In addition,
as originally drafted, Mr. McDonough was eligible to
receive a cash bonus of up to $200,000 per annum, payable
quarterly, in the event that he and Sourcefire achieve
deliverables or reasonable goals approved by Mr. McDonough
and our board of directors or our compensation committee.
Mr. McDonough’s current annual cash bonus target is
$100,000. Mr. McDonough is eligible to participate in any
and all plans providing general benefits to our employees,
subject to the provisions, rules and regulations applicable to
each such plan. Mr. McDonough also executed our standard
employee proprietary information, inventions and non-competition
agreement.
In November of 2002, in connection with the commencement of his
employment, we granted Mr. McDonough 312,192 shares of
restricted stock at a per share purchase price of $0.00162. This
grant of restricted stock was subject to the terms and
conditions of a restricted stock agreement which, among other
things, provided us the unconditional right to repurchase a
certain percentage of this restricted stock at a per share
repurchase price of $0.244 in the event we terminate
Mr. McDonough’s employment for cause or he terminates
his employment without good reason, in each case, within three
years of date of the restricted stock agreement. The percentage
of the restricted stock that we can repurchase under the
restricted stock agreement began at one hundred percent and
decreased by 8.33 percent every three months thereafter
(being reduced to zero percent in September 2005).
Correspondingly, we no longer have any contractual rights under
the restricted stock agreement to repurchase
Mr. McDonough’s shares of restricted stock.
In December of 2003, we granted Mr. McDonough
129,310 shares of restricted stock at a per share purchase
price of $0.00162. This grant of restricted stock was subject to
the terms and conditions of a restricted stock agreement which,
among other things, provided us the unconditional right to
repurchase up to seventy five percent of this restricted stock
at a per share repurchase price of $0.325. With respect to
64,655 shares of this restricted stock, our right to
repurchase those shares terminated upon the achievement of
certain performance metrics or the passage of time. With respect
to 32,328 shares of this restricted stock, our right to
repurchase those shares
86
terminated upon the third anniversary of the vest start date, or
October 2006. Currently all our rights to repurchase
Mr. McDonough’s restricted stock granted in December
2003 have lapsed.
Mr. McDonough is also eligible to participate in our stock
incentive plan. In June 2005, we granted Mr. McDonough an
option to purchase 92,364 shares of our common stock at a
per share exercise price of $2.03 with one quarter of the option
vesting on the first anniversary of the vest start date and the
balance of the option vesting equally on a monthly basis over
the following three years. All vesting requirements with respect
to this June 2005 option would be removed if we terminate
Mr. McDonough’s employment without cause within one
year following a change of control (as defined in our 2002 Stock
Incentive Plan).
Mr. McDonough’s employment agreement may be
terminated, with or without cause, by us or him at any time. If
we terminate the employment agreement for cause (as defined in
the agreement) or on account of death, or if Mr. McDonough
terminates the agreement for any reason other than for good
reason (as defined in the agreement), Mr. McDonough is
entitled to no further compensation or benefits other than those
earned through the date of termination. If we terminate the
agreement for any reason other than for cause or death, if we
terminate the agreement in the event Mr. McDonough becomes
permanently disabled (as defined in the agreement) or if
Mr. McDonough terminates the agreement for good reason (as
defined in the agreement), we will provide continued payment of
base salary and medical benefits for the six months following
the termination of employment, conditioned upon the execution by
Mr. McDonough of a release. In addition, our obligation to
provide his severance payment expires if Mr. McDonough
secures employment following a termination without cause or for
good reason. The terms and provisions of the employee
proprietary information, inventions and non-competition
agreement entered into with Mr. McDonough shall survive
Mr. McDonough’s termination; provided, however, that
if Mr. McDonough is terminated without cause or resigns for
good reason, and agrees to waive his rights to the six months of
post-termination compensation described above, the
non-solicitation and the
12-month
non-competition provisions shall terminate and be of no further
force or effect as of the date of termination.
Mr. McDonough’s employment agreement expires on
September 8, 2008 and may be renewed by our board of
directors for consecutive one-year terms.
Employment
Agreement with Martin F. Roesch
We entered into an employment agreement with Martin F. Roesch,
our Chief Technology Officer, in February 2002 and amended that
agreement effective July 2002. The term of this employment
agreement is one year and may be renewed by our board of
directors for consecutive one year periods. Under this
agreement, Mr. Roesch’s initial base salary was
$150,000 per annum, which is subject to annual increases in
the sole discretion of our board of directors.
Mr. Roesch’s current annual base salary, as approved
by our board of directors, is $200,000. In addition,
Mr. Roesch is eligible to receive a cash bonus of up to
$50,000 per annum, contingent upon Mr. Roesch’s
ability to achieve deliverables or reasonable goals approved by
Mr. Roesch and our board of directors or compensation
committee. Mr. Roesch is eligible to participate in any and
all plans providing general benefits to our employees, subject
to the provisions, rules and regulations applicable to each such
plan. Mr. Roesch executed our assignment of inventions,
non-disclosure, non-solicitation and non-competition agreement.
In February of 2002, we entered into a restricted stock
agreement with Mr. Roesch which provided us the
unconditional right to repurchase a certain percentage of his
restricted stock at a per share repurchase price of $.00162 in
the event we terminate Mr. Roesch’s employment for
cause or he terminates his employment without good reason, in
each case, within three years of the date of the restricted
stock agreement. The percentage of the restricted stock that we
can repurchase under the restricted stock agreement began at
fifty percent and decreased by one-third on each anniversary of
the date of the restricted stock agreement (being reduced to
zero percent in February 2005). Correspondingly, we no longer
have any contractual rights under the restricted stock agreement
to repurchase Mr. Roesch’s shares of restricted stock.
Mr. Roesch is also eligible to participate in our stock
incentive plan. In June of 2005, we granted Mr. Roesch an
option to purchase 61,576 shares of our common stock at a
per share exercise price of $2.03 with one quarter of the option
vesting on the first anniversary of the vest start date and the
balance of the option vesting equally on a monthly basis over
the following three years. All vesting requirements with respect
to this June 2005 option would be removed if we terminate
Mr. Roesch’s employment without cause within one year
following a change of control (as defined in our 2002 Stock
Incentive Plan).
87
Mr. Roesch’s employment agreement may be terminated,
with or without cause, by us or him at any time. If we terminate
the employment agreement for cause (as defined in the agreement)
or on account of death, or if Mr. Roesch terminates the
agreement for any reason other than for good reason (as defined
in the agreement), Mr. Roesch is entitled to no further
compensation or benefits other than those earned through the
date of termination. If we terminate the agreement for any
reason other than for cause or death, if we terminate the
agreement in the event Mr. Roesch becomes permanently
disabled (as defined in the agreement) or if Mr. Roesch
terminates the agreement for good reason (as defined in the
agreement), we will provide continued payment of base salary and
medical benefits for the six months following the termination of
employment, conditioned upon the execution by Mr. Roesch of
a release. In addition, our obligation to provide Mr.
Roesch’s severance payment expires if he secures employment
following a termination without cause or for good reason. The
terms and provisions of the assignment of inventions,
non-disclosure, non-solicitation and non-competition agreement
entered into with Mr. Roesch shall survive the termination
of Mr. Roesch’s employment; provided, however, that if
Mr. Roesch is terminated without cause or resigns for good
reason, and agrees to waive his rights to the six months of
post-termination compensation described above, the
non-solicitation and the
12-month
non-competition provisions shall terminate and be of no further
force or effect as of the date of termination.
Mr. Roesch’s employment agreement expires on
July 1, 2008 and may be renewed by our board of directors
for consecutive one-year terms.
Employment
Agreement with Todd P. Headley
We entered into an employment agreement with Todd P. Headley,
our Chief Financial Officer and Treasurer, in March 2003. The
employment agreement provides for an initial base salary of
$125,000 per annum, and eligibility to receive a quarterly
incentive bonus at the discretion of the compensation committee
of our board of directors, contingent upon the executive’s
ability to achieve management objectives. Compensation for
Mr. Headley is subject to normal periodic review by our
compensation committee. Mr. Headley’s current annual
base salary, as approved by our board of directors, is $175,000
and his current annual bonus is targeted at $50,000.
Mr. Headley is eligible to participate in any and all plans
providing general benefits to our employees, subject to the
provisions, rules and regulations applicable to each such plan.
Mr. Headley’s employment agreement also provides that
he is eligible to participate in our stock incentive plan. In
April of 2003, we granted Mr. Headley an option to purchase
105,911 shares of our common stock at an exercise price of
$0.325. This option vests equally on a quarterly basis over a
four year period commencing on the vest start date, and all
vesting requirements would be removed if we terminate
Mr. Headley’s employment (actually or constructively)
without cause following a change of control (as defined in our
2002 Stock Incentive Plan). In addition, in December of 2004 and
again in June of 2005, we granted Mr. Headley additional
options to purchase 24,630 and 23,399 shares of our common
stock, respectively. The December 2004 option was granted at an
exercise price of $1.62 per share and vests equally on a
quarterly basis over a four year period commencing on the vest
start date. This vesting requirement would be accelerated in an
amount equal to the lesser of fifty percent of the shares
reserved for issuance thereunder or the remaining unvested
portion of that option if we terminate Mr. Headley’s
employment (actually or constructively) without cause following
a change of control (as defined in our 2002 Stock Incentive
Plan). The June 2005 option was granted at an exercise price of
$2.03 per share with one quarter of the option vesting on
the first anniversary of the vest start date and the balance of
the option vesting equally on a monthly basis over the following
three years. All vesting requirements with respect to the June
2005 option would be removed if we terminate
Mr. Headley’s employment without cause within one year
following a change of control (as defined in our 2002 Stock
Incentive Plan). Mr. Headley also executed our standard
employee proprietary information, inventions, and
non-competition agreement.
Mr. Headley’s employment may be terminated at any
time, with or without cause and with or without notice, by
Mr. Headley or by us. If Mr. Headley’s employment
is terminated by us without cause (as defined in the agreement),
we will provide payment of salary and benefits for the three
months following the termination of employment as well as any
bonus earned as of the date of termination. Any obligation to
pay severance would be conditioned upon the execution of a
release by Mr. Headley.
The employment agreement states that Mr. Headley’s
employment is of no set duration.
88
Employment
Agreement with Joseph M. Boyle
We entered into an employment agreement with Joseph M. Boyle,
our General Counsel and Secretary, in April 2006. The employment
agreement provides for an initial base salary of $175,000 per
annum, and eligibility to receive a performance bonus up to an
initial amount of $50,000 per annum, payable quarterly,
contingent upon the executive’s ability to achieve
objectives established jointly by Mr. Boyle and our Chief
Executive Officer. Mr. Boyle is also eligible to receive a
one-time $50,000 bonus payable upon the closing of a definitive
merger or acquisition in which we receive proceeds in excess of
$200.0 million, which was provided as an incentive for
Mr. Boyle to join us following the termination of our
agreement to be acquired by Check Point Software Technologies
Ltd. in light of the significant demands to which our general
counsel would be subject should we agree to be acquired in
another transaction. We believe that the $200.0 million
threshold was appropriate because the anticipated consideration
to be paid under the terms of the merger agreement with Check
Point were $225.0 million. Mr. Boyle is also eligible
to receive a one-time $25,000 bonus once we reach an agreement
with our third OEM customer following the launch of the
Project X IP business unit. Compensation for Mr. Boyle
is subject to normal periodic review by the compensation
committee of our board of directors. Mr. Boyle’s
current annual base salary, as approved by our board of
directors, is $175,000. Mr. Boyle is eligible to
participate in any and all plans providing general benefits to
our employees, subject to the provisions, rules and regulations
applicable to each such plan.
The employment agreement also provides that Mr. Boyle is
eligible to participate in our stock incentive plan. Upon
commencement of his employment in April 2006, we granted
Mr. Boyle an option to purchase 123,512 shares of our
common stock, with 92,364 shares vesting over a four year
period at quarterly intervals, 15,394 shares vesting upon
the first to occur of the filing of a registration statement
with the SEC to raise a minimum of $50 million or the
fourth anniversary of the vesting start date, and
15,394 shares vesting on the first to occur of the Company
reaching an agreement with its third OEM customer following the
launch of the Project X IP business unit or the fourth
anniversary of the vesting start date. In addition, the options
are subject to acceleration of vesting of the lesser of 50% of
the 92,364 shares subject to quarterly vesting or the
remaining unvested shares of the 92,364 shares subject to
quarterly vesting, upon a change of control (as defined in our
stock incentive plan) and a termination other than for cause
(either an actual or constructive termination) subsequent to the
change of control. Mr. Boyle also executed our standard
employee proprietary information, inventions, and
non-competition agreement.
Mr. Boyle’s employment may be terminated at any time,
with or without cause and with or without notice, by
Mr. Boyle or by us. If Mr. Boyle’s employment is
terminated by us without cause (as defined in the agreement), we
will provide payment of salary and benefits for the three months
following the termination of employment, as well as any bonus
earned as of the date of termination. Any obligation to pay
severance would be conditioned upon the execution by
Mr. Boyle of a release.
The employment agreement states that Mr. Boyle’s
employment is of no set duration.
Employment
Agreement with Michele M. Perry-Boucher
We entered into an employment agreement with Michele M.
Perry-Boucher, our Chief Marketing Officer, in February 2004.
The employment agreement provides for an initial base salary of
$150,000 per annum, and eligibility to receive a
performance bonus up to an initial amount of $50,000 per annum,
payable quarterly, contingent upon the executive’s ability
to achieve objectives established jointly by Ms.
Perry-Boucher
and our Chief Executive Officer. Compensation for
Ms. Perry-Boucher is subject to normal periodic review by
our compensation committee. Ms. Perry-Boucher’s
current annual base salary, as approved by our board of
directors, is $185,000. Ms. Perry-Boucher is eligible to
participate in any and all plans providing general benefits to
our employees, subject to the provisions, rules and regulations
applicable to each such plan.
The employment agreement also provides that
Ms. Perry-Boucher is eligible to participate in our stock
incentive plan. In April of 2004, we granted
Ms. Perry-Boucher an initial option to purchase
123,512 shares of our common stock at an exercise price of
$1.14 with vesting over a four year period at quarterly
intervals. In the event of a change of control (as defined in
our stock incentive plan) and Ms. Perry-Boucher’s
employment is terminated (actually or constructively) without
cause following such change of control, this vesting requirement
shall be accelerated in an amount of the lesser of 50% of the
initial grant (or 61,576 shares) or the remaining unvested
portion of the option. In addition, in June 2005 we granted
Ms. Perry-Boucher an additional option to purchase
21,551 shares of our common stock at an exercise price of
$2.03. This option vests over a four year period, with one
89
quarter vesting on the one year anniversary of the vest
commencement date and the remaining vesting equally on a monthly
basis over the following three years. All vesting requirements
with respect to the June 2005 option would be removed if we
terminate Ms. Perry-Boucher’s employment without cause
within one year following a change of control (as defined in our
2002 Stock Incentive Plan). The employment agreement was
contingent upon Ms. Perry-Boucher executing our employee
proprietary information, inventions, and non-competition
agreement.
Ms. Perry-Boucher’s employment may be terminated at
any time, with or without cause and with or without notice, by
Ms. Perry-Boucher or by us.
The employment agreement states that
Ms. Perry-Boucher’s employment is of no set duration.
Potential
Payments Upon Termination or Change in Control
Pursuant to the employment agreement of each of
Mr. Jackson, Mr. McDonough and Mr. Roesch, if we
terminate the agreement for any reason other than for cause or
death, if we terminate the agreement in the event
Mr. Jackson, Mr. McDonough or Mr. Roesch, as
applicable, become permanently disabled, or if Mr. Jackson,
Mr. McDonough or Mr. Roesch, as applicable, terminate
the agreement for good reason, we will provide continued payment
of Mr. Jackson’s, Mr. McDonough’s or
Mr. Roesch’s, as applicable, base salary and medical
benefits for the six months following the termination of
employment. Our obligations to provide severance payments expire
if Mr. Jackson, Mr. McDonough or Mr. Roesch, as
applicable, secures employment following a termination without
cause or for good reason. Pursuant to the employment agreement
of each of Mr. Headley and Mr. Boyle, if we terminate
the agreement without cause, we will provide continued payment
of Mr. Headley’s or Mr. Boyle’s, as
applicable, base salary, benefits and bonus earned for the three
months following the termination of employment. Assuming the
employment of Messrs. Jackson, McDonough and Roesch were to
be terminated by us without cause, by us in the event
Mr. Jackson, Mr. McDonough or Mr. Roesch become
permanently disabled, or by Mr. Jackson for good reason,
and assuming the employment of Messrs. Headley and Boyle
were to be terminated by us without cause, as of
December 31, 2006, the following individuals would be
entitled to payments in the amounts set forth opposite their
names in the below table:
|
|
|
|
|
Name
|
|
Cash severance
|
|
Benefits
|
|
E. Wayne Jackson, III
|
|
$18,750 per month for six
months
|
|
Benefits have an estimated value
of $1,002 per month for six months
|
Todd P. Headley
|
|
$14,583 per month for three
months plus any earned bonus
|
|
Benefits have an estimated value
of $1,001 per month for three months
|
Thomas M. McDonough
|
|
$16,667 per month for six
months
|
|
Benefits have an estimated value
of $983 per month for six months
|
Martin F. Roesch
|
|
$16,667 per month for six
months
|
|
Benefits have an estimated value
of $997 per month for six months
|
Joseph M. Boyle
|
|
$14,583 per month for three
months plus any earned bonus
|
|
Benefits have an estimated value
of $936 per month for three months
|
Michele M. Perry-Boucher
|
|
None
|
|
None
|
We are not obligated to make any cash payments to these
executives if their employment is terminated by us for cause or
on account of death or by the executive other than for good
reason.
Pursuant to Mr. Boyle’s employment agreement, upon the
closing of a definitive merger or acquisition transaction
whereby the Company receives proceeds in excess of
$200.0 million, Mr. Boyle will receive a one-time
bonus equal to $50,000.
In addition, each of Messrs. Jackson, McDonough, Roesch,
Headley and Boyle and Ms. Perry-Boucher hold options that
would vest if such executive ceases to be employed by us as a
result of a change in control and the termination of such
executive without cause following such change in control.
Assuming the employment of our named executive officers were to
be terminated without cause within one year of a change in
control, each as of
90
December 31, 2006, the following individuals would be
entitled to accelerated vesting of their outstanding stock
options as described in the table below:
|
|
|
Name
|
|
Value of accelerated equity
awards: termination without cause following change in
control(1)
|
|
E. Wayne Jackson, III
|
|
Immediate vesting of 61,576
options with a value of $674,257
|
Todd P. Headley
|
|
Immediate vesting of 40,178
options with a value of $468,088
|
Thomas M. McDonough
|
|
Immediate vesting of 57,727
options with a value of $632,122
|
Martin F. Roesch
|
|
Immediate vesting of 38,485
options with a value of $421,411
|
Joseph M. Boyle
|
|
Immediate vesting of 46,182
options with a value of $357,449
|
Michele M. Perry-Boucher
|
|
Immediate vesting of 51,955
options with a value of $616,186
|
|
|
|
(1)
|
|
Assumes a price per share of our
common stock of $13.00 per share, which represents the midpoint
of the range set forth on the cover of this prospectus.
|
In connection with a termination without cause, a termination
due to the executive becoming permanently disabled or a
termination for good reason, no payments are due unless the
executive executes a general release and waiver releasing us
from any obligations and liabilities of any type whatsoever,
except for our obligations with respect to any severance
benefits. Under the terms and conditions of the assignment of
inventions, non-disclosure, non-solicitation and non-competition
agreement, or NDA, executed by each of Messrs. Jackson,
McDonough and Roesch, which survive the termination of such
executive’s employment, such executive cannot, among other
things, (i) disclose confidential information (as defined
in the NDA) during or after employment with us,
(ii) provide services, similar to those the executive
provided to us, to any competitor (as defined in the NDA) within
the United States during employment with us and for a period of
one year following termination for any reason, and
(iii) induce, solicit or attempt to induce or solicit, any
of our employees, customers, clients, vendors or strategic
business partners during employment with us and for a period of
one year following termination for any reason. In the event of a
termination without cause or for good reason, the restrictions
set forth in clauses (ii) and (iii) of the preceding
sentence shall terminate and be of no further force or effect,
provided the executive agrees to waive any rights to any
severance or other termination benefits under such
executive’s employment agreement.
The following definitions apply to the termination and change in
control provisions in the employment agreements and stock option
grant agreements.
A termination for “Cause” occurs under the employment
agreements and stock option grant agreements of
Messrs. Jackson, McDonough and Roesch if we terminate
employment for any of the following reasons:
(i) the executive’s conviction of, or plea of guilty
or nolo contendere to, (a) a felony or (b) any
crime involving moral turpitude that may reasonably be expected
to have an adverse impact on our reputation or standing in the
community;
(ii) misconduct in connection with the executive’s
duties or willful failure to perform such duties (including,
without limitation, material breach by the executive of any
provision of the employment agreement or that certain assignment
of inventions, non-disclosure, non-solicitation and
non-competition agreement, executed by and between us and the
executive, or any similar agreement executed by the executive
for our benefit); or
(iii) engaging in behavior that would constitute grounds
for liability for harassment (as proscribed by the
U.S. Equal Employment Opportunity Commission Guidelines or
any other applicable state or local regulatory body) or other
conduct that violates laws governing the workplace;
provided, however, that the foregoing events or actions shall
not constitute “Cause” unless our board of directors
shall have provided the executive with written notice of the
event or action allegedly constituting
91
“Cause” and the executive has not cured such event or
action within thirty (30) days of executive’s receipt
of such written notice.
A termination for “Cause” occurs under the employment
agreements and stock option grant agreements of
Messrs. Headley and Boyle if we terminate employment for
any of the following reasons:
(i) conviction of, or plea of guilty or nolo contendere
to, (a) a felony or (b) any crime involving moral
turpitude that may reasonably be expected to have an adverse
impact on our reputation or standing in the community;
(ii) fraud on or misappropriation of any of our funds or
property, or the funds or property of any of our affiliates,
customers or vendors;
(iii) personal dishonesty, incompetence, willful
misconduct, willful violation of any law, rule or regulation
(other than minor traffic violations or similar offenses), or
breach of fiduciary duty involving personal profit;
(iv) violation of any of our rules, regulations, procedures
or policies;
(v) breach of the Employee Proprietary Information,
Inventions, and Non-Competition Agreement executed by the
executive, or any similar agreement executed by the executive
for our benefit;
(vi) engaging in behavior that would constitute grounds for
liability for harassment (as proscribed by the U.S. Equal
Employment Opportunity Commission Guidelines or any other
applicable state or local regulatory body) or other conduct that
violates laws governing the workplace; or
(vii) chronic use of alcohol, drugs or other substances
which affects the executive’s performance.
Per Mr. Boyle’s employment agreement, the events of
actions listed above shall not constitute “Cause”
unless Mr. Boyle is provided written notice of the event or
action allegedly constituting “Cause” and
Mr. Boyle has not cured such event or action within thirty
(30) days of his receipt of such written notice.
A termination for “Cause” occurs under the stock
option grant agreement of Ms. Perry-Boucher if we terminate
employment for any of the following reasons:
(i) conviction of, or a plea of nolo contendere to, a
felony or crime involving moral turpitude;
(ii) fraud on or misappropriation of any funds or property
of the Company, any affiliate, customer or vendor;
(iii) personal dishonesty, incompetence, willful
misconduct, willful violation of any law, rule or regulation
(other than minor traffic violations or similar offenses), or
breach of fiduciary duty which involves personal profit;
(iv) willful misconduct in connection with the
executive’s duties or willful failure to perform the
executive’s responsibilities in the best interests of the
Company;
(v) chronic use of alcohol, drugs or similar substances
which affects the executive’s work performance;
(vi) violation of any Company rule, regulation, procedure
or policy; or
(vii) breach of any provision of any employment,
non-disclosures, non-competition, non-solicitation or other
similar agreement executed by the executive for the benefit of
the Company.
A termination for “Good Reason” occurs under the
employment agreements of Messrs. Jackson, McDonough and
Roesch if the executive terminates his employment for any of the
following reasons:
(i) willful failure by us to provide the executive the base
salary and benefits described in the employment agreement,
except for any reduction or other concessionary arrangement
affecting all employees or affecting senior executive officers
generally;
(ii) there is an adverse change in executive’s title,
position, responsibilities or there is otherwise a diminution in
executive’s duties (other than a change due to the
executive’s total and permanent disability or as an
accommodation under the Americans with Disabilities Act); or
(iii) a relocation of our principal executive office to a
location outside of the Washington, D.C. metropolitan area
or requiring the executive to be based anywhere other than our
principal executive office,
92
except for required business travel to the extent that such
travel is substantially consistent with executive’s present
travel obligations;
provided, however, that the foregoing events or actions shall
not constitute “Good Reason” unless the executive
shall have provided us with written notice of the event or
action allegedly constituting Good Reason and we have not cured
such event or action within thirty (30) days of our receipt
of such written notice.
“Permanently Disabled” under the employment agreements
of Messrs. Jackson, McDonough and Roesch means the
executive’s inability, due to physical or mental ill
health, to perform the essential functions of his or her job,
with or without a reasonable accommodation, for a period in
excess of 120 consecutive days or in excess of 180 days in
any consecutive 12-month period.
“Change in Control” means:
(i) the acquisition (other than from us) in one or more
transactions by any Person, of the beneficial ownership (within
the meaning of
Rule 13d-3
promulgated under the Securities Exchange Act of 1934, as
amended) of 50% or more of (A) the then outstanding shares
of our securities, or (B) the combined voting power of our
then outstanding securities entitled to vote generally in the
election of directors (the “Company Voting Stock”);
(ii) the closing of a sale or other conveyance of all or
substantially all of our assets; or
(iii) the effective time of any merger, share exchange,
consolidation or other business combination of ours if
immediately after such transaction persons who hold a majority
of the outstanding voting securities entitled to vote generally
in the election of directors of the surviving entity (or the
entity owning 100% of such surviving entity) are not persons
who, immediately prior to such transaction, held the Company
Voting Stock;
provided, however, that a Change in Control shall not include
(Y) a public offering of our capital stock or (Z) any
transaction pursuant to which shares of our capital stock are
transferred or issued to any trust, charitable organization,
foundation, family partnership or other entity controlled
directly or indirectly by, or established for the benefit of
Martin Roesch or his immediate family members (including
spouses, children, grandchildren, parents and siblings, in each
case to include adoptive relations) or transferred to any such
immediate family members. For purposes of this definition,
“Person” means any individual, entity or group within
the meaning of Rule 13d-3 of the Securities Exchange Act of
1934, as amended, other than: employee benefit plans sponsored
or maintained by us and corporations controlled by us.
Director
Compensation
The following table summarizes compensation that our directors
(other than directors who are named executive officers) earned
during 2006 for services as members of our board of directors.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fees earned
|
|
|
|
Total
|
|
|
or paid in cash
|
|
Stock awards
|
|
compensation
|
Name
|
|
($)
|
|
($)(1)
|
|
($)
|
|
Asheem Chandna
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Joseph R. Chinnici
|
|
|
12,823
|
(2)
|
|
|
48,958
|
(4)
|
|
|
61,781
|
|
Tim A. Guleri
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Steven R. Polk
|
|
|
7,152
|
(3)
|
|
|
31,333
|
(5)
|
|
|
38,485
|
|
Arnold L. Punaro(6)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Harry R. Weller
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
(1)
|
|
Valuation based on the dollar
amount of option grants recognized for financial statement
reporting purposes pursuant to FAS 123R with respect to
2006. The assumptions we used with respect to the valuation of
option grants are set forth in Note 2 to our consolidated
financial statements.
|
|
(2)
|
|
We agreed to pay Mr. Chinnici
$30,000 annually to serve on our board of directors and to serve
as chairman of our audit committee. Mr. Chinnici joined our
board of directors in July 2006.
|
|
(3)
|
|
We agreed to pay General Polk
$20,000 annually to serve on our board of directors and to serve
as chairman of our nominating and governance committee.
General Polk joined our board of directors in August 2006.
|
93
|
|
|
(4)
|
|
On July 28, 2006 we agreed to
issue Mr. Chinnici 15,394 shares of restricted common
stock at a price of $0.001624 per share and vesting on the
earliest to occur of (i) the consummation of a firm
commitment underwritten public offering of our common stock,
along with the expiration of any applicable
lock-up
agreements, (ii) a change in control of Sourcefire or
(iii) June 30, 2008. As of December 31, 2006,
Mr. Chinnici owns 15,394 shares of restricted common
stock, none of which have vested.
|
|
|
|
(5)
|
|
On September 23, 2006 we
agreed to issue General Polk 12,315 shares of
restricted common stock at a price of $0.001624 per share
and vesting on the earliest to occur of (i) the
consummation of a firm commitment underwritten public offering
of our common stock, along with the expiration of any applicable
lock-up
agreements, (ii) a change in control of Sourcefire or
(iii) June 30, 2008. As of December 31, 2006,
General Polk owns 12,315 shares of restricted common
stock, none of which have vested.
|
|
|
|
(6)
|
|
General Punaro joined our
board of directors in January 2007.
|
Summary
of Director Compensation
In 2006 we agreed to pay Joseph R. Chinnici $30,000 annually to
serve on our board of directors and to serve as chairman of our
audit committee, and Steven R. Polk $20,000 annually to serve on
our board of directors and to serve as chairman of our
nominating and governance committee, in each case until the
consummation of this offering. Following the consummation of
this offering, we will pay each of our directors an annual fee
of $15,000 to serve on our board of directors. In addition, we
will pay the chairman of our audit committee an annual fee of
$10,000, the chairman of our compensation committee an annual
fee of $5,000, and the chairman of our nominating and governance
committee an annual fee of $4,000. We will also pay each of our
directors a fee of $1,500 per meeting of the full board of
directors attended, and $1,000 per meeting of a committee
of the board of directors attended. Directors will be also be
reimbursed for reasonable travel and other expenses incurred in
connection with attending meetings of the board and its
committees.
Under our 2002 Plan, directors are eligible to receive stock
option and restricted stock grants at the discretion of our
compensation committee or other administrator of the plan. We
have made the following grants to our directors under our 2002
Plan:
|
|
|
|
•
|
On October 23, 2003 we granted Asheem Chandna an option to
purchase 98,522 shares of our common stock at an exercise
price of $0.325 per share, which our board of directors
determined to be the fair market value of our common stock on
the date of grant. Mr. Chandna exercised this option in
full on December 21, 2004.
|
|
|
|
|
•
|
On July 28, 2006 we agreed to issue Joseph R. Chinnici
15,394 shares of restricted common stock at a price of
$0.001624 per share and vesting on the earliest to occur of
(i) the consummation of a firm commitment underwritten
public offering of our common stock, along with the expiration
of any applicable
lock-up
agreements, (ii) a change in control of Sourcefire or
(iii) June 30, 2008.
|
|
|
|
|
•
|
On September 23, 2006 we agreed to issue Steven R. Polk
12,315 shares of restricted common stock at a price of
$0.001624 per share and vesting on the earliest to occur of
(i) the consummation of a firm commitment underwritten
public offering of our common stock, along with the expiration
of any applicable
lock-up
agreements, (ii) a change in control of Sourcefire or
(iii) June 30, 2008.
|
|
|
|
|
•
|
On January 24, 2007 we agreed to issue Arnold L. Punaro
12,315 shares of restricted common stock at a price of
$0.001624 per share, 4,926 shares of which will vest
on January 24, 2008, 6,157 shares of which will vest
in 1,231 share increments on completion of each of the five
90-day
periods thereafter, and the remaining 1,231 shares of which
will vest on the date of our 2009 annual meeting of stockholders.
|
In addition, upon the effectiveness of our registration
statement, we intend to grant our non-employee directors
restricted stock as additional compensation for their services
through our 2008 annual stockholders meeting. The amount of
restricted stock that we intend to grant these non-employee
directors is 8,209 shares, 6,157 of which will vest on the
first anniversary of the grant date and the remaining
2,052 shares of which will vest on the date of our 2008
annual stockholders meeting.
94
CERTAIN
RELATIONSHIPS AND RELATED PERSONS TRANSACTIONS
Series D
Financing
In May and June 2006, we sold 3,264,449 shares of
Series D convertible preferred stock, or approximately 9.5%
of our total outstanding equity securities on an as-converted
fully-diluted basis, in exchange for approximately
$23 million in cash, or $7.0456 per share (the
post-split conversion price for these shares is $11.4420 per
share). Entities affiliated with each of Inflection Point
Ventures, Sierra Ventures, Core Capital, New Enterprise
Associates and Sequoia Capital were all 5% or greater
stockholders immediately before the time of the sale and
purchased an aggregate of 1,886,902 shares of Series D
convertible preferred stock. Our director Tim Guleri is
currently a managing director with Sierra Ventures. Our director
Harry Weller is currently a partner with New Enterprise
Associates.
Investor
Rights Agreement
In May and June 2006, we and the holders of all series of our
convertible preferred stock entered into the fourth amended and
restated investor rights agreement, which is included as an
exhibit to the registration statement of which this prospectus
is a part. Under the agreement, the holders of registrable
securities (as defined in the agreement) have the right, upon
the occurrence of certain events to require us to file with the
SEC and cause to be declared effective a registration statement
covering the resale of shares of common stock issued or issuable
upon the conversion of the shares of our Series A, B, C and
D convertible preferred stock. Also, if we propose to register
any of our capital stock under the Securities Act, the holders
of all series of our convertible preferred stock will be
entitled to customary “piggyback” registration rights
with respect to shares of common stock issued or issuable upon
the conversion of the shares of our Series A, B, C and D
convertible preferred stock. In addition, the holders of our
convertible preferred stock also have a right of first refusal
to acquire any offered securities (as defined in the agreement)
issued, sold or exchanged by us. This right of first refusal is
not applicable in this offering. The agreement also includes
certain negative covenants that restrict us and the holders of
our convertible preferred stock. This agreement will terminate
upon the closing of the offering contemplated by this
prospectus, except for the registration rights and
confidentiality provisions of the agreement.
Right of
First Refusal and Co-Sale Agreement
In May and June 2006, we and certain key holders of our common
stock and the holders of our preferred stock entered into the
fourth amended and restated right of first refusal and co-sale
agreement, which is included as an exhibit to the registration
statement of which this prospectus is a part. Under this
agreement, certain key holders of our common stock are subject
to contractual restrictions relating to their proposed transfer
of our common stock. In addition, in the event such key holders
desire to transfer their shares of our common stock to a third
party, such transfer is subject to a right of first refusal held
by us and, in the event we do not exercise this right, in whole
or in part, then the holders of our preferred stock have a
right, on a pro-rata basis, to purchase such shares of common
stock proposed to be transferred. The holders of our convertible
preferred stock also have a right of co-sale under this
agreement to sell their own stock, on a pro-rata basis, in the
event of a proposed transfer of stock by such key holders. Under
this agreement, we were also granted certain
“drag-along” rights to require certain security
holders to participate in the event of a proposed sale or merger
of the company. This agreement will terminate upon the closing
of the offering contemplated by this prospectus.
Stockholders’
Voting Agreement
In May and June 2006, we and certain key holders of our common
stock and the holders of our preferred stock entered into the
fourth amended and restated stockholders’ voting agreement,
which is included as an exhibit to the registration statement of
which this prospectus is a part. Under this agreement, key
holders of our common stock and holders of our preferred stock
agreed to vote all shares of capital stock owned by such holders
for the election of our directors in accordance with the terms
set forth in such agreement. This agreement will terminate upon
the closing of the offering contemplated by this prospectus.
95
Restricted
Stock Grants
We have granted restricted stock to certain of our directors, as
described in “Compensation Discussion &
Analysis — Director Compensation.” We have also
granted restricted stock to Messrs. Jackson and McDonough,
as described in “Compensation Discussion &
Analysis — Employment Agreements.”
Employment
Agreements
We have employment agreements with certain of our named
executive officers, as described in “Compensation
Discussion & Analysis — Employment
Agreements.”
Policies
and Procedures With Respect To Related Person
Transactions
We have not adopted formal policies or procedures for the
review, approval or ratification of transactions with related
persons. Prior to the completion of this offering, we expect to
adopt formal policies and procedures for approving related
person transactions.
96
PRINCIPAL
AND SELLING STOCKHOLDERS
The following table provides certain information regarding the
beneficial ownership of our outstanding capital stock with
respect to:
|
|
|
|
•
|
each person or group who beneficially owns more than 5% of our
capital stock on a fully diluted basis;
|
|
|
•
|
each of our executive officers named in the Summary Compensation
Table;
|
|
|
•
|
each of our directors; and
|
|
|
•
|
all of our directors and executive officers as a group
|
This table assumes conversion of all outstanding shares of
preferred stock into 14,302,128 shares of common stock
immediately prior to the completion of this offering. The
percentage of ownership indicated before this offering is based
on 17,793,892 shares of common stock outstanding as of
December 31, 2006. The percentage of ownership indicated
after this offering is based on 23,113,892 shares,
including the shares offered by this prospectus and assuming no
exercise of the underwriters’ over-allotment option and no
exercise of options outstanding after December 31, 2006.
Beneficial ownership of shares is determined under the rules of
the Securities and Exchange Commission and generally includes
any shares over which a person exercises sole or shared voting
or investment power. Except as indicated by footnote, and
subject to applicable community property laws, each person
identified in the table possesses sole voting and investment
power with respect to all shares of common stock held by them.
Shares of common stock subject to options currently exercisable
or exercisable within 60 days of December 31, 2006 and
not subject to repurchase as of that date are deemed outstanding
for calculating the percentage of outstanding shares of the
person holding these options, but are not deemed outstanding for
calculating the percentage of any other person.
Unless otherwise noted, the address for each director and
executive officer is c/o Sourcefire, Inc.,
9770 Patuxent Woods Drive, Columbia, Maryland 21046.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares beneficially
|
|
|
Shares
|
|
|
Shares beneficially
|
|
|
|
owned prior
|
|
|
to be sold
|
|
|
owned after this
|
|
|
|
to this offering
|
|
|
in this
|
|
|
offering
|
|
Name of beneficial
owner
|
|
Number
|
|
|
Percent
|
|
|
offering
|
|
|
Number
|
|
|
Percent
|
|
|
Beneficial owners of 5% or more
of the outstanding common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Entities affiliated with Sierra
Ventures(1)
|
|
|
5,120,519
|
|
|
|
28.8
|
%
|
|
|
255,831
|
|
|
|
4,864,688
|
|
|
|
21.0
|
%
|
Entities affiliated with New
Enterprise
Associates(2)
|
|
|
3,217,565
|
|
|
|
18.1
|
%
|
|
|
—
|
|
|
|
3,217,565
|
|
|
|
13.9
|
%
|
Entities affiliated with Inflection
Point(3)
|
|
|
1,570,711
|
|
|
|
8.8
|
%
|
|
|
78,476
|
|
|
|
1,492,235
|
|
|
|
6.5
|
%
|
Martin F.
Roesch(4)
|
|
|
1,503,489
|
|
|
|
8.4
|
%
|
|
|
—
|
|
|
|
1,503,489
|
|
|
|
6.5
|
%
|
Entities affiliated with Core
Capital
Partners(5)
|
|
|
1,350,810
|
|
|
|
7.6
|
%
|
|
|
66,616
|
|
|
|
1,284,194
|
|
|
|
5.6
|
%
|
Entities affiliated with Sequoia
Capital(6)
|
|
|
1,340,797
|
|
|
|
7.5
|
%
|
|
|
—
|
|
|
|
1,340,797
|
|
|
|
5.8
|
%
|
Named executive
officers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
E. Wayne
Jackson, III(7)
|
|
|
797,565
|
|
|
|
4.5
|
%
|
|
|
39,848
|
|
|
|
757,717
|
|
|
|
3.3
|
%
|
Thomas M.
McDonough(8)
|
|
|
479,987
|
|
|
|
2.7
|
%
|
|
|
—
|
|
|
|
479,987
|
|
|
|
2.1
|
%
|
Todd P.
Headley(9)
|
|
|
122,895
|
|
|
|
*
|
|
|
|
—
|
|
|
|
122,895
|
|
|
|
*
|
|
Joseph M.
Boyle(10)
|
|
|
32,712
|
|
|
|
*
|
|
|
|
—
|
|
|
|
32,712
|
|
|
|
*
|
|
Michele M.
Perry-Boucher(11)
|
|
|
93,647
|
|
|
|
*
|
|
|
|
—
|
|
|
|
93,647
|
|
|
|
*
|
|
Directors
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asheem
Chandna(12)
|
|
|
198,167
|
|
|
|
1.1
|
%
|
|
|
—
|
|
|
|
198,167
|
|
|
|
*
|
|
Joseph R. Chinnici
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Tim A.
Guleri(13)
|
|
|
5,120,519
|
|
|
|
28.8
|
%
|
|
|
255,831
|
|
|
|
4,864,688
|
|
|
|
21.0
|
%
|
Steven R. Polk
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Arnold L. Punaro
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Harry R.
Weller(14)
|
|
|
3,217,565
|
|
|
|
18.1
|
%
|
|
|
—
|
|
|
|
3,217,565
|
|
|
|
13.9
|
%
|
All directors and executive
officers as a group (12 persons)
|
|
|
11,556,546
|
|
|
|
63.7
|
%
|
|
|
295,679
|
|
|
|
11,270,867
|
|
|
|
48.0
|
%
|
Other selling
stockholder
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Northcutt Family Revocable Living
Trust
of
2002(15)
|
|
|
184,729
|
|
|
|
1.0
|
%
|
|
|
9,229
|
|
|
|
175,500
|
|
|
|
*
|
|
97
|
|
|
*
|
|
Less than 1% beneficial ownership.
|
|
|
|
(1)
|
|
Includes 1,599,495 shares of
common stock issuable upon conversion of preferred stock held by
Sierra Ventures VII, L.P., 3,153,956 shares of common stock
issuable upon conversion of preferred stock held by Sierra
Ventures VIII-A, L.P., 30,759 shares of common stock
issuable upon conversion of preferred stock held by Sierra
Ventures VIII-B, L.P., 107,255 shares of common stock
issuable upon conversion of preferred stock held by Sierra
Ventures Associates VII, LLC, as nominee for its members and
229,054 shares of common stock issuable upon conversion of
preferred stock held by Sierra Ventures Associates VIII, LLC, as
nominee for its members. The address of these stockholders is
c/o Sierra Ventures, 2884 Sand Hill Road, Suite 100,
Menlo Park, CA 94025. The securities being sold in this offering
include 81,531 shares of common stock issuable upon
conversion of Series A preferred stock held by Sierra
Ventures VII, L.P., 161,488 shares of common stock issuable
upon conversion of Series A preferred stock held by Sierra
Ventures VIII-A, L.P., 1,574 shares of common stock
issuable upon conversion of Series A preferred stock held
by Sierra Ventures VIII-B, L.P., 3,746 shares of common
stock issuable upon conversion of Series A preferred stock
held by Sierra Ventures Associates VII, LLC, as nominee for its
members and 7,492 shares of common stock issuable upon
conversion of Series A preferred stock held by Sierra
Ventures Associates VIII, LLC, as nominee for its members. The
natural persons who have voting and investment control with
respect to the shares owned by Sierra Ventures VII, L.P. and
Sierra Ventures Associates VII, LLC, as nominee for its members,
are Jeffrey M. Drazan, David C. Schwab, Peter C. Wendell and
Steven P. Williams. The natural persons who have voting and
investment control with respect to the shares owned by Sierra
Ventures VIII-A, L.P., Sierra Ventures VIII-B and Sierra
Ventures Associates VIII, LLC, as nominee for its members, are
Jeffrey M. Drazan, David C. Schwab, Peter C. Wendell, Steven P.
Williams and Tim Guleri.
|
|
|
|
(2)
|
|
Includes 3,209,580 shares of
common stock issuable upon conversion of preferred stock held by
New Enterprise Associates 10, Limited Partnership and
7,985 shares of common stock issuable upon conversion of
preferred stock held by NEA Ventures 2003, Limited Partnership.
The address of these stockholders is c/o New Enterprise
Associates, 1119 St. Paul Street, Baltimore, MD 21202.
|
|
|
|
(3)
|
|
Includes 1,099,498 shares of
common stock issuable upon conversion of preferred stock held by
Inflection Point Ventures II, L.P. and 471,213 shares
of common stock issuable upon conversion of preferred stock held
by Inflection Point Ventures, L.P. The address of these
stockholders is c/o Inflection Point Ventures, 7903
Sleaford Place, Bethesda, MD 20814. The securities being sold in
this offering include 54,933 shares of common stock
issuable upon conversion of Series A preferred stock held
by Inflection Point Ventures II, L.P. and
23,543 shares of common stock issuable upon conversion of
Series A preferred stock held by Inflection Point Ventures,
L.P. The natural persons who have voting and investment control
with respect to the shares owned by Inflection Point
Ventures II, L.P. are Jeffrey A. Davison,
Michael E. A. O’Malley and Timothy J.Webb. The
natural persons who have voting and investment control with
respect to the shares owned by Inflection Point Ventures, L.P.
are Jeffrey A. Davison, Lawrence C. Karlson,
Michael E. A. O’Malley and Timothy J. Webb.
|
|
|
|
(4)
|
|
Includes 1,477,832 shares of
common stock and options exercisable within 60 days of
December 31, 2006 to purchase 25,657 shares of common
stock.
|
|
|
|
(5)
|
|
Includes 1,080,649 shares of
common stock issuable upon conversion of preferred stock held by
Core Capital Partners, L.P., 252,682 shares of common stock
issuable upon conversion of preferred stock held by Minotaur,
LLC and 17,479 shares of common stock issuable upon
conversion of preferred stock held by Minotaur
Annex Fund LLC. The address of these stockholders is
c/o Core Capital Partners, 901 15th Street, N.W.
Suite 950, Washington, D.C. 20005. The securities
being sold in this offering include 53,293 shares of common
stock issuable upon conversion of Series A preferred stock
held by Core Capital Partners, L.P. and 13,323 shares of
common stock issuable upon conversion of Series A preferred
stock held by Minotaur LLC. The natural person who has voting
and investment control with respect to the shares owned by Core
Capital Partners, L.P. is Pascal Luck. The natural person who
has voting and investment control with respect to the shares
owned by Minotaur LLC is Mark Levine.
|
|
|
|
(6)
|
|
Includes 1,179,902 shares of
common stock issuable upon conversion of preferred stock held by
Sequoia Capital Franchise Fund and 160,895 shares of common
stock issuable upon conversion of preferred stock held by
Sequoia Capital Franchise Partners. The address of these
stockholders is c/o Sequoia Capital, 3000 Sand Hill Road,
Bldg. 4, Suite 180, Menlo Park, CA 94025.
|
|
|
|
(7)
|
|
Includes options exercisable within
60 days of December 31, 2006 to purchase
41,051 shares of common stock. Also includes
624,384 shares of common stock and 132,130 shares of
common stock issuable upon conversion of preferred stock held by
The E. Wayne Jackson III “Sourcefire, Inc.”
GRAT. Mr. Jackson has voting and investment control with
respect to the shares held by The E. Wayne Jackson III
“Sourcefire, Inc.” GRAT. The securities being sold in
this offering include 39,848 shares of common stock
issuable upon conversion of Series A preferred stock held
by The E. Wayne Jackson III “Sourcefire, Inc.”
GRAT.
|
|
|
|
(8)
|
|
Includes options exercisable within
60 days of December 31, 2006 to purchase
38,485 shares of common stock. Also includes
441,502 shares of common stock held by The Revocable Trust
of Thomas Michael McDonough, u/a July 19, 2005, Thomas M.
McDonough, Trustee. Mr. McDonough has voting and investment
control with respect to the shares held by The Revocable Trust
of Thomas Michael McDonough, u/a July 19, 2005, Thomas M.
McDonough, Trustee.
|
|
(9)
|
|
Includes options exercisable within
60 days of December 31, 2006 to purchase
122,895 shares of common stock.
|
|
(10)
|
|
Includes options exercisable within
60 days of December 31, 2006 to purchase
32,712 shares of common stock.
|
|
(11)
|
|
Includes options exercisable within
60 days of December 31, 2006 to purchase
93,647 shares of common stock.
|
|
(12)
|
|
Includes 98,522 shares of
common stock and 99,645 shares of common stock issuable
upon conversion of preferred stock held by Asheem Chandna and
Aarti Chandna, as Trustees of the Chandna Family Revocable Trust
of April 13, 1998. Ms. Chandna has voting and
investment control with respect to the shares held by Asheem
Chandna and Aarti Chandna, as Trustees of the Chandna Family
Revocable Trust of April 13, 1998.
|
98
|
|
|
(13)
|
|
Includes 1,599,495 shares of
common stock issuable upon conversion of preferred stock held by
Sierra Ventures VIII, L.P., 3,153,956 shares of common
stock issuable upon conversion of preferred stock held by Sierra
Ventures VIII-A, L.P., 30,759 shares of common stock
issuable upon conversion of preferred stock held by Sierra
Ventures VIII-B, L.P., 107,255 shares of common stock
issuable upon conversion of preferred stock held by Sierra
Ventures Associates VII, L.L.C., as nominee for its members
and 229,054 shares of common stock issuable upon conversion
of preferred stock held by Sierra Ventures Associates VIII,
L.L.C., as nominee for its members. Mr. Guleri is a
managing director of Sierra Ventures Associates VII,
L.L.C., which is the general partner of Sierra
Ventures VII, L.P. and a managing director of Sierra
Ventures Associates VIII, L.L.C., which is the general
partner of Sierra Ventures VIII-A, L.P. and Sierra Ventures
VIII-B, L.P. Mr. Guleri does not have voting or dispositive
power with respect to any of these shares listed. Therefore,
Mr. Guleri disclaims beneficial ownership of all these
shares listed, except to the extent of his proportionate
pecuniary interest therein.
|
|
(14)
|
|
Includes 3,209,580 shares of
common stock issuable upon conversion of preferred stock held by
New Enterprise Associates 10, Limited Partnership, for
which voting and investment power is shared by M. James
Barrett, Peter J. Barris, C. Richard Kramlich, Peter T.
Morris, Charles W. Newhall III, Mark W. Perry, Scott D.
Sandell and Eugene A. Trainor III, each of whom is a
general partner of NEA Partners 10, Limited Partnership, the
general partner of New Enterprise Associates 10, Limited
Partnership and 7,985 shares of common stock issuable upon
conversion of preferred stock held by NEA Ventures 2003, Limited
Partnership, for which voting and investment power is held by
its general partner, J. Daniel Morre. Mr. Weller, a
partner of NEA Partners 10, Limited Partnership, and each of the
general partners of NEA Partners 10, Limited Partnership and NEA
Ventures 2003, Limited Partnership disclaims beneficial
ownership of the shares held by each of the aforementioned
entities except to the extent of his pecuniary interest therein.
Mr. Weller does not have voting power or dispositive power
with respect to any of the shares listed.
|
|
|
|
(15)
|
|
Stephen Northcutt and Jo-Kathlyn
Nortcutt are Co-Trustees of the Northcutt Family Revocable
Living Trust of 2002 and have voting and investment control with
respect to the shares being sold by the Northcutt Family
Revocable Living Trust of 2002 in this offering.
|
99
DESCRIPTION
OF CAPITAL STOCK
Our certificate of incorporation will be restated prior to the
consummation of this offering. The following description of the
material terms of our capital stock contained in the restated
certificate of incorporation is only a summary. You should read
it together with our restated certificate of incorporation and
our amended and restated bylaws, which are included as exhibits
to the registration statement of which this prospectus is a
part. The descriptions of the common stock and preferred stock
reflect changes to our capital structure that will occur
immediately prior to the closing of this offering.
General
As of December 31, 2006, there were 3,491,764 shares
of common stock issued and outstanding and
18,276,107 shares of preferred stock issued and
outstanding. As of December 31, 2006, there were
52 holders of record of our common stock.
Immediately prior to the completion of this offering, all
outstanding shares of our preferred stock will be converted into
shares of our common stock pursuant to a written consent
executed by the holders of the requisite number of shares of
each class of our preferred stock to voluntarily convert their
shares of our preferred stock into shares of our common stock.
Upon the completion of this offering, our authorized capital
stock will consist of 240,000,000 shares of common stock,
par value $0.001 per share, and 20,000,000 shares of
preferred stock, par value $0.001 per share, all of which
shares of preferred stock will be undesignated. Our board of
directors may establish the rights and preferences of the
preferred stock from time to time, without stockholder approval.
Common
Stock
Subject to any preferential voting rights of any outstanding
preferred stock, each holder of our common stock is entitled to
one vote for each share on all matters to be voted upon by the
stockholders, and there are no cumulative rights. Subject to any
preferential rights of any outstanding preferred stock, holders
of our common stock will be entitled to receive ratably the
dividends, if any, as may be declared from time to time by our
board of directors out of funds legally available therefor. If
there is a liquidation, dissolution or winding up of our
company, holders of our common stock would be entitled to
receive all assets of Sourcefire available for distribution to
its stockholders, subject to any preferential rights of any
outstanding preferred stock.
Holders of our common stock will have no preemptive or
conversion rights or other subscription rights, and there will
be no redemption or sinking fund provisions applicable to the
common stock. All outstanding shares of our common stock will be
fully paid and non-assessable. The rights, preferences and
privileges of the holders of our common stock will be subject
to, and may be adversely affected by, the rights of the holders
of shares of any series of preferred stock which we may
designate and issue in the future.
Preferred
Stock
Under the terms of our restated certificate of incorporation,
our board of directors is authorized to designate and issue
shares of preferred stock in one or more series without
stockholder approval. Our board of directors has the discretion
to determine the rights, preferences, privileges and
restrictions, including voting rights, dividend rights,
conversion rights, redemption privileges and liquidation
preferences, of each series of preferred stock.
The purpose of authorizing our board of directors to issue
preferred stock and determine its rights and preferences is to
eliminate delays associated with a stockholder vote on specific
issuances. The issuance of preferred stock, while providing
flexibility in connection with possible future acquisitions and
other corporate purposes, will affect, and may adversely affect,
the rights of holders of common stock. It is not possible to
state the actual effect of the issuance of any shares of
preferred stock on the rights of holders of common stock until
the board of directors determines the specific rights attached
to that preferred stock. The effects of issuing preferred stock
could include one or more of the following:
|
|
|
|
•
|
restricting dividends on the common stock;
|
|
|
•
|
diluting the voting power of the common stock;
|
100
|
|
|
|
•
|
impairing the liquidation rights of the common stock; or
|
|
|
•
|
delaying or preventing changes in control or management of our
Company.
|
We have no present plans to issue any shares of preferred stock.
Registration
Rights for Holders of Our Currently Outstanding Convertible
Preferred Stock
Immediately prior to the completion of this offering, all
outstanding shares of all series of our convertible preferred
stock will be converted into shares of common stock according to
the formula set forth in our current certificate of
incorporation.
In May and June 2006, we and the holders of all series of our
convertible preferred stock entered into the fourth amended and
restated investor rights agreement, which is included as an
exhibit to the registration statement of which this prospectus
is a part.
Under the agreement, upon the request of the holders of at least
20% of the registrable shares (as defined in the agreement) at
any time commencing six months after the closing of this
offering, we are required to file with the SEC and cause to be
declared effective a registration statement on
Form S-1
covering the resale of all shares of common stock issued or
issuable upon the conversion of the shares of our Series A,
B, C and D convertible preferred stock. If requested by the
holders of at least 10% of the registrable shares (as defined in
the agreement), we will effect, subject to certain terms and
conditions, a registration on
Form S-3,
if it is available, to facilitate the sale and distribution of
the shares of common stock issued or issuable upon the
conversion of their shares of Series A, B, C and D
convertible preferred stock. Finally, if we propose to register
any of our capital stock under the Securities Act, the holders
of all series of our convertible preferred stock will be
entitled to customary “piggyback” registration rights
with respect to shares of common stock issued or issuable upon
the conversion of the shares of our Series A, B, C and D
convertible preferred stock.
Transfer
Agent and Registrar
Continental Stock Transfer & Trust Company is the transfer
agent and registrar for the common stock.
101
SHARES ELIGIBLE
FOR FUTURE SALE
If our stockholders sell substantial amounts of our common
stock, including shares issued upon the exercise of outstanding
options or warrants, in the public market following the
offering, the market price of our common stock could decline.
These sales also might make it more difficult for us to sell
equity or equity- related securities in the future at a time and
price that we deem appropriate.
Upon completion of the offering, we will have outstanding an
aggregate of 23,113,892 shares of our common stock,
assuming no exercise of the underwriters’ over-allotment
option and no exercise of outstanding options. Of these shares,
all of the shares sold in the offering will be freely tradeable
without restriction or further registration under the Securities
Act, unless the shares are purchased by “affiliates”
as that term is defined in Rule 144 under the Securities
Act. This leaves shares eligible for sale in the public market
as follows:
|
|
|
|
|
Number of
|
|
|
Shares
|
|
Date
|
|
16,185
|
|
|
After 90 days from the date of
this prospectus (subject, in some cases, to volume limitations).
|
|
17,777,707
|
|
|
At various times after
180 days from the date of this prospectus as described
below under
“Lock-up
Agreements.”
|
Rule 144
In general, under Rule 144 as currently in effect,
beginning 90 days after the date of this prospectus, a
person who has beneficially owned shares of our common stock for
at least one year would be entitled to sell within any
three-month period a number of shares that does not exceed the
greater of:
|
|
|
|
•
|
1.0% of the number of shares of our common stock then
outstanding, which will equal approximately 235,639 shares
immediately after the offering; or
|
|
|
•
|
the average weekly trading volume of our common stock on the
Nasdaq Global Market during the four calendar weeks preceding
the filing of a notice on Form 144 with respect to that
sale.
|
Sales under Rule 144 are also subject to manner of sale
provisions and notice requirements and to the availability of
current public information about us.
Rule 144(k)
Under Rule 144(k), a person who is not deemed to have been
one of our affiliates at any time during the three months
preceding a sale, and who has beneficially owned the shares
proposed to be sold for at least two years, including the
holding period of any prior owner other than an affiliate, is
entitled to sell those shares without complying with the manner
of sale, public information, volume limitation or notice
provisions of Rule 144.
Lock-Up
Agreements
All of our officers and directors and certain of our
stockholders have entered into
lock-up
agreements under which they agreed not to transfer or dispose
of, directly or indirectly, any shares of our common stock or
any securities convertible into or exercisable or exchangeable
for shares of our common stock, for a period of 180 days
after the date of this prospectus, without the prior written
consent of Morgan Stanley & Co. Incorporated on behalf of
the underwriters.
Rule 701
and Form S-8
In general, under Rule 701 of the Securities Act as
currently in effect, any of our employees, consultants or
advisors who is not one of our affiliates and who purchases
shares of our common stock from us in connection with a
compensatory stock or option plan or other written agreement is
eligible to resell those shares 90 days after the effective
date of this prospectus in reliance on Rule 144, but
without compliance with some of the restrictions, including the
holding period, contained in Rule 144.
Following the offering, we intend to file a registration
statement on
Form S-8
under the Securities Act covering approximately
6,362,672 shares of common stock issued or issuable upon
the exercise of stock options, subject to outstanding options or
reserved for issuance under our employee and director stock
benefit plans. Accordingly, shares registered under that
registration statement will, subject to Rule 144 provisions
applicable to affiliates, be available for sale in the open
market, except to the extent that the shares are subject to
vesting restrictions or the contractual restrictions described
above. See “Compensation Discussion and
Analysis — Employee Benefits Plans.”
102
CERTAIN
MATERIAL U.S. FEDERAL INCOME TAX
CONSIDERATIONS TO
NON-U.S. HOLDERS
The following summary describes certain material United States
federal income tax consequences of the ownership and disposition
of our common stock by a
Non-U.S. Holder
(as defined below) holding shares of our common stock as capital
assets as of the date of this prospectus. This discussion does
not address all aspects of United States federal income taxation
and does not deal with estate, gift, foreign, state and local
tax consequences that may be relevant to such
Non-U.S. Holders
in light of their personal circumstances. Special U.S. tax
rules may apply to certain
Non-U.S. Holders,
such as “controlled foreign corporations,”
“passive foreign investment companies,” corporations
that accumulate earnings to avoid U.S. federal income tax,
investors in partnerships or other pass-through entities for
U.S. federal income tax purposes, dealers in securities,
holders of securities held as part of a “straddle,”
“hedge,” “conversion transaction” or other
risk reduction transaction, and certain former citizens or
long-term residents of the United States that are subject
to special treatment under the Internal Revenue Code of 1986, as
amended (the “Code”). Such entities and persons should
consult their own tax advisors to determine the
U.S. federal, state, local and other tax consequences that
may be relevant to them. Furthermore, the discussion below is
based upon the provisions of the Code and Treasury regulations
promulgated thereunder, and rulings and judicial decisions
interpreting the foregoing as of the date hereof; such
authorities may be repealed, revoked or modified with or without
retroactive effect so as to result in United States federal
income tax consequences different from those discussed below.
If a partnership (or an entity treated as a partnership for
U.S. federal income tax purposes) holds our common stock,
the tax treatment of a partner will generally depend on the
status of the partner and the activities of the partnership.
Accordingly, persons who are partners in partnerships holding
our common stock should consult their tax advisors.
The authorities on which this summary is based are subject to
various interpretations, and any views expressed within this
summary are not binding on the Internal Revenue Service (the
“IRS”) or the courts. No assurance can be given that
the IRS or the courts will agree with the tax consequences
described in this prospectus.
As used herein, a
“Non-U.S. Holder”
means a beneficial owner of our common stock that is not any of
the following for U.S. federal income tax purposes:
|
|
|
|
•
|
a citizen or resident of the United States,
|
|
|
•
|
a corporation (or other entity treated as a corporation for
United States federal income tax purposes) created or organized
in or under the laws of the United States, any state
thereof or the District of Columbia,
|
|
|
•
|
an estate the income of which is subject to United States
federal income taxation regardless of its source, or
|
|
|
•
|
a trust (i) which is subject to primary supervision by a
court situated within the United States and as to which one
or more United States persons have the authority to control
all substantial decisions of the trust, or (ii) that has a
valid election in effect under applicable U.S. Treasury
regulations to be treated as a United States person.
|
PROSPECTIVE PURCHASERS ARE URGED TO CONSULT THEIR OWN TAX
ADVISORS REGARDING THE U.S. FEDERAL INCOME TAX
CONSEQUENCES, AS WELL AS OTHER U.S. FEDERAL, STATE, AND
LOCAL INCOME AND ESTATE TAX CONSEQUENCES, AND
NON-U.S. TAX
CONSEQUENCES, TO THEM OF ACQUIRING, OWNING, AND DISPOSING OF OUR
COMMON STOCK.
Dividends
If we make distributions on our common stock, such distributions
paid to a
Non-U.S. Holder
will generally constitute dividends for U.S. federal income
tax purposes to the extent such distributions are paid from our
current or accumulated earnings and profits, as determined under
U.S. federal income tax principles. If a distribution
exceeds our current and accumulated earnings and profits, the
excess will be treated as a tax-free return of the
Non-U.S. Holder’s
investment to the extent of the
Non-U.S. Holder’s
adjusted tax basis in our common stock. Any remaining excess
will be treated as capital gain. See “— Gain on
Disposition of Common Stock” below for additional
information.
103
Dividends paid to a
Non-U.S. Holder
generally will be subject to withholding of United States
federal income tax at a 30% rate or such lower rate as may be
specified by an applicable income tax treaty. A
Non-U.S. Holder
of common stock who wishes to claim the benefit of an exemption
from withholding under provisions of an applicable treaty or an
applicable treaty rate for dividends will be required to
(a) complete IRS
Form W-8BEN
(or appropriate substitute form) and certify, under penalty of
perjury, that such holder is not a U.S. person and is
eligible for the benefits with respect to dividends allowed by
such treaty or (b) hold common stock through certain
foreign intermediaries and satisfy the certification
requirements for treaty benefits of applicable Treasury
regulations. Special certification requirements apply to certain
Non-U.S. Holders
that are “pass-through” entities for U.S. federal
income tax purposes. A
Non-U.S. Holder
eligible for a reduced rate of United States withholding
tax pursuant to an income tax treaty may obtain a refund of any
excess amounts withheld by timely filing an appropriate claim
for refund with the IRS.
Subject to variations under applicable treaties, this
United States withholding tax generally will not apply to
dividends that are effectively connected with the conduct of a
trade or business by the
Non-U.S. Holder
within the United States. Dividends effectively connected
with the conduct of a United States trade or business are
instead subject to United States federal income tax
generally in the same manner as if the
Non-U.S. Holder
were a U.S. person, as defined under the Code. In order to
obtain this exemption from withholding on effectively connected
dividends, a
Non-U.S. Holder
must provide to the payor or withholding agent a valid IRS
Form W-8ECI
or other successor form properly certifying such exemption. Any
such effectively connected dividends received by a
Non-U.S. Holder
that is a foreign corporation may, under certain circumstances,
be subject to an additional “branch profits tax” at a
30% rate or such lower rate as may be specified by an applicable
income tax treaty.
Gain on
Disposition of Common Stock
A
Non-U.S. Holder
generally will not be subject to United States federal income
tax (or any withholding thereof) with respect to gain recognized
on a sale or other disposition of our common stock unless:
|
|
|
|
•
|
the gain is effectively connected with a trade or business of
the
Non-U.S. Holder
in the United States or, where a tax treaty applies, is
attributable to a United States permanent establishment or
fixed base of the
Non-U.S. Holder,
|
|
|
•
|
the
Non-U.S. Holder
is an individual who is present in the United States for
183 or more days during the taxable year of disposition and
meets certain other requirements, or
|
|
|
•
|
we are or have been a “U.S. real property holding
corporation” within the meaning of Section 897(c)(2)
of the Code, also referred to as a USRPHC, for
United States federal income tax purposes at any time
within the five-year period preceding the disposition (or, if
shorter, the
Non-U.S. Holder’s
holding period for the common stock).
|
Gain recognized on the sale or other disposition of our common
stock that is effectively connected with a United States
trade or business, or attributable to a United States
permanent establishment or fixed base of the
Non-U.S. Holder
under an applicable treaty, is subject to United States
federal income tax on a net income basis generally in the same
manner as if the
Non-U.S. Holder
were a U.S. person, as defined under the Code. Any such
effectively connected gain from the sale or disposition of our
common stock received by a
Non-U.S. Holder
that is a foreign corporation may, under certain circumstances,
be subject to an additional “branch profits tax” at a
30% rate or such lower rate as may be specified by an applicable
income tax treaty.
An individual
Non-U.S. Holder
who is present in the United States for 183 or more days
during the taxable year of disposition generally will be subject
to a 30% tax imposed on the gain derived from the sale or
disposition of our common stock, which may be offset by
U.S. source capital losses realized in the same taxable
year.
In general, a corporation is a USRPHC if the fair market value
of its “U.S. real property interests” equals or
exceeds 50% of the sum of the fair market value of its worldwide
(domestic and foreign) real property interest and its other
assets used or held for use in a trade or business. For this
purpose, real property interests include land, improvements and
associated personal property.
104
We believe that we currently are not a USRPHC. In addition,
based on our financial statements and current expectations
regarding the value and nature of our assets and other relevant
data, we do not anticipate becoming a USRPHC.
If we become a USRPHC, a
Non-U.S. Holder
nevertheless will not be subject to United States federal
income tax if our common stock is regularly traded on an
established securities market, within the meaning of applicable
Treasury regulations, and the
Non-U.S. Holder
holds no more than five percent of our outstanding common stock,
directly or indirectly, during the applicable testing period. We
have applied to list our common stock for quotation on the
Nasdaq Global Market and we expect that our common stock may be
regularly traded on an established securities market in the
United States so long as it is so quoted.
Information
Reporting and Backup Withholding
We must report annually to the IRS and to each
Non-U.S. Holder
the amount of dividends paid to such holder and the tax withheld
with respect to such dividends, regardless of whether
withholding was required. Copies of the information returns
reporting such dividends and withholding may also be made
available to the tax authorities in the country in which the
Non-U.S. Holder
resides under the provisions of an applicable income tax treaty.
The United States imposes a backup withholding tax on dividends
and certain other types of payments to United States
persons (currently at a rate of 28%) of the gross amount.
Dividends paid to a
Non-U.S. Holder
will not be subject to backup withholding if proper
certification of foreign status (usually on the forms described
above) is provided, and the payor does not have actual knowledge
or reason to know that the beneficial owner is a United States
person, or the holder is a corporation or one of several types
of entities and organizations that qualify for exemption.
Backup withholding is not an additional tax. Any amounts
withheld under the backup withholding rules may be allowed as a
refund or a credit against such holder’s U.S. federal
income tax liability provided the required information is timely
furnished to the IRS.
105
UNDERWRITERS
Under the terms and subject to the conditions contained in an
underwriting agreement dated the date of this prospectus, the
underwriters named below, for whom Morgan Stanley & Co.
Incorporated is acting as representative, have severally agreed
to purchase, and we and the selling stockholders have agreed to
sell to them, severally, the number of shares indicated below:
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|
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|
|
Number of
|
|
Name
|
|
Shares
|
|
|
Morgan Stanley & Co.
Incorporated
|
|
|
|
|
Lehman Brothers Inc.
|
|
|
|
|
UBS Securities LLC
|
|
|
|
|
Jefferies & Company,
Inc.
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
5,770,000
|
|
|
|
|
|
|
The underwriters are offering the shares of common stock subject
to their acceptance of the shares from us and the selling
stockholders and subject to prior sale. The underwriting
agreement provides that the obligations of the several
underwriters to pay for and accept delivery of the shares of
common stock offered by this prospectus are subject to the
approval of certain legal matters by their counsel and to
certain other conditions. The underwriters are obligated to take
and pay for all of the shares of common stock offered by this
prospectus if any such shares are taken. However, the
underwriters are not required to take or pay for the shares
covered by the underwriters’ over-allotment option
described below.
In the agreement among the underwriters, sales may be made
between the underwriters of any number of shares as may be
mutually agreed. The per share price of any shares sold by the
underwriters shall be the public offering price listed on the
cover page of this prospectus, less an amount not greater than
the per share amount of the concession to dealers described
below.
The underwriters initially propose to offer part of the shares
of common stock directly to the public at the public offering
price listed on the cover page of this prospectus and part to
certain dealers at a price that represents a concession not in
excess of $ a share under the
public offering price. After the initial offering of the shares
of common stock, the offering price and other selling terms may
from time to time be varied by the representative.
We have granted to the underwriters an option, exercisable for
30 days from the date of this prospectus, to purchase up to
an aggregate of 865,500 additional shares of common stock at the
public offering price listed on the cover page of this
prospectus, less underwriting discounts and commissions. The
underwriters may exercise this option solely for the purpose of
covering over-allotments, if any, made in connection with the
offering of the shares of common stock offered by this
prospectus. To the extent the option is exercised, each
underwriter will become obligated, subject to certain
conditions, to purchase about the same percentage of the
additional shares of common stock as the number listed next to
the underwriter’s name in the preceding table bears to the
total number of shares of common stock listed next to the names
of all underwriters in the preceding table. If the
underwriters’ option is exercised in full, the total price
to the public would be $ , the
total underwriting discounts and commissions paid by us and the
selling stockholders would be $
and $ , respectively; and total
proceeds to us and the selling stockholders would be
$
and $ , respectively. Any shares
sold pursuant to the over-allotment option will be sold by the
Company.
The underwriters have informed us that they do not intend sales
to discretionary accounts to exceed five percent of the total
number of shares of common stock offered by them.
We have applied for quotation of our common stock on the Nasdaq
Global Market under the symbol “FIRE.”
106
We, our directors, executive officers, the selling stockholders
and certain other stockholders of Sourcefire, Inc. have agreed
that, without the prior written consent of Morgan
Stanley & Co. Incorporated on behalf of the
underwriters, we and they will not, during the period ending
180 days after the date of this prospectus:
|
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|
•
|
offer, pledge, sell, contract to sell, sell any option or
contract to purchase, purchase any option or contract to sell,
grant any option, right or warrant to purchase, lend, or
otherwise transfer or dispose of, directly or indirectly, any
shares of common stock or any securities convertible into or
exercisable or exchangeable for common stock;
|
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|
•
|
enter into any swap or other arrangement that transfers to
another, in whole or in part, any of the economic consequences
of ownership of the common stock; or
|
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|
•
|
file any registration statement with the SEC relating to the
offering of any shares of common stock or any securities
convertible into or exercisable or exchangeable for common
stock, except for registration statements on Form S-8 (or
other equivalent forms);
|
whether any such transaction described above is to be settled by
delivery of common stock or such other securities, in cash or
otherwise.
The restrictions described in this paragraph do not apply to:
|
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|
|
•
|
the sale of shares to the underwriters;
|
|
|
•
|
the issuance by us of restricted shares of common stock or
options to acquire common stock pursuant to our employee benefit
plans, stock option plans or employee compensation plans
described herein;
|
|
|
•
|
the issuance by us of shares of common stock upon the exercise
of an option that was issued pursuant to our employee benefit
plans, stock option plans or other employee compensation plans;
|
|
|
•
|
the issuance by us of shares of common stock upon the exercise
of a warrant or the conversion of a security outstanding on the
date of this prospectus pursuant to our existing employee
benefit plans or of which the underwriters have been advised in
writing;
|
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|
•
|
transactions relating to shares of common stock or other
securities acquired in open market transactions after the
completion of the offering of the shares;
|
|
|
•
|
transfers of shares of common stock or any security convertible
into common stock as a bona fide gift; or
|
|
|
•
|
transfers of shares of common stock to any trust, partnership or
limited liability company for the direct or indirect benefit of
the signer or the immediate family of the signer;
|
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|
•
|
distributions of shares of common stock or any security
convertible into common stock to limited partners or
stockholders of the signer; or
|
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|
•
|
the issuance by us of up to 300,000 shares of common stock
in connection with an acquisition or other business combination;
|
provided that (i) each recipient shall sign and
deliver a lock-up agreement and (ii) no filing under
Section 16(a) of the Exchange Act, reporting a reduction in
beneficial ownership of shares of common stock, shall be
required or shall be voluntarily made in connection with such
transfer or distribution during the 180 day restricted
period (including extensions).
The 180 day restricted period described in the preceding
paragraph will be extended if:
|
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|
•
|
during the last 17 days of the 180 day restricted
period, we issue an earnings release or material news or a
material event relating to us occurs; or
|
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|
•
|
prior to the expiration of the 180 day restricted period,
we announce that we will release earnings results during the
16 day period beginning on the last day of the 180 day
period,
|
107
in which case the restrictions described in the preceding
paragraph will continue to apply until the expiration of the
18 day period beginning on the issuance of the earnings
release or the occurrence of material news or a material event.
The following table shows the per share and total underwriting
discounts and commissions that we and the selling stockholders
are to pay to the underwriters in connection with this offering.
These amounts are shown assuming both no exercise and full
exercise of the underwriters’ option to purchase additional
shares of our common stock.
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|
|
|
|
|
|
|
|
|
|
|
|
|
Paid by Us
|
|
|
Paid by Selling Stockholders
|
|
|
Total
|
|
|
|
|
|
|
Full
|
|
|
|
|
|
Full
|
|
|
|
|
|
Full
|
|
|
|
No Exercise
|
|
|
Exercise
|
|
|
No Exercise
|
|
|
Exercise
|
|
|
No Exercise
|
|
|
Exercise
|
|
|
Per Share
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Total
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
In order to facilitate the offering of the common stock, the
underwriters may engage in transactions that stabilize, maintain
or otherwise affect the price of the common stock. Specifically,
the underwriters may sell more shares than they are obligated to
purchase under the underwriting agreement, creating a short
position. A short sale is covered if the short position is no
greater than the number of shares available for purchase by the
underwriters under the over-allotment option. The underwriters
can close out a covered short sale by exercising the
over-allotment option or purchasing shares in the open market.
In determining the source of shares to close out a covered short
sale, the underwriters will consider, among other things, the
open market price of shares compared to the price available
under the over-allotment option. The underwriters may also sell
shares in excess of the over-allotment option, creating a naked
short position. The underwriters must close out any naked short
position by purchasing shares in the open market. A naked short
position is more likely to be created if the underwriters are
concerned that there may be downward pressure on the price of
the common stock in the open market after pricing that could
adversely affect investors who purchase in the offering. As an
additional means of facilitating the offering, the underwriters
may bid for, and purchase, shares of common stock in the open
market to stabilize the price of the common stock. The
underwriting syndicate may also reclaim selling concessions
allowed to an underwriter or a dealer for distributing the
common stock in the offering, if the syndicate repurchases
previously distributed common stock to cover syndicate short
positions or to stabilize the price of the common stock. These
activities may raise or maintain the market price of the common
stock above independent market levels or prevent or retard a
decline in the market price of the common stock. The
underwriters are not required to engage in these activities, and
may end any of these activities at any time.
From time to time, Morgan Stanley & Co. Incorporated or
the other underwriters and their respective affiliates may
provide investment banking services to us.
A prospectus in electronic format may be made available on the
web sites maintained by one or more of the underwriters, and one
or more of the underwriters may distribute prospectuses
electronically. The underwriters may agree to allocate a number
of shares to underwriters for sale to their online brokerage
account holders. Internet distributions will be allocated by the
underwriters that make Internet distributions on the same basis
as other allocations.
We, the selling stockholders, and the underwriters have agreed
to indemnify each other against certain liabilities, including
liabilities under the Securities Act.
Pricing
of the Offering
Prior to this offering, there has been no public market for the
shares of our common stock. The initial public offering price
will be determined by negotiations among us, the selling
stockholders and the representative of the underwriters. Among
the factors to be considered in determining the initial public
offering price will be our future prospects and those of our
industry in general, our sales, earnings and certain other
financial operating information in recent periods, and the
price-earnings ratios, price-sales ratios, market prices of
securities and certain financial and operating information of
companies engaged in activities similar to ours. The estimated
initial public offering price range set forth on the cover page
of this preliminary prospectus is subject to change as a result
of market conditions and other factors.
108
LEGAL
MATTERS
The validity of the shares of common stock offered hereby will
be passed upon for us by our counsel, Morrison &
Foerster LLP, McLean, Virginia. Various legal matters relating
to this offering will be passed upon for the underwriters by
Latham & Watkins LLP, New York, New York.
EXPERTS
The consolidated financial statements of Sourcefire, Inc. at
December 31, 2005 and 2006 and for each of the three years
in the period ended December 31, 2006 appearing in this
prospectus and registration statement have been audited by
Ernst & Young LLP, independent registered public
accounting firm, as set forth in their report thereon appearing
elsewhere herein, and are included in reliance upon such report
given on the authority of such firm as experts in accounting and
auditing.
WHERE YOU
CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement under the
Securities Act with respect to the shares of our common stock
offered by this prospectus. This prospectus, filed as a part of
the registration statement, does not contain all of the
information set forth in the registration statement or the
exhibits and schedules thereto as permitted by the rules and
regulations of the SEC. For further information about us and our
common stock, you should refer to the registration statement.
This prospectus summarizes provisions that we consider material
of certain contracts and other documents to which we refer you.
Because the summaries may not contain all of the information
that you may find important, you should review the full text of
those documents. We have included copies of those documents as
exhibits to the registration statement.
The registration statement and the exhibits thereto filed with
the SEC may be inspected, without charge, and copies may be
obtained at prescribed rates, at the public reference facility
maintained by the SEC at 100 F Street, N.E.,
Washington, D.C. 20549. You may obtain information on the
operation of the public reference room by calling the SEC at
1-800-SEC-0330.
The registration statement and other information filed by us
with the SEC are also available at the SEC’s website at
www.sec.gov.
As a result of the offering, we and our stockholders will become
subject to the proxy solicitation rules, annual and periodic
reporting requirements, restrictions of stock purchases and
sales by affiliates and other requirements of the Securities
Exchange Act of 1934, as amended. We will furnish our
stockholders with annual reports containing audited financial
statements certified by independent auditors and quarterly
reports containing unaudited financial statements for the first
three quarters of each fiscal year.
109
SOURCEFIRE,
INC.
Contents
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F-2
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Consolidated Financial Statements:
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|
|
|
|
|
|
|
|
|
|
F-3
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|
F-5
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|
|
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|
F-6
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|
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F-7
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F-8
|
|
F-1
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of
Directors and Stockholders of Sourcefire, Inc.
We have audited the accompanying consolidated balance sheets of
Sourcefire, Inc. (the Company) as of December 31, 2005 and
2006, and the related consolidated statements of operations,
changes in convertible preferred stock and stockholders’
deficit, and cash flows for each of the three years in the
period ended December 31, 2006. These financial statements
are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. We were not engaged to perform an
audit of the Company’s internal control over financial
reporting. Our audit included consideration of internal control
over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of
the Company’s internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Sourcefire, Inc. at December 31, 2005
and 2006, and the consolidated results of its operations and its
cash flows for each of the three years in the period ended
December 31, 2006 in conformity with U.S. generally
accepted accounting principles.
As discussed in Note 2 to the financial statements, in 2006
the Company changed its method of accounting for stock-based
compensation.
/s/ Ernst
& Young LLP
Baltimore, Maryland
January 30, 2007
(except with respect to the matter discussed in Note 14,
as to which the date is February 22, 2007)
F-2
SOURCEFIRE,
INC.
|
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|
|
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|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma
|
|
|
|
December 31
|
|
|
December 31
|
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
|
(dollars in thousands, except share and per share data)
|
|
|
|
|
|
|
|
|
|
(unaudited)
|
|
|
Assets
|
Current assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,106
|
|
|
$
|
13,029
|
|
|
$
|
13,029
|
|
Held-to-maturity
investments
|
|
|
2,005
|
|
|
|
12,385
|
|
|
|
12,385
|
|
Accounts receivable, net of
allowance for doubtful accounts of $127 in 2005 and $166 in 2006
|
|
|
12,917
|
|
|
|
16,507
|
|
|
|
16,507
|
|
Inventory
|
|
|
1,755
|
|
|
|
2,099
|
|
|
|
2,099
|
|
Prepaid expenses and other current
assets
|
|
|
758
|
|
|
|
919
|
|
|
|
919
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
18,541
|
|
|
|
44,939
|
|
|
|
44,939
|
|
Property and equipment, net
|
|
|
2,522
|
|
|
|
2,546
|
|
|
|
2,546
|
|
Held-to-maturity
investments, less current portion
|
|
|
—
|
|
|
|
908
|
|
|
|
908
|
|
Other assets
|
|
|
187
|
|
|
|
1,559
|
|
|
|
1,559
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
21,250
|
|
|
$
|
49,952
|
|
|
$
|
49,952
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities, convertible
preferred stock and
stockholders’ equity (deficit)
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
2,134
|
|
|
$
|
3,081
|
|
|
$
|
3,081
|
|
Accrued compensation and related
expenses
|
|
|
1,552
|
|
|
|
1,783
|
|
|
|
1,783
|
|
Other accrued expenses
|
|
|
652
|
|
|
|
1,312
|
|
|
|
1,312
|
|
Current portion of deferred revenue
|
|
|
9,137
|
|
|
|
11,735
|
|
|
|
11,735
|
|
Current portion of long-term debt
|
|
|
514
|
|
|
|
675
|
|
|
|
675
|
|
Other current liabilities
|
|
|
417
|
|
|
|
501
|
|
|
|
501
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
14,406
|
|
|
|
19,087
|
|
|
|
19,087
|
|
Deferred revenue, less current
portion
|
|
|
1,458
|
|
|
|
2,380
|
|
|
|
2,380
|
|
Long-term debt, less current
portion
|
|
|
476
|
|
|
|
637
|
|
|
|
637
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
16,340
|
|
|
|
22,104
|
|
|
|
22,104
|
|
Series A convertible
preferred stock, $0.001 par value; 2,495,410 shares
authorized, 2,475,410 shares issued and outstanding at
December 31, 2005 and 2006 and no shares outstanding on a
pro forma basis; aggregate liquidation preference of $13,489 and
$14,093 at December 31, 2005 and 2006, respectively
|
|
|
9,598
|
|
|
|
10,308
|
|
|
|
—
|
|
Warrants to purchase Series A
convertible preferred stock
|
|
|
25
|
|
|
|
25
|
|
|
|
—
|
|
F-3
SOURCEFIRE,
INC.
CONSOLIDATED BALANCE SHEETS — (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma
|
|
|
|
December 31
|
|
|
December 31
|
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
|
(dollars in thousands, except share and per share data)
|
|
|
|
|
|
|
|
|
|
(unaudited)
|
|
|
Series B convertible
preferred stock, $0.001 par value; 7,132,205 shares
authorized, issued and outstanding at December 31, 2005 and
2006 and no shares outstanding on a pro forma basis; aggregate
liquidation preference of $19,067 and $19,947 at
December 31, 2005 and 2006, respectively
|
|
|
13,318
|
|
|
|
14,265
|
|
|
|
—
|
|
Series C convertible
preferred stock, $0.001 par value; 5,404,043 shares
authorized, issued and outstanding at December 31, 2005 and
2006 and no shares outstanding on a pro forma basis; aggregate
liquidation preference of $24,850 and $26,050 at
December 31, 2005 and 2006, respectively
|
|
|
17,066
|
|
|
|
18,270
|
|
|
|
—
|
|
Series D convertible
preferred stock, $0.001 par value; 3,264,449 shares
authorized, issued and outstanding at December 31, 2006 and
no shares outstanding on a pro forma basis; aggregate
liquidation preference of $29,847 at December 31, 2006
|
|
|
—
|
|
|
|
23,879
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total convertible preferred stock
|
|
|
40,007
|
|
|
|
66,747
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingent
liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity
(deficit):
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par
value; 35,000,000 and 36,500,000 shares authorized at
December 31, 2005 and 2006, respectively; 3,407,682 and
3,491,764 shares issued and outstanding at
December 31, 2005 and 2006, respectively, and
17,793,892 shares outstanding on a pro forma basis
|
|
|
3
|
|
|
|
3
|
|
|
|
18
|
|
Additional paid-in capital
|
|
|
—
|
|
|
|
—
|
|
|
|
66,732
|
|
Unearned compensation
|
|
|
(20
|
)
|
|
|
—
|
|
|
|
—
|
|
Accumulated deficit
|
|
|
(35,080
|
)
|
|
|
(38,902
|
)
|
|
|
(38,902
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders’ equity
(deficit)
|
|
|
(35,097
|
)
|
|
|
(38,899
|
)
|
|
|
27,848
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities, convertible
preferred stock and stockholders’ equity (deficit)
|
|
$
|
21,250
|
|
|
$
|
49,952
|
|
|
$
|
49,952
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
F-4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
$
|
12,738
|
|
|
$
|
23,589
|
|
|
$
|
30,219
|
|
Technical support and professional
services
|
|
|
3,955
|
|
|
|
9,290
|
|
|
|
14,707
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
16,693
|
|
|
|
32,879
|
|
|
|
44,926
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
4,533
|
|
|
|
6,610
|
|
|
|
8,440
|
|
Technical support and professional
services
|
|
|
872
|
|
|
|
1,453
|
|
|
|
2,632
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
5,405
|
|
|
|
8,063
|
|
|
|
11,072
|
|
Gross profit
|
|
|
11,288
|
|
|
|
24,816
|
|
|
|
33,854
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
5,706
|
|
|
|
6,831
|
|
|
|
8,612
|
|
Sales and marketing
|
|
|
12,585
|
|
|
|
17,135
|
|
|
|
20,652
|
|
General and administrative
|
|
|
2,905
|
|
|
|
5,120
|
|
|
|
5,017
|
|
Depreciation and amortization
|
|
|
752
|
|
|
|
1,103
|
|
|
|
1,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
21,948
|
|
|
|
30,189
|
|
|
|
35,511
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(10,660
|
)
|
|
|
(5,373
|
)
|
|
|
(1,657
|
)
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and investment income
|
|
|
162
|
|
|
|
101
|
|
|
|
784
|
|
Interest expense
|
|
|
(66
|
)
|
|
|
(98
|
)
|
|
|
(87
|
)
|
Other income (expense)
|
|
|
68
|
|
|
|
(88
|
)
|
|
|
95
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other income (expense)
|
|
|
164
|
|
|
|
(85
|
)
|
|
|
792
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes
|
|
|
(10,496
|
)
|
|
|
(5,458
|
)
|
|
|
(865
|
)
|
Income tax expense
|
|
|
—
|
|
|
|
—
|
|
|
|
(67
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(10,496
|
)
|
|
|
(5,458
|
)
|
|
|
(932
|
)
|
Accretion of preferred stock
|
|
|
(2,451
|
)
|
|
|
(2,668
|
)
|
|
|
(3,819
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders
|
|
$
|
(12,947
|
)
|
|
$
|
(8,126
|
)
|
|
$
|
(4,751
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(4.97
|
)
|
|
$
|
(2.54
|
)
|
|
$
|
(1.40
|
)
|
Pro forma (unaudited)
|
|
|
|
|
|
|
|
|
|
|
(0.06
|
)
|
Weighted average shares
outstanding used in computing per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
2,602,743
|
|
|
|
3,200,318
|
|
|
|
3,389,527
|
|
Pro forma (unaudited)
|
|
|
|
|
|
|
|
|
|
|
16,885,981
|
|
See accompanying notes.
F-5
SOURCEFIRE,
INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subscription
|
|
|
Purchase
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Receivable For
|
|
|
Series A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ Deficit
|
|
|
|
Series A Convertible
|
|
|
Series A
|
|
|
Convertible
|
|
|
Series B Convertible
|
|
|
Series C Convertible
|
|
|
Series D Convertible
|
|
|
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred Stock
|
|
|
Convertible
|
|
|
Preferred
|
|
|
Preferred Stock
|
|
|
Preferred Stock
|
|
|
Preferred Stock
|
|
|
Common Stock
|
|
|
Paid-in
|
|
|
Unearned
|
|
|
Accumulated
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Preferred Stock
|
|
|
Stock
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Compensation
|
|
|
Deficit
|
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
|
Balance at January 1, 2004
|
|
|
2,475,410
|
|
|
$
|
8,323
|
|
|
$
|
—
|
|
|
|
$25
|
|
|
|
7,132,205
|
|
|
$
|
11,610
|
|
|
|
—
|
|
|
$
|
—
|
|
|
|
—
|
|
|
|
$ —
|
|
|
|
3,042,117
|
|
|
|
$3
|
|
|
$
|
—
|
|
|
$
|
(167
|
)
|
|
$
|
(14,644
|
)
|
|
$
|
(14,808
|
)
|
Exercise of common stock options
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
250,765
|
|
|
|
—
|
|
|
|
78
|
|
|
|
—
|
|
|
|
—
|
|
|
|
78
|
|
Compensation expense for stock
option modifications
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
85
|
|
|
|
—
|
|
|
|
—
|
|
|
|
85
|
|
Issuance of Series C
redeemable convertible preferred stock, net of direct costs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of issuance of $70
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
5,404,043
|
|
|
|
14,930
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Accretion of convertible preferred
stock to redemption value
|
|
|
—
|
|
|
|
615
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
825
|
|
|
|
—
|
|
|
|
1,011
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(163
|
)
|
|
|
—
|
|
|
|
(2,288
|
)
|
|
|
(2,451
|
)
|
Amortization of unearned
compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
92
|
|
|
|
—
|
|
|
|
92
|
|
Net loss for 2004
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(10,496
|
)
|
|
|
(10,496
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
|
2,475,410
|
|
|
|
8,938
|
|
|
|
—
|
|
|
|
25
|
|
|
|
7,132,205
|
|
|
|
12,435
|
|
|
|
5,404,043
|
|
|
|
15,941
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,292,882
|
|
|
|
3
|
|
|
|
—
|
|
|
|
(75
|
)
|
|
|
(27,428
|
)
|
|
|
(27,500
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise of common stock options
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
114,800
|
|
|
|
—
|
|
|
|
59
|
|
|
|
—
|
|
|
|
—
|
|
|
|
59
|
|
Compensation expense for stock
option modifications
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
415
|
|
|
|
—
|
|
|
|
—
|
|
|
|
415
|
|
Accretion of convertible preferred
stock to redemption value
|
|
|
—
|
|
|
|
660
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
883
|
|
|
|
—
|
|
|
|
1,125
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(474
|
)
|
|
|
—
|
|
|
|
(2,194
|
)
|
|
|
(2,668
|
)
|
Amortization of unearned
compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
55
|
|
|
|
—
|
|
|
|
55
|
|
Net loss for 2005
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(5,458
|
)
|
|
|
(5,458
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
|
2,475,410
|
|
|
|
9,598
|
|
|
|
—
|
|
|
|
25
|
|
|
|
7,132,205
|
|
|
|
13,318
|
|
|
|
5,404,043
|
|
|
|
17,066
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,407,682
|
|
|
|
3
|
|
|
|
—
|
|
|
|
(20
|
)
|
|
|
(35,080
|
)
|
|
|
(35,097
|
)
|
Exercise of common stock options
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
84,082
|
|
|
|
—
|
|
|
|
143
|
|
|
|
—
|
|
|
|
—
|
|
|
|
143
|
|
Issuance of restricted common stock
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
83
|
|
|
|
—
|
|
|
|
—
|
|
|
|
83
|
|
Compensation expense for stock
option vesting
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
703
|
|
|
|
—
|
|
|
|
—
|
|
|
|
703
|
|
Issuance of Series D
redeemable convertible preferred stock, net of direct issuance
costs of $79
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,264,449
|
|
|
|
22,921
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Accretion of convertible preferred
stock to redemption value
|
|
|
—
|
|
|
|
710
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
947
|
|
|
|
—
|
|
|
|
1,204
|
|
|
|
—
|
|
|
|
958
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(929
|
)
|
|
|
—
|
|
|
|
(2,890
|
)
|
|
|
(3,819
|
)
|
Amortization of unearned
compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
20
|
|
|
|
—
|
|
|
|
20
|
|
Net loss for 2006
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(932
|
)
|
|
|
(932
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2006
|
|
|
2,475,410
|
|
|
$
|
10,308
|
|
|
$
|
—
|
|
|
|
$25
|
|
|
|
7,132,205
|
|
|
$
|
14,265
|
|
|
|
5,404,043
|
|
|
$
|
18,270
|
|
|
|
3,264,449
|
|
|
|
$23,879
|
|
|
|
3,491,764
|
|
|
|
$3
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(38,902
|
)
|
|
$
|
(38,899
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
F-6
SOURCEFIRE,
INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
|
(dollars in thousands)
|
|
|
Operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(10,496
|
)
|
|
$
|
(5,458
|
)
|
|
$
|
(932
|
)
|
Adjustments to reconcile net loss
to net cash (used in) provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
756
|
|
|
|
1,127
|
|
|
|
1,261
|
|
Provision for doubtful accounts
|
|
|
70
|
|
|
|
57
|
|
|
|
55
|
|
Amortization of unearned
compensation
|
|
|
92
|
|
|
|
55
|
|
|
|
20
|
|
Other non-cash stock compensation
|
|
|
85
|
|
|
|
415
|
|
|
|
786
|
|
Amortization of (premium) discount
on
held-to-maturity
investments
|
|
|
175
|
|
|
|
126
|
|
|
|
(81
|
)
|
Loss on disposal of assets
|
|
|
27
|
|
|
|
—
|
|
|
|
—
|
|
Changes in operating assets and
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(4,681
|
)
|
|
|
(5,120
|
)
|
|
|
(3,645
|
)
|
Inventory
|
|
|
(409
|
)
|
|
|
(1,065
|
)
|
|
|
(344
|
)
|
Prepaid expenses and other assets
|
|
|
(358
|
)
|
|
|
(229
|
)
|
|
|
(238
|
)
|
Accounts payable
|
|
|
1,089
|
|
|
|
360
|
|
|
|
901
|
|
Accrued expenses
|
|
|
626
|
|
|
|
11
|
|
|
|
681
|
|
Deferred revenue
|
|
|
3,069
|
|
|
|
4,994
|
|
|
|
3,520
|
|
Other current liabilities
|
|
|
144
|
|
|
|
269
|
|
|
|
84
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by
operating activities
|
|
|
(9,811
|
)
|
|
|
(4,458
|
)
|
|
|
2,068
|
|
Investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
|
(1,107
|
)
|
|
|
(2,207
|
)
|
|
|
(1,285
|
)
|
Purchase of
held-to-maturity
investments
|
|
|
(10,028
|
)
|
|
|
—
|
|
|
|
(13,207
|
)
|
Proceeds from maturities of
held-to-maturity
investments
|
|
|
4,103
|
|
|
|
3,620
|
|
|
|
2,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by
investing activities
|
|
|
(7,032
|
)
|
|
|
1,413
|
|
|
|
(12,492
|
)
|
Financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowings under revolving
promissory note
|
|
|
—
|
|
|
|
2,250
|
|
|
|
—
|
|
Repayments of borrowings under
revolving promissory note
|
|
|
—
|
|
|
|
(2,250
|
)
|
|
|
—
|
|
Borrowings of long-term debt
|
|
|
420
|
|
|
|
1,000
|
|
|
|
887
|
|
Repayments of long-term debt
|
|
|
(304
|
)
|
|
|
(471
|
)
|
|
|
(565
|
)
|
Proceeds from issuance of
Series C convertible preferred stock, net of offering costs
|
|
|
14,930
|
|
|
|
—
|
|
|
|
—
|
|
Proceeds from issuance of
Series D convertible preferred stock, net of offering costs
|
|
|
—
|
|
|
|
—
|
|
|
|
22,921
|
|
Proceeds from exercise of stock
options
|
|
|
78
|
|
|
|
59
|
|
|
|
143
|
|
Payment of deferred equity offering
costs
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,039
|
)
|
Other
|
|
|
(33
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing
activities
|
|
|
15,091
|
|
|
|
588
|
|
|
|
22,347
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and
cash equivalents
|
|
|
(1,752
|
)
|
|
|
(2,457
|
)
|
|
|
11,923
|
|
Cash and cash equivalents at
beginning of year
|
|
|
5,315
|
|
|
|
3,563
|
|
|
|
1,106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
year
|
|
$
|
3,563
|
|
|
$
|
1,106
|
|
|
$
|
13,029
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow
information
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
46
|
|
|
$
|
70
|
|
|
$
|
68
|
|
Cash paid for income taxes
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
25
|
|
See accompanying notes.
F-7
SOURCEFIRE,
INC.
|
|
1.
|
Description
of Business and Basis of Presentation
|
Organization
and Description of Business
Sourcefire, Inc. (the “Company”) provides real-time
network defense solutions for information technology
(“IT”) infrastructures of commercial enterprise,
healthcare, manufacturing, technology, educational, and federal
and state organizations. The Company’s appliance products
and software products provide a comprehensive intelligent
network defense system that unifies intrusion detection,
intrusion prevention, and vulnerability management technologies.
The Company is the creator of Snort, a widely deployed
open-source intrusion detection technology. The Snort technology
is incorporated into the Sourcefire 3D (Discover, Determine,
Defend) product suite that includes the following product trade
names: Sourcefire Intrusion Sensors and Agents, Sourcefire RNA
Sensors, and the Sourcefire Defense Center. The Company was
founded in January 2001.
Unaudited
Pro Forma Financial Information
The unaudited pro forma balance sheet gives effect to the
conversion of the convertible preferred stock and the warrants
to purchase convertible preferred stock as if each occurred on
December 31, 2006. The conversion of the outstanding
preferred stock into common stock will occur immediately prior
to, or contemporaneously with, the consummation of the
Company’s initial public offering. In addition, the
warrants to purchase shares of Series A convertible
preferred stock will become exercisable for shares of common
stock upon completion of the Company’s initial public
offering. The unaudited pro forma net loss attributable to
common stockholders per share for the year ended
December 31, 2006 gives effect to the conversion of the
outstanding Series A, Series B, and Series C
convertible preferred stock as if these transactions occurred on
January 1, 2006 and the conversion of the outstanding
Series D convertible preferred stock as if it occurred on
its date of issuance.
|
|
2.
|
Summary
of Significant Accounting Policies
|
Basis
of Presentation
During 2006, the Company formed a wholly-owned subsidiary,
Sourcefire Limited, located in the United Kingdom. The
consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary after elimination of all
intercompany accounts and transactions.
Use of
Estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States
requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those
estimates.
Cash
and Cash Equivalents
The Company considers all highly liquid investments with
maturities of three months or less when purchased to be cash
equivalents.
Held-to-Maturity
Investments
Management determines the appropriate classification of debt
securities at the time of purchase and reevaluates such
designation as of each balance sheet date. Debt securities are
classified as
held-to-maturity
when the Company has the positive intent and ability to hold the
securities to maturity. The Company has historically held all of
these investments until their full maturity.
Held-to-maturity
securities are stated at amortized cost, adjusted for
amortization of premiums and accretion of discounts to maturity
computed under the effective interest method. Such amortization
is included in interest and investment income. Interest on
securities classified as
held-to-maturity
is also included in interest and investment income.
F-8
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
As of December 31, 2005 and 2006,
held-to-maturity
investments, consisting solely of corporate debt instruments for
which the estimated fair value is not materially different from
the amortized cost, have contractual maturities as follows:
$12,385,000 mature in 2007 and $908,000 mature in 2008.
Accounts
Receivable and Allowance for Doubtful Accounts
The Company reports accounts receivable at net realizable value.
The Company maintains an allowance for doubtful accounts for
estimated losses resulting from the inability of its customers
to make required payments. The Company calculates the allowance
based on a specific analysis of past due balances and also
considers historical trends of write-offs. Actual collection
experience has not differed significantly from the
Company’s estimates, due primarily to the Company’s
credit and collections practices and the financial strength of
its customers.
The Company offers standard payment terms that range from 30 to
60 days from the invoice date. Invoices are typically
generated when the Company delivers the product
and/or
service to the customer. Standard terms do not require a down
payment from the customer or any other collateral and payments
terms are not tied to specific milestones or acceptance clauses.
Additionally, the Company does not generally accept product
returns or offer refunds.
Inventories
Inventories are stated at the lower of cost or market. Cost is
determined by the
first-in,
first-out method.
Property
and Equipment
Property and equipment is stated at cost and depreciation is
computed using the straight-line method over estimated useful
lives ranging from three to seven years. Amortization of
leasehold improvements is computed using the straight-line
method over the lesser of the useful life of the asset or the
remaining term of the lease.
Assets held under capital leases are stated at the lesser of the
present value of future minimum lease payments using the
Company’s incremental borrowing rate at the inception of
the lease or the fair value of the property at the inception of
the lease. The assets recorded under capital leases are
amortized over the lesser of the lease term or the estimated
useful life of the assets in a manner consistent with the
Company’s depreciation policy for owned assets.
Amortization of assets under capital leases is included in
depreciation and amortization expense.
Deferred
Equity Offering Costs
Costs have been incurred in connection with the planned initial
public offering of the Company’s common stock. As of
December 31, 2006, costs aggregating approximately
$1,300,000 have been deferred and are classified as a component
of other assets in the accompanying consolidated balance sheet.
Upon the consummation of the offering, these costs will be
treated as a reduction of the proceeds from the offering and
will be included as a component of additional paid-in capital.
If the offering is terminated, the costs will be charged to
expense in the period that it is probable that the costs are no
longer realizable.
Convertible
Preferred Stock
The Company accounts for stock subject to provisions for
redemption outside of its control as mezzanine equity. These
securities are recorded at fair value at the date of issue and
are accreted to the minimum redemption amount at each balance
sheet date (see Note 6). The resulting increases in the
carrying amount of the redeemable stock are reflected through
decreases in additional paid-in capital or, in the absence of
additional paid-in capital, through accumulated deficit.
F-9
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Revenue
Recognition
The Company derives revenue from arrangements that include
products with embedded software, software licenses and
royalties, technical support, and professional services. Revenue
from products in the accompanying consolidated statements of
operations consists primarily of sales of software-based
appliances, but also includes fees and royalties for the license
of the Company’s technology in a software-only format and
subscriptions to receive rules released by the Company’s
Vulnerability Research Team (“VRT”) that are used to
update the appliances for current exploits and vulnerabilities.
Revenues derived from the non-product components of products
currently represent less than 10% of total “products”
revenue in the accompanying consolidated statements of
operations. Technical support, which typically has a term of 12
to 36 months, includes telephone and web-based support,
software updates, and rights to software upgrades on a
when-and-if-available
basis. Professional services include training and consulting.
For each arrangement, the Company defers revenue recognition
until: (a) persuasive evidence of an arrangement exists;
(b) delivery of the product has occurred and there are no
remaining obligations or substantive customer acceptance
provisions; (c) the fee is fixed or determinable; and
(d) collection of the fee is probable.
The Company allocates the total arrangement fee among each
deliverable based on the fair value of each of the deliverables,
determined based on vendor-specific objective evidence. If
vendor-specific objective evidence of fair value does not exist
for each of the deliverables, all revenue from the arrangement
is further deferred until the earlier of the point at which
sufficient vendor-specific objective evidence of fair value can
be determined or all elements of the arrangement have been
delivered. However, if the only undelivered elements are
technical support
and/or
professional services, elements for which the Company currently
has vendor specific objective evidence of fair value, the
Company recognizes revenue for the delivered elements based on
the residual method as prescribed by
SOP 98-9,
Modification of
SOP 97-2,
Software Revenue Recognition with Respect to Certain
Transactions. The Company has established vendor
specific objective evidence of fair value for its technical
support based upon actual renewals of technical support for each
type of technical support that is offered and for each customer
class. Technical support and technical support renewals are
currently priced based on a percentage of the list price of the
respective product or software and historically have not varied
from a narrow range of values in the substantial majority of the
Company’s arrangements. Revenue related to technical
support is deferred and recognized ratably over the contractual
period of the technical support arrangement, which ranges from
12 to 36 months in most arrangements.
The vendor specific objective evidence of fair value of the
Company’s other services is based on the price for these
same services when they are sold separately. Revenue for
services that are sold either on a stand-alone basis or included
in multiple element arrangements is deferred and recognized as
the services are performed.
All amounts billed or received in excess of the revenue
recognized are included in deferred revenue. In addition, the
Company defers all direct costs associated with revenue that has
been deferred. These amounts are included in either prepaid
expenses and other current assets or inventory in the
accompanying balance sheets, depending on the nature of the
costs and the reason for the deferral.
For sales through resellers and distributors, the Company
recognizes revenue upon the shipment of the product only if
those resellers and distributors provide the Company at the time
of placing their order with the identity of the end user
customer to whom it has been sold through. The Company does not
currently offer any rights to return products sold to resellers
and distributors. To the extent that a reseller or distributor
requests an inventory or stock of products, the Company defers
revenue on that product until it receives notification that it
has been sold through to an identified end user.
For the year ended December 31, 2004, the Company had one
significant reseller customer, which accounted for 11% of the
revenue recognized. For the years ended December 31, 2005
and 2006, the Company had no significant customers that
accounted for greater than 10% of the revenue recognized.
F-10
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Warranty
The Company warrants that its software will perform in
accordance with its documentation for a period of ninety days
from the date of shipment. Similarly, the Company warrants that
the hardware will perform in accordance with its documentation
for a period of one year from date of shipment. The Company
further agrees to repair or replace software or products that do
not conform to those warranties. The one year warranty on
hardware coincides with the hardware warranty that the Company
obtains from the manufacturer. The Company estimates the costs
that may be incurred under its warranties and records a
liability at the time product revenue is recognized. Factors
that affect the Company’s warranty liability include the
number of installed units, historical and anticipated rates of
warranty claims and the estimated cost per claim. The Company
periodically assesses the adequacy of its recorded warranty
liability and adjusts the amounts as necessary. While warranty
costs have historically been within management’s
expectations, it is possible that warranty rates will change in
the future based on new product introductions and other factors.
Commissions
The Company records commission expense for orders that include
products in the same period in which the product revenue is
recognized. The Company records commission expense for
arrangements that consist solely of service in the period in
which the non-cancelable order for the services is received.
Shipping
and Handling Costs
All amounts billed to customers related to shipping and handling
are included in product revenues and all costs of shipping and
handling are included in the cost of products in the
accompanying consolidated statements of operations.
Research
and Development Costs
Costs for the development of new software products and
substantial enhancements to existing software products are
expensed as research and development costs as incurred until
technological feasibility has been established, at which time
any additional development costs are capitalized until the
product is available for general release to customers. The
Company defines the establishment of technological feasibility
as the completion of a working model of the software product
that has been tested to be consistent with the product design
specifications and that is free of any uncertainties related to
known high-risk development issues. During the years ended
December 31, 2004, 2005 and 2006, the Company has not
capitalized any significant software development costs.
Advertising
Costs
The Company expenses advertising costs as
incurred. Advertising expense totaled $59,000, $27,000 and
$55,000 for the years ended December 31, 2004, 2005 and
2006, respectively.
Income
Taxes
The Company uses the liability method in accounting for income
taxes. Under this method, deferred tax assets and liabilities
are determined based on differences between the financial
reporting and tax basis of assets and liabilities and are
measured using the enacted tax rates and laws that will be in
effect when the differences are expected to reverse. A valuation
allowance is provided on deferred tax assets if it is determined
that it is more likely than not that the asset will not be
realized.
Stock-Based
Compensation
Prior to January 1, 2006, the Company accounted for
stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees
F-11
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
(“ABP No. 25”), and related interpretations.
Accordingly, compensation cost for stock options generally was
measured as the excess, if any, of the estimated fair value of
the Company’s common stock over the amount an employee must
pay to acquire the common stock on the date that both the
exercise price and the number of shares to be acquired pursuant
to the option are fixed. The Company had adopted the
disclosure-only provisions of Statement of Financial Accounting
Standard (“SFAS”) No. 123, Accounting for
Stock-Based Compensation
(“SFAS No. 123”) and
SFAS No. 148, Accounting for Stock-Based
Compensation — Transition and Disclosure
(“SFAS No. 148”), which was released in
December 2002 as an amendment to SFAS No. 123, and
used the minimum value method of valuing stock options as
allowed for non-public companies.
In December 2004, the Financial Accounting Standards Board
issued SFAS No. 123(R), Share-Based Payment
(“SFAS No. 123(R)”), which revised
SFAS No. 123 and supersedes the APB No. 25.
SFAS No. 123(R), focuses primarily on transactions in
which an entity obtains employee services in exchange for
share-based payments. Under SFAS No. 123(R), an entity
generally is required to measure the cost of employee services
received in exchange for an award of equity instruments based on
the grant-date fair value of the award, with such cost
recognized over the applicable requisite service period. In
addition, SFAS No. 123(R) requires an entity to
provide certain disclosures in order to assist in understanding
the nature of share-based payment transactions and the effects
of those transactions on the financial statements. The
provisions of SFAS No. 123(R) are required to be
applied as of the beginning of the first interim or annual
reporting period of the entity’s first fiscal year that
begins after December 15, 2005.
Effective January 1, 2006, the Company adopted the fair
value recognition provisions of SFAS No. 123(R) using
the prospective transition method, which requires the Company to
apply its provisions only to awards granted, modified,
repurchased or cancelled after the effective date. Under this
transition method, stock-based compensation expense recognized
beginning January 1, 2006 is based on the grant-date fair
value of stock awards granted or modified after January 1,
2006. As the Company had used the minimum value method for
valuing its stock options under the disclosure requirements of
SFAS No. 123, all options granted prior to
January 1, 2006 continue to be accounted for under APB
No. 25. Additionally, the pro forma disclosures that were
required under the original provisions of SFAS No. 123
are no longer provided for outstanding awards accounted for
under the intrinsic-value method of APB No. 25 beginning in
periods after the adoption of SFAS No. 123(R).
The following table summarizes the grants made by the Company
since January 1, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value of
|
|
|
|
|
|
|
Number of
|
|
|
Exercise Price of
|
|
|
Common
|
|
|
Intrinsic Value
|
|
Date of Grant
|
|
Options Granted
|
|
|
Options Granted
|
|
|
Stock
|
|
|
(if any)
|
|
|
January 2006
|
|
|
171,489
|
|
|
$
|
8.36
|
|
|
$
|
8.36
|
|
|
$
|
—
|
|
April
2006(1)
|
|
|
453,178
|
|
|
$
|
5.26
|
|
|
$
|
5.26
|
|
|
$
|
—
|
|
October 2006
|
|
|
399,603
|
|
|
$
|
9.48
|
|
|
$
|
9.48
|
|
|
$
|
—
|
|
November 2006
|
|
|
56,955
|
|
|
$
|
10.41
|
|
|
$
|
10.41
|
|
|
$
|
—
|
|
December 2006
|
|
|
38,484
|
|
|
$
|
11.34
|
|
|
$
|
11.34
|
|
|
$
|
—
|
|
|
|
|
(1) |
|
Includes 165,332 shares originally granted at an exercise
price of $8.36 per share that were cancelled and reissued
at an exercise price of $5.26 per share. |
The fair value of the Company’s common stock underlying
each stock option grant was estimated by the Company’s
board of directors and management using either the market
approach or the income approach, or a combination of both
approaches. The market approach uses direct comparisons to other
enterprises and their equity securities to estimate the fair
value of the common shares of privately-held companies. The
Company’s estimates of fair value using the market approach
considered guideline company valuations, including public
companies and acquisitions, which were discounted based on the
lack of marketability and the minority interest nature of the
F-12
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Company’s common stock. The income approach estimates the
fair value of the enterprise based on expectations of future
income and cash flows. Refer to Note 8 for further
information.
As a result of adopting SFAS No. 123(R) on
January 1, 2006, based on the estimated grant-date fair
value of employee stock options subsequently granted or
modified, the Company recognized aggregate compensation expense
of $703,000 for the year ended December 31, 2006. The
Company uses the Black-Scholes option pricing model to estimate
the fair value of granted stock options. The use of option
valuation models requires the input of highly subjective
assumptions, including the expected term and the expected stock
price volatility. However, the Company is currently a nonpublic
company without sufficient information available on which to
base a reasonable and supportable estimate of the expected
volatility of its share prices. Accordingly, the Company uses an
alternative method (defined as “calculated value”)
that incorporates each of the inputs required by
SFAS No. 123(R), with the exception of the expected
volatility of its stock. Rather than use the expected volatility
of the Company’s own stock, the Company has identified
similar public entities for which share price information is
available and has considered the historical volatility of those
entities’ share prices in estimating expected volatility.
Additionally, the Company has estimated the expected term of
granted options to be the weighted-average mid-point between the
vesting date and the end of the contractual term of an award, in
accordance with SEC Staff Accounting Bulletin No. 107.
The weighted-average estimated fair value of stock options
granted during the year ended December 31, 2006 was
$5.47 per share, calculated using the following weighted
average assumptions:
|
|
|
|
|
Average risk-free interest rate
|
|
|
4
|
.68%
|
Expected dividend yield
|
|
|
0
|
.0%
|
Expected useful life
|
|
|
6
|
.25 years
|
Expected volatility
|
|
|
77
|
.2%
|
The grant date fair value of options not yet recognized as
expense as of December 31, 2006 aggregated $3,389,000, net
of estimated forfeitures, which will be recognized using the
straight-line method over a weighted-average period of
approximately four years.
The Company’s net loss for the year ended December 31,
2006 is $703,000 higher than if the Company had continued to
account for stock-based compensation under APB No. 25.
Basic and diluted net loss per share for the year ended
December 31, 2006 would have been $0.21 lower if the
Company had not adopted SFAS No. 123(R).
The Company accounts for stock option grants to non-employees
who are not directors in accordance with
SFAS No. 123(R) and Emerging Issues Tax Free
(“EITF”) Issue
No. 96-18,
Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services, which require that the estimated fair
value of these instruments measured at the earlier of the
performance commitment date or the date at which performance is
complete be recognized as an expense ratably over the period in
which the related services are rendered. The Company determines
the fair value of these instruments using the Black-Scholes
option pricing model.
Net
Loss Attributable to Common Stockholders Per Share
Basic net loss attributable to common stockholders per share is
computed by dividing net loss attributable to common
stockholders by the weighted average number of common shares
outstanding for the period. Diluted net loss attributable to
common stockholders per share includes the potential dilution
that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock.
F-13
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following summarizes the potential outstanding common stock
of the Company as of the end of each period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
Options to purchase common stock
|
|
|
1,928,222
|
|
|
|
2,412,223
|
|
|
|
3,199,903
|
|
Shares of common stock into which
outstanding preferred stock would be convertible upon exercise
of preferred stock warrants
|
|
|
36,944
|
|
|
|
36,944
|
|
|
|
36,944
|
|
Shares of common stock into which
outstanding preferred stock is convertible
|
|
|
12,292,005
|
|
|
|
12,292,005
|
|
|
|
14,302,128
|
|
Unvested shares of restricted
common stock
|
|
|
290,160
|
|
|
|
75,448
|
|
|
|
27,709
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
14,547,331
|
|
|
|
14,816,620
|
|
|
|
17,566,684
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
If the outstanding options, warrants, unvested restricted stock,
and preferred stock were exercised or converted into common
stock, the result would be anti-dilutive. Accordingly, basic and
diluted net loss attributable to common stockholders per share
are identical for all periods presented in the accompanying
consolidated statements of operations.
The pro forma net loss per share is calculated by dividing the
pro forma net loss attributable to common stockholders by the
pro forma weighted average number of common shares outstanding
during the period. The pro forma weighted average number of
common shares assumes the conversion of the outstanding
Series A, Series B and Series C convertible
preferred stock into common stock on January 1, 2006 and
the conversion of the outstanding Series D convertible
preferred stock into common stock on the date of issuance. The
following details the computation of the unaudited pro forma net
loss per share for the year ended December 31, 2006
(dollars in thousands, except per share data):
|
|
|
|
|
Net loss
|
|
$
|
(932
|
)
|
Pro forma accretion of preferred
stock
|
|
|
—
|
|
|
|
|
|
|
Pro forma net loss attributable to
common stockholders
|
|
$
|
(932
|
)
|
|
|
|
|
|
Weighted average shares
calculation:
|
|
|
|
|
Basic and diluted weighted average
shares outstanding
|
|
|
3,389,527
|
|
Conversion of preferred stock
|
|
|
13,496,454
|
|
|
|
|
|
|
Pro forma basic and diluted
weighted average shares outstanding
|
|
|
16,885,981
|
|
|
|
|
|
|
Pro forma basic and diluted loss
attributable to common stockholders per share
|
|
$
|
(0.06
|
)
|
|
|
|
|
|
Fair
Value of Financial Instruments
The Company’s financial instruments consist primarily of
cash and cash equivalents,
held-to-maturity
investments, accounts receivable, accounts payable, and
long-term debt. The fair value of these financial instruments
approximates their carrying amounts reported in the consolidated
balance sheets.
Reclassifications
Where appropriate, certain amounts in the 2004 and 2005
financial statements have been reclassified to conform to the
2006 presentation.
F-14
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Recent
Account Pronouncements
On July 13, 2006, the Financial Accounting Standards Board
(“FASB”) issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes,
(“FIN 48”). FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with FASB
Statement No. 109, Accounting for Income
Taxes. FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected
to be taken in a tax return. FIN 48 also provides guidance
on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition.
FIN 48 is effective for fiscal years beginning after
December 15, 2006. The Company will adopt FIN 48 on
January 1, 2007. An enterprise is required to disclose the
cumulative effect of the change on retained earnings in the
statement of financial position as of the date of adoption and
such disclosure is required only in the year of adoption. The
Company is currently evaluating the effect FIN 48 will have
on the consolidated financial statements and related
disclosures, but does not believe that the impact will be
material to the consolidated financial statements taken as a
whole.
|
|
3.
|
Property
and Equipment
|
Property and equipment consists of the following (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
|
|
2005
|
|
|
2006
|
|
|
Furniture, fixtures and equipment
|
|
$
|
3,958
|
|
|
$
|
5,025
|
|
Leasehold improvements
|
|
|
766
|
|
|
|
969
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,724
|
|
|
|
5,994
|
|
Less accumulated depreciation and
amortization
|
|
|
2,202
|
|
|
|
3,448
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,522
|
|
|
$
|
2,546
|
|
|
|
|
|
|
|
|
|
|
F-15
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The significant components of the Company’s deferred tax
assets and liabilities are as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
|
|
2005
|
|
|
2006
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforward
|
|
$
|
9,650
|
|
|
$
|
9,721
|
|
Accrued expenses
|
|
|
101
|
|
|
|
127
|
|
Deferred rent
|
|
|
39
|
|
|
|
55
|
|
Deferred revenue
|
|
|
1,076
|
|
|
|
451
|
|
Allowance for doubtful accounts
|
|
|
46
|
|
|
|
62
|
|
Unearned compensation
|
|
|
—
|
|
|
|
292
|
|
Property and equipment
|
|
|
116
|
|
|
|
171
|
|
Other
|
|
|
1
|
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
11,029
|
|
|
|
10,890
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Unearned compensation
|
|
|
(7
|
)
|
|
|
—
|
|
Prepaid expenses
|
|
|
(285
|
)
|
|
|
(174
|
)
|
|
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
(292
|
)
|
|
|
(174
|
)
|
|
|
|
|
|
|
|
|
|
Net future income tax benefit
|
|
|
10,737
|
|
|
|
10,716
|
|
Valuation allowance for deferred
tax assets
|
|
|
(10,737
|
)
|
|
|
(10,716
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax asset
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
The Company has reported a net loss since inception. This loss
has not resulted in a reported tax benefit because of an
increase in the valuation allowance for deferred tax assets that
results from the inability to determine the realizability of
those assets. The Company’s provision for income taxes for
the year ended December 31, 2006 consists primarily of
foreign income taxes related to international operations
including those of Sourcefire Limited. Income before income
taxes of the Company’s foreign operations aggregated
approximately $92,000 for the year ended December 31, 2006.
Deferred income taxes were not provided on these undistributed
earnings aggregating $92,000 because such undistributed earnings
are expected to be indefinitely reinvested outside of the United
States. If these amounts were not considered permanently
reinvested, additional deferred taxes of approximately $14,000
would have been provided with an offsetting reduction in the
valuation allowance of $14,000.
At December 31, 2006, the Company has net operating loss
carryforwards of approximately $28,120,000 (including $806,000
of deduction related to stock option exercises) that will begin
to expire in 2022. The utilization of these net operating losses
could be limited by the Internal Revenue Code as a result of
certain ownership changes, including the issuance of equity
securities. The Company has not determined the annual amount of
the limitation on these net operating losses or whether these
net operating loss carryforwards will expire prior to use as a
result of these limitations. At December 31, 2006, $806,000
of deferred deductions related to stock option exercises have
been generated by the Company. The resulting benefit of
approximately $300,000 will be recorded to stockholders equity
when realized. The realization of these deductions is currently
offset by utilization of net operating losses. The Company has
state net operating loss carryforwards available that expire
through 2025. The utilization of state net operating losses will
be limited in a manner similar to the federal net operating loss
carryforwards. The
F-16
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Company has established a full valuation allowance with respect
to these federal and state loss carryforwards and other net
deferred tax assets due to uncertainties surrounding their
realization.
At December 31, 2006, the Company has a federal alternative
minimum tax (AMT) credit carryforward of $11,000. A valuation
allowance of $11,000 was recorded for the AMT credit. This
credit will not expire.
A reconciliation of the reported income tax expense to the
amount that would result by applying the U.S. federal
statutory rate to the loss for the years ended December 31
is as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
Tax benefit at U.S. statutory
rate of 34%
|
|
$
|
(3,596
|
)
|
|
$
|
(1,856
|
)
|
|
$
|
(294
|
)
|
Effect of permanent differences
|
|
|
28
|
|
|
|
(71
|
)
|
|
|
48
|
|
Effect of foreign income taxed a
different rate
|
|
|
—
|
|
|
|
—
|
|
|
|
11
|
|
State income taxes, net of federal
benefit
|
|
|
(245
|
)
|
|
|
(129
|
)
|
|
|
9
|
|
Effect of change in valuation
allowance for deferred tax assets
|
|
|
3,813
|
|
|
|
2,056
|
|
|
|
293
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In March 2005, the Company entered into an amended Loan and
Security Agreement with a bank under which it may borrow up to
$5 million under an Amended and Restated Revolving
Promissory Note and up to $1 million under a supplemental
equipment term note. Borrowings under the revolving promissory
note bear interest at the prime rate, as defined, plus
0.5% per annum. Interest on borrowings under the revolving
promissory note is payable monthly and all outstanding principal
is due on March 28, 2007. As of December 31, 2006, the
Company has no outstanding borrowings under the revolving
promissory note, but has issued a $201,000 standby letter of
credit which reduces the available borrowings under the
agreement.
The Company was able to make borrowings under the supplemental
equipment term note through March 31, 2006 and such
borrowings bear interest, at the option of the Company, at the
prime rate, plus 1.0% per annum, or a fixed rate of
7.0% per annum. Borrowings under the equipment term notes
are payable in equal monthly payments of principal plus accrued
interest over terms ranging from 30 to 36 months. The
Company is also able to make borrowings under a prior equipment
term loan facility through September 30, 2004 and such
borrowings bear interest, at the option of the Company, at the
prime rate, plus 1.5% per annum or a fixed rate ranging
from 6.5% to 7.0% per annum. Borrowings under these
equipment term notes are payable in equal monthly payments of
principal plus accrued interest over terms ranging from 24 to
30 months.
In June 2005 and August 2005, the Company entered into
additional amendments to the Loan and Security Agreement with
the bank to modify certain financial covenants related to the
agreement.
In July 2006, the Company entered into an amended Loan and
Security Agreement with its bank under which it may borrow up to
an additional $1 million under a second supplemental
equipment term note. The Company was able to make borrowings
under the supplemental equipment term note through
January 31, 2007 and such borrowings bear interest, at the
option of the Company, at the prime rate, plus 0.5% per
annum, or a fixed rate of 9.0% per annum. Borrowings under
the second supplemental equipment term note are payable in equal
monthly payments of principal plus accrued interest over a
36 month period. In connection with this amendment,
borrowings under the revolving promissory note will bear
interest at the prime rate during any period where the Company
has maintained EBITDA (as defined) of at least $1.00 for the
prior three consecutive calendar month period.
F-17
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Borrowings outstanding under the equipment term notes consisted
of the following as of December 31 (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
2006
|
|
|
Notes payable initially dated
May 28, 2004, as amended, bearing interest at 6.5% and due
from May 1, 2006 through November 1, 2006. Monthly
payments ranging from $1 to $6 are due under these notes
|
|
$
|
61
|
|
|
$
|
—
|
|
Notes payable initially dated
August 5, 2004, as amended, bearing interest at 6.5% and
due from August 1, 2006 through February 1, 2007.
Monthly payments of $3 are due under these notes
|
|
|
59
|
|
|
|
6
|
|
Notes payable initially dated
September 27, 2004, as amended, bearing interest at 6.5%
and due from September 1, 2006 through March 1, 2007.
Monthly payments of $4 are due under these notes
|
|
|
61
|
|
|
|
12
|
|
Notes payable initially dated
June 1, 2005, bearing interest at 7.0% and due from
November 1, 2007 through May 1, 2008. Monthly payments
of $31 are due under these notes through November 2007 and $16
thereafter through May 2008
|
|
|
749
|
|
|
|
420
|
|
Note payable initially dated
September 1, 2005, bearing interest at 7.0% and due
August 1, 2008. Monthly payments of $2 are due under this
note
|
|
|
60
|
|
|
|
38
|
|
Note payable initially dated
August 14, 2006, bearing interest at prime plus 0.5% (8.75%
at December 31, 2006) and due August 1, 2009.
Monthly principal payments of $11 plus accrued interest are due
under this note
|
|
|
—
|
|
|
|
341
|
|
Note payable initially dated
October 30, 2006, bearing interest at prime plus 0.5%
(8.75% at December 31, 2006) and due October 1,
2009. Monthly principal payments of $4 plus accrued interest are
due under this note
|
|
|
—
|
|
|
|
148
|
|
Note payable initially dated
December 22, 2006, bearing interest at prime plus 0.5%
(8.75% at December 31, 2006) and due December 1,
2009. Monthly principal payments of $10 plus accrued interest
are due under this note
|
|
|
—
|
|
|
|
347
|
|
|
|
|
|
|
|
|
|
|
|
|
|
990
|
|
|
|
1,312
|
|
Less current portion
|
|
|
(514
|
)
|
|
|
(675
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
476
|
|
|
$
|
637
|
|
|
|
|
|
|
|
|
|
|
Aggregate maturities as of December 31, 2006 of the
Company’s long-term debt for the years ending
December 31 are as follows (dollars in thousands):
|
|
|
|
|
2007
|
|
$
|
675
|
|
2008
|
|
|
392
|
|
2009
|
|
|
245
|
|
|
|
|
|
|
|
|
$
|
1,312
|
|
|
|
|
|
|
Borrowings under the Loan and Security Agreement are secured by
all of the assets of the Company, excluding certain intellectual
property. However, the Company has agreed not to sell, transfer,
or otherwise encumber such intellectual property without the
prior written consent of the bank. Additionally, the Company is
required to comply with certain financial and non-financial
covenants.
In November 2002, in connection with the Loan and Security
Agreement, the Company issued warrants to purchase
14,754 shares of Series A convertible preferred stock
at an exercise price of $3.05 per share that were
immediately exercisable and expire on November 28, 2009.
The estimated value of the warrants of approximately
F-18
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
$15,000 has been recorded as a mezzanine security and deferred
financing costs, which is included in other assets in the
accompanying balance sheets. The Company amortized these
deferred financing costs using the straight-line method over a
three-year period, and such amortization has been included in
interest expense. These warrants remain outstanding as of
December 31, 2006.
In November 2003, in connection with the First Amendment to the
Loan and Security Agreement, the Company issued warrants to
purchase 5,246 shares of Series A convertible
preferred stock at an exercise price of $3.05 per share
that were immediately exercisable and expire on November 2,
2010. The estimated value of the warrants of approximately
$10,000 has been recorded as a mezzanine security and deferred
financing costs, which is included in other assets in the
accompanying balance sheets. The Company amortized these
deferred financing costs using the straight-line method over a
three-year period, and such amortization has been included in
interest expense. These warrants remain outstanding as of
December 31, 2006.
|
|
6.
|
Convertible
Preferred Stock
|
In February and June of 2002, the Company issued a total of
2,475,410 shares of Series A convertible preferred
stock (“Series A”) for $3.05 per share
(“Series A original issue price”). In February
2003, the Company issued a total of 7,132,205 shares of
Series B convertible preferred stock
(“Series B”) for $1.5423 per share
(“Series B original issue price”). In January
2004, the Company issued a total of 5,404,043 shares of
Series C convertible preferred stock
(“Series C”) for $2.7757 per share
(“Series C original issue price”). In May and
June of 2006, the Company issued a total of
3,264,449 shares of Series D convertible preferred
stock (“Series D”) for $7.0456 per share
(“Series D original issue price”).
Holders of the Series A, B, C, and D are entitled to
receive, when and as declared by the Board of Directors,
cumulative dividends per share equal to the sum of
(i) 8% per annum of the Series A, B, C and D
original issue price, and (ii) to the extent that a
dividend is paid to the holders of common stock, the amount such
holders would have received had the Series A, B, C and D
been converted into common stock immediately prior to the
distribution. The dividends on the Series A, B, C and D are
cumulative and continue to accrue whether or not declared.
Dividends in arrears on the Series A were $2,164,000 and
$2,768,000 at December 31, 2005 and 2006, respectively.
Dividends in arrears on the Series B were $2,567,000 and
$3,447,000 at December 31, 2005 and 2006, respectively.
Dividends in arrears on the Series C were $2,350,000 and
$3,550,000 at December 31, 2005 and 2006, respectively.
Dividends in arrears on the Series D were $1,097,000 at
December 31, 2006.
In the event of liquidation, dissolution or winding up of the
Company, holders of the Series A are entitled to receive a
liquidation preference equal to $4.575 per share, holders
of the Series B are entitled to receive a liquidation
preference equal to $2.313 per share, holders of the
Series C are entitled to receive a liquidation preference
equal to $4.164 per share, and holders of the Series D
are entitled to receive a liquidation preference equal to
$8.807 per share, plus any declared
and/or
accrued but unpaid dividends. After payment of the
Series A, B, C, and D liquidation preference and payments
to any other classes of stock entitled to participate in
liquidation distributions, any remaining funds will be
distributed pro rata to all shareholders assuming that all
classes of stock were converted into common stock.
Each share of the Series A, B, C, and D has substantially
the same voting rights as the number of shares of common stock
into which it can be converted. In addition, certain corporate
actions require the consent of a majority of the outstanding
shares of the Series A, B, C, and D. The holders of the
Series A and the Series B are each entitled to appoint
one member of the Board of Directors.
The Series A, B, C, and D are convertible into common stock
at the option of the holder at any time. In addition, the
Series A, B, C, and D will convert automatically into
shares of common stock upon the closing of an underwritten
public offering with a price per share of at least 2.436 times
the Series D original issue price and resulting in at least
$40 million of gross proceeds to the Company. Each share of
Series A is initially convertible into approximately
1.85 shares of common stock. Each share of Series B,
C, and D are initially convertible into
F-19
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
approximately 0.62 shares of common stock. This conversion
ratio is subject to adjustment upon the occurrence of certain
specified dilutive events.
The Series A, B, C, and D are redeemable, at the option of
the holders, at any time after the fifth anniversary of the date
of issuance, at a price equal to the greater of (a) the
Series A original issue price in the case of the
Series A, the Series B original issue price in the
case of the Series B, the Series C original issue
price in the case of the Series C, and the Series D
original issue price in the case of the Series D, plus any
declared
and/or
accrued but unpaid dividends or (b) the fair market value
of such shares, which shall be determined in good faith by the
Board of Directors. As a result of the redemption feature
outside the control of the Company, the Series A, B, C, and
D have been excluded from stockholders’ deficit in the
accompanying balance sheets.
The carrying amount of the Series A securities is being
accreted to the minimum redemption value of $7,550,000 plus
unpaid cumulative dividends using the effective interest method
through charges to additional paid-in capital or
stockholders’ deficit. This minimum redemption value is
expected to total $10,570,000. The accretion period is from the
date of issuance of the Series A to February 2007 for
672,131 shares and to June 2007 for 1,803,279 shares,
the earliest dates at which these securities become redeemable
at the option of the holder.
The carrying amount of the Series B securities is being
accreted to the minimum redemption value of $11,000,000 plus
unpaid cumulative dividends using the effective interest method
through charges to additional paid-in capital or
stockholders’ deficit. This minimum redemption value is
expected to total $15,400,000. The accretion period is from the
date of issuance of the Series B to February 2008, the
earliest date at which these securities become redeemable at the
option of the holder.
The carrying amount of the Series C securities is being
accreted to the minimum redemption value of $15,000,000 plus
unpaid cumulative dividends using the effective interest method
through charges to additional paid-in capital or
stockholders’ deficit. This minimum redemption value is
expected to total $21,000,000. The accretion period is from the
date of issuance of the Series C to January 2009, the
earliest date at which these securities become redeemable at the
option of the holder.
The carrying amount of the Series D securities is being
accreted to the minimum redemption value of $23,000,000 plus
unpaid cumulative dividends using the effective interest method
through charges to additional paid-in capital or
stockholders’ deficit. This minimum redemption value is
expected to total $32,200,000. The accretion period is from the
date of issuance of the Series D to May 2011 for
2,973,485 shares and to June 2011 for 290,964 shares,
the earliest dates at which these securities become redeemable
at the option of the holder.
The minimum redemption value is being used for the
Series A, B, C, and D since the fair market value of the
instruments is not readily determinable; however, if fair market
values at the redemption dates exceed the minimum redemption
values, the redemption values will exceed the carrying values at
the redemption dates.
|
|
7.
|
Restricted
Common Stock
|
In February 2002, the Company and its founders entered into a
Restricted Stock Agreement that grants the Company the option to
repurchase the 1,662,561 shares of common stock held by the
founders upon termination of their employment, and restricts the
founders’ ability to transfer their shares of common stock.
The repurchase price per share is $0.24, which represented the
estimated fair value of the common stock at the date of
issuance. The shares vest and are no longer subject to the
restriction agreement as follows: (a) 50% at the date of
the agreement; and (b) 16.68% on each of the three
successive anniversaries of the date of the agreement. As of
December 31, 2005, these shares were no longer subject to
repurchase.
The Company also issued 559,729 and 312,192 shares of
common stock subject to repurchase during June 2002 and November
2002, respectively, to certain employees. The Company has the
right to repurchase the shares of common stock in the event of
the termination of the employee for cause or the resignation of
the employee without good reason. The repurchase price per share
is $0.24, which represented the estimated fair value of the
F-20
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
common stock on the date of issuance. The shares vest, and are
no longer subject to the restriction, in 12 equal quarterly
installments. The vesting is subject to acceleration upon a
change of control and under certain other circumstances. The
Company measured compensation expense for these awards using the
intrinsic value method and recorded unearned compensation of
$212,000, which has been amortized over the vesting period. As
of December 31, 2005, these shares were no longer subject
to repurchase.
In December 2003, the Company issued 193,965 shares of
common stock subject to repurchase to certain employees. The
Company has the right to repurchase the shares of common stock
in the event of the termination of the employee for cause or the
resignation of the employee without good reason. The repurchase
price per share is $0.325, which represented the estimated fair
value of the common stock on the date of issuance. The shares
vest, and are no longer subject to the restriction on the third
anniversary of the vesting start date. The vesting is subject to
acceleration upon a change of control and under certain other
circumstances. The Company measured compensation expense for
these awards using the intrinsic value method and recorded
unearned compensation of $20,000 which has been amortized over
the vesting period. As of December 31, 2006, these shares
are no longer subject to repurchase.
In July and August 2006, the Company issued 15,394 and
12,315 shares of common stock, respectively, subject to
repurchase to certain directors. The Company has the right to
repurchase the shares of common stock in the event of the
termination of the director for cause. The repurchase price per
share is $7.63, which represented the estimated fair value of
the common stock on the date of issuance. The shares vest, and
are no longer subject to the restriction on the earlier of
(a) consummation of a firm commitment underwritten public
offering of our common stock, along with the expiration of any
applicable
lock-up
agreements; (b) a change of control; or (c) on the
second anniversary of the vesting start date. The Company has
measured aggregate compensation expense for these awards of
$212,000 based on the estimated fair value of the common stock
on the date of grant and is recognizing it ratably over the
estimated vesting period.
During 2002, the Company adopted the Sourcefire, Inc. 2002 Stock
Incentive Plan. The plan provides for the granting of
equity-based awards, including stock options, restricted or
unrestricted stock awards, and stock appreciation rights to
employees, officers, directors, and other individuals as
determined by the Board of Directors. The Company has reserved
5,100,841 shares of common stock under the plan.
The plan administrator determines the vesting period for awards
under the plan, which generally ranges from three to four years,
and options granted have a maximum term of 10 years. The
exercise price of the awards is equal to or greater than the
fair value of the common stock as estimated by the Board of
Directors on the date of grant. In estimating the fair value of
the Company’s common stock at the grant date, the Board of
Directors considers contemporaneous valuations, significant
transactions with independent investors in the Company, relative
rights and preferences retained by preferred shareholders of the
Company compared to those of the common stockholders, market
data received from investment banks regarding private company
merger and acquisition transactions and public company
comparables, the Company’s financial results and execution
against its financial operating plan, new customer penetration,
product development milestones and other relevant factors.
F-21
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following table summarizes the activity of the plan (dollars
in thousands, expect per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
Number of
|
|
|
Range of
|
|
|
Exercise
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Exercise Prices
|
|
|
Price
|
|
|
Value
|
|
|
Outstanding at January 1, 2004
|
|
|
1,669,529
|
|
|
$
|
0.24 to $0.32
|
|
|
$
|
0.29
|
|
|
|
|
|
Granted
|
|
|
829,078
|
|
|
$
|
1.14 to $1.62
|
|
|
$
|
1.22
|
|
|
|
|
|
Exercised
|
|
|
(250,765
|
)
|
|
$
|
0.24 to $1.14
|
|
|
$
|
0.31
|
|
|
|
|
|
Forfeited
|
|
|
(319,620
|
)
|
|
$
|
0.24 to $1.14
|
|
|
$
|
0.55
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31,
2004
|
|
|
1,928,222
|
|
|
$
|
0.24 to $1.62
|
|
|
$
|
0.63
|
|
|
|
|
|
Granted
|
|
|
858,016
|
|
|
$
|
1.62 to $8.36
|
|
|
$
|
2.13
|
|
|
|
|
|
Exercised
|
|
|
(114,800
|
)
|
|
$
|
0.24 to $1.62
|
|
|
$
|
0.50
|
|
|
|
|
|
Forfeited
|
|
|
(259,215
|
)
|
|
$
|
0.24 to $3.69
|
|
|
$
|
1.49
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31,
2005
|
|
|
2,412,223
|
|
|
$
|
0.24 to $8.36
|
|
|
$
|
1.09
|
|
|
|
|
|
Granted
|
|
|
1,119,709
|
|
|
$
|
5.26 to $11.34
|
|
|
$
|
7.71
|
|
|
|
|
|
Exercised
|
|
|
(84,082
|
)
|
|
$
|
0.32 to $2.03
|
|
|
$
|
1.71
|
|
|
|
|
|
Forfeited
|
|
|
(247,947
|
)
|
|
$
|
0.24 to $8.36
|
|
|
$
|
6.72
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31,
2006
|
|
|
3,199,903
|
|
|
$
|
0.24 to $11.34
|
|
|
$
|
2.96
|
|
|
$
|
26,839
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31,
2006
|
|
|
1,706,998
|
|
|
$
|
0.24 to $5.26
|
|
|
$
|
0.97
|
|
|
$
|
17,665
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest at
December 31, 2006
|
|
|
2,975,967
|
|
|
|
|
|
|
$
|
1.58
|
|
|
$
|
25,462
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The total intrinsic value of options exercised during the year
ended December 31, 2006 was $362,000.
The following table summarizes information about stock options
outstanding at December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
|
Options Exercisable
|
|
|
|
|
|
|
Weighted
|
|
|
Weighted Average
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
|
|
|
Average
|
|
|
|
Number of
|
|
|
Exercise
|
|
|
Contractual Life
|
|
|
Number of
|
|
|
Exercise
|
|
Range of Exercise
Prices
|
|
Shares
|
|
|
Prices
|
|
|
(Years)
|
|
|
Shares
|
|
|
Prices
|
|
|
$0.24 - $0.32
|
|
|
1,045,518
|
|
|
$
|
0.29
|
|
|
|
6.3
|
|
|
|
974,070
|
|
|
$
|
0.28
|
|
$1.14 - $2.03
|
|
|
1,208,936
|
|
|
$
|
1.63
|
|
|
|
7.9
|
|
|
|
651,045
|
|
|
$
|
1.52
|
|
$3.69 - $11.34
|
|
|
945,449
|
|
|
$
|
7.58
|
|
|
|
9.6
|
|
|
|
81,883
|
|
|
$
|
5.17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,199,903
|
|
|
$
|
2.95
|
|
|
|
7.9
|
|
|
|
1,706,998
|
|
|
$
|
0.99
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In 2005, the Company modified certain employee options after the
grant date to accelerate vesting upon termination of employment.
The Company measured compensation expense for these
modifications using the difference between the estimated fair
market value of the underlying common stock at the date of
modification and the option strike price and recorded non-cash
compensation expense of $406,000 which has been included in
general and administrative expense in the accompanying
consolidated statement of operations. In April 2006, the Company
exchanged certain employee options granted in 2005 and 2006 with
an exercise price of $8.36 per share for new options with a
reduced exercise price of $5.26 per share. The Company
measured compensation expense for
F-22
SOURCEFIRE,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
these modifications as the excess of the fair value of the
modified share options issued over the fair value of the
original share options at the date of the exchange. The measured
compensation expense aggregated approximately $44,000 and is
being recognized over the vesting period of the options.
|
|
9.
|
Shares Reserved
for Future Issuance
|
As of December 31, 2006, the Company has reserved shares of
common stock for issuance as follows:
|
|
|
|
|
Conversion of Series A
|
|
|
4,572,647
|
|
Exercise of Series A warrants
and conversion of Series A shares to common stock
|
|
|
36,944
|
|
Conversion of Series B
|
|
|
4,391,748
|
|
Conversion of Series C
|
|
|
3,327,610
|
|
Conversion of Series D
|
|
|
2,010,123
|
|
Exercise of outstanding stock
options
|
|
|
3,199,903
|
|
Vesting of restricted common stock
|
|
|
27,709
|
|
Stock options available for
granting as reserved by the Board of Directors
|
|
|
181,934
|
|
|
|
|
|
|
|
|
|
17,748,618
|
|
|
|
|
|
|
The Company leases office space and certain network, lab and
office equipment under noncancelable operating lease agreements.
Future minimum payments under noncancelable operating leases
with initial terms of one year or more consisted of the
following at December 31, 2006 (dollars in thousands):
|
|
|
|
|
2007
|
|
$
|
1,576
|
|
2008
|
|
|
1,374
|
|
2009
|
|
|
1,230
|
|
2010
|
|
|
800
|
|
2011
|
|
|
490
|
|
2012 and thereafter
|
|
|
41
|
|
|
|
|
|
|
|
|
$
|
5,511
|
|
|
|
|
|
|
Rent expense totaled $399,000, $662,000 and $1,453,000 for the
years ended December 31, 2004, 2005 and 2006, respectively.
|
|
11.
|
Business
and Geographic Segment Information
|
The Company manages its operations on a consolidated basis for
purposes of assessing performance and making operating
decisions. Accordingly, the Company does not have reportable
segments of its business.
Revenues by geographic area for the years ended December 31
are as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
United States
|
|
$
|
13,632
|
|
|
$
|
27,027
|
|
|
$
|
36,598
|
|
All foreign countries
|
|
|
3,061
|
|
|
|
5,852
|
|
|
|
8,328
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated total
|
|
$
|
16,693
|
|
|
$
|
32,879
|
|
|
$
|
44,926
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-23
|
|
12.
|
Defined
Contribution Retirement Plan
|
The Company sponsors a defined contribution retirement plan
under section 401(k) of the Internal Revenue Code. The
provisions of this plan allow for voluntary employee
contributions of up to 75% of an employee’s salary but not
exceeding the Federal limit of $15,000, subject to certain
annual limitations. The Company does not currently make matching
contributions.
|
|
13.
|
Commitments
and Contingencies
|
The Company is subject to legal actions arising in the ordinary
course of its business. In management’s opinion, the
Company has adequate legal defenses with respect to the
eventuality of such actions and does not believe any settlement
would materially affect the Company’s financial position.
On April 20, 2006, a lawsuit was filed against the Company
by PredatorWatch Inc. (now named NetClarity) in the Superior
Court for Suffolk County, Massachusetts. The complaint alleges
that the Company: (i) misappropriated and incorporated the
plaintiff’s trade secrets into the Company’s RNA
technology; (ii) breached an oral agreement of
confidentiality; (iii) breached a covenant of good faith
and fair dealing owed to the plaintiff; (iv) was unjustly
enriched; (v) misrepresented certain material facts to the
plaintiff, upon which the plaintiff relied to its detriment; and
(vi) engaged in unfair and deceptive acts in violation of
Massachusetts state law. The plaintiff has sought to recover
amounts yet to be ascertained and established, as well as
damages and attorney’s fees. The Company intends to defend
this matter vigorously. Because the Company is still in the
early stages of discovery and because the plaintiff has yet to
specify the amount of any purported damages, the Company has not
accrued for any damages or settlement of this matter.
The Company has entered into a purchase commitment with a
hardware manufacturing vendor with whom it has a current
arrangement. Under the terms of this commitment, the Company has
agreed to purchase a set quantity of new appliance inventory
over an
18-month
period. The approximate value of the purchase commitment is
$800,000.
The Company has entered into a purchase commitment with vendor
to license database software that is used in the Company’s
products. Under the terms of the commitment, the Company is
permitted to distribute the vendor’s software in the
Company’s products through December 31, 2010 in
exchange for an up front payment, plus annual maintenance fees.
The approximate aggregate value of the purchase commitment is
$855,000, which was paid in January 2007.
14. Subsequent
Event
In February 2007, the Company effected a 1-for-1.624 reverse
split of common stock. Accordingly, all share and per share
amounts have been retroactively adjusted to give effect to this
event.
F-24
PART II
INFORMATION
NOT REQUIRED IN THE PROSPECTUS
|
|
Item 13.
|
Other
Expenses of Issuance and Distribution
|
Set forth below is a table of the registration fee for the
Securities and Exchange Commission, the filing fee for the
National Association of Securities Dealers, Inc., the listing
fee for the Nasdaq Global Market and estimates of all other
expenses to be incurred in connection with the issuance and
distribution of the securities described in the registration
statement, other than underwriting discounts and commissions:
|
|
|
|
|
SEC registration fee
|
|
$
|
8,025
|
|
NASD filing fee
|
|
|
9,790
|
|
Nasdaq Global Market listing fee
|
|
|
5,000
|
|
Printing and engraving expenses
|
|
|
350,000
|
|
Legal fees and expenses
|
|
|
1,200,000
|
|
Accounting fees and expenses
|
|
|
650,000
|
|
Transfer agent and registrar fees
|
|
|
2,500
|
|
Miscellaneous
|
|
|
224,685
|
|
|
|
|
|
|
Total
|
|
$
|
2,450,000
|
|
|
|
|
|
|
|
|
Item 14.
|
Indemnification
of Directors and Officers
|
Sourcefire is incorporated under the laws of the State of
Delaware. Reference is made to Section 102(b)(7) of the
Delaware General Corporation Law, or DGCL, which enables a
corporation in its original certificate of incorporation or an
amendment thereto to eliminate or limit the personal liability
of a director for violations of the director’s fiduciary
duty, except (1) for any breach of the director’s duty
of loyalty to the corporation or its stockholders, (2) for
acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (3) pursuant to
Section 174 of the DGCL, which provides for liability of
directors for unlawful payments of dividends of unlawful stock
purchase or redemptions, or (4) for any transaction from
which a director derived an improper personal benefit.
Reference is also made to Section 145 of the DGCL, which
provides that a corporation may indemnify any person, including
an officer or director, who is, or is threatened to be made,
party to any threatened, pending or completed legal action, suit
or proceeding, whether civil, criminal, administrative or
investigative, other than an action by or in the right of such
corporation, by reason of the fact that such person was an
officer, director, employee or agent of such corporation or is
or was serving at the request of such corporation as a director,
officer, employee or agent of another corporation or enterprise.
The indemnity may include expenses (including attorneys’
fees), judgments, fines and amounts paid in settlement actually
and reasonably incurred by such person in connection with such
action, suit or proceeding, provided such officer, director,
employee or agent acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the
corporation’s best interest and, for criminal proceedings,
had no reasonable cause to believe that his conduct was
unlawful. A Delaware corporation may indemnify any officer or
director in an action by or in the right of the corporation
under the same conditions, except that no indemnification is
permitted without judicial approval if the officer or director
is adjudged to be liable to the corporation. Where an officer or
director is successful on the merits or otherwise in the defense
of any action referred to above, the corporation must indemnify
him against the expenses that such officer or director actually
and reasonably incurred.
|
|
Item 15.
|
Recent
Sales of Unregistered Securities
|
1. In September 2006, pursuant to the Sourcefire, Inc. 2002
Stock Incentive Plan, as amended, we issued 12,315 shares
of restricted common stock to Steven R. Polk at a price per
share of $0.001624.
II-1
2. In August 2006, pursuant to the Sourcefire, Inc. 2002
Stock Incentive Plan, as amended, we issued 15,394 shares
of restricted common stock to Joseph R. Chinnici at a price per
share of $0.001624.
3. In May and June 2006, we issued 3,264,449 shares of
Series D convertible preferred stock to accredited
investors at a price per share of $7.0456.
4. In January 2004, we issued 5,404,043 shares of
Series C convertible preferred stock to accredited
investors at a price per share of $2.7757.
5. In December 2004, we issued 98,522 shares of common
stock to Asheem Chandna at a price per share of $0.32 pursuant
to a stock option exercise under the Sourcefire, Inc. 2002 Stock
Incentive Plan, as amended.
6. Since January 2004, we have issued an aggregate of
449,647 shares of common stock to employees and former
employees pursuant to stock option exercises under the
Sourcefire, Inc. 2002 Stock Incentive Plan, as amended. The
purchase price per share for such option exercises ranged from
$0.24 per share to $2.03 per share.
7. Since January 2004, we have granted options to purchase
an aggregate of 2,806,803 shares of common stock under the
Sourcefire, Inc. 2002 Stock Incentive Plan, as amended, to
employees, consultants and directors with exercise prices
ranging from $1.14 per share to $11.34 per share.
None of the foregoing transactions involved any underwriters,
underwriting discounts or commissions, or any public offering.
We believe the offers, sales and issuances of the securities
described above were exempt from registration under the
Securities Act of 1933 by virtue of Rule 506 of
Regulation D promulgated thereunder because the issuance of
securities to the recipients did not involve a public offering
or in reliance on Rule 701 because the transactions were
pursuant to compensatory benefit plans or contracts relating to
compensation as provided under such rule. The recipients of
securities under compensatory benefit plans and contracts
relating to compensation were our employees, directors or bona
fide consultants and received the securities as compensation for
services. Appropriate legends have been affixed to the
securities issued in these transactions. Each of the recipients
of securities in these transactions had adequate access, through
employment, business or other relationships, to information
about us. When we have relied on Rule 506 of
Regulation D promulgated under the Securities Act of 1933,
the investors in unregistered securities have been accredited
investors.
|
|
Item 16.
|
Exhibits
and Financial Statement Schedule
|
(a) Exhibits
|
|
|
|
|
Exhibit No.
|
|
Description of
Exhibit
|
|
|
1
|
.1**
|
|
Form of Underwriting Agreement
|
|
3
|
.1**
|
|
Fifth Amended and Restated
Certificate of Incorporation of Sourcefire, Inc.
|
|
3
|
.2*
|
|
Form of Sixth Amended and Restated
Certificate of Incorporation of Sourcefire, Inc.
|
|
3
|
.3**
|
|
Third Amended and Restated Bylaws
of Sourcefire, Inc.
|
|
3
|
.4*
|
|
Form of Fourth Amended and
Restated Bylaws of Sourcefire, Inc.
|
|
3
|
.5**
|
|
Certificate of Amendment to the
Fifth Amended and Restated Certificate of Incorporation
|
|
4
|
.1*
|
|
Form of stock certificate of
common stock
|
|
4
|
.2**
|
|
2002 Stock Incentive Plan
|
|
4
|
.3
|
|
2007 Stock Incentive Plan
|
|
4
|
.4**
|
|
Form of Nonstatutory Stock Option
Grant Agreement under the 2002 Stock Incentive Plan
|
|
4
|
.5
|
|
Form of Notice of Stock Option
Award under the 2007 Stock Incentive Plan
|
|
4
|
.6
|
|
Form of Notice of Restricted Stock
Purchase Award under the 2007 Stock Incentive Plan
|
|
4
|
.7
|
|
Form of Notice of Restricted Stock
Purchase Award for Non-Employee Directors under the 2007 Stock
Incentive Plan
|
|
5
|
.1**
|
|
Opinion of Morrison &
Foerster LLP
|
|
10
|
.1**
|
|
Fourth Amended and Restated
Investor Rights Agreement
|
|
10
|
.2**
|
|
Fourth Amended and Restated Right
of First Refusal and Co-Sale Agreement
|
II-2
|
|
|
|
|
Exhibit No.
|
|
Description of
Exhibit
|
|
|
10
|
.3**
|
|
Fourth Amended and Restated
Stockholders’ Voting Agreement
|
|
10
|
.4**
|
|
Employment Agreement of E. Wayne
Jackson, III
|
|
10
|
.5**
|
|
Employment Agreement of Thomas M.
McDonough
|
|
10
|
.6**
|
|
Employment Agreement of Martin F.
Roesch
|
|
10
|
.7**
|
|
Employment Agreement of Todd P.
Headley
|
|
10
|
.8**
|
|
Employment Agreement of Michele M.
Perry-Boucher
|
|
10
|
.9**
|
|
Loan and Security Agreement by and
between Sourcefire, Inc. and Silicon Valley Bank
|
|
10
|
.10**
|
|
Lease Agreement by and between
Liberty Property LP and Sourcefire, Inc.
|
|
10
|
.11†**
|
|
OEM and Distributor Agreement by
and between Sourcefire, Inc. and Nokia Inc., dated July 14,
2006, as amended on July 14, 2006
|
|
10
|
.12†**
|
|
Manufacturing Services and Supply
Agreement by and between Patriot Technologies, Inc. and
Sourcefire, Inc., dated December 12, 2005, as amended on
August 4, 2006
|
|
10
|
.13†**
|
|
Outsourcing Agreement by and
between Sourcefire, Inc. and Intelligent Decisions, Inc., dated
January 31, 2006
|
|
10
|
.14†**
|
|
OEM Purchase Agreement by and
between Bivio Networks, Inc. and Sourcefire, Inc., dated
February 10, 2005
|
|
10
|
.15†**
|
|
License Agreement for Commercial
Use of MySQL Software by and between MySQL Inc. and Sourcefire,
Inc., dated June 13, 2005, as amended on December 29, 2006
|
|
10
|
.16**
|
|
Employment Agreement of Joseph M.
Boyle
|
|
10
|
.17**
|
|
Written Consent in Lieu of a
Special Meeting of the Preferred Stockholders of Sourcefire,
Inc., dated October 25, 2006
|
|
10
|
.18
|
|
Form of Indemnification Agreement
|
|
23
|
.1**
|
|
Consent of Ernst & Young
LLP
|
|
23
|
.2**
|
|
Consent of Morrison &
Foerster LLP (included in Exhibit 5.1)
|
|
24
|
.1**
|
|
Power of Attorney (included in
signature pages to Registration Statement on Form S-1,
filed October 25, 2006)
|
|
24
|
.2**
|
|
Power of Attorney (included in
signature pages to Amendment No. 4 to Registration
Statement on
Form S-1,
filed February 14, 2007)
|
|
|
|
*
|
|
To be filed by Amendment.
|
**
|
|
Previously filed.
|
†
|
|
Portions of this exhibit have been
omitted and were filed separately with the Securities and
Exchange Commission pursuant to the Registrant’s
application requesting confidential treatment under
Rule 406 of the Securities Act.
|
(b) Financial Statement Schedules:
Schedules have been omitted because the information required to
be shown in the schedules is not applicable or is included
elsewhere in our financial statements or accompanying notes.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 (the “Securities Act”) may be
permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise,
the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is,
therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment
by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in
connection with the securities being
II-3
registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question
whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the
final adjudication of such issues.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the
Securities Act, the information omitted from the form of
prospectus filed as part of this registration statement in
reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to
Rule 424(b)(1) or (4) or 497(h) under the Securities
Act shall be deemed to be part of this registration statement as
of the time it was declared effective.
(2) For the purpose of determining any liability under the
Securities Act, each post-effective amendment that contains a
form of prospectus shall be deemed to be a new registration
statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
The undersigned Registrant hereby undertakes to provide to the
underwriters at the closing specified in the Underwriting
Agreement, certificates in such denomination and registered in
such names as required by the underwriters to permit prompt
delivery to each purchaser.
II-4
Signatures
Pursuant to the requirements of the Securities Act of 1933, as
amended, the Registrant has duly caused this amendment to
registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Columbia,
State of Maryland on February 28, 2007.
SOURCEFIRE, INC.
|
|
|
|
By:
|
/s/ E.
Wayne Jackson, III
|
Name: E. Wayne Jackson, III
Title: Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
amendment to registration statement has been signed by the
following persons in the capacities and on the dates indicated.
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
/s/ E.
Wayne Jackson, III
E.
Wayne Jackson, III
|
|
Chief Executive Officer and
Director (principal executive officer)
|
|
February 28, 2007
|
|
|
|
|
|
/s/ Todd
P. Headley
Todd
P. Headley
|
|
Chief Financial Officer and
Treasurer (principal financial and accounting officer)
|
|
February 28, 2007
|
|
|
|
|
|
*
Martin
F. Roesch
|
|
Chief Technology Officer and
Director
|
|
February 28, 2007
|
|
|
|
|
|
*
Asheem
Chandna
|
|
Director
|
|
February 28, 2007
|
|
|
|
|
|
*
Tim
A. Guleri
|
|
Director
|
|
February 28, 2007
|
|
|
|
|
|
*
Harry
R. Weller
|
|
Director
|
|
February 28, 2007
|
|
|
|
|
|
*
Joseph
R. Chinnici
|
|
Director
|
|
February 28, 2007
|
|
|
|
|
|
*
Steven
R. Polk
|
|
Director
|
|
February 28, 2007
|
|
|
|
|
|
*
Arnold
L. Punaro
|
|
Director
|
|
February 28, 2007
|
|
|
|
|
|
|
|
*By:
|
|
/s/ Todd
P. Headley
Todd
P. Headley
as Attorney-in-fact
|
|
|
|
|
II-5
|
|
|
|
|
Exhibit No.
|
|
Description of
Exhibit
|
|
|
1
|
.1**
|
|
Form of Underwriting Agreement
|
|
3
|
.1**
|
|
Fifth Amended and Restated
Certificate of Incorporation of Sourcefire, Inc.
|
|
3
|
.2*
|
|
Form of Sixth Amended and Restated
Certificate of Incorporation of Sourcefire, Inc.
|
|
3
|
.3**
|
|
Third Amended and Restated Bylaws
of Sourcefire, Inc.
|
|
3
|
.4*
|
|
Form of Fourth Amended and
Restated Bylaws of Sourcefire, Inc.
|
|
3
|
.5**
|
|
Certificate of Amendment to the
Fifth Amended and Restated Certificate of Incorporation
|
|
4
|
.1*
|
|
Form of stock certificate of
common stock
|
|
4
|
.2**
|
|
2002 Stock Incentive Plan
|
|
4
|
.3
|
|
2007 Stock Incentive Plan
|
|
4
|
.4**
|
|
Form of Nonstatutory Stock Option
Grant Agreement under the 2002 Stock Incentive Plan
|
|
4
|
.5
|
|
Form of Notice of Stock Option
Award under the 2007 Stock Incentive Plan
|
|
4
|
.6
|
|
Form of Notice of Restricted Stock
Purchase Award under the 2007 Stock Incentive Plan
|
|
4
|
.7
|
|
Form of Notice of Restricted Stock
Purchase Award for Non-Employee Directors under the 2007 Stock
Incentive Plan
|
|
5
|
.1**
|
|
Opinion of Morrison &
Foerster LLP
|
|
10
|
.1**
|
|
Fourth Amended and Restated
Investor Rights Agreement
|
|
10
|
.2**
|
|
Fourth Amended and Restated Right
of First Refusal and Co-Sale Agreement
|
|
10
|
.3**
|
|
Fourth Amended and Restated
Stockholders’ Voting Agreement
|
|
10
|
.4**
|
|
Employment Agreement of E. Wayne
Jackson, III
|
|
10
|
.5**
|
|
Employment Agreement of Thomas M.
McDonough
|
|
10
|
.6**
|
|
Employment Agreement of Martin F.
Roesch
|
|
10
|
.7**
|
|
Employment Agreement of Todd P.
Headley
|
|
10
|
.8**
|
|
Employment Agreement of Michele M.
Perry-Boucher
|
|
10
|
.9**
|
|
Loan and Security Agreement by and
between Sourcefire, Inc. and Silicon Valley Bank
|
|
10
|
.10**
|
|
Lease Agreement by and between
Liberty Property LP and Sourcefire, Inc.
|
|
10
|
.11†**
|
|
OEM and Distributor Agreement by
and between Sourcefire, Inc. and Nokia Inc., dated July 14,
2006, as amended on July 14, 2006
|
|
10
|
.12†**
|
|
Manufacturing Services and Supply
Agreement by and between Patriot Technologies, Inc. and
Sourcefire, Inc., dated December 12, 2005, as amended on
August 4, 2006
|
|
10
|
.13†**
|
|
Outsourcing Agreement by and
between Sourcefire, Inc. and Intelligent Decisions, Inc., dated
January 31, 2006
|
|
10
|
.14†**
|
|
OEM Purchase Agreement by and
between Bivio Networks, Inc. and Sourcefire, Inc., dated
February 10, 2005
|
|
10
|
.15†**
|
|
License Agreement for Commercial
Use of MySQL Software by and between MySQL Inc. and Sourcefire,
Inc., dated June 13, 2005, as amended on December 29, 2006
|
|
10
|
.16**
|
|
Employment Agreement of Joseph M.
Boyle
|
|
10
|
.17**
|
|
Written Consent in Lieu of a
Special Meeting of the Preferred Stockholders of Sourcefire,
Inc., dated October 25, 2006
|
|
10
|
.18
|
|
Form of Indemnification Agreement
|
|
23
|
.1**
|
|
Consent of Ernst & Young
LLP
|
|
|
|
|
|
Exhibit No.
|
|
Description of
Exhibit
|
|
|
23
|
.2**
|
|
Consent of Morrison &
Foerster LLP (included in Exhibit 5.1)
|
|
24
|
.1**
|
|
Power of Attorney (included in
signature pages to Registration Statement on Form S-1, Filed
October 25, 2006)
|
|
24
|
.2**
|
|
Power of Attorney (included in
signature pages to Amendment No. 4 to Registration
Statement on Form S-1, filed February 14, 2007)
|
|
|
|
*
|
|
To be filed by Amendment.
|
**
|
|
Previously filed.
|
†
|
|
Portions of this exhibit have been
omitted and were filed separately with the Securities and
Exchange Commission pursuant to the Registrant’s
application requesting confidential treatment under
Rule 406 of the Securities Act.
|