IMPRIVATA INC filed this 424B4 on 06/25/2014

424B4
Table of Contents

Filed Pursuant to Rule 424(b)(4)
Registration No. 333-194921

Prospectus

5,000,000 shares

 

LOGO

Common stock

This is the initial public offering of shares of common stock by Imprivata, Inc. We are selling 5,000,000 shares of our common stock.

Prior to this offering, there has been no public market for our common stock. The initial public offering price per share is $15.00. The shares will trade on the New York Stock Exchange under the symbol “IMPR.”

We are an “emerging growth company” under applicable Securities and Exchange Commission rules and will be subject to reduced public company reporting requirements. See “Prospectus summary—Implications of being an emerging growth company.”

 

      Per Share        Total  

Initial public offering price

   $ 15.00         $ 75,000,000   

Underwriting discounts and commissions(1)

   $ 1.05         $ 5,250,000   

Proceeds to us, before expenses

   $ 13.95         $ 69,750,000   

 

 

 

(1)   We refer you to “Underwriting” beginning on page 115 of this prospectus for additional information regarding total underwriter compensation.

We have granted the underwriters an option for a period of 30 days to purchase up to 750,000 additional shares of common stock.

Investing in our common stock involves a high degree of risk. Please read “Risk factors” beginning on page 12.

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

Delivery of the shares of common stock is expected to be made on or about June 30, 2014.

 

J.P. Morgan   Piper Jaffray

 

William Blair
Wells Fargo Securities     Stephens Inc.

The date of this prospectus is June 24, 2014.


Table of Contents

LOGO

i imprivata ®
Enabling Healthcare. Securely.
Physicians
Mobile Devices
Nurses
Virtual Desktops
Clinical Staff
PC / Laptops
Solutions that enable optimized clinical workflows, for fast, secure access to patient information.
Anywhere, anytime.


Table of Contents

Table of contents

 

     Page  

Prospectus summary

     1   

Risk factors

     12   

Special note regarding forward-looking statements and industry data

     34   

Use of proceeds

     36   

Dividend policy

     36   

Capitalization

     37   

Dilution

     39   

Selected consolidated financial data

     41   

Management’s discussion and analysis of financial condition and results of operations

     44   

Business

     68   

Management

     81   

Executive officer and director compensation

     89   

Certain relationships and related party transactions

     101   

Principal stockholders

     102   

Description of capital stock

     104   

Shares eligible for future sale

     109   

Certain material United States federal income tax considerations for non-U.S. holders

     111   

Underwriting

     115   

Legal matters

     120   

Experts

     120   

Where you can find more information

     120   

Index to consolidated financial statements

     F-1   

 

 

 

i


Table of Contents

Prospectus summary

This summary highlights information contained elsewhere in this prospectus. Before investing in our common stock, you should carefully read this entire prospectus, including our financial statements and the related notes included elsewhere in this prospectus. You should also consider, among other things, the matters described under “Risk factors” and “Management’s discussion and analysis of financial condition and results of operations,” in each case appearing elsewhere in this prospectus. Unless otherwise stated, all references to “us,” “our,” “Imprivata,” “we,” the “Company” and similar designations refer to Imprivata, Inc.

Overview

We are a leading provider of authentication and access management technology solutions for the healthcare industry. Our flagship solution, Imprivata OneSign, is an integrated enterprise single sign-on, authentication management and workflow automation platform that addresses multiple security and productivity challenges faced by hospitals and other healthcare organizations. By enabling fast, secure access to healthcare information technology systems, we believe our solutions save clinicians significant time to focus on patient care, increase their productivity and satisfaction, and help healthcare organizations comply with privacy and security regulations. Imprivata OneSign can be installed on every workstation and other application access point throughout a healthcare organization and once deployed becomes a critical part of the customer’s security and access infrastructure. As a result, we believe that Imprivata OneSign is one of the most widely-used technology solutions by our customers’ physicians, nurses and other clinicians.

Across the globe, the healthcare industry is transitioning from paper-based records to electronic systems and processes and is facing increasing privacy and security regulations relating to protected health information, or PHI. As a result of the confluence of these two trends, clinicians are required to use numerous usernames and passwords to securely sign-on to multiple applications as they access PHI to manage patient care. This impedes clinical workflows, reduces time available for patient care and reduces clinician satisfaction. By using our solutions, some of our customers have reported that clinicians can save up to 45 minutes per shift. As a result of widespread adoption of healthcare information technology and increasing privacy and security regulation, demand for our solutions continues to grow.

Imprivata OneSign is used by our customers to solve three critical problems in their organizations. Imprivata OneSign allows our customers to eliminate multiple log-ons to different applications by using a single log-on, which we refer to as enterprise single sign-on. Imprivata OneSign also allows our customers to replace username and password-based authentication with a stronger and more efficient form of authentication technology, such as fingerprint biometrics, proximity cards, smartcards or tokens, which we refer to as authentication management. Using single sign-on, authentication management and our other offerings, Imprivata OneSign allows our customers to optimize clinical workflows, which we refer to as workflow automation.

We believe any healthcare organization that relies on information technology is a potential customer for our solutions. As of March 31, 2014, our Imprivata OneSign solution had over 2.8 million licensed users in over 950 healthcare organizations in 20 countries, including large integrated healthcare systems, academic medical centers, and small- and medium-sized independent healthcare facilities. Following the initial sale, many of our healthcare customers continue to add licensed users and purchase additional products and services from us. We estimate that the total available market in healthcare organizations in North America and other global markets that we currently serve is approximately $3.0 billion. Although healthcare is our primary focus, as of March 31, 2014, Imprivata OneSign had over 770,000 licensed users in over 400 non-healthcare organizations, including financial services, the public sector and other industries.

 

 

1


Table of Contents

We sell our solutions through our direct sales force and sales partners in the United States and internationally. During the years ended December 31, 2011, 2012 and 2013, our revenue was $41.4 million, $54.0 million and $71.1 million, respectively, representing growth of 30% from 2011 to 2012 and 32% from 2012 to 2013. Our net income for 2011 and 2012 was $2.7 million and $1.0 million, respectively and in 2013 we had a net loss of $5.5 million. We generated revenue of $14.3 million and $19.4 million for the three months ended March 31, 2013 and 2014, representing growth of 36%, and had net losses of $1.5 million and $7.1 million, respectively. As of March 31, 2014, we had an accumulated deficit of $97.2 million.

Industry overview

Globally, healthcare organizations face challenges in maximizing the use of information technology by their time-pressured clinicians. The use of healthcare information technology systems, coupled with regulatory requirements for privacy and security, create inefficiencies for clinicians in the delivery of patient care. We believe that demand for our solutions is driven by the confluence of two major trends:

 

 

Increased utilization of information technology in delivering patient care: As a result of the continuing shift away from paper-based systems, clinicians are increasingly required to use information technology to access patient information in providing patient care.

 

 

Increased regulation of privacy and security of patient information: A number of privacy and security requirements govern access to and release of PHI globally. These privacy and security requirements continue to evolve, become more stringent, and increasingly are proactively enforced.

This convergence of increasing technology use and privacy and security requirements creates the following critical workflow challenges for hospitals and other healthcare organizations:

 

 

Mobile clinicians and shared workstations drive the need for efficient user access: Clinicians care for patients across various settings throughout a healthcare organization. Workstations are deployed and shared by clinicians to provide access to patient information in multiple locations throughout a hospital or other healthcare facility. This creates inefficiencies as each clinician needs to log-on and log-off from one or more shared workstations in various locations, often in rapid succession.

 

 

Clinicians access many applications and manage multiple passwords: For every patient encounter, clinicians may need to access multiple applications, each requiring a separate user name and password to log-on. This slows access to information and frustrates clinicians.

 

 

Clinicians may leave the workstation without logging off: Privacy regulations require workstations to be secured so that patient information is not exposed. Failure of a clinician to sign out of a workstation may cause a privacy breach, or another clinician to inadvertently access the wrong patient record, potentially resulting in incorrect documentation of care or patient safety issues.

 

 

Electronic prescriptions increasingly require strong authentication: In the United States, the use of electronic prescriptions continues to grow rapidly. In certain situations, electronic prescriptions require “second-factor authentication,” such as fingerprint authentication, in order to verify the identity of the prescribing clinician. Without second factor authentication, clinicians cannot enter these orders electronically and must revert to writing paper prescriptions.

 

 

2


Table of Contents

Without integrated and secure authentication and access management solutions, healthcare organizations may be adversely affected in the following ways:

 

 

Less time for patient care: Inefficient authentication and access management processes are an important factor in reducing the time clinicians have for patient care and can be stressful to the patient and frustrating to the clinician. According to a 2008 study published in the Permanente Journal of how nurses spend their time, some clinicians only spend approximately 20% of their time on patient care, with the balance spent on documentation, communication and other administrative tasks.

 

 

Reduced clinician satisfaction: According to a 2011 survey we commissioned of acute care hospitals in the United States, clinicians spend 25% of their time accessing and using electronic records. We believe that the time delays related to accessing and using electronic records distract clinicians from patient care and have a negative impact on their satisfaction.

 

 

Increased risk of violating data privacy laws such as HIPAA regulations: Without a reliable solution to help secure access to electronic PHI, healthcare providers may increase their risk of incurring a data privacy breach, resulting in costly fines.

 

 

Failure to realize benefits of investment in information technology: In order for healthcare organizations to benefit from the financial incentives available under the HITECH Act, they must meet certain standards for “meaningful use” of electronic health record, or EHR, systems. Despite the significant information technology investments made by healthcare organizations, we believe that clinicians have been slow to use information technology because of its negative impact on clinician workflow productivity. For example, according to a 2009 study published in Health Affairs, the introduction of EHR systems can lead to decreases in clinician productivity by as much as 15%.

We believe that healthcare organizations are increasingly choosing integrated authentication and access management technologies to address these challenges across their entire organization. According to HIMSS Analytics, an independent healthcare information technology research firm, there were approximately 5,400 hospitals in the United States as of December 31, 2013. In addition, based on statistics from the World Health Organization, we estimate that there are over 10,000 hospitals across Europe. We estimate the total available market in healthcare organizations in North America and other global markets that we currently serve is approximately $3.0 billion.

Benefits of our solutions

We believe our solutions provide the following key benefits:

 

 

Save clinicians time: By eliminating the need to type in multiple usernames and passwords across multiple applications, our Imprivata OneSign solution enables clinicians to work more efficiently and spend more time on patient care.

 

 

Improve clinician satisfaction by optimizing workflows: We believe that we improve clinician satisfaction by providing solutions that address clinical workflow challenges, such as switching users rapidly on a shared workstation, keeping a session active as a clinician moves throughout the hospital in providing care, and automating navigation between applications based on clinician preferences.

 

 

Help healthcare organizations comply with security and privacy regulations: By securing access to shared workstations in the healthcare organization, our solutions become a critical part of our customers’ security and access infrastructure and help reduce the risk of breaching security or privacy regulations.

 

 

3


Table of Contents
 

Improve financial performance: We believe that our solutions improve the financial performance of healthcare organizations by enhancing clinician productivity and increasing utilization of investments in information technology systems routinely used to manage patient care.

Our strengths

We believe that the following strengths will enable us to maintain and extend our leadership position as a provider of authentication and access management solutions in the healthcare industry:

 

 

The Imprivata brand: Imprivata is recognized as a leading provider of authentication and access management solutions in healthcare. Imprivata OneSign achieved the number one ranking as the Category Leader for Single Sign-On in the “2012 Best in KLAS: Software & Services” report, dated December 2012, and in the “2013 Best in KLAS: Software & Services” report, dated January 2014, published by KLAS, an independent healthcare technology research firm.

 

 

Compelling feature set and ease of implementation, use and management: We provide our customers with compelling features that differentiate Imprivata OneSign as an enterprise-wide authentication and access management solution, including finger biometric identification, integrated authentication and enterprise single sign-on, application programming interfaces for independent software vendors, virtual desktop support with multiple vendors, including zero- and thin-client devices, and new solutions. Our Imprivata OneSign solution is designed to be easy to implement throughout the enterprise by information technology personnel, use by clinicians, and manage by IT administrators.

 

 

Our healthcare customers view us as a trusted strategic partner: We believe our healthcare customers view us as a strategic partner to help them optimize clinical workflow, improve clinician satisfaction and comply with changing regulatory requirements. Our customers routinely identify specific challenges in the clinical setting and request that we develop innovative solutions to address them.

 

 

Stable customer base with significant additional sales opportunities: Many of our customers continue to add licensed users and purchase additional products and services from us after the initial sale. For example, add-on sales from existing customers accounted for over half of our product revenues in the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014. In addition, in each of the last four years, we retained greater than 90% of the aggregate dollar value of maintenance contracts up for renewal. The consistency of add-on sales to existing customers and the recurring nature of our maintenance revenues provide visibility into our future performance.

 

 

Global distribution network and strong selling relationships: We access our customers through multiple channels, including a direct sales force and sales partners, to sell our solutions worldwide. Our sales partners consist of value-added resellers and EHR systems vendors that resell our Imprivata OneSign solution on a standalone basis or as part of an integrated solution. We also have country- and region-specific sales partners targeting selected international markets. In each of the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014, we generated approximately 59%, 59% and 55%, respectively, of our revenue through our relationships with sales partners.

 

 

Our partner ecosystem: We have strategic relationships with leading EHR systems, virtual desktop infrastructure platforms and device vendors that provide the ability to integrate our solutions with their products and services resulting in streamlined clinical workflows and improved clinician experiences.

 

 

Culture of continuous innovation: We continue to invest in research and development to solve security and productivity challenges and improve overall workflow efficiencies for our customers. Our culture of

 

 

4


Table of Contents
 

innovation has resulted in product enhancements and the development of new solutions, including our recent introduction of Imprivata Cortext, our secure communications solution.

Our strategy

Our goal is to extend our leadership position as a provider of authentication and access management solutions in the healthcare industry. Key elements of our strategy include:

 

 

Acquire new U.S. healthcare customers: According to HIMSS Analytics, our Imprivata OneSign solution was used in approximately 18% of hospitals in the United States as of December 31, 2013. We plan to continue to expand our direct sales force and to continue working closely with our sales partners to win new customers.

 

 

Drive further penetration into our installed base of customers: Our customers’ initial purchases rarely include all of our solutions for all of their users. As a result, many of our customers continue to add licensed users and purchase additional products and services from us after the initial sale. We plan to add sales and customer experience personnel in order to grow our revenue from our installed base.

 

 

Extend our technology leadership, develop innovative products and address additional workflow challenges: We intend to continue our investment in research and development to further differentiate and enhance the functionality of our authentication and access management solutions. We plan to also invest in developing new products and solutions that expand the range of security, productivity and workflow challenges we address within healthcare.

 

 

Grow our international healthcare presence: In addition to our core market in the United States, we offer our solutions in more than 20 countries. We plan to utilize both our direct sales force and local sales partners to expand our presence in countries throughout Europe and develop new markets in Latin America, Middle East and Asia Pacific regions.

 

 

Expand our Imprivata OneSign solution into new healthcare settings: Our Imprivata OneSign solution today is primarily sold to hospitals and other inpatient healthcare facilities, but we believe there are growth opportunities for our authentication and access management solutions in other healthcare settings.

 

 

Acquire complementary businesses, technologies and assets: We may pursue acquisitions that complement our existing business, represent a strategic fit, reinforce our presence in markets we currently serve, help us to access new markets, add functionality and capabilities to our solutions and are consistent with our overall growth strategy.

Risks related to our business

Our business is subject to many risks and uncertainties of which you should be aware before you decide to invest in our common stock. These risks are discussed more fully under “Risk factors” in this prospectus. Some of these risks include:

 

 

we have a history of losses, we expect to continue to incur losses and we may not be profitable in the future;

 

 

we depend on sales of our Imprivata OneSign solution in the healthcare market for a substantial portion of our revenue, and any decrease in its sales would harm our business, financial condition and results of operation;

 

 

we may not be able to attract new customers and retain and increase sales to our existing customers, which could have a material adverse effect on our business, financial condition and results of operations;

 

 

5


Table of Contents
 

developments in the healthcare industry or regulatory environment could negatively affect our business;

 

 

we depend on sole source suppliers and a contract manufacturer for hardware components of our Imprivata OneSign solution. If we are unable to source our components from these suppliers or effectively forecast our customer demand to properly manage our inventory, our business and operating results could be adversely affected;

 

 

if we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights; and

 

 

our executive officers, directors, current 5% or greater stockholders and entities affiliated with any of them, together will beneficially own 67.1% of our common stock outstanding after this offering based on the number of shares outstanding as of March 31, 2014; the concentration of our capital stock ownership with insiders will likely limit your ability to influence corporate matters.

Implications of being an emerging growth company

We qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. As an emerging growth company, we may take advantage of specified reduced disclosure and other requirements that are otherwise applicable generally to public companies. These provisions include:

 

 

only two years of audited financial statements in addition to any required unaudited interim financial statements with correspondingly reduced “Management’s discussion and analysis of financial condition and results of operations” disclosure;

 

 

reduced disclosure about our executive compensation arrangements;

 

 

no non-binding advisory votes on executive compensation or golden parachute arrangements; and

 

 

exemption from the auditor attestation requirement in the assessment of our internal control over financial reporting.

We may take advantage of these exemptions as long as we are an emerging growth company. We would cease to be an emerging growth company on the date that is the earliest of (1) the last day of the fiscal year in which we have total annual gross revenues of $1.0 billion or more; (2) the last day of our fiscal year following the fifth anniversary of the date of the completion of this offering; (3) the date on which we have issued more than $1.0 billion in nonconvertible debt securities during the previous three years; or (4) the date on which we are deemed to be a “large accelerated filer” under the rules of the Securities and Exchange Commission. We may choose to take advantage of some but not all of the exemptions available to emerging growth companies. We have taken advantage of reduced reporting requirements in this prospectus. Accordingly, the information contained herein may be different from the information you receive from other public companies in which you hold stock. Also, we have irrevocably elected to “opt out” of the exemption for the delayed adoption of certain accounting standards and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

Our corporate information

We were incorporated in Delaware on May 7, 2001. Our principal executive office is located at 10 Maguire Road, Building 1, Suite 125, Lexington, Massachusetts 02421, and our telephone number is (781) 674-2700. Our website address is www.imprivata.com. We do not incorporate the information on or accessible through our website into this prospectus, and you should not consider any information on, or that can be accessed through, our website as part of this prospectus or the registration statement of which it forms a part.

 

 

6


Table of Contents

“Imprivata,” “Imprivata Cortext,” “Cortext,” “OneSign,” “OneSign Secure Walk-Away,” “OneSign Anywhere,” “No Click Access” and “Enabling Healthcare. Securely” are our trademarks. Any trademarks or trade names referred to in this prospectus are the property of their respective owners. Solely for convenience, the trademarks and trade names in this prospectus may be referred to without the ® and ™ symbols, but such references should not be construed as any indicator that their respective owners will not assert, to the fullest extent permissible under applicable law, their rights thereto.

 

 

7


Table of Contents

The offering

 

Common stock offered by us

5,000,000 shares

 

Common stock to be outstanding after this offering

22,815,867 shares

 

Option to purchase additional shares

The underwriters have an option for a period of 30 days to purchase up to 750,000 additional shares of our common stock.

 

Use of proceeds

We estimate that we will receive net proceeds from this offering of $66.3 million based upon the initial public offering price of $15.00 per share after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We expect to use the net proceeds from this offering for working capital and general corporate purposes. See “Use of proceeds” for additional information.

 

Risk factors

You should carefully read the section entitled “Risk factors” in this prospectus for a discussion of factors that you should consider before deciding to invest in our common stock.

 

NYSE symbol

IMPR

The number of shares of our common stock to be outstanding after this offering is based on 3,844,933 shares of our common stock outstanding as of March 31, 2014 and 13,970,934 additional shares of our common stock issuable upon conversion of all of our outstanding shares of preferred stock upon the completion of this offering. The number of shares of our common stock to be outstanding after this offering excludes:

 

 

3,605,095 shares of common stock issuable upon the exercise of stock options outstanding as of March 31, 2014 having a weighted-average exercise price of $3.08 per share;

 

 

108,853 shares of common stock issued upon the net exercise of warrants that were outstanding as of March 31, 2014 having an exercise price of $1.10 per share;

 

 

2,559,172 shares of common stock reserved for future issuance under our stock option plans as of the completion of this offering; and

 

 

448,000 shares of common stock reserved for future issuance under our 2014 Employee Stock Purchase Plan, or ESPP.

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

 

 

the filing of our amended and restated certificate of incorporation and the adoption of our amended and restated bylaws, which will occur immediately prior to the completion of this offering;

 

 

the conversion of all of our outstanding shares of preferred stock into 13,970,934 shares of common stock upon the completion of this offering;

 

 

no exercise of outstanding options or warrants after March 31, 2014;

 

 

no exercise by the underwriters of their option to purchase up to an additional 750,000 shares of our common stock in this offering; and

 

 

a 1-for-1.5 reverse split of our common stock effected on May 30, 2014, which has been retrospectively applied throughout this prospectus.

 

 

8


Table of Contents

Summary consolidated financial data

The following tables summarize our consolidated financial data and should be read together with “Selected consolidated financial data,” “Management’s discussion and analysis of financial condition and results of operations” and our consolidated financial statements and related notes, each included elsewhere in this prospectus.

We derived the consolidated statements of operations data for the years ended December 31, 2011, 2012 and 2013 from our audited consolidated financial statements included elsewhere in this prospectus. We derived the consolidated statements of operations data for the three months ended March 31, 2013 and 2014 from our unaudited consolidated financial statements included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results we expect in the future, and our interim results should not necessarily be considered indicative of results we expect for the full year.

We derived the pro forma share and per share data for the three months ended March 31, 2014 from the unaudited pro forma net income (loss) per share information in Note 16 to our consolidated financial statements included elsewhere in this prospectus. The pro forma share and per share data give effect to the conversion of all outstanding shares of our preferred stock into shares of our common stock.

 

      Year ended December 31,     Three months
ended March 31,
 
(in thousands, except per share data)    2011     2012     2013     2013     2014  

 

 

Revenue

          

Product

   $ 22,958      $ 29,992      $ 39,124      $ 7,348      $ 9,274   

Maintenance and services

     18,462        24,032        31,987        6,907        10,166   
  

 

 

 

Total revenue

     41,420        54,024        71,111        14,255        19,440   

Cost of revenue

          

Product

     4,381        6,855        7,849        1,577        2,160   

Maintenance and services

     4,443        6,563        11,020        2,238        4,193   
  

 

 

 

Total cost of revenue

     8,824        13,418        18,869        3,815        6,353   
  

 

 

 

Gross profit

     32,596        40,606        52,242        10,440        13,087   

Operating expenses

          

Research and development

     7,890        12,322        19,609        4,001        6,536   

Sales and marketing

     17,728        22,473        30,538        6,258        10,419   

General and administrative

     4,195        4,564        7,619        1,773        3,013   
  

 

 

 

Total operating expenses

     29,813        39,359        57,766        12,032        19,968   
  

 

 

 

Income (loss) from operations

     2,783        1,247        (5,524     (1,592     (6,881

Other income (expense)

          

Interest and other income (expense), net

     68        (90     109        59        (160
  

 

 

 

Income (loss) before income taxes

     2,851        1,157        (5,415     (1,533     (7,041

Income taxes (benefit)

     129        109        108        (3     26   
  

 

 

 

Net income (loss)

     2,722        1,048        (5,523     (1,530     (7,067

Accretion of redeemable convertible preferred stock

     (4,973     (4,957     (4,952     (1,238     (1,238
  

 

 

 

Net loss attributable to common stockholders

   $ (2,251   $ (3,909   $ (10,475   $ (2,768   $ (8,305
  

 

 

 

Net loss per share attributable to common stockholders

          

Basic and diluted

   $ (1.03   $ (1.36   $ (3.12   $ (0.89   $ (2.29
  

 

 

 

Weighted average common shares outstanding used in computing net loss per share attributable to common stockholders

          

Basic and diluted

     2,188        2,868        3,359        3,120        3,627   
  

 

 

 

 

 

9


Table of Contents
      Year ended December 31,     Three months
ended March 31,
 
(in thousands, except per share data)    2011      2012      2013     2013     2014  

 

 

Pro forma net loss per share

            

Basic and diluted

         $ (0.32     $ (0.40
        

 

 

     

 

 

 

Pro forma weighted average shares used to compute net loss per common share

            

Basic and diluted

           17,330          17,598   
        

 

 

     

 

 

 

Other financial data:

            

Adjusted EBITDA(1)

   $ 4,199       $ 2,348       $ (3,364   $ (821   $ (5,843

 

 

 

(1)   Please see “Adjusted EBITDA” below for more information and for a reconciliation of net income (loss) to Adjusted EBITDA.

Consolidated balance sheet data as of March 31, 2014 are presented below:

 

 

on an actual basis;

 

 

on a pro forma basis to reflect the conversion of our outstanding shares of preferred stock into 13,970,934 shares of our common stock, each immediately upon the closing of this offering as if the conversion had occurred on March 31, 2014; and

 

 

on a pro forma as adjusted basis to reflect the pro forma adjustments described above and to give further effect to the sale by us of 5,000,000 shares of common stock in this offering at the initial public offering price of $15.00 per share after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

March 31, 2014

(in thousands)

   Actual     Pro forma    

Pro forma as

adjusted

 

 

 

Consolidated balance sheet data:

      

Cash and cash equivalents

   $ 5,928      $ 5,928      $ 72,178   

Total assets

     35,626        35,626        101,876   

Deferred revenue

     28,164        28,164        28,164   

Redeemable preferred stock

     92,845                 

Total stockholders’ equity (deficit)

   $ (97,152   $ (4,307 )   $ 61,943   

 

 

 

 

10


Table of Contents

Adjusted EBITDA

To provide investors with additional information about our financial results, we disclose within this prospectus Adjusted EBITDA, a non-GAAP financial measure. We present Adjusted EBITDA because it is used by our board of directors and management to evaluate our operating performance, and we consider it an important supplemental measure of our performance.

Our management uses Adjusted EBITDA:

 

 

as a measure of operating performance to assist in comparing performance from period to period on a consistent basis; and

 

 

as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations.

Adjusted EBITDA is not in accordance with, or an alternative to, measures prepared in accordance with GAAP. In addition, this non-GAAP measure is not based on any comprehensive set of accounting rules or principles. As a non-GAAP measure, Adjusted EBITDA has limitations in that it does not reflect all of the amounts associated with our results of operations as determined in accordance with GAAP. In particular:

 

 

Adjusted EBITDA does not reflect the amounts we paid in taxes or other components of our tax provision;

 

 

Adjusted EBITDA does not include depreciation expense from fixed assets or amortization expense from acquired intangible assets;

 

 

Adjusted EBITDA does not reflect other (expense) income which include interest income we earn on cash and cash equivalents; interest expense, or the cash requirements necessary to service interest or principal payments, on our debt and capital leases; losses on the disposal of assets and the gains or losses on foreign currency transactions;

 

 

Adjusted EBITDA does not include the impact of stock-based compensation;

 

 

Adjusted EBITDA does not include the change in value of our contingent liability related to the acquisition of assets from Validus Medical Systems, as described in the Notes to the consolidated financial statements; and

 

 

others may calculate Adjusted EBITDA differently than we do and these calculations may not be comparable to our Adjusted EBITDA metric. Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including net income (loss) and our financial results presented in accordance with GAAP.

The table below presents a reconciliation of net income (loss) to Adjusted EBITDA for each of the periods indicated:

 

      Year ended December 31,     Three months ended March 31,  
(in thousands)                    2011                   2012                   2013                     2013                     2014  

 

 

Net income (loss)

   $ 2,722      $ 1,048      $ (5,523   $ (1,530   $ (7,067

Income tax expense

     129        109        108        (3     26   

Depreciation and amortization

     842        1,082        2,397        555        695   

Other (expense) income, net

     (68     90        (109     (59     160   

Stock based compensation

     347        450        640        117        298   

Change in value of contingent liability

     227        (431     (877     99        45   
  

 

 

 

Adjusted EBITDA

   $ 4,199      $ 2,348      $ (3,364     (821   $ (5,843

 

 

 

 

11


Table of Contents

Risk factors

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below, as well as the other information in this prospectus, including our financial statements and the related notes and “Management’s discussion and analysis of financial condition and results of operations,” before deciding whether to invest in our common stock. Any of the events or developments described below could harm our business, financial condition and results of operations. In such an event, the market price of our common stock could decline, and you may lose all or part of your investment. Additional risks and uncertainties not presently known to us or that we do not currently deem material may also impair our business operations.

Risks related to our business and industry

We have a history of losses, we expect to continue to incur losses and we may not be profitable in the future.

Although we had operating and net income for the years ended December 31, 2011 and 2012, we incurred operating and net losses for the year ended December 31, 2013 and the three months ended March 31, 2014, and we expect to continue to incur operating and net losses for the foreseeable future. As of March 31, 2014, we had an accumulated deficit of $97.2 million. Our ability to be profitable in the future depends upon continued demand for our authentication and access management solutions. In addition, our profitability will be affected by, among other things, our ability to develop and commercialize new solutions, and products for those solutions, and enhance existing solutions and products. Further market adoption of our solutions, including increased penetration within our existing customers, depends upon our ability to improve clinical workflows related to the utilization of healthcare information technology systems and increase clinician productivity. We expect to incur significant operating costs relating to our research and development initiatives for our new and existing solutions and products, and for our expansion of our sales and marketing operations as we add additional sales personnel and increase our marketing efforts. Furthermore, we may incur significant losses in the future for a number of reasons, including the other risks described in this prospectus, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown events. As a result, we cannot assure you that we will be able achieve or sustain profitability in the future.

We depend on sales of our Imprivata OneSign solution in the healthcare industry for a substantial portion of our revenue, and any decrease in its sales would have a material adverse effect on our business, financial condition and results of operations.

A substantial portion of our revenue has been derived from sales of our Imprivata OneSign solution to the healthcare industry. In the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014, 79%, 83%, and 84%, respectively, of our revenue was derived from sales of our Imprivata OneSign solution to the healthcare industry. We anticipate that sales of our Imprivata OneSign solution to the healthcare industry will represent a significant portion of our revenue for the foreseeable future. Any decrease in revenue from sales of this solution would have a material adverse effect on our business. Healthcare organizations are currently facing significant budget constraints, increasing demands resulting from a growing number of patients, and impediments to obtaining third-party reimbursements and patient payments for their services. Although healthcare organizations are currently allocating funds for capital and infrastructure improvements to benefit from governmental initiatives, they may not choose to prioritize or implement access or authentication management solutions as part of those efforts at this time, or at all, due to financial and resource constraints. Even if clinicians determine that our Imprivata OneSign solution provides benefits over their existing authentication and access management solutions, their healthcare organizations may not have, or may not be willing to spend, the resources necessary to purchase, install and maintain information technology systems, adopt our Imprivata OneSign solution, add licensed users in other departments or purchase additional products and services from us.

 

12


Table of Contents

In addition, our healthcare customers have been experiencing consolidation in response to developments generally affecting the healthcare industry. As a result, we may lose existing or potential healthcare customers for our solutions. If our existing customers combine with other healthcare organizations that are not our customers, they may reduce or discontinue their purchases of our solutions. In addition, the combined organizations may have greater leverage in negotiating terms with us, and we may be forced to accept terms that are less favorable to us.

We do not anticipate that sales of our solutions in non-healthcare industries will represent a significant portion of our revenue for the foreseeable future. As a result, decreased revenue from sales of our Imprivata OneSign solution in the healthcare industry would have a material adverse effect on our business, financial condition and results of operations.

We may not be able to attract new customers and retain and increase sales to our existing customers, which could have a material adverse effect on our business, financial condition and results of operations.

Our success and growth strategy depends in part upon the purchase of our Imprivata OneSign solution by new customers. Our sales and marketing efforts seek to demonstrate to potential new customers that our solutions streamline clinician workflow and increase productivity, enhance the value of existing investments in healthcare information technology, and help ensure compliance with complex privacy and security regulations. If we are not able to persuade new customers that our solutions provide these benefits, or if we fail to generate sufficient sales leads through our marketing programs, then we will not be able to attract new customers, which would have a material adverse effect on our business, financial condition and results of operations.

In most cases, our customers initially license our solutions for a limited number of departments within a healthcare organization. After the initial sale, our customers frequently add licensed users in other departments, functional groups and sites and buy additional products and services over time. Factors that may affect our ability to retain and increase sales to our existing customers include the quality of our customer service, training and technology, as well as our ability to successfully develop and introduce new solutions and products. Additionally, our customers may stop using our Imprivata OneSign solution or may not renew agreements for services, including software maintenance, for reasons entirely out of our control, such as a reduction in their budgets. If our efforts to satisfy our existing customers are not successful, we may not be able to retain them or sell additional functionality to them, which could have a material adverse effect on our business, financial condition and results of operations.

If we fail to successfully develop and introduce new solutions and products for existing solutions, our business, financial condition and results of operations could be adversely affected.

Our success depends, in part, upon our ability to anticipate industry evolution and introduce or acquire new solutions and products to keep pace with technological developments both within our industry and in related industries. However, we may not be able to develop, introduce, acquire and integrate new solutions and products in response to our customers’ changing requirements in a timely manner or on a cost-effective basis, or that sufficiently differentiate us from competing solutions such that customers choose to purchase our solutions. For example, healthcare organizations may shift their existing information technology infrastructure from on-site services to cloud-based services, which may not be compatible with our solutions, requiring us to develop new products or to re-engineer our existing products. In addition, healthcare organizations may adopt mobile applications more quickly than we have anticipated, requiring us to accelerate the development of a mobile version of our authentication and access management solutions. If any of our competitors implements new technologies before we are able to implement them or better anticipates the innovation opportunities in related industries, those competitors may be able to provide more effective or more cost-effective solutions than ours. In addition, we may experience technical problems and additional costs as we introduce new

 

13


Table of Contents

solutions, deploy future iterations of our solutions and integrate new solutions with existing customer systems and workflows. If any of these problems were to arise, our business, financial condition and results of operations could be adversely affected.

Developments in the healthcare industry or regulatory environment could adversely affect our business.

Our growth strategy is focused on the healthcare industry and a substantial portion of our revenue is derived from the healthcare industry. This industry is highly regulated and is subject to changing political, legislative, regulatory and other influences. Developments generally affecting the healthcare industry, including new regulations or new interpretations of existing regulations, such as reductions in funding, changes in pricing for healthcare services or impediments to third-party reimbursement for healthcare costs, may cause deterioration in the financial or business condition of our customers and cause them to reduce their spending on information technology. As a result, these developments could adversely affect our business.

In March 2010, comprehensive healthcare reform legislation was enacted in the United States through the Patient Protection and Affordable Health Care for America Act and the Health Care and Education Reconciliation Act. This law is expected to increase health insurance coverage through individual and employer mandates, subsidies offered to lower income individuals, tax credits available to smaller employers and broadening of Medicaid eligibility, and to affect third-party reimbursement levels for healthcare organizations. We cannot predict what effect federal healthcare reform or any future legislation or regulation, or healthcare initiatives, if any, implemented at the state level, will have on us or our healthcare customers.

In addition, our healthcare customers’ expectations regarding pending or potential industry developments may also affect their budgeting processes and spending plans with respect to our authentication and access management solutions. The healthcare industry has changed significantly in recent years and we expect that significant changes will continue to occur. However, the timing and impact of developments in the healthcare industry are difficult to predict. We cannot assure you that the markets for our solutions will continue to exist at current levels or that we will have adequate technical, financial and marketing resources to react to changes in those markets.

Seasonal variations in the purchasing patterns of our customers may lead to fluctuations in our operating results and financial condition.

We have experienced and expect to continue to experience seasonal variations in the timing of customers’ purchases of our solutions. Many customers make purchasing decisions based on their fiscal year budgets, which typically coincide with the calendar year and result in increased purchasing in the fourth quarter of the year. Because many of our expenses remain relatively fixed throughout the year, the seasonality of our business requires us to manage our working capital carefully over the course of the year. If we fail to manage our working capital effectively or do not accurately predict customer demand in the fourth quarter of the year, our operating results and financial condition may fluctuate.

Our sales cycles for new customers can be lengthy and unpredictable, which may cause our revenue and operating results to fluctuate significantly.

Our sales cycles for new customers can be lengthy and unpredictable. Our sales efforts involve educating our customers about the use and benefits of our authentication and access management solutions, including demonstrating the potential of our solutions in streamlining clinician workflow and increasing productivity. Customers may undertake a significant evaluation process, involving not only our solutions but also the customer’s existing healthcare information technology infrastructure. This assessment can result in a lengthy and unpredictable sales cycle. In addition, purchases of our solutions are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. We spend

 

14


Table of Contents

substantial time, effort and money in our sales efforts without any assurance that our efforts will produce any sales. In addition, cancellation of any implementation after it has begun might result in lost time, effort, and expenses invested in the cancelled implementation process and lost opportunity for implementing paying customers in that same period of time. These factors may contribute to significant fluctuations in our revenue and operating results.

Our revenue and operating results have fluctuated, and are likely to continue to fluctuate, which may make our quarterly results difficult to predict, cause us to miss analyst expectations and cause the price of our common stock to decline.

Our revenue and operating results may be difficult to predict, even in the near term, and are likely to fluctuate as a result of a variety of factors, many of which are outside of our control. Comparisons of our revenue and operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. Each of the following factors, among others, could cause our revenue and operating results to fluctuate from quarter to quarter:

 

 

the financial health of our healthcare customers and budgetary constraints on their ability to purchase authentication and access management solutions;

 

 

changes in the regulatory environment affecting our healthcare customers, including impediments to their ability to obtain third-party reimbursement for their services;

 

 

our ability to develop and introduce new solutions and products and enhance existing solutions that achieve market acceptance;

 

 

the procurement and deployment cycles of our healthcare customers and the length of our sales cycles;

 

 

our ability to forecast demand and manage lead times for the manufacture of hardware used in our solutions;

 

 

the mix of our product and service revenue and pricing, including discounts by us or our competitors; and

 

 

the timing of when orders are fulfilled and revenue is recognized.

The resulting variability and unpredictability could result in our failure to meet our operating plan or the expectations of investors or analysts for any period. If we fail to meet such expectations for these or other reasons, the market price of our common stock may decline.

If we are unable to maintain successful relationships with our channel partners and technology alliance partners, our ability to market, sell and distribute our solutions will be limited and our business, financial condition and results of operations could be adversely affected.

In addition to our direct sales force, we rely on our sales partners, consisting of our channel partners and technology alliance partners, to sell our solutions. We derive a substantial portion of our revenue from sales of our products and services through our sales partners, and we expect that sales through sales partners will continue to be a significant percentage of our revenue. In each of the years ended December 31, 2011, 2012 and 2013, 10% of our total revenues were derived from our largest sales partner. For the three months ended March 31, 2014, 9% of our total revenues were derived from our largest sales partner.

Our agreements with our sales partners are generally non-exclusive, meaning our sales partners may offer their customers products and services from several different companies, including products and services that compete with ours. We depend on channel partners to supplement our direct sales organization within the United States and internationally. If our channel partners do not effectively market and sell our products and services, choose to use greater efforts to market and sell their own products and services or those of our competitors, or fail to meet the needs of our customers, our ability to grow our business and sell our products and services may be adversely

 

15


Table of Contents

affected. Our channel partners may cease marketing our products and services with limited or no notice and with little or no penalty, and they have no obligation to renew their agreements with us on commercially reasonable terms, or at all. The loss of a substantial number of our channel partners, our possible inability to replace them, or the failure to recruit additional channel partners could materially and adversely affect our results of operations. New channel partners require extensive training and may take several months or more to achieve productivity for us. Our channel partner structure could also subject us to lawsuits or reputational harm if, for example, a channel partner misrepresents the functionality of our platform to customers or violates applicable laws or our corporate policies applicable to the partner. We work with our technology alliance partners to design go-to-market strategies that combine our solutions with products or services provided by our technology alliance partners. The loss of a technology alliance partner may mean that certain of our solutions that were designed to interoperate with the products or services provided by the technology alliance partner may no longer function as intended and require substantial re-engineering or the development of new solutions and products.

Our ability to generate revenue in the future will depend in part on our success in maintaining effective working relationships with our sales partners, in expanding our indirect sales channel, in training our channel partners to independently sell and deploy our solutions and in continuing to integrate our solutions with the products and services offered by our technology alliance partners. If we are unable to maintain our relationships with these sales partners, our business, financial condition and results of operations could be adversely affected.

We depend on sole source suppliers and a contract manufacturer for hardware components of our Imprivata OneSign solution. If we are unable to source our components from them or effectively forecast our customer demand to properly manage our inventory, our business and operating results could be adversely affected.

We depend on sole source suppliers for hardware components of our Imprivata OneSign solution. We rely upon DigitalPersona, Inc. as the only provider of our fingerprint readers. Although we currently purchase all of our proximity cards from RF IDeas, Inc., we believe alternative sources are available. In addition, we depend on a contract manufacturer to produce certain other hardware components for our solutions. Our agreements with RF IDeas, Inc. and our contract manufacturer renew automatically on an annual basis. These agreements do not contain supply commitments. We purchase our fingerprint readers from DigitalPersona, Inc. on a purchase order basis, and do not have the benefit of a long-term supply agreement or supply commitments. As a result, we cannot assure you that our suppliers and contract manufacturer will be able to meet our requirements, which could adversely affect our business and operating results.

Any of these suppliers or contract manufacturer could cease production of our components, experience capacity constraints, material shortages, work stoppages, financial difficulties, cost increases or other reductions or disruptions in output, cease operations or be acquired by, or enter into exclusive arrangements with, a competitor. These suppliers and contract manufacturer typically rely on purchase orders rather than long-term contracts with their suppliers. As a result, even if available, an affected supplier or contract manufacturer may not be able to secure sufficient materials at reasonable prices or of acceptable quality to build our components in a timely manner, forcing us to seek components from alternative sources, which may not have the required specifications, or be available in time to meet demand or on commercially reasonable terms, if at all.

We also place orders with our suppliers and contract manufacturer for our inventory based on forecasts of customer demand. Our forecasts are based on multiple assumptions, each of which may introduce errors into our estimates affecting our ability to meet our customers’ demands for our solutions or manage our inventory effectively. We may also be forced to redesign our solutions if a component becomes unavailable in order to incorporate a component from an alternative source, which may increase the cost of providing our solutions. Any of these circumstances could cause interruptions or delays in the delivery of our solutions to our customers, and could adversely affect our business and operating results.

 

16


Table of Contents

Our use of a third-party off-shore development provider could have a material adverse effect on our business, financial condition and results of operations.

Since 2006, we have relied upon a third-party development provider in Lviv, Ukraine to assist with software development, quality assurance, testing and automation to reduce costs and to meet our customers’ needs in a timely manner. These services are performed pursuant to statements of work under a master services agreement. The development provider may terminate its agreement with us without cause with 60 days’ notice, unless a statement of work is in progress. While they have been dependable in the past, we have less control over the development provider’s performance than if it was comprised of our employees or if the development provider was located in the United States. As a result, we are subject to the risk that the development provider will not perform as anticipated. Furthermore, in recent periods, Ukraine has experienced civil unrest and political and economic uncertainties. The evolving economic, political and social developments in the Ukraine may materially and adversely affect the operations of the development provider in ways beyond their control and may constrain our ability to assert or defend our contractual or other legal rights relating to our relationship with the development provider and its handling of our intellectual property. If we are unable to rely upon the development provider for these or other reasons, we may be required to shift development projects to our employees or to another independent contractor. As a result, we may face increased costs and delays in our ability to introduce new solutions or products or provide services. These risks could have a material adverse effect on our business, financial condition and results of operations.

If we are not able to manage our growth effectively, or if our business does not grow as we expect, our operating results will be adversely affected.

We have experienced significant revenue growth in recent periods. For example, our revenue increased from $22.0 million for the year ended December 31, 2009, to $71.1 million for the year ended December 31, 2013. During this period, we significantly expanded our operations and increased the number of our employees from 105 at December 31, 2008 to 301 at December 31, 2013. Our rapid growth has placed, and will continue to place, a significant strain on our management systems, infrastructure and other resources. We plan to hire additional direct sales and marketing personnel domestically and internationally, increase our investment in research and development and acquire complementary businesses, technologies or assets. Our future operating results depend to a large extent on our ability to successfully implement these plans and manage our anticipated expansion. To do so successfully we must, among other things:

 

 

manage our expenses in line with our operating plans and current business environment;

 

 

maintain and enhance our operational, financial and management controls, reporting systems and procedures;

 

 

develop and deliver new solutions and enhancements to existing solutions efficiently and reliably;

 

 

manage operations in multiple locations and time zones; and

 

 

integrate acquired businesses, technologies or assets.

We expect to incur costs associated with the investments made to support our growth before the anticipated benefits or the returns are realized, if at all. If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities or develop new solutions or enhancements to existing solutions. We may also fail to satisfy customer requirements, maintain quality, execute our business plan or respond to competitive pressures, which could adversely affect our operating results.

 

17


Table of Contents

Changes in renewal rates in our software maintenance contracts may not be immediately reflected in our operating results.

We generally recognize revenue from our software maintenance contracts ratably over the contract term. A portion of the maintenance revenue we report in each quarter is derived from the recognition of deferred revenue relating to software maintenance contracts entered into during previous quarters. In each of the years ended December 31, 2011, 2012 and 2013 and the three months ended March 31, 2014, we retained greater than 90% of the aggregate dollar amount of our software maintenance contracts up for renewal. Consequently, a decline in new or renewed software maintenance by our customers in any one quarter may not be immediately reflected in our revenue for that quarter. Such a decline, however, will adversely affect our revenue in future quarters. Accordingly, the effect of significant downturns in our rate of renewals may not be fully reflected in our operating results until future periods.

We primarily operate in the rapidly evolving and highly competitive healthcare market, and if we fail to effectively respond to competitive pressures, our business, financial condition and operating results could be adversely affected.

The market for authentication and access management solutions within the healthcare market is highly fragmented, consisting of a significant number of vendors that is rapidly changing. Competition in our market is primarily based on:

 

 

brand awareness and reputation;

 

breadth of our solutions set and ease of implementation, use and management;

 

breadth of product distribution;

 

strategic relationships and ability to integrate with software and device vendors; and

 

product innovation and ability to meet customer needs.

We believe our primary competitor in the healthcare industry is Caradigm USA LLC, a joint venture of General Electric Company and Microsoft Corporation. We expect competition to intensify in the future with existing competitors and market entrants. Our competitors in the healthcare market for authentication and access management solutions include large, multinational companies with significantly more resources to dedicate to product development and sales and marketing. These companies may have existing relationships within healthcare organizations, which may enhance their ability to gain a foothold in our market. Customers may prefer to purchase a more highly integrated or bundled solution from a single provider or an existing supplier rather than a separate supplier, regardless of performance or features. Increased competition may result in additional pricing pressure, reduced profit margins, higher sales and marketing expenses, lower revenue and the loss of market share, which could adversely affect our business, financial condition and operating results.

Industry consolidation or new market entrants may result in increased competitive pressure, which could result in the loss of customers or a reduction in revenue.

Some of our competitors have made or may make acquisitions or may enter into partnerships or other strategic relationships to offer more comprehensive services than they individually had offered or achieve greater economies of scale. We expect these trends to continue as companies attempt to strengthen or maintain their market positions. For example, potential entrants not currently considered to be our competitors, such as providers of electronic health record systems, may enter our market by acquiring or developing their own access or authentication management solutions. In addition, providers of authentication and access management solutions, such as CA, Inc., International Business Machines Corporation, Oracle Corporation and Novell, Inc., may enter the healthcare market. Such potential entrants, if they enter the healthcare market for authentication and access management solutions, may have competitive advantages over us, such as greater name recognition, longer operating histories, more varied services and larger marketing budgets, as well as greater financial, technical and other resources. The companies resulting from combinations or that expand or

 

18


Table of Contents

vertically integrate their business to include the authentication and access management market that we address may create more compelling service offerings and may offer greater pricing flexibility than we can or may engage in business practices that make it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs, technology or service functionality. These pressures could result in a substantial loss of our customers, which may have a material adverse effect on our business, financial condition and operating results.

Our success depends upon our ability to attract, integrate and retain key personnel, and our failure to do so could adversely affect our ability to grow our business.

Our success depends, in part, on the services of our senior management and other key personnel, and our ability to continue to attract, integrate and retain highly skilled personnel, particularly in engineering, sales and marketing. Competition for highly skilled personnel is intense. If we fail to attract, integrate and retain key personnel, our ability to grow our business could be adversely affected.

The members of our senior management and other key personnel are at-will employees, and may terminate their employment at any time without notice. If they terminate their employment, we may not be able to find qualified individuals to replace them on a timely basis or at all and our senior management may need to divert their attention from other aspects of our business. Former employees may also become employees of a competitor. We may also have to pay additional compensation to attract and retain key personnel. We also anticipate hiring additional engineering, marketing and sales, and services personnel to grow our business. Often, significant amounts of time and resources are required to recruit and train these personnel. We may incur significant costs to attract, integrate and retain them, and we may lose them to a competitor or another company before we realize the benefit of our investments in them.

If we do not achieve the anticipated strategic or financial benefits from our acquisitions, or if we cannot successfully integrate them, our business and operating results could be adversely affected.

We have acquired, and in the future may acquire, complementary businesses, technologies or assets that we believe to be strategic. We may not achieve the anticipated strategic or financial benefits, or be successful in integrating any acquired businesses, technologies or assets. If we cannot effectively integrate newly-acquired technologies and solutions and successfully market and sell these new product offerings, we may not achieve market acceptance for, or significant revenue from, these new product offerings.

Integrating newly-acquired businesses, technologies and assets could strain our resources, could be expensive and time consuming, and might not be successful. If we acquire or invest in additional businesses, technologies or assets, we will be further exposed, to a number of risks, including that we may:

 

 

experience technical issues as we integrate acquired businesses, technologies or assets into our existing solutions;

 

 

encounter difficulties leveraging our existing sales and marketing organizations, and sales channels, to increase our revenue from acquired businesses, technologies or assets;

 

 

find that the acquisition does not further our business strategy, that we overpaid for the acquisition or that the economic conditions underlying our acquisition decision have changed;

 

 

have difficulty retaining the key personnel of acquired businesses;

 

 

suffer disruption to our ongoing business and diversion of our management’s attention as a result of the negotiation of any acquisition as well as related transition or integration issues and the challenges of managing geographically or culturally diverse enterprises; and

 

 

experience unforeseen and significant problems or liabilities associated with quality, technology and legal contingencies relating to the acquisition, such as intellectual property or employment matters.

 

19


Table of Contents

In addition, from time to time we may enter into negotiations for acquisitions that are not ultimately consummated. These negotiations could result in significant diversion of management time, as well as substantial out-of-pocket costs. If we were to proceed with one or more significant acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash. To the extent we issue shares of capital stock or other rights to purchase capital stock, including options and warrants, the ownership of existing stockholders would be diluted. In addition, acquisitions may result in the incurrence of debt, contingent liabilities, write-offs or other unanticipated costs, events or circumstances, any of which adversely affect our business and operating results.

The software and hardware contained in the Imprivata OneSign solution is complex and may contain undetected errors that could have a material adverse effect on our business, financial condition and operating results.

Our Imprivata OneSign solution incorporates complex technology, is used in a variety of healthcare settings and must interoperate with many different types of complex devices and information technology systems. While we test our solutions for defects and errors prior to release, we or our customers may not discover a defect or error until after we have deployed our solutions and our customers have commenced general use of the solution. If we cannot successfully integrate our authentication and access management solutions with health information systems as needed or if any hardware or software of these health information systems contains any defect or error, then our solutions may not perform as designed, or may exhibit a defect or error.

Any defects or errors in, or which are attributed to, our solutions, could result in:

 

 

delayed market acceptance of our affected solutions;

 

loss of customers or inability to attract new customers;

 

diversion of engineering or other resources for remedying the defect or error;

 

damage to our brand and reputation;

 

increased service and warranty costs;

 

legal actions by our customers or third parties, including product liability claims; and

 

penalties imposed by regulatory authorities.

Our solutions are utilized by clinicians in the course of providing patient care. It is possible that our healthcare customers may allege we are responsible for harm to patients or clinicians due to defects in, the malfunction of, the characteristics of, or the use of, our solutions. Although our customer agreements contain disclaimers of liability that are intended to reduce or eliminate our potential liability, we could be required to spend significant amounts of management time and resources to defend ourselves against product liability, tort, warranty or other claims. If any such claims were to prevail, we could be forced to pay damages or stop distributing our solutions. Even if potential claims do not result in liability to us, investigating and defending against these claims could be expensive and time consuming and could divert management’s attention away from our business. We maintain general liability insurance coverage, including coverage for errors and omissions; however, this coverage may not be sufficient to cover large claims against us or otherwise continue to be available on acceptable terms. Further, the insurer could attempt to disclaim coverage as to any particular claim. Such circumstances could have a material adverse effect on our business, financial condition and results of operations.

 

20


Table of Contents

Our international operations subject us, and may increasingly subject us in the future, to operational, financial, economic and political risks abroad, which could have a material adverse effect on our business, financial condition and results of operations.

Although we currently derive a relatively small portion of our revenue from customers outside of the United States, a key element of our growth strategy is to expand internationally. Our international expansion efforts might not be successful in creating demand for our products and services or in effectively selling our solutions in the international markets we enter. In addition, we will face risks in doing business internationally that could adversely affect our business, including:

 

 

difficulties integrating our solutions with information technology systems and processes with which we do not have experience;

 

 

political and economic instability in, or foreign conflicts that involve or affect, the countries where we operate and sell our solution;

 

 

difficulties in staffing and managing personnel and channel partners;

 

 

the need to comply with a wide variety of foreign laws and regulations, including privacy and security regulations, requirements for export controls for encryption technology, employment laws, changes in tax laws and tax audits by government agencies;

 

 

competitors who are more familiar with local markets;

 

 

challenges associated with delivering services, training and documentation in foreign languages;

 

 

difficulties in collecting accounts receivable and longer accounts receivable payment cycles; and

 

 

limited or unfavorable intellectual property protection in some countries.

In addition, as we continue to expand our international operations, we will become more exposed to the effects of fluctuations in currency exchange rates. We incur expenses for employee compensation and other operating expenses at our international locations and accept payment from customers in the local currency. Since we conduct business in currencies other than the U.S. dollar but report our operating results in U.S. dollars, we have exposure to fluctuations in currency exchange rates. We do not currently hedge against the risks associated with currency fluctuations but may do so in the future.

Any of these factors could harm our existing international business and operations, and have a material adverse effect on our business, financial condition and results of operations.

Risks posed by sales to foreign government-operated healthcare organizations could have a material adverse effect on our revenues and operating results.

We expect to continue to derive a substantial portion of our international revenues from foreign government-operated healthcare organizations. Sales to governmental entities present risks in addition to those involved in sales to commercial customers, including potential disruption due to changes in appropriation and spending patterns, delays in budget approvals and exposure to penalties in the event of violations of the Foreign Corrupt Practices Act. General political and economic conditions, which we cannot accurately predict, directly and indirectly may affect the quantity and allocation of expenditures by governmental entities. In addition, obtaining government contracts may involve long purchase and payment cycles, competitive bidding, qualification requirements, delays or changes in funding, budgetary constraints, political agendas, extensive specification development and price negotiations and milestone requirements. In general, each governmental entity also maintains its own rules and regulations with which we must comply and which can vary significantly among departments. These factors may result in cutbacks or re-allocations in the budget or losses of government sales, which could have a material adverse effect on our revenues and operating results.

 

21


Table of Contents

If we fail to offer services that are satisfactory to our customers, our ability to sell our solutions will be adversely affected.

Our ability to sell our Imprivata OneSign solution is dependent upon our ability to provide high-quality services and support. Our services team assists our customers with their clinical workflow design, authentication and access management solution configuration, training and project management during the pre-deployment and deployment stages. Once our solutions are deployed within a customer’s facility, the customer typically depends on our services team to help resolve technical issues, assist in optimizing the use of our solutions and facilitate adoption of new functionality. A substantial proportion of our Imprivata OneSign customers in the United States rely on our Imprivata OneSign solution as a component of their electronic health record, or EHR, systems that they implement to meet regulatory standards for adoption, or “meaningful use,” of EHR technologies. If our solutions do not adequately facilitate our customers’ attainment of meaningful use requirements as defined by the relevant regulatory authorities and interpreted by our customers, or if deployment of our solutions is unsatisfactory, we may incur significant costs to attain and sustain customer satisfaction. As we hire new services personnel, we may inadvertently hire underperforming people who will have to be replaced, or fail to effectively train such employees. If we do not effectively assist our customers in deploying our solutions, succeed in helping our customers resolve technical and other post-deployment issues, or provide effective ongoing services, our ability to expand the use of our solutions with existing customers and to sell our solutions to new customers will be harmed. In addition, the failure of channel partners to provide high-quality services in markets outside of the United States could adversely affect sales of our solutions internationally.

We face potential liability related to the privacy and security of PHI accessed or collected through our solutions.

Our Imprivata OneSign solution customers in the ordinary course of their business handle, access or store PHI. In the United States, the manner in which these customers manage PHI is subject to the Health Insurance Portability and Accountability Act of 1996, or HIPAA, the Health Information Technology for Economic and Clinical Health Act of 2009, or HITECH Act, health data privacy, security and breach notification regulations issued pursuant to these statutes, and state privacy, security and breach notification laws and regulations applicable to such health information. These customers rely on our Imprivata OneSign solution as a tool to facilitate their compliance with applicable health data privacy and security standards. Specifically, HIPAA-covered health care providers are required to implement technical data security safeguards, certain of which are supported by Imprivata OneSign. The failure of our Imprivata OneSign solution to perform an essential function for which it was designed could result in a breach of our obligations under our customer contracts, which could result in monetary damages, adverse publicity, and have an adverse impact on our business.

We may also directly handle, access or store PHI in connection with our commercial solutions, such as our Imprivata Cortext solution, which is a secure, cloud-based communication platform that provides healthcare organizations and healthcare providers with secure SMS texting and messaging capabilities. Although we are transmitting and storing PHI in encrypted format for such customers, and do not, in the ordinary course of our business, require access to such PHI, we are deemed to be a “business associate” of such customers and as such are directly subject to certain HIPAA and HITECH Act requirements as well as contractual obligations that may be imposed by our customers pursuant to their HIPAA and HITECH Act requirements. These statutes, regulations and contractual obligations impose numerous requirements regarding the use and disclosure of PHI. Our failure to effectively implement the required or addressable health data privacy and security safeguards and breach notification procedures, our failure to accurately anticipate the application or interpretation of these statutes, regulations and contractual obligations as we develop our solutions or an allegation that defects in our products have resulted in noncompliance by our customers could result in a breach of our contractual obligations to our customers, create material civil and/or criminal liability for us, which could result in adverse publicity and have a material adverse effect on our business.

 

22


Table of Contents

In addition to complying with applicable U.S. law, the use and disclosure of PHI is subject to regulation in other jurisdictions in which we do business or expect to do business in the future. Those jurisdictions may attempt to apply such laws extraterritorially or through treaties or other arrangements with U.S. governmental entities. We might unintentionally violate such laws, such laws may be modified and new laws may be enacted in the future which may increase the chance that we violate them. Any such developments, or developments stemming from enactment or modification of other laws, or the failure by us to comply with their requirements or to accurately anticipate the application or interpretation of these laws, could discourage us from offering certain of our solutions, such as Imprivata Cortext, to customers outside of the United States, and could create material liability to us, result in adverse publicity and adversely affect our business. A finding that we have failed to comply with applicable laws and regulations regarding the collection, use and disclosure of PHI could create liability for us, result in adverse publicity and materially adversely affect our business.

In addition, the costs of compliance with, and the other burdens imposed by, these and other laws or regulatory actions may prevent us from selling our solutions or increase the costs associated with selling our solutions, and may affect our ability to invest in or jointly develop solutions in the United States and in foreign jurisdictions. Further, we cannot assure you that our privacy and security policies and practices will be found sufficient to protect us from liability or adverse publicity relating to the privacy and security of PHI.

Fluctuating economic conditions could have a material adverse effect on our business, financial condition and results of operations.

Our revenue depends significantly on general economic conditions and the demand for authentication and access management solutions in the healthcare market. Our healthcare customers may experience declining revenues from the decreased utilization of healthcare services and diminishing margins due to impediments in obtaining third-party reimbursement and patient payments. These factors may result in constrained spending on authentication and access management solutions. General economic weakness may also lead to longer collection cycles for payments due from our customers, an increase in customer bad debt, restructuring initiatives and associated expenses, and impairment of investments. Uncertainty about future economic conditions also makes it difficult to forecast operating results and to make decisions about future investments. Such factors could make it difficult to accurately forecast our sales and operating results and could adversely affect our ability to provide accurate forecasts to our suppliers and contract manufacturer and manage our supplier and contract manufacturer relationships and other expenses. Economic weakness faced by us or our customers, failure of our customers and markets to recover from such weakness, customer financial difficulties, and reductions in spending on authentication and access management technologies could have a material adverse effect on demand for our solutions and consequently on our business, financial condition and results of operations.

The market size estimate included in this prospectus may prove to be inaccurate and may not be indicative of our future growth.

The healthcare industry is in the early stages of market acceptance of authentication and access management solutions. Because of rapid and significant technological changes, it is difficult to predict the size of the market and the rate at which the market for our products and services will grow or be accepted. While our estimate of the total available market included in this prospectus was made in good faith and is based on assumptions and estimates we believe to be reasonable, this estimate may not prove to be accurate. This is particularly the case with respect to estimating the size of the international component of the market.

 

23


Table of Contents

Our Imprivata Cortext solution uses a third-party data service provider for web hosting services. Any operational delay or failure of our Cortext solution could expose us to litigation, harm our relationships with customers and have a material adverse effect on our brand and our business.

Our Imprivata Cortext solution utilizes a cloud-based third-party data service provider for web hosting services. We exercise limited control over this third-party data service provider, which increases our vulnerability with respect to the technology and information services it provides. In addition, if we are unable to renew the agreement with the third-party data service provider on commercially reasonable terms, we may be required to transfer our services to new data service providers and we may incur significant costs and possible service interruption in connection with doing so. Our Cortext solution provides communication and information to assist healthcare organizations. Any operational delay or failure of our Cortext solution might result in the disruption of patient care and could harm our relationships with customers, expose us to litigation or have a material adverse effect on our brand and our business.

If we are required to collect sales and use or similar foreign taxes in additional jurisdictions, we might be subject to liability for past sales and our future sales may decrease.

We might lose sales or incur significant expenses if states or foreign jurisdictions successfully impose broader guidelines on state sales and use or similar foreign taxes. A successful assertion by one or more states or foreign jurisdictions requiring us to collect sales or other taxes on the licensing of our software or sale of our services could result in substantial tax liabilities for past transactions and otherwise harm our business. Each state or foreign jurisdiction has different rules and regulations governing sales and use or similar foreign taxes, and these rules and regulations are subject to varying complex interpretations that change over time. We review these rules and regulations periodically and, when we believe we are subject to sales and use or similar foreign taxes in a particular state or foreign jurisdiction, engage tax authorities in order to determine how to comply with their rules and regulations. We cannot assure you that we will not be subject to sales and use or similar taxes or related penalties for past sales in states or foreign jurisdictions where we currently believe no such taxes are required.

Vendors of products and services, like us, are typically held responsible by taxing authorities for the collection and payment of any applicable sales and similar taxes. If one or more taxing authorities determines that taxes should have, but have not, been paid with respect to our services, we might be liable for past taxes in addition to taxes going forward. Liability for past taxes might also include substantial interest and penalty charges. Our customer contracts typically provide that our customers must pay all applicable sales and similar taxes. Nevertheless, our customers might be reluctant to pay back taxes and might refuse responsibility for interest or penalties associated with those taxes. If we are required to collect and pay back taxes and the associated interest and penalties, and if our clients fail or refuse to reimburse us for all or a portion of these amounts, we will incur unplanned expenses that may be substantial. Moreover, imposition of such taxes on us going forward will effectively increase the cost of our products and services to our customers and might adversely affect our ability to retain existing customers or to gain new customers in the areas in which such taxes are imposed.

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

In general, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change net operating losses, or NOLs, to offset future taxable income. If we undergo an ownership change in connection with or after this offering or any future offering, our ability to utilize NOLs could be further limited by Section 382 of the Code. Future changes in our stock ownership, some of which are outside of our control, could result in an ownership change under Section 382 of the Code. Furthermore, our ability to utilize NOLs of companies that we may acquire in the future may be subject to limitations. There is also a risk that due to

 

24


Table of Contents

regulatory changes, such as suspensions on the use of NOLs, or other unforeseen reasons, our existing NOLs could expire or otherwise be unavailable to offset future income tax liabilities. For these reasons, we may not be able to utilize a material portion of the NOLs reflected on our balance sheet, even if we attain profitability.

Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by man-made problems such as power disruptions or terrorism.

A significant natural disaster, such as an earthquake, fire or a flood, occurring at our headquarters, our other facilities or where our contract manufacturer or its suppliers are located, could harm our business, operating results and financial condition. In addition, acts of terrorism could cause disruptions in our business, the businesses of our customers and suppliers, or the economy as a whole. We also rely on information technology systems to communicate among our workforce located worldwide, and in particular, our senior management, general and administrative, and research and development activities that are coordinated with our corporate headquarters in the Boston, Massachusetts area. Any disruption to our internal communications, whether caused by a natural disaster or by man-made problems, such as power disruptions, in the Boston, Massachusetts area could delay our research and development efforts, cause delays or cancellations of customer orders or delay deployment of our solutions, which could have a material adverse effect on our business, operating results and financial condition.

Risks related to our intellectual property

If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.

Our success depends, in part, on our ability to protect our proprietary technology. We seek to protect our proprietary technology through patent, copyright, trade secret and trademark laws in the United States and similar laws in other countries. We also seek to protect our proprietary technology through licensing agreements, nondisclosure agreements and other contractual provisions. These protections may not be available in all cases or may be inadequate to prevent our competitors from copying, reverse engineering or otherwise obtaining and using our technology, proprietary rights or solutions in an unauthorized manner. The laws of some foreign countries may not be as protective of intellectual property rights as those in the United States, and mechanisms for enforcement of intellectual property rights may be inadequate. In addition, third parties may seek to challenge, invalidate or circumvent our patents, trademarks, copyrights and trade secrets, or applications for any of the foregoing. Our competitors may independently develop technologies that are substantially equivalent, or superior, to our technology or design around our proprietary rights. In each case, our ability to compete could be significantly impaired.

To prevent unauthorized use of our intellectual property rights, it may be necessary to prosecute actions for infringement or misappropriation of our proprietary rights. Any such action could result in significant costs and diversion of our resources and management’s attention, and there can be no assurance that we will be successful in such action. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing or misappropriating our intellectual property. While we plan to continue to seek to protect our intellectual property with, among other things, patent protection, there can be no assurance that:

 

25


Table of Contents
 

current or future U.S. or foreign patent applications will be approved;

 

 

our issued patents will adequately protect our intellectual property and not be held invalid or unenforceable if challenged by third parties;

 

 

we will succeed in protecting our technology adequately in all key jurisdictions in which we or our competitors operate; and

 

 

others will not design around any patents that may be issued to us.

Our failure to obtain patents sufficiently broad to cover our technology and possible workarounds, or the invalidation of our patents, or our inability adequately to protect our intellectual property, may weaken our competitive position and harm our business and operating results. We might be required to spend significant resources to monitor and protect our intellectual property rights. We may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel, which may harm our business, operating results and financial condition.

Agreements we have with our employees, consultants and independent contractors may not afford adequate protection for our trade secrets, confidential information and other proprietary information.

In addition to patent protection, we also rely on copyright and trademark protection, trade secrets, know-how, continuing technological innovation and licensing opportunities. In an effort to maintain the confidentiality and ownership of our trade secrets and proprietary information, we require our employees, consultants and independent contractors to execute confidentiality and proprietary information agreements. However, these agreements may not provide us with adequate protection against improper use or disclosure of confidential information and available remedies in the event of unauthorized use or disclosure may not be adequate. The failure by employees, consultants or independent contractors to maintain the secrecy of our confidential information may compromise or prevent our ability to maintain trade secrets or obtain needed or meaningful patent protection. In some situations, our confidentiality and proprietary information agreements may conflict with, or be subject to, the rights of third parties with whom our employees, consultants or independent contractors have prior employment or consulting relationships. Although we require our employees, consultants and independent contractors to maintain the confidentiality of all proprietary information of their previous employers, these individuals, or we, may be subject to allegations of trade secret misappropriation or other similar claims as a result of their prior affiliations. Finally, others may independently develop substantially equivalent proprietary information and techniques or gain access to our trade secrets. Our failure or inability to protect our proprietary information and techniques may inhibit or limit our ability to compete effectively, or exclude certain competitors from the market.

We may not be able to obtain or maintain necessary licenses of third-party technology on commercially reasonable terms, or at all, which could delay product sales and development and have a material adverse effect on product quality and our ability to compete.

We have incorporated third-party licensed technology into certain of our solutions. We anticipate that we are also likely to need to license additional technology from third parties in connection with the development of new solutions or enhancements in the future. Third-party licenses may not be available to us on commercially reasonable terms, or at all. The inability to retain any third-party licenses required in our current solutions or to obtain any new third-party licenses to develop new solutions and products could require us to obtain substitute technology of lower quality or performance standards or at greater cost, and delay or prevent us from introducing these solutions or products, any of which could have a material adverse effect on product quality and our ability to compete.

 

26


Table of Contents

Claims of intellectual property infringement could harm our business.

Vigorous protection and pursuit of intellectual property rights has resulted in protracted and expensive litigation for many companies in our industry. Although claims of this kind have not materially affected our business to date, there can be no assurance such claims will not arise in the future. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements, any of which could harm our business and operating results.

Intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we cannot be certain that we will be successful in defending ourselves against intellectual property claims. In addition, we may not be able to effectively utilize our intellectual property portfolio to assert defenses or counterclaims in response to patent infringement claims or litigation brought against us by third parties. Further, litigation may involve patent holding companies or other adverse patent owners who have no relevant products and against whom our potential patents may provide little or no deterrence.

Many potential litigants have the capability to dedicate substantially greater resources to enforce their intellectual property rights and to defend claims that may be brought against them. Furthermore, a successful claimant could secure a judgment that requires us to pay substantial damages or prevents us from distributing certain solutions or performing certain services. We might also be required to seek a license and pay royalties for the use of such intellectual property, which may not be available on commercially acceptable terms or at all. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful.

Our use of open source and non-commercial software components could impose risks and limitations on our ability to commercialize our solutions.

Our solutions contain software modules licensed under open source and other types of non-commercial licenses. We also may incorporate open source and other licensed software into our solutions in the future. Use and distribution of such software may entail greater risks than use of third-party commercial software, as licenses of these types generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Some of these licenses require the release of our proprietary source code to the public if we combine our proprietary software with open source software in certain manners. This could allow competitors to create similar products with lower development effort and time and ultimately result in a loss of sales for us.

The terms of many open source and other non-commercial licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our solutions. In such event, in order to continue offering our solutions, we could be required to seek licenses from alternative licensors, which may not be available on a commercially reasonable basis or at all, to re-engineer our solutions or to discontinue the sale of our solutions in the event we cannot obtain a license or re-engineer our solutions on a timely basis, any of which could harm our business and operating results. In addition, if an owner of licensed software were to allege that we had not complied with the conditions of the corresponding license agreement, we could incur significant legal costs defending ourselves against such allegations. In the event such claims were successful, we could be subject to significant damages, be required to disclose our source code, or be enjoined from the distribution of our solutions.

 

27


Table of Contents

Our loan agreement contains operating and financial covenants that may restrict our business and financing activities.

We are party to a loan and security agreement relating to a revolving line of credit facility with Silicon Valley Bank. Borrowings under this loan and security agreement are secured by substantially all of our assets. Our loan and security agreement restricts our ability to:

 

 

incur additional indebtedness;

 

 

redeem subordinated indebtedness;

 

 

create liens on our assets;

 

 

enter into transactions with affiliates;

 

 

make investments;

 

 

sell assets;

 

 

make material changes in our business or management;

 

 

pay dividends, other than dividends paid solely in shares of our common stock, or make distributions on and, in certain cases, repurchase our stock; or

 

 

consolidate or merge with other entities.

In addition, our revolving line of credit requires us to maintain specified adjusted quick ratio tests. The operating and financial restrictions and covenants in the loan and security agreement governing our revolving line of credit, as well as any future financing agreements that we may enter into, may restrict our ability to finance our operations, engage in business activities or expand or fully pursue our business strategies. Our ability to comply with these covenants may be affected by events beyond our control, and we may not be able to meet those covenants. A breach of any of these covenants could result in a default under the loan and security agreement, which could cause all of the outstanding indebtedness under the facility to become immediately due and payable and terminate all commitments to extend further credit.

If we are unable to generate sufficient cash available to repay our debt obligations when they become due and payable, either when they mature or in the event of a default, we may not be able to obtain additional debt or equity financing on favorable terms, if at all, which may negatively impact our ability to continue as a going concern.

Risks related to this offering and our common stock

We do not currently intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We have never declared or paid any cash dividends on our common stock and do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future, and the success of an investment in shares of our common stock will depend upon future appreciation in its value, if any. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders purchased their shares.

 

28


Table of Contents

Our management has broad discretion over the use of proceeds from our initial public offering and might not apply the proceeds of our initial public offering in ways that increase the value of your investment in our company.

Our management has broad discretion to use the net proceeds to us from our initial public offering, and you are relying on the judgment of our management regarding the application of these proceeds, without the opportunity to assess whether the proceeds are being used appropriately. The failure of our management to apply the net proceeds effectively could harm our business, financial condition and operating results, and may not increase the value of your investment in our company.

We have not allocated these net proceeds for specific purposes. We intend to use the net proceeds from our initial public offering for general corporate purposes, including working capital. We may also use a portion of the net proceeds to acquire or invest in complementary businesses, technologies or assets, but at this time, we have no current understandings, agreements or commitments to do so. Our management might not be able to yield a significant return or any return on any investment of these net proceeds.

You will experience immediate and substantial dilution.

The initial public offering price will be substantially higher than the net tangible book value of each outstanding share of common stock immediately after this offering. If you purchase common stock in this offering, you will suffer immediate and substantial dilution. At the initial public offering price of $15.00 with estimated net proceeds to us of $66.3 million, if you purchase our common stock in this offering, you will suffer immediate and substantial dilution of $12.53 per share. In addition, if outstanding options or warrants to purchase shares of our common stock are exercised, there could be further dilution. For more information refer to “Dilution”.

An active, liquid, and orderly market for our common stock may not develop.

Prior to this offering, there was no market for shares of our common stock. An active trading market for our common stock might never develop or be sustained, which could depress the market price of our common stock and affect your ability to sell our shares. The initial public offering price was determined through negotiations between us and the representatives of the underwriters and might bear no relationship to the price at which our common stock will trade following the completion of this offering. The trading price of our common stock following this offering is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include:

 

 

our operating performance and the operating performance of similar companies;

 

 

the overall performance of the equity markets;

 

 

announcements by us or our competitors of new products, commercial relationships or acquisitions;

 

 

threatened or actual litigation;

 

 

changes in laws or regulations relating to the healthcare industry;

 

 

any major change in our board of directors or management;

 

 

publication of research reports or news stories about us, our competitors, or our industry, or positive or negative recommendations or withdrawal of research coverage by securities analysts;

 

 

large volumes of sales of our shares of common stock by existing stockholders; and

 

 

general political and economic conditions.

 

29


Table of Contents

In addition, the stock market in general, and the market for healthcare information technology companies in particular, has at times experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies.

These fluctuations might be even more pronounced in the trading market for our stock shortly following this offering. Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. This litigation, if instituted against us, could result in substantial costs, divert our management’s attention and resources, and harm our business, operating results and financial condition.

Future sales of shares of our common stock by existing stockholders could depress the market price of our common stock.

Upon completion of this offering, there will be 22,815,867 shares of our common stock outstanding, based on the number of shares outstanding as of March 31, 2014. The 5,000,000 shares being sold in this offering will be freely tradable immediately after this offering (except for shares purchased by affiliates) and the remaining shares outstanding after this offering will be available for sale, upon the expiration of the 180-day lock-up period beginning from the date of this prospectus, if applicable, subject to volume and other restrictions as applicable under Rule 144 under the Securities Act of 1933, as amended, which we refer to as the Securities Act. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the lead underwriter for this offering.

We also intend to register all common stock that we may issue under our stock plans. In connection with this offering, an aggregate of 2,559,172 shares of our common stock are reserved for future issuance under our stock option plans, and 448,000 shares of our common stock are reserved for future issuance under our ESPP. Once we register these shares, which we plan to do shortly after the completion of this offering, they can be freely sold in the public market upon issuance, subject to the lock-up agreements referred to above. If a large number of these shares are sold in the public market, the sales could reduce the trading price of our common stock. See “Shares eligible for future sale” for a more detailed description of sales that may occur in the future.

The concentration of our capital stock ownership with insiders will likely limit your ability to influence corporate matters.

Our executive officers, directors, current 5% or greater stockholders and entities affiliated with any of them, together will beneficially own 67.1% of our common stock outstanding after this offering, based on the number of shares outstanding as of March 31, 2014. These stockholders, if they act together, will have significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, and may take actions that may not be in the best interests of our other stockholders. This concentration of ownership could also limit stockholders’ ability to influence corporate matters. Accordingly, corporate actions might be taken even if other stockholders, including those who purchase shares in this offering, oppose them, or may not be taken even if other stockholders view them as in the best interests of our stockholders. This concentration of ownership may have the effect of delaying or preventing a change of control of our company, may make the approval of certain transactions difficult or impossible without the support of these stockholders and might adversely affect the market price of our common stock.

 

30


Table of Contents

We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an “emerging growth company.” We will remain an emerging growth company until the earliest of: the end of the fiscal year in which the market value of our common stock that is held by non-affiliates exceeds $700 million as of June 30 of that fiscal year, the end of the fiscal year in which we have total annual gross revenue of $1 billion or more during such fiscal year, the date on which we issue more than $1 billion in non-convertible debt securities in a three-year period, or the last day of the fiscal year following the fifth anniversary of this offering.

Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

We are in the process of evaluating whether to take advantage of exemptions from various other requirements that are available to emerging growth companies, including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved, and exemptions from the requirements of auditor attestation reports on the effectiveness of our internal control over financial reporting. We cannot predict whether investors will find our common stock less attractive to the extent we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

We will incur increased costs as a result of operating as a public company, and our management will be required to devote substantial time to compliance with our public company responsibilities and corporate governance practices. We will also need to ensure that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis. Failure to maintain proper and effective internal controls could impair our ability to produce accurate and timely financial statements, which could harm our operating results, our ability to operate our business, and our investors’ view of us.

As a public company, and particularly after we are no longer an “emerging growth company,” we will incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act, the listing requirements of the New York Stock Exchange, or NYSE, and other applicable securities rules and regulations impose various requirements on public companies. Our management and other personnel will need to devote a substantial amount of time to compliance with these requirements. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. We cannot predict or estimate the amount of additional costs we will incur as a public company or the timing of such costs.

One aspect of complying with these rules and regulations as a public company is that we will be required to ensure that we have adequate financial and accounting controls and procedures in place. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. This is a costly and time-consuming effort that needs to be re-evaluated periodically.

We have begun the process of documenting, reviewing and improving our internal controls and procedures for compliance with Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, which will require that we evaluate, test and document our internal controls and, as a part of that evaluation, testing and documentation, identify areas

 

31


Table of Contents

for further attention and improvement. In the course of that process, we discovered a significant deficiency related to our 2012 financial statements requiring us to make reclassifications of certain previously reported items. We have since remediated this significant deficiency by automating certain financial reporting processes and the hiring of additional personnel. We have hired and continue to recruit additional finance and accounting personnel, as well as outside consultants, and we will need to continue to dedicate internal resources, and potentially engage additional outside consultants, to adopt a detailed work plan to assess and document the adequacy of internal control over financial reporting, continue steps to improve control processes as appropriate, validate through testing that controls are functioning as documented and implement a continuous reporting and improvement process for internal control over financial reporting. Implementing any appropriate changes to our internal controls may distract our officers and employees, entail substantial costs to modify our existing processes and take significant time to complete. These changes may not, however, be effective in maintaining the adequacy of our internal controls. Thus, despite our efforts, there is a risk that we will not be able to conclude, within the prescribed timeframe or at all, that our internal control over financial reporting is effective as required by Section 404. Any failure to maintain the adequacy of our internal controls, consequent inability to produce accurate financial statements on a timely basis, or identification of one or more material weaknesses could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements.

If securities or industry analysts do not publish research or reports about our business, or publish inaccurate or unfavorable research or reports about our business, our stock price and trading volume could decline.

The trading market for our common stock will, to some extent, depend on the research and reports that securities or industry analysts publish about us and our business. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our common stock or change their opinion of our common stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.

Our charter documents and Delaware law could discourage, delay or prevent a change of control of our company or change in our management that stockholders consider favorable and cause our stock price to decline.

Certain provisions of our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law could discourage, delay or prevent a change of control of our company or change in our management that the stockholders of our company consider favorable. These provisions:

 

 

authorize the issuance of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares and to discourage a takeover attempt;

 

 

prohibit stockholder action by written consent, requiring all stockholder actions to be taken at a meeting of stockholders;

 

 

establish advance notice procedures for nominating candidates to our board of directors or proposing matters that can be acted upon by stockholders at stockholder meetings;

 

 

limit the ability of our stockholders to call special meetings of stockholders;

 

 

prohibit stockholders from cumulating their votes for the election of directors;

 

 

permit newly-created directorships resulting from an increase in the authorized number of directors or vacancies on our board of directors to be filled only by majority vote of our remaining directors, even if less than a quorum is then in office;

 

32


Table of Contents
 

provide that our board of directors is expressly authorized to make, alter or repeal our amended and restated bylaws;

 

 

establish a classified board of directors so that not all members of our board are elected at one time;

 

 

provide that our directors may be removed only for “cause” and only with the approval of the holders of at least 75% of our outstanding stock; and

 

 

require super-majority voting to amend certain provisions in our amended and restated certificate of incorporation and amended and restated bylaws.

Section 203 of the Delaware General Corporation Law, which will apply to us, may also discourage, delay or prevent a change of control of our company.

We may not be able to obtain capital when desired on favorable terms, if at all, or without dilution to our stockholders.

We may need additional financing to execute on our current or future business strategies, including to:

 

 

hire additional personnel;

 

develop new or enhance existing products and services;

 

expand our operating infrastructure;

 

acquire businesses or technologies; or

 

otherwise respond to competitive pressures.

If we incur additional funds through debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, thus limiting funds available for our business activities. We cannot assure you that additional financing will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms when we desire them, our ability to fund our operations, take advantage of unanticipated opportunities, develop or enhance our products and services, or otherwise respond to competitive pressures would be significantly limited. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing stockholders.

 

33


Table of Contents

Special note regarding forward-looking statements and industry data

This prospectus, including the sections entitled “Prospectus summary,” “Risk factors,” “Management’s discussion and analysis of financial condition and results of operations” and “Business,” contains forward-looking statements that are based on our management’s belief and assumptions and on information currently available to our management. Although we believe that the expectations reflected in these forward-looking statements are reasonable, these statements relate to future events or our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Forward-looking statements in this prospectus include, but are not limited to, statements about:

 

 

the size and growth of the potential markets for our products and our ability to serve those markets;

 

the rate and degree of market acceptance of our products;

 

the accuracy of our estimates regarding expenses, revenues and capital requirements;

 

regulatory developments in the United States and foreign countries;

 

the success of our sales and marketing capabilities;

 

the success of competing products that are or become available;

 

our use of the net proceeds from this offering;

 

our ability to obtain additional financing if needed;

 

our ability to obtain and maintain intellectual property protection for our proprietary assets; and

 

the loss of key technology or management personnel.

In some cases, you can identify forward-looking statements by terminology such as “may,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other similar terminology. These statements are only predictions. You should not place undue reliance on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which are, in some cases, beyond our control and that could materially affect results. Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under “Risk factors” and elsewhere in this prospectus. If one or more of these risks or uncertainties occur, or if our underlying assumptions prove to be incorrect, actual events or results may vary significantly from those implied or projected by the forward-looking statements. No forward-looking statement is a guarantee of future performance. You should read this prospectus and the documents that we reference in this prospectus and have filed with the Securities and Exchange Commission as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from any future results expressed or implied by these forward-looking statements.

The forward-looking statements in this prospectus represent our views as of the date of this prospectus. We anticipate that subsequent events and developments will cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. You should therefore not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this prospectus.

 

34


Table of Contents

This prospectus contains estimates and other statistical data that we obtained or derived from, or that we estimated in good faith based partly on, industry publications, surveys, forecasts and reports, governmental publications, reports by market research firms or other independent sources. Industry publications generally indicate that they have obtained their information from sources believed to be reliable, but do not guarantee the accuracy and completeness of their information. This information involves a number of assumptions and limitations, and you are cautioned not to give undue weight to these estimates. Although we have not independently verified the accuracy or completeness of the data contained in these industry publications and reports, based on our industry experience we believe that the publications are reliable and the conclusions contained in the publications and reports are reasonable.

 

35


Table of Contents

Use of proceeds

We estimate that the net proceeds to us from the sale of 5,000,000 shares of common stock in this offering will be approximately $66.3 million based upon the initial public offering price of $15.00 per share and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters exercise their option to purchase additional shares in full, we estimate that our net proceeds will be approximately $76.7 million, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

The principal purposes of this offering are to provide access to the public capital markets and to increase our liquidity.

As of the date of this prospectus, we cannot specify with certainty all of the particular uses for our net proceeds from this offering. However, we expect to use the net proceeds from this offering for general corporate purposes, including working capital. We may also use a portion of the net proceeds to acquire or invest in complementary businesses, technologies or assets. We have no present understandings, commitments or agreements to enter into any such acquisitions or make any such investments. The amounts and timing of our actual expenditures may vary significantly from our expectations depending upon numerous factors, including the progress of our research and development efforts, our operating costs and capital expenditures and the other factors described under “Risk factors” in this prospectus. Accordingly, we will retain the discretion to allocate the net proceeds of this offering among the identified uses described above, and we reserve the right to change the allocation of the net proceeds among the uses described above.

Pending these uses, we intend to invest the net proceeds in high quality, investment grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government, or hold them as cash.

Dividend policy

We have never declared or paid any dividends on our capital stock. We currently intend to retain all available funds and any future earnings, if any, to finance the development and expansion of our business and we do not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay dividends will be made at the discretion of our board of directors.

 

36


Table of Contents

Capitalization

The following table sets forth our cash and cash equivalents and our capitalization as of March 31, 2014:

 

 

on an actual basis;

 

 

on a pro forma basis to give effect to the conversion of all of our outstanding shares of preferred stock into an aggregate of 13,970,934 shares of common stock immediately prior to the completion of this offering; and

 

 

on a pro forma as adjusted basis to reflect the pro forma adjustments described above and to give further effect to (1) our sale in this offering of 5,000,000 shares of common stock at the initial public offering price of $15.00 per share after deducting underwriting discounts and commissions and estimated offering expenses payable by us and (2) the filing and effectiveness of our amended and restated certificate of incorporation, which will occur immediately prior to the completion of this offering.

You should read the following table together with “Management’s discussion and analysis of financial condition and results of operations,” “Description of capital stock” and the financial statements and related notes appearing elsewhere in this prospectus.

 

      As of March 31, 2014  
(in thousands, except share and per share data)    Actual      Pro Forma      Pro Forma
As Adjusted
 

 

 

Cash and cash equivalents

   $ 5,928       $   5,928       $   72,178   
  

 

 

 

Indebtedness:

        

Short-term debt, including current portion of long-term debt and capital lease obligations

   $

618

      $

618

      $ 618   

Long-term debt and capital lease obligations, net of current portion

     878         878         878   
  

 

 

 

Total Indebtedness

     1,496         1,496         1,496   
  

 

 

 

Redeemable convertible preferred stock:

        

Series A preferred stock, $0.001 par value per share; 11,200,158 shares authorized, 11,200,158 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

     46,619      





 
—           —     

Series B preferred stock, $0.001 par value per share 5,438,478 shares authorized, 5,438,478 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

     21,800      





 
—           —     

Series C preferred stock, $0.001 par value per share 4,317,790 shares authorized, 4,317,790 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

     24,426      





 
—           —     
  

 

 

 

Total redeemable convertible preferred stock

     92,845         —           —     

 

 

 

37


Table of Contents
      As of March 31, 2014  
(in thousands, except share and per share data)    Actual      Pro Forma     Pro Forma
As Adjusted
 

 

 

Stockholders’ deficit:

       

Common stock, $0.001 par value per share; 32,867,000 shares authorized, 3,787,853 shares issued and outstanding, actual; 32,867,000 shares authorized, 17,758,787 issued and outstanding, pro forma; and 250,000,000 shares authorized and 22,758,787 shares issued and outstanding, pro forma as adjusted

     4      







 
18        23   

Preferred Stock, $0.001 par value per share; 20,000,000 shares authorized, no shares issued or outstanding, pro forma and pro forma as adjusted

          



 
         

Additional paid-in capital

             92,831        159,076   

Accumulated other comprehensive loss

     (1)         (1     (1

Accumulated deficit

     (97,155)         (97,155     (97,155
  

 

 

 

Total stockholders’ equity (deficit)

     (97,152)         (4,307     61,943   
  

 

 

 

Total capitalization

   $ (2,811)         (2,811     63,439   

 

 

The actual, pro forma and pro forma as adjusted information set forth in the table excludes (1) 3,605,095 shares of common stock issuable upon the exercise of stock options outstanding as of March 31, 2014 having a weighted-average exercise price of $3.08 per share, (2) 108,853 shares of common stock issued upon the net exercise of warrants that were outstanding as of March 31, 2014 having an exercise price of $1.10 per share, (3) 2,559,172 shares of common stock reserved for future issuance under our stock option plans, and (4) 448,000 shares of common stock reserved for future issuance under our ESPP.

 

38


Table of Contents

Dilution

If you invest in our common stock in this offering, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma net tangible book value per share of our common stock immediately after this offering.

The net tangible book value of our common stock as of March 31, 2014 was equity of $(102.7) million, or $(26.71) per share. Net tangible book value per share represents our total tangible assets less our total tangible liabilities, divided by the number of shares of common stock before giving effect to the conversion of all of our outstanding shares of preferred stock into shares of common stock upon the completion of this offering. The pro forma net tangible book value of our common stock as of March 31, 2014 was equity of $(9.9) million, or a deficit of approximately $(0.55) per share. Pro forma net tangible book value gives effect to the conversion of all of our outstanding shares of preferred stock into shares of common stock upon the completion of this offering.

Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of common stock in this offering and the pro forma net tangible book value per share of our common stock immediately after the completion of this offering. After giving effect to (1) the automatic conversion of all of our outstanding shares of preferred stock into shares of common stock immediately prior to the completion of this offering and (2) our sale of shares in this offering at the initial public offering price of $15.00 per share and after deducting underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of March 31, 2014 would have been $2.47 per share. This represents an immediate increase in net tangible book value of $3.02 per share to existing stockholders and an immediate dilution in net tangible book value of $12.53 per share to purchasers of common stock in this offering, as illustrated in the following table:

 

Initial public offering price per share           $15.00  

Pro forma net tangible book value per share as of March 31, 2014

   $ (0.55  

Increase per share attributable to new investors

   $ 3.02     
  

 

 

   

Pro forma as adjusted net tangible book value per share after giving effect to the offering

     $ 2.47   
    

 

 

 

Dilution per share to new investors

     $ 12.53   

 

 

If the underwriters exercise their option in full, the pro forma as adjusted net tangible book value would be $2.84 per share, and the dilution in pro forma net tangible book value per share to investors in this offering would be $12.16 per share.

The following table summarizes, on a pro forma basis, as of March 31, 2014, the difference between the number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid by existing stockholders and by new investors at the initial public offering price of $15.00 per share before deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

      Shares purchased     Total consideration     Avg price /
share
 
     Number      Percent     Amount      Percent    

 

 

Existing stockholders

     17,815,867         78.1   $ 51,763,095         40.8   $ 2.91   

New investors

     5,000,000         21.9        75,000,000         59.2        15.00   
  

 

 

 

Total

     22,815,867         100.0   $ 126,763,095         100.0   $ 5.56   

 

 

 

39


Table of Contents

The above discussion and tables are based on 17,815,867 shares of common stock issued and outstanding as of March 31, 2014, including the conversion of all of our outstanding shares of preferred stock into an aggregate of 13,970,934 shares of common stock immediately prior to the completion of this offering, and excludes:

 

 

3,605,095 shares of common stock issuable upon the exercise of stock options outstanding as of March 31, 2014 having a weighted-average exercise price of $3.08 per share;

 

 

108,853 shares of common stock issued upon the net exercise of warrants that were outstanding as of March 31, 2014 having an exercise price of $1.10 per share;

 

 

2,559,172 shares of common stock reserved for future issuance under our stock option plans as of the completion of this offering; and

 

 

448,000 shares of common stock reserved for future issuance under our ESPP.

To the extent that outstanding options are exercised, you will experience further dilution. In addition, we may choose to raise additional capital in the future due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of these securities may result in further dilution to our stockholders.

 

40


Table of Contents

Selected consolidated financial data

You should read the selected consolidated financial data below in conjunction with “Management’s discussion and analysis of financial condition and results of operations” and the consolidated financial statements, related notes and other financial information included elsewhere in this prospectus. The selected consolidated financial data in this section are not intended to replace the consolidated financial statements and are qualified in their entirety by the consolidated financial statements and related notes included elsewhere in this prospectus.

The following table presents selected consolidated financial data. We derived the statement of operations data for the years ended December 31, 2011, 2012 and 2013 and the balance sheet data as of December 31, 2012 and 2013 from our audited consolidated financial statements included elsewhere in this prospectus. We derived the consolidated statements of operations data for the three months ended March 31, 2013 and 2014 from our unaudited financial statements included elsewhere in this prospectus. We derived the balance sheet data as of March 31, 2014 from our unaudited financial statements included elsewhere in this prospectus. We derived the statement of operations data for the years ended December 31, 2009 and 2010 and the balance sheet data as of December 31, 2009, 2010 and 2011 from our audited financial statements that do not appear in this prospectus.

Our historical results are not necessarily indicative of the results to be expected in the future, and our interim results should not necessarily be considered indicative of results we expect for the full year.

We derived the pro forma share and per share data for the year ended March 31, 2014 from the unaudited pro forma net income (loss) per share information in Note 16 to our consolidated financial statements included elsewhere in this prospectus. The pro forma share and per share data give effect to the conversion of all outstanding shares of our preferred stock into shares of our common stock.

 

      Year ended December 31,     Three months
ended March 31,
 
(in thousands, except per share data)    2009     2010     2011     2012     2013     2013     2014  

 

 

Revenue

              

Product

   $ 10,889      $ 13,453      $ 22,958      $ 29,992      $ 39,124      $ 7,348      $ 9,274   

Maintenance and services

     11,066        14,289        18,462        24,032        31,987        6,907        10,166   
  

 

 

 

Total revenue

     21,955        27,742        41,420        54,024        71,111        14,255        19,440   

Cost of revenue

              

Product

     2,342        2,407        4,381        6,855        7,849        1,577        2,160   

Maintenance and services

     2,675        3,203        4,443        6,563        11,020        2,238        4,193   
  

 

 

 

Total cost of revenue

     5,017        5,610        8,824        13,418        18,869        3,815        6,353   
  

 

 

 

Gross profit

     16,938        22,132        32,596        40,606        52,242        10,440        13,087   

Operating expenses

              

Research and development

     5,588        5,709        7,890        12,322        19,609        4,001        6,536   

Sales and marketing

     11,812        13,197        17,728        22,473        30,538        6,258        10,419   

General and administrative

     3,360        3,582        4,195        4,564        7,619        1,773        3,013   
  

 

 

 

Total operating expenses

     20,760        22,488        29,813        39,359        57,766        12,032        19,968   
  

 

 

 

Income (loss) from operations

     (3,822     (356     2,783        1,247        (5,524     (1,592     (6,881

Other income (expense)

              

Interest and other income (expense), net

     (31     (103     68        (90     109        59        (160
  

 

 

 

Income (loss) before income taxes

     (3,853     (459     2,851        1,157        (5,415     (1,533     (7,041

Income taxes (benefit)

     121        87        129        109        108        (3     26   
  

 

 

 

Net income (loss)

     (3,974     (546     2,722        1,048        (5,523     (1,530     (7,067

Accretion of redeemable convertible preferred stock

     (4,985     (4,985     (4,973     (4,957     (4,952     (1,238     (1,238
  

 

 

 

Net loss attributable to common stockholders

   $ (8,959   $ (5,531   $ (2,251   $ (3,909   $ (10,475   $ (2,768   $ (8,305
  

 

 

 

Net loss per share attributable to common stockholders

              

Basic and diluted

   $ (4.79   $ (2.83   $ (1.03   $ (1.36   $ (3.12   $ (0.89   $ (2.29
  

 

 

 

 

41


Table of Contents
      Year ended December 31,     Three months
ended March 31,
 
(in thousands, except per share data)    2009     2010      2011      2012      2013     2013     2014  

 

 

Weighted average common shares outstanding used in computing net loss per share attributable to common stockholders

                 

Basic and diluted

     1,872        1,955         2,188         2,868         3,359        3,120        3,627   
  

 

 

 

Pro forma net loss per share

                 

Basic and diluted

              $ (0.32     $ (0.40
           

 

 

     

 

 

 

Pro forma weighted average shares used to compute net loss per common share

                 

Basic and diluted

                17,330          17,598   
           

 

 

     

 

 

 

Other financial data:

                 

Adjusted EBITDA(1)

   $ (3,039   $ 544       $ 4,199       $ 2,348       $ (3,364   $ (821   $ (5,843
  

 

 

 

 

 

 

(1)   Please see “Adjusted EBITDA” below for more information and for a reconciliation of net income (loss) to Adjusted EBITDA.

 

      As of December 31,     As of
March 31,
 
(in thousands)    2009     2010     2011     2012     2013     2014  

 

 

Consolidated balance sheet data:

            

Cash and cash equivalents

   $ 6,463      $ 7,017      $ 12,678      $ 15,410      $ 13,284      $ 5,928   

Total assets

     15,344        19,496        30,193        43,824        46,470        35,626   

Deferred revenue

     9,697        12,261        16,041        21,756        28,574        28,164   

Redeemable preferred stock

     71,740        76,725        81,698        86,655        91,607        92,845   

Total stockholders’ deficit

   $ (69,772   $ (74,875   $ (77,431   $ (80,310   $ (89,607   $ (97,152

 

 

Adjusted EBITDA

To provide investors with additional information about our financial results, we disclose within this prospectus Adjusted EBITDA, a non-GAAP financial measure. We present Adjusted EBITDA because it is used by our board of directors and management to evaluate our operating performance, and we consider it an important supplemental measure of our performance. Our management uses Adjusted EBITDA:

 

 

as a measure of operating performance to assist in comparing performance from period to period on a consistent basis; and

 

 

as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations.

Adjusted EBITDA is not in accordance with, or an alternative to, measures prepared in accordance with GAAP. In addition, this non-GAAP measure is not based on any comprehensive set of accounting rules or principles. As a non-GAAP measure, Adjusted EBITDA has limitations in that it does not reflect all of the amounts associated with our results of operations as determined in accordance with GAAP. In particular:

 

 

Adjusted EBITDA does not reflect the amounts we paid in taxes or other components of our tax provision;

 

 

Adjusted EBITDA does not include depreciation expense from fixed assets or amortization expense from acquired intangible assets;

 

 

Adjusted EBITDA does not reflect other (expense) income which include interest income we earn on cash and cash equivalents; interest expense, or the cash requirements necessary to service interest or principal payments, on our debt and capital leases; and the gains or losses on foreign currency transactions;

 

42


Table of Contents
 

Adjusted EBITDA does not include the impact of stock-based compensation;

 

 

Adjusted EBITDA does not include the change in value of our continent liability related to the acquisition of assets from Validus Medical Systems, as described in the Notes to consolidated financial statements; and

 

 

others may calculate Adjusted EBITDA differently than we do and these calculations may not be comparable to our Adjusted EBITDA metric. Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including net income (loss) and our financial results presented in accordance with GAAP.

The table below presents a reconciliation of net income (loss) to Adjusted EBITDA for each of the periods indicated:

 

      Year ended December 31,     Three months ended
March 31,
 
(in thousands)    2009     2010     2011     2012     2013     2013     2014  

 

 

Net income (loss)

   $ (3,974   $ (546   $ 2,722      $ 1,048      $ (5,523   $ (1,530   $ (7,067

Income tax expense

     121        87        129        109        108        (3     26   

Depreciation and amortization

     480        575        842        1,082        2,397        555        695   

Other (expense) income, net

     31        103        (68     90        (109     (59     160   

Stock based compensation

     303        325        347        450        640        117        298   

Change in value of contingent liability

                   227        (431     (877     99        45   

Adjusted EBITDA

   $ (3,039   $ 544      $ 4,199      $ 2,348      $ (3,364   $ (821   $ (5,843

 

 

 

43


Table of Contents

Management’s discussion and analysis of financial condition and results of operations

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes and other financial information included elsewhere in this prospectus. Some of the information contained in this discussion and analysis or set forth elsewhere in this prospectus, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the “Risk factors” section of this prospectus for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Overview

We are a leading provider of authentication and access management technology solutions for the healthcare industry. Our flagship solution, Imprivata OneSign, is an integrated enterprise single sign-on, authentication and access management and workflow automation platform that addresses multiple security and productivity challenges faced by hospitals and other healthcare organizations. By enabling fast, secure access to healthcare information technology systems, we believe our solutions save clinicians significant time to focus on patient care, increase their productivity and satisfaction, and help healthcare organizations comply with complex privacy and security regulations. Imprivata OneSign can be installed on every workstation and other application access point throughout a healthcare organization and once deployed becomes a critical part of the customer’s security and access infrastructure. As a result, we believe that Imprivata OneSign is one of the most widely-used technology solutions by our customers’ physicians, nurses and other clinicians.

As of March 31, 2014, our Imprivata OneSign solution had over 2.8 million licensed users in over 950 healthcare organizations in 20 countries, including large integrated healthcare systems, academic medical centers and small- and medium-sized independent healthcare facilities. Many other industries face security and productivity challenges similar to those in healthcare. Although healthcare is our primary focus, as of March 31, 2014 Imprivata OneSign had over 770,000 licensed users in over 400 non-healthcare organizations, including financial services, public sector and other industries.

We sell our solutions through our direct sales force and sales partners in the United States and internationally. We derive substantially all of our revenue from sales of our Imprivata OneSign solution, which is sold primarily on a perpetual license basis. For the years ended December 31, 2011, 2012 and 2013 and the three months ended March 31, 2013 and 2014, we generated 35%, 41%, 41%, 34%, and 44%, respectively, of our revenue through our direct sales force, with the remaining revenue generated through our sales partner relationships. In the years ended December 31, 2011, 2012 and 2013 and the three months ended March 31, 2013 and 2014, no single end customer accounted for more than 5% of our total revenue.

Our revenue growth is derived from both sales to new customers as well as add-on sales to our existing customer base. Consistent with our healthcare focused strategy, in 2013, healthcare customers accounted for the growth in sales to new customers. Many of our customers continue to add licensed users and purchase additional products and services from us after the initial sale. Consistent with our strategy, over 90% of our growth in add-on sales comes from healthcare customers. Non-healthcare customers also continue to purchase our solutions, and while add-on sales to non-healthcare customers have continued to increase, new sales to non-healthcare customers have been decreasing. For example, these add-on sales from existing healthcare and non-healthcare customers accounted for over half of our product revenues in the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014. In each of the years ended December 31, 2012 and

 

44


Table of Contents

2013 and the three months ended March 31, 2014, we retained greater than 90% of the aggregate dollar value of maintenance contracts up for renewal.

In 2011, 2012 and 2013 and for the three months ended March 31, 2014, we derived 25%, 33%, 38% and 36%, respectively, of our revenue from the sales to existing customers. For the same periods, revenue from new customers accounted for 42%, 35%, 30% and 25%, respectively. The remaining revenue in each of those periods was derived from software maintenance renewals and professional services. Maintenance renewals accounted for 25%, 23%, 24% and 27%, respectively while professional services accounted for 8%, 9%, 8% and 12%, respectively. Management uses these sources of revenue as performance indicators to assess our business.

As a result of the widespread adoption of healthcare information technology systems and increasing privacy and security regulations, demand for our solutions has grown, which has driven growth in our revenue. Our revenue for the year ended December 31, 2013 and for the three months ended March 31, 2014 was $71.1 million and $19.4 million, respectively. Our net losses for the year ended December 31, 2013 and for the three months ended March 31, 2014 were $5.5 million and $7.1 million, respectively. As of March 31, 2014, we had an accumulated deficit of $97.2 million. Our Adjusted EBITDA for the year ended December 31, 2013 and for the three months ended March 31, 2014 was a loss of $3.4 million and $5.8 million, respectively. The loss in Adjusted EBITDA in the year ended December 31, 2013 and for the three months ended March 31, 2014 is the result of our decision to make investments in our business to support our anticipated future growth.

We have focused on growing our business to pursue the significant market opportunity we see for our products and services, and we plan to continue to invest in building for growth. As a result, we expect to incur significant operating costs relating to our research and development initiatives for our new and existing solutions and products, and for our expansion of our sales and marketing operations as we add additional sales personnel, increase our marketing efforts and expand into new geographical markets. We also expect to increase our general and administrative expenses as a result of becoming a public company.

Acquisitions

During the last four years, we completed two small acquisitions, one acquiring certain assets of Validus Medical Systems, or Validus, and the other acquiring certain assets of Viion Systems, Inc. The total consideration for these two transactions was $650,000 in cash, plus future earnouts. The Validus earnout was classified as a contingent liability and there have been no payments made with respect to it. These acquisitions have not contributed significantly to our revenue in any year. The assets acquired enhanced our solutions by contributing technology to our Imprivata Cortext solution and the Secure Walk-Away product in our Imprivata OneSign solution.

Adjusted EBITDA

EBITDA consists of net income (loss) plus depreciation and amortization, other interest income (expense) and income tax expense. Adjusted EBITDA consists of EBITDA plus our non-cash, stock-based compensation expense and other income (expense), and the change in value of our contingent liability related to the acquisition of assets from Validus. We use Adjusted EBITDA as a measure of operating performance because it assists us in comparing performance on a consistent basis across reporting periods. We believe this metric is commonly used by the financial community, and we present it to enhance investors’ understanding of our operating performance and cash flows. We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance because it can be used to measure a company’s operating performance without regard to items such as stock based compensation and depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of performance

 

45


Table of Contents

exclusive of our capital structure and the method by which assets were acquired. You should not consider Adjusted EBITDA as an alternative to net income (loss), determined in accordance with generally accepted accounting principles in the United States, or GAAP, as an indicator of ongoing performance, or as an alternative to cash provided by operating activities, determined in accordance with GAAP, as an indicator of our cash flow.

The following table provides a reconciliation of net income (loss) to Adjusted EBITDA:

 

      Year ended December 31,     Three months ended
March 31,
 
(in thousands)    2011     2012     2013     2013     2014  

 

 

Net income (loss)

   $ 2,722      $ 1,048      $ (5,523   $ (1,530   $ (7,067

Income tax expense

     129        109        108        (3     26   

Depreciation and amortization

     842        1,082        2,397        555        695   

Other (expense) income, net

     (68     90        (109     (59     160   

Stock based compensation

     347        450        640        117        298   

Change in value of contingent liability

     227        (431     (877     99        45   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 4,199      $ 2,348      $ (3,364   $ (821   $ (5,843

 

 

Basis of presentation

Revenue

Product revenue is generally recognized upon shipment of the software license key or hardware. See “Critical accounting policies and estimates—Revenue recognition and deferred revenue” for more information. Software maintenance revenue is recognized ratably over the maintenance period. Revenue from our professional service arrangements is recognized as the services are performed. Training revenue is recognized when the training is completed.

Product revenue

We derive our product revenue from the sales of both software and hardware. We derive substantially all of our software revenue from the sale of perpetual licenses for our Imprivata OneSign solution. Our license sales are generally priced on a per user basis, but are sometimes licensed on an enterprise-wide basis with an unlimited number of users. From time to time, we also derive software revenue from licenses sold on a term license basis. The software is delivered pre-loaded on a hardware server or as a software only solution that provides the same functionality as the software delivered on the pre-loaded server. Hardware sales also include the sale of devices such as proximity card and fingerprint readers.

Maintenance and services revenue

Maintenance and services revenue is generated from maintenance and technical support associated with our software as well as professional services, which include implementation and training. Maintenance is typically invoiced annually in advance, recorded as deferred revenue and recognized ratably over the maintenance period. Professional services revenue consists primarily of fees associated with the implementation of our software and training services, and represented less than 10% of our overall revenue for the years 2011, 2012, and 2013. For the three months ended March 31, 2014, professional services represented 12% of our overall revenue. We expect professional services revenue to represent less than 10% for the remainder of fiscal year 2014. Our professional service arrangements are generally billed on a time and materials basis and revenue is recognized as the services are performed. Training is generally billed as a fixed fee and revenue is recognized when the training is completed.

 

46


Table of Contents

Backlog

Our backlog consists of the total future value of our committed customer purchases, whether billed or unbilled. Backlog includes products, software maintenance and professional services which we have billed or been paid for in advance, and are included in deferred revenue on our balance sheet, as well as committed customer purchases where we have not invoiced or fulfilled the order as of the last day of the applicable period and which are not reflected on our balance sheet. We generally complete the unfulfilled committed customer product purchases by shipment in the next fiscal quarter and recognize revenue upon such shipment. We recognize any maintenance and services revenue related to unfulfilled committed customer purchases in subsequent periods in accordance with our revenue recognition policies. As of December 31, 2013, we had backlog of $30.9 million and a backlog of $33.4 million as of March 31, 2014. Of the $33.4 million in backlog as of March 31, 2014, approximately $26.4 million to $27.4 million, which includes $17.5 million of maintenance, is expected to be recognized as revenue during the year ended December 31, 2014. Additionally, $5.5 million of maintenance revenue is expected to be recognized over the five year period subsequent to the year ended December 31, 2014. Revenue in any period is a function of new purchases during the period, the timing of fulfillment of customer orders, maintenance renewals and revenue recognized from backlog. Therefore, backlog viewed in isolation may not be indicative of future performance. Our presentation of backlog may differ from that of other companies in our industry.

Cost of revenue

Cost of revenue is comprised of the following:

Cost of product

Cost of product consists primarily of costs of physical appliances and proximity card and fingerprint readers. Additional product costs include third party software license costs, duties and freight and amortization expense related to acquired intangible assets.

Cost of maintenance and services

Cost of maintenance and services consists primarily of costs related to our support and professional services personnel, including employee wages and benefits, bonuses, stock compensation and travel expense. These costs also include depreciation and overhead related to facilities and information technology used to provide these services.

Operating expenses

Research and development

Research and development expenses consist of costs for our research and development personnel, including salaries, benefits, bonuses and stock-based compensation, the cost of certain third-party contractors, including off-shore development, travel expense and allocated overhead. Research and development costs are expensed as they are incurred. We intend to continue to develop additional products and functionality for our existing solutions as well as develop new solutions for the healthcare market and expect research and development costs to continue to increase in absolute dollars, although they may fluctuate as a percentage of revenue.

Sales and marketing

Sales and marketing expenses consist of costs for our sales and marketing personnel, including salaries, benefits, bonuses, stock-based compensation and sales commissions, costs of marketing and promotional events, corporate communications, online marketing, product marketing and management and other brand-building activities, travel expense and allocated overhead. Sales commissions are generally earned and

 

47


Table of Contents

recorded as expense when the customer order has been received, which may precede recognition of the associated revenue. We expect sales and marketing expenses to increase in absolute dollars as we expand our business both domestically and internationally, although they may fluctuate as a percentage of revenue.

General and administrative

General and administrative expenses consist primarily of costs for administrative, finance, IT, legal and human resource personnel, including salaries, benefits, bonuses and stock-based compensation, professional fees, insurance premiums, other corporate expenses and allocated overhead. General and administrative expenses also include the re-valuing of our contingent liability associated with any earnout we may be required to pay in connection with the Validus acquisition. We measure the liability at each balance sheet date based on revenue earned to date from the acquired Validus product (now our Imprivata Cortext solution) and our projections of revenues from sales of Imprivata Cortext. We expect our general and administrative expenses to continue to increase in absolute dollars as we transition to being a public company, although they may fluctuate as a percentage of revenue. We expect additional general and administrative expenses to include increased personnel costs, insurance costs, costs required to comply with the regulatory requirements of the Securities and Exchange Commission as well as costs associated with enhancing our internal controls and accounting systems.

Other income (expense)

Other income (expense) primarily consists of foreign exchange gains (losses), interest income and interest expense. Foreign exchange gains (losses) relate to transactions denominated in currencies other than the functional currency. Interest income represents interest received on our cash and cash equivalents. Interest expense is associated with our capital leases and term loans.

Income tax expense

We operate in several tax jurisdictions and are subject to taxes in each country or jurisdiction in which we conduct business. Earnings from our activities outside of the United States are subject to local country income tax and may be subject to U.S. income tax. To date we have incurred cumulative net losses and maintain a full valuation allowance on our net deferred tax assets. Therefore, we have not recorded any U.S. federal tax provisions and our effective tax rate differs from statutory rates. Our tax expense to date primarily relates to foreign income taxes, mainly from our international operations, and to a lesser extent state income tax provisions.

 

48


Table of Contents

Results of operations

The following table sets forth our consolidated statements of operations data for each of the periods presented.

 

      Year ended
December  31,
    Three months ended
March 31,
 
(in thousands)    2011      2012     2013     2013     2014  

 

 

Revenue

           

Product

   $ 22,958       $ 29,992      $ 39,124      $ 7,348      $ 9,274   

Maintenance and services

     18,462         24,032        31,987        6,907        10,166   
  

 

 

 

Total revenue

     41,420         54,024        71,111        14,255        19,440   

Cost of revenue

           

Product

     4,381         6,855        7,849        1,577        2,160   

Maintenance and services

     4,443         6,563        11,020        2,238        4,193   
  

 

 

 

Total cost of revenue

     8,824         13,418        18,869        3,815        6,353   
  

 

 

 

Gross profit

     32,596         40,606        52,242        10,440        13,087   

Operating expenses

           

Research and development

     7,890         12,322        19,609        4,001        6,536   

Sales and marketing

     17,728         22,473        30,538        6,258        10,419   

General and administrative

     4,195         4,564        7,619        1,773        3,013   
  

 

 

 

Total operating expenses

     29,813         39,359        57,766        12,032        19,968   
  

 

 

 

Income (loss) from operations

     2,783         1,247        (5,524     (1,592     (6,881

Other income (expense)

           

Interest and other income (expense), net

     68         (90     109        59        (160
  

 

 

 

Income (loss) before income taxes

     2,851         1,157        (5,415     (1,533     (7,041

Income taxes (benefit)

     129         109        108        (3     26   
  

 

 

 

Net income (loss)

     2,722         1,048        (5,523     (1,530     (7,067

 

 

Comparison of the three months ended March 31, 2013 and 2014

Revenue

 

      Three months ended March 31,                  
     2013      2014      Change  
(dollars in thousands)    Amount      % of
Revenue
     Amount      % of
Revenue
     Amount      %  

 

 

Revenue

                 

Product revenue

   $ 7,348         51.5%      $ 9,274         47.7%      $ 1,926         26.2%  

Maintenance and service revenue

     6,907         48.5%         10,166         52.3%         3,259         47.2%   
  

 

 

 

Total revenue

   $ 14,255         100.0%      $ 19,440         100.0%      $ 5,185         36.4%  

 

 

Product revenue.    Product revenue increased by $1.9 million, or 26%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase was driven primarily by an increase of $2.1 million in sales of additional products into our existing customer base, $1.8 million of which were related to healthcare customers. Sales to new customers decreased by approximately $171,000 over the same period. Sales to new healthcare customers increased by $105,000 for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013, which was offset by a $276,000 decrease in sales to new non-healthcare customers due to our focus on the healthcare industry.

 

49


Table of Contents

Maintenance and service revenue.    Maintenance and service revenue increased by $3.3 million, or 47%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase was driven by increased maintenance revenue of $2.0 million resulting from our larger installed base of users. In addition, professional services increased by $1.3 million over the same period due to the increased sales of our products, which resulted in new professional services related to implementation and training. Revenue from professional services represented less than 10% of total revenue for the three months ended March 31, 2013 and represented 12% of total revenue for the three months ended March 31, 2014. We expect professional services revenue to represent less than 10% for the remainder of fiscal year 2014.

Cost of revenue

      Three months ended
March 31,
     Change  
(dollars in thousands)           2013             2014      Amount      %  

 

 

Cost of revenue

           

Product

   $ 1,577       $ 2,160       $ 583         37.0%   

Maintenance and service

     2,238         4,193         1,955         87.4%   
  

 

 

 

Total cost of revenue

   $ 3,815       $ 6,353       $ 2,538         66.5%   
  

 

 

 

Gross Margin

           

Product

     78.5%         76.7%         

Maintenance and service

     67.6%         58.8%         
  

 

 

       

Total gross margin

     73.2%         67.3%         

 

 

Cost of product revenue.    Cost of product revenue increased by $583,000, or 37%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase was primarily attributable to an increase in product sales related to proximity card and fingerprint devices. Product gross margin decreased due to unfavorable changes in the mix between higher-margin software and device sales. Device sales have lower margins than software sales and device sales were lower as a percentage of total product revenue during the three months ended March 31, 2014 as compared to the three months ended March 31, 2013, which resulted in the decrease in product gross margin. Device revenues as a percentage of total product revenues can fluctuate and, as a result, we expect product gross margins to vary depending on the mix of device revenues to total product revenues.

Cost of maintenance and service revenue.    Cost of maintenance and service revenue increased by $2.0 million, or 87%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase was primarily attributable to an increase of $995,000 in payroll-related expenses as a result of the addition of 25 employees to 75 employees. The increase in employees hired also caused an increase in facilities and information technology costs of $329,000 and travel-related costs of $196,000. In addition, we incurred an increase of $306,000 for consulting services. We also incurred an increase of $140,000 related to hardware upgrades for customers who are entitled to hardware upgrades pursuant to their premium maintenance agreements. The decrease in gross margin for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 related to maintenance and services was due to our investments in support and service personnel to support our anticipated future growth.

 

50


Table of Contents

Operating expenses

The following table sets forth our operating expenses.

 

      Three months ended March 31,          
     2013      2014      Change  
(dollars in thousands)    Amount      % of
Revenue
     Amount      % of
Revenue
     Amount      %  

 

 

Operating expenses

                 

Research and development

   $ 4,001         28.1%       $ 6,536         33.6%       $ 2,535         63.4%   

Sales and marketing

     6,258         43.9%         10,419         53.6%         4,161         66.5%   

General and administrative

     1,773         12.4%         3,013         15.5%         1,240         69.9%   
  

 

 

 

Total operating expenses

   $ 12,032         84.4%       $ 19,968         102.7%       $ 7,936         66.0%   

 

 

Research and development

Research and development expenses increased by $2.5 million, or 63%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase was attributable to an increase in payroll-related costs of $1.5 million as a result of an increase in headcount of 26 employees to 89 employees, and to an increase in costs for outside contractors of $393,000 as a result of increased use of third-party developers primarily located in Ukraine. The increase in employees hired also caused an increase of $572,000 in facilities and information technology-related expenses. All of these increases are the result of our continued investment in the development of our existing and new solutions and are expected to continue in the future.

Sales and marketing

Sales and marketing expenses increased by $4.2 million, or 66%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase was attributable to increases in sales-related costs of $2.4 million and marketing and business development-related costs of $1.8 million as we continued to invest in building our brand as well as our sales force. The increase in sales-related costs was due to an increase in payroll-related expenses, including commissions, amounting to $1.8 million as a result of an increase of 24 sales employees to 88 sales employees, increased commissions for existing employees, an increase of $96,000 related to company sales events, and an increase of $58,000 in consulting expenses. The increase in employees hired also caused increases in facilities and information technology-related expenses of $356,000 and travel expense of $266,000. These increases were partially offset by a decrease in third-party recruiting fees of $194,000. The marketing and business development increases were due primarily to an increase of $768,000 in payroll-related expenses as a result of an increase of 15 employees to 37 employees and $255,000 related to third-party recruiting fees. Additionally, spending related to demand generation, marketing events and branding increased by $391,000 along with an increase of $103,000 related to spending on consulting and outside services, $90,000 for travel expense and $128,000 related to facilities and information technology-related expenses.

General and administrative

General and administrative expenses increased by $1.2 million, or 70%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase was driven by $701,000 in headcount and related expenses related to the addition of 24 employees to 45 employees. In addition, we incurred an increase in facilities and information technology-related expenses of $136,000, a $148,000 increase in professional fees related to legal and accounting services, a $142,000 increase in company events and an increase of $99,000 for consulting services.

 

51


Table of Contents

Other income expense

Other expense of $161,000 for the three months ended March 31, 2014 increased by $220,000 as compared to other income of $59,000 for the three months ended March 31, 2013 due to changes in foreign currency exchange rates.

Income tax expense (benefit)

Income tax expense increased $29,000 from a benefit of $3,000 during the three months ended March 31, 2013 to an expense of $26,000 during the three months ended March 31, 2014. The increase was attributable to an increase in foreign income tax expense of $20,000 and an increase in state income tax expense of $9,000.

Comparison of years ended December 31, 2012 and 2013

Revenue

 

      Year ended December 31,                  
     2012      2013      Change  
(dollars in thousands)    Amount      % of
Revenue
     Amount      % of
Revenue
     Amount      %  

 

 

Product revenue

   $ 29,992         55.5%      $ 39,124         55.0%      $ 9,132         30.4%  

Maintenance and service revenue

     24,032         44.5%         31,987         45.0%         7,955         33.1%   
  

 

 

 

Total revenue

   $ 54,024         100.0%      $ 71,111         100.0%      $ 17,087         31.6%  

 

 

Product Revenue.    Product revenue increased by $9.1 million, or 30%, from the year ended December 31, 2012 to the year ended December 31, 2013. The increase was driven primarily by an increase of $6.6 million in sales of additional products into our existing customer base, $6.0 million of which were related to healthcare customers. Sales to new customers increased by $2.5 million. Sales to new healthcare customers increased by $2.9 million from the year ended 2012 to the year ended 2013, which was offset by a $377,000 decrease in new sales to non-healthcare customers due to our focus on the healthcare industry.

Maintenance and services revenue.    Maintenance and services revenue increased by $8.0 million, or 33%, from the year ended December 31, 2012 to the year ended December 31, 2013. The increase was driven by increased maintenance revenue of $6.8 million resulting from our larger installed base of users. In addition, professional services increased by $1.2 million due to increased sales of our products, which resulted in new professional services related to implementations and training. In both years revenue from professional services was less than 10% of total revenue.

Cost of revenue

 

      Year ended
December 31,
     Change  
(dollars in thousands)    2012      2013      Amount      %  

 

 

Cost of revenue

           

Product

   $ 6,855       $ 7,849       $ 994         14.5%  

Maintenance and service

     6,563         11,020         4,457         67.9%   
  

 

 

 

Total cost of revenue

   $ 13,418       $ 18,869       $ 5,451         40.6%  
  

 

 

 

Gross Margin

           

Product

     77.1%        79.9%         

Maintenance and service

     72.7%        65.5%        
  

 

 

       

Total Gross Margin

     75.2%         73.5%         

 

 

 

52


Table of Contents

Cost of product revenue.     Cost of product revenue increased by $994,000, or 15%, from the year ended December 31, 2012 to the year ended December 31, 2013. The increase was primarily attributable to the increase in product sales related to proximity card and fingerprint devices. Product gross margin increased due to favorable changes in the mix between higher-margin software and device sales. Device sales have lower margins than software sales and decreased as a percentage of total product revenue during the year ended 2013 as compared to the year ended 2012 which resulted in the increase in product gross margin. Device revenues as a percentage of total product revenues can fluctuate and, as a result, we expect product gross margins to vary depending on the mix of device revenues to total product revenues.

Cost of maintenance and services revenue.     Cost of maintenance and services revenue increased by $4.5 million, or 68%, from the year ended December 31, 2012 to the year ended December 31, 2013. The increase was primarily attributable to $2.4 million in payroll-related costs as a result of increased investment in our support and service personnel, approximately 30% of which was in Europe, in anticipation of increased revenue growth in the region. In addition, the increase in employees hired also caused an increase in rent and information technology costs of $962,000, travel-related costs of $485,000 and third-party recruiting fees of $159,000. In addition we incurred an increase of $313,000 for consulting services. The decrease in gross margin from the year ended December 31, 2012 to the year ended December 31, 2013 related to maintenance and services was due to our investments in support and service personnel to support our anticipated future growth.

Operating expenses

The following table sets forth our operating expenses.

 

      Year ended December 31,                  
     2012      2013      Change  
(dollars in thousands)    Amount      % of
Revenue
     Amount      % of
Revenue
     Amount      %  

 

 

Operating expenses:

                 

Research and development

   $ 12,322         22.8%       $ 19,609         27.6%       $ 7,287         59.1%   

Sales and marketing

     22,473         41.6%         30,538         42.9%         8,065         35.9%   

General and administrative

     4,564         8.4%         7,619         10.7%         3,055         66.9%   
  

 

 

    

 

 

 

Total operating expenses

     $39,359         72.9%         $57,766         81.2%         $18,407         46.8%   

 

 

Research and development

Research and development expenses increased by $7.3 million, or 59%, from the year ended December 31, 2012 to the year ended December 31, 2013. The increase was attributable to an increase in payroll-related costs of $4.1 million as a result of an increase in headcount of 34 employees to 89 employees, and to an increase in costs for outside contractors of $1.2 million as a result of increased use of third-party developers primarily located in Ukraine. The increase in employees hired also caused increases of $612,000 in facilities and communications charges, $533,000 in information technology-related expenses, $311,000 in travel expense and $308,000 of additional third-party recruiting fees. All of these increases are the result of our continued investment in the development of our existing and new solutions and are expected to continue in the future.

Sales and marketing

Sales and marketing expenses increased by $8.1 million, or 36%, from the year ended December 31, 2012 to the year ended December 31, 2013. The increase was attributable to an increase in spending on sales related costs of $6.8 million and marketing and business development related costs of $1.3 million as we continued to invest in building our brand as well as our sales force. The increase in sales-related costs was due to an increase in

 

53


Table of Contents

payroll-related expenses, including commissions, amounting to $5.2 million as a result of an increase of 26 sales employees to 75 employees and increased commissions for existing employees, and an increase of $134,000 related to company sales events. The increase in employees hired also caused an increase in computer and information technology expenses of $703,000, travel expense of $444,000, facilities costs of $299,000 and additional third-party recruiting fees of $419,000. These increases were partially offset by a decrease in consulting expenses of $386,000. The marketing increases were due primarily to an increase of $248,000 in payroll related expenses and $285,000 of increases in spending related to demand generation, marketing events and branding along with an increase of $345,000 related to spending on consulting and outside services and an increase of $157,000 related to facilities.

General and administrative

General and administrative expenses increased by $3.1 million, or 67%, from the year ended December 31, 2012 to the year ended December 31, 2013. The increase was driven by $2.0 million in headcount and related expenses related to the addition of 20 employees to 40 employees. In addition, we incurred an increase of $741,000 for consulting services, $564,000 for increases in professional fees related to legal and accounting services, $237,000 related to increases in travel expense, a $269,000 increase in company events and a $166,000 increase in office administration related expense. These increases were offset by a net decrease in our contingent consideration liability expense of $446,000 resulting from revised estimates related to our Validus acquisition.

Other income (expense)

Other income of $109,000 for the year ended December 31, 2013 increased by $199,000 as compared to an other expense of $90,000 for the year ended December 31, 2012 due to changes in foreign currency exchange rates.

Income tax expense

Income tax expense decreased $1,000 from $109,000 during the year ended December 31, 2012 to $108,000 during the year ended December 31, 2013. The decrease was attributable to a decrease in foreign income tax expense of $28,000 offset by an increase in state income tax of $27,000.

Comparison of years ended December 31, 2011 and 2012

Revenue

 

      Year ended December 31,                  
     2011      2012      Change  
(dollars in thousands)    Amount      % of
Revenue
     Amount      % of
Revenue
     Amount      %  

 

 
                 

Product revenue

   $ 22,958         55.4%       $ 29,992         55.5%       $ 7,034         30.6%   

Maintenance and services revenue

     18,462         44.6%         24,032         44.5%         5,570         30.2%   
  

 

 

 

Total revenue

   $ 41,420         100.0%       $ 54,024         100.0%       $ 12,604         30.4%   

 

 

Product revenue.    Product revenue increased $7.0 million, or 31%, from the year ended December 31, 2011 to the year ended December 31, 2012. The growth was driven by an increase of $6.9 million in sales of additional products into our existing customer base, $6.5 million of which were related to healthcare customers. Sales to

 

54


Table of Contents

new customers increased by $57,000 to $14.4 million. Sales to new healthcare customers increased by $820,000 from 2011 to 2012, which was offset by a decrease of $760,000 in sales to new non-healthcare customers due to our focus on the healthcare industry. In the years ended December 31, 2011 and 2012, 32% and 47% of our total product revenues were derived from healthcare customers purchasing additional products from us after the initial sale.

Maintenance and services revenue.    Maintenance and services revenue increased $5.6 million, or 30%, from the year ended December 31, 2011 to December 31, 2012. The increase was driven by increased maintenance revenue of $4.2 million resulting from our larger installed base of users. In addition, professional services and training increased by $1.1 million due to the increased demand for our products which resulted in additional professional services related to implementations and additional training.

Cost of revenue

 

      Year ended
December 31,
     Change  
(dollars in thousands)    2011      2012      Amount      %  

 

 

Cost of revenue

           

Product

   $ 4,381       $ 6,855       $ 2,474         56.5%   

Maintenance and services

     4,443         6,563         2,120         47.7%   
  

 

 

 

Total cost of revenue

   $ 8,824       $ 13,418       $ 4,594         52.1%   
  

 

 

 

Gross Margin

           

Product

     80.9%         77.1%         

Maintenance and services

     75.9%         72.7%         
  

 

 

       

Total gross margin

     78.7%         75.2%         

 

 

Cost of product revenue.    Cost of product revenue increased $2.5 million, or 57%, from the year ended December 31, 2011 to the year ended December 31, 2012. The increase was primarily attributable to an increase in the sales of our proximity card and fingerprint readers. Device sales have lower margins than software sales and increased as a percentage of total revenue, which resulted in the decline in gross margin from the year ended December 31, 2011 to the year ended December 31, 2012. Device revenues as a percentage of total product revenues can fluctuate and, as a result, we expect product gross margins to vary depending on the mix of device revenues to total product revenues.

Cost of maintenance and services revenue.    Cost of maintenance and services revenue increased by $2.1 million, or 48%, from the year ended December 31, 2011 to the year ended December 31, 2012. The increase was primarily attributable to $1.4 million in payroll-related expenses as a result of the addition of 16 employees to 45 employees. In addition, the increase in employees hired also caused increases in travel-related costs of $321,000, rent and utilities of $139,000 and third-party recruiting fees of $112,000. The decrease in gross margin from the year ended December 31, 2011 to the year ended December 31, 2012 related to investments in support and service personnel to support our growth.

 

55


Table of Contents

Operating expenses

The following table sets forth our operating expenses.

 

      Year ended December 31,                  
     2011      2012      Change  
(dollars in thousands)    Amount      % of
Revenue
     Amount      % of
Revenue
     Amount      %  

 

 

Operating expenses:

                 

Research and development

   $ 7,890         19.0%       $ 12,322         22.8%       $ 4,432         56.2%   

Sales and marketing

     17,728         42.8%         22,473         41.6%         4,745         26.8%   

General and administrative

     4,195         10.1%         4,564         8.4%         369         8.8%   
  

 

 

 

Total operating expense

   $ 29,813         72.0%       $ 39,359         72.9%       $ 9,546         32.0%   

 

 

Research and development

Research and development expenses increased $4.4 million, or 56%, from the year ended December 31, 2011 to the year ended December 31, 2012. The increase was attributable to an increase of $2.6 million in payroll-related expenses as a result of an increase in headcount of 18 employees to 55 employees, and to an increase in costs for outside consulting services of $742,000 as a result of increased use of third-party developers primarily located in Ukraine. The increase in employees hired also caused increases of $666,000 in facility, communications and information technology costs, $231,000 in third-party recruiting fees and $123,000 in travel-related costs.

Sales and marketing

Sales and marketing expenses increased $4.7 million, or 27%, from the year ended December 31, 2011 to the year ended December 31, 2012. The increase was attributable to an increase in spending on marketing and business development-related costs of $3.6 million and $1.1 million in sales-related costs as we continued to invest in building our sales force as well as our brand. The marketing increases were due mostly to an increase of $2.2 million related to investments in website design and branding as well as increases in spending related to demand generation and marketing events. Salaries and related expense, travel expense and outside services increased by $1.2 million for both marketing and business development. The increase of $1.1 million in sales expenses was the result of a net increase of $241,000 in sales compensation and related expenses, as well as increases of $238,000 related to travel and $357,000 related to customer relationship management software and support. In the year ended December 31, 2012, we added 15 sales employees for a total of 49 sales employees.

General and administrative

General and administrative expenses increased $369,000, or 9%, from the year ended December 31, 2011 to the year ended December 31, 2012. The increase was primarily attributable to increases of $295,000 in payroll- related expenses as a result of the addition of 6 employees to 20 employees. The remaining increase related to additional consulting services of $271,000 primarily related to human resources, office and telecom related expenses of $240,000 and additional reserves for potential bad debt expense of $171,000. These increases were offset by a net decrease in our contingent consideration liability expense of $658,000. The increase in human resources consulting was the result of increased spending for recruiting and human resources outsourcing.

 

56


Table of Contents

Other income (expense)

Other income of $68,000 for the year ended December 31, 2011 decreased by $158,000 as compared to an other expense of $90,000 for the year ended December 31, 2012 due to changes in foreign currency exchange rates.

Income tax expense

Income tax expense decreased $20,000 from $129,000 during the year ended December 31, 2011 to $109,000 during the year ended December 31, 2012. The decrease was attributable to decreases in state income tax of $40,000 offset by an increase in foreign income tax of $20,000.

Quarterly results of operations

The following tables set forth selected unaudited quarterly consolidated statements of operations data for the four quarters in the periods ended December 31, 2012 and 2013 and the quarter ended March 31, 2014. The financial information presented for the interim periods has been prepared on the same basis as the audited consolidated financial statements included elsewhere in this prospectus and, in the opinion of management, includes all adjustments, consisting of normal recurring adjustments, necessary for the fair presentation of the results of operations for such periods. This data should be read in conjunction with the audited consolidated financial statements and the related notes included elsewhere in this prospectus. These quarterly operating results are not necessarily indicative of our operating results to be expected for any future period.

 

     Quarter ended  
(in thousands)   March 31,
2012
    June 30,
2012
    Sept. 30,
2012
    Dec. 31,
2012
    March 31,
2013
    June 30,
2013
    Sept. 30,
2013
    Dec. 31,
2013
    March 31,
2014
 

 

   

 

 

 

Revenue

                 

Product

  $ 4,994      $ 6,691      $ 7,726      $ 10,581      $ 7,348      $ 9,558      $ 10,017      $ 12,201      $ 9,274   

Maintenance and services

    5,488        6,064        6,065        6,415        6,907        7,757        7,890        9,433        10,166   
 

 

 

 

Total revenue

    10,482        12,755        13,791        16,996        14,255        17,315        17,907        21,634        19,440   
 

 

 

 

Cost of revenue

                 

Product

    1,115        1,829        1,478        2,433        1,577        1,593        1,753        2,926        2,160   

Service

    1,362        1,625        1,567        2,009        2,238        2,508        2,779        3,495        4,193   
 

 

 

 

Total cost of revenue

    2,477        3,454        3,045        4,442        3,815        4,101        4,532        6,421        6,353   
 

 

 

 

Gross profit

    8,005        9,301        10,746        12,554        10,440        13,214        13,375        15,213        13,087   
 

 

 

 

Operating expenses

                 

Research and development

    2,618        2,821        3,187        3,696        4,001        4,452        4,923        6,233        6,536   

Sales and marketing

    5,035        4,746        5,144        7,548        6,258        7,201        7,368        9,711        10,419   

General and administrative

    1,192        1,237        1,322        813        1,773        1,596        1,767        2,483        3,013   
 

 

 

 

Total operating expenses

    8,845        8,804        9,653        12,057        12,032        13,249        14,058        18,427        19,968   
 

 

 

 

Income (loss) from operations

    (840     497        1,093        497        (1,592     (35     (683     (3,214     (6,881

Other income (expense)

    (66     32        (73     17        59        (5     66        (11     (160

Income (loss) before income taxes

    (906     529        1,020        514        (1,533     (40     (617     (3,225     (7,041

Income taxes

    22        27        24        36        (3     44        33        34        26   
 

 

 

 

Net income (loss)

  $ (928   $ 502      $ 996      $ 478      $ (1,530   $ (84   $ (650   $ (3,259   $ (7,067

 

 

 

57


Table of Contents

Our quarterly revenue increased year-over-year for all periods presented due to increased product revenue and increased maintenance and service revenue from sales to new customers as well as to existing customers. Comparisons of our quarterly revenues to the corresponding periods in the prior year are more meaningful than comparisons of our quarterly sequential results due to seasonality in the sale of our products and maintenance and services. Our fourth quarter has historically been our strongest quarter for sales as a result of our customers’ buying patterns. We believe that these seasonal trends will continue to affect our quarterly results.

Total gross profit increased year-over-year for all periods presented. Total gross margin has remained relatively consistent over all periods presented, and any fluctuation is primarily due to shifts in the mix of sales between products and maintenance and services, as well as the types and volumes of products sold and investments in support and service personnel to support future growth. Device revenues as a percentage of total product revenues can fluctuate and, as a result, we expect product gross margins to vary depending on the mix of device revenues to total product revenues.

Total operating expenses increased year-over-year for all periods primarily due to the addition of personnel in connection with the expansion of our business. Sales and marketing expense includes costs related to marketing events and the timing of these events can result in the fluctuation of marketing expense from quarter to quarter.

Liquidity and capital resources

 

      Year ended December 31,     Three months ended
March 31,
 
(in thousands)    2011     2012     2013            2013            2014  

 

 

Net cash provided by (used in) operating activities

   $ 7,192      $ 6,082      $ 748      $ 2,613      $ (5,705

Net cash used in investing activities

     (765     (4,191     (3,316     (443     (655

Net cash (used in) provided by financing activities

     (720     624        579        (101     (1,080

Effect of exchange rates on cash and cash equivalents

     (73     217        (137     (212     84   
  

 

 

 

Net increase (decrease) in cash and cash equivalents

   $ 5,634      $ 2,732      $ (2,126   $ 1,857      $ (7,356

 

 

We have financed our operations through 2008 primarily through private placements of preferred stock. Since 2008, we have funded our operations primarily with cash from operating activities, which was driven mainly by our revenue growth. As of March 31, 2014, we had $5.9 million of cash and cash equivalents. We believe our cash and cash equivalents, $10.0 million revolving credit agreement and cash flow from operations will be sufficient to meet our working capital and capital expenditure requirements for at least 12 months.

Net cash provided by (used in) operating activities.    Cash provided by operating activities consists of significant components of the statement of operations adjusted for changes in various working capital items including accounts receivable, prepaid expenses, accounts payable and deferred revenue. Cash provided by operating activities is influenced by the investment we make in personnel and infrastructure costs necessary to support the anticipated growth of the business, the increase in the sales of software licenses and renewal of software maintenance contracts as well as the timing of customer payments.

Our cash used in operating activities during the three months ended March 31, 2014 was primarily due to our net loss of $7.1 million adjusted for $1.1 million of non-cash expenses that included $695,000 of depreciation and amortization, $298,000 in stock-based compensation, $12,000 loss on disposal of fixed assets, and an increase of $45,000 to the value of the contingent purchase price liability. Net increases in working capital amounted to $312,000 attributable primarily to a $6.3 million decrease in accounts receivable offset by a decrease of $410,000 of deferred revenue and a $5.2 million decrease in accounts payable and accrued expenses and a $330,000 increase in prepaid expenses and other current assets.

 

58


Table of Contents

Our cash provided by operating activities during the year ended December 31, 2013 was primarily due to our net loss of $5.5 million adjusted for $2.3 million of non-cash expenses that included $2.4 million of depreciation and amortization, $640,000 in stock-based compensation, $80,000 loss on disposal of fixed assets, and an increase on our provision for doubtful accounts of $61,000, which was offset by $877,000 in change to the value of the contingent purchase price liability. Net increases in working capital amounted to $4.2 million attributable primarily to an increase of $6.8 million of deferred revenue and a $1.9 million increase in accounts payable and accrued expenses offset by, a $1.1 million increase in prepaid expenses and other current assets, a $3.2 million increase in accounts receivable and a $353,000 decrease in deferred rent.

Our cash provided by operating activities during the year ended December 31, 2012 was due to our net income of $1.0 million adjusted for $1.2 million of non-cash expenses that included $1.1 million of depreciation and amortization, $450,000 in stock-based compensation, and an increase on our provision for doubtful accounts of $84,000, which was offset by $431,000 in change to the value of the contingent purchase price liability. Net increases in working capital amounted to $3.8 million attributable primarily to an increase of $5.7 million of deferred revenue, a $2.7 million increase in accounts payable and accrued expenses as well as a $1.6 million increase in deferred rent, offset by an increase of $5.5 million in account receivable and $706,000 in prepaid expenses and other assets.

Our cash used in operating activities during the year ended December 31, 2011 was primarily due to our net income of $2.7 million adjusted for $1.3 million of non-cash expenses that included $842,000 of depreciation and amortization, $347,000 in stock-based compensation and an increase of $227,000 in value of the contingent purchase price liability, slightly offset by a decrease of $88,000 our provision for doubtful accounts. Net increases in working capital amounted to $3.1 million attributable to an increase of $3.8 million of deferred revenue, a $2.3 million increase in accounts payable and accrued expense as well as a $348,000 decrease in prepaid expenses. These increases were offset by an increase of $3.3 million in accounts receivable.

Net cash used in investing activities.    Our primary investing activities have consisted of capital expenditures to purchase computer equipment and furniture and fixtures as well as leasehold improvements to our company headquarters necessary to support the expansion our infrastructure and workforce. As our business grows, we expect our capital expenditures and our investment activity to continue to increase.

For the three months ended March 31, 2014, cash used in investing activities consisted of purchases of $655,000 of property and equipment.

For the year ended December 31, 2013, cash used in investing activities consisted of purchases of $3.4 million of property and equipment and a decrease of $97,000 attributable to the release of the restriction on a cash account.

For the year ended December 31, 2012, cash used in investing activities consisted of purchases of $4.2 million of property and equipment, primarily related to our new corporate headquarters.

For the year ended December 31, 2011, cash used in investing activities consisted of purchases of $565,000 of property and equipment along with $200,000 in cash related to the Validus acquisition.

Net cash provided by (used in) financing activities.    Our primary financing activities have consisted of proceeds from the exercise of stock options as well as proceeds from and payments on equipment debt obligations entered into to finance equipment leases and purchased software costs.

Our cash used in financing activities during the three months ended March 31, 2014 was primarily due to cash used to finance our deferred offering costs of $1.2 million and to pay down $220,000 in debt, capital lease obligations and royalty obligations which was offset by $294,000 of proceeds related to the exercise of stock options.

 

59


Table of Contents

Our cash provided by financing activities during the year ended December 31, 2013 was primarily due to $916,000 of proceeds related to the exercise of stock options which was offset by cash used to pay down $317,000 in debt and capital lease obligations.

Our cash provided by financing activities during 2012 was primarily due to $436,000 of proceeds related to the exercise of stock options and $326,000 resulting from the financing of purchases related to the acquisition of third party software licenses. The cash provided was offset by cash used to pay down $138,000 in debt and capital lease obligations.

Our cash used in financing activities during 2011 was primarily due to payments of $599,000 of withholding taxes associated with the net settlement of stock option exercises as well as cash used to pay down $219,000 in debt and capital lease obligations. The cash used was offset by $88,000 in cash proceeds related to the exercise of stock options.

Contractual obligations and commitments

Our principal commitments consist of obligations under leases for our office space, non-cancelable purchase obligations with our contract manufacturers and purchase obligations related to the purchase of computer equipment, furniture and fixtures and services. The following table summarizes these contractual obligations at December 31, 2013:

 

      Payment due by period  
(in thousands)   

Total

    

Less than
1 year

    

1-2

years

    

3-5 years

    

More than

5 years

 

 

 

Operating lease obligations

   $ 9,630       $ 1,970       $ 3,199       $ 4,461       $  

Non-cancelable purchase commitments

     1,271         1,271                          

Capital leases and long-term debt

     774         332         342         100          
  

 

 

 

Total

   $ 11,675       $ 3,573       $ 3,541       $ 4,561       $   

 

 

Off-balance sheet arrangements

During the periods presented, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical accounting policies and estimates

Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. We will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. To the extent that there are material differences between our estimates and our actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. See also Note 2 of our consolidated financial statements included elsewhere in this prospectus for information about these critical accounting policies as well as a description of our other significant accounting policies.

 

60


Table of Contents

Revenue recognition and deferred revenue

We derive our revenue primarily from the licensing of software, as well as devices, maintenance and services. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is considered probable. Product revenue is recognized upon shipment, assuming all other revenue recognition criteria have been met. Services are considered delivered as the work is performed and maintenance is considered delivered ratably over the contractual maintenance term. We have a limited number of customers who purchase our software on a term basis and we recognize these sales ratably over the term.

Sales of our software that are sold through resellers are recognized as revenue based on the same criteria as direct sales and upon identification of the end user. For sales through resellers, the reseller assumes the risk of collection from the end user and we do not offer a right of return or price protection to any of our resellers.

When arrangements contain software and non-software elements, we allocate the arrangement consideration to the software and non-software elements. The fair value of the elements is determined utilizing vendor-specific objective evidence of fair value, or VSOE, when available, third party evidence or the best estimate of selling price when VSOE of fair value is not determinable. We are currently unable to establish VSOE of fair value or third party evidence for our software elements as a group. Therefore the best estimate of selling price for the software elements is determined by considering various factors including but not limited to our standard software maintenance rates, the historical selling price of these deliverables in similar transactions, and our standard pricing practices along with geographies and customer class. After determining fair value for each deliverable, the arrangement consideration is allocated between the software elements, as a group, and the non-software elements using the relative selling price method. The non-software elements are then recognized upon delivery and when all other revenue recognition criteria are met.

For software arrangements that contain multiple deliverables where VSOE of fair value exists for all undelivered elements such as maintenance and services, we recognize revenue for the delivered elements using the residual method. VSOE of fair value is determined based upon the price charged when the same element is sold separately. VSOE of fair value of maintenance on user based licenses is based on the price customers are charged when they purchase maintenance separately from other products. Separate sales of maintenance occur when customers make the decision to renew their contracts in years subsequent to the initial maintenance term. We analyze our separate sales based on the “bell-shaped” curve method to ensure that the separate sales are sufficiently concentrated around a specific point and within a narrow enough range to enable a reasonable estimate of fair value. VSOE of fair value of maintenance on enterprise licenses is based on separately stated renewal rates in the arrangement that are substantive.

For software elements or elements containing multiple deliverables where VSOE of fair value does not exist for all undelivered elements, we defer revenue for the delivered and undelivered elements until VSOE of fair value is established for all of the undelivered element or all of the elements have been delivered, unless the only undelivered element is delivered over time (e.g., maintenance) where we would record revenue ratably over the delivery period. We recognize maintenance ratably over the term of the maintenance contract, generally 12 months. We recognize revenue allocated to professional service elements, such as installation and training, as the services are performed based on VSOE of fair value for each service performed.

Accounting for stock-based compensation

We record compensation expense for stock awards granted based on the awards estimated fair value. The measurement date for stock awards granted to employees is generally the date of grant. The measurement date for nonemployee awards is the date services are completed or the award is earned. Stock-based compensation is recognized on a straight-line basis over the requisite service period, which generally is the

 

61


Table of Contents

vesting period. The estimation of stock awards that will ultimately vest requires judgment and to the extent that actual results or updated estimates differ from current estimates, such amounts will be recorded as a cumulative adjustment in the period during which estimates are revised. Actual results and future changes in estimates may differ substantially from current estimates.

We utilize the Black-Scholes option-pricing model to estimate the fair value of stock options awarded to employees, which requires several key assumptions to be made. The weighted-average assumptions used to apply this model for each respective period were as follows:

 

      Year ended
December 31,
     Three months ended
March 31,
 
     2011      2012      2013      2013      2014  

 

 
                          (unaudited)  

Risk-free interest rate

     1.65%         0.87%         1.49%         1.10%         1.87%   

Expected life (years)

     6.05         6.02         6.03         6.05         6.04   

Expected dividend yield

     –%         –%         –%         -%         -%   

Expected volatility of underlying stock

     44%         46%         52%         46%         54%   

 

 

In determining the fair value of our stock-based awards, the risk-free interest rate for each award was based on the rate for United States Treasury zero-coupon bonds with maturities similar to the expected term of the award being valued. The expected life was based on a review of the period that our stock option awards are expected to be outstanding and is calculated using the simplified method, which represents the average of the contractual term of the options and the weighted-average vesting period of the options. We use the simplified method because we do not have sufficient historical option exercise data to provide a reasonable basis upon which to estimate the expected term. The expected dividend yield is zero as we have not declared dividends and our expectation is not to pay dividends in the foreseeable future. We do not have relevant historical data to develop our volatility assumptions and as a result we use the volatility of several public peer companies to determine our expected volatility.

Significant factors, assumptions and methodologies used in determining fair value of common stock

Because our common stock was not publically traded prior to our initial public offering, our board of directors estimated the fair value of our common stock at the time of each grant. The board of directors based their estimate on both objective and subjective factors along with valuation analyses prepared by an independent third-party valuation firm. Factors considered by our board of directors included:

 

 

independent third-party valuations;

 

the nature and historical performance of our business;

 

our operating performance and financial condition;

 

general economic conditions and the specific outlook for our industry;

 

the lack of liquidity for our stock;

 

the expected timing and likelihood of achieving different liquidity events or remaining a private company.

We obtained independent third-party valuations of our common stock in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, “Valuation of Privately-Held-Company Equity Securities Issued as Compensation.” The valuation approach selected for these valuations includes both the market approach and the income approach and we used the probability-weighted expected return method to allocate the equity value among the preferred and common classes of stock.

The market approach is a general way of determining a value indication of a business, business ownership interest, security, or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold. Our market

 

62


Table of Contents

approach relied on comparisons to publicly traded stocks or to sales of similar companies. When choosing the comparable companies to be used for the market approach, we focused on companies which provide information technology security or healthcare information technology solutions. Our list of guideline public companies has changed over time due to factors such as acquisitions and initial public offerings. The income approach is a general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated economic benefits into a present single amount. Our income approach utilized the discounted cash flow method.

After estimating our enterprise value, we allocated the equity between the preferred and common stock using the probability-weighted expected return method. Under the probability-weighted expected return method, the value of an enterprise’s common stock is estimated based upon an analysis of our future values assuming various possible future liquidity events, including the likelihood of an initial public offering and other scenarios, such as a sale of our company. Share value is based upon the probability-weighted present value of expected future net cash flows, considering each of the possible future events, as well as the rights and preferences of each share class.

The following table summarizes all option grants from January 1, 2012 through the date of this prospectus:

 

      Number of
options
granted
     Per share
exercise
price
     Common
stock fair
value per
share at
grant date
 

 

    

 

 

 

March 23, 2012

     13,327         3.15         3.15   

May 23, 2012

     5,666         3.15         3.15   

July 20, 2012

     120,988         3.15         3.15   

October 30, 2012

     76,456         3.15         3.15   

December 11, 2012

     131,663         3.15         3.15   

February 7, 2013

     137,316         4.64         4.64   

April 5, 2013

     153,991         4.64         4.64   

July 24, 2013

     104,320         5.88         5.88   

November 6, 2013

     581,955         7.98         7.98   

December 17, 2013

     15,829         9.08         9.08   

February 11, 2014

     60,690         11.15         11.15   

May 1, 2014

     123,650         11.79         11.79   

 

    

 

 

 

Significant factors contributing to changes in common stock fair value at the date of each grant beginning in fiscal year 2012 were as follows:

Grants made in 2012.    On March 23, 2012, our board of directors granted 13,327 options at an exercise price of $3.15 per share. The board reviewed and considered an independent valuation report for our common stock as of December 31, 2011 in estimating the fair value of the common stock on that date. We considered possible liquidity event scenarios and assigned a probably of 15% for an initial public offering at a future equity value of $145 million, 30% for a high-value sale or merger at a future equity value of $162 million, 40% for a mid-value sale or merger at a future equity value of $97 million and 15% for remaining a private company at a present equity value of $68 million. This valuation used a discount rate of 20% and included a marketability discount of 20%.

From May 23, 2012, through December 11, 2012, our board of directors made four grants totaling 334,773 options at an exercise price of $3.15 per share. The exercise price for these grants was based upon our board of directors’ determination of the fair value of our common stock on each grant date. As of each grant date, our performance was consistent with expectations and there had been no meaningful changes in our equity

 

63


Table of Contents

structure, future cash flow projections or liquidity event scenarios since the prior stock option grant on March 23, 2012 and as a result the board concluded that the estimated fair market value had not changed at each grant date.

Grants made in 2013.    On February 7, 2013, our board of directors granted 137,316 options at an exercise price of $4.64 per share. The fair value for this grant was estimated based on the board of directors’ review and consideration of an independent valuation report for our common stock as of December 31, 2012. Our board of directors determined that there were no significant factors affecting the value of our common stock that occurred between December 31, 2012 and February 7, 2013. We considered possible liquidity event scenarios and assigned a probability of 20% for an initial public offering at a future equity value of $197 million, 20% for a high-value sale or merger at a future equity value of $174 million, 45% for a mid-value sale or merger at a future equity value of $132 million and 15% for remaining a private company at a present equity value of $98 million The change in fair value from the previous grant was due to several changes in the assumption used, including an increase in projected future revenue, a decrease from 20% to 18% for the discount rate used, as well as changes in the probabilities associated with future liquidity scenarios.

On April 5, 2013, our board of directors granted 153,991 options at an exercise price of $4.64 per share. The exercise price for this grant was based upon our board of directors’ determination of fair value on the grant date. It was determined that as of the grant date, our performance was consistent with expectations and there had been no meaningful changes in our equity structure, future cash flow projection or liquidity event scenarios since the February 7, 2013 stock option grant and as a result the board concluded that the estimated fair value had not changed.

On July 24, 2013, our board of directors granted 104,320 options at an exercise price of $5.88 per share. The fair value for this grant was estimated based on the board of directors’ review and consideration of an independent valuation report for our common stock as of May 31, 2013. Our board of directors determined that there were no significant factors affecting the value of our common stock that occurred between May 31, 2013 and July 24, 2013. We considered possible liquidity event scenarios and assigned a probably of 35% for an initial public offering at a future equity value of $203 million, 25% for a high-value sale or merger at a future equity value of $194 million, 30% for a mid-value sale or merger at a future equity value of $143 million and 10% for remaining a private company at a present equity value of $129 million. The estimated value of our common stock increased due to an increase in projected revenue, a decrease from 18% to 17% for the discount rate, a decrease in marketability discount from 20% to 18% and changes in the probabilities associated with liquidity scenarios.

On November 6, 2013, our board of directors granted 581,955 options at an exercise price of $7.98 per share. The fair value for this grant was estimated based on the board of directors’ review and consideration of an independent valuation report for our common stock as of September 30, 2013, which was received on October 21, 2013. Our board of directors determined that there were no significant factors affecting the value of our common stock that occurred between September 30, 2013 and November 6, 2013. We considered possible liquidity event scenarios and assigned a probability of 40% for an initial public offering at a future equity value of $219 million, 25% for a high-value sale or merger at a future equity value of $263 million, and 35% for a mid-value sale or merger at a future equity value of $174 million. We eliminated consideration of a remain-private scenario. The estimated value of our common stock increased due to an increase in projected revenue, a decrease from 17% to 15% for the discount rate, a decrease in marketability discount from 18% to 13% and changes in the probabilities associated with liquidity scenarios.

On December 17, 2013, our board of directors granted 15,829 options at an exercise price of $9.08 per share. The fair value for this grant was estimated based on the board of directors’ review and consideration of an independent valuation report for our common stock as of December 1, 2013, which was received on December 4, 2013. Our board of directors determined that there were no significant factors affecting the value

 

64


Table of Contents

of our common stock that occurred between December 1, 2013 and December 17, 2013. We considered possible liquidity event scenarios and assigned a probability of 45% for a mid-value initial public offering at a future equity value of $213 million, 15% for a high value initial public offering at a future equity value of $329 million 10% for a high value sale or merger at a future equity value of $269 million, and 30% for a mid-value sale or merger at a future equity value of $180 million. The estimated value of our common stock increased due to an increase in projected revenue, a decrease in marketability discount from 13% to 9% and changes in the probabilities associated with liquidity scenarios.

On February 11, 2014, our board of directors granted 60,690 options at an exercise price of $11.15 per share. The fair value for this grant was estimated based on the board of directors’ review and consideration of an independent valuation report for our common stock as of January 31, 2014, which was received on February 7, 2014. Our board of directors determined that there were no significant factors affecting the value of our common stock that occurred between January 31, 2014 and February 11, 2014. We considered possible liquidity event scenarios and assigned a probability of 55% for a mid-value initial public offering at a future equity value of $220 million, 30% for a high-value initial public offering at a future equity value of $361 million, 5% for a high-value sale or merger at a future equity value of $271 million, and 10% for a mid-value sale or merger at a future equity value of $181 million. The estimated value of our common stock increased due to an increase in projected revenue, a decrease in marketability discount from 9% to 6% and changes in the probabilities associated with liquidity scenarios.

On May 1, 2014, our board of directors granted 123,650 options at an exercise price of $11.79 per share. The fair value for this grant was estimated based on the board of directors’ review and consideration of an independent valuation report for our common stock as of April 25, 2014, which was received on April 30, 2014. Our board of directors determined that there were no significant factors affecting the value of our common stock that occurred between April 25, 2014 and May 1, 2014. We considered possible liquidity event scenarios and assigned a probability of 30% for a mid-value initial public offering at a future equity value of $223 million, 55% for a high-value initial public offering at a future equity value of $326 million, 5% for a high-value sale or merger at a future equity value of $275 million, and 10% for a mid-value sale or merger at a future equity value of $183 million. The estimated value of our common stock increased due to changes in the probabilities associated with liquidity scenarios.

Goodwill and intangible assets

We allocate the purchase price of any acquisitions to tangible assets and liabilities and identifiable intangible assets acquired. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates are based on information obtained from management of the acquired companies and historical experience. These estimates can include, but are not limited to, the cash flows that an asset is expected to generate in the future, and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable, and if different estimates were used the purchase price for the acquisition could be allocated to the acquired assets and liabilities differently from the allocation that we have made. In addition, unanticipated events and circumstances may occur which affect the accuracy or validity of such estimates, and if such events occur we may be required to record a charge against the value ascribed to an acquired asset or an increase in the amounts recorded for assumed liabilities.

Goodwill

Goodwill is tested for impairment at the reporting unit level at least annually or more often if events or changes in circumstances indicate the carrying value may not be recoverable. Significant judgments required in assessing the

 

65


Table of Contents

impairment of goodwill include the identification of reporting units, identifying whether events or changes in circumstances require an impairment assessment, estimating future cash flows, determining appropriate discount and growth rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value as to whether an impairment exists and, if so, the amount of that impairment.

A reporting unit can be either an operating segment or a component of an operating segment depending on the circumstances. The determination of an operating segment or component is based on the availability of discrete financial information and whether or not that information is reviewed and used by the chief operating decision maker or decision making group. Our chief operating decision maker is our Chief Executive Officer. Our chief operating decision maker reviews consolidated operating results to assess the performance of the entire Company and does not review results on a segment or component basis. Accordingly, we have determined that there is one reporting unit.

No impairment of goodwill was recorded in the years ended December 31, 2011, 2012 or 2013 or the three months ended March 31, 2014.

Intangible assets

In connection with an asset acquisition we made in 2011, we recorded intangible assets. We applied an income approach to determine the value of these intangible assets; the income approach measures the value of an asset based on the future cash flows it is expected to generate over its remaining life. The application of the income approach requires estimates of future cash flows based upon, among other things, certain assumptions about expected future operating performance and an appropriate discount rate determined by our management. In applying the income approach, we used the multi-period excess earnings method to value our in-process research and development intangible assets and the relief from royalty method to value our trade name intangible assets. The cash flows expected to be generated by each intangible asset were discounted to their present value equivalent using discount rates consistent with market participant assumptions.

We also acquired patents and other intellectual property in 2009 and 2010 and recorded intangible assets related to these purchases. These intangible assets were purchased outside of a business combination and were initially recognized and measured based on their cost to us.

Intangible assets are amortized over their estimated useful lives. Upon completion of development, acquired in-process research and development assets are generally considered amortizable, finite-lived assets and are amortized over their estimated useful lives. We evaluate intangible assets for impairment by assessing the recoverability of these assets whenever adverse events or changes in circumstances or business climate indicate that expected undiscounted future cash flows related to such intangible assets may not be sufficient to support the net book value of such assets. An impairment is recognized in the period of identification to the extent the carrying amount of an asset exceeds the fair value of such asset. No impairment of intangible assets was recorded in the years ended December 31, 2011, 2012 or 2013 or the three months ended March 31, 2014.

JOBS Act

On April 5, 2012, the JOBS Act was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an “emerging growth company.” As an emerging growth company, we are electing to not take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards, and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to not take advantage of the extended transition period for complying with new or revised accounting standards is irrevocable. In addition,

 

66


Table of Contents

we are in the process of evaluating the benefits of relying on the other exemptions and reduced reporting requirements provided by the JOBS Act.

Subject to certain conditions set forth in the JOBS Act, if as an emerging growth company we choose to rely on such exemptions, we may not be required to, among other things, (1) provide an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act, (2) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act, (3) comply with any requirement that may be adopted by the PCAOB regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and our audited financial statements (auditor discussion and analysis) and (4) disclose certain executive compensation-related items such as the correlation between executive compensation and performance and comparisons of the Chief Executive Officer’s compensation to median employee compensation. We would cease to be an emerging growth company on the date that is the earliest of (1) the last day of the fiscal year in which we have total annual gross revenues of $1.0 billion or more; (2) the last day of our fiscal year following the fifth anniversary of the date of the completion of this offering; (3) the date on which we have issued more than $1.0 billion in nonconvertible debt securities during the previous three years; or (4) the date on which we are deemed to be a “large accelerated filer” as defined in the Securities and Exchange Act of 1934, which we refer to as the Exchange Act.

Quantitative and qualitative disclosures about market risk

We have operations both within the United States and internationally which expose us to market risk. These risks primarily are primarily the result of fluctuation in foreign exchange rates and interest rates, as well as risks relating to changes in the general economic conditions in the countries where we conduct business. We do not use derivative instruments to mitigate the impact of our market risk exposures.

Foreign currency exchange risk

We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar. Our customer contracts are generally denominated in the currencies of the countries in which the customer is located which exposes us to risk associated with sales made in foreign currencies. Our historical revenue has been denominated in U.S. dollars, the Euro and British Pound Sterling. The functional currency for our foreign operations is denominated in the local currency and as a result operating expenses related to our foreign locations are impacted by fluctuations in foreign currency exchange rates. Increases and decreases in our foreign denominated revenue due to fluctuations in foreign currency exchange rates are somewhat offset by the currency fluctuations in our operating expenses that are denominated in foreign currencies

If the foreign currency exchange rates fluctuated by 10% as of March 31, 2014, our foreign currency exchange gain or loss would have fluctuated by $440,000.

Interest rate risk

At March 31, 2014, we had cash and cash equivalents of $5.9 million. We maintain substantially all of our cash equivalents in an institutional money market mutual fund. The fund provides daily liquidity and invests in a portfolio of short-term money market instruments issued by the U.S. government. We do not enter into investments for trading or speculative purposes. Due to the short-term 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.

At March 31, 2014, we had a 3 year term loan with a fixed interest rate of 6.2%, and a 2.5 year term loan with a fixed interest rate of 6.5%, associated with the purchase of licenses and associated maintenance with an aggregate balance of $462,000. Changes in interest rates would not have a significant impact on our outstanding borrowing.

 

67


Table of Contents

Business

Overview

We are a leading provider of authentication and access management technology solutions for the healthcare industry. Our flagship solution, Imprivata OneSign, is an integrated enterprise single sign-on, authentication management and workflow automation platform that addresses multiple security and productivity challenges faced by hospitals and other healthcare organizations. By enabling fast, secure access to healthcare information technology systems, we believe our solutions save clinicians significant time to focus on patient care, increase their productivity and satisfaction, and help healthcare organizations comply with privacy and security regulations. Imprivata OneSign can be installed on every workstation and other application access point throughout a healthcare organization and once deployed becomes a critical part of the customer’s security and access infrastructure. As a result, we believe that Imprivata OneSign is one of the most widely-used technology solutions by our customers’ physicians, nurses and other clinicians.

Across the globe, the healthcare industry is transitioning from paper-based records to electronic systems and processes, and is facing increasing privacy and security regulations relating to protected health information, or PHI. As a result of the confluence of these trends, clinicians are required to use numerous usernames and passwords to securely sign-on to multiple applications as they access PHI to manage patient care. This impedes clinical workflows, reduces time available for patient care and reduces clinician satisfaction. In a 2011 study that we commissioned of acute care hospitals in the United States, clinicians use on average six to seven different passwords to gain access to clinical applications and PHI. We believe that the combination of unique passwords across multiple applications slows access to information and disrupts the cognitive process of care delivery. By using our solutions, some of our customers have reported that clinicians can save up to 45 minutes per shift. As a result of widespread adoption of healthcare information technology and increasing privacy and security regulation, demand for our solutions continues to grow.

Imprivata OneSign is used by our customers to solve three critical problems in their organizations. Imprivata OneSign allows our customers to eliminate multiple log-ons to different applications by using a single log-on, which we refer to as enterprise single sign-on. Imprivata OneSign also allows our customers to replace username and password-based authentication with a stronger and more efficient form of authentication technology, such as fingerprint biometrics, proximity cards, smartcards or tokens, which we refer to as authentication management. Using single sign-on, authentication management and our other offerings, including integration with leading electronic health record systems for e-prescribing and virtual desktop infrastructure, Imprivata OneSign allows our customers to optimize clinical workflows, which we refer to as workflow automation. Our solutions have been designed to be easy to implement, use and manage in complex healthcare environments and may be purchased together or separately.

We believe any healthcare organization that relies on information technology is a potential customer for our solutions. As of March 31, 2014, our Imprivata OneSign solution had over 2.8 million licensed users in over 950 healthcare organizations in 20 countries, including large integrated healthcare systems, academic medical centers, and small- and medium-sized independent healthcare facilities. Following the initial sale, many of our healthcare customers continue to add licensed users and purchase additional products and services from us. For example, these add-on sales accounted for over half of our new product revenues in the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014. We estimate that the total available market in healthcare organizations in North America and other global markets that we currently serve is approximately $3.0 billion. Many other industries face security and productivity challenges similar to those in healthcare. Although healthcare is our primary focus, as of March 31, 2014, Imprivata OneSign had over 770,000 licensed users in over 400 non-healthcare organizations, including financial services, the public sector and other industries.

 

68


Table of Contents

We sell our solutions through our direct sales force and sales partners in the United States and internationally. During the years ended December 31, 2011, 2012 and 2013, our revenue was $41.4 million, $54.0 million and $71.1 million, respectively, representing growth of 30% from 2011 to 2012, and 32% from 2012 to 2013. Our net income for 2011 and 2012 was $2.7 million and $1.0 million, respectively, and in 2013 we had a net loss of $5.5 million. We generated revenue of $14.3 million and $19.4 million for the three months ended March 31, 2013 and 2014, representing growth of 36%, and had net losses of $1.5 million and $7.1 million, respectively. As of March 31, 2014, we had an accumulated deficit of $97.2 million.

Industry overview

Gartner, a leading information technology research firm, estimates that healthcare providers will increase spending on healthcare information technologies from $98 billion in 2013 to $110 billion in 2016. The United States and Western Europe account for 70% of global spending on enterprise healthcare IT, in a publication dated as of March 19, 2013. However globally, healthcare organizations face challenges in maximizing the use of information technology by their time-pressured clinicians. The use of healthcare information technology systems, coupled with regulatory requirements for privacy and security, create inefficiencies for clinicians in the delivery of patient care. We believe that demand for our solutions is driven by the confluence of two major trends:

 

 

Increased utilization of information technology in delivering patient care: As a result of the continuing shift away from paper-based systems, clinicians are increasingly required to use information technology to access patient information in providing patient care. In the United States, utilization of healthcare information technology has accelerated with the enactment in 2009 of the Health Information Technology for Economic and Clinical Health Act, or the HITECH Act. This regulatory framework provides subsidies to encourage eligible healthcare organizations to implement and use certified electronic health record, or EHR, systems and penalties for failing to attain specified utilization measures, or “meaningful use,” of EHR technologies.

 

 

Increased regulation of privacy and security of patient information: A number of privacy and security requirements govern access to and release of PHI globally. For example, in the United States compliance with the Health Insurance Portability and Accountability Act of 1996, or HIPAA, a federal law which protects the privacy and security of patient information imposes technical data security standards, including requirements for unique user identification, means for accessing necessary electronic PHI during an emergency, termination of electronic sessions after a predetermined time of inactivity, and audit control mechanisms that record and examine activity in information systems that contain or use electronic PHI. Furthermore, recent federal and state regulations require multiple forms of authentication for electronic prescriptions of controlled substances and some states, such as Ohio and New York, have adopted enhanced authentication requirements for electronic prescriptions of controlled substances and certain other medications. These privacy and security requirements continue to evolve, become more stringent, and increasingly are proactively enforced.

This convergence of increasing technology use and privacy and security requirements creates the following critical workflow challenges for hospitals and other healthcare organizations:

 

 

Mobile clinicians and shared workstations drive the need for efficient user access: Clinicians care for patients across various settings throughout a healthcare organization. Workstations are deployed and shared by clinicians to provide access to patient information in multiple locations throughout a hospital or other healthcare facility, including operating rooms, intensive care units, emergency rooms, patient bedsides, hallways, nursing stations and physician lounges. This creates inefficiencies as each clinician needs to log-on and log-off from one or more shared workstations in various locations, often in rapid succession.

 

69


Table of Contents
 

Clinicians access many applications and manage multiple passwords: For every patient encounter, clinicians may need to access multiple applications, each requiring a separate user name and password to log-on. This slows access to information and frustrates clinicians.

 

 

Clinicians may leave the workstation without logging off: Privacy regulations require workstations to be secured so that patient information is not exposed. Failure of a clinician to sign out of a workstation may cause a privacy breach, or another clinician to inadvertently access the wrong patient record, potentially resulting in incorrect documentation of care or patient safety issues.

 

 

Electronic prescriptions increasingly require strong authentication: In the United States, the use of electronic prescriptions continues to grow rapidly. In certain states and for certain medications, electronic prescriptions require “second-factor authentication,” such as fingerprint authentication, in order to verify the identity of the prescribing clinician. Without second factor authentication, clinicians cannot enter these orders electronically and must revert to writing paper prescriptions.

Without integrated and secure authentication and access management solutions, healthcare organizations may be adversely affected in the following ways:

 

 

Less time for patient care: Inefficient authentication and access management processes are an important factor in reducing the time clinicians have for patient care and can be stressful to the patient and frustrating to the clinician. According to a 2008 study entitled “A 36-Hospital Time and Motion Study: How do Medical-Surgical Nurses Spend Their Time?” published in the Permanente Journal, some clinicians spend only approximately 20% of their time on patient care, with the balance spent on documentation, communication and other administrative tasks.

 

 

Reduced clinician satisfaction: According to a 2011 survey we commissioned of acute care hospitals in the United States, clinicians spend 25% of their time accessing and using electronic records. We believe that the time delays related to accessing and using electronic records distract clinicians from patient care and have a negative impact on their satisfaction.

 

 

Increased risk of violating data privacy laws such as HIPAA regulations: Without a reliable solution to help secure access to electronic PHI, healthcare providers may increase their risk of incurring a costly data privacy or security breach, which can lead to contractual, civil, and criminal liability, as well as mandatory notification to affected individuals, reporting of breach incidents to regulatory authorities, and in some cases, public media disclosures. For example, a HIPAA violation can result in fines of up to $1.5 million per violation.

 

 

Failure to realize benefits of investment in information technology: In order for healthcare organizations to benefit from the financial incentives available under the HITECH Act, they must meet certain standards for meaningful use of EHR systems. Despite the significant information technology investments made by healthcare organizations in support of achieving meaningful use, we believe that clinicians have been slow to use EHR systems and other clinical applications because of their negative impact on clinician workflow productivity. For example, according to a 2009 study entitled “The Kaiser Permanente Electronic Health Record: Transforming and Streamlining the Modalities of Care” published in Health Affairs, the introduction of EHR systems can lead to decreases in clinician productivity by as much as 15%.

We believe that healthcare organizations are increasingly choosing integrated authentication and access management technologies to address these challenges across their entire organization. According to HIMSS Analytics, an independent healthcare information technology research firm, there were approximately 5,400 hospitals in the United States as of December 31, 2013. In addition, based on statistics from the World Health Organization, we estimate that there are over 10,000 hospitals across Europe. We estimate that the total

 

70


Table of Contents

available market in hospitals for a full implementation of our products and services is approximately $3.0 billion, which consists of $1.5 billion in North America and $1.5 billion in the global markets that we currently serve outside of North America. Our estimate of our total available market in North America was calculated by multiplying the number of beds at hospitals who are our potential customers as reported by HIMSS Analytics, by our estimate of the full utilization rate for our products and services on a per bed basis based on data from our existing customers in North America, and by the average selling prices for our software licenses, hardware authentication devices, maintenance and services in North America.

Our estimate of our total available market in global markets outside of North America is based on similar calculations which rely on the number of beds in the countries that we currently serve outside of North America as reported by the World Health Organization, our estimate of the full utilization rate for our products and services on a per bed basis based on data from our existing customers in North America adjusted for global markets as described below, and the estimated average selling prices for our software licenses, hardware authentication devices, maintenance and services in global markets outside of North America. To account for differences between our North American market and other global markets, and because we do not have as much experience in global markets outside of North America, we adjusted our estimate of the utilization rate for each global region by the ratio of clinicians per bed as compared to the same ratio in North America, which we calculated from statistics reported by the World Health Organization. We believe that the ratio of clinicians per bed is a useful proxy for estimating differences in healthcare resources across regions. We also adjusted our estimate of our total available market in global markets outside of North America by subtracting our existing sales into these markets. Our estimates of our global market opportunity exclude non-acute care facilities, such as physician offices, ambulatory surgery centers, urgent care centers, skilled nursing facilities and mental health facilities, because of the lack of available data for these facilities, although we believe that such non-acute care facilities are potential customers of our solutions.

Benefits of our solutions

We believe our solutions provide the following key benefits:

 

 

Save clinicians time: Healthcare organizations can utilize our integrated authentication and access management solutions to reduce the time to log-on to applications. By eliminating the need to type in multiple usernames and passwords across multiple applications, our Imprivata OneSign solution enables clinicians to work more efficiently, and spend more time on patient care. By using our solutions, some of our customers have reported that clinicians can save up to 45 minutes per shift.

 

 

Improve clinician satisfaction by optimizing workflows: Imprivata OneSign, through authentication management, enterprise single sign-on and workflow enhancements, optimizes clinical workflows. Our solutions address clinical workflow challenges such as switching users rapidly on a shared workstation, keeping a session active as a clinician moves throughout the hospital in providing care, and automating navigation between applications based on individual clinician preferences. We believe that these and other workflow enhancements increase clinician satisfaction.

 

 

Help healthcare organizations comply with security and privacy regulations: By securing access to shared workstations in the healthcare organization, our solutions help reduce the risk of breaching security or privacy regulations. Our solutions, as a critical part of our customers’ security and access infrastructure, can be deployed at every application access point in the healthcare organization, thereby limiting the risk of a privacy breach. For example, HIPAA requires specific policies, procedures and security controls for access to PHI, wherever it is located or accessed.

 

71


Table of Contents
 

Improve financial performance: We believe that our solutions improve the financial performance of healthcare organizations by enhancing clinician productivity and increasing utilization of investments in EHR systems and other healthcare information technologies. In the United States, we help our customers achieve meaningful use and qualify for the financial incentives available through the HITECH Act. In addition, we believe that our solutions reduce the number of help desk calls and costs associated with forgotten passwords.

Our strengths

We believe that the following strengths will enable us to maintain and extend our leadership position as a provider of authentication and access management solutions in the healthcare industry:

 

 

The Imprivata brand: Imprivata is recognized as a leading provider of authentication and access management solutions in healthcare. Imprivata OneSign achieved the number one ranking as the Category Leader for Single Sign-On in the “2012 Best in KLAS: Software & Services” report, dated December 2012, and in the “2013 Best in KLAS: Software & Services” report, dated January 2014, published by KLAS, an independent healthcare technology research firm.

 

 

Compelling feature set and ease of implementation, use and management: We provide our customers with compelling features that differentiate Imprivata OneSign as an enterprise-wide authentication and access management solution, including finger biometric identification, integrated authentication and enterprise single sign-on, application programming interfaces for independent software vendors, virtual desktop support with multiple vendors, including zero- and thin-client devices, and new solutions. Our Imprivata OneSign solution is designed to be easy to implement throughout the enterprise by information technology personnel, use by clinicians, and manage by IT administrators.

 

 

Our healthcare customers view us as a trusted strategic partner: We believe our healthcare customers view us as a strategic partner to help them optimize clinical workflow, improve clinician satisfaction and comply with changing regulatory requirements. Our customers routinely identify specific challenges in the clinical setting and request that we develop innovative solutions to address them. Recent product developments, such as virtual desktop automation, fade-to-lock and authentication for electronic prescribing resulted from these customer interactions.

 

 

Stable customer base with significant additional sales opportunities: Many of our customers continue to add licensed users and purchase additional products and services from us after the initial sale. For example, add-on sales from existing customers accounted for over half of our new product revenues in the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014. In the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014, we derived 33%, 38% and 36%, respectively, of our revenue from sales to existing customers, 35%, 30% and 25%, respectively, of our revenue from sales to new customers, with the remaining revenue in each of those periods from software maintenance renewals and professional services. In addition, in each of the last four years, we retained greater than 90% of the aggregate dollar value of maintenance contracts up for renewal. The consistency of add-on sales to existing customers and the recurring nature of our maintenance revenues provide visibility into our future performance.

 

 

Global distribution network and strong selling relationships: We access our customers through multiple channels, including a global direct sales force and a network of sales partners, to sell our solutions worldwide. As of March 31, 2014, our direct sales force consisted of 88 people in the United States and internationally. Our sales partners consist of value-added resellers and EHR systems vendors that resell our Imprivata OneSign solution on a standalone basis or as part of an integrated solution. We also have country- and region-specific sales partners targeting selected international markets. In each of the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014, we generated approximately 59%, 59% and 55%, respectively, of our revenue through our relationships with sales partners.

 

72


Table of Contents
 

Our partner ecosystem: We have strategic relationships with leading EHR systems, virtual desktop infrastructure platforms and device vendors that provide the ability to integrate our solutions with their products and services. Integration with EHR systems such as EpicCare and Cerner Millennium allows us to streamline clinical workflow and improve clinician experience. Integration with virtual desktop infrastructure computing environments, such as VMware Horizon View, Citrix XenApp and Citrix XenDesktop, allows us to streamline the authentication process and control and improve the visual experience. Integration with chip and protocol suppliers, such as Teradici and Texas Instruments, allows us to incorporate our authentication functionality directly into thin and zero client devices.

 

 

Culture of continuous innovation: We have fostered a culture that stresses innovation as a core competency. We continue to invest in research and development to solve security and productivity challenges and improve overall workflow efficiencies for our customers. This culture has resulted in the ongoing enhancement of Imprivata OneSign and the development of new solutions, including our recent introduction of Imprivata Cortext, our secure communications solution.

Our strategy

Our goal is to extend our leadership position as a provider of authentication and access management solutions in the healthcare industry. Key elements of our strategy include:

 

 

Acquire new U.S. healthcare customers: According to HIMSS Analytics, our Imprivata OneSign solution was used in approximately 18% of hospitals in the United States as of December 31, 2013. We believe our Imprivata OneSign solution can provide significant value to both large and small hospitals and other healthcare organizations that do not currently license our solutions. To target these potential customers, we have increased our direct sales force in the United States from 36 as of December 31, 2012 to 68 as of March 31, 2014. We plan to continue to expand our direct sales force and to continue working closely with our sales partners to win new customers.

 

 

Drive further penetration into our installed base of customers: Our customers’ initial purchases rarely include all of our solutions for all of their users. As a result, many of our customers continue to add licensed users and purchase additional products and services from us after the initial sale. For example, these add-on sales accounted for over half of our new product revenues in the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014. In the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014, we derived 33%, 38% and 36%, respectively, of our revenue from sales to existing customers, 35%, 30% and 25%, respectively, of our revenue from sales to new customers, with the remaining revenue in each of those periods from software maintenance renewals and professional services. We plan to add sales and customer experience personnel in order to grow our revenue from our installed base.

 

 

Extend our technology leadership, develop innovative products and address additional workflow challenges: We intend to continue our investment in research and development to further differentiate and enhance the functionality of our authentication and access management solutions. We plan to also invest in developing new products and solutions that expand the range of security, productivity and workflow optimization solutions we offer to healthcare organizations. For example, with our Imprivata Cortext solution, we are beginning to provide a secure communication solution for healthcare organizations.

 

 

Grow our international healthcare presence: In addition to our core market in the United States, we offer our solutions in more than 20 countries, including Australia, Belgium, Canada, Denmark, France, Germany, the Netherlands and the United Kingdom. As of March 31, 2014, our solutions were licensed to over 170 healthcare organizations outside the United States. We plan to utilize both our direct sales force and

 

73


Table of Contents
 

local sales partners to expand our presence in countries throughout Europe and develop new markets in Latin America, Middle East and Asia Pacific regions. We estimate that the total available market in healthcare organizations for our solutions in countries we currently serve outside of North America is approximately $1.5 billion.

 

 

Expand our Imprivata OneSign solution into new healthcare settings: Our Imprivata OneSign solution today is primarily sold to hospitals and other inpatient healthcare facilities, but there is an opportunity for us to sell our solution into other healthcare settings as well. For example, we believe there are growth opportunities for our authentication and access management solutions in outpatient or ambulatory facilities in the United States. According to the U.S. Bureau of Labor Statistics, as of September 30, 2013, there were over 560,000 ambulatory healthcare facilities, such as physician offices, ambulatory surgery centers, urgent care centers, skilled nursing facilities and mental health facilities.

 

 

Acquire complementary businesses, technologies and assets: Since 2010, we have completed two technology-based acquisitions to expand our solutions offering. We may pursue acquisitions that complement our existing business, represent a strategic fit and are consistent with our overall growth strategy. We may also target future acquisitions that reinforce our presence in markets we currently serve or that help us to access new markets, or that add functionality and capabilities to our solutions.

Our solutions

Our solutions consist of Imprivata OneSign and Imprivata Cortext. We also provide professional services and support capabilities to help our customers realize the full benefits of our solutions.

Imprivata OneSign

Imprivata OneSign is a suite of authentication and access management products that can be delivered either pre-loaded on a hardware server or as a software only solution with all components required to make the solution operational “out-of-the-box.” Imprivata OneSign enables fast, secure access and workflow optimization to workstations and applications. We derive substantially all of our revenue from sales of Imprivata OneSign and its related products and services. Imprivata OneSign consists of three main offerings: Authentication Management, Enterprise Single Sign-On, and Workflow Automation.

Authentication Management is software used to replace the act of manually entering a user’s log-on name and password with a stronger and more convenient form of authentication technology, such as fingerprint biometrics, proximity cards, smartcards or token. This simplifies and secures the user’s access to physical and virtual desktops. Authentication Management is also used for securely identifying users for transactions such as ordering prescriptions electronically.

Authentication Management also has an application programming interface, called the OneSign ProveID API, which allows for integration with various other healthcare information technologies. For instance, major vendors of acute-care EHR systems integrate with the Imprivata OneSign ProveID API to provide authentication management for electronic prescriptions. Similarly, other solution vendors, such as secure print management, medication dispensing units and virtual desktop infrastructure device manufacturers use our OneSign ProveID API to provide authentication management capabilities.

 

74


Table of Contents

Additional Authentication Management software and hardware products include the following:

 

 

Virtual Desktop Access software enables authentication to virtual desktops for all of the three major virtualization environments: VMware Horizon View, Citrix XenApp, and Citrix XenDesktop. With Virtual Desktop Access, clinicians can quickly and securely “roam” their desktop across locations while preserving their application state.

 

 

Fingerprint Biometric Identification software enables clinicians to verify their identity and access their desktop and applications with just a touch of a finger.

 

 

Proximity Card and Fingerprint Readers are authentication devices that connect to workstations. Proximity Card Readers support a broad range of card types and are able to support multiple card types on a single card reader. When used in conjunction with Authentication Management, clinicians no longer need to type in their usernames and passwords multiple times to access applications and workstations. Instead, they simply tap their badge or touch their finger to a reader to gain instant access, delivering significant time savings for clinicians.

 

 

Self-Service Password Management enables clinicians to securely retrieve or change a lost password, minimizing frustration, interruption and costly user support.

 

 

Secure Walk-Away enables healthcare organizations to address problems associated with unattended workstations. The solution utilizes facial recognition and motion detection software integrated with commercially available desktop cameras to automatically lock a screen when an authenticated user walks away from the workstation.

Enterprise Single Sign-On software simplifies application log-on, automating username and password entry for authenticated users. A licensed user simply completes the initial authentication transaction and subsequent log-ons and log-offs are automated, eliminating the need to separately log-on when accessing workstations or applications. Our Imprivata OneSign solution enables the user to automatically access each application without otherwise modifying it.

 

 

Imprivata OneSign Anywhere provides remote single sign-on access for enterprise and web-based applications from a web-based browser on home computers and tablet devices.

Workflow Automation enables healthcare organizations to automate certain access workflows, such as auto-launching specific applications at the point of a clinician’s authentication to the desktop, roaming a clinician’s desktop as they move from one workstation to another, and enabling users to log into and out of their desktop without going through its log-on and log-off process, which is known as fast user switching.

Imprivata Cortext

Imprivata Cortext is a cloud-supported secure communications platform that provides healthcare organizations with secure SMS texting and messaging capabilities in compliance with applicable data privacy and security regulations. Imprivata Cortext is offered as a software subscription for iPhone and Android devices. Clinicians use Imprivata Cortext to securely transmit text messages and images that may contain PHI in the course of providing patient care, helping healthcare organizations comply with HIPAA regulations while improving and streamlining clinical communication processes for clinicians. This solution was introduced in October 2012 and is offered as either a free or a paid service. As of March 31, 2014, we have generated an immaterial amount of revenue from sales of Imprivata Cortext.

 

75


Table of Contents

Customer experience

We believe that it is important for our customers to realize the full benefits of their investments in our solutions. When our solution is deployed, it is critical to ensure a high degree of uptime for all users because our Imprivata OneSign solution is the access point to accessing all their clinical applications. Although our solutions are easy to use, install and deploy, our customer experience team further works with our customers to ensure successful deployments and utilization of our solutions within existing clinical workflows without disrupting the delivery of patient care.

We provide the following customer services:

 

 

Professional Services provides implementation and deployment services combined with clinical workflow expertise and deployment best practices gained from working with more than 950 healthcare customers in the United States and globally. These services range across every phase of the deployment lifecycle from workflow analysis, solution readiness, implementation, and ongoing workflow optimization.

 

 

Customer Support provides technical product support for all of our customers, including those customers who purchase our solutions through our sales partners. All of our customers receive live phone support during business hours and 24-hour access to our online customer support center where they can download new software releases, gain access to our solution knowledge base and manage their support cases. We offer two levels of support: standard and premium. During the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014, 56%, 61% and 69%, respectively of our customers purchasing customer support purchased premium support, which, as compared to standard customer support, includes 24-by-7 year-round support and accelerated resolution of critical support cases.

 

 

Customer Education provides system administration, system implementation and ongoing maintenance training to the customer personnel involved in a deployment of our solutions.

 

 

Customer Advocacy works with our customers as a single point of contact to help them realize the full benefits of our solutions by understanding their technology roadmap, proactively planning software upgrades and monitoring customer deployment progress. Customer advocates coordinate between professional services, technical support and customer education to deliver services and assist our efforts to respond to customer requests and feedback.

Sales and marketing

Sales.    We use a direct and indirect sales model to reach our customers. In the United States, our field territory account managers sell primarily to larger healthcare organizations, including new and existing customers. Our inside sales team sells primarily to smaller healthcare organizations, including both new and existing customers. Internationally, our territory managers are assigned by geography and target both small and large customers. We extend our sales coverage by utilizing authorized sales partners in the United States and internationally. Our sales partners include EHR vendors and value-added resellers. Our agreements with our sales partners and value-added resellers are generally non-exclusive, may be terminated with 60 to 90 days’ notice and do not contain any obligations for renewal. Our sales force is supported by sales engineers. We also have a team in North America focused on non-healthcare customers. Internationally, opportunities outside of healthcare are managed by our sales partners.

Marketing.    Our marketing efforts are focused on building our brand reputation, increasing market awareness and generating demand for our solutions. This team focuses primarily on product marketing and management, communications, events, international marketing, and public relations functions. Our marketing activities include inbound and outbound lead generation programs, digital media programs such as our website and online advertising, customer advisory boards, industry trade shows and conferences, and press and industry analyst relations.

 

76


Table of Contents

Customers

As of March 31, 2014, our Imprivata OneSign solution had over 2.8 million licensed users in over 950 healthcare organizations in 20 countries, including large integrated healthcare systems, academic medical centers, and small- and medium-sized independent healthcare facilities. Consistent with our healthcare-focused strategy, approximately 80%, 84% and 84% of our revenue from new sales were attributable to sales to healthcare organizations during the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014, respectively. The following is a representative sample of our customers currently purchasing our software maintenance services across the various types of healthcare organizations and geographic regions that we serve:

 

Integrated Delivery Networks

  

Academic Healthcare Organizations

Atlantic Health System    Albany Medical Center
Catholic Health Partners    Hackensack University Medical Center
Fletcher Allen Health Care    McGill University Health Center
Johns Hopkins Health System    Moffitt Cancer Center
OhioHealth    University of Texas MD Anderson Cancer Center

Community Hospitals

  

International Healthcare Organizations

Augusta Health    Centre hospitalier universitaire de Reims (France)
Beaufort Memorial Hospital    Klinikum-Wels (Austria)
Licking Memorial Hospital    NHS Scotland
Memorial Healthcare    Region Hovedstaden (Denmark)
Pomona Valley Hospital    Sydney Adventist HealthCare Limited (Australia)

In addition, our Imprivata OneSign solution had over 770,000 licensed users in over 400 non-healthcare customers as of March 31, 2014, including financial services, the public sector and other industries. No single end-customer accounted for more than 4% of our revenue in the years ended December 31, 2011, 2012 and 2013 and over 5% for the three months ended March 31, 2014.

We sell our products to healthcare organizations internationally, including approximately 170 customers in 20 countries, including Australia, Belgium, Canada, Denmark, France, Germany, the Netherlands and the United Kingdom. During the years ended December 31, 2011, 2012 and 2013 and three months ended March 31, 2014, markets outside of the United States represented 27%, 22%, 20%, and 22% of our revenue, respectively. We expect to continue to derive a substantial portion of our international revenues from foreign government-operated healthcare organizations. Sales to governmental entities present risks in addition to those involved in sales to commercial customers, including potential disruption due to changes in appropriation and spending patterns, delays in budget approvals and exposure to penalties in the event of violations of the Foreign Corrupt Practices Act.

Research and development

Our continued investment in research and development is critical to building innovative solutions and our business. We employ engineers with expertise in various fields, including software and firmware development, database design, user experience, networking, biometrics and mobile communication. We have research and development personnel in Lexington, Massachusetts and Santa Cruz, California, and a third-party development provider in Lviv, Ukraine assists us with quality assurance testing and targeted development projects. The third-party development provider performs services pursuant to statements of work under a master services agreement, which may be terminated by us without cause with 60 days’ notice or by the development provider without cause with 60 days’ notice, unless a statement of work is in progress. As of March 31, 2014, we employed 89 full-time research and development employees and we utilized 55 additional personnel employed by the third-party development provider in Lviv, Ukraine. Our research and development expenditures were $7.9 million, $12.3 million, $19.6 million and $6.5 million in the years ended December 31, 2011, 2012 and 2013 and the three months ended March 31, 2014, respectively.

 

77


Table of Contents

Intellectual property

Our success depends, in part, upon our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including patents, trade secrets, copyrights and trademarks, as well as customary contractual provisions to protect our proprietary technology and our brand.

We have been granted 21 U.S. patents, including patents on aspects of our Imprivata OneSign solution. The expiration dates of these patents range from October 28, 2014 through April 29, 2032 (not accounting for any patent term extension). Currently we have 12 utility patent applications and 1 provisional patent application pending in the United States.

We conduct business under Imprivata OneSign and Imprivata Cortext trademarks, among others. We believe that having distinctive marks may be an important factor in marketing our products. We have registered trademarks in the United States and in selected other jurisdictions. We actively monitor use of our trademarks, and enforce our rights as necessary.

We rely on trade secrets to protect substantial portions of our technology. We generally seek to protect these trade secrets by entering into non-disclosure agreements with our employees and customers and by restricting access and use of our proprietary software and other confidential information.

Our software is also protected by U.S. and international copyright laws. We also license software from third parties for integration into our Imprivata OneSign solution, including open source software and other software available on commercially reasonable terms.

Competition

Our primary competitor in the healthcare market is Caradigm USA, LLC, a joint venture of General Electric Company and Microsoft Corporation. We also compete with several smaller providers of authentication and access management solutions focused on the healthcare market, as well as several large identity and access management vendors that are not specifically focused on the healthcare market.

We believe that we compete effectively on the basis of the following factors:

 

 

healthcare domain expertise;

 

brand awareness and reputation;

 

breadth of our solutions set and ease of implementation, use and management;

 

breadth of product distribution;

 

strategic relationships and ability to integrate with software and device vendors; and

 

product innovation and ability to meet customer needs.

We may face increased competition in the future, including competition from large, multinational companies with significant resources. Potential competitors may have existing relationships with purchasers of other products and services within the healthcare organization, which may enhance their ability to gain a foothold in our market.

 

78


Table of Contents

Government regulation

Substantially all of our revenue is derived from the healthcare industry. The healthcare industry is highly regulated and is subject to changing political, legislative, regulatory and other influences which affect the purchasing practices and operations of our customers, as well as the behavior and attitudes of our licensed users. These laws and regulations are broad in scope and they are subject to evolving interpretations. We devote significant efforts to establish and maintain compliance with all regulatory requirements that we believe are applicable to our business and the services we offer. The principal laws and regulations that affect our operations and contractual relationships include:

HIPAA

HIPAA contains substantial restrictions and health data privacy, security and breach notification requirements with respect to the use and disclosure of PHI. HIPAA applies to covered entities, such as healthcare providers that conduct electronic health transactions and health plans. In 2009, the HITECH Act made certain HIPAA privacy and security standards directly applicable to “business associates,” defined as entities that receive or obtain PHI in connection with performing functions on behalf of or providing services to covered entities. Most of our customers are covered entities under HIPAA, and they rely on our solutions to facilitate their compliance with their HIPAA requirements. We are also subject to direct liability under HIPAA as a business associate when we handle and have access to our customers’ PHI, such as through our Imprivata Cortext solution. Accordingly, in the United States, we are subject to HIPAA and its implementing regulations, as well as comparable state privacy and security laws. The HITECH Act increased the penalties for HIPAA violations, which can result in fines of up to $1.5 million per violation. The penalty amount for a violation is determined by the level of neglect or willful behavior exhibited by the business associate. In addition, the HITECH Act gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts on behalf of any resident of their state against business associates to enforce HIPAA and seek attorney’s fees and costs associated with pursuing federal civil action.

Other laws

In addition to HIPAA, most states have enacted confidentiality laws that protect against the unauthorized disclosure of PHI, and many states have adopted or are considering further legislation in this area, including privacy safeguards, security standards and data security breach notification requirements. Such state laws, if more stringent than HIPAA requirements, are not preempted by the federal requirements, and we must comply with them even though they may be subject to different interpretations by various courts and other governmental authorities.

In addition to complying with applicable U.S. law, the use and disclosure of PHI is subject to regulation in other jurisdictions in which we do business or expect to do business in the future. Those jurisdictions may attempt to apply such laws extraterritorially or through treaties or other arrangements with U.S. governmental entities. We might unintentionally violate such laws, such laws may be modified and new laws may be enacted in the future which may increase the chance that we violate them. Any such developments, or developments stemming from enactment or modification of other laws, or the failure by us to comply with their requirements or to accurately anticipate the application or interpretation of these laws, could discourage us from offering certain of our solutions, such as Imprivata Cortext, to customers outside of the United States.

Our solutions utilize encryption technologies that are subject to multilateral export control laws and regulations. Such regulations require us to maintain an encryption registration with the U.S. Department of Commerce and to submit annual reports that identify the encryption-enabled items that we export. Each encryption-enabled product, component or technology that we export is subject to pre-export classification

 

79


Table of Contents

requirement that may in some cases include mandatory pre-export submissions to the U.S. government, and certain encryption-related technical information is subject to case-by-case export licensing to some destinations in which operate or make disclosures to contractors, such as the Ukraine.

Facilities

Our principal headquarter offices consist of approximately 72,000 square feet of office space in Lexington, Massachusetts under a lease expiring in 2019. In Santa Cruz, California, we currently have approximately 8,500 square feet for research and development under a lease expiring in 2018. In Uxbridge, United Kingdom, we have approximately 4,200 square feet of office space under an agreement expiring in 2015 for sales, marketing, services and support for our European operations. We have additional office locations throughout the United States and in various international locations.

We intend to add new facilities and expand our existing facilities as we add employees and grow our business, and we believe that suitable additional or substitute space will be available on commercially reasonable terms to meet our future needs.

Suppliers

We purchase hardware components for our solutions from various manufacturers. For example, we purchase our fingerprint readers from DigitalPersona, Inc., our proximity card readers from RF IDeas, Inc., and certain other hardware components from a contract manufacturer that produces hardware components for our solutions according to our specifications. In the event we are unable to procure certain components for our solutions from our suppliers, we may be required to redesign some of our solutions in order to incorporate technology from alternative sources. Some of these components are off-the-shelf while others are custom components built exclusively for us.

Employees

As of March 31, 2014, we had 334 employees, consisting of 89 in research and development, 125 in sales and marketing, 75 in customer experience and support, and 45 in general and administrative. None of our employees is covered by a collective bargaining agreement or is represented by a labor union. We consider current employee relations to be good.

Legal proceedings

From time to time, we may be involved in lawsuits, claims, investigations and proceedings, consisting of intellectual property, commercial, employment and other matters which arise in the ordinary course of business. We are not currently involved in any material legal proceedings.

 

80


Table of Contents

Management

Directors, executive officers and key employees

The following table presents our directors, executive officers and key employees and their respective ages and positions as of March 31, 2014:

 

Name    Age      Position

 

Omar Hussain(1)

     50       President, Chief Executive Officer and Director

Jeffrey Kalowski(1)

     58       Chief Financial Officer

Thomas Brigiotta(1)

     51       Senior VP, Worldwide Sales

Carina Edwards

     39       Senior VP, Customer Experience

Edward Gaudet

     48       General Manager, Imprivata Cortext Products Group

Geoff Hogan

     54       Senior VP, Business Development

Dr. Sean Kelly

     43       Chief Medical Officer

Kelliann McCabe

     44       VP, Human Resources

John Milton

     53       VP, General Counsel

Clay Ritchey

     43       Chief Marketing Officer

Christopher Shaw(1)

     52       Senior VP, General Manager, Imprivata OneSign Products Group

David Ting(1)

     62       Chief Technology Officer and Director

David Barrett(2)

     57       Director and Lead Director

John Blaeser(2)(3)(4)

     72       Director

Dr. John Halamka(4)

     51       Director

Paul Maeder(4)

     60       Director

David Orfao(2)(3)

     54       Director

Rodger Weismann(3)

     72       Director

 

 

(1)   Denotes Executive Officer

 

(2)   Member of the Compensation Committee

 

(3)   Member of the Audit Committee

 

(4)   Member of the Nominating and Corporate Governance Committee

Directors, executive officers and key employees

Omar Hussain has served as our President, Chief Executive Officer, and as a member of our board of directors since 2005. From 2002 to 2005, Mr. Hussain served as our Senior Vice President of Marketing and Operations. From 2000 to 2001, Mr. Hussain served as the Chief Executive Officer of Anchorsilk, Inc., an e-commerce software company. From 1998 to 2000, Mr. Hussain was general manager of Compuware Corporation’s NuMega Labs. From 1996 to 1998, Mr. Hussain served as Vice President of Marketing at NuMega. We believe that Mr. Hussain’s experience holding key executive positions at software companies, coupled with his perspective and history as our chief executive officer, provide him with the qualifications and skills to serve as a member of our board of directors.

Jeffrey Kalowski has served as our Chief Financial Officer since 2007. From 2002 to 2005, Mr. Kalowski served as the Chief Financial Officer of ProfitLogic Inc. From 1997 to 2001, Mr. Kalowski was the Chief Financial Officer of Torrent Systems, which was acquired by Ascential Software. Mr. Kalowski served as the Vice President of Finance & Administration at Looking Glass Technologies from 1995 to 1996. Mr. Kalowski was at Price Waterhouse from 1979 to 1984.

 

81


Table of Contents

Thomas Brigiotta has served as our Senior Vice President, Worldwide Sales since 2008. From 2006 to 2008, Mr. Brigiotta served as the Senior Vice President of Worldwide Field Operations of StreamService, Inc. From 2004 to 2006, Mr. Brigiotta was the Vice President of World Wide Sales at PMC-Sierra, Inc. From 2003 to 2004, Mr. Brigiotta served as the Vice President of Worldwide Services Sales and Business Development and, from 2000 to 2003, the Vice President of European Sales and Marketing of Cadence Design Systems, Inc.

Carina Edwards has served as our Senior Vice President, Customer Experience since 2012. From 2011 to 2012, Ms. Edwards served as the Vice President of Solutions Marketing for the healthcare information technology division of Nuance Communications, Inc. From 2009 to 2011, Ms. Edwards served as Vice President of Product Management and Marketing at Zynx Health (a subsidiary of Hearst Corporation). From 2006 to 2009, Ms. Edwards served as Director of Clinical Information Systems at Philips Healthcare. From 2002 to 2006, Ms. Edwards served as Director of Marketing and Client Loyalty at Sapient Corporation.

Edward Gaudet has served as General Manager, Imprivata Cortext Products Group since 2013. From 2010 to 2013, Mr. Gaudet served as our Chief Marketing Officer. From 2007 to 2010, Mr. Gaudet was the Senior Vice President of Corporate Development, Sales and Marketing for Liquid Machines, Inc. and the Vice President of Product Management and Marketing from 2002 to 2007. Mr. Gaudet has held executive-level roles in various start-up and public software companies including IONA Technologies, Inc., Rational Software Corporation, and SQA, Inc.

Geoff Hogan has served as Senior Vice President, Business Development since 2004. From 2001 to 2004, Mr. Hogan was the Executive Vice President of Corporate Development and Alliances at Princeton Softech, Inc. Mr. Hogan has held senior level positions with HighGround Systems, Inc., Quantum Corporation, and Digital Equipment Corporation.

Dr. Sean Kelly has served as our Chief Medical Officer since 2011. Since 2001, Dr. Kelly has practiced as an emergency room physician at Beth Israel Deaconess Medical Center, and served as an Assistant Clinical Professor of Medicine at Harvard Medical School. From 2008 to 2011, Dr. Kelly served in hospital administration at Beth Israel Deaconess Medical Center as Director of Graduate Medical Education.

Kelliann McCabe has served as our Vice President, Human Resources since 2013. From November 2011 to 2013, Ms. McCabe was the Chief People Officer at Symbotic LLC. From 2006 to 2011, Ms. McCabe was the Vice President of Human Resources at Netezza Corporation. Ms. McCabe also served as the Director of Human Resources Northeast for CA Technologies, Inc. from 2005 to 2006 and served in various human resources leadership positions, including Vice President of Human Resources for Concord Communications, Inc. from 1996 to 2005.

John Milton has served as our Vice President and General Counsel since 2012. From 2010 to 2012, Mr. Milton served as General Counsel at Empirix Inc. From 2007 to 2008, Mr. Milton served as General Counsel of EqualLogic, Inc. From 2005 to 2007, Mr. Milton served as Deputy General Counsel at Symantec Corporation. From 2002 to 2005, Mr. Milton served as Associate General Counsel at Veritas Software Corporation. From 1991 to 1997, Mr. Milton served as Corporate Counsel at Lotus Development Corporation/IBM Corporation.

Clay Ritchey has served as our Chief Marketing Officer since 2013. From 2010 to 2013, Mr. Ritchey was the Chief Executive Officer of Equinox Healthcare. Prior to Equinox Healthcare, Mr. Ritchey held senior executive marketing and strategy roles at Hill-Rom IT Solutions from 2007 to 2010 and Kronos Incorporated from 2002 to 2007.

 

82


Table of Contents

Christopher Shaw has served as our Senior Vice President, General Manager, Imprivata OneSign Products Group since 2002. From 1997 to 2002, Mr. Shaw served as the Vice President of Engineering at Netegrity. Prior to Netegrity, Mr. Shaw was an engineering manager and consultant at Switchboard Incorporated, ePresence Inc., and Banyan Systems Inc. Mr. Shaw also held senior engineering roles at Wang Laboratories, Inc., Raytheon Company and Thorn EMI Electronics Ltd.

David Ting, a founder of our company, has served as Chief Technology Officer and a member of our board of directors since 2002. From 1992 to 2002, Mr. Ting was an independent software consultant specializing in advanced digital imaging, on-demand printing and secure imaging solutions for government applications. From 1988 to 1992, Mr. Ting was the technical manager of Kodak’s Boston Technology Center, a systems development group for Eastman Kodak Company. From 1984 to 1988, Mr. Ting managed Atex System’s Imaging Department. We believe that Mr. Ting’s experience in the technology sphere, coupled with his perspective and history as a founder of our company and Chief Technology Officer, provide him with the qualifications and skills to serve as a member of our board of directors.

David Barrett has served as a member of our board of directors since March 2002. Mr. Barrett serves as a Managing Partner of Polaris Partners, where he has been a General Partner since 2000. From 1984 to 2000, Mr. Barrett served in numerous senior executive roles for publicly-held software companies. From 1998 to 2000, he served as Chief Operating Officer of Calico Commerce, Inc. From 1996 to 1998, Mr. Barrett served as Senior Vice President of Worldwide Operations for Pure Atria/Rational Software Corporation. From 1984 to 1996, Mr. Barrett was an executive with Lotus Development Corporation/IBM Corporation, including service as Vice President of Sales & Services and General Manager, Government Sales and Marketing. Mr. Barrett has served and currently serves on the boards of directors of numerous privately-held companies through his venture capital firm. He has also served as a director of LogMeIn, Inc., a publicly-held provider of cloud-based software services, and also serves on the Board of Trustees of the Dana-Farber Cancer Institute. We believe that Mr. Barrett’s extensive experience in management and guidance of private and publicly-held software companies throughout periods of rapid growth provide him with the qualifications and skills to serve as a member of our board of directors.

John Blaeser has served as a member of our board of directors since 2005. From 1995 to 2005, Mr. Blaeser was the President and CEO of Concord Communications, Inc., a publicly held developer of application and network management software. From 1985 to 1995, Mr. Blaeser was a Managing General Partner at EG&G Venture Management. From 1977 to 1985, Mr. Blaeser was the Executive Vice President of Gould Electronics, Inc. From 1999 to 2012, Mr. Blaeser served as a director of Network Engines, Inc. Since 2005, Mr. Blaeser has served as a venture partner as Ascent Venture Partners. We believe that Mr. Blaeser’s experience with private and public technology companies provides him with the qualifications and skills to serve as a member of our board of directors.

Dr. John Halamka has served as a member of our board of directors since April 2013. Dr. Halamka is a practicing emergency room physician and has served as the Chief Information Officer at Beth Israel Deaconess Medical Center since 1998. Dr. Halamka has served as faculty at Harvard Medical School since 1996 and was named full professor in 2012. Dr. Halamka served as a member of the Board of Directors of QuantiaMD Inc. Dr. Halamka has served as Chairman of the New England Healthcare Exchange Network. He has also been the co-Chair of the HIT Standards Committee since 2009. Dr. Halamka serves as a member of the Massachusetts HIT Council. Dr. Halamka serves as co-Chair of the Massachusetts HIT Advisory Committee. We believe that Dr. Halamka’s key experience at the intersection of the healthcare industry and technology provides him with the qualifications and skills to serve as a member of our board of directors.

 

83


Table of Contents

Paul Maeder has served as a member of our board of directors since 2002. Mr. Maeder is a General Partner and Founder of Highland Capital Partners where he has been since 1987. He currently serves on the boards of numerous private companies and is currently a director and the chairman of the board of directors of 2U, Inc. Before co-founding Highland, Mr. Maeder spent three years in venture capital concentrating on software investments. He also held engineering and management positions for six years in medical technology companies. Mr. Maeder was the 2011-2012 Chair of the National Venture Capital Association. He has served on the SEC Advisory Committee on Small and Emerging Companies. Mr. Maeder is a former director of Amp Resources, LLC, Avid Technology, Inc., CheckFree Corporation, Chipcom Corporation, HighGround Systems, Inc., Mainspring, Inc., Relicore, SCH Technologies, SQA, Inc., StreamBase Systems, Inc., Sybase, Inc., Vertica Systems, Inc., VistaPrint Limited, Village Ventures and WebLine Communications Corporation. We believe that Mr. Maeder’s experience in managerial positions at technology companies and in working with numerous start-ups through his venture capital career provide him with the qualifications and skills to serve as a member of our board of directors.

David Orfao has served as a member of our board of directors since March 2002. Since 2000, he has served as a Managing Director of General Catalyst Partners, a venture capital firm, which he co-founded. Prior to joining General Catalyst, Mr. Orfao was the President, Chief Executive Officer and director of Allaire Corporation, a computer software company, from 1997-2000. Mr. Orfao serves on the board of directors of Brightcove Inc., an online video platform company as well as numerous privately-held companies. We believe that Mr. Orfao’s experience providing guidance and counsel to a wide variety of Internet and technology companies, and his service on the boards of directors of a range of public and private companies allow him to make valuable contributions to our board of directors.

Rodger Weismann has served as a member of our board of directors since February 2013. Mr. Weismann has also served as a member of the board of directors of Reval, Inc., a private provider of software-as-a-service solutions for treasury and risk management, since March 2011 and was formerly a member of the board of directors of Soundbite Communications, Inc., a public provider of mobile marketing and contact center solutions, from May 2012 until July 2013. Since 2010, Mr. Weismann has provided consulting and advisory services to technology companies. From 2004 until April 2009, Mr. Weismann was a Senior Vice President and the Chief Financial Officer of Phase Forward, Inc., a publicly traded provider of data management solutions for clinical trials and drug safety. We believe that Mr. Weismann’s prior operating, financial and accounting experience as a senior executive at several publicly traded companies provide him with the qualifications and skills to serve as a member of our board of directors.

Composition of our board of directors

Our board of directors currently consists of eight members, all of whom were elected pursuant to a voting agreement, which will terminate upon the completion of this offering. Upon the termination of these provisions, there will be no further contractual obligations regarding the election of our directors. Our nominating and corporate governance committee and board of directors may therefore consider a broad range of factors relating to the qualifications and background of nominees, which may include diversity and is not limited to race, gender or national origin. We have no formal policy regarding board diversity. Our nominating and corporate governance committee’s and board of directors’ priority in selecting board members is identification of persons who will further the interests of our stockholders through his or her established record of professional accomplishment, the ability to contribute positively to the collaborative culture among board members, knowledge of our business, understanding of the competitive landscape and professional and personal experiences and expertise relevant to our growth strategy. Our directors hold office until their successors have been elected and qualified or until the earlier of their resignation or removal.

 

84


Table of Contents

Our amended and restated certificate of incorporation and amended and restated bylaws that will become effective upon the completion of this offering also provide that our directors may be removed only for cause by the affirmative vote of the holders of at least 75% of the votes that all our stockholders would be entitled to cast in an annual election of directors, and that any vacancy on our board of directors, including a vacancy resulting from an enlargement of our board of directors, may be filled only by vote of a majority of our directors then in office.

Director Independence.    Our board of directors has determined that all members of the board of directors, except David Ting and Omar Hussain, are independent, as determined in accordance with the rules of the NYSE. In making such independence determination, the board of directors considered the relationships that each such non-employee director has with us and all other facts and circumstances that the board of directors deemed relevant in determining their independence, including the beneficial ownership of our capital stock by each non-employee director. In considering the independence of the directors listed above, our board of directors considered the association of our directors with the holders of more than 5% of our common stock. Upon the completion of this offering, we expect that the composition and functioning of our board of directors and each of our committees will comply with all applicable requirements of the NYSE and the rules and regulations of the Securities and Exchange Commission. There are no family relationships among any of our directors or executive officers.

Staggered board.    In accordance with the terms of our amended and restated certificate of incorporation and amended and restated bylaws that will become effective upon the completion of this offering, our board of directors will be divided into three classes, class I, class II and class III, with each class serving staggered three-year terms. Upon the expiration of the term of a class of directors, directors in that class will be eligible to be elected for a new three-year term at the annual meeting of stockholders in the year in which their term expires.

 

 

Our Class I directors will be David Orfao and Omar Hussain;

 

Our Class II directors will be David Barrett, Paul Maeder and John Blaeser; and

 

Our Class III directors will be David Ting, Rodger Weismann and John Halamka.

Our amended and restated certificate of incorporation and amended and restated bylaws that will become effective upon the completion of this offering provide that the authorized number of directors may be changed only by resolution of the board of directors. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class shall consist of one third of the board of directors.

The division of our board of directors into three classes with staggered three-year terms may delay or prevent stockholder efforts to effect a change of our management or a change in control.

Board leadership structure and board’s role in risk oversight

Our board of directors oversees the management of risks inherent in the operation of our business and the implementation of our business strategies. Our board of directors performs this oversight role by using several different levels of review. In connection with its reviews of the operations and corporate functions of our company, our board of directors addresses the primary risks associated with those operations and corporate functions. In addition, our board of directors reviews the risks associated with our company’s business strategies periodically throughout the year as part of its consideration of undertaking any such business strategies.

Each of our board committees also oversees the management of our company’s risk that falls within the committee’s areas of responsibility. In performing this function, each committee has full access to management, as well as the ability to engage advisors. Our Chief Financial Officer reports to the audit committee and is responsible for identifying, evaluating and implementing risk management controls and

 

85


Table of Contents

methodologies to address any identified risks. In connection with its risk management role, our audit committee meets privately with representatives from our independent registered public accounting firm and our Chief Financial Officer. The audit committee oversees the operation of our risk management program, including the identification of the primary risks associated with our business and periodic updates to such risks, and reports to our board of directors regarding these activities.

Our board of directors has established, as a position on our board of directors, a Lead Director, who shall initially be David Barrett. The Lead Director has the non-exclusive authority to preside over meetings of the non-management directors of our board of directors and carry out such other duties as are also granted by our board of directors.

Board committees

Our board of directors has established an audit committee, a compensation committee and a nominating and corporate governance committee, each of which operates pursuant to a separate charter adopted by our board of directors. We expect that the composition and functioning of all of our committees will comply with all applicable requirements of the Sarbanes-Oxley Act of 2002 and the Securities and Exchange Commission rules and regulations.

Audit committee

John Blaeser, David Orfao and Rodger Weismann currently serve on the audit committee, which is chaired by Rodger Weismann. The applicable rules of the NYSE and Rule 10A-3 of the Exchange Act require (1) one independent member at the time of listing; (2) a majority of independent members within 90 days of listing; and (3) all independent members within one year of listing. Our board of directors has determined that each of John Blaeser, David Orfao and Rodger Weismann is an independent director under the applicable rules of the NYSE and Rule 10A-3 of the Exchange Act. Our board of directors has designated Rodger Weismann as an “audit committee financial expert,” as defined under the applicable rules of the Securities and Exchange Commission. The audit committee’s responsibilities include:

 

 

appointing, approving the compensation of, and assessing the independence of our independent registered public accounting firm;

 

 

approving auditing and permissible non-audit services, and the terms of such services, to be provided by our independent registered public accounting firm;

 

 

reviewing the internal audit plan with our independent registered public accounting firm and members of management responsible for preparing our financial statements;

 

 

reviewing and discussing with management and our independent registered public accounting firm our annual and quarterly financial statements and related disclosures as well as critical accounting policies and practices used by us;

 

 

reviewing the adequacy of our internal control over financial reporting;

 

 

establishing policies and procedures for the receipt and retention of accounting-related complaints and concerns;

 

 

recommending, based upon the audit committee’s review and discussions with management and our independent registered public accounting firm, whether our audited financial statements shall be included in our Annual Report on Form 10-K;

 

86


Table of Contents
 

monitoring the integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to our financial statements and accounting matters;

 

 

preparing the audit committee report required by the rules of the Securities and Exchange Commission to be included in our annual proxy statement;

 

 

reviewing all related party transactions for potential conflict of interest situations and approving all such transactions; and