<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 31, 1999
REGISTRATION NO. 333-71893
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------
NETOBJECTS, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 7372 94-3233791
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Incorporation or Classification Code Number) Identification
organization) No.)
</TABLE>
301 GALVESTON DRIVE
REDWOOD CITY, CALIFORNIA 94063
(650) 482-3200
(Address, including zip code, and telephone number, including
area code, of Registrant's principal executive offices)
------------------
SAMIR ARORA, CHIEF EXECUTIVE OFFICER
301 GALVESTON DRIVE
REDWOOD CITY, CALIFORNIA 94063
(650) 482-3200
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------
COPIES TO:
ALAN B. KALIN JOHN W. WHITE
LAURA T. PUCKETT CRAVATH, SWAINE & MOORE
MARK F. HOFFMAN WORLDWIDE PLAZA
KATHI A. RAWNSLEY 825 EIGHTH AVENUE
GRAHAM & JAMES LLP NEW YORK, NEW YORK 10019-7475
600 HANSEN WAY
PALO ALTO, CALIFORNIA 94304-1043
------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
------------------
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: / /
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: / /
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION
MARCH , 1999
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
Shares
[LOGO]
Common Stock
---------
This is the initial public offering of NetObjects, Inc., and we are offering
shares of our common stock. No public market currently exists for our
shares. We anticipate that the initial public offering price will be between
$ and $ per share.
We have applied to list the common stock on the Nasdaq National Market under the
symbol "NETO."
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS"
BEGINNING ON PAGE 7.
<TABLE>
<CAPTION>
PER SHARE TOTAL
----------- --------------
<S> <C> <C>
Public offering price............................................... $ $
Underwriting discounts.............................................. $ $
Proceeds to NetObjects.............................................. $ $
</TABLE>
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
NetObjects has granted the underwriters the right to purchase up to
additional shares of common stock at the initial public offering price to
cover over-allotments.
BT ALEX. BROWN
BANCBOSTON ROBERTSON STEPHENS
U.S. BANCORP PIPER JAFFRAY
, 1999
<PAGE>
DESCRIPTION OF ARTWORK
OUTSIDE PORTION OF GATEFOLD:
GRAPHIC DEPICTING: e-publishing, e-applications, and e-commerce, with arrows
pointing to e-business
INTRODUCTORY TEXT:
The web is changing the world. It's changing the way companies communicate,
do business, and grow. To reap the benefits of improved efficiency, businesses
need a presence on the web. They need an e-business site. One that builds
relationships with employees, partners and customers. One that lets companies
implement e-publishing, e-applications and e-commerce. NetObjects software,
professional services and online resources make it possible for businesses,
large or small, to easily build e-business sites or intranets that let them
leverage the power of the web.
HEADLINE COPY: Software Professional Services Online Resources
GRAPHICS OF PRODUCTS, PROFESSIONAL SERVICES and ONLINE RESOURCES:
(1) two overlapping product boxes: NetObjects Fusion 4.0 for Windows and
NetObjects Authoring Server 3.0
(2) photo of service people
(3) graphic showing overlapping screen shots of four web sites (left to right):
NetObjects corporate site, eFuse.com, eSiteStore.com, and eScriptZone.com
TEXT AT BOTTOM: When it comes to evaluating NetObjects applications, the
industry experts have spoken.
GRAPHICS OF LOGOS:
(1) NetObjects corporate logo
(2) Internet World logo
(3) Cross Roads award logo
(4) PC Magazine award logo
(5) JavaWorld award logo
(6) Web Developer award logo
(7) CNet logo
(8) IDEA logo
(9) InfoWorld logo
(10) IBM e-business logo
LEFT-HAND PAGE OF GATEFOLD:
TITLE: Their success is our success
INTRODUCTORY TEXT:
More than 300,000 copies of NetObjects Fusion have been delivered to date,
and more than 1 million web pages or web sites have been built using NetObjects
Fusion. In addition, over 500 businesses worldwide have deployed NetObjects
Authoring Server. Take a look at how some of our customers are using NetObjects
applications to build web sites that sell products, provide virtual tours, build
online catalogs, auction collectible goods, and more.
NINE GRAPHICS DEPICTING SCREEN SHOTS OF CUSTOMER WEB SITES
<PAGE>
CAPTIONS (ONE FOR EACH SCREEN SHOT, LEFT TO RIGHT, TOP TO BOTTOM):
(1) www.justforfeet.com
(2) www.collectit.net
(3) www.cellone-sf.com
(4) www.shell-lubricants.com
(5) www.northstarnursery.com
(6) www.leasesource.com
(7) www.christmas.com
(8) www.krause.com
(9) www.realty.com
RIGHT-HAND PAGE OF GATEFOLD:
TITLE: Strategic relationships we can count on
INTRO PARAGRAPH:
We have aligned with industry leaders through a host of partnership
agreements that supplement our core strengths. Equity, technology, co-marketing
and distribution partners extend our reach, enhance our products, complement our
sales and distribution efforts and allow us to continue our leadership in web
business solutions.
TWELVE CORPORATE LOGOS (LEFT TO RIGHT, TOP TO BOTTOM):
(1) IBM
(2) Lotus
(3) Novell
(4) Mitsubishi
(5) PeopleSoft Global Alliance Program
(6) Allaire
(7) CompuServe
(8) Compaq
(9) SmartAge
(10) Zip2
<PAGE>
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION REGARDING NETOBJECTS AND THE COMMON STOCK BEING SOLD IN THE
OFFERING, AS WELL AS OUR CONSOLIDATED FINANCIAL STATEMENTS AND NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS.
The terms "NetObjects," "we," "us," and "our" refer to NetObjects, Inc. and
our subsidiary, NetObjects Ltd.
NETOBJECTS
We are a leading provider of software and solutions that enable small
businesses and large enterprises to build, deploy and maintain web sites on the
Internet and corporate intranets. Our solutions address the growing challenges
faced by businesses in capturing the explosive growth of the Internet as a
medium for conducting business online, or e-business. We help companies build
web sites that can publish content, conduct electronic commerce, or e-commerce,
and run web applications. With the introduction in 1996 of our award-winning
flagship product, NetObjects Fusion, we pioneered software for building entire
web sites rather than simple web pages. Since 1996, we have released enhanced
versions of NetObjects Fusion. We have introduced other products, including
NetObjects Authoring Server, a client-server application for large-scale
enterprises and corporate departments, which facilitates collaborative building
of intranet sites. We have also built popular online resources, including
eFuse.com, launched in December 1998, that target communities of business users
and provide sources of information, products and services for building business
web sites. In addition, in October 1998 we began offering professional services
to help our business customers plan, build and maintain their web sites. We have
established a premier Internet brand and estimate that over 300,000 copies of
NetObjects Fusion have been delivered to date, and more than 1,000,000 web pages
or web sites have been built using NetObjects Fusion.
We have experienced rapid growth since the launch of the first commercial
version of NetObjects Fusion in October 1996. Our total revenues have grown from
a base of $0 for fiscal year 1996 to $7.6 million for fiscal year 1997 and to
$15.3 million for fiscal year 1998. As of December 31, 1998, we had an
accumulated deficit of approximately $55.3 million, $42.8 million of which has
been incurred since April 1997. Revenues from IBM have represented a substantial
percentage of our total revenues, representing approximately 36% and 50% of our
total revenues in fiscal year 1998 and in the first quarter of fiscal year 1999,
respectively. Almost all of our revenues from IBM in fiscal year 1998 resulted
from two significant sources. The first comprised royalties paid by Lotus
Development Corporation, an IBM subsidiary, to bundle NetObjects Fusion with
Lotus products. The second consisted of services related to integrating our
software with IBM's WebSphere software products.
We incorporated in Delaware in November 1995 and have a limited operating
history. On April 11, 1997, IBM acquired approximately 80% of our stock. IBM did
not provide us with equity financing in that transaction. Subsequently, through
, 1999, IBM has provided us with approximately $40 million of
financing through:
- $10.5 million in non-refundable cash prepayments against future royalties
and charges for services;
- $19.0 million in a secured credit facility with IBM Credit Corp.;
- $10.1 million in convertible debt securities and warrants to purchase
convertible preferred stock; and
- $3.45 million through the sale of notes and warrants.
3
<PAGE>
Since , 1999, IBM has provided an additional $ million of
financing to us. After the offering, IBM will have only limited commitments to
provide additional revenues and will have no obligation to provide additional
financing.
IBM will retain control of NetObjects after the offering and may continue to
cooperate with us in a number of areas, including product bundling and sales and
marketing. The interests of IBM may conflict with our interests, and IBM is free
to compete with us. IBM's controlling interest in us, our dependence on IBM and
the potential conflicts of interests and potential competition associated with
IBM's relationship with us represent significant risks for an investor acquiring
our stock as more fully described in "Risk Factors--Our dependence on IBM may
present potential conflicts or otherwise adversely affect our business,"
"Business--NetObjects Strategy," "--Sales, Marketing and Distribution" and
"--Competition," "Certain Transactions," "Principal Stockholders," and "Shares
Eligible for Future Sale."
NEITHER IBM'S OWNERSHIP OF OUR SECURITIES NOR IBM'S RELATIONSHIP AND
AGREEMENTS WITH US IS A RECOMMENDATION BY IBM THAT INVESTORS SHOULD ACQUIRE OR
HOLD OUR STOCK. IBM WILL HAVE THE UNRESTRICTED ABILITY TO SELL ALL OR PART OF
NETOBJECTS STOCK WHEN PERMISSIBLE UNDER APPLICABLE SECURITIES LAWS AND
AGREEMENTS WITH THE UNDERWRITERS. IBM HAS NO OBLIGATION TO RESELL OUR PRODUCTS
BEYOND THE LIMITED AMOUNT REQUIRED BY EXISTING AGREEMENTS. AFTER THE OFFERING,
IBM WILL HAVE NO OBLIGATION TO PROVIDE US WITH ADDITIONAL FINANCING. FOR MORE
INFORMATION ABOUT THESE RISKS, SEE "RISK FACTORS--OUR DEPENDENCE ON IBM MAY
PRESENT POTENTIAL CONFLICTS OR OTHERWISE ADVERSELY AFFECT OUR BUSINESS,"
"CERTAIN TRANSACTIONS," "PRINCIPAL STOCKHOLDERS" AND "SHARES ELIGIBLE FOR FUTURE
SALE."
Our principal executive offices are located at 301 Galveston Drive, Redwood
City, CA 94063, and our telephone number is (650) 482-3200. Our web site can be
found at www.netobjects.com. Information contained on any of our web sites does
not constitute part of this prospectus.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered by NetObjects.............. shares
Common stock to be outstanding after the
offering...................................... shares(1)
Use of Proceeds................................. Repayment of approximately $19.0 million of secured debt owed
to IBM Credit Corporation, a subsidiary of IBM, debt of $
million plus accrued interest that we expect to owe to IBM
under notes issued prior to the closing of the offering,
working capital requirements and other general corporate
purposes.
Proposed Nasdaq National Market
symbol........................................ NETO
</TABLE>
SUMMARY FINANCIAL DATA
<TABLE>
<CAPTION>
PERIOD FROM THREE MONTHS ENDED
NOVEMBER 21, 1995 YEAR ENDED
(INCEPTION) TO SEPTEMBER 30, DECEMBER 31,
SEPTEMBER 30, -------------------- --------------------
1996 1997 1998 1997 1998
------------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Total revenues.......................................... $ -- $ 7,567 $ 15,270 $ 2,285 $ 5,617
Cost of revenues........................................ -- 772 5,093 278 2,083
Gross profit............................................ -- 6,795 10,177 2,007 3,534
Operating loss.......................................... (6,741) (17,564) (20,970) (5,892) (4,094)
Nonrecurring interest charge on beneficial conversion
feature of convertible debt(2)........................ -- -- -- -- (3,792)
Net loss................................................ (6,695) (17,799) (22,224) (6,067) (8,600)
Basic and diluted net loss per share applicable to
common stockholders(3)................................ $ (4.10) $ (10.45) $ (12.26) $ (3.47) $ (4.40)
Shares used to compute basic and diluted net loss per
share applicable to common stockholders(3)............ 1,634 1,703 1,812 1,750 1,956
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998
-------------------------
ACTUAL AS ADJUSTED(4)
--------- --------------
<S> <C> <C>
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash..................................................................................... $ 1,288
Working capital (deficit)................................................................ (23,390)
Total assets............................................................................. 7,502
Short-term borrowings from IBM and IBM Credit Corp....................................... (18,813)
Long-term obligations, less current portion.............................................. 7,890
Accumulated deficit...................................................................... (55,318)
Stockholders' deficit.................................................................... (29,177)
</TABLE>
5
<PAGE>
- ------------------------
(1) Excludes
- 2,629,575 shares of common stock issuable at a weighted average exercise
price of $2.38 per share upon exercise of stock options outstanding at
December 31, 1998;
- 258,651 shares reserved for future issuance under our stock option plans;
- 300,000 shares reserved for issuance under our 1999 Employee Stock
Purchase Plan.
Assumes
- conversion of all outstanding shares of preferred stock into common stock
upon the effectiveness of the offering, including 1,664,700 shares of
common stock issuable upon conversion of $10,910,000 in convertible notes
and $208,125 in related accrued interest, at a conversion price of $6.68
per share;
- sale of shares of common stock to be sold in the offering at
the initial public offering price of $ per share;
- application of the estimated net proceeds of the offering;
- The exercise of warrants to purchase 652,224 shares of Series C preferred
stock for cash consideration of $1,188,000; and
- issuance of 2,518,305 shares of common stock, reflecting a cashless
exercise of 1,598,276, 3,482,838 and 163,714 Series C, Series E and Series
E-2 warrants, respectively, by surrendering shares of common stock as
payment of the exercise price to purchase convertible preferred stock at a
weighted average exercise price of $5.20 per share, assuming a fair market
value per share of common stock in the offering of $ .
(2) Nonrecurring non-cash interest charge based on the difference between the
price per share for Series F-2 preferred stock issued to Novell, Inc. and MC
Silicon Valley, Inc. and for Series E-2 preferred stock issuable to IBM and
another investor upon conversion of convertible notes in accordance with
EITF Topic D-60. See note 8 of notes to consolidated financial statements.
Under the terms of an April 1997 contract with IBM, we agreed that any funds
provided by IBM for our operations during 1997 and 1998 through the sale of
equity securities to IBM would have a per share price not higher than $6.68.
In October and November 1998, we issued preferred stock to Novell, Inc. and
MC Silicon Valley, Inc. at a price per share of $9.00. See "Certain
Transactions--IBM Relationship."
(3) Does not include the effect of outstanding shares of convertible preferred
stock, shares from the assumed conversion of convertible notes and shares
issuable upon the exercise of stock options and warrants that are considered
anti-dilutive pursuant to Statement of Financial Accounting Standards (SFAS)
No. 123. For an explanation of basic and diluted net loss per share
applicable to common stockholders and the number of shares used to compute
basic and diluted net loss per share applicable to common stockholders, see
note 1 of notes to consolidated financial statements.
(4) As adjusted to give effect to
- conversion of all outstanding shares of preferred stock into common stock
upon the effectiveness of the offering, including 1,664,700 shares of
common stock issuable upon conversion of $10,910,000 in convertible notes
and $208,125 in related accrued interest, at a conversion price of $6.68
per share;
- sale of shares of common stock to be sold in the offering at
the initial public offering price of $ per share;
- application of the estimated net proceeds of the offering;
- The exercise of warrants to purchase 652,224 shares of Series C preferred
stock for cash consideration of $1,188,000; and
- issuance of 2,518,305 shares of common stock, reflecting a cashless
exercise of 1,598,276, 3,482,838 and 163,714 Series C, Series E and Series
E-2 warrants, respectively, by surrendering shares of common stock as
payment of the exercise price to purchase convertible preferred stock at a
weighted average exercise price of $5.20 per share, assuming a fair market
value per share of common stock in the offering of $ . See "Use of
Proceeds," "Capitalization" and "Description of Capital Stock."
6
<PAGE>
RISK FACTORS
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER
THE RISKS DESCRIBED BELOW AND THE OTHER INFORMATION IN THIS PROSPECTUS BEFORE
DECIDING TO INVEST IN OUR STOCK.
WE HAVE A HISTORY OF SUBSTANTIAL LOSSES AND EXPECT SUBSTANTIAL LOSSES IN THE
FUTURE.
We were incorporated in November 1995 and first recognized revenues in
October 1996. As of December 31, 1998, we had an accumulated deficit of
approximately $55.3 million, $42.8 million of which has been incurred since
April 1997. We expect to sustain significant losses for the foreseeable future.
You should consider our business and prospects in light of the risks and
difficulties frequently encountered by early-stage companies in rapidly evolving
markets, such as the market for web site building software and services.
To achieve and sustain profitability, we must:
- increase substantially our revenues from our two principal products,
NetObjects Fusion, which in fiscal year 1998 accounted for most of our
total revenues, and NetObjects Authoring Server, and our related
professional services, which have generated minimal revenues to date;
- continue to develop successfully new versions of our products, such as
NetObjects Fusion 4.0, which was released in December 1998;
- respond quickly and effectively to competitive, market and technological
developments;
- expand substantially our sales and marketing operations;
- develop our professional services business, which we launched in October
1998;
- control expenses;
- continue to attract, train and retain qualified personnel in the
competitive software industry; and
- maintain existing relationships and establish new relationships with
leading Internet hardware and software companies.
There can be no assurance that we will achieve these objectives, and our
failure to do so would hurt our business and could cause a substantial decline
in the price of our stock.
OUR AUDITORS HAVE EXPRESSED SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A
GOING CONCERN.
KPMG LLP, in their independent auditors' report, has expressed "substantial
doubt" as to our ability to continue as a going concern based on significant
operating losses since inception and significant debt and capital deficit as of
September 30, 1998. Our consolidated financial statements do not include any
adjustments that might result from the outcome of that uncertainty. The going
concern qualification is also described in note 1(d) of the notes to our
consolidated financial statements.
OUR ABILITY TO CONTINUE AS A GOING CONCERN IS DEPENDENT ON THE NET PROCEEDS OF
THIS OFFERING.
Without the net proceeds from the offering, our ability to remain in
business will be in jeopardy. One of the closing conditions to this offering is
that KPMG LLP reissue their independent auditors' report. KPMG LLP will do that
when the firm commitment underwriting agreement is signed by us and the
underwriters. Furthermore, this report, as reissued, must exclude the
explanatory paragraph that states that our recurring losses and net capital
deficiency raise substantial doubt about our ability to continue as a going
concern.
7
<PAGE>
A SUBSTANTIAL PORTION OF THE NET OFFERING PROCEEDS WILL BE USED TO REPAY DEBT
AND NOT TO IMPLEMENT OUR BUSINESS MODEL.
The remaining net proceeds from the offering are estimated to be $ ,
after the repayment of a $19 million secured credit facility with IBM Credit
Corp. and $ million that we expect to owe to IBM under notes issued prior to
the closing of the offering. Accordingly, a substantial portion of the net
offering proceeds will not be available for our business. In addition, our
credit facility will terminate upon repayment and will thus not be available to
us for future borrowings.
OUR DEPENDENCE ON IBM MAY PRESENT POTENTIAL CONFLICTS OR OTHERWISE ADVERSELY
AFFECT OUR BUSINESS.
WE HAVE DEPENDED HEAVILY ON IBM FOR FINANCING BUT IBM HAS NO OBLIGATIONS TO
PROVIDE US WITH FINANCING AFTER THIS OFFERING. Since IBM's acquisition of
approximately 80% of our stock, IBM has provided us with approximately $40
million of financing. Between April 1997 and December 1998, IBM provided us
with:
- $10.5 million of cash prepayments against future royalties for their
licensing of our products and our charges for services. Approximately half
of the recorded prepayments had not been recognized as revenues by the end
of fiscal year 1998,
- $10.1 million through our sale to IBM of convertible debt securities and
warrants for the purchase of convertible preferred stock, and
- a $19 million secured credit facility with IBM Credit Corp. that has been
guaranteed by IBM. We would not have been able to obtain a $19 million
loan from an independent third party without the guarantee by IBM. We were
not in compliance with a financial covenant in the credit facility as of
December 31, 1998, but on February 3, 1999, IBM Credit Corp. waived our
compliance through December 31, 1998 and agreed to take no action with
respect to our noncompliance through April 30, 1999.
Since December 31, 1998, IBM has provided an additional $ million. After
the offering, IBM will have no obligation to provide us with additional
financing.
KEY CONTRACTS WITH IBM ARE EXPIRING AND WE HAVE NO COMMITMENTS FOR FUTURE
REVENUES FROM IBM. Revenues from IBM have represented a substantial portion of
our total revenues-- approximately 36% and 50% of our total revenues in fiscal
year 1998 and in the first quarter of fiscal year 1999, respectively. All of our
revenues from IBM to date have been offset against the $10.5 million prepayment.
Our agreement with IBM for services associated with IBM's WebSphere project
ended on February 28, 1999. In addition, our arrangement with Lotus to bundle
NetObjects Fusion with Designer for Domino 4.0 expires in June 1999. Lotus also
currently markets, bundles and sells our products and has created foreign
language, or "localized," versions of our software, for which it pays us reduced
royalties on products that it sells outside the U.S. Lotus' obligation to create
localized versions of our software expires on December 31, 1999. After that
date, we may need to incur substantial additional expense to obtain localized
versions of new products or product upgrades from Lotus or other vendors if
necessary to satisfy the requirements of key customers like IBM, Lotus and
Novell.
We believe all of the remaining $2.3 million deferred revenues at December
31, 1998 will have been recognized as software license fees and service revenues
by June 30, 1999. We have no commitments from IBM to pay us software license
fees or revenues from services after June 1999. Our software license fees from
IBM in the remaining quarters of fiscal year 1999 are likely to decline, perhaps
substantially, from the level in the first quarter of fiscal year 1999. We
currently have no revenue commitments from IBM or other third parties that will
replace the revenues associated with these terminating contracts. If we are
unable to replace the revenue stream associated with these IBM agreements with
new revenues, our losses will increase and our stock price may fall.
8
<PAGE>
DEPENDENCE ON IBM PERSONNEL. Our ability to work effectively with IBM and
to maintain our strategic relationship with IBM depends to a significant extent
on the efforts of IBM's representatives on our board of directors and other
senior management personnel in Lotus and other IBM software organizations. If
they cease to be involved in our business, we may experience difficulties in
leveraging our strategic relationship with IBM.
WE HAVE POTENTIAL BUSINESS CONFLICTS WITH IBM. Although we have been
dependent on IBM, and IBM has provided substantial support to us, IBM makes
independent business and product decisions that may conflict with our business
objectives. For example, under our original agreement with IBM with respect to
IBM's WebSphere offerings, we were obligated to deliver modified versions of
NetObjects Fusion, NetObjects ScriptBuilder and NetObjects Authoring Server. We
anticipated that all three products would be bundled with IBM's WebSphere
product offerings. In that event, the agreement provided for IBM to pay us
royalties for each of the listed products subject to a minimum royalty amount.
Most of the royalties would have been due for NetObjects Authoring Server, which
is our highest priced product. In October 1998, however, IBM purchased all
rights to Build IT from Wallop, Inc., and decided to bundle that product instead
of NetObjects Authoring Server. We therefore amended our IBM license agreement
to add charges for our services based on the amount of our costs and expenses
instead of royalties from product sales. As a result, we expect to earn less
revenues from our WebSphere agreement with IBM than we had expected to earn and
will need to find other revenue sources.
IBM CONTROLS US AND IS FREE TO SELL ITS CONTROLLING INTEREST IN US. Before
the offering, IBM owned approximately 71% of our common stock, assuming
conversion of all options and warrants, and after the offering IBM will own
approximately % of our common stock. This percentage will decrease to % if
the underwriters' over-allotment option is exercised in full. As our majority
stockholder, IBM will have the power to determine matters submitted to a vote of
our stockholders without the consent of other stockholders, will have the power
to prevent or cause a change in control of us and could take other actions that
might be favorable to IBM and potentially harmful to us. IBM is under no
obligation to provide us with financial or other support after the offering.
IBM HAS FREEDOM TO ACT IN WAYS THAT MAY BE DISADVANTAGEOUS TO US. Our
restated certificate of incorporation contains provisions that expressly
acknowledge IBM's "freedom of action" to conduct its business and pursue other
business opportunities, even in competition with us. These provisions materially
limit the liability of IBM and its affiliates, including IBM's representatives
on our board of directors and Lotus, from conduct and actions taken by IBM or
its affiliates, even if the conduct or actions are beneficial to IBM and harmful
to us. When IBM becomes eligible to sell its stock subject to applicable
securities laws, contractual arrangements with the underwriters and the terms of
a registration rights agreement, if applicable, IBM will be able to transfer
some or all of its stock, including to our competitors. Such a transfer could
result in a transfer of IBM's controlling interest in us, which could cause our
revenues to decrease and our stock price to fall. For a description of the
historical benefits of our relationship with IBM, see "Business--NetObjects
Strategy--Strategic Relationships."
WE HAVE POTENTIAL CONFLICTS OF INTEREST WITH IBM; WE HAVE POTENTIAL AND
ACTUAL COMPETITION WITH IBM. Because IBM is our controlling stockholder and
because IBM executives are directors of NetObjects, conflicts of interest could
arise. Under our restated certificate of incorporation, IBM has no obligation to
refrain from competing with us, investing in our competitors, doing business
with our customers or hiring away our key personnel. Our restated certificate of
incorporation further provides that no director is prohibited from taking
actions or from voting on any action because of any actual or apparent conflict
of interest between that director and us. Our restated certificate of
incorporation also provides that no action taken by our board of directors will
be void or voidable, or give rise to liability for breach of fiduciary duty or
otherwise, solely because a majority of the directors are affiliated with IBM,
or because the action is, or is deemed to be by law,
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beneficial to IBM. In addition, IBM is under no obligation to inform us of any
corporate opportunity and is free to avail itself of any opportunity or to
transfer the opportunity to a third party. Any of these provisions of the
restated certificate of incorporation could give rise to conflicts of interest,
and we cannot be certain that any conflicts would be resolved in our favor. Any
of the risks arising from our relationship with IBM could hurt our business and
cause our stock price to fall.
IBM COULD OBTAIN AND USE OUR SOURCE CODE. Although our license agreements
with IBM contain restrictions on IBM's use and transfer of our software and
intellectual property, these restrictions are subject to exceptions. Under a
software license agreement with IBM, we have placed our key source code in
escrow for IBM's benefit. In the event of our default under the contract, IBM
will have access rights to this source code and will be free to use it to
maintain our products and create derivative works for the benefit of IBM and its
customers.
NON-EXCLUSIVE NATURE OF ARRANGEMENTS WITH IBM. All of our licensing
arrangements with IBM are non-exclusive. IBM has the right to cease promoting
and distributing our software at any time. IBM may license its name, logo and
technology to, or invest in, other web site building companies, and it may more
actively promote the services of our competitors. For example, IBM is currently
selling HomePage Builder, an IBM-developed web page building software product,
in Japan, and HomePage Creator, an IBM web-based service that allows users to
build web pages online.
OBLIGATIONS OF IBM SUBSIDIARIES. As an IBM subsidiary, we are subject to
IBM policies that may not apply to most small public companies, and we may incur
additional expenses in complying with these policies. We also are subject to
many IBM contracts with third parties. These contracts include patent
cross-license agreements between IBM and other companies that provide us with
immunity from suit for patent infringement claims by those companies as long as
we remain an IBM subsidiary. Under those agreements, we have effectively granted
those companies freedom from patent infringement claims that we might make
against them. Contractual obligations to third parties which arise because we
are an IBM subsidiary may have future adverse consequences that are currently
unforeseeable. If we cease to be an IBM subsidiary, we may face material
litigation risks associated with patent infringement claims that IBM's patent
cross-licensees cannot currently assert against us. In addition, we may be
unable to assert patent claims of our own against an IBM cross-licensee, which
may remain free of liability for claims under the terms of the cross-license
agreement even after we cease to be an IBM subsidiary.
MOST OF OUR REVENUES ARE DERIVED FROM SALES OF A SINGLE PRODUCT.
Most of our revenues from software license fees in fiscal year 1998 were
derived from versions of one of our products, NetObjects Fusion, and we expect
that this single product will continue to account for the substantial majority
of our total revenues in the near-term. To remain competitive, software products
typically require frequent updates that add new features. There can be no
assurance that we will succeed in creating and selling updated or new versions
of NetObjects Fusion. A decline in demand for, or in the average selling price
of, NetObjects Fusion, whether as a result of new product introductions or price
competition from competitors, technological change or otherwise, would hurt our
business or cause our stock price to fall.
WE HAVE MANY ESTABLISHED COMPETITORS, INCLUDING MICROSOFT, AND MAY BE UNABLE TO
COMPETE EFFECTIVELY AGAINST THEM.
The market for web site building software and services for the Internet and
corporate intranets is relatively new, constantly evolving and intensely
competitive. We expect competition to intensify in the future. Many of our
current and potential competitors have longer operating histories, greater
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name recognition and significantly greater financial, technical and marketing
resources. Our principal competitors in web site building software include
Microsoft Corporation, Adobe Systems Incorporated and Macromedia, Inc.
Microsoft's FrontPage, a web site building software product, has a dominant
market share. Microsoft has announced but not shipped FrontPage 2000, which may
become one of the products in at least one version of Microsoft's Office product
suite that dominates the market for desktop business application software.
OUR ABILITY TO GENERATE FUTURE REVENUES IS UNCERTAIN AND OUR QUARTERLY OPERATING
RESULTS WILL PROBABLY FLUCTUATE.
Because our business is evolving rapidly and we have a very limited
operating history, we have little experience in forecasting our revenues. Our
expense levels are based in part on our expectations of future revenues, and to
a large extent those expenses are fixed, particularly in the short-term. We
cannot be certain that our revenue expectations will be accurate or that we will
be able to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. As a result, we believe that period-to-period comparisons of
our financial results are not necessarily meaningful, and you should not rely
upon them as an indication of our future performance. In addition, IBM's
commitments, which provided quarterly earnings stability, for software license
fees expire in June 1999 and for service revenues expired in February 1999.
Furthermore, the $10.5 million of cash prepayments under our license agreement
with IBM have provided some revenue certainty for us since April 1997 and we
expect to have recognized all of the prepayments as revenues by June 30, 1999.
Thereafter, our revenues from IBM, if any, are likely to become more variable.
The promptness with which sales data, used for recognizing product royalties,
are reported to us from third parties may cause quarterly results to be more
volatile.
OUR ALLOWANCES FOR PRODUCT RETURNS MAY BE INADEQUATE.
At the time of sale of our software products, we have historically recorded
significant allowances for product returns. We have stock-balancing programs for
our software products that under specified circumstances allow for the return of
software by resellers. These programs also provide for price protection for our
software for some of our direct and indirect channel resellers that, under
specified conditions, allow the reseller a price reduction from us if we reduce
our price to similar channel resellers. In August 1997, our price reduction for
NetObjects Fusion triggered price protection obligations resulting in the need
to record an additional allowance in the three months ended September 30, 1997.
There can be no assurance that actual returns or price protection will not
exceed our estimates, and our estimation policy may cause significant quarterly
fluctuations. For a further discussion of our reserve policy and related risks,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations."
OUR FINANCIAL PERFORMANCE DEPENDS SUBSTANTIALLY ON MARKET ACCEPTANCE AND GROWTH
OF NETOBJECTS AUTHORING SERVER AND PROFESSIONAL SERVICES.
DEPENDENCE ON NETOBJECTS AUTHORING SERVER. We formally announced and
shipped NetObjects Authoring Server in September 1998 as a successor to our
original TeamFusion product released in December 1997. We depend on increasing
revenues from NetObjects Authoring Server and we may not receive these revenues
for the following reasons:
- the success of NetObjects Authoring Server will depend on the rapid
emergence of a market for large-scale enterprise web site and intranet
building products and services;
- information services departments of large enterprises may choose to create
and maintain their web and intranet sites internally or may use
third-party professional developers to create and maintain their sites;
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- NetObjects Authoring Server may not meet customer performance needs or be
free of significant software defects or bugs;
- NetObjects Authoring Server will have a longer sales cycle than NetObjects
Fusion due to higher pricing and different marketing and distribution
characteristics;
- there are no product bundles of NetObjects Authoring Server with IBM or
Lotus; and
- we may not be able to recruit and retain the additional sales personnel
needed to effectively market NetObjects Authoring Server.
We depend heavily on bundling arrangements with third parties to sell our
products. We currently do not have any arrangements for bundling NetObjects
Authoring Server. If NetObjects Authoring Server does not meet customer needs or
expectations, for whatever reason, upgrades or enhancements could be costly,
time-consuming or ultimately unsuccessful.
OUR SERVICES BUSINESS, WHICH WAS LAUNCHED IN OCTOBER 1998, MAY NOT GENERATE
SUFFICIENT REVENUES. In October 1998, we formed a new professional services
organization to assist our customers with training, consulting and
implementation. We cannot be certain that our services business will generate
significant revenues or achieve profitability. We believe that software license
fees growth will depend on our ability to provide our customers with these
services and to educate third-party resellers about how to use our products. We
currently outsource most of our professional services, but we plan to increase
the number of our services personnel to meet the needs of our customers.
Competition for qualified services personnel is intense, and we cannot be
certain that we can attract or retain a sufficient number of highly qualified
services personnel to meet our business needs.
POSSIBLE MARKET REJECTION OF ONLINE SERVICES. Since inception, we have
invested, and we continue to invest, resources to create and enhance our online
services, which we believe support and add to market acceptance of our products.
The failure of the market to accept our online services could cause our stock
price to fall.
WE MAY NOT BE ABLE TO EXPAND OUR DISTRIBUTION CHANNELS OR SALES FORCE.
NEED TO MAINTAIN THIRD-PARTY DISTRIBUTION CHANNEL. While we derive some of
our revenues from NetObjects selling directly to third parties, most of our
revenues are derived from the sale of our products through third-party
distributors and resellers. There can be no assurance that third parties will be
willing or able to carry our products in the future. If third parties were to
reduce or cease carrying our products, our direct sales to third parties would
be insufficient to support our operating expense base.
NEED TO ESTABLISH BUNDLING ARRANGEMENTS. We believe that products that are
not sold in a "suite" containing software products or components that perform
different functions are less likely to be commercially successful. For example,
NetObjects Fusion 4.0 includes software products or components from different
vendors such as Allaire Corporation, IBM, iCat, Lotus and NetStudio. IBM also
bundles our products with some of its software products, such as the bundling of
NetObjects Fusion, NetObjects ScriptBuilder and NetObjects BeanBuilder with
WebSphere Studio and NetObjects Fusion with Lotus Designer for Domino.
NetObjects Fusion is also bundled with Novell's NetWare for Small Business. We
cannot be assured of maintaining or obtaining suitable product or component
bundling arrangements with third parties. Failure to maintain and expand our
distribution channels or conclude suitable software product bundling
arrangements could hurt our business, cause our revenues to decrease and our
stock price to fall.
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OUR PRODUCTS MAY CONTAIN DEFECTS THAT COULD SUBJECT US TO LIABILITY IN EXCESS OF
INSURANCE LIMITATIONS.
Our software products are complex and may contain undetected errors or
result in system failures. Despite extensive testing, errors could occur in any
of our current or future product offerings after commencement of commercial
shipments. Any errors could result in loss of or delay in revenues, loss of
market share, failure to achieve market acceptance, diversion of development
resources, injury to our reputation or damage to our efforts to build brand
awareness. We cannot be certain that the contractual limitations of liability
will be enforceable, or that our insurance coverage will continue to be
available on reasonable terms or will be available in amounts to cover one or
more large claims, or that the insurer will not disclaim coverage as to any
future claim. The successful assertion of one or more large claims that exceed
available insurance coverage or changes in our insurance policies, including
premium increases or the imposition of large deductible or co-insurance
requirements, could cause our revenues to decrease and our stock price to fall.
WE MAY FAIL TO RESPOND ADEQUATELY TO RAPID TECHNOLOGICAL CHANGES.
The market for our products is marked by rapid technological change, which
leads to frequent new product introductions and enhancements, uncertain product
life cycles, changes in customer demands and evolving industry standards. New
web site building products and services based on new technologies or new
industry standards could render our existing products obsolete and unmarketable.
We believe that to succeed, we must enhance our current products and develop new
products on a timely basis to keep pace with technological developments and to
satisfy the increasingly sophisticated requirements of our customers.
DEVELOPMENT DELAYS MAY INCREASE OUR COSTS.
Our product and software development efforts inherently are difficult to
manage and keep on schedule. On occasion, we have experienced development delays
and related cost overruns, and we cannot be certain that we will not encounter
these problems in the future. Any delays in developing and releasing enhanced or
new products could cause our revenues to decrease. In addition, we cannot be
certain that we will successfully develop and market new products or product
enhancements that respond to technological change, evolving industry standards
or customer requirements, or that any product innovations will achieve the
market penetration or price stability necessary for profitability.
THE LOSS OF OUR KEY PERSONNEL, OR FAILURE TO HIRE ADDITIONAL PERSONNEL, COULD
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
We depend on the continued service of our key personnel, and we expect that
we will need to hire additional personnel in all areas. The competition for
personnel throughout our industry is intense, particularly in the San Francisco
Bay Area, where our headquarters are located. We have experienced difficulties
in attracting new personnel, and all of our personnel, including our management,
may terminate their employment at any time for any reason. Currently, we are
dependent upon the services of Samir Arora, our President, Chief Executive
Officer, Chairman of the Board and one of our founders. The loss of Mr. Arora's
services would materially impede the operation and growth of our business at
this time. Michael Shannahan, our former Chief Financial Officer, resigned as of
April 5, 1999. Russell F. Surmanek, Executive Vice President, Finance and
Operations and Chief Financial Officer commenced his employment with us on April
5, 1999. Mr. Surmanek has no prior experience with us. If Mr. Surmanek fails to
quickly become an effective chief financial officer or if he ceases to remain in
our employ, our business could be harmed and our stock price could fall. We do
not maintain key person life insurance for any of our personnel. Furthermore,
our failure to attract new personnel or retain and motivate our current
personnel could hurt our business. For a
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discussion of our employees and management, see "Business--Employees" and
"Management-- Executive Compensation and Management Changes."
A THIRD PARTY COULD BE PREVENTED FROM ACQUIRING YOUR SHARES OF STOCK AT A
PREMIUM TO THE MARKET PRICE BECAUSE OF OUR ANTI-TAKEOVER PROVISIONS.
IBM will own approximately % of our outstanding stock immediately
following the offering, based upon the number of shares outstanding at December
31, 1998. That ownership interest and provisions of our restated certificate of
incorporation, bylaws, a voting agreement between us and IBM and Delaware law
could make it more difficult for a third party to acquire us, even if a change
in control would result in a third party acquiring your shares of common stock
at a premium to the market price. The anti-takeover provisions are further
described in "Certain Transactions" and "Description of Capital Stock."
IF WE FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS OR FACE A
CLAIM OF INTELLECTUAL PROPERTY INFRINGEMENT BY A THIRD PARTY, WE COULD LOSE
OUR INTELLECTUAL PROPERTY RIGHTS OR BE LIABLE FOR SIGNIFICANT DAMAGES.
Trademarks and other proprietary rights are important to our success and our
competitive position. We seek to protect our trademarks and other proprietary
rights, but our actions may be inadequate to prevent misappropriation or
infringement of our technology, trademarks and other proprietary rights or to
prevent others from claiming violations of their trademarks and other
proprietary rights. Although we have obtained federal registration of the
trademark NetObjects Fusion-Registered Trademark- we know that other businesses
use the word "Fusion" in their marks alone or in combination with other words.
We do not believe that we will be able to prevent others from using the word
"Fusion" for competing goods and services. For example, Allaire markets its
application development and server software for web development, including
applications for e-commerce, under the federally registered trademark "Cold
Fusion." Under an agreement with Allaire Corporation, we have agreed that
neither company will identify its products and services with the single word
"Fusion," unless otherwise agreed as in the case of our co-bundled product
"Fusion2Fusion." Business customers may confuse our products and services with
similarly named brands, which could dilute our brand names or limit our ability
to build market share. To license many of our products, we rely in part on
"shrinkwrap" and "clickwrap" licenses that are not signed by the end user and,
therefore may be unenforceable under the laws of certain jurisdictions. In
addition, we may license content from third parties. We could become subject to
infringement actions based upon these third-party licenses, and we could be
required to obtain licenses from other third parties to continue offering our
products.
We cannot be certain that we will be able to avoid significant expenditures
to protect our intellectual property rights, to defend against third-party
infringement or other claims or to license content from third parties alleging
that our products infringe their intellectual property rights. Incurring
significant expenditures to protect our intellectual property rights or to
defend against claims or license content could decrease our revenues and cause
our stock price to fall. Our intellectual property is further described in
"Business--Intellectual Property."
OUR INTERNATIONAL OPERATIONS ARE NEW AND MAY NOT BE SUCCESSFUL.
International sales represented approximately 15% and 16% of our total
revenues in fiscal 1997 and 1998, respectively. We intend to expand the scope of
our international operations and currently have a subsidiary in the United
Kingdom. Our continued growth and profitability will require continued expansion
of our international operations, particularly in Europe, and in Japan, where
Mitsubishi Corporation acts as our master distributor and Lotus is a reseller of
NetObjects Fusion.
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Our international operations are, and any expanded international operations
will be, subject to a variety of risks associated with conducting business
internationally that could materially adversely affect our business, including
the following:
- difficulties in staffing and managing international operations;
- lower gross margins than in the United States;
- slower adoption of the Internet;
- longer payment cycles;
- fluctuations in currency exchange rates;
- seasonal reductions in business activity during the summer months in
Europe and other parts of the world;
- recessionary environments in foreign economies; and
- increases in tariffs, duties, price controls or other restrictions on
foreign currencies or trade barriers imposed by foreign countries.
Furthermore, the laws of foreign countries may provide little or no
protection of our intellectual property rights.
WE MAY BE UNABLE TO MANAGE OUR RAPID GROWTH.
We have expanded our operations rapidly since inception, and we intend to
continue to expand them in the foreseeable future. This rapid growth places a
significant demand on our managerial and operational resources. To manage growth
effectively, we must:
- implement and improve our operational systems, procedures and controls on
a timely basis;
- expand, train and manage our workforce and, in particular, our sales and
marketing and support organizations in light of our recent decision to
offer online and professional services;
- implement and manage new distribution channels to penetrate different and
broader markets, including the market for intranet software products; and
- manage an increasing number of complex relationships with customers,
co-marketers and other third parties.
We cannot be certain that our systems, procedures or controls will be
adequate to support our current or future operations or that our management will
be able to manage the expansion and still achieve the rapid execution necessary
to exploit fully the market for our products and services. Failure to manage our
growth effectively could harm our business.
IF INTERNET AND INTRANET USAGE DOES NOT CONTINUE TO GROW, WE WILL NOT BE
SUCCESSFUL.
Sales of our products and services depend in large part on the emergence of
the Internet as a viable commercial marketplace with a strong and reliable
infrastructure and on the growth of corporate intranets. Critical issues
concerning use of the Internet and intranets, including security, reliability,
cost, ease of use and quality of service, remain unresolved and may inhibit the
growth of, and the degree to which business is conducted over, the Internet and
intranets. Failure of the Internet and intranets to develop into viable
commercial mediums would harm our business and cause our revenues to decrease
and our stock price to fall.
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YEAR 2000 PROBLEMS MAY DISRUPT OUR BUSINESS.
We have made a preliminary assessment of our Year 2000 readiness. We are
also in the process of contacting our third-party vendors, licensors and
providers of software, hardware and services regarding their Year 2000
readiness. Following this testing and after contacting these vendors and
licensors, we will be better able to make a complete evaluation of our Year 2000
readiness to determine what costs will be necessary to be Year 2000 ready, and
to determine whether contingency plans need to be developed. Our inability to
correct a significant Year 2000 problem, if one exists, could result in an
interruption in, or a failure of, certain of our normal business activities and
operations. Furthermore, because NetObjects Fusion and NetObjects Authoring
Server may interact with external databases for purposes of data storage, the
ability of applications integrated with a web site built using Net Objects
Fusion or NetObjects Authoring Server to comply with Year 2000 requirements is
largely dependent on whether the databases underlying the application are Year
2000 ready. If NetObjects Fusion or NetObjects Authoring Server is connected to
a database that is not Year 2000 ready, a web application created or developed
for a web site using NetObjects Fusion or NetObjects Authoring Server could work
incorrectly and could result in unanticipated expenses to address problems or
claims raised by customers that we cannot presently foresee. Any significant
Year 2000 problem could require us to incur significant unanticipated expenses
to remedy these problems and could divert management's time and attention,
either of which could harm our business or increase our losses, and cause our
stock price to fall. For information on our state of readiness, potential risks
and contingency plans regarding the Year 2000 issue, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Year
2000 Readiness."
OUR FAILURE TO INTEGRATE SUCCESSFULLY ANY FUTURE ACQUISITIONS COULD STRAIN OUR
MANAGERIAL, OPERATIONAL AND FINANCIAL RESOURCES.
In the future we may make acquisitions of, or large investments in,
businesses that offer products, services and technologies that we believe would
help us better provide e-business web site and intranet site building software
and services to businesses. Any future acquisitions or investments would present
risks such as difficulty in combining the technology, operations or workforce of
the acquired business with our own, disruption of our ongoing businesses and
difficulty in realizing the anticipated financial or strategic benefits of the
transaction.
To make these acquisitions or large investments we might use cash, common
stock or a combination of cash and common stock. If we use common stock, these
acquisitions could further dilute existing stockholders. Amortization of
goodwill or other intangible assets resulting from acquisitions could materially
impair our operating results and financial condition. Furthermore, there can be
no assurance that we would be able to obtain acquisition financing, or that any
acquisition, if consummated, would be smoothly integrated into our business. If
we make acquisitions or large investments and are unable to surmount these
risks, our business could be harmed, our revenues could decrease and our stock
price could fall.
WE MAY BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATION AND LEGAL
UNCERTAINTIES.
We are not currently subject to direct regulation by any governmental
agency, other than laws and regulations generally applicable to businesses,
although specific U.S. export controls and import controls of other countries,
including controls on the use of encryption technologies, may apply to our
products. Due to the increasing popularity and use of the Internet, it is
possible that a number of laws and regulations may be adopted in the United
States and abroad with particular applicability to the Internet. It is possible
that governments will enact legislation that may apply to us in areas such as
network security, encryption, the use of key escrow, data and privacy
protection, electronic authentication or "digital" signatures, illegal and
harmful content, access charges and retransmission
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activities. Moreover, the applicability to the Internet of existing laws
governing issues such as property ownership, content, taxation, defamation and
personal privacy is uncertain. Any new legislation or regulation or governmental
enforcement of existing regulations may limit the growth of the Internet,
increase our cost of doing business or increase our legal exposure, any of which
could cause our revenues to decrease and our stock price to fall.
IMPOSITION OF SALES AND OTHER TAXES MAY ADVERSELY IMPACT OUR FINANCIAL
CONDITION.
We currently do not collect sales or similar taxes with respect to the sale
of products, license of technology or provision of services in states and
countries other than states in which we have offices. In October 1998, the
Internet Tax Freedom Act, or ITFA, was signed into law. Among other things, the
IFTA imposes a three year moratorium on discriminatory taxes on e-commerce.
Nonetheless, foreign countries, or, following the moratorium, one or more
states, may seek to impose sales or other tax obligations on companies that
engage in online commerce within their jurisdictions. A successful assertion by
one or more states or any foreign country that we should collect sales or other
taxes on the sale of products, license of technology or provision of services or
remit payment of sales or other taxes for prior periods, could hurt our
business.
WE MAY SPEND A SUBSTANTIAL PORTION OF THE NET PROCEEDS IN WAYS WITH WHICH YOU
MAY NOT AGREE.
We have not designated any specific use for a significant amount of net
proceeds from the sale of the common stock offered under this prospectus, other
than the repayment of debt to IBM Credit Corp. and IBM. We intend to use the
remaining net proceeds primarily for general corporate purposes, including
working capital to fund anticipated operating losses and capital expenditures.
Accordingly, management will have significant flexibility in applying the
remaining net proceeds of the offering. The failure of management to apply the
remaining net proceeds effectively could cause our revenues to decrease and our
stock price to fall.
THERE HAS BEEN NO PRIOR PUBLIC MARKET FOR OUR COMMON STOCK.
There has not previously been a public market for our stock. We cannot
predict the extent to which investor interest in us will lead to the development
of a trading market or how liquid that market might become. The initial public
offering price for our stock will be determined by our negotiations with the
representatives of the underwriters and may not be indicative of prices that
will prevail in the trading market. The stock market has experienced significant
price and volume fluctuations, and the market prices of securities of technology
companies, particularly Internet-related companies, have been highly volatile.
Investors may not be able to resell their stock at or above the initial public
offering price.
THE FUTURE SALE OF COMMON STOCK MAY NEGATIVELY AFFECT OUR STOCK PRICE.
If our stockholders sell substantial amounts of our stock, including shares
issued upon the exercise of outstanding options and warrants, in the public
market following the offering, then the market price of our stock could fall.
These sales also might make it more difficult for us to sell equity securities
in the future at a time and price that we deem appropriate. After the offering,
shares of our stock will be outstanding, assuming no exercise of the
underwriters' over-allotment option and no exercise of outstanding options or
warrants. Of those shares, the shares sold in the offering will be
freely tradable except for any shares purchased by our "affiliates," as defined
in Rule 144 under the Securities Act. The remaining shares are
"restricted securities," as that term is defined in Rule 144, and may be sold in
the public market only if registered or if they qualify for an exemption from
registration under Rule 144 or Rule 701 under the Securities Act. All officers,
directors and a substantial majority of our stockholders of
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NetObjects have agreed not to sell any shares of common stock, or any securities
convertible into or exercisable or exchangeable for common stock, for 180 days
after the offering without the prior written consent of BT Alex. Brown. BT Alex.
Brown may, in its sole discretion, release all or any portion of the shares
subject to lock-up agreements. A more detailed description of shares that may be
sold following the offering is contained in "Shares Eligible for Future Sale."
INVESTORS IN THE OFFERING WILL SUFFER IMMEDIATE AND SUBSTANTIAL DILUTION.
Investors purchasing shares in the offering will incur immediate and
substantial dilution in net tangible book value per share. To the extent
outstanding options and warrants to purchase common stock are exercised, there
will be further dilution. For a more detailed discussion, see "Dilution."
FORWARD-LOOKING STATEMENTS
This prospectus contains "forward-looking statements." These forward-looking
statements include, without limitation, statements about the market opportunity
for web site building software and services, our strategy, competition and
expected expense levels, and the adequacy of our available cash resources. Our
actual results could differ materially from those expressed or implied by these
forward-looking statements as a result of various factors, including the risk
factors described above and elsewhere in this prospectus. We undertake no
obligation to update publicly any forward-looking statements for any reason,
even if new information becomes available or other events occur in the future.
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CAPITALIZATION
The following table sets forth our cash, short-term borrowings and
capitalization
- at December 31, 1998;
- pro forma to reflect
(1) a cash payment from IBM of $2,585,000 on January 5, 1999 for the
purchase of convertible notes, which automatically converts into
387,048 shares of stock using a conversion ratio of $6.68 per share.
(2) the conversion of all outstanding shares of preferred stock into
common stock, including 1,277,652 shares of common stock issuable on
automatic conversion of $8,325,000, net of a discount of $843,000, in
convertible notes and $208,125 in related accrued interest at a
conversion price of $6.68 per share, and
(3) the exercise of warrants to purchase 652,224 shares of Series C
preferred stock for cash consideration of $1,188,000, and
(4) issuance of 2,518,305 shares of common stock, reflecting issuance of
1,598,276, 3,482,838 and 163,714 shares of common stock through a
"cashless exercise" of Series C, Series E and Series E-2 warrants,
respectively, in which shares of common stock are surrendered in
payment of the exercise price to purchase convertible preferred stock
at a weighted average exercise price of $5.20 per share, assuming a
fair market value per share of common stock in the offering of
$ ; and
- as adjusted to reflect
- the pro forma capitalization and
- our sale of shares to be sold in the offering at the initial
public offering price of $ per share, after deducting the
underwriting discounts and commissions and estimated expenses of the
offering. See "Use of Proceeds" and note 1(d) of notes to consolidated
financial statements. The information set forth below is unaudited and
should be read in conjunction with our consolidated financial
statements and notes to consolidated financial statements:
<TABLE>
<CAPTION>
DECEMBER 31, 1998
-------------------------------------------------
PRO FORMA PRO AS
ACTUAL ADJUSTMENTS FORMA ADJUSTED
-------- ------------------ -------- --------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Cash........................................................ $ 1,288 $ 3,773(1)(3) $ 5,061 $
-------- -------- -------- --------
-------- -------- -------- --------
Short-term borrowings from IBM Credit Corp.................. $ 18,813 -- $ 18,813
-------- -------- -------- --------
-------- -------- -------- --------
Capital lease obligations, less current portion............. 271 -- 271
Convertible notes from IBM and related party................ 7,690 7,690(2) --
-------- -------- -------- --------
Total long-term obligations............................. 7,961 7,690 271
-------- -------- -------- --------
Preferred stock, $0.01 par value;
22,816,300 shares authorized; 11,965,826 issued and
outstanding, actual; none issued and outstanding, pro
forma; none issued and outstanding, as adjusted......... 113 -- --
Common stock, $0.01 par value;
28,300,000 shares authorized; 2,088,561 shares issued and
outstanding, actual; 18,889,616 shares issued and
outstanding, pro forma; shares issued and
outstanding, as adjusted(5)............................. 21 168(1)(2)(3)(4) 189
Additional paid-in capital.................................. 26,567 11,408(2)(3)(4) 37,975 --
Deferred stock-based compensation........................... (441) -- (441)
Stockholders' notes receivable.............................. (113) -- (113) --
Accumulated other comprehensive losses...................... (6) -- (6) --
Accumulated deficit......................................... (55,318) -- (55,318) --
-------- -------- -------- --------
Total stockholders' deficit............................. (29,177) 11,576 (17,714)
-------- -------- -------- --------
Total capitalization.................................... $(21,287) $ 3,773 $(17,443) $
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
- ------------------------
(5) Excludes (a) 2,629,575 shares of common stock issuable at a weighted average
exercise price of $2.38 per share upon exercise of stock options outstanding
at December 31, 1998; (b) 258,651 shares of common stock reserved for future
issuance under our stock option plans; and (c) 300,000 shares of common
stock reserved for issuance under our 1999 Employee Stock Purchase Plan. See
"Management--Benefit Plans."
19
<PAGE>
DILUTION
Our pro forma net tangible book deficit at December 31, 1998 was
$18,973,000, or $(1.00) per share, as adjusted to give effect to
- a cash payment from IBM of $2,585,000 on January 5, 1999 for the
purchase of convertible notes,
- the conversion of all outstanding shares of preferred stock into common
stock, including 1,664,700 shares of common stock issuable on automatic
conversion of $10,910,000 in convertible notes and $208,125 in related
accrued interest at a conversion price of $6.68 per share,
- the exercise of warrants to purchase 652,224 shares of Series C
preferred stock for cash consideration of $1,188,000, and
- the issuance of 2,518,305 shares of common stock, reflecting issuance
of 1,598,276, 3,482,838 and 163,714 shares of common stock through a
"cashless exercise" of Series C, Series E and Series E-2 warrants,
respectively, in which shares of common stock are surrendered in
payment of the exercise price to purchase convertible preferred stock
at a weighted average exercise price of $5.20 per share assuming a fair
market value per share of common stock in the offering of $ .
Pro forma net tangible book deficit per share represents the amount of our
total pro forma tangible assets less pro forma total liabilities divided by the
aggregate pro forma number of shares of common stock outstanding. After giving
effect to the application of the estimated net proceeds, which reflect an
estimate of underwriting discounts and commissions and an estimate of offering
expenses from the sale of shares of common stock to be sold in the
offering at the initial public offering price of $ per share, our adjusted
pro forma net tangible book value at December 31, 1998 would have been
approximately $ or $ per share of common stock. This represents
an immediate increase in the pro forma net tangible book value of $ per
share of common stock to existing stockholders and an immediate dilution of
$ per share to new investors. The following table illustrates this per
share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............................... $
---------
Pro forma net tangible book deficit per share at December 31, 1998.......... $ (1.00)
Increase in pro forma net tangible book value per share attributable to new
investors.................................................................
---------
Adjusted pro forma net tangible book value per share after the offering.......
---------
Dilution per share to new investors........................................... $
---------
---------
</TABLE>
The following table summarizes, on a pro forma basis at December 31, 1998,
after giving effect to the offering, the difference between existing
stockholders and investors in the offering with respect to the number of shares
of common stock purchased from our Company, the total consideration paid and the
average price paid per share:
<TABLE>
<CAPTION>
SHARES PURCHASED(1)(2) TOTAL CONSIDERATION
-------------------------- --------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------- ----------- -------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Existing stockholders............................... 18,760,231 -- % $ 20,456,000 -- % $ 1.09
New investors....................................... -- -- -- -- --
------------- ----- -------------- -----
Total........................................... -- 100.0% $ -- 100.0%
------------- ----- -------------- -----
------------- ----- -------------- -----
</TABLE>
- ------------------------
(1) The table assumes no exercise of the underwriters' over-allotment option.
Exercise of the over-allotment option in full would (a) reduce the
proportion of shares held by existing stockholders to % of the total
number of shares outstanding after the offering; and (b) increase the number
of shares purchased by investors in the offering to shares, or %
of the total number of shares.
(2) Excludes (a) 2,629,575 shares of common stock issuable at a weighted average
exercise price of $2.38 per share upon exercise of stock options outstanding
at December 31, 1998; (b) 258,651shares of common stock reserved for future
issuance under our stock option plans; and (c) 300,000 shares of common
stock reserved for issuance under our 1999 Employee Stock Purchase Plan. See
"Management--Benefit Plans."
20
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected historical consolidated financial data presented
below are derived from our consolidated financial statements. The financial
statements for the period from November 21, 1995 (inception) to September 30,
1996, and as of and for the fiscal years ended September 30, 1997 and 1998, have
been audited by KPMG LLP, independent auditors, and are included elsewhere in
this prospectus. The balance sheet data as of September 30, 1996 is derived from
audited consolidated financial statements of NetObjects that are not included in
this prospectus. The selected historical consolidated financial data as of
December 31, 1998 and for the three months ended December 31, 1997 and 1998 have
been derived from unaudited consolidated financial statements included elsewhere
in this prospectus, that include, in the opinion of management, all adjustments,
consisting only of normal recurring adjustments, that we consider necessary for
a fair presentation of our financial position and results of operations for
those periods. The selected consolidated financial data set forth below is
qualified in its entirety by, and should be read in conjunction with,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," our consolidated financial statements, the related notes and the
independent auditor's report, which contains an explanatory paragraph that
states that our recurring losses from operations and net capital deficiency
raise substantial doubt about our ability to continue as a going concern,
included elsewhere in this prospectus. The consolidated financial statements and
the selected consolidated financial data do not include any adjustments that
might result from the outcome of that uncertainty. The operating results for the
periods presented are not necessarily indicative of the results to be expected
for the full fiscal year or any other period:
<TABLE>
<CAPTION>
PERIOD FROM THREE MONTHS ENDED
NOVEMBER 21, YEAR ENDED
1995 (INCEPTION) SEPTEMBER 30, DECEMBER 31,
TO SEPTEMBER 30, -------------------- --------------------
1996 1997 1998 1997 1998
--------------------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Software license fees......................... $ -- $ 7,392 $ 9,703 $ 2,086 $ 2,622
Service revenues.............................. -- -- -- -- 190
Software license fees from IBM................ -- 175 2,700 199 1,318
Service revenues from IBM..................... -- -- 2,867 -- 1,487
------- --------- --------- --------- ---------
Total revenues.............................. -- 7,567 15,270 2,285 5,617
------- --------- --------- --------- ---------
Cost of revenues:
Software license fees......................... -- 772 2,531 278 495
Service revenues.............................. -- -- -- -- 184
IBM service revenues.......................... -- -- 2,562 -- 1,404
------- --------- --------- --------- ---------
Total cost of revenues...................... -- 772 5,093 278 2,083
------- --------- --------- --------- ---------
Gross profit................................ -- 6,795 10,177 2,007 3,534
--------- --------- --------- ---------
Operating expenses:
Research and development...................... 2,765 8,436 10,231 3,070 2,204
Sales and marketing........................... 2,998 12,161 17,114 4,060 4,430
General and administrative.................... 978 3,762 3,575 769 894
Stock-based compensation...................... -- -- 227 -- 100
------- --------- --------- --------- ---------
Total operating expenses.................... 6,741 24,359 31,147 7,899 7,628
------- --------- --------- --------- ---------
Operating loss.............................. (6,741) (17,564) (20,970) (5,892) (4,094)
Interest income (expense)....................... 46 (234) (1,194) (168) (712)
Nonrecurring interest charge on beneficial
conversion feature of convertible debt (1).... -- -- -- -- (3,792)
Loss before income taxes.................... (6,695) (17,798) (22,164) (6,060) (8,598)
Income taxes.................................... -- 1 60 7 2
------- --------- --------- --------- ---------
Net loss........................................ $ (6,695) $ (17,799) $ (22,224) $ (6,067) $ (8,600)
------- --------- --------- --------- ---------
------- --------- --------- --------- ---------
Basic and diluted net loss per share applicable
to common stockholders (2).................... $ (4.10) $ (10.45) $ (12.26) $ (3.47) $ (4.40)
------- --------- --------- --------- ---------
------- --------- --------- --------- ---------
Shares used to compute basic and diluted net
loss per share applicable to common
stockholders (2).............................. 1,634 1,703 1,812 1,750 1,956
------- --------- --------- --------- ---------
------- --------- --------- --------- ---------
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------------- DECEMBER 31,
1996 1997 1998 1998
--------- --------- --------- ---------------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash................................................................. $ 1,090 $ 303 $ 459 $ 1,288
Working capital (deficit)............................................ (1,749) (10,116) (30,229) (23,390)
Short-term borrowings from IBM and IBM Credit Corp................... -- -- 20,666 18,813
Long-term obligations, less current portion.......................... 173 633 336 7,890
Total assets......................................................... 2,129 4,605 5,145 7,502
Accumulated deficit.................................................. (6,695) (24,494) (46,718) (55,318)
Stockholders' deficit................................................ (1,357) (8,913) (28,925) (29,177)
</TABLE>
- ------------------------
(1) Nonrecurring non-cash interest charge based on the difference between the
price per share for Series F-2 preferred stock issued to Novell, Inc. and MC
Silicon Valley, Inc. and for Series E-2 preferred stock issuable to IBM and
another investor upon conversion of convertible notes in accordance with
EITF Topic D-60. See note 8 of notes to consolidated financial statements.
Under the terms of an April 1997 contract with IBM, we agreed that any funds
provided by IBM for our operations during 1997 and 1998 through the sale of
equity securities to IBM would have a per share price not higher than $6.68.
In October and November 1998, we issued preferred stock to Novell, Inc. and
MC Silicon Valley, Inc. at a price per share of $9.00. See "Certain
Transactions--IBM Relationship."
(2) Does not include the effect of outstanding shares of convertible preferred
stock, shares from the assumed conversion of convertible notes and shares
issuable upon the exercise of stock options and warrants that are considered
anti-dilutive pursuant to SFAS No. 123. For an explanation of basic and
diluted net loss per share applicable to common stockholders and the number
of shares used to compute basic and diluted net loss per share applicable to
common stockholders, see note 1 of notes to consolidated financial
statements.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL
STATEMENTS AND THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INCLUDED ELSEWHERE
IN THIS PROSPECTUS. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF SEVERAL
FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE SET FORTH UNDER "RISK FACTORS" AND
ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
We provide software and solutions that enable small businesses and large
enterprises to build, deploy and maintain Internet and intranet web sites and
applications. We pioneered the web site building products category with the
introduction of NetObjects Fusion in October 1996, and we have released several
other award-winning software products, including NetObjects Authoring Server, a
successor to NetObjects TeamFusion. In October 1998, we began offering online
and professional services to serve the site building and maintenance needs of
our customers. We were incorporated in November 1995 and first recognized
revenues in October 1996, when we provided our first commercial version of
NetObjects Fusion.
We recognize revenues from software license fees upon delivery of our
software products to our customers, net of allowances for estimated returns and
price protection, as long as we have no significant obligations remaining and we
believe that collection of the resulting receivable is probable. Software
license fees earned from products bundled with OEM resellers, including IBM, are
generally recognized upon the OEM resellers shipping the bundled products to
their customers. We recognize service revenues from IBM in connection with the
integration of our software with IBM's WebSphere software products using the
percentage-of-completion method. We are deferring the recognition of profit on
this arrangement until the amount of profit can be reasonably estimated. We
defer recognition of maintenance revenues, paid primarily for support and
upgrades, upon receipt of payment and recognize the related revenues ratably
over the term of the contract, which typically is 12 months. These payments
generally are made in advance and are nonrefundable. For a description of
reserve policy risks, see "Risk Factors--Our allowances for product returns may
be inadequate."
Through September 30, 1998, we recognized revenues in accordance with
American Institute of Certified Public Accountants (AICPA) Statement of Position
(SOP) 91-1, SOFTWARE REVENUE RECOGNITION. On October 1, 1998, we adopted the
provisions of SOP 97-2 and SOP 98-9, which supersede SOP 91-1. See note 1 of
notes to consolidated financial statements.
We earn revenues from software license fees primarily through indirect sales
of our products by resellers, through direct sales of our products by NetObjects
salespersons and through important strategic relationships such as our
relationship with IBM. Sales of our products by resellers include sales by
distributors, direct and original equipment manufacturer resellers, value-added
resellers and online sales. During fiscal year 1997, our total revenues from
software license fees rose from $0 to $7.6 million, and again grew significantly
in fiscal year 1998, to $12.4 million, as a result of our introduction of new
versions of our main product NetObjects Fusion and, secondarily, the release of
other related products. In fiscal year 1998, our total revenues from IBM grew to
approximately $5.6 million from approximately $175,000 in fiscal year 1997. Our
total revenues from IBM in fiscal year 1998 and for the three months ended
December 31, 1998 included revenues of $2.9 million and $1.5 million,
respectively, for our charges for services under the WebSphere agreement.
We initiated relationships with our primary distributors in North America,
Europe and Asia Pacific in fiscal year 1997. Revenues generated by sales of our
products by resellers accounted for
23
<PAGE>
substantially all of our revenues from sources other than IBM for fiscal years
1997 and 1998. We anticipate that revenues derived from sales of our products by
resellers will decrease as a percentage of our total revenues. We anticipate
that revenues derived from our direct sales will continue to increase as a
percentage of our total revenues. We derive our non-North American revenues
through sales of our products by resellers and distributors.
In April 1997, when IBM acquired approximately 80% of our outstanding stock
from existing investors, we agreed to license IBM the right to market and sell
some of our products to their customers for 10 years under an agreement that
allowed us to receive nonrefundable cash prepayments totaling $10.5 million
between April 1997 and December 31, 1998. We requested and received the full
amount of these prepayments between April and December 1997. These prepayments
have been reflected as deferred revenues from IBM on our balance sheet until
recognized. In the three months ended December 31, 1997, IBM began reselling our
products, and in the three months ended March 31, 1998, we began providing
services under the WebSphere agreement that ended on February 28, 1999. As IBM
reports sales of our products and we perform services, we recognize revenues and
the deferred revenue from IBM declines by the same amount. At December 31, 1998,
approximately $2.3 million of the prepayments remained as deferred revenue from
IBM. As a result, we will not receive cash on sales by IBM of our products or
for services that we provide to IBM until the prepayment balance has been
reduced to zero. Our dependence on IBM has risks that are discussed in "Risk
Factors--Our dependence on IBM may present potential conflicts or otherwise
adversely affect our business."
From our inception through the end of fiscal year 1996, our operating
activities related primarily to recruiting personnel, raising capital,
purchasing operating assets, conducting research and development, building the
NetObjects brand and establishing the market for our products. During fiscal
year 1997, we continued to invest significantly in research and development,
marketing, building our domestic and international sales channels and general
and administrative infrastructure. During both fiscal years we engaged in many
activities designed to gain corporate brand identity, seed the market with our
product, establish the site building product category and educate the market
about our products and services. In addition, we invested in a broad range of
marketing activities such as advertising, trade shows, direct mail and public
relations. We also entered into many co-marketing and distribution arrangements
with well-known companies such as AT&T, Apple Computer, Inc., Compaq Computer,
Inc., Microsoft, Netscape Communications Corp. and PeopleSoft that allowed us to
identify our NetObjects Fusion brand with their brands. Most of these
arrangements have not generated revenues for us, and their principal benefit has
been to help us achieve substantial brand recognition in a relatively short
period. The costs of these activities and arrangements, which were not offset by
revenues, have contributed substantially to our significant losses since
inception, and as of December 31, 1998, we had an accumulated deficit of
approximately $55.3 million.
We believe that our success will depend largely on our ability to extend our
technological leadership and to continue to build our brand position.
Accordingly, we intend to continue to invest heavily in research and development
and sales and marketing. As a result, we expect to continue to incur substantial
operating losses for the foreseeable future. See "Risk Factors--We have a
history of substantial losses and expect substantial losses in the future,"
"--Our auditors have expressed substantial doubt about our ability to continue
as a going concern," and "--Our ability to continue as a going concern is
dependent on the net proceeds of this offering" for a discussion of factors that
could cause these forward looking statements not to come true.
KPMG LLP, in their independent auditors' report, have expressed "substantial
doubt" as to our ability to continue as a going concern based on significant
operating losses since inception and significant debt and capital deficit as of
September 30, 1998. The consolidated financial statements do not include any
adjustments that might result from the outcome of that uncertainty. Our ability
24
<PAGE>
to continue as a going concern is dependent upon the net proceeds from this
offering. The net proceeds from the offering are estimated to be $ ,
after the repayment of a $19 million secured credit facility with IBM Credit
Corp. and $ million that we expect to owe to IBM under notes outstanding as of
the closing date of the offering. The credit facility will terminate upon
repayment. We believe the net proceeds from the offering, together with other
available cash resources, will be sufficient to meet our cash needs through
September 30, 2000.
Our prospects must be considered in light of our limited operating history
and the risks, expenses and difficulties frequently encountered by companies in
early stages of development, particularly companies in rapidly evolving markets
such as the market for web site building software and services. To achieve and
sustain profitability, we must, among other things:
- increase substantially our revenues from our two principal products,
NetObjects Fusion, which in fiscal year 1998 accounted for most of our
total revenues, and NetObjects Authoring Server, and our professional
services, which have generated minimal revenues to date;
- continue to develop successfully new versions of our products, such as
NetObjects Fusion 4.0, which was released in December 1998;
- continue to be a leading provider of e-business software for building web
sites and corporate intranet sites;
- respond quickly and effectively to competitive, market and technological
developments;
- expand substantially our sales and marketing operations;
- develop our professional services business, which we launched in October
1998;
- control expenses;
- continue to attract, train and retain qualified personnel in the
competitive software industry; and
- maintain existing relationships and establish new relationships with
leading Internet hardware and software companies.
There can be no assurance that we will achieve or sustain profitability, as
more fully discussed in "Risk Factors--We have a history of substantial losses
and expect substantial losses in the future," "--Our auditors have expressed
substantial doubt about our ability to continue as a going concern," and "--Our
ability to continue as a going concern is dependent on the net proceeds of this
offering."
25
<PAGE>
The following table sets forth financial data for the periods indicated as a
percentage of total revenues:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, DECEMBER 31,
-------------------- --------------------
1997 1998 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Software license fees................................ 97.7% 63.5% 91.3% 46.7%
Service revenues..................................... -- -- -- 3.4
Software license fees from IBM....................... 2.3 17.7 8.7 23.4
Service revenues from IBM............................ -- 18.8 -- 26.5
--------- --------- --------- ---------
Total revenues..................................... 100.0 100.0 100.0 100.0
--------- --------- --------- ---------
Cost of revenues:
Software license fees................................ 10.2 16.6 12.2 8.8
Service revenues..................................... -- -- -- 3.3
Service revenues from IBM............................ -- 16.8 -- 25.0
--------- --------- --------- ---------
Total cost of revenues............................. 10.2 33.4 12.2 37.1
--------- --------- --------- ---------
Gross profit........................................... 89.8 66.6 87.8 62.9
--------- --------- --------- ---------
Operating expenses:
Research and development............................. 111.5 67.0 134.4 39.2
Sales and marketing.................................. 160.7 112.0 177.6 78.9
General and administrative........................... 49.7 23.4 33.7 15.9
Stock-based compensation............................. -- 1.5 -- 1.8
--------- --------- --------- ---------
Total operating expenses........................... 321.9 203.9 345.7 135.8
--------- --------- --------- ---------
Operating loss......................................... (232.1) (137.3) (257.9) (72.9)
Interest expense..................................... (3.1) (7.8) (7.3) (12.7)
Nonrecurring interest charge on beneficial conversion
feature of convertible debt........................ -- -- -- (67.5)
Income taxes......................................... -- 0.4 0.3 --
--------- --------- --------- ---------
Net loss............................................... (235.2)% (145.5)% (265.5)% (153.1)%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 1997 AND 1998
REVENUES. Total revenues increased from approximately $2.3 million to
approximately $5.6 million for the three months ended December 31, 1997 and
1998, respectively, primarily because of growing market acceptance of our
products and approximately $1.5 million attributed to our performance of
WebSphere services.
For the three months ended December 31, 1997 and 1998, respectively,
non-North American revenues were 14% and 18% of total revenues, respectively.
The increase in non-North American revenues was due to the expansion of our
indirect sales channel in Europe, services revenues for the first time and OEM
arrangements with internet service providers in Europe in December 1998. We sell
our products in United States dollars in international markets. We do not expect
international sales to continue to grow at the same rate during the balance of
fiscal year 1999. See "Risk Factors--Our international operations are new and
may not be successful."
26
<PAGE>
Revenues from IBM increased from approximately 8.7% to 51% of our total
revenues for the three months ended December 31, 1997 and 1998, respectively.
Our agreement with IBM for WebSphere services ended on February 28, 1999. In
addition, our product bundling arrangement with Lotus for Designer for Domino
expires in June 1999. We believe that all of the IBM deferred revenues, which
were $2.3 million at December 31, 1998, will have been recognized as revenues by
June 30, 1999. We have no commitments from IBM to pay us software license fees
or services revenues after June 1999. Our software license revenues from IBM in
the remaining quarters of fiscal year 1999 are likely to decline, perhaps
substantially, from the level in the first quarter of fiscal year 1999. We do
not expect to receive any services revenues from IBM after February 1999. For a
discussion of the risks associated with the loss of IBM revenues and our ability
to replace those revenues, see "Risk Factors--Our dependence on IBM may present
potential conflicts or otherwise adversely affect our business."
COST OF REVENUES. Our cost of software license fees includes the cost of
product media, duplication, manuals, packaging materials, shipping, technology
licensed to us and fees paid to third-party vendors for order fulfillment, and
was approximately $278,000 and $495,000 for the three months ended December 31,
1997 and 1998, respectively, which represented approximately 13% and 19%,
respectively, of non-IBM software license fees. The increase in percentage terms
arose primarily from the increase in royalties we pay to third parties for
software included in NetObjects Fusion 4.0 that was not included in the version
that we sold in the three months ended December 31, 1997. Our cost of services
consists of personnel costs and related overhead as well as fees paid to third
parties who assist us in providing services to our customers. Our cost of IBM
services revenues consists solely of personnel costs and related overhead for
the services provided.
Gross margins may be affected by the mix of distribution channels we use,
the mix of products sold, the mix of product revenues versus services revenues
and the mix of international versus domestic revenues. We typically realize
higher gross margins on direct channel sales relative to indirect channels and
higher gross margins on domestic indirect channel sales relative to
international indirect sales. If sales through indirect channels increase as a
percentage of total revenues, or if, as we anticipate, services revenues
increase as a percentage of total revenues, our gross margins will be adversely
affected.
RESEARCH AND DEVELOPMENT. Our research and development expenses consist
primarily of salaries and consulting fees to support product development. To
date, we have expensed all research and development costs as we have incurred
them because we generally establish the technological feasibility of our
products upon completion of a working model. We have not yet incurred
significant costs between the date of completion of a working model and the date
of general release of a product. We believe that continued investment in
research and development is critical to attaining our strategic objectives and,
as a result, we expect research and development expenses to continue to
increase. Research and development expenses were approximately $3.1 million and
$2.2 million for the three months ended December 31, 1997 and 1998,
respectively, and 134% and 39%, respectively, of total revenues. The decrease in
total dollars and in percentage terms in the three months ended December 31,
1998 occurred primarily because much of our personnel were redirected towards
integrating our software with IBM's WebSphere software products. The associated
expenses are reflected in our cost of IBM revenues from services instead.
SALES AND MARKETING. Our sales and marketing expenses consist primarily of
salaries, commissions, consulting fees, trade show expenses, advertising,
marketing materials and the cost of customer service operations. We intend to
continue to increase staff in our enterprise sales organization and decrease our
aggressive brand building and marketing campaign and, therefore, expect sales
and marketing expenses to continue to increase. Sales and marketing expenses
were approximately
27
<PAGE>
$4.1 million and $4.4 million for the three months ended December 31, 1997 and
1998, respectively, representing 178% and 79%, respectively, of total revenues.
The increase resulted primarily from the growth in our sales personnel,
increased sales commissions and costs related to the continued development and
implementation of our branding and marketing campaigns. As our total revenues
grew at a faster rate than expenses, our sales and marketing expenses decreased
as a percentage of total revenues for the three months ended December 31, 1998.
GENERAL AND ADMINISTRATIVE. Our general and administrative expenses consist
primarily of salaries and fees for professional services. We expect general and
administrative expenses to increase as we expand our staff, incur additional
costs related to growth of our business and become a publicly traded company.
General and administrative expenses were approximately $769,000 and $894,000 for
the three months ended December 31, 1997 and 1998, respectively, representing
approximately 34% and 16%, respectively, of total revenues. The increased amount
resulted primarily from additional personnel and facility expenses related to
our growth, while the decrease in percentage terms occurred because total
revenues grew at a faster rate than general and administrative expenses.
STOCK-BASED COMPENSATION. Beginning with the three months ended March 31,
1998 we have been amortizing aggregate stock-based compensation of $768,000
attributable to the grant of stock options over the 48-month period in which the
options vest in a manner consistent with Financial Accounting Standards Board
(FASB) Interpretation No. 28. Of the total deferred stock-based compensation
expense, approximately $100,000 was amortized during the three months ended
December 31, 1998.
INTEREST EXPENSE. Our interest expense consists primarily of interest on
our borrowings and amounted to approximately $168,000 and $712,000 for the three
months ended December 31, 1997 and 1998, respectively. The increase was due
primarily to the increase in borrowing over the period. In connection with the
in-the-money convertible notes we issued to IBM and another existing investor
that convert to Series E-2 preferred stock at $6.68 per share we recorded $3.8
million of interest expense in accordance with EITF Topic D-60 in the three
months ended December 31, 1998. In connection with the revolving loan and
security agreement with IBM Credit Corp., in December 1997 we issued warrants to
purchase 83,333 shares of Series F preferred stock at $10.80 per share. In
addition, in connection with the convertible notes we issued warrants to
purchase 163,715 shares of Series E preferred stock at $6.68 per share. The
Series E and Series F preferred stock warrants were valued based upon the
Black-Scholes pricing model which resulted in approximately $191,000 of
additional interest expense in the three month period ended December 31, 1998.
INCOME TAXES. We had a net operating loss for each period from our
inception through December 31, 1998. We recorded income tax expense due to
withholding tax on payments made by Mitsubishi, our exclusive master distributor
of our products in Japan.
YEARS ENDED SEPTEMBER 30, 1997 AND 1998
REVENUES. Our total revenues increased from approximately $7.6 million to
$15.3 million for the fiscal years ended September 30, 1997 and 1998,
respectively. The increase was due primarily to growing market acceptance of our
products and $2.9 million of WebSphere services revenues. None of the increase
was due to increase in product price, although we introduced NetObjects
TeamFusion in 1998, which had a higher sales price than our previous products.
Most of the increase was due to increased sales volume of NetObjects Fusion. In
August 1997, we reduced the price of NetObjects Fusion from a suggested retail
price of $495 to $295, and provided credits for unsold inventory to many of our
distributors and other resellers, thereby reducing revenues from software
license fees for the three months ended September 30, 1997 to a lower amount
than in the preceding quarter.
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<PAGE>
Our non-North American revenues were approximately 15% and 16% of total
revenues for the fiscal years ended September 30, 1997 and 1998, respectively.
The increase in non-North American revenues was due in part to the expansion of
the indirect sales channel in Europe as well as the initiation of our master
distributor agreement with Mitsubishi, which also invested in us in November
1998, to manufacture and sell our products in Japan.
Our revenues from IBM were approximately 2% and 36% of total revenues for
the fiscal years ended September 30, 1997 and 1998, respectively. The increased
revenues from IBM were generated primarily from our product bundles with Lotus
Designer for Domino and our provision of WebSphere services beginning in March
1998.
COST OF REVENUES. Our cost of software license fees was approximately
$772,000 and $2.5 million for the fiscal years ended September 30, 1997 and
1998, respectively, representing approximately 10% and 26%, respectively, of
total revenues from sources other than IBM. Approximately $800,000 of the
increase can be attributed to a doubling of units shipped in 1998 over 1997. In
addition, royalty costs grew by approximately $300,000 due to our increased
bundling of third party components and products within NetObjects Fusion and
NetObjects TeamFusion. Finally, approximately $400,000 of the increase was due
to write-offs of product inventory made obsolete by new product releases. Cost
of IBM service revenues consists solely of the costs of providing WebSphere
services.
RESEARCH AND DEVELOPMENT. Our research and development expenses were
approximately $8.4 million and $10.2 million for the fiscal years ended
September 30, 1997 and 1998, respectively, and 111% and 67%, respectively, of
total revenues. The increase in fiscal 1998 resulted primarily from increases in
internal development personnel and independent contractor expenses. The decrease
in percentage terms occurred as revenues grew at a faster rate than expenses.
SALES AND MARKETING. Our sales and marketing expenses were approximately
$12.2 million and $17.1 million for the fiscal years ended September 30, 1997
and 1998, respectively, representing approximately 161% and 112%, respectively,
of total revenues. Approximately $2.9 million of the increase resulted from
salary and associated overhead expense increases for additional personnel. The
remaining $2.1 million is related to additional spending in marketing
communications to increase market awareness of the NetObjects brand and
products. The decrease in percentage terms occurred as revenues grew at a faster
rate than expenses.
GENERAL AND ADMINISTRATIVE. Our general and administrative expenses were
approximately $3.8 million and $3.6 million for the fiscal years ended September
30, 1997 and 1998, respectively, representing approximately 50% and 23%,
respectively, of total revenues. Costs of approximately $300,000 in professional
fees incurred in connection with IBM's acquisition of approximately 80% of our
stock are included in general and administrative expenses in fiscal 1997. The
decrease in percentage terms occurred as revenues grew at a faster rate than
expenses.
STOCK-BASED COMPENSATION. We amortized approximately $227,000 of the total
deferred stock-based compensation in fiscal year 1998.
INTEREST EXPENSE. Our interest expense consisted primarily of interest on
our borrowings and increased from approximately $234,000 to $1.2 million for the
fiscal years ended September 30, 1997 and 1998, respectively, as we increased
our borrowings during fiscal year 1998. Fiscal year 1998 interest expense
included $201,000 for the Series F preferred stock warrants issued to IBM Credit
Corp.
PERIOD FROM NOVEMBER 21, 1995 (INCEPTION) THROUGH SEPTEMBER 30, 1996
During the period from November 21, 1995 (inception) through September 30,
1996, our operating activities related primarily to recruiting personnel,
raising capital, purchasing operating assets, conducting research and
development, building the NetObjects brand and establishing the market for our
products. We recognized no revenue and incurred operating expenses of $6.7
million during the period. Accordingly, a comparison of the operating results
for that period with the operating results for fiscal year 1997 is not
meaningful and has been omitted.
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<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited quarterly results of
operations data for the eight quarters ended December 31, 1998. We believe that
this information has been prepared substantially on the same basis as the
audited consolidated financial statements appearing elsewhere in this
prospectus, and all necessary adjustments, consisting only of normal recurring
adjustments, have been included in the amounts stated below to present fairly
the unaudited quarterly results of operations. The quarterly data should be read
in conjunction with our audited consolidated financial statements and notes to
consolidated financial statements appearing elsewhere in this prospectus. The
operating results for any quarter are not necessarily indicative of the
operating results for any future period:
<TABLE>
<CAPTION>
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30,
1997 1997 1997 1997 1998 1998 1998
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Software license fees............... $ 2,115 $ 2,332 $ 1,721 $ 2,086 $ 2,485 $ 2,524 $ 2,608
Service revenues.................... -- -- -- -- -- -- --
Software license fees from IBM...... -- 75 100 199 1,016 1,069 416
Service revenues from IBM........... -- -- -- -- 206 1,225 1,436
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total revenues.................... 2,115 2,407 1,821 2,285 3,707 4,818 4,460
----------- ----------- ----------- ----------- ----------- ----------- -----------
Cost of revenues:
Software license fees............... 143 240 305 278 704 840 709
Service revenues.................... -- -- -- -- -- -- --
IBM service revenues................ -- -- -- -- 184 1,095 1,284
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total cost of revenues............ 143 240 305 278 888 1,935 1,993
----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross profit.......................... 1,972 2,167 1,516 2,007 2,819 2,883 2,468
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating expenses:
Research and development............ 1,671 2,500 2,711 3,070 2,785 2,175 2,201
Sales and marketing................. 1,888 3,833 4,454 4,060 4,353 4,444 4,257
General and administrative.......... 1,016 1,180 926 769 977 878 951
Stock-based compensation............ -- -- -- -- 53 74 100
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses.......... 4,575 7,513 8,091 7.899 8,168 7,571 7,509
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating loss........................ (2,603) (5,346) (6,575) (5,892) (5,349) (4,688) (5,041)
Net other expense................... 75 37 53 175 303 335 441
Nonrecurring interest charge on
beneficial conversion feature of
convertible debt.................. -- -- -- -- -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss.............................. $ (2,678) $ (5,383) $ (6,628) $ (6,067) $ (5,652) $ (5,023) $ (5,482)
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
Revenues:
Software license fees............... 100.0% 96.9% 94.5% 91.3% 67.4% 52.4% 58.5%
Service revenues.................... -- -- -- -- -- -- --
Software license fees from IBM...... -- 3.1 5.5 8.7 27.4 22.2 9.3
Service revenues from IBM........... -- -- -- -- 5.6 25.4 32.2
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total revenues.................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0
----------- ----------- ----------- ----------- ----------- ----------- -----------
Cost of revenues:
Software license fees............... 6.8 10.0 16.7 12.2 19.0 17.5 15.9
Service revenues.................... -- -- -- -- -- -- --
Service revenues from IBM........... -- -- -- -- 5.0 22.7 28.8
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total cost of revenues............ 6.8 10.0 16.7 12.2 24.0 40.2 44.7
----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross profit.......................... 93.2 90.0 83.3 87.8 76.0 59.8 55.3
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating expenses:
Research and development............ 79.0 103.9 148.9 134.3 75.1 45.1 49.4
Sales and marketing................. 89.3 159.2 244.6 177.7 117.4 92.2 95.4
General and administrative.......... 48.0 49.0 50.8 33.7 26.4 18.2 21.3
Stock-based compensation............ -- -- -- -- 1.4 1.6 2.2
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses.......... 216.3 312.1 444.3 345.7 220.3 157.1 168.3
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating loss........................ (123.1) (222.1) (361.0) (257.9) (144.3) (97.3) (113.0)
Net other expense................... 3.5 1.5 2.9 7.6 8.2 7.0 9.9
Nonrecurring interest charge on
beneficial conversion feature of
convertible debt.................. -- -- -- -- -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss.............................. (126.6)% (223.6)% (363.9)% (265.5)% (152.5)% (104.3)% (122.9)%
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
<CAPTION>
DEC. 31,
1998
-----------
<S> <C>
Revenues:
Software license fees............... $ 2,622
Service revenues.................... 190
Software license fees from IBM...... 1,318
Service revenues from IBM........... 1,487
-----------
Total revenues.................... 5,617
-----------
Cost of revenues:
Software license fees............... 495
Service revenues.................... 184
IBM service revenues................ 1,404
-----------
Total cost of revenues............ 2,083
-----------
Gross profit.......................... 3,534
-----------
Operating expenses:
Research and development............ 2,204
Sales and marketing................. 4,430
General and administrative.......... 894
Stock-based compensation............ 100
-----------
Total operating expenses.......... 7,628
-----------
Operating loss........................ (4,094)
Net other expense................... 714
Nonrecurring interest charge on
beneficial conversion feature of
convertible debt.................. 3,792
-----------
Net loss.............................. $ (8,600)
-----------
-----------
Revenues:
Software license fees............... 46.7%
Service revenues.................... 3.4
Software license fees from IBM...... 23.4
Service revenues from IBM........... 26.5
-----------
Total revenues.................... 100.0
-----------
Cost of revenues:
Software license fees............... 8.8
Service revenues.................... 3.3
Service revenues from IBM........... 25.0
-----------
Total cost of revenues............ 37.1
-----------
Gross profit.......................... 62.9
-----------
Operating expenses:
Research and development............ 39.2
Sales and marketing................. 78.9
General and administrative.......... 15.9
Stock-based compensation............ 1.8
-----------
Total operating expenses.......... 135.8
-----------
Operating loss........................ (72.9)
Net other expense................... 12.7
Nonrecurring interest charge on
beneficial conversion feature of
convertible debt.................. 67.5
-----------
Net loss.............................. (153.1)%
-----------
-----------
</TABLE>
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<PAGE>
Our total revenues fluctuate from quarter-to-quarter due to many factors,
including new product and product upgrade introductions. In addition, we attempt
to limit sales of existing products during the months preceding the release of
upgraded products in order to reduce returns of the older product from some of
our direct and indirect channel resellers. The timing of our recognition of
revenues from strategic arrangements with other companies such as AT&T, IBM or
Netscape has contributed to fluctuations in revenues from quarter to quarter.
During the three months ended September 30, 1997, we reduced the suggested
retail price of NebObjects Fusion from $495 to $295, and provided price
protection credits to our indirect channel distributors for unsold inventory.
Consequently, our total revenues for the quarter declined substantially as a
percentage of the preceding quarter's revenues. While unit volumes increased in
quarters subsequent to the price reduction, the price reduction reduced total
revenue growth in subsequent quarters. For a discussion of IBM revenues in the
remaining quarters of 1999, see "Risk Factors--Our dependence on IBM may present
potential conflicts or otherwise adversely affect our business."
FACTORS AFFECTING OPERATING RESULTS. As a result of our limited operating
history and the emerging nature of the markets in which we compete, we are
unable to forecast accurately our revenues. The success of our business and our
revenue growth to date have depended on our ability to create web site building
software that appeals to our customers, to update our main product, NetObjects
Fusion, with new features and to release and deliver new versions of NetObjects
Fusion on time. We need to develop new products in addition to NetObjects Fusion
and NetObjects Authoring Server and to ship the new products on time. Failure to
do so will materially affect the amount and timing of future revenues.
Furthermore, the $10.5 million of cash prepayments under our license agreement
with IBM have provided some revenue certainty for us since April 1997. We expect
to have recognized all of the prepayments as revenues by June 30, 1999. After
that date, our revenues from IBM, if any, are likely to become more variable.
Our expense levels are based in part on our expectations with regard to
future revenues. We may be unable to adjust spending in a timely manner to
compensate for any unexpected revenues shortfall. As a result, any significant
shortfall in demand for our products and services relative to our expectations
would harm our business and cause our revenues to decrease. Further, as a
strategic response to changes in the competitive environment, we may from time
to time implement pricing, service or marketing changes that could have a
material adverse effect on our business, prospects, financial condition and
results of operations. See "Risk Factors--Our ability to generate future
revenues is uncertain and our quarterly operating results will probably
fluctuate," and "Business-- Competition."
We expect to experience significant fluctuations in our future quarterly
operating results due to a variety of factors, many of which are outside our
control, including
- the expiration of commitments from IBM for software license fees in June
1999 and service revenues in February 1999;
- the timing of the introduction or enhancement of our products and services
and market acceptance of those products and services;
- a longer sales cycle for products for large enterprise customers and for
NetObjects Authoring Server;
- competitors' introductions of other types of software products, for
example, Microsoft's introduction of Windows 98 adversely impacted our
sales temporarily;
- the amount and timing of operating costs and capital expenditures related
to expansion of our business, operations and infrastructure;
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<PAGE>
- price reductions by us or our competitors or changes in how their products
and services are priced;
- the mix of distribution channels through which our products are licensed
and sold; and
- the promptness with which sales data are reported to us from third
parties.
In addition to fluctuations of revenues from IBM, our revenues may become
more variable due to factors such as seasonal demand for our products and
services, for example, annual reductions in sales in Europe in July and August,
costs of litigation and intellectual property protection, technical difficulties
with respect to the use of our products, general economic conditions and
economic conditions specifically related to businesses dependent upon the
Internet. The promptness with which sales data, used in recognizing product
royalties, is delivered to us from third parties also may affect quarterly
operating results. It often is difficult to forecast the effect these factors,
or any combination thereof, would have on our results of operations for any
given fiscal quarter. We have used, and expect to continue to use, price
promotions to increase the trial, purchase and use of our products, as well as
to increase the overall recognition of our brands. The effect of these
promotions on revenues in a particular period may be significant and extremely
difficult to forecast. Quarterly sales and operating results depend primarily on
the volume and timing of orders received in the quarter, both of which are
difficult to forecast. We typically recognize a substantial portion of our
revenues in the last month of each quarter. Based on the foregoing, we believe
that our quarterly revenues, expenses and operating results could vary
significantly in the future, and that period-to-period comparisons should not be
relied upon as indications of future performance.
We generally distribute our software products in "trial" form to the public
electronically from our web site. The "trial" version generally allows the
customer to use the product but either has an expiration period, in which case
the product is automatically deleted from a hard drive, or prohibits the site
from being published. These features may cause some customers to delay
purchasing decisions until they have thoroughly tested the product, or they may
be able to override the "trial" features and use the product in an unlicensed
manner, which could harm our business and cause our stock price to fall.
Due to the factors noted above, it is likely that in some future quarters
our operating results will fall below the expectations of securities analysts
and investors, which would harm our business and cause our stock price to fall.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through a
combination of private placements of equity securities and borrowings, which
yielded an aggregate of $47.3 million of net proceeds from November 1995 through
December 31, 1998. Since December 1997, approximately $7.5 million and $19
million of this financing have been provided by IBM and IBM Credit Corp.,
respectively, in the form of a secured credit facility. In addition, we have
received cash prepayments from IBM of approximately $10.5 million which are
recorded as deferred revenues from IBM on our balance sheet. We have paid
interest to IBM on the amounts of prepayments that we received in advance of the
scheduled prepayment period set forth in our license agreement with IBM. All of
this interest expense ceased at December 31, 1998. Our credit facility with IBM
will be repaid out of the proceeds of this offering and the credit facility will
terminate.
We will not receive additional cash on sales of our products by IBM or for
services that we provide to IBM until the balance of the deferred revenues from
IBM has been reduced to zero. At December 31, 1998 approximately $2.3 million of
the cash prepayments provided by IBM had not been recognized and were reflected
as deferred revenue from IBM on our balance sheet.
32
<PAGE>
We also have established equipment lease lines under which we may finance
the purchase up to approximately $2.7 million in furniture, computer equipment
and software, approximately $720,000 of which is provided by IBM Credit Corp.
The lease terms range from three to five years. At December 31, 1998
approximately $200,000 was available under these lease lines.
Net cash used in operating activities in the period from November 21, 1995
(inception) to December 31, 1996 and for the years ended September 30, 1997 and
1998 was $4.8 million, $10.8 million and $19.0 million, respectively, and $8.2
million in the three months ended December 31, 1998. Net cash used for operating
activities in each of these periods resulted primarily from our net losses,
offset in part by increases in our accounts payable, accrued expenses and
non-cash expenses.
Net cash used in investing activities in the period from November 21, 1995
(inception) to December 31, 1996 and for the years ended September 30, 1997 and
1998 was $551,000, $1.0 million and $792,000, respectively, and $703,000 in the
three months ended December 31, 1998. Net cash used in investing activities in
each of these periods was related to the purchases of property and equipment.
The property and equipment purchased consisted primarily of computer hardware
and software.
Net cash provided by financing activities in the period from November 21,
1995 (inception) to December 31, 1996 and for the years ended September 30, 1997
and 1998 was $6.5 million, $11.0 million and $20.0 million, respectively, and
$9.8 million in the three months ended December 31, 1998. The cash provided by
financing activities was the result of net proceeds from borrowings and the sale
of our preferred stock and common stock.
As of December 31, 1998, we had approximately $1.3 million in cash. Other
than the $19 million of short-term borrowings from IBM, our principal
commitments consisted of obligations outstanding under operating leases.
Although we have no material commitments for capital expenditures, they may
increase consistent with our anticipated growth in operations, infrastructure
and personnel. We will continue to add computer hardware resources. There can be
no assurance, however, that our growth rate will continue at current levels or
that it will meet our current expectations.
In October 1998, we issued units consisting of convertible notes and
warrants to IBM and Perseus Capital L.L.C., a private equity fund in which
several of our directors are investors, for a total of $10.9 million. Prior to
closing of this offering, the convertible notes will be converted into shares of
Series E-2 preferred stock, which converts to common stock automatically at the
closing of this offering. The notes bear interest at 10% per annum. By December
31, 1998, we had received $8.3 million of the $10.9 million amount. We received
the remaining $2.6 million in January 1999. In October and November 1998, we
sold 388,888 shares of Series F-2 preferred stock for a total of $3.5 million.
Prior to the closing of this offering we have the right to sell up to $3.45
million of notes and warrants to IBM to continue to finance our operations. We
expect to incur substantially all of this additional debt and expect IBM to
exercise its right to require the repayment of the additional convertible notes
in full upon the closing of this offering.
After the offering, we anticipate moderate growth in our operating expenses
for the foreseeable future to execute our business plan, particularly in sales
and marketing expenses and to a lesser extent research and development and
general and administrative expenses. As a result, we expect our operating
expenses, as well as planned capital expenditures, to continue to constitute a
material use of our cash resources. In addition, we may require cash resources
to fund acquisitions or investments in complementary businesses, technologies or
product lines. We believe that the net proceeds from the offering, together with
our current cash and cash equivalents, will be sufficient to meet our
anticipated cash requirements for working capital and capital expenditures
through September 30, 2000. Thereafter, if cash generated from operations is
insufficient to satisfy our liquidity
33
<PAGE>
requirements, we may seek to sell additional equity or debt securities, or
obtain additional credit facilities. We currently have no plans, other than this
offering, to remedy our deficiency in liquidity. For a discussion of our
liquidity problems, see "Risk Factors--We have a history of substantial losses
and expect substantial losses in the future," "--Our auditors have expressed
substantial doubt about our ability to continue as a going concern," "--Our
ability to continue as a going concern is dependent on the net proceeds of this
offering" and "--A substantial portion of the net offering proceeds will be used
to repay debt and not to implement our business model."
YEAR 2000 READINESS
Many existing software programs are coded to accept only two digit entries
in their date fields. As a result, these programs are unable to distinguish
whether "00" means the year 1900 or the year 2000, which could result in system
failures or miscalculations causing disruptions to operations. Although we
believe that our products are Year 2000 ready, because NetObjects Fusion and
NetObjects Authoring Server may interact with external databases for purposes of
data storage, the ability of applications integrated with a web site built using
NetObjects Fusion or NetObjects Authoring Server to comply with Year 2000
requirements is largely dependent on whether any databases underlying the
application are Year 2000 ready. If NetObjects Fusion or NetObjects Authoring
Server is connected to a database that is not Year 2000 ready, a web application
created or developed for a web site built using NetObjects Fusion or NetObjects
Authoring Server could work incorrectly and could result in unanticipated
expenses to address problems or claims raised by customers that we cannot
presently foresee. Furthermore, the purchasing patterns of customers or
potential customers may be affected by Year 2000 issues as businesses expend
significant resources to correct their current systems for Year 2000 readiness.
STATE OF READINESS. Our assessment plans consist of the following:
- quality assurance testing of NetObjects Fusion, NetObjects Authoring
Server and NetObjects ScriptBuilder;
- contacting third-party vendors of software that we have purchased for our
internal financial systems, and other third-party service providers of
telecommunications, internet services, utilities and other services and
supplies;
- contacting providers of material non-information technology systems;
- assessment of repair or replacement requirements;
- repair or replacement;
- implementation; and
- creation of contingency plans in the event of Year 2000 failures.
COSTS. To date, we have not incurred significant costs in identifying or
evaluating Year 2000 compliance issues. Most of our expenses have related to,
and are expected to continue to relate to, the indirect operating costs
associated with time spent by employees in the evaluation process and Year 2000
compliance matters generally. At this time, we do not possess the information
necessary to estimate the potential costs of the replacement of third-party
software or hardware that are determined not to be Year 2000 compliant. Although
we do not anticipate that these expenses will be material, these expenses, if
higher than anticipated, could harm our business and cause our revenues to
decrease and our stock price to fall.
RISKS. We are not currently aware of any significant Year 2000 compliance
problems relating to our software for our product offerings or our information
technology or non-information technology systems that would have a material and
adverse effect on our business or results of operations,
34
<PAGE>
without taking into account our efforts to avoid or fix these problems. There
can be no assurance that we will not discover Year 2000 compliance problems in
our software for our product offerings that will require substantial revisions
or replacements. In addition, there can be no assurance that third-party
software, hardware or services incorporated into our material information
technology and non-information technology systems will not need to be revised or
replaced, which could be time-consuming and expensive. Our inability to fix our
software for our product offerings or to fix or replace third-party software or
hardware on a timely basis could result in lost revenues, increased operating
costs and other business interruptions, any of which could harm our business,
cause our revenues to decrease and our stock price to fall.
CONTINGENCY PLAN. As discussed above, we are engaged in an ongoing Year
2000 assessment and have not developed any contingency plans.
REASONABLY LIKELY WORST CAST SCENARIO. At this stage in our analysis, it is
difficult to specifically identify the cause, and the magnitude, of the most
reasonably likely worst case Year 2000 scenario. Such reasonably likely worst
case scenario would include the failure of our products to operate properly,
causing customers' systems and/or operations to fail or be disrupted. Our
inability to correct a significant Year 2000 problem, if one develops, could
result in an interruption in, or a failure of, certain of our normal business
activities or operations. In addition, a significant Year 2000 problem
concerning NetObjects Fusion, NetObjects Authoring Server or NetObjects
ScriptBuilder could cause our customers to seek alternate providers of web site
building software or services. Any material Year 2000 problem could require us
to incur significant unanticipated expenses to remedy and could divert our
management's time and attention, either of which could harm our business, cause
our revenues to decrease and our stock price to fall.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income.
This statement establishes standards for the reporting and display of
comprehensive income and its components. SFAS No. 130 is effective beginning in
1998. Adoption of SFAS No. 130 is for presentation only and did not affect our
financial condition or results of operations.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. The new standard establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. SFAS No.
133 is effective for all fiscal quarters of fiscal years beginning after June
15, 1999. We do not expect SFAS No. 133 to have a material effect on our
financial condition or results of operations.
In February 1998, the AcSEC issued SOP 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. SOP 98-1 establishes
the accounting for costs of software products developed or purchased for
internal use, including when these costs should be capitalized. We do not expect
SOP 98-1, which is effective for us beginning January 1, 1999, to have a
material effect on our financial condition or results of operations.
35
<PAGE>
BUSINESS
OUR COMPANY
We are a leading provider of e-business software and solutions that enable
small businesses and large enterprises to build, deploy and maintain web sites
on the Internet and corporate intranets. Our e-business solutions address the
growing challenges faced by businesses in capturing the explosive growth of the
Internet as an online business medium. Our products are used to build web sites
that can publish content, conduct e-commerce and run web applications. In 1996,
we pioneered the web site building product category with the introduction of our
award-winning flagship product, NetObjects Fusion. NetObjects Fusion is an
easy-to-use desktop software application for building business web sites with an
intuitive, visual interface that helps automate and integrates many site
building functions. NetObjects Fusion supports a wide range of web browsers,
database software and web servers. Since 1996, we have released enhanced
versions of NetObjects Fusion. We have introduced other products, including
NetObjects Authoring Server, a client-server application for large enterprises
and corporate departments. We have also built popular online resources,
including NetObjects.com, eFuse.com, launched in December 1998, eScriptZone.com
and eSiteStore.com, that target communities of business users and provide
sources of information, products and services for building web sites. In
addition, in October 1998, we began offering professional services to our
business customers to better serve their web site planning, building and
maintenance needs.
As part of our strategy to provide complete e-business solutions, we have
formed technology relationships with other Internet companies. Many of these
companies have written software to extend their products to integrate with
NetObjects Fusion and NetObjects Authoring Server, such as Allaire Cold Fusion,
iCat Commerce Online, Lotus Domino, Beatnik audio software and IBM HotMedia. In
addition, we have built extensions for the Microsoft ASP Site Server. These
extensions provide us with broader platform connectivity and interoperability.
We offer online solutions with key online service providers such as web site
hosters and banner exchange providers. We also have product bundling agreements
with leading software companies, such as IBM, Lotus and Novell, that help create
greater brand recognition and awareness. In addition, our strategic relationship
with IBM has furnished us with sales and marketing benefits, including access to
IBM and Lotus sales and distribution channels, co-marketing and co-promotion
benefits, and credibility in the marketplace.
We have established a premier Internet brand and estimate that over 300,000
copies of NetObjects Fusion have been delivered to date, and more than 1,000,000
web pages or sites have been built using NetObjects Fusion. Traffic to our web
sites has grown from approximately 800,000 visitors in 1996 to approximately 2.5
million visitors in 1998. New visitors provided approximately half of the
traffic to our web sites in 1998. We think the increasing number of visitors to
our web sites reflects the broad distribution of our products and the growing
strength of our brand.
INDUSTRY OVERVIEW
GROWTH OF THE WEB
In fewer than five years, the web has emerged as a universal, rapidly
growing online business medium enabling millions of users worldwide to share
information, conduct e-commerce and access business applications. According to
International Data Corp., the number of web users worldwide will grow from an
estimated 142 million at the end of 1998 to an estimated 399 million by the end
of 2002. IDC estimates that worldwide Internet commerce will increase from an
estimated $50 billion at the end of 1998 to an estimated $734 billion by the end
of 2002. The explosive growth of the web as an online business medium has been
fueled by a number of factors, including an increased awareness by businesses of
the revenue, cost and performance benefits from using the web to conduct
business, and the large and growing number of web users.
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In addition, we believe the cycle of growth will accelerate as an increasing
number of web users attracts more businesses to build or enhance their online
web sites, which in turn attracts more users. IDC reported that the number of
web site addresses, or URL's, will grow from 300 million in 1997 at a compound
annual growth rate of approximately 60% to 3.2 million in 2000.
As developing or enhancing a web presence becomes increasingly important to
businesses, business web sites are becoming more complex. As the web's
importance has grown, businesses have applied advances in Internet technology to
convert business web sites from static "billboards" to sophisticated e-business
web sites where businesses can interact and transact with customers, employees,
suppliers and distributors. E-business sites may contain hundreds of pages,
embed audio and video content and provide access to data, or "e-publishing",
provide online commerce, or "e-commerce" capabilities, and run web applications,
or "e-applications" such as interactive forms. E-business web sites are rapidly
becoming a strategic necessity for many companies as they discover how
conducting business online can enhance revenues, reduce costs and improve
performance.
GROWTH OF CORPORATE INTRANETS
The growth of the web as a global communications medium is also driving
large-scale corporate enterprises to enhance communication, collaboration and
productivity by building corporate intranets consisting of numerous internal web
sites. These intranets bring together corporate information and applications
that facilitate communication and information sharing within an organization.
Intranets can also streamline business processes such as customer service, sales
and marketing and human resources, thereby reducing costs or improving
performance through automation or self-service. According to a recent report,
Zona Research estimates that two-thirds of intranet sites are being developed
through team-based web site building, and corporate intranets represent the
greatest business opportunity for providers of Internet and intranet-related
software technologies and products.
THE BUSINESS WEB SITE OPPORTUNITY
Although it has become relatively easy to access the web, it can be
difficult and expensive to build an effective web presence. The challenges of
building a successful Internet or intranet web site require solutions that
address planning, design, building and deployment, as well as web site promotion
and maintenance after the web site is placed online. Companies are often also
faced with a difficult "make or buy" decision, either to build a web site by
using in-house resources or third-party service providers, or to develop a web
site with available "off-the-shelf" applications. Key factors influencing their
choice of solutions include ease and flexibility of building, construction time
and cost and the cost and flexibility of later maintaining and enhancing their
web site. In addition, the web utilizes multiple standards and platforms,
including different web browsers, databases and web servers, which increase the
complexity of building a site that operates in multiple environments.
The first generation of web site building products was technically difficult
to use and generally required the programming expertise of a limited number of
highly skilled users such as HTML programmers or highly skilled designers. The
second generation of products, and online services that facilitated web site
building, targeted consumers with personal "home page" building tools and casual
desktop users with the ability to publish simple, static information. Although
third-party service providers and in-house programmers can provide technical
coding, these resources can be expensive and may not provide the flexibility
required to develop and maintain dynamic, evolving web sites. In addition,
third-party and in-house solutions often have excluded key business users from
the web site building and maintenance process, rather than enabling a truly
collaborative site building development process which includes content
contributions from users.
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We believe that the majority of small businesses have not strategically
embraced the Internet. We believe those that have a web presence often need to
enhance their web sites with new functionality such as e-commerce or
e-applications, or otherwise improve their web site features and promotion.
Businesses with more sophisticated web site requirements, but without access to
programmers, require an easy-to-use, capability-rich and open solution. In-house
programmers or third-party service providers can address technical design and
programming requirements, but often at a higher cost than a packaged application
and with less flexibility in building and maintaining their web sites. In
addition, large enterprises have a variety of departments and need solutions
that allow effective collaboration in developing, deploying and maintaining
their intranet web sites.
THE NETOBJECTS SOLUTION
We provide e-business software and services that enable small businesses, as
well as large enterprises, to build, deploy and maintain web sites on the
Internet and corporate intranets. We believe our e-business solutions help
businesses build web sites to publish content, conduct e-commerce and run
e-applications on the web. Our solutions include products and online services
for small businesses, and products and professional services for large
enterprises and departments, that use collaborating teams to build web sites.
Small businesses require easy-to-use solutions that enable them to build or
enhance their web sites quickly and efficiently, add key functions such as
e-commerce or web applications and work with a variety of industry standards and
platforms. Our award-winning application, NetObjects Fusion, is designed
specifically to address these needs. NetObjects Fusion has an intuitive, visual
interface that integrates and helps automate many site creation functions,
including site layout and design, page building and content management.
In addition, we offer small businesses online solutions to help them
register, host through third parties, build, maintain and promote their web
sites. eFuse.com is the first online resource to provide integrated content,
products and solutions for small businesses. eScriptZone.com is an online
resource that provides articles, tutorials, software and an online community of
forums and newsgroups for webmasters and corporate web applications builders.
eSiteStore.com is our online retail store that provides a one-stop shopping
destination for businesses to purchase our software, third-party software and
also offers online services to customers.
Large-scale corporate enterprises and departments require reliable and
secure solutions that enable them to design, develop, deploy and manage their
complex Internet and intranet web sites. They also need products that will
operate across disparate corporate systems and platforms in order to leverage
existing legacy systems, databases and content. In addition, teams that develop
corporate intranet sites have requirements distinctly different from those of
individuals who develop external Internet sites. They need a client-server
product for web site building that supports creativity and collaboration, while
allowing an administrator to assert control over the site building process. Our
award-winning NetObjects Authoring Server addresses these large-scale corporate
needs. In addition, software components that provide integration with products
from other technology companies, including Allaire, IBM, Lotus, Microsoft and
Netscape, provide additional web applications, database publishing and
e-commerce capabilities for the NetObjects Authoring Server. In response to
customer demand, in October 1998 we formed our Professional Services Group,
which provides training, consulting and implementation services to large
enterprises to help design, build, deploy and maintain their web sites, and
integrate their web sites with existing corporate applications. We provide these
services through our own professional services organization and through
relationships with third-party service providers.
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NETOBJECTS STRATEGY
Our strategy is to establish ourselves as a complete e-business solutions
provider by leveraging our position as a leading provider and brand of web site
building software. As more companies seek solutions for capturing the explosive
growth of the web as an online business medium, we believe our e-business
software and resources serve as ideal starting points. NetObjects Fusion,
NetObjects Authoring Server and our online resources position us to aggregate
broader solutions, including web site hosting by third parties, software and
components, site content, e-commerce using third-party transactional software
and other web applications and services. Key elements of our strategy include:
BRAND RECOGNITION AND BROAD CUSTOMER BASE. As a pioneer of the web site
building product category, and as the recipient of several industry awards, we
believe that we have established a premier Internet brand in the market for web
site building products and services. We estimate that over 300,000 copies of
NetObjects Fusion have been delivered to date, and more than 1,000,000 web pages
or sites have been built using NetObjects Fusion. Our customer base and the
active online communities of builders who use our products help sustain and
promote our brand by participating in our web site forums and bulletin boards
and by providing feedback on pre-release versions of our software. Over 60,000
links exist from other web sites to NetObjects.com, including the web sites of
complementary products and services providers. In addition, over 500 businesses
worldwide have deployed NetObjects Authoring Server, or its predecessor
NetObjects TeamFusion. Our strong brand recognition and growing customer base
are significant assets for attracting new customers, as well as for enhancing
our ability to develop relationships with other leading software and service
solution providers.
STRATEGIC RELATIONSHIPS. We form strategic relationships to enhance our
product and service offerings and help expand our market presence. These
strategic relationships include:
- product bundling arrangements with companies such as Allaire, IBM, Lotus
and Novell, to combine NetObjects Fusion with popular business software;
- technology relationships that integrate our products with web application
servers from Allaire, Lotus, IBM, Microsoft and PeopleSoft, and e-commerce
software from Breakthrough Software and iCat; and
- online solutions which combine our products with online service providers
such as Compuserve, SmartAge, T-Online, Verio.com and Zip2 for hosting and
promoting e-business sites, which enhance our products and solutions, as
well as complement our sales, marketing and distribution reach.
These relationships also greatly enhance our brand recognition and may
provide a short-term source of revenues. Our strategic relationship with IBM has
provided us with other sales and marketing benefits, including access to IBM and
Lotus sales and distribution channels, co-marketing and co-promotion benefits
and credibility in the marketplace. See "Risk Factors--Our dependence on IBM may
present potential conflicts or otherwise adversely affect our business" for a
discussion of risks associated with our strategic relationship with IBM.
TECHNOLOGICAL LEADERSHIP AND OPEN ARCHITECTURE. NetObjects Fusion and
NetObjects Authoring Server are based on proprietary technology that provides an
intuitive, visual building environment that allows for significant productivity
gains compared to web page building products that require programming. In
addition, NetObjects Authoring Server offers a collaborative web site building
environment for teams of builders while providing centralized control over the
site building effort. We have an open architecture that:
- supports all major Internet protocols;
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- is publishable on major web browsers, such as Netscape Navigator and
Microsoft Internet Explorer; and
- allows other website solutions providers to integrate their products with
our products using Java-based components.
By maintaining these advantages, we believe our products will continue to be
recognized as open platforms for easy integration with their products and
services.
PLATFORMS OF CHOICE FOR E-BUSINESS SOLUTIONS AGGREGATION. As businesses
face the increasingly complex and numerous challenges of establishing a
successful e-business presence, we believe they will seek aggregated solutions
to address their needs, from building and hosting their web sites to maintaining
and promoting them. We believe that other web site solutions providers have
compelling incentives to use NetObjects Fusion, NetObjects Authoring Server and
our online resources as platforms for aggregating their e-business solutions, as
well. Other solutions providers can benefit from our strong brand to reach a
growing business customer base through our products, services and web sites. In
turn, we can offer more complete solutions by leveraging our strategic
relationships to include e-commerce services, database access, banner exchange,
content, web applications and other online services from other web site
solutions providers.
PRODUCTS AND SERVICES
We provide solutions for two broad categories of customers: NetObjects
Fusion and online services for businesses, and NetObjects Authoring Server and
professional services for large enterprises and departments.
NETOBJECTS FUSION AND ONLINE SERVICES
NetObjects Fusion is an easy-to-use desktop application designed
specifically for small businesses and corporate intranet builders. NetObjects
Fusion offers a range of publishing and e-commerce capabilities to simplify web
site building and enhance the productivity of both novice and experienced web
site builders. Earlier versions of NetObjects Fusion are available in major
languages including German, French, Spanish, Chinese and Japanese, and our
relationship with IBM has allowed us to release upgraded versions of NetObjects
in a total of nine languages in addition to English.
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<TABLE>
<CAPTION>
PRODUCT DESCRIPTION AWARDS
<S> <C> <C>
NETOBJECTS FUSION NetObjects Fusion provides five views Four out of Four Stars, Internet World,
(suggested selling price that map to the process of site building: February 1999
SITE VIEW lets the author visually plan Editor's Choice, CNET's Builder.com,
$295) and organize the pages on the web site. September 1998
NetObjects Fusion automatically creates Five Stars, PC Computing, August 1998.
[LOGO] and maintains the navigation buttons and Stellar Award, Windows Sources, May 1998
links based on how the author lays out WinList, Windows Magazine, March 1998--
the web site. November 1998.
PAGE VIEW lets the author create pages Best of Internet Showcase "98, David
visually. A wide range of content can be Coursey's Internet Showcase, January 1998
incorporated on the page, including text, Analyst's Choice, InfoWorld, 1997
graphics, rich media, applets and other
components.
STYLES VIEW lets the author create a
consistent, attractive visual style for
the site. Over 150 site styles are
available, and authors can customize or
create their own styles.
ASSETS VIEW serves as a content manager
to make it easy to find and replace
assets throughout the site.
PUBLISH VIEW lets the author publish all
or portions of the site as standard HTML
pages to the server of choice.
</TABLE>
<TABLE>
<CAPTION>
PRODUCT DESCRIPTION AWARDS
<S> <C> <C>
NETOBJECTS FUSION NetObjects Fusion Enterprise Best Scripting Tool of 1998,
ENTERPRISE EDITION Edition contains NetObjects CNET's Builder.com
(suggested selling Fusion, NetObjects ScriptBuilder Editors Choice, PC Magazine,
price $495) and NetObjects BeanBuilder April 1998
NETOBJECTS SCRIPTBUILDER is a
[LOGO] JavaScript building environment
for the web.
[LOGO] NETOBJECTS BEANBUILDER allows
intranet builders to quickly
[LOGO] assemble and connect
JavaBeans-TM- in a visual, point
and click environment without
programming.
</TABLE>
eFuse.com is an online resource dedicated to business web site builders and
features articles from the industry's experienced builders and authors on how to
use NetObjects Fusion and other complementary products. eScriptZone.com is an
online resource that provides articles, tutorials, software and an online
community of forums and newsgroups for webmasters and corporate web application
builders. In November 1998, Web21.com's 100 Hot sites rated it as the 33rd most
visited site for technology developers. eSiteStore.com is our online retail
store that provides a one-stop shopping destination for businesses to purchase
our software, third party software, components and merchandise, and also offers
online services to customers.
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NETOBJECTS AUTHORING SERVER AND PROFESSIONAL SERVICES
We introduced NetObjects Authoring Server Suite 3.0 in September 1998 to
replace our original client-server application, NetObjects TeamFusion, which we
had introduced in December 1997. The family of NetObjects Authoring Server
products now consists of the NetObjects Authoring Server Suite, NetObjects
Authoring Server Connectors and NetObjects Authoring Server for IBM WebSphere,
which may be used with the IBM WebSphere web application server. NetObjects
Authoring Server currently runs only on Windows NT and also supports a variety
of web browsers, databases and web servers. NetObjects Authoring Server Suite
consists of four modules:
AUTHORING SERVER. Authoring Server is the server-side control center of
NetObjects Authoring Server and contains an internal database which stores the
information about assets, site pages, site structure, link information and user
profiles for multiple web sites. It also controls the number of concurrent users
that can access the system. Authoring Server works in conjunction with any web
server.
AUTHORING SERVER ADMINISTRATOR. Authoring Server Administrator is used to
create sites and form teams, assign team members with editing and publishing
privileges and monitor workflow. The product is designed to provide control of
the web site building process, without imposing a specific workflow on team
members.
TEAMFUSION CLIENT. TeamFusion Client provides the "client"-side software of
the client-server application and includes all of NetObjects Fusion's features.
CONTENT CONTRIBUTOR CLIENT. Content Contributor Client enables any business
user to submit content directly onto templates created on completed web sites or
web sites under construction, regardless of their web authoring skills, and
without compromising the web site's integrity. Users can add, modify and delete
text easily and without considering web site design. NetObjects Authoring Server
automatically formats the content contributed as a web page when the web site is
published.
In addition, NetObjects Authoring Server Connectors include NetObjects
Authoring Server Connector for Microsoft FrontPage, which enables Microsoft
FrontPage users to collaborate with team members using NetObjects Authoring
Server.
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<TABLE>
<CAPTION>
PRODUCT DESCRIPTION AWARDS
<S> <C> <C>
NETOBJECTS AUTHORING NetObjects Authoring Server Suite 1999 Crossroads A-List Award,
SERVER SUITE consists of four modules: Open Systems Advisors, January
(suggested selling NETOBJECTS AUTHORING SERVER is 1999
price for 2 user the "server"-side control center Four out of Four Stars, Internet
system inclusive of and runs on a Windows NT server. World, September 1998
server and clients NETOBJECTS AUTHORING SERVER Industrial Design Excellence
is $1,585; 20 user ADMINISTRATOR is used to create Award--Gold, Designers Society of
is $10,475) sites and form teams, assign team America, May 1998
members with editing and (NetObjects Fusion and
[LOGO] publishing privileges, and TeamFusion)
monitor workflow. Win 100 List, Windows Magazine,
NETOBJECTS TEAMFUSION CLIENT is May--July 1998 (TeamFusion)
based on the award-winning
NetObjects Fusion, and connects
to NetObjects Authoring Server.
Its site-oriented, visual
approach, along with its
check-in/check-out controls,
allows a web team to work
collaboratively and efficiently.
NETOBJECTS CONTENT CONTRIBUTOR
CLIENT is a browser-based Java
application that lets
departmental web contributors
submit content directly to sites
under development.
NETOBJECTS AUTHORING NETOBJECTS AUTHORING SERVER
SERVER CONNECTORS CONNECTOR FOR MICROSOFT FRONTPAGE
enables Microsoft FrontPage users
to collaborate using NetObjects
Authoring Server.
NETOBJECTS AUTHORING NETOBJECTS AUTHORING SERVER FOR
SERVER FOR IBM IBM WEBSPHERE is optimized for
WEBSPHERE tight integration with the IBM
WebSphere Application Server
through powerful Java servlets
and special components.
</TABLE>
We formed our Professional Services Group in October 1998 to provide
training, consulting and implementation services to our customers deploying the
NetObjects Authoring Server. We provide these services through our own
professional services organization and, at present, primarily through
relationships with third-party service providers. We believe that providing a
high level of customer service and technical support is necessary to achieve
rapid product implementation which, in turn, is essential to customer
satisfaction and continued license sales and revenue growth. We also offer
support and training services to our customers in addition to our Professional
Services Group, including telephone and online support. Internationally, with
our technical assistance, our distributors provide telephone support to their
customers.
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CUSTOMERS
We market and sell our products to a wide range of customers located in the
U.S. and in over 30 other countries worldwide. We believe that approximately 70%
of our customers have been small businesses and approximately 30% have been
large enterprises, including Fortune 1,000 companies or departments within these
enterprises. Approximately one-third of our small and medium-sized business
customers are third-party service providers that build web sites for other
companies.
SMALL BUSINESSES. Our products appeal to small businesses needing to build
web sites that support rich content and e-commerce, with a minimum of resources
and time, and with little design and HTML programming expertise. Some examples
of small business customers that have built e-commerce web sites with our
products include Cellular Market (cellularmarket.com) and Christmas.com. Some
examples of customers that have built e-publishing web sites with our products
include Pangea Systems (pangeasystems.com), Northstar Nursery
(northstarnursery.com), Raychem (raychem.com) and Realty.com.
LARGE ENTERPRISES. Our products appeal to a wide range of larger customers
across multiple industry segments. The following is a list of some of our large
enterprise customers:
<TABLE>
<CAPTION>
COMMUNICATIONS GOVERNMENT & EDUCATION HEALTHCARE AND MEDICAL
<S> <C> <C>
Cellular One (Bay Area) U.S. Senate Blue Cross/Blue Shield
Bell Atlantic Data Solutions Group State of Utah, Dept. of Community Dept. of Health & Human Services
Nortel Networks &
Economic Development
University of North Carolina
Kings County, California
MANUFACTURING FINANCIAL TECHNOLOGY
The Boeing Company NationsBank Corporation VLSI Technology, Inc.
DaimlerChrysler AG Credit Suisse First Boston Lockheed Martin
Shell Lubricants Travelers Life and Annuity Siemens Microelectronics
Mitsubishi Electronics America
</TABLE>
CUSTOMER SITES BUILT USING NETOBJECTS FUSION
NetObjects Fusion is well-suited for a wide range of web site projects that
require a rapid site building cycle, a combination of rich content and
transaction processing capability, interactivity and personalization and
deployment on a variety of web browsers from multiple server platforms. Some
examples of sites that help demonstrate our product's robust site building
capabilities include:
CHRISTMAS.COM, the most popular Christmas site on the web and selected as
the top Christmas site by Excite, receives over 10 million page views per season
and provides families and children all over the world with rich content sources
about Christmas. First unveiled in 1995, the site was rebuilt with NetObjects
Fusion in 1997 and is enhanced and updated annually using our product, including
recent enhancements to support e-commerce transactions.
JUSTFORFEET.COM, the world's largest athletic shoe store, developed its web
site and corporate intranet using NetObjects Authoring Server Suite. Recently, a
complete web site redesign coincided with the launch of a national television
campaign. The new site provides a variety of information from shoe longevity
tips to store tours to help finding store locations. The state-of-the-art site
also features e-commerce functionality, allowing customers to virtually browse
the shelves, compare prices and purchase shoes online. The sites are maintained
by a core web team of six people, each providing different areas of expertise.
The corporate intranet site, with over 600 pages of information, continuously
maintains up-to-the-minute information provided by over 20 content contributors
throughout the company.
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DAIMLERCHRYSLER AG sites built with our products range from departmental
home pages, to newsletters, to sites that share information across the entire
corporation. Many departments within DaimlerChrysler selected NetObjects Fusion
because it provides an open and robust site building environment that integrates
with existing desktop and server software to create web sites that are easy for
users to navigate and search. DaimlerChrysler estimates that over 40 Internet
and intranet sites have been built using NetObjects Fusion within the company by
departments including DaimlerChrysler's Fleet Operations, General Auditor's
Office and Information Systems.
SALES, MARKETING AND DISTRIBUTION
We sell our products and services to our customers using a combination of
indirect distribution channels, our direct enterprise sales force, our online
distribution channel and strategic relationships, and we market our products and
services using a broad range of activities to generate demand and build brand
awareness. As of December 31, 1998, we had 63 employees, or approximately 41% of
our work force, engaged in sales and marketing activities.
INDIRECT DISTRIBUTION CHANNELS
Our indirect distribution channels include domestic and international
distributors, retail vendors, value-added resellers and other technology
companies with whom we have strategic relationships. We have 15 non-exclusive
distributors worldwide including Ingram Micro, Tech Data and Douglas Stewart in
North America; Softline, Internet 2000, Unipalm and Principal in Europe; and
Mitsubishi, which is our master distributor in Japan. As of December 1998, we
had over 1,500 corporate and catalog resellers, original equipment manufacturers
and value-added resellers purchasing products through these distributors.
DIRECT ENTERPRISE SALES FORCE
Our direct enterprise sales force focuses on sales to larger corporate
customers worldwide. The enterprise sales force is comprised of field
representatives and inside sales representatives. The field representatives
market and sell our products and services to corporate customers that the inside
sales team has identified as sales prospects. The inside representatives develop
and pursue leads generated from inquiries on our web sites, downloads of our
trial products and other direct marketing efforts. Our sales force increased
from 17 employees to 21 employees in fiscal year 1998, and during that period,
revenues per salesperson increased while the number of transactions per
salesperson decreased.
ONLINE DISTRIBUTION CHANNEL
Our web site eSiteStore.com allows users to download and purchase our
products. In addition, several third-party e-commerce and distribution sites,
including buydirect.com, beyond.com and download.com, make our products
available for sale online. The online distribution channel provides us with a
low-cost, globally accessible, 24-hour sales channel.
STRATEGIC RELATIONSHIPS
We have a number of significant ongoing strategic relationships with other
technology companies pursuant to which our products are incorporated into, or
bundled with, the third party's products. We believe that these strategic
relationships significantly enhance our brand recognition and awareness of our
products and services, and also provide a source of revenues. Our strategic
relationships include:
IBM/LOTUS. Lotus markets, bundles and sells a version of NetObjects Fusion
with Lotus Designer for Domino, and IBM markets, bundles and sells NetObjects
Fusion Enterprise Edition,
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which includes NetObjects Fusion, NetObjects ScriptBuilder and NetObjects
BeanBuilder, with its WebSphere Studio product. In addition, our products are
offered for sale through a variety of IBM and Lotus channels including "Passport
Advantage," the worldwide direct purchasing option for Lotus and IBM branded
software and the Lotus Business Partner program, which allows 18,000 program
members access to our products at discounted prices globally. Our relationship
with IBM and Lotus provides us with access to customers and marketing leverage
generally beyond the reach of companies our size, including participation in
advertising, direct marketing, tradeshows and seminars. See "Risk Factors--Our
dependence on IBM may present potential conflicts or otherwise adversely affect
our business" for a discussion of risks associated with our strategic
relationship with IBM.
NOVELL. Novell bundles a version of NetObjects Fusion with its NetWare for
Small Business product offering on a worldwide basis. Novell also offers
end-user training on NetObjects Fusion at over 100 Novell certified training
centers worldwide. Novell is an investor in NetObjects. We discuss our
relationship with Novell in "Certain Transactions."
MARKETING ACTIVITIES
Since our inception, we have invested a substantial percentage of our annual
revenues in a broad range of marketing activities to generate demand, gain
corporate brand identity, establish the site building product category and
educate the market about our products and services. These activities have
included advertising, including both print and online, direct marketing,
including direct mail and e-mail, public relations, sponsoring seminars for
potential customers, participating in trade shows and conferences and providing
product information through our web sites. Our marketing programs are aimed at
informing our customers of the capabilities and benefits of our products and
services, increasing brand awareness, stimulating demand across all market
segments and encouraging independent software developers to develop products and
web applications that are compatible with our products and technology. We also
entered into many co-marketing and distribution arrangements with well-known
companies such as AT&T, Apple Computer, Inc., Compaq Computer, Inc., Microsoft,
Netscape and PeopleSoft that have allowed us to identify our NetObjects Fusion
brand with their brands.
COMPETITION
The market for software and services for the Internet and intranets is
relatively new, constantly evolving and intensely competitive. We expect
competition to intensify in the future. Many of our current and potential
competitors have longer operating histories, greater name recognition and
significantly greater financial, technical and marketing resources. Our
principal competitors in the web site building software market segment include
Microsoft, Adobe and Macromedia, Inc.
Microsoft's FrontPage, a web site building software product, has a dominant
market share. Microsoft has announced but not shipped FrontPage 2000, which may
become one of the products in at least one version of Microsoft's Office product
suite, which dominates the market for desktop business application software. We
believe that NetObjects Fusion and NetObjects Authoring Server contain features
that significantly differentiate them from the announced description of
FrontPage 2000, but widespread distribution of Office with FrontPage 2000, and
the vast number of computer users familiar with Microsoft desktop application
software products, give Microsoft a substantial competitive advantage over us.
In connection with its recent acquisition of GoLive, Inc., Adobe acquired a web
site building software product for Macintosh, which increases the
competitiveness of the market for Macintosh web site building products. Our
current Macintosh product, NetObjects Fusion 3.0, may become less competitive
over time.
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Alternatives to using web site building software also may provide
significant competition. The alternatives include products from third-party web
site builders, in-house resources and online web site building resources, such
as GeoCities, some of which also provide web site hosting and other services.
Competitive factors in our market include:
- the manner in which the software is distributed with other products;
- quality and reliability;
- features for creating, editing and developing web sites;
- pricing (for example, during the three months ended September 30, 1997, we
reduced the price of NetObjects Fusion from $495 to $295, which resulted
in a decline in total revenues from the third to the fourth quarters in
fiscal 1997);
- ease of use and interactive user features;
- scalability and cost per user; and
- compatibility with the user's existing computer systems.
To expand our user base and further enhance the user experience, we must
continue to innovate and improve the performance of our products. We anticipate
that consolidation will continue in the web site building products industry and
related industries such as computer software, media and communications.
Consequently, our competitors may be acquired by, receive investments from or
enter into other commercial relationships with larger, well-established and
well-financed companies. There can be no assurance that we can establish or
sustain a leadership position in this market segment.
We believe that additional competitors may enter the market with competing
products as the size and visibility of the market opportunity increases.
Increased competition could result in additional pricing pressures, reduced
margins or the failure of our products to achieve or maintain market acceptance,
any of which could harm our business and cause our revenues and stock price to
fall. Many of our current and potential competitors such as Microsoft, Adobe and
Macromedia have longer operating histories and substantially greater financial,
technical, marketing and other resources than us and therefore may be able to
respond more quickly to new or changing opportunities, technologies, standards
or customer requirements. Many of these competitors also have broader and more
established distribution channels that may be used to deliver competing products
directly to customers through product bundling or other means. For example,
Microsoft enjoys significant distribution advantages over us, including the vast
number of computer users familiar with Microsoft desktop application software
products. If our competitors bundle competing products with their products, the
demand for our products might be substantially reduced and our ability to
distribute our products successfully would be substantially diminished.
Moreover, Microsoft's dominance in desktop business application software enables
it to vary the pricing for its software sold as part of a suite. As a result of
Microsoft's and other competitors' bundling arrangements, we may need to reduce
our prices for our products to keep them competitive.
New technologies and the enhancement of existing technologies will likely
increase the competitive pressures on us. Competing technologies or the
emergence of new industry standards could adversely affect our competitive
position or render our products or technologies noncompetitive or obsolete.
There is no assurance that we will compete effectively with current or
future competitors or that competitive pressures will not harm our business and
cause our revenues and stock price to fall. For a discussion of
competition-related risks, see "Risk Factors--We have many established
competitors, including Microsoft, and may be unable to compete effectively
against them."
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TECHNOLOGY AND DEVELOPMENT
We devote substantial resources to the development of innovative products
for the market for web site building software and services. During the fiscal
years ended September 30, 1997 and 1998, respectively, we invested approximately
111% and 67%, respectively, of our total revenues on research and development
activities. NetObjects Fusion and NetObjects Authoring Server are among the
earliest and most recognized entrants in the emerging market for web site
building software. We believe that we have been able to leverage our
understanding of the market and technology opportunity as well as our staff and
software development processes to build robust, open solutions for customers. We
intend to continue to use these core strengths to introduce innovative products
and product enhancements for building, deploying and maintaining business web
sites. We intend to continue to devote substantial resources to research and
development for at least the next several years.
Our technology provides the following product advantages:
OPEN ARCHITECTURE
Our products are built upon a flexible object-oriented architecture. This
architecture, which we obtained from Rae Technology, Inc. upon our founding, has
been instrumental in the rapid development of our products. The architecture
provides such significant benefits as:
- separating the visual display of information from its storage;
- supporting multiple databases;
- supporting major Internet protocols;
- allowing any HTML page editor to be used with our products; and
- extending our products using Java components.
We intend to continue to invest in further development of this architecture
to build and integrate new products and technologies.
CONTROL AND COLLABORATION
Intranet web sites are evolving from simple publishing pages coordinated by
a single webmaster to multi-contributor strategic business platforms that
integrate business processes and deploy mission-critical applications.
Enterprise groups that build these intranet web sites face the conflicting needs
of maintaining control and encouraging collaboration. NetObjects Authoring
Server provides the performance needed to support concurrent, collaborating
users across an enterprise-wide deployment with several underlying technologies
such as a Java-based content contributor, an integrated asset manager and remote
systems administrator.
In addition to our products, product enhancements and core proprietary
technology, we have a highly-skilled engineering workforce that includes several
seasoned software industry veterans. As of December 31, 1998, we had 50
employees, or approximately one-third of our workforce, engaged in research and
development activities. Our original key technologists are still NetObjects
employees, and they continue to play an integral role in defining and leading
our technology vision and strategy. We intend to hire additional software
engineers to further our research and development efforts. If we are unable to
hire and retain the required number of skilled engineers, our business will be
harmed, our revenues could decline and our stock price may fall.
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INTELLECTUAL PROPERTY
Our success depends in part on our ability to protect our proprietary
software and other intellectual property. To protect our proprietary rights, we
rely generally on patent, copyright, trademark and trade secret laws,
confidentiality agreements with employees and third parties, license agreements
with consultants, vendors and customers and "shrinkwrap" license agreements.
Despite these protections, a third party could, without authorization, copy or
otherwise obtain and use our products, or develop similar products. There can be
no assurance that our agreements will not be breached, that we will have
adequate remedies for any breach or that our trade secrets will not otherwise
become known or independently developed by competitors.
We currently have several pending patents relating to our product
architecture and technology and have licensed two utility patents from Rae
Technology. For a description of our Rae Technology relationships, see "Certain
Transactions--Transactions with Rae Technology and Studio Archetype." There can
be no assurance that any pending or future patent application will be granted,
that any existing or future patent will not be challenged, invalidated or
circumvented or that the rights granted under any patent that has issued or may
issue will provide competitive advantages to us. If a blocking patent has issued
or issues in the future, we would need to obtain a license or design around the
patent. Except for patents licensed from Rae Technology, which we have rights to
acquire, there can be no assurance that we would be able to obtain a license on
acceptable terms, if at all, or to design around the patent.
We pursue the registration of some of our trademarks and service marks in
the United States and in other countries, although we have not secured
registration of all of our marks. Many of our current and potential competitors
dedicate substantially greater resources to protection and enforcement of
intellectual property rights. We are also aware of other companies that use
"Fusion" in their marks alone or in combination with other words, such as
Allaire's ColdFusion, and we do not expect to be able to prevent third party
uses of the word "Fusion" for competing goods and services. We have agreed with
Allaire that neither party will use the word "Fusion" to describe products in
the absence of appropriate brand identification, such as "NetObjects Fusion."
The laws of some foreign countries do not protect our proprietary rights to
the same extent as do the laws of the United States, and effective patent,
copyright, trademark and trade secret protection may not be available in these
jurisdictions. We license some of our proprietary rights to third parties, and
there can be no assurance that these licensees will abide by compliance and
quality control guidelines with respect to our proprietary rights.
EMPLOYEES
As of December 31, 1998, we had 153 full-time employees and 4 part-time
employees. None of our employees is subject to a collective bargaining
agreement, and we believe that our relations with our employees are good. We
believe that our future success will depend in part on our continued ability to
attract, integrate, retain and motivate highly qualified sales, technical,
professional services and managerial personnel, and upon the continued service
of our current personnel. We also use independent contractors to supplement our
work force. None of our personnel is bound by an employment agreement that
prevents the person from terminating his or her relationship at any time for any
reason. Competition for qualified personnel is intense. There can be no
assurance that we will be successful in attracting, integrating, retaining and
motivating a sufficient number of qualified personnel to conduct our business in
the future.
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FACILITIES
Our executive offices are located in Redwood City, California, in an office
building in which, as of December 31, 1998, we lease an aggregate of
approximately 25,000 square feet. The lease agreement terminates on September
11, 2002. We also lease three serviced office suites in a facility in Windsor,
United Kingdom under a lease that expires in February 1999. We expect to renew
the lease through February 2000.
LEGAL PROCEEDINGS
From time to time, we expect to be subject to legal proceedings and claims
in the ordinary course of business, including claims of alleged infringement of
third-party trademarks and other intellectual property rights by us and our
licensees. These claims, even if not meritorious, could result in the
expenditure of significant financial and managerial resources. We are not aware
of any legal proceedings or claims that we believe would harm our business or
cause our revenues or stock price to fall.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Our directors and executive officers as of April , 1999 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------------ --- ---------------------------------------------------------------
<S> <C> <C>
Samir Arora(1)............................ 33 Chairman of the Board, Chief Executive Officer and President
Russell F. Surmanek....................... 41 Executive Vice President, Finance and Operations and Chief
Financial Officer
David Kleinberg........................... 40 Executive Vice President, Desktop Products and Online Services
Morris Taradalsky......................... 52 Executive Vice President, Server Products and Professional
Services
Mark Patton............................... 40 Senior Vice President, Worldwide Sales and Corporate Marketing
Clement Mok............................... 40 Chief Creative Architect
Gagan (Sal) Arora......................... 25 Chief Technology Architect and Vice President, Engineering,
Desktop Products and Online Services
Robert G. Anderegg(2)..................... 50 Director
Lee A. Dayton(1).......................... 56 Director
John Sculley(1)(2)........................ 59 Director
Christopher M. Stone(2)(3)................ 41 Director
Michael D. Zisman......................... 50 Director
</TABLE>
- ------------------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
(3) Mr. Stone will become a director of NetObjects on the closing date of the
offering.
Set forth below is information regarding the business experience during the
past five years for each of our officers and directors.
SAMIR ARORA has served as our Chairman of the Board, Chief Executive Officer
and President since our inception in November 1995. In 1992, Mr. Arora founded
Rae Technology, a provider of software applications, and from 1992 through
November 1995 served as its CEO. From 1986 to 1992, Mr. Arora served in several
management roles at Apple Computer, Inc. Mr. Arora holds a diploma in sales and
marketing from the London Business School and attended INSEAD, France and BITS,
India. Samir Arora is the brother of Sal Arora, who is our Chief Technology
Architect and Vice President, Engineering Desktop Products and Online Services.
RUSSELL F. SURMANEK has served as our Executive Vice President, Finance and
Operations and Chief Financial Officer , 1999. From 1990 to
March 1999, Mr. Surmanek served in several senior financial management positions
at Oracle Corporation, most recently as Vice President, Finance and
Administration, Worldwide Operations. From 1989 to 1990, Mr. Surmanek was
Controller, North America Sales and Support for International Computers Ltd.
From 1983 to 1989, Mr. Surmanek held various financial management positions at
Racal-Milgo, Inc., a data communications equipment manufacturer. Mr. Surmanek
holds a B.S. in Business Administration from the State University of New York at
Buffalo and an M.B.A. from the University of Michigan.
DAVID KLEINBERG has served as our Executive Vice President, Desktop Products
and Online Services since November 1995. In September 1992, Mr. Kleinberg
co-founded Rae Technology with Samir Arora. Mr. Kleinberg served as Executive
Vice President, Sales and Marketing of Rae Technology from September 1992 to
November 1995. Prior to joining Rae Technology, Mr. Kleinberg held
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executive positions in product marketing and sales at Macromedia. Prior to
Macromedia, Mr. Kleinberg was employed at Apple Computer. Mr. Kleinberg holds a
B.A. in English from Georgetown University and an M.B.A. from Stanford
University.
MORRIS TARADALSKY has served as our Executive Vice President, Server
Products and Professional Services since April 1997. From April 1994 to April
1997, Mr. Taradalsky served as Chief Executive Officer of MicroNet Technology,
Inc., a privately-held storage systems supplier. From December 1988 to April
1994, Mr. Taradalsky was employed at Apple Computer, Inc. where he was General
Manager of the Apple Business Systems Division. Prior to joining Apple Computer,
Mr. Taradalsky was employed by IBM for 18 years in a number of positions,
including Vice President and General Manager, Santa Teresa Laboratory. Mr.
Taradalsky graduated MAGNA CUM LAUDE from Pennsylvania State University with a
B.S. in Mathematics.
MARK PATTON has served as our Senior Vice President, Worldwide Sales and
Corporate Marketing since December 1996. From February 1995 to November 1996,
Mr. Patton was Vice President and General Manager of the Digital and Applied
Imaging Division at Eastman Kodak, Inc. From February 1994 to February 1995, Mr.
Patton was Vice President and General Manager, American Division at Logitech,
Inc., a computer peripheral products manufacturer. From August 1985 to February
1994, Mr. Patton held various sales management positions at Apple Computer, Inc.
Mr. Patton holds a B.A. in Speech Communication from the University of
Washington.
CLEMENT MOK has served as our Chief Creative Architect since September 1998.
Prior to that, Mr. Mok had been our Chief Creative Officer since our founding in
November 1995. In 1988, Mr. Mok founded Studio Archetype, now a wholly-owned
subsidiary of Sapient Corporation. From 1988 to 1998, Mr. Mok was Chairman and
Chief Creative Officer of Studio Archetype. He is currently the Chief Creative
Officer of Sapient Corporation. From 1993 to present, Mr. Mok also has been the
Chief Executive Officer of CMCD, Inc., a media publishing company. Mr. Mok holds
a B.F.A. from the Art Center College of Design.
SAL ARORA has served as our Chief Technology Architect and Vice President,
Engineering, Desktop Products and Online Services since November 1995. From
September 1994 to November 1995, Mr. Arora was the lead engineer at Rae
Technology. From June 1992 to September 1994, Mr. Arora was a software engineer
at ACIUS Inc. Mr. Arora holds a B.S. in Computer Science from the University of
California, Berkeley. Sal Arora is the brother of Samir Arora, who is our
Chairman of the Board, Chief Executive Officer and President.
ROBERT G. ANDEREGG has been a director of our company since April 11, 1997.
Mr. Anderegg has served as Vice President and Assistant General Counsel at IBM
since August 1998. He has been appointed to serve on our board of directors by
IBM as one of its representatives. Mr. Anderegg has served as an Assistant
General Counsel or Associate General Counsel at IBM since 1988. Mr. Anderegg
holds a B.S. degree from Georgia Tech and received his J.D. from Harvard Law
School.
LEE A. DAYTON has been a director of our company since April 11, 1997. Mr.
Dayton is Vice President, Corporate Development and Real Estate at IBM. He has
been appointed to serve on our board of directors by IBM as one of its
representatives. Mr. Dayton has held various management positions at IBM since
he joined in 1965 as a systems engineer. Mr. Dayton holds a B.S. in Engineering
from Northwestern University.
JOHN SCULLEY has been a director of our company since December 20, 1996.
Since April 1994, Mr. Sculley has been a partner of Sculley Brothers, an
investment capital firm. Mr. Sculley also is a director of General Wireless,
Inc., a wireless communications services provider, Talk City, Inc., an online
chat community, and NFO Worldwide, Inc., a market research firm. From 1983 to
1993, Mr. Sculley served as Chief Executive Officer of Apple Computer, Inc. Mr.
Sculley holds a B.A. in
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Architectural Design from Brown University, an M.B.A. from the Wharton School at
the University of Pennsylvania and holds eight honorary doctorates from various
schools.
CHRISTOPHER M. STONE will become a director of our company on the closing
date of this offering. Since August 1997, Mr. Stone has been the Executive Vice
President of Corporate Strategy and Development at Novell, Inc. From September
1989 to August 1997, Mr. Stone was Chairman and Chief Executive Officer of the
Object Management Group, the creator of an industry standard known as CORBA. Mr.
Stone holds a B.S. in Computer Science from the University of New Hampshire.
MICHAEL D. ZISMAN has been a director of our company since April 11, 1997.
Mr. Zisman is an Executive Vice President of Lotus, a position that he has held
since October 1996. He has been appointed to serve on our board of directors by
IBM as one of its representatives. From July 1994 to October 1996, he held other
executive positions at Lotus. Mr. Zisman is also the Vice President of Strategy
for the IBM Software Group. Mr. Zisman was the Chief Executive Officer of
Soft-Switch, Inc., a software development company, from 1979 to July 1994. Mr.
Zisman is a director of Strategic Weather Services, Inc., a privately-held
company. Mr. Zisman holds a B.S. from Lehigh University, an M.S. from the
University of Pennsylvania Moore School and a Ph.D. from The Wharton School at
the University of Pennsylvania.
NUMBER, TERM AND ELECTION OF DIRECTORS
Effective upon the closing of this offering, our bylaws will be amended
automatically to fix the number of directors at six until changed by approval of
the stockholders or a majority of the directors. Each director is elected to
serve until the next annual meeting of stockholders and until the election and
qualification of his or her successor or his or her earlier resignation or
removal.
CONTRACTUAL ARRANGEMENTS
We are party to a voting agreement with IBM that provides, effective upon
the closing of this offering, that IBM will vote its shares of voting stock in a
way that limits the number of IBM representatives on a six-member board of
directors to three, notwithstanding IBM's legal right to elect the entire board
for as long as IBM owns a majority of our voting stock. The agreement defines an
IBM representative as an officer, director or other agent or employee of IBM,
IBM's subsidiaries or any other entity controlled by IBM, other than our
company. The voting agreement also obligates us and IBM to maintain a board of
directors consisting of six members unless the holders of a majority of
outstanding voting stock, excluding IBM's shares, approve an amendment to our
amended and restated bylaws or restated certificate of incorporation to change
the size of the board. The voting agreement remains in effect until IBM holds
less than 45% of our voting securities on a fully-diluted basis for a period of
180 consecutive days. While this remains effective it allows IBM's designees to
our board of directors to control any determinations with respect to most
material transactions outside the ordinary course of our business, including
mergers or other business combinations, the acquisition or disposition of our
assets, future issuances of our equity or debt securities and the payment of
dividends.
DIRECTOR COMPENSATION
Our directors do not receive cash compensation for their services as
directors or members of committees of the board of directors. After the offering
we will automatically grant options to purchase 20,000 shares of common stock to
outside directors upon joining the board. The option exercise price will be
equal to the fair market value of a share of common stock at the date of grant.
The option term will be six years and the option will vest and become
exercisable pro rata at the end of each month for 48 months while the option
holder continues to serve as a director.
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BOARD COMMITTEES
We have established an audit committee and a compensation committee.
The audit committee consists of Messrs. Sculley, Anderegg and, after the
offering, Mr. Stone. The functions of the audit committee are to make
recommendations to the board of directors regarding the selection of independent
auditors, review the results and scope of the audit and other services provided
by our independent auditors and evaluate our internal controls.
The compensation committee consists of Messrs. Arora, Dayton and Sculley.
The functions of the compensation committee are to review and approve the
compensation and benefits for our executive officers, administer our stock
option and stock purchase plans and make recommendations to the board of
directors regarding these matters.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
As of the end of our last fiscal year, we did not have a compensation
committee, and all decisions regarding compensation of our executive officers
were made by the board of directors. During fiscal year 1998, Mr. Samir Arora
participated in deliberations of the board of directors concerning executive
officer compensation. No executive officer currently serves as a member of the
board of directors or compensation committee of any entity that has one or more
executive officers serving as a member of our board of directors or the
compensation committee, which was established during fiscal year 1999.
EXECUTIVE COMPENSATION AND MANAGEMENT CHANGES
The following table sets forth information concerning the compensation
received by our Chief Executive Officer and by the other four most highly
compensated executive officers during the fiscal year ended September 30, 1998:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
------------------------
NAME AND PRINCIPAL POSITION SALARY($)(1) BONUS($)
- --------------------------------------------------------------------------------------- ------------ ----------
<S> <C> <C>
Samir Arora
Chairman of the Board, Chief Executive Officer, President............................ $ 175,338 $ 47,434
Morris Taradalsky
Executive Vice President, Server Products and Professional Services.................. 166,048 86,095(1)
Mark Patton
Senior Vice President, Worldwide Sales and Corporate Marketing....................... 150,000 35,555
David Kleinberg
Executive Vice President, Desktop Products and Online Services....................... 145,600 24,856
Michael J. Shannahan (2)
Vice President, Finance and Chief Financial Officer.................................. 151,436 15,542
</TABLE>
- ------------------------
(1) Includes $65,745 for relocation expenses.
(2) Mr. Shannahan will no longer be an employee of NetObjects after April 5,
1999 and Mr. Russell Surmanek will become Executive Vice President, Finance
and Operations and Chief Financial Officer as of that date.
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The following table sets forth information regarding option exercises, and
the fiscal year-end values of stock options held, by our Chief Executive Officer
and the other four most highly compensated executive officers during the fiscal
year ended September 30, 1998:
AGGREGATED OPTION EXERCISES IN FISCAL 1998 AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT AT SEPTEMBER 30,
SEPTEMBER 30, 1998(#) 1998($)
------------------------ ----------------------
EXERCISABLE/ EXERCISABLE/
NAME UNEXERCISABLE UNEXERCISABLE(1)
- ---------------------------------------------------------------- ------------------------ ----------------------
<S> <C> <C>
Samir Arora..................................................... 84,375/140,625 $ 374,625/$624,375
Morris Taradalsky............................................... 47,222/86,111 209,666/382,334
Mark Patton..................................................... 55,661/69,339 247,136/307,864
David Kleinberg................................................. 56,250/93,750 249,750/416,250
Michael J. Shannahan (2)........................................ 29,340/78,993 130,270/350,730
</TABLE>
- ------------------------
(1) The fair market value of the underlying securities at the close of business
on September 30, 1998 was estimated to be approximately $4.44 per share, as
determined by the board of directors.
(2) Mr. Shannahan will no longer be an employee of NetObjects after April 5,
1999 and Mr. Russell Surmanek will become Executive Vice President, Finance
and Operations and Chief Financial Officer as of that date.
Mr. Surmanek has no prior experience with us and if Mr. Surmanek fails to
quickly become an effective chief financial officer or if he ceases to remain in
our employ, our business could be harmed and our stock price could fall.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
Our amended and restated certificate of incorporation, which takes effect
only upon the closing of this offering, limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except liability for any breach of their
duty of loyalty to the corporation or its stockholders, acts or omissions not in
good faith or that involve intentional misconduct or a knowing violation of law,
unlawful payments of dividends or unlawful stock repurchases or redemptions, or
any transaction from which the director derived an improper personal benefit.
This limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission.
Our amended and restated bylaws, which take effect only upon the closing of
this offering, provide that we will indemnify our directors and officers and may
indemnify our employees and other agents to the fullest extent permitted by law.
The amended and restated bylaws also permit us to secure insurance on behalf of
any officer, director, employee or other agent for any liability arising out of
his or her actions in that capacity, regardless of whether the amended and
restated bylaws would permit indemnification. We have obtained officer and
director liability insurance with respect to liabilities arising out of specific
matters, including matters arising under the Securities Act.
We have entered into agreements with our directors and executive officers
that take effect only upon the closing of this offering and, among other things,
will indemnify them for specific expenses, including attorneys' fees, judgments,
fines and settlement amounts incurred by them in any action
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or proceeding, including any action by us or on our behalf, arising out of the
person's services as a director or officer of NetObjects or any of our
subsidiaries or any other company or enterprise to which the person provides
services at our request. We are obligated to advance expenses incurred by the
indemnified person prior to the conclusion of any such action or proceeding, in
the absence of a determination, as provided in the agreement, that
indemnification would not be permitted under applicable law. We believe that
these provisions and agreements are necessary to attract and retain qualified
directors and officers. These agreements also provide officers with the same
limitation of liability for monetary damages that Delaware corporate law and our
restated certificate of incorporation provide to directors.
BENEFIT PLANS
1997 STOCK OPTION PLAN
The NetObjects 1997 Stock Option Plan, or the 1997 Plan, provides for the
issuance of incentive stock options under the Internal Revenue Code of 1986 and
nonqualified stock options to purchase common stock to employees, non-employee
directors or consultants at prices not less than the fair market value at the
date of grant. A total of 2,158,943 shares of common stock has been authorized
for issuance under the 1997 Plan. The fair market value of the common stock is
determined by the board of directors. Options currently outstanding generally
vest 25% at the end of the first year and then monthly on a pro rata basis over
the next three years. In connection with IBM's acquisition of approximately 80%
of our outstanding stock, the 1996 Stock Option Plan was cancelled and all
options issued under that plan were reissued under the 1997 Plan. Under the 1996
Stock Option Plan, optionees had the right to exercise unvested options, subject
to our Company's right to repurchase unvested shares held at the time of
termination of employment. That right was carried over to the 1997 Plan for
optionees who held options under the 1996 Stock Option Plan that were reissued
under the 1997 Plan, but does not apply to new options granted under the 1997
Plan since April 11, 1997. At December 31, 1998, 81,237 shares of common stock
were subject to our right of repurchase, and 258,651 shares of common stock were
available for future option grants, under the 1997 Plan.
1997 SPECIAL STOCK OPTION PLAN
In March 1997, our board of directors adopted, and in April 1997, our
stockholders approved, the 1997 Special Stock Option Plan. A total of 1,041,056
shares of common stock were authorized for issuance under the plan. On March 18,
1997, our board of directors authorized the grant of options for the purchase of
all shares of common stock authorized for issuance under the plan to 35 key
employees, including Messrs. Samir Arora and David Kleinberg, who received
grants to purchase 225,000 shares and 150,000 shares, respectively. The options
granted under the plan generally vest 25% at the end of the first year and then
monthly on a pro rata basis over the next three years. Our board of directors
does not intend to grant any more options under this stock option plan.
1999 EMPLOYEE STOCK PURCHASE PLAN
Our 1999 Employee Stock Purchase Plan, or ESPP, which has been adopted by
our board of directors and our stockholders, will take effect upon the closing
of this offering. We have reserved 300,000 shares of common stock for issuance
under the ESPP. The ESPP is intended to qualify for favorable tax treatment
under Section 423 of the Internal Revenue Code. Generally, the ESPP will be
implemented through a series of offering periods of six months' duration, with
new offering periods commencing on the first trading day on or after August 1
and February 1 of each year. However, the first offering period will commence on
the first trading day after the closing of the offering and will expire on July
31, 2000. Generally, shares may be purchased at the end of each offering period
but
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during the initial offering period shares may be purchased at the end of each of
July 31, 1999, January 31, 2000 and July 31, 2000.
The ESPP will be administered by the compensation committee of our board of
directors. Each employee of ours or of any majority-owned subsidiary of ours who
has been employed by us or a majority-owned subsidiary for at least 90 days and
for more than 20 hours per week and more than five months per year will be
eligible to participate in the ESPP. The ESPP permits an eligible employee to
purchase common stock through payroll deductions, which may not exceed 10% of
his or her compensation, at a price equal to 85% of the lesser of the fair
market value of the common stock at the beginning of the offering period and the
fair market value of the common stock at the end of each purchase period.
Employees may terminate their participation in the ESPP at any time during the
offering period, but they may not change their level of participation in the
ESPP at any time during the offering period. Participation in the ESPP
terminates automatically on the participant's termination of employment with us.
401(K) PLAN
We maintain a 401(k) plan, a defined contribution plan intended to qualify
under Section 401 of the Internal Revenue Code, that covers all employees who
satisfy specified eligibility requirements relating to minimum age, length of
service and hours worked. Under the profit-sharing portion of the plan, we may
make an annual contribution for the benefit of eligible employees in an amount
determined by the board of directors. We have not made any contributions to date
and currently have no plans to do so. Under the 401(k) portion of the plan,
eligible employees may make pretax elective contributions of up to 15% of their
compensation, subject to maximum limits on contributions prescribed by law.
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CERTAIN TRANSACTIONS
SALES OF COMMON STOCK AND PREFERRED STOCK
Since our inception in November 1995, we have issued, in private placement
transactions, shares of common stock and preferred stock to directors, executive
officers, 5% stockholders, and other purchasers included in the descriptions
below, as follows:
We issued 600,000, 400,000, 333,333 and 250,000 shares of common stock,
respectively, to Samir Arora, David Kleinberg, Clement Mok and Sal Arora, the
founders of NetObjects on December 21, 1995. The purchase price of the shares of
common stock was $0.09 per share. The founders issued three-year full recourse
promissory notes as consideration for the issuance of the shares, in the total
principal amount of $142,500, which bear interest at a rate of 8.00% per annum
and are secured by the shares. As of December 31, 1998, the total principal
balance of the notes was $112,500, of which $90,000 was repaid in March 1999.
The remaining note for $22,500 owed by Sal Arora has been extended for one year.
We issued 166,666 and 1,666,666 shares of Series A preferred stock,
respectively, to Studio Archetype and Rae Technology, respectively, on December
21, 1995. The purchase price of the shares was $0.90 per share. All but 651,945
of the shares were exchanged for IBM common stock and were cancelled in
connection with IBM's acquisition of approximately 80% of our stock in April
1997, and remained outstanding at December 31, 1998. Our relationships with Rae
Technology and Studio Archetype are described in "--Transactions with Rae
Technology and Studio Archetype-- Rae Technology" and "--Studio Archetype."
We issued a total of 2,083,333 shares of Series B preferred stock to Norwest
Equity Partners V, 2,233,333 shares collectively to Venrock Associates, Venrock
Associates II, L.P., and one of their affiliates, and 150,000 shares of Series B
preferred stock to John Sculley, on February 2, 1996. The purchase price of the
shares was $1.20 per share. All of the shares were exchanged for IBM common
stock and cancelled in connection with IBM's acquisition of approximately 80% of
our stock in April 1997.
In December 1996, we agreed to issue warrants for the purchase of a total of
6,863,426 shares of Series C preferred stock to a group of institutional
investors led by Perseus U.S. Investors, L.L.C. that also included Norwest
Equity Partners V, Venrock Associates and John Sculley who, together with other
existing investors agreed to exercise the warrants as needed to enable us to
obtain additional financing of approximately $1 million under an existing
secured loan agreement with a bank. We also received $275,000 in loans from
Norwest and Venrock. On exercise of the warrants, we issued a total of 3,476,090
shares, 304,492 shares, 295,355 and 21,920 shares of Series C preferred stock,
respectively, to Perseus U.S. Investors, L.L.C., Norwest Equity Partners V,
Venrock Associates, L.P. and Venrock Associates II, L.P. collectively, and John
Sculley respectively, on various dates between December 1996 and March 1997 and
515,070 shares to other entities and individuals who are not directors,
executive officers or 5% stockholders. The exercise price under the warrants was
approximately $1.82 per share. All of the shares were exchanged for IBM common
stock and cancelled in connection with IBM's acquisition of approximately 80% of
our stock in April 1997. On February 9, 1999, Norwest exercised its remaining
warrant for 591,855 shares of Series C preferred stock by providing a cash
payment to us. As of February 28, 1999, warrants to purchase a total of
1,478,306 shares of Series C preferred stock were held by Perseus, Venrock and
Mr. Sculley and warrants to purchase 108,338 shares of Series C preferred stock
were held by other entities and individuals who are not directors, executive
officers and 5% stockholders, at an exercise price of approximately $1.82 per
share. These warrants will automatically be surrendered on a cashless exercise
basis by surrendering shares of common stock as payment of the exercise price
upon the closing of this offering, if not exercised earlier. One of our
directors is a member of Perseus U.S. Investors, L.L.C., and three of our
directors are members of Perseus Capital, L.L.C., an affiliate of Perseus U.S.
Investors, L.L.C.
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In connection with IBM's acquisition of approximately 80% of our stock on
April 11, 1997, we issued a warrant to IBM to purchase up to 3,482,838 shares of
Series E preferred stock at an exercise price of approximately $6.68 per share.
IBM's warrant to purchase shares of Series E preferred stock expires on April
11, 2000.
In October and December 1998, we issued convertible notes in the amount of
approximately $10.1 million and $825,000 to IBM and Perseus Capital, L.L.C.,
respectively. The notes may be converted into 1,512,257 and 123,526 shares of
Series E-2 preferred stock at any time and convert automatically on the closing
of an initial public offering of at least $20 million of stock. We also issued
warrants to purchase up to 151,335 shares and 12,379 shares of Series E-2
preferred stock, to IBM and Perseus Capital, L.L.C., respectively, at an
exercise price of approximately $6.68 per share, the same price at which the
related notes convert. Each share of Series E-2 preferred stock will be
automatically converted into one share of common stock upon the effectiveness of
the offering, but is subject to adjustments resulting in a higher conversion
ratio that would be triggered by our failure to complete this or a similar
offering or repay the convertible notes prior to specific dates, the earliest of
which is April 8, 1999. The Series E-2 preferred stock warrants are exercisable
for five years after their issuance dates. All of the warrants to purchase
Series E-2 preferred stock permit a cashless exercise by surrendering shares of
common stock as payment of the exercise price automatically at the closing of
this offering. On February 4, 1999, IBM agreed to purchase up to $3.45 million
of notes and additional warrants, at our option, up to the date of closing of
the offering. The notes are similar to the earlier issued notes, but are not
convertible into preferred stock. The warrants are identical to the earlier
issued warrants and represent the right to purchase 51,771 shares of Series E-2
preferred stock. We issued a note in the amount of $2 million and a warrant to
purchase 30,012 shares of Series E-2 preferred stock to IBM on February 18, 1999
under the February 4, 1999 agreement. On March 23, 1999 we issued a note in the
amount of $1.42 million and a warrant to purchase 21,323 shares of Series E-2
preferred stock to IBM. IBM has the right to require us to repay all
indebtedness under the additional notes in full upon the closing of the
offering.
On April 11, 1997, we issued 10,495,968 shares of Series E preferred stock
to IBM at a purchase price of approximately $6.68 per share. In addition, we
granted the four founders the right to purchase Series E preferred stock in
three equal installments before April 10, 1998 at the same price paid by IBM in
April 1997. On various dates between June 30, 1997 and March 31, 1998, we issued
a total of 299,457, 84,622, 17,891 and 4,596 shares of Series E preferred stock,
respectively, at a purchase price of approximately $6.68 per share, to Samir
Arora, David Kleinberg, Clement Mok and Sal Arora.
On March 14, 1997, we issued warrants to purchase 274,604, 105,511, 73,190,
109,783, 188,636, 13,581 and 10,551 shares of Series F preferred stock,
originally classified as Series D preferred stock, respectively, at a purchase
price of $10.80 per share, to Perseus U.S. Investors, L.L.C., Rae Technology,
LLC, Venrock Associates, L.P., Venrock Associates II, L.P., Norwest Equity
Partners V, John Sculley and Studio Archetype, respectively. On December 23,
1997, we issued a warrant to purchase 83,333 shares of Series F preferred stock,
at a purchase price of $10.80 per share, to IBM Credit Corp. These warrants are
exercisable for three years from the date of issuance. The holders of the
warrants may surrender them on a cashless exercise basis by surrendering shares
of common stock as payment of the exercise price on or after the closing of this
offering and before the expiration date.
Novell purchased 333,333 shares of our Series F-2 preferred stock for $9.00
per share, under a stock purchase agreement dated October 16, 1998. Under the
stock purchase agreement, Novell has "observer rights" at meetings of our board
of directors so long as Novell remains the beneficial owner of not less than 1%,
assuming conversion of all options and warrants, of our stock. In addition,
Christopher M. Stone, an Executive Vice President of Novell, is one of our
directors. Novell also acquired a warrant for the purchase of up to 16,666
shares of Series F-2 preferred stock at an
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exercise price $9.00 per share under the stock purchase agreement. The warrant
may be exercised between January 1, 2001 and December 31, 2003, but only if we
have not completed an initial public offering of our securities resulting in
total cash proceeds of at least $30 million by December 31, 2000.
MC Silicon Valley, Inc., a subsidiary of Mitsubishi, acquired 55,555 shares
of our Series F-2 preferred stock at a price per share of $9.00, under the terms
of a stock purchase agreement dated October 28, 1998. Mitsubishi is also our
master distributor in Japan.
TRANSACTIONS WITH RAE TECHNOLOGY AND STUDIO ARCHETYPE
RAE TECHNOLOGY. In connection with our formation, Rae Technology and we
entered into a technology transfer agreement dated December 21, 1995 under which
Rae Technology granted us, among other things, an exclusive, perpetual,
transferable, worldwide and royalty-free license, with a right of sublicense, to
use technologies referred to as "SOLO" for all commercial applications on
commercial online networks, and all rights to the trademark "NetObjects." In
exchange for our original license and other intangible property we issued
1,666,666 shares of Series A preferred stock to Rae Technology. We also
purchased assets and equipment, and assumed lease obligations, of Rae Technology
and subleased 90% of Rae Technology's office space. Samir Arora, one of our
founders, our Chairman, Chief Executive Officer and President, is the President
and Chief Executive Officer and a director of Rae Technology, and Mr. Arora,
David Kleinberg, our Executive Vice President, Desktop Products and Online
Services, Morris Taradalsky, our Executive Vice President, Server Products and
Professional Services, and Sal Arora, Vice President, Engineering, Desktop
Products and Online Services, collectively own approximately 90% of the
outstanding equity interests of Rae Technology. Messrs. Arora, Kleinberg and
Arora also acquired shares of common stock in connection with our formation, as
more fully described in "--Sales of Common Stock and Preferred Stock."
In March 1997, in connection with IBM's April 1997 acquisition of
approximately 80% of our stock, Rae Technology and we amended the technology
transfer agreement to expand our rights to SOLO and the "NetObjects" trademark
as they existed at the time and to limit Rae Technology's rights to SOLO and our
modifications to it from February 2, 1996 to December 31, 1998. As a result, Rae
Technology now has a non-transferable, perpetual, royalty-free non-exclusive
license to create and sell single user software programs primarily intended to
be used by individuals to manage personal data such as personal contacts,
events, schedules, tasks, projects, notes, pictures, lists of files and other
personal information.
On April 10, 1997, Rae Technology and we entered into a patent transfer and
license agreement under which we assigned all of our rights to four U.S. patent
applications and related rights and inventions and reserved for ourselves a
non-exclusive, perpetual, royalty-free, worldwide, irrevocable license to all of
the transferred rights and inventions, including any patents that issue on them.
Two patents have issued to date. The patent agreement was entered into in
connection with Rae Technology's amendment of the technology transfer agreement
in March 1997. Under the patent agreement we are entitled to receive 85% of all
license revenues earned by Rae Technology and its affiliates from the
transferred rights. We are obligated to reimburse Rae Technology for all patent
prosecution expenses and fees that are not offset by Rae Technology's share of
the licensing revenues. To date, Rae Technology has not earned any licensing
revenues and we have reimbursed Rae Technology a total of approximately $41,000.
We have the right to reacquire all of the transferred rights, including issued
patents, from Rae Technology under a number of circumstances, including on April
10, 1999 and April 10, 2000 upon payment of a $5,000 transfer fee to Rae
Technology, unless we otherwise determine not to reacquire the rights at that
time. We also may reacquire the transferred rights and any patents upon the
occurrence of events of default or Rae Technology's failure to meet licensing
revenue thresholds once it begins earning license fees.
STUDIO ARCHETYPE. In connection with our formation, Studio Archetype and we
entered into a technology license agreement dated December 21, 1995, under which
Studio Archetype granted to
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us, among other things, a non-exclusive, perpetual, transferable, worldwide and
royalty-free license, with a right of sublicense, to use intellectual property
rights and know-how referred to as the iD System. In exchange for that license
agreement, we issued 166,666 shares of Series A preferred stock to Studio
Archetype, valued at that time at approximately $150,000.
IBM RELATIONSHIP
Upon the effectiveness of the merger that resulted in IBM's acquisition of
approximately 80% of our stock, Messrs. Dayton, Zisman and Anderegg became
directors of our Company. After the offering, IBM will beneficially own
approximately % of our common stock and will continue to exercise significant
influence over the election of directors and other corporate matters and over
other matters submitted to a vote of our stockholders. We and IBM have entered
into numerous transactions and arrangements including the following:
MERGER AGREEMENT. IBM acquired its controlling interest in us on April 11,
1997 pursuant to an agreement and plan of merger dated March 18, 1997 under
which IBM acquired 10,495,968 shares of Series E preferred stock for
approximately $6.68 per share, representing at the time approximately 80% of our
voting securities. Pursuant to the merger agreement, each preferred stockholder
agreed, severally and not jointly, to indemnify IBM and its affiliates against
any losses arising from any inaccuracy in, or any breach of, representations and
warranties made by us in the merger agreement and any related documents. The
obligations of any preferred stockholder to indemnify IBM and its affiliates
were to be satisfied only from the preferred stockholder's pro rata portion of
the securities and other funds held in escrow in accordance with an escrow
agreement. Rae Technology agreed to indemnify IBM and its affiliates, to the
extent of Rae Technology's pro rata portion, with respect to any inaccuracy in,
or breach of, representations and warranties pertaining to intellectual property
transferred by Rae Technology to us at the time of our formation. The preferred
stockholders deposited all outstanding shares of, and warrants to purchase
shares of, Series A preferred stock, Series C preferred stock and Series F
preferred stock held by them and outstanding immediately after the effective
time of the merger, and 10% of the IBM common stock issued to them under the
merger agreement into an escrow to secure the payment of the indemnification
obligations described above. The shares of IBM common stock held in escrow were
released without claims or offset in April 1998. The remaining escrowed
securities will be released to the preferred stockholders upon the closing of
this offering, or April 11, 1999, if earlier.
In connection with the merger agreement, IBM also paid $250,000 for a
warrant to acquire 3,482,838 more shares of Series E preferred stock at an
exercise price of approximately $6.68 per share. During the same time period, we
and IBM also entered into a number of other agreements, including a stockholders
agreement, a patent license agreement and a software license agreement, each of
which is discussed below, and a registration rights agreement. For a description
of IBM's registration rights, see "Shares Eligible for Future Sale--Registration
Rights."
STOCKHOLDERS AGREEMENT. On March 18, 1997, NetObjects, IBM and some of our
stockholders executed a stockholders agreement that, among other things,
provided for "freedom of action" for IBM and its affiliates to compete with us
without liability for breach of any fiduciary duty or for usurping any
"corporate opportunity." These protections extended to IBM's representatives on
the board of directors. The stockholders agreement required approval by our
board of directors before our taking a number of actions, and these restrictions
were incorporated into Section 3.14 of our amended and restated bylaws. The
stockholders agreement was terminated in connection with the offering, but the
"freedom of action" provisions are contained in our restated certificate of
incorporation. For a discussion of risks associated with our relationship with
IBM, see "Risk Factors--Our dependence on IBM may present potential conflicts or
otherwise adversely affect our business."
PATENT LICENSE AGREEMENT. On April 10, 1997, we and IBM executed a patent
license agreement that grants IBM a nonexclusive, royalty-free, perpetual
license to our patents as they are issued.
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SOFTWARE LICENSE AGREEMENT. On March 18, 1997, we and IBM executed a
10-year software license agreement which provides for payment of royalties by
IBM to us in connection with sales of product bundles that include our products
and for payment to us for services performed in connection with the IBM
WebSphere project. Between March 18, 1997 and December 31, 1997, IBM made
nonrefundable prepayments to us totaling $10.5 million, which were recorded as
deferred revenues. As a result, any payments under the agreement, which include
services, royalty and internal license fee payment components, are credited
against the prepaid amount. This license agreement has been amended a number of
times. Under this agreement we have licensed IBM to use unlimited numbers of
copies for its employees' and contractors' internal use at a stated royalty rate
or for an annual fixed fee, at IBM's option. Under the software license
agreement we are obligated to place all of our source code into an escrow. IBM
may obtain access to the source code upon events of default related to our
failure to provide required maintenance and support or our bankruptcy or similar
event of financial reorganization. IBM may use the source code that it obtains
to create derivative works, which it will own subject to our rights in the
underlying software. See "Risk Factors--Our dependence on IBM may present
potential conflicts or otherwise adversely affect our business,"
"Business--Sales, Marketing and Distribution" and note 3 to notes to
consolidated financial statements for a discussion of risks associated with our
agreements with IBM.
LOAN AND SECURITY AGREEMENT. On December 23, 1997, we and IBM Credit Corp.
executed a revolving loan and security agreement, as amended, against which we
have drawn approximately $19 million in total principal amount and issued
convertible revolving credit notes to IBM Credit Corp. for a corresponding
amount. The revolving notes bear interest at LIBOR plus 1.5%. In the event of
our default under the revolving notes, IBM Credit Corp. has the right to convert
the unpaid balance into shares of common stock at the lower of approximately
$6.68 per share and a price determined by independent appraisal. To secure our
obligations under the loan agreement, we granted a recorded first priority
security interest in all of our assets, including intangible assets, to IBM
Credit Corp. IBM has guaranteed our obligations under the revolving notes. We
would not have been able to obtain a $19 million loan from an independent third
party without the guarantee from IBM. We were not in compliance with a financial
convenant in the loan agreement concerning the amount of our operating losses as
of December 31, 1998, but on February 3, 1999, IBM Credit Corp. waived our
compliance through December 31, 1998 and agreed to take no action with respect
to our noncompliance through April 30, 1999. We will use proceeds from this
offering to repay the credit facility, and it will terminate upon repayment. See
"Risk Factors--A substantial portion of the net offering proceeds will be used
to repay debt and not to implement our business model," "--Our dependence on IBM
may present potential conflicts or otherwise adversely affect our business--We
have depended heavily on IBM for financing but IBM has no obligation to provide
us with financing after this offering" and note 3 to notes to consolidated
financial statements for a discussion of our loan agreement with IBM.
NOTE AND WARRANT PURCHASE AGREEMENT. We and IBM are parties to a note and
warrant purchase agreement dated October 8, 1998, pursuant to which we have
issued convertible notes in the aggregate principal amount of approximately
$10.1 million and $825,000, respectively, to IBM and Perseus Capital, L.L.C., an
affiliate of Perseus U.S. Investors, L.L.C. The principal and interest due under
the convertible notes will be converted into shares of common stock upon closing
of this offering. The convertible notes are secured by a security interest in
all of our assets and properties that is second in priority to the security
interest we granted to IBM Credit Corp. On February 4, 1999, we and IBM amended
the note and warrant purchase agreement to permit us to sell up to $3.45 million
of notes and additional warrants to IBM. These notes will be payable in full
upon the closing of this offering. See "--Sales of Common Stock and Preferred
Stock."
VOTING AGREEMENT. In January 1999, we entered into a voting agreement with
IBM. For a description of the terms of this agreement, see
"Management--Contractual Arrangements."
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STRATEGIC RELATIONSHIPS. We have a number of relationships with IBM and its
subsidiary, Lotus, under which some of our products are offered for sale through
a variety of IBM and Lotus channels, all of which are governed by the terms of
the software license agreement. The software license agreement has been amended
several times, and letter agreements have been entered into under a specific
provision of the license agreement to address these relationships. During fiscal
year 1998, approximately 36% of our total revenues were derived from IBM. As
long as we remain a subsidiary of IBM we may receive greater access to customers
and marketing activities, including advertising, direct marketing, tradeshows
and seminars, and advertising media rates that are significantly lower than
those generally available to a company of our size in our industry. For a
discussion of risks associated with our strategic relationship with IBM, see
"Risk Factors--Our dependence on IBM may present potential conflicts or
otherwise adversely affect our business." and "Business--NetObjects Strategy."
DISTRIBUTION AGREEMENT WITH NOVELL
We also have a strategic relationship with Novell. On September 30, 1998,
Novell agreed to distribute NetObjects Fusion with Novell's NetWare for Small
Business product offering under a nonexclusive license agreement. This license
agreement continues through September 30, 1999 and will automatically renew for
additional one year periods unless terminated by either party. After the first
renewal year, either party may terminate the agreement on 90 days' written
notice. Christopher M. Stone, a Senior Vice President with Novell, will become a
director of NetObjects as of the offering date.
OUTSIDE DIRECTOR OPTION GRANTS AND EXPENSES
Effective on the closing of the offering, we will grant stock options to
Messrs. Sculley and Stone that will entitle each of them to purchase up to
20,000 shares of common stock at an exercise price equal to the public offering
price, vesting over four years. We also have granted an option to Mr. Sculley to
purchase up to 50,000 shares of common stock at an exercise price of $7.50,
vesting over four years, and will reimburse him for some expenses incurred in
connection with his attendance at board meetings.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of the common stock as of , 1999, assuming conversion of
all shares of preferred stock into common stock, and as adjusted to reflect the
sale of shares of common stock in the offering for (a) each person
known to us to own beneficially more than 5% of the common stock, (b) each of
our directors, (c) each of the named executive officers and (d) all executive
officers and directors as a group. Beneficial ownership is determined in
accordance with rules of the Securities and Exchange Commission (the
"Commission") and includes shares over which the beneficial owner exercises
voting or investment power. Shares of common stock subject to options or
warrants currently exercisable or exercisable within 60 days of ,
1999 are deemed outstanding for the purpose of computing the percentage
ownership of the person holding the options or warrants, but are not deemed
outstanding for the purpose of computing the percentage ownership of any other
person. Except as otherwise indicated, and subject to community property laws
where applicable, we believe, based on information provided by these persons,
that the persons named in the table below have sole voting and investment power
with respect to all shares of common stock shown as beneficially owned by them:
<TABLE>
<CAPTION>
COMMON STOCK
-------------------------------------------------------------
NUMBER OF SHARES
NUMBER OF SHARES ISSUABLE ON
ISSUABLE ON EXERCISE OF
NUMBER OF SHARES EXERCISE OF OUTSTANDING OPTIONS
BENEFICIALLY OUTSTANDING WITHIN 60 DAYS OF ,
NAME OWNED WARRANTS 1999
- -------------------------------------------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C>
International Business Machines Corporation (1)......... 15,723,485 3,717,506
New Orchard Road
Armonk, NY 10504
Samir Arora (2)......................................... 1,705,456 105,510 107,812
c/o NetObjects, Inc.
301 Galveston Drive
Redwood City, CA 94062
Perseus, L.L.C.(3)...................................... 1,272,103 1,148,577
The Army and Navy Club Building
16271 I Street, N.W., Suite 610
Washington, D.C. 20006
Kenneth Socha (4)..................................... 1,272,103 1,148,577
Frank Pearl (4)....................................... 1,272,103 1,148,577
David Kleinberg (4)..................................... 764,775 31,370 71,875
c/o NetObjects, Inc.
301 Galveston Drive
Redwood City, CA 94062
Norwest Equity Partners V (5)........................... 780,489 780,489
245 Lytton Avenue, Suite 250
Palo Alto, CA 94301
Itasca Partners V, LLP (4)............................ 780,489 780,489
George J. Still (4)................................... 780,489 780,489
John E. Lindahl (4)................................... 780,489 780,489
John P. Whaley (4).................................... 780,489 780,489
Venrock Associates, L.P. (6)............................ 757,071 757,071
30 Rockefeller Plaza, Room 5508
New York, NY 10112
Ted H. McCourtney (4)................................. 757,071 757,071
Anthony B. Eunin (4).................................. 757,071 757,071
Anthony Sun (4)....................................... 757,071 757,071
David R. Hathaway (4)................................. 757,071 757,071
Kimberly A. Rummelsburg (4)........................... 757,071 757,071
Ray A. Rothrok (4).................................... 757,071 757,071
Patrick F. Latterell (4).............................. 757,071 757,071
Rae Technology, LLC (7)................................. 698,187 105,510
Rae Technology, LLC II
1072 De Anza Blvd., Suite A107
San Jose, CA 95129
Morris Taradalsky (8)................................... 84,692 61,111
Mark Patton............................................. 68,682 68,682
John Sculley............................................ 56,192 56,192
Robert G. Anderegg...................................... 0
Lee A. Dayton........................................... 0
Michael D. Zisman....................................... 0
All directors and executive officers as a group (12
persons) (9)............................................ 3,247,705 172,255 474,939
<CAPTION>
PERCENT OWNERSHIP
----------------------------
BEFORE AFTER
NAME OFFERING OFFERING
- -------------------------------------------------------- ------------- -------------
<S> <C> <C>
International Business Machines Corporation (1)......... 81.0% %
New Orchard Road
Armonk, NY 10504
Samir Arora (2)......................................... 11.9
c/o NetObjects, Inc.
301 Galveston Drive
Redwood City, CA 94062
Perseus, L.L.C.(3)...................................... 8.3
The Army and Navy Club Building
16271 I Street, N.W., Suite 610
Washington, D.C. 20006
Kenneth Socha (4)..................................... 8.3
Frank Pearl (4)....................................... 8.3
David Kleinberg (4)..................................... 5.4
c/o NetObjects, Inc.
301 Galveston Drive
Redwood City, CA 94062
Norwest Equity Partners V (5)........................... 5.3
245 Lytton Avenue, Suite 250
Palo Alto, CA 94301
Itasca Partners V, LLP (4)............................ 5.3
George J. Still (4)................................... 5.3
John E. Lindahl (4)................................... 5.3
John P. Whaley (4).................................... 5.3
Venrock Associates, L.P. (6)............................ 5.1
30 Rockefeller Plaza, Room 5508
New York, NY 10112
Ted H. McCourtney (4)................................. 5.1
Anthony B. Eunin (4).................................. 5.1
Anthony Sun (4)....................................... 5.1
David R. Hathaway (4)................................. 5.1
Kimberly A. Rummelsburg (4)........................... 5.1
Ray A. Rothrok (4).................................... 5.1
Patrick F. Latterell (4).............................. 5.1
Rae Technology, LLC (7)................................. 5.0
Rae Technology, LLC II
1072 De Anza Blvd., Suite A107
San Jose, CA 95129
Morris Taradalsky (8)................................... *
Mark Patton............................................. *
John Sculley............................................ *
Robert G. Anderegg...................................... *
Lee A. Dayton........................................... *
Michael D. Zisman....................................... *
All directors and executive officers as a group (12
persons) (9)............................................ 22.1% %
</TABLE>
- ----------------------------------
* Less than 1%.
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(1) Includes 1,510,011 shares of common stock issuable on conversion of
outstanding convertible notes.
(2) Includes 299,457 shares owned by Information Capital LLC, wholly owned by
Mr. Arora. Also includes 592,677 shares of common stock and 105,510 shares
of common stock issuable on exercise of outstanding warrants to purchase
convertible preferred stock owned by Rae Technology because he is its
President and owns a majority of its equity interests. Mr. Arora exercises
sole voting and dispositive power over the shares held by Rae Technology,
but disclaims beneficial ownership of the Rae Technology shares except to
the extent of his pecuniary interest therein. Sal Arora is the brother of
Samir Arora.
(3) Perseus U.S. Investors, L.L.C. holds 1,136,198 shares of common stock
issuable on exercise of warrants, and Perseus Capital, L.L.C. holds 12,379
shares of common stock issuable on exercise of warrants. Includes 123,526
shares of common stock issuable on conversion of outstanding convertible
notes held by Perseus Capital, L.L.C. Perseus, L.L.C. is the manager of
Perseus U.S. Investors, L.L.C. and the indirect manager of Perseus Capital,
L.L.C. Three of our directors, Messrs. Sculley, Zisman and Arora, are
members of Perseus Capital, L.L.C. and one director, Mr. Sculley, is also a
member of Perseus U.S. Investors, L.L.C. They have no voting or dispositive
power over shares held by the Perseus entities and disclaim beneficial
ownership of all common stock held by the Perseus entities except to the
extent of their respective pecuniary interests therein.
(4) The individuals or entities listed have sole or shared voting and
dispositive power over the shares. Each party disclaims beneficial
ownership of the shares except to the extent of any pecuniary interest in
the shares.
(5) Includes 176,909 shares of common stock and 31,370 shares of common stock
issuable on exercise of outstanding warrants to purchase convertible
preferred stock, which is Mr. Kleinberg's pro rata share of securities held
by Rae Technology.
(6) Includes 323,592 and 433,479 shares of common stock issuable on exercise of
outstanding warrants for purchase of convertible preferred stock owned by
Venrock Associates L.P. and Venrock Associates II, L.P., respectively.
(7) Five of our officers are members of Rae Technology but only Samir Arora has
voting or dispositive power with respect to the shares.
(8) Includes 20,018 shares of common stock and 3,563 shares of common stock
issuable on exercise of outstanding warrants to purchase convertible
preferred stock, which is Mr. Taradalsky's pro rata share of securities
held by Rae Technology.
(9) Includes securities held by Rae Technology and Studio Archetype, which
entities are owned or controlled by officers of NetObjects.
65
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The following description of our capital stock and provisions of our
restated certificate of incorporation and restated bylaws is a summary only and
is necessarily not a complete description. The descriptions of the common stock
and preferred stock reflect changes to our capital structure that will occur on
effectiveness of the offering under the terms of our restated certificate of
incorporation.
The authorized capital stock of NetObjects consists of 33,333,333 shares of
common stock, par value $0.01 per share, and 22,816,300 shares of preferred
stock, par value $0.01 per share.
COMMON STOCK
As of December 31, 1998, 2,088,561 shares of common stock were outstanding
and held of record by 89 stockholders, assuming no exercise after December 31,
1998 of outstanding options or warrants. Each holder of common stock is entitled
to the following:
- one vote per share;
- dividends as may be declared by our board of directors out of funds
legally available therefor subject to the rights of any preferred stock
that may be outstanding; and
- pro rata share in any distribution of our assets after payment or
providing for the payment of liabilities and the liquidation preference of
any outstanding preferred stock in the event of liquidation.
Holders of common stock have no cumulative voting rights or preemptive rights to
purchase or subscribe for any shares of our common stock or other securities.
All the outstanding shares of common stock are fully paid and nonassessable. As
of December 31, 1998, 2,629,575 shares of common stock were issuable upon
exercise of outstanding options at a weighted average exercise price of $2.38
per share.
PREFERRED STOCK
Our board of directors has the authority, subject to any limitations
prescribed by Delaware law, to issue shares of preferred stock in one or more
series and to fix and determine the relative rights and preferences of the
shares constituting any series to be established without any further vote or
action by the stockholders. Any shares of preferred stock so issued may have
priority over the common stock with respect to dividend, liquidation and other
rights. On closing of the offering, no shares of preferred stock will be
outstanding. We have no current intention to issue any shares of preferred
stock.
WARRANTS TO PURCHASE PREFERRED STOCK
As of December 31, 1998, we had outstanding warrants to purchase:
- 2,250,500 shares of Series C preferred stock at an exercise price of
approximately $1.82 per share which will terminate automatically on the
closing of the offering through cashless exercise by surrender of shares
of common stock as payment of the exercise price;
- 3,482,838 shares of Series E preferred stock at an exercise price of
approximately $6.68 per share which will expire on April 11, 2000;
- 163,715 shares of Series E-2 preferred stock at an exercise price of
approximately $6.68 per share which will expire between October 2003 and
February 2004;
- 16,666 shares of Series F-2 preferred stock at an exercise price of
approximately $9.00 per share which will terminate on the closing of the
offering without becoming exercisable; and
- 916,666 shares of Series F preferred stock at an exercise price of
approximately $10.80 per share which will expire between March 2000 and
December 2000.
66
<PAGE>
The warrants to purchase shares of Series E preferred stock, Series E-2
preferred stock and Series F preferred stock will be exercisable for an
equivalent number of shares of common stock following the offering. For more
detail about the warrants to purchase preferred stock, see "Certain
Transactions--Sales of Common Stock and Preferred Stock."
VOTING AND OTHER MATTERS
The Board may authorize the issuance of preferred stock with voting or
conversion rights that could adversely affect the voting power or other rights
of the holders of common stock. The issuance of preferred stock, while providing
flexibility in connection with possible acquisitions and other corporate
purposes, could, under some circumstances, have the effect of delaying,
deferring or preventing a change of control.
ANTITAKEOVER EFFECTS OF PROVISIONS OF NETOBJECTS' RESTATED CERTIFICATE OF
INCORPORATION AND AMENDED AND RESTATED BYLAWS
The restated certificate of incorporation contains provisions relating to
the rights and powers of IBM that could have the effect of delaying, deferring
or preventing a change in control of NetObjects. For a description of the risks
associated with IBM's control of us, see "Risk Factors-- Our dependence on IBM
may present potential conflicts or otherwise adversely affect our business."
Special meetings of the stockholders may be called only by the board of
directors, the Chairman of the board of directors, the Chief Executive Officer
or any holder of at least 25% of our outstanding common stock. The amended and
restated bylaws provide that stockholders seeking to bring business before, or
to nominate directors at, an annual meeting of stockholders must provide timely
notice thereof in writing. To be timely, a stockholder's notice must be received
by our Secretary not less than 120 calendar days nor more than 150 calendar days
before the date of our proxy statement sent to stockholders for the prior year's
annual meeting. The amended and restated bylaws also contain notice provisions
in the event that no annual meeting was held in the previous year, or if the
date of the applicable annual meeting has been changed by more than 30 days. The
amended and restated bylaws also contain specific requirements for the form of a
stockholder's notice. These provisions may preclude or deter some stockholders
from bringing matters before the stockholders or from making nominations of
directors, and may have the effect of delaying, deferring or preventing a change
in control of our company.
CONTRACTUAL AGREEMENTS RELATING TO VOTING
Under the voting agreement, IBM has agreed, in some circumstances, that it
shall not be permitted to elect more than three of the six directors,
notwithstanding its position as our majority stockholder. For a description of
the terms of this agreement, see "Management--Contractual Arrangements."
WAIVER OF DELAWARE ANTITAKEOVER STATUTE
Section 203 of the DGCL generally prohibits a publicly-held Delaware
corporation from engaging in a merger, asset sale or other transaction resulting
in a financial benefit with any person who, together with affiliation and
association, owns, or within three years, did own, 15% or more of a
corporation's voting stock. The prohibition continues for a period of three
years after the date of the transaction in which the person became an owner of
15% or more of the corporation's voting stock unless the business combination is
approved in a prescribed manner. The statute could prohibit or delay, defer or
prevent a "change in control" with respect to NetObjects. However, we have
waived the provisions of Section 203 by an amendment to our restated certificate
of incorporation.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is Boston EquiServe.
67
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
If our stockholders sell substantial amounts of our stock in the public
market following the offering, then the market price of our stock could fall.
After the offering, shares of our stock will be outstanding,
assuming no exercise of the underwriters' over-allotment option and no exercise
of outstanding options or warrants. Of those shares, the shares sold in
the offering will be freely tradable except for any shares purchased by our
"affiliates," as defined in Rule 144 under the Securities Act. The remaining
restricted shares are "restricted securities," as that term is
defined in Rule 144, and may be sold in the public market only if registered or
if they qualify for an exemption from registration under Rule 144 or Rule 701,
which rules are summarized below. All of our officers and directors and almost
all of our stockholders have signed lock-up agreements pursuant to which they
have agreed not to sell any shares of common stock, or any securities
convertible into or exercisable or exchangeable for common stock, for 180 days
after the offering without the prior written consent of BT Alex. Brown. BT Alex.
Brown may, in its sole discretion, release all or any portion of the shares
subject to the lock up agreements.
The following table depicts securities eligible for future sale:
<TABLE>
<S> <C>
Total shares outstanding...........................................
---------
Total restricted securities........................................
---------
Shares that are freely saleable after the date of this prospectus
under Rule 144(k), subject to the 180-day lock-up agreement......
---------
Shares that are freely saleable 90 days after the date of this
prospectus under Rule 144, subject to the 180-day lock-up
agreement........................................................
---------
Shares that are freely saleable 180 days after the date of this
prospectus under Rule 144 (subject, in some cases, to volume
limitations), under Rule 144(k) or pursuant to a registration
statement to register for resale shares of common stock issued on
exercise of stock options........................................
---------
</TABLE>
Following the offering, we intend to file a registration statement under the
Securities Act covering shares of common stock reserved for
issuance under the 1997 Plan, the Special Plan and the ESPP. Upon expiration of
the lock-up agreements, at least shares of common stock will be
subject to vested options, based on options outstanding as of December 31, 1998.
The registration statement is expected to be filed and become effective prior to
expiration of the lock up agreements; accordingly, shares registered under the
registration statement will, subject to Rule 144 volume limitations applicable
to "affiliates," be available for sale in the open market immediately after the
lock up agreements expire. In addition, shares of common stock
issuable upon exercise of warrants, assuming all outstanding warrants are
exercised, all of which are subject to the lock up agreements, will be eligible
for sale following expiration of the lock up agreements, subject to compliance
with Rule 144.
Assuming the exercise of the Series E preferred stock warrant by IBM, the
conversion of all Series E preferred stock into common stock and conversion of
all Series C preferred stock into common stock, the exercise of a warrant for
Series F-2 preferred stock by Novell and conversion of all Series F-2 preferred
stock into common stock, and the conversion of all convertible notes and
exercise or conversion of the warrants issued under the note and warrant
purchase agreement and conversion of all Series E-2 preferred stock, the holders
of shares of common stock and warrants have demand and piggyback
registration rights. The exercise of these rights could adversely affect the
market price of our stock. For the details of the registration rights, see
"--Registration Rights."
68
<PAGE>
In general, Rule 144 provides that any person who has beneficially owned
shares for at least one year, including an affiliate, is generally entitled to
sell, within any three-month period, a number of shares that does not exceed the
greater of 1% of the shares of common stock then outstanding, approximately
shares immediately after the offering or the reported average
weekly trading volume of the common stock during the four calendar weeks
immediately preceding the date on which notice of the sale is sent to the
Commission. Sales under Rule 144 are subject to manner of sale restrictions,
notice requirements and availability of current public information concerning
us. A person who is not an affiliate of ours, and who has not been an affiliate
within three months prior to the sale, generally may sell shares without regard
to the limitations of Rule 144 provided that the person has held the shares for
at least two years. Under Rule 144(k), a person who is not deemed to have been
an "affiliate" of ours at any time during the 90 days preceding a sale, and who
has beneficially owned the shares proposed to be sold for at least two years, is
entitled to sell the shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.
Any employee, director or officer of ours, or consultant to us, holding
shares purchased pursuant to a written compensatory plan or contract, including
options, entered into prior to the offering is entitled to rely on the resale
provisions of Rule 701, which permit nonaffiliates to sell shares without having
to comply with the public information, holding period, volume limitation or
notice requirements of Rule 144 and permit affiliates to sell their Rule 701
shares without having to comply with the holding period restrictions of Rule
144, in each case beginning 90 days after the date of this prospectus.
REGISTRATION RIGHTS
Our second amended and restated registration rights agreement provides
rights to register shares under the Securities Act to some holders of our
capital stock or their permitted transferees. Under the terms of this agreement,
if we propose to register any of our securities under the Securities Act in an
underwritten primary registration, we must include the shares that we have been
requested to register pursuant to "piggyback" rights, subject to any limitation
set by the underwriters on the number of shares included in the registration.
Also, IBM may require us to use our best efforts, not more than twice, to file a
registration statement under the Securities Act, at our expense, with respect to
IBM's shares of common stock. None of the shares of any stockholder have been
registered for sale in this offering.
Following this offering, IBM also may require us to use our best efforts to
file up to two registration statements on Form S-3, at the expense of IBM,
provided that the aggregate offering price net of underwriting discounts and
commissions for each registration is not less than $500,000. In addition, any
holder of Series E-2 preferred stock and any holder of at least 100,000 shares
of Series F-2 preferred stock may require us to use our best efforts to file
registration statements on Form S-3, at our expense, to register shares of
common stock acquired in connection with the exercise of warrants. IBM may
assign its registration rights to any person to whom it transfers at least
1,000,000 shares of common stock.
69
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement, the
underwriters named below, through their representatives BT Alex. Brown
Incorporated, BancBoston Robertson Stephens and U.S. Bancorp Piper Jaffray Inc.,
the underwriters' representatives, have severally agreed to purchase from us the
following numbers of shares of common stock at the initial public offering price
less the underwriting discounts and commissions set forth on the cover page of
this prospectus:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- -------------------------------------------------------------------------------------------------- --------------
<S> <C>
BT Alex. Brown Incorporated.......................................................................
BancBoston Robertson Stephens.....................................................................
U.S. Bancorp Piper Jaffray Inc....................................................................
--------------
Total.........................................................................................
--------------
--------------
</TABLE>
The underwriting agreement provides that the obligations of the underwriters
are subject to specified conditions and that the underwriters will purchase all
shares of the common stock offered in the offering if any of the shares are
purchased.
One of the closing conditions to this offering is that KPMG LLP reissue
their independent auditors' report on our consolidated financial statements as
of September 30, 1997 and 1998 and for the period from our inception, November
21, 1995, to September 30, 1996, and for the two year period ended September 30,
1998. This report shall exclude the explanatory paragraph that states that our
recurring losses and net capital deficiency raise substantial doubt about our
ability to continue as a going concern.
We have been advised by the underwriters' representatives that the
underwriters propose to offer the shares of common stock to the public at the
initial public offering price set forth on the cover page of this prospectus and
to dealers at that price less a concession not in excess of $ per share.
The underwriters may allow, and the dealers may re-allow, a concession not in
excess of $ per share to other dealers. After the initial public offering,
the offering price and other selling terms may be changed by the underwriters'
representatives.
We have granted to the underwriters an option, exercisable not later than 30
days after the date of this prospectus, to purchase up to additional
shares of common stock at the initial public offering price less the
underwriting discounts and commissions set forth on the cover page of this
prospectus. To the extent that the underwriters exercise the option, each of the
underwriters will have a firm commitment to purchase approximately the same
percentage of the option shares that the number of shares of common stock to be
purchased by it in the above table bears to the total number of shares to be
sold in the offering. The underwriters may exercise the option only to cover
over-allotments made in connection with the sale of the common stock offered in
the offering. If purchased, the underwriters will offer the additional shares on
the same terms as those on which the shares are being offered.
At our request, the underwriters have reserved up to shares of
common stock for sale, at the initial public offering price, to employees and
friends of ours through a directed share program. The number of shares of common
stock available for sale to the general public in the public offering will be
reduced to the extent that employees and friends purchase the reserved shares.
70
<PAGE>
AMOUNTS PAYABLE TO THE UNDERWRITERS
<TABLE>
<CAPTION>
NO EXERCISE FULL EXERCISE
------------ -------------
<S> <C> <C>
Per Share............................................................................ $ $
Total................................................................................ $
</TABLE>
We have agreed to indemnify the underwriters against liabilities, including
liabilities under the Securities Act of 1933.
Each of our officers, directors and a substantial majority of our
stockholders have agreed not to offer, sell, contract to sell or otherwise
dispose of, or enter into any transaction which is designed to, or could be
expected to result in the disposition of any portion of, any common stock for a
period of 180 days after the effective date of the registration statement of
which this prospectus is a part, without the prior written consent of BT Alex.
Brown Incorporated, except in the case of transfers to charitable organizations
or from entities to their partners. Such consent may be given at any time
without public notice. We have entered into a similar agreement, except that we
may issue, and grant options or warrants to purchase, shares of common stock or
any securities convertible into, exercisable for or exchangeable for shares of
common stock, pursuant to the exercise of outstanding options and warrants and
our issuance of options and stock granted under the existing stock option and
stock purchase plans.
The underwriters' representatives have advised us that the underwriters do
not intend to confirm sales to any account over which they exercise
discretionary authority.
Prior to this offering, there has been no public market for our common
stock. Consequently, the initial public offering price for the common stock will
be determined by negotiation among us and the underwriters' representatives.
Among the factors considered in negotiations are prevailing market conditions,
our results of operations in recent periods, the market capitalizations and
stages of development of other companies that we and the underwriters'
representatives believe to be comparable to us, estimates of our business
potential, the present stage of our development and other factors deemed
relevant.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
market price of the common stock. Specifically, the underwriters may over-allot
shares of the common stock in connection with this offering, thereby creating a
short position in the underwriters' syndicate account. Additionally, to cover
over-allotments or to stabilize the market price of the common stock, the
underwriters may bid for, and purchase, shares of the common stock in the open
market. Any of these activities may maintain the market price of the common
stock at a level above that which might otherwise prevail in the open market.
The underwriters are not required to engage in these activities, and, if
commenced, the activities may be discontinued at any time. The underwriters'
representatives, on behalf of the underwriters, also may reclaim selling
concessions allowed to an underwriter or dealer, if the syndicate repurchases
shares distributed by that underwriter or dealer.
LEGAL MATTERS
The validity of the common stock being offered hereby will be passed upon
for NetObjects by Graham & James LLP, Palo Alto, California. Partners of Graham
& James LLP performing services for us directly or indirectly beneficially own
12,934 shares of the common stock. Alan Kalin, a partner in the firm of Graham &
James LLP, serves as our Secretary. Legal matters in connection with the
offering will be passed upon for the underwriters by Cravath, Swaine & Moore,
New York, New York.
71
<PAGE>
EXPERTS
The consolidated financial statements and schedule of NetObjects, Inc. as of
September 30, 1997 and 1998, and for the period from November 21, 1995
(inception) to September 30, 1996, and for each of the years in the two-year
period ended September 30, 1998 included herein and in the registration
statement are included in reliance upon the report of KPMG LLP, independent
auditors, appearing elsewhere herein, and upon the authority of said firm as
experts in accounting and auditing.
The report of KPMG LLP covering the September 30, 1998 consolidated
financial statements contains an explanatory paragraph that states that our
recurring losses from operations and net capital deficiency raise substantial
doubt about our ability to continue as a going concern. The consolidated
financial statements do not include any adjustments that might result from the
outcome of that uncertainty.
CHANGE IN AUDITORS
Ernst & Young LLP was previously our principal accountant. On October 29,
1997, Ernst & Young LLP was dismissed as principal accountants and KPMG LLP was
engaged to audit our consolidated financial statements. The board of directors
has approved the appointment of KPMG LLP as our principal accountants.
In connection with the audit for the period from November 21, 1995, our
inception, through September 30, 1996, and the subsequent interim period through
October 29, 1997, there were no disagreements with Ernst & Young LLP on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedures, which disagreements if not resolved to their
satisfaction would have caused them to make reference in connection with their
opinion on the subject matter of the disagreement.
The audit report of Ernst & Young LLP on our consolidated financial
statements as of and for the period from November 21, 1995, our inception,
through September 30, 1996 contained a statement that our operating loss since
inception raises substantial doubt about our ability to continue as a going
concern.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Commission a registration statement on Form S-1,
including exhibits, schedules and amendments filed with this registration
statement, under the Securities Act with respect to the common stock pursuant to
be sold under this prospectus. Prior to the offering we were not required to
file reports with the Commission. This prospectus does not contain all the
information set forth in the registration statement. For further information
about NetObjects and the shares of common stock to be sold in the offering,
please refer to the registration statement. Statements made in this prospectus
concerning the contents of any contract, agreement or other document filed as an
exhibit to the registration statement are summaries of the terms of contracts,
agreements or documents and are not necessarily complete. Complete exhibits have
been filed with the registration statement.
The registration statement and exhibits may be inspected, without charge,
and copies may be obtained at prescribed rates, at the Commission's Public
Reference facility maintained by the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. The registration
statement and other information filed with the Commission is available at the
web site maintained by the Commission on the world wide web at
http://www.sec.gov.
We intend to furnish our stockholders with annual reports containing
financial statements audited by our independent accountants and quarterly
reports for the first three quarters of each fiscal year containing unaudited
financial statements.
72
<PAGE>
NETOBJECTS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report.......................................................... F-2
Consolidated Balance Sheets as of September 30, 1997 and 1998 and December 31, 1998
(unaudited)......................................................................... F-3
Consolidated Statements of Operations for the period from November 21, 1995
(inception) to September 30, 1996, for the years ended September 30, 1997 and 1998
and for the three month periods ended December 31, 1997 and 1998 (unaudited)........ F-4
Consolidated Statements of Shareholders' Deficit for the period from November 21, 1995
(inception) to September 30, 1996, for the years ended September 30, 1997 and 1998
and for the three month period ended December 31, 1998 (unaudited).................. F-5
Consolidated Statements of Cash Flows for the period from November 21, 1995
(inception) to September 30, 1996, for the years ended September 30, 1997 and 1998
and for the three month periods ended December 31, 1997 and 1998 (unaudited)........ F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
NetObjects, Inc.:
We have audited the accompanying consolidated balance sheets of NetObjects,
Inc. and subsidiary (the Company), a majority owned subsidiary of IBM
Corporation, as of September 30, 1997 and 1998, and the related consolidated
statements of operations, stockholders' deficit, and cash flows for the period
from November 21, 1995 (inception) to September 30, 1996, and for each of the
years in the two-year period ended September 30, 1998. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of NetObjects,
Inc. and subsidiary, a majority owned subsidiary of IBM Corporation, as of
September 30, 1997 and 1998, and the results of their operations and their cash
flows for the period from November 21, 1995 (inception) to September 30, 1996,
and for each of the years in the two-year period ended September 30, 1998, in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1(d) to the consolidated financial statements, the Company has suffered
recurring losses from operations and has a net capital deficit that raises
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1(d). The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
KPMG LLP
Mountain View, California,
December 21, 1998
F-2
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM CORPORATION)
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, 1998
-------------------- ------------------------
1997 1998 ACTUAL PRO FORMA(A)
--------- --------- --------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash............................................................ $ 303 $ 459 $ 1,288 $ 5,061
Accounts receivable, net of allowances of $781, $2,263, and
$1,789 as of September 30, 1997 and 1998, and December 31,
1998, respectively............................................ 2,018 2,292 3,074 3,074
Prepaid expenses and other current assets....................... 448 754 1,037 1,037
--------- --------- --------- -------------
Total current assets........................................ 2,769 3,505 5,399 9,172
Property and equipment, net....................................... 1,836 1,640 2,103 2,103
--------- --------- --------- -------------
Total assets...................................................... $ 4,605 $ 5,145 $ 7,502 $ 11,275
--------- --------- --------- -------------
--------- --------- --------- -------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Short-term borrowings from IBM and IBM Credit Corp.............. $ -- $ 20,666 $ 18,813 $ 18,813
Short-term borrowings........................................... 2,050 -- -- --
Accounts payable................................................ 2,518 4,723 4,461 4,461
Accrued compensation............................................ 1,041 1,690 1,322 1,322
Other accrued liabilities....................................... 684 1,066 1,223 1,223
Deferred revenue from IBM....................................... 6,228 5,121 2,316 2,316
Other deferred revenues......................................... 61 169 297 297
Current portion of capital lease obligations.................... 303 299 286 286
--------- --------- --------- -------------
Total current liabilities................................... 12,885 33,734 28,718 28,718
Capital lease obligations, less current portion................... 633 336 271 271
Convertible notes from IBM and related party...................... -- -- 7,690 --
--------- --------- --------- -------------
Total long-term obligations................................. 633 336 7,961 271
--------- --------- --------- -------------
Total liabilities........................................... 13,518 34,070 36,679 28,989
--------- --------- --------- -------------
Commitments
Stockholders' deficit:
Preferred stock, $0.01 par value; 22,816,333 shares authorized;
11,394,965, 11,576,937 and 11,965,826 shares issued and
outstanding as of September 30, 1997 and 1998 and December 31,
1998, respectively, and none outstanding on a pro forma basis
as of December 31, 1998 (aggregrate liquidation preference of
$75,279,768 as of September 30, 1998)......................... 107 109 113 --
Common stock, $0.01 par value; 28,333,333 shares authorized;
1,857,449, 2,001,186, and 2,088,561 shares issued and
outstanding as of September 30, 1997 and 1998 and December 31,
1998, respectively, and 18,889,616 shares issued and
outstanding on a pro forma basis at December 31, 1998......... 18 20 21 189
Additional paid-in capital...................................... 15,599 18,318 26,567 37,975
Deferred stock-based compensation............................... -- (541) (441) (441)
Notes receivable from stockholders.............................. (143) (113) (113) (113)
Accumulated other comprehensive losses.......................... -- -- (6) (6)
Accumulated deficit............................................. (24,494) (46,718) (55,318) (55,318)
--------- --------- --------- -------------
Total stockholders' deficit................................. (8,913) (28,925) (29,177) (18,973)
--------- --------- --------- -------------
Total liabilities and stockholders' deficit..................... $ 4,605 $ 5,145 $ 7,502 $ 11,275
--------- --------- --------- -------------
--------- --------- --------- -------------
</TABLE>
- ------------------------------
(a) Assumes the conversion of 11,965,826 shares of preferred stock into common
stock, the issuance of $2.6 million in convertible debt, the exercise of
warrants to purchase 652,224 shares of Series C preferred stock for cash
consideration of $1.2 million, the issuance of 1,664,700 shares of common
stock, reflecting the conversion of $10,910,000 of convertible debt and
$208,125 in related interest and the issuance of 2,518,305 shares of common
stock upon the cashless exercise of 1,598,276, 3,482,838 and 163,714
warrants to purchase Series C, Series E and Series E-2 convertible preferred
stock, respectively at a weighted average exercise price of $5.20 per share
by surrending shares of common stock as payment of the exercise price,
assuming an initial public offering price of $ per share.
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
PERIOD FROM
NOVEMBER 21,
1995 YEAR ENDED THREE MONTHS ENDED
(INCEPTION) TO SEPTEMBER 30, DECEMBER 31,
SEPTEMBER 30, ---------------------- ----------------------
1996 1997 1998 1997 1998
-------------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Software license fees....................... $ -- $ 7,392 $ 9,703 $ 2,086 $ 2,622
Service revenues............................ -- -- -- -- 190
Software license fees from IBM.............. -- 175 2,700 199 1,318
Service revenues from IBM................... -- -- 2,867 -- 1,487
-------------- ---------- ---------- ---------- ----------
Total revenues............................ -- 7,567 15,270 2,285 5,617
-------------- ---------- ---------- ---------- ----------
Cost of revenues:
Software license fees....................... -- 772 2,531 278 495
Service revenues............................ -- -- -- -- 184
Service revenues from IBM................... -- -- 2,562 -- 1,404
-------------- ---------- ---------- ---------- ----------
Total cost of revenues.................... -- 772 5,093 278 2,083
-------------- ---------- ---------- ---------- ----------
Gross profit.............................. -- 6,795 10,177 2,007 3,534
-------------- ---------- ---------- ---------- ----------
Operating expenses:
Research and development.................... 2,765 8,436 10,231 3,070 2,204
Sales and marketing......................... 2,998 12,161 17,114 4,060 4,430
General and administrative.................. 978 3,762 3,575 769 894
Stock-based compensation.................... -- -- 227 -- 100
-------------- ---------- ---------- ---------- ----------
Total operating expenses.................. 6,741 24,359 31,147 7,899 7,628
-------------- ---------- ---------- ---------- ----------
Operating loss............................ (6,741) (17,564) (20,970) (5,892) (4,094)
Interest income (expense)..................... 46 (234) (1,194) (168) (712)
Nonrecurring interest charge on beneficial
conversion feature of convertible debt...... -- -- -- -- (3,792)
-------------- ---------- ---------- ---------- ----------
Loss before income taxes.................. (6,695) (17,798) (22,164) (6,060) (8,598)
Income taxes.................................. -- 1 60 7 2
-------------- ---------- ---------- ---------- ----------
Net loss.................................. $ (6,695) $ (17,799) $ (22,224) $ (6,067) $ (8,600)
Translation adjustment........................ -- -- -- -- (6)
-------------- ---------- ---------- ---------- ----------
Comprehensive loss........................ $ (6,695) $ (17,799) $ (22,224) $ (6,067) $ (8,606)
-------------- ---------- ---------- ---------- ----------
-------------- ---------- ---------- ---------- ----------
Basic and diluted net loss per share.......... $ (4.10) $ (10.45) $ (12.26) $ (3.47) $ (4.40)
-------------- ---------- ---------- ---------- ----------
-------------- ---------- ---------- ---------- ----------
Shares used to compute basic and diluted net
loss per share.............................. 1,634,259 1,702,726 1,812,484 1,750,450 1,956,433
-------------- ---------- ---------- ---------- ----------
-------------- ---------- ---------- ---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
NETOBJECTS INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
PERIOD FROM NOVEMBER 21, 1995 (INCEPTION) TO SEPTEMBER 30, 1996 AND FOR THE
YEARS ENDED SEPTEMBER 30, 1997 AND 1998
AND FOR THE THREE MONTH PERIOD ENDED DECEMBER 31, 1998 (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREFERRED STOCK
-----------------------------------------------------------------------------------
SERIES A SERIES B SERIES C SERIES E SERIES F
-------------- -------------- -------------- -------------- ---------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances as of November 21, 1995
(inception)...................... -- $-- -- $-- -- $-- -- $-- -- $--
Exercise of stock options.......... -- -- -- -- -- -- -- -- -- --
Issuance of common stock........... -- -- -- -- -- -- -- -- -- --
Issuance of Series A preferred
stock in exchange for
technology....................... 1,833 -- -- -- -- -- -- -- -- --
Issuance of Series B preferred
stock, net of $59 in issuance
fees............................. -- -- 4,467 45 -- -- -- -- -- --
Net loss........................... -- -- -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Balances, September 30, 1996....... 1,833 -- 4,467 45 -- -- -- -- -- --
Exercise of stock options.......... -- -- -- -- -- -- -- -- -- --
Issuance of common stock........... -- -- -- -- -- -- -- -- -- --
Repurchase of restricted stock..... -- -- -- -- -- -- -- -- -- --
Warrants exercised................. -- -- 27 -- 4,821 48 23 -- -- --
Issuance of Series E and F
warrants......................... -- -- -- -- -- -- -- -- -- --
Conversion of Series A, B, and C
preferred stock to Series E
preferred stock.................. (1,181) -- (4,494) (45) (4,821) (48) 10,495 105 -- --
Issuance of Series E preferred
stock............................ -- -- -- -- -- -- 225 2 -- --
Net loss........................... -- -- -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Balances, September 30, 1997....... 652 -- -- -- -- -- 10,743 107 -- --
Exercise of stock options.......... -- -- -- -- -- -- -- -- -- --
Issuance of common stock........... -- -- -- -- -- -- -- -- -- --
Repurchase of restricted stock..... -- -- -- -- -- -- -- -- -- --
Warrant to purchase Series F
preferred stock.................. -- -- -- -- -- -- -- -- -- --
Issuance of Series E preferred
stock............................ -- -- -- -- -- -- 182 2 -- --
Repayment of stockholder notes
receivable....................... -- -- -- -- -- -- -- -- -- --
Deferred compensation related to
stock option grants.............. -- -- -- -- -- -- -- -- -- --
Amortization of stock-based
compensation..................... -- -- -- -- -- -- -- -- -- --
Net loss........................... -- -- -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Balances, September 30, 1998....... 652 $-- -- $-- -- $-- 10,925 $109 -- $--
Exercise of stock options
(unaudited)...................... -- -- -- -- -- -- -- -- -- --
Issuance of common stock
(unaudited)...................... -- -- -- -- -- -- -- -- -- --
Repurchase of restricted stock
(unaudited)...................... -- -- -- -- -- -- -- -- -- --
Issuance of in the money
convertible debt and warrants to
purchase Series E preferred stock
(unaudited)...................... -- -- -- -- -- -- -- -- -- --
Issuance of Series F preferred
stock net of $30 issuance costs
(unaudited)...................... -- -- -- -- -- -- -- -- 389 4
Amortization of stock-based
compensation (unaudited)......... -- -- -- -- -- -- -- -- -- --
Translation adjustment
(unaudited)...................... -- -- -- -- -- -- -- -- -- --
Net loss (unaudited)............... -- -- -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Balances, December 31, 1998
(unaudited)...................... 652 $-- -- $-- -- $-- 10,925 $109 389 $ 4
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
<CAPTION>
COMMON STOCK NOTES ACCUMULATED
ADDITIONAL DEFERRED RECEIVABLE OTHER
--------------- PAID-IN STOCK-BASED FROM COMPREHENSIVE ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION STOCKHOLDERS LOSSES DEFICIT
------ ------ ---------- ------------ ------------ ------------- -----------
<S> <C>
Balances as of November 21, 1995
(inception)...................... -- $-- -- -- -- -- --
Exercise of stock options.......... 259 3 28 -- -- -- --
Issuance of common stock........... 1,633 16 133 -- (143) -- --
Issuance of Series A preferred
stock in exchange for
technology....................... -- -- -- -- -- -- --
Issuance of Series B preferred
stock, net of $59 in issuance
fees............................. -- -- 5,256 -- -- -- --
Net loss........................... -- -- -- -- -- -- (6,695)
--
------ ------ ---------- ----- ----- -----------
Balances, September 30, 1996....... 1,892 19 5,417 -- (143) -- (6,695)
Exercise of stock options.......... 127 1 15 -- -- -- --
Issuance of common stock........... 2 -- 1 -- -- -- --
Repurchase of restricted stock..... (164) (2) (18) -- -- -- --
Warrants exercised................. -- -- 8,400 -- -- -- --
Issuance of Series E and F
warrants......................... -- -- 298 -- -- -- --
Conversion of Series A, B, and C
preferred stock to Series E
preferred stock.................. -- -- (12) -- -- -- --
Issuance of Series E preferred
stock............................ -- -- 1,498 -- -- -- --
Net loss........................... -- -- -- -- -- -- (17,799)
--
------ ------ ---------- ----- ----- -----------
Balances, September 30, 1997....... 1,857 18 15,599 -- (143) -- (24,494)
Exercise of stock options.......... 144 2 89 -- -- -- --
Issuance of common stock........... 18 -- 116 -- -- -- --
Repurchase of restricted stock..... (18) -- (2) -- -- -- --
Warrant to purchase Series F
preferred stock.................. -- -- 535 -- -- -- --
Issuance of Series E preferred
stock............................ -- -- 1,213 -- -- -- --
Repayment of stockholder notes
receivable....................... -- -- -- -- 30 -- --
Deferred compensation related to
stock option grants.............. -- -- 768 (768) -- -- --
Amortization of stock-based
compensation..................... -- -- -- 227 -- -- --
Net loss........................... -- -- -- -- -- -- (22,224)
--
------ ------ ---------- ----- ----- -----------
Balances, September 30, 1998....... 2,001 $ 20 18,318 (541) (113) -- (46,718)
Exercise of stock options
(unaudited)...................... 103 1 72 -- -- -- --
Issuance of common stock
(unaudited)...................... 5 -- 37 -- -- -- --
Repurchase of restricted stock
(unaudited)...................... (20) -- (2) -- -- -- --
Issuance of in the money
convertible debt and warrants to
purchase Series E preferred stock
(unaudited)...................... -- -- 4,676 -- -- -- --
Issuance of Series F preferred
stock net of $30 issuance costs
(unaudited)...................... -- -- 3,466 -- -- -- --
Amortization of stock-based
compensation (unaudited)......... -- -- -- 100 -- -- --
Translation adjustment
(unaudited)...................... -- -- -- -- -- (6) --
Net loss (unaudited)............... -- -- -- -- -- -- (8,600)
--
------ ------ ---------- ----- ----- -----------
Balances, December 31, 1998
(unaudited)...................... 2,089 $ 21 26,567 (441) (113) (6) (55,318)
--
--
------ ------ ---------- ----- ----- -----------
------ ------ ---------- ----- ----- -----------
<CAPTION>
TOTAL
STOCKHOLDERS'
DEFICIT
-------------
Balances as of November 21, 1995
(inception)...................... --
Exercise of stock options.......... 31
Issuance of common stock........... 6
Issuance of Series A preferred
stock in exchange for
technology....................... --
Issuance of Series B preferred
stock, net of $59 in issuance
fees............................. 5,301
Net loss........................... (6,695)
-------------
Balances, September 30, 1996....... (1,357)
Exercise of stock options.......... 16
Issuance of common stock........... 1
Repurchase of restricted stock..... (20)
Warrants exercised................. 8,448
Issuance of Series E and F
warrants......................... 298
Conversion of Series A, B, and C
preferred stock to Series E
preferred stock.................. --
Issuance of Series E preferred
stock............................ 1,500
Net loss........................... (17,799)
-------------
Balances, September 30, 1997....... (8,913)
Exercise of stock options.......... 91
Issuance of common stock........... 116
Repurchase of restricted stock..... (2)
Warrant to purchase Series F
preferred stock.................. 535
Issuance of Series E preferred
stock............................ 1,215
Repayment of stockholder notes
receivable....................... 30
Deferred compensation related to
stock option grants.............. --
Amortization of stock-based
compensation..................... 227
Net loss........................... (22,224)
-------------
Balances, September 30, 1998....... (28,925)
Exercise of stock options
(unaudited)...................... 73
Issuance of common stock
(unaudited)...................... 37
Repurchase of restricted stock
(unaudited)...................... (2)
Issuance of in the money
convertible debt and warrants to
purchase Series E preferred stock
(unaudited)...................... 4,676
Issuance of Series F preferred
stock net of $30 issuance costs
(unaudited)...................... 3,470
Amortization of stock-based
compensation (unaudited)......... 100
Translation adjustment
(unaudited)...................... (6)
Net loss (unaudited)............... (8,600)
-------------
Balances, December 31, 1998
(unaudited)...................... (29,177)
-------------
-------------
</TABLE>
F-5
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM
NOVEMBER 21, THREE MONTHS ENDED
1995 YEAR ENDED SEPTEMBER
(INCEPTION) TO 30, DECEMBER 31,
SEPTEMBER 30, -------------------- --------------------
1996 1997 1998 1997 1998
--------------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss......................................................... $ (6,695) $ (17,799) $ (22,224) $ (6,067) $ (8,600)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization.................................. 88 697 1,104 216 240
Accretion of discount on borrowings............................ -- -- 201 -- 191
Non recurring interest charge on beneficial conversion feature
of convertible debt.......................................... -- -- -- -- 3,792
Amortization of deferred stock-based compensation.............. -- -- 227 -- 100
Changes in operating assets and liabilities:
Accounts receivable.......................................... -- (2,018) (275) (93) (782)
Prepaid expenses and other current assets.................... (474) 27 (306) (300) (283)
Accounts payable............................................. 1,759 721 2,205 662 (225)
Accrued compensation......................................... 342 699 649 -- (368)
Other accrued liabilities.................................... 37 685 382 281 157
Deferred revenue............................................. 102 6,186 (999) 4,693 (2,677)
Interest payable............................................. -- -- -- -- 208
--------------- --------- --------- --------- ---------
Net cash used in operating activities...................... (4,841) (10,802) (19,036) (608) (8,247)
--------------- --------- --------- --------- ---------
Cash flows used in investing activities--purchases of property and
equipment........................................................ (551) (1,028) (792) (214) (703)
--------------- --------- --------- --------- ---------
Cash flows from financing activities:
Proceeds from short-term borrowings.............................. 1,000 1,050 21,000 3,083 --
Repayments of short-term borrowings.............................. -- -- (2,050) (2,050) (2,000)
Proceeds from convertible debt................................... -- -- -- -- 8,325
Payment on capital lease obligations............................. (35) (252) (300) (71) (78)
Proceeds from sale and leaseback of equipment.................... 179 -- -- -- --
Proceeds from issuance of preferred stock........................ 5,301 10,246 1,215 -- 3,467
Proceeds from issuance of common stock........................... 39 17 91 2 73
Repurchases of common stock...................................... -- (20) (2) -- (2)
Repayment of shareholder notes receivable........................ -- -- 30 -- --
--------------- --------- --------- --------- ---------
Net cash provided by financing activities.................. 6,484 11,041 19,984 964 9,785
--------------- --------- --------- --------- ---------
Effect of exchange rate changes on cash.......................... -- -- -- -- (6)
--------------- --------- --------- --------- ---------
Net increase (decrease) in cash.................................... 1,092 (789) 156 142 829
Cash at beginning of period........................................ -- 1,092 303 303 459
--------------- --------- --------- --------- ---------
Cash at end of period.............................................. $ 1,092 303 459 445 1,288
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Supplemental disclosures of cash flow information:
Interest paid.................................................... $ 28 $ 293 $ 753 $ -- $ 350
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Noncash investing and financing activities:
Equipment recorded under capital leases........................ $ 423 $ 941 $ -- $ -- $ --
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Common stock issued in exchange for notes receivable........... $ 143 $ -- $ -- $ -- $ --
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Deferred stock-based compensation.............................. $ -- $ -- $ 768 $ -- $ --
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Discount on borrowings......................................... $ -- $ 298 $ 535 $ 535 $ 4,676
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Stock issued in exchange for services.......................... $ -- $ -- $ -- $ -- $ 37
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Stock issued for property and equipment........................ $ -- $ -- $ 116 $ -- $ --
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS
NetObjects, Inc. (the Company) was incorporated in Delaware on November 21,
1995. On March 18, 1997, the Company, and certain stockholders of the Company,
entered into an agreement with International Business Machines Corporation (IBM)
whereby IBM would acquire all the Company's outstanding shares of Series B and C
Preferred Stock and the majority of the outstanding Series A Preferred Stock in
exchange for newly issued shares of common stock of IBM (the IBM Transaction).
The Series A, B and C Preferred Stock were then converted into Series E
Preferred Stock of the Company. The transaction closed on April 11, 1997, and as
a result, the Company became a majority owned subsidiary of IBM. The transaction
did not result in a new accounting basis for financial reporting purposes of the
Company.
NetObjects develops and markets software applications that enable businesses
to build and manage Internet and intranet web sites and applications. In fiscal
1998, the Company changed its fiscal year end from September 30 to the Saturday
nearest September 30. For presentation purposes, the consolidated financial
statements and notes refer to the calendar month end.
(B) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary, NetObjects Limited. All
intercompany accounts and transactions have been eliminated in consolidation.
(C) FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's foreign subsidiary is their local
currency. Gains and losses arising from the translation of the subsidiary
financial statements are reflected as a separate component of stockholders'
deficit. Foreign currency transaction losses are shown net on the consolidated
statement of operations.
(D) BASIS OF PRESENTATION
The Company has incurred significant operating losses since inception and
has significant debt and a capital deficit as of September 30, 1998 that raises
substantial doubt about its ability to continue as a going concern. The Company
plans to finance its operations by raising additional capital through an initial
public offering of its common stock (IPO) and by generating revenues. The
Company's ability to continue as a going concern is dependent upon its
successfully completing the IPO. The accompanying financial statements have been
prepared assuming the Company will continue as a going concern, the basis of
which contemplates the realization of assets through continuing operations. No
adjustments have been made to reflect potentially lower realizable values of
assets should the Company be unable to continue its operations.
F-7
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
(E) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated using the
straight-line method over the estimated useful lives of the related assets,
ranging from three to five years. Leasehold improvements and assets recorded
under capital leases are amortized on a straight-line basis over the lesser of
the related asset's estimated useful life or the remaining lease term.
The Company evaluates long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying value of an asset may not be
recoverable. If such assets are considered to be impaired, the impairment to be
recognized is measured as the difference between the carrying amount of the
property and equipment and its fair value. To date, the Company has made no
adjustments to the carrying values of its long-lived assets.
(F) SOFTWARE DEVELOPMENT COSTS
Software development costs associated with new products and enhancements to
existing software products are expensed as incurred until technological
feasibility is established upon completion of a working model. To date, the
Company's software development has been completed concurrent with the
establishment of technological feasibility, and, accordingly, no costs have been
capitalized.
(G) INCOME TAXES
Income taxes are recorded using the asset and liability method. The
Company's tax provision for all years has been calculated on a stand-alone
basis. Deferred tax liabilities and assets are recognized for the expected
future tax consequences attributable to differences between the carrying amounts
and the tax bases of assets and liabilities. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. A valuation allowance is recorded to reduce deferred tax assets to an
amount whose realization is more likely than not. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
(H) CONCENTRATION OF CREDIT RISK
Accounts receivable potentially subject the Company to concentrations of
credit risk. The Company performs ongoing credit evaluations of its customers'
financial condition and generally does not require collateral for accounts
receivable. When required, the Company maintains allowances for credit losses,
and to date such losses have been within management's expectations.
For the years ended September 30, 1997 and 1998, software license fees to
one customer were 31% and 29%, of total revenues, respectively. Accounts
receivables from the customer represented 51% of accounts receivable as of
September 30, 1998. See Note 3 for a discussion of software license fees and
service revenues from IBM.
F-8
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
The Company's principal markets are North America, Europe and Japan. Export
sales represented approximately 15% and 16% of revenues for the fiscal years
ended September 30, 1997 and 1998, respectively. There were no revenues in
fiscal 1996.
(I) FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Company's cash, accounts receivable, accounts payable
and short-term borrowings approximates their carrying values due to their short
maturity or variable-rate structure.
(J) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported results of operations during the reporting period.
Actual results could differ from those estimates.
(K) REVENUE RECOGNITION
Through September 30, 1998, the Company recognized revenue in accordance
with American Institute of Certified Public Accountants (AICPA) Statement of
Position (SOP) 91-1, SOFTWARE REVENUE RECOGNITION. Software license fees were
generally recognized upon delivery to distributors, net of an allowance for
estimated returns, price protection and rebates, provided no significant
obligations of the Company remained and collection for the resulting receivable
was probable. The Company receives inventory on hand and sales information from
its significant distributors on a periodic basis. The allowance for returns and
price protection is determined based on a comparison of inventory on hand in the
distribution channel to historical sales made by the distributors to their
respective customers. This analysis is performed on a product line basis to
estimate potential excess inventory in the distribution channel. The allowance
for rebates is based upon contractual rebate rates certain distributors earn
upon selling products to their respective customers. Software license fees
earned from products bundled with original equipment manufacturer's (OEM)
products are recognized upon the OEM shipping bundled products to its customer.
Service revenues from maintenance agreements for support and upgrades of
existing products are deferred and recognized ratably over the term of the
contract, which typically is 12 months. IBM and Lotus are considered OEMs for
purposes of this accounting policy. See Note 3(b) for a discussion of software
license fees from IBM. Service revenues for training and consulting services are
recognized as the services are performed. See Note 3(b) for a discussion of
service revenues from IBM.
In October 1997, the AICPA issued SOP 97-2, SOFTWARE REVENUE RECOGNITION,
which supersedes SOP 91-1. SOP 97-2 is effective for transactions entered into
during fiscal years beginning after December 15, 1997. Under SOP 97-2, software
license revenue is recognized upon delivery of the software and when persuasive
evidence of an agreement exists, provided the fee is fixed, determinable and
collectible and the arrangement does not involve significant customization of
the software.
F-9
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Maintenance and service revenue are recognized in a similar manner as SOP 91-1.
In addition, SOP 97-2 generally requires revenue earned on software arrangements
involving multiple elements to be allocated to each element based on the
relative fair values of the elements. The fair value of an element must be based
on evidence that is specific to the vendor. If a vendor does not have evidence
of the fair value for all elements in a multiple-element arrangement, all
revenue from the arrangement is deferred until such evidence exists or until all
elements are delivered.
In February 1998, the Accounting Standards Executive Committee (AcSEC) of
the AICPA issued SOP 98-4, "DEFERRAL OF THE EFFECTIVE DATE OF SOP 97-2". The SOP
defers the effective date for applying the provisions regarding vendor-specific
objective evidence ("VSOE") of fair value until the AcSEC can reconsider what
constitutes such VSOE.
In December 1998 AcSEC issued SOP 98-9 "SOFTWARE REVENUE RECOGNITION, WITH
RESPECT TO CERTAIN ARRANGEMENTS", which requires recognition of revenue using
the "residual method" in a multiple element arrangement when fair value does not
exist for one or more of the delivered elements in the arrangement. Under the
"residual method", the total fair value of the undelivered elements is deferred
and subsequently recognized in accordance with SOP 97-2.
On October 1, 1998 the Company adopted the provisions of SOP 97-2, SOP 98-4
and SOP 98-9. The Company modified certain aspects of its business model such
that any impact from adopting SOP 97-2, SOP 98-4 and SOP 98-9 was not material.
(L) STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation plans using the
intrinsic value method. Deferred stock-based compensation expense is recorded,
if on the date of grant, the current market value of the underlying stock
exceeds the exercise price. The Company amortizes deferred stock-based
compensation in accordance with Financial Accounting Standards Board (FASB)
Interpretation No. 28.
(M) NET LOSS PER SHARE
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock. Diluted net loss per share is computed using
the weighted-average number of shares of common stock outstanding and, when
dilutive, potential common shares from options and warrants to purchase common
stock using the treasury stock method and from convertible securities using the
if-converted basis. All potential common shares have been excluded from the
computation of diluted net loss per share for all periods presented because the
effect would have been antidilutive. See Notes 7 and 8 for a discussion of
potential common shares. Pursuant to the Securities and Exchange Commission
(SEC) Staff Accounting Bulletin No. 98, common stock and convertible preferred
stock issued for nominal consideration, prior to the anticipated effective date
of the IPO, are included in the calculation of basic and diluted net loss per
share as if they were outstanding for all
F-10
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
periods presented. To date, the Company has not had any issuances or grants for
nominal consideration.
Diluted net loss per share for the year ended September 30, 1998, does not
include the effect of approximately 11,576,937 (on as if converted basis) shares
of convertible preferred stock outstanding, 2,472,343 stock options with a
weighted-average exercise price of $1.32 per share, 7,530,588 preferred stock
warrants with a weighted-average exercise price of $5.22 per share, or 88,177
shares of common stock issued and subject to repurchase by the Company at a
weighted-average price of $0.12 per share, because their effects are
antidilutive.
Diluted net loss per share for the three months ended December 31, 1998,
does not include the effect of approximately 11,965,826 (on as if converted
basis) shares of convertible preferred stock outstanding, approximately
1,277,652 shares from the assumed conversion of convertible debt, 2,629,575
stock options with a weighted-average exercise price of $2.38 per share,
7,530,588 preferred stock warrants with a weighted-average exercise price of
$5.22 per share, or 74,297 shares of common stock issued and subject to
repurchase by the Company at a weighted-average price of $0.12 per share,
because their effects are antidilutive.
(N) ACCUMULATED OTHER COMPREHENSIVE LOSSES
Accumulated other comprehensive losses consist entirely of cumulative
translation adjustments resulting from the Company's application of its foreign
currency translation policy. The tax effects of translation adjustments were not
significant.
(O) UNAUDITED INTERIM FINANCIAL INFORMATION
The consolidated financial information as of December 31, 1998 and for the
three-months ended December 31, 1997 and 1998 is unaudited, but includes all
adjustments (consisting only of normal recurring adjustments) that the Company
considers necessary for the fair presentation of the financial position at such
dates and the operations and cash flows for the periods then ended. Operating
results for the three-months ended December 31, 1998 are not necessarily
indicative of results that may be expected for the entire year.
(P) RECENT ACCOUNTING PRONOUNCEMENTS
The FASB recently issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. For a derivative not designated as a hedging
instrument, changes in the fair value of the derivative are recognized in
earnings in the period of change. The Company must adopt SFAS No. 133 by
F-11
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
July 1, 1999. Management does not believe the adoption of SFAS No. 133 will have
a material effect on the financial position of the Company.
(Q) ADVERTISING EXPENSE
The cost of advertising is expensed as incurred. Such costs are included in
selling and marketing expense and totaled approximately $376,000, $4.9 million
and $5.8 million, during the period from November 21, 1995 (inception) through
September 30, 1996, and for the years ended September 30, 1997 and 1998,
respectively.
(R) EMPLOYEE BENEFIT PLAN
The Company has an Employee Savings and Retirement Plan under Section 401(k)
of the Internal Revenue Code for its eligible employees (the Benefit Plan). The
Benefit Plan is available to all domestic employees who meet minimum age and
service requirements, and provides employees with tax deferred salary deductions
and alternative investment options. Employees may contribute up to 15% of their
salary, subject to certain limitations. The Benefit Plan allows for
contributions by the Company at the discretion of the Company's Board of
Directors. The Company has not contributed to the Benefit Plan since its
inception.
(2) PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Computer equipment and software............................................ $ 1,893 $ 2,166
Furniture and equipment.................................................... 475 559
Leasehold improvements..................................................... 253 795
--------- ---------
2,621 3,520
Less accumulated depreciation
and amortization........................................................... 785 1,880
--------- ---------
$ 1,836 $ 1,640
--------- ---------
--------- ---------
</TABLE>
Equipment recorded under capital leases is $1.2 million and the related
accumulated amortization is $638,000 as of September 30, 1998.
F-12
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(3) RELATED PARTY TRANSACTIONS
(A) SHORT-TERM BORROWINGS
In December 1997, the Company entered into a line of credit with IBM Credit
Corporation (IBM Credit Corp.), a subsidiary of IBM, for $15 million, secured by
all tangible and intangible assets of the Company. IBM has guaranteed the line
of credit. Subsequently, the agreement was amended to increase the line of
credit to $19 million. The note is repayable on the earlier of the effective
date of an IPO or December 23, 1999. Interest is charged at LIBOR plus 1.5% (6%
as of September 30, 1998) per year. To maintain the line, the Company's net loss
measured on a 12-month basis must not be worse than $20 million. In the event of
default, IBM Credit Corp. has the right to convert amounts outstanding into
shares of Series E preferred stock using the lower of $6.68 per share or a
mutually agreed-upon conversion price.
In connection with the IBM Credit Corp. line of credit, the Company issued
warrants to purchase up to 83,333 shares of Series F preferred stock at an
exercise price of $10.80 per share. These warrants are exercisable at any time
and expire on the earlier of the closing of an IPO or December 23, 2002. IBM
Credit Corp. has the right to exercise the warrants without the payment of cash
by surrendering the warrants and receiving shares of preferred stock equal in
value at the exercise date to the value of the warrants so surrendered. The
Company determined the fair value of these warrants using the Black-Scholes
pricing model with the following assumptions: A risk-free interest rate of 5.6%;
an expected life of five years; volatility of 65%; and no dividend yield. The
resulting discount is being amortized over the term of the line of credit. As of
September 30, 1998, $18.6 million was outstanding under the line of credit, net
of a discount of $334,000.
Additionally, as of September 30, 1998, IBM has advanced the Company $2
million pursuant to certain note agreements. See Note 8.
As of September 30, 1998 the Company was not in compliance with certain
financial covenants on the aforementioned credit facility. The Company has
received a waiver of such non-compliance during the year ended September 30,
1998 from IBM Credit Corp.
(B) LICENSE AGREEMENT
On March 18, 1997, the Company entered into a Master License Agreement with
IBM. A summary of the salient terms of this agreement, as amended as of
September 30, 1998, is as follows (see Note 8):
- IBM may sublicense the Company's software products in exchange for per
unit royalty payments.
- Beginning on April 1, 1997, IBM will make seven quarterly nonrefundable
prepaid royalty payments of $1.5 million.
- At the Company's option, the Company can request the prepaid royalty
payments to be made in advance of the due date and pay 7.5% interest.
F-13
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(3) RELATED PARTY TRANSACTIONS (CONTINUED)
- The Company will perform services as requested by IBM in order to
integrate certain of the Company's software products into IBM's WebSphere
software products. In consideration for such services, IBM will pay the
Company for the cost of providing the services plus a mark up, however
amounts to be paid shall not exceed approximately $6.0 million. Amounts
owed to the Company under this arrangement can be deducted from the
prepaid royalty payments.
In February 1998 the Company entered into an agreement with Lotus to allow
Lotus to bundle up to 200,000 units of certain Company products for a
promotional period from February 1, 1998 through September 30, 1998 (the Special
Promotion), in exchange for per unit royalty payments substantially discounted
from the royalty rates with IBM under the Master License Agreement. The
royalties earned under this arrangement were also applied to the IBM deferred
revenue.
During the years ended September 30, 1997 and 1998, IBM had made payments of
$6.4 million and $4.5 million, respectively, in accordance with the license
agreement which have been recorded as deferred revenue until royalty and
services have been earned. For the year ended September 30, 1998 the Company
recognized approximately $166,000 in interest expense associated with such
advance payments.
During the years ended September 30, 1997 and 1998 and the three-month
period ended December 31, 1998, the Company recognized approximately $175,000,
$2.7 million and $1.3 million (unaudited), respectively, of the IBM prepaid
royalty payments as software license fees from IBM, primarily upon IBM shipping
to customers the Company's software products bundled with certain IBM products.
During the year ended September 30, 1998 and the three month period ended
December 31, 1998, the Company recognized approximately $2.9 million and $1.5
million (unaudited), respectively of the IBM prepaid royalty payments as service
revenues from IBM in connection with the integration of certain of the Company's
software with IBM's WebSphere software products. During the year ended September
30, 1998 and the three-month period ended December 31, 1998, the Company
incurred $2.9 million and $1.7 million in service costs, which includes $305,000
and $259,000 in overhead costs, respectively, in connection with the
arrangement. The Company is recognizing revenue using the
percentage-of-completion method and is deferring the recognition of profit on
this arrangement due to uncertainties related to the amount of profit ultimately
expected to be realized. The Company compares the maximum amount to be paid for
the integration services to the estimated total cost to determine if a provision
for loss is necessary. As of December 31, 1998 no provision for loss has been
recorded.
(C) NOTES RECEIVABLE FROM STOCKHOLDERS
Upon inception, the Company received promissory notes from its founders in
exchange for common stock for a total amount of $143,000. As of September 30,
1998, $30,000 was paid down by the stockholders. The notes bear interest at 8%,
and interest is to be paid annually with any
F-14
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(3) RELATED PARTY TRANSACTIONS (CONTINUED)
accrued but unpaid interest and principal payable in full on or before December
21, 1998. The Company has full recourse against the founders for the amounts of
the notes.
(D) RAE TECHNOLOGY AND STUDIO ARCHETYPE
In December 1995, the Company issued 1,833,333 shares of Series A preferred
stock to the stockholders of Rae Technology, Inc. (Rae) and Studio Archetype,
upon formation of the Company, in exchange for the transfer of certain
technology and intellectual property rights. Rae's and Studio Archetype's
founders and significant shareholders also were the founders of the Company. The
exchange was recorded at predecessor book value.
In April 1997 the Company and Rae entered into a patent transfer and license
agreement whereby the Company assigned all of its rights to four U.S. patent
applications to Rae and the Company reserved a non-exclusive, perpetual, royalty
free license to such patents.
(4) SHORT-TERM BORROWINGS
As of September 30, 1997, the Company had $2.1 million outstanding under a
line of credit granted by a financial institution. Borrowings under the line of
credit bear interest at the bank's prime rate plus 1% (9.5% as of September 30,
1997). In connection with the line of credit, the financial institution was
issued warrants to purchase 244,715 shares of Series C preferred stock at an
exercise price of $1.82 per share. See Note 7(c). The line of credit was repaid
with proceeds from the IBM Credit Corp. line of credit and, accordingly, no
amounts are outstanding as of September 30, 1998.
(5) COMMITMENTS
The Company leases its facilities under a noncancelable operating lease, and
has acquired computers and other equipment through operating and capital leases.
In connection with one of the
F-15
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(5) COMMITMENTS (CONTINUED)
property leases, the Company sublets the space. Future minimum payments for both
operating and capital leases as of September 30, 1998, are as follows (in
thousands):
<TABLE>
<CAPTION>
OPERATING SUBLEASE NET OPERATING CAPITAL
YEAR ENDING SEPTEMBER 30, LEASES INCOME LEASES LEASES
- ---------------------------------------------------- ----------- ----------- --------------- -----------
<S> <C> <C> <C> <C>
1999................................................ $ 659 $ 338 $ 321 $ 338
2000................................................ 651 338 313 290
2001................................................ 181 -- 181 61
2002................................................ 83 -- 83 --
Thereafter,......................................... 34 -- 34 --
----------- ----- ----- -----
$ 1,608 $ 676 $ 932 689
----------- ----- -----
----------- ----- -----
Less amount representing interest................... 54
-----
Present value minimum lease payments................ 635
Less amounts due within one year.................... 299
-----
$ 336
-----
-----
</TABLE>
Total rent expense under the operating leases was $74,000, $341,000 and
$683,000 for the period from November 21, 1995 (inception) through September 30,
1996, and for the years ended September 30, 1997 and 1998, respectively. Total
rent expense paid to IBM under operating leases was $0, $12,000 and $93,000 for
the period from November 21, 1995 (inception) through September 30, 1996, and
for the years ended September 30, 1997 and 1998, respectively
As of September 30, 1998, approximately $200,000 of the Company's cash
balance is pledged as security for a lease line for furniture and fixtures.
F-16
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(6) INCOME TAXES
Significant components of the Company's deferred tax assets are as follows
(in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Net operating loss carryforwards....................................... $ 9,306 $ 17,506
Research and development credit carryforwards.......................... 571 1,649
Accruals and reserves not currently deductible......................... 477 1,767
Property, plant and equipment.......................................... 268 488
--------- ---------
Gross deferred tax assets............................................ 10,622 21,410
Valuation allowance.................................................... (10,622) (21,410)
--------- ---------
Net deferred tax assets.............................................. $ -- $ --
--------- ---------
--------- ---------
</TABLE>
The Company's actual tax expense for the period from November 21, 1995
(inception) to September 30, 1996 and the years ended September 30, 1997 and
1998 differs from the benefit of the federal statutory tax rate of 34%, as
follows (in thousands):
<TABLE>
<CAPTION>
PERIOD FROM
NOVEMBER 21,
1995 YEAR ENDED SEPTEMBER
(INCEPTION) 30,
TO SEPTEMBER --------------------
30, 1996 1997 1998
------------- --------- ---------
<S> <C> <C> <C>
Expense at:
Statutory federal income tax rate......................... $ (2,292) $ (6,051) $ (7,556)
Losses not benefited...................................... 2,292 6,051 7,556
State taxes............................................... -- 1 1
Foreign taxes............................................. -- -- 59
------------- --------- ---------
$ -- $ 1 $ 60
------------- --------- ---------
------------- --------- ---------
</TABLE>
F-17
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(6) INCOME TAXES (CONTINUED)
The components of income taxes for the period from November 21, 1995
(inception) to September 30, 1996 and for the years ended September 30, 1997 and
1998, are as follows (in thousands):
<TABLE>
<CAPTION>
PERIOD FROM
NOVEMBER 21,
1995 YEAR ENDED SEPTEMBER
(INCEPTION) 30,
TO SEPTEMBER --------------------
30, 1996 1997 1998
------------- --------- ---------
<S> <C> <C> <C>
Current:
Foreign................................................... $ -- $ -- $ 59
State..................................................... -- 1 1
------------- --------- ---------
$ -- $ 1 $ 60
------------- --------- ---------
------------- --------- ---------
</TABLE>
The Company has recorded a valuation allowance on its deferred tax assets
due to uncertainty of future realization of such amounts.
As of September 30, 1998, the Company had net operating loss carryforwards
of approximately $40.9 million for both federal and state income tax purposes.
The federal net operating loss carryforwards expire in the years 2012 through
2019. The state net operating loss carryforwards expire in the year 2005. As of
September 30, 1998, the Company has research and development credit
carryforwards for federal and state tax purposes of approximately $964,000 and
$685,000, respectively. The federal research and development credit
carryforwards expire in the years 2012 through 2014. The state research and
development credits can be carried forward indefinitely.
The Tax Reform Act of 1986 and the California Tax Conformity Act of 1987
limit the use of net operating loss carryforwards in certain situations where
changes occur in the stock ownership of a company. The Company had such an
ownership change, as defined, in April 1997. Accordingly, $11.5 million of the
Company's federal and state net operating loss carryforwards are limited in
their annual usage to $3.9 million per year on a cumulative basis.
F-18
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT
(A) PREFERRED STOCK
The Company's restated certificate of incorporation authorizes 22,816,333
shares of preferred stock. As of September 30, 1997 and 1998, and December 31,
1998 the Company has designated and issued preferred stock as follows:
<TABLE>
<CAPTION>
OUTSTANDING SHARES
--------------------------------------------
SEPTEMBER 30,
DESIGNATED ---------------------------- LIQUIDATION
SHARES 1997 1998 PREFERENCE
------------- ------------- ------------- DECEMBER 31, -------------
1998
--------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Series A.............................. 750,000 651,945 651,945 651,945 $ 0.90
Series B.............................. 33,000 -- -- -- 1.20
Series C.............................. 2,833,333 -- -- -- 1.82
Series E.............................. 15,033,333 10,743,020 10,924,992 10,924,992 6.68
Series E-2............................ 2,000,000 -- -- -- 6.68
Series F.............................. 916,666 -- -- -- 10.80
Series F-2............................ 416,666 -- -- 388,889 9.00
------------- ------------- ------------- --------------
21,982,998 11,394,965 11,576,937 11,965,826
------------- ------------- ------------- --------------
------------- ------------- ------------- --------------
</TABLE>
The rights, preferences, and restrictions of the Series A, B, C, E and F
preferred stock are as follows:
- Each share of Series A, B, C, E and F preferred stock is convertible at
the option of the holder at any time into one share of common stock,
subject to certain antidilution provisions. Conversion of all Series A, B,
C, E and F preferred stock is automatic upon the closing of a firm
underwritten commitment public offering of shares of common stock of the
Company, which results in aggregate cash proceeds of at least $30 million.
- Holders of Series A, B, C, E and F preferred stock are entitled to receive
dividends at 8% per annum in preference to any dividend on common stock
when and if declared by the Board of Directors out of legally available
funds. Dividends are noncumulative. No dividends have been declared
through September 30, 1998.
- Series A, B, C, E and F preferred stock have a liquidation preference in
the amounts listed above plus all declared but unpaid dividends on such
shares plus an amount equal to an 8% annually compounded return calculated
from the original issue date through the liquidation date.
- Series A, B, C, E and F preferred stock have the same voting rights as the
number of shares of common stock issuable upon conversion of such shares.
The consent of a majority of the outstanding Series E preferred stock is
required for all major corporate actions. The holders
F-19
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT (CONTINUED)
of the Series E preferred stock have a right to elect a majority of
directors of the Company until the outstanding shares of Series E
preferred stock and warrants to purchase such shares represent less than
45% of the fully diluted shares of voting securities of the Company or the
consummation of an IPO.
(B) COMMON STOCK
The Company's restated certificate of incorporation authorizes 28,333,333
shares of common stock. As of September 30, 1998, the Company has reserved
shares of common stock for future issuance as follows:
<TABLE>
<CAPTION>
SHARES
-------------
<S> <C>
Conversion of preferred stock:
Series A......................................................................................... 651,945
Series C......................................................................................... 2,250,500
Series E......................................................................................... 3,482,838
Series F......................................................................................... 1,833,333
</TABLE>
(C) PREFERRED STOCK WARRANTS
In fiscal 1996, as consideration for a lease line facility from a leasing
company, the Company issued warrants to purchase 33,000 shares of the Company's
Series B preferred stock at an exercise price of $1.20 per share. The warrants
were exercised through a cashless exchange in fiscal 1997. There were no Series
B warrants outstanding as of September 30, 1998.
In fiscal 1997, in consideration for a bank line of credit and an equipment
lease line facility with a financial institution and leasing company,
respectively (the lenders) and other service providers, the Company issued
warrants to purchase 244,147 shares of Series C preferred stock at an exercise
price of $1.82 per share, and 22,459 shares of Series E preferred stock at an
exercise price of $6.68 per share. The Company determined the fair value of
these warrants using the Black-Scholes pricing model with the following
assumptions: a risk-free interest rate of 5.6%; an expected life of three years;
volatility of 65%; and no dividend yield. The fair value of these warrants does
not have a material effect on the consolidated financial statements. During
fiscal 1997, the lenders exercised all warrants by foregoing the receipt of that
number of shares of preferred stock, that would otherwise have been issued upon
exercise, equal in value to the exercise price of all warrants exercised. All
other service providers exercised their warrants for cash.
During fiscal 1997, the Company issued to holders of Series B preferred
stock, and third party investors, warrants to purchase up to 6,863,426 shares of
Series C preferred stock at an exercise price of $1.82 per share. This round of
financing was in the form of warrants to purchase Series C preferred stock which
would be exercised over time. The warrants contained certain provisions
F-20
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT (CONTINUED)
whereby if the third party investors exercised their warrants, the other
warrantholders were required to exercise warrants on a pro rata basis. The fair
value of the warrants was based on the de minimis amount of consideration
received from the investors. These warrants are exercisable at any time and
expire on the earlier of the closing of an IPO or March 13, 2000. During fiscal
1997, warrants to purchase 4,612,926 shares of Series C preferred stock were
exercised. Warrants to purchase 2,250,500 shares of Series C preferred stock
have not been exercised as of September 30, 1998. Each warrant holder has the
right to exercise the warrant by foregoing the receipt of that number of shares
of preferred stock, that would otherwise have been issued upon exercise, equal
in value to the exercise price of all warrants exercised.
In connection with the IBM Transaction, the Company issued warrants to
purchase up to 833,333 shares of Series F preferred stock, previously Series D
preferred stock, at an exercise price of $10.80 per share to the holders of the
Series A, B, and C preferred stock for $48,000 in cash, net of expenses. In
addition, warrants to purchase up to 3,482,838 shares of Series E preferred
stock at an exercise price of $6.68 were issued to IBM for $250,000 in cash.
These warrants are exercisable at any time and expire on the earlier of the
closing of an IPO or April 11, 2000. These warrants to purchase Series E and F
preferred stock have not been exercised as of September 30, 1998. Each warrant
holder has the right to exercise the warrant by foregoing the receipt of that
number of shares of preferred stock, that would otherwise have been issued upon
exercise, equal in value to the exercise price of all warrants exercised.
In connection with the IBM Transaction, the Company granted to its founders,
who are also employees, the right to purchase 673,778 shares of Series E
preferred stock at an exercise price of $6.68 per share in three equal
installments prior to April 10, 1998. In June 1997, the four founders exercised
the first installment. Had the Company valued these stock rights pursuant to
SFAS No. 123 using the minimum value option pricing model, the Company's 1997
net loss would have been greater by approximately $111,000. This determination
was made using the following assumptions: a risk-free interest rate of 6.5%; an
expected life of one year; and no dividends.
During fiscal 1998, the Company entered into a line of credit agreement with
IBM Credit Corp. In connection with the line of credit, NetObjects issued
warrants to purchase 83,333 shares of Series F preferred stock at an exercise
price of $10.80. See Note 3.
(D) STOCK OPTION PLANS
Under the Company's 1996 Stock Option Plan (1996 Plan), a total of 1,658,943
shares of common stock were authorized for issuance. In connection with the IBM
Transaction, the 1996 Plan was terminated and the Company established the 1997
Stock Option Plan and the 1997 Special Stock Option Plan (the 1997 Plans). A
total of 2,158,943 and 1,041,056 shares of the Company's common stock have been
authorized for issuance under these plans, respectively. In April 1997, the
Company canceled the outstanding options under the 1996 Plan and granted
replacement options
F-21
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT (CONTINUED)
under the 1997 Plans with the same terms. The cancellation and reissuance is not
reflected in the stock option activity table below.
Options granted under the 1997 Plans may be designated as qualified or
nonqualified at the discretion of the Company's Board of Directors with exercise
prices not less than the fair value at the date of grant. Options granted under
the 1996 Plan, and the replacement options granted under the 1997 Plans, are
immediately exercisable upon grant, and the Company retains the right to
repurchase the unvested shares held at the time of termination of employment at
the original purchase price. Options generally vest 25% at the end of the first
year and monthly over the next three years. Options expire ten years from the
date of grant. As of September 30, 1998, 88,177 shares were subject to the
Company's right of repurchase.
The Company uses the intrinsic value method to account for the 1997 Plans.
Accordingly, compensation cost has been recognized for its stock options in the
accompanying financial statements if, on the date of grant, the current market
value of the underlying common stock exceeded the exercise price of the stock
options at the date of grant. During fiscal 1998, the Company granted options
with a weighted-average exercise price of $2.10 per share compared to the
weighted-average fair value of approximately $4.44 during the same period. For
the period from November 21, 1995 (inception) to September 30, 1996 and for the
year ended September 30, 1997, the weighted-average exercise price of options
granted approximated the weighted-average fair value. In connection with options
granted in fiscal year 1998, the Company has recorded deferred stock-based
compensation of $768,000 representing the difference between the exercise price
and the fair value of the Company's common stock at the date of grant. The
amount is being amortized over the vesting period for the individual options.
Amortization of deferred stock-based compensation of $227,000 was recognized
during the fiscal year ended September 30, 1998.
Pursuant to SFAS No. 123, the Company is required to disclose the pro forma
effects on the operating results of the Company as if the Company has elected to
use the fair value approach to account for all its stock-based employee
compensation plans. Had compensation cost for the Company's 1997 Plans been
determined consistent with the fair value approach enumerated in SFAS No. 123,
net loss for the period from November 21, 1995 (inception) to September 30, 1996
and for the years ended September 30, 1997 and 1998 would have been greater by
approximately $0, $52,000 and $193,000, respectively. The fair value of each
option is estimated using the minimum value method with the following
assumptions: a risk-free interest rate of 6.5%; an expected life of four years;
and no dividend yield.
F-22
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT (CONTINUED)
The following table summarizes stock option activity during the year:
<TABLE>
<CAPTION>
PERIOD FROM NOVEMBER 21,
THREE
1995 (INCEPTION) TO YEAR ENDED SEPTEMBER 30, YEAR ENDED SEPTEMBER 30, MONTHS
ENDED
DECEMBER
SEPTEMBER 30, 1996 1997 1998 31, 1998
-------------------------- -------------------------- -------------------------- -----------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF
SHARES PRICE SHARES PRICE SHARES PRICE SHARES
----------- ------------- ----------- ------------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Shares under options
outstanding at
beginning of
period............... -- $ -- 738,051 $ 0.12 2,517,670 $ 1.20 2,472,343
Granted................ 1,017,305 0.12 2,251,557 1.08 341,340 2.10 436,081
Exercised.............. (259,254) 0.12 (126,353) 0.12 (144,432) 0.60 (103,030)
Canceled............... -- -- (365,585) 0.48 (242,235) 1.26 (175,819)
----------- ----------- ----------- -----------
Shares under options
outstanding at end of
period............... 758,051 0.12 2,517,670 1.20 2,472,343 1.32 2,629,575
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Shares vested at
period-end........... -- 128,388 852,158 875,081
<CAPTION>
WEIGHTED-
AVERAGE
EXERCISE
PRICE
-------------
<S> <C>
Shares under options
outstanding at
beginning of
period............... $ 1.32
Granted................ 7.44
Exercised.............. 0.72
Canceled............... 1.38
Shares under options
outstanding at end of
period............... 2.38
Shares vested at
period-end...........
</TABLE>
The following table summarizes information about stock options outstanding
as of September 30, 1998:
<TABLE>
<CAPTION>
OUTSTANDING
- ------------------------------------------
WEIGHTED-
AVERAGE
NUMBER REMAINING
OF CONTRACTUAL SHARES
EXERCISE PRICE SHARES LIFE VESTED
- --------------- ----------- ------------ ---------
<S> <C> <C> <C>
$ 0.12 305,942 7.50 years 15,416
0.30 81,948 8.25 37,740
0.60 83,333 8.25 40,036
1.50 1,456,540 8.50 512,265
1.65 225,000 8.50 84,375
2.10 319,577 9.75 12,249
----------- ---------
2,472,340 702,081
----------- ---------
----------- ---------
</TABLE>
(8) SUBSEQUENT EVENTS
On October 8, 1998, the Company entered into Convertible Note and Warrant
Purchase Agreements with IBM and a Series C preferred warrantholder, whereby the
Company may borrow up to $10.9 million, of which $8.3 million was received by
the Company as of December 31, 1998 and the
F-23
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A MAJORITY OWNED SUBSIDIARY OF IBM)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997, AND 1998
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE THREE-MONTHS
ENDED DECEMBER 31, 1997 AND 1998 IS UNAUDITED)
(8) SUBSEQUENT EVENTS (CONTINUED)
remaining amount was received in January, 1999. A portion of the proceeds
received has been used to repay $2 million in notes payable due to IBM. The new
notes are due October 8, 2000, have a stated interest rate of 10% per annum, and
are convertible (principal and accrued interest) into Series E-2 preferred stock
at $6.68 per share at any time or automatically upon the completion of an IPO.
The Company has recorded a $3.8 million nonrecurring interest charge during the
three month period ended December 31, 1998 to account for the "in-the-money"
conversion right of the convertible notes.
In connection with the notes, the Company issued warrants to acquire 163,715
shares of Series E-2 preferred stock at an exercise price of $6.68 per share.
The warrants are exercisable at any time before October 8, 2003. The Company
determined the fair value of these warrants using the Black-Scholes pricing
model with the following assumptions: A risk-free interest rate of 6%; an
expected life of five years; volatility of 65%; and no dividend yield. The
resulting discount is being amortized over the term of the convertible note. As
of September 30, 1998, $7.6 million was outstanding under the convertible note,
net of a discount of $700,000.
On October 16, 1998, NetObjects entered into a Stock Purchase Agreement with
a company authorizing the sale and issuance of 333,333 shares of Series F-2
preferred stock at a purchase price of $9.00 per share for an aggregate price of
$3 million. The transaction closed on October 26, 1998. Warrants to acquire
16,666 shares of Series F-2 preferred stock were also issued at an exercise
price of $10.80 and are exercisable between January 1, 2001 and December 31,
2003 only in the event the Company has not completed an IPO prior to December
31, 2000.
On October 28, 1998, NetObjects entered into a Stock Purchase Agreement with
a company authorizing the sale and issuance of 55,555 shares of Series F-2
preferred stock at a purchase price of $9.00 per share, for an aggregate price
of $500,000. The transaction closed on November 10, 1998.
STOCK SPLIT
On December 9, 1998, the Board of Directors authorized a 1-for-6 reverse
split of all the outstanding shares of the Company's preferred and common stock
which will be effective only upon the closing. Share information has been
restated in the accompanying consolidated financial statements to reflect the
reverse stock split for all periods presented.
INITIAL PUBLIC OFFERING (UNAUDITED)
On February 4, 1999, the Board of Directors authorized the filing of a
registration statement with the SEC permitting the Company to sell shares of the
Company's common stock in connection with a proposed IPO. If the offering is
consummated under the terms presently anticipated, all currently outstanding
shares of preferred stock will automatically convert into approximately
F-24
<PAGE>
(8) SUBSEQUENT EVENTS (CONTINUED)
11,965,826 shares of common stock upon the closing of the proposed IPO. The
conversion of the preferred stock has been reflected in the pro forma balance
sheet as of December 31, 1998.
EMPLOYEE STOCK PURCHASE PLAN (UNAUDITED)
The Company's Board of Directors adopted the 1999 Employee Stock Purchase
Plan (the "1999 Purchase Plan") on February 4, 1999. A total of 300,000 shares
of common stock are proposed to be reserved for issuance under the 1999 Purchase
Plan.
IBM LICENSE AGREEMENT (UNAUDITED)
In January 1999 the Company and IBM amended the NetObjects License Agreement
as follows:
- The Special Promotion period was extended to June 30, 1999 and the maximum
number of units to be shipped under the program was increased from 200,000
to 225,000.
- The maximum amount to be paid to the Company in connection with the
services provided to IBM was reduced to approximately $5.3 million, and
the related mark up on the services to be provided was reduced.
In March 1999 the Company and IBM amended the NetObjects license agreement
to establish a new special promotion program whereby Lotus will bundle certain
NetObjects products with certain Lotus products, and Lotus will pay the Company
royalties based on a percentage of Lotus' net revenue. The promotion period
begins on January 1, 1999 and ends on December 31, 1999.
NOTES AND WARRANT PURCHASE AGREEMENTS (UNAUDITED)
On February 18, 1999 and March 23, 1999, respectively, the Company issued
notes and warrants to IBM pursuant to the note and warrant purchase agreement
dated February 4, 1999, under which the Company borrowed $2 million and $1.4
million, respectively. The new notes are due on the earlier of (i) the closing
of an IPO in which the gross proceeds are in excess of $60 million, (ii) April
30, 1999, or (iii) when declared due and payable by IBM, and have a stated
interest rate of 10% per annum.
In connection with the notes, the Company issued warrants to acquire 51,335
shares of Series E-2 preferred stock at an exercise price of $6.68 per share.
The warrants are exercisable at any time before February 18, 2004.
F-25
<PAGE>
INSIDE BACK COVER OF PROSPECTUS:
TITLE: BROADENING OUR REACH
INTRO PARAGRAPH:
As business use of the Internet and intranets matures, products alone are
not enough to fulfill customers' needs. We have built popular online resources,
including eFuse.com, that target communities of business users and provide
sources of information, products and services for building business web sites.
We also formed our Professional Services Group in October 1998 to provide
training, consulting and implementation services to our customers deploying
NetObjects Authoring Server.
GRAPHICS: four overlapping screen shots of web sites
CAPTIONS (ONE FOR EACH SCREEN SHOT; CLOCKWISE FROM TOP):
(1) eScriptZone.com: articles, tutorials, software and an online community for
webmasters and web application builders
(2) eFuse.com: integrated content, products, and solutions for small and
medium-sized businesses
(3) netobjects.com: information, products, partner solutions and support
(4) eSiteStore.com: software, components, books, merchandise and online services
<PAGE>
- -------------------------------------------
-------------------------------------------
- -------------------------------------------
-------------------------------------------
YOU MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE
NOT AUTHORIZED ANYONE TO PROVIDE INFORMATION DIFFERENT FROM THAT CONTAINED IN
THIS PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR THE SALE OF COMMON
STOCK MEANS THAT INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT AFTER THE
DATE OF THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL OR SOLICITATION
OF AN OFFER TO BUY THESE SHARES OF COMMON STOCK IN ANY CIRCUMSTANCES UNDER WHICH
THE OFFER OR SOLICITATION IS UNLAWFUL.
--------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Prospectus Summary............................. 3
Risk Factors................................... 7
Use of Proceeds................................
Dividend Policy................................
Capitalization................................. 19
Dilution....................................... 20
Selected Consolidated Financial Data........... 21
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 23
Business....................................... 36
Management..................................... 51
Certain Transactions........................... 58
Principal Stockholders......................... 64
Description of Capital Stock................... 66
Shares Eligible for Future Sale................ 68
Underwriting................................... 70
Legal Matters.................................. 71
Experts........................................ 72
Change in Auditors............................. 72
Additional Information......................... 72
Index to Consolidated Financial Statements..... F-1
</TABLE>
--------------
DEALER PROSPECTUS DELIVERY OBLIGATION:
Until , 1999 (25 days after the date of this Prospectus), all
dealers that buy, sell or trade these shares of common stock, whether or not
participating in this offering, may be required to deliver a Prospectus. This is
in addition to the dealers' obligation to deliver a Prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
SHARES
[LOGO]
COMMON STOCK
-----------------
P R O S P E C T U S
-----------------
BT ALEX. BROWN
BANCBOSTON ROBERTSON STEPHENS
U.S. BANCORP PIPER JAFFRAY
, 1999
- -------------------------------------------
-------------------------------------------
- -------------------------------------------
-------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee............ $ 21,100
NASD Filing Fee................................................ 8,090
Nasdaq National Market Listing Fee............................. 95,000
Legal Fees and Expenses........................................ *
Accountants' Fees and Expenses................................. *
Printing and Engraving Expenses................................ *
Directors' and Officers' Liability Insurance................... *
Transfer Agent and Registrar Fees.............................. 10,000
Miscellaneous Expenses......................................... *
---------
Total........................................................ $ *
---------
---------
</TABLE>
- ------------------------
All expenses other than the Securities and Exchange Commission Registration Fee,
the NASD Filing Fee and the Nasdaq National Market Listing Fee are estimates.
* To be completed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law (the "DGCL") authorizes
a court to award, or a corporation's board of directors to grant, indemnity to
directors and officers in terms sufficiently broad to permit such
indemnification under certain circumstances for liabilities (including
reimbursement for expenses incurred) arising under the Securities Act of 1933,
as amended (the "Securities Act").
As permitted by the DGCL, our Amended and Restated Bylaws provide that the
Registrant shall indemnify its directors and officers, and may indemnify its
employees and other agents, to the fullest extent permitted by law. The Amended
and Restated Bylaws also permit the Registrant to secure insurance on behalf of
any officer, director, employee or other agent for any liability arising out of
his or her actions in such capacity, regardless of whether the Amended and
Restated Bylaws would permit indemnification. The Registrant has obtained
officer and director liability insurance with respect to liabilities arising out
of certain matters, including matters arising under the Securities Act.
The Registrant also has entered into agreements with its directors and
executive officers that, among other things, indemnify them for certain expenses
(including attorneys' fees), judgments, fines and settlement amounts incurred by
them in any action or proceeding, including any action by or in the right of the
Registrant, arising out of such person's services as a director or officer of
the Registrant, any subsidiary of the Registrant or any other company or
enterprise to which the person provides services at the request of the
Registrant.
Reference is also made to Section 8 of the form of Underwriting Agreement to
be filed as Exhibit 1.1 to this Registration Statement for certain provisions
regarding the indemnification of officers and directors of the Registrant by the
underwriters.
II-1
<PAGE>
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since November 21, 1995, the Registrant has issued and sold unregistered
securities as follows:
(1) In connection with our formation, we issued an aggregate of 1,583,333
shares of common stock in a private placement on December 21, 1995 to Samir
Arora, David Kleinberg, Sal Arora and Clement Mok, our four founders. The
aggregate consideration received was promissory notes in the aggregate principal
amount of $142,500.
(2) In connection with our formation and the transfer of technology to us,
an aggregate of 1,833,332 shares of Series A preferred stock were issued in a
private placement on December 21, 1995 to Studio Archetype and Rae Technology.
The aggregate consideration received was certain technology and intellectual
property rights.
(3) An aggregate of 4,466,666 shares of Series B preferred stock were issued
in a private placement on February 2, 1996 to five accredited investors. The
aggregate consideration received was $5.36 million.
(4) Warrants for the purchase of up to 6,863,426 shares of Series C
preferred stock were issued in a private placement in December 1996 to seven
institutional investors. No consideration was received in connection with the
issuance of such warrants. On various dates between December 1996 and March
1997, 4,612,926 of the Series C preferred stock warrants were exercised. The
aggregate consideration received was approximately $8.4 million.
(5) A warrant to purchase up to 3,482,838 shares of Series E preferred stock
was issued in a private placement on April 11, 1997 to IBM. The aggregate
consideration received in connection with the issuance of such warrant was
approximately $250,000.
(6) An aggregate of 10,495,968 shares of Series E preferred stock were
issued in a private placement on April 11, 1997 to IBM in exchange for 1,181,388
shares of Series A preferred stock and all outstanding shares of Series B and C
preferred stock.
(7) An aggregate of 406,566 shares of Series E preferred stock were issued
in private placements on various dates between June, 1997 and March, 1998 to our
four founders. The aggregate consideration received was approximately $2.7
million.
(8) Warrants to purchase of up to 833,333 shares of Series F preferred
stock, originally classified as Series D preferred stock, pursuant to an option
agreement made in connection with IBM's acquisition of approximately 80% of our
stock were issued in a private placement on March 14, 1997 to 10 accredited
investors. The aggregate consideration received in connection with the issuance
of such warrants was $50,000.
(9) A warrant to purchase up to 83,333 shares of Series F preferred stock
was issued to IBM Credit Corp. in a private placement effective as of December
23, 1997 in connection with a $15 million loan pursuant to a Revolving Loan and
Security Agreement. The loan was subsequently increased to $19 million.
(10) Units for the purchase of 10% Senior Subordinated Secured Convertible
Promissory Notes representing the right to acquire upon conversion up to
1,664,700 shares of Series E-2 preferred stock assuming accrued interest at
December 31, 1998 of $208,125 were issued in a private placement on October 8,
1998 and December 31, 1998 to IBM and Perseus Capital LLC for an aggregate
consideration of $10.9 million, $2.6 million of which was received from IBM on
January 5, 1999. Warrants to purchase up to 163,714 shares of Series E-2
preferred stock were issued in connection with the convertible notes. The
aggregate consideration received in connection with the issuance of such
warrants was approximately $92,000. In February 1999, we issued to IBM a $2.0
million note and warrants to purchase 30,012 shares of Series E-2 preferred
stock and in March 1999, we issued
II-2
<PAGE>
a $1.42 million note and a warrant to purchase 21,323 shares of Series E-2
preferred stock to IBM under the terms of a February 4, 1999 agreement.
(11) 333,333 shares of Series F-2 preferred stock were issued and a warrant
for the purchase of up to 16,666 shares of Series F-2 preferred stock was issued
in a private placement of shares of preferred stock and warrants for the
purchase of preferred stock on October 16, 1998 to Novell, Inc. The
consideration received in connection with the issuance of the shares was $3
million. No additional consideration was received in connection with the
issuance of such warrants.
(12) 55,555 shares of Series F-2 preferred stock were issued on October 28,
1998 to MC Silicon Valley, Inc., a subsidiary of Mitsubishi. The consideration
received was approximately $500,000.
(13) As of December 31, 1998, an aggregate of 633,069 shares of common stock
had been issued to our employees and consultants on exercise of options. The
aggregate consideration received for such shares was $242,000.
No underwriters were engaged in connection with these issuances and sales.
Each of the transactions noted above was made in reliance upon the exemption
from registration provided by either Section 3(b) or 4(2) of the Securities Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(A) EXHIBITS
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
1.1+ Form of Underwriting Agreement
3.1+ Restated Certificate of Incorporation of the Registrant
3.1.1+ Form of Restated Certificate of Incorporation to be in effect at the closing of the offering made
under this Registration Statement
3.2+ Bylaws of the Registrant as amended through the date of this Registration Statement
3.2.1+ Form of Amended and Restated Bylaws to be in effect upon the closing of the offering made under this
Registration Statement
4.1 Specimen stock certificate
4.2+ Form of Series C Preferred Stock Warrant
4.2.1+ Amendment to Series C Preferred Stock Warrant
4.3+ Form of Series E Preferred Stock Warrant
4.4+ Form of Series E-2 Preferred Stock Warrant
4.5+ Form of Series F Preferred Stock Warrant
5.1** Opinion of Graham & James LLP
9.1+ Voting Agreement between NetObjects, Inc. and International Business Machines Corporation
10.1+ NetObjects, Inc. 1997 Stock Option Plan
10.1.1+ NetObjects, Inc. Amended and Restated 1997 Stock Option Plan to be in effect upon the closing of the
offering made under this Registration Statement
10.1.2+ Form of Stock Option Agreement under the 1997 Stock Option Plan
10.1.3+ Form of Restricted Stock Purchase Agreement under the 1997 Stock Option Plan
10.1.4+ Form of Restricted Stock Transfer Agreement under the 1997 Stock Option Plan
10.2+ NetObjects, Inc. 1997 Special Stock Option Plan
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.3+ 1999 Employee Stock Purchase Plan
10.4+* IBM Software License Agreement (NetObjects License Agreement #L97063) by and between NetObjects and
IBM dated as of March 18, 1997
10.4.1+* Amendment Number 1 to NetObjects License Agreement L97063 dated as of April 30, 1997
10.4.2+ Second Amendment to NetObjects License Agreement L97063 dated as of October 7, 1997
10.4.3+* Third Amendment to NetObjects License Agreement L97063 dated as of December 16, 1997
10.4.4+* Fourth Amendment to NetObjects License Agreement L97063 dated as of April 27, 1998
10.4.5+* Fifth Amendment to NetObjects License Agreement L97063 dated as of January 14, 1999
10.4.6+* Amendment No. 6 to NetObjects License Agreement L97063 dated as of September 18, 1998
10.4.7+* Seventh Amendment to NetObjects License Agreement L97063 effective January 15, 1999
10.4.8+* Eighth Amendment to NetObjects License Agreement L97063 dated September 18, 1998
10.4.9+* Amendment No. 9 to NetObjects License Agreement effective January 21, 1999
10.4.10+ Amendment No. 10 to NetObjects License Agreement dated as of February 4, 1999
10.4.11+* Letter Agreement modifying NetObjects License Agreement L97063 dated as of February 6, 1998
10.4.12+* Letter Agreement modifying NetObjects License Agreement L97063 dated as of June 30, 1998
10.4.13+* Letter Agreement modifying NetObjects License Agreement L97063 dated as of January 14, 1999
10.4.14* Letter Agreement modifying NetObjects License Agreement L97063 dated as of March 25, 1999
10.5+ IBM Patent License Agreement by and between NetObjects and IBM dated as of April 10, 1997
10.6+ Lease Agreement by and between NetObjects and Metropolitan Life Insurance Company dated July 24, 1998
10.7+ Lease Agreement by and between NetObjects Limited and HQ Executive Offices (UK) LTD dated September
1, 1998
10.8+ Revolving Loan and Security Agreement by and between NetObjects, Inc. and IBM Credit Corp. dated as
of December 23, 1997
10.8.1+ Amendment to Revolving Loan and Security Agreement dated July 1998
10.9+ Note and Warrant Purchase Agreement by and among NetObjects, IBM and Perseus Capital, LLC dated as of
October 8, 1998
10.9.1+ Supplement to Note and Warrant Purchase Agreement dated as of February 4, 1999
10.10+ Technology Transfer Agreement between Rae Technology, Inc. and NetObjects, Inc. dated February 2,
1996
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.10.1** Amendment to Technology Transfer Agreement by and between Rae Technology and NetObjects dated as of
March 18, 1997
10.11** Patent Transfer and License Agreement by and between Rae Technology LLC and NetObjects, Inc. dated as
of April 10, 1997, as amended
10.12+ Technology License Agreement by and between NetObjects and Clement Mok Designs dated as of December
21, 1995
10.13+* Distribution Agreement by and between Ingram Micro, Inc. and NetObjects, Inc. dated March 6, 1997
10.14+* Commercial Application Partner Agreement by and between Sybase, Inc. and NetObjects, Inc. dated June
30, 1997
10.15+* Master Distributor Agreement by and between Mitsubishi Corporation and NetObjects, Inc. dated
September 30, 1997
10.16+* Standard Inbound License Agreement by and between NetObjects and Novell effective September 30, 1998
10.17+* Build-It License Agreement dated as of February 2, 1999
10.18+* IBM Trademark License Agreement dated as of January 19, 1999
10.19 Letter Agreement by and between NetObjects and John Sculley dated February 3, 1999
16.1 Letter from Ernst & Young LLP dated February 5, 1999 regarding change in certifying accountant
21.1+ Subsidiaries of the Registrant
23.1 Consent of Graham & James LLP (included in its opinion to be filed as Exhibit 5.1 hereto)
23.2 Consent of KPMG LLP
24.1 Power of Attorney (included in signature page hereto)
27.1+ Financial Data Schedule
</TABLE>
- ------------------------
+ Previously filed.
* Confidential treatment requested.
** To be filed by amendment.
(b) FINANCIAL STATEMENT SCHEDULE
<TABLE>
<S> <C>
Independent Auditors' Report on Schedule
Schedule II--Valuation and Qualifying Accounts
</TABLE>
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission,
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities
II-5
<PAGE>
being registered, the Registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
The undersigned Registrant hereby undertakes to provide to the underwriters,
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be a part of this Registration
Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the city of Redwood City, State of
California, on March 31, 1999.
<TABLE>
<S> <C> <C>
NETOBJECTS, INC.
By: /s/ SAMIR ARORA
-----------------------------------------
Samir Arora
CHIEF EXECUTIVE OFFICER
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities indicated below on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
Chairman of the Board,
/s/ SAMIR ARORA Chief Executive Officer,
- ------------------------------ President (Principal March 31, 1999
Samir Arora Executive Officer)
/s/ MICHAEL J. SHANNAHAN+ Chief Financial Officer
- ------------------------------ (Principal Financial and March 31, 1999
Michael J. Shannahan Accounting Officer)
/s/ JOHN SCULLEY+
- ------------------------------ Director March 31, 1999
John Sculley
/s/ LEE A. DAYTON+
- ------------------------------ Director March 31, 1999
Lee A. Dayton
/s/ MICHAEL D. ZISMAN+
- ------------------------------ Director March 31, 1999
Michael D. Zisman
/s/ ROBERT G. ANDEREGG+
- ------------------------------ Director March 31, 1999
Robert G. Anderegg
/s/ CHRISTOPHER M. STONE*+
- ------------------------------ Director March 31, 1999
Christopher M. Stone
</TABLE>
* Mr. Stone will become a director of our Company on the closing date of the
offering.
<TABLE>
<S> <C> <C> <C>
+By: /s/ SAMIR ARORA
-------------------------
Samir Arora
ATTORNEY-IN-FACT
</TABLE>
II-7
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Net Objects, Inc:
Under date of December 21, 1998, we reported on the consolidated balance
sheets of NetObjects, Inc. and subsidiary as of September 30, 1997 and 1998, and
the related consolidated statements of operations, stockholders' deficit, and
cash flows for the period from November 21, 1995 (inception) to September 30,
1996, and for each of the years in the two-year period ended September 30, 1998,
which are included in the prospectus. In connection with our audits of the
aforementioned consolidated financial statements, we also audited the related
consolidated financial statement schedules in the registration statement. These
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
The accompanying consolidated financial statement schedules have been
prepared assuming that the Company will continue as a going concern. As
discussed in note 1(d) to the consolidated financial statements, the Company has
suffered recurring losses from operations and has a net capital deficiency that
raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in note 1(d).
The consolidated financial statement schedules do not include any adjustments
that might result from the outcome of this uncertainty.
KPMG LLP
Mountain View, California
December 21, 1998
S-1
<PAGE>
NETOBJECTS, INC.
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
ADDITIONS--
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND DEDUCTIONS-- END OF
FISCAL YEAR EXPENSES WRITEOFFS FISCAL YEAR
------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Period from November 21, 1995 (inception)
to September 30, 1996
Allowance for doubtful accounts, returns and price
protection.................................................. -- -- -- --
Year ended September 30, 1997
Allowance for doubtful accounts, returns and price
protection.................................................. -- $ 1,905,810 $ (1,150,228) $ 755,582
Year ended September 30, 1998
Allowance for doubtful accounts, returns and price
protection.................................................. $ 755,582 $ 4,691,000 $ (3,183,475) $ 2,263,107
</TABLE>
S-2
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
1.1+ Form of Underwriting Agreement
3.1+ Restated Certificate of Incorporation of the Registrant
3.1.1+ Form of Restated Certificate of Incorporation to be in effect at the closing of the offering made
under this Registration Statement
3.2+ Restated Bylaws of the Registrant as amended through the date of this Registration Statement
3.2.1+ Form of Amended and Restated Bylaws to be in effect upon the closing of the offering made under this
Registration Statement
4.1 Specimen stock certificate
4.2+ Form of Series C Preferred Stock Warrant
4.2.1+ Amendment to Series C Preferred Stock Warrant
4.3+ Form of Series E Preferred Stock Warrant
4.4+ Form of Series E-2 Preferred Stock Warrant
4.5+ Form of Series F Preferred Stock Warrant
5.1** Opinion of Graham & James LLP
9.1+ Voting Agreement between NetObjects, Inc. and International Business Machines Corporation
10.1+ NetObjects, Inc. 1997 Stock Option Plan
10.1.1+ NetObjects, Inc. Amended and Restated 1997 Stock Option Plan to be in effect upon the closing of the
offering made under this Registration Statement
10.1.2+ Form of Stock Option Agreement under the 1997 Stock Option Plan
10.1.3+ Form of Restricted Stock Purchase Agreement under the 1997 Stock Option Plan
10.1.4+ Form of Restricted Stock Transfer Agreement under the 1997 Stock Option Plan
10.2+ NetObjects, Inc. 1997 Special Stock Option Plan
10.3+ 1999 Employee Stock Purchase Plan
10.4+* IBM Software License Agreement (NetObjects License Agreement #L97063) by and between NetObjects and
IBM dated as of March 18, 1997
10.4.1+* Amendment Number 1 to NetObjects License Agreement L97063 dated as of April 30, 1997
10.4.2+ Second Amendment to NetObjects License Agreement L97063 dated as of October 7, 1997
10.4.3+* Third Amendment to NetObjects License Agreement L97063 dated as of December 16, 1997
10.4.4+* Fourth Amendment to NetObjects License Agreement L97063 dated as of April 27, 1998
10.4.5+* Fifth Amendment to NetObjects License Agreement L97063 dated as of January 14, 1999
10.4.6+* Amendment No. 6 to NetObjects License Agreement L97063 dated as of September 18, 1998
10.4.7+* Seventh Amendment to NetObjects License Agreement L97063 effective January 15, 1999
10.4.8+* Eighth Amendment to NetObjects License Agreement L97063 dated September 18, 1998
10.4.9+* Amendment No. 9 to NetObjects License Agreement effective January 21, 1999
10.4.10+ Amendment No. 10 to NetObjects License Agreement dated as of February 4, 1999
10.4.11+* Letter Agreement modifying NetObjects License Agreement L97063 dated as of February 6, 1998
10.4.12+* Letter Agreement modifying NetObjects License Agreement L97063 dated as of June 30, 1998
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.4.13+* Letter Agreement modifying NetObjects License Agreement L97063 dated as of January 14, 1999
10.4.14* Letter Agreement modifying NetObjects License Agreement L97063 dated as of March 25, 1999
10.5+ IBM Patent License Agreement by and between NetObjects and IBM dated as of April 10, 1997
10.6+ Lease Agreement by and between NetObjects and Metropolitan Life Insurance Company dated July 24, 1998
10.7+ Lease Agreement by and between NetObjects Limited and HQ Executive Offices (UK) LTD dated September
1, 1998
10.8+ Revolving Loan and Security Agreement by and between NetObjects, Inc. and IBM Credit Corp. dated as
of December 23, 1997
10.8.1+ Amendment to Revolving Loan and Security Agreement dated July 1998
10.9+ Note and Warrant Purchase Agreement by and among NetObjects, IBM and Perseus Capital LLC dated as of
October 8, 1998
10.9.1+ Supplement to Note and Warrant Purchase Agreement dated as of February 4, 1999
10.10+ Technology Transfer Agreement between Rae Technology, Inc. and NetObjects, Inc. dated February 2,
1996
10.10.1** Amendment to Technology Transfer Agreement by and between Rae Technology and NetObjects dated as of
March 18, 1997
10.11** Patent Transfer and License Agreement by and between Rae Technology LLC and NetObjects, Inc. dated as
of April 10, 1997, as amended
10.12+ Technology License Agreement by and between NetObjects and Clement Mok Designs dated as of December
21, 1995
10.13+* Distribution Agreement by and between Ingram Micro, Inc. and NetObjects, Inc. dated March 6, 1997
10.14+* Commercial Application Partner Agreement by and between Sybase, Inc. and NetObjects, Inc. dated June
30, 1997
10.15+* Master Distributor Agreement by and between Mitsubishi Corporation and NetObjects, Inc. dated
September 30, 1997
10.16+* Standard Inbound License Agreement by and between NetObjects and Novell effective September 30, 1998
10.17+* Build-It License Agreement dated as of February 2, 1999
10.18+* IBM Trademark License Agreement dated as of January 19, 1999
10.19 Letter Agreement by and between NetObjects and John Sculley dated February 3, 1999
16.1 Letter from Ernst & Young LLP dated February 5, 1999 regarding change in certifying accountant
21.1+ Subsidiaries of the Registrant
23.1 Consent of Graham & James LLP (included in its opinion to be filed as Exhibit 5.1 hereto)
23.2 Consent of KPMG LLP
24.1 Power of Attorney (included in signature page hereto)
27.1+ Financial Data Schedule
</TABLE>
- ------------------------
+ Previously filed.
* Confidential treatment requested.
** To be filed by amendment.
<PAGE>
EXHIBIT 4.1
COMMON STOCK [NETOBJECTS LOGO] COMMON STOCK
NO. SHARES
INCORPORATED UNDER THE LAWS SEE REVERSE FOR CERTAIN DEFINITIONS
OF THE STATE OF DELAWARE CUSIP 641146 10 2
This Certifies that
is the record holder of
FULLY PAID AND NONASSESSABLE SHARES OF COMMON STOCK, $.01 PAR VALUE, OF
NETOBJECTS, INC.
transferable on the books of the Corporation in person or by duly authorized
attorney on surrender of this certificate properly endorsed. This certificate
shall not be valid until countersigned and registered by the Transfer Agent and
Registrar.
WITNESS the facsimile seal of the Corporation and the signatures of its
duly authorized officers.
Dated:
/s/ Alan B. Kalin /s/ Samir Arora
SECRETARY PRESIDENT AND CHIEF EXECUTIVE OFFICER
[NETOBJECTS SEAL]
COUNTERSIGNED AND REGISTERED:
BANKBOSTON, N.A.
TRANSFER AGENT AND REGISTRAR
BY [illegible]
AUTHORIZED SIGNATURE
<PAGE>
The Corporation will furnish without charge to each stockholder who so
requests the powers, designations, preferences and relative, participating,
optional, or other special rights of each class of stock or series thereof
and the qualifications, limitations or restrictions of such preferences
and/or rights. Such requests shall be made to the Corporation's Secretary at
the principal office of the Corporation.
KEEP THIS CERTIFICATE IN A SAFE PLACE. IF IT IS LOST, STOLEN, OR
DESTROYED THE CORPORATION WILL REQUIRE A BOND OF INDEMNITY AS A CONDITION TO
THE ISSUANCE OF A REPLACEMENT CERTIFICATE.
The following abbreviations, when used in the inscription on the face of
this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
TEN COM -- as tenants in common
TEN ENT -- as tenants by the entireties
JT TEN -- as joint tenants with right of
survivorship and not as tenants
in common
<TABLE>
<CAPTION>
<S> <C>
UNIF GIFT MIN ACT -- ......................... Custodian .................
(Cust) (Minor)
under Uniform Gifts to Minors
Act .................................................
(State)
UNIF TRF MIN ACT -- ................. Custodian (until age ........)
(Cust)
..................... under Uniform Transfers
(Minor)
to Minors Act ......................................
(State)
</TABLE>
Additional abbreviations may also be used though not in the above list.
FOR VALUE RECEIVED,__________________hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
- --------------------------------------
- --------------------------------------
- -------------------------------------------------------------------------------
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Shares
- ------------------------------------------------------------------------
of the common stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint
Attorney
- -----------------------------------------------------------------------
to transfer the said stock on the books of the within named Corporation with
full power of substitution in the premises.
Dated
----------------------------------
X----------------------------------------
X----------------------------------------
NOTICE: THE SIGNATURE(S) TO THIS ASSIGNMENT MUST
CORRESPOND WITH THE NAME(S) AS WRITTEN
UPON THE FACE OF THE CERTIFICATE IN
EVERY PARTICULAR, WITHOUT ALTERATION OR
ENLARGEMENT OR ANY CHANGE WHATEVER.
Signature(s) Guaranteed
By -------------------------------------------
THE SIGNATURE(S) MUST BE GUARANTEED BY AN
ELIGIBLE GUARANTOR INSTITUTION (BANKS,
STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS
AND CREDIT UNIONS WITH MEMBERSHIP IN
AN APPROVED SIGNATURE GUARANTEE
MEDALLION PROGRAM), PURSUANT TO S.E.C.
RULE 17Ad-15.
- -------------------------------------------------
AMERICAN BANK NOTE COMPANY MAR 23, 1999 fm
3504 ATLANTIC AVENUE
SUITE 12
LONG BEACH, CA 90807 004484bk
(562) 989-2333
(FAX) (562) 426-7450 Proof_____ NEW
- -------------------------------------------------
<PAGE>
EXHIBIT 10.4.14
CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY
WITH THE COMMISSION. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT
TO THE OMITTED PORTIONS.
March 25, 1999
Ms. Eileen Rudden
Senior Vice President
Communications Products Division
Lotus Development Corporation
One Charles Park
Cambridge, MA 02142-1245
Re: Royalty Rate for Promotional Bundles in accordance with Section 5.4 of the
NetObjects License Agreement, dated March 18, 1997, as amended, between
NetObjects and IBM.
Dear Eileen:
Reference is made to the NetObjects License Agreement, dated March 18, 1997, as
amended, between NetObjects, Inc. ("NetObjects") and International Business
Machines Corporation ("IBM"), (the "Agreement"). Capitalized terms used in this
letter ("Letter"), and not otherwise defined, shall have the meaning given to
them in the Agreement. The effective date of this Letter is January 1, 1999.
Pursuant to Section 5.4 of the Agreement, IBM may request a lower royalty for
the Licensed Work when a licensing transaction requires a substantial discount.
IBM and NetObjects agree that during the time period between January 1, 1999 and
December 31, 1999, ("Promotion Period"), a lower royalty described in Section 4
below will apply instead of the per copy Royalty Rate listed in Section 5 of
Exhibit B of the Agreement for any distribution of the Promotional Bundles
(defined in Section 2 below) by IBM and its Subsidiaries.
1. Licensed Works:
NetObjects Fusion (any version shipping during Promotion Period); and
NetObjects ScriptBuilder (any version shipping during Promotion Period).
2. Promotional Bundles: Studio Bundles and Server Bundles and Upgrade Bundles
are, collectively, Promotional Bundles.
a. Studio Bundle means the product tentatively titled "Lotus Domino
Application Studio" consisting of Licensed Works listed in Section 1 above
Bundled with other software, including NetObjects BeanBuilder and Lotus Domino
Designer or any future update, version, successor product or derivative work of
Lotus Domino Designer or NetObjects BeanBuilder.
b. Server Bundle means the Licensed Works listed in Section 1 above
Bundled with NetObjects BeanBuilder and Lotus Domino Server, or any future
update, version, successor product or derivative work of Lotus Domino Server or
NetObjects BeanBuilder.
c. Upgrade Bundle means the Bundle consisting of the software contained
in the Studio Bundle, except Lotus Domino Designer, and that is sold to
customers that had previously
<PAGE>
purchased Lotus Domino Designer or Lotus Domino Server or some other
predecessor products, usually with subscription maintenance.
3. Promotion Period: January 1, 1999 - December 31, 1999
4. Royalty:
a. Studio Bundle
The royalty payment for the Studio Bundle shall be paid against revenue recorded
by IBM in a royalty payment quarter in accordance with Section 5.6 of the
Agreement, as follows:
CHART 1: Cumulative Royalties paid by IBM for Promotional Bundles And
Corresponding Royalty Rate for the Studio Bundle
<TABLE>
<CAPTION>
BAND CUMULATIVE ROYALTY ACCRUED FOR ROYALTY (% OF BUNDLE ASP) FOR
PROMOTIONAL BUNDLES DURING STUDIO BUNDLE
PROMOTION PERIOD
<S> <C> <C>
Band 1. $[*] - $[*] [*]%
Band 2. $[*] - $[*] [*]%
Band 3. over $[*] [*]%
</TABLE>
The royalty payment for the Studio Bundle shall be [*]% of the revenue
received by IBM and its Subsidiaries for the Studio Bundles in a given
calendar quarter, less any returns and promotional discounts ("Bundle ASP")
until $[*] in cumulative royalty payments for Promotional Bundles has accrued
during the Promotion Period ("Band 1"). Thereafter, until an additional $[*]
in cumulative royalty payments for Promotional Bundles has accrued (for a
total cumulative royalties of $[*]) during the Promotion Period ("Band 2"),
the royalty payment for the Studio Bundle shall be [*]% of Bundle ASP. For
all Studio Bundles sold thereafter, until the end of the Promotion Period
("Band 3"), the royalty payment for Studio Bundles will be [*]% of Bundle
ASP. Although royalties are to be paid to NetObjects on a quarterly basis,
the cumulative royalty payments (Band 1, Band 2 and Band 3) are aggregated
across the Promotion Period.
Following each calendar quarter during the Promotion Period, the per unit
royalty accrued for the Studio Bundles distributed during that quarter will
be calculated in accordance with the Per Unit Formula set forth below ("Per
Unit Royalty"). If the Per Unit Royalty accrued for the Studio Bundles
distributed during that quarter is found to vary by more than $[*] per unit
from the Comparison Royalty per unit listed in Chart 2 below (for example, in
a given calendar quarter, for Band 1, the Per Unit Royalty is either higher
than $[*] or lower than $[*]), a new mutually-agreed upon royalty rate for
the Studio Bundles will be expressed as a percentage of Bundle ASP and set
forth in a separate letter signed by IBM and NetObjects within two months
after the end of the quarter ("New Royalty"), and the New Royalty will apply
for the Studio Bundles sold during that quarter instead of the royalty listed
in Chart 1
* Portions of this exhibit have been omitted and filed separately with the
Commission pursuant to a request for confidential treatment under Rule 406.
<PAGE>
above. The New Royalty will apply for future quarters during the Promotion
Period, unless otherwise stated in the letter signed by IBM and NetObjects.
If a New Royalty is not set forth in a letter signed by NetObjects and IBM
within the aforementioned two-month period, the New Royalty will be equal to
the Comparison Royalty listed in Chart 2 below. The "Per Unit Formula"
derives the per unit royalty for Studio Bundles by dividing the sum of the
royalties earned by NetObjects for Studio Bundles during the calendar quarter
by the number of units of Studio Bundles distributed by IBM and its
Subsidiaries in that calendar quarter. i.e., Per Unit Royalty for a Studio
Bundle = (Bundle ASP * Royalty listed in Chart 1)/number of units of Studio
Bundles.
CHART 2: Cumulative Royalties paid by IBM for Promotional Bundles And
Comparison Royalty per unit
<TABLE>
<CAPTION>
BAND CUMULATIVE ROYALTY ACCRUED FOR COMPARISON ROYALTY PER UNIT
PROMOTIONAL BUNDLES DURING PROMOTION
PERIOD
<S> <C> <C>
Band 1. $[*] - $[*] $[*]
Band 2. $[*] - $[*] $[*]
Band 3. over $[*] $[*]
</TABLE>
b. Server Bundle. The royalty payment for the Server Bundle shall be set forth
in a separate written document signed by IBM and NetObjects, and, like the
Studio Bundle pricing in Section 4a, shall be based upon a percentage of the
revenue received by IBM and its Subsidiaries for the Server Bundle.
c. Upgrade Bundle Royalties: For purposes of this section 5, "Upgrade ASP"
shall be defined as the revenues received by IBM and its Subsidiaries for the
Upgrade Bundles during a calendar quarter, less any returns or discounts. The
"Per Unit Upgrade ASP" shall mean Upgrade ASP for a given calendar quarter
divided by the number of Upgrade Bundles distributed by IBM or its Subsidiaries
during that quarter. The "Per Unit Bundle ASP" shall mean Bundle ASP for a
given calendar quarter divided by the number of Studio Bundles distributed by
IBM or its Subsidiaries during the quarter. The "Upgrade Rate" shall be derived
by multiplying the royalty percentage for Studio Bundles in Chart 1 for the
applicable Band by the quotient of the Per Unit Upgrade ASP divided by the Per
Unit Bundle ASP. The royalties to be paid by IBM to NetObjects for Upgrade
Bundles will be equal to the Upgrade Rate multiplied by Upgrade ASP. An
example of the calculation of the royalty payment for an Upgrade Bundle is
provided below:
Example:
Upgrade Rate = Per Unit Bundle ASP / Per Unit Upgrade ASP * applicable royalty
for Studio Bundles in Chart 1
Royalty Rate for Upgrade Bundles = Upgrade Rate * Upgrade ASP
* Portions of this exhibit have been omitted and filed separately with the
Commission pursuant to a request for confidential treatment under Rule 406.
<PAGE>
Upgrade ASP = $[*]
Bundle ASP = $[*]
applicable royalty rate = [*]%
Upgrade ASP = $[*]
Upgrade Rate = $[*] / $[*] * [*] = [*]%
Royalty for Upgrade Bundles = $[*] * [*]% = $[*]
The royalties paid by IBM or its Subsidiaries to NetObjects for units sold as
part of the "Upgrade Bundle" shall apply towards the aggregate royalties paid by
IBM to NetObjects for the purposes of calculating royalties due as set forth
above in Section 4 or under this section.
5. Marketing: The parties shall develop a joint marketing plan due on the
first customer ship of the Studio Bundle. The Lotus marketing contact is John
Lautenbach and the NetObjects marketing contact is Bernard Desarnauts. On or
before July 1, 1999, the parties shall review the sales of the Studio Bundle and
plan additional marketing efforts, if necessary.
6. Software: Lotus will be responsible for producing the first "Gold" CD for
the Studio Bundle containing NetObjects Fusion 4.1 and 3.01, NetObjects
ScriptBuilder 3.01 and NetObjects BeanBuilder 1.0 and CD artwork ("Gold CD").
Subsequently thereafter, whenever updated versions or releases of the
Licensed Works or updated versions or releases of NetObjects BeanBuilder
become generally available to the public ("Public Availability Date"),
NetObjects shall provide to Lotus a single Gold CD containing the most recent
versions and releases of the Licensed Works listed in Section 1 above along
with the most recent version and release of NetObjects BeanBuilder within
fifteen (15) days of the Public Availability Date. The Gold CDs provided by
NetObjects will contain artwork for each of the Licensed Works and NetObjects
BeanBuilder and will have a unified install experience for the end user which
guides them through installation of the Licensed Works, NetObjects
BeanBuilder and documentation without requiring the user to browse
directories on the Gold CD directly. The Licensed Works and NetObjects
BeanBuilder on the Gold CD will be delivered by NetObjects in such a way that
Lotus will not be required to deliver individual product serial numbers for
the Licensed Works to end users. Lotus will be responsible for duplication
of the Gold CD.
7. Distribution of NetObjects BeanBuilder: Any distribution of NetObjects
BeanBuilder by NetObjects to IBM or by IBM to a third party in conjunction with
Licensed Works as part of Studio Bundle or Server Bundle under this Letter
("BeanBuilder Distribution") shall constitute a distribution of NetObjects
BeanBuilder by IBM (and not a distribution of NetObjects BeanBuilder by
NetObjects) and thus this Letter shall not obligate NetObjects to pay royalties
to IBM for a BeanBuilder Distribution under the agreement number 4998S20724
entered into between IBM and NetObjects, Inc. on September 14, 1998.
* Portions of this exhibit have been omitted and filed separately with the
Commission pursuant to a request for confidential treatment under Rule 406.
<PAGE>
8. Agreement: The terms of the Agreement remain in full force and effect and
shall apply to the Promotional Bundles, except as expressly provided above. In
the event of any conflict between the terms of this letter and the terms of the
Agreement, the terms of this letter shall control with respect to the
Promotional Bundles set forth above.
Please sign below to indicate that the terms of this letter accurately reflect
our agreement for these Promotional Bundles.
Sincerely,
Samir Arora
CEO, NetObjects, Inc.
ACCEPTED AND ACKNOWLEDGED
Eileen Rudden
Senior Vice-President
Lotus Development Corporation
Date: _______________
<PAGE>
EXHIBIT 10.19
NetObjects, Inc.
301 Galveston Drive
Redwood City, CA 94063
February 3, 1999
VIA FACSIMILE
Mr. John Sculley
Sculley & Associates, Inc.
90 Park Avenue, 32nd Floor
New York, New York
Dear John:
We are pleased that you have agreed to continue to serve as a member of
the Board of Directors (the "Board") of NetObjects, Inc. (the "Company") and
to provide consulting services to the Company following the initial public
offering of its Common Stock. In connection with the initial public
offering, the Company intends to split its shares in a one-for-six reverse
stock split. This letter sets forth our agreement with respect to your
compensation by the Company for these services.
As an outside director of the Company, effective upon the closing of the
Company's sale of Common Stock to the underwriters in an Initial Public
Offering (as further defined in the Company's current Restated Certificate of
Incorporation), which results in aggregate cash proceeds to the Company of at
least $30 million (the "Closing Date") you will receive an option to purchase
20,000 shares (post-split) of Common Stock at the offering price per share.
Your options will vest monthly, as long as you remain a director, on a
ratable basis over 48 months from February 1, 1999. In addition, so long as
you remain a director of the Company, the Company will pay your expenses for
each Board meeting that you attend in person after the date of this letter,
not to exceed $4,000 per meeting.
On the Closing Date, the Company also will grant you an option to
purchase 50,000 (post-split) shares of Common Stock at $7.50 per share in
consideration of your providing consulting services to the Company as
reasonably requested by the CEO from time to time. Your rights to exercise
the option will vest ratably each month over a 48-month period commencing on
February 1, 1999 as long as you remain a director and are available to
provide the requested consulting services.
<PAGE>
This letter agreement shall be valid and binding from the date that it
has been executed by both of us until it shall expire by its terms or by
mutual written agreement. We also will enter into stock option agreements
and any other agreements that we may consider necessary to implement the
terms of this letter agreement.
This letter agreement may be executed in counterparts, and delivery of a
signed counterpart by facsimile transmission shall constitute a party's due
execution of this agreement. The terms of this letter agreement shall be
governed by California law. If the terms of this letter agreement are
acceptable to you, please sign below.
I am gratified that I will be able to continue receiving your valuable
support and advice. Best regards.
Very truly yours,
NETOBJECTS, INC.
By /s/ Samir Arora
------------------------------------
Samir Arora, Chief Executive Officer
I hereby agree to the terms and conditions
set forth in this letter.
/s/ John Sculley
- --------------------------------
John Sculley
<PAGE>
EXHIBIT 16.1
February 5, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Ladies and Gentlemen:
We have read paragraphs one through three included under the heading "Change
in Auditors" included on page 75 of Form S-1 dated February 5, 1999, of
NetObjects, Inc. We are in agreement with the statements contained in the
first sentence of paragraph one and paragraph's two and three. We have no
basis to agree or disagree with the statements made in the second and third
sentences of paragraph one.
Very Truly Yours,
/s/ Ernst & Young LLP
Ernst & Young LLP
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
NetObjects, Inc.:
We consent to the use of our reports included herein and to the reference to our
firm under the heading "Experts" in the Prospectus.
Our report dated December 21, 1998 contains an explanatory paragraph that states
that the Company has suffered recurring losses from operations and has a net
capital deficiency, which raise substantial doubt about its ability to continue
as a going concern. The Consolidated Financial Statements and Financial
Statement Schedules do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ KPMG LLP
Mountain View, California
March 30, 1999
