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6,000,000 SHARES
[LOGO]
COMMON STOCK
---------
This is the initial public offering of NetObjects, Inc., and we are offering
6,000,000 shares of our common stock. No public market currently exists for our
shares.
The common stock will be listed 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.
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<CAPTION>
PER SHARE TOTAL
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<S> <C> <C>
Public offering price................................................. $ 12.00 $ 72,000,000
Underwriting discounts................................................ $ 0.84 $ 5,040,000
Proceeds to NetObjects................................................ $ 11.16 $ 66,960,000
</TABLE>
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
NetObjects has granted the underwriters the right to purchase up to 900,000
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
MAY 7, 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):
eScriptZone.com, NetObjects corporate site, eSiteStore.com, and eFuse.com
GRAPHICS OF LOGOS:
NetObjects corporate logo
LEFT-HAND PAGE OF GATEFOLD:
TITLE: Enabling e-business
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 e-business web sites that sell products, provide virtual
tours, build online catalogs, auction collectible goods, and more.
FOUR GRAPHICS DEPICTING SCREEN SHOTS OF CUSTOMER WEB SITES
CAPTIONS (ONE FOR EACH SCREEN SHOT, LEFT TO RIGHT, TOP TO BOTTOM):
(1) www.christmas.com
(2) www.leasesource.com
(3) www.northstarnursery.com
(4) www.shell-lubricants.com
RIGHT-HAND PAGE OF GATEFOLD:
FOUR GRAPHICS DEPICTING SCREEN SHOTS OF CUSTOMER WEB SITES
CAPTIONS (ONE FOR EACH SCREEN SHOT, LEFT TO RIGHT, TOP TO BOTTOM):
(1) www.cellone-sf.com
(2) www.collectit.net
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(3) www.krause.com
(4) www.justforfeet.com
<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 March 31, 1999, we had an accumulated
deficit of approximately $63.6 million, $51.1 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 45% of our total revenues
in fiscal year 1998 and in the first six months of fiscal year 1999,
respectively. Almost all of our revenues from IBM in fiscal year 1998 resulted
from two 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, under a contract that expired on February 28, 1999.
We have no further commitments from IBM to pay us software license fees or
revenues from services. 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 half of fiscal year 1999. We are not expecting to receive
any service revenues from IBM going forward.
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
March 31, 1999, IBM has provided us with approximately $43.0 million of
financing through debt financing and cash prepayments of future royalties and
charges for services.
Since March 31, 1999, IBM has provided an additional $2.0 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.
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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 could conflict with our interests, however, and
IBM is free to compete with us. IBM's controlling interest in us, our dependence
on IBM and the conflicts of interests and potential competition associated with
IBM's relationship with us represent significant risks for an investor acquiring
our stock.
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
ITS NETOBJECTS STOCK WHEN PERMISSIBLE UNDER APPLICABLE SECURITIES LAWS AND
AGREEMENTS WITH THE UNDERWRITERS. IBM HAS NO OBLIGATION TO RESELL OUR PRODUCTS.
AFTER THE OFFERING, IBM WILL HAVE NO OBLIGATION TO PROVIDE US WITH ADDITIONAL
FINANCING. FOR MORE INFORMATION ABOUT THESE RISKS, SEE "RISK FACTORS--OUR
RELATIONSHIP WITH IBM WILL CHANGE SUBSTANTIALLY AFTER THE OFFERING, WHICH COULD
HARM OUR BUSINESS AND COULD CAUSE OUR REVENUES IN FISCAL YEAR 1999 TO FALL BELOW
THOSE OF FISCAL YEAR 1998. WHILE IBM WILL STILL CONTINUE TO CONTROL US, IT HAS
NO FURTHER OBLIGATIONS TO PROVIDE FINANCING, KEY CONTRACTS WITH IBM HAVE
EXPIRED, AND IBM IS EXPRESSLY ALLOWED TO COMPETE WITH US OR ACT IN A MANNER THAT
IS DISADVANTAGEOUS TO US," "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.
NetObjects-Registered Trademark-, NetObjects Fusion-TM-, NetObjects
Authoring Server-TM-, NetObjects TeamFusion-TM-, NetObjects Fusion Personal
Edition-TM-, SiteStructure Editor-TM-, PageDraw-Registered Trademark-,
SiteStyles-Registered Trademark-, SiteStyles Manager-TM-, SiteProducer-TM-,
StyleObject-TM-, WebDraw-TM-, PublishSet-TM-, AutoSites-TM- and The Web Needs
You-TM- are our registered and unregistered trademarks, service marks and trade
names. This prospectus also includes trademarks, service marks and trade names
other than those identified in this paragraph, each of which is the property of
its respective holder.
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THE OFFERING
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<S> <C>
Common stock offered by NetObjects.............. 6,000,000 shares
Common stock to be outstanding after the
offering...................................... 26,112,862 shares
Use of proceeds................................. Repayment of approximately $19.0 million of secured debt owed
to IBM Credit Corporation, a subsidiary of IBM, debt of
approximately $5.4 million plus accrued interest owed 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>
The foregoing information is based on the shares outstanding as of March 31,
1999. The total number of shares that we assume will be outstanding after the
offering excludes (a) 2,900,087 shares of common stock issuable at a weighted
average exercise price of $3.13 per share upon exercise of stock options
outstanding at March 31, 1999; (b) 266,615 shares of common stock reserved for
future issuance under our stock option plan; and (c) 300,000 shares of common
stock reserved for issuance under our 1999 Employee Stock Purchase Plan. See
"Capitalization" for information with respect to our capitalization as of March
31, 1999, our pro forma financial information and our pro forma financial
information as adjusted to reflect the capitalization after the offering.
SUMMARY FINANCIAL DATA
<TABLE>
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PERIOD FROM
NOVEMBER 21, 1995 YEAR ENDED SIX MONTHS ENDED
(INCEPTION) TO SEPTEMBER 30, MARCH 31,
SEPTEMBER 30, -------------------- --------------------
1996 1997 1998 1998 1999
------------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Total revenues....................................... $ -- $ 7,567 $ 15,270 $ 5,992 $ 11,243
Cost of revenues..................................... -- 772 5,093 1,166 3,764
Gross profit......................................... -- 6,795 10,177 4,826 7,479
Operating loss....................................... (6,741) (17,564) (20,970) (11,241) (7,668)
Nonrecurring interest charge on beneficial conversion
feature of convertible debt(1)..................... -- -- -- -- (7,457)
Net loss............................................. (6,695) (17,799) (22,224) (11,719) (16,850)
Basic and diluted net loss per share applicable to
common stockholders(2)............................. $ (4.10) $ (10.45) $ (12.26) $ (6.63) $ (8.33)
Shares used to compute basic and diluted net loss per
share applicable to common stockholders(2)......... 1,634 1,703 1,812 1,768 2,023
</TABLE>
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<TABLE>
<CAPTION>
MARCH 31, 1999
-------------------------
ACTUAL AS ADJUSTED(3)
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<S> <C> <C>
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash..................................................................................... $ 1,816 $ 44,867
Working capital (deficit)................................................................ (22,962) 42,671
Total assets............................................................................. 9,158 52,209
Short-term borrowings from IBM and IBM Credit Corp....................................... (22,165) --
Long-term obligations, less current portion.............................................. 10,323 212
Accumulated deficit...................................................................... (63,568) (63,824)
Stockholders' equity (deficit)........................................................... (31,038) 44,706
</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.
Each share of Series E-2 preferred stock automatically converts into common
stock upon the effectiveness of the offering and due to an adjustment
triggered by our failure to complete this or a similar offering or repay the
convertible notes prior to specific dates, the earliest of which was April
8, 1999, the conversion ratio has increased from 1:1 to 1.25:1. 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 Statement of Financial Accounting Standards (SFAS)
No. 128. 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.
(3) As adjusted to give effect to
- the pro forma capitalization set forth in "Capitalization";
- our sale of 6,000,000 shares to be sold in the offering at the initial
public offering price of $12.00 per share, less the underwriters' discount
and commissions and estimated expenses of the offering; and
- repayment of short-term borrowings and accretion of related interest.
The information set forth above is unaudited and should be read in
conjunction with our consolidated financial statements and notes to consolidated
financial statements.
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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 March 31, 1999, we had an accumulated deficit of
approximately $63.6 million, $51.1 million of which has been incurred since
April 1997. We expect to sustain significant losses for the foreseeable future,
which could harm our business and decrease the market price of our stock.
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 related professional services, which have
generated insubstantial revenues to date.
OUR AUDITORS HAVE SUBSTANTIAL DOUBT ABOUT OUR VIABILITY AS A BUSINESS.
After consideration of our financial condition and our plans, KPMG LLP
issued a form of independent auditors' report on our consolidated financial
statements 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. KPMG's report included an explanatory
paragraph expressing "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.
Without the net proceeds from the offering we will not have enough cash to
remain in business. On May 6, 1999, we signed a firm underwriting agreement for
the offering. After consideration of our current financial condition, the
underwriters' ability to honor the underwriting agreement, and the likelihood of
our ability to complete the offering, KPMG LLP concluded that substantial doubt
about our ability to continue as a going concern for a reasonable period of time
had been alleviated. On May 6, 1999, KPMG LLP reissued their independent
auditors' report on our consolidated financial statements, referred to above,
which excludes the explanatory paragraph expressing "substantial doubt" about
our ability to continue as a going concern. We believe the net proceeds from
this offering and current cash will be sufficient to fund our operations to
September 30, 2000. We have no plans other than the receipt of the offering
proceeds and our intention to increase our revenues to address our liquidity
problems.
A SUBSTANTIAL PORTION OF THE NET OFFERING PROCEEDS WILL BE USED TO REPAY DEBT
OWED TO IBM AND NOT TO IMPLEMENT OUR BUSINESS MODEL.
The remaining net proceeds from the offering are estimated to be
approximately $41.0 million, after the repayment of a $19.0 million secured
credit facility with IBM Credit Corp. and approximately $5.4 million that we owe
to IBM under notes issued prior to the closing of the offering, and after
deducting underwriting discounts and commissions of approximately $5.0 million
and estimated expenses of approximately $1.5 million. 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.
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OUR RELATIONSHIP WITH IBM WILL CHANGE SUBSTANTIALLY AFTER THE OFFERING, WHICH
COULD HARM OUR BUSINESS AND COULD CAUSE OUR REVENUES IN FISCAL YEAR 1999 TO
FALL BELOW THOSE OF FISCAL YEAR 1998. WHILE IBM WILL STILL CONTINUE TO CONTROL
US, IT HAS NO FURTHER OBLIGATIONS TO PROVIDE FINANCING, KEY CONTRACTS WITH IBM
HAVE EXPIRED, AND IBM IS EXPRESSLY ALLOWED TO COMPETE WITH US OR ACT IN A
MANNER THAT IS DISADVANTAGEOUS TO US.
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 $43.0
million of financing through March 31, 1999. Since March 31, 1999, IBM has
provided an additional $2.0 million of financing. After the offering, IBM will
have no obligation to provide us with additional financing. Between April 11,
1997 and April 30, 1999, IBM provided us with:
- $10.5 million of cash prepayments against future royalties for IBM's
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;
- a $19.0 million secured credit facility with IBM Credit Corp. that has
been guaranteed by IBM. We would not have been able to obtain a $19.0
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 has since agreed to take no
action with respect to our noncompliance through May 31, 1999;
- $3.4 million through the sale of notes and warrants; and
- $2.0 million under a demand note.
KEY CONTRACTS WITH IBM ARE EXPIRING AND WE HAVE NO COMMITMENTS FOR FUTURE
REVENUES FROM IBM, OR FROM OTHER THIRD PARTIES, THAT WOULD REPLACE REVENUES
ASSOCIATED WITH EXPIRING IBM CONTRACTS. Revenues from IBM have represented a
substantial portion of our total revenues--approximately 36% and 45% of our
total revenues in fiscal year 1998 and in the first six months of fiscal year
1999, respectively. All but approximately $400,000 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, by March 31, 1999 we had recognized the minimum royalties
that Lotus was obligated to pay us under our contract with Lotus that obligates
Lotus to pay us for bundling NetObjects Fusion with Designer for Domino 4.0 that
expires in June 1999, and we have no other contract with Lotus that provides
commitments for future revenues. Lotus also currently markets, bundles and sells
our products and has created foreign language, or "localized," versions of our
software, for which IBM 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.
All of the remaining $53,000 of deferred revenues at March 31, 1999 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 are
not expecting to receive any service revenues from IBM going forward. 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
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<PAGE>
unable to replace the revenue stream associated with these IBM agreements with
new revenues, our losses will increase and our stock price may fall.
WE DEPEND ON IBM PERSONNEL ON OUR BOARD OF DIRECTORS TO MAINTAIN AND PROMOTE
OUR RELATIONSHIP WITH IBM. 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 BUSINESS CONFLICTS WITH IBM. IBM HAS CHOSEN IN THE PAST AND IS FREE
IN THE FUTURE TO PROMOTE AND BUNDLE COMPETITORS' PRODUCTS OVER OUR
PRODUCTS. Although we have been dependent on IBM, and IBM has provided
substantial support to us, IBM makes independent business and product decisions
that present conflicts with our business objectives. For example, after
initially contracting to provide license fees for our WebSphere products, IBM
decided to bundle a competitor's product. Although this did not materially
affect our results of operations for the period, we expect to earn less revenues
from the WebSphere project than we had anticipated based on our initial contract
with IBM. In addition, IBM developed in Japan TopPage, a web page software
product, which could compete with NetObjects Fusion.
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 no
exercise of outstanding options and warrants and no conversion of convertible
notes, and after the offering IBM will own approximately 54% of our common stock
assuming the cashless exercise of all warrants by surrender of shares of common
stock as payment of the exercise price and assuming no exercise of outstanding
options. This percentage will decrease to 52% 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 CAN ACT IN WAYS THAT MAY BE DISADVANTAGEOUS TO US, SUCH AS COMPETING
WITH US, INVESTING IN OUR COMPETITORS AND TAKING ADVANTAGE OF CORPORATE
OPPORTUNITIES. IBM is contractually or otherwise free to act in ways that may
harm our business. Our restated certificate of incorporation contains provisions
expressly acknowledging that:
- IBM retains "freedom of action" to conduct its business and pursue other
business opportunities, even in competition with us;
- IBM has no obligation to refrain from investing in our competitors, doing
business with our customers or hiring away our key personnel;
- no director appointed by IBM 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; and
- 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, beneficial to IBM.
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.
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Furthermore:
- 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;
and
- 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 IBM's rights could give rise to conflicts of interests, 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 harm our business and cause our
stock price to fall.
IBM COULD OBTAIN AND USE OUR SOURCE CODE IF WE DEFAULT ON OUR OBLIGATIONS
UNDER LICENSE AGREEMENTS WITH IBM. 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.
OUR LICENSING ARRANGEMENTS WITH IBM ARE NOT EXCLUSIVE AND IBM IS FREE TO
ENTER INTO SIMILAR ARRANGEMENTS WITH OUR COMPETITORS. 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.
WE ARE A SUBSIDIARY OF IBM AND ARE SUBJECT TO IBM POLICIES AND IBM CONTRACTS
WITH THIRD PARTIES, WHICH MAY CAUSE US TO INCUR ADDITIONAL EXPENSES AND SUBJECT
US TO OBLIGATIONS TO THIRD PARTIES. 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, AND A DECLINE
IN DEMAND OR THE SALE PRICE OF THAT PRODUCT WOULD HARM OUR BUSINESS AND CAUSE
OUR STOCK PRICE TO FALL.
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
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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 name
recognition and significantly greater financial, technical and marketing
resources, and we may be unable to compete effectively against them. 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.
WE MAY NOT BE ABLE TO ACCURATELY FORECAST REVENUE AND ADJUST SPENDING.
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.
OUR QUARTERLY OPERATING RESULTS WILL PROBABLY FLUCTUATE.
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 for software license
fees, which provided quarterly earnings stability, 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,
including IBM, may cause quarterly results to be more volatile. For example,
approximately half of our software license fees from IBM in the second quarter
of fiscal 1999 were attributable to an adjustment to reflect our minimum
estimated share of previously unreported Lotus site license fees. See
"Management's Discussion and Analysis of Financial Condition of Results of
Operations--Results of Operations--Six Months Ended March 31, 1998 and March 31,
1999." That adjustment materially increased our second quarter revenues, but the
late reporting of license fees or a customer's failure to report license fees in
the future also could cause our quarterly revenues to decrease materially.
WE ALLOW PRODUCT RETURNS AND PROVIDE PRICE PROTECTION TO SOME PURCHASERS AND
RESELLERS OF OUR PRODUCTS AND OUR ALLOWANCES FOR PRODUCT RETURNS MAY BE
INADEQUATE.
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, entitle
the reseller to a credit if we reduce our price to similar channel resellers. In
August 1997, for example, 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, which reduced our
revenues for that quarter. There can be no assurance that actual returns or
price
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protection will not exceed our estimates, and our estimation policy may cause
significant quarterly fluctuations.
OUR FINANCIAL PERFORMANCE DEPENDS SUBSTANTIALLY ON MARKET ACCEPTANCE AND GROWTH
OF NETOBJECTS AUTHORING SERVER AND PROFESSIONAL AND ONLINE SERVICES.
WE INCREASINGLY DEPEND ON NETOBJECTS AUTHORING SERVER TO PROVIDE US WITH
REVENUES, WHICH WILL NOT MATERIALIZE IF NETOBJECTS AUTHORING SERVER IS NOT
SUCCESSFUL. We formally announced and shipped NetObjects Authoring Server in
September 1998 as a successor to our original NetObjects 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;
- 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 RECENTLY LAUNCHED PROFESSIONAL SERVICES BUSINESS, THROUGH WHICH WE
PROVIDE TRAINING AND OTHER SUPPORT FOR OUR PRODUCTS, 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 professional 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 much of our customers' services needs, 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 OUR ONLINE SERVICES COULD IMPEDE MARKET
ACCEPTANCE OF OUR PRODUCTS. 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.
WE NEED TO MAINTAIN OUR THIRD-PARTY DISTRIBUTION CHANNEL BECAUSE OUR DIRECT
SALES TO THIRD PARTIES WOULD BE INSUFFICIENT TO SUPPORT OUR OPERATING
BASE. While we derive some of our revenues from selling our products directly
to third parties, most of our revenues are derived
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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.
WE NEED TO MAINTAIN AND ESTABLISH NEW BUNDLING ARRANGEMENTS BECAUSE WE MAY
BE LESS SUCCESSFUL AT SELLING OUR PRODUCTS ON A STAND-ALONE BASIS. 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 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.
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.
IF WE FAIL TO RESPOND ADEQUATELY TO RAPID TECHNOLOGICAL CHANGES, OUR EXISTING
PRODUCTS AND SERVICES WILL BECOME OBSOLETE OR UNMARKETABLE.
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.
OUR PRODUCT AND SOFTWARE DEVELOPMENT EFFORTS ARE INHERENTLY DIFFICULT TO MANAGE
AND KEEP ON SCHEDULE, SO DEVELOPMENT DELAYS MAY INCREASE OUR COSTS.
On occasion, we have experienced development delays and related cost
overruns, which to date have not materially affected our business, 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.
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THE LOSS OF OUR KEY PERSONNEL, OR FAILURE TO HIRE ADDITIONAL PERSONNEL, COULD
HARM OUR BUSINESS BECAUSE WE WOULD LOSE EXPERIENCED PERSONNEL AND NEW SKILLED
PERSONNEL ARE IN SHORT SUPPLY AND COMMAND HIGH SALARIES.
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 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 54% of our outstanding stock immediately
following the offering, assuming the cashless exercise of all outstanding
warrants by surrender of shares of common stock as payment of the exercise
price, conversion of the convertible notes and no exercise of outstanding
options. 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 the purchase of 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
"ColdFusion." 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
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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 to 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.
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.
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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.
YEAR 2000 PROBLEMS MAY DISRUPT OUR INTERNAL OPERATIONS.
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 NetObjects 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 in our internal systems or in our products 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.
DUE TO OUR SMALL SIZE, LIMITED OPERATIONS AND THE DIFFICULTY OF HIRING PERSONNEL
IN OUR INDUSTRY, 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. Although historically we have not made acquisitions
of, or investments in, other companies, this may become an important part of our
strategy. 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
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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 IN AREAS INCLUDING NETWORK SECURITY, ENCRYPTION AND PRIVACY,
AMONG OTHERS, BECAUSE WE CONDUCT ELECTRONIC COMMERCE AND PROVIDE INFORMATION
AND SERVICES OVER THE INTERNET.
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 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.
A GOVERNMENTAL BODY COULD IMPOSE SALES AND OTHER TAXES ON THE SALE OF OUR
PRODUCTS, LICENSE OF OUR TECHNOLOGY OR PROVISION OF SERVICES, WHICH WOULD HARM
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
ITFA 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.
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,
26,112,862 shares of our stock will be outstanding, assuming no exercise of the
underwriters' over-
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allotment option and no exercise of outstanding options or warrants. Of those
shares, the 6,000,000 shares sold in the offering will be freely tradeable
except for any shares purchased by our "affiliates," as defined in Rule 144
under the Securities Act. The remaining 20,112,862 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 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.
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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.
USE OF PROCEEDS
The net proceeds to our Company from the sale of the 6,000,000 shares of
common stock, at an initial public offering price of $12.00 per share, less
underwriting discount and estimated offering expenses, are estimated to be $65.5
million ($75.5 million if the underwriters' over-allotment option is exercised
in full).
The principal purposes of the offering are to repay $19 million of secured
debt principal to IBM Credit Corp. that will become due and payable upon the
closing of the offering, to repay debt of approximately $5.4 million under notes
that we owe to IBM, to increase our working capital, to create a public market
for our common stock, to increase our visibility in the marketplace and to
facilitate our future access to public equity markets. The net proceeds that
will be left after repaying the debt owed to IBM are $41.0 million. The debt to
IBM Credit Corp. has an interest rate of LIBOR plus 1.5%, was incurred to fund
working capital, and matures on the earlier of the closing of the offering,
termination upon 30 days' advance notice from us to IBM Credit Corp. and
December 23, 1999. The debt under the notes has an interest rate of 10% and
comes due upon the closing of the offering and was incurred to fund working
capital. We have no specific plans for the remaining net proceeds. We estimate,
however, based upon our current operations and our current estimates of future
operations that we may use between $5-10 million for capital expenditures to
provide additional facilities and equipment for additional personnel that we
intend to hire in the U.S. and overseas, approximately $8-12 million for the
enhancement and development of information services infrastructure, including
finance, sales reporting and fulfillment support systems, and approximately
$19-28 million for other working capital and general corporate purposes. We also
may use a portion of the net proceeds for strategic alliances and acquisitions.
In addition, our estimates are subject to change. We have no present
understandings, commitments or agreements with respect to any material
acquisition or investment in third parties. Pending use of the net proceeds for
the above purposes, we intend to invest such funds in interest-bearing,
investment-grade securities.
DIVIDEND POLICY
We have never declared or paid cash dividends on our stock. We currently
anticipate that we will retain all of our future earnings, if any, for use in
the expansion and operations of our business and, therefore, do not anticipate
paying any cash dividends in the foreseeable future.
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CAPITALIZATION
The following table sets forth our cash, short-term borrowings and
capitalization
- at March 31, 1999;
- pro forma to reflect
-- the cash payment from IBM of approximately $2.0 million in April 1999
for the purchase of promissory notes;
-- the conversion of all outstanding shares of preferred stock into
common stock, including 2,118,789 shares of common stock issuable on
automatic conversion of $10,910,000, net of a discount of $799,000, in
convertible notes and $417,060 of related interest accrued in the six
months ended March 31, 1999, respectively, at a conversion price of
$6.68 per share, and as adjusted to reflect a change in the conversion
ratio to approximately 1.25 shares of common stock for each share of
Series E-2 preferred stock;
-- issuance of 3,110,924 shares of common stock, reflecting issuance of
1,598,277, 3,482,838, 215,050 and 916,668 shares of common stock
through a "cashless exercise" of Series C, Series E, Series E-2 and
Series F 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 $6.04 per
share, assuming a fair market value per share of common stock in the
offering of $12.00, and as adjusted to reflect a conversion of
approximately 1.25 shares of common stock for each share of Series E-2
preferred stock;
-- accretion of discount on short term borrowings of $256,000;
- as adjusted to reflect
-- our sale of 6,000,000 shares to be sold in the offering at the initial
public offering price of $12.00 per share, less the underwriters'
discount and commissions and estimated expenses of the offering; and
-- repayment of short-term borrowings.
The table excludes (a) 2,900,087 shares of common stock issuable at a
weighted average exercise price of $3.13 per share upon exercise of stock
options outstanding at March 31, 1999; (b) 266,615 shares of common stock
reserved for future issuance under our stock option plan; and (c) 300,000 shares
of common stock reserved for issuance under our 1999 Employee Stock Purchase
Plan.
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 74.5% of the total number of shares
outstanding after the offering; and (b) increase the number of shares purchased
by investors in the offering to 6,900,000 shares, or 25.5% of the resulting
total number of shares.
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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>
MARCH 31, 1999
-------------------------------------------------
PRO FORMA PRO AS
ACTUAL ADJUSTMENTS FORMA ADJUSTED
-------- ------------------ -------- --------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Cash........................................................ $ 1,816 $ 2,000 $ 3,816 $ 44,867
-------- -------- -------- --------
-------- -------- -------- --------
Short-term borrowings from IBM Credit Corp.................. $ 22,165 $ 2,256 $ 24,421 --
-------- -------- -------- --------
-------- -------- -------- --------
Other accrued liabilities................................... 1,778 417 1,361 1,361
-------- -------- -------- --------
-------- -------- -------- --------
Capital lease obligations, less current portion............. 212 -- 212 212
Convertible notes from IBM and related party................ 10,111 (10,111) -- --
-------- -------- -------- --------
Total long-term obligations............................. 10,323 (10,111) 212 212
-------- -------- -------- --------
Preferred stock, $0.01 par value;
12,700,399 issued and outstanding, actual; none issued and
outstanding, pro forma; none issued and outstanding, as
adjusted................................................ 121 (121) -- --
Common stock, $0.01 par value;
2,182,750 shares issued and outstanding, actual;
20,112,862 shares issued and outstanding, pro forma;
26,112,862 shares issued and outstanding, as adjusted... 21 180 201 261
Additional paid-in capital.................................. 34,252 10,469 44,721 110,133
Deferred stock-based compensation........................... (1,838) -- (1,838) (1,838)
Stockholders' notes receivable.............................. (23) -- (23) (23)
Accumulated other comprehensive losses...................... (3) -- (3) (3)
Accumulated deficit......................................... (63,568) (256) (63,824) (63,824)
-------- -------- -------- --------
Total stockholders' equity (deficit).................... (31,038) 10,272 (20,766) 44,706
-------- -------- -------- --------
Total capitalization.................................... $(20,715) $ 161 $(20,554) $ 44,918
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
21
<PAGE>
DILUTION
Our pro forma net tangible book deficit at March 31, 1999 was $20,766,000,
or ($1.03) per share, as adjusted to give effect to
- the pro forma capitalization;
- our sale of 6,000,000 shares to be sold in the offering at the initial
public offering price of $12.00 per share, less the underwriters' discount
and commissions and estimated expenses of the offering; and
- repayment of short-term borrowings.
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 of the offering, which
reflect an estimate of underwriting discounts and commissions and an estimate of
offering expenses from the sale of 6,000,000 shares of common stock to be sold
in the offering at the initial public offering price of $12.00 per share, our
adjusted pro forma net tangible book value at March 31, 1999 would have been
approximately $45 million or $1.71 per share of common stock. This represents an
immediate increase in the pro forma net tangible total book value of $2.74 per
share of common stock to existing stockholders and an immediate dilution of
$10.29 per share to new investors. The following table illustrates this per
share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share................................... $ 12.00
---------
Pro forma net tangible book deficit per share at March 31, 1999......... $ (1.03)
Increase in pro forma net tangible book value per share attributable to
new investors......................................................... 2.74
---------
Adjusted pro forma net tangible book value per share after the offering... 1.71
---------
Dilution per share to new investors....................................... $ 10.29
---------
---------
</TABLE>
The following table summarizes, on a pro forma basis at March 31, 1999,
after giving effect to the offering, the differences between existing
stockholders and investors in the offering with respect to the number of shares
of common stock purchased from us, the total consideration paid and the average
price paid per share:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
-------------------------- --------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------- ----------- -------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders......................... 20,112,862 77.0% $ 22,828,000 24.1% $ 1.14
New investors................................. 6,000,000 23.0 72,000,000 75.9 $ 12.00
------------- ----- -------------- -----
Total..................................... 26,112,862 100.0% $ 94,828,000 100.0%
------------- ----- -------------- -----
------------- ----- -------------- -----
</TABLE>
22
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The 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 March 31,
1999 and for the six months ended March 31, 1998 and 1999 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
NOVEMBER 21, YEAR ENDED SIX MONTHS ENDED
1995 (INCEPTION) SEPTEMBER 30, MARCH 31,
TO SEPTEMBER 30, -------------------- --------------------
1996 1997 1998 1998 1999
--------------------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Software license fees....................... $ -- $ 7,392 $ 9,703 $ 4,571 $ 5,545
Service revenues............................ -- -- -- -- 630
Software license fees from IBM.............. -- 175 2,700 1,215 2,335
Service revenues from IBM................... -- -- 2,867 206 2,733
------- --------- --------- --------- ---------
Total revenues............................ -- 7,567 15,270 5,992 11,243
------- --------- --------- --------- ---------
Cost of revenues:
Software license fees....................... -- 772 2,531 982 948
Service revenues............................ -- -- -- -- 724
IBM service revenues........................ -- -- 2,562 184 2,092
------- --------- --------- --------- ---------
Total cost of revenues.................... -- 772 5,093 1,166 3,764
------- --------- --------- --------- ---------
Gross profit.............................. -- 6,795 10,177 4,826 7,479
--------- --------- --------- ---------
Operating expenses:
Research and development.................... 2,765 8,436 10,231 5,855 3,985
Sales and marketing......................... 2,998 12,161 17,114 8,413 9,026
General and administrative.................. 978 3,762 3,575 1,746 1,966
Stock-based compensation.................... -- -- 227 53 170
------- --------- --------- --------- ---------
Total operating expenses.................. 6,741 24,359 31,147 16,067 15,147
------- --------- --------- --------- ---------
Operating loss............................ (6,741) (17,564) (20,970) (11,241) (7,668)
Interest income (expense)..................... 46 (234) (1,194) (441) (1,723)
Nonrecurring interest charge on beneficial
conversion feature of convertible debt
(1)......................................... -- -- -- -- (7,457)
------- --------- --------- --------- ---------
Loss before income taxes.................. (6,695) (17,798) (22,164) (11,682) (16,848)
Income taxes.................................. -- 1 60 (37) 2
------- --------- --------- --------- ---------
Net loss...................................... $ (6,695) $ (17,799) $ (22,224) $ (11,719) $ (16,850)
------- --------- --------- --------- ---------
------- --------- --------- --------- ---------
Basic and diluted net loss per share
applicable to common stockholders (2)....... $ (4.10) $ (10.45) $ (12.26) $ (6.63) $ (8.33)
------- --------- --------- --------- ---------
------- --------- --------- --------- ---------
Shares used to compute basic and diluted net
loss per share applicable to common
stockholders (2)............................ 1,634 1,703 1,812 1,768 2,023
------- --------- --------- --------- ---------
------- --------- --------- --------- ---------
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------------------
1996 1997 1998 MARCH 31, 1999
--------- --------- --------- ---------------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash................................................................. $ 1,090 $ 303 $ 459 $ 1,816
Working capital (deficit)............................................ (1,749) (10,116) (30,229) (22,962)
Short-term borrowings from IBM and IBM Credit Corp................... -- -- 20,666 22,165
Long-term obligations, less current portion.......................... 173 633 336 10,323
Total assets......................................................... 2,129 4,605 5,145 9,158
Accumulated deficit.................................................. (6,695) (24,494) (46,718) (63,568)
Stockholders' deficit................................................ (1,357) (8,913) (28,925) (31,038)
</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.
Each share of Series E-2 preferred stock automatically converts into common
stock upon the effectiveness of the offering and due to an adjustment
triggered by our failure to complete this or a similar offering or repay the
convertible notes prior to specific dates, the earliest of which was April
8, 1999, the conversion ratio has increased from 1:1 to 1.25:1. 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. 128. 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.
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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--We allow product returns and provide
price protection to some purchasers and resellers of our products, and 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 six months ended March
31, 1999 included revenues of $2.9 million and $2.7 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 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.
25
<PAGE>
In April 1997, when IBM acquired approximately 80% of our outstanding stock
from existing investors, we agreed to grant IBM the right to market and sell
some of our products to its 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 as we have performed services for IBM, we
recognize revenues and the deferred revenue from IBM declines by the same
amount. At March 31, 1999, approximately $53,000 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 relationship with IBM will change substantially
after the offering, which could harm our business and could cause our revenues
in fiscal year 1999 to fall below those of fiscal year 1998. While IBM will
still continue to control us, it has no further obligations to provide
financing, key contracts with IBM have expired, and IBM is expressly allowed to
compete with us or act in a manner that is disadvantageous to us."
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, tradeshows, 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 March 31, 1999, we had an accumulated deficit of
approximately $63.6 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.
We have incurred significant operating losses since inception and had
significant debt and a capital deficit as of September 30, 1998. We plan to
finance our operations by raising additional capital through the offering and by
generating revenues. Our ability to continue as a going concern is dependent
upon successfully completing the offering. After consideration of our financial
condition and our plans, KPMG LLP issued a form of independent auditors' report
on our consolidated financial statements 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. KPMG's report
included an explanatory paragraph expressing "substantial" doubt about our
ability to continue as a going concern.
26
<PAGE>
On May 6, 1999, we signed a firm underwriting agreement for the offering.
Expected net proceeds from the offering after the underwriting discount,
offering expenses and repayment of debt owed to IBM will be $41.0 million. After
consideration of our current financial condition, the underwriters' ability to
honor the underwriting agreement, and the likelihood of our ability to complete
the offering, KPMG LLP concluded that substantial doubt about our ability to
continue as a going concern for a reasonable period of time had been alleviated.
On May 6, 1999, KPMG LLP reissued their independent auditors' report on our
consolidated financial statements, which excludes the explanatory paragraph
expressing "substantial" doubt about our ability to continue as a going concern.
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 insubstantial 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 substantial
doubt about our viability as a business," and "--Our ability to continue as a
going concern is dependent on the net proceeds of this offering."
27
<PAGE>
The following table sets forth financial data for the periods indicated as a
percentage of total revenues:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, MARCH 31,
-------------------- --------------------
1997 1998 1998 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Software license fees.................................... 97.7% 63.5% 76.3% 49.3%
Service revenues......................................... -- -- -- 5.6
Software license fees from IBM........................... 2.3 17.7 20.3 20.8
Service revenues from IBM................................ -- 18.8 3.4 24.3
--------- --------- --------- ---------
Total revenues......................................... 100.0 100.0 100.0 100.0
--------- --------- --------- ---------
Cost of revenues:
Software license fees.................................... 10.2 16.6 16.4 8.4
Service revenues......................................... -- -- -- 6.4
Service revenues from IBM................................ -- 16.8 3.1 18.7
--------- --------- --------- ---------
Total cost of revenues................................. 10.2 33.4 19.5 33.5
--------- --------- --------- ---------
Gross profit............................................... 89.8 66.6 80.5 66.5
--------- --------- --------- ---------
Operating expenses:
Research and development................................. 111.5 67.0 97.7 35.4
Sales and marketing...................................... 160.7 112.0 140.4 80.3
General and administrative............................... 49.7 23.4 29.1 17.5
Stock-based compensation................................. -- 1.5 0.9 1.5
--------- --------- --------- ---------
Total operating expenses............................... 321.9 203.9 268.1 134.7
--------- --------- --------- ---------
Operating loss............................................. (232.1) (137.3) (187.6) (68.2)
Interest expense......................................... (3.1) (7.8) (7.4) (15.3)
Nonrecurring interest charge on beneficial conversion
feature of convertible debt............................ -- -- -- 66.3
Income taxes............................................. -- 0.4 0.6 0.1
--------- --------- --------- ---------
Net loss................................................... (235.2)% (145.5)% (195.6)% (149.9)%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
RESULTS OF OPERATIONS
SIX MONTHS ENDED MARCH 31, 1998 AND 1999
REVENUES. Total revenues increased from approximately $6.0 million to
approximately $11.2 million for the six months ended March 31, 1998 and 1999,
respectively, primarily because of growing market acceptance of our products
along with approximately $2.7 million attributed to our performance of WebSphere
services and approximately $600,000 related to the introduction of our services
group.
For the six months ended March 31, 1998 and 1999, non-North American
revenues were $1.0 million and $1.9 million or 18% and 17% of total revenues,
respectively. The increased amount 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 invoice professional services in local currency. We do not expect
international sales as a percentage of total revenues to increase significantly
during the balance of fiscal year 1999.
28
<PAGE>
Revenues from IBM increased from approximately 24% to 45% of our total
revenues for the six months ended March 31, 1998 and 1999, respectively. Our
agreement with IBM for WebSphere services ended on February 28, 1999. Software
license fees for the six months ended March 31, 1999 included approximately $2.3
million of royalties from Lotus under our contract for bundling NetObjects
Fusion with Designer for Domino 4.0 that expires in June 1999. During the second
quarter of fiscal 1999, we became aware, and IBM confirmed, that our software
had been bundled, or was contractually required to be bundled, with certain
Lotus site licenses previously sold by IBM and these sales had not been reported
to us by IBM. We recognized $500,000 of software license fees during the
three-month period ended March 31, 1999 reflecting the minimum amount owed to us
and acknowledged by IBM for these previously unreported Lotus site licenses. We
believe the actual amount owed by IBM to be higher; however, this amount will be
the subject of additional analysis and negotiation with IBM. In the event
additional amounts, if any, are owed to us they will be recorded as revenue in
the period agreement is reached with IBM. Lotus had not previously reported
these fees to us during the contract term, which commenced in February 1998.
We believe that all of the IBM deferred revenues, which were approximately
$53,000 at March 31, 1999, 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 are
not expecting to receive any services revenues from IBM going forward. For a
discussion of the risks associated with the loss of IBM revenues and our ability
to replace those revenues, see "Risk Factors--Our relationship with IBM will
change substantially after the offering, which could harm our business and could
cause our revenues in fiscal year 1999 to fall below those of fiscal year 1998."
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 $982,000 and $948,000 for the six months ended March 31, 1998
and 1999, respectively, which represented approximately 21% and 17%,
respectively, of non-IBM software license fees. The decrease in percentage terms
arose primarily from economies of scale efficiencies and improved freight
contract terms. 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 $5.9 million and
$4.0 million for the six months ended March 31, 1998 and 1999, respectively, and
98% and 35%, respectively, of total revenues. The decrease in total dollars and
in percentage terms in the six months ended
29
<PAGE>
March 31, 1999 occurred primarily because a number of our development engineers
and part-time consultants were providing services under our WebSphere contract
with IBM. 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, tradeshow expenses, advertising,
marketing materials and the cost of customer service operations. We intend to
continue to increase staff in our enterprise sales organization and increase our
aggressive brand building and marketing campaign and, therefore, expect sales
and marketing expenses to continue to increase. Sales and marketing expenses
were approximately $8.4 million and $9.0 million for the six months ended March
31, 1998 and 1999, respectively, representing 140% and 80%, respectively, of
total revenues. The increased amount 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 six months ended
March 31, 1999.
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 $1.7 million and $2.0
million for the six months ended March 31, 1998 and 1999, respectively,
representing approximately 29% and 17%, 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. For the six months ending March 31, 1999 we
recorded approximately $1.5 million in additional deferred stock-based
compensation that we will amortize over the vesting period in accordance with
FASB Interpretation No. 28. Of the total deferred stock-based compensation
expense, approximately $170,000 was amortized during the six months ended March
31, 1999.
INTEREST EXPENSE, NET. Our interest expense consists primarily of interest
on our borrowings and amounted to approximately $441,000 and $1.7 million for
the six months ended March 31, 1998 and 1999, 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
approximately $3.8 million of interest expense in accordance with EITF Topic
D-60 in the three months ended December 31, 1998. The terms of the Series E-2
preferred stock provide for an increase in the conversion ratio of Series E-2
preferred stock to common stock from 1:1 to 1:1.25 as of April 8, 1999 in the
event we did not complete an initial public offering with proceeds of at least
$30.0 million by that date. This increase in the conversion ratio resulted in an
additional non-recurring, non-cash interest charge of approximately $3.7 million
during the fiscal quarter ended March 31, 1999.
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
30
<PAGE>
$220,000 of additional interest expense in the six-month period ended March 31,
1999. The discounts of approximately $203,000 and $799,000 on the Series F and E
warrants, respectively, will be amortized over the term of the related notes. In
February and March 1999, we issued warrants to purchase 51,335 shares of Series
E-2 preferred stock at an exercise price of $6.68 per share. Using the
Black-Scholes model, we valued the warrants at $432,000 which resulted in
approximately $176,000 of additional interest expense in the six-month period
ended March 31, 1999. The remaining discount of $256,000 will be amortized by
April 30, 1999.
INCOME TAXES. We had a net operating loss for each period from our
inception through March 31, 1999. We recorded income tax expense relating to
withholding tax on payments made by Mitsubishi, our exclusive master distributor
of our products in Japan and various minimum state taxes.
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 product price increases, although we introduced NetObjects TeamFusion
in 1998, which had a higher sales price than our previous products. 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. Although the price reduction of NetObjects Fusion
resulted in reduced revenues during the three months ended September 30, 1997,
the increased sales volume in subsequent periods more than offset this price
reduction.
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. We have not been exposed to
significant foreign currency translation and transaction exposure from our
operations in fiscal 1997 and 1998.
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.
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 license fees for each of
the listed products with a minimum total amount committed to us. Most of the
license fees 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
provide for revenues from charges for our services based on the amount of our
costs and expenses instead of the minimum total amount of license fees. As a
result of the agreement and IBM's decision not to bundle NetObjects Authoring
Server, 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.
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<PAGE>
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 $1 million of the
increase can be attributed to increased production and freight costs partially
driven by volume increases 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. Most
of the remaining $2.1 million represented 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. Total general and administrative expenses were
higher in fiscal year 1997 than in fiscal year 1998 principally because of costs
incurred in connection with IBM's acquisition of approximately 80% of our stock
in fiscal 1997, including approximately $300,000 in professional fees. 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 March 31, 1999. 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>
JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1998 1998 1998 1998
----------- ----------- ----------- ----------- ----------- ----------- -----------
Revenues:
<S> <C> <C> <C> <C> <C> <C> <C>
Software license fees............... $ 2,332 $ 1,721 $ 2,086 $ 2,485 $ 2,524 $ 2,608 $ 2,622
Service revenues.................... -- -- -- -- -- -- 190
Software license fees from IBM...... 75 100 199 1,016 1,069 416 1,318
Service revenues from IBM........... -- -- -- 206 1,225 1,436 1,487
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total revenues.................... 2,407 1,821 2,285 3,707 4,818 4,460 5,617
----------- ----------- ----------- ----------- ----------- ----------- -----------
Cost of revenues:
Software license fees............... 240 305 278 704 840 709 495
Service revenues.................... -- -- -- -- -- -- 184
IBM service revenues................ -- -- -- 184 1,095 1,284 1,404
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total cost of revenues............ 240 305 278 888 1,935 1,993 2,083
----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross profit.......................... 2,167 1,516 2,007 2,819 2,883 2,468 3,534
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating expenses:
Research and development............ 2,500 2,711 3,070 2,785 2,175 2,201 2,204
Sales and marketing................. 3,833 4,454 4,060 4,353 4,444 4,257 4,430
General and administrative.......... 1,180 926 769 977 878 951 894
Stock-based compensation............ -- -- -- 53 74 100 100
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses.......... 7,513 8,091 7.899 8,168 7,571 7,509 7,628
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating loss........................ (5,346) (6,575) (5,892) (5,349) (4,688) (5,041) (4,094)
Net other expense................... 37 53 175 303 335 441 714
Nonrecurring interest charge on
beneficial conversion feature of
convertible debt.................. -- -- -- -- -- -- 3,792
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss.............................. $ (5,383) $ (6,628) $ (6,067) $ (5,652) $ (5,023) $ (5,482) $ (8,600)
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
Revenues:
Software license fees............... 96.9% 94.5% 91.3% 67.0% 52.4% 58.5% 46.7%
Service revenues.................... -- -- -- -- -- -- 3.4
Software license fees from IBM...... 3.1 5.5 8.7 27.4 22.2 9.3 23.4
Service revenues from IBM........... -- -- -- 5.6 25.4 32.2 26.5
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total revenues.................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0
----------- ----------- ----------- ----------- ----------- ----------- -----------
Cost of revenues:
Software license fees............... 10.0 16.7 12.2 19.0 17.5 15.9 8.8
Service revenues.................... -- -- -- -- -- -- 3.3
Service revenues from IBM........... -- -- -- 5.0 22.7 28.8 25.0
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total cost of revenues............ 10.0 16.7 12.2 24.0 40.2 44.7 37.1
----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross profit.......................... 90.0 83.3 87.8 76.0 59.8 55.3 62.9
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating expenses:
Research and development............ 103.9 148.9 134.3 75.1 45.1 49.4 39.2
Sales and marketing................. 159.2 244.6 177.7 117.4 92.2 95.4 78.9
General and administrative.......... 49.0 50.8 33.7 26.4 18.2 21.3 15.9
Stock-based compensation............ -- -- -- 1.4 1.6 2.2 1.8
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses.......... 312.1 444.3 345.7 220.3 157.1 168.3 135.8
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating loss........................ (222.1) (361.0) (257.9) (144.3) (97.3) (113.0) (72.9)
Net other expense................... 1.5 2.9 7.6 8.2 7.0 9.9 12.7
Nonrecurring interest charge on
beneficial conversion feature of
convertible debt.................. -- -- -- -- -- -- 67.5
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss.............................. (223.6)% (363.9)% (265.5)% (152.5)% (104.3)% (122.9)% (153.1)%
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
<CAPTION>
MAR. 31,
1999
-----------
Revenues:
<S> <C>
Software license fees............... $ 2,923
Service revenues.................... 440
Software license fees from IBM...... 1,017
Service revenues from IBM........... 1,246
-----------
Total revenues.................... 5,626
-----------
Cost of revenues:
Software license fees............... 453
Service revenues.................... 540
IBM service revenues................ 688
-----------
Total cost of revenues............ 1,681
-----------
Gross profit.......................... 3,945
-----------
Operating expenses:
Research and development............ 1,781
Sales and marketing................. 4,596
General and administrative.......... 1,072
Stock-based compensation............ 70
-----------
Total operating expenses.......... 7,519
-----------
Operating loss........................ (3,574)
Net other expense................... 1,011
Nonrecurring interest charge on
beneficial conversion feature of
convertible debt.................. 3,665
-----------
Net loss.............................. $ (8,250)
-----------
-----------
Revenues:
Software license fees............... 52.0%
Service revenues.................... 7.8
Software license fees from IBM...... 18.1
Service revenues from IBM........... 22.1
-----------
Total revenues.................... 100.0
-----------
Cost of revenues:
Software license fees............... 8.1
Service revenues.................... 9.6
Service revenues from IBM........... 12.2
-----------
Total cost of revenues............ 29.9
-----------
Gross profit.......................... 70.1
-----------
Operating expenses:
Research and development............ 31.7
Sales and marketing................. 81.7
General and administrative.......... 19.0
Stock-based compensation............ 1.2
-----------
Total operating expenses.......... 133.6
-----------
Operating loss........................ (63.5)
Net other expense................... 18.0
Nonrecurring interest charge on
beneficial conversion feature of
convertible debt.................. 65.1
-----------
Net loss.............................. (146.6)%
-----------
-----------
</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,
Netscape or Novell 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 NetObjects 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. In addition, our
quarterly revenues may fluctuate significantly in the remaining quarters of 1999
because of the loss of IBM revenue commitments.
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," "--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 in 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 $59.9 million of net proceeds from November 1995 through
March 31, 1999. Since December 1997, approximately $13.5 million and $19.0
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.
The expiration of our services agreement for IBM's WebSphere in February
1999 and software license agreement with Lotus for committed revenues in March
1999 may adversely impact our operating results in subsequent quarters. Because
the IBM revenues under these contracts have been offsetting the $10.5 million of
cash prepayments that we received between April 1997 and December 1997, however,
the expiration of these agreements will not adversely impact our current
35
<PAGE>
liquidity. Although we have no commitments for revenues that will replace these
historical IBM and Lotus revenue streams, we intend to replace the lost revenues
by developing additional customers and through additional license fees and
services from current and potential customers. We have no assurance that our
efforts to replace these lost revenues will succeed.
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 March 31, 1999 approximately $53,000 of the
cash prepayments provided by IBM had not been recognized and were reflected as
deferred revenue from IBM on our balance sheet.
We also have established equipment lease lines under which we may finance
the purchase of 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 March 31, 1999
approximately $129,000 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 $15.2
million in the six months ended March 31, 1999. 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 $1.1 million in
the six months ended March 31, 1999. 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
$17.7 million in the six months ended March 31, 1999. 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 March 31, 1999, we had approximately $1.8 million in cash. Other than
$22.4 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
the 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 March 31, 1999, we had received the full $10.9 million. In October
and November 1998, we sold 388,888 shares of Series F-2 preferred stock for a
total of $3.5 million. In February and March 1999, we obtained an additional
approximately $3.5 million through the issuance of notes and warrants to IBM to
continue to finance our operations. In April 1999, we borrowed $2.0 million from
IBM under a 10% demand note. We expect IBM to exercise its right to require the
repayment of the additional 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
36
<PAGE>
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 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 cash generated from operations relative to anticipated
expenditures. Our liquidity problems are also discussed in "Risk Factors--We
have a history of substantial losses and expect substantial losses in the
future," "--Our auditors have substantial doubt about our viability as a
business," "--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 owed to IBM 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 and NetObjects Authoring
Server;
- 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
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<PAGE>
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 harm our business or
results of operations, 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 and NetObjects Authoring Server 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.
RECENT DEVELOPMENTS
In March 1999, we entered into an agreement with Sun Microsystems, Inc. to
develop a version of NetObjects Authoring Server Suite that runs on Sun hardware
and software server products. Under the agreement Sun will advance up to
$350,000 of development funds and up to $300,000 worth of engineering resources.
We are obligated to repay the funds advanced and the value of the engineering
support with royalties due quarterly on our sales of the product that we develop
under the agreement. We expect to incur similar amounts of expense related to
this project ourselves during the next 12 months.
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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 ColdFusion,
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 $733 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.
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
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users. IDC reported that the number of web site addresses, or URL's, will grow
from 300 million in 1997 to 3.2 billion 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 hypertext markup language, or HTML, programmers or
highly skilled designers. HTML is a programming language that allows Web pages
to be viewed by a browser. 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.
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
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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 to integrate our products with web application
servers from Allaire, Lotus, IBM, Microsoft and PeopleSoft, and e-commerce
software from Breakthrough Software and iCat, by creating components in
Java, a programming language, that provide our products with additional
functions for building web applications and conducting e-commerce; and
- online solutions that combine our products with online service providers
such as Compuserve, T-Online, Verio and Zip2, by offering our products as
part of their online services, 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 relationship with IBM
will change substantially after the offering, which could harm our business and
could cause our revenues in fiscal year 1999 to fall below those of fiscal year
1998." 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 coding products that require manual programming of
each page. Our products are windows based and allow users to generate HTML code
by using words and graphics without requiring users to type in HTML codes that
allow browsers to view the content of web pages. 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;
- is publishable on major web browsers, such as Netscape Navigator and
Microsoft Internet Explorer; and
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- allows other web site solutions providers to integrate their products with
our products using components implemented in the Java language.
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.
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.
<TABLE>
<CAPTION>
PRODUCT DESCRIPTION
<S> <C>
NETOBJECTS FUSION NetObjects Fusion provides five views that map to the process of site building:
(suggested selling price SITE VIEW lets the author visually plan and organize the pages on the web site.
$295) NetObjects Fusion automatically creates and maintains the navigation buttons and
links based on how the author lays out the web site.
[LOGO] PAGE VIEW lets the author create pages visually. A wide range of content can be
incorporated on the page, including text, graphics, video, audio, 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>
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
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shopping destination for businesses to purchase our software, third party
software, components and merchandise, and also offers online services to
customers.
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
<S> <C>
NETOBJECTS AUTHORING NetObjects Authoring Server Suite consists of four modules:
SERVER SUITE AUTHORING SERVER is the "server"-side control center and runs on
(suggested selling price a Windows NT server.
for 2 user system AUTHORING SERVER ADMINISTRATOR is used to create sites and form
inclusive of server and teams, assign team members with editing and publishing
clients is $1,585; 20 privileges, and monitor workflow.
user system is $19,850) TEAMFUSION CLIENT is based on the award-winning NetObjects
Fusion, and connects to NetObjects Authoring Server. Its web
[LOGO] site-oriented, graphical approach, along with its
check-in/check-out controls, allows a web team to work
collaboratively and efficiently.
CONTENT CONTRIBUTOR CLIENT is a browser-based application
written in the Java language that lets departmental web
contributors submit content directly to sites under development.
NETOBJECTS AUTHORING AUTHORING SERVER CONNECTOR FOR MICROSOFT FRONTPAGE enables
SERVER CONNECTORS Microsoft FrontPage users to collaborate using NetObjects
Authoring Server.
NETOBJECTS AUTHORING AUTHORING SERVER FOR IBM WEBSPHERE is optimized for tight
SERVER FOR IBM WEBSPHERE integration with the IBM WebSphere Application Server through
powerful server components written in the Java language 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.
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 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 sample list of some of our
large enterprise customers that
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have purchased our products and services since January 1998. Together they have
accounted for approximately 2% of our total revenues during the last fiscal
year:
<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.
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.
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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 4.0 under a contract with revenue commitments
that expires in June 1999, and under a new contract without revenue commitments
to market, bundle and sell a version of NetObjects Fusion with Designer for
Domino Application Studio that expires on December 31, 1999. IBM markets,
bundles and sells NetObjects Fusion 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.
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."
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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.
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.
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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.
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.
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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 components built using the Java language.
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.
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
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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 March 31, 1999, we had 147 full-time employees and 8 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.
FACILITIES
Our executive offices are located in Redwood City, California, in an office
building in which, as of March 31, 1999, we lease an aggregate of approximately
36,000 square feet. The lease agreement terminates on November 2, 2002. We also
lease three serviced office suites in a facility in Bucks, United Kingdom under
a lease that expires in August 1999.
LEGAL PROCEEDINGS
From time to time, we are 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 15, 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............................... 41 Senior Vice President, Worldwide Sales and Corporate Marketing
Clement Mok............................... 41 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)........................ 60 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 since April 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. 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.A. 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 Institute of Technology 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. Immediately after the offering, IBM will hold 48.6% of our
voting securities on a fully-diluted basis. While this agreement 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 resigned from NetObjects as of April 5, 1999 and Mr. Russell
Surmanek became Executive Vice President, Finance and Operations and Chief
Financial Officer as of that date.
We have entered into an employment agreement with our new Executive Vice
President, Finance and Operations and Chief Financial Officer, Russell F.
Surmanek, as of April 5, 1999. The employment agreement has a term of 24 months.
Under the agreement, Mr. Surmanek will receive an annual salary of $220,000 plus
a 15% sales target bonus payable semi-monthly, 20% of his annual
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salary as an annual fiscal year bonus to executives and stock options to
purchase 235,000 shares, 35,000 of which will vest within three months of April
5, 1999, and the remainder of which vest on varying dates during the following
48 months. Mr. Surmanek also receives a starting bonus of $100,000. If Mr.
Surmanek's employment is terminated without cause before April 5, 2001, he is
entitled to be paid the remaining salary which would have been payable during
the term, including pro-rata bonus amounts. If Mr. Surmanek is terminated for
any reason, other than for cause, the vesting of his stock options will
accelerate so that 65% of the shares underlying the options will be vested as of
the date of termination. If we are acquired by another company, the vesting of
Mr. Surmanek's stock options will also accelerate by one calendar year or as
necessary to provide for vesting of at least 65% of the shares underlying the
options as of the date of the acquisition.
The following table sets forth information regarding option exercises, and
the fiscal year-end values of stock options held, by our Chief Executive Officer
and the other four most highly compensated executive officers during the fiscal
year ended September 30, 1998:
AGGREGATED OPTION EXERCISES IN FISCAL 1998 AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT AT SEPTEMBER 30,
SEPTEMBER 30, 1998(#) 1998($)
------------------------ ----------------------
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 resigned from NetObjects as of April 5, 1999 and Mr. Russell
Surmanek became 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.
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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 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 March 31, 1999, 41,252 shares of common stock were
subject to our right of repurchase, and 266,615 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.
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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 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 5 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 8% annually 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. On March 23, 1999, warrants were exercised for the purchase of
60,369 shares of Series C Preferred Stock. As of March 31, 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 119,969 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
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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.
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 $20.0 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 automatically
converts into common stock upon the effectiveness of the offering and due to an
adjustment triggered by our failure to complete this or a similar offering or
repay the convertible notes prior to specific dates, the earliest of which was
April 8, 1999, the conversion ratio has increased from 1:1 to 1.25:1. 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 approximately $3.4 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 51,335 shares of Series E-2 preferred stock. We
issued a note in the amount of $2.0 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
approximately $1.41 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 February 2, 1999, we
issued a total of 344,374, 122,053, 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
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"observer rights" at meetings of our board of directors so long as Novell
remains the beneficial owner of not less than 1% of our stock, assuming the
exercise or conversion of all options and warrants. 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 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.
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, 2000 upon payment of a $5,000 transfer fee to Rae Technology,
unless we otherwise determine not to reacquire the rights at that
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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 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 54% of our outstanding stock immediately following the offering,
assuming the cashless exercise of all outstanding warrants by surrender of
shares of common stock as payment of the exercise price, conversion of the
convertible notes and no exercise of outstanding options 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 escrow agreement provides
that the remaining escrowed securities will be released to the preferred
stockholders on April 11, 1999, or promptly thereafter, subject to any claims
for indemnification or set-off.
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.
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
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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.
PATENT LICENSE AGREEMENT. On April 10, 1997, we and IBM executed a patent
license agreement that grants IBM a non-exclusive, royalty-free, perpetual
license to our patents as they are issued.
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. The size and the committed nature of this $10.5 nonrefundable prepayment
was more advantageous to us than what we could have obtained from a third party.
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. Additional terms of the
software license agreement and its amendments are as follows:
- Amendment Number 1 and Amendment Number 4 license IBM to use our products
in its internal operations for a one-time fee of $402,000 through April
30, 1998. The license was initially, for 3,000 copies but now provides for
an unlimited quantity. After April 30, 1998, IBM can pay for upgrade
copies at an annual rate of 25% of $402,000 or at a per copy royalty rate.
Amendment Number 4 also sets forth royalty rates for our products if they
are bundled and sold by IBM with IBM products. These rates are based on
the percentage which the value of the NetObjects product bears to the
total value of all of the other products in the bundle. If the value of
our product is equivalent to or less than the total value of all of the
other products in the bundle, we receive 37% of IBM's average selling
price for a stand-alone license of our product during a calendar quarter.
If the value of our product is more than the value of the other products,
we receive 69% of IBM's average selling price for a stand-alone license of
our product during a calendar quarter. If IBM sells our products alone, we
receive 75% of IBM's average selling price for a stand-alone license of
our product during a calendar quarter.
- In Amendment Number 3 and Amendment Number 7, IBM agreed to translate our
software into languages other than English for which we are required to
pay 115% of the costs associated with the translation. The costs are
recovered through the sales of our products outside of the United States
by IBM and Lotus by reducing the royalty rate otherwise due to us by 50%.
We are permitted to repay the translation costs over an extended period of
time, and the repayment is derived solely from earned international
royalties. We would not be able to obtain the same open-ended repayment
terms from a third party.
- We became an IBM "Business Partner" under Amendment Number 5 which permits
us to resell IBM products and pay IBM 50% of the royalty payment received
by us.
- We agreed to perform services for IBM to make our products compatible with
and to integrate our products with IBM's WebSphere products in Amendment
Number 6 and Amendment Number 8. Under Amendment Number 6 we were to
receive a minimum amount of
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license fees equal to the total amount of our expenditures on the project,
plus a 20% profit margin. Amendment No. 8 modified our arrangement to
provide for our receipt of services revenues equal to the total amount of
our expenditures plus a 5% profit margin instead. These amendments further
provide for us to receive license fees on bundles of our products with
IBM's WebSphere products calculated, generally, at 50% of the applicable
software license agreement royalty rate, as described above.
- IBM has paid us $350,000 for developing a capability in one of our
products so that it supports wireless markup language for IBM's wireless
group. Other than the license to IBM, we retain all interests in the
software.
- We have entered into letter agreements subject to all other terms of the
software license agreement to bundle NetObjects Fusion with Lotus'
Designer for Domino. Initially, the letter agreement committed Lotus to
pay us a minimum of $4.0 million in license fees for 200,000 copies of
NetObjects Fusion through September 30, 1998. In January 1999, we signed a
new letter agreement that extended the term to June 30, 1999 and increased
the minimum amount of license fees by $500,000 and the minimum number of
copies by 25,000. We recently entered into a new contract to bundle a
version of NetObjects Fusion with Lotus Designer Application Studio for
Domino R5, which expires on December 31, 1999. There are no commitments
for a minimum number of copies or minimum license fees under this new
contract.
OTHER LICENSE AGREEMENTS. We also entered into a trademark license
agreement wtih IBM that permits IBM to use our NetObjects TopPage trademark on
products developed by IBM in Japan. IBM will pay us fifty cents for each use.
IBM granted us a license to reproduce and create derivative works from and
to distribute a value-added version of IBM's Build-IT software until IBM
terminates the license. We must pay IBM 10% of the gross revenues received when
we distribute the software. There is a minimum royalty of $5 and a maximum
royalty of $20 per software bundle.
Lotus has granted us a license to copy and distribute Lotus FastSite for
NAS, version 2.0, a document conversion program for use with NetObjects
Authoring Server for a one-year term. We are obligated to pay Lotus a per copy
royalty of 25% of our average selling price up to 5,000 units and 20% of our
average selling price for copies in excess of that, but in no event less than
$15 per copy. We have granted to Lotus a royalty-free, perpetual right to copy
and distribute software we developed that facilitates integration between Lotus
FastSite and NetObjects Authoring Server.
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 or 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 $19.0 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, 1999 and March 31, 1999, but on February 3, 1999, IBM
Credit Corp. waived our compliance through December 31, 1998 and has since
agreed to take no action with respect to our noncompliance through May 31, 1999.
We will use proceeds from this offering to repay the credit facility, and it
will terminate upon repayment.
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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 notes bear interest at a rate of
10% per year. The principal and interest due under the convertible notes will be
converted automatically 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.
DEMAND NOTE. On April 23, 1999, we obtained an additional $2 million from
IBM under an unsecured demand note. The note bears interest at a rate of 10% per
annum. The principal and interest will be repaid from the proceeds of this
offering. We would not have been able to obtain this additional financing from
an independent third party.
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."
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.
DISTRIBUTION AGREEMENT WITH NOVELL
We also have a strategic relationship with Novell. On September 30, 1998,
Novell agreed to bundle NetObjects Fusion with Novell's NetWare for Small
Business product offering under a license agreement through which we receive
royalties on a per unit basis as products are sold by Novell. We are entitled to
receive a minimum of $500,000 of royalties under the Novell 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, an Executive 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 March 31, 1999, assuming conversion of all
shares of preferred stock into common stock and the cashless exercise of all
warrants by surrender of shares of common stock in payment of the exercise
price, and as adjusted to reflect the sale of 6,000,000 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, or 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 March
31, 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 PERCENT
ISSUABLE ON EXERCISE OF OWNERSHIP
NUMBER OF SHARES EXERCISE OF OUTSTANDING OPTIONS -------------
BENEFICIALLY OUTSTANDING WITHIN 60 DAYS OF BEFORE
NAME OWNED WARRANTS MARCH 31, 1999 OFFERING
- ------------------------------------------------- ------------------- ------------------- ------------------- -------------
<S> <C> <C> <C> <C>
International Business Machines Corporation (1).. 14,119,537 3,623,569 76.0%
New Orchard Road
Armonk, NY 10504
Samir Arora (2).................................. 1,669,479 10,551 121,875 11.1
c/o NetObjects, Inc.
301 Galveston Drive
Redwood City, CA 94063
Perseus, L.L.C.(3)............................... 925,397 765,148 5.9
The Army and Navy Club Building
16271 I Street, N.W., Suite 610
Washington, D.C. 20006
Kenneth Socha (4).............................. 925,397 765,148 5.9
Frank Pearl (4)................................ 925,397 765,148 5.9
David Kleinberg (5).............................. 774,461 3,137 81,250 5.2
c/o NetObjects, Inc.
301 Galveston Drive
Redwood City, CA 94062
Morris Taradalsky (6)............................ 89,818 356 69,443 *
Mark Patton...................................... 76,493 76,493 *
John Sculley..................................... 37,504 37,504 *
Michael J. Shannahan............................. 42,881 42,881 *
Robert G. Anderegg............................... 0 *
Lee A. Dayton.................................... 0 *
Michael D. Zisman................................ 0 *
All directors and executive officers as a group
(8 persons) (7).................................. 2,490,215 48,055 391,942 16.3%
<CAPTION>
AFTER
NAME OFFERING
- ------------------------------------------------- -------------
<S> <C>
International Business Machines Corporation (1).. 57.6%
New Orchard Road
Armonk, NY 10504
Samir Arora (2).................................. 7.9
c/o NetObjects, Inc.
301 Galveston Drive
Redwood City, CA 94063
Perseus, L.L.C.(3)............................... 4.2
The Army and Navy Club Building
16271 I Street, N.W., Suite 610
Washington, D.C. 20006
Kenneth Socha (4).............................. 4.2
Frank Pearl (4)................................ 4.2
David Kleinberg (5).............................. 3.7
c/o NetObjects, Inc.
301 Galveston Drive
Redwood City, CA 94062
Morris Taradalsky (6)............................ *
Mark Patton...................................... *
John Sculley..................................... *
Michael J. Shannahan............................. *
Robert G. Anderegg............................... *
Lee A. Dayton.................................... *
Michael D. Zisman................................ *
All directors and executive officers as a group
(8 persons) (7).................................. 11.7%
</TABLE>
- ----------------------------------
* Less than 1%.
(1) Includes 2,118,789 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 10,551 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
66
<PAGE>
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 758,291 shares of common stock
issuable on exercise of warrants, and Perseus Capital, L.L.C. holds 6,857
shares of common stock issuable on exercise of warrants. Includes 160,249
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 3,370 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 20,018 shares of common stock and 356 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.
(7) Includes securities held by Rae Technology, of which three of our executive
officers are members, owned or controlled by officers of NetObjects.
67
<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 not a complete description. The descriptions of the common stock and
preferred stock reflect changes to our capital structure, including the
conversion of outstanding preferred stock into common stock and the deletion of
references to Series A, Series B, Series C, Series E, Series E-2, Series F and
Series F-2 preferred stock, that will occur on effectiveness of the offering
under the terms of our restated certificate of incorporation.
Upon completion of the offering our authorized capital stock will consist of
60,000,000 shares of common stock, par value $0.01 per share, and 6,000,000
shares of preferred stock, par value $0.01 per share.
COMMON STOCK
As of March 31, 1999, 2,182,750 shares of common stock were outstanding and
held of record by 110 stockholders, assuming no exercise after March 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
- his, her or its 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 March 31, 1999, 2,900,087 shares of common stock were issuable upon exercise
of outstanding options at a weighted average exercise price of $3.13 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 March 31, 1999, we had outstanding warrants to purchase:
- 1,598,275 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;
- 215,049 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
- 916,668 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.
68
<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 relationship with
IBM will substantially change after the offering which could harm our business
after the offering and could cause our revenues in fiscal year 1999 to fall
below those of fiscal year 1998."
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 EquiServe.
69
<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, 26,112,862 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 6,000,000 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
20,112,862 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......................................... 26,112,862
Total restricted securities...................................... 20,112,862
Shares that are freely tradable after the date of this prospectus
under Rule 144(k), subject to the 180-day lock-up agreement.... 1,439,927
Shares that are freely tradable 90 days after the date of this
prospectus under Rule 144 or Rule 701, subject to the 180-day
lock-up agreement.............................................. 1,945,753
Shares that are freely tradable 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................................... 18,318,973
</TABLE>
Following the offering, we intend to file a registration statement under the
Securities Act covering 3,466,702 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 1,301,232 shares of common stock will be subject to
vested options, based on options outstanding as of March 31, 1999. 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, 3,110,924 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 warrants for
Series F preferred 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 17,278,167 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."
70
<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
261,128 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.
71
<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 Inc. and U.S. Bancorp Piper Jaffray
Inc., 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.......................................................................... 2,375,000
BancBoston Robertson Stephens Inc.................................................................... 1,445,000
U.S. Bancorp Piper Jaffray Inc....................................................................... 980,000
Deutsche Bank Securities Inc......................................................................... 80,000
Hambrecht & Quist LLC................................................................................ 80,000
ING Baring Furman Selz LLC........................................................................... 80,000
Morgan Stanley & Co. Incorporated.................................................................... 80,000
NationsBanc Montgomery Securities LLC................................................................ 80,000
Warburg Dillon Read LLC.............................................................................. 80,000
Advest, Inc.......................................................................................... 60,000
Dain Rauscher Wessels................................................................................ 60,000
Dominick & Dominick LLC.............................................................................. 60,000
FAC/Equities......................................................................................... 60,000
Friedman, Billings, Ramsey & Co., Inc................................................................ 60,000
Jefferies & Company.................................................................................. 60,000
David A. Noyes & Company............................................................................. 60,000
Brad Peery Inc....................................................................................... 60,000
Pennsylvania Merchant Group.......................................................................... 60,000
Muriel Siebert & Co., Inc............................................................................ 60,000
Soundview Technology Group, Inc...................................................................... 60,000
Wit Capital Corporation.............................................................................. 60,000
-----------
Total............................................................................................ 6,000,000
-----------
-----------
</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.
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 $0.47 per share. The
underwriters may allow, and the dealers may re-allow, a concession not in excess
of $0.10 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 900,000 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.
72
<PAGE>
If purchased, the underwriters will offer the additional shares on the same
terms as those on which the 6,000,000 shares are being offered.
At our request, the underwriters have reserved up to 328,000 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.
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 McCutchen, Doyle, Brown & Enersen LLP, Palo Alto, California.
Alan Kalin, a partner in the firm of McCutchen, Doyle, Brown & Enersen LLP,
serves as our Secretary and indirectly beneficially owns 12,060 shares of the
common stock. Legal matters in connection with the offering will be passed upon
for the underwriters by Cravath, Swaine & Moore, New York, New York.
73
<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 reports of KPMG LLP, independent
auditors, appearing elsewhere herein, and upon the authority of said firm as
experts in accounting and auditing.
CHANGE IN AUDITORS
Ernst & Young LLP was previously our principal accountant. On October 29,
1997, Ernst & Young LLP was dismissed as our principal accountant 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.
74
<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 March 31, 1999
(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 six-month periods ended March 31, 1998 and 1999 (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 six-month period ended March 31, 1999 (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 six-month periods ended March 31, 1998 and 1999 (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.
/s/ KPMG LLP
Mountain View, California,
December 21, 1998, except as to Note 1(d),
which is as of May 6, 1999
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, MARCH 31, 1999
-------------------- ------------------------
1997 1998 ACTUAL PRO FORMA(A)
--------- --------- --------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash................................................................. $ 303 $ 459 $ 1,816 $ 3,816
Accounts receivable, net of allowances of $781, $2,263, and $969 as
of September 30, 1997 and 1998, and March 31, 1999, respectively... 2,018 2,292 3,658 3,658
Prepaid expenses and other current assets............................ 448 754 1,437 1,437
--------- --------- --------- -------------
Total current assets............................................. 2,769 3,505 6,911 8,911
Property and equipment, net............................................ 1,836 1,640 2,247 2,247
--------- --------- --------- -------------
Total assets........................................................... $ 4,605 $ 5,145 $ 9,158 $ 11,158
--------- --------- --------- -------------
--------- --------- --------- -------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Short-term borrowings from IBM and IBM Credit Corp................... $ -- $ 20,666 $ 22,165 $ 24,421
Short-term borrowings................................................ 2,050 -- -- --
Accounts payable..................................................... 2,518 4,723 3,556 3,556
Accrued compensation................................................. 1,041 1,690 1,355 1,355
Other accrued liabilities............................................ 684 1,066 1,778 1,361
Deferred revenue from IBM............................................ 6,228 5,121 53 53
Other deferred revenues.............................................. 61 169 673 673
Current portion of capital lease obligations......................... 303 299 293 293
--------- --------- --------- -------------
Total current liabilities........................................ 12,885 33,734 29,873 31,712
Capital lease obligations, less current portion........................ 633 336 212 212
Convertible notes from IBM and related party........................... -- -- 10,111 --
--------- --------- --------- -------------
Total long-term obligations...................................... 633 336 10,323 212
--------- --------- --------- -------------
Total liabilities................................................ 13,518 34,070 40,196 31,924
--------- --------- --------- -------------
Commitments
Stockholders' deficit:
Preferred stock, $0.01 par value; 22,816,333 shares authorized;
11,394,965, 11,576,937 and 12,700,399 shares issued and outstanding
as of September 30, 1997 and 1998 and March 31, 1999, respectively,
and none outstanding on a pro forma basis as of March 31, 1999
(aggregrate liquidation preference of $75,279,768 as of September
30, 1998).......................................................... 107 109 121 --
Common stock, $0.01 par value; 28,333,333 shares authorized;
1,857,449, 2,001,186, and 2,182,750 shares issued and outstanding
as of September 30, 1997 and 1998 and March 31, 1999, respectively,
and 20,112,862 shares issued and outstanding on a pro forma basis
at March 31, 1999.................................................. 18 20 21 201
Additional paid-in capital........................................... 15,599 18,318 34,252 44,721
Deferred stock-based compensation.................................... -- (541) (1,838) (1,838)
Notes receivable from stockholders................................... (143) (113) (23) (23)
Accumulated other comprehensive losses............................... -- -- (3) (3)
Accumulated deficit.................................................. (24,494) (46,718) (63,568) (63,824)
--------- --------- --------- -------------
Total stockholders' deficit...................................... (8,913) (28,925) (31,038) (20,766)
--------- --------- --------- -------------
Total liabilities and stockholders' deficit.......................... $ 4,605 $ 5,145 $ 9,158 $ 11,158
--------- --------- --------- -------------
--------- --------- --------- -------------
</TABLE>
- ------------------------------
(a) Assumes the conversion of all outstanding shares of preferred stock into
common stock, the cash payment from IBM of $2 million for the purchase of
promissory notes, the issuance of 2,118,789 shares of common stock,
reflecting the conversion of $10,910,000 of convertible debt and $417,060 in
related interest, the issuance of 3,110,924 shares of common stock upon the
cashless exercise of 1,598,277, 3,482,838, 215,050 and 916,668 warrants to
purchase Series C, Series E, Series E-2 and Series F convertible preferred
stock, respectively at a weighted average exercise price of $6.04 per share
by surrending shares of common stock as payment of the exercise price,
assuming an initial public offering price of $12.00 per share and the
accretion of discount on short-term borrowings of $256,000.
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 SIX MONTHS ENDED
(INCEPTION) TO SEPTEMBER 30, MARCH 31,
SEPTEMBER 30, -------------------------- --------------------------
1996 1997 1998 1998 1999
-------------- ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Software license fees.................. $ -- $ 7,392 $ 9,703 $ 4,571 $ 5,545
Service revenues....................... -- -- -- -- 630
Software license fees from IBM......... -- 175 2,700 1,215 2,335
Service revenues from IBM.............. -- -- 2,867 206 2,733
-------------- ------------ ------------ ------------ ------------
Total revenues....................... -- 7,567 15,270 5,992 11,243
-------------- ------------ ------------ ------------ ------------
Cost of revenues:
Software license fees.................. -- 772 2,531 982 948
Service revenues....................... -- -- -- -- 724
Service revenues from IBM.............. -- -- 2,562 184 2,092
-------------- ------------ ------------ ------------ ------------
Total cost of revenues............... -- 772 5,093 1,166 3,764
-------------- ------------ ------------ ------------ ------------
Gross profit......................... -- 6,795 10,177 4,826 7,479
-------------- ------------ ------------ ------------ ------------
Operating expenses:
Research and development............... 2,765 8,436 10,231 5,855 3,985
Sales and marketing.................... 2,998 12,161 17,114 8,413 9,026
General and administrative............. 978 3,762 3,575 1,746 1,966
Stock-based compensation............... -- -- 227 53 170
-------------- ------------ ------------ ------------ ------------
Total operating expenses............. 6,741 24,359 31,147 16,067 15,147
-------------- ------------ ------------ ------------ ------------
Operating loss....................... (6,741) (17,564) (20,970) (11,241) (7,668)
Interest income (expense)................ 46 (234) (1,194) (441) (1,723)
Nonrecurring interest charge on
beneficial conversion feature of
convertible debt....................... -- -- -- -- (7,457)
-------------- ------------ ------------ ------------ ------------
Loss before income taxes............. (6,695) (17,798) (22,164) (11,682) (16,848)
Income taxes............................. -- 1 60 37 2
-------------- ------------ ------------ ------------ ------------
Net loss............................. $ (6,695) $ (17,799) $ (22,224) $ (11,719) $ (16,850)
Translation adjustment................... -- -- -- --
-------------- ------------ ------------ ------------ ------------
Comprehensive loss................... $ (6,695) $ (17,799) $ (22,224) $ (11,719) $ (16,850)
-------------- ------------ ------------ ------------ ------------
-------------- ------------ ------------ ------------ ------------
Basic and diluted net loss per share..... $ (4.10) $ (10.45) $ (12.26) $ (6.63) $ (8.33)
-------------- ------------ ------------ ------------ ------------
-------------- ------------ ------------ ------------ ------------
Shares used to compute basic and diluted
net loss per share..................... 1,634,259 1,702,726 1,812,484 1,768,429 2,023,214
-------------- ------------ ------------ ------------ ------------
-------------- ------------ ------------ ------------ ------------
</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 SIX-MONTH PERIOD ENDED MARCH 31, 1999 (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)...................... -- -- -- -- -- -- -- -- --
Warrants exercised (unaudited)..... -- -- -- -- 652 7 -- -- -- --
Warrants to purchase Series E
Preferred 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
Repayment of Stockholder notes
(unaudited)...................... -- -- -- -- -- -- -- -- -- --
Issuance of Series E preferred
stock net of $67 issuance costs
(unaudited)...................... -- -- -- -- -- -- 82 1 -- --
Deferred compensation related to
stock option grants
(unaudited)...................... -- -- -- -- -- -- -- -- -- --
Amortization of stock-based
compensation (unaudited)......... -- -- -- -- -- -- -- -- -- --
Translation adjustment
(unaudited)...................... -- -- -- -- -- -- -- -- -- --
Net loss (unaudited)............... -- -- -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Balances, March 31, 1999
(unaudited)...................... 652 $-- -- $-- 652 $ 7 11,007 $110 389 $ 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)...................... 177 1 129 -- -- -- --
Issuance of common stock
(unaudited)...................... 33 -- 316 -- -- -- --
Repurchase of restricted stock
(unaudited)...................... (28) -- (3) -- -- -- --
Warrants exercised (unaudited)..... -- -- 1,181 -- -- -- --
Warrants to purchase Series E
Preferred Stock (unaudited)...... -- -- 120 -- -- -- --
Issuance of in the money
convertible debt and warrants to
purchase Series E preferred stock
(unaudited)...................... -- -- 8,776 -- -- -- --
Issuance of Series F preferred
stock net of $30 issuance costs
(unaudited)...................... -- -- 3,466 -- -- -- --
Repayment of Stockholder notes
(unaudited)...................... -- -- -- -- 90 -- --
Issuance of Series E preferred
stock net of $67 issuance costs
(unaudited)...................... -- -- 482 -- -- -- --
Deferred compensation related to
stock option grants
(unaudited)...................... -- -- 1,467 (1,467) -- -- --
Amortization of stock-based
compensation (unaudited)......... -- -- -- 170 -- -- --
Translation adjustment
(unaudited)...................... -- -- -- -- -- (3) --
Net loss (unaudited)............... -- -- -- -- -- -- (16,850)
------ ------ ---------- ------------- ----- --- -----------
Balances, March 31, 1999
(unaudited)...................... 2,183 $ 21 34,252 (1,838) (23) (3) (63,568)
------ ------ ---------- ------------- ----- --- -----------
------ ------ ---------- ------------- ----- --- -----------
<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)...................... 130
Issuance of common stock
(unaudited)...................... 316
Repurchase of restricted stock
(unaudited)...................... (3)
Warrants exercised (unaudited)..... 1,188
Warrants to purchase Series E
Preferred Stock (unaudited)...... 120
Issuance of in the money
convertible debt and warrants to
purchase Series E preferred stock
(unaudited)...................... 8,776
Issuance of Series F preferred
stock net of $30 issuance costs
(unaudited)...................... 3,470
Repayment of Stockholder notes
(unaudited)...................... 90
Issuance of Series E preferred
stock net of $67 issuance costs
(unaudited)...................... 483
Deferred compensation related to
stock option grants
(unaudited)...................... --
Amortization of stock-based
compensation (unaudited)......... 170
Translation adjustment
(unaudited)...................... (3)
Net loss (unaudited)............... (16,850)
-------------
Balances, March 31, 1999
(unaudited)...................... (31,038)
-------------
-------------
</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,
1995 YEAR ENDED SEPTEMBER SIX MONTHS ENDED
(INCEPTION) TO 30, MARCH 31,
SEPTEMBER 30, -------------------- --------------------
1996 1997 1998 1998 1999
--------------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss....................................................... $ (6,695) $ (17,799) $ (22,224) $ (11,719) $ (16,850)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization................................ 88 697 1,104 533 522
Accretion of discount on borrowings.......................... -- -- 201 67 599
Nonrecurring interest charge on beneficial conversion feature
of convertible debt........................................ -- -- -- -- 7,457
Amortization of deferred stock-based compensation............ -- -- 227 53 170
Changes in operating assets and liabilities:
Accounts receivable........................................ -- (2,018) (275) 47 (1,366)
Prepaid expenses and other current assets.................. (474) 27 (306) (32) (683)
Accounts payable........................................... 1,759 721 2,205 196 (852)
Accrued compensation....................................... 342 699 649 454 (335)
Other accrued liabilities.................................. 37 685 382 108 260
Deferred revenue........................................... 102 6,186 (999) 3,182 (4,564)
Interest payable........................................... -- -- -- 120 451
--------------- --------- --------- --------- ---------
Net cash used in operating activities.................... (4,841) (10,802) (19,036) (6,991) (15,191)
--------------- --------- --------- --------- ---------
Cash flows used in investing activities--purchases of property
and equipment.................................................. (551) (1,028) (792) (433) (1,129)
--------------- --------- --------- --------- ---------
Cash flows from financing activities:
Proceeds from short-term borrowings............................ 1,000 1,050 21,000 8,583 3,421
Repayments of short-term borrowings............................ -- -- (2,050) (2,050) (2,000)
Proceeds from convertible debt................................. -- -- -- -- 10,910
Payment on capital lease obligations........................... (35) (252) (300) (151) (130)
Proceeds from sale and leaseback of equipment.................. 179 -- -- -- --
Proceeds from issuance of preferred stock...................... 5,301 10,246 1,215 1,215 5,262
Proceeds from issuance of common stock......................... 39 17 91 11 133
Repurchases of common stock.................................... -- (20) (2) (1) (6)
Repayment of shareholder notes receivable...................... -- -- 30 -- 90
--------------- --------- --------- --------- ---------
Net cash provided by financing activities................ 6,484 11,041 19,984 7,607 17,680
--------------- --------- --------- --------- ---------
Effect of exchange rate changes on cash........................ -- -- -- -- (3)
--------------- --------- --------- --------- ---------
Net increase (decrease) in cash.................................. 1,092 (789) 156 183 1,357
Cash at beginning of period...................................... -- 1,092 303 303 459
--------------- --------- --------- --------- ---------
Cash at end of period............................................ $ 1,092 303 459 486 1,816
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Supplemental disclosures of cash flow information:
Interest paid.................................................. $ 28 $ 293 $ 753 $ 282 $ 608
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
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 $ 376 $ 1,467
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Discount on borrowings....................................... $ -- $ 298 $ 535 $ 535 $ 8,776
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
Stock issued in exchange for services........................ $ -- $ -- $ -- $ -- $ 316
--------------- --------- --------- --------- ---------
--------------- --------- --------- --------- ---------
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 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. 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. After consideration of the Company's financial
condition and the Company's plans, KPMG LLP issued a form of independent
auditors' report, dated December 21, 1998, on the Company's consolidated
financial statements 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. Such report included an
explanatory paragraph expressing substantial doubt about the Company's ability
to continue as a going concern.
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
On May 6, 1999, the Company signed a firm underwriting agreement for its
IPO. Expected net proceeds from the IPO after the underwriting discounts,
offering expenses and repayment of debt owed to IBM will be $41.0 million. After
consideration of the Company's current financial condition, the underwriters'
ability to honor the underwriting agreement, and the likelihood of the Company's
ability to complete its IPO, KPMG LLP concluded that substantial doubt about the
Company's ability to continue as a going concern for a reasonable period of time
has been alleviated. On May 6, 1999, KPMG LLP reissued their independent
auditors' report on the Company's consolidated financial statements, referred to
above, and such report excludes the explanatory paragraph expressing substantial
doubt about the Company's ability to continue as a going concern.
(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.
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
(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
receivable 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.
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
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
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. 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
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
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 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, 6,650,006 preferred stock
warrants with a weighted-average exercise price of $5.60 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 six months ended March 31, 1999, does not
include the effect of approximately 12,700,399 (on as if converted basis) shares
of convertible preferred stock outstanding, approximately 2,118,789 shares from
the assumed conversion of convertible debt and interest, 2,900,087 stock options
with a weighted-average exercise price of $3.13 per share, 6,229,499 preferred
stock warrants with a weighted-average exercise price of $6.04 per share, or
41,252 shares of common stock issued and subject to repurchase by the Company at
a weighted-average price of $0.13 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 March 31, 1999 and for the
six-months ended March 31, 1998 and 1999 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 six-months ended March 31, 1999 are not necessarily indicative
of results that may be expected for the entire year.
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
(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 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.
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(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.
(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.
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(3) RELATED PARTY TRANSACTIONS (CONTINUED)
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 for 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.
- 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 six-month period
ended March 31, 1999, the Company recognized approximately $175,000, $2.7
million and $2.3 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
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(3) RELATED PARTY TRANSACTIONS (CONTINUED)
IBM products. During the second quarter of fiscal 1999, the Company became
aware, and IBM confirmed, that the Company's software had been bundled, or was
contractually required to be bundled, with certain Lotus site licenses
previously sold by IBM and these sales had not been reported to the Company by
IBM. The Company recognized $500,000 of software license fees during the
three-month period ended March 31, 1999 reflecting the minimum amount owed the
Company and acknowledged by IBM for these previously unreported Lotus site
licenses. The Company believes the actual amount owed by IBM to be higher;
however, this amount will be the subject of additional analysis and negotiation
with IBM. In the event additional amounts, if any, are owed the Company they
will be recorded as revenue in the period agreement is reached with IBM. Lotus
had not previously reported these fees to us during the contract term, which
commenced in February 1998.
During the year ended September 30, 1998 and the six month period ended
March 31, 1999, the Company recognized approximately $2.9 million and $2.7
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 six-month period ended March 31, 1999, the Company incurred
$2.9 million and $2.3 million in service costs, which includes $305,000 and
$249,000 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. As of
February 28, 1999, the integration services were completed and all profit from
the arrangement was recognized during the six months ended March 31, 1999.
(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 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.
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(3) RELATED PARTY TRANSACTIONS (CONTINUED)
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 237,851 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 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>
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(5) COMMITMENTS (CONTINUED)
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.
(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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT
(A) PREFERRED STOCK
At March 31, 1999, the Company's restated certificate of incorporation
authorizes shares of preferred stock. As of September 30, 1997 and
1998, and March 31, 1999 the Company has designated and issued preferred stock
as follows:
<TABLE>
<CAPTION>
OUTSTANDING SHARES
-------------------------------------------
SEPTEMBER 30,
DESIGNATED ---------------------------- LIQUIDATION
SHARES 1997 1998 PREFERENCE
------------- ------------- ------------- MARCH 31, -------------
1999
-------------
(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 -- -- 652,223 1.82
Series E............................... 15,033,333 10,743,020 10,924,992 11,007,343 6.68
Series E-2............................. 2,000,000 -- -- -- 6.68
Series F............................... 916,666 -- -- 388,888 10.80
Series F-2............................. 416,666 -- -- -- 9.00
------------- ------------- ------------- -------------
21,982,998 11,394,965 11,576,937 12,700,399
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</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. If the Company does not close
an initial public offering by April 8, 1999, the Series E-2 preferred
stock is convertible into 1.25 shares of common stock. 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.
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT (CONTINUED)
- 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 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 244,715 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.
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT (CONTINUED)
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 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
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT (CONTINUED)
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 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 and during the six months ended March 31, 1999, the
Company has recorded deferred stock-based compensation of $768,000 and
$1,467,000 (unaudited), respectively, 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 and was $170,000
(unaudited) during the six months ended March 31, 1999.
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 costs for the Company's 1997 Plans been
determined consistent with the fair value approach enumerated in SFAS No. 123,
net losses 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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(7) STOCKHOLDERS' DEFICIT (CONTINUED)
The following table summarizes stock option activity during the year:
<TABLE>
<CAPTION>
PERIOD FROM NOVEMBER 21,
1995 (INCEPTION) TO YEAR ENDED SEPTEMBER 30, YEAR ENDED SEPTEMBER 30, SIX MONTHS
ENDED MARCH
SEPTEMBER 30, 1996 1997 1998 31, 1999
-------------------------- -------------------------- -------------------------- -----------
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............... -- $ -- 758,051 $ 0.12 2,517,670 $ 1.20 2,472,343
Granted................ 1,017,305 0.12 2,251,557 1.08 341,340 2.10 849,437
Exercised.............. (259,254) 0.12 (126,353) 0.12 (144,432) 0.60 (177,707)
Canceled............... -- -- (365,585) 0.48 (242,235) 1.26 (243,984)
----------- ----------- ----------- -----------
Shares under options
outstanding at end of
period............... 758,051 0.12 2,517,670 1.20 2,472,343 1.32 2,900,087
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Shares vested at
period-end........... -- 128,388 852,158 976,264
<CAPTION>
WEIGHTED-
AVERAGE
EXERCISE
PRICE
-------------
<S> <C>
Shares under options
outstanding at
beginning of
period............... $ 1.32
Granted................ 7.47
Exercised.............. 0.73
Canceled............... 1.74
Shares under options
outstanding at end of
period............... 3.13
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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 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 $7.5 million nonrecurring interest charge during the
six month period ended March 31, 1999 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 March 31, 1999, $10.9 million was outstanding under the convertible note, net
of a discount of $799,000.
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 February 4, 1999, the Board of Directors authorized a recapitalization of
the Company's equity structure, including changes in par value, and the number
of shares authorized and a 1-for-6 reverse split of all the outstanding shares
of the Company's preferred and common stock which will be effective prior to the
closing of the IPO. 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 shares of common
F-24
<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 MARCH 31, 1999 AND FOR THE SIX-MONTHS
ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
(8) SUBSEQUENT EVENTS (CONTINUED)
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 March 31, 1999.
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. 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 of $432,000 was accounted for as additional paid-in capital
and amortized over the term of the notes.
On April 23, 1999, pursuant to a note agreement, the Company borrowed $2
million from IBM. The note bears interest at 10% per annum and is due and
payable on June 23, 1999.
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
Forward-looking Statements..................... 19
Use of Proceeds................................ 19
Dividend Policy................................ 19
Capitalization................................. 20
Dilution....................................... 22
Selected Consolidated Financial Data........... 23
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 25
Business....................................... 39
Management..................................... 52
Certain Transactions........................... 59
Principal Stockholders......................... 66
Description of Capital Stock................... 68
Shares Eligible for Future Sale................ 70
Underwriting................................... 72
Legal Matters.................................. 73
Experts........................................ 74
Change in Auditors............................. 74
Where You Can Find More Information............ 74
Index to Consolidated Financial Statements..... F-1
</TABLE>
--------------
DEALER PROSPECTUS DELIVERY OBLIGATION:
Until June 1, 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.
6,000,000 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
May 7, 1999
- -------------------------------------------
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- -------------------------------------------
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