<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 24, 1996.
REGISTRATION NO. 333-3868
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
FARALLON COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
---------------
CALIFORNIA 3661 94-3033136
(PRIOR TO REINCORPORATION) (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
DELAWARE CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
(AFTER REINCORPORATION)
(STATE OR OTHER
JURISDICTION OF
INCORPORATION OR
ORGANIZATION)
2470 MARINER SQUARE LOOP
ALAMEDA, CALIFORNIA 94501
(510) 814-5100
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------
ALAN B. LEFKOF
PRESIDENT AND CHIEF EXECUTIVE OFFICER
FARALLON COMMUNICATIONS, INC.
2470 MARINER SQUARE LOOP
ALAMEDA, CALIFORNIA 94501
(510) 814-5100
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
---------------
COPIES TO:
ROBERT V. GUNDERSON, JR., ESQ. JORGE DEL CALVO, ESQ.
STEVEN M. SPURLOCK, ESQ. JOHN E. WOOD, ESQ.
SHANNON SOQUI, ESQ. DAVINA K. KAILE, ESQ.
WILLIAM E. GROWNEY, JR., ESQ. PILLSBURY MADISON & SUTRO LLP
GUNDERSON DETTMER STOUGH 2700 SAND HILL ROAD
VILLENEUVE FRANKLIN & HACHIGIAN, LLP MENLO PARK, CA 94025
600 HANSEN WAY, SECOND FLOOR (415) 233-4500
PALO ALTO, CALIFORNIA 94304
(415) 843-0500
---------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
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<PAGE>
FARALLON COMMUNICATIONS, INC.
CROSS-REFERENCE SHEET
SHOWING LOCATION IN PROSPECTUS OF INFORMATION REQUIRED BY ITEMS OF FORM S-1
<TABLE>
<CAPTION>
FORM S-1 REGISTRATION
STATEMENT HEADING HEADING OR LOCATION IN PROSPECTUS
--------------------------------------------- -------------------------------------------
<C> <S>
1. Forepart of the Registration Statement
and Outside Front Cover Page of
Prospectus............................... Forepart of the Registration Statement;
Outside Front Cover Page of Prospectus
2. Inside Front and Outside Back Cover Pages
of Prospectus............................ Inside Front and Outside Back Cover Pages
3. Summary Information, Risk Factors
and Ratio of Earnings to Fixed Charges... Prospectus Summary; Risk Factors
4. Use of Proceeds.......................... Prospectus Summary; Use of Proceeds
5. Determination of Offering Price.......... Outside Front Cover Page; Underwriting
6. Dilution................................. Dilution
7. Selling Security Holders................. Principal and Selling Stockholders
8. Plan of Distribution..................... Outside and Inside Front Cover Pages;
Underwriting; Outside Back Cover Page
9. Description of Securities to be
Registered............................... Outside Front Cover Page; Prospectus
Summary; Capitalization; Description of
Capital Stock
10. Interests of Named Experts and Counsel... Not Applicable
11. Information with Respect to the
Registrant............................... Inside and Outside Cover Pages; Prospectus
Summary; Risk Factors; Use of Proceeds;
Dividend Policy; Capitalization; Dilution;
Selected Consolidated Financial
Information; Management's Discussion and
Analysis of Financial Condition and Results
of Operations; Business; Management;
Certain Transactions; Principal and Selling
Stockholders; Description of Capital Stock;
Shares Eligible for Future Sale; Additional
Information; Experts; Consolidated
Financial Statements
12. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities.............................. Not Applicable
</TABLE>
<PAGE>
PROSPECTUS (Subject to Completion)
Dated May 24, 1996
2,000,000 Shares
[LOGO OF FARALLON COMMUNICATIONS, INC.]
Common Stock
-------------
Of the 2,000,000 shares of Common Stock offered hereby, 1,500,000 shares are
being issued and sold by Farallon Communications, Inc. ("Farallon" or the
"Company") and 500,000 shares are being sold by certain selling stockholders
(the "Selling Stockholders"). See "Principal and Selling Stockholders." The
Company will not receive any of the proceeds from the sale of shares by the
Selling Stockholders.
Prior to this offering, there has been no public market for the Common Stock
of the Company. Application has been made to have the Common Stock approved for
quotation on the Nasdaq National Market under the symbol "FRLN." It is
currently estimated that the initial public offering price will be between
$13.00 and $15.00 per share. See "Underwriting" for information relating to the
determination of the initial public offering price.
-------------
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING ON
PAGE 5 HEREOF.
-------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
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<TABLE>
<CAPTION>
Price to Underwriting Proceeds to Proceeds to Selling
Public Discount (1) Company (2) Stockholders
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share............. $ $ $ $
Total (3)............. $ $ $ $
- -------------------------------------------------------------------------------
</TABLE>
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(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933. See "Underwriting."
(2) Before deducting expenses, estimated to be $800,000, payable by the
Company.
(3) The Company has granted the Underwriters an option, exercisable within 30
days of the date hereof, to purchase up to an aggregate of 300,000
additional shares at the Price to Public less the Underwriting Discount to
cover over-allotments, if any. If all such additional shares are purchased,
the total Price to Public, Underwriting Discount and Proceeds to Company
will be $ , $ and $ , respectively. See "Underwriting."
-------------
The Common Stock is offered by the several Underwriters named herein when, as
and if received and accepted by them, subject to their right to reject orders
in whole or in part and subject to certain other conditions. It is expected
that delivery of certificates for such shares will be made at the offices of
Cowen & Company, New York, New York, on or about , 1996.
COWEN & COMPANY
HAMBRECHT & QUIST
UBS SECURITIES LLC
, 1996
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these
securities in any State in which such offer, solicitation or sale would be
unlawful prior to registration or qualification under the securities laws of
any such State.
<PAGE>
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the consolidated financial statements and notes thereto
appearing elsewhere in this Prospectus.
THE COMPANY
Farallon develops, markets and supports complete, easy-to-use, plug-and-play
Internet connectivity and networking solutions and real-time collaboration
software. The Company's products are designed to increase the productivity and
efficiency of Internet, Intranet and LAN users and to target small businesses,
geographically dispersed facilities of large enterprises, home offices, mobile
users, schools and other small organizations that may not have access to
sophisticated technical support. The Company's Internet/Intranet products
include its Netopia routers and modems, which provide high-speed Internet
connectivity for individuals and workgroups, and its Timbuktu Pro collaboration
software, which enables real-time, peer-to-peer collaboration on the Internet,
Intranets and LANs. To assist users in configuring the Netopia products and in
arranging service from Internet and telecommunications service providers, the
Company offers its Up & Running, Guaranteed! program, which serves as a single
source for complete Internet connectivity. The Company's LAN networking
solutions, a substantial majority of which have been sold to MacOS customers,
include its EtherWave family of products, which enable users to easily and
cost-effectively create Ethernet networks with or without a hub.
Organizations and individuals are increasingly using networks of computers to
enhance productivity, access information and communicate more effectively. The
continuing advancement of networking technologies and the increasing scale,
scope and functionality of network communications and computing have resulted
in a corresponding increase in the complexity of these systems. Headquarters
offices of large enterprises that have access to sophisticated technical
support have generally managed this complexity and realized the benefits of
effective network communications. However, individuals and smaller
organizations typically do not have access to the skills or resources required
to manage the complexity of advanced networking systems. As a result, these
users are increasingly seeking networking solutions that are complete, easy-to-
use and cost-effective.
The Company's objective is to become the leading provider of complete, high-
speed Internet connectivity solutions and real-time, peer-to-peer
Internet/Intranet collaboration software for segments of the networking market
that industry sources have identified as the most rapidly growing and that
typically do not have access to sophisticated technical support. Netopia
products enable plug-and-play Internet connectivity for multiple users through
a single ISDN connection at substantially greater speed than traditional
analog-based Internet connections. Timbuktu Pro expands the functionality of
the Internet beyond e-mail and Web browsing, enabling users to collaborate in
real-time with other Timbuktu Pro users--viewing other users' screens, revising
information, transferring files, controlling other computers and remotely
accessing network resources. The Company intends to leverage its expertise in
developing easy-to-use, plug-and-play LAN networking solutions, its well-
established distribution channels and its customer service and support
infrastructure to more rapidly penetrate the market for Internet/Intranet
products.
The Company's marketing strategy is to achieve broad market penetration by
utilizing multiple distribution channels, including direct sales, Internet
service providers, value-added resellers and two-tier distributors as well as
mail order and electronic merchandising. The Company sells its products through
approximately 70 distributors in 58 countries. The Company's on-line electronic
marketing initiatives include the development and maintenance of a Web server
containing in excess of 1,000 pages, hyperlinked with over 1,000 Web sites, and
electronic distribution of Timbuktu Pro software. The Company has also
established strategic alliances with Cisco, Shiva, PSINet and NetManage for the
distribution of Farallon products.
The Company was incorporated in California in 1986 as Farallon Computing,
Inc. and will be reincorporated in Delaware prior to the completion of this
offering. The Company's principal executive offices are located at 2470 Mariner
Square Loop, Alameda, California 94501. Its telephone number is (510) 814-5100.
3
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered:
By the Company.................... 1,500,000 shares
By the Selling Stockholders....... 500,000 shares
Common Stock to be outstanding
after the offering................ 10,807,085 shares (1)
Use of proceeds.................... For general corporate purposes, including
working capital and potential acquisitions.
See "Use of Proceeds."
Proposed Nasdaq National Market
symbol ........................... FRLN
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS
YEARS ENDED SEPTEMBER 30, ENDED MARCH 31,
CONSOLIDATED STATEMENT OF ----------------------------------------- ---------------
1991 1992 1993 1994 1995 1995 1996
OPERATIONS DATA: ------- ------ ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues
Internet/Intranet
products.............. $ -- $ -- $ -- $ 5,310 $ 6,569 $ 3,188 $ 6,442
LAN products........... 43,904 48,038 48,425 51,691 50,620 26,359 23,003
------- ------ ------- ------- ------- ------- -------
Total revenues........ 43,904 48,038 48,425 57,001 57,189 29,547 29,445
Gross profit............ 24,847 25,084 24,123 26,186 27,673 14,510 14,265
Operating income (loss)
....................... (1,797) (575) (1,662) 2,304 2,665 2,235 527
Net income (loss) (2) .. $(1,893) $ (500) $(1,414) $ 2,187 $ 2,506 $ 1,843 $ 2,875
Net income per share ... $ 0.25 $ 0.19 $ 0.27
Shares used in per share
computations (3)....... 9,891 9,841 10,477
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1996
----------------------
ACTUAL AS ADJUSTED(4)
CONSOLIDATED BALANCE SHEET DATA: ------- --------------
<S> <C> <C>
Working capital......................................... $23,976 $42,706
Total assets............................................ 36,234 54,964
Long-term liabilities, net of current portion .......... 131 131
Total stockholders' equity.............................. 27,295 46,158
</TABLE>
- ----------------
(1) Based on the number of shares outstanding as of March 31, 1996. Excludes
1,372,050 shares of Common Stock issuable upon exercise of outstanding
options as of March 31, 1996 with a weighted average exercise price of
$1.46 per share under the Company's 1987 Restated Stock Option Plan. See
"Management--1996 Stock Option Plan" and Note 6 of Notes to Consolidated
Financial Statements.
(2) At March 31, 1996, the Company reversed a full valuation allowance that it
had previously provided against its deferred tax assets, resulting in a
non-recurring income tax benefit of approximately $2.3 million.
(3) See Note 1 of Notes to Consolidated Financial Statements.
(4) Adjusted to reflect the sale by the Company of 1,500,000 shares of Common
Stock offered hereby at an assumed initial public offering price of $14.00
per share and after deducting the estimated underwriting discount and
offering expenses payable by the Company, and the application of the net
proceeds therefrom. See "Capitalization" and "Use of Proceeds."
----------------
Farallon, the Farallon logo, Timbuktu, EtherWave and PhoneNET are registered
trademarks and Netopia, Look@Me and FlashNote are trademarks of the Company.
All other trademarks or trade names referred to in this Prospectus are the
property of their respective owners.
----------------
Except as otherwise noted herein, information in this Prospectus (i) reflects
a one-for-two reverse split of the Common Stock, which will occur prior to the
effective date of this offering, (ii) assumes no exercise of the Underwriters'
over-allotment option, (iii) except in the Consolidated Financial Statements,
reflects the conversion of all outstanding shares of Preferred Stock of the
Company into an aggregate of 5,591,207 shares of Common Stock upon the closing
of this offering, and (iv) assumes the reincorporation of the Company from
California to Delaware, which will occur prior to the effective date of this
offering, and the associated changes in the Company's charter documents. See
"Description of Capital Stock" and "Underwriting."
4
<PAGE>
RISK FACTORS
In addition to the other information in this Prospectus, prospective
investors should consider carefully the following risk factors in evaluating
an investment in the Company and its business before purchasing any shares of
the Common Stock offered hereby. This Prospectus contains forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ materially from the results discussed in such forward-looking
statements. Factors that may cause such a difference include, but are not
limited to, those discussed below.
FLUCTUATIONS IN QUARTERLY RESULTS; FUTURE RESULTS OF OPERATIONS UNCERTAIN
The Company's quarterly operating results have varied significantly in the
past and are likely to vary significantly in the future, depending on factors
such as changes in networking and communications technologies, price and
product competition, usage of the Internet and developments and changes in the
Internet market, the demand for the Company's products, changes in pricing
policies by the Company or its competitors, including the grant of price
protection terms and discounts by the Company, changes in the mix of products
sold by the Company and the resulting change in total gross margin, changes in
the mix of channels through which the Company's products are offered, product
enhancements and new product announcements by the Company and its competitors,
market acceptance of new products of the Company or its competitors, raw
material costs, write-offs of obsolete inventory, the size and timing of
distributor and end user orders and purchasing cycles, customer order
deferrals in anticipation of enhancements to the Company's or competitors'
products, customer order deferrals in anticipation of new Macintosh operating
system ("MacOS") product offerings by Apple Computer ("Apple"), manufacturing
delays, disruptions in sources of supply, product life cycles, product quality
problems, personnel changes, changes in the Company's strategy, changes in the
level of operating expenses, the timing of research and development
expenditures, the level of the Company's international revenues, fluctuations
in foreign currency exchange rates, general economic conditions, both in the
United States and abroad, and economic conditions specific to the industries
in which the Company competes, among others. The Company's limited
Internet/Intranet operating history makes the prediction of future
Internet/Intranet operating results difficult, if not impossible. Sales orders
are typically shipped shortly after receipt and, consequently, order backlog
at the beginning of any quarter has in the past represented only a small
portion of that quarter's revenues. Accordingly, the Company's net revenues in
any quarter are substantially dependent on orders booked and shipped during
that quarter. Historically, the Company has often recognized a significant
portion of its revenues in the last weeks, or even days, of a quarter. As a
result, the magnitude of quarterly fluctuations may not become evident until
late in, or after the close of, a particular quarter. In addition, the Company
recognizes revenue on products sold through distributors upon shipment to the
distributor. Although the Company maintains reserves for projected returns and
price decreases, there can be no assurance that such reserves will be
adequate. The Company's business also has experienced seasonality in the past,
largely due to customer buying patterns such as budgeting cycles of
educational institutions that purchase the Company's products. There can be no
assurance that the Company's operating results will not be affected by
seasonality in the future or that such seasonality will occur in a manner
consistent with prior periods.
The Company's expense levels are based in large part on expectations as to
future revenues and as a result are relatively fixed in the short term. If
revenues are below expectations in any given quarter, net income is likely to
be disproportionately affected. Due to all of the foregoing factors, revenues
and net income for any future period are not predictable with any significant
degree of certainty. Accordingly, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. There can be
no assurance that the Company's business strategies will be successful or that
the Company will be able to sustain profitability on a quarterly or annual
basis in the future. It is likely that in some future quarter the Company's
operating results will be below the expectations of public market analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially and adversely affected. See "--Dependence on Distributors,"
"Selected Consolidated Financial Information" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
5
<PAGE>
DEPENDENCE ON INTERNET/INTRANET PRODUCTS
The Company's business is substantially dependent upon continued growth in
the sale of its Internet/Intranet products. Rapid growth in the use of the
Internet and Intranets is a recent phenomenon. There can be no assurance that
communication or commerce over the Internet will become widespread. In
addition, to the extent that the Internet continues to experience significant
growth in the number of users and level of use, there can be no assurance that
the Internet infrastructure will continue to be able to support the demands
placed upon it by such potential growth, or will not otherwise lose its
utility due to delays in the development or adoption of new standards and
protocols required to handle increased levels of activity, or due to increased
government regulation. Although the Company has experienced significant
percentage growth in Internet/Intranet revenues over the last three fiscal
quarters, the Company does not believe prior percentage growth rates are
sustainable or indicative of future operating results for these products and
services. The Company's limited Internet/Intranet operating history makes the
prediction of future Internet/Intranet operating results difficult, if not
impossible. There can be no assurance that the Company will continue to
increase sales of its Internet/Intranet products, that the Company's existing
distribution channels are appropriate for the sale of its Internet/Intranet
products or that sales of such products will reach levels significant enough
to offset expected declines in sales, average selling prices and gross margins
of the Company's local area network ("LAN") products. Accordingly, the failure
of the Company's Internet/Intranet products to gain market acceptance or to
achieve significant sales would materially and adversely affect the Company's
business, operating results and financial condition. See "--Competition,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business--The Farallon Strategy."
DEPENDENCE ON LAN PRODUCTS; DECLINING LAN BUSINESS
To date, the Company has derived a substantial majority of its revenues from
LAN products, which represented 100%, 91%, 89% and 78% of total revenues for
fiscal years 1993, 1994 and 1995 and the six months ended March 31, 1996,
respectively. These products have experienced variable average selling prices
and sales volumes, and declining gross margins for the past five fiscal
quarters. The Company anticipates that the average selling prices and gross
margins of its existing LAN products will continue to decline. Accordingly, to
the extent the product mix for any particular period includes a substantial
proportion of LAN products, the Company's total gross margin will be adversely
affected. To date, the Company has been able to partially reduce the decline
in total gross margin by increasing unit sales of existing LAN products, by
reducing the manufacturing cost of products and by introducing new products
with higher margins. There can be no assurance that the Company will achieve
any such reductions in the future. Although the Company's Internet/Intranet
products currently carry a higher average gross margin than its LAN products,
the Company anticipates that competitive pressures in its Internet/Intranet
business may result in declining average selling prices and gross margins in
this business as well. Historically, a substantial majority of the Company's
LAN product revenues have been derived from sales of products designed for
Apple MacOS and compatible computers. Net revenues from the Company's LAN
products fluctuated on a quarterly basis during fiscal 1995 and the six months
ended March 31, 1996, and the Company expects that net revenues from LAN
products may decline in the future as a result of declining average selling
prices of the Company's LAN products, Apple's incorporation of built-in
Ethernet connectivity into certain of its computers, declining sales of MacOS
computers and competition in the LAN products market. In addition, as a result
of technical characteristics in the MacOS environment, Fast Ethernet products,
in general, have not delivered expected performance levels. If these technical
characteristics are not addressed in the future, then Fast Ethernet product
sales in the MacOS market segment will be below the Company's expectations,
and operating results may be materially and adversely affected. The Company is
dependent upon sales and profitability of its LAN products for the foreseeable
future, and to the extent that any decline in revenues and gross margins from
LAN products is not offset by increases in revenues from other sources, such
as sales of the Company's Internet/Intranet products, then the Company's
business, operating results and financial condition will be materially and
adversely affected. See "Selected Consolidated Financial Information" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
6
<PAGE>
DEPENDENCE ON APPLE; COMPETITION WITH APPLE PRODUCTS
To date, the Company has derived approximately 85% to 90% of its LAN
products revenues from products designed for networking the Apple MacOS family
of personal computers. Accordingly, the Company is substantially dependent on
the market for MacOS computers and the development and sale of new Apple
computers, particularly sales of such computers into business environments.
There can be no assurance that competitive personal computers will not
displace the MacOS products or reduce sales of MacOS products. In addition,
sales of the Company's products in the past have been adversely affected by
the announcement by Apple of new products with the potential to replace
existing products. The inability of Apple to successfully develop,
manufacture, market or sell new products, and any decrease in the sales or
market acceptance of the MacOS family of computers, would have a material
adverse effect on the Company's business, operating results and financial
condition. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
The Company relies on an informal working relationship with Apple in
connection with the Company's LAN product development efforts. Although the
Company and Apple have maintained a cooperative working relationship since the
Company's founding, Apple is under no obligation to continue to share product
information or otherwise cooperate with the Company. In addition, there can be
no assurance that Apple will continue to work cooperatively with the Company
in connection with the Company's product development efforts. The absence of
such cooperation in the future, as a result of the restructuring in process at
Apple or any other factors, could have a material adverse effect on the
Company's business, operating results and financial condition. Apple currently
offers products that compete directly with certain of the Company's products.
The Company anticipates that Apple will continue to incorporate additional
connectivity technologies into more of its products in the future, which will
adversely affect sales of the Company's LAN products. Since Apple has
substantially greater financial, technical, sales, marketing and other
resources than the Company, as well as greater name recognition and a larger
customer base, Apple may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or to devote greater
resources to the development, promotion and sales of its products. The Company
believes that it is likely that Apple will in the future sell separately or
bundle with its computers certain Internet access products, such as Integrated
Services Digital Network ("ISDN") terminal adapters similar to the Company's
Netopia ISDN Modem. Any such additional bundling or enhancement by Apple could
have a material adverse effect on the Company's business, operating results
and financial condition. See "--Competition" and "Business--Products."
COMPETITION
The markets for the Company's products and services are intensely
competitive, highly fragmented and characterized by rapidly changing
technology, evolving industry standards, price competition and frequent new
product introductions. A number of companies offer products that compete with
one or more of the Company's products. The Company's current and prospective
competitors include original equipment manufacturer ("OEM") product
manufacturers of Internet access and remote LAN access equipment,
manufacturers of remote control and screen sharing software and manufacturers
of LAN client access and network systems products. In the Internet access and
remote LAN access equipment market, the Company competes primarily with
Ascend, Cisco, Motorola, 3Com, U.S. Robotics, Gandalf and several other
companies. In the remote control and screen sharing software market, the
Company competes primarily with Symantec, Microcom, Traveling Software, Stac
Electronics and several other companies. In the LAN client access and network
systems product market, the Company competes primarily with Apple, Asante,
Dayna, Global Village and several other companies. The Company has experienced
and expects to continue to experience increased competition from current and
potential competitors, many of whom have substantially greater financial,
technical, sales, marketing and other resources, as well as greater name
recognition and a larger customer base, than the Company. Accordingly, such
competitors or future competitors may be able to respond more quickly to new
or emerging technologies and changes in customer requirements or devote
greater resources to the development, promotion and sales of their products
than the Company. In particular, established companies in the personal
computer industry may seek to expand their product offerings by designing and
selling products using competitive technology that could render
7
<PAGE>
the Company's products obsolete or have a material adverse effect on the
Company's sales. For example, Microsoft recently announced the availability of
free, via download on the Internet, communications and collaboration software
compatible with the Microsoft Internet Explorer. This software product, which
enables real-time communication within a workgroup, could undermine the
Company's ability to market its Timbuktu Pro collaboration software. In
addition, Netscape also recently announced its plan to offer software that
enables dispersed workgroups to collaborate in the work environment.
Accordingly, there can be no assurance that the Company can continue to market
its collaboration software, which would have a material and adverse effect on
the Company's business, operating results and financial condition. In
addition, several of the Company's current competitors recently have
introduced free guaranteed service and support programs that appear to be
similar to the Company's Up & Running, Guaranteed! program. As a result, there
can be no assurance that the Company can continue to charge a fee for this
support program, which could have a material and adverse effect upon the
Company's business, operating results and financial condition. The markets in
which the Company competes currently are subject to intense price competition
and the Company expects additional price and product competition as other
established and emerging companies enter these markets and new products and
technologies are introduced. Increased competition may result in further price
reductions, reduced gross margins and loss of market share, any of which could
materially and adversely affect the Company's business, operating results and
financial condition. There can be no assurance that the Company will be able
to compete successfully against current and future competitors, or that
competitive factors faced by the Company will not have a material adverse
effect on the Company's business, operating results and financial condition.
See "--Dependence on Apple; Competition with Apple Products" and "Business--
Competition."
NEW PRODUCT DEVELOPMENT AND RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON ISDN
TECHNOLOGY
The personal computer industry is characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions,
short product life cycles and rapidly changing customer requirements. The
introduction of products embodying new technologies and the emergence of new
industry standards can render existing products obsolete and unmarketable. The
Company's future success will depend on its ability to enhance its existing
products and to introduce new products to meet changing customer requirements
and emerging technologies. For example, the Company's Netopia products
currently operate only over ISDN telecommunication service. As other
communications technologies such as Frame Relay, Asynchronous Transfer Mode
("ATM"), Asymmetric Digital Subscriber Line ("ADSL") and communication over
cable or wireless networks, are developed or gain market acceptance, the
Company will be required to enhance its Internet connectivity products to
support such technologies, which will be costly and time consuming. If the
Company is unable to modify its products to support new Internet access
technologies, or if ISDN does not achieve widespread customer acceptance as a
result of the adoption of alternative technologies or as result of deemphasis
of ISDN by telecommunications service providers, the Company's business,
operating results and financial condition would be materially and adversely
affected. In addition, the Company has historically derived a substantial
majority of its revenues from the sale of Ethernet connectivity products. In
the event that current Ethernet network technology is modified or replaced and
the Company is unable to modify its products to support new Ethernet
technologies or alternative technologies, the Company's business, operating
results and financial condition could be materially and adversely affected.
The Company has in the past and may in the future experience delays in new
product development. There can be no assurance that the Company will be
successful in developing and marketing product enhancements or new products
that respond to technological change, evolving industry standards and changing
customer requirements, that the Company will not experience difficulties that
could delay or prevent the successful development, introduction and marketing
of these products or product enhancements, or that its new products and
product enhancements will adequately meet the requirements of the marketplace
and achieve any significant degree of market acceptance. Failure of the
Company, for technological or other reasons, to develop and introduce new
products and product enhancements in a timely and cost-effective manner would
have a material adverse effect on the Company's business, operating results
and financial condition. In addition, the future introduction or even
announcement of products by the Company or one or more of its competitors
embodying new technologies or changes in industry standards or customer
requirements could render the Company's then existing products obsolete or
unmarketable. There can be no assurance that the introduction or announcement
of new product offerings by the Company or one of or more of its competitors
will not cause customers to defer purchase of existing Company products. Such
deferment of purchases could have a material adverse effect on the Company's
business, operating results or financial condition.
8
<PAGE>
Complex products such as those offered by the Company may contain undetected
or unresolved defects when first introduced or as new versions are released.
There can be no assurance that, despite testing by the Company, defects will
not be found in new products or new versions of products following commercial
release, resulting in loss of market share, delay in or loss of market
acceptance or product recall. Any such occurrence could have a material
adverse effect upon the Company's business, operating results or financial
condition. See "Business--Products" and "--Technology."
MANAGEMENT OF CHANGING BUSINESS
The Company has recently shifted its business strategy from providing only
LAN products to reducing its reliance on LAN products and focusing development
and management efforts on its Internet/Intranet business. This transition
represents a significant challenge for the Company and its administrative,
operational and financial resources and places increased demands on its
systems and controls. The Company's ability to manage the continuing
development of its Internet/Intranet business will require the Company to
continue to change, expand and improve its operational, management and
financial systems and controls and to expand its manufacturing capacity. This
transition has resulted in a continuing increase in the level of
responsibility for both existing and new management personnel. The Company
anticipates that any growth in its Internet/Intranet business will require it
to recruit and hire a substantial number of new engineering, sales and
marketing, customer service and managerial personnel. There can be no
assurance that the Company will be successful in hiring or retaining these
personnel, if needed. If the Company is unable to manage the transition
effectively, the Company's business, operating results and financial condition
will be materially and adversely affected. See "--New Product Development and
Rapid Technological Change; Dependence on ISDN Technology," "--Dependence on
Key Personnel" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
DEPENDENCE ON DISTRIBUTORS
The Company relies primarily on distributors for the sale of its
Internet/Intranet and LAN products. Revenues from distributors accounted for
81%, 76%, 73% and 66% of the Company's total revenues in fiscal 1993, 1994 and
1995 and the six months ended March 31, 1996, respectively. A substantial
amount of the Company's revenues result from a limited number of these
distributors. The Company's three largest distributors accounted for 46%, 45%,
43% and 37% of the Company's total revenues in fiscal 1993, 1994 and 1995 and
the six months ended March 31, 1996, respectively. During fiscal 1993, 1994
and 1995 and the six months ended March 31, 1996, revenue from Ingram Micro
("Ingram") accounted for 24%, 24%, 22% and 20% of the Company's total
revenues, and revenue from MicroWarehouse accounted for 12%, 12%, 13% and 11%
of the Company's total revenues, respectively. Merisel accounted for 10% of
the Company's total revenues for fiscal 1993. No other customers have
accounted for 10% or more of the Company's total revenues during fiscal 1993,
1994 and 1995 and the six months ended March 31, 1996. The distribution of LAN
products such as those offered by the Company has been characterized by rapid
change, including industry consolidations, financial difficulties of
distributors and the emergence of alternative distribution channels. For
example, Merisel has publicly announced greater than expected net losses,
audit difficulties and other financial problems. Accordingly, the Company has
reduced Merisel's credit limit and recorded a partial reserve against
Merisel's accounts receivable balance at March 31, 1996. There can be no
assurance that Merisel will be able to pay in full the amount currently owed
to the Company or that any of the Company's other current or future
distributors will not experience financial difficulties, which could result in
a material adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that Ingram, MicroWarehouse or
Merisel will continue to serve as distributors for the Company since the
Company does not currently have a written agreement regarding price or
quantity commitments with these or other distributors and operates with these
and other distributors on a purchase order basis. The Company's distributors
generally offer products of several different companies, including products
that are competitive with the Company's products. There can be no assurance
that future sales by the Company's distributors will continue at current
levels, that the Company will be able to retain its current distributors in
the future on terms which are acceptable to the Company, that the Company's
current distributors will choose to or be able to market the Company's
products effectively, that economic conditions or industry demand will not
adversely affect these or other distributors, or that these distributors will
not devote greater resources to marketing products of other companies.
Accordingly, the loss of, or a significant reduction in revenue from, one of
the Company's distributors, including Merisel, could have a material adverse
effect on the Company's business, operating results and financial condition.
9
<PAGE>
The Company grants to its distributors limited rights to return unsold
inventories of the Company's products in exchange for new purchases and
provides price protection to its distributors. Although the Company provides
allowances for projected returns and price decreases, any product returns or
price decreases in the future that exceed the Company's allowances will
materially and adversely affect the Company's business, operating results and
financial condition. The Company also provides end users with a lifetime
warranty on certain products and permits end users to return any product for
its full purchase price if the product does not perform as warranted. To date,
the Company has not encountered material warranty claims. Nevertheless, if
future warranty claims exceed the Company's reserves, the Company's business,
operating results and financial condition could be materially and adversely
affected. In addition, the Company attempts to further limit its liability to
end users through disclaimers of special, consequential and indirect damages
and similar provisions in its end user warranty. However, no assurance can be
given that such limitations of liability will be legally enforceable. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business--Sales and Marketing," and Note 9 of Notes to
Consolidated Financial Statements.
INTERNATIONAL OPERATIONS
International revenues accounted for 25%, 25%, 29% and 34% of the Company's
total revenues in fiscal 1993, 1994 and 1995 and the six months ended March
31, 1996, respectively. The Company expects that international revenues will
continue to represent a significant portion of its total revenues. Any
significant decline in international demand for the Company's products would
have a material adverse effect on the Company's business, operating results
and financial condition. The Company believes that in order to increase sales
opportunities and profitability it will be required to expand its
international operations. The Company has committed and continues to commit
significant management attention and financial resources to developing
international sales and support channels. There can be no assurance that the
Company will be able to maintain or increase international market demand for
its products. In addition, the Company is dependent upon the international
demand for Apple products. To the extent that the Company is unable to
maintain or increase international demand for its products, or that
international demand for Apple products does not meet the Company's
expectations, the Company's international sales will be limited, and the
Company's business, operating results and financial condition would be
materially and adversely affected.
The Company's international business is subject to inherent risks, including
the impact of possible recessionary environments in economies outside the
United States, costs of localizing products for foreign countries, longer
receivables collection periods and greater difficulty in accounts receivable
collection, unexpected changes in regulatory requirements, difficulties and
costs of staffing and managing foreign operations, reduced protection for
intellectual property rights in some countries, potentially adverse tax
consequences and political and economic instability. There can be no assurance
that the Company will be able to sustain or increase international revenues,
or that the foregoing factors will not have a material adverse effect on the
Company's future international revenues and its business, operating results
and financial condition. The Company's international revenues are currently
denominated in United States dollars, and revenues generated by the Company's
distributors currently are paid to the Company in United States dollars. If,
in the future, international revenues are denominated in local currencies,
foreign currency translations may contribute to significant fluctuations in,
and could have a material adverse effect on, the Company's business, operating
results and financial condition. In addition, the Company has a substantial
portion of its products and components manufactured by foreign suppliers. The
Company's operating results are subject to the risks inherent in international
purchases, including, but not limited to, various regulatory requirements,
political and economic changes and disruptions, transportation delays,
export/import controls, tariff regulations, higher freight rates and
potentially adverse tax consequences. Duty, tariff and freight costs can
materially increase the cost of crucial components for the Company's products.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations," "Business--Customers" and "--Sales and Marketing."
DEPENDENCE ON STRATEGIC ALLIANCES; DEPENDENCE ON CONTRACT MANUFACTURERS AND
LIMITED SOURCE SUPPLIERS
The Company relies on a number of strategic relationships to help achieve
market acceptance of the Company's products and to leverage the Company's
development, sales and marketing resources. Although the
10
<PAGE>
Company views these relationships as important factors in the development and
marketing of the Company's products and services, a majority of the Company's
agreements with its strategic partners or customers do not require future
minimum commitments to purchase the Company's products, are not exclusive and
generally may be terminated at the convenience of either party. There can be
no assurance that the Company's strategic partners regard their relationship
with the Company as strategic to their own respective businesses and
operations, that they will not reassess their commitment to the Company or its
products at any time in the future, or that they will not develop and/or
market their own competitive technology.
The Company does not manufacture any of the components used in its products
and performs only limited assembly on some products. The Company relies on
independent contractors to manufacture to specification the Company's
components, subassemblies, systems and products. The Company also relies upon
limited source suppliers for a number of components used in the Company's
products, including certain key microprocessors and integrated circuits. There
can be no assurance that these independent contractors and suppliers will be
able to timely meet the Company's future requirements for manufactured
products, components and subassemblies. The Company generally purchases
limited source components pursuant to purchase orders and has no guaranteed
supply arrangements with these suppliers. In addition, the availability of
many of these components to the Company is dependent in part on the Company's
ability to provide its suppliers with accurate forecasts of its future
requirements. The Company believes that there are alternative suppliers or
alternative components for all of the components contained in its products.
However, any extended interruption in the supply of any of the key components
currently obtained from a limited source would disrupt its operations and have
a material adverse effect on the Company's business, operating results and
financial condition. In addition, the Company anticipates that it will be
necessary to establish additional strategic relationships in the future, in
particular with additional national Internet service providers ("ISPs"), and
there can be no assurance that the Company will be able to establish such
alliances or that such alliances will result in increased revenues.
See "--International Operations," "Business--Strategic Alliances" and
"--Manufacturing and Suppliers."
DEPENDENCE ON PROPRIETARY RIGHTS AND TECHNOLOGY
The Company's ability to compete is dependent in part on its proprietary
rights and technology. The Company relies primarily on a combination of
patent, copyright and trademark laws, trade secrets, confidentiality
procedures and contractual provisions to protect its proprietary rights. The
Company generally enters into confidentiality or license agreements with its
employees, resellers, distributors, customers and potential customers and
limits access to the distribution of its software, hardware designs,
documentation and other proprietary information. There can be no assurance
that the steps taken by the Company in this regard will be adequate to prevent
misappropriation of its technology. The Company currently has nine issued
United States patents, one pending United States patent application, and one
pending application for patent in each of Canada and Australia and within the
European Patent Office. There can be no assurance that the Company's patents
will not be invalidated, circumvented or challenged, that the rights granted
thereunder will provide competitive advantages to the Company or that any of
the Company's pending or future patent applications, whether or not being
currently challenged by applicable governmental patent examiners, will be
issued with the scope of the claims sought by the Company, if at all.
Furthermore, there can be no assurance that others will not develop
technologies that are similar or superior to the Company's technology or
design around the patents owned by the Company. Despite the Company's efforts
to protect its proprietary rights, unauthorized parties may attempt to copy
aspects of the Company's products or to obtain and use information that the
Company regards as proprietary. Policing unauthorized use of the Company's
products is difficult, and while the Company is unable to determine the extent
to which piracy of its software products exists, software piracy is expected
to be a persistent problem. In selling its software products, the Company
relies primarily on "shrink wrap" licenses that are not signed by licensees
and, therefore, it is possible that such licenses may be unenforceable under
the laws of certain jurisdictions. In addition, the laws of some foreign
countries do not protect the Company's proprietary rights as fully as do the
laws of the United States. There can be no assurance that the Company's means
of protecting its proprietary rights in the United States or abroad will be
adequate or that competing companies will not independently develop similar
technology.
11
<PAGE>
The Company relies upon certain software, firmware and hardware designs that
it licenses from third parties, including firmware that is integrated with the
Company's internally developed firmware and used in the Company's products to
perform key functions. There can be no assurance that these third-party
licenses will continue to be available to the Company on commercially
reasonable terms. The loss of, or inability to maintain, such licenses could
result in shipment delays or reductions until equivalent firmware could be
developed, identified, licensed and integrated which would materially and
adversely affect the Company's business, operating results and financial
condition. See "Business--Proprietary Rights and Technology."
LITIGATION
From time to time, the Company has received claims of infringement of other
parties' proprietary rights. Although the Company believes that all such
claims received to date are immaterial, there can be no assurance that third
parties will not assert infringement claims in the future with respect to the
Company's current or future products. The Company expects that it will
increasingly be subject to infringement claims as the number of products and
competitors in the Company's industry segments grow and the functionality of
products in different industry segments overlaps. Any such claims, with or
without merit, could be time consuming to defend, result in costly litigation,
divert management's attention and resources, cause product shipment delays or
require the Company to enter into royalty or licensing agreements. Such
royalty or licensing agreements, if required, may not be available on terms
acceptable to the Company, if at all. In the event of a successful claim of
product infringement against the Company and failure or inability of the
Company to license the infringed or similar technology, the Company's
business, operating results and financial condition would be materially and
adversely affected.
In the past, Farallon has found it necessary to file suit to protect its
proprietary rights. Such litigation has resulted in, and any litigation in the
future can be expected to result in, substantial costs to Farallon and a
diversion of efforts of Farallon's personnel. In 1993, the Company filed suit
asserting that a competitor infringed its patented technology, and filed an
International Trade Commission action asserting that products imported into
the United States infringed Farallon's patented technology. Although both
actions were resolved favorably for the Company, there can be no assurance
that future litigation actions, if brought, will result in favorable outcomes.
From time to time, the Company may be involved in litigation or
administrative claims arising out of its operations in the normal course of
business. For example, the Company recently terminated negotiations with a
manufacturer of router products regarding a potential acquisition. Shortly
thereafter, the Company received correspondence from such manufacturer's
counsel asserting that the Company's termination of negotiations was improper
and demanding that Farallon either consummate an acquisition for cash and
stock or license from such manufacturer certain technology. The Company
believes that any potential claim by such manufacturer, if brought, would be
entirely without merit and the Company is prepared to vigorously defend any
such claim. See "Business--Proprietary Rights and Technology" and "--Legal
Matters."
LENGTHY SALES CYCLE
The Company's Timbuktu Pro products are often licensed to customers on a
volume license basis for use on private wide area network ("WAN") Intranets
involving thousands of nodes. These licenses often involve significant license
and maintenance fees. As a result, the license of the Company's Timbuktu Pro
products often involves a significant commitment of management attention and
resources by prospective customers. Accordingly, the Company's sales process
for these products is often subject to delays associated with long approval
processes that typically accompany significant capital expenditures. For these
and other reasons, the sales cycle associated with the license of the Timbuktu
Pro products is often lengthy and subject to a number of significant delays
over which the Company has little or no control. There can be no assurance
that the Company will not experience these and additional delays in the future
on Timbuktu Pro or other products. See""--Fluctuations in Quarterly Results;
Future Results of Operations Uncertain."
12
<PAGE>
TARIFF AND REGULATORY MATTERS
The Company is not currently subject to direct regulation by any government
agency, other than regulations applicable to businesses generally. However,
rates for telecommunications services are governed by tariffs of licensed
carriers that are subject to regulatory approval. Future changes in these
tariffs could have a material adverse effect on the Company's business,
operating results and financial condition. For example, if tariffs for public
switched digital services increase in the future relative to tariffs for
private leased services, then the cost-effectiveness of the Company's products
would be reduced, and its business, operating results and financial condition
would be materially and adversely affected. In addition, the Company's
products must meet standards and receive certification for connection to the
public telecommunications network prior to their sale. In the United States,
the Company's products must comply with Part 15(a) (industrial equipment),
Part 15(b) (residential equipment) and Part 68 (analog lines) of the Federal
Communications Commission regulations. The Company's products also must be
certified by domestic telecommunications carriers. In foreign countries, the
Company's products are subject to a wide variety of governmental review and
certification requirements. While certain foreign countries and the European
Economic Community regulate the importation and certification of the Company's
products, most foreign customers typically require that the Company's products
receive certification from their country's primary telecommunication carriers.
Any future inability to obtain on a timely basis or retain domestic
certification or foreign regulatory approvals could have a material adverse
effect on the Company's business, operating results and financial condition.
See "--International Operations."
DEPENDENCE ON KEY PERSONNEL
The Company's business and prospects depend to a significant degree upon the
continuing contributions of its key management, sales, marketing, product
development and administrative personnel. The Company does not have employment
contracts with its key personnel and does not maintain any key person life
insurance policies. The loss of key management or technical personnel could
materially and adversely affect the Company's business, operating results and
financial condition. The Company believes that its prospects depend in large
part upon its ability to attract and retain highly-skilled engineering,
managerial, sales and marketing, and administrative personnel. Competition for
such personnel is intense, and there can be no assurance that the Company will
be successful in attracting and retaining such personnel. Failure to attract
and retain key personnel could have a material adverse effect on the Company's
business, operating results and financial condition. See "Business--Sales and
Marketing," "--Employees" and "Management."
NO PRIOR PUBLIC MARKET; POTENTIAL VOLATILITY OF STOCK PRICE
Prior to this offering, there has been no public market for the Company's
Common Stock, and there can be no assurance that an active trading market will
develop or be sustained after this offering. The initial public offering price
will be determined through negotiations among the Company, the Selling
Stockholders and the representatives of the Underwriters based on several
factors and may not be indicative of the market price of the Common Stock
after this offering. The market price of the shares of Common Stock is likely
to be highly volatile and may be significantly affected by factors such as
actual or anticipated fluctuations in the Company's results of operations,
announcements of technological innovations, introduction of new products by
the Company or its competitors, developments with respect to patents,
copyrights or proprietary rights, conditions and trends in the networking and
other technology industries, changes in or failure by the Company to meet
securities analysts' expectations, general market conditions and other
factors. In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the common stocks of technology companies. These broad
market fluctuations may adversely affect the market price of the Company's
Common Stock. In the past, following periods of volatility in the market price
of a particular company's securities, securities class action litigation has
often been brought against that company. There can be no assurance that such
litigation will not occur in the future with respect to the Company. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect upon the
Company's business, operating results and financial condition. See
"Underwriting."
13
<PAGE>
CONTROL BY DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS
Upon completion of this offering, the present directors, executive officers
and principal stockholders, and their affiliates and related persons, will
beneficially own approximately 56% of the outstanding shares of the Company's
Common Stock. As a result, these stockholders will continue to be able to
elect all of the Company's directors, will retain the voting power to approve
all matters requiring stockholder approval and will continue to have
significant influence over the affairs of the Company. Such concentration of
ownership may have the effect of delaying, deferring or preventing a change in
control of the Company. See "Management" and "Principal and Selling
Stockholders."
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
Sales of a substantial number of shares of Common Stock in the public market
following this offering could adversely affect the market price for the
Company's Common Stock. The number of shares of Common Stock available for
sale in the public market is limited by restrictions under the Securities Act
of 1933, as amended (the "Securities Act"), and lock-up agreements under which
the holders of such shares have agreed not to sell or otherwise dispose of any
of their shares for a period of 180 days after the date of this Prospectus
without the prior written consent of Cowen & Company. However, Cowen &
Company, may, in its sole discretion and at any time without notice, release
all or any portion of the securities subject to lock-up agreements. As a
result of these restrictions, based on shares outstanding and options granted
as of March 31, 1996, the following shares of Common Stock will be eligible
for future sale. On the date of this Prospectus, 67,685 shares in addition to
the 2,000,000 shares offered hereby will be eligible for sale. A total of
51,250 additional shares will be eligible for sale 90 days after the date of
this Prospectus, 8,208,150 additional shares will be eligible for sale 180
days after the date of this Prospectus and 480,000 additional shares will be
eligible for sale 360 days after the date of this Prospectus. In addition, the
Company intends to register on the effective date of this offering a total of
2,262,030 shares of Common Stock subject to outstanding options or reserved
for issuance under the Company's 1996 Stock Option Plan and 300,000 shares of
Common Stock reserved for issuance under its Employee Stock Purchase Plan.
Further, upon expiration of the lock-up agreements referred to above, holders
of approximately 7,302,022 shares of Common Stock will be entitled to certain
registration rights with respect to such shares. If such holders, by
exercising their registration rights, cause a large number of shares to be
registered and sold in the public market, such sales could have a material
adverse effect on the market price for the Company's Common Stock. See
"Description of Capital Stock--Registration Rights" and "Shares Eligible for
Future Sale."
EFFECT OF CERTAIN CHARTER PROVISIONS; ANTITAKEOVER EFFECTS OF CERTIFICATE OF
INCORPORATION AND DELAWARE LAW
Upon completion of this offering, the Company's Board of Directors will have
the authority to issue up to 5,000,000 shares of Preferred Stock and to
determine the price, rights, preferences, privileges and restrictions,
including voting rights of such shares, without any further vote or action by
the Company's stockholders. The rights of the holders of Common Stock will be
subject to, and may be adversely affected by, the rights of the holders of any
Preferred Stock that may be issued in the future. The issuance of Preferred
Stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could have the effect of making it
more difficult for a third party to acquire a majority of the outstanding
voting stock of the Company. The Company has no current plans to issue shares
of Preferred Stock. Further, certain provisions of the Company's Certificate
of Incorporation and of Delaware law could delay or make more difficult a
merger, tender offer or proxy contest involving the Company. See "Description
of Capital Stock--Preferred Stock" and "--Antitakeover Effects of Provisions
of the Certificate of Incorporation and Delaware Law."
IMMEDIATE AND SUBSTANTIAL DILUTION
Investors participating in this offering will incur immediate and
substantial dilution. To the extent outstanding options to purchase the
Company's Common Stock are exercised, there will be further dilution. If the
net proceeds of this offering, together with available funds and cash
generated from operations, are insufficient to satisfy the Company's cash
needs, the Company may be required to sell additional equity or convertible
debt securities. The sale of additional equity or convertible debt securities
could result in additional dilution to the Company's stockholders. See
"Dilution" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
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<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,500,000 shares of
Common Stock offered by the Company hereby at an assumed initial public
offering price of $14.00 per share are estimated to be $18,730,000
($22,636,000 if the Underwriters' over-allotment option is exercised in full),
after deducting the estimated underwriting discount and offering expenses
payable by the Company. The Company will not receive any proceeds from the
sale of Common Stock by the Selling Stockholders. The primary purposes of this
offering are to create a public market for the Common Stock, to facilitate
future access to public markets and to obtain additional working capital. The
Company plans to use the net proceeds to the Company from this offering
primarily for working capital and general corporate purposes. A portion of the
net proceeds may also be used for the acquisition of businesses, products and
technologies that are complementary to those of the Company. The Company has
no current plans, agreements or commitments, and is not currently engaged in
any negotiations with respect to any such transaction. Pending such uses, the
Company plans to invest the net proceeds of this offering in short-term,
investment-grade, interest-bearing securities.
DIVIDEND POLICY
Since the termination of its S Corporation status for federal and state
income tax purposes in December 1990, the Company has not declared or paid any
cash dividends on its capital stock, and does not expect to pay cash dividends
on its Common Stock in the foreseeable future. The Company's bank line of
credit currently restricts the payment of cash dividends on its capital stock
without the prior written consent of the lender.
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<PAGE>
CAPITALIZATION
The following table sets forth (i) the actual capitalization of the Company
at March 31, 1996 and (ii) the capitalization of the Company as adjusted to
reflect the conversion into Common Stock of all outstanding shares of
Preferred Stock, and the sale by the Company of 1,500,000 shares of Common
Stock offered hereby (assuming an initial public offering price of $14.00 per
share, after deducting the estimated underwriting discount and offering
expenses):
<TABLE>
<CAPTION>
MARCH 31, 1996
--------------------
ACTUAL AS ADJUSTED
------- -----------
(IN THOUSANDS)
<S> <C> <C>
Long-term liabilities, net of current portion............. $ 131 $ 131
Redeemable Common Stock................................... 133 --
Stockholders' equity:
Preferred Stock, $0.001 par value, 7,500,000 shares au-
thorized, 5,591,207 shares issued and outstanding on an
actual basis; 5,000,000 shares authorized, none out-
standing as adjusted .................................. 6 --
Common Stock, $0.001 par value, 15,000,000 shares
authorized, 3,705,164 shares outstanding on an actual
basis; 25,000,000 shares authorized, 10,807,085 shares
outstanding as adjusted (1)............................ 4 11
Additional paid-in capital (2).......................... 24,215 43,077
Deferred compensation................................... (84) (84)
Retained earnings....................................... 3,154 3,154
------- -------
Total stockholders' equity.............................. 27,295 46,158
------- -------
Total capitalization.................................. $27,559 $46,289
======= =======
</TABLE>
- --------------
(1) Common Stock issued and outstanding does not include 1,372,050 shares
issuable at a weighted average exercise price of $1.46 per share upon
exercise of stock options outstanding as of March 31, 1996 under the
Company's 1987 Restated Stock Option Plan (the "1987 Plan"). In April
1996, the Company adopted the 1996 Stock Option Plan (the "1996 Plan") to
succeed the 1987 Plan. The Company has reserved 2,166,995 shares for
issuance under the 1996 Plan. This share reserve is comprised of (i) the
294,945 shares which were available for issuance under the 1987 Plan as of
March 31, 1996, and 1,372,050 shares subject to outstanding options
thereunder, plus (ii) an additional increase of 500,000 shares. In
addition, in April 1996, the Company adopted the Employee Stock Purchase
Plan and reserved 300,000 shares of Common Stock for issuance thereunder.
See "Management--1996 Stock Option Plan" and "--Employee Stock Purchase
Plan" and Notes 6 and 10 of Notes to Consolidated Financial Statements.
(2) Additional paid-in capital as adjusted includes the reclassification of
the redeemable Common Stock balance to account for the expiration of the
related demand purchase right at an assumed initial public offering price
of $14.00 per share.
16
<PAGE>
DILUTION
The pro forma net tangible book value of the Company as of March 31, 1996
was approximately $27.4 million, or $2.95 per share of Common Stock. Without
taking into account any changes in pro forma net tangible book value after
March 31, 1996, other than to give effect to the sale by the Company of
1,500,000 shares offered hereby (at an assumed initial public offering price
of $14.00 per share, after deducting the estimated underwriting discount and
offering expenses), the Company's pro forma net tangible book value as of
March 31, 1996 would have been approximately $46.2 million, or $4.27 per
share. This represents an immediate dilution in pro forma net tangible book
value of $9.73 per share to investors purchasing shares in this offering and
an immediate increase in pro forma net tangible book value of $1.32 per share
to existing stockholders. The following table illustrates the per share
dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................... $14.00
Pro forma net tangible book value before offering (1)........... $2.95
Increase in pro forma net tangible book value attributable to
new investors.................................................. 1.32
-----
Pro forma net tangible book value after the offering.............. 4.27
------
Dilution to new investors (2)..................................... $ 9.73
======
</TABLE>
The following table sets forth on a pro forma basis as of March 31, 1996,
the number of shares of Common Stock purchased from the Company, the total
consideration paid and the average price per share paid by the existing
stockholders and by new investors purchasing shares sold by the Company in
this offering (assuming the sale of 1,500,000 shares by the Company at an
assumed initial public offering price of $14.00 per share):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------ -------------------
AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders (3). 9,307,085 86.1% $19,352,900 48.0% $ 2.08
New investors (3)(4)...... 1,500,000 13.9 21,000,000 52.0 14.00
---------- ----- ----------- -----
Total................... 10,807,085 100.0% $40,352,900 100.0%
========== ===== =========== =====
</TABLE>
The foregoing computations are based on the number of shares outstanding as
of March 31, 1996 and exclude 1,372,050 shares of Common Stock issuable upon
exercise of outstanding options as of March 31, 1996 with a weighted average
exercise price of $1.46 per share under the Company's 1987 Restated Stock
Option Plan. To the extent options are exercised, there will be further
dilution to new investors. See "Management--1996 Stock Option Plan" and Note 6
of Notes to Consolidated Financial Statements. The foregoing table also
assumes no exercise of the Underwriters' over-allotment option.
- --------------
(1) Pro Forma net tangible book value is determined by dividing the number of
shares of Common Stock outstanding at March 31, 1996, on a pro forma
basis, into the tangible net worth of the Company, assuming expiration of
the demand purchase right on the 10,714 shares of redeemable Common Stock.
(2) Dilution is determined by subtracting pro forma net tangible book value
per share after the offering from the amount of cash paid by a new
investor for a share of Common Stock.
(3) Sales by Selling Stockholders in this offering will reduce the number of
shares held by existing stockholders to 8,807,085, or approximately 81.5%
(approximately 79.3% if the Underwriters' over-allotment option is
exercised in full), and will increase the number of shares to be purchased
by new investors to 2,000,000, or approximately 18.5% (2,300,000 shares or
approximately 20.7% if the Underwriters' over-allotment option is
exercised in full) of the total number of shares of Common Stock
outstanding after this offering.
(4) Before deducting the estimated underwriting discount and offering
expenses.
17
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following selected consolidated financial information should be read in
conjunction with the Company's consolidated financial statements and related
notes thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere in this Prospectus. The
consolidated statement of operations data for the fiscal years ended September
30, 1991 and 1992 and the consolidated balance sheet data at September 30,
1991, 1992 and 1993 are derived from audited consolidated financial statements
of the Company that are not included in this Prospectus. The consolidated
statement of operations data for the fiscal years ended September 30, 1993,
1994 and 1995 and the consolidated balance sheet data at September 30, 1994
and 1995 are derived from the audited consolidated financial statements of the
Company that are included elsewhere in this Prospectus. The consolidated
statement of operations data for the six months ended March 31, 1995 and 1996
and the consolidated balance sheet data at March 31, 1996 are derived from
unaudited consolidated financial statements of the Company included elsewhere
in this Prospectus. The unaudited consolidated financial statements have been
prepared by the Company on a basis consistent with the Company's audited
consolidated financial statements and, in the opinion of management, include
all adjustments (consisting only of normal recurring accruals) necessary for a
fair presentation of the Company's operating results and financial position
for the periods to which such statements relate. The operating results for the
periods presented are not necessarily indicative of the results to be expected
for any other interim period or any other future fiscal year.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED SEPTEMBER 30, MARCH 31,
------------------------------------------ -----------------
1991 1992 1993 1994 1995 1995 1996
------- ------- ------- ------- ------- ------- ---------
CONSOLIDATED STATEMENT OF (IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATIONS DATA:
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Internet/Intranet prod-
ucts................... $ -- $ -- $ -- $ 5,310 $ 6,569 $ 3,188 $ 6,442
LAN products............ 43,904 48,038 48,425 51,691 50,620 26,359 23,003
------- ------- ------- ------- ------- ------- -------
Total revenues........ 43,904 48,038 48,425 57,001 57,189 29,547 29,445
Cost of revenues:
Internet/Intranet prod-
ucts................... -- -- -- 447 674 315 1,238
LAN products 19,057 22,954 24,302 30,368 28,842 14,722 13,942
------- ------- ------- ------- ------- ------- -------
Total cost of reve-
nues................. 19,057 22,954 24,302 30,815 29,516 15,037 15,180
------- ------- ------- ------- ------- ------- -------
Gross profit............. 24,847 25,084 24,123 26,186 27,673 14,510 14,265
Operating expenses:
Research and develop-
ment................... 8,091 7,973 7,434 6,671 8,429 4,022 4,315
Selling and marketing... 12,566 13,614 14,087 13,983 13,691 6,765 7,582
General and administra-
tive................... 4,916 3,572 3,216 3,228 2,888 1,488 1,841
Restructuring costs (1). 1,071 500 1,048 -- -- -- --
------- ------- ------- ------- ------- ------- -------
Total operating ex-
penses............... 26,644 25,659 25,785 23,882 25,008 12,275 13,738
------- ------- ------- ------- ------- ------- -------
Operating income (loss).. (1,797) (575) (1,662) 2,304 2,665 2,235 527
Other income (expense),
net..................... (286) 76 249 291 815 324 433
------- ------- ------- ------- ------- ------- -------
Income (loss) before in-
come taxes.............. (2,083) (499) (1,413) 2,595 3,480 2,559 960
Income tax expense (bene-
fit) (2)(3)............. 25 1 1 408 974 716 (1,915)
------- ------- ------- ------- ------- ------- -------
Net income (loss) (4).... $(1,893) $ (500) $(1,414) $ 2,187 $ 2,506 $ 1,843 $ 2,875
======= ======= ======= ======= ======= ======= =======
Net income per share.. $ 0.25 $ 0.19 $ 0.27
======= ======= =======
Shares used in per share
computations (5) ........ 9,891 9,841 10,477
======= ======= =======
<CAPTION>
SEPTEMBER 30,
------------------------------------------ MARCH 31,
1991 1992 1993 1994 1995 1996
------- ------- ------- ------- ------- ---------
CONSOLIDATED BALANCE SHEET
DATA: (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Working capital........... $ 1,085 $17,505 $16,866 $19,569 $21,755 $23,976
Total assets.............. 15,037 26,913 29,075 29,289 33,872 36,234
Long-term liabilities, net
of current portion....... 561 108 1,262 689 218 131
Total stockholders' equi-
ty....................... 4,191 20,395 19,176 21,644 24,279 27,295
</TABLE>
18
<PAGE>
- ------------------
(1) In September 1991, the Company adopted a plan to close a facility and
reduce the number of employees through a restructuring. In fiscal 1992,
the Company adopted a plan to close a European facility. As a result, as
of September 30, 1991 and 1992, the Company accrued severance pay and
office closure costs, including future lease payments for abandoned and
excess office space. In fiscal 1993, the Company further reduced its
number of employees and identified certain impaired assets as part of a
restructuring.
(2) The Company terminated its S Corporation status for federal and state
income tax purposes in December 1990.
(3) As of March 31, 1996, the Company reversed a full valuation allowance that
it had previously provided against its deferred tax assets, resulting in a
non-recurring income tax benefit of approximately $2.3 million.
(4) Net loss for fiscal 1991 includes a benefit of $215,000 for the cumulative
effect of a change in accounting principle.
(5) See Note 1 of Notes to Consolidated Financial Statements.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in such forward-looking statements. Factors that may cause
such a difference include, but are not limited to, those discussed in "Risk
Factors."
OVERVIEW
Farallon develops, markets and supports complete, easy-to-use, plug-and-play
Internet connectivity and networking solutions and real-time collaboration
software to increase the productivity and efficiency of Internet, Intranet and
LAN users. The Company was founded in 1985 and initially focused on the
development of networking products for AppleTalk LANs, including the PhoneNET
network system. To date, the Company has derived a substantial majority of its
revenues from its LAN products, including its EtherWave and Ethernet products.
In 1993, the Company revised its business strategy to concentrate on the
Internet and Intranet markets through the utilization of its TCP/IP and
routing expertise. In the first quarter of fiscal 1994, the Company released
its first Timbuktu Pro Internet/Intranet collaboration software product
(TCP/IP enabled), and in the first quarter of fiscal 1996, the Company
introduced its Netopia family of Internet connectivity products and services.
Although the Company has experienced significant percentage growth in
Internet/Intranet product revenues over the last three quarters, the Company
does not believe prior growth rates are sustainable or indicative of future
Internet/Intranet operating results. There can be no assurance that the
Company will remain profitable on a quarterly or annual basis. The Company's
limited Internet/Intranet operating history makes the prediction of future
Internet/Intranet operating results difficult, if not impossible.
The Company's total revenues are derived from the sale of Internet/Intranet
and LAN connectivity products. Internet/Intranet product revenues include
license revenues for its Timbuktu Pro software, sales of the Netopia family of
products and fees for related services. LAN products revenue is derived
primarily from the sale of EtherWave, Fast Ethernet, Ethernet and LocalTalk
compatible products which include the PhoneNET system network connectivity
products as well as remote access and LAN software. Revenue relating to the
sale and licensing of hardware and software products is recognized upon
shipment of the products by the Company and service revenues are recognized
ratably over the term of the contract. Certain of the Company's sales are made
to customers under agreements permitting limited rights of return for stock
balancing. Revenue is recorded net of an estimated allowance for returns. Any
product returns or price decreases in the future that exceed the Company's
allowances will adversely affect the Company's business, operating results and
financial condition.
As the Company continues to focus on the development of its
Internet/Intranet business, and as a result of variable average selling prices
of the Company's LAN products, declining sales of MacOS computers and
competitive factors, the Company expects that LAN products revenue may decline
and may account for a decreasing percentage of total revenues in future
periods to the extent that Internet/Intranet product revenues increase. As a
result, the Company's future operating results are dependent upon continued
market acceptance of its Internet/Intranet products and enhancements thereto.
However, the Company is dependent upon sales of its LAN products for the
foreseeable future, and to the extent that any decline in revenues from LAN
products is not offset by increases in revenue from other sources, such as
sales of the Company's Internet/Intranet products, then the Company's
business, operating results and financial condition will be materially and
adversely affected. See "Risk Factors--Dependence on Internet/Intranet
Products" and "--Dependence on LAN Products; Declining LAN Business."
The Company's gross margin has varied significantly in the past and will
likely vary significantly in the future depending primarily on the mix of
products sold by the Company. The Company's Timbuktu Pro collaboration
software products have a higher average gross margin than the balance of the
Company's products. Accordingly, to the extent the product mix for any
particular quarter includes a substantial proportion of lower margin products,
there will be a material adverse effect on the Company's business, operating
results and financial condition.
Farallon sells its Internet/Intranet and LAN products and related
maintenance, support and other services primarily through distributors, while
certain products are also sold directly through select ISPs or directly by the
20
<PAGE>
Company to corporate accounts and higher education institutions. Revenues from
distributors accounted for 81%, 76%, 73% and 66% of the Company's total
revenues for fiscal 1993, 1994 and 1995 and for the six months ended March 31,
1996, respectively. The Company's three largest distributors accounted for
46%, 45%, 43% and 37% of the Company's total revenues for fiscal 1993, 1994
and 1995 and for the six months ended March 31, 1996, respectively. The
Company intends to continue to use its existing value-added resellers ("VARs")
to sell the Company's Internet/Intranet products, and to recruit additional
VARs and pursue other marketing channels in the future. There can be no
assurance that the Company's current distributors will choose to or be able to
market the Company's products effectively, that economic conditions or
industry demand will not adversely affect these or other distributors, or that
these distributors will not devote greater resources to marketing products of
other companies. The loss of, or a significant reduction in revenue from, one
of the Company's distributors could have a material adverse effect on the
Company's business, operating results and financial condition. See "Risk
Factors--Dependence on Distributors."
International revenues accounted for 25%, 25%, 29% and 34% of the Company's
total revenues for fiscal 1993, 1994 and 1995 and for the six months ended
March 31, 1996, respectively, and are derived primarily from Europe and Japan.
The Company's international revenues are currently denominated in United
States dollars, and revenues generated by the Company's distributors currently
are paid to the Company in United States dollars. The results of the Company's
international operations may fluctuate from period to period based on global
economic factors including, but not limited to, movements in currency exchange
rates. Historically, movements in exchange rates have not materially affected
the Company's total revenues. However, there can be no assurance that
movements in currency exchange rates will not have a material adverse effect
on the Company's revenues in the future. See "--Quarterly Results of
Operations," "Risk Factors--Fluctuations in Quarterly Results; Future Results
of Operations Uncertain" and "--Dependence on Internet/Intranet Products."
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of operations
data of the Company expressed as a percentage of total revenues for the
periods indicated:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED SEPTEMBER 30, MARCH 31,
----------------------------- ------------------
1993 1994 1995 1995 1996
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Revenues:
Internet/Intranet
products.................... --% 9.3% 11.5% 10.8% 21.9%
LAN products.............. 100.0 90.7 88.5 89.2 78.1
-------- -------- -------- -------- --------
Total revenues.......... 100.0 100.0 100.0 100.0 100.0
Cost of revenues:
Internet/Intranet
products.................... -- 0.8 1.2 1.1 4.2
LAN products.............. 50.2 53.3 50.4 49.8 47.4
-------- -------- -------- -------- --------
Total cost of revenues.. 50.2 54.1 51.6 50.9 51.6
-------- -------- -------- -------- --------
Gross profit................ 49.8 45.9 48.4 49.1 48.4
Operating expenses:
Research and development.. 15.3 11.7 14.7 13.6 14.6
Selling and marketing..... 29.1 24.5 23.9 22.9 25.7
General and
administrative.............. 6.6 5.7 5.1 5.0 6.3
Restructuring costs....... 2.2 -- -- -- --
-------- -------- -------- -------- --------
Total operating
expenses.................... 53.2 41.9 43.7 41.5 46.6
-------- -------- -------- -------- --------
Operating income (loss)..... (3.4) 4.0 4.7 7.6 1.8
Other income (expenses),
net......................... 0.5 0.5 1.4 1.1 1.5
-------- -------- -------- -------- --------
Income (loss) before income
taxes....................... (2.9) 4.5 6.1 8.7 3.3
Income tax expense
(benefit)................... 0.0 0.7 1.7 2.4 (6.5)
-------- -------- -------- -------- --------
Net income (loss)........... (2.9)% 3.8% 4.4% 6.3% 9.8%
======== ======== ======== ======== ========
</TABLE>
21
<PAGE>
SIX MONTHS ENDED MARCH 31, 1995 AND 1996
Revenues. The Company's total revenues decreased 0.3% from $29.5 million to
$29.4 million for the six months ended March 31, 1995 and 1996, respectively.
Internet/Intranet products revenue increased 102.1% from $3.2 million to $6.4
million for the six months ended March 31, 1995 and 1996, respectively,
primarily due to the introduction of the Netopia Router as well as increased
volume licensing of the Company's Timbuktu Pro collaboration software. LAN
products revenue decreased 12.7% from $26.4 million to $23.0 million for the
six months ended March 31, 1995 and 1996, respectively, primarily as a result
of declining sales of the Company's MacOS LocalTalk products.
Internet/Intranet products revenue accounted for 10.8% and 21.9% of the
Company's total revenues for the six months ended March 31, 1995 and 1996,
respectively, while LAN products revenue accounted for 89.2% and 78.1% of the
Company's total revenues for the six months ended March 31, 1995 and 1996,
respectively. The Company anticipates that LAN products revenue will continue
to decline in dollar amount and will account for a decreasing percentage of
total revenues in future periods. See "Risk Factors--Dependence on LAN
Products; Declining LAN Business."
Revenues from distributors accounted for 76% and 66% of the Company's total
revenues for the six months ended March 31, 1995 and 1996, respectively.
International revenues accounted for 30% and 34% of total revenues for the six
months ended March 31, 1995 and 1996, respectively. The decrease in the
percentage of revenues from distributors is primarily due to the decreasing
percentage of sales of the Company's LAN products, which are sold primarily
through the distribution channel, while the increase in the percentage of
international revenues is primarily due to increased sales in the Pacific Rim.
Revenues from Ingram accounted for 25% and 20% of the Company's total revenues
for the six months ended March 31, 1995 and 1996, respectively, and revenues
from MicroWarehouse accounted for 12% and 11% of the Company's total revenues
for the six months ended March 31, 1995 and 1996, respectively. No other
customers have accounted for 10% or more of the Company's total revenues
during the six months ended March 31, 1995 and 1996. See "Risk Factors--
Dependence on Distributors."
Gross Margin. The Company's gross margin for Internet/Intranet and LAN
products is affected by many factors, including pricing strategies, royalties
paid to third parties, new versions of existing products and product mix. The
Company's total gross margin decreased from 49.1% to 48.4% for the six months
ended March 31, 1995 and 1996, respectively. The Company's gross margin for
Internet/Intranet products decreased from 90.1% to 80.8% for the six months
ended March 31, 1995 and 1996, respectively, primarily due to the introduction
of the Netopia Router which has a lower gross margin than the Company's
Internet/Intranet software products. The Company's gross margin for LAN
products decreased from 44.1% to 39.4% for the six months ended March 31, 1995
and 1996, respectively, primarily due to declining sales of the Company's
higher margin LocalTalk products, increased sales of lower margin Ethernet
products at lower average selling prices and introduction of lower margin Fast
Ethernet products. The Company expects gross margin for Internet/Intranet
products to decrease in future periods in the event of any increased sales of
hardware products that carry lower gross margins than software products. In
addition, the Company expects gross margin for LAN products to decrease in
future periods primarily due to declining average selling prices.
Research and Development. Research and development expenses primarily
consist of salaries and other personnel-related expenses, development-related
equipment and license expenses, occupancy costs and depreciation. Research and
development expenses increased from $4.0 million to $4.3 million for the six
months ended March 31, 1995 and 1996, respectively, primarily due to salary
and other personnel costs related to efforts to enhance existing products and
the development of new Internet/Intranet products. Such expenses represented
13.6% and 14.6% of total revenues for the six months ended March 31, 1995 and
1996, respectively. The Company believes that it will continue to devote
substantial resources to product development and that research and development
expenses will increase in absolute dollars for the remainder of fiscal 1996
and into fiscal 1997. The Company believes its process for developing software
is essentially completed concurrent with the establishment of technological
feasibility, and no software costs have been capitalized to date.
Selling and Marketing. Selling and marketing expenses primarily consist of
personnel costs including sales commissions, as well as costs of advertising,
public relations, promotional activities, professional services and travel
expenses. Selling and marketing expenses increased from $6.8 million to $7.6
million for the six months
22
<PAGE>
ended March 31, 1995 and 1996, respectively, primarily due to increased
headcount and associated expenses as well as increased advertising and
promotional spending related to the introduction of the new Internet/Intranet
connectivity products and Internet applets. Such expenses represented 22.9%
and 25.7% of total revenues for the six months ended March 31, 1995 and 1996,
respectively. The Company believes that selling and marketing expenses will
increase in absolute dollars for the remainder of fiscal 1996 and into fiscal
1997 primarily due to personnel-related expenses and increased advertising and
promotional activities.
General and Administrative. General and administrative expenses primarily
consist of personnel costs and associated expenses necessary to manage and
support the Company's operations. General and administrative expenses
increased from $1.5 million to $1.8 million for the six months ended March 31,
1995 and 1996, respectively, primarily due to consulting fees related to the
acquisition of the Netopia trademark. Such expenses represented 5.0% and 6.3%
of total revenues for the six months ended March 31, 1995 and 1996,
respectively. The Company believes that general and administrative expenses
will increase in absolute dollars for the remainder of fiscal 1996 and into
fiscal 1997 as the Company expands its administrative staff, adds
infrastructure and incurs additional costs related to being a public company,
such as expenses related to directors' and officers' insurance, investor
relations programs and increased professional fees.
Other Income, Net. Other income, net, represents interest earned by the
Company on its cash, cash equivalents and short-term investments offset by
interest expense on debt. See Note 5 of Notes to Consolidated Financial
Statements.
Provision for Income Taxes. The effective tax rates for the six months ended
March 31, 1995 and 1996 were 28% and 35%, respectively, prior to the effect of
the elimination of the valuation allowance against deferred tax assets, as
discussed below. These rates differ from the statutory rate primarily due to
state income taxes and the utilization of research and tax credit
carryforwards.
As of March 31, 1996, the Company reversed a full valuation allowance that
it had previously provided against its deferred tax assets, resulting in a
non-recurring income tax benefit of approximately $2.3 million. Prior to March
31, 1996, the Company believed that, based upon available objective evidence,
there was sufficient uncertainty regarding the realizability of its deferred
tax assets to warrant a full valuation allowance. The factors considered
included prior losses, inconsistent profits, lack of carryback potential to
realize deferred tax assets, dependence on LAN products and associated
declining market and gross margins for LAN products, dependence upon Apple,
and uncertain market acceptance of its Internet/Intranet products. As of March
31, 1996, the Company believes that due to the demonstrated market acceptance
of the new Internet/Intranet products over the last two quarters, the
uncertainty regarding the realizability of its deferred tax assets has
diminished to the point where it is now more likely than not that the deferred
tax assets will be realized.
As of September 30, 1995, the Company had research credit carryforwards of
$515,000 and $215,000 for federal and California purposes, respectively. If
not utilized, the credits expire in years 2006 through 2010. In addition, the
Company had federal alternative minimum tax credit carryforwards of $90,000.
YEARS ENDED SEPTEMBER 30, 1993, 1994 AND 1995
Revenues. The Company's total revenues increased 17.7% from $48.4 million in
fiscal 1993 to $57.0 million in fiscal 1994, and increased slightly to $57.2
million for fiscal 1995. The Company had no Internet/Intranet products revenue
in fiscal 1993. Internet/Intranet products revenue increased 23.7% from $5.3
million to $6.6 million in fiscal 1994 and 1995, respectively, due to the
introduction of the Windows version of Timbuktu Pro as well as increased
volume licensing of Timbuktu Pro for the Macintosh. LAN products revenue
accounted for the Company's total revenue in fiscal 1993. LAN products revenue
increased 6.7% from $48.4 million for fiscal 1993 to $51.7 million for fiscal
1994, and decreased 2.1% to $50.6 million for fiscal 1995. The increase in
fiscal 1994 was primarily due to the introduction of the Company's EtherWave
products and was offset in part due to declines in sales and average selling
prices of LocalTalk products. The decrease in fiscal 1995 was primarily due to
reduced sales and average selling prices of LocalTalk products, offset in part
by increased Ethernet and EtherWave revenues. Internet/Intranet products
revenue accounted for 9.3% and 11.5% of the Company's total revenues for
fiscal 1994 and 1995, respectively, while LAN products revenue accounted for
90.7% and 88.5% of the Company's total revenues for fiscal 1994 and 1995,
respectively.
Revenues from distributors accounted for 81%, 76% and 73% of the Company's
total revenues for fiscal 1993, 1994 and 1995, respectively. International
revenues accounted for 25%, 25% and 29% of total revenues for fiscal 1993,
1994 and 1995, respectively. The decrease in the percentage of revenues from
distributors was
23
<PAGE>
primarily due to declining sales of the Company's LAN products which are sold
primarily through the distribution channel, while the increase in the
percentage of international revenues was primarily due to increased sales in
the Pacific Rim. Revenues from Ingram accounted for 24%, 24% and 22% of the
Company's total revenues for fiscal 1993, 1994 and 1995, respectively and
revenues from MicroWarehouse accounted for 12%, 12% and 13% of the Company's
total revenues for fiscal 1993, 1994 and 1995, respectively. Merisel accounted
for 10% of the Company's total revenues in fiscal 1993. No other customers
have accounted for 10% or more of the Company's total revenues during fiscal
1993, 1994 and 1995. See "Risk Factors--Dependence on Distributors."
Gross Margin. The Company's total gross margin decreased from 49.8% for
fiscal 1993 to 45.9% for fiscal 1994, and increased to 48.4% for fiscal 1995.
The Company's Internet/Intranet products were first sold in fiscal 1994.
Internet/Intranet products gross margin decreased from 91.6% for fiscal 1994
to 89.7% for fiscal 1995, primarily due to declining selling prices of
Internet/Intranet software products for the MacOS and increasing sales of the
Company's Windows Internet/Intranet software products, which carry a slightly
lower gross margin than the MacOS product due to higher royalties applicable
to the Windows product. The Company's gross margin for LAN products decreased
from 49.8% for fiscal 1993 to 41.3% for fiscal 1994, and increased to 43.0%
for fiscal 1995. The decrease in LAN products gross margin in fiscal 1994 was
primarily due to declining volume and average selling prices of LocalTalk
products, increasing volume and declining average selling prices of 10Base-T
Ethernet products and introductions of new EtherWave products, which carried a
lower gross margin than the existing base of LAN products. The increase in LAN
products gross margin for fiscal 1995 is primarily due to increased sales
volume and material cost reductions through product re-designs within the
EtherWave product line, partially offset by declining sales volumes and
average selling prices of LocalTalk products.
Research and Development. Research and development expenses decreased from
$7.4 million for fiscal 1993 to $6.7 million for fiscal 1994, and increased to
$8.4 million for fiscal 1995. The decrease in fiscal 1994 was primarily due to
reduced headcount and reduced use of contractors, while the fiscal 1995
increase was primarily due to significant increases in the use of contractors
and product development expenses associated with development of the Company's
Internet/Intranet products. Such expenses represented 15.3%, 11.7% and 14.7%
of the Company's total revenues for fiscal 1993, 1994 and 1995, respectively.
Selling and Marketing. Selling and marketing expenses decreased from $14.1
million for fiscal 1993 to $14.0 million for fiscal 1994, and decreased to
$13.7 million for fiscal 1995. The decrease in 1994 was due to reduced
headcount and reduced production of marketing materials offset in part by the
increased utilization of professional marketing services and the use of
independent manufacturing representatives in addition to the Company's sales
force. The decrease in fiscal 1995 was primarily due to the reduction of
manufacturing sales representatives throughout North America, which was offset
in part by expanded advertising and promotional campaigns associated with the
introduction of new and enhanced products during the year. Such expenses
represented 29.1%, 24.5% and 23.9% of the Company's total revenues for fiscal
1993, 1994 and 1995, respectively.
General and Administrative. General and administrative expenses were $3.2
million for fiscal 1993 and 1994, and decreased to $2.9 million for fiscal
1995. The decrease in fiscal 1995 was primarily due to a significant decline
in legal expenses that were incurred in relation to a suit the Company filed
against a former licensee of certain of the Company's U.S. patents in July
1993 as well as an International Trade Commission lawsuit filed by the Company
in 1994 to ban the importation of network connectors that violate certain of
the Company's patent claims. These claims were resolved in favor of the
Company. Such expenses represented 6.6%, 5.7% and 5.1% of the Company's total
revenues for fiscal 1993, 1994 and 1995, respectively. See "Risk Factors--
Litigation."
Restructuring Costs. In fiscal 1993, the Company recorded a nonrecurring
charge of $1.0 million as part of an organizational restructuring that reduced
headcount and recognized certain impaired assets.
Provision for Income Taxes. The effective tax rates for fiscal 1993, 1994
and 1995 were 0%, 16% and 28%, respectively. These rates differ from the
statutory rate primarily due to research tax credits and changes in the
valuation allowance against deferred tax assets. During these fiscal years,
the Company believed that, based upon available objective evidence, there was
sufficient uncertainty regarding the realizability of the deferred tax assets
24
<PAGE>
to warrant a full valuation allowance. The factors considered included prior
losses, inconsistent profits, lack of carryback capacity to realize deferred
tax assets, dependence on LAN products, declining market and gross margin for
LAN products, dependence upon Apple, and uncertain market acceptance of the
new Internet/Intranet products.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited consolidated statement of
operations data for each of the eight quarters in the period ended March 31,
1996, and such data expressed as a percentage of the Company's total revenues
for the periods indicated. This data has been derived from unaudited
consolidated financial statements that, in the opinion of management, include
all adjustments (consisting only of normal recurring adjustments) necessary
for a fair presentation of such information and have been prepared on the same
basis as the audited consolidated financial statements. Such statement of
operations data should be read in conjunction with the Company's audited
consolidated financial statements and notes thereto. The results of operations
for any quarter are not necessarily indicative of the results to be expected
for any future period. Although the Company has experienced significant recent
growth in the sale of Internet/Intranet products, there can be no assurance
that such growth will continue. See "Risk Factors--Fluctuations in Quarterly
Results; Future Results of Operations Uncertain."
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------------------------
JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1994 1994 1994 1995 1995 1995 1995 1996
-------- --------- -------- -------- -------- --------- -------- --------
CONSOLIDATED STATEMENT OF (IN THOUSANDS)
OPERATIONS DATA:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Internet/Intranet
products................ $ 1,667 $ 1,712 $ 1,584 $ 1,604 $ 1,541 $ 1,840 $ 2,809 $ 3,633
LAN products.......... 12,673 13,959 12,911 13,448 10,858 13,403 11,302 11,701
------- ------- ------- ------- ------- ------- ------- -------
Total revenues...... 14,340 15,671 14,495 15,052 12,399 15,243 14,111 15,334
Cost of revenues:
Internet/Intranet prod-
ucts.................. 133 153 148 166 159 199 458 780
LAN products........... 8,073 8,264 7,579 7,144 6,228 7,893 6,827 7,115
------- ------- ------- ------- ------- ------- ------- -------
Total cost of reve-
nues................ 8,206 8,417 7,727 7,310 6,387 8,092 7,285 7,895
------- ------- ------- ------- ------- ------- ------- -------
Gross profit............ 6,134 7,254 6,768 7,742 6,012 7,151 6,826 7,439
Operating expenses:
Research and
development............. 1,620 1,651 1,824 2,198 2,142 2,265 2,016 2,299
Selling and marketing
..................... 3,253 3,503 3,407 3,358 3,400 3,526 3,787 3,795
General and
administrative.......... 768 786 737 751 685 715 789 1,052
------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses................ 5,641 5,940 5,968 6,307 6,227 6,506 6,592 7,146
------- ------- ------- ------- ------- ------- ------- -------
Operating income (loss). 493 1,314 800 1,435 (215) 645 234 293
Other income, net....... 64 63 115 209 246 245 227 206
------- ------- ------- ------- ------- ------- ------- -------
Income before income
taxes................... 557 1,377 915 1,644 31 890 461 499
Income tax provision.... 88 216 256 460 8 250 162 (2,077)
------- ------- ------- ------- ------- ------- ------- -------
Net income............ $ 469 $ 1,161 $ 659 $ 1,184 $ 23 $ 640 $ 299 $ 2,576
======= ======= ======= ======= ======= ======= ======= =======
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
Internet/Intranet
products................ 11.6% 10.9% 10.9% 10.7% 12.4% 12.1% 19.9% 23.7%
LAN products.......... 88.4 89.1 89.1 89.3 87.6 87.9 80.1 76.3
------- ------- ------- ------- ------- ------- ------- -------
Total revenues...... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenues:
Internet/Intranet prod-
ucts.................. 0.9 1.0 1.0 1.1 1.3 1.3 3.2 5.1
LAN products........... 56.3 52.7 52.3 47.5 50.2 51.8 48.4 46.4
------- ------- ------- ------- ------- ------- ------- -------
Total cost of reve-
nues................ 57.2 53.7 53.3 48.6 51.5 53.1 51.6 51.5
------- ------- ------- ------- ------- ------- ------- -------
Gross profit............ 42.8 46.3 46.7 51.4 48.5 46.9 48.4 48.5
Operating expenses:
Research and
development............. 11.3 10.5 12.6 14.6 17.3 14.9 14.3 15.0
Selling and marketing. 22.7 22.4 23.5 22.3 27.4 23.1 26.8 24.7
General and
administrative.......... 5.4 5.0 5.1 5.0 5.5 4.7 5.6 6.9
------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses................ 39.4 37.9 41.2 41.9 50.2 42.7 46.7 46.6
------- ------- ------- ------- ------- ------- ------- -------
Operating income (loss). 3.4 8.4 5.5 9.5 (1.7) 4.2 1.7 1.9
Other income, net....... 0.5 0.4 0.8 1.4 2.0 1.6 1.6 1.3
------- ------- ------- ------- ------- ------- ------- -------
Income before income
taxes................... 3.9 8.8 6.3 10.9 0.3 5.8 3.3 3.2
Income tax provision.... 0.6 1.4 1.8 3.0 0.1 1.6 1.2 (13.6)
------- ------- ------- ------- ------- ------- ------- -------
Net income............ 3.3% 7.4% 4.5% 7.9% 0.2% 4.2% 2.1% 16.8%
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
25
<PAGE>
Internet/Intranet products gross margin has decreased since the quarter
ended June 30, 1994. The decrease in Internet/Intranet products gross margin
over this period is primarily due to increased sales of Windows based software
products that have lower gross margins than MacOS based software products, and
the increase in sales of hardware products that have lower gross margins than
the Company's software products. The Company believes that Internet/Intranet
products gross margin will decline in future periods because of, among other
things, increasing sales of Internet/Intranet hardware products. LAN products
gross margin has decreased since the quarter ended March 31, 1995, primarily
due to declining sales volume of Local Talk products, introduction of lower
margin Fast Ethernet products and pricing pressures in general. The Company
believes that LAN products gross margin will decline in future periods because
of, among other things, product mix and pricing pressures.
The Company's quarterly operating results have varied significantly in the
past and are likely to vary significantly in the future, depending on factors
such as changes in networking and communications technologies, price and
product competition, usage of the Internet and developments and changes in the
Internet market, the demand for the Company's products, changes in pricing
policies by the Company or its competitors, including the grant of price
protection terms and discounts by the Company, changes in the mix of products
sold by the Company and the resulting change in total gross margin, changes in
the mix of channels through which the Company's products are offered, product
enhancements and new product announcements by the Company and its competitors,
market acceptance of new products of the Company or its competitors, raw
material costs, write-offs of obsolete inventory, the size and timing of
distributor and end user orders and purchasing cycles, customer order
deferrals in anticipation of enhancements to the Company's or competitors'
products, customer order deferrals in anticipation of new MacOS product
offerings by Apple, manufacturing delays, disruptions in sources of supply,
product life cycles, product quality problems, personnel changes, changes in
the Company's strategy, changes in the level of operating expenses, the timing
of research and development expenditures, the level of the Company's
international revenues, fluctuations in foreign currency exchange rates,
general economic conditions, both in the United States and abroad, and
economic conditions specific to the industries in which the Company competes,
among others. The Company's limited Internet/Intranet operating history makes
the prediction of future Internet/Intranet operating results difficult, if not
impossible. Sales orders are typically shipped shortly after receipt and,
consequently, order backlog at the beginning of any quarter has in the past
represented only a small portion of that quarter's revenues. Accordingly, the
Company's net revenues in any quarter are substantially dependent on orders
booked and shipped during that quarter. Historically, the Company has often
recognized a significant portion of its revenues in the last weeks, or even
days, of a quarter. As a result, the magnitude of quarterly fluctuations may
not become evident until late in, or after the close of, a particular quarter.
In addition, the Company recognizes revenue on products sold through
distributors upon shipment to the distributor. Although the Company maintains
reserves for projected returns and price decreases, there can be no assurance
that such reserves will be adequate. The Company's business also has
experienced seasonality in the past, largely due to customer buying patterns
such as budgeting cycles of educational institutions that purchase the
Company's products. There can be no assurance that the Company's operating
results will not be affected by seasonality in the future or that such
seasonality will occur in a manner consistent with prior periods.
The Company's expense levels are based in large part on expectations as to
future revenues and as a result are relatively fixed in the short term. If
revenues are below expectations in any given quarter, net income is likely to
be disproportionately affected. Due to all of the foregoing factors, revenues
and net income for any future period are not predictable with any significant
degree of certainty. Accordingly, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. There can be
no assurance that the Company's business strategies will be successful or that
the Company will be able to sustain profitability on a quarterly or annual
basis in the future. It is likely that in some future quarter the Company's
operating results will be below the expectations of public market analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially and adversely affected. See "Risk Factors--Fluctuations in
Quarterly Results; Future Results of Operations Uncertain," "--Dependence on
Distributors" and "Selected Consolidated Financial Information."
26
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash flow
from operations and the private sale of equity securities. Since inception,
the Company has raised $19.4 million from the private sale of equity
securities. As of March 31, 1996, the Company had working capital of $24.0
million and a $5.0 million credit facility, secured by the assets of the
Company, which expires on February 28, 1997. There were no borrowings under
the credit facility as of March 31, 1996.
The Company generated cash from operating activities of $300,000, $3.6
million and $5.0 million in fiscal 1993, 1994 and 1995, respectively, and used
$1.9 million in the six months ended March 31, 1996. The improvements in cash
flow from operations in fiscal 1994 and 1995 are largely due to growth in the
Company's operating income. The decline in cash generated from operations in
the six months ended March 31, 1996 was primarily due to increases in
operating expenses related to the introduction of Netopia products. In
addition, inventory increases in this period were primarily related to new
Netopia and Fast Ethernet products. The Company's investing activities in
fiscal 1993, 1994 and 1995 and for the six months ended March 31, 1996, have
consisted primarily of purchases of short-term investments, and capital
equipment. Expenditures for capital equipment totaled $2.0 million, $600,000
and $1.3 million for fiscal 1993, 1994 and 1995, respectively, and $1.2
million in the six months ended March 31, 1996, representing acquisitions of
tooling and test fixtures for new products as well as computer equipment used
predominantly in product development. The Company expects that its capital
expenditures will increase in future periods to support new product
development and production. The Company's financing activities in fiscal 1993,
1994 and 1995 and the six months ended March 31, 1996, represent activity on
loans and the Company's line of credit. The Company's principal commitments
consist primarily of leases on its headquarters facilities and operating
equipment. See Note 7 of Notes to Consolidated Financial Statements.
The Company believes that the net proceeds from the offering and its
existing cash, cash equivalents and short-term investments will be adequate to
meet its cash needs for working capital and capital expenditures for at least
the next 12 months. Thereafter, if cash generated from operations is
insufficient to satisfy the Company's liquidity requirements, the Company may
seek to sell additional equity or convertible debt securities or obtain
additional credit facilities. The sale of additional equity or convertible
debt securities could result in additional dilution to the Company's
stockholders. A portion of the Company's cash may be used to acquire or invest
in complementary businesses or products or to obtain the right to use
complementary technologies. From time to time, in the ordinary course of
business, the Company evaluates potential acquisitions of such businesses,
products or technologies. The Company has no current plans, agreements or
commitments, and is not currently engaged in any negotiations with respect to
any such transaction.
27
<PAGE>
BUSINESS
Farallon develops, markets and supports complete, easy-to-use, plug-and-play
Internet connectivity and networking solutions and real-time collaboration
software. The Company's products are designed to increase the productivity and
efficiency of Internet, Intranet and LAN users and to target small businesses,
geographically dispersed facilities of large enterprises, home offices, mobile
users, schools and other small organizations that may not have access to
sophisticated technical support. The Company's Internet/Intranet products
include its Netopia routers and modems, which provide high-speed Internet
connectivity for individuals and workgroups, and its Timbuktu Pro
collaboration software, which enables real-time, peer-to-peer collaboration on
the Internet, Intranets and LANs. To assist users in configuring the Netopia
products and in arranging service from Internet and telecommunications service
providers, the Company offers its Up & Running, Guaranteed! program, which
serves as a single source for complete Internet connectivity. The Company's
LAN networking solutions, a substantial majority of which have been sold to
MacOS customers, include its EtherWave family of products, which enable users
to easily and cost-effectively create Ethernet networks with or without a hub.
INDUSTRY BACKGROUND
Small businesses, geographically dispersed facilities of large enterprises,
home offices, mobile users, schools and other small organizations are
increasingly using networks of computers to enhance productivity, access
information and communicate more effectively. A number of factors have
contributed to this increase in the use of networks, including increasing
personal mobility, the need for information access, a demand for immediate
information and advances in technology and infrastructure such as the
proliferation of communication-enabled PCs, the availability of intuitive
graphical software and the widespread implementation of distributed local and
wide area networks based on client/server architectures and, more recently,
peer-to-peer architectures. These factors also have changed substantially the
way in which organizations and individuals communicate and use PCs, generating
growing demand for products that enhance network communications.
As networking technology has advanced, the scale, scope and functionality of
network communications and computing have increased, resulting in a
corresponding increase in the complexity of these systems. Headquarters
offices of large enterprises that have access to sophisticated technical
support have generally managed this complexity and realized the benefits of
effective network communications. However, individuals and smaller
organizations typically do not have access to the skills or resources required
to manage the complexity of advanced networking systems. As a result, these
users are increasingly seeking networking solutions that are complete, easy-
to-use and cost-effective.
The emergence of the Internet as a viable communications medium has
substantially enhanced the value and potential of network communications and
computing. The Internet is a global, open network of thousands of
interconnected computer networks and millions of computer connections that
allow businesses, individuals and other organizations to communicate
worldwide. International Data Corporation ("IDC") has estimated that the
number of Internet users will be approximately 200 million by the end of 1999,
an increase from approximately 56 million at the end of 1995. In addition,
large enterprises are increasingly adopting private "Intranets" that employ
Internet data formats and communications protocols, such as Transmission
Control Protocol/Internet Protocol ("TCP/IP"), to connect geographically
dispersed networks and facilities. Intranets enable network users to
communicate and access information within an organization, communicate with
external users, such as suppliers, customers and consultants, and use the
World Wide Web (the "Web") to access information available on the Internet.
The emergence of the Internet and Intranets as well as the increased
affordability and availability of advanced hardware, software and
communications services (such as high-speed Integrated Services Digital
Network ("ISDN") telecommunications services) has made network communications
available to a broader range of users.
As organizations and individuals expand the use of the Internet and
Intranets, the need for real-time collaboration and communication becomes
increasingly important to achieving increased user productivity and
efficiency. Real-time, peer-to-peer collaboration software enables users, such
as those at geographically dispersed facilities of large enterprises, remote
sites, traveling or working at home, to access information and enterprise
applications, and permits two or more users at disparate locations to view and
work with the same information at
28
<PAGE>
the same time. Productivity improvements are also derived from peer-to-peer
collaboration software that enables users to receive real-time technical
support and just-in-time training from a help desk or another knowledgeable
user on the Internet or Intranet.
The increasing utility of the Internet and Intranets and the availability of
high-performance infrastructures that enable advanced capabilities, such as
real-time collaboration, are compelling small businesses, geographically
dispersed facilities of large enterprises, home offices, mobile users, schools
and other small organizations to adopt complex network communications and
computing systems. However, these organizations typically do not have access
to sophisticated technical support and therefore may not be well-served by
complex networking systems requiring extensive technical knowledge or
expertise. Today, the tasks of installing and configuring systems, obtaining
high-speed digital services such as ISDN and arranging for an Internet
connection from an ISP can be costly and burdensome for such users. In
addition, traditional vendors, resellers and systems integrators of networking
products historically have not offered products or services specifically
designed for users who may not have access to sophisticated technical support.
Accordingly, the absence of complete, easy-to-use, plug-and-play solutions for
affordable Internet/Intranet connectivity and real-time collaboration has
constrained the ability of these users to fully achieve the benefits of
network communications and computing.
THE FARALLON SOLUTION
Farallon develops, markets and supports complete, easy-to-use, plug-and-play
Internet connectivity and networking solutions and real-time collaboration
software. The Company's products are designed to increase the productivity and
efficiency of Internet, Intranet and LAN users and to target small businesses,
geographically dispersed facilities of large enterprises, home offices, mobile
users, schools and other small organizations that may not have access to
sophisticated technical support. The Company's Internet/Intranet products
include its Netopia routers and modems and its Timbuktu Pro collaboration
software. The Company's LAN products include a broad range of Ethernet network
connectivity devices.
The Company's Netopia product family provides plug-and-play, high-speed
ISDN-based Internet connectivity for workgroups and individuals. The Company
offers comprehensive customer service and technical support, including the Up
& Running, Guaranteed! program, which serves as a single source for complete
Internet connectivity by assisting the user in configuring the Netopia router
and in arranging service from ISPs and telecommunications service providers.
The Timbuktu Pro collaboration software family enables real-time, peer-to-peer
collaboration on the Internet, Intranets and LANs--viewing other users'
screens, revising information, transferring files, controlling other computers
and remotely accessing network resources. The Company's LAN products allow
users to easily and cost-effectively build 10Base-T Ethernet, 100Base-T
Ethernet and LocalTalk networks. In particular, the Company's patented
EtherWave family of products enables users to create plug-and-play 10Base-T
Ethernet networks with or without a hub.
THE FARALLON STRATEGY
The Company's objective is to become the leading provider of complete, high-
speed Internet connectivity solutions and real-time, peer-to-peer
Internet/Intranet collaboration software for small businesses, geographically
dispersed facilities of large enterprises, home offices, mobile users, schools
and other small organizations that may not have access to sophisticated
technical support. Key elements of the Company's strategy include the
following:
Provide Complete, Plug-and-Play Internet/Intranet Connectivity Solutions.
The Company focuses on providing complete, high-speed Internet connectivity
solutions emphasizing ease of use and plug-and-play functionality consistent
with Farallon's tradition of providing products that are simple to install,
use and support. The Netopia products are bundled with Internet software and
are supported with the Company's Up & Running, Guaranteed! program, providing
users a single source for complete Internet connectivity. The Company intends
to develop future generations of its Netopia products that incorporate higher
bandwidth options and increased throughput, while retaining ease of use and
plug-and-play features.
Leverage Collaboration Software Expertise. Utilizing expertise developed in
pioneering collaboration software for the workgroup, remote user and help desk
administrator, the Company intends to continue to offer products that increase
user productivity and efficiency by enabling real-time, peer-to-peer
collaboration over the Internet, Intranets and LANs. The Timbuktu Pro
collaboration software expands the functionality of the Internet
29
<PAGE>
beyond e-mail and Web browsing by enabling users in any location to remotely
access an enterprise network and to engage in real-time collaboration with
other Timbuktu Pro users--viewing other users' screens, revising information,
transferring files, controlling other computers and remotely accessing network
resources. The Company intends to expand the number of real-time collaboration
tools it offers as well as broadly distribute its free Timbuktu Pro Look@Me
and FlashNote Internet applets.
Target Rapidly Growing Markets for Networking and Collaboration Solutions.
The Company targets those segments of the networking market that industry
sources have identified as the most rapidly growing such as small businesses,
geographically dispersed facilities of large enterprises, home offices, mobile
users, schools and other small organizations. These users generally do not
have access to sophisticated technical support and are not well-served by
traditional vendors of networking products, which typically offer products
that are not specifically designed for these markets. The Company intends to
leverage its expertise in developing easy-to-use, plug-and-play LAN networking
solutions to more rapidly penetrate the market for the Company's Internet/
Intranet products.
Expand Strategic Alliances. The Company has formed a variety of strategic
relationships that assist the Company in developing, distributing and
marketing its products. For example, to assist its customers in gaining
Internet access and to increase sales of Netopia products, Farallon has formed
strategic relationships with PSINet, a national ISP, and over 50 regional
ISPs. The Company has also established strategic alliances with Cisco, Shiva
and NetManage for the distribution of Farallon products. The Company has also
formed a variety of strategic relationships with 3Com and Apple. The Company
intends to expand its current strategic relationships and to form additional
strategic relationships to augment its current product development,
distribution and marketing strategies.
Capitalize On Electronic Marketing Expertise. Farallon believes it is a
leader among networking companies in the effective use of on-line electronic
marketing and distribution. The Company's on-line electronic marketing
initiatives, which Farallon believes represent a cost-effective form of
promotion and sale of its products, currently include the development and
maintenance of a Web server containing in excess of 1,000 pages, hyperlinked
with over 1,000 Web sites, a monthly electronic bulletin for customers and
partners, and electronic software distribution to customers and beta sites.
Customers are currently able to purchase certain Farallon products on-line and
the Company intends to expand its use of on-line electronic advertising and
commerce. The Company currently offers two secure methods for on-line commerce
transactions, including Netscape's Secure (SSL) Commerce Server and
CyberCash's Secure Internet Payment Service. The Company intends to expand its
use of on-line electronic marketing and distribution consistent with evolving
industry standards.
Leverage Brand Recognition, Distribution Channels and Customer Support
Infrastructure. Since its inception, Farallon has been a leading provider of
networking solutions for the MacOS market and intends to maintain this market-
leading position. The Company intends to leverage its reputation and expertise
in providing complete, easy-to-use, plug-and-play networking solutions to more
fully penetrate the market for Internet and Windows users. The Company
believes that its relationships with approximately 70 distributors in 58
countries are a valuable asset and that these distributors will significantly
enhance the marketing and sale of its Internet/Intranet products. In addition,
the Company believes that it is recognized in the industry as providing
outstanding customer service and support. The Company intends to leverage its
positive name recognition, long-standing distribution relationships and its
customer support organization to promote its Internet/Intranet products.
PRODUCTS
Farallon offers complete, easy-to-use, plug-and-play Internet connectivity
and networking solutions and real-time collaboration software designed for
small businesses, geographically dispersed facilities of large enterprises,
home offices, mobile users, schools and small organizations that may not have
access to sophisticated technical support. The Company's Internet/Intranet
product family includes its Netopia routers and modems, which provide high-
speed ISDN-based Internet connectivity for workgroups and individuals, as well
as its Timbuktu Pro collaboration software, which enables real-time, peer-to-
peer collaboration on the Internet, Intranets and LANs. The Company's LAN
product family includes Ethernet network connectivity devices as well as other
products, which allow users to easily and cost-effectively build 10Base-T
Ethernet, 100Base-T Ethernet and LocalTalk networks. The tables that follow
summarize the significant features, platforms and estimated U.S. street prices
of the Company's primary products:
30
<PAGE>
INTERNET/INTRANET PRODUCTS
- --------------------------------------------------------------------------------
PLATFORMS
PRODUCTS FEATURES (ESTIMATED
U.S. STREET
PRICE)
- --------------------------------------------------------------------------------
CONNECTIVITY PRODUCTS
- --------------------------------------------------------------------------------
NETOPIA HIGH-SPEED INTERNET CONNECTIVITY FOR MULTIPLE USERS Windows
INTERNET . Performance improvement for all LAN users (up to 3.X
ROUTERS 512Kbps with Multilink PPP and 4:1 Stacker LZS Windows
compression) 95
. Cost savings with shared ISDN Windows
. Multiple LAN connections and protocols for mixed NT MacOS
environments ($1,079-
$1,399)
. Internet Software Starter Kit and bundled cables
for immediate productivity
. Remote configuration and management over TELNET
or SNMP; remote support via analog modem with
built-in PC card (PCMCIA) slot
. Easy administration and cost savings with
automated TCP/IP addressing using built-in
Dynamic Host Configuration Protocol (DHCP)
server
. Maximum control and efficiency with scheduled
connection profiles
- --------------------------------------------------------------------------------
NETOPIA HIGH-SPEED INTERNET CONNECTIVITY FOR INDIVIDUAL Windows
ISDN USERS 3.X
MODEMS . Cost savings and quick file transfer, Web Windows
browsing and telecommuting to corporate 95
resources with ISDN bandwidth on demand (up to Windows
128Kbps with Multilink PPP) NT MacOS
. Integration of multiple functions over a single
ISDN line (ISDN data with analog phone, fax or ($399-
modem) $419)
. Immediate productivity with bundled Internet
Software Starter Kit and cables
- --------------------------------------------------------------------------------
NETOPIA COMPREHENSIVE CUSTOMER SERVICE AND TECHNICAL Windows
UP & SUPPORT PROGRAM 3.X
RUNNING, . Remote configuration and support with included Windows
UARANTEED!G analog 19.2Kbps PC card modem (for router) 95
. Assistance in ordering services with Windows
telecommunications provider and ISP NT MacOS
. One year toll-free technical support ($499--
. Two-node license of Timbuktu Pro software for Router
support $99--
Modem)
- --------------------------------------------------------------------------------
COLLABORATION PRODUCTS
- --------------------------------------------------------------------------------
TIMBUKTU REAL-TIME, PEER-TO-PEER COLLABORATION AND Windows
PRO COMMUNICATIONS SOFTWARE FOR INTERNET, INTRANETS AND 3.X
LANS Windows
. Ease of use and immediate productivity via 95 MacOS
single button installation ($42-
. Collaboration across mixed platforms via observe $139)
and control functions with patented screen
sharing
. Immediate delivery of files with attached
messages through peer-to-peer, drag-and-drop
file send and exchange functions, bypassing mail
servers and gateways
. Collaboration with help desk and knowledgeable
colleagues for troubleshooting, problem
resolution, software upgrades, and just-in-time
training
. Maximum security with comprehensive password
system and options including temporary guest
privileges, password aging and activity logging
. Available in shrink wrap packages of single,
twin, 10, 30 and 100 node packs
. Available in discounted volume/site licenses for
Intranet applications
- --------------------------------------------------------------------------------
LOOK@ME INTERNET APPLET TO INTRODUCE USERS TO TIMBUKTU PRO Windows
FUNCTIONALITY 3.X
. Enables users to remotely view another user's Windows
screen in real time on the Internet 95 MacOS
. For use either as a Netscape browser inline (Free--
"plug-in" or stand-alone mini application with distributed
OLE support over the
. Electronic upgrade to full version of Timbuktu Internet)
Pro for $49
- --------------------------------------------------------------------------------
FLASHNOTE INTERNET APPLET TO INTRODUCE USERS TO TIMBUKTU PRO Windows
FUNCTIONALITY 3.X
. Enables users to instantly and reliably transfer Windows
files and messages across the Internet 95
. Stand-alone mini application with OLE support (Free--
. Electronic upgrade to full version of Timbuktu distributed
Pro for $49 over the
Internet)
31
<PAGE>
LAN PRODUCTS
- -------------------------------------------------------------------------------
PLATFORMS
(ESTIMATED
PRODUCTS FEATURES U.S. STREET
PRICE)
- -------------------------------------------------------------------------------
ETHERWAVE FAMILY OF DAISY-CHAINABLE 10BASE-T ETHERNET CLIENT Windows
(10BASE- ACCESS PRODUCTS 3.X
T) . Includes full line of cards, transceivers and Windows
adapters 95
. Patented design allows customers to build small Windows
networks without a hub NT DOS,
. Allows flexible, plug-and-play expansion of MacOS
existing hub-based networks ($89-
. "Power-off-pass-through" keeps network operating $349) (1)
while nodes are down
- -------------------------------------------------------------------------------
FAST FAMILY OF FAST ETHERNET CARDS, HUBS AND BRIDGES Windows
ETHERNET . Smooth migration from 10Base-T Ethernet with 3.X
(100BASE- 10/100 autosensing port in cards; plug-and-play Windows
T) installation and configuration 95
. Network monitoring and management with Windows
diagnostic LEDs in the 8-port Class II repeater NT DOS
hub MacOS
. Optional Bridge add-in module offers connection ($199-
between 10Base-T and 100Base-T Ethernet $2,199)
networks; includes dual EtherWave ports for plug
and play network expansion
- -------------------------------------------------------------------------------
ETHERNET FAMILY OF 10BASE-T AND 10BASE-2 (THINNET) ETHERNET MacOS
CARDS, ADAPTERS, TRANSCEIVERS AND HUBS ($35-
$999) (1)
- -------------------------------------------------------------------------------
PHONENET FAMILY OF PATENTED TRANSCEIVERS AND HUBS FOR MacOS
LOCALTALK)( BUILDING MACINTOSH LOCALTALK NETWORKS USING ($11-$32)
STANDARD TELEPHONE WIRE (2)
($995-
$1,595)
(3)
(1) Price per node. Certain of the products are available in single or 10
packs.
(2) Price per node for LocalTalk connectors. Available in single, 10 or 50
packs.
(3) Price of the Company's LocalTalk hubs.
Internet/Intranet Products
NETOPIA FAMILY. The Netopia family of products enables cost-effective, plug-
and-play, high-speed Internet connectivity for individual users and workgroups
who may not have access to sophisticated technical support. These products
include the Netopia Internet Router, the Netopia ISDN Modem and the Up &
Running, Guaranteed! service program.
The Netopia Internet Router enables Internet connectivity for multiple users
through a single ISDN connection at substantially faster speed than
traditional analog-based Internet connections. The Netopia Internet Router
includes an ISDN basic rate interface ("BRI") port with built-in NT-1
interface, Point-to-Point Protocol ("PPP"), Multilink PPP and 4:1 compression.
In addition, the Company's Netopia Internet Router includes Farallon's
patented EtherWave technology that enables connectivity to a 10Base-T Ethernet
network in a "daisy-chain" fashion with or without the use of an Ethernet hub.
The Netopia Internet Router includes the "Internet Starter Kit," a software
bundle including Netscape Navigator, Microsoft Windows 95 Internet Jump Start
Kit (including SMTP gateway), Qualcomm Eudora Lite e-mail client, and Network
TeleSystems TCP/IP protocol stack, and, for MacOS users, AppleTalk services
over the Internet.
The Netopia ISDN Modem provides individual users reliable, high-speed ISDN
Internet connectivity and telecommuting. The Netopia ISDN Modem includes
Internet connectivity software and a built-in POTS (Plain Old Telephone
Service) interface that enables the integration of digital data transfer with
traditional analog telephone, fax or modem use over a single ISDN line.
The Company offers users of Netopia products the Up & Running, Guaranteed!
service program. This optional service program assists these users in
obtaining ISP and telecommunications service, provides remote technical
support for the Netopia product line and provides configuration of the Netopia
Internet Router. Toll-free technical support is included with this service
program for one year.
32
<PAGE>
TIMBUKTU PRO FAMILY. The Timbuktu Pro family of collaboration software
products enables real-time, peer-to-peer collaboration over the Internet,
Intranets and LANs. These products include Timbuktu Pro for Windows and MacOS,
and Internet applets Look@Me and FlashNote.
Timbuktu Pro software enables users to collaborate with other Timbuktu Pro
users in real-time over the Internet, Intranets and LANS--viewing other users'
screens, revising information, transferring files, controlling other computers
and remotely accessing network resources. Timbuktu Pro products are also used
by help desk and information systems personnel to remotely solve technical
problems, update software and train users on new applications and operating
systems. The Company believes that the peer-to-peer collaboration features in
its Timbuktu Pro products bring additional functionality to the Internet,
which has historically been used predominantly for e-mail and Web browsing.
The Company's Internet applets, Look@Me and FlashNote, provide enhanced
productivity on the Internet through peer-to-peer collaboration. These applets
are freely downloadable over the Internet to introduce users to the
functionality of Timbuktu Pro collaboration software. Look@Me enables users to
remotely observe another Look@Me or Timbuktu Pro user's screen in real-time
over the Internet. FlashNote enables users to instantly send files and "pop-
up" messages to other FlashNote users over the Internet. The Look@Me applet
may be used within the Netscape Navigator browser as an inline "plug-in" or as
a stand-alone application. Look@Me and FlashNote users may upgrade
electronically over the Internet to a fully functional version of Timbuktu
Pro.
LAN Products
ETHERWAVE FAMILY. The EtherWave family of products enables users, who may
lack network implementation expertise, to easily connect multiple computers
and printers to each other in a daisy-chain fashion, or to connect multiple
devices per port on standard 10Base-T hubs. These products, which are
compatible with the 10Base-T Ethernet standard, include transceivers, adapters
and internal cards. Farallon's patented EtherWave technology enables the
creation of small 10Base-T Ethernet LANs of up to eight nodes without the use
of network hubs, as is required with traditional 10Base-T Ethernet, by simply
plugging together EtherWave products. EtherWave can also be used to easily and
flexibly connect up to seven computers and printers per port to existing hub
ports on a traditional 10Base-T Ethernet LAN.
ETHERNET FAMILY. The Ethernet family of products enables users in workgroup
environments to quickly transfer large data files over a LAN. These products
include a comprehensive line of 100Base-T Fast Ethernet and 10Base-T Ethernet
products, primarily for MacOS computers. Fast Ethernet products include the
Fast EtherTX-10/100 Cards, the Fast Starlet 100TX/8 Hub, and the Fast Starlet
10/100 Bridge. The Company's dual speed Fast EtherTX-10/100 Cards include a
speed autosensing port, providing a flexible network speed migration path from
10Base-T Ethernet, thus protecting existing network investments. The Fast
Starlet 100TX/8 Hub with the add-on 10/100 Bridge includes built-in EtherWave
connectivity ports for easy and cost-effective connection to existing 10Mbps
LANs.
The Company's range of 10Base-T Ethernet products provides solutions to
customers whose networks transfer higher volumes of data than can effectively
be transferred by the LocalTalk-speed hardware built into MacOS computers. The
Company's 10Base-T Ethernet family includes transceivers and adapters to
connect computers and printers to 10Base-T and 10Base-2 (Thinnet) Ethernet,
add-in cards to connect computers to Ethernet, adapters to connect MacOS
computers and printers without available slots to Ethernet, as well as a
family of 10Base-T hubs.
LOCALTALK FAMILY. The LocalTalk family of products enables MacOS users who
lack network implementation expertise to easily connect several computers or
printers. These products include patented PhoneNET connectors which feature an
easy-to-use, plug-and-play approach to creating MacOS LocalTalk networks using
standard telephone wiring. PhoneNET networks can be created without hubs by
daisy-chaining nodes. Farallon's LocalTalk family also includes hubs, routers,
printer adapters and concentrators designed to expand existing LocalTalk LANs,
as well as remote access and LAN software.
33
<PAGE>
STRATEGIC ALLIANCES
The Company has entered into strategic alliances to facilitate the
development, distribution, marketing and support of its products. These
alliances enhance the Company's ability to adapt effectively to technological
change and leverage shared distribution resources, thereby providing increased
utility to end users.
Product and Technology Alliances
3COM. Since 1993, Farallon and 3Com have entered into a series of
agreements under which 3Com has provided Farallon with 3Com's Ethernet
controller technology and certain Ethernet adapter products. Farallon combines
these products and technologies with its own software and firmware
technologies for delivery to certain LAN customers. This strategic
relationship has allowed Farallon to bring 3Com's highly regarded "Parallel
Tasking" technology to Farallon's LAN customers. More recently, 3Com and
Farallon entered into an agreement for the supply of 3Com ISDN modems to
Farallon, which are combined with Farallon-developed MacOS-based installation
and driver software for delivery to Farallon's MacOS customers, and with 3Com-
developed PC-based installation and driver software for delivery to Farallon's
PC customers.
APPLE. Farallon has, from time to time, entered into joint development and
OEM agreements with Apple, such as those providing for the co-development with
Apple of Farallon's AirDock infrared network adapter and the license by
Farallon of Apple's ARA remote access client software for incorporation into
Farallon's MacOS-based Timbuktu Pro products. Farallon believes that these
agreements enhance its efforts to deliver new MacOS products, and additional
features and functionality, to its existing MacOS customers. Additionally,
Farallon has participated in conferences that preview Apple strategies and
initiatives, thereby assisting the Company in formulating market strategies.
Distribution Alliances
CISCO. Farallon and Cisco recently entered into a distribution alliance
under which Farallon's Timbuktu Pro collaboration software (Windows 3.X and
Windows 95 versions) is bundled with Cisco's CiscoRemote software package,
which is distributed by Cisco to users of its remote access server products.
The agreement provides for the payment of certain royalties to Farallon for
the right to distribute the Timbuktu Pro collaboration software with
CiscoRemote, and provides Farallon access to registered users of CiscoRemote.
SHIVA. In November 1994, Farallon and Shiva entered into an agreement to
license ShivaPPP software to Farallon for integration into Farallon's Timbuktu
Pro collaboration software (Windows 3.X version). ShivaPPP is used by
Farallon's Timbuktu Pro customers to establish a remote access connection to
Intranets based upon PPP standards. In addition, in January 1996, Shiva began
distributing evaluation versions of Farallon's Timbuktu Pro collaboration
software (Windows 3.X and Windows 95 versions) with Shiva's LanRover remote
access servers.
NETMANAGE. In April 1996, NetManage selected Farallon's Look@Me applet to
enhance the collaboration module of its Chameleon Internet software products.
Chameleon users will have the opportunity to upgrade electronically from
Look@Me to the full version of Timbuktu Pro.
INTERNET SERVICE PROVIDERS (ISPS). In September 1995, Farallon and PSINet,
a national ISP, entered into a strategic joint marketing relationship under
which users of certain Netopia products are offered various economic
incentives, including discounts on PSINet Internet service registration and
Internet access. Farallon offers training and other incentives to PSINet's
entire sales staff to promote Netopia products. Farallon and PSINet are
jointly developing a set of reseller programs to expand PSINet's Internet
access service with Farallon products.
In addition, Farallon has established the Netopia Internet Service Partner
Program ("NISPP"), under which ISPs may purchase Netopia Internet connectivity
products directly from Farallon for sale or lease to their customers. Farallon
has contracted with over 50 regional ISPs under the NISPP program. Under the
NISPP, ISPs are offered market development funds, router preconfiguration
services, a dedicated technical support telephone number, use of Farallon's
customer database for joint mailings, and use of Timbuktu Pro collaboration
software to provide their customers with immediate help desk support.
In general, each of these alliances may be terminated by either party at any
time with limited notice. There can be no assurance that existing alliances
will remain in effect or that additional relationships will be successfully
established. See "Risk Factors--Dependence on Strategic Alliances; Dependence
on Contract Manufacturers and Limited Source Suppliers."
34
<PAGE>
CUSTOMERS
End users of Farallon products include individuals and a broad range of
organizations, including small businesses, geographically dispersed facilities
of large enterprises, home offices, mobile users, schools and other small
organizations. The Company believes the following is a representative list of
the Company's end user customers that have registered, in the case of large
enterprises (primarily geographically dispersed facilities thereof), over
1,000 units of Farallon products and, in the case of small businesses and
other organizations and K-12 schools, over 200 units of Farallon product (1):
LARGE ENTERPRISES SMALL BUSINESSES AND OTHER
---------------------------------- ORGANIZATIONS
3Com ----------------------------------
A.O. Smith Abelson Consulting
Apple Computer AOP Formation
AVIS Campbell--Ewald Advertising
BC Hydro Doe-Spun Group
Bell Northern Research Doremus & Co.
Bellcore TEC Dorsey & Whitney
Boeing Fattal & Collins
Bose Fraser & Beatty
California State University Interaction Media
Dow Chemical Linbeck Construction
Dupont Maritz Performance Improvement
Ernst & Young Mathworks
Federal Express On Ramp Technology
GE Medical Systems Pittard Sullivan Fitzgerald
The Taunton Press
Glaxo-Wellcome
GTE Telephone Operations K-12 SCHOOLS
Leo Burnett ----------------------------------
Liberty Mutual Insurance Barnegat Township Schools
Los Angeles Times Boulder Valley School District
NASA Brunswick School
Nortel Covina-Valley Unified School
Pentagon OUSD Acquisitions & TechnologyDistrict
Quantum Corporation DeKalb County School District
Scitex America Fulton County School District
Southern California Edison Gloucester City High School
Sprint Holcomb Bridge Middle School
Stanford University Katy, Texas School District
State University of New York Lake Washington School District
Stratus Computer Metro Nashville Public Schools
Sybase Millcreek Township School
Time, Inc. District
United Airlines New Orleans Science & Math High
University of Michigan School
University of Southern California Northern BC Regional
US West Correspondence School
World Bank Orlando Schools, City of
Ruben Dario Middle Community
School
Scottsdale Unified School
District 48
Senn-Delaney School District
Solana Beach School District
Spokane, Washington, Education
Service District 101
Weld County School District #6
- --------
(1) All categories exclude PhoneNET.
35
<PAGE>
SALES AND MARKETING
The Company's sales force assists end users by providing solutions for their
Internet connectivity, collaboration and LAN networking needs. In addition,
the sales force provides pre-sales and order management support to
distributors, resellers, and ISPs, identifies new opportunities for product
development and provides general market information to management. The
Company's marketing strategy is to achieve broad market penetration by
utilizing multiple distribution channels, including the use of two-tier
distributors, direct sales, mail order, ISPs and Internet VARs, and K-12 and
electronic marketing.
Two-Tier Distributors. Farallon's major distributors in North America are
Ingram, Tech Data and Merisel, which distribute Farallon's products to
resellers, VARs, dealers and dealer chains. Internationally, Farallon
distributes its products through approximately 70 distributors in 58
countries. In Europe, distributors sell primarily in the U.K., France, Germany
and Sweden, and in the Pacific Rim, distributors sell primarily in Japan.
Farallon provides periodic training in the development of network solutions to
networking VARs who purchase the Company's products primarily from
distributors. The Company's agreements with its distributors can generally be
terminated without cause and do not provide for minimum purchase commitments.
Additionally, the agreements provide price protection and grant the
distributors limited rights to return unsold inventories of the Company's
products in exchange for new purchases. See "Risk Factors--Dependence on
Distributors" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
Direct Sales. Farallon's direct sales force is primarily focused on the
execution of high volume or site license agreements with corporate accounts in
North America. Timbuktu Pro collaboration software is the primary product sold
through this channel. In addition, certain higher education institutions in
North America have historically purchased LAN products directly from the
Company.
Mail Order. Farallon markets its products in mail order catalogues, such as
those offered by MicroWarehouse, to reach users who are generally more
technically sophisticated. Through lower overhead and service costs, mail
order catalogs are generally able to offer lower prices than dealers and
retailers.
ISPs and Internet VARs. Farallon has formed strategic relationships with
PSINet, a national ISP, and over 50 regional ISPs to assist its customers in
gaining Internet access and to increase sales of Netopia products. The Company
also has recruited approximately 1,000 Internet VARs for the sale of Netopia
products.
K-12 Marketing. Farallon also sells through a group of regional VARs known
as Apple Education Sales Agents ("AESAs") which are Apple's exclusive North
American resellers of Macintosh computers to K-12 educational institutions.
Farallon maintains relationships with all 15 AESAs and believes these VARs
represent an effective channel for sales to the K-12 market.
Electronic Marketing. The Company has developed and maintains a Web server
containing over 1,000 pages, hyperlinked with over 1,000 Web sites, a monthly
electronic bulletin for customers and partners, and electronic software
distribution to customers and beta sites. The Company intends to expand its
use of on-line electronic advertising and commerce, including the on-line sale
of Farallon products. The Company currently supports two secure alternatives
for on-line commerce transactions including Netscape's Secure (SSL) Commerce
Server and CyberCash's Secure Internet Payment Service.
Other Marketing. The Company uses several marketing programs, such as trade
advertising, participation in trade shows, press briefings on strategy and new
products, and telemarketing, to support the sale and distribution of its
products. Through these marketing programs, Farallon seeks to build brand name
recognition, stimulate demand and inform channels about the capabilities and
benefits of the Company's products.
36
<PAGE>
CUSTOMER SERVICE AND SUPPORT
The Company believes that it is recognized in the networking industry as
having an outstanding customer support organization. Farallon believes that
effective customer support is a key criterion used in selecting networking
solutions. Network managers and administrators, VARs, distributors, resellers,
consultants and other experienced technical experts utilize the Company's
toll-free telephone support lines, fax and on-line services to access
Farallon's internal technical databases and support personnel. Additionally,
support personnel are trained to satisfy the needs of end users who are not
technical experts and do not have access to sophisticated technical support.
The Company believes that its support programs have been successful in
creating brand loyalty through its focused support of the specialized needs of
these end users, and through the easy-to-use, plug-and-play design of its
products.
Under the Up & Running, Guaranteed! program, Farallon will remotely
configure the Netopia Internet Router and assist users in setting up service
with the user's telephone company and ISP. The program is also available at a
reduced price for users of the Netopia ISDN Modem. Once unique in the
industry, this concept has recently been adopted by at least three of the
Company's competitors. However, the Company believes that its program remains
the most comprehensive in the market. The Company's expertise in solving
technical problems enables it to commit its resources to analyze any problem
an end user may have, even if it involves a product from another company,
thereby building customer loyalty to Farallon as the single source for
networking solutions.
TECHNOLOGY
The Netopia Internet Routers include several core communications
technologies, including a third-generation multi-protocol routing engine. The
product's operating software has been optimized for the special requirements
of Internet access over high-speed digital WAN links, and provides both packet
header and data-link compression. The routing engine operates in conjunction
with companion modules that provide connection/bandwidth management,
authentication/security and configuration/network management functions. The
connection/ bandwidth management module supports dial-on-demand routing, and
tracks incoming and outgoing data calls. Calls can be initiated based on time
of day, type of data traffic, and packet data thresholds. Utilizing the
standards-based PPP and Multilink PPP protocols, the connection/bandwidth
manager provides a dynamic "bandwidth on demand" capability. By transparently
providing the appropriate amount of bandwidth based on current utilization,
these technologies significantly reduce telecommunications costs, particularly
with ISDN. An authentication/security module provides PPP authentication
services between interconnected routers, dial-back security, and packet
filters that allow a LAN to maintain a degree of network security while
connecting to the Internet. The router supports a wide variety of local and
remote configuration/network management capabilities, including a menu-based
console and virtual terminal ("TELNET") interface, Trivial File Transfer
Protocol ("TFTP"), and the Simple Network Management Protocol ("SNMP").
Finally, the router includes an integrated Dynamic Host Configuration Protocol
("DHCP") server which automates configuration of the TCP/IP protocol stacks of
computers on the Ethernet LAN.
The Timbuktu Pro family of collaboration software includes patented cross
platform collaboration technology that provides remote control capabilities
across disparate operating systems. This collaboration system supports text
and graphical image display between homogeneous and heterogenous computers
connected on a network, the Internet or via other transport media. The system
captures window system event messages during a recording process and then
translates these messages into procedure calls during the imaging process on
the destination platform. For example, this technology allows a Windows NT
workstation to view the screen of a MacOS computer regardless of the
differences in screen size, resolution or color depth. This technology enables
the Company to better address the heterogeneous requirements of the Internet.
The Company has also developed proprietary compression technologies which are
used to minimize resources required for image transmissions over the Internet
and slow speed networks. Windows GDI and MacOS Quickdraw compression, Backing
Store Cache compression, and Font Negotiation technology enable the products
to transmit the minimum amount of data necessary to render an image.
37
<PAGE>
Timbuktu Pro collaboration software also includes multi-level security
technology that protects enterprise network computing resources and individual
users from unauthorized intrusion. Each product maintains its own database
which is used to verify the identity and define the privileges of any user
attempting to gain access to a machine. The Company has also developed unique
administration technology for security-conscious network administrators which
allows them to customize the functionality available to their organization. In
addition, the TCP/IP ports assigned to Farallon by the Internet Engineering
Task Force ("IETF") allow network managers to safeguard their Intranet from
unauthorized access with widely available firewall technology. The Company
believes that the object-oriented modular architecture of its products allows
Farallon to exploit market opportunities quickly and address OEM customer
requirements. For instance, by leveraging the product's built-in Object
Linking and Embedding ("OLE") automation, the Company was one of the first to
market real-time collaboration Netscape plug-ins and Internet applets. This
architecture allows new features, transports, and services to be quickly
incorporated to meet future market demands as well as provide easy integration
into other third-party applications.
The EtherWave family of products incorporates a patented technology for
extending a LAN topology that permits daisy-chained standard 10Base-T Ethernet
segments with multiple nodes on each segment. A non-reclocking repeater re-
transmits data packets from each node to subsequent nodes in a daisy-chained
segment. When a repeater is not powered, bypass circuitry connects the two
ends of 10Base-T twisted pair wiring coupled to the inactive node, thus
removing it from the daisy-chain segment and maintaining the network
connection to the other nodes. Farallon's LAN products include internally
developed application-specific integrated circuits ("ASICs"), that combine
large functional logic blocks into a common silicon core. The Company uses
industry-standard software tools to design these ASICs and several ASIC
manufacturing sources for production. ASIC technology has enabled the Company
to provide increased performance and higher reliability while decreasing
production costs. The Company believes its possesses expertise in real-time,
high-speed, embedded systems hardware design using Complex Instruction Set
Controller ("CISC") and Reduced Instruction Set Controller ("RISC")
processors, and Ethernet and Fast Ethernet technologies. The Company believes
it also possesses expertise in high-volume, low-cost product design and
domestic and international homologation requirements.
PRODUCT DEVELOPMENT
The Company believes that its future business and operating results depend
in part on its ability to continue to enhance existing products, develop new
products and improve the price and performance of its products in a timely
manner. The Company continuously evaluates the emerging needs, developing
standards and emerging technologies of its target markets to identify new
market or product opportunities. Farallon is focusing its development efforts
on Internet connectivity through high-speed digital services, including ISDN,
T-1 and Frame Relay, software enhancements including more Internet-specific
graphical user interfaces ("GUI") for Timbuktu Pro, a Windows NT version of
Timbuktu Pro, additional Internet applets, further internationalization of its
products, PC card-based products for laptop computers and cost-reducing design
improvements. In addition, the Company has relied and will continue to rely on
external development resources, such as OEM suppliers, for the development of
certain of its products and related components.
The personal computer industry is characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions,
short product life cycles and rapidly changing customer requirements. The
introduction of products embodying new technologies and the emergence of new
industry standards can render existing products obsolete and unmarketable. The
Company's Netopia products currently operate only over ISDN telecommunication
service. As other communications technologies such as Frame Relay, ATM, ADSL,
and communication over cable or wireless networks, are developed or gain
market acceptance, the Company will be required to enhance its Internet
connectivity products to support such technologies, which will be costly and
time consuming. If the Company is unable to modify its products to support new
Internet access technologies, or if ISDN does not achieve widespread customer
acceptance as a result of the adoption of alternative technologies or as
result of deemphasis of ISDN by communications service providers, the
Company's business, operating results and financial condition would be
materially and adversely affected.
38
<PAGE>
In addition, the Company has historically derived a substantial majority of
its revenues from the sale of Ethernet connectivity products. In the event
that current Ethernet network technology is modified or replaced and the
Company is unable to modify its products to support new Ethernet technologies
or alternative technologies, the Company's business, operating results and
financial condition could be materially and adversely affected. The Company
has in the past and may in the future experience delays in new product
development. There can be no assurance that the Company will be successful in
developing and marketing product enhancements or new products that respond to
technological change, evolving industry standards and changing customer
requirements, that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of
these products or product enhancements, or that its new products and product
enhancements will adequately meet the requirements of the marketplace and
achieve any significant degree of market acceptance. Failure of the Company,
for technological or other reasons, to develop and introduce new products and
product enhancements in a timely and cost-effective manner would have a
material adverse effect on the Company's business, operating results and
financial condition. In addition, the future introduction or even announcement
of products by the Company or one or more of its competitors embodying new
technologies or changes in industry standards or customer requirements could
render the Company's then existing products obsolete or unmarketable. There
can be no assurance that the introduction or announcement of new product
offerings by the Company or one of or more of its competitors will not cause
customers to defer purchase of existing Company products. Such deferment of
purchases could have a material adverse effect on the Company's business,
operating results or financial condition. See "Risk Factors--Fluctuations in
Quarterly Results; Future Results of Operations Uncertain."
Complex products such as those offered by the Company may contain undetected
or unresolved defects when first introduced or as new versions are released.
There can be no assurance that, despite testing by the Company, defects will
not be found in new products or new versions of products following commercial
release, resulting in loss of market share, delay in or loss of market
acceptance or product recall. Any such occurrence could have a material
adverse effect upon the Company's business, operating results or financial
condition. See "Risk Factors--New Product Development and Rapid Technological
Change; Dependence on ISDN Technology."
As of March 31, 1996, Farallon's Research and Development staff consisted of
62 employees. Of these employees 49 were focused primarily on
Internet/Intranet product development and 13 were focused primarily on LAN
product development. The Company believes that its future success will depend
in large part upon its ability to attract and retain highly-skilled
engineering personnel. Competition for such personnel is intense, and there
can be no assurance that the Company will be successful in attracting and
retaining such personnel, the failure of which could have a material adverse
effect on the Company's business, operating results and financial condition.
See "Risk Factors--Dependence on Key Personnel."
COMPETITION
The markets for the Company's products and services are intensely
competitive, highly fragmented and characterized by rapidly changing
technology, evolving industry standards, price competition and frequent new
product introductions. A number of companies offer products that compete with
one or more of the Company's products. The Company's current and prospective
competitors include OEM product manufacturers of Internet access and remote
LAN access equipment, manufacturers of remote control and screen sharing
software and manufacturers of LAN client access and network systems products.
In the Internet access and remote LAN access equipment market, the Company
primarily competes with Ascend, Cisco, Motorola, 3Com, U.S. Robotics, Gandalf
and several other companies. In the remote control and screen sharing software
market, the Company competes primarily with Symantec, Microcom, Traveling
Software, Stac Electronics and several other companies. In the LAN client
access and network systems product market, the Company competes primarily with
Apple, Asante, Dayna, Global Village and several other companies. The Company
has experienced and expects to continue to experience increased competition
from current and potential competitors, many of whom have substantially
greater financial, technical, sales, marketing and other resources, as well as
greater name recognition
39
<PAGE>
and a larger customer base, than the Company. Accordingly, such competitors or
future competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or devote greater resources
to the development, promotion and sales of their products than the Company. In
particular, established companies in the personal computer industry may seek
to expand their product offerings by designing and selling products using
competitive technology that could render the Company's products obsolete or
have a material adverse effect on the Company's sales. For example, Microsoft
recently announced the availability of free, via download on the Internet,
communications and collaboration software compatible with the Microsoft
Internet Explorer. This software product, which enables real-time
communication within a workgroup, could undermine the Company's ability to
market its Timbuktu Pro collaboration software. In addition, Netscape also
recently announced its plan to offer software that enables dispersed
workgroups to collaborate in the work environment. Accordingly, there can be
no assurance that the Company can continue to market its collaboration
software, which would have a material and adverse effect on the Company's
business, operating results and financial condition. In addition, several of
the Company's current competitors recently have introduced free guaranteed
service and support programs that appear to be similar to the Company's Up &
Running, Guaranteed! program. As a result, there can be no assurance that the
Company can continue to charge a fee for this support program, which could
have a material and adverse effect upon the Company's business, operating
results and financial condition. The markets in which the Company competes
currently are subject to intense price competition and the Company expects
additional price and product competition as other established and emerging
companies enter these markets and new products and technologies are
introduced. Increased competition may result in further price reductions,
reduced gross margins and loss of market share, any of which could materially
and adversely affect the Company's business, operating results and financial
condition. There can be no assurance that the Company will be able to compete
successfully against current and future competitors, or that competitive
factors faced by the Company will not have a material adverse effect on the
Company's business, operating results and financial condition.
Farallon believes that the principal competitive factors in its markets are:
(1) product feature, function and reliability, (2) ease of use, (3) customer
service and support, (4) price and performance, (5) timeliness of new product
introductions, (6) brand name recognition, (7) strategic alliances, (8) size
and scope of distribution channels, (9) breadth of product line, and (10) size
of installed customer base. While the Company believes, in general, that it
currently competes favorably with regard to these factors there can be no
assurance that the Company will be able to compete successfully in the future,
the failure of which would have a material adverse effect on the Company's
business, operating results and financial condition. See "Risk Factors--
Dependence on Apple; Competition with Apple Products" and "--Competition."
PROPRIETARY RIGHTS AND TECHNOLOGY
The Company's ability to compete is dependent in part on its proprietary
rights and technology. The Company relies primarily on a combination of
patent, copyright and trademark laws, trade secrets, confidentiality
procedures and contractual provisions to protect its proprietary rights. The
Company generally enters into confidentiality or license agreements with its
employees, resellers, distributors, customers and potential customers and
limits access to the distribution of its software, hardware designs,
documentation and other proprietary information. There can be no assurance
that the steps taken by the Company in this regard will be adequate to prevent
misappropriation of its technology. The Company currently has nine issued
United States patents, one pending United States patent application, and one
pending application for patent in each of Canada and Australia and within the
European Patent Office. There can be no assurance that the Company's patents
will not be invalidated, circumvented or challenged, that the rights granted
thereunder will provide competitive advantages to the Company or that any of
the Company's pending or future patent applications, whether or not being
currently challenged by applicable governmental patent examiners, will be
issued with the scope of the claims sought by the Company, if at all.
Furthermore, there can be no assurance that others will not develop
technologies that are similar or superior to the Company's technology or
design around the patents owned by the Company. Despite the Company's efforts
to protect its proprietary rights, unauthorized parties may attempt to copy
aspects of the Company's products or to obtain and use information that the
Company regards as proprietary. Policing unauthorized use of the Company's
products is difficult, and while the Company is unable to determine the extent
to which piracy of its software products exists, software piracy is expected
to be a persistent problem. In selling its software products, the Company
relies primarily on "shrink wrap" licenses that are not signed by licensees
and, therefore, it is possible that such licenses may be unenforceable under
the laws of certain jurisdictions. In addition, the laws of some foreign
countries do not protect the Company's proprietary
40
<PAGE>
rights as fully as do the laws of the United States. There can be no assurance
that the Company's means of protecting its proprietary rights in the United
States or abroad will be adequate or that competing companies will not
independently develop similar technology.
The Company relies upon certain software, firmware and hardware designs that
it licenses from third parties, including firmware that is integrated with the
Company's internally developed firmware and used in the Company's products to
perform key functions. There can be no assurance that these third-party
licenses will continue to be available to the Company on commercially
reasonable terms. The loss of, or inability to maintain, such licenses could
result in shipment delays or reductions until equivalent firmware could be
developed, identified, licensed and integrated which would materially and
adversely affect the Company's business, operating results and financial
condition. See "Risk Factors--Dependence on Proprietary Rights and
Technology."
LEGAL MATTERS
From time to time, the Company has received claims of infringement of other
parties' proprietary rights. Although the Company believes that all such
claims received to date are immaterial, there can be no assurance that third
parties will not assert infringement claims in the future with respect to the
Company's current or future products. The Company expects that it will
increasingly be subject to infringement claims as the number of products and
competitors in the Company's industry segments grow and the functionality of
products in different industry segments overlaps. Any such claims, with or
without merit, could be time consuming to defend, result in costly litigation,
divert management's attention and resources, cause product shipment delays or
require the Company to enter into royalty or licensing agreements. Such
royalty or licensing agreements, if required, may not be available on terms
acceptable to the Company, if at all. In the event of a successful claim of
product infringement against the Company and failure or inability of the
Company to license the infringed or similar technology, the Company's
business, operating results and financial condition would be materially and
adversely affected. See "Risk Factors--Dependence on Proprietary Rights and
Technology."
In the past, Farallon has found it necessary to file suit to protect its
proprietary rights. Such litigation has resulted in, and any litigation in the
future can be expected to result in, substantial costs to Farallon and a
diversion of efforts of Farallon's personnel. In 1993, the Company filed suit
asserting that a competitor infringed its patented technology, and filed an
International Trade Commission action asserting that products imported into
the United States infringed Farallon's patented technology. Although both
actions were resolved favorably for the Company, there can be no assurance
that future litigation actions, if brought, will result in favorable outcomes.
See "Risk Factors--Dependence on Proprietary Rights and Technology."
From time to time, the Company may be involved in litigation or
administrative claims arising out of its operations in the normal course of
business. For example, the Company recently terminated negotiations with a
manufacturer of router products regarding a potential acquisition. Shortly
thereafter, the Company received correspondence from such manufacturer's
counsel asserting that the Company's termination of negotiations was improper
and demanding that Farallon either consummate an acquisition for cash and
stock or license from such manufacturer certain technology. The Company
believes that any potential claim by such manufacturer, if brought, would be
entirely without merit and the Company is prepared to vigorously defend any
such claim. See "Risk Factors--Litigation."
MANUFACTURING AND SUPPLIERS
The Company's manufacturing operations consist primarily of manufacturing
engineering, quality assurance, testing, purchasing, material planning,
limited final assembly or packaging on certain products and shipping. The
Company does not manufacture any of the materials or components used in its
products. The Company designs all of the hardware subassemblies for its
products and uses the services of contract manufacturers to build these
subassemblies and its products to the Company's specifications. Farallon
believes that its design standards, quality control procedures, and the
quality standards of its suppliers have contributed significantly to the
reputation of its products for high performance and reliability. Farallon's
manufacturing strategy is to optimize cost, quality, product delivery and
operating flexibility through an external manufacturing model that allows the
Company to focus resources in areas other than plant management.
41
<PAGE>
The Company primarily uses five "turnkey" manufacturers for the production
and certain testing of all of its hardware products. The manufacturers are
located in Colorado, Taiwan, Florida, Utah and California. In addition, a
turnkey manufacturer in Seattle, Washington duplicates and packages the
Company's software products. The Company believes that there are alternative
contract manufacturers that could produce the Company's products. However, it
could take a significant amount of time to identify, approve and begin
production with an alternative manufacturer. The Company generally purchases
turnkey products pursuant to purchase orders and has no contractual
relationships with its turnkey manufacturers. There can be no assurance that
the Company will not experience reduction or interruption of production due to
changes in manufacturer financial stability, priorities or other issues, the
occurrence of which would have a material adverse effect on the Company's
business, operating results and financial condition.
The Company also relies upon limited source suppliers for a number of
components used in the Company's products, including certain key
microprocessors and integrated circuits. There can be no assurance that these
suppliers will be able to timely meet the Company's future requirements for
manufactured products, components and subassemblies. The Company generally
purchases limited source components pursuant to purchase orders and has no
guaranteed supply arrangements with these suppliers. In addition, the
availability of many of these components to the Company is dependent in part
on the Company's ability to provide its suppliers with accurate forecasts of
its future requirements. The Company believes that there are alternative
suppliers or alternative components for all of the components contained in its
products. However, any extended interruption in the supply of any of the key
components currently obtained from a limited source would disrupt its
operations and have a material adverse effect on the Company's business,
operating results and financial condition. In addition, the Company
anticipates that it will be necessary to establish additional strategic
relationships in the future, in particular with additional national ISPs, and
there can be no assurance that the Company will be able to establish such
alliances or that such alliances will result in increased revenues. See "Risk
Factors--Dependence on Strategic Alliances; Dependence on Contract
Manufacturers and Limited Source Suppliers" and "Risk Factors--Competition."
FACILITIES
The Company leases approximately 49,000 square feet of office space for its
headquarters in Alameda, California. The lease expires in December 1997. In
addition, the Company leases approximately 29,000 square feet of warehouse
space in San Leandro, California to accommodate the Company's distribution
center which maintains inventory and provides shipping and handling. This
lease also expires in December 1997. The Company also leases development
office space in San Jose, California and Lawrence, Kansas and maintains an
international sales and service office in Paris, France. The Company believes
that its existing facilities are adequate for its current needs and that
additional space sufficient to meet the Company's needs for the foreseeable
future is available on reasonable terms.
EMPLOYEES
As of March 31, 1996, the Company employed 220 persons, including 54 in
sales and marketing, 62 in research and development, 27 in customer service
and support, 47 in manufacturing operations, and 30 in general and
administrative functions. The Company also contracts with consultants who
provide short and long-term services to the Company in various areas. Farallon
believes that its relations with its employees are good. None of Farallon's
employees is represented by a labor union and the Company has not experienced
a work stoppage. The Company believes its business depends to a significant
extent on the contributions of its senior management and other key personnel
and on Farallon's ability to attract and retain highly qualified personnel.
Competition to hire such personnel in Farallon's industry and location is
intense. See "Risk Factors--Dependence on Key Personnel."
42
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information with respect to the
executive officers and directors of the Company, including their ages as of
March 31, 1996:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
- -------------------- --- ---------------------------------------------
<S> <C> <C>
Alan B. Lefkof.............. 43 President, Chief Executive Officer and Director
James A. Clark.............. 39 Vice President and Chief Financial Officer
Didier Cop.................. 41 Vice President of International
Douglas A. Lifton........... 39 Vice President of Business Development
Richard L. Maslana.......... 59 Vice President of Operations and General Manager of LAN Products
Thomas A. Skoulis........... 40 Vice President of North America Sales
Stephen M. Solomon.......... 40 Vice President and General Manager of Software Products
Michael P. Trupiano......... 40 Vice President of Research and Development, Network Systems
Michael J. Zukerman......... 36 Vice President, General Counsel and Secretary
Reese M. Jones.............. 37 Chairman of the Board of Directors
Bandel L. Carano (1)........ 34 Director
David F. Marquardt (1)(2)... 47 Director
James R. Swartz (2)......... 53 Director
</TABLE>
- --------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
Alan B. Lefkof joined the Company as President in August 1991 and has been
Chief Executive Officer since November 1994. Prior to joining the Company, Mr.
Lefkof spent over nine years at GRiD Systems, a manufacturer of laptop
computers, where he served as President from October 1989 to August 1991,
Chief Financial Officer from March 1987 to September 1989, and Vice President
of Marketing from August 1983 to February 1987. Before joining GRiD Systems,
Mr. Lefkof served as a Management Consultant at McKinsey and Company, from
July 1977 to January 1982. Mr. Lefkof received a B.S. in computer science from
the Massachusetts Institute of Technology in 1975 and an M.B.A. from Harvard
Business School in 1977.
James A. Clark, Vice President and Chief Financial Officer, joined the
Company in November 1994. Prior to joining the Company, Mr. Clark was Vice
President and Chief Financial Officer at Integral, a developer of large scale,
client/server business application software, from November 1985 to November
1994. Before joining Integral, Mr. Clark was Manager of Reporting and
International Accounting at MicroPro from April 1984 to November 1985. Mr.
Clark received a B.A. in business administration/accounting from California
State University at Chico in 1978 and is a Certified Public Accountant.
Didier Cop, Vice President of International, joined the Company in June
1991. Prior to joining the Company, Mr. Cop was Sales and Marketing Manager
for Mood Media, a multimedia and advertising system company, from August 1990
to May 1991. Before joining Mood Media, Mr. Cop was General Manager for
Southern Europe Sales with General Parametrics. Mr. Cop received a degree in
business administration from E.S.S.E.C. in France, in 1976.
Douglas A. Lifton, Vice President of Business Development, joined the
Company in February 1995. Prior to joining the Company, Mr. Lifton spent nine
years with Digital Communications Associates ("DCA"), a communication products
company, where he held Director positions for Remote Access Sales, Third Party
43
<PAGE>
Business Development, and Product Management from January 1989 to February
1995. In addition, Mr. Lifton held other management positions at DCA from
January 1986 to January 1989. Mr. Lifton received a B.S. in economics from
Allegheny College in 1979 and an M.B.A. from Boston College in 1982.
Richard L. Maslana, Vice President of Operations and General Manager of LAN
products, joined the Company in November 1993. Prior to joining the Company,
Mr. Maslana was General Manager of Capetronics from November 1991 to November
1993. Before joining Capetronics, Mr. Maslana spent several years at U.S.
Design where he served as Executive Vice President and General Manager from
April 1986 to June 1991, and as Senior Vice President, Operations from March
1986 to March 1988. Mr. Maslana received a B.S. in business administration
from Pacific Western University in 1977 and completed General Electric's
Manufacturing Studies Program.
Thomas A. Skoulis, Vice President of North American Sales, joined the
Company in September 1991. Prior to joining the Company, Mr. Skoulis held
various sales management positions with 3Com from March 1988 to September
1991. Before joining 3Com, Mr. Skoulis also held the position of Senior Sales
Representative at Digital Equipment from June 1980 to March 1988. Mr. Skoulis
received a B.A. in business administration from Miami University in Oxford,
Ohio, in 1980.
Stephen M. Solomon, Vice President and General Manager of Software Products,
joined the Company in January 1991. Prior to joining the Company, Mr. Solomon
held senior software engineering positions at Xerox Imaging Systems from
January 1990 to January 1991, and Glycomed from August 1988 to January 1990.
Prior to that, Mr. Solomon held the position of Software Engineer at Server
Technology from January 1986 to August 1988.
Michael P. Trupiano, Vice President of Research and Development, Network
Systems, joined the Company in May 1992. Prior to joining the Company, Mr.
Trupiano was Director of R&D/Product Marketing at Verifone, a transaction
processing products company, from January 1989 to May 1992. Before joining
Verifone, Mr. Trupiano was Vice President of Engineering at Isix from June
1987 to December 1989, and was Director of Engineering at Amtel Systems from
January 1984 to June 1987. Mr. Trupiano received a B.S. in electrical
engineering and computer science from Santa Clara University in 1978.
Michael J. Zukerman, Vice President, General Counsel and Secretary, joined
the Company in September 1989. Before joining the Company, Mr. Zukerman
practiced law with Brobeck, Phleger & Harrison, a San Francisco law firm, from
June 1986 to September 1989. Mr. Zukerman received a B.A. from the University
of California at Berkeley in 1981 and a J.D. from the American University,
Washington College of Law in 1985.
Reese M. Jones, founder of the Company, has served as Chairman of the Board
of Directors of the Company since inception, and served as President of the
Company from inception to August 1991 when Mr. Lefkof was appointed President.
Mr. Jones served as Chief Executive Officer of the Company from the date of
the Company's incorporation until Mr. Lefkof was appointed Chief Executive
Officer in November 1994. Mr. Jones currently serves on the Board of Directors
of a number of privately held companies. Mr. Jones received a B.A. in
biophysics from the University of California at Berkeley in 1982.
Bandel L. Carano has been a director of the Company since 1992. Mr. Carano
joined Oak Investment Partners, a venture capital firm, in October 1985 as an
associate and was elected a General Partner of Oak Investment Partners III in
July 1987. Mr. Carano currently serves as a director of Digital Sound and
Polycom. Mr. Carano received a B.S. and an M.S. in electrical engineering from
Stanford University in 1983.
David F. Marquardt has been a director of the Company since 1990. Mr.
Marquardt is a founding general partner of August Capital, formed in 1995 and
has been a general partner of various Technology Venture Investors ("TVI")
entities since August 1980. August Capital and the TVI entities are all
private venture capital partnerships. Mr. Marquardt currently serves on the
Board of Directors of Auspex Systems, Microsoft, Visioneer and a number of
privately held companies. Mr. Marquardt received a B.S. in mechanical
engineering from Columbia University in 1973 and an M.B.A. from Stanford
University in 1979.
44
<PAGE>
James R. Swartz has been a director of the Company since 1992. Mr. Swartz
currently serves as Managing General Partner of Accel Partners, a venture
capital firm, which he founded in September 1983. Mr. Swartz currently serves
on the Board of Directors of Remedy, PictureTel and Polycom. Mr. Swartz is a
graduate of Harvard University with a concentration in Engineering Sciences
and Applied Physics and received an M.S. in Industrial Administration from
Carnegie Mellon University.
All directors hold office until the next annual meeting of stockholders or
until their successors have been elected and qualified. Officers serve at the
discretion of the Board of Directors. There are no family relationships
between any of the directors or executive officers of the Company.
DIRECTOR COMPENSATION
Members of the Company's Board of Directors do not receive compensation for
their services as directors. The Company's 1996 Stock Option Plan provides
that options shall be granted to non-employee directors of the Company. See
"--1996 Stock Option Plan."
EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth the compensation earned
by the Company's Chief Executive Officer and the four other most highly
compensated officers whose salary and bonus for the 1995 fiscal year were in
excess of $100,000 (collectively, the "Named Officers"), for services rendered
in all capacities to the Company and its subsidiary for that fiscal year.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
--------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY (1) BONUS OPTIONS (#) COMPENSATION (2)
- --------------------------- --------------------- ------------ ----------------
<S> <C> <C> <C> <C>
Alan B. Lefkof.............. $ 235,945 $ 38,155 25,000 $6,600
President and Chief
Executive Officer
Steven M. Bauman (3)........ 151,396 26,415 10,000 7,550
Vice President and General
Manager of Software
Products
Richard L. Maslana.......... 152,579 36,415 45,000 6,000
Vice President of
Operations and General
Manager of LAN Products
Didier Cop (4)(5)........... 112,650 56,721 27,000 3,571
Vice President of
International
Michael P. Trupiano......... 124,293 18,197 35,000 6,000
Vice President of Research
and Development, Network
Systems
</TABLE>
- --------------
(1) Salary includes amounts deferred under the Company's 401(k) Plan.
(2) Represents car allowances.
(3) Mr. Bauman terminated employment with the Company in October 1995. Stephen
M. Solomon was promoted to Vice President and General Manager of Software
Products from Vice President, Software Products at the time of Mr.
Bauman's termination; Mr. Solomon's annual salary is currently set at
$134,000.
(4) Mr. Cop's compensation was paid in French francs and converted into U.S.
dollars based on an average exchange rate per quarter.
(5) Bonus includes commissions earned during fiscal 1995 of $44,011.
45
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table contains information concerning the stock option grants
made to each of the Named Officers in the fiscal year ended September 30,
1995. No stock appreciation rights were granted to these individuals during
such year.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF INDIVIDUAL GRANTS ANNUAL RATES
------------------------------------ OF STOCK PRICE
SECURITIES % OF TOTAL APPRECIATION FOR
UNDERLYING OPTIONS GRANTED EXERCISE OPTION TERM (4)
OPTIONS TO EMPLOYEES IN PRICE PER EXPIRATION ---------------------
NAME GRANTED (#)(1) 1995 (2) SHARE (3) DATE 5% 10%
- ---- -------------- --------------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Alan B. Lefkof.......... 25,000 4.83% $1.60 5/30/05 $ 25,156 $63,750
President and Chief
Executive Officer
Steven M. Bauman........ 10,000 1.93 1.60 5/30/05 10,062 25,500
Vice President and
General Manager of
Software Products
Richard L. Maslana...... 35,000 6.76 1.20 12/06/04 26,414 66,937
Vice President of 10,000 1.93 1.60 5/30/05 10,062 25,500
Operations and
General Manager of
LAN Products
Didier Cop.............. 7,500 1.45 1.20 10/24/04 5,660 14,344
Vice President of
International 2,500 0.48 1.60 4/11/05 2,516 6,375
10,000 1.93 1.60 5/30/05 10,062 25,500
7,000 1.35 1.60 5/30/05 7,044 17,850
Michael P. Trupiano..... 20,000 3.86 1.20 10/24/04 15,093 38,250
Vice President of 12,500 2.41 1.60 5/30/05 12,578 31,875
Research and
Development, Network 2,500 0.48 1.60 5/30/05 2,516 6,375
Systems
</TABLE>
- --------------
(1) The options for the following number of shares listed in the table: Mr.
Lefkof: 25,000, Mr. Bauman: 10,000, Mr. Maslana: 10,000, Mr. Trupiano:
12,500, and Mr. Cop: 7,000 become exercisable in annual and quarterly
installments over four years. Each of the other options listed in the
table become exercisable in annual and quarterly installments over five
years, except that the 2,500-share options granted to Messrs. Trupiano and
Cop become exercisable in full at the end of nine years from the grant
date subject to acceleration upon the optionee's achievement of certain
milestones. All outstanding options will terminate upon an acquisition of
the Company by merger or asset sale unless the acquiring company assumes
the outstanding options.
(2) Based on options exercisable for an aggregate of 517,975 shares granted in
the 1995 fiscal year.
(3) The exercise price may be paid in cash or in shares of the Company's
Common Stock valued at fair market value on the exercise date. The Company
may also finance the option exercise by loaning the optionee sufficient
funds to pay the exercise price for the purchased shares, together with
any federal and state income tax liability incurred by the optionee in
connection with such exercise.
(4) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of
the Company's securities that the actual stock price appreciation over the
10-year option term will be at the assumed 5% and 10% levels or at any
other defined level. Unless the market price of the Common Stock
appreciates over the option term, no value will be realized from the
option grants made to the executive officers.
46
<PAGE>
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth information concerning the shares acquired
and the value realized upon the exercise of stock options during the 1995
fiscal year and the year-end number and value of unexercised options with
respect to each of the Named Officers. No stock appreciation rights were
exercised by the Named Officers in the 1995 fiscal year or were outstanding at
the end of that year.
<TABLE>
<CAPTION>
VALUE OF
NUMBER OF UNEXERCISED
SECURITIES UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS
SHARES AT SEPTEMBER 30, 1995 (#) AT SEPTEMBER 30, 1995 (2)
ACQUIRED ON VALUE ------------------------- -------------------------
NAME EXERCISE (#) REALIZED (1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ------------ ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Alan B. Lefkof.......... 12,000 $2,400 175,850 74,150 $104,740 $28,860
Steven M. Bauman........ 5,000 1,000 57,750 47,250 31,200 18,800
Richard L. Maslana...... 0 -- 22,000 88,000 8,800 31,200
Didier Cop.............. 0 -- 7,750 32,250 3,780 5,220
Michael P. Trupiano..... 0 -- 11,000 44,000 4,400 11,600
</TABLE>
- --------------
(1) Market price at exercise less exercise price.
(2) Based on the fair market value of the Company's Common Stock at September
30, 1995 ($1.60 per share), as determined by the Company's Board of
Directors, less the exercise price payable for such shares.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of the Company's Board of Directors (the
"Compensation Committee"), as of March 31, 1996, consists of Messrs. Marquardt
and Swartz. During the 1995 fiscal year, the Compensation Committee consisted
of Messrs. Jones, Lefkof and Marquardt. Both Messrs. Jones and Lefkof were
officers and employees of the Company during the fiscal year ended September
30, 1995. Neither Mr. Marquardt nor Mr. Swartz was at any time during the
fiscal year ended September 30, 1995, or at any other time, an officer or
employee of the Company. No member of the Compensation Committee 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 the Company's Board
of Directors or Compensation Committee.
EXECUTIVE BONUS PLAN
The Company has adopted a bonus program pursuant to which selected full-time
employees are eligible for annual cash bonuses based upon a combination of the
Company having achieved specified financial objectives and the employee having
met specified individual performance objectives.
STOCK BONUS PLAN
The Company has adopted a stock bonus program pursuant to which selected
employees are eligible for stock awards based upon such individual's
contributions to the Company.
1996 STOCK OPTION PLAN
The Company's 1996 Stock Option Plan (the "1996 Plan") was adopted by the
Board of Directors on April 16, 1996, subject to stockholder approval, as the
successor to the 1987 Restated Stock Option Plan ("1987 Plan"). The Company
has reserved 2,166,995 shares for issuance under the 1996 Plan. This share
reserve is comprised of (i) the 1,666,995 shares that were available for
issuance under the 1987 Plan, plus (ii) an increase of 500,000 shares. Shares
of Common Stock subject to outstanding options, including options granted
under the 1987 Plan, which expire or terminate prior to exercise will be
available for future issuance under the 1996 Plan.
47
<PAGE>
Under the 1996 Plan, employees (including officers) and independent
consultants may, at the discretion of the plan administrator, be granted
options to purchase shares of Common Stock at an exercise price not less than
85% of the fair market value of such shares on the grant date. Non-employee
members of the Board of Directors will be eligible solely for automatic option
grants under the 1996 Plan.
The 1996 Plan will be administered by the Compensation Committee after the
effective date of this offering. The Compensation Committee has complete
discretion to determine which eligible individuals are to receive option
grants, the number of shares subject to each such grant, the status of any
granted option as either an incentive option or a non-statutory option under
the Federal tax laws, the vesting schedule to be in effect for each option
grant and the maximum term for which each granted option is to remain
outstanding. In addition, options for up to 10,000 shares of Common Stock may
be granted under the 1996 Plan to individuals who are not officers or
directors by a Stock Option Committee, which currently has as its sole member
Alan B. Lefkof, the Company's Chief Executive Officer. In no event, however,
may any one participant in the 1996 Plan acquire shares of Common Stock under
the 1996 Plan in excess of 500,000 shares over the period beginning on the
effective date of the 1996 Plan and ending on June 30, 1999.
The exercise price for options granted under the 1996 Plan may be paid in
cash or in outstanding shares of Common Stock. Options may also be exercised
on a cashless basis through the same-day sale of the purchased shares. The
Compensation Committee may also permit the optionee to pay the exercise price
through a promissory note payable in installments over a period of years. The
amount financed may include any Federal or state income and employment taxes
incurred by reason of the option exercise.
Each option granted to an officer of the Company subject to the short-swing
profit restrictions of the Federal securities laws may include a special stock
appreciation right which provides that, upon the acquisition of more than 50%
of the Company's outstanding voting stock pursuant to a hostile tender offer,
such option, if outstanding for at least six months and to the extent vested,
may be unconditionally surrendered in exchange for a cash distribution to the
officer based upon the tender offer price per share of Common Stock at the
time subject to the surrendered option.
The Compensation Committee has the authority to effect, from time to time,
the cancellation of outstanding options under the 1996 Plan in return for the
grant of new options for the same or different number of option shares with an
exercise price per share based upon the fair market value of the Common Stock
on the new grant date.
In the event the Company is acquired by merger, consolidation or asset sale,
the shares of Common Stock subject to each option outstanding at the time
under the 1996 Plan will immediately vest in full, except to the extent the
Company's repurchase rights with respect to those shares are to be assigned to
the acquiring entity, and options will accelerate to the extent not assumed by
the acquiring entity. If the acquiring entity assumes the options and an
optionee is involuntarily terminated within 12 months following the date of
the acquisition, the optionee's options will automatically accelerate, and the
options will fully vest following the involuntary termination. In addition,
the Compensation Committee has the discretion to accelerate the vesting of
options that are assumed by the acquiring entity.
Under the automatic grant program, each individual serving as a non-employee
director will receive on the effective date of this offering, and each
individual who first joins the Board as a non-employee director on or after
the effective date of this offering will receive at that time, an automatic
option grant for 25,000 shares of Common Stock. Each option will have an
exercise price equal to the fair market value of the Common Stock on the
automatic grant date and a maximum term of ten years, subject to earlier
termination following the optionee's cessation of Board service. The option
will be immediately exercisable for all of the shares but the shares will be
subject to repurchase at original cost. The shares will vest in five annual
installments. However, vesting of the shares will automatically accelerate
upon (i) an acquisition of the Company by merger, consolidation or asset sale,
(ii) a hostile take over of the Company effected by tender offer for more than
50% of the outstanding voting stock or proxy contest for Board membership or
(iii) the death or disability of the optionee while serving as a Board member.
48
<PAGE>
In the event that more than 50% of the Company's outstanding voting stock
were to be acquired pursuant to a hostile tender offer, each automatic option
grant which has been outstanding for at least six months (whether or not the
optionee is otherwise at the time vested in those shares) shall be
automatically canceled in return for a cash distribution from the Company
based upon the tender offer price per share of Common Stock at the time
subject to the surrendered option.
The Board may amend or modify the 1996 Plan at any time. The 1996 Plan will
terminate on April 15, 2006, unless sooner terminated by the Board.
EMPLOYEE STOCK PURCHASE PLAN
The Company expects to adopt before this offering an Employee Stock Purchase
Plan (the "Purchase Plan"), subject to approval by the stockholders. A total
of 300,000 shares of Common Stock will be reserved for issuance under the
Purchase Plan. The Purchase Plan, which is intended to qualify under Section
423 of the Internal Revenue Code, will be implemented by 24-month offerings
with purchases occurring at six-month intervals, commencing on the closing of
this offering. The Purchase Plan will be administered by the Compensation
Committee. Employees will be eligible to participate if they are employed by
the Company for more than 20 hours per week. The Purchase Plan permits
eligible employees to purchase Common Stock through payroll deductions, which
may not exceed 15% of an employee's compensation, nor more than 2,000 shares
per participant on any purchase date. The price of stock purchased under the
Purchase Plan will be 85% of the lower of the fair market value of the Common
Stock at the beginning of the 24-month offering period or on the applicable
semi-annual purchase date. Employees may end their participation in the
offering at any time during the offering period, and participation ends
automatically on termination of employment with the Company. Each outstanding
purchase right will be exercised immediately prior to a merger or
consolidation. The Board may amend or terminate the Purchase Plan immediately
after the close of any purchase date. However, the Board may not, without
stockholder approval, materially increase the number of shares of Common Stock
available for issuance, alter the purchase price formula so as to reduce the
purchase price payable for shares of Common Stock, or materially modify the
eligibility requirements for participation or the benefits available to
participants. The Purchase Plan will in all events terminate in July 2006.
CHANGE IN CONTROL ARRANGEMENTS
The Compensation Committee, as Plan Administrator of the 1996 Plan, has the
authority to provide for accelerated vesting of the shares of Common Stock
subject to outstanding options held by the Named Officers and any other
executive officer in connection with certain changes in control of the Company
or the subsequent termination of the officer's employment following the change
in control event.
None of the Named Officers have employment agreements with the Company, and
their employment may be terminated at any time. However, the Company has
entered into an agreement with Messrs. Lefkof, Clark, Maslana, Solomon,
Trupiano and Zukerman which provides for acceleration of vesting of option
shares as if the officer remained employed for 12 additional months in the
event the officer's employment is involuntarily terminated following certain
acquisitions or changes in control of the Company. In addition, Messrs. Clark
and Maslana will receive severance pay equal to 12 months salary and Messrs.
Lefkof, Solomon, Trupiano and Zukerman will receive severance pay equal to six
months salary upon any such termination.
49
<PAGE>
CERTAIN TRANSACTIONS
The Company's Certificate of Incorporation limits the liability of its
directors for monetary damages arising from a breach of their fiduciary duty
as directors, except to the extent otherwise required by the Delaware General
Corporation Law. Such limitation of liability does not affect the availability
of equitable remedies such as injunctive relief or rescission.
The Company's Bylaws provide that the Company shall indemnify its directors
and officers to the fullest extent permitted by Delaware law, including in
circumstances in which indemnification is otherwise discretionary under
Delaware law. The Company has also entered into indemnification agreements
with its officers and directors containing provisions that may require the
Company, among other things, to indemnify such officers and directors against
certain liabilities that may arise by reason of their status or service as
directors or officers (other than liabilities arising from willful misconduct
of a culpable nature), to advance their expenses incurred as a result of any
proceeding against them as to which they could be indemnified, and to obtain
directors' and officers' insurance if available on reasonable terms.
The Company has granted options to certain of its executive officers. See
"Management--Option Grants in Last Fiscal Year" and "Principal and Selling
Stockholders."
In 1995, the Company granted to Douglas A. Lifton, Vice President of
Business Development, a loan in the principal amount of $60,000 plus interest
to help defray the cost of Mr. Lifton's relocation expenses. The principal
amount of the loan and any accrued interest thereon shall be forgiven by the
Company over three years so long as Mr. Lifton remains employed by the
Company.
The Company believes that all of the transactions set forth above were made
on terms no less favorable to the Company than could have been otherwise
obtained from unaffiliated third parties. All future transactions, including
loans (if any), between the Company and its officers, directors and principal
stockholders and their affiliates will be approved by a majority of the Board
of Directors, including a majority of the independent and disinterested
outside directors of the Board of Directors, and will be on terms no less
favorable to the Company than could be obtained from unaffiliated third
parties.
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<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership as of March 31, 1996, and as adjusted to reflect the sale of the
Common Stock offered hereby, of the Common Stock by (i) each person known by
the Company to own beneficially more than five percent of the Company's Common
Stock, (ii) each director of the Company, (iii) each Named Officer, (iv) all
executive officers and directors as a group, (v) each Selling Stockholder and
(vi) certain other stockholders of the Company.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO THE NUMBER OWNED AFTER THE
OFFERING (1)(2) OF SHARES OFFERING (1)(2)
----------------------- BEING -----------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT
- ------------------------ ------ ---------- ------- ------ -------
<S> <C> <C> <C> <C> <C>
Reese M. Jones (3)................................ 2,929,555 31.5% 378,400 2,551,155 23.6%
c/o Farallon Communications, Inc.
2470 Mariner Square Loop
Alameda, California 94501
Technology Venture Investors-4, L.P. (4).......... 1,201,410 12.9 -- 1,201,410 11.1
2480 Sand Hill Road, Suite 101
Menlo Park, CA 94025
Entities affiliated with Accel III, L.P. (5)...... 1,026,524 11.0 -- 1,026,524 9.5
One Embarcadero Center, Suite 3820
San Francisco, CA 94111
Entities affiliated with Oak Investment Partners 1,026,524 11.0 -- 1,026,524
V, L.P. (6)....................................... 9.5
One Gorham Island
Westport, CT 06880
Kelley L. Yanes (7)............................... 500,000 5.4 25,000 475,000 4.4
Entities affiliated with Hummer Winblad Venture
Partners, L.P. .................................. 370,191 4.0 -- 370,191 3.4
Entities affiliated with New Enterprise
Associates, L.P................................... 355,094 3.8 -- 355,094 3.3
Entities affiliated with Sequoia Capital, L.P..... 330,835 3.6 -- 330,835 3.1
Alan B. Lefkof (8)................................ 236,400 2.5 -- 236,400 2.1
Steven M. Bauman (9).............................. 62,750 * -- 62,750 *
Richard L. Maslana (10)........................... 39,750 * 2,250 37,500 *
Michael P. Trupiano (11).......................... 22,000 * -- 22,000 *
Didier Cop (12)................................... 11,750 * -- 11,750 *
Bandel L. Carano (13)............................. 1,026,524 11.0 -- 1,026,524 9.5
David F. Marquardt (14)........................... 1,201,410 12.9 -- 1,201,410 11.1
James R. Swartz (15).............................. 1,026,524 11.0 -- 1,026,524 9.5
All directors and officers as a group (13 persons)
(16).............................................. 6,677,800 68.8 380,650 6,297,150 56.2
<CAPTION>
OTHER SELLING STOCKHOLDERS
- --------------------------
<S> <C> <C> <C> <C> <C>
Bradley A. Adams (17)............................. 29,000 * 2,500 26,500 *
Georganne Benesch (18)............................ 8,750 * 2,000 6,750 *
Danny E. Brewer................................... 26,350 * 2,550 23,800 *
Lisa A. Cort...................................... 20,000 * 10,000 10,000 *
Marc Epard (19)................................... 118,674 1.3 12,500 106,174 *
Jesus Fortez...................................... 2,500 * 250 2,250 *
Roger B. Haack (20)............................... 53,382 * 6,000 47,382 *
Brooke A. Hauch (21).............................. 17,275 * 1,750 15,525 *
Robert K. Herrington.............................. 170,890 1.8 15,000 155,890 1.4
Robert Lewis (22)................................. 2,500 * 300 2,200 *
Joseph S. Lima (23)............................... 17,125 * 1,500 15,625 *
Kevin O'Keefe (24)................................ 5,697 * 1,000 4,697 *
Sam Roberts (25).................................. 104,250 1.1 10,000 94,250 *
Barbara Faison Tien (26).......................... 42,125 * 4,000 38,125 *
Harold Webber, Jr................................. 140,000 1.5 25,000 115,000 1.1
</TABLE>
- ----------------
* Less than 1% of the outstanding shares of Common Stock.
51
<PAGE>
- ------------------
(1) Except as indicated in the footnotes to this table and pursuant to
applicable community property laws, the persons named in the table have
sole voting and investment power with respect to all shares of Common
Stock.
(2) Percentage of beneficial ownership is calculated assuming 9,307,085
shares of Common Stock were outstanding on March 31, 1996. This
percentage also includes Common Stock of which such individual or entity
has the right to acquire beneficial ownership within 60 days of March 31,
1996, including but not limited to the exercise of an option; however,
such Common Stock shall not be deemed outstanding for the purpose of
computing the percentage owned by any other individual or entity. The
number of shares outstanding after this offering includes the 1,500,000
shares of Common Stock being offered for sale by the Company in this
offering, and assumes no exercise of the Underwriters' over-allotment
option. See "Underwriting."
(3) Includes 200,000 shares of Common Stock held by the Reese M. Jones 1996
Charitable Remainder Unitrust, some of which may be sold in this
offering.
(4) Includes 1,201,410 shares held by entities affiliated with Technology
Venture Investors-4, L.P., a limited partnership ("TVI-4"). Mr. Marquardt
is a general partner of TVI Management-4, L.P., a limited partnership
("TVI Management"), which is the general partner of TVI-4. Mr. Marquardt
disclaims beneficial ownership of the shares held by TVI-4 and its
affiliated entities except to the extent of his pecuniary interest
therein arising from his general partnership in TVI Management.
(5) Includes 882,812 shares held by Accel III L.P. ("Accel"), a limited
partnership; 61,591 shares held by Accel Investors '92 L.P., a limited
partnership; and 82,121 shares held by Accel Japan L.P., a limited
partnership. Mr. Swartz, a director of the Company, is a general partner
or a general partner of the respective general partner of Accel, Accel
Investors '92 L.P. and Accel Japan L.P. Mr. Swartz disclaims beneficial
ownership of the securities held by these entities except to the extent
of his pecuniary interest.
(6) Includes 1,004,030 shares held by Oak Investment Partners V, L.P. ("Oak
Investment"), a limited partnership, and 22,494 shares held by Oak V
Affiliates Fund, L.P., a limited partnership. Mr. Carano, a director of
the Company, is a general partner of Oak Investment and Oak V Affiliates
Fund, L.P. Mr Carano disclaims beneficial ownership of the securities
held by these entities except to the extent of his pecuniary interest
therein arising from his partnership interest in Oak Investment and Oak V
Affiliates Fund, L.P.
(7) Ms. Yanes' mailing address is P.O. Box 6931, Moraga, CA 94570.
(8) Includes 25,000 shares of Common Stock held by Alan B. Lefkof and Ann
Gordon Lefkof, Trustees of the Lefkof Family Trust of 1992, as amended,
and includes 211,400 shares in the form of stock options exercisable
within 60 days of March 31, 1996.
(9) Includes 48,750 shares of Common Stock held by Steven M. Bauman and Ina
U. Bauman, Trustees of the Steven M. Bauman & Ina U. Bauman Declaration
of Trust dated 2/17/87.
(10) Includes 32,750 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(11) Includes 22,000 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(12) Includes 11,750 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(13) Includes 1,026,524 shares beneficially owned by affiliated entities of
Oak Investment, of which Mr. Carano disclaims beneficial ownership except
as set forth above. See Note (6).
(14) Includes 1,201,410 shares beneficially owned by TVI-4, of which Mr.
Marquardt disclaims beneficial except as set forth above. See Note (4).
(15) Includes 1,026,524 shares beneficially owned by affiliated entities of
Accel, of which Mr. Swartz disclaims beneficial ownership except as set
forth above. See Note (5).
(16) Includes 402,039 shares in the form of stock options exercisable within
60 days of March 31, 1996.
(17) Includes 2,500 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(18) Includes 8,750 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(19) Includes 13,500 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(20) Includes 3,500 shares held by Mr. Haack for the benefit of his children.
(21) Includes 15,525 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(22) Includes 2,500 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(23) Includes 2,125 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(24) Includes 5,697 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(25) Includes 3,750 shares in the form of stock options exercisable within 60
days of March 31, 1996.
(26) Includes 2,125 shares in the form of stock options exercisable within 60
days of March 31, 1996.
52
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company will consist of 25,000,000
shares of Common Stock, $.001 par value, and 5,000,000 shares of Preferred
Stock, $.001 par value, after giving effect to the amendment of the Company's
Certificate of Incorporation to delete references to Series A, Series B and
Series C Preferred Stock which will occur upon conversion of such Preferred
Stock into Common Stock upon the closing of this offering and the subsequent
authorization of shares of undesignated Preferred Stock as described below.
COMMON STOCK
As of March 31, 1996, there were 3,715,878 shares of Common Stock
outstanding that were held of record by approximately 243 stockholders. The
holders of Common Stock are entitled to one vote per share on all matters to
be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding Preferred Stock, the holders of Common Stock are
entitled to receive ratably such dividends, if any, as may be declared from
time to time by the Board of Directors out of funds legally available
therefor. See "Dividend Policy." In the event of the liquidation, dissolution
or winding up of the Company, the holders of Common Stock are entitled to
share ratably in all assets remaining after payment of liabilities, subject to
prior distribution rights of Preferred Stock, if any, then outstanding. The
Common Stock has no preemptive or conversion rights or other subscription
rights. There are no redemption or sinking fund provisions applicable to the
Common Stock, except for 10,714 shares of Common Stock which are redeemable at
the option of the stockholder. All outstanding shares of Common Stock are
fully paid and nonassessable, and the shares of Common Stock to be issued upon
completion of this offering will be fully paid and nonassessable.
PREFERRED STOCK
As of March 31, 1996, there were 5,591,207 shares of Preferred Stock of the
Company. Upon consummation of this offering, each share of the Company's
Preferred Stock will convert into Common Stock at a one-to-one ratio.
Upon completion of this offering, the Company's Certificate of Incorporation
will authorize 5,000,000 shares of Preferred Stock. The Board of Directors has
the authority to issue the Preferred Stock in one or more series and to fix
the rights, preferences, privileges and restrictions thereof, including
dividend rights, dividend rates, conversion rights, voting rights, terms of
redemption, redemption prices, liquidation preferences and the number of
shares constituting any series or the designation of such series, without
further vote or action by the stockholders. The issuance of Preferred Stock
may have the effect of delaying, deferring or preventing a change in control
of the Company without further action by the stockholders and may adversely
affect the voting and other rights of the holders of Common Stock. The
issuance of Preferred Stock with voting and conversion rights may adversely
affect the voting power of the holders of Common Stock, including the loss of
voting control to others. At present, the Company has no plans to issue any of
the Preferred Stock.
ANTITAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION AND
DELAWARE LAW
Certificate of Incorporation
Under the Company's Certificate of Incorporation, the Board of Directors has
the power to authorize the issuance of up to 5,000,000 shares of Preferred
Stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without further vote or
action by the stockholders. The issuance of Preferred Stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, may have the effect of delaying, deferring or preventing a
change in control of the Company, may discourage bids for the Common Stock at
a premium over the market price of the Common stock and may adversely affect
the market price of and the voting and other rights of the holders of the
Common Stock. In addition, the Certificate of Incorporation provides that,
effective upon the closing of this offering, all stockholder actions must be
effected at a duly called meeting and not by a consent in writing. These
provisions of the Certificate of Incorporation could discourage potential
acquisition proposals and could delay or prevent a change in control of the
Company. These provisions are intended to enhance the likelihood of continuity
and
53
<PAGE>
stability in the composition of the Board of Directors and in the policies
formulated by the Board of Directors and to discourage certain types of
transactions that may involve an actual or threatened change of control of the
Company. These provisions are designed to reduce the vulnerability of the
Company to an unsolicited acquisition proposal and to discourage certain
tactics that may be used in proxy fights. Such provisions, however, could have
the effect of discouraging others from making tender offers for the Company's
shares and, as a consequence, they also may inhibit fluctuations in the market
price of the Company's shares that could result from actual or rumored
takeover attempts. Such provisions also may have the effect of preventing
changes in the management of the Company. See "Risk Factors--Effect of Certain
Charter Provisions; Antitakeover Effects of Certificate of Incorporation and
Delaware Law."
Delaware Takeover Statute
The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203"), which, subject to certain exceptions, prohibits a
Delaware corporation from engaging in any business combination with any
interested stockholder for a period of three years following the date that
such stockholder became an interested stockholder, unless: (i) prior to such
date, the board of directors of the corporation approved either the business
combination or the transaction that resulted in the stockholder becoming an
interested stockholder; (ii) upon consummation of the transaction that
resulted in the stockholder becoming an interested stockholder, the interested
stockholder owned at least 85% of the voting stock of the corporation
outstanding at the time the transaction commenced, excluding for purposes of
determining the number of shares outstanding those shares owned (x) by persons
who are directors and also officers and (y) by employee stock plans in which
employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or
exchange offer; or (iii) on or subsequent to such date, the business
combination is approved by the board of directors and authorized at an annual
or special meeting of stockholders, and not by written consent, by the
affirmative vote of at least 66 2/3% of the outstanding voting stock that is
not owned by the interested stockholder.
Section 203 defines business combination to include: (i) any merger or
consolidation involving the corporation and the interested stockholder; (ii)
any sale, transfer, pledge or other disposition of 10% or more of the assets
of the corporation involving the interested stockholder; (iii) subject to
certain exceptions, any transaction that results in the issuance or transfer
by the corporation of any stock of the corporation to the interested
stockholder; (iv) any transaction involving the corporation that has the
effect of increasing the proportionate share of the stock of any class or
series of the corporation beneficially owned by the interested stockholder; or
(v) the receipt by the interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation. In general, Section 203 defines an interested
stockholder as any entity or person beneficially owning 15% or more of the
outstanding voting stock of the corporation and any entity or person
affiliated with or controlling or controlled by such entity or person.
REGISTRATION RIGHTS
Pursuant to an agreement between the Company and the holders (or their
permitted transferees) ("Holders") of approximately 7,302,022 shares of Common
Stock and as of the date of this Prospectus (assuming no exercise of options
after March 31, 1996), the Holders are entitled to certain rights with respect
to the registration of such shares under the Securities Act of 1933, as
amended (the "Securities Act"). If the Company proposes to register any of its
securities under the Securities Act, either for its own account or for the
account of other security holders, the Holders are entitled to notice of the
registration and are entitled to include, at the Company's expense, such
shares therein, provided, among other conditions, that the underwriters have
the right to limit the number of such shares included in the registration. In
addition, certain of the Holders may require the Company at its expense on not
more than two occasions, to file a registration statement under the Securities
Act with respect to their shares of Common Stock, and the Company is required
to use its best efforts to effect the registration, subject to certain
conditions and limitations. Further, certain of the Holders may require the
Company at its expense to register their shares on Form S-3 when such form
becomes available to the Company, subject to certain conditions and
limitations.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is Chemical Mellon
Shareholder Services LLC.
54
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have 10,807,085 shares of
Common Stock outstanding (assuming no exercise of options after March 31,
1996). Of these shares, the 2,000,000 shares sold in this offering will be
freely tradeable without restriction or further registration under the
Securities Act, except that any shares purchased by "affiliates" of the
Company, as that term is defined under the Securities Act ("Affiliates"), may
generally only be sold in compliance with the limitations of Rule 144, as
promulgated under the Securities Act ("Rule 144") described below.
SALES OF RESTRICTED SHARES
Upon completion of this offering, the remaining 8,807,085 shares of Common
Stock will be deemed restricted shares ("Restricted Shares") under Rule 144.
The number of Restricted Shares available for sale in the public market is
limited by restrictions under the Securities Act and lock-up agreements under
which the holders of such shares have agreed not to sell or otherwise dispose
of any of their shares for a period of 180 days after the date of this
Prospectus without the prior written consent of Cowen & Company. On the date
of this Prospectus, 67,685 Restricted Shares in addition to the 2,000,000
shares offered hereby will be eligible for sale and 90 days after the date of
this Prospectus an additional 51,250 Restricted Shares will be eligible for
sale. Beginning 180 days after the date of this Prospectus (or earlier with
the consent of Cowen & Company), an additional 8,208,150 Restricted Shares
will become available for sale in the public market subject to certain
limitations of Rule 144 and 360 days after the date of this Prospectus an
additional 480,000 Restricted Shares will be eligible for sale.
In general, under Rule 144, as currently in effect, beginning 90 days after
this offering, a person (or persons whose shares are aggregated) who has
beneficially owned Restricted Shares for at least two years (including the
holding period of any prior owner other than an Affiliate), including a person
who may be deemed an Affiliate of the Company, is entitled to sell within any
three-month period a number of shares of Common Stock which does not exceed
the greater of one percent of the then-outstanding shares of Common Stock of
the Company (approximately 108,071 shares after giving effect to this
offering) and the average weekly trading volume of the Common Stock on the
Nasdaq National Market during the four calendar weeks preceding the date on
which notice of the sale is filed with the Securities and Exchange Commission.
Sales under Rule 144 are subject to certain restrictions relating to volume
limitations, manner of sale, notice and the availability of current public
information about the Company. In addition, Affiliates of the Company must
comply with the restrictions and requirements of Rule 144, other than the two-
year holding period requirement, in order to sell shares of Common Stock that
are not Restricted Shares. Under Rule 144(k), a person who is not an Affiliate
of the Company at any time during the three months preceding a sale, and who
has beneficially owned shares for at least three years (including the holding
period of any prior owner other than an Affiliate), would be entitled to sell
such shares immediately following this offering without regard to the volume
limitations, manner of sale, notice or other requirements of Rule 144.
However, the transfer agent may require an opinion of counsel that a proposed
sale of shares comes within the terms of Rule 144 prior to effecting a
transfer of such shares.
Prior to this offering, there has been no public market for the Common Stock
of the Company and no predictions can be made of the effect, if any, that the
sale or availability for sale of shares of additional Common Stock will have
on the market price of the Common Stock. Nevertheless, sales of substantial
amounts of such shares in the public market, or the perception that such sales
could occur, could adversely affect the market price of the Common Stock and
could impair the Company's future ability to raise capital through an offering
of its equity securities.
OPTIONS
As of March 31, 1996, options to purchase a total of 1,372,050 shares of
Common Stock pursuant to the 1987 Plan were outstanding and exercisable. Of
the 1,372,050 shares subject to options, 1,360,300 are subject to Lock-up
Agreements. See "Lock-up Agreements." An additional 294,945 shares of Common
Stock were
55
<PAGE>
available as of March 31, 1996 for future option grants under the 1987 Plan.
In addition, subsequent to March 31, 1996, 500,000 shares were reserved for
issuance under the 1996 Plan and 300,000 shares were reserved for issuance
under the Purchase Plan. See "Management--1996 Stock Option Plan," "--Employee
Stock Purchase Plan," and Notes 6 and 10 of Notes to Consolidated Financial
Statements.
Rule 701 under the Securities Act provides that shares of Common Stock
acquired on the exercise of outstanding options may be resold by persons other
than Affiliates, beginning 90 days after the date of this Prospectus, subject
only to the manner of sale provisions of Rule 144, and by Affiliates,
beginning 90 days after the date of this Prospectus, subject to all provisions
of Rule 144 except its two-year minimum holding period. The Company intends to
file one or more registration statements on Form S-8 under the Securities Act
to register all shares of Common Stock subject to outstanding stock options
and Common Stock issued or issuable pursuant to the Company's 1996 Plan. The
Company expects to file the registration statement covering shares offered
pursuant to the 1996 Plan and the Purchase Plan concurrently with the
effectiveness of this offering. Such registration statements are expected to
become effective upon filing. Shares covered by these registration statements
will thereupon be eligible for sale in the public markets, subject to the
Lock-up Agreements, if applicable.
LOCK-UP AGREEMENTS
Holders of 8,688,150 shares of Common Stock have agreed that they will not,
without the prior written consent of Cowen & Company, offer, sell, contract to
sell or otherwise dispose of any shares of Common Stock beneficially owned by
them or any shares issuable upon exercise of stock options for a period of 180
days from the effective date of this offering. See "Underwriting."
56
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the
Underwriters named below, and each of the Underwriters, for whom Cowen &
Company, Hambrecht & Quist LLC and UBS Securities LLC are acting as
representatives (the "Representatives"), has severally agreed to purchase from
the Company and the Selling Stockholders the respective number of shares of
Common Stock set forth opposite the name of such Underwriter below:
<TABLE>
<CAPTION>
NUMBER
NAME OF SHARES
---- ---------
<S> <C>
Cowen & Company...................................................
Hambrecht & Quist LLC.............................................
UBS Securities LLC................................................
---------
Total......................................................... 2,000,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters are
committed to purchase all of the shares of Common Stock offered hereby (other
than those covered by the over-allotment option described below), if any of
such shares are purchased.
The Underwriters propose to offer the shares of Common Stock in part
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus and in part to certain dealers at such price
less a concession not in excess of $ per share. The Underwriters may allow,
and such dealers may reallow, a concession not in excess of $ per share to
certain brokers and dealers. After the shares of Common Stock are released for
sale to the public, the offering price and other selling terms may from time
to time be varied by the Representatives.
The Company has granted the Underwriters an option exercisable for up to 30
days after the date of this Prospectus to purchase up to an aggregate of
300,000 additional shares of Common Stock to cover over-allotments, if any. If
the Underwriters exercise their over-allotment option, the Underwriters have
severally agreed, subject to certain conditions, to purchase approximately the
same percentage thereof that the number of shares to be purchased by each of
them as shown in the foregoing table bears to the 2,000,000 shares of Common
Stock offered hereby. The Underwriters may exercise such option only to cover
over-allotments made in connection with the sale of the 2,000,000 shares of
Common Stock offered hereby.
The Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act, as amended, and to contribute to payments the Underwriters
may be required to make in respect thereof.
The Company, the Company's officers and directors, all Selling Stockholders
and certain other stockholders and option holders of the Company have agreed
not to offer, sell, contract to sell or otherwise dispose of any shares of
Common Stock or any securities convertible into or exercisable or exchangeable
for Common Stock or any right to acquire Common Stock for a period of 180 days
after the date of this Prospectus without the prior written consent (which
consent may be given without notice to the Company's stockholders or other
public announcement) of Cowen & Company. Cowen & Company has advised the
Company that it has no present intention of releasing any of the Company's
stockholders or optionholders from such lock-up agreements until the
expiration of such 180-day period. See "Shares Eligible for Future Sale."
The Representatives have advised the Company and the Selling Stockholders
that the Underwriters do not intend to confirm sales in excess of five percent
of the shares offered hereby to any account over which they exercise
discretionary authority.
Prior to this offering, there has been no public market for the Common
Stock. Consequently, the initial public offering price will be determined by
negotiation among the Company, the Selling Stockholders and the
57
<PAGE>
Representatives. Among the factors to be considered in such negotiations are
the prevailing market conditions, the results of operations of the Company in
recent periods, the market capitalization and stage of development of other
companies that the Company, the Selling Stockholders and the Representatives
believe to be comparable to the Company, estimates of the business potential
of the Company, the present state of the Company's development, and other
factors deemed relevant. The estimated initial public offering price range set
forth on the cover of this Preliminary Prospectus is subject to change as a
result of market conditions and other factors.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission,
Washington D.C. 20549, a Registration Statement on Form S-1 under the
Securities Act and the rules and regulations promulgated thereunder, with
respect to the Common Stock offered hereby. This Prospectus, which constitutes
a part of the Registration Statement, does not contain all of the information
set forth in the Registration Statement and the exhibits and schedules
thereto. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and in
each instance reference is made to the full text of such contract or other
document which is filed as an exhibit to the Registration Statement, each such
statement being qualified in all respects by such reference. For further
information with respect to the Company and the Common Stock offered hereby,
reference is made to such Registration Statement and the exhibits and
schedules thereto. The Registration Statement, including the exhibits and
schedules thereto, may be inspected without charge at the public reference
facilities maintained by the Commission at Judiciary Plaza, 450 Fifth Street,
N.W. Room 1024, Washington, D.C. 20549, and at the Commission's regional
offices located at 7 World Trade Center, Suite 1300, New York, New York 10048
and at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661. Copies of such documents may be obtained from the Commission at its
principal office in Washington, D.C. upon the payment of the charges
prescribed by the Commission.
The Company intends to furnish to its stockholders annual reports containing
audited consolidated financial statements examined by an independent
accounting firm and quarterly reports for the first three quarters of each
fiscal year containing interim unaudited consolidated financial information.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP, Palo
Alto, California. Pillsbury Madison & Sutro LLP, Menlo Park, California, is
acting as counsel for the Underwriters in connection with certain legal
matters relating to the shares of Common Stock offered hereby.
EXPERTS
The consolidated financial statements and schedule of Farallon
Communications, Inc. as of September 30, 1995 and 1994, and for each of the
years in the three-year period ended September 30, 1995, have been included in
this Prospectus and Registration Statement in reliance upon the reports of
KPMG Peat Marwick LLP, independent certified public accountants, appearing
elsewhere herein and in the Registration Statement, and upon the authority of
said firm as experts in accounting and auditing.
58
<PAGE>
FARALLON COMMUNICATIONS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report.............................................. F-2
Consolidated Balance Sheets as of September 30, 1994, 1995 and March 31,
1996...................................................................... F-3
Consolidated Statements of Operations for the Years Ended September 30,
1993, 1994 and 1995,
and the Six Months Ended March 31, 1995 and 1996......................... F-4
Consolidated Statements of Stockholders' Equity for the Years Ended
September 30, 1993, 1994, 1995 and the Six Months Ended March 31, 1996... F-5
Consolidated Statements of Cash Flows for the Years Ended September 30,
1993, 1994 and 1995, and the Six Months Ended March 31, 1995 and 1996.... F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors Farallon Communications, Inc. and subsidiary:
We have audited the accompanying consolidated balance sheets of Farallon
Communications, Inc. and subsidiary (the Company) as of September 30, 1994 and
1995, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the years in the three-year period ended
September 30, 1995. 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 Farallon
Communications, Inc. and subsidiary as of September 30, 1994 and 1995, and the
results of their operations and their cash flows for each of the years in the
three-year period ended September 30, 1995 in conformity with generally
accepted accounting principles.
KPMG PEAT MARWICK LLP
San Francisco, California
November 20, 1995
F-2
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31, 1996
---------------- MARCH 31, PRO FORMA
1994 1995 1996 (NOTE 1)
------- ------- --------- --------------
ASSETS (UNAUDITED)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents.......... $ 2,767 $13,963 $14,079 $14,079
Short-term investments............. 11,844 3,680 504 504
Trade accounts receivable, less
allowance for doubtful accounts
and returns of $920, $1,254,
$1,238 and $1,238, respectively. 7,108 7,724 8,161 8,161
Inventories........................ 4,394 4,758 7,001 7,001
Deferred tax asset................. -- -- 1,886 1,886
Prepaid expenses and other current
assets............................ 412 1,005 1,020 1,020
------- ------- ------- -------
Total current assets............. 26,525 31,130 32,651 32,651
Furniture, fixtures, and equipment,
net................................. 2,572 2,457 2,840 2,840
Deposits and other assets............ 192 285 743 743
------- ------- ------- -------
$29,289 $33,872 $36,234 $36,234
======= ======= ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................... $ 3,668 $ 6,841 $ 5,815 $ 5,815
Accrued compensation............... 1,584 1,482 1,615 1,615
Accrued liabilities................ 803 701 568 568
Deferred income.................... 294 168 433 433
Other short-term liabilities....... 607 183 244 244
------- ------- ------- -------
Total current liabilities........ 6,956 9,375 8,675 8,675
------- ------- ------- -------
Long-term debt....................... 306 -- -- --
Other long-term liabilities.......... 383 218 131 131
------- ------- ------- -------
Total liabilities................ 7,645 9,593 8,806 8,806
------- ------- ------- -------
Redeemable common stock; 10,714
shares outstanding................... -- -- 133 --
Commitments and contingencies
Stockholders' equity:
Preferred stock:
Stated value $0.001 per share;
7,500,000 shares authorized;
5,550,899, 5,591,207, and
5,591,207 shares issued and
outstanding, respectively;
aggregate liquidation preference
of $28,116 as of March 31, 1996;
5,000,000 shares authorized,
none issued and outstanding on a
pro forma basis................. 6 6 6 --
Common stock:
Stated value $0.001 per share;
15,000,000 shares authorized;
3,470,495, 3,624,231 and
3,705,164 shares issued and
outstanding, respectively;
25,000,000 shares authorized,
9,307,085 shares issued and
outstanding on a pro forma
basis........................... 3 4 4 9
Additional paid-in capital......... 23,862 23,990 24,215 24,349
Deferred compensation.............. -- -- (84) (84)
Retained earnings (deficit)........ (2,227) 279 3,154 3,154
------- ------- ------- -------
Total stockholders' equity....... 21,644 24,279 27,295 27,428
------- ------- ------- -------
$29,289 $33,872 $36,234 $36,234
======= ======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF
OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEARS ENDED SEPTEMBER 30, MARCH 31,
---------------------------- ---------------
1993 1994 1995 1995 1996
--------- -------- -------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Internet/Intranet products. $ -- $ 5,310 $ 6,569 $ 3,188 $ 6,442
LAN products............... 48,425 51,691 50,620 26,359 23,003
--------- -------- -------- ------- -------
Total revenues........... 48,425 57,001 57,189 29,547 29,445
Cost of revenues:
Internet/Intranet products. -- 447 674 315 1,238
LAN products............... 24,302 30,368 28,842 14,722 13,942
--------- -------- -------- ------- -------
Total cost of revenues... 24,302 30,815 29,516 15,037 15,180
--------- -------- -------- ------- -------
Gross profit............. 24,123 26,186 27,673 14,510 14,265
--------- -------- -------- ------- -------
Operating expenses:
Research and development... 7,434 6,671 8,429 4,022 4,315
Selling and marketing...... 14,087 13,983 13,691 6,765 7,582
General and administrative. 3,216 3,228 2,888 1,488 1,841
Restructuring costs........ 1,048 -- -- -- --
--------- -------- -------- ------- -------
Total operating expenses. 25,785 23,882 25,008 12,275 13,738
--------- -------- -------- ------- -------
Operating income (loss).. (1,662) 2,304 2,665 2,235 527
--------- -------- -------- ------- -------
Other income, net............ 249 291 815 324 433
--------- -------- -------- ------- -------
Income (loss) before income
taxes........................ (1,413) 2,595 3,480 2,559 960
Income tax expense (benefit). 1 408 974 716 (1,915)
--------- -------- -------- ------- -------
Net income (loss).......... $ (1,414) $ 2,187 $ 2,506 $ 1,843 $ 2,875
========= ======== ======== ======= =======
Pro forma net income per
share data (Note 1):
Pro forma net income per
share........................ $ 0.25 $ 0.19 $ 0.27
======== ======= =======
Weighted average shares
used in per share
computation............. 9,891 9,841 10,477
======== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOREIGN
PREFERRED STOCK COMMON STOCK ADDITIONAL DEFERRED RETAINED CURRENCY TOTAL
---------------- ---------------- PAID-IN COMPEN- EARNINGS TRANSLATION STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL SATION (DEFICIT) ADJUSTMENT EQUITY
--------- ------ --------- ------ ---------- -------- --------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, September 30,
1992................... 5,373,211 $ 5 2,996,566 $ 3 $23,387 $ -- $(3,000) $-- $20,395
Issuance of common stock
bonus.................. -- -- 47,500 -- 57 -- -- -- 57
Issuance of common stock
in license settlement.. -- -- 45,000 -- 54 -- -- -- 54
Exercise of stock
options................ 39,438 -- 131,147 -- 113 -- -- -- 113
Net loss................ -- -- -- -- -- -- (1,414) -- (1,414)
Functional currency
change -- -- -- -- -- -- -- (29) (29)
--------- --- --------- --- ------- ---- ------- --- -------
Balances, September 30,
1993................... 5,412,649 5 3,220,213 3 23,611 -- (4,414) (29) 19,176
Exercise of stock
options................ 138,250 1 250,282 -- 251 -- -- -- 252
Net income.............. -- -- -- -- -- -- 2,187 -- 2,187
Functional currency
change................. -- -- -- -- -- -- -- 29 29
--------- --- --------- --- ------- ---- ------- --- -------
Balances, September 30,
1994................... 5,550,899 6 3,470,495 3 23,862 -- (2,227) -- 21,644
Exercise of stock
options................ 40,308 -- 153,486 1 128 -- -- -- 129
Issuance of common stock
bonus.................. -- -- 250 -- -- -- -- -- --
Net income.............. -- -- -- -- -- -- 2,506 -- 2,506
--------- --- --------- --- ------- ---- ------- --- -------
Balances, September 30,
1995................... 5,591,207 6 3,624,231 4 23,990 -- 279 -- 24,279
Exercise of stock
options (unaudited).... -- -- 72,362 -- 76 -- -- -- 76
Issuance of common stock
for consulting services
(unaudited)............ -- -- 5,000 -- 30 -- -- -- 30
Issuance of common stock
for rights and services
(unaudited)............ -- -- 3,571 -- 29 -- -- -- 29
Deferred compensation
related to grant of
stock options
(unaudited)............ -- -- -- -- 90 (90) -- -- --
Amortization of deferred
compensation
(unaudited)............ -- -- -- -- -- 6 -- -- 6
Net income (unaudited).. -- -- -- -- -- -- 2,875 -- 2,875
--------- --- --------- --- ------- ---- ------- --- -------
Balances, March 31, 1996
(unaudited)............ 5,591,207 $ 6 3,705,164 $ 4 24,215 $(84) $ 3,154 $-- $27,295
========= === ========= === ======= ==== ======= === =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH
FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEARS ENDED SEPTEMBER 30, MARCH 31,
---------------------------- --------------
1993 1994 1995 1995 1996
-------- -------- -------- ------ ------
CASH FLOWS FROM OPERATING
ACTIVITIES: (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net income (loss)................ $ (1,414) $ 2,187 $ 2,506 $1,843 $2,875
Adjustments to reconcile net
income (loss) to
net cash provided by operating
activities:
Depreciation and amortization.. 1,646 1,443 1,466 740 817
Deferred income taxes.......... -- -- -- -- (2,254)
Amortization of deferred
compensation.................. -- -- -- -- 6
Noncash restructuring expenses. 523 -- -- -- --
Noncash compensation........... 111 -- -- -- 192
Change in doubtful accounts and
returns
on accounts receivable...... 191 (364) 334 311 (16)
Changes in operating assets and
liabilities:
Trade accounts receivable.... (712) 1,368 (838) (619) (421)
Inventories.................. (2,517) 763 (363) 429 (2,243)
Prepaid expenses and other
current assets.............. 433 158 (593) 23 (15)
Deposits and other assets.... (20) 2 (109) (54) (100)
Accounts payable and accrued
liabilities................. 1,742 (839) 2,968 1,092 (1,026)
Deferred income.............. 667 (373) (125) (90) 265
Accrued restructuring costs.. (492) (150) -- -- --
Other liabilities............ 124 (558) (257) (308) (26)
-------- -------- -------- ------ ------
Net cash provided by (used
in) operating
activities................ 282 3,637 4,989 3,367 (1,946)
-------- -------- -------- ------ ------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of furniture,
fixtures, and equipment....... (2,021) (637) (1,335) (410) (1,190)
Purchase of short-term
investments................... (9,221) (20,994) (7,273) (3,685) (999)
Proceeds from the sale of
short-term investments........ 1,984 16,498 15,325 10,363 4,175
-------- -------- -------- ------ ------
Net cash provided by (used
in) investing
activities................ (9,258) (5,133) 6,717 6,268 1,986
-------- -------- -------- ------ ------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from long-term loan... 1,000 -- -- -- --
Exercise of stock options...... 113 252 129 103 76
Net repayments on loans and
line of credit................ (28) (333) (639) -- --
-------- -------- -------- ------ ------
Net cash provided by (used
in) financing
activities................ 1,085 (81) (510) 103 76
-------- -------- -------- ------ ------
Effect of foreign currency
translation...................... (29) 29 -- -- --
-------- -------- -------- ------ ------
Net increase (decrease) in cash
and cash equivalents............. (7,920) (1,548) 11,196 9,738 116
Cash and cash equivalents,
beginning of period.............. 12,235 4,315 2,767 2,767 13,963
-------- -------- -------- ------ ------
Cash and cash equivalents, end of
period........................... $ 4,315 $ 2,767 $ 13,963 12,505 14,079
======== ======== ======== ====== ======
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Interest paid.................. $ 31 $ 94 $ 57 $ 35 $ 2
======== ======== ======== ====== ======
Income taxes paid.............. $ -- $ -- $ 1,014 $ 640 $ 477
======== ======== ======== ====== ======
SUPPLEMENTAL DISCLOSURE OF
NONCASH FINANCING ACTIVITIES:
Accrual of stock option
deferred compensation.......... -- -- -- -- $ 90
======== ======== ======== ====== ======
Issuance of common stock for
consulting services............ -- -- -- -- $ 30
======== ======== ======== ====== ======
Issuance of common stock and
redeemable common stock for
rights and services........... -- -- -- -- $ 162
======== ======== ======== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF MARCH 31, 1995 AND 1996 AND FOR THE SIX MONTHS THEN ENDED
ARE UNAUDITED)
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Farallon Communications, Inc. (the Company), formerly Farallon Computing,
Inc., develops, markets, and supports complete, easy-to-use, plug-and-play
Internet connectivity and networking solutions and real-time collaboration
software. Historically, revenues attributable to the Company's
Internet/Intranet products have primarily resulted from the licensing of
software, and revenues attributable to the Company's LAN products have
primarily resulted from the sale of hardware.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary located in France. All significant
intercompany balances and transactions have been eliminated in consolidation.
In fiscal 1994, the Company changed the functional currency for its French
subsidiary to the U.S. dollar.
Pro Forma Balance Sheet
In April 1996, the Board of Directors authorized the filing of a
registration statement with the Securities and Exchange Commission (SEC)
permitting the Company to sell shares of its common stock in connection with a
proposed initial public offering (IPO). If the offering is consummated under
the terms and at the pricing presently anticipated, all the currently
outstanding preferred stock will automatically convert to 5,591,207 shares of
common stock upon closing of the IPO, and the demand repurchase right on the
redeemable common stock will expire. The effect of the above transactions has
been reflected in the accompanying pro forma consolidated balance sheet as of
March 31, 1996.
Cash Equivalents and Short-Term Investments
Cash equivalents consist of instruments with purchased maturities of 90 days
or less.
In 1995, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities. In accordance with SFAS No. 115, prior period financial statements
have not been restated to reflect the change in accounting principle. The
cumulative effect of adopting SFAS No. 115 was not material to the Company's
financial position and results of operations. Cash equivalents and all of the
Company's investments are classified as available-for-sale under the
provisions of SFAS No. 115. The securities are carried at fair value and any
unrealized gains or losses that are material would be reported as a separate
component of stockholders' equity.
The amortized cost of available-for-sale debt securities are adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in other income, net. Realized gains and losses, and
declines in value judged to be other than temporary on available-for-sale
securities are included in other income, net. The cost of securities sold is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in other income, net.
Revenue Recognition
The Company recognizes revenues from licenses of computer software provided
that a firm purchase order has been received, the software and related
documentation have been shipped, collection of the resulting receivable is
deemed probable, and no other significant vendor obligations exist.
Maintenance and service revenues, which have been relatively immaterial, are
recognized over the period in which services are provided. Hardware revenues
are recognized upon shipment.
F-7
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1995 AND 1996 AND FOR THE SIX MONTHS THEN ENDED
ARE UNAUDITED)
Certain of the Company's sales are made to customers under agreements
permitting right of return for stock balancing. Revenue is recorded net of an
estimated allowance for returns.
Concentrations of Credit Risk
Financial instruments that potentially expose the Company to concentrations
of credit risk principally consist of cash, cash equivalents, short-term
investments, and accounts receivable.
The Company limits the amounts invested in any one type of investment. The
Company maintains its cash investments with several financial institutions.
Management believes the financial risks associated with such deposits are
minimal.
The Company sells its products primarily through distributors and other
large scale resellers. Sales are generally not collateralized, credit
evaluations are performed as appropriate, and allowances are provided for
estimated credit losses. Historically, the Company has not experienced
significant losses on trade receivables from any particular customer,
industry, or geographic region.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by
the first-in, first-out (FIFO) method.
Furniture, Fixtures, and Equipment
Furniture, fixtures, and equipment are stated at cost. Depreciation is
calculated using the straight-line method over the shorter of estimated useful
lives or related lease terms ranging from one to seven years.
Software Development Costs
Product development costs include costs related to software products that
are expensed as incurred until the technological feasibility of the product
has been established. The Company has defined technological feasibility as
completion of a working model. After technological feasibility is established,
any additional software development costs would be capitalized in accordance
with SFAS No. 86. Through March 31, 1996, the Company believes its process for
developing software was essentially completed concurrently with the
establishment of technological feasibility and no software development costs
have been capitalized to date.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years that those temporary
differences are expected to be recovered or settled. 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>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1995 AND 1996 AND FOR THE SIX MONTHS THEN ENDED
ARE UNAUDITED)
Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, Accounting for Stock-Based Compensation. SFAS No. 123 will be effective
for fiscal years beginning after December 15, 1995, and will require that the
Company either recognize in its financial statements costs related to its
employee stock-based compensation plans, such as stock option and stock
purchase plans, or make pro forma disclosure of such costs in a footnote to
the consolidated financial statements.
The Company expects to continue to use the intrinsic value based method of
Accounting Principles Board Opinion No. 25, as allowed under SFAS No. 123, to
account for all of its employee stock-based compensation plans. Therefore, in
its consolidated financial statements for fiscal 1996, the Company will make
the required pro forma disclosures in a footnote to the consolidated financial
statements. SFAS No. 123 is not expected to have material effect on the
Company's results of operations or financial position.
Use of Estimates
The preparation of the consolidated 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
disclosures of contingent assets and liabilities at the date of the
consolidated financial statements and the recorded amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Pro Forma Net Income Per Share
Pro forma net income per share is based on the weighted average number of
shares of common stock, common equivalent shares from the convertible
preferred stock using the "as-converted" method and dilutive common equivalent
share from options outstanding during the period using the treasury stock
method.
Pursuant to certain SEC Staff Accounting Bulletins, common stock issued for
consideration below the assumed IPO price and stock options granted with
exercise prices below the assumed IPO price during the 12-month period prior
to the date of the initial filing of the registration statement, even when
antidilutive, have been included in the calculation of pro forma net income
per share, using the treasury stock method based on the assumed IPO price, as
if they were outstanding for all periods presented prior to their issuance or
grant.
Interim Financial Statements
The accompanying unaudited consolidated financial statements for the six
months ended March 31, 1996 and 1995 have been prepared on substantially the
same basis as the audited consolidated financial statements, and include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the consolidated financial information set forth therein.
2. INVENTORIES
Inventories consisted of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------- MARCH 31,
1994 1995 1996
------ ------ ---------
<S> <C> <C> <C>
Raw materials and work in process..................... $2,232 $1,594 $2,808
Finished goods........................................ 2,162 3,164 4,193
------ ------ ------
$4,394 $4,758 $7,001
====== ====== ======
</TABLE>
F-9
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1995 AND 1996 AND FOR THE SIX MONTHS THEN ENDED
ARE UNAUDITED)
3. FURNITURE, FIXTURES, AND EQUIPMENT
Furniture, fixtures, and equipment consisted of the following (in
thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------- MARCH 31,
1994 1995 1996
------- ------- ---------
<S> <C> <C> <C>
Office equipment.................................. $ 1,692 $ 2,296 $ 2,827
Furniture and fixtures............................ 1,070 1,091 1,182
Computers......................................... 5,223 5,916 6,482
Leasehold improvements............................ 491 508 510
------- ------- -------
8,476 9,811 11,001
Accumulated depreciation and amortization......... (5,904) (7,354) (8,161)
------- ------- -------
$ 2,572 $ 2,457 $ 2,840
======= ======= =======
</TABLE>
4. INCOME TAXES
Income tax expense consisted of the following (in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEARS ENDED SEPTEMBER 30, MARCH 31,
--------------------------- -------------
1993 1994 1995 1995 1996
-------- -------- -------- ---- -------
<S> <C> <C> <C> <C> <C>
Current:
Federal......................... $ -- $ 350 $ 922 $678 $ 307
State........................... 1 43 16 12 31
Foreign......................... -- 15 36 26 --
------- -------- -------- ---- -------
1 408 974 716 338
------- -------- -------- ---- -------
Deferred.......................... -- -- -- -- (2,253)
------- -------- -------- ---- -------
Total tax expense (benefit)... $ 1 $ 408 $ 974 $716 $(1,915)
======= ======== ======== ==== =======
Income tax expense differs from the amounts computed by applying the
statutory income tax rate of 34% to pretax income as a result of the following
(in thousands):
<CAPTION>
SIX MONTHS
ENDED
YEARS ENDED SEPTEMBER 30, MARCH 31,
--------------------------- -------------
1993 1994 1995 1995 1996
-------- -------- -------- ---- -------
<S> <C> <C> <C> <C> <C>
Computed "expected" tax expense
(benefit) of 34%.................. $ (480) $ 882 $ 1,183 $870 $ 327
Change in the beginning balance of
the valuation allowance for
deferred tax assets.............. 469 (530) 187 150 (2,253)
Research credits.................. -- -- (433) (316) --
Other, net........................ 12 56 37 12 11
------- -------- -------- ---- -------
$ 1 $ 408 $ 974 $716 $(1,915)
======= ======== ======== ==== =======
</TABLE>
F-10
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1995 AND 1996 AND FOR THE SIX MONTHS THEN ENDED
ARE UNAUDITED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are presented below (in
thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1995 1996
------------- ---------
<S> <C> <C>
Deferred tax asset:
Reserves and accruals not currently deductible...... $ 1,174 $1,402
Deferred rent....................................... 141 113
Research credit..................................... 730 415
Alternative minimum tax credit carryforward......... 90 92
Other............................................... 160 160
------- ------
Total gross deferred tax assets................... 2,295 2,182
Less valuation allowance.......................... (2,295) --
------- ------
Net deferred tax assets........................... $ -- $2,182
======= ======
</TABLE>
The net change in the total valuation allowance for the year ended September
30, 1995 and for the six-months ended March 31, 1996 were an increase of
$187,000 and a decrease of $2,295,000, respectively. As of September 30, 1995,
the Company believed that, based upon available objective evidence, there was
sufficient uncertainty regarding the realizability of its deferred tax assets
to warrant a full valuation allowance. The factors considered included prior
losses, inconsistent profits, lack of carryback potential to realize deferred
tax assets, dependence on LAN products and associated declining market and
gross margins for LAN products, and dependence upon Apple.
As of March 31, 1996, the Company believes that due to the demonstrated
market acceptance of Internet/Intranet products over the last two quarters,
the uncertainty regarding the realizability of its deferred tax assets has
diminished to the point where it is now more likely than not that the deferred
tax assets will be realized.
As of September 30, 1995, the Company had research credit carryforwards of
approximately $515,000 and $215,000 for federal and state tax purposes,
respectively. If not utilized, the federal credit carryforwards will expire in
2006 through 2010. Also, the Company had alternative minimum tax credit
carryforwards of approximately $90,000.
5. CREDIT FACILITIES
As of September 30, 1994, the Company had a $3,000,000 facility secured by
substantially all assets of the Company, comprised of a $2,000,000 revolving
working capital line of credit and a $1,000,000 term loan. Borrowings under
the revolving capital line of credit accrued interest at the prime rate plus
1/2%, and borrowings under the term loan facility accrued interest at the
prime rate plus 1-1/2%. The credit facility expired on January 5, 1995.
Borrowings under the term loan facility as of September 30, 1994 and 1995 were
$639,000 and $0, respectively, with an interest rate of approximately 8.25%.
In November 1995, the Company obtained a $5,000,000 line of credit, bearing
interest at 8.75%. The principal balance plus accrued interest is due on
February 28, 1997. There were no borrowings outstanding under the line of
credit as of March 31, 1996.
F-11
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1995 AND 1996 AND FOR THE SIX MONTHS THEN ENDED
ARE UNAUDITED)
6. STOCKHOLDERS' EQUITY AND STOCK OPTION PLAN
Preferred Stock
The Company has 7,500,000 shares of authorized preferred stock of which
5,822,072 shares have been designated as Series A, B and C shares.
The holders of these shares are entitled to receive cash dividends, when
declared, prior to any payment of dividends to holders of common stock at the
rate of $.24 per share per annum for Series A; $.46 per share per annum for
Series B; and $.64 per share per annum for Series C. Dividends are not
cumulative.
In the event of any liquidation, dissolution, winding up, sale of
substantially all assets, merger, or disposition of more than 50% of the
voting power of the Company, the holders of Series A, B, and C shares are
entitled to receive, prior to any distribution to the holders of common stock,
$3.00, $5.78 and $8.00 per share, respectively, plus declared but unpaid
dividends. Remaining assets would then be distributed among the holders of
common stock, the Series B and C stockholders pro rata based upon the number
of shares of common stock held by each (on an as-converted basis); provided
that distributions with respect to Series B shall cease when the holders have
received an aggregate of $11.56 per share, and distributions with respect to
Series C shall cease when the holders have received an aggregate of $16.00 per
share. Any remaining assets would be distributed pro rata among the holders of
common stock.
Each preferred share may be converted to common stock at any time on a one-
for-one basis, subject to certain conversion price antidilution adjustments.
The shares automatically convert into common stock, upon consummation of an
initial public offering of the Company's stock at an offering price of not
less than $13.00 per share (adjusted to reflect stock dividends, stock splits,
or recapitalizations) and with proceeds to the Company of at least
$10,000,000. The related number of shares of common stock are reserved for
issuance upon conversion.
The Company's certificate of Incorporation provides that so long as at least
150,000 shares of Series B remain outstanding, the holders of Series B are
entitled, voting separately as a class, to elect one member of the Board of
Directors of the Company. So long as at least 1,500,000 shares of Series C
remain outstanding, the holders of Series C are entitled, voting separately as
a class, to elect two members of the Board of Directors of the Company. The
holders of Series A and common stock, voting together and not as separate
classes, are entitled to elect two members of the Board of Directors of the
Company. The bylaws indicate the total members of the Board of Directors to be
no less than five and no more than seven. Remaining members of the Board of
Directors are elected by the holders of Series A, B, C and common stock voting
together as determined in the voting agreement.
Certain of the stockholders of the Company (including all of the holders of
the Series B and C, and a majority of the holders of common stock and Series
A) entered into a voting agreement in March 1992 to vote or act with respect
to the outstanding shares of the Company, in connection with the election of
directors, so that there shall be one designee of a majority of the Series B
holders; two designees of a majority of the Series C holders; and three
designees of a majority of the holders of Series A and common stock. In
addition, such stockholders agreed to vote or act with respect to the
outstanding shares of the Company so as to always elect as a seventh director
an individual designated by at least four of the initial Board designees. In
the event that four of these designees can not agree as to such seventh
director, such stockholders have agreed to vote or act so as to leave one
vacancy on the Board of Directors. The voting agreement will terminate upon
the earlier of (i) the date when there are less than 1,650,000 shares of
Series B and C shares outstanding, or (ii) upon consummation of the Company's
IPO on a firm underwriting basis with aggregate proceeds to the Company in
excess of $10,000,000.
The holders of Series B and C are entitled to vote separately as a class on
any matter affecting the rights, preferences, and privileges of Series B and
C, and in respect of certain other material transactions affecting the
F-12
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1995 AND 1996 AND FOR THE SIX MONTHS THEN ENDED
ARE UNAUDITED)
Company. These holders also have the right, under certain circumstances, to
demand the Company file a registration statement under the Securities Act of
1933. The Company has also granted to the holders of Series B and C the right
of first refusal to purchase up to one half of their pro rata share of any new
securities issued by the Company, subject to certain exceptions and
restrictions.
Redeemable Common Stock
In March 1996, the Company issued 14,285 shares of common stock for services
previously rendered. The stockholder has the right to demand that the Company
repurchase up to 10,714 shares (shown as redeemable common stock in the
accompanying March 31, 1996 balance sheet) should the Company's share price
not achieve a publicly traded value of at least $14.00 per share on selected
dates during a two-year period. The redemption value as of March 31, 1996 is
recorded as the present value of the future repurchases, or $133,000. If the
Company's proposed IPO is consummated under the terms and at the pricing
presently anticipated, the demand repurchase right on the redeemable common
stock will expire.
Stock Option Plan
The Company has a stock option plan (the Plan) providing for the issuance of
incentive or nonstatutory options to directors, employees, and nonemployee
consultants. Options are granted at the discretion of the Board of Directors.
Incentive stock may be granted at not less than 100% of the fair market
value per share and nonstatutory stock options may be granted at not less than
85% of the fair market value per share at the date of grant as determined by
the Board of Directors or committee thereof, except for options granted to a
person owning greater than 10% of the total combined voting power of all
classes of stock of the Company, for which the exercise price of the options
must be not less than 110% of the fair market value.
Options granted under the Plan normally vest over five years commencing on
the date of grant. The options expire 10 years from the date of grant.
In 1990, the Company effected a recapitalization whereby each share of the
Company's common stock outstanding or reserved for issuance upon exercise of
options was converted into a unit for one share of common stock and one share
of Series A preferred stock. The options relating to these units are included
in the table below.
The Company has the right of first refusal to acquire shares obtained by the
exercise of options at a price equal to or greater than the price being
offered for such shares by a third party. For options granted prior to
February 22, 1991, the Company has a right to repurchase shares obtained by
the exercise of options in the event of termination of employment of the
optionee stockholder at a price equal to fair market value (as determined by
the Board of Directors) on the date of termination of employment.
Farallon has recorded deferred compensation of $90,000 for the difference
between the grant price and the deemed fair value of the common stock
underlying the options granted during the six months ended March 31, 1996.
This amount is being amortized over the vesting period of the individual
options, generally five years. Amortization of deferred compensation is
charged to operating expense.
F-13
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1995 AND 1996 AND FOR THE SIX MONTHS THEN ENDED
ARE UNAUDITED)
The following table summarizes activity under the Plan:
<TABLE>
<CAPTION>
INCENTIVE STOCK OPTIONS
-------------------------------------------------
UNITS OF 1 SHARE
EACH COMMON STOCK AND
COMMON STOCK SERIES A PREFERRED STOCK
--------------------- ---------------------------
NUMBER OF PRICE NUMBER OF PRICE
OPTIONS RANGE OPTIONS RANGE
--------- ---------- ---------------------------
<S> <C> <C> <C> <C>
Outstanding as of September
30, 1992...................... 1,083,061 $1.00-1.20 217,996 $1.00-3.68
Options granted............... 457,525 1.20 --
Options exercised............. (91,709) 1.00-1.20 (39,438) $ 1.00-3.68
Options canceled.............. (178,620) 1.00-1.20 --
--------- -----------
Outstanding as of September
30, 1993...................... 1,270,257 1.00-1.20 178,558 $ 1.00-3.68
Options granted............... 214,825 1.20 --
Options exercised............. (112,032) 1.00-1.20 (138,250) $1.00
Options canceled.............. (316,663) 1.00-1.20 --
--------- ---------- -----------
Outstanding as of September
30, 1994...................... 1,056,387 1.00-1.20 40,308 $3.68
Options granted .............. 517,975 1.20-1.60 --
Options exercised ............ (113,177) 1.00-1.20 (40,308) $3.68
Options canceled ............. (110,646) 1.00-1.60 --
--------- ---------- -----------
Outstanding as of September
30, 1995 ..................... 1,350,539 1.00-1.60 --
Options granted (unaudited) .. 177,400 1.60-5.50 --
Options exercised (unaudited)
............................. (72,362) 1.60-5.50 --
Options canceled (unaudited) . (83,527) 1.00-4.00 --
--------- ---------- -----------
Outstanding as of March 31,
1996 (unaudited) ............. 1,372,050 $1.00-5.50 --
========= ===========
Exercisable (unaudited)....... 613,798 --
========= ===========
</TABLE>
7. COMMITMENTS AND CONTINGENCIES
Leases
The Company conducts its operations in leased facilities and with equipment
under operating lease agreements expiring at various dates through 1998.
The following is a schedule of future minimum rental payments required under
these leases that have initial or remaining noncancelable lease terms in excess
of one year (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING SEPTEMBER 30,
- -------------------------
<S> <C>
1996................................................................. $1,178
1997................................................................. 1,101
1998................................................................. 275
------
Total minimum lease payments...................................... $2,554
======
</TABLE>
Total rental expense for all operating leases amounted to approximately
$1,277,000, $1,092,000, $1,169,000 and $549,000 for the years ended September
30, 1993, 1994 and 1995, and the six months ended March 31, 1996, respectively.
F-14
<PAGE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1995 AND 1996 AND FOR THE SIX MONTHS THEN ENDED
ARE UNAUDITED)
Litigation
The Company is involved in various legal matters that have arisen in the
normal course of business. Management believes, after consultation with
counsel, any liability that may result from the disposition of such legal
matters will not have a material adverse effect on the Company's financial
condition.
Plan for Savings and Investments
The Company maintains a plan for savings and investments under which
eligible employees may contribute up to 15% of their annual compensation. In
addition, the Company may make discretionary retirement contributions to the
plan. No discretionary retirement contributions were made in any period
presented.
8. RESTRUCTURING OF OPERATIONS
In fiscal 1993, the Company reduced its number of employees and identified
certain product discontinuances and the impairment of associated assets as
part of a restructuring and recorded a nonrecurring charge of $1,048,000.
9. SIGNIFICANT CUSTOMERS
During the years ended September 30, 1993, 1994 and 1995, one customer
accounted for approximately 24%, 24% and 22%, respectively, and a second
customer accounted for approximately 12%, 12% and 13%, respectively, of total
net revenues. A third customer accounted for 10% of total revenues in 1993.
International revenue accounted for approximately 25%, 25% and 29% of net
revenue for the years ended September 30, 1993, 1994 and 1995, respectively.
10. SUBSEQUENT EVENTS (UNAUDITED)
Delaware Reincorporation
Prior to the completion of the IPO, the Company will be reincorporated in
the State of Delaware with authorized capital consisting of 25,000,000 shares
of $0.001 par value common stock and 5,000,000 shares of $0.001 par value
preferred stock.
Stock Split
On April 16, 1996, the Company's Board of Directors authorized a one-for-two
reverse stock split on outstanding shares and options. Accordingly, all share
and per share amounts have been adjusted to reflect the stock split.
1996 Stock Option Plan
On April 16, 1996, the Board adopted (subject to stockholder approval) the
1996 Stock Option Plan (the "1996 Plan"). The 1996 Plan succeeds the previous
equity incentive program and 2,166,995 shares of the Company's common stock
have been authorized under the 1996 Plan. This share reserve is comprised of
(i) 294,945 shares available for issuance under the predecessor plan and
1,372,050 shares subject to outstanding options thereunder at March 31, 1996
and (ii) an additional increase of 500,000 shares. Included in the 1996 Plan
is a provision for the automatic grant of nonstatutory options to nonemployee
Board of Director members of 25,000 shares on the effective date of the
Company's proposed IPO at the initial offering price. Thereafter, each new
director will be granted an option to purchase 25,000 shares of common stock
on the date they become a Board member of the Company at the then current fair
market value. Options issued to Directors are exercisable immediately subject
to the Company's right of repurchase, which will lapse ratably over five years
or upon the Director's departure from the Board.
1996 Employee Stock Purchase Plan
On April 16, 1996, the Board adopted (subject to stockholder approval) the
1996 Employee Stock Purchase Plan (the "Purchase Plan") and reserved 300,000
shares of common stock for issuance under the Purchase Plan.
F-15
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS NOT CONTAINED HEREIN
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING
STOCKHOLDERS, ANY OF THE UNDERWRITERS OR BY ANY OTHER PERSON. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY
SECURITIES OTHER THAN THE SHARES OF COMMON STOCK OFFERED HEREBY, NOR DOES IT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE
SECURITIES OFFERED HEREBY, TO ANY PERSON IN ANY JURISDICTION IN WHICH IT IS
UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION TO SUCH PERSON. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
-------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 5
Use of Proceeds........................................................... 15
Dividend Policy........................................................... 15
Capitalization............................................................ 16
Dilution.................................................................. 17
Selected Consolidated Financial Information............................... 18
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 20
Business.................................................................. 28
Management................................................................ 43
Certain Transactions...................................................... 50
Principal and Selling Stockholders........................................ 51
Description of Capital Stock.............................................. 53
Shares Eligible for Future Sale........................................... 55
Underwriting.............................................................. 57
Additional Information.................................................... 58
Legal Matters............................................................. 58
Experts................................................................... 58
Consolidated Financial Statements......................................... F-1
</TABLE>
-------------------
UNTIL , 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN
THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2,000,000 Shares
[LOGO OF FARALLON COMMUNICATIONS, INC.]
Common Stock
-------------------
PROSPECTUS
-------------------
COWEN & COMPANY
HAMBRECHT & QUIST
UBS SECURITIES LLC
, 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Company in connection
with the sale of Common Stock being registered. All amounts are estimates
except the SEC registration fee and the NASD filing fees.
<TABLE>
<S> <C>
SEC Registration fee............................................ $11,897
NASD fee........................................................ 3,950
Nasdaq National Market listing fee.............................. 45,000
Printing and engraving expenses................................. 100,000
Legal fees and expenses......................................... 250,000
Accounting fees and expenses.................................... 190,000
Blue sky fees and expenses...................................... 15,000
Transfer agent fees............................................. 10,000
Miscellaneous fees and expenses................................. 174,153
--------
Total......................................................... $800,000
========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law authorizes a court to
award or a corporation's Board of Directors to grant indemnification to
directors and officers in terms sufficiently broad to permit such
indemnification under certain circumstances for liabilities (including
reimbursement for expenses incurred) arising under the Securities Act of 1933,
as amended (the "Securities Act"). Article VII, Section 6, of the Registrant's
Bylaws provides for mandatory indemnification of its directors and officers
and permissible indemnification of employees and other agents to the maximum
extent permitted by the Delaware General Corporation Law. The Registrant's
Certificate of Incorporation provides that, pursuant to Delaware law, its
directors shall not be liable for monetary damages for breach of the
directors' fiduciary duty as directors to the Company and its stockholders.
This provision in the Certificate of Incorporation does not eliminate the
directors' fiduciary duty, and in appropriate circumstances equitable remedies
such as injunctive or other forms of non-monetary relief will remain available
under Delaware law. In addition, each director will continue to be subject to
liability for breach of the director's duty of loyalty to the Company for acts
or omissions not in good faith or involving intentional misconduct, for
knowing violations of law, for actions leading to improper personal benefit to
the director, and for payment of dividends or approval of stock repurchases or
redemptions that are unlawful under Delaware law. The provision also does not
affect a director's responsibilities under any other law, such as the federal
securities laws or state or federal environmental laws. The Registrant has
entered into Indemnification Agreements with its officers and directors, a
form of which is attached as Exhibit 10.1 hereto and incorporated herein by
reference. The Indemnification Agreements provide the Registrant's officers
and directors with further indemnification to the maximum extent permitted by
the Delaware General Corporation Law. Reference is made to Section 6 of the
Underwriting Agreement contained in Exhibit 1.1 hereto, indemnifying officers
and directors of the Registrant against certain liabilities.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since January 1, 1993, the Registrant has sold and issued 521,764 shares
(assuming no exercise of stock options after March 31, 1995) of its Common
Stock and 208,745 shares of its Series A Preferred Stock to employees pursuant
to exercises of options under its 1987 Stock Option Plan. These issuances were
deemed exempt from registration under the Act in reliance upon Rule 701
promulgated under the Act. In addition, the recipients of securities in each
transaction represented their intentions to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates and warrants issued in such transactions. All recipients had
adequate access, through their relationships with the Registrant, to
information about the Registrant.
II-1
<PAGE>
In February 1996, the Registrant issued to Allison C. Ross 5,000 shares of
Common Stock in exchange for consulting services rendered to the Company. In
March 1996, the Registrant issued to Brian Thorson 14,285 shares of Common
Stock in exchange for consulting services rendered to the Company. The
issuances of these securities to Ms. Ross and Mr. Thorson were deemed to be
exempt from registration in reliance on Section 4(2) of the Securities Act as
transactions by an issuer not involving any public offering. In addition, Ms.
Ross and Mr. Thorson have represented their intentions to acquire the
securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed
to the share certificates issued in such transactions. Ms. Ross and Mr.
Thorson had adequate access, through their relationships with the Registrant,
to information about the Registrant.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
*1.1 Form of Underwriting Agreement.
*2.1 Agreement and Plan of Merger for the reincorporation merger of
Farallon Communications, Inc. a California corporation into Farallon
Communications, Inc., a Delaware Corporation.
*3.1 Articles of Incorporation of the Registrant, as amended to date.
*3.2 Certificate of Incorporation filed in connection with the
reincorporation of the Registrant.
*3.3 Form of Amended and Restated Certificate of Incorporation to be filed
upon the closing of the offering made pursuant to this Registration
Statement.
*3.4 Bylaws of the Registrant.
*3.5 Form of Bylaws of the Registrant to be effective after the
reincorporation of the Registrant.
*3.6 Form of Amended and Restated Bylaws of the Registrant to be effective
after the closing of the offering made pursuant to this Registration
Statement.
*4.1 Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4, 3.5 and 3.6.
*4.2 Amended and Restated Investor Rights Agreement, dated March 27, 1992,
among the Registrant and the investors and founders named therein, as
amended.
*4.3 Specimen Common Stock certificate.
*5.1 Opinion of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian,
LLP.
*10.1 Form of Indemnification Agreement entered into between the Registrant
and its directors and officers.
*10.2 1996 Stock Option Plan and forms of agreements thereunder.
*10.3 Employee Stock Purchase Plan.
*10.4 Office Lease Agreement between the Company and Paragon Alameda Gateway
Associates, Ltd., dated June 26, 1992.
*10.5 Real Property Lease Agreement between the Company and Bank of New York
Trust Company of California, dated July 20, 1993.
*10.6 Real Property Lease Agreement between the Company and Bobwhite Meadow,
L.P., dated March 1, 1996.
*11.1 Computation of pro forma net income per share.
*21.1 Subsidiary of the Registrant.
23.1 Report on Schedule and Consent of Independent Auditors.
*23.2 Consent of Counsel. Reference is made to Exhibit 5.1.
*24.1 Power of Attorney.
27 Financial Data Schedule.
</TABLE>
- --------
* Previously filed.
II-2
<PAGE>
(b) FINANCIAL STATEMENT SCHEDULES
Schedule II--Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
consolidated financial statements or notes thereto.
ITEM 17. UNDERTAKINGS
The Registrant hereby undertakes to provide to the Underwriters at the
closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the Delaware General Corporation Law, the Certificate
of Incorporation or the Bylaws of the Registrant, the Underwriting Agreement,
or otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer,
or controlling person of the Registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
The Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of Prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of Prospectus
shall be deemed to be a new Registration Statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Amendment to the Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Alameda, State of California, on this 24th day of May, 1996.
Farallon Communications, Inc.
/s/ Alan B. Lefkof
By: _____________________________________
Alan B. Lefkof
President and Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THIS
AMENDMENT TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING
PERSONS IN THE CAPACITIES AND ON THE DATES INDICATED:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Alan B. Lefkof President, Chief Executive Officer May 24, 1996
________________________________________ and Director (Principal Executive
Alan B. Lefkof Officer)
* James A. Clark Vice President and Chief Financial May 24, 1996
________________________________________ Officer (Principal Financial and
James A. Clark Accounting Officer)
* Reese M. Jones Chairman of the Board of Directors May 24, 1996
________________________________________
Reese M. Jones
* Bandel L. Carano Director May 24, 1996
________________________________________
Bandel L. Carano
* David F. Marquardt Director May 24, 1996
________________________________________
David F. Marquardt
* James R. Swartz Director May 24, 1996
________________________________________
James R. Swartz
</TABLE>
*By: /s/ Alan B. Lefkof
----------------------------
Alan B. Lefkof
Attorney-in-Fact
II-4
<PAGE>
FARALLON COMMUNICATIONS, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
CHARGED
BALANCE AT TO COSTS BALANCE
BEGINNING AND AT END
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
----------- ---------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Allowance for Doubtful Accounts
Year ended September 30, 1993........ $776 $162 $ 62 $876
==== ==== ==== ====
Year ended September 30, 1994........ $876 $120 $464 $532
==== ==== ==== ====
Year ended September 30, 1995........ $532 $121 $136 $517
==== ==== ==== ====
Allowance for Returns
Year ended September 30, 1993........ $317 $258 $167 $408
==== ==== ==== ====
Year ended September 30, 1994........ $408 $151 $171 $388
==== ==== ==== ====
Year ended September 30, 1995........ $388 $434 $ 85 $737
==== ==== ==== ====
</TABLE>
S-1
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGE
------- ----------- ------------
<C> <S> <C>
*1.1 Form of Underwriting Agreement.
*2.1 Agreement and Plan of Merger for the reincorporation
merger of Farallon Communications, Inc. a California
corporation into Farallon Communications, Inc., a
Delaware Corporation.
*3.1 Articles of Incorporation of the Registrant, as amended
to date.
*3.2 Certificate of Incorporation filed in connection with
the reincorporation of the Registrant.
*3.3 Form of Amended and Restated Certificate of
Incorporation to be filed upon the closing of the
offering made pursuant to this Registration Statement.
*3.4 Bylaws of the Registrant.
*3.5 Form of Bylaws of the Registrant to be effective after
the reincorporation of the Registrant.
*3.6 Form of Amended and Restated Bylaws of the Registrant
to be effective after the closing of the offering made
pursuant to this Registration Statement.
*4.1 Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4, 3.5
and 3.6.
*4.2 Amended and Restated Investor Rights Agreement, dated
March 27, 1992, among the Registrant and the investors
and founders named therein, as amended.
*4.3 Specimen Common Stock certificate.
*5.1 Opinion of Gunderson Dettmer Stough Villeneuve Franklin
& Hachigian, LLP.
*10.1 Form of Indemnification Agreement entered into between
the Registrant and its directors and officers.
*10.2 1996 Stock Option Plan and forms of agreements
thereunder.
*10.3 Employee Stock Purchase Plan.
*10.4 Office Lease Agreement between the Company and Paragon
Alameda Gateway Associates, Ltd., dated June 26, 1992.
*10.5 Real Property Lease Agreement between the Company and
Bank of New York Trust Company of California, dated
July 20, 1993.
*10.6 Real Property Lease Agreement between the Company and
Bobwhite Meadow, L.P., dated March 1, 1996.
*11.1 Computation of pro forma net income per share.
*21.1 Subsidiary of the Registrant.
23.1 Report on Schedule and Consent of Independent Auditors.
*23.2 Consent of Counsel. Reference is made to Exhibit 5.1.
*24.1 Power of Attorney.
27 Financial Data Schedule.
</TABLE>
- --------
* Previously filed.
<PAGE>
SIMPLIFYING NETWORKING THROUGH INNOVATION
NETOPIA INTERNET SOLUTION [Picture of Netopia router and modem]
The Netopia Internet Solution includes high-speed ISDN routers and modems,
Internet software and Up & Running, Guaranteed! To provide complete Internet
connectivity for workgroups and individuals
UP & RUNNING, GUARANTEED! [Depiction of the words ISDN, ISP, CONFIG, and
HOTLINE connected by a line]
Netopia Up & Running, Guaranteed! Provides a single source for Internet service
and support to reduce Internet connectivity hassels
[FlashNote cartoon depiction] FlashNote, a free Internet applet, enables users
to instantly and reliably transfer files and
messages across the Internet
[Look@Me cartoon depiction] Look@Me, a free Internet applet, enables users to
remotely view another user's screen in real-time,
anywhere on the Internet
[Picture of two computers connected with the earth in the middle, with the
caption TIMBUKTU PRO and INTERNET/INTRANET COLLABORATION]
Timbuktu Pro software enables users to engage in real-time, peer-to-peer
collaboration; accessing, viewing, and controlling remote computers across the
Internet, Intranets and LANs
[Picture of EtherWave]
EtherWave's plug-and-play 10Base-T technology enables users to easily and cost
effectively network PCs, Macs, workstations and printers--with or without a hub
[Farallon logo]
<PAGE>
[TIMBUKTU PRO]
[INTERNET/INTRANET COLLABORATION]
[Graphics appear on the whole gatefold depicting three scenarios of
collaboration using Timbuktu Pro collaboration software. The computer screens
show a car, a graph and a file chart. The underlying graphic is of the world,
with faded out pictures of the workplace. The words: collaborate, Internet,
communicate, Intranet and connect are also faded out]
. . .Ashley, the ad looks great! Let me take control of your PC and point out
where to place the logos.
. . . Jeff, how's everything in Tokyo? Let's go over tomorrow's presentation--
I'm looking at your screen right now.
. . . Alan, how's the hotel? I'm transferring the latest driver, that should
solve the problem.
<PAGE>
MAINSTREAMING THE INTERNET
[Pictures of the Netopia Router and Netopia Modem connecting a network of
computers, faxes, printers and phones to the Internet, which is depicted by the
globe, an Internet Service Provider, and ISDN connectivity, which is depicted by
a telephone pole.]
<PAGE>
EXHIBIT 23.1
REPORT ON SCHEDULE AND CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Farallon Communications, Inc. and subsidiary:
The audits referred to in our report dated November 20, 1995, included the
related financial statement schedule as of September 30, 1995, 1994 and 1993,
and for each of the years in the three-year period ended September 30, 1995,
included in the Registration Statement. This financial statement schedule is
the responsibility of the Company's management. Our responsibility is to
express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly in all material respects the information set forth therein.
We consent to the use of our reports included herein and to the reference to
our firm under the heading "Experts" in the Prospectus.
KPMG PEAT MARWICK LLP
San Francisco, California
May 24, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FARALLON
COMMUNICATIONS, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEET AND STATEMENT OF
OPERATIONS FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1995 AND THE SIX MONTHS ENDED
MARCH 31, 1996 ON PAGES F-3 AND F-4 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR 6-MOS
<FISCAL-YEAR-END> SEP-30-1995 SEP-30-1996
<PERIOD-START> OCT-01-1994 OCT-01-1995
<PERIOD-END> SEP-30-1995 MAR-31-1996
<CASH> 17,643 14,583
<SECURITIES> 0 0
<RECEIVABLES> 8,978 9,399
<ALLOWANCES> 1,254 1,238
<INVENTORY> 4,758 7,001
<CURRENT-ASSETS> 31,130 32,651
<PP&E> 9,812 11,001
<DEPRECIATION> 7,354 8,161
<TOTAL-ASSETS> 33,872 36,234
<CURRENT-LIABILITIES> 9,375 8,675
<BONDS> 0 0
0 0
6 6
<COMMON> 4 4
<OTHER-SE> 24,269 27,285
<TOTAL-LIABILITY-AND-EQUITY> 33,872 36,234
<SALES> 57,189 29,445
<TOTAL-REVENUES> 57,189 29,445
<CGS> 29,516 15,180
<TOTAL-COSTS> 29,516 15,180
<OTHER-EXPENSES> 25,008 13,738
<LOSS-PROVISION> 1,254 1,238
<INTEREST-EXPENSE> 815 433
<INCOME-PRETAX> 3,480 960
<INCOME-TAX> 974 (1,915)<F1>
<INCOME-CONTINUING> 2,506 2,875
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 2,506 2,875
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0.25 0.27
<FN>
<F1> As of 3/31/96, the Company reversed a full valuation allowance that it had
previously provided against its deferred tax assets, resulting in a non-
recurring income tax benefit of approximately $2.3 million.
</FN>
</TABLE>
