<PAGE>
PROSPECTUS Filed Pursuant to Rule 424(b)(4)
Registration No. 333-82213
[LOGO]
4,000,000 Shares
Common Stock
We are offering 4,000,000 shares of common stock in an initial public offering.
We will list our common stock for quotation on the Nasdaq National Market under
the symbol "BLSW." The market price of the shares of common stock after this
offering may be higher or lower than the initial public offering price.
Investing in our common stock involves a high degree of risk. See "Risk Factors"
beginning on page 5.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
Per Share Total
<S> <C> <C>
Public Offering Price $ 15.00 $ 60,000,000
Underwriting Discount $ 1.05 $ 4,200,000
Proceeds to Bluestone $ 13.95 $ 55,800,000
</TABLE>
Certain selling stockholders have granted the underwriters a 30-day option to
purchase up to 600,000 additional shares of common stock at the initial public
offering price to cover any over-allotments.
We expect to issue these shares on September 29, 1999.
Deutsche Banc Alex / / Brown
SoundView Technology Group
C.E. Unterberg, Towbin
Legg Mason Wood Walker
Incorporated
The date of this Prospectus is September 24, 1999.
<PAGE>
[INSIDE FRONT COVER OF PROSPECTUS]
GRAPHIC:
[Landscape format--1 page graphic]: A graphical figure of a single,
floor-standing server cabinet, is located in the center of the page with the
following text appearing immediately under the server: "APPLICATION SERVER -
Provides standard services to make information access available, secure and
reliable." Five two-directional arrows surround the text, and point, to various
graphical representations located in the corners and bottom center of the page.
Beginning in the bottom left corner of the page and moving in a clockwise
direction are the following graphical figures:
(1) A two-directional arrow cuts through a cloud which represents and is
labelled as the "Internet," and points to the following text: "INFORMATION
ACCESS--Access from applications or information devices." Below the text are
graphical figures of a personal computer, a lap-top computer, a cellular
phone and a handheld personal computing device.
(2) in the upper left hand corner of the page is a graphical figure of a
satellite dish on top of a metal tower. A two-directional arrow points
between the server cabinet and one satellite dish. The following text is
located to the right of the satellite dish: "APPLICATION MANAGEMENT--Control
and reporting of application usage."
(3) in the upper right hand corner of the page are graphical figures of
a personal computer, a lap-top computer, a cellular phone and a handheld
personal computing device. There is a two-directional arrow pointing between
the aforementioned figures and the server cabinet. To the left of the
figures is the following text: "INFORMATION ACCESS--Access from other
information sources or computer systems."
(4) in the right lower corner of the page is a graphical figure of an
electrical plug. A two-directional arrow points between the electrical plug
and the server cabinet. Above the electrical plug is the following text:
"APPLICATION INTEGRATION--Provides access to all information in the
Enterprise."
(5) in the bottom center of the page is a graphical figure of a computer
screen displaying a software application. A two-directional arrow points
between the server cabinet and the computer screen. Directly above the
computer screen is the following text: "APPLICATION DEVELOPMENT--The ability
to build applications that provide information access."
(6) The top center of the page contains a Bluestone logo with the words:
"Bluestone Software--Enterprise Interaction Management."
<PAGE>
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES APPEARING ELSEWHERE IN THIS
PROSPECTUS.
GENERALLY, THE INFORMATION IN THIS PROSPECTUS ASSUMES THAT:
- THE OVER-ALLOTMENT OPTION GRANTED TO THE UNDERWRITERS BY CERTAIN SELLING
STOCKHOLDERS IS NOT EXERCISED;
- THE CONVERSION OF ALL SHARES OF OUR OUTSTANDING SERIES A, SERIES B AND
SERIES C CONVERTIBLE PREFERRED STOCK AND ALL ACCRUED DIVIDENDS THEREON
INTO COMMON STOCK OCCURS IMMEDIATELY UPON COMPLETION OF THIS OFFERING; AND
- A 1 FOR 3.2 REVERSE SPLIT OF THE COMMON STOCK IS EFFECTED IMMEDIATELY
BEFORE THIS OFFERING.
BLUESTONE
We are a leading provider of software for enterprise interaction management,
which enables businesses to extend information over the World Wide Web in a
controlled manner and to support high volumes of users and interactions. Our
flagship product, Sapphire/Web, is a framework for JAVA Web application servers
and is currently in Release 6. A Web application server is a software product
that allows broad access to stored corporate information and applications to a
variety of users, including customers, suppliers and employees via the Web. We
believe that our JAVA Web application server is the leading solution of its kind
based on the breadth of its functionality. We believe that ours is the only
product to adequately address the four defining elements of enterprise
interaction management-- development, deployment, integration and
management--and therefore provides the most complete overall solution to our
customers. In January 1999, we released Bluestone XML-Server, which represents a
new generation of specialized Web application server focused on commerce via the
Internet.
OUR INDUSTRY
Businesses are rapidly adopting technology that allows their existing
computer systems to operate and be accessed over the Web. To date, most
businesses have simply provided marketing material on their Web sites and have
not been able to take full advantage of the interactive potential of the
Internet. The existing information technology infrastructure of most companies
cannot reliably and securely handle a high volume of interactions across the
Internet. Therefore, most companies are unable to utilize, integrate or deploy
their existing information technology assets for Internet commerce or use over
the Web.
Deploying Web application servers allows real time, interactive access to
complex information through the Web that is otherwise only available internally
in an organization through its own applications and existing corporate
databases. This enables a much broader and diverse audience to utilize and
interact with a business' core systems and information. Uses of this capability
include:
- broad dissemination and more effective use of management information for
decision support;
- employee self-service applications that improve internal efficiencies;
- customer relationship management activities that enhance service levels;
- supply chain functions that increase coordination among trading partners;
and
- Internet commerce initiatives that create entirely new revenue streams and
business models.
Demand for these capabilities has resulted in significant growth in the
market for Web application servers. In an August 1998 report, Forrester Research
estimated that the market for application server software would be approximately
$700 million in 1999 and grow to approximately $1.8 billion by 2001,
1
<PAGE>
representing a compound annual growth rate of approximately 60%. Another
independent technology research organization, Ovum, estimated in a June 1999
report that the market for application server technologies, which Ovum defines
in a manner that more closely resembles our addressable market, will grow to $17
billion by 2004. As this market develops, businesses are recognizing that a
broader set of facilities, beyond simple deployment alone, are required to
capture the substantial benefits that Internet computing can provide.
OUR SOLUTION
We provide a comprehensive framework that enables businesses to deploy
information across the Internet to employees, customers, suppliers and partners.
Our solution furnishes businesses with the ability to Web-enable their existing
systems, develop new Web-based applications, integrate their applications and
enable Internet commerce. Our deployment solution is 100% Pure JAVA, a
programming language developed by Sun Microsystems that operates in virtually
all computing environments. We believe our solution is the only one available
that allows organizations to develop, deploy, integrate and manage
enterprise-scale, mission-critical applications. In particular, our solution
offers the following facilities:
- robust development environment and toolset that is open and highly
adaptable and has many features that increase the speed and reduce the
cost of systems development;
- open, high-performance deployment that enables implementation of systems
with high reliability, security and flexibility and supports very high
volumes of interactions;
- extensive integration capabilities that facilitate the integration of a
business' overall computing environment; and
- comprehensive management features that provide the necessary means to
monitor, administer and report on a business' entire Web infrastructure.
OUR GROWTH STRATEGY
Our goal is to maintain and extend our position as a leading provider of Web
application server technology, enterprise application integration and Internet
commerce solutions. Our key growth strategies are to:
- maintain and extend technological leadership;
- expand product offerings;
- continue to focus on enterprise-scale solutions;
- increase marketing and direct sales efforts; and
- further develop indirect channels, partners and alliances.
OUR CUSTOMERS
Our solutions are applicable to a wide variety of industries and are used by
many of the world's leading businesses, including:
- three of the top five FORTUNE 500 companies in the electronics industry;
- five of the top ten FORTUNE 500 companies in the computer equipment
industry;
- four of the top five FORTUNE 500 companies in the aerospace industry;
- seven out of the top ten FORTUNE 500 companies in the telecommunications
industry;
2
<PAGE>
- three of the top four FORTUNE 500 companies in the entertainment industry;
and
- five of the top ten FORTUNE 500 companies in the pharmaceuticals industry.
We market our products and services through our direct sales force and a
network of value added resellers, independent software vendors, and systems
integrators. Since 1996, we have sold our Sapphire/Web software products to over
500 customers. Our customers include ARI, AT&T, Deutsche Bank, Dreyfus
Corporation, Eli Lilly, Hewlett-Packard, Houghton Mifflin Company, Just For
Feet, MCI WorldCom, OpenConnect and Reliance National.
We were originally incorporated in 1989. Our executive offices are located
at 1000 Briggs Road, Mount Laurel, New Jersey 08054. Our telephone number is
(856) 727-4600. Information contained on our Web site at www.bluestone.com does
not constitute a part of this prospectus.
THE OFFERING
<TABLE>
<S> <C>
Common stock offered by Bluestone............ 4,000,000 shares
Common stock outstanding after this
offering................................... 17,274,732 shares
Use of proceeds.............................. product development, sales and marketing
and working capital
Nasdaq National Market symbol................ "BLSW"
</TABLE>
Common stock outstanding after this offering is based on the number of
shares outstanding as of June 30, 1999. It excludes:
- 2,961,411 shares of common stock issuable upon exercise of options and
warrants at a weighted average exercise price of $4.17 per share and
218,750 shares of common stock issued on September 15, 1999 upon the
conversion of a convertible note at a conversion price of $2.29 per share.
- 431,784 shares reserved for future grants under our stock option and
directors' compensation plans.
3
<PAGE>
SUMMARY FINANCIAL INFORMATION
The following table sets forth certain of our historical, pro forma and
adjusted financial data. The pro forma balance sheet data presented below
assumes the conversion of all outstanding preferred stock and accrued dividends
on preferred stock into common stock. The pro forma net loss per share amounts
presented below reflect the outstanding preferred stock during each period
presented on an as converted basis. The adjusted balance sheet data presented
below gives effect to the receipt of the net proceeds from the sale of shares of
common stock offered by us at an offering price of $15.00 per share, after
deducting the estimated underwriting discounts and commissions and our estimated
offering expenses.
In April 1997, in connection with our sale of Series A preferred stock, we
spun off our consulting division to our then sole stockholder. The consulting
division spin-off has been reported as a discontinued operation. In April 1998,
we decided to focus on internally developed software products and curtail the
licensing and services related to third party products. No material license
revenues from third party products were recognized after March 31, 1998.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Software license fees.................................................. $ 1,475 $ 2,337 $ 3,391 $ 1,192 $ 4,727
Services............................................................... 43 2,179 3,620 1,707 1,865
Third party products and related services.............................. 6,555 5,225 1,107 932 --
--------- --------- --------- --------- ---------
Total revenues..................................................... 8,073 9,741 8,118 3,831 6,592
Cost of revenues:
Software license fees.................................................. 113 202 259 96 156
Services............................................................... 305 2,516 4,433 2,078 2,467
Third party products and related services.............................. 4,261 2,798 643 535 --
--------- --------- --------- --------- ---------
Total cost of revenues............................................. 4,679 5,516 5,335 2,708 2,623
--------- --------- --------- --------- ---------
Gross profit............................................................. 3,394 4,225 2,783 1,122 3,969
Operating expenses:
Sales and marketing.................................................... 3,005 5,131 9,551 3,748 6,185
Product development.................................................... 702 1,295 2,474 904 1,869
General and administrative............................................. 1,515 1,616 2,316 950 2,124
Amortization of stock-based compensation............................... -- -- -- -- 112
--------- --------- --------- --------- ---------
Total operating expenses........................................... 5,222 8,042 14,341 5,601 10,290
--------- --------- --------- --------- ---------
Loss from operations..................................................... (1,828) (3,817) (11,558) (4,479) (6,321)
Interest expense, net.................................................... (50) (80) (47) (34) (1,148)
--------- --------- --------- --------- ---------
Loss from continuing operations.......................................... (1,878) (3,896) (11,605) (4,512) (7,469)
Income (loss) from discontinued operations............................... (738) 99 -- -- --
--------- --------- --------- --------- ---------
Net loss................................................................. (2,616) (3,798) (11,605) (4,512) (7,469)
Accretion of preferred stock redemption value............................ -- (240) (846) (308) (779)
--------- --------- --------- --------- ---------
Net loss available to common stockholders................................ $ (2,616) $ (4,038) $ (12,451) $ (4,820) $ (8,247)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Basic and diluted net income (loss) per share:
Continuing operations.................................................. $ (0.67) $ (1.39) $ (4.12) $ (1.60) $ (2.65)
Discontinued operations................................................ (0.26) 0.04 -- -- --
Accretion of preferred stock redemption value.......................... -- (0.09) (0.30) (0.11) (0.28)
--------- --------- --------- --------- ---------
$ (0.93) $ (1.44) $ (4.42) $ (1.71) $ (2.93)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Shares used in computing basic and diluted net income (loss) per share... 2,813 2,813 2,814 2,814 2,815
Pro forma basic and diluted net loss per share from continuing
operations............................................................. $ (1.35) $ (0.68)
--------- ---------
--------- ---------
Shares used in computing pro forma basic and diluted net loss per
share.................................................................. 8,607 10,909
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1999
-----------------------------------
ACTUAL PRO FORMA ADJUSTED
--------- ----------- -----------
(IN THOUSANDS, UNAUDITED)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents....................................... $ 20,600 $ 20,600 $ 75,450
Working capital................................................. 16,576 16,576 71,426
Total assets.................................................... 24,969 24,969 79,819
Long-term obligations, net of current portion................... 1,654 1,654 1,654
Mandatorily redeemable convertible preferred stock.............. 40,453 -- --
Total stockholders' equity (deficit)............................ (24,180) 16,273 71,123
</TABLE>
4
<PAGE>
RISK FACTORS
THIS SECTION HIGHLIGHTS SPECIFIC RISKS WITH RESPECT TO AN INVESTMENT IN OUR
BUSINESS. INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. WE ALSO
CAUTION YOU THAT THIS PROSPECTUS INCLUDES FORWARD-LOOKING STATEMENTS THAT ARE
BASED ON MANAGEMENT'S BELIEFS AND ASSUMPTIONS AND ON INFORMATION CURRENTLY
AVAILABLE TO MANAGEMENT. YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW
AND THE OTHER INFORMATION IN THIS PROSPECTUS BEFORE PURCHASING THE COMMON STOCK.
WE HAVE HAD RECENT LOSSES AND MAY INCUR FUTURE LOSSES THAT MAY DEPRESS OUR STOCK
PRICE.
We have incurred significant net losses since 1996, including losses of
approximately $3.8 million and $11.6 million for the years ended December 31,
1997 and 1998, respectively and $7.5 million for the six months ended June 30,
1999. Our losses have resulted in an accumulated deficit of approximately $26.4
million as of June 30, 1999. Any significant shortfall of revenues in relation
to our expectations or any material delay of customer orders would have an
immediate adverse effect on our business, operating results and financial
condition. We may not be profitable in any future period. Our future operating
results will depend on many factors, including:
- the overall growth rate for the markets in which we compete;
- the level of market acceptance of, and demand for, our software products;
- the level of product and price competition;
- our ability to establish strategic marketing relationships, develop and
market new and enhanced products, and control costs;
- our ability to expand our direct sales force and indirect distribution
channels;
- our ability to integrate acquired businesses and product lines;
- our ability to develop and maintain awareness of our brands; and
- our ability to attract, train and retain consulting, technical and other
key personnel.
LACK OF GROWTH OR DECLINE IN INTERNET USAGE OR THE LACK OF ACCEPTANCE OF
COMMERCE CONDUCTED VIA THE INTERNET COULD BE DETRIMENTAL TO OUR FUTURE OPERATING
RESULTS.
Our products enhance companies' ability to transact business and conduct
operations utilizing the Internet. Therefore, our future sales and any future
profits are substantially dependent upon the widespread acceptance and use of
the Internet as an effective medium of commerce by consumers and businesses.
Rapid growth in the use of the Internet and other online services is a recent
development and we are unsure whether that acceptance and use will continue to
develop or that a sufficiently broad base of consumers will adopt and continue
to use the Internet and other online services as a medium of commerce. To be
successful, we must rely on consumers and businesses, who have historically used
traditional means of commerce to purchase products, accepting and utilizing new
ways of conducting business and exchanging information over the Internet.
In addition, the Internet may not be accepted as a viable commercial
marketplace for a number of reasons, including potentially inadequate
development of the necessary network infrastructure or delayed development of
enabling technologies and Web performance improvements. If the Internet
continues to experience significant growth in the number of users, frequency of
use or an increase in bandwidth requirements, the Internet's infrastructure may
not be able to support the demands placed upon it. In addition, the Internet
could lose its viability due to delays in the development or adoption of new
standards and protocols required to handle increased levels of Internet
activity, or due to increased governmental regulation. If Congress, or other
governing bodies both within and outside the United States, decides to alter
materially the current approach to, and level of, regulation of the Internet, we
may need to adapt our technology. Any required adaptation could cause us to
spend
5
<PAGE>
significant amounts of time and money. If use of the Internet does not continue
to grow or grows more slowly than expected, if the infrastructure for the
Internet does not effectively support growth that may occur, if government
regulations change, or if the Internet does not become a viable commercial
marketplace, our business could suffer.
WE DEPEND ON OUR SAPPHIRE/WEB PRODUCTS AND IF THE MARKET FOR THESE PRODUCTS DOES
NOT CONTINUE TO GROW, OUR BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED.
Software license revenues from our Sapphire/Web software were $3.4 million
or 42% of total revenues in 1998 and $4.7 million or 72% of total revenues in
the first six months of 1999. We expect to continue to be dependent upon the
Sapphire/Web software products in the future, and any factor adversely affecting
the market for Web application server software in general, or our software in
particular, would adversely affect our ability to generate revenues. The market
for Web application server software is competitive, highly fragmented and
characterized by rapid technological change. Our future financial performance
will depend in large part on the successful development, introduction and
customer acceptance of our new products and product enhancements in a timely and
cost effective manner. After the offering, we expect to commit significant
resources to market and further develop the Sapphire/Web software products and
enhance the brand awareness of Sapphire/Web products. The market for our
software may not continue to grow or may grow at a slower rate than we expect.
Furthermore, the market may not accept our products. If this market fails to
grow or grows more slowly than we anticipate, or if the market fails to accept
our products, our business could suffer.
IF THE MARKET'S ACCEPTANCE AND ADOPTION OF JAVA AND XML SERVER TECHNOLOGIES DOES
NOT CONTINUE, OUR FUTURE RESULTS MAY SUFFER.
Our Sapphire/Web product is 100% Pure JAVA. JAVA is a programming language
developed by Sun Microsystems. Therefore, the continued acceptance of our
products in the marketplace depends on JAVA's acceptance as a standard
programming language. If Sun Microsystems were to make significant changes to
the JAVA language or fail to correct defects and limitations in its products,
our ability to continue to improve and ship our products could be impaired. In
the future, our customers may also require the ability to deploy our products on
platforms for which technically acceptable JAVA implementations either do not
exist or are not available on commercially reasonable terms.
In January 1999, we introduced a product based on a document format for the
Web called XML, or extensible mark-up language. We cannot be sure that XML
technology will be adopted as a standard, that XML-based products will achieve
broad market acceptance, that our XML products will be accepted or that other
superior technologies will not be developed. The failure of XML technology to
become a standard or the failure of our XML products to achieve broad acceptance
could adversely affect our ability to generate revenues. The XML server
technology is one of several competing technologies used in information exchange
and Internet commerce. We intend to continue to invest substantial resources in
our XML products.
INTENSE COMPETITION AND INCREASING CONSOLIDATION IN OUR INDUSTRY COULD CREATE
STRONGER COMPETITORS AND HARM OUR BUSINESS.
The market for our products is intensely competitive, highly fragmented,
characterized by rapid technological change and significantly affected by new
product introductions. Recent acquisitions of several of our competitors by
large software companies and other market activities of industry participants
have increased the competition in our market. Our competitors consist of a
number of private and public companies including, among others: BEA Systems
which acquired WebLogic; IBM; Microsoft; Oracle; and Sun Microsystems, which
acquired NetDynamics and the rights to Netscape's Application Server. In
addition, we face competition from in-house software developers who may develop
some or all of the functionality that our products provide. Many of our
competitors have longer operating histories, significantly greater financial,
technical, marketing and other resources,
6
<PAGE>
greater name recognition, a broader range of products to offer and a larger
installed base of customers than us, any of which could provide them with a
significant competitive advantage.
We expect to face increased competition in the future from our current
competitors. In addition, new competitors, or alliances among existing and
future competitors, may emerge and rapidly gain significant market share. We
also may face increased competition from existing large business application
software vendors that may broaden their product offerings to include Web
application server software. Their significant installed customer bases and
abilities to offer a broad solution and price these new products as incremental
add-ons to existing systems could provide them with a significant competitive
advantage.
OUR CUSTOMERS ARE CONCENTRATED AND THE LOSS OF ONE OF OUR LARGEST CUSTOMERS
COULD CAUSE OUR REVENUES TO DROP QUICKLY AND UNEXPECTEDLY.
Our top ten customers for the year ended December 31, 1998 and the six
months ended June 30, 1999 in the aggregate accounted for approximately 39% and
66%, respectively, of our revenues. Hewlett-Packard accounted for more than 10%
of our revenues for the year ended December 31, 1998 and OpenConnect accounted
for more than 10% of our revenues for the six months ended June 30, 1999. We
expect that a small number of customers will continue to account for a
substantial portion of revenues in any given quarter in the foreseeable future,
although it is unusual for the same customer to account for a substantial amount
of revenues in each of several quarters. As a result, our inability to secure
major customers during a given period or the loss of any one major customer
could cause our revenues to drop quickly and unexpectedly.
IF WE FAIL TO DEVELOP NEW PRODUCTS AND SERVICES IN THE FACE OF OUR INDUSTRY'S
RAPIDLY EVOLVING TECHNOLOGY, OUR FUTURE RESULTS MAY BE ADVERSELY AFFECTED.
Due to the recent emergence of the Internet and the Web as a forum for
conducting business, the market for Web application server systems in which we
participate is subject to rapid technological change, changing customer needs,
frequent new product introductions and evolving industry standards that may
render existing products and services obsolete. Our growth and future operating
results will depend in part upon our ability to enhance existing applications
and develop and introduce new applications or components that:
- meet or exceed technological advances in the marketplace;
- meet changing customer requirements;
- achieve market acceptance;
- integrate successfully with third party software; and
- respond to competitive products.
Our product development and testing efforts have required, and are expected
to continue to require, substantial investment. We may not possess sufficient
resources to continue to make the necessary investments in technology. In
addition, we may not successfully identify new software opportunities and
develop and bring new software to market in a timely and efficient manner. If we
are unable, for technological or other reasons, to develop and introduce new and
enhanced software in a timely manner, we may lose existing customers and fail to
attract new customers, resulting in a decline in revenues.
OUR STOCK HAS NOT TRADED PUBLICLY, AND AFTER THIS OFFERING ITS MARKET PRICE MAY
FLUCTUATE WIDELY.
Prior to this offering, there has been no public market for our common
stock. The market price of our common stock could fluctuate substantially due
to:
- quarterly fluctuations in operating results;
7
<PAGE>
- announcements of new products or product enhancements by us or our
competitors;
- technological innovations by us or our competitors;
- general market conditions or market conditions specific to our or our
customers' industries; and
- changes in earnings estimates or recommendations by analysts.
Stock prices of Internet-related companies have been highly volatile. Our
initial public offering price may not be indicative of the price of our stock
that will prevail in the trading market. In the past, following periods of
volatility in the market price of a company's securities, securities class
action litigation has at times been instituted against that company. If we
become subject to securities litigation, we could incur substantial costs and
experience a diversion of management's attention and resources.
THE UNPREDICTABILITY OF OUR QUARTERLY OPERATING RESULTS MAY ADVERSELY AFFECT THE
TRADING PRICE OF OUR COMMON STOCK.
Quarterly fluctuations in operating results may be caused by:
- changes in the growth rate of Internet usage;
- fluctuations in the demand for our products and services;
- the level of product and price competition in our markets;
- the timing and market acceptance of new product introductions and upgrades
by us or our competitors;
- our success in expanding our customer support and marketing and sales
organizations;
- the size and timing of individual transactions;
- delays in, or cancellations of, customer implementations;
- customers' budget constraints;
- the level of product development expenditures;
- our ability to control costs; and
- general economic conditions.
Many of these factors are not in our control. In addition, we also
experience seasonality which causes us to typically recognize a
disproportionately greater amount of our revenues for any fiscal year in our
fourth quarter and a disproportionately lesser amount in our first quarter, due
largely to sales force quota practices in the software industry and to customer
budgeting processes.
WE NEED TO MANAGE OUR GROWTH EFFECTIVELY OR WE MAY NOT SUCCEED.
We are a growing company. Our ability to manage our growth will depend in
large part on our ability to generally improve and expand our operational and
sales and marketing capabilities, to develop the management skills of our
managers and supervisors, many of whom have been employed by us for a relatively
short time, and to train, motivate and manage both our existing employees and
the additional employees that may be required. Additionally, we may not
adequately anticipate all of the demands that growth may impose on our systems,
procedures and structure. Any failure to adequately anticipate and respond to
these demands or manage our growth effectively would have a material adverse
effect on our future prospects.
8
<PAGE>
THE DEVELOPMENT OF INTERNATIONAL OPERATIONS WILL CAUSE US TO FACE ADDITIONAL
RISKS.
We expect to expand our international operations and international sales and
marketing efforts, initially, by opening regional sales and support offices in
Europe and Asia Pacific within the next twelve months. We have limited
experience in marketing, selling and distributing our products and services
internationally. International operations, including operations in those regions
that we are targeting, are subject to the following risks:
- recessions in foreign economies;
- political and economic instability;
- fluctuations in currency exchange rates;
- difficulties and costs of staffing and managing foreign operations;
- potentially adverse tax consequences;
- reduced protection for intellectual property rights in some countries; and
- changes in regulatory requirements.
OUR FAILURE TO MAINTAIN ONGOING SALES THROUGH A LIMITED NUMBER OF INDIRECT
CHANNELS MAY RESULT IN LOWER REVENUES.
We derive over 75% of our license revenues through a limited number of
independent software vendors, systems integrators, distributors and resellers.
Although we intend to increase our marketing and direct sales efforts, we expect
that a limited number of these indirect channels will continue to account for a
significant portion of our revenues in any given quarter in the foreseeable
future. To be successful, we must continue to foster and maintain our existing
indirect channels, as well as develop new relationships. The loss of, or
reduction in orders through, existing indirect channels or the failure to
develop new indirect channel relationships could cause our revenues to decline
and have a material adverse effect on our business.
IF WE LOSE OUR KEY PERSONNEL, OR FAIL TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL, THE SUCCESS AND GROWTH OF OUR BUSINESS MAY SUFFER.
A significant portion of our senior management team has been in place for a
relatively short period of time. Our success will depend to a significant extent
on their ability to gain the trust and confidence of our other employees and to
work effectively as a team.
Our future success will also depend significantly on our ability to attract,
integrate, motivate and retain additional highly skilled technical, managerial,
sales, marketing, and services personnel. Competition for skilled personnel is
intense, and we may not be successful in attracting, motivating and retaining
the personnel required to grow and operate profitably. Failure to attract,
integrate, motivate and retain highly skilled personnel could adversely affect
our business, especially our ability to develop new products and enhance
existing products.
THE LENGTHY AND VARIABLE SALES CYCLES OF OUR SAPPHIRE/WEB PRODUCT COULD CAUSE
SIGNIFICANT FLUCTUATION IN OUR QUARTERLY RESULTS.
Our Sapphire/Web software is generally used for mission-critical or
enterprise-wide purposes and involves a significant commitment of resources by
our customers. A customer's decision to license our Sapphire/Web software
generally involves the evaluation of the available alternatives by a significant
number of personnel in various functional and geographic areas, each often
having specific and conflicting requirements. Accordingly, we typically must
expend substantial resources educating prospective customers about the value of
our Sapphire/Web software solutions. For these reasons, the length of time
between the date of initial contact with the potential customer and the
execution of a
9
<PAGE>
software license agreement typically ranges from three to six months, and is
subject to delays over which we have little or no control. As a result, our
ability to forecast the timing and amount of specific sales is limited and the
delay or failure to complete one or more large license transactions could cause
our operating results to vary significantly from quarter to quarter.
THE FAILURE TO IMPLEMENT SUCCESSFULLY OUR SAPPHIRE/WEB SOFTWARE COULD RESULT IN
DISSATISFIED CUSTOMERS AND DECREASED SALES.
Implementation of our Sapphire/Web software often involves a significant
commitment of financial and other resources by our customers. The customer's
implementation cycle can be lengthy due to the size and complexity of their
systems and operations. In addition, our customers rely heavily on third party
systems integrators to assist them with the installation of the Sapphire/Web
software. Our failure or the failure of our alliance partners, our customers or
our third party integrators to implement successfully our Sapphire/Web software
could result in dissatisfied customers which could adversely affect our
reputation.
WE MAY REQUIRE FUTURE ADDITIONAL FUNDING TO STAY IN BUSINESS.
Over time, we may require additional financing for our operations.
Additionally, we periodically review other companies' product lines and
technologies for potential acquisition. Any material acquisitions or joint
ventures could require additional financing. This additional financing may not
be available to us on a timely basis if at all, or, if available, on terms
acceptable to us. Moreover, additional financing may cause dilution to existing
stockholders.
CAPACITY RESTRICTIONS COULD REDUCE THE DEMAND AND UTILITY OF OUR PRODUCTS.
Concurrency restrictions can limit Internet deployment and use capacity. The
boundaries of our Sapphire/Web software and Bluestone XML server capacity, in
terms of numbers of concurrent users or interactions, are unknown because, to
date, no customer or testing environment has reached these boundaries. The
Sapphire/Web software's or the Bluestone XML server's capacity boundaries may,
at some future time, be reached and, when reached, may be insufficient to enable
our customers to achieve their desired levels of information deployment and
exchange. We may lose customers or fail to gain new customers if either of the
Sapphire/Web software's or the Bluestone XML server's capacity boundary limits
the ability of our customers to achieve expected levels of information
deployment and exchange or Internet commerce transactions.
OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS COULD IMPAIR OUR
ABILITY TO COMPETE EFFECTIVELY.
Our success and ability to compete are substantially dependent on our
internally developed technologies and trademarks, which we protect through a
combination of copyright, trademark and trade secret laws, confidentiality
procedures and contractual provisions.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or obtain and use information that
we regard as proprietary. Policing unauthorized use of our products is difficult
and, though we are unable to determine the extent to which piracy of our
software products exists, we expect software piracy to be a problem. In
addition, the laws of some foreign countries do not protect our proprietary
rights to the same extent as the laws of the United States. Furthermore, our
competitors may independently develop technology similar to ours.
The number of intellectual property claims in our industry may increase as
the number of competing products grows and the functionality of products in
different industry segments overlaps. Although we are not aware that any of our
products infringe upon the proprietary rights of third parties, there can be no
assurance that third parties will not claim infringement by us with respect to
10
<PAGE>
current or future products. Any of these claims, with or without merit, could be
time consuming to address, result in costly litigation, cause product shipment
delays or require us to enter into royalty or license agreements. These royalty
or license agreements might not be available on terms acceptable to us or at
all, which could have a material adverse effect on our business.
OUR FAILURE TO OBTAIN OR MAINTAIN THIRD PARTY LICENSES COULD HARM OUR BUSINESS.
We have in the past and may in the future, resell, under license, certain
third party software that enables our software to interact with other software
systems or databases. In addition, we license certain software technology used
to develop our software. The loss or inability to maintain any of these software
licenses could result in delays or reductions in product shipments until
equivalent software could be identified and licensed or compiled, which could
adversely affect our business.
WE MAY BE SUBJECT TO FUTURE PRODUCT LIABILITY CLAIMS AND OUR PRODUCTS'
REPUTATIONS MAY SUFFER.
Many of our installations involve projects that are critical to the
operations of our customers' businesses and provide benefits that may be
difficult to quantify. Any failure in a customer's system could result in a
claim for substantial damages against us, regardless of our responsibility for
the failure. Although our license agreements with our customers typically
contain provisions designed to limit contractually our liability for damages
arising from negligent acts, errors, mistakes or omissions, it is possible that
these provisions will not be enforceable in certain instances or would otherwise
not protect us from liability for damages. Although we maintain general
liability insurance coverage, this coverage may not continue to be available on
reasonable terms or at all, or may be insufficient to cover one or more large
claims.
We have entered into and plan to continue to enter into agreements with
strategic alliance partners whereby we license our software products for
integration with the alliance partners' software. If an alliance partner's
software fails to meet customer expectations or causes a failure in its
customer's systems, the reputation of our software products could be materially
and adversely affected even if our software products performed in accordance
with their functional specifications.
YEAR 2000 PROBLEMS MAY DISRUPT OUR BUSINESS.
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date field. Beginning in the year 2000,
these date fields will need to accept four digit entries to distinguish
twenty-first century dates from twentieth century dates. As a result, over the
next several months, computer systems and/or software used by many companies may
need to be upgraded to comply with these "Year 2000" requirements. Significant
uncertainty exists in the software industry concerning the potential effects
associated with compliance. While our software products are not time/ date
sensitive, many of the third party software applications run by our customers
are time/date sensitive. In addition, we have in the past resold third party
software that may not be Year 2000 compliant.
We may experience unanticipated problems and costs caused by undetected
errors or defects in the software used in our internal systems related to the
Year 2000 transition. If our internal computer systems are not Year 2000
compliant then we or our customers may suffer system failures or miscalculations
that could cause disruptions of operations.
In addition, we believe that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues in a variety of ways.
Many companies are expending significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase software products such as those offered
by us.
Our reasonable worst case scenarios include:
- exposure to potential business disruption and resulting claims, whether
with or without merit;
11
<PAGE>
- temporary inability to process transactions internally, to send invoices
to vendors and customers or to engage in similar normal business
activities; and
- postponed or delayed sales because existing and potential customers may
choose to defer purchasing, or reduce funds available to purchase,
software products such as those offered by us.
Our insurance coverage may not cover or be adequate to offset these and
other business risks related to the Year 2000.
OUR EXECUTIVE OFFICERS AND DIRECTORS AND THEIR AFFILIATES WILL OWN A LARGE
PERCENTAGE OF OUR VOTING STOCK AND WILL HAVE THE ABILITY TO MAKE DECISIONS THAT
COULD ADVERSELY AFFECT OUR STOCK PRICE.
Following the completion of this offering, our executive officers, directors
and their affiliates will beneficially own approximately 65% of the outstanding
shares of common stock, or 59% if the underwriters' over-allotment option is
exercised in full. As a result, these stockholders will be able to control all
matters requiring stockholder approval and, thereby, our management and affairs.
Matters that require stockholder approval include:
- election of directors;
- approval of mergers or consolidations; and
- sale of all or substantially all of our assets.
This concentration of ownership may delay, deter or prevent acts that would
result in a change of control of Bluestone, which in turn could reduce the
market price of our common stock.
INVESTORS IN THIS OFFERING WILL INCUR IMMEDIATE DILUTION PER SHARE OF THE COMMON
STOCK BASED ON ITS BOOK VALUE AFTER THE OFFERING.
The initial public offering price is substantially higher than the book
value of our common stock. At the initial offering price of $15.00 per share,
the book value of the common stock after the offering will be $4.12 per share.
This represents an immediate and substantial dilution per share of the common
stock. The dilution per share represents the difference between the amount per
share paid by the purchasers of shares of common stock in this offering and the
net tangible book value per share of common stock immediately after the
completion of this offering. In addition, to the extent outstanding options are
exercised, there will be further dilution to new investors.
OUR CHARTER AND BYLAWS AND DELAWARE LAW CONTAIN PROVISIONS THAT COULD DISCOURAGE
A TAKEOVER EVEN IF BENEFICIAL TO STOCKHOLDERS.
At the time we complete this offering, our charter and our bylaws, in
conjunction with Delaware law, will contain provisions that could make it more
difficult for a third party to obtain control of Bluestone even if doing so
would be beneficial to stockholders. For example, our charter will provide for a
classified board of directors and restrict the ability of stockholders to call a
special meeting. Our bylaws will allow the board of directors to expand its size
and fill any vacancies without stockholder approval.
FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE.
The market price of our common stock could decline as a result of sales by
our existing stockholders or the perception that those sales may occur. These
sales could also make it more difficult for us to raise funds through equity
offerings in the future at a time and at a price that we think is appropriate.
After completion of this offering, the current holders of most of our common
stock and all of our preferred stock outstanding prior to this offering, as well
as the holders of outstanding warrants, will be entitled to registration rights
with respect to their common stock or the common stock underlying their
12
<PAGE>
convertible securities. If these holders, by exercising their registration
rights, cause a large number of securities to be registered and sold in the
public market, these sales could have an adverse effect on the market price for
our common stock. If we were to include, in a registration statement initiated
by us, shares held by these holders pursuant to the exercise of their
registration rights, these sales may have an adverse effect on our ability to
raise needed capital.
FORWARD-LOOKING STATEMENTS
Some statements in this prospectus constitute forward-looking statements.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements or
industry results to be materially different from any future results, performance
or achievements expressed or implied by these forward-looking statements. Such
factors include those described in "Risk Factors." The forward-looking
statements included in this prospectus may prove to be inaccurate. In light of
the significant uncertainties inherent in these forward-looking statements, you
should not consider this information to be a guarantee by us or any other person
that our objectives and plans will be achieved.
USE OF PROCEEDS
The net proceeds to us from the sale of 4,000,000 shares of common stock, at
an initial public offering price of $15.00 per share, will be approximately
$54.9 million after deducting underwriting discounts and commissions and
estimated offering expenses payable by us. We will not receive any proceeds from
the sale of shares by the selling stockholders if the underwriters'
over-allotment option is exercised. While we have not determined the specific
allocation of the net proceeds of this offering, we currently intend to use the
net proceeds for product development, sales and marketing and working capital.
Pending their application as described above, we intend to invest the net
proceeds in short-term, investment-grade, interest-bearing securities.
DIVIDEND POLICY
We intend to retain any future earnings to support operations and to finance
the growth and development of our business, and we do not anticipate paying cash
dividends for the foreseeable future. Under our current credit facility, we are
prohibited from paying dividends except those accruing to outstanding preferred
stock. As of June 30, 1999, there were $1.7 million in accrued dividends on our
convertible preferred stock. Upon the conversion of the preferred stock into
common stock, we are required to pay to the holders of the preferred stock being
converted all accumulated and unpaid cash dividends, whether or not declared,
with respect to the preferred stock. However, if requested by any holder of the
shares of preferred stock being converted and approved by the holders of a
majority of the then outstanding shares of common stock, the holder may exchange
all or any portion of the accumulated and unpaid cash dividends into shares of
common stock at the then fair market value of the common stock.
13
<PAGE>
CAPITALIZATION
The following table sets forth our unaudited total capitalization as of June
30, 1999:
- on an actual basis;
- on a pro forma basis assuming the conversion of all outstanding shares of
preferred stock and accrued dividends on preferred stock into 10,454,777
shares of common stock; and
- on an adjusted basis to give effect to the receipt of the net proceeds
from our sale of 4,000,000 shares of common stock in this offering at an
initial public offering price of $15.00 per share, after deducting
estimated underwriting discounts and commissions and estimated offering
expenses.
In the following table, stockholders' equity excludes:
- 218,750 shares of common stock issued in September 1999 upon the
conversion of a convertible note payable to Mark Baiada, a former
director, in the principal amount of $500,000;
- 2,663,589 shares of common stock issuable upon the exercise of outstanding
stock options granted as of June 30, 1999 under our Amended and Restated
1996 Incentive and Non-Qualified Stock Option Plan and 275,534 shares
reserved for issuance under such plan;
- 156,250 shares reserved for issuance under our Director Compensation Plan;
- 9,766 shares of common stock issuable upon the exercise of a warrant to
purchase common stock issued to Silicon Valley Bank;
- 150,448 shares of common stock issuable upon the exercise of a warrant to
purchase common stock issued to Deutsche Bank Securities Inc.; and
- 137,608 shares of common stock issuable upon the exercise of warrants
issued to certain holders of the preferred stock.
You should read this information together with our financial statements and
the corresponding notes included elsewhere in this prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1999
---------------------------------
ACTUAL PRO FORMA ADJUSTED
--------- ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Short-term borrowings, including current portion of long-term
debt........................................................ $ 1,108 $ 1,108 $ 1,108
Long-term debt, less current portion.......................... 1,654 1,654 1,654
--------- ----------- ---------
Total debt.................................................. 2,762 2,762 2,762
--------- ----------- ---------
Mandatorily redeemable convertible preferred stock............ 40,453 -- --
--------- ----------- ---------
Stockholders' equity (deficit):
Common Stock, par value $0.001; 53,800,000 shares
authorized, 2,819,955 shares issued and outstanding
actual; 13,274,732 shares issued and outstanding pro
forma; 17,274,732 shares issued and outstanding
adjusted.................................................. 3 13 17
Common stock warrants....................................... 1,900 1,900 1,900
Deferred compensation....................................... (1,303) (1,303) (1,303)
Additional paid-in capital.................................. 1,630 42,073 96,919
Accumulated deficit......................................... (26,410) (26,410) (26,410)
--------- ----------- ---------
Total stockholders' equity (deficit)........................ (24,180) 16,273 71,123
--------- ----------- ---------
Total capitalization........................................ $ 19,035 $ 19,035 $ 73,885
--------- ----------- ---------
--------- ----------- ---------
</TABLE>
14
<PAGE>
DILUTION
Our pro forma net tangible book value as of June 30, 1999 was $16.3 million
or $1.23 per share of common stock. We determined our pro forma net tangible
book value per share by subtracting our total liabilities from our total
tangible assets and dividing that number by 13,274,732 pro forma shares of
common stock outstanding as of June 30, 1999. The pro forma information provided
immediately above and in the two tables below gives effect to:
- the conversion of all outstanding shares of preferred stock into common
stock; and
- the assumed conversion of accrued dividends on preferred stock into common
stock.
Dilution in net tangible book value per share represents the difference
between the amount per share paid by purchasers of shares of our common stock in
this offering and the net tangible book value per share of our common stock
immediately following this offering. Based on an initial offering price of
$15.00 per share after giving effect to our sale of shares of common stock in
this offering and after deducting the estimated underwriting discount and
commissions and our estimated offering expenses, our pro forma net tangible book
value as of June 30, 1999 would have been $71.1 million or $4.12 per share of
common stock. This represents an immediate increase in net tangible book value
of $2.89 per share to existing stockholders and an immediate dilution of $10.88
per share to new investors. The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share...................... $ 15.00
Pro forma net tangible book value per share as of June 30,
1999..................................................... $ 1.23
Increase per share attributable to new investors........... 2.89
---------
Adjusted pro forma net tangible book value per share as of
June 30, 1999.............................................. 4.12
---------
Dilution per share to new investors.......................... $ 10.88
---------
---------
</TABLE>
The following table summarizes on a pro forma basis as of June 30, 1999 the
difference between the existing stockholders and new investors with respect to
the number of shares of common stock purchased from us, the total consideration
paid to us, and the average price per share paid. The information presented is
based upon an initial public offering price of $15.00 per share, before
deducting estimated underwriting discounts and commissions and estimated
offering expenses.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------- --------------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
------------ ----------- -------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders................................ 13,274,732 77% $ 43,297,000 42% $ 3.26
New investors........................................ 4,000,000 23% 60,000,000 58% $ 15.00
------------ ----- -------------- -----
Total................................................ 17,274,732 100% $ 103,297,000 100% $ 5.98
------------ ----- -------------- -----
------------ ----- -------------- -----
</TABLE>
The tables above assume no exercise of outstanding stock options or warrants
and exclude:
- 218,750 shares of common stock issued in September 1999 upon the
conversion of a convertible note payable to Mark Baiada, a former
director, in the principal amount of $500,000;
- 2,663,589 shares of common stock issuable upon the exercise of outstanding
stock options granted as of June 30, 1999 under our option plan with a
weighted average exercise price of $4.01 per share and 275,534 shares
reserved for issuance under the option plan;
- 156,250 shares reserved for issuance under our director compensation plan;
- 9,766 shares of common stock issuable upon the exercise of a warrant to
purchase common stock issued to Silicon Valley Bank with an exercise price
of $2.56 per share;
- 150,448 shares of common stock issuable upon the exercise of a warrant to
purchase common stock issued to Deutsche Bank Securities Inc. currently
exercisable at $15.00 per share; and
- 137,608 shares of common stock issuable upon the exercise of warrants
issued to certain holders of the preferred stock with a weighted average
exercise price of $2.06 per share.
To the extent that outstanding options or warrants are exercised or the
convertible note is converted, there will be further dilution to new investors.
15
<PAGE>
SELECTED FINANCIAL DATA
The selected financial data set forth below as of December 31, 1997 and 1998
and for each of the three years in the period ended December 31, 1998 have been
derived from our audited financial statements included elsewhere in this
prospectus. The selected financial data set forth below as of December 31, 1995
and 1996 and for the year ended December 31, 1995 have been derived from our
audited financial statements not included in this prospectus. The selected
financial data as of and for the year ended December 31, 1994, and as of and for
the six months ended June 30, 1998 and 1999 have been derived from unaudited
financial statements which, in the opinion of management, include all
adjustments necessary for a fair presentation of our financial position and
results of operations. The pro forma balance sheet data assumes the conversion
of all outstanding preferred stock and accrued dividends on preferred stock into
common stock. The pro forma net loss per share amounts reflect the outstanding
preferred stock during each period presented and corresponding accrued dividends
through June 30, 1999, on an as converted basis. The selected financial data are
not necessarily indicative of results to be expected for any future period and
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our financial statements,
including the notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
----------------------------------------------------- --------------------
1994 1995 1996 1997 1998 1998 1999
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Software license fees........................... $ -- $ -- $ 1,475 $ 2,337 $ 3,391 $ 1,192 $ 4,727
Services........................................ -- -- 43 2,179 3,620 1,707 1,865
Third party products and related services....... 6,074 6,950 6,555 5,225 1,107 932 --
--------- --------- --------- --------- --------- --------- ---------
Total revenues.............................. 6,074 6,950 8,073 9,741 8,118 3,831 6,592
Cost of revenues:
Software license fees........................... -- -- 113 202 259 96 156
Services........................................ -- -- 305 2,516 4,433 2,078 2,467
Third party products and related services....... 3,502 3,975 4,261 2,798 643 535 --
--------- --------- --------- --------- --------- --------- ---------
Total cost of revenues...................... 3,502 3,975 4,679 5,516 5,335 2,708 2,623
--------- --------- --------- --------- --------- --------- ---------
Gross profit...................................... 2,572 2,975 3,394 4,225 2,783 1,122 3,969
Operating expenses:
Sales and marketing............................. 1,226 1,836 3,005 5,131 9,551 3,748 6,185
Product development............................. 246 458 702 1,295 2,474 904 1,869
General and administrative...................... 724 841 1,515 1,616 2,316 950 2,124
Amortization of stock-based compensation........ -- -- -- -- -- -- 112
--------- --------- --------- --------- --------- --------- ---------
Total operating expenses.................... 2,196 3,135 5,222 8,042 14,341 5,601 10,290
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from operations..................... 376 (160) (1,828) (3,817) (11,558) (4,479) (6,321)
Interest expense, net............................. (30) (41) (50) (80) (47) (34) (1,148)
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing operations.......... 346 (201) (1,878) (3,896) (11,605) (4,512) (7,469)
Income (loss) from discontinued operations........ 300 497 (738) 99 -- -- --
--------- --------- --------- --------- --------- --------- ---------
Net income (loss)................................. 646 296 (2,616) (3,798) (11,605) (4,512) (7,469)
Accretion of preferred stock redemption value..... -- -- -- (240) (846) (308) (779)
--------- --------- --------- --------- --------- --------- ---------
Net income (loss) available to common
stockholders.................................... $ 646 $ 296 $ (2,616) $ (4,038) $ (12,451) $ (4,820) $ (8,247)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Basic and diluted net income (loss) per share:
Continuing operations........................... $ 0.12 $ (0.07) $ (0.67) $ (1.39) $ (4.12) $ (1.60) $ (2.65)
Discontinued operations......................... 0.11 0.18 (0.26) 0.04 -- -- --
Accretion of preferred stock redemption value... -- -- -- (0.09) (0.30) (0.11) (0.28)
--------- --------- --------- --------- --------- --------- ---------
$ 0.23 $ 0.11 $ (0.93) $ (1.44) $ (4.42) $ (1.71) $ (2.93)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Shares used in computing net income (loss) per
share........................................... 2,813 2,813 2,813 2,813 2,814 2,814 2,815
Pro forma basic and diluted net loss per share
from continuing operations...................... $ (1.35) $ (0.68)
--------- ---------
--------- ---------
Shares used in computing pro forma basic and
diluted net loss per share...................... 8,607 10,909
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF JUNE 30, 1999
----------------------------------------------------- ----------------------
1994 1995 1996 1997 1998 ACTUAL PRO FORMA
--------- --------- --------- --------- --------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents..................... $ 120 $ 146 $ 1,086 $ 2,330 $ 2,535 $ 20,600 $ 20,600
Working capital (deficit)..................... 1,119 1,205 (640) (48) (340) 16,576 16,576
Total assets.................................. 3,303 4,888 6,734 5,815 7,536 24,969 24,969
Long-term obligations, net of current
portion..................................... 519 518 1,289 1,270 1,876 1,654 1,654
Mandatorily redeemable convertible preferred
stock....................................... -- -- -- 5,331 17,415 40,453 --
Total stockholders' equity (deficit).......... 1,098 1,375 (1,269) (5,703) (18,147) (24,180) 16,273
</TABLE>
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
We were incorporated in New Jersey in 1989 as Bluestone Consulting, Inc. Our
primary business initially consisted of general information technology
consulting on the UNIX platform and information technology staffing. In January
1991, we entered the software business and became a value added reseller of
third party software products. We also began to develop software internally for
sale to customers as part of our software business. In October 1995, our
proprietary product, Sapphire/Web 1.0, was released.
In March 1997, we reincorporated in Delaware and changed our name to
"Bluestone Software, Inc." In April 1997, we spun off our consulting business to
Bluestone Consulting, Inc., a newly formed Delaware corporation. Immediately
after the spin-off, our business consisted of two product lines:
- Sapphire/Web, our proprietary software product; and
- third party graphical user interface software products, which we resold to
our customers.
For the year ended December 31, 1997, the Sapphire/Web products and related
services generated approximately $4.5 million in revenues, while third party
products and related services contributed approximately $5.2 million.
In 1998, we decided to focus on internally developed software products and
curtail the licensing and services related to third party products. Beginning in
March 1998, we increased our sales and marketing efforts and hired new
management. We hired a significant number of sales personnel throughout the
country in order to develop a nationwide presence and generate increased
revenue. The positioning and feature set of the Sapphire/Web product was shifted
from a low-cost development tool to an enterprise-wide software solution for
Internet applications. For the year ended December 31, 1998, the Sapphire/Web
products and related services generated approximately $7.0 million in revenues,
while third party products and related services contributed approximately $1.1
million. In January 1999, we released Bluestone XML-Server, which represents a
new generation of specialized Web application server focused on Internet
commerce. In May 1999, Release 6 of Sapphire/Web was made generally available.
OVERVIEW
Our fiscal year end is December 31. References to 1996, 1997 or 1998 mean
the fiscal year ended December 31 unless otherwise indicated.
We generate revenue from two principal sources:
- license fees for our software products; and
- professional services and support revenue derived from consulting,
training and maintenance services related to our software products.
In 1998, one customer accounted for 11% of our total product and services
revenues and in the six months ended June 30, 1999, one customer accounted for
29% of our total product and services revenues. Our top 10 customers represented
34%, 39% and 66% of total revenues in 1997, 1998 and in the six months ended
June 30, 1999, respectively.
SOFTWARE LICENSE FEES. Typically, our customers pay an up-front, one-time
fee for a perpetual license of our software. The amount of the fee is based on
the number of developer seats and server interactions. A pricing model based on
the number of processors within a server is also available. We also sell annual
and multi-year licenses, primarily to independent software vendors. We generally
require a written license contract that typically provides for an initial
payment within 30-60 days of contract signing. Certain multi-year license
contracts contain payment terms that extend beyond one
17
<PAGE>
year. Pursuant to the American Institute of Certified Public Accountants'
Statement of Position 97-2, any amounts due under contract beyond one year are
not deemed to be fixed and determinable and therefore are deferred and
recognized as revenue when the payments become due.
Prior to 1998, software licenses were principally the result of direct sales
to end-users. Beginning in 1998, we began to focus on channel marketing. This
has resulted in significant sales of products sold through independent software
vendors, resellers and systems integrators. We believe that these alliances have
helped to maximize our exposure in the marketplace. Furthermore, we have
experienced, and expect to continue to experience, significant variation in the
size of individual licensing transactions, ranging from small sales of perpetual
developer licenses to large, multi-year licensing arrangements with independent
software vendors.
We generally recognize license fee revenue when a formal agreement exists,
delivery of the product has occurred, no production, modification, customization
or implementation obligations remain, the license fee is deemed fixed and
determinable and collectibility is probable. Revenue from arrangements with
distributors and resellers is not recognized until our product is delivered to
the end-user.
SERVICES REVENUE. Services revenue consists principally of revenue derived
from consulting services provided to customers during implementation and
integration of our software products, training of customers' employees and fees
for ongoing maintenance, which consists of customer technical support services
and unspecified product upgrades/enhancements on a when-and-if-available basis.
Consulting and training services are typically delivered on a time and material
basis and are typically completed within one month following license contract
signing. Consulting services generally consist of simple installations and
configurations. We recognize services revenue as the services are performed.
Maintenance revenue is generally invoiced in advance and is recognized ratably
over the term of the maintenance agreement, which is generally 12 months.
COST OF SOFTWARE LICENSE FEES. Cost of software license fees consists
primarily of the costs associated with the purchase of product CDs and related
documentation and duplication costs.
COST OF SERVICES. Cost of services consist primarily of salary and benefit
costs of our consulting, support and training organizations, and are expensed
when incurred. Additionally, from time to time we engage outside consultants to
meet peaks in customer demand.
SALES AND MARKETING. We license our products primarily through our indirect
channels and direct sales force. Sales and marketing expenses consist primarily
of personnel costs, commissions to employees, office facilities, travel and
promotional events such as trade shows, advertising and public relations
programs.
PRODUCT DEVELOPMENT. We maintain an in-house development staff to enhance
our existing products and to develop new ones. Product development expenditures
are generally charged to operations as incurred. Statement of Financial
Accounting Standards No. 86 requires the capitalization of certain software
development costs subsequent to the establishment of technological feasibility.
We establish technological feasibility upon the completion of a working model.
To date, we have expensed all software development costs due to the minimal
level of development costs incurred subsequent to the establishment of
technological feasibility.
GENERAL AND ADMINISTRATIVE. General and administrative expenses include our
personnel and other costs of our finance, human resources and information
services activities.
STOCK-BASED COMPENSATION. The amount by which the fair market value of our
common stock exceeded the exercise price of stock options on the date of grant
is recorded as deferred compensation and is amortized to stock-based
compensation expense as the options vest.
18
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth statement of operations data for the periods
indicated as a percentage of total revenues:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
--------------------------- -----------------
1996 1997 1998 1998 1999
------- ------- ------- ------- -------
(AS A PERCENTAGE OF TOTAL REVENUES)
<S> <C> <C> <C> <C> <C>
Revenues:
Software license fees........................... 18% 24% 42% 31% 72%
Services........................................ 1 22 44 45 28
Third party products and related services....... 81 54 14 24 --
------- ------- ------- ------- -------
Total revenues.............................. 100 100 100 100 100
Cost of revenues:
Software license fees........................... 1 2 3 3 2
Services........................................ 4 26 55 54 37
Third party products and related services....... 53 29 8 14 --
------- ------- ------- ------- -------
Total cost of revenues...................... 58 57 66 71 40
------- ------- ------- ------- -------
Gross profit...................................... 42 43 34 29 60
Operating expenses:
Sales and marketing............................. 37 53 118 98 94
Product development............................. 9 13 30 24 28
General and administrative...................... 19 17 29 25 32
Amortization of stock-based compensation........ -- 2
------- ------- ------- ------- -------
Total operating expenses.................... 65 83 177 146 156
------- ------- ------- ------- -------
Loss from operations.............................. (23) (39) (142) (117) (96)
Interest expense, net............................. (1) (1) (1) (1) (17)
------- ------- ------- ------- -------
Loss from continuing operations................... (23)% (40)% (143)% (118)% (113)%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
</TABLE>
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998
SOFTWARE LICENSE FEES
Sapphire/Web license fees were $4.7 million and $1.2 million for the six
months ended June 30, 1999 and 1998, respectively. This increase of 296.6% was
primarily due to a shift in our product position from a low-priced development
tool to a high-end, high-priced enterprise software solution. This change in
product position has resulted in increased revenues per customer. Additionally,
we were able to concentrate solely on our Sapphire/Web products and services
once we curtailed our graphical user interface product line in April 1998. In
addition, we received payment under an extended license fee arrangement with one
customer in February 1999, which accounted for approximately $1.9 million of our
license fee revenue during the six months ended June 30, 1999.
SERVICES REVENUE
Sapphire/Web services revenue was $1.9 million and $1.7 million for the six
months ended June 30, 1999 and 1998, respectively, an increase of 9.3%. Services
revenue remained relatively constant between the two periods due to a strategic
change in the use of our professional staff. By the beginning of 1999, the main
focus of the services organization had shifted to concentrate on short-term,
installation-type engagements, usually 2-3 days in duration, rather than
long-term implementation activities. These implementation activities are now
performed primarily by systems integrators with which we have strategic
alliances.
19
<PAGE>
THIRD PARTY PRODUCTS AND RELATED SERVICES REVENUE
Third party products and related services revenue was zero and $932,000 for
the six months ended June 30, 1999 and 1998, respectively. This decrease was due
to our decision in 1998 to curtail the licensing and services related to third
party products so that we could focus on our proprietary products.
GROSS MARGIN--LICENSE FEES
Our license fee gross margin increased to 96.7% for the six months ended
June 30, 1999 from 91.9% for the same period in 1998. This increase was
primarily due to the increase in revenue per customer. Our focus on positioning
the product as an enterprise-wide solution has increased the revenue associated
with each sale, while the cost of sales for the product has remained relatively
constant.
GROSS MARGIN--SERVICES REVENUE
Our services gross margin decreased to (32.3)% for the six months ended June
30, 1999 from (21.8)% for the same period in 1998. This was primarily due to the
hiring and training of additional services personnel in advance of anticipated
services revenue growth.
SALES AND MARKETING
Sales and marketing expenses were $6.2 million and $3.7 million for the six
months ended June 30, 1999 and 1998, respectively, an increase of 65.0%. Of this
increase, $1.1 million was due to increases in payroll and related costs,
recruiting costs and travel costs as a result of the growth in the number of
sales personnel, $600,000 was due to increased advertising and trade show
expenses, and $256,000 was due to increased commissions expense as a result of
higher sales volume. We have increased our spending on sales and marketing
because we believe that our sales and marketing efforts are essential for us to
increase our market position and our product acceptance. The average number of
sales and marketing employees for the six months ended June 30, 1999 was 54
compared to 42 for the six months ended June 30, 1998. We also incurred
increases in variable marketing expenses due to increased trade show
participation, direct mail campaigns and advertising in order to increase market
awareness and gain market acceptance of our products. These costs as a
percentage of revenue were 93.8% and 97.8% for the six months ended June 30,
1999 and 1998, respectively.
PRODUCT DEVELOPMENT
Product development expenses were $1.9 million and $904,000 for the six
months ended June 30, 1999 and 1998, respectively, an increase of 106.7%. These
costs as a percentage of revenue were 28.3% and 23.6% for the six months ended
June 30, 1999 and 1998, respectively. These increases were associated with the
development of our new products, Sapphire/Web Release 6 and the Bluestone XML
Suite. We believe that our product development investment is essential for us to
maintain our market and technological competitiveness. Average development
headcount for the six months ended June 30, 1999 and 1998 was 30 and 22,
respectively.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $2.1 million and $950,000 for the
six months ended June 30, 1999 and 1998, respectively. Included in expenses for
the six months ended June 30, 1999 were $577,000 for severance and consulting
costs. The severance costs were related to the termination of certain
executives, and the consulting costs were based upon the fair value of options
issued to outside consultants. Excluding these costs, our general and
administrative expenses were $1.5 million, an increase of 63.0% over the six
months ended June 30, 1998. This increase was primarily due to payroll and
related costs resulting from the addition of personnel to support the growth of
our business. General and administrative expenses as a percentage of revenue
were 32.2% and 24.8% for the six
20
<PAGE>
months ended June 30, 1999 and 1998, respectively. Excluding these severance and
consulting costs, the expenses as a percentage of revenue decreased to 23.5%.
AMORTIZATION OF STOCK-BASED COMPENSATION
Amortization of stock-based compensation was $112,000 and zero for the six
months ended June 30, 1999 and 1998, respectively. Deferred compensation of $1.4
million arose due to the issuance of stock options at exercise prices below the
fair market value of our common stock for accounting purposes relative to the
hiring of key employees and directors during the three months ended June 30,
1999. Deferred compensation is included as a component of stockholders' equity
and is being amortized by charges to operations over the vesting periods of the
options. As of June 30, 1999, we had an aggregate of $1.3 million of deferred
compensation to be amortized through June 30, 2003.
INTEREST EXPENSE
Net interest expense was $1.1 million and $34,000 for the six months ended
June 30, 1999 and 1998, respectively. This increase was due to the issuance of
warrants to purchase 137,608 shares of common stock at the weighted exercise
price of $2.06 per share in connection with the issuance of convertible
subordinated bridge notes. Original issue discount interest cost of $1.1 million
was recorded during the three months ended June 30, 1999 based upon the fair
value of the warrants at the dates of issuance. The warrants are recorded as a
component of stockholders' equity.
1998 COMPARED TO 1997
SOFTWARE LICENSE FEES
Sapphire/Web license fees were $3.4 million and $2.3 million for 1998 and
1997, respectively. The increase of 45.1% was due to increased market acceptance
of the Sapphire/Web software suite.
SERVICES REVENUE
Sapphire/Web services revenue was $3.6 million and $2.2 million for 1998 and
1997, respectively. This increase of 66.1% was due to the increase in the number
of consulting and training engagements associated with our growing customer
base.
THIRD PARTY PRODUCTS AND RELATED SERVICES REVENUE
Third party products and related services revenue was $1.1 million and $5.2
million for 1998 and 1997, respectively. This decrease was due to our decision
in 1998 to curtail the sale of third party products and services.
GROSS MARGIN--LICENSE FEES
Our license fee gross margin was 92.4% in 1998 and 91.4% in 1997, remaining
relatively constant.
GROSS MARGIN--SERVICES REVENUE
Our services gross margin decreased to (22.5)% in 1998 from (15.5)% in 1997.
This decrease in the gross margin was primarily due to the hiring and training
of additional personnel to support our growing installed base of customers and
anticipated increase in future revenues.
SALES AND MARKETING
Sales and marketing expenses were $9.6 million and $5.1 million in 1998 and
1997, respectively, an increase of 86.1%. These costs as a percentage of revenue
increased to 117.7% in 1998 from 52.7% in 1997. These increases were primarily
due to an increase in the number of sales and marketing personnel between March
and September 1998, including the addition of a new Senior Vice President, Sales
and a Senior Vice President, Marketing, as well as three Sales Vice Presidents.
In 1998, we
21
<PAGE>
opened seven new remote sales offices in Georgia, California, Texas, Colorado
and Illinois. Beginning in March 1998, we focused our marketing efforts on
achieving market awareness of Bluestone and acceptance of our products, and
subsequently incurred significant costs for trade show participation,
advertising and direct mail campaigns.
PRODUCT DEVELOPMENT
Product development expenses were $2.5 million and $1.3 million for 1998 and
1997, respectively, an increase of 91.0%. These costs as a percentage of revenue
increased to 30.5% in 1998 from 13.3% in 1997. These increases were primarily
due to an increase of $948,000 in payroll and related costs related to the
hiring of additional developers, and $115,000 for additional rent and
depreciation expense related to capital expenditures for software, hardware and
equipment.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $2.3 million and $1.6 million for
1998 and 1997, respectively. This increase of 43.3% was primarily due to
increases in staff to support our growth. These costs as a percentage of revenue
increased to 28.5% in 1998 from 16.6% in 1997.
1997 COMPARED TO 1996
SOFTWARE LICENSE FEES
Sapphire/Web license revenue was $2.3 million and $1.5 million for 1997 and
1996, respectively. The increase of 58.4% was due to increased market acceptance
of the Sapphire/Web software suite.
SERVICES REVENUE
Sapphire/Web services revenue was $2.2 million and $43,000 for 1997 and
1996, respectively. This increase of $2.1 million was primarily due to an
increase in the number of consulting and training engagements associated with
our growing customer base.
THIRD PARTY PRODUCTS AND RELATED SERVICES REVENUE
Third party products and related services revenue was $5.2 million and $6.6
million for 1997 and 1996, respectively. This decrease was due to a shift in our
attention from third party products and services towards proprietary products
and services.
GROSS MARGIN--LICENSE FEES
Our license fee gross margin was 91.4% in 1997 and 92.3% in 1996, remaining
relatively constant.
GROSS MARGIN--SERVICES REVENUE
Our services gross margin increased to (15.5%) in 1997 from (609.3%) in
1996. This increase was primarily due to a significant increase in the sales of
our product and the related consulting, training and maintenance services. We
began to offer our maintenance services in 1996.
SALES AND MARKETING
Sales and marketing expenses were $5.1 million and $3.0 million for 1997 and
1996, respectively. This increase of 70.7% was primarily due to increases in the
number of sales and marketing personnel. These costs as a percentage of revenue
increased to 52.7% in 1997 from 37.2% in 1996.
PRODUCT DEVELOPMENT
Product development expenses were $1.3 million and $702,000 for 1997 and
1996, respectively, an increase of 84.5%. These costs as a percentage of revenue
increased to 13.3% in 1997 from 8.7% in 1996. These increases were primarily due
to the costs of hiring of additional developers.
22
<PAGE>
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $1.6 million and $1.5 million for
1997 and 1996, respectively. This increase of 6.7% was primarily due to
increases in staff to support our growth. These costs as a percentage of revenue
decreased to 16.6% in 1997 from 18.8% in 1996.
SELECTED QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited quarterly statement of operations
data for periods indicated. We derived this data from our unaudited financial
statements, and, in our opinion, they include all adjustments necessary to
present fairly the financial results for the periods. Results of operations for
any previous fiscal quarter do not necessarily indicate what results may be for
any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------------------------------------
6/30/97 9/30/97 12/31/97 3/31/98 6/30/98 9/30/98 12/31/98 3/31/99 6/30/99
------- ------- -------- ------- ------- ------- -------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Software license fees................. $ 530 $ 523 $ 854 $ 432 $ 760 $ 1,354 $ 845 $ 2,257 $ 2,470
Services.............................. 563 624 708 937 769 1,029 885 1,020 845
Third party software and related
services............................ 1,176 1,181 1,272 785 147 114 61 -- --
------- ------- -------- ------- ------- ------- -------- ------- -------
Total revenues.................... 2,269 2,328 2,834 2,154 1,676 2,497 1,791 3,277 3,315
Cost of revenues:
Software license fees................. 23 67 78 39 57 113 50 57 99
Services.............................. 624 682 865 985 1,093 1,192 1,163 1,338 1,129
Third party software and related
services............................ 647 621 683 436 98 73 35 -- --
------- ------- -------- ------- ------- ------- -------- ------- -------
Total cost of revenues............ 1,294 1,370 1,626 1,460 1,248 1,378 1,248 1,395 1,228
------- ------- -------- ------- ------- ------- -------- ------- -------
Gross profit............................ 975 958 1,208 694 428 1,119 543 1,882 2,087
Operating expenses:
Sales and marketing................... 1,099 1,398 1,598 1,545 2,203 2,930 2,874 2,826 3,360
Product development................... 299 338 376 360 544 704 866 904 964
General and administrative............ 381 434 439 447 502 666 701 635 1,489
Amortization of stock-based
compensation........................ -- -- -- -- -- -- -- -- 112
------- ------- -------- ------- ------- ------- -------- ------- -------
Total operating expenses.......... 1,779 2,170 2,413 2,352 3,249 4,300 4,441 4,365 5,925
------- ------- -------- ------- ------- ------- -------- ------- -------
Loss from operations.................... (804) (1,212) (1,205) (1,658) (2,821) (3,181) (3,898) (2,483) (3,838)
Interest income (expense), net.......... (22) 12 (29) (41) 8 42 (56) (48) (1,100)
------- ------- -------- ------- ------- ------- -------- ------- -------
Loss from continuing operations......... $ (826) $(1,200) $(1,234) $(1,699) $(2,813) $(3,139) $(3,954) $(2,531) $(4,938)
------- ------- -------- ------- ------- ------- -------- ------- -------
------- ------- -------- ------- ------- ------- -------- ------- -------
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------------------
6/30/97 9/30/97 12/31/97 3/31/98 6/30/98 9/30/98 12/31/98 3/31/99 6/30/99
------- ------- -------- ------- ------- ------- -------- ------- -------
(AS A PERCENTAGE OF TOTAL REVENUES)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Software license fees.............. 23% 22% 30% 20% 45% 54% 47% 69% 75%
Services........................... 25 27 25 44 46 41 49 31 25
Third party software and related
services......................... 52 51 45 36 9 5 3 -- --
------- ------- --- ------- ------- ------- --- ------- -------
Total revenues................. 100 100 100 100 100 100 100 100 100
Cost of revenues:
Software license fees.............. 1 3 3 2 3 5 3 2 3
Services........................... 28 29 31 46 65 48 65 41 34
Third party software and related
services......................... 29 27 24 20 6 3 2 -- --
------- ------- --- ------- ------- ------- --- ------- -------
Total cost of revenues......... 57 59 57 68 74 55 70 43 37
------- ------- --- ------- ------- ------- --- ------- -------
Gross profit......................... 43 41 43 32 26 45 30 57 63
Operating expenses:
Sales and marketing................ 48 60 56 72 131 117 160 86 101
Product development................ 13 15 13 17 32 28 48 28 29
General and administrative......... 17 19 15 21 30 27 39 19 45
Amortization of stock-based
compensation..................... -- -- -- -- -- -- -- -- 3
------- ------- --- ------- ------- ------- --- ------- -------
Total operating expenses....... 78 93 85 109 194 172 248 133 179
------- ------- --- ------- ------- ------- --- ------- -------
Loss from operations................. (35) (52) (43) (77) (168) (127) (218) (76) (116)
Interest income (expense), net....... (1) 1 (1) (2) -- 2 (3) (1) (33)
------- ------- --- ------- ------- ------- --- ------- -------
Loss from continuing operations...... (36)% (52)% (44)% (79)% (168)% (126)% (221)% (77)% (149)%
------- ------- --- ------- ------- ------- --- ------- -------
------- ------- --- ------- ------- ------- --- ------- -------
</TABLE>
23
<PAGE>
Our comparisons of operating results from 1996 to 1997 and from 1997 to
1998, and for the six months ended June 30, 1998 to the six months ended June
30, 1999, generally apply to the comparison of the results of operations for the
nine quarters in the period ended June 30, 1999. Our third party products and
related services revenue decreased during the four quarters of 1998 due to our
decision to curtail the licensing of third party products so that we could focus
our resources on our proprietary products. Our gross profit margin increased
over the three quarters ended June 30, 1999 due to the increase in our
proprietary software license revenue. The increase in general and administrative
expenses for the three months ended June 30, 1999 resulted primarily from
$577,000 of severance and consulting costs. Net interest expense increased
during the three months ended June 30, 1999 due to the issuance of warrants with
an original issue discount interest cost of $1.1 million in connection with the
issuance of convertible bridge notes. See "Certain Transaction--Bridge
Financing."
Our quarterly operating results have varied in the past and may vary
significantly in the future depending on many factors including, among others:
- the size, timing and recognition of revenue from significant orders;
- increases in operating expenses required for product development and
marketing;
- the timing and market acceptance of new products and product enhancements;
- customer budget constraints;
- our success in expanding our sales and marketing programs; and
- general economic conditions.
We believe that the purchase of our products is relatively discretionary and
generally involves a significant commitment of capital. As a result, purchases
of our products may be deferred or canceled in the event of a downturn in any
potential customer's business or the economy in general. Accordingly, we believe
that, while the quarterly period-to-period comparisons furnish important
information about our revenues and expenses, they are not necessarily meaningful
and should not be relied upon as indicators of future performance.
LIQUIDITY AND CAPITAL RESOURCES
From our incorporation in 1989 through 1996, we primarily financed our
operations and met our capital expenditure requirements through funds generated
from operations and funds borrowed from lending institutions. From April 1997
through May 1999, we raised approximately $41.6 million of venture capital
funding in order to expand the sales and marketing and product development
efforts of the business. As of June 30, 1999 our primary sources of liquidity
consisted of cash in excess of $20.6 million and $1.0 million of available
borrowings under our $1.75 million revolving line of credit, which is secured by
substantially all of our assets. As of June 30, 1999, the balance outstanding on
our line of credit was $671,000. Borrowings under the line of credit are subject
to a borrowing base of 80% of eligible accounts receivable. Interest on our line
of credit is payable monthly at rates of prime plus .75%. We believe that our
existing capital resources are sufficient to meet our capital requirements for
the next 12 months.
Net cash used for operating activities was $3.0 million in 1997, $10.3
million in 1998 and $4.7 million for the six months ended June 30, 1999. The
cash used for operating activities was attributable primarily to net losses of
$3.8 million, $11.6 million and $7.5 million in 1997, 1998 and the six months
ended June 30, 1999, respectively.
Net cash used in investing activities was $872,000 in 1997, $1.2 million in
1998 and $164,000 for the six months ended June 30, 1999. The cash used in
investing activities related primarily to purchases of computers and software
for internal use.
24
<PAGE>
Net cash provided by financing activities amounted to $5.1 million in 1997,
$11.7 million in 1998 and $23.0 million for the six months ended June 30, 1999.
In 1997, $4.8 million was provided from the sale of Series A preferred stock to
certain venture capital investors, $920,000 was provided from borrowings under
the available credit lines and $250,000 was provided from borrowings from a
related party. In April 1998, approximately $11.2 million was provided from the
sale of Series B preferred stock to certain venture capital investors. In May
1999, we sold 9,191,176 shares of Series C preferred stock for gross proceeds of
$25.0 million, $1.35 million of which was comprised of the conversion of
indebtedness under bridge financing incurred earlier in 1999. For more
information on the bridge financing, see "Certain Transactions--Bridge
Financing."
YEAR 2000 ISSUES
GENERAL. Year 2000 issues relate to computer programs or hardware that have
date-sensitive software or embedded chips that may recognize a date using "00"
as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculation causing disruption of operations, including, among
other things, a temporary inability to process transactions, send invoices or
engage in other normal business activities.
The term "computer programs and hardware" includes accounting, data
processing and telephone/ PBX systems, in addition to other miscellaneous
systems. These systems may contain imbedded technology, which complicates our
identification, assessment, remediation and testing efforts.
STATE OF READINESS. We have designed the current versions of our software
products to be Year 2000 compliant, and do not anticipate any Year 2000 issues
related to these products. However, some older versions of our software products
that we no longer sell may not be Year 2000 compliant. Any customer using an
older version of one of our products that is not Year 2000 compliant may need to
upgrade to a newer, compatible version or discontinue using the software prior
to January 1, 2000.
We have performed an assessment of the Year 2000 readiness of our
information technology systems, including the hardware and software we use to
provide and deliver our products. Our testing to date has included our major
infrastructure items, hardware platforms, telephone, voice mail and operating
systems. All of the tested systems are compliant. Desktop computing, servers,
switching and routing platforms have been inventoried and tested with only minor
upgrades necessary to one router family. All personal computer systems have been
tested and, where necessary, upgraded. By July 1999, we had largely completed
the implementation of Year 2000 compliant internal computer applications for our
main financial and order processing systems.
We completed a Year 2000 simulation on our internal systems and software
during the first quarter of 1999. Any discrepancies noted were corrected.
Another testing cycle will be completed during the third quarter of 1999 to
ensure that systems then not compliant or systems that are newly discovered to
be non-compliant are remedied. No information technology projects have been
delayed or deferred by our Year 2000 compliance program.
As of January 1999, all third party vendors who provide us with systems or
software were contacted and provided us with written assurances of their
product's compliance. We have incorporated any recommended changes and upgrades
wherever necessary. We have not used any independent verification or validation
processes to verify the Year 2000 compliance of our third party vendors. In the
event that one or more of our significant vendors or service providers are not
Year 2000 compliant, due to undetected or embedded system components or
technology, we believe that our results of operations will not be materially
adversely affected and that our relationships with customers, vendors and others
will not be materially adversely affected.
We have also sought assurances of Year 2000 compliance from our material
providers of items other than information technology. To date we have received
approximately 95% of the necessary
25
<PAGE>
responses and will complete this portion of our investigations by the end of the
third quarter 1999. We have not received notification from any vendor indicating
that they are not Year 2000 compliant.
COST AND RISK. We have funded our Year 2000 compliance efforts from our
cash flow from operations and we have not incurred any significant costs to date
related to Year 2000 issues and do not expect the cost of future Year 2000
issues to be material. Furthermore, we believe that Year 2000 issues will not
pose significant operational problems for us.
However, if all Year 2000 issues are not properly identified or if Year 2000
issues that are identified are not assessed, remediated and tested in a timely
fashion, the Year 2000 issue may adversely impact our results of operations or
adversely affect our relationships with customers, vendors or others. Also, we
may experience operational difficulties caused by undetected errors or defects
in embedded technologies that we use in our internal systems. Additionally, we
cannot predict whether the Year 2000 issues of third parties will have a
material adverse impact on our systems or results of operations.
The costs and completion dates of our Year 2000 identification, assessment,
remediation and testing efforts are based upon management's best estimates,
which were derived using numerous assumptions regarding future events. We have
not used any independent verification or validation process to assure the
reliability of our risks and costs estimates. These estimates may prove to be
inaccurate and actual results could differ materially from those currently
anticipated. Specific factors that could cause these material differences
include, but are not limited to, the ability to identify, assess, remediate and
test all relevant products and services purchased from or by third parties and
other similar uncertainties. In addition, variability of definitions of
"compliance with Year 2000," and the myriad of different products and services
and combinations thereof, used by our customers in connection with our products
may lead to claims against us which we cannot currently estimate. The aggregate
cost of defending and resolving such claims, if any, may adversely impact our
results of operations.
Year 2000 issues may affect the purchasing patterns of current and potential
customers in a variety of ways. Many companies are expending significant
resources to replace or remedy their current hardware and software systems for
Year 2000 compliance. These expenditures may result in reduced funds available
to purchase software products such as those offered by us. Furthermore, our
customers could be forced to postpone installations of our products due to
dedication of resources to their own Year 2000 issues. We do not believe that
there is any practical way to ascertain the extent of, and have no plan to
address problems associated with, any reduction in purchasing resources of our
customers. Any resulting reduction could have a material adverse effect on our
business.
To date, there has been no material negative impact on our financial
condition or operations as a result of our Year 2000 compliance program.
CONTINGENCIES. We have not yet completed an analysis of the operational
problems and costs, including loss of revenues, that would be reasonably likely
to result from our failure and the failure of certain third parties to complete
efforts necessary to achieve Year 2000 compliance on a timely basis. We plan to
identify the most likely worst case scenario and, if a contingency plan is
required, finalize our plan by September 1999.
26
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop our products in the U.S. and have sold them primarily in North
America. As a result, our financial results have not been affected by factors
such as changes in foreign currency exchange rates or weak economic conditions
in foreign markets. In the future, we expect to increase our international
operations which could increase our exposure to these factors.
Our future interest income will be sensitive to changes in the general level
of U.S. interest rates. However, we plan to invest our excess cash in
short-term, investment-grade, interest-bearing securities and we have concluded
that there is no material market risk exposure relating to these investments.
27
<PAGE>
BUSINESS
OUR COMPANY
We believe we are a leading provider of software for enterprise interaction
management, which enables businesses to extend information over the Web in a
controlled manner and to support high volumes of users and interactions. This
belief is based on our product performance and what we believe to be our
relative share of the fragmented market for application server software. Our
flagship product, Sapphire/Web, is a framework for JAVA Web application servers
and is currently in Release 6. A Web application server is a software product
that allows broad access to stored corporate information and applications to a
variety of users, including customers, suppliers and employees, via the Web. We
believe that our JAVA Web application server is the leading solution of its kind
based on the breadth of its functionality. We believe that ours is the only
product to adequately address the four defining elements of enterprise
interaction management--development, deployment, integration and management--and
therefore provides the most complete overall solution to our customers. In
December 1998 at the Giga Information Group's Emerging Technology Conference, we
demonstrated that our solution can meet the needs of virtually any enterprise by
conducting a live simulation of an Internet commerce site running at a rate of
over 100 million interactions per day. In January 1999, we released Bluestone
XML-Server, which represents a new generation of specialized Web application
server focused on commerce via the Internet.
We participate in the following three separate markets:
- THE MARKET FOR JAVA WEB APPLICATION SERVERS. In this market sector,
enterprises employ our solutions to deploy their existing information
technology assets for use in a Web environment, and to create new
enterprise applications that are used via the Web.
- THE MARKET FOR EXTENDING THE SUPPLY CHAIN. In this market sector, our
products enable the "virtual corporation," which means they allow an
enterprise to integrate its information assets with those of its partners,
vendors and customers to improve collaboration utilizing Web technology in
a highly secure and scalable environment.
- THE MARKET FOR ENTERPRISE APPLICATION INTEGRATION. In this market sector,
our products facilitate the integration of disparate computer systems
within an enterprise. We believe we are particularly well positioned in
this market, since the necessary capabilities, including standardizing
corporate data formats and providing access to existing information
systems, are two of the core strengths of our JAVA Web application server
software.
Our solutions are used by some of the world's leading companies, including
ARI, AT&T, Deutsche Bank, Dreyfus Corporation, Eli Lilly, Hewlett-Packard,
Houghton Mifflin Company, Just For Feet, MCI WorldCom, OpenConnect and Reliance
National.
OUR INDUSTRY
GROWTH IN INTERNET RELATED SOFTWARE
The Internet has experienced dramatic growth, both in terms of the number of
users and as a means of conducting commercial transactions, and is expected to
continue to grow rapidly. According to a report prepared by the Computer
Industry Almanac Inc., an independent research organization, the number of
Internet users was over 150 million in 1998, and is expected to grow to over 720
million by the end of 2005.
The increase of users and business activities on the Web has created a large
and growing market for Web application software as existing businesses and new
Web-based enterprises foster new revenue streams, significantly broaden
information deployment, enable inter-enterprise collaboration and strive to
reduce the cost of maintaining an ever-changing technology infrastructure. An
International Data
28
<PAGE>
Corporation report estimates that Internet-centric software, which accounted for
$4.0 billion in revenue in 1997, will approach $16.0 billion by 2000 due to
aggressive corporate adoption.
THE RISE OF THE ENTERPRISE APPLICATION SERVER
To date, most companies' use of Internet technology has consisted of
employing Internet software products called Web servers to provide marketing
material through their Web sites. This technology allows the presentation of
relatively simple information to users, such as pictures and text, through
static documents. This static information must be preformatted with the
information to be displayed, then manually changed when information is to be
updated. This technology is still heavily in use today, but cannot sufficiently
meet the quickly growing needs of companies to provide complex and dynamic
information to their users. The existing information technology infrastructure
of most companies leaves them unable to utilize, integrate or deploy existing
information technology assets for Internet commerce or use over the Web. These
companies are recognizing that a broader set of facilities is required to
capture the substantial benefits offered by Internet computing. These facilities
include development capabilities that are specifically geared to a Web-based
environment, interaction environments that are scalable and reliable,
integration faculties that allow seamless linkages between the Internet and an
enterprise's existing information infrastructure, and the ability to effectively
monitor and manage Web-based applications and infrastructure. Web application
servers such as our software have emerged to provide these facilities.
Web application servers, by design, allow scalable, secure real time,
interactive access to complex information through the Web that is otherwise only
available internally in an organization through its own applications and
existing databases. They do this by providing the following capabilities:
- load balancing--spreading the workload across multiple processors;
- transaction management--tracking and assuring the completion of
transactions;
- integration to multiple back-end sources--making all enterprise
information available for use;
- an integrated development environment--a graphical tool to assist software
developers;
- application management--monitoring and reporting on all application server
activity; and
- multiple user support--the ability to individually serve a community of
disparate users.
Demand for these capabilities has resulted in significant growth in the
market for Web application servers. In an August 1998 report, Forrester
Research, an independent research organization, estimated that the market for
Application Server software would be approximately $700 million in 1999 and
would grow to approximately $1.8 billion by 2001, representing a compound annual
growth rate of approximately 60%. Another independent technology research
organization, Ovum, estimated in June 1999 that the market for application
server technologies, which they define in a manner that more closely resembles
our addressable market, will grow to $17 billion by 2004.
OUR SOLUTION
We provide a comprehensive framework that enables businesses to deploy
information across the Internet, or their proprietary company networks called
intranets and extranets, to employees, customers, suppliers and partners. Our
solution furnishes businesses with the ability to Web-enable existing
information systems, develop new Web-based applications, and enable Internet
commerce. Our deployment solution is certified by Sun Microsystems as 100% Pure
JAVA and therefore operates in all enterprise computing environments. We have
recently introduced the capability to support Hot Swapping, which enables the
movement of applications from one computer to another, and Hot Versioning, which
enables software programs to be updated between user clicks. These features
allow businesses to upgrade or fix their hardware and software without
interrupting user interactions
29
<PAGE>
permitting true 24x7 operations. This is particularly critical for companies
engaged in Internet commerce where down time can be very costly. We believe our
solution is the only one available that provides the features and capabilities
necessary for use in enterprise-scale, mission-critical applications. In
particular, our solution offers the following facilities:
ROBUST DEVELOPMENT ENVIRONMENT AND TOOLSET. Our solution includes an
integrated development environment, which can be thought of as a programmer's
toolkit, that uses industry-standard programming components to easily assemble
applications and provides improved support for users with varying skill levels.
This toolkit includes automated routines to generate user interfaces and the
ability to import existing user interfaces from other sources, which increases a
programming staff's development speed. The environment is open and highly
adaptable, which allows programmers to increase their productivity by selecting
the most appropriate tools for a given task.
SCALABLE, OPEN, HIGH-PERFORMANCE DEPLOYMENT. The Web application server
framework within our solution enables businesses to make their information
available with a high degree of reliability, security and flexibility. Our Web
application server supports very high volumes of interactions and high numbers
of concurrent users with caching, load balancing and fault-tolerance features,
which optimize response times and ensure the integrity of applications. In
addition, our standards-based, 100% Pure JAVA architecture allows for a high
level of flexibility in operating systems, programming languages, and database
access and communication protocols, with no dependence on proprietary
technology.
EXTENSIVE INTEGRATION CAPABILITIES. Our solution goes beyond application
programming interfaces, or APIs, to facilitate communications between a
business' computing systems with pre-built modules for Web-enabling today's
dominant business applications, such as those from SAP and PeopleSoft. Our
solution also includes tools that allow programmers to rapidly build new
integration modules for other applications, and generally enable complex
information answers to be generated from any data source within the enterprise,
no matter how remote or proprietary. These capabilities allow businesses to
marry existing systems to new information delivery platforms, thereby preserving
legacy investments.
COMPREHENSIVE MANAGEMENT. Our solution provides the necessary means to
monitor, administer and report on a business' entire Web infrastructure. These
advanced features provide the means to perform administrative and management
tasks easily and quickly, allow for real time reconfiguration of the information
infrastructure, assure minimum and/or differentiated levels of service, and
integrate with leading systems management utilities such as those from Computer
Associates, IBM Tivoli, BMC and Hewlett-Packard. Our solution automatically
generates alarms, alerts and reports, which allows for optimal performance of,
and powerful insight into, a business' Web infrastructure.
OUR GROWTH STRATEGY
Our goal is to maintain and extend our position as a leading provider of Web
application server technology, enterprise application integration and Internet
commerce solutions. Our key growth strategies are to:
MAINTAIN AND EXTEND TECHNOLOGICAL LEADERSHIP. We believe that our
technology, solution and features represent a significant competitive advantage
and provide customer benefits that are not available from other solutions.
Highly advanced technological elements incorporated in our solutions
collectively contribute to the speed, scalability, reliability, manageability,
flexibility and extensibility of our product set. For more information on these
technological elements, see "--Technology." We believe that our consistent
record of technological industry firsts, as demonstrated recently by the release
of our Bluestone XML-Server, will continue into the future.
EXPAND PRODUCT OFFERINGS. We intend to continue to develop new products and
enhancements to existing products to fuel continued growth. Recently, we
introduced our XML suite of products, which
30
<PAGE>
expands the markets and applications for our technology, with a focus on
Internet commerce and inter-enterprise information exchange. Upcoming
enhancements to the Sapphire/Web suite consist of enhanced Internet commerce
services including the ability to provide differentiated service levels based on
user profiles, improved content and presentation management capabilities, and
significantly increased bandwidth, transaction processing and security.
Additional upcoming enhancements will include improved high-end management
features like reporting and control systems, new business application
capabilities and increased ease of use. We expect to continue to make
considerable investments in product development to maintain this pace of
innovation.
CONTINUE TO FOCUS ON ENTERPRISE-SCALE SOLUTIONS. An April 5, 1999 article
in PCWEEK ONLINE reported on an independent evaluation of our Web application
server framework against two competitive products. The evaluation employed a
simulated E-commerce site developed by Doculabs, an independent information
advisory company. In this evaluation, our solution posted throughput and
response time results that were 50% higher than our nearest competitor. In
addition, our solution was the only product able to meet the fault-tolerance
requirements of mission-critical and E-commerce applications. At the December
1998 Emerging Technology Conference sponsored by Giga Information Group, we
performed a live demonstration based on a PCWEEK Labs-designed benchmark and
successfully processed a variety of complex transactions at a rate of over 100
million interactions per day. Consequently, we believe that we are uniquely
positioned as a performance leader in our industry and will benefit as an
increasing number of large mission-critical systems move to the Web and as
Internet commerce grows.
INCREASE MARKETING AND DIRECT SALES EFFORTS. We intend to leverage our
previous customer successes by devoting significant marketing and direct sales
resources to specific industry verticals, including telecommunications,
insurance, brokerage, pharmaceuticals and E-commerce. We intend to increase the
number of field sales offices and field sales representatives over the next 12
months. Our direct sales organization is organized around named accounts,
geographic regions and, increasingly, industry verticals. As of June 30, 1999,
we had 52 employees in sales and marketing, 18 of which were quota-carrying
field sales representatives.
FURTHER DEVELOP INDIRECT CHANNELS, PARTNERS AND ALLIANCES. Our sales
efforts are leveraged by indirect channels and partners, and we intend to
continue to foster these relationships to fuel additional growth. These
channels, partners and alliances significantly extend our market reach and
overall opportunity set, and include the following:
- independent software vendors, including Hewlett-Packard, Sanchez Computer
Associates and Platinum technology;
- systems integrators, including American Management Systems, Grant
Thornton, KPMG, PricewaterhouseCoopers and approximately 65 others; and
- value added distributors (VADs) and value added resellers (VARs),
including Intraware and Merisel.
OUR PRODUCTS
SAPPHIRE/WEB SUITE
SAPPHIRE/DEVELOPER. Sapphire/Developer is a software product that delivers
the capability to build applications that are used through the Web to find,
access and deliver enterprise-class information to users. It connects any
back-end data source to any front-end data user. It supports a wide variety of
industry standard data formats and programming languages, such as HTML and
ActiveX, and enables the delivery of information to any database, flat file or
other enterprise application. Sapphire/
31
<PAGE>
Developer's ability to incorporate new technology, tools and development
approaches allows increased productivity and faster deployment of Web
applications.
SAPPHIRE/DEVELOPER ENTERPRISE EDITION. Sapphire/Developer Enterprise
Edition is a bundle of software products which includes the Sapphire/Developer
Enterprise Deployment Kit and Sapphire/ Developer. Sapphire/Enterprise
Deployment Kit is a software tool kit that extends Sapphire/Developer to enable
the use of any combination of operating systems, programming languages and data
definitions such as those from Microsoft, Sun and IBM.
SAPPHIRE/UNIVERSAL BUSINESS SERVER. Sapphire/Universal Business Server is
the Web application server that creates a real time, Web-enabled environment
that scales applications to meet fluctuating needs, balances loads to prevent
system downtime, crashes or poor performance and manages transactions across the
Web infrastructure. Sapphire/Universal Business Server delivers scalability and
consistent availability to mission-critical, enterprise-class Web applications.
SAPPHIRE/APPLICATION MANAGER. Sapphire/Application Manager is a management
engine that proactively collects and provides real-time performance and status
information on a company's entire Web infrastructure, including all components
of the Sapphire/Web application server framework. Sapphire/Application Manager
monitors all user interactions and bolsters the quality, performance and
integrity of work being performed over the Web using the Sapphire/Web
application server.
SAPPHIRE/INTEGRATION MODULES. Sapphire/Integration Modules provide a
solution for integrating a company's existing information assets without the
need for extensive and costly re-engineering of applications and infrastructure.
Sapphire/Integration Modules create reusable programs that are used to access
all of a company's information resources and make them easily available to
programmers and users. We provide Sapphire/Integration Modules to popular
applications and protocols, such as SAP, PeopleSoft, CICS and MQ Series.
THE BLUESTONE XML SUITE
BLUESTONE XML-SERVER. Our Bluestone XML-Server, released in January 1999,
is a specialized application server that automatically converts data from
existing sources into XML documents and then uses the XML documents to
communicate with other applications. XML is a highly flexible document format
for structuring data on the Web. Our XML server enables businesses to conduct
Internet commerce, integrate their supply chains and generally share information
across software applications and with other businesses in an automated fashion.
BLUESTONE VISUAL-XML. Our Bluestone Visual-XML product, announced in
February 1999 and released in May 1999, is a tool kit designed to allow business
users to develop applications based on XML with a graphical drag-and-drop
environment.
XWINGML. Our XwingML product is an open source application that was
released in February 1999 and is used to create JAVA graphical user interfaces
based on XML documents.
BLUESTONE XML-CONTACT. Our Bluestone XML-Contact is open source software
that lets devices using 3Com's Palm operating system exchange contact
information with any corporate database, turning personal productivity tools
into corporate information resources with the power of XML.
SERVICES AND SUPPORT
We offer short-term mentoring, consulting and customer training services
through our Advanced Technology Group. We use our Advanced Technology Group
resources to assist our partners and clients in the early implementation
efforts, which tend to be less than one month in duration, and rely on our
systems integration partners to deliver longer-term professional integration
services. This strategy allows
32
<PAGE>
us to offer a higher degree of pre- and post-sales support to our prospects,
partners and licensees in support of furthering the sales of our software
products.
We have a Customer Support Group that provides ongoing maintenance and
support to customers through maintenance contracts. We furnish support through
the telephone and e-mail, as well as through a portion of our Web site called
Explore Web, which provides users with access to a comprehensive knowledge base
of the Sapphire/Web and XML suite solutions.
We offer extensive training and certification for Sapphire/Web products as
well as course training in related topics, such as JAVA, XML and the Web in
general. Additionally, we also offer formal instruction through interactive
distance learning, which furnishes instruction through an innovative mix of
video, computer-based training and e-mail. We provide ongoing technical support
on a contractual basis to our licensees with annual maintenance agreements.
SALES AND MARKETING
As of June 30, 1999, our sales and marketing organization consisted of 52
individuals, all of whom were based in North America. We had 18 field sales
representatives and 11 inside sales representatives, all of whom carry quotas.
The sales force is comprised of three primary organizations: Named Accounts,
Direct Sales and Indirect Sales. We have diversified our sales activities to
support a target distribution of 70% indirect and 30% direct.
We have sales offices in Sacramento, Los Angeles, Atlanta, Dallas, Chicago,
Boulder, San Francisco, Toronto and Mount Laurel, New Jersey. Sales outside
North America are generated by third party resellers in London, Seoul and
Sydney. We expect to open regional sales support offices in Europe and Asia
Pacific within the next twelve months.
We support our sales efforts through corporate and field marketing
initiatives in North America. Our marketing organization focuses on creating
market awareness, generating leads, promoting our technology leadership and
educating independent research analysts. These efforts include public relations,
advertising, trade shows, alliance programs, seminars, direct mail,
telemarketing and marketing collateral that includes a Web site, brochures,
white papers and demonstrations.
STRATEGIC ALLIANCES
We are building and maintaining significant working relationships with
complementary vendors that we believe will contribute to our ongoing success.
These relationships fall into four categories: strategic technology alliances,
independent software vendors, systems integrators and value added distributors
and resellers. Within our strategic technology alliances, we engage in
collaborative technology exchanges with BEA Systems, Computer Associates,
Informix, IBM, Level III Communications/PKS SI, Microsoft, Netscape,
OpenConnect, Oracle, Platinum technology, Sanchez Computer Associates and Sun
Microsystems, among others.
We have relationships with independent software vendors, including
Hewlett-Packard, Platinum technology, OpenConnect, Sanchez Computer Associates
and Foundation Technologies. These partners deliver their application software
products with some element of our technology embedded therein. We maintain a
close working relationship with these partners and will continue to develop
relationships of this nature.
We also maintain relationships with third party systems integrators who
deliver services to our end-user clients. These companies have been recruited to
deliver long term project support and are required to maintain a level of
proficiency in our products. These relationships include American Management
Systems, KPMG, Grant Thornton, PricewaterhouseCoopers and Level III
Communications/PKS SI.
33
<PAGE>
We have entered into formal two-tier distribution agreements with Intraware
and Merisel to deliver our suite of software products. These agreements provide
Intraware and Merisel with the right to distribute our products in North
America.
We are a member in good standing of the Enterprise JAVA Bean Council, the
World Wide Web Consortium (W3C), the Object Management Group (OMG) and the
Enterprise Integration Council.
CUSTOMERS
From 1996 through 1998, we licensed copies of our Sapphire/Web software to
more than 500 customers. Most of these customers began using our Sapphire/Web
products to Web-enable separate departmental systems and many of them are now
expanding their usage of Sapphire/Web to a company-wide basis. Accordingly, we
have observed a recent shift by our customers from creating Web applications to
creating enterprise applications that are Web-enabled.
Our solutions are applicable to a wide variety of industries and are used by
many of the world's leading businesses. For example, Sapphire/Web users include:
- three of the top five FORTUNE 500 companies in the electronics industry;
- five of the top ten FORTUNE 500 companies in the computer equipment
industry;
- four of the top five FORTUNE 500 companies in the aerospace industry;
- seven out of the top ten FORTUNE 500 companies in the telecommunications
industry;
- three of the top four FORTUNE 500 companies in the entertainment industry;
and
- five of the top ten FORTUNE 500 companies in the pharmaceuticals industry.
Our customers include ARI, AT&T, Deutsche Bank, Dreyfus Corporation, Eli
Lilly, Hewlett-Packard, Houghton Mifflin Company, Just For Feet, MCI WorldCom,
OpenConnect and Reliance National. Each of these customers accounted for at
least $100,000 in revenue.
Examples of successful Sapphire/Web implementations with representative
customers of ours include the following:
- We helped ARI, a large international leasing company, establish its first
Web application in 1998. That application enabled ARI's customers to
inquire directly into ARI's leasing system to manage delivery and
maintenance information for ARI's fleet.
- Reliance National, a major insurance company, has been using Sapphire/Web
software since 1997. Reliance National began with small departmental
solutions. In 1998, Reliance National expanded its usage to include a
system that decentralized its operations by communicating its risk
management system to all of its associated brokers, thereby significantly
expanding the speed in which the broker can prepare premium quotes and the
manner in which Reliance National serves its customers.
- AT&T and MCI WorldCom have each chosen our products to be used in customer
loyalty and retention programs. These companies have engaged in projects
to Web-enable their billing and reporting systems, thereby allowing their
customers to review and approve bills through their Web site.
- Several major publishers have used our products to further their Internet
commerce initiatives. For example, Time, Inc. has utilized the
Sapphire/Web solution to Web-enable the acquisition of pictures from its
large database so that its customers can search for and purchase the
images from its Web site. In another example, Houghton Mifflin Company, a
text book publisher, has
34
<PAGE>
utilized the Sapphire/Web solution to provide an index of products
available on its Web site, thereby considerably enhancing its customer
service capabilities.
- Several independent software vendors have entered into licensing
arrangements with us in which our Sapphire/Web software becomes a core
component for the next generation of their respective software products.
For example, Platinum technology uses Sapphire/Web software as its next
generation technology to move beyond the Web extension of legacy
applications. In another example, Sanchez Computer Associates, a banking
software provider, uses the Sapphire/ Web software as a foundation for its
voice response and ATM systems. Additionally, Hewlett-Packard, a workflow
and process management software vendor, uses Sapphire/Web software as its
application integration engine, thereby giving it access to back-end
legacy applications.
COMPETITION
The market for our products is intensely competitive, highly fragmented and
characterized by rapid technological change and new product introductions.
Recently, several of our competitors have been acquired by large software
companies. Our competitors consist of a number of private and public companies
including, among others:
- BEA Systems, which acquired WebLogic;
- IBM;
- Microsoft;
- Oracle; and
- Sun Microsystems, which acquired NetDynamics and the rights to Netscape's
Application Server.
In addition, we face competition from in-house software developers. Many of
our competitors have longer operating histories, significantly greater
financial, technical, marketing and other resources, greater name recognition, a
broader product range and a larger base of installed customers than us.
We expect to face increased competition in the future from our current
competitors. In addition, new competitors, or alliances among existing and
future competitors, may emerge and rapidly gain significant market share. We may
also face increased competition in the future from existing large business
application and Internet software vendors that may broaden their product
offerings to include Web application server software. To the extent these
vendors are able to offer systems that are functionally comparable or superior
to our products, their significant installed customer bases, ability to offer a
broad solution and ability to price their products as incremental add-ons to
existing systems could provide them with a significant competitive advantage
over us.
TECHNOLOGY
Our technology is based upon two concepts:
- binding front-end objects to back-end objects which connects sources of
data to users of data; and
- protecting users from changes in technology.
Specific technology features of the Bluestone solution include:
100% PURE JAVA APPLICATION SERVER. The JAVA platform offers enormous
benefits to us and our customers. Our products run on any platform where JAVA is
available and has been verified on operating systems such as Windows95,
Windows98, WindowsNT, Linux, all UNIX platforms including Sun, IBM and HP, as
well as the operating systems for IBM's mainframes and AS400 computers. JAVA
35
<PAGE>
has also brought large productivity gains to our development team by decreasing
development time, eliminating porting costs and speeding time to market.
LOAD BALANCING. This is the fundamental technology that provides the high
performance and scalability for large applications and contributes to the fault
tolerant, or continuous operation, of the applications. A Load Balance Broker
runs in any number of Web servers in a Web server farm and manages the load
across any number of copies of Sapphire/Universal Business Server in that server
farm. In addition, the Load Balance Broker can be deployed as a portable
mini-application, such as a JAVA Bean or an Enterprise JAVA Bean, to allow
utilization of the application server from non-Web based applications. The Load
Balance Broker has a unique competitive advantage with a zero-feedback loop, a
sophisticated technique to direct work to non-busy resources that provides
maximum speed and no practical limits in terms of numbers of Load Balance
Brokers and Web application servers deployed.
PERSISTENT STATE SERVER. The persistent state server is also a key
component of fault tolerance. State servers are where "shopping cart"
information is held on Internet commerce sites while a user is shopping. It is
important that even if one of the application servers fails, the state
information is still available. A recent PCWEEK test substantiated
Sapphire/Web's significant lead in this high performance implementation of fault
tolerance.
FAULT TOLERANT DESIGN. Sapphire/Web has been designed to provide fault
tolerance, or nonstop operation, in a Web environment. There are two key pieces
to this technology. First, in the event of an application server failure, the
Load Balance Broker will redirect any requests from Web browsers to other
application servers. Second, the Persistent State Server will make a user's
state information continuously available, even if the application servers fail.
LIVE OBJECT CACHE. The Live Object Cache provides very high performance for
Internet commerce applications. The Live Object Cache holds data and programs
within the memory of the application server, reducing the time required for
accessing frequently used data. It is also contributes to fault tolerance by
working in conjunction with the persistent state server.
CONTENT GENERATION OBJECTS. Sapphire/Web has a powerful template processing
facility to generate Web pages dynamically. Content Generation Objects are
reusable JAVA classes, or computer programs, that can create content in a
consistent manner. This increases programmer productivity and provides Web
developers a simple mechanism to maintain a consistent look and feel to their
Web pages.
SAPPHIRE/DEVELOPER DESIGN ENVIRONMENT. This provides developers a highly
productive design environment for binding front-end objects to back-end objects.
Sapphire/Developer also maintains an open environment for integrating other
industry leading programming tools.
BLUESTONE XML-SERVER COMMUNICATIONS SERVICES. This program recognizes the
protocol of incoming communications and translates it to a request for service
to the XML-Server. XML documents can be passed to and from the XML server from
any combination of industry standard protocols. This separates the
communications from the processing of XML documents, so additional
communications services can be added without changing any code.
BLUESTONE XML-SERVER DOCUMENT HANDLER SERVICES. Bluestone's Document
Handlers are the JAVA programs that process XML documents. The Bluestone
XML-Server is unique in its ability to handle any XML document type via this
mechanism and its ability to dynamically load new document handler classes.
BLUESTONE VISUAL-XML DESIGN ENVIRONMENT. This open tool provides easy to
use creation of Bluestone XML-Server applications and creates XML documents in a
stand-alone mode. This tool is available on all platforms including Linux, UNIX
and Windows. We believe this tool expands the XML market to non-programmers.
36
<PAGE>
HOT VERSIONING AND HOT SWAPPING. These new capabilities of Sapphire/Web
Release 6 are unique in providing companies the ability to run a full 24x7 Web
site. Hot Versioning allows Web applications to be upgraded between user clicks
with no session interruption. It includes testing in a production environment
and roll-forward and roll-back capabilities for versions of an application.
Sapphire/Web Release 6 also supports Hot Swapping so that applications can be
moved from server to server without interrupting service to the user.
INTERNET QUALITY OF SERVICE. This innovative capability provides for
differentiation of service based on each particular user. This allows for
priority customers to always get performance preference over other visitors to a
Web site.
PRODUCT DEVELOPMENT
Historically, we have invested heavily in product development. Our future
success depends in large part on our ability to enhance existing products and
create new products that maintain and expand our technology lead. Accordingly,
we intend to continue to invest heavily in product development.
As of June 30, 1999, we had 31 people in the product development group,
which includes a core group of senior developers and product development
leaders, junior developers, quality assurance and documentation personnel. Our
development team is located at our headquarters in Mount Laurel, New Jersey.
Almost all of our software is being developed in JAVA, thereby improving
productivity and reducing porting and testing costs.
In an attempt to move our products at Internet-speed, we employ a small-team
approach with an interactive design/development/testing methodology that has
evolved over the past five years. To date, our product development group has
benefitted from a very low turnover rate.
We are currently developing new releases to our Sapphire/Web and XML product
families. We anticipate that these new releases will bring even stronger
Internet commerce, high-end management, and ease of use capabilities, together
with integrated Internet commerce solutions for SAP and PeopleSoft in joint
development with our systems integration partners. We expect these new releases
to continue to position our products as the most "feature-rich" in the market.
EMPLOYEES
As of June 30, 1999, we had 152 employees, of which 52 were employed in
sales and marketing, 38 were employed in services, 31 were employed in product
development and 31 were employed in general and administrative positions. None
of our employees are represented by unions. We believe that our relations with
our employees are good.
PROPERTIES
Our principal executive and administrative offices are located in
approximately 41,000 square feet of office space in Mount Laurel, New Jersey. We
also maintain sales offices in Sacramento, Los Angeles, Atlanta, Dallas,
Chicago, Boulder, San Francisco, Toronto and Mount Laurel, New Jersey. Annual
lease payments on the Mount Laurel facility are approximately $480,000. This
lease expires in November 2003. We do not own any real property.
LEGAL PROCEEDINGS
We are from time to time a party to litigation arising in the ordinary
course of our business. We are not currently a party to any material litigation.
37
<PAGE>
TRADEMARKS AND COPYRIGHTS
Bluestone-Registered Trademark- and Sapphire/Web-Registered Trademark- are
registered trademarks of Bluestone Software, Inc. Sapphire/ Universal Business
Server-TM-, Sapphire/Enterprise Deployment Kit-TM-, Sapphire/Application
Manager-TM-, Sapphire/Integration Modules-TM-, Enterprise Interaction
Management-TM-, Bluestone iCommerce Suite-TM-, Sapphire/Developer-TM-,
Sapphire/Developer Enterprise Edition-TM-, Bluestone XML Suite-TM-, Bluestone
XML-Contact-TM-, Bluestone XML-Server-TM-, XwingML-TM-, Bluestone
Visual-XML-TM-, Hot Versioning-TM-, and IQS-TM- (Internet Quality of Service)
are trademarks of Bluestone Software, Inc.
38
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------------------- --- ------------------------------------------------------------------
<S> <C> <C>
P. Kevin Kilroy........................ 45 President, Chief Executive Officer and Director
S. Craig Huke.......................... 38 Senior Vice President and Chief Financial Officer
Robert W. Bickel....................... 42 Senior Vice President, Products
John H. Capobianco..................... 47 Senior Vice President, Marketing
Joseph K. Krivickas.................... 37 Senior Vice President, Worldwide Sales
Mel Baiada............................. 41 Chairman of the Board of Directors and Founder
Gregory M. Case........................ 36 Director
William C. Hulley...................... 40 Director
Anton Simunovic........................ 33 Director
Andrew J. Filipowski................... 48 Director
Paul E. Blondin........................ 48 Director
</TABLE>
P. KEVIN KILROY has served as our President since January 5, 1999 and our
Chief Executive Officer since June 10, 1999. From March 1998 to January 4, 1999,
Mr. Kilroy served as our Senior Vice President, Worldwide Sales. Before joining
Bluestone, Mr. Kilroy served as the Senior Vice President of Worldwide
Distribution for Seer Technologies, Inc., an application development software
company, from March 1996 to March 1998. From April 1993 to October 1995, Mr.
Kilroy served as President of Mantech Systems Corporation and Mantech Solutions
Corporation and Vice President of Mantech International Corporation.
S. CRAIG HUKE has served as our Senior Vice President and Chief Financial
Officer since April 15, 1999. Before joining Bluestone, Mr. Huke was Vice
President, Finance of MetroNet Communications Corp., a broadband
telecommunications services provider, from April 1998 to April 1999. Prior to
joining MetroNet he was Vice President and Corporate Controller of Seer
Technologies, Inc. from November 1994 to April 1998. From September 1991 through
October 1994, Mr. Huke held several positions with Legent Corporation, a
publicly held software development company, including Director of Financial
Planning and Analysis and Assistant Controller.
ROBERT W. BICKEL has served as our Senior Vice President, Products since
January 1998. From April 1997 to January 1998, Mr. Bickel served as our Chief
Operating Officer, and from May 1992 to April 1997, as the Director of Products
at Bluestone Consulting, Inc., a New Jersey corporation and our predecessor.
JOHN H. CAPOBIANCO has served as our Senior Vice President, Marketing since
February 1998. Before joining Bluestone, Mr. Capobianco served as a Senior Vice
President of Marketing at SAP America from March 1997 to February 1998. From
1996 to March 1997, Mr. Capobianco served as the Vice President, Corporate
Marketing of Sybase, Inc., from 1995 to 1996 as Vice President, Marketing of
PRIMAVERA Systems, Inc. and from 1985 to 1995 as Vice President, Marketing of
Computer Associates International, Inc.
JOSEPH K. KRIVICKAS has served as our Senior Vice President, Worldwide Sales
since May 1999. From August 1998 to May 1999, Mr. Krivickas was Vice President,
Sales and Service for E-commerce products at Sanga International. From January
1996 to July 1998, Mr. Krivickas was co-founder and
39
<PAGE>
served as Chief Technology Officer for Kazz Digital Studios. From 1988 to 1995,
Mr. Krivickas held various sales and marketing management positions within
SunSoft, Sun Technology Enterprises and Sun Microsystems Computer Corporation.
MEL BAIADA has served as our Chairman of the Board of Directors since our
incorporation. From April 1997 to January 1999, Mr. Baiada served as our
President and Chief Executive Officer. From April 1989 to April 1997, Mr. Baiada
served as the President and Chief Executive Officer of Bluestone Consulting
Inc., a New Jersey corporation and our predecessor. Mr. Baiada also serves as
the President and a director of Bluestone Consulting, Inc., a Delaware
corporation spun off from us in April 1997.
GREGORY M. CASE has served as a director of Bluestone since April 1997. Mr.
Case has been a Managing Director of Patricof & Co. Ventures, Inc. since May
1995 and a Vice President of Patricof & Co. Managers, Inc. since May 1996. From
January 1994 through May 1995, Mr. Case served as a Vice President of Patricof &
Co. Ventures, Inc.
WILLIAM C. HULLEY has served as a director of Bluestone since April 1997.
Mr. Hulley co-founded Adams Capital Management, Inc. in 1994 and is a Vice
President and General Partner. Adams Capital Management, Inc. is a Managing
Partner of several venture capital partnerships, including Adams Capital
Management, L.P. and the P/A Fund. From 1989 through December 1994, Mr. Hulley
was employed by Fostin Capital Corp and has been a General Partner of Fostin
Capital Partners II, L.P. since 1993. Mr. Hulley is a director of On Technology
Corporation, a publicly traded company.
ANTON SIMUNOVIC has served as director of Bluestone since April 1998. Mr.
Simunovic is a Senior Vice President of the Equity Capital Group at General
Electric Capital Corporation and has served as such since September 1996. From
June 1993 through August 1996, Mr. Simunovic served as Manager at Barents Group
LLC.
ANDREW J. FILIPOWSKI has served as director of Bluestone since June 1999.
Mr. Filipowski is currently the Chief Executive Officer of Divine Interventures,
Inc. Mr. Filipowski was the co-founder, Chairman of the Board, President and
Chief Executive Officer of Platinum technology, inc. since its formation in
April 1987 until its sale to Computer Associates in May 1999. Mr. Filipowski is
a director of System Software Associates, Inc., Blue Rhino and Platinum
Entertainment, Inc., all publicly traded companies.
PAUL E. BLONDIN has served as a director of Bluestone since June 1999. Mr.
Blondin has been the President and Chief Executive Officer of IP Highway since
February 1999. From January 1998 until February 1999, Mr. Blondin was President
and Chief Executive Officer of Netect, Ltd., an Israeli Company. Prior thereto,
he served as Chairman of the Board of Open Development Corporation until October
1997. From March 1993 until May 1997, Mr. Blondin served as the Vice President,
Finance and Administration, Chief Financial Officer and Treasurer of Cascade
Communications.
KEY EMPLOYEE
MARK S. NIGRO, age 41, has served as our Senior Vice President and Chief
Technology Officer since October 1997. From September 1996 to October 1997, Mr.
Nigro served as Chief Technology Officer for us and our predecessor, Bluestone
Consulting Inc., a New Jersey corporation. From June 1993 to September 1996 he
served as our predecessor's Lead Product Developer.
CLASSIFICATION OF DIRECTORS
Following the closing of this offering, our certificate of incorporation
will classify the board of directors into three classes. The directors' terms
will be staggered by class.
40
<PAGE>
BOARD COMMITTEES
The Audit Committee consists of Mel Baiada, Paul E. Blondin and Gregory M.
Case. The Audit Committee makes recommendations to the board of directors
regarding the selection of independent public accountants, reviews the results
and scope of the audit and other services provided by our independent public
accountants and reviews and evaluates our control functions.
The Compensation Committee consists of Andrew J. Filipowski, William C.
Hulley and P. Kevin Kilroy. The Compensation Committee administers the issuance
of stock options under our stock option plan, makes recommendations regarding
nonqualified stock options and various incentive compensation and benefit plans
and determines salaries for the executive officers and incentive compensation
for our employees and consultants.
DIRECTOR ELECTION RIGHTS
Pursuant to our certificate of incorporation, the board of directors is
required to consist of seven members. General Electric Capital Corporation, a
holder of preferred stock, is entitled to designate one member to the board of
directors. The holders of Series A preferred stock, as a class, are entitled to
designate two members to the board of directors. The holders of common stock, as
a class, are entitled to designate one member to the board of directors. The
holders of common stock and preferred stock, as a class, are entitled to
designate three members to the board of directors. These director election
rights are in effect until immediately prior to the closing of this offering,
after which time the board of directors will be elected by the holders of common
stock.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mel Baiada, our chairman and former chief executive officer, was a member of
our compensation committee in 1998. Mr. Baiada is a director, executive officer
and a member of the compensation committee of Bluestone Consulting, Inc. For
additional information regarding Bluestone Consulting, Inc., its spin-off from,
and relationship with, us and Mr. Baiada's transactions with us and Bluestone
Consulting, Inc., see "Certain Transactions."
DIRECTOR COMPENSATION
On June 10, 1999, the board of directors adopted the Directors' Compensation
Plan and reserved 156,250 shares of common stock to be used in connection with
the plan. The plan provides that non-employee directors will receive options at
the intervals and for the number of shares of common stock as follows:
- 6,250 shares upon the initial election to the board of directors;
- 3,125 shares upon the anniversary date each year after their election,
provided there is continuous service;
- 781 shares upon appointment to serve on the Compensation, Audit or other
duly constituted committee of the board of directors, plus an additional
781 shares on each anniversary date of their appointment, provided there
is continuous service on the committee; and
- 3,125 shares upon appointment to serve as the chairperson of the board of
directors.
The options will be fully vested upon issuance. In addition to these option
grants, non-employee directors shall be entitled to compensation as follows:
- $4,000 for in-person board meetings, of which four are anticipated each
year;
- $1,000 for telephone board meetings, of which six are anticipated each
year; and
41
<PAGE>
- $500 for Audit and Compensation Committee meetings, if held independently
of an in-person board meeting.
In addition, reasonable travel and related expenses shall be paid to
non-employee directors for attending board of director meetings or while on
Bluestone approved business.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table summarizes the compensation paid to or earned by
Bluestone's Chief Executive Officer and all other executive officers whose
salary and bonus for services rendered in all capacities to Bluestone for the
fiscal year ended December 31, 1998 exceeded $100,000. We will use the term
"named executive officers" to refer collectively to these individuals later in
this prospectus.
Other annual compensation represents commissions paid in 1998. All other
compensation includes amounts paid by us in 1998 with respect to life insurance
premiums for the benefit of the named executive officers and our contributions
to the 401(k) accounts of these officers as follows:
- Mr. Kilroy, $260 for life insurance premiums;
- Mr. Baiada, $2,715 for life insurance premiums;
- Mr. Capobianco, $218 for life insurance premiums;
- Mr. Bickel, $600 in 401(k) contributions and $196 for life insurance
premiums; and
- Mr. Ballezzi, $600 in 401(k) contributions.
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION -------------
--------------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY BONUS COMPENSATION OPTIONS COMPENSATION
- --------------------------------------- ---------- --------- ---------------- ------------- -------------------
<S> <C> <C> <C> <C> <C>
P. Kevin Kilroy, President and Chief
Executive Officer (1)................ $ 148,077 $ 9,140 $ 83,509 146,257 $ 260
Mel Baiada, Chairman of the Board
(2).................................. 158,654 22,215 -- -- 2,715
John H. Capobianco, Senior Vice
President, Marketing................. 170,077 74,294 -- 142,716 218
Robert W. Bickel, Senior Vice
President, Products.................. 155,330 19,554 -- 56,778 796
Enrico J. Ballezzi (3)................. 123,557 19,992 -- 40,108 600
</TABLE>
- ------------------------
(1) During 1998, Mr. Kilroy served as our Senior Vice President, Worldwide
Sales. He became President on January 5, 1999 and Chief Executive Officer on
June 10, 1999.
(2) During 1998, Mr. Baiada served as our Chairman, President and Chief
Executive Officer.
(3) During 1998, Mr. Ballezzi served as our Chief Financial Officer.
OPTION GRANTS IN LAST FISCAL YEAR
The following table summarizes the options granted to each of our named
executive officers during the fiscal year ended December 31, 1998.
The potential realizable value set forth below is calculated based on the
term of the option at the time of the grant (10 years). Assumed stock price
appreciation of 5% and 10% is based on the initial public offering price. The
assumed stock price appreciation rates used to determine the potential
42
<PAGE>
realizable value are prescribed by the Securities and Exchange Commission rules
for illustrative purposes only and are not intended to forecast or predict
future stock prices.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED ANNUAL
---------------------------------------------------------------------------- RATES OF STOCK PRICE
PERCENT OF TOTAL APPRECIATION FOR
NUMBER OF OUR SHARES OPTIONS GRANTED TO OPTION TERM
UNDERLYING OPTIONS OUR EMPLOYEES IN EXERCISE PRICE EXPIRATION --------------------------
NAME GRANTED FISCAL YEAR PER SHARE DATE 5% 10%
- ------------------------ --------------------- ----------------------- --------------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
P. Kevin Kilroy......... 62,500 8% $ 2.24 2/28/08 $ 1,387,089 $ 2,291,634
49,294 6 3.07 5/18/08 1,052,990 1,766,408
17,813 2 3.07 10/13/08 380,511 638,313
16,650 2 3.07 12/31/08 355,668 596,638
Mel Baiada.............. -- -- -- -- -- --
John H. Capobianco...... 93,750 12 2.24 2/21/08 2,080,633 3,437,450
48,966 6 3.07 5/18/08 1,045,983 1,754,654
Robert W. Bickel........ 48,966 6 3.07 5/18/08 1,045,983 1,754,654
7,813 1 3.07 10/13/08 166,897 279,972
Enrico J. Ballezzi...... 40,108 5 3.07 5/18/08 856,764 1,437,236
</TABLE>
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table presents information with respect to stock options owned
by the named executive officers at December 31, 1998 and with respect to stock
options exercised by the named executive officers during the fiscal year ended
December 31, 1998.
There was no public trading market for the common stock as of December 31,
1998. Accordingly, the values of unexercised options set forth below have been
calculated on the basis of the initial public offering price of $15.00 per
share, less the applicable exercise price per share, multiplied by the number of
shares underlying these options.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS IN-THE-MONEY OPTIONS
AT DECEMBER 31, 1998 AT DECEMBER 31, 1998
-------------------------- --------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------------------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
P. Kevin Kilroy........................................... -- 146,257 $ -- $ 1,796,721
Mel Baiada................................................ -- -- -- --
John H. Capobianco........................................ -- 142,716 -- 1,780,414
Robert W. Bickel.......................................... 75,264 75,264 936,750 936,750
Enrico J. Ballezzi........................................ 35,679 35,679 438,580 438,580
</TABLE>
43
<PAGE>
EMPLOYMENT AGREEMENTS
We entered into an employment agreement with Mel Baiada in April 1997 which
was modified in January 1999 and which expired without being renewed on June 30,
1999. Under this agreement, in 1998 we paid Mr. Baiada a salary of $158,654 and
a $22,215 bonus. This agreement imposes a one year period after termination in
which Mr. Baiada may not compete against us. This agreement also provides that
Mr. Baiada will retain a position on the board of directors until the later of:
- the date his ownership interest in our outstanding common stock, assuming
conversion of all outstanding convertible securities, drops below 10%; and
- June 30, 2000.
For the twelve months commencing on July 1, 1999, Mr. Baiada will receive
$150,000 plus customary benefits as severance under his agreement. As of June
30, 1999, we recorded $154,200 in general and administrative expense associated
with this severance agreement. On July 1, 1999, Mr. Baiada's shares of common
stock deemed to be contingent under his stock repurchase agreement dated April
18, 1997 became vested. For more information about Mr. Baiada's stock repurchase
agreement see "Certain Transactions--Transactions in Connection with the
Spin-Off--Issuance of Series A Preferred Stock and Stock Repurchase Agreement."
We also entered into an employment agreement with Robert Bickel in April
1997 which may be terminated by us or Mr. Bickel at any time, with or without
cause. Under this agreement, in 1998 we paid Mr. Bickel a base salary of
$155,330 and a bonus of $19,554. Future increases to these amounts are at the
discretion of the board of directors. This employment agreement calls for the
payment of customary fringe benefits. Under this employment agreement, Mr.
Bickel has agreed not to compete against us for a period of one year after the
termination of his employment. In addition, as part of this employment
agreement, we granted to Mr. Bickel an option to purchase 93,750 shares of
common stock at an exercise price of $2.24 per share, the fair market value of
the common stock on the date of grant. The option vests in 16 equal installments
on a quarterly basis over a four-year period beginning as of the date of grant.
SEVERANCE AGREEMENTS
Messrs. Kilroy, Bickel, Capobianco and Ballezzi are parties to separate
severance agreements with us which call for the following payments and benefits
to be received upon the termination of their employment other than for cause:
- 12 months of salary and benefits plus an additional month of salary and
benefits for each year of service;
- accrued vacation;
- 6 months of outplacement services up to $12,000; and
- 50% vesting on all outstanding unvested options and the extension of the
exercise period on all vested options to five years.
Mr. Ballezzi's employment with us will terminate effective September 30,
1999. As of June 30, 1999, we recorded $208,700 in general and administrative
expense associated with his severance agreement.
EMPLOYEE CONFIDENTIALITY AGREEMENTS
We enter into agreements with all of our employees containing provisions
regarding confidentiality and assignment of inventions.
44
<PAGE>
EXECUTIVE BONUS POOL
Our board of directors has established an executive bonus pool of 384,794
shares of common stock issuable to our chairman, executive officers and certain
other officers under our stock option plan. Grants of awards under the bonus
pool are contingent upon our meeting predetermined revenue and profit goals on a
quarterly and annual basis in 1999. Our chairman and officers will receive
grants of immediately vested options from the pool on a quarterly and annual
basis if we determine that we have met our profit and revenue goals.
The following table sets forth the total amount of shares that each of our
chairman and executive officers may receive under the bonus pool:
<TABLE>
<S> <C>
P. Kevin Kilroy.................................................... 131,250
S. Craig Huke...................................................... 16,071
Robert W. Bickel................................................... 44,237
John H. Capobianco................................................. 47,125
Joseph K. Krivickas................................................ 36,735
Mel Baiada......................................................... 39,063
</TABLE>
We met our quarterly revenue and profit goals in each of our first two
quarters of 1999. Accordingly, options to purchase 52,650 shares of common stock
were granted in May 1999 and options to purchase 64,983 shares were granted in
August 1999.
STOCK OPTION PLAN
On July 1, 1998, the board of directors adopted the Amended and Restated
Bluestone Software, Inc. 1996 Incentive and Non-Qualified Stock Option Plan,
which replaced all of our previous plans. Our option plan is administered by our
board of directors or a committee of at least two persons appointed by the board
of directors. The option plan permits the payment of the exercise price to be in
the form of cash, check, cashless exercise and such other consideration and
method of payment as the administrator of the plan may, from time to time
determine. Optionees are required to execute a stock purchase and restriction
agreement at the time he or she exercises any options.
As of June 30, 1999, a total of 2,946,578 shares of common stock were
authorized for issuance to directors, officers, employees and consultants
selected by the administrator of the option plan. Of these shares, 2,663,589
shares of common stock were issuable upon the exercise of stock options granted
under the option plan. On August 20, 1999, we increased our authorized shares of
common stock and shares reserved under the option plan by 343,750. The following
table summarizes the option holdings of our chairman and executive officers as
of August 31, 1999:
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK SHARES OF COMMON STOCK
UNDER VESTED OPTIONS UNDER UNVESTED OPTIONS
----------------------- -----------------------
<S> <C> <C>
P. Kevin Kilroy............................. 257,878 649,438
S. Craig Huke............................... 5,358 76,500
Robert W. Bickel............................ 171,664 52,663
John H. Capobianco.......................... 70,965 168,304
Joseph K. Krivickas......................... 8,168 156,250
Mel Baiada.................................. 12,320 --
</TABLE>
Until the option plan terminates, any unpurchased shares of common stock
underlying all options that expire, are terminated or become unexercisable for
any reason, are returned to the option plan and become available for future
grants. The number of shares of common stock underlying an option, the total
number of shares of common stock authorized under the option plan but for which
no options have been granted, and the exercise price per share of the common
stock underlying all outstanding
45
<PAGE>
options are proportionately adjusted for any increase or decrease in the number
of outstanding shares of common stock resulting from stock splits, reverse stock
splits, stock dividends, reclassifications and recapitalizations.
The option plan provides for the grant of either incentive stock options or
non-qualified stock options, except that consultants of Bluestone who are not
also employees are not entitled to receive incentive stock options under the
option plan. Exercise prices for incentive stock options may not be less than
the fair market value per share of common stock on the date of grant, or 110% of
the fair market value in the case of incentive stock options granted to any
person who owns our stock possessing 10% or more of the total voting power of
all of our capital stock. Exercise prices for non-qualified stock options may be
less than the fair market value per share, but must be at least $0.01 per share.
Until there is an established market for the common stock, the board of
directors, at its discretion, determines the fair market value of a share of
common stock. Unless otherwise specified by the terms of an option agreement,
options granted under the option plan vest at a rate of 25% of the shares
underlying the option per year during the consecutive 4 year period beginning on
the date of grant and expire 10 years after the date of grant, or 5 years after
the date of grant with respect to incentive stock options granted to any person
who owns our stock possessing 10% or more of the total voting power of all of
our capital stock. In July 1998, our board of directors authorized us to grant
options to employees with a vesting period that commences on the later of:
- their date of hire; or
- March 1, 1996 (the inception date of the option plan).
Generally, all employee stock option grants made after July 1998 contain this
modified vesting arrangement.
The number of shares of common stock covered by incentive stock options
granted to any optionee is limited so that the total fair market value of stock,
determined as of the date of grant, with respect to which incentive stock
options are exercisable for the first time by such optionee in any calendar year
does not exceed $100,000. Any options in excess of such limits would be treated
as non-qualified stock options.
In the event of a sale of Bluestone, as defined in the option plan, 50% of
all options that have not vested as of the date of the sale become immediately
vested and exercisable. All remaining options vest in accordance with the
vesting schedule set forth in the applicable option agreement. In the event of a
change in control of Bluestone, as defined in the option plan, the board of
directors has the right, in its sole discretion, to accelerate the vesting of
all options that have not vested as of the date of the change in control or
establish an earlier date for the expiration of the exercise of an option or
both. In addition, in the event of a change in control of Bluestone, the board
of directors may, in its sole discretion, subject to and conditioned upon a sale
of Bluestone, arrange for the successor entity to assume all of the rights and
obligations under the option plan. Alternatively, the board of directors may, in
its sole discretion, terminate the option plan and:
- with respect to those options that are vested as of the date of the sale
of Bluestone, pay an amount equal to the amount over which the fair market
value of a share of common stock, exceeds the underlying exercise price
for those options;
- arrange for the exchange of all options for options to purchase common
stock in the successor entity; or
- distribute to each optionee other property in an amount equal to and in
the same form as the optionee would have received from the successor
entity if the optionee had owned the shares of common stock underlying
options that were vested as of the date of the sale of Bluestone rather
than the option at the time of the sale of Bluestone. In this instance,
the fair market value will
46
<PAGE>
be determined as of the termination date of the option plan. The form of
payment or distribution to the optionee is to be determined by the board
of directors, in its sole discretion.
401(k) PLAN
We maintain a 401(k) Plan/Profit Sharing Plan. Under our 401(k) plan, a
participant may contribute, subject to some limitations contained in the
Internal Revenue Code, up to 15% of his or her compensation to the 401(k) plan.
Employees who are at least 21 years old are eligible to participate after six
consecutive months of employment with Bluestone.
We may make discretionary matching contributions into participants' accounts
of an annually determined percentage. This percentage is subject to a maximum of
6% of a participant's total eligible compensation. In addition, we may make
additional annual discretionary profit sharing contributions to participants'
accounts each year at the discretion of the board of the directors. Any profit
sharing allocations made are allocated in the ratio that a participant's total
eligible compensation bears to the total eligible compensation of all eligible
participants for the applicable 401(k) plan year. To be eligible for a
discretionary profit sharing contribution, a participant must be employed with
Bluestone on the last day of the applicable 401(k) plan year and must have
completed at least 500 hours of service for Bluestone during that year.
The portion of a participant's account attributable to his or her own
contributions is 100% vested. The portion of the account attributable to our
contributions vests as to 20% of these contributions each year over 5 years
beginning after completion of 2 years of service with us and ending after 6
years of service with us. Distributions from the 401(k) plan may be made in the
form of installment distributions or lump-sum cash payments.
LIMITATION OF LIABILITY OF DIRECTORS AND INDEMNIFICATION OF DIRECTORS AND
OFFICERS
As permitted by the Delaware General Corporation Law, as amended, our
certificate of incorporation provides that our directors shall not be liable to
us or our stockholders for monetary damages for breach of fiduciary duty as
directors to the fullest extent permitted by the Delaware General Corporation
Law as it now exists or as it may be amended. The Delaware General Corporation
Law permits limitations of liability for a director's breach of fiduciary duty
other than liability:
- for any breach of the director's duty of loyalty to us or our
stockholders;
- for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law; or
- for any transaction from which the director derived an improper personal
benefit.
In addition, our bylaws provide that we shall indemnify all of our
directors, officers, employees and agents for acts performed on our behalf.
47
<PAGE>
CERTAIN TRANSACTIONS
SPIN-OFF OF CONSULTING BUSINESS
In April 1997, we had two operating businesses, the software products
business and the professional consulting services business. At that time and
after our reincorporation from a New Jersey corporation into a Delaware
corporation, all of our issued and outstanding common stock was owned by Mel
Baiada. In order to enable investors to provide capital in connection with the
software products business, we separated the consulting business and the
products business by spinning off the consulting business to Mel Baiada.
To accomplish the spin-off, we created Bluestone Consulting, Inc. in
Delaware and entered into a contribution and distribution agreement dated April
17, 1997 with Bluestone Consulting, Inc. Under the contribution and distribution
agreement, we contributed to Bluestone Consulting, Inc. those assets and
liabilities that constituted the services business in exchange for all of the
stock of Bluestone Consulting, Inc. We then distributed all of the stock of
Bluestone Consulting, Inc. to Mel Baiada. At the time of the distribution, both
Bluestone and Bluestone Consulting, Inc. were "S" corporations for federal
income tax purposes.
Our distribution of assets and liabilities was determined based upon our
internal evaluations of the relative value of the constituent entities and
discussions with third party investors that were proposing an investment in our
preferred stock about the composition and value of the separate companies after
the spin-off. We determined that the constituent entities were approximately
equal in value. Accordingly, we distributed all non-cash assets and liabilities
attributable to the services business to Bluestone Consulting, Inc. The
remaining cash and equivalent assets were divided to equalize the asset
distribution. As described below, the corporate debt outstanding prior to the
spin-off was also allocated equally.
TRANSACTIONS IN CONNECTION WITH THE SPIN-OFF
MARK BAIADA CONVERTIBLE SUBORDINATED NOTE
To achieve an equal distribution of debt between us and Bluestone
Consulting, Inc. in connection with the spin-off, we agreed to assume one-half
of the $1.0 million principal amount of a convertible note payable by Bluestone
Consulting, the former New Jersey corporation, to Mark Baiada, formerly a
director of ours and the brother of Mel Baiada. Bluestone Consulting, Inc.
assumed the liability for the other one-half of the note. At the time we
borrowed the $1.0 million, the proceeds were used for general working capital
purposes. We effected this assumption by issuing an amended and restated
convertible subordinated note dated April 17, 1997 to Mark Baiada in the
principal amount of $500,000, bearing interest at a rate of 10% per annum,
compounded annually. On September 15, 1999 Mr. Baiada converted the note into
218,750 shares of our common stock.
MEL BAIADA PROMISSORY NOTE AND PURCHASE OF SERIES A PREFERRED STOCK
As part of the spin-off, Mel Baiada agreed to cancel a promissory note in
the principal amount of $403,066 originally issued by Bluestone Consulting, the
former New Jersey corporation, in exchange for (1) our issuance to him of a
promissory note in the principal amount of $250,000 and (2) Bluestone
Consulting, Inc.'s issuance to him of a promissory note in the principal amount
of $107,495. The promissory notes were allocated between Bluestone Consulting,
Inc. and us as part of the negotiated distribution of net assets in the
spin-off. Bluestone Consulting, the former New Jersey corporation, used the
$403,066 for general working capital purposes. Concurrently with our issuance of
the Series A preferred stock on April 18, 1997, Mel Baiada contributed our note
payable to him to our capital in exchange for 263,158 shares of Series A
preferred stock.
48
<PAGE>
PROMISSORY NOTE TO BLUESTONE CONSULTING, INC.
To achieve an equal distribution of debt between Bluestone Consulting, Inc.
and us as part of the spin-off, we issued a subordinated promissory note dated
April 17, 1997 to Bluestone Consulting, Inc. in the principal amount of $500,000
that bears interest at a rate of 10% per annum. We are required to make interest
payments in arrears on each anniversary date of the note until paid in full. The
principal amount of the note is payable in full on December 31, 2005. We are
permitted to prepay the note in whole or in part without penalty or premium.
SERVICE MARK LICENSE AGREEMENT
As part of the spin-off, we entered into a service mark license agreement
dated April 17, 1997 with Bluestone Consulting, Inc. Under this license
agreement, we granted Bluestone Consulting, Inc. a non-exclusive, perpetual,
worldwide royalty-free license to use some of our registered and unregistered
trade marks in connection with any services performed by Bluestone Consulting,
Inc. We have the right to terminate the license agreement upon:
- certain events of default by Bluestone Consulting, Inc.; or
- a change in control of Bluestone Consulting, Inc., subject to Bluestone
Consulting, Inc.'s right to continue the license agreement for a period of
not more than 1 year from the date of the change in control.
ISSUANCE OF SERIES A PREFERRED STOCK AND STOCK REPURCHASE AGREEMENT
On the day immediately after the date of the spin-off, and pursuant to a
stock purchase agreement dated April 18, 1997, we issued 5,526,316 shares of
Series A preferred stock for a total cash purchase price of $5.25 million or
$0.95 per share, including 263,158 shares of Series A preferred stock to Mel
Baiada and 5,263,158 shares of Series A preferred stock to the entities
affiliated with Patricof & Co. Ventures, Inc. and Fostin Capital Partners II,
L.P. Holders of Series A preferred stock are entitled to receive annual
dividends of $0.57 per share. Proceeds of the issuance of the Series A preferred
stock were used for general working capital purposes. Each share of our Series A
preferred stock was initially convertible into one share of our common stock,
subject to some anti-dilution protections. As a result of the stock split, each
share of our Series A preferred stock will convert into 0.3125 shares of our
common stock.
We entered into a stock repurchase agreement dated April 18, 1997 with Mel
Baiada as an incentive for Mr. Baiada to remain with us and devote his full-time
and efforts to us. To this end, we also entered into an employment agreement
with Mr. Baiada which is more fully described in this prospectus under the
heading "Management--Employment Agreements." Under the repurchase agreement,
421,875 shares of the 2,812,500 shares of common stock then held by Mr. Baiada
were designated as "contingent shares" which were subject to repurchase at our
option if Mr. Baiada ceased to be employed by us at a purchase price equal to
the fair market value as determined by our board of directors. At the beginning
of each calendar quarter, beginning with the third calendar quarter of 1997 and
until the second calendar quarter of 2001, 26,367 of the contingent shares were
to be reclassified as "vested shares," reducing the total number of "contingent
shares" by 26,367 at the beginning of each calendar quarter. Because Mr.
Baiada's employment agreement was not renewed on July 1, 1999, all outstanding
contingent shares automatically became vested shares.
TAX ALLOCATION AND INDEMNITY AGREEMENT
As a result of the spin-off, we, Bluestone Consulting, Inc. and Mel Baiada
needed to decide how our taxes, and the taxes of Bluestone Consulting, Inc.
would be determined for the year of the spin-off, and how we would deal with any
adjustment to taxes to us and Mel Baiada that resulted after the
49
<PAGE>
spin-off because of a tax audit. These matters are addressed in the tax
allocation and indemnity agreement dated April 18, 1997. The agreement provides
that:
- with respect to federal income taxes, we closed our books as of the day
before the issuance of the preferred stock, so that the income and
expenses earned in the year of the spin-off, before the issuance of the
preferred stock, were not included in our corporate income tax return for
the year of the spin-off. They were included in our final federal income
tax return for the period that we had elected to be an S corporation for
federal income tax purposes, and flowed through to the tax return of Mel
Baiada;
- with respect to state income taxes and taxes that were not imposed on
income, such as property taxes, we allocated them between us and Bluestone
Consulting, Inc. based on the reasonable determination of the boards of
directors Bluestone Consulting, Inc. and us;
- if we undergo a tax audit that results in us increasing our tax liability
for the period after the spin-off, Mr. Baiada will reimburse us for the
additional tax cost, if there is a corresponding reduction in income in an
open tax return in a year when we were an S corporation, and he realizes a
tax benefit because of the decrease in income in the S corporation year;
- if we undergo a tax audit that results in an increase in our income while
we were an S corporation, and also results in a decrease in our income for
a period after the spin-off, we will reimburse Mr. Baiada any additional
tax cost he incurs because of the increase in the income in the S
corporation return; and
- if our election to be treated as an S corporation is deemed invalid or
terminated for a reason other than the issuance of the preferred stock,
Mr. Baiada will reimburse us for any tax costs that we incur, to the
extent he receives a tax benefit from the change in our status, and if Mr.
Baiada has additional tax liability imposed on him because of the
termination, we will indemnify him for the costs.
There have been no claims made under the agreement, by either party, for
reimbursement.
RESELLER AGREEMENT WITH BLUESTONE CONSULTING, INC.
We are a party to a reseller agreement with Bluestone Consulting, Inc.,
dated January 1, 1998. Under the reseller agreement, Bluestone Consulting, Inc.
is a non-exclusive reseller of our products in the United States and Canada.
Bluestone Consulting, Inc. may purchase products from us at our then current
list prices less our standard quantity discounts. The material terms and
conditions contained in the reseller agreement are similar to those contained in
our standard reseller agreement.
SUBLEASE AGREEMENT WITH BLUESTONE CONSULTING, INC.
As part of the spin-off, we entered into a sublease agreement with Bluestone
Consulting, Inc., effective as of April 30, 1997. Bluestone Consulting, Inc.
subleases approximately 7,780 square feet of our Mount Laurel facility.
Bluestone Consulting, Inc. pays us an annual base rent of $94,000, which is paid
in equal monthly installments in advance on the first day of every calendar
month during the term of the Bluestone Consulting, Inc. sublease. The rental
charges to Bluestone Consulting, Inc. were determined on a pro-rata square
footage basis at the same rate and under the same terms that we have with our
landlord. Bluestone Consulting, Inc. also pays us 19% of all taxes, common area
costs, utility costs and other services paid for by us under our lease. The
Bluestone Consulting, Inc. sublease expires when our lease expires or is
terminated for any reason, including our default under our lease.
SALE OF MEL BAIADA SERIES A PREFERRED STOCK
On April 22, 1998, Mel Baiada sold all 263,158 of his shares of Series A
preferred stock to certain of the then existing holders of Series A preferred
stock for a total purchase of $341,053 or $1.296 per share.
50
<PAGE>
ISSUANCE OF SERIES B PREFERRED STOCK
Pursuant to a stock purchase agreement dated April 22, 1998, we issued
8,782,695 shares of Series B preferred stock for a total purchase price of $11.4
million or $1.296 per share, including 3,858,025 shares of Series B preferred
stock to General Electric Capital Corporation and 4,924,670 shares of Series B
preferred stock to the entities affiliated with Patricof & Co. Ventures, Inc.
and Fostin Capital Partners II, L.P. Holders of Series B preferred stock are
entitled to annual dividends of $0.078 per share. The proceeds of the issuance
of the Series B preferred stock were used for general working capital purposes.
Each share of our Series B preferred stock was initially convertible into one
share of our common stock. Under the terms of our Series B issuance, the
conversion ratio changed as of December 31, 1998 so that each share of our
Series B preferred stock became convertible into 2.09 shares of our common
stock. As a result of the stock split, each share of our Series B preferred
stock will convert into 0.6541 shares of our common stock.
BRIDGE FINANCING
On January 21, 1999, we entered into the Note and Warrant Purchase Agreement
with substantially all of the holders of the Series B preferred stock. Under the
Note and Warrant Purchase Agreement, the Series B preferred stockholders agreed
to provide subordinated secured debt financing of up to $5.0 million for general
working capital purposes. To the extent this financing was utilized, we would
have been obligated to issue 10% convertible subordinated secured notes and
warrants to purchase up to 504,032 shares of common stock at an exercise price
equal to $1.98 per share to the Series B preferred stockholders. We were
permitted to draw on the committed principal amount at any time until May 30,
1999.
As of May 25, 1999, we had drawn down approximately $1.35 million of the
$5.0 million available to fulfill general working capital needs and issued
warrants to purchase 137,609 shares of common stock to the Series B preferred
stockholders. This outstanding $1.35 million debt was converted into Series C
preferred stock as part of our issuance of 9,191,176 shares of Series C
preferred stock at $2.72 per share on May 25, 1999.
The issuance of the warrants to the Series B preferred stockholders
triggered anti-dilution protection afforded to Silicon Valley Bank pursuant to
an antidilution agreement between us and Silicon Valley Bank dated November 24,
1997, whereby the number of shares of common stock underlying a warrant issued
to Silicon Valley Bank were readjusted from 8,224 to 9,766 shares of our common
stock and the exercise price under the Silicon Valley Bank warrant was
readjusted from $3.04 to $2.56 per share.
ISSUANCE OF SERIES C PREFERRED STOCK
Pursuant to a stock purchase agreement dated May 25, 1999, we issued
9,191,176 shares of Series C preferred stock for a total purchase price of $25.0
million or $2.72 per share, including 676,524 shares of Series C preferred stock
to General Electric Capital Corporation and 1,161,709 shares of Series C
preferred stock to the entities affiliated with Patricof & Co. Ventures, Inc.
and Fostin Capital Partners II, L.P. Holders of Series C preferred Stock are
entitled to annual dividends of $0.1632 per share. The proceeds of the issuance
of the Series C preferred stock were used for general working capital purposes.
Each share of our Series C preferred stock was initially convertible into one
share of our common stock. As a result of the stock split, each share of our
Series C preferred stock will convert into 0.3125 shares of our common stock.
REGISTRATION RIGHTS
Under the second restated investors' rights agreement dated May 25, 1999 by
and among us and our preferred stockholders, the holders of preferred stock are
entitled to certain rights with respect to the registration under the Securities
Act for resale to the public of our common stock issuable upon
51
<PAGE>
the conversion of preferred stock. The second restated investors' rights
agreement permits the preferred stockholders to twice require us, whether or not
we propose to register our common stock for sale, to register all or part of
those preferred stockholders' common stock, issued upon conversion of the
preferred stock, so long as the securities that would be covered by the
registration statement have an aggregate gross offering price of at least $20.0
million. If any registration involves an underwritten offering, preferred
stockholders that wish to participate in that offering must enter into customary
agreements with us and the underwriter. The underwritten offering will be
subject to certain limitations and restrictions that may be imposed by the
underwriters thereof, including, the right of the underwriters to exclude a
portion of the securities owned by the preferred stockholders from the offering.
The second restated investors' rights agreement also provides demand
registration rights to the preferred stockholders requiring us to register all
or part of the registrable securities on Form S-3, provided, that, among other
things:
- Form S-3 is available to us and the preferred stockholders for this
offering;
- the offering price of the securities to be registered by the preferred
stockholders, together with securities held by other persons entitled to
participate in the registration, is at least $1.0 million in the
aggregate, net of any underwriters' discounts or commissions; and
- the board of directors determines that the registration would not be
seriously detrimental to us and our stockholders at that time. In this
event, the registration of these securities may be delayed for up to 60
days.
Under the second restated investors' rights agreement, the preferred
stockholders have the right, subject to several exceptions, to have their
registrable securities included in any registration statement filed by us. Each
preferred stockholder that wishes to participate in the offering must enter into
a customary agreement with us and the underwriter, which may limit in whole or
in part the inclusion of that preferred stockholder's registrable securities in
the registration statement, as determined by the underwriters in their sole
discretion.
We are required to pay all expenses relating to any of these registrations
other than underwriting discounts and commissions relating to shares sold by the
preferred stockholders. The registration rights provided in the second restated
investors' rights agreement extend for a period of five years following this
offering.
FILIPOWSKI CONSULTING AGREEMENT
We entered into a consulting agreement with Andrew Filipowski in May 1999
under which Mr. Filipowski will provide strategic and general business
consulting services to us from that date until May 2001. In consideration of
these consulting services, we granted to Mr. Filipowski a fully vested option to
purchase 21,875 shares of our common stock at an exercise price of $4.13 per
share. We recorded general and administrative expenses of $165,784 in the three
months ended June 30, 1999 in connection with this option.
FUTURE AFFILIATE TRANSACTIONS
We believe that all of the transactions described above were made on terms
no less favorable to us than would have been obtained from unaffiliated third
parties. All future transactions, including loans, between us and our officers,
directors, 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 on the board of directors, and will be on terms
no less favorable to us than could be obtained from unaffiliated third parties.
52
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information as of August 31, 1999
regarding the beneficial ownership of our common stock by: (1) each person,
entity or group known by us to own beneficially more than 5% of our outstanding
common stock; (2) each director; (3) each of the named executive officers; and
(4) all directors and executive officers as a group. The ownership amounts are
calculated as if the outstanding preferred stock and accrued dividends on
preferred stock were fully converted into common stock as of June 30, 1999.
Unless otherwise indicated, the address of each person identified is c/o
Bluestone Software, Inc., 1000 Briggs Road, Mount Laurel, New Jersey 08054.
The percentages shown are based on 13,277,146 shares of common stock
outstanding prior to the offering and 17,277,146 shares of common stock
outstanding after the offering. Pursuant to Rule 13d-3 under the Exchange Act,
shares of common stock which a person has the right to acquire pursuant to the
exercise of stock options and warrants held by that holder that are exercisable
within 60 days are deemed outstanding for the purpose of computing the
percentage ownership of that person, but are not deemed outstanding for
computing the percentage ownership of any other person.
<TABLE>
<CAPTION>
PERCENT
SHARES BENEFICIALLY BENEFICIALLY
OWNED OWNED
PRIOR TO OFFERING -------------------
------------------- BEFORE AFTER
NAME AND ADDRESS NUMBER OFFERING OFFERING
- -------------------------------------------------------------------------------- ------------------- -------- --------
<S> <C> <C> <C>
Mel Baiada (1).................................................................. 2,813,332 21.2% 16.3%
General Electric Capital Corporation(2)......................................... 2,813,211 21.1% 16.2%
Entities affiliated with Patricof & Co. Ventures, Inc. (3)...................... 5,472,907 40.7% 31.4%
Fostin Capital Partners II, L.P. (4)............................................ 1,664,327 12.5% 9.6%
P. Kevin Kilroy (5)(6).......................................................... 257,878 1.9% 1.5%
Enrico J. Ballezzi (5).......................................................... 87,377 * *
Robert W. Bickel (5)............................................................ 171,664 1.3% 1.0%
John H. Capobianco (5).......................................................... 70,965 * *
Gregory M. Case (7)............................................................. 5,472,907 40.7% 31.4%
William C. Hulley (8)........................................................... 1,664,327 12.5% 9.6%
Anton Simunovic (9)............................................................. 2,813,211 21.1% 16.2%
Andrew J. Filipowski (5)(10).................................................... 28,125 * *
Paul E. Blondin (5)(11)......................................................... 6,250 * *
All directors and executive officers as a group (11 persons) (12)............... 11,721,709 82.8% 64.6%
</TABLE>
- ------------------------
* Represents less than 1% of the outstanding shares of Common Stock.
(1) Includes 779,336 shares of common stock owned by four trusts for which Mr.
Baiada or his wife act as trustees. Mr. Baiada intends to grant the
underwriters the right to purchase 152,253 shares pursuant to the
underwriters' over-allotment option.
(2) The address for General Electric Capital Corporation is 260 Long Ridge Road,
Stamford, CT 06927. Includes 3,934,534 shares of Series B preferred stock
which is convertible into 2,547,371 shares of common stock, 688,628 shares
of Series C preferred stock convertible into 215,196 of common stock, and
50,644 shares of common stock underlying warrants. General Electric Capital
Corporation is a subsidiary of the General Electric Company. General
Electric Capital Corporation intends to grant the underwriters the right to
purchase 158,000 shares pursuant to the underwriters' over-allotment option.
The Directors of General Electric Company are James I. Cash, Jr., Silas S.
Cathcart, Dennis D. Dammerman, Paolo Fresco, Claudio X. Gonzalez, Andrea
Jung, Kenneth G. Langone, Gertrude G. Michelson, Eugene F. Murphy, Sam Nunn,
John D. Opie, Roger S. Penske, Frank H. T. Rhodes, Andrew C. Sigler, Douglas
A. Warner III, and John F. Welch, Jr.
53
<PAGE>
(3) The address for Patricof & Co. Ventures, Inc. is 445 Park Avenue, New York,
NY 10022. The directors and managing directors of Patricof & Co. Ventures,
Inc. are Alan Patricof-Director, Co-Chairman, Patricia Cloherty-Director,
Co-Chairman, Ronald Cohen-Director, Maurice Tchenio-Director, Robert
Chefitz-Managing Director, Salem Shuchman-Managing Director, David
Landau-Managing Director, Thomas Hirschfeld-Managing Director, George
Jenkins-Managing Director, Greg Case-Managing Director, Paul Vais-Managing
Director, George Phipps-Managing Director, and Janet Effland-Managing
Director. The share amount is comprised of:
(A) shares held by the P/A Fund, L.P., consisting of 2,435,570 shares of
Series A preferred stock convertible into 761,116 shares of common stock,
1,272,326 shares of Series B preferred stock convertible into 823,754 shares
of common stock, 205,823 shares of Series C preferred stock convertible into
64,320 shares of common stock, and 15,137 shares of common stock underlying
warrants. Fostin Capital Partners II, L.P. and APA Pennsylvania Partners II,
L.P. (a Patricof affiliate) are the general partners of The P/A Fund, L.P.
The address of the P/A Fund, L.P. is 455 South Gulph Road, Suite 410, King
of Prussia, PA 19406. The P/A Fund intends to grant the underwriters the
right to purchase 66,860 shares pursuant to the underwriters' over-allotment
option.
(B) shares held by APA Excelsior IV, L.P., consisting of 2,699,867
shares of Series A preferred stock convertible into 843,708 shares of common
stock, 3,129,923 shares of Series B preferred stock convertible into
2,026,434 shares of common stock, 816,888 shares of Series C preferred stock
convertible into 255,278 shares of common stock and 60,076 shares of common
stock underlying warrants. Patricof & Co. Managers, Inc. is the general
partner of APA Excelsior IV Partners, which is the general partner of APA
Excelsior IV, L.P. The address of APA Excelsior IV, L.P. is 445 Park Avenue,
New York, NY 10022. APA Excelsior IV, L.P. intends to grant the underwriters
the right to purchase 127,875 shares pursuant to the underwriters'
over-allotment option.
(C) shares held by APA Excelsior IV/Offshore, L.P., consisting of
476,448 shares of Series A preferred stock convertible into 148,890 shares
of common stock, 552,340 shares of Series B preferred stock convertible into
357,606 shares of common stock, 144,157 shares of Series C preferred stock
convertible into 45,049 shares of common stock and 10,602 shares of common
stock underlying warrants. Patricof & Co. Managers, Inc. is the general
partner of APA Excelsior IV Partners, which is the general partner of APA
Excelsior IV/Offshore, L.P. The address of APA Excelsior IV/Offshore, L.P.
is c/o Patricof & Co. Ventures, Inc. 445 Park Avenue, New York, NY 10022.
APA Excelsior IV/Offshore, L.P. intends to grant the underwriters the right
to purchase 22,566 shares pursuant to the underwriters' over-allotment
option.
(D) shares held by Patricof Private Investment Club, L.P. including
51,647 shares of Series A preferred stock convertible into 16,140 shares of
common stock, 59,874 shares of Series B preferred stock convertible into
38,765 shares of common stock, 15,627 shares of Series C preferred stock
convertible into 4,883 shares of common stock and 1,149 shares of common
stock underlying warrants. Patricof & Co. Managers, Inc. is the general
partner of APA Excelsior IV Partners, which is the general partner of
Patricof Private Investment Club, L.P. The address of Patricof Private
Investment Club, L.P. is 445 Park Avenue, New York, NY 10022. Patricof
Private Investment Club, L.P. intends to grant the underwriters the right to
purchase 2,446 shares pursuant to the underwriters' over-allotment option.
(4) Fostin Capital Partners II, L.P. is a general partner of The P/A Fund, L.P.
The address for Fostin Capital Partners II, L.P. is 518 Broad Street,
Sewickley, PA 15143. William C. Hulley and Joel P. Adams are general
partners of Fostin Capital Partners II, L.P.
54
<PAGE>
(5) Represents the total number of shares of our common stock issuable upon
exercise of stock options which are currently exercisable and which are
exercisable within 60 days after August 31, 1999.
(6) Mr. Kilroy intends to grant the underwriters the right to purchase 70,000
shares pursuant to the underwriters' over-allotment option.
(7) The address for Mr. Case is c/o Patricof & Co. Ventures, Inc., 455 South
Gulph Road, Suite 410, King of Prussia, PA 19406. Mr. Case is a Vice
President of Patricof & Co. Managers, Inc., the general partner of each of
APA Excelsior IV, L.P., APA Excelsior IV/Offshore, L.P. and Patricof Private
Investment Club, L.P. Mr. Case is a Managing Director of Patricof & Co.
Ventures, Inc., the investment advisor of APA Excelsior IV/Offshore, L.P.
Mr. Case is a general partner of APA Pennsylvania Partners II, L.P., a
general partner of The P/A Fund, L.P. Mr. Case shares voting and investment
powers with respect to the shares owned by these funds. Mr. Case does not
own any of our outstanding securities as an individual.
(8) The address for Mr. Hulley is c/o The P/A Fund, L.P., 578 Broad Street,
Sewickley, PA 15143. Mr. Hulley is a general partner of Fostin Capital
Partners II, L.P., which is a general partner of The P/A Fund L.P. Mr.
Hulley shares voting and investment powers with respect to the shares owned
by The P/A Fund L.P. Mr. Hulley does not own any of our outstanding
securities as an individual.
(9) The address for Mr. Simunovic is c/o General Electric Capital Corporation,
260 Long Ridge Road, Stamford, CT 06927. Mr. Simunovic is a Senior Vice
President of the GE Capital Equity Capital Group, a wholly owned subsidiary
of General Electric Capital Corporation, a subsidiary of General Electric
Company. Mr. Simunovic does not own any of our outstanding securities as an
individual.
(10) Mr. Filipowski was appointed as a director on June 10, 1999. The address
for Mr. Filipowski is c/o Platinum technology, inc., 1815 South Meyers Road,
Oakbrook Terrace, IL 60181.
(11) Mr. Blondin was appointed as a director on June 16, 1999. The address for
Mr. Blondin is 50 Battery Street, Boston, MA 02109.
(12) Includes 634,579 shares of our common stock issuable upon the exercise of
stock options which are currently exercisable and which are exercisable
within 60 days after August 31, 1999.
55
<PAGE>
DESCRIPTION OF SECURITIES
Our authorized capital stock as of June 30, 1999 consisted of 53,800,000
shares of common stock, par value $0.001 per share, and 23,500,187 shares of
preferred stock, par value $0.001 per share, of which 5,526,316 shares were
designated as "Series A preferred stock," 8,782,695 shares were designated as
"Series B preferred stock," and 9,191,176 shares were designated as "Series C
preferred stock." Immediately prior to the closing of this offering all of the
outstanding preferred stock will automatically convert to common stock.
The following is a summary of certain provisions of our common stock, our
preferred stock and our third amended and restated certificate of incorporation.
COMMON STOCK
As of June 30, 1999, there were 2,819,955 shares of common stock held of
record by 11 stockholders. Holders of common stock, together with the holders of
the preferred stock, who are entitled to vote on an "as converted" basis as
described below, are entitled to one vote for each share held on all matters
submitted to a vote of stockholders and do not have cumulative voting rights.
Subject to the applicable provisions of the Delaware General Corporation Law,
stockholders holding a majority of the issued and outstanding shares entitled to
vote constitute a quorum for the purposes of convening a stockholders' meeting.
Accordingly, a majority of a quorum may elect directors standing for election,
subject to the director election rights of the stockholders described below.
Holders of common stock are entitled to receive ratably any dividends as may be
declared on the common stock by the board of directors. Upon liquidation,
dissolution or winding up of Bluestone, holders of common stock are entitled to
receive ratably the net assets of Bluestone available for distribution after the
payment of all debts and other liabilities subject to the prior and superior
liquidation preference rights of holders of preferred stock, if any are
outstanding. Holders of common stock have no preemptive or subscription rights
with respect to other issuances of securities. Our common stock has no
conversion rights and is not redeemable.
PREFERRED STOCK
All of our presently authorized preferred stock is outstanding. Immediately
prior to this offering's closing, all outstanding preferred stock will
automatically convert into common stock as follows:
- Series A: one share of Series A preferred stock for 0.3125 shares of
common stock;
- Series B: one share of Series B preferred stock for 0.6541 shares of
common stock; and
- Series C: one share of Series C preferred stock for 0.3125 shares of
common stock.
Holders of our outstanding preferred stock are entitled to receive annual
dividends as follows:
- Series A: $0.057 per share;
- Series B: $0.078 per share; and
- Series C: $0.1632 per share.
The Series A preferred stock dividends have accrued since April 17, 1997,
the Series B preferred stock dividends have accrued since April 22, 1998 and the
Series C preferred stock dividends have accrued since May 25, 1999. Aggregate
accrued dividends on the preferred stock as of June 30, 1999 amounted to
approximately $1.7 million.
We are required to pay any federal or state income taxes to which the
holders of preferred stock may be subject with respect to the accrued and unpaid
cash dividends, whether or not earned or declared. Accumulated but unpaid
dividends will be reduced by these tax payments. Upon the
56
<PAGE>
conversion of our preferred stock into common stock, we are required to pay to
the holders of the preferred stock being converted all accumulated and unpaid
cash dividends, whether or not declared, with respect to the preferred stock.
However, if requested by any holder of the shares of preferred stock being
converted and approved by the holders of a majority of the then outstanding
shares of common stock, the holder may exchange all or any portion of the
accumulated and unpaid cash dividends into shares of common stock at the then
fair market value of the common stock.
ANTI-TAKEOVER EFFECTS OF BLUESTONE'S CERTIFICATE OF INCORPORATION AND BYLAWS AND
PROVISIONS OF DELAWARE LAW
Following the closing of this offering, our certificate of incorporation and
bylaws and provisions of Delaware corporate law may hinder or delay a third
party's attempt to acquire us. They may also make it difficult for the
stockholders to remove incumbent management.
CLASSIFIED BOARD OF DIRECTORS; VACANCIES. Following the closing of this
offering, the certificate of incorporation will divide the board of directors
into three classes. The directors' terms will be staggered by class. Our
classified board of directors is intended to provide continuity and stability in
board membership and policies. However, the classified board of directors makes
it more difficult for stockholders to change the board composition quickly. In
addition, a majority of the directors then in office can increase the size of
the board of directors and fill board of directors vacancies and newly created
directorships resulting from any increase in the size of the board of directors.
This is true even if those directors do not constitute a quorum or if only one
director is left in office. These provisions could prevent stockholders,
including parties who want to take over or acquire us, from removing incumbent
directors without cause and filling the resulting vacancies with their own
nominees.
ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER PROPOSALS AND STOCKHOLDER
NOMINATIONS OF DIRECTORS. The bylaws will establish an advance notice procedure
regarding nominations of directors by stockholders and other stockholder
proposals. The advance notice procedure will not apply to nominations of
directors by the board of directors. For matters a stockholder wishes to bring
before an annual meeting of stockholders, the stockholder must deliver to us a
notice not less than 90 days nor more than 120 days before the first anniversary
of the preceding year's annual meeting of nominations and other business to be
brought before our annual meeting. The stockholder must put information in the
notice regarding:
- the stockholder and its holdings;
- the background of any nominee for director;
- the written consent to being named as a nominee and to serving as a
director if elected;
- any business desired to be brought before the meeting;
- the reasons for conducting the business at the meeting; and
- any material interest of the stockholder in the business proposed.
At a special meeting of stockholders called to elect directors, stockholders
can make a nomination only if they deliver to us a notice that complies with the
above requirements no later than the tenth day following the day on which public
announcement of the special meeting is made. The bylaws could preclude a
nomination for the election of directors or the conduct of certain business at a
particular meeting if the proper procedures are not followed. This may
discourage or deter a third party from conducting a solicitation of proxies to
elect its own slate of directors or otherwise attempting to obtain control of
us.
SPECIAL STOCKHOLDERS' MEETINGS. Our certificate of incorporation and bylaws
will permit special meetings of the stockholders to be called only by the board
of directors, the chief executive officer or
57
<PAGE>
the president or holders of at least 75% of our securities that are outstanding
and entitled to vote in an election of directors.
AUTHORIZED BUT UNISSUED SHARES. We will be able to issue shares of common
stock without stockholder approval, up to the number of shares authorized for
issuance in our certificate of incorporation, except as limited by Nasdaq rules.
We could use these additional shares for a variety of corporate purposes. These
purposes include future public offerings to raise additional capital, corporate
acquisitions and employee benefit plans. Our ability to issue these additional
shares could make it more difficult or discourage an attempt to obtain control
of us by means of a proxy contest, tender offer, merger or otherwise.
SECTION 203 OF DELAWARE LAW. After this offering is completed, Section 203
of the Delaware General Corporation Law will apply to us. This section will
prohibit us from engaging in a "business combination" with an "interested
stockholder." This restriction will apply for three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. A "business
combination" includes (1) mergers, (2) asset sales and (3) other transactions
resulting in a financial benefit to an interested stockholder. Generally, an
"interested stockholder" is a person who, together with affiliates and
associates, owns, or within three years did own, 15% or more of our voting
stock. Section 203 could delay, defer or prevent a change in control of us. It
might also reduce the price that investors might be willing to pay in the future
for shares of common stock.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is StockTrans, Inc.
LISTING
We have been approved for listing our common stock on the Nasdaq National
Market under the trading symbol "BLSW."
58
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock. Based on the number of shares outstanding on June 30, 1999, upon
completion of this offering we will have outstanding an aggregate of 17,274,732
shares of our common stock, excluding any exercises of outstanding options. Of
these shares, all of the shares sold in this offering will be freely tradable
without restriction or further registration under the Securities Act, unless
such shares are purchased by "affiliates" as that term is defined in Rule 144
under the Securities Act. The remaining 13,274,732 shares of common stock to be
held by existing stockholders will be "restricted securities" as that term is
defined in Rule 144 under the Securities Act. Restricted securities may be sold
in the public market only if registered or if they qualify for an exemption from
registration under Rule 144 or Rule 701 promulgated under the Securities Act,
which rules are summarized below.
As a result of the lock up agreements described below and the provisions of
Rule 144, additional shares will be available for sale in the public market as
follows:
- 2,070 shares of common stock outstanding will be available for sale into
the public market 90 days following the effectiveness of this registration
statement;
- 2,663,589 shares of common stock issuable upon exercise of outstanding
options will be eligible for sale as the options vest and following the
effectiveness of a registration statement on Form S-8 covering the stock
options, which we expect to file shortly after the completion of this
offering; and
- the remainder of the restricted securities will be eligible for sale from
time to time after the expiration of the lock up period and upon
expiration of their respective one-year holding periods.
LOCK-UP AGREEMENTS
All of our officers and directors and some of our stockholders are expected
to enter into lock-up agreements under which they agreed not to transfer or
otherwise dispose of, directly or indirectly, without the consent of Deutsche
Bank Securities Inc., any shares of our common stock or any securities
convertible into or exchangeable or exercisable for shares of our common stock
for a period of 180 days following the effective date of the registration
statement of which this prospectus is a part.
Transfers or dispositions can be made during the lock-up periods in the case
of gifts for estate planning purposes where the donee signs a lock-up agreement.
RULE 144
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this registration statement, a person who has beneficially owned
shares of our common stock for at least one year would be entitled to sell
within any three-month period a number of shares that does not exceed the
greater of:
- 1% of the number of shares of common stock then outstanding, which will
equal approximately 173,025 shares immediately after this offering; or
- the average weekly trading volume of the common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 of the sale with the SEC.
Sales under Rule 144 are also subject to manner of sale provisions and
notice requirements and to the availability of current public information about
us.
59
<PAGE>
RULE 144(k)
Under Rule 144(k), a person who is not deemed to have been one of our
affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years,
including the holding period of any prior owner other than an affiliate, is
entitled to sell their shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144. Therefore,
unless otherwise restricted, "144(k) shares" may be sold immediately upon the
completion of this offering.
RULE 701
In general, under Rule 701 of the Securities Act as currently in effect, any
of our employees, consultants or advisors who purchases shares from us in
connection with a compensatory stock or option plan or other written agreement
are eligible to resell their shares 90 days after the effective date of this
offering in reliance on Rule 144, but without compliance with some restrictions,
including the holding period, contained in Rule 144.
REGISTRATION RIGHTS
After this offering, the holders of 10,454,777 shares of our common stock
and warrants exercisable for 288,056 shares of our common stock will be entitled
to demand registration of their shares under the Securities Act. All of these
holders have agreed not to demand registration of their common stock for one
year after the date of this offering. After this one year period, the holders of
a majority of the shares eligible for demand rights may require us, on not more
than two occasions, to use our best efforts to file a registration statement
under the Securities Act with respect to their shares eligible for demand rights
if the gross offering amount would be expected to exceed $20.0 million. In
addition, if at any time after this offering we propose to register any of our
securities under the Securities Act in a public offering in excess of $1.0
million, for ourselves or for other holders, we will send notice of this
registration to holders of the shares eligible for demand rights, as well as to
Mel Baiada with respect to his shares of our common stock and Silicon Valley
Bank with respect to its warrants exercisable for 9,766 shares of our common
stock. Subject to limitations and conditions set forth in the agreements
governing their registration rights, they may elect to register their eligible
shares. Further, if we propose to file a registration statement on Form S-3, a
short form registration statement, when we become eligible therefor, for an
offering in excess of $1.0 million, the holders of shares eligible for demand
rights and "piggyback" rights may register their common stock along with that
registration. We will be responsible for the expenses incurred in connection
with these registrations, other than underwriters' discounts or commissions,
except that we will pay expenses of only one registration on Form S-3 at a
holder's request per year. All registration rights expire five years from the
date of this offering.
STOCK OPTIONS
Shortly after completion of this offering, we plan to file a registration
statement on Form S-8 under the Securities Act covering shares of common stock
reserved for issuance under our stock option and director compensation plans. As
of June 30, 1999, options to purchase 2,663,589 shares of common stock were
issued and outstanding, 1,028,050 of which are vested. This registration
statement is expected to be filed and become effective as soon as practicable
after the date of this prospectus. Accordingly, shares registered under the S-8
registration statement will, subject to lock-up agreements, vesting provisions
and Rule 144 volume limitations applicable to our affiliates, be available for
sale in the open market immediately after the registration statement becomes
effective.
60
<PAGE>
PLAN OF DISTRIBUTION
Subject to the terms and conditions of the underwriting agreement, the
underwriters, named below through their representatives Deutsche Bank Securities
Inc., SoundView Technology Group, Inc., C.E. Unterberg, Towbin and Legg Mason
Wood Walker, Incorporated have severally agreed to purchase from us the
following respective numbers of shares of common stock at the initial public
offering price less the underwriting discounts and commissions set forth on the
cover page of this prospectus.
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
- --------------------------------------------------------------------------- -----------------
<S> <C>
Deutsche Bank Securities Inc............................................... 1,716,000
SoundView Technology Group, Inc............................................ 715,000
C.E. Unterberg, Towbin..................................................... 214,500
Legg Mason Wood Walker, Incorporated....................................... 214,500
Banc of America Securities LLC............................................. 80,000
BancBoston Robertson Stephens Inc.......................................... 80,000
Goldman, Sachs & Co........................................................ 80,000
Hambrecht & Quist LLC...................................................... 80,000
Lehman Brothers Inc........................................................ 80,000
Wasserstein Perella Securities, Inc........................................ 80,000
Advest, Inc................................................................ 60,000
J.C. Bradford & Co......................................................... 60,000
Fac/Equities............................................................... 60,000
Friedman Billings Ramsey................................................... 60,000
Jefferies & Company, Inc................................................... 60,000
Kaufman Bros., L.P......................................................... 60,000
Edgar M. Norris & Co. Inc.................................................. 60,000
Pennsylvania Merchant Group................................................ 60,000
Raymond James & Associates, Inc............................................ 60,000
The Seidler Companies Incorporated......................................... 60,000
SunTrust Equitable Securities Corporation.................................. 60,000
-----------------
Total.................................................................... 4,000,000
-----------------
-----------------
</TABLE>
The underwriting agreement provides that the obligations of the underwriters
are subject to conditions precedent and that the underwriters will purchase all
of the shares of common stock offered hereby if any of such shares are
purchased.
We have been advised by the representatives of the underwriters that the
underwriters propose to offer the shares of our common stock to the public at
the initial public offering price set forth on the cover page of this prospectus
and to certain dealers at that price less a concession not in excess of $0.62
per share. The underwriters may allow to some other dealers, and those dealers
may reallow, a concession not in excess of $0.10 per share. After the initial
public offering, the offering price and other selling terms may be changed by
the representatives of the underwriters.
We have requested that, of the 4,000,000 shares of common stock to be sold
in this offering, up to 200,000 shares be offered at the price to the public set
forth on the cover page of this prospectus to our directors, officers, employees
and business associates. As a result, the number of shares of common stock
available for sale to the general public will be reduced to the extent these
persons purchase the reserved shares. The underwriters will offer to the general
public, on the same basis as the other shares to be sold in this offering, any
reserved shares that were not purchased.
Certain stockholders have granted the underwriters an option, exercisable
not later than 30 days after the date of this prospectus, to purchase up to
600,000 additional shares of common stock at the
61
<PAGE>
initial public offering price less the underwriting discounts and commissions
set forth on the cover page of this prospectus. To the extent that the
underwriters exercise this option, each of the underwriters will have a firm
commitment to purchase approximately the same percentage of the option shares
that the number of shares of common stock to be purchased by it in the above
table bears to 4,000,000. The underwriters may exercise this option only to
cover over-allotments made in connection with the sale of the common stock
offered in this offering. If purchased, the underwriters will offer the
additional shares on the same terms as those on which the 4,000,000 shares are
being offered. If the underwriters fully exercise their option, net proceeds to
the selling stockholders will be $8,370,000 after the payment of $630,000 of
underwriting discounts.
We and the selling stockholders have agreed to indemnify the underwriters
against specified liabilities, including liabilities under the Securities Act.
We have agreed not to offer, sell, sell short, transfer, hypothecate, pledge
or otherwise dispose of any shares of our common stock or other securities
convertible into or exchangeable or exercisable for shares of our common stock
or derivatives of our common stock, or enter into an agreement for our common
stock, for a period of 180 days after the date of our registration statement, of
which this prospectus is a part, directly or indirectly, by us or otherwise,
except as consideration for business acquisitions, on exercise of currently
outstanding stock options or on the issuance of options to key employees and
directors under our stock option plans and the exercise of such options, without
the prior written consent of Deutsche Bank Securities Inc.
All of our officers and directors and certain of our stockholders intend to
enter into lock-up agreements under which they agreed not to transfer or
otherwise dispose of, directly or indirectly, without the consent of Deutsche
Bank Securities Inc. any shares of our common stock or any securities
convertible into or exchangeable or exercisable for shares of our common stock
for a period of 180 days following the date of this registration statement.
Transfers or dispositions can be made during the lock-up periods in the case
of gifts for estate planning purposes where the donee signs a lock-up agreement.
The representatives of the underwriters have advised us that the
underwriters do not intend to confirm sales to any account over which they
exercise discretionary authority.
To facilitate this offering, the underwriters may engage in transactions
that stabilize, maintain or otherwise affect the market price of our common
stock. Specifically, the underwriters may over-allot shares of our common stock
in connection with this offering, creating a short position in the underwriters'
syndicate account. Additionally, to cover the over-allotments or to stabilize
the market price of our common stock, the underwriters may bid for, and
purchase, shares of our common stock in the open market. Any of these activities
may maintain the market price of our common stock at a level above that which
might otherwise prevail in the open market. The underwriters are not required to
engage in these activities and may end any of these activities at any time. The
representatives of the underwriters, on behalf of the syndicate of underwriters,
also may reclaim selling concessions allowed to an underwriter or dealer if the
syndicate repurchases shares distributed by that underwriter or dealer.
We paid $1.4 million and issued a warrant, exercisable for five years, to
purchase up to 150,448 shares of common stock at an exercise price of $8.70 per
share to Deutsche Bank Securities Inc. for providing placement agent services to
us in connection with the offering of Series C preferred stock that was
consummated on May 25, 1999. The exercise price was adjusted to $15.00 per share
on September 23, 1999. The amount paid for these services was determined by
arms' length negotiations between us and Deutsche Bank Securities Inc. We
believe that this amount is within standard industry parameters for a
transaction of that nature. The underwriters and their respective affiliates
may, in the future, be lenders to, engage in transactions with and perform
services for us in the ordinary course of
62
<PAGE>
business. No transactions with the underwriters are presently contemplated. The
warrant issued to Deutsche Banc Securities Inc., 9,191 shares of Series C
preferred stock held by Mr. James Moore and 18,346 shares of Series C preferred
stock held by U.S. Development Capital Investment Co. are considered to be
compensation in connection with this offering and are subject to lock-up
agreements under which they agree not to transfer or otherwise dispose of,
directly or indirectly, any shares of common stock or any securities convertible
into or exchangeable or exercisable for shares of our common stock for a period
of one year after the effective date of this registration statement, except to
officers or partners of the underwriters and member of the selling group and
their officers or partners.
Prior to this offering, there has been no public market for our common
stock. Consequently, the initial public offering price for our common stock has
been determined by negotiations between us and the representatives of the
underwriters. Among the factors to be considered in these negotiations were
prevailing market conditions, the results of our operations in recent periods,
the market capitalizations and stages of development of other companies which we
and the representatives of the underwriters believed to be comparable to us,
estimates of our business potential, the present state of our development and
other factors deemed relevant.
LEGAL MATTERS
The validity of the shares of common stock offered hereby will be passed
upon for us by Pepper Hamilton LLP. Some legal matters related to this offering
will be passed upon for the underwriters by Willkie Farr & Gallagher.
EXPERTS
Our financial statements as of December 31, 1997 and 1998, and for the years
ended December 31, 1996, 1997 and 1998 included in this prospectus and
registration statement have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their reports with respect thereto, and are
included herein upon the authority of said firm as experts in giving said
reports.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-l pursuant to
the Securities Act with respect to the common stock offered in this offering.
The prospectus, which is part of the registration statement, does not contain
all the information set forth in the registration statement. Statements
contained in the prospectus as to the contents of any contract, agreement or
other document filed with the registration statement as exhibits are necessarily
summaries of such documents, but are complete in all material respects, and are
qualified in their entirety by reference to the copy of the applicable document
filed as an exhibit to the registration statement. For further information about
us and the securities offered in this offering, reference is made to the
registration statement and to the financial statements, schedules and exhibits
filed as a part of the registration statement.
We are subject to the information requirements of the Exchange Act, and, in
accordance therewith, file reports and other information with the SEC. The
registration statement, the exhibits and schedules forming a part of the
registration statement and the reports and other information filed by us with
the SEC in accordance with the Exchange Act may be inspected without charge at
the public reference facilities maintained by the SEC at 450 Fifth Street, N.W.,
Washington, D.C. 20549 and at the following regional offices of the SEC: 7 World
Trade Center, Suite 1300, New York, New York 10048; and Northwestern Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois, 60661-2511.
Copies of these materials may also be obtained from the Public Reference Room of
the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates.
You may obtain information regarding the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet Web
site at http://www.sec.gov that contains reports, proxy statements and other
information.
63
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Report of Independent Public Accountants................................................................... F-2
Balance Sheets............................................................................................. F-3
Statements of Operations................................................................................... F-4
Statements of Mandatorily Redeemable Convertible Preferred Stock and Stockholders' Equity (Deficit)........ F-5
Statements of Cash Flows................................................................................... F-6
Notes to Financial Statements.............................................................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Bluestone Software, Inc.:
We have audited the accompanying balance sheets of Bluestone Software, Inc.
(a Delaware corporation), formerly Bluestone Consulting, Inc., as of December
31, 1997 and 1998, and the related statements of operations, mandatorily
redeemable convertible preferred stock and stockholders' equity (deficit) and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with 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 financial statements referred to above present fairly,
in all material respects, the financial position of Bluestone Software, Inc. as
of December 31, 1997 and 1998 and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Philadelphia, PA
March 31, 1999 (except with
respect to matters discussed
in Note 2, as to which the
date is May 25, 1999
and Note 13, as to
which the date is September 23, 1999.)
F-2
<PAGE>
BLUESTONE SOFTWARE, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30, 1999
------------------------- ---------------------------
1997 1998 ACTUAL PRO FORMA
---------- ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents... $2,330,372 $ 2,534,819 $ 20,600,454 $ 20,600,454
Restricted certificate of
deposit................... 400,000 -- -- --
Accounts receivable, net of
allowance of $37,012,
$44,473 and $210,314...... 1,747,672 3,369,514 2,757,076 2,757,076
Prepaid expenses and
other..................... 312,011 149,318 259,878 259,878
Due from related party...... 79,011 -- -- --
---------- ------------ ------------ ------------
Total current assets.... 4,869,066 6,053,651 23,617,408 23,617,408
---------- ------------ ------------ ------------
Property and equipment:
Equipment................... 1,465,570 2,418,590 2,577,672 2,577,672
Furniture and fixtures...... 86,852 183,767 185,704 185,704
Leasehold improvements...... 20,552 131,845 134,445 134,445
---------- ------------ ------------ ------------
1,572,974 2,734,202 2,897,821 2,897,821
Less--Accumulated
depreciation and
amortization.............. (640,741) (1,284,921) (1,585,649) (1,585,649)
---------- ------------ ------------ ------------
Net property and
equipment............. 932,233 1,449,281 1,312,172 1,312,172
---------- ------------ ------------ ------------
Deposits...................... 13,744 32,997 38,981 38,981
---------- ------------ ------------ ------------
$5,815,043 $ 7,535,929 $ 24,968,561 $ 24,968,561
---------- ------------ ------------ ------------
---------- ------------ ------------ ------------
LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Line of credit.............. $1,610,561 $ 473,365 $ 671,366 $ 671,366
Current portion of long-term
debt...................... 83,971 356,728 436,648 436,648
Accounts payable............ 781,703 1,094,286 1,294,176 1,294,176
Accrued wages............... 478,970 579,371 1,604,540 1,604,540
Other accrued expenses...... 401,468 477,246 1,228,117 1,228,117
Due to related parties...... -- 188,898 29,103 29,103
Deferred revenues........... 1,560,632 3,223,338 1,777,584 1,777,584
---------- ------------ ------------ ------------
Total current
liabilities........... 4,917,305 6,393,232 7,041,534 7,041,534
---------- ------------ ------------ ------------
Long-term debt................ 269,676 875,642 654,169 654,169
---------- ------------ ------------ ------------
Subordinated notes due to
related parties............. 1,000,000 1,000,000 1,000,000 1,000,000
---------- ------------ ------------ ------------
Mandatorily redeemable Series
A convertible preferred
stock....................... 5,330,727 5,672,339 5,841,856 --
---------- ------------ ------------ ------------
Mandatorily redeemable Series
B convertible preferred
stock....................... -- 11,742,212 12,102,550 --
---------- ------------ ------------ ------------
Mandatorily redeemable Series
C convertible preferred
stock....................... -- -- 22,508,745 --
---------- ------------ ------------ ------------
Commitments and contingencies
(Note 12)
Stockholders' equity
(deficit):
Common stock, $.001 par
value, 53,800,000 shares
authorized, 2,812,500,
2,815,039, 2,819,955 and
13,274,732 shares issued
and outstanding........... 2,813 2,816 2,821 13,275
Common stock warrants....... -- -- 1,900,000 1,900,000
Deferred stock-based
compensation.............. -- -- (1,303,344) (1,303,344)
Additional paid-in
capital................... 6,187 11,871 1,629,797 42,072,494
Accumulated deficit......... (5,711,665) (18,162,183) (26,409,567) (26,409,567)
---------- ------------ ------------ ------------
Total stockholders'
equity (deficit)...... (5,702,665) (18,147,496) (24,180,293) 16,272,858
---------- ------------ ------------ ------------
$5,815,043 $ 7,535,929 $ 24,968,561 $ 24,968,561
---------- ------------ ------------ ------------
---------- ------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
BLUESTONE SOFTWARE, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------- -------------------------
1996 1997 1998 1998 1999
----------- ----------- ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues:
Software license
fees............ $ 1,475,368 $ 2,337,199 $ 3,391,226 $ 1,192,117 $ 4,726,889
Services.......... 42,908 2,178,664 3,619,997 1,706,506 1,865,096
Third party
products and
related
services........ 6,555,095 5,225,429 1,106,688 932,162 --
----------- ----------- ------------ ----------- -----------
Total
revenues.... 8,073,371 9,741,292 8,117,911 3,830,785 6,591,985
Cost of revenues:
Software license
fees............ 112,732 202,219 258,572 96,047 156,232
Services.......... 305,109 2,516,451 4,433,309 2,077,872 2,466,660
Third party
products and
related
services........ 4,261,078 2,797,656 643,120 534,522 --
----------- ----------- ------------ ----------- -----------
Total cost of
revenues.... 4,678,919 5,516,326 5,335,001 2,708,441 2,622,892
----------- ----------- ------------ ----------- -----------
Gross profit.... 3,394,452 4,224,966 2,782,910 1,122,344 3,969,093
Operating expenses:
Sales and
marketing....... 3,004,760 5,130,799 9,551,284 3,747,872 6,185,414
Product
development..... 701,789 1,295,148 2,473,771 903,833 1,868,554
General and
administrative... 1,515,456 1,615,787 2,316,017 949,520 2,124,128
Amortization of
stock-based
compensation.... -- -- -- -- 112,204
----------- ----------- ------------ ----------- -----------
Total
operating
expenses.... 5,222,005 8,041,734 14,341,072 5,601,225 10,290,300
----------- ----------- ------------ ----------- -----------
Operating
loss........ (1,827,553) (3,816,768) (11,558,162) (4,478,881) (6,321,207)
Interest expense,
net............... (50,458) (79,701) (46,520) (33,575) (1,147,676)
----------- ----------- ------------ ----------- -----------
Loss from continuing
operations........ (1,878,011) (3,896,469) (11,604,682) (4,512,456) (7,468,883)
Income (loss) from
discontinued
operations........ (737,699) 98,898 -- -- --
----------- ----------- ------------ ----------- -----------
Net loss............ (2,615,710) (3,797,571) (11,604,682) (4,512,456) (7,468,883)
Accretion of
preferred stock
redemption
value............. -- (240,399) (845,836) (307,768) (778,501)
----------- ----------- ------------ ----------- -----------
Net loss available
to common
stockholders...... $(2,615,710) $(4,037,970) $(12,450,518) $(4,820,224) $(8,247,384)
----------- ----------- ------------ ----------- -----------
----------- ----------- ------------ ----------- -----------
Basic and diluted
net loss per
share:
Continuing
operations...... $ (0.67) $ (1.39) $ (4.12) $ (1.60) $ (2.65)
Discontinued
operations...... (0.26) 0.04 -- -- --
Accretion of
preferred stock
redemption
value........... -- (0.09) (0.30) (0.11) (0.28)
----------- ----------- ------------ ----------- -----------
$ (0.93) $ (1.44) $ (4.42) $ (1.71) $ (2.93)
----------- ----------- ------------ ----------- -----------
----------- ----------- ------------ ----------- -----------
Shares used in
computing net
loss per
share........... 2,812,500 2,812,500 2,814,105 2,813,612 2,815,488
----------- ----------- ------------ ----------- -----------
----------- ----------- ------------ ----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
BLUESTONE SOFTWARE, INC.
STATEMENTS OF MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
STOCKHOLDERS' DEFICIT
------------------------------------------------
SERIES A SERIES B SERIES C
CONVERTIBLE CONVERTIBLE CONVERTIBLE COMMON STOCK
PREFERRED PREFERRED PREFERRED ----------------- COMMON STOCK DEFERRED
STOCK STOCK STOCK SHARES AMOUNT WARRANTS COMPENSATION
----------- ----------- ------------ --------- ------ -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995.............. $ -- $ -- $ -- 2,812,500 $2,813 $ -- $ --
Distribution of foreign tax credits... -- -- -- -- -- -- --
Net loss.............................. -- -- -- -- -- -- --
----------- ----------- ------------ --------- ------ -------------- -------------
Balance, December 31, 1996.............. -- -- -- 2,812,500 2,813 -- --
Spin-off of consulting division to
majority stockholder................ -- -- -- -- -- -- --
Issuance of Preferred stock, net of
financing costs..................... 5,090,328 -- -- -- -- -- --
Accretion of Preferred stock
redemption value.................... 240,399 -- -- -- -- -- --
Net loss.............................. -- -- -- -- -- -- --
----------- ----------- ------------ --------- ------ -------------- -------------
Balance, December 31, 1997.............. 5,330,727 -- -- 2,812,500 2,813 -- --
Issuance of Preferred stock, net of
financing costs..................... -- 11,237,988 -- -- -- -- --
Accretion of preferred stock
redemption value.................... 341,612 504,224 -- -- -- -- --
Exercise of common stock options...... -- -- -- 2,539 3 -- --
Net loss.............................. -- -- -- -- -- -- --
----------- ----------- ------------ --------- ------ -------------- -------------
Balance, December 31, 1998.............. 5,672,339 11,742,212 -- 2,815,039 2,816 -- --
Issuance of preferred stock, net of
financing costs..................... -- -- 22,260,099 -- -- -- --
Accretion of preferred stock
redemption value (unaudited)........ 169,517 360,338 248,646 -- -- -- --
Issuance of options to purchase common
stock below fair market value
(unaudited)......................... -- -- -- -- -- -- (1,415,548)
Amortization of stock-based
compensation (unaudited)............ -- -- -- -- -- -- 112,204
Issuance of common stock options to
non-employees (unaudited)........... -- -- -- -- -- -- --
Issuance of common stock warrants
(unaudited)......................... -- -- -- -- -- 1,900,000 --
Exercise of common stock options
(unaudited)......................... -- -- -- 4,916 5 -- --
Net loss (unaudited).................. -- -- -- -- -- -- --
----------- ----------- ------------ --------- ------ -------------- -------------
Balance, June 30, 1999 (unaudited)...... $ 5,841,856 $12,102,550 $ 22,508,745 2,819,955 $2,821 $ 1,900,000 $(1,303,344)
----------- ----------- ------------ --------- ------ -------------- -------------
----------- ----------- ------------ --------- ------ -------------- -------------
<CAPTION>
ADDITIONAL
PAID-IN- ACCUMULATED
CAPITAL DEFICIT TOTAL
---------- ------------ ------------
<S> <C> <C> <C>
Balance, December 31, 1995.............. $ 6,187 $ 1,366,254 $ 1,375,254
Distribution of foreign tax credits... -- (28,501) (28,501)
Net loss.............................. -- (2,615,710) (2,615,710)
---------- ------------ ------------
Balance, December 31, 1996.............. 6,187 (1,277,957) (1,268,957)
Spin-off of consulting division to
majority stockholder................ -- (395,738) (395,738)
Issuance of Preferred stock, net of
financing costs..................... -- -- --
Accretion of Preferred stock
redemption value.................... -- (240,399) (240,399)
Net loss.............................. -- (3,797,571) (3,797,571)
---------- ------------ ------------
Balance, December 31, 1997.............. 6,187 (5,711,665) (5,702,665)
Issuance of Preferred stock, net of
financing costs..................... -- -- --
Accretion of preferred stock
redemption value.................... -- (845,836) (845,836)
Exercise of common stock options...... 5,684 -- 5,687
Net loss.............................. -- (11,604,682) (11,604,682)
---------- ------------ ------------
Balance, December 31, 1998.............. 11,871 (18,162,183) (18,147,496)
Issuance of preferred stock, net of
financing costs..................... -- -- --
Accretion of preferred stock
redemption value (unaudited)........ -- (778,501) (778,501)
Issuance of options to purchase common
stock below fair market value
(unaudited)......................... 1,415,548 -- --
Amortization of stock-based
compensation (unaudited)............ -- -- 112,204
Issuance of common stock options to
non-employees (unaudited)........... 190,954 -- 190,954
Issuance of common stock warrants
(unaudited)......................... -- -- 1,900,000
Exercise of common stock options
(unaudited)......................... 11,424 -- 11,429
Net loss (unaudited).................. -- (7,468,883) (7,468,883)
---------- ------------ ------------
Balance, June 30, 1999 (unaudited)...... 1$,629,797 $(26,409,567) $(24,180,293)
---------- ------------ ------------
---------- ------------ ------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
BLUESTONE SOFTWARE, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------- ------------------------
1996 1997 1998 1998 1999
----------- ----------- ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating activities:
Net loss.................................................. $(2,615,710) $(3,797,571) $(11,604,682) $(4,512,456) $(7,468,883)
Adjustments to reconcile net loss to net cash used in
operating activities-
Depreciation and amortization........................... 302,010 239,835 656,654 273,388 304,522
Provision for doubtful accounts......................... 94,217 95,883 32,800 7,462 140,000
Accrued interest on subordinated notes.................. 30,048 103,109 109,352 49,799 (57,278)
Issuance of Bridge loan warrants........................ -- -- -- -- 1,100,000
Amortization of stock-based compensation................ -- -- -- -- 112,204
Issuance of common stock options to non-employees....... -- -- -- -- 190,954
Changes in operating assets and liabilities--
Accounts receivable................................... (975,630) (310,896) (1,654,641) 322,865 409,827
Prepaid expenses and other assets..................... (81,801) (84,169) 130,619 188,325 (57,729)
Accounts payable and accrued expenses................. 1,308,129 408,822 379,410 118,871 2,033,208
Deferred revenues..................................... 221,186 314,263 1,662,706 (464,804) (1,445,754)
----------- ----------- ------------ ----------- -----------
Net cash used in operating activities............... (1,717,551) (3,030,724) (10,287,782) (4,016,550) (4,738,929)
----------- ----------- ------------ ----------- -----------
Investing activities:
Purchases of property and equipment....................... (273,936) (871,717) (1,160,882) (500,959) (163,617)
----------- ----------- ------------ ----------- -----------
Financing activities:
Net proceeds from (repayments of) line of credit.......... 2,190,000 604,311 (1,137,196) (1,610,424) 198,001
Proceeds from long-term debt.............................. 54,000 315,620 919,481 -- --
Proceeds from subordinated notes.......................... 750,000 250,000 -- -- --
Repayments of long-term debt.............................. (63,030) (122,056) (40,758) (35,239) (141,553)
Proceeds from issuance of preferred stock, net............ -- 4,840,328 11,237,988 11,237,988 23,060,099
Restricted cash........................................... -- (400,000) 400,000 400,000 --
Spin-off of consulting division to sole stockholder....... -- (274,538) -- -- --
Net advances from (repayments to) related party........... -- (66,532) 267,909 192,453 (159,795)
Proceeds from exercise of common stock options............ -- -- 5,687 -- 11,429
----------- ----------- ------------ ----------- -----------
Net cash provided by financing activities........... 2,930,970 5,147,133 11,653,111 10,184,778 22,968,181
----------- ----------- ------------ ----------- -----------
Net increase in cash and cash equivalents................... 939,483 1,244,692 204,447 5,667,269 18,065,635
Cash and cash equivalents, beginning of period.............. 146,197 1,085,680 2,330,372 2,330,372 2,534,819
----------- ----------- ------------ ----------- -----------
Cash and cash equivalents, end of period.................... $ 1,085,680 $ 2,330,372 $ 2,534,819 $ 7,997,641 $20,600,454
----------- ----------- ------------ ----------- -----------
----------- ----------- ------------ ----------- -----------
Supplemental cash flow information:
Cash paid for interest.................................... $ 169,870 $ 133,409 $ 170,232 $ 93,033 $ 204,965
----------- ----------- ------------ ----------- -----------
----------- ----------- ------------ ----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
1. BACKGROUND:
Bluestone Software, Inc. (the "Company"), formerly Bluestone Consulting,
Inc., was incorporated in New Jersey on March 17, 1989. The Company develops,
markets and supports web application server software products that enable its
customers to deploy information across the Internet, intranets and extranets. On
April 17, 1997, in connection with the sale of Series A Convertible Preferred
Stock (see Note 7), the Company spun off its consulting division to its then
sole stockholder for no consideration. The Company reincorporated in Delaware as
Bluestone Software, Inc. The consulting division, Bluestone Consulting, Inc.
("BCI") provides its clients information technology staffing resources and in
1997 provided the Company with certain administrative services under a shared
services agreement (see Note 11). The consulting division spin-off is reported
in the accompanying financial statements as a discontinued operation (see Note
3).
2. LIQUIDITY:
The Company has recurring operating losses that have continued subsequent to
year-end. The losses are primarily due to product development costs, marketing
expenditures and administrative infrastructure costs related to the expansion of
the Company's business.
On January 21, 1999, the Company and substantially all of the Series B
Preferred stockholders (collectively, the "Investors") entered into the Note and
Warrant Purchase Agreement, whereby the Company could, from time to time before
May 30, 1999, request that the Investors purchase 10% convertible subordinated
secured notes totaling an aggregate of $5 million. Upon the purchase of a note,
the Investors would be granted a warrant to purchase the number of shares of the
Company's Common stock equal to the note amount multiplied by .1008, at an
exercise price of $1.98 per share. The Company issued warrants to purchase an
aggregate of 136,088 shares of common stock in connection with notes purchased
in April 1999 and May 1999. The Company also issued warrants to purchase an
aggregate of 1,520 shares of common stock at an exercise price of $8.70 per
share related to interest on the notes. The warrants issued in connection with
the notes and related interest thereon were valued at $1,100,000 using the
black-scholes option pricing model and the following assumptions: volatility of
70%, risk-free interest rates of 5.2% to 5.3%, fair market value of a share of
common stock of $8.70 and a term of 10 years. The value of the warrants was
charged to operations during the three months ended June 30, 1999. The notes
were converted into 496,322 shares of Series C Preferred stock on May 25, 1999
(see below).
On March 31, 1999, the Company amended its bank loan agreement, which had
expired on February 7, 1999. The amendment extended the Company's credit
facility through April 1, 2000 and reset certain financial covenants. The
amended agreement provides for the interest rate on the credit facility to
increase by 0.50% and for certain quarterly fees to be paid if the Company does
not meet certain quarterly net revenue requirements, as defined in the
amendment.
On May 25, 1999, the Company sold 9,191,176 shares of Series C Convertible
Preferred Stock to certain venture capital investors, including certain Series B
Preferred investors for $25 million in cash. The Series C Preferred will be
senior to the Series A Preferred and Series B Preferred and is automatically
convertible into Common stock upon a public stock offering, as defined.
Dividends on the Series C Preferred are cumulative at $0.1632 per share per
annum. The Series C Preferred stockholders participate in Common stock dividends
and have Common stock voting rights on an as converted basis.
F-7
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
2. LIQUIDITY: (CONTINUED)
In conjunction with the sale of the Series C Preferred, the Company issued a
warrant to purchase 150,448 shares of common stock at $8.70 to the placement
agent, valued at $800,000 using the black-scholes option pricing model and the
following assumptions: volatility of 70%, a risk-free interest rate of 5.2%,
fair market value of a share of common stock of $8.70 and a term of 5 years. The
value of the warrant was recorded as a cost of the Series C Preferred Stock sale
and, accordingly, deducted from the proceeds of the Series C Preferred Stock.
The Company believes that the proceeds from the sale of the Series C
Convertible Preferred Stock and borrowing availability under its amended credit
facility will provide adequate funding to sustain the Company's operations
through 1999. However, there is no assurance that the funding will be sufficient
to sustain operations until the Company begins generating positive cash flows.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
INTERIM FINANCIAL STATEMENTS
The financial statements as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 are unaudited and, in the opinion of management, include
adjustments necessary for a fair presentation of results for those interim
periods. The results of operations for the six months ended June 30, 1998 and
1999 are not necessarily indicative of the results to be expected for the entire
year.
PRO FORMA FINANCIAL INFORMATION
The unaudited pro forma balance sheet as of June 30, 1999 reflects the
conversion of all outstanding preferred stock and all accrued preferred stock
dividends as of June 30, 1999 into common stock immediately before the
completion of the contemplated public offering.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of certain assets and liabilities
and related disclosures at the date of the financial statements and the reported
amounts of certain revenues and expenses during the reporting periods. Actual
results could differ from these estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
PREPAID EXPENSES AND OTHER
Prepaid expenses and other at December 31, 1997 includes $243,834 of
deferred costs related to support contracts purchased from third parties for
resale in connection with the sale of third party product.
F-8
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost. Depreciation is provided using
the double declining balance method over the estimated useful lives of the
related assets, generally three to seven years. Leasehold improvements are
amortized on a straight-line basis over the lease term.
PRODUCT DEVELOPMENT
Product development expenditures are charged to operations as incurred.
Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed," requires
the capitalization of certain software development costs subsequent to the
establishment of technological feasibility. The Company has determined that
technological feasibility for its products is generally achieved upon completion
of a working model. Since software development costs have not been significant
after the completion of a working model, all such costs have been charged to
product development expense.
REVENUE RECOGNITION
The Company sells perpetual licenses to end-users and annual and multi-year
licenses primarily to independent software vendors. The Company also sells its
software through value added resellers and system integrators. The Company
derives its services revenues from annual maintenance agreements, which consist
of customer technical support services and unspecified product
upgrades/enhancements on a when-and-if-available basis, and consulting and
training services.
License fee revenue is generally recognized when a formal agreement exists,
delivery of the product has occurred, the license fee is deemed fixed and
determinable and collectibility is probable. License revenue from arrangements
with resellers and system integrators is not recognized until the product is
delivered to end-users. Maintenance revenue is recognized on a straight-line
basis over the term of the contract. Revenues from training and consulting
services are recognized as services are performed.
Deferred revenues generally consist of advance customer payments on
maintenance contracts. Certain of the Company's multi-year license agreements
provide for payment terms that extend beyond 12 months. Revenue on such
long-term arrangements are recognized when payments become due. Included in
accounts receivable and deferred revenues at December 31, 1998 is $1,865,294
related to an extended term license fee where the Company received payment and
recorded revenue in February 1999.
CONCENTRATION OF CREDIT RISK
One customer accounted for approximately 11% of the Company's net revenues
for the year ended December 31, 1998 and one customer accounted for
approximately 55% of net accounts receivable at December 31, 1998. One customer
accounted for approximately 29% of net revenues for the six months ended June
30, 1999. No one customer accounted for greater than 10% of net revenues for the
years ended December 31, 1996 and 1997 or greater than 10% of net accounts
receivable at December 31, 1996 and 1997 and June 30, 1999.
F-9
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Advertising expense for
continuing operations for the years ended December 31, 1996, 1997 and 1998 and
the six months ended June 30, 1998 and 1999 was $781,634, $615,374, $882,761,
$199,910 and $793,921, respectively, including $394,808, $251,640, $549,487,
$184,094 and $307,352, respectively, related to attending trade shows.
INCOME TAXES
Prior to April 17, 1997, the Company was taxed as a subchapter S corporation
under the Internal Revenue Code for federal and state income tax purposes.
Accordingly, all S Corporation taxable income or losses were included in the
sole stockholder's tax return. In connection with the Series A Convertible
Preferred Stock sale (see Note 7), the Company's subchapter S election was
terminated.
Deferred tax assets and liabilities are determined based on differences
between the financial reporting and tax bases of assets and liabilities and are
measured using enacted tax rates. The Company accounts for certain income and
expense items for financial reporting purposes differently than for income tax
purposes. The principal differences relate to the Company's conversion to the
accrual basis of accounting for income taxes and certain financial statement
reserves that are not currently deductible for income tax purposes.
STOCK COMPENSATION
The Company has elected to follow Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its employee stock options. Under APB No. 25,
if the exercise price of the Company's employee stock options equals or exceeds
the market price of the underlying stock on the date of the grant, no
compensation expense is recognized. If the exercise price of an option is below
the market price of the underlying stock on the date of grant, compensation cost
is recorded and is recognized in the statements of operations over the vesting
period (see Note 9).
EARNINGS PER SHARE
The Company follows SFAS No. 128, "Earnings Per Share," which requires a
dual presentation of "basic" and "diluted" earnings per share ("EPS") on the
face of the statements of operations. Basic EPS is computed by dividing net
income (loss) by the weighted average number of shares of common stock
outstanding for the period. Diluted EPS includes the dilutive effect, if any,
from the potential exercise or conversion of securities like stock options,
which would result in the issuance of additional shares of common stock. For
each of the three years in the period ended December 31, 1998 and the six months
ended June 30, 1998 and 1999, the impact of stock options was not considered as
their effect on EPS would be anti-dilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash, accounts receivable, prepaid expenses, accounts payable and accrued
expenses are reflected in the accompanying financial statements at fair value
due to the short-term nature of those
F-10
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
instruments. The carrying amount of long-term debt obligations approximate fair
value at the balance sheet dates.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 is effective for fiscal years
beginning December 31. 1997, SFAS No. 130 establishes standards for the
reporting and display of comprehensive income in a set of financial statements.
Comprehensive income is defined as the change in net assets of a business
enterprise during a period from transactions generated from non-owner sources.
It includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners. The Company has no other
comprehensive income items, therefore, the adoption of SFAS No. 130 had no
impact on the financial statements.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 applies to all public companies and is effective for fiscal years beginning
after December 15, 1997. SFAS No. 131 requires that business segment financial
information be reported in the financial statements utilizing the management
approach. The management approach is defined as the manner in which management
organizes the segments within the enterprise for making operating decisions and
assessing performance. Subsequent to the spin-off of the consulting segment,
management believes the Company operates in one business segment, therefore, the
adoption of SFAS No. 131 had no impact on the financial statements.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." The Company adopted SOP 98-1
in January 1999. The adoption had no material effect on the Company's financial
position or results of operations.
DISCONTINUED OPERATIONS
On April 17, 1997, in connection with the sale of Series A Convertible
Preferred Stock (see Note 7), the Company spun off its consulting division,
which operated as a separate segment, to its then sole stockholder for no
consideration. The spin-off, which included cash of $274,538, has been recorded
as a deemed distribution in the accompanying financial statements. The
discontinued operation generated net revenues of $13,369,459 and $4,537,147 for
the years ended December 31, 1996 and 1997, respectively. The spin-off was
treated as a tax-free reorganization for federal and state income tax purposes.
RECLASSIFICATIONS
Prior year financial statements have been reclassified to conform with the
current year presentation.
F-11
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
4. LINE OF CREDIT:
On December 8, 1997, the Company entered into an agreement with a bank that
provides for a $1,750,000 revolving line of credit and a $500,000 equipment line
(see Note 5). The revolver is collateralized by substantially all of the
Company's assets and a $400,000 certificate of deposit at December 31, 1997.
Borrowings under the line are subject to a borrowing base of 80% of eligible
accounts receivable, as defined. The restricted certificate of deposit was sold
in 1998 as it was no longer required collateral. The line bore interest at prime
plus 1.5%, through August 16, 1998 at which date the interest rate was changed
to prime plus .75% in conjunction with the equipment line modification (see Note
5), and expired on December 7, 1998. In December 1998, the Company and the bank
agreed to extended the term of the credit facility to February 7, 1999. The line
is cross-defaulted and cross-collateralized with the equipment line with the
bank (see Note 5). The loan agreement also requires the Company to maintain
certain financial and nonfinancial covenants, as defined.
On March 31, 1999, the Company amended its bank loan agreement. The
amendment extended the Company's credit facility through April 1, 2000 and reset
certain financial covenants. The amended agreement provides for the interest
rate on the credit facility to increase to prime plus 1.25% and for certain
quarterly fees to be paid if the Company does not meet certain quarterly net
revenue requirements, as defined in the amendment. At June 30, 1999, borrowings
of $1,023,463 were available under the line.
A warrant to purchase 9,766 shares of the Company's Common stock at $2.56
per share, as adjusted was issued to the bank in December 1997 in conjunction
with the loan agreement. The warrant is fully exercisable, has a seven-year term
and is subject to an anti-dilution provision, as defined. No value has been
assigned to the warrant as it is not material to the Company's financial
statements.
5. LONG-TERM DEBT:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ JUNE 30,
1997 1998 1999
---------- ------------ ------------
<S> <C> <C> <C>
Equipment line with bank.................................................. $ 237,620 $ 1,157,101 $ 1,037,461
Capital leases............................................................ 116,027 75,269 53,356
---------- ------------ ------------
353,647 1,232,370 1,090,817
Less- Current portion..................................................... (83,971) (356,728) (436,648)
---------- ------------ ------------
$ 269,676 $ 875,642 $ 654,169
---------- ------------ ------------
---------- ------------ ------------
</TABLE>
At December 31, 1997, the Company's equipment line provided for borrowings
of up to $500,000 for approved capital expenditures, as defined and interest
payable monthly on the outstanding balance at a rate of prime plus 1.5%. In June
1998, the outstanding borrowings as of that date of $237,620 converted to a term
note payable in 36 monthly installments. On August 16, 1998, the Company and the
bank modified the equipment line to provide for additional borrowings of up to
$1,762,380 for approved capital expenditures, as defined. Interest is payable
monthly on the outstanding balance at a rate of prime plus 1.25%. On March 31,
1999, in connection with the loan agreement amendment, the then outstanding
balance of $959,086 was converted to a term note payable in 36 monthly
installments
F-12
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
5. LONG-TERM DEBT: (CONTINUED)
and no additional borrowings are available under the equipment line. The
equipment line is secured by equipment and is cross-defaulted and
cross-collateralized with the Company's line of credit (see Note 4).
At December 31, 1997, 1998 and June 30, 1999, property under capital leases
totaled $130,897 with corresponding accumulated amortization of $30,908, $90,900
and $104,232, respectively.
6. SUBORDINATED NOTES DUE TO RELATED PARTIES:
<TABLE>
<S> <C>
Note payable to Bluestone Consulting, Inc..................................................................... $ 500,000
Convertible subordinated note to related party................................................................ 500,000
----------
$1,000,000
----------
----------
</TABLE>
In January 1996, the Company entered into a $1,000,000, subordinated 10%
loan agreement with the brother of the Company's founder. The agreement, as
amended in connection with the BCI spin-off, provided for BCI to assume $500,000
of the convertible note with the Company assuming the remaining $500,000 of the
convertible note. To achieve an equal distribution of debt between BCI and the
Company as part of the spin-off, the Company issued BCI a $500,000, 10% note.
Interest on both notes is payable annually. Principal on the convertible note is
due on December 31, 2002 and principal on the note with BCI is due on December
31, 2005. At December 31, 1997 and 1998 and June 30, 1999 other accrued expenses
includes $97,526, $206,878 and $149,600, respectively, related to interest on
the notes. The $500,000 convertible subordinated note is convertible into
218,750 shares of the Company's Common stock at the option of the holder.
7. MANDATORILY REDEEMABLE SERIES A CONVERTIBLE PREFERRED STOCK:
On April 18, 1997, the Company sold 5,526,316 shares of $0.001 par value
Series A Convertible Preferred Stock to certain venture capital investors, an
individual investor and the Company's former sole shareholder for $5,250,000.
This includes 263,158 shares sold to the former sole stockholder in exchange for
canceling a $250,000 note payable due him. The Series A Preferred stock is
convertible into 0.3125 shares of Common stock, subject to adjustment, as
defined, and is automatically convertible upon a public stock offering, as
defined.
Dividends on the Series A Preferred are cumulative at $0.057 per share per
annum and the Series A Preferred has a liquidation preference of $0.95 per
share. At December 31, 1997 and 1998 cumulative dividends accrued but not
declared were $222,658 and $537,658, respectively. Beginning in April 2003, the
holders may require the Company to redeem the Preferred at $0.95 per share plus
accrued dividends over a three-year period. The Series A Preferred stockholders
participate in Common stock dividends and have Common stock voting rights on an
as converted basis.
F-13
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
8. MANDATORILY REDEEMABLE SERIES B CONVERTIBLE PREFERRED STOCK:
On April 23, 1998, the Company sold 8,782,695 shares of Series B Convertible
Preferred Stock to certain venture capital investors, including its original
investors (see Note 7) for approximately $11.4 million in cash. The Series B
Preferred is senior to the Series A Preferred and was originally convertible
into 0.3125 shares of Common stock. In 1998, in accordance with the original
terms of the Series B Preferred stock purchase agreement, the conversion ratio
was adjusted so that each share of Series B Preferred is convertible into 0.6541
shares of Common stock. In addition, the Series B Preferred is automatically
convertible upon a public stock offering, as defined.
Dividends on the Series B Preferred are cumulative at $0.078 per share per
annum and the Series B Preferred has a liquidation preference of $1.296 per
share. At December 31, 1998, cumulative dividends accrued but not declared were
$476,720. Beginning in October 2001, the holders may require the Company to
redeem the Preferred at $1.296 per share plus accrued dividends over an
eighteen-month period. The Series B Preferred stockholders participate in Common
stock dividends and have Common stock voting rights on an as converted basis.
9. STOCK OPTION AND EMPLOYEE BENEFIT PLANS:
STOCK OPTION PLANS
In 1996, the Company adopted the 1996 Incentive and Non-Qualified Stock
Option Plan (the "1996 Plan") under which incentive and nonstatutory stock
options to acquire shares of the Company's Common stock may be granted to
officers, employees and consultants of the Company. Incentive stock options must
be issued at an exercise price not less than the fair market value of the
underlying shares on the date of grant. Options granted under the 1996 Plan are
exercisable over a period of time, not to exceed ten years, and are subject to
other terms and conditions specified in the individual option grants. In April
1997, in connection with the sale of Series A Convertible Preferred Stock (see
Note 7), the 1996 Plan was amended and restated, increasing the total shares
available under the plan to 781,250. On August 7, 1997, all outstanding options
granted under the 1996 Plan were canceled and 151,219 were reissued at an
exercise price of $2.24 per share. In April 1998, in connection with the sale of
Series B Convertible Preferred Stock (see Note 8), the 1996 Plan was amended and
restated, increasing the total shares available under the plan to 1,406,250. In
June 1999, the 1996 Plan was amended to increase the total shares available
under the plan to 2,946,578.
F-14
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
9. STOCK OPTION AND EMPLOYEE BENEFIT PLANS: (CONTINUED)
Information relative to the 1996 Plan is as follows:
<TABLE>
<CAPTION>
WEIGHTED
RANGE OF AGGREGATE AVERAGE
EXERCISES EXERCISE EXERCISE
SHARES PRICES PRICE PRICE
----------- ------------- ------------- -----------
<S> <C> <C> <C> <C>
Outstanding January 1, 1996................................ -- $ -- $ -- $ --
Granted at fair market value........................... 238,156 6.40 1,524,200 6.40
----------- ------------- ------------- -----
Outstanding December 31, 1996.............................. 238,156 6.40 1,524,200 6.40
Granted at fair market value........................... 512,545 2.24-9.60 1,279,200 2.50
Canceled............................................... (334,688) 2.24-9.60 (1,871,530) 5.59
----------- ------------- ------------- -----
Outstanding December 31, 1997.............................. 416,013 2.24 931,870 2.24
Granted at fair market value........................... 787,118 2.24-3.07 2,249,416 2.86
Exercised.............................................. (2,539) 2.24 (5,688) 2.24
Canceled............................................... (18,523) 2.24 (41,493) 2.24
----------- ------------- ------------- -----
Outstanding December 31, 1998.............................. 1,182,069 2.24-3.07 3,134,105 2.65
Granted at fair market value........................... 1,215,045 3.07-9.60 6,502,145 5.35
Granted below fair market value........................ 309,313 3.07-8.70 1,224,108 3.96
Exercised.............................................. (4,916) 2.24-3.07 (11,429) 2.32
Canceled............................................... (37,922) 2.24-3.07 (105,020) 2.77
----------- ------------- ------------- -----
$
Outstanding June 30, 1999.................................. 2,663,589 2.24-$9.60 $ 10,743,909 $ 4.03
----------- ------------- ------------- -----
----------- ------------- ------------- -----
</TABLE>
The options under the 1996 Plan generally vest over a four year period. At
June 30, 1999 there were options to purchase 1,028,050 shares of common stock
exercisable and options to purchase 275,534 shares of common stock were
available for future grant under the 1996 Plan. The weighted average remaining
contractual life of the outstanding options at June 30, 1999 was 9.23 years.
In connection with certain options granted to employees during the six
months ended June 30, 1999, the Company recorded $1,415,548 of deferred
compensation. This amount represents the difference between the fair market
value of the Company's common stock on the date of grant and the exercise price
of options to purchase 284,313 shares of the Company's common stock. Deferred
compensation is amortized over the vesting periods of the options, which range
from immediate vesting to periods of up to four years. For the six months ended
June 30, 1999 $112,204 of deferred compensation was charged to expense. At June
30, 1999, the Company had $1,303,344 of deferred compensation to be amortized
over the remaining vesting periods of four years.
Included in options granted below fair market value during the six months
ended June 30, 1999 are options to purchase 25,000 shares of common stock issued
to non-employees for consulting services. The Company recorded $190,954 in
general and administrative expenses during the six months ended June 30, 1999
related to these options.
In 1999 the Company established an executive bonus pool for issuance of
common stock options to the Chairman and to certain officers of the Company
under the 1996 Plan. Grants of stock option awards under the bonus pool are
contingent upon the Company meeting certain performance goals.
F-15
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
9. STOCK OPTION AND EMPLOYEE BENEFIT PLANS: (CONTINUED)
The Company granted 52,650 options relating to the bonus pool in May 1999 for
the Company's operating results during the three months ended March 31, 1999. In
August 1999 the Company will grant 64,983 options relating to the bonus pool for
the Company's operating results for the three months ended June 30, 1999.
Options granted in connection with the bonus pool vest immediately.
In June 1999, the Company adopted the Directors' Compensation Plan under
which non-qualified options to acquire shares of the Company's common stock may
be granted to non-employee directors of the Company. Options granted under the
Directors Compensation Plan vest immediately and are exercisable over a period
of time not to exceed five years. The total number of shares available under the
Directors Compensation Plan is 156,250.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and the related interpretations, in accounting
for its stock option plan. Had compensation cost for the 1996 Plan been
determined based upon the fair value of the options at the date of grant, as
prescribed under SFAS 123, the Company's net loss for the years ended December
31, 1997 and 1998 would have increased to the following pro forma amount:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1998
------------- --------------
<S> <C> <C>
Net loss, as reported.............................................................. $ (3,797,571) $ (11,604,682)
------------- --------------
------------- --------------
Pro forma net loss................................................................. $ (3,871,550) $ (11,764,529)
------------- --------------
------------- --------------
</TABLE>
The weighted average fair value of the options granted are estimated as
$0.25 to $0.28 per share on the date of grant using the Black-Scholes
option-pricing model with the following assumptions: no expected dividend yield,
a volatility of 0.0%, risk-free interest rates ranging from 4.514% to 6.738%
based on the rates in effect on the date of grant, and an expected life of seven
years.
RETIREMENT SAVINGS PLAN
The Company has a retirement savings plan (the "Plan") that qualifies under
Section 401(k) of the Internal Revenue Code. Eligible employees may contribute
up to 15% of their annual compensation, as defined by the Plan. The Company
contributes to the Plan at a rate of 10% of the employee's contributions up to a
maximum of 6% of the employee's salary. The Company's contributions to the Plan
were $10,452, $22,009, $31,807, $14,351 and $22,688 for the years ended December
31, 1996, 1997 and 1998, and the six months ended June 30, 1998 and 1999,
respectively.
F-16
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
10. INCOME TAXES:
The income tax provision consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1998
----------- -----------
<S> <C> <C>
Current provision...................................................................... $ -- $ --
Deferred benefit....................................................................... (64,000) (81,000)
Net operating loss not benefited....................................................... (1,134,000) (4,410,000)
Termination of S corporation status.................................................... (121,000) --
Increase in valuation allowance........................................................ 1,319,000 4,491,000
----------- -----------
$ -- $ --
----------- -----------
----------- -----------
</TABLE>
The tax effect of the differences that give rise to deferred income taxes is
as follows:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------
1997 1998
----------- -----------
<S> <C> <C>
Net operating loss
carryforwards............... $ 1,134,000 $ 5,544,000
Accounts receivable........... 15,000 18,000
Accrued expenses.............. 71,000 174,000
Property and equipment........ 24,000 24,000
Deferred revenue adjustment... 315,000 252,000
Cash-to-accrual adjustment.... (240,000) (202,000)
----------- -----------
1,319,000 5,810,000
Less-Valuation allowance...... (1,319,000) (5,810,000)
----------- -----------
$ -- $ --
----------- -----------
----------- -----------
</TABLE>
The Company has established a valuation allowance for the full amount of the
net deferred tax asset due to the limited operating history of the Company and
uncertainty surrounding realizability. At December 31, 1998, the Company had a
net operating loss carryforward of approximately $14 million beginning to expire
in 2012 for federal tax purposes and in 2004 for state tax purposes.
11. TRANSACTIONS WITH BCI:
On April 17, 1997, in connection with the sale of the Series A Convertible
Preferred Stock (see Note 7), the Company spun off its consulting division, BCI,
to its then sole stockholder, who is currently a director of the Company.
In connection with the spin-off, the Company entered into the Intercompany
Services Agreement with BCI, whereby BCI provided the Company certain
administrative services at an allocated cost based on actual cost and usage. For
the year ended December 31, 1997, general and administrative expense includes
$871,784 for such services provided by BCI.
The Company also sells certain software products and services to BCI and
purchases certain consulting services from BCI. For the years ended December 31,
1997 and 1998 and for the six months ended June 30, 1998 and 1999, the Company's
sales to BCI totaled $40,448, $58,607, $28,582 and
F-17
<PAGE>
BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
11. TRANSACTIONS WITH BCI: (CONTINUED)
$75,520, respectively, and total purchases from BCI were $47,088, $351,739,
$194,638 and $52,725, respectively. At December 31, 1997 and 1998 and June 30,
1999, accounts receivable includes $5,217, $23,299 and $85,860, respectively,
due from BCI and accounts payable includes $43,889, $77,097 and $3,925,
respectively, payable to BCI.
On March 31, 1998, the Company decided to no longer sell non-proprietary
software products. In addition, the Company agreed to allow BCI to commence the
sale and support of this product line, and sub-contracted support services to
BCI related to previously sold maintenance contracts. The Company paid BCI
$450,000 in 1998 and paid BCI $150,000 in 1999, for the sub-contracted support
services.
The Company also sub-leases a portion of its operating facility to BCI (see
Note 12). Amounts charged to BCI, which reduced the Company's rent expense for
the years ended December 31, 1997 and 1998 and the six months ended June 30,
1998 and 1999, totaled $130,588, $74,165, $28,586 and $46,949, respectively.
During the year ended December 31, 1998 and the six months ended June 30, 1998
and 1999, the Company rented certain equipment from BCI, totaling $89,489,
$39,845 and $49,510, respectively.
In connection with the Series A Convertible Preferred Stock sale and
spin-off of BCI, the Company issued a $500,000, 10% note payable to BCI (see
Note 6).
12. COMMITMENTS AND CONTINGENCIES:
The Company has operating leases on its office facilities (see Note 11) and
certain equipment. Future minimum lease payments under such noncancelable
operating leases are summarized as follows, as of December 31, 1998:
<TABLE>
<S> <C>
1999.......................................................................................................... $ 739,851
2000.......................................................................................................... 598,608
2001.......................................................................................................... 502,980
2002.......................................................................................................... 502,980
2003.......................................................................................................... 454,662
----------
$2,799,081
----------
----------
</TABLE>
Rent expense for continuing operations was $263,079, $551,832, $691,615,
$272,788 and $430,500 for the years ended December 31, 1996, 1997 and 1998 and
the six months ended June 30, 1998 and 1999, respectively.
The Company is involved in certain legal actions arising in the ordinary
course of business. Management believes that the outcome of such actions will
not have a material adverse effect on the Company's financial position or
results of operations.
13. PUBLIC OFFERING SUBSEQUENT TO DECEMBER 31, 1998:
On June 10, 1999, the Company's Board of Directors authorized management to
file a Registration Statement with the SEC to permit the Company to commence an
initial public offering. In connection therewith, on August 13, 1999, the
Company's Board of Directors authorized a 1-for-3.2 reverse split of its common
stock to be effected immediately prior to the offering. The reverse stock split
has been retroactively reflected in the accompanying financial statements.
F-18
<PAGE>
You may rely only on the information contained in this prospectus. We have
not authorized anyone to provide information different from that contained in
this prospectus. Neither the delivery of this prospectus nor the sale of common
stock means that information contained in this prospectus is correct after the
date of the prospectus. This prospectus is not an offer to sell or solicitation
of an offer to buy these shares of common stock in any circumstances under which
the offer or solicitation is unlawful.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
---------
<S> <C>
Prospectus Summary.............................. 1
Risk Factors.................................... 5
Forward-looking Statements...................... 13
Use of Proceeds................................. 13
Dividend Policy................................. 13
Capitalization.................................. 14
Dilution........................................ 15
Selected Financial Data......................... 16
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 17
Business........................................ 28
Management...................................... 39
Certain Transactions............................ 48
Principal and Selling Stockholders.............. 53
Description of Securities....................... 56
Shares Eligible For Future Sale................. 59
Plan of Distribution............................ 61
Legal Matters................................... 63
Experts......................................... 63
Where You Can Find More Information............. 63
Index to Financial Statements................... F-1
</TABLE>
------------------------
Until October 20, 1999 (25 days after the date of this prospectus), all
dealers that buy, sell or trade these shares of common stock, whether or not
participating in this offering, may be required to deliver a prospectus. This is
in addition to the dealers' obligation to deliver a prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
4,000,000 Shares
[LOGO]
Common Stock
---------------------
PROSPECTUS
---------------------
Deutsche Banc Alex. Brown
SoundView Technology Group
C.E. Unterberg, Towbin
Legg Mason Wood Walker
Incorporated
September 24, 1999
