<PAGE>
As filed with the Securities and Exchange Commission on October 14, 1999
Registration No. 333-86759
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
Amendment No. 1
to
FORM S-1
REGISTRATION STATEMENT
Under The Securities Act of 1933
--------------
COBALT NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
--------------
<TABLE>
<S> <C> <C>
California 3670 77-0440751
(before reincorporation) (Primary Standard Industrial (I.R.S. Employer
Classification Code Number) Identification Number)
Delaware 555 Ellis Street
(after reincorporation) Mountain View, CA 94043
(State or other jurisdiction of (650) 623-2500
incorporation or organization)
</TABLE>
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
--------------
Kenton D. Chow
Chief Financial Officer
555 Ellis Street
Mountain View, CA 94043
(650) 623-2500
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
--------------
Please send copies of all communications to:
<TABLE>
<S> <C>
Robert P. Latta, Esq. Kevin P. Kennedy, Esq.
Wilson Sonsini Goodrich & Rosati Shearman & Sterling
Professional Corporation 1550 El Camino Real
650 Page Mill Road Menlo Park, CA 94025
Palo Alto, CA 94304 (650) 330-2200
(650) 493-9300
</TABLE>
--------------
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this Registration
Statement.
--------------
If the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), please check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
--------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this
Registration Statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until the Registration Statement
shall become effective on such date as the Commission, acting pursuant to said
Section 8(a), may determine.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this preliminary prospectus is not complete and may be +
+changed. These securities may not be sold until the registration statement +
+filed with the Securities and Exchange Commission is effective. This +
+preliminary prospectus is not an offer to sell nor does it seek an offer to +
+buy these securities in any jurisdiction where the offer or sale is not +
+permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Subject to Completion. Dated October 14, 1999.
5,000,000 Shares
[COBALT LOGO APPEARS HERE]
Common Stock
----------
This is an initial public offering of shares of common stock of Cobalt
Networks, Inc. All of the shares of our common stock are being sold by Cobalt.
At the request of Cobalt, the underwriters have reserved up to 250,000 shares
of common stock for sale at the initial public offering price to friends of
Cobalt through a directed share program. These friends include Cobalt's
distributors, suppliers, original equipment manufacturers, open source software
developers, friends and family members of employees and other persons Cobalt
believes have contributed to the success of its products and the acceptance of
server appliances.
Prior to this offering, there has been no public market for our common stock.
We anticipate that the initial public offering price will be between $14 and
$16 per share. We have applied for quotation of our common stock on the Nasdaq
National Market under the symbol "COBT".
See "Risk Factors" beginning on page 7 to read about factors you should
consider before buying shares of the common stock.
----------
Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
----------
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Initial public offering price................................... $ $
Underwriting discount........................................... $ $
Proceeds, before expenses, to Cobalt............................ $ $
</TABLE>
To the extent that the underwriters sell more than 5,000,000 shares of common
stock, the underwriters have the option to purchase up to an additional 750,000
shares from Cobalt at the initial public offering price less the underwriting
discount.
----------
The underwriters expect to deliver the shares on , 1999.
Goldman, Sachs & Co.
Merrill Lynch & Co.
Robertson Stephens
SoundView Technology Group
----------
Prospectus dated , 1999.
<PAGE>
[Description for EDGAR: Three pictures of Cobalt products showing in
descending order, (1) a Cobalt Qube sitting on a Cobalt RaQ, (2) a stack of
Cobalt RaQs and (3) a Cobalt Qube sitting on a desktop. Above the pictures is
the name "Cobalt Networks". To the left of the pictures is the phrase "we take
the power of networking and make it affordable, accessible and simple" and the
Cobalt logo.]
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and our financial statements and notes to
those statements appearing elsewhere in this prospectus.
Cobalt Networks, Inc.
We provide server appliances, which are a new category of servers that work
with other computing devices to provide services to network users. Server
appliances are a type of network infrastructure device that is designed to
facilitate the exchange of information over a computing network. Server
appliances differ from general purpose servers because they are specifically
designed and tailored to deliver one or a few network-based applications well
as opposed to general purpose servers. Our server appliances enable small- to
medium-sized organizations that could not previously establish a presence on
the internet to do so easily, cost-effectively and reliably. As the number of
internet users and businesses online increases, we believe the demand for
server appliances will continue to grow.
Our principal product lines, the Cobalt Qube and Cobalt RaQ, enable our
customers to perform critical internet-related applications. Our server
appliances can be used for file serving, web hosting and providing software
applications over the internet. For example, our server appliances are often
used to provide electronic mail to network users and to facilitate electronic
commerce. Our products use Linux, which is referred to as an open source
operating system because the source code is available at little or no cost. We
have adapted Linux to the tasks our server appliances are designed to perform.
We deliver our products with pre-loaded software applications developed by us
and by the open source software developer community, as well as proprietary
third-party applications. Our use of the Linux operating system enables us to
leverage the rapid application development cycles of the open source software
community to reduce the time to market for our innovative products.
As of October 1, 1999, we had sold over 17,000 server appliances to more than
1,300 end user customers in more than 65 countries. Our target customers are
small- to medium-sized organizations, including businesses, educational and
government entities and branch offices of large organizations. We also target
web hosting and application service providers that offer outsourced internet
services to these end users. We sell our products directly and through channel
partners such as distributors and system integrators.
Our Market Opportunity
Historically, to create an internet presence an organization needed access to
complex network technologies and one or more costly general purpose servers,
which often require a technically skilled staff to maintain. The expense and
technical complexity of these network technologies and general purpose servers
often discourage their adoption by small- to medium-sized organizations, due to
their limited budgets and technology skills. The high cost and complexity of
general purpose servers also create challenges for web hosting and application
service providers that seek to profitably differentiate themselves in an
intensely competitive and price sensitive market by offering high value added
services.
Server appliances have been developed to address these challenges faced by
small- to medium-sized organizations and web hosting and application service
providers. Because server appliances are specifically designed and tailored to
provide one or a few dedicated applications, they can be easy to use,
administer and integrate with other infrastructure components, while providing
a low cost, reliable solution.
3
<PAGE>
Dataquest, an independent research firm, expects the server appliance market
to grow from $2.2 billion in 1999 to approximately $15.8 billion in 2003,
representing a 64% compound annual growth rate. Dataquest expects the Linux-
based server appliance market to grow at approximately 69% a year between 1999
and 2003 and represent approximately 24% of the total server appliance market,
or $3.8 billion, in 2003.
Our Strategy
Our objective is to become the leading global provider in the emerging market
for flexible, low cost server appliances. We intend to increase market
acceptance of server appliances by continuing to offer products that are simple
to operate without costly technical staff or a substantial investment in server
hardware. We also intend to continue to promote third-party development of
software applications for our products through partnership programs with
independent, open source software developers. We expect to actively seek to
encourage channel partners, original equipment manufacturers and web hosting
and application service providers to add value to our products by modifying our
products to meet specific customer needs. We intend to continue to create brand
awareness with our products and creative marketing. Finally, we intend to
continue to develop and release products that meet specific customer needs at
relatively low prices that are customized in design to perform their tasks.
Recent Developments
In September 1999, we entered into a five year agreement with Gateway, Inc.,
a build-to-order personal computer and services company, under which we have
agreed, subject to agreement on product specifications, quantities and pricing,
to design jointly and manufacture our products with modifications Gateway
requests to meet the needs of Gateway's customers. These products will be sold
by Gateway under its brand. We have agreed to provide support to Gateway for
these Gateway labeled products. We have also agreed that we will not enter into
similar arrangements for those jointly developed products with Gateway's
competitors during the term of the agreement and Gateway has no current
obligation to make any purchase orders under the agreement.
Other Information
Unless otherwise noted, this prospectus assumes:
. our reincorporation in Delaware to be completed prior to this offering;
. the automatic conversion of our outstanding mandatorily redeemable
convertible preferred stock into common stock upon the closing of this
offering;
. the filing of our amended and restated certificate of incorporation
authorizing a class of 10,000,000 shares of undesignated preferred stock
upon the closing of the offering; and
. no exercise by the underwriters of their option to purchase additional
shares of our common stock in the offering.
Our net revenues were $3.5 million for 1998 and $13.8 million for the nine
months ended October 1, 1999. Our net losses were $10.5 million and $13.7
million for the same periods. Our total accumulated deficit was $13.2 million
as of December 31, 1998 and was $28.2 million as of October 1, 1999.
We filed our articles of incorporation in California in October 1996 under
the name Viavision Systems, Inc. We changed our name to Cobalt Microserver,
Inc. in March 1997 and to Cobalt Networks, Inc. in June 1998. We intend to
reincorporate in Delaware prior to the completion of this offering. Our
principal executive offices are located at 555 Ellis Street, Mountain View,
California 94043. Our telephone number is (650) 623-2500.
4
<PAGE>
The Offering
<TABLE>
<S> <C>
Shares offered by Cobalt........................ 5,000,000 shares
Shares to be outstanding after the offering..... 27,298,052 shares
Use of proceeds................................. For general corporate purposes, including
working capital, funding our operating
losses, capital expenditures and
potential acquisitions of complementary
businesses, products and technologies.
Proposed Nasdaq National Market symbol.......... "COBT"
</TABLE>
The above information is based on 22,298,052 shares outstanding as of October
1, 1999 and excludes:
. 3,275,516 shares issuable upon exercise of options outstanding at a
weighted average exercise price of $1.79 per share as of October 1,
1999;
. 431,100 shares issuable upon exercise of warrants outstanding at a
weighted average exercise price of $3.05 per share as of October 1,
1999; and
. a total of 5,083,913 shares available for future issuance under our
various stock plans excluding the annual increases in the number of
shares authorized under each of our plans beginning January 1, 2001. See
"Management--Incentive Plans" for a description of how these annual
increases are determined.
5
<PAGE>
Summary Consolidated Financial Information
(in thousands, except per share data)
The following table sets forth a summary of our consolidated statement of
operations data for the periods presented. The pro forma net loss per share for
the year ended December 31, 1998 and the nine months ended October 1, 1999
reflects the conversion of our mandatorily redeemable convertible preferred
stock and the elimination of dividends and related charges.
<TABLE>
<CAPTION>
Year Ended
Period from December 31, Nine Months Ended
Oct. 18, 1996 ----------------- ------------------------
(inception) to September 30, October 1,
Dec. 31, 1996 1997 1998 1998 1999
-------------- ------- -------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Consolidated Statement
of Operations Data:
Net revenues............ $ -- $ -- $ 3,537 $ 1,513 $ 13,849
Gross profit............ -- -- 414 123 4,820
Loss from operations.... (82) (1,757) (10,545) (6,679) (13,896)
Net loss................ (82) (1,769) (10,478) (6,634) (13,722)
Accretion of mandatorily
redeemable
convertible preferred
stock.................. -- -- (828) (331) (1,330)
Net loss attributable to
holders of common
stock.................. (82) (1,769) (11,306) (6,965) (15,052)
Basic and diluted net
loss per share
attributable to holders
of common stock........ $ (4.09) $ (5.48) $ (3.67) $ (4.31)
Pro forma basic and
diluted net loss per
share ................. $ (1.43) $ (0.85)
Basic and diluted
weighted average shares
outstanding............ 432 2,065 1,896 3,491
Pro forma basic and
diluted weighted
average shares
outstanding............ 7,330 16,163
</TABLE>
The following table sets forth a summary of our consolidated balance sheet
data as of October 1, 1999:
. on an actual basis;
. on a pro forma basis to give effect to the automatic conversion of all
of the outstanding shares of our mandatorily redeemable convertible
preferred stock into shares of common stock upon the closing of this
offering; and
. on a pro forma as adjusted basis to reflect the automatic conversion of
the mandatorily redeemable convertible preferred stock and our receipt
of the estimated net proceeds from the sale of 5,000,000 shares of
common stock in this offering at an assumed initial public offering
price of $15 per share.
<TABLE>
<CAPTION>
October 1, 1999
-------------------------------
Pro forma
Actual Pro forma as adjusted
-------- --------- -----------
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents..................... $ 25,730 $ 25,730 $94,430
Working capital............................... 19,867 19,867 88,567
Total assets.................................. 33,758 33,758 102,458
Notes payable, less current portion........... 52 52 52
Mandatorily redeemable convertible preferred
stock........................................ 45,907 -- --
Total stockholders' equity (deficit).......... (24,553) 21,354 90,054
</TABLE>
6
<PAGE>
RISK FACTORS
Any investment in our common stock involves a high degree of risk. You should
consider the risks described below carefully and all of the information
contained in this prospectus before deciding whether to purchase our common
stock. If any of the following risks actually occur, our business, financial
condition and results of operations would suffer. In such case, the trading
price of our common stock could decline, and you may lose all or part of your
investment in our common stock.
Risks Related to Our Financial Results
We only began selling our products in March 1998 and, as a result, you may have
difficulty evaluating our business and operating results.
Our company was founded in October 1996, and we did not begin selling our
products until March 1998. An investor in our common stock must consider the
risks and difficulties we may encounter as an early stage company in the new
and rapidly evolving server appliance market. Our limited historical financial
performance may make it difficult for you to evaluate the success of our
business to date and to assess its future viability. We cannot be certain that
our business strategy will be successful.
We have a history of losses and may experience losses in the future, which
could result in the market price of our common stock declining.
Since our inception, we have incurred significant net losses, including net
losses of $10.5 million in 1998 and $13.7 million in the nine months ended
October 1, 1999. In addition, we had an accumulated deficit of $28.2 million as
of October 1, 1999. We expect to continue to incur significant product
development, sales and marketing and administrative expenses. As a result, we
will need to generate significant revenues to achieve profitability. We cannot
be certain that we will achieve profitability in the future or, if we achieve
profitability, to sustain it. If we do not achieve and maintain profitability,
the market price for our common stock may decline, perhaps substantially.
We anticipate that our expenses will increase substantially in the next 12
months as we:
. increase our direct sales and marketing activities, particularly by
expanding our direct sales forces;
. develop our technology, expand our existing product lines and create and
market additional server appliance products;
. make additional investments to develop our brand;
. expand our distribution and reseller channels;
. pursue original equipment manufacturing relationships; and
. implement additional internal systems, develop additional infrastructure
and hire additional management to keep pace with our growth.
Any failure to significantly increase our revenues as we implement our
product and distribution strategies would also harm our ability to achieve and
maintain profitability and could negatively impact the market price of our
common stock.
We may not be able to sustain our current revenue growth rates, which could
cause our stock price to decline.
Although our revenues grew rapidly in 1998 and have grown rapidly in 1999 to
date, we do not believe that we will maintain this rate of revenue growth
because we started from a small base of
7
<PAGE>
revenue, and it is difficult to maintain high percentage increases over a
larger revenue base. In addition, growing competition, the incremental manner
in which customers implement server appliances and our inexperience in selling
our products to small- to medium-sized organizations could also affect our
revenue growth. Any significant decrease in our rate of revenue growth after
this offering would likely result in a decrease in our stock price.
Because our ability to accurately forecast our quarterly sales is limited, our
costs are relatively fixed in the short term and we expect our business to be
affected by seasonality, our quarterly operating results and our stock price
may fluctuate.
Because of our limited operating history and the new and rapidly evolving
market for our server appliances, our ability to accurately forecast our
quarterly sales is limited, which makes it difficult to predict the quarterly
revenues that we will recognize. In addition, we cannot forecast operating
expenses based on historical results, and most of our costs are for personnel
and facilities, which are relatively fixed in the short term. If we have a
shortfall in revenues in relation to our expenses, we may be unable to reduce
our expenses quickly enough to avoid lower quarterly operating results. We do
not know whether our business will grow rapidly enough to absorb the costs of
these employees and facilities. As a result, our quarterly operating results
could fluctuate, and such fluctuation could adversely affect the market price
of our common stock.
In addition, we expect to experience seasonality in the sales of our
products. For example, we expect that sales may decline during summer months,
particularly in Asian and European markets. We also anticipate that sales may
be lower in our first fiscal quarter due to patterns in the capital budgeting
and purchasing cycles of our current and prospective customers. These
seasonable variations in our sales may lead to fluctuations in our quarterly
operating results. It is difficult for us to evaluate the degree to which this
seasonality may affect our business because our growth may have largely
overshadowed this seasonality in recent periods. In addition, concerns
regarding year 2000 compliance issues may adversely affect the demand for
products like ours if our customers divert resources to address year 2000
issues.
We have relied and expect to continue to rely on sales of our Cobalt Qube and
Cobalt RaQ products for our revenues, and a decline in sales of these products
could cause our revenues to fall.
Historically, we have derived substantially all of our revenues from sales of
our Cobalt Qube and Cobalt RaQ products. During 1998 and the nine months ended
October 1, 1999, sales of Cobalt Qube and Cobalt RaQ products accounted for
approximately 83% and 84% of our total revenues. We expect that these products
will continue to account for a large portion of our total revenues for at least
the next two fiscal years. Any factors adversely affecting the pricing of or
demand for our Cobalt Qube and Cobalt RaQ products, including competition or
technological change, could cause our revenues to decline and our business to
suffer. Factors that may affect the market acceptance of our products, some of
which are beyond our control, include the following:
. the growth and changing requirements of the server appliance market;
. the performance, quality, price and total cost of ownership of our
products;
. the availability, price, quality and performance of competing products
and technologies; and
. the successful development of our relationships with original equipment
manufacturer customers and existing and potential channel partners.
8
<PAGE>
We may not succeed in developing and marketing new server appliance products,
and our operating results may decline as a result.
We are developing additional server appliance products that use the Linux
operating system, particularly for use by web hosting and application service
providers. Developing new products that meet the needs of web hosting and
application service providers requires significant additional expenses and
development resources. If we fail to successfully develop and market new
products, our operating results will decline.
We introduced our caching products in July 1998 and network attached storage
products in May 1999. To date, these products have accounted for only a limited
portion of our revenues. However, our future growth and profitability could be
affected by our ability to increase sales of our caching and network attached
storage products.
If we experience any increase in the length of our sales cycle, our quarterly
operating results could become more unpredictable and our stock price may
decline as a result.
We experience sales cycles ranging from three weeks to four months for our
products depending on the identity of the end user and whether the sale is
direct or indirect. If we experience any increase in the length of our sales
cycle, our quarterly operating results could become more unpredictable and our
stock price could decline as a result. Sales of our Cobalt Qube products are
generally limited to one unit per end user and do not involve a lengthy
evaluation cycle, if any. We rely heavily for sales of this product on indirect
selling, where our product is recommended by a reseller or distributor. If the
sales cycle for our Cobalt Qube products becomes longer, our revenues could
become less predictable. Our Cobalt RaQ and Cobalt Cache products are generally
sold to customers who evaluate the products before committing to purchase them.
In addition, for these products, a typical customer may purchase a small number
of units and then incrementally increase the size of the installation over
time. If customers were to implement enterprise-wide evaluation programs or
purchase products for the entire organization at once, our sales cycle could
lengthen and our revenues could be erratic from quarter to quarter. We do not
have enough historical experience selling our Cobalt NAS products to determine
how the sales cycle for these products will affect our revenues.
If we cannot increase our sales volumes, reduce our costs or introduce higher
margin products to offset anticipated reductions in the average unit price of
our products, our operating results may suffer.
We have not experienced an overall decrease in the average selling prices of
our products. However, we anticipate that as products in the server appliance
market become more commoditized, the average unit price of our products may
decrease in the future. The average unit price of our products may also
decrease in response to changes in product mix, competitive pricing pressures,
new product introductions by us or our competitors or other factors. If we are
unable to offset the anticipated decrease in our average selling prices by
increasing our sales volumes, our revenues will decline. Changes in the mix of
our sales, including the mix between higher margin Cobalt RaQ products and
somewhat lower margin Cobalt Qube products, could adversely affect our
operating results for future quarters. In addition, our margins could be
affected if we invest additional resources in our lower margin Cobalt NAS
products. To maintain our gross margins, we also must continue to reduce the
manufacturing cost of our products. Further, as average unit prices of our
current products decline, we must develop and introduce new products and
product enhancements that sell at higher margins.
9
<PAGE>
Risks Related to Growth of Our Market and Acceptance of Linux
Our business is dependent on the adoption of server appliances to perform
discrete tasks for corporate and internet-based computer networks and a
decrease in their rates of adoption could cause the market price for our common
stock to decline as a result of lower revenues or more limited investor
expectations of the size of the market for our products.
We expect that substantially all of our revenues will continue to come from
sales of our server appliance products. As a result, we depend on the growing
use of server appliances to perform discrete tasks for corporate and internet-
based networks. If the role of server appliances does not increase as we
anticipate, or if it in any way decreases, our revenues would decline. We
believe that our expectations for the growth of the server appliance market may
not be fulfilled if customers continue to use general purpose servers. The role
of our server appliances could, for example, be limited if general purpose
servers become better at performing the functions currently being performed by
our server appliances or are offered at a lower cost. This could force us to
lower the prices of our products or result in fewer sales of our products. In
addition, if corporate information technology organizations do not accept
Linux-based operating systems, or if there is a wide acceptance of alternative
operating systems that provide enhanced capabilities, the market price of our
stock could decline due to our lower operating results or investors' assessment
that the growth potential for sales of our products is limited.
The server appliance market for web hosting and application service providers
in which we compete is new and unpredictable, and if this market does not
develop and expand as we anticipate, our revenues may not grow. In addition,
consolidation in this market could result in our clients being absorbed into
larger organizations which might not be as receptive to our products.
The market for server appliance products, particularly those for use
primarily by web hosting and application service providers--companies that
provide internet, intranet, extranet and application hosting services to
others--has only recently begun to develop and is evolving rapidly. Because
this market is new, we cannot predict its potential size or future growth rate.
Our revenues may not continue to grow and the market price for our common stock
could decline if the server appliance market does not grow rapidly over a
number of years.
Our Cobalt RaQ products are used primarily by web hosting and application
service providers. Recently, consolidation has begun to occur in the web
hosting and application service provider market, and many large web hosting and
application service providers are acquiring the smaller and the regional
companies. For example, Verio, Inc. recently acquired our customer,
digitalNation. Large web hosting and application service providers that provide
hosting services may not be as receptive to our products, because their buying
programs are more likely to be based on established, proprietary operating
systems and general purpose servers. In addition, we expect that internet
service providers that specialize in providing internet access and non-hosting
services to consumers will not be substantial purchasers of our products.
Small- to medium-sized organizations may not accept server appliances because
they are less likely to be early adopters of new technologies due to their need
for minimal service disruptions. As a result, we believe the rates of adoption
of server appliances for small- to medium-sized organizations are
unpredictable. Our success in generating net revenues in this emerging market
will depend on, among other things, our ability to:
. educate potential end users, original equipment manufacturers and
channel partners about the benefits of server appliances;
. establish and maintain relationships with leading original equipment
manufacturers and maintain and enhance our relationships with our other
channel partners; and
. predict and base our products on technology that ultimately becomes
industry standard.
10
<PAGE>
Because our products use Linux as their operating system, the failure of Linux
developers to enhance and develop the Linux kernel could impair our ability to
release major product upgrades and maintain market share.
We may not be able to release major upgrades of our Cobalt Qube, Cobalt RaQ,
Cobalt Cache and Cobalt NAS products on a timely basis because our products use
Linux as their operating system. The heart of Linux, the Linux kernel, is
maintained by third parties. Linus Torvalds, the original developer of the
Linux kernel, and a small group of independent engineers are primarily
responsible for the development and evolution of the Linux kernel. If this
group of developers fails to further develop the Linux kernel or if Mr.
Torvalds or other prominent Linux developers were to no longer work on the
Linux kernel, we would have to either rely on another party to further develop
the kernel or develop it ourselves. To date we have optimized our Linux-based
operating system based on a version of Red Hat Linux, which we have licensed
for a nominal price. If we were unable to access Red Hat Linux, or Red Hat
Linux were to become substantially more expensive to obtain, we would be
required to spend additional time to obtain a tested, recognized version of the
Linux kernel from another source or develop our own operating system
internally. We cannot predict whether enhancements to the kernel would be
available from reliable alternative sources. We could be forced to rely to a
greater extent on our own development efforts, which would increase our
development expenses and might delay our product release and upgrade schedules.
In addition, any failure on the part of the kernel developers to further
develop and enhance the kernel could stifle the development of additional
Linux-based applications for use with our products.
We may not succeed if Linux fragments, and application developers do not
develop software for our products.
Our products utilize a version of the Red Hat Linux operating system that we
have optimized for our server appliances. If Linux becomes a proprietary
operating system model, like UNIX or Windows NT, and our products do not use
the predominant Linux operating system, we may not be able to encourage third
party developers to write software applications for use with our products. If
this were to occur, our sales might be limited and our revenues could suffer.
Risks Related to Our Product Manufacturing
We may be unable to manufacture the targeted volume of our products, or any
products at all, if our outside manufacturers are unable to meet our
manufacturing needs because we have no internal manufacturing capacity.
We rely on contract manufacturers to produce our products. In the future, we
may need to find a new outside manufacturer that can manufacture our products
in higher volume and at lower costs. We may not find a outside manufacturer
that meets our needs. Additionally, qualifying a new outside manufacturer and
commencing volume production is expensive and time consuming. If we are
required or choose to change outside manufacturers, we may lose sales and our
customer relationships may suffer.
We recently switched our outside product manufacturer and may experience
transitional problems, including delays and quality control issues, that could
cause us to lose sales and impair our ability to achieve profitability. In
addition, we cannot be certain that our relationship with our second
manufacturing source will continue in light of this change.
We recently switched our contract manufacturer and we do not have enough
experience with our new manufacturer to adequately judge the quality of its
products or its capability to deliver these products on time. Prior to August
1999, almost all of our products were manufactured for us by a single
manufacturer that also provided supply chain management for our products'
components. In
11
<PAGE>
the quarter ended July 2, 1999, we experienced problems getting our products
manufactured by this contractor in a timely fashion due in part to the increase
in our volume requirements. In response to these problems, we switched the
majority of our manufacturing to SMTC Manufacturing Corp., in August 1999.
Although we believe that this will largely resolve the problems we faced during
the quarter ended July 2, 1999, we cannot be certain that we will not face
similar problems in the future. If we face similar problems in the future, we
could lose sales and may not achieve profitability. Moreover, because our
relationship with SMTC Manufacturing is new, we could face transitional
problems with either the quality of the products or the coordination of the
relationship that could delay our product shipments or increase our costs. If
SMTC Manufacturing does not meet our volume and quality requirements, we may
experience increased costs or lose sales to other vendors.
SMTC Manufacturing is only obligated to supply products to us until August
2000 and only up to a quantity based on our forecasts. If SMTC Manufacturing
experiences delays, disruptions, capacity constraints or quality control
problems in its manufacturing operations, then product shipments to our
customers could be delayed, which would negatively impact our net revenues,
competitive position and reputation.
We have also qualified an additional manufacturing source, Flash Electronics,
Inc. Although Flash has built limited quantities of our products in the past,
we cannot be certain that we will be able to access sufficient production
capacity at Flash upon demand or that Flash will agree to continue as a
secondary manufacturer for us in light of our decision to use SMTC
Manufacturing as our primary manufacturing contractor. If Flash does not
continue to be available to manufacture our products, we may not be able to
meet customer orders if SMTC Manufacturing cannot accommodate our needs.
We may experience production delays or disruptions if we relocate our
manufacturing to offshore facilities, which could result in lost revenues.
We anticipate that we may relocate our manufacturing operations for sales
outside North America to one of SMTC Manufacturing's offshore manufacturing
facilities during 2000. We could experience difficulties and disruptions in the
manufacture of our products while we transition to a new facility.
Manufacturing disruption could prevent us from achieving timely delivery of
products and could result in lost revenues.
Because we depend on sole source and limited source suppliers for key
components, we are susceptible to supply shortages that could prevent us from
shipping customer orders on time, if at all, and result in lost sales.
We depend upon single source suppliers for our industry standard processors
and power supplies and our custom printed circuit boards, chassis and sheet
metal parts. We also depend on limited sources to supply several other industry
standard components. We have in the past experienced and may in the future
experience shortages of, or difficulties in acquiring, these components. If we
are unable to buy these components, we will not be able to manufacture our
products on a timely basis or deliver our products to our customers.
Because we order components and materials based on rolling forecasts, we may
overestimate or underestimate our component and material requirements, which
could increase our costs or prevent us from meeting customer demand.
We use rolling forecasts based on anticipated product orders to determine our
component requirements. Lead times for materials and components that we order
vary significantly and depend on factors including specific supplier
requirements, contract terms and current market demand for those components. As
a result, our component requirement forecasts may not be accurate. If we
12
<PAGE>
overestimate our component requirements, we may have excess inventory, which
would increase our costs. If we underestimate our component requirements, we
may have inadequate inventory, which could interrupt our manufacturing and
delay delivery of our products to our customers. Any of these occurrences would
negatively impact our business and operating results.
Risks Related to Our Marketing and Sales Efforts
Because we rely on channel partners to sell a majority of our products, our
revenues could decline substantially if our existing channel partners do not
continue to purchase products from us.
We rely on our channel partners who are distributors, such as Ingram Micro,
Merisel and Tech Data, resellers and system integrators to sell a majority of
our products in the United States. A substantial majority of our sales outside
of the United States are through other channel partners, and we rely on Nissho
Electronics to sell a majority of our products in Japan. Sales to distributors
accounted for 54% of our net revenues in 1998 and 85% of our net revenues in
the nine months ended October 1, 1999. If we fail to sell our products through
our existing channel partners, we would experience a material decline in
revenues. Even if we are successful in selling our products through new channel
partners, the rate of growth of our net revenues could be materially and
adversely affected if our existing channel partners do not continue to sell a
substantial number of our products. We cannot be certain that we will be able
to attract channel partners that market our products effectively or provide
timely and cost-effective customer support and service. None of our current
channel partners are obligated to continue selling our products. We cannot be
certain that any channel partner will continue to represent our products or
that our channel partners will devote a sufficient amount of effort and
resources to selling our products in their territories.
We may incur significant costs to promote our brand that may not result in the
desired brand recognition by customers or increased sales.
We believe that we need a strong brand to compete successfully. In order to
attract and retain customers, we believe that our brand must be recognized and
viewed favorably by end user customers. Although we intend to advertise and
promote our brand, we cannot be certain that these strategies will be
successful. If we are unable to design and implement effective marketing
campaigns or otherwise fail to promote and maintain our brand, our sales could
decline. Our business may also suffer if we incur excessive expenses in an
attempt to promote and maintain our brand without a corresponding increase in
revenues.
We need to expand our direct and indirect sales channels, and if we fail to do
so, our growth could be limited.
In order to increase market awareness and sales of our products, we will need
to substantially expand our direct and indirect sales operations, both
domestically and internationally. If we fail in this endeavor, our growth will
be limited. To date, we have relied primarily on our direct sales force to
generate demand for our products by regional and national web hosting and
application service providers. Our products require a sophisticated sales
effort targeted at our prospective customers' information technology
departments. We have recently expanded our direct sales force and plan to hire
additional sales personnel. Competition for qualified sales people is intense,
and we might not be able to hire the quality and number of sales people we
require.
Our expansion to international markets will result in higher personnel costs
and could reduce our operating margins due to the higher costs of international
sales.
We must expand the number of channel partners who sell our products or our
direct international sales presence to significantly increase our international
sales. We may incur higher personnel costs
13
<PAGE>
by hiring direct sales staff that may not result in an increase in our
revenues. We may not realize corresponding increases in operating margins from
increases in international sales, due to the higher costs of these sales. Our
sales outside of the United States represented 44% of our total revenues in
1998 and 56% of our total revenues in the nine months ended October 1, 1999. To
date, we have relied primarily on international channel partners and have only
recently begun to employ direct sales staff outside of the United States. Even
if we are able to successfully expand our direct and indirect international
selling efforts, we cannot be certain that we will be able to create or
increase international market demand for our products.
If we are unable to expand our customer service and support organization, we
may not be able to retain our existing customers and attract new customers.
We currently have a small customer service and support organization and will
need to increase our staff to support new customers and the expanding needs of
our existing customers. If we are unable to expand our customer service and
support organization, we may not be able to retain our existing customers and
attract new customers. Hiring customer service and support personnel is very
competitive in our industry due to the limited number of people available with
the necessary technical skills and understanding of the Linux operating
environment.
We do not have a consulting staff, and our revenues may suffer if customers
demand extensive consulting or other support services.
Our products are designed to require little or no support from us and to be
deployed quickly and easily by our customers. Many of our competitors offer
extensive consulting services in addition to server appliance products. If we
introduced a product that required extensive consulting services for
installation and use or if our customers wanted to purchase from a single
vendor a menu of items that included extensive consulting services, we would be
required to change our business model. We would be required to hire and train
consultants, outsource the consulting services or enter into a joint venture
with another company that could provide those services. If these events were to
occur, our future profits would likely suffer because customers would choose
another vendor or we would incur the added expense of hiring and retaining
consulting personnel.
Risks Related to Competition Within Our Industry
We may not be able to effectively compete against providers of general purpose
servers or limited purpose servers as a result of their greater financial
resources and brand awareness.
In the market for server appliances, we face significant competition from
larger companies who market general purpose servers or limited purpose servers
and have greater financial resources and name recognition than we do. We
believe that Compaq, Dell, Gateway, Hewlett-Packard, IBM, Sun Microsystems or
other server manufacturers, each of which is also currently competing with us
by manufacturing and selling general purpose servers or limited purpose
servers, could also introduce server products that include the functionality
that we currently provide in our products at lower prices. If these vendors
provide lower cost server appliances that perform comparable functions to our
products coupled with the broader applications of their existing product lines,
our products could become obsolete. Even if the functionality of the standard
features of these products is equivalent to ours, we face a substantial risk
that a significant number of customers would elect to pay a premium for similar
functionality rather than purchase products from a less well-known vendor.
We may face competition in the future from established companies that have
only recently entered the server appliance market, such as Intel, Novell or
Oracle or from emerging software companies. Barriers to entry in the server
appliance market are relatively low. Increased competition may negatively
affect our business and future operating results by leading to price
reductions, higher selling expenses or a reduction in our market share.
14
<PAGE>
Our revenues could be reduced if general purpose server manufacturers make
acquisitions in order to join their extensive distribution capabilities with
our smaller competitors' products.
Compaq, Dell, Gateway, Hewlett-Packard, IBM, Sun Microsystems and other
server manufacturers may not only develop their own server appliance solutions,
but they may also acquire or establish cooperative relationships with our other
current competitors, including smaller private companies. Because general
purpose server manufacturers have significant financial and organizational
resources available, they may be able to quickly penetrate the server appliance
market by leveraging the technology and expertise of smaller companies and
utilizing their own extensive distribution channels. We expect that the server
appliance industry will continue to consolidate. For example, Whistle
Communications, a server appliance company, was recently acquired by IBM. It is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share.
We may sell fewer products if other vendors' products are no longer compatible
with ours or other vendors bundle their products with those of our competitors
and sell them at lower prices.
Our ability to sell our products depends in part on the compatibility of our
products with other vendors' software and hardware products. Developers of
these products may change their products so that they will no longer be
compatible with our products. These other vendors may also decide to bundle
their products with other server appliances for promotional purposes and
discount the sales price of the bundle. If that were to happen, our business
and future operating results could suffer if we were no longer able to offer
commercially viable products.
Server appliance products are subject to rapid technological change due to
changing operating system software and network hardware and software
configurations, and our products could be rendered obsolete by new
technologies.
The server appliance market is characterized by rapid technological change,
frequent new product introductions and enhancements, uncertain product life
cycles, changes in customer demands and evolving industry standards. Our
products could be rendered obsolete if products based on new technologies are
introduced or new industry standards emerge. For example, sales of our products
may be limited if customers widely adopt Windows 2000-based server appliances,
and our products, which do not currently operate on the Windows 2000 platform,
fail to provide comparable functionality.
Computer networks in which servers perform functions for other computers,
such as a personal computer on an employee's desk, are inherently complex. As a
result, we cannot accurately estimate the life cycles of our server appliance
products. New products and product enhancements can require long development
and testing periods, which requires us to hire and retain increasingly scarce,
technically competent personnel. Significant delays in new product releases or
significant problems in installing or implementing new products could seriously
damage our business. We have, on occasion, experienced delays in the scheduled
introduction of new and enhanced products and cannot be certain that we will
avoid similar delays in the future.
Our future success depends upon our ability to enhance existing products,
develop and introduce new products, satisfy customer requirements and achieve
market acceptance. We cannot be certain that we will successfully identify new
product opportunities and develop and bring new products to market in a timely
and cost-effective manner.
15
<PAGE>
Risks Related to Our Products' Dependence on Intellectual Property and Our Use
of Our Brand
We may not be able to preserve the value of our products' intellectual property
because we do not have any patents and other vendors could challenge our other
intellectual property rights.
Our products are differentiated from those of our competitors by our
internally developed technology that is incorporated into our products. If we
fail to protect our intellectual property, other vendors could sell products
with features similar to ours, and this could reduce demand for our products.
We protect our intellectual property through a combination of copyright, trade
secret and trademark laws. We have only recently commenced a patent program and
to date have not filed any patent applications. We generally enter into
confidentiality or license agreements with our employees, consultants and
corporate partners, and generally control access to our intellectual property
and the distribution of our server appliances, integrated software,
documentation and other proprietary information. We believe that such measures
afford only limited protection. Others may develop technologies that are
similar or superior to our technology or design around the copyrights and trade
secrets we own. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and use our
products or technology. Policing unauthorized use of our products is difficult,
and we cannot be certain that the steps we have taken will prevent
misappropriation of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as those in the United
States. Our means of protecting our proprietary rights may be inadequate.
We have invested substantial resources in developing our products and our
brand, and our operating results would suffer if we were subject to a
protracted infringement claim or one with a significant damages award.
Substantial litigation regarding intellectual property rights and brand names
exists in our industry. We expect that server appliance products may be
increasingly subject to third-party infringement claims as the number of
competitors in our industry segment grows and the functionality of products in
different industry segments overlaps. We are not aware that our products employ
technology that infringes any proprietary rights of third parties. However,
third parties may claim that we infringe their intellectual property rights.
Any claims, with or without merit, could:
. be time consuming to defend;
. result in costly litigation;
. divert our management's attention and resources;
. cause product shipment delays; or
. require us to enter into royalty or licensing agreements.
These royalty or licensing agreements may not be available on terms
acceptable to us, if at all. A successful claim of product infringement against
us or our failure or inability to license the infringed or similar technology
could adversely affect our business because we would not be able to sell the
impacted product without redeveloping it or incurring significant additional
expenses.
For example, in December 1998, CUBE Computer Corporation sued us for
trademark infringement, alleging that our use of the term "Qube" in connection
with our products infringes CUBE Computer Corporation's trademark. To date,
CUBE has not made a claim for damages. Although we believe this claim is
without merit, in the event we were to lose this litigation with CUBE, we could
be forced to pay CUBE a royalty for continuing use of our Cobalt Qube trademark
or be barred from using the name altogether. This could result in us losing the
brand equity which we have established for our Cobalt Qube products.
16
<PAGE>
Other Risks Related to Our Business
Our recent growth has placed a significant strain on our management systems and
resources and we may be unable to effectively control our costs and implement
our business strategies as a result.
We continue to increase the scope of our operations and have grown our
headcount substantially. As of December 31, 1998, we had a total of 68
employees, and as of October 1, 1999 we had a total of 127 employees. Our
productivity and the quality of our products may be adversely affected if we do
not integrate and train our new employees quickly and effectively. We also
cannot be sure that our revenues will continue to grow at a sufficient rate to
absorb the costs associated with a larger overall headcount, as well as
recruiting-related expenses.
This growth has placed, and we expect that any future growth we experience
will continue to place, a significant strain on our management, systems and
resources. To manage the anticipated growth of our operations, we may be
required to:
. improve existing and implement new operational, financial and management
information controls, reporting systems and procedures;
. hire, train and manage additional qualified personnel; and
. establish relationships with additional suppliers and partners while
maintaining our existing relationships.
Because our strategy to expand our international operations is subject to
uncertainties, we may not be able to enter new international markets or
generate a significant level of revenues from those markets outside of the
United States in which we currently operate.
Customers outside of the United States accounted for $1.6 million of our net
revenues in 1998 and $7.8 million of our net revenues in the nine months ended
October 1, 1999. Although international sales represented a majority of our
sales in the nine months ended October 1, 1999, the absolute dollar amount of
our international sales was relatively small and must grow substantially in
order for us to achieve and maintain profitability. We plan to increase our
international sales activities, but we have limited experience in developing
foreign language translations of our products and little direct experience
marketing and distributing our products internationally.
We conduct direct sales activities in Japan, the United Kingdom, Germany and
the Netherlands and indirect sales activities in Asia, elsewhere in Europe and
Mexico. Our international operations are subject to other inherent risks,
including:
. the impact of recessions in economies outside the United States;
. greater difficulty in accounts receivable collection and longer
collection periods;
. unexpected changes in regulatory requirements;
. difficulties and costs of staffing and managing foreign operations;
. reduced protection for intellectual property rights in some countries;
. potentially adverse tax consequences; and
. political and economic instability.
17
<PAGE>
We do not know what the impact of any Year 2000 problems with our products or
our internal systems would be.
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
determine whether "00" means 1900 or 2000. This may result in software failures
or the creation of erroneous results.
We are in the final stages of assessing our Year 2000 readiness. We have
concluded a preliminary investigation and performed limited testing to
determine whether each component of our products and our products in
development are Year 2000 compliant. Our server appliance products operate in
complex system environments and directly and indirectly interact with a number
of other hardware and software systems. Despite the investigation and testing
by us and our partners, our server appliance products and the underlying
systems and protocols running our products may contain errors or defects
associated with Year 2000 date functions. We are unable to predict to what
extent our business may be affected if our software or the systems that operate
in conjunction with our software experience a material Year 2000 failure. Known
or unknown errors or defects that affect the operation of our server appliances
could result in:
. delay or loss of revenues;
. cancellation of customer contracts;
. diversion of development resources;
. damage to our reputation;
. increased maintenance and warranty costs; or
. litigation costs;
any of which could adversely affect our business, financial condition and
results of operations.
Despite investigation and testing by us, our internal systems may contain
errors or defects associated with Year 2000 date functions. We are unable to
predict to what extent our core business functions may be affected if our
internal systems or software experience a material Year 2000 failure. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation--Year 2000 Readiness" for a description of our Year 2000 readiness
efforts.
We rely on the services of our founders and other key personnel, and those
persons' knowledge of our business and technical expertise would be difficult
to replace.
Our products and technologies are complex and we are substantially dependent
upon the continued service of our existing engineering personnel, and
especially Stephen DeWitt, our President and Chief Executive Officer, and Vivek
Mehra, our Chief Technology Officer and one of our founders. The loss of any of
our key employees could adversely affect our business and slow our product
development processes. Although we maintain key person life insurance policies
on our key employees, the amount of this insurance may be inadequate to
compensate us for their loss.
Errors in our products or the failure of our products to conform to
specifications could result in our customers demanding refunds from us or
asserting claims for damages against us.
Because our server appliance products are complex, they could contain errors
or bugs that can be detected at any point in a product's life cycle. In the
past we have discovered errors in some of our products and have experienced
delays in the shipment of our products during the period required to correct
these errors. These delays have principally related to new product releases. To
date none of these delays has materially affected our business. While we
continually test our products for errors
18
<PAGE>
and work with customers through our customer support services to identify and
correct bugs in our software and other product problems, errors in our products
may be found in the future. Although many of these errors may prove to be
immaterial, any of these errors could be significant. Detection of any
significant errors may result in:
. the loss of or delay in market acceptance and sales of our products;
. diversion of development resources;
. injury to our reputation; or
. increased maintenance and warranty costs.
These problems could harm our business and future operating results. Product
errors or delays could be material, including any product errors or delays
associated with the introduction of new products or the versions of our
products that support operating systems other than Linux. Occasionally, we have
warranted that our products will operate in accordance with specified customer
requirements. If our products fail to conform to these specifications,
customers could demand a refund for the purchase price or assert claims for
damages.
Moreover, because our products are used in connection with critical
distributed computing systems services, we may receive significant liability
claims if our products do not work properly. Our agreements with customers
typically contain provisions intended to limit our exposure to liability
claims. However, these limitations may not preclude all potential claims.
Liability claims could require us to spend significant time and money in
litigation or to pay significant damages. Any such claims, whether or not
successful, could seriously damage our reputation and our business.
Risks Related to this Offering
Our stock will likely be subject to substantial price and volume fluctuations
due to a number of factors, many of which will be beyond our control, that may
prevent our stockholders from reselling our common stock at a profit.
The securities markets have experienced significant price and volume
fluctuations in the past and the market prices of the securities of technology
companies have been especially volatile. This market volatility, as well as
general economic, market or political conditions, could reduce the market price
of our common stock in spite of our operating performance. In addition, our
operating results could be below the expectations of public market analysts and
investors, and in response the market price of our common stock could decrease
significantly. Investors may be unable to resell their shares of our common
stock at or above the offering price. In the past, companies that have
experienced volatility in the market price of their stock have been the object
of securities class action litigation. If we were the object of securities
class action litigation, it could result in substantial costs and a diversion
of management's attention and resources.
We have broad discretion in how we use the proceeds of this offering, and we
may not use these proceeds effectively.
Our management could spend most of the proceeds from this offering in ways
with which our stockholders may not agree or that do not yield a favorable
return. Our primary purpose in conducting this offering is to create a public
market for our common stock. As of the date of this prospectus, we plan to use
the proceeds from this offering for working capital and general corporate
purposes. We may also use the proceeds in future strategic acquisitions but do
not have any acquisitions planned. Until we need to use the proceeds of this
offering, we plan to invest the net proceeds in investment grade, interest-
bearing securities.
19
<PAGE>
Our officers and persons affiliated with our directors hold a substantial
portion of our stock and could reject mergers or other business combinations
that a stockholder may believe are desirable.
We anticipate that our directors, officers and individuals or entities
affiliated with our directors will beneficially own approximately 20.9% of our
outstanding common stock as a group after this offering closes. Acting
together, these stockholders would be able to significantly influence all
matters that our stockholders vote upon, including the election of directors or
the rejection of a merger or other business combination that other stockholders
may believe is desirable.
The provisions of our charter documents may inhibit potential acquisition bids
that a stockholder may believe are desirable, and the market price of our
common stock may be lower as a result.
Upon completion of this offering, our board of directors will have the
authority to issue up to 10,000,000 shares of preferred stock. The board of
directors can fix the price, rights, preferences, privileges and restrictions
of the preferred stock without any further vote or action by our stockholders.
The issuance of shares of preferred stock may delay or prevent a change in
control transaction. As a result, the market price of our common stock and the
voting and other rights of our stockholders may be adversely affected. The
issuance of preferred stock may result in the loss of voting control to other
stockholders. We have no current plans to issue any shares of preferred stock.
Our charter documents contain anti-takeover devices including:
. only one of the three classes of directors is elected each year;
. the ability of our stockholders to remove directors without cause is
limited;
. the right of stockholders to act by written consent has been eliminated;
. the right of stockholders to call a special meeting of stockholders has
been eliminated; and
. a requirement of advance notice to nominate directors or submit
proposals for consideration at stockholder meetings.
These provisions could discourage potential acquisition proposals and could
delay or prevent a change in control transaction. They could also have the
effect of discouraging others from making tender offers for our common stock.
As a result, these provisions may prevent the market price of our common stock
from increasing substantially in response to actual or rumored takeover
attempts. These provisions may also prevent changes in our management.
Delaware law may inhibit potential acquisition bids; this may adversely affect
the market price of our common stock, discourage merger offers and prevent
changes in our management.
Section 203 of the Delaware General Corporation Law may inhibit potential
acquisition bids for our company. Upon completion of this offering, we will be
subject to the antitakeover provision of the Delaware General Corporation Law,
which regulates corporate acquisitions. See "Description of Capital Stock" for
a discussion of how Section 203 operates. Under Delaware law, a corporation may
opt out of the antitakeover provisions. We do not intend to opt out of the
antitakeover provisions of Delaware Law.
A total of 22,298,052, or 81.7%, of our total outstanding shares after the
offering are restricted from immediate resale, but may be sold into the market
in the near future. This could cause the market price of our common stock to
drop significantly, even if our business is doing well.
Our current stockholders hold a substantial number of shares, which they will
be able to sell in the public market in the near future. Sales of a substantial
number of shares of our common stock
20
<PAGE>
could cause our stock price to fall. In addition, the sale of these shares
could impair our ability to raise capital through the sale of additional stock.
After this offering, we will have outstanding 27,298,052 shares of common
stock. This includes 5,000,000 shares that we are selling in the offering,
which may be resold immediately in the public market. The remaining 22,298,052
shares will become eligible for resale in the public market as shown in the
table below.
<TABLE>
<CAPTION>
Number of shares/% of total
outstanding after the offering Date of availability for resale into public market
------------------------------ --------------------------------------------------
<C> <S>
100,000 / 0.4% 30 days after the date of the final prospectus due to an agreement
the family of a deceased co-founder has with Cobalt and the
underwriters. However, the underwriters can waive this restriction
and allow these stockholders to sell their shares at any time.
22,198,052 / 81.3% 180 days after the date of the final prospectus due to agreements
these stockholders have with Cobalt and the underwriters.
However, the underwriters can waive this restriction and allow
these stockholders to sell their shares at any time. Of these shares,
13,972,832 shares will be subject to sales volume limitations under
the federal securities laws.
</TABLE>
FORWARD-LOOKING STATEMENTS
This prospectus, including the sections entitled "Prospectus Summary", "Risk
Factors", "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business", contains forward-looking statements.
These statements relate to future events or our future financial performance
and involve known and unknown risks, uncertainties and other factors that may
cause our or our industry's actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by the forward-
looking statements. These risks and other factors include those listed under
"Risk Factors" and elsewhere in this prospectus. In some cases, you can
identify forward-looking statements by terminology such as "may", "will",
"should", "expects", "plans", "anticipates", "believes", "estimates",
"predicts", "potential", "continue" or the negative of these terms or other
comparable terminology. These statements are only predictions. Actual events or
results may differ materially. In evaluating these statements, you should
specifically consider various factors, including the risks outlined under "Risk
Factors". These factors may cause our actual results to differ materially from
any forward-looking statement.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other
person assumes responsibility for the accuracy and completeness of these
forward-looking statements. We are under no duty to update any of the forward-
looking statements after the date of this prospectus to conform our prior
statements to actual results.
21
<PAGE>
USE OF PROCEEDS
We estimate that the net proceeds from the sale of the shares of common stock
that we are selling in this offering will be approximately $68.7 million or
$79.2 million if the underwriters exercise their over-allotment option in full,
based on an assumed initial public offering price of $15 per share and after
deducting the estimated underwriting discounts and commissions and estimated
offering expenses payable by us.
The principal purposes of this offering are to:
. fund our operating losses;
. increase our working capital;
. fund our capital expenditures; and
. create a public market for our common stock.
The amounts that we actually expend for working capital purposes will vary
significantly depending on a number of factors, including future revenue
growth, if any, and the amount of cash we generate from operations. As a
result, we will retain broad discretion in the allocation of the net proceeds
of this offering. In addition, we may use a portion of the net proceeds for
further development of our product lines through acquisitions of or investments
in products, technologies and businesses. However, we currently have no present
commitments or agreements with respect to any acquisitions or investments.
Pending these uses, we intend to invest the net proceeds in interest-bearing,
investment-grade securities.
DIVIDEND POLICY
We have never declared or paid any dividends on our capital stock. We
currently expect to retain any future earnings for use in the operation and
expansion of our business and do not anticipate paying any cash dividends.
22
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of October 1, 1999. Our
capitalization is presented:
. on an actual basis;
. on a pro forma basis to give effect to the automatic conversion of all
outstanding shares of our mandatorily redeemable convertible preferred
stock into shares of common stock upon the closing of this offering; and
. on a pro forma as adjusted basis to reflect the automatic conversion of
our mandatorily redeemable convertible preferred stock and our receipt
of the estimated net proceeds from the sale of 5,000,000 shares of
common stock in this offering at an assumed initial public offering
price of $15 per share.
<TABLE>
<CAPTION>
As of October 1, 1999
--------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(in thousands)
<S> <C> <C> <C>
Notes payable, less current portion............ $ 52 $ 52 $ 52
-------- -------- --------
Mandatorily redeemable convertible preferred
stock, $.001 par value, 17,609,875 shares
authorized actual and pro forma, 17,179,383
shares issued and outstanding, actual; no
shares issued or outstanding, pro forma and
pro forma as adjusted......................... 45,907 -- --
-------- -------- --------
Stockholders' equity (deficit):
Preferred stock, $.001 par value, no shares
authorized, issued or outstanding, actual
and pro forma; 10,000,000 shares authorized,
no shares issued or outstanding, pro forma
as adjusted.................................. -- -- --
Common stock, $.001 par value, 26,000,000
shares authorized, actual and pro forma;
5,118,669 shares issued and outstanding,
actual; 22,298,052 shares issued and
outstanding, pro forma; 120,000,000 shares
authorized, 27,298,052 shares issued and
outstanding, pro forma as adjusted........... 5 22 27
Additional paid-in capital.................... 11,840 57,730 126,425
Unearned stock compensation................... (7,747) (7,747) (7,747)
Note receivable from stockholder.............. (442) (442) (442)
Accumulated deficit........................... (28,209) (28,209) (28,209)
-------- -------- --------
Total stockholders' equity (deficit)........ (24,553) 21,354 90,054
-------- -------- --------
Total capitalization...................... $ 21,406 $ 21,406 $ 90,106
======== ======== ========
</TABLE>
In addition to the shares of common stock to be outstanding after the
offering, we may issue additional shares of common stock under the following
plans and arrangements:
. 3,275,516 shares issuable upon exercise of options outstanding at a
weighted average exercise price of $1.79 per share as of October 1,
1999;
. 431,100 shares issuable upon exercise of warrants outstanding at a
weighted average exercise price of $3.05 per share as of October 1,
1999; and
. a total of 5,083,913 shares available for future issuance under our
various stock plans excluding the annual increases in the number of
shares authorized under each of our plans beginning January 1, 2001. See
"Management--Incentive Plans" for a description of how these annual
increases are determined.
Please read the capitalization table together with the sections of this
prospectus entitled "Selected Consolidated Financial Data" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
with the financial statements and related notes beginning on page F-1.
23
<PAGE>
DILUTION
Our pro forma net tangible book value as of October 1, 1999 was $21.4
million, or $0.96 per share. Pro forma net tangible book value per share
represents the amount of our total tangible assets reduced by the amount of our
total liabilities and divided by the total number of shares of common stock
outstanding after giving effect to the automatic conversion of our mandatorily
redeemable convertible preferred stock. Dilution in pro forma net tangible book
value per share represents the difference between the amount per share paid by
purchasers of shares of common stock in this offering and the pro forma net
tangible book value per share of common stock immediately after the completion
of this offering. After giving effect to the sale of the shares of common stock
offered by us at an assumed initial public offering price of $15 per share, and
after deducting the estimated underwriting discounts and commissions and
estimated offering expenses payable by us, our pro forma net tangible book
value as of October 1, 1999 would have been approximately $90.1 million or
$3.30 per share of common stock. This represents an immediate increase in pro
forma net tangible book value of $2.34 per share to existing stockholders and
an immediate dilution of $11.70 per share to new investors of common stock. The
following table illustrates this dilution on a per share basis:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................... $15.00
Pro forma net tangible book value per share as of October 1,
1999........................................................... $0.96
Increase per share attributable to new investors................ 2.34
-----
Pro forma net tangible book value per share after this offering... 3.30
------
Dilution per share to new investors............................... $11.70
======
</TABLE>
The following table summarizes on a pro forma basis after giving effect to
the offering, based on an assumed initial public offering price of $15 per
share, as of October 1, 1999, the differences 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:
<TABLE>
<CAPTION>
Average
Shares Purchased Total Consideration Price
------------------ -------------------- Per
Number Percent Amount Percent Share
---------- ------- ------------ ------- -------
<S> <C> <C> <C> <C> <C>
Existing stockholders........... 22,298,052 81.7% $ 48,201,369 39.1% $2.16
New investors................... 5,000,000 18.3 75,000,000 60.9 15.00
---------- ----- ------------ -----
Total......................... 27,298,052 100.0% $123,201,369 100.0%
========== ===== ============ =====
</TABLE>
The foregoing discussion and tables are based upon the number of shares
actually issued and outstanding on October 1, 1999 and assume no exercise of
options or warrants outstanding as of October 1, 1999. As of that date, there
were:
. 3,275,516 shares issuable upon exercise of options outstanding at a
weighted average exercise price of $1.79 per share; and
. 431,100 shares issuable upon exercise of warrants outstanding at a
weighted average exercise price of $3.05 per share.
Assuming the exercise in full of all of the outstanding options and warrants,
our pro forma as adjusted net tangible book value at October 1, 1999 would be
$3.14 per share, representing an immediate increase in net tangible book value
of $2.18 per share to our existing stockholders and an immediate decrease in
the net tangible book value of $11.86 to new investors.
24
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and our consolidated financial statements and notes thereto. The
selected consolidated statement of operations data for the period from October
18, 1996 (inception) to December 31, 1996, for the years ended December 31,
1997 and 1998 and for the nine months ended October 1, 1999, and the selected
consolidated balance sheet data as of December 31, 1997 and 1998 and October 1,
1999, are derived from, and are qualified by reference to, the audited
consolidated financial statements included elsewhere in this prospectus. The
selected consolidated balance sheet data as of December 31, 1996 is derived
from our audited consolidated financial statements that are not included in
this prospectus. The selected consolidated statement of operations data for the
nine months ended September 30, 1998, are derived from unaudited consolidated
financial statements included elsewhere in this prospectus. We prepared the
unaudited consolidated financial statements on substantially the same basis as
the audited consolidated financial statements and, in our opinion, they include
all adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of the results of operations for these periods. The
historical results presented below are not necessarily indicative of future
results.
Our mandatorily redeemable convertible preferred stock had a feature which
required us to repurchase the preferred stock from its holders at their
election. Accretion of mandatorily redeemable convertible preferred stock
represents the charge to retained earnings we took in 1998 and the nine months
ended October 1, 1999 to reflect this potential liability. As of April 26,
1999, the accretion was no longer required due to a change in the terms of the
preferred stock. The outstanding shares of mandatorily redeemable convertible
preferred stock will convert into shares of our common stock on a one for one
basis in connection with the closing of this offering and no dividends will be
paid or converted into common stock. The pro forma net loss per share for the
year ended December 31, 1998 and the nine months ended October 1, 1999 reflect
the elimination of the accretion and the conversion of our preferred stock.
25
<PAGE>
<TABLE>
<CAPTION>
Year Ended
Period from December 31, Nine Months Ended
Oct. 18, 1996 ----------------- ------------------------
(Inception) September 30, October 1,
to Dec. 31, 1996 1997 1998 1998 1999
---------------- ------- -------- ------------- ----------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement
of Operations Data:
Net revenues............ $ -- $ -- $ 3,537 $ 1,513 $ 13,849
Cost of revenues........ -- -- 3,123 1,390 9,029
----- ------- -------- ------- --------
Gross profit........... -- -- 414 123 4,820
----- ------- -------- ------- --------
Operating expenses:
Research and
development........... 22 1,067 3,483 2,373 4,337
Sales and marketing.... -- 245 5,581 3,349 10,246
General and
administrative........ 60 445 1,895 1,080 2,624
Amortization of stock
compensation.......... -- -- -- -- 1,509
----- ------- -------- ------- --------
Total operating
expenses............ 82 1,757 10,959 6,802 18,716
----- ------- -------- ------- --------
Loss from operations.... (82) (1,757) (10,545) (6,679) (13,896)
Interest income
(expense), net......... -- (12) 67 45 174
----- ------- -------- ------- --------
Net loss................ (82) (1,769) (10,478) (6,634) (13,722)
Accretion of mandatorily
redeemable convertible
preferred stock........ -- -- (828) (331) (1,330)
----- ------- -------- ------- --------
Net loss attributable to
holders of common
stock.................. $ (82) $(1,769) $(11,306) $(6,965) $(15,052)
===== ======= ======== ======= ========
Basic and diluted net
loss per share
attributable to holders
of common stock........ $ (4.09) $ (5.48) $ (3.67) $ (4.31)
======= ======== ======= ========
Basic and diluted
weighted average shares
outstanding............ 432 2,065 1,896 3,491
======= ======== ======= ========
Pro forma basic and
diluted net loss per
share.................. $ (1.43) $ (0.85)
======== ========
Pro forma basic and
diluted weighted
average shares
outstanding............ 7,330 16,163
======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31,
------------------------ October 1,
1996 1997 1998 1999
----- ------- -------- ----------
<S> <C> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents................ $ 15 $ 1,738 $ 2,090 $25,730
Working capital (deficit)................ (105) 1,542 (1,912) 19,867
Total assets............................. 42 1,998 6,145 33,758
Notes payable, less current portion...... 70 -- 84 52
Mandatorily redeemable convertible
preferred stock......................... -- 3,551 12,339 45,907
Total stockholders' deficit.............. (82) (1,847) (13,073) (24,553)
</TABLE>
26
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with "Selected Consolidated
Financial Data" and our financial statements and related notes included
elsewhere in this prospectus. In addition to historical information, the
discussion in this prospectus contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
anticipated by these forward-looking statements due to factors including, but
not limited to, those factors set forth under "Risk Factors" and elsewhere in
this prospectus.
Overview
We provide server appliances, which are computers that work with other
devices to deliver one or a few network-based applications well to network
users. Server appliances are a type of equipment known as network
infrastructure devices. Our products deliver network-based applications in a
flexible and reliable manner that is simpler and more cost-effective than
current solutions. From our inception in October 1996 to March 1998, our
operations consisted primarily of start-up and initial product development
activities, recruiting personnel and raising capital. In March 1998, we shipped
our first server appliance product, the Cobalt Qube. Since that time, we have
expanded our product family into several new markets with our Cobalt RaQ,
Cobalt Cache and Cobalt NAS product lines.
Since our inception in 1996, we have incurred substantial costs to develop
our technology and products, to recruit and train personnel for our
engineering, sales and marketing and technical support departments, and to
establish an administrative organization. As a result, we had an accumulated
deficit of $28.2 million as of October 1, 1999. We anticipate that our
operating expenses will increase substantially in the future as we increase our
sales and marketing operations, develop new channels, fund greater levels of
research and development, broaden our technical support and improve our
operational and financial systems. Accordingly, we will need to generate
significant revenues to achieve profitability. In addition, our limited
operating history makes it difficult for us to predict future operating results
and, accordingly, there can be no assurance that we will sustain revenue growth
or achieve profitability in future quarters.
We currently derive substantially all of our net revenues from sales of a
limited number of products. During 1998 and the nine months ended October 1,
1999, respectively, 83% and 84% of our net revenues were derived from sales of
our Cobalt Qube and Cobalt RaQ products. Although we began selling our Cobalt
Cache products in 1998 and Cobalt NAS products during the nine months ended
October 1, 1999, we expect that a substantial majority of our revenues in 1999
will continue to be generated from sales of our Cobalt Qube and Cobalt RaQ
products.
We sell our products directly through our sales force and indirectly through
channel partners that include distributors, resellers and system integrators.
Indirect sales are a majority of our total sales and account for substantially
all of our sales outside of the United States. In 1998 and the nine months
ended October 1, 1999, respectively, 46% and 15% of our net revenues were from
direct sales. The decrease in direct sales as a percentage of net revenues
reflected the more rapid growth of sales through channel partners relative to
the growth of direct sales. However, the absolute dollar amount of direct sales
rose from $1.6 million in 1998 to $2.0 million in the nine months ended October
1, 1999.
Indirect sales were 54% of our net revenues in 1998 and 85% of our net
revenues in the nine months ended October 1, 1999. In 1998, approximately 12%
of our net revenues came from sales to one of our distributors, Nissho
Electronics. For the nine months ended October 1, 1999, sales to two
27
<PAGE>
of our distributors, Nissho Electronics and Tech Data, accounted for 16% and
12% of our net revenues, respectively. While we are seeking to diversify our
customer base and expand the portion of our net revenues which is derived from
sales through various channels, we anticipate that our operating results will
continue to depend on volume sales to a relatively small number of channel
partners.
For direct sales and sales to resellers and system integrators, we record
revenues upon shipment. For sales to distributors, we recognize revenues upon
estimated sell through to the end users as our contracts generally provide the
distributor with limited rights of return. As a result, we defer recognition of
gross profit, captioned on our balance sheet as deferred margin, on inventory
held by distributors until we record the revenues and cost of revenues on a
sell through basis. Revenues from service obligations are deferred and
recognized on a straight line basis over the contractual period.
We provide allowances for estimated sales returns and warranty costs at the
time of revenue recognition based on our historical results. To date, our
actual sales returns and warranty expenditures have each been less than 5% of
net revenues in any quarter. However, our past product return and warranty
experience may not be indicative of future product return rates and warranty
costs.
Although we enter into general sales contracts with our channel partners,
none of our channel partners is obligated to purchase any amount of our
products pursuant to these contracts. We rely on our channel partners to submit
purchase orders for specific quantities of our products.
Our gross profit is affected by:
. fluctuations in demand for our products;
. the mix of products sold;
. the mix of sales channels through which our products are sold;
. the mix of sales within and outside North America;
. the timing and size of customer orders;
. new product introductions by us and our competitors;
. changes in our pricing policies;
. changes in component costs; and
. the volume manufacturing prices we are able to obtain from our contract
manufacturers.
We recorded unearned stock compensation on our balance sheet of $8.9 million
in connection with stock option grants to our employees that were granted
between July 1, 1998 and October 1, 1999. We will amortize this stock
compensation over the vesting period of the related options. During the nine
months ended October 1, 1999, we amortized $1.2 million of stock compensation.
During the remainder of 1999 and in 2000, we expect to amortize stock
compensation of:
<TABLE>
<CAPTION>
Fiscal Quarter Expected Amortization of
Ending Stock Compensation
-------------- ------------------------
(in thousands)
<S> <C>
December 31, 1999..................................... $1,244
March 31, 2000........................................ 1,232
June 30, 2000......................................... 1,211
September 29, 2000.................................... 865
December 29, 2000..................................... 626
</TABLE>
28
<PAGE>
We then expect aggregate per quarter stock compensation amortization of
between $531,000 and $318,000 during 2001, between $262,000 and $116,000 during
2002 and between $78,000 and $10,000 during 2003. The amount of stock
compensation expense to be recorded in future periods could decrease if options
for which accrued but unvested compensation has been recorded are forfeited.
As of October 1, 1999, we had approximately $18 million of federal and $14
million of state net operating loss carryforwards for tax reporting purposes
available to offset future taxable income. These net operating loss
carryforwards expire beginning in 2011 and 2004, respectively. We have not
recognized any benefit from the future use of loss carryforwards for these
periods or for any other period since inception because of uncertainty
surrounding their realization. The amount of net operating losses that we can
utilize may be limited under tax regulations in circumstances including a
cumulative stock ownership change of more than 50% over a three year period. It
is possible that such a change may have already occurred or could occur as a
result of this offering.
Our net loss attributable to holders of common stock includes accretion
charges to increase over time the carrying amount of our mandatorily redeemable
convertible preferred stock to the amount we would be required to pay if the
preferred stock were to be redeemed. As of April 26, 1999, we stopped recording
these charges because we changed the terms of the preferred stock to limit the
redemption amount to its original issue price plus accrued dividends.
We had 127 employees as of October 1, 1999, a substantial increase from 68 as
of December 31, 1998 and 14 as of December 31, 1997. This rapid growth has
placed significant demands on our management and operational resources. In
order to manage our growth effectively, we must implement and improve our
operational systems, procedures and controls on a timely basis.
. our total revenues do not increase relative to our operating
expenses;
. our management systems do not expand to meet increasing demands;
. we fail to attract, assimilate and retain qualified personnel, or
. our management otherwise fails to manage our expansion effectively,
We could experience a decline in our revenues and operating results.
Until January 1, 1999, we operated on calendar fiscal quarters and a fiscal
year ending December 31. Beginning in 1999, we operate on thirteen week fiscal
quarters ending on a Friday. Therefore, in 1999 our fiscal quarters end on
April 2, July 2, October 1 and December 31. Fiscal 2000 will end on December
29, 2000.
Results of Operations
Nine Months Ended September 30, 1998 and October 1, 1999
Net Revenues
We began volume shipments of our Cobalt Qube product line in March 1998. Net
revenues increased from $1.5 million for the nine months ended September 30,
1998 to $13.8 million in the nine months ended October 1, 1999. Of the increase
in net revenues, 33% was the result of increased sales to new and existing
customers of our Cobalt Qube product line and 51% to the September 1998
introduction of the Cobalt RaQ. The remaining increase was due to the
introduction of our Cobalt Cache product line and Cobalt NAS product line in
July 1998 and April 1999, respectively, and an expansion of our sales through
our channel partners.
Net revenues from sales outside the United States increased from $630,000 in
the nine months ended September 30, 1998 to $7.8 million in the nine months
ended October 1, 1999. The increase
29
<PAGE>
in absolute dollars was due to expansion of our operations in Japan, Europe and
other countries. One factor relating to the increase in net revenues in the
Japanese market was our introduction of a Japanese language user interface in
May 1998. Our net revenues from sales outside the United States were primarily
denominated in U.S. dollars. The effect of foreign exchange fluctuations did
not have a significant impact on our results.
Cost of Revenues and Gross Profit
Cost of revenues includes technology license fees, manufacturing costs,
manufacturing personnel expenses, packaging and shipping costs and warranty
expenses. We have outsourced our manufacturing and repair operations.
Accordingly, for the nine months ended September 30, 1998 approximately 62% and
for the nine months ended October 1, 1999 approximately 80% of our cost of
revenues consists of payments to our contract manufacturers. Cost of revenues
increased from $1.4 million in the nine months ended September 30, 1998 to $9.0
million in the nine months ended October 1, 1999. The increase in cost of
revenues was primarily due to increased sales volume and the introduction of
new products. We believe that our cost of revenues will increase in absolute
dollars in future periods but will continue to fluctuate as a percentage of net
revenues.
Gross profit increased from $123,000 in the nine months ended September 30,
1998 to $4.8 million in the nine months ended October 1, 1999. Gross profit as
a percentage of net revenues increased from 8.1% in the nine months ended
September 30, 1998 to 34.8% in the nine months ended October 1, 1999. The
increase in gross profit was primarily due to increased sales volume and the
introduction of new products. We believe that the rate of growth of the
increase in gross profit will not be sustainable in future quarters.
Research and Development Expenses
Research and development expenses consist primarily of salaries and related
expenses for personnel engaged in research and development, fees paid to
consultants and outside service providers, material costs for prototype and
test units and other expenses related to the design, development, testing and
enhancements of our products. We expense all of our research and development
costs as they are incurred. Research and development expenses increased from
$2.4 million in the nine months ended September 30, 1998 to $4.3 million in the
nine months ended October 1, 1999. Of this increase, 62% was due to the hiring
of additional research and development personnel, 17% was due to consulting
costs and 14% was due to materials used in research and development. As net
revenues have increased, research and development expenses have declined as a
percentage of net revenues from 157% in the nine months ended September 30,
1998 to 31% in the nine months ended October 1, 1999. We believe that a
significant level of investment in product research and development is required
to remain competitive. Accordingly, we expect to continue to devote substantial
resources to product research and development such that research and
development expenses will increase in absolute dollars but will continue to
fluctuate as a percentage of net revenues.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of salaries, commissions and
related expenses for personnel engaged in marketing, sales and customer support
functions, as well as costs associated with trade shows, promotional
activities, advertising and public relations. Sales and marketing expenses
increased from $3.3 million in the nine months ended September 30, 1998 to
$10.2 million in the nine months ended October 1, 1999. Of the increase in
sales and marketing expenses, 40% was due to the expansion of our international
sales and marketing efforts, particularly with respect to our branding
campaign, advertising and tradeshows and 25% was due to the hiring of
additional sales and marketing personnel in the United States. As net revenues
have increased,
30
<PAGE>
these expenses have declined as a percentage of net revenues from 221% in the
nine months ended September 30, 1998 to 74% in the nine months ended October 1,
1999. We intend to expand our sales and marketing operations and efforts
substantially, both domestically and internationally, in order to increase
market awareness and to generate sales of our products. Accordingly, we expect
our sales and marketing expenses to increase in absolute dollars but continue
to fluctuate as a percentage of net revenues.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries and related
expenses for executive, finance, accounting, information technology, facilities
and human resources personnel, recruiting expenses, professional fees and costs
associated with expanding our information systems. General and administrative
expenses increased from $1.1 million in the nine months ended September 30,
1998 to $2.6 million in the nine months ended October 1, 1999. Of the increase,
64% was due to the hiring of additional administrative personnel, and 27% was
due to increased facilities costs. As net revenues have increased, these
expenses have declined as a percentage of net revenues from 71% in the nine
months ended September 30, 1998 to 19% in the nine months ended October 1,
1999. We expect these expenses to increase in absolute dollars but continue to
fluctuate as a percentage of net revenues as we add personnel and incur
additional costs related to the growth of our business, expansion of our
information infrastructure and our operation as a public company.
Amortization of Stock Compensation
In connection with the grant of stock options to employees for the period
from July 1, 1998 to October 1, 1999, we recorded unearned stock compensation
within stockholders' equity of approximately $8.9 million, representing the
difference between the estimated fair value of the common stock for accounting
purposes and the option exercise price of these options at the date of grant.
We recorded no stock compensation amortization in the nine months ended
September 30, 1998. We recorded amortization of stock compensation of $1.5
million during the nine months ended October 1, 1999. The amount of stock
compensation expense to be recorded in future periods could decrease if options
for which accrued but unvested compensation has been recorded are forfeited.
Interest Income (Expense), Net
Interest income (expense), net includes income from our cash investments net
of expenses related to our debt and lease financing obligations. We had net
interest income of $45,000 in the nine months ended September 30, 1998 and
$174,000 net interest income in the nine months ended October 1, 1999. The
change from the nine months ended September 30, 1998 was primarily due to an
increase in interest income earned on proceeds from issuances of our preferred
stock and was partially offset by increased interest charges on debt and
capital lease obligations.
October 18, 1996 (inception) to December 31, 1996 and Years Ended December 31,
1997 and 1998
Net Revenues
We had net revenues of $3.5 million in 1998, principally related to sales of
the Cobalt Qube and Cobalt RaQ. We had no net revenues in either 1996 or 1997.
Net revenues from sales outside of the United States were approximately 44% of
net revenues in 1998, primarily in Japan and Europe, which accounted for 21%
and 15% of our net revenues in 1998, respectively.
Cost of Revenues
Cost of revenues was $3.1 million in 1998. There was no cost of revenues in
1996 or 1997.
31
<PAGE>
Research and Development
Research and development expenses increased from $22,000 in 1996 to $1.1
million in 1997 and to $3.5 million in 1998 of the increase in research and
development expenses, 83% was due to expanded technology development efforts
related to our new products, user interfaces, Linux operating system
customization and application software.
Sales and Marketing
We had no sales and marketing expenses in 1996. Sales and marketing expenses
increased from $245,000 in 1997 to $5.6 million in 1998. Of the increase in
sales and marketing expenses during 1998, 38% was due to the addition of new
sales, marketing and customer support personnel and 52% was due to product
launches, sales channel growth and our expansion of our global selling efforts,
which emphasizes the support of sales and service through distributors and
resellers.
General and Administrative
General and administrative expenses increased from $60,000 in 1996 to
$445,000 in 1997 and to $1.9 million in 1998. Of the increase in general and
administrative expenses in each period, 48% was due to the hiring of additional
personnel and 20% was related to expansion of our facilities to support the
growth of our business.
Interest Income (Expense), Net
We had no interest income (expense), net in 1996. We had net interest expense
of $12,000 in 1997 and net interest income of $67,000 in 1998. The net change
from 1997 to 1998 was due to interest income on the increased average cash and
cash equivalents balances as a result of our issuances of capital stock.
32
<PAGE>
Quarterly Results of Operations
The following table presents our consolidated operating results for each of
the seven quarters in the period from January 1, 1998 through October 1, 1999.
The information for each of these quarters is unaudited and has been prepared
on the same basis as our audited consolidated financial statements appearing
elsewhere in this prospectus. In the opinion of management, all necessary
adjustments, consisting only of normal recurring adjustments, have been
included to present fairly the unaudited quarterly results when read in
conjunction with our audited consolidated financial statements and related
notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
Quarter Ended
-------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Apr. 2, July 2, Oct. 1,
1998 1998 1998 1998 1999 1999 1999
-------- -------- --------- -------- -------- ------- -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statement
of Operations Data:
Net revenues............ $ 70 $ 379 $ 1,064 $ 2,024 $ 2,634 $ 5,029 $ 6,186
Cost of revenues........ 155 427 808 1,733 2,002 3,154 3,873
-------- -------- -------- -------- -------- ------- -------
Gross profit (loss).. (85) (48) 256 291 632 1,875 2,313
-------- -------- -------- -------- -------- ------- -------
Operating expenses:
Research and
development........... 528 855 990 1,110 1,397 1,374 1,566
Sales and marketing.... 590 1,050 1,709 2,232 2,753 3,520 3,973
General and
administrative........ 242 351 487 815 621 833 1,170
Amortization of stock
compensation.......... -- -- -- -- 140 113 1,256
-------- -------- -------- -------- -------- ------- -------
Total operating
expenses............ 1,360 2,256 3,186 4,157 4,911 5,840 7,965
-------- -------- -------- -------- -------- ------- -------
Loss from operations.... (1,445) (2,304) (2,930) (3,866) (4,279) (3,965) (5,652)
Interest income
(expense), net......... 7 (10) 48 22 (128) 128 174
-------- -------- -------- -------- -------- ------- -------
Net loss................ $ (1,438) $ (2,314) $ (2,882) $ (3,844) $ (4,407) $(3,837) $(5,478)
======== ======== ======== ======== ======== ======= =======
As a Percentage of Net
Revenues:
Net revenues............ 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Cost of revenues........ 221.4 112.7 75.9 85.6 76.0 62.7 62.6
-------- -------- -------- -------- -------- ------- -------
Gross profit (loss).. (121.4) (12.7) 24.1 14.4 24.0 37.3 37.4
-------- -------- -------- -------- -------- ------- -------
Operating expenses:
Research and
development........... 754.3 225.6 93.0 54.8 53.0 27.3 25.3
Sales and marketing.... 842.9 277.0 160.6 110.3 104.5 70.0 64.2
General and
administrative........ 345.7 92.6 45.8 40.3 23.6 16.6 18.9
Amortization of stock
compensation.......... -- -- -- -- 5.3 2.2 20.3
-------- -------- -------- -------- -------- ------- -------
Total operating
expenses............ 1,942.9 595.2 299.4 205.4 186.4 116.1 128.7
-------- -------- -------- -------- -------- ------- -------
Loss from operations.... (2,064.3) (607.9) (275.3) (191.0) (162.4) (78.8) (91.3)
Interest income
(expense), net......... 10.0 (2.6) 4.5 1.1 (4.9) 2.5 2.8
-------- -------- -------- -------- -------- ------- -------
Net loss................ (2,054.3)% (610.5)% (270.8)% (189.9)% (167.3)% (76.3)% (88.5)%
======== ======== ======== ======== ======== ======= =======
</TABLE>
Net revenues increased in each of the seven quarters from January 1, 1998
through October 1, 1999. These quarterly increases were primarily due to the
introduction of our Cobalt RaQ and to a lesser extent, our Cobalt Cache and
Cobalt NAS products, increased sales of our Cobalt Qube products, and the
addition of new channel partners and web hosting and application service
provider customers.
Cost of revenues increased in each of the seven quarters from January 1, 1998
through October 1, 1999 as a result of increased unit sales. Gross profit
generally increased in each of the seven quarters from January 1, 1998 through
October 1, 1999 due to increases in the volume of sales and the realization of
associated economies of scale as well as the introduction of the higher margin
Cobalt RaQ products.
33
<PAGE>
Research and development expenses increased in each of the five quarters from
January 1, 1998 to April 2, 1999 and the quarter ended October 1, 1999,
primarily due to the addition of personnel and costs incurred for the
development of new products. For the quarter ended July 2, 1999, research and
development expenses decreased relative to the prior quarter as a result of
relatively high contract research and development expenses in the prior
quarter.
Sales and marketing expenses increased in each of the seven quarters from
January 1, 1998 to October 1, 1999 due to the hiring of additional sales
personnel, higher commission expense resulting from increased unit sales,
marketing programs, tradeshows and customer support.
General and administrative expenses generally increased for each of the five
quarters from January 1, 1998 to April 2, 1999 and the quarter ended October 1,
1999. For the quarter ended April 2, 1999, general and administrative expenses
decreased relative to the prior quarter as a result of moving costs we incurred
in connection with our move to a new corporate headquarters facility in
Mountain View, California during the prior quarter.
As a result of our limited operating history, we cannot forecast operating
expenses based on historical results. Accordingly, we base our expenses in part
on future revenue projections. Most of our expenses are fixed in nature, and we
may not be able to quickly reduce spending if revenues are lower than we have
projected. Our ability to forecast our quarterly sales accurately is limited,
which makes it difficult to predict the quarterly revenues that we will
recognize. We expect that our business, operating results and financial
condition would be harmed if revenues did not meet projections.
We expect that our revenues and operating results may vary significantly from
quarter to quarter, and we anticipate that our expenses will increase
substantially for at least the next two fiscal years as we:
. increase our sales and marketing activities, including expanding our
North American and international direct sales forces;
. expand our indirect channels;
. develop our technology, expand our product lines and create and market
new products; and
. pursue strategic relationships and acquisitions.
Accordingly, we believe that quarter to quarter comparisons of our operating
results are not necessarily meaningful. Investors should not rely on the
results of one quarter as an indication of future performance.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through private
sales of mandatorily redeemable convertible preferred stock, the issuance of
convertible notes, equipment financings and net revenues generated from product
sales. As of October 1, 1999, we had cash and cash equivalents of $25.7
million, an accumulated deficit of $28.2 million and working capital of $19.9
million.
Our operating activities used cash of $1.6 million in 1997, $7.5 million in
1998, and $8.4 million during the nine months ended October 1, 1999. Cash used
in operating activities for 1997 and 1998 was primarily attributable to net
losses of $1.8 million and $10.5 million, respectively. In 1998, cash used in
operating activities was also attributable to increases in accounts receivable
and inventories of $2.0 million and $500,000, respectively, offset in part by
increases in accounts payable of $4.0 million and accrued expenses of $1.1
million. Cash used in operating activities during the nine months ended October
1, 1999 was attributable to a net loss of $13.7 million and increases in
accounts receivable of $3.2 million and inventory of $124,000 but was offset in
part by increases in
34
<PAGE>
accounts payable of $3.7 million, accrued expenses of $2.1 million and deferred
margin of $567,000, as well as depreciation, amortization of stock compensation
and other non-cash expenses.
Our investing activities used cash of $157,000 in 1997, $1.4 million in 1998
and $1.4 million in the nine months ended October 1, 1999. Our investing
activities primarily reflect purchases of computer equipment and other fixed
assets.
Our financing activities provided cash of $3.5 million in 1997, $9.3 million
in 1998 and $33.4 million in the nine months ended October 1, 1999. The
increases in each period resulted primarily from the net proceeds from the
issuances of mandatorily redeemable convertible preferred stock and convertible
promissory notes, borrowings under bank lines of credit and advances from a
related party.
From inception, we have made capital expenditures of $2.5 million to support
our research and development, sales and marketing and administrative
activities. We expect to have capital expenditures of approximately $2.0
million for the remainder of 1999 and 2000. We also anticipate that our capital
expenditures will increase over the next several years as we expand our
facilities and acquire equipment to support expansion of our sales and
marketing and research and development activities.
In September 1998, we entered into an equipment lease financing agreement
with a leasing corporation. This agreement provides for borrowings of up to
$1.0 million at an interest rate of 10.95% per annum, and those advances are
secured by our equipment, machinery and fixtures. We are required to repay
advances under the line in 34 equal installments. As of December 31, 1998 and
October 1, 1999, respectively, we had outstanding borrowings of $123,000 and
$95,000 under this lease line.
We intend to continue to invest heavily in the development of new products
and enhancements to our existing products. Our future liquidity and capital
requirements will depend upon numerous factors, including:
. the costs and timing of expansion of sales and marketing activities;
. the costs and timing of expansion of product development efforts and the
success of these development efforts;
. the extent to which our existing and new products gain market
acceptance;
. the level and timing of license revenues;
. the costs involved in maintaining and enforcing intellectual property
rights;
. market developments;
. available borrowings under line of credit arrangements; and
. other factors.
We believe that the proceeds from this offering, together with our current
cash and investment balances and any cash generated from operations and from
current or future debt financing, will be sufficient to meet our operating and
capital requirements for at least the next 12 months. However, it is possible
that we may require additional financing within this period. We have no current
plans, and we are not currently negotiating, to obtain additional financing
following the completion of this offering. The factors described above will
affect our future capital requirements and the adequacy of our available funds.
In addition, even if we raise sufficient funds to meet our anticipated cash
needs during the next 12 months, we may need to raise additional funds beyond
this time. We may be required to raise those funds through public or private
financings, strategic relationships or other
35
<PAGE>
arrangements. We cannot assure you that such funding, if needed, will be
available on terms attractive to us, or at all. Furthermore, any additional
equity financing may be dilutive to stockholders, and debt financing, if
available, may involve restrictive covenants. If we fail to raise capital when
needed, our failure could have a negative impact on our ability to pursue our
business strategy and achieve and maintain profitability.
Recent Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. We will be subject to
SFAS No. 133 commencing in 2001. We have not yet determined what the impact of
SFAS No. 133 will be on our financial position or results of operations.
Year 2000 Readiness
The Year 2000 Issue
The year 2000 issue refers to the potential for disruption to business
activities caused by system failures or miscalculations which are triggered by
advancement of date records past the year 1999. For example, if software that
uses the calendar year in computations is not ready for the millennial calendar
change, it may interpret a 21st century date as a 20th century date (for
example, mistaking 2001 for 1901).
Readiness of Our Products
We have designed our products to be ready for the year 2000 calendar change.
We represent to our customers that each software and hardware product supplied
by us will accurately process date data from, into and between the 20th and
21st centuries and the years 1999 and 2000, including leap year calculations,
when used in accordance with the product documentation provided by us. We also
represent to our customers that upon notification of any year 2000 problems
with our products, we will remedy it by product repair or replacement.
We do not represent to our customers that the networks to which our products
are connected will not have problems with year 2000 issues, since these
networks incorporate hardware and software products supplied by other
companies. We cannot evaluate the readiness of our products for year 2000 with
the innumerable combinations possible with other companies' products because
that project is not logistically feasible for a company of our size and
resources. We have not contacted any vendors other than those that have advised
us that their software applications are designed and are being marketed to run
on our server appliances to determine if their products are year 2000
compliant. We may, therefore, face claims or complaints based on year 2000
problems related to our customers' networks, even if we are not the cause of
their problems. We are not aware of any such claims or complaints about us, but
we may incur the cost of legal or other defense and explanation of our product
regardless of the merits of such claims.
Readiness of Our Systems and Facilities
Our business may be affected by year 2000 issues. We have completed our
systems updates, upgrades and replacements of non-ready systems. Systems
include internal hardware and software as well as external services provided by
other companies, including contract manufacturing, product development,
information processing and facility services. We are not currently aware of any
unresolved year 2000 problems relating to any of our internal systems. We do
not believe that we have any significant systems that are not year 2000
compliant. The majority of our software,
36
<PAGE>
hardware and operating systems have been acquired as new product in the last
two years. Most of it is shrink wrapped product and is still maintained by
existing vendors. We do not believe that we have any significant systems that
contain embedded chips that are not year 2000 compliant. Most of our hardware
is made of branded components and has been acquired in the last two years from
manufacturers which are still in business. We are not using legacy hardware or
software that would be more likely to have calendar issues because of its age.
We have contacted our material sales channel partners and manufacturing
contractors to determine whether their systems are year 2000 compliant. We have
no contractual right to receive year 2000 compliance information from our sales
channel partners and to date, only 19% of those we contacted have responded. Of
those that have responded, all have reported their internal systems are year
2000 compliant or will be by December 31, 1999.
Cost of Product and Internal Systems Preparation
Based on our assessment to date, we do not expect the total cost of year 2000
preparation and remediation to be material to our business. To date, our
preparation and remediation costs have not been material.
Year 2000 Risk
An internal or external business disruption caused by the year 2000 issue
could interrupt our operations and damage our relationships with our customers.
An internal disruption unique to us could give a comparative advantage to our
competitors. Failure of our internal systems and critical external services to
be ready for the year 2000 could delay order processing, issuing invoices or
development and shipment of products. The cost of recovery from failures could
be significant and result in lost revenues.
Our customers' purchasing plans could be affected by year 2000 issues if they
need to expend significant resources to fix their existing systems. This
situation could divert funds and resources otherwise available for new product
purchase. In addition, some customers may wait to purchase our products until
after the year 2000, which may reduce our revenues in the near future.
We are unable to determine at this time whether these or other year 2000
failures will occur and will have a material impact on our business, results of
operations or financial condition. We are also unable to determine the costs
and consequences to us of year 2000 failures we, our vendors, customers or
manufacturing contractors experience due to the scope and complexity of how
those failures may be manifest. This inability is particularly due to the
potential scope of the year 2000 problem on and the inability to assure the
readiness of external service providers, including utilities, government
entities and other vendors. We have not developed, and we have no current plans
to develop a contingency plan to deal with the effects of this worst case
scenario.
37
<PAGE>
BUSINESS
Overview
We provide server appliances, which are a new category of network
infrastructure devices that combine hardware and software to deliver one or a
few network-based applications well. Server appliances differ from general
purpose servers, which are designed to support a broad range of applications
and are not designed specifically to perform any particular function. Our
server appliances enable organizations that could not previously establish an
online presence to do so easily, cost-effectively and reliably. As the number
of internet users and businesses online increases, we believe the demand for
server appliances will continue to grow.
Our principal product lines, the Cobalt Qube and Cobalt RaQ, enable our
customers to perform critical internet-related applications including file
serving, web hosting and providing software applications over the internet,
such as electronic mail and electronic commerce. We also offer network-attached
storage products, which provide overflow file storage for network users, and
network caching products, which enable more efficient bandwidth usage and
improve speed of internet content delivery. Our products are designed to enable
Linux, an open source operating system for which the source code is available
at little or no cost, to work well with software applications and hardware
components delivered pre-configured in our products. These software
applications include applications for web-based communications developed by us
and by the open source software developer community, as well as proprietary
third party applications. Our use of the Linux operating system enables us to
leverage the rapid application development cycles of the open source software
community to reduce the time to market for our new and innovative products.
As of October 1, 1999, we had sold over 17,000 server appliances to more than
1,300 end user customers in more than 65 countries. We market and sell our
products globally through our direct sales force and our channel partners. Our
target customers are small- to medium-sized organizations, including
businesses, educational and government entities and branch offices of large
organizations. We also target web hosting and application service providers
that offer outsourced internet services to these end users.
Our objective is to become the leading global provider in the emerging market
for server appliances. We intend to increase market acceptance of server
appliances through a focus on providing solutions with a compelling value
proposition to targeted market segments. We intend to continue to encourage
open source and third party software application developers to create and
market software applications for our products through a comprehensive
partnership program. We expect to continue to base our products on industry
standard hardware components and the Linux operating system, so that we can
encourage our distributors, original equipment manufacturers and web hosting
and application service providers to sell our products by enabling them to add
value through modification of our solutions for specific customer needs. We
intend to establish Cobalt as the premier server appliance brand for our target
customers and third party application developers.
Industry Background
The emergence of the internet as the backbone of electronic commerce and
content delivery has created the opportunity for small- to medium-sized
organizations to significantly expand their market reach. The internet allows
these organizations to benefit from powerful information technology previously
beyond their economic and technical resources. In order to create an online
presence, these organizations can purchase and deploy their own network
infrastructure or rely upon outsourced infrastructure deployed by web hosting
and application service providers that offer services such as electronic mail
and electronic commerce.
Traditionally, creating an online presence required the deployment of general
purpose servers and complex network technologies. General purpose servers are
designed to perform a large variety
38
<PAGE>
of functions including providing database, electronic mail, network management,
file management and application services. However, the high cost of ownership
and the complexity of general purpose servers often discourage their adoption
by small- and medium-sized organizations,due to limited budgets and scarce and
costly technology skills. The high cost and complexity also create challenges
for web hosting and application service providers that seek to profitably
differentiate themselves in an intensely competitive and price sensitive market
by offering high value added services to small- to medium-sized organizations.
Server appliances have been developed to address the challenges faced by
small- to medium-sized organizations and web hosting and application service
providers in deploying their internet infrastructures. Because server
appliances are explicitly designed and customized to provide one or a few
dedicated applications, they can:
. be easy to install, use and administer;
. be easy to integrate with other infrastructure components;
. have a low acquisition price and low total cost of ownership; and
. deliver robust and scalable performance on an ongoing basis.
These benefits enable small- to medium-sized organizations to rapidly and
cost-effectively establish an online presence through the use of server
appliances. These benefits also enable larger organizations to easily
complement their existing general purpose servers by deploying application
specific server appliances and thereby reduce conflicting capacity demands on
their general purpose servers. In addition, these benefits allow web hosting
and application service providers to increase profitability by offering value
added services. In situations that may require the dedication of a single
server to a single customer to provide customized services, server appliances
enable these providers to avoid the high cost and complexity of a general
purpose server.
Server appliances can be developed either with proprietary or open source
operating systems, such as Linux. Proprietary operating systems are owned and
protected by a single vendor. A single vendor's limited engineering staff may
be the only developers with access to the source code needed to create other
software applications. As a result, the owner of the proprietary operating
system is the primary developer of new applications. Other developers may be
required to satisfy lengthy qualification procedures and pay license fees for
access to the elements of source code needed to create compatible applications.
These access limitations and fees result in slower development cycles and
higher end user costs of proprietary operating systems than can be achieved
using open source software. Open source software uses publicly available source
code that can be copied, modified and distributed by any software developer
with very few restrictions. Unlike proprietary, or closed, software products,
open source software is developed by a community of independent developers who
permit others to access their improvements and modifications freely. Open
source software, such as Apache web server, Perl and Sendmail, is gaining
increasing acceptance, particularly among web hosting and application service
providers. Open source software may provide the following benefits to server
appliances:
. Better application integration: because the source code is open, server
appliance vendors may have a better understanding of the interaction of
all system components, which allows them to more thoroughly coordinate
their applications with the operating system and improve system
stability.
. Lower cost base: open source operating systems and software are
available at no cost and therefore can be incorporated in a system
without the need for royalty payments or significant internal research
and development costs.
39
<PAGE>
. Shorter development cycles: the collaborative nature of the worldwide
developer base for open source software enables server appliance vendors
to improve their products more quickly than they can improve products
based on proprietary operating systems.
Dataquest, an industry research firm, expects the server appliance market to
grow from $2.2 billion in 1999 to approximately $15.8 billion in 2003,
representing a 64% compound annual growth rate. Dataquest also expects that
approximately $2.0 billion of this $15.8 billion market opportunity will be
revenue that server appliances will cannibalize from the market opportunity for
traditional servers. Dataquest believes that server appliances based on open
source operating systems, including Linux, will be a significant market
segment. Dataquest expects the Linux-based server appliance market to grow at
approximately 72% a year between 1999 and 2003 and represent approximately 24%
of the total server appliance market, or $3.8 billion, in 2003. The web hosting
and application service provider market represents an important part of the
overall server appliance market opportunity. Forrester Research estimates that
internet hosting revenues will increase from approximately $2.0 billion in 1999
to approximately $14.6 billion by 2003.
In response to the growth and opportunities in the server appliance market,
several server appliance vendors have emerged. However, many of the server
appliances available today do not deliver fully on the promise of the benefits
of server appliances. Some of these server appliances use closed, proprietary
architectures that restrict users' abilities to integrate them with other
applications and services. In order to achieve ease of use and low cost, others
offer systems that are not easily scalable or offer insufficient power to
adequately perform the functions for which they were designed. In addition,
server appliances offered by more established server vendors are typically
scaled down versions of their general purpose servers that fail to achieve an
optimal mix of low cost, ease of use, scalability, openness and performance.
Finally, some general purpose server vendors have long-standing relationships
with third party operating system and application vendors that may limit their
ability to aggressively pursue the opportunity for open source server
appliances.
The Cobalt Solution
We provide server appliances that deliver network-based applications in a
flexible and reliable manner that are simpler and more cost-effective than
other current solutions. Our server appliances include a tailored version of
the Red Hat Linux operating system that we have customized to more effectively
perform the particular applications for which our products are designed. Our
server appliances also include web-based communications applications which have
been developed by us and the open source software developer community and
industry-standard hardware components. We believe that we are well positioned
to become the leading provider of server appliance solutions for small- to
medium-sized organizations and web hosting and application service providers by
offering the following advantages:
Complete, integrated solutions
Our products provide our customers with complete solutions that do not
require additional hardware or software to cost-effectively deliver the
specific applications for which the product is designed. Our use of open source
software and industry standard hardware enables us to fully understand the
interaction of all components of the system and design an efficient and
reliable solution. In addition, our products provide significant advantages
over other servers based on open source operating systems that are not
customized to fully integrate the applications and operating system to perform
a specific function. The integrated design of our software applications,
operating system and hardware results in a more reliable and stable product
that is less likely to cause disruptions in network services. This integration
also enhances the security of our solutions and enables us to design the
hardware in a cost-effective manner.
40
<PAGE>
Ease of installation and use
Our products are pre-configured and include a simple set up procedure
designed to require less than 15 minutes for deployment by a non-technical
person. In addition, our products are easy to use, can be administered from any
internet-accessible location and require minimal space and power. Our web-based
user interface shields the user from technical complexities and minimizes the
need for trained information technology staff.
Low cost of ownership
We design our server appliances to deliver robust performance at an installed
cost that is 10% to 85% less than the published list prices of general purpose
servers equipped to perform the same functions. We can sell our products at
lower prices because our operating systems are based on royalty-free open
source software, and we avoid the use of unnecessary hardware components by
designing our products to perform a specific function. Our products require
limited skills and time to deploy and do not require a network shut-down to
install or add additional appliances. In addition, the software tools included
in our products minimize ongoing system management and support efforts that
would otherwise be provided by trained information technology staff, thus
greatly reducing the appliances' lifetime cost of ownership.
Building blocks for future growth
As the amount of data traffic handled by a Cobalt server appliance increases,
additional units can be added to increase capacity at little incremental
expense beyond the cost of the units themselves. The ability to easily add
additional server appliances provides an evolution path that allows customers
to develop their network services and its architecture according to their needs
without a high upfront investment. Our low cost server appliances are designed
to be building blocks for scalable solutions. We are developing a software tool
to enable our Cobalt RaQ products to interoperate in a fully scalable fashion.
We expect this software tool to be released in early 2000.
Stable, open source development environment
Our products use a version of the Red Hat Linux operating system, an open
source operating system that undergoes a continuous cycle of enhancement by a
global community of open source developers. We customize Red Hat Linux for our
server appliances by eliminating large portions of general purpose source code
that is unnecessary for a dedicated server appliance and tailoring the
remaining source code to work effectively with our dedicated hardware. Our open
source operating system is designed to work with our hardware components to
provide a reliable and stable environment upon which we and third party
developers can develop applications with a rapid time to market. In addition,
because our source code is royalty free and open, we believe our products will
attract a large community of third party application developers. We enjoy the
benefits of our customized operating system exclusively for a short period of
time, then publish our customizations for further enhancement by the open
source development community.
Cross platform compatibility
Our products employ an internet standards-based architecture that enables
them to function with other networked computers that operate on a variety of
operating systems, including Windows NT and UNIX. By being cross platform
compatible, our products enable our customers to realize the benefits of our
products as part of their existing network infrastructure.
The Cobalt Strategy
Our objective is to become the leading global provider in the emerging market
for flexible, low cost server appliance products. To accomplish our objective,
the key elements of our strategy include:
41
<PAGE>
Increase market acceptance of server appliances
We intend to increase market acceptance of server appliances through a focus
on providing solutions with a compelling value proposition to targeted markets.
We intend to continue to offer products that complement general purpose servers
by removing one or more specific, resource intensive functions from a network's
general purpose server to improve network performance and stability. Our
approach to increase market acceptance of server appliances is to:
. Add new applications. We intend to continue to deliver high value
results with application specific products. Our current proprietary
applications include solutions for web hosting, electronic mail, web
publishing, electronic commerce, file management and network services.
We intend to leverage this experience to expand the scope of our
software applications to address other specific needs of our target
customers. In addition we will continue to integrate third-party
applications into our products.
. Simplify management. We intend to further enhance the ease of use and
reliability of our products. For example, we are working to develop a
management tool that enables outsourced hosting and application service
providers to manage, troubleshoot and monitor a number of server
appliances from a single console.
. Add new hardware designs. We intend to continue to develop hardware
designs that address our customers' specific needs. We expect to
continue to rapidly introduce innovative, new products with enhanced
functionality that incorporates customer feedback and demands.
. Continue to offer low prices. We expect to continue to offer our server
applications at low cost by using readily available standard hardware
components and leveraging a royalty-free Linux-based operating system.
We believe our use of an open source operating system will provide our
products with an advantage relative to server appliances based on
proprietary operating systems, where substantial license fees are a cost
passed through to the consumer.
. Enable partners to add value. We intend to continue to design our
products with our open source operating system and application
interfaces to allow channel partners to add value through software
applications that they sell with our products. This design strategy will
also enable web hosting and application service providers to provide
value added services.
Attract and support application developers
Ensuring the existence of a complete set of software applications is a vital
requirement for offering integrated solutions and driving the success of our
server appliances. We intend to actively promote third-party development of
software applications for our products through a comprehensive partnership
program with independent, open source software developers. We believe that our
use of the Linux operating system is a fundamental element of this program,
since an open source operating system better enables developers to create
optimized and reliable high value added applications. On the basis of our
business development and engineering contacts with third party developers, we
believe there are currently over 50 applications developed by third parties for
our product platform. We intend to leverage our position in the Linux community
in order to expand upon the base of third party developers for our products
significantly by providing a high volume channel for their internet and
electronic commerce applications. In order to encourage the continued growth of
the Linux community, we will continue to give back to the community those
elements of source code that we write that are relevant to the Linux kernel,
while still developing a proprietary base of intellectual property.
42
<PAGE>
Develop and leverage partnerships to enhance our market reach
We base our products on industry standard hardware components and our open
source operating system to encourage channel partners, original equipment
manufacturers and web hosting and application service providers to add value by
modifying our solutions to address specific needs of our customers. Our
leveraged distribution strategy includes:
. Multi-tier sales channel. We believe that a highly leveraged sales
channel is critical for effectively penetrating our target markets. We
make it attractive for our distribution, reseller and system integrator
partners to resell our solutions by maximizing the opportunity for them
to add value to our products. In order to effectively reach small- to
medium-sized businesses, we intend to continue to enter into agreements
with many of the world's leading distributors, resellers and system
integrators. We also intend to continue to expand our sales channel
globally, while strengthening our direct sales efforts in key
geographies where use of the internet is growing most rapidly.
. Web hosting and application service providers. We intend to promote the
sale of our products by leveraging our relationships with outsourced,
dedicated web hosting and application service providers. We believe our
highly-focused approach to serving this market provides us with an
advantage over competitors. Through our direct sales model we have
developed relationships with many of the prominent web hosting and
application service providers that are competing effectively by offering
higher revenue, value added application and hosting services. We expect
to leverage our leadership in this market by assisting our customers to
market to their customers.
. Original equipment manufacturer partnerships. We also intend to enter
into original equipment manufacturer partnerships. Our growing presence
in the server appliance market makes us an appealing partner for general
purpose server vendors. For example, we entered into an agreement with
Gateway in September 1999 that will enable Gateway to deliver Linux-
based, affordable server appliances to its customers under Gateway's
brand name without expending its development resources outside of its
core business. We believe our relationship with Gateway will enable us
to reach a broader customer base. We intend to form other strategic
original equipment manufacturer partnerships for our products in order
to rapidly expand our market reach and become the technology provider of
choice for server appliances.
Establish a strong brand identity
We intend to establish Cobalt as the premier server appliance brand for our
target customers and third party application developers. We intend to continue
to create brand awareness with innovative, award winning products, progressive
product styling and creative marketing. We believe that this distinctive brand
identity is an important component of our efforts to increase market acceptance
of server appliances, expand participation in our software development program
and develop our reputation within a broad community of potential partners and
customers. We intend to actively seek new opportunities to refine and extend
our brand recognition.
Provide focused server appliances for specific needs
We intend to continue to develop and release products that meet specific
customer needs while continuing to perform specified tasks reliably at a low
price in comparison to both general purpose servers and other server
appliances. For example, our Cobalt Qube and Cobalt RaQ products are available
with a user interface in the Japanese language, and we are developing several
other language specific user interfaces. Our Cobalt RaQ products are designed
specifically to minimize space usage, because more effective use of rack space
in a service provider's facility can increase the number of customers that the
service provider can host from a single facility. Our target customers are
small-to medium-sized organizations, including small- to medium-sized
businesses, educational and governmental entities and branch offices of large
organizations. We also target the
43
<PAGE>
web hosting and application service providers that offer outsourced internet
services to these end users.
Products
All of our products are built on a common core software and hardware
architecture that enables us to develop and market new products rapidly. We
have introduced 18 products based on our four principal product lines in the
last 18 months. Our products are based on the Linux operating system, an
operating system known for its high reliability, performance, scalability,
customizability and low memory requirements. We have customized the Red Hat
Linux operating system to improve the performance and reliability of our
products. We have invested in the development of proprietary technology for our
products that includes core applications, software toolkits, management tools,
system maintenance daemons and clustering technologies.
We also have an application developer program through which we encourage
third-party software developers to create additional software applications for
our products. Examples of those applications are electronic commerce engines, a
medical imaging file server program and a cellular telephone voicemail server
program. We believe that end users will benefit from our open source model by
having many additional applications available to them. We provide the relevant
portions of our source code to third party software developers to assist them
in creating applications that are closely integrated with our products'
operating systems, applications and hardware. We provide other assistance to
application developers including telephone support, electronic mail bulletin
boards and a web site. We believe that there are currently more than 50
applications that have been developed by third parties for our products. We
believe that other third party applications for our products are currently in
development.
The following table reflects our product lines:
<TABLE>
<CAPTION>
Date of First Starting
Product Line Commercial Sale List Price Function
------------ --------------- ---------- --------
<C> <C> <C> <S>
Cobalt Qube March 1998 $ 999 Small- to medium-sized organizations
(1st generation) can use these products for
dedicated functions such as
January 1999 electronic mail, file servers and
(2nd generation) print servers or to provide
internet access and web serving. We
introduced a Japanese language user
interface in May 1998 and French
and German language user interfaces
in September 1999.
Cobalt RaQ September 1998 $1,299 Web hosting and application service
(1st generation) providers can use our Cobalt RaQ
products for dedicated hosting
March 1999 services. The compact design of the
(2nd generation) product is intended to facilitate
its use in standard size networking
facility racks. We introduced a
Japanese language user interface
for this product in December 1998.
Cobalt Cache July 1998 $1,899 Customers can use our Cobalt
(1st generation) CacheQube and CacheRaQ products to
provide faster web response time
April 1999 and eliminate redundant traffic
(2nd generation) travelling over wide area network
links. These products are targeted
at markets where bandwidth is at a
premium and public communications
networks are less developed.
Cobalt NAS April 1999 $1,799 Customers can use the Cobalt NASRaQ
to add storage to an existing
network. For users of the network,
the Cobalt NASRaQ appears to be
another hard drive.
</TABLE>
44
<PAGE>
Industry Recognition of Our Products
Our Cobalt Qube products have received recognition for their innovation and
quality, including the following industry awards:
. ""Editor's Choice "99", PC Expert Magazine, September 1999
. ""Best of Show", Showcase, January 1999
. ""Innovation of the Year", PC Computing, November 1998
. ""Most Valuable Product Award--Small Business Server Category", PC
Computing, November 1998
. ""Editor's Choice", PC Magazine, July 1998
. ""Best New System Hardware", VARVision industry show, Spring 1998
. ""Best of Show", VARVision industry show, Spring 1998
. ""Best New Hardware Product", Reseller XChange, March 1998
. ""Best of Show", Reseller XChange, March 1998
In addition, our other products have received industry awards including the
following:
. The Cobalt NASRaQ for "Editor's Choice "99", PC Magazine U.K., September
1999
. The Cobalt CacheRaQ for "Editor's Choice", Network Computing, May 1999
. The Cobalt CacheQube for "Best of Show for Infrastructure Hardware",
Internet World industry show, July 1998
Technology
We have invested in developing proprietary technology for our products that
includes our operating system, web-based communications applications, software
toolkits, management tools, system maintenance daemons and clustering
technologies.
Operating System
Our products are based on the Linux operating system, an operating system
known for its high reliability, performance, scalability, customizability and
low memory requirements. We recognize the many benefits that an open source
operating system, such as Linux, provides for the development of server
appliances. Linux is open source software that is constantly being improved by
a broad base of developers without requirements for royalty obligations to the
developers. We can customize existing Linux operating system applications or
adopt different versions of Linux without lengthy product transitions. We have
free access to the entire Linux source code and have modified Red Hat's version
of the Linux operating system to optimize it for use in our products.
Web-based Communications Applications
Our server appliances offer web-based communications applications such as web
serving, domain name serving, file transfer protocol, electronic mail,
discussion groups and web authoring. We provide integrated and optimized
royalty-free industry standard software such as Apache, a web serving software,
Perl, a scripting language for web site development, and Sendmail, an
electronic mail program. We also provide our internally developed software for
discussion groups and web page authoring as integrated features of our Cobalt
Qube and Cobalt RaQ products. We are investing significant resources in
deploying, testing and effectively integrating these diverse applications with
consistent, user friendly interfaces.
45
<PAGE>
Software Toolkit
We have developed and are continuing to enhance a proprietary software
toolkit that provides a consistent interface between the applications and the
operating system. Our software toolkit enables us to provide uniform browser-
based user interfaces across all server functions and applications. Our custom
software toolkit overcomes the complexity generally associated with setting up,
managing, monitoring and using various complex network daemons and
applications. We intend to continue to develop and improve interfaces to our
software to assist third parties such as web hosting and application service
providers and value added resellers to add software applications to our
platform.
System Maintenance Daemons
To improve reliability and reduce cost of ownership of our server appliances,
we have developed a set of software daemons, which are software programs that
continuously monitor the state of the various software and hardware functions
on the server to permit troubleshooting. Our system maintenance daemons
automatically inform the user of excessive server resource utilization and
recommend corrective action. Our system maintenance daemons also attempt to fix
any problems automatically that the software detects and proactively inform the
user if an attempted solution was unsuccessful. The proactive problem
resolution enhances the overall reliability of the server appliance while
reducing management overhead. Our products also support industry standards
including Simple Network Management Protocol.
Clustering Technologies
Our products incorporate our proprietary clustering technologies that
distribute network usage across a number of server appliances for improved
network performance. These technologies allow our server appliances to be
clustered without using expensive load balancing equipment. For example, these
technologies enable a user to deploy additional Cobalt CacheRaQ units as needed
to support increased network usage.
Management Tools
We have several management tools, such as our maintenance and restore
toolkit, that assist the user to perform maintenance and administrative tasks
on our server appliances. In addition, we are developing a web-based remote
management tool for monitoring the status and configurations of a large number
of our server appliances on a single network. In addition, this management
software will allow systems administrators to provide software upgrades to
multiple server appliances and configure multiple machines from a single
management console in an easy to use and cost effective manner.
Embedded Processor Hardware Platform
We enable our products to deliver high performance cost effectively through
our proprietary hardware and motherboards that leverage standard components
including hard disk drives, memory and processors. We have eliminated
unnecessary components, thus reducing cost and power consumption and increasing
reliability. With the compact size of our Cobalt RaQ products, our service
provider customers are able to achieve three to four times the server density
of general purpose servers, a key advantage in the web hosting and application
service provider market where rack space is at a premium.
Customers
As of October 1, 1999, we had sold over 17,000 of our server appliance
products to more than 1,300 end user customers in over 65 countries. Our direct
customers include regional and national web hosting and application service
providers in the United States, in addition to our channel
46
<PAGE>
partners. Our indirect customers are primarily composed of small- to medium-
sized organizations and web hosting and application service providers. With
respect to both our direct and indirect sales, customers often buy for a single
location, department or division, and then, based upon the initial success of
the products, later expand their use of our products into other parts of the
organization. In 1998 and the nine months ended October 1, 1999, no single end
user customer accounted for more than 10% of our revenues.
Sales and Marketing
We sell our products through our direct sales force and channel partners
including distributors, resellers and system integrators. Historically our
direct sales efforts have focused on regional and national web hosting and
application service providers in the United States. We intend to continue and
expand our sales efforts to web hosting and application service providers. We
also intend to pursue sales to the growing number of web hosting and
application service providers outside of the United States. We have relied on
original equipment manufacturers for only a limited number of sales, but we
intend to explore opportunities to work with additional original equipment
manufacturers in the future.
Direct Sales
The primary function of our direct sales force is to generate demand for our
products that is fulfilled either directly or through channel partners. As of
October 1, 1999, we had a direct sales organization of 19 persons. We encourage
our direct sales staff to work with potential web hosting and application
service provider customers regardless of whether the customer ultimately
purchases our product from us or one of our channel partners. We believe this
model enables us to encourage proliferation of our products in this key
customer group. Our direct sales force uses a team approach, which we believe
allows us to achieve better control of the sales process and respond more
rapidly to customer needs. Our direct sales force for North America is
distributed throughout the United States. In 1998 and the nine months ended
October 1, 1999, respectively, 46% and 15% of our net revenues were from direct
sales, substantially all of which was from the United States.
We opened sales offices in Japan, the United Kingdom and Germany in 1998.
During the nine months ended October 1, 1999, we established direct sales
activities in the Netherlands. Although 44% and 56% of our net revenues were
from outside the United States in 1998 and the nine months ended October 1,
1999, respectively, almost all of our direct revenues were from the United
States.
Channel Partners
As the server appliance market has matured, we have developed a multi-tier
sales channel that is comprised of distributors, resellers and system
integrators. We believe that as the market for server appliances matures, sales
through channel partners will represent an increasing percentage of our sales.
Sales to our channel partners represented 85% of our net revenues in the nine
months ended October 1, 1999. Channel partner sales in the United States and
outside the United States were approximately 30% and 55% of net revenues,
respectively, in the nine months ended October 1, 1999. Our top five channel
partners based on net revenues in the nine months ended October 1, 1999 were:
<TABLE>
<S> <C>
Ingram Micro Nissho Electronics (Japan)
Merisel Tech Data
Mitsui (Japan)
</TABLE>
47
<PAGE>
In addition to delivering our server appliances to small web hosting and
application service providers and small- to medium-sized organizations,
distributors enable us to more effectively pursue a number of vertical markets.
Vertical markets and applications such as branch offices of large
organizations, government, education and web-based direct resellers are targets
of our channel partners.
Original Equipment Manufacturer Relationships
We recently began to sell our products through original equipment
manufacturer relationships. As part of these relationships, we design and
manufacture products that are customized to meet the end users' needs and which
are branded and sold under that company's label. We have initiated several
original equipment manufacturer relationships for our Cobalt Qube products. We
plan to expand our selling efforts through original equipment manufacturer
relationships and are currently evaluating opportunities, particularly with
respect to sales of our Cobalt Qube products.
In September 1999, we entered into an agreement with Gateway, Inc. under
which we and Gateway will design jointly and Cobalt will manufacture Linux-
based server appliances for Gateway, subject to agreement on product
specifications, quantity and pricing. We will manufacture products from our
Cobalt Qube line modified with hardware and software enhancements developed by
Gateway that will be packaged and labeled as Gateway products. We have agreed
not to sell the customized products we provide to Gateway under this agreement
to any of Gateway's competitors. We will provide customer support for Gateway
for the jointly developed products that are sold under the Gateway brand. Our
agreement with Gateway has a five year term and is subject to automatic one
year renewals, but Gateway currently has no obligation to make any purchase
orders under the agreement.
Marketing Programs
To support our growing sales organization and channel, we have devoted
significant resources in the past year to building and launching a series of
marketing campaigns. Our marketing efforts have included a number of programs,
such as seminars, industry trade shows, mailings to resellers, analyst and
press tours, print and online advertising and public relations. We believe
these marketing programs have resulted in better awareness of our Cobalt brand.
In March 1999, we announced the launch of a two-tier distribution marketing
program. Our True Blue Partner and True Blue Sapphire Partner programs are for
web hosting and application service providers that resell a specified number of
Cobalt products. These web hosting and application service providers resell our
products for dedicated web hosting with our marketing support. We have similar
True Blue and True Blue Sapphire programs for value added resellers. In
addition to partner development activities, we also actively work on end user
education.
Customer Advocacy and Support
We believe that high quality customer service and support is critical to the
successful marketing and sale of our products. We are developing a
comprehensive service and support organization to manage customer accounts and
expect to provide an increasing level of support as our products are deployed
across a range of customers. We provide support for our products and services
primarily from our Mountain View, California location. We plan to establish
additional service and support sites internationally commensurate with customer
needs.
Our products are designed to be deployed quickly and effectively by our
customers and to require minimal support from us. We offer various levels of
service and support programs to meet pre- and post-sale technical requirements.
Our CobaltCare program offers extended warranties, advanced product
replacement, telephone and electronic mail trouble shooting assistance and
other
48
<PAGE>
support and services. We price our CobaltCare variably depending on the level
of support selected by the customer. We also offer a variety of services
specifically tailored for web hosting and application service providers and
resellers that provide immediate access to the latest support information,
white papers and answers to frequently asked questions.
Manufacturing
We use contract vendors to manufacture our products, and they perform tasks
that include material procurement, assembly, test, packaging, warehousing and
shipment. Utilizing a contract manufacturer enables us to reduce investment in
manufacturing capital and inventory warehousing costs. Our internal
manufacturing expertise is primarily focused on product testability,
manufacturability and the transfer of products from development to
manufacturing. However, we also manage the evaluation and selection of key
components.
In August 1999, we changed our contract manufacturer to SMTC Manufacturing.
We have also used Flash Electronics to a lesser extent on a periodic basis. Our
agreement with SMTC Manufacturing requires us to submit three months of rolling
purchase orders and rolling forecasts for the three months immediately
following the purchase order period. In any given month we have the ability to
double our forecast and require them to fill those orders. However, if we
inaccurately forecast demand for our products, SMTC Manufacturing may be unable
to provide us with adequate manufacturing capacity. Purchase prices will
fluctuate based on changes in component prices throughout the one year contract
period. However, SMTC Manufacturing is obligated to reduce component costs by a
fixed percentage in each quarter for those components we have previously
identified. We may be liable for materials that SMTC Manufacturing purchases on
our behalf that we cannot use, cannot be cancelled before receipt or are unique
parts otherwise unusable by SMTC Manufacturing. The agreement restricts our
ability to reschedule orders and allows us to cancel existing orders subject to
penalties of up to the total purchase price. SMTC Manufacturing provides
warranties on workmanship and pass-through warranties on component parts.
SMTC Manufacturing purchases most of the key components used to manufacture
our products. We obtain some of these key components, such as our custom
printed circuit boards, sheet metal parts and chassis, directly from sole
sources and other industry standard components, such as our processors and
power supplies, from sole or limited sources. SMTC Manufacturing may not be
able to obtain adequate supplies of components to meet our customers' delivery
requirements. Alternatively, excess inventories may be accumulated by SMTC
Manufacturing for our account.
In order to reduce the costs of sales, we anticipate that we may relocate a
portion of our manufacturing operations from SMTC Manufacturing's manufacturing
facility in Milpitas, California to one of its offshore manufacturing
facilities during 2000. Additionally, we may consider moving the outsourced
manufacturing to other new locations or to a new contract manufacturer. These
relocations could be time consuming and expensive and there can be no assurance
that such moves would not disrupt the manufacturing of our products. Such
disruptions could cause us to lose net revenues and damage our customer
relationships.
Prior to August 1999, our primary contract manufacturer was an electronics
component supply chain company that procured materials and subcontracted the
assembly, test, packaging and shipment of our products to a subcontract
manufacturer. This contract manufacturer experienced difficulty in obtaining
selected components and coordinating with the subcontract manufacturer for the
manufacture of our products in the quarter ended July 2, 1999. We resolved this
difficulty in the quarter ended July 2, 1999 by internally managing procurement
of some of our key components and qualifying and commencing production of our
products with a second manufacturing partner, Flash Electronics, in May 1999.
We subsequently switched to SMTC Manufacturing as our primary contract
manufacturer in August 1999.
49
<PAGE>
As our needs and the needs of our customers continue to evolve, we plan to
reassess our manufacturing requirements on a periodic basis and address changes
as we consider necessary.
Research and Development
Our research and development expenses were $1.1 million in 1997, $3.5 million
in 1998 and $4.3 million in the nine months ended October 1, 1999. We believe
that our research and development efforts are essential to our ability to
deliver innovative products that address the needs of the market and help
evolve the capabilities of server appliances. As of October 1, 1999, our staff
included personnel with expertise in several key areas, including 22 people
engaged in software-related activities, 10 people engaged in hardware-related
activities and 2 people involved in other research and development activities.
We recognize the need to integrate new and enhanced technologies into our
products and to continue to extend the open architecture of our products' Linux
operating system. In addition to the development of proprietary core
technologies, we plan to continue partnerships with other leading providers of
Linux technologies, products and services to jointly develop architectures and
industry standards.
Competition
We compete in markets that are new, intensely competitive, highly fragmented
and rapidly changing. We face competition primarily from server vendors that
provide solutions for distributed computing systems.
Companies offering competitive products vary in scope and breadth of products
and services offered and include:
. general purpose server manufacturers such as Compaq Computer,
Dell Computer, Hewlett-Packard Company, IBM, Sun Microsystems and VA
Linux, some of which, including Compaq, IBM and Sun Microsystems, have
recently begun manufacturing dedicated versions of their general purpose
server products for sale as server appliances;
. server appliance vendors such as Encanto Networks, Freegate, Intel and
Whistle Communications (recently acquired by IBM);
. network caching companies such as CacheFlow and Novell; and
. network attached storage vendors such as Meridian (recently acquired by
Quantum) and Network Appliance.
We believe we compete favorably on the principal factors that will draw end
users to a server appliance product, which include:
. depth of product functionality;
. ability to work with network components utilizing other operating
systems such as Windows NT;
. scalability;
. product quality and performance;
. open systems architecture;
. strength of channel;
. brand name recognition;
. competitive pricing; and
. customer support.
50
<PAGE>
We expect competition in the server appliance market to increase
significantly as new companies enter the market and current competitors expand
their product lines and services. Many of these potential competitors are
likely to enjoy substantial competitive advantages including:
. greater resources that can be devoted to the development, promotion and
sale of their products;
. more established sales channels;
. greater software development experience; and
. greater name recognition.
Intellectual Property
We have invested significantly in the development of proprietary technology
for our products. Key areas of intellectual property development relate to the
tight integration of embedded software with industry standard platforms and
components, intuitive user interfaces that provide easy to use appliance
functionality and clustering technology. Our success depends significantly upon
our proprietary technology. Additionally, we have integrated third party
intellectual property into our products. We may occasionally reach agreements
with third parties to provide additional functionality for our products and may
offer third parties our technology for integration into products on an original
equipment manufacturer or other basis. We have also trademarked the Cobalt name
as well as our individual product names in the United States and are evaluating
whether to register our trademarks in international markets where we currently
conduct or may in the future do business.
We currently rely on a combination of copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights. We protect our software, documentation and other written
materials under trade secret and copyright laws, which afford only limited
protection. We do not hold any patents and currently have no patent
applications pending. We cannot be certain that any patents we seek will be
issued or that, if issued, those patents will not be challenged. We have
registered and applied for registration of some of the service marks and
trademarks we use with the appropriate state agencies and the United States
Patent and Trademark Office. We will continue to analyze whether we should
register additional service marks and trademarks.
We generally enter into confidentiality agreements with our employees,
consultants, business partners and major customers. Despite our efforts to
protect our proprietary rights and other intellectual property, unauthorized
parties may attempt to copy aspects of our products, obtain and use information
that we regard as proprietary or misappropriate our copyrights, trademarks,
trade dress and similar proprietary rights. In addition, the laws of some
foreign countries do not protect proprietary rights to as great an extent as do
the laws of the United States. Our means of protecting our proprietary rights
may not be adequate. In addition, our competitors might independently develop
similar technology or duplicate our products or circumvent any patents or our
other intellectual property rights.
Cobalt, Cobalt Networks, the Cobalt logo, Cobalt Qube, Cobalt RaQ, Cobalt
NASRaQ, Cobalt CacheRaQ and RaQ are trademarks of our company. This prospectus
also contains brand names, trademarks or service marks of companies other than
Cobalt, and these brand names, trademarks and service marks are the property of
their respective holders.
Employees
As of October 1, 1999, we had 127 full time employees, of whom 34 were
engaged in research and development, 65 in sales and marketing and 28 in
finance, administration and
51
<PAGE>
operations. None of our employees is represented by a labor union. We have not
experienced any work stoppages and consider our relations with our employees to
be good.
Facilities
Our principal offices are located in a 28,000 square foot facility in
Mountain View, California. Our lease on the Mountain View facility expires in
December 2003. We expect that we will need additional space in the next twelve
months and have obtained an option to lease a 30,000 square foot facility
contiguous to our current facility to expand our Mountain View operations. We
also have sales and marketing offices in Germany, Japan, the Netherlands and
the United Kingdom. None of the leases for those offices is for a period of a
year or longer.
Legal Proceedings
In December 1998, CUBE Computer Corporation sued us in the United States
District Court for the Southern District of New York for trademark
infringement. CUBE, an original equipment manufacturer of personal computers,
argues that this alleged infringement resulted from our use of "Qube" in
connection with our products. CUBE has not claimed any specific monetary
damages in its complaint. We intend to defend this matter vigorously. The
parties are currently conducting depositions. We believe, based on information
regarding our industry, CUBE's industry, other litigation over similar
allegations and the facts we have reviewed to date, that the resolution of this
matter will not adversely affect us.
52
<PAGE>
MANAGEMENT
Executive Officers and Directors
Cobalt's officers and directors and their ages as of October 1, 1999 are as
follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<C> <C> <S>
Gordon A. Campbell......... 55 Chairman of the Board
Chief Executive Officer, President and
Stephen W. DeWitt.......... 33 Director
Chief Technology Officer and Vice President,
Vivek Mehra................ 35 Products
Gary A. Martell............ 36 Chief Operating Officer
Vice President, Finance, Chief Financial
Kenton D. Chow............. 35 Officer and Secretary
Vice President, Sales, Americas and Asia
Patrick J. Conte........... 41 Pacific
Mark H. Orr................ 49 Vice President, Business Development
George M. Korchinsky....... 58 Vice President, International Sales
Kelly M. Herrell........... 33 Vice President, Marketing
Jordan A. Levy............. 44 Director
</TABLE>
Gordon A. Campbell, one of our co-founders, has served as our Chairman and a
director since October 1996. Mr. Campbell has been a managing member of
TechFund Capital, a venture capital fund, since August 1997. In 1993, Mr.
Campbell created Techfarm Management, Inc., an incubation company for new
technology companies including Cobalt Networks. Mr. Campbell has founded and
been involved in the start-up of numerous Silicon Valley companies, including
3Dfx Interactive, a semiconductor graphics company, and CHIPS and Technologies,
Inc., a semiconductor and related device company. In addition to his role at
Cobalt Networks, Mr. Campbell serves as chairman of the board of 3Dfx
Interactive and is a member of the boards of directors of 3Com Corporation, a
network infrastructure company, and Bell Microproducts, a computer components
company.
Stephen W. DeWitt has served as our President and Chief Executive Officer
since February 1998. Prior to joining Cobalt, Mr. DeWitt was Vice President and
General Manager of the Enterprise Network Management Business Unit at Cisco
Systems, a network infrastructure company, from January 1997 to February 1998.
Mr. DeWitt also served as Vice President of Enterprise Marketing for Cisco from
January 1996 to February 1997. From September 1994 to January 1996, he was Vice
President of Marketing for Symantec Corporation, a system utilities,
development tools and contact management software company. From June 1992 to
September 1994, Mr. DeWitt served as General Manager of Symantec's Canadian
subsidiary. Mr. DeWitt holds a Bachelor of Science in Finance and Economics
from Babson College in Wellesley, Massachusetts.
Vivek Mehra, one of our co-founders, has served as our Chief Technology
Officer since September 1999 and as our Vice President of Products since
November 1996. Mr. Mehra leads our engineering and product management teams.
Mr. Mehra also served as one of our directors from October 1996 to August 1999.
From January 1992 to November 1996, Mr. Mehra was a senior architect and
systems engineering manager at Apple Computer, a computer design and
manufacturing company. From March 1991 to January 1992, Mr. Mehra was a
developer at Silicon Graphics, a high performance workstation company. From
July 1988 to March 1991 Mr. Mehra served as a principal engineer for ASIC and
Board Design at Digital Equipment Corporation, a computer maker that is now a
division of Compaq Computer. Mr. Mehra holds a Bachelor of Science in
Electronics and Electrical Communications from Punjab University, India and a
Master of Science in Computer Engineering from Iowa State University.
Gary A. Martell has served as our Chief Operating Officer since July 1999.
From February 1988 to July 1999, Mr. Martell served as Chief Financial Officer
and Senior Vice President of Operations at Wyse Technology, a computer hardware
company. Mr. Martell holds a Bachelor of Science in Finance and Computer
Science from the University of Massachusetts at Amherst.
53
<PAGE>
Mark H. Orr, a co-founder of our company, has served as our Vice President of
Business Development since October 1998. Mr. Orr served as our Vice President
of Marketing and Business Development from March 1997 to September 1998. From
August 1994 to February 1997, Mr. Orr served in various capacities at Apple
Computer, including most recently as a business development manager. Mr. Orr
holds a Bachelor of Science in Mathematics from the University of Washington.
Kenton D. Chow has served as our Vice President of Finance and Chief
Financial Officer since April 1998 and as our Secretary since September 1999.
From October 1996 to January 1998, Mr. Chow served as the Director of Finance
at OpenTV, Inc., an interactive software developer for digital television. From
January 1995 to October 1996, Mr. Chow served as Controller, Worldwide Sales of
Symantec Corporation. Mr. Chow served as Senior Manager, Financial Reporting at
Bay Networks, Inc., a networking company, now part of Nortel Networks, from
November 1991 to January 1995. Prior to that time, Mr. Chow was a Senior
Associate at PricewaterhouseCoopers LLP. Mr. Chow is a certified public
accountant. He holds both a Bachelor of Science in Finance and a Masters of
Business Administration from Santa Clara University.
Patrick J. Conte has served as our Vice President of Sales Americas and Asia
Pacific since July 1999. From October 1998 to June 1999, Mr. Conte served as
our Vice President of Sales and Marketing. Mr. Conte served as Vice President
of Sales and Channel Marketing for Dynamic Pictures, a graphics company, from
January 1997 to September 1998. From April 1995 to December 1996, Mr. Conte
served as Vice President of Sales, Americas for Wyse Technology. Prior to that
time, Mr. Conte was Director, OEM Sales with Wyse Technology from October 1994
to March 1995. Mr. Conte holds a Bachelor of Science in Political Science and
History from James Madison University and a Masters of Arts in Political
Science from Northern Illinois University.
George M. Korchinsky has served as our Vice President of International Sales
since July 1998 and is based in offices in the Netherlands. Mr. Korchinsky
served as a vice president of sales for Europe, the Middle East and Africa at
Aurora Electronics, from October 1996 to May 1998. From May 1991 to October
1996, Mr. Korchinsky served as a vice president of sales for Europe, the Middle
East and Africa at Symantec. Prior to that time, Mr. Korchinsky served in
various capacities at Cognos Limited, Paradyne Corporation and IBM. Mr.
Korchinsky is currently a member of the board of DataCore Ltd., a United
Kingdom software company. Mr. Korchinsky holds a Bachelor of Science in
Mechanical Engineering from University of Alberta.
Kelly M. Herrell has served as our Vice President of Marketing since July
1999. Prior to joining our company, Mr. Herrell served as Vice President of
Marketing at CacheFlow, Inc., a caching products company, from September 1997
to May 1999. Mr. Herrell served as a Senior Director of Marketing at Oracle
Corporation from September 1996 to September 1997. Prior to that time, Mr.
Herrell acted as Director of Strategy for NCR Corporation from January 1995 to
September 1996. Mr. Herrell was also a Senior Marketing Manager at AT&T Global
Information Systems from January 1993 to January 1995. Mr. Herrell holds a
Bachelor of Arts from Washington State University and a Masters of Business
Administration from Cornell University.
Jordan A. Levy has served as one of our directors since July 1998. Mr. Levy
was a co-founder, and from July 1990 to October 1998, the President and Co-
Chief Executive Officer of Softbank Services Group, previously Upgrade
Corporation of America, an outsourcing services company specializing in
providing call center services for technology companies. From September 1988 to
February 1990, Mr. Levy served as an Executive Vice President and Chief
Operating Officer of Software Etc. Inc. Mr. Levy is a co-founder of Ingram
Software, now known as Ingram Micro, and served as an Executive Vice President
from February 1982 to August 1988. Mr. Levy also sits on the boards of the
Rights Exchange, Inc., a producer of software applications for the metering,
sale and distribution of digital products, GT Interactive Software, a publisher
of entertainment software, and
54
<PAGE>
Client Logic Corp., where he also serves as Vice Chairman of the board of
directors. Mr. Levy holds a Bachelor of Arts in Political Science from the
State University of New York at Buffalo.
Our board of directors currently consists of three members. Prior to the
closing of this offering, our board of directors will be divided into three
classes, with each director serving a three-year term and one class being
elected at each year's annual meeting of stockholders. Mr. DeWitt will be in
the class of directors whose initial term expires at the 2000 annual meeting of
stockholders. Mr. Campbell will be in the class of directors whose initial term
expires at the 2001 annual meeting of the stockholders. Mr. Levy will be in the
class of directors whose initial term expires at the 2002 annual meeting of
stockholders. Following completion of this offering, the board of directors
intends to appoint at least two additional directors who will not be officers
or employees of Cobalt.
Executive officers are elected by the board of directors on an annual basis
and serve until their successors have been duly elected and qualified. There
are no family relationships among any of our directors, officers or key
employees.
Board Committees
We have established an audit committee and a compensation committee. Messrs.
Campbell and Levy are members of both the audit and compensation committees.
The audit committee reviews our internal accounting procedures and consults
with and reviews the services provided by our independent accountants. The
compensation committee reviews and recommends to the board of directors the
compensation and benefits of all of our officers and establishes and reviews
general policies relating to compensation and benefits of our other employees.
Compensation Committee Interlocks and Insider Participation
Our board of directors established its compensation committee in March 1998.
Prior to establishing the compensation committee, our board of directors as a
whole performed the functions delegated to the compensation committee. No
interlocking relationship exists between any member of our compensation
committee and any member of any other company's board of directors or
compensation committee.
Director Compensation
Directors do not currently receive any cash compensation from our company for
their service as members of our board of directors, except for reimbursement
for reasonable travel expenses in connection with attendance at board and
committee meetings. Under our 1997 stock option plan, nonemployee directors are
eligible to receive stock option grants at the discretion of the board of
directors, and, after this offering is completed, all nonemployee directors
will receive stock options pursuant to the automatic option grant program in
effect under the 1999 director option plan. See "--Incentive Stock Plans" for
more about the automatic grant program.
55
<PAGE>
Executive Compensation
Summary Compensation Information
The following table sets forth the compensation earned for services rendered
to us in all capacities by our Chief Executive Officer and our four most highly
compensated executive officers whose total cash compensation exceeded
$100,000--collectively, the "Named Executive Officers"--for the year ended
December 31, 1998.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Long-Term
Compensation Compensation
---------------- ------------
Securities
Underlying All Other
Name and Principal Position Salary Bonus Options (#) Compensation
--------------------------- -------- ------- ------------ ------------
<S> <C> <C> <C> <C>
Stephen W. DeWitt.................. $156,771 $53,594 400,000 $ 9,136
President and Chief Executive
Officer
Vivek Mehra........................ 143,959 -- -- 3,288
Chief Technology Officer and Vice
President, Products
Robin Porter....................... 127,917 -- -- 10,375
Vice President, Manufacturing
Mark Orr........................... 125,000 -- -- 11,721
Vice President, Business
Development
Kenton D. Chow..................... 100,000 25,550 140,000 8,517
Vice President, Finance and Chief
Financial Officer
</TABLE>
Ms. Porter resigned as our Vice President of Manufacturing in July 1999.
The amounts in the column titled "All Other Compensation" represent premiums
for health, dental and life insurance paid by Cobalt for Messrs. DeWitt, Mehra,
Orr and Chow and Ms. Porter.
Option Grants
The following table sets forth certain information with respect to stock
options granted to each of the Named Executive Officers during the year ended
December 31, 1998. For grants in 1999 to the Named Executive Officers, see
"Related Party Transactions--Option Grants to Directors and Executive
Officers." All of the options were granted under our 1997 stock option plan.
Options under the stock option plan generally vest over four years with 25% of
the shares subject to the option vesting on the first anniversary of the grant
date, and the remaining option shares vesting ratably monthly thereafter.
Option Grants in 1998
<TABLE>
<CAPTION>
Percent
of Total Potential Realizable
Options Value at Assumed
Number of Granted Annual Rates of Stock
Securities to Appreciation for
Underlying Employees Exercise Option Term
Options During Price per Expiration ----------------------
Name Granted (#) Period Share Date 5% 10%
---- ----------- --------- --------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Stephen W. DeWitt....... 400,000 26.9% $0.10 03/18/08 9,733,000 15,522,000
Vivek Mehra............. -- -- -- -- -- --
Robin Porter............ -- -- -- -- -- --
Mark Orr................ -- -- -- -- -- --
Kenton D. Chow.......... 90,000 6.0 0.10 04/15/08 2,190,000 3,493,000
50,000 3.4 0.50 12/15/08 1,197,000 1,920,000
</TABLE>
The exercise price per share of each option was equal to the fair market
value of the common stock as determined by the board of directors on the date
of grant. To determine fair market value, our board of directors considered a
number of factors. For instance, in determining that the fair
56
<PAGE>
market value of our common stock was $0.10 in March and April 1998, the board
of directors considered, among other things, the youth of our company, our
small number of customers, that we shipped our first product in mid-March 1998
and the uncertainty regarding a market for our products. The potential
realizable values assume that the initial public offering price of $15 per
share was the fair market value of the common stock on the date of grant and
that the price of the applicable stock increases from the date of grant until
the end of the ten-year option term of the annual rates specified. There is no
assurance provided to any holder of our securities that the actual stock price
appreciation over the ten-year option term will be at the assumed 5% and 10%
levels or at any other defined level.
The percentages above are based on an aggregate of 1,487,300 shares subject
to options we granted to employees and consultants in the year ended December
31, 1998.
Option Exercises
The following table sets forth information with respect to the Named
Executive Officers concerning option exercises for the year ended December 31,
1998 and exercisable and unexercisable options held as of December 31, 1998.
Aggregate Option Exercises in 1998 and Values at December 31, 1998
<TABLE>
<CAPTION>
Number of
Securities Underlying Value of Unexercised
Unexercised Options at In-the-Money Options at
Shares December 31, 1998 (#) December 31, 1998
Acquired on Value ------------------------- -------------------------
Name Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Stephen W. DeWitt....... -- -- -- 400,000 $ -- $160,000
Vivek Mehra............. -- -- -- -- -- --
Robin Porter............ -- -- 24,375 65,625 9,750 26,250
Mark Orr................ -- -- -- -- -- --
Kenton D. Chow.......... -- -- -- 140,000 -- 36,000
</TABLE>
The value of in-the-money options represents the positive spread between the
exercise price of the stock options and the deemed fair market value of the
common stock as of December 31, 1998, which our board of directors determined
was $0.50 per share.
Incentive Plans
1997 Stock Option Plan
Our 1997 stock option plan was adopted by our board of directors in April
1997 and approved by our stockholders in May 1997. The stock option plan was
amended in September 1999. A total of 6,100,334 shares of common stock have
been reserved for issuance under our stock option plan, together with an annual
increase in the number of shares reserved thereunder beginning on the first day
of our fiscal year, commencing January 1, 2001, in an amount equal to the
lesser of:
. 2,500,000 shares;
. five percent of our outstanding shares of common stock on the last day
of the prior fiscal year; or
. an amount determined by our board of directors.
As a result of these annual increases, a maximum of 17,500,000 additional
shares could be issued over the remaining seven year life of the 1997 stock
option plan.
The 1997 stock option plan provides for grants of incentive stock options to
our employees including officers and employee directors and nonstatutory stock
options to our consultants including
57
<PAGE>
nonemployee directors. The purposes of our stock option plan are to attract and
retain the best available personnel for positions of substantial
responsibility, to provide additional incentive to our employees and
consultants and to promote the success of our business. At the request of the
board of directors, the compensation committee administers our stock option
plan and determines the optionees and the terms of options granted, including
the exercise price, number of shares subject to the option and the
exercisability thereof.
The term of the options granted under the 1997 stock option plan is stated in
the option agreement. However, the term of an incentive stock option may not
exceed ten years and, in the case of an option granted to an optionee who owns
more than 10 percent of our outstanding stock at the time of grant, the term of
an option may not exceed five years. Options granted under the 1997 stock
option plan vest and become exercisable as set forth in each option agreement.
With respect to any optionee who owns more than 10 percent of our outstanding
stock, the exercise price of any stock option granted must be at least 110% of
the fair market value on the grant date.
No incentive stock options may be granted to an optionee, which, when
combined with all other incentive stock options becoming exercisable in any
calendar year that are held by that person, would have an aggregate fair market
value in excess of $100,000. In any fiscal year, we may not grant any employee
options to purchase more than 500,000 shares or 1,000,000 shares in the case of
an employee's initial employment.
The 1997 stock option plan will terminate in April 2007, unless our board of
directors terminates it sooner.
As of October 1, 1999, we had issued 390,905 shares of common stock upon the
exercise of options granted under our stock option plan, we had outstanding
options to purchase 3,275,516 shares of common stock at a weighted average
exercise price of $1.79 per share and 2,433,913 shares remain available for
future option grants under our stock option plan.
1999 Employee Stock Purchase Plan
Our 1999 employee stock purchase plan was adopted by our board of directors
in September 1999 and will become effective upon the closing of this offering.
We have reserved a total of 2,250,000 shares of common stock for issuance under
the 1999 employee stock purchase plan, together with an annual increase in the
number of shares reserved thereunder beginning on the first day of our fiscal
year commencing January 1, 2001 in an amount equal to the lesser of:
. 1,500,000 shares;
. three percent of our outstanding common stock on the last day of the
prior fiscal year; or
. an amount determined by our board of directors.
As a result of these annual increases, a maximum of 13,500,000 additional
shares could be sold over the remaining nine year life of the employee stock
purchase plan.
Our employee stock purchase plan is administered by the board of directors
and is intended to qualify under Section 423 of the Internal Revenue Code. Our
employees, including our officers and employee directors but excluding our five
percent or greater stockholders, are eligible to participate if they are
customarily employed for at least 20 hours per week and for more than five
months in any calendar year. Our employee stock purchase plan permits eligible
employees to purchase common stock through payroll deductions, which may not
exceed the lesser of 15% of an employee's compensation, as defined on Form W-2,
or $25,000 per annum.
58
<PAGE>
Our employee stock purchase plan will be implemented in a series of
overlapping 24 month offering periods, and each offering period consists of
four six month purchase periods. The initial offering period under our employee
stock purchase plan will begin on the effective date of this offering, and the
subsequent offering periods will begin on the first trading day on or after May
1 and November 1 of each year. Each participant will be granted an option on
the first day of the offering period and the option will be automatically
exercised on the date six months later, the end of a purchase period,
throughout the offering period. If the fair market value of our common stock on
any purchase date is lower than such fair market value on the start date of
that offering period, then all participants in that offering period will be
automatically withdrawn from such offering period and re-enrolled in the
immediately following offering period. The purchase price of our common stock
under our employee stock purchase plan will be 85 percent of the lesser of the
fair market value per share on the start date of the offering period or at the
end of the purchase period. Employees may end their participation in an
offering period at any time, and their participation ends automatically on
termination of employment with our company.
Our employee stock purchase plan will terminate in September 2009, unless our
board of directors terminates it sooner.
1999 Director Option Plan
Our 1999 director option plan will become effective upon the closing of this
offering. We have reserved a total of 400,000 shares of common stock for
issuance under the 1999 director option plan, together with an annual increase
in the number of shares reserved thereunder beginning on the first day of our
fiscal year commencing January 1, 2001 equal to the lesser of:
. 100,000 shares;
. one quarter of one percent of the outstanding shares of our common stock
on the last day of the prior fiscal year; or
. an amount determined by the board of directors.
As a result of these annual increases, a maximum of 900,000 additional shares
could be issued over the remaining nine year life of the 1999 director option
plan.
The option grants under the 1999 director option plan are automatic and non-
discretionary, and the exercise price of the options is 100% of the fair market
value of our common stock on the grant date.
The 1999 director option plan provides for an initial grant to a nonemployee
director of an option to purchase 50,000 shares of common stock. A nonemployee
director who becomes chairman will receive an additional initial option to
purchase 5,000 shares on the date on which he or she becomes chairman.
Additional initial options to purchase 5,000 shares also will be granted to a
nonemployee director on the date the nonemployee director first joins the audit
committee of the board of directors and on the date the nonemployee director
first joins the compensation committee of the board of directors. Subsequent to
the initial grants, each nonemployee director will be granted an option to
purchase 10,000 shares of common stock at the next meeting of the board of
directors following the annual meeting of stockholders, if on the date of the
annual meeting, the director has served on the board of directors for six
months. This subsequent option will be increased by:
. 2,500 shares for service as chairman;
. 2,500 shares for service on the audit committee; and
. 2,500 shares for service on the compensation committee.
59
<PAGE>
The term of the options granted under the 1999 director plan is ten years,
but the options expire three months following the termination of the optionee's
status as a director or twelve months if the termination is due to death or
disability. The initial 50,000 share grants, and the additional 5,000 share
grant with respect to the chairman, will become exercisable at a rate of one-
fourth of the shares on the first anniversary of the grant date and at a rate
of 1/48th of the shares per month thereafter. The subsequent 10,000 share
grants and 2,500 share grants will become exercisable at the rate of 1/48th of
the shares per month.
401(k) Plan
In January 1998, we adopted a Retirement Savings and Investment Plan, the
401(k) Plan, covering our full-time employees located in the United States. The
401(k) Plan is intended to qualify under Section 401(k) of the Internal Revenue
Code, so that contributions to the 401(k) Plan by employees or by us and the
investment earnings thereon are not taxable to the employees until withdrawn.
If our 401(k) Plan qualifies under Section 401(k) of the Internal Revenue Code,
our contributions will be deductible by us when made. Our employees may elect
to reduce their current compensation by up to the statutorily prescribed annual
limit of $10,000 in 1999 and to have those funds contributed to the 401(k)
Plan. The 401(k) Plan permits us, but does not require us, to make additional
matching contributions on behalf of all participants. To date, we have not made
any contributions to the 401(k) Plan.
Employment Agreements and Change in Control Arrangements
We have entered into the following employment, noncompete and change in
control arrangements and agreements with our current officers. For a
description of arrangements with our former officers, directors and substantial
stockholders, see "Related Party Transactions" on page 62.
Each of our executive officers listed in "Management--Executive Officers and
Management" other than Mr. Korchinsky and Mr. Martell entered into an
employment agreement with us in August 1999. These agreements provide that if
the officer is terminated without cause or constructively terminated he will
receive:
. one year accelerated vesting of any of his stock options;
. one year of salary and target bonus.
In addition, Mr. Mehra's agreement provides that he will receive one year
accelerated vesting of common stock purchased by him pursuant to restricted
stock purchase agreements.
If the officer voluntarily resigns, is terminated for cause or is terminated
for any other reason, he is not entitled to these benefits.
In June 1998, we entered into a letter agreement with George Korchinsky, our
Vice President of International Sales. Pursuant to the agreement, Mr.
Korchinsky receives an annual salary of $150,000 and is eligible for an
incentive-based sales bonus. In addition, Mr. Korchinsky received options to
purchase 120,000 shares of our common stock pursuant to our employee stock
plan, 25% of which vest after one year and 1/48 of which vest every month
thereafter; provided, however, that 50% of the option shares will vest if we
experience a change in control. Pursuant to the terms of the
option grant, a change in control is defined as:
. any person becoming the beneficial owner of 50% or more of the total
voting power of our then outstanding voting securities; or
. a merger or consolidation with any other corporation, other than a
merger or consolidation which would result in our voting securities
outstanding immediately prior thereto continuing
60
<PAGE>
to represent at least 50% of the total voting power of the surviving
entity outstanding immediately after such merger or consolidation, or
our stockholders approve a plan of complete liquidation or an agreement
for the sale or disposition of all or substantially all of our assets.
In the event of a change of control of our company, Mr. Korchinsky has 90
days following the completion of such a transaction to decide whether it
constitutes a constructive termination of his employment in which case all of
his options will vest up to the date of constructive termination regardless of
the one year initial anniversary vesting, plus an additional six months of
options will be deemed vested. If he terminated without cause, Mr. Korchinsky
is entitled to receive twelve (12) months of his annual base salary and
benefits in exchange for a general release.
In July 1999, we entered into a letter agreement with Gary Martell, our Chief
Operating Officer. Pursuant to the agreement, Mr. Martell:
. receives an annual base salary of $200,000;
. was granted options to purchase 400,000 shares of common stock; and
. is eligible for an annual bonus of up to $50,000.
Mr. Martell is entitled to accelerated vesting of 50% of his outstanding
options in the event of a greater than 50% change in ownership of our shares.
If Mr. Martell is terminated without cause, his salary and benefits will
continue for six months after termination.
Limitations on Directors' Liability and Indemnification
Our certificate of incorporation limits the liability of our directors and
executive officers to the maximum extent permitted by Delaware law. Delaware
law provides that directors of a corporation will not be personally liable for
monetary damages for breach of their fiduciary duties as directors, except
liability for:
. any breach of their duty of loyalty to our company or our stockholders;
. acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of the Delaware General
Corporation Law; or
. any transaction from which the director derived an improper personal
benefit.
The limits on a director or officer's liability in our certificate of
incorporation do not apply to liabilities arising under the federal securities
laws and do not affect the availability of equitable remedies such as
injunctive relief or rescission.
Our certificate of incorporation together with our bylaws provide that we
must indemnify our directors and executive officers and may indemnify our other
officers and employees and other agents to the fullest extent permitted by law.
We believe that indemnification under our bylaws covers at least negligence and
gross negligence on the part of indemnified parties. Our bylaws also permit us
to secure insurance on behalf of any officer, director, employee or other agent
for any liability arising out of his or her actions in that capacity,
regardless of whether our bylaws would otherwise permit indemnification. We
believe that the indemnification provisions of our certificate of incorporation
and bylaws are necessary to attract and retain qualified persons as directors
and officers. We also maintain directors' and officers' liability insurance.
61
<PAGE>
Prior to the effective time of this offering, we expect to enter into
agreements to indemnify our directors, executive officers and other employees
as determined by the board of directors. These agreements provide for
indemnification for related expenses including attorneys' fees, judgments,
fines and settlement amounts incurred by any such person in any action or
proceeding. We believe that these provisions and agreements are necessary to
attract and retain qualified persons as our directors and executive officers.
At present we are not aware of any pending litigation or proceeding involving
any director, officer, employee or agent of our company where indemnification
will be required or permitted. Nor are we aware of any threatened litigation or
proceeding that might result in a claim for indemnification.
62
<PAGE>
RELATED PARTY TRANSACTIONS
All future transactions, other than compensation, stock options pursuant to
the plans and other benefits available to employees generally, including any
loans from us to our officers, directors, principal stockholders or affiliates,
will be approved by a majority of our board of directors, including a majority
of our independent and disinterested members of our board of directors. If
required by law, the future transactions will be approved by a majority of the
disinterested stockholders. These future transactions will be on terms no less
favorable to us than we could obtain from unaffiliated third parties.
Stock Issuances to our Directors, Officers and Principal Stockholders
In May and June of 1997, we issued 4,181,426 shares of common stock at the
fair market value price of $0.001 per share to our founders, Mark Wu, Techfarm
II, L.P., Vivek Mehra, our Chief Technology Officer, and Mark Orr, our Vice
President of Business Development, for aggregate proceeds of $4,181. In August
1997, we issued 471,338 shares of common stock at the fair market value price
of $0.001 per share for aggregate proceeds of $471. Of such shares, we issued
111,338 shares to Vivek Mehra. In March 1998, we issued 800,000 shares of
common stock at the fair market value price of $0.10 per share to Stephen
DeWitt, our Chief Executive Officer and President, for aggregate proceeds of
$80,000. In February 1999, we issued 100,000 shares of common stock at the fair
market value price of $0.50 per share to Vivek Mehra for aggregate proceeds
of $50,000.
We repurchased 570,000 shares of common stock on September 29, 1997 from the
estate of Mark Wu at the original purchase price. The balance of his shares
were transferred to his heirs.
Between October 1996 and June 1997, we issued warrants to purchase 163,500
shares of Series A preferred stock at a per share exercise price of $1.00 per
share to 13 persons as consideration for bridge loans that were converted to
Series A preferred stock. Of these warrants, we issued warrants to purchase
32,500 shares of Series A preferred stock to Gordon Campbell, one of our
directors. Between August and November 1997, we sold 3,572,401 shares of Series
A preferred stock at a per share price of $1.00 for aggregate proceeds of $3.6
million.
Between April and June 1998, we issued warrants to purchase 41,612 shares of
Series B preferred stock at a per share exercise price of $2.16 to Vanguard V,
TechFund Capital, LP and Stephen W. Dewitt as consideration for bridge loans
that were converted to Series B preferred stock. In July 1998, we issued
3,698,910 shares of Series B preferred stock at a per share price of $2.16 for
aggregate proceeds of $8.0 million.
In February and March 1999, we issued warrants to purchase an aggregate of
79,045 shares of Series C preferred stock with a per share exercise price of
$3.70 to 12 investors as consideration for bridge loans that were converted to
Series C preferred stock. Of the warrants, we issued warrants to purchase:
. 20,270 shares of Series C preferred stock to SPLZ One Partners, LLC;
. 6,756 shares of Series C preferred stock to Vanguard V, LP;
. 13,512 shares of Series C preferred stock to Crystal Internet Venture
Fund, L.P.;
. 1,351 shares of Series C preferred stock to Stephen W. Dewitt;
. 2,702 shares of Series C preferred stock to George Korchinsky, our Vice
President of International Sales;
. 13,039 shares of Series C preferred stock to Chase Venture Capital
Associates, LP;
. 2,364 shares of Series C preferred stock to TechFund Capital II, LP;
. 472 shares of Series C preferred stock to TechFund Capital Management
II, LP; and
. 121 shares of Series C preferred stock to Kenton D. Chow, our Chief
Financial Officer.
63
<PAGE>
In May 1999, we issued 9,813,507 shares of Series C preferred stock at a per
share price of $3.70 for aggregate proceeds of $36.3 million. In connection
with our Series C preferred stock financing, we issued a warrant to BT Alex.
Brown to purchase 242,508 shares of common stock with a per share exercise
price of $3.70 that expires in May 2002 as consideration for BT Alex. Brown's
services as placement agent in the Series C preferred stock financing.
Upon closing of this offering, all shares of outstanding preferred stock will
be automatically converted into shares of common stock. Listed below are those
persons who participated in the financings described above who are our
executive officers, directors or stockholders who beneficially own five percent
or more of our securities.
<TABLE>
<CAPTION>
Series A Series B Series C
Common Preferred Series A Preferred Series B Preferred Series C Aggregate
Stockholder Stock Stock Warrants Stock Warrants Stock Warrants Consideration
----------- --------- --------- -------- --------- -------- --------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
August Capital
entities............... -- -- -- -- -- 2,702,701 -- $10,004,992
Chase Venture Capital
Assoc. L.P............. -- 517,500 -- 1,387,091 -- 531,081 13,039 5,530,744
Kenton D. Chow.......... -- -- -- 2,312 -- 2,433 121 14,450
Crystal Internet
Ventures Fund, L.P..... -- -- -- 924,728 -- 445,946 13,512 3,699,996
Stephen W. DeWitt....... 800,000 -- -- 115,591 18,494 27,027 1,351 390,799
George M. Korchinsky.... -- -- -- -- -- 27,027 2,702 109,997
Vivek Mehra............. 946,382 5,000 -- -- -- -- -- 5,946
Mark H. Orr............. 946,382 -- -- -- -- -- -- 946
SPLZ One Partners, LLC
(Jordan A. Levy)....... -- -- -- -- -- 135,135 20,720 500,000
Techfarm/TechFund
Capital entities....... 1,200,000 982,500 32,500 213,214 11,559 56,757 2,836 1,654,243
Vanguard V, L.P......... -- 1,202,465 -- 462,364 11,559 135,135 6,756 2,752,462
Mark Wu................. 1,200,000 -- -- -- -- -- -- 1,200
</TABLE>
The entities listed above as Techfarm/TechFund Capital entities include
TechFund Capital, LP and its general partner, TechFund Capital Management, LLC;
TechFund Capital II, LP and its general partner, TechFund Capital Management
II, LLC; and Techfarm Management, Inc. Mr. Campbell, our Chairman, is a
managing member of TechFund Capital Management, LLC and TechFund Capital
Management II, LLC and the President and a shareholder of Techfarm Management,
Inc. Mr. Campbell disclaims beneficial ownership of the shares held by each
entity, except to the extent of his pecuniary interest therein.
Jordan A. Levy, one of our directors, is a managing member of SPLZ One
Partners, LLC. Mr. Levy disclaims beneficial ownership of the shares held by
each entity, except to the extent of his pecuniary interest therein.
64
<PAGE>
Option Grants to our Directors and Executive Officers
Stock option grants to directors and executive officers of our company are
described under the captions "Management--Board Compensation" and "--Executive
Compensation". Since our inception, we have granted options to our directors
and current and former executive officers, including the Named Executive
Officers as follows:
<TABLE>
<CAPTION>
Number
of Exercise
Name Shares Grant Date Price
---- ------- ---------- --------
<S> <C> <C> <C>
Kenton D. Chow.............................. 90,000 April 15, 1998 $0.10
50,000 December 15, 1998 0.50
60,000 July 27, 1999 2.50
Patrick J. Conte............................ 100,000 September 23, 1998 0.50
40,000 February 16, 1999 0.80
40,000 July 27, 1999 2.50
Stephen W. DeWitt........................... 400,000 March 18, 1998 0.10
100,000 May 18, 1999 1.85
250,000 July 27, 1999 2.50
Kelly M. Herrell............................ 250,000 July 27, 1999 2.50
George M. Korchinsky........................ 120,000 July 15, 1998 0.50
60,000 July 27, 1999 2.50
Jordan A. Levy.............................. 30,000 July 15, 1998 0.50
Gary A. Martell............................. 400,000 July 27, 1999 2.50
Vivek Mehra................................. 100,000 July 27, 1999 2.50
Mark H. Orr................................. 30,000 July 27, 1999 2.50
Robin Porter................................ 90,000 November 25, 1997 0.10
</TABLE>
In connection with a separation agreement dated July 28, 1999, we accelerated
the vesting of options to purchase 37,500 shares of our common stock held by
Ms. Porter. Pursuant to the separation agreement, Ms. Porter will receive her
regular salary and benefits other than accrued vacation pay until October 31,
1999. Ms. Porter released any and all claims against us that arose prior to the
date of the agreement, whether known or unknown, arising out of any agreement,
act or omission, including matters arising from her employment relationship
with us.
Other Relationships
Our company has a management consulting agreement with Techfarm Management,
Inc. pursuant to which it provides management consulting services to our
company for a fee of $5,000 per month. These services and our payment of the
related fees will cease upon the closing of this offering. Gordon Campbell is
the President of Techfarm Management, Inc. and serves as the Chairman of our
board of directors. In addition, Mr. Campbell is also a managing member of
TechFund Capital Management, LLC, the general partner of TechFund Capital, L.P.
On August 20, 1999, we made an interest free loan of $500,000 to Stephen W.
Dewitt, our President and Chief Executive Officer. The loan is secured by
50,000 shares of our Series B preferred stock held by Mr. DeWitt and is full
recourse. The loan is payable on August 20, 2003. In the event Mr. DeWitt
leaves our employment, the note will be due and payable in full 60 days after
his last day of employment with us.
65
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of October 1, 1999, and as adjusted
to reflect the sale of 5,000,000 shares of common stock offered hereby by:
. each stockholder known by us to own beneficially more than five percent
of our common stock;
. each of the Named Executive Officers;
. each director of our company; and
. all directors and executive officers as a group.
<TABLE>
<CAPTION>
Percent Beneficially Owned
Total Number ------------------------------
Name and Address of Shares Before Offering After Offering
---------------- ------------ --------------- --------------
<S> <C> <C> <C>
August Capital entities........... 2,702,701 12.1% 9.9%
2480 Sand Hill Road, Suite 101
Menlo Park, California 94025
Chase Venture Capital Assoc. L.P.
................................. 2,448,711 11.0 9.0
380 Madison Avenue, 12th Floor
New York, New York 10017
Techfarm/TechFund Capital
entities......................... 2,446,866 11.1 9.0
111 West Evelyn Avenue Suite 101
Sunnyvale, California 94086
Vanguard V, L.P................... 1,818,279 8.2 6.7
525 University Avenue Suite 600
Palo Alto, California 94301
Crystal Internet Venture Fund,
L.P.............................. 1,384,186 6.2 5.1
1120 Chester Avenue, Suite 310
Cleveland, Ohio 44114
Gordon A. Campbell................ 2,446,866 11.0 9.0
Stephen W. DeWitt................. 1,054,155 4.7 3.8
Vivek Mehra....................... 1,019,382 4.6 3.7
Mark H. Orr....................... 946,382 4.2 3.5
Robin Porter...................... 75,000 * *
Kenton D. Chow.................... 40,491 * *
Jordan A. Levy.................... 155,135 * *
All executive officers and
directors as a group
(11 persons)..................... 5,699,088 25.2 20.6
</TABLE>
- --------
* Less than 1% of the outstanding shares of common stock.
Except as otherwise noted above, the address of each person listed on the
table is 555 Ellis Street, Mountain View, California 94043.
As of October 1, 1999, 22,298,052 shares of our common stock were
outstanding, assuming that each share of preferred stock was converted on a one
for one basis to common stock. The columns regarding beneficial ownership
before and after the offering assume that the underwriters' over-allotment
option is not exercised. If the over-allotment option is exercised in full, we
will sell an aggregate of shares of new common stock.
We have determined beneficial ownership in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person, we
have included the shares of common stock subject to options or warrants held by
that person that are currently exercisable or will become exercisable within 60
days after October 1, 1999, but we have not included those shares for purposes
of computing percentage
66
<PAGE>
ownership of any other person. We have assumed unless otherwise indicated below
that the persons and entities named in the table have sole voting and
investment power with respect to all shares beneficially owned, subject to
community property laws where applicable.
The beneficial ownership reported for August Capital entities includes
2,583,782 shares held by August Capital II, LP and 118,919 shares held by
August Capital Strategic Partners II, LP. The general partner of each of these
entities is August Capital Management II, LLC. The managing members of August
Capital Management II, LLC are David F. Marquardt, John R. Johnston, Andrew L.
Anker and Andrew S. Rappaport. Each of these persons disclaims beneficial
ownership of the shares except to the extent of his pecuniary interest therein.
The general partner of Chase Venture Capital Associates, L.P. is Chase
Capital Partners. The general partners of Chase Capital Partners are Jeffrey
Walker, Mitchel Blutt, M.D., Arnold Chavkin, Steven Murray, Michael Hannon,
Shahan Soghikian, Brian Richmand, Donald Hofmann, Chris Behrens, John M.B.
O'Connor, John Baron, Damion Wicker, M.D., Susan Segal, Lindsay Stuart and
Chase Capital Corporation. Jeffrey Walter is the President of Chase Capital
Corporation, which is a wholly-owned subsidiary of Chase Manhattan Corporation.
Each of these persons disclaims beneficial ownership of the shares except to
the extent of his or her pecuniary interest therein.
The beneficial ownership reported for the Techfarm/TechFund Capital entities
and Gordon A. Campbell includes:
. 1,147,500 shares held by Techfarm II, LP;
. 1,015,590 shares held by TechFund Capital, LP;
. 96,321 shares held by TechFund Capital Management, LLC;
. 83,803 shares held by Gordon A. Campbell;
. 47,297 shares held by TechFund Capital II, LP;
. 9,460 shares held by TechFund Capital II, LP; and
. 46,895 shares subject to warrants held by Mr. Campbell.
Mr. Campbell disclaims beneficial ownership of these shares except to the
extent of his pecuniary interest.
The general partners of Vanguard V, L.P. are Robert Ulrich, Clifford
Higgerson, Jack Gill and Curtis Kipling Myers. Each of these persons disclaims
beneficial ownership of the Cobalt shares held by Vanguard V, L.P. except to
the extent of his pecuniary interest therein.
The general partner of Crystal Internet Venture Fund, L.P. is Crystal
Venture, Ltd. Joseph Tzeng is the President and Dan Kellog is the Vice
President of Crystal Venture Ltd. Each of Messrs. Tzeng and Kellog disclaims
beneficial ownership of the Cobalt shares held by Crystal Internet Venture Fund
except to the extent of his pecuniary interest therein.
The beneficial ownership of Jordan Levy as reported above includes 135,135
shares of Series C preferred stock and warrants to purchase 20,720 shares of
Series C preferred stock held by SPLZ One Partners, LLC. Mr. Levy is a managing
member of SPLZ One Partners, LLC. However, Mr. Levy disclaims beneficial
ownership of the shares and warrants held by SPLZ One Partners except to the
extent of his pecuniary interest therein.
The beneficial ownership of the persons set forth in the table above includes
the following options or warrants to purchase our common stock that may be
exercised by such person within 60 days of October 1, 1999:
67
<PAGE>
Securities Exercisable Within 60 Days of October 1, 1999
<TABLE>
<CAPTION>
Options Warrants
------- --------
<S> <C> <C>
Techfarm/TechFund entities..................................... -- 46,895
Chase Venture Capital Assoc. L.P. ............................. -- 13,039
Crystal Internet Venture Fund, L.P............................. -- 13,512
Gordon A. Campbell............................................. -- 46,895
Stephen W. DeWitt.............................................. 175,000 19,845
Kenton D. Chow................................................. 7,500 121
Jordan Levy.................................................... 20,000 --
All directors and officers..................................... 269,583 69,500
</TABLE>
68
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the closing of this offering, we will be authorized to issue 120,000,000
shares of common stock, $0.001 par value, and 10,000,000 shares of undesignated
preferred stock, $0.001 par value.
Common Stock
As of October 1, 1999, we had 22,298,052 shares of common stock outstanding
held by approximately 137 stockholders.
The holders of common stock are entitled to one vote per share on all matters
to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding preferred stock, the holders of common stock are
entitled to receive ratably any dividends that may be declared from time to
time by the board of directors out of funds legally available for that purpose.
In the event of our liquidation, dissolution or winding up, the holders of
common stock are entitled to share ratably in all assets remaining after
payment of liabilities, subject to prior distribution rights of preferred stock
then outstanding. The common stock has no preemptive or conversion rights or
other subscription rights. There are no redemption or sinking fund provisions
applicable to the common stock. All outstanding shares of common stock are
fully paid and nonassessable, and the shares of common stock to be issued upon
the closing of this offering will be fully paid and nonassessable.
Preferred Stock
Upon the closing of this offering, our board of directors will have the
authority, without action by our stockholders, to designate and issue preferred
stock in one or more series. The board of directors may also designate the
rights, preferences and privileges of each series of preferred stock; any or
all of which may be superior to the rights of the common stock. It is not
possible to state the actual effect of the issuance of any shares of preferred
stock upon the rights of holders of the common stock until the board of
directors determines the specific rights of the holders of the preferred stock.
However, these effects might include:
. restricting dividends on the common stock;
. diluting the voting power of the common stock;
. impairing the liquidation rights of the common stock; and
. delaying or preventing a change in control of our company without
further action by the stockholders.
We have no present plans to issue any shares of preferred stock.
Warrants
As of October 1, 1999, we had outstanding warrants to purchase:
. 242,508 shares of common stock issued to BT Alex. Brown at an exercise
price of $3.70 per share that will expire in May 2002;
. 86,250 shares of Series A preferred stock issued to 6 stockholders at an
exercise price of $1.00 per share that will expire at various times from
October 2001 to June 2002;
. 30,053 shares of Series B preferred stock issued to two stockholders at
an exercise price of $2.16 per share that will expire at various times
from April 2000 to June 2000; and
. 72,289 shares of Series C preferred stock issued to 11 stockholders at
an exercise price of $3.70 per share that will expire at various times
from February 2002, to March 2002.
69
<PAGE>
Our outstanding warrants to purchase preferred stock will convert to warrants
to purchase common stock upon the closing of this offering.
Holders of Registration Rights Can Require Us to Register Shares of Our Stock
for Resale
The holders of 17,179,383 shares of common stock and 188,592 shares of common
stock issuable upon the exercise of warrants or their permitted transferees are
entitled to require us to register their shares under the Securities Act of
1933, as amended. These rights are provided under the terms of our agreement
with the holders of registrable securities. Under these registration rights,
holders of at least a majority of the then outstanding registrable securities
may require on two occasions that we register their shares for public resale.
We are obligated to register these shares if the holders of a majority of the
eligible shares request registration and only if the shares to be registered
have an anticipated public offering price of at least $10,000,000. In addition,
holders of registrable securities may require on two separate occasions that we
register their shares for public resale on Form S-3 or similar short-form
registration, if we are eligible to use Form S-3 or similar short-form
registration, and the value of the securities to be registered is at least
$10,000,000. If we elect to register any of our shares of common stock for any
public offering, the holders of registrable securities are entitled to include
shares of common stock in the registration. However we may reduce the number of
shares proposed to be registered in view of market conditions. We will pay all
expenses in connection with any registration, other than underwriting discounts
and commissions.
Anti-Takeover Effects of Some Provisions of Delaware Law and Our Charter
Documents
A number of the provisions of Delaware law and our certificate of
incorporation and bylaws could make the acquisition of our company through a
tender offer, a proxy contest or other means more difficult and could make the
removal of incumbent officers and directors more difficult. These provisions
include our failure to "opt out" of the protections of Section 203 of the
Delaware Code, as described below, as well as our reservation of 10,000,000
shares of blank check preferred and our staggered board of directors. We expect
these provisions to discourage coercive takeover practices and inadequate
takeover bids and to encourage persons seeking to acquire control of our
company to first negotiate with our board of directors. We believe that the
benefits provided by our ability to negotiate with the proponent of an
unfriendly or unsolicited proposal outweigh the disadvantages of discouraging
such proposals. We believe the negotiation of an unfriendly or unsolicited
proposal could result in an improvement of its terms.
Delaware Law
We are subject to Section 203 of the Delaware General Corporation Law, an
anti-takeover law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years following the date the person became
an interested stockholder, unless:
. prior to the date of the transaction, the board of directors of the
corporation approved either the business combination or the transaction
which resulted in the stockholder becoming an interested stockholder;
. the stockholder owned at least 85% of the voting stock of the
corporation outstanding at the time the transaction commenced, excluding
for purposes of determining the number of shares outstanding (a) shares
owned by persons who are directors and also officers, and (b) shares
owned by employee stock plans in which employee participants do not have
the right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or
. on or subsequent to the date of the transaction, the business
combination is approved by the board and authorized at an annual or
special meeting of stockholders, and not by written
70
<PAGE>
consent, by the affirmative vote of at least 66 2/3% of the outstanding
voting stock which is not owned by the interested stockholder.
Generally, a "business combination" includes a merger, asset or stock sale,
or other transaction resulting in a financial benefit to the interested
stockholder. An "interested stockholder" is a person who, together with
affiliates and associates, owns or, within three years prior to the
determination of interested stockholder status, did own 15% or more of a
corporation's outstanding voting securities. We expect the existence of this
provision to have an anti-takeover effect with respect to transactions our
board of directors does not approve in advance. We also anticipate that
Section 203 may also discourage attempts that might result in a premium over
the market price for the shares of common stock held by stockholders.
Charter Documents
Upon completion of this offering, our certificate of incorporation provides
for our board of directors to be divided into three classes serving staggered
terms. Approximately one-third of the board of directors will be elected each
year. The provision for a classified board could prevent a party who acquires
control of a majority of the outstanding voting stock from obtaining control
of the board of directors until the second annual stockholders meeting
following the date the acquirer obtains the controlling stock interest. The
classified board provision could discourage a potential acquirer from making a
tender offer or otherwise attempting to obtain control of our company and
could increase the likelihood that incumbent directors will retain their
positions. Our certificate of incorporation provides that directors may be
removed:
. with cause by the affirmative vote of the holders of at least a majority
of the outstanding shares of voting stock; or
. without cause by the affirmative vote of the holders of at least 66 2/3%
of the then-outstanding shares of the voting stock.
Our bylaws establish an advance notice procedure for stockholder proposals
to be brought before an annual meeting of our stockholders, including proposed
nominations of persons for election to the board of directors. At an annual
meeting, stockholders may only consider proposals or nominations specified in
the notice of meeting or brought before the meeting by or at the direction of
the board of directors. Stockholders may also consider a proposal or
nomination by a person who was a stockholder of record on the record date for
the meeting, who is entitled to vote at the meeting and who has given to our
Secretary timely written notice, in proper form, of his or her intention to
bring that business before the meeting. The bylaws do not give the board of
directors the power to approve or disapprove stockholder nominations of
candidates or proposals regarding other business to be conducted at a special
or annual meeting of the stockholders. However, our bylaws may have the effect
of precluding the conduct of that item of business at a meeting if the proper
procedures are not followed. These provisions may also discourage or deter a
potential acquirer from conducting a solicitation of proxies to elect the
acquirer's own slate of directors or otherwise attempting to obtain control of
our company.
Under Delaware law, a special meeting of stockholders may be called by the
board of directors or by any other person authorized to do so in the
certificate of incorporation or the bylaws. The following persons are
authorized to call a special meeting of stockholders:
. a majority of our board of directors;
. the chairman of the board;
. the chief executive officer; or
. 50% of our stockholders entitled to vote at the special meeting.
71
<PAGE>
The limitation on the right of our stockholders to call a special meeting will
make it more difficult for a stockholder to force stockholder consideration of
a proposal over the opposition of the board of directors by calling a special
meeting of stockholders. The restriction on the ability of stockholders to call
a special meeting also will make it more difficult to replace the board until
the next annual meeting.
Although Delaware law provides that stockholders may execute an action by
written consent in lieu of a stockholder meeting, it also allows us to
eliminate stockholder actions by written consent. Elimination of written
consents of stockholders may lengthen the amount of time required to take
stockholder actions since actions by written consent are not subject to the
minimum notice requirement of a stockholder's meeting. However, we believe that
the elimination of stockholders' written consents may deter hostile takeover
attempts. Without the availability of stockholder's actions by written consent,
a holder controlling a majority of our capital stock would not be able to amend
our bylaws or remove directors without holding a stockholders meeting. The
holder would have to obtain the consent of a majority of the board of
directors, the chairman of the board or the chief executive officer to call a
stockholders' meeting and satisfy the notice periods determined by the board of
directors. Our certificate of incorporation provides for the elimination of
actions by written consent of stockholders upon the closing of this offering.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is BankBoston, N.A.
BankBoston is located at 150 Royall Street, Canton, Massachusetts, 02021 and
its telephone number is (781) 575-3120.
Nasdaq Stock Market Listing
We have applied to have our common stock listed on the Nasdaq National Market
for quotation under the symbol "COBT".
72
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our stock. Future
sales of substantial amounts of our common stock in the public market following
this offering or the possibility of such sales occurring could adversely affect
prevailing market prices for our common stock or could impair our ability to
raise capital through an offering of equity securities.
After this offering, we will have outstanding 27,298,052 shares of common
stock, based upon shares outstanding as of October 1, 1999, assuming no
exercise of the underwriters' over-allotment option and no exercise of
outstanding options or warrants after October 1, 1999. All of the shares sold
in this offering will be freely tradeable without restriction under the
Securities Act except for any shares purchased by our "affiliates" as that term
is defined in Rule 144 under the Securities Act. The remaining 22,298,052
shares of common stock held by existing stockholders are "restricted" shares as
that term is defined in Rule 144 under the Securities Act. We issued and sold
the restricted shares in private transactions in reliance upon exemptions from
registration under the Securities Act. Restricted shares may be sold in the
public market only if they are registered under the Securities Act or if they
qualify for an exemption from registration, such as Rule 144 or 701 under the
Securities Act, which are summarized below.
Our officers, directors, employees, and other stockholders, who collectively
hold an aggregate of 22,298,052 restricted shares, and the underwriters entered
into lock-up agreements in connection with this offering. These lock-up
agreements provide that, with limited exceptions, our officers, directors,
employees and stockholders have agreed not to offer, sell, contract to sell,
grant any option to purchase or otherwise dispose of any of our shares for a
period of 180 days after the effective date of this offering. Goldman, Sachs &
Co. may, in its sole discretion and at any time without prior notice, release
all or any portion of the shares subject to these lock-up agreements. We have
also entered into an agreement with Goldman, Sachs & Co. that we will not
offer, sell or otherwise dispose of our common stock until 180 days after the
effective date of this offering.
Taking into account the lock-up agreements, the number of shares that will be
available for sale in the public market under the provisions of Rules 144,
144(k) and 701 will be as follows:
<TABLE>
<CAPTION>
Number of
Date of Availability for Sale Shares
----------------------------- ----------
<S> <C>
At various times between October 1, 1999 and the date 30 days
after the effective date of this offering......................... --
At various times between the date 30 days and the date
180 days after the effective date of this offering................ 100,000
At various times thereafter upon the expiration of applicable
holding periods................................................... 22,198,052
</TABLE>
Following the expiration of the lock-up period, shares issued upon exercise
of options granted by us prior to the completion of this offering will also be
available for sale in the public market pursuant to Rule 701 under the
Securities Act unless those shares are held by one of our affiliates, directors
or officers.
In general, under Rule 144 as currently in effect, a person, or persons whose
shares are aggregated, who has beneficially owned restricted shares for at
least one year, including the holding period of any prior owner except an
affiliate, would be entitled to sell within any three-month period a number of
shares that does not exceed the greater of:
. one percent of the number of shares of common stock then outstanding,
which will equal approximately 272,981 shares immediately after the
offering; or
. the average weekly trading volume of the common stock during the four
calendar weeks preceding the filing of a Form 144 with respect to such
sale.
73
<PAGE>
Sales under Rule 144 are also subject to manner of sale provisions that
require arm's length sales through a stockbroker, notice requirements with
respect to sales by our officers, directors and greater than five percent
stockholders and to the availability of current public information about us.
Under Rule 144(k), a person who is not deemed to have been an affiliate of our
company at any time during the three months 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 except an affiliate, is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.
Rule 701, as currently in effect, permits our employees, officers, directors
or consultants who purchased shares under a written compensatory plan or
contract to resell these shares in reliance upon Rule 144. Rule 701 provides
that affiliates may sell their Rule 701 shares under Rule 144 without complying
with the holding period requirement and that non-affiliates may sell these
shares in reliance on Rule 144 without complying with the holding period,
public information, volume limitation or notice provisions of Rule 144.
We intend to file, shortly after the effectiveness of this offering, a
registration statement on Form S-8 under the Securities Act covering all shares
of common stock reserved for issuance under the stock plans and subject to
outstanding options under our 1997 stock option plan. See "Management--Stock
Plans". Shares of common stock issued upon exercise of options under the Form
S-8 will be available for sale in the public market, subject to Rule 144 volume
limitations applicable to affiliates and subject to the contractual
restrictions described above. As of October 1, 1999, options to purchase
3,275,516 shares of common stock were outstanding of which approximately
369,093 options were then vested and exercisable. Beginning 180 days after the
effective date of this offering, approximately 659,072 shares issuable upon the
exercise of vested stock options will become eligible for sale in the public
market, if such options are exercised.
Following this offering, the holders of an aggregate of 17,179,383 shares of
outstanding common stock and 188,592 shares of common stock issuable upon the
exercise of warrants have the right to require us to register their shares for
sale upon meeting requirements to which the parties have previously agreed. See
"Description of Capital Stock--Holders of Registration Rights Can Require Us to
Register Shares of Our Stock for Resale" for additional information regarding
registration rights.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us by
Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California. Legal matters specified by the underwriters in connection with this
offering will be passed upon for the underwriters by Shearman & Sterling, Menlo
Park, California.
EXPERTS
The financial statements as of December 31, 1997, 1998 and October 1, 1999,
and for the period from inception (October 18, 1996) to December 31, 1996, for
the years ended December 31, 1997 and 1998 and the nine months ended October 1,
1999, included in this Prospectus have been so included in reliance on the
report of PricewaterhouseCoopers LLP, independent accountants, given on the
authority of said firm as experts in auditing and accounting.
74
<PAGE>
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act with respect to the shares of
common stock offered hereby. This prospectus does not contain all the
information set forth in the registration statement and the exhibits and
schedules thereto. For further information with respect to our company and our
common stock, reference is made to the registration statement and to the
exhibits and schedules filed therewith. A copy of the registration statement
may be inspected by anyone without charge at the Public Reference Section of
the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of all or any portion of the registration
statement may be obtained from the Public Reference Section of the Commission,
450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of prescribed
fees. The public may obtain information on the operations of the public
reference facilities in Washington, D.C. by calling the Commission at 1-800-
SEC-0330. The Commission maintains a web site at http://www.sec.gov that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.
75
<PAGE>
COBALT NETWORKS , INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants.......................................... F-2
Consolidated Balance Sheet................................................. F-3
Consolidated Statement of Operations....................................... F-4
Consolidated Statement of Stockholders' Deficit............................ F-5
Consolidated Statement of Cash Flows....................................... F-6
Notes to Consolidated Financial Statements................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Cobalt Networks, Inc.
The reincorporation described in Note 1 to the consolidated financial
statements has not been consummated as of October 13, 1999. When it has been
consummated, we will be in a position to issue the following report:
"In our opinion, the accompanying consolidated balance sheet and the
related consolidated statements of operations, of stockholders' equity
(deficit) and of cash flows present fairly, in all material respects, the
financial position of Cobalt Networks, Inc. and its subsidiaries at
December 31, 1997, 1998 and October 1,1999, and the results of their
operations and their cash flows for the period from October 18, 1996
(inception) through December 31, 1996, the years ended December 31, 1997
and 1998, and the nine months ended October 1, 1999, in conformity with
generally accepted accounting principles. 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 of these statements in accordance with generally
accepted auditing standards which 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, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable
basis for the opinion expressed above."
PricewaterhouseCoopers LLP
San Jose, California
October 11, 1999,
F-2
<PAGE>
COBALT NETWORKS, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Pro Forma
December 31, Stockholders'
----------------- October 1, Equity as of
1997 1998 1999 October 1, 1999
------- -------- ---------- ---------------
(unaudited)
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents....... $ 1,738 $ 2,090 $ 25,730
Accounts receivable, net of
allowance for doubtful
accounts of $--, $335 and
$367........................... -- 2,040 5,207
Inventories..................... 20 514 638
Other current assets............ 78 239 644
------- -------- --------
Total current assets.......... 1,836 4,883 32,219
Property and equipment, net...... 162 1,262 1,539
------- -------- --------
$ 1,998 $ 6,145 $ 33,758
======= ======== ========
Liabilities, mandatorily
redeemable convertible preferred
stock and stockholders' equity
(deficit)
Current liabilities:
Notes payable, current.......... $ -- $ 39 $ 43
Borrowings under line of
credit......................... -- 600 --
Advance from related party...... -- 500 --
Accounts payable................ 209 4,179 7,912
Accrued liabilities............. 85 1,183 3,536
Deferred margin on distributor
inventory...................... -- 294 861
------- -------- --------
Total current liabilities..... 294 6,795 12,352
Notes payable.................... -- 84 52
------- -------- --------
294 6,879 12,404
------- -------- --------
Mandatorily Redeemable
Convertible Preferred Stock
(Note 4)........................ 3,551 12,339 45,907 $ --
------- -------- -------- --------
Commitments and contingencies
(Notes 10 and 11)
Stockholders' equity (deficit)
Preferred Stock: $0.001 par
value; 10,000,000 shares
authorized, none issued and
outstanding pro forma.......... -- -- -- --
Common Stock: $0.001 par value;
120,000,000 shares authorized;
4,193,000, 4,750,000 and
5,119,000 shares issued and
outstanding at December 31,
1997, 1998 and October 1,
1999; 22,298,000 (unaudited)
shares issued and outstanding
pro forma...................... 4 5 5 22
Additional paid-in capital...... -- 79 11,840 57,730
Unearned stock compensation..... -- -- (7,747) (7,747)
Note receivable from
stockholders................... -- -- (442) (442)
Accumulated deficit............. (1,851) (13,157) (28,209) (28,209)
------- -------- -------- --------
Total stockholders' equity
(deficit).................... (1,847) (13,073) (24,553) $ 21,354
------- -------- -------- ========
$ 1,998 $ 6,145 $ 33,758
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
COBALT NETWORKS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Period From
October 18,
1996 Year Ended
(inception) to December 31, Nine Months Ended
December 31, ---------------------- ----------------------------------
1996 1997 1998 September 30, 1998 October 1, 1999
-------------- ---------- ---------- ------------------ ---------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net revenues............ $ -- $ -- $ 3,537 $ 1,513 $ 13,849
Cost of revenues........ -- -- 3,123 1,390 9,029
---------- ---------- ---------- ---------- ----------
Gross profit............ -- -- 414 123 4,820
---------- ---------- ---------- ---------- ----------
Operating expenses:
Research and
development........... 22 1,067 3,483 2,373 4,337
Sales and marketing.... -- 245 5,581 3,349 10,246
General and
administrative........ 60 445 1,895 1,080 2,624
Amortization of stock
compensation.......... -- -- -- -- 1,509
---------- ---------- ---------- ---------- ----------
Total operating
expenses............ 82 1,757 10,959 6,802 18,716
---------- ---------- ---------- ---------- ----------
Loss from operations.... (82) (1,757) (10,545) (6,679) (13,896)
Interest income......... -- 17 82 57 500
Interest expense........ -- (29) (15) (12) (218)
Other expense........... -- -- -- -- (108)
---------- ---------- ---------- ---------- ----------
Net loss................ (82) (1,769) (10,478) (6,634) (13,722)
Accretion of Mandatorily
Redeemable Convertible
Preferred Stock........ -- -- (828) (331) (1,330)
---------- ---------- ---------- ---------- ----------
Net loss attributable to
holders of Common
Stock.................. $ (82) $ (1,769) $ (11,306) $ (6,965) $ (15,052)
========== ========== ========== ========== ==========
Basic and diluted net
loss per share
attributable to holders
of Common Stock........ $ (4.09) $ (5.48) $ (3.67) $ (4.31)
========== ========== ========== ==========
Basic and diluted
weighted average shares
outstanding............ 432,000 2,065,000 1,896,000 3,491,000
========== ========== ========== ==========
Pro forma basic and
diluted net loss per
share.................. $ (1.43) $ (0.85)
========== ==========
Pro forma basic and
diluted weighted
average shares
outstanding ........... 7,330,000 16,163,000
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
COBALT NETWORKS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
<TABLE>
<CAPTION>
Common Stock Additional Unearned Note Receivable
---------------------- Paid-in Stock from Accumulated
Shares Amount Capital Compensation Stockholder Deficit Total
--------- ----------- ----------- ------------ --------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Net loss................ -- $ -- $ -- $ -- $ -- $ (82) $ (82)
--------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31,
1996................... -- -- -- -- -- (82) (82)
Issuance of Common
Stock.................. 4,763,000 5 -- -- -- -- 5
Repurchase of Common
Stock.................. (570,000) (1) -- -- -- -- (1)
Net loss................ -- -- -- -- -- (1,769) (1,769)
--------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31,
1997................... 4,193,000 4 -- -- -- (1,851) (1,847)
Issuance of Common
Stock.................. 812,000 1 79 -- -- -- 80
Repurchase of Common
Stock.................. (255,000) -- -- -- -- -- --
Accretion of Mandatorily
Redeemable Convertible
Preferred Stock........ -- -- -- -- -- (828) (828)
Net loss................ -- -- (10,478) (10,478)
--------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31,
1998................... 4,750,000 5 79 -- -- (13,157) (13,073)
Issuance of Common
Stock.................. 369,000 -- 108 -- (50) -- 58
Issuance of warrants.... -- -- 532 -- -- -- 532
Stock compensation...... -- -- 346 -- -- -- 346
Unearned stock compensa-
tion (Note 7).......... -- -- 8,910 (8,910) -- -- --
Amortization of stock
compensation .......... -- -- -- 1,163 -- -- 1,163
Accretion of Mandatorily
Redeemable Convertible
Preferred Stock ....... -- -- -- -- -- (1,330) (1,330)
Issuance of Note
receivable to
stockholder............ -- -- -- -- (392) -- (392)
Adjustments to
redemption value of
Mandatorily Redeemable
Preferred Stock........ -- -- 1,865 -- -- -- 1,865
Net loss................ -- -- -- -- -- (13,722) (13,722)
--------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at October 1,
1999 .................. 5,119,000 $ 5 $ 11,840 $ (7,747) $ (442) $ (28,209) $ (24,553)
========= =========== =========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
COBALT NETWORKS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended
Period From December 31, Nine Months Ended
October 18, 1996 -------------------- ------------------------
(inception) to September 30, October 1,
December 31, 1996 1997 1998 1998 1999
----------------- --------- --------- ------------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss.............. $ (82) $ (1,769) $ (10,478) $ (6,634) $(13,722)
Adjustments to
reconcile net loss
to net cash used in
operating
activities:
Depreciation......... -- 18 323 181 594
Stock compensation... -- -- -- -- 346
Amortization of
stock
compensation........ -- -- -- -- 1,163
Non-cash interest
expense............. -- 20 2 -- 130
Other non-cash
expense............. -- -- -- -- 108
Changes in assets
and liabilities:
Accounts
receivable......... -- -- (2,040) (1,270) (3,167)
Inventories......... -- (20) (494) (50) (124)
Other current
assets............. (4) (74) (161) (296) (134)
Accounts payable.... 45 164 3,970 1,613 3,733
Accrued
liabilities........ 9 76 1,096 517 2,132
Deferred margin on
distributor
inventory.......... -- -- 294 128 567
--------- --------- --------- --------- --------
Net cash used in
operating
activities........ (32) (1,585) (7,488) (5,811) (8,374)
--------- --------- --------- --------- --------
Cash flows used in
investing activities:
Acquisition of
property and
equipment............ (23) (157) (1,423) (741) (871)
Loan to shareholder... -- -- -- -- (500)
--------- --------- --------- --------- --------
Net cash used in
investing
activities.......... (23) (157) (1,423) (741) (1,371)
--------- --------- --------- --------- --------
Cash flows from
financing activities:
Proceeds from
issuance of
Mandatorily
Redeemable
Convertible
Preferred Stock,
net.................. -- 2,992 7,210 7,270 29,705
Proceeds from
issuance of Common
Stock................ -- 4 80 80 58
Proceeds from advance
from related party... -- -- 500 -- --
Proceeds from
borrowings under
line of credit....... -- -- 600 -- --
Principal payments on
line of credit....... -- -- -- -- (600)
Proceeds from
borrowings under
notes payable........ 70 -- 431 -- --
Principal payments on
notes payable........ -- (130) (308) -- (28)
Proceeds from
borrowings under
convertible
promissory notes..... -- 599 750 750 4,250
--------- --------- --------- --------- --------
Net cash provided by
investing
activities......... 70 3,465 9,263 8,100 33,385
--------- --------- --------- --------- --------
Net increase (decrease)
in cash and cash
equivalents........... 15 1,723 352 1,548 23,640
Cash and cash
equivalents at
beginning of period... -- 15 1,738 1,738 2,090
--------- --------- --------- --------- --------
Cash and cash
equivalents at end of
period................ $ 15 $ 1,738 $ 2,090 $ 3,286 $ 25,730
========= ========= ========= ========= ========
Supplemental disclosure
of cash flow
information:
Cash paid for
interest............. $ -- $ 9 $ 13 $ 13 $ 88
========= ========= ========= ========= ========
Conversion of notes
payable and accrued
interest into
Mandatorily
Redeemable
Convertible
Preferred Stock...... $ -- $ 559 $ 750 $ 750 $ 4,800
========= ========= ========= ========= ========
Issuance of
warrants............. $ -- $ -- $ -- $ -- $ 402
========= ========= ========= ========= ========
Issuance of Common
Stock for promissory
note................. $ -- $ -- $ -- $ -- $ 50
========= ========= ========= ========= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Company
Cobalt Networks, Inc., (formerly ViavisionSystems Inc. and Cobalt
Microserver, Inc.) (the "Company"), was incorporated in California in October
1996. The Company is a leading provider of server appliances. Server appliances
are a new category of network infrastructure devices that are optimized to
deliver one or a few network-based applications well. The Company markets and
sells its products globally through its direct sales force and its channel
partners. The Company operates in one business segment.
Reincorporation
On September 1, 1999, the Company's Board of Directors authorized the
reincorporation of the Company in the State of Delaware. As a result of the
reincorporation, the Company is authorized to issue 120,000,000 shares of
$0.001 par value Common Stock and 10,000,000 shares of $0.001 par value
Preferred Stock. The Board of Directors has the authority to issue the
undesignated Preferred Stock in one or more series and to fix the rights,
preferences, privileges and restrictions thereof. The par value and shares of
Common Stock and Preferred Stock authorized, issued and outstanding at each
balance sheet date presented, and for each period presented in the consolidated
statement of stockholders' deficit have been retroactively adjusted to reflect
the reincorporation.
Principles of consolidation and basis of presentation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All material intercompany transactions and
balances have been eliminated in consolidation.
Through December 31, 1998 the Company operated on a calendar quarter-end and
year-end basis. Beginning in 1999 the Company changed its accounting periods to
thirteen-week fiscal quarters ending on the Friday closest to the end of the
month.
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue recognition
Revenue from product sales to other than distributors is generally recognized
at the time the product is shipped. Provisions for estimated future product
returns and exchanges are recognized upon product shipment.
The Company grants distributors limited rights of return on unsold inventory
held by such distributors. The Company has limited control over the extent to
which products sold to distributors are sold through to end users. Accordingly,
the Company recognizes revenues on sales to distributors at the time its
products are sold through to end users. The recognition of the gross profit on
the products held by distributors is deferred until the sale to the end user
occurs. The deferred gross profit is captioned as "deferred margin" on the
Company's balance sheet.
Upon shipment, the Company also provides for the estimated cost that may be
incurred for product warranties.
F-7
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Cash equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. The majority of the
Company's cash equivalents consist of money market funds.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
using standard cost which approximates the first-in, first-out method.
Property and equipment
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the shorter of the estimated useful lives of the
assets, generally eighteen months to five years, or the lease term of the
respective assets.
Long-lived assets
The Company periodically evaluates the recoverability of its long-lived
assets based upon expected undiscounted cash flows and recognizes impairment
from the carrying value of long-lived assets, if any, based on the fair value
of such assets.
Research and development
Research and development costs are charged to operations as incurred.
Software development costs are included in research and development and are
expensed as incurred. After technological feasibility is established, material
software development costs are capitalized. The capitalized cost is then
amortized on a straight-line basis over the estimated product life, or on the
ratio of current revenues to total projected product revenues, whichever is
greater. To date, the period between achieving technological feasibility, which
the Company has defined as the establishment of a working model which typically
occurs when the beta testing commences, and the general availability of such
software has been short and software development costs qualifying for
capitalization have been insignificant. Accordingly, the Company has not
capitalized any software development costs.
Income taxes
Income taxes are computed using the asset and liability method. Deferred
income tax assets or liabilities are established for the expected future
consequences resulting from the temporary differences between the financial
reporting and income tax bases of assets and liabilities and from net operating
loss and tax credit carryforwards. The Company records a valuation allowance
against deferred tax assets when it is more likely than not that such assets
will not be realized.
Fair value of financial instruments
The Company's financial instruments, including cash, cash equivalents,
accounts receivable, accounts payable, notes payable and capital lease
obligations are carried at cost, which approximates their fair value because of
the short-term maturity of these instruments.
Concentration of credit risk
Financial instruments which potentially subject the Company to a
concentration of credit risk consist principally of cash equivalents and
accounts receivable. The Company places its cash and cash equivalents primarily
in market rate accounts with high credit financial institutions. The Company's
accounts receivable are derived from revenue earned from customers located in
the
F-8
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
United States, Europe and Asia. Sales to foreign customers in 1998, and the
nine months ended October 1, 1999, which are denominated in U.S. dollars,
accounted for 44% and 56%, respectively of total revenue. Sales in the United
States, Japan, Europe and other foreign countries were 56%, 21%, 15% and 8%,
respectively, of total revenues in 1998, and were 44%, 25%, 22% and 9%,
respectively of total revenues in the nine month period ended October 1, 1999.
The Company performs ongoing credit evaluations of its customers' financial
condition and generally requires no collateral from its customers. The Company
maintains an allowance for doubtful accounts receivable based upon the expected
collectibility of accounts receivable.
During the year ended December 31, 1998, one customer accounted for
approximately 12% of net revenues. As of December 31, 1998, this customer
accounted for 15% of total accounts receivable. During the period ended October
1, 1999 two customers accounted for approximately 16% and 12%, respectively, of
net revenues. As of October 1, 1999, two of these customers accounted for 11%
and 10%, respectively of total accounts receivable.
Stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123 "Accounting for Stock-Based Compensation."
The Company accounts for stock issued to non-employees in accordance with the
provisions of SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18,
"Accounting for Equity Instruments That are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services."
Foreign currency translation
The Company uses the U.S. dollar as its functional currency for all of its
worldwide operations. All sales worldwide are billed in U.S. dollars. Foreign
currency assets and liabilities are remeasured into U.S. dollars at the end-of-
period exchange rates. Expenses are translated at average exchange rates in
effect during each period, except for those expenses related to balance sheet
amounts which are translated at historical exchange rates. Gains or losses from
foreign currency remeasurements and transactions are included in net loss and
were not material for all periods presented.
Comprehensive income
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity (net assets)
during a period from nonowner sources. To date, the Company has not had any
transactions that are required to be reported in comprehensive income (loss) as
compared to its reported net loss.
Net loss per share
The Company computes net loss per share in accordance with SFAS No. 128,
"Earnings per Share" and SEC Staff Accounting Bulletin No. 98 ("SAB 98"). Under
the provisions of SFAS No. 128 and SAB 98, basic net loss per share is computed
by dividing the net loss available to holders of Common Stock for the period by
the weighted average number of shares of Common Stock
F-9
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
outstanding during the period. Weighted average shares exclude shares of Common
Stock subject to repurchase ("restricted shares"). Diluted net loss per share
is computed by dividing the net loss available to holders of Common Stock for
the period by the weighted average number of shares of Common Stock and
potential Common Stock outstanding during the period, if dilutive. Potential
Common Stock includes unvested restricted shares of Common Stock and
incremental shares of Common Stock issuable upon the exercise of stock options
and warrants and upon conversion of Series A, B, and C Mandatorily Redeemable
Convertible Preferred Stock.
The following table sets forth the computation of basic and diluted net loss
per share for the periods indicated (in thousands, except share and per share
data):
<TABLE>
<CAPTION>
Period From Nine Months Ended
October 18, 1996 Year Ended December 31, -----------------------
(inception) to ------------------------ September 30, October 1,
December 31, 1996 1997 1998 1998 1999
----------------- ----------- ----------- ------------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C>
Numerator:
Net loss attributable
to holders of Common
Stock................ $ (82) $ (1,769) $ (11,306) $ (6,965) $ (15,052)
========== =========== =========== ========= =========
Denominator:
Weighted average
shares outstanding... -- 2,519,000 4,700,000 4,667,000 4,903,000
Weighted average
shares of Common
Stock subject to
repurchase........... -- 2,087,000 2,635,000 2,771,000 1,412,000
---------- ----------- ----------- --------- ---------
Denominator for basic
and diluted
calculation.......... -- 432,000 2,065,000 1,896,000 3,491,000
========== =========== =========== ========= =========
Basic and diluted net
loss per share
attributable to holders
of Common Stock........ $ -- $ (4.09) $ (5.48) $ (3.67) $ (4.31)
========== =========== =========== ========= =========
</TABLE>
The effects of options to purchase 238,000, 1,622,000 and 3,275,000 shares of
Common Stock at an average exercise price of $0.03, $0.26 and $1.79 per share;
warrants to purchase 164,000, 204,000 and 189,000 shares of Preferred Stock at
an average exercise price of $1.00, $1.24 and $2.22 per share; and 3,572,000,
7,271,000 and 17,179,000 shares of Mandatorily Redeemable Convertible Preferred
Stock for the years ended December 31, 1997 and 1998 and the nine months ended
October 1, 1999, respectively, and warrants to purchase 243,000 shares of
Common Stock at $3.70 per share at October 1, 1999, have not been included in
the computation of diluted net loss per share as their effect would have been
anti-dilutive.
F-10
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pro forma net loss per share (unaudited)
Pro forma net loss per share for the year ended December 31, 1998 and the
nine months ended October 1, 1999 is computed using the weighted average number
of shares of Common Stock outstanding, including the pro forma effects of the
automatic conversion of the Company's Series A, B, and C Mandatorily Redeemable
Convertible Preferred Stock into shares of the Company's Common Stock effective
upon the closing of the Company's initial public offering as if such conversion
occurred on January 1, 1998 or at the date of original issuance, if later. The
resulting pro forma adjustment includes an increase in the weighted average
shares used to compute basic net loss per share of 5,265,000 for the year ended
December 31, 1998 and 12,672,000 for the nine months ended October 1, 1999.
Segment information
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
This statement establishes standards for the way companies report information
about operating segments in annual financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. During each period presented, the Company operated in a
single business segment, primarily in the United States, Japan and Europe.
New accounting pronouncement
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 established methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. The Company has not
yet determined what the effect of SFAS No. 133 will be on the operations and
financial position of the Company. The Company will be required to implement
SFAS No. 133 beginning in 2001.
Unaudited interim results
The accompanying consolidated statements of operations and cash flows for the
nine months ended September 30, 1998 are unaudited. In the opinion of
management, these statements have been prepared on the same basis as the
audited financial statements and include all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the Company's
financial position and its results of operations and cash flows for the interim
periods. The data included in notes to the financial statements for these
periods is unaudited.
F-11
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 2--BALANCE SHEET COMPONENTS (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------- October 1,
1997 1998 1999
------- ------- ----------
<S> <C> <C> <C>
Inventories:
Finished goods................................ $ -- $ 498 $ 612
Raw materials................................. 20 16 26
------- ------- -------
Total....................................... $ 20 $ 514 $ 638
======= ======= =======
Property and equipment:
Computer equipment............................ $ 100 $ 456 $ 994
Office equipment and fixtures................. 4 280 587
Production equipment and tooling.............. 76 417 417
Leasehold improvements........................ -- 450 476
------- ------- -------
180 1,603 2,474
Less: Accumulated depreciation................ (18) (341) (935)
------- ------- -------
$ 162 $ 1,262 $ 1,539
======= ======= =======
Accrued liabilities:
Employee benefits............................. $ 55 $ 543 $ 1,320
Reserve for sales returns..................... -- 386 1,303
Warranty...................................... -- 181 568
Other......................................... 30 73 345
------- ------- -------
$ 85 $ 1,183 $ 3,536
======= ======= =======
</TABLE>
NOTE 3--DEBT:
Line of credit
At December 31, 1998, the Company had $600,000 outstanding under a line of
credit agreement with a bank. The line of credit provided for borrowings of up
to $800,000 which are secured by the assets of the Company. The line of credit
expired in May 1999 and bore interest at prime plus 0.75% per annum (8.75% at
December 31, 1998).
Notes payable
In September 1998, the Company entered into an equipment lease financing
agreement with a leasing company. The agreement provides for borrowings of up
to $1.0 million which are secured by the Company's equipment, machinery and
fixtures. As of December 31, 1998 and October 1, 1999, the Company had
outstanding borrowings under this agreement of $123,000 and $95,000,
respectively. The note balance is payable in 34 equal monthly installments and
bears interest at 10.95% per annum. Future principal payments under this note
are as follows (in thousands):
<TABLE>
<CAPTION>
Year Ending
December 31,
------------
<S> <C>
1999................................................................ 11
2000................................................................ 44
2001................................................................ 40
---
$95
===
</TABLE>
F-12
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In November 1996 and December 1996, the Company borrowed a total of $70,000
from a stockholder which bore interest at 10% per annum. In connection with
this loan, the Company issued warrants to purchase 17,500 shares of Series A
Mandatorily Redeemable Convertible Preferred Stock at $1.00 per share. The
estimated fair value of the warrants at the grant date was not material to the
financial statements.
In January 1997 and March 1997, the Company borrowed an additional $60,000
from the same stockholder which bore interest at 10% per annum. In connection
with this loan, the Company issued warrants to purchase 15,000 shares of Series
A Mandatorily Redeemable Convertible Preferred Stock at $1.00 per share. The
estimated fair value of the warrants at the grant date was not material to the
financial statements.
In September 1997, the Company repaid the above loans.
In June 1998, the Company borrowed $300,000 from a stockholder which bore
interest at 5.5% per annum. In connection with the loan, the Company issued
warrants to purchase 7,000 shares of Series B Mandatorily Redeemable
Convertible Preferred Stock at $2.163 per share. The estimated fair value of
the warrants at the grant date was not material to the financial statements. In
July 1998, the Company repaid the loan in full.
Convertible promissory notes payable
During the year ended December 31, 1997, the Company borrowed $539,000 from
various individuals under convertible promissory notes bearing interest at 10%
per annum. In connection with these notes, the Company issued warrants to
purchase 131,000 shares of Series A Mandatorily Redeemable Convertible
Preferred Stock at $1.00 per share. The estimated fair value of these warrants
at the grant date was not material to the financial statements. These notes,
including $20,000 of accrued interest, were converted into Series A Mandatorily
Redeemable Convertible Preferred Stock at $1.00 per share in September 1997.
In April 1998, the Company borrowed $750,000 from various individuals under
convertible promissory notes bearing interest at 5.5% per annum. In connection
with these borrowings, the Company issued warrants to purchase 35,000 shares of
Series B Mandatorily Redeemable Convertible Preferred Stock at $2.163 per
share. The estimated fair value of the warrants at the grant date was not
material to the financial statements. These notes were converted into Series B
Mandatorily Redeemable Convertible Preferred Stock at $2.163 per share in July
1998.
In December 1998, the Company borrowed $500,000 from an affiliate of a member
of its Board of Directors and $50,000 from an individual investor under
convertible promissory notes bearing interest at 6% per annum. These notes were
converted to Series C Mandatorily Redeemable Preferred Stock in May 1999 (See
Note 5).
In February and March 1999, the Company borrowed $4.3 million from various
investors under convertible promissory notes bearing interest at 6.0% per
annum, including $2.9 million from affiliates of the Company. These notes were
converted into Series C Mandatorily Redeemable Preferred Stock in May 1999. In
connection with the notes, the Company issued warrants to purchase 79,000
shares of Series C Mandatorily Redeemable Convertible Preferred Stock at $3.70
per share, including 61,000 of such shares to affiliates of the Company. The
estimated fair value of the warrants at the grant date was $130,000 and was
recorded as interest expense.
F-13
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 4--RELATED PARTY TRANSACTION
In August 1999, the Company advanced $500,000 to its Chief Executive Officer.
In September 1999, the advance was converted into a full recourse non-interest
bearing promissory note payable in four years and is secured by 50,000 shares
of Series B Preferred Stock.
NOTE 5--MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK:
Mandatorily Redeemable Convertible Preferred Stock ("Preferred Stock") at
October 1, 1999 consists of the following (in thousands, except share data):
<TABLE>
<CAPTION>
Shares
---------------------- Liquidation Redemption
Authorized Outstanding Amount Amounts
---------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Series A......................... 3,735,000 3,649,000 $ 3,649 $ 3,649
Series B......................... 3,741,000 3,710,000 8,024 8,024
Series C ........................ 10,134,000 9,820,000 36,335 34,234
---------- ---------- ------- -------
Balance at October 1, 1999 ...... 17,610,000 17,179,000 $48,008 $45,907
========== ========== ======= =======
</TABLE>
During 1997, the Company issued 3,571,000 shares of Series A Preferred Stock
at $1.00 per share for net proceeds of approximately $3.0 million and the
conversion of $559,000 of notes payable described in Note 3. In July 1998, the
Company issued 1,000 shares of Series A Preferred Stock at $1.00 per share for
net proceeds of $1,000 upon the exercise of a warrant. In September 1999, the
Company issued 77,000 shares of Series A Preferred Stock at $1.00 per share for
net proceeds of $77,000 upon the exercise of warrants.
In July 1998, the Company issued 3,699,000 shares of Series B Preferred
Stock at $2.163 per share for net proceeds of approximately $7.2 million and
the conversion of $750,000 of notes payable described in Note 3. In September
1999, the Company issued 11,000 shares of Series B Preferred Stock at $2.163
per share for net proceeds at approximately $25,000 upon the exercise of
warrants.
In May 1999, the Company issued 9,814,000 shares of Series C Mandatorily
Redeemable Preferred Stock at $3.70 per share for net proceeds of approximately
$29.6 million and the conversion of $4.80 million of notes payable described in
Note 3 and above. In connection with the transaction, the Company issued a
warrant to purchase 243,000 shares of Common Stock at $3.70 per share. The
estimated fair value of the warrants at the date of grant was $402,000, which
was recorded as additional paid in capital. In September 1999, the Company
issued 6,000 shares of Series C Preferred stock at $3.70 per share for net
proceeds of approximately $25,000 upon the exercise of warrants.
The holders of Preferred Stock have various rights and preferences as
follows:
Voting
Each share of Preferred Stock has voting rights equal to an equivalent number
of shares of Common Stock into which it is convertible and votes together as
one class with the Common Stock.
As long as at least 750,000 shares of Preferred Stock are outstanding, the
Company must obtain approval from two-thirds of the then outstanding shares of
Preferred Stock in order to alter the articles of incorporation as related to
Preferred Stock, authorize or issue any other equity security senior to or on a
parity with Preferred Stock, redeem or purchase any shares of Preferred Stock
F-14
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
other than by redemption in accordance with the certificate of incorporation,
increase or decrease the number of authorized shares of Preferred Stock,
authorize a dividend for any class or series other than Preferred Stock,
increase the size of the Board of Directors, or acquire any other company or
business.
Conversion
Each share of Preferred Stock outstanding is convertible into one share of
Common Stock, subject to adjustment for dilution, and will be converted into
Common Stock in the event of the closing of a public offering of at least
$20,000,000 at a minimum price of $7.50 per share. As of October 1, 1999, the
Company had reserved 17,179,000 shares of its Common Stock for issuance upon
conversion of the outstanding Preferred Stock.
Dividends
Holders of Series A, B and C are entitled to receive cumulative dividends at
the per annum rate of $0.10, $0.2163 and $0.37 per share, respectively, when
and if declared by the Board of Directors, prior to payment of dividends on
Common Stock. No dividends have been declared.
Liquidation
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, holders of the Series B and C are entitled to
receive $2.163 and $3.70 per share respectively, plus any declared but unpaid
dividends, prior to any distribution to the holders of Series A and Common
Stock. Holders of Series A are entitled to receive $1.00 per share, plus any
declared but unpaid dividends, prior to distribution to the holders of Common
Stock. Any assets remaining after distribution of the preference amounts on the
Series A and Common Stock will be distributed on a pro rata basis, assuming
conversion of the Preferred Stock.
Redemption
The holders of Preferred Stock may cause the Company to redeem their shares
after the fifth and before the seventh anniversary of the Series B issue date.
Redemption will be at the greater of fair market value or the original purchase
price plus accrued but unpaid dividends. During 1998 and nine months ended
October 1, 1999, the Company recorded a charge to its accumulated deficit of
approximately $828,000 and $1.3 million, respectively related to the accretion
to the Preferred Stock redemption value. In connection with the issuance of
Series C Preferred Stock in April 1999, the redemption amount was modified to
equal the original purchase price plus accrued but unpaid dividends.
NOTE 6--COMMON STOCK:
Certain shares of Common Stock outstanding were sold under Restricted Stock
Purchase Agreements (the "Agreements"). According to the terms of the
Agreements, in the event that the purchaser ceases their relationship with the
Company, the Company has the right to repurchase shares issued at the original
purchase price ("purchase option"), subject to a declining percentage over
time. During 1998 and 1997, the Company exercised its purchase option for
255,000 shares and 570,000 shares, respectively, of Common Stock at $0.001 per
share. As of October 1, 1999, a total of 1,123,000 shares were subject to
repurchase by the Company. Additionally, in the event that the purchase option
has lapsed and the purchaser decides to sell their shares, the Company has the
first right of refusal with respect to such shares.
F-15
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 7--STOCK OPTIONS PLAN:
In April 1997, the Company adopted the Employee Stock Option Plan ( the
"Plan"). The Plan provides for the granting of stock options and Common Stock
to employees and consultants of the Company. Options granted under the Plan may
be either incentive stock options or nonqualified stock options. Incentive
stock options ("ISO") may be granted only to Company employees (including
officers and directors who are also employees). Nonqualified stock options
("NSO") may be granted to Company employees and consultants. At October 1,
1999, the Company has reserved 6,100,000 shares of Common Stock for issuance
under the Plan.
Options under the Plan may be granted for periods of up to ten years and at
prices no less than 85% of the estimated fair value of the shares on the date
of grant as determined by the Board of Directors, provided, however, that (i)
the exercise price of an ISO and NSO shall not be less than 100% and 85% of the
estimated fair value of the shares on the date of grant, respectively, and (ii)
the exercise price of an ISO and NSO granted to a 10% shareholder shall not be
less than 110% of the estimated fair value of the shares on the date of grant,
respectively. Options are generally exercisable immediately, subject to
repurchase options held by the Company. The repurchase options lapse over a
maximum period of five years at such times and under such conditions as
determined by the Board of Directors. Options vest over 4 years, 25% after the
first year and ratably each month over the remaining 36 months.
During 1998, the Company issued NSOs to an outside consultant to purchase
25,000 shares of Common Stock at $0.50 per share, the estimated grant date fair
market value. The estimated fair value of the options was not material to the
financial statements.
The following table summarizes stock option activity under the Plan:
<TABLE>
<CAPTION>
Weighted
Average
Options Exercise
Available Options Price
for Grant Outstanding Per Share
---------- ----------- ---------
<S> <C> <C> <C>
Balance at December 31, 1996.................. -- -- $ --
Authorized.................................. 1,145,000 -- --
Granted..................................... (826,000) 826,000 0.008
Exercised................................... -- (110,000) 0.001
Canceled.................................... 478,000 (478,000) 0.001
---------- ---------
Balance at December 31, 1997.................. 797,000 238,000
Authorized.................................. 1,405,000 -- --
Granted..................................... (1,437,000) 1,437,000 0.500
Exercised................................... -- (12,000) 0.001
Canceled.................................... 41,000 (41,000) 0.190
---------- ---------
Balance at December 31, 1998.................. 806,000 1,622,000
Authorized.................................. 3,550,000 -- --
Granted..................................... (2,159,000) 2,159,000 2.66
Exercised................................... -- (269,000) 0.22
Canceled.................................... 237,000 (237,000) 0.61
---------- ---------
Balance at October 1, 1999 ................... 2,434,000 3,275,000
========== =========
</TABLE>
F-16
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information about stock options outstanding
and exercisable as of October 1, 1999.
<TABLE>
<CAPTION>
Options
Options Outstanding Exercisable at
at October 1, 1999 October 1, 1999
----------------------------------- ------------------
Weighted Weighted
Weighted Average Average Average
Range of Exercise Number of Remaining Exercise Number of Exercise
Prices Shares Contractual Life Price Shares Price
------------------- --------- ---------------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
$0.001............. 11,000 7.63 $0.001 11,000 $ .001
0.100............. 665,000 8.44 0.10 665,000 0.10
0.500............. 595,000 8.91 0.50 595,000 0.50
1.00 - 1.40....... 166,000 9.43 1.16 166,000 1.16
1.85 - 2.50....... 1,712,000 9.77 2.35 1,712,000 2.35
10.00 - 10.25..... 126,000 9.95 10.12 126,000 10.12
--------- ---------
3,275,000 3,275,000
========= =========
</TABLE>
Fair value disclosures
Had compensation cost for the Company's stock-based compensation plan been
determined based on the fair value at the grant dates for the awards under a
method prescribed by SFAS No. 123, the Company's net loss for the years ended
December 31, 1996, 1997 and 1998 would have been increased to the pro forma
amounts indicated in the following table (in thousands, except per share data):
<TABLE>
<CAPTION>
Year Ended December 31, Nine Months
----------------------------- Ended October 1,
1996 1997 1998 1999
-------- -------- --------- ----------------
<S> <C> <C> <C> <C>
Net loss attributable to
holders of Common Stock:
As reported.............. $ (82) $ (1,769) $ (11,306) $(15,052)
======== ======== ========= ========
Pro forma................ $ (82) $ (1,774) $ (11,412) $(15,833)
======== ======== ========= ========
Basic and diluted net loss
per share attributable to
holders of Common Stock:
As reported.............. $ (4.09) $ (5.48) $ (4.31)
======== ========= ========
Pro forma................ $ (4.11) $ (5.53) $ (4.54)
======== ========= ========
</TABLE>
The Company calculated the minimum fair value of each option grant on the
date of grant using the Black-Scholes pricing model with the following
assumptions:
<TABLE>
<CAPTION>
Year Ended
December 31, Nine Months
-------------- Ended October 1,
1997 1998 1999
------ ------ ----------------
<S> <C> <C> <C>
Expected life (years)....................... 5 5 5
Risk free interest rate..................... 6.03% 6.66% 5.8%
Expected volatility......................... -- -- --
Dividend yield.............................. -- -- --
</TABLE>
The estimated weighted average fair value of options granted to purchase
shares of common stock under the Plan in 1997, 1998 and the nine months ended
October 1, 1999 was $0.01, $0.07 and $3.79 respectively.
F-17
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Compensation
In connection with two employee separation agreements in July and September
1999, the Company accelerated the vesting of options to purchase 41,000 Shares
of Common Stock. The intrinsic value of these shares amounted to $346,000 and
has been recognized as compensation expense.
Unearned stock compensation
In connection with certain stock option grants during the period from July 1,
1998, to October 1, 1999, the Company recorded unearned stock compensation cost
totaling $8.9 million which is being recognized over the vesting period of the
related options of four years. Amortization expense associated with unearned
stock compensation totaled $1.2 million for the nine months ended October 1,
1999.
The Company will record amortization expense associated with unearned stock
compensation of $1.2 million in the fourth quarter of fiscal 1999 and $1.2
million, $1.2 million, $865,000 and $626,000 in the first, second, third and
fourth quarters of fiscal 2000, respectively.
NOTE 8--EMPLOYEE BENEFIT PLANS:
The Company sponsors a 401(k) defined contribution plan (the "Plan") covering
all eligible employees. Contributions made by the Company are determined
annually by the Board of Directors. No contributions have been made to the Plan
by the Company.
NOTE 9--INCOME TAXES:
No provision or benefit for income taxes has been recognized for any of the
periods presented as the Company has incurred net operating losses since
inception.
At October 1, 1999, the Company has approximately $18 million and $14 million
of net operating loss carryforwards available to offset future taxable income
for Federal and California purposes, respectively, which expire beginning in
2011 and 2004, respectively. Under the Tax Reform Act of 1986, the amount of
net operating losses that can be utilized may be limited in certain
circumstances including, but not limited to, a cumulative stock ownership
change of more than 50% over a three-year period.
Deferred taxes comprise the following (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------- October 1,
1997 1998 1999
----- ------- ----------
<S> <C> <C> <C>
Deferred tax assets:
Depreciation................................... $ (1) $ 21 $ 80
Other accruals and liabilities................. 13 84 2,443
Capitalized startup costs...................... 185 148 172
Research and development credits............... 68 163 166
Net operating loss and credit carryforwards.... 506 3,985 6,992
----- ------- -------
Total deferred tax assets...................... 771 4,401 9,853
Less: Valuation allowance...................... (771) (4,401) (9,853)
----- ------- -------
Net deferred tax assets.......................... $ -- $ -- $ --
===== ======= =======
</TABLE>
F-18
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For financial reporting purposes, the Company has incurred a loss in each
period since its inception. Based on the available objective evidence,
including the Company's history of losses, management believes it is more
likely than not that the net deferred tax assets will not be fully realizable.
Accordingly, the Company provided for a full valuation allowance against its
net deferred tax assets for all periods presented.
A reconciliation between the amount of income tax benefit determined by
applying the applicable U.S. statutory income tax rate to pre-tax loss is as
follows:
<TABLE>
<CAPTION>
Period from Year Ended Nine Months
October 18, 1996 December 31, Ended
(Inception) to ---------------- October 1,
December 31, 1996 1997 1998 1999
----------------- ------ ------ -----------
<S> <C> <C> <C> <C>
Federal statutory rate... (35)% (35)% (35)% (35)%
State tax, net of federal
impact.................. (6)% (6)% (6)% (6)%
Provision for valuation
allowance on deferred
tax assets.............. 41% 41% 41% 41%
--- ------ ------ ---
--% --% --% --%
=== ====== ====== ===
</TABLE>
NOTE 10--COMMITMENTS:
The Company leases office space under a noncancelable operating lease which
expires on December 31, 2003. Rent expense for the years ended December 31,
1998 and 1997 was $316,000 and $73,000, respectively. Rent expense for the
period ended October 1, 1999 was $627,000.
Future minimum lease payments under noncancelable operating leases are as
follows (in thousands):
<TABLE>
<CAPTION>
Year Ending
December 31,
------------
<S> <C>
2000............................................................. $ 743
2001............................................................. 794
2002............................................................. 827
2003............................................................. 844
------
$3,208
======
</TABLE>
NOTE 11--CONTINGENCIES:
Pursuant to the Company's turnkey service and purchase agreement with its
subcontract manufacturer, in the event that the agreement is terminated, the
Company would be required to purchase remaining surplus or obsolete inventory
which is specific to the Company's products.
On December 4, 1998, Cube Computer Corporation filed suit against the Company
claiming the use of the trademark Qube for its server products constitutes a
trademark infringement of Cube Computer Corporation's registered Cube trademark
for computer hardware products. The Company intends to defend this matter
vigorously but is unable to provide an evaluation of the probability of a
favorable or unfavorable outcome. Management believes, based on currently
available information, the resolution of this matter will not have a material
adverse effect on its financial position, results of operations or cash flows.
F-19
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 12--SUBSEQUENT EVENTS:
Initial Public Offering
In September 1999, the Company's Board of Directors authorized management to
file a registration statement with the Securities and Exchange Commission to
permit the Company to sell 5,000,000 shares of its Common Stock to the Public.
1999 Stock Option Plan
In September 1999, the Board adopted the 1999 Employee Stock Purchase Plan
(the "Purchase Plan") which will become effective on the date of the Company's
initial public offering, and reserved 2,250,000 shares of Common Stock for
issuance thereunder. This reserve will be automatically increased on the first
day of the fiscal year beginning January 1, 2001, by an amount equal to the
lesser of 1,500,000 shares per year, 3% of the number of shares of Common Stock
which are issued and outstanding on the last day of the preceding fiscal year
or a number of shares determined by the Company's board of directors. Employees
generally will be eligible to participate in the Purchase Plan if they are
customarily employed by the Company for more than 20 hours per week and more
than five months in a fiscal year end. The first offering period is expected to
begin on the first business day on which quotations for the Company's Common
Stock are available. Depending on the effective date, the first Offering Period
may be more or less than 24 months long. Offering Periods and Purchase Periods
thereafter will begin on the first day of May and November of each year. The
price at which the Common Stock is purchased under the Purchase plan is 85% of
the lesser of the fair market value of the Company's Common Stock on the first
day of the applicable Offering Period or at the end of the purchase period.
1999 Director Option Plan
In September 1999, the Board adopted the 1999 Director Option Plan (the
"Option Plan") which will become effective on the date of the Company's initial
public offering, and reserved 400,000 shares of Common Stock for issuance
thereunder. This reserve will be automatically increased on the first day of
the fiscal year beginning January 1, 2001, by an amount equal to the lesser of
100,000 shares per year, 0.25% of the number of shares of Common Stock which
are issued and outstanding on the last day of the preceding fiscal year or a
number of shares determined by the Company's board of directors. The option
grants under the Option Plan are automatic and non-discretionary, and the
exercise price of the options is 100% of the fair market value of the Common
Stock on the grant date. The term of the options granted under the Option Plan
is ten years. Options vest over 4 years, 25% after the first year and ratably
each month over the remaining 36 months.
F-20
<PAGE>
UNDERWRITING
Cobalt and the underwriters for the offering named below have entered into an
underwriting agreement with respect to the shares being offered. Subject to
conditions set forth in the underwriting agreement, each underwriter has
severally agreed to purchase the number of shares indicated in the following
table. Goldman, Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith
Incorporated, BancBoston Robertson Stephens Inc. and SoundView Technology
Group, Inc. are the representatives of the underwriters.
<TABLE>
<CAPTION>
Underwriter Number of Shares
----------- ----------------
<S> <C>
Goldman, Sachs & Co. .......................................
Merrill Lynch, Pierce, Fenner & Smith Incorporated..........
BancBoston Robertson Stephens Inc. .........................
SoundView Technology Group, Inc.............................
---------
Total..................................................... 5,000,000
=========
</TABLE>
---------------
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional 750,000
shares from Cobalt to cover such sales. They may exercise that option for 30
days. If any shares are purchased under this option, the underwriters will
severally purchase shares in approximately the same proportion as set forth in
the table above.
The following tables show the per share and total underwriting discounts and
commissions to be paid to the underwriters by Cobalt. These amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase additional shares.
<TABLE>
<CAPTION>
Paid by Cobalt
-------------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share............................................. $ $
Total................................................. $ $
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus.
Any shares sold by the underwriters to securities dealers may be sold at a
discount of up to $ per share from the initial public offering price. Any of
these securities dealers may resell any shares purchased from the underwriters
to other brokers or dealers at a discount of up to $ per share from the
initial public offering price. If all the shares are not sold at the initial
public offering price, the representatives may change the offering price and
the other selling terms.
Cobalt and its directors, officers, employees and other holders of shares of
Cobalt's common stock other than as described below have agreed with the
underwriters not to dispose of or hedge any of their common stock or securities
convertible into or exchangeable for shares of common stock during the period
from the date of this prospectus continuing through the date 180 days after the
date of this prospectus, except with the prior written consent of Goldman,
Sachs & Co. This restriction does not apply to any issuances under Cobalt's
existing employee benefit plans. The underwriters have also agreed that the
family of a deceased co-founder may collectively sell up to 100,000 shares in
the aggregate beginning 30 days after the date this offering is declared
effective
U-1
<PAGE>
provided that the shares are sold through Goldman, Sachs & Co. and at a time
agreeable to both Goldman, Sachs & Co. and Cobalt. See "Shares Eligible for
Future Sale" for a discussion of transfer restrictions.
Prior to this offering, there has been no public market for the common stock.
The initial public offering price for the common stock will be negotiated among
Cobalt and the representatives of the underwriters. Among the factors to be
considered in determining the initial public offering price of the shares, in
addition to prevailing market conditions, are Cobalt's historical performance,
estimates of Cobalt's business potential and earnings prospects, an assessment
of Cobalt's management and the consideration of the above factors in relation
to market valuation of companies in related businesses.
Application has been made for quotation of the common stock on the Nasdaq
National Market under the symbol "COBT".
In connection with this offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering.
Stabilizing transactions consist of bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.
The underwriters may also impose a penalty bid. This occurs when a particular
underwriter repays to the underwriters a portion of the underwriting discount
received by it because the representatives have repurchased shares sold by or
for the account of this underwriter in stabilizing or short-sale covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the
open market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
The underwriters do not expect sales to discretionary accounts to exceed five
percent of the total number of shares offered.
At Cobalt's request, the underwriters have reserved up to 250,000 shares of
the common stock offered hereby for sale, at the initial public offering price,
to Cobalt's distributors, suppliers, original equipment manufacturing, open
source software developers, friends and family members of employees and other
friends of Cobalt through a directed share program. The number of shares
available for sale to the general public will be reduced to the extent these
persons purchase the reserved shares. There can be no assurance that any of the
reserved shares will be so purchased. Any reserved shares not so purchased will
be offered by the underwriters to the general public on the same basis as other
shares offered hereby.
Cobalt estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $1,050,000.
Cobalt has agreed to indemnify the underwriters against liabilities,
including liabilities under the Securities Act of 1933.
U-2
<PAGE>
[Description for EDGAR: Picture of a woman holding 4 Cobalt RaQ server
appliances with stacks of Cobalt RaQ server appliances in the background.
Underneath the picture is the caption "The Cobalt RaQ" and beneath that is the
following text: "Simple. Affordable. The dedicated hosting solution that is
less than two inches tall." Beneath this text is the Cobalt logo and the words
"Cobalt Networks".]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is an offer to
sell only the shares offered hereby, but only under circumstances and in
jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
--------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Forward-Looking Statements............................................... 21
Use of Proceeds.......................................................... 22
Dividend Policy.......................................................... 22
Capitalization........................................................... 23
Dilution................................................................. 24
Selected Consolidated Financial Data..................................... 25
Management's Discussion and Analysis of Financial Condition and Results
of Operations .......................................................... 27
Business................................................................. 38
Management............................................................... 53
Related Party Transactions............................................... 63
Principal Stockholders................................................... 66
Description of Capital Stock ............................................ 69
Shares Eligible for Future Sale.......................................... 73
Legal Matters............................................................ 74
Experts.................................................................. 74
Where You Can Find Additional Information................................ 75
Index to Consolidated Financial Statements............................... F-1
Underwriting............................................................. U-1
</TABLE>
--------------
Through and including , 1999 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to a dealer's obligation to deliver a prospectus when
acting as underwriter and with respect to an unsold allotment or subscription.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
5,000,000 Shares
Cobalt Networks, Inc.
Common Stock
--------------
[COBALT LOGO APPEARS HERE]
--------------
Goldman, Sachs & Co.
Merrill Lynch & Co.
Robertson Stephens
SoundView Technology Group
Representatives of the Underwriters
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth the costs and expenses, other than the
underwriting discounts, payable by the Registrant in connection with the sale
of the securities being registered. All amounts are estimates except the SEC
registration fee, the NASD filing fee and the Nasdaq National Market listing
fee.
<TABLE>
<S> <C>
SEC Registration Fee............................................. $ 23,978
NASD Filing Fee.................................................. 9,125
Nasdaq National Market Listing Fee............................... 95,000
Printing Costs................................................... 275,000
Legal Fees and Expenses.......................................... 350,000
Accounting Fees and Expenses..................................... 250,000
Blue Sky Fees and Expenses....................................... 5,000
Transfer Agent and Registrar Fees................................ 10,000
Miscellaneous.................................................... 31,897
----------
Total...................................................... $1,050,000
==========
</TABLE>
Item 14. Indemnification of Directors and Officers.
As permitted by Section 204(a) of the California General Corporation Law, the
Registrant's Amended and Restated Articles of Incorporation eliminate a
director's personal liability for monetary damages to the Registrant and its
shareholders arising from a breach or alleged breach of the director's
fiduciary duty, except for liability arising under Sections 310 and 316 of the
California General Corporation Law or liability for (i) acts or omissions that
involve intentional misconduct or knowing and culpable violation of law, (ii)
acts or omissions that a director believes to be contrary to the best interests
of the Registrant or its shareholders or that involve the absence of good faith
on the part of the director, (iii) any transaction from which a director
derived an improper personal benefit, (iv) acts or omissions that show a
reckless disregard for the director's duty to the Registrant or its
shareholders in circumstances in which the director was aware, or should have
been aware, in the ordinary course of performing a director's duties, of a risk
of serious injury to the Registrant or its shareholders, (v) acts or omissions
that constitute an unexcused pattern of inattention that amounts to an
abdication of the director's duty to the Registrant or its shareholders, (vi)
interested transactions between the corporation and a director in which a
director has a material financial interest, and (vii) liability for improper
distributions, loans or guarantees. This provision does not eliminate the
directors' duty of care, and in appropriate circumstances equitable remedies
such as an injunction or other forms of non-monetary relief would remain
available under California law.
Sections 204(a) and 317 of the California General Corporation Law authorize a
corporation to indemnify its directors, officers, employees and other agents in
terms sufficiently broad to permit indemnification (including reimbursement for
expenses) under certain circumstances for liabilities arising under the
Securities Act of 1933, as amended (the "Securities Act"). The Registrant's
Amended and Restated Articles of Incorporation and Bylaws contain provisions
covering indemnification to the maximum extent permitted by the California
General Corporation Law of corporate directors, officers and other agents
against certain liabilities and expenses incurred as a result of proceedings
involving such persons in their capacities as directors, officers employees or
agents, including proceedings under the Securities Act or the Securities
Exchange Act of 1934, as amended. Prior to the effective date of this Offering,
the Registrant will enter into indemnification agreements with its directors
and executive officers.
In connection with its reincorporation in Delaware, the Registrant will be
subject to Section 145 of the Delaware General Corporation Law ("Section 145").
Section 145 permits indemnification of
II-1
<PAGE>
officers and directors of the Company under certain conditions and subject to
certain limitations. Section 145 also provides that a corporation has the power
to maintain insurance on behalf of its officers and directors against any
liability asserted against such person and incurred by him or her in such
capacity, or arising out of his or her status as such, whether or not the
corporation would have the power to indemnify him or her against such liability
under the provisions of Section 145. Upon shareholder approval of such
reincorporation, Article VI, Section 6.1, of the Registrant's Bylaws will
provide for mandatory indemnification of its directors and officers and
permissible indemnification of employees and other agents to the maximum extent
not prohibited by the Delaware General Corporation Law. The rights to indemnity
thereunder continue as to a person who has ceased to be a director, officer,
employee or agent and inure to the benefit of the heirs, executors and
administrators of the person. In addition, expenses incurred by a director or
executive officer in defending any civil, criminal, administrative or
investigative action, suit or proceeding by reason of the fact that he or she
is or was a director or officer of the Registrant (or was serving at the
Registrant's request as a director or officer of another corporation) shall be
paid by the Registrant in advance of the final disposition of such action, suit
or proceeding upon receipt of an undertaking by or on behalf of such director
or officer to repay such amount if it shall ultimately be determined that he or
she is not entitled to be indemnified by the Registrant as authorized by the
relevant section of the Delaware General Corporation Law.
As permitted by Section 102(b)(7) of the Delaware General Corporation Law,
the Registrant's Certificate of Incorporation provides that, pursuant to
Delaware law, its directors shall not be personally liable for monetary damages
for breach of the directors' fiduciary duty as directors to the Registrant and
its stockholders. This provision in the Certificate of Incorporation does not
eliminate the directors' fiduciary duty, and in appropriate circumstances
equitable remedies such as injunctive or other forms of non-monetary relief
will remain available under Delaware law. In addition, each director will
continue to be subject to liability for breach of the director's duty of
loyalty to the Registrant for acts or omission not in good faith or involving
international misconduct, for knowing violations of law, for actions leading to
improper personal benefit to the director, and for payment of dividends or
approval of Stock repurchases or redemptions that are unlawful under Section
174 of the Delaware General Corporation Law. The provision also does not affect
a director's responsibilities under any other law, such as the federal
securities laws or state or federal environmental laws. The Registrant has
entered into indemnification agreements with each of its directors and
executive officers. Generally, the indemnification agreements attempt to
provide the maximum protection permitted by Delaware law as it may be amended
from time to time. Moreover, the indemnification agreements provide for certain
additional indemnification. Under such additional indemnification provisions,
however, an individual will not receive indemnification for judgments,
settlements or expenses if he or she is found liable to the Registrant (except
to the extent the court determines he or she is fairly and reasonably entitled
to indemnity for expenses), for settlements not approved by the Registrant or
for settlements and expenses if the settlement is not approved by the court.
The indemnification agreements provide for the Registrant to advance to the
individual any and all reasonable expenses (including legal fees and expenses)
incurred in investigating or defending any such action, suit or proceeding. In
order to receive an advance of expenses, the individual must submit to the
Registrant copies of invoices presented to him or her for such expenses. Also,
the individual must repay such advances upon a final judicial decision that he
or she is not entitled to indemnification.
The Registrant intends to enter into additional indemnification agreements
with each of its directors and executive officers to effectuate these indemnity
provisions and to purchase directors' and officers' liability insurance.
In addition to the foregoing, the Underwriting Agreement contains certain
provisions by which the Underwriters have agreed to indemnify the Registrant,
each person, if any, who controls the
II-2
<PAGE>
Registrant within the meaning of Section 15 of the Securities Act, each
director of the Registrant, each officer of the Registrant who signs the
Registration Statement, with respect to information furnished in writing by or
on behalf of the Underwriters for use in the Registration Statement.
At present, there is no pending litigation or proceeding involving a
director, officer, employee or other agent of the Registrant in which
indemnification is being sought, nor is the Registrant aware of any threatened
litigation that may result in a claim for indemnification by any director,
officer, employee or other agent of the Registrant.
Item 15. Recent Sales of Unregistered Securities.
Since our incorporation in October 1996, we have sold and issued the
following securities:
(1) In May and June 1997 the Registrant issued and sold 4,181,426 shares
of Common Stock to employees for $4,181 pursuant to Section 4(2) of the
Securities Act.
(2) In August 1997, the Registrant issued and sold 471,338 shares of
Common Stock to three employees for $471 pursuant to Section 4(2) of the
Securities Act.
(3) From August to November 1997, the Registrant issued and sold
3,572,401 shares of Series A Preferred Stock to 13 investors for $3.6
million pursuant to Section 4(2) of the Securities Act.
(4) In March and April 1998, the Registrant issued and sold 800,000
shares of Common Stock to one employee for $80,000 pursuant to Section 4(2)
of the Securities Act.
(5) In July 1998, the Registrant issued and sold 3,698,910 shares of
Series B Preferred Stock to 21 investors for $8.0 million pursuant to
Section 4(2) of the Securities Act.
(6) In February 1999, the Registrant issued and sold 100,000 shares of
Common Stock to one employee for $50,000 pursuant to Section 4(2) of the
Securities Act.
(7) In May 1999, the Registrant issued and sold 9,813,507 shares of
Series C Preferred Stock to 60 investors for $36.3 million pursuant to
Section 4(2) of the Securities Act.
(8) In August, September and October 1999, the Registrant issued and sold
76,250 shares of Series A Preferred Stock upon the exercise of warrants to
seven stockholders for aggregate consideration of $76,250 pursuant to
Section 4(2) of the Securities Act.
(9) In August 1999, the Registrant issued and sold 11,559 shares of
Series B Preferred Stock upon the exercise of a warrant to one stockholder
for aggregate consideration of $25,000 pursuant to Section 4(2) of the
Securities Act.
(10) In August 1999, the Registrant issued and sold 6,756 shares of
Series C Preferred Stock upon the exercise of a warrant to one stockholder
for aggregate consideration of $24,997 pursuant to Section 4(2) of the
Securities Act.
(11) Pursuant to Rule 701 promulgated under the Securities Act, from
October 18, 1996 to October 1, 1999, the Registrant issued and sold 390,905
shares of Common Stock to employees and consultants for aggregate
consideration of $56,809 upon the exercise of stock options pursuant to the
Registrant's Employee Stock Plan.
The recipients of securities in each such transaction represented their
intentions to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof and appropriate legends
were affixed to the share certificates and warrants issued in such
transactions. All recipients had adequate access, through their relationships
with us, to information about us.
II-3
<PAGE>
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
1.1 Form of Underwriting Agreement
2.1* Form of Merger Agreement between Cobalt Networks, Inc., a
California corporation, and Cobalt Networks, Inc., a Delaware
corporation
3.1* Certificate of Incorporation of the Registrant, as currently in
effect
3.1.1 Form of Amended and Restated Certificate of Incorporation of
Registrant
3.1.2 Form of Certificate of Incorporation of the Registrant to be filed
after the closing of the offering made under this Registration
Statement
3.2 Bylaws of the Registrant
3.3* California Restated Articles of Incorporation
3.4* California Bylaws
4.1 Specimen Common Stock Certificate
4.2* Second Amended and Restated Investors' Rights Agreement, dated
April 30, 1999, by and among the Registrant and certain
stockholders of the Registrant
5.1 Opinion of Wilson Sonsini Goodrich & Rosati, Professional
Corporation
10.1* Form of Indemnification Agreement between the Registrant and each
of its directors and officers
10.2* Amended and Restated 1997 Employee Stock Plan
10.2.1* Form of Option Agreement under the Employee Stock Plan
10.3* 1999 Employee Stock Purchase Plan
10.3.1* Form of Subscription Agreement under the 1999 Employee Stock
Purchase Plan
10.4* 1999 Director Option Plan
10.4.1* Form of Option Agreement under 1999 Director Plan
10.5* Form of Executive Officer Employment Agreement
10.6* Consulting Agreement dated August 30, 1996 by and between the
Registrant and Techfarm Management, Inc.
10.7* Lease Agreement dated August 5, 1998 between Registrant and Renault
& Handley Solar Ellis Joint Venture for 555 Ellis Street, Mountain
View, California office
10.7.1* Assignment of lease dated September 2, 1998 between Registrant and
Netscape Communications, Inc.
10.7.2* Sublease dated October 28, 1996 between Netscape Communications,
Inc. and Banta Corporation
10.7.3* Addendum One to sublease dated November 6, 1996 among Netscape
Communications, Inc., Banta Corporation and Renault & Handley Solar
Ellis Joint Venture
10.7.4* Lease dated August 10, 1993 ("Master Lease") between Banta Digital
Services, Inc. and Renault & Handley Solar Ellis Joint Venture
10.8* Employee Option Agreement dated July 15, 1998 between the
Registrant and George M. Korchinsky
10.9* Employment Offer Letter dated July 20, 1999 from the Registrant to
Gary Martell
10.10* Separation Agreement dated July 28, 1999 by and between the
Registrant and Robin Porter
10.11+* Turnkey Service and Purchase Agreement dated August 31, 1999 by and
among the Registrant and SMTC Manufacturing Corporation
10.12* Promissory Note and Security Agreement dated August 20, 1999
between the Registrant and Stephen W. DeWitt
10.13+** Gateway Master Supply Agreement dated September 16, 1999 between
the Registrant and Gateway, Inc.
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
10.14 Employment Agreement dated August 31, 1999 between the Registrant
and Vivek Mehra
21.1* Subsidiaries
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants
24.1* Power of Attorney
27.1 Financial Data Schedule
</TABLE>
- --------
* Previously filed
** To be filed by amendment
+ Confidential treatment requested
(b) Financial Statement Schedules.
Schedules not listed above have been omitted because the information required
to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
Item 17. Undertakings
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreements certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer, or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 19314, the registrant
has duly caused this amendment no. 1 to this registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Mountain View, State of California on October 14, 1999.
/s/ Stephen W. DeWitt
By: _________________________________
Stephen W. DeWitt
President and Chief Executive
Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 19314, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Stephen W. DeWitt President, Chief Executive October 14, 1999
______________________________________ Officer and Director
Stephen W. DeWitt (Principal Executive
Officer)
/s/ Kenton D. Chow Vice President Finance and October 14, 1999
______________________________________ Chief Financial Officer
Kenton D. Chow (Principal Financial and
Accounting Officer)
Gordon A. Campbell* Chairman of the Board of October 14, 1999
______________________________________ Directors
Gordon A. Campbell
Jordan A. Levy* Director October 14, 1999
______________________________________
Jordan A. Levy
*By: /s/ Stephen W. DeWitt
____________________________________
Stephen W. DeWitt
Attorney-in-fact
</TABLE>
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
1.1 Form of Underwriting Agreement
2.1* Form of Merger Agreement between Cobalt Networks, Inc., a
California corporation, and Cobalt Networks, Inc., a Delaware
corporation
3.1* Certificate of Incorporation of the Registrant, as currently in
effect
3.1.1 Form of Amended and Restated Certificate of Incorporation of
Registrant
3.1.2 Form of Certificate of Incorporation of the Registrant to be filed
after the closing of the offering made under this Registration
Statement
3.2 Bylaws of the Registrant
3.3* California Restated Articles of Incorporation
3.4* California Bylaws
4.1 Specimen Common Stock Certificate
4.2* Second Amended and Restated Investors' Rights Agreement, dated
April 30, 1999, by and among the Registrant and certain
stockholders of the Registrant
5.1 Opinion of Wilson Sonsini Goodrich & Rosati, Professional
Corporation
10.1* Form of Indemnification Agreement between the Registrant and each
of its directors and officers
10.2* Amended and Restated 1997 Employee Stock Plan
10.2.1* Form of Option Agreement under the Employee Stock Plan
10.3* 1999 Employee Stock Purchase Plan
10.3.1* Form of Subscription Agreement under the 1999 Employee Stock
Purchase Plan
10.4* 1999 Director Option Plan
10.4.1* Form of Option Agreement under 1999 Director Plan
10.5* Form of Executive Officer Employment Agreement
10.6* Consulting Agreement dated September 30, 1996 by and between the
Registrant and Techfarm Management, Inc.
10.7* Lease Agreement dated August 5, 1998 between Registrant and Renault
& Handley Solar Ellis Joint Venture for 555 Ellis Street, Mountain
View, California office
10.7.1* Assignment of lease dated September 2, 1998 between Registrant and
Netscape Communications, Inc.
10.7.2* Sublease dated October 28, 1996 between Netscape Communications,
Inc. and Banta Corporation
10.7.3* Addendum One to sublease dated November 6, 1996 among Netscape
Communications, Inc., Banta Corporation and Renault & Handley Solar
Ellis Joint Venture
10.7.4* Lease dated August 10, 1993 ("Master Lease") between Banta Digital
Services, Inc. and Renault & Handley Solar Ellis Joint Venture
10.8* Employee Option Agreement dated July 15, 1998 between the
Registrant and George Korchinsky
10.9* Employment Offer Letter dated July 20, 1999 from the Registrant to
Gary Martell
10.10* Separation Agreement dated July 28, 1999 by and between the
Registrant and Robin Porter
10.11+* Turnkey Service and Purchase Agreement dated August 31, 1999 by and
among the Registrant and SMTC Manufacturing Corporation
10.12* Promissory Note and Security Agreement dated August 20, 1999
between the Registrant and Stephen W. DeWitt
10.13+** Gateway Master Supply Agreement dated September 16, 1999 between
the Registrant and Gateway, Inc.
10.14 Employment Agreement dated August 31, 1999 between the Registrant
and Vivek Mehra
21.1* Subsidiaries
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants
23.2 Form of Consent of Counsel (included in Exhibit 5.1)
24.1* Power of Attorney
27.1 Financial Data Schedule
</TABLE>
- -------
* Previously filed
** To be filed by amendment
+ Confidential treatment requested
<PAGE>
EXHIBIT 1.1
Cobalt Networks, Inc.
Common Stock
Underwriting Agreement
----------------------
....................., 1999
Goldman, Sachs & Co.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated
BancBoston Robertson Stephens Inc.
SoundView Technology Group, Inc.
As representatives of the several Underwriters
named in Schedule I hereto,
c/o Goldman, Sachs & Co.,
85 Broad Street,
New York, New York 10004
Ladies and Gentlemen:
Cobalt Networks, Inc., a Delaware corporation (the "Company"), proposes,
subject to the terms and conditions stated herein, to issue and sell to the
Underwriters named in Schedule I hereto (the "Underwriters") an aggregate of
5,000,000 shares (the "Firm Shares") and, at the election of the Underwriters,
up to 750,000 additional shares of common stock (the "Optional Shares") of the
Company. The Firm Shares and the Optional Shares that the Underwriters elect to
purchase pursuant to Section 2 hereof being collectively called the "Shares".
1. The Company represents and warrants to, and agrees with, each of the
Underwriters that:
(a) A registration statement on Form S-1 (File No. 333-86759) (the
"Initial Registration Statement") in respect of the Shares has been filed
with the Securities and Exchange Commission (the "Commission"); the Initial
Registration Statement and any post-effective amendment thereto, each in
the form heretofore delivered to you, and, excluding exhibits thereto, to
you for each of the other Underwriters, have been declared effective by the
Commission in such form; other than a registration statement, if any,
increasing the size of the offering (a "Rule 462(b) Registration
Statement"), filed pursuant
<PAGE>
to Rule 462(b) under the Securities Act of 1933, as amended (the "Act"),
which became effective upon filing, no other document with respect to the
Initial Registration Statement has heretofore been filed with the
Commission other than a registration statement on Form 8-A filed pursuant
to the Securities Exchange Act of 1934, as amended; and no stop order
suspending the effectiveness of the Initial Registration Statement, any
post-effective amendment thereto or the Rule 462(b) Registration Statement,
if any, has been issued and no proceeding for that purpose has been
initiated or threatened by the Commission (any preliminary prospectus
included in the Initial Registration Statement or filed with the Commission
pursuant to Rule 424(a) of the rules and regulations of the Commission
under the Act is hereinafter called a "Preliminary Prospectus"; the various
parts of the Initial Registration Statement and the Rule 462(b)
Registration Statement, if any, including all exhibits thereto and
including the information contained in the form of final prospectus filed
with the Commission pursuant to Rule 424(b) under the Act in accordance
with Section 5(a) hereof and deemed by virtue of Rule 430A under the Act to
be part of the Initial Registration Statement at the time it was declared
effective, each as amended at the time such part of the Initial
Registration Statement became effective or such part of the Rule 462(b)
Registration Statement, if any, became or hereafter becomes effective, are
hereinafter collectively called the "Registration Statement"; and such
final prospectus, in the form first filed pursuant to Rule 424(b) under the
Act, is hereinafter called the "Prospectus";
(b) No order preventing or suspending the use of any Preliminary
Prospectus has been issued by the Commission, and each Preliminary
Prospectus, at the time of filing thereof, conformed in all material
respects to the requirements of the Act and the rules and regulations of
the Commission thereunder, and did not contain an untrue statement of a
material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in the light of the
circumstances under which they were made, not misleading; provided,
however, that this representation and warranty shall not apply to any
statements or omissions made in reliance upon and in conformity with
information furnished in writing to the Company by an Underwriter through
Goldman, Sachs & Co. expressly for use therein;
(c) The Registration Statement conforms, and the Prospectus and any
further amendments or supplements to the Registration Statement or the
Prospectus will conform, in all material respects to the requirements of
the Act and the rules and regulations of the Commission thereunder and do
not and will not, as of the applicable effective date as to the
Registration Statement and any amendment thereto and as of the applicable
filing date as to the Prospectus and any amendment or supplement thereto,
contain an untrue statement of a material fact or omit to state a material
fact required to be stated therein or necessary to make the statements
therein not misleading; provided, however, that this representation and
warranty shall not apply to any statements or omissions made in reliance
upon and in conformity with information furnished in writing to the Company
by an Underwriter through Goldman, Sachs & Co. expressly for use therein;
2
<PAGE>
(d) Neither the Company nor any of its subsidiaries has sustained
since the date of the latest audited financial statements included in the
Prospectus any material loss or interference with its business from fire,
explosion, flood or other calamity, whether or not covered by insurance, or
from any labor dispute or court or governmental action, order or decree,
otherwise than as set forth or contemplated in the Prospectus; and, since
the respective dates as of which information is given in the Registration
Statement and the Prospectus, there has not been any change in the capital
stock (other than the exercise of stock options or warrants outstanding and
grants of stock options authorized under the employee stock plans described
in the Prospectus) or long-term debt of the Company or any of its
subsidiaries or any material adverse change, or any development involving a
prospective material adverse change, in or affecting the general affairs,
management, financial position, stockholders' equity or results of
operations of the Company and its subsidiaries, otherwise than as set forth
or contemplated in the Prospectus;
(e) The Company and its subsidiaries have good and marketable title
in fee simple to all real property and good and marketable title to all
personal property owned by them, in each case free and clear of all liens,
encumbrances and defects except such as are described in the Prospectus or
such as do not materially affect the value of such property and do not
interfere with the use made and proposed to be made of such property by the
Company and its subsidiaries; and any real property and buildings held
under lease by the Company and its subsidiaries are held by them under
valid, subsisting and enforceable leases with such exceptions as are not
material and do not interfere with the use made and proposed to be made of
such property and buildings by the Company and its subsidiaries;
(f) The Company has been duly incorporated and is validly existing as
a corporation in good standing under the laws of the Delaware, with power
and authority (corporate and other) to own its properties and conduct its
business as described in the Prospectus, and has been duly qualified as a
foreign corporation for the transaction of business and is in good standing
under the laws of each other jurisdiction in which it owns or leases
properties or conducts any business so as to require such qualification, or
is subject to no material liability or disability by reason of the failure
to be so qualified in any such jurisdiction; and each subsidiary of the
Company has been duly incorporated and is validly existing as a corporation
in good standing under the laws of its jurisdiction of incorporation;
(g) The Company has an authorized capitalization as set forth in the
Prospectus, and all of the issued shares of capital stock of the Company
have been duly and validly authorized and issued, are fully paid and non-
assessable and conform to the description of the Stock contained in the
Prospectus; the shares of Stock issuable upon conversion of the Series A
Preferred Stock, the Series B Preferred Stock and the Series C Preferred
Stock (collectively, the "Preferred Stock") have been duly and validly
authorized and reserved for issuance upon such conversion and, upon
conversion of the Preferred Stock on the First Time of Delivery (as defined
in Section 4 hereof), the shares of Stock issuable upon such
3
<PAGE>
conversion will be validly issued, fully paid and non-assessable and will
conform to the description of the Stock contained in the Prospectus; all
outstanding warrants (the "Warrants") to purchase shares of capital stock
of the Company have been duly and validly authorized, executed and
delivered by the Company and constitute valid and binding obligations of
the Company enforceable against the Company in accordance with their terms,
and the shares of capital stock issuable upon exercise of such Warrants
have been duly and validly authorized and reserved for issuance upon such
exercise and, upon payment of the exercise price thereof upon exercise of
such Warrants, such shares of capital stock will be validly issued, fully
paid and non-assessable and will conform to the description of such stock
contained in the Prospectus; except as described or contemplated in the
Prospectus, there are no outstanding rights, warrants or options to
acquire, or instruments convertible into or exchangeable for, any shares of
capital stock of, or other equity interests in, the Company, or any
contract, commitment, agreement, understanding or arrangement of any kind
relating to the issuance of any capital stock of the Company or any such
convertible or exchangeable securities or any such rights, warrants or
options; and all of the issued shares of capital stock of each subsidiary
of the Company have been duly and validly authorized and issued, are fully
paid and non-assessable and (except for directors' qualifying shares) are
owned directly or indirectly by the Company, free and clear of all liens,
encumbrances, equities or claims;
(h) The unissued Shares to be issued and sold by the Company to the
Underwriters hereunder have been duly and validly authorized and, when
issued and delivered against payment therefor as provided herein, will be
duly and validly issued and fully paid and non-assessable and will conform
to the description of the Stock contained in the Prospectus;
(i) The issue and sale of the Shares to be sold by the Company and
the compliance by the Company with all of the provisions of this Agreement
and the consummation of the transactions herein contemplated will not
conflict with or result in a breach or violation of any of the terms or
provisions of, or constitute a default under, any indenture, mortgage, deed
of trust, loan agreement or other agreement or instrument to which the
Company or any of its subsidiaries is a party or by which the Company or
any of its subsidiaries is bound or to which any of the property or assets
of the Company or any of its subsidiaries is subject, nor will such action
result in any violation of the provisions of the Certificate of
Incorporation or By-laws of the Company or any statute or any order, rule
or regulation of any court or governmental agency or body having
jurisdiction over the Company or any of its subsidiaries or any of their
properties; and no consent, approval, authorization, order, registration or
qualification of or with any such court or governmental agency or body is
required for the issue and sale of the Shares or the consummation by the
Company of the transactions contemplated by this Agreement, except the
registration under the Act of the Shares and such consents, approvals,
authorizations, registrations or qualifications as may be required under
state securities or Blue Sky laws in connection with the purchase and
distribution of the Shares by the Underwriters;
4
<PAGE>
(j) No holder of securities of the Company has any rights, not
effectively satisfied or waived, to the registration of such securities for
sale under the Act in connection with this offering as a result of the
filing of the Registration Statement or otherwise in connection with the
offer and sale of the Shares by the Underwriters hereunder;
(k) Neither the Company nor any of its subsidiaries is in violation
of its Certificate of Incorporation or By-laws or in default in the
performance or observance of any material obligation, agreement, covenant
or condition contained in any indenture, mortgage, deed of trust, loan
agreement, lease or other agreement or instrument to which it is a party or
by which it or any of its properties may be bound;
(l) The statements set forth in the Prospectus under the caption
"Description of Capital Stock", insofar as they purport to constitute a
summary of the terms of the Stock, and under the caption "Underwriting",
insofar as they purport to describe the provisions of the laws and
documents referred to therein, are accurate, complete and fair;
(m) Other than as set forth in the Prospectus, there are no legal or
governmental proceedings pending to which the Company or any of its
subsidiaries is a party or of which any property of the Company or any of
its subsidiaries is the subject which, if determined adversely to the
Company or any of its subsidiaries, would individually or in the aggregate
have a material adverse effect on the current or future consolidated
financial position, stockholders' equity or results of operations of the
Company and its subsidiaries; and, to the best of the Company's knowledge,
no such proceedings are threatened or contemplated by governmental
authorities or threatened by others;
(n) The Company is not and, after giving effect to the offering and
sale of the Shares, will not be an "investment company", as such term is
defined in the Investment Company Act of 1940, as amended (the "Investment
Company Act");
(o) Neither the Company nor any of its affiliates does business with
the government of Cuba or with any person or affiliate located in Cuba
within the meaning of Section 517.075, Florida Statutes;
(p) Pricewaterhouse Coopers LLC, who have certified certain financial
statements of the Company and its subsidiaries, are each independent public
accountants as required by the Act and the rules and regulations of the
Commission thereunder;
(q) The financial statements and schedules of the Company and its
subsidiaries included in the Registration Statement and the Prospectus were
prepared in accordance with generally accepted accounting principles
consistently applied throughout the periods involved and present fairly the
financial condition of the Company and its subsidiaries as of
5
<PAGE>
the dates indicated therein and the results of operations of the Company
and its subsidiaries for the periods indicated therein;
(r) The Company maintains a system of internal accounting controls
sufficient to provide reasonable assurance that (i) transactions are
executed in accordance with management's general or specific
authorizations; (ii) transactions are recorded as necessary to permit
preparation of financial statements in conformity with generally accepted
accounting principles and to maintain asset accountability; (iii) access to
assets is permitted only in accordance with management's general or
specific authorization; and (iv) the recorded accountability for assets is
compared with the existing assets at reasonable intervals and appropriate
action is taken with respect to any differences;
(s) The Company and its subsidiaries own or possess, or can acquire
on reasonable terms, all licenses, inventions, copyrights, know-how
(including trade secrets and other unpatented and/or unpatentable
proprietary or confidential information, systems or procedures),
trademarks, service marks and trade names, patents and patent rights
necessary for the conduct of its business as described in the Prospectus,
and the Company has no reason to believe that the conduct of its business
will conflict with, and has not received any notice of any claim of
conflict with, any such rights of others, except as would not have a
material adverse effect on the business, financial condition, results of
operations or prospects of the Company; and, to the Company's knowledge,
neither the Company nor any of its subsidiaries have infringed or are
infringing any trademarks, service marks, trade mark registrations, service
mark registrations, domain names or copyrights, which infringement could
reasonably be expected to results in a material adverse change in or
affecting the general affairs, financial position, stockholder's equity or
results of operations of the Company and its subsidiaries; and
(t) The Company has reviewed its operations and that of its
subsidiaries and any third parties with which the Company or any of its
subsidiaries has a material relationship to evaluate the extent to which
the business or operations of the Company or any of its subsidiaries will
be affected by the Year 2000 Problem. As a result of such review, the
Company has no reason to believe, and does not believe, that the Year 2000
Problem will have a material adverse effect on the general affairs,
management, the current or future consolidated financial position, business
prospects, stockholders' equity or results of operations of the Company and
its subsidiaries or result in any material loss or interference with the
Company's business or operations. The "Year 2000 Problem" as used herein
means any significant risk that computer hardware or software used in the
receipt, transmission, processing, manipulation, storage, retrieval,
retransmission or other utilization of data or in the operation of
mechanical or electrical systems of any kind will not, in the case of dates
or time periods occurring after December 31, 1999, function at least as
effectively as in the case of dates or time periods occurring prior to
January 1, 2000.
6
<PAGE>
2. Subject to the terms and conditions herein set forth, (a) the Company
agrees to issue to each of the Underwriters, and each of the Underwriters
agrees, severally and not jointly, to purchase from the Company, at a purchase
price per share of $.............., the number of Firm Shares (to be adjusted by
you so as to eliminate fractional shares) set forth opposite the name in
Schedule I hereto and (b) in the event and to the extent that the Underwriters
shall exercise the election to purchase Optional Shares as provided below, the
Company agrees to sell to each of the Underwriters, and each of the Underwriters
agrees, severally and not jointly, to purchase from the Company, at the purchase
price per share set forth in clause (a) of this Section 2, that portion of the
number of Optional Shares as to which such election shall have been exercised
(to be adjusted by you so as to eliminate fractional shares) determined by
multiplying such number of Optional Shares by a fraction the numerator of which
is the maximum number of Optional Shares which such Underwriter is entitled to
purchase as set forth opposite the name of such Underwriter in Schedule I hereto
and the denominator of which is the maximum number of Optional Shares that all
of the Underwriters are entitled to purchase hereunder.
The Company grants to the Underwriters the right to purchase at their
election up to 750,000 Optional Shares, at the purchase price per share set
forth in the paragraph above, for the sole purpose of covering sales of shares
in excess of the number of Firm Shares. Any such election to purchase Optional
Shares may be exercised only by written notice from you to the Company given
within a period of 30 calendar days after the date of this Agreement and setting
forth the aggregate number of Optional Shares to be purchased and the date on
which such Optional Shares are to be delivered, as determined by you but in no
event earlier than the First Time of Delivery (as defined in Section 4 hereof)
or, unless you and the Company otherwise agree in writing, earlier than two or
later than ten business days after the date of such notice.
3. Upon the authorization by you of the release of the Firm Shares, the
several Underwriters propose to offer the Firm Shares for sale upon the terms
and conditions set forth in the Prospectus.
4. (a) The Shares to be purchased by each Underwriter hereunder, in
definitive form, and in such authorized denominations and registered in such
names as Goldman, Sachs & Co. may request upon at least forty-eight hours' prior
notice to the Company shall be delivered by or on behalf of the Company to
Goldman, Sachs & Co., through the facilities of the Depository Trust Company
("DTC"), for the account of such Underwriter, against payment by or on behalf of
such Underwriter of the purchase price therefor by wire transfer of Federal
(same-day) funds to the account specified by the Company, to Goldman, Sachs &
Co. at least forty-eight hours in advance. The Company will cause the
certificates representing the Shares to be made available for checking and
packaging at least twenty-four hours prior to the Time of Delivery (as defined
below) with respect thereto at the office of DTC or its designated custodian
(the "Designated Office"). The time and date of such delivery and payment shall
be, with respect to the Firm Shares, 9:30 a.m., New York time, on .............,
1999 or such other time and date as Goldman, Sachs & Co. and the Company may
agree upon in writing, and, with respect to the Optional Shares, 9:30 a.m., New
York time, on the date
7
<PAGE>
specified by Goldman, Sachs & Co. in the written notice given by Goldman, Sachs
& Co. of the Underwriters' election to purchase such Optional Shares, or such
other time and date as Goldman, Sachs & Co. and the Company may agree upon in
writing. Such time and date for delivery of the Firm Shares is herein called the
"First Time of Delivery", such time and date for delivery of the Optional
Shares, if not the First Time of Delivery, is herein called the "Second Time of
Delivery", and each such time and date for delivery is herein called a "Time of
Delivery".
(b) The documents to be delivered at each Time of Delivery by or on behalf
of the parties hereto pursuant to Section 7 hereof, including the cross receipt
for the Shares and any additional documents requested by the Underwriters
pursuant to Section 7(k) hereof, will be delivered at the offices of Wilson
Sonsini Goodrich & Rosati, 650 Page Mill Road, Palo Alto, CA 94304 (the "Closing
Location"), and the Shares will be delivered at the Designated Office, all at
such Time of Delivery. A meeting will be held at the Closing Location at 6:00
p.m., New York City time, on the New York Business Day next preceding such Time
of Delivery, at which meeting the final drafts of the documents to be delivered
pursuant to the preceding sentence will be available for review by the parties
hereto. For the purposes of this Section 4, "New York Business Day" shall mean
each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which
banking institutions in New York are generally authorized or obligated by law or
executive order to close.
5. The Company agrees with each of the Underwriters:
(a) To prepare the Prospectus in a form approved by you and to file
such Prospectus pursuant to Rule 424(b) under the Act not later than the
Commission's close of business on the second business day following the
execution and delivery of this Agreement, or, if applicable, such earlier
time as may be required by Rule 430A(a)(3) under the Act; to make no
further amendment or any supplement to the Registration Statement or
Prospectus prior to the last Time of Delivery which shall be disapproved by
you promptly after reasonable notice thereof; to advise you, promptly after
it receives notice thereof, of the time when any amendment to the
Registration Statement has been filed or becomes effective or any
supplement to the Prospectus or any amended Prospectus has been filed and
to furnish you with copies thereof; to advise you, promptly after it
receives notice thereof, of the issuance by the Commission of any stop
order or of any order preventing or suspending the use of any Preliminary
Prospectus or prospectus, of the suspension of the qualification of the
Shares for offering or sale in any jurisdiction, of the initiation or
threatening of any proceeding for any such purpose, or of any request by
the Commission for the amending or supplementing of the Registration
Statement or Prospectus or for additional information; and, in the event of
the issuance of any stop order or of any order preventing or suspending the
use of any Preliminary Prospectus or prospectus or suspending any such
qualification, promptly to use its best efforts to obtain the withdrawal of
such order;
(b) Promptly from time to time to take such action as you may
reasonably request to qualify the Shares for offering and sale under the
securities laws of such jurisdictions as
8
<PAGE>
you may request and to comply with such laws so as to permit the
continuance of sales and dealings therein in such jurisdictions for as long
as may be necessary to complete the distribution of the Shares, provided
that in connection therewith the Company shall not be required to qualify
as a foreign corporation or to file a general consent to service of process
in any jurisdiction;
(c) Prior to 10:00 a.m., New York City time, on the New York Business
Day next succeeding the date of this Agreement and from time to time, to
furnish the Underwriters with copies of the Prospectus in New York City in
such quantities as you may reasonably request, and, if the delivery of a
prospectus is required at any time prior to the expiration of nine months
after the time of issue of the Prospectus in connection with the offering
or sale of the Shares and if at such time any event shall have occurred as
a result of which the Prospectus as then amended or supplemented would
include an untrue statement of a material fact or omit to state any
material fact necessary in order to make the statements therein, in the
light of the circumstances under which they were made when such Prospectus
is delivered, not misleading, or, if for any other reason it shall be
necessary during such period to amend or supplement the Prospectus in order
to comply with the Act, to notify you and upon your request to prepare and
furnish without charge to each Underwriter and to any dealer in securities
as many copies as you may from time to time reasonably request of an
amended Prospectus or a supplement to the Prospectus which will correct
such statement or omission or effect such compliance, and in case any
Underwriter is required to deliver a prospectus in connection with sales of
any of the Shares at any time nine months or more after the time of issue
of the Prospectus, upon your request but at the expense of such
Underwriter, to prepare and deliver to such Underwriter as many copies as
you may request of an amended or supplemented Prospectus complying with
Section 10(a)(3) of the Act;
(d) To make generally available to its securityholders as soon as
practicable, but in any event not later than eighteen months after the
effective date of the Registration Statement (as defined in Rule 158(c)
under the Act), an earnings statement of the Company and its subsidiaries
(which need not be audited) complying with Section 11(a) of the Act and the
rules and regulations of the Commission thereunder (including, at the
option of the Company, Rule 158);
(e) During the period beginning from the date hereof and continuing
to and including the date 180 days after the date of the Prospectus, not to
offer, sell, contract to sell or otherwise dispose of, except as provided
hereunder, any securities of the Company that are substantially similar to
the Shares, including but not limited to any securities that are
convertible into or exchangeable for, or that represent the right to
receive, Stock or any such substantially similar securities (other than
pursuant to employee stock option plans existing on, or upon the conversion
or exchange of convertible or exchangeable securities outstanding as of,
the date of this Agreement), without your prior written consent;
9
<PAGE>
(f) To furnish to its stockholders as soon as practicable after the
end of each fiscal year an annual report (including a balance sheet and
statements of income, stockholders' equity and cash flows of the Company
and its consolidated subsidiaries certified by independent public
accountants) and, as soon as practicable after the end of each of the first
three quarters of each fiscal year (beginning with the fiscal quarter
ending after the effective date of the Registration Statement), to make
available to its stockholders consolidated summary financial information of
the Company and its subsidiaries for such quarter in reasonable detail;
(g) During a period of three years from the effective date of the
Registration Statement, to furnish to you copies of all reports or other
communications (financial or other) furnished to stockholders, and to
deliver to you (i) as soon as they are available, copies of any reports and
financial statements furnished to or filed with the Commission or any
national securities exchange on which any class of securities of the
Company is listed; and (ii) such additional information concerning the
business and financial condition of the Company as you may from time to
time reasonably request (such financial statements to be on a consolidated
basis to the extent the accounts of the Company and its subsidiaries are
consolidated in reports furnished to its stockholders generally or to the
Commission);
(h) To use the net proceeds received by it from the sale of the
Shares pursuant to this Agreement in the manner specified in the Prospectus
under the caption "Use of Proceeds";
(i) To use its best efforts to list for quotation the Shares on the
National Association of Securities Dealers Automated Quotations National
Market System ("NASDAQ");
(j) To file with the Commission such information on Form 10-Q or Form
10-K as may be required by Rule 463 under the Act; and
(k) If the Company elects to rely upon Rule 462(b), the Company shall
file a Rule 462(b) Registration Statement with the Commission in compliance
with Rule 462(b) by 10:00 P.M., Washington, D.C. time, on the date of this
Agreement, and the Company shall at the time of filing either pay to the
Commission the filing fee for the Rule 462(b) Registration Statement or
give irrevocable instructions for the payment of such fee pursuant to Rule
111(b) under the Act.
6. The Company covenants and agrees and with the several Underwriters
that (a) the Company will pay or cause to be paid the following: (i) the fees,
disbursements and expenses of the Company's counsel and accountants in
connection with the registration of the Shares under the Act and all other
expenses in connection with the preparation, printing and filing of the
Registration Statement, any Preliminary Prospectus and the Prospectus and
amendments and supplements thereto
10
<PAGE>
and the mailing and delivering of copies thereof to the Underwriters and
dealers; (ii) the cost of printing or producing any Agreement among
Underwriters, this Agreement, the Blue Sky Memorandum, closing documents
(including any compilations thereof) and any other documents in connection with
the offering, purchase, sale and delivery of the Shares; (iii) all expenses in
connection with the qualification of the Shares for offering and sale under
state securities laws as provided in Section 5(b) hereof, including the fees and
disbursements of counsel for the Underwriters in connection with such
qualification and in connection with the Blue Sky survey; (iv) all fees and
expenses in connection with listing the Shares on the NASDAQ; (v) the filing
fees incident to, and the fees and disbursements of counsel for the Underwriters
in connection with, securing any required review by the National Association of
Securities Dealers, Inc. of the terms of the sale of the Shares; (vi) the cost
of preparing stock certificates; (vii) the cost and charges of any transfer
agent or registrar and (viii) all other costs and expenses incident to the
performance of its obligations hereunder which are not otherwise specifically
provided for in this Section. It is understood, however, that, except as
provided in this Section, and Sections 8 and 11 hereof, the Underwriters will
pay all of their own costs and expenses, including the fees of their counsel,
stock transfer taxes on resale of any of the Shares by them, and any advertising
expenses connected with any offers they may make.
7. The obligations of the Underwriters hereunder, as to the Shares to be
delivered at each Time of Delivery, shall be subject, in their discretion, to
the condition that all representations and warranties and other statements of
the Company herein are, at and as of such Time of Delivery, true and correct,
the condition that the Company shall have performed all of its and their
obligations hereunder theretofore to be performed, and the following additional
conditions:
(a) The Prospectus shall have been filed with the Commission pursuant
to Rule 424(b) within the applicable time period prescribed for such filing
by the rules and regulations under the Act and in accordance with Section
5(a) hereof; if the Company has elected to rely upon Rule 462(b), the Rule
462(b) Registration Statement shall have become effective by 10:00 p.m.,
Washington, D.C. time, on the date of this Agreement; no stop order
suspending the effectiveness of the Registration Statement or any part
thereof shall have been issued and no proceeding for that purpose shall
have been initiated or threatened by the Commission; and all requests for
additional information on the part of the Commission shall have been
complied with to your reasonable satisfaction;
(b) Shearman & Sterling, counsel for the Underwriters, shall have
furnished to you such written opinion or opinions (a draft of each such
opinion is attached as Annex II(a) hereto), dated such Time of Delivery,
with respect to certain matters covered in paragraphs (i), (ii), (vii),
(xi) and (xiv) of subsection (c) below as well as such other related
matters as you may reasonably request, and such counsel shall have received
such papers and information as they may reasonably request to enable them
to pass upon such matters;
11
<PAGE>
(c) Wilson Sonsini Goodrich & Rosati, a Professional Corporation,
counsel for the Company, shall have furnished to you their written opinion
(a draft of such opinion is attached as Annex II(b) hereto), dated such
Time of Delivery, in form and substance satisfactory to you, to the effect
that:
(i) The Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of the state
of Delaware, with power and authority (corporate and other) to own its
properties and conduct its business as described in the Prospectus;
(ii) At the Time of Delivery, the Company will have an
authorized capitalization as set forth in the Prospectus for "pro
forma as adjusted" under the caption "Capitalization," excluding any
modification to the capitalization which may have occurred as a result
of the exercise of options issued under the Company's various equity
incentive plans and warrants between such date as set forth under
the caption "Capitalization" and the Time of Delivery, and all of the
issued shares of capital stock of the Company (including the Shares
being delivered at such Time of Delivery and the shares of Stock
issued on the First Time of Delivery upon conversion of all of the
Shares of Preferred Stock) have been duly and validly authorized and
issued and are fully paid and non-assessable; and the Shares conform
to the description of the Stock contained in the Prospectus;
(iii) The Company has been duly qualified as a foreign
corporation for the transaction of business and is in good standing
under the laws of each other jurisdiction in which it owns or leases
properties or conducts any business so as to require such
qualification, or is subject to no material liability or disability by
reason of failure to be so qualified in any such jurisdiction (such
counsel being entitled to rely in respect of the opinion in this
clause upon opinions of local counsel and in respect of matters of
fact upon certificates of officers of the Company, provided that such
counsel shall state that they believe that both you and they are
justified in relying upon such opinions and certificates);
(iv) Each subsidiary of the Company has been duly incorporated
and is validly existing as a corporation in good standing under the
laws of its jurisdiction of incorporation; and all of the issued
shares of capital stock of each such subsidiary have been duly and
validly authorized and issued, are fully paid and non-assessable, and
(except for directors' qualifying shares) are owned directly or
indirectly by the Company, free and clear of all liens, encumbrances,
equities or claims (such counsel being entitled to rely in respect of
the opinion in this clause upon opinions of local counsel and in
respect of matters of fact upon certificates of officers of the
Company or its subsidiaries, provided that such counsel shall state
that they believe that both you and they are justified in relying upon
such opinions and certificates);
12
<PAGE>
(v) The Company and its subsidiaries have good and marketable
title in fee simple to all real property owned by them, in each case
free and clear of all liens, encumbrances and defects except such as
are described in the Prospectus or such as do not materially affect
the value of such property and do not interfere with the use made and
proposed to be made of such property by the Company and its
subsidiaries; and any real property and buildings subject to leases
filed as Exhibits to the Registration Statement are held by the
Company and its subsidiaries under valid, subsisting and enforceable
leases with such exceptions as are not material and do not interfere
with the use made and proposed to be made of such property and
buildings by the Company and its subsidiaries (in giving the opinion
in this clause, such counsel may state that no examination of record
titles for the purpose of such opinion has been made, and that they
are relying upon a general review of the titles of the Company and its
subsidiaries, upon opinions of local counsel and abstracts, reports
and policies of title companies rendered or issued at or subsequent to
the time of acquisition of such property by the Company or its
subsidiaries, upon opinions of counsel to the lessors of such property
and, in respect of matters of fact, upon certificates of officers of
the Company or its subsidiaries, provided that such counsel shall
state that they believe that both you and they are justified in
relying upon such opinions, abstracts, reports, policies and
certificates);
(vi) To the best of such counsel's knowledge and other than as
set forth in the Prospectus, there are no legal or governmental
proceedings pending to which the Company or any of its subsidiaries is
a party or of which any property of the Company or any of its
subsidiaries is the subject which, if determined adversely to the
Company or any of its subsidiaries, would individually or in the
aggregate have a material adverse effect on the current or future
consolidated financial position stockholders' equity or results of
operations of the Company and its subsidiaries; and, to the best of
such counsel's knowledge, no such proceedings are threatened or
contemplated by governmental authorities or threatened by others;
(vii) This Agreement has been duly authorized, executed and
delivered by the Company;
(viii) The issue and sale of the Shares being delivered at such
Time of Delivery to be sold by the Company and the compliance by the
Company with all of the provisions of this Agreement and the
consummation of the transactions herein contemplated will not conflict
with or result in a breach or violation of any of the terms or
provisions of, or constitute a default under, any indenture, mortgage,
deed of trust, loan agreement or other agreement or instrument filed
as an Exhibit to the Registration Statement to which the Company or
any of its subsidiaries is a party or by which the Company or any of
its subsidiaries is bound or to which any of the property or assets of
the Company or any of its subsidiaries is subject, nor will such
13
<PAGE>
action result in any violation of the provisions of the Certificate of
Incorporation or By-laws of the Company or any statute or any order,
rule or regulation known to such counsel of any court or governmental
agency or body having jurisdiction over the Company or any of its
subsidiaries or any of their properties;
(ix) No consent, approval, authorization, order, registration
or qualification of or with any such court or governmental agency or
body is required for the issue and sale of the Shares or the
consummation by the Company of the transactions contemplated by this
Agreement, except the registration under the Act of the Shares, and
such consents, approvals, authorizations, registrations or
qualifications as may be required under state securities or Blue Sky
laws in connection with the purchase and distribution of the Shares by
the Underwriters;
(x) Neither the Company nor any of its subsidiaries is in
violation of its Certificate of Incorporation or By-laws or in default
in the performance or observance of any material obligation,
agreement, covenant or condition contained in any indenture, mortgage,
deed of trust, loan agreement, or lease or agreement or other
instrument filed as an Exhibit to the Registration Statement to which
it is a party or by which it or any of its properties may be bound;
(xi) The statements set forth in the Prospectus under the
caption "Description of Capital Stock", insofar as they purport to
constitute a summary of the terms of the Stock and under the caption
"Underwriting", insofar as they purport to describe the provisions of
the laws and documents referred to therein, are accurate, complete and
fair;
(xii) The Company is not an "investment company", as such term
is defined in the Investment Company Act;
(xiii) No holder of any security of the Company has the right,
not effectively satisfied or waived, to require inclusion of any
shares of Stock or any other security in the Registration Statement;
and
(xiv) The Registration Statement and the Prospectus and any
further amendments and supplements thereto made by the Company prior
to such Time of Delivery (other than the financial statements and
related schedules therein, as to which such counsel need express no
opinion) comply as to form in all material respects with the
requirements of the Act and the rules and regulations thereunder;
although they do not assume any responsibility for the accuracy,
completeness or fairness of the statements contained in the
Registration Statement or the Prospectus, except for those referred to
in the opinion in subsection (xi) of this Section 7(c), they have no
reason to believe that, as of its effective date, the Registration
Statement or
14
<PAGE>
any further amendment thereto made by the Company prior to such Time
of Delivery (other than the financial statements and related schedules
therein, as to which such counsel need express no opinion) contained
an untrue statement of a material fact or omitted to state a material
fact required to be stated therein or necessary to make the statements
therein not misleading or that, as of its date, the Prospectus or any
further amendment or supplement thereto made by the Company prior to
such Time of Delivery (other than the financial statements and related
schedules therein, as to which such counsel need express no opinion)
contained an untrue statement of a material fact or omitted to state a
material fact necessary to make the statements therein, in the light
of the circumstances under which they were made, not misleading or
that, as of such Time of Delivery, either the Registration Statement
or the Prospectus or any further amendment or supplement thereto made
by the Company prior to such Time of Delivery (other than the
financial statements and related schedules therein, as to which such
counsel need express no opinion) contains an untrue statement of a
material fact or omits to state a material fact necessary to make the
statements therein, in the light of the circumstances under which they
were made, not misleading; and they do not know of any amendment to
the Registration Statement required to be filed or of any contracts or
other documents of a character required to be filed as an exhibit to
the Registration Statement or required to be described in the
Registration Statement or the Prospectus which are not filed or
described as required;
(d) On the date of the Prospectus at a time prior to the execution of
this Agreement, at 9:30 a.m., New York City time, on the effective date of
any post-effective amendment to the Registration Statement filed subsequent
to the date of this Agreement and also at such Time of Delivery,
PricewaterhouseCoopers LLP shall have furnished to you a letter or letters,
dated the respective dates of delivery thereof, in form and substance
satisfactory to you, to the effect set forth in Annex I hereto (the
executed copy of the letter delivered prior to the execution of this
Agreement is attached as Annex I(a) hereto and a draft of the form of
letter to be delivered on the effective date of any post-effective
amendment to the Registration Statement and as of each Time of Delivery is
attached as Annex I(b) hereto);
(e)(i) Neither the Company nor any of its subsidiaries shall have
sustained since the date of the latest audited financial statements
included in the Prospectus any loss or interference with its business from
fire, explosion, flood or other calamity, whether or not covered by
insurance, or from any labor dispute or court or governmental action, order
or decree, otherwise than as set forth or contemplated in the Prospectus,
and (ii) since the respective dates as of which information is given in the
Prospectus there shall not have been any change in the capital stock or
long-term debt of the Company or any of its subsidiaries or any change, or
any development involving a prospective change, in or affecting the
15
<PAGE>
general affairs, management, financial position, stockholders' equity or
results of operations of the Company and its subsidiaries, otherwise than
as set forth or contemplated in the Prospectus, the effect of which, in any
such case described in clause (i) or (ii), is in the judgment of the
Representatives so material and adverse as to make it impracticable or
inadvisable to proceed with the public offering or the delivery of the
Shares being delivered at such Time of Delivery on the terms and in the
manner contemplated in the Prospectus;
(f) On or after the date hereof (i) no downgrading shall have
occurred in the rating accorded the Company's debt securities or preferred
stock, and (ii) no such organization shall have publicly announced that it
has under survelliance or review, with possible negative implications, its
rating of any of the Company's debt securities or preferred stock;
(g) On or after the date hereof there shall not have occurred any of
the following: (i) a suspension or material limitation in trading in
securities generally on the New York Stock Exchange or on NASDAQ; (ii) a
suspension or material limitation in trading in the Company's securities on
NASDAQ; (iii) a general moratorium on commercial banking activities
declared by either Federal or New York or California State authorities; or
(iv) the outbreak or escalation of hostilities involving the United States
or the declaration by the United States of a national emergency or war, if
the effect of any such event specified in this clause (iv) in the judgment
of the Representatives makes it impracticable or inadvisable to proceed
with the public offering or the delivery of the Shares being delivered at
such Time of Delivery on the terms and in the manner contemplated in the
Prospectus;
(h) The Shares at such Time of Delivery shall have been duly listed
for quotation on NASDAQ;
(i) The Company has obtained and delivered to the Underwriters
executed copies of an agreement from each Stockholder of the Company,
substantially to the effect set forth in Subsection 1(b)(iv) hereof in form
and substance satisfactory to you;
(j) The Company shall have complied with the provisions of Section
5(c) hereof with respect to the furnishing of prospectuses on the New York
Business Day next succeeding the date of this Agreement;
(k) The Company shall have furnished or caused to be furnished to you
at such Time of Delivery certificates of officers of the Company,
satisfactory to you as to the accuracy of the representations and
warranties of the Company herein at and as of such Time of Delivery, as to
the performance by the Company of all of their respective obligations
hereunder to be performed at or prior to such Time of Delivery, and as to
such other matters as you may reasonably request, and the Company shall
have furnished or caused to be furnished certificates as to the matters set
forth in subsections (a) and (e) of this Section; and
16
<PAGE>
(l) The Company shall not have received any notice of infringement or
of conflict with asserted rights of others with respect to any patents,
trademarks, service marks, trade names, copyrights, mask work rights,
technology or know-how which individually or in the aggregate, is
reasonably likely to have a material adverse effect on the Company.
8. (a) The Company will indemnify and hold harmless each Underwriter
against any losses, claims, damages or liabilities, joint or several, to which
such Underwriter may become subject, under the Act or otherwise, insofar as such
losses, claims, damages or liabilities (or actions in respect thereof) arise out
of or are based upon an untrue statement or alleged untrue statement of a
material fact contained in any Preliminary Prospectus, the Registration
Statement or the Prospectus, or any amendment or supplement thereto, or arise
out of or are based upon the omission or alleged omission to state therein a
material fact required to be stated therein or necessary to make the statements
therein not misleading, and will reimburse each Underwriter for any legal or
other expenses reasonably incurred by such Underwriter in connection with
investigating or defending any such action or claim as such expenses are
incurred; provided, however, that the Company shall not be liable in any such
case to the extent that any such loss, claim, damage or liability arises out of
or is based upon an untrue statement or alleged untrue statement or omission or
alleged omission made in any Preliminary Prospectus, the Registration Statement
or the Prospectus or any such amendment or supplement in reliance upon and in
conformity with written information furnished to the Company by any Underwriter
through Goldman, Sachs & Co. expressly for use therein.
(b) Each Underwriter will indemnify and hold harmless the Company against
any losses, claims, damages or liabilities to which the Company may become
subject, under the Act or otherwise, insofar as such losses, claims, damages or
liabilities (or actions in respect thereof) arise out of or are based upon an
untrue statement or alleged untrue statement of a material fact contained in any
Preliminary Prospectus, the Registration Statement or the Prospectus, or any
amendment or supplement thereto, or arise out of or are based upon the omission
or alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein not misleading, in each case
to the extent, but only to the extent, that such untrue statement or alleged
untrue statement or omission or alleged omission was made in any Preliminary
Prospectus, the Registration Statement or the Prospectus or any such amendment
or supplement in reliance upon and in conformity with written information
furnished to the Company by such Underwriter through Goldman, Sachs & Co.
expressly for use therein; and will reimburse the Company for any legal or other
expenses reasonably incurred by the Company in connection with investigating or
defending any such action or claim as such expenses are incurred.
(c) Promptly after receipt by an indemnified party under subsection (a) or
(b) above of notice of the commencement of any action, such indemnified party
shall, if a claim in respect thereof is to be made against the indemnifying
party under such subsection, notify the indemnifying party in writing of the
commencement thereof; but the omission so to notify the indemnifying party shall
not relieve it from any liability which it may have to any indemnified party
otherwise than under such subsection. In case any such action shall be brought
against any indemnified party and it shall
17
<PAGE>
notify the indemnifying party of the commencement thereof, the indemnifying
party shall be entitled to participate therein and, to the extent that it shall
wish, jointly with any other indemnifying party similarly notified, to assume
the defense thereof, with counsel satisfactory to such indemnified party (who
shall not, except with the consent of the indemnified party, be counsel to the
indemnifying party), and, after notice from the indemnifying party to such
indemnified party of its election so to assume the defense thereof, the
indemnifying party shall not be liable to such indemnified party under such
subsection for any legal expenses of other counsel or any other expenses, in
each case subsequently incurred by such indemnified party, in connection with
the defense thereof other than reasonable costs of investigation. No
indemnifying party shall, without the written consent of the indemnified party,
effect the settlement or compromise of, or consent to the entry of any judgment
with respect to, any pending or threatened action or claim in respect of which
indemnification or contribution may be sought hereunder (whether or not the
indemnified party is an actual or potential party to such action or claim)
unless such settlement, compromise or judgment (i) includes an unconditional
release of the indemnified party from all liability arising out of such action
or claim and (ii) does not include a statement as to or an admission of fault,
culpability or a failure to act, by or on behalf of any indemnified party.
(d) If the indemnification provided for in this Section 8 is unavailable
to or insufficient to hold harmless an indemnified party under subsection (a) or
(b) above in respect of any losses, claims, damages or liabilities (or actions
in respect thereof) referred to therein, then each indemnifying party shall
contribute to the amount paid or payable by such indemnified party as a result
of such losses, claims, damages or liabilities (or actions in respect thereof)
in such proportion as is appropriate to reflect the relative benefits received
by the Company on the one hand and the Underwriters on the other from the
offering of the Shares. If, however, the allocation provided by the immediately
preceding sentence is not permitted by applicable law or if the indemnified
party failed to give the notice required under subsection (d) above, then each
indemnifying party shall contribute to such amount paid or payable by such
indemnified party in such proportion as is appropriate to reflect not only such
relative benefits but also the relative fault of the Company on the one hand and
the Underwriters on the other in connection with the statements or omissions
which resulted in such losses, claims, damages or liabilities (or actions in
respect thereof), as well as any other relevant equitable considerations. The
relative benefits received by the Company on the one hand and the Underwriters
on the other shall be deemed to be in the same proportion as the total net
proceeds from the offering (before deducting expenses) received by the Company
bear to the total underwriting discounts and commissions received by the
Underwriters, in each case as set forth in the table on the cover page of the
Prospectus. The relative fault shall be determined by reference to, among other
things, whether the untrue or alleged untrue statement of a material fact or the
omission or alleged omission to state a material fact relates to information
supplied by the Company on the one hand or the Underwriters on the other and the
parties' relative intent, knowledge, access to information and opportunity to
correct or prevent such statement or omission. The Company and the Underwriters
agree that it would not be just and equitable if contributions pursuant to this
subsection (d) were determined by pro rata allocation (even if the Underwriters
were treated as one entity for such purpose) or by any other method of
allocation which does not take account of the
18
<PAGE>
equitable considerations referred to above in this subsection (d). The amount
paid or payable by an indemnified party as a result of the losses, claims,
damages or liabilities (or actions in respect thereof) referred to above in this
subsection (d) shall be deemed to include any legal or other expenses reasonably
incurred by such indemnified party in connection with investigating or defending
any such action or claim. Notwithstanding the provisions of this subsection (d),
no Underwriter shall be required to contribute any amount in excess of the
amount by which the total price at which the Shares underwritten by it and
distributed to the public were offered to the public exceeds the amount of any
damages which such Underwriter has otherwise been required to pay by reason of
such untrue or alleged untrue statement or omission or alleged omission. No
person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Act) shall be entitled to contribution from any person who was not
guilty of such fraudulent misrepresentation. The Underwriters' obligations in
this subsection (d) to contribute are several in proportion to their respective
underwriting obligations and not joint.
(e) The obligations of the Company under this Section 8 shall be in
addition to any liability which the Company may otherwise have and shall extend,
upon the same terms and conditions, to each person, if any, who controls any
Underwriter within the meaning of the Act; and the obligations of the
Underwriters under this Section 8 shall be in addition to any liability which
the respective Underwriters may otherwise have and shall extend, upon the same
terms and conditions, to each officer and director of the Company and to each
person, if any, who controls the Company within the meaning of the Act.
9. (a) If any Underwriter shall default in its obligation to purchase
the Shares which it has agreed to purchase hereunder at a Time of Delivery, you
may in your discretion arrange for you or another party or other parties to
purchase such Shares on the terms contained herein. If within thirty-six hours
after such default by any Underwriter you do not arrange for the purchase of
such Shares, then the Company shall be entitled to a further period of thirty-
six hours within which to procure another party or other parties satisfactory to
you to purchase such Shares on such terms. In the event that, within the
respective prescribed periods, you notify the Company that you have so arranged
for the purchase of such Shares, or the Company notify you that it has so
arranged for the purchase of such Shares, you or the Company shall have the
right to postpone (a) Time of Delivery for a period of not more than seven days,
in order to effect whatever changes may thereby be made necessary in the
Registration Statement or the Prospectus, or in any other documents or
arrangements, and the Company agrees to file promptly any amendments to the
Registration Statement or the Prospectus which in your opinion may thereby be
made necessary. The term "Underwriter" as used in this Agreement shall include
any person substituted under this Section with like effect as if such person had
originally been a party to this Agreement with respect to such Shares.
(b) If, after giving effect to any arrangements for the purchase of the
Shares of a defaulting Underwriter or Underwriters by you and the Company as
provided in subsection (a) above, the aggregate number of such Shares which
remains unpurchased does not exceed
19
<PAGE>
one-eleventh of the aggregate number of all the Shares to be purchased at such
Time of Delivery, then the Company shall have the right to require each non-
defaulting Underwriter to purchase the number of Shares which such Underwriter
agreed to purchase hereunder at such Time of Delivery and, in addition, to
require each non-defaulting Underwriter to purchase its pro rata share (based on
the number of Shares which such Underwriter agreed to purchase hereunder) of the
Shares of such defaulting Underwriter or Underwriters for which such
arrangements have not been made; but nothing herein shall relieve a defaulting
Underwriter from liability for its default.
(c) If, after giving effect to any arrangements for the purchase of the
Shares of a defaulting Underwriter or Underwriters by you and the Company as
provided in subsection (a) above, the aggregate number of such Shares which
remains unpurchased exceeds one-eleventh of the aggregate number of all of the
Shares to be purchased at such Time of Delivery, or if the Company shall not
exercise the right described in subsection (b) above to require non-defaulting
Underwriters to purchase Shares of a defaulting Underwriter or Underwriters,
then this Agreement (or, with respect to the Second Time of Delivery, the
obligations of the Underwriters to purchase and of the Company to sell the
Optional Shares) shall thereupon terminate, without liability on the part of any
non-defaulting Underwriter or the Company, except for the expenses to be borne
by the Company and the Underwriters as provided in Section 6 hereof and the
indemnity and contribution agreements in Section 8 hereof; but nothing herein
shall relieve a defaulting Underwriter from liability for its default.
10. The respective indemnities, agreements, representations, warranties
and other statements of the Company and the several Underwriters, as set forth
in this Agreement or made by or on behalf of them, respectively, pursuant to
this Agreement, shall remain in full force and effect, regardless of any
investigation (or any statement as to the results thereof) made by or on behalf
of any Underwriter or any controlling person of any Underwriter, or the Company,
or any officer or director or controlling person of the Company, and shall
survive delivery of and payment for the Shares.
11. If this Agreement shall be terminated pursuant to Section 9 hereof,
the Company shall not then be under any liability to any Underwriter except as
provided in Sections 6 and 8 hereof; but, if for any other reason any Shares are
not delivered by or on behalf of the Company as provided herein, the Company
will reimburse the Underwriters through you for all out-of-pocket expenses
approved in writing by you, including fees and disbursements of counsel,
reasonably incurred by the Underwriters in making preparations for the purchase,
sale and delivery of the Shares not so delivered, but the Company shall then be
under no further liability to any Underwriter in respect of the Shares not so
delivered except as provided in Sections 6 and 8 hereof.
12. In all dealings hereunder, you shall act on behalf of each of the
Underwriters, and the parties hereto shall be entitled to act and rely upon any
statement, request, notice or agreement on behalf of any Underwriter made or
given by you jointly or by Goldman, Sachs & Co. on behalf of you as the
representatives.
20
<PAGE>
All statements, requests, notices and agreements hereunder shall be in
writing, and if to the Underwriters shall be delivered or sent by mail, telex or
facsimile transmission to you as the representatives in care of Goldman, Sachs &
Co., 32 Old Slip, 21st Floor, New York, New York 10005, Attention: Registration
Department; and if to the Company shall be delivered or sent by mail, telex or
facsimile transmission to the address of the Company set forth in the
Registration Statement, Attention: Secretary; provided, however, that any notice
to an Underwriter pursuant to Section 8(d) hereof shall be delivered or sent by
mail, telex or facsimile transmission to such Underwriter at its address set
forth in its Underwriters' Questionnaire or telex constituting such
Questionnaire, which address will be supplied to the Company by you on request.
Any such statements, requests, notices or agreements shall take effect upon
receipt thereof.
13. This Agreement shall be binding upon, and inure solely to the benefit
of, the Underwriters and the Company and, to the extent provided in Sections 8
and 10 hereof, the officers and directors of the Company and each person who
controls the Company or any Underwriter, and their respective heirs, executors,
administrators, successors and assigns, and no other person shall acquire or
have any right under or by virtue of this Agreement. No purchaser of any of the
Shares from any Underwriter shall be deemed a successor or assign by reason
merely of such purchase.
14. Time shall be of the essence of this Agreement. As used herein, the
term "business day" shall mean any day when the Commission's office in
Washington, D.C. is open for business.
15. This Agreement shall be governed by and construed in accordance with
the laws of the State of New York.
16. This Agreement may be executed by any one or more of the parties
hereto in any number of counterparts, each of which shall be deemed to be an
original, but all such counterparts shall together constitute one and the same
instrument.
21
<PAGE>
If the foregoing is in accordance with your understanding, please sign and
return to us counterparts hereof, and upon the acceptance hereof by you, on
behalf of each of the Underwriters, this letter and such acceptance hereof shall
constitute a binding agreement between the Underwriters and the Company. It is
understood that your acceptance of this letter on behalf of each of the
Underwriters is pursuant to the authority set forth in a form of Agreement among
Underwriters, the form of which shall be submitted to the Company for
examination, upon request, but without warranty on your part as to the authority
of the signers thereof.
Very truly yours,
Cobalt Networks, Inc.
By: ..........................................
Name:
Title:
Accepted as of the date hereof
Goldman, Sachs & Co.
Merrill Lynch, Pierce, Fenner & Smith Incorporated
BancBoston Robertson Stephens Inc.
By:...............................
(Goldman, Sachs & Co.)
On behalf of each of the Underwriters
22
<PAGE>
SCHEDULE I
<TABLE>
<CAPTION>
Number of Option
Total Number Shares to be
of Purchased if
Firm Shares Maximum Option
Underwriter to be Purchased Exercised
----------- --------------- ----------------
<S> <C> <C>
Goldman, Sachs & Co..........................................
Merrill Lynch, Pierce, Fenner & Smith Incorporated...........
BancBoston Robertson Stephens Inc. ..........................
SoundView Technology Group, Inc. ............................
[Names of other Underwriters]
_________ _________
Total.......................................................
========= =========
</TABLE>
23
<PAGE>
ANNEX I
FORM OF ANNEX I DESCRIPTION OF COMFORT LETTER
FOR REGISTRATION STATEMENTS ON FORM S-1
Pursuant to Section 7(e) of the Underwriting Agreement, the accountants
shall furnish letters to the Underwriters to the effect that:
(i) They are independent certified public accountants with respect
to the Company and its subsidiaries within the meaning of the Act and the
applicable published rules and regulations thereunder;
(ii) In their opinion, the financial statements and any
supplementary financial information and schedules (and, if applicable,
financial forecasts and/or pro forma financial information) examined by
them and included in the Prospectus or the Registration Statement comply as
to form in all material respects with the applicable accounting
requirements of the Act and the related published rules and regulations
thereunder; and, if applicable, they have made a review in accordance with
standards established by the American Institute of Certified Public
Accountants of the unaudited consolidated interim financial statements,
selected financial data, pro forma financial information, financial
forecasts and/or condensed financial statements derived from audited
financial statements of the Company for the periods specified in such
letter, as indicated in their reports thereon, copies of which have been
separately furnished to the representatives of the Underwriters (the
"Representatives");
(iii) They have made a review in accordance with standards
established by the American Institute of Certified Public Accountants of
the unaudited condensed consolidated statements of income, consolidated
balance sheets and consolidated statements of cash flows included in the
Prospectus as indicated in their reports thereon copies of which have been
separately furnished to the Representatives and on the basis of specified
procedures including inquiries of officials of the Company who have
responsibility for financial and accounting matters regarding whether the
unaudited condensed consolidated financial statements referred to in
paragraph (vi)(A)(i) below comply as to form in all material respects with
the applicable accounting requirements of the Act and the related published
rules and regulations, nothing came to their attention that caused them to
believe that the unaudited condensed consolidated financial statements do
not comply as to form in all material respects with the applicable
accounting requirements of the Act and the related published rules and
regulations;
(iv) The unaudited selected financial information with respect to
the consolidated results of operations and financial position of the
Company for the five most recent fiscal years included in the Prospectus
agrees with the corresponding amounts (after restatements where applicable)
in the audited consolidated financial statements for such five fiscal
years;
24
<PAGE>
(v) They have compared the information in the Prospectus under
selected captions with the disclosure requirements of Regulation S-K and on
the basis of limited procedures specified in such letter nothing came to
their attention as a result of the foregoing procedures that caused them to
believe that this information does not conform in all material respects
with the disclosure requirements of Items 301, 302, 402 and 503(d),
respectively, of Regulation S-K;
(vi) On the basis of limited procedures, not constituting an
examination in accordance with generally accepted auditing standards,
consisting of a reading of the unaudited financial statements and other
information referred to below, a reading of the latest available interim
financial statements of the Company and its subsidiaries, inspection of the
minute books of the Company and its subsidiaries since the date of the
latest audited financial statements included in the Prospectus, inquiries
of officials of the Company and its subsidiaries responsible for financial
and accounting matters and such other inquiries and procedures as may be
specified in such letter, nothing came to their attention that caused them
to believe that:
(A) (i) the unaudited consolidated statements of income,
consolidated balance sheets and consolidated statements of cash flows
included in the Prospectus do not comply as to form in all material
respects with the applicable accounting requirements of the Act and
the related published rules and regulations, or (ii) any material
modifications should be made to the unaudited condensed consolidated
statements of income, consolidated balance sheets and consolidated
statements of cash flows included in the Prospectus for them to be in
conformity with generally accepted accounting principles;
(B) any other unaudited income statement data and balance sheet
items included in the Prospectus do not agree with the corresponding
items in the unaudited consolidated financial statements from which
such data and items were derived, and any such unaudited data and
items were not determined on a basis substantially consistent with the
basis for the corresponding amounts in the audited consolidated
financial statements included in the Prospectus;
(C) the unaudited financial statements which were not included
in the Prospectus but from which were derived any unaudited condensed
financial statements referred to in clause (A) and any unaudited
income statement data and balance sheet items included in the
Prospectus and referred to in clause (B) were not determined on a
basis substantially consistent with the basis for the audited
consolidated financial statements included in the Prospectus;
(D) any unaudited pro forma consolidated condensed financial
statements included in the Prospectus do not comply as to form in all
material respects with the applicable accounting requirements of the
Act and the published rules and regulations
25
<PAGE>
thereunder or the pro forma adjustments have not been properly applied
to the historical amounts in the compilation of those statements;
(E) as of a specified date not more than five days prior to the
date of such letter, there have been any changes in the consolidated
capital stock (other than issuances of capital stock upon exercise of
options and stock appreciation rights, upon earn-outs of performance
shares and upon conversions of convertible securities, in each case
which were outstanding on the date of the latest financial statements
included in the Prospectus) or any increase in the consolidated long-
term debt of the Company and its subsidiaries, or any decreases in
consolidated net current assets or stockholders' equity or other items
specified by the Representatives, or any increases in any items
specified by the Representatives, in each case as compared with
amounts shown in the latest balance sheet included in the Prospectus,
except in each case for changes, increases or decreases which the
Prospectus discloses have occurred or may occur or which are described
in such letter; and
(F) for the period from the date of the latest financial
statements included in the Prospectus to the specified date referred
to in clause (E) there were any decreases in consolidated net revenues
or operating profit or the total or per share amounts of consolidated
net income or other items specified by the Representatives, or any
increases in any items specified by the Representatives, in each case
as compared with the comparable period of the preceding year and with
any other period of corresponding length specified by the
Representatives, except in each case for decreases or increases which
the Prospectus discloses have occurred or may occur or which are
described in such letter; and
(vii) In addition to the examination referred to in their report(s)
included in the Prospectus and the limited procedures, inspection of minute
books, inquiries and other procedures referred to in paragraphs (iii) and
(vi) above, they have carried out certain specified procedures, not
constituting an examination in accordance with generally accepted auditing
standards, with respect to certain amounts, percentages and financial
information specified by the Representatives, which are derived from the
general accounting records of the Company and its subsidiaries, which
appear in the Prospectus, or in Part II of, or in exhibits and schedules
to, the Registration Statement specified by the Representatives, and have
compared certain of such amounts, percentages and financial information
with the accounting records of the Company and its subsidiaries and have
found them to be in agreement.
26
<PAGE>
EXHIBIT 3.1.1
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
COBALT NETWORKS, INC.
Cobalt Networks, Inc., a corporation organized and existing under laws of
the State of Delaware, hereby certifies as follows:
1. The name of the Corporation is Cobalt Networks, Inc. The original
Certificate of Incorporation of the Corporation was filed with the Secretary of
State of the state of Delaware on September 2, 1999.
2. Pursuant to Sections 228, 242 and 245 of the General Corporation Laws
of the State of Delaware, this Restated Certificate of Incorporation restates
and integrates and further amends the provisions of the Certificate of
Incorporation of this corporation.
3. The text of the Certificate of Incorporation as heretofore amended or
supplemented is hereby amended and restated to read in its entirety as follows:
"ARTICLE I.
The name of this corporation is Cobalt Networks, Inc.
ARTICLE II.
The address of the corporation's registered office in the State of Delaware
is 1209 Orange Street, City of Wilmington, County of Newcastle, Delaware 19801.
The name of its registered agent at such address is The Corporation Trust
Company.
ARTICLE III.
The purpose of the corporation is to engage in any lawful act or activity
for which a corporation may be organized under the General Corporation Law of
Delaware.
<PAGE>
ARTICLE IV.
The total number of shares of all classes of stock which the
Corporation is authorized to issue is 137,609,875 shares, consisting of
120,000,000 shares of Common Stock, $0.001 par value, and 17,609,875 shares of
Preferred Stock, $0.001 par value. The Preferred Stock consists of three series,
of which 3,734,901 shares have been designated as Series A Preferred Stock (the
"Series A Preferred Stock"), of which 3,740,522 shares have been designated as
Series B Preferred Stock (the "Series B Preferred Stock") and of which
10,134,452 shares have been designated as Series C Preferred Stock (the "Series
C Preferred Stock").
The relative rights, preferences, privileges and restrictions granted
to or imposed on the respective series or classes of capital stock or the
holders thereof are as follows:
Section 1. Dividends.
---------
1.1 Dividend Rights. The holders of the Series C Preferred Stock and
---------------
Series B Preferred Stock shall be entitled to receive dividends, prior to the
payment of any dividends on the Series A Preferred Stock and the Common Stock,
at the rate of $0.37 per annum per share of Series C Preferred Stock then held
by them (the "Series C Dividend Rate") and at the rate of $0.21628 per annum per
share of Series B Preferred Stock then held by them (the "Series B Dividend
Rate") out of any funds legally available therefor when, if and as declared by
the Board of Directors. The holders of the Series A Preferred Stock shall be
entitled to receive dividends, prior to the payment of any dividends on the
Common Stock, at the rate of $0.10 per annum per share of Series A Preferred
Stock then held by them (the "Series A Dividend Rate") out of any funds legally
available therefor when, if and as declared by the Board of Directors. Without
limiting the foregoing, no distribution shall be made in respect of the Common
Stock unless the holders of the Series A Preferred Stock, Series B Preferred
Stock and Series C Preferred Stock shall receive a proportionate share of any
such distribution as though the holders of the Series A Preferred Stock, Series
B Preferred Stock and Series C Preferred Stock were the holders of the number of
shares of Common Stock of the Corporation into which such shares of Series A
Preferred Stock, Series B Preferred Stock and Series C Preferred Stock are then
convertible.
1.2 Definition of Distribution. For purposes of this Section 1, unless the
--------------------------
context otherwise requires, a "distribution" shall mean the transfer of cash or
other property without consideration whether by way of dividend or otherwise or
the purchase or redemption of shares of the Corporation (other than repurchases
of Common Stock issued to or held by employees, officers, directors or
consultants of the Corporation or its subsidiaries upon termination of their
employment or services pursuant to agreements providing for the right of said
repurchase) for cash or property.
1.3 Certain Repurchases not Distributions. As authorized by Section
-------------------------------------
402.5(c) of the California Corporations Code, the provisions of Sections 502 and
503 of the California Corporations Code shall not apply with respect to
repurchases by the Corporation of shares of Common Stock issued to or held by
employees, officers, directors or consultants of the Corporation or its
2
<PAGE>
subsidiaries upon termination of their employment or services pursuant to
agreements providing for the right of said repurchase.
Section 2. Liquidation Preference.
----------------------
(a) In the event of any liquidation, dissolution or winding up
of the Corporation, either voluntary or involuntary, distributions to the
stockholders of the Corporation shall be made in the following manner:
(i) The holders of Series C Preferred Stock and Series B
Preferred Stock shall be entitled to receive, prior and in preference to
any distribution of any of the assets of the Corporation to the holders of
the Series A Preferred Stock and the Common Stock by reason of their
ownership thereof, an amount equal to $3.70 for each outstanding share of
Series C Preferred Stock (the Series C Preferential Amount") and $2.1628
for each outstanding share of Series B Preferred Stock (the "Series B
Preferential Amount"), adjusted for any stock split, combination,
consolidation, or stock distributions or stock dividends with respect to
such shares, and, in addition, an amount equal to all declared but unpaid
dividends on the Series C Preferred Stock and Series B Preferred Stock. If
the assets and funds thus distributed among the holders of the Series C
Preferred Stock and Series B Preferred Stock shall be insufficient to
permit the payment to such holders of the full Series C Preferential Amount
and Series B Preferential Amount, then the entire assets and funds of the
Corporation legally available for distribution shall be distributed among
the holders of the Series C Preferred Stock and Series B Preferred Stock in
proportion to the respective Series C Preferential Amounts and Series B
Preferential Amounts which each such holder is entitled to receive pursuant
to this Section 2(a)(i).
(ii) After payment has been made to the holders of the Series C
Preferred Stock and the Series B Preferred Stock of the full amounts to
which they shall be entitled as set forth in Section 2(a)(i) above, the
Series A Preferred Stock shall be entitled to receive, prior and in
preference to any distribution of any of the assets of the Corporation to
the holders of the Common Stock by reason of their ownership thereof, an
amount equal to $1.00 for each outstanding share of Series A Preferred
Stock (the "Series A Preferential Amount"), adjusted for any stock split,
combination, consolidation, or stock distributions or stock dividends with
respect to such shares, and, in addition, an amount equal to all declared
but unpaid dividends on the Series A Preferred Stock. If the assets and
funds thus distributed among the holders of the Series A Preferred Stock
shall be insufficient to permit the payment to such holders of the full
Series A Preferential Amount, then the entire assets and funds of the
Corporation legally available for distribution shall be distributed among
the holders of the Series A Preferred Stock in proportion to the respective
Series A Preferential Amounts which each such holder is entitled to receive
pursuant to this Section 2(a)(ii).
(iii) After payment has been made to the holders of the Series
A Preferred Stock of the full amounts to which they shall be entitled as
set forth in Section 2(a)(ii) above,
3
<PAGE>
then the holders of the Common Stock shall be entitled to receive an amount
equal to $0.10 for each outstanding share of Common Stock (the "Common
Preferential Amount"), adjusted for any stock split, combination,
consolidation, or stock distributions or stock dividends with respect to
such shares, and, in addition, an amount equal to all declared but unpaid
dividends on the Common Stock. If the assets and funds legally available
for distribution among the holders of Common Stock shall be insufficient to
permit the payment to such holders of the full Common Preferential Amount,
then such assets and funds shall be distributed ratably among the holders
of Common Stock in proportion to the total Common Preferential Amount which
each such holder is entitled to receive pursuant to this Section 2(a)(iii).
(viii) Any assets remaining after the distributions pursuant to
Sections 2(a)(i) through (iii) shall be distributed on a pro rata basis to
the holders of Common Stock and Preferred Stock based on the number of
shares (assuming conversion of each holder's shares of Preferred Stock into
the number of shares of Common Stock into which such holder's Preferred
Stock is then convertible, as adjusted from time to time pursuant to
Section 4 hereof) then held by each holder of Common Stock and Preferred
Stock.
(b) (i) Any (x) consolidation or merger of the Corporation
with or into any other corporation or other entity or person, or any other
corporate reorganization, in which the stockholders of the Corporation
immediately prior to such consolidation, merger or reorganization, own less
than fifty percent (50%) of the Corporation's voting power immediately
after such consolidation, merger or reorganization, or any transaction or
series of related transactions in which in excess of fifty percent (50%) of
the Company's voting power is transferred or (y) a sale, lease or other
disposition of all or substantially all of the assets of the Corporation
shall be deemed to be a liquidation subject to this Section 2.
(i) In any of such events, if the consideration received by
the Corporation is other than cash or indebtedness, its value will be
deemed to be its fair market value. In the case of securities, fair market
value shall be determined as follows:
(A) Securities not subject to investment letter or other
similar restrictions on free marketability:
(I) If traded on a securities exchange, or over-
the-counter as a NASDAQ National Market System security, the value
shall be deemed to be the average of the closing prices of the
securities on such exchange or NASDAQ National Market System over
the 30-day period ending three (3) days prior to the closing;
(II) If actively traded over-the-counter (but not
on the National Market System), the value shall be deemed to be
the average of the closing bid prices over the 30-day period
ending three (3) days prior to the closing; and
4
<PAGE>
(III) If there is no active public market, the
value shall be the fair market value thereof, as determined by
the unanimous consent or vote of the Board of Directors and the
approval of holders of at least 66 2/3% of the Series A Preferred
Stock, of at least 66 2/3% of the Series B Preferred Stock and of
at least 66 2/3% of the Series C Preferred Stock and such
determination shall be binding upon the holders of the Preferred
Stock; and
(IV) The method of valuation of securities
subject to investment letter or other restrictions on free
marketability shall be to make an appropriate discount from the
market value determined as above in subparagraphs (A) (I), (II)
or (III) to reflect the approximate fair market value thereof, as
determined by the unanimous consent or vote of the Board of
Directors and the approval of holders of at least 66 2/3% of the
Series A Preferred Stock, of at least 66 2/3% of the Series B
Preferred Stock and of at least 66 2/3% of the Series C Preferred
Stock, and such determination shall be binding upon the
stockholders.
(c) The liquidation preference of holders of Preferred Stock
provided herein shall not be deemed to be impaired by distributions made by the
Corporation in connection with the repurchase of shares of Common Stock,
including the Reserved Shares, as hereinafter defined, at the lower of fair
market value or the original issue price from former employees or consultants
upon termination of their employment or services pursuant to stock restriction
agreements between the Corporation and such persons approved by the
Corporation's Board of Directors, and such holders shall be deemed to have
consented to such repurchases.
Section 3. Voting Rights.
-------------
(a) General. Except with respect to the election of directors
-------
of the Corporation as set forth below, the holder of each share of Common Stock
issued and outstanding shall have one vote and each holder of Preferred Stock
issued and outstanding shall have the number of votes equal to the number of
shares of Common Stock into which such holder's shares of Preferred Stock are
then convertible, as adjusted from time to time pursuant to Section 4 hereof, at
the record date for determination of the stockholders entitled to vote on such
matters or, if no record date is established, at the date such vote is taken or
any written consent of stockholders is first solicited. The holders of Preferred
Stock shall be entitled to receive notice, together with the holders of Common
Stock, of all stockholder meetings even if only the holders of Common Stock are
entitled to vote on the issues addressed at such meeting .
(b) Board of Directors. Subject to Section 3(c) below, the
------------------
authorized number of directors comprising the Company's Board of Directors shall
be seven (7). As long as there are at least 2,000,000 shares of Preferred Stock
issued and outstanding, of the authorized number of members of the Corporation's
Board of Directors:
5
<PAGE>
(i) the holders of Series A Preferred Stock voting
separately as a class shall be entitled to elect one (1) director (and to fill
any vacancies with respect thereto), with each holder of Series A Preferred
Stock entitled to the number of votes determined as provided in Section 3(a)
above;
(ii) the holders of Series B Preferred Stock voting
separately as a class shall be entitled to elect one (1) director (and to
fill any vacancies with respect thereto), with each holder of Series B
Preferred Stock entitled to the number of votes determined as provided in
Section 3(a) above;
(iii) the holders of Series C Preferred Stock voting
separately as a class shall be entitled to elect one (1) director (and to
fill any vacancies with respect thereto), with each holder of Series C
Preferred Stock entitled to the number of votes determined as provided in
Section 3(a) above; and
(iv) the holders of Series A Preferred Stock, Series B
Preferred Stock, Series C Preferred Stock and Common Stock, voting together
as a single class, shall be entitled to elect four (4) directors (and to
fill any vacancies with respect thereto).
Subject to Section 302 and Section 303 of the California Corporations Code, any
director who shall have been elected by a specified group of stockholders may be
removed during the aforesaid term of office, either for or without cause, by and
only by, the affirmative vote of the holders of a majority of the shares of such
specified group, given at a special meeting of such stockholders duly called or
by an action by written consent for that purpose.
The Holders of Common Stock, Series A Preferred Stock, Series B Stock and
Series C Preferred Stock shall be entitled to cumulative voting rights as to the
directors to be elected by each series or class, or the combined classes in
accordance with the provisions of Section 214 of the Delaware General
Corporation Law.
(c) Designated Default. If the holders of 66 2/3 % of the Preferred
------------------
Stock elect to declare a Designated Default in accordance with the Second
Amended and Restated Investors' Rights Agreement, dated as of the Series C
Original Issue Date, among the Corporation and certain stockholders of the
Corporation (the "Investors' Rights Agreement"), the authorized number of
directors comprising the Corporation's Board of Directors shall be increased by
four (4) directors to eleven (11) directors. One of such additional directors
shall be elected by the holders of Series A Preferred Stock voting separately as
a class, with each holder of Series A Preferred Stock entitled to the number of
votes determined as provided in Section 3(a) above, one of such additional
directors shall be elected by the holders of Series B Preferred Stock voting
separately as a class, with each holder of Series B Preferred Stock entitled to
the number of votes determined as provided in Section 3(a) above, one of such
additional directors shall be elected by the holders of Series C Preferred Stock
voting separately as a class, with each holder of Series C Preferred Stock
entitled to the number of votes determined as provided in Section 3(a) above and
one of such additional directors shall be elected by the holders of Series A
Preferred Stock, Series B Preferred Stock and Series C Preferred Stock voting
together as a single class, with each holder of Series A Preferred Stock, Series
B Preferred Stock and Series C Preferred Stock entitled to the number of votes
determined as provided in Section 3(a) above.
6
<PAGE>
(d) Audit Committee. The Corporation's Board of Directors shall
---------------
establish an Audit Committee consisting of three (3) directors, which shall
include the directors elected in accordance with Section 3(b)(i), (ii) and (iii)
above.
(e) Compensation Committee. The Corporation's Board of Directors
----------------------
shall establish an Compensation Committee consisting of three (3) directors,
which shall include the directors elected in accordance with Section
3(b)(i),(ii) and (iii) above.
Section 4. Conversion. The holders of Preferred Stock shall have
----------
conversion rights as follows (the "Conversion Rights"):
(a) Right to Convert.
----------------
(i) Optional Conversion. Each share of Preferred Stock shall
-------------------
be convertible at the option of the holder thereof at any time after the date of
issuance of such share, at the office of the Corporation or any transfer agent
for Preferred Stock, into such number of fully paid and nonassessable shares of
Common Stock as is determined in the case of the Series A Preferred Stock, by
dividing $1.00 by the Series A Conversion Price at the time in effect, as is
determined in the case of the Series B Preferred Stock, by dividing $2.1628 by
the Series B Conversion Price at the time in effect and as is determined in the
case of the Series C Preferred Stock, by dividing $3.70 by the Series C
Conversion Price at the time in effect. As of the effective date of this
Certificate of Incorporation, the Series A Conversion Price shall be $1.00, the
Series B Conversion Price shall be $2.1628 and the Series C Conversion Price
shall be $3.70 Such initial Series A Conversion Price, Series B Conversion Price
and Series C Conversion Price shall be subject to adjustment as set forth below.
(ii) Series A Preferred Stock. Each share of Series A
------------------------
Preferred Stock shall automatically be converted into shares of Common
Stock at the Series A Conversion Price then in effect upon the earlier of
(1) the affirmative vote of holders of 66 2/3 % of the Series A Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock, voting
together as a single class, to convert all shares of Series A Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock into shares of
Common Stock, (2) the date on which fewer than 50,000 shares of Series A
Preferred Stock (appropriately adjusted for any stock splits, combinations,
consolidations, or stock distributions or dividends with respect to such
shares) remain outstanding or (3) the closing of an underwritten public
offering pursuant to an effective registration statement under the
Securities Act of 1933, as amended, covering the offer and sale of Common
Stock for the account of the Corporation to the public at a price per share
(before deduction of underwriter discounts and commissions and offering
expenses) of not less than $7.50 per share (as adjusted for any stock
splits, combinations, consolidations, or stock distributions or dividends
with respect to such shares) and an aggregate offering price to the public
of not less than $20,000,000.
(iii) Series B Preferred Stock. Each share of Series B
------------------------
Preferred Stock shall
7
<PAGE>
automatically be converted into shares of Common Stock at the Series B
Conversion Price then in effect upon the earlier of (1) the affirmative
vote of holders of 66 2/3 % of the Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock, voting together as a single
class, to convert all shares of Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock into shares of Common Stock,
(2) the date on which fewer than 50,000 shares of Series B Preferred Stock
(appropriately adjusted for any stock splits, combinations, consolidations,
or stock distributions or dividends with respect to such shares) remain
outstanding or (3) the closing of an underwritten public offering pursuant
to an effective registration statement under the Securities Act of 1933, as
amended, covering the offer and sale of Common Stock for the account of the
Corporation to the public at a price per share (before deduction of
underwriter discounts and commissions and offering expenses) of not less
than $7.50 per share (appropriately adjusted for any stock splits,
combinations, consolidations, or stock distributions or dividends with
respect to such shares) and an aggregate offering price to the public of
not less than $20,000,000.
(iv) Series C Preferred Stock. Each share of Series C
------------------------
Preferred Stock shall automatically be converted into shares of Common
Stock at the Series C Conversion Price then in effect upon the earlier of
(1) the affirmative vote of holders of 66 2/3 % of the Series A Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock, voting
together as a single class, to convert all shares of Series A Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock into shares of
Common Stock, (2) the date on which fewer than 50,000 shares of Series C
Preferred Stock (appropriately adjusted for any stock splits, combinations,
consolidations, or stock distributions or dividends with respect to such
shares) remain outstanding or (3) the closing of an underwritten public
offering pursuant to an effective registration statement under the
Securities Act of 1933, as amended, covering the offer and sale of Common
Stock for the account of the Corporation to the public at a price per share
(before deduction of underwriter discounts and commissions and offering
expenses) of not less than $7.50 per share (appropriately adjusted for any
stock splits, combinations, consolidations, or stock distributions or
dividends with respect to such shares) and an aggregate offering price to
the public of not less than $20,000,000.
(v) In the event of the automatic conversion of the Series A,
Series B or Series C Preferred Stock as set forth in Sections 4 (a)(ii)(3),
4(a)(iii)(3) and 4(a)(iv)(3) above, the person(s) entitled to receive the
Common Stock issuable upon such conversion shall not be deemed to have
converted such shares until immediately prior to the closing of such sale
of securities causing the conversion, at which time the Preferred Stock
shall be converted automatically without any further action by the holders
of such shares and whether or not the certificates representing such shares
are surrendered to the Corporation or its transfer agent; provided,
however, that the Corporation shall not be obligated to issue certificates
evidencing the shares of Common Stock issuable upon such conversion unless
certificates evidencing such shares of the Preferred Stock being converted
are either delivered to the Corporation or its transfer agent, as
hereinafter provided, or the holder notifies the Corporation or its
transfer agent, as hereinafter provided, that such certificates have been
lost,
8
<PAGE>
stolen or destroyed and executes an agreement satisfactory to the
Corporation to indemnify the Corporation from any loss incurred by it in
connection therewith. Upon the automatic conversion of the Preferred Stock,
the holders of the Preferred Stock shall surrender the certificates
representing such shares at the office of the Corporation or of any
transfer agent for the Preferred Stock. Thereupon, there shall be issued
and delivered to such holder, promptly at such office and in his name as
shown on such surrendered certificate or certificates, a certificate or
certificates for the number of shares of Common Stock into which the shares
of the Preferred Stock surrendered were convertible on the date on which
such automatic conversion occurred.
(vi) Upon conversion of the Preferred Stock, the Common Stock
so issued shall be duly and validly issued, fully paid and nonassessable
shares of the Corporation.
(b) Mechanics of Conversion. No fractional shares of Common
-----------------------
Stock shall be issued upon conversion of Preferred Stock. In lieu of any
fractional shares to which the holder would otherwise be entitled, the
Corporation shall pay cash equal to such fraction multiplied by the then-
effective conversion price for a particular series of Preferred Stock (a
"Conversion Price"). Except as provided in Section 4(a)(ii), before any holder
of Preferred Stock shall be entitled to convert the same into full shares of
Common Stock, he shall surrender the certificate or certificates therefor, duly
endorsed, at the office of the Corporation or of any transfer agent for the
Preferred Stock, and shall give written notice by mail, postage prepaid, to the
Corporation at its principal corporate office, of the election to convert the
same. The Corporation shall, as soon as practicable thereafter, issue and
deliver at such office to such holder of Preferred Stock, a certificate or
certificates for the number of shares of Common Stock to which he shall be
entitled as aforesaid and a check payable to the holder in the amount of any
cash payable in lieu of fractional shares of Common Stock (after aggregating all
shares of Common Stock issuable to such holder of Preferred Stock upon
conversion of the number of shares of Preferred Stock at the time being
converted). In addition, if less than all of the shares represented by such
certificates are surrendered for conversion pursuant to Section 4(a)(i), the
Corporation shall issue and deliver to such holder a new certificate for the
balance of the shares of Preferred Stock not so converted. Except as provided in
Section 4(a)(ii), such conversion shall be deemed to have been made immediately
prior to the close of business on the date of the surrender of the shares of
such Preferred Stock to be converted, and the person or persons entitled to
receive the shares of Common Stock issuable upon such conversion shall be
treated for all purposes as the record holder or holders of such shares of
Common Stock as of such date. If the conversion is in connection with an
underwritten offer of securities registered pursuant to the Securities Act of
1933, the conversion may, at the option of any holder tendering such Preferred
Stock for conversion, be conditioned upon the closing with the underwriter of
the sale of securities pursuant to such offering, in which event the person(s)
entitled to receive Common Stock issuable upon such conversion of such Preferred
Stock shall not be deemed to have converted such Preferred Stock until
immediately prior to the closing of such sale of securities. In addition, any
conversion may be conditional upon the happening of a specific event, in which
event the person(s) entitled to receive Common Stock issuable upon such
conversion of such Preferred Stock shall not
9
<PAGE>
be deemed to have converted such Preferred Stock until immediately prior to the
happening of such event.
(c) Adjustment to Conversion Price for Diluting Issues.
--------------------------------------------------
(i) Special Definitions. For purposes of this Section 4(c),
-------------------
the following definitions shall apply:
(1) "Convertible Securities" shall mean any evidences
----------------------
of indebtedness, shares (other than Common Stock, Series A Preferred
Stock, Series B Preferred Stock or Series C Preferred Stock) or other
securities convertible into or exchangeable for Common Stock.
(2) "Options" shall mean rights, options or warrants
-------
to subscribe for, purchase or otherwise acquire either Common Stock or
Convertible Securities, except for those issued to officers or
employees of, or consultants to, the Corporation as provided in
Section 4(c)(i)(6)(B).
(3) "Series C Original Issue Date" shall mean the
----------------------------
date on which the first share of Series C Preferred Stock is issued.
(4) "Dilutive Financing" means any issuance or deemed
------------------
issuance of Additional Shares of Common Stock after the Series C
Original Issue Date for a consideration per share less than the
applicable Series A, Series B or Series C Conversion Price in effect
on the date of and immediately prior to such sale.
(5) "New Securities" means shares of Common Stock,
--------------
Preferred Stock or any other class of capital stock of the Company,
whether or not now authorized, securities of any type that are
convertible into shares of such capital stock, and options, warrants
or rights to acquire shares of such capital stock. Notwithstanding the
foregoing, the term "New Securities" will not include: (A) securities
issued in connection with bona fide equipment lease or working capital
debt financings with lending institutions that have been approved by
the Corporation's Board of Directors; (B) securities offered to the
public pursuant to a registration statement filed under the Securities
Act; (C) securities issued to the sellers of a corporation pursuant to
the acquisition of such corporation by the Company by merger, purchase
of substantially all of the assets, or other reorganization whereby
the Company owns not less than 51% of the voting power of such
corporation; (D) securities issued upon exercise or conversion of
options, warrants and other convertible securities outstanding on the
date of filing of this Certificate of Incorporation; (E) shares of
Common Stock or Preferred Stock issued in connection with any stock
split, stock dividend or recapitalization by the Company in which all
classes and series of capital stock are adjusted equally; and (F)
securities issued to the
10
<PAGE>
Corporation's placement agent in connection with the sale and issuance
of the Corporation's Series C Preferred Stock.
(6) "Additional Shares of Common Stock" shall mean all
---------------------------------
shares of Common Stock issued (or, pursuant to Section 4(c)(iii),
deemed to be issued) by the Corporation after the Series C Original
Issue Date, including New Securities, other than shares of Common
Stock issued or issuable:
(A) upon conversion of shares of Preferred
Stock;
(B) to officers or employees of, or
consultants to, the Corporation pursuant to a stock grant, stock
option plan, stock purchase plan or other stock incentive
agreement (collectively, the "Plans"), (collectively, the
"Reserved Shares") up to an aggregate of 805,812 shares;
(C) as a dividend or distribution on Series
A Preferred Stock, Series B Preferred Stock and Series C
Preferred Stock;
(D) as securities excluded from the
definition of New Securities in Section 4(c)(i)(5);
(E) following a vote of the holders of 66
2/3% of the Preferred Stock voting on the basis of the number of
shares of Common Stock into which each holder's shares of
Preferred Stock are then convertible, as adjusted from time to
time pursuant to Section 4 hereof, that designated shares of
Common Stock issued or deemed to be issued shall not constitute
Additional Shares of Common Stock;
(F) in connection with any transaction for
which adjustment is made pursuant to Section 4(d) hereof; and
(G) by way of dividend or distribution on
shares of Common Stock excluded from the definition of Additional
Shares of Common Stock by the foregoing clauses (A), (B), (C),
(D), (E), (F) or this clause (G).
(ii) No Adjustment of Conversion Price. No adjustment
---------------------------------
in the Conversion Price of a share of Preferred Stock shall be made in
respect of the issuance of Additional Shares of Common Stock unless the
consideration per share for an Additional Share of Common Stock issued or
deemed to be issued by the Corporation is less than the Conversion Price in
effect on the date of, and immediately prior to, such issuance, for such
share of Preferred Stock.
(iii) Deemed Issue of Additional Shares of Common
-------------------------------------------
Stock.
-----
11
<PAGE>
(1) Options and Convertible Securities. In the event
the Corporation at any time or from time to time after the Series C
Original Issue Date shall issue any Options or Convertible Securities
or shall fix a record date for the determination of holders of any
class of securities entitled to receive any such Options or
Convertible Securities, then the maximum number of shares (as set
forth in the instrument relating thereto without regard to any
provisions contained therein for a subsequent adjustment of such
number) of Common Stock issuable upon the exercise of such Options or,
in the case of Convertible Securities and Options therefor, the
conversion or exchange of such Convertible Securities, shall be deemed
to be Additional Shares of Common Stock issued as of the time of such
issue or, in case such a record date shall have been fixed, as of the
close of business on such record date; provided, however, that
Additional Shares of Common Stock shall not be deemed to have been
issued unless the consideration per share (determined pursuant to
Section 4(c)(v) hereof) of such Additional Shares of Common Stock
would be less than the Conversion Price in effect on the date of and
immediately prior to such issue, or such record date, as the case may
be; and, provided, further, that in any such case in which Additional
Shares of Common Stock are deemed to be issued:
(A) no further adjustment in the Conversion Price
shall be made upon the subsequent issue of Convertible Securities
or shares of Common Stock upon the exercise of such Options or
conversion or exchange of such Convertible Securities;
(B) if such Options or Convertible Securities by their
terms provide, with the passage of time or otherwise, for any
increase or decrease in the consideration payable to the
Corporation, or increase or decrease in the number of shares of
Common Stock issuable, upon the exercise, conversion or exchange
thereof, the Conversion Price computed upon the original issue
thereof (or upon the occurrence of a record date with respect
thereto), and any subsequent adjustments based thereon, shall,
upon any such increase or decrease becoming effective, be
recomputed to reflect such increase or decrease, insofar as it
affects such Conversion Price, but no further change in the
Conversion Price shall be made upon the exercise, conversion or
exchange of such Options or Convertible Securities, and no such
adjustment of the Conversion Price shall affect Common Stock
previously issued upon conversion of the Preferred Stock;
(C) if any such Options or Convertible Securities
shall expire or be canceled without having been exercised or
converted, the Conversion Price as adjusted upon the original
issuance thereof (or upon the occurrence of a record date with
respect thereto) shall be readjusted as if
12
<PAGE>
(I) in the case of Convertible Securities or
Options for Common Stock, the only Additional Shares of
Common Stock so issued were shares of Common Stock, if any,
actually issued or sold on the exercise of such Options or
the conversion or exchange of such Convertible Securities,
and such Additional Shares of Common Stock, if any, were
issued or sold for the consideration actually received by
the Corporation upon such exercise, plus the consideration,
if any, actually received by the Corporation for the
granting of all such Options, whether or not exercised, plus
the consideration received for issuing or selling the
Convertible Securities actually converted plus the
consideration, if any, actually received by the Corporation
(other than by cancellation of liabilities or obligations
evidenced by such Convertible Securities) on the conversion
or exchange of such Convertible Securities; and
(II) in the case of Options for Convertible
Securities, only the Convertible Securities, if any,
actually issued upon the exercise thereof were issued at the
time of issue of such Options, and the consideration
received by the Corporation for the Additional Shares of
Common Stock deemed to have been then issued was the
consideration actually received by the Corporation for the
issue of all such Options, whether or not exercised, plus
the consideration deemed to have been received by the
Corporation upon the issue of the Convertible Securities
with respect to which such Options were actually exercised;
(D) no readjustment pursuant to clauses (B) or (C)
above shall have the effect of increasing the Conversion Price to
an amount which exceeds the lower of (i) the Conversion Price on
the original adjustment date (immediately prior to the
adjustment), or (ii) the Conversion Price that would have
resulted from any actual issuance of Additional Shares of Common
Stock between the original adjustment date and such readjustment
date.
(iv) Adjustment of Conversion Price Upon Issuance of Additional
----------------------------------------------------------
Shares of Common Stock. Subject to Section 4(c)(ii), the Conversion Price
----------------------
of the Preferred Stock shall be subject to adjustment under this Section
4(c)(iv) as follows:
(1) In the event the Corporation shall at any time after
the Series C Original Issue Date issue Additional Shares of Common
Stock (including Additional Shares of Common Stock deemed to be issued
pursuant Section 4(c)(iii)), without consideration or for a
consideration per share less than the Conversion Price in effect on
the date of and immediately prior to such issue, then and in such
event, such Conversion Price shall be reduced, concurrently with such
issue, to the price
13
<PAGE>
(calculated to the nearest cent) determined by multiplying such
Conversion Price by a fraction (x) the numerator of which shall be the
number of shares of Common Stock outstanding immediately prior to such
issue plus the number of shares of Common Stock which the aggregate
consideration received by the Corporation for the total number of
Additional Shares of Common Stock so issued would purchase at such
Conversion Price, and (y) the denominator of which shall be the number
of shares of Common Stock outstanding immediately prior to such issue
plus the number of such Additional Shares of Common Stock so issued;
provided, however, that, for the purposes of this Section 4(c)(iv),
all shares of Common Stock issuable upon conversion of outstanding
shares of Preferred Stock shall be deemed to be outstanding; and,
further provided, that any Additional Shares of Common Stock deemed
issued pursuant to Section 4(c)(iii) shall be deemed to be
outstanding.
(v) Determination of Consideration. For purposes of this
------------------------------
Section 4(c), the consideration received by the Corporation for the
issuance of any Additional Shares of Common Stock shall be computed, after
deducting all commissions, expenses and fees, as follows:
(1) Cash and Property. Such consideration shall:
-----------------
(A) insofar as it consists of cash, be computed
at the aggregate amount of cash received by the
Corporation excluding amounts paid or payable for accrued
interest or accrued dividends;
(B) insofar as it consists of property other than
cash, be computed at the fair value thereof at the time of
such issue, as determined in good faith by the Board of
Directors; and
(C) in the event Additional Shares of Common
Stock are issued together with other shares or securities
or other assets of the Corporation for consideration which
covers both, by the proportion of such consideration so
received, computed as provided in clauses (A) and (B)
above, as determined in good faith by the Board of
Directors.
(2) Options and Convertible Securities. The consideration
----------------------------------
per share received by the Corporation for Additional Shares of
Common Stock deemed to have been issued pursuant to Section
4(c)(iii)(1), relating to Options and Convertible Securities,
shall be determined by dividing:
(A) the total amount, if any, received or
receivable by the Corporation as consideration for the
issue of such Options or Convertible Securities, plus the
minimum aggregate amount of additional consideration (as
set forth in the instruments relating
14
<PAGE>
thereto, without regard to any provisions contained
therein for a subsequent adjustment of such consideration)
payable to the Corporation upon the exercise of such
Options or the conversion or exchange of such Convertible
Securities, or in the case of Options for Convertible
Securities, the exercise of such Options for Convertible
Securities and the conversion or exchange of such
Convertible Securities, by
(B) the maximum number of shares of Common Stock
(as set forth in the instruments relating thereto, without
regard to any provisions contained therein for a
subsequent adjustment of such number) issuable upon the
exercise of such Options or the conversion or exchange of
such Convertible Securities.
(d) Adjustments for Stock Dividends, Distributions, Subdivisions,
-------------------------------------------------------------
Combinations or Consolidations of Common Stock.
- ----------------------------------------------
(i) Stock Dividends, Distributions or Subdivisions. In the
----------------------------------------------
event the Corporation shall issue Additional Shares of Common Stock
pursuant to a stock dividend, stock distribution or subdivision, the
Conversion Price in effect immediately prior to such stock dividend, stock
distribution or subdivision shall concurrently with such stock dividend,
stock distribution or subdivision, be proportionately decreased.
(ii) Combinations or Consolidations. In the event the
------------------------------
outstanding shares of Common Stock shall be combined or consolidated, by
reclassification or otherwise, into a lesser number of shares of Common
Stock, the Conversion Price in effect immediately prior to such combination
or consolidation shall, concurrently with the effectiveness of such
combination or consolidation, be proportionately increased.
(iii) Adjustments for Other Distributions. In the event the
-----------------------------------
Corporation at any time or from time to time makes, or fixes a record date
for the determination of holders of Common Stock entitled to receive any
distribution payable in securities of the Corporation other than shares of
Common Stock and other than as otherwise adjusted in this Section 4(c) or
(d) or as otherwise provided in Section 1, then, and in each such event,
provision shall be made so that the holders of Preferred Stock shall
receive upon conversion thereof, in addition to the number of shares of
Common Stock receivable thereupon, the amount of securities of the
Corporation which they would have received had their Preferred Stock been
converted into Common Stock on the date of such event and had they
thereafter, during the period from the date of such event to and including
the date of conversion, retained such securities receivable by them as
aforesaid during such period, subject to all other adjustments called for
during such period under this Section 4(c) or (d) with respect to the
rights of the holders of the Preferred Stock.
15
<PAGE>
(iv) Adjustments for Reclassification, Exchange, and
-----------------------------------------------
Substitution. If the Common Stock issuable upon conversion of the
------------
Preferred Stock shall be changed into the same or a different number of
shares of any other class or classes of stock, whether by capital
reorganization, reclassification or otherwise (other than a subdivision or
combination of shares provided for above), the applicable Conversion Price
then in effect shall, concurrently with the effectiveness of such
reorganization or reclassification, be proportionately adjusted such that
the Preferred Stock shall be convertible into, in lieu of the number of
shares of Common Stock which the holders would otherwise have been entitled
to receive, a number of shares of such other class or classes of stock
equivalent to the number of shares of Common Stock that would have been
subject to receipt by the holders upon conversion of their Preferred Stock
immediately before that change.
(e) No Impairment. The Corporation will not, by amendment of its
-------------
Certificate of Incorporation or through any reorganization, transfer of assets,
consolidation, merger, dissolution, issue or sale of securities or any other
voluntary action, avoid or seek to avoid the observance or performance of any
other terms to be observed or performed hereunder by the Corporation but will at
all times in good faith assist in the carrying out of all the provisions of this
Section 4 and in the taking of all such action as may be necessary or
appropriate in order to protect the Conversion Rights of the holders of the
Preferred Stock against impairment.
(f) Reservation of Stock Issuable Upon Conversion. The Corporation
---------------------------------------------
shall at all times reserve and keep available out of its authorized but unissued
shares of Common Stock solely for the purpose of effecting the conversion of the
Preferred Stock, such number of shares of its Common Stock as shall from time to
time be sufficient to effect the conversion of all outstanding shares of
Preferred Stock; and if at any time the number of authorized but unissued shares
of Common Stock shall not be sufficient to effect the conversion of all then-
outstanding shares of Preferred Stock, in addition to such other remedies as
shall be available to the holders of Preferred Stock, the Corporation will take
such corporate actions as may, in the opinion of its counsel, be necessary to
increase its authorized but unissued shares of Common Stock to such number of
shares as shall be sufficient for such purposes.
(g) Certificate as to Adjustments. Upon the occurrence of each
-----------------------------
adjustment or readjustment of the Conversion Price pursuant to this Section 4,
the Corporation at its expense shall promptly compute such adjustment or
readjustment in accordance with the terms hereof and furnish to each holder of
Preferred Stock a certificate setting forth such adjustment or readjustment and
showing in detail the facts upon which such adjustment or readjustment is based.
The Corporation shall, upon the written request at any time of any holder of
Preferred Stock, furnish or cause to be furnished to such holder a like
certificate setting forth (i) all such adjustments and readjustments, (ii) the
Conversion Price at the time in effect, and (iii) the number of shares of Common
Stock and the amount, if any, of other property which at the time would be
received upon the conversion of such Preferred Stock.
16
<PAGE>
(h) Notices of Record Date. In the event that the Corporation shall
----------------------
propose at any time:
(i) to declare any dividend or distribution upon the Common
Stock, whether in cash, property, stock or other securities, whether or not
a regular cash dividend and whether or not out of earnings or earned
surplus, other than distributions to stockholders in connection with the
repurchase of shares of Common Stock, including the Reserved Shares, of
former employees or consultants, to which the holders of Preferred Stock
have consented in Section 2(c) hereof; or
(ii) to offer for subscription to the holders of any class or
series of its capital stock any additional shares of stock of any class or
series or any other rights; or
(iii) to effect any reclassification or recapitalization; or
(iv) to merge or consolidate with or into any other
corporation, or sell, lease or convey all or substantially all its property
or business, or to liquidate, dissolve or wind up, or to effect any other
transaction subject to the provisions of Section 2 of this Certificate of
Incorporation;
then, in connection with each such event, the Corporation shall send to the
holders of the Preferred Stock:
(1) at least 20 days' prior written notice of the date on
which a record shall be taken for such dividend, distribution or
subscription rights (and specifying the date on which the holders of
Common Stock shall be entitled thereto) or for determining the rights
to vote in respect of the matters referred to in (iii) and (iv) above;
and
(2) in the case of the matters referred to in (iii) and
(iv) above, at least 20 days' prior written notice of the date of a
stockholders meeting at which a vote on such matters shall take place
or the effective date of any written consent (and specifying the
material terms and conditions of the proposed transaction or event and
the date on which the holders of Preferred Stock and Common Stock
shall be entitled to exchange their Preferred Stock and Common Stock
for securities or other property deliverable upon the occurrence of
such event and the amount of securities or other property deliverable
upon such event).
Each such written notice shall be given personally or by first
class mail, postage prepaid, addressed to the holders of Preferred Stock at the
address for each such holder as shown on the books of the Corporation.
17
<PAGE>
Section 5. No Reissuance of Preferred Stock. No share or shares of
--------------------------------
Preferred Stock acquired by the Corporation by reason of redemption, purchase,
conversion or otherwise shall be reissued, and all such shares shall be
canceled, retired and eliminated from the shares which the Corporation shall be
authorized to issue.
Section 6. Protective Provisions.
---------------------
(a) Preferred Stock. In addition to any other rights provided by
---------------
law and without limiting the last paragraph of this Section 6(a), so long as at
least 750,000 shares of Preferred Stock (as such number may be adjusted for
stock splits, combinations and the like) shall be outstanding, the Corporation
shall not, without first obtaining the affirmative vote or written consent of
the holders of 66 2/3% of the outstanding shares of Preferred Stock voting as a
single class (in each case based on the number of shares of Common Stock into
which each holder's Preferred Stock is then convertible, as adjusted from time
to time pursuant to Section 4 hereof):
(i) amend or repeal any provision of, or add any
provision to, this Corporation's Certificate of Incorporation or bylaws if
such action would alter or change the preferences, rights, privileges or
powers of, or the restrictions provided for the benefit of, any series of
Preferred Stock or the Preferred Stock in an adverse manner;
(ii) increase the authorized number of shares of any
series of Preferred Stock;
(iii) authorize or issue any new shares or reclassify
any Common Stock or other shares into shares of any class or series of
stock senior to or on parity with any series of Preferred Stock as to
dividends, redemption rights, liquidation preferences, conversion rights,
voting rights or otherwise;
(iv) sell, license or otherwise dispose of all or
substantially all of the assets or business of the Corporation or authorize
any liquidation or winding up of the Corporation;
(v) effect a consolidation, reorganization or merger
of the Corporation with or into any other corporation, or any other
transaction in which ownership of a majority of the Corporation's capital
stock is transferred;
(vi) redeem any shares of the Corporation's capital
stock, other than redemptions of Preferred Stock required under the
Investors' Rights Agreement; or
(vii) increase the authorized number of directors of
this Corporation to more than seven (7) , other than any increase required
under the Investors' Rights Agreement.
In addition to any other rights provided by law and without limiting the
foregoing, so long as any shares of Preferred Stock shall be outstanding, the
Corporation shall not, without first obtaining
18
<PAGE>
the affirmative vote or written consent of the holders of a majority of the
outstanding shares of Preferred Stock voting as a single class (based on the
number of shares of Common Stock into which each holder's Preferred Stock is
then convertible, as adjusted from time to time pursuant to Section 4 hereof),
take any action to amend the Certificate of Incorporation in which the dividend,
liquidation preference, conversion, voting, redemption or other rights of the
Preferred Stock will be adversely affected.
Section 7. Redemption. The shares of Preferred Stock shall be redeemed as
----------
follows:
(a) Mandatory Redemption. The holders of 66 2/3 % of the
--------------------
shares of Preferred Stock (the "Electing Holders") may elect, at any time from
time to time following July 2, 2003 but prior to July 2, 2005, by written notice
(the "Redemption Notice") to the Corporation and all other holders of Preferred
Stock, to require that the Corporation redeem all (but not less than all) shares
of Preferred Stock owned by the Electing Holders (and/or any permitted assignee
of such Electing Holders) (the "Redemption Shares") in accordance with this
Section 7 (a "Mandatory Redemption"). Holders of Preferred Stock receiving such
Redemption Notice may elect by written notice to the Corporation and the
Electing Holders within ten (10) days following delivery of the Redemption
Notice to participate in the Mandatory Redemption and become an Electing Holder
for purposes of this Section 7.
(b) Redemption Price and Payment. The aggregate purchase
----------------------------
price (the "Redemption Price") for the Redemption Shares shall be the aggregate
purchase price paid to the Corporation by the Electing Holders for such
Redemption Shares, plus all accrued but unpaid dividends with respect to such
Redemption Shares. The shares of Preferred Stock to be redeemed following
delivery of the Redemption Notice shall be redeemed by paying for each share in
cash an amount (such amount being referred to as the "Redemption Price") equal
to $1.00 per share of Series A Preferred Stock, $2.1628 per share of Series B
Preferred Stock and $3.70 per share of Series C Preferred Stock plus, in the
case of each share, an amount equal to all dividends declared but unpaid
thereon, computed to the date of such Redemption Notice. The Company shall
redeem the Redemption Shares no later than ninety (90) days following delivery
of the Redemption Notice, by paying the Redemption Price to such Electing
Holders in immediately available funds (the "Redemption Date").
(c) Redemption Mechanics. The Redemption Notice shall be by
--------------------
given delivery in person, certified or registered mail, return receipt
requested, telecopier or telex, to each holder of record (at the close of
business on the business day next preceding the day on which the Redemption
Notice is given) of shares of Preferred Stock. The Redemption Notice shall set
forth the aggregate purchase price paid to the Corporation by the Electing
Holders for such Redemption Shares, plus all accrued but unpaid dividends with
respect to such Redemption Shares. The Redemption Notice shall be addressed to
each holder of Preferred Stock at his address as shown by the records of the
Corporation. From and after the close of business on a Redemption Date, unless
there shall have been a default in the payment of the Redemption Price, all
rights of holders of shares of Preferred Stock (except the right to receive the
Redemption Price) shall cease with respect to the shares to be redeemed on such
Redemption Date, and such shares shall not thereafter be transferred on the
books
19
<PAGE>
of the Corporation or be deemed to be outstanding for any purpose whatsoever. If
the funds of the Corporation legally available for redemption of shares of
Preferred Stock on a Redemption Date are insufficient to redeem the total number
of shares of Preferred Stock to be redeemed on such Redemption Date, the holders
of such shares shall share ratably in any funds legally available for redemption
of such shares according to the respective amounts which would be payable to
them if the full number of shares to be redeemed on such Redemption Date were
actually redeemed. The shares of Preferred Stock required to be redeemed but not
so redeemed shall remain outstanding and entitled to all rights and preferences
provided herein. At any time thereafter when additional funds of the Corporation
are legally available for the redemption of such shares of Preferred Stock, such
funds will be used, at the end of the next succeeding fiscal quarter, to redeem
the balance of such shares, or such portion thereof for which funds are then
legally available, on the basis set forth above.
(d) Redeemed or Otherwise Acquired Shares to be Retired. Any
---------------------------------------------------
shares of Preferred Stock redeemed pursuant to this Section 7 or otherwise
acquired by the Corporation in any manner whatsoever shall be cancelled and
shall not under any circumstances be reissued; and the Corporation may from time
to time take such appropriate corporate action as may be necessary to reduce
accordingly the number of authorized shares of Preferred Stock.
ARTICLE V.
The Corporation reserves the right to amend, alter, change, or repeal any
provision contained in this Certificate of Incorporation, in the manner now or
hereafter prescribed by statute, and all rights conferred upon the stockholders
herein are granted subject to this right.
ARTICLE VI.
The Corporation is to have perpetual existence.
ARTICLE VII.
1. Limitation of Liability. To the fullest extent permitted by the
-----------------------
General Corporation Law of the State of Delaware as the same exists or as may
hereafter be amended, a director of the Corporation shall not be personally
liable to the corporation or its stockholders for monetary damages for breach of
fiduciary duty as a director.
2. Indemnification. The corporation may indemnify to the fullest extent
---------------
permitted by law any person made or threatened to be made a party to an action
or proceeding, whether criminal, civil, administrative or investigative, by
reason of the fact that such person or his or her testator or intestate is or
was a director, officer or employee of the corporation, or any predecessor of
the corporation, or serves or served at any other enterprise as a director,
officer or employee at the request of the corporation or any predecessor to the
corporation.
20
<PAGE>
3. Amendments. Neither any amendment nor repeal of this Article VII, nor
----------
the adoption of any provision of the corporation's Certificate of Incorporation
inconsistent with this Article VII, shall eliminate or reduce the effect of this
Article VII, in respect of any matter occurring, or any action or proceeding
accruing or arising or that, but for this Article VII, would accrue or arise,
prior to such amendment, repeal, or adoption of an inconsistent provision.
ARTICLE VIII.
In furtherance and not in limitation of the powers conferred by statute,
the Board of Directors is expressly authorized to make, alter, amend or repeal
the Bylaws of the corporation.
ARTICLE IX.
Following the closing of a public offering pursuant to an effective
registration statement under the Securities Act of 1933, as amended, covering
any of the corporation's securities (as that term is defined under the
Securities Act of 1933, as then in effect) and at such time as the corporation
is no longer subject to Section 2115 of the California Corporations Code, no
action shall be taken by the stockholders of the corporation except at an annual
or special meeting of the stockholders called in accordance with the Bylaws of
the corporation and no action shall be taken by the stockholders by written
consent.
ARTICLE X.
Meetings of stockholders may be held within or without the State of
Delaware, as the By-laws may provide. The books of the Corporation may be kept
(subject to any provision contained in the statutes) outside of the State of
Delaware at such place or places as may be designated from time to time by the
Board of Directors or in the Bylaws of the Corporation."
* * *
The foregoing Amended and Restated Certificate of Incorporation has been
duly approved by the Board of Directors.
The foregoing Amended and Restated Certificate of Incorporation has been
duly approved by the required vote of stockholders in accordance with Section
228 of the Delaware General Corporation Law. No shares of Common Stock or
Preferred Stock of the Corporation are outstanding as of the date hereof.
21
<PAGE>
IN WITNESS WHEREOF, this Restated Certificate of Incorporation has been
signed this ____ day of September, 1999.
Cobalt Networks, Inc.
By:_____________________________________
Stephen DeWitt
President and Chief Executive Officer
ATTEST:
_____________________________________
Kenton D. Chow, Secretary
22
<PAGE>
EXHIBIT 3.1.2
RESTATED CERTIFICATE OF INCORPORATION
OF
COBALT NETWORKS, INC.
Cobalt Networks, Inc., a corporation organized and existing under laws of
the State of Delaware, hereby certifies as follows:
1. The name of the Corporation is Cobalt Networks, Inc. The original
Certificate of Incorporation of the Corporation was filed with the Secretary of
State of the state of Delaware on September 2, 1999 and was amended on September
__, 1999.
2 Pursuant to Sections 228, 242 and 245 of the General Corporation Laws
of the State of Delaware, this Restated Certificate of Incorporation restates
and integrates and further amends the provisions of the Certificate of
Incorporation of this corporation.
3. The text of the Certificate of Incorporation as heretofore amended or
supplemented is hereby amended and restated to read in its entirety as follows:
FIRST: The name of this corporation is Cobalt Networks, Inc.
SECOND: The address of the corporation's registered office in the State of
Delaware is 1209 Orange Street, City of Wilmington, County of New Castle, State
of Delaware. The name of its registered agent at such address is The Corporation
Trust Company.
THIRD: The purpose of this corporation is to engage in any lawful act or
activity for which corporations may be organized under the General Corporation
Law of Delaware.
FOURTH: This corporation is authorized to issue two classes of stock to be
designated, respectively, "Common Stock" and "Preferred Stock." The total number
of shares which the corporation is authorized to issue is 130,000,000 shares.
120,000,000 shares shall be Common Stock, par value $.001 per share, and
10,000,000 shares shall be Preferred Stock, par value $.001 per share.
The Preferred Stock may be issued from time to time in one or more series.
The Board of Directors is authorized to fix the number of shares of any series
of Preferred Stock and to determine the designation of any such series. The
Board of Directors is also authorized to determine and alter the powers, rights,
preferences and privileges and the qualifications, limitations and restrictions
granted to or imposed upon any wholly unissued series of Preferred Stock and
within the limitations or restrictions stated in any resolution or resolutions
of the Board of Directors originally fixing the number of shares constituting
any series, to increase or decrease (but not below the number of shares of such
series then outstanding) the number of shares of any series subsequent to the
issue of shares of that series, to determine the designation of any series, and
to fix the number of shares of any series. In case the number of shares of any
series shall be so decreased, the share constituting such decrease shall resume
<PAGE>
the status which they had prior to the adoption of the resolution originally
fixing the number of shares of such series.
FIFTH: "Qualified Public Offering" as used in this Certificate of
Incorporation shall mean the corporation's initial firm commitment underwritten
public offering pursuant to an effective registration under the Securities Act
of 1933, as amended, covering the offer and sale of Common Stock for the account
of the Corporation to the public. For the management of the business and for the
conduct of the affairs of the corporation, and in further definition, limitation
and regulation of the powers of the corporation, of its directors and of its
stockholders or any class thereof, as the case may be, it is further provided
that, effective upon the closing of a Qualified Public Offering:
1. The management of the business and the conduct of the affairs of
the corporation shall be vested in its Board of Directors. The number of
directors which shall constitute the whole Board of Directors shall be fixed
exclusively by one or more resolutions adopted from time to time by the Board of
Directors.
The Board of Directors shall be divided into three classes designated as
Class I, Class II and Class III, respectively. Directors shall be assigned to
each class in accordance with a resolution or resolutions adopted by the Board
of Directors. At the first annual meeting of stockholders following the date
hereof, the term of office of the Class I directors shall expire and Class I
directors shall be elected for a full term of three years. At the second annual
meeting of stockholders following the date hereof, the term of office of the
Class II directors shall expire and Class II directors shall be elected for a
full term of three years. At the third annual meeting of stockholders following
the date hereof, the term of office of the Class III directors shall expire and
Class III directors shall be elected for a full term of three years. At each
succeeding annual meeting of stockholders, directors shall be elected for a full
term of three years to succeed the directors of the class whose terms expire at
such annual meeting. Each holder of voting stock or of any class or series
thereof shall be entitled to cumulative voting rights as to the directors to be
elected by each series or class or the combined classes in accordance with the
provisions of Section 214 of the Delaware General Corporation Law.
Notwithstanding the foregoing provisions of this Article, each director
shall serve until his or her successor is duly elected and qualified or until
his or her death, resignation or removal. No decrease in the number of
directors constituting the Board of Directors shall shorten the term of any
incumbent director.
Any vacancies on the Board of Directors resulting from death, resignation,
disqualification, removal, or other causes shall be filled by either (i) the
affirmative vote of the holders of a majority of the voting power of the then-
outstanding shares of voting stock of the corporation entitled to vote generally
in the election of directors (the "Voting Stock") voting together as a single
class; or (ii) by the affirmative vote of a majority of the remaining directors
then in office, even though less than a quorum of the Board of Directors. Newly
created directorships resulting from any increase in the number of directors
shall, unless the Board of Directors determines by resolution that any such
newly created directorship shall be filled by the stockholders, be filled only
by the affirmative vote of the directors then in office, even though less than a
quorum of the Board of Directors. Any director elected in accordance with the
preceding sentence shall hold office for the remainder of the full term of the
class of directors
-2-
<PAGE>
in which the new directorship was created or the vacancy occurred and until such
director's successor shall have been elected and qualified.
2. In furtherance and not in limitation of the powers conferred by
statute, the Board of Directors is expressly authorized to make, alter, amend,
or repeal the Bylaws of the corporation.
3. The directors of the corporation need not be elected by written ballot
unless a stockholder demands election by written ballot at the meeting and
before voting begins, or unless the Bylaws so provide.
4. The affirmative vote of sixty-six and two-thirds percent (66-2/3%) of
the voting power of the then outstanding shares of Voting Stock, voting together
as a single class, shall be required for the adoption, amendment or repeal of
the following sections of the corporation's Bylaws by the stockholders of this
corporation: 2.3 (Annual Meeting) and 2.4 (Special Meeting).
5. No action shall be taken by the stockholders of the corporation except
at an annual or special meeting of the stockholders called in accordance with
the Bylaws.
6. Advance notice of stockholder nomination for the election of directors
and of business to be brought by stockholders before any meeting of the
stockholders of the corporation shall be given in the manner provided in the
Bylaws of the corporation.
7. Any director, or the entire Board of Directors, may be removed from
office at any time (i) with cause by the affirmative vote of the holders of at
least a majority of the voting power of all of the then-outstanding shares of
the Voting Stock, voting together as a single class; or (ii) without cause by
the affirmative vote of the holders of at least sixty-six and two-thirds percent
(66-2/3%) of the voting power of all of the then-outstanding shares of the
Voting Stock.
SIXTH: Notwithstanding any other provision in this Certificate of
Incorporation or in any provision of law which might otherwise permit a lesser
vote or no vote, but in addition to any affirmative vote of the holders of any
particular class or series of the Voting Stock required by law, this Certificate
of Incorporation or any Preferred Stock Designation, the affirmative vote of the
holders of at least sixty-six and two-thirds percent (66-2/3%) of the voting
power of all of the then-outstanding shares of the Voting Stock, voting together
as a single class, shall be required to alter, amend or repeal Article FIFTH or
this Article SIXTH.
SEVENTH: The corporation reserves the right to amend, alter, change or
repeal any provision contained in this Certificate of Incorporation, in the
manner now or hereafter prescribed by statute, except as provided in Article
SIXTH of this Certificate, and all rights conferred upon the stockholders herein
are granted subject to this right.
EIGHTH:
-3-
<PAGE>
1. To the fullest extent permitted by the Delaware General
Corporation Law as the same exists or as may hereafter be amended, a director of
the corporation shall not be personally liable to the Corporation or its
stockholders for monetary damages for breach fiduciary duty as a director.
2. The corporation may indemnify to the fullest extent permitted by
law any person made or threatened to be made a party to an action or proceeding,
whether criminal, civil, administrative or investigative, by reason of the fact
that he or she, his or her testator or intestate is or was a director, officer
or employee of the corporation or any predecessor of the corporation or serves
or served at any other enterprise as a director, officer or employee at the
request of the corporation or any predecessor to the corporation.
3. Neither an amendment nor repeal of this Article I, nor the
adoption of any provision of the corporation's Certificate of Incorporation
inconsistent with this Article EIGHTH, shall eliminate or reduce the effect of
this Article EIGHTH, in respect of any matter occurring, or any action or
proceeding accruing or arising or that, but for this Article EIGHTH, would
accrue or arise, prior to such amendment, repeal, or adoption of an inconsistent
provision.
NINTH: Meetings of stockholders may be held within or without the State
of Delaware, as the Bylaws may provide. The books of the corporation may be kept
(subject to any provision contained in the statutes) outside of the State of
Delaware at such place or places as may be designated from time to time by the
Board of Directors or in the Bylaws of the corporation.
The foregoing Restated Certificate of Incorporation has been duly approved
by the Board of Directors.
The foregoing Restated Certificate of Incorporation has been duly approved
by the required vote of stockholders in accordance with Section 228 of the
Delaware General Corporation Law. The total number of outstanding shares of the
Corporation is ______________ shares of Common Stock. The number of shares
voting in favor of the amendment equaled or exceeded the vote required. The
percentage vote required was more than 50% of the Common Stock.
-4-
<PAGE>
IN WITNESS WHEREOF, this Restated Certificate of Incorporation has been signed
this ____ day of November, 1999.
Cobalt Networks, Inc.
By:_____________________________________
Stephen DeWitt
President and Chief Executive Officer
ATTEST:
_________________________
Kenton D. Chow, Secretary
-5-
<PAGE>
EXHIBIT 3.2
BYLAWS
OF
COBALT NETWORKS, INC.
Article 1
Offices
-------
Section 1.1. Registered Office. The registered office of the Corporation
-----------------
which is required by the state of Delaware to be maintained in the state of
Delaware shall be the registered office named in the charter documents of the
Corporation, or such other office as may be designated from time to time by the
Board of Directors in the manner provided by law.
Section 1.2. Other Offices. The Corporation may also have offices at such
-------------
other places both within and without the state of Delaware as the Board of
Directors may from time to time determine or the business of the Corporation may
require .
Article 2
Stockholders
------------
Section 2.1. Place of Meetings. All meetings of the stockholders shall be
-----------------
held at the principal office of the Corporation, or at such other place within
or without the state of Delaware as shall be specified or fixed in the notices
or waivers of notice thereof.
Section 2.2. Quorum; Adjournment of Meetings. Unless otherwise required
-------------------------------
by law or provided in the charter documents of the Corporation or these Bylaws,
(i) the holders of a majority of the stock issued and outstanding and entitled
to vote thereat, present in person or represented by proxy, shall constitute a
quorum at any meeting of stockholders for the transaction of business, (ii) in
all matters other than election of directors, the affirmative vote of the
holders of a majority of such stock so present or represented at any meeting of
stockholders at which a quorum is present shall constitute the act of the
stockholders, and (iii) where a separate vote by a class or classes is required,
a majority of the outstanding shares of such class or classes, present in person
or represented by proxy shall constitute a quorum entitled to take action with
respect to that vote on that matter and the affirmative vote of the majority of
the shares of such class or classes present in person or represented by proxy at
the meeting shall be the act of such class. The stockholders present at a duly
organized meeting may continue to transact business until adjournment,
notwithstanding the withdrawal of enough stockholders to leave less than a
quorum, subject to the provisions of clauses (ii) and (iii) above.
Directors shall be elected by a plurality of the votes of the shares
present in person or represented by proxy at the meeting and entitled to vote on
the election of directors.
<PAGE>
Notwithstanding the other provisions of the charter documents of the
Corporation or these Bylaws, the chairman of the meeting or the holders of a
majority of the issued and outstanding stock, present in person or represented
by proxy and entitled to vote thereat, at any meeting of stockholders, whether
or not a quorum is present, shall have the power to adjourn such meeting from
time to time, without any notice other than announcement at the meeting of the
time and place of the holding of the adjourned meeting. If the adjournment is
for more than thirty (30) days, or if after the adjournment a new record date is
fixed for the adjourned meeting, a notice of the adjourned meeting shall be
given to each stockholder of record entitled to vote at such meeting. At such
adjourned meeting at which a quorum shall be present or represented any business
may be transacted which might have been transacted at the meeting as originally
called.
Section 2.3. Annual Meeting.
--------------
(a) An annual meeting of the stockholders, for the election of
directors to succeed those whose terms expire and for the transaction of such
other business as may properly come before the meeting, shall be held at such
place (within or without the state of Delaware), on such date, and at such time
as the Board of Directors shall fix and set forth in the notice of the meeting,
which date shall be within thirteen (13) months subsequent to the last annual
meeting of stockholders.
(b) At an annual meeting of stockholders, only such business
shall be conducted as shall have been properly brought before the meeting. To be
properly brought before an annual meeting, business must be: (A) specified in
the notice of meeting (or any supplement thereto) given by or at the direction
of the Board of Directors, (B) otherwise properly brought before the meeting by
or at the direction of the Board of Directors, or (C) otherwise properly brought
before the meeting by a stockholder. For business to be properly brought before
an annual meeting by a stockholder, the stockholder must have given timely
notice thereof in writing to the Secretary of the corporation. To be timely, a
stockholder's notice must be delivered to or mailed and received at the
principal executive offices of the corporation not less than one hundred twenty
(120) calendar days in advance of the date specified in the corporation's proxy
statement released to stockholders in connection with the previous year's annual
meeting of stockholders; provided, however, that in the event that no annual
meeting was held in the previous year or the date of the annual meeting has been
changed by more than thirty (30) days from the date contemplated at the time of
the previous year's proxy statement, notice by the stockholder to be timely must
be so received a reasonable time before the solicitation is made. A
stockholder's notice to the Secretary shall set forth as to each matter the
stockholder proposes to bring before the annual meeting: (i) a brief description
of the business desired to be brought before the annual meeting and the reasons
for conducting such business at the annual meeting, (ii) the name and address,
as they appear on the corporation's books, of the stockholder proposing such
business, (iii) the class and number of shares of the corporation which are
beneficially owned by the stockholder, (iv) any material interest of the
stockholder in such business and (v) any other information that is required to
be provided by the stockholder pursuant to Regulation 14A under the Securities
Exchange Act of 1934, as amended (the "1934 Act"), in his capacity as a
proponent to a stockholder proposal. Notwithstanding the foregoing, in order to
include information with respect to a stockholder proposal in the proxy
statement and form of proxy for a stockholder's meeting, stockholders must
provide notice as required by the regulations promulgated under the 1934 Act.
Notwithstanding anything in these Bylaws to the contrary, no business shall be
conducted at any annual meeting except in accordance with the procedures set
forth
-2-
<PAGE>
in this paragraph (b). The chairman of the annual meeting shall, if the facts
warrant, determine and declare at the meeting that business was not properly
brought before the meeting and in accordance with the provisions of this
paragraph (b), and, if he should so determine, he shall so declare at the
meeting that any such business not properly brought before the meeting shall not
be transacted .
(c) Only persons who are nominated in accordance with the
procedures set forth in this paragraph (c) shall be eligible for election as
Directors. Nominations of persons for election to the Board of Directors of the
corporation may be made at a meeting of stockholders by or at the direction of
the Board of Directors or by any stockholder of the corporation entitled to vote
in the election of Directors at the meeting who complies with the notice
procedures set forth in this paragraph (c). Such nominations, other than those
made by or at the direction of the Board of Directors, shall be made pursuant to
timely notice in writing to the Secretary of the corporation in accordance with
the provisions of paragraph (b) of this Section 2.2. Such stockholder's notice
shall set forth (i) as to each person, if any, whom the stockholder proposes to
nominate for election or re-election as a Director: (A) the name, age, business
address and residence address of such person, (B) the principal occupation or
employment of such person, (C) the class and number of shares of the corporation
which are beneficially owned by such person, (D) a description of all
arrangements or understandings between the stockholder and each nominee and any
other person or persons (naming such person or persons) pursuant to which the
nominations are to be made by the stockholder, and (E) any other information
relating to such person that is required to be disclosed in solicitations of
proxies for elections of Directors, or is otherwise required, in each case
pursuant to Regulation 14A under the 1934 Act (including without limitation such
person's written consent to being named in the proxy statement, if any, as a
nominee and to serving as a Director if elected); and (ii) as to such
stockholder giving notice, the information required to be provided pursuant to
paragraph (b) of this Section 2.2. At the request of the Board of Directors, any
person nominated by a stockholder for election as a Director shall furnish to
the Secretary of the corporation that information required to be set forth in
the stockholder's notice of nomination which pertains to the nominee. No person
shall be eligible for election as a Director of the corporation unless nominated
in accordance with the procedures set forth in this paragraph (c). The chairman
of the meeting shall, if the facts warrants, determine and declare at the
meeting that a nomination was not made in accordance with the procedures
prescribed by these Bylaws, and if he should so determine, he shall so declare
at the meeting, and the defective nomination shall be disregarded.
Section 2.4. Special Meetings. Special meetings of stockholders may be
----------------
called at any time by a majority of the Board of Directors, by the Chairman of
the Board, the Chief Executive Officer or by the holders of at least 10% of the
shares of the corporation's capital stock entitled to vote at such meeting, but
such special meetings may not be called by any other person or persons;
provided, however, that effective upon closing of the Corporation's initial
public offering of shares of its Common Stock pursuant to an effective
registration statement filed with the Securities and Exchange Commission (the
"IPO") and the corporation is no longer subject to Section 2115 of the
California Corporation Code, special meetings of stockholders may be called at
any time by a majority of the Board of Directors, by the Chairman of the Board,
by the Chief Executive Officer or by the holders of at least 50% of the shares
of the corporation's capital stock entitled to vote at such meeting, but such
special meetings may not be called by any other person or persons.
-3-
<PAGE>
Section 2.5. Record Date. For the purpose of determining stockholders
-----------
entitled to notice of or to vote at any meeting of stockholders, or any
adjournment thereof, or entitled to receive payment of any dividend or other
distribution or allotment of any rights, or entitled to exercise any rights in
respect of any change, conversion or exchange of stock or for the purpose of any
other lawful action, the Board of Directors of the Corporation may fix a date as
the record date for any such of stockholders, which record date shall not
precede the date on which the resolutions fixing the record date are adopted and
which record date shall not be more than sixty (60) days nor less than ten (10)
days before the date of such meeting of stockholders, nor more than sixty (60)
days prior to any other action to which such record date relates.
If the Board of Directors does not fix a record date for any meeting of the
stockholders, the record date for determining stockholders entitled to notice of
or to vote at such meeting shall be at the close of business on the day next
preceding the day on which notice is given, or, in accordance with Article 7,
Section 7.3 of these Bylaws notice is waived, at the close of business on the
day next preceding the day on which the meeting is held. The record date for
determining stockholders for any other purpose (other than the consenting to
corporate action in writing without a meeting) shall be at the close of business
on the day on which the Board of Directors adopts the resolution relating
thereto. A determination of stockholders of record entitled to notice of or to
vote at a meeting of stockholders shall apply to any adjournment of the meeting;
provided, however, that the Board of Directors may fix a new record date for the
adjourned meeting.
For the purpose of determining the stockholders entitled to consent to
corporate action in writing without a meeting, the Board of Directors may fix a
record date, which record date shall not precede the date upon which the
resolution fixing the record date is adopted by the Board of Directors, and
which date shall not be more than ten (10) days after the date upon which the
resolution fixing the record date is adopted by the Board of Directors. If the
Board of Directors does not fix the record date, the record date for determining
stockholders entitled to consent to corporate action in writing without a
meeting, when no prior action by the Board of Directors is necessary, shall be
the first date on which a signed written consent setting forth the action taken
or proposed to be taken is delivered to the Corporation at its registered office
in the state of incorporation of the Corporation or at its principal place of
business. If the Board of Directors does not fix the record date, and prior
action by the Board of Directors is necessary, the record date for determining
stockholders entitled to consent to corporate action in writing without a
meeting shall be at the close of business on the day on which the Board of
Directors adopts the resolution taking such prior action.
Section 2.6. Notice of Meetings. Written notice of the place, date and of
------------------
hour all meetings, and, in case of a special meeting, the purpose or purposes
for which the meeting is called, shall be given by or at the direction of the
President, the Secretary or the other person(s) calling the meeting to each
stockholder entitled to vote thereat not less than ten (10) nor more than sixty
(60) days before the date of the meeting. Such notice may be delivered either
personally or by mail. If mailed, notice is given when deposited in the United
States mail, postage prepaid, directed to the stockholder at such stockholder's
address as it appears on the records of the Corporation.
Section 2.7. Stockholder List. A complete list of stockholders entitled to
----------------
vote at any meeting of stockholders, arranged in alphabetical order for each
class of stock and showing the
-4-
<PAGE>
address of each such stockholder and the number of shares registered in the name
of such stockholder, shall be open to the examination of any stockholder, for
any purpose germane to the meeting, during ordinary business hours, for a period
of at least ten (10) days prior to the meeting, either at a place within the
city where the meeting is to be held, which place shall be specified in the
notice of the meeting, or, if not so specified, at the place where the meeting
is to be held. The stockholder list shall also be produced and kept at the time
and place of the meeting during the whole time thereof, and may be inspected by
any stockholder who is present.
Section 2.8. Proxies. Each stockholder entitled to vote at a meeting of
-------
stockholders or to express consent or dissent to a corporate action in writing
without a meeting may authorize another person or persons to act for him by
proxy. Proxies for use at any meeting of stockholders shall be filed with the
Secretary, or such other officer as the Board of Directors may from time to time
determine by resolution, before or at the time of the meeting. All proxies shall
be received and taken charge of and all ballots shall be received and canvassed
by the secretary of the meeting, who shall decide all questions touching upon
the qualification of voters, the validity of the proxies, and the acceptance or
rejection of votes, unless an inspector or inspectors shall have been appointed
by the chairman of the meeting, in which event such inspector or inspectors
shall decide all such questions.
No proxy shall be valid after three (3) years from its date, unless the
proxy provides for a longer period. Each proxy shall be revocable unless
expressly provided therein to be irrevocable and coupled with an interest
sufficient in law to support an irrevocable power.
Should a proxy designate two or more persons to act as proxies, unless such
instrument shall provide the contrary, a majority of such persons present at any
meeting at which their powers thereunder are to be exercised shall have and may
exercise all the powers of voting or giving consents thereby conferred, or if
only one be present, then such powers may be exercised by that one; or, if an
even number attend and a majority do not agree on any particular issue, each
proxy so attending shall be entitled to exercise such powers in respect of such
portion of the shares as is equal to the reciprocal of the fraction equal to the
number of proxies representing such shares divided by the total number of shares
represented by such proxies.
Section 2.9. Voting; Election; Inspectors. Unless otherwise required by
----------------------------
law or provided for in the charter documents of the Corporation, each
stockholder shall on each matter submitted to a vote at a meeting of
stockholders have one vote for each share of the stock entitled to vote which is
registered in his name on the record date for the meeting. For the purposes
hereof, each election to fill a directorship shall constitute a separate matter.
Shares registered in the name of another corporation, domestic or foreign, may
be voted by such officer, agent or proxy as the bylaws (or comparable body) of
such corporation may determine. Shares registered in the name of a deceased
person may be voted by the executor or administrator of such person's estate,
either in person or by proxy.
All voting, except as required by the charter documents of the Corporation
or where otherwise required by law, may be by a voice vote; provided, however,
upon request of the chairman of the meeting or upon demand therefor by
stockholders holding a majority of the issued and outstanding stock present in
person or by proxy at any meeting a stock vote shall be taken. Every stock vote
shall be taken by written ballots, each of which shall state the name of the
stockholder or
-5-
<PAGE>
proxy voting and such other information as may be required under the procedure
established for the meeting. All elections of directors shall be by written
ballots, unless otherwise provided in the charter documents of the Corporation.
At any meeting at which a vote is taken by written ballots, the chairman of
the meeting may appoint one or more inspectors; each of whom shall subscribe an
oath or affirmation to execute faithfully the duties of inspector at such
meeting with strict impartiality and according to the best of such inspector's
ability. Such inspector shall receive the written ballots, count the votes, and
make and sign a certificate of the result thereof. The chairman of the meeting
may appoint any person to serve as inspector, except no candidate for the office
of director shall be appointed as an inspector.
Unless otherwise provided in the charter documents of the Corporation,
cumulative voting for the election of directors shall be prohibited.
Section 2.10. Conduct of Meetings. The meetings of the stockholders shall
-------------------
be presided over by the President, or, if the President is not present, by a
chairman elected at the meeting. The Secretary of the Corporation, if present,
shall act as secretary of such meetings, or, if the Secretary is not present, an
Assistant Secretary shall so act; if neither the Secretary of or Assistant
Secretary is present, then a secretary shall be appointed by the chairman of the
meeting.
The chairman of any meeting of stockholders shall determine the order of
business and the procedure at the meeting, including such regulation of the
manner of voting and the conduct of discussion as seem to the chairman in order.
Section 2.11. Treasury Stock. The Corporation shall not vote, directly or
--------------
indirectly, shares of its own stock owned by it and such shares shall not be
counted for quorum purposes. Nothing in this Section 2.11 shall be construed as
limiting the right of the Corporation to vote stock, including but not limited
to its own stock, held by it in a fiduciary capacity.
Section 2.12. Action Without Meeting. Unless otherwise provided in the
----------------------
Certificate of Incorporation, any action which may be taken at any annual or
special meeting of stockholders may be taken without a meeting and without prior
notice, if a consent in writing, setting forth the action so taken, is signed by
the holders of outstanding shares having not less than the minimum number of
votes that would be necessary to authorize or take that action at a meeting at
which all shares entitled to vote on that action were present and voted.
Prompt notice of the taking of the corporate action without a meeting by
less than unanimous written consent shall be given to those stockholders who
have not consented in writing. If the action which is consented to is such as
would have required the filing of a certificate under any section of the General
Corporation Law of Delaware if such action had been voted on by stockholders at
a meeting thereof, then the certificate filed under such section shall state, in
lieu of any statement required by such section concerning any vote of
stockholders, that written notice and written consent have been given as
provided in Section 228 of the General Corporation Law of Delaware.
Following the closing date of the IPO and the date that the Corporation is
no longer subject to Section 2115 of the California Corporations Code, no action
of stockholders shall be taken by the
-6-
<PAGE>
stockholders except at an annual or special meeting of stockholders called in
accordance with the notice requirements of Section 2.6 above and no action of
the stockholders shall be taken by written consent.
Article 3
Board of Directors
------------------
Section 3.1. Power; Number; Term of Office. The business and affairs of
-----------------------------
the Corporation shall be managed by or under the direction of the Board of
Directors, and, subject to the restrictions imposed by law or the charter
documents of the Corporation, the Board of Directors may exercise all the powers
of the Corporation.
Notwithstanding anything contained in these Bylaws to the contrary, at any
time that a valid agreement among the stockholders is in force with respect to
the nomination, election and removal of directors or similar matters, such
agreement is hereby recognized and directors shall be nominated, elected and
removed in accordance therewith.
The number of directors which shall constitute the whole Board of Directors
shall be determined from time to time by the Board of Directors (provided that
no decrease in the number of directors which would have the effect of shortening
the term of an incumbent director may be made by the Board of Directors). Each
director shall hold office for the term for which such director is elected, and
until such director's successor shall have been elected and qualified or until
such director's earlier death, resignation or removal.
Unless otherwise provided in the charter documents of the Corporation,
directors need not be stockholders nor resident of the state of Delaware.
Section 3.2. Classes of Directors. Effective upon the closing of the
--------------------
Corporation's IPO and the date that the Corporation is no longer subject to
Section 2115 of the California Corporations Code, the Directors shall be divided
into three classes designated as Class I, Class II and Class III, respectively.
Directors shall be assigned to each class in accordance with a resolution or
resolutions adopted by the Board of Directors. At the first annual meeting of
stockholders following the closing of the IPO, the term of office of the Class I
Directors shall expire and Class I Directors shall be elected for a full term of
three years. At the second annual meeting of stockholders following the closing
of the IPO, the term of office of the Class II Directors shall expire and Class
II Directors shall be elected for a full term of three years. At the third
annual meeting of stockholders following the closing of the Initial Public
Offering, the term of office of the Class III Directors shall expire and Class
III Directors shall be elected for a full term of three years. At each
succeeding annual meeting of stockholders, Directors shall be elected for a full
term of three years to succeed the Directors of the class whose terms expire at
such annual meeting.
Notwithstanding the foregoing provisions of this Article, each Director
shall serve until his successor is duly elected and qualified or until his
earlier death, resignation or removal. No decrease in the number of Directors
constituting the Board of Directors shall shorten the term of any incumbent
Director.
-7-
<PAGE>
Section 3.3. Quorum; Voting. Unless otherwise provided in the charter
--------------
documents of the Corporation, a majority of the number of directors then in
office shall constitute a quorum for the transaction of business of the Board of
Directors and the vote of a majority of the directors present at a meeting at
which a quorum is present shall be the act of the Board of Directors.
Section 3.4. Place of Meetings; Order of Business. The directors may hold
------------------------------------
their meetings and may have an office and keep the books of the Corporation,
except as otherwise provided by law, in such place or places, within or without
the state of incorporation of the Corporation, as the Board of Directors may
from time to time determine. At all meetings of the Board of Directors business
shall be transacted in such order as shall from time to time be determined by
the President or by the Board of Directors.
Section 3.5. First Meeting. Each newly elected Board of Directors may
-------------
hold its first meeting for the purpose of organization and the transaction of
business, if a quorum is present, immediately after and at the same place as the
annual meeting of the stockholders. Notice of such meeting shall not be
required. At the first meeting of the Board of Directors in each year at which a
quorum shall be present, held after the annual meeting of stockholders, the
Board of Directors shall elect the officers of the Corporation.
Section 3.6. Regular Meetings. Regular meetings of the Board of Directors
----------------
shall be held at such times and places as shall be designated from time to time
by the President, or in the President's absence, by another officer of the
Corporation. Notice of such regular meetings shall not be required.
Section 3.7. Special Meetings. Special meetings of the Board of Directors
----------------
may be called by the President, or on the written request of any director, by
the Secretary, in each case on at least twenty-four (24) hours' personal,
written, telegraphic, cable or wireless notice to each director. Such notice, or
any waiver thereof pursuant to Article 7, Section 7.3 hereof, need not state the
purpose or purposes of such meeting, except as may otherwise be required by law
or provided for in the charter documents of the Corporation or these Bylaws.
Meetings may be held at any time without notice if all the directors are present
or if those not present waive notice of the meeting in writing.
Section 3.8. Removal. Any director or the entire Board of Directors may be
-------
removed as set forth in the Certificate of Incorporation of the corporation, as
amended from time to time.
Section 3.9. Vacancies; Increases in the Number of Directors. Any
-----------------------------------------------
director may resign effective on giving written notice to the chairman of the
board, the president, the secretary or the board of directors, unless the notice
specifies a later time for that resignation to become effective. If the
resignation of a director is effective at a future time, the board of directors
may elect a successor to take office when the resignation becomes effective.
Unless otherwise provided in the Certificate of Incorporation or these
bylaws, vacancies in the board of directors may be filled by a majority of the
remaining directors, even if less than a quorum, or by a sole remaining
director; however, a vacancy created by the removal of a director by the vote or
written consent of the stockholders or by court order may be filled only by the
affirmative vote of a majority of the shares represented and voting at a duly
held meeting at which a quorum is
-8-
<PAGE>
present (which shares voting affirmatively also constitute a majority of the
required quorum), or by the unanimous written consent of all shares entitled to
vote thereon. Each director so elected shall hold office until the next annual
meeting of the stockholders and until a successor has been elected and
qualified.
Unless otherwise provided in the Certificate of Incorporation or these
bylaws:
(i) Vacancies and newly created directorships resulting from any
increase in the authorized number of directors elected by all of the
stockholders having the right to vote as a single class may be filled by a
majority of the directors then in office, although less than a quorum, or by a
sole remaining director.
(ii) Whenever the holders of any class or classes of stock or
series thereof are entitled to elect one or more directors by the provisions of
the certificate of incorporation, vacancies and newly created directorships of
such class or classes or series may be filled by a majority of the directors
elected by such class or classes or series thereof then in office, or by a sole
remaining director so elected.
If at any time, by reason of death or resignation or other cause, the
corporation should have no directors in office, then any officer or any
stockholder or an executor, administrator, trustee or guardian of a stockholder,
or other fiduciary entrusted with like responsibility for the person or estate
of a stockholder, may call a special meeting of stockholders in accordance with
the provisions of the certificate of incorporation or these bylaws, or may apply
to the Court of Chancery for a decree summarily ordering an election as provided
in Section 211 of the General Corporation Law of Delaware.
If, at the time of filling any vacancy or any newly created directorship,
the directors then in office constitute less than a majority of the whole board
(as constituted immediately prior to any such increase), then the Court of
Chancery may, upon application of any stockholder or stockholders holding at
least ten (10) percent of the total number of the shares at the time outstanding
having the right to vote for such directors, summarily order an election to be
held to fill any such vacancies or newly created directorships, or to replace
the directors chosen by the directors then in office as aforesaid, which
election shall be governed by the provisions of Section 211 of the General
Corporation Law of Delaware as far as applicable.
Section 3.10. Compensation. Directors and members of standing committees
------------
may receive such compensation as the Board of Directors from time to time shall
determine to be appropriate, and shall be reimbursed for all reasonable expenses
incurred in attending and returning from meetings of the board of Directors.
Section 3.11. Action Without a Meeting: Telephone Conference Meeting.
------------------------------------------------------
Unless otherwise restricted by the charter documents of the Corporation, any
action required or permitted to be taken at any of the Board of Directors or any
committee designated by the Board of Directors may be taken without a meeting if
all members of the Board of Directors or committee, as the case may be, consent
thereto in writing, and the writing or writings are filed with the minutes of
proceedings of the Board of Directors or committee. Such consent shall have the
same force and
-9-
<PAGE>
effect as a unanimous vote at a meeting, and may be stated as such in any
document or instrument filed with the Secretary of State of the state of
incorporation of the Corporation.
Unless otherwise restricted by the charter documents of the Corporation,
subject to the requirement for notice of meetings, members of the Board of
Directors, or members of any committee designated by the Board of Directors, may
participate in a meeting of such Board of Directors or committee, as the case
may be, by means of a conference telephone connection or similar communications
equipment by means of which all persons participating in the meeting can hear
each other, and participation in such a meeting shall constitute presence in
person at such meeting, except where a person participates in the meeting for
the express purpose of objecting to the transaction of any business on the
ground that the meeting is not lawfully called or convened.
Section 3.12. Approval or Ratification of Acts or Contracts by
------------------------------------------------
Stockholders. The Board of Directors in its discretion may submit any act or
- ------------
contract for approval or ratification at any annual meeting of the stockholders,
or at any special meeting of the stockholders called for the purpose of
considering any such act or contract, and any act or contract that shall be
approved or be ratified by the vote of the stockholders holding a majority of
the issued and outstanding shares of stock of the Corporation entitled to vote
and present in person or by proxy at such meeting (provided that a quorum is
present) shall be as valid and as binding upon the Corporation and upon all the
stockholders as if it has been approved or ratified by every stockholder of the
Corporation. In addition, any such act or contract may be approved or ratified
by the written consent of stockholders holding a majority of the issued and
outstanding shares of capital stock of the Corporation entitled to vote, and
such consent shall be as valid and binding upon the Corporation and upon all the
stockholders as if it had been approved or ratified by every stockholder of the
Corporation.
Article 4
Committees
----------
Section 4.1. Designation; Powers. The Board of Directors may, by
-------------------
resolution passed by a majority of the board, designate one or more committees,
including, if they shall so determine, an executive committee and a compensation
committee, with each such committee to consist of one or more of the directors
of the Corporation. Any such designated committee shall have and may exercise
such of the powers and authority of the Board of Directors in the management of
the business and affairs of the Corporation as may be provided in such
resolution, except that no such committee shall have the power or authority of
the Board of Directors in reference of amending the charter documents of the
Corporation, adopting an agreement of merger or consolidation, recommending to
the stockholders the sale, lease or exchange of all or substantially all of the
Corporation's property and assets, recommending to the stockholders a
dissolution of the Corporation or a revocation of a dissolution of the
Corporation, or amending, altering or repealing these Bylaws or adopting new
bylaws for the Corporation. Any such designated committee may authorize the seal
of the Corporation to be affixed to all papers which may require it. In addition
to the above, such committee or committees shall have such other powers and
limitations of authority as may be determined from time to time by the Board of
Directors.
Section 4.2. Procedure; Meetings; Quorum. Any committee designated
---------------------------
pursuant to this Article 4 shall keep regular minutes of its actions and
proceedings in a book provided for that
-10-
<PAGE>
purpose and report the same to the Board of Directors at its meeting next
succeeding such action, shall fix its own rules or procedures, and shall meet at
such times and at such place or places as may be provided by such rules, or by
such committee or the board of Directors. Should a committee fail to fix its own
rules, the provisions of these Bylaws, pertaining to the calling of meetings and
conduct of business by the Board of Directors, shall apply as nearly as may be
possible. At every meeting of any such committee, the presence of a majority of
all the members thereof shall constitute a quorum, except as provided in Section
4.3 of this Article 4 and the affirmative vote of a majority of the members
present shall be necessary for the adoption by it of any resolution.
Section 4.3. Substitution and Removal of Members: Vacancies. The Board of
----------------------------------------------
Directors may designate one or more directors as alternate members of any
committee, who may replace any absent or disqualified member at any meeting of
such committee. In the absence or disqualification of a member of a committee,
the member or members present at any meeting and not disqualified from voting,
whether or not constituting a quorum, may unanimously appoint another member of
the Board of Directors to act at the meeting in the place of the absent or
disqualified member. The Board of Directors shall have the power at any time to
remove any member(s) of a committee and to appoint other directors in lieu of
the person(s) so removed and shall also have the power to fill vacancies in a
committee.
Article 5
Officers
--------
Section 5.1. Number, Titles, and Term of Office. The officers of the
----------------------------------
Corporation shall be a President, Treasurer, a Secretary, and such other
officers as the Board of Directors may from time to time elect or appoint
(including, but not limited to, a Chairman of the Board, and or more Vice
Presidents, (anyone or more of whom may be designated Executive Vice President
or Senior Vice President) Vice Chairman of the Board, one or more Assistant
Secretaries and one or more Assistant Treasurers). Each officer shall hold
office until such officer's successor shall be duly elected and shall qualify or
until such officer's death or until such officer shall resign or shall have been
removed. Any number of offices may be held by the same person, unless the
Articles of Incorporation of the Corporation provide otherwise. Except for the
Chairman of the Board and the Vice Chairman of the Board, no officer need be a
director.
Section 5.2. Powers and Duties of the President. The President shall be
----------------------------------
the chief executive officer of the Corporation. Subject to the control of the
Board of Directors and the Executive Committee (if any), the President shall
have general executive charge, management and control of the properties,
business and operations of the Corporation with all such powers as may be
reasonably incident to such responsibilities; may agree upon and execute all
leases, contracts, evidences of indebtedness and other obligations in the name
of the Corporation and may sign all certificates for shares of capital stock of
the Corporation; and shall have such other powers and duties as designated in
accordance with these Bylaws and as from time to time may be assigned to the
President by the Board of Directors. The President shall preside at all meetings
of the stockholders and of the Board of Directors.
Section 5.3. Vice Presidents. Each Vice President shall at all times
---------------
possess power to sign all certificates, contracts and other instruments of the
Corporation, except as otherwise limited in
-11-
<PAGE>
writing by the Chairman of the Board, the President or the Vice Chairman of the
Board of the Corporation. Each Vice President shall have such other powers and
duties as from time to time may be assigned to such Vice President by the Board
of Directors, the Chairman of the Board, the President or the Vice Chairman of
the Board.
Section 5.4. Secretary. The Secretary shall keep the minutes of all
---------
meetings of the Board of Directors, committees of the Board of Directors and the
stockholders, in books provided for that purpose; shall attend to the giving and
serving of all notices; may in the name of the Corporation affix the seal of the
Corporation to all contracts and attest the affixation of the seal of the
Corporation thereto; may sign with the other appointed officers all certificates
for shares of capital stock of the Corporation; shall have charge of the
certificate books, transfer books and stock ledgers, and such other books and
papers as the Board of Directors may direct, all of which shall at all
reasonable times be open to inspection of any director upon application at the
office of the Corporation during business hours; shall have such other powers
and duties as designated in these Bylaws and as from time to time may be
assigned to the Secretary by the Board of Directors, the Chairman of the Board,
the President or the Vice Chairman of the Board; and shall in general perform
all acts incident of the office of Secretary, subject to the control of the
Board of Directors, the Chairman of the Board, the President or the Vice
Chairman of the Board.
Section 5.5. Assistant Secretaries. Each Assistant Secretary shall have
---------------------
the usual powers and duties pertaining to such offices, together with such other
powers and duties as designated in these Bylaws and as from time to time may be
assigned to an Assistant Secretary by the board of directors, the President, or
the Secretary. The Assistant Secretaries shall exercise the powers of the
Secretary during that officer's absence or inability or refusal to act.
Section 5.6. Treasurer. The Treasurer shall have responsibility for the
---------
custody and control of all the funds and securities of the Corporation, and
shall have such other powers and duties as designated in these Bylaws and as
from time to time may be assigned to the Treasurer by the Board of Directors or
the President. The Treasurer shall perform all acts incident to the position of
Treasurer, subject to the control of the Board of Directors or the President;
and the Treasurer shall, if required by the Board of Directors, give such bond
for the faithful discharge of the Treasurer's duties in such form as the Board
of Directors may require.
Section 5.7. Assistant Treasurers. Each Assistant Treasurer shall have the
--------------------
usual powers and duties pertaining to such office, together with such other
powers and duties as designated in these Bylaws and as from time to time may be
assigned to each Assistant Treasurer by the Board of Directors, the President,
or the Treasurer. The Assistant Treasurers shall exercise the powers of the
Treasurer during that officer's absence or inability or refusal to act.
Section 5.8. Action with Respect to Securities of Other Corporations.
-------------------------------------------------------
Unless otherwise directed by the Board of Directors, the President, together
with the Secretary or any Assistant Secretary shall have power to vote and
otherwise act on behalf of the Corporation, in person or by proxy, at any
meeting of security holders of or with respect to any action of security holders
of any other corporation in which this Corporation may hold securities and
otherwise to exercise any and all rights and powers which this Corporation may
possess by reason of its ownership of securities in such other corporation.
-12-
<PAGE>
Section 5.9. Delegation. For any reason that the Board of Directors may
----------
deem sufficient, the Board of Directors may, except where otherwise provided by
statute, delegate the powers or duties of any officer to any other person, and
may authorize any officer to delegate specified duties of such office to any
other person. Any such delegation or authorization by the Board shall be
effected from time to time by resolution of the Board of Directors.
Article 6
Capital Stock
-------------
Section 6.1. Certificates of Stock. The certificates for shares of the
---------------------
capital stock of the Corporation shall be in such form, not inconsistent with
that required by law and the charter documents of the Corporation, as shall be
approved by the Board of Directors. Every holder of stock represented by
certificates shall be entitled to have a certificate signed by or in the name of
the Corporation by the President or a Vice President and the Secretary or an
Assistant Secretary or the Treasurer or an Assistant Treasurer of the
Corporation representing the number of shares (and, if the stock of the
Corporation shall be divided into classes or series, certifying the class and
series of such shares) owned by such stockholder which are registered in
certified form; provided, however, that any of or all the signatures on the
certificate may be facsimile. The stock record books and the blank stock
certificate books shall be kept by the Secretary or at the office of such
transfer agent or transfer agents as the Board of Directors may from time to
time determine. In case any officer, transfer agent or registrar who shall have
signed or whose facsimile signature or signatures shall have been placed upon
any such certificate or certificates shall have ceased to be such officer,
transfer agent or registrar before such certificate is issued by the
Corporation, such certificate may nevertheless be issued by the Corporation with
the same effect as if such person were such officer, transfer agent or registrar
at the date of issue. The stock certificates shall be consecutively numbered and
shall be entered in the books of the Corporation as they are issued and shall
exhibit the holder's name and number of shares.
Section 6.2. Transfer of Shares. The shares of stock of the Corporation
------------------
shall be transferable only on the books of the Corporation by the holders
thereof in person or by their duly authorized attorneys or legal representatives
upon surrender and cancellation of certificates for a like number of shares.
Upon surrender to the Corporation or a transfer agent of the Corporation of a
certificate for shares duly endorsed or accompanied by proper evidence of
succession, assignment or authority to transfer, it shall be the duty of the
Corporation to issue a new certificate to the person entitled thereto, cancel
the old certificate and record the transaction upon its books.
Section 6.3. Ownership of Shares. The Corporation shall be entitled to
-------------------
treat the holder of record of any share or shares of capital stock of the
Corporation as the holder in fact thereof and, accordingly, shall not be bound
to recognize any equitable or other claim to or interest in such share or shares
on the part of any other person, whether or not it shall have express or other
notice thereof, except as otherwise provided by the laws of the state of
Delaware.
Section 6.4. Regulations Regarding Certificates. The Board of Directors
----------------------------------
shall have the power and authority to make all such rules and regulations as
they may deem expedient concerning the issue, transfer and registration or the
replacement of certificates for shares of capital stock of the Corporation.
-13-
<PAGE>
Section 6.5. Lost or Destroyed Certificates. The Board of Directors may
------------------------------
determine the conditions upon which the Corporation may issue a new certificate
of stock in place of a certificate theretofore issued by it which is alleged to
have been lost, stolen or destroyed and may require the owner of such
certificate or such owner's legal representative to give bond, with surety
sufficient to indemnify the Corporation and each transfer agent and registrar
against any and all losses or claims which may arise by reason of the alleged
loss, theft or destruction of any such certificate or the issuance of such new
certificate in the place of the one so lost, stolen destroyed.
Article 7
Miscellaneous Provisions
------------------------
Section 7.1. Fiscal Year. The fiscal year of the Corporation shall begin
-----------
on the first day of January of each year.
Section 7.2. Corporate Seal. The corporate seal shall be circular in form
--------------
and shall have inscribed thereon the name of the Corporation and the state of
its incorporation, which seal shall be in the charge of the Secretary and shall
be affixed to certificates of stock, debentures, bonds and other documents, in
accordance with the direction of the Board of Directors or a committee thereof,
and as may be required by law; however, the Secretary may, if the Secretary
deems it expedient, have a facsimile of the corporate seal inscribed on any such
certificates of stock, debentures, bonds, contract or other documents.
Duplicates of the seal may be kept for use by any Assistant Secretary.
Section 7.3. Notice and Waiver of Notice. Whenever any notice is required
---------------------------
to be given by law, the charter documents of the Corporation or under the
provisions of these Bylaws, said notice shall be deemed to be sufficient if
given (i) by telegraphic, cable or wireless transmission (including by telecopy
or facsimile transmission) or (ii) by deposit of the same in a post office box
or by delivery to an overnight courier service company in a sealed prepaid
wrapper addressed to the person entitled thereto at such person's post office
address, as it appears on the records of the Corporation, and such notice shall
be deemed to have been given on the day of such transmission or mailing or
delivery to courier, as the case may be.
Whenever notice is required to be given by law, the charter documents of
the Corporation or under any of the provisions of these Bylaws, a written waiver
thereof, signed by the person entitled to notice, whether before or after the
time stated therein, shall be deemed equivalent to notice. Attendance of a
person, including without limitation a director, at meeting shall constitute a
waiver of notice of such meeting, except when the person attends a meeting for
the express purpose of objecting, at the beginning of the meeting, to the
transaction of any business because the meeting is not lawfully called or
convened. Neither the business to be transacted at, nor the purpose of, any
regular or special meeting of the stockholders, directors, or members of a
committee of directors need be specified in any written waiver of notice unless
so required by the charter documents of the Corporation or these Bylaws.
Section 7.4. Facsimile Signature. In addition to the provisions for the
-------------------
use of facsimile signatures elsewhere specifically authorized in these Bylaws,
facsimile signatures of any officer or officers of the Corporation may be used
whenever and as authorized by the Board of Directors.
-14-
<PAGE>
Section 7.5. Reliance upon Books, Reports and Records. A member of the
----------------------------------------
Board of Directors, or a member of any committee designated by the Board of
Directors, shall, in the performance of such person's duties, be protected to
the fullest extent permitted by law in relying upon the records of the
Corporation and upon information, opinion, reports or statements presented to
the Corporation.
Section 7.6. Application of Bylaws. In the event that any provisions of
---------------------
these Bylaws is or may be in conflict with any law of the United States, of the
state of Delaware, or of any other governmental body or power having
jurisdiction over this Corporation, or over the subject matter to which such
provision of these Bylaws applies, or may apply, such provision of these Bylaws
shall be inoperative to the extent only that the operation thereof unavoidably
conflicts with such law, and shall in all other respects be in full force and
effect.
Article 8
Indemnification of Officers and Directors
-----------------------------------------
Section 8.1. Indemnification. The corporation shall, to the maximum
---------------
extent and in the manner permitted by the General Corporation Law of Delaware,
indemnify each of its directors and officers against expenses (including
attorneys' fees), judgments, fines, settlements and other amounts actually and
reasonably incurred in connection with any proceeding, arising by reason of the
fact that such person is or was an agent of the corporation. For purposes of
this Section 6.1, a "director" or "officer" of the corporation includes any
person (i) who is or was a director or officer of the corporation, (ii) who is
or was serving at the request of the corporation as a director or officer of
another corporation, partnership, joint venture, trust or other enterprise, or
(iii) who was a director or officer of a corporation which was a predecessor
corporation of the corporation or of another enterprise at the request of such
predecessor corporation.
Section 8.2. Indemnification of Others. The corporation shall have the
-------------------------
power, to the maximum extent and in the manner permitted by the General
Corporation Law of Delaware, to indemnify each of its employees and agents
(other than directors and officers) against expenses (including attorneys'
fees), judgments, fines, settlements and other amounts actually and reasonably
incurred in connection with any proceeding, arising by reason of the fact that
such person is or was an agent of the corporation. For purposes of this Section
6.2, an "employee" or "agent" of the corporation (other than a director or
officer) includes any person (i) who is or was an employee or agent of the
corporation, (ii) who is or was serving at the request of the corporation as an
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise, or (iii) who was an employee or agent of a corporation which
was a predecessor corporation of the corporation or of another enterprise at the
request of such predecessor corporation.
Section 8.3. Insurance. The corporation may purchase and maintain
---------
insurance on behalf of any person who is or was a director, officer, employee or
agent of the corporation, or is or was serving at the request of the corporation
as a director, officer, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise against any liability asserted against
him or her and incurred by him or her in any such capacity, or arising out of
his or her status as such, whether or not the corporation would have the power
to indemnify him or her against such liability under the provisions of the
General Corporation Law of Delaware.
-15-
<PAGE>
Article 9
Amendments
----------
Section 9.1. Amendments. The Board of Directors shall have the power to
----------
adopt, amend and repeal from time to time Bylaws of the Corporation, subject to
the right of the stockholders entitled to vote with respect thereto to amend or
repeal such Bylaws as adopted or amended by the Board of Directors
-16-
<PAGE>
EXHIBIT 4.1
[LOGO of COMPANY NAME]
[LOGO] NUMBER [LOGO] SHARES
INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE
CN
COMMON STOCK CUSIP 19074R 10 1
SEE REVERSE FOR CERTAIN DEFINITIONS
THIS CERTIFIES THAT
is the owner of
FULLY PAID AND NONASSESSABLE SHARES OF COMMON STOCK, PAR VALUE $.001 PER
SHARE, OF COBALT NETWORKS, INC.
(the "Corporation"), a Delaware corporation. The Shares represented by this
certificate are transferable only on the stock transfer books of the
Corporation by the holder of record hereof, or by his duly authorized attorney
or legal representative, upon the surrender of this certificate properly
endorsed. This certificate is not valid until countersigned and registered by
the Corporation's transfer agent and registrar.
IN WITNESS WHEREOF, the Corporation has caused this certificate to be
executed by the facsimile signature of its duly authorized officers and has
caused a facsimile of its corporate seal to be hereunto affixed.
Dated:
[LOGO OF COBALT NETWORKS, INC. SEAL]
/s/ Kenton D. Chow /s/ Stephen W. Dewitt
- ----------------------------------- -----------------------
CHIEF FINANCIAL OFFICER & SECRETARY CHIEF EXECUTIVE OFFICER
COUNTERSIGNED AND REGISTERED:
BANKBOSTON, N.A.
TRANSFER AGENT
AND REGISTRAR
BY /s/ Win L. *
--------------------------
AUTHORIZED SIGNATURE
A statement of the rights, preferences, privileges and restrictions granted
to or imposed upon the respective classes or series of shares of stock of the
Corporation, and upon the holders thereof as established by the Certificate of
Incorporation or by any certificate of determination of preferences, and the
number of shares constituting each class or series, and the designations
thereof, may be obtained by the holder hereof upon request and without charge
from the Secretary of the Corporation at the principal office of the
Corporation.
The following abbreviations, when used in the inscription on the face of
this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
<TABLE>
<CAPTION>
<S> <C> <C>
TEN COM - as tenants in common UNIF GIFT MIN ACT - _______Custodian_____________
(Cust) (Minor)
TEN ENT - as tenants by the entireties under Uniform Gifts to Minors
Act________________
JT TEN - as joint tenants with right (State)
of survivorship and not as tenants
in common
</TABLE>
Additional abbreviations may also be used though not in the above list.
For value received, _____________ hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER TAXPAYER IDENTIFYING NUMBER OF ASSIGNEE
- -----------------
- -----------------
__________________________________________________________________________
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS INCLUDING ZIP CODE OF ASSIGNEE)
- --------------------------------------------------------------------------
- --------------------------------------------------------------------------
- --------------------------------------------------------------------shares
of the Common Stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint
____________________________________________________________________Attorney
to transfer the said shares on the books of the within-named Corporation with
full power of substitution in the premises.
Dated_______________________________
______________________________________________________________
Notice: The signature to this assignment must correspond with the name
as written upon the face of the Certificate in every
particular, without alteration or enlargement or any change
whatever.
<PAGE>
EXHIBIT 5.1
Wilson Sonsini Goodrich & Rosati
PROFESSIONAL CORPORATION
650 PAGE MILL ROAD
PALO ALTO, CALIFORNIA 94304-1050
TELEPHONE 650-493-9300 FACSIMILE 650-493-6811
WWW.WSGR.COM
October 13, 1999
Cobalt Networks, Inc.
555 Ellis Street
Mountain View, California 94043
Re: REGISTRATION STATEMENT ON FORM S-1
Ladies and Gentlemen:
We have examined Amendment No. 1 to the Registration Statement on Form S-1
(File No. 333-86759) to be filed by you with the Securities and Exchange
Commission on October 13, 1999 (the "Registration Statement") in connection with
the registration under the Securities Act of 1933, as amended, of 5,750,000
shares (including shares issuable upon exercise of the underwriters' over-
allotment option) of Common Stock of Cobalt Networks, Inc. (the "Shares"). As
your counsel in connection with this transaction, we have examined the
proceedings proposed to be taken in connection with said sale and issuance of
the Shares.
It is our opinion that, upon completion of the proceedings being taken or
contemplated by us, as your counsel, to be taken prior to the issuance of the
Shares, and upon completion of the proceedings being taken in order to permit
such transactions to be carried out in accordance with the securities laws of
various states, where required, the Shares when issued and sold in the manner
referred to in the Registration Statement will be legally and validly issued,
fully paid and nonassessable.
We consent to the use of this opinion as an exhibit to the Registration
Statement, and further consent to the use of our name wherever appearing in the
Registration Statement, including the prospectus constituting a part thereof,
and any amendment thereto.
Sincerely,
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
/s/ Wilson Sonsini Goodrich & Rosati
<PAGE>
EXHIBIT 10.14
COBALT NETWORKS, INC.
EMPLOYMENT AGREEMENT
This Agreement (the "Agreement") is made as of August 31, 1999 by and
between Cobalt Networks, Inc., a California corporation (the "Company"), and
Vivek Mehra (the "Executive").
1. Employment and Duties. Executive shall be employed as an Executive
---------------------
Vice President of the Company, reporting directly to the Chief Executive
Officer, President or Chief Operating Officer of the Company, as the Company
designates, and assuming and discharging such responsibilities as are
commensurate with such office and position. Executive shall comply with and be
bound by the Company's operating policies, procedures and practices as in effect
from time to time during the term of Executive's employment hereunder. During
the term of Executive's employment with the Company, Executive shall devote his
full business time, skill and attention to his duties and responsibilities, and
shall perform them faithfully, diligently and competently, and Executive shall
use his best efforts to further the business of the Company and its affiliated
entities.
2. At-Will Employment. The Company and Executive acknowledge that
------------------
Executive's employment hereunder is and shall continue to be at-will (as defined
under applicable law), and may be terminated at any time, with or without cause,
at the option of either party. If Executive's employment terminates for any
reason, Executive shall not be entitled to any payments, benefits, damages
awards or compensation other than as specifically provided by this Agreement, or
as may otherwise be established pursuant to the then existing benefit plans or
policies of the Company in effect at the time of such termination. No
provision of this Agreement shall be construed as conferring upon Executive a
right to continue in his position or in any other position with the Company.
3. Salary. In consideration of Executive's services, Executive will be
------
paid a minimum base salary at the rate of $175,000 and 20% of base salary bonus
per year (the "Base Salary") during the term of his employment, to be paid in
installments in accordance with the Company's standard payroll practices.
Executive's Base Salary shall be reevaluated by the Board of Directors of the
Company (or persons appointed by the Board of Directors), at the same frequency
as the Company's other executive officers.
4. Benefits; Expenses. Executive shall be permitted, to the extent
------------------
eligible, to participate in the employee benefit plans and programs maintained
by the Company and offered to employees of comparable position, including
without limitation retirement plans, savings and profit sharing plans, stock
option, incentive or other bonus plans, group medical, dental, life, disability
and other insurance plans and other similar benefit plans of the Company,
subject in each case to the generally applicable terms and conditions of the
applicable plan or program and to the determination of the Company or any
committee administering such plan or program.
The Company shall reimburse Executive for all reasonable business and
travel expenses actually incurred or paid by Executive in the performance of
Executive's services on behalf of the
<PAGE>
Company, in accordance with the Company's expense reimbursement policy as in
effect from time to time.
5. Vacation. Executive shall be entitled to paid Company holidays and
--------
vacation in accordance with the Company's policies in effect from time to time
for its executive officers.
6. Termination by Company.
----------------------
(a) The Company may terminate the Executive's employment in the event
Executive is unable, for a period of at least three consecutive months, due to
illness, accident or other physical or mental incapacity, to perform his duties
hereunder; provided, that in the event Executive shall become permanently
unable, due to illness, accident or other physical and mental incapacity, to
perform such duties, the Company may forthwith terminate his employment, prior
to the expiration of such three month period;
(b) The Company may terminate the Executive's employment for
"Cause" which is defined as any one or more of the following occurrences:
(i) Executive's conviction by, or entry of a plea of guilty
or nolo contendere in, a court of competent and final jurisdiction for any crime
which constitutes a felony in the jurisdiction involved;
(ii) Executive's commission of an act of fraud or
misappropriation of material property, whether prior to or subsequent to the
date hereof, upon the Company, or any of its respective affiliates;
(iii) A willful breach by Executive of a material provision
of this Agreement;
(iv) Failure of Executive to perform the lawful duties and
responsibilities assigned to him by the Company, as determined by the Company's
Board of Directors in its discretion.
Notwithstanding the foregoing, Executive shall not be deemed to have been
terminated for Cause without (i) reasonable notice to Executive setting forth
the reasons for Company's intention to terminate for Cause, and (ii) an
opportunity for Executive, together with his counsel, if any, to be heard.
(c) The Company may terminate Executive's employment for any
other reason upon not less than 30 days advance written notice to Executive.
7. Termination by Executive. Executive may terminate Executive's
------------------------
employment hereunder at any time upon 30 days advance written notice to
Company.
8. Effect of Termination.
---------------------
-2-
<PAGE>
(a) Except as otherwise expressly set forth in this Section 8,
Executive's right to receive salary or any other payments not required by law
shall cease upon the effective date of any termination of Executive's employment
and the Company shall have no further liability or obligation to the Executive,
his executors, administrators or assigns hereunder except for unpaid salary and
benefits accrued to the date of termination.
(b) If executive is terminated without Cause or pursuant to a
Constructive Termination (as defined below), then Executive shall receive (i)
one year accelerated vesting of any Company stock options held by him (ii) one
year acceleration of vesting of shares of the Company's common stock purchased
by him pursuant to Restricted Stock Purchase Agreements and (iii) one year of
salary and bonus payable at the same rate and frequency as in effect at the time
of such termination. If Executive is terminated for Cause or terminates as a
result of a Voluntary Resignation (as defined below) or for any other reason,
then Executive shall not be entitled to any accelerated vesting with respect to
the options and common stock held by him referenced above. For purposes of this
Agreement, (i) a "Voluntary Resignation" means the Executive's voluntary
resignation from employment, excluding a voluntary resignation as a result of a
Constructive Termination and (ii) "Constructive Termination" means (A) a
------------------------
material reduction in salary and benefits other than a reduction applied to all
employees, (B) a requirement to relocate without the Executive's consent beyond
50 miles from the principal offices of the Company in Mountain View, California,
(C) a material reduction in responsibilities reasonably accorded or expected of
an Executive Vice President of the Company, (D) the Company materially breaches
the terms of this Agreement or any other agreement between the Executive and the
Company with respect to the payment or vesting of compensation or benefits or in
any other material respect and such breach is not cured within 30 days after the
Company receives written notice thereof, and (E) the Company requires the
Executive, as a condition to his continued employment with the Company to
perform felonious or fraudulent acts or omissions; provided, however, that a
Constructive Termination shall not include any matters set forth in (A), (B) and
(C) above which are proposed by the Company and agreed to by Executive.
9. Confidential Information Agreement. The Company and Executive
----------------------------------
shall execute and deliver the Company's standard Confidential Information and
Invention Assignment Agreement.
10. Successors. The Company shall require any successor or assignee,
----------
in connection with any sale, transfer or other disposition of all or
substantially all of the Company's assets or business, whether by purchase,
merger, consolidation or otherwise, expressly to assume and agree to perform the
Company's obligations under this Agreement in the same manner and to the same
extent that the Company would be required to perform if no such succession or
assignment had taken place. In such event, the term "Company," as used in this
Agreement, shall mean any successor or assignee to the business and assets which
by reason hereof becomes bound by the terms and provisions of this Agreement.
11. Arbitration.
-----------
-3-
<PAGE>
(a) Any claim, dispute or controversy arising out of this Agreement,
the interpretation, validity or enforceability of this Agreement or the alleged
breach thereof shall be submitted by the parties to binding arbitration by the
American Arbitration Association in California; provided, however, that this
arbitration provision shall not preclude the Company from seeking injunctive
relief from any court having jurisdiction with respect to any disputes or claims
relating to or arising out of the misuse or misappropriation of the trade
secrets or confidential and proprietary information of the Company, or any of
its respective affiliates. The losing party to any such arbitration shall bear
all costs of the arbitration, including the reasonable fees and expenses of
counsel and experts retained by both parties. The fees and expenses of counsel
and experts retained by each party shall be paid by the party retaining such
services. Judgment may be entered on the award of the arbitrator in any court
having jurisdiction.
(b) EXECUTIVE HAS READ AND UNDERSTANDS THIS SECTION, WHICH DISCUSSES
ARBITRATION. EXECUTIVE UNDERSTANDS THAT BY SIGNING THE AGREEMENT, EXECUTIVE
AGREES TO SUBMIT ANY FUTURE CLAIMS ARISING OUT OF, RELATING TO, OR IN
CONNECTION WITH HIS EMPLOYMENT OR TERMINATION THEREOF, OR THE INTERPRETATION,
VALIDITY, CONSTRUCTION, PERFORMANCE OR BREACH OF THIS AGREEMENT, TO BINDING
ARBITRATION, AND THAT THIS ARBITRATION SECTION CONSTITUTES A WAIVER OF
EXECUTIVE'S RIGHT TO A JURY TRIAL AND RELATES TO THE RESOLUTION OF ALL DISPUTES
RELATING TO ALL ASPECTS OF THE EXECUTIVE/COMPANY RELATIONSHIP, INCLUDING BUT NOT
LIMITED TO, DISCRIMINATION CLAIMS.
12. Governing Law. This Agreement shall be governed by and construed in
-------------
accordance with the laws of the State of California applicable to agreements
made and to be performed entirely within such state.
13. Integration. This Agreement and any written Company plans and
-----------
written agreements between the parties that are referenced herein represent the
entire agreement and understanding between the parties hereto as to the subject
matter hereof and supersede all prior or contemporaneous agreements, whether
written or oral. No waiver, alteration, or modification, if any, of the
provisions of this Agreement shall be binding unless in writing and signed by
duly authorized representatives of the parties hereto.
14. Assignment. This Agreement and all rights under this Agreement shall
----------
be binding upon and inure to the benefit of and be enforceable by the parties
hereto and their respective personal or legal representatives, executors,
administrators, heirs, distributees, devisees, legatees, successors and assigns.
The Executive shall not, without the written consent of the Company, assign or
transfer this Agreement or any right or obligation under this Agreement to any
other person or entity. If Executive should die while any amounts are still
payable to Executive hereunder, all such amounts, unless otherwise provided
herein, shall be paid in accordance with the terms of this Agreement to the
Executive's devisee, legatee, or other designee or, if there be no such
designee, to the Executive's estate.
-4-
<PAGE>
15. Counterparts. This Agreement may be executed in counterparts, which
------------
together will constitute one instrument.
16. Surviving Provisions. Nothwithstanding any other provision of this
--------------------
Agreement, the provisions of Sections 4 and 5, and 8 through 15 shall survive
the termination of this Agreement.
IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the
case of the Company by its duly authorized officer, as of the day and year first
set forth above.
COBALT NETWORKS, INC.
/s/ Kenton D. Chow
By: _______________________
Title: VP Finance & CFO
----------------
EXECUTIVE
/s/ Vivek Mehra
__________________________
Vivek Mehra
-5-
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in this Registration Statement on Form S-1 of
our report dated October 11, 1999, relating to the financial statements of
Cobalt Networks, Inc., which appears in such Registration Statement. We also
consent to the references to us under the headings "Experts" in such
Registration Statement.
PricewaterhouseCoopers LLP
San Jose, California
October 13, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> OCT-01-1999 DEC-31-1998
<CASH> 25,730 2,090
<SECURITIES> 0 0
<RECEIVABLES> 5,574 2,375
<ALLOWANCES> 367 335
<INVENTORY> 638 514
<CURRENT-ASSETS> 32,219 4,883
<PP&E> 2,474 1,603
<DEPRECIATION> 935 341
<TOTAL-ASSETS> 33,758 6,145
<CURRENT-LIABILITIES> 12,352 6,795
<BONDS> 52 84
45,907 12,339
0 0
<COMMON> 5 5
<OTHER-SE> (24,558) (13,078)
<TOTAL-LIABILITY-AND-EQUITY> 33,758 6,145
<SALES> 13,849 3,537
<TOTAL-REVENUES> 13,849 3,537
<CGS> 9,029 3,123
<TOTAL-COSTS> 18,716 10,959
<OTHER-EXPENSES> 108 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 218 15
<INCOME-PRETAX> (13,722) (10,478)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (13,722) (10,478)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (13,722) (10,478)
<EPS-BASIC> (4.31) (5.48)
<EPS-DILUTED> (4.31) (5.48)
</TABLE>
