<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 000-24360
----------------
COBALT NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0440751
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
555 Ellis Street, Mountain View, CA 94043
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (650) 623-2500
----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
As of June 30, 2000, 29,561,000 shares of common stock of the Registrant
were outstanding.
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<PAGE>
COBALT NETWORKS, INC.
<TABLE>
<S> <C>
PART I--FINANCIAL INFORMATION.............................................. 3
ITEM 1. FINANCIAL STATEMENTS (unaudited)................................. 3
CONDENSED CONSOLIDATED BALANCE SHEET................................... 3
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS......................... 4
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS......................... 5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS................................................... 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....... 30
PART II--OTHER INFORMATION................................................. 31
ITEM 1. LEGAL PROCEEDINGS................................................ 31
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS........................ 31
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 31
</TABLE>
2
<PAGE>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999(1)
-------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 80,945 $141,777
Short-term investments................................. 50,943 --
Accounts receivable, net of allowance.................. 9,015 5,846
Inventories............................................ 318 714
Other current assets................................... 2,318 1,835
-------- --------
Total current assets................................. 143,539 150,172
Property and equipment, net.............................. 2,732 1,685
Long-term investments.................................... 3,200 --
Goodwill and intangible assets........................... 75,833 --
-------- --------
Total assets......................................... $225,304 $151,857
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable, current................................. $ 46 $ 44
Accounts payable....................................... 13,439 15,101
Accrued liabilities.................................... 9,561 4,611
Deferred margin on distributor inventory............... 1,951 1,305
-------- --------
Total current liabilities............................ 24,997 21,061
Notes payable............................................ 17 40
-------- --------
Total liabilities.................................... 25,014 21,101
-------- --------
Stockholders' equity:
Preferred Stock........................................ -- --
Common Stock........................................... 30 28
Additional paid-in capital............................. 250,127 174,462
Unearned stock compensation............................ (4,011) (6,444)
Notes receivable from stockholders..................... (412) (450)
Accumulated deficit.................................... (45,444) (36,840)
-------- --------
Total stockholders' equity........................... 200,290 130,756
-------- --------
Total liabilities and stockholders' equity........... $225,304 $151,857
======== ========
</TABLE>
--------
(1) The information in this column was derived from the Company's audited
financial statements for the year ended December 31, 1999.
See Notes to Condensed Consolidated Financial Statements
3
<PAGE>
COBALT NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
--------------------- -----------------
June 30, July 2, June 30, July 2,
2000 1999 2000 1999
--------- --------- -------- -------
<S> <C> <C> <C> <C>
Net revenues........................ $ 16,242 $ 5,029 $ 28,275 $ 7,663
Cost of revenues.................... 8,577 3,154 15,293 5,156
--------- --------- -------- -------
Gross profit.................... 7,665 1,875 12,982 2,507
--------- --------- -------- -------
Operating expenses:
Research and development.......... 2,383 1,374 4,013 2,771
Sales and marketing............... 6,373 3,520 11,595 6,273
General and administrative........ 2,031 833 3,609 1,454
Amortization of stock
compensation..................... 1,198 113 2,433 253
Amortization of goodwill and other
intangible assets................ 2,764 -- 2,764 --
In-process research and
development...................... 830 -- 830 --
--------- --------- -------- -------
Total operating expenses........ 15,579 5,840 25,244 10,751
--------- --------- -------- -------
Loss from operations................ (7,914) (3,965) (12,262) (8,244)
Interest income (expense), net...... 1,893 128 3,658 --
--------- --------- -------- -------
Net loss............................ (6,021) (3,837) (8,604) (8,244)
Accretion of preferred stock to
redemption value................... -- (392) -- (1,191)
--------- --------- -------- -------
Net loss attributable to holders of
common stock....................... $ (6,021) $ (4,229) $ (8,604) $(9,435)
========= ========= ======== =======
Net loss attributable to holders of
common stock per share:
Basic and diluted................. $ (.21) $ (1.22) $ (.31) $ (2.83)
========= ========= ======== =======
Basic and diluted weighted average
shares outstanding................. 28,109 3,471 27,787 3,338
========= ========= ======== =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
<PAGE>
COBALT NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six months ended
-----------------
June 30, July 2,
2000 1999
-------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................... $(8,604) $(8,244)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation............................................. 419 369
Purchase of in-process research and development.......... 830 --
Amortization of goodwill and other intangible assets..... 2,764 --
Amortization of stock compensation....................... 2,433 253
Non-cash interest (income) expense....................... (12) 130
Changes in assets and liabilities:
Accounts receivable.................................... (2,864) (2,630)
Inventories............................................ 396 (505)
Other current assets................................... (223) (227)
Accounts payable....................................... (2,781) 1,324
Accrued liabilities.................................... 3,569 1,648
Deferred margin on distributor inventory............... 646 423
------- -------
Net cash used in operating activities................ (3,427) (7,459)
------- -------
Cash flows used in investing activities:
Acquisition of property and equipment...................... (1,158) (428)
Acquisition of Chili!Soft, Inc. (net of cash acquired)..... (2,263) --
Purchases of long-term investments......................... (3,200) --
Purchases of short-term investments........................ (50,943) --
------- -------
Net cash used in investing activities................ (57,564) (428)
------- -------
Cash flows from financing activities:
Proceeds from issuance of Mandatorily Redeemable
Convertible Preferred Stock, net.......................... -- 29,583
Proceeds from exercise of stock options, net............... 130 8
Principal payments on line of credit....................... -- (600)
Principal payments on notes payable........................ (21) (18)
Proceeds from loan to shareholder.......................... 50 --
Proceeds from borrowings under convertible promissory
notes..................................................... -- 4,250
------- -------
Net cash provided by financing activities............ 159 33,223
------- -------
Net increase (decrease) in cash and cash equivalents....... (60,832) 25,336
Cash and cash equivalents at beginning of period........... 141,777 2,090
------- -------
Cash and cash equivalents at end of period................. $80,945 $27,426
======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements
5
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Interim Results
The interim unaudited financial information of Cobalt Networks, Inc. (the
"Company") is prepared in conformity with generally accepted accounting
principles and such principles are applied on a basis consistent with the
audited financial information contained in the Company's Annual Report on Form
10-K for the year ended December 31, 1999 filed with the Securities and
Exchange Commission on March 30, 2000. The financial information included
herein has been prepared by management, without audit by independent
accountants who do not express an opinion thereon, and should be read in
conjunction with the audited financial statements contained in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1999. The
condensed consolidated balance sheet as of December 31, 1999, has been derived
from, but does not include all the disclosures contained in, the audited
financial statements for the year ended December 31, 1999. The information
furnished includes all adjustments consisting only of normal recurring
adjustments that are, in the opinion of management, necessary for a fair
presentation of results for the interim periods. Certain information or
footnote disclosure normally included in financial statements prepared in
accordance with generally accepted accounting principles has been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission.
The interim results are not necessarily indicative of the results of
operations for the full year ending December 29, 2000.
2. Reclassifications
Certain prior period amounts have been reclassified to the current period
presentation.
3. Long-term investments
The Company has an investment in a private company. This investment is
included in "Long-term investments" in the Company's balance sheet and is
carried at cost. The Company monitors this investment for impairment and makes
appropriate reductions in carrying value when necessary.
6
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Balance Sheet Components (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------- ------------
<S> <C> <C>
Inventories:
Finished goods...................................... $ 230 $ 517
Raw materials....................................... 88 197
------- ------
Total............................................. $ 318 $ 714
======= ======
Property and equipment:
Computer equipment.................................. $ 2,173 $1,337
Office equipment and fixtures....................... 1,048 619
Leasehold improvements.............................. 971 485
------- ------
4,192 2,441
Less: Accumulated depreciation...................... (1,460) (756)
------- ------
$ 2,732 $1,685
======= ======
Accrued liabilities:
Employee benefits................................... $ 3,633 $1,539
Reserve for sales returns........................... 2,453 1,817
Warranty............................................ 1,314 885
Other............................................... 2,161 370
------- ------
$ 9,561 $4,611
======= ======
</TABLE>
5. Acquisition of Chili!Soft, Inc.
Effective May 23, 2000, the Company acquired Chili!Soft, Inc. ("Chili!Soft")
a provider of software solutions for platform-independent Active Server Pages
(ASP) ("the Acquisition"). An aggregate of approximately 1,150,000 shares of
Cobalt Common Stock were issuable pursuant to the Acquisition, including
options to purchase approximately 226,000 shares of Cobalt Common Stock
issuable in connection with the exercise of options to purchase Chili!Soft
Common Stock that Cobalt assumed in connection with the Acquisition.
The Company accounted for the Acquisition as a purchase business
combination. The consolidated financial statements include the results of
operations of Chili!Soft commencing on May 24, 2000. The total purchase price
has been calculated as follows (in thousands):
<TABLE>
<S> <C>
Market value of 924,000 shares of common stock issued............. $60,112
Fair value of options assumed..................................... 14,647
Cash advances to acquisition prior to May 23, 2000................ 2,350
Direct acquisition costs.......................................... 1,232
-------
Total purchase price............................................ $78,341
=======
</TABLE>
The total purchase price has been allocated to tangible and intangible
assets acquired and liabilities assumed on the basis of their respective fair
values on the acquisition date. The fair value of intangible assets was
determined using a combination of methods, including estimates based on risk-
based or risk-adjusted
7
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
income approach for acquired in-process research and development, completed
technology and non-compete agreement, and on a cost replacement approach for
acquired work force. This valuation was determined by an independent appraiser.
The allocation of the purchase price to assets acquired and liabilities
assumed is presented in the table that follows (in thousands):
<TABLE>
<S> <C>
Developed technology.............................................. $ 1,790
In-process research and development............................... 830
Non-compete agreement............................................. 2,250
Workforce......................................................... 2,210
Goodwill.......................................................... 72,347
Net liabilities assumed........................................... (1,086)
-------
Total purchase price............................................ $78,341
=======
</TABLE>
Amounts allocated to the non-compete agreements and workforce are being
amortized over their estimated useful lives of 3 and 2 years, respectively.
Amounts allocated to existing technology and goodwill are being amortized over
their estimated useful lives of 3 years.
In addition, the Company recorded a $830,000 charge for in-process research
and development related to in-process technology for projects that, as of the
date of the acquisition, had not yet reached technological feasibility and had
no alternative future use. The value of these projects was determined by
estimating the resulting net cash flows from the sale of the products resulting
from the completion of the projects, reduced by the portion of the revenue
attributable to core technology and the percentage completion of the project.
The resulting cash flows were then discounted back to their present value at
appropriate discount rates. Cash flows related to the in-process research and
development were discounted at 30%.
The in-process research and development relates to the development of
ChililSoft's Active Server Pages which were under development as of the
acquisition date. Research and development costs to bring the products from the
acquired company to technological feasibility are estimated to total
approximately $1.0 million. The Company anticipates the development will be
completed between nine and fifteen months.
Developed technology is technology that is being used in existing products
of the business and is distinguished from in process technology because it has
achieved technological feasibility. Core technology represents fundamental
technology and advances that are the basis for the Company's developed and in-
process products. New and in-process products may leverage core technology to
different degrees depending on the extent of incorporation of new, previously
undeveloped technologies.
The nature of the efforts to develop the purchased in-process research and
development into commercially viable products principally relates to the
completion of all planning, designing, prototyping and testing activities that
are necessary to establish that the product can be produced to meet its design
specification, features and technical performance requirements. The resulting
net cash flows from such products are based on estimates of revenue, cost of
revenue, research and development costs, sales and marketing costs, and income
taxes from such projects.
It is reasonably possible that the development of this technology could fail
because of either prohibitive cost, inability to perform the required efforts
to complete the technology or other factors outside of the Company's control
such as a change in the market for the resulting developed products. In
addition, at such time that the project is completed it is reasonably possible
that the completed product does not receive market acceptance or that we are
unable to produce and market the product cost effectively.
8
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following unaudited pro forma net revenues, net loss and net loss per
share data for the six months ended June 30, 2000 and 1999 are based on the
respective historical financial statements of the Company and Chili!Soft. The
pro forma data reflects the consolidated results of operations as if the
Acquisition with Chili!Soft occurred at the beginning of each of the periods
indicated and includes the amortization of the resulting goodwill and other
intangible assets. The pro forma financial data presented are not necessarily
indicative of the Company's results of operations that might have occurred had
the transaction been completed at the beginning of the periods specified, and
do not purport to represent what the Company's consolidated results of
operations might be for any future period.
<TABLE>
<CAPTION>
Six Months Ended
------------------
June 30, July 2,
2000 1999
-------- --------
<S> <C> <C>
Pro forma net revenue.................................. $ 28,818 $ 8,236
Pro forma loss from operations......................... $(24,006) $(23,739)
Pro forma net loss attributable to holders of common
stock................................................. $(20,379) $(24,922)
Pro forma basic and diluted net loss per share
attributable to holders of common stock............... $ (.72) $ (5.85)
Pro forma shares used in basic and diluted net loss per
share calculation..................................... 28,335 4,262
</TABLE>
6. Net Loss Per Share
The Company computes net loss per share in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" and SEC
Staff Accounting Bulletin ("SAB") No. 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 outstanding during the period. Weighted
average shares exclude shares of Common Stock subject to repurchase by the
Company ("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. Because the inclusion of
Potential Common Stock would be anti-dilutive, diluted net loss per share is
the same as basic net loss per share. 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 and B Mandatorily Redeemable Convertible Preferred Stock (with respect
to the three and six months ended July 2, 1999).
The following table sets forth the computation of basic and diluted net loss
per share for the periods indicated (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
--------------------- -----------------
June 30, July 2, June 30, July 2,
2000 1999 2000 1999
--------- --------- -------- -------
<S> <C> <C> <C> <C>
Numerator:
Net loss attributable to holders of
Common Stock........................ $ (6,021) $ (4,229) $(8,604) $(9,435)
========= ========= ======= =======
Denominator:
Weighted average shares outstanding.. 28,826 4,867 28,589 4,834
Weighted average shares of Common
Stock subject to repurchase......... (717) (1,396) (802) (1,496)
--------- --------- ------- -------
Denominator for basic and diluted
calculation......................... 28,109 3,471 27,787 3,338
========= ========= ======= =======
Basic and diluted net loss per share
attributable to holders of Common
Stock............................... $ (.21) $ (1.22) $ (.31) $ (2.83)
========= ========= ======= =======
</TABLE>
9
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The effects of options to purchase 5,500,085 and 2,145,000 shares of Common
Stock at an average exercise price of $14.33 and $0.69 per share at June 30,
2000 and July 2, 1999, respectively, warrants to purchase 243,000 shares of
Common Stock at $3.70 per share at June 30, 2000 and warrants to purchase
283,000 shares of Preferred Stock at an average exercise price of $1.93 at July
2, 1999; and 17,085,000 shares of Mandatorily Redeemable Convertible Preferred
Stock at July 2, 1999, have not been included in the computation of diluted net
loss per share as their effect would have been anti-dilutive.
7. New Accounting Pronouncements
In December 1999, the staff of the Securities and Exchange Commission issued
Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition," which outlines
the basic criteria that must be met to recognize revenue and provides guidance
for presentation of revenue and for disclosure related to revenue recognition
policies in financial statements filed with Securities and Exchange Commission.
The effective date of this pronouncement is the fourth quarter of the fiscal
year beginning after December 15, 1999. We believe that adopting SAB 101 will
not have a material impact on our financial position and results of operations.
In March 2000 the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44 ("FIN 44") Accounting for Certain Transactions involving
Stock Compensation an interpretation of APB Opinion No. 25. FIN 44 clarifies
the application of Opinion 25 for (a) the definition of employee for purposes
of applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination.
FIN 44 is effective July 1, 2000, but certain provisions cover specific
events that occur after either December 15, 1999 or January 12, 2000. The
adoption of certain other provisions of FIN 44 did not have a material effect
on the financial position or results of the Company. We do not expect that the
adoption of the remaining provisions will have a material effect on the
financial position or results of operations .
In June 1998, the FASB issued 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. In July 1999, the
FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133." SFAS No.
137 deferred the effect of SFAS No. 133 until fiscal year beginning after June
15, 2000. We will adopt SFAS No. 133 in 2001. To date, we have not engaged in
derivative or hedging activities. We are unable to predict the impact of
adopting SFAS No 133 if we were to engage in derivative and hedging activities
in the future.
8. Litigation and Other Events
In June 2000, the Company filed suit against NetMachines, Inc. claiming that
the use of the RedRak for its server products constitutes trademark
infringement of the Company's registered RaQ trademark for computer hardware
products, which includes servers. The Company intends to pursue this matter
vigorously but is unable to provide an evaluation of the probability of a
favorable or unfavorable outcome. We believe, based on currently available
information, the resolution of this matter will not have a material effect on
our financial position, results of operations or cash flows.
9. Segment information
During each period presented, the Company operated in a single business
segment, primarily in the United States, Japan and Europe.
10
<PAGE>
COBALT NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Comprehensive Income
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.
11. Acquisition of Progressive Systems, Inc.
On June 30, 2000, Cobalt entered into a definitive agreement to acquire
Progessive Systems, Inc., a privately held company that makes network firewall
solutions and appliances. Cobalt has agreed to acquire all outstanding stock
and rights to acquire capital stock of Progressive Systems, Inc. in exchange
for a combination of Cobalt common stock and cash totaling $11.0 million. The
transaction is expected to be accounted for as a purchase business combination
and is expected to close during the three months ended September 29, 2000.
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Certain statements in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" are 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
"Factors Affecting Future Operating Results" and elsewhere in this quarterly
report on Form 10-Q. 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 "Factors Affecting Future Operating
Results". These factors may cause our actual results to differ materially from
any forward-looking statement.
Overview
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 $45.4 million as of June 30, 2000. 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. In the three months ended June 30, 2000 and July 2,
1999, respectively, 90% and 83% 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 in 1999, we expect that a
substantial majority of our revenues in 2000 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 the three months ended June
30, 2000 and July 2, 1999, respectively, 42% and 12% of our net revenues were
from direct sales. The increase in direct sales as a percentage of net revenues
is due to focused efforts by our direct sales force. Direct sales in absolute
dollars rose to $6.8 million in the three months ended June 30, 2000 from
$603,000 in the three months ended July 2, 1999.
Indirect sales were 58% and 88% of our net revenues in the three months
ended June 30, 2000 and July 2, 1999, respectively. In the three months ended
June 30, 2000, sales to two of our distributors, Nissho Electronics and Tech
Data, each accounted for 10% of our net revenues. In the three months ended
July 2, 1999, approximately 12% of our net revenues came from sales to Nissho
Electronics. 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. We recognize revenues on sales to distributors at the
time products are sold through to end-users. As a result, we defer recognition
of gross profit, captioned on our balance sheet as "deferred margin on
distributor inventory"
12
<PAGE>
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.
Our customers and distributors are generally able to cancel their orders at
any time prior to shipment without penalty. In addition, Cobalt is typically
able to fulfill a majority of orders in less than seven days. Consequently,
backlog measured on any given day is not a meaningful predictor of our
prospects in the ensuing weeks and months.
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 options granted to our employees between July 1, 1998
and October 1, 1999. We are amortizing this stock compensation over the vesting
period of the related options. During the six months ended June 30, 2000, we
amortized $2.4 million of stock compensation. During the remainder of 2000, we
expect to amortize stock compensation of:
<TABLE>
<CAPTION>
Expected
Amortization
of Stock
Compensation
------------
(in
thousands)
<S> <C>
Quarter Ended
September 29, 2000............................................ $861
December 29, 2000............................................. $623
</TABLE>
We then expect aggregate per quarter stock compensation amortization of
between $533,000 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 in the
event of the forfeiture of options for which accrued but unvested compensation
has been recorded.
Prior to April 26, 1999, 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
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amount we would be required to pay if the preferred stock were to be redeemed.
As of April 26, 1999, we ceased 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 226 employees as of June 30, 2000, a substantial increase from 101
employees as of July 2, 1999. 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. We could experience a decline in our revenues
and operating results if:
. 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.
Until January 1, 1999, we operated on calendar fiscal quarters and a fiscal
year ended December 31. Beginning in 1999, we began to operate on thirteen week
fiscal quarters ending on a Friday. Therefore, in 2000 our fiscal quarters end
on March 31, June 30, September 29 and December 29.
Results of Operations--Three and Six Months Ended June 30, 2000 and July 2,
1999
Net Revenues
Net revenues for the three months ended June 30, 2000 were $16.2 million, an
increase of $11.2 million, or 223% as compared to the same period of 1999. For
the six months ended June 30, 2000, total net revenues were $28.3 million, an
increase of 269% over the $7.7 million in the comparable period of 1999. These
increases were primarily the result of an increase in sales to new and existing
customers of our Cobalt Qube and Cobalt RaQ product lines. We expect that the
majority of our revenues in the future may continue to be generated from sales
of our Cobalt Qube and Cobalt RaQ products.
Net revenues from sales to international customers increased to $7.1
million, or 44% of net revenues, in the three months ended June 30, 2000 from
$2.8 million, or 55% of net revenues in the three months ended July 2, 1999.
For the six months ended June 30, 2000 and July 2, 1999, international net
revenues accounted for 47% and 57%, respectively. The increase in absolute
dollars of international revenues was due to the expansion of our operations in
Japan, Europe and other countries. One factor relating to the increase in net
revenues from sales outside the United States was our introduction of various
local language user interfaces including Japanese, German, French and Chinese.
Our net revenues from sales outside the United States were primarily valued 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, in the three months ended June 30, 2000 approximately 68% and in
the three months ended July 2, 1999 approximately 83% of our cost of revenues
consisted of payments to our contract manufacturers. The cost of revenues as a
percentage of net revenues for the three months ended June 30, 2000 and July 2,
1999 were 53% and 63%, respectively. For the six months ended June 30, 2000 and
July 2, 1999, the cost of net revenues as a percentage of net revenues were 54%
and 67%, respectively. The decrease in cost as a percentage of net revenues is
attributable to the continued focus on our manufacturing operations and
economies of scale.
Gross profit for the three months ended June 30, 2000 were $7.7 million, an
increase of $5.8 million, or 309%, as compared to the $1.9 million in the same
period of 1999. Gross profit as a percentage of net revenues
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for the three months ended June 30, 2000 and 1999 were 47% and 37%,
respectively. Gross profit for the six months ended June 30, 2000 were $13.0
million, an increase of $10.5 million or 18%, as compared to the $2.5 million
in the same period of 1999. Gross profit as a percentage of net revenues for
the six months ended June 30, 2000 and July 2, 1999 were 46% and 33%,
respectively. 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
Research and development expenses consist primarily of salaries and related
expenses for personnel engaged in research and development including the
development of application and server management software, material costs for
prototype and test units and other expenses related to the design, development,
testing and enhancements of our products. Due to the quick turn around time of
new product introduction, we expense all research and development costs as they
are incurred. Research and development expenses increased to $2.4 million in
the three months ended June 30, 2000 from $1.4 million in the three months
ended July 2, 1999. For the six months ended June 30, 2000, research and
development expenses were $4.0 million, an increase of 45% over the $2.8
million in the comparable period of 1999. The increase resulted from hiring
additional research and development personnel. 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 may continue to fluctuate as a percentage
of net revenues.
Sales and Marketing
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 to $6.4 million in the three months ended June 30, 2000 from $3.5
million in the three months ended July 2, 1999. For the six months ended June
30, 2000, sales and marketing expenses were $11.6 million, an increase of 85%
over the $6.3 million in the comparable period of 1999. The increase in sales
and marketing expenses was due to the expansion of our sales and marketing
efforts, our branding campaign, advertising and tradeshows, and hiring
additional sales and marketing personnel. 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 may continue to fluctuate as a percentage of
net revenues.
General and Administrative
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 to $2.0 million in the three months ended
June 30, 2000 from $833,000 in the three months ended July 2, 1999. For the six
months ended June 30, 2000, general and administrative expenses were
$3.6 million, an increase of 148% over the $1.5 million in the comparable
period of 1999. The increase was due to hiring additional administrative
personnel and increased costs associated with the expansion of our facilities
and information infrastructure. We expect these expenses to increase in
absolute dollars but may continue to fluctuate as a percentage of net revenues
as we add personnel and incur additional costs related to the growth of our
business and the expansion of our information infrastructure.
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 $1.2 million of stock compensation
15
<PAGE>
amortization during the three months ended June 30, 2000 and $113,000 of stock
compensation amortization in the three months ended July 2, 1999. For the six
months ended June 30, 2000, we recorded $2.4 million of stock compensation
amortization and $253,000 in the comparable period of 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.
During the three months ended June 30, 2000, no unearned stock compensation
costs were reversed upon the cancellation of options.
Amortization of Goodwill and Other Intangible Assets
In the three and six months ended June 30, 2000, we recorded $2.8 million
for the amortization of goodwill and intangibles related to the acquisition of
Chili!Soft. The details for the basis and expected amortization period are
specified in Note 3 to the financial statements.
In-Process Research and Development
In the three and six months ended June 30, 2000, we charged a total of
$830,000 for in-process research and development. This research and development
was acquired as part of the acquisition of Chili!Soft. The amount allocated to
in-process research and development was determined through established
valuation techniques as detailed in Note 3 to the financial statements.
The development of this technology may fail because of prohibitive cost,
inability to perform the required efforts to complete the technology or other
factors outside our control such as changes in the market for the resulting
developed products. In addition, at such time that the project is completed,
the completed products may not receive market acceptance or we may be unable to
produce and market the products cost effectively.
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 $1.9 million and $128,000 in the three months ended June 30,
2000 and July 2, 1999, respectively. For the six months ended June 30, 2000, we
recorded net interest income of $3.7 million. For the six months ended July 2,
1999 we recorded no net interest income. The growth in net interest income was
primarily due to an increase in interest income earned on proceeds from our
initial public offering of common stock.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through private
sales of mandatorily redeemable convertible preferred stock, proceeds from our
initial public offering of common stock, the issuance of convertible notes,
equipment financings and net revenues generated from product sales. As of June
30, 2000, we had cash and cash equivalents of $80.9 million, short-term
investments of $50.9 million, an accumulated deficit of $45.4 million and
working capital of $118.5 million.
Our operating activities used cash of $3.4 million in the six months ended
June 30, 2000 and $7.5 million in the six months ended July 2, 1999. Cash used
in operating activities during the six months ended June 30, 2000 was
attributable to a net loss of $8.6 million, and increases in accounts
receivable of $2.9 million and a decrease in accounts payable of $2.8 million,
but was offset in part by increases in accrued liabilities of $3.6 million,
deferred margin on distributor inventory of $646,000, depreciation,
amortization of stock compensation, acquired intangibles and other non-cash
expenses aggregating $6.4 million. Cash used in operating activities for the
six months ended July 2, 1999 was primarily attributable to net losses of
$8.2 million. In the six months ended July 2, 1999, cash used in operating
activities was also attributable to increases in accounts receivable and
inventories of $2.6 million and $505,000, respectively, offset in part by
increases in accounts payable and accrued expenses of $1.3 million and $1.6
million, respectively.
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<PAGE>
Our investing activities used cash of $57.6 million in the six months ended
June 30, 2000 and $428,000 in the six months ended July 2, 1999. Cash used in
investing activities for the six months ended June 30, 2000 was primarily
attributable to purchases of short-term investments and acquisition of
Chili!Soft, Inc. for working capital. The decreases in the six months ended
July 2, 1999 reflect purchases of computer equipment and other fixed assets.
Our financing activities provided cash of $159,000 in the six months ended
June 30, 2000 and $33.2 million in the six months ended July 2, 1999. The
increases in the six months ended June 30, 2000 resulted primarily from the net
proceeds from the issuances of common stock to our employees upon the exercise
of stock options. The increases in the six months ended July 2, 1999 resulted
from the net proceeds from the issuance 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 $4.1 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 next twelve months. 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 available borrowings of up to $1.0 million at an interest rate of 10.95%
per annum secured by our equipment, machinery and fixtures. We are required to
repay advances under the line in equal installments. Under this lease line, as
of June 30, 2000 and July 2, 1999, we had outstanding borrowings of $63,000 and
$105,000.
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 costs involved in maintaining and enforcing intellectual property
rights;
. market developments;
. available borrowings under line of credit arrangements; and
. other factors.
We believe that our current cash and investment balances and any cash
generated from operations and 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. 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 arrangements. We cannot assure that such funding, if
needed, will be available at attractive terms, 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.
17
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Recent Accounting Pronouncements
In December 1999, the staff of the Securities and Exchange Commission issued
Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition," which outlines
the basic criteria that must be met to recognize revenue and provides guidance
for presentation of revenue and for disclosure related to revenue recognition
policies in financial statements filed with Securities and Exchange Commission.
The effective date of this pronouncement is the fourth quarter of the fiscal
year beginning after December 15, 1999. We believe that adopting SAB 101 will
not have a material impact on our financial position and results of operations.
In March 2000 the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44 ("FIN 44") Accounting for Certain Transactions involving
Stock Compensation an interpretation of APB Opinion No. 25. FIN 44 clarifies
the application of Opinion 25 for (a) the definition of employee for purposes
of applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination.
FIN 44 is effective July 1, 2000, but certain provisions cover specific
events that occur after either December 15, 1999 or January 12, 2000. The
adoption of certain other provisions of FIN 44 did not have a material effect
on the financial position or results of the Company. We do not expect that the
adoption of the remaining provisions will have a material effect on our
financial position or results of operations.
In June 1998, the FASB issued 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. In July 1999, the
FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133." SFAS No.
137 deferred the effect of SFAS No. 133 until fiscal year beginning after June
15, 2000. We will adopt SFAS No. 133 in 2001. To date, we have not engaged in
derivative or hedging activities. We are unable to predict the impact of
adopting SFAS No 133 if we were to engage in derivative and hedging activities
in the future.
Factors That May Affect Future Operating Results
We only began selling our products in March of 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. You should 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 $6.0 million in the three months ended June 30, 2000 and $4.2 million
in the three months ended July 2, 1999. In addition, we had an accumulated
deficit of $45.4 million as of June 30, 2000.
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.
18
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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 the three months ended June 30, 2000,
we do not believe that we will maintain this rate of revenue growth because we
started from a small base of 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 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 generally anticipate sales to
be lower in our first fiscal quarter due to patterns in the capital budgeting
and purchasing cycles of our current and prospective customers. These seasonal
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.
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 the three months ended June
30, 2000 and July 2, 1999, sales of Cobalt Qube and Cobalt
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RaQ products accounted for approximately 90% and 83% 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.
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.
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
20
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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.
Our business is dependent on the adoption of server appliances and a decrease
in their rate of adoption could cause the market price for our common stock
to decline .
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, or if our clients are consolidated into
larger organizations which may not be as receptive to our products, our
revenues may not grow.
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.
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.
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, NTT has announced its intent to acquire one of our
customers, Verio in 2000. 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.
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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.
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 anticipate that we may engage with additional contract manufacturing
partners to manufacture our products in higher volume and at lower costs. We
may not find an outside manufacturer that will meet our needs. Additionally,
qualifying a new outside manufacturer and commencing volume production are
expensive and time consuming. If we are required or choose to change or add
outside manufacturers, we may lose sales and our customer relationships may
suffer.
We may experience transitional problems if we switch outside manufacturers,
including delays and quality control issues that could cause us to lose sales
and impair our ability to achieve profitability.
Prior to August 1999, almost all of our products were manufactured by a
single manufacturer which also provided supply chain management for our
products' components. We experienced problems in having our products
manufactured by this contractor in a timely fashion in part due to the
increase in our volume requirements. In response to these problems, in August
1999 we switched the majority of our manufacturing to SMTC Corp. Although we
believe that SMTC will continue to support our manufacturing requirements,
they are only obligated to supply qualities based on our forecasts, and may
cancel their manufacturing obligations to us upon 90 days notices. If SMTC
experiences delays, disruptions, capacity constraints or quality control
certain problems in its manufacturing operations, product shipments to our
customers could be delayed, which would negatively impact our net revenues,
competitive position and reputation.
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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 some of our manufacturing operations to
offshore manufacturing facilities during 2001. Additionally, we may consider
moving our manufacturing to other locations or to a different contract
manufacturer. 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
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.
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
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 58% of our net revenues in the three months ended June 30, 2000
and 88% of our net revenues in the three months ended July 2, 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
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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 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 the three months
ended June 30, 2000 and 55% of our total revenues in the three months ended
July 2, 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.
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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, VA
Linux 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.
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, VA Linux,
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 was 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
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widely adopt Windows NT-based server appliances, and our products, which do
not currently operate on the Windows NT 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.
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 only filed two 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
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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.
If we were named in an infringement suit in the future, we could be forced
to pay significant monetary damages, a royalty for continuing use of the
intellectual property or trademark or be barred from using certain
technologies or product names altogether. This could result in us losing brand
equity.
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 June 30, 2000 we had a total of 226 employees,
and as of July 2, 1999, we had a total of 101 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 $7.1 million of our
net revenues in the three months ended June 30, 2000 and $2.8 million of our
net revenues in the three months ended July 2, 1999. Although international
sales represented a majority of our sales in the three months ended June 30,
2000, 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.
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Acquisition related accounting charges will reduce our profits or increase our
net losses.
We may continue our expansion into complementary businesses through internal
growth as well as acquisitions. We expect that we will continue to incur
substantial expenses as we acquire other businesses including charges for the
write-off of in-process research and development. Our operating results have
fluctuated in the past and may fluctuate in the future because of the timing of
such write-offs. For example, we incurred a charge to operations in the three
months ended June 30, 2000 of $830,000 for the write-off of in-process research
and development related to our acquisition of Chili!Soft and we will experience
ongoing charges related to that acquisition for amortization of goodwill and
intangibles currently amounting to approximately $6.6 million per quarter.
Any acquisitions that we undertake could be difficult to integrate, disrupt
our business, dilute stockholder value or harm our operating results.
We may make investments in complementary businesses, products or
technologies. If we buy a company, we may have difficulty in assimilating that
company's personnel and operations. In addition, the key personnel of the
acquired company may decide not to work for us. If we make other types of
acquisitions, we could have difficulty in assimilating the acquired technology
or products into our operations. These difficulties could disrupt our ongoing
business, distract our management and employees and increase our expenses. We
also expect that we would incur substantial expenses if we acquired other
businesses or technologies. Any acquisition could result in our incurring
additional debt, contingent liabilities or amortization expenses related to
goodwill and other intangible assets, any of which could harm our profits.
Furthermore, we may incur debt or issue equity securities to pay for any future
acquisitions. If we issue additional equity securities, our stockholders could
experience dilution.
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 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
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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.
Our stock has been and will likely continue to be subject to substantial
price and volume fluctuations due to a number of factors, many of which will
be beyond our control, which 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. The market price of our common stock ranged from
a low of $22 to a high of $172 during the period from November 5, 1999 to June
30, 2000. Investors may be unable to resell their shares of our common stock
for a profit. 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.
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 reduced as a result.
Our board of directors has the authority to issue up to 10,000,000 shares
of preferred stock at any time. 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:
. the election of only one of the three classes of directors each year;
. the limitation of the ability of our stockholders to remove directors
without cause;
. the elimination of the right of stockholders to act by written consent;
. the elimination of the right of stockholders to call a special meeting of
stockholders; 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.
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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. We are subject to the antitakeover provision
of the Delaware General Corporation Law, which regulates corporate
acquisitions. Under Delaware law, a corporation may opt out of the antitakeover
provisions. We have not and do not intend to opt out of the antitakeover
provisions of Delaware Law.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We do not engage in any foreign currency hedging transactions and therefore,
do not believe we are subject to exchange rate risk. Our exposure to market
risk for changes in interest rates relates primarily to our cash and cash
equivalents. We are subject to fluctuating interest rates that may impact,
adversely or otherwise, our results of operations or cash flows for our cash
and cash equivalents.
As of June 30, 2000, we had short-term investments of $50.9 million. These
short-term investments consist of highly liquid investments with original
maturities at the date of purchase between three and nine months. These
investments are subject to interest rate risk and will decrease in value if
market interest rates increase. An immediate 10% change in interest rates would
be immaterial to our financial condition or results of operations. Because we
have the ability to hold these investments until maturity we would not expect
any significant decline in value of our investments caused by market interest
rate changes. Declines in interest rates over time will, however, reduce our
interest income.
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PART II--OTHER INFORMATION
Item 1. Legal Proceedings.
OPEN
Item 2. Changes in Securities and Use of Proceeds.
With respect to the requirements of Item 701(f) of Regulation S-K regarding
the reporting of use of proceeds, pursuant to the information required to be
reported by Item 701(f)(4)(viii), Cobalt used net proceeds in the amounts noted
for the stated purposes since its December 31, 1999 Annual Report on Form 10-K:
purchase and installation of machinery and equipment--$1,158,000 and working
capital--$118.5 million.
Item 6. Exhibits and Reports on Form 8-k.
(a) Exhibits:
27.1 Financial Data Schedule.
(b) Reports on Form 8-K. We filed a report on Form 8-K during the three
months ended June 30, 2000 related to our acquisition of Chili!Soft, Inc. on
June 8, 2000.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Cobalt Networks, Inc.
Date August 11, 2000
/s/ Stephen W. DeWitt
_____________________________________
Stephen W. DeWitt
President and Chief Executive
Officer
(Principal Executive Officer)
/s/ Kenton D. Chow
_____________________________________
Kenton D. Chow
Vice President of Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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