ECHELON CORP
S-8, EX-4.2, 2000-08-21
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                                                                     EXHIBIT 4.2


                              ECHELON CORPORATION

                           1998 DIRECTOR OPTION PLAN
                      (as amended through April 22, 1999)

     1.   Purposes of the Plan. The purposes of this 1998 Director Option Plan
          --------------------
are attract and retain the best available personnel for service as Outside
Directors (as defined herein) of the Company, to provide additional incentive to
the Outside Directors of the Company to serve as Directors, and to encourage
their continued service on the Board.

     All options granted hereunder shall be nonstatutory stock options.

     2.   Definitions.  As used herein, the following definitions shall apply:
          -----------

          (a)  "Board" means the Board of Directors of the Company.
                -----

          (b)  "Code" means the Internal Revenue Code of 1986, as amended.
                ----

          (c)  "Common Stock" means the common stock of the Company.
                ------------

          (d)  "Company" means Echelon Corporation, a Delaware corporation.
                -------

          (e)  "Director" means a member of the Board.
                --------

          (f)  "Disability" means total and permanent disability as defined in
                ----------
Section 22(e)(3) of the Code.

          (g)  "Employee" means any person, including officers and Directors,
                --------
employed by the Company or any Parent or Subsidiary of the Company. The payment
of a Director's fee by the Company shall not be sufficient in and of itself to
constitute "employment" by the Company.

          (h)  "Exchange Act" means the Securities Exchange Act of 1934, as
                ------------
amended.

          (i)  "Fair Market Value" means, as of any date, the value of Common
                -----------------
Stock determined as follows:

               (i)    If the Common Stock is listed on any established stock
exchange or a national market system, including without limitation the Nasdaq
National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its
Fair Market Value shall be the closing sales price for such stock (or the
closing bid, if no sales were reported) as quoted on such exchange or system for
the last market trading day prior to the time of determination as reported in
The Wall Street Journal or such other source as the Administrator deems
reliable;
<PAGE>

               (ii)   If the Common Stock is regularly quoted by a recognized
securities dealer but selling prices are not reported, the Fair Market Value of
a Share of Common Stock shall be the mean between the high bid and low asked
prices for the Common Stock for the last market trading day prior to the time of
determination, as reported in The Wall Street Journal or such other source as
the Board deems reliable; or

               (iii)  In the absence of an established market for the Common
Stock, the Fair Market Value thereof shall be determined in good faith by the
Board.

     Notwithstanding the foregoing, with respect to any Options granted upon the
effective date of the IPO, as set forth in Section 4 below, the Fair Market
Value shall be the price as it appears in the final prospectus relating to the
IPO.
          (j)  "Inside Director" means a Director who is an Employee.
                ---------------

          (k)  "Option" means a stock option granted pursuant to the Plan.
                ------

          (l)  "Optioned Stock" means the Common Stock subject to an Option.
                --------------

          (m)  "Optionee"  means a Director who holds an Option.
                --------

          (n)  "Outside Director" means a Director who is not an Employee.
                ----------------

          (o)  "Parent" means a "parent corporation," whether now or hereafter
                ------
existing, as defined in Section 424(e) of the Code.

          (p)  "Plan" means this 1998 Director Option Plan.
                ----

          (q)  "Share" means a share of the Common Stock, as adjusted in
               -----
accordance with Section 10 of the Plan.

          (r)  "Subsidiary" means a "subsidiary corporation," whether now or
                ----------
hereafter existing, as defined in Section 424(f) of the Internal Revenue Code of
1986.

     3.   Stock Subject to the Plan. Subject to the provisions of Section 10 of
          -------------------------
the Plan, the maximum aggregate number of Shares which may be optioned and sold
under the Plan is 300,000 Shares, plus an annual increase to be added on the
first day of the Company's fiscal year (beginning in 1999) equal to the lesser
of (i) 100,000 shares or (ii) a lesser amount determined by the Board (the
"Pool"). The Shares may be authorized, but unissued, or reacquired Common Stock.

     If an Option expires or becomes unexercisable without having been exercised
in full, the unpurchased Shares which were subject thereto shall become
available for future grant or sale under the Plan (unless the Plan has
terminated). Shares that have actually been issued under the Plan shall not be
returned to the Plan and shall not become available for future distribution
under the Plan.

                                      -2-
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     4.   Administration and Grants of Options under the Plan.
          ---------------------------------------------------

          (a)    Procedure for Grants. Option grants to Outside Directors under
                 --------------------
this Plan shall be made as follows:

                 (i)   Each Outside Director shall be automatically granted an
Option to purchase 25,000 Shares (the "First Option") on the date on which such
person first becomes an Outside Director (provided such date is after May 29,
1998), whether through election by the stockholders of the Company or
appointment by the Board to fill a vacancy; provided, however, that an Inside
Director who ceases to be an Inside Director but who remains a Director shall
not receive a First Option.

                 (ii)  Each Outside Director shall be automatically granted an
Option to purchase 10,000 Shares (a "Subsequent Option") on both (A) the
effective date of the Company's initial public offering (the "IPO") and on (B)
the date of the Company's Annual Stockholders Meeting each year, provided that
he or she is re-elected to the Board or otherwise remains on the Board on such
date; provided, however, that on such date, he or she shall have served on the
Board for at least the preceding six (6) months.

                 (iii) Notwithstanding the provisions of subsections (i) and
(ii) hereof, any exercise of an Option granted before the Company has obtained
stockholder approval of the Plan in accordance with Section 16 hereof shall be
conditioned upon obtaining such stockholder approval of the Plan in accordance
with Section 16 hereof.

                 (iv)  The terms of a First Option granted hereunder shall be as
follows:

                       (A)  the term of the First Option shall be five (5)
years.

                       (B)  the First Option shall be exercisable only while the
Outside Director remains a Director of the Company, except as set forth in
Sections 8 and 10 hereof.

                       (C)  the exercise price per Share shall be 100% of the
Fair Market Value per Share on the date of grant of the First Option.

                       (D)  Each First Option granted prior to April 22, 1999
shall become exercisable as to 25% of the Shares subject to such First Option on
each anniversary of its date of grant, provided that the Optionee continues to
serve as a Director on such dates. Each First Option granted after April 22,
1999 shall be fully vested and exercisable as of its date of grant.

                 (v)   The terms of a Subsequent Option granted hereunder shall
be as follows:

                       (A)  the term of the Subsequent Option shall be five (5)
years.

                       (B)  the Subsequent Option shall be exercisable only
while the Outside Director remains a Director of the Company, except as set
forth in Sections 8 and 10 hereof.

                                      -3-
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                         (C) the exercise price per Share shall be 100% of the
Fair Market Value per Share on the date of grant of the Subsequent Option.

                         (D) Each Subsequent Option granted prior to April 22,
1999 shall become exercisable as to 25% of the Shares subject to such Subsequent
Option on each anniversary of its date of grant, provided that the Optionee
continues to serve as a Director on such dates. Each Subsequent Option granted
after April 22, 1999 shall be fully vested and exercisable as of its date of
grant.
                  (vi)   In the event that any Option granted under the Plan
would cause the number of Shares subject to outstanding Options plus the number
of Shares previously purchased under Options to exceed the Pool, then the
remaining Shares available for Option grant shall be granted under Options to
the Outside Directors on a pro rata basis. No further grants shall be made until
such time, if any, as additional Shares become available for grant under the
Plan through action of the Board or the stockholders to increase the number of
Shares which may be issued under the Plan or through cancellation or expiration
of Options previously granted hereunder.

     5.    Eligibility. Options may be granted only to Outside Directors in
           -----------
accordance with the terms set forth in Section 4 hereof. The Plan shall not
confer upon any Optionee any right with respect to continuation of service as a
Director or nomination to serve as a Director, nor shall it interfere in any way
with any rights which the Director or the Company may have to terminate the
Director's relationship with the Company at any time.

     6.    Term of Plan. The Plan shall become effective upon the effective
           ------------
date of the IPO. It shall continue in effect for a term of ten (10) years unless
sooner terminated under Section 11 of the Plan.

     7.    Form of Consideration. The consideration to be paid for the Shares to
           ---------------------
be issued upon exercise of an Option, including the method of payment, shall
consist of (i) cash, (ii) check, (iii) other shares which (x) in the case of
Shares acquired upon exercise of an option, have been owned by the Optionee for
more than six (6) months on the date of surrender, and (y) have a Fair Market
Value on the date of surrender equal to the aggregate exercise price of the
Shares as to which said Option shall be exercised, (iv) consideration received
by the Company under a cashless exercise program implemented by the Company in
connection with the Plan, or (v) any combination of the foregoing methods of
payment.

     8.    Exercise of Option.
           ------------------

           (a)   Procedure for Exercise; Rights as a Stockholder. Any Option
                 ----------------------
granted hereunder shall be exercisable at such times as are set forth in Section
4 hereof; provided, however, that no Options shall be exercisable until
stockholder approval of the Plan in accordance with Section 16 hereof has been
obtained.

     An Option may not be exercised for a fraction of a Share.

     An Option shall be deemed to be exercised when written notice of such
exercise has been given to the Company in accordance with the terms of the
Option by the person entitled to exercise

                                      -4-
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the Option and full payment for the Shares with respect to which the Option is
exercised has been received by the Company. Full payment may consist of any
consideration and method of payment allowable under Section 7 of the Plan. Until
the issuance (as evidenced by the appropriate entry on the books of the Company
or of a duly authorized transfer agent of the Company) of the stock certificate
evidencing such Shares, no right to vote or receive dividends or any other
rights as a stockholder shall exist with respect to the Optioned Stock,
notwithstanding the exercise of the Option. A share certificate for the number
of Shares so acquired shall be issued to the Optionee as soon as practicable
after exercise of the Option. No adjustment shall be made for a dividend or
other right for which the record date is prior to the date the stock certificate
is issued, except as provided in Section 10 of the Plan.

     Exercise of an Option in any manner shall result in a decrease in the
number of Shares which thereafter may be available, both for purposes of the
Plan and for sale under the Option, by the number of Shares as to which the
Option is exercised.

          (b)  Termination of Continuous Status as a Director. Subject to
               ----------------------------------------------
Sections 8(e) and 10 hereof, in the event an Optionee's status as a Director
terminates (other than upon the Optionee's death or Disability), the Optionee
may exercise his or her Option, but only within three (3) months following the
date of such termination, and only to the extent that the Optionee was entitled
to exercise it on the date of such termination (but in no event later than the
expiration of its ten (10) year term). To the extent that the Optionee was not
entitled to exercise an Option on the date of such termination, and to the
extent that the Optionee does not exercise such Option (to the extent otherwise
so entitled) within the time specified herein, the Option shall terminate.

          (c)  Disability of Optionee. Subject to Sections 8(e) and 10 hereof,
               ----------------------
in the event Optionee's status as a Director terminates as a result of
Disability, the Optionee may exercise his or her Option, but only within twelve
(12) months following the date of such termination, and only to the extent that
the Optionee was entitled to exercise it on the date of such termination (but in
no event later than the expiration of its ten (10) year term). To the extent
that the Optionee was not entitled to exercise an Option on the date of
termination, or if he or she does not exercise such Option (to the extent
otherwise so entitled) within the time specified herein, the Option shall
terminate.

          (d)  Death of Optionee. Subject to Sections 8(e) and 10 hereof, in the
               -----------------
event of an Optionee's death, the Optionee's estate or a person who acquired the
right to exercise the Option by bequest or inheritance may exercise the Option,
but only within twelve (12) months following the date of death, and only to the
extent that the Optionee was entitled to exercise it on the date of death (but
in no event later than the expiration of its ten (10) year term). To the extent
that the Optionee was not entitled to exercise an Option on the date of death,
and to the extent that the Optionee's estate or a person who acquired the right
to exercise such Option does not exercise such Option (to the extent otherwise
so entitled) within the time specified herein, the Option shall terminate.

          (e)  Accelerated Vesting; Extended Option Term for Certain Directors.
               ---------------------------------------------------------------
In the event an Optionee's status as a Director terminates (including upon the
Optionee's death or Disability), and if on the date of such termination the
Optionee has served as a Director for at least five (5) years, (A) the Option
shall become fully exercisable, including as to Shares for which it

                                      -5-
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would not otherwise be exercisable, and (B) such Option shall remain so
exercisable until the end of its term as set forth in Section 4.

     9.   Non-Transferability of Options.  The Option may not be sold, pledged,
          ------------------------------
assigned, hypothecated, transferred, or disposed of in any manner other than by
will or by the laws of descent or distribution and may be exercised, during the
lifetime of the Optionee, only by the Optionee.

     10.  Adjustments Upon Changes in Capitalization, Dissolution, Merger or
          ------------------------------------------------------------------
Asset Sale.
----------
          (a)  Changes in Capitalization.  Subject to any required action by the
               -------------------------
stockholders of the Company, the number of Shares covered by each outstanding
Option, the number of Shares which have been authorized for issuance under the
Plan (including the maximum annual increase in the number of Shares under
Section 3) (but as to which no Options have yet been granted or which have been
returned to the Plan upon cancellation or expiration of an Option) and the price
per Share covered by each such outstanding Option shall be proportionately
adjusted for any increase or decrease in the number of issued Shares resulting
from a stock split, reverse stock split, stock dividend, combination or
reclassification of the Common Stock, or any other increase or decrease in the
number of issued Shares effected without receipt of consideration by the
Company; provided, however, that the number of Shares to be subject to First and
Subsequent Options granted pursuant to the automatic grant provisions of Section
4 hereof shall not be proportionately adjusted as described above; provided,
further, that conversion of any convertible securities of the Company shall not
be deemed to have been "effected without receipt of consideration." Except as
expressly provided herein, no issuance by the Company of shares of stock of any
class, or securities convertible into shares of stock of any class, shall
affect, and no adjustment by reason thereof shall be made with respect to, the
number or price of Shares subject to an Option.

          (b)  Dissolution or Liquidation. In the event of the proposed
               --------------------------
dissolution or liquidation of the Company, to the extent that an Option has not
been previously exercised, it shall terminate immediately prior to the
consummation of such proposed action.

          (c)  Merger or Asset Sale. In the event of a merger of the Company
               --------------------
with or into another corporation or the sale of substantially all of the assets
of the Company, outstanding Options may be assumed or equivalent options may be
substituted by the successor corporation or a Parent or Subsidiary thereof (the
"Successor Corporation"). If an Option is assumed or substituted for, the Option
or equivalent option shall continue to be exercisable as provided in Section 4
hereof for so long as the Optionee serves as a Director or a director of the
Successor Corporation. Following such assumption or substitution, if the
Optionee's status as a Director or director of the Successor Corporation, as
applicable, terminates other than upon a voluntary resignation by the Optionee,
the Option or option shall become fully exercisable, including as to Shares for
which it would not otherwise be exercisable. Thereafter, the Option or option
shall remain exercisable in accordance with Sections 8(b) through (e) above.

     If the Successor Corporation does not assume an outstanding Option or
substitute for it an equivalent option, the Option shall become fully vested and
exercisable, including as to Shares for which it would not otherwise be
exercisable.  In such event the Board shall notify the Optionee that

                                      -6-
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the Option shall be fully exercisable for a period of thirty (30) days from the
date of such notice, and upon the expiration of such period the Option shall
terminate.

     For the purposes of this Section 10(c), an Option shall be considered
assumed if, following the merger or sale of assets, the Option confers the right
to purchase or receive, for each Share of Optioned Stock subject to the Option
immediately prior to the merger or sale of assets, the consideration (whether
stock, cash, or other securities or property) received in the merger or sale of
assets by holders of Common Stock for each Share held on the effective date of
the transaction (and if holders were offered a choice of consideration, the type
of consideration chosen by the holders of a majority of the outstanding Shares).
If such consideration received in the merger or sale of assets is not solely
common stock of the successor corporation or its Parent, the Administrator may,
with the consent of the successor corporation, provide for the consideration to
be received upon the exercise of the Option, for each Share of Optioned Stock
subject to the Option, to be solely common stock of the successor corporation or
its Parent equal in fair market value to the per share consideration received by
holders of Common Stock in the merger or sale of assets.

     11.  Amendment and Termination of the Plan.
          -------------------------------------

          (a)  Amendment and Termination. The Board may at any time amend,
               -------------------------
alter, suspend, or discontinue the Plan, but no amendment, alteration,
suspension, or discontinuation shall be made which would impair the rights of
any Optionee under any grant theretofore made, without his or her consent. In
addition, to the extent necessary and desirable to comply with any applicable
law, regulation or stock exchange rule, the Company shall obtain stockholder
approval of any Plan amendment in such a manner and to such a degree as
required.

          (b)  Effect of Amendment or Termination. Any such amendment or
               ----------------------------------
termination of the Plan shall not affect Options already granted and such
Options shall remain in full force and effect as if this Plan had not been
amended or terminated.

     12.  Time of Granting Options. The date of grant of an Option shall, for
          ------------------------
all purposes, be the date determined in accordance with Section 4 hereof.

     13.  Conditions Upon Issuance of Shares. Shares shall not be issued
          ----------------------------------
pursuant to the exercise of an Option unless the exercise of such Option and the
issuance and delivery of such Shares pursuant thereto shall comply with all
relevant provisions of law, including, without limitation, the Securities Act of
1933, as amended, the Exchange Act, the rules and regulations promulgated
thereunder, state securities laws, and the requirements of any stock exchange
upon which the Shares may then be listed, and shall be further subject to the
approval of counsel for the Company with respect to such compliance.

     As a condition to the exercise of an Option, the Company may require the
person exercising such Option to represent and warrant at the time of any such
exercise that the Shares are being purchased only for investment and without any
present intention to sell or distribute such Shares, if, in the opinion of
counsel for the Company, such a representation is required by any of the
aforementioned relevant provisions of law.

                                      -7-
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     Inability of the Company to obtain authority from any regulatory body
having jurisdiction, which authority is deemed by the Company's counsel to be
necessary to the lawful issuance and sale of any Shares hereunder, shall relieve
the Company of any liability in respect of the failure to issue or sell such
Shares as to which such requisite authority shall not have been obtained.

     14.  Reservation of Shares.  The Company, during the term of this Plan,
          ---------------------
will at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan.

     15.  Option Agreement.  Options shall be evidenced by written option
          ----------------
agreements in such form as the Board shall approve.

     16.  Stockholder Approval. The Plan shall be subject to approval by the
          --------------------
stockholders of the Company within twelve (12) months after the date the Plan is
adopted.  Such stockholder approval shall be obtained in the degree and manner
required under applicable state and federal law and any stock exchange rules.

                                      -8-


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