<PAGE>
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the
Securities Exchange Act of 1934
Filed by the Registrant [X]
Filed by a Party other than the Registrant [_]
Check the appropriate box:
[X] Preliminary Proxy Statement [_] Confidential, for Use of the
Commission Only (as Permitted By
Rule 14a-6(e)(2))
[_] Definitive Proxy Statement
[_] Definitive Additional Materials
[_] Soliciting Material Pursuant to Section 240.14a-11(c) or
Section 240.14a-12
RATIONAL SOFTWARE CORPORATION
(Name of Registrant as Specified In Its Charter)
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[_] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
(1) Title of each class of securities to which transaction applies:
(2) Aggregate number of securities to which transaction applies:
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):
(4) Proposed maximum aggregate value of transaction:
(5) Total fee paid:
[_] Fee paid previously with preliminary materials.
[_] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
(2) Form, Schedule or Registration Statement No.:
(3) Filing Party:
(4) Date Filed:
Notes:
<PAGE>
RATIONAL SOFTWARE CORPORATION
----------------
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD AUGUST 17, 2000
TO THE STOCKHOLDERS:
The Annual Meeting of Stockholders of Rational Software Corporation (the
"Company") will be held at the principal offices of the Company at 18880
Homestead Road, Cupertino, CA 95014, on August 17, 2000 at 11:00 a.m. local
time, for the following purposes:
1. To elect two Class II members of the Board of Directors (Proposal 1);
2. To approve an amendment to the Company's Amended and Restated
Certificate of Incorporation to increase the number of authorized shares of
Common Stock (Proposal 2);
3. To approve an amendment to the 1997 Stock Option Plan reserving an
additional 6,000,000 shares of the Company's authorized but unissued Common
Stock for issuance thereunder (Proposal 3);
4. To approve the adoption of the 2000 Directors Option Plan reserving
500,000 shares of the Company's authorized but unissued Common Stock for
issuance thereunder (Proposal 4);
5. To ratify the appointment of Ernst & Young LLP as the Company's
independent auditors to examine the financial statements of the Company for
the fiscal year ending March 31, 2001 (Proposal 5); and
6. To transact such other business as may properly come before the
meeting or any adjournment thereof.
Only holders of record of the Company's Common Stock at the close of
business on June 23, 2000, the record date fixed by the Company's Board of
Directors, are entitled to notice of and to vote at the Annual Meeting.
By Order of the Board of Directors,
Timothy A. Brennan
Secretary
Cupertino, California
July , 2000
IT IS IMPORTANT THAT PROXIES BE RETURNED PROMPTLY. THEREFORE, WHETHER OR
NOT YOU PLAN TO ATTEND THE ANNUAL MEETING, PLEASE COMPLETE, DATE, SIGN AND
RETURN THE ENCLOSED PROXY IN THE ENCLOSED POSTAGE PAID ENVELOPE. YOU MAY,
IF YOU WISH, REVOKE YOUR PROXY AT ANY TIME PRIOR TO THE TIME IT IS VOTED.
STOCKHOLDERS WHO HOLD THEIR SHARES IN "STREET NAME" MAY VOTE VIA THE
INTERNET OR TELEPHONE BY FOLLOWING INSTRUCTIONS ON THE VOTING FORM
RECEIVED FROM THEIR BROKER OR BANK.
<PAGE>
RATIONAL SOFTWARE CORPORATION
----------------
PROXY STATEMENT
----------------
FOR THE ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD AUGUST 17, 2000
INFORMATION CONCERNING
SOLICITATION, VOTING AND REVOCABILITY OF PROXIES
This Proxy Statement is furnished to stockholders in connection with the
solicitation by the Board of Directors of Rational Software Corporation
("Rational" or the "Company") of proxies in the accompanying form for use at
the Annual Meeting of Stockholders of the Company to be held at the principal
offices of the Company at 18880 Homestead Road, Cupertino, CA 95014, at 11:00
a.m. on Thursday, August 17, 2000, and at any adjournment thereof. If a proxy
in the accompanying form is duly executed and returned, the shares represented
thereby will be voted at the Annual Meeting and, where a choice is specified,
will be voted in accordance with the specification made. Any stockholder who
gives a proxy may revoke it at any time before it is exercised by giving a
later proxy, by attending the meeting and voting in person, or by giving
written notice of revocation to the Company's Secretary. These proxy materials
are first being provided to stockholders on or about July , 2000.
The Annual Meeting has been called for the following purposes: (1) to elect
two Class II members of the Board of Directors; (2) to approve an amendment to
the Company's Amended and Restated Certificate of Incorporation to increase the
authorized number of shares of Common Stock to 500,000,000; (3) to approve an
amendment to the 1997 Stock Option Plan reserving an additional 6,000,000
shares of the Company's authorized but unissued Common Stock for issuance
thereunder; (4) to approve the 2000 Director Option Plan, reserving 500,000
shares of the Company's authorized but unissued Common Stock for issuance
thereunder; (5) to ratify the appointment of Ernst & Young LLP as the Company's
independent auditors to examine the financial statements of the Company for the
fiscal year ending March 31, 2001; and (6) to transact such other business as
may properly come before the meeting or any adjournment thereof. Only holders
of record of the Company's Common Stock at the close of business on June 23,
2000, the record date fixed by the Company's Board of Directors (the "Record
Date"), are entitled to notice of and to vote at the Annual Meeting.
If the enclosed form of proxy is properly executed and returned to the
Company in time to be voted at the Annual Meeting, the shares represented
thereby will be voted in accordance with the instructions marked therein.
Executed but unmarked proxies will be voted FOR the election of the Company's
one nominee to the Board of Directors and FOR each of the other proposals.
The Company's capital stock currently consists of a single class of Common
Stock, par value $0.01 per share, of which shares were outstanding at the
close of business on the Record Date. Stockholders of record at the close of
business on the Record Date have the right to receive notice of and to vote at
the Annual Meeting. For each share held, a stockholder is entitled to one vote
on each matter to be considered and acted upon at the Annual Meeting. There are
no cumulative voting rights in the election of directors.
The presence, in person or by proxy, of at least the majority of the total
number of outstanding shares of Common Stock entitled to vote at the Annual
Meeting is necessary to constitute a quorum at the Annual Meeting.
Stockholders' votes will be tabulated by persons appointed by the Board of
Directors to act as inspectors of election for the Annual Meeting. While there
is no definitive statutory or case law authority in Delaware as to the proper
treatment of abstentions in the counting of votes, the Company believes that
abstentions should be counted for purposes of determining both (i) the presence
or absence of a quorum for the transaction of business and (ii) the total
number of shares present and entitled to vote with respect to the particular
proposal on which the stockholder has abstained. In the absence of controlling
precedent to the
<PAGE>
contrary, the Company intends to treat abstentions in this manner. In a 1988
Delaware case, Berlin v. Emerald Partners, the Delaware Supreme Court held
that, while broker non-votes may be counted for purposes of determining the
presence or absence of a quorum for the transaction of business, broker non-
votes should not be counted for purposes of determining the number of shares
present and entitled to vote with respect to the particular proposal on which
the broker has expressly not voted.
A copy of the Company's Annual Report on Form 10-K, without exhibits
thereto, for the fiscal year ended March 31, 2000, as filed with the Securities
and Exchange Commission (the "SEC") accompanies copies of this Proxy Statement
mailed to stockholders. Stockholders may obtain, for the cost of copying, a
copy of any exhibits thereto by writing: Rational Software Corporation, 18880
Homestead Road, Cupertino, CA 95014, Attention: Investor Relations.
2
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BENEFICIAL OWNERSHIP OF COMMON STOCK
Under the proxy rules of the SEC, a person who directly or indirectly has or
shares voting power or investment power with respect to a security is
considered a beneficial owner of the security. Voting power is the power to
vote or direct the voting of shares and investment power is the power to
dispose of or direct the disposition of shares. Shares as to which voting power
or investment power may be acquired within 60 days are also considered as
beneficially owned under the proxy rules.
The following table sets forth certain information as of the Record Date,
regarding beneficial ownership of the Company's Common Stock by (i) each person
who is known to the Company to own beneficially more than 5% of the Company's
Common Stock, (ii) each director and each nominee for election as a director of
the Company, (iii) each executive officer named in the Summary Compensation
Table set forth in this Proxy Statement, and (iv) all current directors and
current executive officers of the Company as a group. The information on
beneficial ownership in the table and the footnotes thereto is based upon the
Company's records and , in the case of holders of more than 5% of the Company's
stock, the most recent Schedule 13D or 13F filed by each such person or entity
and information supplied to the Company by such person or entity. Unless
otherwise indicated, each person has sole voting power and sole investment
power with respect to the shares shown.
<TABLE>
<CAPTION>
Number of
Shares
Beneficially Percent
Directors, Officers and 5% Stockholders Owned Owned(1)
--------------------------------------- ------------ --------
<S> <C> <C>
Putnam Investment Management, Inc.(2)................... 8,275,160 9.17
One Post Office Square, Boston MA 02109
Wellington Management Company, LLP(3)................... 5,779,655 6.40
75 State Street, Boston MA 02109
Fidelity Management & Research, Inc.(4)................. 5,555,651 6.16
82 Devonshire Street, Boston MA 02109
Kopp Investment Advisors Inc.(5)........................ 5,535,325 6.13
7701 France Ave. South, Suite 500, Edina MN 55435
Paul D. Levy(6)......................................... 1,569,096 1.74
Michael T. Devlin(7).................................... 1,603,196 1.78
David H. Bernstein(8)................................... 395,730 *
Kevin J. Haar(9)........................................ 549,965 *
John R. Lovitt(10)...................................... 362,186 *
Leslie G. Denend(11).................................... 62,250 *
John E. Montague(12).................................... 86,100 *
Allison R. Schleicher(13)............................... 125,832 *
All current Directors and current Executive Officers as
a group (15 persons)(14)............................... 6,277,756 *
</TABLE>
--------
* Represents less than one percent of the outstanding shares of Common Stock.
(1) The percent owned is calculated based on a total of 90,242,697 shares of
Common Stock outstanding.
(2) Includes all shares held by Putnam Investment Management, Inc., and
affiliated persons as reported on Form 13-F as of March 31, 2000.
(3) Includes all shares held by Wellington Management Company, LLP and
affiliated persons as reported on Form 13-F as of March 31, 2000.
(4) Includes all shares held by Fidelity Management & Research, Inc., and
affiliated persons as reported on Form 13-F as of March 31, 2000.
(5) Includes all shares held by Kopp Investment Advisors, Inc., and affiliated
persons as reported on Form 13-F as of March 31, 2000.
(6) Includes 1,554,690 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 278,546 of which are subject to vested
options and 1,276,144 of which are subject to unvested options.
3
<PAGE>
(7) Includes 1,597,066 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 319,251 of which are subject to vested
options and 1,277,815 of which are subject to unvested options.
(8) Includes 386,144 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 78,987 of which are subject to vested
options and 307,157 of which are subject to unvested options.
(9) Includes 462,800 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 121,339 of which are subject to vested
options and 341,461 of which are subject to unvested options.
(10) Includes 318,818 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 124,440 of which are subject to vested
options and 194,378 of which are subject to unvested options.
(11) Includes 55,250 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 17,000 of which are subject to vested
options and 38,250 of which are subject to unvested options.
(12) Includes 82,250 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 31,500 of which are subject to vested
options and 50,750 of which are subject to unvested options.
(13) Includes 125,332 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 87,082 of which are subject to vested
options and 38,250 of which are subject to unvested options.
(14) Includes 5,669,296 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 903,066 of which are subject to vested
options and 4,766,230 of which are subject to unvested options.
4
<PAGE>
PROPOSAL 1
ELECTION OF DIRECTORS
The Company's bylaws provide for a Board of five directors. The Company's
Certificate of Incorporation provides that the Board of Directors be divided
into three classes as nearly equal in number as possible. The term of the Class
I directors expires in 2002, the term of the Class II directors expires in
2000, and the term of the Class III director expires in 2001. The two Class II
directors who were serving as directors at the end of fiscal year 2000 are
nominated for re-election. The directors elected at the Annual Meeting will
hold office for a three-year term expiring in 2003 or until their successors
are elected and qualified. The other directors will continue in office for the
remainder of their terms as indicated below. Unless authority so to vote is
withheld, proxies received pursuant to this solicitation will be voted for the
election of the two nominees named below. If any of the nominees should for any
reason not be available for election, proxies will be voted for the election of
the remaining nominees and such substitute nominees as may be designated by the
Board of Directors.
NOMINEES FOR ELECTION AT THE ANNUAL MEETING
Paul D. Levy, age 44, co-founded the Company in 1981, has been a director
since the inception of the Company, and is currently Chairman of the Board.
From September 1996 to April 1999, Mr. Levy served as Chairman of the Board and
Chief Executive Officer. Prior to September 1996, Mr. Levy served as President
and Chief Executive Officer of the Company. Mr. Levy is a director of Broadbase
Software.
John E. Montague, age 46, has been a director of the Company since 1994.
Since September 1998, he has been Vice President and Chief Financial Officer of
Lockheed Martin Global Telecommunications. From March 1995 to September 1998,
he served as Vice President, Financial Strategies at Lockheed Martin
Corporation, a diversified manufacturer of aerospace products. Previously, he
was Vice President, Corporate Development and Investor Relations at Martin
Marietta Corporation. He is a director of L-3 Communications Corporation.
DIRECTOR CONTINUING IN OFFICE IN THE CLASS OF 2001
Allison R. Schleicher, age 56, has been a director of the Company since
1990. From 1967 to May 1999 he has been with IBM Corporation in various
executive and management positions. Most recently, he has served as Vice
President, Finance & Planning, Sales and Distribution Group. In 1997, he served
as Vice President, Finance & Planning, Personal Systems Technology Group. From
1994 to 1997, he served as Vice President, Finance of IBM Credit Corporation.
DIRECTORS CONTINUING IN OFFICE IN THE CLASS OF 2002
Michael T. Devlin, age 45, co-founded the Company in 1981, has been a
director since the inception of the Company, and is currently Chief Executive
Officer. From September 1996 to April 1999, Mr. Devlin served as President of
the Company. Prior to September 1996, Mr. Devlin served as Chairman of the
Board of the Company.
Leslie G. Denend, age 59, has been a director of the Company since 1993.
Since December 1997, he has served as a Director of Networks Associates, Inc.,
a supplier of products that protect, manage and monitor corporate networks.
From December 1997 until May 1998, he served as President of Networks
Associates, Inc. From 1993 until December 1997, he served as President and
Chief Executive Officer of Network General Corporation, a supplier of local and
wide area computer network communications management systems, which through a
strategic business combination with McAfee Associates, Inc. in December 1997,
formed Networks Associates, Inc. He currently serves as a director of Proxim,
Inc. and Informix Software, Inc.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE NOMINATED DIRECTORS.
Because the two nominees who receive the greatest number of votes will be
elected to serve as Class II directors, abstentions and broker non-votes will
have no effect on the outcome of the election of directors.
5
<PAGE>
BOARD MEETINGS AND COMMITTEES
The Company's Board of Directors held four regular meetings (and took two
actions by unanimous written consent) during fiscal year 2000. Each incumbent
director attended at least 75% of the meetings held during the part of fiscal
year 2000 during which he was a director, in the aggregate, by the Board and
each committee of the Board of which he was a member. The Company's Board of
Directors has a Compensation Committee and Audit Committee. The Company does
not have a Nominating Committee.
The Compensation Committee (consisting of Messrs. Schleicher, Denend and
Montague) reviews and recommends to the Board action with respect to
compensation of and benefits granted to officers and other key employees of the
Company and administers the Company's several stock option plans and stock
purchase plan. The Compensation Committee held six meetings during fiscal year
2000.
The Audit Committee (consisting of Messrs. Montague, Denend and Schleicher)
nominates the Company's independent auditors, reviews with the Company's
independent auditors matters relating to the scope and plan of the audit, the
adequacy of internal controls, and the preparation of the Company's financial
statements, reports and makes recommendations to the Board with respect
thereto, and reviews related party transactions for conflicts of interest. The
Audit Committee held three meetings during fiscal year 2000.
BOARD MEMBER COMPENSATION
The Company pays directors' fees only to directors who are not employees of
the Company. During fiscal 2000, non-employee directors were compensated at a
rate of $1,250.00 per regular Board meeting attended, with no additional fee
being payable for attendance at committee meetings. Directors are also
reimbursed reasonable out-of-pocket expenses in connection with attending
meetings. Directors who are not employees of the Company participate in the
Directors' Stock Option Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee during the 2000 fiscal year consisted of Messrs.
Schleicher, Denend and Montague, none of whom is or has been an officer or
employee of the Company. No interlocking relationship exists between the
Company's Board of Directors or Compensation Committee and the board of
directors or compensation committee of any other company.
6
<PAGE>
PROPOSAL 2
AMENDMENT TO THE COMPANY'S AMENDED AND RESTATED CERTIFICATE OF INCORPORATION TO
INCREASE NUMBER OF AUTHORIZED SHARES OF COMMON STOCK
GENERAL
In June, 2000, the Board of Directors declared advisable and unanimously
approved an Amendment to the Company's Amended and Restated Certificate of
Incorporation to increase the aggregate number of shares of Common Stock which
the Company is authorized to issue to 500,000,000 shares.
If approved by the Stockholders, the Amendment will become effective upon
the filing of a Certificate of Amendment of Amended and Restated Certificate of
Incorporation with the Delaware Secretary of State. The Amendment would change
paragraph A of Article 4 of the Company's Amended & Restated Certificate of
Incorporation to read in its entirety as follows:
"The total number of shares of Common Stock which the corporation shall
have authority to issue shall be five hundred million (500,000,000) and
each of such shares shall have a par value of one cent ($0.01)."
PURPOSE AND EFFECT OF AMENDMENT
As of the Record Date, of the Company's shares of authorized Common
Stock, shares were issued and outstanding, shares were reserved for
future issuance under the Company's stock incentive plans and employee stock
plans, of which, currently, approximately are covered by outstanding
options and are available for grant or purchase and shares reserved for
future issuance upon conversion of the Company's 5% subordinated convertible
debt. Based upon the foregoing number of outstanding and reserved shares of
Common Stock, the Company currently has approximately shares remaining
available for other purposes.
The Board of Directors believes that it is in the Company's best interests
to increase the number of authorized but unissued shares of Common Stock in
order to have additional shares available to meet the Company's future business
needs as they arise. Among other things, the increase will provide shares to
finance acquisitions of other businesses consistent with the Company's growth
strategy. The Company's management has no other present arrangements,
agreements, understandings or plans for the use of the additional shares
proposed to be authorized. The Board believes that the availability of such
additional shares will provide the Company with the flexibility to issue Common
Stock for a variety of other purposes the Board of Directors may deem advisable
without further action by the Company's Stockholders, unless required by law,
regulation or stock exchange rule. These purposes could include, among other
things, the sale of stock to obtain additional capital funds, the purpose of
property, the acquisition of other companies, the use of additional shares for
various equity compensation and other employee benefit plans, the declaration
of future stock splits or distributions, and other bona fide purposes.
There will be no change in the voting rights, dividend rights, liquidation
rights, preemptive rights or any other Stockholder rights as a result of the
proposed Amendment. The additional shares might be issued at such times and
under such circumstances as to have a dilutive effect on earnings per share and
on the equity ownership of the present holders of Common Stock.
POTENTIAL ANTI-TAKEOVER EFFECT
The proposed Amendment could, under certain circumstances, have an anti-
takeover effect, although this is not the intention of the Proposal. The
increased number of authorized shares of Common Stock could discourage, or be
used to impede, an attempt to acquire or otherwise change control of the
Company. The
7
<PAGE>
private placement of shares of Common Stock into "friendly" hands, for example,
could dilute the voting strength of a party seeking control of the Company.
VOTE REQUIRED
Because approval of this proposal requires the affirmative vote of the
majority of shares of Common Stock outstanding on the Record Date, abstentions
and broker votes will have the same effect as a vote against the proposal.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 2.
8
<PAGE>
PROPOSAL 3
AMENDMENT TO THE 1997 STOCK OPTION PLAN RESERVING AN ADDITIONAL 6,000,000
SHARES OF THE COMPANY'S AUTHORIZED BUT UNISSUED COMMON STOCK
The stockholders are being asked to approve an amendment to the 1997 Stock
Option Plan (the "1997 Plan") reserving an additional 6,000,000 shares of the
Company's authorized but unissued Common Stock for issuance thereunder. The
Board of Directors believes that this amendment to the 1997 Plan is important
to the continued functioning of the 1997 Plan, which has proved an effective
means of motivating and encouraging the continued employment of the employees
of Rational and its subsidiaries. In the past several years the labor markets
in which the Company operates have become more intensely competitive, and
recruiting and retaining the highly skilled employees the Company needs has
become increasingly difficult. As a result, the Board believes that the
proposed increase is necessary to allow grants of new options to existing
employees whose present options are becoming fully vested, and to recruit new
employees or increase existing employees' equity stakes in the Company. For a
description of the 1997 Plan, see "Description of the 1997 Plan," elsewhere in
this Proxy Statement
As of the Record Date, and without giving effect to this Proposal 3,
XX,XXX,000 shares have been reserved for issuance under the 1997 Plan, of which
have been issued pursuant to option exercises, are subject to
outstanding options and are available for grant. As of the Record Date, of
the shares issued pursuant to option exercises, are subject to a lapsing
right of repurchase in favor of the Company as of the Record Date. Proposal 3
was adopted by the Board of Directors on July , 2000, subject to stockholder
approval. As of the Record Date, there were approximately employees of
Rational and its subsidiaries who are eligible to participate in the 1997 Plan.
As of the Record Date, under the Company's other option plans shares are
subject to outstanding but unexercised options, and there are no shares that
are outstanding but subject to a lapsing right of repurchase in favor of the
Company pursuant to exercised unvested options. Pursuant to the terms of the
1997 Plan, as of the Record Date an aggregate of shares either subject to
outstanding options or issued but subject to a lapsing right of repurchase
under the 1994 Stock Option Plan could be rolled over to the 1997 Plan if the
outstanding options under the 1994 Stock Option Plan expire, terminate
unexercised, or are otherwise returned to the Company or if the outstanding
shares are repurchased by the Company.
VOTE REQUIRED
While all Directors are eligible for option grants under the terms of the
1997 Plan, the Company has adopted the policy of granting non-employee
Directors options only out of the Directors' Stock Option Plan. However,
Directors who are employees of the Company may benefit from adoption of this
amendment, and to that extent may have a conflict of interest in recommending
the amendment. Because approval of this proposal requires the affirmative vote
of the majority of shares of Common Stock present in person or represented by
proxy at the Annual Meeting and entitled to vote on the proposal, abstentions
will have the same effect as a vote against the proposal, and broker non-votes
will have no effect on the outcome of the proposal.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 3.
9
<PAGE>
PROPOSAL 4
APPROVAL OF 2000 DIRECTORS OPTION PLAN AND RESERVATION OF 500,000 SHARES OF THE
COMPANY'S AUTHORIZED BUT UNISSUED COMMON STOCK FOR ISSUANCE THEREUNDER
On June 22, 2000, the Board of Directors of the Company (the "Board")
adopted the 2000 Director Option Plan (the "2000 Director Plan"), subject to
the approval of the Company's shareholders.
1. The Board believes that the 2000 Director Plan will be important to the
Company's efforts to encourage director equity participation and increase
retention. Although non-employee directors have an interest in acquiring
approval for the 2000 Director Plan since they will be the beneficiaries of the
approval, the Board believes that the offer of equity incentives to all
directors has been a key factor in the Company's overall financial performance.
2. The following is a summary description of the 2000 Director Plan under
which no options have yet been granted.
SUMMARY OF THE 2000 DIRECTOR PLAN
Purpose. The purposes of the 2000 Director Plan are to attract and retain
the best available personnel for service as a Director who is not an Employee
(an "Outside Director") of the Company, to provide additional incentive to
Outside Directors of the Company to serve as directors, and to encourage their
continued service on the Board.
Shares Subject to the 2000 Director Plan. The Board has reserved a maximum
of 500,000 shares of Common Stock for issuance under the 2000 Director Plan.
The Shares may be authorized, but unissued, or reacquired Common Stock.
Administration. The 2000 Director Plan provides for grants of options to be
made in two ways:
(a) Each Outside Director is automatically granted an option to purchase
70,000 shares (the "First Option") upon the date such individual first
becomes a director, whether through election by the stockholders of the
Company or by appointment by the Board in order to fill a vacancy; and
(b) Each Outside Director is automatically granted an option to purchase
20,000 shares (the "Subsequent Option") on the date of the Company's annual
stockholder's meeting, provided that on such date he or she shall have
served on the Board for at least the preceding six (6) months.
The Board has the authority, in its discretion, to: (i) determine the fair
market value of the Common Stock; (ii) interpret the Director Plan; (iii)
prescribe, amend and rescind rules and regulations relating to the Director
Plan; (iv) authorize any person to execute, on behalf of the Company, any
instrument required to effectuate the grant of an option previously granted
under the 2000 Director Plan; and (v) make all other determinations deemed
necessary or advisable for the administration of the Director Plan. All
decisions, determinations and interpretations of the Board shall be final.
Eligibility; Limitations. Only Outside directors of the Board are eligible
to receive nonstatutory stock options under the 2000 Director Plan.
Terms and Conditions of Options. Each option is evidenced by a director
option agreement between the Company and the optionee, and is subject to the
following additional terms and conditions:
(a) Exercise Price. The exercise price of options granted under the
Director Plan is 100% of the fair market value per share of the Common
Stock on the date of grant, generally determined with reference to the
closing sale price for the Common Stock (or the closing bid if no sales
were reported) on the date of grant.
10
<PAGE>
(b) Exercise of Option. Twenty-five percent (25%) of the shares subject
to the First Option shall vest on the first anniversary of its date of
grant, and 1/48 of the Shares subject to the First Option shall vest each
month thereafter, provided that the optionee continues to serve as a
Director on such dates. 1/48 of the shares subject to the Subsequent Option
shall vest each month from the date of grant (commencing on the date which
is one month from the date of grant) provided that the optionee continues
to serve as a Director on such dates. An option shall be exercisable in
whole or in part by giving written notice to the Company, stating the
number of shares with respect to which the option is being exercised,
accompanied by payment in full for such shares.
(c) Forms of Consideration. The means of payment for shares issued upon
exercise of an option is specified in each option agreement. The 2000
Director Plan permits payment to be made by cash, check, zother shares of
Common Stock of the Company (with some restrictions), cashless exercises,
or any combination thereof.
(d) Term of Option. The term of any option shall be ten (10) years from
the date of grant. No option may be exercised after the expiration of its
term.
(e) Termination of Directorship. If an optionee's status as a director
terminates (other than upon the optionee's death or disability), then all
options held by the optionee under the 2000 Director Plan expire three
months following the termination. If the optionee's status as a director
terminates due to death or disability, then all options held by the
optionee under the 2000 Director Plan expire twelve months following the
termination. In no case may an option be exercised after the expiration
date of the option.
(f) Nontransferability of Options: Options granted under the 2000
Director Plan are not transferable other than by will or the laws of
descent and distribution, and may be exercised during the optionee's
lifetime only by the optionee.
(g) Other Provisions: The director option agreement may contain other
terms, provisions and conditions not inconsistent with the 2000 Director
Plan as may be determined by the Board.
Adjustments Upon Changes in Capitalization. In the event that the stock of
the Company changes by reason of any stock split, reverse stock split, stock
dividend, combination, reclassification or other similar change in the capital
structure of the Company effected without the receipt of consideration,
appropriate adjustments shall be made in the number and class of shares of
stock subject to the 2000 Director Plan, the number and class of shares of
stock subject to any option outstanding under the Director Plan, and the
exercise price of any such outstanding option.
In the event of a proposed liquidation or dissolution, any unexercised
options will terminate prior to such action.
In the event of a merger of the Company or the sale of substantially all of
the assets of the Company, each option may be assumed or an equivalent option
substituted for by the successor corporation. If an option is assumed or
substituted for by the successor corporation, it shall continue to vest as
provided in the 2000 Director Plan. If subsequent to such assumption or
substitution, the optionee's status as a Director or director of the successor
corporation is terminated other than upon a voluntary resignation by the
optionee, the Option or option shall become fully exercisable.
If the successor corporation does not agree to assume or substitute for the
option, each option shall become fully vested and exercisable for a period of
thirty (30) days from the date the Board notifies the optionee of the option's
full exercisability, after which period the option will terminate.
Amendment and Termination of the 2000 Director Plan. The Board may amend,
alter, suspend or terminate the 2000 Director Plan, or any part thereof, at any
time and for any reason. However, the Company shall obtain stockholder approval
for any amendment to the 2000 Director Plan to the extent necessary to comply
with applicable laws or regulations. No such action by the Board or
shareholders may alter or impair any option previously granted under the 2000
Director Plan without the consent of the optionee. Unless terminated earlier,
the 2000 Director Plan shall terminate ten years from the date of its approval
by the shareholders or the Board, whichever is earlier.
11
<PAGE>
Federal Income Tax Consequences. The following discussion summarizes certain
U.S. federal income tax considerations for directors receiving options under
the 2000 Director Plan and certain tax effects on the Company, based upon the
provisions of the Code as in effect on the date of this Proxy Statement,
current regulations and existing administrative rulings of the Internal Revenue
Service. However, the summary is not intended to be a complete discussion of
all the federal income tax consequences of these plans:
(a) Nonstatutory Stock Options. Options granted under the 2000 Director
Plan do not qualify as incentive stock options under Section 422 of the
Code. An optionee does not recognize any taxable income at the time he or
she is granted a nonstatutory stock option. Upon exercise, the optionee
recognizes taxable income generally measured by the excess of the then fair
market value of the shares over the exercise price. The Company is entitled
to a deduction in the same amount as the ordinary income recognized by the
optionee. Upon a disposition of such shares by the optionee, any difference
between the sale price and the optionee's exercise price, to the extent not
recognized as taxable income as provided above, is treated as long-term or
short-term capital gain or loss, depending on the holding period. Net
capital gains on shares held more than 12 months may be taxed at a maximum
federal rate of 20%. Capital losses are allowed in full against capital
gains and up to $3,000 against other income.
3. VOTE REQUIRED
The affirmative vote of a majority of the shares of Common Stock of the
Company represented in person or by proxy at the Meeting and entitled to vote
will be required to approve the adoption of the 2000 Director Plan. The Board
unanimously recommends a vote FOR the approval of the adoption of the 2000
Director Plan.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 4.
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<PAGE>
PROPOSAL 5
RATIFICATION OF INDEPENDENT AUDITORS
Action is to be taken at the Annual Meeting with respect to the ratification
of independent auditors, who were nominated by the Audit Committee, to examine
the financial statements of the Company for fiscal year 2001. Unless otherwise
directed therein, proxies received pursuant to this solicitation will be voted
for the ratification of Ernst & Young LLP, who served as the Company's auditors
for fiscal year 2001. Although the ratification of independent auditors is not
required to be submitted to a vote of the stockholders, the Board of Directors
believes that such ratification is a matter on which the stockholders should
express their opinion. If the stockholders do not ratify Ernst & Young LLP, the
selection of independent auditors will be reconsidered by the Audit Committee
of the Board of Directors. Ernst & Young LLP has advised the Company that no
member of its firm has any direct or indirect material financial interest in
the Company. Representatives of Ernst & Young LLP are expected to be present at
the Annual Meeting, will have the opportunity to make a statement if they so
desire, and will be available to respond to appropriate questions from the
stockholders. Because approval of this proposal requires the affirmative vote
of the majority of shares of Common Stock present in person or represented by
proxy at the Annual Meeting and entitled to vote on the proposal, abstentions
will have the same effect as a vote against the proposal, and broker non-votes
will have no effect on the outcome of the proposal.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 5.
13
<PAGE>
OTHER MATTERS
No business other than that set forth above is expected to come before the
Annual Meeting or any adjournment thereof. Should other business properly come
before the meeting or any adjournment thereof, the proxy holders will vote upon
the same according to their discretion and best judgment.
COMPLIANCE WITH THE BENEFICIAL OWNERSHIP REPORTING REQUIREMENTS OF SECTION
16(A) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's directors and executive officers and the holders of 10% or more
of the Company's Common Stock to file with the SEC initial reports of ownership
and reports of changes in ownership of equity securities of the Company. Robert
H. Dickerson filed on September 10, 1999 a Form 5 in connection with an option
grant. Daniel Case filed on September 9, 1999 a Form 4 in connection with sale
of common shares. Based solely upon a review of copies of reports of beneficial
ownership provided to the Company by officers and directors and 10%
stockholders of the Company, the Company believes that all other reports
required pursuant to Section 16(a) with respect to the 2000 fiscal year were
timely filed.
14
<PAGE>
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The Securities and Exchange Commission requires the following table setting
forth for the fiscal years ending March 31, 2000, 1999 and 1998, the cash
compensation paid by the Company to the Chief Executive Officer and each of the
four other most highly compensated executive officers during the last fiscal
year.
<TABLE>
<CAPTION>
Annual Long-Term
Compensation Compensation
Name and Principal ------------------ Stock Option All Other
Position Year Salary($) Bonus($) Awarded(#) Compensation($)
------------------ ---- --------- -------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Paul D. Levy(1).......... 2000 474,167 340,700 900,000 348(2)
Chairman of the Board 1999 385,000 196,700 1,000,000 348(2)
1998 354,170 250,000 500,000 348(2)
Michael T. Devlin(1)..... 2000 474,167 340,700 900,000 348(2)
Chief Executive Officer 1999 385,000 196,700 1,000,000 348(2)
1998 354,170 250,000 500,000 348(2)
David H. Bernstein....... 2000 384,583 140,000 250,000 348(2)
Senior Vice President 1999 335,000 95,700 290,000 348(2)
and General Manager, 1998 270,000 125,000 100,000 1,938,405(2)(3)
Products
John R. Lovitt........... 2000 322,917 226,012 150,000 348(2)
Senior Vice President, 1999 300,000 215,523 240,000 348(2)
Services 1998 259,176 150,000 100,000 348(2)
Kevin J. Haar............ 2000 275,000 191,721 250,000 348(2)
Senior Vice President, 1999 255,700 126,176 160,000 348(2)
Worldwide Field 1998 211,874 145,000 340,000 348(2)
Operations
</TABLE>
--------
(1) Throughout fiscal year 2000, Mr. Levy was Chairman and Mr. Devlin was Chief
Executive Officer.
(2) Includes $348 in premiums paid pursuant to a long-term disability plan
through which the Company provides long-term disability income insurance
for all its employees. In the event of an insured officer's disability, the
officer may be eligible after three consecutive months of disability for a
monthly benefit of 60% of his tax-free monthly earnings up to a $6,000 per
month maximum.
(3) Includes $1,938,057 paid to Mr. Bernstein in connection with his relocation
to Boston, Massachusetts, consisting of a relocation bonus of $1,000,000, a
payment of $800,000 sufficient to pay Mr. Bernstein's federal and state
income taxes and a payment of $138,057 to cover expenses incurred in
connection with the relocation.
15
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information with respect to each of the named
executive officers of the Company concerning the grant of stock options during
the last fiscal year and the potential realizable value at certain assumed
annual rates of stock price appreciation.
The total number of shares of Common Stock subject to options granted in
fiscal year 2000 was 8,715,332.
<TABLE>
<CAPTION>
Individual Grants
---------------------
Percent of Potential Realizable
Number of Total Value at Assumed Annual
Shares of Options Rates of Stock Price
Common Granted to Appreciation For Option
Stock Employees Term(1)
Underlying In Fiscal Exercise Price Expiration -----------------------
Name Options(#) Year ($/Share) Date 5%($) 10%($)
---- ---------- ---------- -------------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Paul D. Levy............ 4,177 0.05 $23.9375 4/12/09 $ 62,881 $ 159,353
95,823 1.13 $23.9375 4/12/09 $ 1,442,535 $ 3,655,668
1,911 0.02 $52.3125 2/1/10 $ 62,870 $ 159,325
798,089 9.38 $52.3125 2/1/10 $26,256,370 $66,538,797
Michael T. Devlin....... 4,177 0.05 $23.9375 4/12/09 $ 62,881 $ 159,353
95,823 1.13 $23.9375 4/12/09 $ 1,442,535 $ 3,655,668
1,911 0.02 $52.3125 2/1/10 $ 62,870 $ 159,325
798,089 9.38 $52.3125 2/1/10 $26,256,370 $66,538,797
David H. Bernstein...... 3,851 0.05 $23.9375 4/12/09 $ 57,974 $ 146,916
46,149 0.54 $23.9375 4/12/09 $ 694,735 $ 1,760,594
100,000 1.18 $47.7500 12/17/09 $ 3,002,972 $ 7,610,120
1,911 0.02 $52.3125 2/1/10 $ 62,870 $ 159,325
98,089 1.15 $52.3125 2/1/10 $ 3,227,035 $ 8,177,940
John R. Lovitt.......... 2,719 0.03 $23.9375 4/12/09 $ 40,932 $ 103,730
47,281 0.56 $23.9375 4/12/09 $ 711,776 $ 1,803,780
100,000 1.18 $47.7500 12/17/09 $ 3,002,972 $ 7,610,120
Kevin J. Haar........... 100,000 1.18 $47.7500 12/17/09 $ 3,002,972 $ 7,610,120
998 0.01 $51.5625 1/12/10 $ 32,363 $ 82,013
149,002 1.75 $51.5625 1/12/10 $ 4,831,744 $12,244,589
</TABLE>
--------
(1) The Potential Realizable Value is calculated based on the fair market value
of the Common Stock on the date of grant, which is equal to the exercise
price of fiscal year 2000 granted options, assuming that the Common Stock
appreciates in value from the date of grant until the end of the option
term at the annual rate specified (5% and 10%). Potential Realizable Value
is net of the option exercise price. The assumed rates of appreciation are
specified in rules of the Securities and Exchange Commission, and do not
represent the Company's estimate or projection of future Common Stock
price. Actual gains, if any, resulting from stock option exercises and
Common Stock holdings are dependent on the future performance of the Common
Stock and overall stock market conditions, as well as the option holder's
continued employment through the exercise/vesting period. There can be no
assurance that the amounts reflected in this table will be achieved.
16
<PAGE>
OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END VALUES
The following table sets forth information with respect to each of the named
executive officers of the Company concerning the exercise of stock options
during the last fiscal year and the fiscal year 2000 year-end value of all
unexercised options held by such individuals.
<TABLE>
<CAPTION>
Number of Securities Dollar Value of
Underlying Unexercised Unexercised, In-the-money
Number of Options Held at March 31, Options Held at March 31,
Shares Dollar 2000(1) 2000(1)(2)
Acquired on Value ------------------------- -------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Paul D. Levy............ 595,310 $12,424,596 1,854,690 0 $86,311,576 $0.00
Michael T. Devlin....... 443,858 $ 9,999,668 1,897,066 0 $88,881,098 $0.00
David H. Bernstein...... 102,656 $ 2,757,147 486,144 0 $23,068,717 $0.00
John R. Lovitt.......... 88,764 $ 1,772,218 407,568 0 $22,571,483 $0.00
Kevin J. Haar........... 122,922 $ 4,136,643 462,800 0 $20,635,537 $0.00
</TABLE>
--------
(1) Includes unvested options, which may be exercised subject to a lapsing
right of repurchase in favor of the Company.
(2) Value based on market value of the Company's Common Stock at March 31, 1999
(the last business day of the fiscal year), minus the exercise price. The
market value at March 31, 2000, was $76.50 per share.
DESCRIPTION OF THE 1997 PLAN
General. The purpose of the 1997 Plan is to attract and retain the best
available personnel for positions of substantial responsibility with Rational,
to provide additional incentive to the employees and consultants of Rational
and to promote the success of Rational's business. Options and stock purchase
rights may be granted under the 1997 Plan. Options granted under the 1997 Plan
may be either "incentive stock options," as defined in Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"), or nonstatutory stock
options. As of the Record Date, the number of shares of Common Stock reserved
for issuance under the 1997 Plan is xx,xxx,000. In addition, approval of
Proposal 2 would increase the number of shares of Common Stock reserved for
issuance under the 1997 Plan by 6,000,000 shares.
Administration. The 1997 Plan may be administered by the Board of Directors
or a committee of the Board (the "Administrator"), which Administrator shall,
in the case of options intended to qualify as "performance-based compensation"
within the meaning of Section 162(m) of the Code, consist of two or more
"outside directors" within the meaning of Section 162(m) of the Code. The
Administrator has the power to determine the terms of the options or stock
purchase rights granted, including the exercise price, the number of shares
subject to each option or stock purchase right, the exercisability thereof, and
the form of consideration payable upon such exercise. In addition, the
Administrator has the authority to amend, suspend or terminate the 1997 Plan,
provided that no such action may affect any shares of Common Stock previously
issued and sold or any option previously granted under the 1997 Plan.
Eligibility; Limitations. Nonstatutory stock options and stock purchase
rights may be granted under the 1997 Plan to directors, employees and
consultants of Rational and any parent or subsidiary of Rational, although
Rational has adopted the policy of granting non-employee directors options only
out of the Company's Directors stock option plan. Incentive stock options may
be granted only to employees. The Administrator, in its discretion, selects the
employees and consultants to whom options and stock purchase rights may be
granted, the time or times at which such options and stock purchase rights
shall be granted, and the number of shares subject to each such grant.
Section 162(m) of the Code places limits on the deductibility for federal
income tax purposes of compensation paid to certain executive officers of
Rational. In order to preserve Rational's ability to deduct the compensation
income associated with options and stock purchase rights granted to such
persons, the 1997 Plan currently provides that no employee may be granted, in
any fiscal year of Rational, options and stock purchase
17
<PAGE>
rights to purchase more than 1,000,000 shares of Common Stock (as appropriately
adjusted for changes in the capitalization of Rational), except in the case of
a new employee joining Rational, in which case such employee may be granted
options for an additional 500,000 shares in connection with the start of
employment.
Terms and Conditions of Options. Each option is evidenced by a stock option
agreement between Rational and the optionee, and is subject to the following
additional terms and conditions:
(a) Exercise Price. The Administrator determines the exercise price of
options at the time the options are granted. The exercise price of an
incentive stock option may not be less than 100% of the fair market value
of the Common Stock on the date such option is granted; provided, however,
the exercise price of an incentive stock option granted to a 10%
stockholder may not be less than 110% of the fair market value of the
Common Stock on the date such option is granted. The exercise price of a
non-statutory stock option may not be less that 100% of the fair market
value of the Common Stock on the date such option is granted if the option
is intended to qualify as "performance-based compensation" under Section
162(m) of the Code. Otherwise, there is no restriction on the exercise
price of non-statutory stock options. The fair market value of the Common
Stock is generally determined with reference to the closing sale price for
the Common Stock (or the closing bid if no sales were reported) on the last
market trading day prior to the date the option is granted.
(b) Exercise of Option; Form of Consideration. The Administrator
determines when options become vested and may, in its discretion,
accelerate the vesting of any outstanding option. Stock options granted
under the 1997 Plan generally vest over four (4) years. Such options are
exercisable prior to the time when they have vested, subject to a lapsing
right of repurchase in favor of the Company. The means of payment for
shares issued upon exercise of an option is specified in each option
agreement. The 1997 Plan permits payment to be made by cash, check,
promissory note, other shares of Common Stock of Rational (with some
restrictions), cashless exercises, a reduction in the amount of any Company
liability to the optionee, any other form of consideration permitted by
applicable law, or any combination thereof.
(c) Term of Option. The term of an incentive stock option may be no more
than ten (10) years from the date of grant; provided that in the case of an
incentive stock option granted to a 10% stockholder, the term of the option
may be no more than five (5) years from the date of grant. No option may be
exercised after the expiration of its term.
(d) Termination of Employment. If an optionee's employment or consulting
relationship terminates for any reason (other than death or disability),
then all options held by the optionee under the 1997 Plan expire on the
earlier of (i) the date set forth in his or her notice of grant or, in the
absence thereof, three (3) months after the date of termination or (ii) the
expiration date of such option. To the extent the option is exercisable at
the time of such termination, the optionee may exercise all or part of his
or her option at any time before termination.
(e) Death or Disability. If an optionee's employment or consulting
relationship terminates as a result of death or disability, then all
options held by such optionee under the 1997 Plan expire on the earlier of
(i) the date set forth in his or her notice of grant or, in the absence
thereof, twelve (12) months from the date of such termination or (ii) the
expiration date of such option. The optionee (or the optionee's estate or
the person who acquires the right to exercise the option by bequest or
inheritance), may exercise all or part of the option at any time before
such expiration to the extent that the option was exercisable at the time
of such termination.
(f) Nontransferability of Options. Options granted under the 1997 Plan
are not transferable other than by will or the laws of descent and
distribution, and may be exercised during the optionee's lifetime only by
the optionee.
(g) Other Provisions. The stock option agreement may contain other
terms, provisions and conditions not inconsistent with the 1997 Plan as may
be determined by the Administrator.
18
<PAGE>
Stock Purchase Rights. A stock purchase right gives the purchaser a period
as determined by the Administrator from the date of grant to purchase Common
Stock. A stock purchase right is accepted by the execution of a restricted
stock purchase agreement between Rational and the purchaser, accompanied by the
payment of the purchase price for the shares. Unless the Administrator
determines otherwise, the restricted stock purchase agreement shall give
Rational a repurchase option exercisable upon the voluntary or involuntary
termination of the purchaser's employment or consulting relationship with
Rational for any reason (including death and disability). The purchase price
for any shares repurchased by Rational shall be the original price paid by the
purchaser. The repurchase option lapses at a rate determined by the
Administrator. A stock purchase right is nontransferable other than by will or
the laws of descent and distribution, and may be exercised during the
optionee's lifetime only by the grantee thereof.
Changes in Capitalization. In the event that the stock of Rational changes
by reason of any stock split, reverse stock split, stock dividend, combination,
reclassification or other similar change in the capital structure of Rational
effected without the receipt of consideration, appropriate adjustments shall be
made in the number and class of shares of stock subject to the 1997 Plan, the
number and class of shares of stock subject to any option or stock purchase
right outstanding under the 1997 Plan, and the exercise price of any such
outstanding option or stock purchase right.
In the event of a liquidation or dissolution, any unexercised options or
stock purchase rights will terminate. The Administrator may, in its discretion
provide that each optionee shall have the right to exercise all of the
optionee's options and stock purchase rights, including those not otherwise
exercisable, until the date ten (10) days prior to the consummation of the
liquidation or dissolution, or that any rights of repurchase in Rational with
respect to stock purchase rights shall lapse provided the proposed dissolution
or liquidation takes place at the time and in the manner anticipated.
In connection with any merger, consolidation, acquisition of assets or like
occurrence involving Rational, each outstanding option or stock purchase right
shall be assumed or an equivalent option or right substituted by the successor
corporation. If the successor corporation refuses to assume the options and
stock purchase rights or to substitute substantially equivalent options and
stock purchase rights, the optionee shall have the vested right to exercise the
option or stock purchase right as to all the optioned stock, including shares
not otherwise vested. In such event, the Administrator shall notify the
optionee that the option or stock purchase right is fully exercisable for
fifteen (15) days from the date of such notice and that the option or stock
purchase right terminates upon expiration of such period.
Amendment and Termination of the 1997 Plan. The Board may amend, alter,
suspend or terminate the 1997 Plan, or any part thereof, at any time and for
any reason. However, Rational shall obtain stockholder approval for any
amendment to the 1997 Plan to the extent necessary to comply with Rule 16b-3,
Section 162(m) and Section 422 of the Code, or any similar rule or statute. No
such action by the Board or stockholders may alter or impair any option or
stock purchase right previously granted under the 1997 Plan without the written
consent of the optionee. Unless terminated earlier, the 1997 Plan shall
terminate ten years from the date of its initial approval by the stockholders
or the Board of Rational, whichever is earlier.
FEDERAL INCOME TAX CONSEQUENCES
Incentive Stock Options. An optionee who is granted an incentive stock
option does not recognize taxable income at the time the incentive stock option
is granted or upon its exercise, although the exercise may subject the optionee
to the alternative minimum tax. Upon a disposition of the shares more than two
years after grant of the incentive stock option and one year after exercise of
the incentive stock option, any gain or loss is treated as long- term capital
gain or loss. If these holding periods are not satisfied, the optionee
recognizes ordinary income at the time of disposition equal to the difference
between the exercise price and the lower of (i) the fair market value of the
shares at the date of the option exercise or (ii) the sale price of the shares.
Any
19
<PAGE>
gain or loss recognized on such a premature disposition of the shares in excess
of the amount treated as ordinary income is treated as long-term or short-term
capital gain or loss, depending on the holding period. A different rule for
measuring ordinary income upon such a premature disposition may apply if the
optionee is also an officer, director, or 10% stockholder of Rational. Rational
is entitled to a deduction in the same amount as the ordinary income recognized
by the optionee.
Nonstatutory Stock Options. An optionee does not recognize any taxable
income at the time he or she is granted a nonstatutory stock option. Upon
exercise, the optionee recognizes taxable income generally measured by the
excess of the then fair market value of the shares over the exercise price. Any
taxable income recognized in connection with an option exercise by an employee
or former employee of Rational is subject to tax withholding by Rational.
Rational is entitled to a deduction in the same amount as the ordinary income
recognized by the optionee. Upon a disposition of such shares by the optionee,
any difference between the sale price and the optionee's exercise price, to the
extent not recognized as taxable income as provided above, is treated as long-
term or short-term capital gain or loss, depending on the holding period.
Stock Purchase Rights. Stock purchase rights will generally be taxed in the
same manner as nonstatutory stock options. However, restricted stock is
generally purchased upon the exercise of a stock purchase right. At the time of
purchase, restricted stock is subject to a "substantial risk of forfeiture"
within the meaning of Section 83 of the Code. As a result, the purchaser will
not recognize ordinary income at the time of purchase. Instead, the purchaser
will recognize ordinary income on the dates when the stock ceases to be subject
to a substantial risk of forfeiture. The stock will generally cease to be
subject to a substantial risk of forfeiture when it is no longer subject to
Rational's right to repurchase the stock upon the purchaser's termination of
employment with Rational. At such times, the purchaser will recognize ordinary
income measured as the difference between the purchase price and the fair
market value of the stock on the date the stock is no longer subject to a
substantial risk of forfeiture.
The purchaser may accelerate his or her recognition of ordinary income, if
any, to the date of purchase and begin the capital gain holding period by
timely filing an election pursuant to Section 83(b) of the Code. In such event,
the ordinary income recognized, if any, is measured as the difference between
the purchase price and the fair market value of the stock on the date of
purchase, and the capital gain holding period commences on such date. The
ordinary income recognized by a purchaser who is an employee or former employee
will be subject to tax withholding by Rational. Different rules may apply if
the purchaser is also an officer, director, or 10% stockholder of Rational.
THE FOREGOING IS ONLY A SUMMARY OF THE EFFECT OF FEDERAL INCOME TAXATION
UPON OPTIONEES, HOLDERS OF STOCK PURCHASE RIGHTS, AND RATIONAL WITH RESPECT TO
THE GRANT AND EXERCISE OF OPTIONS AND STOCK PURCHASE RIGHTS UNDER THE 1997
PLAN. IT DOES NOT PURPORT TO BE COMPLETE, AND DOES NOT DISCUSS THE TAX
CONSEQUENCES OF THE OPTIONEE'S DEATH OR THE PROVISIONS OF THE INCOME TAX LAWS
OF ANY MUNICIPALITY, STATE OR FOREIGN COUNTRY IN WHICH THE OPTIONEE MAY RESIDE.
SUMMARY OF THE 2000 DIRECTOR PLAN
Purpose. The purposes of the 2000 Director Plan are to attract and retain
the best available personnel for service as a Director who is not an Employee
(an "Outside Director") of the Company, to provide additional incentive to
Outside Directors of the Company to serve as directors, and to encourage their
continued service on the Board.
Shares Subject to the 2000 Director Plan. The Board has reserved a maximum
of 500,000 shares of Common Stock for issuance under the 2000 Director Plan.
The Shares may be authorized, but unissued, or reacquired Common Stock.
20
<PAGE>
Administration. The 2000 Director Plan provides for grants of options to be
made in two ways:
(a) Each Outside Director is automatically granted an option to purchase
70,000 shares (the "First Option") upon the date such individual first
becomes a director, whether through election by the stockholders of the
Company or by appointment by the Board in order to fill a vacancy; and
(b) Each Outside Director is automatically granted an option to purchase
20,000 shares (the "Subsequent Option") on the date of the Company's annual
stockholder's meeting, provided that on such date he or she shall have
served on the Board for at least the preceding six (6) months.
The Board has the authority, in its discretion, to: (i) determine the fair
market value of the Common Stock; (ii) interpret the Director Plan; (iii)
prescribe, amend and rescind rules and regulations relating to the Director
Plan; (iv) authorize any person to execute, on behalf of the Company, any
instrument required to effectuate the grant of an option previously granted
under the 2000 Director Plan; and (v) make all other determinations deemed
necessary or advisable for the administration of the Director Plan. All
decisions, determinations and interpretations of the Board shall be final.
Eligibility; Limitations. Only Outside directors of the Board are eligible
to receive nonstatutory stock options under the 2000 Director Plan.
Terms and Conditions of Options. Each option is evidenced by a director
option agreement between the Company and the optionee, and is subject to the
following additional terms and conditions:
(a) Exercise Price. The exercise price of options granted under the
Director Plan is 100% of the fair market value per share of the Common
Stock on the date of grant, generally determined with reference to the
closing sale price for the Common Stock (or the closing bid if no sales
were reported) on the date of grant.
(b) Exercise of Option. Twenty-five percent (25%) of the shares subject
to the First Option shall vest on the first anniversary of its date of
grant, and 1/48 of the Shares subject to the First Option shall vest each
month thereafter, provided that the optionee continues to serve as a
Director on such dates. 1/48 of the shares subject to the Subsequent Option
shall vest each month from the date of grant (commencing on the date which
is one month from the date of grant) provided that the optionee continues
to serve as a Director on such dates. An option shall be exercisable in
whole or in part by giving written notice to the Company, stating the
number of shares with respect to which the option is being exercised,
accompanied by payment in full for such shares.
(c) Forms of Consideration. The means of payment for shares issued upon
exercise of an option is specified in each option agreement. The 2000
Director Plan permits payment to be made by cash, check, other shares of
Common Stock of the Company (with some restrictions), cashless exercises,
or any combination thereof.
(d) Term of Option. The term of any option shall be ten (10) years from
the date of grant. No option may be exercised after the expiration of its
term.
(e) Termination of Directorship. If an optionee's status as a director
terminates (other than upon the optionee's death or disability), then all
options held by the optionee under the 2000 Director Plan expire three
months following the termination. If the optionee's status as a director
terminates due to death or disability, then all options held by the
optionee under the 2000 Director Plan expire twelve months following the
termination. In no case may an option be exercised after the expiration
date of the option.
(f) Nontransferability of Options: Options granted under the 2000
Director Plan are not transferable other than by will or the laws of
descent and distribution, and may be exercised during the optionee's
lifetime only by the optionee.
(g) Other Provisions: The director option agreement may contain other
terms, provisions and conditions not inconsistent with the 2000 Director
Plan as may be determined by the Board.
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<PAGE>
Adjustments Upon Changes in Capitalization. In the event that the stock of
the Company changes by reason of any stock split, reverse stock split, stock
dividend, combination, reclassification or other similar change in the capital
structure of the Company effected without the receipt of consideration,
appropriate adjustments shall be made in the number and class of shares of
stock subject to the 2000 Director Plan, the number and class of shares of
stock subject to any option outstanding under the Director Plan, and the
exercise price of any such outstanding option.
In the event of a proposed liquidation or dissolution, any unexercised
options will terminate prior to such action.
In the event of a merger of the Company or the sale of substantially all of
the assets of the Company, each option may be assumed or an equivalent option
substituted for by the successor corporation. If an option is assumed or
substituted for by the successor corporation, it shall continue to vest as
provided in the 2000 Director Plan. If subsequent to such assumption or
substitution, the optionee's status as a Director or director of the successor
corporation is terminated other than upon a voluntary resignation by the
optionee, the Option or option shall become fully exercisable.
If the successor corporation does not agree to assume or substitute for the
option, each option shall become fully vested and exercisable for a period of
thirty (30) days from the date the Board notifies the optionee of the option's
full exercisability, after which period the option will terminate.
Amendment and Termination of the 2000 Director Plan. The Board may amend,
alter, suspend or terminate the 2000 Director Plan, or any part thereof, at any
time and for any reason. However, the Company shall obtain stockholder approval
for any amendment to the 2000 Director Plan to the extent necessary to comply
with applicable laws or regulations. No such action by the Board or
shareholders may alter or impair any option previously granted under the 2000
Director Plan without the consent of the optionee. Unless terminated earlier,
the 2000 Director Plan shall terminate ten years from the date of its approval
by the shareholders or the Board, whichever is earlier.
Federal Income Tax Consequences. The following discussion summarizes certain
U.S. federal income tax considerations for directors receiving options under
the 2000 Director Plan and certain tax effects on the Company, based upon the
provisions of the Code as in effect on the date of this Proxy Statement,
current regulations and existing administrative rulings of the Internal Revenue
Service. However, the summary is not intended to be a complete discussion of
all the federal income tax consequences of these plans:
(a) Nonstatutory Stock Options. Options granted under the 2000 Director
Plan do not qualify as incentive stock options under Section 422 of the
Code. An optionee does not recognize any taxable income at the time he or
she is granted a nonstatutory stock option. Upon exercise, the optionee
recognizes taxable income generally measured by the excess of the then fair
market value of the shares over the exercise price. The Company is entitled
to a deduction in the same amount as the ordinary income recognized by the
optionee. Upon a disposition of such shares by the optionee, any difference
between the sale price and the optionee's exercise price, to the extent not
recognized as taxable income as provided above, is treated as long-term or
short-term capital gain or loss, depending on the holding period. Net
capital gains on shares held more than 12 months may be taxed at a maximum
federal rate of 20%. Capital losses are allowed in full against capital
gains and up to $3,000 against other income.
22
<PAGE>
COMPENSATION COMMITTEE REPORT
Pursuant to rules adopted by the SEC designed to enhance disclosure of
public companies' policies toward executive compensation, set forth below is a
report submitted by the Company's Compensation Committee (the "Committee")
addressing the Company's compensation policies with respect to executive
officers.
The Committee reviews and recommends to the Board action with respect to
compensation of and benefits granted to officers and other key employees of the
Company and administers the Company's several stock option plans and stock
purchase plan. During fiscal year 2000, the Committee comprised three non-
employee directors.
GENERAL COMPENSATION POLICIES
The Company structures executive compensation in a manner designed to
provide competitive levels of compensation and to assist the Company in
attracting and retaining qualified executives. The compensation paid to the
Company's executive officers consists primarily of base salary, cash bonuses
under a management incentive bonus plan, and grants of equity incentives
pursuant to the Company's stock option plans.
Base-Salary Compensation
The Committee annually reviews base salaries of executive officers,
including the executive officers named in the Summary Compensation Table.
Industry compensation surveys are used to establish base salaries that are
within the range of those of persons holding comparably responsible positions
at other similar-sized companies, both regionally and nationally. While salary
surveys that directly correspond to the companies included in the "peer group"
used to construct the Performance Graph included in this Proxy Statement are
not available, there is substantial overlap between the companies included in
the salary surveys used by the Company and the companies included in such "peer
group," and the Committee believes that it is appropriate to consider such
surveys in establishing the range of competitive salaries for its executive
officers. The Company's current compensation structure falls generally within
the range of compensation structures adopted by the other companies in the
salary surveys reviewed. In addition, other factors are considered in setting
salaries, such as cost-of-living increases, management performance, as well as
the individual's past performance and potential with the Company. The
consideration of additional factors and the weight given to any particular
factor are within the discretion of the Committee. After considering the
factors described above in connection with salary adjustments, and giving
particular emphasis to competitive factors and individual performance, the
Committee recommended that the base salary of the named executive officers,
including Mr. Devlin, who was Chief Executive Officer throughout fiscal 2000,
be increased in fiscal year 2000 as summarized in the Summary Compensation
Table elsewhere in this Proxy Statement.
Bonus Compensation
The Company's management incentive bonus plan ties payment of benefits to
executive officers, including the executive officers named in the Summary
Compensation Table, to corporate profit goals established by the Board of
Directors and a minimum level of profitability must be achieved before any
amounts are paid pursuant to the plan. Payments under the plan are based upon
the following factors: (a) annual base salary; (b) an employee's targeted
percentage (a percentage of base salary that generally increases for higher
positions within the Company, which places a greater percentage of compensation
at risk for those with greater responsibility); and (c) a corporate performance
factor based on a comparison of corporate results to profitability objectives
established by the Board of Directors, based on the Company's operating plan
established each year for the succeeding year.
23
<PAGE>
Equity-Based Compensation
The option incentive component of the total compensation package is intended
to retain and motivate executives to improve long-term stock performance and to
increase value for all stockholders. The Committee generally grants options
under the Company's plans with an exercise price equal to the market price at
the date of grant and, as a result, the options will have value only if the
Company's stock price increases from the time of the award. Grants are made to
executive officers based on salary, responsibility, and performance of the
individual officer. Consistent with the Committee's philosophy that the award
of stock options should be used to incentivize key executive officers and to
further align their interests with those of the stockholders, during fiscal
year 1999 the Committee examined the stock and option holdings of the Company's
executive officers and determined that the awards set forth in the Option
Grants in Last Fiscal Year Table were appropriate.
CERTAIN TAX CONSIDERATIONS
The Committee has considered the potential future effects of Section 162(m)
of the Code, as amended. Section 162(m) limits the deductibility by public
companies of certain executive compensation in excess of $1 million per
executive per year, but excludes from the calculation of such $1 million limit
certain elements of compensation, including performance-based compensation,
provided that certain requirements are met. With the exception of Mr.
Bernstein, none of the Company's executive officers approached the $1 million
limit in prior fiscal years nor is any expected to approach such limit in
fiscal year 2001 [Note: Review Paul, Mike situations with Katie Martin]..
However, the provisions of Section 162(m) merit current consideration because,
under certain circumstances, the difference between the fair market value and
the exercise price of options granted in the present time period, measured at
the time of exercise, could be included in the calculation under Section 162(m)
of the executive officers' compensation in the time period in which the
exercise occurs. This result can be avoided if the plans under which such
options are granted comply with certain requirements at the time of grant,
including administration by a committee consisting solely of two or more
outside directors and stockholder approval of the terms of the plan, including
approval of an annual limit stated in the plan on the number of shares with
respect to which options may be granted to any employee. The Company's 1997
Plan, which is the only stock option plan under which the Company's executive
officers are currently eligible to receive options, has been designed and
administered to meet such requirements. The Company has not attempted to
structure other elements of executive compensation to qualify as performance-
based compensation for purposes of Section 162(m).
SUMMARY
The Compensation Committee believes that the Company's general compensation
policies and the special measures taken since the beginning of fiscal 1998 have
been successful in attracting and retaining qualified employees and in linking
compensation directly to corporate performance relative to the Company's goals.
The Company's compensation policies will evolve over time as the Company moves
to attain the near-term goals it has set for itself while maintaining its focus
on building long-term stockholder value.
Allison R. Schleicher
Leslie G. Denend
John E. Montague
24
<PAGE>
PERFORMANCE GRAPH
The following graph compares the five-year cumulative total returns for the
Company, the NASDAQ Market Index and an index constructed from a peer group
consisting of 563 companies that are classified in the same Standard Industrial
Classification (SIC) code as the Company.
Compare 5-Year Cumulative Total Return
Among Rational Software Corporation,
Nasdaq Market Index And Sic Code Index
[PERFORMANCE CHART APPEARS HERE]
ASSUMES $100 INVESTED ON APRIL 1, 1996
FISCAL YEAR ENDING MARCH 31, 2000
<TABLE>
<CAPTION>
1996 1997 1998 1999 2000
------ ------ ------ ------ -------
<S> <C> <C> <C> <C> <C>
Rational Software Corporation........ 421.33 440.00 277.33 572.00 1383.04
SIC Code Index....................... 205.77 247.34 439.63 636.03 770.27
Nasdaq Market Index.................. 142.70 159.64 241.26 315.28 547.25
</TABLE>
25
<PAGE>
CERTAIN TRANSACTIONS
On December 3, 1999, we closed a $50,000,000 investment in the Series A
Preferred Stock of Catapulse, founded by Paul Levy and Mike Devlin. As of March
31, 2000, after taking into account additional investments by third parties in
Catapulse, most notably the venture capital firm Benchmark Capital, our Series
A Preferred Stock represented approximately 43% of the voting power of the
outstanding capital stock of Catapulse. Paul Levy serves as its Chief Executive
Officer and Mike Devlin serves as the Vice-Chairman of the board of directors.
Catapulse's board of directors is made up five directors. The Company has the
right to designate two of the members of Catapulse's board of directors. As of
the date hereof, four of Catapulse's board members also serve on the Company's
board of directors. Paul Levy and Mike Devlin will continue in their roles as
Company's Chairman of the Board and Chief Executive Officer, respectively.
Catapulse will focus on developing an Internet portal, exploiting the power of
the Internet, to deliver software development solutions as a hosted service to
professional software development team members. Catapulse also intends to
develop an electronic marketplace for products and services relating to
software development.
EXPENSES OF SOLICITATION
The cost of solicitation of proxies for the Annual Meeting will be paid by
the Company. In addition to solicitation of proxies by mail, the officers,
directors, and regular employees of the Company may solicit proxies in person
or by telegraph or telephone. Brokerage houses, nominees, fiduciaries, and
other custodians will be requested by the Company to forward proxy soliciting
material to beneficial owners of shares held of record by them and the Company
will reimburse them for reasonable out-of-pocket expenses incurred in doing so.
The Company has retained ChaseMellon Shareholder Services, a professional
solicitation firm, to assist in the solicitation of proxies at a cost not to
exceed $12,500, plus reasonable expenses.
STOCKHOLDER PROPOSALS
Pursuant to Rule 14a-8 under the Exchange Act, stockholders may present
proper proposals for inclusion in the Company's Proxy Statement and for
consideration at the next Annual Meeting of stockholders by submitting their
proposals to the Company in a timely manner. In order to be included in the
Company's proxy material for the 2001 Annual Meeting of stockholders,
stockholder proposals must be received by the Company no later than March 17,
2001, and have complied with the requirements of Rule 14a-8 of the Securities
Exchange Act of 1934, as amended. In addition, the Company's proxy for the 2001
Annual Meeting of Stockholders may grant the holder thereof discretionary
authority to vote on any proposals brought before such meeting after May 31,
2001.
VOTING VIA THE INTERNET OR BY TELEPHONE
For shares of Common Stock that are registered in the name of the
stockholder, the stockholder may only vote by returning a signed proxy card or
voting in person at the meeting.
For shares of Common Stock that the stockholder beneficially owns and holds
in "street name" through a broker, or bank, the stockholder may vote by
completing and returning the voting form provided by their broker or bank or
via the internet or by telephone through their broker, or bank, if such a
service is provided. To vote via the Internet or telephone, the stockholder
should follow the instructions on the voting form provided by their broker or
bank. Votes submitted electronically via the Internet or by telephone must be
received by 12:00 a.m. (PST) on August 17, 2000.
The Internet voting procedures are designed to authenticate stockholder
identities, to allow stockholders to give their voting instructions and to
confirm that stockholders' instructions have been recorded properly.
26
<PAGE>
Stockholders voting via the Internet should understand that there may be costs
associated with electronic access, such as usage charges from Internet access
providers and telephone companies, that must be borne by the stockholder.
By Order of the Board of Directors,
Timothy A. Brennan
Secretary
27
<PAGE>
RATIONAL SOFTWARE CORPORATION
ANNUAL MEETING OF STOCKHOLDERS
AUGUST 17, 2000
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned stockholder of Rational Software Corporation hereby
acknowledges receipt of the Notice of Annual Meeting of Stockholders and Proxy
Statement, each dated July __, 2000, and hereby appoints Thomas F. Bogan and
Timothy A. Brennan, and each of them, with full power of substitution, as Proxy
or Proxies, to vote all shares of the Common Stock of the undersigned at the
Annual Meeting of Stockholders of Rational Software Corporation to be held on
August 17, 2000, and at any adjournments thereof, upon the proposals set forth
on this form of proxy and described in the Proxy Statement, and in their
discretion with respect to such other matters as may be properly brought before
the meeting or any adjournments thereof.
1. To elect two Class II members of the Board of Directors:
[_] FOR all nominees listed below [_] WITHHOLD authority to vote
(except as indicated) for all nominees listed below
If you wish to withhold authority to vote for an individual nominee,
strike a line through that nominee's name below:
Paul D. Levy John E. Montague
2. To approve and amendment to the Company's Amended and Restated
Certificate of Incorporation to increase the number of authorized
shares of Common Stock to 500,000,000:
[_] FOR [_] AGAINST [_] ABSTAIN
3. To approve an amendment to the 1997 Stock Option Plan reserving an
additional 6,000,000 shares of the Company's authorized but unissued
Common Stock for issuance thereunder:
[_] FOR [_] AGAINST [_] ABSTAIN
4. To approve adoption of the 2000 Director Option Plan reserving 500,000
shares of the Company's authorized but unissued Common Stock for
issuance thereunder:
[_] FOR [_] AGAINST [_] ABSTAIN
5. To ratify the appointment of Ernst & Young LLP as the Company's
independent auditors to examine the financial statements of the
Company for the fiscal year ending March 31, 2001:
[_] FOR [_] AGAINST [_] ABSTAIN
<PAGE>
Either of such Proxies or substitutes shall have and may exercise all of
the powers of said proxies hereunder.
Dated:__________________________________________________________________________
_________________________________
(Signature)
_________________________________
(Signature)
(This proxy should be marked, dated, signed by the
stockholder or stockholders exactly as the
stockholder's or stockholders' names appear
hereon, and returned promptly in the enclosed
envelope. Persons signing in a fiduciary or
representative capacity should so indicate. If
shares are held by joint tenants, as community
property or otherwise by more than one person, all
should sign.)
THIS PROXY WILL BE VOTED AS DIRECTED OR, IF NO DIRECTION IS INDICATED, WILL BE
VOTED FOR EACH OF THE PROPOSALS LISTED ABOVE, AND AS SAID PROXIES DEEM ADVISABLE
ON SUCH OTHER MATTERS AS MAY COME BEFORE THE MEETING.