PROSPECTUS
5,000,000 Shares
COMMON STOCK
_______________
Of the 5,000,000 Shares of Common Stock offered, 4,250,000 Shares are being
offered initially in the United States and Canada by the U.S. Underwriters and
750,000 Shares are being offered initially outside of the United States and
Canada by the International Underwriters. See "Underwriters." All of the
Shares of Common Stock offered hereby are being sold by the Company.
Prior to this offering, there has been no public market for the Common Stock
of the Company. See " Underwriters" for a discussion of the factors considered
in determining the initial public offering price.
_______________
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS"
COMMENCING ON PAGE 6 HEREOF.
_______________
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
_______________
PRICE $28 A SHARE
_______________
Price to
Public
______ Underwriting
Discounts and
Commissions(1)
______________ Proceeds to
Company(2)
__________
Per Share . . . . . . . . . . . . . . $28.00 $1.96 $26.04
Total(3) . . . . . . . . . . . . . . . $140,000,000 $9,800,000 $130,200,000
__________
(1) The Company has agreed to indemnify the U.S. Underwriters and the
International Underwriters against certain liabilities, including liabilities
under the Securities Act of 1933, as amended.
(2) Before deducting expenses payable by the Company estimated at $900,000.
(3) The Company has granted the U.S. Underwriters an option, exercisable
within 30 days of the date hereof, to purchase up to an aggregate of 750,000
additional Shares at the price to public less underwriting discounts and
commissions for the purpose of covering over-allotments, if any. If the U.S.
Underwriters exercise such option in full, the total price to public,
underwriting discounts and commissions and proceeds to Company will be
$161,000,000, $11,270,000 and $149,730,000, respectively. See "Underwriters."
_______________
The Shares are offered, subject to prior sale, when, as and if accepted by the
Underwriters named herein and subject to approval of certain legal matters by
Morrison & Foerster, counsel for the Underwriters. It is expected that
delivery of certificates for the Shares will be made on or about
August 14, 1995, at the office of Morgan Stanley & Co. Incorporated, New York,
N.Y., against payment therefor in New York funds.
_______________
MORGAN STANLEY & CO. HAMBRECHT & QUIST
Incorporated
August 8, 1995
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[ARTWORK]
The inside front and inside back cover pages of this Prospectus depict a
sample GDK home page and Web page, respectively.
_______________
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the consolidated financial statements and notes thereto
appearing elsewhere in this Prospectus.
THE COMPANY
THE OFFERING
Common Stock offered
U.S. offering . . . . . . . . . . . . . . . . . . . . . . . . . 4,250,000 shares
International offering . . . . . . . . . . . . . . . . . 750,000 shares
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000,000 shares
Common Stock to be outstanding
after the offering . . . . . . . . . . . . . . . . . . . . . 38,161,444 shares(1)
Use of proceeds . . . . . . . . . . . . . . . . . . . . . . For general corporate purposes,
including working capital and
capital expenditures
Nasdaq National Market symbol . . . . . . . . GDKE
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
Period from
inception
(April 4, 1994) to
December 31, 1994 Quarter Ended
------------------------------ Six Months
Ended
June 30, 1995
_________________ _____________
March 31, 1995 June 30, 1995
Consolidated Statement of Operations Data: _____________ _____________
Total revenues . . . . . . . . . . . . . . $695,871 $4,737,591 $11,887,800 $16,625,391
Gross profit . . . . . . . . . . . . . . . . 476,781 4,287,547 10,602,032 14,889,579
Total operating expenses(2) . . 9,001,556 7,004,588 12,559,635 19,564,223
Operating loss . . . . . . . . . . . . . . (8,524,775) (2,717,041) (1,957,603) (4,674,644)
Net loss . . . . . . . . . . . . . . . . . . . . (8,469,845) (2,699,023) (1,608,693) (4,307,716)
June 30, 1995
_____________
Actual As Adjusted(3)
______ ______________
Consolidated Balance Sheet Data:
Working capital . . . . . . . . . . . . . . . $10,698,225 $139,998,225
Total assets . . . . . . . . . . . . . . . . . . . 42,531,203 171,831,203
Deferred revenues . . . . . . . . . . . . . 14,963,843 14,963,843
Long-term obligations . . . . . . . . . . 2,236,331 2,236,331
Stockholders' equity . . . . . . . . . . . 16,474,521 145,774,521
__________
(1) Based on shares of Common Stock outstanding at June 30, 1995. Excludes 855,000 shares of Common Stock issuable upon exercise of outstanding options at June 30, 1995, with a weighted average exercise price of $7.91 per share. Subsequent to June 30, 1995, the Board of Directors granted options to purchase an additional 870,600 shares of Common Stock at an exercise price of $9.60 per share. Assumes no exercise of the Underwriters' over-allotment option. See "Capitalization," "Management--Stock Plans," "Underwriters" and Note 6 of Notes to Consolidated Financial Statements.
(2) Total operating expenses for the quarter ended March 31, 1995, the quarter ended June 30, 1995 and the six months ended June 30, 1995 include $861,512, $413,390 and $1,274,902, respectively, in amortization of deferred compensation related to stock option grants. See Note 6 of Notes to Consolidated Financial Statements.
(3) Adjusted to reflect the sale of the shares of Common Stock and the application of the net proceeds therefrom. Assumes no exercise of the Underwriters' over-allotment option. See "Use of Proceeds," "Capitalization" and "Underwriters."
No person is authorized in connection with any offering made hereby to give any information or to make any representation other than as contained in this Prospectus, and, if given or made, such information or representation must not be relied upon as having been authorized by the Company or any Underwriter. This Prospectus does not constitute an offer to sell or a solicitation of an offer to buy by any person in any jurisdiction in which it is unlawful for such person to make such an offering or solicitation. Neither the delivery of this Prospectus nor any sale made hereunder shall under any circumstances imply that the information contained herein is correct as of any date subsequent to the date hereof.
_______________
Until September 2, 1995 (25 days after the commencement of this offering), all dealers effecting transactions in the Common Stock, whether or not participating in this distribution, may be required to deliver a Prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a Prospectus when acting as Underwriters and with respect to their unsold allotments or subscriptions.
_______________
The Company intends to furnish to its stockholders annual reports containing consolidated financial statements audited by an independent public accounting firm and quarterly reports for the first three quarters of each fiscal year containing interim unaudited financial information.
_______________
The Company has applied for registration of the following trademarks: Uswitch, Hi-jack Busters and the Company's logo. This Prospectus also includes product names and other trade names and trademarks of the Company and of other organizations.
_______________
Except as otherwise noted herein, all information in this Prospectus (i) assumes the conversion of each outstanding share of Preferred Stock into two shares of Common Stock, which will occur automatically upon the closing of the offering, (ii) assumes no exercise of the Underwriters' over-allotment option, and (iii) reflects a two-for-one split of the Common Stock, an increase in the authorized number of shares of Common Stock from 30,000,000 to 100,000,000 shares and an increase in the authorized number of shares of undesignated Preferred Stock from 2,000,000 to 5,000,000 shares, all of which was effected in August 1995. See "Description of Capital Stock" and "Underwriters."
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THE COMPANY
RISK FACTORS
In evaluating the Company's business, prospective investors should consider carefully the following factors in addition to the other information presented in this Prospectus.
USE OF PROCEEDS
The net proceeds to the Company from the sale of 5,000,000 shares of Common Stock being offered hereby are estimated to be approximately $129.3 million (approximately $148.8 million if the Underwriters' over-allotment option is exercised in full). The principal purposes of this offering are to obtain additional capital, create a public market for the Company's Common Stock and facilitate future access by the Company to public equity markets. The Company expects to use the net proceeds from this offering for general corporate purposes, including working capital and capital expenditures. The Company estimates that 1995 capital expenditures will be approximately $12 million, of which $5 million is related to the implementation of a new management information system. A portion of the proceeds may also be used to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies; however, the Company has no present plans, agreements or commitments and is not currently engaged in any negotiations with respect to any such transactions. Pending use of the net proceeds for the above purposes, the Company intends to invest such funds in short-term, interest-bearing, investment grade obligations.
DIVIDEND POLICY
The Company has never paid cash dividends on its Common Stock or other securities. The Company currently anticipates that it will retain all of its future earnings for use in the expansion and operation of its business and does not anticipate paying any cash dividends in the foreseeable future.
CAPITALIZATION
The following table sets forth the total capitalization of the Company at June 30, 1995 and the as adjusted capitalization at June 30, 1995 assuming the conversion of each outstanding share of Preferred Stock into two shares of Common Stock and reflecting the sale by the Company of 5,000,000 shares of Common Stock offered hereby after deducting underwriting discounts and commissions and estimated offering expenses:
June 30, 1995
____________
Actual As Adjusted
_______ _____________
Long-term obligations(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,236,331 $2,236,331
Total stockholders' equity:
Preferred Stock, $0.0001 par value; issuable in series;
11,286,222 shares authorized, 9,008,222 shares issued and
outstanding, actual; 5,000,000 shares authorized, none
issued and outstanding, as adjusted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 901 --
Common Stock, $0.0001 par value; 30,000,000 shares
authorized, 15,145,000 shares issued and outstanding,
actual; 100,000,000 shares authorized, 38,161,444 shares
issued and outstanding, as adjusted(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,514 3,816
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39,683,666 168,982,265
Notes receivable from stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (638,065) (638,065)
Deferred compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9,812,151) (9,812,151)
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (12,777,561) (12,777,561)
Accumulated translation adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,217 16,217
_____ ______
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,474,521 145,774,521
__________ ___________
Total capitalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $18,710,852 $148,010,852
__________ ___________
__________ ___________
__________
(1) See Notes 4 and 5 of Notes to Consolidated Financial Statements.
(2) As of June 30, 1995, there were options outstanding to purchase a total of 855,000 shares of Common Stock at a weighted average exercise price of $7.91 per share and 443,672 shares were reserved for grant of future options under the Company's 1994 Stock Option Plan. The Company intends to terminate the 1994 Stock Option Plan effective upon the closing of this offering. In addition, in June 1995 the Board of Directors adopted the 1995 Stock Plan, the 1995 Employee Stock Purchase Plan and the 1995 Director Option Plan, pursuant to which 4,500,000, 1,000,000 and 100,000 shares, respectively, were reserved for issuance thereunder. As of June 30, 1995, no options or shares had been issued under any of these plans. Subsequent to June 30, 1995, the Board of Directors granted options to purchase an additional 870,600 shares of Common Stock at an exercise price of $9.60 per share, of which options to purchase 443,500 shares were granted under the 1994 Stock Option Plan and options to purchase 427,100 shares were granted under the 1995 Stock Plan. See " Management -- Stock Plans" and Notes 6 and 10 of Notes to Consolidated Financial Statements.
DILUTION
The net tangible book value of the Company as of June 30, 1995 was $16,232,746 or $0.49 per share of Common Stock. Net tangible book value per share is determined by dividing the net tangible book value of the Company (total tangible assets less total liabilities) by the number of outstanding shares of Common Stock at that date (assuming the conversion of each outstanding share of Preferred Stock into two shares of Common Stock). After giving effect to the sale by the Company of the 5,000,000 shares of Common Stock offered hereby (after deduction of underwriting discounts and commissions and estimated offering expenses), the Company's pro forma net tangible book value at June 30, 1995 would have been $145,532,746 or $3.81 per share. This represents an immediate increase in net tangible book value to existing stockholders of $3.32 per share and an immediate dilution to new investors of $24.19 per share. The following table illustrates the per share dilution:
Initial public offering price per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $28.00
Net tangible book value per share as of June 30, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in net tangible book value per share attributable to new investors . . . . . . . $0.49
3.32
____
Pro forma net tangible book value per share after offering . . . . . . . . . . . . . . . . . . . . . . . .
Dilution per share to new investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.81
____
$24.19
______
______
The following table sets forth on a pro forma basis as of June 30, 1995 the difference between the number of shares of Common Stock purchased from the Company, the total consideration paid, and the average price per share paid by the existing stockholders and by the new investors (before deduction of underwriting discounts and commissions and estimated offering expenses), assuming the conversion of each outstanding share of Preferred Stock into two shares of Common Stock:
Shares Purchased
---------------------- Total Consideration
------------------------- Average
Price
Per Share
-------------
Number
______ Percent
_______ Amount
______ Percent
_______
Existing Stockholders . . . . . . . . .
New investors . . . . . . . . . . . . . . . 33,161,444
5,000,000
_________
86.9%
13.1
_____
$29,287,961
140,000,000
_________
17.3%
82.7
______
$0.88
28.00
_____
Total . . . . . . . . . . . . . . . . . . . 38,161,444
_________
_________
100.0%
______
______
$169,287,961
_________
_________
100.0%
______
______
The foregoing table assumes no exercise of the Underwriters' over-allotment option and no exercise of stock options outstanding at June 30, 1995. As of June 30, 1995, there were options outstanding to purchase a total of 855,000 shares of Common Stock at a weighted average exercise price of $7.91 per share and 443,672 shares were reserved for grant of future options under the Company's 1994 Stock Option Plan. The Company intends to terminate the 1994 Stock Option Plan effective upon the closing of this offering. In addition, in June 1995 the Board of Directors adopted the 1995 Stock Plan, the 1995 Employee Stock Purchase Plan and the 1995 Director Option Plan, pursuant to which 4,500,000, 1,000,000 and 100,000 shares, respectively, were reserved for issuance thereunder. As of June 30, 1995, no options or shares had been issued under any of these plans. Subsequent to June 30, 1995, the Board of Directors granted options to purchase an additional 870,600 shares of Common Stock at an exercise price of $9.60 per share, of which options to purchase 443,500 shares were granted under the 1994 Stock Option Plan and options to purchase 427,100 shares were granted under the 1995 Stock Plan. To the extent that any of these options are exercised, there will be further dilution to new investors. See "Capitalization," "Management -- Stock Plans" and Notes 6 and 10 of Notes to Consolidated Financial Statements.
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein. The consolidated statement of operations data set forth below with respect to the period from inception (April 4, 1994) to December 31, 1994, and the consolidated balance sheet data at December 31, 1994, are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Prospectus and should be read in conjunction with those consolidated financial statements and notes thereto. The consolidated statement of operations data for the period from inception (April 4, 1994) to June 30, 1994, the quarter ended March 31, 1995, the quarter ended June 30, 1995, the six months ended June 30, 1995 and the balance sheet data at June 30, 1995, are derived from unaudited consolidated financial statements that have been prepared on the same basis as the audited financial statements and in the opinion of management, contain all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of operations for such period. The historical results are not necessarily indicative of the results of operations to be expected in the future.
Inception Inception Quarter Ended
------------------------- Six Months
(April 4, 1994) to (April 4, 1994) to Ended
June 30, December 31, March 31, June 30, June 30,
1994 1994 1995 1995 1995
Consolidated Statement of Operations Data:
Revenues:
Product revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- $378,490 $4,496,031 $11,084,227 $15,580,258
Service revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 317,381 241,560 803,573 1,045,133
__ _____ _____ _____ ______
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 695,871 4,737,591 11,887,800 16,625,391
Cost of revenues:
Cost of product revenues . . . . . . . . . . . . . . . . . . . . . . . . -- 114,777 273,169 948,876 1,222,045
Cost of service revenues . . . . . . . . . . . . . . . . . . . . . . . . . -- 104,313 176,875 336,892 513,767
__ _____ _____ _____ ______
Total cost of revenues . . . . . . . . . . . . . . . . . . . . . . . -- 219,090 450,044 1,285,768 1,735,812
__ _____ _____ _____ ______
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 476,781 4,287,547 10,602,032 14,889,579
Operating expenses:
Research and development . . . . . . . . . . . . . . . . . . . . . . . 172,065 2,031,986 1,981,292 4,133,860 6,115,152
Sales and marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48,369 2,813,689 2,782,772 6,473,294 9,256,066
General and administrative . . . . . . . . . . . . . . . . . . . . . . . 232,519 1,669,193 1,740,524 1,952,481 3,693,005
Property rights agreement and related charges . . . . . . -- 2,486,688 500,000 -- 500,000
__ _____ _____ _____ ______
Total operating expenses(1) . . . . . . . . . . . . . . . . . . . 452,953 9,001,556 7,004,588 12,559,635 19,564,223
__ _____ _____ _____ ______
Operating loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (452,953) (8,524,775) (2,717,041) (1,957,603) (4,674,644 )
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 55,238 45,074 450,509 495,583
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- (308) (27,056) (101,599) (128,655 )
__ _____ _____ _____ ______
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(452,953) $(8,469,845) $(2,699,023) $(1,608,693) $(4,307,716)
__________ ____________ ____________ ____________ ___________
__________ ____________ ____________ ____________ ___________
Net loss per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(0.01) $(0.26) $(0.08) $(0.05) $(0.13 )
______ ______ ______ ______ ______
______ ______ ______ ______ ______
Shares used in computing net loss per share . . . . . . . . . . 30,767,418 32,256,307 33,000,751 33,000,751 33,000,751
__________ ____________ ____________ ____________ ___________
__________ ____________ ____________ ____________ ___________
December 31,
1994
____ June 30,
1995
____
Consolidated Balance Sheet Data:
Working capital (deficit) . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . .
Long-term obligations . . . . . . . . . . . . .
Stockholders' equity . . . . . . . . . . . . . . .
$(1,337,613)
7,158,641
725,000
1,083,585
$10,698,225
42,531,203
2,236,331
16,474,521
__________
(1) Total operating expenses for the quarter ended March 31, 1995, the quarter ended June 30, 1995 and the six months ended June 30, 1995 include $861,512, $413,390 and $1,274,902, respectively, in amortization of deferred compensation related to stock option grants. See Note 6 of Notes to Consolidated Financial Statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Results of Operations
Revenues
The Company derives its revenues from license fees for its software products and fees for services, which are generally charged separately from software licenses. Product revenues consist of product licensing fees, and service revenues consist of fees for maintenance and support services, training, consulting and advertising space. Product revenues are generally recognized upon delivery, net of allowances for estimated future returns, provided that no significant obligations of the Company remain and collection of the resulting receivable is deemed probable. Product returns and sales allowances (which have not been significant through June 30, 1995) and costs of free telephone support are estimated and provided for at the time of sale. Service revenues from customer maintenance fees for ongoing customer support and product updates are recognized ratably over the term of the maintenance period, which is typically 12 months. Payments for maintenance fees are generally made in advance and are non-refundable. Service revenues from training and consulting are recognized when the services are performed. Service revenues from the sale of advertising space are recognized in the period in which the advertisement is displayed on a Web page of the Company.
Total Revenues. Total revenues were $696,000, $4,738,000 and $11,888,000 for the period from inception (April 4, 1994) through December 31, 1994 (the "Inception Period"), the quarter ended March 31, 1995 and the quarter ended June 30, 1995, respectively. The Inception Period reflects only two weeks of product sales. The quarter ended March 31, 1995 is the first full quarter in which the Company's products and services were made commercially available. MCI Telecommunications Corporation ("MCI") and Bell- Northern Research Ltd. ("BNR") accounted for 45% and 36%, respectively, of total revenues in the Inception Period. Licenses to Digital and SGI accounted for 14% and 9%, respectively, of total revenues in the quarter ended March 31, 1995. Licenses to Access Graphics, Inc., a distributor, accounted for 11% of total revenues in the quarter ended June 30, 1995.
Product Revenues. Product revenues were $378,000, $4,496,000 and $11,084,000 for the Inception Period, the quarter ended March 31, 1995 and the quarter ended June 30, 1995, respectively. Product revenues in the Inception Period, the quarter ended March 31, 1995 and the quarter ended June 30, 1995 were primarily attributable to licenses of Tyhe program begins. During each of these periods, licenses accounted for a majority of the Company's product revenues. Product revenues increased from the quarter ended March 31, 1995 to the quarter ended June 30, 1995 due primarily to increased licenses.
Through the quarter ended March 31, 1995, the Company had distributed substantially all of its products through direct sales (including field sales and telesales), sales over the Internet through the Company's electronic store and OEMs. In the quarter ended June 30, 1995, the Company began offering its products through VARs and through distribution for retail sale. Currently, only the Company's product is being offered through distribution for retail sale.
Service Revenues. Service revenues were $317,000, $242,000 and $804,000 for the Inception Period, the quarter ended March 31, 1995 and the quarter ended June 30, 1995, respectively. In each of the Inception Period, the quarter ended March 31, 1995 and the quarter ended June 30, 1995, service revenues were attributable to fees for consulting, maintenance and support and, to a lesser extent, to fees for training. Service revenues increased from the quarter ended March 31, 1995 to the quarter ended June 30, 1995 due primarily to increased consulting, maintenance and support provided to a larger installed base and, to a lesser extent, to the initial sales of advertising space. The Company expects that service revenues will increase as a percentage of total revenues in the future.
International Revenues. International revenues (sales outside of North America) were immaterial in the Inception Period and were approximately 10% and 14% of total revenues for the quarters ended March 31, 1995 and June 30, 1995, respectively. As of June 30, 1995, all international revenues had been recognized by the U.S. parent corporation and denominated in U.S. currency. The Company established a subsidiary in Japan in December 1994 and intends to establish subsidiaries in Europe. Although its Japanese subsidiary had not recognized any revenues as of June 30, 1995, it had entered into several OEM reseller arrangements pursuant to which it has received prepaid royalty payments denominated and collected in Japanese currency. Such prepaid royalties have been deferred at June 30, 1995 due to the Company's remaining obligation to deliver foreign country localized versions of its products. The Company expects to invoice customers of its international subsidiaries in local currencies. The Company has not engaged in foreign currency hedging activities, and international revenues are currently subject to currency exchange fluctuation risks. The Company anticipates that international revenues will increase as a percentage of total revenues in the future, and, as a result, foreign currency exposure may increase.
Cost of Revenues
Cost of Product Revenues. Cost of product revenues consists primarily of the cost of product media and duplication, manuals, packaging materials, amounts paid for licensed technology, and fees paid to third party vendors for sales administration, order fulfillment and free telephone support. Cost of product revenues was $115,000, $273,000 and $949,000 for the Inception Period, the quarter ended March 31, 1995 and the quarter ended June 30, 1995, respectively, and was 30%, 6% and 9%, respectively, of the related product revenues. In each of the periods, the cost of product revenues consisted primarily of the cost of product media and duplication, manuals, packing materials and fees paid to third party vendors. Cost of product revenues increased from the quarter ended March 31, 1995 to the quarter ended June 30, 1995 due primarily to increased costs related to increased product licenses and, to a lesser extent, to the amortization of amounts paid for licensed technology and costs associated with free telephone support. The Company believes that cost of product revenues may increase as a percentage of the related product revenues in future periods due to increased amounts paid for licensed technology to be incorporated in future products and increased costs associated with providing free telephone support. In particular, the Company expects that the costs of providing free telephone support will continue to correspondingly increase with any increase in the number of licenses of its product, which is offered through retail channels. Some of the Company's products include free telephone support for a certain period of time and such costs are accrued at the time of sale. Increases in the cost of product revenues as a percentage of the related product revenues would adversely effect gross margins. All development costs incurred to date in the research and development of new software products and enhancements to existing software products have been expensed as incurred. As a result, cost of product revenues does not include amortization of capitalized software development costs. See Note 1 of Notes to Consolidated Financial Statements.
Cost of Service Revenues. Cost of service revenues consists primarily of personnel related costs incurred in providing customer support, consulting services and training to customers. Cost of service revenues also includes fees paid to a third party related to the sale of advertising space on the Company's Web pages. Cost of service revenues was $104,000, $177,000 and $337,000 for the Inception Period, the quarter ended March 31, 1995 and the quarter ended June 30, 1995, respectively, and was 33%, 73% and 42%, respectively, of related service revenues. In each of the periods, the cost of service revenues related primarily to outside consulting services and to maintenance, support and consulting provided by the Company. Cost of service revenues increased from the quarter ended March 31, 1995 to the quarter ended June 30, 1995 primarily due to increased staffing necessary to provide consulting, maintenance and support to a larger installed base and to increased use of outside consulting services. In future periods, the Company believes that the cost of service revenues will increase as a percentage of the related service revenues as a result of personnel related costs incurred in building the Company's customer support and training organizations and due to fees incurred in connection with selling advertising space. Increases in the cost of service revenues as a percentage of related service revenues would have an adverse impact on the Company's gross margins.
Gross margins may be impacted by the mix of distribution channels used by the Company, the mix of products sold, the mix of product revenues versus service revenues and the mix of international versus North American revenues. The Company typically realizes higher gross margins on direct sales than on sales through indirect channels and higher gross margins on product revenues than on service revenues. If sales through indirect channels, especially OEMs and VARs, increase as a percentage of total revenues, or if, as the Company anticipates, service revenues increase as a percentage of total revenues, the Company's gross margins will be adversely impacted.
Operating Expenses
The Company's operating expenses, excluding property rights agreement and related charges, have increased in absolute dollar amounts in every consecutive quarter through the quarter ended June 30, 1995. This trend reflects the Company's rapid transition from the product development phase to its first two full quarters of marketing and licensing products and offering services. The Company believes that continued expansion of operations is essential to achieving and maintaining market leadership. As a consequence, the Company intends to continue to increase expenditures in all operating areas.
The Company has recorded deferred compensation of $11,087,000 for the difference between the grant price and the deemed fair value of the Company's Common Stock for 10,199,000 shares subject to options granted in the first six months of 1995. Deferred compensation expense attributed to 2,000,000 shares of Common Stock was fully amortized in the quarter ended March 31, 1995, as such shares were fully vested upon grant. The remaining deferred compensation will be amortized to operating expense over the related 50-month vesting period of the shares and will therefore continue to have a material adverse impact on the Company's results of operations. See Note 6 of Notes to Consolidated Financial Statements.
Research and Development. Research and development expenses consist primarily of salaries and consulting fees to support product development. Research and development expenses were $2,032,000, $1,981,000 and $4,134,000 for the Inception Period, the quarter ended March 31, 1995 and the quarter ended June 30, 1995, respectively, and were 292%, 42% and 35%, respectively, of total revenues. The dollar increase from the quarter ended March 31, 1995 to the quarter ended June 30, 1995 was primarily attributable to increased staffing and associated costs and to fees paid to consultants. Research and development expenses for the quarters ended March 31, 1995 and June 30, 1995 included non-cash charges of $16,000 and $117,000, respectively, related to the amortization of deferred compensation. To date, all software development costs have been expensed as incurred. The Company believes that significant investments in research and development are required to remain competitive in the software business. As a consequence, the Company intends to increase the absolute amount of its research and development expenditures in the future.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries (including sales commissions), consulting fees, trade show expenses, advertising and cost of marketing literature. Sales and marketing expenses were $2,814,000, $2,783,000 and $6,473,000, respectively, for the Inception Period, the quarter ended March 31, 1995 and the quarter ended June 30, 1995, respectively, and were 404%, 59% and 54%, respectively, of total revenues. The dollar increase from the quarter ended March 31, 1995 to the quarter ended June 30, 1995 was primarily attributable to increased staffing and to sales commissions on higher sales. Sales and marketing expenses for the quarters ended March 31, 1995 and June 30, 1995 included non-cash charges of $25,000 and $105,000, respectively, related to the amortization of deferred compensation. The Company intends to increase the level of sales and marketing expenses in future periods.
General and Administrative. General and administrative expenses consist primarily of salaries and fees for professional services. General and administrative expenses were $1,669,000, $1,741,000 and $1,952,000 for the Inception Period, the quarter ended March 31, 1995 and the quarter ended June 30, 1995, respectively, and were 240%, 37% and 16%, respectively, of total revenues. General and administrative expenses for the quarters ended March 31, 1995 and June 30, 1995 included non-cash charges of $821,000 and $191,000, respectively, related to the amortization of deferred compensation. The increased amortization of deferred compensation expense in the quarter ended March 31, 1995 as compared to the quarter ended June 30, 1995 was due to the grant by the Company in the quarter ended March 31, 1995 of an option pursuant to which 2,000,000 shares of Common Stock were fully vested upon grant. The Company intends to increase the level of general and administrative expenses in future periods.
Property Rights Agreement and Related Charges. The Company has segregated certain expenses totaling $2,487,000 and $500,000 for the Inception Period and for the quarter ended March 31, 1995, respectively. These expenses relate to an agreement with the University of Illinois and Spyglass and associated costs, including fees for expert and professional services, trademark search costs and other related expenses. All of these expenses have been recorded for financial reporting purposes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 5. The Company has not yet paid $1,450,000 of the amount recorded, which is payable in two equal installments of $725,000 on each of the first and second anniversaries of the date of the agreement. The Company will incur additional charges related to this agreement in the event that it enters into certain types of agreements with two specified companies. See "Business -- Proprietary Rights" and Note 5 of Notes to Consolidated Financial Statements.
Income Taxes
As of December 31, 1994, the Company had federal net operating loss carryforwards of approximately $7,000,000. The Company also had federal research and development tax credit carryforwards of approximately $90,000. The federal net operating loss and credit carryforwards will expire in 2009 if not utilized. The Company also has state net operating loss carryforwards of approximately $5,000,000 which will expire in 2002 if not utilized. Utilization of the net operating losses and credits may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. See Note 7 of Notes to Consolidated Financial Statements.
Factors Affecting Operating Results
As a result of the Company's limited operating history, the Company does not have historical financial data for a significant number of periods on which to base planned operating expenses. Accordingly, the Company's expense levels are based in part on its expectations as to future revenues and to a large extent are fixed. However, the Company typically operates with no backlog. As a result, quarterly sales and operating results generally depend on the volume and timing of and ability to fulfill orders received within the quarter, which are difficult to forecast. The Company may be unable to adjust spending in a timely manner to compensate for any unexpected revenues shortfall. Accordingly, any significant shortfall of demand for the Company's products and services in relation to the Company's expectations would have an immediate adverse impact on the Company's business, operating results and financial condition. In addition, the Company plans to increase its operating expenses to fund greater levels of research and development, increase its sales and marketing operations, develop new distribution channels and broaden its customer support capabilities. To the extent that such expenses precede or are not subsequently followed by increased revenues, the Company's business, operating results and financial condition will be materially adversely affected.
The Company expects to experience significant fluctuations in future quarterly operating results that may be caused by many factors, including demand for the Company's products, introduction or enhancement of products by the Company and its competitors, market acceptance of new products, mix of distribution channels through which products are sold, mix of products and services sold, mix of international and North American revenues, and general economic conditions. As a result, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as any indication of future performance. Due to all of the foregoing factors, it is likely that in some future quarter the Company's operating results will be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely be materially adversely affected.
Liquidity and Capital Resources
The Company has primarily financed its operations through private sales of equity securities. In the six months ended June 30, 1995, cash provided by operating activities of $7,290,000 was primarily attributable to increases in deferred revenues and accounts payable, partially offset by the growth in accounts receivable and a net loss. Cash used in investment activities of $22,135,000 in the six months ended June 30, 1995 related primarily to $16,567,000 in short-term investment purchases and $4,955,000 in capital expenditures. Cash flows from financing activities of $20,470,000 in the six months ended June 30, 1995 were primarily attributable to the net proceeds of $17,300,000 from the issuance of Series C Preferred Stock and borrowings of $2,200,000 under a debt facility.
Deferred revenues consist of the unrecognized portion of service revenues received pursuant to maintenance and support contracts and the unrecognized portion of product revenues received pursuant to reseller agreements with significant obligations remaining. Pursuant to the reseller agreements, the Company typically receives non-refundable prepaid royalties. The significant obligations resulting in the deferral of revenues relate primarily to unreleased products. Deferred revenues increased from $2,575,000 at December 31, 1994 to $14,964,000 at June 30, 1995 due to an increase in the number of reseller agreements, the amount of prepayments received pursuant to reseller agreements and, to a lesser extent, to an increase in the number of training, consulting and maintenance and support contracts. Deferred revenues related to products licensed pursuant to reseller agreements are generally recognized on a per copy or per user basis as copies are shipped or usage is reported, respectively, by the reseller. Deferred revenues related to training and consulting contracts are generally recognized when the services are performed. As the recognition of such deferred revenues is based either upon the selling and marketing efforts of the reseller or upon customer requests for training or consulting, the Company cannot predict when such revenues will be recognized. There can be no assurance that any of such deferred revenues will be recognized in 1995. Deferred revenues related to maintenance and support contracts are recognized ratably over the term of the maintenance period, which is typically 12 months. The Company estimates that it will recognize approximately $974,000 of deferred revenues related to maintenance and support contracts in the six months ended December 31, 1995.
Capital expenditures were approximately $2,663,000 and $4,955,000 for the Inception Period and the six months ended June 30, 1995, respectively. The Company has no material commitments other than obligations under its agreement with the University of Illinois and Spyglass, a debt facility agreement and operating leases. The Company estimates that 1995 capital expenditures will be approximately $12,000,000, of which $5,000,000 is related to the implementation of a new management information system. See Notes 3 and 4 of Notes to Consolidated Financial Statements.
At June 30, 1995, the Company's principal source of liquidity was approximately $8,868,000 in cash and cash equivalents and $16,567,000 in short-term investments. Further, the Company has a $2,200,000 debt facility agreement, secured by certain assets of the Company, all of which was utilized at June 30, 1995. The outstanding obligations under this facility are payable in 36 monthly installments. See Note 4 of Notes to Consolidated Financial Statements.
The Company adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," during the Inception Period. The adoption of SFAS No. 115 did not have a material impact on the Company's results of operations or financial condition.
The Company believes that the net proceeds from this offering, together with available funds and cash flows expected to be generated by operations, will be sufficient to meet its anticipated cash needs for working capital and capital expenditures for at least the next 12 months. Thereafter, if cash generated by operations is insufficient to satisfy the Company's liquidity requirements, the Company may sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity or convertible debt securities will result in additional dilution to the Company's stockholders.
BUSINESS
Overview
MANAGEMENT
Executive Officers and Directors
The executive officers and directors of the Company, and their ages and positions as of June 30, 1995, are as follows:
Name Age Position(s)
____ ___ ___________
Chairman of the Board
President, Chief Executive Officer and Director
Vice President, Technology and Director
Vice President and Chief Financial Officer
Vice President, Sales and Field Operations
Vice President, Marketing
Vice President, General Counsel and Secretary
Vice President, Engineering
Vice President and General Manager, Integrated
Applications
Vice President, Human Resources
Director
Director
__________
(1) Member of the Audit and Compensation Committees
The Company currently has authorized five directors. In June 1995, the Board of Directors approved an amendment to the Company's Amended and Restated Certificate of Incorporation to provide for a classified Board of Directors effective upon the closing of this offering. In accordance with the terms of such amendment, the terms of office of the Board of Directors will be divided into three classes: Class I will expire at the annual meeting of stockholders to be held in 1996; Class II will expire at the annual meeting of stockholders to be held in 1997; and Class III will expire at the annual meeting of stockholders to be held in 1998. At each annual meeting of stockholders beginning with the 1996 annual meeting, the successors to directors whose terms will then expire will be elected to serve from the time of election and qualification until the third annual meeting following election and until their successors have been duly elected and qualified. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of an equal number of directors.
In connection with the Series B Preferred Stock financing, was elected to the Board of Directors pursuant to the Company's Amended and Restated Certificate of Incorporation. In connection with the Series C Preferred Stock financing, was elected to the Board of Directors pursuant to the Company's Amended and Restated Certificate of Incorporation. These provisions will terminate upon the closing of this offering.
Each officer serves at the discretion of the Board of Directors. There are no family relationships among any of the directors or officers of the Company.
Director Compensation
Effective upon the closing of this offering, the Company's non-employee directors will be paid an annual retainer of $10,000 and a fee of $2,500 for each meeting attended of the Board of Directors or of a committee of the Board. In addition, in January 1995, in exchange for his services as a director, James L. Barksdale was granted an option to purchase 200,000 shares of the Company's Common Stock at an exercise price of $0.1125 per share under the Company's 1994 Stock Option Plan. The Company has recently established a director stock option plan, which provides for automatic grants to non-employee directors commencing upon the consummation of this offering. See "Stock Plans -- 1994 Stock Option Plan" and "-- 1995 Director Option Plan."
Compensation Committee Interlocks and Insider Participation
The Company's Compensation Committee was formed in June 1995 to review and approve the compensation and benefits for the Company's executive officers, administer the Company's stock purchase and stock option plans and make recommendations to the Board of Directors regarding such matters. The committee is currently composed of . 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, nor has any such interlocking relationship existed in the past.
Employment Agreements
The Company has an employment agreement with , the Company's President and Chief Executive Officer, which is terminable at will by either the Company or . In connection with such agreement, was granted an option to purchase 4,000,000 shares of the Company's Common Stock at an exercise price of $0.1125 per share. The options were all immediately exercisable, with 2,000,000 shares vested immediately upon grant and an additional 40,000 shares vesting per month over 50 months. The Company retains the right to repurchase any unvested shares at $0.1125 upon the cessation of Mr. service for any reason. Upon a change in control of the Company, the Company or its successor entity shall be obligated to employ Mr. until all shares subject to his option have vested in full. The Company has an employment offer letter with , Vice President, Sales and Field Operations of the Company, pursuant to which the Company has agreed to pay Mr. , in the event of involuntary termination, his salary for a six-month period following such termination.
Limitation of Liability and Indemnification Matters
The Company's Amended and Restated Certificate of Incorporation limits the liability of directors to the maximum extent permitted by Delaware law. Delaware law provides that a corporation's certificate of incorporation may contain a provision eliminating or limiting the personal liability of a director for monetary damages for breach of their fiduciary duties as directors, except for liability (i) for any breach of their duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) for unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law or (iv) for any transaction from which the director derived an improper personal benefit.
The Company's Amended and Restated Bylaws provide that the Company shall indemnify its directors and officers and may indemnify its employees and agents to the fullest extent permitted by law. The Company believes that indemnification under its Amended and Restated Bylaws covers at least negligence and gross negligence on the part of indemnified parties.
The Company has entered into agreements to indemnify its directors and officers, in addition to the indemnification provided for in the Company's Amended and Restated Bylaws. These agreements, among other things, indemnify the Company's directors and officers for certain expenses (including attorneys' fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by or in the right of the Company, arising out of such person's services as a director or officer of the Company, any subsidiary of the Company or any other company or enterprise to which the person provides services at the request of the Company. The Company believes that these provisions and agreements are necessary to attract and retain qualified directors and officers.
At present, there is no pending litigation or proceeding involving any director, officer, employee or agent of the Company where indemnification will be required or permitted. The Company is not aware of any threatened litigation or proceeding that might result in a claim for such indemnification.
Executive Compensation
The following table sets forth information concerning the compensation paid by the Company during the period from the Company's inception (April 1994) to December 31, 1994 to the Company's Chief Executive Officer and each of the Company's four other most highly compensated executive officers (collectively, the "Named Officers"):
Summary Compensation Table
Long-Term
Compensation
____________
Securities
Annual Compensation Underlying All Other
___________________
Name and Principal Position Salary($) Bonus($) Options Compensation
___________________________ _________ ________ _______ ____________
(1) . . . . . . . . . . . . . . . . . . $0 $0 -- $0
Chairman of the Board
(2) . . . . . . . . . . . . . . . . . . $69,230 $0 -- $0
Vice President and General
Manager, Integrated Applications
(3) . . . . . . . . . . . . $60,000 $0 280,000 $0
Vice President, Technology
(4) . . . . . . . . . . . . $53,846 $0 -- $0
Vice President, Sales and Field
Operations
(5) . . . . . . . . . . . . . . . $49,615 $0 400,000 $0
Vice President, Engineering
__________
The following table sets forth for each of the Named Officers certain information concerning stock options granted during the period from inception (April 1994) to December 31, 1994:
Individual Grants Potential Realizable
__________
Number of Percent of Total Value at Assumed
Securities Options Annual Rates of Stock
Underlying Granted to Exercise Price Appreciation
Options Employees in Price Expiration for Option Term(5)
__________
Name Granted(1) 1994(2) Per Share(3) Date(4) 5%($) 10%($)
____ ________ ______ __________ _____ ____ _____
. . . . . . . . . -- -- -- -- -- --
. . . . . . . . . -- -- -- -- -- --
. . . . 280,000 8.6% $0.0375 07/14/04 $6,603 $16,734
. . . -- -- -- -- -- --
. . . . . . 400,000 12.3% $0.1125 09/14/04 $28,300 $71,718
__________
(1) These options are incentive stock options granted pursuant to the 1994 Stock Option Plan and have ten year terms. The options are immediately exercisable; however, the shares purchasable under such options are subject to repurchase by the Company at the original exercise price paid per share upon the optionee's cessation of service prior to the vesting of such shares. In this context, "vesting" means that the shares subject to options are no longer subject to repurchase by the Company. Twenty percent of the options vest upon completion of 10 months of service with the Company, and the remaining shares vest at the rate of two percent over the next 40 months of service.
(2) In 1994, the Company granted options to purchase an aggregate of 3,261,200 shares.
(3) In determining the fair market value of the Company's Common Stock, the Board of Directors considered various factors, including the Company's financial condition and business prospects, its operating results, the absence of a market for its Common Stock and the risks normally associated with high technology companies. The exercise price may be paid in cash, check, promissory note, shares of the Company's Common Stock, through a cashless exercise procedure involving same-day sale of the purchased shares or any combination of such methods.
(4) Options may terminate before their expiration dates if the optionee's status as an employee or consultant is terminated or upon the optionee's death or disability.
(5) The 5% and 10% assumed annual rates of compounded stock price appreciation are mandated by rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of the Company's future Common Stock prices.
Aggregate Option Exercises in 1994 and Year-End Option Values
The following table sets forth for each of the Named Officers certain information concerning options exercised during the period from inception (April 1994) to December 31, 1994 and the number of shares subject to both exercisable and unexercisable stock options as of December 31, 1994. Also reported are values for "in-the-money" options that represent the positive spread between the respective exercise prices of outstanding options and the fair market value of the Company's Common Stock as of December 31, 1994.
Number of Number of Securities Value of Unexercised
Shares Value Realized Underlying Unexercised in-the-Money Options at
Acquired (Market Price at Options at 12/31/94 12/31/94 (1)
--------------------------- ---------------------------
on Exercise Less
Name Exercise Exercise Price) Exercisable Unexercisable Exercisable Unexercisable
____ ________ ______________ ___________ _____________ ___________ _____________
. . . . . . . -- -- -- -- -- --
. . . . . . . . -- -- -- -- -- --
. -- -- 280,000 0 $21,000 $0
. -- -- -- -- -- --
. . . . . . -- -- 400,000 0 $0 $0
__________
(1) Calculated by determining the difference between the fair market value of the securities underlying the option at December 31, 1994 ($0.1125 per share as determined by the Board of Directors) and the exercise price of the Named Officer's option. In determining the fair market value of the Company's Common Stock, the Board of Directors considered various factors, including the Company's financial condition and business prospects, its operating results, the absence of a market for its Common Stock and the risks normally associated with high technology companies.
Stock Plans
1994 Stock Option Plan
The Company's 1994 Stock Option Plan (the "1994 Plan") provides for the grant to employees of incentive stock options and the grant of nonstatutory stock options to employees and consultants of the Company. As of June 30, 1995, an aggregate of 9,036,672 shares of Common Stock has been reserved for issuance under the 1994 Plan, and options to purchase an aggregate of 855,000 shares of Common Stock were outstanding under the 1994 Plan. Subsequent to June 30, 1995, the Board of Directors granted options to purchase 443,500 shares of Common Stock under the 1994 Plan. The Board of Directors has determined that no further options will be granted under the 1994 Plan after this offering.
1995 Stock Plan
The Company's 1995 Stock Plan (the "1995 Plan") was approved by the Board of Directors in June 1995 and by the stockholders in July 1995. The 1995 Plan provides for the granting to employees (including officers and employee directors) of incentive stock options and for the granting to employees (including officers and employee directors) and consultants of nonstatutory stock options, stock purchase rights ("SPRs"), and long-term performance awards. A total of 4,500,000 shares of Common Stock has been reserved for issuance under the 1995 Plan, which number shall be increased on the first day of each new fiscal year of the Company, beginning in 1997, by a number of shares equal to four percent of the Company's outstanding Common Stock as of the last business day of the immediate preceding fiscal year. However, the maximum number of shares of Common Stock available for issuance pursuant to incentive stock option grants under the 1995 Plan is 4,500,000. As of June 30, 1995, there were no options outstanding under the 1995 Plan. Subsequent to June 30, 1995, the Board of Directors granted options to purchase 427,100 shares of Common Stock under the 1995 Plan.
The 1995 Plan may be administered by the Board of Directors or a committee designated by the Board (the "Administrator"). Options, SPRs, and long-term performance awards granted under the 1995 Plan are not generally transferable by the optionee except by will or by the laws of descent and distribution, and are exercisable during the lifetime of the optionee only by such optionee. Options granted under the 1995 Plan must be exercised within three months of the end of optionee's status as an employee or consultant of the Company, or within twelve months after such optionee's termination by death or disability, but in no event later than the expiration of the option term. The exercise price of all incentive and nonstatutory stock options granted under the 1995 Plan shall be determined by the Administrator. With respect to any participant who owns stock possessing more than ten percent of the voting power of all classes of the Company's outstanding capital stock (a "10% Stockholder"), the exercise price of any incentive stock option granted must equal at least 110% of the fair market value on the grant date. The exercise price of incentive stock options for all other employees shall be no less than 100% of the fair market value per share on the date of the grant. The maximum term of an option granted under the 1995 Plan may not exceed ten years from the date of grant (five years in the case of an incentive stock option granted to a 10% Stockholder). In the case of SPRs, unless the Administrator determines otherwise, the Company shall have a repurchase option exercisable upon the voluntary or involuntary termination of the purchaser's employment with the Company for any reason (including death or disability). Such repurchase option lapses at a rate determined by the Administrator. The purchase price for shares repurchased by the Company shall be the original price paid by the purchaser and may be paid by cancellation of any indebtedness of the purchaser to the Company. Long-term performance awards are cash or stock bonus awards, and may be granted alone or in conjunction with other awards under the 1995 Plan.
1995 Employee Stock Purchase Plan
The Company's 1995 Employee Stock Purchase Plan (the "1995 Purchase Plan") was adopted by the Board of Directors in June 1995 and by the stockholders in July 1995. The Company has reserved a total of 1,000,000 shares of Common Stock for issuance under the 1995 Purchase Plan. The 1995 Purchase Plan, which is intended to qualify under Section 423 of the Internal Revenue Code of 1986, as amended, permits eligible employees of the Company to purchase Common Stock through payroll deductions of up to ten percent of their compensation (including commissions, overtime, shift premium, and bonuses), up to a maximum of $21,250 for all purchase periods ending within any calendar year. The price of Common Stock purchased under the 1995 Purchase Plan will be 85% of the lower of the fair market value of the Common Stock on the first or last day of each six month purchase period. Employees may end their participation in the 1995 Purchase Plan at any time during an offering period, and they will be paid their payroll deductions to date. Participation ends automatically upon termination of employment with the Company. Rights granted under the 1995 Purchase Plan are not transferable by a participant other than by will, the laws of descent and distribution, or as otherwise provided under the plan. The 1995 Purchase Plan will be implemented by an initial offering period of approximately 23 months commencing on the first trading day on or after the effective date of this offering and ending on the last trading day in the period ending July 31, 1997. Subsequent offering periods will last 24 months and will commence on the first trading day on or after February 1 and August 1 of each year during which the 1995 Purchase Plan is in effect, and will terminate on the last trading day in the periods ending 24 months later. Each 24-month offering period will consist of four purchase periods of approximately six months duration. The 1995 Purchase Plan will be administered by the Board of Directors or by a committee appointed by the Board. Employees are eligible to participate if they are customarily employed by the Company or any designated subsidiary for at least 20 hours per week and for more than five months in any calendar year.
1995 Director Option Plan
Non-employee directors are entitled to participate in the 1995 Director Option Plan (the "Director Plan"). The Director Plan was adopted by the Board of Directors in June 1995 and by the stockholders in July 1995, but shall not become effective until the effective date of this offering. A total of 100,000 shares of Common Stock has been reserved for issuance under the Director Plan. As of June 30, 1995, there were no options outstanding under the Director Plan.
The Director Plan provides for an automatic grant of an option to purchase 8,000 shares of Common Stock (the "First Option") to each non-employee director on the date on which the Director Plan becomes effective or, if later, on the date on which the person first becomes a non-employee director. After the First Option is granted to the non-employee director, he or she shall automatically be granted an option to purchase 2,000 shares (a "Subsequent Option") on January 1 of each subsequent year provided he or she is then a non- employee director and, provided further, that on such date he or she has served on the Board for at least six months. First Options and each Subsequent Option shall have a term of ten years. Twenty percent of the shares subject to the First Option shall vest on the date ten months after the grant of the option, and an additional two percent of the shares subject to the First Option shall become exercisable each month thereafter, provided that the optionee continues to serve as a director on such dates. One twenty-fourth of the shares subject to a Subsequent Option shall become exercisable at the end of each month after the option grant, provided that the optionee continues to serve as a director on such dates. The exercise prices of the First Option and each Subsequent Option shall be 100% of the fair market value per share of the Company's Common Stock on the date of the grant of the option.
CERTAIN TRANSACTIONS
Since the inception of the Company in April 1994, the Company has issued, in private placement transactions, shares of Preferred Stock as follows: 4,151,000 shares of Series A Preferred Stock at $0.75 per share; 2,857,222 shares of Series B Preferred Stock at $2.25 per share and 2,000,000 shares of Series C Preferred Stock at $9.00 per share. Each share of Preferred Stock will convert on a two-for-one basis into an aggregate of 18,016,444 shares of Common Stock upon the closing of this offering. The holders of such converted shares of Common Stock are entitled to certain registration rights with respect to the Common Stock issued or issuable upon conversion thereof. See "Description of Capital Stock -- Registration Rights." The following table sets forth the series of Preferred Stock and number of shares purchased by the Company's directors, executive officers, five percent stockholders and their respective affiliates:
Series A Series B Series C
Preferred Preferred Preferred
Investor Stock Stock Stock
________ _____ _____ _____
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000,000 500,000 --
25,000 75,000 --
Entities affiliated with Kleiner Perkins Caufield &
Byers(1) -- 2,200,000 --
Adobe Systems Incorporated(2) -- -- 444,445
__________
(1) Includes 1,881,000 shares, 209,000 shares and 110,000 shares held by , KPCB VII Founders Fund and KPCB Information Sciences Zaibatsu Fund II, respectively. is a general partner of KPCB VII Associates, which is a general partner of Kleiner Perkins Caufield & Byers VII, KPCB VII Founders Fund and KPCB Information Sciences Zaibatsu Fund II. serves on the Board of Directors as the representative of the holders of Series B Preferred Stock pursuant to the Company's Amended and Restated Certificate of Incorporation. disclaims beneficial ownership of such shares except for his proportional interest therein.
(2) All shares are held by Adobe. is a founder of Adobe and currently serves as its President and Chief Executive Officer and as a director. Dr. Warnock may therefore be deemed to share voting and investment power with respect to such shares. Dr. Warnock also serves on the Board of Directors as the representative of the holders of Series C Preferred Stock pursuant to the Company's Amended and Restated Certificate of Incorporation.
In May 1994, and , executive officers and directors of the Company, each purchased 720,000 shares of Common Stock at $0.0005 per share (the then fair market value of the Common Stock as determined by the Company's Board of Directors). The Company issued a total of 3,350,000 shares of Common Stock in this financing. In August 1994, , an executive officer of the Company, purchased 400,000 shares of Common Stock at $0.0375 per share (the then fair market value of the Common Stock as determined by the Company's Board of Directors).
The Company has agreed to loan $200,000 to , an executive officer of the Company, to assist in his relocation to the San Francisco Bay Area and purchase of a home. Such loan may be forgiven by the Company when options have vested in full. In June 1995, the Company loaned $135,000 to , an executive officer of the Company, in connection with the exercise of incentive stock options to purchase 300,000 shares of Common Stock at $0.45 per share, with interest payable at a rate of 6.72%. This loan is secured by the Common Stock purchased.
In January 1995, the Company entered into an employment agreement with . See "Management -- Employment Agreements." The Company has also entered into indemnification agreements with each of its executive officers and directors. See "Management -- Limitation of Liability and Indemnification Matters."
The Company believes that all of the transactions set forth above were made on terms no less favorable to the Company then could have been obtained from unaffiliated third parties. All future transactions, including loans, between the Company and its officers, directors and principal stockholders and their affiliates will be approved by a majority of the Board of Directors, including a majority of the independent and disinterested directors of the Board of Directors, and will be on terms no less favorable to the Company than could be obtained from unaffiliated third parties.
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the beneficial ownership of the Company's Common Stock as of June 30, 1995 and as adjusted to reflect the sale of Common Stock offered hereby for (i) each person or entity who is known by the Company to beneficially own one percent or more of the outstanding Common Stock of the Company, (ii) each of the Company's directors, (iii) each of the Named Officers, and (iv) all directors and executive officers of the Company as a group:
Percentage of Shares
Beneficially
Owned(1)
Number of Shares -----------------
Beneficially Before After
Name or Group of Beneficial Owners Owned(1) Offering Offering
_____________________________ ________ ________ ________
(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,340,000 28.2% 24.5%
(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,840,000 11.6 10.1
(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,400,000 13.3 11.5
(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000,000 3.0 2.6
(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888,890 2.7 2.3
(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888,890 2.7 2.3
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888,890 2.7 2.3
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888,890 2.7 2.3
(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600,000 1.8 1.6
. . . . . . . . . . . . . . . . . . . . . . . . . 444,446 1.3 1.2
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 444,446 1.3 1.2
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 444,438 1.3 1.2
(8) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000 1.2 1.0
(9) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000 1.2 1.0
All directors and executive officers as a group (12 persons)(10) . . 22,068,890 66.4 57.8
__________
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 100,000,000 shares of Common Stock, $0.0001 par value, and 5,000,000 shares of undesignated Preferred Stock, $0.0001 par value.
The following summary of certain provisions of the Common Stock and Preferred Stock does not purport to be complete and is subject to, and qualified in its entirety by, the provisions of the Company's Amended and Restated Certificate of Incorporation which is included as an exhibit to the Registration Statement of which this Prospectus is a part and by the provisions of applicable law.
Common Stock
As of June 30, 1995, there were 33,161,444 shares of Common Stock outstanding that were held of record by approximately 212 stockholders. There will be 38,161,444 shares of Common Stock outstanding (assuming no exercise of the Underwriters' over-allotment option and no exercise of outstanding options) after giving effect to the sale of Common Stock offered to the public hereby.
The holders of Common Stock are entitled to one vote for each share held of record on all matters submitted to a vote of stockholders. Subject to preferences that may be applicable to any outstanding shares of Preferred Stock, the holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of funds legally available for the payment of dividends. See "Dividend Policy." In the event of a liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities and liquidation preferences of any outstanding shares of Preferred Stock. Holders of Common Stock have no preemptive rights or rights to convert their Common Stock into any other securities. There are no redemption or sinking fund provisions applicable to the Common Stock. All outstanding shares of Common Stock are fully paid and non-assessable, and the shares of Common Stock to be issued upon completion of this offering will be fully paid and non-assessable.
Preferred Stock
Pursuant to the Company's Amended and Restated Certificate of Incorporation, the Board of Directors has the authority, without further action by the stockholders, to issue up to 5,000,000 shares of Preferred Stock in one or more series and to fix the designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions thereof, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights of the Common Stock. The Board of Directors, without stockholder approval, can issue Preferred Stock with voting, conversion or other rights that could adversely affect the voting power and other rights of the holders of Common Stock. Preferred Stock could thus be issued quickly with terms calculated to delay or prevent a change in control of the Company or make removal of management more difficult. Additionally, the issuance of Preferred Stock may have the effect of decreasing the market price of the Common Stock, and may adversely affect the voting and other rights of the holders of Common Stock. At present, there are no shares of Preferred Stock outstanding and the Company has no plans to issue any of the Preferred Stock.
Antitakeover Effects of Provisions of the Certificate of Incorporation, Bylaws and Delaware Law
Certificate of Incorporation and Bylaws
The Company's Amended and Restated Certificate of Incorporation provides that, upon the closing of this offering, the Company's Board of Directors will be classified into three classes of directors. See "Management -- Executive Officers and Directors." The Amended and Restated Certificate of Incorporation also provides that all stockholder action must be effected at a duly called meeting of stockholders and not by a consent in writing. In addition, the Company's Amended and Restated Bylaws do not permit stockholders of the Company to call a special meeting of stockholders; only the Company's Chief Executive Officer or a majority of the members of the Company's Board of Directors may call a special meeting of stockholders. These provisions of the Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws could discourage potential acquisition proposals and could delay or prevent a change in control of the Company. Such provisions also may have the effect of preventing changes in the management of the Company. See "Risk Factors -- Effect of Certain Charter Provisions; Antitakeover Effects of Certificate of Incorporation, Bylaws and Delaware Law."
Delaware Takeover Statute
The Company is subject to Section 203 of the Delaware General Corporation Law ("Section 203") which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that such stockholder became an interested stockholder, unless: (i) prior to such date, the board of directors of the corporation approved either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned (x) by persons who are directors and also officers and (y) by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or (iii) on or subsequent to such date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 2/3% of the outstanding voting stock which is not owned by the interested stockholder.
Section 203 defines business combination to include: (i) any merger or consolidation involving the corporation and the interested stockholder; (ii) any sale, transfer, pledge or other disposition involving the interested stockholder of 10% or more of the assets of the corporation; (iii) subject to certain exceptions, any transaction which results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder; (iv) any transaction involving the corporation which has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or (v) the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation. In general, Section 203 defines an interested stockholder as any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation and any entity or person affiliated with or controlling or controlled by such entity or person.
Registration Rights
Pursuant to an agreement between the Company and the holders (the "Holders") of approximately 18,016,444 shares of Common Stock (the "Registrable Securities"), the Holders are entitled to certain rights with respect to the registration of such shares under the Securities Act. If the Company proposes to register any of its securities under the Securities Act, either for its own account or for the account of other security Holders exercising registration rights, such Holders are entitled to notice of such registration and are entitled to include shares of such Common Stock therein. Additionally, Holders of the Registrable Securities are also entitled to certain demand registration rights pursuant to which they may require the Company to file a registration statement under the Securities Act at the Company's expense with respect to their shares of Common Stock, and the Company is required to use its best efforts to effect such registration. Further, the Holders of such Registrable Securities may require the Company to file additional registration statements on Form S-3 at the Company's expense. All of these registration rights are subject to certain conditions and limitations, among them the right of the underwriters of an offering to limit the number of shares included in such registration and the right of the Company not to effect a requested registration within nine months following an offering of the Company's securities, including the offering made hereby.
Transfer Agent and Registrar
The Transfer Agent and Registrar for the Company's Common Stock is The First National Bank of Boston. Its address is 435 Tasso Street, Suite 250, Palo Alto, California 94301, and its telephone number at this location is (415) 853-0404.
Listing
The Common Stock has been approved for quotation on the Nasdaq National Market under the symbol "NSCP."
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for the Common Stock of the Company. Future sales of substantial amounts of Common Stock in the public market could adversely affect market prices prevailing from time to time. Furthermore, since only a limited number of shares will be available for sale shortly after this offering because of certain contractual and legal restrictions on resale (as described below), sales of substantial amounts of Common Stock of the Company in the public market after the restrictions lapse could adversely affect the prevailing market price and the ability of the Company to raise equity capital in the future.
Upon completion of this offering, the Company will have outstanding an aggregate of 38,161,444 shares of Common Stock, assuming no exercise of the Underwriters' over-allotment option and no exercise of outstanding options. Of these shares, the 5,000,000 shares sold in this offering will be freely tradeable without restriction or further registration under the Securities Act, unless such shares are purchased by "affiliates" of the Company as that term is defined in Rule 144 under the Securities Act (the "Affiliates"). The remaining 33,161,444 shares of Common Stock held by existing stockholders are "restricted securities" as that term is defined in Rule 144 under the Securities Act ("Restricted Shares"). Restricted Shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144, 144(k) or 701 promulgated under the Securities Act, which rules are summarized below. As a result of the contractual restrictions described below and the provisions of Rules 144, 144(k) and 701, additional shares will be available for sale in the public market as follows: (i) no shares will be eligible for immediate sale on the date of this Prospectus, (ii) 11,436,000 shares will be eligible for sale upon expiration of the lock-up agreements 180 days after the date of this Prospectus and (iii) 21,725,444 shares will be eligible for sale upon expiration of their respective two-year holding periods.
Upon completion of this offering, the holders of 18,016,444 shares of Common Stock, or their transferees, will be entitled to certain rights with respect to the registration of such shares under the Securities Act. See "Description of Capital Stock -- Registration Rights." Registration of such shares under the Securities Act would result in such shares becoming freely tradeable without restriction under the Securities Act (except for shares purchased by Affiliates) immediately upon the effectiveness of such registration.
All officers, directors, stockholders and option holders of the Company have agreed not to sell, make any short sale of, grant any option for the purchase of, or otherwise transfer or dispose of, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock for a period of 180 days after the date of this Prospectus, without the prior written consent of Morgan Stanley & Co. Incorporated. Morgan Stanley & Co. Incorporated currently has no plans to release any portion of the securities subject to lock-up agreements. When determining whether or not to release shares from the lock-up agreements, Morgan Stanley & Co. Incorporated will consider, among other factors, the stockholder's reasons for requesting the release, the number of shares for which the release is being requested and market conditions at the time.
In general, under Rule 144 as currently in effect, beginning 90 days after the date of this Prospectus, a person (or persons whose shares are aggregated) who has beneficially owned Restricted Shares for at least two years (including the holding period of any prior owner except an Affiliate) would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: (i) one percent of the number of shares of Common Stock then outstanding (which will equal approximately 381,614 shares immediately after this offering); or (ii) the average weekly trading volume of the Common Stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a notice on Form 144 with respect to such sale. Sales under Rule 144 are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about the Company. Under Rule 144(k), a person who is not deemed to have been an Affiliate of the Company at any time during the 90 days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least three years (including the holding period of any prior owner except an Affiliate), is entitled to sell such shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144; therefore, unless otherwise restricted, "144(k) shares" may therefore be sold immediately upon the completion of this offering. In general, under Rule 701 of the Securities Act as currently in effect, any employee, consultant or advisor of the Company who purchased shares from the Company in connection with a compensatory stock or option plan or other written agreement is eligible to resell such shares 90 days after the effective date of this offering in reliance on Rule 144, but without compliance with certain restrictions, including the holding period, contained in Rule 144.
The Company intends to file a registration statement under the Securities Act covering shares of Common Stock reserved for issuance under the Company's 1994 Plan, 1995 Plan, Director Plan and 1995 Purchase Plan. Based on the number of options outstanding and options and shares reserved for issuance at June 30, 1995 under all such plans, such registration statement would cover approximately 6,898,672 shares. See "Management -- Stock Plans." Such registration statement is expected to be filed and become effective as soon as practicable after the effective date of this offering. Accordingly, shares registered under such registration statement will, subject to Rule 144 volume limitations applicable to Affiliates, be available for sale in the open market, unless such shares are subject to vesting restrictions with the Company or the lock-up agreements described above. As of June 30, 1995, options to purchase 855,000 shares of Common Stock were issued and outstanding under the 1994 Plan, and no options to purchase shares had been granted under the Company's 1995 Plan, Director Plan, and 1995 Purchase Plan. Subsequent to June 30, 1995, the Board of Directors granted options to purchase an additional 870,600 shares of Common Stock at an exercise price of $9.60 per share, of which options to purchase 443,500 shares were granted under the 1994 Stock Option Plan and options to purchase 427,100 shares were granted under the 1995 Stock Plan. See "Management -- Director Compensation" and "-- Stock Plans."
CERTAIN UNITED STATES FEDERAL TAX CONSIDERATIONS
FOR NON-U.S. HOLDERS OF COMMON STOCK
The following discussion concerns the material United States federal income and estate tax consequences of the ownership and disposition of shares of Common Stock applicable to Non-U.S. Holders of such shares of Common Stock. In general, a "Non-U.S. Holder" is any holder other than (i) a citizen or resident of the United States, (ii) a corporation or partnership created or organized in the United States or under the laws of the United States or any State or (iii) an estate or trust whose income is includible in gross income for United States federal income tax purposes regardless of its source. The discussion is based on current law, which is subject to change retroactively or prospectively, and is for general information only. The discussion does not address all aspects of federal income and estate taxation and does not address any aspects of state, local or foreign tax laws. The discussion does not consider any specific facts or circumstances that may apply to a particular Non-U.S. Holder (including the fact that in the case of a Non-U.S. Holder that is a partnership, the United States tax consequences of holding and disposing of shares of Common Stock may be affected by certain determinations made at the partner level). Accordingly, prospective investors are urged to consult their tax advisors regarding the United States federal, state, local and non-U.S. income and other tax consequences of holding and disposing of shares of Common Stock.
Dividends. Dividends, if any (see "Dividend Policy"), paid to a Non-U.S. Holder generally will be subject to United States withholding tax at a 30% rate (or a lower rate as may be prescribed by an applicable tax treaty) unless the dividends are effectively connected with a trade or business of the Non-U.S. Holder within the United States. Dividends effectively connected with a trade or business will generally not be subject to withholding (if the Non-U.S. Holder properly files an executed United States Internal Revenue Service ("IRS") Form 4224 with the payor of the dividend) and generally will be subject to United States federal income tax on a net income basis at regular graduated rates. In the case of a Non-U.S. Holder which is a corporation, such effectively connected income also may be subject to the branch profits tax (which is generally imposed on a foreign corporation on the repatriation from the United States of effectively connected earnings and profits). The branch profits tax may not apply if the recipient is a qualified resident of certain countries with which the United States has an income tax treaty. To determine the applicability of a tax treaty providing for a lower rate of withholding, dividends paid to a stockholder's address of record in a foreign country are presumed, under the current IRS position, to be paid to a resident of that country, unless the payor has knowledge that such presumption is not warranted or an applicable tax treaty (or United States Treasury Regulations thereunder) requires some other method for determining a Non-U.S. Holder's residence. However, under proposed U.S. Treasury regulations, which have not yet been put into effect, to claim the benefits of a tax treaty, a Non-U.S. Holder of Common Stock would be required to file certain forms accompanied by a statement from a competent authority of the treaty country.
Sale of Common Stock. Generally, a Non-U.S. Holder will not be subject to United States federal income tax on any gain realized upon the disposition of such holder's shares of Common Stock unless (i) the gain is effectively connected with a trade or business carried on by the Non-U.S. Holder with the United States (in which case the branch profits tax may apply); (ii) the Non-U.S. Holder is an individual who holds the shares of Common Stock as a capital asset and is present in the United States for 183 days or more in the taxable year of the disposition and to whom such gain is United States source; (iii) the Non-U.S. Holder is subject to tax pursuant to the provisions of U.S. tax law applicable to certain former United States citizens or residents; or (iv) the Company is or has been a "U.S. real property holding corporation" for federal income tax purposes (which the Company does not believe that it is or is likely to become) at any time during the five year period ending on the date of disposition (or such shorter period that such shares were held) and, subject to certain exceptions, the Non-U.S. Holder held, directly or indirectly, more than five percent of the Common Stock.
Estate Tax. Shares of Common Stock owned or treated as owned by an individual who is not a citizen or resident (as specifically defined for United States federal estate tax purposes) of the United States at the time of death will be includible in the individual's gross estate for United States federal estate tax purposes, unless an applicable tax treaty provides otherwise, and may be subject to United States federal estate tax.
Backup Withholding and Information Reporting
Dividends. The Company must report annually to the IRS and to each Non-U.S. Holder the amount of dividends paid to and the tax withheld, if any, with respect to such holder. These information reporting requirements apply regardless of whether withholding was reduced by an applicable tax treaty. Copies of these information returns may also be available under the provisions of a specific treaty or agreement with the tax authorities in the country in which the Non-U.S. Holder resides. Dividends that are subject to United States withholding tax at the 30% statutory rate or at a reduced tax treaty rate and dividends that are effectively connected with the conduct of a trade or business in the Untied States (if certain certification and disclosure requirements are met) are exempt from backup withholding of U.S. federal income tax. In general, backup withholding at a rate of 31% and information reporting will apply to other dividends paid on shares of Common Stock to holders that are not "exempt recipients" and fail to provide in the manner required certain identifying information (such as the holder's name, address and taxpayer identification number). Generally, individuals are not exempt recipients, whereas corporations and certain other entities generally are exempt recipients.
Disposition of Common Stock. The payment of the proceeds from the disposition of shares of Common Stock through the United States office of a broker will be subject to information reporting and backup withholding unless the holder, under penalties of perjury, certifies, among other things, its status as a Non-U.S. Holder, or otherwise establishes an exemption. Generally, the payment of the proceeds from the disposition of shares of Common Stock to or through a non-U.S. office of a broker will not be subject to backup withholding and will not be subject to information reporting. In the case of the payment of proceeds from the disposition of shares of Common Stock through a non-U.S. office of a broker that is a U.S. person or a "U.S.-related person," existing regulations require information reporting (but not backup withholding) on the payment unless the broker receives a statement from the owner, signed under penalties of perjury, certifying, among other things, its status as a Non-U.S. Holder, or the broker has documentary evidence in its files that the owner is a Non-U.S. Holder and the broker has no actual knowledge to the contrary. For tax purpose, a "U.S.-related person" is (i) a "controlled foreign corporation" for United States federal income tax purposes of (ii) a foreign person 50% or more of whose gross income from all sources for the three year period ending with the close of its taxable year preceding the payment (or for such part of the period that the broker has been in existence) is derived form activities that are effectively connected with the conduct of a United States trade or business.
Any amounts withheld from a payment to a Non-U.S. Holder under the backup withholding rules will be allowed as a credit against such holder's United States federal income tax liability and may entitle such holder to a refund, provided that the required information is furnished to the IRS. Non-U.S Holders should consult their tax advisors regarding the application of these rules to their particular situations, the availability of an exemption therefrom and the procedures for obtaining such an exemption, if available.
UNDERWRITERS
Under the terms and subject to conditions contained in an Underwriting Agreement dated the date hereof, the U.S. Underwriters named below, for whom Morgan Stanley & Co. Incorporated and Hambrecht & Quist LLC are serving as U.S. Representatives, have severally agreed to purchase, and the Company has agreed to sell 4,250,000 shares of the Company's Common Stock, and the International Underwriters named below, for whom Morgan Stanley & Co. International Limited and Hambrecht & Quist LLC are serving as International Representatives (collectively with the U.S. Representatives, the "Representatives"), have severally agreed to purchase, and the Company has agreed to sell 750,000 shares of the Company's Common Stock, which in the aggregate equals the number of shares set forth opposite the name of such Underwriters below.
Number
Name of Shares
____ _________
U.S. Underwriters:
Morgan Stanley & Co. Incorporated . . . . . . . . . . . . . . . . . . . . . . 1,075,000
Hambrecht & Quist LLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,075,000
Bear, Stearns & Co. Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000
Alex. Brown & Sons Incorporated . . . . . . . . . . . . . . . . . . . . . . . . 120,000
Cowen & Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
A.G. Edwards & Sons, Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000
First of Michigan Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Goldman, Sachs & Co . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000
Janney Montgomery Scott Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Kemper Securities, Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Legg Mason Wood Walker, Incorporated . . . . . . . . . . . . . . . . . 60,000
McDonald & Company Securities, Inc . . . . . . . . . . . . . . . . . . . . 60,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated . . . . . . . . 120,000
Montgomery Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000
J.P. Morgan Securities Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000
Morgan, Keegan & Company, Inc . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Needham & Company, Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
PaineWebber Incorporated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000
Punk, Ziegel & Knoell, L.P . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Rauscher Pierce Refsnes, Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Raymond James & Associates, Inc . . . . . . . . . . . . . . . . . . . . . . . 60,000
Salomon Brothers Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000
SoundView Financial Group, Inc . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Sutro & Co. Incorporated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Van Kasper & Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Volpe, Welty & Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Wessels, Arnold & Henderson, L.L.C . . . . . . . . . . . . . . . . . . . . . 60,000
Wheat, First Securities, Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
_____
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,250,000
_______
International Underwriters:
Morgan Stanley & Co. International Limited . . . . . . . . . . . . . . . 375,000
Hambrecht & Quist LLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 375,000
______
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750,000
______
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000,000
The U.S. Underwriters and the International Underwriters are collectively referred to as the "Underwriters." The Underwriting Agreement provides that the obligations of the several Underwriters to pay for and accept delivery of the shares of Common Stock offered hereby are subject to the approval of certain legal matters by counsel and to certain other conditions, including the conditions that no stop order suspending the effectiveness of the Registration Statement is in effect and no proceedings for such purpose are pending before or threatened by the Securities and Exchange Commission and that there has been no material adverse change or any development involving a prospective material adverse change in the business, financial condition or results of operations of the Company and its subsidiaries, taken as a whole, from that set forth in the Registration Statement. The Underwriters are obligated to take and pay for all of the shares of Common Stock offered hereby (other than those covered by the over-allotment option described below) if any are taken.
Pursuant to the Agreement Between U.S. and International Underwriters, each U.S. Underwriter has represented and agreed that, with certain exceptions set forth below, (a) it is not purchasing any U.S. Shares (as defined below) for the account of anyone other than a United States or Canadian Person (as defined below) and (b) it has not offered or sold, and will not offer or sell, directly or indirectly, any U.S. Shares or distribute this Prospectus outside the United States or Canada or to anyone other than a United States or Canadian Person. Pursuant to the Agreement Between U.S. and International Underwriters, each International Underwriter has represented and agreed that, with certain exceptions set forth below, (a) it is not purchasing any International Shares (as defined below) for the account of any United States or Canadian Person and (b) it has not offered or sold, and will not offer or sell, directly or indirectly, any International Shares or distribute this Prospectus within the United States or Canada or to any United States or Canadian Person. The foregoing limitations do not apply to stabilization transactions or to certain other transactions specified in the Agreement Between U.S. and International Underwriters. With respect to Hambrecht & Quist LLC, the foregoing representations or agreements (i) made by it in its capacity as a U.S. Underwriter shall apply only to shares of Common Stock purchased by it in its capacity as a U.S. Underwriter, (ii) made by it in its capacity as an International Underwriter shall apply only to shares of Common Stock purchased by it in its capacity as an International Underwriter and (iii) shall not restrict its ability to distribute this Prospectus to any person. As used herein, "United States or Canadian Person" means any national or resident of the United States or Canada or any corporation, pension, profit-sharing or other trust or other entity organized under the laws of the United States or Canada or of any political subdivision thereof (other than a branch located outside of the United States and Canada of any United States or Canadian Person) and includes any United States or Canadian branch of a person who is not otherwise a United States or Canadian Person, and "United States" means the United States of America, its territories, its possessions and all areas subject to its jurisdiction. All shares of Common Stock to be offered by the U.S. Underwriters and International Underwriters under the Underwriting Agreement are referred to herein as the "U.S. Shares" and the "International Shares," respectively.
Pursuant to the Agreement Between U.S. and International Underwriters, sales may be made between the U.S. Underwriters and the International Underwriters of any number of shares of Common Stock to be purchased pursuant to the Underwriting Agreement as may be mutually agreed. The per share price and currency settlement of any shares of Common Stock so sold shall be the public offering price set forth on the cover page hereof, in United States dollars, less an amount not greater than the per share amount of the concession to dealers set forth below.
Pursuant to the Agreement Between U.S. and International Underwriters, each U.S. Underwriter has represented that it has not offered or sold, and has agreed not to offer or sell, any shares of Common Stock, directly or indirectly, in Canada in contravention of the securities laws of Canada or any province or territory thereof and has represented that any offer of such shares in Canada will be made only pursuant to an exemption from the requirement to file a prospectus in the province or territory of Canada in which such offer is made. Each U.S. Underwriter has further agreed to send to any dealer who purchases from it any shares of Common Stock a notice stating in substance that, by purchasing such shares, such dealer represents and agrees that it has not offered or sold, and will not offer or sell, directly or indirectly, any of such shares in Canada in contravention of the securities laws of Canada or any province or territory thereof and that any offer of shares of Common Stock in Canada will be made only pursuant to an exemption from the requirement to file a prospectus in the province or territory of Canada in which such offer is made, and that such dealer will deliver to any other dealer to whom it sells any of such shares a notice to the foregoing effect.
Pursuant to the Agreement Between U.S. and International Underwriters, each International Underwriter has represented that (i) it has not offered or sold and will not offer or sell any shares of Common Stock to persons in the United Kingdom except to persons whose ordinary activities involve them in acquiring, holding, managing or disposing of investments (as principal or agent) for the purposes of their businesses or otherwise in circumstances which have not resulted and will not result in an offer to the public in the United Kingdom within the meaning of the Public Offers of Securities Regulations 1995 (the "Regulations"); (ii) it has complied and will comply with all applicable provisions of the Financial Services Act 1986 and the Regulations with respect to anything done by it in relation to such shares in, from or otherwise involving the United Kingdom; and (iii) it has only issued or passed on and will only issue or pass on to any person in the United Kingdom any document received by it in connection with the issue of such shares, if that person is of a kind described in Article 11(3) of the Financial Services Act 1986 (Investment Advertisements) (Exemptions) Order 1995, or is a person to whom such document may otherwise lawfully be issued or passed on.
Pursuant to the Agreement Between U.S. and International Underwriters, each International Underwriter has represented and agreed that it has not offered or sold, and will not offer or sell, directly or indirectly, in Japan or to or for the account of any resident thereof, any shares of Common Stock acquired in connection with this offering, except for offers or sales to Japanese International Underwriters or dealers and except pursuant to any exemption from the registration requirements of the Securities and Exchange Law of Japan. Each International Underwriter has further agreed to send to any dealer who purchases from it any of such shares of Common Stock a notice stating in substance that such dealer may not offer or sell any of such shares, directly or indirectly, in Japan or to or for the account of any resident thereof, except pursuant to any exemption from the registration requirements of the Securities and Exchange Law of Japan, and that such dealer will send to any other dealer to whom it sells any of such shares a notice to the foregoing effect.
The Underwriters propose to offer part of the shares of Common Stock offered hereby directly to the public at the public offering price set forth on the cover page hereof and part to certain dealers at a price which represents a concession not in excess of $1.175 per share under the public offering price. The Underwriters may allow, and such dealers may re-allow, a concession not in excess of $.10 per share to other Underwriters or to certain other dealers.
Pursuant to the Underwriting Agreement, the Company has granted to the U.S. Underwriters an option, exercisable for 30 days from the date of this Prospectus, to purchase up to an additional 750,000 shares of Common Stock at the public offering price set forth on the cover page hereof, less underwriting discounts and commissions. The U.S. Underwriters may exercise such option to purchase solely for the purpose of covering over-allotments, if any, incurred in the sale of the shares of Common Stock offered hereby. To the extent such option is exercised, each U.S. Underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of such additional shares as the number set forth next to such U.S. Underwriters' name in the preceding table bears to the total number of shares of Common Stock offered hereby to the U.S. Underwriters.
The Representatives have informed the Company that the Underwriters do not intend to confirm sales to accounts over which they exercise discretionary authority.
The Company and the Underwriters have agreed to indemnify each other against certain liabilities, including liabilities under the Securities Act.
See "Shares Eligible for Future Sale" for a description of certain arrangements by which all officers, directors, stockholders and option holders of the Company have agreed not to sell or otherwise dispose of Common Stock or convertible securities of the Company for up to 180 days after the date of this Prospectus without the prior consent of Morgan Stanley & Co. Incorporated. The Company has agreed in the Underwriting Agreement that it will not, directly or indirectly, without the prior written consent of Morgan Stanley & Co. Incorporated, offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of any shares of Common Stock or any securities convertible into or exchangeable for Common Stock, for a period of 180 days after the date of this Prospectus, except under certain circumstances.
Pricing of the Offering
Prior to this offering, there has been no public market for the Company's Common Stock. The initial public offering price was determined by negotiation between the Company and the Representatives. Among the factors considered in determining the initial public offering price were the future prospects of the Company and its industry in general, sales, earnings and certain other financial and operating information of the Company in recent periods, and the price-earnings ratios, price-sales ratios, market prices of securities and certain financial and operating information of companies engaged in activities similar to those of the Company.
LEGAL MATTERS
Certain legal matters with respect to the legality of the issuance of the shares of Common Stock offered hereby will be passed upon for the Company by Wilson Sonsini Goodrich & Rosati, Professional Corporation, 650 Page Mill Road, Palo Alto, California 94304. Certain legal matters in connection with this offering will be passed upon for the Underwriters by Morrison & Foerster, 755 Page Mill Road, Palo Alto, California 94304.
EXPERTS
The consolidated financial statements and schedule of the Company at December 31, 1994 and for the period from April 4, 1994 (inception) to December 31, 1994 appearing in this Prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein and in the Registration Statement, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the "Commission"), Washington, D.C. 20549, a Registration Statement on Form S-1 under the Securities Act with respect to the shares of Common Stock offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement and the exhibits and schedules thereto. Certain items are omitted in accordance with the rules and regulations of the Commission. For further information with respect to the Company and the Common Stock offered hereby, reference is made to the Registration Statement and the exhibits and schedules filed therewith. Statements contained in this Prospectus as to the contents of any contract or any other document referred to are not necessarily complete, and, in each instance, reference is made to the copy of such contract or other document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. A copy of the Registration Statement, and the exhibits and schedules thereto, may be inspected without charge at the public reference facilities maintained by the Commission in Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices located at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and Seven World Trade Center, 13th Floor, New York, New York 10048, and copies of all or any part of the Registration Statement may be obtained from such offices upon the payment of the fees prescribed by the Commission.
(This Page Intentionally Left Blank)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors .
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . . .
Consolidated Statements of Operations . . . . . . . . . . . . .
Consolidated Statements of Stockholders' Equity . . . . .
Consolidated Statements of Cash Flows . . . . . . . . . . . . .
Notes to Consolidated Financial Statements . . . . . . . . .
Page
____
F-2
F-3
F-4
F-5
F-6
F-7
--------------------------------------------------------------------------------
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
We have audited the accompanying consolidated balance sheet of as of December 31, 1994 and the related consolidated statements of operations, stockholders' equity and cash flows for the period from inception (April 4, 1994) to December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AOL / Netscape Communications at December 31, 1994, and the consolidated results of its operations and its cash flows for the period from inception (April 4, 1994) to December 31, 1994, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Palo Alto, California
February 22, 1995,
except for Note 10,
as to which the date is
June 19, 1995
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
ASSETS
Pro Forma
Stockholders'
Equity
December 31, June 30, June 30,
1994 1995 1995
------------ ------------ ------------
(Unaudited) (Unaudited)
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . $3,243,510 $8,868,436
Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . -- 16,567,300
Accounts receivable, net of allowance for
doubtful accounts of $131,153 in 1995 . . . . . . . . . . . 701,649 8,277,869
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67,284 804,971
_____ ______
Total current assetss . . . . . . . . . . . . . . . . . . . 4,012,443 34,518,576
Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . 2,447,098 6,761,045
Deposits and other assets . . . . . . . . . . . . . . . . . . . . . . . . . 699,100 1,251,582
______ ________
$7,158,641 $42,531,203
_________ __________
_________ __________
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $855,068 $4,607,174
Accrued compensation and related liabilities . . . . . . . 527,340 1,075,066
Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . 667,503 1,897,819
Deferred revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,575,145 14,963,843
Current portion of long-term obligations . . . . . . . . . . . 725,000 725,000
Installment notes payable . . . . . . . . . . . . . . . . . . . . . . . -- 551,449
__ ______
Total current liabilitiess . . . . . . . . . . . . . . . . . 5,350,056 23,820,351
Long-term obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . 725,000 725,000
Installment notes payable . . . . . . . . . . . . . . . . . . . . . . . . . -- 1,511,331
Commitments and contingencies . . . . . . . . . . . . . . . . . . .
Stockholders' equity:
Preferred stock, $0.0001 par value; issuable in
series; 7,608,222 shares in 1994 and
11,286,222 shares in 1995 authorized,
7,008,222 shares in 1994 and 9,008,222 shares
in 1995 issued and outstanding; aggregate
liquidation preference of $27,541,999
(5,000,000 shares authorized, none issued and
outstanding, pro forma) . . . . . . . . . . . . . . . . . . . . . . . 701 901 --
Common stock, $0.0001 par value; 30,000,000
shares authorized, 4,511,000 shares in 1994
and 15,145,000 shares in 1995 issued and
outstanding (100,000,000 shares authorized,
33,161,444 shares issued and outstanding, pro
forma) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 451 1,514 3,316
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . 9,552,278 39,683,666 39,682,765
Notes receivable from stockholders . . . . . . . . . . . . . . . -- (638,065) (638,065)
Deferred compensationn . . . . . . . . . . . . . . . . . . . . . . . . -- (9,812,151) (9,812,151)
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,469,845) (12,777,561) (12,777,561)
Accumulated translation adjustment . . . . . . . . . . . . . . -- 16,217 16,217
__ _____ _____
Total stockholders' equity . . . . . . . . . . . . . . . 1,083,585 16,474,521 $16,474,521
$7,158,641 $42,531,203 __________
_________ __________ __________
_________ __________
See accompanying notes.
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
Inception Inception Six Months
(April 4, 1994) to April 4, 1994) to Ended
December 31, June 30, June 30,
1994 1994 1995
------------------ ------------------ ------------------
Revenues: (Unaudited) (Unaudited)
Product revenues . . . . . . . . . . . . . . . . . . . . . . . $378,490 $-- $15,580,258
Service revenues . . . . . . . . . . . . . . . . . . . . . . . . 317,381 -- 1,045,133
______ __ ______
Total revenues . . . . . . . . . . . . . . . . . . 695,871 -- 16,625,391
Cost of revenues:
Cost of product revenues . . . . . . . . . . . . . . . . . 114,777 -- 1,222,045
Cost of service revenues . . . . . . . . . . . . . . . . . 104,313 -- 513,767
_____ __ _____
Total cost of revenues . . . . . . . . . . . 219,090 -- 1,735,812
_____ __ _____
Gross profit 476,781 -- 14,889,579
Operating expenses:
Research and development . . . . . . . . . . . . . . . . 2,031,986 172,065 6,115,152
Sales and marketing . . . . . . . . . . . . . . . . . . . . . . 2,813,689 48,369 9,256,066
General and administrative . . . . . . . . . . . . . . . . 1,669,193 232,519 3,693,005
Property rights agreement and related
charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,486,688 -- 500,000
______ __ _____
Total operating expenses . . . . . . . . . . 9,001,556 452,953 19,564,223
______ ______ _______
Operating loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,524,775) (452,953) (4,674,644)
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55,238 -- 495,583
_____ ___ ______
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . (308) -- (128,655)
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(8,469,845) $(452,953) $(4,307,716)
_______ _______ ________
_______ _______ ________
Net loss per share . . . . . . . . . . . . . . . . . . . . . . . . . . $(0.26) $(0.01) $(0.13)
_____ _____ ______
_____ _____ ______
Shares used in computing net loss per share . . . 32,256,307 30,767,418 33,000,751
_______ _______ ________
_______ _______ ________
See accompanying notes.
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Notes
Additional Receivable Accumulated Total
Preferred Common Paid-in from Deferred Accumulated Translation Stockholders'
Stock Stock Capital Stockholders Compensation Deficit Adjustment Equity
_____ _____ ______ ___________ ___________ ______ __________ _____
Issuance of 3,750,000
shares of common
stock to founders
and employees for
cash . . . . . . . . . . . . . . . . $-- $375 $16,300 $-- $-- $-- $-- $16,675
Issuance of 4,151,000
shares of Series A
convertible
preferred stock at
$0.75 per share for
cash and
technology . . . . . . . . . . 415 -- 3,112,835 -- -- -- -- 3,113,250
Issuance of 2,857,222
shares of Series B
convertible
preferred stock at
$2.25 per share for
cash, net of
issuance costs of
$33,933 . . . . . . . . . . . . . . 286 -- 6,394,531 -- -- -- -- 6,394,817
Exercise of 761,000
shares of common
stock options . . . . . . . . -- 76 28,612 -- -- -- -- 28,688
Net loss . . . . . . . . . . . . . . -- -- -- -- -- (8,469,845) -- (8,469,845)
Net loss . . . . . . . . . . . . . . __ __ __ __ __ _________ __ _________
Balance at December
31, 1994 . . . . . . . . . . . . . 701 451 9,552,278 -- -- (8,469,845) -- 1,083,585
Issuance of
10,634,000 shares
of common stock
upon exercise of
stock options, net
of repurchases for
cash and notes
(unaudited) . . . . . . . . . . -- 1,063 1,744,535 (638,065) -- -- -- 1,107,533
Issuance of 2,000,000
shares of Series C
convertible
preferred stock at
$9.00 per share for
cash, net of
issuance costs of
$700,000
(unaudited) . . . . . . . . . . 200 -- 17,299,800 -- -- -- -- 17,300,000
Deferred compensation
related to grant of
stock options
(unaudited) . . . . . . . . . . -- -- 11,087,053 -- (11,087,053) -- -- --
Amortization of
deferred
compensation
(unaudited) . . . . . . . . . . -- -- -- -- 1,274,902 -- -- 1,274,902
Net loss
(unaudited) . . . . . . . . . . -- -- -- -- -- (4,307,716 ) -- (4,307,716)
Accumulated
translation
adjustment
(unaudited) . . . . . . . . . . -- -- -- -- -- -- 16,217 16,217
__ __ __ __ __ __ _____ _____
Balance at June 30,
1995 (unaudited) $901 $1,514 $39,683,666 $(638,065) $(9,812,151 ) $(12,777,561) $16,217 $16,474,521
____ _____ __________ _________ ___________ ____________ ______ __________
____ _____ __________ _________ ___________ ____________ ______ __________
See accompanying notes.
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
Inception Inception Six Months
(April 4, 1994) to (April 4, 1994) to Ended
December 31, June 30, June 30,
1994 1994 1995
------------------ ------------------ -------------
(Unaudited) (Unaudited)
Cash flows from operating activities
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(8,469,845) $(452,953) $(4,307,716)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Amortization of deferred compensation . . . . . . . . . . . . -- -- 1,274,902
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . 215,868 9,133 701,698
Changes in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (701,649) (17,302) (7,576,220)
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (67,284) (52,411) (737,687)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 855,068 14,519 3,752,106
Accrued compensation and related
liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 527,340 114,396 547,726
Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 667,503 -- 1,246,533
Deferred revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,575,145 -- 12,388,698
Long-term obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,450,000 -- --
________ __ __
Net cash (used in) provided by operating
activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,947,854) (384,618) 7,290,040
__________ ________ ________
Cash flows from investing activities . . . . . . . . . . . . . . . . . . .
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,662,966) (346,131) (4,954,920)
Increase in deposits and other assets . . . . . . . . . . . . . . . . . . (654,100) (42,973) (613,207)
Purchase of short-term investments . . . . . . . . . . . . . . . . . . . -- -- (16,567,300)
__ __ ___________
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . (3,317,066) (389,104) (22,135,427)
Cash flows from financing activities
Proceeds from the issuance of installment
notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- -- 2,200,000
Payments on installment notes payable . . . . . . . . . . . . . . . . -- -- (137,220)
Proceeds from issuance of preferred stock, net . . . . . . . . . . 9,463,067 1,000,000 17,300,000
Proceeds from issuance of common stock, net . . . . . . . . . . 45,363 1,675 1,107,533
_____ ____ ________
Net cash provided by financing activities . . . . . . . . . . . . . . 9,508,430 1,001,675 20,470,313
Net increase in cash and cash equivalents . . . . . . . . . . . . . . 3,243,510 227,953 5,624,926
Cash and cash equivalents at beginning of
__ __ ________
Cash and cash equivalents at end of period . . . . . . . . . . . . . $3,243,510 $227,953 $8,868,436
_________ _______ _________
_________ _______ _________
See accompanying notes.
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
The Company
("GDK" or the "Company") provides open client, server and integrated applications software that enables information exchange and commerce over the Internet and private Internet Protocol networks. The Company was formed in April 1994 and commenced shipment of its initial products in December 1994.
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated.
Interim Financial Information
The interim financial information for 1994 and 1995 is unaudited but includes all adjustments, consisting only of normal recurring adjustments, which the Company considers necessary for a fair presentation of the financial position at such date and the operating results and cash flows for those periods. Results of the six months ended July 30, 1995 are not necessarily indicative of results for the entire year.
Revenue Recognition
The Company's product revenues are derived from product licensing fees, while service revenues are derived from fees for maintenance and support, training, consulting and advertising space. Product revenues are generally recognized upon delivery, net of allowances for estimated future returns, provided that no significant vendor obligations remain and collection of the resulting receivable is deemed probable. Service revenues from customer maintenance fees for ongoing customer support and product updates are recognized ratably over the term of the maintenance period which is typically 12 months. Payments for maintenance fees are generally made in advance and are nonrefundable. Service revenues from training and consulting are recognized when the services are performed. Service revenues from the sale of advertising space are recognized in the period in which the advertisement is displayed on a Web page of the Company. Costs related to insignificant obligations, primarily telephone support, are accrued upon shipment and included in cost of goods sold.
Cash, Cash Equivalents and Short-Term Investments
Effective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities". The cumulative effect as of January 1, 1995 was immaterial.
Cash and cash equivalents consist of cash on deposit with banks and money market instruments with original maturities of 90 days or less. Short-term investments, classified as available-for-sale, consist of high quality debt securities with original maturities greater than 90 days, such debt securities, which generally mature within one year from June 30, 1995. Short-term investments are stated at amortized cost as of June 30, 1995. The difference between amortized cost and market value as of June 30, 1995 was immaterial.
The following table details the Company's investments as of June 30, 1995:
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
____ _____ ______ _________
U.S. corporate notes . . . $16,567,300 $27,685 ($16,273) $16,578,712
__________ ______ _______ __________
__________ ______ _______ __________
Depreciation and Amortization
Depreciation is provided using the straight-line method over the estimated useful lives of the assets, generally three to five years. Leasehold improvements are amortized over the lesser of the term of the lease or the estimated useful life of the asset.
Concentration of Credit Risk
The Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have been within management's expectations.
Research and Development
Research and development expenditures are charged to operations as incurred. Statement of Financial Accounting Standard No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," requires capitalization of certain software development costs subsequent to the establishment of technological feasibility.
Based on the Company's product development process, technological feasibility is established upon completion of a working model. Costs incurred by the Company between completion of the working model and the point at which the product is ready for general release have been insignificant. All research and development costs have been expensed.
Per Share Amounts
Net loss per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Pursuant to the Securities and Exchange Commission Staff Accounting Bulletins and Staff Policy, such computations include all common and common equivalent shares issued within 12 months of the filing date as if they were outstanding for all periods presented using the treasury stock method. Common equivalent shares consist of the incremental common shares issuable upon conversion of the convertible preferred stock (using the if-converted method) and shares issuable upon the exercise of stock options (using the treasury stock method).
Reclassification
Certain prior period balances have been reclassified to conform with current period presentation.
2. Property and Equipment
Property and equipment, at cost, consists of the following:
December 31, June 30,
1994 1995
------------ -----------
(Unaudited)
Computers and equipment . . . . . . . . $2,169,537 $6,192,974
Furniture and fixtures . . . . . . . . . . . . 486,439 1,133,314
Leasehold improvements . . . . . . . . . 6,990 291,598
____ ______
2,662,966 7,617,886
Less accumulated depreciation . . . . 215,868 856,841
______ ______
$2,447,098 $6,761,045
_________ _________
_________ _________
3. Leases
The Company leases its facilities and certain other equipment under operating lease agreements expiring through December 31, 2001. Future minimum payments as of December 31, 1994 under these leases, net of sublease payments, are as follows:
1995 . . . . . . . . . . . . . . . . . . . . $815,750
1996 . . . . . . . . . . . . . 1,480,860
1997 . . . . . . . . . . . . . 1,480,860
1998 . . . . . . . . . . . . . 1,588,720
1999 and thereafter . . . . . . . 4,864,227
________
$10,230,417
Rent expense for the period from inception (April 4, 1994) to December 31, 1994 was $59,287, net of sublease payments.
4. Installment Notes Payable
On March 3, 1995, the Company entered into a senior loan agreement for total borrowings not to exceed $2,200,000. Borrowings made under the agreement are secured by certain assets of the Company. The notes are payable in 36 monthly installments. Maturities subsequent to June 30, 1995 are as follows: $262,116 in 1995; $600,716 in 1996; $713,150 in 1997 and $486,798 in 1998.
5. Property Rights Agreement
On December 20, 1994, the Company entered into an agreement with the University of Illinois (the "University") and Spyglass, Inc. ("Spyglass"). Under the terms of the agreement, the University and Spyglass agreed not to assert any claim of trademark infringement arising out of the Company's prior use of the word "Mosaic" or other symbols or words used by the Company to market itself or its products. The University and Spyglass further agreed not to assert against the Company any claim of copyright infringement, trade secret misappropriation or related claims based on the Company's use of former University employees in the development of the Company's present and future products. As consideration for these covenants not to assert, the Company agreed to make certain payments to the University over a two year period. The amount of this agreement and associated costs, including fees for experts and professional services, as well as trademark search and other costs, was expensed in 1994 and was included as "Property rights agreement and related charges" on the consolidated statements of operations. Certain amounts become payable to the University in 1995 and 1996, and have been recorded as long-term obligations.
If over the term of the agreement (two years from December 21, 1994) the Company enters into a license, distribution, remarketing or sublicensing agreement with certain specific companies, the Company may pay up to $1.3 million to the University. During the six months ended June 30, 1995, the Company made two such additional payments totaling $500,000. In addition, if over the term of the agreement any of these companies acquires a controlling interest in the Company, there is a per unit royalty paid to the University over the remaining term.
6. Stockholders' Equity
Preferred Stock
Preferred stock as of December 31, 1994 consists of the following convertible preferred stock, par value $0.0001 per share:
Shares Shares Issued Liquidation
Authorized and Outstanding Preference
_________ ____________ __________
Series A . . . . . . . . . . 4,151,000 4,151,000 $3,113,250
Series B . . . . . . . . . . 3,457,222 2,857,222 6,428,749
________ ________ ________
7,608,222 7,008,222 $9,541,999
________ ________ ________
________ ________ ________
Each share of Series A and B preferred stock is convertible into common stock at the option of the holder on a two-for-one basis, subject to certain adjustments. Each series of preferred stock will automatically convert upon the earliest of the closing date of an underwritten public offering of the Company's common stock with aggregate proceeds of more than $10,000,000 or the date of written consent of the holders of a majority of the outstanding shares of the preferred stock. The Company has reserved a sufficient number of shares of common stock to permit conversion of the preferred stock in accordance with its terms.
Holders of the preferred stock are entitled to one vote for each share of common stock into which such shares may be converted. Each share of Series A and B preferred stock entitles the holder to receive noncumulative dividends, if and when declared by the board of directors, prior to any dividend paid on the common stock. Dividends, if any, on preferred stock shall be declared at an annual rate of $0.0675 per share for Series A preferred stock and $0.20 per share for Series B preferred stock. As of December 31, 1994, no dividends have been declared.
In the event of liquidation, the preferred stock has preference over the common stock in the amounts of $0.75 and $2.25 per share for the Series A and B preferred stock, respectively, plus declared but unpaid dividends.
Common Stock
All shares of common stock issued by the Company at December 31, 1994 were subject to stock repurchase agreements whereby the Company has the option to repurchase the unvested shares upon termination of employment for any reason, with or without cause, at the original price paid for the shares. Generally, the stock vests over 50 months from the date of issuance.
In addition, the Company has the right of first refusal upon sale or transfer of shares of common stock. This right will expire upon the Company's initial public offering.
1994 Stock Option Plan
During 1994, the Company adopted the 1994 Stock Option Plan under which incentive stock options or nonqualified stock options to purchase common stock may be granted to employees and certain consultants or independent contractors. Under the Plan, options to purchase common stock may be granted at prices not less than 85% of the fair value on the date of grant (110% of fair value in certain instances), as determined by the board of directors. Options granted are immediately exercisable and the resulting shares issued to employees under the Plan are subject to repurchase by the Company, at the discretion of the Company, upon the individual's cessation of service prior to vesting in the shares at the original purchase price. The right expires as determined by the board of directors, generally over a 50-month period.
A summary of activity under the option portion of the Plan is as follows:
Options Outstanding
Shares ------------------------------
Available
for Number of Price Per
Grant Shares Share
_____ ______ _____
Shares reserved . . . . . . . . . . . . . . . . . . 5,729,232 -- --
Options granted . . . . . . . . . . . . . . . . . . (3,261,200) 3,261,200 $0.038-$0.1125
Options cancelled . . . . . . . . . . . . . . . . . 640,000 (640,000) $0.038
Options exercised . . . . . . . . . . . . . . . . . -- (761,000) $0.038-$0.1125
__ _______ _____________
__ _______ _____________
Balance at December 31, 1994 . . . . . . 3,108,032 1,860,200 $0.038-$0.1125
Shares reserved (unaudited) . . . . . . . . 3,307,440 -- --
Options granted (unaudited) . . . . . . . . (6,255,000) 6,255,000 $0.1125-$9.60
Options cancelled (unaudited) . . . . . . . 283,200 (283,200) $0.038-$0.1125
Options exercised (unaudited) . . . . . . . -- (6,977,000) $0.038-$0.45
__ __________ __________
__ __________ __________
Balance at June 30, 1995 (unaudited) . 443,672 855,000 $0.038-$9.60
______ ______ __________
______ ______ __________
In the six months ended June 30, 1995, the Company granted an option to purchase 4,000,000 shares of common stock outside of the Plan. The exercise price was $0.1125 per share. This option was immediately exercisable in its entirety with 2,000,000 shares subject to repurchase at the option of the Company upon the individual's cessation of service prior to vesting in the shares at the original purchase price. The remaining stock vests over a 50-month period. In the six months ended June 30, 1995, the option was exercised.
At December 31, 1994, no options were vested and 3,947,000 shares of common stock were subject to repurchase at the option of the Company at the original purchase price. In the six months ended June 30, 1995, the Company repurchased 343,000 shares of common stock at the original exercise price. At June 30, 1995, no options for shares were vested and 12,429,460 shares were subject to repurchase.
The Company has recorded deferred compensation expense of $11,087,053 for the difference between the grant price and the deemed fair value of certain of the Company's common stock options granted in 1995. This amount is being amortized over the vesting period of the individual options, generally a 50-month period. Deferred compensation expense attributed to 2,000,000 shares of common stock was fully amortized at June 30, 1995, as such shares were fully vested upon grant. Deferred compensation expense recognized in the six months ended June 30, 1995 totaled $1,274,902.
Unaudited Pro Forma Stockholders' Equity
Unaudited pro forma stockholders' equity at June 30, 1995 gives effect to a two-for-one conversion of 9,008,222 shares of preferred stock into common stock upon the close of the Company's initial public offering of shares of its common stock.
7. Income Taxes
As of December 31, 1994, the Company had federal net operating loss carryforwards of approximately $7,000,000. The Company also had federal research and development tax credit carryforwards of approximately $90,000. The net operating loss and credit carryforwards will expire in 2009 if not utilized. The Company also has state net operating loss carryforwards of approximately $5,000,000 which will expire in 2002 if not utilized.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and the amount used for income tax purposes. As of December 31, 1994, the Company had deferred tax assets of approximately $3,500,000 relating primarily to net operating loss carryforwards. The net deferred tax asset has been fully offset by a valuation allowance.
Utilization of the net operating losses and credits may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986 and similar state provisions.
8. Benefit Plan
The Company maintains a 401(k) retirement savings plan for its full time employees. Each participant in the Plan may elect to contribute from 1% to 15% of his or her annual compensation to the Plan. The Company, at its discretion, may make contributions to the Plan, however has made none through June 30, 1995.
9. Segment Information
The Company conducts its business within one industry segment. Two customers accounted for 45% and 36% of total revenues in the period from inception (April 4, 1994) through December 31, 1994. No customer accounted for more than 10% of total revenues in the six months ended June 30, 1995.
Revenues to customers outside North America were less than 10% of total revenues in the period from inception (April 4, 1994) through December 31, 1994 and were approximately 13% of total revenues in the six months ended June 30, 1995.
10. Subsequent Events
In April 1995, the Company issued 2,000,000 shares of Series C convertible preferred stock to investors at $9.00 per share, resulting in net cash proceeds of approximately $17,300,000 to the Company. In conjunction with the issuance, the Company increased the number of authorized preferred shares to 11,286,222 of which 2,278,000 have been designated Series C and 2,000,000 have been undesignated, and increased the number of authorized common shares to 30,000,000. Holders of Series C preferred stock are entitled to noncumulative dividends of $0.81 per share if and when declared by the board of directors and in advance of any distribution to Series A or B preferred stock or common stock. Each share of Series C preferred stock is convertible into common stock at the option of the holder on a two-for-one basis, subject to certain adjustments. Each series of preferred stock will automatically convert upon the earliest of the closing date of an underwritten public offering of the Company's common stock with aggregate proceeds of more than $15,000,000 at a public offering price of not less than $6.00 per share until April 5, 1996 or $7.50 after April 5, 1996 or the date of written consent of the holders of a majority of the outstanding shares of the preferred stock and of the Series C preferred stock.
On June 19, 1995, the board of directors authorized management of the Company to file a Registration Statement with the Securities and Exchange Commission permitting the Company to sell shares of its common stock to the public. In addition, the Company's board of directors authorized an increase in the number of authorized common and preferred shares to 100,000,000 and 5,000,000 shares, respectively. In addition, the Company's board of directors initiated a two-for-one stock split. Accordingly, all the common share and per share data has been adjusted to reflect this change. At the same meeting, the Company's board of directors adopted the 1995 Employee Stock Purchase Plan (the "Purchase Plan") which authorizes the issuance of 1,000,000 shares of common stock. Shares may be purchased under the Purchase Plan at 85% of the lesser of the fair market value of the common stock on the grant or purchase date. In addition, the Company's board of directors adopted the 1995 Stock Plan and 1995 Director Stock Option Plan which authorized the issuance of 4,500,000 shares and 100,000 shares of common stock, respectively.