-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WTNE7zw07pVDYivkChLJREnve+AlFBx/3B1n67qPyisfk3T6e5e66l4Njt/J0TKV JyK1Goa9VzF0+TVfStmJvw== 0000912057-97-021698.txt : 19970625 0000912057-97-021698.hdr.sgml : 19970625 ACCESSION NUMBER: 0000912057-97-021698 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19970624 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: LIVINGSTON ENTERPRISES INC CENTRAL INDEX KEY: 0001039111 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 770127305 STATE OF INCORPORATION: CA FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-27335 FILM NUMBER: 97628839 BUSINESS ADDRESS: STREET 1: 4464 WILLOW RD CITY: PLEASANTON STATE: CA ZIP: 94588 BUSINESS PHONE: 5107372100 MAIL ADDRESS: STREET 1: 4464 WILLOW RD STREET 2: 4464 WILLOW RD CITY: PLEASANTON STATE: CA ZIP: 04588 S-1/A 1 FORM S-1/A AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 24, 1997 REGISTRATION NO. 333-27335 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 2 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ LIVINGSTON ENTERPRISES, INC. (Exact name of Registrant as specified in its charter) CALIFORNIA 7373 77-0127305 (State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer of Classification Code Number) Identification incorporation or organization) Number)
4464 WILLOW ROAD PLEASANTON, CALIFORNIA 94588 (510) 737-2100 (Address, including zip code, and telephone number, including area code, of Registrant's principal executive offices) STEVEN M. WILLENS PRESIDENT AND CHIEF EXECUTIVE OFFICER LIVINGSTON ENTERPRISES, INC. 4464 WILLOW ROAD PLEASANTON, CALIFORNIA 94588 (510) 737-2100 (Name, address, including zip code, and telephone number, including area code, of agent for service) -------------------------- COPIES TO: Steven E. Bochner, Esq. William L. Hudson, Esq. Nevan C. Elam, Esq. Randall M. Lake, Esq. Richard S. Arnold, Jr., Esq. Brobeck, Phleger & Harrison LLP Wilson Sonsini Goodrich & Rosati Spear Street Tower One Market Plaza Professional Corporation San Francisco, California 94105 650 Page Mill Road (415) 442-0900 Palo Alto, California 94304 (415) 493-9300
-------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. -------------------------- If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box: / / If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: / / If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box: / / -------------------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. PROSPECTUS (SUBJECT TO COMPLETION) ISSUED JUNE , 1997 SHARES [LOGO] COMMON STOCK ----------------- OF THE SHARES OF COMMON STOCK OFFERED HEREBY, SHARES ARE BEING SOLD BY THE COMPANY AND SHARES ARE BEING SOLD BY A SELLING SHAREHOLDER. SEE "PRINCIPAL AND SELLING SHAREHOLDERS." THE COMPANY WILL NOT RECEIVE ANY OF THE PROCEEDS FROM THE SALE OF SHARES BY THE SELLING SHAREHOLDERS. PRIOR TO THIS OFFERING, THERE HAS BEEN NO PUBLIC MARKET FOR THE COMMON STOCK OF THE COMPANY. IT IS CURRENTLY ESTIMATED THAT THE INITIAL PUBLIC OFFERING PRICE WILL BE BETWEEN $ AND $ PER SHARE. SEE "UNDERWRITERS" FOR A DISCUSSION OF THE FACTORS TO BE CONSIDERED IN DETERMINING THE INITIAL OFFERING PRICE. APPLICATION HAS BEEN MADE TO LIST THE SHARES FOR QUOTATION ON THE NASDAQ NATIONAL MARKET UNDER THE SYMBOL "LIVS." ------------------------ THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" COMMENCING ON PAGE 5 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 $ A SHARE -------------------
UNDERWRITING PROCEEDS TO PRICE TO DISCOUNTS AND PROCEEDS TO SELLING PUBLIC COMMISSIONS (1) COMPANY (2) SHAREHOLDERS --------------- --------------- --------------- -------------- PER SHARE............................... $ $ $ $ TOTAL (3)............................... $ $ $ $
- ------------ (1) THE COMPANY AND THE SELLING SHAREHOLDERS HAVE AGREED TO INDEMNIFY THE UNDERWRITERS AGAINST CERTAIN LIABILITIES, INCLUDING LIABILITIES UNDER THE SECURITIES ACT OF 1933, AS AMENDED. SEE "UNDERWRITERS." (2) BEFORE DEDUCTING EXPENSES PAYABLE BY THE COMPANY ESTIMATED AT $ . (3) THE COMPANY AND CERTAIN SELLING SHAREHOLDERS HAVE GRANTED THE UNDERWRITERS AN OPTION, EXERCISABLE WITHIN 30 DAYS OF THE DATE HEREOF, TO PURCHASE UP TO AN AGGREGATE OF AND ADDITIONAL SHARES OF COMMON STOCK, RESPECTIVELY, AT THE PRICE TO PUBLIC LESS UNDERWRITING DISCOUNTS AND COMMISSIONS FOR THE PURPOSE OF COVERING OVER-ALLOTMENTS, IF ANY. IF THE UNDERWRITERS EXERCISE SUCH OPTION IN FULL, THE TOTAL PRICE TO PUBLIC, UNDERWRITING DISCOUNTS AND COMMISSIONS, PROCEEDS TO COMPANY AND PROCEEDS TO SELLING SHAREHOLDERS WILL BE $ , $ , $ AND $ , 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 BROBECK, PHLEGER & HARRISON LLP, COUNSEL FOR THE UNDERWRITERS. IT IS EXPECTED THAT DELIVERY OF THE SHARES WILL BE MADE ON OR ABOUT , 1997 AT THE OFFICE OF MORGAN STANLEY & CO. INCORPORATED, NEW YORK, N.Y., AGAINST PAYMENT THEREFOR IN IMMEDIATELY AVAILABLE FUNDS. ------------------- MORGAN STANLEY DEAN WITTER HAMBRECHT & QUIST ROBERTSON, STEPHENS & COMPANY , 1997 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, ANY SELLING SHAREHOLDER 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 , 1997 (25 DAYS AFTER THE COMMENCEMENT OF THE 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. ------------------------ TABLE OF CONTENTS
PAGE ----- Prospectus Summary......................................................................................... 3 The Company................................................................................................ 4 Risk Factors............................................................................................... 5 Use of Proceeds............................................................................................ 16 Dividend Policy............................................................................................ 16 Capitalization............................................................................................. 17 Dilution................................................................................................... 18 Selected Consolidated Financial Data....................................................................... 19 Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 20 Business................................................................................................... 27 Management................................................................................................. 38 Certain Transactions....................................................................................... 45 Principal and Selling Shareholders......................................................................... 46 Description of Capital Stock............................................................................... 48 Shares Eligible for Future Sale............................................................................ 49 Underwriters............................................................................................... 51 Legal Matters.............................................................................................. 53 Experts.................................................................................................... 53 Additional Information..................................................................................... 53 Index to Consolidated Financial Statements................................................................. F-1
------------------------ The Company intends to furnish to its shareholders 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 unaudited consolidated financial information. ------------------------ The Company's logo, Livingston, PortMaster, ComOS, PMconsole, RADIUS and ChoiceNet are trademarks of the Company. ProVision is a service mark of the Company. This Prospectus also includes product names and other trade names and trademarks of the Company and of other organizations. ------------------------ UNLESS OTHERWISE INDICATED, THE INFORMATION IN THIS PROSPECTUS DOES NOT GIVE EFFECT TO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION. ------------------------ CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK. SPECIFICALLY, THE UNDERWRITERS MAY OVERALLOT IN CONNECTION WITH THE OFFERING, AND MAY BID FOR, AND PURCHASE, SHARES OF COMMON STOCK IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITERS." 2 INTEGRATED REMOTE ACCESS SOLUTIONS FOR INTERNET SERVICE PROVIDERS Livingston's high performance, integrated remote access solutions enable Internet Service Providers ("ISPs") worldwide to cost-effectively connect their subscribers to the Internet. All of the Company's remote access products incorporate Livingston's ComOS operating system, which has been architected specifically for remote access applications to provide robust routing, security, centralized device management and subscriber administration functions. Since the Company's introduction of its first remote access server in 1990, over 2,000 ISPs have purchased the Company's products. The Company believes that more ISPs worldwide use Livingston's remote access servers than those of any other vendor based on data compiled by Infonetics Research, Inc. and the Company's knowledge of the remote access market. Diagram of an ISP's Point of Presence Housed within the ISP's local Point of Presence, Livingston's remote access products connect dial-up subscribers communicating with the ISP over standard analog, ISDN, Frame Relay or T1/E1 leased line connections to the Internet via the ISP's router-based network. The Company's ComOS operating system enables the ISP to perform a number of critical functions including: - - Routing: support for TCP/IP, IPX, OSPF, PPP, RIP and other LAN/WAN protocols - - Security: subscriber authentication, encryption and firewall filtering - - Network management: configuration and device management - - Subscriber administration: accounting, billing and Internet content management Photo of Livingston's PortMaster 3, PortMaster 2, FireWall Router, and Office Router products In November 1996, Livingston introduced the PortMaster 3, the Company's next generation access concentrator, which integrates digital modem, router and communications server functionality with support for conventional analog, ISDN, Frame Relay and T1/E1 service connections in a compact 3.5 inch high chassis. The PortMaster 3 combines the Company's core software technology, the ComOS operating system, with a streamlined hardware design to offer ISPs the following advantages: - - Integrated hardware solution - - Designed to support emerging technologies such as 56K modems - - Scalability and manageability - - Reliability - - Security and administrative capabilities - - Low price per port Livingston also provides office routers and firewall routers that are resold by ISPs to corporate customers for Internet connectivity and other remote access networking applications. PROSPECTUS SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN THIS PROSPECTUS. THE COMPANY Livingston is a leading provider of integrated remote access networking solutions for ISPs worldwide. Used by ISPs to connect their subscribers to the Internet, the Company's remote access servers deliver high performance at a low price per port, making them particularly well-suited for the intensely competitive ISP market. The Company also provides office routers and firewall routers that are resold by ISPs to corporate customers for Internet connectivity and other remote access networking applications. Since the Company's introduction of its first remote access server in 1990, over 2,000 ISPs have purchased the Company's remote access products. The Company believes that more ISPs worldwide use Livingston's remote access servers than those of any other vendor based on data compiled by Infonetics Research, Inc.* and the Company's knowledge of the remote access market. In November 1996, the Company introduced the PortMaster 3 access concentrator, its next generation remote access platform, which integrates digital modem, router and communications server functionality with support for analog modems, ISDN PRI, Frame Relay and T1/E1 service connections in a compact 3.5 inch high chassis. The PortMaster 3 has been designed to be easily upgraded to support emerging technologies such as 56K modem functionality. The PortMaster 3 combines the Company's core software technology, the ComOS operating system, with an integrated hardware design that provides ISPs with a high port density, highly scalable remote access solution. Architected specifically for remote access applications, ComOS is incorporated in all of the Company's remote access products and provides robust routing, security, centralized device management and subscriber administration capabilities. Based on the foregoing factors, the Company believes that the PortMaster 3 platform positions it to better address the needs of large ISPs and Telcos, and to maintain its leadership position with the Company's established base of local and regional ISP customers. THE OFFERING Common Stock offered........................................ shares, including shares by the Company and shares by a Selling Shareholder Common Stock to be outstanding after the offering........... shares (1) Use of proceeds............................................. For general corporate purposes, including working capital Proposed Nasdaq National Market symbol...................... LIVS
SUMMARY CONSOLIDATED FINANCIAL INFORMATION (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NINE MONTHS ENDED YEARS ENDED AUGUST 31, ----------- ----------------------------------------------------- MAY 31, 1992 1993 1994 1995 1996 1996 --------- --------- --------- --------- --------- ----------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Net revenues............................................... $ 1,424 $ 2,083 $ 6,180 $ 20,461 $ 46,107 $ 34,809 Gross profit............................................... 951 1,121 3,327 12,407 27,540 20,688 Net income................................................. 320 86 1,027 4,904 8,845 7,543 Net income per share (2)................................... $ .03 $ .01 $ .08 $ .38 $ .63 $ .54 Shares used in per share computations (2).................. 12,423 12,423 12,423 12,842 14,102 13,942 MAY 31, 1997 ----------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Net revenues............................................... $ 54,485 Gross profit............................................... 32,890 Net income................................................. 10,381 Net income per share (2)................................... $ .72 Shares used in per share computations (2).................. 14,374
MAY 31, 1997 -------------------------- ACTUAL AS ADJUSTED(3) --------- --------------- CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents............................................................................ $ 16,005 $ Working capital...................................................................................... 23,654 Total assets......................................................................................... 39,917 Total shareholders' equity........................................................................... 26,244
- ------------ (1) Based on 12,405,735 shares of Common Stock outstanding as of May 31, 1997. Excludes 2,601,247 shares of Common Stock issuable upon the exercise of options outstanding under the Company's 1994 Stock Option Plan at May 31, 1997, with a weighted average exercise price of $3.99 per share, and 40,190 shares of Common Stock issuable upon the exercise of options granted under the Company's 1994 Stock Option Plan subsequent to May 31, 1997, with a weighted average exercise price of $17.50 per share. Also excludes (i) 1,500,000 shares of Common Stock reserved for issuance under the Company's 1997 Stock Plan and (ii) 500,000 shares of Common Stock reserved for issuance under the Company's 1997 Employee Stock Purchase Plan. See "Management--Executive Compensation," "Description of Capital Stock" and Note 5 of Notes to Consolidated Financial Statements. (2) See Note 1 of Notes to Consolidated Financial Statements for an explanation of the determination of net income per share and shares used in per share computations. (3) As adjusted to reflect the sale of shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $ per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by the Company. See "Use of Proceeds" and "Capitalization." - ------------ * "The ISP Opportunity 1997" by Infonetics Research, Inc. 3 THE COMPANY Livingston Enterprises, Inc. ("Livingston" or the "Company") is a leading provider of integrated remote access networking solutions for Internet Service Providers ("ISPs") worldwide. Used by ISPs to connect their subscribers to the Internet, the Company's remote access servers deliver high performance at a low price per port, making them particularly well-suited for the intensely competitive ISP market. The Company also provides office routers and firewall routers that are resold by ISPs to corporate customers for Internet connectivity and other remote access networking applications. Since the Company's introduction of its first remote access server in 1990, over 2,000 ISPs have purchased the Company's remote access products. The Company believes that more ISPs worldwide use Livingston's remote access servers than those of any other vendor based on data compiled by Infonetics Research, Inc.* and the Company's knowledge of the remote access market. In November 1996, the Company introduced the PortMaster 3 access concentrator, its next generation remote access platform, which integrates digital modem, router and communications server functionality with support for analog modems, ISDN PRI, Frame Relay and T1/E1 service connections in a compact 3.5 inch high chassis. The PortMaster 3 has been designed to be easily upgraded to support emerging technologies such as 56K modem functionality. The PortMaster 3 combines the Company's core software technology, the ComOS operating system, with an integrated hardware design that provides ISPs with a high port density, highly scalable remote access solution. Architected specifically for remote access applications, ComOS is incorporated in all of the Company's remote access products and provides robust routing, security, centralized device management and subscriber administration capabilities. Based on the foregoing factors, the Company believes that the PortMaster 3 platform positions it to better address the needs of large ISPs and Telcos, and to maintain its leadership position with the Company's established base of local and regional ISP customers. The number of Internet subscribers and Internet traffic is growing rapidly as the Internet continues to emerge as a global medium for communication, commerce and entertainment. To accommodate Internet subscriber growth and customers' increasing bandwidth requirements, many ISPs are dramatically increasing their investments in networking infrastructure, particularly in the area of remote access equipment. The ISP market is evolving rapidly and competition in the industry has intensified as many major telecommunications service providers have entered or announced plans to enter the ISP market. ISPs increasingly need to provide reliable service with maximum accessibility and minimum downtime to maintain customer satisfaction, forcing ISPs to continually expand and upgrade their networks without service interruption. Competition to attract and maintain subscribers requires ISPs to improve the performance of their networks by incorporating new technologies such as 56K modems. As a result, ISPs are increasingly focused on procuring remote access equipment that is cost-effective, reliable, scalable and interoperable, includes comprehensive network management and security capabilities and provides support for emerging technologies. Livingston's goal is to be the leading supplier of technologically advanced and cost-effective remote access solutions to ISPs worldwide. Livingston's strategy is to leverage its flexible ComOS operating system and its modular hardware design to provide cost-effective, highly scalable and reliable remote access technologies that incorporate next generation networking functionality. The Company is focused on maintaining its market leadership with local and regional ISPs, continuing to build its direct sales and technical support capabilities, and increasing its market share with major national and international ISPs. The Company also plans to expand its presence in Europe, Japan and other international markets. Livingston was incorporated in California in 1986. Unless the context otherwise requires, references in this Prospectus to "Livingston" and the "Company" refer to Livingston Enterprises, Inc., a California corporation, and its subsidiaries. The Company's principal executive offices are located at 4464 Willow Road, Pleasanton, California 94588. Its telephone number is (510) 737-2100 and its World Wide Web site is located at http://www.livingston.com. Information contained in the Company's World Wide Web site is not part of this Prospectus. - --------- * "The ISP Opportunity 1997" by Infonetics Research, Inc. 4 RISK FACTORS IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY. THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS WHICH INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH BELOW AND ELSEWHERE IN THIS PROSPECTUS. UNPREDICTABLE AND FLUCTUATING QUARTERLY OPERATING RESULTS. Due to the emerging and evolving nature of the markets for the Company's products and the likelihood of increased competition, there can be no assurance that growth in net revenues will continue or that the Company will continue to be profitable. As a result of the Company's recent transition to its new product, PortMaster 3, the Company believes that future quarterly operating results could be negatively impacted by factors such as a continuing decline in sales of many of the Company's earlier generation products, which the Company expects, and a lack of sustained market acceptance of PortMaster 3. In addition, the Company expects that software licensing royalties from US Robotics Access Corp., Inc. ("USR") will terminate in fiscal 1998, if not sooner. For the Company's fiscal year ended August 31, 1996 and the nine months ended May 31, 1997, royalty revenues from USR represented 6.2% and 12.8% of net revenues, respectively. To the extent that such termination in royalty revenue and a decline in revenue of the Company's earlier generation products is not offset by sales of PortMaster 3 and future products, the Company's business, quarterly operating results and financial condition would be materially adversely affected. See "--Risks Associated with the Termination of the USR Relationship." The Company's quarterly operating results could also be materially adversely affected by a wide variety of factors including the following: price competition; the mix of products sold; the ability of the Company to provide product features required by ISPs; product flaws that cannot be detected or remedied in a timely manner; shortages of critical components; the buying patterns of ISPs and other customers; the level of Internet usage by customers of ISPs; the ability of the Company to succeed in selling products to large ISPs, interexchange carriers such as AT&T, MCI and Sprint, and Regional Bell Operating Companies ("RBOCs") (interexchange carriers and RBOCs may be collectively referred to as "Telcos"); the ability of the Company to hire and retain additional sales personnel; consolidation in the ISP markets; the mix of distribution channels employed by the Company; changes in the levels of inventory held by third party resellers; the timing of orders from, and shipments to, customers; and seasonality and general economic conditions. The Company typically operates with a relatively small backlog and, 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. A significant portion of the Company's spending is relatively fixed in advance based on the Company's forecasts of future sales. If sales are below expectations in any given quarter, the adverse impact of the shortfall on the Company's quarterly operating results may be magnified by the Company's inability to adjust spending to compensate for the shortfall. As a result of the Company's plans to expand its direct sales and marketing and research and development capabilities, the Company anticipates that its operating expenses will substantially increase, which, in the absence of increased sales of the Company's products, could have a material adverse effect on the Company's quarterly operating results. Accordingly, there can be no assurance that the Company will be able to sustain profitability in the future, particularly on a quarter-to-quarter basis, or that the Company will not experience material fluctuations in quarterly operating results. Additionally, it is possible that the Company's future quarterly operating results may fall below the expectations of analysts and investors. In such event, the market price of the Company's Common Stock would likely be materially adversely affected. See "--Possible Volatility of Stock Price" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." 5 DEPENDENCE ON SALES OF PORTMASTER 3. In the fall of 1996, the Company introduced PortMaster 3, sales of which represented a majority of the Company's net revenues in the third quarter of fiscal 1997. There can be no assurance that such level of sales will be maintained. In particular, there can be no assurance that the initial level of sales does not reflect pent up demand from prior quarters as a result of the anticipated introduction of PortMaster 3. The PortMaster 3 is the Company's first product that contains an integrated modem and thus directly competes with remote access products with integrated modems offered by larger competitors such as Ascend Communications, Inc. ("Ascend"), USR and Cisco Systems, Inc. ("Cisco") which have dominated this segment of the remote access market. There can be no assurance that the PortMaster 3 can successfully compete with products offered by these competitors. See "-- Allegation of Patent Infringement." In addition, future sales of PortMaster 3 would be materially adversely affected in the event that the Company is unable to offer on a timely basis a 56K modem upgrade for PortMaster 3. Sales of PortMaster 3 would also be materially adversely affected in the event that the ISP market widely adopts an alternative 56K modem technology such as USR's x2 modem technology. See "-- Risks Associated with 56K Modem Technology." From time to time, the Company's products may contain product flaws. Due to the complexity of the PortMaster 3, there can be no assurance that the PortMaster 3 does not contain undetected product flaws or that the Company will be able to timely or effectively remedy such flaws. See "--Risks Associated with Rapid Technological Changes." In addition, because the PortMaster 3 is the Company's first product intended to address large ISPs and Telcos, there can be no assurance that this product will prove suitable for, or achieve acceptance in, these markets. See "--Risks Associated with Entry into New and Unfamiliar Markets." Sales of the Company's earlier generation PortMaster products declined in the fourth quarter of fiscal 1996 and the nine months ended May 31, 1997, and the Company expects such sales will continue to decline and that the Company will be increasingly dependent upon sales of PortMaster 3 to sustain and grow its net revenues. There can be no assurance that sales of PortMaster 3 will be sufficient to sustain and grow the Company's net revenues. The inability of the Company to increase sales of its PortMaster 3 would have a material adverse effect on the Company's business, results of operations and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Industry Background and Market" and "--Technology and Products." RISKS ASSOCIATED WITH NEW PRODUCT INTRODUCTIONS. The market for the Company's products is characterized by rapidly changing technologies, evolving industry standards, frequent competitive product introductions and short product life cycles. The Company's introduction of new or enhanced products requires the Company to effectively manage the transition from older products to newer generation products in order to minimize disruption in customer ordering patterns, avoid excessive levels of older product inventories and ensure that adequate supplies of new products can be delivered to meet customer demand. In the past, the Company has experienced problems with product transitions. For example, the Company experienced a decrease in net revenues in the fourth quarter of fiscal 1996, when sales of the Company's earlier generation products decreased primarily as a result of the anticipated introduction of PortMaster 3. As a result, the Company recorded charges aggregating approximately $3.3 million through the first quarter of fiscal 1997 as a reserve for obsolete PortMaster 2 inventory. A failure by the Company to effectively manage new product introductions in the future could have a material adverse effect on the Company's business, results of operations and financial condition. See "--Risks Associated with Rapid Technological Changes." DEPENDENCE ON SALES TO LOCAL AND REGIONAL ISPS. Historically, the Company has sold a substantial majority of its products to local and regional ISPs. The business of local and regional ISPs is largely dependent upon free reciprocal access to networks of large regional and national ISPs. Recently, certain national ISPs have announced that they plan to eliminate such free access to local and regional ISPs. There can be no assurance such limitations, or other limitations by national ISPs, would not materially adversely impact the growth or success of local and regional ISPs and thereby materially adversely impact the sales of the Company's products. Additionally, local and regional ISPs often have limited access to capital and as a result may be constrained in their ability to purchase the Company's products. Accordingly, there can be 6 no assurance that sales to such ISPs, individually or as a group, will equal or exceed historical levels in any future period. A decrease in purchases of the Company's products by local and regional ISPs generally would materially adversely affect the Company's business, results of operations and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Sales and Marketing." RISKS ASSOCIATED WITH 56K MODEM TECHNOLOGY. Modem technology is rapidly evolving and with the recent introduction of 56K modem technology, ISPs are increasingly demanding remote access solutions that incorporate 56K modem technology. There currently are two principal competing 56K modem technologies: (i) the x2 modem technology developed by USR and (ii) the K56flex modem technology developed by Lucent Technologies ("Lucent") and Rockwell Semiconductor Systems, Inc. ("Rockwell"). The Company has adopted the Lucent/Rockwell technology and has announced its offer to provide an upgrade, when and if available, to existing PortMaster 3 customers, upon request and at no additional charge (other than shipping costs), to support K56flex specifications. The Company does not plan to support the USR technology. In the event that USR's technology becomes widely adopted by ISPs, or an industry standard is adopted that is not compatible with the 56K modem solution implemented by the Company, the Company's business, results of operations and financial condition would be materially adversely affected. The Company believes that in order to remain competitive it must successfully introduce a 56K modem solution before the end of fiscal 1997. The Company depends on Lucent for the development of microchips for its 56K implementation. There can be no assurance that Lucent will be able to deliver to the Company sufficient quantities of 56K microchips, that the Company will not experience problems or delays incorporating these microchips into its products or that the Company will not experience other difficulties introducing a 56K modem solution. Another competitor of the Company which has adopted the Lucent/Rockwell technology recently announced that it expected to experience an unanticipated delay in availability of the 56K modem technology. There can be no assurance that the Company will not also experience unanticipated delays in offering a 56K modem solution. The inability of the Company to offer a 56K modem solution on a timely basis would materially adversely impact sales of the PortMaster 3 and would have a material adverse effect on the Company's business, results of operations and financial condition. See "--Dependence on Sales of PortMaster 3." RISKS ASSOCIATED WITH ENTRY INTO NEW AND UNFAMILIAR MARKETS. To date, a substantial majority of the Company's revenues have been derived from sales to local and regional ISPs. With the introduction of PortMaster 3, the Company believes that it can better address the needs of large ISP and Telco markets. These markets are characterized by longer, more costly sales cycles and substantially greater competition than the local and regional ISP markets. Many of the Company's competitors, such as Ascend, USR and Cisco, have substantially greater resources, name recognition and experience than the Company, as well as established relationships with many of the large ISPs and Telcos. Because the PortMaster 3 is the Company's first product intended to address large ISPs and Telcos, there can be no assurance that this product will prove suitable for, or achieve acceptance in, these markets. To enter into and compete in these markets, the Company will be required to expand its sales and marketing capabilities, which will result in increased operating expenses. See "--Intense Competition," "--Dependence on Developing a Direct Sales Capability" and "--Unpredictable and Fluctuating Quarterly Operating Results." To the extent that the Company is unable to penetrate such markets for its products or sales of products in these unfamiliar markets do not offset such increased expenses, the Company's business, results of operations and financial condition could be materially adversely affected. INTENSE COMPETITION. The remote access market is intensely competitive and the Company's principal competitors include Ascend, USR and Cisco. Competitive factors in the remote access ISP market include the breadth of product features, pricing, product quality, reliability and functionality, marketing and sales resources, customer service and support and reputation. The PortMaster 3 is the Company's first product that contains an integrated modem and thus directly competes with remote access products with integrated modems offered by larger competitors such as Ascend, USR and Cisco which have dominated this segment 7 of the remote access market. Competition in the large ISP and Telco segments of the remote access market is particularly intense and the Company's competitors have greater name recognition, resources, sales capabilities and market share than the Company. As a result, the Company has a competitive disadvantage in these markets. Increased competition could result in price reductions, the inability of the Company to increase market share, or a loss of market share by the Company, any of which could materially adversely affect the Company's business, results of operations and financial condition. Additionally, industry-wide consolidation, such as the recently announced mergers of USR with 3Com Systems, Inc. ("3Com") and Ascend with Cascade Communications, Inc. ("Cascade"), could result in increased competition in the remote access ISP market because, among other things, such companies will be able to provide a complete solution for integrated remote access combined with other networking products not offered by the Company. Furthermore, the ISP industry could experience consolidation and the acquisition of one of the Company's larger customers by a corporation with relationships with one of the Company's competitors could result in a loss of revenue attributable to such customer. To the extent Telcos increase their share of the ISP market and the Company is unsuccessful in penetrating the Telco segment of the market, the Company's business, results of operations and financial condition could be materially adversely affected. There can be no assurance that the Company's current and future competitors will not develop or market technologies and products that offer higher performance and are more cost-effective than the Company's current or future products, thereby rendering the Company's technologies and products obsolete. See "Business--Competition." DEPENDENCE ON DEVELOPING A DIRECT SALES CAPABILITY. The Company believes that it must augment its direct sales capability in order to effectively compete in the large ISP and Telco markets. Accordingly, the Company has expanded, and plans to continue to expand, its direct sales capabilities to establish direct customer relationships. However, there can be no assurance that the Company will be able to find, train and retain sufficient personnel to enhance or further develop such direct sales capability or that the Company will be successful in penetrating the large ISP and Telco markets. The market in which the Company competes is characterized by intense competition for attracting and retaining qualified sales personnel and there can be no assurance that the Company will be successful in competing for such personnel. Many of the Company's competitors have significant direct sales departments and possess substantially greater resources to attract such personnel. In the event that the Company is unsuccessful in developing its direct sales capability, the Company's business, results of operations and financial condition could be materially adversely affected. RISKS ASSOCIATED WITH RELIANCE ON RESELLERS. For the year ended August 31, 1996 and for the nine months ended May 31, 1997, 88.1% and 79.6%, respectively, of the Company's product revenues were made through value added resellers and distributors ("resellers"). The Company's top ten resellers represented 73.8% and 56.5%, respectively, of product revenues during such periods. The Company's top reseller in each period represented 27.2% and 19.4%, respectively, of the Company's product revenues and the second largest reseller in each period represented 13.3% and 6.5%, respectively. Accordingly, the Company is dependent upon the continued viability and financial stability of its resellers. Furthermore, the Company expects to become more dependent upon resellers in the international markets. While the Company maintains contractual relationships with most of its resellers, these agreements generally do not require a reseller to purchase the Company's products and may be terminated by a reseller at any time without penalty. There can be no assurance that any of the Company's resellers will continue to market the Company's products. Additionally, the Company's resellers generally offer products of several different companies, including those of the Company's competitors. Consequently, there is a risk that resellers will give higher priority to products of other suppliers, thus reducing their efforts to sell the Company's products. The foregoing risk is exacerbated by the Company's plans to expand its direct sales capability which could have a negative impact on the Company's relationship with resellers and result in a reduction in the sales of the Company's products by such resellers. In addition, the Company may, from time to time, terminate some of its relationships with resellers and any such termination could have a material adverse 8 effect on the Company's business and result in threatened or actual litigation. For example, in November 1996, the Company terminated its relationship with one of its largest resellers, who then threatened to sue the Company. There can be no assurance that any future termination of a reseller would not have a material adverse effect on the Company's business or that such termination would not result in a lawsuit or that the Company would be successful in defending itself in such a lawsuit. Livingston provides most of its resellers with product return rights for stock balancing and price protection. There can be no assurance that the Company will not experience significant product returns or claims for price protection with respect to products held by resellers which could materially adversely affect the Company's business, results of operations and financial condition. See "--Risks Associated with International Sales" and "Business-- Sales and Marketing." RISKS ASSOCIATED WITH THE MANAGEMENT OF EXPANDING OPERATIONS. The Company has recently experienced a period of rapid growth and an expansion in the number of its employees, the scope and complexity of its operating and financial systems, and the geographic area of its operations. Such growth has placed and, if sustained, will continue to place a significant strain upon the Company's management, operations, financial systems and resources. The Company believes that it must expand its manufacturing, research and development, marketing, sales and customer support capabilities in order to effectively serve the evolving needs of the Company's present and future customers. The Company's Chief Executive Officer also serves as the Company's Chief Technical Officer and the Company's Vice President of Sales also serves as the Company's Vice President of Marketing. Consequently, the Company believes it needs to hire additional senior management in the areas of research and development and marketing. There can be no assurance that this can be achieved without disruption to the Company's current management team. The failure by the Company to hire additional qualified personnel in a timely manner could have a material adverse effect on the Company's business, results of operations and financial condition. See "--Dependence on Key Personnel" and "Management." RISKS ASSOCIATED WITH RAPID TECHNOLOGICAL CHANGES. The market for the Company's products is characterized by rapidly changing technologies, evolving industry standards, frequent competitive product introductions and short product life cycles. The Company's success will depend to a substantial degree upon its ability to enhance its existing products and to develop and introduce, on a timely and cost-effective basis, new products and features that meet changing customer requirements and emerging industry standards. Inherent in the product development process are a number of risks. The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. The Company's introduction of new or enhanced products may contain undetected or unresolved software or hardware defects when they are first introduced or as new versions are released. There can be no assurance that, despite extensive testing by the Company, design defects will not be found in new products or upgrades after commencement of commercial shipments, resulting in additional costs to the Company, reduced acceptance of the Company's products or damage to the Company's reputation and relationships with its customers. Future delays in the introduction or shipment of new or enhanced products, the inability of such products to gain market acceptance or problems associated with new product transitions could have a material adverse effect on the Company's business, results of operations and financial condition, particularly on a quarterly basis. See "--Unpredictable and Fluctuating Quarterly Operating Results," "--Risks Associated with New Product Introductions," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Industry Background and Market" and "--Research and Development." RISKS ASSOCIATED WITH INTERNATIONAL SALES. International sales accounted for approximately 29.7% and 41.4% of the Company's product revenues in fiscal 1996 and the nine months ended May 31, 1997, respectively, and the Company expects that international sales will continue to account for a significant portion of its product revenues in future periods. The Company is substantially dependent on resellers for 9 its international sales. Certain of the Company's resellers also act as resellers for the Company's competitors and such resellers could devote greater effort and resources to marketing competitive products. The loss of certain resellers could have a material adverse effect on the Company's business, results of operations and financial condition. In addition, in each calendar year sales in Europe and certain other parts of the world in the third quarter and sales in Japan in the second quarter are typically adversely affected as many customers reduce their business activities during those periods. The Company intends to enter into additional international markets and to continue to expand its operations outside of North America by expanding its direct sales force, adding resellers and pursuing additional strategic relationships which will require significant management attention and expenditure of significant financial resources. Sales to international customers are subject to additional risks including longer receivables collection periods, greater difficulty in accounts receivable collection, political and economic instability, nationalization, trade restrictions, the impact of possible recessionary environments in economies outside the United States, reduced protection for intellectual property rights in some countries, currency fluctuations and tariff regulations and requirements for export licenses. In particular, United States law currently prohibits the export of certain encryption technology which the Company may include in its future products. To the extent the export or import of the Company's products is prohibited by the domestic laws of the United States or any foreign country in which the Company does business, or uncertainty relating to such laws limits the marketability of the Company's products internationally, the Company could lose a substantial portion of its international sales. There can be no assurance that the foregoing risks associated with international sales will not materially adversely impact the future level of such sales and, consequently, the Company's business, results of operations and financial condition. Although the Company's international sales are currently denominated in U.S. dollars, fluctuations in currency exchange rates could cause the Company's products to become relatively more expensive to customers in a particular country, leading to a reduction in sales or profitability in that country. The Company currently does not hedge against foreign currency price fluctuations. Furthermore, future international activity may result in foreign currency denominated sales, and, in such event, gains and losses on the conversion to U.S. dollars of accounts receivable and accounts payable arising from international operations may contribute to fluctuations in the Company's results of operations. These factors may have a material adverse effect on the Company's business, results of operations and financial condition. See "-- Risks Associated with Reliance on Resellers," "--Tariff and Regulatory Matters," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Sales and Marketing." DEPENDENCE ON KEY PERSONNEL. The Company's success depends on the continuing contributions of its key personnel, all of whom would be difficult to replace. In particular, the Company is dependent upon Steven M. Willens, who serves as the Company's Chief Technical Officer as well as its President and Chief Executive Officer. The Company has no long-term employment arrangements with Mr. Willens. While the Company has a key man life insurance policy in the amount of $5 million on the life of Mr. Willens with the Company designated as beneficiary, the loss of Mr. Willens' services would have a material adverse effect upon the Company. The Company's future success will depend, in part, upon its ability to attract and retain highly qualified personnel. There can be no assurance that the Company will be successful in hiring or retaining qualified personnel. Loss of, or the inability to hire, key personnel could have a material adverse effect on the Company's business, results of operations and financial condition. See "--Risks Associated with the Management of Expanding Operations" and "Management." DEPENDENCE ON CONTRACT MANUFACTURERS AND SINGLE-SOURCE SUPPLIERS. The Company's production operations consist primarily of materials planning and procurement, quality control, kitting, final assembly, burn-in and testing of certain products. The Company designs all of the hardware subassemblies for its products and uses the services of contract manufacturers to build these subassemblies and certain of its products to the Company's specifications. The Company is also dependent upon single or limited source 10 suppliers for a number of components and parts used in the Company's products, including certain key microprocessors and integrated circuits. There can be no assurance that these independent contractors and suppliers will be able to meet the Company's future requirements for manufactured products, components and subassemblies. The Company generally purchases single or limited source components pursuant to purchase orders and has no guaranteed supply arrangements with these suppliers. For example, the Company currently purchases all of its modem microchips from Analog Devices, Inc. and with the Company's implementation of 56K modem technology, the Company anticipates that it will become dependent upon Lucent for modem microchips. In addition, the availability of many of these components is dependent in part on the Company's ability to provide its suppliers with accurate forecasts of its future requirements. Any extended interruption in the supply of any of the key components currently obtained from a single or limited source or the time necessary to transition a replacement supplier's product or replacement component into the Company's products could disrupt its operations and have a material adverse effect on the Company's business, results of operations and financial condition in any given period. The Company purchases certain components from foreign suppliers and the supply of such components could be materially adversely affected by changing tariff and regulatory structures, particularly those affecting the import and export of electronics and technology. The Company may also be subject to increases in component costs, which could also have a material adverse effect on the Company's business, results of operations and financial condition. See "Business--Manufacturing." RISKS ASSOCIATED WITH THE TERMINATION OF THE USR RELATIONSHIP. Under an OEM Software License Agreement (the "USR Agreement") dated September 1, 1994 entered into between the Company and USR, Livingston granted USR a license to use the Company's ComOS operating system. On December 17, 1996, the Company and USR settled a lawsuit related to the USR Agreement and in connection with such settlement, the parties entered into Amendment No. 1 to the USR Agreement (the "Amendment"). Pursuant to the Amendment, the parties agreed that USR's right and license to Livingston's ComOS source code will terminate on December 31, 1997. Under the terms of the USR Agreement, USR may, in its sole discretion terminate the Agreement upon 30 days notice. Unless earlier terminated, the Amendment terminates on December 31, 1998. USR may for a period of two months, sublicense, sell, lease and distribute any inventory of products based on or containing the Livingston ComOS, on hand at the time of such termination. In that regard, the Company believes that it is likely that its royalty revenue from USR will terminate in fiscal 1998, if not sooner. For the Company's fiscal year ended August 31, 1996 and the nine months ended May 31, 1997, royalty revenues from USR represented 6.2% and 12.8% of net revenues, respectively. To the extent that such termination in royalty revenues is not offset by increased sales of the Company's products, the Company's business, quarterly operating results and financial condition would be materially adversely affected. See "--Risks Associated with Legal Proceedings" and "--Allegation of Patent Infringement." RISKS ASSOCIATED WITH LEGAL PROCEEDINGS. On December 17, 1996, the Company settled a lawsuit with USR arising from a dispute regarding the USR Agreement. USR currently uses code developed by USR based on Livingston's ComOS operating system in USR's NETServer access server card, which is incorporated into its Total Control Enterprises Network Hub. In addition, the USR NETServer 8 and 16 products use code also based on Livingston's ComOS. As a result of the termination of USR's right and license to Livingston's ComOS source code on December 31, 1997, the Company believes that its royalty revenue from the USR Agreement will terminate in fiscal 1998, if not sooner. USR has substantially greater resources than the Company and no assurance can be given that the Company will be able to successfully compete with USR or that the Company and USR will not enter into future litigation concerning the relationship between the two corporations and their respective technologies. In fact, while to date no lawsuit has been filed, the Company has alleged that USR has breached the terms of the settlement and USR has alleged that the PortMaster 3 product infringes USR's U.S. patent 5,528,595, captioned "Modem Input/Output Signal Processing Techniques." See "--Dependence on Proprietary Technology" and "--Allegation of Patent Infringement." The occurrence of future litigation with USR 11 could have a material adverse effect on the Company's business, results of operations and financial condition. In April 1997, a complaint for unfair competition was filed against the Company as one of a group of companies separately developing 56K modem technology by a plaintiff on behalf of the general public. The complaint alleges that the Company knowingly made false and misleading statements regarding the capabilities of its 56K modem technology. On June 5, 1997, a complaint was filed against the Company in California Superior Court by Capella Worldwide Networking, Inc. ("Capella"), the Company's largest distributor in fiscal 1996. The Company terminated its relationship with Capella in November 1996. The complaint purports to allege contract and tort causes of action arising out of the Company's termination of Capella as a distributor. The complaint seeks injunctive and declaratory relief as well as unspecified damages for alleged lost profits, including compensatory, punitive and treble damages. The Company has not yet responded to the complaint and discovery has not yet commenced. The Company denies the allegations in both of the above complaints and intends to vigorously defend its position in both instances. Nevertheless, litigation is subject to inherent uncertainties and thus there can be no assurance that either of these suits will be resolved favorably to the Company or that either suit will not have a material adverse effect on the Company. The defense of these suits or any other lawsuit could result in time-consuming and expensive litigation, damages, and diversion of the attention of key personnel, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON PROPRIETARY TECHNOLOGY. The Company's future success and ability to compete is dependent in part upon its proprietary technology. The Company relies on a combination of contractual rights, trade secrets and copyright laws to establish and protect its proprietary technology. The Company currently has one patent application pending, but there can be no assurance that a patent will be issued as a result of such application, that the Company's patent will be upheld as valid, or that such patent will prevent the development of competitive products. The Company generally enters into confidentiality agreements with its employees, consultants, resellers, customers and potential customers, and strictly limits access to and distribution of its source code, and further limits the disclosure and use of other proprietary information. However, as a result of the Company's licensing relationship with USR, the Company has licensed, for a specified term, to USR the source code to its ComOS operating software and in the event that such source code is released to unauthorized third parties before the expiration of the license, the Company could be materially adversely affected. There can be no assurance that the steps taken by the Company in this regard will be adequate to prevent misappropriation of its technology or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. ALLEGATION OF PATENT INFRINGEMENT. On June 2, 1997, the Company received written notice from USR alleging that the PortMaster 3 infringes USR's U.S. patent 5,528,595, captioned "Modem Input/Output Signal Processing Techniques." Although the Company believes that such patent may be invalid, it is possible that USR may file suit against the Company to enforce such alleged patent or other intellectual property rights. Regardless of the merits of any such potential suit, there can be no assurance that the Company will prevail in defending itself or that it would not be required to enter into license arrangements or develop non-infringing technology. Furthermore, there can be no assurance that USR will not assert other infringement claims in the future with respect to the Company's current or future products. Any litigation could result in product delays or costs which could have a material adverse effect on the Company's business, results of operations and financial condition. 12 The Company is also subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of other third parties. There can be no assurance that other third parties will not assert infringement claims in the future with respect to the Company's current or future products or that any such claims will not require the Company to enter into license arrangements or develop non-infringing technology, or result in litigation, regardless of the merits of such claims. No assurance can be given that any necessary licenses will be available or that, if available, such licenses can be obtained on commercially reasonable terms. The failure of the Company to adequately obtain such licenses, or to protect its own proprietary technology through contractual rights, trade secrets, patent and copyrights laws, could have a material adverse effect on the Company's business, results of operations and financial condition. The defense of any lawsuit could result in time-consuming and expensive litigation, damages, license fees, royalty payments, and diversion of the attention of key personnel, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. See "--Risks Associated with Legal Proceedings" and "Business-- Proprietary Rights." TARIFF AND REGULATORY MATTERS. Rates for telecommunications services are governed by tariffs of licensed carriers that are subject to regulatory approval. Future changes in these tariffs could have a material adverse effect on the Company's business, results of operations and financial condition. For example, should tariffs for public switched digital services increase in the future relative to tariffs for private leased services, the cost-effectiveness of the Company's products would be reduced, and its business, results of operations and financial condition could be materially adversely affected. In addition, the Company's products must meet standards and receive certification for connection to the public telecommunications network prior to their sale. In the United States, the Company's products must comply with Part 15(a) (industrial equipment), Part 15(b) (residential equipment) and Part 68 (analog lines) of the Federal Communications Commission regulations. The Company's products also must be certified by domestic telecommunications carriers in both the United States and in foreign countries. In foreign countries, the Company's products are subject to a wide variety of government review and certification requirements. The Company is currently undertaking an effort to qualify for ISO 9002 series quality certification in order to fulfill the quality system requirements for the European markets. The Company applied for ISO 9002 certification on November 11, 1996. Foreign customers typically require that the Company's products receive certification from the country's primary telecommunication carriers. The failure to obtain on a timely basis or retain domestic certification or foreign regulatory approvals could have a material adverse effect on the Company's business, results of operations and financial condition. See "Business--Industry Background and Market." CONTROL BY OFFICERS AND DIRECTORS; CERTAIN FAMILY RELATIONSHIPS. Following this offering, the Company's executive officers and directors, together with entities affiliated with such individuals, will beneficially own approximately % of the Company's Common Stock (approximately % if the Underwriters' over-allotment option is exercised in full). Following this offering, Steven Willens, the Company's President, Chief Executive Officer and Chairman of the Board, Ronald Willens, the Company's Executive Vice President, Secretary, a director and the father of Steven Willens, and Jerrold Livingston, a director, former President and Chief Executive Officer and the father-in-law of Steven Willens will beneficially own approximately % of the Company's outstanding Common Stock. Accordingly, these shareholders will be able to elect at least a majority of the Company's directors, will retain the voting power to approve all matters requiring shareholder approval and will continue to have significant influence over the affairs of the Company. This concentration of ownership could have the effect of delaying or preventing a change in control of the Company. See "Management" and "Principal and Selling Shareholders." BROAD DISCRETION OF MANAGEMENT TO ALLOCATE OFFERING PROCEEDS. The Company will use the proceeds from this offering for general corporate purposes, including working capital and as a result, the Company's 13 management will have broad discretion to allocate the proceeds of this offering and to determine the timing of expenditures. See "Use of Proceeds." ABSENCE OF DIVIDENDS. The Company has not paid any dividends on its Common Stock since its inception and does not anticipate paying any dividends upon its Common Stock in the foreseeable future. NO PRIOR PUBLIC TRADING MARKET. Prior to this offering, there has been no public market for the Common Stock, and there can be no assurance that an active trading market will develop or be sustained. The initial public offering price, which will be established by negotiations between the Company and the Underwriters, may not be indicative of the market price of the shares of Common Stock after the offering. See "Underwriters." POSSIBLE VOLATILITY OF STOCK PRICE. The equity markets, particularly the market for high-technology corporations, recently have experienced significant price and volume fluctuations that are unrelated to the operating performance of individual companies. These broad market fluctuations may materially adversely affect the market price of the Common Stock. In addition, the market price of the shares of Common Stock is likely to be highly volatile. Factors such as fluctuations in the Company's operating results, announcements of technological innovations or new products by the Company or its competitors, developments with respect to patents or proprietary rights, announcement of litigation by or against the Company, changes in stock market analyst recommendations regarding the Company or its competitors and general market conditions may have a material adverse effect on the market price of the Common Stock. CERTAIN ANTI-TAKEOVER PROVISIONS. Certain provisions of the Company's Articles of Incorporation and Bylaws, each as amended, may have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. Such provisions could limit the price that certain investors might be willing to pay in the future for shares of the Company's Common Stock. Certain of these provisions provide for a classified board of directors and eliminate cumulative voting in the election of directors. In addition, upon completion of this offering, the Company's Board of Directors will have the authority to issue up to 5,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the shareholders. The rights of the holders of Common Stock will be subject to, and may be materially adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock, while providing flexibility in connection with possible financings or acquisitions or other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company. The Company has no current plans to issue shares of Preferred Stock. The Company's Bylaws and indemnity agreements provide that the Company will indemnify officers and directors against losses they may incur in legal proceedings resulting from their service to the Company. These provisions may make it more difficult for shareholders to take certain corporate actions and could have the effect of delaying or preventing a change in control of the Company. SHARES ELIGIBLE FOR FUTURE SALE. Sales of Common Stock (including shares issued upon the exercise of outstanding options) in the public market after this offering could materially adversely affect the market price of the Common Stock. Such sales also might make it more difficult for the Company to sell equity securities or equity-related securities in the future at a time and price that the Company deems appropriate. Upon completion of this offering (based on shares outstanding at May 31, 1997), the Company will have outstanding an aggregate of shares of Common Stock, assuming no exercise of the Underwriters' over-allotment option and no exercise of outstanding options. Of these shares, all of the 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 12,405,735 shares of Common Stock 14 held by existing shareholders 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 or 701 promulgated under the Securities Act. As a result of the contractual restrictions described below and the provisions of Rules 144 and 701, the Restricted 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) no shares will be eligible for sale beginning 90 days after the date of this Prospectus; and (iii) 12,405,735 shares will be eligible for sale upon expiration of the lock-up agreements 180 days after the date of this Prospectus. All officers, directors, shareholders and certain option holders of the Company have agreed not to offer, pledge, sell, contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly (or enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of), any shares of Common Stock or any securities convertible into or exercisable or exchangeable for shares of Common Stock, for a period of 180 days after the date of this Prospectus, without the prior written consent of Morgan Stanley & Co. Incorporated. The Company intends to file a registration statement on Form S-8 which would allow shares issuable upon exercise of options previously granted to be freely tradeable following release of such lock-up obligations, subject to compliance with Rule 144 in the case of Affiliates of the Company. See "Shares Eligible for Future Sale." IMMEDIATE AND SUBSTANTIAL DILUTION. Purchasers of the Common Stock offered hereby will suffer an immediate and substantial dilution of $ per share in the net tangible book value of the Common Stock from the initial public offering price of $ per share. To the extent outstanding options to purchase the Company's Common Stock are exercised, there will be further dilution. See "Dilution." 15 USE OF PROCEEDS The net proceeds to the Company from the sale of the shares of Common Stock offered by the Company hereby are estimated to be approximately $ million (approximately $ million if the Underwriters' over-allotment option is exercised in full), at an assumed initial public offering price of $ per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by the Company. The principal purposes of this offering are to obtain additional equity capital, to create a public market for the Common Stock and to facilitate future access by the Company to the capital markets. The Company expects to use the net proceeds of this offering for general corporate purposes, including working capital. The Company expects to use approximately $2.5 million of the net proceeds for capital expenditures over the next twelve months. A portion of the net proceeds may also be used for the acquisition of businesses, products and technologies that are complementary to those of the Company. The Company has no present plans, agreements or commitments with respect to any such transaction. Pending such uses, the Company intends to invest the net proceeds of this offering in short-term, interest-bearing, investment-grade securities. DIVIDEND POLICY The Company has never declared or paid cash dividends on its Common Stock and does not anticipate paying cash dividends in the foreseeable future. In addition, the Company's bank line of credit prohibits the payment of cash dividends without the bank's consent. 16 CAPITALIZATION The following table sets forth the consolidated capitalization of the Company as of May 31, 1997 (i) on an actual basis and (ii) as adjusted to give effect to the receipt by the Company of the estimated net proceeds from the sale of shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $ per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by the Company.
MAY 31, 1997 ---------------------- ACTUAL AS ADJUSTED --------- ----------- (IN THOUSANDS, EXCEPT SHARE DATA) Preferred stock, no par value: no shares authorized, issued and outstanding, actual; 5,000,000 shares authorized; none issued and outstanding, as adjusted................... -- Common stock, no par value: 30,000,000 shares authorized; 12,405,735 shares issued and outstanding, actual; 30,000,000 shares authorized; shares issued and outstanding, as adjusted................................................................ $ 2,165 Deferred stock compensation............................................................... (1,409) Retained earnings......................................................................... 25,488 --------- ----------- Total shareholders' equity............................................................ 26,244 --------- ----------- Total capitalization.............................................................. $ 26,244 $ --------- ----------- --------- -----------
- --------- (1) Excludes 2,601,247 shares of Common Stock issuable upon the exercise of options outstanding under the Company's 1994 Stock Option Plan at May 31, 1997, with a weighted average exercise price of $3.99 per share, and 40,190 shares of Common Stock issuable upon the exercise of options granted under the Company's 1994 Stock Option Plan subsequent to May 31, 1997, with a weighted average exercise price of $17.50 per share. Also excludes (i) 1,500,000 shares of Common Stock reserved for issuance under the Company's 1997 Stock Plan and (ii) 500,000 shares of Common Stock reserved for issuance under the Company's 1997 Employee Stock Purchase Plan. See "Management--Executive Compensation," "Description of Capital Stock" and Note 5 of Notes to Consolidated Financial Statements. 17 DILUTION The net tangible book value of the Company as of May 31, 1997, was $26,074,000 or $2.10 per share of Common Stock. Net tangible book value per share is determined by dividing the tangible book value of the Company (total tangible assets less total liabilities) by the number of outstanding shares of Common Stock at that date. After giving effect to the sale by the Company of the shares of Common Stock offered hereby at an assumed initial public offering price of $ per share, and after deducting underwriting discounts and commissions and estimated offering expenses payable by the Company, the Company's as adjusted net tangible book value at May 31, 1997 would have been $ or $ per share. This represents an immediate increase in net tangible book value of $ per share to existing shareholders and an immediate dilution of $ per share to new public investors. The following table illustrates the per share dilution: Assumed initial public offering price per share................... $ Net tangible book value per share before offering............... $ 2.10 Increase in net tangible book value attributable to new investors..................................................... --------- As adjusted net intangible book value per share after the offering........................................................ --------- Dilution per share to new public investors........................ $ --------- ---------
The following table summarizes on an as adjusted basis, as of May 31, 1997, the difference between the number of shares of Common Stock purchased from the Company, the total consideration paid and the average price per share of Common Stock paid by the existing shareholders and by the new investors (at an assumed initial public offering price of $ per share and before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by the Company):
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE ---------------------- ---------------------- PRICE PER NUMBER PERCENT AMOUNT PERCENT SHARE --------- ----------- --------- ----------- ------------ Existing shareholders...................................... % $ % $ New public investors....................................... --------- ----- --------- ----- Total.................................................. % $ % --------- ----- --------- ----- --------- ----- --------- -----
The foregoing analysis assumes no exercise of the Underwriters' over-allotment option and no exercise of stock options outstanding at May 31, 1997. As of May 31, 1997, there were options outstanding to purchase a total of 2,601,247 shares of Common Stock at a weighted average exercise price of $3.99 per share. In addition, in May 1997, the Board of Directors adopted the 1997 Stock Plan and the 1997 Employee Stock Purchase Plan, pursuant to which 1,500,000 and 500,000 shares, respectively, were reserved for issuance thereunder. As of June 24, 1997, no options or shares had been issued under any of these plans. Subsequent to May 31, 1997, the Board of Directors granted options under the 1994 Stock Plan to purchase an additional 40,190 shares of Common Stock at a weighted average exercise price of $17.50 per share. To the extent these stock options are exercised, there will be further dilution to purchasers in this offering. See "Management--Executive Compensation," "Description of Capital Stock" and Note 5 of Notes to Consolidated Financial Statements. 18 SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with the Company's consolidated financial statements and related notes thereto, and with Management's Discussion and Analysis of Financial Condition and Results of Operations, included elsewhere herein. The consolidated statement of operations data for the years ended August 31, 1994, 1995 and 1996 and the nine months ended May 31, 1997 and the consolidated balance sheet data at August 31, 1995 and 1996 and May 31, 1997 are derived from, and are qualified by reference to, the audited consolidated financial statements of the Company included elsewhere in this Prospectus and should be read in conjunction with those financial statements and the notes thereto, which have been audited by KPMG Peat Marwick LLP, independent certified public accountants, whose report is included elsewhere in this Prospectus. The consolidated balance sheet data at August 31, 1994 are derived from audited consolidated financial statements not included in this Prospectus. The consolidated statement of operations data for the years ended August 31, 1992 and 1993 and the consolidated balance sheet data at August 31, 1992 and 1993 are derived from unaudited consolidated financial statements not included in this Prospectus. The consolidated statement of operations data for the nine months ended May 31, 1996 are derived from unaudited consolidated financial statements included elsewhere in this Prospectus. The unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, contain all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company's financial position and results of operations for such periods. The results of operations for the nine months ended May 31, 1997 are not necessarily indicative of results to be expected for future periods.
NINE MONTHS ENDED MAY YEAR ENDED AUGUST 31, 31, ----------------------------------------------------- ------------------------ 1992 1993 1994 1995 1996 1996 1997 --------- --------- --------- --------- --------- ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Product revenues.................................. $ 1,424 $ 2,083 $ 6,180 $ 20,138 $ 43,229 $ 32,865 $ 47,488 Royalty revenues.................................. -- -- -- 323 2,878 1,944 6,997 --------- --------- --------- --------- --------- ----------- ----------- Net revenues...................................... 1,424 2,083 6,180 20,461 46,107 34,809 54,485 Cost of revenues.................................. 473 962 2,853 8,054 18,567 14,121 21,595 --------- --------- --------- --------- --------- ----------- ----------- Gross profit.................................... 951 1,121 3,327 12,407 27,540 20,688 32,890 Operating expenses: Research and development........................ 126 277 462 890 2,512 1,153 3,074 Selling and marketing........................... 213 327 673 2,831 8,670 6,094 11,934 General and administrative...................... 122 401 449 667 1,771 992 2,305 --------- --------- --------- --------- --------- ----------- ----------- Total operating expenses...................... 461 1,005 1,584 4,388 12,953 8,239 17,313 --------- --------- --------- --------- --------- ----------- ----------- Operating income.................................. 490 116 1,743 8,019 14,587 12,449 15,577 Interest income (expense), net.................... (6) (9) (21) (20) 85 43 276 --------- --------- --------- --------- --------- ----------- ----------- Income before income taxes........................ 484 107 1,722 7,999 14,672 12,492 15,853 Provision for income taxes........................ 164 21 695 3,095 5,827 4,949 5,472 --------- --------- --------- --------- --------- ----------- ----------- Net income.................................... $ 320 $ 86 $ 1,027 $ 4,904 $ 8,845 $ 7,543 $ 10,381 --------- --------- --------- --------- --------- ----------- ----------- --------- --------- --------- --------- --------- ----------- ----------- Net income per share.............................. $ .03 $ .01 $ .08 $ .38 $ .63 $ .54 $ .72 --------- --------- --------- --------- --------- ----------- ----------- --------- --------- --------- --------- --------- ----------- ----------- Shares used in per share computations (1)......... 12,423 12,423 12,423 12,842 14,102 13,942 14,374
AUGUST 31, ------------------------------------------------------- MAY 31, 1992 1993 1994 1995 1996 1997 --------- --------- --------- --------- ----------- ----------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents................................. $ 187 $ 46 $ 627 $ 1,486 $ 3,749 $ 16,005 Working capital........................................... 323 509 1,511 5,891 14,243 23,654 Total assets.............................................. 554 839 2,706 9,303 21,321 39,917 Total shareholders' equity................................ 375 352 1,379 6,283 15,323 26,244
- ------------ (1) See Note 1 of Notes to Consolidated Financial Statements for an explanation of the determination of net income per share and shares used in per share computations. 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Livingston is a leading provider of remote access networking solutions for ISPs worldwide. In 1990, the Company introduced its first PortMaster communications server incorporating its proprietary ComOS operating system, which was developed specifically for remote access applications. In 1991, the Company introduced its remote access routers which are resold by ISPs to corporate customers for Internet connectivity and other remote access networking applications. In November 1996, the Company began shipping its PortMaster 3 access concentrator which incorporates the Company's enhanced ComOS, support for high speed digital connections such as ISDN PRI and T1/E1, and up to 60 digital modems. Because this remote access solution includes modem functionality, the PortMaster 3 has a substantially higher selling price than the Company's earlier generation products. The PortMaster 3 has been designed to be easily upgraded to support emerging technologies such as 56K modem functionality. The Company has announced its offer to provide this upgrade, when and if available, to existing PortMaster 3 customers, upon request, at no additional charge (other than shipping costs). The Company accrues for the cost of providing the 56K upgrade at the time of sale. Sales of the PortMaster 3 have increased significantly since its introduction while sales of the Company's earlier generation communications servers have declined. The Company believes that it will be dependent upon sales of the PortMaster 3 for a majority of the Company's net revenues for the foreseeable future. See "Risk Factors--Dependence on Sales of PortMaster 3." See "Risk Factors--Allegation of Patent Infringement." In 1994, the Company entered into an OEM Software License and Development agreement with USR, pursuant to which the Company receives software license royalties related to sales by USR of products that incorporate the Company's ComOS operating system. Royalty payments are normally received by Livingston sixty days after USR's quarter end, and are recorded as royalty revenue at that time. Through May 31, 1997, cumulative royalties from USR totaled $10.2 million. As a result of the Settlement with USR, the Company expects royalty revenues from USR to terminate in fiscal 1998, if not earlier. See "Risk Factors--Risks Associated with the Termination of the USR Relationship." International sales accounted for 29.7% and 41.4% of the Company's product revenues in fiscal 1996 and the first nine months of fiscal 1997, respectively. The Company expects that international sales will continue to account for a significant portion of its product revenues in future periods. Although the Company's international sales are currently denominated in U.S. dollars, fluctuations in currency exchange rates could cause the Company's products to become relatively more expensive to customers in a particular country, leading to a reduction in sales or profitability in such country. Furthermore, future international activity may result in foreign currency denominated sales, and, in such event, gains and losses on the conversion to U.S. dollars of accounts receivable and accounts payable arising from international operations may cause material fluctuations in the Company's results of operations. Historically, the majority of the Company's sales have been made to local and regional ISPs through the Company's reseller channel. In connection with the introduction of the PortMaster 3, the Company began to significantly expand its direct sales force in order to better address the needs of large ISPs and Telcos. Recently, the Company has expanded its direct sales force and has established eight branch offices in North America, a European headquarters in France and a branch office in the United Kingdom. In response to growth in the ISP market and the Company's expanded base of customers, the Company has significantly increased its research and development activities. The Company has also expanded its technical support operations and manufacturing capacity. These activities, and the expansion of the Company's infrastructure to support them, have resulted in significantly higher operating expenses in fiscal 1996 and the first nine months of fiscal 1997. The Company typically provides certain postcontract customer support ("PCS") in connection with the sale of its products. Prior to the second quarter of fiscal 1996, PCS consisted principally of telephone 20 support and minor maintenance for its PortMaster 2 products. During this period, the Company recognized revenue at the time of product shipment and accrued the estimated costs of providing PCS. During the second quarter of fiscal 1996, the Company decided to provide significant feature enhancements to ComOS, free of charge, to the Company's installed customer base. Accordingly, the Company recognized the portion of product revenue attributable to the value of PCS ratably over 12 months, the period during which PCS is expected to be provided. In November 1996, the Company began selling PortMaster 3, which is accompanied by a one year hardware and software warranty. The portion of the PortMaster 3 selling price that is attributable to PCS is recognized ratably over the 12 month support period. Additional warranty and support coverage is made available to PortMaster 3 customers as a purchase option. PCS revenues to date have not been significant. RESULTS OF OPERATIONS The following table sets forth, as a percentage of net revenues (except for gross margin on product revenues), certain statement of operations data for the periods indicated:
NINE MONTHS ENDED YEAR ENDED AUGUST 31, ------------------------ ------------------------------- MAY 31, MAY 31, 1994 1995 1996 1996 1997 --------- --------- --------- ----------- ----------- Product revenues...................................... 100.0% 98.4% 93.8% 94.4% 87.2% Royalty revenues...................................... -- 1.6 6.2 5.6 12.8 --------- --------- --------- ----- ----- Net revenues.......................................... 100.0% 100.0% 100.0% 100.0% 100.0% Cost of revenues...................................... 46.2 39.4 40.3 40.6 39.6 --------- --------- --------- ----- ----- Gross profit........................................ 53.8 60.6 59.7 59.4 60.4 Operating expenses: Research and development............................ 7.4 4.3 5.5 3.3 5.6 Selling and marketing............................... 10.9 13.8 18.8 17.5 22.0 General and administrative.......................... 7.3 3.3 3.8 2.8 4.2 --------- --------- --------- ----- ----- Total operating expenses.......................... 25.6 21.4 28.1 23.6 31.8 --------- --------- --------- ----- ----- Operating income...................................... 28.2 39.2 31.6 35.8 28.6 Interest income (expense), net........................ (0.3) (0.1) 0.2 0.1 0.5 --------- --------- --------- ----- ----- Income before income taxes............................ 27.9 39.1 31.8 35.9 29.1 Provision for income taxes............................ 11.3 15.1 12.6 14.2 10.0 --------- --------- --------- ----- ----- Net income........................................ 16.6% 24.0% 19.2% 21.7% 19.1% --------- --------- --------- ----- ----- --------- --------- --------- ----- ----- Gross margin on product revenues...................... 53.8% 60.0% 57.0% 57.0% 54.5% --------- --------- --------- ----- ----- --------- --------- --------- ----- -----
NINE MONTHS ENDED MAY 31, 1997 COMPARED TO NINE MONTHS ENDED MAY 31, 1996 NET REVENUES. Net revenues increased 56.5% to $54.5 million for the nine months ended May 31, 1997 as compared to $34.8 million for the nine months ended May 31, 1996. The increased net revenues reflect introduction and increased sales of the Company's PortMaster 3 product and increased royalties, partially offset by declining sales of the PortMaster 2 products. Specifically, sales of the Company's PortMaster 2 products declined by 48% from the nine month period ended May 31, 1996 to the corresponding period ending May 31, 1997, while royalty revenues increased 260% from the nine month period ending May 31, 1996 to the corresponding period ending May 31, 1997. Royalty revenues were $7.0 million and $1.9 million for the nine months ended May 31, 1997 and 1996, respectively. Sales to international customers accounted for approximately 41.4% of product revenues for the nine months ended May 31, 1997 compared to 25.5% for the prior period. 21 GROSS PROFIT. The Company's gross profit for the nine months ended May 31, 1997 increased to $32.9 million from $20.7 million for the nine months ended May 31, 1996. This increase was attributable to the introduction and increased sales of the PortMaster 3 products and to increased royalties, partially offset by $2.3 million in charges for obsolete PortMaster 2 product and component inventory. Gross margin on product revenues declined to 54.5% for the nine months ended May 31, 1997, compared to 57.0% for the comparable period of 1996. The lower gross margin was due to the charge for obsolete PortMaster 2 inventory and approximately $2.5 million reserved to provide, when and if available, the Company's 56K modem solution, upon request, for PortMaster 3 products sold during the period. RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily of employee compensation, amounts paid for outside services, and costs of materials utilized in product development. Research and development expenses increased to $3.1 million, or 5.6% of net revenues, during the nine months ended May 31, 1997, from $1.2 million, or 3.3% of net revenues, for the nine months ended May 31, 1996. The increase was due primarily to the addition of personnel for the development of PortMaster 3, enhancement of the ComOS operating system and development of future products. The Company believes that significant research and development efforts are necessary in order for it to compete in the evolving market for remote access products. Accordingly, the Company expects its research and development expenditures to increase in absolute dollars and as a percentage of net revenues. SELLING AND MARKETING. Selling and marketing expenses consist primarily of base and incentive compensation paid to sales, customer support and marketing personnel, travel and related expenses, and costs associated with promotional and trade show activities. Selling and marketing expenses increased to $11.9 million, or 22.0% of net revenues, for the nine months ended May 31, 1997 from $6.1 million, or 17.5% of net revenues, for the nine months ended May 31, 1996. The increase reflects significant hiring of direct sales personnel in North America and Europe and technical support personnel in North America, as well as increased incentive compensation due to increased sales volume. Also included are charges relating to a marketing program to promote the Company's presence in Europe. The Company expects selling and marketing expenses to increase both in absolute dollars and as a percentage of net revenues as the Company pursues its strategy of expanding its direct sales force. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of compensation paid to administrative personnel and related overhead. General and administrative expenses increased to $2.3 million, or 4.2% of net revenues, for the nine months ended May 31, 1997 from $1.0 million, or 2.8% of net revenues, for the corresponding period in the prior year as the Company continued to build its infrastructure to support growth in its manufacturing, research and development, and selling and marketing functions. The Company expects that general and administrative expenses will increase in absolute dollars as the Company continues to expand its operations and incurs higher administration expenses related to reporting and other requirements of a public company. PROVISION FOR INCOME TAXES. The Company's effective tax rate for the first nine months of fiscal 1997 was 34.5% compared to 39.7% in fiscal 1996. See Notes 1 and 4 of Notes to Consolidated Financial Statements. YEAR ENDED AUGUST 31, 1996 COMPARED TO THE YEAR ENDED AUGUST 31, 1995 NET REVENUES. Net revenues increased 125% to $46.1 million for fiscal 1996, as compared to $20.5 million for fiscal 1995. This increase was due primarily to higher sales of the Company's communication servers and routers. Royalty revenues were $2.9 million and $323,000 in fiscal 1996 and fiscal 1995, respectively. Sales to international customers accounted for 29.7% of product revenues in fiscal 1996 compared to 16.9% in fiscal 1995. This increase in international sales was the result of an expansion of the Company's reseller relationships in Japan and Europe. 22 GROSS PROFIT. The Company's gross profit for fiscal 1996 increased to $27.5 million from $12.4 million for fiscal 1995. This increase was due primarily to higher unit sales and increased royalties. Gross margin on product revenues (excluding royalty revenues) declined to 57.0% in fiscal 1996 compared to 60.0% in fiscal 1995 as a result of a charges of $1.3 million taken in the second half of fiscal 1996 related to the Company's establishment of an inventory reserve in connection with the PortMaster 2 product line. RESEARCH AND DEVELOPMENT. Research and development expenses increased to $2.5 million, or 5.5% of net revenues, in fiscal 1996 compared to $890,000, or 4.3% of net revenues, in fiscal 1995, due primarily to the addition of personnel for the development of the PortMaster 3 and for enhancements and feature upgrades to ComOS. Research and development expenses in fiscal 1996 included $632,000 for purchased in-process research and development, primarily related to modem technology. SELLING AND MARKETING. Selling and marketing expenses increased to $8.7 million, or 18.8% of net revenues, in fiscal 1996 compared to $2.8 million, or 13.8% of net revenues, in fiscal 1995. The increase was due primarily to increased staffing levels in sales intended to broaden the geographic reach for the Company's products, increased marketing expenses related to trade show participation and development of collateral materials, and increased staffing of technical support operations in response to a growing installed base of products. GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to $1.8 million, or 3.8% of net revenues, in fiscal 1996 compared to $667,000, or 3.3% of net revenues, in fiscal 1995 due to increased personnel and overhead costs and increased use of outside professional services as the Company began to build its infrastructure to support growth in its manufacturing, research and development, and selling and marketing functions. PROVISION FOR INCOME TAXES. The Company's effective tax rate for fiscal 1996 was 39.7% compared to 38.7% in fiscal 1995. YEAR ENDED AUGUST 31, 1995 COMPARED TO THE YEAR ENDED AUGUST 31, 1994 NET REVENUES. Net revenues increased 231% to $20.5 million for fiscal 1995 from $6.2 million for fiscal 1994. This increase was due to an increase in unit sales of PortMaster 2 products and router products. In fiscal 1995 royalty revenues were $323,000. GROSS PROFIT. The Company's gross profit for fiscal 1995 increased to $12.4 million from $3.3 million for fiscal 1994, due primarily to higher unit sales and royalties from USR. Gross margin on product revenues increased to 60.0% in fiscal 1995 from 53.8% in fiscal 1994. This increase was primarily due to decreased component material costs related to increased volume purchases of components. RESEARCH AND DEVELOPMENT. Research and development expenses increased to $890,000, or 4.3% of net revenues, in fiscal 1995 compared to $462,000, or 7.4% of net revenues, in fiscal 1994. This increase primarily reflects increased spending for consulting services. SELLING AND MARKETING. Selling and marketing expenses increased to $2.8 million, or 13.8% of net revenues, in fiscal 1995 compared to $673,000, or 10.9% of net revenues, in fiscal 1994. These increases reflect higher staffing levels in sales, marketing, and technical service in order to develop the Company's reseller channel domestically and internationally and to support a growing installed product base. GENERAL AND ADMINISTRATIVE. General and administrative expenses were $667,000, or 3.3% of net revenues, in fiscal 1995 compared to $449,000, or 7.3% of net revenues, in fiscal 1994. PROVISION FOR INCOME TAXES. The Company's effective tax for fiscal 1995 was 38.7% compared to 40.4% in fiscal 1994. 23 QUARTERLY RESULTS OF OPERATIONS The following table presents consolidated statement of operations data, both in absolute dollars and as a percentage of net revenues, for the seven most recent quarters. This information is unaudited, but in the opinion of the Company's management, has been prepared on the same basis as the audited Consolidated Statements of Operations appearing elsewhere in this Prospectus and includes all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation thereof. Such statement of operations data should be read in conjunction with the Company's audited consolidated financial statements and notes thereto. The results for any quarter are not necessarily indicative of results for any future period.
QUARTER ENDED --------------------------------------------------------------------------- NOV. 30, FEB. 29, MAY 30, AUG. 31, NOV. 30, FEB. 28, MAY 31, 1995 1996 1996 1996 1996 1997 1997 --------- --------- --------- --------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Product revenues..................... $ 8,617 $ 11,825 $ 12,423 $ 10,364 $ 11,415 $ 15,866 $ 20,207 Royalty revenues..................... 538 425 981 934 2,263 1,771 2,963 --------- --------- --------- --------- --------- --------- --------- Net revenues......................... 9,155 12,250 13,404 11,298 13,678 17,637 23,170 Cost of revenues..................... 3,457 5,203 5,461 4,446 6,782 7,177 7,636 --------- --------- --------- --------- --------- --------- --------- Gross profit....................... 5,698 7,047 7,943 6,852 6,896 10,460 15,534 Operating expenses: Research and development........... 243 478 432 1,359 973 880 1,221 Selling and marketing.............. 1,488 1,953 2,653 2,576 2,745 3,689 5,500 General and administrative......... 211 333 448 779 623 761 921 --------- --------- --------- --------- --------- --------- --------- Total operating expenses......... 1,942 2,764 3,533 4,714 4,341 5,330 7,642 --------- --------- --------- --------- --------- --------- --------- Operating income..................... 3,756 4,283 4,410 2,138 2,555 5,130 7,892 Interest income (expense), net....... (1) 2 42 42 55 69 152 --------- --------- --------- --------- --------- --------- --------- Income before income taxes........... 3,755 4,285 4,452 2,180 2,610 5,199 8,044 Provision for income taxes........... 1,485 1,698 1,766 878 901 1,795 2,776 --------- --------- --------- --------- --------- --------- --------- Net income....................... $ 2,270 $ 2,587 $ 2,686 $ 1,302 $ 1,709 $ 3,404 $ 5,268 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Net income per share................. $ .17 $ .19 $ .18 $ .09 $ .12 $ .24 $ .37 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Shares used in per share computations....................... 13,333 13,904 14,589 14,588 14,359 14,371 14,391
AS A PERCENTAGE OF NET REVENUES (1) --------------------------------------------------------------------------- NOV. 30, FEB. 29, MAY 30, AUG. 31, NOV. 30, FEB. 28, MAY 31, 1995 1996 1996 1996 1996 1997 1997 --------- --------- --------- --------- --------- --------- --------- Product revenues..................... 94.1% 96.5% 92.7% 91.7% 83.5% 90.0% 87.2% Royalty revenues..................... 5.9 3.5 7.3 8.3 16.5 10.0 12.8 --------- --------- --------- --------- --------- --------- --------- Net revenues......................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of revenues..................... 37.8 42.5 40.7 39.4 49.6 40.7 33.0 --------- --------- --------- --------- --------- --------- --------- Gross profit....................... 62.2 57.5 59.3 60.6 50.4 59.3 67.0 Operating expenses: Research and development........... 2.7 3.9 3.2 12.0 7.1 5.0 5.3 Selling and marketing.............. 16.2 15.9 19.8 22.8 20.1 20.9 23.7 General and administrative......... 2.3 2.7 3.4 6.9 4.5 4.3 4.0 --------- --------- --------- --------- --------- --------- --------- Total operating expenses......... 21.2 22.5 26.4 41.7 31.7 30.2 33.0 --------- --------- --------- --------- --------- --------- --------- Operating income..................... 41.0 35.0 32.9 18.9 18.7 29.1 34.0 Interest income (expense), net....... 0.0 0.0 0.3 0.4 0.4 0.4 0.7 --------- --------- --------- --------- --------- --------- --------- Income before income taxes........... 41.0 35.0 33.2 19.3 19.1 29.5 34.7 Provision for income taxes........... 16.2 13.9 13.2 7.8 6.6 10.2 12.0 --------- --------- --------- --------- --------- --------- --------- Net income....................... 24.8% 21.1% 20.0% 11.5% 12.5% 19.3% 22.7% --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Gross margin on product revenues..... 59.9% 56.0% 56.0% 57.1% 40.6% 54.8% 62.2% --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
- --------- (1) Except gross margin on product revenues. 24 Net revenues increased in each of the first three quarters of fiscal 1996 principally as a result of increased remote access unit shipments. Product revenues declined in the fourth quarter of fiscal 1996 due primarily to the decrease in sales of PortMaster 2 communication servers. The Company believes that the decline in PortMaster 2 sales was due primarily to delays in purchasing decisions by the Company's customers in anticipation of the introduction of PortMaster 3. The Company commenced shipment of PortMaster 3 in the first quarter of fiscal 1997, and sales of PortMaster 3 represented a majority of net revenues in the third quarter of fiscal 1997. The Company does not expect sequential quarterly growth in product revenues to continue at the same rate experienced from the second to the third quarter of fiscal 1997. Royalties from USR increased from $538,000 in the first quarter of fiscal 1996 to $3.0 million in the third quarter of fiscal 1997. The Company believes that its royalty revenues from USR will terminate in fiscal 1998, if not sooner. See "Risk Factors--Risks Associated with the Termination of the USR Relationship." Gross margin on product revenues has fluctuated on a quarterly basis generally because of product mix. Gross margin on product revenues in the quarter ended November 30, 1996 was adversely affected by a charge of approximately $2.0 million related to the provision for obsolete and overstocked product and component inventory due to the decline in PortMaster 2 sales, and due to approximately $2.0 million reserved for further upgrades to implement the Company's 56K modem solution for PortMaster 3 products sold. Research and development expenses have generally increased in dollar amount due to increased staffing and higher amounts spent on outside consulting. In the quarter ended August 31, 1996, research and development expenses included $632,000 for purchased in-process research and development, principally related to modem technology. Selling and marketing expenses have increased in dollar amount and as a percentage of net revenues reflecting increased personnel and related expenses, spending for promotional expenses, travel expense, and costs associated with opening new sales offices in North America and Europe. General and administrative expenses have increased in dollar amount due to increased personnel and related expenses and increased outside professional services. The increase in general and administrative expenses in the quarter ended August 31, 1996 included a charge of approximately $117,000 related to a buy-out of the Company's lease commitment for its previous headquarters facilities in connection with the Company's move to its new, larger headquarters facility in November 1996. The Company's future net revenues are difficult to predict. Although the Company typically operates with some backlog, net revenues and operating results in any quarter depend on the volume and timing of, and the ability to fulfill, orders received within the quarter. In addition, due to the Company's utilization of its reseller channel, the Company's net revenues in any period are highly dependent upon the sales efforts and success of its resellers, which are not within the Company's control. There can be no assurance that the Company's resellers will give a high priority to the marketing of the Company's products as compared to competitive products or alternative networking solutions, or that the resellers will continue to carry the Company's products. Further, the Company's strategy is to broaden its customer base by increasing its direct sales force and there can be no assurance that this new sales force and the resellers will be capable of achieving the Company's growth goals. The Company anticipates that quarterly operating results will fluctuate as a result of a number of factors, including customers' capital spending cycles, the timing of new product announcements by the Company or its competitors, changes in pricing policies by the Company, its competitors or its suppliers, the availability and cost of key components, and market acceptance of new and enhanced versions of the Company's products. In addition, it is possible that in some future quarter the Company's operating results may be below the expectations of public market analysts and investors. In such event, the market price of the Company's Common Stock would likely be materially adversely affected. See "Risk Factors-- Unpredictable and Fluctuating Quarterly Operating Results" and "--Possible Volatility of Stock Price." 25 LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has financed its operations primarily through cash flows from operating activities. As of May 31, 1997, the Company's principal sources of liquidity consisted of $16.0 million of cash and cash equivalents and an unsecured $5 million line of credit. The line of credit bears interest at the bank's prime rate and specifies financial and operating covenants, including restrictions on the Company's ability to purchase its own stock and a prohibition on payment of cash dividends. There have been no borrowings under the line of credit. During the nine months ended May 31, 1997, cash provided by operating activities was $13.6 million compared to $4.2 million during the nine months ended May 31, 1996. The Company's operating activities in fiscal 1996, 1995 and 1994 provided cash flows of $3.4 million, $1.2 million, and $644,000, respectively. Cash provided by operating activities during these periods was attributable primarily to increases in net income, partially offset by increases in accounts receivable and inventories. As of May 31, 1997, the Company's working capital was $23.7 million, which included $10.8 million and $4.2 million of accounts receivable and inventory, respectively. The Company's investing activities have consisted primarily of purchases of property and equipment. Cash used in investing activities increased to $1.8 million in the nine months ended May 31, 1997 from $455,000 in the nine months ended May 31, 1996 due primarily to purchases of furniture and fixtures for the new headquarters facility which the Company moved into in November 1996. Cash used in investing activities totaled $881,000, $348,000, and $63,000 in fiscal 1996, 1995 and 1994, respectively. The Company expects to use approximately $2.5 million for capital expenditures over the next twelve months. The Company believes that the net proceeds from this offering, together with available funds, its existing bank line of credit and cash flows expected to be generated from operations, will be sufficient to meet its anticipated cash needs at least through fiscal 1998. 26 BUSINESS Livingston is a leading provider of remote access networking solutions for ISPs worldwide. Used by ISPs to connect their subscribers to the Internet, the Company's remote access servers deliver high performance at a low price per port, making them particularly well-suited for the intensely competitive ISP market. The Company also provides office routers and firewall routers that are resold by ISPs to corporate customers for Internet connectivity and other remote access networking applications. Since the introduction of its first remote access server in 1990, over 2,000 ISPs have purchased the Company's remote access products. The Company believes that more ISPs worldwide use Livingston's remote access servers than those of any other vendor based on data compiled by Infonetics Research, Inc.* and the Company's knowledge of the remote access market. In November 1996, the Company introduced the PortMaster 3 access concentrator, its next generation remote access platform, which the Company believes positions it to better address the needs of large ISPs and Telcos, and to maintain its leadership position with the Company's established base of local and regional ISP customers. The Company's goal is to be the leading supplier of technologically advanced and cost-effective remote access solutions to ISPs worldwide. INDUSTRY BACKGROUND AND MARKET GROWTH OF THE INTERNET AND INTERNET INFRASTRUCTURE The Internet has emerged as a global network enabling millions of businesses, organizations and individuals to communicate, share information and conduct business electronically. A network of networks, the Internet comprises hundreds of publicly and commercially owned networks that communicate and share traffic using a common, industry standard communications protocol suite called TCP/IP. According to International Data Corporation, the number of Internet World Wide Web users will increase to 163 million in 2000, from an estimated 35 million users in 1996. Individuals and corporate customers typically access the Internet through ISPs which maintain networks offering Internet access through local points of presence ("POPs"). A POP consists of telecommunications and internetworking equipment connected to the Internet through high speed dedicated lines leased from telecommunications providers or through Frame Relay or ATM service connections. To accommodate the growing numbers of Internet users and their bandwidth requirements, many ISPs are dramatically increasing investments in networking infrastructure, particularly in the area of remote access equipment. REMOTE ACCESS EQUIPMENT AND THE MARKET FOR REMOTE ACCESS SOLUTIONS Internet subscribers connect to ISPs through remote access equipment, such as access concentrators, communications servers and access routers, utilizing analog or digital dial-up lines or leased line connections. The remote access market is among the fastest growing segments in the networking industry. In its report entitled "The ISP Opportunity 1997," Infonetics Research, Inc. forecasts that network product expenditures by ISPs will increase from approximately $3.6 billion in 1997 to $7.9 billion in 1999. As depicted on the following page, a dial-up subscriber communicates with an ISP over a standard analog, ISDN or T1/E1 leased line connection. An access concentrator, which contains multiple digital modems, or a communications server with externally connected analog modems housed within the POP, receives the subscriber's call, performs user authentication and billing functions, and passes traffic through to the Internet via the ISP's router-based network. For high speed communications, access routers located at the subscribers' premises manage the exchange of Internet traffic between the ISP's network and the subscribers' network over dedicated leased lines. Software operating with the remote access hardware enables the ISP to perform critical functions such as device and network management, subscriber administration, authorization and accounting, firewall filtering and protocol routing. - --------- * "The ISP Opportunity 1997" by Infonetics Research, Inc. 27 [This diagram shows the principal pieces of networking equipment (including remote access servers, ethernet hubs, and routers) utilized in an Internet service providers' point of presence.] OVERVIEW OF THE ISP MARKET AND INDUSTRY DYNAMICS The worldwide ISP market currently includes local, regional, national and international companies providing a range of services for business and consumers including Internet access, Web site hosting, sales of network equipment and network management, design and consulting services. An ISP's business model, and the ISP's requirements for remote access solutions, differ based on the size and nature of the ISP's subscriber base and the scope of the ISP's operations. Local ISPs tend to focus on a relatively small geographic market and generally operate networks consisting of a small number of POPs. Local ISPs typically provide basic Internet dial-up connectivity to their customers and differentiate themselves by providing value-added services. These ISPs demand remote access equipment that is easy to install, configure and operate, and tend to purchase this equipment primarily through indirect distribution channels. Regional ISPs address a broader customer base, operate relatively complex networks consisting of multiple POPs, and usually demand remote access equipment that is highly scalable and that integrates seamlessly in a heterogeneous networking environment. Regional ISPs have historically purchased the majority of their remote access products through resellers, although the direct sales channel is increasingly becoming an important method of sale for this class of ISP. The large national and international ISPs, which include companies such as UUNET, Netcom, PSINet, and BBN Planet, as well as the major online service providers such as America Online and Compuserve, provide Internet service to millions of users, operate networks consisting of hundreds of POPs and represent the most sophisticated category of ISP. These large ISPs also have greater requirements for device scalability and manageability, in addition to requiring support for heterogeneous networking environments and technical support. Large ISPs primarily purchase remote access equipment from the vendor's direct sales force. In addition, many of the regional, national and international ISPs resell remote access equipment to their corporate customers for Internet connectivity, intranet and other remote access networking applications. The ISP market is evolving rapidly and competition in the industry has recently intensified. New groups of telecommunications service providers, including the major interexchange carriers, RBOCs and other competitive access providers have entered, or have announced plans to enter, the ISP market and are rapidly building their dial-up networks. To remain competitive, many ISPs have adopted a flat rate pricing model for Internet access, which has put pressure on their margins as user connect time and bandwidth requirements have increased. ISPs increasingly need to provide reliable service with maximum accessibility and minimum downtime to maintain customer satisfaction, forcing ISPs to continually expand and improve their networks without service interruption. Competition to attract and maintain subscribers requires ISPs to improve the performance of their networks by incorporating new technologies such as 56K modems. As a result, ISPs are increasingly focused on procuring remote access equipment that is cost-effective, reliable, scalable and interoperable, includes comprehensive network management and security capabilities and provides support for emerging technologies. 28 THE LIVINGSTON SOLUTION Livingston's remote access concentrators and servers solve the needs of ISPs by delivering high performance at a low price per port, making them particularly well-suited for the intensely competitive ISP market. The Company's products combine its core software technology, the ComOS operating system, with an integrated hardware design that provides ISPs with a high port density, highly scalable remote access solution. ComOS has been specifically designed for remote access applications and is incorporated in all of the Company's remote access products. ComOS provides robust routing, security, centralized device management and subscriber administration capabilities. In November 1996, the Company introduced the PortMaster 3 access concentrator, its next generation remote access platform, which integrates digital modem, router and communications server functionality with support for analog modems, ISDN PRI, Frame Relay and T1/E1 service connections in a compact 3.5 inch high chassis. The PortMaster 3 has been designed to be easily upgraded to support emerging technologies such as 56K modem functionality. Based on the foregoing factors, the Company believes that the PortMaster 3 platform positions it to better address the needs of large ISPs and Telcos, and to maintain its leadership position with the Company's established base of local and regional ISP customers. The PortMaster 3 offers ISPs the following advantages: INTEGRATED HARDWARE SOLUTION: The PortMaster 3 eliminates the need for externally connected modems within a POP by integrating digital modem, router and communications server functionality in a compact 3.5 inch high chassis. The integration of these separate remote access functions reduces the cost per port and the support requirements for product installation, operation and management. SUPPORT OF EMERGING TECHNOLOGIES: The PortMaster 3 employs a modular design that facilitates the incorporation of new communications technologies as they become available. For example, the PortMaster 3 has been designed to be easily upgraded to support 56K modem functionality. The Company has announced its offer to provide this upgrade, when and if available, to existing PortMaster 3 customers, upon request, at no additional charge (other than shipping costs). SCALABILITY AND MANAGEABILITY: Livingston's ComOS assists ISPs in establishing POPs that can scale to accommodate any number of users and accept any combination of dial-up or leased-line services. The scalability of ComOS allows ISPs to link dozens of PortMaster 3 chassis stacked together to form one larger logical unit that can be centrally managed and administered. RELIABILITY: The combination of Livingston's ComOS and the Company's advanced hardware architecture results in a reliable solution for ISPs. The Company's True Digital modem technology has minimal power requirements, thus reducing heat dissipation and significantly decreasing the potential for equipment downtime. This technology also provides for real time diagnostics and fault-tolerant modem pooling, further reducing service disruptions. SECURITY AND ADMINISTRATION: The Company's ComOS provides a comprehensive set of security capabilities for ISPs including encryption, firewall filtering and subscriber authorization. ComOS includes the Company's RADIUS software module which provides subscriber authentication and accounting for remote network access. The RADIUS specifications developed by the Company are generally regarded as the industry standard for subscriber administration. ComOS also includes ChoiceNet, a network filtering feature that provides Internet content management on a per-user basis so that a subscriber can specify authorized World Wide Web sites and eliminate access to unauthorized sites. LOW PRICE PER PORT: The streamlined and efficient product architecture of the PortMaster 3, along with the Company's ComOS operating system, enables the Company to provide remote access solutions at one of the lowest prices per port in the industry. 29 COMPANY STRATEGY The Company's goal is to be the leading supplier of technologically advanced and cost-effective remote access solutions to ISPs worldwide. The Company is pursuing the following strategies to achieve this goal: LEVERAGE TECHNOLOGY TO PROVIDE LEADING REMOTE ACCESS SOLUTIONS. Livingston seeks to leverage its highly flexible ComOS operating system and its modular hardware design capabilities to provide cost-effective, highly scalable and reliable remote access solutions that incorporate next generation networking technologies such as 56K modem functionality. The Company's future development efforts will focus on enhancing the capabilities of ComOS and designing remote access solutions that provide higher port density and support for high speed communications technologies such as Fast Ethernet, ATM, and xDSL, as well as Virtual Private Network security standards. MAINTAIN MARKET SHARE WITH LOCAL AND REGIONAL ISPS. The Company is focused on maintaining its leadership position with local and regional ISPs by continuing to offer comprehensive and cost-effective solutions such as the PortMaster 3. The Company established its leadership in this market by providing scalable, affordable, reliable solutions that have enabled many ISPs to easily expand and upgrade their remote access networks. The Company believes that it has also differentiated itself by providing high quality technical support, and plans to continue helping local and regional ISPs succeed by addressing their specific support requirements. TARGET LARGE ISPS AND TELCOS. The Company believes that its recently-introduced high port density PortMaster 3 platform provides it with the opportunity to pursue the large ISPs and Telcos. Based on the flexibility, scalability and reliability of the PortMaster 3, the Company believes it is able to meet the demanding requirements of these potential customers. An important element of this strategy involves the expansion of the Company's direct sales force and the development of key account relationships. In addition, the Company plans to expand its product support capabilities as well as to continue development of higher port density products that provide enhanced features and higher performance. INCREASE PENETRATION OF INTERNATIONAL MARKETS. The Company is focused on continuing to capitalize on the growth of the Internet in Europe and Asia, by targeting additional ISPs through enhancing its sales and service efforts and by developing relationships with strategic resellers. The Company recently established a European headquarters in Mougins, France as well as a branch office in the United Kingdom. Currently, the Company manages its Japan and Asia Pacific region resellers from its Pleasanton, California headquarters. The Company anticipates establishing a direct sales and service presence in Japan and developing new reseller relationships in the rest of the Asia Pacific region. TECHNOLOGY AND PRODUCTS Livingston offers the PortMaster 3 remote access concentrator, communication servers and access routers that are targeted to ISPs and their customers and are designed specifically for remote access applications such as connecting to the Internet, linking remote offices to corporate computing resources, and providing public access to corporate World Wide Web sites. All of the Company's products are based on its ComOS operating system, and include a one year warranty on the hardware as well as one year of free technical support and software upgrades. COMOS OPERATING SYSTEM ComOS is a hardware independent operating system designed specifically for remote access applications and has been continuously tested and improved since its introduction in 1990. ComOS incorporates a modular architecture, well defined interfaces and reduced code size, supports all major routing protocols and facilitates system configuration and device management through its network management module. Also included is the Company's RADIUS software module which provides subscriber authentication and 30 accounting for remote network access. The RADIUS specifications developed by the Company are generally regarded as the industry standard for subscriber administration. ComOS also includes ChoiceNet, a network filtering feature that provides Internet content management on a per-user basis so that a subscriber can specify authorized World Wide Web sites and eliminate access to unauthorized sites. The Company believes that ComOS provides it with a significant competitive advantage. ComOS is critical to the Company's ability to provide remote access solutions which are cost-effective, reliable, scalable and interoperable, include comprehensive network management and security capabilities and provide support for emerging technologies. THE PORTMASTER 3 ACCESS CONCENTRATOR The PortMaster 3, the Company's next generation remote access platform, is an integrated access concentrator used by ISPs to receive and process in-bound calls from subscribers. PortMaster 3 performs user authentication, authorization, accounting and billing functions and passes data traffic through to the Internet via the ISP's router-based network. The PortMaster 3 hardware together with the ComOS operating system provide a solution which utilizes fewer electrical components, consumes less power, generates less heat, and is relatively inexpensive to manufacture. The PortMaster 3 consolidates analog modem, ISDN PRI, Frame Relay, and T1/E1 services together with the Company's proven router communications server technology into a single unit. The PortMaster 3 can be configured with up to 60 digital modem ports per system, and currently supports the V.34 28.8K modem standard. The PortMaster 3 has been designed to be easily upgraded to support emerging technologies such as 56K modem functionality. Unlike competing products, which utilize modem hardware consisting of an analog-based modem and a digital-to-analog converter, Livingston's True Digital modem technology implements all modem functionality in a single Digital Signal Processor (DSP). True Digital modem technology is designed to provide lower energy consumption, greater reliability, and more consistent system performance. Multiple PortMaster 3 chassis can be stacked together to form one larger logical unit that supports hundreds of high-bandwidth dial-up connections that can be centrally managed. The list price for the PortMaster 3 chassis ranges from $6,950 to $11,150, and can be configured with up to six modem cards. Each 8-port and 10-port modem card is priced at $3,450 and $4,300, respectively. The PortMaster 3 is the Company's first product that contains an integrated modem and thus directly competes with remote access products with integrated modems offered by larger competitors such as Ascend, USR and Cisco which have dominated this segment of the remote access market. THE PORTMASTER 2 COMMUNICATION SERVERS The Company's initial dial-up remote access products were introduced in 1990 and provide network access over standard analog telephone lines, when used in conjunction with external V.34 modems from other vendors. PortMaster 2 products include: the PortMaster 2E, a modular unit which can be configured with 10 to 30 asynchronous ports, priced from $2,695 to $3,750; and the PortMaster 25, a 25-port fixed-configuration unit, priced at $3,495. To date, the installed base of PortMaster 2 products represents almost 1 million ports supporting approximately 10 million dial-up subscribers. The Company believes the success of its PortMaster 2 products has been critical to establishing the Company's reputation among ISPs and that the Company has a significant opportunity to migrate PortMaster 2 customers to the PortMaster 3 platform over time. ACCESS ROUTERS In addition to access concentrators and servers, the Company provides office routers and firewall routers that are resold by ISPs to corporate customers for Internet connectivity and other remote access networking applications. OFFICE ROUTERS. Livingston's Office Routers are targeted for use by small businesses and remote offices that need to connect to an ISP's network. These systems are available with support for dial-up 31 analog, ISDN BRI, Frame Relay, and T1/E1 services and allow PCs on a subscriber's LAN to share bandwidth and phone line costs. Office Router prices range from $1,195 to $1,395. FIREWALL IRX ROUTERS. The Company's FireWall IRX Routers allow a company to provide public access to its World Wide Web site or File Transfer Protocol server through a connection to the Internet while simultaneously granting employees, working at home or at remote office sites, access to the corporate network. FireWall IRX Routers utilize Livingston's packet filtering technology and multiple ethernet ports to isolate the corporate network from the public network, log and control internal and outbound access, and prevent network attacks from the outside world. FireWall IRX Routers support analog modem, ISDN BRI, fractional T1, full T1/E1 and Frame Relay services. Prices for these products range from $2,395 to $3,250. SALES AND MARKETING The Company sells its products through direct and indirect channels in North America. To date, the majority of the Company's sales have been generated through resellers which accounted for 88.1% and 79.6% of product revenues in fiscal 1996 and the first nine months of fiscal 1997, respectively. The Company has expanded and plans to continue to expand its direct sales force and key account relationships in an effort to increase its market share with large ISPs and Telcos in North America. The Company uses telemarketing, direct mail, trade shows and seminars, selected advertising and the Internet to market its products. In international markets, the Company primarily sells its products through its network of over 30 resellers, who assist in the marketing process. Recently, the Company increased its focus on its international sales and marketing efforts and has established a European headquarters in France with a branch office in the United Kingdom. Sales operations for the Asia Pacific region are currently managed out of the Company's headquarters in Pleasanton, California. Sales to international customers accounted for 29.7% of product revenues in fiscal 1996 and 41.4% for the first nine months of 1997. The Company recently began to offer an equipment finance program that allows customers to fund the acquisition of the Company's products through leases offered by a third-party leasing broker, doing business as Livingston Capital Corporation ("LCC"). Under the terms of the master lease agreements with LCC, upon termination of the lease and return of the equipment, the Company is generally obligated to remarket the products. In the event the Company is requested to remarket on behalf of LCC it will be on a best-efforts basis. Livingston provides most of its resellers with product return rights for stock balancing and price protection. Subject to purchasing an equal dollar amount of other Livingston products and within certain limits, stock balancing rights permit resellers to return products for credit. Price protection would require the Company to grant retroactive price adjustments for inventory of Livingston products held by resellers if Livingston lowers its prices for such products. Although Livingston believes that it has adequate reserves to cover product returns and price reductions, there can be no assurance that the Company will not experience significant returns or price protection adjustments in the future. See "Risk Factors--Risks Associated with Reliance on Resellers." As of May 31, 1997, the Company employed 50 people in sales and marketing. CUSTOMER SERVICE AND SUPPORT The Company believes that a high level of technical support is essential in achieving end-user customer satisfaction. The Company provides a range of customer services with an escalating level of costs depending on the level of service required. The majority of Livingston's service and support activities relate to WAN connection and network configuration issues that can generally be resolved by a technician by telephone or electronic mail. Certain of the Company's resellers also provide end-user customers with service and support. 32 The Company typically provides certain postcontract customer support ("PCS") in connection with the sale of its products. Prior to the second quarter of fiscal 1996, PCS consisted principally of telephone support and minor maintenance for its PortMaster 2 products. During this period, the Company recognized revenue at the time of product shipment and accrued the estimated costs of providing PCS. During the second quarter of fiscal 1996, the Company decided to provide significant feature enhancements to ComOS, free of charge, to the Company's installed customer base. Accordingly, the Company recognized the portion of product revenue attributable to the value of PCS ratably over 12 months, the period during which PCS is expected to be provided. In November 1996, the Company began selling PortMaster 3, which is accompanied by a one year hardware and software warranty. The portion of the PortMaster 3 selling price that is attributable to PCS is recognized ratably over the 12 month support period. Additional warranty and support coverage is made available to PortMaster 3 customers as a purchase option, under the ProVision program or on a fee per hour basis. The ProVision Services program offers customers 24 hours, seven days a week technical support over the phone, extended hardware warranty, upgrades of the latest ComOS software, and updated product manuals. To date, revenue attributable to post warranty services has not been significant. Livingston makes extensive use of on-line services to distribute technical advice and software updates including a bulletin board service and the Company's Web site. Livingston also offers technical training to its resellers and end-user customers, a one year warranty on its hardware and software products and free upgrades of its software for the one year warranty period. The PortMaster 3 has been designed to be easily upgraded to support emerging technologies such as 56K modem functionality. The Company has announced its offer to provide this upgrade, when and if available, to existing PortMaster 3 customers, upon request, at no additional charge (other than shipping costs). The Company accrues for this cost at the time of sale. As of May 31, 1997, the Company employed 59 people in customer service. RESEARCH AND DEVELOPMENT The Company's research and development efforts are focused on developing new products and core technologies for the remote access market, further enhancing the functionality, performance and flexibility of the Company's ComOS, and providing support for WAN protocol standards and telecommunication carrier services. Livingston currently focuses its development efforts on additional remote access technologies, particularly in the area of higher port density, integration of higher speed digital transmission services such as T3, development of ISP administrative software programs and support for network security standards. The Company's future success depends on its ability to continue to enhance its existing products and to develop new products that address the remote access requirements of its customers. The Company closely monitors changing customer requirements by communicating directly with ISP customers, resellers and market research organizations. Livingston also receives input by actively participating in industry groups responsible for establishing technical standards. Product development schedules are inherently difficult to predict, and there can be no assurance that the Company will achieve its targets for product development, introduction and shipment. Also, there can be no assurance that the Company's product development efforts will result in commercially successful products or that the Company's products will not be rendered obsolete by changing technology or new product announcements by other companies. The Company's research and development expenditures were $2.5 million, $890,000 and $462,000 in fiscal 1996, 1995 and 1994, respectively. As of May 31, 1997, Livingston's research and development staff consisted of 32 employees. 33 MANUFACTURING Livingston's manufacturing operations consist primarily of materials planning and procurement, quality control, kitting, final assembly, burn-in, and testing. The Company designs all of the hardware subassemblies for its products and uses the services of contract manufacturers to build these subassemblies to the Company's specifications. The Company presently uses a variety of independent third party contract assembly companies to perform printed circuit board assembly and in-circuit testing. The manufacturing process enables the Company to configure the hardware and software in combinations to meet a wide variety of individual customer requirements. The Company uses automated test equipment, burn-in procedures, and comprehensive inspection, testing and statistical process control testing by technicians to assure the quality and reliability of its products. To date, the Company has not experienced any significant product defects or product returns. The Company is dependent upon single or limited source suppliers for a number of components and parts used in the Company's products, including certain key microprocessors and integrated circuits. There can be no assurance that these independent contractors and suppliers will be able to meet the Company's future requirements for manufactured products, components and subassemblies. The Company generally purchases single or limited source components pursuant to purchase orders and has no guaranteed supply arrangements with these suppliers. For example, the Company currently purchases all of its modem microchips from Analog Devices, Inc. and with the implementation of the Company's 56K modem technology, the Company anticipates that it will become dependent upon Lucent for modem microchips. In addition, the availability of many of these components is dependent in part on the Company's ability to provide its suppliers with accurate forecasts of its future requirements. Any extended interruption in the supply of any of the key components currently obtained from a single or limited source or in the time necessary to transition a replacement component into the Company's products could disrupt its operations and have a material adverse effect on the Company in any given period. The Company purchases certain components from foreign suppliers and the supply of such components could be adversely affected by changing tariff and regulatory structures, particularly those affecting the import and export of electronics and technology. The Company may also be subject to increases in component costs, which could also have a material adverse effect on the Company's business, results of operations and financial condition. The Company uses a rolling six month forecast based on anticipated product orders to determine its general materials and component requirements. Lead times for materials and components ordered by the Company vary and depend on factors such as the specific supplier, contract terms, and demand for a component at a given time. Currently, the Company acquires materials, completes certain standard subassemblies and assembles fully-configured systems based on the Company's forecast. If orders do not match forecasts, the Company may have excess or inadequate inventory of certain materials and components. In November 1996, with the introduction of the PortMaster 3 access concentrator, the Company experienced a decrease in demand for its older PortMaster 2 products. As a result, the Company recorded charges aggregating approximately $3.3 million through the first quarter of fiscal 1997 as a reserve for obsolete PortMaster 2 inventory. There can be no assurance that the Company will not experience a similar problem as it introduces future products and attempts to adjust its production planning as demand for older products declines. As of May 31, 1997 there were 36 employees in manufacturing. REGULATORY MATTERS The Company's products must meet standards and receive certification for connection to the public telecommunications network prior to their sale. In the United States, the Company's products must comply with Part 15(a) (industrial equipment), Part 15(b) (residential equipment) and Part 68 (analog lines) of the Federal Communications Commission regulations. The Company's products also must be certified by domestic telecommunications carriers in both the United States and in foreign countries. In foreign countries, the Company's products are subject to a wide variety of government review and certification 34 requirements. The Company is currently undertaking an effort to qualify for ISO 9002 series quality certification in order to fulfill the quality system requirements for the European markets. The Company made application for ISO 9002 certification November 11, 1996. ISO (the International Organization for Standardization) is a worldwide federation of national standards bodies who collaborate with the International Electromechanical Commission (IEC) on all matters of electrotechnical standardization. ISO 9002 is the quality system used when conformance to specified requirements is to be assured by a supplier during production, installation, and servicing of manufactured products. The ISO 9002 certification process includes a number of tasks including the development of quality control manuals, establishment of written operational procedures, establishment of processes for reviewing and updating procedures, and internal compliance audits of these processes and procedures. An external audit of the ISO 9002 process is conducted by an affiliate of ISO, the National Standards Authority of Ireland (NSAI). If the subject company is determined to be in compliance with the provision of ISO 9002, certification is awarded. Currently, Livingston has completed approximately 25% of the work required for certification and intends to complete the entire process by November 1998. COMPETITION The remote access market is intensely competitive and the Company's principal competitors include Ascend, USR and Cisco. Competitive factors in the remote access ISP market include the breadth of product features, pricing, product quality, reliability and functionality, marketing and sales resources, customer service and support, and reputation. The Company believes that it competes favorably with respect to the foregoing factors. Competition in the large ISP and Telco segments of the remote access market is particularly intense and the Company's competitors have greater name recognition, resources, sales capabilities and market share than the Company. As a result, the Company has a competitive disadvantage in these markets. Increased competition could result in price reductions, the inability of the Company to increase market share, or a loss of market share by the Company, any of which could materially adversely affect the Company's business, results of operations and financial condition. Additionally, industry-wide consolidation, such as the recently announced mergers of USR with 3Com and Ascend with Cascade, could result in increased competition in the remote access ISP market because, among other things, such companies will be able to provide a complete solution for integrated remote access combined with other networking products not offered by the Company. Furthermore, the ISP industry could experience consolidation and the acquisition of one of the Company's larger customers by a corporation with relationships with one of the Company's competitors could result in a loss of revenue attributable to such customer. To the extent Telcos increase their share of the ISP market and the Company is unsuccessful in penetrating the Telco segment of the market, the Company's business, results of operations and financial condition could be materially adversely affected. There can be no assurance that the Company's current and future competitors will not develop or market technologies and products that offer higher performance and are more cost-effective than the Company's current or future products, thereby rendering the Company's technologies and products obsolete. PROPRIETARY RIGHTS Although the Company believes that its success is more dependent upon its technical expertise than its proprietary rights, the Company's future success and ability to compete is dependent in part upon its proprietary technology. The Company relies on a combination of contractual rights, trade secrets and copyright laws to establish and protect its proprietary technology. The Company currently has one patent application pending, but there can be no assurance that a patent will be issued as a result of such application, that the Company's patent will be upheld as valid, or that such patent will prevent the development of competitive products. The Company generally enters into confidentiality agreements with its employees, consultants, resellers, customers and potential customers, and strictly limits access to, and 35 distribution of its source code, and further limits the disclosure and use of other proprietary information. There can be no assurance that the steps taken by the Company in this regard will be adequate to prevent misappropriation of its technology or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. The Company is also subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of others. There can be no assurance that third parties will not assert infringement claims in the future with respect to the Company's current or future products or that any such claims will not require the Company to enter into license arrangements or develop non-infringing technology, or result in litigation, regardless of the merits of such claims. In addition, any such litigation could result in product delays or costs which would have a material adverse effect on the Company's business, results of operations and financial condition. No assurance can be given that any necessary licenses will be available or that, if available, such licenses can be obtained on commercially reasonable terms. The failure of the Company to adequately obtain such licenses, or to protect its own proprietary technology through contractual rights, trade secrets, patent and copyrights laws, could have a material adverse effect on the Company's business, results of operations and financial condition. See "Risk Factors--Dependence on Proprietary Technology." FACILITIES The Company's principal operations are conducted out of two leased buildings located in Pleasanton, and Dublin, California with a total of 64,472 square feet of office and manufacturing space. The Company also maintains eight branch offices in the United States. The Company's European operations are headquartered in Mougins, France with a branch office in the United Kingdom. In April 1997, the Company entered into an agreement to lease an additional 45,525 square feet of office space adjacent to its current headquarters building. The expansion facility will be available for occupancy in Spring 1998. The Company believes that its current and expansion facilities will be adequate to meet the anticipated level of operations through fiscal 1998. EMPLOYEES On May 31, 1997, Livingston employed 200 individuals. Of these, 32 were involved in research and development, 109 in sales, marketing, and customer support, 36 in manufacturing, and 23 in administration. The Company believes that it maintains good relations with its employees and has not experienced any interruption of operations as a result of labor disagreements. BACKLOG The Company's sales are generally fulfilled within a few weeks from the date of an order and customers have up to two weeks to cancel or delay orders. Accordingly, the Company does not believe that backlog is a meaningful indicator of future sales. LEGAL PROCEEDINGS On June 5, 1997, a complaint was filed against the Company in California Superior Court by Capella Worldwide Networking, Inc., the Company's largest distributor in fiscal 1996. The Company terminated its relationship with Capella in November 1996. The complaint purports to allege contract and tort causes of action arising out of the Company's termination of Capella as a distributor. The complaint seeks injunctive and declaratory relief as well as unspecified damages for alleged lost profits, including compensatory, punitive and treble damages. The Company has not yet responded to the Complaint and discovery has not yet commenced. The Company denies the allegations in the complaint and intends to defend its position. 36 Nevertheless, litigation is subject to inherent uncertainties and thus there can be no assurance that this suit will be resolved favorably to the Company or that it will not have a material adverse effect on the Company. In April 1997, a complaint for unfair competition was filed against the Company as one of a group of companies separately developing 56K modem technology by a plaintiff on behalf of the general public. The complaint alleges that the Company knowingly made false and misleading statements regarding the capabilities of its 56K modem technology. The Company denies the allegations in the complaint and intends to vigorously defend its position. Nevertheless, litigation is subject to inherent uncertainties and thus there can be no assurance that this suit will be resolved favorably to the Company or that it will not have a material adverse effect on the Company. On December 17, 1996, the Company settled a lawsuit with USR arising from a dispute regarding an OEM Software License and Development Agreement between the parties. See "Risk Factors--Risks Associated with Legal Proceedings" and "--Allegation of Patent Infringement." 37 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth certain information with respect to the executive management and directors of the Company:
NAME AGE POSITION - --------------------------------------------------- ----------- ------------------------------------------------------- Steven M. Willens.................................. 37 President, Chief Executive Officer, Chief Technology Officer and Chairman Ronald H. Willens.................................. 65 Executive Vice President, Secretary and Director Joseph E. Sasek.................................... 38 Vice President of Sales and Marketing Steven A. Hess..................................... 45 Chief Financial Officer Jurgen Obermann.................................... 34 Managing Director of Europe, the Middle East and Africa Paul L. Harvey..................................... 45 Director of Customer Service Jerrold Livingston................................. 67 Director Albert A. Pimentel (1)(2).......................... 42 Director Robert C. Hawk (1)(2).............................. 57 Director
- --------- (1) Member of the Compensation Committee. (2) Member of the Audit Committee. MR. STEVEN WILLENS co-founded the Company in 1986 and joined the Company on a full-time basis in 1989, serving as Vice President of Engineering. In October 1994, he was appointed President and Chief Executive Officer. In October 1995, he was appointed Chairman of the Board of Directors. Mr. Willens also served as Secretary of the Company from 1986 to October 1994. From 1984 to 1989, Mr. Willens held several management positions in engineering and marketing at Sun Microsystems. From 1981 to 1984, he was a Product Manager at Hewlett Packard. DR. RONALD WILLENS co-founded the Company in 1986, has served as Executive Vice President of the Company since 1988 and has served as Secretary of the Company since October 1994. From 1962 to 1988, Dr. Willens served in various technical management capacities with AT&T Labs in Murray Hill, New Jersey. MR. SASEK joined the Company in July 1994 as Director of Sales, and was promoted to Vice President of Sales in August 1995 and to Vice President of Sales and Marketing in June 1996. From 1990 to 1992, Mr. Sasek held several field sales management positions, and from February 1992 to July 1994 was field sales director for Telebit Corporation, a dial-up networking company. MR. HESS joined the Company in February 1996 as Chief Financial Officer. From January 1995 to February 1996, he was Vice President of Finance and Chief Financial Officer at Asante Technologies, Inc., a manufacturer of local area networking equipment. From 1988 to October 1995, Mr. Hess held executive management positions, primarily as Chief Financial Officer for Telebit Corporation, a dial-up networking company. MR. OBERMANN joined the Company in September 1996, as Managing Director of the Company's Europe, the Middle East and Africa operations. From April 1993 to September 1996, Mr. Obermann was the Director of Marketing for Cisco responsible for Europe, the Middle East and Africa. Prior to that, from July 1991 to April 1993, he was product manager for LAN, WAN and Internet products at PanDacom GmbH, a German company which distributes telecommunications and internetworking equipment. MR. HARVEY joined the Company in February 1997 as Director of Customer Service. From May 1992 to February 1997, Mr. Harvey was Director of Worldwide Customer Support Center of Amdahl Corporation, 38 a manufacturer of mainframe computers. From 1976 to April 1992, he held a variety of customer support positions with Amdahl Corporation. MR. LIVINGSTON co-founded the Company in 1986, and served as its President and Chief Executive Officer until September 1994 and as its Chairman until October 1995 at which time he retired. From 1983 to 1986, Mr. Livingston was Director, Environmental Medical Services with Litton Industries. From 1971 to 1983 he served as Director of Environmental Safety for ITEK, a defense contractor. MR. PIMENTEL has served as a member of the Company's Board of Directors since November 1995. Mr. Pimentel has been Senior Vice President of Finance and Chief Financial Officer with WebTV Networks, Inc., an Internet appliance and service company, since November 1996. From July 1992 to October 1996, Mr. Pimentel was Senior Vice President and Chief Financial Officer with LSI Logic Corporation, a semiconductor company. From 1990 to June 1992, Mr. Pimentel was Vice President of Finance and Chief Financial Officer for Momenta Corporation, a pen based PC company. MR. HAWK has served as a member of the Company's Board of Directors since February 1997. Mr. Hawk is currently retired. From May 1996 to April 1997, Mr. Hawk was President and Chief Executive Officer of US West Multimedia Group, a Denver, Colorado based RBOC. From 1988 to April 1996, Mr. Hawk served as President of the Carrier and Information Provider division of US West Communications. Mr. Hawk currently serves as a director of Premisys Communications, Inc., PairGain Technologies, Inc. and Xylan Corporation. Dr. Ronald Willens and Mr. Steven Willens are father and son respectively, and Jerrold Livingston is Steven Willens' father-in-law. Other than those relationships, there are no other family relationships between any of the directors or executive officers of the Company. CLASSIFIED BOARD The Company's Bylaws currently authorize up to five directors. All directors hold office until the next annual meeting of shareholders or until their successors are duly elected and qualified. The Company's Board of Directors approved an amendment and restatement of its Bylaws, subject to shareholder approval, that provides, among other things, that effective upon qualification of the Company as a "listed corporation," as defined in Section 301.5(d) of the California Code, the Board of Directors will consist of two classes with directors in each class serving staggered two-year terms. Class I consists of Steven M. Willens and Albert A. Pimentel. The initial term of office of the Class I directors expires at the annual meeting of shareholders in calendar 1997. Class II consists of Robert C. Hawk, Jerrold Livingston and Ronald H. Willens. The initial term of office of the Class II directors expires at the annual meeting of shareholders in calendar 1998. Upon the expiration of the term of each class of directors, members constituting such class of directors will be elected for a two-year term at the next succeeding annual meeting of shareholders. See "Description of Capital Stock." BOARD COMMITTEES The Board of Directors has a Compensation Committee, currently comprised of Mr. Hawk and Mr. Pimentel, which makes recommendations to the Board of Directors concerning salaries and incentive compensation for all officers, directors and consultants of the Company, and an Audit Committee, currently comprised of Mr. Hawk and Mr. Pimentel, which reviews the internal accounting procedures of the Company and consults with and reviews the services provided by the Company's independent auditors. See "--Compensation Committee Interlocks and Insider Participation." DIRECTOR COMPENSATION Directors receive no cash compensation for services provided in that capacity but are reimbursed for out-of-pocket expenses incurred in connection with attendance at meetings of the Board of Directors. 39 Upon joining the Board of Directors, Mr. Pimentel was granted an option to purchase 150,000 shares of the Company's Common Stock at a price of $.25 per share and Mr. Hawk was granted an option to purchase 35,000 shares of the Company's Common Stock at a price of $10.50 per share, pursuant to the Company's 1994 Stock Option Plan. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The members of the Compensation Committee of the Board of Directors are Mr. Pimentel and Mr. Hawk. No member of the Compensation Committee or executive manager of the Company has a relationship that would constitute an interlocking relationship with executive managers or directors of another entity. LIMITATIONS ON DIRECTORS' LIABILITY AND INDEMNIFICATION The Company's Restated Articles of Incorporation include a provision that eliminates the personal liability of its directors to the Company and its shareholders for monetary damages for breach of the directors' fiduciary duties in certain circumstances. This limitation has no effect on a director's liability (i) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) for acts or omissions that a director believes to be contrary to the best interest of the Company or its shareholders or that involve the absence of good faith on the part of the director, (iii) for any transaction from which a director derived an improper personal benefit, (iv) for acts or omissions that show a reckless disregard for the director's duty to the Company or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of a serious injury to the Company or its shareholders, (v) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Company or its shareholders, (vi) under Section 310 of the California Corporations Code (the "California Code") concerning contracts or transactions between the Company and a director or (vii) under Section 316 of the California Code concerning directors' liability for improper dividends, loans and guarantees. The provision does not affect the availability of injunctions and other equitable remedies available to the Company's shareholders for any violation of a director's fiduciary duty to the Company or its shareholders. The Company's Restated Articles of Incorporation also include an authorization for the Company to indemnify its agents (as defined in Section 317 of the California Code), through bylaw provisions, by agreement or otherwise, to the fullest extent permitted by law. Pursuant to this provision, the Company's Bylaws provide for indemnification of the Company's directors, officers and employees. In addition, the Company, at its discretion, may provide indemnification to persons whom the Company is not obligated to indemnify. The Bylaws also allow the Company to enter into indemnity agreements with individual directors, officers, employees and other agents. These indemnity agreements have been entered into with all directors and executive officers and provide the maximum indemnification permitted by law. These agreements, together with the Company's Bylaws and Articles of Incorporation, may require the Company, among other things, to indemnify these directors or executive officers (other than for liability resulting from willful misconduct of a culpable nature), to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification, and to obtain directors' and officers' insurance if available on reasonable terms. Section 317 of the California Code and the Company's Bylaws make provision for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities (including reimbursement of expense incurred) arising under the Securities Act. The Company, with the approval of the Board of Directors, intends to obtain directors' and officers' liability insurance prior to the effectiveness of this offering. 40 EXECUTIVE COMPENSATION The following table shows the compensation received in the fiscal year ended August 31, 1996 by the Company's Chief Executive Officer and the Company's other executive managers who earned in excess of $100,000 during such fiscal year (collectively, the "Named Executive Officers"). SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION AWARDS ------------- ANNUAL COMPENSATION SECURITIES ----------------------- UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION SALARY BONUS (1) OPTIONS (#) COMPENSATION - ------------------------------------------------------------ ---------- ----------- ------------- ------------- Steven M. Willens........................................... $ 170,885 $ 25,000 -- -- Chairman, President and Chief Executive Officer Ronald H. Willens........................................... 160,420 25,000 -- -- Executive Vice President and Secretary Joseph E. Sasek............................................. 110,042 40,000 225,000 $ 57,801 (2) Vice President of Sales and Marketing Steven A. Hess (3).......................................... 77,765 -- 225,000 -- Chief Financial Officer Jurgen Obermann (4)......................................... -- -- -- -- Managing Director of Europe, the Middle East and Africa Paul L. Harvey (5).......................................... -- -- -- -- Director of Customer Service
- --------- (1) Earned for services during the year. (2) Amount represents $54,077 in sales commissions earned during fiscal 1996. (3) Steven A. Hess joined the Company in February 1996 at an annual salary of $140,000. (4) Jurgen Obermann joined the Company in September 1996 at an annual salary of $150,000 and was granted an option to purchase 45,000 shares of Common Stock. (5) Paul L. Harvey joined the Company in February 1997 at an annual salary of $125,000 and was granted an option to purchase 30,000 shares of Common Stock. 41 OPTIONS GRANTS IN FISCAL 1996 The following table sets forth information for the Named Executive Officers with respect to grants of options to purchase Common Stock of the Company made during the fiscal year ended August 31, 1996.
POTENTIAL REALIZABLE INDIVIDUAL GRANTS(1) VALUE ---------------------------- AT ASSUMED ANNUAL RATES NUMBER OF % OF TOTAL OF STOCK PRICE SECURITIES OPTIONS APPRECIATION UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM (2) OPTIONS EMPLOYEES IN PRICE ------------------------ NAME GRANTED FISCAL YEAR PER SHARE EXPIRATION DATE 5% 10% - -------------------------------- ----------- --------------- ----------- --------------- ----------- ----------- Steven M. Willens............... -- -- -- -- -- -- Ronald H. Willens............... -- -- -- -- -- -- Joseph E. Sasek................. 225,000 13.5% $ .25 09/08/05 $ 35,375 $ 89,646 Steven A. Hess.................. 225,000 13.5 1.67 02/29/06 236,307 598,849 Jurgen Obermann................. -- -- -- -- -- -- Paul L. Harvey.................. -- -- -- -- -- --
- --------- (1) Consists of stock options granted pursuant to the Company's 1994 Stock Option Plan. Mr. Sasek's option became exercisable immediately, subject to a right of repurchase which lapses according to a vesting schedule of 25% at the end of one year following the vesting commencement date as determined by the Board of Directors and 1/36 of the remaining amount per month thereafter, and Mr. Hess' option became exerciseable immediately, subject to a right of repurchase which lapses according to a vesting schedule of 20% at the end of one year following the vesting commencement date as determined by the Board of Directors and 1/48 of the remaining amount per month thereafter, as long as each optionee remains an employee with, consultant to or director of the Company. The maximum term of each option granted is ten years from the date of grant. The exercise price is equal to the fair market value of the stock on the date of grant as determined by the Board of Directors. (2) Potential gains are net of the exercise price but before taxes associated with the exercise. The 5% and 10% assumed annual rates of compounded stock appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of the future Common Stock price. Actual gains, if any, on stock option exercises are dependent on the future financial performance of the Company, overall market conditions and the option holders' continued employment through the vesting period. This table does not take into account any appreciation in the price of the Common Stock from the date of grant to the date of this Prospectus, other than the columns reflecting assumed rates of appreciation of 5% and 10%. AGGREGATED OPTION EXERCISES IN FISCAL 1996 AND FISCAL 1996 YEAR-END OPTION VALUES The following table sets forth information for the Named Executive Officers with respect to exercises of options to purchase Common Stock of the Company in the fiscal year ended August 31, 1996.
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS OPTIONS AT 8/31/96 AT 8/31/96 (1) SHARES ACQUIRED -------------------------- --------------------------- NAME ON EXERCISE (#) VALUE REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ------------------------------- --------------- --------------------- ----------- ------------- ------------ ------------- Steven M. Willens.............. -- -- -- -- -- -- Ronald H. Willens.............. -- -- -- -- -- -- Joseph E. Sasek................ -- -- 375,000 -- $ 3,875,253 -- Steven A. Hess................. -- -- 225,000 -- 1,986,750 -- Jurgen Obermann................ -- -- -- -- -- -- Paul L. Harvey................. -- -- -- -- -- --
- --------- (1) Based on the fair market value of the Company's Common Stock at August 31, 1996 ($10.50 per share as determined by the Board of Directors) less the exercise price payable for such shares. 42 STOCK PLANS 1994 STOCK OPTION PLAN. The Company's 1994 Stock Option Plan was adopted by the Board of Directors on August 19, 1994. An aggregate of 3,000,000 of the Company's Common Stock is reserved for issuance under the 1994 Stock Option Plan. The 1994 Stock Option Plan provides for grants to employees (including executive management and employee directors) of "incentive stock options" within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), and for grants to employees and consultants of nonstatutory stock options. As of May 31, 1997, options to purchase a total of 2,601,247 shares at a weighted average exercise price of $3.99 per share were outstanding, and 176,018 shares remained available for future option grants. The 1994 Stock Option Plan may be administered by the Board of Directors or a committee of the Board (the "Administrator"). The Administrator determines the terms of options granted under the 1994 Stock Option Plan, including the number of shares subject to the option, exercise price, term and the rate at which the options become exercisable. Currently, each option that has been granted under the 1994 Plan is immediately exerciseable, subject to a right of repurchase which lapses according to a vesting schedule determined by the Administrator. The exercise price of all incentive stock options granted under the 1994 Stock Option Plan must be at least equal to the fair market value of the Common Stock of the Company on the date of grant. The exercise price of all nonstatutory stock options must equal at least 85% of the fair market value of the Common Stock on the date of grant. The exercise price of any stock option granted to an optionee who owns stock representing more than 10% of the voting power of all classes of stock of the Company must equal at least 110% of the fair market value of the Common Stock on the date of grant. The exercise price may be paid in cash or pursuant to a loan or installment arrangement approved by the Board. With respect to any participant who owns stock representing more than 10% of the voting power of all classes of stock of the Company, the term of incentive stock options are limited to five years or less. The term of all options may not exceed ten years. If not terminated earlier by the Administrator, the 1994 Stock Option Plan will terminate in 2004. The Administrator has the authority to amend or terminate the 1994 Stock Option Plan as long as such action does not adversely affect any outstanding option. In the event of a proposed sale of all or substantially all of the Company's assets, or a merger of the Company with or into another corporation, each option may be assumed or an equivalent option substituted by the successor corporation (if any). Upon completion of this offering, no further option grants will be made under the 1994 Stock Option Plan. 1997 STOCK PLAN. The Company's 1997 Stock Plan was adopted by the Board of Directors in May 1997 and will be submitted to shareholders for approval in May 1997. The 1997 Stock Plan provides for the grant of incentive stock options to employees (including officers and directors) and for the grant of nonstatutory stock options and stock purchase rights ("SPRs") to employees, directors and consultants. A total of 1,500,000 shares of Common Stock has been reserved for issuance under the 1997 Stock Plan plus any shares which have been reserved but unissued under the 1994 Stock Option Plan. In addition, an annual increase in the number of shares reserved will be added on each anniversary date of the adoption of the 1997 Stock Plan equal to the lesser of (i) 600,000 shares, (ii) 4% of the outstanding shares on such date or (iii) a lesser amount determined by the Board. Prior to this offering, there were no options or SPRs outstanding under the 1997 Stock Plan. The 1997 Stock Plan may be administered by the Board of Directors or a committee designated by the Board (the "Administrator"). Options and SPRs granted under the 1997 Stock 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 1997 Stock Plan must be exercised within three months of the end of the optionee's status as an employee, director or consultant of the Company, or within twelve months after such optionee's 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 1997 Stock 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 43 option granted must equal at least 110% of the fair market value on the grant date. The exercise price of incentive stock options and nonstatutory stock options for all other employees shall be no less than 100% of the fair market value per share on the date of grant. The maximum term of an option granted under the 1997 Stock 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 purchase price paid by the purchaser and may be paid by cancellation of any indebtedness of the purchaser to the Company. In the event of a merger or sale of substantially all of the assets of the Company, the acquiring or successor corporation must either assume the outstanding options and SPRs under the 1997 Stock Plan or substitute equivalent options or SPRs to purchase shares of the acquiring or successor corporation (or a parent or subsidiary of the acquiring or successor corporation). If an employee is involuntarily terminated by the acquiring or successor corporation within twelve months of the merger or asset sale (other than for cause), or if such acquiring or successor corporation refuses to substitute or assume outstanding options or SPRs, the employee's options and SPRs fully vest and become immediately exercisable. 1997 EMPLOYEE STOCK PURCHASE PLAN. The Company's 1997 Employee Stock Purchase Plan (the "Stock Purchase Plan") was adopted by the Board of Directors in May 1997 and will be submitted to the shareholders for approval in May 1997. The Company has reserved a total of 500,000 shares of Common Stock for issuance under the Stock Purchase Plan, plus an annual increase to be added on each anniversary date of the adoption of the Stock Purchase Plan equal to the lesser of (i) 150,000 shares, (ii) 1% of the outstanding shares on such date or (iii) a lesser amount determined by the Board. The Stock Purchase Plan, which is intended to qualify under Section 423 of the Internal Revenue Code of 1986, as amended (the "Code"), permits eligible employees of the Company to purchase shares of Common Stock through payroll deductions of up to ten percent (10%) of their compensation, up to a maximum of $25,000 worth of Common Stock (valued at the date of grant) in each calendar year. The Stock Purchase Plan will be implemented by consecutive overlapping 24-month offering periods (each an "Offering Period"). The initial Offering Period will begin on the effective date of this offering and will end on the last trading day in the period ending March 31, 1999. All employees who work at least twenty hours per week and more than five months per calendar year are eligible to participate in the Stock Purchase Plan. The price of Common Stock purchased under the Stock Purchase Plan will be 85% of the lower of the fair market value of the Common Stock on the first day of each Offering Period or the date of purchase. Employees may withdraw from the Stock Purchase Plan at any time during an Offering Period, and the balance of the payroll deductions will be returned to the employee. Participation in the Stock Purchase Plan ends automatically upon termination of employment with the Company. Rights granted under the Stock Purchase Plan are not transferable by a participant other than by will, the laws of descent and distribution or as otherwise provided under the Stock Purchase Plan. The Stock Purchase Plan will be administered by the Board of Directors or by a committee appointed by the Board. The Board may amend or modify the Stock Purchase Plan at any time. The Stock Purchase Plan will terminate ten years after the effective date of its adoption, unless sooner terminated by the Board. SECTION 401(k) PLAN In September 1995, the Board approved the Livingston Retirement Savings Plan (the "401(k) Plan"), covering the Company's full-time employees located in the United States. Pursuant to the 401(k) Plan, employees may elect to reduce their current compensation by up to the statutorily prescribed annual limit ($9,500 in calendar years 1996 and 1997) and to have the amount of such reduction contributed to the 401(k) Plan. The 401(k) Plan permits, but does not require, additional matching contributions to the 44 401(k) Plan by the Company on behalf of all participants in the 401(k) Plan. The Company has not made any contributions to the 401(k) Plan. The 401(k) Plan is intended to qualify under Section 401(k) of the Code, such that contributions to the 401(k) Plan by employees or by the Company, and the investment earnings thereon, are not taxable to employees until withdrawn from the 401(k) Plan, and such that contributions by the Company, if any, will be deductible by the Company. CERTAIN TRANSACTIONS The Company and Jerrold Livingston entered into a Deferred Compensation Plan dated May 2, 1996, as amended (the "Compensation Plan"). Under the terms of the Compensation Plan, Mr. Livingston is entitled to receive an aggregate annual amount of $110,000 in recognition of past services rendered to the Company. The Compensation Plan will terminate upon the earlier of (i) January 1, 2005, (ii) the termination of the lock-up period in connection with the closing of an initial public offering of the Company's Common Stock or (iii) the closing of a merger or sale of the Company. 45 PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth information known to the Company with respect to the beneficial ownership of its Common Stock as of April 30, 1997 and as adjusted to reflect the sale of Common Stock offered hereby, for (i) each person who is known by the Company to own beneficially more than five percent of the Common Stock, (ii) each of the Company's directors, (iii) each Named Executive Officer, (iv) all directors and executive officers as a group and (v) by the Selling Shareholders.
PERCENT SHARES TO BENEFICIALLY NUMBER OF BE OWNED(2)(3) SHARES SOLD IN ------------------------ BENEFICIALLY THIS BEFORE AFTER NAME AND ADDRESS OF BENEFICIAL OWNER OWNED(1) OFFERING OFFERING OFFERING - --------------------------------------------------------------- --------------- ----------- ----------- ----------- Ronald H. Willens.............................................. 4,050,000 -- 32.7% Steven M. Willens.............................................. 4,050,000 -- 32.7 Jerrold Livingston............................................. 4,050,000(4) 32.7 Joseph E. Sasek................................................ 375,000(5) -- 2.9 Steven A. Hess................................................. 225,000(6) -- 1.8 Jurgen Obermann................................................ 45,000(7) -- * Albert A. Pimentel............................................. 150,000(8) -- 1.2 Robert C. Hawk................................................. 35,000 -- * All directors and executive officers as a group (9 persons).... 13,010,000(9) 98.6
- --------- * Less than one percent. (1) Except as otherwise indicated in the footnotes to this table and pursuant to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of Common Stock. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Options under the 1994 Stock Option Plan are immediately exercisable in full but subject to a right of repurchase by the Company which lapses according to a vesting schedule. All shares of Common Stock subject to options exerciseable are deemed outstanding for computing the percentage of the person holding such options but are not deemed outstanding for computing the percentage of any other person. (2) Based on 12,405,735 shares outstanding as of May 31, 1997. (3) This column assumes no exercise of the Underwriter's over-allotment option. If, however, the Underwriters' over-allotment option is exercised in full, certain shareholders will sell an aggregate of additional shares of Common Stock. Specifically, in such event, in addition to those share amounts set forth in the table above, (i) Ronald Willens will sell an aggregate of shares and will beneficially own shares, which is % of the Company's outstanding Common Stock, after completion of this Offering, and (ii) Steven Willens will sell an aggregate of shares and will beneficially own shares, which is % of the Company's outstanding Common Stock, after completion of the Offering. (4) Includes 72,460 shares held by the Randall Scott Livingston Trust, 17,390 shares held by the Joshua Matthew Livingston Trust, 17,390 shares held by the Travis Michael Livingston Trust, 17,390 shares held by the Rebecca Roseann Livingston Trust, 14,490 shares held by the Rhonda Denise Willens Trust, 14,490 shares held by the Melissa Leanne Willens Trust and 14,490 shares held by the Mark Daniel Willens Trust. (5) Includes 375,000 shares issuable under stock options held by Mr. Sasek exerciseable within 60 days of April 30, 1997. 46 (6) Includes 225,000 shares issuable under stock options held by Mr. Hess exerciseable within 60 days of April 30, 1997. (7) Includes 45,000 shares issuable under stock options held by Mr. Obermann exerciseable within 60 days of April 30, 1997. (8) Includes 150,000 shares issuable under stock options held by Mr. Pimentel exerciseable within 60 days of April 30, 1997. (9) Includes 825,000 shares issuable under stock options held by such directors and executive officers exerciseable within 60 days of April 30, 1997. 47 DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 30,000,000 shares of Common Stock. The following summaries of certain provisions of the Common Stock do not purport to be complete, are subject to, and qualified in their entirety by, the provisions of the Company's Amended and Restated Articles of Incorporation (the "Restated Articles"), which is included as an exhibit to the Registration Statement of which this Prospectus forms a part, and by applicable law. COMMON STOCK As of May 31, 1997, there were 12,405,735 shares of Common Stock outstanding, which were held of record by 52 shareholders. The holders of Common Stock are entitled to one vote per share on all matters to be voted upon by the shareholders. The holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared from time to time by the Board of Directors out of funds legally available for that purpose. 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. Holders of Common Stock have no preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the Common Stock. All outstanding shares of Common Stock are fully paid and non-assessable, and the shares of Common Stock to be issued upon the closing of this offering will be fully paid and non-assessable. PREFERRED STOCK The Board of Directors has approved an amendment to the Restated Articles which authorizes the issuance of up to 5,000,000 shares of Preferred Stock in one or more series and to fix the designations, powers, preferences and 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. Subject to approval of such amendment by the shareholders, and effective upon the filing of the Restated Articles, the Board of Directors, without further shareholder approval, can issue Preferred Stock with voting, conversion or other rights that could adversely affect the voting power and other rights of 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 the 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. CALIFORNIA LAW AND CERTAIN PROVISIONS Certain provisions of California law and the Company's Restated Articles of Incorporation and Bylaws, could make more difficult the removal of incumbent officers and directors and the acquisition of the Company by means of a tender offer, a proxy contest or otherwise. Upon qualification of the Company as a "listed corporation," as defined in Section 301.5(d) of the California Code, cumulative voting will be eliminated and the Board of Directors will be divided into two classes of directors, serving staggered two-year terms. At each annual meeting, one class of directors will be elected for a two-year term. See "Management." These provisions are expected to discourage certain types of coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of the Company to negotiate first with the Company. The Company believes that the benefits of increased protection of the Company's potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure the Company outweigh the disadvantages of discouraging such proposals because, among other things, negotiation of such proposals could result in an improvement of their terms. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the Common Stock is ChaseMellon Shareholder Services, L.L.P. of San Francisco, California. Its telephone number is (415) 954-9512. 48 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no public market for the Common Stock of the Company. Future sales of substantial amounts of Common Stock in the public market could adversely affect prevailing market prices 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 shares of Common Stock (based upon shares outstanding at May 31, 1997), assuming no exercise of the Underwriters' over-allotment option and no exercise of outstanding options. Of these shares, all of the 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 remaining 12,405,735 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 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 and 701, the Restricted 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) no shares will be eligible for sale beginning 90 days after the date of this Prospectus, and (iii) 12,405,735 shares will be eligible for sale upon expiration of the lock-up agreements 180 days after the date of this Prospectus. All officers, directors and certain stockholders of the Company have agreed not to 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, directly or indirectly (or enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of), any shares of Common Stock or any securities convertible into or exercisable or exchangeable for shares of Common Stock, for a period of 180 days after the date of this Prospectus, without the prior written consent of Morgan Stanley & Co. Incorporated. In general, under Rule 144, 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 one year (including the holding period of any prior owner except an Affiliate) would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: (i) one percent of the number of shares of Common Stock then outstanding (which will equal approximately 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 two years (including the holding period of any prior owner except an Affiliate), is entitled to sell such shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144; 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 purchases 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. 49 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 Stock Option Plan, 1997 Stock Plan and Stock Purchase Plan. 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 May 31, 1997, options to purchase 2,601,247 shares of Common Stock were issued and outstanding under the 1994 Stock Option Plan, and no options to purchase shares had been granted under the Company's 1997 Stock Plan and Stock Purchase Plan. 50 UNDERWRITERS Under the terms and subject to the conditions contained in the Underwriting Agreement dated the date hereof, (the "Underwriting Agreement") Underwriters named below, for whom Morgan Stanley & Co. Incorporated, Hambrecht & Quist LLC, and Robertson, Stephens & Company LLC are acting as Representatives, have severally agreed to purchase, and the Company and the Selling Shareholder have severally agreed to sell them, the respective number of shares of Common Stock, set forth opposite the name of such Underwriters below:
NUMBER OF NAME SHARES - ---------------------------------------------------------------------------------- ----------- Morgan Stanley & Co. Incorporated................................................. Hambrecht & Quist LLC............................................................. Robertson, Stephens & Company LLC................................................. ----------- Total......................................................................... ----------- -----------
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 their counsel and to certain other conditions. The Underwriters are obligated to take and pay for all of the shares of Common Stock offered hereby (other than those covered by the Underwriters' over-allotment option described below) if any such shares are taken. The Underwriters initially propose to offer part of the shares of Common Stock offered hereby directly to the public at the initial 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 $ per share under the initial public offering price. The Underwriters may allow, and such dealers may re-allow, a concession not in excess of $ per share to other Underwriters or to certain other dealers. After the initial offering of the shares of Common Stock, the offering price and other selling terms may from time to time be varied by Morgan Stanley & Co. Incorporated. Pursuant to the Underwriting Agreement, the Company and certain of the Selling Shareholders have granted to the Underwriters an option, exercisable for 30 days from the date of this Prospectus, to purchase up to an aggregate of additional shares of Common Stock, at the public offering price set forth on the cover page hereof, less underwriting discounts and commissions. The Underwriters may exercise such option to purchase solely for the purpose of covering over-allotments, if any, made in connection with the offering of the shares of Common Stock offered hereby. To the extent such option is exercised, each Underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of such additional shares of Common Stock as the number set forth next to such Underwriter's name in the preceding table bears to the total number of shares of Common Stock set forth next to the names of all Underwriters in the preceding table. In order to facilitate the offering of the Common Stock, the Underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of the Common Stock. Specifically, the Underwriters may overallot in connection with the offering, creating a short position in the Common Stock for their own 51 account. In addition, to cover overallotments or to stabilize the price of the Common Stock, the Underwriters may bid for, and purchase, shares of Common Stock in the open market. Finally, the underwriting syndicate may reclaim selling concessions allowed to an underwriter or a dealer for distributing the Common Stock in the offering, if the syndicate repurchases previously distributed Common Stock in transactions to cover syndicate short positions, in stabilization transactions or otherwise. Any of these activities may stabilize or maintain the market price of the Common Stock above independent market levels. The Underwriters are not required to engage in these activities, and may end any of these activities at any time. The Underwriters have informed the Company that they do not intend sales to discretionary accounts to exceed five percent of the total number of shares of Common Stock offered by them. The Company, the Selling Shareholders and the Underwriters have agreed to indemnify each other against certain liabilities, including liabilities under the Securities Act. Each of the Company and the directors, executive officers and certain other stockholders of the Company has agreed that, without the prior written consent of Morgan Stanley & Co. Incorporated on behalf of the Underwriters, it will not (i) 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, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or (ii) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise, during the period ending 180 days after the date of this Prospectus, other than (x) the Shares and (y) the issuance by the Company of shares of Common Stock upon the exercise of an option or a warrant or the conversion of a security outstanding on the date of this Prospectus of which the Underwriters have been advised in writing. The Underwriters have reserved up to shares of Common Stock for sale at the initial public offering price to certain persons associated with the Company, as such persons have expressed an interest in purchasing such shares of Common Stock in the Offering. The number of shares available for sale to the general public will be reduced to the extent such persons purchase such reserved shares. Any reserved shares not so purchased will be offered by the Underwriters to the general public on the same basis as the other shares offered hereby. PRICING OF THE OFFERING Prior to the Offering, there has been no public market for the Common Stock of the Company. The initial public offering price for the Common Stock was determined by negotiations among the Company, representatives of the Selling Shareholders and the Representatives of the Underwriters. Among the factors to be considered in determining the initial public offering price will be 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. 52 LEGAL MATTERS The validity of the Common Stock offered hereby will be passed upon for the Company by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. Certain legal matters will be passed upon for the Underwriters by Brobeck, Phleger & Harrison LLP, San Francisco, California. EXPERTS The consolidated financial statements of the Company as of August 31, 1995 and 1996 and May 31, 1997, and for each of the years in the three-year period ended August 31, 1996 and the nine months ended May 31, 1997, have been included herein and in the registration statement in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission, a Registration Statement on Form S-1 under the Securities Act with respect to the shares of Common Stock offered hereby. This Prospectus does not contain all the information set forth in the Registration Statement and the exhibits and schedules thereto. For further information with respect to the Company and such Common Stock, reference is made to the Registration Statement and to the exhibits and schedules filed therewith. Statements contained in this Prospectus as to the contents of any contract or 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 may be inspected by anyone without charge at the principal office of the Securities and Exchange Commission in Washington, D.C., and copies of all or any part of the Registration Statement may be obtained from the Public Reference Section of the Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of certain fees. The Commission maintains a World Wide Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of the site is http://www.sec.gov. The Company intends to furnish to its shareholders annual reports containing audited financial statements examined by independent auditors and quarterly reports containing interim unaudited financial information for the first three quarters of each fiscal year. 53 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE --------- Report of Independent Auditors............................................................................. F-2 Consolidated Balance Sheets................................................................................ F-3 Consolidated Statements of Operations...................................................................... F-4 Consolidated Statements of Shareholders' Equity............................................................ F-5 Consolidated Statements of Cash Flows...................................................................... F-6 Notes to Consolidated Financial Statements................................................................. F-7
F-1 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders Livingston Enterprises, Inc. We have audited the accompanying consolidated balance sheets of Livingston Enterprises, Inc. and subsidiaries as of August 31, 1995 and 1996 and May 31, 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended August 31, 1996 and the nine months ended May 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated statements based on our audits. We conducted our audits 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 audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Livingston Enterprises, Inc. and subsidiaries at August 31, 1995 and 1996 and May 31, 1997, and the results of operations and its cash flows for each of the years in the three-year period ended August 31, 1996 and the nine months ended May 31, 1997 in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Palo Alto, California June 18, 1997 F-2 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
AUGUST 31, -------------------- MAY 31, 1995 1996 1997 --------- --------- --------- ASSETS Current assets: Cash and cash equivalents....................................................... $ 1,486 $ 3,749 $ 16,005 Accounts receivable, net of allowance of $150, $648, and $1,008, respectively... 3,674 6,796 10,754 Inventories..................................................................... 3,557 7,650 4,220 Deferred income taxes........................................................... 139 1,893 5,900 Prepaid expenses and other current assets....................................... 55 153 448 --------- --------- --------- Total current assets.......................................................... 8,911 20,241 37,327 Property and equipment, net....................................................... 330 940 2,298 Other assets...................................................................... 62 140 292 --------- --------- --------- Total assets...................................................................... $ 9,303 $ 21,321 $ 39,917 --------- --------- --------- --------- --------- --------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable................................................................ $ 1,695 $ 2,787 $ 2,062 Accrued liabilities............................................................. 1,087 1,575 8,318 Deferred revenue................................................................ -- 1,636 3,293 Current portion of notes payable to shareholders................................ 238 -- -- --------- --------- --------- Total current liabilities..................................................... 3,020 5,998 13,673 --------- --------- --------- Commitments and contingencies Shareholders' equity: Preferred stock, no par value; 1,500,000 shares authorized in 1995; none issued and outstanding in 1995....................................................... -- -- -- Common stock, no par value; 30,000,000 shares authorized in 1995, 1996, and 1997; 12,150,000, 12,235,200, and 12,405,735 issued and outstanding in 1995, 1996, and 1997, respectively.................................................. 21 216 2,165 Deferred stock compensation..................................................... -- -- (1,409) Retained earnings............................................................... 6,262 15,107 25,488 --------- --------- --------- Total shareholders' equity.................................................... 6,283 15,323 26,244 --------- --------- --------- Total liabilities and shareholders' equity.................................... $ 9,303 $ 21,321 $ 39,917 --------- --------- --------- --------- --------- ---------
The accompanying notes are an integral part of these consolidated financial statements. F-3 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED AUGUST 31, NINE MONTHS ENDED ------------------------------- -------------------------- 1994 1995 1996 MAY 31, 1997 --------- --------- --------- MAY 31, 1996 ------------ ------------ (UNAUDITED) Product revenues.................................... $ 6,180 $ 20,138 $ 43,229 $ 32,865 $ 47,488 Royalty revenues.................................... -- 323 2,878 1,944 6,997 --------- --------- --------- ------------ ------------ Net revenues........................................ 6,180 20,461 46,107 34,809 54,485 Cost of revenues.................................... 2,853 8,054 18,567 14,121 21,595 --------- --------- --------- ------------ ------------ Gross profit...................................... 3,327 12,407 27,540 20,688 32,890 Operating expenses: Research and development.......................... 462 890 2,512 1,153 3,074 Selling and marketing............................. 673 2,831 8,670 6,094 11,934 General and administrative........................ 449 667 1,771 992 2,305 --------- --------- --------- ------------ ------------ Total operating expenses........................ 1,584 4,388 12,953 8,239 17,313 --------- --------- --------- ------------ ------------ Operating income.................................... 1,743 8,019 14,587 12,449 15,577 Interest income (expense), net...................... (21) (20) 85 43 276 --------- --------- --------- ------------ ------------ Income before income taxes.......................... 1,722 7,999 14,672 12,492 15,853 Provision for income taxes.......................... 695 3,095 5,827 4,949 5,472 --------- --------- --------- ------------ ------------ Net income...................................... $ 1,027 $ 4,904 $ 8,845 $ 7,543 $ 10,381 --------- --------- --------- ------------ ------------ --------- --------- --------- ------------ ------------ Net income per share................................ $ .08 $ .38 $ .63 $ .54 $ .72 --------- --------- --------- ------------ ------------ --------- --------- --------- ------------ ------------ Shares used in per share computations............... 12,423 12,842 14,102 13,942 14,374
The accompanying notes are an integral part of these consolidated financial statements. F-4 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)
COMMON STOCK DEFERRED TOTAL ----------------------- STOCK RETAINED SHAREHOLDERS' SHARES AMOUNT COMPENSATION EARNINGS EQUITY ------------ --------- ------------- --------- ------------- Balances at August 31, 1993...................... 12,150,000 $ 21 $ -- $ 331 $ 352 Net income..................................... -- -- -- 1,027 1,027 ------------ --------- ------------- --------- ------------- Balances at August 31, 1994...................... 12,150,000 21 -- 1,358 1,379 Net income..................................... -- -- -- 4,904 4,904 ------------ --------- ------------- --------- ------------- Balances at August 31, 1995...................... 12,150,000 21 -- 6,262 6,283 Issuance of common stock....................... 15,000 4 -- -- 4 Issuance of common stock for acquired in process research and development............. 18,000 189 -- -- 189 Exercise of common stock options............... 52,200 2 -- -- 2 Net income..................................... -- -- -- 8,845 8,845 ------------ --------- ------------- --------- ------------- Balances at August 31, 1996...................... 12,235,200 216 -- 15,107 15,323 Exercise of common stock options............... 170,535 482 -- -- 482 Deferred compensation related to grants of stock options................................ -- 1,467 (1,467) -- -- Amortization of deferred stock compensation.... -- -- 58 -- 58 Net income..................................... -- -- -- 10,381 10,381 ------------ --------- ------------- --------- ------------- Balances at May 31, 1997......................... 12,405,735 $ 2,165 $ (1,409) $ 25,488 $ 26,244 ------------ --------- ------------- --------- ------------- ------------ --------- ------------- --------- -------------
The accompanying notes are an integral part of these consolidated financial statements. F-5 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED AUGUST 31, NINE MONTHS ENDED ------------------------------- --------------------------- 1994 1995 1996 MAY 31, 1997 --------- --------- --------- MAY 31, 1996 ------------ ------------- (UNAUDITED) CASH FLOW FROM OPERATING ACTIVITIES: Net income...................................................... $ 1,027 $ 4,904 $ 8,845 $ 7,543 $ 10,381 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization................................. 25 60 193 122 331 In-process research and development charged to expense as acquired.................................................... -- -- 189 -- -- Interest on notes payable to shareholders..................... 12 22 -- -- -- Deferred income taxes......................................... (60) (91) (1,754) (546) (4,007) Amortization of deferred stock compensation................... -- -- -- -- 58 Changes in operating assets and liabilities: Accounts receivable......................................... (729) (2,446) (3,122) (1,081) (3,958) Inventories................................................. (391) (2,951) (4,093) (2,954) 3,430 Prepaids and other current assets........................... (62) 20 (98) (40) (295) Accounts payable............................................ 11 1,523 1,092 (511) (725) Accrued liabilities......................................... 811 186 488 313 6,743 Deferred revenue............................................ -- -- 1,636 1,373 1,657 --------- --------- --------- ------ ------------ Net cash provided by operating activities....................... 644 1,227 3,376 4,219 13,615 --------- --------- --------- ------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment........................... (63) (288) (803) (387) (1,689) Other assets.................................................. -- (60) (78) (68) (152) --------- --------- --------- ------ ------------ Net cash used in investing activities:.......................... (63) (348) (881) (455) (1,841) --------- --------- --------- ------ ------------ CASH FLOWS USED IN FINANCING ACTIVITIES: Proceeds from common stock issued............................. -- -- 6 -- 482 Repayment of notes payable to shareholders.................... -- (20) (238) (238) -- --------- --------- --------- ------ ------------ Net cash flows provided by (used in) financing activities....... -- (20) (232) (238) 482 --------- --------- --------- ------ ------------ Net increase in cash and cash equivalents....................... 581 859 2,263 3,526 12,256 Cash and cash equivalents at beginning of period................ 46 627 1,486 1,486 3,749 --------- --------- --------- ------ ------------ Cash and cash equivalents at end of period...................... $ 627 $ 1,486 $ 3,749 $ 5,012 $ 16,005 --------- --------- --------- ------ ------------ --------- --------- --------- ------ ------------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Common stock issued in exchange for acquired in-process research and development charged to expense................. $ -- $ -- $ 189 $ -- $ -- Cash paid for income taxes.................................... 22 2,862 8,063 5,530 4,229 Cash paid for interest........................................ 21 20 35 35 --
The accompanying notes are an integral part of these consolidated financial statements. F-6 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY Livingston Enterprises, Inc. (the Company), a California corporation, is a provider of integrated remote access networking solutions for Internet Service Providers. BASIS OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries for which intercompany accounts and transactions have been eliminated. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS The Company considers all highly liquid investments with remaining maturities of three months or less at time of acquisition to be cash equivalents. Approximately $15.5 million of short-term investments were considered cash equivalents at May 31, 1997. The Company accounts for cash equivalents and short-term investments in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. All cash and cash equivalents are classified as available-for-sale under the provisions of SFAS No. 115. The securities are carried at cost, which approximates fair value, and any unrealized gains or losses, net of taxes, would be reported as a separate component of shareholders' equity. REVENUE RECOGNITION The Company recognizes revenues from sales of remote access products upon shipment. The Company grants its value-added resellers limited rights to exchange products and price protection on unsold merchandise. The Company establishes an estimated allowance for future product returns based on historical returns experience and provides for appropriate price protection reserves at the time the related revenue is recorded. To date, returns for exchange and amounts granted from price protection have not been significant. The Company accounts for revenue related to the software portion of their product in accordance with Statement of Position 91-1, SOFTWARE REVENUE RECOGNITION. Postcontract customer support ("PCS") revenues generally are recognized ratably over the term of the support period (generally one year). PCS revenues to date have not been significant and are included in product revenues. The unamortized portion of PCS is reported as deferred revenue. The Company records royalty revenue at the time the amount is determinable and collection is certain. F-7 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INVENTORIES Inventories are valued using standard costs, which approximate the lower of cost or market using the first-in, first-out method. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful lives of the assets, generally three to five years. Leasehold improvements are amortized using the straight-line method over the estimated useful life of the assets or related lease term, whichever is shorter. The Company adopted the provisions of SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, on September 1, 1996. SFAS No. 121 requires that long-lived assets and certain identified intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Adoption of this statement did not have a material impact on the Company's financial position, results of operations, or liquidity. RESEARCH AND DEVELOPMENT COSTS Research and development expenditures are generally charged to operations as incurred. SFAS No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED, governs accounting for software development costs. This statement provides for the capitalization of certain software development costs once technological feasibility is established. The cost capitalized is then amortized on a straight-line basis over the estimated product life, or using the ratio of current revenue to total projected product revenues, whichever is greater. To date, software development costs incurred subsequent to the establishment of technological feasibility have not been material. In June 1996, the Company acquired in process research and development for 18,000 shares of common stock. The Company also expended $443,000 cash for in process modem technology. Both of these amounts are included in research and development expense in fiscal 1996. CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. Cash and cash equivalents consist of deposits with a major U.S. commercial bank. The Company sells its products primarily to Internet Service Providers through resellers. To reduce its credit risk, the Company performs ongoing credit evaluations of its customers and maintains an allowance for doubtful accounts to cover any credit losses. F-8 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of cash, cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate fair values due to the short maturity of the instruments. PRODUCT RELATED COSTS Product related costs consist of warranty costs, modem technology license fees, and costs related to the Company's 56K Modem Swap Program. This program allows customers to upgrade to 56K modem technology as it becomes available at no charge to them. The Company provides for all of the above costs at the time revenue is recognized. INCOME TAXES The Company accounts for income taxes in accordance with SFAS No. 109, ACCOUNTING FOR INCOME TAXES. SFAS No. 109 prescribes an asset and liability approach that results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's consolidated financial statements or tax returns. In estimating future tax consequences, SFAS No. 109 generally considers all expected future events other than enactment of changes in tax laws or rates. INTERIM ACCOUNTING The financial statements for the nine months ended May 31, 1996 include all adjustments (consisting only of normal adjustments) that management considers necessary for a fair presentation of its financial position at such date and its operating results and cash flows for those periods. Results for interim periods are not necessarily indicative of results for the entire year. Income taxes for the nine months ended May 31, 1996 have been provided based on an estimate of the Company's effective tax rate for fiscal 1996. PER SHARE INFORMATION Net income per share is computed using the weighted average number of common shares and common share equivalents outstanding during the periods presented. Common share equivalents result from the dilutive effect of outstanding options to purchase common stock. Pursuant to the requirements of the Securities and Exchange Commission (SEC), common shares issued by the Company during the twelve months immediately preceding the initial public offering, plus the number of equivalent shares resulting from options granted during this period, have been included in the calculation of the shares used in computing net income per share as if they were outstanding for all periods presented (using the treasury stock method and the estimated public offering price). The Financial Accounting Standards Board recently issued SFAS No. 128, EARNINGS PER SHARE, which requires the presentation of basic earnings per share (EPS) and, for companies with potentially dilutive securities, such as convertible debt, options, and warrants, diluted EPS. SFAS No. 128 is effective for annual and interim periods ending after December 31, 1997. The Company expects that basic EPS will be higher than primary EPS as presented in the accompanying consolidated financial statements and that F-9 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) diluted EPS will not differ materially from fully diluted EPS as presented in the accompanying consolidated financial statements. STOCK-BASED COMPENSATION The Company accounts for its stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the fair value of the underlying stock exceeded the exercise price. On September 1, 1996, the Company adopted the disclosure provisions of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which requires entities to provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in fiscal year 1995 and future years as if the fair value-based method defined in SFAS No. 123 had been applied. RECLASSIFICATIONS Certain amounts in the accompanying 1994 and 1995 consolidated financial statements have been reclassified to conform with the 1996 consolidated financial statement presentation. 2. BALANCE SHEET COMPONENTS Inventories consisted of the following (in thousands):
AS OF AUGUST 31, -------------------- AS OF 1995 1996 MAY 31, 1997 --------- --------- ------------- Raw materials............................................... $ 2,022 $ 5,215 $ 2,121 Work in process............................................. 732 439 811 Finished goods.............................................. 803 1,996 1,288 --------- --------- ------ $ 3,557 $ 7,650 $ 4,220 --------- --------- ------ --------- --------- ------
Property and equipment consisted of the following (in thousands):
AS OF AUGUST 31, -------------------- AS OF 1995 1996 MAY 31, 1997 --------- --------- ------------- Equipment..................................................... $ 397 $ 1,026 $ 1,854 Furniture and fixtures........................................ 72 91 678 Leasehold improvements........................................ 22 177 452 --------- --------- ------ 491 1,294 2,984 Less accumulated depreciation and amortization................ 161 354 686 --------- --------- ------ $ 330 $ 940 $ 2,298 --------- --------- ------ --------- --------- ------
F-10 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 2. BALANCE SHEET COMPONENTS (CONTINUED) Accrued liabilities consisted of the following (in thousands):
AS OF AUGUST 31, -------------------- AS OF 1995 1996 MAY 31, 1997 --------- --------- ------------- Compensation and related benefits........................... $ 377 $ 825 $ 1,657 Warranty costs.............................................. -- 85 400 Modem swap program.......................................... -- -- 1,991 Modem license fees.......................................... -- -- 600 Income taxes................................................ 549 2 1,956 Other....................................................... 161 663 1,714 --------- --------- ------ $ 1,087 $ 1,575 $ 8,318 --------- --------- ------ --------- --------- ------
3. RELATED PARTY TRANSACTIONS The Directors of the Company periodically made cash advances to the Company to fund operations. Outstanding amounts due to the Directors aggregated $238,000 as of August 31, 1995, which included interest of $34,000 at the rate of 9% per annum. In October 1995, all outstanding principal balances and accrued interest were repaid to the Directors. 4. INCOME TAXES The components of income tax expense are as follows (in thousands):
NINE MONTHS YEAR ENDED AUGUST 31, ENDED MAY 31, ------------------------------- ------------- 1994 1995 1996 1997 --------- --------- --------- ------------- Current: Federal.......................................... $ 593 $ 2,444 $ 5,873 7,494 State............................................ 162 742 1,708 1,985 --------- --------- --------- ------ 755 3,186 7,581 9,479 --------- --------- --------- ------ Deferred: Federal.......................................... (62) (68) (1,488) (3,015) State............................................ 2 (23) (266) (992) --------- --------- --------- ------ (60) (91) (1,754) (4,007) --------- --------- --------- ------ $ 695 $ 3,095 $ 5,827 5,472 --------- --------- --------- ------ --------- --------- --------- ------
F-11 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 4. INCOME TAXES (CONTINUED) The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are presented below (in thousands):
AS OF AUGUST 31, -------------------- AS OF 1995 1996 MAY 31, 1997 --------- --------- ------------- Deferred tax assets: Accruals and reserves....................................... $ 92 $ 1,350 $ 4,933 Deferred revenue............................................ -- 650 1,444 Costs capitalized in inventory.............................. 39 27 27 Other....................................................... 8 (134) (504) --------- --------- ------ $ 139 $ 1,893 5,900 Less valuation allowance...................................... -- -- -- --------- --------- ------ Net deferred asset............................................ $ 139 $ 1,893 $ 5,900 --------- --------- ------ --------- --------- ------
The differences between the "expected" income tax expense computed at the federal statutory rate of 35% and the Company's actual income tax expense are as follows (in thousands):
AS OF AUGUST 31, ------------------------------- AS OF 1994 1995 1996 MAY 31, 1997 --------- --------- --------- ------------- Income tax at statutory rate........................ $ 603 $ 2,800 $ 5,135 $ 5,548 State tax, net of federal benefit................... 108 474 951 646 Research and development tax credits................ -- (30) -- (115) Foreign Sales Corporation benefit................... -- -- (92) (661) Other............................................... (16) (149) (167) 54 --------- --------- --------- ------ $ 695 $ 3,095 $ 5,827 5,472 --------- --------- --------- ------ --------- --------- --------- ------
Management believes that it is more likely than not, based on historical operating results, that the Company will generate sufficient future taxable income to realize the net deferred tax assets. 5. SHAREHOLDERS' EQUITY In March 1996, the Company restated its Articles of Incorporation cancelling its authorized Preferred Stock and the shareholders approved a three for one stock split. Common Share and per share data in these consolidated financial statements have been retroactively adjusted to reflect the stock split. In May 1997, the Board of Directors approved that the Company restate its Articles of Incorporation to increase authorized common stock to 100,000,000 shares, and, upon completion of the Company's initial public offering, to authorize 5,000,000 shares of preferred stock. At May 31, 1997, the Company has three stock-based compensation plans, which are described below. The Company applied APB Opinion No. 25 and related Interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its plans, except for certain grants of common stock options to employees during fiscal 1997 where the fair value of the underlying common stock exceeded the exercise price at the time of grant. Had compensation expense for the Company's F-12 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 5. SHAREHOLDERS' EQUITY (CONTINUED) stock-based compensation plans been determined consistent with SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
YEAR ENDED NINE MONTHS AUGUST 31, ENDED MAY 31, 1996 1997 ----------- -------------- Net income As reported $ 8,845 $ 10,381 Proforma $ 8,765 $ 9,734 Earnings As reported .63 .72 per share Proforma .62 .68
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
1996 1997 --------- --------- Dividend yield............................................................... 0.0% 0.0% Expected volatility.......................................................... 63.0% 63.0% Risk-free interest rate...................................................... 5.6% 6.2% Expected option life (years)................................................. 3.5 3.5
A summary of stock option activity under the 1994 Plan follows:
WEIGHTED AVERAGE NUMBER OF EXERCISE SHARES PRICE ----------- ------------- Balances as of August 31, 1994.................................... -- $ -- Options granted................................................. 1,043,250 0.04 Options forfeited............................................... (132,000) 0.03 ----------- Balances as of August 31, 1995.................................... 911,250 0.04 Options granted................................................. 1,688,250 2.56 Options exercised............................................... (52,200) 0.04 Options forfeited............................................... (301,500) 0.16 ----------- Balances as of August 31, 1996.................................... 2,225,800 1.91 Options granted................................................. 696,050 11.46 Options exercised............................................... (170,535) 2.83 Options forfeited............................................... (150,068) 9.03 ----------- Balances as of May 31, 1997....................................... 2,601,247 $ 3.99 ----------- ------ ----------- ------
F-13 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 5. SHAREHOLDERS' EQUITY (CONTINUED) The weighted average fair value of options granted during the year ended August 31, 1996 and the nine months ended May 31, 1997 was $1.290 and $5.135, respectively. A summary of stock option outstanding at May 31, 1997 under the 1994 Plan follows:
OPTIONS OUTSTANDING -------------------------------------- WEIGHTED AVERAGE -------------------------- OPTIONS EXERCISABLE REMAINING ----------------------- RANGE OF CONTRACTUAL EXERCISE EXERCISE EXERCISE PRICES NUMBER LIFE PRICE NUMBER PRICE - ----------------- ---------- ------------- ----------- ---------- ----------- $0.03 to $0.25 1,380,077 8.22 $ 0.16 1,380,077 $ 0.16 $1.67 328,520 8.75 $ 1.67 328,520 $ 1.67 $3.20 10,300 8.82 $ 3.20 10,300 $ 3.20 $6.90 52,500 8.92 $ 6.90 52,500 $ 6.90 $10.50 756,200 9.45 $ 10.50 756,200 $ 10.50 $17.50 73,650 9.94 $ 17.50 73,650 $ 17.50 ---------- ---------- $0.03 to $17.50 2,601,247 8.71 $ 3.99 2,601,247 $ 3.99 ---------- ---------- ---------- ----------
At August 31, 1996 and May 31, 1997, 219,010 and 612,789 options were vested, and all options, whether or not vested, are exercisable, subject to a right of repurchase, at the original issuance price, which lapses according to the vesting schedule. In connection with options granted in 1997, the Company has recorded deferred compensation expense of $1,467,000 for the difference between the option grant price and the deemed fair value of the Company's common stock at the date of grant. The amount is being amortized over the vesting period of the individual options, generally a 60 month period. Deferred compensation expense of $58,000 was recognized during the nine months ended May 31, 1997. The Company has reserved 3,000,000 shares of common stock for issuance under the 1994 Stock Option Plan (the 1994 Plan). The 1994 Plan provides for incentive and non-statutory stock options to be granted to employees (including officers), directors, consultants, and other independent contractors. Stock options are granted at prices of not less than 85% of the fair market value of the common stock at the time of grant, except that stock options granted to any employee who owns stock representing more than 10% of total combined voting power of all classes of the Company's capital stock must have an exercise price of not less than 110% of fair market value. Shares available for purchase on the exercise of options generally vest at a rate of 20% in the first year and thereafter at a rate of 1/48 per each month the optionee is employed or acts as a consultant of the Company. Options expire ten years from the date of grant. In May 1997, the Company reserved 1,500,000 shares of common stock for issuance under the 1997 Stock Plan (the 1997 Plan) which provides for grants of stock options and stock purchase rights to employees, consultants, non-employee directors, and any parent or subsidiary of the Company. Options and rights are granted at prices equal to the fair market value of the common stock at the time of grant. other conditions of the 1997 Plan are substantially the same as those of the 1994 Plan. No options or purchase rights have been granted under the 1997 Plan to date. F-14 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 5. SHAREHOLDERS' EQUITY (CONTINUED) Also in May 1997, the Company reserved 500,000 shares of common stock for issuance under the 1997 Employee Stock Purchase Plan (the "Purchase Plan"), effective upon the closing of the Company's initial public offering. Under the Purchase Plan, eligible employees may purchase common shares during six month payment periods commencing November 1 and May 1 of each year at a price per share of 85% of the lower of the average market price per share on the first or last business day of the six month period. Participating employees may elect to have up to 10% of regular pay withheld and applied toward the purchase of such shares up to a maximum of 10,000 shares in any six month period. An employee's rights under the Purchase Plan terminate upon voluntary withdrawal from the Purchase Plan at any time or upon termination of employment. No shares have been issued to date. 6. REVENUE The Company distributes its products primarily through value-added resellers. Export sales, identified by region, are summarized below:
YEAR ENDED AUGUST 31, NINE MONTHS ENDED ------------------------------- -------------------------------- 1994 1995 1996 MAY 31, 1996 MAY 31, 1997 --------- --------- --------- --------------- --------------- (UNAUDITED) Asia Pacific.................................................. 2% 5% 18% 14% 20% Europe........................................................ 5% 7% 7% 6% 15% Canada........................................................ 2% 3% 3% 3% 4% Latin America................................................. 9% 2% 2% 2% 2% --- --- --- --- --- 18% 17% 30% 25% 41% --- --- --- --- --- --- --- --- --- ---
F-15 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 6. REVENUE (CONTINUED) Significant resellers are summarized below:
YEAR ENDED AUGUST 31, NINE MONTHS ENDED ------------------------------------- ------------------------------------ 1994 1995 1996 MAY 31, 1996 MAY 31, 1997 ----- ----- ----- ----------------- ----------------- Customer A................................... 28% 30% 27% 28% 1% Customer B................................... 17% 18% 6% 6% 3% Customer C................................... 7% 11% 13% 14% 19% RECEIVABLE BALANCE AT MAY 31, 1997 ----------------------- Customer A................................... 0% Customer B................................... 0% Customer C................................... 22%
7. COMMITMENTS The Company leases its facilities under non-cancelable operating leases. At May 31, 1997, future minimum lease payments under operating leases with initial remaining non-cancelable terms of one or more years are as follows (in thousands):
FISCAL YEAR ENDING AUGUST 31, - ------------------------------------------------------------------------------------- 1997 (three months remaining)........................................................ $ 188 1998................................................................................. 708 1999................................................................................. 718 2000................................................................................. 704 2001................................................................................. 670 Thereafter........................................................................... 1,641 --------- Total minimum lease payments......................................................... $ 4,629 --------- ---------
Rent expense was $62,000, $156,000, and $566,000 for the years ended August 31, 1994, 1995, and 1996, respectively. Rent expense for the nine month periods ended May 31, 1996 and May 31, 1997 was $260,000 and $597,000, respectively. The Company and one of its directors entered into a Deferred Compensation Plan dated May 2, 1996, as amended (the "Compensation Plan"). Under the terms of the Compensation Plan, the director is entitled to receive an aggregate annual amount of $110,000 in recognition of past services rendered to the Company. The Compensation Plan will terminate upon the earlier of (i) January 1, 2005, (ii) the termination of the lock-up period in connection with the closing of an initial public offering of the Company's Common Stock or (iii) the closing of a merger or sale of the Company. 8. BANK LINE OF CREDIT In May 1996, the Company obtained an unsecured, $5 million bank line of credit which bears interest at the bank's prime interest rate (8.50% as of May 31, 1997). The line of credit expires March 1, 1998. Covenants under the line of credit require the Company to maintain certain minimum levels of profitability, net worth, and financial ratios, and restrict dividends and stock repurchases. There have been no borrowings under the line of credit agreement. F-16 LIVINGSTON ENTERPRISES, INC. AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION RELATING TO THE NINE MONTHS ENDED MAY 31, 1996 IS UNAUDITED) 9. RETIREMENT SAVINGS PLAN The Company sponsors a 401(k) defined contribution plan that covers all employees who have completed at least three months of service. This plan allows for employees to defer up to 15% of their pretax salary in certain investments at the discretion of the employees. The Company has the option to make discretionary employer contributions, however, no such contributions have been made since inception of the plan. 10. CONTINGENCIES In April 1997, a complaint for unfair competition was filed against the Company as one of a group of companies separately developing 56K modem technology by a plaintiff on behalf of the general public. The complaint alleges that the Company knowingly made false and misleading statements regarding the capabilities of its 56K modem technology. The Company denies the allegation in the complaint and intends to vigorously defend its position. Nevertheless, litigation is subject to inherent uncertainties and thus there can be no assurance that this suit will be resolved favorably to the Company or that it will not have a material adverse effect on the Company's business, results of operations and financial condition. On June 2, 1997, the Company received written notice from US Robotics Access Corp., Inc. ("USR") alleging that the PortMaster 3 infringes USR's U.S. patent 5,528,595, captioned "Modem Input/Output Signal Processing Techniques." Although the Company believes that such patent may be invalid, it is possible that USR may file suit against the Company to enforce such alleged patent or other intellectual property rights. Regardless of the merits of any such potential suit, there can be no assurance that the Company will prevail in defending itself or that it would not be required to enter into license arrangements or develop non-infringing technology. Furthermore, there can be no assurance that USR will not assert other infringement claims in the future with respect to the Company's current or future products. Any litigation could result in product delays or costs which could have a material adverse effect on the Company's business, results of operations and financial condition. On June 5, 1997, a complaint was filed against the Company in California Superior Court by Capella Worldwide Networking, Inc. ("Capella"), the Company's largest distributor in fiscal 1996. The Company terminated its relationship with Capella in November 1996. The complaint purports to allege contract and tort causes of action arising out of the Company's termination of Capella as a distributor. The complaint seeks injunctive and declaratory relief as well as unspecified damages for alleged lost profits, including compensatory, punitive and treble damages. The Company has not yet responded to the Complaint and discovery has not yet commenced. The Company denies the allegations in the complaint and intends to defend its position. Nevertheless, litigation is subject to inherent uncertainties and thus there can be no assurance that this suit will be resolved favorably to the Company or that it will not have a material adverse effect on the Company. Due to the fact that the above mentioned legal matters are at an early stage, no estimate of loss can be made by the Company at this time. The Company is also subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of other third parties. There can be no assurance that other third parties will not assert infringement claims in the future with respect to the Company's current or future products or that any such claims will not require the Company to enter into license arrangements or develop non-infringing technology, or result in litigation, regardless of the merits of such claims. F-17 [LOGO] PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by the Company in connection with the sale of Common Stock being registered. All amounts are estimates except the SEC registration fee and NASD filing fee. SEC registration fee.............................................. $ 12,122 NASD filing fee................................................... 4,500 Nasdaq National Market listing fee................................ 50,000 Printing and engraving costs...................................... 125,000 Legal fees and expenses........................................... 310,000 Accounting fees and expenses...................................... 250,000 Blue Sky fees and expenses........................................ 10,000 Transfer Agent and Registrar fees................................. 5,000 Miscellaneous expenses............................................ 35,000 --------- Total......................................................... 801,622 --------- ---------
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS The Bylaws of the Company provide for the indemnification of the Company's officers and directors against certain liabilities and expenses relating to lawsuits and other proceedings in which they may become involved. Section 317 of the California Corporations Code also provides for indemnification of a corporation's directors and officers under certain circumstances. Section 204(a)(10) and (11) and Section 317 of the California Corporations Code and the Bylaws of the Company contain provisions covering indemnification of corporate directors and officers against certain liabilities and expenses incurred as a result of proceedings involving such persons in their capacities as directors and officers, including proceedings under the Securities Act or the Exchange Act. The Company provides indemnity insurance pursuant to which its directors and officers are indemnified or insured under certain circumstances against certain liabilities or losses, including liabilities under the Securities Act. The Company has obtained shareholder approval to enter into indemnity agreements with their respective directors and officers. Each agreement provides for indemnification of the fines, settlements and other amounts incurred by such person in connection with the good faith performance of his or her duties as a director or officer. The indemnification agreements also provide for the advance payment by the Company of expenses incurred in defending any proceeding to which the director or officer may be a party, provided that the affected director or officer executed an undertaking, acceptable to the disinterested members of the board of directors, agreeing to repay all amounts advanced for defense of the proceeding if it shall be ultimately determined that such director or officer was not entitled to be indemnified in accordance with Sections 204(a)(10) and (11) and Section 317 of the California Corporations Code. The Company understands that the staff of the Commission is of the opinion that statutory, charter and contractual provisions as are described above have no effect on claims arising under the federal securities laws. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES Since 1994 the registrant has issued and sold the following unregistered securities: as of May 31, 1997, the Registrant has issued and sold 222,735 shares of Common Stock to employees and consultants at prices II-1 ranging from $.033 to $17.50 per share, upon exercise of stock options, pursuant to the Registrant's 1994 Stock Option Plan; in December 1995, the Company issued 15,000 shares of Common Stock to Douglas Meltzer in consideration of past services rendered to the Company and the signing of a confidentiality agreement; and in connection with the Company's acquisition of certain assets, with a value of $189,000 as determined by the Company's Board of Directors, of Lloyd Internetworking, Inc. ("Lloyd") on June 28, 1996, the Company issued 18,000 shares of Common Stock to Lloyd shareholders. The sales of the above securities were deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act, or Rule 701 promulgated under Section 3(b) of the Securities Act, as transactions by an issuer not involving a public offering or transactions pursuant to compensatory benefit plans and contracts relating to compensation as provided under such Rule 701. The recipients of securities in each such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates and instruments issued in such transaction. All recipients had adequate access, through their relationships with the Company, to information about the Registrant. ITEM 16. EXHIBITS (a) Exhibits 1.1+ Underwriting Agreement. 3.1+ Restated Articles of Incorporation of Livingston Enterprises, Inc., a California corporation, as currently in effect. 3.4+ Bylaws of the Registrant, as currently in effect. 3.5+ Bylaws of the Registrant, as in effect immediately following the closing of the offering made under this Registration Statement. 4.1* Specimen Common Stock Certificate. 5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation. 10.1+ Form of Indemnification Agreement between the Company and each of its directors and officers. 10.2+ 1994 Stock Option Plan and forms of agreement thereunder. 10.3+ 1997 Stock Plan and form of agreement thereunder. 10.4+ 1997 Employee Stock Purchase Plan and forms of agreements thereunder. 10.5+ Lease dated January 24, 1996 between Registrant and Willow Road Associates, LLC for the facility located at 4464 Willow Road, Pleasanton, CA 94588. 10.6+ Deferred Compensation Plan dated May 2, 1996, as amended, between the Company and Jerrold Livingston. 10.7+ Master Revolving Note with Comerica Bank dated April 30, 1996. 10.8** OEM Software License and Development Agreement between the Company and U.S. Robotics Access Corp. (f/k/a U.S. Robotics, Inc.), as amended. 11.1 Calculation of earnings per share.
II-2 23.1 Consent of KPMG Independent Auditors. 23.2* Consent of Counsel (included in Exhibit 5.1). 24.1+ Power of Attorney (see page II-4).
- --------- * To be filed by amendment. ** Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission. + Previously filed. (b) Financial Statement Schedules II. Valuation and Qualifying Accounts Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto. ITEM 17. UNDERTAKINGS The undersigned Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. Insofar as indemnification by the Registrant for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions referenced in Item 14 of this Registration Statement or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of Prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of Prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-3 SIGNATURES Pursuant to the requirements of the Securities Act, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Pleasanton, State of California, on the 24th day of June, 1997. LIVINGSTON ENTERPRISES, INC. By: /s/ STEVEN M. WILLENS ---------------------------------- Steven M. Willens PRESIDENT AND CHIEF EXECUTIVE OFFICER POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Steven M. Willens and Steven A. Hess and each of them his attorneys-in-fact, each with the power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Registration Statement, and to sign any registration statement for the same offering covered by this Registration Statement that is to be effective upon filing pursuant to Rule 462(b) promulgated under the Securities Act of 1933, and all post-effective amendments thereto, and to file the same, with all exhibits thereto in all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming that such attorneys-in-fact and agents or any of them, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated:
SIGNATURE TITLE DATE - ---------------------------------------- ------------------------------------------------------ --------------- /s/ STEVEN M. WILLENS ---------------------------- President, Chief Executive Officer and Chairman June 24, 1997 Steven M. Willens /s/ STEVEN A. HESS ---------------------------- Chief Financial Officer (Principal Financial and June 24, 1997 Steven A. Hess Accounting Officer) /s/ JERROLD LIVINGSTON ---------------------------- Director June 24, 1997 Jerrold Livingston /s/ RONALD H. WILLENS ---------------------------- Director June 24, 1997 Ronald H. Willens /s/ ALBERT A. PIMENTEL ---------------------------- Director June 24, 1997 Albert A. Pimentel /s/ ROBERT C. HAWK ---------------------------- Director June 24, 1997 Robert C. Hawk
II-4 LIVINGSTON ENTERPRISES, INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE AT DEDUCTIONS: BEGINNING OF WRITE OFFS BALANCE AT CLASSIFICATION PERIOD ADDITIONS OF ACCOUNTS END OF PERIOD - ------------------------------------------------------------- --------------- ----------- ------------- ------------- Allowance for returns and doubtful accounts Year ended August 31, 1994............................... $ -- $ 13 $ -- $ 13 Year ended August 31, 1995............................... $ 13 $ 137 $ -- $ 150 Year ended August 31, 1996............................... $ 150 $ 563 $ 65 $ 648 Nine months ended May 31, 1996 (unaudited)............... $ 150 $ 539 $ 3 $ 686 Nine months ended May 31, 1997........................... $ 648 $ 642 $ 282 $ 1,008 Warranty accrual Year ended August 31, 1994............................... $ -- $ -- $ -- $ -- Year ended August 31, 1995............................... $ -- $ -- $ -- $ -- Year ended August 31, 1996............................... $ -- $ 85 $ -- $ 85 Nine months ended May 31, 1996 (unaudited)............... $ -- $ -- $ -- $ -- Nine months ended May 31, 1997........................... $ 85 $ 340 $ 25 $ 400
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION - --------- 1.1+ Underwriting Agreement. 3.1+ Restated Articles of Incorporation of Livingston Enterprises, Inc., a California corporation, as currently in effect. 3.4+ Bylaws of the Registrant, as currently in effect. 3.5+ Bylaws of the Registrant, as in effect immediately following the closing of the offering made under this Registration Statement. 4.1* Specimen Common Stock Certificate. 5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation. 10.1+ Form of Indemnification Agreement between the Company and each of its directors and officers. 10.2+ 1994 Stock Option Plan and forms of agreement thereunder. 10.3+ 1997 Stock Plan and form of agreement thereunder. 10.4+ 1997 Employee Stock Purchase Plan and forms of agreements thereunder. 10.5+ Lease dated January 24, 1996 between Registrant and Willow Road Associates, LLC for the facility located at 4464 Willow Road, Pleasanton, CA 94588. 10.6+ Deferred Compensation Plan dated May 2, 1996, as amended, between the Company and Jerrold Livingston. 10.7+ Master Revolving Note with Comerica Bank dated April 30, 1996. 10.8** OEM Software License and Development Agreement between the Company and U.S. Robotics Access Corp. (f/k/a U.S. Robotics, Inc.), as amended. 11.1 Calculation of earnings per share. 23.1 Consent of KPMG Independent Auditors. 23.2* Consent of Counsel (included in Exhibit 5.1). 24.1+ Power of Attorney (see page II-4).
- --------- * To be filed by amendment. ** Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission. + Previously filed. EX-10.8 2 EXHIBIT 10.8 OEM SOFTWARE LICENSE AND DEVELOPMENT AGREEMENT Dated September 1, 1994 between Livingston Enterprises, Inc. and U.S. Robotics, Inc. This OEM Software License and Development Agreement (this "Agreement") is made effective September 1, 1994, by and between U.S. Robotics, Inc., a Delaware corporation with a place of business at 8100 North McCormick Blvd., Skokie, Illinois 60076 ("USR"), as licensee, and Livingston Enterprises, Inc., a California corporation with a place of business at 6920 Koll Center Parkway, Pleasanton, California 94566 ("Livingston" or "Licensor"), as licensor. In consideration of the premises and of the mutual covenants and promises set forth herein, USR and Licensor hereby agree as follows: SECTION 1. PURPOSE OF AGREEMENT. Licensor has developed certain computer software identified in Exhibit 2.7 attached hereto which USR desires to license for inclusion in and sublicensing with certain USR products and systems. Licensor desires to grant to USR, its Subsidiaries and Permitted Assigns, certain rights with respect to such software. In order to include such software in its products, USR will require certain software development services and the technical support and assistance of Licensor's software engineering and development personnel and Licensor is willing to provide such development services, support and assistance for a fee. SECTION 2. DEFINED TERMS. When used in this Agreement and any Exhibits or Schedules attached hereto, the capitalized terms listed below shall have the respective meanings indicated: 2.1 "CODE" means computer programming code. If not otherwise specified, "Code" means only Object Code and NOT Source Code, which are defined as follows: 2.1.1 "OBJECT CODE" means the machine-readable form of the Code. 2.1.2 "SOURCE CODE" means the human-readable form of the Code and related program and system documentation, including all comments and any procedural code. 2.2 "DERIVATIVE WORK" means a work which is based upon one or more preexisting works, such as a revision, enhancement, modification, translation, abridgment, condensation, expansion, or any other form in which such preexisting works may be transformed or adapted, and which if prepared without authorization of the owner of the copyright in such preexisting work, would constitute a copyright infringement. "Derivative Work" also includes any compilation that incorporates such a preexisting work. 2.3 "DEVELOPMENT PROJECT" means the development, testing and implementation of all Maintenance Modifications, Enhancements and Upgrades to the Licensed Software described in Exhibit 4.1 attached which are necessary or reasonably required in order to allow the Licensed Software to run on the USR Hardware Platforms and perform in accordance with the Specifications for such Licensed Software. 2.4 "LICENSOR DEVELOPMENT SERVICES" means the software engineering and development and technical support services described in the Statement of Work for the Development Project attached as Exhibit 4.1 which Licensor shall perform in accordance with Section 4 of this Agreement. 2.5 "DOCUMENTATION" means user manuals and other written materials that relate to the Licensed Software. 2.6 "ENHANCEMENTS" means all changes or additions to the Code and related Documentation comprising the Licensed Software, other than Maintenance Modifications and Upgrades, including, but not limited to, all new releases, that improve functions, add new functions, or improve performance by changes in system design or coding and all changes and/or additions made to support new releases of the operating systems with which the Code is designed to operate, support new input/output (I/O) devices, or provide other incidental updates. 2.7 "LICENSED SOFTWARE" means the Object Code, Documentation and other materials relating to the programs specified and/or described in Exhibit 2.7 and any further Schedules or Exhibits attached hereto, together with the Object Code, Documentation and other materials relating to all Maintenance Modifications and Enhancements thereto, and together with the Object Code, Documentation and other materials relating to any Upgrades that are hereafter made subject to this Agreement. 2.8 "PERMITTED ASSIGNS" means any person to whom USR assigns its rights or interests under this Agreement with the written approval of Livingston, as set forth in Section 11.11 hereof. 2.9 "MAINTENANCE MODIFICATION" means any modification or revision, other than Enhancements and Upgrades, to Code or Documentation that correct programming -2- errors or make other incidental changes or corrections. "Maintenance Modifications" include, but are not limited to any Bug fixes. 2.10 "SPECIFICATIONS" means the specifications for the functional and operational parameters and characteristics of the Licensed Software set forth or referenced in Exhibit 2.7 attached hereto. 2.11 "SUBSIDIARY" means a corporation, company or other entity (1) more than fifty percent (50%) of whose outstanding shares or securities having the right to vote for the election of directors of other managing authority are, or (2) which does not have outstanding shares or securities, as may be the case in a partnership, joint venture or unincorporated association, but more than fifty percent (50%) of the ownership interest of which, representing the right to make the decisions for such corporation company or other entity, is now or hereafter owned or controlled, directly or indirectly, by a party hereto, but such corporation, company or other entity shall be deemed to be a Subsidiary only so long as such ownership or control exists. 2.12 "THIRD PARTY SOFTWARE" means any third party Code and Documentation identified in Exhibits 2.7 and/or 4.1 attached hereto, including any Maintenance Modifications, Enhancements and Upgrades thereto, which Livingston obtains and provides or sublicenses to USR pursuant to Sections 4.4 and 6.3 of this Agreement. 2.13 "UPGRADES" means changes or additions to Code and related Documentation that (1) provide substantial additional value and utility, (2) as a practical matter could be priced and offered separately as optional additions to the Code and Documentation, and (3) are not made available to any other customers or licensees without a separate or additional charge. 2.14 "USR HARDWARE PLATFORMS" means the specific hardware products of USR and its Subsidiaries described in Section 3.1.1 of this Agreement. 2.15 "OEM SUPPLY AGREEMENT" means the OEM Supply Agreement entered into by and between Livingston and USR, dated as of September 1, 1994 pursuant to which USR has agreed to sell certain modem products to Livingston. 2.16 "BUG" means a defect in the Licensed Software which causes the software to perform in a manner which substantially differs from the specifications of the Licensed Software and which can be replicated with reasonable effort on the then applicable model of the Livingston product line corresponding to Livingston's current PortMaster product line or on such other equipment as the Parties reasonably agree is appropriate under the circumstances. Without limiting the generality of any defect in Code which affects more than 5% of the units of Products containing such Code or which causes any Product to be inoperable more than 5% of the time shall be deemed a "Bug" unless the parties otherwise agree. -3- 2.17 "CLIENT CODE" means a program which executes on a remote CPU to connect to the USR hardware platforms over a network. SECTION 3. LICENSE GRANT FOR LICENSED SOFTWARE. 3.1 SCOPE. Subject to the terms and conditions set forth in this Agreement, Licensor hereby grants to USR and its Permitted Assigns a worldwide, nonexclusive. non-transferable, perpetual right and license to use, copy, reproduce, display, execute, modify, distribute, lease and prepare Derivative Works based on all License Software that is now, or hereafter becomes, the subject of this Agreement, subject further to the following restrictions: 3.1.1 USR shall only distribute or lease copies of the Licensed Software in executable form and in conjunction with the manufacture and/or sale or lease of, and only for use in, those USR Hardware Platforms described in Exhibit 3.1.1 attached hereto, regardless of the name or names under which such products are marketed and sold; provided that USR and its Subsidiaries may not supply such products to any unaffiliated third party on an OEM or private label basis without the prior written consent of Livingston. 3.1.2 No Code in whole or in part shall be used or incorporated in any USR Hardware Platform except those which are described in Exhibit 3.1.1 and any amendments thereto which the parties may hereafter agree to. 3.1.3 Except as otherwise agreed in writing by Livingston, USR shall include appropriate copyright and other proprietary notices (in the form provided by Livingston) in all copies of the Licensed Software distributed to other parties. 3.1.4 All contracts and purchase orders, if any, for USR Hardware Platform Products supplied to the U.S. Government under a prime contract or to a contractor operating under a U.S. Government contract shall include the following paragraph or substantially equivalent language. "Use, duplication, or disclosure by the Government is subject to restrictions as set forth in subparagraph (c)(1)(ii) of the Rights in Technical Data and Computer Software clause at 252.227-7013." 3.1.5 In addition, subject to the same restrictions, USR may copy and distribute Client Code related to the Licensed Software as provided by Licensor and as modified to operate in conjunction with the USR Hardware Platforms incorporating the Licensed Software. 3.2 RIGHT TO GRANT SUBLICENSES. The right and license granted above shall include the right of USR to sublicense and authorize other parties (including its Subsidiaries, -4- subcontractors, dealers, distributors, and agents collectively, "Sublicensees") to do any, some, or all of the foregoing, with respect to the Licensed Software, provided that such other parties agree to be bound by the terms of this Agreement. Specifically, sublicensing pursuant to the foregoing shall only be authorized pursuant to the following terms: 3.2.1 Such sublicenses shall only be granted pursuant to a written sublicense agreement. Such sublicense agreements may be in any form, provided that they contain substantially the same provisions relating to the Licensed Software as are contained in this Agreement with respect to intellectual property rights, warranties, limitations of liability, indemnities and confidential information. Livingston shall have the right to approve the relevant provisions of the sublicense agreement utilized in connection with the foregoing issues. Without limiting the generality of the foregoing, Sublicensees shall be prohibited from further sublicensing, assigning or transferring the Licensed Software without the prior written consent of Livingston. 3.2.2 USR shall not sublicense and Sublicensees shall have no rights to the Licensed Source Code. Further, sublicensees shall be prohibited from reverse engineering, disassembling or decompiling the Licensed Software. 3.2.3 USR agrees to notify Livingston in writing of any sublicense granted pursuant hereto. Such notice shall include the Sublicensee's name, address and contact person, and shall give a brief summary of the nature of the transaction. 3.2.4 With respect to any activities of Sublicensees, royalties shall be payable in accordance with the terms as set forth in Section 6 and Exhibit 6.2 of this Agreement. Reporting and auditing of such royalties shall also be effected in accordance with Section 6 and Exhibit 6.2 herein. 3.3 PATENTS AND PATENT APPLICATIONS. Licensor further grants to USR its Subsidiaries and its and their respective customers, mediate and immediate, a worldwide, nonexclusive, nontransferable, and royalty-free license under all patents or patent applications if any, covering the Licensed Software owned or licensable by Licensor during the term of this Agreement to make, have made, use, have used, lease, and/or otherwise transfer such Licensed Software, including Derivative Works thereof, as set forth in Section 3.1 above. 3.4 COPIES FOR INTERNAL USE. The foregoing grant of license includes the right to make and use reasonable numbers of copies of the Licensed Software exclusively for archival, test, maintenance, warranty service and product demonstration purposes without any obligation to pay royalties with respect thereto. -5- SECTION 3A. LICENSE GRANT FOR SOURCE CODE. 3A.1 Subject to the terms and conditions contained in this Agreement, Licensor hereby grants to USR and its Permitted Assigns a nonperpetual, nonexclusive, nontransferable right and license (revocable as set forth in Section 3A.1.4) to use, copy, reproduce and create Derivative Works of the Source Code (the "Licensed Source Code") which is required to generate the Object Code contained in the Licensed Software (as defined herein and specified in Exhibit 2.7 hereto), subject further to the following limitations and restrictions: 3A.1.1 USR shall use the Licensed Source Code only for the following purposes and subject to the following limitations, (i) the modification and creation of Derivative Works based upon the Licensed Software in connection with porting of the Licensed Software to the USR Hardware Platforms described in Exhibit 3.1.1 and as appropriate for any USR Hardware Platforms added thereto by amendment, (ii) developing and/or porting Maintenance Modifications, Enhancements and Upgrades of the Licensed Software to the USR Hardware Platforms described in Exhibit 3.1.1 or subsequently added thereto by amendment, and (iii) developing customized modifications of the Licensed Software and otherwise supporting and servicing the needs of purchasers and end users of the USR Hardware Platforms described in Exhibit 3.1.1 or subsequently added thereto by amendment. 3A.1.2 USR acknowledges and agrees that it is acquiring only the right to use the Licensed Source Code as strictly authorized hereunder. All ownership, copyrights, patent rights (if any) and other intellectual property rights in and to the Licensed Source Code shall remain vested in Licensor. USR shall not transfer, assign or sublicense the Licensed Source Code. USR further acknowledges the confidential and proprietary nature of the Licensed Source Code and agrees to exert and implement all commercially reasonable efforts and measures to maintain and preserve the confidentiality and to prevent the unauthorized use thereof, which efforts and measures shall include, but not be limited to, the following: (a) all such efforts and measures as USR exerts and implements for the protection of its own trade secrets of a similar nature (which shall in no event comprise less than reasonable care and diligence); (b) restriction of access to the Licensed Source Code to those employees of USR who have a bona fide need for such access in connection with the activities contemplated herein and -6- who have executed written instruments acknowledging and agreeing to honor their duties and obligations to maintain the confidentiality and abstain from unauthorized use of such confidential and proprietary information. In addition, USR shall maintain a list of all such employees who at any time have accessed the Licensed Source Code while it is in the possession of control of USR and such list shall include, for each such employee, his or her name, title and a brief summary specifying the portions of the Licensed Source Code which he or she has accessed and setting forth the reason that such employee needed such access. (c) maintenance of all copies of the Licensed Source Code in a physically secure place and on computers the use of and access to which are restricted to authorized personnel. USR shall further notify Licensor of the location of all copies of the Licensed Source Code. (d) prompt destruction or return to Licensor of all copies of the Licensed Source Code upon termination of this Agreement or upon Licensor's request in the event of termination of the right and license granted herein for the Licensed Source Code in accordance with Section 3A.1.4 below. Except in the case of a material breach by USR of the provisions of this Section 3A.1.2., USR may retain a copy of any portions of the Licensed Source Code which are reasonably required to fix "Bugs" which have been reported by USR to Livingston prior to such request. All Licensed Source Code shall be returned to Livingston or destroyed upon repair of the reported "Bugs" or upon the expiration of three months following the date of such request, whichever is earlier. (e) In all cases in which USR destroys Licensed Source Code as set forth herein USR shall provide to Licensor a written certification signed by an officer of USR which states that such destruction has been accomplished in accordance with the terms of this Agreement. 3A.1.3 Subject to reasonable undertakings by Livingston with respect to maintaining the confidentiality and restraining from unauthorized use of USR's confidential and proprietary information, Livingston shall be afforded, upon request, reasonable opportunities to observe and evaluate the adequacy of the efforts and measures exerted and implemented by USR -7- with respect to its obligations to maintain the confidentiality and prevent unauthorized use of the Licensed Source Code. 3A.1.4 Livingston shall have the option to terminate the right and license to the Licensed Source Code granted herein at any time on or after August 31, 1996, as follows: (a) Such option shall be exercised by written notice given to USR not less than one year prior to the date on which the termination is to become effective. (b) Livingston may request the return or destruction of the Licensed Source Code at any time on or after the effective date of such termination. (c) Nothing in this Section 3A.1.4 and no notice or request given pursuant hereto shall prevent Livingston from requesting an earlier return or destruction of the Licensed Source Code upon termination of this Agreement pursuant to and in accordance with any other provisions of this Agreement. (d) Notwithstanding the foregoing, during the term of this Agreement and after the return or destruction of the Licensed Software by USR, Livingston agrees that in the event it fails to fulfill its support obligations as set forth in Section 5 hereof, Livingston will grant USR personnel reasonable access to and use of the Licensed Source Code at Livingston's facilities or at the facilities of a mutually agreeable third party so as to permit USR to perform such maintenance and support functions in a reasonably efficient and effective manner. 3A.1.5 Upon termination of USR's rights to use the Licensed Source Code pursuant to 3A. 1.4 above, USR may request that the Licensed Source Code be placed and maintained in Escrow with a recognized software Escrowee at USR's expense to be held for release to USR upon mutually agreed terms and conditions in the event that Livingston fails or refuses to fulfill its obligations to grant access pursuant to Section 3 A.1.4(d). SECTION 4. DEVELOPMENT PROJECT. 4.1 SCOPE. The Development Project shall be carried out by USR with the full support of Licensor, including but not limited to the provision by Licensor of the Licensor Development Services described in the Statement of Work set forth on Exhibit 4.1 attached hereto. -8- 4.2 PROJECT SCHEDULE. Licensor agrees to cooperate with USR and make qualified personnel available at the times and places reasonably requested by USR for consultation with and to provide direct assistance to USR to the extent reasonably necessary to enable the Development Project to be completed in accordance with the schedule established. 4.3 QUALITY OF WORK. All of the Licensor Development Services shall be performed in a good and professional manner and the work product produced by Licensor's personnel shall meet or exceed all applicable industry standards for similar work as well as meeting the Specifications. 4.4 THIRD PARTY SOFTWARE DEVELOPMENT. As set forth in Exhibits 2.7 and 4.1 attached, Livingston may obtain licenses for certain Third Party Software subject to a paid up license under which Livingston is entitled, upon payment of an additional license fee to sublicense such Third Parry Software to USR as a part of the Licensed Software. Upon receipt from Licensor of satisfactory documentation evidencing such Third Party Software licenses and USR's potential rights as a sublicensee thereunder, USR shall promptly notify Livingston with respect to whether USR is willing to accept a sublicense of such Third Party Software. If USR does accept a sublicense of such Third Party Software, USR shall promptly reimburse or pay the incremental license fees which Livingston shall have paid or become obligated to pay to the third party licensor with respect to such sublicense for USR as provided in Section 6.3 hereof. If USR accepts the sublicense of the Third Party Software, USR must agree to accept all of the terms, conditions and restrictions of the Licensee agreement between Livingston and the third party as are applicable to sublicensees thereunder. 4.5 JOINT EFFORTS; CROSS-LICENSING. The parties agree that, except as otherwise specifically provided herein, the copyright and other intellectual property rights in any Code, Documentation or other work, trade secret or invention which is created, conceived or invented by either of them but which results directly from their joint development efforts and cooperation pursuant to this Agreement, shall belong to the party who creates such Code, Documentation or other work, trade secret or inventions. Further, except as they may otherwise agree in writing hereafter, the parties agree that in the event they should be deemed joint authors, joint creators or co-inventors of any such work, trade secret or invention, all intellectual property rights in such newly authored, created or invented work, trade secret or invention (excluding any portion thereof consisting of preexisting Source Code or Derivative Works thereof) shall be transferred and assigned, subject to the license back described below, to the party making the greatest contribution of time and effort, to creation and development work resulting in such work, trade secret or invention. Licensor shall own all portions of any joint work consisting of pre-existing Source Code or Derivative Works thereof. -9- Each such jointly created work, trade secret or invention shall be disclosed promptly by the creator or inventor thereof to the other party hereunder and such other party shall be granted a perpetual, royalty-free license to copy, make, use, sublicense and sell such work, trade secret or invention, subject only to such restrictions or are reasonably necessary to protect and preserve the owner's intellectual property rights therein. However, except as may be otherwise specifically agreed in writing, nothing in this Section 4.5 shall be construed as a transfer or unrestricted license by either party to the other of any of such party's Source Code which may be used by the other party in such joint effort. SECTION 5. SUPPORT AND MAINTENANCE: ENHANCEMENTS AND UPGRADES. 5.1 INITIAL MAINTENANCE PERIOD. During the period commencing on the date hereof and ending upon the expiration of one (1) year following first shipment of a production version of the Licensed Software in a USR Product, Licensor, at no additional charge to USR shall provide USR with (i)"Bug" fixes for all defects in the Licensed Software which are reported by USR or discovered independently by Licensor and (ii) all Maintenance Modifications to the Licensed Software which are otherwise created by or for Licensor, whether or not such Maintenance Modifications, are released to Licensor's other customers during such period. Licensor shall provide USR with copies of the Source Code for all such Bug fixes, and Maintenance Modifications, subject to the provisions of Section 3A hereof, on a timely basis, which shall in no event be later than the earlier of (i) the expiration of three months following implementation of the Bug fix, (ii) the release of Maintenance Modifications that incorporate it or (iii) its incorporation into a new standard release of the Licensed Software. 5.2 ONGOING MAINTENANCE AND SUPPORT. Following the initial maintenance period described in Section 5.1 above and so long thereafter as USR continues to pay royalties to Licensor pursuant hereto, Licensor shall make available to USR ongoing maintenance and support consisting of Maintenance Modifications ("Support Services") pursuant to an annual Software Support Agreement in the form attached as Exhibit 5.2. In the event of any conflict or inconsistency between this Agreement and such Software Support Agreement, the provisions of this agreement shall control. USR may elect to purchase Support Services or choose not to on an annual basis, in its sole discretion such support services shall be provided for the compensation set forth in Section 6.5. 5.3 ENHANCEMENTS AND UPGRADES. During the initial maintenance period described above, Livingston shall provide, at no additional charge beyond the royalties and other compensation payable hereunder, all Enhancements and Upgrades to the Licensed Software. During all subsequent periods in which USR subscribes for Support Services, Licensor shall have an option to also offer any Enhancements and Upgrades to the Licensed Software to USR upon terms and conditions not less favorable than -10- those offered to any other of Licensor's Customers determined in accordance with Section 6.4 of this Agreement. USR shall be responsible for distributing such Enhancements and Upgrades to its customers who have purchased USR Hardware Platforms containing the Licensed Software. 5.4 CHANGES TO LICENSED SOFTWARE. All Maintenance Modifications, Enhancements and Upgrades provided to USR pursuant to this Section 5 and Exhibit 5.2 shall be and become Licensed Software subject to this Agreement. Licensor shall deliver complete Code and Documentation, including Source Code subject to the provisions of Section 3A, for all such Maintenance Modifications, Enhancements and Upgrades to USR promptly and in no event later than the first general release thereof to Licensor's other customers. 5.5 COOPERATION BY USR. USR will cooperate with Licensor in the maintenance and support of the Licensed Software during the term hereof by: 5.5.1 promptly reporting any "Bugs" or other defects in the Licensed Software which are discovered by USR; 5.5.2 working, with the cooperation of Licensor. to develop Enhancements and Upgrades to the Licensed Software which USR deems to be desirable. The Rights in such Enhancements and Upgrades shall be determined as provided in Section 4.5. 5.6 CUSTOMER SUPPORT PROCEDURES. 5.6.1 USR will provide technical support to its customers and end users of the USR Hardware Platform products incorporating the Licensed Software, and will provide such technical training to its resellers as USR in its discretion determines to be necessary or appropriate. 5.6.2 Livingston agrees to regularly supply bug notes or other documentation defining the relevant hardware and software information, symptoms, solutions, or work-arounds for major Licensed Software problems. 5.6.3 Livingston agrees to supply technical documentation that is useful or necessary to perform customer support and troubleshooting or to analyze the technical benefits and risks of introducing a new software or hardware release of the Licensed Software into USR's customer base. 5.6.4 USR and Livingston agree to the following escalation policy to manage problems that impact the performance of the Licensed Software at end-user sites: -11- (a) If USR is unable to resolve a problem experienced by a customer that is seriously impacting the performance of the Licensed Software in the USR Hardware Platform products in a customer's network, then USR technical services personnel will call upon the designated engineering resources at USR for assistance. Within 5 business days, USR's Technical Services and Engineering personnel will determine if contact with Livingston is required. (b) Within 5 business days of written or electronic mail notification to Livingston's designated technical support organization USR and Livingston will jointly agree to classify the problem in one of three categories: (a) user problem; (b) USR problem; or (c) Licensed Software problem. A "user problem" is one that is a consequence of user error, and is not a function of an inherent problem with the product or documentation. A 'Licensed Software problem' is one that is a function of an inherent problem with the product, and is likely the consequence of a "Bug" or other apparent defect in the Licensed Software or Documentation as developed and implemented by Livingston. A "USR problem" is any other problem. (c) If the Parties cannot determine and agree on the correct category for the problem by the end of 5 business days at the level of their respective customer service and support organizations, it will be immediately escalated to the responsible product managers of the products at USR and Livingston. Within 5 business days of that escalation. the product managers will jointly establish an action plan and timetable designed both to identify the category of the problem, and, if USR so requests, to solve the problem for the customer and the Parties will jointly execute that plan. (d) A category (a) 'user problem' and category (b) 'USR problem' should generally be managed by USR without additional support from Livingston. A category (c) 'Licensed Software problem' is a problem that by definition may require support from and-involvement of Livingston. USR may elect to implement its own solution or to request Livingston's assistance. In the event that a category (c) 'Licensed Software problem' is being worked on by the Parties' respective service and support organizations, no charges by Livingston to USR for support will be justified or warranted during the Initial Maintenance Period described in Section 5.1 and thereafter during all periods for which the applicable support and maintenance fees, as per Section 6.5, have been paid, and Livingston will cooperate fully in the development of a solution to the problem. All Category (c) problems must be brought to the attention of the responsible product managers of the products at USR and Livingston. -12- (e) Within 5 business days of the decision that any given problem is a category (c) 'Licensed Software problem, and USR's determination to involve Livingston, Livingston and USR will jointly develop and implement an action plan aimed at eliminating the problem the customer is experiencing. Category (c) 'Licensed Software problem' will be further classified into two categories, 1) Critical Problems and 2) Non-Critical Problems. Critical Problems are problems classified by Livingston and USR as critical to the fundamental operation of the USR product. Livingston will generate a fix for each such critical problem and send it to USR on the appropriate media as soon as possible. Livingston will contact USR within five(5) working days as to the status of resolution of the problem. Non-Critical Problems are problems which are not critical to the fundamental operation of the affected USR product. At USR's request, Livingston will attempt to generate fixes for problems classified by Livingston and USR as non-critical to the fundamental operation of the affected USR Hardware Platform products in the next release of the Licensed Software. When possible Livingston will describe temporary work-arounds to USR. (f) Livingston acknowledges and agrees that Category (c) 'Licensed Software problems' which are critical problems or are otherwise of material significance which remain unresolved for an extended duration threaten the success of the USR products in the market place, and may require that USR gain access to the source code, if the Source Code is not then otherwise in USR's possession pursuant to this Agreement. USR has the right to identify unresolved category (c) 'problems' of material significance that must be resolved within the next three months by Livingston, after which USR will be granted access to the Source Code as specified in Section 3A.1.4(d) to implement a fix for its customer base. At no time will Livingston's rights in such Source Code and documentation be transferred to USR. USR will have the right to distribute, royalty free, the fixes so created in binary form to its customers. 5.7 GOVERNMENT CONTRACTS. USR agrees to include the following paragraph in all contracts and purchase orders for the Licensed Products supplied to the U.S. Government under a prime contract or to a contractor operating under a US. Government contract: "Use, duplication, or disclosure by the Government is subject to restrictions as set forth in subparagraph (c)(1)(ii) of the Rights in Technical Data and Computer Software clause at 252.227-7013." SECTION 6. FEES AND ROYALTIES; PAYMENT. -13- 6.1 NON-RECURRING ENGINEERING FEES. In consideration of the Development Services to be performed by Licensor, USR agrees to pay Licensor non-recurring engineering fees totaling [CONFIDENTIAL TREATMENT REQUESTED], as follows: 6.1.1 [CONFIDENTIAL TREATMENT REQUESTED] will be paid upon execution and delivery of this Agreement; 6.1.2 [CONFIDENTIAL TREATMENT REQUESTED] be paid upon satisfactory completion of Phase I of the Development Project and 6.1.3 [CONFIDENTIAL TREATMENT REQUESTED] be paid upon satisfactory completion of Phase II of the Development Project. 6.2 ROYALTIES. In consideration of the rights and licenses granted to USR pursuant to Section 3 hereof, USR agrees to pay royalties to Licensor, with respect to the Licensed Software, which royalties shall be computed as set forth in Exhibit 6.2 attached hereto (the "Royalties"). The Royalties shall be paid in accordance with the following procedure: 6.2.1 Royalties shall be computed and paid an a quarterly basis within 60 days following the end of each of USR's fiscal quarters during the term hereof. 6.2.2 Each Royalty payment shall be accompanied by USR's sales and sublicense report which shall set forth in reasonable detail the product sales and sublicenses of the Licensed Software for such quarterly period upon which the Royalties are based and the calculations used by USR to determine the amount of the Royalty payment then due. 6.2.3 Licensor shall have the right, exercisable not more frequently than once in any 12-month period, upon reasonable notice and regular business hours, to inspect and review, directly or through its certified public accountants, USR's books and records which are related to sales of products and grants of sublicenses relevant to the computation of the Royalties for the sole purpose of verifying or testing the accuracy of USR's reports and Royalty payments. The costs and expenses of such inspection shall be borne by Licensor except that Licensor shall not be required to reimburse USR for any time spent by USR staff or any USR overhead. 6.3 THIRD PARTY SOFTWARE FEES. Licensor shall be entitled to reimbursement for the out-of-pocket costs reasonably incurred by Licensor in connection with any sublicense to USR of Third Party Software included in the Licensed Software with USR's consent. USR, at its option may decline to pay such sublicense fee, in which case, unless USR obtains the necessary license directly, the Enhancements to the Licensed Software provided by the Third Party Software will be omitted from the Licensed Software. In -14- addition, if USR elects to accept a sublicense of any Third Party Software from Livingston, USR will also be obligated to reimburse or pay any incremental annual maintenance fees incurred by Livingston in accordance with the license documents disclosed to USR with respect to the sublicense of the Third Party Software to USR. 6.4 MOST FAVORED LICENSEE. If at any time during the term of this Agreement, Licensor enters into a similar agreement with any other licensee with respect to the Licensed Software or other Software with essentially identical functionality, on terms, conditions or rates more favorable than those accorded to USR hereunder for amounts of royalty and fee revenues which are not demonstrably substantially greater than those paid or payable to Licensor pursuant hereto, Licensor shall, within thirty (30) days of its acceptance of the new agreement with the other licensee, notify USR of such transaction. Within thirty (30) days of receipt of Licensor's notice, USR may give written notice to Licensor that this Agreement is to be amended to provide USR with the same terms, conditions and/or royalty rates provided to the other Licensee. Such amendment shall be made retroactive to the effective date of the other licensee's agreement. 6.5 SUPPORT AND MAINTENANCE FEES. For Support Services provided by Licensor pursuant to Section 5.2 above (after the first year), USR shall pay an annual maintenance fee which does not exceed [CONFIDENTIAL TREATMENT REQUESTED] per year in the first year following the initial maintenance period. In subsequent years the maximum annual maintenance fee will not exceed [CONFIDENTIAL TREATMENT REQUESTED]% ([CONFIDENTIAL TREATMENT REQUESTED]) of the previous year's fee. SECTION 7. LICENSOR'S WARRANTIES; INDEMNIFICATION. 7.1 MEDIA WARRANTY. For a period of ninety (90) days from the date of delivery of any item of the Licensed Software, to USR, Licensor warrants that the media in which such item of the Licensed Software is embodied and the media on which any later version or release is delivered will be free from defects in material and workmanship. 7.2 NO SOFTWARE PERFORMANCE WARRANTY. Licensor represents and warrants only that the Code (including Source Code) delivered by it to USR pursuant hereto constitutes a complete copy of the Licensed Software and the Licensed Source Code which Licensor has agreed to deliver pursuant hereto. With respect to the operating and performance characteristics of such Code, Licensor delivers and USR accepts it "AS IS," without warranty. 7.3 RIGHTS WARRANTY. Licensor warrants that it has the authority to enter into and perform its obligations under this Agreement and to grant the licenses provided herein. Licensor further warrants that, except for the Third Party Software, the Licensed Software is the property of Licensor, and with respect to the Third Party Software, the -15- Licensor has full rights under valid licenses covering the Third Party Software licensed to USR under this Agreement and the use and dealings therewith by USR and its successors, assigns and customers, immediate and intermediate. 7.4 INDEMNIFICATION. Licensor agrees to defend, indemnify and hold USR harmless against any claims that the Licensed Software infringes upon or violates any patent, copyright, trade secret, trade name, trademark, maskwork right or any other proprietary right of any third party (Intellectual Property Right"). If any claim that the Licensed Software infringes upon or violates any Intellectual Property Right is made against USR or its customers, USR shall promptly notify Licensor, and Licensor shall defend, indemnify and hold USR harmless against any and all liability, losses, damages, expenses (including attorney's fees) and demands of any kind arising out of any such claim, whether or not notorious or successful, provided that USR (i) gives Licensor reasonably prompt notice of such claim, (ii) fully cooperates with Licensor, at Licensor's expense, in the defense of such claim, and (iii) gives Licensor the right to control the defense and settlement of any such claim, except that Licensor shall not enter into any settlement that affects USR's rights or interests without USR's prior written approval. USR shall have no authority to settle any claim on behalf of Licensor. If by reason of any such claim, USR or its customers shall be prevented or are likely to be prevented from selling or using any USR Products, or if, in Licensor's opinion, such claim is likely to occur, Licensor will use its best efforts, at its expense, to (i) obtain all rights required to permit the sale or use of such products by USR and its customers; or (ii) modify or replace the Licensed Software to make it non-infringing (and extend this indemnity thereto), provided that any such replacement or modified Licensed Software are satisfactory to USR. If Licensor is unable to achieve either of the options set forth above within a reasonable period of time after the issuance of an injunction, but in no event longer than one hundred eighty (180) days, Licensor shall promptly refund to USR an amount equal to all Royalties, if any, theretofore paid by USR to Licensor with respect to such products, plus the fees paid by USR pursuant to Section 6.1 hereof, provided, however, that this refund obligation shall not apply in the case of an injunction affecting only Third Party Software. 7.5 DISCLAIMER. THE LIMITED WARRANTIES AND INDEMNIFICATION CONTAINED IN THIS SECTION 7 ARE GIVEN AND MADE IN LIEU OF ALL OTHER WARRANTIES, EXPRESS, IMPLIED OR STATUTORY, INCLUDING BUT NOT LIMITED TO ANY IMPLIED WARRANTIES OF MERCHANTABILITY. FITNESS FOR A PARTICULAR PURPOSE OR NONINFRINGMENT. SECTION 8. TERM AND TERMINATION. -16- 8.1 TERM OF AGREEMENT. This Agreement shall become effective on the first day that it has been executed by an authorized representative of USR, and by an authorized representative of Livingston. Unless sooner terminated hereunder, this Agreement shall remain in force through expiration of all copyrights and other intellectual property rights in all Licensed Software. 8.2 TERMINATION. USR may, at its option, terminate this Agreement at any time for any reason. Such termination shall become effective thirty (30) days after USR gives written notice of termination executed by an authorized representative of USR. Either party may terminate this Agreement in the event of a material breach by the other party which continues uncured ninety (90) days after the breaching party has received a written notice from the terminating party which describes the breach in reasonable detail. If this Agreement is in effect for a period exceeding one (1) year and USR terminates this Agreement pursuant to the first sentence of this Section 8.2 with the intent of replacing Licensor's Code in the USR Hardware Platforms described in Exhibit 3.1.1 (to the extent, if any, that such Code has theretofore been integrated or incorporated into any of such USR Hardware Platforms) and any subsequent amendments thereto, without 180 days written notice, then royalty fees shall be paid with respect to the sales of Products which contain functionality that is substantially equivalent to that provided by the Licensed Software, with or without Livingston's Code, for a period of 180 days from the date of notice of termination. Notwithstanding the forgoing sentence, USR shall have no obligation to make any such payment in the event that Livingston commits a material breach of its obligations under this Agreement or permits such a breach to remain uncured during such 180 day period or any portion thereof and nothing herein shall prohibit or restrict USR from independently developing or licensing any technology which is similar in function to the Licensed Software. 8.3 TERMINATION BY LIVINGSTON. In addition to its right to terminate as provided in Section 8.2 above. Livingston may. at its option. terminate this Agreement for any of the following reasons: 8.3.1 USR breaches any obligation to pay any determinable amount of money owed pursuant hereto which it fails to cure within five (5) business days following receipt of written notice thereof describing such breach and the amount or amounts owed in reasonable detail. 8.3.2 USR commits a material breach of its obligations under Section 3A hereof which remains uncured fifteen (15) business days following receipt of written notice thereof describing such breach in reasonable detail. 8.3.3 USR voluntarily effects termination of the OEM Supply Agreement for any reason other than breach by Livingston or mutual agreement of the parties thereto. -17- Such termination shall become effective thirty (30) days after Livingston gives written notice of termination executed by an authorized representative of Livingston. 8.4 SURVIVAL AFTER TERMINATION. The termination of this Agreement shall not affect any liability of USR accrued pursuant hereto or any paid-up right or license granted to USR hereunder. In the event of termination of this Agreement, in whole or in part, any right, license or sublicense exercised or granted prior to such termination (including those for internal use by USR, USR's Subsidiaries, and other third parties such as dealers, distributors, agents, and customers), and any corresponding payment obligations of USR hereunder, shall survive and continue. Without limiting the generality of the foregoing, (1) USR may sublicense, sell, lease and distribute any inventory of products based on or containing Licensed Software, including work in progress, on hand at the time of such termination, (2) USR may continue to exercise the rights and licenses granted hereunder for a period of up to six (6) months after termination to fill any orders received by USR, its Subsidiaries, distributors, agents or dealers received and accepted from their customers prior to the effective date of termination, and (3) USR may continue to exercise the rights and licenses granted hereunder as necessary to provide maintenance and support for customers. Neither, USR, its Subsidiaries, dealers, distributors, agents nor customers shall have any obligation to return to Licensor any copies of Licensed Software or Derivative Works thereof made or obtained prior to such termination, except that, upon demand by Licensor following termination of this Agreement. USR shall return to Licensor or destroy all copies of the Licensed Source Code and design Documentation for the Licensed Software as provided in Section 3A. In addition, the provisions of Sections 2, 3, 4.5, 7, 8, 10 and 11 shall survive and continue with respect to all Licensed Software that is the subject of this Agreement at the time of termination. 8.5 RESERVATION OF PUBLIC DOMAIN RIGHTS. The existence, termination or expiration of this Agreement shall not be construed as eliminating or limiting any rights that USR, its Subsidiaries, dealers, distributors, agents and customers would have had if USR had never entered into this Agreement, including but not limited to rights to copy works that are in the public domain. 8.6 INDEPENDENT DEVELOPMENT PROCEDURES. During the time that USR is in possession of the Licensed Source Code delivered to it pursuant to Section 3A and for a period of nine (9) months thereafter, if USR undertakes or commences any independent development (as contemplated in Sections 8.2 and 11.1 herein) of any Code with functionality that is comparable to that of the Licensed Software, then USR shall comply with the following "clean room" procedures: 8.6.1 No personnel who have accessed any portion of the Licensed Source Code delivered to USR pursuant to Section 3A hereof, which is related to the -18- functionality that is the subject of such independent development (which shall include all persons whose names have been recorded in the list described in Section 3A.1.2(b) and who are designated therein as having had such access), shall perform any such independent development work. Further, no personnel who have accessed the Licensed Source Code shall disclose any information contained in the Licensed Source Code to, or otherwise consult with or advise, any persons performing such development work with respect to the development of Code having any functionality that is comparable to that of the Licensed Software. 8.6.2 No personnel connected with such independent development shall reverse engineer, disassemble or decompile any of the Licensed Software. 8.6.3 Such independently developed Code shall not include or incorporate any Livingston trade secreted, proprietary, copyrighted or patented materials, in any form. 8.6.4 In order to ensure USR's compliance with the foregoing measures, Livingston shall be entitled to inspect USR's facilities and review its procedures, records and development efforts, provided that Livingston and its representatives may use the information obtained thereby only for the foregoing purposes and shall maintain all such information in confidence in accordance with Section 11.9 hereof and, provided further, that nothing herein shall entitle Livingston to have access to any Source Code licensed by USR from any third party. The scope and timing of any such inspection or review shall be agreed to by the Parties, in good faith. 8.6.5 Notwithstanding the foregoing, the Parties hereby agree that if USR licenses or otherwise acquires Code that has functionality comparable to that of the Licensed Software and that was developed independently by any third party or by USR personnel in accordance with the foregoing provisions and ports such independently developed Code into any USR product without enhancing or altering the functionality of such Code in any material respect, such porting activity, in and of itself shall not be deemed an independent development effort subject to subsection 8.6.1 hereof. SECTION 9. NO UNDERTAKING TO MARKET. USR shall have full freedom and flexibility in its decisions concerning the development or marketing of products consisting of the USR Hardware Platforms that incorporate or are based on Licensed Software, including the decision of whether to market or discontinue marketing any particular product whether to offer products separately and/or in combination with other code and Documentation and in its decisions regarding terms, conditions and pricing. Nothing in this Agreement, shall be construed as an obligation, guarantee or -19- commitment by USR that any product that incorporates or is based on the Licensed Software shall be announced and marketed by USR, or that any marketing effort will be productive of any particular level of sales or of royalties or other additional payments to Licensor. It is understood that USR may license or transfer copies of products that incorporate or are based on Licensed Software at volume discounts, promotional or special charges, dealer discounts, special bids or other pricing arrangements and may increase or decrease any prices, charges or fees relating to any products, without notice to or approval of Licensor. SECTION 10. LIMITATION OF LIABILITIES. 10.1 EXCLUSION OF CERTAIN DAMAGES. IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER FOR ANY CONSEQUENTIAL. INDIRECT, SPECIAL OR INCIDENTAL DAMAGES RESULTING FROM BREACH OF THE AGREEMENT, EVEN IF SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH POTENTIAL LOSS OR DAMAGE. 10.2 LIMITED LIABILITY. In no event shall USR be liable for amounts in excess of the amounts payable in accordance with the terms of this Agreement and the applicable Schedules and Exhibits hereto. SECTION 11. GENERAL. 11.1 FREEDOM OF ACTION. This Agreement shall not be construed to limit either party's right to obtain services or software programs from other sources, or to prohibit or restrict either party from independently developing (in accordance with the provisions of Section 8.6 hereof, or acquiring competitive materials. Nothing in this Agreement restricts either Party from making, having made, using, leasing, licensing, selling or otherwise disposing of any products or services whatsoever, nor is either Party's right to deal with any other vendors, suppliers, contractors or customers limited thereby. 11.2 ENTIRE AGREEMENT. The provisions of this Agreement and the applicable Schedules and Exhibits hereto. in effect from time to time, constitute the entire agreement between the parties and supersede all prior agreements. oral or written. and all other communications relating to the subject matter hereof and thereof. 11.3 GOVERNING LAW: VENUE. This Agreement shall be construed and enforced in accordance with the laws of the State of California applicable to agreements between residents of California wholly executed and wholly performed in such state. Any action or proceeding brought by either party against the other arising out of or related to this Agreement shall be brought only in a state or federal court of competent -20- jurisdiction located in the State of California or the State of Illinois, and the parties hereby consent to the in personam Jurisdiction of said courts. 11.4 SEVERABILITY. This Agreement is intended to constitute an independent and distinct agreement of the parties. If any provision of this Agreement or Schedules and Exhibits hereto is held by a court of competent jurisdiction to be unenforceable or contrary to law, the remaining provisions of this Agreement and the Schedules and Exhibits hereto will remain in full force and effect. 11.5 NOTICE; AND PAYMENTS. Any notice required or permitted to be made or given by either party hereto pursuant to this Agreement will be sufficiently made or given on the date of issuance if sent by such party to the other party by mail. telecopy, commercial courier, personal delivery, or a similar reliable delivery method, addressed as set forth below or to such other address as a party shall designate by written notice given to the other party. In the case of USR: U.S. Robotics, Inc. 8100 North McCormick Blvd. Skokie, IL 60076 Attn: Semir Sirazi With a copy to: U.S. Robotics, Inc. 8100 North McCormick Blvd. Skokie, IL 60076 Attn: Legal Department In the case of Licensor: Livingston Enterprises, Inc. 6920 Koll Center Parkway, # 220 Pleasanton, CA 94566 Attn: Mr. Steve Willens With a copy to: Livingston Enterprises. Inc. 6920 Koll Center Parkway, 4220 Pleasanton, CA 94566 Attn: Vice President of Operations -21- 11.6 AMENDMENT; WAIVER. No amendment or modification of this Agreement shall be effective unless it is set forth in a writing which refers to the particular provisions so amended or modified and is executed by officers of both parties. No waiver or any provision of this Agreement shall be effective unless it is set forth in a writing which refers to the provision so waived and the instrument containing such provision and is executed by an officer of the party waiving its rights. No failure or delay by either party in exercising any right, power or remedy will operate as a waiver of any such right, power or remedy. 11.7 TRADEMARKS AND ADVERTISING. Nothing in the Agreement confers upon Licensor any right to use USR's trademarks, trade names or service marks in connection with any non-USR product, service, promotion, publication, or to adopt any trademark which is confusing similar to any Customer trademark or which includes a prominent portion of any USR trademark so as to indicate Licensor's product equivalence or affinity to, or applicability or compatibility with any USR product. Licensor may represent that its products operate in conjunction with or on certain USR products, if such is the case and if Licensees reference to USR is not misleading. USR may, at its option, identify the Licensed Software as having been developed by the Licensor. USR shall take reasonable steps to modify any such reference to Licensor if Licensor objects in writing to the manner of such use. 11.8 NOTICE OF BREACH. Except in the event of a material breach of a provision contained in Section 3A hereof, USR shall not be deemed to be in breach of any of its obligations hereunder unless and until Licensor shall have given USR written notice by certified or registered mail, return receipt requested, specifying the nature of such breach and USR shall have failed to cure such breach within ninety (90) days after USR'S receipt of such written notice. 11.9 CONFIDENTIALITY. In order to protect their respective trade secrets and other proprietary or confidential information which the parties have therefore disclosed or may hereafter disclose to one another in connection with the negotiation and preparation of this Agreement or with the performance by the parties of their respective duties and obligations hereunder, the parties have entered into a separate Non-Disclosure Agreement dated and effective 11 November, 1993, a true and complete copy of which is attached hereto and incorporated herein by this reference. The parties hereby agree that such Non-Disclosure Agreement shall hereafter cover all confidential information created or disclosed by either party pursuant hereto and that, in the event of any conflict or inconsistency between this Agreement and such Non-Disclosure Agreement, the provisions of this Agreement shall control. 11.10 PUBLIC ANNOUNCEMENTS. USR and Licensor further agree that their discussions relating to this Agreement and the existence and terms hereof shall be treated as confidential and neither party shall issue any press release or make any public announcement with respect thereto without the prior review and approval of the other party. -22- 11.11 ASSIGNMENT. This agreement will bind and inure to the benefit of the respective Party's successors and assigns; provided that USR may not assign (or delegate) this Agreement, in whole or in part, without Livingston's prior written consent. Any attempted assignment (or delegation) without such consent shall be void. 11.12 INJUNCTIVE RELIEF. If USR breaches any of the provisions contained in Sections 3, 3A, 8.6, 11.7, 11.9 or 11.10 (or if Livingston reasonably anticipates such a breach), then Livingston shall be entitled, in addition to any other remedy available to it, to injunctive relief enjoining such breach. USR acknowledges that other remedies would be inadequate in the event of such a breach. If Livingston breaches any of the provisions contained in Sections 3, 3A, 4, 5, 7, 8.6, 11.7, 11.9 or 11.10 (or if USR reasonably anticipates such a breach), then USR shall be entitled, in addition to any other remedy available to it, to injunctive relief enjoining such breach. Livingston acknowledges that other remedies would be inadequate in the event of such a breach. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized officers, representatives or principals. U.S. ROBOTICS, INC. LIVINGSTON ENTERPRISES, INC. ("USR") ("Licensor") By: /s/ George A. Vineyard By: /s/ Ronald H. Willens -------------------------------- ---------------------------------- Name: George A. Vineyard Name: Ronald H. Willens -------------------------------- -------------------------------- Title: Vice President Title: Vice President Operations -------------------------------- ------------------------------- -23- EXHIBIT 2.7 TO OEM SOFTWARE LICENSE AND DEVELOPMENT AGREEMENT DATED SEPTEMBER 1, 1994 BETWEEN LIVINGSTON ENTERPRISES, INC. AND U.S. ROBOTICS, INC. LICENSED SOFTWARE, LICENSED SOURCE CODE AND SYSTEM SPECIFICATIONS The programs listed below as Licensed Software which may be ported to execute in machine-readable (binary) form in the USR Hardware Platforms, specified UNIX or DOS based hosts, or remote user client machines, comprise the "Licensed Software" and are included under this Agreement. The Licensed Software is described below and in the related manuals at time of execution of this Agreement which are attached hereto and made a part hereof. As required by the Agreement, Licensor shall also make the related Source Code which is listed or described below as Licensed Source Code or Additional Source Code available to USR. As used herein. all references to "UNIX" mean only the following specified releases: (i) Sun Platform: OS4.1.3. Solaris and subsequent revisions (ii) Hewlett Packard 9000 Platform: HPUX 9.3 and subsequent revisions (iii) IBM-RS 6000 Platform: AIX Rel.3.2 and subsequent revisions. LICENSED SOFTWARE (OBJECT CODE) 1. The executable Object Code generated by Licensor's Source Code for Release [CONFIDENTIAL TREATMENT REQUESTED] of the Portmaster Model PM-2E dated June 1, 1994. 2. The executable Object Code generated by Licensor's Source Code for the Frame Relay Protocol from Release [CONFIDENTIAL TREATMENT REQUESTED] of the IRX Router product. This specifically excludes hardware device drivers which send and receive HDLC data frames. 3. The executable Object Code distributed by Licensor as a DOS device driver known as PPPODI.COM version 1.9 and a Microsoft Windows virtual device driver known as PPVXD.386 version 1.0. These device drivers provide an Ethernet system interface to the client IBM compatible PC (386 only) and send and receive PPP compliant network frames for the TCP/IP and IPX protocols. 2.7.1 4. The executable Object Code distributed by Licensor as a DOS executable known as NWTELNET.EXE version 1.4. This utility program provides administrative telnet access to a host using the SPX/IPX protocol. 5. The executable Object Code distributed by Licensor as both a DOS executable and a UNIX executable known as PMDIAL version 1.3. This utility initiates a dial-our SLIP or PPP session on a host which supports the functionality of the Portmaster Model PM-2E running Release [CONFIDENTIAL TREATMENT REQUESTED] 6. The executable Object Code distributed by Licensor as a UNIX executable known as PM-OPEN version [CONFIDENTIAL TREATMENT REQUESTED] referred to in product documentation as PMCONSOL for X windows). This management application utilizes the X Window systems. This executable application is specifically licensed to Licensee until September 1, 1995. 7. The executable Object Code distributed by Licensor as both a DOS executable and a UNIX executable known as PMRESET version 1.3. This utility resets a serial port on a host which supports the functionality of the Portmaster Model PM-2E running Release [CONFIDENTIAL TREATMENT REQUESTED] 8. The Object Code library known as PMLIB for Release [CONFIDENTIAL TREATMENT REQUESTED] of the Portmaster Model PM-2E. 9. The executable Object Code known as the boot prom code (other than BIOS specific Code which is licensed from third parties) for the Portmaster Model PM-2E. LICENSED SOURCE CODE 1. The Source Code used to generate Licensor's Release [CONFIDENTIAL TREATMENT REQUESTED] of the Portmaster PM-2E dated June 1, 1994. 2. The Source Code used to generate Licensor's Frame Relay Protocol from Release [CONFIDENTIAL TREATMENT REQUESTED] of the IRX Router product. This specifically excludes hardware device drivers which send and receive HDLC data frames. 3. The Source Code for the library known as PMLIB for Release [CONFIDENTIAL TREATMENT REQUESTED] of the Portmaster Model PM-2E. 4. The Source Code for the boot prom (other than BIOS specific Code which is licensed from third parties) described above. ADDITIONAL LICENSED SOFTWARE (OBJECT CODE) AND LICENSED SOURCE CODE PLANNED FOR FUTURE DEVELOPMENT. 2.7.2 1. Upgrade functionality which provides dial-in and dial-out capability for Appletalk over PPP. for the Source Code licensing of this functionality, USR must either pay the Source Code licensing fee to the third party as described in the contract between Livingston and the third party or otherwise obtain the required license from the third party. 2. Upgrade functionality for providing dial-out modem pooling for Macintosh computers on an Appletalk ethernet network. For the Source Code licensing of this functionality, USR must either pay the Source Code licensing fee to the third party as described in the contract between Livingston and the third party or otherwise obtain the required license from the third party. 3. Upgrades, Enhancements, and Maintenance Modifications made available in Licensor's general software distribution for the Portmaster Model PM-2E during the first year of this Agreement. 4. Upgrade functionality, if any, that is developed in Phase 3 of the Development Project with respect to (1) Modem dial-out (sharing) with Novell Networks, (2) Additional Routing Protocols, (3) Event/Security Logging and (4) SNMP Configuration Management as described in the Statement of Work attached as Exhibit 4.1. ADDITIONAL SOURCE CODE From time to time Licensor may provide additional Source Code (including but not limited to the Source Code for PPODI) to Licensee for the purpose of debugging application problems. Unless specified in writing by Licensor, no rights to this Source Code will be granted to Licensee. This Source Code must be returned to Licensor within 90 days of receipt by Licensee. SYSTEM SPECIFICATIONS FOR PHASE 1 Includes the current functionality of the Licensed Software as described the manuals which are attached hereto and made a part hereof. ADDITIONAL SYSTEM SPECIFICATIONS FOR PHASE 2 Additional functionality to be added in Phase 2 described in Exhibit 4.1 are also included under this licensing agreement. The functionality to be added for Phase 2 includes: - - Appletalk over PPP - - Appletalk dial out/modem pooling PHASE 3 (FUTURES) SYSTEM SPECIFICATIONS Additional functionality which may be added pursuant to Phase 3 described in Exhibit 4.1. - - Dial-out modem sharing for Novell networks, supporting the Novell NASI interface and Int14 method 2.7.3 - - Additional Routing protocols - OSPF - BGP - EGP - - Improved system and security event logging to Novell, Apple and UNIX servers - - Windows Virtual Driver (VxD replacement for PPPODI) - - SNMP Configuration management 2.7.4 EXHIBIT 3.1.1 SYSTEM INTEGRATION AND TESTING TO OEM SOFTWARE LICENSE AND DEVELOPMENT AGREEMENT DATED SEPTEMBER 1, 1994 BETWEEN LIVINGSTON ENTERPRISES, INC. AND U.S. ROBOTICS, INC. USR HARDWARE PLATFORMS The Livingston Software is licensed to be incorporated and execute in the following hardware platforms: 1. Current and future Total Control WAN HUB (a rack mountable chassis with 17 application slots, a mid-plane, a dual T1 direct connect interface, which may include 1 network management card, a gateway application card and up to 16 quad modem cards, x.25 PAD, etc.) gateway application cards installed in Total Control WAN/HUB products wherein such gateway application cards service only direct telco interfaces such as channelized T1/E1, Analog PSTN, primary rate ISDN and Switched 56 Connections. 2. 1 or 2 port units which may be developed consisting of standalone devices with a fixed configuration of 1 ethernet or token ring interface and either 8 or 16 direct telco interfaces for analog PSTN, basic rate ISDN or Switched 56 service, but not primary rate ISDN. 3. 8 or 16 port units which may be developed consisting of standalone devices with a fixed configuration of 1 ethernet or token ring interface and either 8 or 16 direct telco interfaces for analog PSTN, basic rate ISDN or Switched 56 service, but not primary rate ISDN. 4. A standalone unit which may be developed consisting of a fixed configuration of 1 ethernet or token ring interface and one direct telco interface for primary rate ISDN service which supports 24 or 30 64-KBPS channels. 3.1.1 EXHIBIT 4.1 TO OEM SOFTWARE LICENSE AND DEVELOPMENT AGREEMENT DATED SEPTEMBER 1, 1994 BETWEEN LIVINGSTON ENTERPRISES, INC. AND U.S. ROBOTICS, INC. STATEMENT OF WORK Livingston and USR will primarily be responsible for completing certain work during the phases of the project under this Agreement. In all cases, timely support will be required from either company to the party who is primarily responsible for a functional area of the project. PHASE 1 OPERATING SOFTWARE The Livingston Operating Software includes the operating system, protocol stacks, call control/management code, and network interface drivers. Livingston will prepare the code to be compiled by a 32-bit compiler and run in an Intel x86 protected mode environment. USR will port this code to run in the Total Control Gateway card and Shared Access platforms under the VRTX operating system. GATEWAY CARD PACKET BUS USR will design the Packet Bus API and will port the Livingston code to this interface. Livingston will directly assist in this effort. TOKEN RING NETWORK INTERFACE Each company will independently develop its token ring network interface cards and port the token ring drivers to their respective platforms. USR will grant to Livingston an non-exclusive, paid-up license to use the source code for USR's proprietary token ring driver software. Livingston shall not distribute, sub-license, transfer, sell or lease copies of the source code to any third party. Livingston and its successors have the right to incorporate compiled versions, object code, in any of its products and may distribute, sub-license, transfer, sell or lease copies of the executable code which are bundled with the Livingston software. 4.1.1 BOOT PROM/LOADER CODE A BIOS extension will be required in the USR Total Control Gateway card and Shared Access platforms to provide the functionality of TFTP boot, and software download into FLASH memory. Livingston will provide the Portmaster boot prom source code (excluding any BIOS specific code that is licensed by Livingston from third parties) to be used as a reference to aid USR in this development. DOS/WINDOWS REMOTE CLIENT USER INTERFACE USR will develop its own user interface software for DOS and Windows for configuration and dialing, to be used with Livingston's PPPODI. Source code modifications may need to be made to PPPODI to support this user interface as heretofore discussed by the Parties. NETWORK MANAGEMENT Livingston will replace all reference to "Livingston" and "Portmaster" in the UNIX versions of pmconsol. and replace them with names to be provided in writing by USR. USR will distribute and support the UNIX version of pmconsol. USR will develop a Windows version of pmconsol which uses the pmlib library and such version shall become part of the Licensed Software. USR will have to modify pmlib to, at minimum, add support for the Novell LAN Workplace protocol stacks and the WINSOCK interface. INSTALLATION AND UTILITY PROGRAMS USR will develop their own installation and utility programs, and use the Livingston version of these programs as reference. SYSTEM INTEGRATION AND TESTING Both companies will participate in the system integration and testing of the new products. Livingston will provide to USR any test applications or test jigs that can aid in functional, stress, or production testing. PHASE 2 APPLETALK OVER PPP Livingston will develop an Appletalk connectivity solution, which will at least include routing protocols, zone information protocols, and service information protocols. Additionally, dial-out shared modem (modem pool) support will be developed. This functionality will be integrated into the base Livingston software by Livingston and ported to the USR platforms by USR. Livingston may use Third Party software to accomplish this functionality. PHASE 3 FUTURES The following functionality is anticipated in future Livingston software releases. If developed, this functionality will be included with this Software Licensing Agreement. This functionality may be developed by either party or be developed jointly. 4.1.2 MODEM DIAL-OUT (SHARING) WITH NOVELL NETWORKS This is an important feature which will provide DOS INT14 and NovellNASI support for dial out modem sharing/pooling. WINDOWS VIRTUAL DRIVER Livingston will develop and make available to UR a VxD Windows virtual driver replacement for PPPODI. ADDITIONAL ROUTING PROTOCOLS Livingston may add support for OSPF and BGP routing protocols. EVENT/SECURITY LOGGING Phase 1 functionality is limited to logging security events to a UNIX syslog daemon. Phase 1 event and security logging functionality may be adapted to work equally well in UNIX, DOS (Novell) and Apple environment, and additional event and security logging functionality may be added as jointly agreed. SNMP CONFIGURATION MANAGEMENT The current supports MIBII. Livingston may extend SNMP management to fully support configuration of the system with SNMP. USR will assist Livingston in developing an Enterprise MIB. 4.1.3 EXHIBIT 5.2 TO OEM SOFTWARE LICENSE AND DEVELOPMENT AGREEMENT DATED SEPTEMBER 1, 1994 BETWEEN LIVINGSTON ENTERPRISES, INC. AND U.S. ROBOTICS, INC. SOFTWARE MAINTENANCE AND SUPPORT AGREEMENT [LIVINGSTON SOFTWARE SUPPORT AGREEMENT ATTACHED] 5.1 EXHIBIT 6.2 TO OEM SOFTWARE LICENSE AND DEVELOPMENT AGREEMENT DATED SEPTEMBER 1, 1994 BETWEEN LIVINGSTON ENTERPRISES, INC. AND U.S. ROBOTICS, INC. -------------- ROYALTY RATES AND COMPUTATION 1. The Royalty payable with respect to Licensed Software embodied in or bundled with gateway cards for WAN Hub products shall be computed at the rate of: (1) [CONFIDENTIAL TREATMENT REQUESTED] of the actual net revenues received by USR from the sale of each gateway card; incorporating the Licensed Software or (2) [CONFIDENTIAL TREATMENT REQUESTED] for each dial-in modem and/or RS232 port supported by such gateway card; whichever is greater. Notwithstanding the foregoing, the aggregate royalties paid by USR pursuant to this Agreement during any 12 month period with respect to gateway cards incorporating the Licensed Software and Upgrades thereto sold during such period divided by the aggregate number of dial-in modems and/or RS 232 ports supported thereby shall equal an average of not less than [CONFIDENTIAL TREATMENT REQUESTED] per modem/port. This computation shall be performed not less frequently than once each six (6) months and, in the event of a shortfall, USR shall have the option of paying sufficient incremental royalties to meet this requirement or giving Livingston the option to terminate this Agreement upon 180 days written notice. The Parties agree to discuss the foregoing minimum average royalties per port during the 12th month following the first customer shipment of the gateway cards and to consider in good faith whether such provision should be amended in light of then prevailing market conditions. 2. The Royalty payable with respect to Licensed Software embodied in or bundled with each stand-alone of 1 or 2 port LAN access server product, shall be computed at the rate of 6.1 [CONFIDENTIAL TREATMENT REQUESTED] of actual net revenue received by USR from sales of such products. The Royalty payable with respect to Licensed Software embodied in or bundled with each stand-alone or rackmountable 8 or 16 port LAN access server product, or any standalone product supporting primary rate ISDN telco interfaces shall be computed at the rate of [CONFIDENTIAL TREATMENT REQUESTED] of actual net revenue received by USR from sales of such products. 3. If USR provides Client Code or Upgrades to the Licensed Software to any of its customers or end users of the USR Hardware Platform products and imposes a separate fee or charge therefor, USR shall pay to Licensor an additional Royalty equal to [CONFIDENTIAL TREATMENT REQUESTED] of the actual net revenue derived by USR from such separate fees or charges. 4. For purposes of this Exhibit 6.2 and the Agreement to which it is attached, "net revenue" means the payments actually received by USR with respect to sales of the products in question, less any rebates, refunds, returns, sales taxes, use taxes or other transaction taxes, shipping and other handling charges actually incurred by USR which are paid or owed to unrelated third parties and are separately invoiced to USR's customers. 6.2 LOGO SOFTWARE SUPPORT AGREEMENT AGREEMENT NO. _______________ ______________________________________________________________________________ CUSTOMER LOCATION (SITE) CUSTOMER BILLING ADDRESS ____________________________________ _______________________________________ Name Name ____________________________________ _______________________________________ Address Address ____________________________________ _______________________________________ City State Zip City State Zip ____________________________________ _______________________________________ Primary Contact Telephone Customer PO No. ____________________________________ Alternate Contact Telephone This Agreement includes the Terms and Conditions and schedules attached (collectively, the "Agreement") and is entered into by and between Livingston Enterprise and the Customer set forth above. 1.0 Product Schedule Warranty Product # Description Expiration Annual Charge ______________________________________________________________________________ 1. ______________________________________________________________________________ 2. ______________________________________________________________________________ 3. ______________________________________________________________________________ Comments Total Annual Charge $ _____________ Customer acknowledges that Customer has read, understands, and agrees to be bound by the Terms and Conditions set forth in this Agreement. __________________________________ Livingston Enterprises By:_______________________________ By:___________________________________ (Signature) (Signature) __________________________________ ______________________________________ Name (Please print or type) Name (Please print or type) __________________________________ ______________________________________ Title Date Title Date Page 1 of 3 SOFTWARE SUPPORT AGREEMENT _____________________________________________________________________________ 2.0 DEFINITIONS 2.1 "Products" mean all of the software items listed on the Product Schedule on the front side of this agreement and on any Supplemental Product Schedule. 2.2 "Software" means the software supplied by Livingston Enterprises. 2.3 "Site" means the location specified on the front side of the Agreement. 3.0 TERM OF AGREEMENT 3.1 This Agreement shall be effective on the Commencement Date specified on the front side provided it has been signed by an authorized Customer representative and accepted by Livingston Enterprises. 3.2 The initial term of this Agreement is twelve months from the Commencement Date. the Agreement will be automatically renewed for additional annual periods at Livingston Enterprises' then prevailing support charges. This Agreement may be terminated by either party at any time after the initial term by delivery of 60 days written notice. If either party fails to perform its obligations under this Agreement and such failure continues for a period of twenty (20) days after written notice thereof, the other party shall have the right to terminate this Agreement. 3.3 Coverage for products added to this Agreement after the Commencement Date shall commence at the expiration of the Products' warranty period and shall terminate at the termination of this Agreement. Coverage for added products will be billed at Livingston Enterprises support rates prevailing at the time the Products are added, at the same invoice frequency as other billings under this Agreement. 4.0 ELIGIBILITY FOR SUPPORT 4.1 This Agreement shall apply to all Software Products supplied by Livingston Enterprises located at the Site, including Products added after the Agreement's Commencement Date. When Customer purchases or licenses additional products from Livingston Enterprises for shipment to the Site, Customer agrees to add these products to this Agreement at Livingston Enterprises then prevailing support charges. 4.2 Products must be at Livingston Enterprises specified revision level to be eligible for coverage. Products covered under warranty automatically meet this requirement. 5.0 SERVICE PROVIDED 5.1 All services provided herein are performed within Livingston Enterprises' normal working hours of 8 a.m. to 5 p.m. Pacific Tim, Monday through Friday, excluding Livingston Enterprises holidays. 5.2 Livingston Enterprises will distribute new releases of Software on a periodic basis as stated in this Agreement. Releases will be distributed on the same type of tape media on which the original product was delivered. One (1) copy of Software will be sent for the Site covered by this Agreement. Customer agrees to install the new releases. 5.3 Livingston Enterprises will provide telephone consulting on the routine use and operation of the software. Telephone consulting is limited to questions not explicitly covered in documentation provided by Livingston Enterprises. Telephone consulting will include software problem reporting service, which will be handled as follows: Critical Problems - For problems classified by Livingston Enterprises as critical to the fundamental operation of the Product, Livingston Enterprises will generate a fix and send it to the Customer on the appropriate tape media as soon as possible. Livingston Enterprises will contact the Customer with a status report within one (1) working day after the initial problem report call. Non-critical Problems - Livingston Enterprises will attempt to install fixes for problems classified by Livingston Enterprises as non-critical to the fundamental operation of the Product in the next release of the Software. When feasible, Livingston Enterprises will describe temporary work-arounds to the Customer. 6.0 EXCLUSIONS 6.1 Livingston Enterprises obligation to provide support service under this Agreement is contingent upon proper use of the Product. Livingston Enterprises shall be under no obligation to provide services under this Agreement should such service be required in Livingston Enterprises' opinion, because of failure of the Product caused by improper use, Page 2 of 3 accident or because Software is not maintained at Livingston Enterprises specified release level. 6.2 On-site support by Livingston Enterprises personnel at the Site is not provided under this Agreement. 6.3 Operating supplies or accessories such as magnetic tape are not covered by this Agreement. 7.0 CUSTOMER RESPONSIBILITIES 7.1 Customer shall notify Livingston Enterprises immediately of Software malfunction and provide Livingston Enterprises with complete information concerning the malfunction. 7.2 Customer shall designate a Primary and Alternate system Administrator for the Site. Authorized use of telephone consulting services described herein is limited to these designated System Administrators. 8.0 CHARGES 8.1 Support charges for this Agreement will be invoiced annually in advance. Invoices shall be due and payable upon receipt. 8.2 Livingston Enterprises may at its sole option immediately terminate or temporarily suspend all of its responsibilities stated in this Agreement. In the event Customer is delinquent in the payment of any invoice from Livingston Enterprises for a period in excess of thirty (30) days. 8.3 Customer will be invoiced for any Products added to this Agreement at the expiration of the Product's warranty. Charges for a partial period of coverage shall be prorated on the basis of a 30-day month. 8.4 Livingston Enterprises may change support charges at any time after the expiration of the minimum initial term upon providing sixty (60) days prior written notice. 8.5 Charges for services not covered under this Agreement shall be invoiced at Livingston Enterprises' time and materials rates in effect at the time service is performed. 8.6 Charges are exclusive of all sales, use, and like taxes. Customer shall pay or reimburse Livingston Enterprises for all such taxes. 9.0 DISCLAIMER OF WARRANTY 9.1 LIVINGSTON ENTERPRISES DISCLAIMS ALL WARRANTIES EXPRESS OR IMPLIED INCLUDING ALL IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. 10.0 LIVINGSTON ENTERPRISES LIABILITY TO THE CUSTOMER FOR DAMAGES FROM ANY CAUSE WHATSOEVER AND REGARDLESS OF THE FORM OF ACTION WHETHER IN CONTRACT OR TORT INCLUDING NEGLIGENCE, SHALL BE LIMITED TO THE PURCHASE PRICE OF THE SPECIFIC PRODUCT BEING SERVICED WHICH CAUSED THE DAMAGE. LIVINGSTON ENTERPRISES SHALL NOT BE LIABLE FOR DAMAGES RESULTING FROM LOSS OF DATA, PROFITS, USE OF PRODUCTS, OR FOR ANY INCIDENTAL, INDIRECT, OR CONSEQUENTIAL DAMAGES IN CONNECTION WITH THIS AGREEMENT OR SERVICES OR MATERIALS PROVIDED. 11.0 GENERAL 11.1 This Agreement is the complete agreement between the parties with respect to the subject matter therein, and supersedes all other understandings whether written or oral, and may only be modified in writing signed by both parties. 11.2 The waiver of any breach or default under this Agreement shall not constitute the waiver of any subsequent breach or default. 11.3 This Agreement shall be governed by the laws of California. Page 3 of 3 AMENDMENT NO. 1 TO OEM SOFTWARE LICENSE AND DEVELOPMENT AGREEMENT DATED SEPTEMBER 1, 1994 BETWEEN LIVINGSTON ENTERPRISES, INC. AND U.S. ROBOTICS ACCESS CORP. (F/K/A U.S. ROBOTICS, INC.) This Amendment (this "Amendment") is made effective December 17, 1996, by and between U.S. Robotics Access Corp. ("USR") (formerly U.S. Robotics, Inc.) a Delaware corporation with executive offices at 8100 N. McCormick Blvd., Skokie, IL 60076, as licensee, and Livingston Enterprises, Inc. ("Livingston" or "Licensor"), a California corporation with its executive offices at 4464 Willow Road, Pleasanton, CA 94588. USR and Livingston are sometimes referred to herein individually as a "Party" and collectively "Parties." WHEREAS, the Parties heretofore entered into a certain OEM Software License and Development Agreement dated September 1, 1994 (the "License Agreement"); and WHEREAS, the Parties have had certain disputes and engaged in litigation with respect to the interpretation of the License Agreement; and WHEREAS, the Parties now wish to settle and compromise such disputes and litigation and, in connection therewith, desire to amend the License Agreement as set forth herein. NOW, THEREFORE, in consideration of the premises, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Parties hereby agree as follows: 1. Except as otherwise expressly provided herein or as the context otherwise clearly requires, all references to capitalized terms set forth in this Amendment shall have the same meanings as provided in the License Agreement. 2. This Amendment shall become effective upon its execution and delivery by both Parties, which may be effected with counterparts. Upon and after the effectiveness of this Amendment, all references in the License Agreement as amended hereby to "this Agreement" shall mean and included the License Agreement as so amended. 3. Section 2.9 ("Maintenance Modification") of the License Agreement is hereby amended by the deletion of the words "changes or" appearing after the words "or make other" in the third line thereof. 4. Section 3.1 of the License Agreement is hereby amended by the deletion of the word "perpetual" appearing after the word "non-transferable" in the third line thereof. 5. Section 3 of the License Agreement is hereby modified by the insertion at the end thereof of a new Section 3.5 as follows: 3.5 ACKNOWLEDGMENT OF COMOS. Commencing on and after January 1, 1997, USR shall exert commercially reasonable efforts to acknowledge in its marketing, advertising and product promotional materials, where appropriate, for USR products which incorporate some portion of the Licensed Software, the fact that the USR Code developed for such products is based upon Livingston's ComOS Code under license. The Parties acknowledge that advanced commitments are required for the production and distribution of many marketing, advertising and product promotion materials and that USR will not be expected to revise all such materials immediately, but that USR will exert commercially reasonable efforts to complete such revisions within 120 days of January 1, 1997. 6. Section 3A.1.2(d) is hereby amended to delete the second and third sentences. 7. Section 3A.1.4 of the License Agreement is hereby amended in its entirety to read as follows: 3A.1.4. The right and license to the Licensed Source code granted in this Section 3A shall terminate at the close of business on December 31, 1997, except as otherwise expressly provided in Section 3A.1.5 below or as otherwise authorized in writing by Livingston. Such termination shall become effective on such date without any further act or notice on the part of Livingston. 8. Section 3A.1.5 of the License Agreement shall be amended in its entirety to read as follows: 3A.1.5 Upon termination (December 31, 1997) of the right and license to the Licensed Source Code granted pursuant to Section 3A, USR shall promptly (no later than three business days) return and deliver to a mutually agreed upon escrow agent (i) a true and complete copy of the most current version of Licensed Source Code including any code files containing any Derivative Works created by USR; and, (ii) a true and complete copy of the most current version of the Licensed source Code. The escrow agent will hold such copies of the Licensed source Code intrust for the benefit of USR until December 31, 1998, for the sole purpose of USR access for the customer support and maintenance purposes that are described below and for archival purposes. Such escrow account will be maintained at the sole cost of USR and will be in accordance with the terms and conditions and substantially in the form as set forth in Exhibit 3A.1.5. All other copies of the Licensed Source Code described above shall be removed from backup and destroyed by USR in accordance with Sections 3A1.2(d) and (e) of the Agreement. 2 USR shall have the right, until December 31, 1998 to receive from the escrow agent the Licensed Source Code (or any appropriate portions) under the following conditions and circumstances: A. Use of the Licensed Source Code by USR shall be strictly limited to the maintenance and support of its customer base which has sublicensed the Licensed Software under the terms of the Agreement. Specifically, such maintenance and support shall be limited to: (i) Bug fixes, (ii) Maintenance Modifications, (as such definition has been revised herein) and (iii) identification and correction of "latent defects" in the Licensed Source Code which cause "significant" problems for USR customers. It is expressly agreed by USR that under no circumstances shall the Licensed Source Code be used for the development of Enhancements or, to accomplish any feature advances in the Licensed Source Code and/or Licensed Software. The reference model for such a determination shall be Livingston's ComOS, as archived in the escrow account referred to above. B. To effect a release of the Licensed Source Code by the escrow agent, USR shall submit to the designated Livingston contact (specified in E. below), a written Notice requesting the Licensed Source Code which shall contain the following information: (i) a description of, and relevant information relating to, the nature of the Bug, Maintenance Modification, or "latent defect" in the Licensed Source Code; (ii) whether the above has been duplicated; (iii) why USR believes that it needs the Licensed Source Code to fix the Bug, perform the Maintenance Modification or fix the latent defect; (iv) an estimate of the time necessary to perform the authorized work. C. Acceptance of a USR request based on the Notice described above shall not be unreasonably withheld by Livingston. Livingston will use its "best efforts" to notify the escrow agent to release the Licensed Source Code to USR as soon as is practically possible, but no later than five (5) business days following receipt of USR's Notice. When USR has completed its authorized use of the Licensed Source Code, it will delete all copies that it has obtained and certify to Livingston that it has done so. D. If Livingston rejects the USR request, based upon good faith concern that the request appears to be outside the authorized scope of use, it will notify USR of such rejection within five (5) business days following receipt of USR's Notice. The parties will then attempt to negotiate in good faith, to resolve any 3 misunderstandings and resolve the issue. If necessary, the negotiations will be escalated to designated officers (specified below) of the respective parties. If, within a period of fifteen (15) business days, the parties have not resolved their dispute, the matter will be submitted to a third party arbitrator, to be designated in advance by the parties. Such arbitrator will be familiar with software issues and computer law, the costs of the arbitrator to be split between the parties. The parties agree to use all reasonable efforts to resolve the matter within thirty (30) days of the engagement of the arbitrator. The parties agree to abide by the decision of the arbitrator on whether the Licensed Source Code shall be released to USR by the escrow agent. E. The primary Livingston contact for Notices shall be Carl Rigney, the secondary Livingston contact shall be David Hanson, with copies to Richard Godfrey. The primary USR contact authorized to submit notices shall be Ken Peirce, with copies to Rebecca Maxwell. The designated Livingston officer for escalation shall be Steven Willens. The designated USR contact for escalation shall be Ross Manire. The parties agree to immediately notify one another upon the changes of any of the above contacts. F. Upon termination of the Agreement on December 31, 1998, USR will immediately remove and destroy all copies of Licensed source Code in its possession, and the Escrow Agreement will terminate. The escrow agent will then destroy all copies of the Licensed Source Code in its possession. 9. Section 5.2 of the License Agreement shall be amended in its entirety to read as follows: 5.2 ONGOING MAINTENANCE AND SUPPORT. From and after September 30, 1996, Livingston shall have no ongoing maintenance or support obligations to USR in connection with the Licensed Software, except that Livingston shall provide to USR, upon request, copies of any and all support and user documentation, bug fix notes, troubleshooting tips, etc. which Livingston routinely provides to its customers using any version of Livingston's ComOS. 10. Section 8.1 of the License Agreement is hereby amended in its entirety to read as follows: 8.1 TERM OF AGREEMENT. This Agreement shall become effective on the first day that is has been executed by an authorized representative of USR and by an authorized representative of Livingston. Unless sooner terminated as provided hereunder, this Agreement shall expire on December 31, 1998. 11. Section 8.4 of the License Agreement is hereby amended in its entirety to read as follows: 4 8.4 SURVIVAL AFTER TERMINATION/EXPIRATION. The termination or expiration of this Agreement shall not affect any liability of USR accrued pursuant hereto or any paid-up right or license granted to USR hereunder. In the event of termination or expiration of this Agreement, in whole or in part, any right, license or sublicense exercised or granted prior to such termination or expiration (including those for internal use by USR, USR's Subsidiaries, and other third parties such as dealers, distributors, agents, customers, and endusers), and any corresponding payment obligations of USR hereunder, shall survive and continue and the rights of USR to further market, distribute and sublicense the Licensed Source Code shall terminate. Without limiting the generality of the foregoing, (1) USR may for a period of two (2) months, sublicense, sell, lease and distribute any inventory of products based on or containing Licensed Software, on hand at the time of such termination or expiration, (2) USR may for a term of two (2) months, continue to exercise the rights and licenses granted hereunder to fill any orders received by USR, its Subsidiaries, distributors, agents or dealers received and accepted from their customers prior to the effective date of termination or expiration, and (3) USR may indefinitely continue to exercise the rights and licenses granted hereunder as necessary to provide maintenance and support for customers. Neither, USR, its Subsidiaries, dealers, distributors, agents nor customers shall have any obligation to return to Licensor any copies of Licensed Software or Derivative Works thereof made or obtained prior to such termination. In addition, the provisions of Sections 2, 4.5, 7, 8, 10, and 11 shall survive and continue with respect to all Licensed Software that is the subject of this Agreement at the time of termination. 12. Section 8.2 of the License Agreement shall be amended by the deletion of all of the text thereof appearing after the words "in reasonable detail" at the end of the third sentence thereof. 13. Section 11.5 of the License Agreement shall be amended by the substitution of the name "Rick Spotts" for "Semir Sirazi" as the principle contact person for notices sent to USR, and by the substitution of the following for the address for Livingston Enterprises, Inc. to which notices and copies of notices addressed to Livingston shall be sent: 4464 Willow Road, Pleasanton, CA 94588. 14. The License Agreement shall be further amended by the deletion of the following sections, subsections and exhibits: 2.3 ("Development Project"); 2.4 ("Licensor Development Services"); 2.12 ("Third Party Software"); 2.15. ("OEM Supply Agreement"); 4.1 (Scope); 4.2 (Schedule); 4.3 (Quality of Work); 4.4 (Third Party Software Development); 5.1 (Initial Maintenance Period); 5.3 (Enhancements and Upgrades); 5.4 (Changes to Licensed Software); 5.5 (Cooperation by USR); 5.6 (Customer Support Procedures); 6.1 (Non-Recurring Engineering Fees); 6.3 (Third Party Software Fees); 6.5 (Support and Maintenance Fees); 8.3.3; Exhibit 4.1 and Exhibit 5.2. 15. Except as expressly otherwise provided in this Amendment, the terms, conditions and provisions of the License Agreement shall continue in full force and effect. 5 IN WITNESS WHEREOF, the Parties have caused this Amendment to be executed by their duly authorized officers, effective as of the date first set forth above. U.S. ROBOTICS ACCESS CORP. LIVINGSTON ENTERPRISES, INC. ("USR") ("LIVINGSTON") By: /s/ George A. Vineyard By: /s/ Richard J. Godfrey ------------------------------------- -------------------------------- Name: George A. Vineyard Name: Richard J. Godfrey ----------------------------------- ------------------------------ Title: Vice President and General Counsel Title: General Counsel ----------------------------------- ----------------------------- 6 EX-11.1 3 EXHIBIT 11.1 EXHIBIT 11.1
YEAR ENDED NINE MONTHS ENDED ---------------------------------------- -------------------------- 8/31/94 8/31/95 8/31/96 5/31/97 ------------ ------------ ------------ 5/31/96 ------------ ------------ (UNAUDITED) Net income........................................ 1,027,000 4,904,000 8,845,000 7,543,000 10,381,000 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Weighted average common shares outstanding........ 12,150,000 12,150,000 12,168,838 12,162,870 12,312,514 Common stock options, utilizing treasury stock method when dilutive............................ -- 418,640 1,659,827 1,506,219 1,787,819 Staff Accounting Bulletin No. 83 issuances and grants (1)...................................... 273,333 273,333 273,333 273,333 273,333 ------------ ------------ ------------ ------------ ------------ Weighted average shares outstanding............... 12,423,333 12,841,973 14,101,998 13,942,422 14,373,666 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Earnings per share:............................... 0.08 0.38 0.63 0.54 0.72 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
- --------- (1) Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, common and preferred stock issued for consideration below the assumed initial public offering (IPO) price, and stock options and warrants granted with exercise prices below the IPO price during the 12-month period preceding the date of the initial filing of the Registration Statement, have been included in the calculation of common equivalent shares, using the treasury stock method, as if they were outstanding for all periods presented. EX-23.1 4 EXHIBIT 23.1 EXHIBIT 23.1 The Board of Directors Livingston Enterprises, Inc. The audits referred to in our report dated June 18, 1997 included the related financial statement schedule as of May 31, 1997, and for each of the years in the three-year period ended August 31, 1996 and the nine-month period ended May 31, 1997, included in the registration statement. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We consent to the use of our reports included herein and to the reference to our firm under the heading "Experts" and "Selected Consolidated Financial Data" in the prospectus. Palo Alto, CA KPMG PEAT MARWICK LLP June 24, 1997 -----END PRIVACY-ENHANCED MESSAGE-----