<PAGE>

   As filed with the Securities and Exchange Commission on September 8, 1999
                                                     Registration No. 333-
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                --------------

                                   FORM S-1
                            REGISTRATION STATEMENT
                       Under The Securities Act of 1933

                                --------------

                             COBALT NETWORKS, INC.
            (Exact name of Registrant as specified in its charter)

                                --------------

<TABLE>
 <S>                              <C>                                <C>
           California                            3670                            77-0440751
    (before reincorporation)         (Primary Standard Industrial             (I.R.S. Employer
                                     Classification Code Number)           Identification Number)

            Delaware                       555 Ellis Street
     (after reincorporation)           Mountain View, CA 94043
 (State or other jurisdiction of            (650) 623-2500
 incorporation or organization)
</TABLE>
  (Address, including zip code, and telephone number, including area code, of
                   Registrant's principal executive offices)

                                --------------

                                Kenton D. Chow
                            Chief Financial Officer
                               555 Ellis Street
                            Mountain View, CA 94043
                                (650) 623-2500
(Name, address, including zip code, and telephone number, including area code,
                             of agent for service)

                                --------------

                 Please send copies of all communications to:

<TABLE>
<S>                               <C>
     Robert P. Latta, Esq.                      Kevin P. Kennedy, Esq.
Wilson Sonsini Goodrich & Rosati                 Shearman & Sterling
    Professional Corporation                     1550 El Camino Real
       650 Page Mill Road                        Menlo Park, CA 94025
      Palo Alto, CA 94304                           (650) 330-2200
         (650) 493-9300
</TABLE>

                                --------------

       Approximate date of commencement of proposed sale to the public:
     As soon as practicable after the effective date of this Registration
                                  Statement.

                                --------------

  If 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, as amended (the "Securities Act"), please 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 this Form is a post-effective amendment filed pursuant to Rule 462(d)
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. [_]

                                --------------

                        CALCULATION OF REGISTRATION FEE
<TABLE>
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<CAPTION>
                                              Proposed Maximum
           Title of Each Class of            Aggregate Offering    Amount of
        Securities to be Registered               Price(1)      Registration Fee
--------------------------------------------------------------------------------
<S>                                          <C>                <C>
Common stock, $0.001 par value.............     $86,250,000         $23,978
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
</TABLE>
(1) Estimated solely for the purpose of computing the amount of the
    registration fee pursuant to Rule 457(o) under the Securities Act of 1933.

                                --------------

   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.

-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<PAGE>

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this preliminary prospectus is not complete and may be     +
+changed. These securities may not be sold until the registration statement    +
+filed with the Securities and Exchange Commission is effective. This          +
+preliminary prospectus is not an offer to sell nor does it seek an offer to   +
+buy these securities in any jurisdiction where the offer or sale is not       +
+permitted.                                                                    +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
                Subject to Completion. Dated September 8, 1999.

                                        Shares

                           [COBALT LOGO APPEARS HERE]

                                  Common Stock

                                  ----------

  This is an initial public offering of shares of common stock of Cobalt
Networks, Inc. All of the shares of our common stock are being sold by Cobalt.

  Prior to this offering, there has been no public market for our common stock.
We anticipate that the initial public offering price will be between $   and
$   per share. We have applied for quotation of our common stock on the Nasdaq
National Market under the symbol "COBT".

  See "Risk Factors" beginning on page 7 to read about certain factors you
should consider before buying shares of the common stock.

                                  ----------

  Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.

                                  ----------

<TABLE>
<CAPTION>
                                                                 Per Share Total
                                                                 --------- -----
<S>                                                              <C>       <C>
Initial public offering price...................................   $       $
Underwriting discount...........................................   $       $
Proceeds, before expenses, to Cobalt............................   $       $
</TABLE>

  To the extent that the underwriters sell more than    shares of common stock,
the underwriters have the option to purchase up to an additional    shares from
Cobalt at the initial public offering price less the underwriting discount.

                                  ----------

  The underwriters expect to deliver the shares on           , 1999.

Goldman, Sachs & Co.

            Merrill Lynch & Co.

                                                  BancBoston Robertson Stephens

                                  ----------

                         Prospectus dated       , 1999.
<PAGE>




  [Description for EDGAR: Three pictures of Cobalt products showing in
descending order, (1) a Cobalt Qube sitting on a Cobalt RaQ, (2) a stack of
Cobalt RaQs and (3) a Cobalt Qube sitting on a desktop. Above the pictures is
the name "Cobalt Networks". To the left of the pictures is the phrase "we take
the power of networking and make it affordable, accessible and simple" and the
Cobalt logo.]
<PAGE>

                               PROSPECTUS SUMMARY

  You should read the following summary together with the more detailed
information regarding our company and our financial statements and notes to
those statements appearing elsewhere in this prospectus.

                             Cobalt Networks, Inc.


  We are a leading provider of server appliances. Server appliances are a new
category of network infrastructure devices that are specifically designed and
optimized to deliver one or a few network-based applications well. Server
appliances differ from general purpose servers, which are designed to support a
broad range of applications and are not optimized for any particular function.
Our server appliances enable organizations that could not previously establish
an online presence to do so easily, cost-effectively and reliably. As the
number of Internet users and businesses online increases, we believe the demand
for server appliances will continue to grow.

  Our principal product lines, the Cobalt Qube and Cobalt RaQ, enable our
customers to perform critical Internet-related applications including file
serving, web hosting and providing software applications over the Internet such
as electronic mail and electronic commerce. Our products tightly integrate the
open source Linux operating system with software applications embedded in
dedicated hardware designs. This software includes a rich set of core
applications developed by us and by the open source software developer
community, as well as proprietary third-party applications. Our use of the
Linux operating system enables us to leverage the rapid application development
cycles of the open source software community to reduce the time to market for
our new and innovative products.

  As of July 2, 1999, we had sold over 11,000 appliances to more than 1,000 end
user customers in more than 60 countries. We market and sell our products
globally through our direct sales force and our channel partners. Our target
customers are small- to medium-sized organizations, including businesses,
educational and government entities and branch offices of large organizations.
We also target web hosting and application service providers that offer
outsourced Internet services to these end users.

                             Our Market Opportunity


  Traditionally, creating an online presence has required complex network
technologies and the deployment of costly general purpose servers, which
require a technically skilled staff to maintain. However, these limitations
often prevent their adoption by small- to medium-sized organizations seeking to
deploy their own infrastructure, due to limited budgets and technology skills.
The high cost and complexity of general purpose servers also create challenges
for web hosting and application service providers that seek to profitably
differentiate themselves in an intensely competitive and price sensitive market
by offering high value added services.

  Server appliances have been developed to address the challenges faced by
small- to medium-sized organizations and web hosting and application service
providers in deploying their Internet infrastructures. Because server
appliances are explicitly designed and optimized to provide one or a few
dedicated applications, they can be easy to use, administer and integrate with
other infrastructure components, while providing a low cost, reliable solution.

                                       3
<PAGE>


  Dataquest, an industry research firm, expects the server appliance market to
grow from $2.2 billion in 1999 to approximately $15.8 billion in 2003,
representing a 64% compound annual growth rate. Dataquest expects the Linux-
based server appliance market to grow at approximately 69% a year between 1999
and 2003 and represent approximately 24% of the total server appliance market,
or $3.8 billion, in 2003.

                                  Our Strategy

  Our objective is to become the leading global provider in the emerging market
for flexible, low cost server appliances. To accomplish our objective we intend
to:

  . Increase market acceptance of server appliances. We intend to increase
    market acceptance of server appliances by continuing to offer products
    that are simple to manage at a low cost of total ownership.

  . Attract and support application developers. We intend to continue to
    promote third-party development of software applications for our products
    through partnership programs with independent, open source software
    developers.

  . Develop and leverage partnerships to enhance our market reach. We
    actively seek to encourage channel partners, original equipment
    manufacturers and web hosting and application service providers to add
    value to our products by modifying our solutions for specific customer
    needs.

  . Establish a strong brand identity. We intend to continue to create brand
    awareness with innovative, award winning products, progressive product
    styling and creative marketing.

  . Provide focused server appliances for specific needs. We intend to
    continue to develop and release products that meet specific customer
    needs while retaining their relatively low prices and optimized
    functionality.

                               Other Information

  Unless otherwise noted, this prospectus assumes:

  .  our reincorporation in Delaware to be completed prior to this offering;

  .  the automatic conversion of our outstanding mandatorily redeemable
     convertible preferred stock into common stock upon the closing of this
     offering;

  .  the filing of our amended and restated certificate of incorporation
     authorizing a class of 10,000,000 shares of undesignated preferred stock
     upon the closing of the offering; and

  .  no exercise by the underwriters of their option to purchase additional
     shares of our common stock in the offering.

  Our net revenues were $3.5 million for 1998 and $7.7 million for the six
months ended July 2, 1999. Our net losses were $10.5 million and $8.2 million
for the same periods. Our total accumulated deficit was $13.2 million as of
December 31, 1998 and was $22.6 million as of July 2, 1999.

  We filed our articles of incorporation in California in October 1996 under
the name Viavision Systems, Inc. We changed our name to Cobalt Microserver,
Inc. in March 1997 and to Cobalt Networks, Inc. in June 1998. We intend to
reincorporate in Delaware prior to the completion of this offering. Our
principal executive offices are located at 555 Ellis Street, Mountain View,
California 94043. Our telephone number is (650) 623-2500.

                                       4
<PAGE>


                                  The Offering

<TABLE>
<S>                                       <C>
Shares offered by Cobalt................             shares
Shares to be outstanding after the
 offering...............................             shares
Use of proceeds.........................  For general corporate purposes, including
                                           working capital, funding our operating losses,
                                           capital expenditures and potential acquisitions
                                           of complementary businesses, products and
                                           technologies.
Proposed Nasdaq National Market symbol..  "COBT"
</TABLE>

  The above information is based on 22,010,103 shares outstanding as of July 2,
1999 and excludes:

  .  2,144,943 shares issuable upon exercise of options outstanding at a
     weighted average exercise price of $0.69 per share as of July 2, 1999;

  .  525,665 shares issuable upon exercise of warrants outstanding at a
     weighted average exercise price of $2.74 per share as of July 2, 1999;
     and

  .  a total of 6,407,870 shares available for future issuance under our
     various stock plans excluding the annual increases in the number of
     shares authorized under each of our plans beginning January 1, 2001. See
     "Management--Incentive Plans" for a description of how these annual
     increases are determined.

                                       5
<PAGE>

                   Summary Consolidated Financial Information
                     (in thousands, except per share data)

  The following table sets forth a summary of our consolidated statement of
operations data for the periods presented. The pro forma net loss per share for
the year ended December 31, 1998 and the six months ended July 2, 1999 reflects
the conversion of our mandatorily redeemable convertible preferred stock and
the elimination of dividends and related charges.

<TABLE>
<CAPTION>
                                             Year Ended
                            Period from     December 31,     Six Months Ended
                           Oct. 18, 1996  -----------------  -----------------
                           (inception) to                    June 30,  July 2,
                           Dec. 31, 1996   1997      1998      1998     1999
                           -------------- -------  --------  --------  -------
<S>                        <C>            <C>      <C>       <C>       <C>
Consolidated Statement of
 Operations Data:
Net revenues.............      $   --     $   --   $  3,537  $   449   $ 7,663
Gross profit (loss)......          --         --        414     (133)    2,507
Loss from operations.....         (82)     (1,757)  (10,545)  (3,749)   (8,244)
Net loss.................         (82)     (1,769)  (10,478)  (3,752)   (8,244)
Accretion of mandatorily
 redeemable
 convertible preferred
 stock...................          --         --       (828)     --     (1,191)
Net loss attributable to
 holders of common
 stock...................         (82)     (1,769)  (11,306)  (3,752)   (9,435)
Basic and diluted net
 loss per share
 attributable to holders
 of common stock.........                 $ (4.10) $  (5.47) $ (2.09)  $ (2.83)
Pro forma basic and
 diluted net loss per
 share ..................                          $  (1.43)           $ (0.60)
Basic and diluted
 weighted average shares
 outstanding.............                     432     2,065    1,792     3,338
Pro forma basic and
 diluted weighted average
 shares outstanding......                             7,330             13,808
</TABLE>

  The following table sets forth a summary of our consolidated balance sheet
data as of July 2, 1999:

  .  on an actual basis;

  .  on a pro forma basis to give effect to the automatic conversion of all
     of the outstanding shares of our mandatorily redeemable convertible
     preferred stock into shares of common stock upon the closing of this
     offering; and

  .  on a pro forma as adjusted basis to reflect the automatic conversion of
     the mandatorily redeemable convertible preferred stock and our receipt
     of the estimated net proceeds from the sale of            shares of
     common stock in this offering at an assumed initial public offering
     price of $    per share.

<TABLE>
<CAPTION>
                                                        July 2, 1999
                                               -------------------------------
                                                                    Pro forma
                                                Actual   Pro forma as adjusted
                                               --------  --------- -----------
<S>                                            <C>       <C>       <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents..................... $ 27,426  $ 27,426     $
Working capital...............................   24,539    24,539
Total assets..................................   34,902    34,902
Notes payable, less current portion...........       64        64
Mandatorily redeemable convertible preferred
 stock........................................   45,646       --
Total stockholders' equity (deficit)..........  (19,850)   25,796
</TABLE>

                                       6
<PAGE>

                                  RISK FACTORS

  Any investment in our common stock involves a high degree of risk. You should
consider the risks described below carefully and all of the information
contained in this prospectus before deciding whether to purchase our common
stock. If any of the following risks actually occur, our business, financial
condition and results of operations would suffer. In such case, the trading
price of our common stock could decline, and you may lose all or part of your
investment in our common stock.

                     Risks Related to Our Financial Results

We only began selling our products in March 1998 and, as a result, you may have
difficulty evaluating our business and operating results.

  Our company was founded in October 1996, and we did not begin selling our
products until March 1998. An investor in our common stock must consider the
risks and difficulties we may encounter as an early stage company in the new
and rapidly evolving server appliance market. These risks and difficulties
include:

  .  an evolving and unpredictable business model;

  .  the uncertain demand for our products;

  .  the need to expand our sales and support organizations;

  .  the need to obtain sufficient manufacturing capacity from third parties;

  .  the rate of growth in usage and acceptance of the Internet; and

  .  the competition we face from general purpose server manufacturers.

  We cannot be certain that our business strategy will be successful or that we
will successfully manage these risks. If we fail to address any of these risks
or difficulties adequately, our business would likely suffer.

We have a history of losses and may experience losses in the future.

  Since our inception, we have incurred significant net losses, including net
losses of $10.5 million in 1998 and $8.2 million in the six months ended July
2, 1999. In addition, we had an accumulated deficit of $22.6 million as of July
2, 1999. We expect to continue to incur significant product development, sales
and marketing and administrative expenses. As a result, we will need to
generate significant revenues to achieve profitability. We cannot be certain
that we will achieve profitability in the future or, if we achieve
profitability, to sustain it.

  We anticipate that our expenses will increase substantially in the
foreseeable future as we:

  .  increase our direct sales and marketing activities, particularly by
     expanding our direct sales forces;

  .  develop our technology, expand our existing product lines and create and
     market additional server appliance products;

  .  make additional investments to develop our brand;

  .  expand our distribution and reseller channels;

                                       7
<PAGE>

  .  pursue original equipment manufacturing relationships; and

  .  implement additional internal systems, develop additional infrastructure
     and hire additional management to keep pace with our growth.

  Any failure to significantly increase our revenues as we implement our
product and distribution strategies would also harm our business.

We may not be able to sustain our current revenue growth rates, which could
cause our stock price to decline.

  Although our revenues grew rapidly in 1998 and have grown rapidly in 1999 to
date, we do not believe that we will maintain this rate of revenue growth
because we started from a small base of revenue, and it is difficult to
maintain high percentage increases over a larger revenue base. In addition,
growing competition, the incremental manner in which customers implement server
appliances and our inexperience in selling our products to small- to medium-
sized organizations could also affect our revenue growth. Any significant
decrease in our rate of revenue growth after this offering would likely result
in a decrease in our stock price.

Because our ability to accurately forecast our quarterly sales is limited, our
costs are relatively fixed in the short term and we expect our business to be
affected by seasonality, our quarterly operating results and our stock price
may fluctuate.

  Because of our limited operating history and the new and rapidly evolving
market for our server appliances, our ability to accurately forecast our
quarterly sales is limited, which makes it difficult to predict the quarterly
revenues that we will recognize. In addition, we cannot forecast operating
expenses based on historical results, and most of our costs are for personnel
and facilities, which are relatively fixed in the short term. If we have a
shortfall in revenues in relation to our expenses, we may be unable to reduce
our expenses quickly enough to avoid lower quarterly operating results. We do
not know whether our business will grow rapidly enough to absorb the costs of
these employees and facilities. As a result, our quarterly operating results
could fluctuate, and such fluctuation could adversely affect the market price
of our common stock.

  In addition, we expect to experience seasonality in the sales of our
products. For example, we expect that sales may decline during summer months,
particularly in Asian and European markets. We also anticipate that sales may
be lower in our first fiscal quarter due to patterns in the capital budgeting
and purchasing cycles of our current and prospective customers. These
seasonable variations in our sales may lead to fluctuations in our quarterly
operating results. It is difficult for us to evaluate the degree to which this
seasonality may affect our business, because our growth may have largely
overshadowed this seasonality in recent periods. In addition, concerns
regarding year 2000 compliance issues may adversely affect the demand for
products like ours if our customers divert resources to address year 2000
issues.

We have relied and expect to continue to rely on sales of our Cobalt Qube and
Cobalt RaQ products for our revenues, and a decline in sales of these products
could cause our revenues to fall.

  Historically, we have derived substantially all of our revenues from sales of
our Cobalt Qube and Cobalt RaQ products. During 1998 and the six months ended
July 2, 1999, sales of Cobalt Qube and Cobalt RaQ products accounted for
approximately 83% and 84% of our total revenues. We expect

                                       8
<PAGE>

that these products will continue to account for a large portion of our total
revenues for the foreseeable future. Any factors adversely affecting the
pricing of or demand for our Cobalt Qube and Cobalt RaQ products, including
competition or technological change, could cause our revenues to decline and
our business to suffer. Factors that may affect the market acceptance of our
products, some of which are beyond our control, include the following:

  .  the growth and changing requirements of the server appliance market;

  .  the performance, quality, price and total cost of ownership of our
     products;

  .  the availability, price, quality and performance of competing products
     and technologies; and

  .  the successful development of our relationships with original equipment
     manufacturer customers and existing and potential channel partners.

We may not succeed in developing and marketing new server appliance products,
and our operating results may decline as a result.

  We are developing additional server appliance products that use the Linux
operating system, particularly for use by web hosting and application service
providers. Developing new products that meet the needs of web hosting and
application service providers requires significant additional expenses and
development resources. If we fail to successfully develop and market new
products, our operating results will decline.

  We introduced our caching products in July 1998 and network attached storage
products in May 1999. To date, these products have accounted for only a limited
portion of our revenues. However, our future growth and profitability could be
affected by our ability to increase sales of our caching and network attached
storage products.

If we experience any increase in the length of our sales cycle, our quarterly
operating results could become more unpredictable and our stock price may
decline as a result.

  We experience different sales cycles for our various products depending on
the nature of the product, the identity of the end user and whether the sale is
direct or indirect. If we experience any increase in the length of our sales
cycle, our quarterly operating results could become more unpredictable and our
stock price could decline as a result. Sales of our Cobalt Qube products are
generally limited to one unit per end user and do not involve a lengthy
evaluation cycle, if any. We rely heavily for sales of this product on indirect
selling, where our product is recommended by a reseller or distributor. If the
sales cycle for our Cobalt Qube products becomes longer, our revenues could
become less predictable. Our Cobalt RaQ and Cobalt Cache products are generally
sold to customers who evaluate the products before committing to purchase them.
In addition, for these products, a typical customer may purchase a small number
of units and then incrementally increase the size of the installation over
time. If customers were to implement enterprise-wide evaluation programs or
purchase products for the entire organization at once, our sales cycle could
lengthen and our revenues could be erratic from quarter to quarter. We do not
have enough historical experience selling our Cobalt NAS products to determine
how the sales cycle for these products will affect our revenues.

If we cannot increase our sales volumes, reduce our costs or introduce higher
margin products to offset anticipated reductions in the average unit price of
our products, our operating results may suffer.

  We have not experienced an overall decrease in the average selling prices of
our products. However, we anticipate that as products in the server appliance
market become more commoditized, the average unit price of our products may
decrease in the future. The average unit price of our

                                       9
<PAGE>

products may also decrease in response to changes in product mix, competitive
pricing pressures, new product introductions by us or our competitors or other
factors. If we are unable to offset the anticipated decrease in our average
selling prices by increasing our sales volumes, our revenues will decline.
Changes in the mix of our sales, including the mix between higher margin Cobalt
RaQ products and somewhat lower margin Cobalt Qube products, could adversely
affect our operating results for future quarters. In addition, our margins
could be affected if we invest additional resources in our lower margin Cobalt
NAS products. To maintain our gross margins, we also must continue to reduce
the manufacturing cost of our products. Further, as average unit prices of our
current products decline, we must develop and introduce new products and
product enhancements that sell at higher margins.

         Risks Related to Growth of Our Market and Acceptance of Linux

Our business is dependent on the adoption of server appliances to perform
discrete tasks for corporate and Internet-based computer networks and a
decrease in their rates of adoption could cause our revenues to decline.

  For the foreseeable future, we expect that substantially all of our revenues
will continue to come from sales of our server appliance products. As a result,
we depend on the growing use of server appliances to perform discrete tasks for
corporate and Internet-based networks. If the role of server appliances does
not increase as we anticipate, or if it in any way decreases, our revenues
would decline. We believe that our expectations for the growth of the server
appliance market may not be fulfilled if customers continue to use general
purpose servers. The role of our server appliances could, for example, be
limited if general purpose servers become better at performing the functions
currently being performed by our server appliances or are offered at a lower
cost. This could force us to lower the prices of our products or result in
fewer sales of our products. In addition, if corporate information technology
organizations do not accept Linux-based operating systems, or if there is a
wide acceptance of alternative operating systems that provide enhanced
capabilities, our business would likely suffer.

The server appliance market for web hosting and application service providers
in which we compete is new and unpredictable, and if this market does not
develop and expand as we anticipate, our business will suffer. In addition,
consolidation in this market could result in our clients being absorbed into
larger organizations which might not be as receptive to our products.

  The market for server appliance products, particularly those for use
primarily by web hosting and application service providers--companies that
provide Internet, intranet, extranet and application hosting services to
others--has only recently begun to develop and is evolving rapidly. Because
this market is new, we cannot predict its potential size or future growth rate.
Our Cobalt RaQ products are used primarily by web hosting and application
service providers. Recently, consolidation has begun to occur in the web
hosting and application service provider market, and many large web hosting and
application service providers are acquiring the smaller and the regional
companies. Large web hosting and application service providers that provide
hosting services may not be as receptive to our products, because their buying
programs are more likely to be based on established, proprietary operating
systems and general purpose servers. In addition, we expect that Internet
service providers that specialize in providing Internet access and non-hosting
services to consumers will not be substantial purchasers of our products.

  Small- to medium-sized organizations may not accept server appliances because
they are less likely to be early adopters of new technologies due to their need
for minimal service disruptions. As a result, we believe the rates of adoption
of server appliances for small- to medium-sized organizations

                                       10
<PAGE>

are unpredictable. Our success in generating net revenues in this emerging
market will depend on, among other things, our ability to:

  .  educate potential end users, original equipment manufacturers and
     channel partners about the benefits of server appliances;

  .  establish and maintain relationships with leading original equipment
     manufacturers and maintain and enhance our relationships with our other
     channel partners; and

  .  predict and base our products on technology that ultimately becomes
     industry standard.

Because our products use Linux as their operating system, the failure of Linux
developers to enhance and develop the Linux kernel could impair our ability to
release major product upgrades and maintain market share.

  We may not be able to release major upgrades of our Cobalt Qube, Cobalt RaQ,
Cobalt Cache and Cobalt NAS products on a timely basis because our products use
Linux as their operating system. The heart of Linux, the Linux kernel, is
maintained by third parties. Linus Torvalds, the original developer of the
Linux kernel, and a small group of independent engineers are primarily
responsible for the development and evolution of the Linux kernel. If this
group of developers fails to further develop the Linux kernel or if Mr.
Torvalds or other prominent Linux developers were to no longer work on the
Linux kernel, we would have to either rely on another party to further develop
the kernel or develop it ourselves. To date we have optimized our Linux-based
operating system based on a version of Red Hat Linux, which we have licensed
for a nominal price. If we were unable to access Red Hat Linux, or Red Hat
Linux were to become substantially more expensive to obtain, we would be
required to spend additional time to obtain a tested, recognized version of the
Linux kernel from another source or develop our own operating system
internally. We cannot predict whether enhancements to the kernel would be
available from reliable alternative sources. We could be forced to rely to a
greater extent on our own development efforts, which would increase our
development expenses and might delay our product release and upgrade schedules.
In addition, any failure on the part of the kernel developers to further
develop and enhance the kernel could stifle the development of additional
Linux-based applications for use with our products.

We may not succeed if Linux fragments, and application developers do not
develop software for our products.

  Our products utilize a version of the Red Hat Linux operating system that we
have optimized for our server appliances. If Linux becomes a proprietary
operating system model, like UNIX or Windows NT, and our products do not use
the predominant Linux operating system, we may not be able to encourage third
party developers to write software applications for use with our products. If
this were to occur, our sales might be limited and our revenues could suffer.

                   Risks Related to Our Product Manufacturing

We will be unable to manufacture or sell our products if our contract
manufacturers are unable to meet our manufacturing needs.

  We rely on contract manufacturers to produce our products. In the future, we
may need to find a new contract manufacturer that can manufacture our products
in higher volume and at lower costs. We may not find a contract manufacturer
that meets our needs. Additionally, qualifying a new contract manufacturer and
commencing volume production is expensive and time consuming. If we are
required or choose to change contract manufacturers, we may lose sales and our
customer relationships may suffer.

                                       11
<PAGE>

We recently switched our outside product manufacturer and may experience
transitional problems, including delays and quality control issues. In
addition, we cannot be certain that our relationship with our second
manufacturing source will continue in light of this change.

  We recently switched our contract manufacturer and we do not have enough
experience with our new manufacturer to adequately judge the quality of its
products or its capability to deliver these products on time. Prior to August
1999, almost all of our products were manufactured for us by a single
manufacturer that also provided supply chain management for our products'
components. In the quarter ending July 2, 1999, we experienced problems getting
our products manufactured by this contractor in a timely fashion due in part to
the increase in our volume requirements. In response to these problems, we
switched the majority of our manufacturing to SMTC Manufacturing Corp., in
August 1999. Although we believe that this will largely resolve the problems we
faced during the quarter ending July 2, 1999, we cannot be certain that we will
not face similar problems in the future. Moreover, because our relationship
with SMTC Manufacturing is new, we could face transitional problems with either
the quality of the products or the coordination of the relationship. If SMTC
Manufacturing does not meet our volume and quality requirements, our business
could be adversely affected.

  SMTC Manufacturing is only obligated to supply products to us until August
2000 and only up to certain quantities based on our forecasts. If SMTC
Manufacturing experiences delays, disruptions, capacity constraints or quality
control problems in its manufacturing operations, then product shipments to our
customers could be delayed, which would negatively impact our net revenues,
competitive position and reputation.

  We have also qualified an additional manufacturing source, Flash Electronics,
Inc. Although Flash has built limited quantities of our products in the past,
we cannot be certain that we will be able to access sufficient production
capacity at Flash upon demand or that Flash will agree to continue as a
secondary manufacturer for us in light of our decision to use SMTC
Manufacturing as our primary manufacturing contractor.

We may experience production delays or disruptions if we relocate our
manufacturing to offshore facilities, which could result in lost revenues.

  We anticipate that we may relocate our manufacturing operations for sales
outside North America to one of SMTC Manufacturing's offshore manufacturing
facilities during 2000. We could experience difficulties and disruptions in the
manufacture of our products while we transition to a new facility.
Manufacturing disruption could prevent us from achieving timely delivery of
products and could result in lost revenues.

Because we depend on sole source and limited source suppliers for key
components, we are susceptible to supply shortages that could adversely affect
our operating results.

  We depend upon single source suppliers for our industry standard processors
and power supplies and our custom printed circuit boards, chassis and sheet
metal parts. We also depend on limited sources to supply several other industry
standard components. We have in the past experienced and may in the future
experience shortages of, or difficulties in acquiring, these components. If we
are unable to buy these components, we will not be able to manufacture our
products on a timely basis.


                                       12
<PAGE>

Because we order components and materials based on rolling forecasts, we may
overestimate or underestimate our component and material requirements, which
could increase our costs or prevent us from meeting customer demand.

  We use rolling forecasts based on anticipated product orders to determine our
component requirements. Lead times for materials and components that we order
vary significantly and depend on factors including specific supplier
requirements, contract terms and current market demand for those components. As
a result, our component requirement forecasts may not be accurate. If we
overestimate our component requirements, we may have excess inventory, which
would increase our costs. If we underestimate our component requirements, we
may have inadequate inventory, which could interrupt our manufacturing and
delay delivery of our products to our customers. Any of these occurrences would
negatively impact our business and operating results.

                Risks Related to Our Marketing and Sales Efforts

Because we rely on channel partners to sell a majority of our products, our
revenues could decline substantially if our existing channel partners do not
continue to purchase products from us.

  We rely on our channel partners who are distributors, such as Ingram Micro,
Merisel and Tech Data, resellers and system integrators to sell a majority of
our products in the United States. A substantial majority of our sales outside
of the United States are through other channel partners, and we rely on Nissho
Electronics to sell a majority of our products in Japan. Sales to distributors
accounted for 54% of our net revenues in 1998 and 86% of our net revenues in
the six months ended July 2, 1999. If we fail to sell our products through our
existing channel partners, we would experience a material decline in revenues.
Even if we are successful in selling our products through new channel partners,
the rate of growth of our net revenues could be materially and adversely
affected if our existing channel partners do not continue to sell a substantial
number of our products. We cannot be certain that we will be able to attract
channel partners that market our products effectively or provide timely and
cost-effective customer support and service. None of our current channel
partners are obligated to continue selling our products. We cannot be certain
that any channel partner will continue to represent our products or that our
channel partners will devote a sufficient amount of effort and resources to
selling our products in their territories.

We face risks associated with the development of our brand, and we may incur
significant costs to promote our brand and compete effectively.

  We believe that we need a strong brand to compete successfully. In order to
promote and maintain our brand identity and to attract and retain customers, we
plan to increase our spending on advertising and promotions and to implement
new marketing campaigns. We cannot be certain that these strategies will be
successful. If we are unable to design and implement effective marketing
campaigns or otherwise fail to promote and maintain our brand, our sales could
decline. Our business may also suffer if we incur excessive expenses in an
attempt to promote and maintain our brand without a corresponding increase in
revenues.

We need to expand our direct and indirect sales channels, and if we fail to do
so, our growth could be limited.

  In order to increase market awareness and sales of our products, we will need
to substantially expand our direct and indirect sales operations, both
domestically and internationally. If we fail in this endeavor, our growth will
be limited. To date, we have relied primarily on our direct sales force to
generate demand for our products by regional and national web hosting and
application service providers. Our products require a sophisticated sales
effort targeted at our prospective customers' information technology
departments. We have recently expanded our direct sales force and plan to hire
additional sales personnel. Competition for qualified sales people is intense,
and we might not be able to hire the quality and number of sales people we
require.

                                       13
<PAGE>

Our expansion to international markets will result in higher personnel costs
and could reduce our operating margins due to the higher costs of international
sales.

  We must expand the number of channel partners who sell our products or our
direct international sales presence to significantly increase our international
sales. We may incur higher personnel costs by hiring direct sales staff that
may not result in an increase in our revenues. We may not realize corresponding
increases in operating margins from increases in international sales, due to
the higher costs of these sales. Our sales outside of the United States
represented 44% of our total revenues in 1998 and 56% of our total revenues in
the six months ended July 2, 1999. To date, we have relied primarily on
international channel partners and have only recently begun to employ direct
sales staff outside of the United States. Even if we are able to successfully
expand our direct and indirect international selling efforts, we cannot be
certain that we will be able to create or increase international market demand
for our products.

If we are unable to expand our customer service and support organization, we
may not be able to retain our existing customers and attract new customers.

  We currently have a small customer service and support organization and will
need to increase our staff to support new customers and the expanding needs of
our existing customers. If we are unable to expand our customer service and
support organization, we may not be able to retain our existing customers and
attract new customers. Hiring customer service and support personnel is very
competitive in our industry due to the limited number of people available with
the necessary technical skills and understanding of the Linux operating
environment.

We do not have a consulting staff, and our revenues may suffer if customers
demand extensive consulting or other support services.

  Our products are designed to require little or no support from us and to be
deployed quickly and easily by our customers. Many of our competitors offer
extensive consulting services in addition to server appliance products. If we
introduced a product that required extensive consulting services for
installation and use or if our customers wanted to purchase from a single
vendor a menu of items that included extensive consulting services, we would be
required to change our business model. We would be required to hire and train
consultants, outsource the consulting services or enter into a joint venture
with another company that could provide those services. If these events were to
occur, our future profits would likely suffer because customers would choose
another vendor or we would incur the added expense of hiring and retaining
consulting personnel.

                Risks Related to Competition Within Our Industry

We may not be able to effectively compete against providers of general and/or
limited purpose servers.

  In the market for server appliances, we face significant competition from
larger companies who market general and/or limited purpose servers and have
greater financial resources and name recognition than we do. We believe that
Compaq, Dell, Gateway, Hewlett-Packard, IBM, Sun Microsystems or other server
manufacturers, each of which is also currently competing with us by
manufacturing and selling general and/or limited purpose servers, could also
introduce server products that include the functionality that we currently
provide in our products at lower prices. If these vendors provide lower cost
server appliances with the functionality of our products coupled with the
functionality of their existing product lines, our products could become
obsolete. Even if the functionality of the standard features of these products
is equivalent to ours, we face a substantial risk that a significant number of
customers would elect to pay a premium for similar functionality rather than
purchase products from a less well-known vendor.

                                       14
<PAGE>

  We may face competition in the future from established companies that have
only recently entered the server appliance market, such as Intel, Novell or
Oracle or from emerging software companies. Barriers to entry in the server
appliance market are relatively low. Increased competition may negatively
affect our business and future operating results by leading to price
reductions, higher selling expenses or a reduction in our market share.

If we fail to compete successfully in the market for server appliances
products, our revenues will decline.

  We face competition from different sources, and we must compete effectively
against other current and future competitors to retain and expand our customer
base. If we fail to retain and expand our customer base, our revenues could
decline substantially.

  We believe the principal factors that will draw end users to a server
appliance product include:

  .  depth of product functionality for the specific purpose of the device;

  .  ease of use;

  .  brand name;

  .  distribution and customer support; and

  .  total cost of ownership.

  To be competitive, we must respond promptly and effectively to the challenges
of technological change, evolving standards and our competitors' innovations by
continuing to enhance our products and sales channels. Any pricing pressures or
loss of market share resulting from our failure to compete effectively could
reduce our revenues.

Our revenues could be reduced if general purpose server manufacturers make
acquisitions in order to join their extensive distribution capabilities with
our smaller competitors' products.

  Compaq, Dell, Gateway, Hewlett-Packard, IBM, Sun Microsystems and other
server manufacturers may not only develop their own server appliance solutions,
but they may also acquire or establish cooperative relationships with our other
current competitors, including smaller private companies. Because general
purpose server manufacturers have significant financial and organizational
resources available, they may be able to quickly penetrate the server appliance
market by leveraging the technology and expertise of smaller companies and
utilizing their own extensive distribution channels. We expect that the server
appliance industry will continue to consolidate. For example, Whistle
Communications, a server appliance company, was recently acquired by IBM. It is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share.

Our products may become less attractive to customers if other vendors' products
are no longer compatible with ours or other vendors bundle their products with
those of our competitors.

  Our ability to sell our products depends in part on the compatibility of our
products with other vendors' software and hardware products. Developers of
these products may change their products so that they will no longer be
compatible with our products. These other vendors may also decide to bundle
their products with other server appliances for promotional purposes. If that
were to happen, our business and future operating results could suffer if we
were no longer able to offer commercially viable products.

                                       15
<PAGE>

Server appliance products are subject to rapid technological change due to
changing operating system software and network hardware and software
configurations, and our products could be rendered obsolete by new
technologies.

  The server appliance market is characterized by rapid technological change,
frequent new product introductions and enhancements, uncertain product life
cycles, changes in customer demands and evolving industry standards. Our
products could be rendered obsolete if products based on new technologies are
introduced or new industry standards emerge. For example, sales of our products
may be limited if customers widely adopt Windows 2000-based server appliances,
and our products, which do not currently operate on the Windows 2000 platform,
fail to provide comparable functionality.

  Client/server computing environments are inherently complex. As a result, we
cannot accurately estimate the life cycles of our server appliance products.
New products and product enhancements can require long development and testing
periods, which requires us to hire and retain increasingly scarce, technically
competent personnel. Significant delays in new product releases or significant
problems in installing or implementing new products could seriously damage our
business. We have, on occasion, experienced delays in the scheduled
introduction of new and enhanced products and cannot be certain that we will
avoid similar delays in the future.

  Our future success depends upon our ability to enhance existing products,
develop and introduce new products, satisfy customer requirements and achieve
market acceptance. We cannot be certain that we will successfully identify new
product opportunities and develop and bring new products to market in a timely
and cost-effective manner.

 Risks Related to Our Products' Dependence on Intellectual Property and Our Use
                                  of Our Brand

Our server appliance products rely on our intellectual property, and any
failure by us to protect our intellectual property could enable our competitors
to market products with similar features that may reduce demand for our
products.

  Our success and ability to compete are substantially dependent upon our
internally developed technology that is incorporated into our products. We
protect our intellectual property through a combination of copyright, trade
secret and trademark laws. We have only recently commenced a patent program and
to date have not filed any patent applications. We generally enter into
confidentiality or license agreements with our employees, consultants and
corporate partners, and generally control access to our intellectual property
and the distribution of our server appliances, integrated software,
documentation and other proprietary information. We believe that such measures
afford only limited protection. Others may develop technologies that are
similar or superior to our technology or design around the copyrights and trade
secrets we own. We license our proprietary software products primarily under
shrink wrap licenses, which are licenses included as part of the product
packaging or system initiation menus. Shrink wrap licenses are not negotiated
with or signed by individual customers and purport to take effect upon the
opening of the product package or commencing use of the product. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or otherwise obtain and use our products or technology. Policing
unauthorized use of our products is difficult, and we cannot be certain that
the steps we have taken will prevent misappropriation of our technology,
particularly in foreign countries where the laws may not protect our
proprietary rights as fully as those in the United States. Our means of
protecting our proprietary rights may be inadequate.

                                       16
<PAGE>

Our products and the brand names we use to market them may infringe upon the
intellectual property rights of others, and any resulting claims against us
could be costly to defend or subject us to significant damages.

  Substantial litigation regarding intellectual property rights exists in the
computer equipment and network infrastructure industries. We expect that server
appliance products may be increasingly subject to third-party infringement
claims as the number of competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. We are not
aware that our products employ technology that infringes any proprietary rights
of third parties. However, third parties may claim that we infringe their
intellectual property rights. Any claims, with or without merit, could:

  .  be time consuming to defend;

  .  result in costly litigation;

  .  divert our management's attention and resources;

  .  cause product shipment delays; or

  .  require us to enter into royalty or licensing agreements.

  These royalty or licensing agreements may not be available on terms
acceptable to us, if at all. A successful claim of product infringement against
us or our failure or inability to license the infringed or similar technology
could adversely affect our business because we would not be able to sell the
impacted product without redeveloping it or incurring significant additional
expenses.

  For example, in December 1998, CUBE Computer Corporation sued us for
trademark infringement, alleging that our use of the term "Qube" in connection
with our products infringes CUBE Computer Corporation's trademark. Although we
believe this claim is without merit, in the event we were to lose this
litigation with CUBE Computer Corporation, we could be forced to pay CUBE a
royalty for continuing use of our Cobalt Qube trademark or be barred from using
the name altogether. This could result in us losing the brand equity which we
have established for our Cobalt Qube products.

                      Other Risks Related to Our Business

We have experienced significant growth and change in our business and our
failure to manage this growth and any future growth could harm our business.

  We continue to increase the scope of our operations and have grown our
headcount substantially. As of December 31, 1998, we had a total of 68
employees, and as of July 2, 1999 we had a total of 101 employees. Our
productivity and the quality of our products may be adversely affected if we do
not integrate and train our new employees quickly and effectively. We also
cannot be sure that our revenues will continue to grow at a sufficient rate to
absorb the costs associated with a larger overall headcount, as well as
recruiting-related expenses.

Because our strategy to expand our international operations is subject to
uncertainties, we may not be able to enter new international markets or
generate significant revenues from those markets outside of the United States
in which we currently operate.

  Customers outside of the United States accounted for 44% of our net revenues
in 1998 and 56% of our net revenues in the six months ended July 2, 1999. We
plan to increase our international sales activities, but we have limited
experience in developing foreign language translations of our products and
little direct experience marketing and distributing our products
internationally.

                                       17
<PAGE>

  We conduct direct sales activities in Japan, the United Kingdom, Germany and
the Netherlands and indirect sales activities in Asia, elsewhere in Europe and
Mexico. Our international operations are subject to other inherent risks,
including:

  .  the impact of recessions in economies outside the United States;

  .  greater difficulty in accounts receivable collection and longer
     collection periods;

  .  unexpected changes in regulatory requirements;

  .  difficulties and costs of staffing and managing foreign operations;

  .  reduced protection for intellectual property rights in some countries;

  .  potentially adverse tax consequences; and

  .  political and economic instability.

Any acquisitions that we undertake could be difficult to integrate, disrupt our
business, dilute stockholder value or harm our operating results.

  We may make investments in complementary companies, products or technologies.
If we buy a company, we could have difficulty in assimilating that company's
personnel and operations. In addition, the key personnel of the acquired
company may decide not to work for us. If we make other types of acquisitions,
we could have difficulty in assimilating the acquired technology or products
into our operations. These difficulties could disrupt our ongoing business,
distract our management and employees and increase our expenses. We also expect
that we would incur substantial expenses if we acquired other businesses or
technologies. Any acquisition could result in us incurring additional debt,
contingent liabilities or amortization expenses related to goodwill and other
intangible assets, any of which could harm our profits. If we issue additional
equity securities, our stockholders could experience dilution. As of the date
of this prospectus, we have no agreements or understandings regarding any
future acquisitions.

We are in the final stages of assessing our Year 2000 readiness and any Year
2000 problems with our products or our internal systems could result in third-
party claims.

  Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
determine whether "00" means 1900 or 2000. This may result in software failures
or the creation of erroneous results.

  We are in the final stages of assessing our Year 2000 readiness. We have
concluded a preliminary investigation and performed limited testing to
determine whether each component of our products and our products in
development are Year 2000 compliant. Our server appliance products operate in
complex system environments and directly and indirectly interact with a number
of other hardware and software systems. Despite the investigation and testing
by us and our partners, our server appliance products and the underlying
systems and protocols running our products may contain errors or defects
associated with Year 2000 date functions. We are unable to predict to what
extent our business may be affected if our software or the systems that operate
in conjunction with our software experience a material Year 2000 failure. Known
or unknown errors or defects that affect the operation of our server appliances
could result in:

  .  delay or loss of revenues;

  .  cancellation of customer contracts;

  .  diversion of development resources;

                                       18
<PAGE>

  .  damage to our reputation;

  .  increased maintenance and warranty costs; or

  .  litigation costs;

any of which could adversely affect our business, financial condition and
results of operations.

  Despite investigation and testing by us, our internal systems may contain
errors or defects associated with Year 2000 date functions. We are unable to
predict to what extent our core business functions may be affected if our
internal systems or software experience a material Year 2000 failure. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation--Year 2000 Readiness" for a description of our Year 2000 readiness
efforts.

We must continue to hire and retain research and development and sales and
marketing staff to sustain our revenue growth.

  We intend to hire a significant number of additional research and
development, sales, support, marketing and other personnel in 1999 and 2000.
Competition for these individuals is intense, and we may not be able to
attract, assimilate or retain highly qualified personnel. Our future success
and ability to sustain our revenue growth also depend upon the continued
service of our executive officers and other key sales, marketing and support
personnel, particularly since we have experienced disruption from the turnover
of senior management in the past. Competition for qualified personnel in our
industry and in the San Francisco Bay Area, as well as the other geographic
markets in which we recruit, is extremely intense and characterized by rapidly
increasing salaries, which may increase our operating expenses or hinder our
ability to recruit qualified candidates.

  To achieve our business objectives, we may recruit and employ skilled
technical professionals from other countries to work in the United States.
Limitations imposed by federal immigration laws and the availability of visas
could harm our ability to attract necessary qualified personnel. This may have
a negative effect on our business and future operating results.

We rely on the services of our founders and other key personnel, and those
persons' knowledge of our business and technical expertise would be difficult
to replace.

  Our products and technologies are complex and we are substantially dependent
upon the continued service of our existing engineering personnel, and
especially Stephen DeWitt, our President and Chief Executive Officer, and Vivek
Mehra, our Vice President of Products and one of our founders. The loss of any
of our key employees could adversely affect our business and slow our product
development processes. Although we maintain key person life insurance policies
on our key employees, the amount of this insurance may be inadequate to
compensate us for their loss.

Errors in our products or the failure of our products to conform to
specifications could result in our customers demanding refunds from us or
asserting claims for damages against us.

  Because our server appliance products are complex, they could contain errors
or bugs that can be detected at any point in a product's life cycle. In the
past we have discovered errors in some of our products and have experienced
delays in the shipment of our products during the period required to correct
these errors. These delays have principally related to new product releases. To
date none of these delays has materially affected our business. While we
continually test our products for errors and work with customers through our
customer support services to identify and correct bugs in our software and
other product problems, errors in our products may be found in the future.
Although many of these errors may prove to be immaterial, any of these errors
could be significant. Detection of any significant errors may result in:

  .  the loss of or delay in market acceptance and sales of our products;

                                       19
<PAGE>

  .  diversion of development resources;

  .  injury to our reputation; or

  .  increased maintenance and warranty costs.

  These problems could harm our business and future operating results. Product
errors or delays could be material, including any product errors or delays
associated with the introduction of new products or the versions of our
products that support operating systems other than Linux. Occasionally, we have
warranted that our products will operate in accordance with specified customer
requirements. If our products fail to conform to these specifications,
customers could demand a refund for the purchase price or assert claims for
damages.

  Moreover, because our products are used in connection with critical
distributed computing systems services, we may receive significant liability
claims if our products do not work properly. Our agreements with customers
typically contain provisions intended to limit our exposure to liability
claims. However, these limitations may not preclude all potential claims.
Liability claims could require us to spend significant time and money in
litigation or to pay significant damages. Any such claims, whether or not
successful, could seriously damage our reputation and our business.

                         Risks Related to this Offering

Our stock will likely be subject to substantial price and volume fluctuations
due to a number of factors, many of which will be beyond our control, that may
prevent our stockholders from reselling our common stock at a profit.

  The securities markets have experienced significant price and volume
fluctuations in the past and the market prices of the securities of technology
companies have been especially volatile. This market volatility, as well as
general economic, market or political conditions, could reduce the market price
of our common stock in spite of our operating performance. In addition, our
operating results could be below the expectations of public market analysts and
investors, and in response the market price of our common stock could decrease
significantly. Investors may be unable to resell their shares of our common
stock at or above the offering price. In the past, companies that have
experienced volatility in the market price of their stock have been the object
of securities class action litigation. If we were the object of securities
class action litigation, it could result in substantial costs and a diversion
of management's attention and resources.

We have broad discretion in how we use the proceeds of this offering, and we
may not use these proceeds effectively.

  Our management could spend most of the proceeds from this offering in ways
with which our stockholders may not agree or that do not yield a favorable
return. Our primary purpose in conducting this offering is to create a public
market for our common stock. As of the date of this prospectus, we plan to use
the proceeds from this offering for working capital and general corporate
purposes. We may also use the proceeds in future strategic acquisitions but do
not have any acquisitions planned. Until we need to use the proceeds of this
offering, we plan to invest the net proceeds in investment grade, interest-
bearing securities.

Our officers and persons affiliated with our directors hold a substantial
portion of our stock and could reject mergers or other business combinations
that a stockholder may believe are desirable.

  We anticipate that our directors, officers and individuals or entities
affiliated with our directors will beneficially own approximately   % of our
outstanding common stock as a group after this offering closes. Acting
together, these stockholders would be able to significantly influence all
matters that

                                       20
<PAGE>

our stockholders vote upon, including the election of directors or the
rejection of a merger or other business combination that other stockholders may
believe is desirable.

The provisions of our charter documents may inhibit potential acquisition bids
that a stockholder may believe are desirable, and the market price of our
common stock may be lower as a result.

  Upon completion of this offering, our board of directors will have the
authority to issue up to 10,000,000 shares of preferred stock. The board of
directors can fix the price, rights, preferences, privileges and restrictions
of the preferred stock without any further vote or action by our stockholders.
The issuance of shares of preferred stock may delay or prevent a change in
control transaction. As a result, the market price of our common stock and the
voting and other rights of our stockholders may be adversely affected. The
issuance of preferred stock may result in the loss of voting control to other
stockholders. We have no current plans to issue any shares of preferred stock.

  Our charter documents contain anti-takeover devices including:

  .  only one of the three classes of directors is elected each year;

  .  the ability of our stockholders to remove directors without cause is
     limited;

  .  the right of stockholders to act by written consent has been eliminated;

  .  the right of stockholders to call a special meeting of stockholders has
     been eliminated; and

  .  a requirement of advance notice to nominate directors or submit
     proposals for consideration at stockholder meetings.

  These provisions could discourage potential acquisition proposals and could
delay or prevent a change in control transaction. They could also have the
effect of discouraging others from making tender offers for our common stock.
As a result, these provisions may prevent the market price of our common stock
from increasing substantially in response to actual or rumored takeover
attempts. These provisions may also prevent changes in our management.

Delaware law may inhibit potential acquisition bids; this may adversely affect
the market price of our common stock, discourage merger offers and prevent
changes in our management.

  Section 203 of the Delaware General Corporation Law may inhibit potential
acquisition bids for our company. Upon completion of this offering, we will be
subject to the antitakeover provisions of the Delaware General Corporation Law,
which regulate corporate acquisitions. Delaware law will prevent us from
engaging, under certain circumstances, in a "business combination" with any
"interested stockholder" for three years following the date that the interested
stockholder became an interested stockholder unless our board of directors or a
supermajority of our uninterested stockholders agree. For purposes of Delaware
law, a "business combination" includes a merger or consolidation involving us
and the interested stockholder and the sale of more than 10% of our assets. In
general, Delaware law defines an "interested stockholder" as any holder
beneficially owning 15% or more of the outstanding voting stock of a
corporation and any entity or person affiliated with or controlling or
controlled by the holder. Under Delaware law, a corporation may opt out of the
foregoing antitakeover provisions. We do not intend to opt out of the
antitakeover provisions of Delaware Law.

A total of 22,010,103, or  %, of our total outstanding shares after the
offering are restricted from immediate resale, but may be sold into the market
in the near future. This could cause the market price of our common stock to
drop significantly, even if our business is doing well.

  Our current stockholders hold a substantial number of shares, which they will
be able to sell in the public market in the near future. Sales of a substantial
number of shares of our common stock

                                       21
<PAGE>

could cause our stock price to fall. In addition, the sale of these shares
could impair our ability to raise capital through the sale of additional stock.

  After this offering, we will have outstanding            shares of common
stock. This includes            shares that we are selling in the offering,
which may be resold immediately in the public market. The remaining 22,010,103
shares will become eligible for resale in the public market as shown in the
table below.

<TABLE>
<CAPTION>
    Number of shares/% of total
   outstanding after the offering                    Date of availability for resale into public market
   ------------------------------                    --------------------------------------------------
   <S>                              <C>
        100,000/  %                 30 days after the date of the final prospectus due to an agreement
                                     the family of a deceased co-founder has with Cobalt and the
                                     underwriters. However, the underwriters can waive this restriction
                                     and allow these stockholders to sell their shares at any time.

     21,910,103/  %                 180 days after the date of the final prospectus due to agreements
                                     these stockholders have with Cobalt and the underwriters.
                                     However, the underwriters can waive this restriction and allow
                                     these stockholders to sell their shares at any time. 14,975,753 of
                                     these shares will be subject to sales volume limitations under the
                                     federal securities laws.
</TABLE>

                           FORWARD-LOOKING STATEMENTS

  This prospectus, including the sections entitled "Prospectus Summary", "Risk
Factors", "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business", contains forward-looking statements.
These statements relate to future events or our future financial performance
and involve known and unknown risks, uncertainties and other factors that may
cause our or our industry's actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by the forward-
looking statements. These risks and other factors include those listed under
"Risk Factors" and elsewhere in this prospectus. In some cases, you can
identify forward-looking statements by terminology such as "may", "will",
"should", "expects", "plans", "anticipates", "believes", "estimates",
"predicts", "potential", "continue" or the negative of these terms or other
comparable terminology. These statements are only predictions. Actual events or
results may differ materially. In evaluating these statements, you should
specifically consider various factors, including the risks outlined under "Risk
Factors". These factors may cause our actual results to differ materially from
any forward-looking statement.

  Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other
person assumes responsibility for the accuracy and completeness of these
forward-looking statements. We are under no duty to update any of the forward-
looking statements after the date of this prospectus to conform our prior
statements to actual results.


                                       22
<PAGE>

                                USE OF PROCEEDS

  We estimate that the net proceeds from the sale of the shares of common stock
that we are selling in this offering will be approximately $    , or $     if
the underwriters exercise their over-allotment option in full, based on an
assumed public offering price of $   per share and after deducting the
estimated underwriting discounts and commissions and estimated offering
expenses payable by us.

  The principal purposes of this offering are to fund our operating losses,
increase our working capital, fund our capital expenditures and create a public
market for our common stock. The amounts that we actually expend for working
capital purposes will vary significantly depending on a number of factors,
including future revenue growth, if any, and the amount of cash we generate
from operations. As a result, we will retain broad discretion in the allocation
of the net proceeds of this offering. In addition, we may use a portion of the
net proceeds for further development of our product lines through acquisitions
of products, technologies and businesses. However, we currently have no present
commitments or agreements with respect to any acquisitions. Pending these uses,
we intend to invest the net proceeds in interest-bearing, investment-grade
securities.

                                DIVIDEND POLICY

  We have never declared or paid any dividends on our capital stock. We
currently expect to retain any future earnings for use in the operation and
expansion of our business and do not anticipate paying any cash dividends in
the foreseeable future.

                                       23
<PAGE>

                                 CAPITALIZATION

  The following table sets forth our capitalization as of July 2, 1999. Our
capitalization is presented:

  .  on an actual basis;

  .  on a pro forma basis to give effect to the automatic conversion of all
     outstanding shares of our mandatorily redeemable convertible preferred
     stock into shares of common stock upon the closing of this offering; and

  .  on a pro forma as adjusted basis to reflect the automatic conversion of
     our mandatorily redeemable convertible preferred stock and our receipt
     of the estimated net proceeds from the sale of     shares of common
     stock in this offering at an assumed initial public offering price of
     $    per share.

<TABLE>
<CAPTION>
                                                      As of July 2, 1999
                                                --------------------------------
                                                                      Pro Forma
                                                 Actual   Pro Forma  As Adjusted
                                                --------  ---------  -----------
                                                        (in thousands)
<S>                                             <C>       <C>        <C>
Notes payable, less current portion............ $     64  $     64    $     64
                                                --------  --------    --------
Mandatorily redeemable convertible preferred
 stock, $.001 par value, 17,609,875 shares
 authorized, 17,084,818 shares issued and
 outstanding, actual and pro forma; no shares
 authorized, issued or outstanding, pro forma
 as adjusted...................................   45,646       --          --
                                                --------  --------    --------
Stockholders' equity (deficit):
 Preferred stock, $.001 par value, no shares
  authorized, issued or outstanding, actual
  and pro forma; 10,000,000 shares authorized,
  no shares issued or outstanding, pro forma
  as adjusted..................................      --        --          --
 Common stock, $.001 par value, 26,000,000
  shares authorized, actual and pro forma,
  4,925,285 shares issued and outstanding,
  actual; 22,010,103 shares issued and
  outstanding, pro forma; 120,000,000 shares
  authorized,            shares issued and
  outstanding, pro forma as adjusted...........        5        22
 Additional paid-in capital....................    3,921    49,550
 Unearned stock compensation...................   (1,134)   (1,134)     (1,134)
 Note receivable from stockholder..............      (50)      (50)        (50)
 Accumulated deficit...........................  (22,592)  (22,592)    (22,592)
                                                --------  --------    --------
   Total stockholders' equity (deficit)........  (19,850)   25,796
                                                --------  --------    --------
     Total capitalization...................... $ 25,860  $ 25,860    $
                                                ========  ========    ========
</TABLE>

  In addition to the shares of common stock to be outstanding after the
offering, we may issue additional shares of common stock under the following
plans and arrangements:

  .  2,144,943 shares issuable upon exercise of options outstanding at a
     weighted average exercise price of $0.69 per share as of July 2, 1999;

  .  525,665 shares issuable upon exercise of warrants outstanding at a
     weighted average exercise price of $2.74 per share as of July 2, 1999;
     and

  .  a total of 6,407,870 shares available for future issuance under our
     various stock plans excluding the annual increases in the number of
     shares authorized under each of our plans beginning January 1, 2001. See
     "Management--Incentive Plans" for a description of how these annual
     increases are determined.

  Please read the capitalization table together with the sections of this
prospectus entitled "Selected Consolidated Financial Data" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
with the financial statements and related notes beginning on page F-1.



                                       24
<PAGE>

                                    DILUTION

  Our pro forma net tangible book value as of July 2, 1999 was $25.8 million,
or $1.17 per share. Pro forma net tangible book value per share represents the
amount of our total tangible assets reduced by the amount of our total
liabilities and divided by the total number of shares of common stock
outstanding after giving effect to the automatic conversion of our mandatorily
redeemable convertible preferred stock. Dilution in pro forma net tangible book
value per share represents the difference between the amount per share paid by
purchasers of shares of common stock in this offering and the pro forma net
tangible book value per share of common stock immediately after the completion
of this offering. After giving effect to the sale of the shares of common stock
offered by us at an assumed initial public offering price of $    per share,
and after deducting the estimated underwriting discounts and commissions and
estimated offering expenses payable by us, our pro forma net tangible book
value as of July 2, 1999 would have been approximately $    million or $    per
share of common stock. This represents an immediate increase in pro forma net
tangible book value of $    per share to existing stockholders and an immediate
dilution of $    per share to new investors of common stock. The following
table illustrates this dilution on a per share basis:

<TABLE>
<S>                                                                    <C>   <C>
Assumed initial public offering price per share.......................       $
  Pro forma net tangible book value per share as of July 2, 1999...... $1.17
  Increase per share attributable to new investors....................
                                                                       -----
Pro forma net tangible book value per share after this offering.......
                                                                             ---
Dilution per share to new investors...................................       $
                                                                             ===
</TABLE>

  The following table summarizes on a pro forma basis after giving effect to
the offering, based on an assumed initial public offering price of $     per
share, as of July 2, 1999, the differences between the existing stockholders
and new investors with respect to the number of shares of common stock
purchased from us, the total consideration paid to us and the average price
per share paid:

<TABLE>
<CAPTION>
                                                              Total      Average
                                        Shares Purchased  Consideration   Price
                                       ------------------ --------------   Per
                                         Number   Percent Amount Percent  Share
                                       ---------- ------- ------ ------- -------
<S>                                    <C>        <C>     <C>    <C>     <C>
Existing stockholders................. 22,010,103      %              %  $
New investors.........................
                                       ----------   ---    ----    ---
  Total...............................                 %              %
                                       ==========   ===    ====    ===
</TABLE>

  The foregoing discussion and tables are based upon the number of shares
actually issued and outstanding on July 2, 1999 and assume no exercise of
options or warrants outstanding as of July 2, 1999. As of that date, there
were:

  .  2,144,943 shares issuable upon exercise of options outstanding at a
     weighted average exercise price of $0.69 per share; and

  .  525,665 shares issuable upon exercise of warrants outstanding at a
     weighted average exercise price of $2.74 per share.

  To the extent these options and warrants are exercised, there will be further
dilution to new investors.

                                       25
<PAGE>

                      SELECTED CONSOLIDATED FINANCIAL DATA

  The selected consolidated financial data below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and our consolidated financial statements and notes thereto. The
selected consolidated statement of operations data for the period from October
18, 1996 (inception) to December 31, 1996 and for the years ended December 31,
1997 and 1998, and the selected consolidated balance sheet data as of December
31, 1997 and 1998, are derived from, and are qualified by reference to, the
audited consolidated financial statements included elsewhere in this
prospectus. The selected consolidated balance sheet data as of December 31,
1996 is derived from our audited consolidated financial statements that are not
included in this prospectus. The selected consolidated statement of operations
data for the six month periods ended June 30, 1998 and July 2, 1999, and the
selected consolidated balance sheet data as of July 2, 1999, are derived from
unaudited consolidated financial statements included elsewhere in this
prospectus. We prepared the unaudited consolidated financial statements on
substantially the same basis as the audited consolidated financial statements
and, in our opinion, they include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the results of
operations for these periods. The historical results presented below are not
necessarily indicative of future results.

  Our mandatorily redeemable convertible preferred stock had a feature which
required us to repurchase the preferred stock from its holders at their
election. Accretion of mandatorily redeemable convertible preferred stock
represents the charge to retained earnings we took in 1998 and the six months
ended July 2, 1999 to reflect this potential liability. As of April 26, 1999,
the accretion was no longer required due to a change in the terms of the
preferred stock. The outstanding shares of mandatorily redeemable convertible
preferred stock will convert into shares of our common stock on a one for one
basis in connection with the closing of this offering and no dividends will be
paid or converted into common stock. The pro forma net loss per share for the
year ended December 31, 1998 and the six months ended July 2, 1999 reflect the
elimination of the accretion and the conversion of our preferred stock.


                                       26
<PAGE>

<TABLE>
<CAPTION>
                                              Year Ended
                             Period from     December 31,     Six Months Ended
                           Oct. 18, 1996   -----------------  -----------------
                            (Inception)                       June 30,  July 2,
                          to Dec. 31, 1996  1997      1998      1998     1999
                          ---------------- -------  --------  --------  -------
                                (in thousands, except per share data)
<S>                       <C>              <C>      <C>       <C>       <C>
Consolidated Statement
 of Operations Data:
Net revenues............       $ --        $   --   $  3,537  $   449   $ 7,663
Cost of revenues........         --            --      3,123      582     5,156
                               -----       -------  --------  -------   -------
 Gross profit (loss)....         --            --        414     (133)    2,507
                               -----       -------  --------  -------   -------
Operating expenses:
 Research and
  development...........          22         1,067     3,483    1,204     2,771
 Sales and marketing....         --            245     5,581    1,801     6,273
 General and
  administrative........          60           445     1,895      611     1,454
 Amortization of stock
  compensation..........         --            --        --       --        253
                               -----       -------  --------  -------   -------
   Total operating
    expenses............          82         1,757    10,959    3,616    10,751
                               -----       -------  --------  -------   -------
Loss from operations....         (82)       (1,757)  (10,545)  (3,749)   (8,244)
Interest income
 (expense), net.........         --            (12)       67       (3)      --
                               -----       -------  --------  -------   -------
Net loss................         (82)       (1,769)  (10,478)  (3,752)   (8,244)
Accretion of mandatorily
 redeemable convertible
 preferred stock........         --            --       (828)     --     (1,191)
                               -----       -------  --------  -------   -------
Net loss attributable to
 holders of common
 stock..................       $ (82)      $(1,769) $(11,306) $(3,752)  $(9,435)
                               =====       =======  ========  =======   =======
Basic and diluted net
 loss per share
 attributable to holders
 of common stock........                   $ (4.10) $  (5.47) $ (2.09)  $ (2.83)
                                           =======  ========  =======   =======
Basic and diluted
 weighted average shares
 outstanding............                       432     2,065    1,792     3,338
                                           =======  ========  =======   =======
Pro forma basic and
 diluted net loss per
 share..................                            $  (1.43)           $ (0.60)
                                                    ========            =======
Pro forma basic and
 diluted weighted
 average shares
 outstanding............                               7,330             13,808
                                                    ========            =======
</TABLE>

<TABLE>
<CAPTION>
                                                December 31,
                                           ------------------------  July 2,
                                           1996    1997      1998      1999
                                           -----  -------  --------  --------
<S>                                        <C>    <C>      <C>       <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents................. $  15  $ 1,738  $  2,090  $ 27,426
Working capital (deficit).................  (105)   1,542    (1,912)   24,539
Total assets..............................    42    1,998     6,145    34,902
Notes payable, less current portion.......    70      --         84        64
Mandatorily redeemable convertible
 preferred stock..........................   --     3,551    12,339    45,646
Total stockholders' deficit...............   (82)  (1,847)  (13,073)  (19,850)
</TABLE>

                                       27
<PAGE>

                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with "Selected Consolidated
Financial Data" and our financial statements and related notes included
elsewhere in this prospectus. In addition to historical information, the
discussion in this prospectus contains certain forward-looking statements that
involve risks and uncertainties. Our actual results could differ materially
from those anticipated by these forward-looking statements due to factors
including, but not limited to, those factors set forth under "Risk Factors" and
elsewhere in this prospectus.

Overview

  We are a leading provider of server appliances. Server appliances are a new
category of network infrastructure devices that are specifically designed and
optimized to deliver one or a few network-based applications well. Our products
deliver network-based applications in a flexible and reliable manner that is
simpler and more cost-effective than current solutions. From our inception in
October 1996 to March 1998, our operations consisted primarily of start-up and
initial product development activities, recruiting personnel and raising
capital. In March 1998, we shipped our first server appliance product, the
Cobalt Qube. Since that time, we have expanded our product family into several
new markets with our Cobalt RaQ, Cobalt Cache and Cobalt NAS product lines.

  Since our inception in 1996, we have incurred substantial costs to develop
our technology and products, to recruit and train personnel for our
engineering, sales and marketing and technical support departments, and to
establish an administrative organization. As a result, we had an accumulated
deficit of $22.6 million as of July 2, 1999. We anticipate that our operating
expenses will increase substantially in the future as we increase our sales and
marketing operations, develop new channels, fund greater levels of research and
development, broaden our technical support and improve our operational and
financial systems. Accordingly, we will need to generate significant revenues
to achieve profitability. In addition, our limited operating history makes it
difficult for us to predict future operating results and, accordingly, there
can be no assurance that we will sustain revenue growth or achieve
profitability in future quarters.

  We currently derive substantially all of our net revenues from sales of a
limited number of products. During 1998 and the six months ended July 2, 1999,
respectively, 83% and 84% of our net revenues were derived from sales of our
Cobalt Qube and Cobalt RaQ products. Although we began selling our Cobalt Cache
products in 1998 and Cobalt NAS products during the six months ended July 2,
1999, we expect that a substantial majority of our net revenues in 1999 will
continue to be generated from sales of our Cobalt Qube and Cobalt RaQ products.

  We sell our products directly through our sales force and indirectly through
channel partners that include distributors, resellers and system integrators.
Indirect sales are a majority of our total sales and account for substantially
all of our sales outside of the United States. In 1998 and the six months ended
July 2, 1999, respectively, 46% and 14% of our net revenues were from direct
sales.

  Indirect sales were 54% of our net revenues in 1998 and 86% of our net
revenues in the six months ended July 2, 1999. In 1998, approximately 12% of
our net revenues came from sales to one of our distributors, Nissho
Electronics. For the six months ended July 2, 1999, sales to two of our
distributors, Tech Data and Nissho Electronics, accounted for 18% and 13% of
our net revenues, respectively. While we are seeking to diversify our customer
base and expand the portion of our net revenues which is derived from sales
through various channels, we anticipate that our operating results will
continue to depend on volume sales to a relatively small number of channel
partners.

                                       28
<PAGE>

  For direct sales and sales to resellers and system integrators, we record
revenues upon shipment. For sales to distributors, we recognize revenues upon
estimated sell through to the end users as our contracts generally provide the
distributor with limited rights of return. As a result, we defer recognition of
gross profit, captioned on our balance sheet as deferred margin, on inventory
held by distributors until we record the revenues and cost of revenues on a
sell through basis. Revenues from service obligations are deferred and
recognized on a straight line basis over the contractual period.

  We provide allowances for estimated sales returns and warranty costs at the
time of revenue recognition based on our historical results. To date, our
actual sales returns and warranty expenditures have each been less than 5% of
net revenues in any quarter. However, our past product return and warranty
experience may not be indicative of future product return rates and warranty
costs.

  Although we enter into general sales contracts with our channel partners,
none of our channel partners is obligated to purchase any amount of our
products pursuant to these contracts. We rely on our channel partners to submit
purchase orders for specific quantities of our products.

Our gross profit is affected by:

  .  fluctuations in demand for our products;

  .  the mix of products sold;

  .  the mix of sales channels through which our products are sold;

  .  the mix of sales within and outside North America;

  .  the timing and size of customer orders;

  .  new product introductions by us and our competitors;

  .  changes in our pricing policies;

  .  changes in component costs; and

  .  the volume manufacturing prices we are able to obtain from our contract
     manufacturers.

  During the six months ended July 2, 1999 and during the period from July 3,
1999 to August 31, 1999, respectively, we recorded unearned stock compensation
on our balance sheet of $1.4 million and $7.4 million in connection with
certain stock option grants. We will amortize this stock compensation over the
vesting period of the related award. During the six months ended July 2, 1999,
we amortized $253,000 of stock compensation. During the remainder of 1999 and
in 2000, we expect to amortize stock compensation of:

<TABLE>
<CAPTION>
 Fiscal Quarter                                        Expected Amortization of
     Ending                                               Stock Compensation
 --------------                                        ------------------------
                                                            (in thousands)
<S>                                                    <C>
October 1, 1999.......................................          $  893
December 31, 1999.....................................           1,235
March 31, 2000........................................           1,221
June 30, 2000.........................................           1,198
September 29, 2000....................................             847
December 29, 2000.....................................             615
</TABLE>

  We then expect aggregate per quarter stock compensation amortization of
between $522,000 and $309,000 during 2001, between $254,000 and $115,000 during
2002 and between $77,000 and $10,000 during 2003. The amount of stock
compensation expense to be recorded in future periods could decrease if options
for which accrued but unvested compensation has been recorded are forfeited.

                                       29
<PAGE>

  As of December 31, 1998, we had approximately $11 million of federal and
state net operating loss carryforwards for tax reporting purposes available to
offset future taxable income. These net operating loss carryforwards expire
beginning in 2011 and 2004, respectively. We have not recognized any benefit
from the future use of loss carryforwards for these periods or for any other
period since inception because of uncertainty surrounding their realization.
The amount of net operating losses that we can utilize may be limited under tax
regulations in circumstances including a cumulative stock ownership change of
more than 50% over a three year period. It is possible that such a change may
have already occurred or could occur as a result of this offering.

  Our net loss attributable to holders of common stock includes accretion
charges to increase over time the carrying amount of our mandatorily redeemable
convertible preferred stock to the amount we would be required to pay if
redeemed. As of April 26, 1999, we stopped recording these charges because we
changed the terms of the preferred stock to limit the redemption amount to its
original issue price plus accrued dividends.

  We had 101 employees as of July 2, 1999, a substantial increase from 68 as of
December 31, 1998 and 14 as of December 31, 1997. This rapid growth has placed
significant demands on our management and operational resources. In order to
manage our growth effectively, we must implement and improve our operational
systems, procedures and controls on a timely basis. If our total revenues do
not increase relative to our operating expenses, our management systems do not
expand to meet increasing demands, we fail to attract, assimilate and retain
qualified personnel or our management otherwise fails to manage our expansion
effectively, we could experience a decline in our revenues and operating
results.

  Until January 1, 1999, we operated on calendar fiscal quarters and a fiscal
year ending December 31. Beginning in 1999, we operate on thirteen week fiscal
quarters ending on a Friday. Therefore, in 1999 our fiscal quarters end on
April 2, July 2, October 1 and December 31. Fiscal 2000 will end on December
29, 2000.

Results of Operations

Six Months ended June 30, 1998 and July 2, 1999

 Net Revenues

  We began volume shipments of our Cobalt Qube product line in March 1998. Net
revenues increased from $449,000 for the six months ended June 30, 1998 to $7.7
million in the six months ended July 2, 1999. Net revenues increased primarily
as a result of increased sales to new and existing customers of our Cobalt Qube
product line and the September 1998 introduction of the Cobalt RaQ . To a
lesser extent, our net revenues increased due to the introduction of our Cobalt
Cache product line and Cobalt NAS product line in July 1998 and April 1999,
respectively, and an expansion of our sales through our channel partners.

  Net revenues from sales outside the United States increased from $143,000 in
the six months ended June 30, 1998 to $4.3 million in the six months ended July
2, 1999. The increase in absolute dollars reflected expansion of our operations
in Japan, Europe and other countries. One factor relating to the increase in
net revenues in the Japanese market was our introduction of a Japanese language
user interface in May 1998. Our net revenues from sales outside the United
States were primarily denominated in U.S. dollars. The effect of foreign
exchange fluctuations did not have a significant impact on our results.

 Cost of Revenues and Gross Profit

  Cost of revenues includes technology license fees, manufacturing costs,
manufacturing personnel expenses, packaging and shipping costs and warranty
expenses. We have outsourced our manufacturing and repair operations.
Accordingly, a significant portion of our cost of revenues consists of payments
to our contract manufacturers. Cost of revenues increased from $582,000 in

                                       30
<PAGE>

the six months ended June 30, 1998 to $5.2 million in the six months ended July
2, 1999. The increase in cost of revenues was primarily due to increased sales
volume and the introduction of new products. We believe that our cost of
revenues will increase in absolute dollars in future periods but will continue
to fluctuate as a percentage of net revenues.

  Gross profit increased from a gross loss of $133,000 in the six months ended
June 30, 1998 to a gross profit $2.5 million in the six months ended July 2,
1999. Gross profit (loss) as a percentage of net revenues increased from (30)%
in the six months ended June 30, 1998 to 33% in the six months ended July 2,
1999. The increase in gross profit was primarily due to increased sales volume
and the introduction of new products. We believe that the rate of growth of the
increase in gross profit will not be sustainable in future quarters.

 Research and Development Expenses

  Research and development expenses consist primarily of salaries and related
expenses for personnel engaged in research and development, fees paid to
consultants and outside service providers, material costs for prototype and
test units and other expenses related to the design, development, testing and
enhancements of our products. We expense all of our research and development
costs as they are incurred. Research and development expenses increased from
$1.2 million in the six months ended June 30, 1998 to $2.8 million in the six
months ended July 2, 1999. This increase was primarily due to the hiring of
additional research and development personnel. As net revenues have increased,
research and development expenses have declined as a percentage of net revenues
from 268% in the six months ended June 30, 1998 to 36% in the six months ended
July 2, 1999. We believe that a significant level of investment in product
research and development is required to remain competitive. Accordingly, we
expect to continue to devote substantial resources to product research and
development such that research and development expenses will increase in
absolute dollars but will continue to fluctuate as a percentage of net
revenues.

 Sales and Marketing Expenses

  Sales and marketing expenses consist primarily of salaries, commissions and
related expenses for personnel engaged in marketing, sales and customer support
functions, as well as costs associated with trade shows, promotional
activities, advertising and public relations. Sales and marketing expenses
increased from $1.8 million in the six months ended June 30, 1998 to
$6.3 million in the six months ended July 2, 1999. The increase in absolute
dollars was primarily due to the hiring of additional sales and marketing
personnel and the expansion of our global sales and marketing efforts,
particularly with respect to our branding campaign. As net revenues have
increased, these expenses have declined as a percentage of net revenues from
401% in the six months ended June 30, 1998 to 82% in the six months ended July
2, 1999. We intend to expand our sales and marketing operations and efforts
substantially, both domestically and internationally, in order to increase
market awareness and to generate sales of our products. Accordingly, we expect
our sales and marketing expenses to increase in absolute dollars but continue
to fluctuate as a percentage of net revenues.

 General and Administrative Expenses

  General and administrative expenses consist primarily of salaries and related
expenses for executive, finance, accounting, information technology, facilities
and human resources personnel, recruiting expenses, professional fees and costs
associated with expanding our information systems. General and administrative
expenses increased from $611,000 in the six months ended June 30, 1998 to $1.5
million in the six months ended July 2, 1999. The increase in absolute dollars
was primarily due to the hiring of additional administrative personnel and
associated expenses necessary

                                       31
<PAGE>

to manage and support our increased scale of operations. As net revenues have
increased, these expenses have declined as a percentage of net revenues from
136% in the six months ended June 30, 1998 to 19% in the six months ended July
2, 1999. We expect these expenses to increase in absolute dollars but continue
to fluctuate as a percentage of net revenues as we add personnel and incur
additional costs related to the growth of our business, expansion of our
information infrastructure and our operation as a public company.

 Amortization of Stock Compensation

  In connection with the grant of stock options to employees during the six
months ended July 2, 1999, we recorded unearned stock compensation within
stockholders' equity of approximately $1.4 million, representing the difference
between the estimated fair value of the common stock for accounting purposes
and the option exercise price of these options at the date of grant. We
recorded no stock compensation amortization in the six months ended June 30,
1998. We recorded amortization of stock compensation of $253,000 during the six
months ended July 2, 1999. The amount of stock compensation expense to be
recorded in future periods could decrease if options for which accrued but
unvested compensation has been recorded are forfeited.

 Interest Income (Expense), Net

  Interest income (expense), net includes income from our cash investments net
of expenses related to our debt and lease financing obligations. We had net
interest expense of $3,000 in the six months ended June 30, 1998 and no
interest income (expense), net in the six months ended July 2, 1999. The change
from the six months ended June 30, 1998 was primarily due to an increase in
interest income earned on proceeds from issuances of our preferred stock and
was partially offset by increased interest charges on debt and capital lease
obligations.

October 18, 1996 to December 31, 1996 and Years Ended December 31, 1997 and
1998

 Net Revenues

  We had net revenues of $3.5 million in 1998, principally related to sales of
the Cobalt Qube and Cobalt RaQ. We had no net revenues in either 1996 or 1997.
Net revenues from sales outside of the United States were approximately 44% of
net revenues in 1998, primarily in Japan and Europe, which accounted for 21%
and 15% of our net revenues in 1998, respectively.

 Cost of Revenues

  Cost of revenues was $3.2 million in 1998. There was no cost of revenues in
1996 or 1997.

 Research and Development

  Research and development expenses increased from $22,000 in 1996 to $1.1
million in 1997 and to $3.5 million in 1998. The increase in research and
development expenses was due primarily to expanded technology development
efforts related to our new products, user interfaces, Linux operating system
optimization and application software.

 Sales and Marketing

  We had no sales and marketing expenses in 1996. Sales and marketing expenses
increased from $245,000 in 1997 to $5.6 million in 1998. The increase in sales
and marketing expenses during 1998 was due primarily to the addition of new
sales, marketing and customer support personnel,

                                       32
<PAGE>

product launches, sales channel growth and our expansion of our global selling
efforts, which emphasizes the support of sales and service through distributors
and resellers.

 General and Administrative

  General and administrative expenses increased from $60,000 in 1996 to
$445,000 in 1997 and to $1.9 million in 1998. The increase in general and
administrative expenses in each period was due primarily to the hiring of
additional personnel and expansion of our facilities to support the growth of
our business.

 Interest Income (Expense), Net

  We had no interest income (expense), net in 1996. We had net interest expense
of $12,000 in 1997 and net interest income of $67,000 in 1998. The net change
from 1997 to 1998 was due to interest income on the increased average cash and
cash equivalents balances as a result of our issuances of capital stock.


                                       33
<PAGE>

Quarterly Results of Operations

  The following table presents our consolidated operating results for each of
the six quarters in the period from January 1, 1998 through July 2, 1999. The
information for each of these quarters is unaudited and has been prepared on
the same basis as our audited consolidated financial statements appearing
elsewhere in this prospectus. In the opinion of management, all necessary
adjustments, consisting only of normal recurring adjustments, have been
included to present fairly the unaudited quarterly results when read in
conjunction with our audited consolidated financial statements and related
notes appearing elsewhere in this prospectus.

<TABLE>
<CAPTION>
                                             Quarter Ended
                         ---------------------------------------------------------------
                         Mar. 31,   June 30,   Sept. 30,   Dec. 31,   Apr. 2,    July 2,
                           1998       1998       1998        1998       1999      1999
                         --------   --------   ---------   --------   --------   -------
                                        (dollars in thousands)
<S>                      <C>        <C>        <C>         <C>        <C>        <C>
Consolidated Statement
 of Operations Data:
Net revenues............ $     70   $    379   $  1,064    $  2,024   $  2,634   $ 5,029
Cost of revenues........      155        427        808       1,733      2,002     3,154
                         --------   --------   --------    --------   --------   -------
   Gross profit (loss)..      (85)       (48)       256         291        632     1,875
                         --------   --------   --------    --------   --------   -------
Operating expenses:
 Research and
  development...........      528        855        990       1,110      1,397     1,374
 Sales and marketing....      590      1,050      1,709       2,232      2,753     3,520
 General and
  administrative........      242        351        487         815        621       833
 Amortization of stock
  compensation..........      --         --         --          --         140       113
                         --------   --------   --------    --------   --------   -------
   Total operating
    expenses............    1,360      2,256      3,186       4,157      4,911     5,840
                         --------   --------   --------    --------   --------   -------
Loss from operations....   (1,445)    (2,304)    (2,930)     (3,866)    (4,279)   (3,965)
Interest income
 (expense), net.........        7        (10)        48          22       (128)      128
                         --------   --------   --------    --------   --------   -------
Net loss................ $ (1,438)  $ (2,314)  $ (2,882)   $ (3,844)  $ (4,407)  $(3,837)
                         ========   ========   ========    ========   ========   =======
As a Percentage of Net
 Revenues:
Net revenues............    100.0 %    100.0 %    100.0 %     100.0 %    100.0 %   100.0 %
Cost of revenues........    221.4      112.7       75.9        85.6       76.0      62.7
                         --------   --------   --------    --------   --------   -------
   Gross profit (loss)..   (121.4)     (12.7)      24.1        14.4       24.0      37.3
                         --------   --------   --------    --------   --------   -------
Operating expenses:
 Research and
  development...........    754.3      225.6       93.0        54.8       53.0      27.3
 Sales and marketing....    842.9      277.1      160.6       110.3      104.5      70.0
 General and
  administrative........    345.7       92.6       45.8        40.3       23.6      16.6
 Amortization of stock
  compensation..........      --         --         --          --         5.3       2.2
                         --------   --------   --------    --------   --------   -------
   Total operating
    expenses............  1,942.9      595.2      299.4       205.4      186.4     116.1
                         --------   --------   --------    --------   --------   -------
Loss from operations.... (2,064.3)    (607.9)    (275.3)     (191.0)    (162.4)    (78.8)
Interest income
 (expense), net.........     10.0       (2.6)       4.5         1.1       (4.9)      2.5
                         --------   --------   --------    --------   --------   -------
Net loss................ (2,054.3)%   (610.5)%   (270.8)%    (189.9)%   (167.3)%   (76.3)%
                         ========   ========   ========    ========   ========   =======
</TABLE>

  Net revenues increased in each of the six quarters from January 1, 1998
through July 2, 1999. These quarterly increases were primarily due to the
introduction of our Cobalt RaQ and to a lesser extent, our Cobalt Cache and
Cobalt NAS products, increased sales of our Cobalt Qube products, and the
addition of new channel partners and web hosting and application service
provider customers.

  Cost of revenues increased in each of the six quarters from January 1, 1998
through July 2, 1999 as a result of increased unit sales. Gross profit
generally increased in each of the six quarters from January 1, 1998 through
July 2, 1999 due to increases in the volume of sales and the realization of
associated economies of scale as well as the introduction of the higher margin
Cobalt RaQ products.


                                       34
<PAGE>

  Research and development expenses increased in each of the six quarters from
January 1, 1998 to March 31, 1999, primarily due to the addition of personnel
and costs incurred for the development of new products. For the quarter ended
July 2, 1999, research and development expenses decreased relative to the prior
quarter as a result of relatively high contract research and development
expenses in the prior quarter.

  Sales and marketing expenses increased in each of the six quarters from
January 1, 1998 to July 2, 1999 due to the hiring of additional sales
personnel, higher commission expense resulting from increased unit sales,
marketing programs, tradeshows and customer support.

  General and administrative expenses generally increased for each of the six
quarters from January 1, 1998 through July 2, 1999. We incurred moving costs
during the quarter ended December 31, 1998 in connection with our move to a new
corporate headquarters facility in Mountain View, California.

  As a result of our limited operating history, we cannot forecast operating
expenses based on historical results. Accordingly, we base our expenses in part
on future revenue projections. Most of our expenses are fixed in nature, and we
may not be able to quickly reduce spending if revenues are lower than we have
projected. Our ability to forecast our quarterly sales accurately is limited,
which makes it difficult to predict the quarterly revenues that we will
recognize. We expect that our business, operating results and financial
condition would be harmed if revenues did not meet projections.

  We expect that our revenues and operating results may vary significantly from
quarter to quarter, and we anticipate that our expenses will increase
substantially in the foreseeable future as we:

  .  increase our sales and marketing activities, including expanding our
     North American and international direct sales forces;

  .  expand our indirect channels;

  .  develop our technology, expand our product lines and create and market
     new products; and

  .  pursue strategic relationships and acquisitions.

Accordingly, we believe that quarter to quarter comparisons of our operating
results are not necessarily meaningful. Investors should not rely on the
results of one quarter as an indication of future performance.

Liquidity and Capital Resources

  Since inception, we have financed our operations primarily through private
sales of mandatorily redeemable convertible preferred stock, the issuance of
convertible notes, equipment financings and net revenues generated from product
sales. As of July 2, 1999, we had cash and cash equivalents of $27.4 million,
an accumulated deficit of $22.6 million and working capital of $24.5 million.

  Our operating activities used cash of $1.6 million in 1997, $7.5 million in
1998, and $7.5 million during the six months ended July 2, 1999. Cash used in
operating activities for 1997 and 1998 was primarily attributable to net losses
of $1.8 million and $10.5 million, respectively. In 1998, cash used in
operating activities was also attributable to increases in accounts receivable
and inventories of $2.0 million and $500,000, respectively, offset in part by
increases in accounts payable of $4.0 million and accrued expenses of $1.1
million. Cash used in operating activities during the six months ended July 2,
1999 was attributable to a net loss of $8.2 million and increases in accounts
receivable of $2.8 million and inventory of $505,000 but was offset in part by
increases in accounts payable of

                                       35
<PAGE>

$1.3 million, accrued expenses of $1.6 million and deferred margin of $423,000,
as well as depreciation, amortization of stock compensation and other non-cash
expenses.

  Our investing activities used cash of $157,000 in 1997, $1.4 million in 1998
and $428,000 in the six months ended July 2, 1999. Our investing activities
primarily reflect purchases of computer equipment and other fixed assets.

  Our financing activities provided cash of $3.5 million in 1997, $9.3 million
in 1998 and $33.2 million in the six months ended July 2, 1999. The increases
in each period resulted primarily from the net proceeds from the issuances of
mandatorily redeemable convertible preferred stock and convertible promissory
notes, borrowings under bank lines of credit and advances from a related party.

  From inception, we have made capital expenditures of $2.0 million to support
our research and development, sales and marketing and administrative
activities. We expect to have capital expenditures of approximately $2.0
million for the remainder of 1999 and 2000. We also anticipate that our capital
expenditures will increase over the next several years as we expand our
facilities and acquire equipment to support expansion of our sales and
marketing and research and development activities.

  In September 1998, we entered into an equipment lease financing agreement
with a leasing corporation. This agreement provides for borrowings of up to
$1.0 million at an interest rate of 10.95% per annum, and those advances are
secured by our equipment, machinery and fixtures. We are required to repay
advances under the line in 34 equal installments. As of December 31, 1998 and
July 2, 1999, respectively, we had outstanding borrowings of $123,000 and
$105,000 under this lease line.

  We intend to continue to invest heavily in the development of new products
and enhancements to our existing products. Our future liquidity and capital
requirements will depend upon numerous factors, including the costs and timing
of expansion of product development efforts and the success of these
development efforts, the costs and timing of expansion of sales and marketing
activities, the extent to which our existing and new products gain market
acceptance, market developments, the costs involved in maintaining and
enforcing intellectual property rights, the level and timing of license
revenues, available borrowings under line of credit arrangements and other
factors. We believe that the proceeds from this offering, together with our
current cash and investment balances and any cash generated from operations and
from current or future debt financing, will be sufficient to meet our operating
and capital requirements for at least the next 12 months. However, it is
possible that we may require additional financing within this period. We have
no current plans, and we are not currently negotiating, to obtain additional
financing following the completion of this offering. The factors described in
this paragraph will affect our future capital requirements and the adequacy of
our available funds. We may be required to raise additional funds through
public or private financings, strategic relationships or other arrangements. We
cannot assure you that such funding, if needed, will be available on terms
attractive to us, or at all. Furthermore, any additional equity financing may
be dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. If we fail to raise capital when needed, our failure
could have a negative impact on our operating results and financial condition.

Recent Accounting Pronouncement

  In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. We will be subject

                                       36
<PAGE>

to SFAS No. 133 commencing in 2001. We have not yet determined what the impact
of SFAS No. 133 will be on our financial position or results of operations.

Year 2000 Readiness

 The Year 2000 Issue

  The year 2000 issue refers to the potential for disruption to business
activities caused by system failures or miscalculations which are triggered by
advancement of date records past the year 1999. For example, if software that
uses the calendar year in computations is not ready for the millennial calendar
change, it may interpret a 21st century date as a 20th century date (for
example, mistaking 2001 for 1901).

 Readiness of Our Products

  We have designed our products to be ready for the year 2000 calendar change.
We represent to our customers that each software and hardware product supplied
by us will accurately process date data from, into and between the 20th and
21st centuries and the years 1999 and 2000, including leap year calculations,
when used in accordance with the product documentation provided by us. We also
represent to our customers that upon notification of any year 2000 problems
with our products, we will remedy it by product repair or replacement.

  We do not represent to our customers that the networks to which our products
are connected will not have problems with year 2000 issues, since these
networks incorporate hardware and software products supplied by other
companies. We cannot evaluate the readiness of our products for year 2000 with
the innumerable combinations possible with other companies' products. We may,
therefore, face claims or complaints based on year 2000 problems related to our
customers' networks, even when we are not the source of their problem. We are
not aware of any such claims or complaints about us, but we may incur the cost
of legal or other defense and explanation of our product regardless of the
merits of such claims.

 Readiness of Our Systems and Facilities

  Our business may be affected by year 2000 issues. We have completed our
systems updates, upgrades and replacements of non-ready systems. Systems
include internal hardware and software as well as external services provided by
other companies, including contract manufacturing, product development,
information processing and facility services. We are not currently aware of any
unresolved year 2000 problems relating to any of our internal systems. We do
not believe that we have any significant systems that are not year 2000
compliant. The majority of our software, hardware and operating systems have
been acquired as new product in the last two years. Most of it is shrink
wrapped product and is still maintained by existing vendors. We do not believe
that we have any significant systems that contain embedded chips that are not
year 2000 compliant. Most of our hardware is made of branded components and has
been acquired in the last two years from manufacturers which are still in
business. We are not using legacy hardware or software that would be more
likely to have calendar issues because of its age.

 Cost of Product and Internal Systems Preparation

  Based on our assessment to date, we do not expect the total cost of year 2000
preparation and remediation to be material to our business. To date, our
preparation and remediation costs have not been material.


                                       37
<PAGE>

 Year 2000 Risk

  An internal or external business disruption caused by the year 2000 issue
could interrupt our operations and damage our relationships with our customers.
An internal disruption unique to us could give a comparative advantage to our
competitors. Failure of our internal systems and critical external services to
be ready for the year 2000 could delay order processing, issuing invoices or
development and shipment of products. The cost of recovery from failures could
be significant.

  Our customers' purchasing plans could be affected by year 2000 issues if they
need to expend significant resources to fix their existing systems. This
situation could divert funds and resources otherwise available for new product
purchase. In addition, some customers may wait to purchase our products until
after the year 2000, which may reduce our revenues in the near future.

  We are unable to determine at this time whether these or other year 2000
failures will occur and will have a material impact on our business, results of
operations, or financial condition. This inability is particularly due to the
potential scope of the year 2000 problem on and the inability to assure the
readiness of external service providers, including utilities, government
entities and other vendors. We have not developed, and we have no current plans
to develop in the near future, a contingency plan to deal with the effects of
this worst case scenario.

                                       38
<PAGE>

                                    BUSINESS

Overview

  We are a leading provider of server appliances. Server appliances are a new
category of network infrastructure devices that are specifically designed and
optimized to deliver one or a few network-based applications well. Server
appliances differ from general purpose servers, which are designed to support a
broad range of applications and are not optimized for any particular function.
Our server appliances enable organizations that could not previously establish
an online presence to do so easily, cost-effectively and reliably. As the
number of Internet users and businesses online increases, we believe the demand
for server appliances will continue to grow.

  Our principal product lines, the Cobalt Qube and Cobalt RaQ, enable our
customers to perform critical Internet-related applications including file
serving, web hosting and providing software applications over the Internet,
such as electronic mail and electronic commerce. We also offer network-attached
storage products, which provide overflow file storage for network users, and
network caching products, which enable more efficient bandwidth usage and
improve speed of Internet content delivery. Our products tightly integrate the
open source Linux operating system software with applications embedded in
dedicated hardware designs. This software includes a rich set of core
applications developed by us and by the open source software developer
community, as well as proprietary third party applications. Our use of the
Linux operating system enables us to leverage the rapid application development
cycles of the open source software community to reduce the time to market for
our new and innovative products.

  As of July 2, 1999, we had sold over 11,000 appliances to more than 1,000 end
user customers in more than 60 countries. We market and sell our products
globally through our direct sales force and our channel partners. Our target
customers are small- to medium-sized organizations, including businesses,
educational and government entities and branch offices of large organizations.
We also target web hosting and application service providers that offer
outsourced Internet services to these end users.

  Our objective is to become the leading global provider in the emerging market
for server appliances. We intend to increase market acceptance of server
appliances through a focus on providing solutions with a compelling value
proposition to targeted market segments. We intend to continue to encourage
open source and third party software application developers to create and
market software applications for our products through a comprehensive
partnership program. We expect to continue to base our products on industry
standard hardware components and the Linux open source operating system, so
that we can encourage our distributors, original equipment manufacturers and
web hosting and application service providers to sell our products by enabling
them to add value through modification of our solutions for specific customer
needs. We intend to establish Cobalt as the premier server appliance brand for
our target customers and third party application developers.

Industry Background

  The emergence of the Internet as the backbone of electronic commerce and
content delivery has created the opportunity for small- to medium-sized
organizations to significantly expand their market reach. The Internet allows
these organizations to benefit from powerful information technology previously
beyond their economic and technical resources. In order to create an online
presence, these organizations can purchase and deploy their own infrastructure
or rely upon outsourced infrastructure deployed by web hosting and application
service providers that offer services such as electronic mail and electronic
commerce.

  Traditionally, creating an online presence required the deployment of general
purpose servers and complex network technologies. General purpose servers are
designed to perform a large variety

                                       39
<PAGE>

of functions including providing database, electronic mail, network management,
file management and application services. However, the high cost of ownership
and the complexity of general purpose servers often prevent their adoption by
small- and medium-sized organizations seeking to deploy their own
infrastructure, due to limited budgets and scarce and costly technology skills.
The high cost and complexity also create challenges for web hosting and
application service providers that seek to profitably differentiate themselves
in an intensely competitive and price sensitive market by offering high value
added services to small- to medium-sized organizations.

  Server appliances have been developed to address the challenges faced by
small- to medium-sized organizations and web hosting and application service
providers in deploying their Internet infrastructures. Because server
appliances are explicitly designed and optimized to provide one or a few
dedicated applications, they can:

  .  be easy to install, use and administer;

  .  be easy to integrate with other infrastructure components;

  .  have a low acquisition price and low total cost of ownership; and

  .  deliver robust and scalable performance on an ongoing basis.

  These benefits enable small- to medium-sized organizations to rapidly and
cost-effectively establish an online presence through the use of server
appliances. These benefits also enable larger organizations to easily
complement their existing general purpose servers by deploying application
specific server appliances and thereby reduce conflicting capacity demands on
their general purpose servers. In addition, these benefits allow web hosting
and application service providers to increase profitability by offering value
added services. In situations that may require the dedication of a single
server to a single customer to provide customized services, server appliances
enable these providers to avoid the high cost and complexity of a general
purpose server infrastructure.

  Server appliances can be developed either with proprietary or open source
operating systems, such as Linux. Open source software uses publicly available
source code that can be copied, modified and distributed by any software
developer with very few restrictions. Unlike proprietary, or closed, software
products whose development is typically controlled by a single company, open
source software is developed by a community of independent developers who
permit others to access their improvements and modifications freely. Open
source software, such as Apache web server, Perl and Sendmail, is gaining
increasing acceptance, particularly among web hosting and application service
providers. Open source software may provide the following benefits to server
appliances:

  .  Better application integration: because the source code is open, server
     appliance vendors may have a better understanding of the interaction of
     all system components, which allows them to more tightly integrate their
     applications with the operating system and improve system stability.

  .  Lower cost base: open source operating systems and software are
     available at no cost and therefore can be incorporated in a system
     without the need for royalty payments or significant internal research
     and development costs.

  .  Shorter development cycles: the collaborative nature of the worldwide
     developer base for open source software enables server appliance vendors
     to improve their products more quickly than they can improve products
     based on proprietary operating systems.

  Dataquest, an industry research firm, expects the server appliance market to
grow from $2.2 billion in 1999 to approximately $15.8 billion in 2003,
representing a 64% compound annual growth rate. Dataquest believes that server
appliances based on open source operating systems, including

                                       40
<PAGE>

Linux, will be a significant market segment. Dataquest expects the Linux-based
server appliance market to grow at approximately 69% a year between 1999 and
2003 and represent approximately 24% of the total server appliance market, or
$3.8 billion, in 2003. The web hosting and application service provider market
represents an important part of the overall server appliance market
opportunity. Forrester Research estimates that Internet hosting revenues will
increase from approximately $2.0 billion in 1999 to approximately $14.6 billion
by 2003.

  In response to the growth and opportunities in the server appliance market,
several server appliance vendors have emerged. However, many of the server
appliances available today do not deliver fully on the promise of the benefits
of server appliances. Some of these server appliances use closed, proprietary
architectures that restrict users' abilities to integrate them with other
applications and services. In order to achieve ease of use and low cost, others
offer systems that are not easily scalable or offer insufficient power to
adequately perform the functions for which they were designed. In addition,
server appliances offered by more established server vendors are typically
scaled down versions of their general purpose servers that fail to achieve an
optimal mix of low cost, ease of use, scalability, openness and performance.
Finally, some general purpose server vendors have long-standing relationships
with third party operating system and application vendors that may limit their
ability to aggressively pursue the opportunity for open source based server
appliances.

The Cobalt Solution

  We are a leading provider of a new category of network infrastructure devices
known as server appliances. Our products deliver network-based applications in
a flexible and reliable manner that is simpler and more cost-effective than
other current solutions. Our server appliances tightly integrate a version of
the Red Hat Linux operating system that we have optimized for our products, a
rich set of core applications which have been developed by us and the open
source software developer community, and industry-standard hardware components.
We believe that we are well positioned to become the leading provider of server
appliance solutions for small- to medium-sized organizations and web hosting
and application service providers by offering the following advantages:

 Complete, integrated solutions

  Our products provide our customers with complete solutions that do not
require additional hardware or software to cost-effectively deliver the
specific applications for which the product is designed. Our use of open source
software and industry standard hardware enables us to fully understand the
interaction of all components of the system and design a more tightly
integrated solution. In addition, our products provide significant advantages
over other servers based on open source operating systems that are not designed
to fully integrate the applications and operating system to perform a specific
function. The tight integration of our software applications, operating system
and hardware results in a more reliable and stable product that is less likely
to cause disruptions in network services. This integration also enhances the
security of our solutions and enables us to optimize the hardware design in a
cost-effective manner.

 Ease of installation and use

  Our products are pre-configured and include a simple set up procedure
designed to require less than 15 minutes for deployment by a non-technical
person. In addition, our products are easy to use, can be administered from any
Internet-accessible location and require minimal space and power. Our web-based
user interface shields the user from technical complexities and minimizes the
need for trained information technology staff.


                                       41
<PAGE>

 Low cost of ownership

  We design our server appliances to deliver robust performance at a
significantly lower installed cost than general purpose servers. We can sell
our products at lower prices because our operating systems are based on
royalty-free open source software, and we avoid the use of unnecessary hardware
components by optimizing our products to perform a specific function. Our
products require limited skills and time to deploy and do not require a network
shut-down to install or add additional appliances. In addition, the software
tools included in our products minimize ongoing system management and support
efforts that would otherwise be provided by trained information technology
staff, thus greatly reducing the appliances' lifetime cost of ownership.

 Building blocks for future growth

  As the amount of data traffic handled by a Cobalt server appliance increases,
additional units can be added to increase capacity at little incremental
expense beyond the cost of the units themselves. The ability to easily add
additional server appliances provides an evolution path that allows customers
to develop their network infrastructure according to their needs without a high
upfront investment. Our low cost server appliances are designed to be building
blocks for scalable solutions. We are developing a software tool to enable our
Cobalt RaQ products to interoperate in a fully scalable fashion. We expect this
software tool to be released in early 2000.

 Stable, open source development environment

  Our products use a version of the Red Hat Linux operating system, an open
source operating system that undergoes a continuous cycle of enhancement by a
global community of open source developers. We optimize Red Hat Linux for our
server appliances by eliminating large portions of general purpose source code
that is unnecessary for a dedicated server appliance and tailoring the
remaining source code to work effectively with our dedicated hardware. Our open
source operating system is tightly integrated with our hardware components to
provide a reliable and stable environment upon which we and third party
developers can develop applications with a rapid time to market. In addition,
because our source code is royalty free and open, we believe our products will
attract a large community of third party application developers. We enjoy the
benefits of our optimizations exclusively for a short period of time, then
publish them for further enhancement by the open source development community.

 Cross platform compatibility

  Our products employ an Internet standards-based architecture that enables
them to function with other network devices that operate on a variety of
operating systems, including Windows NT and UNIX. By being cross platform
compatible, our products enable our customers to realize the benefits of our
products as part of their existing network infrastructure.

The Cobalt Strategy

  Our objective is to become the leading global provider in the emerging market
for flexible, low cost server appliance products. To accomplish our objective,
the key elements of our strategy include:

 Increase Market Acceptance of Server Appliances

  We intend to increase market acceptance of server appliances through a focus
on providing solutions with a compelling value proposition to targeted markets.
We intend to continue to offer products that complement general purpose servers
by removing one or more specific, resource

                                       42
<PAGE>

intensive functions from a network's general purpose server to improve network
performance and stability. Our approach to increase market acceptance of server
appliances is to:

  .  Add new applications. We intend to continue to deliver high value
     results with application specific products. Our current proprietary
     applications include solutions for web hosting, electronic mail, web
     publishing, electronic commerce, file management and network services.
     We intend to leverage this experience to expand the scope of our
     software applications to address other specific needs of our target
     customers. In addition we will continue to integrate third-party
     applications into our products.

  .  Simplify management. We intend to further enhance the ease of use and
     reliability of our products. For example, we are working to develop a
     management tool that enables outsourced hosting and application service
     providers to manage, troubleshoot and monitor a number of server
     appliances from a single console.

  .  Add new hardware designs. We intend to continue to develop hardware
     designs that address our customers' specific needs. We expect to
     continue to rapidly introduce innovative, new products with enhanced
     functionality that incorporates customer feedback and demands.

  .  Continue to offer low prices. We expect to continue to offer our server
     applications at low cost by using readily available standard hardware
     components and leveraging a royalty-free Linux-based operating system.

  .  Enable partners to add value. We intend to continue to design our
     products with our open source operating system and application
     interfaces to allow channel partners to add value through software
     applications that they sell with our products. This design strategy will
     also enable web hosting and application service providers to provide
     value added services.

 Attract and support application developers

  Ensuring the existence of a rich set of software applications is a vital
requirement for offering complete, tightly integrated solutions and driving the
success of our server appliances. We intend to actively promote third-party
development of software applications for our products through a comprehensive
partnership program with independent, open source software developers. We
believe that our use of the Linux operating system is a fundamental element of
this program, since an open source operating system better enables developers
to create optimized and reliable high value added applications. We believe
there are currently over 40 applications developed by third parties for our
product platform. We intend to leverage our position in the Linux community in
order to expand upon the base of third party developers for our products
significantly by providing a high volume channel for their Internet and
electronic commerce applications. In order to encourage the continued growth of
the Linux community, we will continue to give back to the community those
elements of source code that we write that are relevant to the Linux kernel,
while still developing a proprietary base of intellectual property.

 Develop and leverage partnerships to enhance our market reach

  We base our products on industry standard hardware components and our open
source operating system to encourage channel partners, original equipment
manufacturers and web hosting and application service providers to add value by
modifying our solutions to address specific needs of our customers. Our
leveraged distribution strategy includes:

  .  Multi-tier sales channel. We believe that a highly leveraged sales
     channel is critical for effectively penetrating our target markets. We
     make it attractive for our distribution, reseller and system integrator
     partners to resell our solutions by maximizing the opportunity for them
     to add value to our products. In order to effectively reach small- to
     medium-sized

                                       43
<PAGE>

     businesses, we intend to continue to enter into agreements with many of
     the world's leading distributors, resellers and system integrators. We
     also intend to continue to expand our sales channel globally, while
     strengthening our direct sales efforts in key geographies where use of
     the Internet is growing most rapidly.

  .  Web hosting and application service providers. We intend to promote the
     sale of our products by leveraging our relationships with outsourced,
     dedicated web hosting and application service providers. We believe our
     highly-focused approach to serving this market provides us with an
     advantage over competitors. Through our direct sales model we have
     developed relationships with many of the prominent web hosting and
     application service providers that are competing effectively by offering
     higher revenue, value added application and hosting services. We expect
     to leverage our leadership in this market by assisting our customers to
     market to their customers.

  .  Original equipment manufacturer partnerships. We also intend to enter
     into original equipment manufacturer partnerships. Our growing presence
     in the server appliance market makes us an appealing partner for general
     purpose server vendors. We intend to form strategic partnerships with
     original equipment manufacturers for our products in order to rapidly
     expand our market reach and become the technology provider of choice for
     server appliances.

 Establish a strong brand identity

  We intend to establish Cobalt as the premier server appliance brand for our
target customers and third party application developers. We intend to continue
to create brand awareness with innovative, award winning products, progressive
product styling and creative marketing. We believe that this distinctive brand
identity is an important component of our efforts to increase market
acceptance of server appliances, expand participation in our software
development program and develop our reputation within a broad community of
potential partners and customers. We intend to actively seek new opportunities
to refine and extend our brand recognition.

 Provide focused server appliances for specific needs

  We intend to continue to develop and release products that meet specific
customer needs while retaining their relatively low prices and optimized
functionality in comparison to both general purpose servers and other server
appliances. For example, our Cobalt Qube and Cobalt RaQ products are available
with a user interface in the Japanese language, and we are developing several
other language specific user interfaces. Our Cobalt RaQ products are designed
specifically to minimize space usage, because more effective use of rack space
in a service provider's facility can increase the number of customers that the
service provider can host from a single facility. Our target customers are
small- to medium-sized organizations, including small- to medium-sized
businesses, educational and governmental entities and branch offices of large
organizations. We also target the web hosting and application service
providers that offer outsourced Internet services to these end users.

Products

  All of our products are built on a common core software and hardware
architecture that enables us to develop and market new products rapidly. We
have introduced 16 products based on our four principal product lines in the
last 18 months. Our products are based on the Linux operating system, an
operating system known for its high reliability, performance, scalability,
customizability and low memory requirements. We have optimized the Red Hat
Linux operating system to improve the functionality and reliability of our
products. We have invested in the development of proprietary technology for
our products that includes core applications, software toolkits, management
tools, system maintenance daemons and clustering technologies.

                                      44
<PAGE>

  We also have an application developer program through which we encourage
third-party software developers to create additional software applications for
our products. Examples of those applications are electronic commerce engines, a
medical imaging file server program and a cellular telephone voicemail server
program. We believe that end users will benefit from our open source model by
having many additional applications available to them. We provide the relevant
portions of our source code to third party software developers to assist them
in creating applications that are closely integrated with our products'
operating systems, applications and hardware. We provide other assistance to
application developers including telephone support, electronic mail bulletin
boards and a web site. We believe that there are currently more than 40
applications that have been developed by third parties for our products. We
believe that other third party applications for our products are currently in
development.

  The following table reflects our product lines:

<TABLE>
<CAPTION>
                Date of First    Starting
 Product Line  Commercial Sale  List Price               Function
 ------------  ---------------  ----------               --------
 <C>           <C>              <C>        <S>
 Cobalt Qube   March 1998         $  999   Small- to medium-sized organizations
               (1st generation)             can use these products for
                                            dedicated functions such as
               January 1999                 electronic mail, file servers and
               (2nd generation)             print servers or to provide
                                            Internet access and web serving. We
                                            introduced a Japanese language user
                                            interface for the Cobalt Qube in
                                            May 1998.

 Cobalt RaQ    September 1998     $1,299   Web hosting and application service
               (1st generation)             providers can use our Cobalt RaQ
                                            products for dedicated hosting
               March 1999                   services. The compact design of the
               (2nd generation)             product is intended to facilitate
                                            its use in standard size networking
                                            facility racks. We introduced a
                                            Japanese language user interface
                                            for this product in December 1998.
 Cobalt Cache  July 1998          $1,899   Customers can use our Cobalt
               (1st generation)             CacheQube and CacheRaQ products to
                                            provide faster web response time
               April 1999                   and eliminate redundant traffic
               (2nd generation)             travelling over wide area network
                                            links. These products are targeted
                                            at markets where bandwidth is at a
                                            premium and public communications
                                            networks are less developed.
 Cobalt NAS    April 1999         $1,799   Customers can use the Cobalt NASRaQ
                                            to add storage to an existing
                                            network. For users of the network,
                                            the Cobalt NASRaQ appears to be
                                            another hard drive.
</TABLE>

 Industry Recognition of Our Products

  Our Cobalt Qube products have received recognition for their innovation and
quality, including the following industry awards:

  .  ""Best of Show", Showcase, January 1999

  .  ""Innovation of the Year", PC Computing, November 1998

  .  ""Most Valuable Product Award--Small Business Server Category", PC
     Computing, November 1998

                                       45
<PAGE>

  .  ""Editor's Choice", PC Magazine, July 1998

  .  ""Best New System Hardware", VARVision industry show, Spring 1998

  .  ""Best of Show", VARVision industry show, Spring 1998

  .  ""Best New Hardware Product", Reseller XChange, March 1998

  .  ""Best of Show", Reseller XChange, March 1998

  In addition, our other products have received industry awards including the
following:

  .  The Cobalt RaQ for "Best Security", Internet World industry show, July
     1999

  .  The Cobalt CacheRaQ for "Editor's Choice", Network Computing, May 1999

  .  The Cobalt CacheQube for "Best of Show for Infrastructure Hardware",
     Internet World industry show, July 1998

Technology

  We have invested in developing proprietary technology for our products that
includes our core operating system, core applications, software toolkits,
management tools, system maintenance daemons and clustering technologies.

 Core Operating System

  Our products are based on the Linux operating system, an operating system
known for its high reliability, performance, scalability, customizability and
low memory requirements. We recognize the many benefits that an open source
operating system, such as Linux, provides for the development of server
appliances. Linux is open source software that is constantly being improved by
a broad base of developers without requirements for royalty obligations to the
developers. We can customize existing Linux operating system applications or
adopt different versions of Linux without lengthy product transitions. We have
free access to the entire Linux source code and have modified Red Hat's version
of the Linux operating system to optimize it for use in our products.

 Core Applications

  Our server appliances offer a rich set of core applications such as web
serving, domain name serving, file transfer protocol, electronic mail,
discussion groups and web authoring. We provide integrated and optimized
royalty-free industry standard software such as Apache, a web serving software,
BIND, a file serving application, Perl, a scripting language for web site
development, and Sendmail, an electronic mail program. We also provide our
internally developed software for discussion groups and web page authoring as
integrated features of our Cobalt Qube and Cobalt RaQ products. We are
investing significant resources in deploying, testing and tightly integrating
these diverse applications with consistent, user friendly interfaces.

 Software Toolkit

  We have developed and are continuing to enhance a proprietary software
toolkit that provides a consistent interface between the applications and the
operating system. Our software toolkit enables us to provide uniform browser-
based user interfaces across all server functions and applications. Our custom
software toolkit overcomes the complexity generally associated with setting up,
managing, monitoring and using various complex network daemons and
applications. We intend to continue to develop and improve interfaces to our
software to assist third parties such as web hosting and application service
providers and value added resellers to add software applications to our
platform.

                                       46
<PAGE>

 System Maintenance Daemons

  To improve reliability and reduce cost of ownership of our server appliances,
we have developed a set of software daemons, which are software programs that
continuously monitor the state of the various software and hardware functions
on the server to permit troubleshooting. Our system maintenance daemons
automatically inform the user of excessive server resource utilization and
recommend corrective action. Our system maintenance daemons also attempt to fix
any problems automatically that the software detects and proactively inform the
user if an attempted solution was unsuccessful. The proactive problem
resolution enhances the overall reliability of the appliance while reducing
management overhead. Our products also support industry standards including
Simple Network Management Protocol.

 Clustering Technologies

  Our products incorporate our proprietary clustering technologies that
distribute network usage across a number of server appliances for improved
network performance. These technologies allow our server appliances to be
clustered without using expensive load balancing equipment. For example, these
technologies enable a user to deploy additional Cobalt CacheRaQ units as needed
to support increased network usage.

 Management Tools

  We have several management tools, such as our maintenance and restore
toolkit, that assist the user to perform maintenance and administrative tasks
on our server appliances. In addition, we are developing a web-based remote
management tool for monitoring the status and configurations of a large number
of our server appliances on a single network. In addition, this management
software will allow systems administrators to provide software upgrades to
multiple server appliances and configure multiple machines from a single
management console in an easy to use and cost effective manner.

 Embedded Processor Hardware Platform

  We enable our products to deliver high performance cost effectively through
our proprietary hardware and motherboards that leverage standard components
including hard disk drives, memory and processors. We have eliminated
unnecessary components, thus reducing cost and power consumption and increasing
reliability. With the compact size of our Cobalt RaQ products, our service
provider customers are able to achieve three to four times the server density
of general purpose servers, a key advantage in the web hosting and application
service provider market where rack space is at a premium.

Customers

  As of July 2, 1999, we had sold more than 11,000 of our server appliance
products to more than 1,000 end user customers in over 60 countries. Our direct
customers include regional and national web hosting and application service
providers in the United States, in addition to our channel partners. Our
indirect customers are primarily composed of small- to medium-sized
organizations and web hosting and application service providers. With respect
to both our direct and indirect sales, customers often buy for a single
location, department or division, and then, based upon the initial success of
the products, later expand their use of our products into other parts of the
organization. In 1998 and the six months ended July 2, 1999, no single end user
customer accounted for more than 10% of our revenues.

Sales and Marketing

  We sell our products through our direct sales force and channel partners
including distributors, resellers and system integrators. Historically our
direct sales efforts have focused on regional and

                                       47
<PAGE>

national web hosting and application service providers in the United States. We
intend to continue and expand our sales efforts to web hosting and application
service providers. We also intend to pursue sales to the growing number of web
hosting and application service providers outside of the United States. We have
relied on original equipment manufacturers for only a limited number of sales,
but we intend to explore opportunities to work with additional original
equipment manufacturers in the future.

 Direct Sales

  The primary function of our direct sales force is to generate demand for our
products that is fulfilled either directly or through channel partners. As of
July 2, 1999, we had a direct sales organization of 13 persons. We encourage
our direct sales staff to work with potential web hosting and application
service provider customers regardless of whether the customer ultimately
purchases our product from us or one of our channel partners. We believe this
model enables us to encourage proliferation of our products in this key
customer group. Our direct sales force uses a team approach, which we believe
allows us to achieve better control of the sales process and respond more
rapidly to customer needs. Our direct sales force for North America is
distributed throughout the United States. In 1998 and the six months ended July
2, 1999, respectively, 46% and 14% of our net revenues were from direct sales,
substantially all of which was from the United States.

  We opened sales offices in Japan, the United Kingdom and Germany in 1998.
During the six months ended July 2, 1999, we established direct sales
activities in the Netherlands. Although 44% and 56% of our net revenues were
from outside the United States in 1998 and the six months ended July 2, 1999,
respectively, almost all of our direct revenues were from the United States.

 Channel Partners

  As the server appliance market has matured, we have developed a multi-tier
sales channel that is comprised of distributors, resellers and system
integrators. Our channel consisted of over 250 partners in 30 countries as of
July 2, 1999. We believe that as the market for server appliances matures,
sales through channel partners will represent an increasing percentage of our
sales.

  Sales to our channel partners represented 86% of our net revenues in the six
months ended July 2, 1999. Channel partner sales in the United States and
outside the United States were approximately 45% and 41% of net revenues,
respectively, in the six months ended July 2, 1999. Our top five channel
partners based on net revenues in the six months ended July 2, 1999 were:

<TABLE>
   <S>             <C>
   Ingram Micro    Nissho Electronics (Japan)
   Merisel         Tech Data
   Mitsui (Japan)
</TABLE>

  In addition to delivering our server appliances to small web hosting and
application service providers and small- to medium-sized organizations,
distributors enable us to more effectively pursue a number of vertical markets.
Vertical markets and applications such as branch offices of large
organizations, government, education and web-based direct resellers are targets
of our channel partners.


                                       48
<PAGE>

 Original Equipment Manufacturers

  We recently began utilizing original equipment manufacturers in our selling
efforts. We have initiated several original equipment manufacturer
relationships for our Cobalt Qube products. We plan to expand our selling
efforts through original equipment manufacturers and are currently evaluating
opportunities, particularly with respect to sales of our Cobalt Qube products.

 Marketing Programs

  To support our growing sales organization and channel, we have devoted
significant resources in the past year to building and launching a series of
marketing campaigns. Our marketing efforts have included a number of programs,
such as seminars, industry trade shows, mailings to resellers, analyst and
press tours, print and online advertising and public relations. We believe
these marketing programs have resulted in better awareness of our Cobalt brand.

  In March 1999, we announced the launch of a two-tier distribution marketing
program. Our True Blue Partner and True Blue Sapphire Partner programs are for
web hosting and application service providers that resell a specified number of
Cobalt products. These web hosting and application service providers resell our
products for dedicated web hosting with our marketing support. We have similar
True Blue and True Blue Sapphire programs for value added resellers. In
addition to partner development activities, we also actively work on end user
education.

 Customer Advocacy and Support

  We believe that high quality customer service and support is critical to the
successful marketing and sale of our products. We are developing a
comprehensive service and support organization to manage customer accounts and
expect to provide an increasing level of support as our products are deployed
across a range of customers. We provide support for our products and services
primarily from our Mountain View, California location. We plan to establish
additional service and support sites internationally commensurate with customer
needs.

  Our products are designed to be deployed quickly and effectively by our
customers and to require minimal support from us. We offer various levels of
service and support programs to meet pre- and post-sale technical requirements.
Our CobaltCare program offers extended warranties, advanced product
replacement, telephone and electronic mail trouble shooting assistance and
other support and services. We price our CobaltCare variably depending on the
level of support selected by the customer. We also offer a variety of services
specifically tailored for web hosting and application service providers and
resellers that provide immediate access to the latest support information,
white papers and answers to frequently asked questions.

Manufacturing

  We use contract vendors to manufacture our products, and they perform tasks
that include material procurement, assembly, test, packaging, warehousing and
shipment. Utilizing a contract manufacturer enables us to reduce investment in
manufacturing capital and inventory warehousing costs. Our internal
manufacturing expertise is primarily focused on product testability,
manufacturability and the transfer of products from development to
manufacturing. However, we also manage the evaluation and selection of certain
key components.

  In August 1999, we changed our contract manufacturer to SMTC Manufacturing.
We also use Flash Electronics to a lesser extent. Our agreement with SMTC
Manufacturing requires us to submit three months of rolling purchase orders and
rolling forecasts for the three months immediately following the purchase order
period. In any given month we have the ability to double

                                       49
<PAGE>

our forecast and require them to fill those orders. However, if we inaccurately
forecast demand for our products, SMTC Manufacturing may be unable to provide
us with adequate manufacturing capacity. Purchase prices will fluctuate based
on changes in component prices throughout the one year contract period.
However, SMTC Manufacturing is obligated to reduce certain component costs by a
fixed percentage in each quarter. We may be liable for materials that SMTC
Manufacturing purchases on our behalf that we cannot use, cannot be cancelled
before receipt or are unique parts otherwise unusable by SMTC Manufacturing.
The agreement restricts our ability to reschedule orders and allows us to
cancel existing orders subject to penalties of up to the total purchase price.
SMTC Manufacturing provides warranties on workmanship and pass-through
warranties on component parts.

  SMTC Manufacturing purchases most of the key components used to manufacture
our products. We obtain some of these key components, such as our custom
printed circuit boards, sheet metal parts and chassis, directly from sole
sources and other industry standard components, such as our processors and
power supplies, from sole or limited sources. SMTC Manufacturing may not be
able to obtain adequate supplies of components to meet our customers' delivery
requirements. Alternatively, excess inventories may be accumulated by SMTC
Manufacturing for our account.

  In order to reduce the costs of sales, we anticipate that we may relocate a
portion of our manufacturing operations from SMTC Manufacturing's manufacturing
facility in Milpitas, California to one of its offshore manufacturing
facilities during 2000. Additionally, we may consider moving the outsourced
manufacturing to other new locations or to a new contract manufacturer. These
relocations could be time consuming and expensive and there can be no assurance
that such moves would not disrupt the manufacturing of our products. Such
disruptions could cause us to lose net revenues and damage our customer
relationships.

  Prior to August 1999, our primary contract manufacturer was an electronics
component supply chain company that procured materials and subcontracted the
assembly, test, packaging and shipment of our products to a subcontract
manufacturer. This contract manufacturer experienced difficulty in obtaining
selected components and coordinating with the subcontract manufacturer for the
manufacture of our products in the quarter ending July 2, 1999. We resolved
this difficulty in the quarter ended July 2, 1999 by internally managing
procurement of specified components and qualifying and commencing production of
our products with a second contract manufacturing partner, Flash Electronics,
in May 1999. We subsequently switched to SMTC Manufacturing as our primary
contract manufacturer in August 1999.

  As our needs and the needs of our customers continue to evolve, we plan to
reassess our manufacturing requirements on a periodic basis and address changes
as we consider necessary.

Research and Development

  Our research and development expenses were $1.1 million in 1997, $3.5 million
in 1998 and $2.8 million in the six months ended July 2, 1999. We believe that
our research and development efforts are essential to our ability to deliver
innovative products that address the needs of the market and help evolve the
capabilities of server appliances. As of July 2, 1999, our staff included
personnel with expertise in several key areas, including 22 people engaged in
software-related activities, 9 people engaged in hardware-related activities
and 3 people involved in other research and development activities.

  We recognize the need to integrate new and enhanced technologies into our
products and to continue to extend the open architecture of our products' Linux
operating system. In addition to the

                                       50
<PAGE>

development of proprietary core technologies, we plan to continue partnerships
with other leading providers of Linux technologies, products and services to
jointly develop architectures and industry standards.

Competition

  We compete in markets that are new, intensely competitive, highly fragmented
and rapidly changing. We face competition primarily from server vendors that
provide solutions for distributed computing systems.

  Companies offering competitive products vary in scope and breadth of products
and services offered and include:

  .  general purpose server manufacturers such as Compaq Computer,
     Dell Computer, Hewlett-Packard Company, IBM, Sun Microsystems and VA
     Linux, some of which, including Compaq, IBM and Sun Microsystems, have
     recently begun manufacturing dedicated versions of their general purpose
     server products for sale as server appliances;

  .  server appliance vendors such as Encanto Networks, Freegate, Intel and
     Whistle Communications (recently acquired by IBM);

  .  network caching companies such as CacheFlow and Novell; and

  .  network attached storage vendors such as Meridian (recently acquired by
     Quantum) and Network Appliance.

  We believe we compete favorably on the principal factors that will draw end
users to a server appliance product, which include:

  .  depth of product functionality;

  .  ability to work with network components utilizing other operating
     systems such as Windows NT;

  .  scalability;

  .  product quality and performance;

  .  open systems architecture;

  .  strength of channel;

  .  brand name recognition;

  .  competitive pricing; and

  .  customer support.

  We expect competition in the server appliance market to increase
significantly as new companies enter the market and current competitors expand
their product lines and services. Many of these potential competitors are
likely to enjoy substantial competitive advantages including:

  .  greater resources that can be devoted to the development, promotion and
     sale of their products;

  .  more established sales channels;

  .  greater software development experience; and

  .  greater name recognition.

Intellectual Property

  We have invested significantly in the development of proprietary technology
for our products. Key areas of intellectual property development relate to the
tight integration of embedded software with industry standard platforms and
components, intuitive user interfaces that provide easy to use

                                       51
<PAGE>

appliance functionality and clustering technology. Our success depends
significantly upon our proprietary technology. Additionally, we have integrated
third party intellectual property into our products. We may occasionally reach
agreements with third parties to provide additional functionality for our
products and may offer third parties our technology for integration into
products on an original equipment manufacturer or other basis. We have also
trademarked the Cobalt name as well as our individual product names in the
United States and are evaluating trademark registration in certain
international markets.

  We currently rely on a combination of copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights. We protect our software, documentation and other written
materials under trade secret and copyright laws, which afford only limited
protection. We do not hold any patents and currently have no patent
applications pending. We cannot be certain that any patents we seek will be
issued or that, if issued, those patents will not be challenged. We have
registered and applied for registration of some of the service marks and
trademarks we use with the appropriate state agencies and the United States
Patent and Trademark Office. We will continue to analyze whether we should
register additional service marks and trademarks.

  We generally enter into confidentiality agreements with our employees,
consultants, business partners and major customers. Despite our efforts to
protect our proprietary rights and other intellectual property, unauthorized
parties may attempt to copy aspects of our products, obtain and use information
that we regard as proprietary or misappropriate our copyrights, trademarks,
trade dress and similar proprietary rights. In addition, the laws of some
foreign countries do not protect proprietary rights to as great an extent as do
the laws of the United States. Our means of protecting our proprietary rights
may not be adequate. In addition, our competitors might independently develop
similar technology or duplicate our products or circumvent any patents or our
other intellectual property rights.

  Cobalt, Cobalt Networks, the Cobalt logo, Cobalt Qube, Cobalt RaQ, Cobalt
NASRaQ, Cobalt CacheRaQ and RaQ are trademarks of our company. This prospectus
also contains brand names, trademarks or service marks of companies other than
Cobalt, and these brand names, trademarks and service marks are the property of
their respective holders.

Employees

  As of July 2, 1999, we had 101 full time employees, of whom 34 were engaged
in research and development, 44 in sales and marketing and 23 in finance,
administration and operations. None of our employees is represented by a labor
union. We have not experienced any work stoppages and consider our relations
with our employees to be good.

Facilities

  Our principal offices are located in a 28,000 square foot facility in
Mountain View, California. Our lease on the Mountain View facility expires in
December 2003. We expect that we will need additional space in the next twelve
months and have obtained an option to lease a 30,000 square foot facility
contiguous to our current facility to expand our Mountain View operations. We
also have sales and marketing offices in Germany, Japan, the Netherlands and
the United Kingdom. None of the leases for those offices is for a period of a
year or longer.

Legal Proceedings

  In December 1998, CUBE Computer Corporation sued us in the United States
District Court for the Southern District of New York for trademark
infringement. CUBE, an original equipment manufacturer of personal computers,
argues that this alleged infringement resulted from our use of "Qube" in
connection with our products. We intend to defend this matter vigorously. We
believe, based on currently available information, the resolution of this
matter will not adversely affect us.

                                       52
<PAGE>

                                   MANAGEMENT

Executive Officers and Directors

  Cobalt's officers and directors and their ages as of July 2, 1999 are as
follows:

<TABLE>
<CAPTION>
            Name             Age                   Position
            ----             ---                   --------
 <C>                         <C> <S>
 Gordon A. Campbell.........  55 Chairman of the Board
                                 Chief Executive Officer, President and
 Stephen W. DeWitt..........  33 Director
                                 Chief Technology Officer and Vice President,
 Vivek Mehra................  35 Products
 Gary A. Martell............  36 Chief Operating Officer
                                 Vice President, Finance, Chief Financial
 Kenton D. Chow.............  34 Officer and Secretary
                                 Vice President, Sales, Americas and Asia
 Patrick J. Conte...........  40 Pacific
 Mark H. Orr................  49 Vice President, Business Development
 George M. Korchinsky.......  58 Vice President, International Sales
 Kelly M. Herrell...........  33 Vice President, Marketing
 Jordan A. Levy.............  43 Director
</TABLE>

  Gordon A. Campbell, one of our co-founders, has served as our Chairman and a
director since October 1996. Mr. Campbell has been a managing member of
TechFund Capital, a venture capital fund, since August 1997. In 1993, Mr.
Campbell created Techfarm Management, Inc., an incubation company for new
technology companies including Cobalt Networks. Mr. Campbell has founded and
been involved in the start-up of numerous Silicon Valley companies, including
3Dfx Interactive, a semiconductor graphics company, and CHIPS and Technologies,
Inc., a semiconductor and related device company. In addition to his role at
Cobalt Networks, Mr. Campbell serves as chairman of the board of 3Dfx
Interactive and is a member of the boards of directors of 3Com Corporation, a
network infrastructure company, and Bell Microproducts, a computer components
company.

  Stephen W. DeWitt has served as our President and Chief Executive Officer
since February 1998. Prior to joining Cobalt, Mr. DeWitt was Vice President and
General Manager of the Enterprise Network Management Business Unit at Cisco
Systems, a network infrastructure company, from January 1997 to February 1998.
Mr. DeWitt also served as Vice President of Enterprise Marketing for Cisco from
January 1996 to February 1997. From September 1994 to January 1996, he was Vice
President of Marketing for Symantec Corporation, a system utilities,
development tools, and contact management software company. From June 1992 to
September 1994, Mr. DeWitt served as General Manager of Symantec's Canadian
subsidiary. Mr. DeWitt holds a Bachelor of Science in Finance and Economics
from Babson College in Wellesley, Massachusetts.

  Vivek Mehra, one of our co-founders, has served as our Chief Technology
Officer since September 1999 and as our Vice President of Products since
November 1996. Mr. Mehra leads our engineering and product management teams.
Mr. Mehra also served as one of our directors from October 1996 to August 1999.
From January 1992 to November 1996, Mr. Mehra was a senior architect and
systems engineering manager at Apple Computer, a computer design and
manufacturing company. From March 1991 to January 1992, Mr. Mehra was a
developer at Silicon Graphics, a high performance workstation company. From
July 1988 to March 1991 Mr. Mehra served as a principal engineer for ASIC and
Board Design at Digital Equipment Corporation, a computer maker that is now a
division of Compaq Computer. Mr. Mehra holds a Bachelor of Science in
Electronics and Electrical Communications from Punjab University, India and a
Master of Science in Computer Engineering from Iowa State University.

  Gary A. Martell has served as our Chief Operating Officer since July 1999.
From February 1988 to July 1999, Mr. Martell served as Chief Financial Officer
and Senior Vice President of Operations at Wyse Technology, a computer hardware
company. Mr. Martell holds a Bachelor of Science in Finance and Computer
Science from the University of Massachusetts at Amherst.

                                       53
<PAGE>

  Mark H. Orr, a co-founder of our company, has served as our Vice President of
Business Development since October 1998. Mr. Orr served as our Vice President
of Marketing and Business Development from March 1997 to September 1998. From
August 1994 to February 1997, Mr. Orr served in various capacities at Apple
Computer, including most recently as a business development manager. Mr. Orr
holds a Bachelor of Science in Mathematics from the University of Washington
and a Masters of Business Administration from the Stanford University Graduate
School of Business.

  Kenton D. Chow has served as our Vice President of Finance and Chief
Financial Officer since April 1998 and as our Secretary since September 1999.
From October 1996 to January 1998, Mr. Chow served as the Director of Finance
at OpenTV, Inc., an interactive software developer for digital television. From
January 1995 to October 1996, Mr. Chow served as Controller, Worldwide Sales of
Symantec Corporation. Mr. Chow served as Senior Manager, Financial Reporting at
Bay Networks, Inc., a networking company, now part of Nortel Networks, from
November 1991 to January 1995. Prior to that time, Mr. Chow was a Senior
Associate at PricewaterhouseCoopers LLP. Mr. Chow is a certified public
accountant. He holds both a Bachelor of Science in Finance and a Masters of
Business Administration from Santa Clara University.

  Patrick J. Conte has served as our Vice President of Sales Americas and Asia
Pacific since July 1999. From October 1998 to June 1999, Mr. Conte served as
our Vice President of Sales and Marketing. Mr. Conte served as Vice President
of Sales and Channel Marketing for Dynamic Pictures, a graphics company, from
January 1997 to September 1998. From April 1995 to December 1996, Mr. Conte
served as Vice President of Sales, Americas for Wyse Technology. Prior to that
time, Mr. Conte was Director, OEM Sales with Wyse Technology from October 1994
to March 1995. Mr. Conte holds a Bachelor of Science in Political Science and
History from James Madison University and a Masters of Arts in Political
Science from Northern Illinois University.

  George M. Korchinsky has served as our Vice President of International Sales
since July 1998 and is based in offices in the Netherlands. Mr. Korchinsky
served as a vice president of sales for Europe, the Middle East and Africa at
Aurora Electronics, from October 1996 to May 1998. From May 1991 to October
1996, Mr. Korchinsky served as a vice president of sales for Europe, the Middle
East and Africa at Symantec. Prior to that time, Mr. Korchinsky served in
various capacities at Cognos Limited, Paradyne Corporation and IBM. Mr.
Korchinsky is currently a member of the board of DataCore Ltd., a United
Kingdom software company. Mr. Korchinsky holds a Bachelor of Science in
Mechanical Engineering from University of Alberta.

  Kelly M. Herrell has served as our Vice President of Marketing since July
1999. Prior to joining our company, Mr. Herrell served as Vice President of
Marketing at CacheFlow, Inc., a caching products company, from September 1997
to May 1999. Mr. Herrell served as a Senior Director of Marketing at Oracle
Corporation from September 1996 to September 1997. Prior to that time, Mr.
Herrell acted as Director of Strategy for NCR Corporation from January 1995 to
September 1996. Mr. Herrell was also a Senior Marketing Manager at AT&T Global
Information Systems from January 1993 to January 1995. Mr. Herrell holds a
Bachelor of Arts from Washington State University and a Masters of Business
Administration from Cornell University.

  Jordan A. Levy has served as one of our directors since July 1998. Mr. Levy
was a co-founder, and from July 1990 to October 1998, the President and Co-
Chief Executive Officer of Softbank Services Group, previously Upgrade
Corporation of America, an outsourcing services company specializing in
providing call center services for technology companies. From September 1988 to
February 1990, Mr. Levy served as an Executive Vice President and Chief
Operating Officer of Software Etc. Inc. Mr. Levy is a co-founder of Ingram
Software, now known as Ingram Micro, and served as an Executive Vice President
from February 1982 to August 1988. Mr. Levy also sits on the boards of the
Rights Exchange, Inc., a producer of software applications for the metering,
sale and distribution of digital products, GT Interactive Software, a publisher
of entertainment software, and

                                       54
<PAGE>

Client Logic Corp., where he also serves as Vice Chairman of the board of
directors. Mr. Levy holds a Bachelor of Arts in Political Science from the
State University of New York at Buffalo.

  Our board of directors currently consists of three members. Prior to the
closing of this offering, our board of directors will be divided into three
classes, with each director serving a three-year term and one class being
elected at each year's annual meeting of stockholders. Mr. DeWitt will be in
the class of directors whose initial term expires at the 2000 annual meeting of
stockholders. Mr. Campbell will be in the class of directors whose initial term
expires at the 2001 annual meeting of the stockholders. Mr. Levy will be in the
class of directors whose initial term expires at the 2002 annual meeting of
stockholders. Following completion of this offering, the board of directors
intends to appoint at least two additional directors who will not be officers
or employees of Cobalt.

  Executive officers are elected by the board of directors on an annual basis
and serve until their successors have been duly elected and qualified. There
are no family relationships among any of our directors, officers or key
employees.

Board Committees

  We have established an audit committee and a compensation committee. Messrs.
Campbell and Levy are members of both the audit and compensation committees.
The audit committee reviews our internal accounting procedures and consults
with and reviews the services provided by our independent accountants. The
compensation committee reviews and recommends to the board of directors the
compensation and benefits of all of our officers and establishes and reviews
general policies relating to compensation and benefits of our other employees.

Compensation Committee Interlocks and Insider Participation

  Our board of directors established its compensation committee in March 1998.
Prior to establishing the compensation committee, our board of directors as a
whole performed the functions delegated to the compensation committee. No
interlocking relationship exists between any member of our compensation
committee and any member of any other company's board of directors or
compensation committee.

Director Compensation

  Directors do not currently receive any cash compensation from our company for
their service as members of our board of directors, except for reimbursement
for reasonable travel expenses in connection with attendance at board and
committee meetings. Under our 1997 stock option plan, nonemployee directors are
eligible to receive stock option grants at the discretion of the board of
directors, and, after this offering is completed, all nonemployee directors
will receive stock options pursuant to the automatic option grant program in
effect under the 1999 director option plan. See "--Incentive Stock Plans" for
more about the automatic grant program.

                                       55
<PAGE>

Executive Compensation

 Summary Compensation Information

  The following table sets forth the compensation earned for services rendered
to us in all capacities by our Chief Executive Officer and our four most highly
compensated executive officers whose total cash compensation exceeded
$100,000--collectively, the "Named Executive Officers"--for the year ended
December 31, 1998.

                           Summary Compensation Table

<TABLE>
<CAPTION>
                                         Annual       Long-Term
                                      Compensation   Compensation
                                    ---------------- ------------
                                                      Securities
                                                      Underlying   All Other
    Name and Principal Position      Salary   Bonus  Options (#)  Compensation
    ---------------------------     -------- ------- ------------ ------------
<S>                                 <C>      <C>     <C>          <C>
Stephen W. DeWitt.................. $156,771 $53,594   400,000      $ 9,136
 President and Chief Executive
  Officer
Vivek Mehra........................  143,959      --        --        3,288
 Chief Technology Officer and Vice
  President, Products
Robin Porter.......................  127,917      --        --       10,375
 Vice President, Manufacturing
Mark Orr...........................  125,000      --        --       11,721
 Vice President, Business
  Development
Kenton D. Chow.....................  100,000  25,550   140,000        8,517
 Vice President, Finance and Chief
  Financial Officer
</TABLE>

  Ms. Porter resigned as our Vice President of Manufacturing in July 1999.

  The amounts in the column titled "All Other Compensation" represent premiums
for health, dental and life insurance paid by Cobalt for Messrs. DeWitt, Mehra,
Orr and Chow and Ms. Porter.

 Option Grants

  The following table sets forth certain information with respect to stock
options granted to each of the Named Executive Officers during the year ended
December 31, 1998. For grants in 1999 to the Named Executive Officers, see
"Related Party Transactions--Option Grants to Directors and Executive
Officers." All of the options were granted under our 1997 stock option plan.
Options under the stock option plan generally vest over four years with 25% of
the shares subject to the option vesting on the first anniversary of the grant
date, and the remaining option shares vesting ratably monthly thereafter.

                             Option Grants in 1998

<TABLE>
<CAPTION>
                                      Percent
                                     of Total                        Potential Realizable
                                      Options                          Value at Assumed
                          Number of   Granted                       Annual Rates of Stock
                         Securities     to                             Appreciation for
                         Underlying  Employees Exercise                  Option Term
                           Options    During   Price per Expiration -----------------------
          Name           Granted (#)  Period     Share      Date        5%         10%
          ----           ----------- --------- --------- ---------- ----------- -----------
<S>                      <C>         <C>       <C>       <C>        <C>         <C>
Stephen W. DeWitt.......   400,000     26.9%     $0.10    03/18/08
Vivek Mehra.............        --       --         --          --          --         --
Robin Porter............        --       --         --          --          --         --
Mark Orr................        --       --         --          --          --         --
Kenton D. Chow..........    90,000      6.0       0.10    04/15/08
                            50,000      3.4       0.50    12/15/08
</TABLE>

                                       56
<PAGE>

  The exercise price per share of each option was equal to the fair market
value of the common stock as determined by the board of directors on the date
of grant. The potential realizable values assume that the initial public
offering price of $      per share was the fair market value of the common
stock on the date of grant and that the price of the applicable stock increases
from the date of grant until the end of the ten-year option term of the annual
rates specified. There is no assurance provided to any holder of our securities
that the actual stock price appreciation over the ten-year option term will be
at the assumed 5% and 10% levels or at any other defined level.

  The percentages above are based on an aggregate of 1,488,550 shares subject
to options we granted to employees and consultants in the year ended December
31, 1998.

 Option Exercises

  The following table sets forth information with respect to the Named
Executive Officers concerning option exercises for the year ended December 31,
1998 and exercisable and unexercisable options held as of December 31, 1998.

       Aggregate Option Exercises in 1998 and Values at December 31, 1998

<TABLE>
<CAPTION>
                                                           Number of
                                                     Securities Underlying     Value of Unexercised
                                                    Unexercised Options at    In-the-Money Options at
                            Shares                   December 31, 1998 (#)       December 31, 1998
                         Acquired on     Value     ------------------------- -------------------------
          Name           Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
          ----           ------------ ------------ ----------- ------------- ----------- -------------
<S>                      <C>          <C>          <C>         <C>           <C>         <C>
Stephen W. DeWitt.......      --           --            --       400,000      $   --      $160,000
Vivek Mehra.............      --           --            --            --          --            --
Robin Porter............      --           --        24,375        65,625       9,750        26,250
Mark Orr................      --           --            --            --          --            --
Kenton D. Chow..........      --           --            --       140,000          --        36,000
</TABLE>

  The value of in-the-money options represents the positive spread between the
exercise price of the stock options and the deemed fair market value of the
common stock as of December 31, 1998, which our board of directors determined
was $0.50 per share.

Incentive Plans

 1997 Stock Option Plan

  Our 1997 stock option plan was adopted by our board of directors in April
1997 and approved by our stockholders in May 1997. The stock option plan was
amended in September 1999. A total of 3,000,000 shares of common stock have
been reserved for issuance under our stock option plan, together with an annual
increase in the number of shares reserved thereunder beginning on the first day
of our fiscal year, commencing January 1, 2001, in an amount equal to the
lesser of:

  .  2,500,000 shares;

  .  five percent of our outstanding shares of common stock on the last day
     of the prior fiscal year; or

  .  an amount determined by our board of directors.

As a result of these annual increases, a maximum of 17,500,000 additional
shares could be issued over the remaining seven year life of the 1997 stock
option plan.

  The 1997 stock option plan provides for grants of incentive stock options to
our employees including officers and employee directors and nonstatutory stock
options to our consultants including nonemployee directors. The purposes of our
stock option plan are to attract and retain the best available personnel for
positions of substantial responsibility, to provide additional incentive to our

                                       57
<PAGE>

employees and consultants and to promote the success of our business. At the
request of the board of directors, the compensation committee administers our
stock option plan and determines the optionees and the terms of options
granted, including the exercise price, number of shares subject to the option
and the exercisability thereof.

  The term of options granted under the 1997 stock option plan is stated in the
option agreement. However, the term of an incentive stock option may not exceed
ten years and, in the case of an option granted to an optionee who owns more
than 10 percent of our outstanding stock at the time of grant, the term of an
option may not exceed five years. Options granted under the 1997 stock option
plan vest and become exercisable as set forth in each option agreement.

  With respect to any optionee who owns more than 10 percent of our outstanding
stock, the exercise price of any stock option granted must be at least 110% of
the fair market value on the grant date.

  No incentive stock options may be granted to an optionee, which, when
combined with all other incentive stock options becoming exercisable in any
calendar year that are held by that person, would have an aggregate fair market
value in excess of $100,000. In any fiscal year, we may not grant any employee
options to purchase more than 500,000 shares or 1,000,000 shares in the case of
an employee's initial employment.

  The 1997 stock option plan will terminate in April 2007, unless our board of
directors terminates it sooner.

  As of July 2, 1999, we had issued 197,521 shares of common stock upon the
exercise of options granted under our stock option plan, we had outstanding
options to purchase 2,144,943 shares of common stock at a weighted average
exercise price of $0.69 per share and shares remain available for future option
grants under our stock option plan.

 1999 Employee Stock Purchase Plan

  Our 1999 employee stock purchase plan was adopted by our board of directors
in August 1999 and will become effective upon the closing of this offering. We
have reserved a total of 2,250,000 shares of common stock for issuance under
the 1999 employee stock purchase plan, together with an annual increase in the
number of shares reserved thereunder beginning on the first day of our fiscal
year commencing January 1, 2001 in an amount equal to the lesser of:

  .  1,500,000 shares;

  .  three percent of our outstanding common stock on the last day of the
     prior fiscal year; or

  .  an amount determined by our board of directors.

As a result of these annual increases, a maximum of 13,500,000 additional
shares could be sold over the remaining nine year life of the employee stock
purchase plan.

  Our employee stock purchase plan is administered by the board of directors
 and is intended to qualify under Section 423 of the Internal Revenue Code. Our
 employees, including our officers and employee directors but excluding our
 five percent or greater stockholders, are eligible to participate if they are
 customarily employed for at least 20 hours per week and for more than five
 months in any calendar year. Our employee stock purchase plan permits eligible
 employees to purchase common stock through payroll deductions, which may not
 exceed the lesser of 15% of an employee's compensation, where compensation is
 defined on Form W-2, or $25,000.

  Our employee stock purchase plan will be implemented in a series of
overlapping 24 month offering periods, and each offering period consists of
four six month purchase periods. The initial offering period under our employee
stock purchase plan will begin on the effective date of this offering, and the
subsequent offering periods will begin on the first trading day on or after May
1 and

                                       58
<PAGE>

November 1 of each year. Each participant will be granted an option on the
first day of the offering period and the option will be automatically exercised
on the date six months later, the end of a purchase period, throughout the
offering period. If the fair market value of our common stock on any purchase
date is lower than such fair market value on the start date of that offering
period, then all participants in that offering period will be automatically
withdrawn from such offering period and re-enrolled in the immediately
following offering period. The purchase price of our common stock under our
employee stock purchase plan will be 85 percent of the lesser of the fair
market value per share on the start date of the offering period or at the end
of the purchase period. Employees may end their participation in an offering
period at any time, and their participation ends automatically on termination
of employment with our company.

  Our employee stock purchase plan will terminate in August 2009, unless our
board of directors terminates it sooner.

 1999 Director Option Plan

  Our 1999 director option plan will become effective upon the closing of this
offering. We have reserved a total of 400,000 shares of common stock for
issuance under the 1999 director option plan, together with an annual increase
in the number of shares reserved thereunder beginning on the first day of our
fiscal year commencing January 1, 2001 equal to the lesser of:

  .  100,000 shares;

  .  one quarter of one percent of the outstanding shares of our common stock
     on the last day of the prior fiscal year; or

  .  an amount determined by the board of directors.

As a result of these annual increases, a maximum of 900,000 additional shares
could be issued over the remaining nine year life of the 1999 director option
plan.

  The option grants under the 1999 director option plan are automatic and non-
discretionary, and the exercise price of the options is 100% of the fair market
value of our common stock on the grant date.

  The 1999 director option plan provides for an initial grant to a nonemployee
director of an option to purchase 50,000 shares, other than the chairman whose
initial grant will be 55,000 shares, on the date on which he or she becomes a
member of the board of directors. Each nonemployee director will thereafter
automatically be granted an additional option to purchase 10,000 shares of
common stock at the next meeting of the board of directors following the annual
meeting of stockholders, if on the date of the annual meeting the director has
served on the board of directors for at least six months. At the time a
nonemployee director joins a committee of our board of directors, the
nonemployee director will also receive a one-time 5,000 share option for each
committee upon which the director serves.

  The term of the options granted under the 1999 director plan is ten years,
but the options expire three months following the termination of the optionee's
status as a director or twelve months if the termination is due to death or
disability. The initial 50,000 share grants, or 55,000 share grant with respect
to the chairman, will become exercisable at a rate of one-fourth of the shares
on the first anniversary of the grant date and at a rate of 1/48th of the
shares per month thereafter. The subsequent 10,000 share grants and the
committee grants will become exercisable at the rate of one-fourth of the
shares on the first anniversary of the grant date and at a rate of 1/48th of
the shares per month thereafter.

 401(k) Plan

  In January 1998, we adopted a Retirement Savings and Investment Plan, the
401(k) Plan, covering our full-time employees located in the United States. The
401(k) Plan is intended to qualify

                                       59
<PAGE>

under Section 401(k) of the Internal Revenue Code, so that contributions to the
401(k) Plan by employees or by us and the investment earnings thereon are not
taxable to the employees until withdrawn. If our 401(k) Plan qualifies under
Section 401(k) of the Internal Revenue Code, our contributions will be
deductible by us when made. Our employees may elect to reduce their current
compensation by up to the statutorily prescribed annual limit of $10,000 in
1999 and to have those funds contributed to the 401(k) Plan. The 401(k) Plan
permits us, but does not require us, to make additional matching contributions
on behalf of all participants. To date, we have not made any contributions to
the 401(k) Plan.

Employment Agreements and Change in Control Arrangements

  We have entered into the following employment, noncompete and change in
control arrangements and agreements with our current officers. For a
description of arrangements with our former officers, directors and substantial
stockholders, see "Related Party Transactions" on page 62.

  Each of our executive officers listed in "Management--Executive Officers and
Management" other than Mr. Korchinsky and Mr. Martell entered into an
employment agreement with us in September 1999. These agreements provide that
if the officer is terminated without cause or constructively terminated he will
receive:

  .  one year accelerated vesting of any of his stock options;

  .  one year accelerated vesting of common stock purchased by him pursuant
     to restricted stock purchase agreements; and

  .  one year of salary and target bonus.

If the officer voluntarily resigns, is terminated for cause or is terminated
for any other reason, he is not entitled to these benefits.

  In June 1998, we entered into a letter agreement with George Korchinsky, our
Vice President of International Sales. Pursuant to the agreement, Mr.
Korchinsky receives an annual salary of $150,000 and is eligible for an
incentive-based sales bonus. In addition, Mr. Korchinsky received options to
purchase 120,000 shares of our common stock pursuant to our employee stock
plan, 25% of which vest after one year and 1/48 of which vest every month
thereafter; provided, however, that 50% of the option shares will vest if we
experience a change in control. Pursuant to the terms of the option grant, a
change in control is defined as:


  .  any person becoming the beneficial owner of 50% or more of the total
     voting power of our then outstanding voting securities; or

  .  a merger or consolidation with any other corporation, other than a
     merger or consolidation which would result in our voting securities
     outstanding immediately prior thereto continuing to represent at least
     50% of the total voting power of the surviving entity outstanding
     immediately after such merger or consolidation, or our stockholders
     approve a plan of complete liquidation or an agreement for the sale or
     disposition of all or substantially all of our assets.

  In the event of a change of control of our company, Mr. Korchinsky has 90
days following the completion of such a transaction to decide whether it
constitutes a constructive termination of his employment in which case all of
his options will vest up to the date of constructive termination regardless of
the one year initial anniversary vesting, plus an additional six months of
options will be deemed vested. If he terminated without cause, Mr. Korchinsky
is entitled to receive twelve (12) months of his annual base salary and
benefits in exchange for a general release.

  In July 1999, we entered into a letter agreement with Gary Martell, our Chief
Operating Officer. Pursuant to the agreement, Mr. Martell:

                                       60
<PAGE>

  .  receives an annual base salary of $200,000;

  .  was granted options to purchase 400,000 shares of common stock; and

  .  is eligible for an annual bonus of up to $50,000.

  Mr. Martell is entitled to accelerated vesting of 50% of his outstanding
options in the event of a greater than 50% change in ownership of our shares.
If Mr. Martell is terminated without cause, his salary and benefits will
continue for six months after termination.

Limitations on Directors' Liability and Indemnification

  Our certificate of incorporation limits the liability of our directors and
executive officers to the maximum extent permitted by Delaware law. Delaware
law provides that directors of a corporation will not be personally liable for
monetary damages for breach of their fiduciary duties as directors, except
liability for:

  .  any breach of their duty of loyalty to our company or our stockholders;

  .  acts or omissions not in good faith or which involve intentional
     misconduct or a knowing violation of law;

  .  unlawful payments of dividends or unlawful stock repurchases or
     redemptions as provided in Section 174 of the Delaware General
     Corporation Law; or

  .  any transaction from which the director derived an improper personal
     benefit.

  The limits on a director or officer's liability in our certificate of
incorporation do not apply to liabilities arising under the federal securities
laws and do not affect the availability of equitable remedies such as
injunctive relief or rescission.

  Our certificate of incorporation together with our bylaws provide that we
must indemnify our directors and executive officers and may indemnify our other
officers and employees and other agents to the fullest extent permitted by law.
We believe that indemnification under our bylaws covers at least negligence and
gross negligence on the part of indemnified parties. Our bylaws also permit us
to secure insurance on behalf of any officer, director, employee or other agent
for any liability arising out of his or her actions in that capacity,
regardless of whether our bylaws would otherwise permit indemnification. We
believe that the indemnification provisions of our amended and restated
certificate of incorporation and bylaws are necessary to attract and retain
qualified persons as directors and officers. We also maintain directors' and
officers' liability insurance.

  Prior to the effective time of this offering, we expect to enter into
agreements to indemnify our directors and executive officers. These agreements
provide for indemnification of our directors and executive officers for certain
expenses including attorneys' fees, judgments, fines and settlement amounts
incurred by any such person in any action or proceeding. We expect the actions
and right of our company, arising out of such person's services as a director
or executive officer of our company, one of our subsidiaries or any other
company or enterprise to which the person provides services at our request. We
believe that these provisions and agreements are necessary to attract and
retain qualified persons as our directors and executive officers.

  At present we are not aware of any pending litigation or proceeding involving
any director, officer, employee or agent of our company where indemnification
will be required or permitted. Nor are we aware of any threatened litigation or
proceeding that might result in a claim for indemnification.

                                       61
<PAGE>

                           RELATED PARTY TRANSACTIONS

  All future transactions, other than compensation, stock options pursuant to
the plans and other benefits available to employees generally, including any
loans from us to our officers, directors, principal stockholders or affiliates,
will be approved by a majority of our board of directors, including a majority
of our independent and disinterested members of our board of directors. If
required by law, the future transactions will be approved by a majority of the
disinterested stockholders. These future transactions will be on terms no less
favorable to us than we could obtain from unaffiliated third parties.

Stock Issuances to our Directors, Officers and Principal Stockholders

  In May and June of 1997, we issued 4,181,426 shares of common stock at $0.001
per share to 4 individuals for aggregate proceeds of $4,181. In August 1997, we
issued 471,338 shares of common stock at $0.001 per share for aggregate
proceeds of $471. Of such shares, we issued 111,338 shares to Vivek Mehra. In
March 1998, we issued 800,000 shares of common stock at $0.10 per share to
Stephen DeWitt for aggregate proceeds of $80,000. In February 1999, we issued
100,000 shares of common stock at $0.50 per share to Vivek Mehra for aggregate
proceeds of $50,000.

  We repurchased 570,000 shares of common stock in September 1997 from the
estate of Mark Wu. Mark Wu was one of our founders. The company repurchased
570,000 shares of his common stock at the original purchase price on September
29, 1997. The balance of his shares were transferred to his heirs.

  Between October 1996 and June 1997, we issued warrants to purchase 162,500
shares of Series A preferred stock at a per share exercise price of $1.00 per
share to 13 persons as consideration for bridge loans that were converted to
Series A preferred stock. Between August and November 1997, we sold 3,572,401
shares of Series A preferred stock at a per share price of $1.00 for aggregate
proceeds of $3.6 million.

  Between April and June 1998, we issued warrants to purchase 41,612 shares of
Series B preferred stock at a per share exercise price of $2.16 to three
stockholders as consideration for bridge loans that were converted to Series B
preferred stock. In July 1998, we issued 3,698,910 shares of Series B preferred
stock at a per share price of $2.16 for aggregate proceeds of $8.0 million.

  In February and March 1999, we issued warrants to purchase an aggregate of
79,045 shares of Series C preferred stock with a per share exercise price of
$3.70 to 12 investors as consideration for bridge loans that were converted to
Series C preferred stock. In May 1999, we issued 9,813,507 shares of Series C
preferred stock at a per share price of $3.70 for aggregate proceeds of $36.3
million. In connection with our Series C preferred stock financing, we issued a
warrant to BT Alex. Brown to purchase 242,508 shares of common stock with a per
share exercise price of $3.70 that expires in May 2002 as consideration for BT
Alex. Brown's services as placement agent in the Series C preferred stock
financing.

                                       62
<PAGE>

  Upon closing of this offering, all shares of outstanding preferred stock will
be automatically converted into shares of common stock. Listed below are those
persons who participated in the financings described above who are our
executive officers, directors or stockholders who beneficially own five percent
or more of our securities.

<TABLE>
<CAPTION>
                                   Series A           Series B           Series C
                          Common   Preferred Series A Preferred Series B Preferred Series C   Aggregate
      Stockholder          Stock     Stock   Warrants   Stock   Warrants   Stock   Warrants Consideration
      -----------        --------- --------- -------- --------- -------- --------- -------- -------------
<S>                      <C>       <C>       <C>      <C>       <C>      <C>       <C>      <C>
August Capital
 entities...............        --        --      --         --      --  2,702,701      --   $10,004,992
Chase Venture Capital
 Assoc. L.P.............        --   517,500      --  1,387,091      --    531,081  13,039     5,530,744
Kenton D. Chow..........        --        --      --      2,312      --      2,433     121        14,450
Crystal Internet
 Ventures Fund, L.P.....        --        --      --    924,728      --    445,946  13,512     3,699,996
Stephen W. DeWitt.......   800,000        --      --    115,591  18,494     27,027   1,351       390,799
George M. Korchinsky....        --        --      --         --      --     27,027   2,702       109,997
Vivek Mehra.............   946,382     5,000      --         --      --         --      --         5,946
Mark H. Orr.............   946,382        --      --         --      --         --      --           946
SPLZ One Partners, LLC
 (Jordan A. Levy).......        --        --      --         --      --    135,135  20,720       500,000
Techfarm/TechFund
 Capital entities....... 1,200,000   982,500  32,500    213,214  11,559     56,757   2,836     1,654,243
Vanguard V, L.P.........        -- 1,202,465      --    462,364  11,559    135,135   6,756     2,752,462
Mark Wu................. 1,200,000        --      --         --      --         --      --         1,200
</TABLE>

  The entities listed above as Techfarm/TechFund Capital entities include
TechFund Capital, LP and its general partner, TechFund Capital Management, LLC;
TechFund Capital II, LP and its general partner, TechFund Capital Management
II, LLC; and Techfarm Management, Inc. Mr. Campbell, our Chairman, is a
managing member of TechFund Capital Management, LLC and TechFund Capital
Management II, LLC and the President and a shareholder of Techfarm Management,
Inc. Mr. Campbell disclaims beneficial ownership of the shares held by each
entity, except to the extent of his pecuniary interest therein.

  Jordan A. Levy, one of our directors, is a managing member of SPLZ One
Partners, LLC. Mr. Levy disclaims beneficial ownership of the shares held by
each entity, except to the extent of his pecuniary interest therein.

                                       63
<PAGE>

Option Grants to our Directors and Executive Officers

  Stock option grants to directors and executive officers of our company are
described under the captions "Management--Board Compensation" and "--Executive
Compensation". Since our inception, we have granted options to our directors
and current and former executive officers, including the Named Executive
Officers as follows:

<TABLE>
<CAPTION>
                                             Number
                                               of                       Exercise
         Name                                Shares      Grant Date      Price
         ----                                -------     ----------     --------
<S>                                          <C>     <C>                <C>
Kenton D. Chow..............................  90,000 April 15, 1998      $0.10
                                              50,000 December 15, 1998    0.50
                                              60,000 July 27, 1999        2.50
Patrick J. Conte............................ 100,000 September 23, 1998   0.50
                                              40,000 February 16, 1999    0.80
                                              40,000 July 27, 1999        2.50
Stephen W. DeWitt........................... 400,000 March 18, 1998       0.10
                                             100,000 May 18, 1999         1.85
                                             250,000 July 27, 1999        2.50
Kelly M. Herrell............................ 250,000 July 27, 1999        2.50
George M. Korchinsky........................ 120,000 July 15, 1998        0.50
                                              60,000 July 27, 1999        2.50
Jordan A. Levy..............................  30,000 July 15, 1998        0.50
Gary A. Martell............................. 400,000 July 27, 1999        2.50
Vivek Mehra................................. 100,000 July 27, 1999        2.50
Mark H. Orr.................................  30,000 July 27, 1999        2.50
Robin Porter................................  90,000 November 25, 1997    0.10
</TABLE>

  In connection with a separation agreement dated July 28, 1999, we accelerated
the vesting of options to purchase 37,500 shares of our common stock held by
Ms. Porter. Pursuant to the separation agreement, Ms. Porter will receive her
regular salary and benefits other than accrued vacation pay until October 31,
1999. Ms. Porter released any and all claims against us that arose prior to the
date of the agreement, whether known or unknown, arising out of any agreement,
act or omission, including matters arising from her employment relationship
with us.

Other Relationships

  Our company has a management consulting agreement with Techfarm Management,
Inc. pursuant to which it provides management consulting services to our
company for a fee of $5,000 per month. These services and our payment of the
related fees will cease upon the closing of this offering. Gordon Campbell is
the President of Techfarm Management, Inc. and serves as the Chairman of our
board of directors. In addition, Mr. Campbell is also a managing member of
TechFund Capital Management, LLC, the general partner of TechFund Capital, L.P.

  On August 20, 1999, we made an interest free loan of $500,000 to Stephen W.
Dewitt, our President and Chief Executive Officer. The loan is secured by
50,000 shares of our Series B preferred stock held by Mr. DeWitt and is full
recourse. The loan is payable on August 20, 2003. In the event Mr. DeWitt
leaves our employment, the note will be due and payable in full 60 days after
his last day of employment with us.

                                       64
<PAGE>

                             PRINCIPAL STOCKHOLDERS

  The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of July 2, 1999, and as adjusted to
reflect the sale of common stock offered hereby by:

  .  each stockholder known by us to own beneficially more than five percent
     of our common stock;

  .  each of the Named Executive Officers;

  .  each director of our company; and

  .  all directors and executive officers as a group.

<TABLE>
<CAPTION>
                                                  Percent Beneficially Owned
                                   Total Number ------------------------------
         Name and Address           of Shares   Before Offering After Offering
         ----------------          ------------ --------------- --------------
<S>                                <C>          <C>             <C>
August Capital entities...........  2,702,701        12.3%
  2480 Sand Hill Road, Suite 101
  Menlo Park, California 94025

Chase Venture Capital Assoc. L.P.
 .................................  2,448,711        11.1
  380 Madison Avenue, 12th Floor
  New York, New York 10017

Techfarm/TechFund Capital
 entities.........................  2,446,866        11.1
  111 West Evelyn Avenue Suite 101
  Sunnyvale, California 94086

Vanguard V, L.P...................  1,818,279         8.2
  525 University Avenue Suite 600
  Palo Alto, California 94301

Crystal Internet Venture Fund,
 L.P..............................  1,384,186         6.3
  1120 Chester Avenue, Suite 310
  Cleveland, Ohio 44114

Gordon A. Campbell................  2,446,866        11.1
Stephen W. DeWitt.................  1,112,463         5.0
Vivek Mehra.......................    951,382         4.3
Mark H. Orr.......................    946,382         4.3
Robin Porter......................     35,625          *
Kenton D. Chow....................     34,866          *
Jordan A. Levy....................    171,655          *
All executive officers and
 directors as a group
 (11 persons).....................  5,884,176        26.5
</TABLE>
--------
* Less than 1% of the outstanding shares of common stock.

  Except as otherwise noted above, the address of each person listed on the
table is 555 Ellis Street, Mountain View, California 94043.

  As of July 2, 1999, 22,010,103 shares of our common stock were outstanding,
assuming that each share of preferred stock was converted on a one for one
basis to common stock. The columns regarding beneficial ownership before and
after the offering assume that the underwriters' over-allotment option is not
exercised. If the over-allotment option is exercised in full, we will sell an
aggregate of shares of new common stock.

  We have determined beneficial ownership in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person, we
have included the shares of common stock subject to options or warrants held by
that person that are currently exercisable or will become exercisable within 60
days after July 2, 1999, but we have not included those shares for purposes of
computing

                                       65
<PAGE>

percentage ownership of any other person. We have assumed unless otherwise
indicated below that the persons and entities named in the table have sole
voting and investment power with respect to all shares beneficially owned,
subject to community property laws where applicable.

  The beneficial ownership reported for August Capital entities includes
2,583,782 shares held by August Capital II, LP and 118,919 shares held by
August Capital Strategic Partners II, LP. The general partner of each of these
entities is August Capital Management II, LLC. The managing members of August
Capital Management II, LLC are David F. Marquardt, John R. Johnston, Andrew L.
Anker and Andrew S. Rappaport.

  The general partner of Chase Venture Capital Associates, L.P. is Chase
Capital Partners. The general partners of Chase Capital Partners are Jeffrey
Walker, Mitchel Blutt, M.D., Arnold Chavkin, Steven Murray, Michael Hannon,
Shahan Soghikian, Brian Richmand, Donald Hofmann, Chris Behrens, John M.B.
O'Connor, John Baron, Damion Wicker, M.D., Susan Segal, Lindsay Stuart and
Chase Capital Corporation. Jeffrey Walter is the President of Chase Capital
Corporation, which is a wholly-owned subsidiary of Chase Manhattan Corporation.

  The beneficial ownership reported for the Techfarm/TechFund Capital entities
and Gordon A. Campbell includes:

  .  1,147,500 shares held by Techfarm II, LP;

  .  1,015,590 shares held by TechFund Capital, LP;

  .  96,321 shares held by TechFund Capital Management, LLC;

  .  83,803 shares held by Gordon A. Campbell;

  .  47,297 shares held by TechFund Capital II, LP;

  .  9,460 shares held by TechFund Capital II, LP; and

  .  46,895 shares subject to warrants held by Mr. Campbell.

  Mr. Campbell disclaims beneficial ownership of these shares except to the
extent of his pecuniary interest.

  The general partners of Vanguard V, L.P. are Robert Ulrich, Clifford
Higgerson, Jack Gill and Curtis Kipling Myers.

  The general partner of Crystal Internet Venture Fund, L.P. is Crystal
Venture, Ltd. Joseph Tzeng is the President and Dan Kellog is the Vice
President of Crystal Venture Ltd.

  The beneficial ownership of Jordan Levy as reported above includes 135,135
shares of Series C preferred stock and warrants to purchase 20,720 shares of
Series C preferred stock held by SPLZ One Partners, LLC. Mr. Levy is a managing
member of SPLZ One Partners, LLC. However, Mr. Levy disclaims beneficial
ownership of the shares and warrants held by SPLZ One Partners except to the
extent of his pecuniary interest therein.

  The beneficial ownership of the persons set forth in the table above includes
the following options or warrants to purchase our common stock that may be
exercised by such person within 60 days of July 2, 1999:

                                       66
<PAGE>

             Securities Exercisable Within 60 Days of July 2, 1999

<TABLE>
<CAPTION>
                                                                Options Warrants
                                                                ------- --------
<S>                                                             <C>     <C>
Techfarm/TechFund entities.....................................     --   46,895
Chase Venture Capital Assoc. L.P. .............................     --   13,039
Crystal Internet Venture Fund, L.P.............................     --   13,512
Vanguard V, L.P................................................     --   18,315
Gordon A. Campbell.............................................     --   46,895
Stephen W. DeWitt.............................................. 150,000  19,845
Kenton D. Chow.................................................   1,875     121
Robin Porter...................................................  35,625     --
Jordan Levy....................................................  16,250     --
All directors and officers..................................... 236,250  86,995
</TABLE>


                                       67
<PAGE>

                          DESCRIPTION OF CAPITAL STOCK

  Upon the closing of this offering, we will be authorized to issue 120,000,000
shares of common stock, $0.001 par value, and 10,000,000 shares of undesignated
preferred stock, $0.001 par value.

Common Stock

  As of July 2, 1999, we had 22,010,103 shares of common stock outstanding held
by approximately 105 stockholders.

  The holders of common stock are entitled to one vote per share on all matters
to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding preferred stock, the holders of common stock are
entitled to receive ratably any dividends that may be declared from time to
time by the board of directors out of funds legally available for that purpose.
In the event of our liquidation, dissolution or winding up, the holders of
common stock are entitled to share ratably in all assets remaining after
payment of liabilities, subject to prior distribution rights of preferred stock
then outstanding. The common stock has 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 nonassessable, and the shares of common stock to be issued upon
the closing of this offering will be fully paid and nonassessable.

Preferred Stock

  Upon the closing of this offering, our board of directors will have the
authority, without action by our stockholders, to designate and issue preferred
stock in one or more series. The board of directors may also designate the
rights, preferences and privileges of each series of preferred stock; any or
all of which may be superior to the rights of the common stock. It is not
possible to state the actual effect of the issuance of any shares of preferred
stock upon the rights of holders of the common stock until the board of
directors determines the specific rights of the holders of the preferred stock.
However, these effects might include:

  .  restricting dividends on the common stock;

  .  diluting the voting power of the common stock;

  .  impairing the liquidation rights of the common stock; and

  .  delaying or preventing a change in control of our company without
     further action by the stockholders.

  We have no present plans to issue any shares of preferred stock.

Warrants

  As of July 2, 1999, we had outstanding warrants to purchase:

  .  242,508 shares of common stock issued to BT Alex. Brown at an exercise
     price of $3.70 per share that will expire in May 2002;

  .  162,500 shares of Series A preferred stock issued to 13 stockholders at
     an exercise price of $1.00 per share that will expire at various times
     from October 2001 to June 2002;

  .  41,612 shares of Series B preferred stock issued to three stockholders
     at an exercise price of $2.16 per share that will expire at various
     times from April 2000 to June 2000; and

  .  79,045 shares of Series C preferred stock issued to 12 stockholders at
     an exercise price of $3.70 per share that will expire at various times
     from February 2002, to March 2002.

                                       68
<PAGE>

Our outstanding warrants to purchase preferred stock will convert to warrants
to purchase common stock upon the closing of this offering.

Holders of Registration Rights Can Require Us to Register Shares of Our Stock
for Resale

  The holders of 17,084,818 shares of common stock and 283,157 shares of common
stock issuable upon the exercise of warrants or their permitted transferees are
entitled to certain rights with respect to registration of such shares under
the Securities Act of 1933, as amended. These rights are provided under the
terms of our agreement with the holders of registrable securities. Under these
registration rights, holders of at least a majority of the then outstanding
registrable securities may require on two occasions that we register their
shares for public resale. We are obligated to register these shares if the
holders of a majority of the eligible shares request registration and only if
the shares to be registered have an anticipated public offering price of at
least $10,000,000. In addition, holders of registrable securities may require
on two separate occasions that we register their shares for public resale on
Form S-3 or similar short-form registration, if we are eligible to use Form S-3
or similar short-form registration, and the value of the securities to be
registered is at least $10,000,000. If we elect to register any of our shares
of common stock for any public offering, the holders of registrable securities
are entitled to include shares of common stock in the registration. However we
may reduce the number of shares proposed to be registered in view of market
conditions. We will pay all expenses in connection with any registration, other
than underwriting discounts and commissions.

Anti-Takeover Effects of Some Provisions of Delaware Law and Our Charter
Documents

  Certain provisions of Delaware law and our certificate of incorporation and
bylaws could make the acquisition of our company through a tender offer, a
proxy contest or other means more difficult and could make the removal of
incumbent officers and directors more difficult. We expect these provisions to
discourage certain types of coercive takeover practices and inadequate takeover
bids and to encourage persons seeking to acquire control of our company to
first negotiate with our board of directors. We believe that the benefits
provided by our ability to negotiate with the proponent of an unfriendly or
unsolicited proposal outweigh the disadvantages of discouraging such proposals.
We believe the negotiation of an unfriendly or unsolicited proposal could
result in an improvement of its terms.

 Delaware Law

  We are subject to Section 203 of the Delaware General Corporation Law, an
anti-takeover law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years following the date the person became
an interested stockholder, unless:

  .  prior to the date of the transaction, the board of directors of the
     corporation approved either the business combination or the transaction
     which resulted in the stockholder becoming an interested stockholder;

  .  the stockholder owned at least 85% of the voting stock of the
     corporation outstanding at the time the transaction commenced, excluding
     for purposes of determining the number of shares outstanding (a) shares
     owned by persons who are directors and also officers, and (b) shares
     owned by employee stock plans in which employee participants do not have
     the right to determine confidentially whether shares held subject to the
     plan will be tendered in a tender or exchange offer; or

  .  on or subsequent to the date of the transaction, the business
     combination is approved by the board and authorized at an annual or
     special meeting of stockholders, and not by written

                                       69
<PAGE>

     consent, by the affirmative vote of at least 66 2/3% of the outstanding
     voting stock which is not owned by the interested stockholder.

  Generally, a "business combination" includes a merger, asset or stock sale,
or other transaction resulting in a financial benefit to the interested
stockholder. An "interested stockholder" is a person who, together with
affiliates and associates, owns or, within three years prior to the
determination of interested stockholder status, did own 15% or more of a
corporation's outstanding voting securities. We expect the existence of this
provision to have an anti-takeover effect with respect to transactions our
board of directors does not approve in advance. We also anticipate that
Section 203 may also discourage attempts that might result in a premium over
the market price for the shares of common stock held by stockholders.

  Charter Documents

  Upon completion of this offering, our certificate of incorporation provides
for our board of directors to be divided into three classes serving staggered
terms. Approximately one-third of the board of directors will be elected each
year. The provision for a classified board could prevent a party who acquires
control of a majority of the outstanding voting stock from obtaining control
of the board of directors until the second annual stockholders meeting
following the date the acquirer obtains the controlling stock interest. The
classified board provision could discourage a potential acquirer from making a
tender offer or otherwise attempting to obtain control of our company and
could increase the likelihood that incumbent directors will retain their
positions. Our certificate of incorporation provides that directors may be
removed:

  .  with cause by the affirmative vote of the holders of at least a majority
     of the outstanding shares of voting stock; or

  .  without cause by the affirmative vote of the holders of at least 66 2/3%
     of the then-outstanding shares of the voting stock.

  Our bylaws establish an advance notice procedure for stockholder proposals
to be brought before an annual meeting of our stockholders, including proposed
nominations of persons for election to the board of directors. At an annual
meeting, stockholders may only consider proposals or nominations specified in
the notice of meeting or brought before the meeting by or at the direction of
the board of directors. Stockholders may also consider a proposal or
nomination by a person who was a stockholder of record on the record date for
the meeting, who is entitled to vote at the meeting and who has given to our
Secretary timely written notice, in proper form, of his or her intention to
bring that business before the meeting. The bylaws do not give the board of
directors the power to approve or disapprove stockholder nominations of
candidates or proposals regarding other business to be conducted at a special
or annual meeting of the stockholders. However, our bylaws may have the effect
of precluding the conduct of certain business at a meeting if the proper
procedures are not followed. These provisions may also discourage or deter a
potential acquirer from conducting a solicitation of proxies to elect the
acquirer's own slate of directors or otherwise attempting to obtain control of
our company.

  Under Delaware law, a special meeting of stockholders may be called by the
board of directors or by any other person authorized to do so in the
certificate of incorporation or the bylaws. Our bylaws authorize a majority of
our board of directors, the chairman of the board or the chief executive
officer to call a special meeting of stockholders. Because our stockholders do
not have the right to call a special meeting, a stockholder could not force
stockholder consideration of a proposal over the opposition of the board of
directors by calling a special meeting of stockholders prior to such time as a
majority of the board of directors believed or the chief executive officer
believed the matter should be considered or until the next annual meeting
provided that the requestor met the notice

                                      70
<PAGE>

requirements. The restriction on the ability of stockholders to call a special
meeting means that a proposal to replace the board also could be delayed until
the next annual meeting.

  Although Delaware law provides that stockholders may execute an action by
written consent in lieu of a stockholder meeting, it also allows us to
eliminate stockholder actions by written consent. Elimination of written
consents of stockholders may lengthen the amount of time required to take
stockholder actions since actions by written consent are not subject to the
minimum notice requirement of a stockholder's meeting. However, we believe that
the elimination of stockholders' written consents may deter hostile takeover
attempts. Without the availability of stockholder's actions by written consent,
a holder controlling a majority of our capital stock would not be able to amend
our bylaws or remove directors without holding a stockholders meeting. The
holder would have to obtain the consent of a majority of the board of
directors, the chairman of the board or the chief executive officer to call a
stockholders' meeting and satisfy the notice periods determined by the board of
directors. Our certificate of incorporation provides for the elimination of
actions by written consent of stockholders upon the closing of this offering.

Transfer Agent and Registrar

  The transfer agent and registrar for our common stock is BankBoston, N.A.
BankBoston is located at 150 Royall Street, Canton, Massachusetts, 02021 and
its telephone number is (508) 575-3120.

Nasdaq Stock Market Listing

  We have applied to have our common stock listed on the Nasdaq National Market
for quotation under the symbol "COBT".

                                       71
<PAGE>

                        SHARES ELIGIBLE FOR FUTURE SALE

  Prior to this offering, there has been no public market for our stock. Future
sales of substantial amounts of our common stock in the public market following
this offering or the possibility of such sales occurring could adversely affect
prevailing market prices for our common stock or could impair our ability to
raise capital through an offering of equity securities.

  After this offering, we will have outstanding      shares of common stock,
based upon shares outstanding as of July 2, 1999, assuming no exercise of the
underwriters' over-allotment option and no exercise of outstanding options or
warrants after July 2, 1999. All of the shares sold in this offering will be
freely tradeable without restriction under the Securities Act except for any
shares purchased by our "affiliates" as that term is defined in Rule 144 under
the Securities Act. The remaining 22,010,103 shares of common stock held by
existing stockholders are "restricted" shares as that term is defined in Rule
144 under the Securities Act. We issued and sold the restricted shares in
private transactions in reliance upon exemptions from registration under the
Securities Act. Restricted shares may be sold in the public market only if they
are registered under the Securities Act or if they qualify for an exemption
from registration, such as Rule 144 or 701 under the Securities Act, which are
summarized below.

  Our officers, directors, employees, and other stockholders, who collectively
hold an aggregate of 22,010,103 restricted shares, and the underwriters entered
into lock-up agreements in connection with this offering. These lock-up
agreements provide that, with certain limited exceptions, our officers,
directors, employees and stockholders have agreed not to offer, sell, contract
to sell, grant any option to purchase or otherwise dispose of any of our shares
for a period of 180 days after the effective date of this offering. Goldman,
Sachs & Co. may, in its sole discretion and at any time without prior notice,
release all or any portion of the shares subject to these lock-up agreements.
We have also entered into an agreement with Goldman, Sachs & Co. that we will
not offer, sell or otherwise dispose of our common stock until 180 days after
the effective date of this offering.

  Taking into account the lock-up agreements, the number of shares that will be
available for sale in the public market under the provisions of Rules 144,
144(k) and 701 will be as follows:

<TABLE>
<CAPTION>
                                                                    Number of
                   Date of Availability for Sale                      Shares
                   -----------------------------                    ----------
<S>                                                                 <C>
At various times between July 2, 1999 and the date 30 days
 after the effective date of this offering.........................        --
At various times between the date 30 days and the date
 180 days after the effective date of this offering................    100,000
At various times thereafter upon the expiration of applicable
 holding periods................................................... 21,910,103
</TABLE>

  Following the expiration of the lock-up period, shares issued upon exercise
of options granted by us prior to the completion of this offering will also be
available for sale in the public market pursuant to Rule 701 under the
Securities Act unless those shares are held by one of our affiliates, directors
or officers.

  In general, under Rule 144 as currently in effect, 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:

  .  one percent of the number of shares of common stock then outstanding,
     which will equal approximately       shares immediately after the
     offering; or

  .  the average weekly trading volume of the common stock during the four
     calendar weeks preceding the filing of a Form 144 with respect to such
     sale.

                                       72
<PAGE>

  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 us. Under Rule 144(k), a person who is not deemed to have been an
affiliate of our company at any time during the three months 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.

  Rule 701, as currently in effect, permits our employees, officers, directors
or consultants who purchased shares under a written compensatory plan or
contract to resell these shares in reliance upon Rule 144 but without
compliance with specific restrictions. Rule 701 provides that affiliates may
sell their Rule 701 shares under Rule 144 without complying with the holding
period requirement and that non-affiliates may sell these shares in reliance on
Rule 144 without complying with the holding period, public information, volume
limitation or notice provisions of Rule 144.

  We intend to file, shortly after the effectiveness of this offering, a
registration statement on Form S-8 under the Securities Act covering all shares
of common stock reserved for issuance under the stock plans and subject to
outstanding options under our 1997 stock option plan. See "Management--Stock
Plans". Shares of common stock issued upon exercise of options under the Form
S-8 will be available for sale in the public market, subject to Rule 144 volume
limitations applicable to affiliates and subject to the contractual
restrictions described above. As of July 2, 1999, options to purchase 2,144,943
shares of common stock were outstanding of which approximately 382,486 options
were then vested and exercisable. Beginning 180 days after the effective date
of this offering, approximately 728,687 shares issuable upon the exercise of
vested stock options will become eligible for sale in the public market, if
such options are exercised.

  Following this offering, the holders of an aggregate of 17,084,818 shares of
outstanding common stock and 283,157 shares of common stock issuable upon the
exercise of warrants have the right to require us to register their shares for
sale upon meeting certain requirements. See "Description of Capital Stock--
Holders of Registration Rights Can Require Us to Register Shares of Our Stock
for Resale" for additional information regarding registration rights.

                                 LEGAL MATTERS

  The validity of the common stock offered hereby will be passed upon for us by
Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California. Legal matters specified by the underwriters in connection with this
offering will be passed upon for the underwriters by Shearman & Sterling, Menlo
Park, California.

                                    EXPERTS

  The financial statements as of December 31, 1997 and 1998 and for the period
from inception (October 18, 1996) to December 31, 1996 and for each of the two
years in the period ended December 31, 1998 included in this Prospectus have
been so included in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.

                                       73
<PAGE>

                   WHERE YOU CAN FIND ADDITIONAL INFORMATION

  We have 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 our company and our
common stock, reference is made to the registration statement and to the
exhibits and schedules filed therewith. A copy of the registration statement
may be inspected by anyone without charge at the Public Reference Section of
the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of all or any portion of the registration
statement may be obtained from the Public Reference Section of the Commission,
450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of prescribed
fees. The public may obtain information on the operations of the public
reference facilities in Washington, D.C. by calling the Commission at 1-800-
SEC-0330. The Commission maintains a web site at http://www.sec.gov that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.

                                       74
<PAGE>

                             COBALT NETWORKS , INC.
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                         <C>
Report of Independent Accountants.......................................... F-2

Consolidated Balance Sheet................................................. F-3

Consolidated Statement of Operations....................................... F-4

Consolidated Statement of Stockholders' Deficit............................ F-5

Consolidated Statement of Cash Flows....................................... F-6

Notes to Consolidated Financial Statements................................. F-7
</TABLE>

                                      F-1
<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Cobalt Networks, Inc.

  The reincorporation described in Note 1 to the consolidated financial
statements has not been consummated as of September 8, 1999. When it has been
consummated, we will be in a position to issue the following report:

    "In our opinion, the accompanying consolidated balance sheet and the
  related consolidated statements of operations, of stockholders' equity
  (deficit) and of cash flows present fairly, in all material respects, the
  financial position of Cobalt Networks, Inc. and its subsidiaries at
  December 31, 1997 and 1998, and the results of their operations and their
  cash flows for the period from October 18, 1996 (inception) through
  December 31, 1996 and the years ended December 31, 1997 and 1998, in
  conformity with generally accepted accounting principles. These financial
  statements are the responsibility of the Company's management; our
  responsibility is to express an opinion on these financial statements based
  on our audits. We conducted our audits of these statements in accordance
  with generally accepted auditing standards which 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, assessing the accounting principles used and
  significant estimates made by management, and evaluating the overall
  financial statement presentation. We believe that our audits provide a
  reasonable basis for the opinion expressed above."

PricewaterhouseCoopers LLP

San Jose, California
January 18, 1999, except as to
Note 11, which is as of September 1, 1999.

                                      F-2
<PAGE>

                             COBALT NETWORKS, INC.
                           CONSOLIDATED BALANCE SHEET
                (in thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                                     Pro Forma
                                      December 31,                 Stockholders'
                                     ----------------    July 2,   Equity as of
                                      1997     1998       1999     July 2, 1999
                                     ------  --------  ----------- -------------
                                                       (unaudited)  (unaudited)
<S>                                  <C>     <C>       <C>         <C>
Assets
Current assets:
 Cash and cash equivalents.........  $1,738  $  2,090    $27,426
 Accounts receivable, net of
  allowance for doubtful accounts
  of $--, $335 and $485............     --      2,040      4,829
 Inventories.......................      20       514      1,019
 Other current assets..............      78       239        307
                                     ------  --------    -------
   Total current assets............   1,836     4,883     33,581
Property and equipment, net........     162     1,262      1,321
                                     ------  --------    -------
                                     $1,998  $  6,145    $34,902
                                     ======  ========    =======
Liabilities, mandatorily redeemable
 convertible preferred stock and
 stockholders' equity (deficit)
Current liabilities:
 Notes payable, current............  $  --   $     39    $    41
 Borrowings under line of credit...     --        600        --
 Advance from related party........     --        500        --
 Accounts payable..................     209     4,179      5,503
 Accrued liabilities...............      85     1,183      2,781
 Deferred margin on distributor
  inventory........................     --        294        717
                                     ------  --------    -------
   Total current liabilities.......     294     6,795      9,042
Notes payable......................     --         84         64
                                     ------  --------    -------
                                        294     6,879      9,106
                                     ------  --------    -------
Mandatorily Redeemable Convertible
 Preferred Stock (Note 4)..........   3,551    12,339     45,646      $   --
                                     ------  --------    -------      -------
Commitments and contingencies
 (Notes 9 and 10)
Stockholders' equity (deficit)
 Preferred Stock: $0.001 par
  value; 10,000,000 shares
  authorized, none issued and
  outstanding pro forma............     --        --         --           --
 Common Stock: $0.001 par value;
  120,000,000 shares authorized;
  4,193,000, 4,750,000 and
  4,925,000 (unaudited) shares
  issued and outstanding at
  December 31, 1997, 1998 and July
  2, 1999; 22,010,103 (unaudited)
  shares issued and outstanding
  pro forma........................       4         5          5           22
 Additional paid-in capital........     --         79      3,921       49,550
 Unearned stock compensation.......     --        --      (1,134)      (1,134)
 Note receivable from
  stockholder......................     --        --         (50)         (50)
 Accumulated deficit...............  (1,851)  (13,157)   (22,592)     (22,592)
                                     ------  --------    -------      -------
   Total stockholders' equity
    (deficit)......................  (1,847)  (13,073)   (19,850)     $25,796
                                     ------  --------    -------      =======
                                     $1,998  $  6,145    $34,902
                                     ======  ========    =======
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-3
<PAGE>

                             COBALT NETWORKS, INC.
                      CONSOLIDATED STATEMENT OF OPERATIONS
                (in thousands, except share and per share data)

<TABLE>
<CAPTION>
                           Period From
                           October 18,
                               1996           Year Ended
                          (inception) to     December 31,             Six Months Ended
                           December 31,  ----------------------  --------------------------
                               1996         1997        1998     June 30, 1998 July 2, 1999
                          -------------- ----------  ----------  ------------- ------------
                                                                        (unaudited)
<S>                       <C>            <C>         <C>         <C>           <C>
Net revenues............    $      --    $      --   $    3,537   $      449    $    7,663
Cost of revenues........           --           --        3,123          582         5,156
                            ----------   ----------  ----------   ----------    ----------
Gross profit (loss).....           --           --          414         (133)        2,507
                            ----------   ----------  ----------   ----------    ----------
Operating expenses:
 Research and
  development...........            22        1,067       3,483        1,204         2,771
 Sales and marketing....           --           245       5,581        1,801         6,273
 General and
  administrative........            60          445       1,895          611         1,454
 Amortization of stock
  compensation..........           --           --          --           --            253
                            ----------   ----------  ----------   ----------    ----------
   Total operating
    expenses............            82        1,757      10,959        3,616        10,751
                            ----------   ----------  ----------   ----------    ----------
Loss from operations....           (82)      (1,757)    (10,545)      (3,749)       (8,244)
Interest income.........           --            17          82            9           217
Interest expense........           --           (29)        (15)         (12)         (217)
                            ----------   ----------  ----------   ----------    ----------
Net loss................           (82)      (1,769)    (10,478)      (3,752)       (8,244)
Accretion of Mandatorily
 Redeemable Convertible
 Preferred Stock........           --           --         (828)         --         (1,191)
                            ----------   ----------  ----------   ----------    ----------
Net loss attributable to
 holders of Common
 Stock..................    $      (82)  $   (1,769) $  (11,306)  $   (3,752)   $   (9,435)
                            ==========   ==========  ==========   ==========    ==========
Basic and diluted net
 loss per share
 attributable to holders
 of Common Stock........                 $    (4.10) $    (5.47)  $    (2.09)   $    (2.83)
                                         ==========  ==========   ==========    ==========
Basic and diluted
 weighted average shares
 outstanding............                    432,000   2,065,000    1,792,000     3,338,000
                                         ==========  ==========   ==========    ==========
Pro forma basic and
 diluted net loss per
 share (unaudited)......                             $    (1.43)                $    (0.60)
                                                     ==========                 ==========
Pro forma basic and
 diluted weighted
 average shares
 outstanding
 (unaudited)............                              7,330,000                 13,808,000
                                                     ==========                 ==========
</TABLE>


  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-4
<PAGE>

                             COBALT NETWORKS, INC.
            CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
                       (in thousands, except share data)

<TABLE>
<CAPTION>
                              Common Stock        Additional    Unearned    Note Receivable
                          ----------------------    Paid-in      Stock           from       Accumulated
                           Shares      Amount       Capital   Compensation    Stockholder     Deficit       Total
                          ---------  -----------  ----------- ------------  --------------- -----------  -----------
<S>                       <C>        <C>          <C>         <C>           <C>             <C>          <C>

Net loss................        --   $       --   $       --  $       --      $       --    $       (82) $       (82)
                          ---------  -----------  ----------- -----------     -----------   -----------  -----------
Balance at December 31,
 1996...................        --           --           --          --              --            (82)         (82)

Issuance of Common
 Stock..................  4,763,000            5          --          --              --            --             5
Repurchase of Common
 Stock..................   (570,000)          (1)         --          --              --            --            (1)
Net loss................        --           --           --          --              --         (1,769)      (1,769)
                          ---------  -----------  ----------- -----------     -----------   -----------  -----------
Balance at December 31,
 1997...................  4,193,000            4          --          --              --         (1,851)      (1,847)

Issuance of Common
 Stock..................    812,000            1           79         --              --            --            80
Repurchase of Common
 Stock..................   (255,000)         --           --          --              --            --           --
Accretion of Mandatorily
 Redeemable Convertible
 Preferred Stock........        --           --           --          --              --           (828)        (828)
Net loss................        --           --                                                 (10,478)     (10,478)
                          ---------  -----------  ----------- -----------     -----------   -----------  -----------
Balance at December 31,
 1998...................  4,750,000            5           79         --              --        (13,157)     (13,073)

Issuance of Common Stock
 (unaudited)............    175,000          --            58         --              (50)          --             8
Issuance of warrants
 (unaudited)............        --           --           532         --              --            --           532
Unearned stock
 compensation
 (unaudited) (Note 11)..        --           --         1,387      (1,387)            --            --           --
Amortization of stock
 compensation
 (unaudited)............        --           --           --          253             --            --           253
Accretion of Mandatorily
 Redeemable Convertible
 Preferred Stock
 (unaudited)............        --           --           --          --              --         (1,191)      (1,191)
Adjustments to
 redemption value of
 Mandatorily Redeemable
 Preferred Stock
 (unaudited)............        --           --         1,865         --              --            --         1,865
Net loss (unaudited)....        --           --           --          --              --         (8,244)      (8,244)
                          ---------  -----------  ----------- -----------     -----------   -----------  -----------
Balance at July 2, 1999
 (unaudited)............  4,925,000  $         5  $     3,921 $    (1,134)    $       (50)  $   (22,592) $   (19,850)
                          =========  ===========  =========== ===========     ===========   ===========  ===========
</TABLE>


  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-5
<PAGE>

                             COBALT NETWORKS, INC.
                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>
                                               Year Ended
                            Period From       December 31,        Six Months Ended
                         October 18, 1996  --------------------  -------------------
                          (inception) to                         June 30,   July 2,
                         December 31, 1996   1997       1998       1998       1999
                         ----------------- ---------  ---------  ---------  --------
                                                                    (unaudited)
<S>                      <C>               <C>        <C>        <C>        <C>
Cash flows from
 operating activities:
 Net loss..............      $     (82)    $  (1,769) $ (10,478) $  (3,752) $ (8,244)
 Adjustments to
  reconcile net loss
  to net cash used in
  operating
  activities:
  Depreciation.........            --             18        323         82       369
  Amortization of
   stock
   compensation........            --            --         --         --        253
  Non-cash interest
   expense.............            --             20          2        --        130
  Changes in assets
   and liabilities:
   Accounts
    receivable.........            --            --      (2,040)      (331)   (2,789)
   Inventories.........            --            (20)      (494)        19      (505)
   Other current
    assets.............             (4)          (74)      (161)       (25)      (68)
   Accounts payable....             45           164      3,970        955     1,324
   Accrued
    liabilities........              9            76      1,096        130     1,648
   Deferred margin on
    distributor
    inventory..........            --            --         294        --        423
                             ---------     ---------  ---------  ---------  --------
    Net cash used in
     operating
     activities........            (32)       (1,585)    (7,488)    (2,922)   (7,459)
                             ---------     ---------  ---------  ---------  --------
Cash flows used in
 investing activities
 for acquisition of
 property and
 equipment:                        (23)         (157)    (1,423)      (407)     (428)
                             ---------     ---------  ---------  ---------  --------
Cash flows from
 financing activities:
 Proceeds from
  issuance of
  Mandatorily
  Redeemable
  Convertible
  Preferred Stock,
  net..................            --          2,992      7,210        597    29,583
 Proceeds from
  issuance of Common
  Stock................            --              4         80         80         8
 Proceeds from advance
  from related party...            --            --         500        300       --
 Proceeds from
  borrowings under
  line of credit.......            --            --         600        300       --
 Principal payments on
  line of credit.......            --            --         --         --       (600)
 Proceeds from
  borrowings under
  notes payable........             70           --         431        --        --
 Principal payments on
  notes payable........            --           (130)      (308)       --        (18)
 Proceeds from
  borrowings under
  convertible
  promissory notes.....            --            599        750        750     4,250
                             ---------     ---------  ---------  ---------  --------
   Net cash provided by
    investing
    activities.........             70         3,465      9,263      2,027    33,223
                             ---------     ---------  ---------  ---------  --------
Net increase (decrease)
 in cash and cash
 equivalents...........             15         1,723        352     (1,302)   25,336
Cash and cash
 equivalents at
 beginning of period...            --             15      1,738      1,738     2,090
                             ---------     ---------  ---------  ---------  --------
Cash and cash
 equivalents at end of
 period................      $      15     $   1,738  $   2,090  $     436  $ 27,426
                             =========     =========  =========  =========  ========
Supplemental disclosure
 of cash flow
 information:
 Cash paid for
  interest.............      $     --      $       9  $      13  $     --   $     88
                             =========     =========  =========  =========  ========
 Conversion of notes
  payable and accrued
  interest into
  Mandatorily
  Redeemable
  Convertible
  Preferred Stock......      $     --      $     559  $     750  $     --   $  4,800
                             =========     =========  =========  =========  ========
 Issuance of
  warrants.............      $     --      $     --   $     --   $     --   $    402
                             =========     =========  =========  =========  ========
 Issuance of Common
  Stock for promissory
  note.................      $     --      $     --   $     --   $     --   $     50
                             =========     =========  =========  =========  ========
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-6
<PAGE>

                             COBALT NETWORKS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

 The Company

  Cobalt Networks, Inc., (formerly ViavisionSystems Inc. and Cobalt
Microserver, Inc.) (the "Company"), was incorporated in California in October
1996. The Company is a leading provider of server appliances. Server appliances
are a new category of network infrastructure devices that are optimized to
deliver one or a few network-based applications well. The Company markets and
sells its products globally through its direct sales force and its channel
partners. The Company operates in one business segment.

 Reincorporation

  On September 1, 1999, the Company's Board of Directors authorized the
reincorporation of the Company in the State of Delaware. As a result of the
reincorporation, the Company is authorized to issue 120,000,000 shares of
$0.001 par value Common Stock and 10,000,000 shares of $0.001 par value
Preferred Stock. The Board of Directors has the authority to issue the
undesignated Preferred Stock in one or more series and to fix the rights,
preferences, privileges and restrictions thereof. The par value and shares of
Common Stock and Preferred Stock authorized, issued and outstanding at each
balance sheet date presented, and for each period presented in the consolidated
statement of stockholders' deficit have been retroactively adjusted to reflect
the reincorporation.

 Principles of consolidation and basis of presentation

  The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All material intercompany transactions and
balances have been eliminated in consolidation.

  Through December 31, 1998 the Company operated on a calendar quarter-end and
year-end basis. Beginning in 1999 the Company changed its accounting periods to
thirteen-week fiscal quarters ending on the Friday closest to the end of the
month.

 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 and 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.

 Revenue recognition

  Revenue from product sales to other than distributors is generally recognized
at the time the product is shipped. Provisions for estimated future product
returns and exchanges are recognized upon product shipment.

  The Company grants distributors limited rights of return on unsold inventory
held by such distributors. The Company has limited control over the extent to
which products sold to distributors are sold through to end users. Accordingly,
the Company recognizes revenues on sales to distributors based on estimates of
products sold through to end users.

  Upon shipment, the Company also provides for the estimated cost that may be
incurred for product warranties.

                                      F-7
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Cash equivalents

  The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. The majority of the
Company's cash equivalents consist of money market funds.

 Inventories

  Inventories are stated at the lower of cost or market. Cost is determined
using standard cost which approximates the first-in, first-out method.

 Property and equipment

  Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the shorter of the estimated useful lives of the
assets, generally eighteen months to five years, or the lease term of the
respective assets.

 Research and development

  Research and development costs are charged to operations as incurred.

  Software development costs are included in research and development and are
expensed as incurred. After technological feasibility is established, material
software development costs are capitalized. The capitalized cost is then
amortized on a straight-line basis over the estimated product life, or on the
ratio of current revenues to total projected product revenues, whichever is
greater. To date, the period between achieving technological feasibility, which
the Company has defined as the establishment of a working model which typically
occurs when the beta testing commences, and the general availability of such
software has been short and software development costs qualifying for
capitalization have been insignificant. Accordingly, the Company has not
capitalized any software development costs.

 Income taxes

  Income taxes are computed using the asset and liability method. Deferred
income tax assets or liabilities are established for the expected future
consequences resulting from the temporary differences between the financial
reporting and income tax bases of assets and liabilities and from net operating
loss and tax credit carryforwards. The Company records a valuation allowance
against deferred tax assets when it is more likely than not that such assets
will not be realized.

 Fair value of financial instruments

  The Company's financial instruments, including cash, cash equivalents,
accounts receivable, accounts payable, notes payable and capital lease
obligations are carried at cost, which approximates their fair value because of
the short-term maturity of these instruments.

 Concentration of credit risk

  Financial instruments which potentially subject the Company to a
concentration of credit risk consist principally of cash equivalents and
accounts receivable. The Company places its cash and cash equivalents primarily
in market rate accounts with high credit financial institutions. The Company's
accounts receivable are derived from revenue earned from customers located in
the

                                      F-8
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

United States, Europe and Asia. Sales to foreign customers in 1998, which are
denominated in U.S. dollars, accounted for 44% of total revenue. Sales in the
United States, Japan, Europe and other foreign countries were 56%, 21%, 15% and
8%, respectively, of total revenues in 1998. The Company performs ongoing
credit evaluations of its customers' financial condition and generally requires
no collateral from its customers. The Company maintains an allowance for
doubtful accounts receivable based upon the expected collectibility of accounts
receivable.

  During the year ended December 31, 1998, one customer accounted for
approximately 12% of net revenues. As of December 31, 1998, this customer
accounted for 15% of total accounts receivable. During the period ended July 2,
1999 two customers accounted for approximately 18% and 13% (unaudited),
respectively, of net revenues. As of July 2, 1999, one of these customers
accounted for 23% (unaudited) of total accounts receivable.

 Stock-based compensation

  The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123 "Accounting for Stock-Based Compensation."

  The Company accounts for stock issued to non-employees in accordance with the
provisions of SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18,
"Accounting for Equity Instruments That are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services."

 Foreign currency translation

  The Company uses the U.S. dollar as its functional currency for all of its
worldwide operations. All sales worldwide are billed in U.S. dollars. Foreign
currency assets and liabilities are remeasured into U.S. dollars at the end-of-
period exchange rates. Expenses are translated at average exchange rates in
effect during each period, except for those expenses related to balance sheet
amounts which are translated at historical exchange rates. Gains or losses from
foreign currency remeasurements and transactions are included in net loss and
were not material for all periods presented.

 Comprehensive income

  Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity (net assets)
during a period from nonowner sources. To date, the Company has not had any
transactions that are required to be reported in comprehensive income (loss) as
compared to its reported net loss.

 Net loss per share

  The Company computes net loss per share in accordance with SFAS No. 128,
"Earnings per Share" and SEC Staff Accounting Bulletin No. 98 ("SAB 98"). Under
the provisions of SFAS No. 128 and SAB 98, basic net loss per share is computed
by dividing the net loss available to holders of Common Stock for the period by
the weighted average number of shares of Common Stock outstanding during the
period. Weighted average shares exclude shares of Common Stock subject to
repurchase ("restricted shares"). Diluted net loss per share is computed by
dividing the net loss

                                      F-9
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

available to holders of Common Stock for the period by the weighted average
number of shares of Common Stock and potential Common Stock outstanding during
the period, if dilutive. Potential Common Stock includes unvested restricted
shares of Common Stock and incremental shares of Common Stock issuable upon the
exercise of stock options and warrants and upon conversion of Series A, B, and
C Mandatorily Redeemable Convertible Preferred Stock.

  The following table sets forth the computation of basic and diluted net loss
per share for the periods indicated (in thousands, except share and per share
data):

<TABLE>
<CAPTION>
                               Period From                               Six Months Ended
                            October 18, 1996  Year Ended December 31,   --------------------
                             (inception) to   ------------------------    June 30,July 2,
                            December 31, 1996    1997         1998        1998       1999
                            ----------------- -----------  -----------  ---------  ---------
                                                                            (unaudited)
   <S>                      <C>               <C>          <C>          <C>        <C>
   Numerator:
     Net loss attributable
      to holders of Common
      Stock................    $      (82)    $    (1,769) $   (11,306) $  (3,752) $  (9,435)
                               ==========     ===========  ===========  =========  =========
   Denominator:
     Weighted average
      shares outstanding...           --        2,519,000    4,700,000  4,626,000  4,834,000
     Weighted average
      shares of Common
      Stock subject to
      repurchase...........           --        2,087,000    2,635,000  2,834,000  1,496,000
                               ----------     -----------  -----------  ---------  ---------
     Denominator for basic
      and diluted
      calculation..........           --          432,000    2,065,000  1,792,000  3,338,000
                               ==========     ===========  ===========  =========  =========
   Basic and diluted net
    loss per share
    attributable to holders
    of Common Stock........    $      --      $     (4.10) $     (5.47) $   (2.09) $   (2.83)
                               ==========     ===========  ===========  =========  =========
</TABLE>

  The effects of options to purchase 238,000, 1,622,000 and 2,145,000
(unaudited) shares of Common Stock at an average exercise price of $0.03, $0.26
and $0.69 (unaudited) per share; warrants to purchase 164,000, 204,000 and
283,000 (unaudited) shares of Preferred Stock at an average exercise price of
$1.00, $1.24 and $1.93 (unaudited) per share; and 3,572,000, 7,271,000 and
17,085,000 (unaudited) shares of Mandatorily Redeemable Convertible Preferred
Stock for the years ended December 31, 1997 and 1998 and the six months ended
July 2, 1999, respectively, and warrants to purchase 243,000 (unaudited) shares
of Common Stock at $3.70 (unaudited) per share at July 2, 1999, have not been
included in the computation of diluted net loss per share as their effect would
have been anti-dilutive.

 Pro forma net loss per share (unaudited)

  Pro forma net loss per share for the year ended December 31, 1998 and the six
months ended July 2, 1999 is computed using the weighted average number of
shares of Common Stock

                                      F-10
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

outstanding, including the pro forma effects of the automatic conversion of the
Company's Series A, B, and C Mandatorily Redeemable Convertible Preferred Stock
into shares of the Company's Common Stock effective upon the closing of the
Company's initial public offering as if such conversion occurred on January 1,
1998 or at the date of original issuance, if later. The resulting pro forma
adjustment includes an increase in the weighted average shares used to compute
basic net loss per share of 5,265,000 for the year ended December 31, 1998 and
10,470,000 for the six months ended July 2, 1999.

 Segment information

  In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
This statement establishes standards for the way companies report information
about operating segments in annual financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. During each period presented, the Company operated in a
single business segment, primarily in the United States, Japan and Europe.

 New accounting pronouncement

  In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 established methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. The Company has not
yet determined what the effect of SFAS No. 133 will be on the operations and
financial position of the Company. The Company will be required to implement
SFAS No. 133 beginning in 2001.

 Unaudited interim results

  The accompanying consolidated balance sheet as of July 2, 1999, the
consolidated statements of operations and cash flows for the six months ended
July 2, 1999 and June 30, 1998 and the consolidated statement of stockholders'
deficit for the six months ended July 2, 1999 are unaudited. In the opinion of
management, these statements have been prepared on the same basis as the
audited financial statements and include all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the Company's
financial position and its results of operations and cash flows for the interim
periods. The data included in notes to the financial statements for these
periods is unaudited.

                                      F-11
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


NOTE 2--BALANCE SHEET COMPONENTS (in thousands):

<TABLE>
<CAPTION>
                                                    December 31,
                                                   ----------------    July 2,
                                                    1997     1998       1999
                                                   -------  -------  -----------
                                                                     (unaudited)
   <S>                                             <C>      <C>      <C>
   Inventories:
     Finished goods............................... $   --   $   498    $   813
     Raw materials................................      20       16        206
                                                   -------  -------    -------
       Total...................................... $    20  $   514    $ 1,019
                                                   =======  =======    =======

   Property and equipment:
     Computer equipment........................... $   100  $   456    $   737
     Office equipment and fixtures................       4      280        416
     Production equipment and tooling.............      76      417        417
     Leasehold improvements.......................     --       450        461
                                                   -------  -------    -------
                                                       180    1,603      2,031
     Less: Accumulated depreciation...............     (18)    (341)      (710)
                                                   -------  -------    -------
                                                   $   162  $ 1,262    $ 1,321
                                                   =======  =======    =======
   Accrued liabilities:
     Employee benefits............................ $    55  $   543    $ 1,042
     Reserve for sales returns....................     --       386        979
     Warranty.....................................     --       181        494
     Other........................................      30       73        266
                                                   -------  -------    -------
                                                   $    85  $ 1,183    $ 2,781
                                                   =======  =======    =======
</TABLE>

NOTE 3--DEBT:

 Line of credit

  At December 31, 1998, the Company had $600,000 outstanding under a line of
credit agreement with a bank. The line of credit provides for borrowings of up
to $800,000 which are secured by the assets of the Company. The line of credit
expired in May 1999 and bears interest at prime plus 0.75% per annum (8.75% at
December 31, 1998).

 Notes payable

  In September 1998, the Company entered into an equipment lease financing
agreement with a leasing company. The agreement provides for borrowings of up
to $1.0 million which are secured by the Company's equipment, machinery and
fixtures. As of December 31, 1998 and July 2, 1999, the Company had outstanding
borrowings under this agreement of $123,000 and $105,000 (unaudited),
respectively. The note balance is payable in 34 equal monthly installments and
bears interest at 10.95% per annum. Future principal payments under this note
are as follows (in thousands):

<TABLE>
<CAPTION>
       Year Ending
       December 31,
       ------------
       <S>                                                                  <C>
        1999............................................................... $ 39
        2000...............................................................   44
        2001...............................................................   40
                                                                            ----
                                                                            $123
                                                                            ====
</TABLE>


                                      F-12
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  In November 1996 and December 1996, the Company borrowed a total of $70,000
from a stockholder which bore interest at 10% per annum. In connection with
this loan, the Company issued warrants to purchase 17,500 shares of Series A
Mandatorily Redeemable Convertible Preferred Stock at $1.00 per share. The
estimated fair value of the warrants at the grant date was not material to the
financial statements.

  In January 1997 and March 1997, the Company borrowed an additional $60,000
from the same stockholder which bore interest at 10% per annum. In connection
with this loan, the Company issued warrants to purchase 15,000 shares of Series
A Mandatorily Redeemable Convertible Preferred Stock at $1.00 per share. The
estimated fair value of the warrants at the grant date was not material to the
financial statements.

  In September 1997, the Company repaid the above loans.

  In June 1998, the Company borrowed $300,000 from a stockholder which bore
interest at 5.5% per annum. In connection with the loan, the Company issued
warrants to purchase 7,000 shares of Series B Mandatorily Redeemable
Convertible Preferred Stock at $2.163 per share. The estimated fair value of
the warrants at the grant date was not material to the financial statements. In
July 1998, the Company repaid the loan in full.

 Convertible promissory notes payable

  During the year ended December 31, 1997, the Company borrowed $539,000 from
various individuals under convertible promissory notes bearing interest at 10%
per annum. In connection with these notes, the Company issued warrants to
purchase 131,000 shares of Series A Mandatorily Redeemable Convertible
Preferred Stock at $1.00 per share. The estimated fair value of these warrants
at the grant date was not material to the financial statements. These notes,
including $20,000 of accrued interest, were converted into Series A Mandatorily
Redeemable Convertible Preferred Stock at $1.00 per share in September 1997.

  In April 1998, the Company borrowed $750,000 from various individuals under
convertible promissory notes bearing interest at 5.5% per annum. In connection
with these borrowings, the Company issued warrants to purchase 35,000 shares of
Series B Mandatorily Redeemable Convertible Preferred Stock at $2.163 per
share. The estimated fair value of the warrants at the grant date was not
material to the financial statements. These notes were converted into Series B
Mandatorily Redeemable Convertible Preferred Stock at $2.163 per share in July
1998.

  In December 1998, the Company borrowed $500,000 from an affiliate of a member
of its Board of Directors and $50,000 from an individual investor under
convertible promissory notes bearing interest at 6% per annum. These notes were
converted to Series C Mandatorily Redeemable Preferred Stock in May 1999 (See
Note 11).

                                      F-13
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


NOTE 4--MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK:

  Mandatorily Redeemable Convertible Preferred Stock ("Preferred Stock") at
December 31, 1998 and July 2, 1999 (unaudited) consists of the following (in
thousands, except share data):

<TABLE>
<CAPTION>
                                         Shares
                                 ---------------------- Liquidation Redemption
                                 Authorized Outstanding   Amount     Amounts
                                 ---------- ----------- ----------- ----------
<S>                              <C>        <C>         <C>         <C>
Series A........................  3,735,000  3,572,000    $ 3,572    $ 3,572
Series B........................  3,741,000  3,699,000      8,000      8,000
                                 ---------- ----------    -------
Balance at December 31, 1998....  7,476,000  7,271,000     11,572
Series C (unaudited)............ 10,134,000  9,814,000     36,310     34,074
                                 ---------- ----------    -------    -------
Balance at July 2, 1999
 (unaudited).................... 17,610,000 17,085,000    $47,882    $45,646
                                 ========== ==========    =======    =======
</TABLE>

  During 1997, the Company issued 3,571,000 shares of Series A Preferred Stock
at $1.00 per share for net proceeds of approximately $3.0 million and the
conversion of $559,000 of notes payable described in Note 3. In July 1998, the
Company issued 1,000 shares of Series A Preferred Stock at $1.00 per share for
net proceeds of $1,000 upon the exercise of a warrant.

   In July 1998, the Company issued 3,699,000 shares of Series B Preferred
Stock at $2.163 per share for net proceeds of approximately $7.2 million and
the conversion of $750,000 of notes payable described in Note 3.

  The holders of Preferred Stock have various rights and preferences as
follows:

 Voting

  Each share of Preferred Stock has voting rights equal to an equivalent number
of shares of Common Stock into which it is convertible and votes together as
one class with the Common Stock.

  As long as at least 750,000 shares of Preferred Stock are outstanding, the
Company must obtain approval from two-thirds of the then outstanding shares of
Preferred Stock in order to alter the articles of incorporation as related to
Preferred Stock, authorize or issue any other equity security senior to or on a
parity with Preferred Stock, redeem or purchase any shares of Preferred Stock
other than by redemption in accordance with the certificate of incorporation,
increase or decrease the number of authorized shares of Preferred Stock,
authorize a dividend for any class or series other than Preferred Stock,
increase the size of the Board of Directors, or acquire any other company or
business.

 Conversion

  Each share of Preferred Stock outstanding is convertible into one share of
Common Stock, subject to adjustment for dilution, and will be converted into
Common Stock in the event of the closing of a public offering of at least
$20,000,000 at a minimum price of $7.50 per share. As of December 31, 1998, the
Company had reserved 7,271,000 shares of its Common Stock for issuance upon
conversion of the outstanding Preferred Stock.

                                      F-14
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Dividends

  Holders of Series A and B are entitled to receive cumulative dividends at the
per annum rate of $0.10 and $0.2163 per share, respectively, when and if
declared by the Board of Directors, prior to payment of dividends on Common
Stock. No dividends have been declared.

 Liquidation

  In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, holders of the Series B are entitled to
receive $2.163 per share, plus any declared but unpaid dividends, prior to any
distribution to the holders of Series A and Common Stock. Holders of Series A
are entitled to receive $1.00 per share, plus any declared but unpaid
dividends, prior to distribution to the holders of Common Stock. Any assets
remaining after distribution of the preference amounts on the Series A and
Common Stock will be distributed on a pro rata basis, assuming conversion of
the Preferred Stock.

 Redemption

  The holders of Preferred Stock may cause the Company to redeem their shares
after the fifth and before the seventh anniversary of the Series B issue date.
Redemption will be at the greater of fair market value or the original purchase
price plus accrued but unpaid dividends. During 1998, the Company recorded a
charge to its accumulated deficit of approximately $828,000 related to the
accretion to the Preferred Stock redemption value. As described in Note 11, in
connection with the issuance of Series C Preferred Stock in April 1999, the
redemption amount was modified to equal the original purchase price plus
accrued but unpaid dividends.

NOTE 5--COMMON STOCK:

  Certain shares of Common Stock outstanding were sold under Restricted Stock
Purchase Agreements (the "Agreements"). According to the terms of the
Agreements, in the event that the purchaser ceases their relationship with the
Company, the Company has the right to repurchase shares issued at the original
purchase price ("purchase option"), subject to a declining percentage over
time. During 1998 and 1997, the Company exercised its purchase option for
255,000 shares and 570,000 shares, respectively, of Common Stock at $0.001 per
share. As of December 31, 1998 and July 2, 1999, a total of 2,232,000 and
1,287,000 (unaudited) shares, respectively, were subject to repurchase by the
Company. Additionally, in the event that the purchase option has lapsed and the
purchaser decides to sell their shares, the Company has the first right of
refusal with respect to such shares.

NOTE 6--STOCK OPTIONS PLAN:

  In April 1997, the Company adopted the Employee Stock Option Plan ( the
"Plan"). The Plan provides for the granting of stock options and Common Stock
to employees and consultants of the Company. Options granted under the Plan may
be either incentive stock options or nonqualified stock options. Incentive
stock options ("ISO") may be granted only to Company employees (including
officers and directors who are also employees). Nonqualified stock options
("NSO") may be granted to Company employees and consultants. At December 31,
1998 and July 2, 1999, the Company has reserved 2,550,000 and 3,100,000
(unaudited) shares, respectively, of Common Stock for issuance under the Plan.

                                      F-15
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  Options under the Plan may be granted for periods of up to ten years and at
prices no less than 85% of the estimated fair value of the shares on the date
of grant as determined by the Board of Directors, provided, however, that (i)
the exercise price of an ISO and NSO shall not be less than 100% and 85% of the
estimated fair value of the shares on the date of grant, respectively, and (ii)
the exercise price of an ISO and NSO granted to a 10% shareholder shall not be
less than 110% of the estimated fair value of the shares on the date of grant,
respectively. Options are generally exercisable immediately, subject to
repurchase options held by the Company. The repurchase options lapse over a
maximum period of five years at such times and under such conditions as
determined by the Board of Directors. Options vest over 4 years, 25% after the
first year and ratably each month over the remaining 36 months.

  During 1998, the Company issued NSOs to an outside consultant to purchase
25,000 shares of Common Stock at $0.50 per share, the estimated grant date fair
market value. The estimated fair value of the options was not material to the
financial statements.

  The following table summarizes stock option activity under the Plan:

<TABLE>
<CAPTION>
                                                                      Weighted
                                                                      Average
                                             Options                  Exercise
                                            Available     Options      Price
                                            for Grant   Outstanding  Per Share
                                            ----------  -----------  ----------
<S>                                         <C>         <C>          <C>
Balance at December 31, 1996...............        --          --    $      --
  Authorized...............................  1,145,000         --           --
  Granted..................................   (826,000)    826,000        0.008
  Exercised................................        --     (110,000)       0.001
  Canceled.................................    478,000    (478,000)       0.001
                                            ----------  ----------
Balance at December 31, 1997...............    797,000     238,000
  Authorized...............................  1,405,000         --           --
  Granted.................................. (1,437,000)  1,437,000        0.500
  Exercised................................        --      (12,000)       0.001
  Canceled.................................     41,000     (41,000)       0.190
                                            ----------  ----------
Balance at December 31, 1998...............    806,000   1,622,000
  Authorized (unaudited)...................    550,000         --           --
  Granted (unaudited)......................   (742,000)    742,000         1.53
  Exercised (unaudited)....................        --      (75,000)        0.17
  Canceled (unaudited).....................    144,000    (144,000)        0.38
                                            ----------  ----------
Balance at July 2, 1999 (unaudited)........    758,000   2,145,000
                                            ==========  ==========
</TABLE>

                                      F-16
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The following table summarizes information about stock options outstanding
and exercisable as of December 31, 1998.

<TABLE>
<CAPTION>
                                                                Options
                               Options Outstanding           Exercisable at
                              at December 31, 1998         December 31, 1998
                       ----------------------------------- ------------------
                                                  Weighted           Weighted
                                 Weighted Average Average            Average
    Range of Exercise  Number of    Remaining     Exercise Number of Exercise
         Prices         Shares   Contractual Life  Price    Shares    Price
   ------------------- --------- ---------------- -------- --------- --------
   <S>                 <C>       <C>              <C>      <C>       <C>
   $0.001.............    32,000    8.38 years    $ 0.001   12,000   $ 0.001
    0.100.............   928,000    9.17 years      0.100   48,000     0.100
    0.500.............   662,000    9.65 years      0.500      --        --
                       ---------                            ------
                       1,622,000                            60,000
                       =========                            ======
</TABLE>

 Fair value disclosures

  Had compensation cost for the Company's stock-based compensation plan been
determined based on the fair value at the grant dates for the awards under a
method prescribed by SFAS No. 123, the Company's net loss for the years ended
December 31, 1996, 1997 and 1998 would have been increased to the pro forma
amounts indicated in the following table (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                  Year Ended December 31,
                                                -----------------------------
                                                  1996      1997      1998
                                                --------  --------  ---------
   <S>                                          <C>       <C>       <C>
   Net loss attributable to holders of Common
    Stock:
     As reported............................... $    (82) $ (1,769) $ (11,306)
                                                ========  ========  =========
     Pro forma................................. $    (82) $ (1,774) $ (11,412)
                                                ========  ========  =========
   Basic and diluted net loss per share
    attributable to holders of Common Stock:
     As reported...............................           $  (4.10) $   (5.47)
                                                          ========  =========
     Pro forma.................................           $  (4.11)  $  (5.53)
                                                          ========  =========
</TABLE>

  The Company calculated the minimum fair value of each option grant on the
date of grant using the Black-Scholes pricing model with the following
assumptions:

<TABLE>
<CAPTION>
                                                                  Year Ended
                                                                 December 31,
                                                                 --------------
                                                                  1997    1998
                                                                 ------  ------
   <S>                                                           <C>     <C>
   Expected life (years)........................................      5       5
   Risk free interest rate......................................   6.03%   6.66%
   Expected volatility..........................................    --      --
   Dividend yield...............................................    --      --
</TABLE>

  The estimated weighted average fair value of options granted to purchase
shares of common stock under the Plan in 1997 and 1998 was $0.01 and $0.07,
respectively.

                                      F-17
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


NOTE 7--EMPLOYEE BENEFIT PLANS:

  The Company sponsors a 401(k) defined contribution plan (the "Plan") covering
all eligible employees. Contributions made by the Company are determined
annually by the Board of Directors. No contributions have been made to the Plan
by the Company.

NOTE 8--INCOME TAXES:

  No provision or benefit for income taxes has been recognized for any of the
periods presented as the Company has incurred net operating losses since
inception.

  At December 31, 1998, the Company has approximately $11 million of net
operating loss carryforwards available to offset future taxable income for
Federal and California purposes which expire beginning in 2011 and 2004,
respectively. Under the Tax Reform Act of 1986, the amount of net operating
losses that can be utilized may be limited in certain circumstances including,
but not limited to, a cumulative stock ownership change of more than 50% over a
three-year period.

  Deferred tax assets of approximately $4.4 million and $400,000 at December
31, 1998 and 1997, respectively, consist primarily of federal and California
net operating loss carryforwards. Based on a number of factors, including the
lack of a history of profits and the fact that the Company competes in a
developing market that is characterized by rapidly changing technology,
management believes there is sufficient uncertainty regarding the realization
of deferred tax assets such that a full valuation allowance has been provided.

NOTE 9--COMMITMENTS:

  The Company leases office space under a noncancelable operating lease which
expires on December 31, 2003. Rent expense for the year ended December 31, 1998
and 1997 was $316,000 and $73,000, respectively. Rent expense for the period
ended July 2, 1999 was $392,000 (unaudited).

  Future minimum lease payments under noncancelable operating leases are as
follows (in thousands):

<TABLE>
<CAPTION>
       Year Ended
       December 31,
       ------------
       <S>                                                                <C>
        1999............................................................. $  726
        2000.............................................................    743
        2001.............................................................    794
        2002.............................................................    827
        2003.............................................................    844
                                                                          ------
                                                                          $3,934
                                                                          ======
</TABLE>

NOTE 10--CONTINGENCIES:

  Pursuant to the Company's turnkey service and purchase agreement with its
subcontract manufacturer, in the event that the agreement is terminated, the
Company would be required to purchase remaining surplus or obsolete inventory
which is specific to the Company's products.

  On December 4, 1998, Cube Computer Corporation filed suit against the Company
claiming the use of the trademark Qube for its server products constitutes a
trademark infringement of Cube Computer Corporation's registered Cube trademark
for computer hardware products. The Company

                                      F-18
<PAGE>

                             COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

intends to defend this matter vigorously but is unable to provide an evaluation
of the probability of a favorable or unfavorable outcome. Management believes,
based on currently available information, the resolution of this matter will
not have a material adverse effect on its financial position or cash flows.

NOTE 11--SUBSEQUENT EVENTS

 Financings

  In February and March 1999, the Company borrowed $4.25 million from various
investors under convertible promissory notes bearing interest at 6.0% per
annum. These notes were converted into Series C Mandatorily Redeemable
Preferred Stock in May 1999. In connection with the notes, the Company issued
warrants to purchase 79,045 shares of Series C Mandatorily Redeemable
Convertible Preferred Stock at $3.70 per share. The estimated fair value of the
warrants at the grant date was $130,000 and was recorded as interest expense.

  In April 1999, the Company amended its articles of incorporation to increase
its authorized shares to 26,000,000 shares of Common Stock and 17,610,000
shares of Preferred Stock, of which 10,134,452 shares were designated as Series
C Mandatorily Redeemable Convertible Preferred Stock. The Company also revised
the redemption provisions of its Preferred Stock such that the redemption
amount is the original issue price plus accrued dividends.

  In May 1999, the Company issued 9,814,000 shares of Series C Mandatorily
Redeemable Preferred Stock at $3.70 per share for net proceeds of approximately
$29.6 million and the conversion of $4.80 million of notes payable described in
Note 3 and above. In connection with the transaction, the Company issued a
warrant to purchase 243,000 shares of Common Stock at $3.70 per share. The
estimated fair value of the warrants at the date of grant was $402,000, which
was recorded as additional paid in capital. The rights of Series C are similar
to Series B except, among other differences, the holders of Series C are
entitled to noncumulative dividends of $0.37 per share and the liquidation
preference is $3.70 per share.

 Unearned stock compensation

  In connection with certain stock option grants during the six months ended
July 2, 1999, the Company recorded unearned stock compensation cost totaling
$1.4 million which is being recognized over the vesting period of the related
options of four years. Amortization expense associated with unearned stock
compensation totaled $253,000 for the six months ended July 2, 1999.

  During the period from July 3, 1999 through September 3, 1999, the Company
granted options to purchase an aggregate of 1,355,000 shares of Common Stock at
exercise prices ranging from $2.50 to $10.00 per share. The Company expects to
record additional unearned stock compensation with respect to these options
totaling $7.4 million. The Company will record amortization expense associated
with unearned stock compensation of $893,000 and $1.2 million in the third and
fourth quarters of fiscal 1999 and $1.2 million, $1.2 million, $847,000 and
$615,000 in the first, second, third and fourth quarters of fiscal 2000,
respectively.

 Note Receivable from Stockholder

  In August 1999, the Company advanced $500,000 to its Chief Executive Officer.
In September 1999, the advance was converted into a full recourse non-interest
bearing promissory note payable in four years and is secured by 50,000 shares
of Series B Preferred Stock.


                                      F-19
<PAGE>

                                  UNDERWRITING

  Cobalt and the underwriters for the offering named below have entered into an
underwriting agreement with respect to the shares being offered. Subject to
certain conditions, each underwriter has severally agreed to purchase the
number of shares indicated in the following table. Goldman, Sachs & Co.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated and BancBoston Robertson
Stephens Inc. are the representatives of the underwriters.

<TABLE>
<CAPTION>
                           Underwriter                          Number of Shares
                           -----------                          ----------------
   <S>                                                          <C>
   Goldman, Sachs & Co. .......................................
   Merrill Lynch, Pierce, Fenner & Smith Incorporated..........
   BancBoston Robertson Stephens Inc. .........................
                                                                   ---------
     Total.....................................................
                                                                   =========
</TABLE>

                                ---------------

  If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional
shares from Cobalt to cover such sales. They may exercise that option for 30
days. If any shares are purchased under this option, the underwriters will
severally purchase shares in approximately the same proportion as set forth in
the table above.

  The following tables show the per share and total underwriting discounts and
commissions to be paid to the underwriters by Cobalt. These amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase additional shares.

<TABLE>
<CAPTION>
                                                            Paid by Cobalt
                                                       -------------------------
                                                       No Exercise Full Exercise
                                                       ----------- -------------
<S>                                                    <C>         <C>
Per Share............................................. $            $
Total................................................. $            $
</TABLE>

  Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus.
Any shares sold by the underwriters to securities dealers may be sold at a
discount of up to $    per share from the initial public offering price. Any of
these securities dealers may resell any shares purchased from the underwriters
to other brokers or dealers at a discount of up to $    per share from the
initial public offering price. If all the shares are not sold at the initial
public offering price, the representatives may change the offering price and
the other selling terms.

  Cobalt and its directors, officers, employees and substantially all holders
of shares of Cobalt's common stock have agreed with the underwriters not to
dispose of or hedge any of their common stock or securities convertible into or
exchangeable for shares of common stock during the period from the date of this
prospectus continuing through the date 180 days after the date of this
prospectus, except with the prior written consent of Goldman, Sachs & Co. This
restriction does not apply to any issuances under Cobalt's existing employee
benefit plans. The underwriters have agreed that the holders of up to 100,000
shares may sell those shares beginning 30 days after the date this offering is
declared effective provided that the shares are sold through Goldman, Sachs &
Co. and at a time agreeable to both Goldman, Sachs & Co. and Cobalt. See
"Shares Eligible for Future Sale" for a discussion of transfer restrictions.

                                      U-1
<PAGE>

  Prior to this offering, there has been no public market for the common stock.
The initial public offering price for the common stock will be negotiated among
Cobalt and the representatives of the underwriters. Among the factors to be
considered in determining the initial public offering price of the shares, in
addition to prevailing market conditions, are Cobalt's historical performance,
estimates of Cobalt's business potential and earnings prospects, an assessment
of Cobalt's management and the consideration of the above factors in relation
to market valuation of companies in related businesses.

  Application has been made for quotation of the common stock on the Nasdaq
National Market under the symbol "COBT".

  In connection with this offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering.
Stabilizing transactions consist of bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.

  The underwriters may also impose a penalty bid. This occurs when a particular
underwriter repays to the underwriters a portion of the underwriting discount
received by it because the representatives have repurchased shares sold by or
for the account of this underwriter in stabilizing or short-sale covering
transactions.

  These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the
open market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.

  The underwriters do not expect sales to discretionary accounts to exceed five
percent of the total number of shares offered.

  At Cobalt's request, the underwriters have reserved up to        shares of
the common stock offered hereby for sale, at the initial public offering price,
to customers and other friends of Cobalt through a directed share program. The
number of shares available for sale to the general public will be reduced to
the extent these persons purchase the reserved shares. There can be no
assurance that any of the reserved shares will be so purchased. Any reserved
shares not so purchased will be offered by the underwriters to the general
public on the same basis as other shares offered hereby.

  Cobalt estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $1,050,000.

  Cobalt has agreed to indemnify the underwriters against liabilities,
including liabilities under the Securities Act of 1933.

                                      U-2
<PAGE>




  [Description for EDGAR: Picture of a woman holding 4 Cobalt RaQ server
appliances with stacks of Cobalt RaQ server appliances in the background.
Underneath the picture is the caption "The Cobalt RaQ" and beneath that is the
following text: "Simple. Affordable. The dedicated hosting solution that is
less than two inches tall." Beneath this text is the Cobalt logo and the words
"Cobalt Networks".]
<PAGE>

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

  No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is an offer to
sell only the shares offered hereby, but only under circumstances and in
jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.

                                --------------

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
<S>                                                                       <C>
Prospectus Summary.......................................................   3
Risk Factors.............................................................   7
Forward-Looking Statements...............................................  22
Use of Proceeds..........................................................  23
Dividend Policy..........................................................  23
Capitalization...........................................................  24
Dilution.................................................................  25
Selected Consolidated Financial Data.....................................  26
Management's Discussion and Analysis of Financial Condition and Results
 of Operations ..........................................................  28
Business.................................................................  39
Management...............................................................  53
Related Party Transactions...............................................  62
Principal Stockholders...................................................  65
Description of Capital Stock ............................................  68
Shares Eligible for Future Sale..........................................  72
Legal Matters............................................................  73
Experts..................................................................  73
Where You Can Find Additional Information................................  74
Index to Consolidated Financial Statements............................... F-1
Underwriting............................................................. U-1
</TABLE>

                                --------------

  Through and including     , 1999 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to a dealer's obligation to deliver a prospectus when
acting as underwriter and with respect to an unsold allotment or subscription.

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

                                        Shares

                             Cobalt Networks, Inc.

                                  Common Stock

                                --------------

                           [COBALT LOGO APPEARS HERE]

                                --------------

                              Goldman, Sachs & Co.

                              Merrill Lynch & Co.

                         BancBoston Robertson Stephens

                      Representatives of the Underwriters

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>

                                    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 the
underwriting discounts, payable by the Registrant in connection with the sale
of the securities being registered. All amounts are estimates except the SEC
registration fee, the NASD filing fee and the Nasdaq National Market listing
fee.

<TABLE>
   <S>                                                               <C>
   SEC Registration Fee............................................. $   23,978
   NASD Filing Fee..................................................      9,125
   Nasdaq National Market Listing Fee...............................     95,000
   Printing Costs...................................................    275,000
   Legal Fees and Expenses..........................................    350,000
   Accounting Fees and Expenses.....................................    250,000
   Blue Sky Fees and Expenses.......................................      5,000
   Transfer Agent and Registrar Fees................................     10,000
   Miscellaneous....................................................     31,897
                                                                     ----------
         Total...................................................... $1,050,000
                                                                     ==========
</TABLE>

Item 14. Indemnification of Directors and Officers.

  As permitted by Section 204(a) of the California General Corporation Law, the
Registrant's Amended and Restated Articles of Incorporation eliminate a
director's personal liability for monetary damages to the Registrant and its
shareholders arising from a breach or alleged breach of the director's
fiduciary duty, except for liability arising under Sections 310 and 316 of the
California General Corporation Law or liability for (i) acts or omissions that
involve intentional misconduct or knowing and culpable violation of law, (ii)
acts or omissions that a director believes to be contrary to the best interests
of the Registrant or its shareholders or that involve the absence of good faith
on the part of the director, (iii) any transaction from which a director
derived an improper personal benefit, (iv) acts or omissions that show a
reckless disregard for the director's duty to the Registrant 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 serious injury to the Registrant or its shareholders, (v) acts or omissions
that constitute an unexcused pattern of inattention that amounts to an
abdication of the director's duty to the Registrant or its shareholders, (vi)
interested transactions between the corporation and a director in which a
director has a material financial interest, and (vii) liability for improper
distributions, loans or guarantees. This provision does not eliminate the
directors' duty of care, and in appropriate circumstances equitable remedies
such as an injunction or other forms of non-monetary relief would remain
available under California law.

  Sections 204(a) and 317 of the California General Corporation Law authorize a
corporation to indemnify its directors, officers, employees and other agents in
terms sufficiently broad to permit indemnification (including reimbursement for
expenses) under certain circumstances for liabilities arising under the
Securities Act of 1933, as amended (the "Securities Act"). The Registrant's
Amended and Restated Articles of Incorporation and Bylaws contain provisions
covering indemnification to the maximum extent permitted by the California
General Corporation Law of corporate directors, officers and other agents
against certain liabilities and expenses incurred as a result of proceedings
involving such persons in their capacities as directors, officers employees or
agents, including proceedings under the Securities Act or the Securities
Exchange Act of 1934, as amended. Prior to the effective date of this Offering,
the Registrant will enter into indemnification agreements with its directors
and executive officers.

  In connection with its reincorporation in Delaware, the Registrant will be
subject to Section 145 of the Delaware General Corporation Law ("Section 145").
Section 145 permits indemnification of

                                      II-1
<PAGE>

officers and directors of the Company under certain conditions and subject to
certain limitations. Section 145 also provides that a corporation has the power
to maintain insurance on behalf of its officers and directors against any
liability asserted against such person and incurred by him or her in such
capacity, or arising out of his or her status as such, whether or not the
corporation would have the power to indemnify him or her against such liability
under the provisions of Section 145. Upon shareholder approval of such
reincorporation, Article VI, Section 6.1, of the Registrant's Bylaws will
provide for mandatory indemnification of its directors and officers and
permissible indemnification of employees and other agents to the maximum extent
not prohibited by the Delaware General Corporation Law. The rights to indemnity
thereunder continue as to a person who has ceased to be a director, officer,
employee or agent and inure to the benefit of the heirs, executors and
administrators of the person. In addition, expenses incurred by a director or
executive officer in defending any civil, criminal, administrative or
investigative action, suit or proceeding by reason of the fact that he or she
is or was a director or officer of the Registrant (or was serving at the
Registrant's request as a director or officer of another corporation) shall be
paid by the Registrant in advance of the final disposition of such action, suit
or proceeding upon receipt of an undertaking by or on behalf of such director
or officer to repay such amount if it shall ultimately be determined that he or
she is not entitled to be indemnified by the Registrant as authorized by the
relevant section of the Delaware General Corporation Law.

  As permitted by Section 102(b)(7) of the Delaware General Corporation Law,
the Registrant's Certificate of Incorporation provides that, pursuant to
Delaware law, its directors shall not be personally liable for monetary damages
for breach of the directors' fiduciary duty as directors to the Registrant and
its stockholders. This provision in the Certificate of Incorporation does not
eliminate the directors' fiduciary duty, and in appropriate circumstances
equitable remedies such as injunctive or other forms of non-monetary relief
will remain available under Delaware law. In addition, each director will
continue to be subject to liability for breach of the director's duty of
loyalty to the Registrant for acts or omission not in good faith or involving
international misconduct, for knowing violations of law, for actions leading to
improper personal benefit to the director, and for payment of dividends or
approval of Stock repurchases or redemptions that are unlawful under Section
174 of the Delaware General Corporation Law. The provision also does not affect
a director's responsibilities under any other law, such as the federal
securities laws or state or federal environmental laws. The Registrant has
entered into indemnification agreements with each of its directors and
executive officers. Generally, the indemnification agreements attempt to
provide the maximum protection permitted by Delaware law as it may be amended
from time to time. Moreover, the indemnification agreements provide for certain
additional indemnification. Under such additional indemnification provisions,
however, an individual will not receive indemnification for judgments,
settlements or expenses if he or she is found liable to the Registrant (except
to the extent the court determines he or she is fairly and reasonably entitled
to indemnity for expenses), for settlements not approved by the Registrant or
for settlements and expenses if the settlement is not approved by the court.
The indemnification agreements provide for the Registrant to advance to the
individual any and all reasonable expenses (including legal fees and expenses)
incurred in investigating or defending any such action, suit or proceeding. In
order to receive an advance of expenses, the individual must submit to the
Registrant copies of invoices presented to him or her for such expenses. Also,
the individual must repay such advances upon a final judicial decision that he
or she is not entitled to indemnification.

  The Registrant intends to enter into additional indemnification agreements
with each of its directors and executive officers to effectuate these indemnity
provisions and to purchase directors' and officers' liability insurance.

  In addition to the foregoing, the Underwriting Agreement contains certain
provisions by which the Underwriters have agreed to indemnify the Registrant,
each person, if any, who controls the

                                      II-2
<PAGE>

Registrant within the meaning of Section 15 of the Securities Act, each
director of the Registrant, each officer of the Registrant who signs the
Registration Statement, with respect to information furnished in writing by or
on behalf of the Underwriters for use in the Registration Statement.

  At present, there is no pending litigation or proceeding involving a
director, officer, employee or other agent of the Registrant in which
indemnification is being sought, nor is the Registrant aware of any threatened
litigation that may result in a claim for indemnification by any director,
officer, employee or other agent of the Registrant.

Item 15. Recent Sales of Unregistered Securities.

  Since our incorporation in October 1996, we have sold and issued the
following securities:

    (1) In May and June 1997 the Registrant issued and sold 4,181,426 shares
  of Common Stock to employees for $4,181 pursuant to Section 4(2) of the
  Securities Act.

    (2) In August 1997, the Registrant issued and sold 471,338 shares of
  Common Stock to three employees for $471 pursuant to Section 4(2) of the
  Securities Act.

    (3) From August to November 1997, the Registrant issued and sold
  3,572,401 shares of Series A Preferred Stock to 13 investors for $3.6
  million pursuant to Section 4(2) of the Securities Act.

    (4) In March and April 1998, the Registrant issued and sold 800,000
  shares of Common Stock to one employee for $80,000 pursuant to Section 4(2)
  of the Securities Act.

    (5) In July 1998, the Registrant issued and sold 3,698,910 shares of
  Series B Preferred Stock to 21 investors for $8.0 million pursuant to
  Section 4(2) of the Securities Act.

    (6) In February 1999, the Registrant issued and sold 100,000 shares of
  Common Stock to one employee for $50,000 pursuant to Section 4(2) of the
  Securities Act.

    (7) In May 1999, the Registrant issued and sold 9,813,507 shares of
  Series C Preferred Stock to 60 investors for $36.3 million pursuant to
  Section 4(2) of the Securities Act.

    (8) Pursuant to Rule 701 promulgated under the Securities Act, from
  October 18, 1996 to July 2, 1999, the Registrant issued and sold 197,521
  shares of Common Stock to employees and consultants for aggregate
  consideration of $13,260 upon the exercise of stock options pursuant to the
  Registrant's Employee Stock Plan.

  The recipients of securities in each such transaction represented their
intentions 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 warrants issued in such
transactions. All recipients had adequate access, through their relationships
with us, to information about us.

Item 16. Exhibits and Financial Statement Schedules

(a) Exhibits.

<TABLE>
<CAPTION>
 Exhibit
 Number  Description of Document
 ------- -----------------------
 <C>     <S>
  1.1*    Form of Underwriting Agreement
  2.1     Form of Merger Agreement between Cobalt Networks, Inc., a California
          corporation, and Cobalt Networks, Inc., a Delaware corporation
  3.1     Certificate of Incorporation of the Registrant, as currently in
          effect
  3.1.1   Form of Certificate of Incorporation of the Registrant to be filed
          after the closing of the offering made under this Registration
          Statement
  3.2     Bylaws of the Registrant
</TABLE>

                                      II-3
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
 Number  Description of Document
 ------- -----------------------
 <C>     <S>
  3.3     California Restated Articles of Incorporation
  3.4     California Bylaws
  4.1*    Specimen Common Stock Certificate
  4.2     Second Amended and Restated Investors' Rights Agreement, dated April
          30, 1999, by and among the Registrant and certain stockholders of
          the Registrant
  5.1     Form of Opinion of Wilson Sonsini Goodrich & Rosati, Professional
          Corporation
 10.1     Form of Indemnification Agreement between the Registrant and each of
          its directors and officers
 10.2     Amended and Restated 1997 Employee Stock Plan
 10.2.1   Form of Option Agreement under the Employee Stock Plan
 10.3     1999 Employee Stock Purchase Plan
 10.3.1   Form of Subscription Agreement under the 1999 Employee Stock
          Purchase Plan
 10.4     1999 Director Option Plan
 10.4.1   Form of Option Agreement under 1999 Director Plan
 10.5     Form of Executive Officer Employment Agreement
 10.6     Consulting Agreement dated August 30, 1996 by and between the
          Registrant and Techfarm Management, Inc.
 10.7     Lease Agreement dated August 5, 1998 between Registrant and Renault
          & Handley Solar Ellis Joint Venture for 555 Ellis Street, Mountain
          View, California office
 10.7.1   Assignment of lease dated September 2, 1998 between Registrant and
          Netscape Communications, Inc.
 10.7.2   Sublease dated October 28, 1996 between Netscape Communications,
          Inc. and Banta Corporation
 10.7.3   Addendum One to sublease dated November 6, 1996 among Netscape
          Communications, Inc., Banta Corporation and Renault & Handley Solar
          Ellis Joint Venture
 10.7.4   Lease dated August 10, 1993 ("Master Lease") between Banta Digital
          Services, Inc. and Renault & Handley Solar Ellis Joint Venture
 10.8    Employee Option Agreement dated July 15, 1998 between the Registrant
         and George M. Korchinsky
 10.9     Employment Offer Letter dated July 20, 1999 from the Registrant to
          Gary Martell
 10.10    Separation Agreement dated July 28, 1999 by and between the
          Registrant and Robin Porter
 10.11+   Turnkey Service and Purchase Agreement dated August 31, 1999 by and
          among the Registrant and SMTC Manufacturing Corporation
 10.12    Promissory Note and Security Agreement dated August 20, 1999 between
          the Registrant and Stephen W. DeWitt
 21.1     Subsidiaries
 23.1     Consent of PricewaterhouseCoopers LLP, Independent Accountants
 23.2     Form of Consent of Counsel (included in Exhibit 5.1)
 24.1     Power of Attorney (see Page II-6)
 27.1     Financial Data Schedule
</TABLE>
--------
*  To be filed by amendment
+  Confidential treatment requested


                                      II-4
<PAGE>

(b) Financial Statement Schedules.

  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 agreements certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.

  Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, 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 of
  1933, 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
  of 1933, 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-5
<PAGE>

                                   SIGNATURES

  Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Mountain View, State of
California on September 8, 1999.

                                                   /s/ Stephen W. DeWitt
                                          By: _________________________________
                                                     Stephen W. DeWitt
                                               President and Chief Executive
                                                          Officer

                               POWER OF ATTORNEY

  KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints, jointly and severally, Stephen W. DeWitt
and Kenton D. Chow, and each of them, as his attorney-in-fact, with full power
of substitution, for him in any and all capacities, to sign any and all
amendments to this registration statement (including post-effective
amendments), and any and all registration statements filed pursuant to Rule 462
under the Securities Act of 1933, as amended, in connection with or related to
the offering contemplated by this registration statement and its amendments, if
any, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming our signatures as they may be signed by our said
attorney to any and all amendments to said registration statement.

  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION
STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE
DATES INDICATED:

<TABLE>
<CAPTION>
              Signature                           Title                    Date
              ---------                           -----                    ----

<S>                                    <C>                          <C>
        /s/ Stephen W. DeWitt          President, Chief Executive    September 8, 1999
______________________________________  Officer and Director
          Stephen W. DeWitt             (Principal Executive
                                        Officer)

          /s/ Kenton D. Chow           Vice President Finance and    September 8, 1999
______________________________________  Chief Financial Officer
            Kenton D. Chow              (Principal Financial and
                                        Accounting Officer)

        /s/ Gordon A. Campbell         Chairman of the Board of      September 8, 1999
______________________________________  Directors
          Gordon A. Campbell

          /s/ Jordan A. Levy           Director                      September 8, 1999
______________________________________
            Jordan A. Levy
</TABLE>

                                      II-6
<PAGE>

                                 EXHIBIT INDEX
<TABLE>
<CAPTION>
 Exhibit
 Number  Description of Document
 ------- -----------------------
 <C>     <S>
  1.1*    Form of Underwriting Agreement
  2.1     Form of Merger Agreement between Cobalt Networks, Inc., a California
          corporation, and Cobalt Networks, Inc., a Delaware corporation
  3.1     Certificate of Incorporation of the Registrant, as currently in
          effect
  3.1.1   Form of Certificate of Incorporation of the Registrant to be filed
          after the closing of the offering made under this Registration
          Statement
  3.2     Bylaws of the Registrant
  3.3     California Restated Articles of Incorporation
  3.4     California Bylaws
  4.1*    Specimen Common Stock Certificate
  4.2     Second Amended and Restated Investors' Rights Agreement, dated April
          30, 1999, by and among the Registrant and certain stockholders of
          the Registrant
  5.1     Form of Opinion of Wilson Sonsini Goodrich & Rosati, Professional
          Corporation
 10.1     Form of Indemnification Agreement between the Registrant and each of
          its directors and officers
 10.2     Amended and Restated 1997 Employee Stock Plan
 10.2.1   Form of Option Agreement under the Employee Stock Plan
 10.3     1999 Employee Stock Purchase Plan
 10.3.1   Form of Subscription Agreement under the 1999 Employee Stock
          Purchase Plan
 10.4     1999 Director Option Plan
 10.4.1   Form of Option Agreement under 1999 Director Plan
 10.5     Form of Executive Officer Employment Agreement
 10.6     Consulting Agreement dated September 30, 1996 by and between the
          Registrant and Techfarm Management, Inc.
 10.7     Lease Agreement dated August 5, 1998 between Registrant and Renault
          & Handley Solar Ellis Joint Venture for 555 Ellis Street, Mountain
          View, California office
 10.7.1   Assignment of lease dated September 2, 1998 between Registrant and
          Netscape Communications, Inc.
 10.7.2   Sublease dated October 28, 1996 between Netscape Communications,
          Inc. and Banta Corporation
 10.7.3   Addendum One to sublease dated November 6, 1996 among Netscape
          Communications, Inc., Banta Corporation and Renault & Handley Solar
          Ellis Joint Venture
 10.7.4   Lease dated August 10, 1993 ("Master Lease") between Banta Digital
          Services, Inc. and Renault & Handley Solar Ellis Joint Venture
 10.8     Employee Option Agreement dated July 15, 1998 between the Registrant
          and George Korchinsky
 10.9     Employment Offer Letter dated July 20, 1999 from the Registrant to
          Gary Martell
 10.10    Separation Agreement dated July 28, 1999 by and between the
          Registrant and Robin Porter
 10.11+   Turnkey Service and Purchase Agreement dated August 31, 1999 by and
          among the Registrant and SMTC Manufacturing Corporation
 10.12    Promissory Note and Security Agreement dated August 20, 1999 between
          the Registrant and Stephen W. DeWitt
 21.1     Subsidiaries
 23.1     Consent of PricewaterhouseCoopers LLP, Independent Accountants
 23.2     Form of Consent of Counsel (included in Exhibit 5.1)
 24.1     Power of Attorney (see Page II-6)
 27.1     Financial Data Schedule
</TABLE>
--------
*  To be filed by amendment
+  Confidential treatment requested
[{"type": "S-1", "sequence": "1", "description": "FORM S-1", "secsgml_size_bytes": 363364}]
{"company-data": {"conformed-name": "COBALT NETWORKS INC", "cik": "0001053355", "assigned-sic": "", "irs-number": "770440751", "state-of-incorporation": "DE"}, "filing-values": {"form-type": "S-1", "act": "33", "file-number": "333-86759", "film-number": "99708023"}, "business-address": {"street1": "555 ELLIS AVENUE", "city": "MOUNTAIN VIEW", "state": "CA", "zip": "94043", "phone": "6509302500"}, "mail-address": {"street1": "555 ELLIS STREET", "city": "MOUNTAIN VIEW", "state": "CA", "zip": "94043"}}
As filed with the Securities and Exchange Commission on September 8, 1999
                                                     Registration No. 333-
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                --------------

                                   FORM S-1
                            REGISTRATION STATEMENT
                       Under The Securities Act of 1933

                                --------------

                             COBALT NETWORKS, INC.
            (Exact name of Registrant as specified in its charter)

                                --------------
California                            3670                            77-0440751
    (before reincorporation)         (Primary Standard Industrial             (I.R.S. Employer
                                     Classification Code Number)           Identification Number)

            Delaware                       555 Ellis Street
     (after reincorporation)           Mountain View, CA 94043
 (State or other jurisdiction of            (650) 623-2500
 incorporation or organization)
(Address, including zip code, and telephone number, including area code, of
                   Registrant's principal executive offices)

                                --------------

                                Kenton D. Chow
                            Chief Financial Officer
                               555 Ellis Street
                            Mountain View, CA 94043
                                (650) 623-2500
(Name, address, including zip code, and telephone number, including area code,
                             of agent for service)

                                --------------

                 Please send copies of all communications to:
Robert P. Latta, Esq.                      Kevin P. Kennedy, Esq.
Wilson Sonsini Goodrich & Rosati                 Shearman & Sterling
    Professional Corporation                     1550 El Camino Real
       650 Page Mill Road                        Menlo Park, CA 94025
      Palo Alto, CA 94304                           (650) 330-2200
         (650) 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 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, as amended (the "Securities Act"), please 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 this Form is a post-effective amendment filed pursuant to Rule 462(d)
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. [_]

                                --------------

                        CALCULATION OF REGISTRATION FEE

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Proposed Maximum
           Title of Each Class of            Aggregate Offering    Amount of
        Securities to be Registered               Price(1)      Registration Fee
--------------------------------------------------------------------------------
Common stock, $0.001 par value.............     $86,250,000         $23,978
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
(1) Estimated solely for the purpose of computing the amount of the
    registration fee pursuant to Rule 457(o) under the Securities Act of 1933.

                                --------------

   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.

-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this preliminary prospectus is not complete and may be     +
+changed. These securities may not be sold until the registration statement    +
+filed with the Securities and Exchange Commission is effective. This          +
+preliminary prospectus is not an offer to sell nor does it seek an offer to   +
+buy these securities in any jurisdiction where the offer or sale is not       +
+permitted.                                                                    +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
                Subject to Completion. Dated September 8, 1999.

                                        Shares

                           [COBALT LOGO APPEARS HERE]

                                  Common Stock

                                  ----------

  This is an initial public offering of shares of common stock of Cobalt
Networks, Inc. All of the shares of our common stock are being sold by Cobalt.

  Prior to this offering, there has been no public market for our common stock.
We anticipate that the initial public offering price will be between $   and
$   per share. We have applied for quotation of our common stock on the Nasdaq
National Market under the symbol "COBT".

  See "Risk Factors" beginning on page 7 to read about certain factors you
should consider before buying shares of the common stock.

                                  ----------

  Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.

                                  ----------
Per Share Total
                                                                 --------- -----
Initial public offering price...................................   $       $
Underwriting discount...........................................   $       $
Proceeds, before expenses, to Cobalt............................   $       $
To the extent that the underwriters sell more than    shares of common stock,
the underwriters have the option to purchase up to an additional    shares from
Cobalt at the initial public offering price less the underwriting discount.

                                  ----------

  The underwriters expect to deliver the shares on           , 1999.

Goldman, Sachs & Co.

            Merrill Lynch & Co.

                                                  BancBoston Robertson Stephens

                                  ----------

                         Prospectus dated       , 1999.
[Description for EDGAR: Three pictures of Cobalt products showing in
descending order, (1) a Cobalt Qube sitting on a Cobalt RaQ, (2) a stack of
Cobalt RaQs and (3) a Cobalt Qube sitting on a desktop. Above the pictures is
the name "Cobalt Networks". To the left of the pictures is the phrase "we take
the power of networking and make it affordable, accessible and simple" and the
Cobalt logo.]
PROSPECTUS SUMMARY

  You should read the following summary together with the more detailed
information regarding our company and our financial statements and notes to
those statements appearing elsewhere in this prospectus.

                             Cobalt Networks, Inc.

  We are a leading provider of server appliances. Server appliances are a new
category of network infrastructure devices that are specifically designed and
optimized to deliver one or a few network-based applications well. Server
appliances differ from general purpose servers, which are designed to support a
broad range of applications and are not optimized for any particular function.
Our server appliances enable organizations that could not previously establish
an online presence to do so easily, cost-effectively and reliably. As the
number of Internet users and businesses online increases, we believe the demand
for server appliances will continue to grow.

  Our principal product lines, the Cobalt Qube and Cobalt RaQ, enable our
customers to perform critical Internet-related applications including file
serving, web hosting and providing software applications over the Internet such
as electronic mail and electronic commerce. Our products tightly integrate the
open source Linux operating system with software applications embedded in
dedicated hardware designs. This software includes a rich set of core
applications developed by us and by the open source software developer
community, as well as proprietary third-party applications. Our use of the
Linux operating system enables us to leverage the rapid application development
cycles of the open source software community to reduce the time to market for
our new and innovative products.

  As of July 2, 1999, we had sold over 11,000 appliances to more than 1,000 end
user customers in more than 60 countries. We market and sell our products
globally through our direct sales force and our channel partners. Our target
customers are small- to medium-sized organizations, including businesses,
educational and government entities and branch offices of large organizations.
We also target web hosting and application service providers that offer
outsourced Internet services to these end users.

                             Our Market Opportunity

  Traditionally, creating an online presence has required complex network
technologies and the deployment of costly general purpose servers, which
require a technically skilled staff to maintain. However, these limitations
often prevent their adoption by small- to medium-sized organizations seeking to
deploy their own infrastructure, due to limited budgets and technology skills.
The high cost and complexity of general purpose servers also create challenges
for web hosting and application service providers that seek to profitably
differentiate themselves in an intensely competitive and price sensitive market
by offering high value added services.

  Server appliances have been developed to address the challenges faced by
small- to medium-sized organizations and web hosting and application service
providers in deploying their Internet infrastructures. Because server
appliances are explicitly designed and optimized to provide one or a few
dedicated applications, they can be easy to use, administer and integrate with
other infrastructure components, while providing a low cost, reliable solution.

                                       3
Dataquest, an industry research firm, expects the server appliance market to
grow from $2.2 billion in 1999 to approximately $15.8 billion in 2003,
representing a 64% compound annual growth rate. Dataquest expects the Linux-
based server appliance market to grow at approximately 69% a year between 1999
and 2003 and represent approximately 24% of the total server appliance market,
or $3.8 billion, in 2003.

                                  Our Strategy

  Our objective is to become the leading global provider in the emerging market
for flexible, low cost server appliances. To accomplish our objective we intend
to:

  . Increase market acceptance of server appliances. We intend to increase
    market acceptance of server appliances by continuing to offer products
    that are simple to manage at a low cost of total ownership.

  . Attract and support application developers. We intend to continue to
    promote third-party development of software applications for our products
    through partnership programs with independent, open source software
    developers.

  . Develop and leverage partnerships to enhance our market reach. We
    actively seek to encourage channel partners, original equipment
    manufacturers and web hosting and application service providers to add
    value to our products by modifying our solutions for specific customer
    needs.

  . Establish a strong brand identity. We intend to continue to create brand
    awareness with innovative, award winning products, progressive product
    styling and creative marketing.

  . Provide focused server appliances for specific needs. We intend to
    continue to develop and release products that meet specific customer
    needs while retaining their relatively low prices and optimized
    functionality.

                               Other Information

  Unless otherwise noted, this prospectus assumes:

  .  our reincorporation in Delaware to be completed prior to this offering;

  .  the automatic conversion of our outstanding mandatorily redeemable
     convertible preferred stock into common stock upon the closing of this
     offering;

  .  the filing of our amended and restated certificate of incorporation
     authorizing a class of 10,000,000 shares of undesignated preferred stock
     upon the closing of the offering; and

  .  no exercise by the underwriters of their option to purchase additional
     shares of our common stock in the offering.

  Our net revenues were $3.5 million for 1998 and $7.7 million for the six
months ended July 2, 1999. Our net losses were $10.5 million and $8.2 million
for the same periods. Our total accumulated deficit was $13.2 million as of
December 31, 1998 and was $22.6 million as of July 2, 1999.

  We filed our articles of incorporation in California in October 1996 under
the name Viavision Systems, Inc. We changed our name to Cobalt Microserver,
Inc. in March 1997 and to Cobalt Networks, Inc. in June 1998. We intend to
reincorporate in Delaware prior to the completion of this offering. Our
principal executive offices are located at 555 Ellis Street, Mountain View,
California 94043. Our telephone number is (650) 623-2500.

                                       4
The Offering
Shares offered by Cobalt................             shares
Shares to be outstanding after the
 offering...............................             shares
Use of proceeds.........................  For general corporate purposes, including
                                           working capital, funding our operating losses,
                                           capital expenditures and potential acquisitions
                                           of complementary businesses, products and
                                           technologies.
Proposed Nasdaq National Market symbol..  "COBT"
The above information is based on 22,010,103 shares outstanding as of July 2,
1999 and excludes:

  .  2,144,943 shares issuable upon exercise of options outstanding at a
     weighted average exercise price of $0.69 per share as of July 2, 1999;

  .  525,665 shares issuable upon exercise of warrants outstanding at a
     weighted average exercise price of $2.74 per share as of July 2, 1999;
     and

  .  a total of 6,407,870 shares available for future issuance under our
     various stock plans excluding the annual increases in the number of
     shares authorized under each of our plans beginning January 1, 2001. See
     "Management--Incentive Plans" for a description of how these annual
     increases are determined.

                                       5
Summary Consolidated Financial Information
                     (in thousands, except per share data)

  The following table sets forth a summary of our consolidated statement of
operations data for the periods presented. The pro forma net loss per share for
the year ended December 31, 1998 and the six months ended July 2, 1999 reflects
the conversion of our mandatorily redeemable convertible preferred stock and
the elimination of dividends and related charges.
Year Ended
                            Period from     December 31,     Six Months Ended
                           Oct. 18, 1996  -----------------  -----------------
                           (inception) to                    June 30,  July 2,
                           Dec. 31, 1996   1997      1998      1998     1999
                           -------------- -------  --------  --------  -------
Consolidated Statement of
 Operations Data:
Net revenues.............      $   --     $   --   $  3,537  $   449   $ 7,663
Gross profit (loss)......          --         --        414     (133)    2,507
Loss from operations.....         (82)     (1,757)  (10,545)  (3,749)   (8,244)
Net loss.................         (82)     (1,769)  (10,478)  (3,752)   (8,244)
Accretion of mandatorily
 redeemable
 convertible preferred
 stock...................          --         --       (828)     --     (1,191)
Net loss attributable to
 holders of common
 stock...................         (82)     (1,769)  (11,306)  (3,752)   (9,435)
Basic and diluted net
 loss per share
 attributable to holders
 of common stock.........                 $ (4.10) $  (5.47) $ (2.09)  $ (2.83)
Pro forma basic and
 diluted net loss per
 share ..................                          $  (1.43)           $ (0.60)
Basic and diluted
 weighted average shares
 outstanding.............                     432     2,065    1,792     3,338
Pro forma basic and
 diluted weighted average
 shares outstanding......                             7,330             13,808
The following table sets forth a summary of our consolidated balance sheet
data as of July 2, 1999:

  .  on an actual basis;

  .  on a pro forma basis to give effect to the automatic conversion of all
     of the outstanding shares of our mandatorily redeemable convertible
     preferred stock into shares of common stock upon the closing of this
     offering; and

  .  on a pro forma as adjusted basis to reflect the automatic conversion of
     the mandatorily redeemable convertible preferred stock and our receipt
     of the estimated net proceeds from the sale of            shares of
     common stock in this offering at an assumed initial public offering
     price of $    per share.
July 2, 1999
                                               -------------------------------
                                                                    Pro forma
                                                Actual   Pro forma as adjusted
                                               --------  --------- -----------
Consolidated Balance Sheet Data:
Cash and cash equivalents..................... $ 27,426  $ 27,426     $
Working capital...............................   24,539    24,539
Total assets..................................   34,902    34,902
Notes payable, less current portion...........       64        64
Mandatorily redeemable convertible preferred
 stock........................................   45,646       --
Total stockholders' equity (deficit)..........  (19,850)   25,796
6
RISK FACTORS

  Any investment in our common stock involves a high degree of risk. You should
consider the risks described below carefully and all of the information
contained in this prospectus before deciding whether to purchase our common
stock. If any of the following risks actually occur, our business, financial
condition and results of operations would suffer. In such case, the trading
price of our common stock could decline, and you may lose all or part of your
investment in our common stock.

                     Risks Related to Our Financial Results

We only began selling our products in March 1998 and, as a result, you may have
difficulty evaluating our business and operating results.

  Our company was founded in October 1996, and we did not begin selling our
products until March 1998. An investor in our common stock must consider the
risks and difficulties we may encounter as an early stage company in the new
and rapidly evolving server appliance market. These risks and difficulties
include:

  .  an evolving and unpredictable business model;

  .  the uncertain demand for our products;

  .  the need to expand our sales and support organizations;

  .  the need to obtain sufficient manufacturing capacity from third parties;

  .  the rate of growth in usage and acceptance of the Internet; and

  .  the competition we face from general purpose server manufacturers.

  We cannot be certain that our business strategy will be successful or that we
will successfully manage these risks. If we fail to address any of these risks
or difficulties adequately, our business would likely suffer.

We have a history of losses and may experience losses in the future.

  Since our inception, we have incurred significant net losses, including net
losses of $10.5 million in 1998 and $8.2 million in the six months ended July
2, 1999. In addition, we had an accumulated deficit of $22.6 million as of July
2, 1999. We expect to continue to incur significant product development, sales
and marketing and administrative expenses. As a result, we will need to
generate significant revenues to achieve profitability. We cannot be certain
that we will achieve profitability in the future or, if we achieve
profitability, to sustain it.

  We anticipate that our expenses will increase substantially in the
foreseeable future as we:

  .  increase our direct sales and marketing activities, particularly by
     expanding our direct sales forces;

  .  develop our technology, expand our existing product lines and create and
     market additional server appliance products;

  .  make additional investments to develop our brand;

  .  expand our distribution and reseller channels;

                                       7
.  pursue original equipment manufacturing relationships; and

  .  implement additional internal systems, develop additional infrastructure
     and hire additional management to keep pace with our growth.

  Any failure to significantly increase our revenues as we implement our
product and distribution strategies would also harm our business.

We may not be able to sustain our current revenue growth rates, which could
cause our stock price to decline.

  Although our revenues grew rapidly in 1998 and have grown rapidly in 1999 to
date, we do not believe that we will maintain this rate of revenue growth
because we started from a small base of revenue, and it is difficult to
maintain high percentage increases over a larger revenue base. In addition,
growing competition, the incremental manner in which customers implement server
appliances and our inexperience in selling our products to small- to medium-
sized organizations could also affect our revenue growth. Any significant
decrease in our rate of revenue growth after this offering would likely result
in a decrease in our stock price.

Because our ability to accurately forecast our quarterly sales is limited, our
costs are relatively fixed in the short term and we expect our business to be
affected by seasonality, our quarterly operating results and our stock price
may fluctuate.

  Because of our limited operating history and the new and rapidly evolving
market for our server appliances, our ability to accurately forecast our
quarterly sales is limited, which makes it difficult to predict the quarterly
revenues that we will recognize. In addition, we cannot forecast operating
expenses based on historical results, and most of our costs are for personnel
and facilities, which are relatively fixed in the short term. If we have a
shortfall in revenues in relation to our expenses, we may be unable to reduce
our expenses quickly enough to avoid lower quarterly operating results. We do
not know whether our business will grow rapidly enough to absorb the costs of
these employees and facilities. As a result, our quarterly operating results
could fluctuate, and such fluctuation could adversely affect the market price
of our common stock.

  In addition, we expect to experience seasonality in the sales of our
products. For example, we expect that sales may decline during summer months,
particularly in Asian and European markets. We also anticipate that sales may
be lower in our first fiscal quarter due to patterns in the capital budgeting
and purchasing cycles of our current and prospective customers. These
seasonable variations in our sales may lead to fluctuations in our quarterly
operating results. It is difficult for us to evaluate the degree to which this
seasonality may affect our business, because our growth may have largely
overshadowed this seasonality in recent periods. In addition, concerns
regarding year 2000 compliance issues may adversely affect the demand for
products like ours if our customers divert resources to address year 2000
issues.

We have relied and expect to continue to rely on sales of our Cobalt Qube and
Cobalt RaQ products for our revenues, and a decline in sales of these products
could cause our revenues to fall.

  Historically, we have derived substantially all of our revenues from sales of
our Cobalt Qube and Cobalt RaQ products. During 1998 and the six months ended
July 2, 1999, sales of Cobalt Qube and Cobalt RaQ products accounted for
approximately 83% and 84% of our total revenues. We expect

                                       8
that these products will continue to account for a large portion of our total
revenues for the foreseeable future. Any factors adversely affecting the
pricing of or demand for our Cobalt Qube and Cobalt RaQ products, including
competition or technological change, could cause our revenues to decline and
our business to suffer. Factors that may affect the market acceptance of our
products, some of which are beyond our control, include the following:

  .  the growth and changing requirements of the server appliance market;

  .  the performance, quality, price and total cost of ownership of our
     products;

  .  the availability, price, quality and performance of competing products
     and technologies; and

  .  the successful development of our relationships with original equipment
     manufacturer customers and existing and potential channel partners.

We may not succeed in developing and marketing new server appliance products,
and our operating results may decline as a result.

  We are developing additional server appliance products that use the Linux
operating system, particularly for use by web hosting and application service
providers. Developing new products that meet the needs of web hosting and
application service providers requires significant additional expenses and
development resources. If we fail to successfully develop and market new
products, our operating results will decline.

  We introduced our caching products in July 1998 and network attached storage
products in May 1999. To date, these products have accounted for only a limited
portion of our revenues. However, our future growth and profitability could be
affected by our ability to increase sales of our caching and network attached
storage products.

If we experience any increase in the length of our sales cycle, our quarterly
operating results could become more unpredictable and our stock price may
decline as a result.

  We experience different sales cycles for our various products depending on
the nature of the product, the identity of the end user and whether the sale is
direct or indirect. If we experience any increase in the length of our sales
cycle, our quarterly operating results could become more unpredictable and our
stock price could decline as a result. Sales of our Cobalt Qube products are
generally limited to one unit per end user and do not involve a lengthy
evaluation cycle, if any. We rely heavily for sales of this product on indirect
selling, where our product is recommended by a reseller or distributor. If the
sales cycle for our Cobalt Qube products becomes longer, our revenues could
become less predictable. Our Cobalt RaQ and Cobalt Cache products are generally
sold to customers who evaluate the products before committing to purchase them.
In addition, for these products, a typical customer may purchase a small number
of units and then incrementally increase the size of the installation over
time. If customers were to implement enterprise-wide evaluation programs or
purchase products for the entire organization at once, our sales cycle could
lengthen and our revenues could be erratic from quarter to quarter. We do not
have enough historical experience selling our Cobalt NAS products to determine
how the sales cycle for these products will affect our revenues.

If we cannot increase our sales volumes, reduce our costs or introduce higher
margin products to offset anticipated reductions in the average unit price of
our products, our operating results may suffer.

  We have not experienced an overall decrease in the average selling prices of
our products. However, we anticipate that as products in the server appliance
market become more commoditized, the average unit price of our products may
decrease in the future. The average unit price of our

                                       9
products may also decrease in response to changes in product mix, competitive
pricing pressures, new product introductions by us or our competitors or other
factors. If we are unable to offset the anticipated decrease in our average
selling prices by increasing our sales volumes, our revenues will decline.
Changes in the mix of our sales, including the mix between higher margin Cobalt
RaQ products and somewhat lower margin Cobalt Qube products, could adversely
affect our operating results for future quarters. In addition, our margins
could be affected if we invest additional resources in our lower margin Cobalt
NAS products. To maintain our gross margins, we also must continue to reduce
the manufacturing cost of our products. Further, as average unit prices of our
current products decline, we must develop and introduce new products and
product enhancements that sell at higher margins.

         Risks Related to Growth of Our Market and Acceptance of Linux

Our business is dependent on the adoption of server appliances to perform
discrete tasks for corporate and Internet-based computer networks and a
decrease in their rates of adoption could cause our revenues to decline.

  For the foreseeable future, we expect that substantially all of our revenues
will continue to come from sales of our server appliance products. As a result,
we depend on the growing use of server appliances to perform discrete tasks for
corporate and Internet-based networks. If the role of server appliances does
not increase as we anticipate, or if it in any way decreases, our revenues
would decline. We believe that our expectations for the growth of the server
appliance market may not be fulfilled if customers continue to use general
purpose servers. The role of our server appliances could, for example, be
limited if general purpose servers become better at performing the functions
currently being performed by our server appliances or are offered at a lower
cost. This could force us to lower the prices of our products or result in
fewer sales of our products. In addition, if corporate information technology
organizations do not accept Linux-based operating systems, or if there is a
wide acceptance of alternative operating systems that provide enhanced
capabilities, our business would likely suffer.

The server appliance market for web hosting and application service providers
in which we compete is new and unpredictable, and if this market does not
develop and expand as we anticipate, our business will suffer. In addition,
consolidation in this market could result in our clients being absorbed into
larger organizations which might not be as receptive to our products.

  The market for server appliance products, particularly those for use
primarily by web hosting and application service providers--companies that
provide Internet, intranet, extranet and application hosting services to
others--has only recently begun to develop and is evolving rapidly. Because
this market is new, we cannot predict its potential size or future growth rate.
Our Cobalt RaQ products are used primarily by web hosting and application
service providers. Recently, consolidation has begun to occur in the web
hosting and application service provider market, and many large web hosting and
application service providers are acquiring the smaller and the regional
companies. Large web hosting and application service providers that provide
hosting services may not be as receptive to our products, because their buying
programs are more likely to be based on established, proprietary operating
systems and general purpose servers. In addition, we expect that Internet
service providers that specialize in providing Internet access and non-hosting
services to consumers will not be substantial purchasers of our products.

  Small- to medium-sized organizations may not accept server appliances because
they are less likely to be early adopters of new technologies due to their need
for minimal service disruptions. As a result, we believe the rates of adoption
of server appliances for small- to medium-sized organizations

                                       10
are unpredictable. Our success in generating net revenues in this emerging
market will depend on, among other things, our ability to:

  .  educate potential end users, original equipment manufacturers and
     channel partners about the benefits of server appliances;

  .  establish and maintain relationships with leading original equipment
     manufacturers and maintain and enhance our relationships with our other
     channel partners; and

  .  predict and base our products on technology that ultimately becomes
     industry standard.

Because our products use Linux as their operating system, the failure of Linux
developers to enhance and develop the Linux kernel could impair our ability to
release major product upgrades and maintain market share.

  We may not be able to release major upgrades of our Cobalt Qube, Cobalt RaQ,
Cobalt Cache and Cobalt NAS products on a timely basis because our products use
Linux as their operating system. The heart of Linux, the Linux kernel, is
maintained by third parties. Linus Torvalds, the original developer of the
Linux kernel, and a small group of independent engineers are primarily
responsible for the development and evolution of the Linux kernel. If this
group of developers fails to further develop the Linux kernel or if Mr.
Torvalds or other prominent Linux developers were to no longer work on the
Linux kernel, we would have to either rely on another party to further develop
the kernel or develop it ourselves. To date we have optimized our Linux-based
operating system based on a version of Red Hat Linux, which we have licensed
for a nominal price. If we were unable to access Red Hat Linux, or Red Hat
Linux were to become substantially more expensive to obtain, we would be
required to spend additional time to obtain a tested, recognized version of the
Linux kernel from another source or develop our own operating system
internally. We cannot predict whether enhancements to the kernel would be
available from reliable alternative sources. We could be forced to rely to a
greater extent on our own development efforts, which would increase our
development expenses and might delay our product release and upgrade schedules.
In addition, any failure on the part of the kernel developers to further
develop and enhance the kernel could stifle the development of additional
Linux-based applications for use with our products.

We may not succeed if Linux fragments, and application developers do not
develop software for our products.

  Our products utilize a version of the Red Hat Linux operating system that we
have optimized for our server appliances. If Linux becomes a proprietary
operating system model, like UNIX or Windows NT, and our products do not use
the predominant Linux operating system, we may not be able to encourage third
party developers to write software applications for use with our products. If
this were to occur, our sales might be limited and our revenues could suffer.

                   Risks Related to Our Product Manufacturing

We will be unable to manufacture or sell our products if our contract
manufacturers are unable to meet our manufacturing needs.

  We rely on contract manufacturers to produce our products. In the future, we
may need to find a new contract manufacturer that can manufacture our products
in higher volume and at lower costs. We may not find a contract manufacturer
that meets our needs. Additionally, qualifying a new contract manufacturer and
commencing volume production is expensive and time consuming. If we are
required or choose to change contract manufacturers, we may lose sales and our
customer relationships may suffer.

                                       11
We recently switched our outside product manufacturer and may experience
transitional problems, including delays and quality control issues. In
addition, we cannot be certain that our relationship with our second
manufacturing source will continue in light of this change.

  We recently switched our contract manufacturer and we do not have enough
experience with our new manufacturer to adequately judge the quality of its
products or its capability to deliver these products on time. Prior to August
1999, almost all of our products were manufactured for us by a single
manufacturer that also provided supply chain management for our products'
components. In the quarter ending July 2, 1999, we experienced problems getting
our products manufactured by this contractor in a timely fashion due in part to
the increase in our volume requirements. In response to these problems, we
switched the majority of our manufacturing to SMTC Manufacturing Corp., in
August 1999. Although we believe that this will largely resolve the problems we
faced during the quarter ending July 2, 1999, we cannot be certain that we will
not face similar problems in the future. Moreover, because our relationship
with SMTC Manufacturing is new, we could face transitional problems with either
the quality of the products or the coordination of the relationship. If SMTC
Manufacturing does not meet our volume and quality requirements, our business
could be adversely affected.

  SMTC Manufacturing is only obligated to supply products to us until August
2000 and only up to certain quantities based on our forecasts. If SMTC
Manufacturing experiences delays, disruptions, capacity constraints or quality
control problems in its manufacturing operations, then product shipments to our
customers could be delayed, which would negatively impact our net revenues,
competitive position and reputation.

  We have also qualified an additional manufacturing source, Flash Electronics,
Inc. Although Flash has built limited quantities of our products in the past,
we cannot be certain that we will be able to access sufficient production
capacity at Flash upon demand or that Flash will agree to continue as a
secondary manufacturer for us in light of our decision to use SMTC
Manufacturing as our primary manufacturing contractor.

We may experience production delays or disruptions if we relocate our
manufacturing to offshore facilities, which could result in lost revenues.

  We anticipate that we may relocate our manufacturing operations for sales
outside North America to one of SMTC Manufacturing's offshore manufacturing
facilities during 2000. We could experience difficulties and disruptions in the
manufacture of our products while we transition to a new facility.
Manufacturing disruption could prevent us from achieving timely delivery of
products and could result in lost revenues.

Because we depend on sole source and limited source suppliers for key
components, we are susceptible to supply shortages that could adversely affect
our operating results.

  We depend upon single source suppliers for our industry standard processors
and power supplies and our custom printed circuit boards, chassis and sheet
metal parts. We also depend on limited sources to supply several other industry
standard components. We have in the past experienced and may in the future
experience shortages of, or difficulties in acquiring, these components. If we
are unable to buy these components, we will not be able to manufacture our
products on a timely basis.

                                       12
Because we order components and materials based on rolling forecasts, we may
overestimate or underestimate our component and material requirements, which
could increase our costs or prevent us from meeting customer demand.

  We use rolling forecasts based on anticipated product orders to determine our
component requirements. Lead times for materials and components that we order
vary significantly and depend on factors including specific supplier
requirements, contract terms and current market demand for those components. As
a result, our component requirement forecasts may not be accurate. If we
overestimate our component requirements, we may have excess inventory, which
would increase our costs. If we underestimate our component requirements, we
may have inadequate inventory, which could interrupt our manufacturing and
delay delivery of our products to our customers. Any of these occurrences would
negatively impact our business and operating results.

                Risks Related to Our Marketing and Sales Efforts

Because we rely on channel partners to sell a majority of our products, our
revenues could decline substantially if our existing channel partners do not
continue to purchase products from us.

  We rely on our channel partners who are distributors, such as Ingram Micro,
Merisel and Tech Data, resellers and system integrators to sell a majority of
our products in the United States. A substantial majority of our sales outside
of the United States are through other channel partners, and we rely on Nissho
Electronics to sell a majority of our products in Japan. Sales to distributors
accounted for 54% of our net revenues in 1998 and 86% of our net revenues in
the six months ended July 2, 1999. If we fail to sell our products through our
existing channel partners, we would experience a material decline in revenues.
Even if we are successful in selling our products through new channel partners,
the rate of growth of our net revenues could be materially and adversely
affected if our existing channel partners do not continue to sell a substantial
number of our products. We cannot be certain that we will be able to attract
channel partners that market our products effectively or provide timely and
cost-effective customer support and service. None of our current channel
partners are obligated to continue selling our products. We cannot be certain
that any channel partner will continue to represent our products or that our
channel partners will devote a sufficient amount of effort and resources to
selling our products in their territories.

We face risks associated with the development of our brand, and we may incur
significant costs to promote our brand and compete effectively.

  We believe that we need a strong brand to compete successfully. In order to
promote and maintain our brand identity and to attract and retain customers, we
plan to increase our spending on advertising and promotions and to implement
new marketing campaigns. We cannot be certain that these strategies will be
successful. If we are unable to design and implement effective marketing
campaigns or otherwise fail to promote and maintain our brand, our sales could
decline. Our business may also suffer if we incur excessive expenses in an
attempt to promote and maintain our brand without a corresponding increase in
revenues.

We need to expand our direct and indirect sales channels, and if we fail to do
so, our growth could be limited.

  In order to increase market awareness and sales of our products, we will need
to substantially expand our direct and indirect sales operations, both
domestically and internationally. If we fail in this endeavor, our growth will
be limited. To date, we have relied primarily on our direct sales force to
generate demand for our products by regional and national web hosting and
application service providers. Our products require a sophisticated sales
effort targeted at our prospective customers' information technology
departments. We have recently expanded our direct sales force and plan to hire
additional sales personnel. Competition for qualified sales people is intense,
and we might not be able to hire the quality and number of sales people we
require.

                                       13
Our expansion to international markets will result in higher personnel costs
and could reduce our operating margins due to the higher costs of international
sales.

  We must expand the number of channel partners who sell our products or our
direct international sales presence to significantly increase our international
sales. We may incur higher personnel costs by hiring direct sales staff that
may not result in an increase in our revenues. We may not realize corresponding
increases in operating margins from increases in international sales, due to
the higher costs of these sales. Our sales outside of the United States
represented 44% of our total revenues in 1998 and 56% of our total revenues in
the six months ended July 2, 1999. To date, we have relied primarily on
international channel partners and have only recently begun to employ direct
sales staff outside of the United States. Even if we are able to successfully
expand our direct and indirect international selling efforts, we cannot be
certain that we will be able to create or increase international market demand
for our products.

If we are unable to expand our customer service and support organization, we
may not be able to retain our existing customers and attract new customers.

  We currently have a small customer service and support organization and will
need to increase our staff to support new customers and the expanding needs of
our existing customers. If we are unable to expand our customer service and
support organization, we may not be able to retain our existing customers and
attract new customers. Hiring customer service and support personnel is very
competitive in our industry due to the limited number of people available with
the necessary technical skills and understanding of the Linux operating
environment.

We do not have a consulting staff, and our revenues may suffer if customers
demand extensive consulting or other support services.

  Our products are designed to require little or no support from us and to be
deployed quickly and easily by our customers. Many of our competitors offer
extensive consulting services in addition to server appliance products. If we
introduced a product that required extensive consulting services for
installation and use or if our customers wanted to purchase from a single
vendor a menu of items that included extensive consulting services, we would be
required to change our business model. We would be required to hire and train
consultants, outsource the consulting services or enter into a joint venture
with another company that could provide those services. If these events were to
occur, our future profits would likely suffer because customers would choose
another vendor or we would incur the added expense of hiring and retaining
consulting personnel.

                Risks Related to Competition Within Our Industry

We may not be able to effectively compete against providers of general and/or
limited purpose servers.

  In the market for server appliances, we face significant competition from
larger companies who market general and/or limited purpose servers and have
greater financial resources and name recognition than we do. We believe that
Compaq, Dell, Gateway, Hewlett-Packard, IBM, Sun Microsystems or other server
manufacturers, each of which is also currently competing with us by
manufacturing and selling general and/or limited purpose servers, could also
introduce server products that include the functionality that we currently
provide in our products at lower prices. If these vendors provide lower cost
server appliances with the functionality of our products coupled with the
functionality of their existing product lines, our products could become
obsolete. Even if the functionality of the standard features of these products
is equivalent to ours, we face a substantial risk that a significant number of
customers would elect to pay a premium for similar functionality rather than
purchase products from a less well-known vendor.

                                       14
We may face competition in the future from established companies that have
only recently entered the server appliance market, such as Intel, Novell or
Oracle or from emerging software companies. Barriers to entry in the server
appliance market are relatively low. Increased competition may negatively
affect our business and future operating results by leading to price
reductions, higher selling expenses or a reduction in our market share.

If we fail to compete successfully in the market for server appliances
products, our revenues will decline.

  We face competition from different sources, and we must compete effectively
against other current and future competitors to retain and expand our customer
base. If we fail to retain and expand our customer base, our revenues could
decline substantially.

  We believe the principal factors that will draw end users to a server
appliance product include:

  .  depth of product functionality for the specific purpose of the device;

  .  ease of use;

  .  brand name;

  .  distribution and customer support; and

  .  total cost of ownership.

  To be competitive, we must respond promptly and effectively to the challenges
of technological change, evolving standards and our competitors' innovations by
continuing to enhance our products and sales channels. Any pricing pressures or
loss of market share resulting from our failure to compete effectively could
reduce our revenues.

Our revenues could be reduced if general purpose server manufacturers make
acquisitions in order to join their extensive distribution capabilities with
our smaller competitors' products.

  Compaq, Dell, Gateway, Hewlett-Packard, IBM, Sun Microsystems and other
server manufacturers may not only develop their own server appliance solutions,
but they may also acquire or establish cooperative relationships with our other
current competitors, including smaller private companies. Because general
purpose server manufacturers have significant financial and organizational
resources available, they may be able to quickly penetrate the server appliance
market by leveraging the technology and expertise of smaller companies and
utilizing their own extensive distribution channels. We expect that the server
appliance industry will continue to consolidate. For example, Whistle
Communications, a server appliance company, was recently acquired by IBM. It is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share.

Our products may become less attractive to customers if other vendors' products
are no longer compatible with ours or other vendors bundle their products with
those of our competitors.

  Our ability to sell our products depends in part on the compatibility of our
products with other vendors' software and hardware products. Developers of
these products may change their products so that they will no longer be
compatible with our products. These other vendors may also decide to bundle
their products with other server appliances for promotional purposes. If that
were to happen, our business and future operating results could suffer if we
were no longer able to offer commercially viable products.

                                       15
Server appliance products are subject to rapid technological change due to
changing operating system software and network hardware and software
configurations, and our products could be rendered obsolete by new
technologies.

  The server appliance market is characterized by rapid technological change,
frequent new product introductions and enhancements, uncertain product life
cycles, changes in customer demands and evolving industry standards. Our
products could be rendered obsolete if products based on new technologies are
introduced or new industry standards emerge. For example, sales of our products
may be limited if customers widely adopt Windows 2000-based server appliances,
and our products, which do not currently operate on the Windows 2000 platform,
fail to provide comparable functionality.

  Client/server computing environments are inherently complex. As a result, we
cannot accurately estimate the life cycles of our server appliance products.
New products and product enhancements can require long development and testing
periods, which requires us to hire and retain increasingly scarce, technically
competent personnel. Significant delays in new product releases or significant
problems in installing or implementing new products could seriously damage our
business. We have, on occasion, experienced delays in the scheduled
introduction of new and enhanced products and cannot be certain that we will
avoid similar delays in the future.

  Our future success depends upon our ability to enhance existing products,
develop and introduce new products, satisfy customer requirements and achieve
market acceptance. We cannot be certain that we will successfully identify new
product opportunities and develop and bring new products to market in a timely
and cost-effective manner.

 Risks Related to Our Products' Dependence on Intellectual Property and Our Use
                                  of Our Brand

Our server appliance products rely on our intellectual property, and any
failure by us to protect our intellectual property could enable our competitors
to market products with similar features that may reduce demand for our
products.

  Our success and ability to compete are substantially dependent upon our
internally developed technology that is incorporated into our products. We
protect our intellectual property through a combination of copyright, trade
secret and trademark laws. We have only recently commenced a patent program and
to date have not filed any patent applications. We generally enter into
confidentiality or license agreements with our employees, consultants and
corporate partners, and generally control access to our intellectual property
and the distribution of our server appliances, integrated software,
documentation and other proprietary information. We believe that such measures
afford only limited protection. Others may develop technologies that are
similar or superior to our technology or design around the copyrights and trade
secrets we own. We license our proprietary software products primarily under
shrink wrap licenses, which are licenses included as part of the product
packaging or system initiation menus. Shrink wrap licenses are not negotiated
with or signed by individual customers and purport to take effect upon the
opening of the product package or commencing use of the product. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or otherwise obtain and use our products or technology. Policing
unauthorized use of our products is difficult, and we cannot be certain that
the steps we have taken will prevent misappropriation of our technology,
particularly in foreign countries where the laws may not protect our
proprietary rights as fully as those in the United States. Our means of
protecting our proprietary rights may be inadequate.

                                       16
Our products and the brand names we use to market them may infringe upon the
intellectual property rights of others, and any resulting claims against us
could be costly to defend or subject us to significant damages.

  Substantial litigation regarding intellectual property rights exists in the
computer equipment and network infrastructure industries. We expect that server
appliance products may be increasingly subject to third-party infringement
claims as the number of competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. We are not
aware that our products employ technology that infringes any proprietary rights
of third parties. However, third parties may claim that we infringe their
intellectual property rights. Any claims, with or without merit, could:

  .  be time consuming to defend;

  .  result in costly litigation;

  .  divert our management's attention and resources;

  .  cause product shipment delays; or

  .  require us to enter into royalty or licensing agreements.

  These royalty or licensing agreements may not be available on terms
acceptable to us, if at all. A successful claim of product infringement against
us or our failure or inability to license the infringed or similar technology
could adversely affect our business because we would not be able to sell the
impacted product without redeveloping it or incurring significant additional
expenses.

  For example, in December 1998, CUBE Computer Corporation sued us for
trademark infringement, alleging that our use of the term "Qube" in connection
with our products infringes CUBE Computer Corporation's trademark. Although we
believe this claim is without merit, in the event we were to lose this
litigation with CUBE Computer Corporation, we could be forced to pay CUBE a
royalty for continuing use of our Cobalt Qube trademark or be barred from using
the name altogether. This could result in us losing the brand equity which we
have established for our Cobalt Qube products.

                      Other Risks Related to Our Business

We have experienced significant growth and change in our business and our
failure to manage this growth and any future growth could harm our business.

  We continue to increase the scope of our operations and have grown our
headcount substantially. As of December 31, 1998, we had a total of 68
employees, and as of July 2, 1999 we had a total of 101 employees. Our
productivity and the quality of our products may be adversely affected if we do
not integrate and train our new employees quickly and effectively. We also
cannot be sure that our revenues will continue to grow at a sufficient rate to
absorb the costs associated with a larger overall headcount, as well as
recruiting-related expenses.

Because our strategy to expand our international operations is subject to
uncertainties, we may not be able to enter new international markets or
generate significant revenues from those markets outside of the United States
in which we currently operate.

  Customers outside of the United States accounted for 44% of our net revenues
in 1998 and 56% of our net revenues in the six months ended July 2, 1999. We
plan to increase our international sales activities, but we have limited
experience in developing foreign language translations of our products and
little direct experience marketing and distributing our products
internationally.

                                       17
We conduct direct sales activities in Japan, the United Kingdom, Germany and
the Netherlands and indirect sales activities in Asia, elsewhere in Europe and
Mexico. Our international operations are subject to other inherent risks,
including:

  .  the impact of recessions in economies outside the United States;

  .  greater difficulty in accounts receivable collection and longer
     collection periods;

  .  unexpected changes in regulatory requirements;

  .  difficulties and costs of staffing and managing foreign operations;

  .  reduced protection for intellectual property rights in some countries;

  .  potentially adverse tax consequences; and

  .  political and economic instability.

Any acquisitions that we undertake could be difficult to integrate, disrupt our
business, dilute stockholder value or harm our operating results.

  We may make investments in complementary companies, products or technologies.
If we buy a company, we could have difficulty in assimilating that company's
personnel and operations. In addition, the key personnel of the acquired
company may decide not to work for us. If we make other types of acquisitions,
we could have difficulty in assimilating the acquired technology or products
into our operations. These difficulties could disrupt our ongoing business,
distract our management and employees and increase our expenses. We also expect
that we would incur substantial expenses if we acquired other businesses or
technologies. Any acquisition could result in us incurring additional debt,
contingent liabilities or amortization expenses related to goodwill and other
intangible assets, any of which could harm our profits. If we issue additional
equity securities, our stockholders could experience dilution. As of the date
of this prospectus, we have no agreements or understandings regarding any
future acquisitions.

We are in the final stages of assessing our Year 2000 readiness and any Year
2000 problems with our products or our internal systems could result in third-
party claims.

  Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
determine whether "00" means 1900 or 2000. This may result in software failures
or the creation of erroneous results.

  We are in the final stages of assessing our Year 2000 readiness. We have
concluded a preliminary investigation and performed limited testing to
determine whether each component of our products and our products in
development are Year 2000 compliant. Our server appliance products operate in
complex system environments and directly and indirectly interact with a number
of other hardware and software systems. Despite the investigation and testing
by us and our partners, our server appliance products and the underlying
systems and protocols running our products may contain errors or defects
associated with Year 2000 date functions. We are unable to predict to what
extent our business may be affected if our software or the systems that operate
in conjunction with our software experience a material Year 2000 failure. Known
or unknown errors or defects that affect the operation of our server appliances
could result in:

  .  delay or loss of revenues;

  .  cancellation of customer contracts;

  .  diversion of development resources;

                                       18
.  damage to our reputation;

  .  increased maintenance and warranty costs; or

  .  litigation costs;

any of which could adversely affect our business, financial condition and
results of operations.

  Despite investigation and testing by us, our internal systems may contain
errors or defects associated with Year 2000 date functions. We are unable to
predict to what extent our core business functions may be affected if our
internal systems or software experience a material Year 2000 failure. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation--Year 2000 Readiness" for a description of our Year 2000 readiness
efforts.

We must continue to hire and retain research and development and sales and
marketing staff to sustain our revenue growth.

  We intend to hire a significant number of additional research and
development, sales, support, marketing and other personnel in 1999 and 2000.
Competition for these individuals is intense, and we may not be able to
attract, assimilate or retain highly qualified personnel. Our future success
and ability to sustain our revenue growth also depend upon the continued
service of our executive officers and other key sales, marketing and support
personnel, particularly since we have experienced disruption from the turnover
of senior management in the past. Competition for qualified personnel in our
industry and in the San Francisco Bay Area, as well as the other geographic
markets in which we recruit, is extremely intense and characterized by rapidly
increasing salaries, which may increase our operating expenses or hinder our
ability to recruit qualified candidates.

  To achieve our business objectives, we may recruit and employ skilled
technical professionals from other countries to work in the United States.
Limitations imposed by federal immigration laws and the availability of visas
could harm our ability to attract necessary qualified personnel. This may have
a negative effect on our business and future operating results.

We rely on the services of our founders and other key personnel, and those
persons' knowledge of our business and technical expertise would be difficult
to replace.

  Our products and technologies are complex and we are substantially dependent
upon the continued service of our existing engineering personnel, and
especially Stephen DeWitt, our President and Chief Executive Officer, and Vivek
Mehra, our Vice President of Products and one of our founders. The loss of any
of our key employees could adversely affect our business and slow our product
development processes. Although we maintain key person life insurance policies
on our key employees, the amount of this insurance may be inadequate to
compensate us for their loss.

Errors in our products or the failure of our products to conform to
specifications could result in our customers demanding refunds from us or
asserting claims for damages against us.

  Because our server appliance products are complex, they could contain errors
or bugs that can be detected at any point in a product's life cycle. In the
past we have discovered errors in some of our products and have experienced
delays in the shipment of our products during the period required to correct
these errors. These delays have principally related to new product releases. To
date none of these delays has materially affected our business. While we
continually test our products for errors and work with customers through our
customer support services to identify and correct bugs in our software and
other product problems, errors in our products may be found in the future.
Although many of these errors may prove to be immaterial, any of these errors
could be significant. Detection of any significant errors may result in:

  .  the loss of or delay in market acceptance and sales of our products;

                                       19
.  diversion of development resources;

  .  injury to our reputation; or

  .  increased maintenance and warranty costs.

  These problems could harm our business and future operating results. Product
errors or delays could be material, including any product errors or delays
associated with the introduction of new products or the versions of our
products that support operating systems other than Linux. Occasionally, we have
warranted that our products will operate in accordance with specified customer
requirements. If our products fail to conform to these specifications,
customers could demand a refund for the purchase price or assert claims for
damages.

  Moreover, because our products are used in connection with critical
distributed computing systems services, we may receive significant liability
claims if our products do not work properly. Our agreements with customers
typically contain provisions intended to limit our exposure to liability
claims. However, these limitations may not preclude all potential claims.
Liability claims could require us to spend significant time and money in
litigation or to pay significant damages. Any such claims, whether or not
successful, could seriously damage our reputation and our business.

                         Risks Related to this Offering

Our stock will likely be subject to substantial price and volume fluctuations
due to a number of factors, many of which will be beyond our control, that may
prevent our stockholders from reselling our common stock at a profit.

  The securities markets have experienced significant price and volume
fluctuations in the past and the market prices of the securities of technology
companies have been especially volatile. This market volatility, as well as
general economic, market or political conditions, could reduce the market price
of our common stock in spite of our operating performance. In addition, our
operating results could be below the expectations of public market analysts and
investors, and in response the market price of our common stock could decrease
significantly. Investors may be unable to resell their shares of our common
stock at or above the offering price. In the past, companies that have
experienced volatility in the market price of their stock have been the object
of securities class action litigation. If we were the object of securities
class action litigation, it could result in substantial costs and a diversion
of management's attention and resources.

We have broad discretion in how we use the proceeds of this offering, and we
may not use these proceeds effectively.

  Our management could spend most of the proceeds from this offering in ways
with which our stockholders may not agree or that do not yield a favorable
return. Our primary purpose in conducting this offering is to create a public
market for our common stock. As of the date of this prospectus, we plan to use
the proceeds from this offering for working capital and general corporate
purposes. We may also use the proceeds in future strategic acquisitions but do
not have any acquisitions planned. Until we need to use the proceeds of this
offering, we plan to invest the net proceeds in investment grade, interest-
bearing securities.

Our officers and persons affiliated with our directors hold a substantial
portion of our stock and could reject mergers or other business combinations
that a stockholder may believe are desirable.

  We anticipate that our directors, officers and individuals or entities
affiliated with our directors will beneficially own approximately   % of our
outstanding common stock as a group after this offering closes. Acting
together, these stockholders would be able to significantly influence all
matters that

                                       20
our stockholders vote upon, including the election of directors or the
rejection of a merger or other business combination that other stockholders may
believe is desirable.

The provisions of our charter documents may inhibit potential acquisition bids
that a stockholder may believe are desirable, and the market price of our
common stock may be lower as a result.

  Upon completion of this offering, our board of directors will have the
authority to issue up to 10,000,000 shares of preferred stock. The board of
directors can fix the price, rights, preferences, privileges and restrictions
of the preferred stock without any further vote or action by our stockholders.
The issuance of shares of preferred stock may delay or prevent a change in
control transaction. As a result, the market price of our common stock and the
voting and other rights of our stockholders may be adversely affected. The
issuance of preferred stock may result in the loss of voting control to other
stockholders. We have no current plans to issue any shares of preferred stock.

  Our charter documents contain anti-takeover devices including:

  .  only one of the three classes of directors is elected each year;

  .  the ability of our stockholders to remove directors without cause is
     limited;

  .  the right of stockholders to act by written consent has been eliminated;

  .  the right of stockholders to call a special meeting of stockholders has
     been eliminated; and

  .  a requirement of advance notice to nominate directors or submit
     proposals for consideration at stockholder meetings.

  These provisions could discourage potential acquisition proposals and could
delay or prevent a change in control transaction. They could also have the
effect of discouraging others from making tender offers for our common stock.
As a result, these provisions may prevent the market price of our common stock
from increasing substantially in response to actual or rumored takeover
attempts. These provisions may also prevent changes in our management.

Delaware law may inhibit potential acquisition bids; this may adversely affect
the market price of our common stock, discourage merger offers and prevent
changes in our management.

  Section 203 of the Delaware General Corporation Law may inhibit potential
acquisition bids for our company. Upon completion of this offering, we will be
subject to the antitakeover provisions of the Delaware General Corporation Law,
which regulate corporate acquisitions. Delaware law will prevent us from
engaging, under certain circumstances, in a "business combination" with any
"interested stockholder" for three years following the date that the interested
stockholder became an interested stockholder unless our board of directors or a
supermajority of our uninterested stockholders agree. For purposes of Delaware
law, a "business combination" includes a merger or consolidation involving us
and the interested stockholder and the sale of more than 10% of our assets. In
general, Delaware law defines an "interested stockholder" as any holder
beneficially owning 15% or more of the outstanding voting stock of a
corporation and any entity or person affiliated with or controlling or
controlled by the holder. Under Delaware law, a corporation may opt out of the
foregoing antitakeover provisions. We do not intend to opt out of the
antitakeover provisions of Delaware Law.

A total of 22,010,103, or  %, of our total outstanding shares after the
offering are restricted from immediate resale, but may be sold into the market
in the near future. This could cause the market price of our common stock to
drop significantly, even if our business is doing well.

  Our current stockholders hold a substantial number of shares, which they will
be able to sell in the public market in the near future. Sales of a substantial
number of shares of our common stock

                                       21
could cause our stock price to fall. In addition, the sale of these shares
could impair our ability to raise capital through the sale of additional stock.

  After this offering, we will have outstanding            shares of common
stock. This includes            shares that we are selling in the offering,
which may be resold immediately in the public market. The remaining 22,010,103
shares will become eligible for resale in the public market as shown in the
table below.
Number of shares/% of total
   outstanding after the offering                    Date of availability for resale into public market
   ------------------------------                    --------------------------------------------------
100,000/  %                 30 days after the date of the final prospectus due to an agreement
                                     the family of a deceased co-founder has with Cobalt and the
                                     underwriters. However, the underwriters can waive this restriction
                                     and allow these stockholders to sell their shares at any time.

     21,910,103/  %                 180 days after the date of the final prospectus due to agreements
                                     these stockholders have with Cobalt and the underwriters.
                                     However, the underwriters can waive this restriction and allow
                                     these stockholders to sell their shares at any time. 14,975,753 of
                                     these shares will be subject to sales volume limitations under the
                                     federal securities laws.
FORWARD-LOOKING STATEMENTS

  This prospectus, including the sections entitled "Prospectus Summary", "Risk
Factors", "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business", contains forward-looking statements.
These statements relate to future events or our future financial performance
and involve known and unknown risks, uncertainties and other factors that may
cause our or our industry's actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by the forward-
looking statements. These risks and other factors include those listed under
"Risk Factors" and elsewhere in this prospectus. In some cases, you can
identify forward-looking statements by terminology such as "may", "will",
"should", "expects", "plans", "anticipates", "believes", "estimates",
"predicts", "potential", "continue" or the negative of these terms or other
comparable terminology. These statements are only predictions. Actual events or
results may differ materially. In evaluating these statements, you should
specifically consider various factors, including the risks outlined under "Risk
Factors". These factors may cause our actual results to differ materially from
any forward-looking statement.

  Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other
person assumes responsibility for the accuracy and completeness of these
forward-looking statements. We are under no duty to update any of the forward-
looking statements after the date of this prospectus to conform our prior
statements to actual results.

                                       22
USE OF PROCEEDS

  We estimate that the net proceeds from the sale of the shares of common stock
that we are selling in this offering will be approximately $    , or $     if
the underwriters exercise their over-allotment option in full, based on an
assumed public offering price of $   per share and after deducting the
estimated underwriting discounts and commissions and estimated offering
expenses payable by us.

  The principal purposes of this offering are to fund our operating losses,
increase our working capital, fund our capital expenditures and create a public
market for our common stock. The amounts that we actually expend for working
capital purposes will vary significantly depending on a number of factors,
including future revenue growth, if any, and the amount of cash we generate
from operations. As a result, we will retain broad discretion in the allocation
of the net proceeds of this offering. In addition, we may use a portion of the
net proceeds for further development of our product lines through acquisitions
of products, technologies and businesses. However, we currently have no present
commitments or agreements with respect to any acquisitions. Pending these uses,
we intend to invest the net proceeds in interest-bearing, investment-grade
securities.

                                DIVIDEND POLICY

  We have never declared or paid any dividends on our capital stock. We
currently expect to retain any future earnings for use in the operation and
expansion of our business and do not anticipate paying any cash dividends in
the foreseeable future.

                                       23
CAPITALIZATION

  The following table sets forth our capitalization as of July 2, 1999. Our
capitalization is presented:

  .  on an actual basis;

  .  on a pro forma basis to give effect to the automatic conversion of all
     outstanding shares of our mandatorily redeemable convertible preferred
     stock into shares of common stock upon the closing of this offering; and

  .  on a pro forma as adjusted basis to reflect the automatic conversion of
     our mandatorily redeemable convertible preferred stock and our receipt
     of the estimated net proceeds from the sale of     shares of common
     stock in this offering at an assumed initial public offering price of
     $    per share.
As of July 2, 1999
                                                --------------------------------
                                                                      Pro Forma
                                                 Actual   Pro Forma  As Adjusted
                                                --------  ---------  -----------
                                                        (in thousands)
Notes payable, less current portion............ $     64  $     64    $     64
                                                --------  --------    --------
Mandatorily redeemable convertible preferred
 stock, $.001 par value, 17,609,875 shares
 authorized, 17,084,818 shares issued and
 outstanding, actual and pro forma; no shares
 authorized, issued or outstanding, pro forma
 as adjusted...................................   45,646       --          --
                                                --------  --------    --------
Stockholders' equity (deficit):
 Preferred stock, $.001 par value, no shares
  authorized, issued or outstanding, actual
  and pro forma; 10,000,000 shares authorized,
  no shares issued or outstanding, pro forma
  as adjusted..................................      --        --          --
 Common stock, $.001 par value, 26,000,000
  shares authorized, actual and pro forma,
  4,925,285 shares issued and outstanding,
  actual; 22,010,103 shares issued and
  outstanding, pro forma; 120,000,000 shares
  authorized,            shares issued and
  outstanding, pro forma as adjusted...........        5        22
 Additional paid-in capital....................    3,921    49,550
 Unearned stock compensation...................   (1,134)   (1,134)     (1,134)
 Note receivable from stockholder..............      (50)      (50)        (50)
 Accumulated deficit...........................  (22,592)  (22,592)    (22,592)
                                                --------  --------    --------
   Total stockholders' equity (deficit)........  (19,850)   25,796
                                                --------  --------    --------
     Total capitalization...................... $ 25,860  $ 25,860    $
                                                ========  ========    ========
In addition to the shares of common stock to be outstanding after the
offering, we may issue additional shares of common stock under the following
plans and arrangements:

  .  2,144,943 shares issuable upon exercise of options outstanding at a
     weighted average exercise price of $0.69 per share as of July 2, 1999;

  .  525,665 shares issuable upon exercise of warrants outstanding at a
     weighted average exercise price of $2.74 per share as of July 2, 1999;
     and

  .  a total of 6,407,870 shares available for future issuance under our
     various stock plans excluding the annual increases in the number of
     shares authorized under each of our plans beginning January 1, 2001. See
     "Management--Incentive Plans" for a description of how these annual
     increases are determined.

  Please read the capitalization table together with the sections of this
prospectus entitled "Selected Consolidated Financial Data" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
with the financial statements and related notes beginning on page F-1.

                                       24
DILUTION

  Our pro forma net tangible book value as of July 2, 1999 was $25.8 million,
or $1.17 per share. Pro forma net tangible book value per share represents the
amount of our total tangible assets reduced by the amount of our total
liabilities and divided by the total number of shares of common stock
outstanding after giving effect to the automatic conversion of our mandatorily
redeemable convertible preferred stock. Dilution in pro forma net tangible book
value per share represents the difference between the amount per share paid by
purchasers of shares of common stock in this offering and the pro forma net
tangible book value per share of common stock immediately after the completion
of this offering. After giving effect to the sale of the shares of common stock
offered by us at an assumed initial public offering price of $    per share,
and after deducting the estimated underwriting discounts and commissions and
estimated offering expenses payable by us, our pro forma net tangible book
value as of July 2, 1999 would have been approximately $    million or $    per
share of common stock. This represents an immediate increase in pro forma net
tangible book value of $    per share to existing stockholders and an immediate
dilution of $    per share to new investors of common stock. The following
table illustrates this dilution on a per share basis:
Assumed initial public offering price per share.......................       $
  Pro forma net tangible book value per share as of July 2, 1999...... $1.17
  Increase per share attributable to new investors....................
                                                                       -----
Pro forma net tangible book value per share after this offering.......
                                                                             ---
Dilution per share to new investors...................................       $
                                                                             ===
The following table summarizes on a pro forma basis after giving effect to
the offering, based on an assumed initial public offering price of $     per
share, as of July 2, 1999, the differences between the existing stockholders
and new investors with respect to the number of shares of common stock
purchased from us, the total consideration paid to us and the average price
per share paid:
Total      Average
                                        Shares Purchased  Consideration   Price
                                       ------------------ --------------   Per
                                         Number   Percent Amount Percent  Share
                                       ---------- ------- ------ ------- -------
Existing stockholders................. 22,010,103      %              %  $
New investors.........................
                                       ----------   ---    ----    ---
  Total...............................                 %              %
                                       ==========   ===    ====    ===
The foregoing discussion and tables are based upon the number of shares
actually issued and outstanding on July 2, 1999 and assume no exercise of
options or warrants outstanding as of July 2, 1999. As of that date, there
were:

  .  2,144,943 shares issuable upon exercise of options outstanding at a
     weighted average exercise price of $0.69 per share; and

  .  525,665 shares issuable upon exercise of warrants outstanding at a
     weighted average exercise price of $2.74 per share.

  To the extent these options and warrants are exercised, there will be further
dilution to new investors.

                                       25
SELECTED CONSOLIDATED FINANCIAL DATA

  The selected consolidated financial data below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and our consolidated financial statements and notes thereto. The
selected consolidated statement of operations data for the period from October
18, 1996 (inception) to December 31, 1996 and for the years ended December 31,
1997 and 1998, and the selected consolidated balance sheet data as of December
31, 1997 and 1998, are derived from, and are qualified by reference to, the
audited consolidated financial statements included elsewhere in this
prospectus. The selected consolidated balance sheet data as of December 31,
1996 is derived from our audited consolidated financial statements that are not
included in this prospectus. The selected consolidated statement of operations
data for the six month periods ended June 30, 1998 and July 2, 1999, and the
selected consolidated balance sheet data as of July 2, 1999, are derived from
unaudited consolidated financial statements included elsewhere in this
prospectus. We prepared the unaudited consolidated financial statements on
substantially the same basis as the audited consolidated financial statements
and, in our opinion, they include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the results of
operations for these periods. The historical results presented below are not
necessarily indicative of future results.

  Our mandatorily redeemable convertible preferred stock had a feature which
required us to repurchase the preferred stock from its holders at their
election. Accretion of mandatorily redeemable convertible preferred stock
represents the charge to retained earnings we took in 1998 and the six months
ended July 2, 1999 to reflect this potential liability. As of April 26, 1999,
the accretion was no longer required due to a change in the terms of the
preferred stock. The outstanding shares of mandatorily redeemable convertible
preferred stock will convert into shares of our common stock on a one for one
basis in connection with the closing of this offering and no dividends will be
paid or converted into common stock. The pro forma net loss per share for the
year ended December 31, 1998 and the six months ended July 2, 1999 reflect the
elimination of the accretion and the conversion of our preferred stock.

                                       26
Year Ended
                             Period from     December 31,     Six Months Ended
                           Oct. 18, 1996   -----------------  -----------------
                            (Inception)                       June 30,  July 2,
                          to Dec. 31, 1996  1997      1998      1998     1999
                          ---------------- -------  --------  --------  -------
                                (in thousands, except per share data)
Consolidated Statement
 of Operations Data:
Net revenues............       $ --        $   --   $  3,537  $   449   $ 7,663
Cost of revenues........         --            --      3,123      582     5,156
                               -----       -------  --------  -------   -------
 Gross profit (loss)....         --            --        414     (133)    2,507
                               -----       -------  --------  -------   -------
Operating expenses:
 Research and
  development...........          22         1,067     3,483    1,204     2,771
 Sales and marketing....         --            245     5,581    1,801     6,273
 General and
  administrative........          60           445     1,895      611     1,454
 Amortization of stock
  compensation..........         --            --        --       --        253
                               -----       -------  --------  -------   -------
   Total operating
    expenses............          82         1,757    10,959    3,616    10,751
                               -----       -------  --------  -------   -------
Loss from operations....         (82)       (1,757)  (10,545)  (3,749)   (8,244)
Interest income
 (expense), net.........         --            (12)       67       (3)      --
                               -----       -------  --------  -------   -------
Net loss................         (82)       (1,769)  (10,478)  (3,752)   (8,244)
Accretion of mandatorily
 redeemable convertible
 preferred stock........         --            --       (828)     --     (1,191)
                               -----       -------  --------  -------   -------
Net loss attributable to
 holders of common
 stock..................       $ (82)      $(1,769) $(11,306) $(3,752)  $(9,435)
                               =====       =======  ========  =======   =======
Basic and diluted net
 loss per share
 attributable to holders
 of common stock........                   $ (4.10) $  (5.47) $ (2.09)  $ (2.83)
                                           =======  ========  =======   =======
Basic and diluted
 weighted average shares
 outstanding............                       432     2,065    1,792     3,338
                                           =======  ========  =======   =======
Pro forma basic and
 diluted net loss per
 share..................                            $  (1.43)           $ (0.60)
                                                    ========            =======
Pro forma basic and
 diluted weighted
 average shares
 outstanding............                               7,330             13,808
                                                    ========            =======
December 31,
                                           ------------------------  July 2,
                                           1996    1997      1998      1999
                                           -----  -------  --------  --------
Consolidated Balance Sheet Data:
Cash and cash equivalents................. $  15  $ 1,738  $  2,090  $ 27,426
Working capital (deficit).................  (105)   1,542    (1,912)   24,539
Total assets..............................    42    1,998     6,145    34,902
Notes payable, less current portion.......    70      --         84        64
Mandatorily redeemable convertible
 preferred stock..........................   --     3,551    12,339    45,646
Total stockholders' deficit...............   (82)  (1,847)  (13,073)  (19,850)
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with "Selected Consolidated
Financial Data" and our financial statements and related notes included
elsewhere in this prospectus. In addition to historical information, the
discussion in this prospectus contains certain forward-looking statements that
involve risks and uncertainties. Our actual results could differ materially
from those anticipated by these forward-looking statements due to factors
including, but not limited to, those factors set forth under "Risk Factors" and
elsewhere in this prospectus.

Overview

  We are a leading provider of server appliances. Server appliances are a new
category of network infrastructure devices that are specifically designed and
optimized to deliver one or a few network-based applications well. Our products
deliver network-based applications in a flexible and reliable manner that is
simpler and more cost-effective than current solutions. From our inception in
October 1996 to March 1998, our operations consisted primarily of start-up and
initial product development activities, recruiting personnel and raising
capital. In March 1998, we shipped our first server appliance product, the
Cobalt Qube. Since that time, we have expanded our product family into several
new markets with our Cobalt RaQ, Cobalt Cache and Cobalt NAS product lines.

  Since our inception in 1996, we have incurred substantial costs to develop
our technology and products, to recruit and train personnel for our
engineering, sales and marketing and technical support departments, and to
establish an administrative organization. As a result, we had an accumulated
deficit of $22.6 million as of July 2, 1999. We anticipate that our operating
expenses will increase substantially in the future as we increase our sales and
marketing operations, develop new channels, fund greater levels of research and
development, broaden our technical support and improve our operational and
financial systems. Accordingly, we will need to generate significant revenues
to achieve profitability. In addition, our limited operating history makes it
difficult for us to predict future operating results and, accordingly, there
can be no assurance that we will sustain revenue growth or achieve
profitability in future quarters.

  We currently derive substantially all of our net revenues from sales of a
limited number of products. During 1998 and the six months ended July 2, 1999,
respectively, 83% and 84% of our net revenues were derived from sales of our
Cobalt Qube and Cobalt RaQ products. Although we began selling our Cobalt Cache
products in 1998 and Cobalt NAS products during the six months ended July 2,
1999, we expect that a substantial majority of our net revenues in 1999 will
continue to be generated from sales of our Cobalt Qube and Cobalt RaQ products.

  We sell our products directly through our sales force and indirectly through
channel partners that include distributors, resellers and system integrators.
Indirect sales are a majority of our total sales and account for substantially
all of our sales outside of the United States. In 1998 and the six months ended
July 2, 1999, respectively, 46% and 14% of our net revenues were from direct
sales.

  Indirect sales were 54% of our net revenues in 1998 and 86% of our net
revenues in the six months ended July 2, 1999. In 1998, approximately 12% of
our net revenues came from sales to one of our distributors, Nissho
Electronics. For the six months ended July 2, 1999, sales to two of our
distributors, Tech Data and Nissho Electronics, accounted for 18% and 13% of
our net revenues, respectively. While we are seeking to diversify our customer
base and expand the portion of our net revenues which is derived from sales
through various channels, we anticipate that our operating results will
continue to depend on volume sales to a relatively small number of channel
partners.

                                       28
For direct sales and sales to resellers and system integrators, we record
revenues upon shipment. For sales to distributors, we recognize revenues upon
estimated sell through to the end users as our contracts generally provide the
distributor with limited rights of return. As a result, we defer recognition of
gross profit, captioned on our balance sheet as deferred margin, on inventory
held by distributors until we record the revenues and cost of revenues on a
sell through basis. Revenues from service obligations are deferred and
recognized on a straight line basis over the contractual period.

  We provide allowances for estimated sales returns and warranty costs at the
time of revenue recognition based on our historical results. To date, our
actual sales returns and warranty expenditures have each been less than 5% of
net revenues in any quarter. However, our past product return and warranty
experience may not be indicative of future product return rates and warranty
costs.

  Although we enter into general sales contracts with our channel partners,
none of our channel partners is obligated to purchase any amount of our
products pursuant to these contracts. We rely on our channel partners to submit
purchase orders for specific quantities of our products.

Our gross profit is affected by:

  .  fluctuations in demand for our products;

  .  the mix of products sold;

  .  the mix of sales channels through which our products are sold;

  .  the mix of sales within and outside North America;

  .  the timing and size of customer orders;

  .  new product introductions by us and our competitors;

  .  changes in our pricing policies;

  .  changes in component costs; and

  .  the volume manufacturing prices we are able to obtain from our contract
     manufacturers.

  During the six months ended July 2, 1999 and during the period from July 3,
1999 to August 31, 1999, respectively, we recorded unearned stock compensation
on our balance sheet of $1.4 million and $7.4 million in connection with
certain stock option grants. We will amortize this stock compensation over the
vesting period of the related award. During the six months ended July 2, 1999,
we amortized $253,000 of stock compensation. During the remainder of 1999 and
in 2000, we expect to amortize stock compensation of:
Fiscal Quarter                                        Expected Amortization of
     Ending                                               Stock Compensation
 --------------                                        ------------------------
                                                            (in thousands)
October 1, 1999.......................................          $  893
December 31, 1999.....................................           1,235
March 31, 2000........................................           1,221
June 30, 2000.........................................           1,198
September 29, 2000....................................             847
December 29, 2000.....................................             615
We then expect aggregate per quarter stock compensation amortization of
between $522,000 and $309,000 during 2001, between $254,000 and $115,000 during
2002 and between $77,000 and $10,000 during 2003. The amount of stock
compensation expense to be recorded in future periods could decrease if options
for which accrued but unvested compensation has been recorded are forfeited.

                                       29
As of December 31, 1998, we had approximately $11 million of federal and
state net operating loss carryforwards for tax reporting purposes available to
offset future taxable income. These net operating loss carryforwards expire
beginning in 2011 and 2004, respectively. We have not recognized any benefit
from the future use of loss carryforwards for these periods or for any other
period since inception because of uncertainty surrounding their realization.
The amount of net operating losses that we can utilize may be limited under tax
regulations in circumstances including a cumulative stock ownership change of
more than 50% over a three year period. It is possible that such a change may
have already occurred or could occur as a result of this offering.

  Our net loss attributable to holders of common stock includes accretion
charges to increase over time the carrying amount of our mandatorily redeemable
convertible preferred stock to the amount we would be required to pay if
redeemed. As of April 26, 1999, we stopped recording these charges because we
changed the terms of the preferred stock to limit the redemption amount to its
original issue price plus accrued dividends.

  We had 101 employees as of July 2, 1999, a substantial increase from 68 as of
December 31, 1998 and 14 as of December 31, 1997. This rapid growth has placed
significant demands on our management and operational resources. In order to
manage our growth effectively, we must implement and improve our operational
systems, procedures and controls on a timely basis. If our total revenues do
not increase relative to our operating expenses, our management systems do not
expand to meet increasing demands, we fail to attract, assimilate and retain
qualified personnel or our management otherwise fails to manage our expansion
effectively, we could experience a decline in our revenues and operating
results.

  Until January 1, 1999, we operated on calendar fiscal quarters and a fiscal
year ending December 31. Beginning in 1999, we operate on thirteen week fiscal
quarters ending on a Friday. Therefore, in 1999 our fiscal quarters end on
April 2, July 2, October 1 and December 31. Fiscal 2000 will end on December
29, 2000.

Results of Operations

Six Months ended June 30, 1998 and July 2, 1999

 Net Revenues

  We began volume shipments of our Cobalt Qube product line in March 1998. Net
revenues increased from $449,000 for the six months ended June 30, 1998 to $7.7
million in the six months ended July 2, 1999. Net revenues increased primarily
as a result of increased sales to new and existing customers of our Cobalt Qube
product line and the September 1998 introduction of the Cobalt RaQ . To a
lesser extent, our net revenues increased due to the introduction of our Cobalt
Cache product line and Cobalt NAS product line in July 1998 and April 1999,
respectively, and an expansion of our sales through our channel partners.

  Net revenues from sales outside the United States increased from $143,000 in
the six months ended June 30, 1998 to $4.3 million in the six months ended July
2, 1999. The increase in absolute dollars reflected expansion of our operations
in Japan, Europe and other countries. One factor relating to the increase in
net revenues in the Japanese market was our introduction of a Japanese language
user interface in May 1998. Our net revenues from sales outside the United
States were primarily denominated in U.S. dollars. The effect of foreign
exchange fluctuations did not have a significant impact on our results.

 Cost of Revenues and Gross Profit

  Cost of revenues includes technology license fees, manufacturing costs,
manufacturing personnel expenses, packaging and shipping costs and warranty
expenses. We have outsourced our manufacturing and repair operations.
Accordingly, a significant portion of our cost of revenues consists of payments
to our contract manufacturers. Cost of revenues increased from $582,000 in

                                       30
the six months ended June 30, 1998 to $5.2 million in the six months ended July
2, 1999. The increase in cost of revenues was primarily due to increased sales
volume and the introduction of new products. We believe that our cost of
revenues will increase in absolute dollars in future periods but will continue
to fluctuate as a percentage of net revenues.

  Gross profit increased from a gross loss of $133,000 in the six months ended
June 30, 1998 to a gross profit $2.5 million in the six months ended July 2,
1999. Gross profit (loss) as a percentage of net revenues increased from (30)%
in the six months ended June 30, 1998 to 33% in the six months ended July 2,
1999. The increase in gross profit was primarily due to increased sales volume
and the introduction of new products. We believe that the rate of growth of the
increase in gross profit will not be sustainable in future quarters.

 Research and Development Expenses

  Research and development expenses consist primarily of salaries and related
expenses for personnel engaged in research and development, fees paid to
consultants and outside service providers, material costs for prototype and
test units and other expenses related to the design, development, testing and
enhancements of our products. We expense all of our research and development
costs as they are incurred. Research and development expenses increased from
$1.2 million in the six months ended June 30, 1998 to $2.8 million in the six
months ended July 2, 1999. This increase was primarily due to the hiring of
additional research and development personnel. As net revenues have increased,
research and development expenses have declined as a percentage of net revenues
from 268% in the six months ended June 30, 1998 to 36% in the six months ended
July 2, 1999. We believe that a significant level of investment in product
research and development is required to remain competitive. Accordingly, we
expect to continue to devote substantial resources to product research and
development such that research and development expenses will increase in
absolute dollars but will continue to fluctuate as a percentage of net
revenues.

 Sales and Marketing Expenses

  Sales and marketing expenses consist primarily of salaries, commissions and
related expenses for personnel engaged in marketing, sales and customer support
functions, as well as costs associated with trade shows, promotional
activities, advertising and public relations. Sales and marketing expenses
increased from $1.8 million in the six months ended June 30, 1998 to
$6.3 million in the six months ended July 2, 1999. The increase in absolute
dollars was primarily due to the hiring of additional sales and marketing
personnel and the expansion of our global sales and marketing efforts,
particularly with respect to our branding campaign. As net revenues have
increased, these expenses have declined as a percentage of net revenues from
401% in the six months ended June 30, 1998 to 82% in the six months ended July
2, 1999. We intend to expand our sales and marketing operations and efforts
substantially, both domestically and internationally, in order to increase
market awareness and to generate sales of our products. Accordingly, we expect
our sales and marketing expenses to increase in absolute dollars but continue
to fluctuate as a percentage of net revenues.

 General and Administrative Expenses

  General and administrative expenses consist primarily of salaries and related
expenses for executive, finance, accounting, information technology, facilities
and human resources personnel, recruiting expenses, professional fees and costs
associated with expanding our information systems. General and administrative
expenses increased from $611,000 in the six months ended June 30, 1998 to $1.5
million in the six months ended July 2, 1999. The increase in absolute dollars
was primarily due to the hiring of additional administrative personnel and
associated expenses necessary

                                       31
to manage and support our increased scale of operations. As net revenues have
increased, these expenses have declined as a percentage of net revenues from
136% in the six months ended June 30, 1998 to 19% in the six months ended July
2, 1999. We expect these expenses to increase in absolute dollars but continue
to fluctuate as a percentage of net revenues as we add personnel and incur
additional costs related to the growth of our business, expansion of our
information infrastructure and our operation as a public company.

 Amortization of Stock Compensation

  In connection with the grant of stock options to employees during the six
months ended July 2, 1999, we recorded unearned stock compensation within
stockholders' equity of approximately $1.4 million, representing the difference
between the estimated fair value of the common stock for accounting purposes
and the option exercise price of these options at the date of grant. We
recorded no stock compensation amortization in the six months ended June 30,
1998. We recorded amortization of stock compensation of $253,000 during the six
months ended July 2, 1999. The amount of stock compensation expense to be
recorded in future periods could decrease if options for which accrued but
unvested compensation has been recorded are forfeited.

 Interest Income (Expense), Net

  Interest income (expense), net includes income from our cash investments net
of expenses related to our debt and lease financing obligations. We had net
interest expense of $3,000 in the six months ended June 30, 1998 and no
interest income (expense), net in the six months ended July 2, 1999. The change
from the six months ended June 30, 1998 was primarily due to an increase in
interest income earned on proceeds from issuances of our preferred stock and
was partially offset by increased interest charges on debt and capital lease
obligations.

October 18, 1996 to December 31, 1996 and Years Ended December 31, 1997 and
1998

 Net Revenues

  We had net revenues of $3.5 million in 1998, principally related to sales of
the Cobalt Qube and Cobalt RaQ. We had no net revenues in either 1996 or 1997.
Net revenues from sales outside of the United States were approximately 44% of
net revenues in 1998, primarily in Japan and Europe, which accounted for 21%
and 15% of our net revenues in 1998, respectively.

 Cost of Revenues

  Cost of revenues was $3.2 million in 1998. There was no cost of revenues in
1996 or 1997.

 Research and Development

  Research and development expenses increased from $22,000 in 1996 to $1.1
million in 1997 and to $3.5 million in 1998. The increase in research and
development expenses was due primarily to expanded technology development
efforts related to our new products, user interfaces, Linux operating system
optimization and application software.

 Sales and Marketing

  We had no sales and marketing expenses in 1996. Sales and marketing expenses
increased from $245,000 in 1997 to $5.6 million in 1998. The increase in sales
and marketing expenses during 1998 was due primarily to the addition of new
sales, marketing and customer support personnel,

                                       32
product launches, sales channel growth and our expansion of our global selling
efforts, which emphasizes the support of sales and service through distributors
and resellers.

 General and Administrative

  General and administrative expenses increased from $60,000 in 1996 to
$445,000 in 1997 and to $1.9 million in 1998. The increase in general and
administrative expenses in each period was due primarily to the hiring of
additional personnel and expansion of our facilities to support the growth of
our business.

 Interest Income (Expense), Net

  We had no interest income (expense), net in 1996. We had net interest expense
of $12,000 in 1997 and net interest income of $67,000 in 1998. The net change
from 1997 to 1998 was due to interest income on the increased average cash and
cash equivalents balances as a result of our issuances of capital stock.

                                       33
Quarterly Results of Operations

  The following table presents our consolidated operating results for each of
the six quarters in the period from January 1, 1998 through July 2, 1999. The
information for each of these quarters is unaudited and has been prepared on
the same basis as our audited consolidated financial statements appearing
elsewhere in this prospectus. In the opinion of management, all necessary
adjustments, consisting only of normal recurring adjustments, have been
included to present fairly the unaudited quarterly results when read in
conjunction with our audited consolidated financial statements and related
notes appearing elsewhere in this prospectus.
Quarter Ended
                         ---------------------------------------------------------------
                         Mar. 31,   June 30,   Sept. 30,   Dec. 31,   Apr. 2,    July 2,
                           1998       1998       1998        1998       1999      1999
                         --------   --------   ---------   --------   --------   -------
                                        (dollars in thousands)
Consolidated Statement
 of Operations Data:
Net revenues............ $     70   $    379   $  1,064    $  2,024   $  2,634   $ 5,029
Cost of revenues........      155        427        808       1,733      2,002     3,154
                         --------   --------   --------    --------   --------   -------
   Gross profit (loss)..      (85)       (48)       256         291        632     1,875
                         --------   --------   --------    --------   --------   -------
Operating expenses:
 Research and
  development...........      528        855        990       1,110      1,397     1,374
 Sales and marketing....      590      1,050      1,709       2,232      2,753     3,520
 General and
  administrative........      242        351        487         815        621       833
 Amortization of stock
  compensation..........      --         --         --          --         140       113
                         --------   --------   --------    --------   --------   -------
   Total operating
    expenses............    1,360      2,256      3,186       4,157      4,911     5,840
                         --------   --------   --------    --------   --------   -------
Loss from operations....   (1,445)    (2,304)    (2,930)     (3,866)    (4,279)   (3,965)
Interest income
 (expense), net.........        7        (10)        48          22       (128)      128
                         --------   --------   --------    --------   --------   -------
Net loss................ $ (1,438)  $ (2,314)  $ (2,882)   $ (3,844)  $ (4,407)  $(3,837)
                         ========   ========   ========    ========   ========   =======
As a Percentage of Net
 Revenues:
Net revenues............    100.0 %    100.0 %    100.0 %     100.0 %    100.0 %   100.0 %
Cost of revenues........    221.4      112.7       75.9        85.6       76.0      62.7
                         --------   --------   --------    --------   --------   -------
   Gross profit (loss)..   (121.4)     (12.7)      24.1        14.4       24.0      37.3
                         --------   --------   --------    --------   --------   -------
Operating expenses:
 Research and
  development...........    754.3      225.6       93.0        54.8       53.0      27.3
 Sales and marketing....    842.9      277.1      160.6       110.3      104.5      70.0
 General and
  administrative........    345.7       92.6       45.8        40.3       23.6      16.6
 Amortization of stock
  compensation..........      --         --         --          --         5.3       2.2
                         --------   --------   --------    --------   --------   -------
   Total operating
    expenses............  1,942.9      595.2      299.4       205.4      186.4     116.1
                         --------   --------   --------    --------   --------   -------
Loss from operations.... (2,064.3)    (607.9)    (275.3)     (191.0)    (162.4)    (78.8)
Interest income
 (expense), net.........     10.0       (2.6)       4.5         1.1       (4.9)      2.5
                         --------   --------   --------    --------   --------   -------
Net loss................ (2,054.3)%   (610.5)%   (270.8)%    (189.9)%   (167.3)%   (76.3)%
                         ========   ========   ========    ========   ========   =======
Net revenues increased in each of the six quarters from January 1, 1998
through July 2, 1999. These quarterly increases were primarily due to the
introduction of our Cobalt RaQ and to a lesser extent, our Cobalt Cache and
Cobalt NAS products, increased sales of our Cobalt Qube products, and the
addition of new channel partners and web hosting and application service
provider customers.

  Cost of revenues increased in each of the six quarters from January 1, 1998
through July 2, 1999 as a result of increased unit sales. Gross profit
generally increased in each of the six quarters from January 1, 1998 through
July 2, 1999 due to increases in the volume of sales and the realization of
associated economies of scale as well as the introduction of the higher margin
Cobalt RaQ products.

                                       34
Research and development expenses increased in each of the six quarters from
January 1, 1998 to March 31, 1999, primarily due to the addition of personnel
and costs incurred for the development of new products. For the quarter ended
July 2, 1999, research and development expenses decreased relative to the prior
quarter as a result of relatively high contract research and development
expenses in the prior quarter.

  Sales and marketing expenses increased in each of the six quarters from
January 1, 1998 to July 2, 1999 due to the hiring of additional sales
personnel, higher commission expense resulting from increased unit sales,
marketing programs, tradeshows and customer support.

  General and administrative expenses generally increased for each of the six
quarters from January 1, 1998 through July 2, 1999. We incurred moving costs
during the quarter ended December 31, 1998 in connection with our move to a new
corporate headquarters facility in Mountain View, California.

  As a result of our limited operating history, we cannot forecast operating
expenses based on historical results. Accordingly, we base our expenses in part
on future revenue projections. Most of our expenses are fixed in nature, and we
may not be able to quickly reduce spending if revenues are lower than we have
projected. Our ability to forecast our quarterly sales accurately is limited,
which makes it difficult to predict the quarterly revenues that we will
recognize. We expect that our business, operating results and financial
condition would be harmed if revenues did not meet projections.

  We expect that our revenues and operating results may vary significantly from
quarter to quarter, and we anticipate that our expenses will increase
substantially in the foreseeable future as we:

  .  increase our sales and marketing activities, including expanding our
     North American and international direct sales forces;

  .  expand our indirect channels;

  .  develop our technology, expand our product lines and create and market
     new products; and

  .  pursue strategic relationships and acquisitions.

Accordingly, we believe that quarter to quarter comparisons of our operating
results are not necessarily meaningful. Investors should not rely on the
results of one quarter as an indication of future performance.

Liquidity and Capital Resources

  Since inception, we have financed our operations primarily through private
sales of mandatorily redeemable convertible preferred stock, the issuance of
convertible notes, equipment financings and net revenues generated from product
sales. As of July 2, 1999, we had cash and cash equivalents of $27.4 million,
an accumulated deficit of $22.6 million and working capital of $24.5 million.

  Our operating activities used cash of $1.6 million in 1997, $7.5 million in
1998, and $7.5 million during the six months ended July 2, 1999. Cash used in
operating activities for 1997 and 1998 was primarily attributable to net losses
of $1.8 million and $10.5 million, respectively. In 1998, cash used in
operating activities was also attributable to increases in accounts receivable
and inventories of $2.0 million and $500,000, respectively, offset in part by
increases in accounts payable of $4.0 million and accrued expenses of $1.1
million. Cash used in operating activities during the six months ended July 2,
1999 was attributable to a net loss of $8.2 million and increases in accounts
receivable of $2.8 million and inventory of $505,000 but was offset in part by
increases in accounts payable of

                                       35
$1.3 million, accrued expenses of $1.6 million and deferred margin of $423,000,
as well as depreciation, amortization of stock compensation and other non-cash
expenses.

  Our investing activities used cash of $157,000 in 1997, $1.4 million in 1998
and $428,000 in the six months ended July 2, 1999. Our investing activities
primarily reflect purchases of computer equipment and other fixed assets.

  Our financing activities provided cash of $3.5 million in 1997, $9.3 million
in 1998 and $33.2 million in the six months ended July 2, 1999. The increases
in each period resulted primarily from the net proceeds from the issuances of
mandatorily redeemable convertible preferred stock and convertible promissory
notes, borrowings under bank lines of credit and advances from a related party.

  From inception, we have made capital expenditures of $2.0 million to support
our research and development, sales and marketing and administrative
activities. We expect to have capital expenditures of approximately $2.0
million for the remainder of 1999 and 2000. We also anticipate that our capital
expenditures will increase over the next several years as we expand our
facilities and acquire equipment to support expansion of our sales and
marketing and research and development activities.

  In September 1998, we entered into an equipment lease financing agreement
with a leasing corporation. This agreement provides for borrowings of up to
$1.0 million at an interest rate of 10.95% per annum, and those advances are
secured by our equipment, machinery and fixtures. We are required to repay
advances under the line in 34 equal installments. As of December 31, 1998 and
July 2, 1999, respectively, we had outstanding borrowings of $123,000 and
$105,000 under this lease line.

  We intend to continue to invest heavily in the development of new products
and enhancements to our existing products. Our future liquidity and capital
requirements will depend upon numerous factors, including the costs and timing
of expansion of product development efforts and the success of these
development efforts, the costs and timing of expansion of sales and marketing
activities, the extent to which our existing and new products gain market
acceptance, market developments, the costs involved in maintaining and
enforcing intellectual property rights, the level and timing of license
revenues, available borrowings under line of credit arrangements and other
factors. We believe that the proceeds from this offering, together with our
current cash and investment balances and any cash generated from operations and
from current or future debt financing, will be sufficient to meet our operating
and capital requirements for at least the next 12 months. However, it is
possible that we may require additional financing within this period. We have
no current plans, and we are not currently negotiating, to obtain additional
financing following the completion of this offering. The factors described in
this paragraph will affect our future capital requirements and the adequacy of
our available funds. We may be required to raise additional funds through
public or private financings, strategic relationships or other arrangements. We
cannot assure you that such funding, if needed, will be available on terms
attractive to us, or at all. Furthermore, any additional equity financing may
be dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. If we fail to raise capital when needed, our failure
could have a negative impact on our operating results and financial condition.

Recent Accounting Pronouncement

  In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. We will be subject

                                       36
to SFAS No. 133 commencing in 2001. We have not yet determined what the impact
of SFAS No. 133 will be on our financial position or results of operations.

Year 2000 Readiness

 The Year 2000 Issue

  The year 2000 issue refers to the potential for disruption to business
activities caused by system failures or miscalculations which are triggered by
advancement of date records past the year 1999. For example, if software that
uses the calendar year in computations is not ready for the millennial calendar
change, it may interpret a 21st century date as a 20th century date (for
example, mistaking 2001 for 1901).

 Readiness of Our Products

  We have designed our products to be ready for the year 2000 calendar change.
We represent to our customers that each software and hardware product supplied
by us will accurately process date data from, into and between the 20th and
21st centuries and the years 1999 and 2000, including leap year calculations,
when used in accordance with the product documentation provided by us. We also
represent to our customers that upon notification of any year 2000 problems
with our products, we will remedy it by product repair or replacement.

  We do not represent to our customers that the networks to which our products
are connected will not have problems with year 2000 issues, since these
networks incorporate hardware and software products supplied by other
companies. We cannot evaluate the readiness of our products for year 2000 with
the innumerable combinations possible with other companies' products. We may,
therefore, face claims or complaints based on year 2000 problems related to our
customers' networks, even when we are not the source of their problem. We are
not aware of any such claims or complaints about us, but we may incur the cost
of legal or other defense and explanation of our product regardless of the
merits of such claims.

 Readiness of Our Systems and Facilities

  Our business may be affected by year 2000 issues. We have completed our
systems updates, upgrades and replacements of non-ready systems. Systems
include internal hardware and software as well as external services provided by
other companies, including contract manufacturing, product development,
information processing and facility services. We are not currently aware of any
unresolved year 2000 problems relating to any of our internal systems. We do
not believe that we have any significant systems that are not year 2000
compliant. The majority of our software, hardware and operating systems have
been acquired as new product in the last two years. Most of it is shrink
wrapped product and is still maintained by existing vendors. We do not believe
that we have any significant systems that contain embedded chips that are not
year 2000 compliant. Most of our hardware is made of branded components and has
been acquired in the last two years from manufacturers which are still in
business. We are not using legacy hardware or software that would be more
likely to have calendar issues because of its age.

 Cost of Product and Internal Systems Preparation

  Based on our assessment to date, we do not expect the total cost of year 2000
preparation and remediation to be material to our business. To date, our
preparation and remediation costs have not been material.

                                       37
Year 2000 Risk

  An internal or external business disruption caused by the year 2000 issue
could interrupt our operations and damage our relationships with our customers.
An internal disruption unique to us could give a comparative advantage to our
competitors. Failure of our internal systems and critical external services to
be ready for the year 2000 could delay order processing, issuing invoices or
development and shipment of products. The cost of recovery from failures could
be significant.

  Our customers' purchasing plans could be affected by year 2000 issues if they
need to expend significant resources to fix their existing systems. This
situation could divert funds and resources otherwise available for new product
purchase. In addition, some customers may wait to purchase our products until
after the year 2000, which may reduce our revenues in the near future.

  We are unable to determine at this time whether these or other year 2000
failures will occur and will have a material impact on our business, results of
operations, or financial condition. This inability is particularly due to the
potential scope of the year 2000 problem on and the inability to assure the
readiness of external service providers, including utilities, government
entities and other vendors. We have not developed, and we have no current plans
to develop in the near future, a contingency plan to deal with the effects of
this worst case scenario.

                                       38
BUSINESS

Overview

  We are a leading provider of server appliances. Server appliances are a new
category of network infrastructure devices that are specifically designed and
optimized to deliver one or a few network-based applications well. Server
appliances differ from general purpose servers, which are designed to support a
broad range of applications and are not optimized for any particular function.
Our server appliances enable organizations that could not previously establish
an online presence to do so easily, cost-effectively and reliably. As the
number of Internet users and businesses online increases, we believe the demand
for server appliances will continue to grow.

  Our principal product lines, the Cobalt Qube and Cobalt RaQ, enable our
customers to perform critical Internet-related applications including file
serving, web hosting and providing software applications over the Internet,
such as electronic mail and electronic commerce. We also offer network-attached
storage products, which provide overflow file storage for network users, and
network caching products, which enable more efficient bandwidth usage and
improve speed of Internet content delivery. Our products tightly integrate the
open source Linux operating system software with applications embedded in
dedicated hardware designs. This software includes a rich set of core
applications developed by us and by the open source software developer
community, as well as proprietary third party applications. Our use of the
Linux operating system enables us to leverage the rapid application development
cycles of the open source software community to reduce the time to market for
our new and innovative products.

  As of July 2, 1999, we had sold over 11,000 appliances to more than 1,000 end
user customers in more than 60 countries. We market and sell our products
globally through our direct sales force and our channel partners. Our target
customers are small- to medium-sized organizations, including businesses,
educational and government entities and branch offices of large organizations.
We also target web hosting and application service providers that offer
outsourced Internet services to these end users.

  Our objective is to become the leading global provider in the emerging market
for server appliances. We intend to increase market acceptance of server
appliances through a focus on providing solutions with a compelling value
proposition to targeted market segments. We intend to continue to encourage
open source and third party software application developers to create and
market software applications for our products through a comprehensive
partnership program. We expect to continue to base our products on industry
standard hardware components and the Linux open source operating system, so
that we can encourage our distributors, original equipment manufacturers and
web hosting and application service providers to sell our products by enabling
them to add value through modification of our solutions for specific customer
needs. We intend to establish Cobalt as the premier server appliance brand for
our target customers and third party application developers.

Industry Background

  The emergence of the Internet as the backbone of electronic commerce and
content delivery has created the opportunity for small- to medium-sized
organizations to significantly expand their market reach. The Internet allows
these organizations to benefit from powerful information technology previously
beyond their economic and technical resources. In order to create an online
presence, these organizations can purchase and deploy their own infrastructure
or rely upon outsourced infrastructure deployed by web hosting and application
service providers that offer services such as electronic mail and electronic
commerce.

  Traditionally, creating an online presence required the deployment of general
purpose servers and complex network technologies. General purpose servers are
designed to perform a large variety

                                       39
of functions including providing database, electronic mail, network management,
file management and application services. However, the high cost of ownership
and the complexity of general purpose servers often prevent their adoption by
small- and medium-sized organizations seeking to deploy their own
infrastructure, due to limited budgets and scarce and costly technology skills.
The high cost and complexity also create challenges for web hosting and
application service providers that seek to profitably differentiate themselves
in an intensely competitive and price sensitive market by offering high value
added services to small- to medium-sized organizations.

  Server appliances have been developed to address the challenges faced by
small- to medium-sized organizations and web hosting and application service
providers in deploying their Internet infrastructures. Because server
appliances are explicitly designed and optimized to provide one or a few
dedicated applications, they can:

  .  be easy to install, use and administer;

  .  be easy to integrate with other infrastructure components;

  .  have a low acquisition price and low total cost of ownership; and

  .  deliver robust and scalable performance on an ongoing basis.

  These benefits enable small- to medium-sized organizations to rapidly and
cost-effectively establish an online presence through the use of server
appliances. These benefits also enable larger organizations to easily
complement their existing general purpose servers by deploying application
specific server appliances and thereby reduce conflicting capacity demands on
their general purpose servers. In addition, these benefits allow web hosting
and application service providers to increase profitability by offering value
added services. In situations that may require the dedication of a single
server to a single customer to provide customized services, server appliances
enable these providers to avoid the high cost and complexity of a general
purpose server infrastructure.

  Server appliances can be developed either with proprietary or open source
operating systems, such as Linux. Open source software uses publicly available
source code that can be copied, modified and distributed by any software
developer with very few restrictions. Unlike proprietary, or closed, software
products whose development is typically controlled by a single company, open
source software is developed by a community of independent developers who
permit others to access their improvements and modifications freely. Open
source software, such as Apache web server, Perl and Sendmail, is gaining
increasing acceptance, particularly among web hosting and application service
providers. Open source software may provide the following benefits to server
appliances:

  .  Better application integration: because the source code is open, server
     appliance vendors may have a better understanding of the interaction of
     all system components, which allows them to more tightly integrate their
     applications with the operating system and improve system stability.

  .  Lower cost base: open source operating systems and software are
     available at no cost and therefore can be incorporated in a system
     without the need for royalty payments or significant internal research
     and development costs.

  .  Shorter development cycles: the collaborative nature of the worldwide
     developer base for open source software enables server appliance vendors
     to improve their products more quickly than they can improve products
     based on proprietary operating systems.

  Dataquest, an industry research firm, expects the server appliance market to
grow from $2.2 billion in 1999 to approximately $15.8 billion in 2003,
representing a 64% compound annual growth rate. Dataquest believes that server
appliances based on open source operating systems, including

                                       40
Linux, will be a significant market segment. Dataquest expects the Linux-based
server appliance market to grow at approximately 69% a year between 1999 and
2003 and represent approximately 24% of the total server appliance market, or
$3.8 billion, in 2003. The web hosting and application service provider market
represents an important part of the overall server appliance market
opportunity. Forrester Research estimates that Internet hosting revenues will
increase from approximately $2.0 billion in 1999 to approximately $14.6 billion
by 2003.

  In response to the growth and opportunities in the server appliance market,
several server appliance vendors have emerged. However, many of the server
appliances available today do not deliver fully on the promise of the benefits
of server appliances. Some of these server appliances use closed, proprietary
architectures that restrict users' abilities to integrate them with other
applications and services. In order to achieve ease of use and low cost, others
offer systems that are not easily scalable or offer insufficient power to
adequately perform the functions for which they were designed. In addition,
server appliances offered by more established server vendors are typically
scaled down versions of their general purpose servers that fail to achieve an
optimal mix of low cost, ease of use, scalability, openness and performance.
Finally, some general purpose server vendors have long-standing relationships
with third party operating system and application vendors that may limit their
ability to aggressively pursue the opportunity for open source based server
appliances.

The Cobalt Solution

  We are a leading provider of a new category of network infrastructure devices
known as server appliances. Our products deliver network-based applications in
a flexible and reliable manner that is simpler and more cost-effective than
other current solutions. Our server appliances tightly integrate a version of
the Red Hat Linux operating system that we have optimized for our products, a
rich set of core applications which have been developed by us and the open
source software developer community, and industry-standard hardware components.
We believe that we are well positioned to become the leading provider of server
appliance solutions for small- to medium-sized organizations and web hosting
and application service providers by offering the following advantages:

 Complete, integrated solutions

  Our products provide our customers with complete solutions that do not
require additional hardware or software to cost-effectively deliver the
specific applications for which the product is designed. Our use of open source
software and industry standard hardware enables us to fully understand the
interaction of all components of the system and design a more tightly
integrated solution. In addition, our products provide significant advantages
over other servers based on open source operating systems that are not designed
to fully integrate the applications and operating system to perform a specific
function. The tight integration of our software applications, operating system
and hardware results in a more reliable and stable product that is less likely
to cause disruptions in network services. This integration also enhances the
security of our solutions and enables us to optimize the hardware design in a
cost-effective manner.

 Ease of installation and use

  Our products are pre-configured and include a simple set up procedure
designed to require less than 15 minutes for deployment by a non-technical
person. In addition, our products are easy to use, can be administered from any
Internet-accessible location and require minimal space and power. Our web-based
user interface shields the user from technical complexities and minimizes the
need for trained information technology staff.

                                       41
Low cost of ownership

  We design our server appliances to deliver robust performance at a
significantly lower installed cost than general purpose servers. We can sell
our products at lower prices because our operating systems are based on
royalty-free open source software, and we avoid the use of unnecessary hardware
components by optimizing our products to perform a specific function. Our
products require limited skills and time to deploy and do not require a network
shut-down to install or add additional appliances. In addition, the software
tools included in our products minimize ongoing system management and support
efforts that would otherwise be provided by trained information technology
staff, thus greatly reducing the appliances' lifetime cost of ownership.

 Building blocks for future growth

  As the amount of data traffic handled by a Cobalt server appliance increases,
additional units can be added to increase capacity at little incremental
expense beyond the cost of the units themselves. The ability to easily add
additional server appliances provides an evolution path that allows customers
to develop their network infrastructure according to their needs without a high
upfront investment. Our low cost server appliances are designed to be building
blocks for scalable solutions. We are developing a software tool to enable our
Cobalt RaQ products to interoperate in a fully scalable fashion. We expect this
software tool to be released in early 2000.

 Stable, open source development environment

  Our products use a version of the Red Hat Linux operating system, an open
source operating system that undergoes a continuous cycle of enhancement by a
global community of open source developers. We optimize Red Hat Linux for our
server appliances by eliminating large portions of general purpose source code
that is unnecessary for a dedicated server appliance and tailoring the
remaining source code to work effectively with our dedicated hardware. Our open
source operating system is tightly integrated with our hardware components to
provide a reliable and stable environment upon which we and third party
developers can develop applications with a rapid time to market. In addition,
because our source code is royalty free and open, we believe our products will
attract a large community of third party application developers. We enjoy the
benefits of our optimizations exclusively for a short period of time, then
publish them for further enhancement by the open source development community.

 Cross platform compatibility

  Our products employ an Internet standards-based architecture that enables
them to function with other network devices that operate on a variety of
operating systems, including Windows NT and UNIX. By being cross platform
compatible, our products enable our customers to realize the benefits of our
products as part of their existing network infrastructure.

The Cobalt Strategy

  Our objective is to become the leading global provider in the emerging market
for flexible, low cost server appliance products. To accomplish our objective,
the key elements of our strategy include:

 Increase Market Acceptance of Server Appliances

  We intend to increase market acceptance of server appliances through a focus
on providing solutions with a compelling value proposition to targeted markets.
We intend to continue to offer products that complement general purpose servers
by removing one or more specific, resource

                                       42
intensive functions from a network's general purpose server to improve network
performance and stability. Our approach to increase market acceptance of server
appliances is to:

  .  Add new applications. We intend to continue to deliver high value
     results with application specific products. Our current proprietary
     applications include solutions for web hosting, electronic mail, web
     publishing, electronic commerce, file management and network services.
     We intend to leverage this experience to expand the scope of our
     software applications to address other specific needs of our target
     customers. In addition we will continue to integrate third-party
     applications into our products.

  .  Simplify management. We intend to further enhance the ease of use and
     reliability of our products. For example, we are working to develop a
     management tool that enables outsourced hosting and application service
     providers to manage, troubleshoot and monitor a number of server
     appliances from a single console.

  .  Add new hardware designs. We intend to continue to develop hardware
     designs that address our customers' specific needs. We expect to
     continue to rapidly introduce innovative, new products with enhanced
     functionality that incorporates customer feedback and demands.

  .  Continue to offer low prices. We expect to continue to offer our server
     applications at low cost by using readily available standard hardware
     components and leveraging a royalty-free Linux-based operating system.

  .  Enable partners to add value. We intend to continue to design our
     products with our open source operating system and application
     interfaces to allow channel partners to add value through software
     applications that they sell with our products. This design strategy will
     also enable web hosting and application service providers to provide
     value added services.

 Attract and support application developers

  Ensuring the existence of a rich set of software applications is a vital
requirement for offering complete, tightly integrated solutions and driving the
success of our server appliances. We intend to actively promote third-party
development of software applications for our products through a comprehensive
partnership program with independent, open source software developers. We
believe that our use of the Linux operating system is a fundamental element of
this program, since an open source operating system better enables developers
to create optimized and reliable high value added applications. We believe
there are currently over 40 applications developed by third parties for our
product platform. We intend to leverage our position in the Linux community in
order to expand upon the base of third party developers for our products
significantly by providing a high volume channel for their Internet and
electronic commerce applications. In order to encourage the continued growth of
the Linux community, we will continue to give back to the community those
elements of source code that we write that are relevant to the Linux kernel,
while still developing a proprietary base of intellectual property.

 Develop and leverage partnerships to enhance our market reach

  We base our products on industry standard hardware components and our open
source operating system to encourage channel partners, original equipment
manufacturers and web hosting and application service providers to add value by
modifying our solutions to address specific needs of our customers. Our
leveraged distribution strategy includes:

  .  Multi-tier sales channel. We believe that a highly leveraged sales
     channel is critical for effectively penetrating our target markets. We
     make it attractive for our distribution, reseller and system integrator
     partners to resell our solutions by maximizing the opportunity for them
     to add value to our products. In order to effectively reach small- to
     medium-sized

                                       43
businesses, we intend to continue to enter into agreements with many of
     the world's leading distributors, resellers and system integrators. We
     also intend to continue to expand our sales channel globally, while
     strengthening our direct sales efforts in key geographies where use of
     the Internet is growing most rapidly.

  .  Web hosting and application service providers. We intend to promote the
     sale of our products by leveraging our relationships with outsourced,
     dedicated web hosting and application service providers. We believe our
     highly-focused approach to serving this market provides us with an
     advantage over competitors. Through our direct sales model we have
     developed relationships with many of the prominent web hosting and
     application service providers that are competing effectively by offering
     higher revenue, value added application and hosting services. We expect
     to leverage our leadership in this market by assisting our customers to
     market to their customers.

  .  Original equipment manufacturer partnerships. We also intend to enter
     into original equipment manufacturer partnerships. Our growing presence
     in the server appliance market makes us an appealing partner for general
     purpose server vendors. We intend to form strategic partnerships with
     original equipment manufacturers for our products in order to rapidly
     expand our market reach and become the technology provider of choice for
     server appliances.

 Establish a strong brand identity

  We intend to establish Cobalt as the premier server appliance brand for our
target customers and third party application developers. We intend to continue
to create brand awareness with innovative, award winning products, progressive
product styling and creative marketing. We believe that this distinctive brand
identity is an important component of our efforts to increase market
acceptance of server appliances, expand participation in our software
development program and develop our reputation within a broad community of
potential partners and customers. We intend to actively seek new opportunities
to refine and extend our brand recognition.

 Provide focused server appliances for specific needs

  We intend to continue to develop and release products that meet specific
customer needs while retaining their relatively low prices and optimized
functionality in comparison to both general purpose servers and other server
appliances. For example, our Cobalt Qube and Cobalt RaQ products are available
with a user interface in the Japanese language, and we are developing several
other language specific user interfaces. Our Cobalt RaQ products are designed
specifically to minimize space usage, because more effective use of rack space
in a service provider's facility can increase the number of customers that the
service provider can host from a single facility. Our target customers are
small- to medium-sized organizations, including small- to medium-sized
businesses, educational and governmental entities and branch offices of large
organizations. We also target the web hosting and application service
providers that offer outsourced Internet services to these end users.

Products

  All of our products are built on a common core software and hardware
architecture that enables us to develop and market new products rapidly. We
have introduced 16 products based on our four principal product lines in the
last 18 months. Our products are based on the Linux operating system, an
operating system known for its high reliability, performance, scalability,
customizability and low memory requirements. We have optimized the Red Hat
Linux operating system to improve the functionality and reliability of our
products. We have invested in the development of proprietary technology for
our products that includes core applications, software toolkits, management
tools, system maintenance daemons and clustering technologies.

                                      44
We also have an application developer program through which we encourage
third-party software developers to create additional software applications for
our products. Examples of those applications are electronic commerce engines, a
medical imaging file server program and a cellular telephone voicemail server
program. We believe that end users will benefit from our open source model by
having many additional applications available to them. We provide the relevant
portions of our source code to third party software developers to assist them
in creating applications that are closely integrated with our products'
operating systems, applications and hardware. We provide other assistance to
application developers including telephone support, electronic mail bulletin
boards and a web site. We believe that there are currently more than 40
applications that have been developed by third parties for our products. We
believe that other third party applications for our products are currently in
development.

  The following table reflects our product lines:
Date of First    Starting
 Product Line  Commercial Sale  List Price               Function
 ------------  ---------------  ----------               --------
Cobalt Qube   March 1998         $  999   Small- to medium-sized organizations
               (1st generation)             can use these products for
                                            dedicated functions such as
               January 1999                 electronic mail, file servers and
               (2nd generation)             print servers or to provide
                                            Internet access and web serving. We
                                            introduced a Japanese language user
                                            interface for the Cobalt Qube in
                                            May 1998.

 Cobalt RaQ    September 1998     $1,299   Web hosting and application service
               (1st generation)             providers can use our Cobalt RaQ
                                            products for dedicated hosting
               March 1999                   services. The compact design of the
               (2nd generation)             product is intended to facilitate
                                            its use in standard size networking
                                            facility racks. We introduced a
                                            Japanese language user interface
                                            for this product in December 1998.
 Cobalt Cache  July 1998          $1,899   Customers can use our Cobalt
               (1st generation)             CacheQube and CacheRaQ products to
                                            provide faster web response time
               April 1999                   and eliminate redundant traffic
               (2nd generation)             travelling over wide area network
                                            links. These products are targeted
                                            at markets where bandwidth is at a
                                            premium and public communications
                                            networks are less developed.
 Cobalt NAS    April 1999         $1,799   Customers can use the Cobalt NASRaQ
                                            to add storage to an existing
                                            network. For users of the network,
                                            the Cobalt NASRaQ appears to be
                                            another hard drive.
Industry Recognition of Our Products

  Our Cobalt Qube products have received recognition for their innovation and
quality, including the following industry awards:

  .  ""Best of Show", Showcase, January 1999

  .  ""Innovation of the Year", PC Computing, November 1998

  .  ""Most Valuable Product Award--Small Business Server Category", PC
     Computing, November 1998

                                       45
.  ""Editor's Choice", PC Magazine, July 1998

  .  ""Best New System Hardware", VARVision industry show, Spring 1998

  .  ""Best of Show", VARVision industry show, Spring 1998

  .  ""Best New Hardware Product", Reseller XChange, March 1998

  .  ""Best of Show", Reseller XChange, March 1998

  In addition, our other products have received industry awards including the
following:

  .  The Cobalt RaQ for "Best Security", Internet World industry show, July
     1999

  .  The Cobalt CacheRaQ for "Editor's Choice", Network Computing, May 1999

  .  The Cobalt CacheQube for "Best of Show for Infrastructure Hardware",
     Internet World industry show, July 1998

Technology

  We have invested in developing proprietary technology for our products that
includes our core operating system, core applications, software toolkits,
management tools, system maintenance daemons and clustering technologies.

 Core Operating System

  Our products are based on the Linux operating system, an operating system
known for its high reliability, performance, scalability, customizability and
low memory requirements. We recognize the many benefits that an open source
operating system, such as Linux, provides for the development of server
appliances. Linux is open source software that is constantly being improved by
a broad base of developers without requirements for royalty obligations to the
developers. We can customize existing Linux operating system applications or
adopt different versions of Linux without lengthy product transitions. We have
free access to the entire Linux source code and have modified Red Hat's version
of the Linux operating system to optimize it for use in our products.

 Core Applications

  Our server appliances offer a rich set of core applications such as web
serving, domain name serving, file transfer protocol, electronic mail,
discussion groups and web authoring. We provide integrated and optimized
royalty-free industry standard software such as Apache, a web serving software,
BIND, a file serving application, Perl, a scripting language for web site
development, and Sendmail, an electronic mail program. We also provide our
internally developed software for discussion groups and web page authoring as
integrated features of our Cobalt Qube and Cobalt RaQ products. We are
investing significant resources in deploying, testing and tightly integrating
these diverse applications with consistent, user friendly interfaces.

 Software Toolkit

  We have developed and are continuing to enhance a proprietary software
toolkit that provides a consistent interface between the applications and the
operating system. Our software toolkit enables us to provide uniform browser-
based user interfaces across all server functions and applications. Our custom
software toolkit overcomes the complexity generally associated with setting up,
managing, monitoring and using various complex network daemons and
applications. We intend to continue to develop and improve interfaces to our
software to assist third parties such as web hosting and application service
providers and value added resellers to add software applications to our
platform.

                                       46
System Maintenance Daemons

  To improve reliability and reduce cost of ownership of our server appliances,
we have developed a set of software daemons, which are software programs that
continuously monitor the state of the various software and hardware functions
on the server to permit troubleshooting. Our system maintenance daemons
automatically inform the user of excessive server resource utilization and
recommend corrective action. Our system maintenance daemons also attempt to fix
any problems automatically that the software detects and proactively inform the
user if an attempted solution was unsuccessful. The proactive problem
resolution enhances the overall reliability of the appliance while reducing
management overhead. Our products also support industry standards including
Simple Network Management Protocol.

 Clustering Technologies

  Our products incorporate our proprietary clustering technologies that
distribute network usage across a number of server appliances for improved
network performance. These technologies allow our server appliances to be
clustered without using expensive load balancing equipment. For example, these
technologies enable a user to deploy additional Cobalt CacheRaQ units as needed
to support increased network usage.

 Management Tools

  We have several management tools, such as our maintenance and restore
toolkit, that assist the user to perform maintenance and administrative tasks
on our server appliances. In addition, we are developing a web-based remote
management tool for monitoring the status and configurations of a large number
of our server appliances on a single network. In addition, this management
software will allow systems administrators to provide software upgrades to
multiple server appliances and configure multiple machines from a single
management console in an easy to use and cost effective manner.

 Embedded Processor Hardware Platform

  We enable our products to deliver high performance cost effectively through
our proprietary hardware and motherboards that leverage standard components
including hard disk drives, memory and processors. We have eliminated
unnecessary components, thus reducing cost and power consumption and increasing
reliability. With the compact size of our Cobalt RaQ products, our service
provider customers are able to achieve three to four times the server density
of general purpose servers, a key advantage in the web hosting and application
service provider market where rack space is at a premium.

Customers

  As of July 2, 1999, we had sold more than 11,000 of our server appliance
products to more than 1,000 end user customers in over 60 countries. Our direct
customers include regional and national web hosting and application service
providers in the United States, in addition to our channel partners. Our
indirect customers are primarily composed of small- to medium-sized
organizations and web hosting and application service providers. With respect
to both our direct and indirect sales, customers often buy for a single
location, department or division, and then, based upon the initial success of
the products, later expand their use of our products into other parts of the
organization. In 1998 and the six months ended July 2, 1999, no single end user
customer accounted for more than 10% of our revenues.

Sales and Marketing

  We sell our products through our direct sales force and channel partners
including distributors, resellers and system integrators. Historically our
direct sales efforts have focused on regional and

                                       47
national web hosting and application service providers in the United States. We
intend to continue and expand our sales efforts to web hosting and application
service providers. We also intend to pursue sales to the growing number of web
hosting and application service providers outside of the United States. We have
relied on original equipment manufacturers for only a limited number of sales,
but we intend to explore opportunities to work with additional original
equipment manufacturers in the future.

 Direct Sales

  The primary function of our direct sales force is to generate demand for our
products that is fulfilled either directly or through channel partners. As of
July 2, 1999, we had a direct sales organization of 13 persons. We encourage
our direct sales staff to work with potential web hosting and application
service provider customers regardless of whether the customer ultimately
purchases our product from us or one of our channel partners. We believe this
model enables us to encourage proliferation of our products in this key
customer group. Our direct sales force uses a team approach, which we believe
allows us to achieve better control of the sales process and respond more
rapidly to customer needs. Our direct sales force for North America is
distributed throughout the United States. In 1998 and the six months ended July
2, 1999, respectively, 46% and 14% of our net revenues were from direct sales,
substantially all of which was from the United States.

  We opened sales offices in Japan, the United Kingdom and Germany in 1998.
During the six months ended July 2, 1999, we established direct sales
activities in the Netherlands. Although 44% and 56% of our net revenues were
from outside the United States in 1998 and the six months ended July 2, 1999,
respectively, almost all of our direct revenues were from the United States.

 Channel Partners

  As the server appliance market has matured, we have developed a multi-tier
sales channel that is comprised of distributors, resellers and system
integrators. Our channel consisted of over 250 partners in 30 countries as of
July 2, 1999. We believe that as the market for server appliances matures,
sales through channel partners will represent an increasing percentage of our
sales.

  Sales to our channel partners represented 86% of our net revenues in the six
months ended July 2, 1999. Channel partner sales in the United States and
outside the United States were approximately 45% and 41% of net revenues,
respectively, in the six months ended July 2, 1999. Our top five channel
partners based on net revenues in the six months ended July 2, 1999 were:
Ingram Micro    Nissho Electronics (Japan)
   Merisel         Tech Data
   Mitsui (Japan)
In addition to delivering our server appliances to small web hosting and
application service providers and small- to medium-sized organizations,
distributors enable us to more effectively pursue a number of vertical markets.
Vertical markets and applications such as branch offices of large
organizations, government, education and web-based direct resellers are targets
of our channel partners.

                                       48
Original Equipment Manufacturers

  We recently began utilizing original equipment manufacturers in our selling
efforts. We have initiated several original equipment manufacturer
relationships for our Cobalt Qube products. We plan to expand our selling
efforts through original equipment manufacturers and are currently evaluating
opportunities, particularly with respect to sales of our Cobalt Qube products.

 Marketing Programs

  To support our growing sales organization and channel, we have devoted
significant resources in the past year to building and launching a series of
marketing campaigns. Our marketing efforts have included a number of programs,
such as seminars, industry trade shows, mailings to resellers, analyst and
press tours, print and online advertising and public relations. We believe
these marketing programs have resulted in better awareness of our Cobalt brand.

  In March 1999, we announced the launch of a two-tier distribution marketing
program. Our True Blue Partner and True Blue Sapphire Partner programs are for
web hosting and application service providers that resell a specified number of
Cobalt products. These web hosting and application service providers resell our
products for dedicated web hosting with our marketing support. We have similar
True Blue and True Blue Sapphire programs for value added resellers. In
addition to partner development activities, we also actively work on end user
education.

 Customer Advocacy and Support

  We believe that high quality customer service and support is critical to the
successful marketing and sale of our products. We are developing a
comprehensive service and support organization to manage customer accounts and
expect to provide an increasing level of support as our products are deployed
across a range of customers. We provide support for our products and services
primarily from our Mountain View, California location. We plan to establish
additional service and support sites internationally commensurate with customer
needs.

  Our products are designed to be deployed quickly and effectively by our
customers and to require minimal support from us. We offer various levels of
service and support programs to meet pre- and post-sale technical requirements.
Our CobaltCare program offers extended warranties, advanced product
replacement, telephone and electronic mail trouble shooting assistance and
other support and services. We price our CobaltCare variably depending on the
level of support selected by the customer. We also offer a variety of services
specifically tailored for web hosting and application service providers and
resellers that provide immediate access to the latest support information,
white papers and answers to frequently asked questions.

Manufacturing

  We use contract vendors to manufacture our products, and they perform tasks
that include material procurement, assembly, test, packaging, warehousing and
shipment. Utilizing a contract manufacturer enables us to reduce investment in
manufacturing capital and inventory warehousing costs. Our internal
manufacturing expertise is primarily focused on product testability,
manufacturability and the transfer of products from development to
manufacturing. However, we also manage the evaluation and selection of certain
key components.

  In August 1999, we changed our contract manufacturer to SMTC Manufacturing.
We also use Flash Electronics to a lesser extent. Our agreement with SMTC
Manufacturing requires us to submit three months of rolling purchase orders and
rolling forecasts for the three months immediately following the purchase order
period. In any given month we have the ability to double

                                       49
our forecast and require them to fill those orders. However, if we inaccurately
forecast demand for our products, SMTC Manufacturing may be unable to provide
us with adequate manufacturing capacity. Purchase prices will fluctuate based
on changes in component prices throughout the one year contract period.
However, SMTC Manufacturing is obligated to reduce certain component costs by a
fixed percentage in each quarter. We may be liable for materials that SMTC
Manufacturing purchases on our behalf that we cannot use, cannot be cancelled
before receipt or are unique parts otherwise unusable by SMTC Manufacturing.
The agreement restricts our ability to reschedule orders and allows us to
cancel existing orders subject to penalties of up to the total purchase price.
SMTC Manufacturing provides warranties on workmanship and pass-through
warranties on component parts.

  SMTC Manufacturing purchases most of the key components used to manufacture
our products. We obtain some of these key components, such as our custom
printed circuit boards, sheet metal parts and chassis, directly from sole
sources and other industry standard components, such as our processors and
power supplies, from sole or limited sources. SMTC Manufacturing may not be
able to obtain adequate supplies of components to meet our customers' delivery
requirements. Alternatively, excess inventories may be accumulated by SMTC
Manufacturing for our account.

  In order to reduce the costs of sales, we anticipate that we may relocate a
portion of our manufacturing operations from SMTC Manufacturing's manufacturing
facility in Milpitas, California to one of its offshore manufacturing
facilities during 2000. Additionally, we may consider moving the outsourced
manufacturing to other new locations or to a new contract manufacturer. These
relocations could be time consuming and expensive and there can be no assurance
that such moves would not disrupt the manufacturing of our products. Such
disruptions could cause us to lose net revenues and damage our customer
relationships.

  Prior to August 1999, our primary contract manufacturer was an electronics
component supply chain company that procured materials and subcontracted the
assembly, test, packaging and shipment of our products to a subcontract
manufacturer. This contract manufacturer experienced difficulty in obtaining
selected components and coordinating with the subcontract manufacturer for the
manufacture of our products in the quarter ending July 2, 1999. We resolved
this difficulty in the quarter ended July 2, 1999 by internally managing
procurement of specified components and qualifying and commencing production of
our products with a second contract manufacturing partner, Flash Electronics,
in May 1999. We subsequently switched to SMTC Manufacturing as our primary
contract manufacturer in August 1999.

  As our needs and the needs of our customers continue to evolve, we plan to
reassess our manufacturing requirements on a periodic basis and address changes
as we consider necessary.

Research and Development

  Our research and development expenses were $1.1 million in 1997, $3.5 million
in 1998 and $2.8 million in the six months ended July 2, 1999. We believe that
our research and development efforts are essential to our ability to deliver
innovative products that address the needs of the market and help evolve the
capabilities of server appliances. As of July 2, 1999, our staff included
personnel with expertise in several key areas, including 22 people engaged in
software-related activities, 9 people engaged in hardware-related activities
and 3 people involved in other research and development activities.

  We recognize the need to integrate new and enhanced technologies into our
products and to continue to extend the open architecture of our products' Linux
operating system. In addition to the

                                       50
development of proprietary core technologies, we plan to continue partnerships
with other leading providers of Linux technologies, products and services to
jointly develop architectures and industry standards.

Competition

  We compete in markets that are new, intensely competitive, highly fragmented
and rapidly changing. We face competition primarily from server vendors that
provide solutions for distributed computing systems.

  Companies offering competitive products vary in scope and breadth of products
and services offered and include:

  .  general purpose server manufacturers such as Compaq Computer,
     Dell Computer, Hewlett-Packard Company, IBM, Sun Microsystems and VA
     Linux, some of which, including Compaq, IBM and Sun Microsystems, have
     recently begun manufacturing dedicated versions of their general purpose
     server products for sale as server appliances;

  .  server appliance vendors such as Encanto Networks, Freegate, Intel and
     Whistle Communications (recently acquired by IBM);

  .  network caching companies such as CacheFlow and Novell; and

  .  network attached storage vendors such as Meridian (recently acquired by
     Quantum) and Network Appliance.

  We believe we compete favorably on the principal factors that will draw end
users to a server appliance product, which include:

  .  depth of product functionality;

  .  ability to work with network components utilizing other operating
     systems such as Windows NT;

  .  scalability;

  .  product quality and performance;

  .  open systems architecture;

  .  strength of channel;

  .  brand name recognition;

  .  competitive pricing; and

  .  customer support.

  We expect competition in the server appliance market to increase
significantly as new companies enter the market and current competitors expand
their product lines and services. Many of these potential competitors are
likely to enjoy substantial competitive advantages including:

  .  greater resources that can be devoted to the development, promotion and
     sale of their products;

  .  more established sales channels;

  .  greater software development experience; and

  .  greater name recognition.

Intellectual Property

  We have invested significantly in the development of proprietary technology
for our products. Key areas of intellectual property development relate to the
tight integration of embedded software with industry standard platforms and
components, intuitive user interfaces that provide easy to use

                                       51
appliance functionality and clustering technology. Our success depends
significantly upon our proprietary technology. Additionally, we have integrated
third party intellectual property into our products. We may occasionally reach
agreements with third parties to provide additional functionality for our
products and may offer third parties our technology for integration into
products on an original equipment manufacturer or other basis. We have also
trademarked the Cobalt name as well as our individual product names in the
United States and are evaluating trademark registration in certain
international markets.

  We currently rely on a combination of copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights. We protect our software, documentation and other written
materials under trade secret and copyright laws, which afford only limited
protection. We do not hold any patents and currently have no patent
applications pending. We cannot be certain that any patents we seek will be
issued or that, if issued, those patents will not be challenged. We have
registered and applied for registration of some of the service marks and
trademarks we use with the appropriate state agencies and the United States
Patent and Trademark Office. We will continue to analyze whether we should
register additional service marks and trademarks.

  We generally enter into confidentiality agreements with our employees,
consultants, business partners and major customers. Despite our efforts to
protect our proprietary rights and other intellectual property, unauthorized
parties may attempt to copy aspects of our products, obtain and use information
that we regard as proprietary or misappropriate our copyrights, trademarks,
trade dress and similar proprietary rights. In addition, the laws of some
foreign countries do not protect proprietary rights to as great an extent as do
the laws of the United States. Our means of protecting our proprietary rights
may not be adequate. In addition, our competitors might independently develop
similar technology or duplicate our products or circumvent any patents or our
other intellectual property rights.

  Cobalt, Cobalt Networks, the Cobalt logo, Cobalt Qube, Cobalt RaQ, Cobalt
NASRaQ, Cobalt CacheRaQ and RaQ are trademarks of our company. This prospectus
also contains brand names, trademarks or service marks of companies other than
Cobalt, and these brand names, trademarks and service marks are the property of
their respective holders.

Employees

  As of July 2, 1999, we had 101 full time employees, of whom 34 were engaged
in research and development, 44 in sales and marketing and 23 in finance,
administration and operations. None of our employees is represented by a labor
union. We have not experienced any work stoppages and consider our relations
with our employees to be good.

Facilities

  Our principal offices are located in a 28,000 square foot facility in
Mountain View, California. Our lease on the Mountain View facility expires in
December 2003. We expect that we will need additional space in the next twelve
months and have obtained an option to lease a 30,000 square foot facility
contiguous to our current facility to expand our Mountain View operations. We
also have sales and marketing offices in Germany, Japan, the Netherlands and
the United Kingdom. None of the leases for those offices is for a period of a
year or longer.

Legal Proceedings

  In December 1998, CUBE Computer Corporation sued us in the United States
District Court for the Southern District of New York for trademark
infringement. CUBE, an original equipment manufacturer of personal computers,
argues that this alleged infringement resulted from our use of "Qube" in
connection with our products. We intend to defend this matter vigorously. We
believe, based on currently available information, the resolution of this
matter will not adversely affect us.

                                       52
MANAGEMENT

Executive Officers and Directors

  Cobalt's officers and directors and their ages as of July 2, 1999 are as
follows:
Name             Age                   Position
            ----             ---                   --------
Gordon A. Campbell.........  55 Chairman of the Board
                                 Chief Executive Officer, President and
 Stephen W. DeWitt..........  33 Director
                                 Chief Technology Officer and Vice President,
 Vivek Mehra................  35 Products
 Gary A. Martell............  36 Chief Operating Officer
                                 Vice President, Finance, Chief Financial
 Kenton D. Chow.............  34 Officer and Secretary
                                 Vice President, Sales, Americas and Asia
 Patrick J. Conte...........  40 Pacific
 Mark H. Orr................  49 Vice President, Business Development
 George M. Korchinsky.......  58 Vice President, International Sales
 Kelly M. Herrell...........  33 Vice President, Marketing
 Jordan A. Levy.............  43 Director
Gordon A. Campbell, one of our co-founders, has served as our Chairman and a
director since October 1996. Mr. Campbell has been a managing member of
TechFund Capital, a venture capital fund, since August 1997. In 1993, Mr.
Campbell created Techfarm Management, Inc., an incubation company for new
technology companies including Cobalt Networks. Mr. Campbell has founded and
been involved in the start-up of numerous Silicon Valley companies, including
3Dfx Interactive, a semiconductor graphics company, and CHIPS and Technologies,
Inc., a semiconductor and related device company. In addition to his role at
Cobalt Networks, Mr. Campbell serves as chairman of the board of 3Dfx
Interactive and is a member of the boards of directors of 3Com Corporation, a
network infrastructure company, and Bell Microproducts, a computer components
company.

  Stephen W. DeWitt has served as our President and Chief Executive Officer
since February 1998. Prior to joining Cobalt, Mr. DeWitt was Vice President and
General Manager of the Enterprise Network Management Business Unit at Cisco
Systems, a network infrastructure company, from January 1997 to February 1998.
Mr. DeWitt also served as Vice President of Enterprise Marketing for Cisco from
January 1996 to February 1997. From September 1994 to January 1996, he was Vice
President of Marketing for Symantec Corporation, a system utilities,
development tools, and contact management software company. From June 1992 to
September 1994, Mr. DeWitt served as General Manager of Symantec's Canadian
subsidiary. Mr. DeWitt holds a Bachelor of Science in Finance and Economics
from Babson College in Wellesley, Massachusetts.

  Vivek Mehra, one of our co-founders, has served as our Chief Technology
Officer since September 1999 and as our Vice President of Products since
November 1996. Mr. Mehra leads our engineering and product management teams.
Mr. Mehra also served as one of our directors from October 1996 to August 1999.
From January 1992 to November 1996, Mr. Mehra was a senior architect and
systems engineering manager at Apple Computer, a computer design and
manufacturing company. From March 1991 to January 1992, Mr. Mehra was a
developer at Silicon Graphics, a high performance workstation company. From
July 1988 to March 1991 Mr. Mehra served as a principal engineer for ASIC and
Board Design at Digital Equipment Corporation, a computer maker that is now a
division of Compaq Computer. Mr. Mehra holds a Bachelor of Science in
Electronics and Electrical Communications from Punjab University, India and a
Master of Science in Computer Engineering from Iowa State University.

  Gary A. Martell has served as our Chief Operating Officer since July 1999.
From February 1988 to July 1999, Mr. Martell served as Chief Financial Officer
and Senior Vice President of Operations at Wyse Technology, a computer hardware
company. Mr. Martell holds a Bachelor of Science in Finance and Computer
Science from the University of Massachusetts at Amherst.

                                       53
Mark H. Orr, a co-founder of our company, has served as our Vice President of
Business Development since October 1998. Mr. Orr served as our Vice President
of Marketing and Business Development from March 1997 to September 1998. From
August 1994 to February 1997, Mr. Orr served in various capacities at Apple
Computer, including most recently as a business development manager. Mr. Orr
holds a Bachelor of Science in Mathematics from the University of Washington
and a Masters of Business Administration from the Stanford University Graduate
School of Business.

  Kenton D. Chow has served as our Vice President of Finance and Chief
Financial Officer since April 1998 and as our Secretary since September 1999.
From October 1996 to January 1998, Mr. Chow served as the Director of Finance
at OpenTV, Inc., an interactive software developer for digital television. From
January 1995 to October 1996, Mr. Chow served as Controller, Worldwide Sales of
Symantec Corporation. Mr. Chow served as Senior Manager, Financial Reporting at
Bay Networks, Inc., a networking company, now part of Nortel Networks, from
November 1991 to January 1995. Prior to that time, Mr. Chow was a Senior
Associate at PricewaterhouseCoopers LLP. Mr. Chow is a certified public
accountant. He holds both a Bachelor of Science in Finance and a Masters of
Business Administration from Santa Clara University.

  Patrick J. Conte has served as our Vice President of Sales Americas and Asia
Pacific since July 1999. From October 1998 to June 1999, Mr. Conte served as
our Vice President of Sales and Marketing. Mr. Conte served as Vice President
of Sales and Channel Marketing for Dynamic Pictures, a graphics company, from
January 1997 to September 1998. From April 1995 to December 1996, Mr. Conte
served as Vice President of Sales, Americas for Wyse Technology. Prior to that
time, Mr. Conte was Director, OEM Sales with Wyse Technology from October 1994
to March 1995. Mr. Conte holds a Bachelor of Science in Political Science and
History from James Madison University and a Masters of Arts in Political
Science from Northern Illinois University.

  George M. Korchinsky has served as our Vice President of International Sales
since July 1998 and is based in offices in the Netherlands. Mr. Korchinsky
served as a vice president of sales for Europe, the Middle East and Africa at
Aurora Electronics, from October 1996 to May 1998. From May 1991 to October
1996, Mr. Korchinsky served as a vice president of sales for Europe, the Middle
East and Africa at Symantec. Prior to that time, Mr. Korchinsky served in
various capacities at Cognos Limited, Paradyne Corporation and IBM. Mr.
Korchinsky is currently a member of the board of DataCore Ltd., a United
Kingdom software company. Mr. Korchinsky holds a Bachelor of Science in
Mechanical Engineering from University of Alberta.

  Kelly M. Herrell has served as our Vice President of Marketing since July
1999. Prior to joining our company, Mr. Herrell served as Vice President of
Marketing at CacheFlow, Inc., a caching products company, from September 1997
to May 1999. Mr. Herrell served as a Senior Director of Marketing at Oracle
Corporation from September 1996 to September 1997. Prior to that time, Mr.
Herrell acted as Director of Strategy for NCR Corporation from January 1995 to
September 1996. Mr. Herrell was also a Senior Marketing Manager at AT&T Global
Information Systems from January 1993 to January 1995. Mr. Herrell holds a
Bachelor of Arts from Washington State University and a Masters of Business
Administration from Cornell University.

  Jordan A. Levy has served as one of our directors since July 1998. Mr. Levy
was a co-founder, and from July 1990 to October 1998, the President and Co-
Chief Executive Officer of Softbank Services Group, previously Upgrade
Corporation of America, an outsourcing services company specializing in
providing call center services for technology companies. From September 1988 to
February 1990, Mr. Levy served as an Executive Vice President and Chief
Operating Officer of Software Etc. Inc. Mr. Levy is a co-founder of Ingram
Software, now known as Ingram Micro, and served as an Executive Vice President
from February 1982 to August 1988. Mr. Levy also sits on the boards of the
Rights Exchange, Inc., a producer of software applications for the metering,
sale and distribution of digital products, GT Interactive Software, a publisher
of entertainment software, and

                                       54
Client Logic Corp., where he also serves as Vice Chairman of the board of
directors. Mr. Levy holds a Bachelor of Arts in Political Science from the
State University of New York at Buffalo.

  Our board of directors currently consists of three members. Prior to the
closing of this offering, our board of directors will be divided into three
classes, with each director serving a three-year term and one class being
elected at each year's annual meeting of stockholders. Mr. DeWitt will be in
the class of directors whose initial term expires at the 2000 annual meeting of
stockholders. Mr. Campbell will be in the class of directors whose initial term
expires at the 2001 annual meeting of the stockholders. Mr. Levy will be in the
class of directors whose initial term expires at the 2002 annual meeting of
stockholders. Following completion of this offering, the board of directors
intends to appoint at least two additional directors who will not be officers
or employees of Cobalt.

  Executive officers are elected by the board of directors on an annual basis
and serve until their successors have been duly elected and qualified. There
are no family relationships among any of our directors, officers or key
employees.

Board Committees

  We have established an audit committee and a compensation committee. Messrs.
Campbell and Levy are members of both the audit and compensation committees.
The audit committee reviews our internal accounting procedures and consults
with and reviews the services provided by our independent accountants. The
compensation committee reviews and recommends to the board of directors the
compensation and benefits of all of our officers and establishes and reviews
general policies relating to compensation and benefits of our other employees.

Compensation Committee Interlocks and Insider Participation

  Our board of directors established its compensation committee in March 1998.
Prior to establishing the compensation committee, our board of directors as a
whole performed the functions delegated to the compensation committee. No
interlocking relationship exists between any member of our compensation
committee and any member of any other company's board of directors or
compensation committee.

Director Compensation

  Directors do not currently receive any cash compensation from our company for
their service as members of our board of directors, except for reimbursement
for reasonable travel expenses in connection with attendance at board and
committee meetings. Under our 1997 stock option plan, nonemployee directors are
eligible to receive stock option grants at the discretion of the board of
directors, and, after this offering is completed, all nonemployee directors
will receive stock options pursuant to the automatic option grant program in
effect under the 1999 director option plan. See "--Incentive Stock Plans" for
more about the automatic grant program.

                                       55
Executive Compensation

 Summary Compensation Information

  The following table sets forth the compensation earned for services rendered
to us in all capacities by our Chief Executive Officer and our four most highly
compensated executive officers whose total cash compensation exceeded
$100,000--collectively, the "Named Executive Officers"--for the year ended
December 31, 1998.

                           Summary Compensation Table
Annual       Long-Term
                                      Compensation   Compensation
                                    ---------------- ------------
                                                      Securities
                                                      Underlying   All Other
    Name and Principal Position      Salary   Bonus  Options (#)  Compensation
    ---------------------------     -------- ------- ------------ ------------
Stephen W. DeWitt.................. $156,771 $53,594   400,000      $ 9,136
 President and Chief Executive
  Officer
Vivek Mehra........................  143,959      --        --        3,288
 Chief Technology Officer and Vice
  President, Products
Robin Porter.......................  127,917      --        --       10,375
 Vice President, Manufacturing
Mark Orr...........................  125,000      --        --       11,721
 Vice President, Business
  Development
Kenton D. Chow.....................  100,000  25,550   140,000        8,517
 Vice President, Finance and Chief
  Financial Officer
Ms. Porter resigned as our Vice President of Manufacturing in July 1999.

  The amounts in the column titled "All Other Compensation" represent premiums
for health, dental and life insurance paid by Cobalt for Messrs. DeWitt, Mehra,
Orr and Chow and Ms. Porter.

 Option Grants

  The following table sets forth certain information with respect to stock
options granted to each of the Named Executive Officers during the year ended
December 31, 1998. For grants in 1999 to the Named Executive Officers, see
"Related Party Transactions--Option Grants to Directors and Executive
Officers." All of the options were granted under our 1997 stock option plan.
Options under the stock option plan generally vest over four years with 25% of
the shares subject to the option vesting on the first anniversary of the grant
date, and the remaining option shares vesting ratably monthly thereafter.

                             Option Grants in 1998
Percent
                                     of Total                        Potential Realizable
                                      Options                          Value at Assumed
                          Number of   Granted                       Annual Rates of Stock
                         Securities     to                             Appreciation for
                         Underlying  Employees Exercise                  Option Term
                           Options    During   Price per Expiration -----------------------
          Name           Granted (#)  Period     Share      Date        5%         10%
          ----           ----------- --------- --------- ---------- ----------- -----------
Stephen W. DeWitt.......   400,000     26.9%     $0.10    03/18/08
Vivek Mehra.............        --       --         --          --          --         --
Robin Porter............        --       --         --          --          --         --
Mark Orr................        --       --         --          --          --         --
Kenton D. Chow..........    90,000      6.0       0.10    04/15/08
                            50,000      3.4       0.50    12/15/08
56
The exercise price per share of each option was equal to the fair market
value of the common stock as determined by the board of directors on the date
of grant. The potential realizable values assume that the initial public
offering price of $      per share was the fair market value of the common
stock on the date of grant and that the price of the applicable stock increases
from the date of grant until the end of the ten-year option term of the annual
rates specified. There is no assurance provided to any holder of our securities
that the actual stock price appreciation over the ten-year option term will be
at the assumed 5% and 10% levels or at any other defined level.

  The percentages above are based on an aggregate of 1,488,550 shares subject
to options we granted to employees and consultants in the year ended December
31, 1998.

 Option Exercises

  The following table sets forth information with respect to the Named
Executive Officers concerning option exercises for the year ended December 31,
1998 and exercisable and unexercisable options held as of December 31, 1998.

       Aggregate Option Exercises in 1998 and Values at December 31, 1998
Number of
                                                     Securities Underlying     Value of Unexercised
                                                    Unexercised Options at    In-the-Money Options at
                            Shares                   December 31, 1998 (#)       December 31, 1998
                         Acquired on     Value     ------------------------- -------------------------
          Name           Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
          ----           ------------ ------------ ----------- ------------- ----------- -------------
Stephen W. DeWitt.......      --           --            --       400,000      $   --      $160,000
Vivek Mehra.............      --           --            --            --          --            --
Robin Porter............      --           --        24,375        65,625       9,750        26,250
Mark Orr................      --           --            --            --          --            --
Kenton D. Chow..........      --           --            --       140,000          --        36,000
The value of in-the-money options represents the positive spread between the
exercise price of the stock options and the deemed fair market value of the
common stock as of December 31, 1998, which our board of directors determined
was $0.50 per share.

Incentive Plans

 1997 Stock Option Plan

  Our 1997 stock option plan was adopted by our board of directors in April
1997 and approved by our stockholders in May 1997. The stock option plan was
amended in September 1999. A total of 3,000,000 shares of common stock have
been reserved for issuance under our stock option plan, together with an annual
increase in the number of shares reserved thereunder beginning on the first day
of our fiscal year, commencing January 1, 2001, in an amount equal to the
lesser of:

  .  2,500,000 shares;

  .  five percent of our outstanding shares of common stock on the last day
     of the prior fiscal year; or

  .  an amount determined by our board of directors.

As a result of these annual increases, a maximum of 17,500,000 additional
shares could be issued over the remaining seven year life of the 1997 stock
option plan.

  The 1997 stock option plan provides for grants of incentive stock options to
our employees including officers and employee directors and nonstatutory stock
options to our consultants including nonemployee directors. The purposes of our
stock option plan are to attract and retain the best available personnel for
positions of substantial responsibility, to provide additional incentive to our

                                       57
employees and consultants and to promote the success of our business. At the
request of the board of directors, the compensation committee administers our
stock option plan and determines the optionees and the terms of options
granted, including the exercise price, number of shares subject to the option
and the exercisability thereof.

  The term of options granted under the 1997 stock option plan is stated in the
option agreement. However, the term of an incentive stock option may not exceed
ten years and, in the case of an option granted to an optionee who owns more
than 10 percent of our outstanding stock at the time of grant, the term of an
option may not exceed five years. Options granted under the 1997 stock option
plan vest and become exercisable as set forth in each option agreement.

  With respect to any optionee who owns more than 10 percent of our outstanding
stock, the exercise price of any stock option granted must be at least 110% of
the fair market value on the grant date.

  No incentive stock options may be granted to an optionee, which, when
combined with all other incentive stock options becoming exercisable in any
calendar year that are held by that person, would have an aggregate fair market
value in excess of $100,000. In any fiscal year, we may not grant any employee
options to purchase more than 500,000 shares or 1,000,000 shares in the case of
an employee's initial employment.

  The 1997 stock option plan will terminate in April 2007, unless our board of
directors terminates it sooner.

  As of July 2, 1999, we had issued 197,521 shares of common stock upon the
exercise of options granted under our stock option plan, we had outstanding
options to purchase 2,144,943 shares of common stock at a weighted average
exercise price of $0.69 per share and shares remain available for future option
grants under our stock option plan.

 1999 Employee Stock Purchase Plan

  Our 1999 employee stock purchase plan was adopted by our board of directors
in August 1999 and will become effective upon the closing of this offering. We
have reserved a total of 2,250,000 shares of common stock for issuance under
the 1999 employee stock purchase plan, together with an annual increase in the
number of shares reserved thereunder beginning on the first day of our fiscal
year commencing January 1, 2001 in an amount equal to the lesser of:

  .  1,500,000 shares;

  .  three percent of our outstanding common stock on the last day of the
     prior fiscal year; or

  .  an amount determined by our board of directors.

As a result of these annual increases, a maximum of 13,500,000 additional
shares could be sold over the remaining nine year life of the employee stock
purchase plan.

  Our employee stock purchase plan is administered by the board of directors
 and is intended to qualify under Section 423 of the Internal Revenue Code. Our
 employees, including our officers and employee directors but excluding our
 five percent or greater stockholders, are eligible to participate if they are
 customarily employed for at least 20 hours per week and for more than five
 months in any calendar year. Our employee stock purchase plan permits eligible
 employees to purchase common stock through payroll deductions, which may not
 exceed the lesser of 15% of an employee's compensation, where compensation is
 defined on Form W-2, or $25,000.

  Our employee stock purchase plan will be implemented in a series of
overlapping 24 month offering periods, and each offering period consists of
four six month purchase periods. The initial offering period under our employee
stock purchase plan will begin on the effective date of this offering, and the
subsequent offering periods will begin on the first trading day on or after May
1 and

                                       58
November 1 of each year. Each participant will be granted an option on the
first day of the offering period and the option will be automatically exercised
on the date six months later, the end of a purchase period, throughout the
offering period. If the fair market value of our common stock on any purchase
date is lower than such fair market value on the start date of that offering
period, then all participants in that offering period will be automatically
withdrawn from such offering period and re-enrolled in the immediately
following offering period. The purchase price of our common stock under our
employee stock purchase plan will be 85 percent of the lesser of the fair
market value per share on the start date of the offering period or at the end
of the purchase period. Employees may end their participation in an offering
period at any time, and their participation ends automatically on termination
of employment with our company.

  Our employee stock purchase plan will terminate in August 2009, unless our
board of directors terminates it sooner.

 1999 Director Option Plan

  Our 1999 director option plan will become effective upon the closing of this
offering. We have reserved a total of 400,000 shares of common stock for
issuance under the 1999 director option plan, together with an annual increase
in the number of shares reserved thereunder beginning on the first day of our
fiscal year commencing January 1, 2001 equal to the lesser of:

  .  100,000 shares;

  .  one quarter of one percent of the outstanding shares of our common stock
     on the last day of the prior fiscal year; or

  .  an amount determined by the board of directors.

As a result of these annual increases, a maximum of 900,000 additional shares
could be issued over the remaining nine year life of the 1999 director option
plan.

  The option grants under the 1999 director option plan are automatic and non-
discretionary, and the exercise price of the options is 100% of the fair market
value of our common stock on the grant date.

  The 1999 director option plan provides for an initial grant to a nonemployee
director of an option to purchase 50,000 shares, other than the chairman whose
initial grant will be 55,000 shares, on the date on which he or she becomes a
member of the board of directors. Each nonemployee director will thereafter
automatically be granted an additional option to purchase 10,000 shares of
common stock at the next meeting of the board of directors following the annual
meeting of stockholders, if on the date of the annual meeting the director has
served on the board of directors for at least six months. At the time a
nonemployee director joins a committee of our board of directors, the
nonemployee director will also receive a one-time 5,000 share option for each
committee upon which the director serves.

  The term of the options granted under the 1999 director plan is ten years,
but the options expire three months following the termination of the optionee's
status as a director or twelve months if the termination is due to death or
disability. The initial 50,000 share grants, or 55,000 share grant with respect
to the chairman, will become exercisable at a rate of one-fourth of the shares
on the first anniversary of the grant date and at a rate of 1/48th of the
shares per month thereafter. The subsequent 10,000 share grants and the
committee grants will become exercisable at the rate of one-fourth of the
shares on the first anniversary of the grant date and at a rate of 1/48th of
the shares per month thereafter.

 401(k) Plan

  In January 1998, we adopted a Retirement Savings and Investment Plan, the
401(k) Plan, covering our full-time employees located in the United States. The
401(k) Plan is intended to qualify

                                       59
under Section 401(k) of the Internal Revenue Code, so that contributions to the
401(k) Plan by employees or by us and the investment earnings thereon are not
taxable to the employees until withdrawn. If our 401(k) Plan qualifies under
Section 401(k) of the Internal Revenue Code, our contributions will be
deductible by us when made. Our employees may elect to reduce their current
compensation by up to the statutorily prescribed annual limit of $10,000 in
1999 and to have those funds contributed to the 401(k) Plan. The 401(k) Plan
permits us, but does not require us, to make additional matching contributions
on behalf of all participants. To date, we have not made any contributions to
the 401(k) Plan.

Employment Agreements and Change in Control Arrangements

  We have entered into the following employment, noncompete and change in
control arrangements and agreements with our current officers. For a
description of arrangements with our former officers, directors and substantial
stockholders, see "Related Party Transactions" on page 62.

  Each of our executive officers listed in "Management--Executive Officers and
Management" other than Mr. Korchinsky and Mr. Martell entered into an
employment agreement with us in September 1999. These agreements provide that
if the officer is terminated without cause or constructively terminated he will
receive:

  .  one year accelerated vesting of any of his stock options;

  .  one year accelerated vesting of common stock purchased by him pursuant
     to restricted stock purchase agreements; and

  .  one year of salary and target bonus.

If the officer voluntarily resigns, is terminated for cause or is terminated
for any other reason, he is not entitled to these benefits.

  In June 1998, we entered into a letter agreement with George Korchinsky, our
Vice President of International Sales. Pursuant to the agreement, Mr.
Korchinsky receives an annual salary of $150,000 and is eligible for an
incentive-based sales bonus. In addition, Mr. Korchinsky received options to
purchase 120,000 shares of our common stock pursuant to our employee stock
plan, 25% of which vest after one year and 1/48 of which vest every month
thereafter; provided, however, that 50% of the option shares will vest if we
experience a change in control. Pursuant to the terms of the option grant, a
change in control is defined as:

  .  any person becoming the beneficial owner of 50% or more of the total
     voting power of our then outstanding voting securities; or

  .  a merger or consolidation with any other corporation, other than a
     merger or consolidation which would result in our voting securities
     outstanding immediately prior thereto continuing to represent at least
     50% of the total voting power of the surviving entity outstanding
     immediately after such merger or consolidation, or our stockholders
     approve a plan of complete liquidation or an agreement for the sale or
     disposition of all or substantially all of our assets.

  In the event of a change of control of our company, Mr. Korchinsky has 90
days following the completion of such a transaction to decide whether it
constitutes a constructive termination of his employment in which case all of
his options will vest up to the date of constructive termination regardless of
the one year initial anniversary vesting, plus an additional six months of
options will be deemed vested. If he terminated without cause, Mr. Korchinsky
is entitled to receive twelve (12) months of his annual base salary and
benefits in exchange for a general release.

  In July 1999, we entered into a letter agreement with Gary Martell, our Chief
Operating Officer. Pursuant to the agreement, Mr. Martell:

                                       60
.  receives an annual base salary of $200,000;

  .  was granted options to purchase 400,000 shares of common stock; and

  .  is eligible for an annual bonus of up to $50,000.

  Mr. Martell is entitled to accelerated vesting of 50% of his outstanding
options in the event of a greater than 50% change in ownership of our shares.
If Mr. Martell is terminated without cause, his salary and benefits will
continue for six months after termination.

Limitations on Directors' Liability and Indemnification

  Our certificate of incorporation limits the liability of our directors and
executive officers to the maximum extent permitted by Delaware law. Delaware
law provides that directors of a corporation will not be personally liable for
monetary damages for breach of their fiduciary duties as directors, except
liability for:

  .  any breach of their duty of loyalty to our company or our stockholders;

  .  acts or omissions not in good faith or which involve intentional
     misconduct or a knowing violation of law;

  .  unlawful payments of dividends or unlawful stock repurchases or
     redemptions as provided in Section 174 of the Delaware General
     Corporation Law; or

  .  any transaction from which the director derived an improper personal
     benefit.

  The limits on a director or officer's liability in our certificate of
incorporation do not apply to liabilities arising under the federal securities
laws and do not affect the availability of equitable remedies such as
injunctive relief or rescission.

  Our certificate of incorporation together with our bylaws provide that we
must indemnify our directors and executive officers and may indemnify our other
officers and employees and other agents to the fullest extent permitted by law.
We believe that indemnification under our bylaws covers at least negligence and
gross negligence on the part of indemnified parties. Our bylaws also permit us
to secure insurance on behalf of any officer, director, employee or other agent
for any liability arising out of his or her actions in that capacity,
regardless of whether our bylaws would otherwise permit indemnification. We
believe that the indemnification provisions of our amended and restated
certificate of incorporation and bylaws are necessary to attract and retain
qualified persons as directors and officers. We also maintain directors' and
officers' liability insurance.

  Prior to the effective time of this offering, we expect to enter into
agreements to indemnify our directors and executive officers. These agreements
provide for indemnification of our directors and executive officers for certain
expenses including attorneys' fees, judgments, fines and settlement amounts
incurred by any such person in any action or proceeding. We expect the actions
and right of our company, arising out of such person's services as a director
or executive officer of our company, one of our subsidiaries or any other
company or enterprise to which the person provides services at our request. We
believe that these provisions and agreements are necessary to attract and
retain qualified persons as our directors and executive officers.

  At present we are not aware of any pending litigation or proceeding involving
any director, officer, employee or agent of our company where indemnification
will be required or permitted. Nor are we aware of any threatened litigation or
proceeding that might result in a claim for indemnification.

                                       61
RELATED PARTY TRANSACTIONS

  All future transactions, other than compensation, stock options pursuant to
the plans and other benefits available to employees generally, including any
loans from us to our officers, directors, principal stockholders or affiliates,
will be approved by a majority of our board of directors, including a majority
of our independent and disinterested members of our board of directors. If
required by law, the future transactions will be approved by a majority of the
disinterested stockholders. These future transactions will be on terms no less
favorable to us than we could obtain from unaffiliated third parties.

Stock Issuances to our Directors, Officers and Principal Stockholders

  In May and June of 1997, we issued 4,181,426 shares of common stock at $0.001
per share to 4 individuals for aggregate proceeds of $4,181. In August 1997, we
issued 471,338 shares of common stock at $0.001 per share for aggregate
proceeds of $471. Of such shares, we issued 111,338 shares to Vivek Mehra. In
March 1998, we issued 800,000 shares of common stock at $0.10 per share to
Stephen DeWitt for aggregate proceeds of $80,000. In February 1999, we issued
100,000 shares of common stock at $0.50 per share to Vivek Mehra for aggregate
proceeds of $50,000.

  We repurchased 570,000 shares of common stock in September 1997 from the
estate of Mark Wu. Mark Wu was one of our founders. The company repurchased
570,000 shares of his common stock at the original purchase price on September
29, 1997. The balance of his shares were transferred to his heirs.

  Between October 1996 and June 1997, we issued warrants to purchase 162,500
shares of Series A preferred stock at a per share exercise price of $1.00 per
share to 13 persons as consideration for bridge loans that were converted to
Series A preferred stock. Between August and November 1997, we sold 3,572,401
shares of Series A preferred stock at a per share price of $1.00 for aggregate
proceeds of $3.6 million.

  Between April and June 1998, we issued warrants to purchase 41,612 shares of
Series B preferred stock at a per share exercise price of $2.16 to three
stockholders as consideration for bridge loans that were converted to Series B
preferred stock. In July 1998, we issued 3,698,910 shares of Series B preferred
stock at a per share price of $2.16 for aggregate proceeds of $8.0 million.

  In February and March 1999, we issued warrants to purchase an aggregate of
79,045 shares of Series C preferred stock with a per share exercise price of
$3.70 to 12 investors as consideration for bridge loans that were converted to
Series C preferred stock. In May 1999, we issued 9,813,507 shares of Series C
preferred stock at a per share price of $3.70 for aggregate proceeds of $36.3
million. In connection with our Series C preferred stock financing, we issued a
warrant to BT Alex. Brown to purchase 242,508 shares of common stock with a per
share exercise price of $3.70 that expires in May 2002 as consideration for BT
Alex. Brown's services as placement agent in the Series C preferred stock
financing.

                                       62
Upon closing of this offering, all shares of outstanding preferred stock will
be automatically converted into shares of common stock. Listed below are those
persons who participated in the financings described above who are our
executive officers, directors or stockholders who beneficially own five percent
or more of our securities.
Series A           Series B           Series C
                          Common   Preferred Series A Preferred Series B Preferred Series C   Aggregate
      Stockholder          Stock     Stock   Warrants   Stock   Warrants   Stock   Warrants Consideration
      -----------        --------- --------- -------- --------- -------- --------- -------- -------------
August Capital
 entities...............        --        --      --         --      --  2,702,701      --   $10,004,992
Chase Venture Capital
 Assoc. L.P.............        --   517,500      --  1,387,091      --    531,081  13,039     5,530,744
Kenton D. Chow..........        --        --      --      2,312      --      2,433     121        14,450
Crystal Internet
 Ventures Fund, L.P.....        --        --      --    924,728      --    445,946  13,512     3,699,996
Stephen W. DeWitt.......   800,000        --      --    115,591  18,494     27,027   1,351       390,799
George M. Korchinsky....        --        --      --         --      --     27,027   2,702       109,997
Vivek Mehra.............   946,382     5,000      --         --      --         --      --         5,946
Mark H. Orr.............   946,382        --      --         --      --         --      --           946
SPLZ One Partners, LLC
 (Jordan A. Levy).......        --        --      --         --      --    135,135  20,720       500,000
Techfarm/TechFund
 Capital entities....... 1,200,000   982,500  32,500    213,214  11,559     56,757   2,836     1,654,243
Vanguard V, L.P.........        -- 1,202,465      --    462,364  11,559    135,135   6,756     2,752,462
Mark Wu................. 1,200,000        --      --         --      --         --      --         1,200
The entities listed above as Techfarm/TechFund Capital entities include
TechFund Capital, LP and its general partner, TechFund Capital Management, LLC;
TechFund Capital II, LP and its general partner, TechFund Capital Management
II, LLC; and Techfarm Management, Inc. Mr. Campbell, our Chairman, is a
managing member of TechFund Capital Management, LLC and TechFund Capital
Management II, LLC and the President and a shareholder of Techfarm Management,
Inc. Mr. Campbell disclaims beneficial ownership of the shares held by each
entity, except to the extent of his pecuniary interest therein.

  Jordan A. Levy, one of our directors, is a managing member of SPLZ One
Partners, LLC. Mr. Levy disclaims beneficial ownership of the shares held by
each entity, except to the extent of his pecuniary interest therein.

                                       63
Option Grants to our Directors and Executive Officers

  Stock option grants to directors and executive officers of our company are
described under the captions "Management--Board Compensation" and "--Executive
Compensation". Since our inception, we have granted options to our directors
and current and former executive officers, including the Named Executive
Officers as follows:
Number
                                               of                       Exercise
         Name                                Shares      Grant Date      Price
         ----                                -------     ----------     --------
Kenton D. Chow..............................  90,000 April 15, 1998      $0.10
                                              50,000 December 15, 1998    0.50
                                              60,000 July 27, 1999        2.50
Patrick J. Conte............................ 100,000 September 23, 1998   0.50
                                              40,000 February 16, 1999    0.80
                                              40,000 July 27, 1999        2.50
Stephen W. DeWitt........................... 400,000 March 18, 1998       0.10
                                             100,000 May 18, 1999         1.85
                                             250,000 July 27, 1999        2.50
Kelly M. Herrell............................ 250,000 July 27, 1999        2.50
George M. Korchinsky........................ 120,000 July 15, 1998        0.50
                                              60,000 July 27, 1999        2.50
Jordan A. Levy..............................  30,000 July 15, 1998        0.50
Gary A. Martell............................. 400,000 July 27, 1999        2.50
Vivek Mehra................................. 100,000 July 27, 1999        2.50
Mark H. Orr.................................  30,000 July 27, 1999        2.50
Robin Porter................................  90,000 November 25, 1997    0.10
In connection with a separation agreement dated July 28, 1999, we accelerated
the vesting of options to purchase 37,500 shares of our common stock held by
Ms. Porter. Pursuant to the separation agreement, Ms. Porter will receive her
regular salary and benefits other than accrued vacation pay until October 31,
1999. Ms. Porter released any and all claims against us that arose prior to the
date of the agreement, whether known or unknown, arising out of any agreement,
act or omission, including matters arising from her employment relationship
with us.

Other Relationships

  Our company has a management consulting agreement with Techfarm Management,
Inc. pursuant to which it provides management consulting services to our
company for a fee of $5,000 per month. These services and our payment of the
related fees will cease upon the closing of this offering. Gordon Campbell is
the President of Techfarm Management, Inc. and serves as the Chairman of our
board of directors. In addition, Mr. Campbell is also a managing member of
TechFund Capital Management, LLC, the general partner of TechFund Capital, L.P.

  On August 20, 1999, we made an interest free loan of $500,000 to Stephen W.
Dewitt, our President and Chief Executive Officer. The loan is secured by
50,000 shares of our Series B preferred stock held by Mr. DeWitt and is full
recourse. The loan is payable on August 20, 2003. In the event Mr. DeWitt
leaves our employment, the note will be due and payable in full 60 days after
his last day of employment with us.

                                       64
PRINCIPAL STOCKHOLDERS

  The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of July 2, 1999, and as adjusted to
reflect the sale of common stock offered hereby by:

  .  each stockholder known by us to own beneficially more than five percent
     of our common stock;

  .  each of the Named Executive Officers;

  .  each director of our company; and

  .  all directors and executive officers as a group.
Percent Beneficially Owned
                                   Total Number ------------------------------
         Name and Address           of Shares   Before Offering After Offering
         ----------------          ------------ --------------- --------------
August Capital entities...........  2,702,701        12.3%
  2480 Sand Hill Road, Suite 101
  Menlo Park, California 94025

Chase Venture Capital Assoc. L.P.
 .................................  2,448,711        11.1
  380 Madison Avenue, 12th Floor
  New York, New York 10017

Techfarm/TechFund Capital
 entities.........................  2,446,866        11.1
  111 West Evelyn Avenue Suite 101
  Sunnyvale, California 94086

Vanguard V, L.P...................  1,818,279         8.2
  525 University Avenue Suite 600
  Palo Alto, California 94301

Crystal Internet Venture Fund,
 L.P..............................  1,384,186         6.3
  1120 Chester Avenue, Suite 310
  Cleveland, Ohio 44114

Gordon A. Campbell................  2,446,866        11.1
Stephen W. DeWitt.................  1,112,463         5.0
Vivek Mehra.......................    951,382         4.3
Mark H. Orr.......................    946,382         4.3
Robin Porter......................     35,625          *
Kenton D. Chow....................     34,866          *
Jordan A. Levy....................    171,655          *
All executive officers and
 directors as a group
 (11 persons).....................  5,884,176        26.5
--------
* Less than 1% of the outstanding shares of common stock.

  Except as otherwise noted above, the address of each person listed on the
table is 555 Ellis Street, Mountain View, California 94043.

  As of July 2, 1999, 22,010,103 shares of our common stock were outstanding,
assuming that each share of preferred stock was converted on a one for one
basis to common stock. The columns regarding beneficial ownership before and
after the offering assume that the underwriters' over-allotment option is not
exercised. If the over-allotment option is exercised in full, we will sell an
aggregate of shares of new common stock.

  We have determined beneficial ownership in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person, we
have included the shares of common stock subject to options or warrants held by
that person that are currently exercisable or will become exercisable within 60
days after July 2, 1999, but we have not included those shares for purposes of
computing

                                       65
percentage ownership of any other person. We have assumed unless otherwise
indicated below that the persons and entities named in the table have sole
voting and investment power with respect to all shares beneficially owned,
subject to community property laws where applicable.

  The beneficial ownership reported for August Capital entities includes
2,583,782 shares held by August Capital II, LP and 118,919 shares held by
August Capital Strategic Partners II, LP. The general partner of each of these
entities is August Capital Management II, LLC. The managing members of August
Capital Management II, LLC are David F. Marquardt, John R. Johnston, Andrew L.
Anker and Andrew S. Rappaport.

  The general partner of Chase Venture Capital Associates, L.P. is Chase
Capital Partners. The general partners of Chase Capital Partners are Jeffrey
Walker, Mitchel Blutt, M.D., Arnold Chavkin, Steven Murray, Michael Hannon,
Shahan Soghikian, Brian Richmand, Donald Hofmann, Chris Behrens, John M.B.
O'Connor, John Baron, Damion Wicker, M.D., Susan Segal, Lindsay Stuart and
Chase Capital Corporation. Jeffrey Walter is the President of Chase Capital
Corporation, which is a wholly-owned subsidiary of Chase Manhattan Corporation.

  The beneficial ownership reported for the Techfarm/TechFund Capital entities
and Gordon A. Campbell includes:

  .  1,147,500 shares held by Techfarm II, LP;

  .  1,015,590 shares held by TechFund Capital, LP;

  .  96,321 shares held by TechFund Capital Management, LLC;

  .  83,803 shares held by Gordon A. Campbell;

  .  47,297 shares held by TechFund Capital II, LP;

  .  9,460 shares held by TechFund Capital II, LP; and

  .  46,895 shares subject to warrants held by Mr. Campbell.

  Mr. Campbell disclaims beneficial ownership of these shares except to the
extent of his pecuniary interest.

  The general partners of Vanguard V, L.P. are Robert Ulrich, Clifford
Higgerson, Jack Gill and Curtis Kipling Myers.

  The general partner of Crystal Internet Venture Fund, L.P. is Crystal
Venture, Ltd. Joseph Tzeng is the President and Dan Kellog is the Vice
President of Crystal Venture Ltd.

  The beneficial ownership of Jordan Levy as reported above includes 135,135
shares of Series C preferred stock and warrants to purchase 20,720 shares of
Series C preferred stock held by SPLZ One Partners, LLC. Mr. Levy is a managing
member of SPLZ One Partners, LLC. However, Mr. Levy disclaims beneficial
ownership of the shares and warrants held by SPLZ One Partners except to the
extent of his pecuniary interest therein.

  The beneficial ownership of the persons set forth in the table above includes
the following options or warrants to purchase our common stock that may be
exercised by such person within 60 days of July 2, 1999:

                                       66
Securities Exercisable Within 60 Days of July 2, 1999
Options Warrants
                                                                ------- --------
Techfarm/TechFund entities.....................................     --   46,895
Chase Venture Capital Assoc. L.P. .............................     --   13,039
Crystal Internet Venture Fund, L.P.............................     --   13,512
Vanguard V, L.P................................................     --   18,315
Gordon A. Campbell.............................................     --   46,895
Stephen W. DeWitt.............................................. 150,000  19,845
Kenton D. Chow.................................................   1,875     121
Robin Porter...................................................  35,625     --
Jordan Levy....................................................  16,250     --
All directors and officers..................................... 236,250  86,995
67
DESCRIPTION OF CAPITAL STOCK

  Upon the closing of this offering, we will be authorized to issue 120,000,000
shares of common stock, $0.001 par value, and 10,000,000 shares of undesignated
preferred stock, $0.001 par value.

Common Stock

  As of July 2, 1999, we had 22,010,103 shares of common stock outstanding held
by approximately 105 stockholders.

  The holders of common stock are entitled to one vote per share on all matters
to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding preferred stock, the holders of common stock are
entitled to receive ratably any dividends that may be declared from time to
time by the board of directors out of funds legally available for that purpose.
In the event of our liquidation, dissolution or winding up, the holders of
common stock are entitled to share ratably in all assets remaining after
payment of liabilities, subject to prior distribution rights of preferred stock
then outstanding. The common stock has 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 nonassessable, and the shares of common stock to be issued upon
the closing of this offering will be fully paid and nonassessable.

Preferred Stock

  Upon the closing of this offering, our board of directors will have the
authority, without action by our stockholders, to designate and issue preferred
stock in one or more series. The board of directors may also designate the
rights, preferences and privileges of each series of preferred stock; any or
all of which may be superior to the rights of the common stock. It is not
possible to state the actual effect of the issuance of any shares of preferred
stock upon the rights of holders of the common stock until the board of
directors determines the specific rights of the holders of the preferred stock.
However, these effects might include:

  .  restricting dividends on the common stock;

  .  diluting the voting power of the common stock;

  .  impairing the liquidation rights of the common stock; and

  .  delaying or preventing a change in control of our company without
     further action by the stockholders.

  We have no present plans to issue any shares of preferred stock.

Warrants

  As of July 2, 1999, we had outstanding warrants to purchase:

  .  242,508 shares of common stock issued to BT Alex. Brown at an exercise
     price of $3.70 per share that will expire in May 2002;

  .  162,500 shares of Series A preferred stock issued to 13 stockholders at
     an exercise price of $1.00 per share that will expire at various times
     from October 2001 to June 2002;

  .  41,612 shares of Series B preferred stock issued to three stockholders
     at an exercise price of $2.16 per share that will expire at various
     times from April 2000 to June 2000; and

  .  79,045 shares of Series C preferred stock issued to 12 stockholders at
     an exercise price of $3.70 per share that will expire at various times
     from February 2002, to March 2002.

                                       68
Our outstanding warrants to purchase preferred stock will convert to warrants
to purchase common stock upon the closing of this offering.

Holders of Registration Rights Can Require Us to Register Shares of Our Stock
for Resale

  The holders of 17,084,818 shares of common stock and 283,157 shares of common
stock issuable upon the exercise of warrants or their permitted transferees are
entitled to certain rights with respect to registration of such shares under
the Securities Act of 1933, as amended. These rights are provided under the
terms of our agreement with the holders of registrable securities. Under these
registration rights, holders of at least a majority of the then outstanding
registrable securities may require on two occasions that we register their
shares for public resale. We are obligated to register these shares if the
holders of a majority of the eligible shares request registration and only if
the shares to be registered have an anticipated public offering price of at
least $10,000,000. In addition, holders of registrable securities may require
on two separate occasions that we register their shares for public resale on
Form S-3 or similar short-form registration, if we are eligible to use Form S-3
or similar short-form registration, and the value of the securities to be
registered is at least $10,000,000. If we elect to register any of our shares
of common stock for any public offering, the holders of registrable securities
are entitled to include shares of common stock in the registration. However we
may reduce the number of shares proposed to be registered in view of market
conditions. We will pay all expenses in connection with any registration, other
than underwriting discounts and commissions.

Anti-Takeover Effects of Some Provisions of Delaware Law and Our Charter
Documents

  Certain provisions of Delaware law and our certificate of incorporation and
bylaws could make the acquisition of our company through a tender offer, a
proxy contest or other means more difficult and could make the removal of
incumbent officers and directors more difficult. We expect these provisions to
discourage certain types of coercive takeover practices and inadequate takeover
bids and to encourage persons seeking to acquire control of our company to
first negotiate with our board of directors. We believe that the benefits
provided by our ability to negotiate with the proponent of an unfriendly or
unsolicited proposal outweigh the disadvantages of discouraging such proposals.
We believe the negotiation of an unfriendly or unsolicited proposal could
result in an improvement of its terms.

 Delaware Law

  We are subject to Section 203 of the Delaware General Corporation Law, an
anti-takeover law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years following the date the person became
an interested stockholder, unless:

  .  prior to the date of the transaction, the board of directors of the
     corporation approved either the business combination or the transaction
     which resulted in the stockholder becoming an interested stockholder;

  .  the stockholder owned at least 85% of the voting stock of the
     corporation outstanding at the time the transaction commenced, excluding
     for purposes of determining the number of shares outstanding (a) shares
     owned by persons who are directors and also officers, and (b) shares
     owned by employee stock plans in which employee participants do not have
     the right to determine confidentially whether shares held subject to the
     plan will be tendered in a tender or exchange offer; or

  .  on or subsequent to the date of the transaction, the business
     combination is approved by the board and authorized at an annual or
     special meeting of stockholders, and not by written

                                       69
consent, by the affirmative vote of at least 66 2/3% of the outstanding
     voting stock which is not owned by the interested stockholder.

  Generally, a "business combination" includes a merger, asset or stock sale,
or other transaction resulting in a financial benefit to the interested
stockholder. An "interested stockholder" is a person who, together with
affiliates and associates, owns or, within three years prior to the
determination of interested stockholder status, did own 15% or more of a
corporation's outstanding voting securities. We expect the existence of this
provision to have an anti-takeover effect with respect to transactions our
board of directors does not approve in advance. We also anticipate that
Section 203 may also discourage attempts that might result in a premium over
the market price for the shares of common stock held by stockholders.

  Charter Documents

  Upon completion of this offering, our certificate of incorporation provides
for our board of directors to be divided into three classes serving staggered
terms. Approximately one-third of the board of directors will be elected each
year. The provision for a classified board could prevent a party who acquires
control of a majority of the outstanding voting stock from obtaining control
of the board of directors until the second annual stockholders meeting
following the date the acquirer obtains the controlling stock interest. The
classified board provision could discourage a potential acquirer from making a
tender offer or otherwise attempting to obtain control of our company and
could increase the likelihood that incumbent directors will retain their
positions. Our certificate of incorporation provides that directors may be
removed:

  .  with cause by the affirmative vote of the holders of at least a majority
     of the outstanding shares of voting stock; or

  .  without cause by the affirmative vote of the holders of at least 66 2/3%
     of the then-outstanding shares of the voting stock.

  Our bylaws establish an advance notice procedure for stockholder proposals
to be brought before an annual meeting of our stockholders, including proposed
nominations of persons for election to the board of directors. At an annual
meeting, stockholders may only consider proposals or nominations specified in
the notice of meeting or brought before the meeting by or at the direction of
the board of directors. Stockholders may also consider a proposal or
nomination by a person who was a stockholder of record on the record date for
the meeting, who is entitled to vote at the meeting and who has given to our
Secretary timely written notice, in proper form, of his or her intention to
bring that business before the meeting. The bylaws do not give the board of
directors the power to approve or disapprove stockholder nominations of
candidates or proposals regarding other business to be conducted at a special
or annual meeting of the stockholders. However, our bylaws may have the effect
of precluding the conduct of certain business at a meeting if the proper
procedures are not followed. These provisions may also discourage or deter a
potential acquirer from conducting a solicitation of proxies to elect the
acquirer's own slate of directors or otherwise attempting to obtain control of
our company.

  Under Delaware law, a special meeting of stockholders may be called by the
board of directors or by any other person authorized to do so in the
certificate of incorporation or the bylaws. Our bylaws authorize a majority of
our board of directors, the chairman of the board or the chief executive
officer to call a special meeting of stockholders. Because our stockholders do
not have the right to call a special meeting, a stockholder could not force
stockholder consideration of a proposal over the opposition of the board of
directors by calling a special meeting of stockholders prior to such time as a
majority of the board of directors believed or the chief executive officer
believed the matter should be considered or until the next annual meeting
provided that the requestor met the notice

                                      70
requirements. The restriction on the ability of stockholders to call a special
meeting means that a proposal to replace the board also could be delayed until
the next annual meeting.

  Although Delaware law provides that stockholders may execute an action by
written consent in lieu of a stockholder meeting, it also allows us to
eliminate stockholder actions by written consent. Elimination of written
consents of stockholders may lengthen the amount of time required to take
stockholder actions since actions by written consent are not subject to the
minimum notice requirement of a stockholder's meeting. However, we believe that
the elimination of stockholders' written consents may deter hostile takeover
attempts. Without the availability of stockholder's actions by written consent,
a holder controlling a majority of our capital stock would not be able to amend
our bylaws or remove directors without holding a stockholders meeting. The
holder would have to obtain the consent of a majority of the board of
directors, the chairman of the board or the chief executive officer to call a
stockholders' meeting and satisfy the notice periods determined by the board of
directors. Our certificate of incorporation provides for the elimination of
actions by written consent of stockholders upon the closing of this offering.

Transfer Agent and Registrar

  The transfer agent and registrar for our common stock is BankBoston, N.A.
BankBoston is located at 150 Royall Street, Canton, Massachusetts, 02021 and
its telephone number is (508) 575-3120.

Nasdaq Stock Market Listing

  We have applied to have our common stock listed on the Nasdaq National Market
for quotation under the symbol "COBT".

                                       71
SHARES ELIGIBLE FOR FUTURE SALE

  Prior to this offering, there has been no public market for our stock. Future
sales of substantial amounts of our common stock in the public market following
this offering or the possibility of such sales occurring could adversely affect
prevailing market prices for our common stock or could impair our ability to
raise capital through an offering of equity securities.

  After this offering, we will have outstanding      shares of common stock,
based upon shares outstanding as of July 2, 1999, assuming no exercise of the
underwriters' over-allotment option and no exercise of outstanding options or
warrants after July 2, 1999. All of the shares sold in this offering will be
freely tradeable without restriction under the Securities Act except for any
shares purchased by our "affiliates" as that term is defined in Rule 144 under
the Securities Act. The remaining 22,010,103 shares of common stock held by
existing stockholders are "restricted" shares as that term is defined in Rule
144 under the Securities Act. We issued and sold the restricted shares in
private transactions in reliance upon exemptions from registration under the
Securities Act. Restricted shares may be sold in the public market only if they
are registered under the Securities Act or if they qualify for an exemption
from registration, such as Rule 144 or 701 under the Securities Act, which are
summarized below.

  Our officers, directors, employees, and other stockholders, who collectively
hold an aggregate of 22,010,103 restricted shares, and the underwriters entered
into lock-up agreements in connection with this offering. These lock-up
agreements provide that, with certain limited exceptions, our officers,
directors, employees and stockholders have agreed not to offer, sell, contract
to sell, grant any option to purchase or otherwise dispose of any of our shares
for a period of 180 days after the effective date of this offering. Goldman,
Sachs & Co. may, in its sole discretion and at any time without prior notice,
release all or any portion of the shares subject to these lock-up agreements.
We have also entered into an agreement with Goldman, Sachs & Co. that we will
not offer, sell or otherwise dispose of our common stock until 180 days after
the effective date of this offering.

  Taking into account the lock-up agreements, the number of shares that will be
available for sale in the public market under the provisions of Rules 144,
144(k) and 701 will be as follows:
Number of
                   Date of Availability for Sale                      Shares
                   -----------------------------                    ----------
At various times between July 2, 1999 and the date 30 days
 after the effective date of this offering.........................        --
At various times between the date 30 days and the date
 180 days after the effective date of this offering................    100,000
At various times thereafter upon the expiration of applicable
 holding periods................................................... 21,910,103
Following the expiration of the lock-up period, shares issued upon exercise
of options granted by us prior to the completion of this offering will also be
available for sale in the public market pursuant to Rule 701 under the
Securities Act unless those shares are held by one of our affiliates, directors
or officers.

  In general, under Rule 144 as currently in effect, 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:

  .  one percent of the number of shares of common stock then outstanding,
     which will equal approximately       shares immediately after the
     offering; or

  .  the average weekly trading volume of the common stock during the four
     calendar weeks preceding the filing of a Form 144 with respect to such
     sale.

                                       72
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 us. Under Rule 144(k), a person who is not deemed to have been an
affiliate of our company at any time during the three months 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.

  Rule 701, as currently in effect, permits our employees, officers, directors
or consultants who purchased shares under a written compensatory plan or
contract to resell these shares in reliance upon Rule 144 but without
compliance with specific restrictions. Rule 701 provides that affiliates may
sell their Rule 701 shares under Rule 144 without complying with the holding
period requirement and that non-affiliates may sell these shares in reliance on
Rule 144 without complying with the holding period, public information, volume
limitation or notice provisions of Rule 144.

  We intend to file, shortly after the effectiveness of this offering, a
registration statement on Form S-8 under the Securities Act covering all shares
of common stock reserved for issuance under the stock plans and subject to
outstanding options under our 1997 stock option plan. See "Management--Stock
Plans". Shares of common stock issued upon exercise of options under the Form
S-8 will be available for sale in the public market, subject to Rule 144 volume
limitations applicable to affiliates and subject to the contractual
restrictions described above. As of July 2, 1999, options to purchase 2,144,943
shares of common stock were outstanding of which approximately 382,486 options
were then vested and exercisable. Beginning 180 days after the effective date
of this offering, approximately 728,687 shares issuable upon the exercise of
vested stock options will become eligible for sale in the public market, if
such options are exercised.

  Following this offering, the holders of an aggregate of 17,084,818 shares of
outstanding common stock and 283,157 shares of common stock issuable upon the
exercise of warrants have the right to require us to register their shares for
sale upon meeting certain requirements. See "Description of Capital Stock--
Holders of Registration Rights Can Require Us to Register Shares of Our Stock
for Resale" for additional information regarding registration rights.

                                 LEGAL MATTERS

  The validity of the common stock offered hereby will be passed upon for us by
Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California. Legal matters specified by the underwriters in connection with this
offering will be passed upon for the underwriters by Shearman & Sterling, Menlo
Park, California.

                                    EXPERTS

  The financial statements as of December 31, 1997 and 1998 and for the period
from inception (October 18, 1996) to December 31, 1996 and for each of the two
years in the period ended December 31, 1998 included in this Prospectus have
been so included in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.

                                       73
WHERE YOU CAN FIND ADDITIONAL INFORMATION

  We have 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 our company and our
common stock, reference is made to the registration statement and to the
exhibits and schedules filed therewith. A copy of the registration statement
may be inspected by anyone without charge at the Public Reference Section of
the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of all or any portion of the registration
statement may be obtained from the Public Reference Section of the Commission,
450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of prescribed
fees. The public may obtain information on the operations of the public
reference facilities in Washington, D.C. by calling the Commission at 1-800-
SEC-0330. The Commission maintains a web site at http://www.sec.gov that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.

                                       74
COBALT NETWORKS , INC.
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
                                                                            ----
Report of Independent Accountants.......................................... F-2

Consolidated Balance Sheet................................................. F-3

Consolidated Statement of Operations....................................... F-4

Consolidated Statement of Stockholders' Deficit............................ F-5

Consolidated Statement of Cash Flows....................................... F-6

Notes to Consolidated Financial Statements................................. F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Cobalt Networks, Inc.

  The reincorporation described in Note 1 to the consolidated financial
statements has not been consummated as of September 8, 1999. When it has been
consummated, we will be in a position to issue the following report:

    "In our opinion, the accompanying consolidated balance sheet and the
  related consolidated statements of operations, of stockholders' equity
  (deficit) and of cash flows present fairly, in all material respects, the
  financial position of Cobalt Networks, Inc. and its subsidiaries at
  December 31, 1997 and 1998, and the results of their operations and their
  cash flows for the period from October 18, 1996 (inception) through
  December 31, 1996 and the years ended December 31, 1997 and 1998, in
  conformity with generally accepted accounting principles. These financial
  statements are the responsibility of the Company's management; our
  responsibility is to express an opinion on these financial statements based
  on our audits. We conducted our audits of these statements in accordance
  with generally accepted auditing standards which 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, assessing the accounting principles used and
  significant estimates made by management, and evaluating the overall
  financial statement presentation. We believe that our audits provide a
  reasonable basis for the opinion expressed above."

PricewaterhouseCoopers LLP

San Jose, California
January 18, 1999, except as to
Note 11, which is as of September 1, 1999.

                                      F-2
COBALT NETWORKS, INC.
                           CONSOLIDATED BALANCE SHEET
                (in thousands, except share and per share data)
Pro Forma
                                      December 31,                 Stockholders'
                                     ----------------    July 2,   Equity as of
                                      1997     1998       1999     July 2, 1999
                                     ------  --------  ----------- -------------
                                                       (unaudited)  (unaudited)
Assets
Current assets:
 Cash and cash equivalents.........  $1,738  $  2,090    $27,426
 Accounts receivable, net of
  allowance for doubtful accounts
  of $--, $335 and $485............     --      2,040      4,829
 Inventories.......................      20       514      1,019
 Other current assets..............      78       239        307
                                     ------  --------    -------
   Total current assets............   1,836     4,883     33,581
Property and equipment, net........     162     1,262      1,321
                                     ------  --------    -------
                                     $1,998  $  6,145    $34,902
                                     ======  ========    =======
Liabilities, mandatorily redeemable
 convertible preferred stock and
 stockholders' equity (deficit)
Current liabilities:
 Notes payable, current............  $  --   $     39    $    41
 Borrowings under line of credit...     --        600        --
 Advance from related party........     --        500        --
 Accounts payable..................     209     4,179      5,503
 Accrued liabilities...............      85     1,183      2,781
 Deferred margin on distributor
  inventory........................     --        294        717
                                     ------  --------    -------
   Total current liabilities.......     294     6,795      9,042
Notes payable......................     --         84         64
                                     ------  --------    -------
                                        294     6,879      9,106
                                     ------  --------    -------
Mandatorily Redeemable Convertible
 Preferred Stock (Note 4)..........   3,551    12,339     45,646      $   --
                                     ------  --------    -------      -------
Commitments and contingencies
 (Notes 9 and 10)
Stockholders' equity (deficit)
 Preferred Stock: $0.001 par
  value; 10,000,000 shares
  authorized, none issued and
  outstanding pro forma............     --        --         --           --
 Common Stock: $0.001 par value;
  120,000,000 shares authorized;
  4,193,000, 4,750,000 and
  4,925,000 (unaudited) shares
  issued and outstanding at
  December 31, 1997, 1998 and July
  2, 1999; 22,010,103 (unaudited)
  shares issued and outstanding
  pro forma........................       4         5          5           22
 Additional paid-in capital........     --         79      3,921       49,550
 Unearned stock compensation.......     --        --      (1,134)      (1,134)
 Note receivable from
  stockholder......................     --        --         (50)         (50)
 Accumulated deficit...............  (1,851)  (13,157)   (22,592)     (22,592)
                                     ------  --------    -------      -------
   Total stockholders' equity
    (deficit)......................  (1,847)  (13,073)   (19,850)     $25,796
                                     ------  --------    -------      =======
                                     $1,998  $  6,145    $34,902
                                     ======  ========    =======
The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-3
COBALT NETWORKS, INC.
                      CONSOLIDATED STATEMENT OF OPERATIONS
                (in thousands, except share and per share data)
Period From
                           October 18,
                               1996           Year Ended
                          (inception) to     December 31,             Six Months Ended
                           December 31,  ----------------------  --------------------------
                               1996         1997        1998     June 30, 1998 July 2, 1999
                          -------------- ----------  ----------  ------------- ------------
                                                                        (unaudited)
Net revenues............    $      --    $      --   $    3,537   $      449    $    7,663
Cost of revenues........           --           --        3,123          582         5,156
                            ----------   ----------  ----------   ----------    ----------
Gross profit (loss).....           --           --          414         (133)        2,507
                            ----------   ----------  ----------   ----------    ----------
Operating expenses:
 Research and
  development...........            22        1,067       3,483        1,204         2,771
 Sales and marketing....           --           245       5,581        1,801         6,273
 General and
  administrative........            60          445       1,895          611         1,454
 Amortization of stock
  compensation..........           --           --          --           --            253
                            ----------   ----------  ----------   ----------    ----------
   Total operating
    expenses............            82        1,757      10,959        3,616        10,751
                            ----------   ----------  ----------   ----------    ----------
Loss from operations....           (82)      (1,757)    (10,545)      (3,749)       (8,244)
Interest income.........           --            17          82            9           217
Interest expense........           --           (29)        (15)         (12)         (217)
                            ----------   ----------  ----------   ----------    ----------
Net loss................           (82)      (1,769)    (10,478)      (3,752)       (8,244)
Accretion of Mandatorily
 Redeemable Convertible
 Preferred Stock........           --           --         (828)         --         (1,191)
                            ----------   ----------  ----------   ----------    ----------
Net loss attributable to
 holders of Common
 Stock..................    $      (82)  $   (1,769) $  (11,306)  $   (3,752)   $   (9,435)
                            ==========   ==========  ==========   ==========    ==========
Basic and diluted net
 loss per share
 attributable to holders
 of Common Stock........                 $    (4.10) $    (5.47)  $    (2.09)   $    (2.83)
                                         ==========  ==========   ==========    ==========
Basic and diluted
 weighted average shares
 outstanding............                    432,000   2,065,000    1,792,000     3,338,000
                                         ==========  ==========   ==========    ==========
Pro forma basic and
 diluted net loss per
 share (unaudited)......                             $    (1.43)                $    (0.60)
                                                     ==========                 ==========
Pro forma basic and
 diluted weighted
 average shares
 outstanding
 (unaudited)............                              7,330,000                 13,808,000
                                                     ==========                 ==========
The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-4
COBALT NETWORKS, INC.
            CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
                       (in thousands, except share data)
Common Stock        Additional    Unearned    Note Receivable
                          ----------------------    Paid-in      Stock           from       Accumulated
                           Shares      Amount       Capital   Compensation    Stockholder     Deficit       Total
                          ---------  -----------  ----------- ------------  --------------- -----------  -----------
Net loss................        --   $       --   $       --  $       --      $       --    $       (82) $       (82)
                          ---------  -----------  ----------- -----------     -----------   -----------  -----------
Balance at December 31,
 1996...................        --           --           --          --              --            (82)         (82)

Issuance of Common
 Stock..................  4,763,000            5          --          --              --            --             5
Repurchase of Common
 Stock..................   (570,000)          (1)         --          --              --            --            (1)
Net loss................        --           --           --          --              --         (1,769)      (1,769)
                          ---------  -----------  ----------- -----------     -----------   -----------  -----------
Balance at December 31,
 1997...................  4,193,000            4          --          --              --         (1,851)      (1,847)

Issuance of Common
 Stock..................    812,000            1           79         --              --            --            80
Repurchase of Common
 Stock..................   (255,000)         --           --          --              --            --           --
Accretion of Mandatorily
 Redeemable Convertible
 Preferred Stock........        --           --           --          --              --           (828)        (828)
Net loss................        --           --                                                 (10,478)     (10,478)
                          ---------  -----------  ----------- -----------     -----------   -----------  -----------
Balance at December 31,
 1998...................  4,750,000            5           79         --              --        (13,157)     (13,073)

Issuance of Common Stock
 (unaudited)............    175,000          --            58         --              (50)          --             8
Issuance of warrants
 (unaudited)............        --           --           532         --              --            --           532
Unearned stock
 compensation
 (unaudited) (Note 11)..        --           --         1,387      (1,387)            --            --           --
Amortization of stock
 compensation
 (unaudited)............        --           --           --          253             --            --           253
Accretion of Mandatorily
 Redeemable Convertible
 Preferred Stock
 (unaudited)............        --           --           --          --              --         (1,191)      (1,191)
Adjustments to
 redemption value of
 Mandatorily Redeemable
 Preferred Stock
 (unaudited)............        --           --         1,865         --              --            --         1,865
Net loss (unaudited)....        --           --           --          --              --         (8,244)      (8,244)
                          ---------  -----------  ----------- -----------     -----------   -----------  -----------
Balance at July 2, 1999
 (unaudited)............  4,925,000  $         5  $     3,921 $    (1,134)    $       (50)  $   (22,592) $   (19,850)
                          =========  ===========  =========== ===========     ===========   ===========  ===========
The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-5
COBALT NETWORKS, INC.
                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                 (in thousands)
Year Ended
                            Period From       December 31,        Six Months Ended
                         October 18, 1996  --------------------  -------------------
                          (inception) to                         June 30,   July 2,
                         December 31, 1996   1997       1998       1998       1999
                         ----------------- ---------  ---------  ---------  --------
                                                                    (unaudited)
Cash flows from
 operating activities:
 Net loss..............      $     (82)    $  (1,769) $ (10,478) $  (3,752) $ (8,244)
 Adjustments to
  reconcile net loss
  to net cash used in
  operating
  activities:
  Depreciation.........            --             18        323         82       369
  Amortization of
   stock
   compensation........            --            --         --         --        253
  Non-cash interest
   expense.............            --             20          2        --        130
  Changes in assets
   and liabilities:
   Accounts
    receivable.........            --            --      (2,040)      (331)   (2,789)
   Inventories.........            --            (20)      (494)        19      (505)
   Other current
    assets.............             (4)          (74)      (161)       (25)      (68)
   Accounts payable....             45           164      3,970        955     1,324
   Accrued
    liabilities........              9            76      1,096        130     1,648
   Deferred margin on
    distributor
    inventory..........            --            --         294        --        423
                             ---------     ---------  ---------  ---------  --------
    Net cash used in
     operating
     activities........            (32)       (1,585)    (7,488)    (2,922)   (7,459)
                             ---------     ---------  ---------  ---------  --------
Cash flows used in
 investing activities
 for acquisition of
 property and
 equipment:                        (23)         (157)    (1,423)      (407)     (428)
                             ---------     ---------  ---------  ---------  --------
Cash flows from
 financing activities:
 Proceeds from
  issuance of
  Mandatorily
  Redeemable
  Convertible
  Preferred Stock,
  net..................            --          2,992      7,210        597    29,583
 Proceeds from
  issuance of Common
  Stock................            --              4         80         80         8
 Proceeds from advance
  from related party...            --            --         500        300       --
 Proceeds from
  borrowings under
  line of credit.......            --            --         600        300       --
 Principal payments on
  line of credit.......            --            --         --         --       (600)
 Proceeds from
  borrowings under
  notes payable........             70           --         431        --        --
 Principal payments on
  notes payable........            --           (130)      (308)       --        (18)
 Proceeds from
  borrowings under
  convertible
  promissory notes.....            --            599        750        750     4,250
                             ---------     ---------  ---------  ---------  --------
   Net cash provided by
    investing
    activities.........             70         3,465      9,263      2,027    33,223
                             ---------     ---------  ---------  ---------  --------
Net increase (decrease)
 in cash and cash
 equivalents...........             15         1,723        352     (1,302)   25,336
Cash and cash
 equivalents at
 beginning of period...            --             15      1,738      1,738     2,090
                             ---------     ---------  ---------  ---------  --------
Cash and cash
 equivalents at end of
 period................      $      15     $   1,738  $   2,090  $     436  $ 27,426
                             =========     =========  =========  =========  ========
Supplemental disclosure
 of cash flow
 information:
 Cash paid for
  interest.............      $     --      $       9  $      13  $     --   $     88
                             =========     =========  =========  =========  ========
 Conversion of notes
  payable and accrued
  interest into
  Mandatorily
  Redeemable
  Convertible
  Preferred Stock......      $     --      $     559  $     750  $     --   $  4,800
                             =========     =========  =========  =========  ========
 Issuance of
  warrants.............      $     --      $     --   $     --   $     --   $    402
                             =========     =========  =========  =========  ========
 Issuance of Common
  Stock for promissory
  note.................      $     --      $     --   $     --   $     --   $     50
                             =========     =========  =========  =========  ========
The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-6
COBALT NETWORKS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

 The Company

  Cobalt Networks, Inc., (formerly ViavisionSystems Inc. and Cobalt
Microserver, Inc.) (the "Company"), was incorporated in California in October
1996. The Company is a leading provider of server appliances. Server appliances
are a new category of network infrastructure devices that are optimized to
deliver one or a few network-based applications well. The Company markets and
sells its products globally through its direct sales force and its channel
partners. The Company operates in one business segment.

 Reincorporation

  On September 1, 1999, the Company's Board of Directors authorized the
reincorporation of the Company in the State of Delaware. As a result of the
reincorporation, the Company is authorized to issue 120,000,000 shares of
$0.001 par value Common Stock and 10,000,000 shares of $0.001 par value
Preferred Stock. The Board of Directors has the authority to issue the
undesignated Preferred Stock in one or more series and to fix the rights,
preferences, privileges and restrictions thereof. The par value and shares of
Common Stock and Preferred Stock authorized, issued and outstanding at each
balance sheet date presented, and for each period presented in the consolidated
statement of stockholders' deficit have been retroactively adjusted to reflect
the reincorporation.

 Principles of consolidation and basis of presentation

  The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All material intercompany transactions and
balances have been eliminated in consolidation.

  Through December 31, 1998 the Company operated on a calendar quarter-end and
year-end basis. Beginning in 1999 the Company changed its accounting periods to
thirteen-week fiscal quarters ending on the Friday closest to the end of the
month.

 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 and 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.

 Revenue recognition

  Revenue from product sales to other than distributors is generally recognized
at the time the product is shipped. Provisions for estimated future product
returns and exchanges are recognized upon product shipment.

  The Company grants distributors limited rights of return on unsold inventory
held by such distributors. The Company has limited control over the extent to
which products sold to distributors are sold through to end users. Accordingly,
the Company recognizes revenues on sales to distributors based on estimates of
products sold through to end users.

  Upon shipment, the Company also provides for the estimated cost that may be
incurred for product warranties.

                                      F-7
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

 Cash equivalents

  The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. The majority of the
Company's cash equivalents consist of money market funds.

 Inventories

  Inventories are stated at the lower of cost or market. Cost is determined
using standard cost which approximates the first-in, first-out method.

 Property and equipment

  Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the shorter of the estimated useful lives of the
assets, generally eighteen months to five years, or the lease term of the
respective assets.

 Research and development

  Research and development costs are charged to operations as incurred.

  Software development costs are included in research and development and are
expensed as incurred. After technological feasibility is established, material
software development costs are capitalized. The capitalized cost is then
amortized on a straight-line basis over the estimated product life, or on the
ratio of current revenues to total projected product revenues, whichever is
greater. To date, the period between achieving technological feasibility, which
the Company has defined as the establishment of a working model which typically
occurs when the beta testing commences, and the general availability of such
software has been short and software development costs qualifying for
capitalization have been insignificant. Accordingly, the Company has not
capitalized any software development costs.

 Income taxes

  Income taxes are computed using the asset and liability method. Deferred
income tax assets or liabilities are established for the expected future
consequences resulting from the temporary differences between the financial
reporting and income tax bases of assets and liabilities and from net operating
loss and tax credit carryforwards. The Company records a valuation allowance
against deferred tax assets when it is more likely than not that such assets
will not be realized.

 Fair value of financial instruments

  The Company's financial instruments, including cash, cash equivalents,
accounts receivable, accounts payable, notes payable and capital lease
obligations are carried at cost, which approximates their fair value because of
the short-term maturity of these instruments.

 Concentration of credit risk

  Financial instruments which potentially subject the Company to a
concentration of credit risk consist principally of cash equivalents and
accounts receivable. The Company places its cash and cash equivalents primarily
in market rate accounts with high credit financial institutions. The Company's
accounts receivable are derived from revenue earned from customers located in
the

                                      F-8
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

United States, Europe and Asia. Sales to foreign customers in 1998, which are
denominated in U.S. dollars, accounted for 44% of total revenue. Sales in the
United States, Japan, Europe and other foreign countries were 56%, 21%, 15% and
8%, respectively, of total revenues in 1998. The Company performs ongoing
credit evaluations of its customers' financial condition and generally requires
no collateral from its customers. The Company maintains an allowance for
doubtful accounts receivable based upon the expected collectibility of accounts
receivable.

  During the year ended December 31, 1998, one customer accounted for
approximately 12% of net revenues. As of December 31, 1998, this customer
accounted for 15% of total accounts receivable. During the period ended July 2,
1999 two customers accounted for approximately 18% and 13% (unaudited),
respectively, of net revenues. As of July 2, 1999, one of these customers
accounted for 23% (unaudited) of total accounts receivable.

 Stock-based compensation

  The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123 "Accounting for Stock-Based Compensation."

  The Company accounts for stock issued to non-employees in accordance with the
provisions of SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18,
"Accounting for Equity Instruments That are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services."

 Foreign currency translation

  The Company uses the U.S. dollar as its functional currency for all of its
worldwide operations. All sales worldwide are billed in U.S. dollars. Foreign
currency assets and liabilities are remeasured into U.S. dollars at the end-of-
period exchange rates. Expenses are translated at average exchange rates in
effect during each period, except for those expenses related to balance sheet
amounts which are translated at historical exchange rates. Gains or losses from
foreign currency remeasurements and transactions are included in net loss and
were not material for all periods presented.

 Comprehensive income

  Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity (net assets)
during a period from nonowner sources. To date, the Company has not had any
transactions that are required to be reported in comprehensive income (loss) as
compared to its reported net loss.

 Net loss per share

  The Company computes net loss per share in accordance with SFAS No. 128,
"Earnings per Share" and SEC Staff Accounting Bulletin No. 98 ("SAB 98"). Under
the provisions of SFAS No. 128 and SAB 98, basic net loss per share is computed
by dividing the net loss available to holders of Common Stock for the period by
the weighted average number of shares of Common Stock outstanding during the
period. Weighted average shares exclude shares of Common Stock subject to
repurchase ("restricted shares"). Diluted net loss per share is computed by
dividing the net loss

                                      F-9
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

available to holders of Common Stock for the period by the weighted average
number of shares of Common Stock and potential Common Stock outstanding during
the period, if dilutive. Potential Common Stock includes unvested restricted
shares of Common Stock and incremental shares of Common Stock issuable upon the
exercise of stock options and warrants and upon conversion of Series A, B, and
C Mandatorily Redeemable Convertible Preferred Stock.

  The following table sets forth the computation of basic and diluted net loss
per share for the periods indicated (in thousands, except share and per share
data):
Period From                               Six Months Ended
                            October 18, 1996  Year Ended December 31,   --------------------
                             (inception) to   ------------------------    June 30,July 2,
                            December 31, 1996    1997         1998        1998       1999
                            ----------------- -----------  -----------  ---------  ---------
                                                                            (unaudited)
Numerator:
     Net loss attributable
      to holders of Common
      Stock................    $      (82)    $    (1,769) $   (11,306) $  (3,752) $  (9,435)
                               ==========     ===========  ===========  =========  =========
   Denominator:
     Weighted average
      shares outstanding...           --        2,519,000    4,700,000  4,626,000  4,834,000
     Weighted average
      shares of Common
      Stock subject to
      repurchase...........           --        2,087,000    2,635,000  2,834,000  1,496,000
                               ----------     -----------  -----------  ---------  ---------
     Denominator for basic
      and diluted
      calculation..........           --          432,000    2,065,000  1,792,000  3,338,000
                               ==========     ===========  ===========  =========  =========
   Basic and diluted net
    loss per share
    attributable to holders
    of Common Stock........    $      --      $     (4.10) $     (5.47) $   (2.09) $   (2.83)
                               ==========     ===========  ===========  =========  =========
The effects of options to purchase 238,000, 1,622,000 and 2,145,000
(unaudited) shares of Common Stock at an average exercise price of $0.03, $0.26
and $0.69 (unaudited) per share; warrants to purchase 164,000, 204,000 and
283,000 (unaudited) shares of Preferred Stock at an average exercise price of
$1.00, $1.24 and $1.93 (unaudited) per share; and 3,572,000, 7,271,000 and
17,085,000 (unaudited) shares of Mandatorily Redeemable Convertible Preferred
Stock for the years ended December 31, 1997 and 1998 and the six months ended
July 2, 1999, respectively, and warrants to purchase 243,000 (unaudited) shares
of Common Stock at $3.70 (unaudited) per share at July 2, 1999, have not been
included in the computation of diluted net loss per share as their effect would
have been anti-dilutive.

 Pro forma net loss per share (unaudited)

  Pro forma net loss per share for the year ended December 31, 1998 and the six
months ended July 2, 1999 is computed using the weighted average number of
shares of Common Stock

                                      F-10
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

outstanding, including the pro forma effects of the automatic conversion of the
Company's Series A, B, and C Mandatorily Redeemable Convertible Preferred Stock
into shares of the Company's Common Stock effective upon the closing of the
Company's initial public offering as if such conversion occurred on January 1,
1998 or at the date of original issuance, if later. The resulting pro forma
adjustment includes an increase in the weighted average shares used to compute
basic net loss per share of 5,265,000 for the year ended December 31, 1998 and
10,470,000 for the six months ended July 2, 1999.

 Segment information

  In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
This statement establishes standards for the way companies report information
about operating segments in annual financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. During each period presented, the Company operated in a
single business segment, primarily in the United States, Japan and Europe.

 New accounting pronouncement

  In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 established methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. The Company has not
yet determined what the effect of SFAS No. 133 will be on the operations and
financial position of the Company. The Company will be required to implement
SFAS No. 133 beginning in 2001.

 Unaudited interim results

  The accompanying consolidated balance sheet as of July 2, 1999, the
consolidated statements of operations and cash flows for the six months ended
July 2, 1999 and June 30, 1998 and the consolidated statement of stockholders'
deficit for the six months ended July 2, 1999 are unaudited. In the opinion of
management, these statements have been prepared on the same basis as the
audited financial statements and include all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the Company's
financial position and its results of operations and cash flows for the interim
periods. The data included in notes to the financial statements for these
periods is unaudited.

                                      F-11
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 2--BALANCE SHEET COMPONENTS (in thousands):
December 31,
                                                   ----------------    July 2,
                                                    1997     1998       1999
                                                   -------  -------  -----------
                                                                     (unaudited)
Inventories:
     Finished goods............................... $   --   $   498    $   813
     Raw materials................................      20       16        206
                                                   -------  -------    -------
       Total...................................... $    20  $   514    $ 1,019
                                                   =======  =======    =======

   Property and equipment:
     Computer equipment........................... $   100  $   456    $   737
     Office equipment and fixtures................       4      280        416
     Production equipment and tooling.............      76      417        417
     Leasehold improvements.......................     --       450        461
                                                   -------  -------    -------
                                                       180    1,603      2,031
     Less: Accumulated depreciation...............     (18)    (341)      (710)
                                                   -------  -------    -------
                                                   $   162  $ 1,262    $ 1,321
                                                   =======  =======    =======
   Accrued liabilities:
     Employee benefits............................ $    55  $   543    $ 1,042
     Reserve for sales returns....................     --       386        979
     Warranty.....................................     --       181        494
     Other........................................      30       73        266
                                                   -------  -------    -------
                                                   $    85  $ 1,183    $ 2,781
                                                   =======  =======    =======
NOTE 3--DEBT:

 Line of credit

  At December 31, 1998, the Company had $600,000 outstanding under a line of
credit agreement with a bank. The line of credit provides for borrowings of up
to $800,000 which are secured by the assets of the Company. The line of credit
expired in May 1999 and bears interest at prime plus 0.75% per annum (8.75% at
December 31, 1998).

 Notes payable

  In September 1998, the Company entered into an equipment lease financing
agreement with a leasing company. The agreement provides for borrowings of up
to $1.0 million which are secured by the Company's equipment, machinery and
fixtures. As of December 31, 1998 and July 2, 1999, the Company had outstanding
borrowings under this agreement of $123,000 and $105,000 (unaudited),
respectively. The note balance is payable in 34 equal monthly installments and
bears interest at 10.95% per annum. Future principal payments under this note
are as follows (in thousands):
Year Ending
       December 31,
       ------------
1999............................................................... $ 39
        2000...............................................................   44
        2001...............................................................   40
                                                                            ----
                                                                            $123
                                                                            ====
F-12
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  In November 1996 and December 1996, the Company borrowed a total of $70,000
from a stockholder which bore interest at 10% per annum. In connection with
this loan, the Company issued warrants to purchase 17,500 shares of Series A
Mandatorily Redeemable Convertible Preferred Stock at $1.00 per share. The
estimated fair value of the warrants at the grant date was not material to the
financial statements.

  In January 1997 and March 1997, the Company borrowed an additional $60,000
from the same stockholder which bore interest at 10% per annum. In connection
with this loan, the Company issued warrants to purchase 15,000 shares of Series
A Mandatorily Redeemable Convertible Preferred Stock at $1.00 per share. The
estimated fair value of the warrants at the grant date was not material to the
financial statements.

  In September 1997, the Company repaid the above loans.

  In June 1998, the Company borrowed $300,000 from a stockholder which bore
interest at 5.5% per annum. In connection with the loan, the Company issued
warrants to purchase 7,000 shares of Series B Mandatorily Redeemable
Convertible Preferred Stock at $2.163 per share. The estimated fair value of
the warrants at the grant date was not material to the financial statements. In
July 1998, the Company repaid the loan in full.

 Convertible promissory notes payable

  During the year ended December 31, 1997, the Company borrowed $539,000 from
various individuals under convertible promissory notes bearing interest at 10%
per annum. In connection with these notes, the Company issued warrants to
purchase 131,000 shares of Series A Mandatorily Redeemable Convertible
Preferred Stock at $1.00 per share. The estimated fair value of these warrants
at the grant date was not material to the financial statements. These notes,
including $20,000 of accrued interest, were converted into Series A Mandatorily
Redeemable Convertible Preferred Stock at $1.00 per share in September 1997.

  In April 1998, the Company borrowed $750,000 from various individuals under
convertible promissory notes bearing interest at 5.5% per annum. In connection
with these borrowings, the Company issued warrants to purchase 35,000 shares of
Series B Mandatorily Redeemable Convertible Preferred Stock at $2.163 per
share. The estimated fair value of the warrants at the grant date was not
material to the financial statements. These notes were converted into Series B
Mandatorily Redeemable Convertible Preferred Stock at $2.163 per share in July
1998.

  In December 1998, the Company borrowed $500,000 from an affiliate of a member
of its Board of Directors and $50,000 from an individual investor under
convertible promissory notes bearing interest at 6% per annum. These notes were
converted to Series C Mandatorily Redeemable Preferred Stock in May 1999 (See
Note 11).

                                      F-13
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 4--MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK:

  Mandatorily Redeemable Convertible Preferred Stock ("Preferred Stock") at
December 31, 1998 and July 2, 1999 (unaudited) consists of the following (in
thousands, except share data):
Shares
                                 ---------------------- Liquidation Redemption
                                 Authorized Outstanding   Amount     Amounts
                                 ---------- ----------- ----------- ----------
Series A........................  3,735,000  3,572,000    $ 3,572    $ 3,572
Series B........................  3,741,000  3,699,000      8,000      8,000
                                 ---------- ----------    -------
Balance at December 31, 1998....  7,476,000  7,271,000     11,572
Series C (unaudited)............ 10,134,000  9,814,000     36,310     34,074
                                 ---------- ----------    -------    -------
Balance at July 2, 1999
 (unaudited).................... 17,610,000 17,085,000    $47,882    $45,646
                                 ========== ==========    =======    =======
During 1997, the Company issued 3,571,000 shares of Series A Preferred Stock
at $1.00 per share for net proceeds of approximately $3.0 million and the
conversion of $559,000 of notes payable described in Note 3. In July 1998, the
Company issued 1,000 shares of Series A Preferred Stock at $1.00 per share for
net proceeds of $1,000 upon the exercise of a warrant.

   In July 1998, the Company issued 3,699,000 shares of Series B Preferred
Stock at $2.163 per share for net proceeds of approximately $7.2 million and
the conversion of $750,000 of notes payable described in Note 3.

  The holders of Preferred Stock have various rights and preferences as
follows:

 Voting

  Each share of Preferred Stock has voting rights equal to an equivalent number
of shares of Common Stock into which it is convertible and votes together as
one class with the Common Stock.

  As long as at least 750,000 shares of Preferred Stock are outstanding, the
Company must obtain approval from two-thirds of the then outstanding shares of
Preferred Stock in order to alter the articles of incorporation as related to
Preferred Stock, authorize or issue any other equity security senior to or on a
parity with Preferred Stock, redeem or purchase any shares of Preferred Stock
other than by redemption in accordance with the certificate of incorporation,
increase or decrease the number of authorized shares of Preferred Stock,
authorize a dividend for any class or series other than Preferred Stock,
increase the size of the Board of Directors, or acquire any other company or
business.

 Conversion

  Each share of Preferred Stock outstanding is convertible into one share of
Common Stock, subject to adjustment for dilution, and will be converted into
Common Stock in the event of the closing of a public offering of at least
$20,000,000 at a minimum price of $7.50 per share. As of December 31, 1998, the
Company had reserved 7,271,000 shares of its Common Stock for issuance upon
conversion of the outstanding Preferred Stock.

                                      F-14
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

 Dividends

  Holders of Series A and B are entitled to receive cumulative dividends at the
per annum rate of $0.10 and $0.2163 per share, respectively, when and if
declared by the Board of Directors, prior to payment of dividends on Common
Stock. No dividends have been declared.

 Liquidation

  In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, holders of the Series B are entitled to
receive $2.163 per share, plus any declared but unpaid dividends, prior to any
distribution to the holders of Series A and Common Stock. Holders of Series A
are entitled to receive $1.00 per share, plus any declared but unpaid
dividends, prior to distribution to the holders of Common Stock. Any assets
remaining after distribution of the preference amounts on the Series A and
Common Stock will be distributed on a pro rata basis, assuming conversion of
the Preferred Stock.

 Redemption

  The holders of Preferred Stock may cause the Company to redeem their shares
after the fifth and before the seventh anniversary of the Series B issue date.
Redemption will be at the greater of fair market value or the original purchase
price plus accrued but unpaid dividends. During 1998, the Company recorded a
charge to its accumulated deficit of approximately $828,000 related to the
accretion to the Preferred Stock redemption value. As described in Note 11, in
connection with the issuance of Series C Preferred Stock in April 1999, the
redemption amount was modified to equal the original purchase price plus
accrued but unpaid dividends.

NOTE 5--COMMON STOCK:

  Certain shares of Common Stock outstanding were sold under Restricted Stock
Purchase Agreements (the "Agreements"). According to the terms of the
Agreements, in the event that the purchaser ceases their relationship with the
Company, the Company has the right to repurchase shares issued at the original
purchase price ("purchase option"), subject to a declining percentage over
time. During 1998 and 1997, the Company exercised its purchase option for
255,000 shares and 570,000 shares, respectively, of Common Stock at $0.001 per
share. As of December 31, 1998 and July 2, 1999, a total of 2,232,000 and
1,287,000 (unaudited) shares, respectively, were subject to repurchase by the
Company. Additionally, in the event that the purchase option has lapsed and the
purchaser decides to sell their shares, the Company has the first right of
refusal with respect to such shares.

NOTE 6--STOCK OPTIONS PLAN:

  In April 1997, the Company adopted the Employee Stock Option Plan ( the
"Plan"). The Plan provides for the granting of stock options and Common Stock
to employees and consultants of the Company. Options granted under the Plan may
be either incentive stock options or nonqualified stock options. Incentive
stock options ("ISO") may be granted only to Company employees (including
officers and directors who are also employees). Nonqualified stock options
("NSO") may be granted to Company employees and consultants. At December 31,
1998 and July 2, 1999, the Company has reserved 2,550,000 and 3,100,000
(unaudited) shares, respectively, of Common Stock for issuance under the Plan.

                                      F-15
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  Options under the Plan may be granted for periods of up to ten years and at
prices no less than 85% of the estimated fair value of the shares on the date
of grant as determined by the Board of Directors, provided, however, that (i)
the exercise price of an ISO and NSO shall not be less than 100% and 85% of the
estimated fair value of the shares on the date of grant, respectively, and (ii)
the exercise price of an ISO and NSO granted to a 10% shareholder shall not be
less than 110% of the estimated fair value of the shares on the date of grant,
respectively. Options are generally exercisable immediately, subject to
repurchase options held by the Company. The repurchase options lapse over a
maximum period of five years at such times and under such conditions as
determined by the Board of Directors. Options vest over 4 years, 25% after the
first year and ratably each month over the remaining 36 months.

  During 1998, the Company issued NSOs to an outside consultant to purchase
25,000 shares of Common Stock at $0.50 per share, the estimated grant date fair
market value. The estimated fair value of the options was not material to the
financial statements.

  The following table summarizes stock option activity under the Plan:
Weighted
                                                                      Average
                                             Options                  Exercise
                                            Available     Options      Price
                                            for Grant   Outstanding  Per Share
                                            ----------  -----------  ----------
Balance at December 31, 1996...............        --          --    $      --
  Authorized...............................  1,145,000         --           --
  Granted..................................   (826,000)    826,000        0.008
  Exercised................................        --     (110,000)       0.001
  Canceled.................................    478,000    (478,000)       0.001
                                            ----------  ----------
Balance at December 31, 1997...............    797,000     238,000
  Authorized...............................  1,405,000         --           --
  Granted.................................. (1,437,000)  1,437,000        0.500
  Exercised................................        --      (12,000)       0.001
  Canceled.................................     41,000     (41,000)       0.190
                                            ----------  ----------
Balance at December 31, 1998...............    806,000   1,622,000
  Authorized (unaudited)...................    550,000         --           --
  Granted (unaudited)......................   (742,000)    742,000         1.53
  Exercised (unaudited)....................        --      (75,000)        0.17
  Canceled (unaudited).....................    144,000    (144,000)        0.38
                                            ----------  ----------
Balance at July 2, 1999 (unaudited)........    758,000   2,145,000
                                            ==========  ==========
F-16
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  The following table summarizes information about stock options outstanding
and exercisable as of December 31, 1998.
Options
                               Options Outstanding           Exercisable at
                              at December 31, 1998         December 31, 1998
                       ----------------------------------- ------------------
                                                  Weighted           Weighted
                                 Weighted Average Average            Average
    Range of Exercise  Number of    Remaining     Exercise Number of Exercise
         Prices         Shares   Contractual Life  Price    Shares    Price
   ------------------- --------- ---------------- -------- --------- --------
$0.001.............    32,000    8.38 years    $ 0.001   12,000   $ 0.001
    0.100.............   928,000    9.17 years      0.100   48,000     0.100
    0.500.............   662,000    9.65 years      0.500      --        --
                       ---------                            ------
                       1,622,000                            60,000
                       =========                            ======
Fair value disclosures

  Had compensation cost for the Company's stock-based compensation plan been
determined based on the fair value at the grant dates for the awards under a
method prescribed by SFAS No. 123, the Company's net loss for the years ended
December 31, 1996, 1997 and 1998 would have been increased to the pro forma
amounts indicated in the following table (in thousands, except per share data):
Year Ended December 31,
                                                -----------------------------
                                                  1996      1997      1998
                                                --------  --------  ---------
Net loss attributable to holders of Common
    Stock:
     As reported............................... $    (82) $ (1,769) $ (11,306)
                                                ========  ========  =========
     Pro forma................................. $    (82) $ (1,774) $ (11,412)
                                                ========  ========  =========
   Basic and diluted net loss per share
    attributable to holders of Common Stock:
     As reported...............................           $  (4.10) $   (5.47)
                                                          ========  =========
     Pro forma.................................           $  (4.11)  $  (5.53)
                                                          ========  =========
The Company calculated the minimum fair value of each option grant on the
date of grant using the Black-Scholes pricing model with the following
assumptions:
Year Ended
                                                                 December 31,
                                                                 --------------
                                                                  1997    1998
                                                                 ------  ------
Expected life (years)........................................      5       5
   Risk free interest rate......................................   6.03%   6.66%
   Expected volatility..........................................    --      --
   Dividend yield...............................................    --      --
The estimated weighted average fair value of options granted to purchase
shares of common stock under the Plan in 1997 and 1998 was $0.01 and $0.07,
respectively.

                                      F-17
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 7--EMPLOYEE BENEFIT PLANS:

  The Company sponsors a 401(k) defined contribution plan (the "Plan") covering
all eligible employees. Contributions made by the Company are determined
annually by the Board of Directors. No contributions have been made to the Plan
by the Company.

NOTE 8--INCOME TAXES:

  No provision or benefit for income taxes has been recognized for any of the
periods presented as the Company has incurred net operating losses since
inception.

  At December 31, 1998, the Company has approximately $11 million of net
operating loss carryforwards available to offset future taxable income for
Federal and California purposes which expire beginning in 2011 and 2004,
respectively. Under the Tax Reform Act of 1986, the amount of net operating
losses that can be utilized may be limited in certain circumstances including,
but not limited to, a cumulative stock ownership change of more than 50% over a
three-year period.

  Deferred tax assets of approximately $4.4 million and $400,000 at December
31, 1998 and 1997, respectively, consist primarily of federal and California
net operating loss carryforwards. Based on a number of factors, including the
lack of a history of profits and the fact that the Company competes in a
developing market that is characterized by rapidly changing technology,
management believes there is sufficient uncertainty regarding the realization
of deferred tax assets such that a full valuation allowance has been provided.

NOTE 9--COMMITMENTS:

  The Company leases office space under a noncancelable operating lease which
expires on December 31, 2003. Rent expense for the year ended December 31, 1998
and 1997 was $316,000 and $73,000, respectively. Rent expense for the period
ended July 2, 1999 was $392,000 (unaudited).

  Future minimum lease payments under noncancelable operating leases are as
follows (in thousands):
Year Ended
       December 31,
       ------------
1999............................................................. $  726
        2000.............................................................    743
        2001.............................................................    794
        2002.............................................................    827
        2003.............................................................    844
                                                                          ------
                                                                          $3,934
                                                                          ======
NOTE 10--CONTINGENCIES:

  Pursuant to the Company's turnkey service and purchase agreement with its
subcontract manufacturer, in the event that the agreement is terminated, the
Company would be required to purchase remaining surplus or obsolete inventory
which is specific to the Company's products.

  On December 4, 1998, Cube Computer Corporation filed suit against the Company
claiming the use of the trademark Qube for its server products constitutes a
trademark infringement of Cube Computer Corporation's registered Cube trademark
for computer hardware products. The Company

                                      F-18
COBALT NETWORKS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

intends to defend this matter vigorously but is unable to provide an evaluation
of the probability of a favorable or unfavorable outcome. Management believes,
based on currently available information, the resolution of this matter will
not have a material adverse effect on its financial position or cash flows.

NOTE 11--SUBSEQUENT EVENTS

 Financings

  In February and March 1999, the Company borrowed $4.25 million from various
investors under convertible promissory notes bearing interest at 6.0% per
annum. These notes were converted into Series C Mandatorily Redeemable
Preferred Stock in May 1999. In connection with the notes, the Company issued
warrants to purchase 79,045 shares of Series C Mandatorily Redeemable
Convertible Preferred Stock at $3.70 per share. The estimated fair value of the
warrants at the grant date was $130,000 and was recorded as interest expense.

  In April 1999, the Company amended its articles of incorporation to increase
its authorized shares to 26,000,000 shares of Common Stock and 17,610,000
shares of Preferred Stock, of which 10,134,452 shares were designated as Series
C Mandatorily Redeemable Convertible Preferred Stock. The Company also revised
the redemption provisions of its Preferred Stock such that the redemption
amount is the original issue price plus accrued dividends.

  In May 1999, the Company issued 9,814,000 shares of Series C Mandatorily
Redeemable Preferred Stock at $3.70 per share for net proceeds of approximately
$29.6 million and the conversion of $4.80 million of notes payable described in
Note 3 and above. In connection with the transaction, the Company issued a
warrant to purchase 243,000 shares of Common Stock at $3.70 per share. The
estimated fair value of the warrants at the date of grant was $402,000, which
was recorded as additional paid in capital. The rights of Series C are similar
to Series B except, among other differences, the holders of Series C are
entitled to noncumulative dividends of $0.37 per share and the liquidation
preference is $3.70 per share.

 Unearned stock compensation

  In connection with certain stock option grants during the six months ended
July 2, 1999, the Company recorded unearned stock compensation cost totaling
$1.4 million which is being recognized over the vesting period of the related
options of four years. Amortization expense associated with unearned stock
compensation totaled $253,000 for the six months ended July 2, 1999.

  During the period from July 3, 1999 through September 3, 1999, the Company
granted options to purchase an aggregate of 1,355,000 shares of Common Stock at
exercise prices ranging from $2.50 to $10.00 per share. The Company expects to
record additional unearned stock compensation with respect to these options
totaling $7.4 million. The Company will record amortization expense associated
with unearned stock compensation of $893,000 and $1.2 million in the third and
fourth quarters of fiscal 1999 and $1.2 million, $1.2 million, $847,000 and
$615,000 in the first, second, third and fourth quarters of fiscal 2000,
respectively.

 Note Receivable from Stockholder

  In August 1999, the Company advanced $500,000 to its Chief Executive Officer.
In September 1999, the advance was converted into a full recourse non-interest
bearing promissory note payable in four years and is secured by 50,000 shares
of Series B Preferred Stock.

                                      F-19
UNDERWRITING

  Cobalt and the underwriters for the offering named below have entered into an
underwriting agreement with respect to the shares being offered. Subject to
certain conditions, each underwriter has severally agreed to purchase the
number of shares indicated in the following table. Goldman, Sachs & Co.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated and BancBoston Robertson
Stephens Inc. are the representatives of the underwriters.
Underwriter                          Number of Shares
                           -----------                          ----------------
Goldman, Sachs & Co. .......................................
   Merrill Lynch, Pierce, Fenner & Smith Incorporated..........
   BancBoston Robertson Stephens Inc. .........................
                                                                   ---------
     Total.....................................................
                                                                   =========
---------------

  If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional
shares from Cobalt to cover such sales. They may exercise that option for 30
days. If any shares are purchased under this option, the underwriters will
severally purchase shares in approximately the same proportion as set forth in
the table above.

  The following tables show the per share and total underwriting discounts and
commissions to be paid to the underwriters by Cobalt. These amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase additional shares.
Paid by Cobalt
                                                       -------------------------
                                                       No Exercise Full Exercise
                                                       ----------- -------------
Per Share............................................. $            $
Total................................................. $            $
Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus.
Any shares sold by the underwriters to securities dealers may be sold at a
discount of up to $    per share from the initial public offering price. Any of
these securities dealers may resell any shares purchased from the underwriters
to other brokers or dealers at a discount of up to $    per share from the
initial public offering price. If all the shares are not sold at the initial
public offering price, the representatives may change the offering price and
the other selling terms.

  Cobalt and its directors, officers, employees and substantially all holders
of shares of Cobalt's common stock have agreed with the underwriters not to
dispose of or hedge any of their common stock or securities convertible into or
exchangeable for shares of common stock during the period from the date of this
prospectus continuing through the date 180 days after the date of this
prospectus, except with the prior written consent of Goldman, Sachs & Co. This
restriction does not apply to any issuances under Cobalt's existing employee
benefit plans. The underwriters have agreed that the holders of up to 100,000
shares may sell those shares beginning 30 days after the date this offering is
declared effective provided that the shares are sold through Goldman, Sachs &
Co. and at a time agreeable to both Goldman, Sachs & Co. and Cobalt. See
"Shares Eligible for Future Sale" for a discussion of transfer restrictions.

                                      U-1
Prior to this offering, there has been no public market for the common stock.
The initial public offering price for the common stock will be negotiated among
Cobalt and the representatives of the underwriters. Among the factors to be
considered in determining the initial public offering price of the shares, in
addition to prevailing market conditions, are Cobalt's historical performance,
estimates of Cobalt's business potential and earnings prospects, an assessment
of Cobalt's management and the consideration of the above factors in relation
to market valuation of companies in related businesses.

  Application has been made for quotation of the common stock on the Nasdaq
National Market under the symbol "COBT".

  In connection with this offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering.
Stabilizing transactions consist of bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.

  The underwriters may also impose a penalty bid. This occurs when a particular
underwriter repays to the underwriters a portion of the underwriting discount
received by it because the representatives have repurchased shares sold by or
for the account of this underwriter in stabilizing or short-sale covering
transactions.

  These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the
open market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.

  The underwriters do not expect sales to discretionary accounts to exceed five
percent of the total number of shares offered.

  At Cobalt's request, the underwriters have reserved up to        shares of
the common stock offered hereby for sale, at the initial public offering price,
to customers and other friends of Cobalt through a directed share program. The
number of shares available for sale to the general public will be reduced to
the extent these persons purchase the reserved shares. There can be no
assurance that any of the reserved shares will be so purchased. Any reserved
shares not so purchased will be offered by the underwriters to the general
public on the same basis as other shares offered hereby.

  Cobalt estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $1,050,000.

  Cobalt has agreed to indemnify the underwriters against liabilities,
including liabilities under the Securities Act of 1933.

                                      U-2
[Description for EDGAR: Picture of a woman holding 4 Cobalt RaQ server
appliances with stacks of Cobalt RaQ server appliances in the background.
Underneath the picture is the caption "The Cobalt RaQ" and beneath that is the
following text: "Simple. Affordable. The dedicated hosting solution that is
less than two inches tall." Beneath this text is the Cobalt logo and the words
"Cobalt Networks".]
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

  No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is an offer to
sell only the shares offered hereby, but only under circumstances and in
jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.

                                --------------

                               TABLE OF CONTENTS
Page
                                                                          ----
Prospectus Summary.......................................................   3
Risk Factors.............................................................   7
Forward-Looking Statements...............................................  22
Use of Proceeds..........................................................  23
Dividend Policy..........................................................  23
Capitalization...........................................................  24
Dilution.................................................................  25
Selected Consolidated Financial Data.....................................  26
Management's Discussion and Analysis of Financial Condition and Results
 of Operations ..........................................................  28
Business.................................................................  39
Management...............................................................  53
Related Party Transactions...............................................  62
Principal Stockholders...................................................  65
Description of Capital Stock ............................................  68
Shares Eligible for Future Sale..........................................  72
Legal Matters............................................................  73
Experts..................................................................  73
Where You Can Find Additional Information................................  74
Index to Consolidated Financial Statements............................... F-1
Underwriting............................................................. U-1
--------------

  Through and including     , 1999 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to a dealer's obligation to deliver a prospectus when
acting as underwriter and with respect to an unsold allotment or subscription.

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

                                        Shares

                             Cobalt Networks, Inc.

                                  Common Stock

                                --------------

                           [COBALT LOGO APPEARS HERE]

                                --------------

                              Goldman, Sachs & Co.

                              Merrill Lynch & Co.

                         BancBoston Robertson Stephens

                      Representatives of the Underwriters

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
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 the
underwriting discounts, payable by the Registrant in connection with the sale
of the securities being registered. All amounts are estimates except the SEC
registration fee, the NASD filing fee and the Nasdaq National Market listing
fee.
SEC Registration Fee............................................. $   23,978
   NASD Filing Fee..................................................      9,125
   Nasdaq National Market Listing Fee...............................     95,000
   Printing Costs...................................................    275,000
   Legal Fees and Expenses..........................................    350,000
   Accounting Fees and Expenses.....................................    250,000
   Blue Sky Fees and Expenses.......................................      5,000
   Transfer Agent and Registrar Fees................................     10,000
   Miscellaneous....................................................     31,897
                                                                     ----------
         Total...................................................... $1,050,000
                                                                     ==========
Item 14. Indemnification of Directors and Officers.

  As permitted by Section 204(a) of the California General Corporation Law, the
Registrant's Amended and Restated Articles of Incorporation eliminate a
director's personal liability for monetary damages to the Registrant and its
shareholders arising from a breach or alleged breach of the director's
fiduciary duty, except for liability arising under Sections 310 and 316 of the
California General Corporation Law or liability for (i) acts or omissions that
involve intentional misconduct or knowing and culpable violation of law, (ii)
acts or omissions that a director believes to be contrary to the best interests
of the Registrant or its shareholders or that involve the absence of good faith
on the part of the director, (iii) any transaction from which a director
derived an improper personal benefit, (iv) acts or omissions that show a
reckless disregard for the director's duty to the Registrant 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 serious injury to the Registrant or its shareholders, (v) acts or omissions
that constitute an unexcused pattern of inattention that amounts to an
abdication of the director's duty to the Registrant or its shareholders, (vi)
interested transactions between the corporation and a director in which a
director has a material financial interest, and (vii) liability for improper
distributions, loans or guarantees. This provision does not eliminate the
directors' duty of care, and in appropriate circumstances equitable remedies
such as an injunction or other forms of non-monetary relief would remain
available under California law.

  Sections 204(a) and 317 of the California General Corporation Law authorize a
corporation to indemnify its directors, officers, employees and other agents in
terms sufficiently broad to permit indemnification (including reimbursement for
expenses) under certain circumstances for liabilities arising under the
Securities Act of 1933, as amended (the "Securities Act"). The Registrant's
Amended and Restated Articles of Incorporation and Bylaws contain provisions
covering indemnification to the maximum extent permitted by the California
General Corporation Law of corporate directors, officers and other agents
against certain liabilities and expenses incurred as a result of proceedings
involving such persons in their capacities as directors, officers employees or
agents, including proceedings under the Securities Act or the Securities
Exchange Act of 1934, as amended. Prior to the effective date of this Offering,
the Registrant will enter into indemnification agreements with its directors
and executive officers.

  In connection with its reincorporation in Delaware, the Registrant will be
subject to Section 145 of the Delaware General Corporation Law ("Section 145").
Section 145 permits indemnification of

                                      II-1
officers and directors of the Company under certain conditions and subject to
certain limitations. Section 145 also provides that a corporation has the power
to maintain insurance on behalf of its officers and directors against any
liability asserted against such person and incurred by him or her in such
capacity, or arising out of his or her status as such, whether or not the
corporation would have the power to indemnify him or her against such liability
under the provisions of Section 145. Upon shareholder approval of such
reincorporation, Article VI, Section 6.1, of the Registrant's Bylaws will
provide for mandatory indemnification of its directors and officers and
permissible indemnification of employees and other agents to the maximum extent
not prohibited by the Delaware General Corporation Law. The rights to indemnity
thereunder continue as to a person who has ceased to be a director, officer,
employee or agent and inure to the benefit of the heirs, executors and
administrators of the person. In addition, expenses incurred by a director or
executive officer in defending any civil, criminal, administrative or
investigative action, suit or proceeding by reason of the fact that he or she
is or was a director or officer of the Registrant (or was serving at the
Registrant's request as a director or officer of another corporation) shall be
paid by the Registrant in advance of the final disposition of such action, suit
or proceeding upon receipt of an undertaking by or on behalf of such director
or officer to repay such amount if it shall ultimately be determined that he or
she is not entitled to be indemnified by the Registrant as authorized by the
relevant section of the Delaware General Corporation Law.

  As permitted by Section 102(b)(7) of the Delaware General Corporation Law,
the Registrant's Certificate of Incorporation provides that, pursuant to
Delaware law, its directors shall not be personally liable for monetary damages
for breach of the directors' fiduciary duty as directors to the Registrant and
its stockholders. This provision in the Certificate of Incorporation does not
eliminate the directors' fiduciary duty, and in appropriate circumstances
equitable remedies such as injunctive or other forms of non-monetary relief
will remain available under Delaware law. In addition, each director will
continue to be subject to liability for breach of the director's duty of
loyalty to the Registrant for acts or omission not in good faith or involving
international misconduct, for knowing violations of law, for actions leading to
improper personal benefit to the director, and for payment of dividends or
approval of Stock repurchases or redemptions that are unlawful under Section
174 of the Delaware General Corporation Law. The provision also does not affect
a director's responsibilities under any other law, such as the federal
securities laws or state or federal environmental laws. The Registrant has
entered into indemnification agreements with each of its directors and
executive officers. Generally, the indemnification agreements attempt to
provide the maximum protection permitted by Delaware law as it may be amended
from time to time. Moreover, the indemnification agreements provide for certain
additional indemnification. Under such additional indemnification provisions,
however, an individual will not receive indemnification for judgments,
settlements or expenses if he or she is found liable to the Registrant (except
to the extent the court determines he or she is fairly and reasonably entitled
to indemnity for expenses), for settlements not approved by the Registrant or
for settlements and expenses if the settlement is not approved by the court.
The indemnification agreements provide for the Registrant to advance to the
individual any and all reasonable expenses (including legal fees and expenses)
incurred in investigating or defending any such action, suit or proceeding. In
order to receive an advance of expenses, the individual must submit to the
Registrant copies of invoices presented to him or her for such expenses. Also,
the individual must repay such advances upon a final judicial decision that he
or she is not entitled to indemnification.

  The Registrant intends to enter into additional indemnification agreements
with each of its directors and executive officers to effectuate these indemnity
provisions and to purchase directors' and officers' liability insurance.

  In addition to the foregoing, the Underwriting Agreement contains certain
provisions by which the Underwriters have agreed to indemnify the Registrant,
each person, if any, who controls the

                                      II-2
Registrant within the meaning of Section 15 of the Securities Act, each
director of the Registrant, each officer of the Registrant who signs the
Registration Statement, with respect to information furnished in writing by or
on behalf of the Underwriters for use in the Registration Statement.

  At present, there is no pending litigation or proceeding involving a
director, officer, employee or other agent of the Registrant in which
indemnification is being sought, nor is the Registrant aware of any threatened
litigation that may result in a claim for indemnification by any director,
officer, employee or other agent of the Registrant.

Item 15. Recent Sales of Unregistered Securities.

  Since our incorporation in October 1996, we have sold and issued the
following securities:

    (1) In May and June 1997 the Registrant issued and sold 4,181,426 shares
  of Common Stock to employees for $4,181 pursuant to Section 4(2) of the
  Securities Act.

    (2) In August 1997, the Registrant issued and sold 471,338 shares of
  Common Stock to three employees for $471 pursuant to Section 4(2) of the
  Securities Act.

    (3) From August to November 1997, the Registrant issued and sold
  3,572,401 shares of Series A Preferred Stock to 13 investors for $3.6
  million pursuant to Section 4(2) of the Securities Act.

    (4) In March and April 1998, the Registrant issued and sold 800,000
  shares of Common Stock to one employee for $80,000 pursuant to Section 4(2)
  of the Securities Act.

    (5) In July 1998, the Registrant issued and sold 3,698,910 shares of
  Series B Preferred Stock to 21 investors for $8.0 million pursuant to
  Section 4(2) of the Securities Act.

    (6) In February 1999, the Registrant issued and sold 100,000 shares of
  Common Stock to one employee for $50,000 pursuant to Section 4(2) of the
  Securities Act.

    (7) In May 1999, the Registrant issued and sold 9,813,507 shares of
  Series C Preferred Stock to 60 investors for $36.3 million pursuant to
  Section 4(2) of the Securities Act.

    (8) Pursuant to Rule 701 promulgated under the Securities Act, from
  October 18, 1996 to July 2, 1999, the Registrant issued and sold 197,521
  shares of Common Stock to employees and consultants for aggregate
  consideration of $13,260 upon the exercise of stock options pursuant to the
  Registrant's Employee Stock Plan.

  The recipients of securities in each such transaction represented their
intentions 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 warrants issued in such
transactions. All recipients had adequate access, through their relationships
with us, to information about us.

Item 16. Exhibits and Financial Statement Schedules

(a) Exhibits.
Exhibit
 Number  Description of Document
 ------- -----------------------
1.1*    Form of Underwriting Agreement
  2.1     Form of Merger Agreement between Cobalt Networks, Inc., a California
          corporation, and Cobalt Networks, Inc., a Delaware corporation
  3.1     Certificate of Incorporation of the Registrant, as currently in
          effect
  3.1.1   Form of Certificate of Incorporation of the Registrant to be filed
          after the closing of the offering made under this Registration
          Statement
  3.2     Bylaws of the Registrant
II-3
Exhibit
 Number  Description of Document
 ------- -----------------------
3.3     California Restated Articles of Incorporation
  3.4     California Bylaws
  4.1*    Specimen Common Stock Certificate
  4.2     Second Amended and Restated Investors' Rights Agreement, dated April
          30, 1999, by and among the Registrant and certain stockholders of
          the Registrant
  5.1     Form of Opinion of Wilson Sonsini Goodrich & Rosati, Professional
          Corporation
 10.1     Form of Indemnification Agreement between the Registrant and each of
          its directors and officers
 10.2     Amended and Restated 1997 Employee Stock Plan
 10.2.1   Form of Option Agreement under the Employee Stock Plan
 10.3     1999 Employee Stock Purchase Plan
 10.3.1   Form of Subscription Agreement under the 1999 Employee Stock
          Purchase Plan
 10.4     1999 Director Option Plan
 10.4.1   Form of Option Agreement under 1999 Director Plan
 10.5     Form of Executive Officer Employment Agreement
 10.6     Consulting Agreement dated August 30, 1996 by and between the
          Registrant and Techfarm Management, Inc.
 10.7     Lease Agreement dated August 5, 1998 between Registrant and Renault
          & Handley Solar Ellis Joint Venture for 555 Ellis Street, Mountain
          View, California office
 10.7.1   Assignment of lease dated September 2, 1998 between Registrant and
          Netscape Communications, Inc.
 10.7.2   Sublease dated October 28, 1996 between Netscape Communications,
          Inc. and Banta Corporation
 10.7.3   Addendum One to sublease dated November 6, 1996 among Netscape
          Communications, Inc., Banta Corporation and Renault & Handley Solar
          Ellis Joint Venture
 10.7.4   Lease dated August 10, 1993 ("Master Lease") between Banta Digital
          Services, Inc. and Renault & Handley Solar Ellis Joint Venture
 10.8    Employee Option Agreement dated July 15, 1998 between the Registrant
         and George M. Korchinsky
 10.9     Employment Offer Letter dated July 20, 1999 from the Registrant to
          Gary Martell
 10.10    Separation Agreement dated July 28, 1999 by and between the
          Registrant and Robin Porter
 10.11+   Turnkey Service and Purchase Agreement dated August 31, 1999 by and
          among the Registrant and SMTC Manufacturing Corporation
 10.12    Promissory Note and Security Agreement dated August 20, 1999 between
          the Registrant and Stephen W. DeWitt
 21.1     Subsidiaries
 23.1     Consent of PricewaterhouseCoopers LLP, Independent Accountants
 23.2     Form of Consent of Counsel (included in Exhibit 5.1)
 24.1     Power of Attorney (see Page II-6)
 27.1     Financial Data Schedule
--------
*  To be filed by amendment
+  Confidential treatment requested

                                      II-4
(b) Financial Statement Schedules.

  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 agreements certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.

  Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, 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 of
  1933, 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
  of 1933, 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-5
SIGNATURES

  Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Mountain View, State of
California on September 8, 1999.

                                                   /s/ Stephen W. DeWitt
                                          By: _________________________________
                                                     Stephen W. DeWitt
                                               President and Chief Executive
                                                          Officer

                               POWER OF ATTORNEY

  KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints, jointly and severally, Stephen W. DeWitt
and Kenton D. Chow, and each of them, as his attorney-in-fact, with full power
of substitution, for him in any and all capacities, to sign any and all
amendments to this registration statement (including post-effective
amendments), and any and all registration statements filed pursuant to Rule 462
under the Securities Act of 1933, as amended, in connection with or related to
the offering contemplated by this registration statement and its amendments, if
any, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming our signatures as they may be signed by our said
attorney to any and all amendments to said registration statement.

  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION
STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE
DATES INDICATED:
Signature                           Title                    Date
              ---------                           -----                    ----
/s/ Stephen W. DeWitt          President, Chief Executive    September 8, 1999
______________________________________  Officer and Director
          Stephen W. DeWitt             (Principal Executive
                                        Officer)

          /s/ Kenton D. Chow           Vice President Finance and    September 8, 1999
______________________________________  Chief Financial Officer
            Kenton D. Chow              (Principal Financial and
                                        Accounting Officer)

        /s/ Gordon A. Campbell         Chairman of the Board of      September 8, 1999
______________________________________  Directors
          Gordon A. Campbell

          /s/ Jordan A. Levy           Director                      September 8, 1999
______________________________________
            Jordan A. Levy
II-6
EXHIBIT INDEX
Exhibit
 Number  Description of Document
 ------- -----------------------
1.1*    Form of Underwriting Agreement
  2.1     Form of Merger Agreement between Cobalt Networks, Inc., a California
          corporation, and Cobalt Networks, Inc., a Delaware corporation
  3.1     Certificate of Incorporation of the Registrant, as currently in
          effect
  3.1.1   Form of Certificate of Incorporation of the Registrant to be filed
          after the closing of the offering made under this Registration
          Statement
  3.2     Bylaws of the Registrant
  3.3     California Restated Articles of Incorporation
  3.4     California Bylaws
  4.1*    Specimen Common Stock Certificate
  4.2     Second Amended and Restated Investors' Rights Agreement, dated April
          30, 1999, by and among the Registrant and certain stockholders of
          the Registrant
  5.1     Form of Opinion of Wilson Sonsini Goodrich & Rosati, Professional
          Corporation
 10.1     Form of Indemnification Agreement between the Registrant and each of
          its directors and officers
 10.2     Amended and Restated 1997 Employee Stock Plan
 10.2.1   Form of Option Agreement under the Employee Stock Plan
 10.3     1999 Employee Stock Purchase Plan
 10.3.1   Form of Subscription Agreement under the 1999 Employee Stock
          Purchase Plan
 10.4     1999 Director Option Plan
 10.4.1   Form of Option Agreement under 1999 Director Plan
 10.5     Form of Executive Officer Employment Agreement
 10.6     Consulting Agreement dated September 30, 1996 by and between the
          Registrant and Techfarm Management, Inc.
 10.7     Lease Agreement dated August 5, 1998 between Registrant and Renault
          & Handley Solar Ellis Joint Venture for 555 Ellis Street, Mountain
          View, California office
 10.7.1   Assignment of lease dated September 2, 1998 between Registrant and
          Netscape Communications, Inc.
 10.7.2   Sublease dated October 28, 1996 between Netscape Communications,
          Inc. and Banta Corporation
 10.7.3   Addendum One to sublease dated November 6, 1996 among Netscape
          Communications, Inc., Banta Corporation and Renault & Handley Solar
          Ellis Joint Venture
 10.7.4   Lease dated August 10, 1993 ("Master Lease") between Banta Digital
          Services, Inc. and Renault & Handley Solar Ellis Joint Venture
 10.8     Employee Option Agreement dated July 15, 1998 between the Registrant
          and George Korchinsky
 10.9     Employment Offer Letter dated July 20, 1999 from the Registrant to
          Gary Martell
 10.10    Separation Agreement dated July 28, 1999 by and between the
          Registrant and Robin Porter
 10.11+   Turnkey Service and Purchase Agreement dated August 31, 1999 by and
          among the Registrant and SMTC Manufacturing Corporation
 10.12    Promissory Note and Security Agreement dated August 20, 1999 between
          the Registrant and Stephen W. DeWitt
 21.1     Subsidiaries
 23.1     Consent of PricewaterhouseCoopers LLP, Independent Accountants
 23.2     Form of Consent of Counsel (included in Exhibit 5.1)
 24.1     Power of Attorney (see Page II-6)
 27.1     Financial Data Schedule
--------
*  To be filed by amendment
+  Confidential treatment requested