<PAGE>
As filed with the Securities And Exchange Commission on March 22, 2000
Registration No. 333-94985
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
AMENDMENT NO. 2
to
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
LINUXCARE, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C> <C>
Delaware 7379 94-3315402
(State or other (Primary Standard Industrial (I.R.S. Employer
jurisdiction of
incorporation or Classification Code Number) Identification Number)
organization)
</TABLE>
Linuxcare, Inc.
650 Townsend Street
San Francisco, California 94103
(415) 354-4878
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
---------------
Fernand B. Sarrat
President and Chief Executive Officer
Linuxcare, Inc.
650 Townsend Street
San Francisco, California 94103
(415) 354-4878
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
---------------
Copies to:
<TABLE>
<S> <C>
John V. Roos, Esq. William J. Whelan, III, Esq.
Page Mailliard, Esq. Cravath, Swaine & Moore
Jonathan D. Levy, Esq. Worldwide Plaza
James P.A. Shulman, Esq. 825 Eighth Avenue
Deanna M. Butler, Esq. New York, NY 10019
Wilson Sonsini Goodrich & Rosati (212) 474-1000
Professional Corporation
650 Page Mill Road
Palo Alto, California 94304
(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 any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, 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,
check the following box. [_]
---------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this
Registration Statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until the Registration Statement
shall become effective on such date as the Commission, acting pursuant to said
Section 8(a), may determine.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell these securities and it is not soliciting an offer to buy these +
+securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED MARCH 22, 2000
4,500,000 Shares
[LOGO OF LINUXCARE]
Common Stock
--------
Prior to this offering, there has been no public market for our common stock.
The initial public offering price of our common stock is expected to be between
$13.00 and $15.00 per share. Our common stock has been approved for listing on
the Nasdaq Stock Market's National Market, subject to official notice of
issuance, under the symbol "LXCR."
The underwriters have an option to purchase a maximum of 675,000 additional
shares to cover over-allotments of shares.
Upon completion of this offering, our executive officers and directors will
beneficially own approximately 57.7% of our outstanding common shares. If they
choose to act together, they could control all matters requiring approval by
shareholders.
Investing in our common stock involves risks. See "Risk Factors" on page 5.
<TABLE>
<CAPTION>
Underwriting
Price to Discounts and Proceeds to
Public Commissions Linuxcare
------------ ------------- ------------
<S> <C> <C> <C>
Per Share.................................. $ $ $
Total...................................... $ $ $
</TABLE>
Delivery of the shares of common stock will be made on or about , 2000.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
Credit Suisse First Boston
Chase H&Q
Robertson Stephens
The date of this prospectus is , 2000.
<PAGE>
Inside front cover: A depiction of an advertisement used by the Company
with copy that reads as set forth below.
Headline: IF YOU THINK AN OPERATION SYSTEM SHOULD ADAPT TO YOUR BUSINESS
AND NOT VICE VERSA, YOU HAVE OUR SUPPORT.
Text: For flexibility, Linux is unrivalled. And with Linuxcare, you now
have the comprehensive enterprise-class support and services you need to take
full advantage of Linux technology. We offer everything from professional
services, to 24X7 support, to training--all in one place. The Linux revolution
has begun. And now it means business. To learn more, call 888.LIN.GURU
(546.4878) or visit www.linuxcare.com.
Bottom tagline: SUPPORT FOR THE REVOLUTION. LINUXCARE.
Gatefold two-page spread at front of prospectus: A depiction of an
advertisement used by the Company with a table of six columns and five rows
and bars going across the rows of the table.
The headings of the columns of the table read: EVALUATE, BUY, SET UP, USE,
MAINTAIN, FIX.
The headings of the rows of the table read: PROFESSIONAL SERVICES strategy,
development, migration and integration, TECHNICAL SUPPORT 24X7 telephone and
Web-based support, LINUXCARE UNIVERSITY classroom and online training and
courseware, LINUXCARE LABS vendor-neutral hardware and software certification,
WWW.LINUXCARE.COM up-to-date technology, information and guidance.
The bars extend across the columns as follows: In the PROFESSIONAL SERVICES
row, from EVALUATE through USE. In the TECHNICAL SUPPORT row, from SET UP
through FIX. In the LINUXCARE UNIVERSITY row, from EVALUATE through MAINTAIN.
In the LINUXCARE LABS row, from EVALUATE through SET UP. In the
WWW.LINUXCARE.COM row, from EVALUATE through FIX.
<PAGE>
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................. 1
Risk Factors........................ 5
Special Note Regarding Forward-
Looking Statements................. 15
Use of Proceeds..................... 16
Dividend Policy..................... 16
Capitalization...................... 17
Dilution............................ 18
Unaudited Pro Forma Combined
Financial Statements............... 19
Selected Financial Data............. 21
Management's Discussion and
Analysis of Financial Condition and
Results of Operations.............. 23
Business............................ 31
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Management......................... 42
Certain Relationships and
Related Transactions.............. 54
Principal Stockholders............. 56
Description of Capital Stock....... 58
Shares Eligible for Future Sale.... 61
United States Tax Consequences to
Non-United States Holders......... 63
Underwriting....................... 66
Notice to Canadian Residents....... 69
Legal Matters...................... 70
Experts............................ 70
Additional Information............. 70
Index to Financial Statements...... F-1
</TABLE>
------------
You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information in this document may only be accurate
on the date of this document.
Dealer Prospectus Delivery Obligation
Until , 2000 (25 days after the commencement of this offering), all
dealers that effect transactions in these securities, whether or not
participating in this offering, may be required to deliver a prospectus. This
is in addition to the dealer's obligation to deliver a prospectus when acting
as an underwriter and with respect to unsold allotments or subscriptions.
<PAGE>
PROSPECTUS SUMMARY
This section sets forth a summary of all material information that is
described in more detail throughout this prospectus. This summary is not
complete and may not contain all the information you should consider before
investing in our common stock. You should read the entire prospectus, including
the financial statements and their related notes, before making an investment
decision. Except as otherwise indicated, all information in this prospectus
reflects the conversion of all shares of our preferred stock into shares of
common stock automatically upon completion of this offering, and assumes that
the underwriters' over-allotment option will not be exercised.
Upon completion of this offering, our executive officers and directors will
beneficially own 18,021,129 shares or approximately 57.7% of our outstanding
common shares assuming the exercise of all warrants and options held by them.
If they choose to act together, they could control all matters requiring
approval by shareholders.
[LOGO OF LINUXCARE]
We are a provider of services for Linux. We offer a comprehensive range of
services spanning the entire software and hardware life cycle for Linux, open-
source software packages and related technologies. We offer services for 21
distributions of Linux. We help our customers choose the best Linux solution,
integrate it with their existing computing infrastructure and provide them with
ongoing support. We have assembled a worldwide team of individuals who we
believe are Linux experts and who actively participate in the Linux and open-
source communities. We are implementing an advanced Internet-based
infrastructure to communicate with and to deliver services to our customers.
This infrastructure is designed to deliver our services remotely, by telephone
or over the Internet, thereby reducing the need for on-site professionals. As
part of this infrastructure, we have built a knowledge sharing and management
database consisting of information gained from all of our business units.
Since our inception, we have targeted our services toward large business
customers. We focus our sales and marketing efforts on original equipment
manufacturers, software vendors, Global 1000 companies and Internet
infrastructure providers. During 1999, we derived 55% of our revenues from
three customers, Motorola, Silicon Graphics, Inc. and Sun Microsystems. Our
next five largest customers were Dell Computer, Densa Techno Tokyo, Hewlett-
Packard, KPMG Peat Marwick and Macmillan USA.
Linux is emerging as the leading operating system for the Internet.
According to an April 1999 survey conducted by the Internet Operating System
Counter, Linux ran on approximately 31% of the Web servers polled, more than
any other operating system. As compared with other operating systems, we
believe that Linux offers multiple benefits to businesses, including
reliability, reduced total cost of ownership, greater flexibility and improved
compatibility with existing computing infrastructures.
To enable customers to benefit fully from their Linux investments, we offer
a broad range of services, including:
. professional services--consulting services to help customers
successfully implement Linux solutions;
. technical support--customer support services 24 hours a day, seven days
a week on complex issues ranging from operating system installation to
application usage;
. education--courseware for Linux and other open-source technologies
through Linuxcare University, our group that provides education for
Linux; and
. product certification--vendor-neutral certification of hardware for use
with Linux by Linuxcare Labs, our group devoted to assuring
compatibility with the Linux operating system.
1
<PAGE>
Our objective is to become the leading provider of Linux-related services
by:
. establishing relationships with other companies that are direct
consumers of our services and provide us with an opportunity to reach a
broad customer base;
. expanding our sales and marketing efforts and strengthening our brand;
. extending our technical knowledge to increase the effectiveness of our
services and attract and retain Linux experts;
. using our advanced Internet-based infrastructure to deliver quality
services; and
. continuing to promote the adoption and development of Linux.
We believe it is imperative for us to maintain a close relationship with the
open-source community. Therefore, we actively support open-source initiatives,
dedicating time and resources to projects that improve the Linux operating
system and related applications. We also sponsor and participate in
organizations that foster the development and adoption of Linux. Through our
active involvement in the Linux and open-source communities, we feel that we
have made ourselves an attractive company for Linux experts to join.
We were incorporated in Delaware in December 1998. For the year ended
December 31, 1999, we incurred losses of $21.2 million. We operate in a
competitive market and, in an effort to establish our business, we anticipate
recording substantial net losses in the foreseeable future. Many of our
competitors, including Caldera Systems, Red Hat and VA Linux Systems have
longer operating histories, better name recognition, larger client bases and
greater financial, technical, marketing and public relations resources than we
do.
Our principal executive offices are located at 650 Townsend Street, San
Francisco, California 94103 and our telephone number is (415) 354-4878. Our
corporate website is located at www.linuxcare.com. Information contained on
this website or on any other website referenced elsewhere in this prospectus
does not constitute a part of this prospectus.
2
<PAGE>
The Offering
<TABLE>
<S> <C>
Common stock offered................ 4,500,000 shares
Common stock to be outstanding after
this offering...................... 30,214,721 shares
Use of proceeds..................... For general corporate purposes, expansion
of our information technology
infrastructure, working capital and
potential acquisitions. See "Use of
Proceeds."
Proposed Nasdaq National Market
symbol............................. LXCR
</TABLE>
The total number of outstanding shares of our common stock above is based
on:
. the assumed conversion of all shares of Series A preferred stock
outstanding as of January 31, 2000 into 7,917,536 shares of common stock
upon completion of this offering.
. the assumed conversion of all shares of Series B preferred stock as of
January 31, 2000 into 7,297,900 shares of common stock upon completion
of this offering;
. 10,499,285 shares of our common stock outstanding as of January 31,
2000;
This number assumes no exercise of the underwriters' over-allotment option
and excludes the following:
. 391,744 shares represented by warrants for Series A redeemable
convertible preferred stock;
. 3,089,060 shares of common stock available for grant under our 1999
Stock Plan as of January 31, 2000;
. 1,000,000 shares of common stock available for issuance under our 2000
Employee Stock Purchase Plan immediately following the offering;
. 300,000 shares of common stock available for issuance under our 2000
Director Option Plan immediately following the offering; and
. 2,897,501 shares of common stock issuable upon exercise of options
outstanding as of January 31, 2000 with a weighted average exercise
price of $0.31 per share.
3
<PAGE>
Summary Consolidated Financial Information
The following summary financial data has been derived from our unaudited
1999 pro forma combined statement of operations which reflect the acquisitions
of the Puffin Group and Prosa Progettazione Suiluppo Agento S.r.l. as if such
transactions had occurred on January 1, 1999 and our audited December 31, 1999
consolidated balance sheet. You should read the information set forth below in
conjunction with our "Unaudited Pro Forma Combined Financial Statements,"
"Selected Financial Data," "Consolidated Financial Statements" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this prospectus.
<TABLE>
<CAPTION>
Pro forma
combined
year ended
December 31,
1999
------------
<S> <C>
Statement of Operations Data:
Revenues.......................................................... $ 1,531,471
Cost of revenues.................................................. 2,987,049
Gross margin...................................................... (1,455,578)
Loss from operations ............................................. (20,727,157)
Net loss applicable to common stockholders........................ (21,423,683)
Basic and diluted net loss per share.............................. $(7.37)
Weighted average shares used in computing pro forma combined
basic and diluted net loss per share ............................ 2,908,756
Pro forma basic and diluted net loss per share.................... $ (2.27)
Weighted average shares used in computing pro forma combined
basic and diluted net loss per share............................. 9,327,635
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999
------------------------
Pro Forma
Actual As adjusted
----------- -----------
<S> <C> <C>
Balance Sheet Data:
Cash and cash equivalents............................ $29,994,575 $86,584,595
Working capital ..................................... 25,029,759 81,619,759
Total assets......................................... 36,366,003 92,956,003
Note payable and equipment financing, less current
portion............................................. 1,926,018 1,926,018
Redeemable convertible preferred stock............... 40,374,016 --
Total stockholders' (deficit) equity................. (12,628,592) 84,335,424
</TABLE>
See note 1 of notes to financial statements included elsewhere in this
prospectus for an explanation of the determination of the number of shares used
in computing basic and diluted net loss per share data and in computing pro
forma basic and diluted net loss per share. Also see note (b) of our unaudited
pro forma combined statement of operations for an explanation of shares used in
computing unaudited pro forma loss per share.
The pro forma as adjusted amounts above give effect to the sale of the
4,500,000 shares of common stock offered hereby at an assumed public offering
price of $14.00 per share (less underwriting discounts and commissions and
estimated offering expenses) and the conversion at the closing of this offering
of 14,999,803 shares of preferred stock into 15,215,436 shares of common stock
as of January 31, 2000. See "Use of Proceeds" and "Capitalization."
4
<PAGE>
RISK FACTORS
Any investment in our common stock involves a high degree of risk. You
should carefully consider the risks described below and all of the information
contained in this prospectus before deciding whether to purchase our common
stock.
Risks Related to Our Business
We have a limited operating history and operate in a new industry which makes
evaluating our business prospects and results of operations difficult.
We were incorporated in December 1998. We have a limited operating history
upon which an investor may evaluate our business and prospects. Our potential
for future profitability must be considered in light of the risks,
uncertainties, expenses and difficulties frequently encountered by recently
established companies, particularly companies in new and rapidly evolving
markets such as the Linux services market. These difficulties are more fully
described throughout the individual risk factors in this section. To date, few
Linux-based products have gained widespread acceptance. Our success depends on
the growth, usage and acceptance of the Linux operating system and related
open-source software.
If the market for the Linux operating system fails to grow or if we fail to
successfully address the risks associated with new companies, our business may
not grow.
We have incurred substantial losses and anticipate future losses.
We incurred losses of $21.2 million during the year ended December 31, 1999
as we expanded our operations and had an accumulated stockholders' deficit of
approximately $12.6 million as of December 31, 1999. For the year ended
December 31, 1999, our losses constituted 1751% of our revenues. For the
foreseeable future, we expect to incur significant expenditures for marketing,
recruiting and hiring additional personnel, upgrading our information
technology infrastructure and expanding into new markets. As a result, upon
completion of the offering, we expect that our operating expenses, excluding
amortization of deferred stock compensation, will total approximately $65
million during the year ending December 31, 2000 and, consequently, we expect
to incur losses in 2000 and 2001. In addition, we may not be able to maintain
our current rate of revenue growth. Increased competition or slower than
anticipated growth in our market could also affect our revenue growth. We
cannot be certain that we will achieve profitability or that, if we do achieve
profitability, we will be able to sustain it.
We may be unable to attract and retain Linux experts and other personnel to
grow our business.
Our future success depends, in part, on our ability to identify, attract,
retain and motivate highly skilled personnel. We intend to hire approximately
250 new employees during 2000, including additional technical professionals,
Linux experts, sales and marketing and other personnel. Competition for these
individuals is intense, and we may not be able to attract, assimilate or retain
sufficient highly qualified personnel. Our ability to achieve revenue growth
also depends upon the continued service of our executive officers and other key
marketing and support personnel. 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.
We have historically generated 55% of our revenues from three customers.
To date, we have derived a significant portion of our revenues from a
limited number of customers. Our three largest customers, Sun Microsystems
Inc., Motorola, Inc. and Silicon Graphics, Inc., accounted for 26%, 18% and
11%, respectively, of our revenues during the year ended December 31, 1999. We
performed primarily technical support, professional services, and training for
Sun Microsystems, Motorola and Silicon
5
<PAGE>
Graphics, Inc., respectively. The professional services engagement with
Motorola was to help Motorola's engineering organization develop a customized
version of the Linux operating system. The volume of work performed for these
customers may not be sustained from year to year, and there is a risk that
these principal customers may not retain us in the future. Any cancellation,
deferral or significant reduction in the amount of work performed for these
customers could have a material adverse effect on our business, financial
condition and results of operations.
We may not be able to achieve high gross margins if we are unable to utilize
our technical staff effectively, if there are fluctuations in work flow or if
our implementation of a new information technology infrastructure does not
result in the efficiencies that we expect from it.
Our success as a service business is highly dependent on our ability to
improve our gross margins. For the year ended December 31, 1999, we had
negative gross margin of $1.6 million. Our gross margins are affected by
fluctuations in the work flow from our customers as well as the efficient use
of the time of our professional staff. Some of our highly skilled personnel may
have to spend extensive amounts of time marketing our services and performing
administrative tasks instead of solving customer problems. In particular, our
skilled Linux professionals may be required to cultivate their relationships
with the open-source community to help establish our brand. In addition, we are
implementing an advanced information technology infrastructure to help handle
the expected growth of our business. If we are unable to carry out such
implementation or if our new infrastructure does not result in the efficiencies
that we expect from it, we may not achieve high gross margins. Our failure to
achieve high gross margins may adversely affect the market price of our common
stock and our ability to achieve profitability.
Our revenues are difficult to predict because they will in part be generated on
a project-by-project basis.
We expect to derive revenues for our professional services offerings
primarily from fees for services generated on a project-by-project basis. These
projects will likely vary in size and scope. Therefore, a customer that
accounts for a significant portion of our revenues in a given period may not
generate a similar amount of revenues, if any, in subsequent periods. In
addition, after we complete a project, we have no assurance that a customer
will retain our services in the future. Furthermore, our existing clients can
generally reduce the scope of an engagement or cancel their use of our services
without penalty and with little or no notice. If clients terminate existing
engagements or if we are unable to enter into new engagements, our revenues in
the relevant period could substantially decline and we may underutilize
existing resources that cannot be quickly redeployed to other client
engagements.
Our ability to accurately forecast our quarterly revenues is made difficult
by our limited operating history and the new and rapidly evolving market for
Linux. In addition, we have hired a significant number of employees and entered
into contracts requiring future minimum operating lease payments of $6.0
million over five years based on our revenue expectations. Therefore, if we
have a shortfall in revenues, 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 these costs. As a result, our
quarterly operating results could fluctuate, and such fluctuation could
adversely affect the market price of our common stock.
If we are unable to implement appropriate systems, procedures and controls to
manage our expected growth, we may not be able to successfully offer our
services and grow our business.
Since we began operations in December 1998, we have significantly increased
the size of our operations. During 1999, we increased our number of employees
by 127 people and greatly increased our operating expenses. This growth has
placed, and we expect that any future growth we experience will continue to
place, a significant strain on our management, systems and resources. Our
management team has not previously worked together. The quality of the services
we render may be adversely affected if we do not create a highly cooperative
environment within the management team and with employees. To manage growth
effectively, we will need to continue to implement or update our operational
and financial systems, procedures and controls. If we fail to implement
appropriate internal systems, and necessary modifications and improvements to
these systems, our business will suffer.
6
<PAGE>
A failure of our information technology infrastructure to handle the demands of
our current or future business would adversely affect our business.
Our service offerings and business strategy are highly dependent on the
efficient performance of our Internet-based information technology. Although we
divide our information technology infrastructure among four locations in
anticipation of possible system outages or failures, we cannot be certain that
the systems operated by us or by outside service providers will be adequate to
handle the demands of our business or will be maintained without any material
interruption. A significant growth of our business could result in an
unexpected increase in the demand for our Internet-based services. We are
implementing an advanced information technology infrastructure that is designed
to handle increased demand, but we cannot be certain that our infrastructure
will be in place when we experience such increased demand, or if we do, such
infrastructure will be able to handle the increased demand. Any system failure,
including network, software or hardware failure, that causes an interruption in
our service or a decrease in our responsiveness to our customers could harm our
reputation and adversely affect our business.
Our customers and competitors may offer their own technical support and
services which could result in a loss of market share.
Currently, we provide services and technical support for large businesses
and major hardware and software vendors. To the extent the Linux operating
system gains broader market acceptance, these companies may develop their own
technical support and services for Linux-based operations. These companies,
which have large customer bases, greater financial resources and better name
recognition than we do, may be able to undertake more extensive promotional
activities, adopt more aggressive pricing policies and offer more attractive
terms to their customers than we can. These companies also may be able to
leverage their existing service organizations and provide a more comprehensive
offering of services and higher levels of support on a more cost-effective
basis than we can. Furthermore, other suppliers of Linux operating systems are
focusing on technical support and services. We believe that Caldera, Red Hat,
S.u.S.E. and VA Linux currently offer technical support and services. It is
possible that these businesses will form alliances to enable them to provide
more effective services. Increased competition and the emergence of other
Linux-related services companies may result in price reductions, lower-than-
expected gross margins or our inability to establish a meaningful market share,
any of which may cause our business to fail.
Our management team is new and, if they are unable to work together
effectively, our business could be seriously harmed.
Our business is highly dependent on the ability of our management team to
work together effectively to meet demands of our growth. We grew from three
employees at December 31, 1998 to 130 employees at December 31, 1999, including
adding seven members to our management team. These individuals have not
previously worked together as a management team and have only had limited
experience managing a rapidly growing company.
We face risks related to expanding into new services and business areas.
To increase our revenues, we could expand our operations by promoting new or
complementary services and by expanding into new business areas. These services
could require both modification of existing systems and the creation or
acquisition of new software, systems and other technologies. We may lack the
managerial and technical resources necessary to expand our service offerings.
These initiatives may not generate sufficient revenues to offset their cost. If
we are unable for any reason to expand our services in line with our customer
demands, our reputation and business could suffer.
7
<PAGE>
We intend to expand by means of business combinations and strategic alliances,
which may harm our operational efficiency, financial performance and
relationships with employees and third parties.
We currently intend to expand our operations and market presence by making
investments in or entering into business combinations, joint ventures or other
strategic alliances with other businesses in the United States, Europe and
Asia-Pacific. Our ability to expand in this way may be limited due to the many
financial and operational risks accompanying such transactions. For example:
. these transactions may be time consuming, place strains on our resources
and divert management's attention away from our core, day-to-day
business;
. efficient integration of the acquired businesses or technologies may not
be successful, thereby reducing any anticipated revenues and cost
benefits;
. our stockholders will incur dilution if we issue equity in connection
with these transactions; and
. our relationships with existing employees, customers and business
partners may be weakened or terminated as a result of these
transactions.
If we fail to adequately promote and maintain our brand name or are unable to
continue using "Linux" as part of our brand name, our business may be adversely
affected.
We believe that increasing the recognition of the Linuxcare brand is
critical to our success. To promote our brand identity and to attract
customers, we plan to spend approximately $14 million during the year ending
December 31, 2000 on advertising, promotions and 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 our
brand, our revenues will not grow sufficiently. Our business will suffer if we
incur excessive expenses in an attempt to promote our brand without a
corresponding increase in revenues. Mr. Linus Torvalds owns the trademark to
"Linux" and has approved our use of the word Linux in our company name as well
as in the title of our websites. This approval may be revoked for any reason,
however, and we may no longer be able to use this trademark in our brand or in
the title of our website. Trademark owners must enforce their trademarks
effectively in order for their trademarks to remain valid. Should the "Linux"
trademark not be enforced adequately, because of lack of resources or
otherwise, or be invalidated through legal action, our business could suffer.
We have no right to police the use of the term "Linux." Lack of policing could
cause the loss of the trademark as well as confusion about the source, quality,
reputation and dependability of Linux, which would harm our company's
reputation. In addition, the trademark "Linux" is widely used and may become
diluted. The number of companies currently using the "Linux" trademark may also
cause confusion as to the source, quality, reputation and dependability of the
"Linux" trademark. This may, in turn, dilute our brand and decrease the
efficacy of our branding strategy.
We may be unable to execute our business model in international markets.
A key component to our growth strategy is to expand our presence in Asia-
Pacific and Europe and become recognized as an international leader in the
provision of Linux-related services. We believe the market for Linux-related
services is worldwide. To date, we have only limited experience marketing,
selling and supporting our services on an international basis. We have recently
expanded our operations internationally and we have offices in Australia,
Canada, Germany, Italy, Japan, The Netherlands and the United Kingdom. We are
considering further international expansion, which may include opening new
offices, acquiring established businesses or working with other companies to
market and deliver our services. It will be costly to establish international
operations, promote our brand internationally and develop localized websites
and network support. Revenues from international activities may not offset the
expense of establishing and maintaining these foreign operations. Furthermore,
expanding our international operations subjects us to additional risks,
including the following:
. increased competition from local service providers, including S.u.S.E.
in Europe and TurboLinux in Japan;
8
<PAGE>
. delivering our services in multiple languages;
. fluctuations in currency exchange rates or recessionary environments in
overseas economies;
. tariffs, duties, price controls or other trade barriers, and compliance
with export and import laws; and
. longer payment cycles and increased difficulties developing and
maintaining credit procedures.
Our failure to address these risks could inhibit or preclude our efforts to
expand our business in international markets.
If we are unable to introduce new services in a timely manner, our business
will be harmed.
The computer systems market is characterized by rapid technological change,
changes in customer demands and evolving industry standards. Our services could
be rendered obsolete if new technologies are introduced or new industry
standards emerge and we are not able to keep up with such innovation.
Computing environments are inherently complex. As a result, we cannot
accurately estimate the long-term need for our services. New environments and
new techniques may require us to hire and retain increasingly scarce,
technically competent personnel. Significant delays or problems in installing
or implementing new services could seriously damage our business.
Our future success depends upon our ability to enhance existing services,
develop new services and grow our business to satisfy customer demands. We may
not be able to successfully identify new service opportunities to grow our
business.
We may not be able to use intellectual property to protect ourselves from
competition.
Most of our activities and knowledge may not be protectable as proprietary
intellectual property. Some of the computer code resulting from the
professional services and technical support that we provide will be published
and freely-available to all Linux licensees with no payment to us. To date, we
have taken only limited steps to protect our intellectual property.
Accordingly, we may be unable to use our intellectual property to prevent other
companies from competing with us. In addition, we are unable to prevent third
parties from developing techniques that are similar or superior to our
technology, or from designing around our intellectual property.
We may be sued as a result of information published on, posted on or accessible
from our websites.
We may be subjected to claims for defamation, negligence, copyright or
trademark infringement (including contributory infringement), or other claims
relating to the information contained on our website, whether written by us or
third parties. These types of claims have been brought against online services
in the past, and can be costly to defend, regardless of the merit of the
lawsuit. Although recent federal legislation protects online services from some
claims when the material is written by third parties, this protection is
limited. Furthermore, the law in this area remains in flux, and varies from
state to state. While no claims have been made against us to date, our business
could be seriously harmed if one were asserted.
The operating performance of our systems is dependent on outside providers.
We rely on outside service providers to help maintain our networks and
systems. For example, we outsource our Web server hosting to Digital Island, an
outside co-location service provider. This provider's failure to maintain its
systems and operations could adversely affect our business. In addition, our
technical support services are highly dependent on Internet-based technology.
Any system failure, including network, software or hardware failure, that
causes an interruption in our service or a decrease in our responsiveness could
harm our reputation.
9
<PAGE>
Increased sales of Linuxcare's services depends upon the expansion of the
Internet as a platform for commerce and communication.
Our success depends on the continued use and expansion of the Internet. If
the Internet does not continue to become a widespread communications medium and
commercial marketplace, the demand for Linuxcare's services could be
significantly reduced. The Internet infrastructure may not be able to support
the demands placed on it by continued growth. The Internet could lose its
viability due to delays in the development or adoption of new equipment,
standards and protocols to handle increased levels of Internet activity,
security, reliability, cost, ease of use, accessibility and quality of service.
Other factors that could inhibit the growth of the Internet and its use by
business as a medium for communication and commerce include:
. concerns about security of transactions conducted over the Internet;
. concerns about privacy and the use of data collected and stored
recording interactions over the Internet; and
. the possibility that federal, state, local or foreign governments will
adopt laws or regulations limiting the use of the Internet or the use of
information collected from communications or transactions over the
Internet.
We granted 6,235,189 options during the year ended December 31, 1999 at
exercise prices substantially below the per share price of this offering. The
exercise of these options will result in dilution of the book value of the
shares being offered.
During the year ended December 31, 1999, we granted 6,235,189 options to
purchase common stock at a weighted average exercise price of $0.26. Through
December 31, 1999, 2,526,312 of these options to purchase shares of common
stock have been exercised and 550,667 of these options were cancelled. To the
extent the remaining options are exercised, the investors in this offering will
experience dilution.
We are recording a significant amount of deferred stock compensation relating
to recent stock option grants. The amortization of this compensation expense in
the aggregate is estimated to be $36.2 million over the next four years.
Amortization of deferred stock compensation represents an expense associated
with the amortization of the difference between the deemed fair market value of
the common stock at the time of the option grant and the option exercise price
over the vesting period. In the year ended December 31, 1999, we recorded
deferred stock compensation of approximately $20.0 million. In addition, we
expect to record an additional deferred compensation charge relating to option
grants made after December 31, 1999 but prior to the completion of the offering
of approximately $20.3 million, based upon the low end of the assumed offering
price range of $13.00 per share. We amortize deferred stock compensation on an
accelerated basis. We amortized $4.1 million of deferred stock compensation in
1999 and we estimate the amortization charge for the next four years will be as
follows: $20.6 million during fiscal 2000, $9.8 million during fiscal 2001,
$4.5 million during fiscal 2002, and $1.3 million during fiscal 2003.
10
<PAGE>
Risks Related to Linux
If widespread adoption of the Linux operating system does not occur, our
business will be harmed.
Our business depends on the willingness of customers to purchase Linux
systems. For the foreseeable future, we expect to derive most of our revenues
from the provision of Linux-related services and support. The Linux operating
system is still in the early stages of gaining broad market acceptance. To
date, this acceptance has been mostly limited to Internet infrastructure
applications and academic research environments. Our success is dependent upon
the continued and increased rate of adoption of Linux in these and other
markets. If this does not occur, our business will materially suffer.
The Linux operating system is an open-source software product, which users
are licensed to freely copy, use, modify and distribute. Accordingly, anyone
can download or otherwise copy the Linux operating system and numerous related
software applications from the Internet, without cost. Few open-source software
products have gained widespread commercial acceptance partly due to the lack of
viable open source industry participants to offer adequate service and support.
Moreover, open-source vendors are not able to provide standard warranties and
indemnities for their products, because these products have been developed by
independent parties over whom open source vendors exercise no control or
supervision. If open-source software should fail to gain widespread commercial
acceptance, our business could be adversely affected.
If Linux developers fail to enhance the core source code of the Linux operating
system and develop Linux-based applications, our business will suffer.
The core of the Linux operating system, the Linux kernel, is maintained by
third parties. Mr. Linus Torvalds, the original developer of the Linux kernel,
and a group of independent engineers, are primarily responsible for the
development and evolution of the Linux kernel. 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, which will affect our
ability to expand our business.
If additional software applications compatible with Linux are not developed,
the market for our services will not grow.
The growth in our business depends, in part, on the development of
additional third-party software applications. Currently, many widely used
applications have not been made compatible with Linux. Moreover, many standard
applications, such as word processors, databases, accounting packages,
spreadsheets, e-mail programs, graphics software and personal productivity
applications that have been made compatible with Linux, have not achieved
market acceptance. These applications must gain mainstream acceptance in
business and consumer markets for our business to grow. We intend to encourage
the development of additional applications that operate on Linux-based
operating systems by providing services that assist developers in porting
applications to the Linux platform. If we are not successful in achieving these
goals, however, our services and products will not gain mainstream business and
consumer acceptance and we may not be able to grow our business. If additional
applications are not written for the Linux operating system or do not achieve
widespread acceptance, the growth of Linux as an operating system and the
growth of our business will be harmed.
If multiple and incompatible versions of Linux achieve sufficient market
acceptance, demand for our services could decline.
Currently, most Linux distributions are compatible and Linux applications
can operate across these distributions. If incompatible versions of Linux
should develop, however, customers may become less likely to purchase Linux
products and our business would suffer. In addition, should multiple and
incompatible versions of Linux achieve sufficient market acceptance, we may be
required to support more distributions, which could result in increased
operating expenses.
11
<PAGE>
We may not succeed if the Linux developer community fails to support us or
reacts negatively to our business strategy.
The Linux developer community may not continue to support us. Some members
of the open-source software community have criticized companies that profit
from open-source software. This type of negative reaction, from either
customers or open source developers, could harm our reputation, diminish the
Linuxcare brand and damage our business. If the Linux community fails to
support us, we may be unable to stay aware of technological developments, which
may harm our revenues.
We could be prevented from selling or developing our services and products if
the GNU General Public License (GPL) and similar licenses under which the
Linux-based systems operate are unenforceable.
The Linux kernel and the Linux operating system have been developed and
licensed under the GPL and similar open source licenses. These licenses require
that any software program licensed under them may be copied, modified and
distributed freely, so long as all modifications are also freely made available
and licensed under the same conditions. We know of no instance in which a party
has challenged the validity of these licenses or in which these licenses have
been interpreted in a legal proceeding.
It is possible that parties may refuse to comply with the restrictions of
these licenses. It is also possible that a court would hold one or more of the
restrictions in these licenses to be unenforceable in the event that someone
were to file a claim asserting proprietary rights in a program developed and
distributed under them. Any ruling by a court that the restrictions in these
licenses are not enforceable, or that Linux-based operating systems, or
modifications to them, may not be copied, modified, or distributed freely,
would have the effect of preventing us from developing our services, unless we
are able to negotiate a license for the use of the software or replace the
affected portions. In the event that we obtain such a license, we would likely
be required to make royalty payments with respect to sales covered by the
license. Any royalty payments would harm our operating results. There can be no
assurance that we can obtain such a license.
Failure of computer systems and software to be year 2000 compliant could
increase our costs, disrupt our services and reduce demand from our customers.
We confront the year 2000 problem in two contexts.
Our customers. The failure of our customers to ensure that their operations
are year 2000 compliant could have an adverse effect on them, which in turn
could limit their ability to retain us as a third-party service provider or
process our invoices in a timely manner. In addition, customers or potential
customers may delay purchasing our services to the extent such customers or
potential customers are required to devote resources to resolving the year 2000
problem. To date, we have not encountered any year 2000 difficulties from our
customers.
Our services. The solutions that we provide our customers integrate software
and other technology from different providers. If there is a year 2000 problem
with respect to a solution provided by us, it may be difficult to determine
whether the problem relates to services that we have performed or is due to the
software, technology or services of other providers. To date, our customers
have not reported any year 2000-related problems arising from our services. We
may, however, be subjected to year 2000-related lawsuits whether or not the
services we have performed are year 2000 compliant. We cannot be certain what
the outcomes of these types of lawsuits may be.
12
<PAGE>
Risks Related to this Offering
Our stock price may be volatile and you may not be able to resell your shares
at or above the initial public offering price.
There has been no public market for our common stock prior to this offering.
The initial public offering price for our common stock will be determined
through negotiations between the underwriters and us. This initial public
offering price may vary from the market price of our common stock after the
offering. If you purchase shares of common stock, you may not be able to resell
those shares at or above the initial public offering price. The market price of
our common stock may fluctuate significantly in response to factors, some of
which are beyond our control, include the following:
. actual or anticipated fluctuations in our annual and quarterly operating
results;
. the growth and acceptance of the Linux operating system and related
open-source software;
. changes in financial estimates by securities analysts;
. increased competition in the Linux industry, including announcements by
us or our competitors of significant technical innovations, contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
. additions or departures of key personnel;
. future sale of equity or debt securities; and
. general economic, industry and market conditions.
In addition, the stock prices of Linux-based companies have been extremely
volatile. Our stock price may reflect the Linux industry's performance and fall
regardless of our performance.
We may be unable to meet our future capital requirements and, if we seek
additional funding, stockholders will experience additional dilution.
We may be required, or could elect to seek additional funding during the
next 12 months or thereafter, particularly if we elect to acquire complementary
businesses, products or technologies or if our losses during and after the year
ending December 31, 2000 are greater than we expect. However, we currently do
not have any plans to issue any debt or additional equity. In the event we are
required to raise additional funds, we may not be able to do so on favorable
terms, if at all. Further, if we issue new equity securities, stockholders will
experience dilution and the holders of new equity securities may have rights,
preferences or privileges senior to those of existing holders of common stock.
Substantial future sales of our common stock in the public market may depress
our stock price.
After this offering, our current stockholders will hold 85.1% of the
outstanding shares of our common stock. These stockholders will be able to sell
in the public market in the near future. Most of our stockholders have entered
into lock-up agreements that provide for restrictions on the sale of their
shares for 180 days after the effectiveness of this offering. These lock-up
agreements can be waived at any time at the sole discretion of Credit Suisse
First Boston Corporation. After this 180-day lock-up period assuming an
effective date of May 1, 2000, 12,514,579 shares will become eligible for sale,
which 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.
You will experience immediate and substantial dilution in the book value of
your shares.
The initial public offering price is substantially higher than the book
value per share of our outstanding common stock immediately after the offering.
Accordingly, if you purchase common stock in the offering, you will incur
immediate dilution of approximately $11.16 in the book value per share of our
common stock from
13
<PAGE>
the price you pay for our common stock. To the extent that existing options and
warrants owned by our existing stockholders are exercised, new investors will
experience further dilution. For additional information on this calculation,
see "Dilution."
Because our directors and officers own 67.4% of our stock prior to the offering
and will own 57.7% after the offering, the voting power of other stockholders,
including purchasers in this offering, may be limited.
After this offering, it is anticipated that our officers, directors, and
five percent or greater stockholders will beneficially own or control, directly
or indirectly, 57.7% of our shares of common stock. Our directors, together
with their affiliated entities who are our 5% or greater stockholders, and our
officers will control 57.7% of our shares of common stock. As a result, if our
directors and officers choose to act together, they will have the ability to
control all matters submitted to our stockholders for approval, including the
election and removal of directors and the approval of any business
combinations. This concentration of ownership may delay or prevent an
acquisition, which could prevent our stockholders from realizing a premium over
the market price for their common shares, or cause the market price of our
stock to decline. Our directors and officers may have interests different from
yours. For example, they may be less interested than other investors in selling
our company or pursuing different business strategies.
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 five million shares of preferred stock. Our 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 by-laws also contain other provisions which may discourage, delay or
prevent a merger or acquisition, including:
. only one of the three classes of directors is elected each year, thereby
delaying potential acquirors from gaining control of the board;
. our stockholders have limited rights to remove directors without cause,
thereby hindering the ability of potential acquirors to replace the
members of our board; and
. our stockholders have no right to act by written consent, thereby
potentially delaying the approval of an acquisition.
These provisions 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.
We have broad discretion in how we use the proceeds of this offering, and we
may not use these proceeds effectively.
Our management has broad discretion in the use of the net proceeds of this
offering and could spend the net proceeds in ways that do not yield a favorable
return or to which stockholders object. We may also use the proceeds to acquire
complementary businesses or technologies, although no such acquisitions are
currently planned. Until we need to use the proceeds of this offering, we plan
to invest the net proceeds in investment grade, interest-bearing securities.
14
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future financial
performance and include statements about our plans, objectives and services as
well as our expectations and intentions. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of such terms or other comparable
terminology. These statements are only predictions and involve known and
unknown risks, uncertainties and other factors, including the risks outlined
under "Risk Factors," that may cause our or our industry's actual results,
levels of activity, performance or achievements expressed or implied by any
forward-looking statements.
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. Except as otherwise provided under the
securities laws, we are under no duty to update any of the forward-looking
statements after the date of this prospectus to conform these statements to
actual results.
15
<PAGE>
USE OF PROCEEDS
We expect to receive net proceeds from the sale of the 4,500,000 shares of
common stock of approximately $56.6 million (approximately $65.3 million if the
underwriters' over-allotment option is exercised in full), at an assumed
initial public offering price of $14.00 per share, after deducting underwriting
discounts and commissions and estimated offering expenses.
We intend to use the net proceeds from this offering primarily for general
corporate purposes, including working capital, funding our operating losses,
expansion of our information technology infrastructure and capital
expenditures. In addition, we may use a portion of the net proceeds to acquire
complementary products, technologies or businesses; however, we currently have
no commitments or agreements and are not involved in any negotiations with
respect to any such transactions. We have not specifically allocated the
proceeds of this offering to any of these purposes. However, we currently plan
to spend approximately $32 million on sales and marketing and approximately $19
million on information technology during the year ending December 31, 2000.
These amounts include funds for hiring of personnel dedicated to these
activities. Nevertheless, our business plan, including the amount of these
expenditures, may change materially as a result of competition, changing market
conditions or lack of anticipated growth. If our business plan changes, we may
allocate these funds among the planned uses in different amounts, including
potential acquisitions. We anticipate that these expenditures will be funded in
part by our revenue. Pending use of the net proceeds of this offering, 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 future earnings, if any, for use in the operation
and expansion of our business and do not anticipate paying any cash dividends
in the foreseeable future.
16
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1999 on
the following two bases:
. on an actual basis; and
. on a pro forma as adjusted basis to give effect to the conversion of all
shares of preferred stock into 15,215,436 shares of common stock and the
sale of 4,500,000 shares of common stock at an assumed initial offering
price of $14.00 per share (less underwriting discounts and commissions
and estimated offering expenses).
You should read this table in conjunction with our financial statements and
the accompanying notes included elsewhere in this prospectus, "Selected
Financial Data" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
<TABLE>
<CAPTION>
December 31, 1999
--------------------------
Pro Forma
Actual As Adjusted
------------ ------------
<S> <C> <C>
Note payable and equipment financing, less current
portion........................................... $ 1,926,018 $ 1,926,018
Redeemable convertible preferred stock............. --
Preferred stock, $0.0001 par value: 18,566,075
shares authorized (actual), 14,999,803 issued
and outstanding (actual); none (pro forma as
adjusted)....................................... 40,374,016 --
Stockholders' equity:
Common stock, $0.0001 par value: 32,000,000
authorized (actual); 9,685,136 issued and
outstanding (actual); 29,400,572 issued and
outstanding (pro forma as adjusted)............. 969 2,940
Additional paid-in capital....................... 24,677,072 121,639,117
Deferred compensation............................ (15,860,562) (15,860,562)
Stockholder note receivable...................... (482,014) (482,014)
Accumulated deficit.............................. (20,964,057) (20,964,057)
------------ ------------
Total stockholders' equity (deficit)........... (12,628,592) 84,335,424
------------ ------------
Total capitalization........................... $ 29,671,442 $ 86,261,442
============ ============
</TABLE>
The data in the table above excludes:
. 3,158,210 shares issuable upon exercise of outstanding stock options
outstanding as of December 31, 1999;
. 618,216 shares of common stock available for issuance at December 31,
1999 under our 1999 Stock Plan; and
. 391,744 shares represented by warrants for Series A redeemable
convertible preferred stock.
For additional information regarding these shares, see "Management--Stock
Plan," "Certain Relationships and Related Transactions," "Description of
Capital Stock" and note 8 of the notes to financial statements included
elsewhere in this prospectus.
17
<PAGE>
DILUTION
If you invest in our common stock, your interest will be diluted to the
extent of the difference between the public offering price per share of our
common stock and the pro forma net tangible book value per share of common
stock after this offering. Pro forma net tangible book value per share
represents the amount of our total tangible assets less total liabilities,
divided by the pro forma number of shares of common stock outstanding. The pro
forma net tangible book value assumes the conversion of preferred stock into
common stock. Our pro forma net tangible book value as of December 31, 1999 was
$27,000,973 or $1.08 per share of common 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 4,500,000
shares of common stock offered hereby at an assumed public offering price of
$14.00 per share (less underwriting discounts and commissions and estimated
offering expenses), our pro forma net tangible book value as of December 31,
1999 would have been $83,590,973 or approximately $2.84 per share. This
represents an immediate increase in pro forma net tangible book value of $1.76
per share to existing stockholders and an immediate dilution in pro forma net
tangible book value of $11.16 per share to new investors, or approximately
79.7% of the assumed initial public offering price of $14.00 per share. The
following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share.................. $14.00
Pro forma net tangible book value per share at December 31,
1999.......................................................... $1.08
Increase per share attributable to this offering............... 1.76
-----
Pro forma as adjusted net tangible book value per share after
this offering................................................... 2.84
------
Dilution per share to new investors.............................. $11.16
======
</TABLE>
The following table shows on a pro forma basis after giving effect to this
offering, based on an assumed initial public offering price of $14.00 per
share, as of December 31, 1999, the differences between the existing holders of
common stock and the 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, before deducting the underwriting discounts and
commissions and estimated offering expenses:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ -------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ------------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders..... 24,900,572 84.7% $ 45,154,000 41.7% $ 1.81
New investors............. 4,500,000 15.3 63,000,000 58.3 14.00
---------- ----- ------------ -----
Total................... 29,400,572 100.0% $108,154,000 100.0%
========== ===== ============ =====
</TABLE>
The foregoing discussion and table are based on actual shares outstanding on
December 31, 1999 and assume no exercise of any stock options outstanding as of
December 31, 1999. As of December 31, 1999, there were options outstanding to
purchase 3,158,210 shares of common stock at a weighted average exercise price
of $0.31 per share. To the extent any of these options are exercised, there
will be further dilution to investors. See "Capitalization," "Management--Stock
Plans," "Description of Capital Stock" and note 8 of notes to consolidated
financial statements include elsewhere in this prospectus.
18
<PAGE>
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma combined financial statements for the year
ended December 31, 1999 have been prepared from the historical financial
statements of Linuxcare, Inc., The Puffin Group, Inc. ("Puffin") and Prosa
Progettazione Sviluppo Aperto s.r.l. ("Prosa"). The unaudited pro forma
combined statement of operations gives effect to the acquisitions of Puffin and
Prosa as if such transactions had occurred on January 1, 1999. The consolidated
balance sheet is presented in the audited financial statements.
On October 1, 1999, we purchased the outstanding common stock of Puffin, a
Canadian company, for 100,000 shares of our common stock and options to
purchase approximately 25,000 shares of our common stock with an exercise price
of $0.13. The option to purchase additional shares vested immediately. The
Puffin transaction was accounted for as a purchase in accordance with the
provisions of APB 16. Under the purchase method of accounting, the purchase
price is allocated to the assets acquired and liabilities assumed based on
their estimated fair values at the date of acquisition. Accordingly, the shares
and options were valued at their deemed fair value on the date of the
transaction, amounting to $4.26 per share and approximately $527,000 in the
aggregate. An intangible asset of $513,690 was recorded at the date of
purchase, reflecting the difference between the net fair value of the
underlying assets and liabilities and the deemed fair value of the shares and
options paid as consideration. The intangible asset represents the value of the
workforce acquired and is being amortized over the employment term of the
employees acquired, which was estimated as 3 years. The adjustments to the pro
forma statement of operations reflect one year of amortization of the
intangible asset. Additionally, 330,000 options to purchase our common stock,
with vesting terms of three years and an exercise price of $.13 per share, were
granted to Puffin's key employees. As these option grants reflect grants to new
employees consistent with the number of options granted by us to key employees
with commensurate responsibilities and these grants are conditional upon
continuous employment, the deemed fair value of these additional options in the
amount of $1.4 million was included in our deferred stock compensation
calculations.
On December 30, 1999, we purchased the outstanding shares of the common
stock of Prosa, an Italian company, for cash and the assumption of liabilities
totaling $290,000 and options to purchase 25,000 shares with an exercise price
of $2.00. The cash payment was considered purchase consideration, and the
options to purchase 25,000 shares were considered employment consideration. The
Prosa transaction was accounted for as a purchase in accordance with APB 16.
Under the purchase method of accounting, the purchase price is allocated to the
assets acquired and liabilities assumed based on their estimated fair values at
the date of acquisition. An intangible asset of $273,569 was recorded at the
date of the purchase, reflecting the difference between the net fair value of
the underlying assets and the total consideration paid. The intangible asset is
being amortized over the employment term of the employees acquired, which was
estimated as 3 years. The adjustments to the pro forma statement of operations
reflect one year of amortization of the intangible asset.
The purchase price for the Puffin and Prosa transactions was allocated to
the assets acquired and liabilities assumed based on their estimated fair
values as determined by us as follows as of the date of the respective
acquisitions:
<TABLE>
<CAPTION>
Puffin Prosa
September 30, December 31,
1999 1999
------------- ------------
<S> <C> <C>
Current assets.................................... $ 59,207 $ 123,880
Intangible asset.................................. 513,690 273,569
Long term assets.................................. 8,461 12,845
Current liabilities............................... (54,038) (120,709)
-------- ---------
Purchase Price.................................... $527,320 $ 289,585
======== =========
</TABLE>
19
<PAGE>
LINUXCARE, INC.
Unaudited Pro Forma Combined Statement of Operations
For the Year Ended December 31, 1999
Unaudited
<TABLE>
<CAPTION>
Puffin
Linuxcare, Inc. Prosa Nine Months
Year Ended Year Ended Ended Unaudited Unaudited
December 31, December 31, September 30, Combined Pro Forma Pro Forma
1999 1999 1999 Total Adjustments Combined
--------------- ------------ ------------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Revenue................. $ 1,210,806 $222,930 $ 97,735 $ 1,531,471 $ -- $ 1,531,471
Cost of sales........... 2,814,546 120,335 52,168 2,987,049 -- 2,987,049
------------ -------- -------- ------------ --------- ------------
Gross margin............ (1,603,740) 102,595 45,567 (1,455,578) -- (1,455,578)
Operating expenses:
Selling, general and
administrative........ 14,755,289 87,250 45,264 14,887,803 -- 14,887,803
Amortization of
deferred stock
compensation.......... 4,121,356 -- -- 4,121,356 4,121,356
Amortization of
intangible asset...... 42,808 -- -- 42,808 219,612 (a) 262,420
------------ -------- -------- ------------ --------- ------------
Total operating
expenses............... 18,919,453 87,250 45,264 19,051,967 219,612 19,271,579
------------ -------- -------- ------------ --------- ------------
Income (loss) from
operations............. (20,523,193) 15,345 303 (20,507,545) (219,612) (20,727,157)
Interest income......... 45,061 -- -- 45,061 -- 45,061
Interest expense........ (468,267) (1,048) -- (469,315) -- (469,315)
Other................... -- (1,399) -- (1,399) -- (1,399)
------------ -------- -------- ------------ --------- ------------
Net income (loss) before
income taxes........... (20,946,399) 12,898 303 (20,933,198) (219,612) (21,152,810)
Income tax expense...... 4,200 6,293 -- 10,493 -- 10,493
------------ -------- -------- ------------ --------- ------------
Net income (loss)....... (20,950,599) 6,605 303 (20,943,691) (219,612) (21,163,303)
Preferred stock
accretion.............. (260,380) -- -- (260,380) -- (260,380)
------------ -------- -------- ------------ --------- ------------
Net income (loss)
applicable to common
stockholders........... $(21,210,979) $ 6,605 $ 303 $(21,204,071) $(219,612) $(21,423,683)
============ ======== ======== ============ ========= ============
Basic and diluted net
loss per share ........ $ (7.49) $ (7.37)
============ ============
Weighted average shares
outstanding (b)........ 2,833,756 2,908,756
============ ============
Pro forma basic and
diluted net loss per
share ................. $ (2.26) $ (2.27)
============ ============
Pro forma weighted-
average shares
outstanding (b)........ 9,252,635 9,327,635
============ ============
</TABLE>
- --------
(a) Reflects the amortization of the intangible asset related to the purchase
of Puffin and Prosa over three years.
(b) The pro forma weighted average shares outstanding gives effect to the
conversion of preferred shares that will automatically convert upon
completion of our initial public offering as if such conversion occurred at
the original issuance date, as discussed in note 1 to the financial
statements. The difference between the pro forma combined weighted average
shares outstanding of 2,958,756 and the December 31, 1999 weighted average
shares outstanding of 2,833,756, as reported in our financial statements,
is comprised of the incremental weighted average of 100,000 shares
outstanding from January 1, 1999 through the date of acquisition (October
1, 1999) issued pursuant to the Puffin acquisition as if this acquisition
had occurred on January 1, 1999. Similarly, the increase between the
unaudited pro forma combined weighted average shares outstanding of
9,377,635 and our December 31, 1999 pro-forma weighted-average shares
outstanding is comprised of the incremental weighted average of the same
100,000 shares mentioned above.
20
<PAGE>
SELECTED FINANCIAL DATA
In the table below, we provide summary historical financial data of
Linuxcare. We have prepared this information using the financial statements of
Linuxcare as of December 31, 1998 and December 31, 1999 and for the period from
December 9, 1998 (inception) to December 31, 1998 and for the year ended
December 31, 1999.
When you read this summary historical financial data it is important that
you read along with it the historical financial statements and related notes
included elsewhere in this prospectus, as well as the section titled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
Period from
December 9, 1998
(inception) to Year ended
December 31, December 31,
1998 1999
---------------- ------------
<S> <C> <C>
Statement of Operations Data:
Revenues........................................ $ -- $ 1,210,806
Cost of revenues(1)............................. -- 2,814,546
-------- ------------
Gross margin.................................... -- (1,603,740)
Operating expenses:
Sales and marketing(2)........................ -- 4,518,801
General and administrative(3)................. 13,458 10,236,488
Amortization of deferred stock compensation... -- 4,121,356
Amortization of intangible asset.............. -- 42,808
-------- ------------
Total operating expenses.................... 13,458 18,919,453
-------- ------------
Loss from operations............................ (13,458) (20,523,193)
Interest income................................. -- 45,061
Interest expense................................ -- (468,267)
-------- ------------
Loss before income taxes........................ (13,458) (20,946,399)
Income tax expense.............................. -- 4,200
-------- ------------
Net loss........................................ (13,458) (20,950,599)
Preferred stock accretion....................... -- (260,380)
-------- ------------
Net loss applicable to common stockholders...... $(13,458) $(21,210,979)
======== ============
Basic and diluted net loss per share............ $ -- $ (7.49)
======== ============
Weighted average shares used in computing basic
and diluted net loss per share................. -- 2,833,756
======== ============
Pro forma basic and diluted net loss per share
(unaudited).................................... $ (2.26)
============
Weighted average shares used in computing pro
forma basic and diluted net loss per share
(unaudited).................................... 9,252,635
============
</TABLE>
- --------
(1) Excludes $1,511,855 of deferred stock compensation in 1999.
(2) Excludes $63,654 of deferred stock compensation in 1999.
(3) Excludes $2,545,847 of deferred stock compensation in 1999.
21
<PAGE>
<TABLE>
<CAPTION>
December 31,
----------------------
1998 1999
-------- ------------
<S> <C> <C>
Balance Sheet Data (end of period):
Cash and cash equivalents............................. $138,920 $ 29,994,575
Working capital....................................... 186,842 25,029,759
Total assets.......................................... 200,300 36,366,003
Notes payable and equipment financing, less current
portion.............................................. 200,000 1,926,018
Redeemable convertible preferred stock................ -- 40,374,016
Total stockholders' deficit........................... (13,158) (12,628,592)
</TABLE>
See note 1 of notes to financial statements for an explanation of the
determination of the average number of shares of common stock used to compute
net loss per share.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Financial Data" and our financial statements and the related notes
included elsewhere in this prospectus. Our actual results could differ
materially from those anticipated in the forward-looking statements as a result
of certain factors including the risks discussed in "Risk Factors" and
elsewhere in this prospectus.
Overview
We are a provider of services for Linux. We commenced operations in December
1998 and offer a comprehensive range of services to support business customers.
We offer our customers professional services, technical support, education and
product certification across 21 Linux distributions and eight hardware
platforms: DEC Alpha, IBM, Intel, MIPS, Power PC, SGI, SPARC and Transmeta. We
are implementing an Internet-based infrastructure to enable us to provide
solutions to our customers in a timely and cost-effective manner.
We offer a range of services, including professional services, technical
support, education and product certification. We often combine these service
offerings to provide our customers with comprehensive solutions. We currently
provide professional services on a time-and-materials basis and recognize these
revenues as and when the services are provided. We have begun to provide a
portion of our professional services on a fixed fee basis and expect this trend
to increase as our business expands. Fees for technical support are generated
on an hourly basis, a per incident basis or pursuant to long-term service
agreements. We recognize such revenues as services are performed or pro-rata
over the term of the service agreement, as applicable. Our educational
materials are licensed to customers in return for a training fee and a per
student royalty, and the resulting revenues are recognized upon completion of
the training. We expect to provide our product certification services either on
a per usage basis or pursuant to long-term, fixed-fee contracts. We will
recognize these revenues when the service is completed or pro rata over the
term of the contract. Under the terms of multiple element arrangements
(training, technical support services, and certifications), where we do not
have vendor specific objective evidence of pricing, aggregate fees are
amortized over the service period after the initial training or initial
certification services have been performed, which is usually early in the term
of the agreement. Revenue from fixed price long-term computer software
development contracts is recognized over the contract term based on the
percentage of services provided during the period compared to the total
estimated services provided over the entire contract. For the year ended
December 31, 1999, 50% and 31% of our revenues were derived from technical
support and professional services, respectively. Other revenues representing
19% of total revenues for year ended December 31, 1999 consisted primarily of
revenue from education and product certification. As our business matures, we
expect professional services and technical support to represent a majority of
our revenues.
As of December 31, 1999, we had international operations with sales
personnel located in Canada, the United Kingdom, Germany, The Netherlands,
Sweden and Australia. We also had direct sales coverage in Japan and France.
Through December 31, 1999, 9% of our revenues related to companies in Japan.
All of our international revenues during the year related to sales made to
companies in Japan. In 1999, we completed acquisitions of two small Linux
consulting companies, one in Canada and one in Italy and we intend to continue
to increase our international operations through new hires and selective
acquisitions.
Cost of revenues consists primarily of direct labor costs, including
salaries, employee benefits and incentive compensation, of employees directly
associated with the delivery of our services in client engagements, non-
reimbursed out-of-pocket expenses incurred by such employees and a
proportionate share of certain operating expenses.
We define gross margin as our revenues less our cost of revenues. We expect
that our ability to achieve favorable gross margins will depend on our ability
to improve our efficiencies in the delivery of our services, as measured by
utilization rates and effective billing rates. We define effective billing rate
as our total revenues over total billable employee hours.
23
<PAGE>
Sales and marketing expenses consist primarily of the salaries, commissions
and related expenses for employees dedicated to our sales and marketing
efforts. Additionally, we include in sales and marketing expenses costs
associated with public relations, the expenses associated with the maintenance
of our website, marketing events and promotions. We expect sales and marketing
expenses to substantially increase in the future, primarily as a result of a
significant expansion in our direct sales force and increase in expenses
associated with marketing programs and events.
General and administrative expenses consist of the salaries, employee
benefits and incentive compensation of employees performing managerial, finance
and administrative functions, depreciation and amortization expenses largely
related to our information technology infrastructure and costs associated with
recruiting and training activities. We expect our general and administrative
expenses to substantially increase in the future as we invest in our support
infrastructure and technology.
Amortization of deferred stock compensation represents the non-cash expense
associated with the amortization of the difference between the deemed fair
value of the common stock for accounting purposes and the option exercise price
over the vesting period or the service period, as applicable. In connection
with the grant of certain stock options to employees for the year ended
December 31, 1999, we recorded deferred stock compensation within stockholders'
deficit of approximately $20.0 million, representing the difference between the
deemed fair value of the common stock at the date of the option grant for
accounting purposes and the option exercise price of these options at the date
of grant. We recorded amortization of deferred compensation of approximately
$4.1 million for the year ended December 31, 1999. The deferred stock
compensation expense is being amortized on an accelerated basis over the
vesting period of the individual award, generally four years. This method is in
accordance with Financial Accounting Standards Board Interpretation No. 28.
Accordingly, the remaining deferred compensation at December 31, 1999 of
approximately $15.9 million will be amortized as follows: $9.7 million during
fiscal 2000, $4.0 million during fiscal 2001, $1.8 million during fiscal 2002
and $0.4 million in fiscal 2003. The amortization expense relates to options
awarded to employees in all operating expense categories. In addition, we
expect to record an additional deferred compensation charge relating to option
grants made after December 31, 1999 but prior to the completion of the
offering. We estimate the charge relating to these additional grants will be
approximately $20.3 million, based upon the low end of the assumed offering
price range of $13.00 per share, for the year ending December 31, 2000.
Accordingly, we estimate the amortization charge for these additional grants
will be amortized as follows: $10.9 million during fiscal 2000, $5.8 million
during fiscal 2001, $2.7 million during fiscal 2002, and $0.9 million during
fiscal 2003. The amount of deferred compensation expense to be recorded in
future periods could decrease if options for which accrued but unvested
compensation has been recorded are forfeited.
We have completed two acquisitions to date. In October 1999, we acquired
Puffin, a Canadian company, and in December 1999, we acquired Prosa, an Italian
company. The acquisition of Puffin adds to Linuxcare's worldwide professional
services capabilities, serving to further accelerate the rapid growth of Linux
and open-source solutions in enterprise environments. The Prosa acquisition was
made in order to add employees to bolster our embedded systems expertise. While
we continue to consider new acquisitions in the United States and
internationally as opportunities arise, we are not currently party to any
acquisition-related agreements. The outstanding common stock of Puffin was
purchased by us for 100,000 shares of our common stock and options to purchase
an additional 355,000 shares with an exercise price of $0.13. The options to
purchase 355,000 shares were allocated between purchase price consideration
(approximately 25,000 shares) and deferred compensation given to certain key
employees contingent upon their continued employment for a period of
approximately three years (approximately 330,000 shares). The total value of
the purchase price consideration was deemed to be $4.26 per share, amounting to
approximately $527,000 in the aggregate. We also purchased the outstanding
common stock of Prosa for cash of $225,000 and the assumption of liabilities of
$65,000, both aggregating to $290,000, and options to employees to purchase
25,000 shares of our common stock with an exercise price of $2.00. The cash
payment was considered purchase consideration, and the options to purchase
25,000 shares were considered employment consideration. The amount of deferred
stock compensation recognized in the acquisition of Puffin and Prosa employees
and included in the total described
24
<PAGE>
in the preceding paragraphs was $1.4 million. We recorded intangible assets of
$514,000 and $274,000 in the acquisitions of Puffin and Prosa, respectively,
representing the value of the workforce acquired and calculated as the
difference between the net fair value of the assets acquired and the total
consideration paid. The intangible asset is being amortized over the employment
term of the employees acquired, which was estimated as three years. Other than
accounts receivable denominated in Italian Lire totaling approximately $115,000
and the value of the workforce acquired of $787,259, no other significant
financial assets or liabilities were acquired. Both subsidiaries continue to
operate as separate businesses and the nature of their operations has not
significantly changed from that at the date of the respective acquisitions. We
believe that these acquisitions have added to our capacity to provide
professional services for embedded systems and in enterprise environments,
consistent with our planned growth in these areas. Additionally, we expect the
significance of the operations of these entities will increase as our
international client base grows. The Prosa transaction included a contingent
payment clause whereby the purchase price and salary paid to the former owners
would be decreased if certain operating results and accounts receivable
collections of the acquired entity were not achieved for 1999. We do not expect
this contingency to be significant to the purchase price paid and no gain
contingency has been recorded. There were no contingent payments related to the
Puffin transaction.
We incurred significant start-up expenses during 1999 in salaries,
infrastructure development, marketing and general administration. We reported
an operating loss in 1999 and anticipate incurring operational losses in 2000
and 2001. In particular, we expect that our plans for increases in expenses and
capital expenditures over the next two years to support our expected growth
will adversely affect our operating results. As we grow our business, we expect
to incur significant expenditures for marketing, recruiting and hiring
additional personnel, upgrading our technology infrastructure and expanding
into new markets.
Predicting our future operating performance based on only one year is
difficult given the uncertainty of our industry and the market as a whole.
Since past results are not necessarily indicative of future outcome, our
revenues and net income (loss) will likely fluctuate significantly from period
to period. The primary factors that may cause our quarterly operating results
to fluctuate include:
. the uncertain rate of growth in the usage and acceptance of the Linux
operating system and related open source software;
. our ability to continue to hire and retain leading Linux experts;
. the uncertain short-term and long-term demand for our services;
. increased competition in the Linux industry as well as the competition
we face from offerings based on proprietary operating systems;
. reductions in the cost of services offered by our competitors;
. our ability to expand our professional services, sales and customer
support organizations and develop new service offerings; and
. general economic conditions and conditions in the particular industries
in which we and our competitors operate.
Results of Operations
Quarterly Results of Operations
The following table presents our unaudited quarterly data for the periods
indicated. We derived these data from our unaudited consolidated interim
financial statements, and, in our opinion, these data include all necessary
adjustments, which consist only of normal recurring adjustments necessary to
present fairly the financial results for the period.
25
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended
--------------------------------------
Year Ended
March 31, June 30, Sept. 30, Dec. 31, Dec. 31,
1999 1999 1999 1999 1999
--------- -------- --------- -------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues..................... $ 10 $ 139 $ 156 $ 906 $ 1,211
Cost of revenues............. 173 465 692 1,485 2,815
------- ------- ------- -------- --------
Gross margin................. (163) (326) (536) (579) (1,604)
Operating expenses:
Sales and marketing........ 675 654 908 2,282 4,519
General and
administrative............ 666 1,867 2,476 5,227 10,236
Amortization of deferred
stock compensation........ -- 554 1,001 2,566 4,121
Amortization of intangible
asset..................... -- -- -- 43 43
------- ------- ------- -------- --------
Total operating
expenses................ 1,341 3,075 4,385 10,118 18,919
------- ------- ------- -------- --------
Loss from operations......... (1,504) (3,401) (4,921) (10,697) (20,523)
Interest expense, net........ -- -- 199 224 423
------- ------- ------- -------- --------
Loss before income taxes..... (1,504) (3,401) (5,120) (10,921) (20,946)
Income tax expense........... -- -- -- 5 5
------- ------- ------- -------- --------
Net loss................... $(1,504) $(3,401) $(5,120) $(10,926) $(20,951)
======= ======= ======= ======== ========
</TABLE>
Year ended December 31, 1999
Revenues
Revenues of $1.2 million were generated from the provision of services for
Linux and other open source technologies. Revenue by geographic region was 91%
from the United States and 9% from Japan. Approximately 75% of our revenues
were earned in the fourth quarter. The revenue increase during the period was
driven primarily by the addition of several customers who represented
significant revenues. Silicon Graphics, Inc. was added in the second quarter,
Densa Techno Tokyo in the third quarter and Motorola and Sun Microsystems in
the fourth quarter. These customers represented 11%, 7%, 18% and 26% of
revenues for the year, respectively. Revenue from technical support,
professional services and other services was 50%, 31% and 19% of total
revenues, respectively.
Cost of Revenues
Costs of revenues were $2.8 million consisting primarily of headcount and
related costs. During the period, we increased headcount significantly to
support anticipated revenue growth. During the year, billable headcount
increased from 12 at the end of the first quarter to 22, 25 and 44 at the end
of the second, third and fourth quarters, respectively.
Sales and Marketing Expenses
Sales and marketing expenses were $4.5 million, primarily attributable to
costs of sales and marketing personnel of $1.4 million, public relations
activities of $1.0 million and advertising and other promotions of $1.0
million. Sales and marketing expenses grew during the period as a result of the
hiring of additional personnel and expenses associated with the launch of our
service offerings. Headcount in sales and marketing grew from three at the end
of the first quarter to seven, 12 and 34 at the end of the second, third and
fourth quarters, respectively. We expect sales and marketing expenses to
increase as we invest worldwide in additional employees as well as public
relations, advertising and promotions.
26
<PAGE>
General and Administrative Expenses
General and administrative expenses were $10.2 million, primarily
attributable to personnel costs of $2.3 million, consulting services of $5.7
million and recruiting expense of $1.0 million. Personnel costs grew during the
period as a result of hiring additional personnel in the areas of executive
administration and information technologies. General and administrative
personnel grew from six at the end of the first quarter to 27, 29 and 52 at the
end of the second, third and fourth quarters, respectively. We expect general
and administrative expenses to increase as we invest in additional facilities
and computer networking infrastructure.
Amortization of Intangible Asset
The intangible asset amortized in the fourth quarter of approximately
$43,000 relates to the workforce purchased in the Puffin transaction.
Amortization of Deferred Stock Compensation
In connection with the grant of restricted stock and stock options to
employees and consultants, we recorded deferred stock compensation of $20.0
million and amortized $4.1 million during the period.
Net Loss
We recorded a net loss of $21.0 million during the period, primarily
attributable to increasing general and administrative expenses, sales and
marketing expenses and amortization of deferred stock compensation as described
above. Total headcount increased from 21 at the end of the first quarter to 56,
66 and 130 at the end of the second, third and fourth quarters, respectively.
Period from December 9, 1998 (inception) to December 31, 1998
During the period from inception to December 31, 1998, we incurred general
and administrative expenses of $13,458.
Liquidity and Capital Resources
Since inception, our operations have been financed primarily through the
issuance of Series A and Series B redeemable convertible preferred stock. On
February 1, 1999 and April 16, 1999, we issued a total of 7.9 million shares of
Series A Preferred Stock, for approximately $4.8 million. On December 17, 1999
we raised approximately $33.5 million from the sale of 7.1 million shares of
Series B preferred stock. The proceeds from the sale of Series B preferred
stock include the conversion of $1.0 million of notes payable and receipt of a
subscription receivable of $1.0 million. Upon completion of this offering, each
Series A and B preferred share will convert into common stock at a ratio of 1:1
and 1:1.030447, respectively. As of December 31, 1999, we had cash of
$29,994,575 and positive working capital of approximately $25.0 million.
Cash used in operating activities during the year ended December 31, 1999
was $9.0 million. This was the result of a net loss of $21.0 million before
preferred stock accretion for the year ended December 31, 1999, partially
offset by non-cash expenses including $4.1 million of amortization of deferred
stock compensation, $2.9 million of equity compensation to consultants, $1.0
million of compensation for stock options to consultants, $0.2 million of
depreciation, $0.3 million of amortization of debt issuance costs, and $3.5
million of other net changes in working capital.
Cash used in investing activities during the year ended December 31, 1999
was $2.3 million, consisting of purchases of property and equipment, and the
purchase of Prosa. We anticipate substantial capital expenditures in 2000
consistent with our anticipated growth in operations, investments,
infrastructure and personnel.
27
<PAGE>
Cash provided by financing activities during the year ending December 31,
1999 was $41.2 million 1999. We raised $36.0 million through the sale of
redeemable convertible preferred stock, $5.0 million through notes payable, and
$0.1 million through the exercise of stock options.
On July 27, 1999, we entered into a subordinated loan and security agreement
with a financial institution for maximum borrowings of $2.0 million. At
December 31, 1999, we had outstanding $2.0 million in notes payable. This note
payable bears an annual interest rate of 10% and is due in 36 months. We will
be obligated to make interest and principal payments beginning six months after
the issuance date. Until that time, interest accrues but is not payable. If we
default, the note payable will bear an annual interest rate of 15%. This note
payable is secured by certain of our tangible and intangible assets.
We also have a line of credit for equipment financing for up to $1.0
million. The annual interest rate on amounts borrowed under the line of credit
is 7.5%. The credit facility contains customary covenants and expires in
December 2002. As of December 31, 1999, we had drawn down $510,662 under the
line of credit. This loan is secured by the equipment purchased.
The subordinated loan and security agreement and equipment financing
arrangements are subject to non-financial covenants, including:
. we shall not merge with or into any other entity, or sell or convey all
or substantially all of its assets or stock without notifying and
requesting consent from the lender;
. we shall not, without the prior written consent of the lender, declare
or pay a cash dividend or make a distribution on any class of stock; and
. we shall not sell, transfer, assign or otherwise encumber its
intellectual property.
We are obligated under various non-cancelable operating leases for our
office space. Future annual minimum rental commitments under the leases range
in the aggregate from $1.17 million to $1.23 million over the next five years.
Total future minimum rental commitments are approximately $6.0 million.
Our future liquidity and capital requirements will depend upon numerous
factors, including the costs associated with the expansion of our information
technology infrastructure and service offerings, the increases in our
requirements for professionals, our sales and marketing activities and the
amount of working capital and fixed asset investment required in our business.
We do not believe we will generate positive cash flow from operations until
2002. At our current rate of expenditures, we believe that our current cash and
investment balances and available lines of credit facilities will be sufficient
to meet our operating and capital requirements for at least the next 12 months.
Our current capital resources together with the proceeds of this offering
should be sufficient to fund our anticipated growth and operations and
expenditures through the end of 2001. However, we may be required, or could
elect to seek additional funding during the next 12 months or thereafter,
particularly if we acquire complementary businesses, products or technologies
or if our losses during the year ending December 31, 2000 are greater than we
expect. As a result, we may be required to raise additional funds through
public or private financing, strategic relationships or other arrangements. We
cannot assure you that additional funding, if needed, will be available on
reasonable terms, or at all. Furthermore, any additional equity financing may
be dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. Our inability to raise capital when needed could
seriously harm our business.
Recent Accounting Pronouncements
In March 1998, the AICPA issued Statement of Position (SOP) No. 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. SOP No. 98-1 requires entities to capitalize certain costs
related to internal-use software once certain criteria have been met. SOP No.
98-1 was adopted by us in fiscal 1999. The adoption of SOP No. 98-1 did not
have a material effect on our financial position or results of operations.
28
<PAGE>
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. SFAS No. 133, as recently amended, is effective for
fiscal years beginning after June 15, 2000. We believe that the adoption of
SFAS No. 133 will not have a material effect on our financial position or
results of operations.
Staff Accounting Bulletin No. 101
In December 1999 the SEC issued Staff Accounting Bulletin (SAB 101), Revenue
Recognition in Financial Statements. The SAB spells out four basic criteria
that must be met before registrants can record revenue. These are: (a)
persuasive evidence that an arrangement exists; (b) delivery has occurred or
services have been rendered; (c) the seller's price to the buyer is fixed or
determinable; and (d) collectability is reasonably assured. The Company is
currently in the process of evaluating the impact of the SAB upon its current
accounting policies.
Year 2000 Impact
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 data records past the year 1999. Our business has not been
affected by year 2000 issues. However, we cannot assure you that we will not
experience any disruption related to year 2000 issues in the future. We are not
currently aware of any unresolved year 2000 problems relating to any of our
internal systems, nor do we believe that we have any significant systems that
are not year 2000 compliant. Based on our assessment to date, we do not expect
the total cost of year 2000 remediation to be material to our business. To
date, our preparation and remediation costs have not been material.
We confront the year 2000 risk in two contexts.
Our customers. The failure of our customers to ensure that their operations
are year 2000 compliant could have an adverse effect on them, which in turn
could limit their ability to retain us as a third-party service provider or
process our invoices in a timely manner. In addition, customers or potential
customers may delay purchasing our services to the extent such customers or
potential customers are required to devote resources to resolving the year 2000
problem.
Our services. The solutions that we provide our customers integrate software
and other technology from different providers. If there is a year 2000 problem
with respect to a solution provided by us, it may be difficult to determine
whether the problem relates to services that we have performed or is due to the
software, technology or services of the other providers. As a result, we may be
subjected to year 2000-related lawsuits whether or not the services we have
performed are year 2000 compliant. We cannot be certain what the outcomes of
these types of lawsuits may be.
Quantitative and Qualitative Disclosures about Market Risk
We are exposed to minimal market risks. We manage our investment activities
with the primary objective of preserving principal while at the same time
maximizing the income we receive from our investments without significantly
increasing risk. Some of the securities that we may invest in may be subject to
market risk. A change in prevailing interest rates may cause the principal
amount of the investment to fluctuate. For example, if we hold a security that
was issued with a fixed interest rate at the then-prevailing rate and the
prevailing interest rate subsequently rises, the principal amount of our
investment will likely decline. To minimize this risk in the future, we intend
to maintain our portfolio of cash equivalents and short-term investments in a
variety of securities, including commercial paper, money market funds and
government and non-government debt securities. In general, money market funds
are not subject to market risk because the interest paid on such
29
<PAGE>
funds fluctuates with the prevailing interest rate. As of December 31, 1999,
all of our cash and cash equivalents were in money market and checking funds.
We do not hold or issue derivative, derivative commodity instruments or other
financial instruments for trading purposes.
Impact of Foreign Currencies
While international operations have been limited to date, we are exposed to
the effects of exchange rate fluctuations, particularly related to the Italian
Lire. At December 31, 1999, we had approximately $115,000 in receivables
denominated in Italian Lire. We expect that our exposure to exchange rate
fluctuations will increase as the significance of our international operations
grows. Our financial results could be affected by changes in foreign currency
exchange rates or weak economic conditions in foreign markets.
30
<PAGE>
BUSINESS
Overview
We are a provider of services for Linux. We offer professional services,
technical support, education and product certification for Linux, leading open-
source software packages and other related technologies. We deliver rapid,
cost-effective, customized and expert solutions to our customers' Linux-related
service needs. We are implementing an advanced Internet-based infrastructure
that enhances our knowledge management and customer service delivery. We
currently support 21 distributions of Linux.
We focus on customer services for large businesses, with our sales and
marketing efforts targeted toward original equipment manufacturers, or OEMs,
software vendors, Global 1000 companies and Internet infrastructure providers.
During 1999, our eight largest customers were Dell Computer, Densa Techno
Tokyo, Hewlett-Packard, KPMG Peat Marwick, MacMillan USA, Motorola, Silicon
Graphics and Sun Microsystems.
Industry Background
The Growth of the Internet
Companies are increasingly using the Internet to build cost-effective,
reliable, efficient channels of communication and commerce with their global
base of customers, suppliers and distribution partners. In addition, companies
are adopting Internet-based business models to address the rapidly growing,
global base of online consumers. According to International Data Corporation,
or IDC, the number of worldwide Internet users is expected to grow from 142
million in 1998 to 502 million in 2003 and worldwide e-commerce revenues are
projected to increase from approximately $50 billion to more than $1.3 trillion
during the same period.
To remain competitive, companies must implement more sophisticated, reliable
and flexible Internet solutions. As a result, companies are rapidly deploying
and integrating new technologies as their Internet information technology
infrastructure needs grow. According to IDC, spending on Internet information
technology infrastructure will grow from approximately $110 billion in 1998 to
approximately $592 billion in 2003. With Linux emerging as the leading
operating system for the Internet, we believe Linux will benefit directly from
the growth of the Internet. Because Linuxcare's success is dependent upon the
growth of demand for Linux and applications based on Linux, we believe
increased use of Linux as a result of Internet growth will result in greater
demand for our services.
The Emergence of Open-source Software
Open source refers to software distributed under a legal license that
permits free distribution and requires open availability of the source code,
the instructions contained within a software program. The best known open-
source software is the Linux operating system, or Linux. Linux can be
downloaded from the Internet free of charge and used with few restrictions.
Open-source licenses such as those governing the use of Linux and related
applications permit the public the right to read, modify, redistribute and use
the software freely. Furthermore, because developers have access to the
underlying source code, they are able to customize it for their specific needs.
Developers can then submit their changes and enhancements for inclusion in
future Linux releases. As a result, Linux is continuously improved by a
worldwide community of software developers. The Internet's growth has enhanced
the development of Linux, enabling large communities of independent developers
to collaborate more effectively. This growth has accelerated development cycles
and increased product quality. Businesses are increasingly adopting Linux and
other open-source technologies for their Internet infrastructures. For example,
according to the Netcraft Web Server Survey (netcraft.com/survey) during
February 2000, Apache, an open-source Web server, commanded a 58% market share,
as compared to 23% for Microsoft's Internet Information Server.
31
<PAGE>
Linux is Becoming the Leading Operating System for the Internet
Companies are increasingly adopting Linux as a platform for applications and
for file, print, Web and e-mail servers. According to IDC, shipments of Linux
server operating environments grew 93% from 1998 to 1999. In addition, several
technology industry leaders, including Hewlett-Packard, IBM and Motorola, have
recently announced that they will provide hardware or software compatible with
Linux operating systems. We believe that Linux offers multiple benefits to
businesses, including:
. reduced total cost of ownership;
. improved compatibility with other operating systems, applications and
networks; and
. ease of customization due to the open availability of the source code.
Linux is particularly well suited for the Internet where highly reliable,
secure, low-cost and customizable solutions are essential. As a result, Linux
is emerging as the leading operating system for the Internet. According to an
April 1999 survey conducted by the Internet Operating System Counter
(leb.net/hzo/ioscount), Linux ran on approximately 31% of the Web servers
polled, more than any other single system.
Market Opportunity
Despite the various benefits and initial market acceptance of Linux, a
number of challenges exist to the widespread adoption of Linux. We believe that
the greatest obstacle impeding this adoption is the lack of professional
services, technical support, education and product certification comparable to
those available for traditional, proprietary operating systems such as
Microsoft's Windows NT. According to a June 1999 Miller-Freeman survey, which
we co-sponsored, 33% of the respondents cited the lack of commercial support
and services as the largest obstacle to buying open-source products. This study
revealed that 79% of the respondents considered service and support to be an
important factor in their buying decision.
The open-source nature of Linux enables companies to market variations, or
distributions, of Linux. Other Linux vendors have begun to bundle Linux
distributions with hardware systems. However, these Linux software and hardware
vendors generally provide services limited to their distributions and systems.
In addition, other technology vendors and information technology services
providers have focused neither on building the depth of expertise nor on
providing the full range of services necessary to support Linux for business
customers.
We believe an opportunity exists for a vendor-neutral Linux services
provider to emerge with the reputation and skills necessary to provide Linux-
based solutions for enterprises. This provider must have:
. the ability to provide a full service offering, including professional
services, technical support, education and product certification;
. knowledge of Linux distributions and compatible hardware platforms, and
the ability to integrate Linux with existing computing environments;
. technical expertise;
. a technology infrastructure to efficiently serve an expanding customer
base; and
. the active support of and involvement in the Linux and open-source
communities.
Solution
To address the need for comprehensive services for Linux, we offer the
following solutions:
Complete Software and Hardware Life Cycle Support
We offer a comprehensive range of services spanning the entire software and
hardware life cycle. We help customers evaluate Linux, select Linux hardware
and software solutions, implement and maintain Linux
32
<PAGE>
solutions and receive ongoing education. Our service offerings consist of
business analysis, systems implementation, application porting, device driver
development, security audits, performance analysis, technical support,
education and product certification. Our engineers' knowledge of major
operating systems, applications and networks enables us to effectively
integrate Linux and other open-source solutions with existing computing
infrastructures. As an example of our broad-based services, Linuxcare provides
Motorola with technical support for its engineering group, courseware for
Motorola University and engineering support for Motorola's embedded systems
group. Our relationship with Motorola is indicative of the type of customer
relationship we plan to build and demonstrates our ability to provide multiple
services. We believe that our comprehensive range of services will help us
develop long-term customer relationships.
In-depth Linux and Open-source Expertise
We have assembled a worldwide team of individuals who we believe are Linux
experts and who actively participate in the open-source community. As of
December 31, 1999, we employed 65 Linux and open-source hardware and software
technologists on a full-time basis. As part of their employment, many of these
professionals continue to contribute to open-source projects, such as:
. the Linux kernel, the core of the operating system that directs the most
fundamental operations of the computer;
. SAMBA, a file and print server;
. Apache, a Web server;
. Professional Home Page, or PHP, a solution that allows Internet servers
to connect with back-end resources such as databases and scripting
engines;
. EMACS, a text editing tool;
. ET-Linux, a leading Linux distribution for embedded systems;
. Majordomo, a mailing list management program; and
. the development of Linux for computer chips from Hewlett-Packard, Intel
and Motorola.
We believe that the involvement of our professionals in these projects and
our investment in Linux expertise make us an integral member of the Linux and
open-source development communities. Our involvement in these communities
enables us to maintain our technical expertise and react quickly to new
developments.
Internet-based Delivery Model
We are implementing an Internet-based infrastructure to help us more
efficiently and effectively serve our expanding customer base. We are able to
deliver services such as installation, diagnostics and maintenance remotely
over the Internet, reducing the need for on-site personnel. As part of our
infrastructure, we have implemented a knowledge sharing and management database
consisting of information gained from all of our business units. We use our
knowledge database to efficiently provide solutions to our customers. We also
provide our customers Internet-based access to our knowledge database, which
delivers automated responses to their questions. Our advanced infrastructure
and knowledge database enable us to provide high-quality solutions to our
customers in a timely and cost-effective manner.
Vendor-neutral Services Offerings
Our service offerings are designed to support many different Linux
distributions across a number of hardware platforms. We believe there are
approximately 110 distributions of Linux. We currently support 21 different
Linux distributions on eight hardware platforms. Our vendor neutrality has
helped us develop a
33
<PAGE>
comprehensive knowledge database that enables our experts to respond to our
customers' diverse needs. We can help our customers choose the best Linux
distribution and hardware platform for their needs and integrate these
technologies with their existing computing infrastructures. Furthermore, some
customers with global operations, such as Dell Computer, use multiple
distributions of Linux. We can provide worldwide support to these customers
under a single contract.
Support of the Open-source Community
Linuxcare actively supports open-source initiatives, dedicating time and
resources to projects that improve the Linux operating system and related
applications. Our staff of experts continues to contribute to the development
of Linux. We also participate in organizations such as Linux International, a
Linux advocacy organization, the Linux Professional Institute, which
establishes Linux skills certification standards, and the Linux Standards Base,
which establishes design standards for Linux. Additionally, our website,
linuxcare.com, provides a repository of technical information and resources
about Linux and open-source solutions for developers and information technology
professionals. We believe our expertise gained through our strong relationships
with the Linux community allows us to serve our customers more effectively. We
believe that our active involvement in the Linux community, combined with the
fact that we do not package and resell a Linux distribution, make us a well-
respected member of the community and an attractive company for Linux experts
to join.
Strategy
Our objective is to become the leading provider of services for Linux. The
key elements of our strategy are:
Focus on the Enterprise
We intend to focus additional sales and marketing efforts toward Global 1000
companies and Internet infrastructure providers. We believe these companies
require stable and cost-effective platforms such as Linux to run their
increasingly complex software applications and take full advantage of the
Internet. These companies require in-depth expertise in the integration of
Linux and open-source solutions with existing computing environments. We have
started working with Global 1000 companies and Internet infrastructure
providers and we intend to leverage our experience with these customers to
market and sell our services to new customers.
Extend Technical Leadership
To maintain the quality of our services, increase the effectiveness of our
solutions and attract and retain Linux experts, we believe it is imperative for
us to remain an active member of the Linux community and stay involved with the
latest Linux developments. We continually research, test and evaluate new
Linux-related technologies, which we incorporate into our solutions to better
serve our existing and future customers. These efforts allow us to address the
growing demand for Linux services.
Use Scalable Internet-based Infrastructure
We are implementing an Internet-based infrastructure, rather than the more
labor-intensive model of traditional service providers, to deliver responsive
services to our customers. We are replacing the traditional geographically-
oriented service model with virtual work groups, which we refer to as Global
Centers of Expertise. These Global Centers of Expertise are designed to allow
technical experts of similar disciplines to work together regardless of their
geographical locations. In addition, our knowledge database is a key component
of our service model, providing our business units with ready access to
valuable technical information. We believe that our technology infrastructure
will allow us to grow our business in a cost-effective manner.
34
<PAGE>
Capitalize on Customer and Third-Party Relationships
We intend to continue to develop both informal and formal relationships with
customers and hardware and software vendors that can provide a range of
benefits to Linuxcare, including sales leads, co-marketing initiatives and the
opportunity to provide services to the customers of these companies. Our goal
in establishing these relationships is to broaden the market for Linux and
open-source software and increase the demand for our services.
Strengthen Our Brand
Continuing to build our brand is essential to attracting new customers,
strengthening our relationships with OEMs and software vendors, and enhancing
our presence in the Linux and open-source communities. We intend to build our
brand through a variety of strategies, including the promotion of
linuxcare.com, public relations activities, co-marketing initiatives, direct
marketing and focused advertising campaigns. Through our Linuxcare Labs
business unit, we have developed a branding program that encourages vendors of
products that have been awarded certification status to display the "Certified
by Linuxcare Labs" logo on their products and websites. This program is
designed to give end-users the assurance that certified products have been
fully tested by Linuxcare for compliance with the Linux kernel and major
distributions of Linux. To maintain the goodwill of the Linux community, a
foundation of our brand, we will continue to contribute resources to open-
source development projects.
Promote the Adoption and Development of Linux
We have forged relationships with a variety of technology vendors to
encourage the development of commercial applications for Linux. We have a team
of Linux experts who work on open-source projects and continue to support the
development of Linux. We also actively support and sponsor the Linux
Professional Institute, Linux International and the Linux Standards Base. We
have developed a half-day training session, "Linux for the Executive," which is
currently available in a tutorial and will be made available via the Internet.
We believe that our efforts to improve Linux and educate customers on its
benefits encourage the adoption of Linux.
Linuxcare Services
We offer a broad range of services for Linux, including professional
services, technical support, education and product certification. We support a
variety of Linux distributions and hardware platforms, giving customers options
to meet their needs.
Professional Services
Linuxcare Professional Services offers customers consulting services to help
them fully benefit from their Linux investments. Linuxcare Professional
Services uses Global Centers of Expertise to effectively deliver services on a
worldwide basis. Each Global Center of Expertise is a team of experts with
extensive skills in a technology area who work together independent of
geographical location. These collaborative methods promote rapid solution
development, allowing us to execute large, complex projects and enabling us to
handle increased business volume. We have established Global Centers of
Expertise in the following areas:
. Application Porting, which enables an application written for a
different operating system to run on Linux.
. Parallel Computing and Clustering, which permits complex computing tasks
to be subdivided and handled by several processors.
. Device Driver Development, which makes Linux compatible with different
devices including printers and other peripherals.
. Network Management, which enables file and printer sharing and other
network installation and administration tasks.
35
<PAGE>
. Security Audits, which help identify and correct security weaknesses.
. Performance Optimization, which improves the speed and capacity of
existing Linux distributions.
. Web and e-mail Servers, which provide on-site and remote services for
planning, deployment and fine tuning of Internet and e-mail servers.
. Open-source Strategy Consulting, which provides consulting services for
Linux and other open-source software.
To ensure successful project management and delivery of our professional
services, we have established consistent, company-wide procedures for client
engagements. These procedures consist of project analysis and proposal,
engagement and contracting, development, testing and delivery. This project
life cycle is also used to manage changes in project scope. Knowledge gained
throughout a project is captured in the knowledge database for use in future
client engagements.
Customized Linux Solutions. As a service to our customers, we can customize
Linux and Linux-based solutions to offer full compliance and optimized
performance with their hardware or software products. A standard Linux
distribution, typically sold through the retail channels, is designed to run on
as many hardware configurations as possible, and must be suitable for a wide
range of computing solutions. We customize Linux-based solutions from Linuxcare
to streamline them for optimal performance, reliability, ease of use and
security with a specific hardware or software configuration. As part of our
customization service, we use the most current Linux kernel and driver versions
available, perform a full security audit and certify the solution through
Linuxcare Labs.
Embedded Systems. We have recently established a group to focus on providing
engineering support for our customers' embedded systems efforts. We acquired
Prosa, an Italian company with six employees, to enhance our ability to provide
embedded systems services. Embedded systems are operating systems that are
built into equipment such as mobile phones, medical devices and industrial
control systems. We believe that the cost-effective, portable, compact and
robust characteristics of Linux are well suited to the rapidly expanding market
for embedded systems.
Technical Support
We offer customer support services 24 hours a day, seven days a week through
our global network of customer service centers. Our technical support
professionals provide customers with ongoing support on complex issues ranging
from operating system installation to application usage. We support the
installation and maintenance of 21 Linux distributions as well as database
products from IBM, Informix, Oracle and Sybase that run on Linux. In addition,
we support numerous software applications, including StarOffice, Sendmail,
Apache and SAMBA. Customer questions are typically received via e-mail, Web
submission, telephone or fax and are routed to the appropriate technical
resource. When appropriate, complex questions are referred to our Linux
experts. We typically respond to customer questions by e-mail to provide
efficient, accurate instructions.
36
<PAGE>
We currently support the following distributions of Linux:
<TABLE>
<S> <C>
. Caldera . Red Hat
. Corel . RT-Linux
. Debian GNU/Linux . Slackware Linux
. ET-Linux . Stampede
. EZ Linux . S.u.S.E.
. Laser5 . Storm
. Linux-Mandrake . TurboLinux
. LinuxPPC . UltraLinux
. Macmillian Linux . Vine Linux
. MkLinux . YellowDog Linux
. Red Flag
</TABLE>
Our technical support services business unit has grown rapidly since its
inception. We handled 140 incidents in the second quarter of 1999, increasing
to approximately 15,000 incidents in the fourth quarter of 1999. We capture the
knowledge gained in resolving these incidents in the knowledge database,
increasing our level of automation and improving our service quality.
Linuxcare University
We offer educational materials for Linux and other open source technologies
through our Linuxcare University business unit. Our courseware is designed by
expert Linux developers and open source engineers in conjunction with
professional courseware developers. We license our courseware to professional
training centers in return for training fees and a per-student royalty. In
addition, we have formed a revenue and expense sharing relationship with
Viviance to deliver our courseware via the Internet.
Our current courseware covers all major Linux distributions and includes:
. Linux Fundamentals . Network Protocols
. Linux for Managers . Network Operating Systems
. Extreme SAMBA . Network Design, Implementation
and Maintenance
. Linux Programming
. Networking Essentials
. Linux System Administration
. Local Area Network Implementation
. Linux System Administration for and Maintenance
NT Professionals
. LANs, WANs and the Internet
. Internetworking with Linux and
TCP/IP
. Internet Fundamentals
. Apache Web Server . Internet and Internet Security
. Architecture and Design of . Intranet Design and Migration
Enterprise Systems
. Using the TCP/IP Protocol
. IT Infrastructure Implementation
and Management
. Enterprise-wide Communications
and Networking
Linuxcare Labs
Linuxcare Labs is our vendor-neutral testing facility that certifies
hardware for use with the Linux operating system to customers who pay a
certification fee. Certification by Linuxcare Labs gives Linux users
37
<PAGE>
the assurance that all components of the tested product operate at full
functionality with the Linux kernel and successfully run all major Linux
distributions. Once certified, products earn the Linuxcare Labs certification
mark, signifying that the product is "Linux-ready."
Linuxcare Labs reviews written material for Macmillan USA, a book publishing
subsidiary of Macmillan Publishing, Ltd. for technical accuracy and
completeness on a time and materials basis.
Information Technology
We are implementing an Internet-based infrastructure to communicate with and
to deliver applications and services to our global base of employees, customers
and partners. Through the use of technology, we provide our customers with
services that would traditionally require on-site professional staffing. We can
perform remote Linux system installation, software updates, software
distribution, diagnostics, maintenance, monitoring and automated recovery
services by connecting to our customers' computers securely over the Internet.
Distributed Infrastructure
Our distributed infrastructure facilitates low-cost, rapid growth while
protecting us from system failures or network outages. Through an outside
service provider, Digital Island, we are hosting our Web servers in California,
Hong Kong, London and New York to provide redundancy, enhanced disaster
recovery protection and the ability to deliver electronic services to customers
globally with fast response times. We believe that our four locations are
capable of handling approximately five million concurrent user sessions for a
total concurrent user session capacity of 20 million. We currently use 25% or
less of our aggregate capacity during peak periods of usage.
Our information technology infrastructure is designed to enable us to form
virtual work groups, or Global Centers of Expertise, regardless of the
geographical location of individual team members. We believe these tightly
integrated teams will allow us to serve our customers efficiently as we expand
our operations and customer base. These teams can evaluate and respond to
customer requests remotely, by telephone or over the Internet, without
inefficient on-site customer service. Furthermore, our experts can draw on our
expanding knowledge database to address questions quickly and efficiently.
We expect the distributed nature of this infrastructure will facilitate our
expansion. Through our Internet infrastructure, we will be able to support
offices in remote locations with the following capabilities: sales and
marketing automation, customer relationship management, human resources,
financial management, project accounting, order entry, video conferencing,
Internet and e-mail.
Knowledge Accumulation and Management
We have built a central knowledge database that serves as a repository for
open-source software information. The knowledge database stores corrective
instructions for our customers' service requests derived from multiple sources
and is continuously improved as we respond to questions from our customers. We
use a natural language search engine to analyze e-mail requests and rapidly
find responses in our knowledge database. Our knowledge database is available
to our staff and customers. Customers continually help us to refine the
accuracy of the knowledge database by providing feedback on the relative
usefulness of responses received. We believe that our knowledge database is a
cost-effective method for providing responses to our customers' questions.
Our knowledge database is also used internally by all of our business units
to deliver services. For example, a professional services consultant can
capitalize on solutions previously developed by Linuxcare Labs to help a new
customer.
Engineering Talent
To offer the most comprehensive Linux services, we recruit and employ
accomplished engineering talent, including developers experienced in Linux and
open-source communities. By encouraging participation in
38
<PAGE>
open-source projects, we strive to foster a corporate culture that attracts
and nurtures technical talent. As we successfully attract and retain Linux and
open-source experts, we extend our internal base of engineering talent and
create momentum to attract other Linux engineers.
Customers
The following is a list of all our customers who accounted for more than
$5,000 in revenues during 1999:
<TABLE>
<S> <C>
Ameriteach Maxspeed Corporation
Browning-Ferris
Industries Motorola, Inc.
Cybernet Systems NEC Software
Cisco Systems, Inc. OK International
Dell Computer Corp. Panasonic-Fujitsu-Uchida Limited
Densa Techno Tokyo
Co., LTD Silicon Graphics, Inc.
Gannett Telematch Sun Microsystems, Inc.
Hewlett Packard
Company VA Linux Systems
Interspace Planning Wells Fargo Bank
KPMG Peat Marwick
LLP Xenote, Inc.
Macmillan USA
</TABLE>
We negotiate the business terms of each contract with each of our customers
to deliver services that fit that customer's particular needs. The contract
fees vary, and may be billed on an hourly, daily, monthly or annual basis,
depending upon the scope and nature of the services delivered. Contracts for
professional services are typically entered into on a project-by-project
basis. Contracts for technical support are typically for a term of one year.
For the period ended December 31, 1999, three customers, Sun Microsystems,
Motorola and Silicon Graphics, Inc. represented 26%, 18% and 11%,
respectively, of our revenues. The following customer case studies are
representative of the type of customers we added in 1999 because they are
either suppliers of technology or derive significant revenues from technology-
related initiatives. The case studies illustrate and are representative of the
range of services we provide because they include technical support,
professional services, certification and embedded systems support.
Dell Computer. Dell is a direct seller of desktop computer systems and a
leading supplier of enterprise servers. Dell has outsourced its warranty
support under a one-year contract, expiring on October 22, 2000, with
Linuxcare for installation and ongoing support of Linux and related software.
Linuxcare Labs provides certification of Dell hardware, which consists of
installing specified Linux distributions on Dell hardware and verifying that
these distributions function correctly.
Densa Techno Tokyo's (DTT). DTT, a wholly owned subsidiary of Hitachi,
provides support for Hitachi's mainframes. DTT has recently started to provide
service and support for Linux and has established a call center in Tokyo for
basic support. DTT has contracted with Linuxcare for a one-year term, expiring
at the earlier of June 1, 2000 or the date a stated number of DTT's customer
issues are addressed, to provide in-depth technical support to enhance its
basic support services.
Hewlett-Packard. Hewlett-Packard is a global provider of computing and
imaging solutions and services. Hewlett-Packard's Business Desktop division,
based in France, has contracted with Linuxcare for a one-year term, expiring
on January 6, 2001, to provide Linux distribution certification for their
Kayak, Vectra and Brio models. We ensure that these model configurations work
optimally with specific Linux distributions.
Macmillan USA. Macmillan USA is the computer book and trade reference
publishing division of Viacom. Macmillan USA distributes Mandrake Linux and
other Linux utilities, and publishes popular Linux books. Our engineers review
Macmillan USA's books for technical accuracy and completeness prior to
publication. Under a
39
<PAGE>
one-year contract with Macmillan USA, expiring on August 30, 2000, we also
provide technical support to customers of Macmillan's Linux distribution and
utilities and have handled over 4,000 customer incidents since October 1999.
Motorola. Motorola provides integrated communications and embedded
electronic solutions. Motorola has contracted with Linuxcare, for an initial
term of one year expiring on December 13, 2000, to provide engineering support
to Motorola Computer Group's support and development organizations. Linuxcare
will work with the Motorola Computer Group's product engineering and customer
support services on product customization and application development.
Linuxcare University will provide worldwide courseware licensing and instructor
technical support for Motorola Computer Group's training programs.
Sun Microsystems. Sun Microsystems provides computer hardware, software and
services. Sun has entered into a six-month contract with us to provide
technical support services for its StarOffice product suite. The contract
expires on March 24, 2000. We are also in discussions to provide professional
services to Sun Microsystems regarding device driver development and other
open-source projects.
Sales and Marketing
We sell our services primarily through our direct sales organization. We
also employ indirect sales professionals to capitalize on our relationships
with our OEM and software vendor customers. For the year ended December 31,
1999, 91% of our revenues were generated from OEM and software vendor
customers. As of December 31, 1999, we employed 36 sales and marketing
professionals located in the United States, Canada, the United Kingdom,
Germany, The Netherlands, Sweden and Australia. We also have direct sales
coverage in Japan and France. We employ resellers in certain geographic
locations where a direct sales organization has not yet been established. In
addition, our senior executives and key technology personnel, many of whom are
experienced in the Linux community, frequently participate in building
relationships with potential customers and business partners as well as in
securing engagements. We also generate sales leads through our involvement in
the open-source community.
To date, we have focused our sales and marketing efforts on OEMs and
software vendors. Some of our OEM customers provide our services in conjunction
with their products and services. We are also expanding our worldwide sales and
marketing efforts that focus on Global 1000 companies and Internet
infrastructure providers.
Our marketing strategy is to build the Linuxcare brand to enhance our
position as a leading provider of Linux-related services. We build our brand,
market our services and generate sales leads through our linuxcare.com website,
public relations activities, co-marketing initiatives, direct marketing and
targeted advertising. We have retained outside public relations and advertising
firms to assist us with our marketing efforts.
Competition
We compete in the emerging market for Linux-based professional services and
support. This market is highly competitive. Many of our competitors have longer
operating histories, better name recognition, larger client bases and greater
financial, technical, marketing and public relations resources than we. Because
the Linux-based solutions market has relatively low barriers to entry, we
believe competition will intensify as the market evolves.
Our current and potential competitors include:
. Linux distribution and services firms such as Caldera Systems, Red Hat
and VA Linux Systems;
. Hardware systems vendors such as Dell, Hewlett-Packard and Sun
Microsystems;
40
<PAGE>
. Systems integrators and professional services providers such as Andersen
Consulting, IBM Global Services and the big five accounting firms; and
. Internal information technology departments of our prospective clients.
We believe that the key competitive factors relevant to our business are an
ability to provide integrated solutions that span the entire hardware and
software life cycle, reputation for in-depth Linux expertise across all major
distributions and hardware platforms and high quality of professional services
and customer support. We believe that we compete successfully with respect to
each of these factors.
Employees
As of December 31, 1999, we had a total of 130 employees, of which 112 were
located in the United States, seven in Europe, five in Canada and six in
Australia.
None of our employees is subject to a collective bargaining agreement, and
we believe that our relationship with our employees is satisfactory.
Facilities
Our headquarters is located in a leased facility in San Francisco,
California consisting of 10,500 square feet of office space. The lease for this
office expires December 31, 2003. Additionally, we plan to occupy 30,000 square
feet of office space currently under construction in the second quarter of
2000. The lease for this office space expires on October 31, 2004. We also
lease office space in Canberra, Australia, Ottawa, Canada, Berkshire, England,
and Amsterdam, The Netherlands and Rome, Milan and Padua, Italy.
We do not own any real estate. We do not consider any specific leased
location to be material to our operations, and we believe that equally suitable
alternative locations are available in all areas where we currently operate.
Legal Proceedings
We are not currently a party to any material legal proceedings. We may in
the future be party to litigation arising in the course of our business.
Intellectual Property
While we have developed some proprietary techniques and know-how, including
software tools and utilities, optimization techniques and solutions to
recurring Linux questions, most of our knowledge is not protectable as
proprietary intellectual property. To protect our intellectual property, we
generally enter into confidentiality or license agreements with our employees,
consultants and corporate partners. Our three founders, David LaDuke, David
Sifry and Arthur Tyde III, have signed non-competition agreements with us that
extend for the duration of their employment with Linuxcare. In addition, we
have an agreement with Linus Torvalds, owner of the "Linux" trademark
registration, allowing us to use Linux as part of our company name.
41
<PAGE>
MANAGEMENT
Executive Officers and Directors
The following table sets forth certain information with respect to our
officers and directors.
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Fernand B. Sarrat(1)....... 49 President, Chief Executive Officer and Director
Arthur F. Tyde III......... 35 Executive Vice President and Director
David LaDuke............... 39 Vice President, Marketing
Patricia Lambs............. 51 Vice President, Service Solutions
Thomas W. Phillips......... 48 Vice President, Worldwide Sales
Robert V. Walters.......... 42 Vice President, Business Development
Christian A. Paul.......... 39 Chief Financial Officer
David L. Sifry............. 31 Chief Technology Officer
Douglas C. Nassaur......... 33 Chief Information Officer
David Schellhase........... 36 Vice President, General Counsel and Secretary
Ted E. Schlein(1)(2)(3).... 35 Chairman of the Board of Directors and Director
Regis McKenna.............. 60 Director
John Drew(1)(3)............ 43 Director
Paul Vais(2)(3)............ 40 Director
Ernest von Simson(2)....... 61 Director
</TABLE>
- --------
(1) Member of the executive committee.
(2) Member of the audit committee.
(3) Member of the compensation committee.
Fernand B. Sarrat has served as President and Chief Executive Officer of
Linuxcare since May 1999. Prior to joining the company, Mr. Sarrat held the
positions of President and Chief Executive Officer of Cylink Corporation, a
California-based security and cryptography firm from November 1996 to November
1998. Before leading Cylink, Mr. Sarrat spent 23 years as an executive at IBM.
His career at IBM culminated as General Manager of Network-Centric Computing
Marketing and Services. Mr. Sarrat received an M.B.A. from the Wharton School
of Business and dual B.A. degrees in economics and psychology from Stanford
University.
Arthur F. Tyde III, one of our founders, has served as Executive Vice
President since May 1999, and prior to that was acting Chief Executive Officer
from the inception of the company. Before co-founding Linuxcare, Mr. Tyde held
senior consulting and management positions at Gap, Inc. from December 1996, in
addition to his post as president and founder of the Bay Area Linux User Group.
Prior to working at Gap, Inc., Mr. Tyde held senior consulting and management
positions at Fireman's Fund Insurance Company from November 1995 until December
1996, and at California State Automobile Association from June 1993 to November
1995. Mr. Tyde earned his B.A. from Michigan State University.
David LaDuke, one of our founders, has served as Vice President of Marketing
since December 1998. Prior to Linuxcare, Mr. LaDuke was an independent
marketing consultant, working with a number of high-technology companies from
March 1993 to December 1998. From 1989 to 1993, Mr. LaDuke was a marketing
manager at NeXT Computer. Before this, from 1986 to 1989, he worked in
marketing at Apple Computer where he participated in the launch of desktop
publishing. Mr. LaDuke received an M.B.A. from the Tuck Graduate School of
Business at Dartmouth College with a concentration in marketing, and a B.A. and
M.F.A. from Columbia University.
Patricia Lambs has served as our Vice President of Service Solutions since
August 1999. For five years prior to joining Linuxcare, Mrs. Lambs served as
Executive Vice President and Chief Operating Officer at Ascent Logic
Corporation, where she led a world wide sales and service delivery organization
and managed the Central Engineering Group. In this role, Mrs. Lambs served as
Chairman of the Board for Ascent Logic
42
<PAGE>
Norway and Ascent Logic Ltd. in the United Kingdom. Prior to joining Ascent
Logic, Mrs. Lambs spent 18 years in management positions of Integration Service
for Digital Equipment. Mrs. Lambs attended Temple University.
Thomas W. Phillips has served as our Vice President of Worldwide Sales since
September 1999. Prior to Linuxcare, Mr. Phillips served as Vice President,
North American Sales for Baystone Software/Remedy Corporation from October 1998
to September 1999. He also served as Vice President of North American Sales for
Wayfarer Communications/Vantive Corporation, from October 1997 to September
1998. Previously, Phillips spent several years at Sterling Software, from June
1987 to September 1997, attaining the position of Vice President, North
American Sales. Mr. Phillips earned a B.A. in Sales and Marketing from
California State University.
Robert V. Walters has served as our Vice President of Business Development
since December 1999. Before joining Linuxcare, Mr. Walters was Vice President
of Corporate Strategy for Informix Software where he worked from March 1998 to
November 1999. Previously, Mr. Walters worked at Red Brick Systems, Inc, a data
warehouse software vendor, from April 1996 to February 1998, where he served as
Director of Strategic Marketing. Prior to that, Mr. Walters was a principal
technical consultant at Dynasty Technologies, Inc., an object-oriented software
development start-up, from January 1995 to March 1996. Mr. Walters holds a B.S.
in Systems Engineering from the U.S. Naval Academy.
Christian A. Paul has served as our Chief Financial Officer since December
1999. Prior to joining Linuxcare, Mr. Paul was Vice President and Chief
Financial Officer of Cloudscape, Inc., a provider of Java-based data management
systems, from October 1998 to December 1999. Before that, Mr. Paul was Vice
President and Chief Financial Officer of ICVERIFY, an e-commerce company from
July 1996 to August 1998, where he directed the finance and administration
functions and also served as Vice President and Chief Financial Officer of
Integral Systems Inc. from January 1994 to June 1996. Mr. Paul holds an M.A. in
Accounting and Taxation from the University of Cape Town, and is also a
Chartered Accountant.
David L. Sifry, one of our founders, has served as Chief Technical Officer
since December 1998 and is a recognized expert in open source development and
the Linux operating system. Prior to co-founding Linuxcare, he ran an Internet
technology consulting business, Sifry Consulting, from January 1995 to December
1998. Mr. Sifry holds a B.S. in Computer Science from Johns Hopkins University.
Douglas C. Nassaur has served as our Chief Information Officer since
November 1999. Previously, Mr. Nassaur was Vice President, Technical
Operations, for E*TRADE Technologies from September 1998 to October 1999. Prior
to E*TRADE, Mr. Nassaur directed the daily engineering, operation, and support
of distributed systems for Holiday Inn Worldwide/BASS PLC from August 1997 to
September 1998. Previously, at BellSouth.net, Mr. Nassaur led the management of
the company's Internet/intranet services, help-desk operations, corporate
service delivery, and billing systems from July 1996 to August 1997. Before
working for Bellsouth.net, Mr. Nassaur held a senior-level technology
management position at GTE Mobilnet from May 1994 to July 1996. Mr. Nassaur
earned a B.S. in Computer Science from the University of Kentucky.
David Schellhase has served as Vice President, General Counsel and Secretary
since February 2000. Prior to joining Linuxcare, Mr. Schellhase was Vice
President, General Counsel and Secretary of The Vantive Corporation, a customer
relationship management software company, from August 1997 until its
acquisition by PeopleSoft, Inc. in January 2000. From November 1995 until
August 1997 he was General Counsel of Premenos Corporation, a provider of
electronic commerce software. Prior to November 1995 he was Corporate Counsel
at Oracle Corporation and an associate at the law firm of Brobeck, Phleger &
Harrison. Mr. Schellhase received a J.D. from Cornell Law School and a B.A.
from Columbia University.
Ted E. Schlein has served as Chairman of our Board of Directors since May
1999. Mr. Schlein is a partner in the venture capital firm Kleiner Perkins
Caufield & Byers which he joined in November 1996. From June 1986 to November
1996, Mr. Schlein worked at Symantec. Mr. Schlein also serves on the board of
directors for Corio, Inc., Extensity, Inc., NONSTOP Solutions, Inc., Portera
Systems and WineShopper. Prior to Kleiner Perkins Caufield & Byers, Mr. Schlein
worked at Symantec Corporation, most recently as Vice President of
43
<PAGE>
Networking and Client Server Technology. Mr. Schlein holds a B.S. in Economics
from the University of Pennsylvania.
Regis McKenna has served on our Board of Directors since September 1999. He
is also Chairman of The McKenna Group, an international consulting firm
specializing in the application of information and telecommunications
technologies to business strategies, which he founded in 1970. In his capacity
as Chairman of The McKenna Group, Mr. McKenna advised many high-tech start-up
companies. Mr. McKenna also serves as director on the following companies'
boards: Caliper "Lab on A chip," bio-information systems; Cybergold Incentive,
management software for Internet transactions systems; Cylink Encryption and
security systems software; Diabeteswell.com, E-medicine diabetes portal and
management systems; Graham Technologies Live video and audio servers for
distance monitoring, surveillance and broadcast via the Internet. Mr. McKenna
attended Saint Vincent College and Duquesne University.
John Drew has served on our Board of Directors since November 1999. Mr. Drew
also serves as executive vice president and CEO of Lucent Technologies' NetCare
Professional Services group, a portfolio of network professional services and
software solutions. Mr. Drew was president and chief executive officer of
International Network Services prior to its acquisition by Lucent in October
1999. Mr. Drew joined International Network Services in 1994 as vice president
of operations and became president in 1996. Mr. Drew holds a B.S. degree in
Engineering from West Point and an M.S. in Business Policy from Columbia
University.
Paul Vais has served on our Board of Directors since November 1999. Mr. Vais
is also managing director with Patricof & Co. Ventures, Inc., an international
private equity investment firm, which he joined in early 1997. Previously, from
March 1995 to December 1996, Mr. Vais was a vice president with Enterprise
Partners Venture Capital. Mr. Vais also serves on the Boards of Directors of
Icarian, Oblix, Ravisent Technologies, Infolibria, Peregrine Semicondutcor and
iVendor. Mr. Vais holds a B.S. in Computer Science from the University of
California.
Ernest von Simson has served on our Board of Directors since October 1999.
Mr. von Simson is a senior partner at Ostriker von Simson, Inc., which assists
Fortune 200 enterprises in developing partnerships with Web solution providers.
From October 1969 to September 1999, Mr. von Simson was the co-founder,
chairman and research director of the Research Board, a private sector think
tank that serves the chief information officers of Fortune 200 enterprises in
Europe and North America. Mr. von Simson holds a B.A. from Brown University,
and an M.B.A. from New York University.
Board of Directors
Our Board of Directors currently consists of seven members. Each director
holds office until his term expires or until his successor is duly elected and
qualified. Upon completion of this offering, our amended and restated
certificate of incorporation and bylaws will provide for a classified Board of
Directors. Our Board of Directors will be divided into three classes whose
terms will expire at different times. The three classes will be comprised of
the following directors:
. Class I consists of Messrs. Tyde and von Simson, who will serve until
the annual meeting of stockholders to be held in 2001;
. Class II consists of Messrs. Vais, Schlein and Drew, who will serve
until the annual meeting of stockholders to be held in 2002; and
. Class III consists of Messrs. Sarrat and McKenna, who will serve until
the annual meeting of stockholders to be held in 2003.
At each annual meeting of stockholders beginning with the 2001 annual
meeting, the successors to directors whose terms will then expire will be
elected to serve from the time of election and qualification until the third
annual meeting following election and until their successors have been duly
elected and qualified. Any additional directorships resulting from an increase
in the number of directors will be distributed among the three classes so that,
as nearly as possible, each class will consist of an equal number of directors.
44
<PAGE>
Committees
Our Board of Directors has an executive committee, an audit committee and a
compensation committee. The executive committee consists of Messrs. Sarrat,
Schlein and Drew. The executive committee approves acquisitions of businesses
in amounts up to $5 million and takes such other actions as may be delegated by
the Board from time to time. The audit committee consists of Messrs. Vais,
Schlein and von Simson. The audit committee reviews our internal accounting
procedures, consults with and reviews the services provided by our independent
accountants and makes recommendations to the Board of Directors regarding the
selection of independent accountants. The compensation committee consists of
Messrs. Vais, Schlein and Drew. The compensation committee reviews and
recommends to the Board of Directors the salaries, incentive compensation and
benefits of our officers and employees and administers our stock plans and
employee benefit plans.
Compensation Committee Interlocks and Insider Participation
Our Board of Directors established the compensation committee in January
2000. No member of our compensation committee has served as a member of the
Board of Directors or compensation committee of any entity that has one or more
executive officers serving as a member of our Board of Directors or
compensation committee. Since the formation of the compensation committee, none
of its members has been our officer or employee.
Compensation
During fiscal year 1999, our non-employee directors were granted options to
purchase an aggregate 200,000 shares of our common stock. 100,000 of those
shares were granted at an exercise price of $0.13 per share and 100,000 shares
were granted at $1.00 per share. The aggregate value of these options based on
these exercise prices is $113,000. The aggregate value of these options based
on a per share price of $14.00, which represents the midpoint of the range, is
$2,800,000.
In January 2000, our Board of Directors approved compensation guidelines for
directors who are not our officers or employees. The compensation guidelines
provide that these directors will be reimbursed for expenses incurred in
attending any Board of Directors or committee meeting. Directors who are also
our officers or employees will not receive reimbursement for expenses incurred
in attending Board of Directors or committee meetings.
Effective upon the closing of this offering, our non-employee directors also
will be eligible to participate in our 2000 Director Option Plan. Each non-
employee director who joins our Board of Directors after this offering will
automatically receive a grant of an option to purchase 20,000 shares of our
common stock on the date on which such person becomes a director. The shares
subject to each of these options will vest and become exercisable as to 25% of
the shares on each anniversary of the date of grant, such that the options will
be fully vested after four years. Additionally, beginning at our annual meeting
of stockholders to be held in 2001 and at each successive annual stockholder
meeting, each non-employee director who has previously served at least six
consecutive months prior thereto will receive an option to purchase 5,000
shares of our common stock. The shares subject to each of these options will
vest and become fully exercisable as to 100% of the shares on the first
anniversary date of the date of grant. The exercise price per share for all
options automatically granted to directors under our 2000 Director Option Plan
will be equal to the market price of our common stock on the date of grant and
will have a ten year term, but will generally terminate within a specified
time, as defined in the 2000 Director Option Plan, following the date the
option holder ceases to be a director or consultant. Employee directors are
eligible to participate in our 2000 Employee Stock Purchase Plan and to receive
discretionary grants under our Amended and Restated 1999 Stock Plan.
Executive Officers
Our executive officers are appointed by and serve at the discretion of our
Board of Directors.
45
<PAGE>
Compensation
The following table sets forth all compensation paid or accrued during our
fiscal 1999 to our President and Chief Executive Officer, and each of our four
other most highly compensated officers whose annual compensation exceeded
$100,000 for the period. Mr. Sarrat, Mr. Nassaur, Mr. Walters, Mr. Phillips,
Mrs. Lambs and Mr. Pollace joined us during fiscal 1999, therefore their annual
compensation does not reflect their full base salary.
<TABLE>
<CAPTION>
Long Term
Compensation
------------
Annual Compensation Securities
------------------------- Underlying
Name and Principal Positions Salary Bonus Other(3) Options
- ---------------------------- -------- ------- -------- ------------
<S> <C> <C> <C> <C>
Fernand B. Sarrat........ $200,000 $41,667 -- 1,865,112
President and Chief
Executive Officer
Arthur F. Tyde III (1)... 150,000 -- -- --
Executive Vice President
Douglas C. Nassaur....... 41,667 70,000 -- 415,049
Chief Information
Officer
Robert V. Walters........ 15,224 -- -- 300,000
Vice President, Business
Development
Thomas W. Phillips....... 63,697 42,000 15,098 290,533
Vice President,
Worldwide Sales
Patricia Lambs........... 75,000 15,000 -- 415,049
Vice President, Service
Solutions
Anthony Pollace (2)...... 59,118 25,000 -- 450,000
Former Chief Financial
Officer
</TABLE>
- --------
(1) Mr. Tyde served as our Chief Executive Officer until May 1999.
(2) Mr. Pollace resigned his position as our Chief Financial Officer in
December 1999.
(3) Pursuant to the terms of his employment agreement, Mr. Phillips received
$12,500 as a non-recoverable draw. Mr. Phillips also received $3,098 as a
recoverable draw which may be recoverable from his annual bonus should he
fail to meet certain specified criteria.
46
<PAGE>
Option Grants in Fiscal Year 1999
The following table sets forth information concerning grants of stock
options to each of the executive officers named in the table above during
fiscal year 1999. All options granted to these executive officers in the last
fiscal year were granted under the 1999 Stock Plan. One-quarter of the shares
subject to each option vests and becomes exercisable on the first anniversary
of the date of grant, and an additional one-forty-eighth of the shares subject
to each option vests each month thereafter. In addition, options granted to
each of the individuals set forth below may be early exercised, provided that
such individual enters into a restricted stock purchase agreement. The shares
thus acquired remain subject to a right of repurchase by the Company. The
percentage of the total options set forth below is based on an aggregate of
6,235,189 options granted during 1999. All options were granted at a fair
market value as determined by our Board of Directors on the date of grant.
The 0%, 5% and 10% assumed annual rates of stock price appreciation are
required by the rules of the Securities and Exchange Commission and do not
represent our estimate or projection of future common stock prices. The
potential realizable values at 0%, 5% and 10% appreciation are calculated by
assuming that the value of the options at the date of grant was $14.00 per
share, the assumed initial offering price, that the value of the shares
appreciates at the indicated rate for the entire term of the options and that
the option is exercised at the exercise price and sold on the last day of its
term at the appreciated price.
<TABLE>
<CAPTION>
Individual Grants
---------------------------------------------- Potential Realizable
Number of % of Total Value at Assumed
Securities Options Annual Rates of Stock Price
Underlying Granted to Appreciation for Option Term
Options Employees in Exercise Expiration --------------------------------
Name Granted Fiscal Year Price Date 0% 5% 10%
---- ---------- ------------ -------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Fernand B. Sarrat....... 1,660,194(1) 26.6% 0.07 05/02/09 23,126,502 37,743,722 60,169,406
Fernand B. Sarrat....... 204,918(1) 3.3% 0.13 10/21/09 2,842,213 4,646,418 7,414,424
Arthur F. Tyde III...... -- -- -- -- -- -- --
Douglas C. Nassaur...... 415,049 6.7% 0.13 11/01/09 5,756,730 9,411,039 15,017,467
Robert V. Walters....... 300,000 4.8% 1.00 12/09/09 3,900,000 6,541,357 10,593,718
Thomas W. Phillips...... 290,533 4.8% 0.13 10/21/09 4,029,693 6,587,698 10,512,180
Patricia Lambs.......... 415,049 6.7% 0.13 10/21/09 5,756,730 9,411,039 15,017,467
Anthony Pollace......... 450,000(2) 7.2% 0.13 10/21/09 1,549,973 2,533,878 4,043,383
</TABLE>
- --------
(1) Such options are subject to a change in control provision. Fifty percent
(50%) of the unvested shares subject to the option shall vest and become
immediately exercisable upon the occurrence of a change in control (as that
term is explained in the section "Employment Agreements and Change in
Control Arrangements" below) and twenty-five percent (25%) of the total
option shares shall vest upon the constructive termination of service with
us or the termination of service with us without cause (as that term is
explained in the section "Employment Agreements and Change in Control
Arrangements" below).
(2) Mr. Pollace was granted options to purchase 450,000 shares of common stock,
however options to purchase 338,250 shares were forfeited and returned to
the plan when Mr. Pollace resigned. The "Potential Realizable Value"
amounts are calculated based on the remaining options to purchase 111,750
shares.
47
<PAGE>
Aggregate Option Exercises in Fiscal Year 1999 and Values at December 31,
1999
The following table sets forth information concerning exercisable and
unexercisable stock options held by the executive officers named in the
summary compensation table at December 31, 1999. The "Value of Unexercised In-
the-Money Options at December 31, 1999" is based on a value of $14.00 per
share of our common stock, which is the assumed initial public offering price,
minus the actual per share exercise price, multiplied by the number of shares
underlying the option. All options were granted under our 1999 Stock Plan.
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Options at In-the-Money Options
Shares December 31, 1999 at December 31, 1999
Acquired ---------------------- --------------------
On Exercise Exercisable Exercisable
----------- ---------------------- --------------------
<S> <C> <C> <C>
Fernand B. Sarrat....... 1,865,112 -- $ --
Arthur F. Tyde III...... -- -- --
Douglas C. Nassaur...... -- 415,049 5,756,730
Robert V. Walters....... -- 300,000 3,900,000
Thomas W. Phillips...... -- 290,533 4,029,693
Patricia Lambs.......... -- 415,049 5,756,730
Anthony Pollace......... -- 111,750 1,543,038
</TABLE>
Employment Agreements and Change in Control Arrangements
We have entered into the following employment agreements with our current
officers:
Employment Agreements with Messrs. Tyde, Sifry and LaDuke. In April 1999,
we entered into letter agreements with each of Messrs. Tyde, Sifry and LaDuke
regarding their employment. These agreements, as amended, provide that Messrs.
Tyde, Sifry and LaDuke will each be employed "at will" and paid an annual base
salary of $150,000. The agreements provide that if the respective officer's
employment is terminated without cause (as defined below), such officer will
become vested in a number of shares of our common stock as if such officer
provided services to us for an additional twelve months. In addition, the
stock purchase agreements, as amended, pursuant to which each of Messrs. Tyde,
Sifry and LaDuke purchased 2,000,000 shares of our common stock, give us a
right to repurchase those shares, which right shall lapse with respect to 25%
of such shares if a change in control (as defined in the stock purchase
agreements) occurs.
Under the employment agreements of Messrs. Tyde, Sifry and LaDuke, cause
means the commission of:
. any act of fraud, embezzlement or dishonesty,
. any unauthorized use or disclosure of our confidential information or
trade secrets (or any parent or subsidiary), or
. any other intentional misconduct adversely affecting our business or
affairs (or any parent or subsidiary) in a material manner.
Employment Agreement of Fernand Sarrat. In April 1999, we entered into an
employment agreement with Mr. Sarrat. This agreement provides that Mr. Sarrat
will be paid an annual base salary of $300,000 and a bonus payment of $100,000
in the first year of his employment. After the first year of his employment,
the amount of his salary and bonus will be determined by our Board of
Directors; however, he will be guaranteed a bonus of at least $50,000 a year.
Under his employment agreement, Mr. Sarrat was granted options to purchase
shares of our common stock at an exercise price of $0.07 per share and $0.13
per share, which will vest over a four-year period beginning on May 3, 2000.
If Mr. Sarrat's employment is terminated before all of his options vest, we
will have the right to repurchase any unvested shares at cost. If Mr. Sarrat's
employment is
48
<PAGE>
involuntarily terminated, other than for cause, or is constructively terminated
(as such terms are defined below) within the first year of his employment, he
is entitled to receive, as severance, nine months of continuation of his
salary, employee benefits and a pro-rated target bonus for such year. He will
also be entitled to 1/48 vesting of stock option shares each month through the
termination date. If such termination occurs within the second year of Mr.
Sarrat's employment, he is entitled to receive, as severance, 12 months of
continuation of his salary, employee benefits and a pro-rated target bonus. He
will also be entitled to 1/48 vesting of his stock options shares for an
additional 12 months after his termination date. If such termination occurs
after the second year of Mr. Sarrat's employment, he is entitled to receive as
severance, six months of continuation of his salary, employee benefits, a pro-
rated target bonus and the continuation of the vesting of his stock option
shares for an additional 12 months after his termination date.
"Involuntary termination" is defined as:
. Termination other than for cause.
"Cause" is defined as:
. demonstrably willful misconduct which is materially injurious to us
which is not cured within 60 days following receipt of written notice
specifying such misconduct from our Board of Directors;
. conviction of a felony (other than traffic-related offenses); or
. gross negligence in the performance of duties.
provided, however, that Mr. Sarrat shall not be deemed to have been
terminated for cause without reasonable notice setting forth the reasons for
our intention to terminate and an opportunity for him to be heard before our
Board.
"Constructive termination" is defined as voluntary resignation following:
. the assignment of duties and responsibilities that are incommensurate
with the duties and responsibilities immediately before resignation, or
any material reduction of the duties, authority, or responsibilities;
. a reduction by the company in the base salary or annual target bonus as
in effect immediately before such reduction; or
. Mr. Sarrat's relocation to a facility that is more than 50 miles from
Los Altos Hills, California.
Upon a change in control (as this term is defined below), 50% of Mr.
Sarrat's option shares that remain unvested will vest on the closing date of
such change in control. Following such acceleration, the remaining unvested
options shall continue to vest at the same monthly rate that applied prior to
the acceleration. Also, following a change in control, if Mr. Sarrat does not
execute a new employment agreement with the successor corporation and if the
successor corporation terminates his employment (other than for cause), or if
his employment is constructively terminated, then Mr. Sarrat will be entitled
to receive the severance benefits described above (excluding any additional
acceleration of vesting).
Pursuant to the terms of Mr. Sarrat's employment agreement and stock option
agreements, a "change in control" is defined as:
. The consummation of a merger or consolidation with or into another
entity or any other corporate reorganization if persons who are not our
stockholders immediately prior to such merger, consolidation or other
reorganization own immediately after such merger, consolidation or other
reorganization 50% or more of the voting power of the outstanding
securities of each of (A) the continuing or surviving entity and (B) any
direct or indirect parent corporation of such continuing or surviving
entity; or
. The sale, transfer or other disposition of all or substantially all of
our assets.
Employment Agreements of Messrs. Paul, Walters, Phillips and Mrs. Lambs.
During 1999, we entered into letter agreements with Messrs. Paul, Walters,
Phillips and Mrs. Lambs regarding their employment. According to these
agreements, Messrs. Paul, Walters, Phillips and Mrs. Lambs will be employed "at
will" and paid an annual salary of $175,000, $250,000, $150,000 and $200,000,
respectively. Each will also be entitled to an
49
<PAGE>
annual performance-based bonus targeted to be $25,000, $50,000, $125,000 and
$50,000, respectively. According to their agreements, Messrs. Paul, Walters,
Phillips and Mrs. Lambs were granted options to purchase 340,000 shares at an
exercise price per share of $1.00, 300,000 shares at an exercise price per
share of $1.00, 290,533 shares at an exercise price per share of $0.13 and
415,049 shares at an exercise price per share of $0.13 of our common stock,
respectively. The options that are granted to each are also subject to the
provisions of their stock option agreements with us and our 1999 Stock Plan
that was in effect on the date of the grant of the options. These options will
vest proportionally over a four-year period beginning on the first anniversary
of their employment. If the employment of any officer is terminated before all
of such officer's options vest, we will have the right to repurchase any
unvested shares at the exercise price.
Limitations on Directors' and Officers' Liability and Indemnification
Our amended and restated certificate of incorporation limits the liability
of our directors 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 associated with any of the following:
. any breach of their duty of loyalty to the corporation or its
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
redemption; or
. any transaction from which the director derived an improper personal
benefit.
The limitation of our director's liability does not apply to liabilities
arising under the federal securities laws and does not affect the availability
of equitable remedies such as injunctive relief or rescission.
misconduct of a culpable nature), to reimburse their expenses as incurred as a
result of any proceeding against them as to which they could be indemnified,
and to cover our directors and officers under any of our liability insurance
policies applicable to our directors and officers. We believe that these
provisions and agreements are necessary to attract and retain qualified persons
as directors and executive officers.
Our amended and restated certificate of incorporation and bylaws also
provide that we shall 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 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 such
capacity, regardless of whether our bylaws would permit indemnification.
We have entered into indemnification agreements with each of our officers
and directors containing provisions that require us to, among other things,
indemnify such officers and directors against liabilities that may arise by
reason of their status or service as directors or officers (other than
liabilities arising from willful misconduct of a culpable nature), to advance
their expenses incurred as a result of any proceeding against them as to which
they could be indemnified, and to cover our directors and officers under any of
our liability insurance policies applicable to our directors and officers. We
believe that the provisions and agreements are necessary to attract and retain
qualified persons as directors and executive officers.
Stock Plans
Amended and Restated 1999 Stock Plan
Our 1999 Stock Plan was amended and restated by our Board of Directors on
January 18, 2000 and our stockholders approved the plan in February 2000. This
stock plan provides for the grant of incentive stock options to our employees
and nonstatutory stock options and stock purchase rights to our employees,
directors and consultants. As of December 31, 1999, we have issued 2,526,312
shares of our common stock pursuant to the exercise of options granted under
our stock plan and we have outstanding options to purchase 3,158,210 shares of
common stock at a weighted average exercise price of $0.31 per share.
50
<PAGE>
Number of Shares of Common Stock Available under our 1999 Stock Plan. As of
December 31, 1999, a total of 3,776,424 shares of our common stock were
available for issuance and 6,302,738 has been authorized for issuance pursuant
to our stock plan. We amended our 1999 Stock Plan in January 2000 to provide
for an annual increase to the number of shares available under the plan
beginning in 2001. Such annual increase will be equal to the lesser of: 5% of
the outstanding shares of our common stock on the first day of our fiscal year,
4,000,000 shares, or such lesser amount as our board of directors may
determine.
Administration of the 1999 Stock Plan. Our Board of Directors or a committee
of our Board of Directors administers the stock plan. The committee may consist
of two or more "outside directors" to satisfy certain tax and securities
requirements. The administrator has the power to determine the terms of the
options or stock purchase rights granted, including the exercise price, the
number of shares subject to each option or stock purchase right, the
exercisability of the options and the form of consideration payable upon
exercise.
Options. The administrator determines the exercise price and term of options
granted under our stock plan. With respect to incentive stock options, however,
the exercise price must at least be equal to the fair market value of our
common stock on the date of grant and its term may not exceed ten years.
No optionee may be granted an option to purchase more than 3,000,000 shares
in any fiscal year. In connection with his or her initial service, an optionee
may be granted an option to purchase up to an additional 3,000,000 shares of
our common stock.
After termination of one of our employees, directors or consultants, he or
she may exercise his or her option for the period of time stated in the option
agreement. If termination is due to death, the option will generally remain
exercisable for 12 months following such termination. If termination is due to
disability, the option will generally remain exercisable for 6 months following
such termination. In all other cases, the option will generally remain
exercisable for three months unless another time period is prescribed in the
option agreement. However, an option may never be exercised later than the
expiration of its term.
Stock Purchase Rights. The administrator determines the exercise price of
stock purchase rights granted under our stock plan. Unless the administrator
determines otherwise, the restricted stock purchase agreement that an optionee
will enter into upon the exercise of options will grant us a repurchase option
that we may exercise upon the voluntary or involuntary termination of the
purchaser's service with us for any reason (including death or disability). The
purchase price for shares we repurchase will generally be the original price
paid by the purchaser. The administrator determines the rate at which our
repurchase option will lapse.
Transferability of Options and Stock Purchase Rights. Our stock plan
generally does not allow for the transfer of options or stock purchase rights
and only the optionee may exercise an option and stock purchase right during
his or her lifetime.
Adjustments upon Merger or Asset Sale. Our stock plan provides that in the
event of our merger with or into another corporation or a sale of substantially
all of our assets, the successor corporation will assume or substitute an
equivalent option or right for each outstanding option or stock purchase right.
If the outstanding options or stock purchase rights are not assumed or
substituted for, all outstanding options and stock purchase rights will vest
and become exercisable and terminate as of the closing of such merger or sale
of assets.
Amendment and Termination of our Stock Plan. Our stock plan will
automatically terminate in 2009, unless we terminate it sooner. In addition,
our Board of Directors has the authority to amend, suspend or terminate the
stock plan provided that it does not adversely affect any option previously
granted under our stock plan.
2000 Employee Stock Purchase Plan
Our Board of Directors adopted the 2000 Employee Stock Purchase Plan on
January 18, 2000 and our stockholders approved the plan in February 2000.
Number of Shares of Common Stock Available under the Employee Stock Purchase
Plan. A total of 1,000,000 shares of our common stock will be made available
for sale. In addition, the plan provides for annual
51
<PAGE>
increases in the number of shares available for issuance under the purchase
plan beginning in 2001, equal to the lesser of 2% of the outstanding shares of
our common stock on the first day of our fiscal year, 1,000,000 shares, or such
other lesser amount as may be determined by our Board of Directors.
Administration of the Employee Stock Purchase Plan. Our Board of Directors
or a committee of our board administers the plan. Such administrator has full
and exclusive authority to interpret the terms of the plan and determine
eligibility.
Eligibility to Participate. All of our employees are eligible to participate
if they are customarily employed by us or any participating subsidiary for at
least 20 hours per week and more than five months in any calendar year.
However, an employee may not be permitted to purchase stock under the plan if
such employee:
. immediately after grant owns stock possessing 5% or more of the total
combined voting power or value of all classes of our capital stock, or
. whose rights to purchase stock under all of our employee stock purchase
plans accrues at a rate that exceeds $25,000 worth of stock for each
calendar year.
Offering Periods and Contributions. Our plan is intended to qualify for
special tax treatment and contains consecutive, overlapping 24-month offering
periods. Each offering period includes four 6-month purchase periods. The
offering periods generally start on the first trading day on or after November
1 and May 1 of each year, except for the first such offering period which will
commence on the first trading day on or after the effective date of this
offering and will end on the last trading day on or before April 30, 2002.
The plan permits participants to purchase common stock through payroll
deductions of up to 10% of their eligible compensation which includes a
participant's base straight time gross earnings and commissions but excluding
all other compensation paid to our employees. A participant may purchase no
more than 5,000 shares during any 6-month purchase period.
Purchase of Shares. Amounts deducted and accumulated by the participant are
used to purchase shares of our common stock at the end of each 6-month purchase
period. The price is 85% of the lower of the fair market value of our common
stock at the beginning of an offering period or the last day of a purchase
period ends. If the fair market value at the end of a purchase period is less
than the fair market value at the beginning of the offering period,
participants will be withdrawn from the current offering period following their
purchase of shares on the purchase date and will be automatically re-enrolled
in a new offering period. Participants may end their participation at any time
during an offering period, and will be paid their payroll deductions to date.
Participation ends automatically upon termination of employment with us.
Transferability of Rights. A participant may not transfer rights granted
under the plan other than by will, the laws of descent and distribution or as
otherwise provided under the plan.
Adjustments upon Merger or Asset Sale. In the event of our merger with or
into another corporation or a sale of all or substantially all of our assets, a
successor corporation may assume or substitute each outstanding option. If the
successor corporation refuses to assume or substitute for the outstanding
options, the offering period then in progress will be shortened, and a new
exercise date will be set.
Amendment and Termination of the Employee Stock Purchase Plan. The plan will
terminate by its terms in 2010. Our Board of Directors has the authority to
amend or terminate our plan, except that, subject to certain exceptions
described in the plan, no such action may adversely affect any outstanding
rights to purchase stock under our plan.
2000 Director Option Plan
Our Board of Directors adopted the 2000 Director Option Plan on January 18,
2000 and our stockholders approved it in February 2000. The director plan
provides for the periodic grant of nonstatutory stock options to our non-
employee directors.
52
<PAGE>
Number of Shares Available under the Director Plan. As of February 2000, a
total of 300,000 shares of our common stock were reserved for issuance under
our director option plan, none of which were issued and outstanding as of this
date.
Options. Each non-employee director who joins our Board of Directors after
the effective date of this offering will automatically receive an option to
purchase 20,000 shares on the date on which such person becomes a director. All
non-employee directors who have been directors for at least the preceding 6
months receive an option to purchase 5,000 shares each year on the date of our
annual stockholders meeting.
All options granted under our director option plan have a term of ten years
and an exercise price equal to the fair market value per share of common stock
determined on the date of grant. The option granted initially to non-employee
directors becomes exercisable over four years as follows: 25% on each
anniversary of the date of grant, provided that the non-employee director
remains a director on such dates. The option granted to non-employee directors
on the date of our annual stockholders meeting becomes exercisable as to 100%
of the shares subject to the option on the first anniversary of the date of
grant.
After termination as a non-employee director with us, an optionee must
exercise an option at the time set forth in his or her option agreement. If
termination is due to death, the option will remain exercisable for 12 months
following the date of death. If termination is due to disability, the option
will remain exercisable for 6 months following the date of termination. In all
other cases, the option will remain exercisable for a period of 3 months.
However, an option may never be exercised later than the expiration of its
term.
Transferability of Options. A non-employee director may not transfer options
granted under our director option plan other than by will or the laws of
descent and distribution. Only the non-employee director may exercise the
option during his or her lifetime.
Adjustments upon Merger or an Asset Sale. In the event of our merger with or
into another corporation or a sale of substantially all of our assets, the
successor corporation may assume or substitute an equivalent option for each
outstanding option. If such assumption or substitution occurs, the options will
continue to be exercisable according to the same terms as before the merger or
sale of assets. Following such assumption or substitution, if a non-employee
director is terminated other than by voluntary resignation, the option will
become fully exercisable and generally will remain exercisable for a period of
3 months. If the outstanding options are not assumed or substituted for, our
Board of Directors will notify each non-employee director that he or she has
the right to exercise the option as to all shares subject to the option for a
period of 30 days following the date of the notice. The option will terminate
upon the expiration of the 30-day period.
Amendment and Termination of the Director Option Plan. Unless terminated
sooner, our director plan will automatically terminate in 2010. Our Board of
Directors has the authority to amend, alter, suspend, or discontinue the
director option plan, but no such action may adversely affect any grant made
under the director option plan.
401(k) Plan
We adopted a 401(k) Plan effective January 1999 covering our employees who
are 21 years old as of the effective date of the 401(k) Plan. Employees become
eligible to participate in the 401(k) Plan on the first day of the month
coinciding with or following the date the employee satisfies the eligibility
requirements. The 401(k) Plan excludes nonresident alien employees. The 401(k)
Plan is intended to qualify under Section 401(k) of the United States 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 United
States 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 $10,500 in 2000 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.
53
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Preferred Stock
On February 1, 1999, and April 16, 1999 we sold an aggregate of 2,636,916
shares and 5,246,008 shares, respectively, of our Series A Preferred Stock at a
purchase price of $0.61625 per share (as adjusted for a two-for-one stock split
which occurred in April 1999). On December 17, 1999, we sold an aggregate of
7,082,267 shares of our Series B Preferred Stock at a purchase price of $4.728
per share. The following officers, directors and 5% stockholders purchased
shares in these financings:
<TABLE>
<CAPTION>
Series A Stock Series B Stock
-------------------- --------------------
Shares Aggregate Shares Aggregate
Purchaser Purchased Price Paid Purchased Price Paid
- --------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Patricof & Co. Entities (1):
APA Excelsior V, L.P................ -- -- 1,671,742 $7,903,996
Patricof Private Investment Club II,
L.P................................ -- -- 20,305 $ 96,002
Apax Europe IV--A, L.P. ............ -- -- 423,012 $2,000,000
KPCB Holdings, Inc. (2).............. 4,381,340 $2,700,000 1,057,529 $4,999,997
McKenna Ventures L.P. (3)............ -- -- 52,876 $ 249,998
John Drew............................ -- -- 423,011 $1,999,996
Ernest von Simson.................... -- -- 52,876 $ 249,998
</TABLE>
- --------
(1) APA Excelsior V, L.P., Patricof Private Investment Club II, L.P. and Apax
Europe IV-A, L.P. are affiliated entities and together are considered a 5%
stockholder. Mr. Vais, one of our directors, is a general partner of
Patricof & Co., an entity affiliated with APA Excelsior V, L.P., Patricof
Private Investment Club II, L.P. and Apax Europe IV-A, L.P. Mr. Vais
disclaims beneficial ownership of the securities held by such entities,
except for his proportional interest in the entities.
(2) KPCB Holdings, Inc. is considered a 5% stockholder and Mr. Schlein, one of
our directors, is a general partner of Kleiner Perkins Caufield & Byers, an
entity affiliated with KPCB Holdings, Inc. Mr. Schlein disclaims beneficial
ownership of the securities held by KPCB Holdings, Inc., except for his
proportional interest in the entity.
(3) Regis McKenna, one of our directors, is a general partner of The McKenna
Group, an entity affiliated with McKenna Ventures L.P. Mr. McKenna shares
voting control of the securities held by such entity.
Other Material Transactions
Investor Rights Agreement
We have entered into an agreement with the preferred stockholders described
above pursuant to which these and other preferred stockholders will have
registration rights with respect to their shares of common stock following this
offering. For a description of these registration rights, see "Description of
Capital Stock." Upon the completion of this offering, all shares of our
outstanding preferred stock will be automatically converted into an equal
number of shares of common stock.
54
<PAGE>
Stock Option Grants to Certain Officers and Directors
During 1999, we granted the following options to purchase our common stock
to our officers, directors and stockholders who beneficially own 5% or more of
our common stock.
<TABLE>
<CAPTION>
Accounting
Exercise Price Deemed
Name Date of Grant Options Per Share Fair Value
- ---- ------------- --------- -------------- -----------
<S> <C> <C> <C> <C>
Fernand B. Sarrat............ 5/3/99 1,660,194 $0.07 $5,096,796
Fernand B. Sarrat............ 10/21/99 204,918 $0.13 872,951
Patricia Lambs............... 10/21/99 415,049 $0.13 1,768,109
Thomas W. Phillips........... 10/21/99 290,533 $0.13 1,237,671
Robert V. Walters............ 12/9/99 300,000 $1.00 1,419,000
Christian A. Paul............ 12/9/99 340,000 $1.00 1,608,200
Douglas C. Nassaur........... 11/16/99 415,049 $0.13 1,863,570
Regis McKenna................ 10/21/99 50,000 $0.13 213,000
Ernest von Simson............ 10/21/99 50,000 $0.13 213,000
John Drew.................... 11/24/99 100,000 $1.00 449,000
</TABLE>
Indemnification and Employment Agreements
We have entered into indemnification agreements with each of our directors
and officers. Such indemnification agreements require us to indemnify our
directors and officers to the fullest extent permitted by Delaware law. For a
description of the limitation of our directors' liability and our
indemnification of such officers, see "Management--Limitation on Directors' and
Officers' Liability and Indemnification."
For a description of employment agreements we entered into with our
officers, see "Management--Employment Agreements and Change in Control
Arrangements."
Agreements with Directors or Executive Officers
In May 1999, Mr. Sarrat was granted options to purchase 1,660,194 shares of
common stock at an exercise price of $.07 per share. Mr. Sarrat exercised the
options by paying cash for the par value of the shares and executed a full-
recourse promissory note for $116,048, the balance of the purchase price. The
note is secured by a stock pledge agreement which pledges the underlying shares
of common stock as collateral. The note bears interest at a rate of 5.22%.
In December 1999, Mr. Paul was granted options to purchase 340,000 shares of
common stock at an exercise price of $1.00 per share. Mr. Paul exercised the
options by paying cash for the par value of the shares and executed a full-
recourse promissory note for $339,966, the balance of the purchase price. The
note is secured by a stock pledge agreement which pledges the underlying shares
of common stock as collateral. The note bears interest at a rate of 6.2%.
55
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of January 31, 2000, and as
adjusted to reflect the sale of common stock offered hereby by the following:
. each stockholder known by us to own beneficially more than 5% of our
common stock;
. each of our executive officers named in the compensation table above;
. each of our directors; and
. all directors and executive officers as a group.
As of January 31, 2000, there were 25,714,721 shares of our common stock
outstanding, assuming that all outstanding preferred stock has been converted
into common stock. Except as otherwise indicated, we believe that the
beneficial owners of the common stock listed below, on the information
furnished by such owners, have sole voting power and investment power with
respect to such shares. Beneficial ownership is determined in accordance with
the rules of the Securities and Exchange Commission. In computing the number of
shares beneficially owned by a person and the percent ownership of that person,
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
January 31, 2000 are deemed outstanding, while such shares are not deemed
outstanding for purposes of computing percent ownership of any other person.
The address for those individuals for which an address is not otherwise
indicated in the table below is Linuxcare, Inc., 650 Townsend Street, San
Francisco, California 94103.
<TABLE>
<CAPTION>
Percentage of
Shares Shares Outstanding
Beneficially -----------------------
Owned Prior to Prior To
Name or group of beneficial owners Offering Offering After Offering
---------------------------------- -------------- -------- --------------
<S> <C> <C> <C>
Directors And Executive Officers
Ted E. Schlein(1)....................... 5,471,068 21.3% 18.1%
Kleiner Perkins Caufield & Byers
2750 Sand Hill Road
Menlo Park, CA 94025
Paul Vais(2)............................ 2,179,456 8.5 7.2
Patricof & Co.
2100 Geng Road
Palo Alto, CA 94303
John Drew(3)............................ 535,890 2.1 1.8
Regis McKenna(4)........................ 104,486 * *
The McKenna Group
1409 Galloway Court
Sunnyvale, CA 94087
Ernest von Simson(5).................... 104,486 * *
Fernand Sarrat(6)....................... 1,865,112 7.3 6.2
Arthur Tyde III(7)...................... 2,000,000 7.8 6.6
Douglas C. Nassaur(8)................... 415,049 1.6 1.4
Robert V. Walters(9).................... 300,000 1.2 1.0
Thomas W. Phillips(9)................... 290,533 1.1 1.0
Patricia Lambs(10)...................... 415,049 1.6 1.4
Anthony Pollace......................... 111,750 * *
All Officers and Directors (16
persons)(11)........................... 18,021,129 67.4 57.7
</TABLE>
56
<PAGE>
<TABLE>
<CAPTION>
Percentage of
Shares Shares Outstanding
Beneficially -----------------------
Owned Prior to Prior To
Name or group of beneficial owners Offering Offering After Offering
---------------------------------- -------------- -------- --------------
<S> <C> <C> <C>
5% Stockholders
KPCB Holdings, Inc.(1).................. 5,471,068 21.3% 18.1%
Patricof & Company(2)................... 2,179,456 8.5 7.2
David LaDuke(7)......................... 2,000,000 7.8 6.6
David Sifry(7).......................... 2,000,000 7.8 6.6
Arthur F. Tyde III(7)................... 2,000,000 7.8 6.6
Fernand Sarrat(6)....................... 1,865,112 7.3 6.2
</TABLE>
- --------
* Less than 1% of the outstanding shares of common stock.
(1) Includes 5,471,068 shares held by KPCB Holdings, Inc. Mr. Schlein is a
general partner of Kleiner Perkins Caufield & Byers and has signature
authority for KPCB Holdings, Inc. Mr. Schlein disclaims beneficial
ownership of shares held by KPCB Holdings, Inc. except to the extent of
his pecuniary interest in it.
(2) Includes 1,722,642 shares held by APA Excelsior V, L.P., 435,891 shares
held by Apax Europe IV-A, L.P. and 20,923 shares held by Patricof Private
Investment Club II, L.P. Mr. Vais is the managing director of Patricof &
Company, and has signature authority for APA Excelsior V, L.P., Apax
Europe IV-A, L.P., and Patricof Private Investment Club II, L.P. Mr. Vais
disclaims beneficial ownership of shares held by these entities except to
the extent of his pecuniary interest in it.
(3) Includes 100,000 shares subject to our right of repurchase, which lapses
over time.
(4) Includes 54,486 shares held by McKenna Ventures, L.P. Mr. McKenna is the
chairman of The McKenna Group and has signature authority for McKenna
Ventures. Mr. McKenna disclaims beneficial ownership of shares held by
this entity except to the extent of his pecuniary interest in this entity.
Mr. McKenna also holds an option exercisable for 50,000 shares, which is
exercisable within 60 days of January 31, 2000 and upon exercise will
become subject to our right of repurchase, which lapses over time.
(5) Includes an option exercisable for 50,000 shares which is exercisable
within 60 days of January 31, 2000 and upon exercise will become subject
to our right of repurchase, which lapses over time.
(6) Includes 1,865,112 shares subject to our right of repurchase, which lapses
over time.
(7) Includes 1,375,000 shares subject to our right of repurchase, which lapses
over time.
(8) Includes 415,049 shares subject to our right of repurchase, which lapses
over time.
(9) The number of shares shown represents shares subject to options that are
exercisable within 60 days of January 31, 2000 and which upon exercise
will become subject to our right of repurchase, which lapses over time.
(10) Includes 100,000 shares subject to our right of repurchase, which lapses
over time, and options to purchase 315,049 shares which is exercisable
within 60 days of January 31, 2000 and which upon exercise will become
subject to our right of repurchase, which lapses over time.
(11) Includes 1,005,582 shares of common stock issuable upon the exercise of
options exercisable within 60 days of January 31, 2000.
57
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, we will be authorized to issue
205,000,000 shares, $0.0001 par value per share, to be divided into two classes
to be designated common stock and preferred stock. Of the shares authorized,
200,000,000 shares shall be designated as common stock and 5,000,000 shares
shall be designated as preferred stock. The following description of our
capital stock is only a summary. You should refer to our certificate of
incorporation and bylaws as in effect upon the closing of this offering, which
are included as exhibits to the registration statement of which this prospectus
forms a part, and by the provisions of applicable Delaware law.
Common Stock
As of January 31, 2000, and assuming the conversion of all outstanding
shares of preferred stock into common stock, there were 25,714,721 shares of
common stock outstanding which were held of record by approximately 93
stockholders. There will be 30,214,721 shares of common stock outstanding
(assuming no exercise of the underwriters' over-allotment option and no
exercise of outstanding options) after giving effect to the sale of our common
stock in this offering. In addition to 2,897,501 shares issuable upon exercise
of outstanding options under our 1999 Stock Plan, there are an aggregate of
1,300,000 shares reserved for issuance under our 2000 Employee Stock Purchase
Plan and 2000 Director Option Plan. See "Management--Stock Plans" for a
description of our stock plans.
The holders of our common stock are entitled to one vote per share held of
record on all matters submitted to a vote of the stockholders. Our amended and
restated certificate of incorporation to be filed concurrently with completion
of this offering, does not provide for cumulative voting in the election of
directors. Subject to preferences that may be applicable to any outstanding
preferred stock, the holders of common stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by our Board of
Directors out of funds legally available for that purpose. In the event of our
liquidation, dissolution or winding up, holders of our common stock are
entitled to share ratably in all assets remaining after payment of liabilities,
subject to prior distribution rights of preferred stock, if any, then
outstanding. Holders of our common stock have no preemptive or other
subscription or conversion rights. There are no redemption or sinking fund
provisions applicable to our common stock. All outstanding shares of common
stock are fully paid and non-assessable, and the shares of common stock to be
issued upon the completion of this offering will be fully paid and non-
assessable.
Preferred Stock
Upon the completion of this offering and filing of our amended and restated
certificate of incorporation, our Board of Directors will be authorized,
without action by the stockholders, to issue 5,000,000 shares of preferred
stock in one or more series and to fix the rights, preferences, privileges and
restrictions thereof. These rights, preferences and privileges may include
dividend rights, conversion rights, voting rights, terms of redemption,
liquidation preferences, sinking fund terms and the number of shares
constituting any series or the designation of any series, all or any of which
may be greater than the rights of the common stock.
The issuance of preferred stock could adversely affect the voting power of
holders of common stock and the likelihood that the holders of common stock
will receive dividend payments and payments upon liquidation. In addition, the
issuance of preferred stock could have the effect of delaying or preventing a
change in our control without further action by the stockholders. We have no
present plans to issue any shares of preferred stock.
Registration Rights
Pursuant to a registration rights agreement we entered into with holders of
21,215,436 shares of our common stock (assuming conversion of all outstanding
shares of preferred stock), the holders of these shares are entitled to
58
<PAGE>
certain registration rights regarding these shares. The registration rights
provide that if we propose to register any securities under the Securities Act,
either for our own account or for the account of other security holders
exercising registration rights, they are entitled to notice of the registration
and are entitled to include shares of their common stock in the registration.
This right is subject to conditions and limitations, including the right of the
underwriters in an offering to limit the number of shares included in the
registration. The holders of these shares may also require us to file up to two
registration statements under the Securities Act at our expense with respect to
their shares of common stock. We are required to us our best efforts to effect
this registration, subject to conditions and limitations. Furthermore, the
holders of these shares may require us to file additional registration
statements on Form S-3, subject to conditions and limitations. These rights
terminate on the earlier of five years after the effective date of this
offering or the date on which a holder is able to sell all its shares pursuant
to Rule 144 under the Securities Act in any 90-day period.
Delaware Anti-Takeover Law and Certain Charter and Bylaw Provisions
Certain provisions of Delaware law and our certificate of incorporation and
bylaws could make our acquisition more difficult by means of a tender offer, a
proxy contest or otherwise and could also make the removal of incumbent
officers and directors more difficult. These provisions, summarized below, are
expected to discourage certain types of coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
us to first negotiate with us. We believe that the benefits of increased
protection of our potential ability to negotiate with the proponent of an
unfriendly or unsolicited proposal to acquire or restructure us outweighs the
disadvantages of discouraging such proposals because, among other things,
negotiation of such proposals could result in an improvement of their terms.
The amendment of any of the following provisions would require approval by
holders of at least 66 2/3% of our outstanding common stock.
Board of Directors
Effective with the first annual meeting of stockholders following completion
of this offering, our amended and restated bylaws provide for the division of
our Board of Directors into three classes, as nearly equal in number as
possible, with the directors in each class serving for a three-term, and one
class being elected each year by our stockholders. This system of electing and
removing directors may tend to discourage a third party from making a tender
offer or otherwise attempting to obtain control of us and may maintain the
incumbency of the Board of Directors, as it generally makes it more difficult
for stockholders to replace a majority of the directors. Further, our amended
and restated certificate of incorporation and restated bylaws do not provide
for cumulative voting in the election of directors.
Stockholder Meetings
Under our amended and restated certificate of incorporation and amended and
restated bylaws, only our Board of Directors, Chairman of the Board, Chief
Executive Officer or the holders of a majority of the outstanding stock may
call special meetings of stockholders. Our restated bylaws establish advance
notice procedures with respect to stockholder proposals and the nomination of
candidates for election as directors, other than nominations made by or at the
direction of the Board of Directors or a committee thereof. In addition, our
amended and restated certificate of incorporation eliminates the right of
stockholders to act by written consent without a meeting and eliminates
cumulative voting.
Undesignated Preferred Stock
The authorization of undesignated preferred stock makes it possible for the
Board of Directors to issue preferred stock with voting or other rights or
preferences that could impede the success of any attempt to change control of
us. These and other provisions may have the effect of deferring hostile
takeovers or delaying changes in control or management.
59
<PAGE>
Section 203
We are subject to Section 203 of the Delaware General Corporation Law. In
general, the statute prohibits a Delaware corporation from engaging in any
business combination with any interested stockholder for a period of three
years following the date that the stockholder became an interested stockholder
unless:
. prior to the date, the board of directors of the corporation approved
either the business combination or the transaction that resulted in the
stockholder becoming an interested stockholder;
. upon consummation of the transaction that resulted in the stockholder's
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced, excluding those shares owned by persons who
are directors and also officers, and 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, the business combination is approved by
the board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at
least two-thirds of the outstanding voting stock that is not owned by
the interested stockholder.
Section 203 defines "business combination" to include:
. any merger or consolidation involving the corporation and the interested
stockholder;
. any sale, transfer, pledge or other disposition involving the interested
stockholder of 10% or more of the assets of the corporation;
. subject to exceptions, any transaction that results in the issuance or
transfer by the corporation of any stock of the corporation to the
interested stockholder; or
. the receipt by the interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation.
In general, Section 203 defines an interested stockholder as any entity or
person beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by the entity or person.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is Norwest Bank
Minnesota, N.A.
Nasdaq Stock Market National Market Listing
We will list our common stock on The Nasdaq Stock Market's National Market,
subject to official notice of issuance, under the symbol "LXCR."
60
<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 market prices for our common stock or could impair our ability
to raise capital through an offering of equity securities. Furthermore, since
no shares will be available for sale shortly after this offering because of
contractual and legal restrictions on resale as described below, sales of
substantial amounts of our common stock in the public after these restrictions
lapse could adversely affect the prevailing market price and our ability to
raise equity capital in the future.
Upon completion of this offering, we will have 30,214,721 shares of common
stock outstanding (assuming conversion of all of the currently outstanding
shares of preferred stock) based on shares outstanding as of January 31, 2000
and assuming no exercise of the underwriters' over-allotment option and no
exercise of outstanding options. Of these shares, all of the shares sold in
this offering will be freely transferable without restriction under the
Securities Act of 1933, unless these shares are purchased by "affiliates" as
that term is used under the Securities Act and the Regulations promulgated
thereunder.
Of these shares, the remaining 25,714,721 shares as of January 31, 2000,
which were sold by us in reliance on exemptions from the registration
requirements of the Securities Act, are restricted securities within the
meaning of Rule 144 under the Securities Act and become eligible for sale in
the public market as follows:
. no shares will be eligible for immediate sale on the date the
registration statement of which this prospectus is a part is declared
effective;
. no shares will be eligible for sale prior to 180 days from the date the
registration statement of which this prospectus is a part is declared
effective; and
. beginning 181 days after the effective date, 25,714,721 shares will
become eligible for sale, subject to the provisions of Rules 144 or 701,
upon the expiration of agreements not to sell such shares entered into
between the underwriters and such stockholders.
Beginning 180 days after the date of this prospectus, approximately 247,572
additional shares subject to vested options as of the date of completion of
this offering will be available for sale subject to compliance with Rule 701
and upon the expiration of agreements not to sell such shares entered into
between the underwriters and such stockholders. Any shares subject to lock-up
agreements may be released at any time without notice by the underwriters.
In general, under Rule 144 as currently in effect, a person (or group of
persons whose shares are aggregated), including an affiliate, who has
beneficially owned restricted shares for at least one year is entitled to sell,
within any three-month period commencing 90 days after the date of completion
of this offering, a number of shares that does not exceed the greater of 1% of
the then outstanding shares of common stock (approximately 302,147 shares
immediately after this offering), or the average weekly trading volume in the
common stock during the four calendar weeks preceding such sale, subject to the
filing of a Form 144 with respect to such sale and certain other limitations
and restrictions. In addition, a person who is not deemed to have been our
affiliate at any time during the 90 days preceding a sale and who has
beneficially owned the shares proposed to be sold for at least two years, would
be entitled to sell such shares without regard to the requirements described
above.
Any of our employees, officers or directors of or consultant who purchased
his or her shares prior to the date of completion of this offering or who holds
vested options as of that date pursuant to a written compensatory plan or
contract is entitled to rely on the resale provisions of Rule 701, which
permits non-affiliates to sell their Rule 701 shares without having to comply
with the public-information, holding-period, volume-limitation or notice
provisions of Rule 144 and permits affiliates to sell their Rule 701 shares
without having to comply with Rule 144's holding-period restrictions, in each
case commencing 90 days after the date
61
<PAGE>
of completion of this offering. However, we and our officers, directors and
stockholders have agreed not to sell or otherwise dispose of any shares of our
common stock for the 180-day period after the date of this prospectus without
the prior written consent of the underwriters. See "Underwriting."
As soon as practicable after the effective date of the registration
statement of which this prospectus is a part, we intend to file a registration
statement on Form S-8 under the Securities Act to register shares of common
stock issuable under our 1999 Stock Plan our 2000 Director Option Plan, and our
2000 Employee Stock Purchase Plan, thus permitting the resale of such shares by
non-affiliates in the public market without restriction under the Securities
Act. Such registration statement will become effective immediately upon filing.
Prior to this offering, there has been no public market for our common
stock, and any sale of substantial amounts in the open market may adversely
affect the market price of our common stock offered hereby.
62
<PAGE>
UNITED STATES TAX CONSEQUENCES TO NON-UNITED STATES HOLDERS
The following is a general discussion of the principal U.S. federal income
and estate tax consequences of the ownership and disposition of our common
stock by a Non-U.S. Holder. As used in this prospectus, the term "Non-U.S.
Holder" is a person other than:
. a citizen or individual resident of the United States,
. a corporation or other entity taxable as a corporation that is created
or organized in or under the laws of the United States or of any
political subdivision of the United States,
. an estate whose income is includible in gross income for U.S. federal
income tax purposes regardless of its source, or
. a trust, the administration of which is subject to the primary
supervision of a court within the United States and for which one or
more U.S. persons have the authority to control all substantial
decisions.
If a partnership holds our common stock, the tax treatment of a partner
generally will depend upon the status of the partner and upon the activities of
the partnership. Partners of partnerships holding our common stock should
consult their tax advisors.
This discussion does not consider:
. U.S. state and local or non-U.S. tax consequences,
. the tax consequences for the shareholders, partners or beneficiaries of
a Non-U.S. Holder,
. special tax rules that may apply to certain Non-U.S. Holders, including
without limitation, banks, insurance companies, dealers in securities
and traders in securities, or
. special tax rules that may apply to a Non-U.S. Holder that holds our
common stock as part of a "straddle," "hedge" or "conversion
transaction."
The following discussion is based on provisions of the U.S. Internal Revenue
Code of 1986, applicable Treasury regulations, and administrative and judicial
interpretations, all as of the date of this prospectus, and all of which may
change, retroactively or prospectively. The following summary is for general
information. Accordingly, each Non-U.S. Holder should consult a tax advisor
regarding the U.S. federal, state, local and non-U.S. income and other tax
consequences of acquiring, holding and disposing of shares of our common stock.
Dividends
We do not anticipate paying cash dividends on our common stock in the
foreseeable future. See "Dividend Policy." In the event, however, that
dividends are paid on shares of common stock, dividends paid to a Non-U.S.
Holder of common stock generally will be subject to withholding of U.S. federal
income tax at a 30% rate, or such lower rate as may be provided by an
applicable income tax treaty. Non-U.S. Holders should consult their tax
advisors regarding their entitlement to benefits under a relevant income tax
treaty.
Dividends that are effectively connected with a Non-U.S. Holder's conduct of
a trade or business in the United States or, if an income tax treaty applies,
attributable to a permanent establishment, or in the case of an individual, a
"fixed base," in the United States, as provided in that treaty ("U.S. trade or
business income"), are generally subject to U.S. federal income tax on a net
income basis at regular graduated rates, but are not generally subject to the
30% withholding tax if the Non-U.S. Holder files the appropriate U.S. Internal
Revenue Service form with the payor. Any U.S. trade or business income received
by a Non-U.S. Holder that is a corporation may also, under certain
circumstances, be subject to an additional "branch profits tax" at a 30% rate
or such lower rate as specified by an applicable income tax treaty.
63
<PAGE>
Dividends paid prior to 2001 to an address in a foreign country are
presumed, absent actual knowledge to the contrary, to be paid to a resident of
such country for purposes of the withholding discussed above and for purposes
of determining the applicability of a tax treaty rate. For dividends paid after
2000, a Non-U.S. Holder of common stock who claims the benefit of an applicable
income tax treaty rate generally will be required to satisfy applicable
certification and other requirements.
A Non-U.S. Holder of common stock that is eligible for a reduced rate of
U.S. withholding tax under an income tax treaty may obtain a refund or credit
of any excess amounts withheld by filing an appropriate claim for a refund with
the IRS.
Gain on disposition of common stock
A Non-U.S. Holder generally will not be subject to U.S. federal income tax
in respect of gain recognized on a disposition of common stock unless:
. the gain is U.S. trade or business income, in which case, the branch
profits tax described above may also apply to a corporate Non-U.S.
Holder;
. the Non-U.S. Holder is an individual who holds the common stock as a
capital asset within the meaning of Section 1221 of the Internal Revenue
Code, is present in the United States for more than 182 days in the
taxable year of the disposition and meets certain other requirements;
. the Non-U.S. Holder is subject to tax pursuant to the provisions of the
U.S. tax law applicable to certain U.S. expatriates; or
. we are or have been a "U.S. real property holding corporation" for
federal income tax purposes at any time during the shorter of a five-
year period ending on the date of disposition or the period that the
Non-U.S. Holder held our common stock.
Generally, a corporation is a "U.S. real property holding corporation" if
the fair market value of its "U.S. real property interests" equals or exceeds
50% of the sum of the fair market value of its worldwide real property
interests plus its other assets used or held for use in a trade or business. We
believe that we have not been, are not currently, and do not anticipate
becoming, a "U.S. real property holding corporation" for U.S. federal income
tax purposes. The tax relating to stock in a "U.S. real property holding
corporation" will not apply to a Non-U.S. Holder whose holdings, direct and
indirect, at all times during the applicable period, constituted 5% or less of
the common stock, provided that the common stock was regularly traded on an
established securities market.
Federal estate tax
Common stock owned or treated as owned by an individual who is a Non-U.S.
Holder at the time of death will be included in the individual's gross estate
for U.S. federal estate tax purposes, unless an applicable estate tax or other
treaty provides otherwise and, therefore, may be subject to U.S. federal estate
tax.
Information reporting and backup withholding tax
We must report annually to the IRS and to each Non-U.S. Holder the amount of
dividends paid to that holder and the tax withheld with respect to those
dividends. Copies of the information returns reporting those dividends and
withholding may also be made available to the tax authorities in the country in
which the Non-U.S. Holder is a resident under the provisions of an applicable
income tax treaty or agreement.
Under certain circumstances, U.S. Treasury Regulations require information
reporting and backup withholding at a rate of 31% on certain payments on common
stock. Under currently applicable law, Non-U.S. Holders of common stock
generally will be exempt from these information reporting requirements and from
backup withholding on dividends paid prior to 2001 to an address outside the
United States. For dividends paid
64
<PAGE>
after 2000, however, a Non-U.S. Holder of common stock that fails to certify
its Non-U.S. Holder status in accordance with U.S. Treasury Regulations may be
subject to backup withholding at a rate of 31% on payments of dividends.
The payments of the proceeds of the disposition of common stock by a holder
to or through the U.S. office of a broker or through a non-U.S. broker
generally will be subject to information reporting and backup reporting at a
rate of 31% unless the holder either certifies its status as a Non-U.S. Holder
under penalties of perjury or otherwise establishes an exemption. The payment
of the proceeds of the disposition by a Non-U.S. Holder of common stock to or
through a non-U.S. office of a non-U.S. broker will not be subject to backup
withholding or information reporting unless a non-U.S. broker is a "U.S.
related person." In the case of the payment of proceeds from the disposition of
common stock by or through a non-U.S. office of a broker that is a U.S. person
or a "U.S. related person," information reporting, but currently not backup
withholding, on the payment applies unless the broker receives a statement from
the owner, signed under penalty of perjury, certifying its non-U.S. status or
the broker has documentary evidence in its files that the holder is a Non-U.S.
Holder and the broker has no actual knowledge to the contrary. For this
purpose, a "U.S. related person" is:
. a "controlled foreign corporation" for U.S. federal income tax purposes;
. a foreign person 50% or more of whose gross income from all sources for
the three-year period ending with the close of its taxable year
preceding the payment, or for such part of the period that the broker
has been in existence, is derived from activities that are effectively
connected with the conduct of a U.S. trade or business; or
. effective after 2000, a foreign partnership if, at any time during the
taxable year, (A) at least 50% of the capital or profits interest in the
partnership is owned by U.S. persons, or (B) the partnership is engaged
in a U.S. trade or business.
Effective after 2000, backup withholding may apply to the payment of
disposition proceeds by or through a non-U.S. office of a broker that is a U.S.
person or a "U.S. related person" unless certain certification requirements are
satisfied or an exemption is otherwise established and the broker has no actual
knowledge that the holder is a U.S. person. Non-U.S. Holders should consult
their own tax advisors regarding the application of the information reporting
and backup withholding rules to them, including changes to these rules that
will become effective after 2000.
Any amounts withheld under the backup withholding rules from a payment to a
Non-U.S. Holder will be refunded, or credited against the holder's U.S. federal
income tax liability, if any, provided that the required information is
furnished to the IRS.
65
<PAGE>
UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement dated , 2000, we have agreed to sell to the underwriters named
below, for whom Credit Suisse First Boston Corporation, Chase Securities Inc.,
of which Chase H&Q is an operating division, and FleetBoston Robertson Stephens
Inc. are acting as representatives, the following respective numbers of shares
of common stock:
<TABLE>
<CAPTION>
Number
Underwriter of Shares
----------- ---------
<S> <C>
Credit Suisse First Boston Corporation.............................
Chase Securities Inc...............................................
FleetBoston Robertson Stephens Inc. ...............................
---------
Total............................................................ 4,500,000
=========
</TABLE>
The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of common stock in the offering if any are purchased,
other than those shares covered by the over-allotment option described below.
The underwriting agreement also provides that if an underwriter defaults, the
purchase commitments of non-defaulting underwriters may be increased or the
offering of common stock may be terminated.
We have granted to the underwriters a 30-day option to purchase on a pro
rata basis up to 675,000 additional shares at the initial public offering price
less the underwriting discounts and commissions. The option may be exercised
only to cover any over-allotments of common stock.
The underwriters propose to offer the shares of common stock initially at
the public offering price on the cover page of this prospectus and to selling
group members at that price less a concession of $ per share. The
underwriters and selling group members may allow a discount of $ per share on
sales to other broker/dealers. After the initial public offering, the public
offering price and concession and discount to broker/dealers may be changed by
the representatives.
The compensation we will pay to the underwriters will consist solely of the
underwriting discount, which is equal to the public offering price per share of
common stock less the amount the underwriters pay to us per share of common
stock. The underwriters have not received and will not receive from us any
other item of compensation or expense in connection with this offering
considered by the National Association of Securities Dealers, Inc. to be
underwriting compensation under its rules of fair practice. The underwriting
fee will be determined based upon our negotiations with the underwriters at the
time the initial public offering price of our common stock is determined.
The following table summarizes the compensation and estimated expenses we
will pay.
<TABLE>
<CAPTION>
Per Share Total
----------------------------- -----------------------------
Without With Without With
Over-allotment Over-allotment Over-allotment Over-allotment
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Underwriting Discounts
and Commissions
paid by us............. $ $ $ $
Expenses payable by us.. $0.44 $0.41 $2,000,000 $2,100,000
</TABLE>
The underwriters have informed us that they do not expect discretionary
sales to exceed 5% of the shares of common stock being offered.
66
<PAGE>
We have agreed that we will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, or file with the Securities and
Exchange Commission a registration statement under the Securities Act of 1933
relating to, any additional shares of our common stock or securities
convertible into or exchangeable or exercisable for any of our common stock, or
publicly disclose the intention to make any such offer, sale, pledge,
disposition or filing, without the prior written consent of Credit Suisse First
Boston Corporation for a period of 180 days after the date of this prospectus.
Our officers, directors and certain other of our security holders have
agreed that they will not offer, sell, contract to sell, pledge or otherwise
dispose of, directly or indirectly, any shares of our common stock or
securities convertible into or exchangeable or exercisable for any shares of
our common stock, enter into a transaction which would have the same effect, or
enter into any swap, hedge or other arrangement that transfers, in whole or in
part, any of the economic consequences of ownership of our common stock,
whether any such aforementioned transaction is to be settled by delivery of our
common stock or such other securities, in cash or otherwise, or publicly
disclose the intention to make any such offer, sale, pledge or disposition, or
to enter into any such transaction, swap, hedge or other arrangement without,
in each case, the prior written consent of Credit Suisse First Boston
Corporation for a period of 180 days after the date of this prospectus.
The underwriters have reserved for sale, at the initial public offering
price, up to 225,000 shares of the common stock for employees, directors and
certain other individuals involved in the Linux community who are associated
with us and have expressed an interest in purchasing common stock in the
offering. The number of shares available for sale to the general public in the
offering will be reduced to the extent such persons purchase such reserved
shares. Any reserved shares not so purchased will be offered by the
underwriters to the general public on the same terms as the other shares.
We have agreed to indemnify the underwriters against liabilities under the
Securities Act of 1933, or contribute to payments which the underwriters may be
required to make in that respect.
Our common stock has been approved for listing on the Nasdaq Stock Market's
National Market, subject to official notice of issuance, under the symbol
"LXCR."
Prior to this offering, there has been no public market for our common
stock. The initial public offering price for our common stock will be
determined by negotiation between us and the representatives and may not
reflect the market price for the common stock following the offering. The
principal factors considered in determining the initial public offering price
will be:
. the information in this prospectus and otherwise available to the
representatives;
. the history of and the prospects for the industry in which we will
compete;
. the capability of our management;
. our past and present operations;
. our past and present earnings;
. the prospects for our future earnings;
. the present state of our development and our current financial
condition;
. the general condition of the securities markets at the time of this
offering;
. and the recent market prices of, and the demand for, publicly traded
common stock of generally comparable companies.
We can offer no assurances that the initial public offering price will
correspond to the price at which our common stock will trade in the public
market subsequent to the offering or that an active trading market for our
common stock will develop and continue after this offering.
67
<PAGE>
The representatives may engage in over-allotment, stabilizing transactions,
syndicate covering transactions, and penalty bids in accordance with Regulation
M under the Securities Exchange Act of 1934.
. Over-allotment involves syndicate sales in excess of the offering size,
which creates a syndicate short position.
. Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.
. Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions.
. Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by such
syndicate member is purchased in a stabilizing transaction or a
syndicate covering transaction to cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions and penalty
bids may cause the price of the common stock to be higher than it would
otherwise be in the absence of these transactions. These transactions may be
effected on The Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.
68
<PAGE>
NOTICE TO CANADIAN RESIDENTS
Resale Restrictions
The distribution of the common stock in Canada is being made only on a
private placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of common stock are effected. Accordingly, any resale of the common
stock in Canada must be made in accordance with applicable securities laws
which will vary depending on the relevant jurisdiction, and which may require
resales to be made in accordance with available statutory exemptions or
pursuant to a discretionary exemption granted by the applicable Canadian
securities regulatory authority. Purchasers are advised to seek legal advice
prior to any resale of the common stock.
Representations of Purchasers
Each purchaser of common stock in Canada who receives a purchase
confirmation will be deemed to represent to us and the dealer from whom such
purchase confirmation is received that (i) such purchaser is entitled under
applicable provincial securities laws to purchase such common stock without the
benefit of a prospectus qualified under such securities laws, (ii) where
required by law, that such purchaser is purchasing as principal and not as
agent, and (iii) such purchaser has reviewed the text above under "Resale
Restrictions".
Rights of Action (Ontario Purchasers)
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.
Enforcement of Legal Rights
All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada, and, as a result, it may not be
possible for Canadian purchasers to effect service of process within Canada
upon the issuer or such persons. All or a substantial portion of the assets of
the issuer and such persons may be located outside of Canada, and, as a result,
it may not be possible to satisfy a judgment against the issuer or such persons
in Canada or to enforce a judgment obtained in Canadian courts against the
issuer or such persons outside of Canada.
Notice to British Columbia Residents
A purchaser of common stock to whom the Securities Act (British Columbia)
applies is advised that such purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
common stock acquired by such purchaser in this offering. Such report must be
in the form attached to British Columbia Securities Commission Blanket Order
BOR #95/17, a copy of which may be obtained from us. Only one such report must
be filed in respect of common stock acquired on the same date and under the
same prospectus exemption.
Taxation and Eligibility for Investment
Canadian purchasers of common stock should consult with their own legal and
tax advisors with respect to the tax consequences of an investment in the
common stock in their particular circumstances and with respect to the
eligibility of the common stock for investment by the purchaser under relevant
Canadian legislation.
69
<PAGE>
LEGAL MATTERS
The validity of the shares of common stock offered by this prospectus will
be passed upon for us by Wilson Sonsini Goodrich & Rosati, Professional
Corporation, Palo Alto, California. The underwriters are being represented by
Cravath, Swaine & Moore, New York, New York. As of the date of this prospectus,
WS Investment Company 99B, an investment partnership composed of certain
current and former members of and persons associated with Wilson Sonsini
Goodrich & Rosati, Professional Corporation, beneficially owns an aggregate of
10,897 shares of Linuxcare, Inc. common stock.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at December 31, 1999 and December 31, 1998, and for the
year ended December 31, 1999 and for period from December 9, 1998 (inception)
to December 31, 1999 and the financial statements of The Puffin Group Inc. at
September 30, 1999 and December 31, 1998 and for the nine months ended
September 30, 1999 and for the period from December 14, 1998 (inception) to
December 31, 1998, as set forth in their reports. We have included our
financial statements and the financial statements of The Puffin Group Inc. in
the prospectus and elsewhere in the registration statement in reliance on Ernst
& Young LLP's reports, given upon the authority of such firm as experts in
accounting and auditing.
Reconta Ernst & Young S.p.A., independent auditors, have audited the
financial statements of Prosa Progettazione Suiluppo Aperto S.r.l. at December
31, 1999 and 1998, and for the year ended December 31, 1999 and for the period
from May 4, 1998 (date of inception) to December 31, 1998, as set forth in
their report. We have included their financial statements in the prospectus and
elsewhere in the registration statement in reliance on Reconta Ernst & Young
S.p.A.'s report, given on authority of such firm as experts in accounting and
auditing.
ADDITIONAL INFORMATION
This prospectus is part of a registration statement on Form S-1 that we
filed with the SEC. This prospectus does not contain all of the information
contained in the registration statement and all of its exhibits and schedules.
For further information about us, please see the complete registration
statement. Summaries of agreements or other documents referred to in this
prospectus are not necessarily complete. Please refer to the exhibits to the
registration statement for complete copies of these documents.
You may read and copy our registration statement and all of its exhibits and
schedules at the following SEC public reference rooms:
<TABLE>
<S> <C> <C>
450 Fifth Street, N.W. Seven World Trade Center Citicorp Center
Judiciary Plaza Suite 1300 500 West Madison Street
Room 1024 New York, NY 10048 Suite 1400
Washington, D.C. 20549 Chicago, IL 60661
</TABLE>
You may obtain information on the operation of the SEC public reference room
in Washington, D.C. by calling the SEC at 1-800-SEC-0330. The registration
statement is also available from the SEC's website at http://www.sec.gov, which
contains reports, proxy and information statements and other information
regarding issuers that file electronically.
We intend to furnish our stockholders with annual reports containing
financial statements audited by an independent public accounting firm and make
available to our stockholders quarterly reports for the first three quarters of
each fiscal year containing interim unaudited financial information.
70
<PAGE>
Linuxcare, Inc.
Index to Consolidated Financial Statements
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.......................... F-2
Consolidated Balance Sheets................................................ F-3
Consolidated Statements of Operations...................................... F-4
Consolidated Statements of Stockholders' Deficit........................... F-5
Consolidated Statements of Cash Flows...................................... F-6
Notes to the Consolidated Financial Statements............................. F-7
</TABLE>
The Puffin Group
Index to Financial Statements
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.......................... F-23
Balance Sheets............................................................. F-24
Statements of Operations................................................... F-25
Statements of Stockholder's Equity......................................... F-26
Statements of Cash Flows................................................... F-27
Notes to Financial Statements.............................................. F-28
</TABLE>
Prosa Progettazione Sviluppo Aperto S.R.L.
Index to Financial Statements
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Reconta Ernst & Young S.p.A., Independent Auditors............... F-32
Balance Sheets............................................................. F-33
Statements of Operations and Retained Earnings............................. F-34
Statements of Owners' Equity............................................... F-35
Statements of Cash Flows................................................... F-36
Notes to Financial Statements.............................................. F-37
</TABLE>
F-1
<PAGE>
Report of Ernst & Young LLP, Independent Auditors
To The Board of Directors and Stockholders of
Linuxcare, Inc.
We have audited the accompanying consolidated balance sheets of Linuxcare,
Inc. and subsidiaries as of December 31, 1998 and 1999, and the related
consolidated statements of operations, stockholders' deficit and cash flows for
the period from December 9, 1998 (inception) to December 31, 1998 and for the
year ended December 31, 1999. 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 in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Linuxcare,
Inc. and subsidiaries at December 31, 1998 and 1999, and the consolidated
results of their operations and their cash flows for the period from December
9, 1998 (inception) to December 31, 1998 and for the year ended December 31,
1999 in conformity with accounting principles generally accepted in the United
States.
/s/ Ernst & Young LLP
Palo Alto, California
February 14, 2000, except for
Note 8, paragraph 6, which is
dated March 20, 2000.
F-2
<PAGE>
LINUXCARE, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
Pro Forma
Stockholders'
December 31, Equity
---------------------- December 31,
1998 1999 1999
-------- ------------ -------------
(unaudited)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents.............. $138,920 $ 29,994,575
Accounts receivable, net of allowances
of $0 in 1998 and $76,000 in 1999..... -- 650,904
Other receivable....................... -- 1,000,000
Prepaid expenses and other assets...... 61,380 78,841
-------- ------------
Total current assets..................... 200,300 31,724,320
Property and equipment, net.............. -- 2,375,824
Debt issuance costs, net................. -- 1,503,788
Intangible asset......................... -- 744,451
Other assets............................. -- 17,620
-------- ------------
$200,300 $ 36,366,003
======== ============
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable....................... $ -- $ 1,138,027
Accrued liabilities.................... 13,458 2,514,982
Deferred revenue....................... -- 456,908
Note payable to stockholder............ -- 2,000,000
Current portion of note payable........ -- 487,682
Current portion of equipment
financing............................. -- 96,962
-------- ------------
Total current liabilities................ 13,458 6,694,561
Note payable, less current portion....... 200,000 1,512,318
Equipment financing, less current
portion................................. -- 413,700
Redeemable convertible preferred stock,
$.0001 par value, issuable in series:
18,566,075 authorized, none and
14,999,803 shares issued and outstanding
in 1998 and 1999, respectively, and no
shares pro forma for conversion of
redeemable convertible preferred stock
(aggregate liquidation value of
$38,364,140 and redemption value of
$38,617,538)............................ -- 40,374,016 $ --
Stockholders' deficit:
Common stock, $.0001 par value:
32,000,000 authorized; 7,058,824 and
9,685,136 issued and outstanding in
1998 and in 1999, respectively, and
24,900,572 shares pro forma for
conversion of redeemable convertible
preferred stock....................... 706 969 2,490
Additional paid-in capital............. 327,829 24,677,072 65,049,567
Deferred stock compensation............ (328,235) (15,860,562) (15,860,562)
Stockholder notes receivable........... -- (482,014) (482,014)
Accumulated deficit.................... (13,458) (20,964,057) (20,964,057)
-------- ------------ -----------
Total stockholders' deficit.............. (13,158) (12,628,592) $27,745,424
-------- ------------ ===========
$200,300 $ 36,366,003
======== ============
</TABLE>
See accompanying notes.
F-3
<PAGE>
LINUXCARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period from
December 9, 1998
(inception) to Year ended
December 31, December 31,
1998 1999
---------------- ------------
<S> <C> <C>
Revenues........................................ $ -- $ 1,210,806
Cost of revenues (1)............................ -- 2,814,546
-------- ------------
Gross margin.................................... -- (1,603,740)
Operating expenses:
Sales and marketing (2)....................... -- 4,518,801
General and administrative (3)................ 13,458 10,236,488
Amortization of deferred stock compensation... -- 4,121,356
Amortization of intangible asset.............. -- 42,808
-------- ------------
Total operating expenses.................... 13,458 18,919,453
-------- ------------
Loss from operations............................ (13,458) (20,523,193)
Interest income................................. -- 45,061
Interest expense................................ -- (468,267)
-------- ------------
Loss before income taxes........................ (13,458) (20,946,399)
Income tax expense.............................. -- 4,200
-------- ------------
Net loss........................................ (13,458) (20,950,599)
Preferred stock accretion....................... -- (260,380)
-------- ------------
Net loss applicable to common stockholders...... $(13,458) $(21,210,979)
======== ============
Basic and diluted net loss per share............ $ -- $(7.49)
======== ============
Weighted average shares used in computing basic
and diluted net loss per share................. -- 2,833,756
======== ============
Pro forma basic and diluted net loss per share
(unaudited).................................... $(2.26)
============
Weighted average shares used in computing pro
forma basic and diluted net loss per share
(unaudited).................................... 9,252,635
============
</TABLE>
- --------
(1) Excludes $1,511,855 of deferred stock compensation in 1999.
(2) Excludes $63,654 of deferred stock compensation in 1999.
(3) Excludes $2,545,847 of deferred stock compensation in 1999.
See accompanying notes.
F-4
<PAGE>
LINUXCARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Common Stock Additional Deferred Stockholder
---------------- Paid-in Stock Notes Accumulated
Shares Amount Capital Compensation Receivable Deficit Total
--------- ------ ----------- ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock
to founders............ 6,000,000 $300 $ -- $ -- $ -- $ -- $ 300
Issuance of common stock
for services to
consultants............ 1,058,824 406 327,829 (328,235) -- -- --
Net loss................ -- -- -- -- -- (13,458) (13,458)
--------- ---- ----------- ------------ --------- ------------ ------------
Balances at December 31,
1998................... 7,058,824 706 327,829 (328,235) -- (13,458) (13,158)
Equity compensation for
services performed by
consultants for common
shares issued in 1998.. -- -- 2,542,037 328,235 -- -- 2,870,272
Exercise of stock
options for cash....... 321,200 32 112,660 -- -- -- 112,692
Exercise of stock
options for notes
receivable............. 2,205,112 221 482,014 -- (482,014) -- 221
Issuance of stock
options to
consultants............ -- -- 963,684 -- -- -- 963,684
Issuance of common stock
and stock options for
Puffin acquisition..... 100,000 10 527,310 -- -- -- 527,320
Deferred stock
compensation........... -- -- 19,981,918 (19,981,918) -- -- --
Amortization of deferred
stock compensation..... -- -- -- 4,121,356 -- -- 4,121,356
Preferred stock
accretion.............. -- -- (260,380) -- -- -- (260,380)
Net loss................ -- -- -- -- -- (20,950,599) (20,950,599)
--------- ---- ----------- ------------ --------- ------------ ------------
Balances at December 31,
1999................... 9,685,136 $969 $24,677,072 $(15,860,562) $(482,014) $(20,964,057) $(12,628,592)
========= ==== =========== ============ ========= ============ ============
</TABLE>
See accompanying notes.
F-5
<PAGE>
LINUXCARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
December 9, 1998
(inception) to Year ended
December 31, December 31,
1998 1999
---------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss........................................ $(13,458) $(20,950,599)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization................. -- 208,849
Amortization of debt issuance costs........... -- 329,569
Amortization of deferred stock compensation... -- 4,121,356
Amortization of intangible asset.............. -- 42,808
Equity compensation for common stock issued to
consultants for services..................... -- 2,870,272
Issuance of stock options to consultants...... -- 963,684
Changes in assets and liabilities:
Accounts receivable......................... -- (650,904)
Prepaid expenses and other current assets... (61,380) (17,461)
Other assets................................ -- (17,620)
Accounts payable............................ -- 1,138,027
Accrued liabilities......................... 13,458 2,501,524
Deferred revenue............................ -- 456,908
-------- ------------
Net cash used in operating activities........... (61,380) (9,003,587)
Cash flows from investing activities:
Purchase of property and equipment (excluding
equipment financing)........................... -- (2,074,011)
Purchase of businesses, net of cash............. -- (259,939)
-------- ------------
Net cash use in investing activities............ -- (2,333,950)
Cash flows from financing activities:
Proceeds from borrowings on notes payable....... 200,000 3,000,000
Proceeds of borrowings on notes payable to
stockholders................................... -- 2,000,000
Proceeds from issuance of redeemable convertible
preferred stock................................ -- 36,080,279
Proceeds from issuance of common stock.......... 300 --
Exercise of stock options....................... -- 112,913
-------- ------------
Net cash provided by financing activities....... 200,300 41,193,192
-------- ------------
Net increase in cash and cash equivalents....... 138,920 29,855,655
Cash and cash equivalents, beginning of period.. -- 138,920
-------- ------------
Cash and cash equivalents, end of year.......... $138,920 $ 29,994,575
======== ============
Supplemental disclosures of cash flow
information:
Deferred stock compensation..................... $328,235 $ 19,981,918
Preferred stock accretion....................... -- 260,380
Warrants issued for financing commitments....... -- 1,833,357
Equipment purchased though equipment financing.. -- 510,662
Notes receivable issued from stockholder issued
for common stock............................... -- 482,014
Stock and options issued for purchase of
subsidiary..................................... -- 527,320
Preferred stock issued for note receivable...... -- 1,000,000
Conversion of debt to preferred stock........... -- 1,200,000
</TABLE>
See accompanying notes.
F-6
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Description of Business
Linuxcare, Inc. ("the Company") was incorporated in Delaware on December 9,
1998 and is a provider of technical support services for Linux and other open
source technology. The Company offers a comprehensive range of services
including professional services, technical support, education and product
certification for Linux, leading open source software packages and other
related technologies. The Company supports all major variations, or
distributions, of Linux on a variety of hardware platforms.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, Prosa Progettazione Sviluppo Aperto S.r.l
and The Puffin Group. All significant intercompany accounts and transactions
have been eliminated in consolidation. The consolidated financial statements
for fiscal 1998 include the operations of the Company from inception on
December 9, 1998.
Effective April 8, 1999, the Company completed a 2-for-1 stock split. As a
result of the stock split, outstanding and reserved common shares increased.
The rights of the holders of these securities were not otherwise modified. The
financial statements have been restated for all periods to reflect this stock
split.
Proposed Public Offering of Common Stock
In December 1999, the Board of Directors authorized the Company to proceed
with an initial public offering of its common stock. If the offering is
consummated as presently anticipated, each share of outstanding redeemable
convertible preferred stock will automatically convert into common stock (Note
7).
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
Revenues are derived primarily through the performance of services to third
parties, under a variety of contractual arrangements. Under professional
service agreements where services are performed on a time-and-materials basis,
revenues are recognized as and when the services are provided. Fees for
technical support are generated on an hourly basis, a per incident basis, or
pursuant to long-term service agreements and revenues for such services is
recognized as the services are performed or pro-rata over the term of the
service agreement, which ranges from 6 to 12 months as applicable. Under
contractual arrangements for training services, revenue is recognized upon
completion of the training. Under the terms of agreements to perform
certification services, revenues are amortized over the term the certification
must be performed or, in the case of one-time certifications, as the
certification service is completed. Under the terms of multiple element
arrangements (training, technical support services, and certifications), where
the Company does not have vendor specific objective evidence of pricing,
aggregate fees are amortized over the service period after the initial training
or initial certification services have been performed, which is usually early
in the term of the agreement. Revenue from fixed price long-term computer
software development contracts is recognized over the contract term based on
the percentage of services provided during the period compared with the total
estimated services provided over the entire contract.
F-7
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Deferred revenue consists of prepaid services agreements. As of December 31,
1999, one customer represented 57% of the deferred revenue balance.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of cash and cash equivalents and trade
receivables. The Company performs ongoing credit evaluations of its customers
and generally does not require collateral. The Company did not write-off any
accounts receivable in 1999. As of December 31, 1999, four significant
customers individually represent 33%, 19%, 18% and 12% of trade receivables. Of
the total accounts receivable balance, 18% related to customers in Italy.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expenses were
$356,423 for the year ended December 31, 1999.
Cash and Cash Equivalents
Cash and cash equivalents consist principally of cash deposited in money
market and checking accounts, which amounts approximate fair value. The Company
considers all highly liquid debt instruments or money-market type funds with an
original maturity of three months or less to be cash equivalents.
Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives (three to five years) of
the assets. Assets acquired pursuant to the equipment financing arrangement are
amortized over the assets' estimated useful lives. Leasehold improvements are
amortized over the corresponding lease term.
Property and equipment consists of the following at December 31, 1999:
<TABLE>
<S> <C>
Computer and office equipment................................. $1,011,630
Furniture and fixtures........................................ 180,055
Leasehold improvements........................................ 84,832
Software...................................................... 1,308,156
----------
Total property and equipment.................................. 2,584,673
Less: accumulated depreciation and amortization............... 208,849
----------
Property and equipment, net................................... $2,375,824
==========
</TABLE>
Property and equipment includes $510,662 of financed equipment at December
31, 1999. Accumulated depreciation for such equipment for the year ended
December 31, 1999 was $32,244. Upon completion of certain equipment financing
terms, the Company has the option to purchase the leased equipment at 15% of
original cost.
The Company capitalizes certain internal use software costs in accordance
with Statement of Position 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. Capitalized internal use software
costs, including web site development costs, with an expected useful life in
excess of one year are amortized on a straight-line basis over their estimated
useful lives (three years). Internal use software costs with an expected useful
life of less than one year are expensed as incurred.
F-8
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Impairment of Long-lived Assets
In accordance with Statement of Financial Accounting Standards (SFAS) No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-lived
Assets to be Disposed Of, the Company reviews long-lived and intangible assets
for impairment whenever events or circumstances indicate the carrying value of
an asset may not be recoverable.
Debt Issuance Costs
Debt issuance costs related to stock warrants issued in connection with
certain loan arrangements are amortized over the term of the debt using the
effective interest rate method. Accumulated amortization for debt issuance
costs as of December 31, 1999 is $329,569.
Intangible Asset
The intangible asset is stated at cost and amortized using the straight-line
method over the estimated economic useful life. The Company continually
evaluates whether subsequent events and circumstances have occurred that
indicate the remaining estimated useful life of the intangible asset may
warrant revision, or that the remaining balance of the intangible asset may not
be recoverable. The Company evaluates the recoverability of the intangible
asset by measuring the carrying amount of the assets against the estimated
undiscounted future cash flows associated with them. At the time such
evaluations indicate that the future undiscounted cash flows of such assets are
not sufficient to recover the carrying value of such assets, the assets are
adjusted to their fair values. Based on these evaluations, there were no
adjustments to the carrying value of the intangible asset in 1999.
Foreign Currency Translation
The Company's Canadian subsidiary uses the U.S. dollar as the functional
currency and, accordingly, has remeasured its financial statements into U.S.
dollars using current rates of exchange for monetary assets and liabilities and
historical rates of exchange for nonmonetary assets. Gains and losses from
remeasurement are included in general and administrative expense. Items of
revenue and expense for the Company's subsidiaries are translated using the
monthly average exchange rates in effect for the period in which the items
occur.
The Company's Italian subsidiary uses the local currency, the Italian lire,
as the functional currency and, accordingly, has measured its financial
statements into US dollars using year end rates of exchange for assets and
liabilities.
Income Taxes
The Company provides for income taxes based on the liability method, which
requires recognition of deferred tax assets and liabilities based on
differences between financial reporting and tax bases of assets and liabilities
measured using enacted tax rates and laws that are expected to be in effect
when the differences are expected to reverse.
Stock Options and Equity Instruments Exchanged for Services
The Company has elected to follow Accounting Principles Board Opinion (APB)
No. 25, Accounting for Stock Issued to Employees and related Interpretations in
accounting for its employee stock options rather than adopting the alternative
fair value accounting provided for under SFAS No. 123, Accounting for Stock-
based Compensation. Under APB No. 25, because the exercise price of the
Company's stock options equals the deemed fair value of the underlying stock on
the date of grant, no compensation expense is recognized.
F-9
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The value of options, warrants, and restricted stock exchanged for services
rendered or assets acquired are valued using the Black-Scholes option pricing
model. To calculate the expense or asset value, the Company uses either the
fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measurable.
Comprehensive Income
In June 1998, the Financial Accounting Standards Board issued SFAS No. 130,
Reporting Comprehensive Income, which established new standards for reporting
and displaying comprehensive income and its components in a full set of general
purpose financial statements. There is no difference in the Company's
historical net losses as reported and the comprehensive net losses under the
provisions of SFAS No. 130 for all periods presented. Accordingly, the adoption
of SFAS No. 130 had no effect on the Company's reported results of operations.
Net Loss Per Share
Basic and diluted net loss per share information for all periods is
presented in conformity with SFAS No. 128, Earnings Per Share. Basic earnings
per share has been computed using the weighted-average number of common shares
outstanding during the period, less shares subject to repurchase, and excludes
any dilutive effects of stock options, warrants, and convertible securities.
Potentially dilutive securities have been excluded from the computation of
diluted net loss per share as their inclusion would be antidilutive.
Pro forma Stockholders' Equity and Pro forma Net Loss
Pro forma stockholders' equity and net loss per share gives effect, under
Securities and Exchange Commission guidance, to the conversion of preferred
shares not included above that will automatically convert upon completion of
the Company's initial public offering, using the if-converted method. Pro forma
net loss per share begins with net loss per share, described above, and
increases the number of shares outstanding to give effect to the conversion of
preferred shares as if such conversion occurred at the original issuance date.
Pro forma net loss does not include preferred stock accretion under the
assumption that preferred shares have been converted into common stock.
F-10
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The calculation of historical and pro forma basic and diluted net loss per
share is as follows:
<TABLE>
<CAPTION>
Period from
December 9,
1998 (inception) Year ended
to December 31, December 31,
1998 1999
---------------- ------------
<S> <C> <C>
Historical:
Net loss applicable to common
stockholders............................. $ (13,458) $(21,210,979)
=========== ============
Weighted average shares of common stock
outstanding.............................. 6,529,412 8,258,434
Less: weighted average shares of common
stock that may be repurchased............ (6,529,412) (5,424,678)
----------- ------------
Weighted average shares of common stock
outstanding used in computing basic and
diluted net loss per share............... -- 2,833,756
=========== ============
Basic and diluted net loss per share...... $ -- $ (7.49)
=========== ============
Pro forma (unaudited):
Net loss.................................. $(20,950,599)
============
Weighted average shares used in computing
basic and diluted net loss per share
(from above)............................. 2,833,756
Adjustment to reflect the effect of the
assumed conversion of preferred stock to
common stock from the date of issuance... 6,418,879
------------
Weighted average shares used in computing
pro forma basic and diluted net loss per
share.................................... 9,252,635
============
Pro forma basic and diluted net loss per
share.................................... $ (2.26)
============
</TABLE>
If the Company had reported net income, the calculation of historical and
pro forma diluted earnings per share would have included approximately an
additional 0 and 2,179,165 common equivalent shares related to the outstanding
stock options and warrants not included above (determined using the treasury
stock method) for the period from December 9, 1998 (inception) to December 31,
1998 and for the year ended December 31, 1999, respectively.
Segment Information
The Company adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." SFAS No. 131 requires publicly held
companies to report financial and other information about key revenue segments
of the entity for which such information is available and is utilized by the
chief operating decision maker. The Company conducts its business within one
business segment: technical support for Linux and other open source technology.
a. Revenue by geographic region is presented as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended
December 31,
------------
1998 1999
----- ------
<S> <C> <C>
United States................................................... $ -- $1,099
Japan........................................................... -- 112
----- ------
Total........................................................... $ -- $1,211
===== ======
</TABLE>
F-11
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
b. Major customer data as a percentage of total revenues:
<TABLE>
<CAPTION>
Year ended
December 31,
1999
------------
<S> <C>
Customer A...................................................... 26%
Customer B...................................................... 18
Customer C...................................................... 11
</TABLE>
c. Information about services:
The following presents revenue data as a percentage of total revenues by
service type:
<TABLE>
<CAPTION>
Year Ended
December 31,
1999
------------
<S> <C>
Technical support............................................... 50%
Professional services........................................... 31
Other services.................................................. 19
</TABLE>
Impact of Recent Accounting Pronouncements
In April 1998, the Accounting Standards Executive Committee issued SOP 98-5,
Reporting on the Costs of Start-Up Activities. This SOP provides guidance on
the financial reporting of start-up activities and organization costs be
expensed as incurred. The SOP is effective for financial statements for fiscal
years beginning after December 15, 1998. The impact from adopting SOP 98-5 in
1999 was not material on the consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. SFAS No. 133, as recently amended, is effective for
fiscal years beginning after June 15, 2000. Management believes the adoption of
SFAS No. 133 will not have a material effect on the Company's financial
position or results of operations.
Staff Accounting Bulletin No. 101
In December 1999 the SEC issued Staff Accounting Bulletin (SAB 101), Revenue
Recognition in Financial Statements. The SAB spells out four basic criteria
that must be met before registrants can record revenue. These are: (a)
persuasive evidence that an arrangement exists; (b) delivery has occurred or
services have been rendered; (c) the seller's price to the buyer is fixed or
determinable; and (d) collectability is reasonably assured. The Company is
currently in the process of evaluating the impact of the SAB upon its current
accounting policies.
2. Acquisitions
On October 1, 1999, the Company purchased the outstanding common stock of
The Puffin Group, Inc. ("Puffin") a Canadian company, for 100,000 shares of the
Company's common stock and options to purchase approximately 25,000 shares of
the Company's common stock with an exercise price of $.13. The option to
purchase additional shares vested immediately. The Puffin transaction was
accounted for as a purchase in accordance with the provisions of APB16. Under
the purchase method of accounting, the purchase price is allocated to the
assets acquired and liabilities assumed based on their estimated fair values at
the date of acquisition. Accordingly, the shares and options were valued based
on the deemed fair value of the common stock on the date of the transaction,
which was $4.26 per share. The aggregate purchase price approximated
F-12
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$527,000 in the aggregate. An intangible asset of $513,690 was recorded at the
date of purchase, reflecting the value of the work force acquired and
calculated as the difference between the net fair value of the underlying
assets and liabilities and the deemed fair value of the shares and options paid
as consideration. The intangible asset is being amortized over the estimated
employment term of the employees acquired, which was estimated as 3 years.
Additionally 330,000 options to purchase the Company's common stock, with
vesting terms of three years and an exercise price of $.13 per share, were
granted to Puffin's key employees. As the option grants reflect grants to new
employees consistent with the number of options granted by the Company to key
employees with commensurate responsibilities and these grants are conditional
upon continuous employment, the deemed fair value of these additional options
in the amount of $1.4 million was included in the Company's deferred
compensation calculations. Results of operations for Puffin have been included
with those of the Company for the period subsequent to the date of acquisition.
On December 30, 1999, the Company purchased the outstanding shares of the
common stock of Prosa Progettazione Sviluppe Aparto s.r.l. ("Prosa"), an
Italian company, for cash of $225,000 and the assumption of liabilities of
$65,000, both aggregating to $290,000, and options to purchase 25,000 shares
with an exercise price of $2.00. The cash payment was considered purchase
consideration, and the options to purchase 25,000 shares were considered
employment consideration. The Prosa transaction was accounted for as a purchase
in accordance with ABP16. Under the purchase method of accounting, the purchase
price is allocated to the assets acquired and liabilities assumed based on
their estimated fair values at the date of acquisition. An intangible asset of
$273,569, representing the value of the work force acquired, was recorded at
the date of the purchase reflecting the difference between the net fair value
of the underlying assets and the total consideration paid. The intangible asset
is being amortized over the estimated employment term of the employees acquired
which was estimated as 3 years. Results of operations for Prosa have been
included with those of the Company for the period subsequent to the date of
acquisition.
The purchase price for the Puffin and Prosa transactions was allocated to
the assets acquired and liabilities assumed based on their estimated fair
values as determined by the Company as follows:
<TABLE>
<CAPTION>
Puffin Prosa
September 30, December 31,
1999 1999
------------- ------------
<S> <C> <C>
Current assets................................. $ 59,207 $ 123,880
Intangible asset............................... 513,690 273,569
Long term assets............................... 8,461 12,845
Current liabilities............................ (54,038) (120,709)
-------- ---------
Purchase Price................................. $527,320 $ 289,585
======== =========
</TABLE>
The unaudited pro forma results of operations assuming consummation of these
acquisitions as of December 9, 1998 (inception) are as follows:
<TABLE>
<CAPTION>
1998 1999
-------- ------------
<S> <C> <C>
Revenues......................................... $ 5,201 $ 1,531,471
Net loss applicable to common stockholders....... $(30,513) $(21,423,683)
Basic and diluted net loss per share............. $ -- $ (7.37)
======== ============
Weighted average shares outstanding.............. -- 2,908,756
======== ============
Pro forma basic and diluted net loss per share... $ -- $ (2.27)
======== ============
Pro forma weighted-average shares outstanding.... -- 9,327,635
======== ============
</TABLE>
The weighted average shares outstanding and pro forma weighted-average
shares outstanding reflect the effect of the 100,000 shares issued pursuant to
the Puffin acquisition as if the transaction had occurred on January 1, 1999.
F-13
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Notes Payable and Equipment Financing
Note Payable
In December 1998, the Company issued promissory notes for total
consideration of $200,000 to common stock holders. These notes were
subsequently converted into 324,544 shares of Series A preferred stock on
February 1, 1999, the offering date, at the offering price of $.61625 per
share.
In December 1999, the Company issued a promissory note totaling $1.0
million. This note was subsequently exchanged for 211,506 shares of Series B
preferred stock on December 15, 1999, the offering date, at the offering price
of $4.73 per share.
In October 1999, the Company issued promissory notes totaling $2.0 million
to a Series A preferred stockholder. The promissory notes were originally due
after 30 days but were later extended. The promissory notes bear interest at
six percent (6%). The promissory notes were subsequently repaid in January
2000.
Note Payable, Equipment Financing and Letter of Credit with Lender
On July 27, 1999, the Company entered into a subordinated loan and security
agreement ("Note Payable") with a financial institution ("Lender") for maximum
borrowings of $2,000,000. The Note Payable bears interest at ten percent (10%)
per annum and is due in 36 months. Payments of principal and interest begin six
months after the Note Payable's issuance. For that six-month period, interest
is accrued but not paid. In the event of default by the Company, the Note
Payable shall bear interest at a rate of 15% per annum. The Note Payable is
secured by certain tangible and intangible assets of the Company and is subject
to certain non financial covenants. In connection with the Note Payable, the
Company issued to the Lender warrants to purchase 268,423 shares of Series A
preferred stock at an exercise price of $1.4902 per share. At December 31,
1999, the Company has $2,000,000 outstanding in notes payable and was in
compliance with its covenants.
On July 27, 1999, the Company entered into an equipment financing agreement
for a maximum loan amount of $1,000,000 with the above lender. As of December
31, 1999, the Company has drawn $510,662 on the equipment financing agreement.
The loan is secured by equipment purchased, bears interest at a stated rate of
7.5% and is due in December 2002. In connection with the equipment financing
agreement, the Company issued to the Lender warrants to purchase 26,842 shares
of Series A preferred stock at an exercise price of $1.4902 per share.
On October 15, 1999, the Company signed a Letter of Credit agreement with
the Lender for $1,150,000 as security on the rental of additional office space.
The Letter of Credit bears interest at one and one-half percent (1.5%) and
expires on October 15, 2004. As of December 31, 1999, the Letter of Credit
remains unused. In connection with the agreement, a warrant to purchase 96,478
shares of Series A preferred stock with an exercise price of $1.4902 per share
was issued. The warrant expires 10 years from the grant date.
In connection with the Note Payable, equipment financing agreement, and
letter of credit agreement, the Company issued to the Lender warrants to
purchase 391,744 shares of preferred stock at an exercise price of $1.4902 per
share. The value attributable to these warrants was calculated using the Black-
Scholes valuation model with the following weighted-average assumptions: risk-
free interest rate of approximately 6.2%, fair value at date of grant of $4.73,
expected life of 5 years, 150% volatility, and no expected dividends. The
deemed fair value associated with these warrants was calculated at $1,833,357
and is recorded as a debt issuance cost and an increase to redeemable
convertible preferred stock. This discount is being amortized over the life of
the related debt as additional interest cost. Based on the fair value of the
warrant, the Company's effective interest rate on the note payable, equipment
financing agreement, and letter of credit agreement is 45.9%, 21.6%, and 9.4%,
respectively. These warrants expire the earlier of ten years from the date of
the above agreements or five years from the date of an initial public offering.
As of December 31, 1999, these warrants remained outstanding.
F-14
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Commitments
The Company leases its facilities under operating leases that expire at
various dates through December 31, 2004.
Future minimum equipment financing and operating lease payments as follows
for the year ended December 31:
<TABLE>
<CAPTION>
Equipment Operating
Financing Leases
--------- ----------
<S> <C> <C>
2000................................................... $139,517 $1,226,234
2001................................................... 187,769 1,222,212
2002................................................... 185,226 1,198,848
2003................................................... 69,395 1,176,948
2004................................................... -- 1,170,264
-------- ----------
Future minimum lease payments.......................... 581,907 $5,994,506
==========
Amounts representing interest.......................... 71,245
--------
Present value of future minimum lease obligations...... 510,662
Amounts due within one year............................ 96,962
--------
Amounts due after one year............................. $413,700
========
</TABLE>
Rent expense for the year ended December 31, 1999 was approximately
$279,245.
5. Retirement Savings Plan
The Company maintains an employee savings and retirement plan that is
intended to be qualified under Section 401(k) of the Internal Revenue Code and
is available to substantially all full-time employees of the Company. The plan
provides for tax deferred salary deductions and after-tax employee
contributions. Contributions include employee salary deferral contributions and
discretionary employer contributions. To date, there have been no employer
discretionary contributions.
6. Income Taxes
Significant components of the provision for income taxes attributable to
operations are as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
-------------
1998 1999
------ ------
<S> <C> <C>
Current:
$ --
Federal......................................................... $ --
State........................................................... -- --
Foreign......................................................... -- 4,200
------ ------
Total Current..................................................... -- 4,200
Deferred:
Federal.......................................................... -- --
State............................................................ -- --
------ ------
Total deferred.................................................... -- --
------ ------
$4,200
Total............................................................. $ --
====== ======
</TABLE>
F-15
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A reconciliation of income taxes at the statutory federal income tax rate to
net income taxes included in the accompanying statements of operations is as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------
1998 1999
------------------------
<S> <C> <C>
U.S. federal taxes (benefit) at statutory rate....... $ (4,576) $ (6,895,617)
State................................................ (807) (1,216,874)
Foreign.............................................. -- --
Valuation allowance.................................. 5,383 6,262,863
Amortization of deferred compensation................ -- 1,648,542
Other................................................ -- 205,286
--------- -------------
Total................................................ $ -- $ 4,200
========= =============
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
December 31,
--------------------
1998 1999
------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.................. $ 5,383 $ 4,417,526
Stock option compensation......................... -- 1,533,582
Other............................................. -- 317,138
------- -----------
Total deferred tax assets .......................... 5,383 6,268,246
Valuation allowance................................. (5,383) (6,268,246)
------- -----------
Net deferred tax assets............................. $ -- $ --
======= ===========
</TABLE>
Realization of deferred tax assets is dependent upon future earnings, if
any, the timing and amount of which are uncertain. Accordingly, the net
deferred tax assets have been fully offset by a valuation allowance. The
valuation allowance increased by $5,383 and $6,262,863 during the years ended
December 31, 1998 and 1999.
As of December 31, 1999, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $11,044,000 which expire in
the years 2018 to 2019. The Company also had net operating loss carryforwards
for state income tax purposes of approximately $11,040,000 expiring in the year
2006. Utilization of the Company's net operating loss may be subject to
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code and similar state provisions. Such an annual
limitation could result in the expiration of the net operating loss before
utilization.
7. Redeemable Convertible Preferred Stock
On February 1, 1999 and April 16, 1999, the Company issued 2,636,916 and
5,246,008 shares, respectively, of Series A redeemable convertible preferred
stock ("Series A") in private placement offerings at a price of $0.61625 per
share. There are 10,695,314 shares authorized of Series A at a par value of
$0.0001.
On December 17, 1999 the Company issued 7,082,267 of Series B redeemable
convertible preferred stock ("Series B") in a private placement offering at a
price of $4.728 per share. There are 7,082,267 shares authorized of Series B at
a par value of $0.0001. In connection with Series B Financing, a noteholder
F-16
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
exchanged an extended 30 day promissory note totaling $1,000,000 to the
Company for 211,506 shares of Series B valued at $4.728 per share. The note
was exchanged for shares of Series B redeemable convertible preferred stock as
a part of the December 17, 1999 Series B offering. In addition, a major
corporation purchased 423,011 shares of Series B in the offering for cash of
$1,000,000 and a receivable of $1,000,000. The receivable is recorded as an
other receivable on the accompanying 1999 balance sheet. The other receivable
for $1,000,000 was settled on January 19, 2000, when the cash was received.
The balance of Series A and Series B is comprised of the following at
December 31, 1999:
<TABLE>
<CAPTION>
Liquidation
Shares Amount Value
---------- ----------- -----------
<S> <C> <C> <C>
Series A:
Issuance of preferred stock for cash
and promissory notes totaling
$200,000, net of financing costs... 7,882,924 $ 4,816,836 $ 4,857,852
Exercise of warrant related to
Series A legal services............ 34,612 21,330 21,330
Warrant issued for financing
commitments........................ -- 1,833,357 --
Preferred stock accretion........... -- 189,180 --
---------- ----------- -----------
Total Series A........................ 7,917,536 6,860,703 4,879,182
Series B:
Issuance of preferred stock for cash
and a note receivable of
$1,000,000, net of financing
costs.............................. 7,082,267 33,442,113 33,484,958
Preferred stock accretion........... -- 71,200 --
---------- ----------- -----------
Total Series B........................ 7,082,267 33,513,313 33,484,958
---------- ----------- -----------
Balance in redeemable preferred stock
at December 31, 1999................. 14,999,803 $40,374,016 $38,364,140
========== =========== ===========
</TABLE>
Significant terms of the outstanding Series A and Series B preferred stock,
as amended, are as follows:
. In the event of any liquidation, dissolution or winding up of the
Company, the holders of Series A and Series B are entitled to receive
proceeds equal to $0.61625 and $4.728 per share respectively, plus all
declared but unpaid dividends, prior and in preference to any
distribution to holders of common stock. If the assets available for
distribution are insufficient to pay the preferred stockholders in full,
the assets will be distributed ratably among the preferred stockholders.
. Each share of Series A and Series B is redeemable at the option of the
holder in three annual installments from and after December 14, 2004. The
Series A and Series B are redeemable at a sum equal to $0.61625 and
$4.728 respectively, plus five percent (5%) of the original issue price
compounded annually. In connection with the redemption feature, the
Company recorded the accretion of the Series A and Series B in the amount
of $260,380 in 1999 through the reduction of additional paid-in capital.
The carrying amount of Series A and Series B approximates their
redemption values.
. Each share of Series A and B is convertible at the option of the holder
into one share and 1.030447 shares, respectively of common stock, subject
to certain adjustments. Each share of preferred stock converts
automatically into common stock at the earlier of (1) the closing of an
underwritten public offering of the Company's common stock at an
aggregate offering price of greater than $10,000,000 or (2) the date
specified by affirmative consent or agreement of a majority of the
holders of Series A outstanding.
F-17
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
. Each share of preferred stock has voting rights equivalent to the number
of shares of common stock into which it is convertible.
. Dividends may be declared at the discretion of the Board of Directors and
are non-cumulative. Dividends of $0.0308 and $0.2364 per share on Series
A and Series B, respectively, must be declared and paid prior and in
preference to any cash dividend declarations or distributions to holders
of common stock.
8. Stockholders' Deficit
Amended and Restated Certificate of Incorporation
In December 1999, the Board of Directors approved an increase in the total
number of shares that the Company is authorized to issue to 50,556,075 shares,
of which 32,000,000 will be common stock and 18,566,075 will be preferred
stock.
Common Stock
On December 23, 1998, the Company issued a total of 1,058,824 shares of
common stock to two consultants in exchange for future business strategy
consulting services and a nominal cash amount. In accordance with EITF 96-18,
Accounting for Equity Instruments Issued to Other Than Employees for Acquiring,
or in Conjunction with Selling, Goods or Services, the fair value of the common
stock is being recorded to general and administrative expense in the
accompanying statement of operations as of the date the services are being
provided. Fair value of the services is the deemed fair value of the common
stock for accounting purposes. Each consultant provided approximately 32 hours
per month of services through December 15, 1999, the date the agreement was
completed. At December 31, 1998, the Company recorded deferred stock
compensation to the consultants of $328,235, the estimated fair value of future
services based on the then deemed fair value. The consultants vested in the
shares over the service period. As of December 31, 1999, all of the
consultants' shares are fully vested. Accordingly, for the year ended December
31, 1999, the Company recorded a total of $2,870,272 to general and
administrative expense.
In connection with the issuance of common stock to founders and the exercise
of options pursuant to the Company's 1999 Stock Option Plan, employees entered
into restricted stock purchase agreements with the Company. Under the terms of
these agreements, the Company has a right to repurchase any unvested shares up
to 60 days after the termination of the employee's service at the original
exercise price of the shares. With continuous employment, the repurchase rights
lapse at a rate of 25% after the first year, and at a rate of 1/48th of the
purchased shares for each continuous month of service thereafter. The right of
repurchase lapses with respect to 50% of the purchased shares upon a change in
control. All repurchase rights lapse in the event of a change in control when
the repurchase rights are not assigned to the new control entity. As of
December 31, 1999, 5,424,678 shares were subject to repurchase by the Company.
Deferred Stock Compensation
In connection with the grant of certain stock options to employees for the
year ended December 31, 1999, the Company recorded deferred stock compensation
within stockholders' deficit of approximately $20.0 million, representing the
difference between the deemed fair value of the common stock for accounting
purposes and the option exercise price of these options at the date of grant.
The Company recorded amortization of deferred compensation of approximately
$4.1 million for the year ended December 31, 1999.
The deferred stock compensation expense is being amortized on an accelerated
basis over the vesting period of the individual award, generally four years.
This method is in accordance with Financial Accounting Standards Board
Interpretation No. 28. Accordingly, at December 31, 1999, the remaining
deferred
F-18
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
compensation of approximately $15.9 million will be amortized as follows: $9.7
million during fiscal 2000, $4.0 million during fiscal 2001, $1.8 million
during fiscal 2002 and $.4 during fiscal 2003. The amortization expense relates
to options awarded to employees in all operating expense categories. The amount
of deferred compensation expense to be recorded in future periods could
decrease if options for which accrued but unvested compensation has been
recorded are forfeited.
Additionally, the Company expects to record a deferred compensation charge
relating to option grants made after December 31, 1999 but prior to the
completion of the Company's planned initial public offering. The Company
granted 612,940 and 594,000 options to purchase common stock in January and
February 2000, respectively, and expects to grant 1,531,750 options in March
2000. The Company estimates the charge relating to these additional grants will
be approximately $20.3 million, based upon the low point of the offering range
of $13.00 per share, for the year ended December 31, 2000. The Company
estimates the amortization charge of these additional grants will be amortized
on the accelerated basis over four years as follows: $10.9 million during
fiscal 2000, $5.8 million during fiscal 2001, $2.7 million during fiscal 2002,
and $0.9 million during fiscal 2003.
Stockholder Notes Receivable
In May 1999, the Board of Directors approved the issuance of options to
purchase 1,660,194 shares of common stock to a key officer at an exercise price
of $.07 per share. In exchange for a note receivable in the amount of $116,048,
the officer exercised the options subject to the terms of a stock repurchase
agreement. The note receivable has been recorded as a reduction of
stockholders' equity in the consolidated balance sheet at December 31, 1999.
The note is full recourse and bears interest at 5.22%.
In December 1999, the Company issued notes receivable for $26,000 and
$339,966 to executives of the Company to exercise 204,918 and 340,000 stock
options, respectively. The notes are secured by the underlying stock. The notes
are full recourse and bear interest at 6.20%. In connection with the note
receivable for $339,966, the Company violated a non financial covenant on its
Note Payable with its Lender (see Note 3--Notes Payable and Equipment
Financing). The Company obtained a waiver from the Lender related to this
covenant.
Stock Option Plan
On April 5, 1999, the Company adopted and the Board of Directors approved
the 1999 Stock Plan (the "1999 Plan"). The number of shares reserved for
issuance under the 1999 Plan is 6,302,738. Under the 1999 Plan, the Board of
Directors may grant to employees, outside directors, and consultants options
and/or stock awards. The term and price of options is determined by the Board
of Directors. The Plan will terminate in 2009. Nonqualified options granted
under the 1999 Plan must be issued at a price equal to at least 85% of the fair
market value of the Company's common stock at the date of grant. All options
may be exercised at any time within 10 years of the date of grant or within
three months of termination of employment, or such shorter time as may be
provided in the stock option agreement, and vest over a vesting schedule
determined by the Board of Directors, which generally is four years.
Pro forma information regarding net loss and net loss per share is required
by SFAS No. 123, and has been determined as if the Company had accounted for
its employee stock options under the fair value method of that Statement. The
fair value of these options was estimated at the date of grant using a Minimum
Value option pricing model with the following weighted average assumptions for
1999: risk-free interest rates of 6.2%; dividend yield of 0%; and a weighted-
average expected life of the options of 8 years.
F-19
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of stock option activity and related information follows:
<TABLE>
<CAPTION>
Outstanding Stock Options Weighted-
Shares --------------------------- Average
Available Number of Price Per Exercise
for Grant share share Price
---------- ------------- ------------ ---------
<S> <C> <C> <C> <C>
Original authorization--
April 5, 1999 3,674,766 -- -- --
Additional
authorization.......... 2,627,972 -- -- --
Options granted......... (6,235,189) 6,235,189 $ .07-1.00 $.26
Options exercised....... -- (2,526,312) $ .07-1.00 $.24
Options canceled........ 550,667 (550,667) $ .07- .13 $.11
---------- ------------- ------------ ----
Balance at December 31,
1999................... 618,216 3,158,210 $ .07-1.00 $.31
========== ============= ============ ====
</TABLE>
The weighted-average fair value of options granted to employees and
consultants for the year ended December 31, 1999 was $0.10 and $4.51,
respectively.
Below are the segregated ranges of exercise prices as of December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------- -----------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
-------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
$ .07-.10 180,476 9.3 years $ .08 -- $--
$ .13 2,331,234 9.8 years $ .13 237,516 $.13
$ 1.00 646,500 9.9 years $1.00 -- $--
--------- --------- --------- ----- ------- ----
$.07-1.00 3,158,210 9.8 years $ .31 237,516 $.13
========= ========= ===== ======= ==== ===
</TABLE>
Stock Options to Consultants
During 1999, the Company granted a total of 213,732 stock options to
consultants for recruiting and accounting services. The value attributable to
these warrants was calculated using the Black-Scholes valuation model with the
following weighted-average assumptions: risk-free interest rate of
approximately 6.2%, expected life of 8 years, 150% volatility, and no expected
dividends. The weighted-average fair value of the stock options granted to
consultants was $4.51. For the year ended December 31, 1999, the Company
recorded $963,684 to general and administrative expense.
Warrants
On January 21, 1999, the Company issued a warrant to a partnership for the
purchase of 34,612 shares of Series A preferred stock at an exercise price of
$.61625 per share in connection with Series A legal services. In September
1999, this warrant was exercised. As the consulting services were directly
related to the first round of Series A financing, the fair value of the warrant
of $21,330 was considered an issuance cost. As of December 31, 1999, all shares
were exercised under this warrant (see Note 7--Redeemable Convertible Preferred
Stock).
On July 27, 1999, the Company issued warrants in connection with a Note
Payable and equipment financing agreement to purchase 295,266 shares of Series
A preferred stock at an exercise price of $1.4902 per share. As of December 31,
1999, these warrants remain outstanding (see Note 3--Notes Payable and
Equipment Financing).
F-20
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On October 15, 1999, the Company issued warrants in connection with a Letter
of Credit to purchase 96,478 shares of Series A preferred stock at an exercise
price of $1.4902 per share. As of December 31, 1999, these warrants remain
outstanding (see Note 3--Notes Payable and Equipment Financing).
Shares Reserved for Future Issuance
As of December 31, 1999, the Company had reserved shares of its common stock
for future issuance as follows:
<TABLE>
<S> <C>
Conversion of Series A preferred stock......................... 7,917,536
Conversion of Series B preferred stock......................... 7,297,900
1999 Stock Plan................................................ 3,776,426
Exercise of outstanding warrants............................... 391,743
----------
19,383,605
==========
</TABLE>
9. Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance
sheet for cash and cash equivalents approximates its fair value.
Note payable, note payable to stockholder, and equipment financing: The
fair values of the Company's short- and long-term debt are estimated using
discounted cash flow analyses, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements. Due to the
recent issuance of the note payable, note payable to stockholder and
equipment financing, the estimated fair value approximates the carrying
amount.
Redeemable convertible preferred stock: The fair values of the Company's
redeemable preferred stock is estimated using discounted cash flow analyses
from the redemption value beginning December 14, 2004, based on the
Company's current incremental borrowing rates for similar types of
borrowing arrangements. Due to the recent issuance of the redeemable
convertible preferred stock, the estimated fair value approximates the
carrying amount.
The carrying amounts and fair values of the Company's financial instruments
are as follows:
<TABLE>
<CAPTION>
1998 1999
----------------- -----------------------
Carrying Fair Carrying
Amount Value Amount Fair Value
-------- -------- ----------- -----------
<S> <C> <C> <C> <C>
Cash and cash equivalents..... $138,920 $138,920 $29,994,575 $29,994,575
Note payable.................. -- -- 2,000,000 2,000,000
Note payable to stockholder... -- -- 2,000,000 2,000,000
Equipment financing........... -- -- 510,662 510,662
Redeemable convertible
preferred stock.............. -- -- 40,374,016 40,374,016
</TABLE>
F-21
<PAGE>
LINUXCARE, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Subsequent Events
2000 Employee Stock Purchase Plan
The Company's 2000 Employee Stock Purchase Plan was approved by shareholders
in February 2000 to be effective upon the completion of the Company's initial
public offering of its common stock. The Company has reserved a total of
1,000,000 shares of common stock for issuance under this plan. The plan
contains consecutive, overlapping 24-month offering periods, each including
four 6-month purchase periods. Eligible employees may purchase common stock at
85% of the lesser of the fair market value of the Company's common stock on the
first day of the applicable 24-month offering period or the fair market value
of the Company's common stock on the last day of a purchase period. In
addition, the plan provides for automatic annual increases in the number of
shares available for issuance on the first day of each fiscal year equal to the
lowest of 1,000,000, 2% of the outstanding shares of the Company's common stock
on the first day of the fiscal year, or such other amount as determined by the
Board of Directors.
2000 Director Option Plan
In February 2000, the shareholders approved the 2000 Director Option Plan
for the participation of its non-employee directors. A total of 300,000 shares
were reserved for issuance none of which have been issued. Each non-employee
director who joins the Board of Directors after the completion of the offering
will automatically receive a grant of an option to purchase 20,000 shares of
common stock on the date on which such person becomes a director. The shares
subject to each of these options will vest and become fully exercisable over
four years as follows: 25% of the shares on each anniversary of the date of
grant, provided that the non-employee director remains a director on such
dates.
Additionally, beginning at the annual meeting of stockholders to be held in
2001 and at each successive annual stockholder meeting, each non-employee
director who has previously served at least six consecutive months prior
thereto will receive an option to purchase 5,000 shares of our common stock.
The shares subject to each of these options will fully vest and become fully
exercisable as to 100% of the shares subject to the option on the first
anniversary date of the date of grant. The exercise price per share for all
options automatically granted to directors under our 2000 Director Option Plan
will be equal to the market price of the Company's common stock on the date of
grant and will have a ten year term, but will generally terminate within a
specified time, as defined in the 2000 Director Option Plan, following the date
the option holder ceases to be a director or consultant.
1999 Employee Stock Options Plan
In February 2000, the shareholders approved an increase in the number of
shares of common stock available for grant by 3,000,000 under the 1999 stock
plan.
F-22
<PAGE>
Report of Ernst & Young LLP, Independent Auditors
To The Board of Directors and Stockholders of
The Puffin Group Inc.:
We have audited the accompanying balance sheets of The Puffin Group Inc. as
at December 31, 1998 and September 30, 1999, and the related statements of
operations, stockholders' (deficit) equity and cash flows for the period from
September 14, 1998 (inception) to December 31, 1998 and the nine month period
ended September 30, 1999. 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 in accordance with generally accepted auditing
standards in Canada and in the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of The Puffin Group Inc. as at
December 31, 1998 and September 30, 1999, and the results of its operations and
its cash flows for the periods from September 14, 1998 (inception) to December
31, 1998 and the nine month period ended September 30, 1999 in accordance with
accounting principles generally accepted in Canada and in the United States of
America.
/s/ Ernst & Young LLP
Ottawa, Canada
January 7, 2000
F-23
<PAGE>
THE PUFFIN GROUP INC.
BALANCE SHEET
US DOLLARS
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------ -------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents......................... $ 1,862 $14,335
Accounts receivable (note 1)...................... 3,955 40,000
Prepaid expenses.................................. -- 2,462
Other assets...................................... 192 2,400
------- -------
Total current assets............................ 6,009 59,197
Property and equipment, net (note 1)................ 1,887 8,461
------- -------
$ 7,896 $67,658
======= =======
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable.................................. $ 7,400 $35,864
Accrued professional fees......................... 3,252 14,077
Accrued salaries.................................. 550 4,087
------- -------
Total current liabilities....................... 11,202 54,028
Commitments and contingencies (note 2 and 5)
Stockholders'(deficit) equity (note 1):
Class A shares, voting on a two for one basis,
unlimited number authorized, 500,000 issued...... 67 67
Class C shares, voting on a one for one basis,
unlimited number authorized, 500,000 issued...... 67 67
Class D shares, non-voting, unlimited number
authorized, 25,000 issued........................ -- 16,633
Class B shares, non-voting, unlimited number
authorized, 0 shares issued -- --
First preferred shares, non-voting, unlimited
number authorized, 0 shares issued............... -- --
------- -------
134 16,767
Accumulated deficit............................... (3,440) (3,137)
------- -------
Total stockholders' (deficit) equity............ (3,306) 13,630
------- -------
$ 7,896 $67,658
======= =======
</TABLE>
See accompanying notes.
F-24
<PAGE>
THE PUFFIN GROUP INC.
STATEMENTS OF OPERATIONS
US DOLLARS
<TABLE>
<CAPTION>
Period from
September 14, Nine month
1998 to period ended
December 31, September 30,
1998 1999
------------- -------------
<S> <C> <C>
Revenues:
Software development and
support.................. $14,700 $97,735
------- -------
Total revenues.......... 14,700 97,735
Cost of revenues............ 14,277 52,168
------- -------
Gross margin................ 423 45,567
Operating expenses:
Sales and marketing....... -- 1,381
General and
administrative........... 3,863 43,883
------- -------
Total operating
expenses............... 3,863 45,264
------- -------
Net income (loss) and
comprehensive income
(loss)..................... $(3,440) $ 303
======= =======
</TABLE>
See accompanying notes.
F-25
<PAGE>
THE PUFFIN GROUP INC.
STATEMENT OF STOCKHOLDER'S (DEFICIT) EQUITY
US DOLLARS
<TABLE>
<CAPTION>
Class
Class A Class C D Accumulated
Shares Amount Shares Amount Shares Amount Deficit Total
------- ------ ------- ------ ------ ------- ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of shares to
founders............... 500,000 $67 500,000 $67 -- $ -- $ -- $ 134
Net loss and
comprehensive loss..... -- -- -- -- -- -- (3,440) (3,440)
------- --- ------- --- ------ ------- ------- -------
December 31, 1998....... 500,000 67 500,000 67 -- -- (3,440) (3,306)
Issuance of shares for
cash................... -- -- -- -- 25,000 16,633 -- 16,633
Net income and
comprehensive income... -- -- -- -- -- -- 303 303
------- --- ------- --- ------ ------- ------- -------
September 30, 1999...... 500,000 $67 500,000 $67 25,000 $16,633 $(3,137) $13,630
======= === ======= === ====== ======= ======= =======
</TABLE>
See accompanying notes.
F-26
<PAGE>
THE PUFFIN GROUP INC.
STATEMENTS OF OPERATIONS
US DOLLARS
<TABLE>
<CAPTION>
Period from
September 14, Nine Month
1998 to Period ended
December 31, September 30,
1998 1999
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)................................. $(3,440) $ 303
Adjustments to reconcile net loss to net cash used
in operating activities
Depreciation.................................... 377 798
Changes in assets and liabilities:
Accounts receivable........................... (3,955) (36,045)
Prepaid expenses.............................. -- (2,462)
Other assets.................................. (192) (2,208)
Accounts payable.............................. 7,400 28,464
Accrued liabilities........................... 3,802 14,362
------- --------
Net cash used in operating activities............. 3,992 3,212
Cash flows from investing activities:
Purchase of property and equipment................ (2,264) (7,372)
------- --------
Net cash use in investing activities.............. (2,264) (7,372)
Cash flows from financing activities:
Proceeds from issuance of common stock............ 134 16,633
------- --------
Net cash provided by financing activities......... 134 16,633
------- --------
Net increase in cash and cash equivalents......... 1,862 12,473
Cash and cash equivalents, beginning of period.... -- 1,862
------- --------
Cash and cash equivalents, end of period.......... $ 1,862 $ 14,335
======= ========
</TABLE>
See accompanying notes.
F-27
<PAGE>
THE PUFFIN GROUP INC.
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Description of Business
The Puffin Group Inc. ("the Company"), was incorporated under the Ontario
Corporation Act on September 14, 1998. The Company provides Linux-based
computer software development and consulting services.
Use of Estimates
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America 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 period. Actual results could differ from those
estimates.
Foreign Currency Translation
The financial statements have been translated into US dollars in accordance
with Financial Accounting Standards Board issued SFAS No. 52, Foreign Currency
Translation. Monetary assets and liabilities are translated at the rates of
exchange in effect at the applicable year end. Non-monetary assets and
liabilities are translated at the rates of exchange in effect at the dates of
the transactions. Revenue and expenses are translated at the rates of exchange
in effect during the year except for depreciation which is translated at the
same rate as the asset to which is relates. Gains and losses from translations
are included in earnings in the year in which they occur.
Revenue Recognition
Revenue from fixed price long-term computer software development contracts
is recognized over the contract term based on the percentage of services
provided during the period compared to the total estimated services provided
over the entire contract. Revenue from consulting services is recognized as the
services are provided.
Fair Value of Financial instruments
The carrying values of the Company's financial instruments approximate their
fair value given their short-term nature.
Concentrations of Credit Risk and Significant Customers
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of trade receivables. The Company provides
credit, in the normal course of business, to its customers and performs ongoing
credit evaluations of its customers. As of December 31, 1998 and September 30,
1999, accounts receivable and total revenue were concentrated as follows:
<TABLE>
<CAPTION>
Accounts Total
receivable revenue
---------- -------
<S> <C> <C>
December 31, 1998
Customer A.............................................. $ 3,955 $14,700
======= =======
September 30, 1999
Customer A.............................................. -- 32,100
Customer B.............................................. 40,000 65,635
------- -------
Total................................................... $40,000 $97,735
======= =======
</TABLE>
F-28
<PAGE>
THE PUFFIN GROUP INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. All cash and cash
equivalents at December 31, 1998 and September 30, 1999 were held with one
financial institution.
Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives (three to five years) of
the assets. Leasehold improvements are amortized over the corresponding lease
term.
Property and equipment consists of the following at December 31, 198 and
September 30, 1999:
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------ -------------
<S> <C> <C>
Original cost:
Computer equipment.............................. $2,264 $ 3,216
Furniture and fixtures.......................... -- 5,651
Leasehold improvements.......................... -- 768
------ -------
Total property and equipment.................... 2,264 9,636
Less: accumulated depreciation.................. (377) (1,175)
------ -------
Property and equipment, net..................... $1,887 $ 8,461
====== =======
</TABLE>
Impairment of Long-lived Assets
In accordance with Statement of Financial Accounting Standards (SFAS) No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-lived
Assets to be Disposed Of, the Company reviews long-lived and intangible assets
for impairment whenever events or circumstances indicate the carrying value of
an asset may not be recoverable.
Income Taxes
The Company provides for income taxes based on the liability method, which
requires recognition of deferred tax assets and liabilities based on
differences between financial reporting and tax bases of assets and liabilities
measured using enacted tax rates and laws that are expected to be in effect
when the differences are expected to reverse.
Stock Split
Effective August 31, 1999, the Company completed a 500-for-1 stock split. As
a result of the stock split, outstanding and issued shares increased with the
effect of the stock split accounted for retroactively in these financial
statements. The rights of the holders of these securities were not otherwise
modified.
Impact of Recent Accounting Pronouncements
In March 1998, the AICPA issued Statement of Position (SOP) No. 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. SOP No. 98-1 requires entities to capitalize certain costs
related to internal-use software once certain criteria have been met. SOP No.
98-1 was adopted by
F-29
<PAGE>
THE PUFFIN GROUP INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
the Company in fiscal 1999. The adoption of SOP No. 98-1 did not have a
material impact on the Company's financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. SFAS No. 133, as recently amended, is effective for
fiscal years beginning after June 15, 2000. Management has not yet determined
the effects of the adoption of SFAS No. 133 on the Company's financial position
or results of operations.
2. Commitments
The Company leases its facilities under operating leases that expire at
various dates through June 30, 2002.
Future minimum operating lease payments as of September 30, 1999 are as
follows:
<TABLE>
<S> <C>
2000 $ 35,150
2001 43,320
2002 32,500
--------
Total future minimum lease payments.............................. $110,970
========
</TABLE>
Rent expense for the period to December 31, 1998 and September 30, 1999 was
$0 and $4,652, respectively.
3. Income Taxes
As of September 30, 1999, the Company had federal and provincial net loss
carryforwards of approximately $2,000 which expire in the year ending 2006, if
not utilized.
Significant components of the Company's deferred tax assets for federal and
provincial income taxes as of December 31, 1998 and September 30, 1999 are as
follows:
<TABLE>
<S> <C>
Deferred tax assets:
Net operating loss carryforwards.................................. $ 452
Valuation allowance............................................... (452)
-----
$ --
=====
</TABLE>
4. Segmented information
The Company has adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information.
The Company operates in one business segment--Linux-based computer software
development and consulting services. This segment engages in business
activities from which it earns Linux-based computer software development and
support revenue and incurs expenses.
The Company has generated all of its revenue from the United States of
America. All of the Company's assets are located in Canada.
F-30
<PAGE>
THE PUFFIN GROUP INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
5. Uncertainty due to the year 2000 (unaudited)
The Year 2000 Issue arises because many computerized systems use two digits
rather than four to identify a year. Date-sensitive systems may recognize the
year 2000 as 1900 or some other date, resulting in errors when information
using year 2000 dates is processed. In addition, similar problems may arise in
some systems which use certain dates in 1999 to represent something other than
a date. The effects of the Year 2000 Issue may be experienced before, on, or
after January 1, 2000, and, if not addressed, the impact on operations and
financial reporting may range from minor errors to significant systems failure
which could affect an entity's ability to conduct normal business operations.
It is not possible to be certain that all aspects of the Year 2000 Issue
affecting the entity, including those related to the efforts of customers,
suppliers, or other third parties, will be fully resolved.
6. Subsequent event
On October 1, 1999 the Company's shareholders sold 100% of their interest in
the Company to Linuxcare Inc. in exchange for shares of Linuxcare Inc. Upon
completion of the acquisition the Company's name will be changed to Linuxcare
Canada.
F-31
<PAGE>
Report of Reconta Ernst & Young, S.p.A., Independent Auditors
To the Board of Directors and Shareholders of
Prosa Progettazione Sviluppo Aperto S.r.l.:
We have audited the accompanying balance sheets of Prosa Progettazione
Sviluppo Aperto S.r.l., hereinafter referred to as Prosa S.r.l., as of December
31, 1999 and 1998, and the related statements of operations, retained earnings
and cash flows for year ended December 31, 1999 and for the period from May 4,
1998 (date of inception) to December 31, 1998. 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 in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Prosa S.r.l. as of December
31, 1999 and 1998, and the results of its operations and its cash flows for the
year ended December 31, 1999 and for the period from May 4, 1998 (inception) to
December 31, 1998 in conformity with accounting principles generally accepted
in the United States of America.
/s/ Reconta Ernst & Young, S.p.A.
Milan, Italy
February 7, 2000
F-32
<PAGE>
PROSA S.r.l.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-----------------------
1999 1998
(in U.S. $) (in U.S. $)
----------- -----------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents............................. $ 489 $ 5,343
Accounts receivable................................... 115,049 6,114
Inventories........................................... 2,837 3,082
Deferred income taxes................................. 185 185
Prepaid expenses and other assets..................... 5,120 --
-------- -------
Total current assets................................ $123,680 $14,724
Fixed assets:
Property and equipment, net........................... 6,727 2,736
Deposit on lease...................................... 5,711 --
-------- -------
12,438 2,736
Deferred income taxes................................... 407 592
-------- -------
Total assets........................................ $136,525 $18,052
======== =======
Liability and Owners' Equity
Current liabilities:
Accounts payable...................................... $120,709 $ 1,258
Accrued liabilities................................... -- 300
Advances from owners.................................. -- 5,331
-------- -------
Total current liabilities........................... 120,709 6,889
Owners' equity:
Share Capital......................................... 12,703 12,703
Currency translation adjustment....................... (2,024) (72)
Retained earnings..................................... 5,137 (1,468)
-------- -------
Total owners' equity................................ 15,816 11,163
-------- -------
Total liabilities and owners' equity................ $136,525 $18,052
======== =======
</TABLE>
See accompanying notes
F-33
<PAGE>
PROSA S.r.l.
STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
<TABLE>
<CAPTION>
Period from
May 4, 1998
Year ended (inception) to
December 31, December 31,
1999 1998
(in U.S. $) (in U.S. $)
------------ --------------
<S> <C> <C>
Net sales.......................................... $222,930 $12,208
Cost of sales...................................... 120,335 8,534
-------- --------
Gross profit....................................... 102,595 3,674
Selling, general and administrative expenses....... 87,250 5,960
-------- --------
Income (loss) from operations...................... 15,345 (2,286)
Other income (expense):
Interest income (expense), net................... (1,048) 41
Other, net....................................... (1,399) --
-------- --------
Total other income (expense)................... (2,447) 41
-------- --------
Income (loss) before income taxes.................. 12,898 (2,245)
Income taxes (benefit)............................. 6,293 (777)
-------- --------
Net income (loss).................................. $ 6,605 $ (1,468)
======== ========
</TABLE>
See accompanying notes
F-34
<PAGE>
PROSA S.r.l.
STATEMENTS OF OWNERS' EQUITY
(In U.S. Dollars)
<TABLE>
<CAPTION>
Capital
-------------- Translation Retained
Quotas Amount adjustments earnings Total
------ ------- ----------- -------- -------
<S> <C> <C> <C> <C> <C>
Issuance of quotas...... $ 5 $12,703 $ -- $ -- $12,703
Currency translation
adjustment............. -- -- (72) -- (72)
Net income (loss)....... -- -- -- (1,468) (1,468)
--- ------- ------- ------- -------
Balances at December 31,
1998................... 5 12,703 (72) (1,468) 11,163
Currency translation
adjustment............. -- -- (1,952) -- (1,952)
Net income (loss)....... -- -- -- 6,605 6,605
--- ------- ------- ------- -------
Balances at December 31,
1999................... $ 5 $12,703 $(2,024) $ 5,137 $15,816
=== ======= ======= ======= =======
</TABLE>
See accompanying notes.
F-35
<PAGE>
PROSA S.r.l.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
May 4, 1998
Year ended (inception) to
December 31, December 31,
1999 1998
(in U.S. $) (in U.S. $)
------------ --------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)................................. $ 6,605 $(1,468)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation.................................... 1,060 275
Changes in operating assets and liabilities:
Accounts receivable........................... (108,935) (6,114)
Inventories................................... 245 (3,082)
Prepaid expenses and other current assets..... (5,120) --
Accounts payable.............................. 119,451 1,258
Deferred income tax provision (benefit)....... 185 (777)
Accrued liabilities........................... (300) 300
Currency translation adjustment............... (1,639) (63)
--------- -------
Net cash provided by (used in) operating
activities....................................... 11,552 (9,671)
Cash flows from investing activities:
Purchase of property and equipment................ (5,364) (3,020)
Deposit on lease.................................. (5,711) --
--------- -------
Net cash used in investing activities............. (11,075) (3,020)
Cash flows from financing activities:
Advances from owners'............................. (5,331) 5,331
Proceeds from issuance of capital................. -- 12,703
--------- -------
Net cash provided by (used in) financing
activities....................................... (5,331) 18,034
--------- -------
Net increase (decrease) in cash and cash
equivalents...................................... (4,854) 5,343
Cash and cash equivalents, beginning of year...... 5,343 --
--------- -------
Cash and cash equivalents, end of year............ $ 489 $ 5,343
========= =======
</TABLE>
See accompanying notes
F-36
<PAGE>
PROSA S.r.l.
NOTES TO FINANCIAL STATEMENTS
1. Background and Presentation
Prosa S.r.l. ("the Company") is a legal entity incorporated under the laws
of Italy. The Company was incorporated in Bergamo, Italy on May 4, 1998. The
Company provides Linux-based computer software and services, including system
architecture design, system integration and security consulting. The share
capital (quota) is divided into five quota shares of approximately $2,540 each.
On December 30, 1999, the share quota of the Company has been purchased by
Linuxcare, Inc. in exchange for $125,000 and 25,000 options to purchase shares
of Linuxcare, Inc. common stock. The financial statements do not reflect the
effects of push-down amounts to reflect the purchase of the Company by
Linuxcare, Inc.
To comply with appropriate statutory requirements, the Company maintains its
accounts to prepare financial statements presented in accordance with
accounting principles generally accepted in Italy (Italian GAAP). Adjustments
have been made to such financial statements presented on the basis of Italian
GAAP to prepare the accompanying financial statements, which are presented in
conformity with generally accepted accounting principles in the United States
of America (U.S. GAAP). The Company's year end is December 31.
2. Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results may differ from those
estimates.
Cash and Cash Equivalents
Cash and cash equivalents consist principally of cash deposited in money
market and checking accounts, which amounts approximate fair value.
Inventories
Inventories are stated at the lower of cost or market using the first-in,
first-out (FIFO) method.
Property and Equipment
Office equipment, computers, and furniture and fixtures are stated at cost
and are depreciated using the straight-line method based on the following
estimated useful lives:
<TABLE>
<CAPTION>
Years
-----
<S> <C>
Computer & Office equipment......................................... 5
Furniture and fixtures.............................................. 5-8
</TABLE>
Revenue Recognition
Revenues from professional services, including planning, deployment and
installation, systems integration, performance analysis and security consulting
of Linux-based solutions, are recognized as services are performed.
Income taxes
Income taxes are calculated in accordance with applicable Italian law.
Deferred income taxes are accounted for under the liability method and reflect
the tax effects of all significant temporary differences
F-37
<PAGE>
PROSA S.r.l.
NOTES TO FINANCIAL STATEMENTS--(Continued)
between the tax basis of assets and liabilities and their reported amounts in
the financial statements. A valuation allowance is provided against deferred
tax assets when it is more likely than not that some portion or all of the
deferred tax asset will not be realized.
Information expressed in U.S. Dollars
The financial statements are stated in Italian Lire, the currency of the
country in which the Company operates (functional currency). Asset and
liability accounts are translated using the current exchange rate (the rate of
translation in effect at the balance sheet date). Revenue and expenses are
translated into U.S. Dollars at the weighted average rate for the current year.
The translation adjustment results from the translation of foreign currency
statements and it has been reported separately as a component of owners'
equity. The exchange rate for the years ended December 31, 1999 and 1998 was
1,926.06 Lire per U.S. Dollar and 1,653.10 Lire per U.S. Dollar respectively.
The weighted average exchange rate for year ended December 31, 1999 and for
the period from May 4, 1998 (inception) to December 31, 1998 was 1,790.08 Lire
per U.S. Dollar and 1,735.05 Lire per U.S. Dollar respectively.
Impairment of Long-lived Assets
In accordance with Statement of Financial Accounting Standards (SFAS) No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-lived
Assets to be Disposed Of, the Company reviews long-lived and intangible assets
for impairment whenever events or circumstances indicate the carrying value of
an asset may not be recoverable.
Impact of Recent Accounting Pronouncements
In March 1998, the AICPA issued Statement of Position (SOP) No. 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. SOP No. 98-1 requires entities to capitalize certain costs
related to internal-use software once certain criteria have been met. The
adoption of SOP No. 98-1 did not have a material impact on the Company's
financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. SFAS No. 133, as recently amended, is effective for
fiscal years beginning after June 15, 2000. Management believes the adoption of
SFAS No. 133 will not have a material effect on the Company's financial
position or results of operations.
Concentrations of Credit Risk and Significant Customers
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of trade receivables. The Company provides
credit, in the normal course of business, to a number of companies and performs
ongoing credit evaluations of its customers. As of December 31, 1999,
approximately 38% of accounts receivable was concentrated with one customer.
The net sales to the same customer accounted for approximately 32% of total
revenues for the year ended December 31, 1999.
F-38
<PAGE>
PROSA S.r.l.
NOTES TO FINANCIAL STATEMENTS--(Continued)
3. Property and Equipment
Property and equipment consists of the following at December 31, 1999 and
1998 (in U.S. Dollars):
<TABLE>
<CAPTION>
December 31,
-----------------------
1999 1998
(in U.S. $) (in U.S. $)
----------- -----------
<S> <C> <C>
Computer and office equipment..................... 7,766 2,799
Furniture and fixtures............................ 190 221
------ -----
Total property and equipment...................... 7,956 3,020
Less: accumulated depreciation.................... (1,229) (284)
------ -----
Property and equipment, net....................... 6,727 2,736
====== =====
</TABLE>
4. Commitments
The Company leases its facilities under an operating lease that expires at
September 17, 2005 and it is renewable for a successive term of six years, at
the Company's option. Rent expense for the year ended December 31, 1999 was
approximately U.S. 9,160 Dollars. Future minimum lease payments as of December
31, 1999 are as follows (in U.S. Dollars):
<TABLE>
<CAPTION>
Operating
Leases
---------
<S> <C>
2000........................... 23,364
2001........................... 23,364
2002........................... 23,364
2003........................... 23,364
2004........................... 23,364
Thereafter..................... 16,680
-------
Future minimum lease payments.. 133,500
=======
</TABLE>
5. Income Taxes
Income before income taxes and provision for income taxes are as follows for
the year ended December 31, 1999 and for the period ended December 31, 1998 (in
U.S. Dollars):
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Income (loss) before income taxes.......................... 12,898 (2,245)
Provision for income taxes:
Current.................................................. 6,108 --
Deferred (benefit)....................................... 185 (777)
------ ------
Net income (loss).......................................... 6,605 (1,468)
====== ======
</TABLE>
The Italian statutory rate for 1999 is 41.25% comprised of a 37% national
tax (IRPEG) and 4.25% IRAP (Regional Tax on Productive Activities) tax. A
reconciliation between the Italian statutory tax rate and the effective tax
rate is as follows:
<TABLE>
<CAPTION>
1999 1998
----- ----
<S> <C> <C>
Income tax at Statutory rate (41.25%)........................ 5,320 (926)
Permanent differences........................................ 146 149
Non deductible costs--Intent and Labor (IRAP only)........... 1,041 --
Other........................................................ (214) --
----- ----
Income tax actual (48.80%)................................... 6,293 (777)
===== ====
</TABLE>
F-39
<PAGE>
PROSA S.r.l.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The components of deferred income tax assets and liabilities at December 31,
1999 and 1998 are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------
1999 1998
(in U.S. $) (in U.S. $)
----------- -----------
<S> <C> <C>
Deferred tax assets:
Operating loss carryforward (NOL).............. -- 127
Depreciation of capitalized costs.............. 592 777
Valuation allowance............................ -- (127)
Deferred tax liabilities: -- --
--- ----
Net deferred tax asset (liability)............... 592 777
=== ====
<CAPTION>
December 31,
-----------------------
1999 1998
(in U.S. $) (in U.S. $)
----------- -----------
<S> <C> <C>
Balance sheet classification:
Tax assets current portion....................... 185 185
Tax assets non-current portion................... 407 592
--- ----
592 777
=== ====
</TABLE>
In 1998 the Company provided a 100% valuation allowance for deferred tax
assets related to operating loss carryforward because the weight of available
evidence indicated that it was more likely than not that the portion of the
deferred tax asset would not be realized.
6. Owners' Equity
Italian law requires that 5% of a company's net income be retained as a
legal reserve, until such reserve equals 20% of share capital. Included in
retained earnings are legal reserves of approximately U.S. 340 Dollars at
December 31, 1999. This reserve is not available for distribution.
7. Related Party Transactions
Significant related party transactions for year ended December 31, 1999 and
1998 were as follows (in U.S. Dollars):
<TABLE>
<CAPTION>
Year ended Period ended
Dec. 31, 1999 Dec. 31, 1998
------------- -------------
<S> <C> <C>
Compensation to the Board of Directors...... 21,780 0
Other compensations for services provided to
the Company by the owners.................. 11,865 0
Advances from owners........................ 9,481 5,331
</TABLE>
In 1999 and 1998 the Company received advances, free of interest from the
owners. These advances were fully repaid in December 1999.
The owners are actively involved in Company operations and its business
development.
F-40
<PAGE>
PROSA S.r.l.
NOTES TO FINANCIAL STATEMENTS--(Continued)
8. Termination Indemnity
In accordance with Italian severance pay laws and regulations statutes, an
employee benefit is accrued for service to date, representing the amount which
the employee would be entitled if the employee separates immediately. The
termination indemnity liability is calculated in accordance with local civil
and labor laws based on each employee's length of service, employment category
and remuneration. The termination liability is adjusted annually by a cost-of-
living index provided by the Italian Government. There is no vesting period or
funding requirement associated with the liability. No liability for termination
indemnities has been recorded since the Company has no employees.
9. Subsequent Events
On February 7, 1999, the Company was converted into an S.p.A. (Societa per
azioni), the corporate name was changed to LINUXCARE Italia S.p.A., and a new
registered office has been established in Rome (Italy). Following the
conversion, the Company's capital was increased to Italian Lire 1 billion by a
contribution from Linuxcare, Inc.
F-41
<PAGE>
Inside back cover: A depiction of an advertisement used by the Company with
copy that reads as set forth below.
Headline: IF WHERE YOU WANT TO GO TODAY IS LINUX, YOU HAVE OUR SUPPORT.
Text: Linuxcare offers a comprehensive range of enterprise-class support and
services for the Linux operating system. When you work with us, you'll gain
access to deep expertise in everything from integrating Linux with your current
systems, to 24 X 7 support, to training--all in one place. The Linux revolution
has begun. And now it means business. To learn more, call 888.LIN.GURU (546-
4878) or visit www.linuxcare.com.
Bottom tagline: SUPPORT FOR THE REVOLUTION LINUXCARE.
<PAGE>
[LINUXCARE LOGO]
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the costs and expense other than underwriting
discounts and commissions, payable by Linuxcare, Inc. in connection with the
sale of Common Stock being registered. All amounts are estimates except the SEC
registration fee and the NASD filing fee.
<TABLE>
<S> <C>
SEC registration fee................................................ $20,493
NASD filing fee..................................................... 9,700
Nasdaq National Market listing fee.................................. 95,000
Printing and engraving costs........................................ *
Legal fees and expenses............................................. *
Accounting fees and expenses........................................ *
Transfer Agent and Registrar fees................................... *
Miscellaneous expenses.............................................. *
-------
Total............................................................. $ *
=======
</TABLE>
- --------
*To be filed by amendment.
Item 14. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law permits a corporation to
include in its charter documents, and in agreements between the corporation and
its directors and officers, provisions expanding the scope of indemnification
beyond that specifically provided by the current law.
Article 11 of the Registrant's Amended and Restated Certificate of
Incorporation provides for the indemnification of directors to the fullest
extent permissible under Delaware law.
Article 7 Section 7.6 of the Registrant's Bylaws provides for the
indemnification of officers, directors and third parties acting on behalf of
the Registrant if such person acted in good faith and in a manner reasonably
believed to be in and not opposed to the best interest of the Registrant, and,
with respect to any criminal action or proceeding, the indemnified party had no
reason to believe his or her conduct was unlawful.
The Registrant has entered into indemnification agreements with its
directors and executive officers, in addition to indemnification provided for
in the Registrant's Bylaws, and intends to enter into indemnification
agreements with any new directors and executive officers in the future.
Item 15. Recent Sales of Unregistered Securities
Since May 3, 1999 we have issued and sold the securities described below:
(a) From May 3, 1999 to January 31, 2000 we issued and sold an aggregate of
3,316,677 shares of unregistered common stock to 49 directors, officers,
employees, former employees, and consultants at prices ranging from $0.07
to $2.00 per share, for aggregate cash consideration of approximately
$711,825, of which approximately $187,053 is subject to outstanding
promissory notes payable to us. These shares were sold pursuant to the
exercise of options granted by the board under our 1999 stock plan. As to
each of our directors, officers, employees, former employees and
consultants who were issued such securities, we relied upon Rule 701 of the
Securities Act of 1933. Each such person purchased our securities pursuant
to a written contract between such person and us. In addition, we met the
conditions imposed under Rule 701 (b).
II-1
<PAGE>
(b) On December 14, 1998 we issued and sold an aggregate of 6,000,000 shares of
unregistered common stock at a price per share of $0.00005 to our three
founders, David LaDuke, David Sifry, and Arthur Tyde, for an aggregate
purchase price of $300.00 and their shares of Linux Care, Inc., a Nevada
company. We relied upon Section 4(2) of the Securities Act of 1933 in
connection with the issuance of these securities.
(c) On December 23, 1998 we issued and sold an aggregate of 1,058,824 shares of
common stock at a price per share of $0.00005 to Constantin Delivanis and
Madhaven Rangaswami, each an accredited investor, for an aggregate purchase
price of $53.00. We relied upon Section 4(2) of the Securities Act of 1933
in connection with the issuance of these securities.
(d) On February 1, 1999 and April 16, 1999 we issued and sold (1) in the
aggregate 7,882,924 shares of unregistered Series A Preferred stock at a
price per share of $0.61625, and (2) an unregistered warrant to purchase
2,777,778 shares of Series A preferred stock, with an exercise price per
share of $0.61625, to Chemical and Materials Enterprise Associates II LP,
Jens Christensen, Debachi Family Trust, Constantin Delivanis, Melodie Keane
Haller, KPCB Holdings Inc., David McGuerty, William "Shawn" J. McLaren, MSD
Portfolio L.P.--Investments, Hasso Plattner, Raj Popli, Madhaven
Rangaswami, RPKS Investments LLC, Triple Marlin Investments LLC, Ashok
Trivedi, and Sunil Wadhwani for aggregate cash consideration of
approximately $4,857,852. The warrant was terminated, unexercised, in
December, 1999. On January 21, 1999 we issued an unregistered warrant to
purchase 34,612 shares of Series A Preferred stock, with an exercise price
per share of $0.61625, to G & H Partners in consideration of cancellation
of indebtedness. This warrant was exercised in full on September 9, 1999.
These shares and warrants were sold pursuant to Series A Preferred stock
and warrant purchase agreements between such investors and us. We relied
upon Section 4(2) of the Securities Act of 1933 and Regulation D, Rule 506,
in connection with the sale of these securities. The sale of Series A
preferred stock and warrants was made in compliance with all the terms of
Rules 501 and 502 of Regulation D, there were no more than 35 investors, as
calculated pursuant to Rule 501(e) of Regulation D, and each investor who
was not an accredited investor represented to us that it had such knowledge
and experience in financial and business matters that it was capable of
evaluating the merits and risks of the investment.
(e) On July 27, 1999, in connection with obtaining equipment leases and loans,
we issued unregistered warrants to purchase an aggregate of 295,266 shares
of Series A preferred stock, with an exercise price per share of $1.49, to
Comdisco, Inc. We relied upon Section 4(2) of the Securities Act of 1933
and Regulation D, Rule 506, in connection with the issuance of the
warrants. The issuance of the warrants was made in compliance with all the
terms of Rules 501 and 502 of Regulation D, there were no more than 35
investors, as calculated pursuant to Rule 501(e) of Regulation D, and each
investor who was not an accredited investor represented to us that it had
such knowledge and experience in financial and business matters that it was
capable of evaluating the merits and risks of the investment.
(f) On October 15, 1999 we entered into an L.O.C. Subordinated Loan and
Security Agreement with Comdisco, Inc. under which Comdisco may be issued
an unregistered warrant to purchase up to a maximum of 96,478 shares of
Series A preferred stock with an exercise price per share of $1.49. As of
January 31, 2000, no funds had been drawn down under the letter of credit
and therefore no warrant had been issued to Comdisco, Inc. We relied upon
Section 4(2) of the Securities Act of 1933 and Regulation D, Rule 506, in
connection with the issuance of the warrants. The issuance of the warrants
was made in compliance with all the terms of Rules 501 and 502 of
Regulation D, there were no more than 35 investors, as calculated pursuant
to Rule 501(e) of Regulation D, and each investor who was not an accredited
investor represented to us that it had such knowledge and experience in
financial and business matters that it was capable of evaluating the merits
and risks of the investment.
(g) On November 15, 1999, we issued and sold to the shareholders of Puffin
Group, Inc. (1) 100,000 shares of unregistered common stock and (2) options
to purchase an aggregate of 355,000 unregistered shares of common stock
with an exercise price per share of $0.13 in exchange for all outstanding
shares of Puffin Group, Inc., 23,784 of such option shares have been
exercised. These securities were issued pursuant to a share exchange
agreement. We relied upon Regulation S of the Securities Act of 1933 in
connection with the sale and issuance of these securities.
II-2
<PAGE>
(h) On December 17, 1999 we sold an aggregate 7,082,267 shares of unregistered
Series B Preferred stock at a price per share of $4.728 to APA Excelsior V
L.P., Apax Europe IV--A L.P., Austin I LLC, Black Marlin Investments LLC,
Comdisco Inc., Dell USA L.P., John Drew, Integral Capital Partners IV L.P.,
Integral Capital Partners IV MS Side Fund L.P., KPCB Holdings Inc., McKenna
Ventures L.P., Motorola Inc., Oracle Corporation, Patricof Private
Investment Club II L.P., Hasso Plattner, Sun Microsystems Inc., Vermeer
Investments LLC, Ernest von Simson, and WS Investment Company 99B for an
aggregate cash consideration of approximately $33,484,958. These shares
were sold pursuant to a Series B Preferred stock purchase agreement between
such investors and us. We relied upon Section 4(2) of the Securities Act of
1933 and Regulation D, Rule 506, in connection with the sale of these
securities. The sale of Series B preferred stock was made in compliance
with all the terms of Rules 501 and 502 of Regulation D, there were no more
than 35 investors, as calculated pursuant to Rule 501(e) of Regulation D,
and each investor who was not an accredited investor represented to us that
it had knowledge and experience in financial and business matters that it
was capable of evaluating the merits and risks of the investment.
(i) On December 30, 1999 we granted a right to purchase 25,000 shares of common
stock at a purchase price per share of $2.00 to the Prosa company. This
grant was made pursuant to a quota purchase agreement between Prosa and us.
We relied upon Regulation S of the Securities Act of 1933 in connection
with the sale and issuance of these securities.
(j) On January 18, 2000, in connection with obtaining equipment leases and
loans, we issued an unregistered warrant to purchase a maximum of 25,380
shares of Series B preferred stock, with an exercise price per share of
$4.728, to Comdisco, Inc. We relied upon Section 4(2) of the Securities Act
of 1933 and Regulation D, Rule 506, in connection with the issuance of the
warrant. The issuance of the warrant was made in compliance with all the
terms of Rules 501 and 502 of Regulation D, there were no more than 35
investors, as calculated pursuant to Rule 501(e) of Regulation D, and each
investor who was not an accredited investor represented to us that it had
such knowledge and experience in financial and business matters that it was
capable of evaluating the merits and risks of the investment.
For additional information concerning these equity investment transactions,
reference is made to the information contained under the caption "Certain
Relationships and Related Transactions" in the form of prospectus included
herein. The sales of the above securities were deemed to be exempt from
registration in reliance on Rule 701 promulgated under Section 3(b) under the
Securities Act as transactions pursuant to a compensatory benefit plan or a
written contract relating to compensation, or in reliance on Section 4(2) of
the Securities Act or Regulation D promulgated thereunder as transactions by an
issuer not involving any public offering. The recipients of securities in each
such transaction represented their intention to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates and other instruments issued in such transactions. All recipients
either received adequate information about Linuxcare or had access, through
employment or other relationships, to such information.
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
1.1* Form of Underwriting Agreement.
2.1.1** Share Exchange Agreement with Puffin Group, dated October 1, 1999.
2.1.2** Quota Purchase Agreement dated December 30, 1999.
3.1** Amended and Restated Certificate of Incorporation of the Registrant.
3.2** Bylaws of the Registrant.
4.1* Form of stock certificates.
4.2** Second Amended and Restated Investors' Rights Agreement, dated
December 17, 1999.
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional
Corporation.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
10.1** Form of Indemnification Agreement between the Registrant and each
of its directors and officers.
10.2.1** Master Services Agreement with Amdahl Corporation, dated November
5, 1999.
10.2.2+** Support Training and Certification Agreement with Dell Products, LP
regarding support services, dated October 22, 1999.
10.2.3+** Master Services Agreement with Hewlett-Packard Company, dated
January 6, 2000.
10.2.4+** Master Services Agreement with Densa Techno Tokyo Co., Ltd., dated
June 1, 1999.
10.2.5** Statement of Work with IBM Global Services, dated October 21, 1999.
10.2.6** Master Outsourcing Agreement with Motorola, dated August 6, 1999.
10.2.7+** Consulting Services Agreement with Macmillan USA, Inc., dated
August 30, 1999.
10.2.8+** Master Services Agreement with NEC Software Ltd., dated June 1,
1999.
10.2.9+** Master Services Agreement with Sun Microsystems, Inc., dated
October 20, 1999.
10.2.10+** StarOffice Support Services Agreement with Sun Microsystems, Inc.
dated September 24, 1999.
10.2.11** Consulting Services Agreement with Silicon Graphics, Inc. dated
April 30, 1999.
10.3.1** Lease Agreement with Euro Business Center, dated September 17,
1999.
10.3.2** Lease Agreement with Swallowfield Office Services Limited, dated
November 1, 1999.
10.3.3** Third amendment to lease with ZORO, LLC, dated October 7, 1999.
10.3.4** Lease Agreement for 650 Townsend Street, dated February 11, 1999.
10.4** Amended and Restated 1999 Stock Option Plan and form of agreements
thereunder.
10.5** 2000 Employee Stock Purchase Plan.
10.6** 2000 Director Option Plan.
11.1* Statement regarding computation of per share earnings.
12.1* Statements regarding computation of ratios.
21.1* Subsidiaries of the registrant.
23.1.1 Consent of Ernst & Young, LLP, Independent Auditors.
23.1.2 Consent of Ernst & Young, LLP, Independent Auditors.
23.1.3 Consent of Reconta Ernst & Young S.p.A., Independent Auditors.
23.2* Consent of Wilson Sonsini Goodrich & Rosati, Professional
Corporation (see Exhibit 5.1).
24.1** Power of Attorney.
27.1 Financial Data Schedules.
</TABLE>
- --------
+ Confidential treatment has been requested for certain portions of this
exhibit. The omitted portions have been separately filed with the
Commission.
* To be filed by amendment
** Previously filed
(b) Financial Statement Schedules
Schedule II--Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
Item 17. Undertakings
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the provisions referenced in Item 14 of this
registration statement or otherwise, the registrant has been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred or
paid by a director, officer, or controlling person of the
II-4
<PAGE>
registrant in the successful defense of any action, suit or proceeding) is
asserted by a director, officer or controlling person in connection with the
securities being registered hereunder, 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, as amended, the
registrant has duly caused this Amendment to the Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of San Francisco, State of California, on the 22nd day of March, 2000.
Linuxcare, Inc.
/s/ Fernand Sarrat
By: __________________________________
Fernand Sarrat
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<C> <S> <C>
/s/ Fernand Sarrat President and Chief Executive March 22, 2000
_______________________________ Officer and Director
Fernand Sarrat (Principal Executive Officer)
/s/ Christian Paul Chief Financial Officer March 22, 2000
_______________________________ (Principal Financial and
Christian Paul Accounting Officer)
* Director March 22, 2000
_______________________________
Arthur Tyde III
* Chairman of the Board of March 22, 2000
_______________________________ Directors
Ted E. Schlein
* Director March 22, 2000
_______________________________
Paul Vais
* Director March 22, 2000
_______________________________
John Drew
* Director March 22, 2000
_______________________________
Regis McKenna
* Director March 22, 2000
_______________________________
Ernest von Simson
</TABLE>
/s/ Christian Paul
*By: _________________
Christian Paul, Attorney- March 22, 2000
in-fact
II-6
<PAGE>
Report of Ernst & Young LLP, Independent Auditors
To the Board of Directors and Stockholders of
Linuxcare, Inc.:
We have audited the consolidated balance sheets of Linuxcare, Inc. and
subsidiaries as of December 31, 1998 and 1999, and the related consolidated
statements of operations, stockholders' deficit and cash flows from December 9,
1998 (inception) to December 31, 1998 and for the year ended December 31, 1999,
and have issued our report thereon date February 14, 2000, except for Note 8,
paragraph 6, which is dated March 20, 2000 (included elsewhere in this
Registration Statement). Our audits also included the financial statement
schedule listed in Item 16(b) of this Registration Statement. This schedule is
the responsibility of the Company's management. Our responsibility is to
express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Palo Alto, California
February 14, 2000
<PAGE>
Schedule II--Valuation and Qualifying Accounts
Linuxcare Inc. and Subsidiaries
December 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COL. A COL. B COL. C COL. D COL. E
- -------------------------------------------------------------------------------
Additions
-----------------
Balance at Charged Charged Balance at
Beginning to to other End
Description of Period expenses accounts Deductions of Period
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31,
1999:
Allowance for Doubtful
Accounts................. -- $76,000 -- -- $76,000
Year Ended December 31,
1998:
Allowance for Doubtful
Accounts................. -- -- -- -- --
</TABLE>
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
1.1* Form of Underwriting Agreement.
2.1.1** Share Exchange Agreement with Puffin Group, dated October 1, 1999.
2.1.2** Quota Purchase Agreement dated December 30, 1999.
3.1** Amended and Restated Certificate of Incorporation of the
Registrant.
3.2** Bylaws of the Registrant.
4.1* Form of stock certificates.
4.2** Second Amended and Restated Investors' Rights Agreement, dated
December 17, 1999.
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional
Corporation.
10.1** Form of Indemnification Agreement between the Registrant and each
of its directors and officers.
10.2.1** Master Services Agreement with Amdahl Corporation, dated November
5, 1999.
10.2.2+** Support Training and Certification Agreement with Dell Products, LP
regarding support services, dated October 22, 1999.
10.2.3+** Master Services Agreement with Hewlett-Packard Company, dated
January 6, 2000.
10.2.4+** Master Services Agreement with Densa Techno Tokyo Co., Ltd., dated
June 1, 1999.
10.2.5** Statement of Work with IBM Global Services, dated October 21, 1999.
10.2.6** Master Outsourcing Agreement with Motorola, dated August 6, 1999.
10.2.7+** Consulting Services Agreement with Macmillan USA, Inc., dated
August 30, 1999.
10.2.8+** Master Services Agreement with NEC Software Ltd., dated June 1,
1999.
10.2.9+** Master Services Agreement with Sun Microsystems, Inc., dated
October 20, 1999.
10.2.10+** StarOffice Support Services Agreement with Sun Microsystems, Inc.
dated September 24, 1999.
10.2.11** Consulting Services Agreement with Silicon Graphics, Inc. dated
April 30, 1999.
10.3.1** Lease Agreement with Euro Business Center, dated September 17,
1999.
10.3.2** Lease Agreement with Swallowfield Office Services Limited, dated
November 1, 1999.
10.3.3** Third amendment to lease with ZORO, LLC, dated October 7, 1999.
10.3.4** Lease Agreement for 650 Townsend Street, dated February 11, 1999.
10.4** Amended and Restated 1999 Stock Option Plan and form of agreements
thereunder.
10.5** 2000 Employee Stock Purchase Plan.
10.6** 2000 Director Option Plan.
11.1* Statement regarding computation of per share earnings.
12.1* Statements regarding computation of ratios.
21.1* Subsidiaries of the registrant.
23.1.1 Consent of Ernst & Young, LLP, Independent Auditors.
23.1.2 Consent of Ernst & Young, LLP, Independent Auditors.
23.1.3 Consent of Reconta Ernst & Young S.p.A., Independent Auditors.
23.2* Consent of Wilson Sonsini Goodrich & Rosati, Professional
Corporation (see Exhibit 5.1).
24.1** Power of Attorney.
27.1 Financial Data Schedule.
</TABLE>
- --------
+ Confidential treatment has been requested for certain portions of this
exhibit. The omitted portions have been separately filed with the
Commission.
* To be filed by amendment
** Previously filed
<PAGE>
Exhibit 23.1.1
Consent of Ernst & Young LLP, Independent Auditors
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated February 14, 2000, except for Note 8, paragraph 6
which is dated March 20, 2000, in the Registration Statement (Form S-1
Amendment No. 2 No. 333-94985) and related Prospectus of Linuxcare, Inc. for
the registration of 4,500,000 shares of common stock.
/s/ Ernst & Young LLP
Palo Alto, California
March 20, 2000
<PAGE>
Exhibit 23.1.2
Consent of Ernst & Young LLP, of Independent Auditors
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated January 7, 2000, in the Registration Statement
(Form S-1 Amendment No. 2 No. 333-94985) and related Prospectus of Linuxcare,
Inc. for the registration of 4,500,000 shares of common stock.
/s/ Ernst & Young LLP
Ottawa, Canada
March 20, 2000
<PAGE>
Exhibit 23.1.3
Consent of Reconta Ernst & Young S.p.A., Independent Auditors
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated February 7, 2000, in the Registration Statement
(Form S-1 Amendment No. 2 No. 333-94985) and related Prospectus of Linuxcare,
Inc. for the registration of 4,500,000 shares of common stock.
/s/ Reconta Ernst & Young S.p.A
Milan, Italy
March 20, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> OTHER YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1999
<PERIOD-START> DEC-09-1998 JAN-01-1999
<PERIOD-END> DEC-31-1998 DEC-31-1999
<CASH> 138,920 29,994,575
<SECURITIES> 0 0
<RECEIVABLES> 0 726,904
<ALLOWANCES> 0 76,000
<INVENTORY> 0 0
<CURRENT-ASSETS> 200,300 31,724,320
<PP&E> 0 2,584,673
<DEPRECIATION> 0 208,849
<TOTAL-ASSETS> 200,300 36,366,003
<CURRENT-LIABILITIES> 13,458 6,694,561
<BONDS> 0 0
0 0
0 40,374,016
<COMMON> 706 969
<OTHER-SE> (13,864) (12,629,561)
<TOTAL-LIABILITY-AND-EQUITY> 200,300 36,366,003
<SALES> 0 1,210,806
<TOTAL-REVENUES> 0 1,210,806
<CGS> 0 2,814,546
<TOTAL-COSTS> 13,458 18,919,453
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 468,267
<INCOME-PRETAX> (13,458) (20,946,399)
<INCOME-TAX> 0 4,200
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (13,458) (21,210,979)
<EPS-BASIC> 0 (7.49)
<EPS-DILUTED> 0 (2.26)
</TABLE>
