<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 16, 1999
REGISTRATION NO. 333-80051
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
RED HAT, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 7375 06-1364380
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
------------------------
2600 MERIDIAN PARKWAY
DURHAM, N.C. 27713
(919) 547-0012
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
------------------------------
ROBERT F. YOUNG
Chairman and Chief Executive Officer
Red Hat, Inc.
2600 Meridian Parkway
Durham, NC 27713
(919) 547-0012
(Name, address including zip code, and telephone number, including area code, of
agent for service)
------------------------------
COPIES TO:
<TABLE>
<S> <C>
WILLIAM J. SCHNOOR, JR., ESQ. MARK G. BORDEN, ESQ.
GREGG A. GRINER, ESQ. PATRICK J. RONDEAU, ESQ.
Testa, Hurwitz & Thibeault, LLP Hale and Dorr LLP
125 High Street 60 State Street
Boston, Massachusetts 02110 Boston, Massachusetts 02109
Telephone: (617) 248-7000 Telephone: (617) 526-6000
Telecopy: (617) 248-7100 Telecopy: (617) 526-5000
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date hereof.
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. / /
------------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE AGGREGATE OFFERING AGGREGATE OFFERING REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED (1) PRICE PER SHARE PRICE (2) FEE(3)
<S> <C> <C> <C> <C>
Common Stock, $.0001 par value.................... 6,900,000 $12.00 $82,800,000 $0
</TABLE>
(1) Includes 900,000 shares of common stock which may be purchased by the
underwriters to cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(a) under the Securities Act of 1933, as amended.
(3) A registration fee of $31,970 was paid at the time of the initial filing of
this registration statement based on an estimate of the aggregate offering
price.
------------------------------
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 THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION. DATED JULY 16, 1999.
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PRELIMINARY
PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
6,000,000 Shares
[LOGO]
Common Stock
----------------
This is an initial public offering of shares of Red Hat, Inc. All of the
6,000,000 shares of common stock are being sold by Red Hat. It is currently
estimated that the initial public offering price per share will be between
$10.00 and $12.00.
At the request of Red Hat, the underwriters have reserved up to 800,000
shares of common stock for sale at the initial public offering price, to
directors, officers, employees and friends of Red Hat through a directed share
program.
Prior to this offering, there has been no public market for the common
stock. Application has been made for quotation of the common stock on the Nasdaq
National Market under the symbol "RHAT".
SEE "RISK FACTORS" BEGINNING ON PAGE 6 TO READ ABOUT CERTAIN FACTORS YOU
SHOULD CONSIDER BEFORE BUYING SHARES OF THE COMMON STOCK.
------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY
HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY OR
ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
<TABLE>
<CAPTION>
Per Share Total
-------------------- --------------------
<S> <C> <C>
Initial public offering price................... $ $
Underwriting discount........................... $ $
Proceeds, before expenses, to Red Hat........... $ $
</TABLE>
If the underwriters sell more than 6,000,000 shares of common stock, the
underwriters have the option to purchase up to an additional 900,000 shares from
Red Hat at the initial public offering price less the underwriting discount.
------------------------
The underwriters expect to deliver the shares against payment in New York,
New York on , 1999.
GOLDMAN, SACHS & CO.
THOMAS WEISEL PARTNERS LLC
HAMBRECHT & QUIST
E*TRADE SECURITIES, INC.
------------------------
Prospectus dated , 1999.
<PAGE>
DESCRIPTION OF INSIDE BACK COVER:
[Graphic Description]
This inside back cover contains the following:
Awards Red Hat has won in the last three years with the graphical
representations or logos of each award. The presentation of the awards is
surrounded by the words "And the Winner is... Red Hat Linux". The Red Hat
"Shadow Man" logo appears above the award presentation.
<PAGE>
DESCRIPTION OF INSIDE FRONT COVER:
[Graphic Description]
This inside front cover contains the following:
A picture of the shrink-wrapped Official Red Hat Linux 6.0 operating system
package. This picture is surrounded by the names of entities which are OEM,
distribution or marketing partners of Red Hat. The Red Hat "Shadow Man" logo
appears in the lower right corner of the page.
<PAGE>
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION AND OUR FINANCIAL STATEMENTS AND NOTES TO THOSE STATEMENTS APPEARING
ELSEWHERE IN THIS PROSPECTUS.
RED HAT
OUR BUSINESS
We are a leading developer and provider of open source software and
services, including the Red Hat Linux operating system. Unlike proprietary
software, open source software has publicly available source code and can be
copied, modified and distributed with minimal restrictions. Our web site,
REDHAT.COM, is a leading online source of information and news about open source
software and one of the largest online communities of open source software users
and developers. In addition to offering extensive content for the open source
community, REDHAT.COM serves as an important forum for open source software
development and offers software downloads and a shopping site. Our broad range
of professional services includes technical support, training and education,
custom development, consulting and hardware certification. We are committed to
serving the interests and needs of open source software users and developers and
to sharing all of our product developments with the open source community.
Red Hat Linux is our principal product. Since its introduction in 1994, we
believe Red Hat Linux has emerged as the most popular Linux-based operating
system in the world. Red Hat Linux represented approximately 56% of new license
shipments of Linux-based server operating systems in 1998, according to
International Data Corporation. Our web site had over 265,000 unique visitors
and approximately 2.5 million page views during March 1999. A unique visitor is
an individual visitor to our REDHAT.COM web site. Page views are the total
number of complete pages retrieved and viewed by visitors to REDHAT.COM. We
generated approximately $10.8 million in revenue for the fiscal year ended
February 28, 1999, primarily from the sale of Official Red Hat Linux. Our
products are also generally available via free download from REDHAT.COM and
other sites across the internet, but do not include technical support or printed
user documentation in these instances. Companies with which we have strategic
alliances or investment relationships include Compaq, Dell, IBM, Intel,
Netscape, Novell, Oracle, SAP and Silicon Graphics.
OUR MARKET OPPORTUNITY
The rapid growth of the internet in recent years has accelerated the
development of open source software. Under the open source software model,
software is created through the collaborative efforts of large communities of
independent developers. Developers work alone or in groups to write code, make
the code available over the internet, solicit feedback on it from other
developers, then modify and share it with others for general use. This
continuous process results in the rapid evolution and improvement of open source
software.
We believe open source software offers many potential benefits for software
customers, users and vendors. Customers and users are able to acquire the
software at little or no cost, install the software on as many computers as they
wish, and customize the software to suit their particular needs. In addition,
customers and users can obtain software updates, improvements and support from
multiple vendors, reducing reliance on any single vendor. Vendors are able to
leverage the community of open source developers, allowing them to reduce
development costs and decrease their time to market. Vendors are also able to
distribute their products freely over the internet, enabling them to create
large global user bases quickly.
Open source software is particularly well-suited to the internet and
includes the
2
<PAGE>
following leading internet software and server products:
- Apache Web Server--the most common web server in use today;
- Perl--a standard scripting language for Apache servers; and
- Sendmail--an e-mail routing tool that handles a majority of all e-mail
traffic.
Operating systems based on the Linux kernel are some of the better known
open source products. Linux-based operating systems represented 17% of new
license shipments of server operating systems in 1998, according to
International Data. Despite strong initial market acceptance, these operating
systems have been slow to penetrate large corporations at the enterprise level
due in part to the lack of viable open source industry participants to offer
technical support and other services on a long-term basis.
OUR STRATEGY
We seek to enhance our position as a leading provider of open source
software and services by:
- continuing to enhance our web site to create the definitive online
destination for the open source community;
- expanding our professional services capabilities to capture large
corporate business on an enterprise basis;
- increasing market acceptance of open source software, particularly through
technology alliances and sharing our development efforts and resources
with third-party developers;
- continuing to invest in the development of open source technology; and
- enhancing the Red Hat brand through targeted advertising and public
relations campaigns.
OUR HISTORY
Red Hat, Inc. was incorporated in Connecticut in March 1993 as ACC Corp.,
Inc. In September 1995, ACC Corp., Inc. changed its name to Red Hat Software,
Inc. In September 1998, Red Hat Software, Inc. reincorporated in Delaware. In
June 1999, Red Hat Software, Inc. changed its name to Red Hat, Inc. Unless the
context otherwise requires, any reference to "Red Hat", "we", "our" and "us" in
this prospectus refers to Red Hat, Inc., a Delaware corporation, and its
subsidiaries and predecessors. Our principal executive offices are located at
2600 Meridian Parkway, Durham, N.C. 27713. Our telephone number is (919)
547-0012.
"Red Hat", the Red Hat "Shadow Man" logo, "RPM", and "PowerTools" are
trademarks or service marks of Red Hat, Inc. Other trademarks and tradenames in
this prospectus are the property of their respective owners.
Except as presented in the financial statements or as otherwise specified in
this prospectus, all information in this prospectus:
- assumes no exercise of the underwriters' over-allotment option;
- reflects a 2-for-1 stock split of the common stock which will occur prior
to the closing of this offering; and
- reflects the automatic conversion of all outstanding shares of our
preferred stock into a total of 33,945,452 shares of common stock upon the
closing of this offering.
3
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Shares offered by Red Hat.................... 6,000,000 shares
Shares to be outstanding after the 66,579,704 shares
offering.....................................
Use of proceeds.............................. To provide working capital and for other
general corporate purposes including
geographic expansion. See "Use of Proceeds".
Proposed Nasdaq National Market symbol....... RHAT
</TABLE>
The number of shares of common stock to be outstanding after the offering is
based on the number of shares outstanding on June 30, 1999. This number does not
include 5,176,888 shares of common stock issuable upon the exercise of stock
options outstanding on June 30, 1999 with a weighted average exercise price of
$1.58 per share or 3,197,450 shares of common stock issuable upon exercise of
warrants outstanding on June 30, 1999 with an exercise price of $.0001 per
share. This number also does not include an aggregate of 9,011,860 shares
reserved for future stock option grants and purchases under Red Hat's equity
compensation plans. See "Management-- Employee Benefit Plans" and note 11 of
notes to financial statements.
4
<PAGE>
SUMMARY FINANCIAL DATA
The following table summarizes the financial data of our business. You
should read this information with the discussion in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our financial
statements and notes to those statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED FEBRUARY 28, MAY 31,
------------------------------------------------------- --------------------
1995 1996(1) 1997 1998 1999 1998 1999
--------- ----------- --------- --------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue.......................................... $ 482 $ 930 $ 2,603 $ 5,156 $ 10,790 $ 1,551 $ 2,797
Net income (loss)................................ (128) (155) 33 8 (91) (53) (2,017)
Net income (loss) available to common
stockholders................................... (128) (155) 33 8 (130) (53) (2,060)
Earnings (loss) per common share:
Basic.......................................... $ (0.01) $ (0.01) $ 0.00 $ 0.00 $ (0.01) $ 0.00 $ (0.08)
Diluted........................................ (0.01) (0.01) 0.00 0.00 (0.01) 0.00 (0.08)
Weighted average common shares outstanding:()
Basic.......................................... 12,000 22,626 23,500 23,500 23,550 23,500 24,383
Diluted........................................ 12,000 22,626 27,233 34,578 23,550 23,500 24,383
Pro forma earnings (loss) per common share:
Basic.......................................... $ (0.01) $ (0.01) $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ (0.03)
Diluted........................................ (0.01) (0.01) 0.00 0.00 0.00 0.00 (0.03)
Pro forma weighted average common shares
outstanding:
Basic.......................................... 12,000 22,626 23,500 30,842 43,930 37,103 57,782
Diluted........................................ 12,000 22,626 27,233 34,578 43,930 37,103 57,782
</TABLE>
- ------------------------------
(1) Red Hat's fiscal year ended on February 29, 1996.
The following table presents a summary of our balance sheet at May 31, 1999:
- on an actual basis;
- on a pro forma basis to reflect conversion of all outstanding shares of
our preferred stock into a total of 33,945,452 shares of common stock,
which will occur upon closing of this offering; and
- on a pro forma as adjusted basis to reflect the sale of 6,000,000 shares
of common stock in this offering at an assumed initial public offering
price of $11.00 per share after deducting the estimated underwriting
discount and offering expenses.
<TABLE>
<CAPTION>
MAY 31, 1999
-------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............................... $ 13,982 $ 13,982 $ 74,112
Working capital......................................... 13,217 13,217 73,347
Total assets............................................ 22,162 22,162 82,292
Long-term liabilities................................... 385 385 385
Mandatorily redeemable preferred stock.................. 15,338 -- --
Total stockholders' equity (deficit).................... (196) 15,142 75,272
</TABLE>
5
<PAGE>
RISK FACTORS
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER
THE RISKS DESCRIBED BELOW AND THE OTHER INFORMATION IN THIS PROSPECTUS BEFORE
DECIDING TO INVEST IN THE SHARES OF COMMON STOCK.
RISKS RELATED TO OUR LINUX-BASED OPEN SOURCE BUSINESS MODEL
OUR BUSINESS MAY NOT SUCCEED BECAUSE OPEN SOURCE SOFTWARE BUSINESS MODELS ARE
UNPROVEN
We have not demonstrated the success of our open source business model,
which gives our customers the right freely to copy and distribute our software.
No other company has built a successful open source business. 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 on a long term basis. In addition, open source vendors are not able to
provide industry standard warranties and indemnities for their products, since
these products have been developed largely by independent parties over whom open
source vendors exercise no control or supervision. If open source software
should fail to gain widespread commercial acceptance, we would not be able to
sustain our revenue growth and our business could fail.
OUR RELIANCE ON THE SUPPORT OF LINUS TORVALDS AND OTHER PROMINENT LINUX
DEVELOPERS COULD IMPAIR OUR ABILITY TO RELEASE MAJOR PRODUCT UPGRADES AND
MAINTAIN MARKET SHARE
We may not be able to release major product upgrades of Red Hat Linux on a
timely basis because the heart of Red Hat Linux, the Linux kernel, is maintained
by third parties. Linus Torvalds, the original developer of the Linux kernel and
a small group of independent engineers are primarily responsible for the
development and evolution of the Linux kernel. If this group of developers fails
to further develop the Linux kernel or if Mr. Torvalds or other prominent Linux
developers, such as Alan Cox, David Miller or Stephen Tweedie, were to join one
of our competitors or no longer work on the Linux kernel, we will have to either
rely on another party to further develop the kernel or develop it ourselves. We
cannot predict whether enhancements to the kernel would be available from
reliable alternative sources. We could be forced to rely to a greater extent on
our own development efforts, which would increase our development expenses and
may delay our product release and upgrade schedules. In addition, any failure on
the part of the kernel developers to further develop and enhance the kernel
could stifle the development of additional Linux-based applications.
OUR SOFTWARE IS DIFFICULT FOR US TO ASSEMBLE AND TEST BECAUSE IT CONSISTS
LARGELY OF CODE DEVELOPED BY INDEPENDENT THIRD PARTIES
Red Hat Linux, in compressed form, consists of approximately 573 megabytes
of code. Of that total, approximately 500 megabytes have been developed by
independent third parties, including approximately 10 megabytes of code
contained in the Linux kernel. Included within the 573 megabytes of code are
approximately 645 distinct software components developed by thousands of
individual programmers which we must assemble and test before we can release a
new version of Red Hat Linux. If these components are not reliable, Red Hat
Linux could fail, resulting in serious damage to our reputation and potential
litigation. Although we attempt to assemble only the best available components,
we cannot be sure that we will be able to identify the highest quality and most
reliable components or to successfully assemble and test them. In addition, if
these components were no longer available, we would have to develop them
ourselves, which would significantly increase our development expenses.
6
<PAGE>
THE SCARCITY OF SOFTWARE APPLICATIONS FOR LINUX-BASED OPERATING SYSTEMS COULD
PREVENT COMMERCIAL ADOPTION OF OUR PRODUCTS
Our products will not gain widespread commercial adoption until there are
more third-party software applications designed to operate on Linux-based
operating systems. These applications include word processors, databases,
accounting packages, spreadsheets, e-mail programs, internet browsers,
presentation and graphics software and personal productivity applications. We
intend to encourage the development of additional applications that operate on
Linux-based operating systems by attracting third-party developers to the Linux
platform and by maintaining our existing developer relationships through
marketing and technical support for third-party developers. If we are not
successful in achieving these goals, however, our products will not gain
widespread commercial acceptance and we will not be able to maintain our product
sales growth.
OUR ABILITY TO GENERATE REVENUE FROM SALES OF OFFICIAL RED HAT LINUX MAY BE
ADVERSELY AFFECTED IF USERS CAN MORE QUICKLY DOWNLOAD IT FROM THE INTERNET
Anyone can download a free copy of Red Hat Linux from the internet. However,
because this download can take up to 36 hours using a standard telephone
connection, many of our users choose to buy the shrink-wrapped version of
Official Red Hat Linux. If hardware and data transmission technology advances in
the future to the point where increased bandwidth allows users to more quickly
download our products from the internet, users may no longer choose to purchase
Official Red Hat Linux. This could lead to a significant loss of product
revenue.
THE DIFFICULTY OF CUSTOMER DEPLOYMENT OF RED HAT LINUX COULD LEAD TO CUSTOMER
DISSATISFACTION AND DAMAGE OUR REPUTATION
Deployment of Red Hat Linux often involves a significant commitment of
resources, financial and otherwise, by our customers. The deployment process can
be lengthy due to the size and complexity of our products and the need to
purchase and install new applications. The failure by us to attract and retain
services personnel to support our customers, the failure of companies with which
we have strategic alliances to commit sufficient resources towards deploying our
products, or a delay in deployment for any other reason could result in
dissatisfied customers. This could damage our reputation and the Red Hat brand,
resulting in decreased product revenue.
NEGATIVE REACTION WITHIN THE OPEN SOURCE COMMUNITY TO OUR BUSINESS STRATEGY
COULD HARM OUR REPUTATION AND BUSINESS
Some members of the open source software community have criticized the
expansion of our strategic focus in online chat rooms, electronic bulletin
boards and articles posted on the web. These critics argue that our strategy
could fragment the Linux community into a variety of competing factions,
resulting in a less cohesive and cooperative development process. Others have
suggested that by expanding our focus, we are trying to dominate the market for
Linux-based operating systems and the open source community in the same way that
some companies have been able to dominate the traditional software markets. This
type of negative reaction, if widely shared by our customers, developers or the
rest of the open source community, could harm our reputation, diminish the Red
Hat brand and result in decreased revenue.
7
<PAGE>
RISKS RELATED TO OUR FINANCIAL RESULTS AND CONDITION
OUR LIMITED OPERATING HISTORY IN THE NEW AND DEVELOPING MARKET FOR LINUX- BASED
OPERATING SYSTEMS MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS
Red Hat was formed in March 1993. We began offering Red Hat Linux in October
1994. Our limited operating history makes it difficult to evaluate the risks and
uncertainties that we face. Our failure to address these risks and uncertainties
could cause our business results to suffer and result in the loss of all or part
of your investment.
WE EXPECT TO INCUR SUBSTANTIAL LOSSES IN THE FUTURE
We have incurred operating losses in four of our previous five fiscal years,
including our most recent fiscal year ended February 28, 1999. We expect to
incur significant losses at least through the fiscal year ending February 28,
2001 as we substantially increase our sales and marketing, research and
development and administrative expenses. In addition, we are investing
considerable resources in our web initiative. As a result, we cannot be certain
when or if we will achieve sustained profitability. Failure to become and remain
profitable may adversely affect the market price of our common stock and our
ability to raise capital and continue operations. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Overview",
"--Results of Operations" and "--Liquidity and Capital Resources".
YOU SHOULD NOT RELY ON OUR QUARTERLY RESULTS OF OPERATIONS AS AN INDICATION OF
OUR FUTURE RESULTS BECAUSE THEY FLUCTUATE SIGNIFICANTLY AND ARE DIFFICULT TO
FORECAST
Due to our limited operating history and the unpredictability of our
business, our revenue and operating results may fluctuate significantly from
quarter to quarter and are difficult to forecast. We base our current and
projected future expense levels in part on our estimates of future revenue. Our
expenses are to a large extent fixed in the short term. We may not be able to
adjust our spending quickly if our revenue falls short of our expectations.
Accordingly, a revenue shortfall in a particular quarter would have a
disproportionate adverse effect on our operating results for that quarter. You
should not rely on quarter-to-quarter comparisons of our results of operations
as an indication of our future performance. Our future operating results may
fall below expectations of securities analysts or investors, which would likely
cause the market price of our common stock to decline significantly. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-- Quarterly Results of Operations".
OUR INTERNAL SYSTEMS, PROCEDURES AND CONTROLS MAY BE INADEQUATE TO SUPPORT OUR
EXPECTED GROWTH
To manage our growth, we must improve our operational and financial systems,
procedures and controls. We cannot assure you that we will successfully do so.
If our internal systems, procedures and controls are inadequate, our business
will be harmed.
TO SUCCEED IN IMPLEMENTING OUR BUSINESS PLAN WE MUST RECRUIT AND RETAIN
QUALIFIED PROFESSIONALS, WHO ARE CURRENTLY IN HIGH DEMAND
We compete intensely with other software companies to recruit and hire from
a limited pool of qualified personnel. Many qualified candidates may be
unwilling to relocate to our headquarters in North Carolina. If we cannot hire,
train and manage additional qualified sales and marketing, professional services
and software engineering and development personnel, our business results will
suffer.
IF OUR MANAGEMENT TEAM IS NOT ABLE TO WORK TOGETHER EFFECTIVELY OUR BUSINESS
WILL BE SUBSTANTIALLY WEAKENED
Our business is highly dependent on the ability of our management to work
together effectively to meet the demands of our growth. Several members of our
senior management
8
<PAGE>
joined us in 1998 and 1999, including our President, Matthew Szulik, and our
Chief Operating Officer, Tim Buckley. We are also actively searching for a new
Chief Financial Officer and expect to hire one within the next few months. These
individuals have not previously worked together as a management team. In
addition, the members of our management team who have been with us since 1997 or
earlier have had only limited experience managing a rapidly growing company on
either a public or private basis. If our senior managers are not able to work
together effectively, we will not be able to execute our business strategies or
grow our revenue.
IF WE LOSE ROBERT YOUNG, MATTHEW SZULIK, TIM BUCKLEY, MARC EWING OR OTHER KEY
PERSONNEL, OUR BUSINESS WOULD SUFFER
Our future success depends on the continued services of a number of key
officers, including our Chairman and Chief Executive Officer, Robert Young; our
President, Matthew Szulik; our Chief Operating Officer, Tim Buckley; and our
Executive Vice President and Chief Technology Officer, Marc Ewing. The loss of
the technical knowledge and industry expertise of any of these officers could
seriously impede our success. Moreover, the loss of one or a group of our key
employees, particularly to a competitor, and any resulting loss of customers
could reduce our market share and diminish the Red Hat brand.
WE MAY NOT BE ABLE TO EFFECTIVELY COMPETE AGAINST MICROSOFT AND OTHER
ESTABLISHED OPERATING SYSTEMS DEVELOPERS AND OTHER SERVICE AND SUPPORT
PROVIDERS
In the market for operating systems, we face significant competition from
larger companies with greater financial resources and name recognition than we
have. These competitors, which offer hardware-independent multi-user operating
systems for Intel platforms and/or UNIX-based operating systems, include
Microsoft, Novell, IBM, Sun Microsystems, The Santa Cruz Operation, AT&T,
Compaq, Hewlett-Packard, Olivetti and Unisys. We do not believe that any of
these competitors currently produce and market any open source software
products.
As we increase our services offerings, we may face competition from larger
and more capable companies that currently service and support other operating
systems, particularly UNIX-based operating systems, due to the fact that Linux-
and UNIX-based operating systems share many common features. These companies may
be able to leverage their existing service organizations and provide higher
levels of support on a more cost-effective basis than we can. We may not be able
to compete successfully with these current or potential competitors. See
"Business--Competition".
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY AGAINST OTHER SUPPLIERS OF LINUX-BASED
AND OTHER OPEN SOURCE OPERATING SYSTEMS
In the new and rapidly-evolving market for Linux-based operating systems, we
face intense competition from a number of other suppliers of Linux-based
operating systems. We also face competition to a lesser extent from developers
of non-Linux-based open source operating systems such as BSD-based operating
systems. BSD-based operating systems such as FreeBSD, NetBSD and OpenBSD are
open source operating systems produced by communities of developers working
together via the internet, and which are published and distributed by Walnut
Creek CD-ROM, among others. We expect competition in broader open source
operating systems and the Linux-based operating systems market to intensify. In
addition, companies like Sun Microsystems, Corel and Cygnus Solutions, which
have large customer bases and greater financial resources and name recognition
than we do, have indicated a growing interest in the market for Linux-based
operating systems. These companies 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. Furthermore, because
Linux-based operating systems can be downloaded from the internet for free or
purchased at a nominal cost and modified and re-sold with few restrictions,
9
<PAGE>
traditional barriers to entry are minimal. Accordingly, it is possible that new
competitors or alliances among existing competitors may emerge and rapidly
acquire significant market share. See "Business--Competition".
IF WE FAIL TO ESTABLISH AND MAINTAIN STRATEGIC DISTRIBUTION AND OTHER
COLLABORATIVE RELATIONSHIPS WITH INDUSTRY-LEADING COMPANIES, WE MAY NOT BE
ABLE TO ATTRACT AND RETAIN A LARGER CUSTOMER BASE
Our success depends on our ability to continue to establish and maintain
strategic distribution and other collaborative relationships with
industry-leading hardware manufacturers, distributors, software vendors and
enterprise solutions providers. These relationships allow us to offer our
products and services to a much larger customer base than we would otherwise be
able to through our direct sales and marketing efforts. We may not be able to
maintain these relationships or replace them on attractive terms.
In addition, our existing strategic relationships do not, and any future
strategic relationships may not, afford us any exclusive marketing or
distribution rights. As a result, the companies with which we have strategic
alliances are free to pursue alternative technologies and to develop alternative
products and services in addition to or in lieu of our products and services,
either on their own or in collaboration with others, including our competitors.
Moreover, we cannot guarantee that the companies with which we have strategic
relationships will market our products effectively or continue to devote the
resources necessary to provide us with effective sales, marketing and technical
support. See "Business--Sales, Marketing and Distribution".
ANY DISRUPTION IN OUR RELATIONSHIPS WITH OUR TWO LARGEST DISTRIBUTORS, ON WHOM
WE RELY FOR A SIGNIFICANT PERCENTAGE OF OUR PRODUCT REVENUE, COULD CAUSE OUR
REVENUE TO DECLINE
We are highly dependent on revenue from sales to our two largest
distributors, Frank Kasper & Associates and Ingram Micro, who together accounted
for approximately 54% of our total revenue for the fiscal year ended February
28, 1999. These distributors are not obligated to purchase products from us and
the loss of one or both of these distributors, or a reduction in the amount of
product sales generated by them, could significantly reduce our product revenue.
See "Business--Sales, Marketing and Distribution".
IF WE ARE NOT SUCCESSFUL IN EXPANDING OUR OVERSEAS REVENUE OUR FINANCIAL RESULTS
MAY SUFFER
A key component of our growth strategy is to expand our presence in foreign
markets. We have little experience in marketing and distributing products or
services for these markets and may not benefit from any first-to-market
advantages. It will be costly to establish international facilities and
operations, promote our brand internationally, and develop localized web sites
and other systems. Revenue from international activities may not offset the
expense of establishing and maintaining foreign operations.
As we expand our international operations, we will face a number of
additional risks associated with the conduct of business overseas, including:
- difficulties relating to the management and administration of a globally-
dispersed business;
- fluctuations in exchange rates;
- limitations on repatriation of earnings of our foreign operations;
- the burdens of complying with a wide variety of foreign laws;
- the uncertainty of laws and enforcement in certain countries relating to
the protection of intellectual property rights;
- reductions in business activity during the summer months in Europe and
certain other parts of the world;
- export controls;
- multiple and possibly overlapping tax structures;
10
<PAGE>
- changes in import/export duties and quotas; and
- economic or political instability in some international markets.
EXPANDING OUR SERVICES BUSINESS WILL BE COSTLY AND MAY NOT RESULT IN ANY BENEFIT
TO US
We have recently expanded our strategic focus to place additional emphasis
on consulting, custom development, education and support services, from which we
have historically derived an insignificant amount of revenue. We cannot be
certain that our customers will engage our professional services organization to
assist with support, consulting, custom development, training and implementation
of our products. We also cannot be certain that we can attract or retain a
sufficient number of the highly qualified services personnel that the expansion
of our services business will need. In addition, this expansion has required,
and will continue to require, significant additional expenses and development,
financial and operational resources. The need for these additional resources
will place further strain on our management, financial and operational resources
and may make it more difficult for us to achieve and maintain profitability.
WE MAY ENTER INTO BUSINESS COMBINATIONS AND STRATEGIC ALLIANCES WHICH WILL
STRAIN OUR FINANCIAL AND OPERATIONAL RESOURCES
We may expand our operations or market presence by entering into business
combinations, investments, joint ventures or other strategic alliances with
hardware manufacturers, software vendors, internet companies, open source
software developers or other companies. These transactions create risks such as:
- difficulty assimilating the operations, technology and personnel of the
combined companies;
- disruption of our ongoing business;
- problems retaining key technical and managerial personnel;
- one-time in-process research and development charges and ongoing expenses
associated with amortization of goodwill and other purchased intangible
assets;
- potential dilution to our stockholders;
- additional operating losses and expenses of acquired businesses;
- harm to our reputation caused by negative reactions within the open source
development community; and
- impairment of relationships with existing employees, customers and
business partners.
RISKS RELATED TO OUR INTERNET STRATEGY
WE WILL NOT BE ABLE TO ATTRACT NEW VISITORS, ADVERTISERS OR ELECTRONIC COMMERCE
PARTNERS IF WE FAIL TO PROMOTE AND ENHANCE OUR WEB SITE EFFECTIVELY
Enhancing the REDHAT.COM web site is critical to our ability to increase our
revenue. In order to attract and retain internet users, advertisers and
electronic commerce partners, we intend to substantially increase our
expenditures for enhancing and further developing our web site. Our success in
promoting and enhancing the REDHAT.COM web site will also depend on our ability
to provide high quality content, features and functionality. If we fail to
promote our web site successfully or if visitors to our web site or advertisers
do not perceive our services to be useful, current or of high quality, our
ability to generate revenue from our web site will be significantly impaired.
11
<PAGE>
OUR WEB SITE MAY NOT GENERATE THE REVENUE WE EXPECT DUE TO UNCERTAINTIES IN THE
DEMAND FOR AND MARKET ACCEPTANCE OF INTERNET ADVERTISING
As we execute our internet strategy, we expect to derive an increasing
percentage of our revenue from sponsorships and advertising on our web site.
Demand for and market acceptance of internet advertising is uncertain. There are
currently no standards for the measurement of the effectiveness of internet
advertising, and the industry may need to develop standard measurements to
support and promote internet advertising as a significant advertising medium. If
standards do not develop, existing advertisers may not continue their levels of
internet advertising. Furthermore, advertisers that have traditionally relied on
other advertising media may be reluctant to advertise on the internet. Our
ability to successfully execute our internet strategy will be adversely affected
if the market for internet advertising fails to develop or develops more slowly
than expected.
In addition, different pricing models are used to sell advertising on the
internet. It is difficult to predict which, if any, will emerge as the industry
standard. This makes it difficult to project our future advertising rates and
revenue. Our advertising revenue could be adversely affected if we are unable to
adapt to new forms of internet advertising pricing models. Moreover, software
programs that limit or prevent advertisements from being delivered to an
internet user's computer are available. Widespread adoption of this software
could adversely affect the commercial viability of internet advertising and our
ability to generate significant revenue from our web site.
WE MAY BE UNABLE TO ADEQUATELY MEASURE THE DEMOGRAPHICS OF VISITORS TO OUR WEB
SITE, WHICH IS CRITICAL TO OUR ABILITY TO ATTRACT ADVERTISING REVENUE
We expect that it will be important to our advertisers that we accurately
measure the demographics of the visitors to our web site. While we have not
committed significant resources to the measurement of demographics to date, we
are currently implementing systems designed to record demographic data on our
web site's visitors. This implementation may be costly, and if not done
effectively, may not permit us to accurately measure the demographic
characteristics of our web site's visitors. Until these new systems are
functional, we will continue to rely on third parties to provide some of these
measurement services. If these parties were unable to provide these services, we
would need to obtain them from other providers, which might not be readily
available. Companies may choose not to advertise on our web site or may pay less
for advertising if they do not perceive our measurements or measurements made by
third parties to be reliable.
OUR INTERNET STRATEGY WILL FAIL IF THE INFRASTRUCTURE OF THE INTERNET IS NOT
CONTINUALLY DEVELOPED AND MAINTAINED
The success of our internet strategy will depend in large part on the
continued development and maintenance of the infrastructure of the internet.
Because global commerce and the online exchange of information is new and
evolving, we cannot predict with any certainty that the internet will be a
viable commercial marketplace in the long term. The internet has experienced,
and we expect it to continue to experience, significant growth in the number of
users and amount of traffic. If the internet continues to experience an
increased number of users, frequency of use or increased bandwidth requirements
of users, it may not be able to support the demands placed upon it by this
growth, and its performance and reliability may suffer. Furthermore, the
internet has experienced a variety of outages and other delays as a result of
damage to portions of its infrastructure, and could face similar outages and
delays in the future. Any outage or delay could affect the level of internet
usage, as well as the volume of traffic on our web site. In addition, the
internet could lose its viability due to increased governmental regulation and
delays in the development or adoption of new standards and protocols to handle
increased levels of activity. If the necessary infrastructure, standards or
12
<PAGE>
protocols or complementary products, services or facilities are not developed,
or if the internet does not become a viable commercial marketplace, our internet
strategy will not succeed.
WE ARE VULNERABLE TO UNEXPECTED NETWORK INTERRUPTIONS CAUSED BY SYSTEM FAILURES,
WHICH MAY RESULT IN REDUCED VISITOR TRAFFIC ON OUR WEB SITE, DECREASED REVENUE
AND HARM TO OUR REPUTATION
Substantially all of our communications hardware and other hardware related
to our web site is located at our facilities, although we are considering
locating them to a third-party facility within the next six months. Fire,
floods, hurricanes, tornadoes, earthquakes, power loss, telecommunications
failures, break-ins and similar events could damage these systems. In addition,
although we have implemented network security measures, our servers are
vulnerable to computer viruses, electronic break-ins, human error and other
similar disruptive problems which could adversely affect our systems and web
site. Although we try to prevent unauthorized access to our systems, we cannot
eliminate this risk entirely. We could lose revenue and suffer damage to our
reputation if our systems were affected by any of these occurrences. Our
insurance policies may not adequately compensate us for any losses that may
occur due to failures or interruptions in our systems. We do not presently have
any secondary "off-site" systems or a formal disaster recovery plan.
VISITORS TO OUR WEB SITE COULD EXPERIENCE DELAYS AND DECREASED PERFORMANCE
DURING PERIODS OF HEAVY TRAFFIC, WHICH COULD RESULT IN DISSATISFACTION WITH
OUR WEB SITE AND DAMAGE TO OUR REPUTATION
Our web site must accommodate a high volume of traffic and deliver
frequently updated information. Our web site has in the past experienced slower
response times or decreased traffic for a variety of reasons. These occurrences
have not had a material impact on our business. These types of occurrences in
the future, however, could materially adversely affect our reputation and brand
name and could cause users to perceive our web site as not functioning properly.
Under these circumstances, our users might choose another web site or other
methods to obtain Linux-based operating systems or Linux-related information.
RISKS RELATED TO LEGAL UNCERTAINTY
WE COULD BE PREVENTED FROM SELLING OR DEVELOPING OUR PRODUCTS IF THE GNU GENERAL
PUBLIC LICENSE AND SIMILAR LICENSES UNDER WHICH OUR PRODUCTS ARE DEVELOPED AND
LICENSED ARE NOT ENFORCEABLE
The Linux kernel and the Red Hat Linux operating system have been developed
and licensed under the GNU General Public License and similar licenses. These
licenses state that any program licensed under them may be liberally copied,
modified and distributed. We know of no circumstance under which these licenses
have been challenged or interpreted in court. Accordingly, it is possible that a
court would hold 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 these licenses are not
enforceable, or that Linux-based operating systems, or significant portions of
them, may not be liberally copied, modified or distributed, would have the
effect of preventing us from selling or developing our products.
OUR PRODUCTS MAY CONTAIN DEFECTS THAT MAY BE COSTLY TO CORRECT, DELAY MARKET
ACCEPTANCE OF OUR PRODUCTS AND EXPOSE US TO LITIGATION
Despite testing by us and our customers, errors may be found in our products
after commencement of commercial shipments. This risk is exacerbated by the fact
that most of the code in our products is developed by independent parties over
whom we exercise no supervision or control. If errors are discovered, we may
have to make significant expenditures
13
<PAGE>
of capital to eliminate them and yet may not be able to successfully correct
them in a timely manner or at all. Errors and failures in our products could
result in a loss of, or delay in, market acceptance of our products and could
damage our reputation and our ability to convince commercial users of the
benefits of Linux-based operating systems and other open source software
products.
In addition, failures in our products could cause system failures for our
customers who may assert warranty and other claims for substantial damages
against us. Although our license agreements with our customers typically contain
provisions designed to limit our exposure to potential product liability claims,
it is possible that these provisions may not be effective or enforceable under
the laws of some jurisdictions. Our insurance policies may not adequately limit
our exposure to this type of claim. These claims, even if unsuccessful, could be
costly and time consuming to defend.
WE ARE VULNERABLE TO CLAIMS THAT OUR PRODUCTS INFRINGE THIRD-PARTY INTELLECTUAL
PROPERTY RIGHTS PARTICULARLY BECAUSE OUR PRODUCTS ARE COMPRISED OF MANY
DISTINCT SOFTWARE COMPONENTS DEVELOPED BY THOUSANDS OF INDEPENDENT PARTIES
We may be exposed to future litigation based on claims that our products
infringe the intellectual property rights of others. This risk is exacerbated by
the fact that most of the code in our products is developed by independent
parties over whom we exercise no supervision or control. Claims of infringement
could require us to reengineer our products or seek to obtain licenses from
third parties in order to continue offering our products. In addition, an
adverse legal decision affecting our intellectual property, or the use of
significant resources to defend against this type of claim, could place a
significant strain on our financial resources and harm our reputation.
OUR EFFORTS TO PROTECT OUR TRADEMARKS MAY NOT BE ADEQUATE TO PREVENT THIRD
PARTIES FROM MISAPPROPRIATING OUR INTELLECTUAL PROPERTY RIGHTS
Our most valuable intellectual property is our collection of trademarks. The
protective steps we have taken in the past have been, and may in the future
continue to be, inadequate to deter misappropriation of our trademark rights.
Although we do not believe that we have suffered any material harm from
misappropriation to date, we may be unable to detect the unauthorized use of, or
take appropriate steps to enforce, our trademark rights. We have registered some
of our trademarks in the United States, Europe and Australia and have other
trademark applications pending in Australia, Canada and Europe. Effective
trademark protection may not be available in every country in which we offer or
intend to offer our products and services. Failure to adequately protect our
trademark rights could damage or even destroy the Red Hat brand and impair our
ability to compete effectively. Furthermore, defending or enforcing our
trademark rights could result in the expenditure of significant financial and
managerial resources. See "Business-- Intellectual Property".
WE MAY BE SUED AS A RESULT OF INFORMATION PUBLISHED OR POSTED ON OR ACCESSIBLE
FROM OUR REDHAT.COM WEB SITE
We may be subjected to claims for defamation, negligence, copyright or
trademark infringement or other claims relating to the information we publish on
our web site. These types of claims have been brought, sometimes successfully,
against online services in the past, and can be costly to defend. We may also be
subjected to claims based on content that is accessible from our web site
through links to other web sites or through content and materials that may be
posted by visitors to our web site. We believe that the scope and amount of our
commercial and general liability insurance is appropriate, given our current
financial position. However, this insurance may not adequately protect us
against these types
14
<PAGE>
of claims. We have not been a party to any lawsuit of this type to date.
OUR SOFTWARE PRODUCTS, AS WELL AS THOSE OF OUR CUSTOMERS AND SUPPLIERS, COULD
FAIL AS A RESULT OF THE YEAR 2000 PROBLEM
We have conducted a review of Red Hat Linux and our internal systems to
identify functions that need correction to be "Year 2000 compliant". We have
not, however, tested our other products and have not tested or sought
certifications from third parties bundling software applications and components
with Official Red Hat Linux. Any failure by our products or third-party software
bundled with our products to function in the Year 2000 may decrease the value of
our products, give rise to warranty claims and tarnish the Red Hat brand.
Additionally, the Year 2000 problem may affect us by causing disruptions in the
business operations of, or delay technology purchases by, companies with which
we do business, such as customers and suppliers causing a decrease in our
product revenue. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Year 2000 Compliance".
RISKS RELATED TO THIS OFFERING
CONCENTRATION OF OWNERSHIP WILL LIMIT YOUR ABILITY TO INFLUENCE CORPORATE
MATTERS
Immediately following this offering, our directors, executive officers and
their affiliates will beneficially own approximately 67.7% of our outstanding
common stock. These stockholders could determine the outcome of actions taken by
us that require stockholder approval. For example, these stockholders could
elect all of our directors, delay or prevent a transaction in which stockholders
might receive a premium over the prevailing market price for their shares and
control changes in management.
PROVISIONS OF OUR CHARTER AND BY-LAWS MAY DELAY OR PREVENT TRANSACTIONS THAT
MANY STOCKHOLDERS MAY FAVOR
Provisions of our certificate of incorporation and by-laws may discourage,
delay or prevent a merger or acquisition that stockholders may consider
favorable, including transactions in which you might otherwise receive a premium
for your shares. These provisions include:
- authorizing the issuance of "blank check" preferred stock without any need
for action by stockholders;
- providing for a classified board of directors with staggered three-year
terms;
- requiring supermajority stockholder voting to effect certain amendments to
our certificate of incorporation and by-laws;
- eliminating the ability of stockholders to call special meetings of
stockholders;
- prohibiting stockholder action by written consent; and
- establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
Some provisions of Delaware law may also discourage, delay or prevent
someone from acquiring us or merging with us. See "Description of Capital
Stock--Delaware Law and Certain Charter and By-Law Provisions and Anti-Takeover
Effects".
MANAGEMENT MAY INVEST OR SPEND THE PROCEEDS FROM THIS OFFERING IN WAYS WITH
WHICH YOU MAY NOT AGREE
The primary purposes of this offering are to obtain additional capital,
create a public market for our common stock and facilitate future access to
public markets. We expect to use the net proceeds from this offering for working
capital and other general corporate purposes, including geographic expansion
overseas. Because of the number and variability of the factors that may
determine our use of the proceeds from this offering, we cannot assure
15
<PAGE>
you that you will agree with our use of proceeds.
OUR STOCK PRICE MAY BE EXTREMELY VOLATILE AND YOU MAY NOT BE ABLE TO RESELL YOUR
SHARES AT OR ABOVE THE INITIAL OFFERING PRICE
Following this offering, the price at which our common stock will trade may
be extremely volatile and may fluctuate significantly. We will determine the
initial public offering price of our common stock, together with the
underwriters, based on an assessment of the valuation of our stock. The public
market may not agree with or accept this valuation. In addition, the stock
market has from time to time experienced significant price and volume
fluctuations that have affected the market prices for the securities of
technology companies, particularly software and internet companies. After this
offering, therefore, you might not be able to resell your shares at or above the
initial public offering price.
FUTURE SALES OF OUR COMMON STOCK BY EXISTING INVESTORS AFTER THIS OFFERING MAY
DEPRESS OUR STOCK PRICE
Once a trading market develops for our common stock, many of our
stockholders will have an opportunity to sell their common stock for the first
time. Sales of a substantial number of shares of common stock in the public
market, or the threat that substantial sales might occur, could cause the market
price of the common stock to decrease significantly. These factors could also
make it difficult for us to raise additional capital by selling stock. See
"Shares Eligible for Future Sale".
16
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary", "Risk Factors",
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Business", and elsewhere in this prospectus constitute
forward-looking statements. In some cases, you can identify forward-looking
statements by terminology such as "may", "will", "should", "expects", "plans",
"anticipates", "believes", "estimated", "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 that may cause our or our industry's actual results, levels of
activity, performance, or achievements to be materially different from any
future results, levels of activity, performance, or achievements expressed or
implied by such forward-looking statements. These factors include, among other
things, those listed under "Risk Factors" and elsewhere in this prospectus.
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. We are under no duty to update any of
the forward-looking statements after the date of this prospectus to conform
forward-looking statements to actual results.
USE OF PROCEEDS
We estimate the net proceeds to us from the sale of 6,000,000 shares of
common stock in this offering to be approximately $60,130,000 assuming an
initial public offering price of $11.00 per share and after deducting the
estimated underwriting discount and offering expenses. If the underwriters'
over-allotment option is exercised in full, we estimate net proceeds to be
$69,337,000.
The principal purposes of this offering are to increase our capitalization
and financial flexibility, to provide a public market for the common stock and
to facilitate access to public equity markets.
We expect to use the net proceeds for working capital and other general
corporate purposes, including geographic expansion involving the establishment
of additional foreign offices and/or subsidiaries. We have not allocated any
specific portion of the net proceeds to any particular purpose, and our
management will have the ability to allocate the proceeds at its discretion. A
portion of the net proceeds may be used for the acquisition of businesses,
products and technologies that are complementary to our own. The net proceeds of
this offering will be invested in short-term, interest-bearing, investment-grade
securities until allocated for specific use.
DIVIDEND POLICY
We have never paid any cash dividends on our common stock and do not
anticipate paying any cash dividends in the foreseeable future. We presently
intend to retain future earnings, if any, to finance the expansion and growth of
our business. Payment of future dividends, if any, will be at the discretion of
our Board of Directors after taking into account various factors, including our
financial condition, operating results, current and anticipated cash needs and
plans for expansion.
17
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of Red Hat as of May 31,
1999:
- on an actual basis;
- on a pro forma basis after giving effect to the conversion of our
outstanding preferred stock into common stock which will occur upon the
closing of this offering; and
- on a pro forma as adjusted basis to reflect the sale of the 6,000,000
shares of common stock offered in this offering at an assumed initial
public offering price of $11.00 per share after deducting the estimated
underwriting discount and offering expenses.
The outstanding share information excludes 5,369,088 shares of common stock
issuable upon the exercise of stock options outstanding on May 31, 1999,
3,197,450 shares of common stock issuable upon the exercise of warrants
outstanding on May 31, 1999 and 9,011,860 shares reserved for future stock
option grants and purchases under Red Hat's equity compensation plans. See
"Management-- Employee Benefit Plans" and note 11 to notes to financial
statements.
You should read this information together with Red Hat's financial
statements and the notes to those statements appearing elsewhere in this
prospectus.
<TABLE>
<CAPTION>
MAY 31, 1999
------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Long-term obligations......................................................... $ -- $ -- $ --
Stockholders' equity (deficit):
Preferred stock:
Series A preferred stock, par value $.0001; 6,801,400 shares authorized,
issued and outstanding (actual); no shares authorized, issued or
outstanding (pro forma and pro forma as adjusted)......................... 1,997 -- --
Series B preferred stock, par value $.0001; 8,116,550 shares authorized,
issued and outstanding (actual); no shares authorized, issued or
outstanding (pro forma and pro forma as adjusted)......................... 6,936 -- --
Series C preferred stock, par value $.0001; 2,054,776 shares authorized,
2,054,776 issued and outstanding (actual); no shares authorized, issued or
outstanding (pro forma and pro forma as adjusted)......................... 6,405 -- --
Preferred stock, par value $0.0001; no shares authorized, issued or
outstanding (actual); 5,000,000 shares authorized and no shares issued or
outstanding (pro forma and pro forma as adjusted)......................... -- -- --
Common stock, par value $.0001; 225,000,000 shares authorized, 26,134,502
shares issued and outstanding (actual); 225,000,000, shares authorized,
60,079,954 shares issued and outstanding (pro forma); 225,000,000 shares
authorized, 66,079,954 shares issued and outstanding (pro forma as
adjusted)................................................................. 3 6 7
Additional paid-in capital.................................................. 3,011 18,346 78,475
Deferred compensation....................................................... (715) (715) (715)
Accumulated deficit......................................................... (2,495) (2,495) (2,495)
--------- -----------
Total stockholders' equity (deficit)........................................ (196) 15,142 75,272
--------- ----------- ------------
Total capitalization........................................................ $ 15,142 $ 15,142 $ 75,272
--------- ----------- ------------
--------- ----------- ------------
</TABLE>
18
<PAGE>
DILUTION
Red Hat's net tangible book value per share immediately after this offering
will be substantially less than the assumed initial public offering price. Red
Hat's pro forma net tangible book value as of May 31, 1999 was $15.1 million, or
$0.25 per share. Pro forma net tangible book value per share represents the pro
forma amount of total tangible assets less total liabilities, divided by the
number of pro forma shares of common stock outstanding. After giving effect to
the sale by us of the 6,000,000 shares of common stock in this offering at an
assumed initial public offering price of $11.00 per share, after deducting the
estimated underwriting discount and offering expenses, the pro forma as adjusted
net tangible book value of Red Hat as of May 31, 1999 would have been $75.2
million, or $1.14 per share. This represents an immediate increase in pro forma
as adjusted net tangible book value of $.89 per share to existing stockholders
and an immediate dilution of $9.86 per share to investors purchasing common
stock in this offering. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price....................................... $ 11.00
Pro forma net tangible book value per share prior to this offering........ $ .25
Increase per share attributable to this offering.......................... .89
---------
Adjusted pro forma net tangible book value per share after this offering.... 1.14
---------
Dilution per share to new investors......................................... $ 9.86
---------
---------
</TABLE>
Assuming the exercise in full of the underwriters' over-allotment option,
Red Hat's pro forma as adjusted net tangible book value at May 31, 1999 would
have been approximately $1.26 per share, representing an immediate increase in
the pro forma net tangible book value of $1.01 per share to Red Hat's existing
stockholders and an immediate decrease in net tangible book value of $9.74 per
share to new investors.
The following table summarizes, on a pro forma as adjusted basis, as of May
31, 1999, the difference between the number of shares of common stock purchased
from Red Hat, the total consideration paid to Red Hat, and the average price per
share paid by existing stockholders and by new investors at an assumed initial
public offering price of $11.00 per share, before deducting the estimated
underwriting discounts and offering expenses.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
---------------------------- --------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------------- ----------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
Existing stockholders...................... 60,079,954 90.9% $ 17,516,806 21.0% $ .29
New investors.............................. 6,000,000 9.1 66,000,000 79.0 11.00
--------------- ----- -------------- -----
Total.................................. 66,079,954 100.0% $ 83,516,806 100.0%
--------------- ----- -------------- -----
--------------- ----- -------------- -----
</TABLE>
------------------------
The discussion and the tables above assume no exercise of stock options or
warrants outstanding on May 31, 1999 and no issuance of shares reserved for
future issuance under Red Hat's equity plans. As of May 31, 1999, there were
options outstanding to purchase 5,369,088 shares of common stock at a weighted
average exercise price of $1.23 per share and warrants outstanding to purchase
3,197,450 shares of common stock at an exercise price of $.0001 per share. If
any of these options or warrants are exercised, there will be further dilution
to new investors. See "Capitalization" and "Management--Employee Benefit Plans".
19
<PAGE>
SELECTED FINANCIAL DATA
The statement of operations data presented below for the fiscal years ended
February 28, 1997, February 28, 1998 and February 28, 1999, and the balance
sheet data as of February 28, 1998 and February 28, 1999, have been derived from
our financial statements which have been audited by PricewaterhouseCoopers LLP,
independent accountants, and are included elsewhere in this prospectus. The
statement of operations data for the three months ended May 31, 1998 and May 31,
1999 and the balance sheet data as of May 31, 1999 have been derived from our
unaudited financial statements included elsewhere in this prospectus. In the
opinion of management, these unaudited interim financial statements include all
adjustments (consisting of normal recurring adjustments) necessary for the fair
presentation of financial position, results of operations and cash flows. The
balance sheet data as of February 28, 1997 have been derived from our audited
financial statements which are not included in this prospectus. The statement of
operations data for the fiscal years ended February 28, 1995 and February 29,
1996, and the balance sheet data as of February 28, 1995 and February 29, 1996
have been derived from our unaudited financial statements which are not included
in this prospectus. You should read the data presented below in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements and notes to those statements appearing
elsewhere in this prospectus.
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
--------------------------------------------
1995 1996(2) 1997 1998 1999
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenue:
Software and related products............................. $ 482 $ 930 $ 2,603 $ 5,132 $10,013
Web advertising........................................... -- -- -- -- --
Services and other........................................ -- -- -- 24 777
------- ------- ------- ------- -------
Total revenue........................................... 482 930 2,603 5,156 10,790
Cost of revenue:
Software and related products............................. 352 432 1,205 2,211 4,013
Web advertising........................................... -- -- -- -- --
Services and other........................................ -- -- -- -- 28
------- ------- ------- ------- -------
Total cost of revenue................................... 352 432 1,205 2,211 4,041
------- ------- ------- ------- -------
Gross profit................................................ 130 498 1,398 2,945 6,749
------- ------- ------- ------- -------
Operating expense:
Sales and marketing....................................... 133 241 491 1,252 3,083
Research and development.................................. 80 250 325 903 2,220
General and administrative................................ 44 140 526 799 1,484
------- ------- ------- ------- -------
Total operating expenses................................ 257 631 1,342 2,954 6,787
------- ------- ------- ------- -------
Income (loss) from operations............................. (127) (133) 56 (9) (38)
Other income (expense), net................................. (1) (22) (23) 22 162
------- ------- ------- ------- -------
Income (loss) before income taxes........................... (128) (155) 33 13 124
Provision for income taxes.................................. -- -- -- 5 215
------- ------- ------- ------- -------
Net income (loss)........................................... (128) (155) 33 8 (91)
Accretion on mandatorily redeemable preferred stock......... -- -- -- -- (39)
------- ------- ------- ------- -------
Net income (loss) available to common stockholders.......... $ (128) $ (155) $ 33 $ 8 $ (130)
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Earnings (loss) per common share (1):
Basic..................................................... (0.01) (0.01) 0.00 0.00 (0.01)
Diluted................................................... (0.01) (0.01) 0.00 0.00 (0.01)
Weighted average common shares outstanding:
Basic..................................................... 12,000 22,626 23,500 23,500 23,550
Diluted................................................... 12,000 22,626 27,233 34,578 23,550
Pro forma net income (loss) per common share (1):
Basic..................................................... (0.01) (0.01) 0.00 0.00 0.00
Diluted................................................... (0.01) (0.01) 0.00 0.00 0.00
Shares of common stock used in computing pro forma net
income (loss) per share:
Basic..................................................... 12,000 22,626 23,500 30,842 43,930
Diluted................................................... 12,000 22,626 27,233 34,578 43,930
<CAPTION>
THREE MONTHS
ENDED MAY 31,
----------------
1998 1999
------- -------
(UNAUDITED)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
Software and related products............................. $ 1,374 $ 1,936
Web advertising........................................... -- 80
Services and other........................................ 177 781
------- -------
Total revenue........................................... 1,551 2,797
Cost of revenue:
Software and related products............................. 682 1,181
Web advertising........................................... -- 123
Services and other........................................ -- 443
------- -------
Total cost of revenue................................... 682 1,747
------- -------
Gross profit................................................ 869 1,050
------- -------
Operating expense:
Sales and marketing....................................... 382 1,629
Research and development.................................. 341 826
General and administrative................................ 214 752
------- -------
Total operating expenses................................ 937 3,207
------- -------
Income (loss) from operations............................. (68) (2,157)
Other income (expense), net................................. 15 140
------- -------
Income (loss) before income taxes........................... (53) (2,017)
Provision for income taxes.................................. -- --
------- -------
Net income (loss)........................................... (53) (2,017)
Accretion on mandatorily redeemable preferred stock......... -- (43)
------- -------
Net income (loss) available to common stockholders.......... $ (53) $(2,060)
------- -------
------- -------
Earnings (loss) per common share (1):
Basic..................................................... 0.00 (0.08)
Diluted................................................... 0.00 (0.08)
Weighted average common shares outstanding:
Basic..................................................... 23,500 24,383
Diluted................................................... 23,500 24,383
Pro forma net income (loss) per common share (1):
Basic..................................................... 0.00 (0.03)
Diluted................................................... 0.00 (0.03)
Shares of common stock used in computing pro forma net
income (loss) per share:
Basic..................................................... 37,103 57,782
Diluted................................................... 37,103 57,782
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
FEBRUARY 28, MAY 31,
--------------------------------------- -------
1995 1996(2) 1997 1998 1999 1999
----- ------- ----- ------ ------- -------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents.............................. $ -- $ -- $ -- $1,293 $10,055 $13,982
Working capital (deficit).............................. (129) (160) (324) 1,541 11,100 13,217
Total assets........................................... 106 245 670 3,131 15,276 22,162
Long term liabilities.................................. -- 30 145 65 420 385
Mandatorily redeemable preferred stock................. -- -- -- 1,983 12,107 15,338
Total stockholders' equity (deficit)................... (42) (79) (46) (38) (5) (196)
</TABLE>
- --------------------------
(1) See note 2 to notes to financial statements.
(2) Red Hat's fiscal year ended on February 29, 1996.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH RED
HAT'S FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS
PROSPECTUS. THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
INDICATED IN SUCH FORWARD-LOOKING STATEMENTS. SEE "SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS".
OVERVIEW
Red Hat, Inc. is a leading developer and provider of open source software
products and services, and has built a comprehensive web site dedicated to the
open source software community. Red Hat, Inc. was incorporated in Connecticut in
March 1993 as ACC Corp., Inc. In September 1995, ACC Corp., Inc. changed its
name to Red Hat Software, Inc. In September 1998, Red Hat Software, Inc.
reincorporated in Delaware. In June 1999, Red Hat Software, Inc. changed its
name to Red Hat, Inc. We have financed our activities to date through proceeds
from the private sale of equity securities and cash flow from operations.
Sales of Official Red Hat Linux have represented our principal source of
revenue since its introduction in October 1994. We derive our software and
related products revenue primarily from the sale of software products:
- through distributors to enterprise and retail accounts;
- directly to individual users and enterprises through our REDHAT.COM web
site and our call center; and
- from original equipment manufacturers which license our software directly.
We recognize revenue from software product sales to distributors and original
equipment manufacturers for which no technical support is provided at the time
our products are shipped, net of a reserve for estimated sales returns. This
reserve is recognized based on our historical experience of these distributors'
rates of sell-through to the end user. Revenue from the sale of software
products to individual users and enterprises for which no technical support is
provided is recognized on the date we ship the software products. Upon the
release of Version 6.0 of Red Hat Linux in May 1999, we began selling Official
Red Hat Linux with 30 days of free telephone technical support and 90 days of
free e-mail technical support. In accordance with the provisions of Statement of
Opinion No. 97-2 "Software Revenue Recognition", we are recognizing all of the
revenue from the sale of Version 6.0 of Official Red Hat Linux ratably over the
period that the technical support services are provided in proportion to the
costs incurred to provide such technical support services as compared to
estimated total costs to be incurred.
We have recently added new features to our REDHAT.COM web site. We intend to
develop additional features for our web site which we believe will result in
both a substantial increase in the number of visitors who access our web site
and increased advertising revenue. Advertising revenue is derived principally
from short-term advertising contracts in which we typically guarantee a minimum
number of impressions to be delivered to users over a specified period of time
for a fixed fee. Advertising rates are typically measured on a cost per thousand
impressions basis. Advertising revenue is recognized ratably in the period in
which the advertisement is displayed, provided that we have no significant
remaining obligations, at the lesser of the ratio of impressions delivered over
total guaranteed impressions or the straight line basis over the term of the
contract. If we do not meet minimum guaranteed impressions requirements, we
defer recognition of the corresponding revenue until the minimum number of
guaranteed impressions is
22
<PAGE>
achieved. We did not generate revenue from the sale of advertising on our web
site until the first quarter of the fiscal year ending February 29, 2000.
However, we believe that the expected increase in traffic on our web site, along
with our focus on marketing our advertising services, will generate significant
advertising revenue in the future.
Prior to March 1999, we did not provide any service offerings to our
customers. In March 1999, we expanded our service offerings to include
comprehensive support and maintenance, custom development, consulting and
education services. Although these services generated only an insignificant
amount of revenue through February 28, 1999, we earned $0.6 million in service
revenues during the three months ended May 31, 1999. We believe that because our
revenue has historically been derived from product offerings, this expansion in
and active marketing of our service offerings will cause our services revenue to
continue to increase significantly as a percentage of total revenue in the
fiscal year ending February 29, 2000. Revenue from support and maintenance
agreements is deferred and recognized ratably over the term of the related
agreement, which is typically one year. Revenue from custom development,
consulting and education services, which includes offering training courses and
hardware certification services, is recognized as the services are provided.
Our software products are sold worldwide, with all of our total revenue
coming from North America, except for some royalties received from international
sources which totalled less than $50,000 for the fiscal year ended February 28,
1999. In June 1999 we established international operations and we expect that
total revenue derived from sales outside of North America will increase in the
fiscal year ending February 29, 2000 as we expand these operations.
We have historically experienced fluctuations in our results of operations
related to the release of major upgrades to Red Hat Linux. We believe that the
anticipation by our customers of the release of these upgrades has resulted in,
and will continue to result in, a decline in sales for several months prior to
the release and an increase in sales immediately following the release. Prior to
our release in May 1999 of Version 6.0 of Official Red Hat Linux, software
product sales decreased, but after the release we experienced an immediate
significant increase in both the volume and dollar amount of software product
sales. In addition, we believe that revenue from the sale of Official Red Hat
Linux and related products will decline as a percentage of total revenue in the
future as we continue to expand our services offerings and execute our web
initiative.
Sales of software products to distributors comprised $0.7 million or 26.1%
of total software and related products revenue in the fiscal year ended February
28, 1997, $0.9 million or 17.3% of total software and related products revenue
in the fiscal year ended February 28, 1998, and $5.9 million or 58.2% of total
software and related products revenue in the fiscal year ended February 28,
1999. Sales of software products to end users through our REDHAT.COM web site
and call center comprised $1.9 million or 73.9% of total software and related
products revenue in the fiscal year ended February 28, 1997, $3.0 million or
58.8% of total software and related products revenue in the fiscal year ended
February 28, 1998 and $3.2 million or 29.6% of total software and related
products revenue in the fiscal year ended February 28, 1999.
We plan to expand sales through distributors as well as direct sales through
our web site. We also plan to expand our original equipment manufacturer
relationships in the fiscal year ending February 29, 2000 and therefore expect
that our original equipment manufacturer-related revenue for this fiscal year
will increase significantly as a percentage of total revenue as compared to the
fiscal year ended February 28, 1999.
Sales to Frank Kasper & Associates, one of our primary distributors,
constituted approximately 16.0% of total revenue in the fiscal year ended
February 28, 1997, and
23
<PAGE>
26.0% of total revenue in the fiscal year ended February 28, 1998. Sales to
Frank Kasper & Associates and to Ingram Micro, our two largest distributors in
fiscal 1999, comprised 54.0% of total revenue in the fiscal year ended February
28, 1999. We provide our distributors an advertising allowance on a quarterly
basis, determined upon our approval of the distributors' advertising plans.
Distributors must then submit to us a detailed list of expenses incurred by us.
We pay all approved expenses and recognize these costs as a component of sales
and marketing expense as such expenses are incurred.
We employed 140 people at June 30, 1999, compared to 38 at March 1, 1998.
This increase in headcount resulted primarily from:
- an increase in administrative personnel as we recruited our management
team;
- an increase in support, maintenance, consulting and education personnel
associated with our efforts to develop the infrastructure of our services
organization;
- an increase in research and development personnel; and
- the commencment of international operations.
We expect to continue to increase expenses associated with our sales and
marketing, research and development and general and administrative groups in
anticipation of continued growth and expansion. Given the expected increase in
headcount, we anticipate that we will need to either expand our existing offices
or lease additional office space at a separate location within the next 12 to 18
months. We believe that this expansion will result in an increase in total
facilities costs.
24
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the results of operations for Red Hat
expressed as a percentage of total revenue. The historical results are not
necessarily indicative of results to be expected for any future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED FEBRUARY 28, MAY 31,
------------------------------- --------------------
<S> <C> <C> <C> <C> <C>
1997 1998 1999 1998 1999
--------- --------- --------- --------- ---------
(UNAUDITED)
Revenue:
Software and related products................... 100.0% 99.5% 92.8% 88.6% 69.2%
Web advertising................................. 0.0 0.0 0.0 0.0 2.9
Services and other.............................. 0.0 0.5 7.2 11.4 27.9
--------- --------- --------- --------- ---------
Total revenue................................. 100.0 100.0 100.0 100.0 100.0
Cost of revenue:
Software and related products................... 46.3 42.9 37.2 44.0 42.2
Web advertising................................. 0.0 0.0 0.0 0.0 4.4
Services and other.............................. 0.0 0.0 0.2 0.0 15.8
--------- --------- --------- --------- ---------
Total cost of revenue......................... 46.3 42.9 37.4 44.0 62.4
Gross profit...................................... 53.7 57.1 62.6 56.0 37.6
Operating expense:
Sales and marketing............................. 18.8 24.3 28.6 24.6 58.2
Research and development........................ 12.5 17.5 20.6 22.0 29.5
General and administrative...................... 20.2 15.5 13.7 13.8 26.9
--------- --------- --------- --------- ---------
Total operating expense....................... 51.5 57.3 62.9 60.4 114.6
Income (loss) from operations..................... 2.2 (0.2) (0.3) (4.4) (77.0)
Other income (expense), net....................... (0.9) 0.4 1.5 1.0 5.0
Income before income taxes........................ 1.3 0.2 1.2 (3.4) (72.0)
Provision for income taxes........................ 0.0 0.1 2.0 0.0 0.0
--------- --------- --------- --------- ---------
Net income (loss)................................. 1.3 0.1 (0.8) (3.4) (72.0)
Accretion on mandatorily redeemable preferred
stock........................................... 0.0 0.0 (0.4) 0.0 (1.5)
--------- --------- --------- --------- ---------
Net income (loss) available to common
stockholders.................................... 1.3% 0.1% (1.2)% (3.4)% (73.5)%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
25
<PAGE>
THREE MONTHS ENDED MAY 31, 1999 AND 1998
TOTAL REVENUE
Total revenue increased 80.3% to $2.8 million in the three months ended May
31, 1999 from $1.6 million in the three months ended May 31, 1998. Substantially
all of our revenue for the three months ended May 31, 1999 came from customers
located in the United States.
SOFTWARE AND RELATED PRODUCTS REVENUE
Software and related products revenue is comprised primarily of sales of
Official Red Hat Linux and related software products and sales of publications
about Linux-based operating systems. Software and related products revenue
increased 40.9% to $1.9 million or 69.2% of total revenue in the three months
ended May 31, 1999 from $1.4 million or 88.6% of total revenue in the three
months ended May 31, 1998. The decrease in software and related products as a
percentage of total revenue was due to the increase in services and other
revenue.
Software products revenue increased to $1.3 million during the three months
ended May 31, 1999 from $1.0 million for the three months ended May 31, 1998.
The increase in software products revenue was due to higher sales of Official
Red Hat Linux, as a result of the release of Version 6.0 of Official Red Hat
Linux in May 1999.
Related products revenue, which is comprised of revenue from sales of books
and other products, increased to $0.6 million during the three months ended May
31, 1999 compared to $0.4 million in the three months ended May 31, 1998.
WEB ADVERTISING REVENUE
Web advertising revenue is comprised of fees generated from short-term
contracts with advertisers to present advertising on our web site. Web
advertising revenue increased to $80,000 in the three months ended May 31, 1999
from zero in the three months ended May 31, 1998. As a percentage of total
revenue, web advertising revenue increased to 2.9% in the three months ended May
31, 1999 from zero in the three months ended May 31, 1998. These increases were
due to the commencement of our web initiative during the three months ended May
31, 1999.
SERVICES AND OTHER REVENUE
Services and other revenue is comprised of support and maintenance fees,
custom development fees, consulting and education fees and royalties received
from licensing our trademarks. Services and other revenue increased to $0.8
million in the three months ended May 31, 1999 from $0.2 million in the three
months ended May 31, 1998. As a percentage of total revenue, services and other
revenue increased to 27.9% in the three months ended May 31, 1999 from 11.4% in
the three months ended May 31, 1998.
Services and other revenue was comprised of $0.6 million in services revenue
and $0.2 million in royalties for the three months ended May 31, 1999 as
compared to $0.1 million in services revenue and $0.1 million in royalties for
the three months ended May 31, 1998. The increase in services revenue resulted
primarily from an increase in consulting and education revenue earned in the
three months ended May 31, 1999 as we expanded our course offerings, and, to a
lesser extent, an increase in support and maintenance revenues as we began to
sell support and maintenance services. We expect services revenue to increase
significantly in dollar amount and as a percentage of revenues as we continue to
develop and expand our support and maintenance, custom development and
consulting and education services and as we actively market these services.
COST OF REVENUE
COST OF SOFTWARE AND RELATED PRODUCTS
Cost of software and related products primarily consists of expenses we
incur to manufacture, package and distribute our products and related
documentation. These costs include expenses for physical media, literature and
packaging, fulfillment and
26
<PAGE>
shipping. Also included are royalties paid by us for licensing third-party
applications included in our software products and third-party publications.
Cost of software and related products increased 73.0% to $1.2 million in the
three months ended May 31, 1999 from $0.7 million in the three months ended May
31, 1998. The increase in cost of software and related products was directly
related to the increase in sales of software and related products. As a
percentage of software and related products revenue, cost of software and
related products increased to 61.0% in the three months ended May 31, 1999 from
44.0% in the three months ended May 31, 1998. This increase was primarily due to
the commencement of our program providing 30 days of telephone installation
support with the purchase of Version 6.0 of Official Red Hat Linux in May 1999.
COST OF WEB ADVERTISING
Cost of web advertising revenue includes the cost of developing the
advertising and supporting the website. Cost of web advertising revenue
increased to $0.1 million in the three months ended May 31, 1999, compared to
zero in the three months ended May 31, 1998. As a percentage of total revenue,
cost of web advertising revenue increased to 4.4% in the three months ended May
31, 1999, as compared to zero in the three months ended May 31, 1998. These
increases were due to our offering web advertising for the first time during the
three months ended May 31, 1999.
COST OF SERVICES AND OTHER
Cost of services includes salaries of support and maintenance, custom
development, consulting and education personnel and related costs. Cost of
services and other for the three months ended May 31, 1999 was primarily
comprised of costs of salaries and other related costs incurred for our training
and certification program. We incur no direct costs related to royalties
received for our trademarks to third parties. Cost of services and other
increased to $0.4 million in the three months ended May 31, 1999 from zero in
the three months ended May 31, 1998. As a percentage of services and other
revenue, cost of services and other increased to 56.7% in the three months ended
May 31, 1999 from zero in the three months ended May 31, 1998.
We expect cost of services and other to increase in the fiscal year ending
February 29, 2000, as we expand our service offerings, which will include the
costs associated with providing technical support and maintenance, custom
development, consulting and education. We expect these costs to be high in
dollar amount and as a percentage of services and other revenue due to costs
that we will incur in connection with developing and expanding our services
organization. Cost of services and other as a percentage of services and other
revenue is expected to vary significantly from period to period depending upon
the mix of services we provide, whether such services are provided by us or
third-party contractors, and overall utilization rate of our services staff.
GROSS PROFIT
Gross profit increased 21.0% to $1.0 million in the three months ended May
31, 1999 from $0.9 million in the three months ended May 31, 1998. As a
percentage of total revenue, gross profit decreased to 37.6% in the three months
ended May 31, 1999 from 56.0% in the three months ended May 31, 1998. The
increase in gross profit is due to the increased sales of our software products,
which is primarily the result of the release of Version 6.0 of Official Red Hat
Linux in May 1999. The decrease in gross profit as a percentage of revenue is
the result of the commencement of our program providing telephone installation
support with the purchase of Version 6.0 of Official Red Hat Linux for no
additional fee and our support, maintenance, consulting and education services
during the three months ended May 31, 1999.
OPERATING EXPENSE
SALES AND MARKETING
Sales and marketing expense consists primarily of salaries and other related
costs for sales and marketing personnel, sales
27
<PAGE>
commissions, travel, public relations, marketing materials and tradeshows. Sales
and marketing expense increased 326.4% to $1.6 million in the three months ended
May 31, 1999 from $0.4 million in the three months ended May 31, 1998. As a
percentage of total revenue, sales and marketing expense increased to 58.2% in
the three months ended May 31, 1999 from 24.6% in the three months ended May 31,
1998. These increases were due to higher advertising and promotional costs
incurred to promote the release of Version 6.0 of Official Red Hat Linux, and
costs incurred to promote our web site and service offerings. Sales and
marketing expense also includes costs resulting from joint marketing
arrangements with distributors. These costs totaled $0.1 million in the three
months ended May 31, 1999, as compared to zero in the three months ended May 31,
1998. This increase is due to Ingram Micro becoming a distributor of our
software products in November 1998. We expect sales and marketing expense to
increase in the foreseeable future as we promote the expansion of our services
offerings and web site and expand our international operations.
RESEARCH AND DEVELOPMENT
Research and development expense consists primarily of personnel and related
costs for our software products and web development efforts. Research and
development expense increased 142.2% to $0.8 million in the three months ended
May 31, 1999 from $0.3 million in the three months ended May 31, 1998. As a
percentage of total revenue, research and development expense increased to 29.5%
in the three months ended May 31, 1999 from 22.0% in the three months ended May
31, 1998. These increases resulted from increased spending related to the
development of our web initiative and costs incurred to complete the development
of Version 6.0 of Official Red Hat Linux. We expect research and development
expenses to continue to increase in the future as we develop our web site and
expand features in Red Hat Linux.
GENERAL AND ADMINISTRATIVE
General and administrative expense consists primarily of personnel and
related costs for general corporate functions, including finance, accounting,
legal, human resources, facilities and information system expenses. General and
administrative expense increased 251.4% to $0.8 million in the three months
ended May 31, 1999 from $0.2 million in the three months ended May 31, 1998. As
a percentage of total revenue, general and administrative expense increased to
26.9% in the three months ended May 31, 1999 from 13.8% in the three months
ended May 31, 1998. The increase in general and administrative expense resulted
from:
- an increase in payroll costs of $0.3 million due to the increase in the
number of general and administrative personnel to 17 at May 31, 1999 from
7 at May 31, 1998
- an increase in legal and accounting costs of $0.1 million in the three
months ended May 31, 1999 as compared to the three months ended May 31,
1998
- an increase in facilities cost of $0.1 million due to higher costs
associated with our new headquarters.
OTHER INCOME (EXPENSE), NET
Other income (expense) consists of interest income earned on cash deposited
in money market accounts and other short-term investments and interest expense
incurred on capital leases. Other income (expense), net increased 833.3% to
income of $0.1 million in the three months ended May 31, 1999 from income of
$15,000 in the three months ended May 31, 1998. As a percentage of total
revenue, other income (expense), net increased to 5.0% in the three months ended
May 31, 1999 from 1.0% in the three months ended May 31, 1998. These increases
resulted from higher average cash and cash equivalents and short-term investment
balances in the three months ended May 31, 1999 as compared to the three months
ended May 31, 1998 due to receipt of proceeds from
28
<PAGE>
sale of preferred stock in September 1998 and in February, March and April 1999.
PROVISION FOR INCOME TAXES
We had no provision for income taxes for the three months ended May 31, 1999
and 1998, as we incurred losses during these periods.
ACCRETION OF MANDATORILY REDEEMABLE PREFERRED STOCK
The increase in the accretion from mandatorily redeemable preferred stock to
$43,000 in the three months ended May 31, 1999 from zero for the three months
ended May 31, 1998 was a result of the fact that we had no outstanding
mandatorily redeemable preferred stock prior to September 1998.
FISCAL YEARS ENDED FEBRUARY 28, 1999 AND 1998
TOTAL REVENUE
Total revenue increased 109.3% to $10.8 million in the fiscal year ended
February 28, 1999 from $5.2 million in the fiscal year ended February 28, 1998.
SOFTWARE AND RELATED PRODUCTS REVENUE
Software and related products revenue increased 95.1% to $10.0 million, or
92.8% of total revenue, in the fiscal year ended February 28, 1999 from $5.1
million, or 99.5% of total revenue, in the fiscal year ended February 28, 1998.
The decrease in software and related products revenue as a percentage of total
revenue was due to the increase in services and other revenue.
Software products revenue increased to $9.0 million during the fiscal year
ended February 28, 1999 from $3.9 million for the fiscal year ended February 28,
1998. The increase in software products revenue was due to higher sales of
Official Red Hat Linux. We met the higher demand for Official Red Hat Linux by
establishing a relationship with a major distributor in November 1998 and
subsequently adding prominent national computer and software retailers.
Related products revenue decreased to $1.0 million during the fiscal year
ended February 28, 1999 compared to $1.2 million in the fiscal year ended
February 28, 1998. During the fiscal year ended February 28, 1999, we reduced
the number of publications that we published and distributed to focus our
efforts on our software products.
SERVICES AND OTHER REVENUE
Services and other revenue increased to $0.8 million in the fiscal year
ended February 28, 1999 from $24,000 in the fiscal year ended February 28, 1998.
As a percentage of total revenue, services and other revenue increased to 7.2%
in the fiscal year ended February 28, 1999 from 0.5% in the fiscal year ended
February 28, 1998.
Services and other revenue was comprised of $0.1 million in services revenue
and $0.7 million in royalties for the fiscal year ended February 28, 1999
compared to no services revenue and $24,000 in royalties for the fiscal year
ended February 28, 1998. The increase in services revenue resulted from the
introduction of our training and certification program during February 1999.
The increase in royalties resulted from the licensing of some of our
trademarks to third parties, nationally and internationally, as a way of
increasing our market share in markets or geographic locations important to our
business plan. This strategy allowed us to have a local presence without
incurring the costs associated with establishing separate operations in each of
these markets or geographic locations. During the fiscal year ended February 28,
1999, we licensed some of our trademarks to publishers, who paid us a royalty
based on their sales. We expect to discontinue some of these agreements during
the fiscal year ending February 29, 2000 due to our geographic expansion plans.
COST OF REVENUE
COST OF SOFTWARE AND RELATED PRODUCTS
Cost of software and related products increased 81.5% to $4.0 million in the
fiscal year ended February 28, 1999 from $2.2 million in the fiscal year ended
29
<PAGE>
February 28, 1998. The increase in cost of software and related products was
directly related to the increase in sales of software and related products. As a
percentage of software and related products revenue, cost of software and
related products decreased to 40.1% in the fiscal year ended February 28, 1999
from 43.1% in the fiscal year ended February 28, 1998. This decrease was due to
the decline in royalties paid to third parties because of the reduction in the
number of third-party applications included in our software products.
COST OF SERVICES AND OTHER
Cost of services for the fiscal year ended February 28, 1999 was primarily
comprised of salaries and other related costs incurred for our training and
certification program which commenced in February 1999. Cost of services and
other increased to $28,000 in the fiscal year ended February 28, 1999 from zero
in the fiscal year ended February 28, 1998. As a percentage of services and
other revenue, cost of services and other increased to 3.6% in the fiscal year
ended February 28, 1999 from zero percent in the fiscal year ended February 28,
1998. These increases were due to greater costs associated with our preparation
to expand our service offerings through the hiring of additional personnel.
GROSS PROFIT
Gross profit increased 129.2% to $6.7 million in the fiscal year ended
February 28, 1999 from $2.9 million in the fiscal year ended February 28, 1998.
As a percentage of total revenue, gross profit increased to 62.6% in the fiscal
year ended February 28, 1999 from 57.1% in the fiscal year ended February 28,
1998. These increases were primarily due to an increase in royalties received
for licensing our trademarks to third parties of $0.7 million in the fiscal year
ended February 28, 1999 for which we incurred no direct costs.
OPERATING EXPENSE
SALES AND MARKETING
Sales and marketing expense increased 146.2% to $3.1 million in the fiscal
year ended February 28, 1999 from $1.3 million in the fiscal year ended February
28, 1998. Costs associated with joint marketing arrangements with distributors
totaled $0.1 million in the fiscal year ended February 28, 1999, as compared to
zero in the fiscal year ended February 28, 1998. As a percentage of total
revenue, sales and marketing expense increased to 28.6% in the fiscal year ended
February 28, 1999 from 24.3% in the fiscal year ended February 28, 1998. These
increases were due to greater costs attributable to cooperative marketing
arrangements with distributors, which were approximately $0.1 million in the
fiscal year ended February 28, 1999 and were zero in the fiscal year ended
February 28, 1998, and extensive public relations activities in the fiscal year
ended February 28, 1999 to promote our brand.
RESEARCH AND DEVELOPMENT
Research and development expense increased 145.9% to $2.2 million in the
fiscal year ended February 28, 1999 from $0.9 million in the fiscal year ended
February 28, 1998. As a percentage of total revenue, research and development
expense increased to 20.6% in the fiscal year ended February 28, 1999 from 17.5%
in the fiscal year ended February 28, 1998. These increases resulted from an
increase in the number of research and development personnel necessary to
support both expanded functionality and ease of use of Official Red Hat Linux,
costs of personnel involved in the GNOME graphical user interface project, and
increases in quality assurance and technical documentation projects.
GENERAL AND ADMINISTRATIVE
General and administrative expense increased 85.8% to $1.5 million in the
fiscal year ended February 28, 1999 from $0.8 million in the fiscal year ended
February 28, 1998. The increase in general and administrative expense resulted
from:
- an increase in payroll costs of $0.3 million due to the increase in the
number of general and administrative
30
<PAGE>
personnel to 14 at February 28, 1999 from 5 at February 28, 1998;
- an increase in legal and accounting costs of $0.4 million in the fiscal
year ended February 28, 1999 incurred in connection with establishment of
new business activities; and
- to a lesser extent, due to approximately $60,000 in costs incurred
associated with relocating our offices in January 1999.
As a percentage of total revenue, general and administrative expense
decreased to 13.7% in the fiscal year ended February 28, 1999 from 15.5% in the
fiscal year ended February 28, 1998. This decrease was due primarily to revenue
increasing at a higher rate than general and administrative expense.
OTHER INCOME (EXPENSE), NET
Other income (expense), net increased 656.6% to income of $0.2 million in
the fiscal year ended February 28, 1999 from income of $20,000 in the fiscal
year ended February 28, 1998. As a percentage of total revenue, other income
(expense), net increased to 1.5% in the fiscal year ended February 28, 1999 from
0.4% in the fiscal year ended February 28, 1998. These increases resulted from
higher average cash and cash equivalents and short-term investment balances in
the fiscal year ended February 28, 1999 compared to fiscal 1998 due to receipt
of proceeds from the sale of preferred stock in September 1998 and the repayment
of outstanding notes payable during the fiscal year ended Feburary 28, 1998.
PROVISION FOR INCOME TAXES
Provision for income taxes increased to $0.2 million in the fiscal year
ended February 28, 1999 from $5,000 in the fiscal year ended February 28, 1998.
Our effective tax rate increased to 173.6% of income before income taxes for the
fiscal year ended February 28, 1999 from 38.7% of income for the fiscal year
ended February 28, 1998. These increases resulted from the growth in our taxable
income and an increase in the valuation allowance on our net deferred tax assets
due to uncertainty of realization.
ACCRETION OF MANDATORILY REDEEMABLE PREFERRED STOCK
Accretion of mandatorily redeemable preferred stock of $39,000 in the fiscal
year ended February 28, 1999 was a result of the issuance of mandatorily
redeemable preferred stock in September 1998. All of the outstanding preferred
stock will convert into common stock upon the closing of this offering.
FISCAL YEARS ENDED FEBRUARY 28, 1998 AND 1997
TOTAL REVENUE
Total revenue increased 98.1% to $5.1 million in the fiscal year ended
February 28, 1998 from $2.6 million in the fiscal year ended February 28, 1997.
SOFTWARE AND RELATED PRODUCTS REVENUE
Software and related products revenue increased by 97.1% to $5.1 million in
the fiscal year ended February 28, 1998 from $2.6 million in the fiscal year
ended February 28, 1997. The increase in software and related products revenue
resulted from increasing acceptance of Official Red Hat Linux by technical users
as a viable operating system.
SERVICES AND OTHER REVENUE
Services and other revenue increased to $24,000 in the fiscal year ended
February 28, 1998 from zero in the fiscal year ended February 28, 1997. This
increase resulted from royalty payments received from international publishers
of products bearing our trademarks in the fiscal year ended February 28, 1998.
COST OF REVENUE
COST OF SOFTWARE AND RELATED PRODUCTS
Cost of software and related products increased 83.5% to $2.2 million in the
fiscal year ended February 28, 1998 from $1.2 million in the fiscal year ended
February 28, 1997. The increase in cost of software and related products
resulted from increased sales of our software and related products. As a
percentage of software and
31
<PAGE>
related products revenue, cost of software and related products decreased to
42.9% in the fiscal year ended February 28, 1998 from 46.3% in the fiscal year
ended February 28, 1997. This decrease was due to growing sales and declining
costs on a per unit basis.
GROSS PROFIT
Gross profit increased 110.6% to $2.9 million in the fiscal year ended
February 28, 1998 from $1.4 million in the fiscal year ended February 28, 1997.
As a percentage of total revenue, gross profit increased to 57.1% in the fiscal
year ended February 28, 1998 from 53.7% in the fiscal year ended February 28,
1997.
OPERATING EXPENSES
SALES AND MARKETING EXPENSE
Sales and marketing expense increased 154.8% to $1.3 million in the fiscal
year ended February 28, 1998 from $0.5 million in the fiscal year ended February
28, 1997. As a percentage of total revenue, sales and marketing expense
increased to 24.3% in the fiscal year ended February 28, 1998 from 18.8% in the
fiscal year ended February 28, 1997. These increases resulted from additional
expense incurred due to significantly increasing the number of sales and
marketing personnel, increased costs attributable to cooperative marketing
arrangements with distributors, and higher advertising and tradeshows costs.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense increased 177.6% to $0.9 million in the
year ended February 28, 1998 from $0.3 million in the year ended February 28,
1997. As a percentage of total revenue, research and development expense
increased to 17.5% in the fiscal year ended February 28, 1998 from 12.5% in the
fiscal year ended February 28, 1997. These increases in research and development
expense were primarily due to the addition of software engineering and
development personnel in the fiscal year ended February 28, 1998.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense increased 51.8% to $0.8 million in the
fiscal year ended February 28, 1998 from $0.5 million in the fiscal year ended
February 28, 1997. The increase in general and administrative expense resulted
from the growth in the number of general and administrative personnel. As a
percentage of total revenue, general and administrative expense decreased to
15.5% in the fiscal year ended February 28, 1998 from 20.2% in the fiscal year
ended February 28, 1997. This decrease was due to total revenue increasing at a
higher rate than general and administrative expense.
OTHER INCOME (EXPENSE), NET
Other income (expense), net increased to income of $22,000 in the fiscal
year ended February 28, 1998 from expense of $23,000 in the fiscal year ended
February 28, 1997. This increase in other income (expense), net was due to an
increase in interest income resulting from higher average balances of cash and
cash equivalents and short-term investments and lower interest expense on our
notes payable which were repaid during the fiscal year ended February 28, 1997.
PROVISION FOR INCOME TAXES
Provision for income taxes increased to a provision of $5,000 in the fiscal
year ended February 28, 1998 from zero in the fiscal year ended February 28,
1997. For fiscal years ended February 28, 1998 and 1997, a full valuation
allowance was provided against net deferred tax assets due to uncertainty of
realization.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited quarterly statement of operations
data for each of the five quarters in the period ended May 31, 1999. This
information has been derived from unaudited interim financial statements that,
in the opinion of management, have been prepared on a basis consistent with the
financial statements contained elsewhere in this prospectus and include all
adjustments,
32
<PAGE>
consisting only of normal recurring adjustments, necessary for a fair
presentation of the financial information for the periods presented. This
information should be read in conjunction with the financial statements and
notes to those statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------------------------
MAY 31, AUG. 31, NOV. 30, FEB. 28, MAY 31,
1998 1998 1998 1999 1999
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Software and related products............................. $ 1,374 $ 2,167 $ 2,964 $ 3,508 $ 1,936
Web advertising........................................... -- -- -- -- 80
Services and other........................................ 177 71 360 169 781
----------- ----------- ----------- ----------- -----------
Total revenue........................................... 1,551 2,238 3,324 3,677 2,797
----------- ----------- ----------- ----------- -----------
Cost of revenue:
Software and related products............................. 683 785 1,179 1,366 1,181
Web advertising........................................... -- -- -- -- 123
Services and other........................................ -- -- -- 28 443
----------- ----------- ----------- ----------- -----------
Total cost of revenue................................... 683 785 1,179 1,394 1,747
----------- ----------- ----------- ----------- -----------
Gross profit............................................ 868 1,453 2,145 2,283 1,050
----------- ----------- ----------- ----------- -----------
Operating expense:
Sales and marketing....................................... 382 482 781 1,438 1,629
Research and development.................................. 341 458 624 797 826
General and administrative................................ 214 331 502 437 752
----------- ----------- ----------- ----------- -----------
Total operating expense................................. 937 1,271 1,907 2,672 3,207
----------- ----------- ----------- ----------- -----------
Income (loss) from operations............................... (69) 182 238 (389) (2,157)
----------- ----------- ----------- ----------- -----------
Other income (expense), net................................. 15 13 34 100 140
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes........................... (54) 195 272 (289) (2,017)
Provision for income taxes.................................. -- 62 153 -- --
----------- ----------- ----------- ----------- -----------
Net income (loss)........................................... $ (54) $ 133 $ 119 $ (289) $ (2,017)
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Accretion on mandatorily redeemable preferred stock......... -- -- (16) (23) (43)
----------- ----------- ----------- ----------- -----------
Net income (loss) available to common stockholders.......... $ (54) $ 133 $ 103 $ (312) $ (2,060)
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
</TABLE>
The operating results for any quarter are not necessarily indicative of the
operating results for any future period. In particular, due to our limited
operating history and the unpredictability of our industry, our revenue and net
income may fluctuate significantly from quarter to quarter and are difficult to
forecast. We base our current and future expense levels in part on our estimates
of future revenue. Our expenses are to a large extent fixed in the short term.
We may not be able to adjust our spending quickly if our revenue falls short of
our expectations. Accordingly, a revenue shortfall in a particular quarter would
have a disproportionate adverse effect on our net income for that quarter.
Furthermore, we may make pricing, purchasing, service, marketing, acquisition or
financing decisions that could adversely affect our business, operating results
and financial condition.
Our quarterly operating results will fluctuate for many reasons, including:
- our ability to retain existing customers, attract new customers and
satisfy our customers' demand;
- changes in gross margins of our current and future products and services;
- the timing of our release of upgrade versions of our products;
- introduction of new products and services by us or our competitors;
- changes in the market acceptance of Linux-based operating systems;
- changes in the usage of the internet and online services;
- timing of upgrades and developments in the Linux kernel and other open
source software products;
33
<PAGE>
- the effects of acquisitions and other business combinations, including
one-time charges, goodwill amortization and integration expenses or
difficulties; and
- technical difficulties or system downtime affecting the internet or our
web site.
For these reasons, you should not rely on period-to-period comparisons of
our financial results to forecast our future performance. Our future operating
results may fall below
expectations of securities analysts or investors, which would likely cause the
trading price of our common stock to decline significantly.
LIQUIDITY AND CAPITAL RESOURCES
We have historically derived a significant portion of our liquidity and
operating capital from sales of preferred stock and from cash flow from
operations. At May 31, 1999, cash and cash equivalents totaled $13.9 million, an
increase of $3.9 million as compared to February 28, 1999. The increase in cash
and cash equivalents resulted from $3.2 million of net proceeds from the sale of
our preferred stock, $1.8 million in proceeds from exercise of common stock
options and warrants and $1.0 million from maturities of investment securities,
partially offset by $1.5 million in cash used by operating activities during the
three months ended May 31, 1999.
Cash used by operations of $1.5 million for the three months ended May 31,
1999, resulted primarily from our net loss of $2.0 million, an increase in
accounts receivable of $2.2 million, an increase in inventory of $0.7 million
and deferred initial public offering costs of $0.4 million, partially offset by
an increase in deferred revenue of $3.0 million. The increase in accounts
receivable, inventory and deferred revenue resulted from the release of Version
6.0 Official Red Hat Linux to our distributors in late April 1999. This release
resulted in a significant amount of accounts receivable from distributors at May
31, 1999, due to large shipments of Version 6.0 of Official Red Hat Linux to
distributors from the last week of April through the end of May 1999. The
predominant portion of these outstanding accounts receivable was collected in
June 1999.
Cash provided by investing activities totaled $0.4 million for the three
months ended May 31, 1999 as a result $1.0 million in proceeds received from
maturities of investments partially offset by purchases of equipment of $0.6
million.
Cash generated by financing activities of $5.0 million for the three months
ended May 31, 1999 was comprised of $3.2 million of net proceeds from the sale
of our preferred stock, and $1.8 million in proceeds from exercise of stock
options and warrants.
At February 28, 1999, cash and cash equivalents totaled $10.0 million, an
increase of $8.7 million as compared to February 28, 1998. The increase in cash
and cash equivalents resulted primarily from $1.2 million in cash generated by
operations and $10.1 million of net proceeds from issuance of preferred stock
during the fiscal year ended February 28, 1999. These amounts were partially
offset by $1.9 million of cash used to purchase short-term debt securities, net
of maturities, and $0.7 million of additions to property and equipment.
Cash generated by operations of $1.2 million for the fiscal year ended
February 28, 1999 resulted primarily from an increase in accounts payable and
accrued liabilities of $1.5 million and net noncash charges to income of $0.6
million partially offset by our net loss of $0.1 million and an increase in
accounts receivable of $0.6 million.
Cash used in investing activities of $2.6 million was used to purchase $1.9
million of short-term debt securities, net of maturities, and office and
computer equipment totaling $0.7 million.
Cash from financing activities totaled $10.1 million in the fiscal year
ended February 28, 1999 as a result of $6.9 million in net proceeds received
from sales of Series B preferred stock in September 1998 and
34
<PAGE>
$3.2 million in net proceeds received from sales of Series C preferred stock in
February 1999. We received an additional $3.2 million in net proceeds from the
sale of Series C preferred stock subsequent to February 28, 1999.
We have experienced a substantial increase in our operating expenses since
our inception in connection with the growth of our operations and staffing and
the expansion of our services operation and web site. Our capital requirements
during the fiscal year ending February 29, 2000 depend on numerous factors
including the amount of resources we devote to:
- fund our domestic and international expansion;
- enhance our REDHAT.COM web site;
- improve and extend our service offerings;
- make possible investments in businesses, products and technologies; and
- expand our sales and marketing programs and conduct more aggressive brand
promotions.
We believe that the net proceeds from this offering, together with our cash
and cash equivalents, short-term investments and cash flow from operations, will
be sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 12 months, as we are projecting that our
capital needs will be approximately $35 million during this period. We may need
to raise additional funds, however, in order to fund more rapid expansion. We
may seek to sell additional equity or debt securities or to obtain a credit
facility. The sale of additional equity or debt securities, if convertible,
could result in additional dilution to our stockholders. The incurrence of
indebtedness would result in increased fixed obligations and could result in
operating covenants that would restrict our operations. We cannot guarantee that
financing will be available in amounts or on terms acceptable to us, if at all.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities". This statement establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. As issued, this
statement is effective for all fiscal quarters of all fiscal years beginning
after June 15, 1999, with earlier application encouraged. In May 1999, the
Financial Accounting Standards Board delayed the effective date of this
statement for one year, to fiscal years beginning after June 15, 2000. We do not
currently nor do we intend in the future to use derivative instruments and
therefore do not expect that the adoption of Statement of Accounting Standards
No. 133 will have any impact on our financial position or results of operations.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants, issued Statement of Position No.
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use", which provides guidance regarding when software developed or
obtained for internal use should be capitalized. This statement is effective for
transactions entered into in fiscal years beginning after December 15, 1998. We
do not expect that the adoption of this statement will have a material impact on
our financial position or results of operations.
In December 1998, the Accounting Standards Executive Committee issued
Statement of Position No. 98-9, "Modification of Statement of Position No. 97-2,
Software Revenue Recognition, with Respect to Certain Transactions". Statement
of Position No. 98-9 amends Statement of Position No. 97-2 to require
recognition of revenue using the "residual method" in circumstances outlined in
Statement of Position No. 98-9. Under the residual method, revenue is recognized
as follows:
35
<PAGE>
- the total fair value of undelivered elements, as indicated by vendor
specific objective evidence is deferred and subsequently recognized in
accordance with the relevant sections of Statement of Position No. 97-2;
and
- the difference between the total arrangement fee and the amount deferred
for the undelivered elements is recognized as revenue related to the
delivered elements.
Statement of Position No. 98-9 is effective for transactions entered into in
fiscal years beginning after March 15, 1999. Also, the provisions of Statement
of Position No. 97-2 that were deferred by Statement of Position No. 98-4 will
continue to be deferred until the date Statement of Position No. 98-9 becomes
effective. We do not expect that the adoption of Statement of Position No. 98-9
will have a significant impact on our results of operations or financial
position.
YEAR 2000 COMPLIANCE
The year 2000 issue refers generally to the problems that some software may
have in determining the correct century for the year. For example, software and
computer systems with date-sensitive functions that are not Year 2000 compliant
may not be able to distinguish whether "00" means 1900 or 2000, which may result
in failures or the creation of erroneous results.
We have defined "Year 2000 compliant" as the ability to:
- correctly handle date information needed for the December 31, 1999 to
January 1, 2000 date change;
- function according to the product documentation provided for this date
change, without changes in operation resulting from the advent of a new
century, assuming correct configuration;
- where appropriate, respond to two-digit date input in a way that resolves
the ambiguity as to century in a disclosed, defined, and predetermined
manner;
- if the date elements in interfaces and data storage specify the century,
store and provide output of date information in ways that are unambiguous
as to century; and
- recognize the year 2000 as a leap year.
In November 1998, we formed a committee consisting of our Chief Financial
Officer, our controller, a financial analyst and a systems administrator, as
part of our effort to perform a coordinated audit of:
- our products;
- the software components and applications with which our products are
bundled; and
- the systems upon which we rely for our internal operations.
PRODUCTS
The committee has tested Version 4.2 and later versions of Red Hat Linux by
accelerating the date within these software programs to December 31, 1999 and
observing which software components failed as the date changed to January 1,
2000. These tests revealed that all of these versions of Red Hat Linux were Year
2000 compliant. In addition, in June 1999 we hired an independent contractor to
test Versions 5.2 and 6.0 of Red Hat Linux for Year 2000 readiness. The
independent contractor certified these products as Year 2000 compliant. In light
of the testing results and certification, we do not plan to generate a
contingency plan if either of these products is later found not to be Year 2000
compliant. We have not, however, tested any products other than Red Hat Linux.
The Year 2000 committee plans to test or have these products tested by the end
of November 1999.
If it is later determined that products that we have not tested are not Year
2000 compliant, we believe that we have the resources, either in-house or within
the open source community, to quickly remedy any non-compliant products. If it
is necessary to remedy problems related to the Year 2000 issue, such efforts
could otherwise divert our
36
<PAGE>
resources from pursuing our business strategy. In addition, known or unknown
errors or defects in our products could result in delay or loss of revenue,
diversion of development resources, damage to our reputation, or increased
service and warranty costs, any of which could materially adversely affect our
business, operating results or financial condition. Furthermore, some
commentators have predicted significant litigation regarding Year 2000
compliance issues, and we are aware of such claims and actions against other
software vendors. Because of the unprecedented nature of this litigation, it is
uncertain whether or to what extent we may be affected by it.
THIRD-PARTY PRODUCTS
We bundle third-party applications and software components with Official Red
Hat Linux. To date, the committee has made no assessment of and has no knowledge
of third-party Year 2000 readiness. We intend to contact these third parties and
remedy problems on a case-by-case basis, as problems arise. Because we believe
that the costs associated with the failure of third-party products will not be
material to our business, results of operations or financial condition, we do
not intend to expend resources to seek out and correct problems before they
arise. Accordingly, it is possible that some of our customers may experience
difficulties related to third-party software, which may affect the performance
of our products and may lead to adverse results such as an unusually high number
of calls to our technical support department or other unusual requests for
information or assistance. Responding to these requests may divert resources
from pursuing our business strategy. Moreover, failure of applications bundled
with our software may reduce the value of our products, decrease or delay
revenues, tarnish our brand, give rise to breach of warranty claims or divert
resources, any of which could materially adversely affect our business, results
of operations and financial condition.
INTERNAL SYSTEMS
We are in the process of identifying and evaluating the Year 2000 compliance
of systems upon which we rely for internal operations such as our computer
hardware, software, web server and other related equipment and systems, such as
phone systems and security systems. In August 1999 we plan to test our internal
systems by simulating a century roll-over. We do not believe that the costs
involved in making our internal systems Year 2000 compliant will be material
because all of our internal mission-critical hardware and enterprise software
vendors and systems are certified Year 2000 compliant. These vendors include
Oracle, Sun Microsystems, Lucent and Cisco. In addition, most of our internal
systems run on Red Hat Linux. Most of our computer hardware is new, but in the
event any of our hardware malfunctions, we will replace it. We do not expect to
incur material costs to replace any such defective hardware.
The lessor of our corporate headquarters has indicated that our offices are
Year 2000 compliant. We currently house substantially all of our communications
hardware and our other computer operations related to our web site on site at
our facilities, although we plan to move these operations to third-party
facilities within the next six months. The owners of facilities we plan to use
for that purpose have also certified to us that all of their systems and
facilities are Year 2000 compliant.
WORST CASE SCENARIO
We have not tested any of our products other than Red Hat Linux and have not
tested software provided by, nor sought certifications from, third-parties
bundling software with Official Red Hat Linux. Our reasonably likely worst case
Year 2000 scenario would be that these products and bundled software from
third-parties fail in the year 2000, resulting in a decreased demand for our
products and damage to the Red Hat brand. In the event of a Year 2000 failure we
would devote resources to correct it. Because of our skilled in-house developers
and relationships with the open
37
<PAGE>
source community and third-parties whose software we bundle with Red Hat Linux,
we believe we will be able to respond promptly to any failures that occur. The
costs of such response and the diversion of resources, however, could have a
material adverse effect on our business, results of operation and financial
condition.
CONTINGENCY PLANS AND EXPECTED COSTS
The committee is in the process of developing further checklists of software
applications to test and systems upon which we rely and, as we deem appropriate,
we will seek certification documents from the developers and providers regarding
Year 2000 compliance of their systems and products. The committee will develop
contingency plans based on the responses regarding its critical systems that it
receives, or does not receive, from its providers and developers. We presently
expect that we will complete this effort in the fall of 1999.
To date, we have not expended a material amount of capital resources on Year
2000 compliance and do not anticipate future expenditures to be material to our
business, results of operations and financial condition. We have not hired
additional personnel to specifically address our Year 2000 compliance issues,
and presently, we do not expect to do so. Through June 30, 1999, we have
incurred approximately $300,000 in costs to make our internal systems Year 2000
compliant. These costs were primarily incurred to update our accounting and
financial management software and systems. The product and testing expenditures
to date relate primarily to on-going salary costs of personnel, including
committee members, participating at various levels in our compliance efforts, as
well as payments of approximately $30,000 to the independent contractor that
tested Versions 5.2 and 6.0 of Red Hat Linux. All costs related to achieving
Year 2000 readiness are being expensed as incurred, unless they relate to the
cost of new software or hardware for our internal systems.
38
<PAGE>
BUSINESS
RED HAT
We are a leading developer and provider of open source software and
services, including the Red Hat Linux operating system. Our web site,
REDHAT.COM, is a leading online source of information and news about open source
software and one of the largest online communities of open source software users
and developers. In addition to offering extensive content for the open source
community, REDHAT.COM serves as an important forum for open source software
development and offers software downloads and a shopping site. Our broad range
of professional services includes custom development and consulting, technical
support, training and education and hardware certification. We are committed to
serving the interests and needs of open source software users and developers and
to sharing all of our product developments with the open source community.
INDUSTRY BACKGROUND
IMPACT OF THE INTERNET
The internet has emerged as a global communications medium, enabling
millions of people to gather information, communicate and conduct business
electronically. Industry sources estimate that there were approximately 142
million users of the internet at the end of 1998 and that the number of users
will grow to over 500 million by the end of 2003. In addition, those sources
estimate that worldwide internet commerce revenue will increase from
approximately $50 billion in 1998 to more than $1 trillion in 2003.
The internet's ability to empower customers, reduce transaction costs and
product development times and accelerate the pace of business transactions has
dramatically transformed the competitive landscape of a wide range of
industries. The internet provides customers with a broader selection, increased
purchasing power and unparalleled convenience while enabling businesses to reach
a global audience, increase economies of scale and operate with minimal
infrastructure. The internet has facilitated the emergence of new competitors
and is increasingly affecting the methods by which incumbent competitors sell
goods and services and manage relationships with customers.
For example, in the software industry, the internet is profoundly changing
the way that software is developed and distributed. The internet has enabled
multiple groups of developers to collaborate on specific projects from remote
locations around the globe. Developers can write code alone or in groups, make
their code available over the internet, give and receive comments on other
developers' code and modify it accordingly. The internet has also provided an
avenue not only for less expensive and speedier delivery of code, but also for
support and other online services.
OPEN SOURCE SOFTWARE MOVEMENT
The internet has accelerated the development of open source software. Open
source software has its origins in the academic and research environments and is
based on an open, collaborative approach to the development and distribution of
software. The growth of the internet has greatly increased the scale and
efficiency of open source development through the availability of collaborative
technologies such as e-mail lists, news groups and web sites. These technologies
have enabled increasingly large communities of independent developers to
collaborate on more complex open source projects. An early example of open
source development is the X Windows system, a graphical user interface developed
by the X Consortium. The members of the X Consortium, originally Digital,
Hewlett-Packard, IBM and Sun Microsystems, wanted a common user interface for
their own proprietary operating systems. By openly sharing development ideas and
coding efforts, these companies were able to quickly and cost-effectively
develop a superior user interface.
39
<PAGE>
Open source software has emerged as a viable alternative to traditional
proprietary software. Under the proprietary model of software development, a
software developer generally licenses to the user only the object or binary
code. Binary code consists of the 1s and 0s that only the computer understands.
By contrast, under the open source development model, the software developer
provides to the user access to both the binary code and the source code. Source
code is the language used by the developers. The principal differentiating
points of open source software include:
- development process--open source software allows a company's in-house
development team to collaborate with a community of independent
developers;
- license terms--under open source licenses, the user has access to both
binary and source code, and the rights to copy, modify, alter and
redistribute the software; and
- shared improvements--under the open source model, the user has ongoing
access to improvements made to the software by others.
We believe open source software offers many potential benefits for software
customers, users and vendors. Customers and users are able to acquire the
software at little or no cost, install the software on as many computers as they
wish, and customize the software to suit their particular needs. In addition,
customers and users can obtain software updates, improvements and support from
multiple vendors, reducing reliance on any single vendor. Vendors are able to
leverage the community of open source developers, allowing them to reduce
development costs and decrease their time to market. Vendors are also able to
distribute their products freely over the internet, enabling them to create
large global user bases quickly.
Participants in open source development can generate revenue in a variety of
ways, including:
- making their own open source products widely available, and then offering
technical support, custom development, and related services to customers;
- using open source products as a means of attracting visitors to their web
sites, where they can earn money from the sale of other products,
services, and advertising; and
- developing brand loyalty and a reputation for quality by providing
technically superior open source software products, which they can
leverage to sell additional products and services to customers.
Just as the open source model has benefited from the success of the
internet, it has also greatly contributed to the internet's success. Open source
software comprises much of the internet's infrastructure, from domain name
server software to web servers and e-mail router software. Open source software
is particularly well-suited to the internet. With access to the source code,
system administrators and developers can collaborate to debug, fix and optimally
configure their software on a real-time basis. This enables them to improve
performance and keep data flowing continually across the internet, minimizing
the disruptions and downtime common with proprietary software.
The following examples demonstrate the prevalence of open source software on
the internet:
- Apache Web Server--based on code originally written at the National Center
for Supercomputing Applications at the University of Illinois at
Champaign-Urbana, is the most common web server in use today according to
a survey conducted by Netcraft.
- Perl--a standard scripting language for Apache servers.
- Sendmail--the internet's standard e-mail routing tool, which we believe
handles a majority of the internet's e-mail traffic.
40
<PAGE>
One of the better known open source products is the Linux kernel, the engine
of Linux-based operating systems. An operating system is the software that
allows a computer and its various hardware and software components to interact.
An initial goal of the open source software movement was to develop an operating
system that was better, faster and more reliable than the proprietary operating
systems then available. Viewing UNIX as the best commercially-available
operating system, the open source community decided to incorporate the best
design ideas from UNIX. Open source developers rewrote all of the underlying
source code so that it could not be controlled by a single corporation or
individual. By the early 1990s, these efforts had resulted in a number of
significant software initiatives but had fallen short of building a complete
operating system. Still missing from the project was the engine upon which the
new operating system was to run, known as the kernel.
In 1991, Linus Torvalds, a young Finnish developer, supplied a stable and
powerful open source kernel, known as Linux, to run the operating system.
Operating systems based on the Linux kernel are robust and dynamic. Thousands of
developers worldwide continually collaborate on improving Linux-based operating
systems and update them on a regular basis.
Since 1991, the use of Linux-based operating systems has rapidly grown.
According to International Data, Linux-based operating systems represented 17%
of all new license shipments of server operating systems in 1998. Beginning in
1998, a number of major technology industry leaders, including IBM, Intel and
Hewlett-Packard, announced support for Linux-based operating systems. The Linux
kernel and the standards around which it is developed remain under the close
supervision of Linus Torvalds and a small group of kernel developers working
under his leadership.
Some of the benefits enjoyed by users of Linux-based operating systems
include:
- reduced licensing costs;
- flexibility resulting from access to and legal right to modify source
code;
- stability and high performance;
- comprehensive internet support;
- compliance with standards; and
- multi-platform capability.
Despite a strong initial market acceptance of Linux-based operating systems
and other open source products, there exists a number of obstacles to widespread
adoption within the enterprise, including:
- lack of service and support;
- scarcity of applications supporting Linux-based operating systems; and
- lack of well-financed, viable open source industry participants.
The ability of a Linux-based operating system to penetrate large businesses
on an enterprise-wide basis and to gain widespread acceptance as a viable
alternative to operating systems developed under the proprietary software model,
depends, in large part, on the emergence of a proven leader in the open source
community. This open source leader must demonstrate to the business enterprise,
as well as to the community of application developers upon whom the business
enterprise relies, a successful business model and the ability to support and
service its products at a consistently high level.
THE RED HAT SOLUTION
To address the challenges facing the open source software market, our
products and services offer the following features and benefits:
SUPERIOR OPEN SOURCE PRODUCT OFFERINGS
We engineer what we believe to be the most technically advanced open source
operating system, Red Hat Linux. Our software engineers collaborate with
critical open source software development teams working across the internet.
This involvement enables us to remain abreast of technical advances, plans for
41
<PAGE>
development of new features and timing of releases, as well as other information
related to the development of the Linux kernel and other open source projects.
As a participant in these processes, we are able to react quickly to new
developments and to contribute to the future direction of the Linux kernel and
the open source development paradigm.
We compile and integrate more than 640 separate software packages into Red
Hat Linux, consisting of some of the most technically advanced software products
available, including compilers and web, e-mail, file transfer protocol and file
servers. Red Hat Linux is:
- flexible and scalable--capable of running a single desktop machine or the
entire network of a large business enterprise;
- functional--able to handle discrete or multiple applications being
accessed by multiple users;
- adaptable--allowing the user to modify the software to meet particular
needs and requirements; and
- reliable--constantly monitored and fine-tuned by thousands of developers
worldwide.
These benefits have led many industry analysts to identify Red Hat Linux as
a superior operating system. This recognition has accelerated the deployment of
Red Hat Linux within the business enterprise. According to International Data,
Red Hat Linux accounted for approximately 56% of new license shipments of
Linux-based server operating systems in 1998, or approximately 9% of total new
server license shipments.
In addition to offering technically advanced products, we provide purchasers
of our Official Red Hat Linux with extensive written documentation and limited
installation support. Our team of technical writers works closely with our
software development engineers to prepare manuals and other documentation that
accurately and clearly describe the many features of Red Hat Linux and advise
the user on how to exploit these features. In addition, we make Red Hat Linux
available to users via free download from our web site and other sites across
the internet.
LEADING ONLINE DESTINATION FOR THE OPEN SOURCE COMMUNITY
We have established our web site as a leading online destination related to
the open source movement. We are dedicated to serving the interests and needs of
open source software users and developers online. Our web site is a
comprehensive resource for the latest information related to Linux and other
open source projects. It contains news of interest to open source users and
developers, features for the open source community, software updates and
downloads, a shopping center for our shrink-wrapped products and support
offerings, and a wealth of technical information related to open source
products, including Red Hat Linux. Visitors to our site can organize and
participate in user groups, make available bug fixes and incremental code
improvements and share knowledge regarding the use and development of open
source software.
Our web site had more than 265,000 unique visitors and approximately 2.5
million page views during March 1999.
By acting as a clearinghouse of open source and Linux-related information,
and facilitating the interaction of developers, businesses and technology
enthusiasts, our web site has become a community center for the open source
movement.
COMMITMENT TO THE OPEN SOURCE MODEL
Red Hat has fully embraced the open source model. Whereas others have
incorporated certain aspects of the open source software model into their
businesses while retaining various features of the proprietary model, our
product offerings are true open source offerings. We share all of our
developments on and improvements to the Linux kernel and other open source
products with the development community. In this way, we benefit independent
developers by making our products more useful for them in their own
42
<PAGE>
development projects. In addition, we have aggressively promoted and distributed
our products in the marketplace by making them available free of charge by
download from our web site and other internet sites worldwide, by issuing
thousands of free CD-ROMs containing Red Hat Linux at trade shows and through
direct mailing campaigns, and by providing copies to academic and research
institutions. Furthermore, in addition to the open source software we develop
ourselves, we help fund a broad range of open source software projects and
organizations, including the XFree86 group, the linuxconf open source software
product and the Free Software Foundation.
EXTENSIVE PROFESSIONAL SERVICES
We also offer a broad range of professional services relating to the
development and use of open source products. These services include technical
support, custom development, consulting, training, education and hardware
certification. By servicing Red Hat Linux, we provide our customers and the open
source community with a respected and reliable technology partner, one that is
available to help with the purchase, deployment, customization and maintenance
of open source software solutions. We believe that providing these services and
establishing ourselves as our customers' technology development partner will
allow us to facilitate the widespread adoption of Red Hat Linux as a full scale
enterprise solution.
STRATEGIC ALLIANCES
In an effort to increase the market acceptance of open source software in
general, and the Red Hat Linux operating system in particular, we have
established development, marketing or distribution relationships with leading
technology companies, including Compaq, Dell, Hewlett-Packard, IBM, Intel,
Oracle and Silicon Graphics. In addition, we share our development efforts with
and commit resources to third party developers and vendors in order to expand
the number of applications available for Linux-based operating systems. By
establishing and maintaining these relationships, we are able to increase market
awareness of open source software, gather industry support for our products and
penetrate new markets. See "--Sales, Marketing and Distribution".
STRATEGY
Our objective is to enhance our position as a leading worldwide developer
and provider of advanced, open source products and services, both via
traditional channels and the internet. The key elements of our strategy are:
CONTINUE TO ENHANCE OUR WEB SITE
We are continuing to enhance our web site in an effort to create the
definitive online destination for open source software products, software
updates, news, and other information related to Linux-based operating systems
and other open source projects, and to provide advertisers with a large and
technically sophisticated audience. At REDHAT.COM, people from around the world
will be able to obtain updates to open source software, purchase a wide array of
open source products and services, access and copy code for their own
programming efforts, read news related to topics of interest to the community
and interact with other community members. New features we anticipate adding to
our web site include:
- software update notification;
- automatic software updating for those who want it;
- registries and hosting of open source web sites and projects;
- open source classifieds (including products for sale and employment
listings);
- event calendars; and
- virtual trade shows.
By adding these features to our web site, we believe that our visitors will
continue to visit on a regular basis, and that we will attract an increasing
number of new visitors. In addition, we believe that these new features and
43
<PAGE>
offerings will keep visitors on our site for longer periods of time, which we
believe will be crucial to our ability to generate significant advertising
revenue.
EXPAND SERVICE CAPABILITIES TO ADDRESS THE ENTERPRISE NEEDS OF LARGE
CORPORATIONS
We believe that we must expand our services capabilities to address the
market need for quality custom engineering and development. We are currently
expanding our professional services organization to enhance our ability to
provide such services. Between March 1, 1998 and June 30, 1999 we added 23
people to our professional services organization. We believe that as our user
base grows, more of our customers, particularly our larger customers, will look
to us to help them customize their operating systems to perform optimally within
their particular computing environments. We expect that many of our larger
customers will also expect us to assume the role of their technology partner,
and perform on-site consulting services such as large-scale system assessments
and enterprise-wide system enhancements. We believe that by increasing our
capacity to offer such services, we will be able to significantly increase our
services revenue and establish ourselves as the premier open source service
provider.
INCREASE MARKET ACCEPTANCE OF OPEN SOURCE SOFTWARE
Although recent years have seen a substantial increase in the market
acceptance of Linux-based operating systems and other open source software, we
intend to promote further acceptance of open source software through a variety
of means, including strengthening our existing alliances with other information
technology companies and by establishing new alliances. The strength of these
alliances is crucial to the expansion of the open source community, the
technical advancement and widespread distribution of open source products and
the development of third party applications suitable for Linux-based operating
systems.
By aligning ourselves with companies widely regarded as producing high
quality and highly reliable software developed under the traditional software
development model, we expect to bridge the gap between the open source community
and those customers who are currently skeptical or unaware of the benefits of
open source software. We believe that by continuing to collaborate with
industry-leading information technology companies, we will be able to further
improve the performance and features of Red Hat Linux and other open source
software products. Although we intend to increase our own engineering and
development efforts, we believe that by entering into and maintaining strategic
relationships with other market-leading companies, we will ensure that Red Hat
Linux continues to develop technically, and that such development is compatible
with the technological innovations of other key vendors in our industry.
By entering into additional strategic distribution relationships with major
distributors, retail outlets, original equipment manufacturers, and value-added
resellers worldwide, we intend to make Red Hat Linux and other open source
products more widely available. In order to support and develop leads for our
indirect distribution channels, we plan to expand our field sales and support
staff significantly. In addition, we expect to continue to share our development
efforts with and commit additional resources to applications developers and
vendors in an effort to increase the third-party applications offerings that
will run on Red Hat Linux. Third-party applications currently available for
Linux-based operating systems include desktop office productivity tools from
Applix, Corel and Star Division and enterprise software applications from IBM,
Oracle and SAP.
Additional means of increasing the market acceptance for Linux-based
operating systems and other open source software include expanding our
international presence, broadening our services offerings and publicizing
success stories. We have only recently commenced operations in Europe, and while
we have a significant installed base
44
<PAGE>
of international users, we intend to increase our overseas presence in the near
future by establishing additional foreign offices or subsidiaries. In addition,
we intend to expand our services offerings, including training, consulting and
related services that customers have come to expect from information technology
providers, which will increase their confidence in open source products and
providers. Finally, we will continue to publicize, to the extent possible,
success stories of customers who have found open source products to be more
valuable than restrictive, proprietary products.
CONTINUE TO INVEST IN THE DEVELOPMENT OF OPEN SOURCE TECHNOLOGY
We intend to continue to invest significant resources in the development of
new open source technology, capitalizing on our extensive experience working
within the open source model. We expect this continued investment to take the
form of increased expenditures on internal development efforts, including our
Red Hat Advanced Development Laboratory, as well as continued funding of
third-party open source projects. We also plan to continue our financial support
of the development efforts of many of the top-tier engineers in the open source
community. This support will be directed towards an array of projects, ranging
from the development of ease of use features, which we believe will take Red Hat
Linux from the server to the desktop, to the design of new networking and
scalability features, which are expected to make Red Hat Linux more attractive
as a server operating system. In particular, we are currently exploring the
possibility of establishing a foundation to support the development of open
source software. We would fund this foundation with cash, stock or a combination
thereof. We expect that, through these efforts, we will be able not only to
foster the advancement of open source technology, but also to enhance and
maintain our relationships within the open source community.
MAINTAIN AND CONTINUE TO ENHANCE THE
RED HAT BRAND
We believe that continuing to build the Red Hat brand is vital to the
expansion of our customer base and the maintenance of the energy of the current
open source community. We intend to continue to aggressively promote our web
site as the definitive source for open source products, services, resources and
other information. Another component of our brand enhancement strategy is to
expand our use of aggressive public relations campaigns by continuing to work
with the media to educate the public on the benefits of open source software. In
addition, we expect to continue our pursuit of tightly-focused advertising
campaigns, both in computer related publications and in general purpose media,
in order to attract new users to Red Hat Linux and open source software.
Moreover, we also intend to continue to devote substantial engineering resources
to open source development projects and to otherwise demonstrate our commitment
to the open source philosophy. Through these measures, we intend to build the
Red Hat brand into the preeminent symbol of quality for open source software.
PRODUCTS AND SERVICES
We are a leading provider of open source software products and services. Our
product offerings include Red Hat Linux and related tools, documentation,
manuals and general merchandise. Our professional services offerings,
principally directed towards our larger corporate customers and strategic
partners, include technical support, training and education, consulting and
custom development and hardware certification.
RED HAT LINUX AND RELATED SOFTWARE
OFFICIAL RED HAT LINUX 6.0. Official Red Hat Linux is our principal product.
We first released Official Red Hat Linux in October 1994, and began shipping the
latest release, Version 6.0, in May 1999. Official Red Hat Linux is available
for the Intel, Sun SPARC and Compaq Alpha platforms. Official Red Hat
45
<PAGE>
Linux provides everything the user needs to perform a wide variety of server
functions, including setting-up a web, e-mail, file or print server as well as
using his computer as a general purpose desktop workstation to perform virtually
any computing function. Official Red Hat Linux comes with a number of
third-party applications including office productivity and e-commerce
applications, as well as comprehensive user manuals and limited installation
support. The suggested retail price for Official Red Hat Linux is $79.95.
Examples of the components included within the 573 megabytes of code that
comprise Red Hat Linux 6.0 are:
<TABLE>
<CAPTION>
COMPONENT FUNCTION
- ---------------------------------------------- --------------------------------------------
<S> <C>
Linux Kernel (Version 2.2).................... Core of the operating system
X Windows System.............................. Graphical layer
Gnome......................................... Graphical desktop user interface
Gtx........................................... Graphical development libraries
Netscape Communicator......................... Web browser
Apache........................................ Web server
Sendmail...................................... E-mail routing software
Perl.......................................... High-level programming language
Efax.......................................... Fax utility
Pilot Link.................................... Palm Pilot-Registered Trademark-
synchronization
Gnome PIM..................................... Personal Information Manager
Howto Greek (and other languages)............. Help files translated into Greek (and other
languages)
RPM........................................... Manages the various software packages
All other components.......................... Libraries, tools, games and other integrated
applications
</TABLE>
Other Red Hat products include:
RED HAT POWERTOOLS: Red Hat Powertools is a collection of open source tools
and applications that run on top of Red Hat Linux. The suggested retail price
for Powertools is $39.95.
RED HAT LINUX CORE: Red Hat Linux Core, consisting of Official Red Hat
Linux 6.0 and the Official Red Hat Linux Installation Guide, is designed for
developers and experienced users of Linux-based operating systems. Red Hat Linux
Core does not include installation support or third-party applications. The
suggested retail price for Red Hat Linux Core is $39.95.
EXTREME LINUX: Extreme Linux, popular among students and researchers, is
designed to run on multiple computers using parallel processing. The open source
software included in this product was developed in part by the National
Aeronautics and Space Administration. Extreme Linux does not include user
manuals or installation support. The suggested retail price for Extreme Linux is
$29.95.
RED HAT SECURE WEB SERVER: Red Hat Secure Web Server combines the Apache
open source web server with certain cryptography software we licensed from RSA
Data Security, Inc. to create a secure web server suitable for conducting secure
transactions via the internet. Red Hat Secure Web Server won a "Best of Show"
award at the 1998 Networld + Interop conference. Red Hat Secure Web Server
cannot be downloaded from our web site and is available only in the U.S. and
Canada due to export controls on encryption software. The suggested retail price
for Red Hat Secure Web Server is $99.95.
Our products are also available for free download via the internet from
REDHAT.COM and other web sites worldwide, except for Red Hat Secure Web Server
and the third-party
46
<PAGE>
application software that is sold with Official Red Hat Linux. We encourage our
customers to download Red Hat Linux and our other software products. By allowing
users to download our software free of charge, we are able to strengthen the Red
Hat brand and increase our installed base of users, at no incremental cost to
us. Customers who obtain Red Hat Linux in this way receive substantially the
same operating system software as is included in our shrink-wrapped packages,
but do not receive installation support, documentation and other additional
features.
REDHAT.COM
We have 21 professionals focused on the development and maintenance of our
REDHAT.COM web site. REDHAT.COM offers users access to broad and authoritative
content on open source software including news, documentation, educational
materials and case studies. This content is directed at a wide spectrum of open
source software users, from system administrators to developers to academics. We
also offer extensive features for the open source community, software updates
and downloads and a shopping center for our shrink-wrapped products and support
offerings.
We intend to also offer the following benefits via our web site to our
partners and users:
- Personalization--users will be able to register on the site and select
custom presentations of information that are specifically tailored to
their needs. These presentations, which will be known as MY.REDHAT.COM,
will filter news and information (according to user-specified criteria),
promote various features of the site likely to be of interest to a
specific user and notify the user by e-mail of new content and upgrades.
- Advertising and sponsorships--the REDHAT.COM audience is highly focused
and technically sophisticated, representing an attractive target market of
computing professionals for advertisers. We offer a number of advertising
and sponsorship programs to our partners and others seeking to reach this
market.
- Content subscriptions--we intend to make special market reports and data
and access to real-time support available to our users on an annual
subscription basis. By subscribing to our site, our customers will also be
able to purchase additional features and services such as online training
and certification and remote software maintenance packages.
- Commerce--we intend to build the REDHAT.COM store into the most
comprehensive open source shopping resource for corporate enterprise
buyers. Offerings and upsell opportunities will be presented throughout
the site in a context-relevant manner.
- Licensing--we intend to license our content to other content providers,
thereby generating additional traffic, extending the Red Hat brand and
increasing revenue.
PROFESSIONAL SERVICES
Although we have not generated significant revenue to date from our
professional services, we have recently significantly expanded the scope of our
service offerings and expect them to generate significant revenue in the future.
SUPPORT AND MAINTENANCE. Customers who purchase our Official Red Hat Linux
Version 6.0 product are entitled to 30 days of telephone installation support or
90 days of e-mail installation support at no additional charge. Customers
seeking additional technical support may purchase telephone support agreements
from us ranging in price from $995 for up to three incidents to $60,000 for
24-hour-a-day unlimited support for one year. We have a highly-trained and
skilled staff of technical support engineers to provide these services to our
customers. In addition, we maintain relationships with several third-party
47
<PAGE>
support providers in order to enhance and expand our technical support
capabilities.
TRAINING AND EDUCATION. We provide training and educational programs to
those customers who want to learn how to optimize their use of Red Hat Linux.
The most popular of these programs is the "Red Hat Certified Engineer" course
that we offer at our corporate offices. This week-long course, taught by Red Hat
instructors and priced at approximately $2,500, gives a comprehensive overview
of the use of Red Hat Linux. We also conduct on-site training for customers. We
anticipate that we will work with third-party training and educational program
providers to develop and offer additional training courses on a variety of
topics related to Red Hat Linux and open source software.
CONSULTING AND CUSTOM DEVELOPMENT. We offer specific consulting and custom
development services on an individualized basis. We have performed such services
related to the optimization of Red Hat Linux when used in conjunction with
certain hardware products. We intend to expand our consulting and custom
development capabilities in the near future.
HARDWARE CERTIFICATION. We perform testing and certification services for
hardware vendors seeking to market their products to Red Hat Linux users.
Hardware vendors submit their products to us and, in exchange for a fee, we test
the hardware to determine whether it is compatible with Red Hat Linux. Products
meeting our performance criteria are certified as Red Hat Linux compatible.
Companies for which we have performed such services include Dell, IBM and
Toshiba.
PRODUCT AWARDS
Red Hat Linux has won numerous awards, including:
- Operating System Product of the Year, InfoWorld magazine, 1996, 1997 and
1998
- Productivity Award, Software Development Magazine, 1997
- "Jolt" Product Excellence Award, Software Development Magazine, 1998
- Reader's Choice Award, Linux Journal, 1998
- Just PLAIN COOL Award, Australian Personal Computing Magazine, 1998
- Environment/Desktop finalist, Ziff-Davis European Excellence awards, 1997
- Editor's Choice Award, Australian Personal Computing Magazine, 1998
PRODUCTION AND FULFILLMENT
We outsource the production, packaging and order fulfillment of our products
to third parties when it is cost effective to do so. To the extent possible, we
limit our internal production activities to such tasks as quality inspection and
testing. We currently have production arrangements with JVC Disc America Co.,
Webcom, Inc. and Brightstar Services, and order fulfillment arrangements with
JVC. We believe that our existing production arrangements are sufficient to
accommodate potential increases in sales volume for the foreseeable future.
48
<PAGE>
CUSTOMERS AND APPLICATIONS
CUSTOMERS
Our customers range from individuals using our products for a wide variety
of personal and professional purposes to multinational Fortune 500 companies,
government agencies, and research and academic institutions. The following is a
partial list of our customers:
<TABLE>
<CAPTION>
CORPORATE GOVERNMENT RESEARCH / ACADEMIC
- --------------------------- ------------------------ -------------------------
<S> <C> <C>
AT&T Canadian Department of Carnegie Mellon
University
Bell Atlantic Human Resources
Boeing Cern Laboratories
Burlington Coat Factory Internal Revenue Service
Cisco Systems Fermi National
Accelerator
GTE NASA Laboratory
Hewlett-Packard
Hughes Telecommunications Waco Public Schools Harvard-Smithsonian
IBM Astrophysical Observatory
Intel
Lucent Technologies University of North
Carolina
Nortel
Sony Electronics University of Rochester
</TABLE>
The following case studies provide examples of the manner in which our
products are used:
- The Exploration Department of Amerada Hess, a Fortune 500 global oil
company, was frustrated with the cost and difficulty of upgrading its
supercomputing hardware. In 1998, the Exploration Department replaced
approximately $2.5 million of its supercomputing hardware with a $420,000
cluster of more than 90 servers running Red Hat Linux. The department uses
this cluster to identify potential offshore oil and gas reservoirs using
three-dimensional modeling software.
- Cisco Systems relies on Red Hat Linux to run 100 networked printer servers
which are connected to 3,000 printers and support the network's 20,000
users.
- Burlington Coat Factory is deploying Red Hat Linux on 1,250 customized
Dell OptiPlex PCs over Oracle databases in more than 265 stores
nationwide. The PCs host Burlington's Gift Registry, and will facilitate
all other in-store functions, such as shipping and receiving.
- Garden Grove, California, a city with a population of 153,000, runs its
government and public services entirely on Red Hat Linux. Since 1994,
Garden Grove has not had a computer-related interruption in service for
any department, including its police department.
THIRD-PARTY APPLICATIONS
Some of the third party applications that are included in Red Hat Linux are:
- Apache Web Server;
- Netscape Navigator and Communicator internet browsers;
- file transfer protocol servers;
- e-mail routing software;
- GNU C and C++ computer language compilers and debuggers;
- editors;
- databases; and
- games.
49
<PAGE>
Some of the stand-alone third-party applications that are currently
available to users of Linux-based operating systems are:
- Oracle, Informix and IBM databases;
- Computer Associates UNICENTER network control software;
- Lotus Domino Notes Server;
- Corel WordPerfect;
- Applixware Office Suite;
- Star Office Suite;
- NEXS Spreadsheet; and
- MetroWerks Rapid Application Development tools.
SALES, MARKETING AND DISTRIBUTION
SOFTWARE PRODUCTS AND SERVICES
We sell our products and services worldwide through direct marketing and
telesales campaigns and our web site, and indirectly through our distributors,
retailers, catalogs and original equipment manufacturers. Our direct sales force
of individuals as of June 30, 1999, is dedicated to increasing worldwide
sales through our retail, distribution and original equipment manufacturers
channels. As of June 30, 1999, our indirect distribution channel was composed of
five distributors, over 500 retailers and 12 original equipment manufacturers.
We have recently begun to focus our sales efforts more aggressively on the
business enterprise market.
Our two largest distributors are Ingram Micro and Frank Kasper & Associates.
Ingram Micro, which began distributing our products during the fiscal year ended
February 28, 1999, accounted for approximately 34% of our total revenue during
that fiscal year. Frank Kasper & Associates accounted for approximately 26% of
our total revenue for the fiscal year ended February 28, 1998 and 20% for the
fiscal year ended February 28, 1999.
Our agreements with our distributors typically are not exclusive, have no
stated minimum purchase or license obligations and may be terminated by either
party without cause. We believe that in the event of the termination of our
relationship with one or more of our indirect channel partners, we could enter
into replacement agreements with new partners. However, the failure to replace
these partners with distributors of equal marketing capabilities and reputation
could have a material adverse effect on our business, operating results and
financial condition.
We permit our original equipment manufacturers to distribute Red Hat Linux
with their own hardware in exchange for royalty payments to us. We currently
have original equipment manufacturer agreements in place with Dell, Silicon
Graphics and others. These agreements are not exclusive, have no stated minimum
purchase or license obligations, and generally may not be terminated prior to
the expiration of their terms which, in the case of Dell, is one year and, in
the case of Silicon Graphics, is an initial term of one year, renewable for two
additional one-year terms.
We have established joint marketing relationships with a number of leading
technology companies including Compaq, Hewlett-Packard, IBM, Intel and Oracle.
These agreements have one- or two-year terms and, with the exception of the
Hewlett-Packard and Oracle agreements, may be terminated prior to the expiration
of their terms by either party with prior notice.
Our direct marketing efforts support our sales and distribution efforts
through participation in industry trade shows, targeted advertising, channel
sales programs, public relations campaigns, retail promotions, customer surveys
and the promotion of our products through our web site. In addition, we offer
our software products for free download from REDHAT.COM and other internet sites
worldwide.
REDHAT.COM
We have a team of professionals dedicated to selling advertising on our web
site. Though these sales have been insignificant to date, we expect to generate
50
<PAGE>
significant revenue from the sale of advertising and sponsorships in the future.
COMPETITION
In the market for operating systems, we compete with a limited number of
large and well-established companies that have significantly greater financial
resources, larger development staffs and more extensive marketing and
distribution capabilities. These competitors include Microsoft, Novell, IBM, Sun
Microsystems and The Santa Cruz Operation, all of which offer
hardware-independent multi-user operating systems for Intel platforms, and AT&T,
Compaq, Hewlett-Packard, Olivetti and Unisys, each of which, together with IBM
and Sun Microsystems, offers its own version of the UNIX operating system. Many
of these competitors bundle competitive operating systems with their own
hardware offerings, thereby making it more difficult for us to penetrate their
customer bases.
In the newer and rapidly evolving Linux-based operating system market, we
compete with a number of well-respected vendors and development projects. These
competitors have established and stable customer bases and continue to attract
new customers. We also compete for services revenue with a number of companies
that provide technical support and other professional services to users of
Linux-based operating systems, including some original equipment manufacturers
with which we have agreements. Many of these companies have larger and more
experienced services organizations than we do currently. In addition, we face
potential competition from several companies with larger customer bases and
greater financial resources and name recognition than we have, such as Sun
Microsystems, Corel Corp. and Cygnus Solutions, each of which has indicated a
growing interest in the Linux-based operating systems market.
The Linux-based operating systems market is not characterized by the
traditional barriers to entry that are found in most other markets, due to the
open source nature of our products. For example, anyone can copy, modify and
redistribute Red Hat Linux themselves. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share.
We believe that the major factors affecting the competitive landscape for
our products include:
- name and reputation of vendor;
- product performance, functionality and price;
- strength of relationships in the open source community;
- availability of user applications;
- ease of use;
- networking capability;
- breadth of hardware compatibility;
- quality of support and customer services;
- distribution strength; and
- alliances with industry partners.
Although we believe that we compete favorably with many of our competitors in a
number of respects, including product performance, functionality and price,
networking capability, and breadth of hardware compatibility, we believe that
many of our competitors enjoy greater name recognition, have superior
distribution capabilities and offer more extensive support services than we
currently do. In addition, there are significantly more user applications
available for competing operating systems, such as Windows NT and UNIX, than
there are for Linux-based operating systems. An integral part of our strategy in
the near future, however, is to address these shortcomings by, among other
things, strengthening our existing strategic relationships and entering into new
ones in an effort to enhance our name recognition, expand our distribution
capabilities and attract more attention to the open source movement, which in
turn should create additional incentives for software developers to write more
applications for Red Hat Linux.
51
<PAGE>
In the market for advertising revenue, we will compete with other online
content providers and traditional forms of media such as newspapers, magazines,
radio and television. We believe that the principal competitive factors in
attracting advertisers include the amount of traffic on REDHAT.COM, brand
recognition, customer service and support, the demographics of our users and
visitors, our ability to offer targeted audiences and the overall
cost-effectiveness of the advertising medium that we offer.
SOFTWARE ENGINEERING AND DEVELOPMENT
We have invested, and intend to continue to invest, significant resources in
product and technology development. We focus and modify our product development
efforts based on the needs of users and changes in the marketplace. We are
currently focusing our development efforts on improving the Linux kernel, as
well as commercializing our software innovations into new products and product
enhancements that are easier to use and provide greater functionality.
Our software engineers have contributed to the development and maintenance
of some of the most important components of the Red Hat Linux operating system,
including the installation program and the package management program. The
installation program provides users with a single method to install the hundreds
of separate software programs that are included with Red Hat Linux so that from
the user's perspective, the hundreds of programs appear as one. This simplified
process sharply reduces the time and effort required to install a Linux-based
operating system, as compared to the alternative of gathering the hundreds of
programs one by one via the internet. The installation program provides default
settings for the user depending upon whether the user wishes to use Red Hat
Linux as a server operating system or as a workstation operating system. The
installation also provides advanced users with the ability to customize the
programs that are installed, allowing for significant flexibility and control
over the operating system. The installation also automatically detects the type
of hardware that comprises the user's computer, in order to ensure that all
programs necessary for Red Hat Linux to work on the hardware are properly
installed.
Our software development engineers perform extensive testing of Red Hat
Linux to ensure that it is properly assembled and works as a coherent whole from
the user's perspective. We use industry standard methods of quality assurance
testing to ensure that Red Hat Linux is solidly engineered and ready for use by
our customers when shipped. We also operate an extensive beta testing program
for Red Hat Linux. Under this beta testing program, we post a beta or test
version of the operating system on the internet. Developers and users around the
world then suggest improvements and identify bugs. Each suggestion is circulated
over the internet in an attempt to encourage others to assist in the programming
of a solution. In this way, Red Hat Linux users are treated as co-developers.
Bug fixes and enhancements are tested by other users and our engineers, and when
corrected, added to the next release. When the beta version is viewed as stable
and complete, it becomes the next production version, and a new beta cycle
begins.
Our web development team consists of engineers with considerable experience
in developing scalable web-based applications. We continue to develop
applications on REDHAT.COM for user registration, commerce, and content
management and publication. We rigorously test these programs and have built in
the software necessary to ensure high quality visits to our web site.
Most of our software engineering and development work takes place at our
headquarters. As of June 30, 1999, we employed 53 individuals in our engineering
group, consisting of 22 software engineers, including several of the top Linux
kernel developers in the world, 21 web design and development professionals, 5
quality assurance engineers and 5 documentation specialists.
52
<PAGE>
INTELLECTUAL PROPERTY
Red Hat Linux has been developed and made available for licensing under the
GNU General Public License and similar licenses. These licenses generally permit
anyone to copy, modify and distribute the software, subject only to the
restriction that any resulting or derivative work is made available to the
public under the same terms. Therefore, although we retain the copyrights to the
code that we develop ourselves, due to the open source nature of our software
products and the licenses under which we develop and distribute them, our most
valuable intellectual property is our collection of trademarks. We rely
primarily on a combination of trademarks and copyrights to protect our
intellectual property. We also enter into confidentiality and nondisclosure
agreements with our employees and consultants, and generally control access to
and distribution of our documentation and other proprietary information.
We pursue registration of some of our trademarks in the United States and in
other countries. We have registered the trademark "Red Hat" in the United States
and have registrations pending in the Australian, Canadian and European Union
trademark offices. We have registered the Red Hat "Shadow Man" logo in the U.S.,
European Union and Australia and have registrations pending for it in the
Canadian trademark office.
Despite our efforts to protect our trademark rights, unauthorized third
parties have in the past attempted and in the future may attempt to
misappropriate our trademark rights. We are currently investigating possible
infringement claims against a third party in France whom we believe has
misappropriated our tradename and trademarks. We cannot be certain that we will
succeed in preventing the continued misappropriation of our tradename and
trademarks in these circumstances or that we will be able to prevent this type
of unauthorized use in the future. The laws of some foreign countries do not
protect our trademark rights to the same extent as do the laws of the United
States. In addition, policing unauthorized use of our trademark rights is
difficult, expensive and time consuming. The loss of any material trademark or
trade name could have a material adverse effect on our business, operating
results and financial condition.
Although we do not believe that our products infringe the rights of third
parties, third parties have in the past asserted, and may in the future assert
infringement claims against us which may result in costly litigation or require
us to obtain a license to third-party intellectual rights. There can be no
assurance that such licenses will be available on reasonable terms or at all,
which could have a material adverse effect on our business, operating results
and financial condition.
EMPLOYEES
As of June 30, 1999, we had a total of 140 employees. Of the total
employees, 53 were in software engineering, 35 in sales and marketing, 32 in
customer service and technical support and 20 in finance and administration. Our
future success will depend in part on our ability to attract, retain and
motivate highly qualified technical and management personnel, for whom
competition is intense. From time to time we also employ independent contractors
to support our professional services, product development, sales, marketing and
business development organizations. Our employees are not represented by any
labor union and are not organized under a collective bargaining agreement, and
we have never experienced a work stoppage. We believe our relations with our
employees are good.
FACILITIES
Our headquarters are currently located in a leased facility in Durham, North
Carolina, consisting of approximately 51,800 square feet under a five year lease
that will expire on January 14, 2004. The annual rental expense under this lease
is approximately $900,000. We believe that additional space will be required as
our business expands and will be available on acceptable terms.
LEGAL PROCEEDINGS
We are not a party to any material legal proceedings. We may from time to
time become a party to various legal proceedings arising in the ordinary course
of our business.
53
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth the executive officers, directors and key
employees of Red Hat, their ages and the positions held by them with Red Hat as
of June 30, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---------------------------------------------------- --------- ----------------------------------------------------
<S> <C> <C>
EXECUTIVE OFFICERS AND DIRECTORS
Robert F. Young..................................... 45 Chief Executive Officer and Chairman of the Board of
Directors
Matthew J. Szulik................................... 42 President and Director
Marc Ewing.......................................... 30 Executive Vice President, Chief Technology Officer
and Director
Timothy J. Buckley.................................. 48 Senior Vice President and Chief Operating Officer
Manoj K. George..................................... 32 Chief Financial Officer, Director of Administration
and Treasurer
David G. Shumannfang................................ 31 Counsel and Secretary
Frank Batten, Jr. (1)(2)............................ 40 Director
William S. Kaiser (1)(2)............................ 44 Director
Eric Hahn (1)(2).................................... 39 Director
KEY EMPLOYEES
Erik W. Troan....................................... 25 Director of Engineering
Donald J. Barnes.................................... 26 Director of Technical Projects
Theresa A. Williams-Spangler........................ 41 Business Unit Leader--Sales
Dr. Charles A. Coleman, Jr.......................... 53 Director of Information Services
Matthew Butterick................................... 28 Director of Internet Business
Colin Tenwick....................................... 39 General Manager for European Operations
Carolyn Sparano..................................... 36 Director of Services
</TABLE>
- ------------------------
(1) Member of Compensation Committee.
(2) Member of Audit Committee.
ROBERT F. YOUNG co-founded Red Hat and served as its President and a
Director from its inception until November 1998. In November 1998, he was
elected to his current positions as Chief Executive Officer and Chairman of the
Board of Directors.
MATTHEW J. SZULIK has served as President of Red Hat since November 1998 and
a Director since April 1999. Mr. Szulik also served as Chief Operating Officer
of Red Hat from November 1998 to April 1999. Prior to joining Red Hat, from
September 1997 to October 1998, Mr. Szulik served as President of Relativity
Technologies, a computer software company. From February 1996 to May 1997, Mr.
Szulik served as President of Sapiens International, a computer software
company. Prior to that, from January 1993 to December 1995, he served as Senior
Vice President in charge of sales and marketing for MapInfo Corp., a computer
software company.
MARC EWING co-founded Red Hat and has served as its Executive Vice President
and Chief Technology Officer and as a Director since its inception. Mr. Ewing
participated in the design and development of Red Hat Linux and founded Red Hat
Advanced Development Laboratories to develop open source graphical desktop
applications for Linux in cooperation with the open source development
community. Prior to founding Red Hat, for various periods
54
<PAGE>
from January 1991 to August 1992, Mr. Ewing worked as a systems programmer for
IBM.
TIMOTHY J. BUCKLEY has served as Senior Vice President and Chief Operating
Officer of Red Hat since April 1999. Prior to joining Red Hat, from October 1997
until April 1999, Mr. Buckley was Senior Vice President of Worldwide Sales at
Visio Corp., a business software company. Mr. Buckley joined Visio in November
1993 and served as Visio's Vice President of Worldwide Sales until his promotion
in October 1997.
MANOJ K. GEORGE has served as Red Hat's Chief Financial Officer and
Treasurer since May 1998. From May 1997 to the present, he has held the position
of Director of Administration, and from May 1997 to May 1998 he served as Red
Hat's Controller. From November 1994 to May 1997, Mr. George, a certified public
accountant, served, first as a staff accountant, then as a senior accountant
with a regional accounting firm.
DAVID G. SHUMANNFANG has served as Counsel of Red Hat since October 1996 and
Secretary of Red Hat since April 1997. From August 1993 to May 1996, Mr.
Shumannfang earned his Juris Doctor from the University of North Carolina at
Chapel Hill School of Law. Mr. Shumannfang is a member of the North Carolina
State Bar.
FRANK BATTEN, JR. has served as a Director of Red Hat since August 1997. Mr.
Batten is currently Chairman of Landmark Communications Inc., a media company,
and has served in that position since January 1998. Prior to that, Mr. Batten
served Landmark Communications as its Executive Vice President, Corporate
Development from October 1995 to January 1998. From June 1991 to October 1995,
Mr. Batten was President and Publisher of the Virginian Pilot, a newspaper
division of Landmark Communications.
WILLIAM S. KAISER has served as a Director of Red Hat since September 1998.
Mr. Kaiser has been employed by Greylock Management Corporation, a venture
capital firm, since May 1986 and has been a general partner of the Greylock
Limited Partnerships since January 1988. Mr. Kaiser is also a director of Open
Market Inc., Clarus Corporation and Student Advantage, Inc.
ERIC HAHN has served as a Director of Red Hat since April 1999. Mr. Hahn is
a founding partner of Inventures Group, a leading "mentor investment" venture
capital firm. He served as Executive Vice President and Chief Technology Officer
of Netscape from November 1996 until June 1998. Prior to serving as Netscape's
Chief Technology Officer, from November 1995 to November 1996, Mr. Hahn was
general manager of Netscape's Server Products Division, overseeing product
development for Netscape's enterprise, internet and extranet servers. Mr. Hahn
joined Netscape following its acquisition of Collabra Software, Inc., which Mr.
Hahn founded in February 1993.
ERIK W. TROAN has served as Red Hat's Director of Engineering since February
1999. Prior to that, between May 1995 and February 1999, he served as Chief
Developer at Red Hat. He is the co-author of LINUX APPLICATION DEVELOPMENT, a
book covering mid-level programming on the Linux operating system and from 1995
to 1996, was a regular columnist for the X Journal Magazine, covering free
software topics.
DONALD J. BARNES has served Red Hat as Director of Technical Projects since
February 1999. From November 1997 to February 1999, he served as Red Hat's
Development Manager of Quality Assurance and from May 1995 to November 1997 he
served as a System's Engineer for Red Hat. From May 1994 to May 1995, Mr. Barnes
was a Systems Engineer for Northern Telecom Limited.
THERESA SPANGLER has served as Business Unit Leader--Sales for Red Hat since
February 1999. Prior to joining Red Hat, from October 1997 to February 1999, she
served as Vice President of Sales and Marketing at Technauts, Inc., a software
company. From December 1991 to March 1997, Ms. Spangler served as Senior
Territory Manager for
55
<PAGE>
PictureTel Corp., a video conferencing equipment manufacturer.
CHARLES A. COLEMAN has served as Red Hat's Director of Information Services
since April 1999. From February 1999 to March 1999, Mr. Coleman acted as a
consultant to Red Hat in connection with systems vendor evaluation, selection
and implementation. From April 1998 to January 1999, Mr. Coleman served as
President and Chief Information Officer at Critical Information Technologies,
LLC, a data modeling and systems integration firm. From September 1996 to April
1998 he was employed by Ellora Software, Inc., a clinical data management
software developer, first as a consultant and then as a Vice President. From
February 1994 to September 1996, Mr. Coleman was Senior Vice President of
Inquiry Management and Database Systems for Computerworld, Inc. From August 1983
to February 1994 he served as President and Chief Information Officer of
Response Technologies, Inc., a business processing reengineering company.
MATTHEW BUTTERICK has served as Red Hat's Director of Internet Business
since May 1999. Prior to joining Red Hat, Mr. Butterick was founder and
President of Atomic Vision, a web site development company, from September 1994
until May 1999.
COLIN TENWICK has served as Red Hat's General Manager for European
Operations since June 1999. Prior to joining Red Hat, Mr. Tenwick held numerous
positions with Sybase, including Vice President and General Manager, European
Operations from October 1998 to June 1999; Vice President and Managing Director,
U.K. Operations from November 1995 to October 1998; and Vice President,
Marketing and Channel Sales, European Operations from April 1994 to November
1995.
CAROLYN SPARANO has served as Red Hat's Director of Services since June
1999. Prior to joining Red Hat, Ms. Sparano served in several positions with
INTERSOLV ASQ, including Vice President of Worldwide Training from March 1999 to
May 1999; Director of Consulting Services from August 1998 to March 1999;
Director of World Wide DataDirect Solutions from March 1997 to August 1998;
Director of DataDirect Technical Support from August 1995 to March 1997; and
Manager of Technical Support from January 1992 to August 1995.
ELECTION OF OFFICERS AND DIRECTORS
Red Hat's executive officers are elected by the Board of Directors on an
annual basis and serve until their successors are duly elected and qualified.
All of the current Directors were selected as Directors of Red Hat under the
First Amended and Restated Stockholder's Voting Agreement dated February 25,
1999, as amended, between Red Hat and some of its stockholders, which agreement
will automatically terminate upon the closing of this offering. There are no
family relationships among any of the executive officers or directors of Red
Hat.
Upon the closing of this offering, Red Hat's Board of Directors will be
divided into three classes, with the members of each class of directors serving
for staggered three-year terms. Messrs. Ewing and Hahn will serve in the class
the term of which expires in 2000; Messrs. Szulik and Batten will serve in the
class the term of which expires in 2001; and Messrs. Young and Kaiser will serve
in the class the term of which expires in 2002. At each annual meeting of
stockholders, a class of directors will be elected for a three-year term to
succeed the directors of the same class whose term is then expiring. Red Hat's
adoption of a classified Board of Directors could have the effect of increasing
the length of time necessary to change the composition of a majority of the
Board of Directors. See "Description of Capital Stock--Delaware Law and Certain
Charter and By-Law Provisions and Anti-Takeover Effects".
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has appointed a Compensation Committee consisting of
Messrs. Batten, Kaiser and Hahn. The Compensation Committee reviews and
evaluates the compensation and benefits of all of Red Hat's officers, reviews
general policy
56
<PAGE>
matters relating to compensation and benefits of Red Hat's employees and makes
recommendations concerning these matters to the Board of Directors. The
Compensation Committee also administers Red Hat's stock option and stock
purchase plans. See "--Employee Benefit Plans".
The Board of Directors has also appointed an Audit Committee consisting of
Messrs. Batten, Kaiser and Hahn. The Audit Committee reviews, with Red Hat's
independent auditors, the scope and timing of the auditors' services, the
auditors' report on Red Hat's financial statements following completion of the
auditors' audit, and Red Hat's internal accounting and financial control
policies and procedures. In addition, the Audit Committee will make annual
recommendations to the Board of Directors for the appointment of independent
auditors for the ensuing year.
DIRECTOR COMPENSATION
Directors are reimbursed for reasonable out-of-pocket expenses incurred in
attending meetings of the Board of Directors and for meetings of any committees
of the Board of Directors on which they serve. Directors are also eligible to
participate in Red Hat's 1998 Stock Option Plan and 1999 Stock Option and
Incentive Plan. In accordance with a policy approved by the Board of Directors,
upon initial election or appointment to the Board of Directors, new non-employee
Directors will be granted non-qualified stock options to purchase 20,000 shares
of common stock at a price at least equal to the fair market value of Red Hat's
common stock on the date of grant. These options will vest 33 1/3% one year from
grant date and 8 1/3% at the end of each three-month period thereafter. Upon
re-election, non-employee directors will be granted non-qualified stock options
to purchase 10,000 shares of common stock to vest 33 1/3% one year from the date
of re-election and 8 1/3% at the end of each three-month period thereafter. Each
year of a non-employee director's tenure, the director will be granted
non-qualified stock options to purchase 5,000 shares of common stock which will
be fully vested upon grant. Upon the effectiveness of the registration statement
of which this prospectus is a part, according to the policy established by the
Board of Directors, Messrs. Batten and Kaiser will each be granted non-qualified
stock options to purchase 10,000 shares of common stock at the initial public
offering price. These options will vest as provided above. See "--Employee
Benefit Plans". In addition, in April 1999, Mr. Hahn was granted a non-qualified
stock option under the 1998 Stock Option Plan to purchase 171,552 shares of
common stock at an exercise price of $1.5705 per share.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between the Board of Directors or
Compensation Committee and the board of directors or compensation committee of
any other company, nor has any interlocking relationship existed in the past.
57
<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth the compensation earned by Robert F. Young,
Red Hat's Chief Executive Officer, and Red Hat's only other executive officer
during the fiscal year ended February 28, 1999 whose salary and bonus exceeded
$100,000 for such fiscal year for services rendered in all capacities to Red Hat
during the fiscal year ended February 28, 1999. As of June 30, 1999, the
annualized base salaries of Red Hat's executive officers not listed in the table
below who, had they been employed by Red Hat for the full fiscal year ended
February 28, 1999, would have earned in excess of $100,000, were: Matthew J.
Szulik -- $185,000 and Timothy J. Buckley -- $155,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL AWARDS
COMPENSATION ---------------------------
NAME AND PRINCIPAL ------------------------ SECURITIES UNDERLYING ALL OTHER
POSITION SALARY($) BONUS($) OPTIONS(#) COMPENSATION ($)
- --------------------------- ----------- ----------- --------------------------- -------------------
<S> <C> <C> <C> <C>
Robert F. Young
Chairman and Chief
Executive Officer........ 161,458 25,000 -- 41,141
Marc Ewing
Executive Vice President
and Chief Technology
Officer.................. 145,125 20,000 -- --
</TABLE>
Red Hat has never granted any stock options to Mr. Young or Mr. Ewing.
CHANGE IN CONTROL ARRANGEMENTS
Matthew Szulik, Red Hat's President, is a party to an incentive stock option
agreement and a non-qualified stock option agreement, which both provide for the
lapsing of Red Hat's repurchase right as to 33 1/3% of his option shares if he
is terminated without cause on or before March 13, 2000 and for the lapsing in
full of Red Hat's repurchase right as to any unvested option shares upon the
termination of his employment, either by Red Hat's successor without cause or by
Mr. Szulik for good reason, following a change in control of Red Hat.
Tim Buckley, Red Hat's Chief Operating Officer, is a party to an incentive
stock option agreement and a non-qualified stock option agreement, which both
provide for the lapsing of Red Hat's repurchase right as to 33 1/3% of his
option shares if he is terminated without cause on or before April 12, 2000 and
for the lapsing in full of Red Hat's repurchase right as to any unvested option
shares upon the termination of his employment, either by Red Hat's successor
without cause or by Mr. Buckley for good reason, following a change in control
of Red Hat.
EMPLOYEE BENEFIT PLANS
1998 STOCK OPTION PLAN, AS AMENDED
Red Hat's 1998 Stock Option Plan, as amended, was adopted by the Board of
Directors and approved by Red Hat's stockholders in August 1998, and was amended
in November 1998, February 1999 and June 1999. The aggregate number of shares of
common stock which may be issued under the 1998 Stock Option Plan is 9,434,800.
Under the 1998 Stock Option Plan, Red Hat is authorized to grant incentive stock
options and non-qualified stock options, as well as awards of common stock and
opportunities to make direct purchases of common stock to employees,
consultants, directors and officers
58
<PAGE>
of Red Hat. The 1998 Stock Option Plan is administered by the Board of Directors
and the Compensation Committee. The 1998 Stock Option Plan provides that the
Board of Directors and the Compensation Committee each has the authority to
select the participants and determine the terms of the stock options, awards and
purchase rights granted under the 1998 Stock Option Plan. Options granted under
the 1998 Stock Option Plan are immediately exercisable. Red Hat has a right of
repurchase over all exercised but unvested shares. Generally, Red Hat's right of
repurchase lapses over a period of four years. An incentive stock option is not
transferable by the recipient except by will or by the laws of descent and
distribution. Non-qualified stock options and other awards are transferable only
to the extent provided in the agreement relating to such option or award or in
response to a valid domestic relations order. Generally, no Incentive Stock
Options may be exercised more than three months following termination of
employment, and no stock option may be exercised following termination of
employment for cause. However, in the event that termination is due to death or
disability, the stock option is exercisable for a maximum of 180 days after such
termination. In June 1999, the Board of Directors and the stockholders voted to
terminate the 1998 Stock Option Plan effective on the consummation of the
offering. As of June 30, 1999 Red Hat had outstanding under the 1998 Stock
Option Plan incentive stock options exercisable for 2,471,858 shares of common
stock and non-qualified stock options exercisable for 2,705,030 shares of common
stock.
1999 STOCK OPTION AND INCENTIVE PLAN
Red Hat's 1999 Stock Option and Incentive Plan was adopted by Red Hat's
Board of Directors and approved by its stockholders in June 1999. The 1999 Stock
Option and Incentive Plan provides for the grant of stock-based awards to
employees, officers and directors of, and consultants or advisors to, Red Hat
and its subsidiaries, including incentive stock options and non-qualified stock
options and other equity-based awards. Incentive stock options may be granted
only to employees of Red Hat. A total of 6,500,000 shares of common stock may be
issued upon the exercise of options or other awards granted under the 1999 Stock
Option and Incentive Plan. The maximum number of shares that may be granted to
any employee under the 1999 Stock Option and Incentive Plan shall not exceed
3,250,000 shares of common stock during any calendar year.
The 1999 Stock Option and Incentive Plan is administered by the Board of
Directors and the Compensation Committee. The 1999 Stock Option and Incentive
Plan provides that the Board of Directors and the Compensation Committee each
has the authority to select the persons to whom awards are granted and determine
the terms of each award, including the number of shares of common stock to be
granted. Payment of the exercise price of an award may be made in cash, shares
of common stock, a combination of cash or stock or by any other method approved
by the Board or Compensation Committee, consistent with Section 422 of the
Internal Revenue Code and Rule 16b-3 under the Exchange Act. Unless otherwise
permitted by Red Hat, awards are not assignable or transferable except by will
or the laws of descent and distribution.
Each of the Board of Directors or Compensation Committee may, in its sole
discretion, amend, modify or terminate any award granted or made under the 1999
Stock Option and Incentive Plan, so long as such amendment, modification or
termination would not materially and adversely affect the participant. Each of
the Board or Compensation Committee may also, in its sole discretion, accelerate
or extend the date or dates on which all or any particular option or options
granted under the 1999 Stock Option and Incentive Plan may be exercised.
1999 EMPLOYEE STOCK PURCHASE PLAN
The 1999 Employee Stock Purchase Plan was adopted by the Board of Directors
and approved by the stockholders in June 1999. The 1999 Employee Stock Purchase
Plan
59
<PAGE>
provides for the issuance of a maximum of 750,000 shares of common stock.
The 1999 Employee Stock Purchase Plan is administered by the Board of
Directors and the Compensation Committee. All employees of Red Hat whose
customary employment is for more than 20 hours per week and for more than three
months in any calendar year and who have completed more than 90 days of
employment with Red Hat on or before the first day of any six-month payment
period are eligible to participate in the 1999 Employee Stock Purchase Plan.
Outside directors and employees who would own 5% or more of the total combined
voting power of value of Red Hat's stock immediately after the grant may not
participate in the 1999 Employee Stock Purchase Plan. To participate in the 1999
Employee Stock Purchase Plan, an employee must authorize Red Hat to deduct an
amount not less than one percent nor more than 10 percent of a participant's
total cash compensation from his or her pay during six-month payment periods.
The first payment period will commence on a date to be determined by the Board
of Directors and end on March 31, 2000. Thereafter, the payment periods will
commence on the first day of April and October, and end on the last day of the
following March and September, respectively, of each year, but in no case shall
an employee be entitled to purchase more than 1,000 shares in any one payment
period. The exercise price for the option granted in each payment period is 85%
of the lesser of the average market price of the common stock on the first or
last business day of the payment period, in either event rounded up to the
nearest cent. If an employee is not a participant on the last day of the payment
period, such employee is not entitled to exercise his or her option, and the
amount of his or her accumulated payroll deductions will be refunded. Options
granted under the 1999 Employee Stock Purchase Plan may not be transferred or
assigned. An employee's rights under the 1999 Employee Stock Purchase Plan
terminate upon his or her voluntary withdrawal from the plan at any time or upon
termination of employment. No options have been granted to date under the 1999
Employee Stock Purchase Plan.
401(K) PLAN
Red Hat has a Section 401(k) Profit Sharing Plan. The 401(k) plan is a
tax-qualified plan covering all full-time Red Hat employees who are over 21
years of age and who have completed three months of service with Red Hat. If,
however, an employee was employed by Red Hat prior to February 1999, the 401(k)
plan covered such employee regardless of age or length of service with Red Hat.
Under the 401(k) plan, participants generally may elect to defer a portion of
their compensation. In addition, at the discretion of the Board of Directors,
Red Hat may make matching contributions into the 401(k) plan for all eligible
employees. Red Hat has not made any contributions to the 401(k) plan to date.
LIMITATION OF LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
Red Hat's Third Amended and Restated Certificate of Incorporation and
Amended and Restated By-Laws provide that the directors and officers of Red Hat
shall be indemnified by Red Hat to the fullest extent permitted by Delaware law,
as it now exists or may in the future be amended, against all expenses and
liabilities reasonably incurred in connection with their service for or on
behalf of Red Hat. In addition, the Third Amended and Restated Certificate of
Incorporation provides that the directors of Red Hat will not be personally
liable for monetary damages to Red Hat for breaches of their fiduciary duty as
directors, unless they violated their duty of loyalty to Red Hat or its
stockholders, acted in bad faith, knowingly or intentionally violated the law,
authorized illegal dividends or redemptions or derived an improper personal
benefit from their action as directors. Red Hat intends to obtain insurance
which insures the directors and officers of Red Hat against certain losses and
which insures Red Hat against its obligations to indemnify the directors and
officers.
60
<PAGE>
TRANSACTIONS WITH AFFILIATES
On August 15, 1997, Red Hat sold 6,801,400 shares of its Series A preferred
stock to Frank Batten, Jr., Frank Batten, Louis F. Ryan as trustees under a
trust agreement dated April 11, 1988, as amended in a private financing at a
price of $.294057 per share. The trust is a 5% stockholder of Red Hat.
On September 29, 1998, Red Hat sold an aggregate of 8,116,550 shares of its
Series B preferred stock in a private financing at a price of $.857 per share.
Among the purchasers in this financing were Frank Batten, Jr., Frank Batten,
Louis F. Ryan as trustees under a trust agreement dated April 11, 1988, as
amended, Intel Corporation, Greylock IX Limited Partnership and Benchmark
Capital Partners II, L.P., each a 5% stockholder of Red Hat.
From February 25, 1999 through April 1, 1999, Red Hat sold an aggregate of
2,054,776 shares of its Series C preferred stock in a private financing at a
price of $3.141 per share. Among the purchasers in this financing were Frank
Batten, Jr., Frank Batten, Louis F. Ryan as trustees under a trust agreement
dated April 11, 1988, as amended, Intel Corporation, Greylock IX Limited
Partnership and Benchmark Capital Partners II, L.P., each a 5% stockholder of
Red Hat.
Red Hat believes that all transactions set forth above were made on terms no
less favorable to it than would have been obtained from unaffiliated third
parties. Red Hat has adopted a policy providing that all future transactions
between Red Hat and any of its officers, directors and affiliates will be on
terms no less favorable to Red Hat than could be obtained from unaffiliated
third parties and will be approved by a majority of the disinterested members of
Red Hat's Board of Directors.
61
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to Red Hat
regarding beneficial ownership of Red Hat's common stock as June 30, 1999 and as
adjusted to reflect the sale of the shares of common stock in this offering by:
- each person known by Red Hat to be the beneficial owner of more than 5% of
Red Hat's common stock;
- Red Hat's Chief Executive Officer and only other executive officer whose
salary and bonus during the fiscal year ended February 28, 1999 exceeded
$100,000 for such fiscal year;
- each of Red Hat's directors; and
- all executive officers and directors as a group.
Unless otherwise indicated, to the knowledge of Red Hat, each stockholder
possesses sole voting and investment power over the shares listed, except for
shares owned jointly with that person's spouse.
The number of shares of common stock deemed outstanding includes shares
issuable upon exercise of options and warrants held by the respective person or
group which may be exercised within 60 days after June 30, 1999. For purposes of
calculating each person's or group's percentage ownership, stock options
exercisable within 60 days after June 30, 1999 and warrants are included for
that person or group but not the stock options and warrants of any other person
or group.
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED
------------------------
NAME AND ADDRESS OF BEFORE AFTER
BENEFICIAL OWNER (1) SHARES BENEFICIALLY OWNED OFFERING OFFERING
- ------------------------------------------------------------ -------------------------- ----------- -----------
<S> <C> <C> <C>
5% STOCKHOLDERS
Greylock IX Limited Partnership............................. 8,723,866 14.4% 13.1%
One Federal Street
Boston, MA 02110
Benchmark Capital Partners II, L.P.......................... 5,815,910 9.6 8.7
2840 Sand Hill Road, Suite 2000
Menlo Park, CA 94025
Intel Corporation........................................... 3,005,058 5.0 4.5
2200 Mission College Blvd. RN6-46
Santa Clara, CA 95052
EXECUTIVE OFFICERS AND DIRECTORS
Robert F. Young (2)......................................... 9,081,826 15.0 13.6
Marc Ewing (3).............................................. 9,088,476 15.0 13.7
Matthew Szulik (4).......................................... 2,736,248 4.4 4.0
Frank Batten, Jr. (5)....................................... 15,005,888 24.8 22.5
c/o Landmark Communications
150 W. Brambleton Avenue
Norfolk, VA 23510-2075
William S. Kaiser (6)....................................... 8,723,866 14.4 13.1
c/o Greylock IX Limited Partnership
One Federal Street
Boston, MA 02110
Eric Hahn................................................... 171,552 * *
All executive officers and directors as
a group (9 persons) (7)................................... 47,145,578 74.1% 67.7%
</TABLE>
- ------------------------
* Represents beneficial ownership of less than one percent of outstanding
common stock.
62
<PAGE>
(1) Unless otherwise indicated, the address for each beneficial owner is c/o Red
Hat, Inc., 2600 Meridian Parkway, Durham, N.C. 27713.
(2) Includes 3,222,746 shares held of record by Nancy Young, Mr. Young's wife,
300,000 held by the Nancy R. Young GRAT dated April 28, 1999, 200,000 shares
held of record by the Young Family Trust dated April 28, 1999 and 1,418,160
shares held of record by trusts for the benefit of Mr. Young's children. Mr.
Young disclaims beneficial ownership of these shares. Also includes 300,000
shares held of record by the Robert F. Young GRAT dated April 28, 1999.
(3) Includes 200,000 shares held of record by the Ewing Family Trust dated April
28, 1999 and 1,012,720 shares held of record by trusts for the benefit of
Mr. Ewing's children. Mr. Ewing disclaims beneficial ownership of these
shares. Also includes 600,000 shares held of record by the Marc Ewing GRAT
dated April 28, 1999.
(4) Includes 36,000 shares held of record by trusts for the benefit of Mr.
Szulik's children. Mr. Szulik disclaims beneficial ownership of these
shares. Also includes 27,678 shares held of record by the Matthew J. Szulik
GRAT dated May 26, 1999. Also includes 1,672,570 shares of common stock
issuable upon exercise of stock options.
(5) Includes 1,519,246 shares held of record by the 1988 Batten Trust and
13,486,642 shares held of record by the 1998 Frank Batten, Jr. Grantor
Annuity Trust.
(6) Includes shares held by Greylock IX Limited Partnership. Mr. Kaiser is a
general partner of Greylock IX GP Limited Partnership, the general partner
of Greylock IX Limited Partnership. Mr. Kaiser disclaims beneficial
ownership of these shares.
(7) Includes 3,031,190 shares of common stock issuable upon exercise of stock
options.
DESCRIPTION OF CAPITAL STOCK
GENERAL
Effective upon the closing of this offering and the filing of Red Hat's
Third Amended and Restated Certificate of Incorporation, as amended as of that
date, the authorized capital stock of Red Hat will consist of 225,000,000 shares
of common stock, par value $.0001 per share, and 5,000,000 shares of preferred
stock, par value $.0001 per share.
Prior to the effectiveness of the registration statement of which this
prospectus is a part, and in accordance with Red Hat's Second Amended and
Restated Certificate of Incorporation, as amended and currently in effect, Red
Hat is authorized to issue up to 70,620,652 shares of common stock, par value
$.0001 per share, of which 26,634,252 shares are issued and outstanding as of
June 30, 1999 and 16,972,726 shares of preferred stock, par value $.0001 per
share, of which as of June 30, 1999, 16,972,726 shares are issued and
outstanding. Upon the closing of this offering, all shares of preferred stock
will automatically convert into 33,945,452 shares of common stock.
The following summary description of Red Hat's capital stock is not intended
to be complete and is qualified by reference to the provisions of applicable law
and to Red Hat's Third Amended and Restated Certificate of Incorporation and
Amended and Restated By-laws, filed as exhibits to the registration statement of
which this prospectus is a part.
COMMON STOCK
As of June 30, 1999, there were 26,634,252 shares of common stock
outstanding held by 63 stockholders of record. Based upon the number of shares
outstanding as of that date and giving effect to the issuance of the 6,000,000
shares of common stock offered by Red Hat in this offering and the conversion of
the outstanding shares of preferred stock, there will be 66,579,704 shares of
common stock outstanding upon the closing of this offering. In addition, as of
June 30, 1999, there were outstanding stock options for the purchase of
5,176,888 shares of common stock and outstanding warrants for
63
<PAGE>
the purchase of 3,197,450 shares of common stock.
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Directors are elected by a plurality of the votes of the shares present
in person or by proxy at the meeting and entitled to vote in such election.
Holders of common stock are entitled to receive ratably such dividends, if any,
as may be declared by the Board of Directors out of funds legally available
therefor, after provision has been made for any preferential dividend rights of
outstanding preferred stock. Upon the liquidation, dissolution or winding up of
Red Hat, the holders of common stock are entitled to receive ratably the net
assets of Red Hat available after the payment of all debts and other liabilities
of Red Hat, and after the satisfaction of the rights of any outstanding
preferred stock. Holders of the common stock have no preemptive, subscription,
redemption or conversion rights, nor are they entitled to the benefit of any
sinking fund. The outstanding shares of common stock are, and the shares offered
by Red Hat in this offering will be, when issued and paid for, validly issued,
fully paid and non-assessable. The rights, powers, preferences and privileges of
holders of common stock are subordinate to, and may be adversely affected by,
the rights of the holders of shares of any series of preferred stock which Red
Hat may designate and issue in the future.
PREFERRED STOCK
The Board of Directors will generally be authorized, without further
stockholder approval, to issue from time to time up to an aggregate of 5,000,000
shares of preferred stock, in one or more series. Each series of preferred stock
shall have such number of shares, designations, preferences, voting powers,
qualifications and special or relative rights or privileges as shall be
determined by the Board of Directors, which may include, among others, dividend
rights, voting rights, redemption and sinking fund provisions, liquidation
preferences, conversion rights and preemptive rights.
The stockholders of Red Hat have granted the Board of Directors authority to
issue the preferred stock and to determine its rights and preferences in order
to eliminate delays associated with a stockholder vote on specific issuances.
The rights of the holders of common stock will be subordinate to the rights of
holders of any preferred stock issued in the future. The issuance of preferred
stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could adversely affect the voting
power or other rights of the holders of common stock, and could make it more
difficult for a third party to acquire, or discourage a third party from
attempting to acquire, a majority of the outstanding voting stock of Red Hat.
Red Hat has not, to date, issued any shares of such preferred stock and has no
present plans to issue any shares of preferred stock.
DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS AND ANTI-TAKEOVER EFFECTS
Upon completion of this offering, the provisions of Section 203 of the
General Corporation Law of Delaware will prohibit Red Hat from engaging in a
"business combination" with an "interested stockholder" for a period of three
years after the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
A "business combination" includes mergers, asset sales and other transactions
resulting in a financial benefit to the interested stockholder. An "interested
stockholder" is generally defined as a person who, together with affiliates and
associates, owns, or within three years did own, 15% or more of the
corporation's voting stock.
Red Hat's Third Amended and Restated Certificate of Incorporation provides
for the division of the Board of Directors into three classes as nearly equal in
size as possible with staggered three-year terms. See "Management--Election of
Officers and Directors". In addition, Red Hat's Third
64
<PAGE>
Amended and Restated Certificate of Incorporation provides that directors may be
removed only for cause by the affirmative vote of the holders of 75% of the
shares of capital stock of Red Hat entitled to vote. Under Red Hat's Third
Amended and Restated Certificate of Incorporation, any vacancy on the Board of
Directors, however occurring, including a vacancy resulting from an enlargement
of the Board, may only be filled by vote of a majority of the directors then in
office. The likely effect of the classification of the Board of Directors and
the limitations on the removal of directors and filling of vacancies is an
increase in the time required for the stockholders to change the composition of
the Board of Directors. For example, in general, at least two annual meetings of
the stockholders will be necessary for stockholders to effect a change in a
majority of the members of the Board of Directors.
Red Hat's Third Amended and Restated Certificate of Incorporation also
provides that, after the effective date of the registration statement of which
this prospectus is a part, any action required or permitted to be taken by the
stockholders of Red Hat at an annual meeting or special meeting of stockholders
may only be taken if it is properly brought before the meeting and may not be
taken by written action in lieu of a meeting. Red Hat's Amended and Restated
By-laws provide that special meetings of the stockholders may only be called by
the Board of Directors, the Chairman of the Board of Directors, the Chief
Executive Officer or the President of Red Hat. Red Hat's Amended and Restated
By-laws further provide that in order for any matter to be considered "properly
brought" before a meeting, a stockholder must comply with requirements regarding
advance notice to Red Hat. The foregoing provisions could have the effect of
delaying until the next stockholders meeting stockholder actions which are
favored by the holders of a majority of the outstanding voting securities of Red
Hat. These provisions may also discourage another person or entity from making a
tender offer for Red Hat's common stock, because such person or entity, even if
it acquired a majority of the outstanding voting securities of Red Hat, would be
able to take action as a stockholder, such as electing new directors or
approving a merger, only at a duly called stockholders meeting, and not by
written consent.
The General Corporation Law of Delaware provides generally that the
affirmative vote of a majority of the shares entitled to vote on any matter is
required to amend a corporation's certificate of incorporation or by-laws,
unless a corporation's certificate of incorporation or by-laws, as the case may
be, requires a greater percentage. Red Hat's Third Amended and Restated
Certificate of Incorporation requires the affirmative vote of the holders of at
least 75% of the shares of capital stock of Red Hat issued and outstanding and
entitled to vote to amend or repeal any of the foregoing provisions of the
Restated Certificate of Incorporation. Red Hat's Amended and Restated By-laws
may generally be amended or repealed by a majority vote of the Board of
Directors and may also be amended or repealed by the affirmative vote of the
holders of at least 75% of the shares of capital stock of Red Hat issued and
outstanding and entitled to vote. The 75% stockholder vote would be in addition
to any separate class vote that might in the future be required in accordance
with the terms of any series of preferred stock that might be outstanding at the
time any such amendments are submitted to stockholders.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is Chase Mellon
Shareholder Services, LLC.
65
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for Red Hat's common stock.
Future sales of substantial amounts of common stock in the public market could
adversely affect prevailing market prices from time to time. Furthermore, since
only a limited number of shares will be available for sale shortly after this
offering because of certain contractual and legal restrictions on resale
described below, sales of substantial amounts of Red Hat's common stock in the
public market after the restrictions lapse could adversely affect the prevailing
market price and Red Hat's the ability to raise equity capital in the future.
SALES OF RESTRICTED SHARES
Based on shares outstanding at June 30, 1999 upon completion of this
offering, Red Hat will have outstanding an aggregate of 66,579,704 shares of
common stock, assuming no exercise of the underwriters' over-allotment option
and no exercise of outstanding options or warrants. Of these shares, the
6,000,000 shares sold in this offering will be freely tradable without
restrictions or further registration under the Securities Act, unless such
shares are purchased by an existing affiliate of Red Hat as that term is defined
in Rule 144 under the Securities Act.
The remaining 60,579,704 shares of common stock held by existing
stockholders are restricted shares or are restricted by the contractual
provisions described below. Restricted shares may be sold in the public market
only if registered or if they qualify for an exemption from registration under
Rule 144, 144(k) or 701 promulgated under the Securities Act, which are
summarized below. Of these restricted shares, 1,990,000 shares will be available
for resale in the public market in reliance on Rule 144(k), all of which shares
are restricted by the terms of the lock-up agreements described below. An
additional 31,773,102 shares will be available for resale in the public market
in reliance on Rule 144, all of which shares are restricted by the terms of the
lock-up agreements. The remaining 26,296,852 shares become eligible for resale
in the public market at various dates thereafter, all of which shares are
restricted by the terms of the lock-up agreements.
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this prospectus, a person who has beneficially owned restricted
shares for at least one year would be entitled to sell a certain number of
shares within any three-month period. That number of shares cannot exceed the
greater of one percent of the number of shares of common stock then outstanding,
which will equal approximately 666,000 shares immediately after this offering,
or the average weekly trading volume of the common stock on the Nasdaq National
Market during the four calendar weeks preceding the filing of a notice on Form
144 reporting such sale. Sales under Rule 144 are also restricted by certain
manner of sale provisions, notice requirements and the availability of current
public information about Red Hat. Rule 144 also provides that affiliates of Red
Hat who are selling shares of common stock that are not restricted shares must
nonetheless comply with the same restrictions applicable to restricted shares
with the exception of the holding period requirement.
Under Rule 144(k), a person who is not deemed to have been an affiliate of
Red Hat 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, is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144. Accordingly,
unless otherwise restricted, these shares may therefore be sold immediately upon
the completion of this offering.
OPTIONS
Rule 701 provides that the shares of common stock acquired upon the exercise
of currently outstanding options or other rights granted under Red Hat's stock
plans may be resold, to the extent not restricted by the terms of the lock-up
agreements, by persons, other than affiliates, beginning 90 days after the date
66
<PAGE>
of this prospectus, restricted only by the manner of sale provisions of Rule
144, and by affiliates in accordance with Rule 144, without compliance with its
one-year minimum holding period. As of June 30, 1999, 459,750 shares will be
available for resale in the public market in reliance on Rule 701, all of which
shares are restricted by the terms of the lock-up agreements. As of June 30,
1999, the Board of Directors has authorized an aggregate of up to 16,684,800
shares of common stock for issuance under Red Hat's stock option and stock
purchase plans. As of June 30, 1999, options to purchase a total of 5,176,888
shares of common stock were outstanding, all of which options are exercisable
but restricted by Red Hat's right to repurchase unvested shares upon the
termination of such optionee's business relationship with Red Hat. Of these
options, 407,425 shares are no longer restricted by Red Hat's right of
repurchase and will be eligible for sale, if not restricted by the terms of the
lock-up agreements, in the public market in accordance with Rule 701 under the
Securities Act beginning 90 days after the date of this prospectus. Of the total
shares issuable upon exercise of these options, all of these shares are
restricted by the terms of the lock-up agreements.
Red Hat intends to file one or more registration statements on Form S-8
under the Securities Act following this offering to register all shares of
common stock which are issuable upon exercise of outstanding stock options or
other rights granted under Red Hat's stock plan(s) and common stock issuable
under Red Hat's stock option and stock purchase plans. These registration
statements are expected to become effective upon filing. Shares covered by these
registration statements will thereupon be eligible for sale in the public
markets, upon the expiration or release from the terms of the lock-up
agreements, to the extent applicable.
WARRANTS
As of June 30, 1999, Red Hat had outstanding warrants exercisable for a
total of 3,197,450 shares of common stock, all of which are currently
exercisable. All of these shares are restricted by the terms of the lock-up
agreements.
LOCK-UP AGREEMENTS
Except for sales of common stock to the underwriters in accordance with the
terms of the underwriting agreement Red Hat, the executive officers, directors,
stockholders and all optionholders have agreed not to sell or otherwise dispose
of, directly or indirectly, any shares of common stock (or any security
convertible into or exchangeable or exercisable for common stock) without the
prior written consent of Goldman, Sachs & Co. for a period of 180 days after the
date of this prospectus. In addition, for a period of 180 days from the date of
this prospectus, except as required by law, Red Hat has agreed that its Board of
Directors will not consent to any offer for sale, sale or other disposition, or
any transaction which is designed or could be expected to result in the
disposition by any person, directly or indirectly, of any shares of common stock
without the prior written consent of Goldman Sachs. See "Underwriting". Goldman
Sachs, in its sole discretion, at any time or from time to time and without
notice, may release for sale in the public market all or any portion of the
shares restricted by the terms of the lock-up agreements.
REGISTRATION RIGHTS
Upon the expiration of the contractual lock-up period, certain stockholders
of Red Hat will be entitled to require Red Hat to register under the Securities
Act up to a total of 55,725,622 shares of outstanding common stock under the
terms of an investor rights agreement between Red Hat and the Rights Holders.
The Investor Rights Agreement provides that if Red Hat proposes to register in a
firm commitment underwritten offering any of its securities under the Securities
Act at any time or times, the stockholders having registration rights shall
generally be entitled to include shares of common stock held by them in such
registration. However, the managing underwriter of any offering may exclude for
marketing reasons some or all of the shares from the registration. Some of these
stockholders also have the right to require Red Hat, on no more than five
occasions, to prepare and file a registration statement under the Securities Act
registering the shares of
67
<PAGE>
common stock held by them. Red Hat is generally required to bear the expenses of
all such registrations, except underwriting discounts and commissions. The
Investor Rights Agreement terminates in 2002 on the third anniversary of the
offering.
EFFECTS OF SALES OF SHARES
Prior to this offering, there has been no public market for the common stock
of Red Hat, and no predictions can be made as to the effect, if any, that market
sales of shares of common stock prevailing from time to time, or the
availability of shares for future sale, may have on the market price for the
common stock. Sales of substantial amounts of common stock, or the perception
that such sales could occur, could adversely effect prevailing market prices for
the common stock and could impair Red Hat's future ability to obtain capital
through an offering of equity securities.
LEGAL MATTERS
The validity of the shares of common stock to be issued in this offering
will be passed upon for Red Hat by Testa, Hurwitz & Thibeault, LLP, Boston,
Massachusetts. Certain legal matters in connection with this offering will be
passed upon for the underwriters by Hale and Dorr LLP, Boston, Massachusetts.
EXPERTS
The financial statements as of February 28, 1998 and 1999 and for each of
the three years in the period ended February 28, 1999 included in this
prospectus have been so included in reliance upon the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
Red Hat has filed with the Commission a registration statement on Form S-1
under the Securities Act registering the common stock to be sold in this
offering. As permitted by the rules and regulations of the Commission, this
prospectus omits certain information contained in the registration statement and
the exhibits and schedules filed as a part of the registration statement. For
further information concerning Red Hat and the common stock to be sold in this
offering, you should refer to the registration statement and to the exhibits and
schedules filed as part of the registration statement. Statements contained in
this prospectus regarding the contents of any agreement or other document filed
as an exhibit to the registration statement are not necessarily complete, and in
each instance reference is made to the copy of the agreement filed as an exhibit
to the registration statement each statement being qualified by this reference.
The registration statement, including the exhibits and schedules filed as a part
of the registration statement, may be inspected at the public reference
facilities maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, and at its regional offices located at
Seven World Trade Center, New York, New York 10007 and 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661, and copies of all or any part thereof may
be obtained from such offices upon payment of the prescribed fees. You may call
the Commission at 1-800-SEC-0330 for further information on the operation of the
public reference rooms and you can request copies of the documents upon payment
of a duplicating fee, by writing to the Commission. In addition, the Commission
maintains a web site that contains reports, proxy and information statements and
other information regarding registrants (including Red Hat) that file
electronically with the Commission which can be accessed at http://www.sec.gov.
68
<PAGE>
RED HAT, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Accountants.................................................... F-2
Balance Sheets at February 28, 1998 and 1999 and May 31, 1999........................ F-3
Statements of Operations for the years ended February 28, 1997, 1998 and 1999 and the
three months ended May 31, 1998 and 1999........................................... F-4
Statements of Stockholders' Equity (Deficit) for the years ended February 28, 1997,
1998 and 1999 and the three months ended May 31, 1999.............................. F-5
Statements of Cash Flows for the years ended February 28, 1997, 1998 and 1999 and the
three months ended May 31, 1998 and 1999........................................... F-6
Notes to Financial Statements........................................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders of
Red Hat, Inc.
The two-for-one stock split discussed in note 14 to the financial statements
has not been consummated at July 15, 1999. When it has been consummated, we will
be in a position to furnish the following audit report:
"In our opinion, the accompanying balance sheets and the related
statements of operations, of stockholders' equity (deficit), and of cash
flows present fairly, in all material respects, the financial position of
Red Hat, Inc. at February 28, 1998 and 1999, and the results of its
operations and its cash flows for each of the three years in the period
ended February 28, 1999, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for the opinion expressed
above."
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
April 30, 1999
F-2
<PAGE>
RED HAT, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
FEBRUARY 28, PRO
-------------------------------------- FORMA
1998 1999 MAY 31, MAY 31,
----------- ----------- 1999 1999
------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................... $ 1,292,562 $10,055,227 $13,982,093 $13,982,093
Short-term investments.................................. 100,000 2,037,992 1,023,518 1,023,518
Accounts receivable, net................................ 744,551 1,127,193 3,321,175 3,321,175
Inventory............................................... 141,176 345,630 1,074,190 1,074,190
Prepaid expenses........................................ 383,830 173,730 337,107 337,107
Income tax receivable................................... -- 114,145 114,145 114,145
----------- ----------- ------------ ------------
Total current assets.................................. 2,662,119 13,853,917 19,852,228 19,852,228
Property and equipment, net............................... 337,327 1,270,576 1,797,790 1,797,790
Other assets, net......................................... 81,188 151,310 512,440 512,440
Investments............................................... 50,000 -- -- --
----------- ----------- ------------ ------------
Total assets.......................................... $ 3,130,634 $15,275,803 $22,162,458 $22,162,458
----------- ----------- ------------ ------------
----------- ----------- ------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable........................................ $ 773,936 $ 2,087,305 $3,264,987 $3,264,987
Royalties payable....................................... 247,323 144,074 92,000 92,000
Accrued expenses........................................ 50,334 379,757 185,465 185,465
Deferred revenue........................................ 26,207 33,352 2,983,734 2,983,734
Current portion of capital lease obligations............ 22,797 108,897 108,897 108,897
----------- ----------- ------------ ------------
Total current liabilities............................. 1,120,597 2,753,385 6,635,083 6,635,083
Capital lease obligations................................. 65,032 419,778 384,937 384,937
Commitments and contingencies (Note 12)...................
Mandatorily redeemable preferred stock:
Series A, 6,801,400 shares authorized, issued and
outstanding; none pro forma........................... 1,983,209 1,992,184 1,997,139 --
Series B, 8,116,550 shares authorized, issued and
outstanding; none pro forma........................... -- 6,919,644 6,936,415 --
Series C, 1,797,929 and 2,054,776 shares authorized at
February 28, 1999 and May 31, 1999, respectively;
1,027,388 and 2,054,776 shares issued and outstanding
at February 28, 1999 and May 31, 1999, respectively;
none pro forma........................................ -- 3,195,591 6,404,980 --
Stockholders' equity (deficit):
Common stock, $.0001 par value, 225,000,000 shares
authorized, 23,500,000, 23,852,950 and 26,134,502
shares issued and outstanding at February 28, 1998,
1999 and May 31, 1999, respectively (60,079,954 shares
issued and outstanding pro forma at May 31, 1999)..... 2,350 2,385 2,613 6,008
Additional paid-in capital.............................. 263,650 427,464 3,011,439 18,346,578
Deferred compensation................................... -- -- (715,236) (715,236)
Accumulated deficit..................................... (304,204) (434,628) (2,494,912) (2,494,912)
----------- ----------- ------------ ------------
Total stockholders' equity (deficit).................. (38,204) (4,779) (196,096) 15,142,438
----------- ----------- ------------ ------------
Total liabilities and stockholders' equity
(deficit)........................................... $ 3,130,634 $15,275,803 $22,162,458 $22,162,458
----------- ----------- ------------ ------------
----------- ----------- ------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
RED HAT, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED FEBRUARY 28, ENDED MAY 31,
------------------------------- --------------------
1997 1998 1999 1998 1999
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Software and related products........ $2,603,131 $5,131,623 $10,012,923 $1,373,650 $1,935,818
Web advertising...................... -- -- -- -- 80,050
Services and other................... -- 24,000 776,996 177,315 781,351
--------- --------- --------- --------- ---------
Total revenue...................... 2,603,131 5,155,623 10,789,919 1,550,965 2,797,219
--------- --------- --------- --------- ---------
Cost of revenue:
Software and related products........ 1,204,721 2,210,538 4,012,685 682,415 1,180,904
Web advertising -- -- -- -- 123,000
Services and other................... -- -- 28,148 -- 443,160
--------- --------- --------- --------- ---------
Total cost of revenue.............. 1,204,721 2,210,538 4,040,833 682,415 1,747,064
--------- --------- --------- --------- ---------
Gross profit........................... 1,398,410 2,945,085 6,749,086 868,550 1,050,155
--------- --------- --------- --------- ---------
Operating expense:
Sales and marketing.................. 491,473 1,252,362 3,083,162 381,658 1,628,567
Research and development............. 325,244 902,826 2,220,115 340,965 826,124
General and administrative........... 525,978 798,592 1,483,909 213,651 751,972
--------- --------- --------- --------- ---------
Total operating expense............ 1,342,695 2,953,780 6,787,186 936,274 3,206,663
--------- --------- --------- --------- ---------
Income (loss) from operations.......... 55,715 (8,695) (38,100) (67,724) (2,156,508)
--------- --------- --------- --------- ---------
Other income (expense):
Interest income...................... 200 34,410 171,181 15,223 150,109
Interest expense..................... (23,304) (13,036) (9,463) -- (10,805)
--------- --------- --------- --------- ---------
Other income (expense), net........ (23,104) 21,374 161,718 15,223 139,304
--------- --------- --------- --------- ---------
Income (loss) before income taxes...... 32,611 12,679 123,618 (52,501) (2,017,204)
Provision for income taxes............. -- 4,906 214,686 -- --
--------- --------- --------- --------- ---------
Net income (loss)...................... 32,611 7,773 (91,068) (52,501) (2,017,204)
Accretion on mandatorily redeemable
preferred stock...................... -- -- (39,356) -- (43,080)
--------- --------- --------- --------- ---------
Net income (loss) available to common
stockholders......................... $ 32,611 $ 7,773 $(130,424) $ (52,501) $(2,060,284)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss) per common share:
Basic................................ 0.0014 0.0003 (0.0055) (0.0022) (0.0845)
Diluted.............................. 0.0012 0.0002 (0.0055) (0.0022) (0.0845)
Weighted average common shares
outstanding:
Basic................................ 23,500,000 23,500,000 23,550,050 23,500,000 24,383,353
Diluted.............................. 27,232,520 34,578,277 23,550,050 23,500,000 24,383,353
Pro forma net income (loss) per common
share (unaudited):
Basic................................ 0.0014 0.0003 (0.0021) (0.0014) (0.0349)
Diluted.............................. 0.0012 0.0002 (0.0021) (0.0014) (0.0349)
Pro forma weighted average common
shares outstanding (unaudited):
Basic................................ 23,500,000 30,841,785 43,929,824 37,102,800 57,781,609
Diluted.............................. 27,232,520 34,578,277 43,929,824 37,102,800 57,781,609
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
RED HAT, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
----------------------- PAID-IN DEFERRED ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL COMPENSATION DEFICIT EQUITY (DEFICIT)
---------- ----------- ---------- -------------- ------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Balance at February 29,
1996...................... 23,500,000 $ 2,350 $ 263,650 $ -- $ (344,588) $ (78,588)
Net income.................. -- -- -- -- 32,611 32,611
---------- ----------- ---------- -------------- ------------- ----------------
Balance at February 28,
1997...................... 23,500,000 2,350 263,650 -- (311,977) (45,977)
Net income.................. -- -- -- -- 7,773 7,773
---------- ----------- ---------- -------------- ------------- ----------------
Balance at February 28,
1998...................... 23,500,000 2,350 263,650 -- (304,204) (38,204)
Exercise of common stock
warrants.................. 352,950 35 (17) -- -- 18
Tax benefit on exercise of
common stock warrants..... -- -- 163,831 -- -- 163,831
Accretion of mandatorily
redeemable preferred
stock..................... -- -- -- -- (39,356) (39,356)
Net loss.................... -- -- -- -- (91,068) (91,068)
---------- ----------- ---------- -------------- ------------- ----------------
Balance at February 28,
1999...................... 23,852,950 2,385 427,464 -- (434,628) (4,779)
Exercise of common stock
options and warrants...... 2,281,552 228 1,840,624 -- -- 1,840,852
Deferred compensation....... -- -- 743,351 (743,351) -- --
Amortization of deferred
compensation.............. -- -- -- 28,115 -- 28,115
Accretion of mandatorily
redeemable preferred
stock..................... -- -- -- -- (43,080) (43,080)
Net loss.................... -- -- -- -- (2,017,204) (2,017,204)
---------- ----------- ---------- -------------- ------------- ----------------
Balance at May 31, 1999
(unaudited)............... 26,134,502 $ 2,613 $3,011,439 $ (715,236) $(2,494,912) $ (196,096)
---------- ----------- ---------- -------------- ------------- ----------------
---------- ----------- ---------- -------------- ------------- ----------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
RED HAT, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED FEBRUARY 28, MAY 31,
---------------------------------- ------------------------
1997 1998 1999 1998 1999
--------- ---------- ----------- ---------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................... $ 32,611 $ 7,773 $ (91,068) $ (52,501) $ (2,017,204)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization................. 37,134 102,876 177,656 31,379 65,657
Tax benefit of options exercised.............. -- -- 163,831 -- --
Deferred compensation......................... -- -- -- -- 28,115
Provision for doubtful accounts............... 38,986 38,141 185,092 -- 19,120
Provision for inventory obsolescence.......... -- -- 182,509 68,439 --
Deferred revenue.............................. -- 26,207 7,145 -- 2,950,382
Changes in operating assets and liabilities:
Accounts receivable......................... (251,774) (479,746) (567,734) 105,851 (2,213,102)
Inventory................................... (14,934) (84,507) (386,963) (74,482) (728,560)
Prepaid expenses............................ (12,248) (370,571) 210,100 (120,991) (163,377)
Income tax receivable....................... -- -- (114,145) -- --
Other assets................................ 1,613 (15,408) (75,478) (2,790) (362,428)
Accounts payable............................ 282,453 290,253 1,313,369 (33,465) 1,177,682
Royalties payable........................... 57,477 189,846 (103,249) 118,727 (52,074)
Accrued expenses............................ (66,044) 19,019 329,423 (11,290) (194,292)
--------- ---------- ----------- ---------- ------------
Net cash provided by (used in) operating
activities.............................. 105,274 (276,117) 1,230,488 28,877 (1,490,081)
--------- ---------- ----------- ---------- ------------
Cash flows from investing activities:
Purchase of investment securities............... -- (150,000) (1,966,600) -- --
Proceeds from maturity of investment
securities.................................... -- -- 100,000 100,000 1,014,474
Purchase of equipment........................... (201,322) (158,004) (654,235) (71,537) (591,573)
Proceeds from sale of equipment................. -- 24,272 -- -- --
--------- ---------- ----------- ---------- ------------
Net cash provided by (used in) investing
activities.............................. (201,322) (283,732) (2,520,835) 28,463 422,901
--------- ---------- ----------- ---------- ------------
Cash flows from financing activities:
Proceeds from borrowing from stockholders....... 50,000 -- -- -- --
Repayments of borrowings from stockholders...... -- (86,243) -- -- --
Proceeds from notes payable..................... 46,048 239,214 -- -- --
Repayments of notes payable..................... -- (279,019) -- -- --
Proceeds from issuance of mandatorily redeemable
preferred stock, net.......................... -- 1,983,209 10,084,854 -- 3,188,035
Proceeds from exercise of common stock options
and warrants.................................. -- -- 18 -- 1,840,852
Payments on capital lease obligations........... -- (4,750) (31,860) (7,737) (34,841)
--------- ---------- ----------- ---------- ------------
Net cash provided by (used in) financing
activities.............................. 96,048 1,852,411 10,053,012 (7,737) 4,994,046
--------- ---------- ----------- ---------- ------------
Net increase in cash and cash equivalents....... -- 1,292,562 8,762,665 49,603 3,926,866
Cash and cash equivalents beginning of the
year.......................................... -- -- 1,292,562 1,292,562 10,055,227
--------- ---------- ----------- ---------- ------------
Cash and cash equivalents end of year........... $ -- $1,292,562 $10,055,227 $1,342,165 $ 13,982,093
--------- ---------- ----------- ---------- ------------
--------- ---------- ----------- ---------- ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
BUSINESS ACTIVITY
Red Hat, Inc. ("Red Hat" or the "Company") is a leading developer and global
provider of open source software products and services, and has built a
comprehensive web site dedicated to the open source software community. Red Hat,
Inc. was incorporated in Connecticut in March 1993 as ACC Corp., Inc. In
September 1995 ACC Corp., Inc. changed its name to Red Hat Software, Inc. In
September 1998, Red Hat Software, Inc. reincorporated in Delaware. In June 1999,
Red Hat Software, Inc. changed its name to Red Hat, Inc. The Linux operating
system ("Linux") is copyrighted under the terms of the GNU General Public
License (the "GPL") which states that the source code must be freely
distributable. The Company develops and publishes software applications that are
sold as shrink-wrapped software and releases freely-redistributable software
available for unrestricted download on the internet. In addition, the Company
publishes and sells reference books on the Linux operating system.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
UNAUDITED INTERIM FINANCIAL STATEMENTS
The financial statements as of May 31, 1998 and 1999 and for the three month
period then ended are unaudited and reflect all adjustments (consisting of
normal recurring adjustments) which are, in the opinion of the Company's
management, necessary for a fair presentation of financial position, results of
operations and cash flows. All financial statement disclosures related to the
three month period ended May 31, 1998 and 1999 are unaudited.
UNAUDITED PRO FORMA BALANCE SHEET
The Board of Directors has authorized the Company to file a Registration
Statement with the Securities and Exchange Commission permitting the Company to
sell shares of common stock in an initial public offering ("IPO"). If the IPO is
consummated as presently anticipated, each share of the Series A, Series B, and
Series C mandatorily redeemable preferred stock will automatically convert into
two shares of common stock. The unaudited pro forma balance sheet reflects the
subsequent conversion of Series A, Series B, and Series C preferred shares into
common stock at a 2 for 1 conversion ratio as if such conversion has occurred as
of February 28, 1999.
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.
CASH AND CASH EQUIVALENTS
The Company considers investments purchased with a maturity period of three
months or less at the date of purchase to be cash equivalents.
F-7
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVESTMENTS
The Company's investments are all in debt securities which are classified as
held-to-maturity and are carried at amortized cost in accordance with Statement
of Financial Accounting Standards No. 115 "Accounting for Investments in Debt
and Equity Securities", as the Company has both the positive intent and ability
to hold them to maturity.
INVENTORY
The costs incurred for duplicating the computer software, documentation, and
training materials from the product masters and for packaging the product for
distribution are capitalized as inventory using the weighted average method and
charged to cost of sales when revenue from the sale of units is recognized.
Management periodically evaluates the realizability of inventory based on
planned release dates of product updates and records a reserve for obsolescence
when necessary. The reserve for inventory obsolescence was $0 and $182,509 at
February 28, 1998 and 1999, respectively. The reserve for inventory obsolescence
was $182,509 at May 31, 1999.
CAPITALIZED SOFTWARE COSTS
Capitalization of software development costs begins upon the establishment
of technological feasibility and ceases when the product is available for
general release. The establishment of technological feasibility and the ongoing
assessment of recoverability of capitalized software development costs require
considerable judgment by management concerning certain external factors
including, but not limited to, technological feasibility, anticipated future
gross revenue, estimated economic life and changes in software and hardware
technologies. As a result of the Company's practice of releasing source code
that it has developed on a weekly basis for unrestricted download on the
internet, there is generally no passage of time between achievement of
technological feasibility and the availability of the Company's product for
general release. Therefore, the Company has no capitalized software development
costs at February 28, 1998 and 1999.
PROPERTY AND EQUIPMENT
Property and equipment is primarily comprised of furniture and computer
equipment which are recorded at cost and depreciated over their estimated useful
lives using the straight line method. Expenditures for maintenance and repairs
are charged to operations as incurred; major expenditures for renewals and
betterments are capitalized and depreciated. Property and equipment acquired
under capital leases are being depreciated over their estimated useful lives or
the respective lease term, if shorter. Depreciation periods used for property
and equipment are as follows:
<TABLE>
<S> <C>
Computer equipment........................................... 3 years
Furniture and fixtures....................................... 7 years
4 to 25
Leasehold improvements....................................... years
</TABLE>
F-8
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER ASSETS
Costs incurred for acquiring trademarks, copyrights and patents are
capitalized and amortized over their estimated useful lives, which range from 5
to 15 years, using the straight line method. Other assets also includes security
deposits which are expected to be refunded to the Company upon termination of
certain leases.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates the recoverability of its property and equipment, and
other assets in accordance with Statement of Financial Accounting Standards No.
121, "Accounting for the Impairment of Long-Lived Assets to be Disposed of"
("SFAS 121"). SFAS 121 requires recognition of impairment of long-lived assets
in the event the net book value of such assets exceeds the estimated future
undiscounted cash flows attributable to such assets or the business to which
such intangible assets relate. No impairments were required to be recognized
during the years ended February 28, 1997, 1998 and 1999.
REVENUE RECOGNITION
Revenues from the sale of software products for which no technical support
is provided are generally recognized upon shipment of the products, net of
estimated returns. A reserve for sales returns is recognized for sales of
software products to distributors, who have a right of return, based on the
Company's historical experience of sell-through to the end user by the
distributor. The Company recognizes revenues from the sale of software products
to new distributors of its software products based upon sell-through to the end
user until the Company has sufficient historical experience with the distributor
to allow the accurate estimation of sales returns.
Upon the release of Version 6.0 of Official Red Hat Linux in May 1999, the
Company began providing certain telephone and e-mail technical support services
for a period of 90 days from the date of registration of the software products
for no additional fee. In accordance with the provisions of Statement of Opinion
No. 97-2, "Software Revenue Recognition" ("SOP 97-2"), the Company is
recognizing all of the revenue from the sale of Version 6.0 of Official Red Hat
Linux over the period that the technical support services are provided as the
Company does not sell these technical support services separately and therefore
does not have vendor specific objective evidence of the fair value of these
services. These revenues are recognized ratably over the period that the
technical support services are provided in proportion to the costs incurred to
provide such technical support services as compared to estimated total costs to
be incurred. The Company currently does not provide support and maintenance
services as part of the fee for any of its software products, other than Version
6.0 of Official Red Hat Linux.
Revenue for maintenance and support services, other than installation
support, is deferred and recognized ratably over the term of the agreement,
which is typically twelve months. Such revenues have been insignificant to date.
Revenue from customer training, and other services is recognized as the
service is performed.
Royalty revenue, which is included in services and other revenue, is
comprised primarily of royalties received from the sale of rights to the
Company's brand and trademark and royalties received from international
distributors of the Company's products. Royalty revenue is recognized
F-9
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
when received. Revenue from sale of books, which is include in software and
related products revenue, published by the Company, is recognized at the date of
shipment, net of estimated returns.
Web advertising revenue is recognized ratably in the period in which the
advertisement is displayed, provided that the Company has no significant
remaining obligations, at the lesser of the ratio of connections to the
advertiser's website delivered over total guaranteed connections to the
advertiser's website or the straight line basis over the term of the contract.
If minimum guaranteed connections are not met, the Company defers recognition of
the corresponding revenue until the guaranteed connections are achieved. The
Company did not generate revenue from the sale of advertising on its web site
during the fiscal years ended February 28, 1997, 1998 and 1999. The Company
began selling advertising space on its website during the three months ended May
31, 1999.
ROYALTY COSTS
Royalties that the Company is required to pay on applications licensed from
third parties that are a component of the software products sold by the Company
are expensed as cost of sales on a per unit basis as software products are sold.
Royalties paid in advance of the sale of the Company's software products are
included in prepaid expenses and recorded as expense when the related software
products are sold.
SIGNIFICANT CUSTOMERS AND CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash investments
and trade receivables. The Company places its temporary cash investments with
high-credit quality financial institutions which invest primarily in U.S.
Government instrumentalities, commercial paper of prime quality and certificates
of deposit guaranteed by banks which are members of the FDIC. The Company
performs ongoing credit evaluations to reduce credit risk and requires no
collateral from its customers. Management estimates the allowance for
uncollectible accounts based on their historical experience and credit
evaluation. Sales to one distributor comprised $416,501 or 16%, $1,340,462 or
26% and $2,135,733 or 20% of total revenues for the years ended February 28,
1997, 1998 and 1999, respectively. Sales to one other distributor comprised
$3,719,162 or 34% of total revenues for the year ended February 28, 1999.
Receivables from two distributors comprised 75% and 25%, respectively, of net
accounts receivable at February 28, 1999. Accounts receivable from one
distributor comprised 42% of net receivables at February 28, 1998.
All of the Company's software revenues are from sales transactions
originating in the United States. The Company has received certain royalty
payments from international sources; however, such amounts have been
insignificant to date.
STOCK BASED COMPENSATION
The Company accounts for stock based compensation based on the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25"), which states that no compensation expense is recorded
for stock options or other stock-based awards to employees that are granted with
an exercise price equal to or above the estimated fair
F-10
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
value per share of the Company's common stock on the grant date. The Company has
adopted the disclosure requirements of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), which
requires compensation expense to be disclosed based on the fair value of the
options granted at the date of the grant.
SALES AND MARKETING EXPENSES
Sales and marketing expenses consist primarily of costs, including salaries
and sales commissions, of all personnel involved in the sales process and
related expenses. Sales and marketing expenses also include costs of advertising
and trade shows. All costs of advertising, including cooperative marketing
arrangements, the software products, books and related services offered by the
Company are expensed as incurred. Advertising expense totaled $69,109, $152,939
and $597,822 for the years ended February 28, 1997, 1998 and 1999, respectively.
RESEARCH AND DEVELOPMENT COSTS
Research and development expenses include all direct costs, primarily
salaries for Company personnel and outside consultants, related to the
development of new products and significant enhancements to existing products
and are charged to operations as incurred until such time as technological
feasibility is achieved.
INCOME TAXES
The Company accounts for income taxes using the liability method which
requires the recognition of deferred tax assets or liabilities for the temporary
differences between financial reporting and tax bases of the Company's assets
and liabilities and for tax carryforwards at enacted statutory tax rates in
effect for the years in which the differences are expected to reverse. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. In addition, valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be realized.
CASH FLOWS
The Company made cash payments for interest of $23,304, $13,036, and $9,463
for the years ended February 28, 1997, 1998, and 1999, respectively. The Company
made no cash payments for income taxes during the years ended February 28, 1997
and 1998 and $163,831 during the year ended February 28, 1999.
The Company acquired property and equipment through the assumption of
capital lease obligations amounting to $22,466, $75,299 and $472,706 for the
years ended February 28, 1997, 1998, and 1999 respectively.
NET INCOME (LOSS) PER COMMON SHARE
HISTORICAL
The Company computes net income (loss) per common share in accordance with
Statement of Financial Accounting Standards No. 128, "Earnings Per Share,"
("SFAS 128") and SEC Staff Accounting Bulletin No. 98 ("SAB No. 98"). Under the
provisions of SFAS 128 and SAB No. 98,
F-11
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
basic net income (loss) per common share ("Basic EPS") is computed by dividing
net income (loss) available to common stockholders by the weighted average
number of common shares outstanding. Diluted net income (loss) available to
common stockholders per common share ("Diluted EPS") is computed by dividing net
income (loss) by the weighted average number of common shares and dilutive
potential common share equivalents then outstanding. Potential common shares
consist of shares issuable upon the exercise of stock options and warrants and
shares issuable upon conversion of outstanding mandatorily redeemable preferred
stock. The calculation of the net loss per share available to common
stockholders for the fiscal year ended February 28, 1999 does not include
24,299,071 potential shares of common stock equivalents, as their impact would
be antidilutive.
PRO FORMA (UNAUDITED)
Pro forma net income (loss) per common share is calculated assuming
conversion of all mandatorily redeemable preferred stock which converts
automatically upon the completion of the initial public offering into 31,890,676
and 33,945,452 shares of common stock (see Note 9) at February 28, 1999 and May
31, 1999, respectively. Therefore, accretion of mandatorily redeemable preferred
stock of $43,080 for the three months ended May 31, 1999 is excluded from the
calculation of pro forma net income (loss) per common share.
The calculation of pro forma net loss per common share for the three months
ended May 31, 1999 does not include 5,536,707 potential shares of common stock
equivalents, as their impact would be anti-dilutive.
SEGMENT REPORTING
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"). This statement requires companies to report information about
operating segments in interim and annual financial statements. It also requires
segment disclosures about products and services, geographic areas and major
customers. The Company adopted SFAS 131 effective for its fiscal year ended
February 28, 1998. The Company has determined that it did not have any
separately reportable operating segments as of February 28, 1997, 1998 or 1999
or as of May 31, 1999.
COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. SFAS 130 is effective for
financial statements for fiscal years beginning after December 15, 1997. Its
adoption did not impact the Company's financial position, results of operations,
or cash flows as the Company had no items of other comprehensive income during
the three year period ended February 28, 1999 or the three months ended May 31,
1998 and 1999.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging
F-12
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. SFAS 133 as amended by SFAS 137, is effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000, with earlier
application encouraged. The Company does not currently nor does it intend in the
future to use derivative instruments and therefore does not expect that the
adoption of SFAS 133 will have any impact on its financial position or results
of operations.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AICPA"), issued Statement of
Position No. 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP No. 98-1"), which provides guidance regarding
when software developed or obtained for internal use should be capitalized. SOP
No. 98-1 is effective for fiscal years beginning after December 15, 1998. The
adoption of SOP No. 98-1 in the three months ended May 31, 1999, did not have a
material impact on its financial position or results of operations.
In December 1998, the AICPA issued Statement of Position No. 98-9,
"Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to
Certain Transactions" ("SOP No. 98-9"). SOP No. 98-9 amends SOP No. 97-2 to
require recognition of revenue using the "residual method" in circumstances
outlined in the SOP. Under the residual method, revenue is recognized as
follows: (1) the total fair value of undelivered elements, as indicated by
vendor specific objective evidence, is deferred and subsequently recognized in
accordance with the relevant sections of SOP No. 97-2 and (2) the difference
between the total arrangement fee and the amount deferred for the undelivered
elements is recognized as revenue related to the delivered elements. SOP No.
98-9 is effective for transactions entered into in fiscal years beginning after
March 15, 1999. Also, the provisions of SOP No. 97-2 that were deferred by SOP
No. 98-4 will continue to be deferred until the date SOP No. 98-9 becomes
effective. The Company does not expect that the adoption of SOP No. 98-9 will
have a significant impact on the Company's results of operations or financial
position.
3. ACCOUNTS RECEIVABLE
Accounts receivable, which are primarily from product sales, are presented
net of an allowance for doubtful accounts. The activity in the Company's
allowance for doubtful accounts for the years ended February 28, 1997, 1998 and
1999 is presented in the following table:
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING INCOME OR END OF
YEAR ENDED FEBRUARY 28, OF PERIOD EXPENSE DEDUCTIONS (A) PERIOD
- ------------------------------------- ----------- ----------- --------------- -----------
<S> <C> <C> <C> <C>
1997................................. $ -- $ 38,986 $ (554) $ 38,432
1998................................. 38,432 38,141 (27,829) 48,744
1999................................. 48,744 185,092 (73,458) 160,378
</TABLE>
- ------------------------
(a) Represents amounts written-off as uncollectible accounts receivable.
F-13
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. ACCOUNTS RECEIVABLE
Accounts receivable, which are primarily from product sales, are presented
net of an allowance for doubtful accounts. The activity in the Company's
allowance for doubtful accounts for the years ended February 28, 1997, 1998 and
1999 is presented in the following table:
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING INCOME OR END OF
YEAR ENDED FEBRUARY 28, OF PERIOD EXPENSE DEDUCTIONS (A) PERIOD
- ------------------------------------- ----------- ----------- --------------- -----------
<S> <C> <C> <C> <C>
1997................................. $ -- $ 38,986 $ (554) $ 38,432
1998................................. 38,432 38,141 (27,829) 48,744
1999................................. 48,744 185,092 (73,458) 160,378
</TABLE>
- ------------------------
(a) Represents amounts written-off as uncollectible accounts receivable.
4. PROPERTY AND EQUIPMENT
The Company's property and equipment consisted of the following:
<TABLE>
<CAPTION>
FEBRUARY 28, MAY 31,
--------------------- ----------
<S> <C> <C> <C>
1998 1999 1999
--------- ---------- ----------
Computer equipment...................... $ 420,523 $ 818,676 $1,410,246
Furniture and fixtures.................. 69,256 583,175 583,174
Leasehold improvements.................. -- 214,868 214,868
--------- ---------- ----------
489,779 1,616,719 2,208,288
Less: accumulated depreciation.......... (152,452) (346,143) (410,498)
--------- ---------- ----------
$ 337,327 $1,270,576 $1,797,790
--------- ---------- ----------
--------- ---------- ----------
</TABLE>
5. OTHER ASSETS
Other assets were comprised of the following:
<TABLE>
<CAPTION>
FEBRUARY 28, MAY 31,
-------------------- ---------
<S> <C> <C> <C>
1998 1999 1999
--------- --------- ---------
Security deposits............................ $ 11,900 $ 78,130 $ 11,900
Trademarks, patents and copyrights, net...... 69,288 73,180 72,706
Deferred offering costs...................... -- -- 427,834
--------- --------- ---------
$ 81,188 $ 151,310 $ 512,440
--------- --------- ---------
--------- --------- ---------
</TABLE>
6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, accounts payable and
accounts receivable at February 28, 1998 and 1999 approximated their fair value
due to the short-term nature of these items.
F-14
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The fair value of the Company's short-term and long-term investments at
February 28, 1998 and 1999 approximated their carrying values as these
investments were primarily in short-term U.S. Government obligations.
7. ACCRUED EXPENSES
Accrued expenses were comprised of the following:
<TABLE>
<CAPTION>
FEBRUARY 28, MAY 31,
-------------------- ---------
1998 1999 1999
--------- --------- ---------
<S> <C> <C> <C>
Payroll...................................... $ -- $ 212,608 $ 22,064
Vacation..................................... 3,501 59,165 126,044
Taxes........................................ 5,151 14,025 9,623
Other........................................ 41,682 93,959 27,734
--------- --------- ---------
$ 50,334 $ 379,757 $ 185,465
--------- --------- ---------
--------- --------- ---------
</TABLE>
8. INCOME TAXES
The components of the Company's provision for income taxes consisted of the
following:
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
-------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Current tax provision:
Federal....................................... $ -- $ -- $ 149,284
State......................................... -- 4,906 65,402
--------- --------- ---------
Current tax expense........................... -- 4,906 214,686
--------- --------- ---------
Deferred tax benefit:
Federal....................................... -- -- --
State......................................... -- -- --
--------- --------- ---------
Deferred tax benefit.......................... -- -- --
--------- --------- ---------
Net provision for income taxes.............. $ -- $ 4,906 $ 214,686
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-15
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
at February 28, 1999 and 1998 consisted of the following:
<TABLE>
<CAPTION>
FEBRUARY 28,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Domestic net operating loss carryforwards............ $ 23,697 $ --
Accounts receivable.................................. 21,818 217,777
Allowance for inventory obsolescence................. -- 70,785
Research and development credit...................... 67,629 --
Other accruals....................................... 1,376 22,947
--------- ---------
Total deferred tax assets.......................... 114,520 311,509
Valuation allowance for deferred tax assets.......... (109,040) (307,423)
--------- ---------
Deferred tax assets................................ 5,480 4,086
--------- ---------
Property and equipment............................... (5,480) (4,086)
--------- ---------
Total deferred tax liabilities..................... (5,480) (4,086)
--------- ---------
Net deferred tax assets............................ $ -- $ --
--------- ---------
--------- ---------
</TABLE>
As of February 28, 1998 and 1999, and May 31, 1999 the Company provided a
full valuation allowance against its net deferred tax assets since realization
of these benefits can not be reasonably assured. An increase in the valuation
allowance was recorded during fiscal 1999 and the three months ended May 31,
1999 to reserve the increase in total deferred tax assets at February 28, 1999
and May 31, 1999 due to uncertainty of realizability.
As of February 28, 1998, the Company had federal and state net operating
loss carryforwards of approximately $70,000. This carryforward was fully
utilized during 1999.
Taxes computed at the statutory federal income tax rate of 34% are
reconciled to the provision for income taxes as follows:
<TABLE>
<CAPTION>
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Effective rate............................... 0% 39% 174%
--------- --------- ---------
United States Federal tax at statutory
rate....................................... $ 12,214 $ 4,311 $ 42,030
State taxes (net of Federal benefit)......... 1,897 13,392 7,619
Change in valuation reserves................. (17,040) 28,993 198,477
Research and development credit.............. -- (67,629) (43,959)
Non-deductible items......................... 2,929 25,839 10,519
--------- --------- ---------
Provision for income taxes................... $ -- $ 4,906 $ 214,686
--------- --------- ---------
--------- --------- ---------
</TABLE>
9. MANDATORILY REDEEMABLE PREFERRED STOCK
The Company has authorized 6,801,400, 8,116,550 and 2,054,776 shares of
Series A, Series B and Series C mandatorily redeemable preferred stock,
respectively. The shares of Series A,
F-16
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. MANDATORILY REDEEMABLE PREFERRED STOCK (CONTINUED)
Series B and Series C mandatorily redeemable preferred stock have a par value of
$0.0001 per share.
On August 15, 1997, the Company entered into a purchase agreement with an
investor (the "Series A Investor"). In connection with this agreement, the
Company issued 6,801,400 shares of Series A preferred stock to the Series A
Investor for $2,000,000 or $0.2941 per share, less related issuance costs of
$16,791. The Series A preferred stock became mandatorily redeemable with the
issuance of the Series B mandatorily preferred stock in September 1998.
On September 29, 1998, the Company entered into a purchase agreement with
several investors (the "Series B Investors"). In connection with this agreement,
the Company issued 8,116,550 shares of Series B mandatorily redeemable preferred
stock to the Series B Investors for $6,955,884, or $0.857 per share, less
related issuance costs of $66,621.
On February 25, 1999, the Company entered into a purchase agreement with
several investors (the "Series C Investors"). In connection with this agreement,
the Company issued 1,027,388 shares of Series C mandatorily redeemable preferred
stock to the Series C Investors for $3,227,026, or $3.141 per share.
The Company had additional closings of the Series C mandatorily redeemable
preferred stock financing subsequent to February 28, 1999. Additional Series C
Investors purchased 1,027,388 shares of Series C mandatorily redeemable
preferred stock for $3,227,026, or $3.141 per share in March and April of 1999.
Total issuance costs related to sales of Series C mandatorily redeemable
preferred stock were $62,870.
DIVIDENDS
The Series A, Series B and Series C stockholders (the "Holders") are not
entitled to dividends unless dividends are declared on shares of common stock,
in which case the Holders shall receive a distribution on each outstanding share
of Series A, Series B and Series C mandatorily redeemable preferred stock on an
as if converted basis.
CONVERSION
Each share of Series A, Series B and Series C mandatorily redeemable
preferred stock can be converted to common stock at the option of the Holders at
a two-to-one conversion rate, after certain adjustments. This conversion rate
shall be adjusted upon the issuance by the Company of additional common shares
(with certain exceptions) for consideration per share less than $0.343 per
share, in the case of Series A mandatorily redeemable preferred stock, $0.996
per share, in the case of Series B mandatorily redeemable preferred stock and
$3.893 per share, in the case of Series C mandatorily redeemable preferred
stock. The conversion rate shall also be adjusted for common stock splits,
reverse common stock splits, dividends and distributions.
Each share of Series A, Series B and Series C mandatorily redeemable
preferred stock will be automatically converted into shares of common stock, at
the then effective conversion rate, upon the closing of a sale of the common
stock of the Company in a qualified public offering.
F-17
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. MANDATORILY REDEEMABLE PREFERRED STOCK (CONTINUED)
VOTING RIGHTS
Holders of Series A, Series B and Series C mandatorily redeemable preferred
stock have the right to one vote for each common share into which such shares
could then be converted, as described above.
LIQUIDATION
In the event of the liquidation, dissolution or winding up of the Company,
Holders shall be entitled to receive, prior to any distributions to common
stockholders, an amount in cash equal to the greater of (i) $0.343 per share, in
the case of Series A, $0.996 per share, in the case of Series B, and $3.893 per
share, in the case of Series C, plus any dividends declared but unpaid, or (ii)
such amount per share as would have been payable had each such share been
converted into common stock immediately prior to liquidation, dissolution or
winding up, as described above. In the event that assets of the Company are
insufficient to permit payment of the above mentioned amounts, the Holders shall
share ratably in any distribution of the remaining assets and funds of the
Company in proportion to the respective amounts which would otherwise be payable
under these circumstances.
REDEMPTION
The Company could be required to redeem the Series A, Series B and Series C
mandatorily redeemable preferred stock from the Holders upon receipt of written
request from Holders of shares representing at least 66 2/3% of the aggregate
number of shares of common stock issuable upon conversion. Redemption may first
be made by the Holders on February 25, 2004 and on each of the first and second
anniversaries thereof. Redemption is limited to 33% and 50% of the Series A,
Series B and Series C shares outstanding on February 25, 2004 and the first
anniversary thereof, respectively. There is no limitation on the number of
shares on February 25, 2006. The redemption price is equal to $0.343 per share
in the case of Series A, $0.996 per share, in the case of Series B and $3.893
per share, in the case of Series C, after adjustment for certain events. The
carrying value of the Company's mandatorily redeemable preferred stock is being
accreted to its redemption price over the redemption period using the effective
interest rate method. In conjunction with the sale of the Series B mandatorily
redeemable preferred stock, the Series A mandatorily redeemable preferred stock
became mandatorily redeemable.
CARRYING VALUE
The Series A, Series B and Series C mandatorily redeemable preferred stock
were initially recorded at the total net proceeds received by the Company upon
issuance. The difference between the total net proceeds at issuance of
$12,068,063 and the total redemption price of $14,416,585 is charged to
accumulated deficit over the period from issuance until redemption first becomes
available. The amount of accretion recognized during each period is determined
by using the effective interest rate method. For the year ended February 28,
1999 the accretion was $39,356. The Company had no outstanding mandatorily
redeemable preferred stock prior to the fiscal year ended February 28, 1999. The
Company sold an additional 1,027,388 shares of Series C preferred stock for net
proceeds of $3,164,156 in March and April 1999 with a redemption value of
$4,004,758. Accretion on preferred stock was $43,080 for the three months ended
May 31, 1999.
F-18
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK
On September 28, 1998, the Company effected a 100 for 1 stock split for
holders of its common stock. Amounts presented for the periods prior to the
stock split have been restated to reflect the stock split on a retroactive
basis.
The Company has authorized 68,620,652 shares of common stock with a par
value of $0.0001 per share. Holders of these shares have one vote per share.
Upon the dissolution, liquidation or winding up of the Company, holders of
common stock will be entitled to receive the assets of the Company after
satisfaction of the preferential rights of the outstanding Series A, Series B
and Series C mandatorily redeemable preferred stock or any other outstanding
stock ranking on liquidation senior to or on parity with the common stock.
On September 29, 1998, in connection with the above mentioned sale of Series
B mandatorily redeemable preferred stock, certain stockholders, primarily
comprised of officers of the Company, entered into a common stock purchase
agreement with the Series B Investors. In connection with this agreement, those
stockholders sold 2,625,500 shares of common stock to the Series B Investors for
$1,125,000 or $0.429 per share.
On February 25, 1999, in connection with the above mentioned sale of Series
C mandatorily redeemable preferred stock, certain stockholders, primarily
comprised of officers of the Company, entered into a common stock purchase
agreement with the Series C Investors. In connection with this agreement, those
stockholders sold 492,184 shares of common stock to the Series C Investors for
$772,975 or $1.571 per share. Upon additional closings of the Series C
mandatorily redeemable preferred stock financing in March and April of 1999, an
additional 492,184 shares of common stock were sold by certain stockholders,
primarily comprised of officers of the Company, to the additional Series C
Investors for $772,975 or $1.571 per share.
11. STOCK OPTIONS AND WARRANTS
STOCK OPTIONS
During September 1998, the Company's Board of Directors approved a stock
option plan. As of February 28, 1999 and May 31, 1999, 7,434,800 shares of
common stock were reserved for issuance upon exercise of options granted to any
employee, officer or director or consultant of the Company at terms and prices
to be determined by the Board of Directors. In June 1999, the option pool was
increased to 9,434,800 shares. The plan provides that the exercise price per
share and the purchase price per share for each non-qualified option should be
set by the Board on the date of grant. The price for each Incentive Stock Option
(ISO) shall not be less than the fair market value of the common stock on the
date of grant. The maximum term for an option granted is ten years from the date
of grant. The Company believes that all options and warrants, granted through
February 28, 1999, have been granted at their fair values on their respective
grant dates. Options granted under the plan generally vest 25% upon completion
of one full year of service and 6.25% on the first day of each subsequent
three-month period. All options are immediately exercisable upon grant into
restricted shares of the Company's common stock with the same vesting provisions
as the original option. The Company, at its option, may repurchase these
restricted shares at the original purchase price under certain circumstances.
F-19
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS AND WARRANTS (CONTINUED)
The activity for the stock option plan for the year ended February 28, 1999
and for the period from March 1, 1999 to May 31, 1999 is presented in the
following table:
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVERAGE
UNDERLYING EXERCISE PRICE
OPTIONS PER SHARE
----------- -----------------
<S> <C> <C>
Outstanding at February 28, 1998............................... -- $ --
Granted........................................................ 4,322,570 0.36
Forfeited...................................................... (20,000) 0.18
-----------
Outstanding at February 28, 1999............................... 4,302,570 0.36
Granted (unaudited)............................................ 3,207,070 2.17
Exercised (unaudited).......................................... (2,091,552) 0.88
Forfeited (unaudited).......................................... (49,000) 0.89
-----------
Outstanding at May 31, 1999 (unaudited)........................ 5,369,088 $ 1.23
</TABLE>
Prior to February 28, 1998, the Company had granted no stock options.
The following summarizes information about the Company's stock options at
February 28, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------ -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTURAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ----------- ------------ --------------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
$ 0.18 1,200,000 9.58 $ 0.18 1,200,000 $ 0.18
$ 0.43 3,102,570 9.67 $ 0.43 3,102,570 $ 0.43
</TABLE>
During the month ended June 30, 1999, the Company granted stock options for
the purchase of a total of 333,800 shares to employees. As of June 30, 1999, the
Company had outstanding stock options for the purchase of 5,176,888 shares with
a weighted average exercise price of $1.58. The Company has recorded deferred
compensation of $743,351 and $1,851,360 for the three months ended May 31, 1999
and the month ended June 30, 1999, respectively. The following
F-20
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS AND WARRANTS (CONTINUED)
summarizes certain information regarding stock option grants during the period
from March 1, 1999 to June 30, 1999 (unaudited):
<TABLE>
<CAPTION>
EXERCISE NUMBER OF
DATE OF GRANT PRICE SHARES
- ----------------------------------------------------- ----------- -----------
<S> <C> <C>
March 1999........................................... $ 1.57 212,000
April 1999........................................... $ 1.57 2,393,972
May 3, 1999.......................................... $ 1.57 40,000
May 10, 1999......................................... $ 5.00 561,098
June 16, 1999........................................ $ 5.00 79,200
June 30, 1999........................................ $ 10.80 14,600
June 30, 1999........................................ $ 5.00 240,000
-----------
3,540,870
</TABLE>
STOCK WARRANTS
On October 10, 1995, the Company issued warrants (which are equivalent to
nonqualified stock options) to purchase 3,740,400 shares of common stock to
three of its employees with an exercise price of $.0001 per share. The warrants
vest 25% annually on each May 1, beginning May 1, 1996 and ending May 1, 1999.
The warrants terminate upon death, permanent disability, termination of
employment or May 1, 2006. The Company and certain founding shareholders have a
right of first refusal to purchase the warrant shares on the same terms as a
proposed purchaser and a right to purchase the shares upon the death,
disability, or termination of employment of the employee. Upon the death,
disability, or termination without cause of the employee, the purchase price
shall be 80% of the fair market value of the Company's common stock as
determined by the board of directors. If the employee is terminated for cause,
the purchase price shall be 80% of the lesser of the book value or the fair
market value of the Company's common stock.
The activity for the stock warrants is presented in the following table:
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
----------------------------------------------------------------------------
1997 1998 1999
------------------------ ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE
UNDERLYING PRICE UNDERLYING PRICE UNDERLYING PRICE
WARRANTS PER SHARE WARRANTS PER SHARE WARRANTS PER SHARE
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year................ 3,740,400 $ 0.0001 3,740,400 $ 0.0001 3,740,400 $ 0.0001
----------- ----------- ----------- ----------- ----------- -----------
Exercised................ -- -- -- -- (352,950) $ 0.0001
Outstanding at end of
year................... 3,740,400 $ 0.0001 3,740,400 $ 0.0001 3,387,450 $ 0.0001
Exercisable at end of
year................... 935,100 $ 0.0001 1,870,200 $ 0.0001 2,452,350 $ 0.0001
</TABLE>
F-21
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS AND WARRANTS (CONTINUED)
During the three month period ended May 31, 1999, warrants to purchase
190,000 shares were exercised. At May 31, 1999, warrants to purchase 3,197,450
shares remained outstanding. Amounts as of May 31, 1999 are unaudited.
SFAS 123 requires the Company to disclose pro forma information regarding
option grants made and warrants issued to its employees. SFAS 123 specifies
certain valuation techniques that produce estimated compensation charges that
are included in the pro forma results below. These amounts have not been
reflected in the Company's statement of operations, because APB No. 25 specifies
that no compensation charge arises when the exercise price of employees' stock
options and warrants equal the market value of the underlying stock at the grant
date, as in the case of options and warrants granted to the Company's employees.
The fair value of options and warrants was estimated using the minimum value
method with the following assumptions:
<TABLE>
<CAPTION>
EMPLOYEE EMPLOYEE
STOCK STOCK
OPTIONS WARRANTS
------------- -------------
<S> <C> <C>
Expected dividend yield............................. 0.00% 0.00%
Risk-free interest rate............................. 4.98% 5.81%
Expected volatility................................. 0.00% 0.00%
Expected life (in years)............................ 6 6
</TABLE>
SFAS 123 pro forma numbers are as follows:
<TABLE>
<CAPTION>
1999
---------
<S> <C>
Net loss available to common stockholders as reported
under APB No. 25............................................... $ 130,424
Pro forma net loss available to common stockholders.............. $ 287,288
</TABLE>
The Company did not grant any stock options or warrants in fiscal 1998 or
1997 and, therefore, no pro forma disclosure for these years is provided.
The weighted average estimated fair value of employee stock options granted
during the year ended February 28, 1999 was $0.27 per share. The weighted
average estimated fair value of the warrants at the time of grant was $0.0001
per share.
F-22
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES
As of February 28, 1999, the Company leased office space and certain
equipment under various noncancelable operating and capital leases. Future
minimum lease payments required under the operating and capital leases at
February 28, 1999 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
---------- ---------
<S> <C> <C>
2000................................................. $ 945,612 $ 139,698
2001................................................. 934,208 136,901
2002................................................. 931,283 120,863
2003................................................. 932,200 112,089
2004................................................. 819,266 99,687
---------- ---------
Total minimum lease payments....................... $4,562,569 609,238
----------
----------
Less amount representing interest (at rates ranging
from 8.2% to 9.6%)................................. 80,563
---------
Present value of net minimum lease payments.......... 528,675
Less current portion................................. 108,897
---------
Long-term portion.................................. $ 419,778
---------
---------
</TABLE>
Rent expense under operating leases for the years ended February 28, 1997,
1998 and 1999 was $86,313, $171,191 and $308,973 respectively.
The Company has entered into an agreement with a bank to provide a letter of
credit pertaining to its building lease. The Company is required by the bank to
maintain a compensating balance of $65,000 which is equal to the amount of the
letter of credit. This amount is included in cash and cash equivalents.
The Company has executed licensing contracts to publish, bundle and
distribute software products developed by other companies in return for royalty
payments based on a percentage of the revenues generated by the Company from the
sale of these products. Prepaid royalty payments are included in current assets
and royalty payments due are included in royalties payable.
In April 1999, the Company also contracted with a web support firm to
maintain its backup web site. The initial fee of $98,000 was due upon receipt
and installation of the hardware. The Company has agreed to pay a monthly
maintenance fee of $17,000 for a period of 36 months.
13. EMPLOYEE BENEFIT PLAN
The Company provides a retirement plan qualified under Section 401(k) of the
Internal Revenue Code ("IRC") of 1986, as amended. Participants may elect to
contribute a portion of their annual compensation to the plan, after complying
with certain limitations set by the IRC. Employees are eligible to participate
in the plan who are over 21 years of age and have completed three months of
service with Red Hat. If, however, an employee was employed by the Company prior
to February 1999, the 401(k) Plan covers such employee regardless of age or
length of service. The Company has the option to make contributions to the plan
but did not make any contributions to the plan for the years ended February 28,
1997, 1998 and 1999.
F-23
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
14. SUBSEQUENT EVENTS
On June 2, 1999, the Board of Directors approved a two-for-one common stock
split to be effective prior to the effective date of the Company's planned
initial public offering. All share and per share information in the accompanying
financial statements and notes to the financial statements has been
retroactively restated to reflect the effect of this stock split.
In addition, the Board of Directors approved an amendment to the certificate
of incorporation to take effect as of the effective date of the registration
statement, increasing the authorized capital stock to 225,000,000 shares of
common stock and 5,000,000 shares of preferred stock each with a par value of
$.0001 per share.
F-24
<PAGE>
UNDERWRITING
Red Hat and the underwriters named below have entered into an underwriting
agreement concerning the shares being offered. Generally, each underwriter has
severally agreed to purchase the number of shares indicated in the following
table. Goldman, Sachs & Co., Thomas Weisel Partners LLC, Hambrecht & Quist LLC
and E*TRADE Securities, Inc. are the representatives of the underwriters.
<TABLE>
<CAPTION>
Number of
Underwriters Shares
- ---------------------------------------------------------------- -----------
<S> <C>
Goldman, Sachs & Co. ...........................................
Thomas Weisel Partners LLC......................................
Hambrecht & Quist LLC...........................................
E*TRADE Securities, Inc.........................................
-----------
Total................................................... 6,000,000
-----------
-----------
</TABLE>
If the underwriters sell more shares than the total number presented in the
table above, the underwriters have an option to buy up to an additional 900,000
shares from Red Hat to cover such sales. They may exercise that option for 30
days. If any shares are purchased upon exercise of this option, the underwriters
will severally purchase shares in approximately the same proportion as presented
in the table above.
The following table shows the per share and total underwriting discounts to
be paid to the underwriters by Red Hat. These amounts are shown assuming both no
exercise and full exercise of the underwriters' option to purchase additional
shares.
Paid by Red Hat
<TABLE>
<CAPTION>
No Full
Exercise Exercise
----------- -----------
<S> <C> <C>
Per Share...... $ $
Total.......... $ $
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial public offering price presented on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $ per share from the initial public offering price. Any of these
securities dealers may resell any shares purchased from the underwriters to
certain other brokers or dealers at a discount of up to $ per share from the
initial public offering price. If all the shares are not sold at the initial
offering price, the representatives may change the offering price and the other
selling terms.
Red Hat and its officers, directors, and securityholders have agreed with
the underwriters not to dispose of or hedge any of its common stock or
securities convertible into or exchangeable for shares of common stock during
the period from the date of this prospectus continuing through the date 180 days
after the date of this prospectus, except with the prior written consent of
Goldman Sachs. See "Shares Eligible for Future Sale" for a discussion of
restrictions by transfer of Red Hat's common stock.
At the request of Red Hat, the underwriters have reserved up to 800,000
shares of common stock for sale, at the initial public offering price, to
directors, officers, employees and friends of Red Hat through a directed share
program. There can be no assurance that any of the reserved shares will be so
purchased. The number of shares of common stock available for sale to the
general public in the public offering will be reduced to the extent these
persons purchase these reserved shares. Any reserved shares not so purchased
will be offered to the general public on the same basis as the other shares
offered hereby.
Thomas Weisel Partners LLC, one of the representatives of the underwriters,
was organized and registered as a broker-dealer in
U-1
<PAGE>
December 1998. Since December 1998, Thomas Weisel Partners has been named as a
lead or co-manager of 41 filed public offerings of equity securities, of which
24 have been completed, and has acted as a syndicate member in an additional 19
public offerings of equity securities. Thomas Weisel Partners does not have any
material relationship with Red Hat or any of our officers, directors or other
controlling persons, except for its contractual relationship with Red Hat under
the terms of the underwriting agreement entered into in connection with this
offering.
Prior to this offering, there has been no public market for our common
stock. The initial public offering price will be negotiated among Red Hat and
the representatives. Among the factors to be considered in determining the
initial public offering price of the shares, in addition to prevailing market
conditions, will be Red Hat's historical performance, estimates of the business
potential and earnings prospects of Red Hat, an assessment of Red Hat's
management and the consideration of the above factors in relation to market
valuation of companies in related businesses.
Red Hat has applied to list the common stock on the Nasdaq National Market
under the symbol "RHAT".
In connection with this offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. Stabilizing
transactions consist of certain bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of that underwriter in stabilizing or short covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
The underwriters do not expect sales to discretionary accounts to exceed
five percent of the total number of shares offered.
Red Hat estimates that its share of the total expenses of the offering,
excluding underwriting commissions, will be approximately $1,250,000.
Red Hat has agreed to indemnify the several underwriters against certain
liabilities, including liabilities under the Securities Act.
U-2
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. This prospectus is an
offer to sell only the shares offered hereby, but only under circumstances and
in jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary........................................................ 2
Risk Factors.............................................................. 6
Special Note Regarding Forward-Looking Statements......................... 17
Use of Proceeds........................................................... 17
Dividend Policy........................................................... 17
Capitalization............................................................ 18
Dilution.................................................................. 19
Selected Financial Data................................................... 20
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 22
Business.................................................................. 37
Management................................................................ 53
Transactions with Affiliates.............................................. 60
Principal Stockholders.................................................... 61
Description of Capital Stock.............................................. 62
Shares Eligible for Future Sale........................................... 67
Legal Matters............................................................. 67
Experts................................................................... 67
Where You Can Find More Information....................................... 67
Index to Financial Statements............................................. F-1
Underwriting.............................................................. U-1
</TABLE>
------------------------
Through and including , 1999 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to the dealer's obligation to deliver a prospectus when
acting as an underwriter and concerning an unsold allotment or subscription.
6,000,000 Shares
Red Hat
Common Stock
----------------
[LOGO]
----------------
GOLDMAN, SACHS & CO.
THOMAS WEISEL PARTNERS LLC
HAMBRECHT & QUIST
E*TRADE SECURITIES, INC.
Representatives of the Underwriters
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Estimated expenses payable in connection with the sale of the common stock
in this offering are as follows:
<TABLE>
<S> <C>
SEC registration fee........................................... $ 26,855
NASD filing fee................................................ 10,160
Nasdaq National Market listing fee............................. 95,000
Printing and engraving expenses................................ 125,000
Legal fees and expenses........................................ 500,000
Accounting fees and expenses................................... 250,000
Transfer agent and registrar fees and expenses................. 10,000
Miscellaneous.................................................. 232,985
----------
Total.................................................... $1,250,000
----------
----------
</TABLE>
The registrant will bear all of the expenses shown above.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Delaware General Corporation Law, the registrant's charter and by-laws
provide for indemnification of the registrant's directors and officers for
liabilities and expenses that they may incur in such capacities. In general,
directors and officers are indemnified with respect to actions taken in good
faith in a manner reasonably believed to be in, or not opposed to, the best
interests of the registrant, and with respect to any criminal action or
proceeding, actions that the indemnitee had no reasonable cause to believe were
unlawful. Reference is made to the registrant's corporate charter and by-laws
filed as Exhibits 3.1 and 3.2 hereto, respectively.
The Underwriting Agreement provides that the underwriters are obligated,
under certain circumstances, to indemnify directors, officers and controlling
persons of the registrant against certain liabilities, including liabilities
under the Securities Act. Reference is made to the form of underwriting
agreement filed as Exhibit 1.1 hereto.
The registrant intends to apply for a directors' and officers' insurance
policy.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
In the three years preceding the filing of this registration statement, the
registrant has sold the following securities that were not registered under the
Securities Act:
On August 15, 1997, the registrant sold an aggregate of 6,801,400 shares of
its Series A convertible preferred stock to one investor at a price of $.294057
per share.
On September 29, 1998, the registrant sold an aggregate of 8,116,550 shares
of its Series B convertible preferred stock to five investors at a price of
$.857 per share.
During the period between February 25, 1999 and April 1, 1999, the
registrant sold an aggregate of 2,054,776 shares of its Series C convertible
preferred stock to ten investors at a price of $3.141 per share.
On October 10, 1995, the registrant issued warrants to certain employees
exercisable for an aggregate of 3,740,400 shares of common stock with an
exercise price per share of $.0001.
II-1
<PAGE>
Since September 4, 1998, the registrant has granted options to purchase an
aggregate of 7,863,440 shares of common stock under the 1998 Stock Option Plan,
as amended, currently exercisable at a weighted average price of $1.58 per
share.
No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon the exemption provided by Section 4(2) of the
Securities Act for transactions not involving a public offering and/or Rule 701
under the Securities Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT INDEX
- ----------- -----------------------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement
3.1* Second Amended and Restated Certificate of Incorporation, as amended, of the
registrant (currently in effect)
3.2* Form of Third Amended and Restated Certificate of Incorporation of the registrant
to be filed upon the effectiveness of the registration statement
3.3 Form of Certificate of Amendment to the Third Amended and Restated Certificate of
Incorporation to be filed upon the closing of the offering
3.4* By-laws of the registrant
3.5* Form of Amended and Restated By-laws to take effect as of the effective date of the
registration statement
4.1** Specimen certificate representing the common stock
5.1** Opinion of Testa, Hurwitz & Thibeault, LLP
10.1* 1998 Stock Option Plan, as amended
10.2* 1999 Stock Option and Incentive Plan
10.3* 1999 Employee Stock Purchase Plan
10.4* Warrant Agreement by and among the registrant, Robert F. Young, Nancy R. Young,
Marc Ewing and Erik Troan, dated as of September 29, 1998, as amended
10.5* Warrant Agreement, by and among the registrant, Robert F. Young, Nancy R. Young,
Marc Ewing and Donald Barnes, dated as of September 29, 1998, as amended
10.6* Warrant Agreement by and among the registrant, Robert F. Young, Nancy R. Young,
Marc Ewing and Lisa Sullivan, dated as of September 29, 1998, as amended
10.7* First Amended and Restated Investor Rights Agreement by and among the registrant
and the Investors and Founders listed therein, dated as of February 25, 1999, as
amended
10.8* Office Lease by and between the registrant and CMD Properties, Inc., dated November
13, 1998
10.9* Non-Qualified Stock Option Agreement by and between the registrant and Matthew
Szulik
10.10* Incentive Stock Option Agreement by and between the registrant and Matthew Szulik
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT INDEX
- ----------- -----------------------------------------------------------------------------------
<C> <S>
10.11* Non-Qualified Stock Option Agreement by and between the registrant and Timothy
Buckley
10.12* Incentive Stock Option Agreement by and between the registrant and Timothy Buckley
10.13* GNU General Public License
10.14+* Distribution Agreement by and between the registrant and Ingram Micro Inc. dated as
of October 15, 1998, as amended
10.15+* Red Hat Product Distribution Agreement by and between the registrant and Frank
Kasper Associates, Inc., dated as of April 30, 1999
10.16+* Software Distribution Agreement between Tech Data Product Management, Inc. and the
registrant, dated as of April 29, 1999
10.17+* Agreement by and between the registrant and Building Number Three, Ltd., dated as
of June 10, 1998
10.18+* Independent Contractor Agreement by and between the registrant and Ingo Molnar,
dated as of August 18, 1998
10.19+* Software License and Shipment Agreement by and among the registrant, Dell Products
L.P. and Dell Computer Corporation, dated as of February 25, 1999
23.1** Consent of Testa, Hurwitz & Thibeault, LLP (included in Exhibit 5.1)
23.2 Consent of PricewaterhouseCoopers LLP
24.1* Power of Attorney
27.1 Financial Data Schedule
27.2 Financial Data Schedule
</TABLE>
- ------------------------
+ Confidential materials omitted and filed separately with the Securities and
Exchange Commission.
* Previously filed.
** To be filed by amendment.
(b) FINANCIAL STATEMENTS SCHEDULES:
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions, the required information is disclosed in the notes to the
financial statements or the schedules are inapplicable, and therefore have been
omitted.
ITEM 17. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to provisions described in Item 14 above, 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,
II-3
<PAGE>
officer or controlling person of the registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The registrant hereby undertakes (1) 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; (2) that for purposes of determining
any liability under the Securities Act, the information omitted from the form of
prospectus filed as part of a registration statement in reliance upon Rule 430A
and contained in the 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; and (3)
that for the purpose of determining any liability under the Securities Act, each
post-effective amendment that contains a form of prospectus shall be deemed to
be a new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this amendment no. 1 to the registration statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in Durham, North
Carolina on July 16, 1999.
RED HAT, INC.
BY: /S/ MATTHEW SZULIK
-----------------------------------------
Matthew Szulik
PRESIDENT
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, this amendment
no. 1 to the registration statement has been signed below by the following
persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
<C> <S> <C>
Chairman and Chief
* Executive Officer
- ------------------------------ (principal executive July 16, 1999
Robert F. Young officer)
Chief Financial Officer
* (principal
- ------------------------------ financial and accounting July 16, 1999
Manoj George officer)
* Director
- ------------------------------ July 16, 1999
Marc Ewing
* Director
- ------------------------------ July 16, 1999
Frank Batten, Jr.
* Director
- ------------------------------ July 16, 1999
William S. Kaiser
/s/ MATTHEW SZULIK Director
- ------------------------------ July 16, 1999
Matthew Szulik
* Director
- ------------------------------ July 16, 1999
Eric Hahn
</TABLE>
<TABLE>
<S> <C>
By: /S/ MATTHEW SZULIK
-----------------------------
Matthew Szulik
Attorney-in-Fact
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT INDEX
- ----------- -----------------------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement
3.1* Second Amended and Restated Certificate of Incorporation, as amended, of the
registrant (currently in effect)
3.2* Form of Third Amended and Restated Certificate of Incorporation of the registrant
to be filed upon the effectiveness of the registration statement
3.3 Form of Certificate of Amendment to the Third Amended and Restated Certificate of
Incorporation to be filed upon the closing of the offering
3.4* By-laws of the registrant
3.5* Form of Amended and Restated By-laws to take effect as of the effective date of the
registration statement
4.1** Specimen certificate representing the common stock
5.1** Opinion of Testa, Hurwitz & Thibeault, LLP
10.1* 1998 Stock Option Plan, as amended
10.2* 1999 Stock Option and Incentive Plan
10.3* 1999 Employee Stock Purchase Plan
10.4* Warrant Agreement by and among the registrant, Robert F. Young, Nancy R. Young,
Marc Ewing and Erik Troan, dated as of September 29, 1998, as amended
10.5* Warrant Agreement, by and among the registrant, Robert F. Young, Nancy R. Young,
Marc Ewing and Donald Barnes, dated as of September 29, 1998, as amended
10.6* Warrant Agreement by and among the registrant, Robert F. Young, Nancy R. Young,
Marc Ewing and Lisa Sullivan, dated as of September 29, 1998, as amended
10.7* First Amended and Restated Investor Rights Agreement by and among the registrant
and the Investors and Founders listed therein, dated as of February 25, 1999, as
amended
10.8* Office Lease by and between the registrant and CMD Properties, Inc., dated November
13, 1998
10.9* Non-Qualified Stock Option Agreement by and between the registrant and Matthew
Szulik
10.10* Incentive Stock Option Agreement by and between the registrant and Matthew Szulik
10.11* Non-Qualified Stock Option Agreement by and between the registrant and Timothy
Buckley
10.12* Incentive Stock Option Agreement by and between the registrant and Timothy Buckley
10.13* GNU General Public License
10.14+* Distribution Agreement by and between the registrant and Ingram Micro Inc. dated as
of October 15, 1998, as amended
10.15+* Red Hat Product Distribution Agreement by and between the registrant and Frank
Kasper Associates, Inc., dated as of April 30, 1999
10.16+* Software Distribution Agreement between Tech Data Product Management, Inc. and the
registrant, dated as of April 29, 1999
10.17+* Agreement by and between the registrant and Building Number Three, Ltd., dated as
of June 10, 1998
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT INDEX
- ----------- -----------------------------------------------------------------------------------
<C> <S>
10.18+* Independent Contractor Agreement by and between the registrant and Ingo Molnar,
dated as of August 18, 1998
10.19+* Software License and Shipment Agreement by and among the registrant, Dell Products
L.P. and Dell Computer Corporation, dated as of February 25, 1999
23.1** Consent of Testa, Hurwitz & Thibeault, LLP (included in Exhibit 5.1)
23.2 Consent of PricewaterhouseCoopers LLP
24.1* Power of Attorney
27.1 Financial Data Schedule
27.2 Financial Data Schedule
</TABLE>
- ------------------------
+ Confidential materials omitted and filed separately with the Securities and
Exchange Commission.
* Previously filed.
** To be filed by amendment.
<PAGE>
Exhibit 1.1
RED HAT, INC.
COMMON STOCK
(PAR VALUE $0.0001 PER SHARE)
UNDERWRITING AGREEMENT
...................., 1999
Goldman, Sachs & Co.
Thomas Weisel Partners LLC
Hambrecht & Quist LLC
E*TRADE Securities, Inc.
As representatives of the several Underwriters
named in Schedule I hereto
c/o Goldman, Sachs & Co.
85 Broad Street
New York, New York 10004
Ladies and Gentlemen:
Red Hat, Inc., a Delaware corporation (the "Company"), proposes,
subject to the terms and conditions stated herein, to issue and sell to the
Underwriters named in Schedule I hereto (the "Underwriters") an aggregate of . .
. . . . .shares (the "Firm Shares") and, at the election of the Underwriters, up
to . . . . . . additional shares (the "Optional Shares") of Common Stock,
$0.0001 par value per share ("Stock"), of the Company. The Firm Shares and the
Optional Shares that the Underwriters elect to purchase pursuant to Section 2
hereof are herein collectively called the "Shares".
1. The Company represents and warrants to, and agrees with, each of the
Underwriters that:
(a) A registration statement on Form S-1 (File No. 333-80051) (the "Initial
Registration Statement") in respect of the Shares has been filed with the
Securities and Exchange Commission (the "Commission"); copies of the Initial
Registration Statement and any pre- and post-effective amendments thereto have
heretofore been delivered to you by the Company; the Initial Registration
Statement, as amended, has been declared effective by the Commission; other than
a registration statement, if any, increasing the size of the offering (a "Rule
462(b) Registration Statement"), filed pursuant to Rule 462(b) under the
Securities Act of 1933, as amended (the "Act"), which became effective upon
filing, and other than any pre- and post-effective amendments to the Initial
Registration Statement (including schedules and exhibits thereto), together with
any transmittal letters, each previously delivered to you, no other document
with respect to the Initial Registration Statement has heretofore been filed
with the Commission; and no stop order suspending the effectiveness of the
Initial Registration Statement, any post-effective amendment thereto or the Rule
462(b) Registration Statement, if any, has been issued
<PAGE>
and no proceeding for that purpose has been initiated or threatened by the
Commission; any preliminary prospectus included in the Initial Registration
Statement or filed with the Commission pursuant to Rule 424(a) of the rules and
regulations of the Commission under the Act is hereinafter called a "Preliminary
Prospectus"; the various parts of the Initial Registration Statement and the
Rule 462(b) Registration Statement, if any, including all exhibits thereto and
including the information contained in the form of final prospectus filed with
the Commission pursuant to Rule 424(b) under the Act in accordance with Section
5(a) hereof and deemed by virtue of Rule 430A under the Act to be part of the
Initial Registration Statement at the time it was declared effective, each as
amended at the time such part of the Initial Registration Statement became
effective or such part of the Rule 462(b) Registration Statement, if any, became
or hereafter becomes effective, are hereinafter collectively called the
"Registration Statement"; and such final prospectus, in the form first filed
pursuant to Rule 424(b) under the Act, is hereinafter called the "Prospectus";
(b) No order preventing or suspending the use of any Preliminary Prospectus has
been issued by the Commission, and each Preliminary Prospectus, at the time of
filing thereof, conformed in all material respects to the requirements of the
Act and the rules and regulations of the Commission thereunder, and did not
contain an untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein, in
the light of the circumstances under which they were made, not misleading;
provided, however, that this representation and warranty shall not apply to any
statements or omissions made in reliance upon and in conformity with information
furnished in writing to the Company by an Underwriter through Goldman, Sachs &
Co. expressly for use therein;
(c) The Registration Statement conforms, and the Prospectus and any further
amendments or supplements to the Registration Statement or the Prospectus will
conform, in all material respects to the requirements of the Act and the rules
and regulations of the Commission thereunder and do not and will not, as of the
applicable effective date as to the Registration Statement and any amendment
thereto and as of the applicable filing date as to the Prospectus and any
amendment or supplement thereto, contain an untrue statement of a material fact
or omit to state a material fact required to be stated therein or necessary to
make the statements therein not misleading; provided, however, that this
representation and warranty shall not apply to any statements or omissions made
in reliance upon and in conformity with information furnished in writing to the
Company by an Underwriter through Goldman, Sachs & Co. expressly for use
therein;
(d) Neither the Company nor any of its subsidiaries has sustained since the date
of the latest audited financial statements included in the Prospectus any
material loss or interference with its business from fire, explosion, flood or
other calamity, whether or not covered by insurance, or from any labor dispute
or court or governmental action, order or decree, otherwise than as set forth or
contemplated in the Prospectus; and, since the respective dates as of which
information is given in the Registration Statement and the Prospectus, there has
not been any change in the capital stock or long-term debt of the Company or any
of its subsidiaries or any material adverse change, or any development involving
a prospective material adverse change, in or affecting the general affairs,
management, financial position, stockholders' equity or results
<PAGE>
of operations of the Company and its subsidiaries, otherwise than as set forth
or contemplated in the Prospectus;
(e) The Company and its subsidiaries have good and marketable title to all
personal property owned by them as described in the Prospectus as owned by them,
in each case free and clear of all liens, encumbrances and defects except such
as are described in the Prospectus or such as do not materially affect the value
of such property and do not interfere with the use made and proposed to be made
of such property by the Company and its subsidiaries; neither the Company nor
any subsidiary owns any real property; and any real property and buildings held
under lease by the Company and its subsidiaries are held by them under valid,
subsisting and enforceable leases with such exceptions as are not material and
do not interfere with the use made and proposed to be made of such property and
buildings by the Company and its subsidiaries;
(f) The Company has been duly incorporated and is validly existing as a
corporation in good standing under the laws of the State of Delaware, with power
and authority (corporate and other) to own its properties and conduct its
business as described in the Prospectus, and has been duly qualified as a
foreign corporation for the transaction of business and is in good standing
under the laws of each other jurisdiction in which it owns or leases properties
or conducts any business so as to require such qualification, or is subject to
no material liability or disability by reason of the failure to be so qualified
in any such jurisdiction; and each subsidiary of the Company has been duly
incorporated and is validly existing as a corporation in good standing under the
laws of its jurisdiction of incorporation;
(g) The Company has an authorized capitalization as set forth in the Prospectus,
and all of the issued shares of capital stock of the Company have been duly and
validly authorized and issued, are fully paid and non-assessable and conform to
the description of the Stock contained in the Prospectus; and all of the issued
shares of capital stock of each subsidiary of the Company have been duly and
validly authorized and issued, are fully paid and non-assessable and (except for
directors' qualifying shares and except as set forth in the Prospectus) are
owned directly or indirectly by the Company, free and clear of all liens,
encumbrances, equities or claims;
(h) The Shares to be issued and sold by the Company to the Underwriters
hereunder have been duly and validly authorized and, when issued and delivered
against payment therefor as provided herein, will be duly and validly issued and
fully paid and non-assessable and will conform to the description of the Stock
contained in the Prospectus;
(i) The issue and sale of the Shares to be sold by the Company and the
compliance by the Company with all of the provisions of this Agreement and the
consummation of the transactions herein contemplated will not conflict with or
result in a breach or violation of any of the terms or provisions of, or
constitute a default under, any indenture, mortgage, deed of trust, loan
agreement or other agreement or instrument to which the Company or any of its
subsidiaries is a party or by which the Company or any of its subsidiaries is
bound or to which any of the property or assets of the Company or any of its
subsidiaries is subject, nor will such action result in any violation of the
provisions of the Certificate of Incorporation or By-laws of the Company or any
statute or any order, rule or regulation of any court or governmental agency or
body having jurisdiction over the Company or any of its subsidiaries or any of
their properties; and no consent, approval, authorization, order, registration
or qualification of or with any such court or
3
<PAGE>
governmental agency or body is required for the issue and sale of the Shares or
the consummation by the Company of the transactions contemplated by this
Agreement, except the registration under the Act of the Shares, and such
consents, approvals, authorizations, registrations or qualifications as may be
required under state securities or Blue Sky laws in connection with the purchase
and distribution of the Shares by the Underwriters;
(j) Neither the Company nor any of its subsidiaries is in violation of its
Certificate of Incorporation, By-laws or other organizational documents or in
default in the performance or observance of any material obligation, agreement,
covenant or condition contained in any indenture, mortgage, deed of trust, loan
agreement, lease or other agreement or instrument to which it is a party or by
which it or any of its properties may be bound;
(k) The statements set forth in the Prospectus under the caption "Description of
Capital Stock", insofar as they purport to constitute a summary of the terms of
the Stock, are accurate, complete and fair;
(l) Other than as set forth in the Prospectus, there are no legal or
governmental proceedings pending to which the Company or any of its subsidiaries
is a party or of which any property of the Company or any of its subsidiaries is
the subject which, if determined adversely to the Company or any of its
subsidiaries, would individually or in the aggregate have a material adverse
effect on the current or future business, properties, financial position,
stockholders' equity or results of operations of the Company and its
subsidiaries taken as a whole (a "Material Adverse Effect"); and, to the best of
the Company's knowledge, no such proceedings are threatened or contemplated by
governmental authorities or threatened by others;
(m) Other than as set forth in the Prospectus, the Company and its subsidiaries
have sufficient interests in all patents, trademarks, service marks, trade
names, domain names, copyrights, trade secrets, information, proprietary rights
and processes ("Intellectual Property") necessary for their business as
described in the Prospectus and, to the Company's knowledge, necessary in
connection with the products and services under development, without any
conflict with or infringement of the interests of others, except for such
conflicts which, individually or in the aggregate, have not had, and are not
reasonably likely to result in, a Material Adverse Effect, and have taken all
reasonable steps necessary to secure interests in such Intellectual Property
from their contractors; except as set forth in the Prospectus, the Company is
not aware of outstanding options, licenses or agreements of any kind relating to
the Intellectual Property of the Company which are required to be set forth in
the Prospectus, and, except as set forth in the Prospectus, neither the Company
nor any of its subsidiaries is a party to or bound by any options, licenses or
agreements with respect to the Intellectual Property of any other person or
entity which are required to be set forth in the Prospectus; none of the
technology employed by the Company has been obtained or is being used by the
Company or its subsidiaries in violation of any contractual or fiduciary
obligation binding on the Company or any of its subsidiaries or, to the
Company's knowledge, any of its directors or officers or any of its employees or
otherwise in violation of the rights of any persons; except as disclosed in the
Prospectus, neither the Company nor any of its subsidiaries has received any
written or, to the Company's knowledge, oral communications alleging that the
Company or any of its subsidiaries has violated, infringed or conflicted with,
or, by conducting its business as set forth in the Prospectus, would violate,
infringe or conflict with any of the Intellectual Property of any other person
or entity other than any such violations, infringements or conflicts which,
individually or in the aggregate, have not had, and are not reasonably likely to
result in, a Material Adverse Effect; and the Company and
4
<PAGE>
its subsidiaries have taken and will maintain reasonable measures to prevent the
unauthorized dissemination or publication of their confidential information and,
to the extent contractually required to do so, the confidential information of
third parties in their possession;
(n) The Company maintains insurance of the types and in the amounts generally
deemed adequate for its business, including, but not limited to, general
liability insurance, business interruption insurance and insurance covering real
and personal property owned or leased by the Company against theft, damage,
destruction, acts of vandalism and all other risks customarily insured against,
all of which insurance is in full force and effect;
(o) There are no contracts, other documents or other agreements required to be
described in the Registration Statement or to be filed as exhibits to the
Registration Statement by the Act or by the rules and regulations thereunder
which have not been described or filed as required; except as described in the
Prospectus, the contracts so described in the Prospectus are in full force and
effect on the date hereof; and neither the Company nor, to the Company's
knowledge, any other party is in breach of or default under any of such
contracts other than such breaches or defaults which, individually or in the
aggregate, have not had, and are not reasonably likely to result in, a Material
Adverse Effect;
(p) Except as described in or contemplated by the Prospectus, the Company and
its subsidiaries possess all certificates, authorizations and permits issued by
the appropriate federal, state or foreign regulatory authorities necessary to
conduct their respective businesses, and neither the Company nor any such
subsidiary has received any notice of proceedings relating to the revocation or
modification of, or failure to obtain, any such certificate, authorization or
permit which, individually or in the aggregate, if the subject of an unfavorable
decision, ruling or finding, would result in a Material Adverse Effect;
(q) Except as described in the Prospectus, there are no contracts, agreements or
understandings between the Company and any person granting such person the right
to require the Company to file a registration statement under the Act with
respect to any securities of the Company or to require the Company to include
such securities with the Shares registered pursuant to the Registration
Statement, and the right of each person who is a party to any contract,
agreement or understanding so described to include such securities pursuant to
the Registration Statement has been effectively satisfied or waived;
(r) The Company has reviewed its operations and that of its subsidiaries and any
third parties with which the Company or any of its subsidiaries has a material
relationship to evaluate the extent to which the business or operations of the
Company or any of its subsidiaries will be affected by the Year 2000 Problem. As
a result of such review, the Company has no reason to believe, and does not
believe, that the Year 2000 Problem will have a Material Adverse Effect. The
"Year 2000 Problem" as used herein means any significant risk that computer
hardware or software used in the receipt, transmission, processing,
manipulation, storage, retrieval, retransmission or other utilization of data or
in the operation of mechanical or electrical systems of any kind will not, in
the case of dates or time periods occurring after December 31, 1999, function at
least as effectively as in the case of dates or time periods occurring prior to
January 1, 2000;
(s) The Company is not and, after giving effect to the offering and sale of the
Shares, will not be an "investment company", or an entity "controlled" by an
"investment company", as such
5
<PAGE>
terms are defined in the Investment Company Act of 1940, as amended (the
"Investment Company Act"); and
(t) PricewaterhouseCoopers LLP, who have certified certain financial statements
of the Company and its subsidiaries, are independent public accountants as
required by the Act and the rules and regulations of the Commission thereunder.
2. Subject to the terms and conditions herein set forth, (a) the Company agrees
to sell to each of the Underwriters, and each of the Underwriters agrees,
severally and not jointly, to purchase from the Company, at a purchase price per
share of $.............., the number of Firm Shares set forth opposite the name
of such Underwriter in Schedule I hereto, and (b) in the event and to the extent
that the Underwriters shall exercise the election to purchase Optional Shares as
provided below, the Company agrees to sell to each of the Underwriters, and each
of the Underwriters agrees, severally and not jointly, to purchase from the
Company, at the purchase price per share set forth in clause (a) of this Section
2, that portion of the number of Optional Shares as to which such election shall
have been exercised (to be adjusted by you so as to eliminate fractional shares)
determined by multiplying such number of Optional Shares by a fraction the
numerator of which is the maximum number of Optional Shares which such
Underwriter is entitled to purchase as set forth opposite the name of such
Underwriter in Schedule I hereto and the denominator of which is the maximum
number of Optional Shares that all of the Underwriters are entitled to purchase
hereunder.
The Company hereby grants to the Underwriters the right to purchase at their
election up to ................... Optional Shares, at the purchase price per
share set forth in the paragraph above, for the sole purpose of covering sales
of shares in excess of the number of Firm Shares. Any such election to purchase
Optional Shares may be exercised only by written notice from you to the Company,
given within a period of 30 calendar days after the date of this Agreement and
setting forth the aggregate number of Optional Shares to be purchased and the
date on which such Optional Shares are to be delivered, as determined by you but
in no event earlier than the First Time of Delivery (as defined in Section 4
hereof) or, unless you and the Company otherwise agree in writing, earlier than
two or later than ten business days after the date of such notice.
3. Upon the authorization by you of the release of the Firm Shares, the several
Underwriters propose to offer the Firm Shares for sale upon the terms and
conditions set forth in the Prospectus.
4. (a) The Shares to be purchased by each Underwriter hereunder, in definitive
form, and in such authorized denominations and registered in such names as
Goldman, Sachs & Co. may request upon at least forty-eight hours' prior notice
to the Company shall be delivered by or on behalf of the Company to Goldman,
Sachs & Co., through the facilities of the Depository Trust Company ("DTC"), for
the account of such Underwriter, against payment by or on behalf of such
Underwriter of the purchase price therefor by wire transfer of Federal
(same-day) funds to the account specified by the Company to Goldman, Sachs & Co.
at least forty-eight hours in advance. The Company will cause the certificates
representing the Shares to be made available for checking and packaging at least
twenty-four hours prior to the Time of Delivery (as defined below) with respect
thereto at the office of DTC or its designated custodian (the "Designated
Office"). The time and date of such delivery and payment shall be, with respect
to the Firm Shares, 9:30 a.m., New York time, on ............., 1999 or such
other time and date as
6
<PAGE>
Goldman, Sachs & Co. and the Company may agree upon in writing, and, with
respect to the Optional Shares, 9:30 a.m., New York time, on the date specified
by Goldman, Sachs & Co. in the written notice given by Goldman, Sachs & Co. of
the Underwriters' election to purchase such Optional Shares, or such other time
and date as Goldman, Sachs & Co. and the Company may agree upon in writing. Such
time and date for delivery of the Firm Shares is herein called the "First Time
of Delivery", such time and date for delivery of the Optional Shares, if not the
First Time of Delivery, is herein called the "Second Time of Delivery", and each
such time and date for delivery is herein called a "Time of Delivery".
(b) The documents to be delivered at each Time of Delivery by or on behalf of
the parties hereto pursuant to Section 7 hereof, including the cross-receipt for
the Shares and any additional documents requested by the Underwriters pursuant
to Section 7(k) hereof, will be delivered at the offices of Testa, Hurwitz &
Thibeault, LLP, 125 High Street, Boston, Massachusetts 02110 (the "Closing
Location"), and the Shares will be delivered at the Designated Office, all at
such Time of Delivery. A meeting will be held at the Closing Location at 3:00
p.m., New York City time, on the New York Business Day next preceding such Time
of Delivery, at which meeting the final drafts of the documents to be delivered
pursuant to the preceding sentence will be available for review by the parties
hereto. For the purposes of this Section 4, "New York Business Day" shall mean
each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which
banking institutions in New York are generally authorized or obligated by law or
executive order to close.
5. The Company agrees with each of the Underwriters:
(a) To prepare the Prospectus in a form approved by you and to
file such Prospectus pursuant to Rule 424(b) under the Act not later
than the Commission's close of business on the second business day
following the execution and delivery of this Agreement, or, if
applicable, such earlier time as may be required by Rule 430A(a)(3)
under the Act; to make no further amendment or any supplement to the
Registration Statement or Prospectus which shall be disapproved by you
promptly after reasonable notice thereof; to advise you, promptly
after it receives notice thereof, of the time when any amendment to
the Registration Statement has been filed or becomes effective or any
supplement to the Prospectus or any amended Prospectus has been filed
and to furnish you with copies thereof; to advise you, promptly after
it receives notice thereof, of the issuance by the Commission of any
stop order or of any order preventing or suspending the use of any
Preliminary Prospectus or prospectus, of the suspension of the
qualification of the Shares for offering or sale in any jurisdiction,
of the initiation or threatening of any proceeding for any such
purpose, or of any request by the Commission for the amending or
supplementing of the Registration Statement or Prospectus or for
additional information; and, in the event of the issuance of any stop
order or of any order preventing or suspending the use of any
Preliminary Prospectus or prospectus or suspending any such
qualification, promptly to use its best efforts to obtain the
withdrawal of such order;
(b) Promptly from time to time to take such action as you may
reasonably request to qualify the Shares for offering and sale under
the securities laws of such jurisdictions as you may request and to
comply with such laws so as to permit the continuance of sales and
dealings therein in such jurisdictions for as long as may be necessary
to complete the distribution of the Shares, provided that in
connection therewith the
7
<PAGE>
Company shall not be required to qualify as a foreign corporation or
to file a general consent to service of process in any jurisdiction;
(c) Prior to 10:00 a.m., New York City time, on the New York
Business Day next succeeding the date of this Agreement and from time
to time, to furnish the Underwriters with copies of the Prospectus in
New York City in such quantities as you may reasonably request, and,
if the delivery of a prospectus is required at any time prior to the
expiration of nine months after the time of issue of the Prospectus in
connection with the offering or sale of the Shares and if at such time
any event shall have occurred as a result of which the Prospectus as
then amended or supplemented would include an untrue statement of a
material fact or omit to state any material fact necessary in order to
make the statements therein, in the light of the circumstances under
which they were made when such Prospectus is delivered, not
misleading, or, if for any other reason it shall be necessary during
such period to amend or supplement the Prospectus in order to comply
with the Act, to notify you and upon your request to prepare and
furnish without charge to each Underwriter and to any dealer in
securities as many copies as you may from time to time reasonably
request of an amended Prospectus or a supplement to the Prospectus
which will correct such statement or omission or effect such
compliance, and in case any Underwriter is required to deliver a
prospectus in connection with sales of any of the Shares at any time
nine months or more after the time of issue of the Prospectus, upon
your request but at the expense of such Underwriter, to prepare and
deliver to such Underwriter as many copies as you may request of an
amended or supplemented Prospectus complying with Section 10(a)(3) of
the Act;
(d) To make generally available to its securityholders as soon
as practicable, but in any event not later than eighteen months after
the effective date of the Registration Statement (as defined in Rule
158(c) under the Act), an earnings statement of the Company and its
subsidiaries (which need not be audited) complying with Section 11(a)
of the Act and the rules and regulations of the Commission thereunder
(including, at the option of the Company, Rule 158);
(e) During the period beginning from the date hereof and
continuing to and including the date 180 days after the date of the
Prospectus, not to sell, offer to sell, contract to sell, grant any
option or warrant for the sale or purchase of, or otherwise dispose
of, except as provided hereunder, any shares of Stock or any
securities of the Company that are substantially similar to the
Shares, including but not limited to any securities that are
convertible into or exchangeable for, or that represent the right to
receive, Stock or any such substantially similar securities (other
than pursuant to employee stock option plans existing on, or upon the
conversion or exchange of convertible or exchangeable securities
outstanding as of, the date of this Agreement), without the prior
written consent of Goldman, Sachs & Co.;
(f) To furnish to its stockholders as soon as practicable after
the end of each fiscal year an annual report (including a balance
sheet and statements of income, stockholders' equity and cash flows of
the Company and its consolidated subsidiaries certified by independent
public accountants) and, as soon as practicable after the end of each
of the first three quarters of each fiscal year (beginning with the
fiscal quarter ending after the effective date of the Registration
Statement), to make available to its
8
<PAGE>
stockholders consolidated summary financial information of the Company
and its subsidiaries for such quarter in reasonable detail;
(g) During a period of five years from the effective date of the
Registration Statement, to furnish to you copies of all reports or
other communications (financial or other) furnished to stockholders,
and to deliver to you (i) as soon as they are available, copies of any
reports and financial statements furnished to or filed with the
Commission or any national securities exchange on which any class of
securities of the Company is listed; and (ii) such additional
information concerning the business and financial condition of the
Company as you may from time to time reasonably request (such
financial statements to be on a consolidated basis to the extent the
accounts of the Company and its subsidiaries are consolidated in
reports furnished to its stockholders generally or to the Commission);
(h) To use the net proceeds received by it from the sale of the
Shares pursuant to this Agreement in the manner specified in the
Prospectus under the caption "Use of Proceeds";
(i) To use its best efforts to list for quotation the Shares on
the Nasdaq National Market ("NASDAQ");
(j) To file with the Commission such information on Form 10-Q or
Form 10-K as may be required by Rule 463 under the Act; and
(k) If the Company elects to rely upon Rule 462(b), the Company
shall file a Rule 462(b) Registration Statement with the Commission in
compliance with Rule 462(b) by 10:00 P.M., Washington, D.C. time, on
the date of this Agreement, and the Company shall at the time of
filing either pay to the Commission the filing fee for the Rule 462(b)
Registration Statement or give irrevocable instructions for the
payment of such fee pursuant to Rule 111(b) under the Act.
6. The Company covenants and agrees with the several Underwriters that the
Company will pay or cause to be paid the following: (a) the fees, disbursements
and expenses of the Company's counsel and accountants in connection with the
registration of the Shares under the Act and all other expenses in connection
with the preparation, printing and filing of the Registration Statement, any
Preliminary Prospectus and the Prospectus and amendments and supplements thereto
and the mailing and delivering of copies thereof to the Underwriters and
dealers; (b) the cost of printing or producing any Agreement among Underwriters,
this Agreement, the Blue Sky Memorandum, closing documents (including any
compilations thereof) and any other documents in connection with the offering,
purchase, sale and delivery of the Shares; (c) all expenses in connection with
the qualification of the Shares for offering and sale under state securities
laws as provided in Section 5(b) hereof, including the fees and disbursements of
counsel for the Underwriters in connection with such qualification and in
connection with the Blue Sky survey; (d) all fees and expenses in connection
with listing the Shares on NASDAQ; (e) the filing fees incident to, and the fees
and disbursements of counsel for the Underwriters in connection with, securing
any required review by the National Association of Securities Dealers, Inc.
("NASD") of the terms of the sale of the Shares; (f) the cost of preparing stock
certificates; (g) the cost and charges of any transfer agent or registrar and
(h) all other costs and expenses incident to the performance of its obligations
hereunder
9
<PAGE>
which are not otherwise specifically provided for in this Section. It is
understood that, except as provided in this Section, and Sections 8 and 11
hereof, the Underwriters will pay all of their own costs and expenses, including
the fees of their counsel, stock transfer taxes on resale of any of the Shares
by them, and any advertising expenses connected with any offers they may make.
7. The obligations of the Underwriters hereunder, as to the Shares to be
delivered at each Time of Delivery, shall be subject, in their discretion, to
the condition that all representations and warranties and other statements of
the Company herein are, at and as of such Time of Delivery, true and correct,
the condition that the Company shall have performed all of its obligations
hereunder theretofore to be performed, and the following additional conditions:
(a) The Prospectus shall have been filed with the Commission
pursuant to Rule 424(b) within the applicable time period prescribed
for such filing by the rules and regulations under the Act and in
accordance with Section 5(a) hereof; if the Company has elected to
rely upon Rule 462(b), the Rule 462(b) Registration Statement shall
have become effective by 10:00 p.m., Washington, D.C. time, on the
date of this Agreement; no stop order suspending the effectiveness of
the Registration Statement or any part thereof shall have been issued
and no proceeding for that purpose shall have been initiated or
threatened by the Commission; and all requests for additional
information on the part of the Commission shall have been complied
with to your reasonable satisfaction;
(b) Hale and Dorr LLP, counsel for the Underwriters, shall have
furnished to you their written opinion (a draft of such opinion is
attached as Annex II(a) hereto), dated such Time of Delivery, with
respect to the matters covered in paragraphs (i), (ii), (vi), (x) and
(xii) of subsection (c) below as well as such other related matters as
you may reasonably request, and such counsel shall have received such
papers and information as they may reasonably request to enable them
to pass upon such matters;
(c) Testa, Hurwitz & Thibeault, LLP, counsel for the Company,
shall have furnished to you their written opinion (a draft of such
opinion is attached as Annex II(b) hereto), dated such Time of
Delivery, in form and substance satisfactory to you, to the effect
that:
(i) The Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of the
State of Delaware, with corporate power and authority to own its
properties and conduct its business, as such properties and
business are described in the Prospectus;
(ii) The Company has an authorized capitalization as set
forth in the Prospectus, and all of the issued shares of capital
stock of the Company (including the Shares being delivered at
such Time of Delivery) have been duly and validly authorized and
issued and are fully paid and non-assessable; and the Shares
conform, or when issued, delivered and paid for in accordance
with the terms of this Agreement will conform, in all material
respects, to the description of the Stock contained in the
Prospectus;
(iii) The Company has been duly qualified as a foreign
corporation for the transaction of business and is in good
standing under the laws of the State
10
<PAGE>
of California, the State of North Carolina and the State of
Texas, which are the only jurisdictions in the United States in
which, to such counsel's knowledge, the Company currently
maintains an office or owns or leases real property;
(iv) Each subsidiary of the Company has been duly
incorporated and is validly existing as a corporation in good
standing under the laws of its jurisdiction of incorporation;
and all of the issued shares of capital stock of each such
subsidiary have been duly and validly authorized and issued, are
fully paid and non-assessable, and (except for directors'
qualifying shares and except as otherwise set forth in the
Prospectus), are owned of record directly or indirectly by the
Company, to such counsel's knowledge free and clear of all
liens, encumbrances, equities or claims (such counsel being
entitled to rely in respect of the opinion in this clause upon
opinions of local counsel and in respect of matters of fact upon
certificates of officers of the Company or its subsidiaries,
provided that such counsel shall state that they believe that
both you and they are justified in relying upon such opinions
and certificates);
(v) To the best of such counsel's knowledge and other than
as set forth in the Prospectus as amended or supplemented, there
are no legal or governmental proceedings pending to which the
Company or any of its subsidiaries is a party or of which any
property of the Company or any of its subsidiaries is the
subject which, if determined adversely to the Company or any of
its subsidiaries, would individually or in the aggregate have a
Material Adverse Effect; and, to the best of such counsel's
knowledge, no such proceedings are threatened or contemplated by
governmental authorities or threatened by others;
(vi) This Agreement has been duly authorized, executed and
delivered by the Company;
(vii) The issue and sale of the Shares being delivered at
such Time of Delivery by the Company and the compliance by the
Company with all of the provisions of this Agreement and the
consummation of the transactions herein contemplated will not
conflict with or result in a breach or violation of any of the
terms or provisions of, or constitute a default under, any
indenture, mortgage, deed of trust, loan agreement or other
agreement or instrument known to such counsel to which the
Company or any of its subsidiaries is a party or by which the
Company or any of its subsidiaries is bound or to which any of
the property or assets of the Company or any of its subsidiaries
is subject, nor will such action result in any violation of the
provisions of the Certificate of Incorporation or By-laws of the
Company or any applicable statute or any order, rule or
regulation known to such counsel of any court or governmental
agency or body having jurisdiction over the Company or any of
its subsidiaries or any of their properties;
(viii) No consent, approval, authorization, order,
registration or qualification of or with any such court or
governmental agency or body is required for the issue and sale
of the Shares or the consummation by the Company of the
transactions contemplated by this Agreement, except the
registration under the Act of the Shares, the approval by the
NASD of the terms of the sale of the Shares, and such consents,
approvals, authorizations, registrations or qualifications as
may be
11
<PAGE>
required under state securities or Blue Sky laws in connection
with the purchase and distribution of the Shares by the
Underwriters;
(ix) To such counsel's knowledge, the Company is not in
violation of its Certificate of Incorporation or By-laws, which
violation could be reasonably expected to have a Material
Adverse Effect;
(x) The statements set forth in the Prospectus under the
caption "Description of Capital Stock", insofar as they purport
to constitute a summary of the terms of the Stock, are accurate
summaries and descriptions of such terms and provisions in all
material respects;
(xi) The Company is not an "investment company", or an
entity "controlled" by an "investment company", as such terms
are defined in the Investment Company Act; and
(xii) The Registration Statement and the Prospectus and
any further amendments and supplements thereto made by the
Company prior to such Time of Delivery (other than the financial
statements, including the notes and schedules thereto, and other
financial data, as to which such counsel need express no belief)
comply as to form in all material respects with the requirements
of the Act and the rules and regulations thereunder. Such
counsel shall also state that although they do not assume any
responsibility for the accuracy, completeness or fairness of the
statements contained in the Registration Statement or the
Prospectus, except for those referred to in the opinion in
subsection (x) of this Section 7(c), they have no reason to
believe that, as of its effective date, the Registration
Statement or any further amendment thereto made by the Company
prior to such Time of Delivery (other than the financial
statements, including the notes and schedules thereto, and other
financial data, as to which such counsel need express no belief)
contained an untrue statement of a material fact or omitted to
state a material fact required to be stated therein or necessary
to make the statements therein not misleading or that, as of its
date, the Prospectus or any further amendment or supplement
thereto made by the Company prior to such Time of Delivery
(other than the financial statements, including the notes and
schedules thereto, and other financial data, as to which such
counsel need express no belief) contained an untrue statement of
a material fact or omitted to state a material fact necessary to
make the statements therein, in the light of the circumstances
under which they were made, not misleading or that, as of such
Time of Delivery, either the Registration Statement or the
Prospectus or any further amendment or supplement thereto made
by the Company prior to such Time of Delivery (other than the
financial statements, including the notes and schedules thereto,
and other financial data, as to which such counsel need express
no belief) contains an untrue statement of a material fact or
omits to state a material fact necessary to make the statements
therein, in the light of the circumstances under which they were
made, not misleading; and they do not know of any contracts or
other documents of a character required to be filed as an
exhibit to the Registration Statement or required to be
described in the Registration Statement or the Prospectus which
are not filed or described as required;
12
<PAGE>
The foregoing opinion of Testa, Hurwitz & Thibeault, LLP may be
limited to the laws of the Commonwealth of Massachusetts, the General
Corporation Law of the State of Delaware and the Federal laws of the
United States. In rendering any such opinion, such counsel may rely,
as to matters of fact, to the extent such counsel deems proper, on
certificates of responsible officers of the Company and of public
officials.
(d) On the date of the Prospectus at a time prior to the
execution of this Agreement, at 9:30 a.m., New York City time, on the
effective date of any post-effective amendment to the Registration
Statement filed subsequent to the date of this Agreement and also at
each Time of Delivery, PricewaterhouseCoopers LLP shall have furnished
to you a letter or letters, dated the respective dates of delivery
thereof, in form and substance satisfactory to you, to the effect set
forth in Annex I hereto (the executed copy of the letter delivered
prior to the execution of this Agreement is attached as Annex I(a)
hereto and a draft of the form of letter to be delivered on the
effective date of any post-effective amendment to the Registration
Statement and as of each Time of Delivery is attached as Annex I(b)
hereto);
(e)(i) Neither the Company nor any of its subsidiaries shall
have sustained since the date of the latest audited financial
statements included in the Prospectus any loss or interference with
its business from fire, explosion, flood or other calamity, whether or
not covered by insurance, or from any labor dispute or court or
governmental action, order or decree, otherwise than as set forth or
contemplated in the Prospectus, and (ii) since the respective dates as
of which information is given in the Prospectus there shall not have
been any material change in the capital stock or long-term debt of the
Company or any of its subsidiaries or any change, or any development
involving a prospective change, in or affecting the general affairs,
management, financial position, stockholders' equity or results of
operations of the Company and its subsidiaries, otherwise than as set
forth or contemplated in the Prospectus, the effect of which, in any
such case described in clause (i) or (ii), is in the judgment of the
Representatives so material and adverse as to make it impracticable or
inadvisable to proceed with the public offering or the delivery of the
Shares being delivered at such Time of Delivery on the terms and in
the manner contemplated in the Prospectus;
(f) On or after the date hereof there shall not have occurred
any of the following: (i) a suspension or material limitation in
trading in securities generally on the New York Stock Exchange or on
NASDAQ; (ii) a suspension or material limitation in trading in the
Company's securities on NASDAQ; (iii) a general moratorium on
commercial banking activities declared by either Federal or New York
State authorities; or (iv) the outbreak or escalation of hostilities
involving the United States or the declaration by the United States of
a national emergency or war, if the effect of any such event specified
in this clause (iv) in the judgment of the Representatives makes it
impracticable or inadvisable to proceed with the public offering or
the delivery of the Shares being delivered at such Time of Delivery on
the terms and in the manner contemplated in the Prospectus;
(g) The Shares to be sold at such Time of Delivery shall have
been duly listed for quotation on NASDAQ;
13
<PAGE>
(h) The Company has obtained and delivered to the Underwriters
executed copies of an agreement from each director, officer,
stockholder and optionholder of the Company (except for those listed
on Annex III hereto), in form and substance satisfactory to you, to
the effect that, during the period beginning from the date hereof and
continuing to and including the date 180 days after the date of the
Prospectus, such person will not sell, offer to sell, contract to
sell, grant any option or warrant for the sale or purchase of, or
otherwise dispose of, any shares of Stock or any securities of the
Company that are substantially similar to the Shares, including but
not limited to any securities that are convertible into or
exchangeable for, or that represent the right to receive, Stock or any
such substantially similar securities (other than transfers as bona
fide gifts or to any trust for the direct or indirect benefit of the
holder or his immediate family, or upon the conversion or exchange of
convertible or exchangeable securities outstanding as of, the date of
this Agreement), without the prior written consent of Goldman, Sachs &
Co.;
(i) The Company shall have complied with the provisions of
Section 5(c) hereof with respect to the furnishing of prospectuses on
the New York Business Day next succeeding the date of this Agreement;
and
(j) The Company shall have furnished or caused to be furnished
to you at such Time of Delivery certificates of officers of the
Company satisfactory to you as to the accuracy of the representations
and warranties of the Company herein at and as of such Time of
Delivery, as to the performance by the Company of all of its
obligations hereunder to be performed at or prior to such Time of
Delivery, and as to such other matters as you may reasonably request,
and the Company shall have furnished or caused to be furnished
certificates as to the matters set forth in subsections (a) and (e) of
this Section.
8. (a) The Company will indemnify and hold harmless each Underwriter against any
losses, claims, damages or liabilities, joint or several, to which such
Underwriter may become subject, under the Act or otherwise, insofar as such
losses, claims, damages or liabilities (or actions in respect thereof) arise out
of or are based upon an untrue statement or alleged untrue statement of a
material fact contained in any Preliminary Prospectus, the Registration
Statement or the Prospectus, or any amendment or supplement thereto, or arise
out of or are based upon the omission or alleged omission to state therein a
material fact required to be stated therein or necessary to make the statements
therein not misleading, and will reimburse each Underwriter for any legal or
other expenses reasonably incurred by such Underwriter in connection with
investigating or defending any such action or claim as such expenses are
incurred; provided, however, that the Company shall not be liable in any such
case to the extent that any such loss, claim, damage or liability arises out of
or is based upon an untrue statement or alleged untrue statement or omission or
alleged omission made in any Preliminary Prospectus, the Registration Statement
or the Prospectus or any such amendment or supplement in reliance upon and in
conformity with written information furnished to the Company by any Underwriter
through Goldman, Sachs & Co. expressly for use therein.
(b) Each Underwriter will indemnify and hold harmless the Company against any
losses, claims, damages or liabilities to which the Company may become subject,
under the Act or otherwise, insofar as such losses, claims, damages or
liabilities (or actions in respect thereof) arise out of or are based upon an
untrue statement or alleged untrue statement of a material
14
<PAGE>
fact contained in any Preliminary Prospectus, the Registration Statement or the
Prospectus, or any amendment or supplement thereto, or arise out of or are based
upon the omission or alleged omission to state therein a material fact required
to be stated therein or necessary to make the statements therein not misleading,
in each case to the extent, but only to the extent, that such untrue statement
or alleged untrue statement or omission or alleged omission was made in any
Preliminary Prospectus, the Registration Statement or the Prospectus or any such
amendment or supplement in reliance upon and in conformity with written
information furnished to the Company by such Underwriter through Goldman, Sachs
& Co. expressly for use therein; and will reimburse the Company for any legal or
other expenses reasonably incurred by the Company in connection with
investigating or defending any such action or claim as such expenses are
incurred.
(c) Promptly after receipt by an indemnified party under subsection (a) or (b)
above of notice of the commencement of any action, such indemnified party shall,
if a claim in respect thereof is to be made against the indemnifying party under
such subsection, notify the indemnifying party in writing of the commencement
thereof; but the omission so to notify the indemnifying party shall not relieve
it from any liability which it may have to any indemnified party otherwise than
under such subsection. In case any such action shall be brought against any
indemnified party and it shall notify the indemnifying party of the commencement
thereof, the indemnifying party shall be entitled to participate therein and, to
the extent that it shall wish, jointly with any other indemnifying party
similarly notified, to assume the defense thereof, with counsel satisfactory to
such indemnified party (who shall not, except with the consent of the
indemnified party, be counsel to the indemnifying party), and, after notice from
the indemnifying party to such indemnified party of its election so to assume
the defense thereof, the indemnifying party shall not be liable to such
indemnified party under such subsection for any legal expenses of other counsel
or any other expenses, in each case subsequently incurred by such indemnified
party, in connection with the defense thereof other than reasonable costs of
investigation. No indemnifying party shall, without the written consent of the
indemnified party, effect the settlement or compromise of, or consent to the
entry of any judgment with respect to, any pending or threatened action or claim
in respect of which indemnification or contribution may be sought hereunder
(whether or not the indemnified party is an actual or potential party to such
action or claim) unless such settlement, compromise or judgment (i) includes an
unconditional release of the indemnified party from all liability arising out of
such action or claim and (ii) does not include a statement as to or an admission
of fault, culpability or a failure to act, by or on behalf of any indemnified
party.
(d) If the indemnification provided for in this Section 8 is unavailable to or
insufficient to hold harmless an indemnified party under subsection (a) or (b)
above in respect of any losses, claims, damages or liabilities (or actions in
respect thereof) referred to therein, then each indemnifying party shall
contribute to the amount paid or payable by such indemnified party as a result
of such losses, claims, damages or liabilities (or actions in respect thereof)
in such proportion as is appropriate to reflect the relative benefits received
by the Company on the one hand and the Underwriters on the other from the
offering of the Shares. If, however, the allocation provided by the immediately
preceding sentence is not permitted by applicable law or if the indemnified
party failed to give the notice required under subsection (c) above, then each
indemnifying party shall contribute to such amount paid or payable by such
indemnified party in such proportion as is appropriate to reflect not only such
relative benefits but also the relative fault of the Company on the one hand and
the Underwriters on the other in connection with the statements or omissions
which resulted in such losses, claims, damages or liabilities (or actions in
respect thereof), as well as any other relevant equitable considerations. The
relative benefits
15
<PAGE>
received by the Company on the one hand and the Underwriters on the other shall
be deemed to be in the same proportion as the total net proceeds from the
offering (before deducting expenses) received by the Company bear to the total
underwriting discounts received by the Underwriters, in each case as set forth
in the table on the cover page of the Prospectus. The relative fault shall be
determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission or alleged omission to state
a material fact relates to information supplied by the Company on the one hand
or the Underwriters on the other and the parties' relative intent, knowledge,
access to information and opportunity to correct or prevent such statement or
omission. The Company and the Underwriters agree that it would not be just and
equitable if contributions pursuant to this subsection (d) were determined by
pro rata allocation (even if the Underwriters were treated as one entity for
such purpose) or by any other method of allocation which does not take account
of the equitable considerations referred to above in this subsection (d). The
amount paid or payable by an indemnified party as a result of the losses,
claims, damages or liabilities (or actions in respect thereof) referred to above
in this subsection (d) shall be deemed to include any legal or other expenses
reasonably incurred by such indemnified party in connection with investigating
or defending any such action or claim. Notwithstanding the provisions of this
subsection (d), no Underwriter shall be required to contribute any amount in
excess of the amount by which the total price at which the Shares underwritten
by it and distributed to the public were offered to the public exceeds the
amount of any damages which such Underwriter has otherwise been required to pay
by reason of such untrue or alleged untrue statement or omission or alleged
omission. No person guilty of fraudulent misrepresentation (within the meaning
of Section 11(f) of the Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation. The Underwriters'
obligations in this subsection (d) to contribute are several in proportion to
their respective underwriting obligations and not joint.
(e) The obligations of the Company under this Section 8 shall be in addition to
any liability which the Company may otherwise have and shall extend, upon the
same terms and conditions, to each person, if any, who controls any Underwriter
within the meaning of the Act; and the obligations of the Underwriters under
this Section 8 shall be in addition to any liability which the respective
Underwriters may otherwise have and shall extend, upon the same terms and
conditions, to each officer and director of the Company (including any person
who, with his or her consent, is named in the Registration Statement as about to
become a director of the Company) and to each person, if any, who controls the
Company within the meaning of the Act.
9. (a) If any Underwriter shall default in its obligation to purchase the Shares
which it has agreed to purchase hereunder at a Time of Delivery, you may in your
discretion arrange for you or another party or other parties to purchase such
Shares on the terms contained herein. If within thirty-six hours after such
default by any Underwriter you do not arrange for the purchase of such Shares,
then the Company shall be entitled to a further period of thirty-six hours
within which to procure another party or other parties satisfactory to you to
purchase such Shares on such terms. In the event that, within the respective
prescribed periods, you notify the Company that you have so arranged for the
purchase of such Shares, or the Company notifies you that it has so arranged for
the purchase of such Shares, you or the Company shall have the right to postpone
such Time of Delivery for a period of not more than seven days, in order to
effect whatever changes may thereby be made necessary in the Registration
Statement or the Prospectus, or in any other documents or arrangements, and the
Company agrees to file promptly any amendments to the Registration Statement or
the Prospectus which in your opinion may thereby be made necessary. The term
"Underwriter" as used in this Agreement
16
<PAGE>
shall include any person substituted under this Section with like effect as if
such person had originally been a party to this Agreement with respect to such
Shares.
(b) If, after giving effect to any arrangements for the purchase of the Shares
of a defaulting Underwriter or Underwriters by you and the Company as provided
in subsection (a) above, the aggregate number of such Shares which remains
unpurchased does not exceed one-eleventh of the aggregate number of all the
Shares to be purchased at such Time of Delivery, then the Company shall have the
right to require each non-defaulting Underwriter to purchase the number of
Shares which such Underwriter agreed to purchase hereunder at such Time of
Delivery and, in addition, to require each non-defaulting Underwriter to
purchase its pro rata share (based on the number of Shares which such
Underwriter agreed to purchase hereunder) of the Shares of such defaulting
Underwriter or Underwriters for which such arrangements have not been made; but
nothing herein shall relieve a defaulting Underwriter from liability for its
default.
(c) If, after giving effect to any arrangements for the purchase of the Shares
of a defaulting Underwriter or Underwriters by you and the Company as provided
in subsection (a) above, the aggregate number of such Shares which remains
unpurchased exceeds one-eleventh of the aggregate number of all of the Shares to
be purchased at such Time of Delivery, or if the Company shall not exercise the
right described in subsection (b) above to require non-defaulting Underwriters
to purchase Shares of a defaulting Underwriter or Underwriters, then this
Agreement (or, with respect to the Second Time of Delivery, the obligations of
the Underwriters to purchase and of the Company to sell the Optional Shares)
shall thereupon terminate, without liability on the part of any non-defaulting
Underwriter or the Company, except for the expenses to be borne by the Company
and the Underwriters as provided in Section 6 hereof and the indemnity and
contribution agreements in Section 8 hereof; but nothing herein shall relieve a
defaulting Underwriter from liability for its default.
10. The respective indemnities, agreements, representations, warranties and
other statements of the Company and the several Underwriters, as set forth in
this Agreement or made by or on behalf of them, respectively, pursuant to this
Agreement, shall remain in full force and effect, regardless of any
investigation (or any statement as to the results thereof) made by or on behalf
of any Underwriter or any controlling person of any Underwriter, or the Company,
or any officer or director or controlling person of the Company, and shall
survive delivery of and payment for the Shares.
11. If this Agreement shall be terminated pursuant to Section 9 hereof, the
Company shall then be under no liability to any Underwriter except as provided
in Sections 6 and 8 hereof; but, if for any other reason any Shares are not
delivered by or on behalf of the Company as provided herein, the Company will
reimburse the Underwriters through you for all out-of-pocket expenses approved
in writing by you, including fees and disbursements of counsel, reasonably
incurred by the Underwriters in making preparations for the purchase, sale and
delivery of the Shares not so delivered, but the Company shall then be under no
further liability to any Underwriter in respect of the Shares not so delivered
except as provided in Sections 6 and 8 hereof.
12. In all dealings hereunder, you shall act on behalf of each of the
Underwriters, and the parties hereto shall be entitled to act and rely upon any
statement, request, notice or agreement on behalf of any Underwriter made or
given by you jointly or by Goldman, Sachs & Co. on behalf of you as the
Representatives.
17
<PAGE>
All statements, requests, notices and agreements hereunder shall be in writing,
and if to the Underwriters shall be delivered or sent by mail, telex or
facsimile transmission to you as the representatives in care of Goldman, Sachs &
Co., 32 Old Slip, 21st Floor, New York, New York 10005, Attention: Registration
Department; and if to the Company shall be delivered or sent by mail, telex or
facsimile transmission to the address of the Company set forth in the
Registration Statement, Attention: Secretary; provided, however, that any notice
to an Underwriter pursuant to Section 8(c) hereof shall be delivered or sent by
mail, telex or facsimile transmission to such Underwriter at its address set
forth in its Underwriters' Questionnaire or telex constituting such
Questionnaire, which address will be supplied to the Company by you on request.
Any such statements, requests, notices or agreements shall take effect upon
receipt thereof.
13. This Agreement shall be binding upon, and inure solely to the benefit of,
the Underwriters and the Company and, to the extent provided in Sections 8 and
10 hereof, the officers and directors of the Company and each person who
controls the Company or any Underwriter, and their respective heirs, executors,
administrators, successors and assigns, and no other person shall acquire or
have any right under or by virtue of this Agreement. No purchaser of any of the
Shares from any Underwriter shall be deemed a successor or assign by reason
merely of such purchase.
14. Time shall be of the essence of this Agreement. As used herein, the term
"business day" shall mean any day when the Commission's office in Washington,
D.C. is open for business.
15. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE
LAWS OF THE STATE OF NEW YORK.
16. This Agreement may be executed by any one or more of the parties hereto in
any number of counterparts, each of which shall be deemed to be an original, but
all such counterparts shall together constitute one and the same instrument.
If the foregoing is in accordance with your understanding, please sign and
return to us one for the Company and each of the Representatives plus one for
each counsel counterparts hereof, and upon the acceptance hereof by you, on
behalf of each of the Underwriters, this letter and such acceptance hereof shall
constitute a binding agreement among each of the Underwriters and the Company.
It is understood that your acceptance of this letter on behalf of each of the
Underwriters is pursuant to the authority set forth in a form of Agreement among
Underwriters, the form of which shall be submitted to the Company for
examination, upon request, but without warranty on your part as to the authority
of the signers thereof.
Very truly yours,
Red Hat, Inc.
By:
--------------------------------------
Name:Robert F. Young
Title: Chief Executive Officer
Accepted as of the date hereof
18
<PAGE>
Goldman, Sachs & Co.
Thomas Weisel Partners LLC
Hambrecht & Quist LLC
E*TRADE Securities, Inc.
By:
-------------------------
(Goldman, Sachs & Co.)
On behalf of each of the Underwriters
SCHEDULE I
<TABLE>
<CAPTION>
NUMBER OF OPTIONAL
SHARES TO BE PURCHASED
TOTAL NUMBER OF FIRM IF MAXIMUM OPTION
SHARES TO BE PURCHASED EXERCISED
UNDERWRITER
-----------
<S> <C> <C>
Goldman, Sachs & Co.
Thomas Weisel Partners LLC
Hambrecht & Quist LLC
E*TRADE Securities, Inc..
</TABLE>
19
<PAGE>
ANNEX I
Pursuant to Section 7(d) of the Underwriting Agreement, the accountants
shall furnish letters to the Underwriters to the effect that:
(i) They are independent certified public accountants with
respect to the Company and its subsidiaries within the meaning of the
Act and the applicable published rules and regulations thereunder;
(ii) In their opinion, the financial statements and any
supplementary financial information and schedules (and, if applicable,
financial forecasts and/or pro forma financial information) examined by
them and included in the Prospectus or the Registration Statement
comply as to form in all material respects with the applicable
accounting requirements of the Act and the related published rules and
regulations thereunder; and, if applicable, they have made a review in
accordance with standards established by the American Institute of
Certified Public Accountants of the unaudited consolidated interim
financial statements, selected financial data, pro forma financial
information, financial forecasts and/or condensed financial statements
derived from audited financial statements of the Company for the
periods specified in such letter, as indicated in their reports
thereon, copies of which have been separately furnished to the
representatives of the Underwriters (the "Representatives");
(iii) They have made a review in accordance with standards
established by the American Institute of Certified Public Accountants
of the unaudited condensed consolidated statements of income,
consolidated balance sheets and consolidated statements of cash flows
included in the Prospectus as indicated in their reports thereon copies
of which have been separately furnished to the Representatives and on
the basis of specified procedures including inquiries of officials of
the Company who have responsibility for financial and accounting
matters regarding whether the unaudited condensed consolidated
financial statements referred to in paragraph (vi)(A)(i) below comply
as to form in all material respects with the applicable accounting
requirements of the Act and the related published rules and
regulations, nothing came to their attention that caused them to
believe that the unaudited condensed consolidated financial statements
do not comply as to form in all material respects with the applicable
accounting requirements of the Act and the related published rules and
regulations;
(iv) The unaudited selected financial information with respect
to the consolidated results of operations and financial position of the
Company for the five most recent fiscal years included in the
Prospectus agrees with the corresponding amounts (after restatements
where applicable) in the audited consolidated financial statements for
such five fiscal years which were included in the Prospectus;
(v) They have compared the information in the Prospectus under
selected captions with the disclosure requirements of Regulation S-K
and on the basis of limited procedures specified in such letter nothing
came to their attention as a result of the foregoing procedures that
caused them to believe that this information does not conform
20
<PAGE>
in all material respects with the disclosure requirements of Items
301, 302, 402 and 503(d), respectively, of Regulation S-K;
(vi) On the basis of limited procedures, not constituting an
examination in accordance with generally accepted auditing standards,
consisting of a reading of the unaudited financial statements and other
information referred to below, a reading of the latest available
interim financial statements of the Company and its subsidiaries,
inspection of the minute books of the Company and its subsidiaries
since the date of the latest audited financial statements included in
the Prospectus, inquiries of officials of the Company and its
subsidiaries responsible for financial and accounting matters and such
other inquiries and procedures as may be specified in such letter,
nothing came to their attention that caused them to believe that:
(A) (i) the unaudited consolidated statements of
income, consolidated balance sheets and consolidated
statements of cash flows included in the Prospectus do not
comply as to form in all material respects with the applicable
accounting requirements of the Act and the related published
rules and regulations, or (ii) any material modifications
should be made to the unaudited condensed consolidated
statements of income, consolidated balance sheets and
consolidated statements of cash flows included in the
Prospectus for them to be in conformity with generally
accepted accounting principles;
(B) any other unaudited income statement data and
balance sheet items included in the Prospectus do not agree
with the corresponding items in the unaudited consolidated
financial statements from which such data and items were
derived, and any such unaudited data and items were not
determined on a basis substantially consistent with the basis
for the corresponding amounts in the audited consolidated
financial statements included in the Prospectus;
(C) the unaudited financial statements which were not
included in the Prospectus but from which were derived any
unaudited condensed financial statements referred to in clause
(A) and any unaudited income statement data and balance sheet
items included in the Prospectus and referred to in clause (B)
were not determined on a basis substantially consistent with
the basis for the audited consolidated financial statements
included in the Prospectus;
(D) any unaudited pro forma consolidated condensed
financial statements included in the Prospectus do not comply
as to form in all material respects with the applicable
accounting requirements of the Act and the published rules and
regulations thereunder or the pro forma adjustments have not
been properly applied to the historical amounts in the
compilation of those statements;
(E) as of a specified date not more than five days
prior to the date of such letter, there have been any changes
in the consolidated capital stock (other than issuances of
capital stock upon exercise of options and stock appreciation
rights, upon earn-outs of performance shares and upon
conversions of convertible securities, in each case which were
outstanding on the date of the latest financial statements
included in the Prospectus) or any increase in the
consolidated long-term debt of the Company and its
subsidiaries, or any
21
<PAGE>
decreases in consolidated net current assets or
stockholders' equity or other items specified by the
Representatives, or any increases in any items specified by
the Representatives, in each case as compared with amounts
shown in the latest balance sheet included in the
Prospectus, except in each case for changes, increases or
decreases which the Prospectus discloses have occurred or
may occur or which are described in such letter; and
(F) for the period from the date of the latest
financial statements included in the Prospectus to the
specified date referred to in clause (E) there were any
decreases in consolidated net revenues or operating profit or
the total or per share amounts of consolidated net income or
other items specified by the Representatives, or any increases
in any items specified by the Representatives, in each case as
compared with the comparable period of the preceding year and
with any other period of corresponding length specified by the
Representatives, except in each case for decreases or
increases which the Prospectus discloses have occurred or may
occur or which are described in such letter; and
(vii) In addition to the examination referred to in their
report included in the Prospectus and the limited procedures,
inspection of minute books, inquiries and other procedures referred to
in paragraphs (iii) and (vi) above, they have carried out certain
specified procedures, not constituting an examination in accordance
with generally accepted auditing standards, with respect to certain
amounts, percentages and financial information specified by the
Representatives, which are derived from the general accounting records
of the Company and its subsidiaries, which appear in the Prospectus, or
in Part II of, or in exhibits and schedules to, the Registration
Statement specified by the Representatives, and have compared certain
of such amounts, percentages and financial information with the
accounting records of the Company and its subsidiaries and have found
them to be in agreement.
22
<PAGE>
Exhibit 3.3
CERTIFICATE OF AMENDMENT
OF
THIRD AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
RED HAT, INC.
Red Hat, Inc. (the "Corporation"), a corporation organized and existing
under and by virtue of the General Corporation Law of the State of Delaware,
does hereby certify as follows:
FIRST: That the Board of Directors of the Corporation, by unanimous
written consent, duly adopted resolutions setting forth a proposed amendment
to the Corporation's Third Amended and Restated Certificate of Incorporation,
declaring said amendment to be advisable and directing consideration thereof by
the stockholders of the Corporation. The resolutions setting forth the proposed
amendment are as follows:
RESOLVED: That, subject to stockholder approval, Article FOURTH of
the Corporation's Third Amended and Restated Certificate
of Incorporation, be amended and restated and shall read
in its entirety as set forth on Exhibit A attached
hereto.
SECOND: The Board of Directors of the Corporation directed that such
amendment be submitted to the stockholders of the Corporation for their consent
and approval and, in lieu of a meeting and vote of stockholders, the
stockholders having not less than the minimum number of votes that is necessary
to consent to this amendment have given written consent to said amendment in
accordance with the provisions of Section 228 of the DGCL.
THIRD: That said amendment was duly adopted in accordance with the
provisions of Sections 242 and 228 of the DGCL.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
-2-
IN WITNESS WHEREOF, the undersigned has executed, signed and
acknowledged this Certificate of Amendment this __ day of ____, 1999.
RED HAT, INC.
By:__________________________________
Name: Robert F. Young
Title: Chief Executive Officer
[SEAL]
Attest:
By:_________________________
David Shumannfang
Secretary
<PAGE>
-3-
EXHIBIT A
"FOURTH. The total number of shares of all classes of capital stock which the
Corporation shall have authority to issue is 230,000,000 shares, consisting of
225,000,000 shares of Common Stock with a par value of $.0001 per share (the
"Common Stock") and 5,000,000 shares of Preferred Stock with a par value of
$.0001 per share (the "Preferred Stock").
A description of the respective classes of stock and a statement of the
designations, powers, preferences and rights, and the qualifications,
limitations and restrictions of the Preferred Stock and Common Stock are as
follows:
A. COMMON STOCK
1. GENERAL. All shares of Common Stock will be identical and will
entitle the holders thereof to the same rights, powers and privileges. The
rights, powers and privileges of the holders of the Common Stock are subject to
and qualified by the rights of holders of the Preferred Stock.
2. DIVIDENDS. Dividends may be declared and paid on the Common Stock
from funds lawfully available therefor as and when determined by the Board of
Directors and subject to any preferential dividend rights of any then
outstanding Preferred Stock.
3. DISSOLUTION, LIQUIDATION OR WINDING UP. In the event of any
dissolution, liquidation or winding up of the affairs of the Corporation,
whether voluntary or involuntary, each issued and outstanding share of Common
Stock shall entitle the holder thereof to receive an equal portion of the net
assets of the Corporation available for distribution to the holders of Common
Stock, subject to any preferential rights of any then outstanding Preferred
Stock.
4. VOTING RIGHTS. Except as otherwise required by law or this Third
Amended and Restated Certificate of Incorporation, each holder of Common Stock
shall have one vote in respect of each share of stock held of record by such
holder on the books of the Corporation for the election of directors and on all
matters submitted to a vote of stockholders of the Corporation. Except as
otherwise required by law or provided herein, holders of Common Stock shall vote
together with holders of the Preferred Stock as a single class, subject to any
special or preferential voting rights of any then outstanding Preferred Stock.
There shall be no cumulative voting.
<PAGE>
-4-
B. PREFERRED STOCK
The Preferred Stock may be issued in one or more series at such time or
times and for such consideration or considerations as the Board of Directors of
the Corporation may determine. Each series shall be so designated as to
distinguish the shares thereof from the shares of all other series and classes.
Except as otherwise provided in this Third Amended and Restated Certificate of
Incorporation, different series of Preferred Stock shall not be construed to
constitute different classes of shares for the purpose of voting by classes.
The Board of Directors is expressly authorized to provide for the
issuance of all or any shares of the undesignated Preferred Stock in one or more
series, each with such designations, preferences, voting powers (or special,
preferential or no voting powers), relative, participating, optional or other
special rights and privileges and such qualifications, limitations or
restrictions thereof as shall be stated in the resolution or resolutions adopted
by the Board of Directors to create such series, and a certificate of said
resolution or resolutions (a "Certificate of Designation") shall be filed in
accordance with the General Corporation Law of the State of Delaware. The
authority of the Board of Directors with respect to each such series shall
include, without limitation of the foregoing, the right to provide that the
shares of each such series may be: (i) subject to redemption at such time or
times and at such price or prices; (ii) entitled to receive dividends (which may
be cumulative or non-cumulative) at such rates, on such conditions, and at such
times, and payable in preference to, or in such relation to, the dividends
payable on any other class or classes or any other series; (iii) entitled to
such rights upon the dissolution of, or upon any distribution of the assets of,
the Corporation; (iv) convertible into, or exchangeable for, shares of any other
class or classes of stock, or of any other series of the same or any other class
or classes of stock of the Corporation at such price or prices or at such rates
of exchange and with such adjustments, if any; (v) entitled to the benefit of
such limitations, if any, on the issuance of additional shares of such series or
shares of any other series of Preferred Stock; or (vi) entitled to such other
preferences, powers, qualifications, rights and privileges, all as the Board of
Directors may deem advisable and as are not inconsistent with law and the
provisions of this Third Amended and Restated Certificate of Incorporation."
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in this Registration Statement on Form S-1 of
our report dated April 30, 1999, relating to the financial statements of Red
Hat, Inc., which appears in such Registration Statement. We also consent to the
references to us under the headings "Experts" and "Selected Financial Data" in
such Registration Statement.
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
July 15, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM OUR
FINANCIAL STATEMENTS AS OF AND FOR THE FISCAL YEARS ENDED FEBRUARY 28, 1996,
FEBRUARY 28, 1997, FEBRUARY 28, 1998 AND FEBRUARY 28, 1999 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO THE NOTES TO OUR FINANCIAL STATEMENTS INCLUDED IN
OUR REGISTRATION STATEMENT ON FORM S-1.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR YEAR YEAR
<FISCAL-YEAR-END> FEB-28-1995 FEB-28-1996 FEB-28-1997 FEB-28-1998 FEB-28-1999
<PERIOD-END> FEB-28-1995 FEB-28-1996 FEB-28-1997 FEB-28-1998 FEB-28-1999
<CASH> 0 0 0 1,293 10,055
<SECURITIES> 0 0 0 150 2,038
<RECEIVABLES> 64 90 342 794 1,287
<ALLOWANCES> 0 0 38 49 160
<INVENTORY> 20 42 57 141 346
<CURRENT-ASSETS> 84 133 373 2,662 13,854
<PP&E> 28 57 281 490 1,617
<DEPRECIATION> 6 26 55 153 346
<TOTAL-ASSETS> 106 245 670 3,131 15,276
<CURRENT-LIABILITIES> 148 0 0 1,121 2,753
<BONDS> 0 30 145 65 420
0 0 0 1,983 12,107
0 0 0 0 0
<COMMON> 1 1 1 2 2
<OTHER-SE> (43) (80) (47) (40) (7)
<TOTAL-LIABILITY-AND-EQUITY> 106 245 670 3,131 15,276
<SALES> 482 930 2,603 5,132 10,013
<TOTAL-REVENUES> 482 930 2,603 5,156 10,790
<CGS> 352 432 1,205 2,211 4,013
<TOTAL-COSTS> 485 673 1,696 3,463 7,124
<OTHER-EXPENSES> 123 390 851 1,702 3,704
<LOSS-PROVISION> 0 0 39 38 185
<INTEREST-EXPENSE> 1 22 23 13 9
<INCOME-PRETAX> (128) (155) 33 13 124
<INCOME-TAX> 0 0 0 5 215
<INCOME-CONTINUING> (128) (155) 33 8 (91)
<DISCONTINUED> 0 0 0 0 0
<EXTRAORDINARY> 0 0 0 0 0
<CHANGES> 0 0 0 0 0
<NET-INCOME> (128) (155) 33 8 (91)
<EPS-BASIC> (.011) (.007) .001 .00 (.001)
<EPS-DILUTED> (.011) (.007) .001 .00 (.001)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM OUR
FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTHS ENDED MAY 31,1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE NOTES TO OUR FINANCIAL STATEMENTS
INCLUDED IN OUR REGISTRATION STATEMENT ON FORM S-1.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> FEB-29-2000
<PERIOD-END> MAY-31-1999
<CASH> 13,982
<SECURITIES> 1,024
<RECEIVABLES> 3,462
<ALLOWANCES> 141
<INVENTORY> 1,074
<CURRENT-ASSETS> 19,852
<PP&E> 2,208
<DEPRECIATION> 410
<TOTAL-ASSETS> 22,162
<CURRENT-LIABILITIES> 6,635
<BONDS> 385
15,339
0
<COMMON> 3
<OTHER-SE> (199)
<TOTAL-LIABILITY-AND-EQUITY> 22,162
<SALES> 1,936
<TOTAL-REVENUES> 2,797
<CGS> 1,181
<TOTAL-COSTS> 3,376
<OTHER-EXPENSES> 1,578
<LOSS-PROVISION> 19
<INTEREST-EXPENSE> 10
<INCOME-PRETAX> (2,017)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,017)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,017)
<EPS-BASIC> .085
<EPS-DILUTED> .085
</TABLE>
