<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of report (Date of earliest event reported): JANUARY 6, 2000
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RED HAT, INC.
--------------------------------------------------
(Exact Name of Registrant as Specified in Charter)
DELAWARE 000-26281 06-1364380
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(State or Other Jurisdiction (Commission (I.R.S. Employer
of Incorporation) File Number) Identification No.)
2600 MERIDIAN PARKWAY
DURHAM, NORTH CAROLINA 27713
---------------------- -----
(Address of Principal (Zip Code)
Executive Offices)
Registrant's telephone number, including area code: 919-547-0012
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<PAGE>
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ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS.
HELL'S KITCHEN SYSTEMS, INC.
On January 6, 2000, Red Hat, Inc. ("Red Hat") completed its acquisition of
all of the capital stock of Hell's Kitchen Systems, Inc., a Pennsylvania
corporation ("HKS"), by means of a merger (the "HKS Merger") of HKS Acquisition
Corp., a Pennsylvania corporation and wholly owned subsidiary of Red Hat ("HKS
Merger Sub"), with and into HKS, pursuant to the Agreement and Plan of Merger
dated as of January 4, 2000 (the "HKS Merger Agreement") by and among Red Hat,
HKS Merger Sub, HKS and the majority shareholders of HKS. As a result of the HKS
Merger, HKS became a wholly owned subsidiary of Red Hat and will continue to
operate as a wholly-owned subsidiary of Red Hat. The HKS Merger was effected by
the filing of a Certificate of Merger with the Secretary of State of
Pennsylvania on January 6, 2000.
HKS is a leading developer of Linux- and UNIX-based credit card processing
software that reduces the cost and effort involved in delivering payment
processing of any type, through any channel, to any number of merchants in
support of electronic commerce. HKS embeds payment processing in applications
that support single stand-alone merchants or large-scale merchant hosts.
Pursuant to the terms of the HKS Merger Agreement, upon the effective time
of the HKS Merger, each outstanding share of common stock of HKS was converted
into the right to receive 0.3316512 shares of Red Hat common stock and the
contingent right to receive an additional 0.221103 shares of Red Hat common
stock. The former shareholders of HKS did not (and will not) receive any
fractional shares of Red Hat common stock, but have received (and will, to the
extent they become entitled to any contingent consideration, receive) the
aggregate number of shares of Red Hat common stock that they were (and may be)
entitled to receive, rounded to the nearest whole share. As a result of the HKS
Merger, Red Hat issued an aggregate of 478,004 shares of Red Hat common stock to
former HKS shareholders upon the closing of the transaction. In addition, over a
three-year period following the closing of the HKS Merger, Red Hat is committed
to issue up to an additional 318,666 shares of Red Hat common stock on a pro
rata basis (1) to former HKS shareholders who were employed by HKS or Red Hat
prior to the closing and remain employed by HKS or Red Hat on a full time basis
for a period of three years thereafter and (2) to all former HKS shareholders
(whether or not employed by HKS or Red Hat) based upon the achievement by the
HKS business of designated performance targets over a period of three years.
In accordance with the terms of the HKS Merger Agreement and an Escrow
Agreement dated January 6, 2000 by and among Red Hat and Lawrence J. Weidman (as
Shareholder Representative) (the "HKS Escrow Agreement"), 47,801 of the shares
of Red Hat common stock that were issued at closing have been placed in an
escrow account for a period of 18 months to secure certain indemnification
obligations of the majority shareholders of HKS under the HKS Merger Agreement.
The shares of Red Hat common stock issued in the HKS Merger were issued in
reliance on the exemption from registration provided by Section 4(2) under the
Securities Act of 1933, as amended (the "Securities Act"). Consequently, all
such shares are subject to restrictions on transfer under the applicable
provisions of the Securities Act and will carry a legend reflecting such
restrictions. Pursuant to the terms of the HKS Merger Agreement and a
Registration Rights Agreement dated January 6, 2000 between Red Hat and the
former HKS shareholders listed
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therein (the "Registration Rights Agreement"), Red Hat has granted such
shareholders certain rights to require Red Hat to register under the
Securities Act the shares of Red Hat common stock received by them in
connection with the HKS Merger. In addition, each of the former HKS
shareholders has executed a lock-up agreement with Red Hat, whereby each such
shareholder agreed that he, she or it would not, without the prior written
consent of Red Hat, sell transfer or otherwise dispose of any of his, her or
its shares of Red Hat common stock during the three year period following the
closing of the HKS Merger; provided, however, that these lock-up restrictions
will lapse for each such shareholder as to one-twelfth of the shares held by
him, her or it on each successive April 1, July 1, October 1 and January 1
over the three-year period following closing of the HKS Merger.
The purchase price and terms for the transaction were determined in
arms-length negotiations. The acquisition of HKS is intended to qualify a
tax-free reorganization under Section 368 of the Internal Revenue Code of 1986,
as amended. Red Hat will account for the transaction under the purchase method
of accounting.
The terms of the HKS Merger are more fully described in the HKS Merger
Agreement, the HKS Escrow Agreement and the Registration Rights Agreement.
Copies of the HKS Merger Agreement and the Registration Rights Agreement are
incorporated herein by reference from Exhibits 2.2 and 10.11, respectively, to
Red Hat's Registration Statement on Form S-1 (File No. 333-94775). A copy of the
HKS Escrow Agreement is filed as Exhibit 99.3 hereto and is incorporated herein
by this reference.
CYGNUS SOLUTIONS
On January 7, 2000, Red Hat completed its acquisition of all of the capital
stock of Cygnus Solutions, a California corporation ("Cygnus"), by means of a
merger (the "Cygnus Merger") of Miami Acquisition Corp., a North Carolina
corporation and wholly owned subsidiary of Red Hat ("Cygnus Merger Sub"), with
and into Cygnus, pursuant to the Agreement and Plan of Reorganization dated as
of November 15, 1999 (the "Cygnus Merger Agreement") by and among Red Hat,
Cygnus Merger Sub, Cygnus and Michael Tiemann, as Securityholder Agent. As a
result of the Cygnus Merger, Cygnus became a wholly owned subsidiary of Red Hat
and will continue to operate as a wholly-owned subsidary of Red Hat. The Cygnus
Merger was effected by the filing of Articles of Merger with the Secretary of
State of North Carolina and by the filing of an Agreement of Merger with the
Secretary of State of California on January 7, 2000.
Cygnus is a leading developer and provider of open source development tools
and custom engineering services. Cygnus offers software development platforms
based on an open source model. Cygnus's products and services enable customers
to bring products to market faster at reduced system development costs.
Pursuant to the terms of the Cygnus Merger Agreement, upon the effective
time of the Cygnus Merger, each outstanding share of common stock of Cygnus
was converted into the right to receive 1.5720 shares (the "Applicable
Fraction") of Red Hat common stock (subject to payment of cash in lieu of any
fractional shares). Each holder of Cygnus common stock who is otherwise
entitled to a fraction of a share of Red Hat common stock will receive cash
in lieu thereof, equal to such fraction multiplied by $90.575. As a result of
the Cygnus Merger, upon the closing of the transaction on January 7, 2000,
Red Hat issued an aggregate of 10,867,966 shares of Red Hat common stock (the
"Shares") and approximately $3,320 in cash in lieu of fractional shares of
Red Hat common stock in exchange for all of the outstanding shares of capital
stock of Cygnus. In accordance with the terms of the Cygnus Merger Agreement
and an Escrow Agreement dated <PAGE>
- 4 -
November 15, 1999 by and among Red Hat, Cygnus, Cygnus Merger Sub, First Union
National Bank (as Escrow Agent) and Michael Tiemann (as Securityholder Agent)
(the "Escrow Agreement"), 1,086,797 of the Shares have been placed in an escrow
account for a one-year period to secure certain indemnification obligations of
Cygnus under the Cygnus Merger Agreement. The Shares were issued in reliance on
the exemption from registration provided by Section 3(a)(10) under the
Securities Act. Consequently, all Shares acquired by the former shareholders of
Cygnus who are not affiliates of Red Hat or of Cygnus are freely tradeable under
the Securities Act as of the closing of the Cygnus Merger. In connection with
the Cygnus Merger, however, certain affiliates of Cygnus and of Red Hat have
agreed not to dispose of their Shares until two days after the public
announcement of financial results covering 30 days of combined operations of Red
Hat and Cygnus.
Also, pursuant to the terms of the Cygnus Merger Agreement, upon the
effective time of the Cygnus Merger, Red Hat assumed Cygnus's obligations under
Cygnus's 1995 Stock Plan, 1997 Stock Plan and 1998 Executive Stock Plan, and all
stock options of Cygnus granted pursuant to such plans, whether vested or
unvested, outstanding as of the effective time of the Cygnus Merger. The number
of shares of Red Hat common stock to be issued upon exercise of any such stock
option is determined by multipying the number of shares of Cygnus common stock
underlying such option by the Applicable Fraction (rounded down to the nearest
whole share). The exerise price to be paid upon any such exercise is determined
by dividing the exercise price per share of Cygnus common stock for such option
by the Applicable Fraction (rounded up to the nearest whole cent). Red Hat has
reserved an additional 2,412,737 shares of Red Hat common stock for issuance
upon exercise all such outstanding options.
The purchase price and terms for the transaction were determined in
arms-length negotiations. The acquisition of Cygnus is intended to qualify a
tax-free reorganization under Section 368 of the Internal Revenue Code of 1986,
as amended. Red Hat will account for the transaction under the pooling of
interests method of accounting.
The terms of the Cygnus Merger are more fully described in the Cygnus
Merger Agreement and the Escrow Agreement. Copies of the Cygnus Merger Agreement
and the Escrow Agreement are incorporated herein by reference from Exhibits 2.1
and 10.13, respectively, to Red Hat's Registration Statement on Form S-1 (File
No. 333-94775).
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(a) FINANCIAL STATEMENTS OF BUSINESSES ACQUIRED.
The following historical financial statements of HKS, together with the
report thereon signed by PricewaterhouseCoopers LLP, are included as Exhibit
99.4 to this report and incorporated herein by this reference:
Balance Sheets at December 31, 1998, March 9, 1999 and September 30, 1999
Statements of Operations for the year ended December 31, 1998, the period
from January 1, 1999 to March 9, 1999 and for the period from
March 10, 1999 to September 30, 1999
Statements of Stockholders Equity (Deficit) for the year ended
December 31, 1998, the period from January 1, 1999 to March 9,
1999 and for the period from March 10, 1999 to September 30, 1999
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Statements of Cash Flows for the for the year ended December 31, 1998,
the period from January 1, 1999 to March 9, 1999 and for the period
from March 10, 1999 to September 30, 1999
Notes to Consolidated Financial Statements
The following historical consolidated financial statements of Cygnus as
of and for the years ended June 30, 1999 and 1998, together with the report
thereon signed by PricewaterhouseCoopers LLP, are included as Exhibit 99.5 to
this report and incorporated herein by this reference. The unaudited
historical consolidated financial statements of Cygnus as September 30, 1999
and for the nine month periods ended September 30, 1998 and 1999 are also
included as an exhibit to this report and incorporated herein by this
reference.
Consolidated Balance Sheets at June 30, 1998 and 1999 and September 30,
1999 (unaudited)
Consolidated Statements of Operations for the years ended June 30, 1998 and
1999 and for the three months ended September 30, 1998 and 1999
(unaudited)
Consolidated Statements of Stockholders Equity (Deficit) for the years
ended June 30, 1998 and 1999 and for the three months ended September
30, 1998 and 1999 (unaudited)
Consolidated Statements of Cash Flows for the years ended June 30, 1998 and
1999 and for the three months ended September 30, 1998 and 1999
(unaudited)
Notes to Consolidated Financial Statements
(B) PRO FORMA FINANCIAL INFORMATION.
The following pro forma consolidated financial statements are included as
Exhibit 99.6 to this report and are incorporated herein by this reference:
Supplemental Pooled Pro Forma Consolidated Balance Sheets at November 30,
1999 (unaudited)
Supplemental Pooled Pro Forma Consolidated Statements of Operations for the
year ended February 28, 1999 and the nine months ended November 30,
1999
<PAGE>
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(C) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
<S> <C>
2.1 Agreement and Plan of Reorganization dated November 5,
1999 by and among Red Hat, Cygnus Solutions, Miami
Acquisition Corp. and Michael Tiemann, as Securityholder
Agent (incorporated by reference from Exhibit 2.1 to Red
Hat's Quarterly Report on Form 10-Q for the fiscal
quarter ended November 30, 1999)
2.2 Agreement and Plan of Merger dated January 4, 2000 by
and among Red Hat, HKS Acquisition Corp., Hell's Kitchen
Systems, Inc. and certain shareholders Hell's Kitchen
Systems, Inc. (incorporated by reference from Exhibit
2.2 to Red Hat's Registration Statement on Form S-1
(File No. 333-94775))
99.1 Escrow Agreement dated as of January 7, 2000 by and
among Red Hat, Miami Acquisition Corp., Cygnus
Solutions,, Michael Tiemann, as Securityholder Agent,
and First Union National Bank, as Escrow Agent
(incorporated by reference from Exhibit 10.1 to Red
Hat's Quarterly Report on Form 10-Q for the fiscal
quarter ended November 30, 1999)
99.2 Registration Rights Agreement dated January 6, 2000 by
and among Red Hat and the sellers listed therein
(incorporated by reference from Exhibit 10.11 to Red
Hat's Registration Statement on Form S-1 (File No.
333-94775))
99.3 Escrow Agreement dated as of January 6, 2000 by and
among Red Hat and Lawrence Weidman, as Shareholder
Representative
99.4 Hell's Kitchen Systems Historical Financial
Statements
99.5 Cygnus Solutions Historical Consolidated Financial
Statements
99.6 Red Hat Pro Forma Consolidated Financial Statements
</TABLE>
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this current report on Form 8-K to be signed on its
behalf by the undersigned hereunto duly authorized.
Red Hat, INC.
By: /s/ Matthew J. Szulik
------------------------------
Matthew J. Szulik
President and Chief Executive Officer
Dated: January 21, 2000
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
<S> <C>
2.1 Agreement and Plan of Reorganization dated November 5, 1999 by and
among Red Hat, Cygnus Solutions, Miami Acquisition Corp. and Michael
Tiemann, as Securityholder Agent (incorporated by reference from
Exhibit 2.1 to Red Hat's Quarterly Report on Form 10-Q for the fiscal
quarter ended November 30, 1999)
2.2 Agreement and Plan of Merger dated January 4, 2000 by and among Red
Hat, HKS Acquisition Corp., Hell's Kitchen Systems, Inc. and certain
shareholders Hell's Kitchen Systems, Inc. (incorporated by reference
from Exhibit 2.2 to Red Hat's Registration Statement on Form S-1 (File
No. 333-94775))
99.1 Escrow Agreement dated as of January 7, 2000 by and among Red Hat,
Miami Acquisition Corp., Cygnus Solutions,, Michael Tiemann, as
Securityholder Agent, and First Union National Bank, as Escrow Agent
(incorporated by reference from Exhibit 10.1 to Red Hat's Quarterly
Report on Form 10-Q for the fiscal quarter ended November 30, 1999)
99.2 Registration Rights Agreement dated January 6, 2000 by and among Red
Hat and the sellers listed therein (incorporated by reference from
Exhibit 10.11 to Red Hat's Registration Statement on Form S-1 (File
No. 333-94775))
99.3 Escrow Agreement dated as of January 6, 2000 by and among Red Hat and
Lawrence Weidman, as Shareholder Representative
99.4 Hell's Kitchen Systems Historical Consolidated Financial Statements
99.5 Cygnus Solutions Historical Consolidated Financial Statements
99.6 Red Hat Supplemental Pooled Pro Forma Consolidated Financial
Statements
</TABLE>
<PAGE>
EXHIBIT 99.3
ESCROW AGREEMENT
This Escrow Agreement (the "ESCROW AGREEMENT") is made and entered into
this 6th day of January, 2000, by and among Red Hat, Inc., a Delaware
corporation ("RED HAT"), and the Shareholders whose names are listed on EXHIBIT
A, attached hereto and made a part hereof (each a "SHAREHOLDER" and
collectively, the "SHAREHOLDERS"), by and through Lawrence J. Weidman, as their
representative (the "SHAREHOLDER Representative").
RECITALS
A. Red Hat and Lawrence J. Weidman and L. Todd Masco (the "PRINCIPAL
SHAREHOLDERS") are parties to an Agreement and Plan of Merger, dated January 4,
2000, by and among Red Hat, the Principal Shareholders, HKS Acquisition Co., a
Pennsylvania corporation, and Hell's Kitchen Systems, Inc., a Pennsylvania
corporation ("HKS") (the "MERGER Agreement").
B. Pursuant to the Merger Agreement, the Shareholders have agreed to place
in escrow a certificate representing for 47,801 shares of Parent Stock
(collectively, the "ESCROW SHARES"). The number of Escrow Shares placed into
escrow attributable to each Shareholder is set forth opposite his or her name on
EXHIBIT A.
C. The Shareholders have appointed the Shareholder Representative to act as
their agent and representative in connection with this Agreement and the Escrow
Shares.
D. The Shareholders, acting through the Shareholder Representative, and Red
Hat have agreed that Red Hat shall retain and release the Escrow Shares pursuant
to the terms hereof.
E. Capitalized terms used in this Agreement but not defined herein shall
have the meanings provided in the Merger Agreement.
NOW, THEREFORE, in consideration of the foregoing recitals and the mutual
covenants and agreements hereinafter set forth, the parties hereto agree as
follows:
1. DELIVERY OF ESCROW SHARES. At the Closing, upon the execution hereof by
Red Hat and the Shareholder Representative, Red Hat will retain a certificate
issued in the name of the Shareholder Representative as agent for the
Shareholders evidencing the Escrow Shares, and the Shareholder Representative
will deliver to Red Hat a stock power duly executed in blank substantially in
the form set forth as Exhibit B hereto.
2. RIGHTS IN ESCROW SHARES. Except as provided herein, all legal and
beneficial ownership rights to the Escrow Shares, including, but not limited to,
any right to vote or to receive distributions, shall remain with the Shareholder
Representative, as agent for the Shareholders, during such time as the Escrow
Shares are retained by Red Hat. Shares issuable as a result of stock dividends,
stock splits and other shares issued in respect of the Escrow Shares shall be
issued in the name of the Shareholder Representative, as agent for the
Shareholders, and shall be retained as Escrow Shares pursuant to the terms of
this Agreement. Exhibit A may be revised from time to time to reflect any such
stock dividends, stock splits and other shares issued in respect of the Escrow
Shares.
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3. Release of Holdback Escrow Shares. Red Hat agrees to disburse the Escrow
Shares as follows:
a. SET-OFF SHARES. In the event that
(i) there is no dispute that Red Hat is entitled to indemnification
for any Loss pursuant to Article XI of the Merger Agreement, or
(ii) it is finally determined by arbitration conducted in accordance
with Section 13.12 of the Merger Agreement that Red Hat is entitled to
indemnification for any Loss pursuant to Article XI of the Merger
Agreement,
then Red Hat shall be entitled to retain Escrow Shares having a value
(determined as set forth in Section 3 below) equal to the full amount of
such Loss(es) (the "Set-Off Shares"). Such value and the number of Escrow
Shares corresponding to it shall be attributed to the Shareholders on a pro
rata basis in accordance with the percentage set forth opposite each
Shareholder's name on Exhibit A, rounded up or down to the nearest whole
share (hereinafter their "Pro Rata Share"). Any undisputed entitlement of
Red Hat to indemnification pursuant to Article XI of the Merger Agreement
or any final determination by arbitration in accordance with Section 13.12
of the Merger Agreement that Red Hat is entitled to indemnification
pursuant to Article XI of the Merger Agreement shall be referred to herein
as a "Claim" or, if multiple, "Claims". For purposes of determining the
number of Escrow Shares equivalent to the dollar value of payments to which
Red Hat is entitled under this Agreement, the Escrow Shares shall be valued
at the average of the closing price per share of Parent Stock on the NASDAQ
National Market on the ten (10) trading days immediately preceding the date
on which Red Hat is entitled to retain Escrow Shares pursuant to the
occurrence of one of the events described in paragraph 3(a)(i) or (ii)
above.
b. RELEASE OF ESCROW. Subject to this Paragraph 3(b), on the eighteen
(18) month anniversary of the Closing Date (the "ESCROW RELEASE DATE"), Red
Hat shall release to each Shareholder his or her Pro Rata Share of the
Escrow Shares, less the sum of (i) his or her Pro Rata Share of that number
of Escrow Shares that shall have been used to satisfy any Claims, and (ii)
his or her Pro Rata Share of any Retained Shares (defined below), together
with a corresponding stock power. In the event that there are any Claims
which are unresolved on the Escrow Release Date, Red Hat shall retain in
the escrow account such number of Escrow Shares as, in the reasonable
judgment of Red Hat and the Shareholder Representative, are necessary to
satisfy any such unsatisfied Claim(s) until such Claim(s) has been fully
and finally resolved (the "RETAINED SHARES"). Red Hat and the Shareholder
Representative shall attempt in good faith within thirty (30) calendar days
after the Escrow Release Date (the "RETENTION RESOLUTION PERIOD") to agree
upon the number of Retained Shares necessary to satisfy any such
unsatisfied Claims. If Red Hat and the Shareholder Representative should so
agree, a memorandum setting forth such agreement shall be prepared and
signed by Red Hat and the Shareholder Representative, and Red Hat shall
distribute and/or retain such Escrow Shares in accordance with the terms
thereof. If Red Hat and the Shareholder Representative cannot agree within
the Retention Resolution Period, the number of Retained Shares shall be
determined pursuant to paragraph 3(c) below.
c. ARBITRATION. If Red Hat and the Shareholder Representative cannot
agree within the Retention Resolution Period, the number of Retained Shares
shall be determined by arbitration as set forth in Section 11 below. The
arbitrators shall deliver their decision in writing, which shall include a
calculation of the number of Retained Shares, to Red Hat and the
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Shareholder Representative, and Red Hat shall distribute and/or retain in
the escrow account such Escrow Shares in accordance with the decision of
the arbitrators.
4. TRANSFER OF ESCROW SHARES. Red Hat, upon becoming entitled to any Escrow
Shares in accordance with the terms of this Escrow Agreement and the Merger
Agreement, shall have full legal and beneficial ownership of such Escrow Shares,
and may either cancel such shares, hold them in treasury or reissue them as it
deems appropriate.
5. TERMINATION OF ESCROW. This Escrow Agreement and the escrow account
created hereby shall terminate upon delivery of all of the Escrow Shares
pursuant to the terms of Section 3.
6. AMENDMENT. This Escrow Agreement may be amended, modified or
supplemented but only in writing signed by Red Hat and the Shareholder
Representative.
7. NOTICES. Any notice, request, instruction or other document to be given
hereunder by a party hereto shall be in writing and shall be deemed to have been
given or received: (a) when received if given in person; (b) when sent by telex,
facsimile or other wire transmission to a party at the number listed below for
such party; (c) two (2) Business Days after the day on which the same has been
delivered prepaid to a national courier service or (d) three (3) Business Days
after being deposited in the U.S. mail, certified or registered mail, return
receipt requested, postage prepaid, at or to the following addresses:
If to Red Hat: Red Hat, Inc.
2600 Meridian Parkway
Research Triangle Park, NC 27713
Attention: Counsel
Facsimile: (919) 547-0024
with a copy to: Moore & Van Allen, PLLC
One Hannover Square, Suite 1700
P.O. Box 26507
Raleigh, NC 26507
Attention: Martin H. Brinkley, Esq.
Facsimile: (919) 828-4254
If to the Shareholders: c/o Lawrence J. Weidman
1252 Murray Hill Avenue
Pittsburgh, PA 15217
Facsimile: (412) 521-2994
with a copy to: Thorp Reed & Armstrong, LLP
One Riverfront Center
20 Stanwix Street
Pittsburgh, PA 15222-4895
Attention: Priscilla S. Johnson, Esq.
Facsimile: (412) 394-2555
or to such other address as any party hereto may, from time to time, designate
in writing delivered in a like manner to the other parties hereto.
8. WAIVERS. The failure of a party hereto at any time or times to require
performance of any provision hereof shall in no manner affect its right at a
later time to enforce the same. No waiver by a
<PAGE>
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party of any condition or of any breach of any term, covenant, representation or
warranty contained in this Escrow Agreement shall be effective unless in
writing, and no waiver in any one or more instances shall be deemed to be a
further or continuing waiver of any such condition or breach in other instances
or a waiver of any other condition or breach of any other term, covenant,
representation or warranty.
9. ASSIGNMENT. This Escrow Agreement shall be binding upon and inure to the
benefit of the parties hereto and their respective successors and permitted
assigns; provided that no assignment of any rights or obligations shall be made
by any party without the written consent of the other parties.
10. APPLICABLE LAW. This Escrow Agreement shall be governed by and
construed and enforced in accordance with the internal laws of the State of
North Carolina without giving effect to the principles of conflicts of law
thereof.
11. ARBITRATION. Any dispute, controversy or claim ("Dispute") arising out
of or relating to this Escrow Agreement shall be finally and conclusively
determined in accordance with the arbitration procedures set forth in Section
13.12 of the Merger Agreement.
12. COUNTERPARTS. This Escrow Agreement may be executed in counterparts,
each of which shall be deemed an original, but all of which together shall
constitute one and the same instrument.
<PAGE>
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IN WITNESS WHEREOF, the parties hereto have executed this Escrow Agreement
effective this 6th day of January, 2000.
RED HAT, INC.
By: /s/ Manoj George
------------------------------------
Name: Manoj George
Title: Chief Financial Officer
SHAREHOLDERS REPRESENTATIVE:
/s/ Lawrence J. Weidman
------------------------------------
Lawrence J. Weidman
<PAGE>
EXHIBIT A
ESCROW SHARES
<TABLE>
<CAPTION>
Number of Shares
of Red Hat
Name of Shareholder Common Stock Percentage of Total
- ------------------- ----------------- -------------------
<S> <C> <C>
Lawrence J. Weidman 15,562 32.5567%
L. Todd Masco 14,672 30.6935
Andrew M. Bressen 3,317 6.9383
Barbara Jean Masco Abdul-Malek 4,270 8.9330
Stephen G. Wadlow 17 0.0347
Victoria Landgraf 232 0.4857
Gregory Plesur 580 1.2143
Joshua Bluestein 166 0.3469
Robert Miles 580 1.2142
Regis Donovan 83 0.1735
Maurice Rickard 83 0.1735
Andrew M. Boardman 50 0.1041
John G. Myers 56 0.1180
Neil Masco 33 0.0694
Richard Horn 1,658 3.4691
Eleanor DeJulio 3 0.0069
Robert A. & Mary K. Cumming 50 0.1041
Frank J. DeJulio 663 1.3877
Robert Weidman 298 0.6244
Clifford B. & Rosanne M. Levine 995 2.0815
Maria DiMaria 17 0.0347
Marina LaCagnina 3 0.0069
Douglas DeJulio 2,521 5.2731
R. Joseph Vetter 249 0.5204
Thomas G. Dopirak 99 0.2081
Jonathan L. Coburn 83 0.1735
Thomas N. Canfield 553 1.1564
Cynthia McMillin 133 0.2775
Andrew Plotkin 365 0.7632
Thorp, Reed & Armstrong, LLP 410 0.8569
Totals 47,801 100.0000%
====== ====== =========
</TABLE>
<PAGE>
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EXHIBIT B
STOCK TRANSFER POWER
FOR VALUE RECEIVED, the undersigned, Lawrence J. Weidman, as representative
of the Shareholders (as defined in the Escrow Agreement, dated January ___,
2000, by and between Red Hat, Inc. and Lawrence J. Weidman, as Shareholder
Representative), hereby assigns, transfers and conveys unto RED HAT, INC.
[_______] shares of common stock, without par value, of RED HAT, INC., a
Delaware corporation (the "COMPANY"), consisting of [_______] shares represented
by Certificate No. [_______] of the Company registered in the name of the
undersigned on the books of said Company, and does hereby irrevocably constitute
and appoint _________________ attorney to transfer the foregoing on the books of
the Company, with full power of substitution in the premises, hereby ratifying
and confirming all that said attorney shall lawfully do by virtue hereof.
Dated: _____________________________
______________________________________
Lawrence J. Weidman
Shareholder Representative
<PAGE>
Exhibit 99.4
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Hell's Kitchen Systems, Inc.
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 Hell's Kitchen
Systems, Inc. at December 31, 1998, March 9, 1999 and September 30, 1999, and
the results of its operations and its cash flows for the year ended
December 31, 1998, the period from January 1, 1999 to March 9, 1999, and the
period from March 10, 1999 to September 30, 1999 in conformity with accounting
principles generally accepted in the United States. 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 auditing standards
generally accepted in the United States 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.
Raleigh, North Carolina
December 16, 1999
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
BALANCE SHEETS
<TABLE>
DECEMBER 31, MARCH 9, | SEPTEMBER 30,
1998 1999 | 1999
--------- --------- | ---------
<S> <C> <C> | <C>
ASSETS |
Current assets: |
Cash.......................................... $ 27,238 $ 9,940 | $ 62,988
Prepaid expenses and other current assets..... 7,882 -- | 8,585
--------- --------- | ---------
Total current assets...................... 35,120 9,940 | 71,573
|
Property and equipment, net..................... 34,769 34,247 | 28,150
Goodwill, net................................... -- -- | 575,721
--------- --------- | ---------
Total assets.............................. $ 69,889 $ 44,187 | $ 675,444
========= ========= | =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) |
Current Liabilities: |
Accounts payable.............................. $ 3,000 $ 6,153 | $ 108,322
Accrued expenses.............................. 11,304 41,874 | 48,131
Deferred revenue.............................. 390 1,690 | 10,977
Current portion of capital lease |
obligations................................. 706 676 | 1,267
--------- --------- | ---------
Total current liabilities................. 15,400 50,393 | 168,697
|
Capital lease obligations....................... 3,786 5,419 | 5,878
|
Stockholders' equity (deficit): |
Common stock, no par value, 2,000,000 shares |
authorized; no shares issued or outstanding |
at December 31, 1998 and March 9, 1999; and |
1,344,932 shares issued and outstanding at |
September 30, 1999.......................... 483,695 491,195 | 962,233
Stockholder receivables....................... -- -- | (2,757)
Accumulated deficit........................... (432,992) (502,820)| (458,607)
--------- --------- | ---------
Total stockholders' equity (deficit)...... 50,703 (11,625)| 500,869
--------- --------- | ---------
Total liabilities and stockholders' equity |
(deficit)............................... $ 69,889 $ 44,187 | $ 675,444
========= ========= | =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
PERIOD FROM | PERIOD FROM
JANUARY 1, 1999 | MARCH 10, 1999
YEAR ENDED TO | TO
DECEMBER 31, 1998 MARCH 9, 1999 | SEPTEMBER 30, 1999
--------- -------- | ---------
<S> <C> <C> | <C>
Revenue: |
Software and related |
products.................... $ 33,694 $ 11,714 | $ 84,578
Services and other............ 2,443 5,858 | 4,669
--------- -------- | ---------
Total revenue............. 36,137 17,572 | 89,247
--------- -------- | ---------
Cost of revenue: |
Software and related |
products.................... 23,364 8,872 | 25,354
Services and other............ 21,238 5,258 | 15,025
--------- -------- | ---------
Total cost of revenue..... 44,602 14,130 | 40,379
--------- -------- | ---------
Gross margin (loss)............. (8,465) 3,442 | 48,868
--------- -------- | ---------
Operating expense: |
Sales and marketing........... 28,048 -- | 23,362
Research and development...... 114,155 29,703 | 87,826
General and administrative.... 143,992 43,462 | 395,755
--------- -------- | ---------
Total operating |
expenses................ 286,195 73,165 | 506,943
--------- -------- | ---------
Loss from operations............ (294,660) (69,723) | (458,075)
Interest expense.............. -- (105) | (532)
--------- -------- | ---------
Net loss........................ $(294,660) $(69,828) | $(458,607)
========= ======== | =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK STOCKHOLDERS
--------------------- ACCUMULATED STOCKHOLDER EQUITY
SHARES AMOUNT DEFICIT RECEIVABLES (DEFICIT)
--------- --------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1997.... -- $164,782 $(138,332) $ -- $ 26,450
Proceeds from capital
contributions................. -- 318,913 -- -- 318,913
Net loss........................ -- -- (294,660) -- (294,660)
--------- -------- --------- ------ ---------
Balance at December 31, 1998.... -- 483,695 (432,992) -- 50,703
Stock issued in lieu of
compensation.................. -- 7,500 -- -- 7,500
Net loss........................ -- -- (69,828) -- (69,828)
--------- -------- --------- ------ ---------
Balance at March 9, 1999........ -- $491,195 $(502,820) $ -- $ (11,625)
========= ======== ========= ====== =========
- ------------------------------------------------------------------------------------------------------
Balance at March 10, 1999....... -- $ -- $ -- $ -- $ --
Stock issued in formation of
Heureka....................... 407,803 13,207 -- -- 13,207
Issuance of common stock to
acquire Hell's Kitchen
Systems, Inc. on March 10,
1999.......................... 690,950 690,950 -- -- 690,950
Proceeds from issuance of common
stock......................... 243,345 255,319 -- -- 255,319
Issuance of common stock in
exchange for stockholder
receivable.................... 2,834 2,757 -- (2,757) --
Net loss........................ -- -- (458,607) -- (458,607)
--------- -------- --------- ------ ---------
Balance at September 30, 1999... 1,344,932 $962,233 $(458,607) $(2,757) $ 500,869
========= ======== ========= ====== =========
</TABLE>
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
PERIOD FROM | PERIOD FROM
YEAR ENDED JANUARY 1, 1999 | MARCH 10, 1999
DECEMBER 31, TO MARCH 9, | TO SEPTEMBER 30,
1998 1999 | 1999
--------- -------- | ---------
<S> <C> <C> | <C>
Cash flows from operating activities: |
Net loss................................ $(294,660) $(69,828) | $(458,607)
Adjustments to reconcile net loss to net |
cash used in operating activities: |
Depreciation and amortization......... 14,708 2,333 | 135,521
Noncash compensation expense.......... -- 7,500 | 13,207
Changes in operating assets and |
liabilities: |
Prepaid expenses...................... (1,527) 7,882 | (8,585)
Accounts payable...................... 3,000 3,153 | 102,169
Accrued expenses...................... (591) 30,570 | 6,257
Deferred revenue...................... 390 1,300 | 9,287
--------- -------- | ---------
Net cash used in operating |
activities........................ (278,680) (17,090) | (200,751)
--------- -------- | ---------
Cash flows used in investing activities: |
Purchase of equipment................. (19,873) -- | (982)
--------- -------- | ---------
Cash flows from financing activities: |
Capital contributions/proceeds from |
issuance of common stock............ 318,913 -- | 255,319
Payments on capital lease obligations... -- (208) | (538)
--------- -------- | ---------
|
Net cash provided by (used in) |
financing activities.............. 318,913 (208) | 254,781
--------- -------- | ---------
Net increase (decrease) in cash......... 20,360 (17,298) | 53,048
Cash beginning of the period............ 6,878 27,238 | 9,940
--------- -------- | ---------
Cash end of period...................... $ 27,238 $ 9,940 | $ 62,988
========= ======== | =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
BUSINESS ACTIVITY
Hell's Kitchen Systems, Inc. ("HKS" or the "Company") develops and markets
Internet credit card verification software ("CCVS") that enables users to
process credit card transactions directly with the credit card clearinghouses.
HKS was incorporated on September 20, 1994 in New Jersey.
BASIS OF PRESENTATION
Prior to March 10, 1999 HKS was a New Jersey corporation. Effective
March 10, 1999 HKS was acquired by Heureka Management Corporation ("Heureka"),
which was a Pennsylvania corporation, which was established with the sole
purpose of acquiring HKS. Immediately following the acquisition, Heureka changed
its name to Hell's Kitchen Systems, Inc.
The financial statements of HKS for the year ended December 31, 1998 and the
period from January 1, 1999 to March 9, 1999 represent the results of operations
and financial position of HKS based on the carrying values of its assets and
liabilities prior to the acquisition by Heureka. The financial statements of HKS
for the period subsequent to the acquisition by Heureka (March 10, 1999 to
September 30, 1999) reflect the impact on HKS's financial position and results
of operations of the purchase accounting adjustments discussed in Note 9.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
PROPERTY AND EQUIPMENT
Property and equipment is primarily equipment and computer software which
are recorded at cost and depreciated over their estimated useful lives using the
double declining balance 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. The rest of HKS's property and equipment
is depreciated over a period of three years.
IMPAIRMENT OF LONG-LIVED ASSETS
HKS evaluates the recoverability of its property and equipment and other
long-lived assets in accordance with Statement of Financial Accounting Standards
No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed of,
("SFAS No. 121"). SFAS No. 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 assets relate. No impairments were required to be recognized during
the year ended December 31, 1998, the period from January 1, 1999 to March 9,
1999 or the period from March 10, 1999 to September 30, 1999.
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
HKS's revenue is derived from software licenses as well as related support
and maintenance and consulting services. The Company adopted American Institute
of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 97-2,
"Software Revenue Recognition," as amended by SOP No. 98-4 effective January 1,
1998. The adoption did not have a material effect on the timing of the Company's
revenue recognition or cause changes to its revenue recognition policies.
Revenue from software licenses is recognized when there is evidence of an
arrangement, the product has been shipped, fees are fixed and determinable, and
collection of the related receivable is probable. Support and maintenance
revenue, which is included in services and other revenue, is deferred and
recognized ratably over the service period which is typically twelve months.
When software and services are sold under one contract, revenue is allocated to
each element based on their respective fair values, with these fair values being
determined using the price charged when that element is sold separately.
Consulting revenue, which is included in services and other revenue, is
recognized as the related consulting services are performed which generally take
less than one week to complete.
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 value per share of the
Company's common stock on the grant date. In the event that stock options are
granted with an exercise price below the estimated fair value of the Company's
common stock at the grant date, the difference between the fair value of the
Company's common stock and the exercise price of the stock option is recorded as
deferred compensation. Deferred compensation is amortized to compensation
expense over the vesting period of the stock option. Management of the Company
believes that all stock options which have been issued by the Company to date
have been issued with an exercise price equal to the fair value of the Company's
common stock on the date of the grant. The Company has adopted the disclosure
requirements of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation," ("SFAS No. 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 of costs, including salaries and sales
commissions, of all personnel involved in the sales process. Sales and marketing
expenses also include costs of advertising, trade shows and certain indirect
costs. Advertising expense totaled $23,624 for the year ended December 31, 1998,
$0 for the period from January 1, 1999 to March 9, 1999 and $23,362 for the
period from March 10, 1999 to September 30, 1999. All advertising costs are
expensed as incurred.
SOFTWARE AND WEB SITE DEVELOPMENT COSTS
Software development costs have been accounted for in accordance with
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of
Computer Software to be
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Sold, Leased or Otherwise Marketed." Under this standard, capitalization of
software development costs begins upon the establishment of technological
feasibility and ceases upon general release of the product, subject to net
realizable value considerations. To date, the period between achieving
technological feasibility and the general availability of such software has
substantially coincided; therefore, no software development costs have been
capitalized.
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. The
Company adopted SOP No. 98-1 effective January 1, 1999 and accounts for its web
site development costs in accordance with SOP No. 98-1. The adoption of SOP
No. 98-1 did not have a material impact on the Company's financial position or
results of operations.
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.
CONCENTRATION OF CREDIT RISK
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 credit evaluations.
All of the Company's software licensing and services and other revenue are
from sales transactions originating in the United States.
CASH FLOW INFORMATION
The Company acquired property and equipment through the assumption of
capital lease obligations amounting to $4,492 for the year ended December 31,
1998, $1,811 for the period from January 1, 1999 to March 9, 1999 and $1,588 for
the period from March 10, 1999 to September 30, 1999.
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 year ended
December 31, 1998. The Company has determined that it did not have any
separately reportable operating segments as of December 31, 1998, March 9, 1999
and September 30, 1999.
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME (LOSS)
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 on January 1, 1998 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 year ended December 31, 1998, the period from
January 1, 1999 to March 9, 1999 or the period from March 10, 1999 to
September 30, 1999.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 "Accounting for Derivative Instruments and Hedging Activities," ("SFAS
No. 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, is effective for fiscal years beginning after
June 15, 2000, with earlier application encouraged. The Company does not
currently 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 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 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 ("VSOE") 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 97-2 that were deferred by SOP
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 98-9 will have a
significant impact on the Company's results of operations or financial position.
3. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments, which are comprised primarily of cash
in demand deposit accounts and accounts payable, are carried at cost which
approximates their fair market value at December 31, 1998, March 9, 1999 and
September 30, 1999.
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. PROPERTY AND EQUIPMENT, NET
The Company's property and equipment consisted of the following:
<TABLE>
DECEMBER 31, MARCH 9, | SEPTEMBER 30,
1998 1999 | 1999
------- ------- | -------
<S> <C> <C> | <C>
Equipment........................................ $75,007 $76,818 | $36,817
Computer software................................ 12,425 12,425 | --
------- ------- | -------
87,432 89,243 | 36,817
Less: accumulated depreciation................... (52,663) (54,996) | (8,667)
------- ------- | -------
$34,769 $34,247 | $28,150
======= ======= | =======
</TABLE>
5. GOODWILL, NET
The Company's goodwill consisted of the following:
<TABLE>
DECEMBER 31, MARCH 9, | SEPTEMBER 30,
1998 1999 | 1999
--------- --------- | --------
<S> <C> <C> | <C>
Goodwill......................................... $ -- $ -- | $702,575
Less: accumulated amortization................... -- -- | (126,854)
--------- --------- | --------
$ -- $ -- | $575,721
========= ========= | ========
</TABLE>
6. ACCRUED EXPENSES
Accrued expenses were comprised of the following:
<TABLE>
DECEMBER 31, MARCH 9, | SEPTEMBER 30,
1998 1999 | 1999
------- ------- | -------
<S> <C> <C> | <C>
Payroll.......................................... $ 3,324 $33,948 | $13,589
Taxes............................................ 4,772 5,626 | 10,207
Legal............................................ -- -- | 21,527
Other............................................ 3,208 2,300 | 2,808
------- ------- | -------
$11,304 $41,874 | $48,131
======= ======= | =======
</TABLE>
7. INCOME TAXES
There is no current income tax provision or benefit for the year ended
December 31, 1998, the period from January 1, 1999 to March 9, 1999 or the
period from March 10, 1999 to September 30, 1999 because the Company has
generated net operating losses since inception.
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
at December 31, 1998, March 9, 1999 and September 30, 1999 consisted of the
following:
<TABLE>
DECEMBER 31, MARCH 9, | SEPTEMBER 30,
1998 1999 | 1999
-------- -------- | --------
<S> <C> <C> | <C>
Net operating loss carryforwards................. $170,097 $198,361 | $335,414
Total deferred tax assets...................... 170,097 198,361 | 335,414
Valuation allowance for deferred tax assets...... (170,097) (198,361) | (335,414)
-------- -------- | --------
Net deferred tax assets........................ $ -- $ -- | $ --
======== ======== | ========
</TABLE>
At December 31, 1998, March 9, 1999 and September 30, 1999, the Company
provided a full valuation allowance against its net deferred tax assets since
realization of these benefits could not be reasonably assured. The increase in
the valuation allowance during 1998, the period from January 1, 1999 to
March 9, 1999 and the period from March 10, 1999 to September 30, 1999 resulted
from the net operating losses generated.
As of December 31, 1998, March 9, 1999 and September 30, 1999, the Company
had Federal and state net operating loss carryforwards of approximately
$420,000, $489,000 and $826,000, respectively. The net operating loss
carryforwards expire in various amounts starting in 2009 and 2001 for Federal
and state tax purposes, respectively. The utilization of the Federal net
operating loss carryforward may be subject to limitation under the rules
regarding a change in stock ownership as determined by the Internal Revenue
Code. If the Company's utilization of its net operating loss carryforwards is
limited, and the Company has taxable income which exceeds the permissible yearly
net operating loss carryforward, the Company would incur a Federal income tax
liability even though its net operating loss carryforwards exceed its taxable
income.
Taxes computed at the statutory Federal income tax rate of 34% are
reconciled to the provision for income taxes as follows:
<TABLE>
PERIOD FROM | PERIOD FROM
YEAR ENDED JANUARY 1, 1999 | MARCH 10, 1999
DECEMBER 31, TO MARCH 9, | TO SEPTEMBER 30,
1998 1999 | 1999
--------- -------- | ---------
<S> <C> <C> | <C>
Effective rate.......................... 0% 0% | 0%
United States Federal tax at statutory |
rate.................................. $(100,184) $(23,674) | $(155,926)
State taxes (net of Federal benefit).... (19,310) (4,590) | (22,262)
Change in valuation allowance........... 118,884 28,264 | 137,053
Non-deductible items.................... 610 -- | 41,135
--------- -------- | ---------
Provision for income taxes.............. $ -- $ -- | $ --
========= ======== | =========
</TABLE>
8. STOCKHOLDER RECEIVABLES
Stockholder receivables consist of amounts due from stockholders for the
purchase of 2,834 shares of common stock in August and September 1999. The total
receivable of $2,757 was repaid in December 1999.
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. CAPITAL STOCK
The Company has authorized 2,000,000 shares of common stock with no par
value per share. Holders of these shares have one vote per share.
Prior to the merger of HKS into Heureka Management Corporation ("Heureka")
on March 10, 1999 (the "Effective Date"), no shares of HKS were legally issued.
The cash and other contributions to HKS were instead accounted for as capital
stock with no related share amounts. In conjunction with the merger, individuals
that had contributed capital to HKS were granted a total of 690,950 shares with
a fair value of $1 per share in the surviving corporation, Heureka. Heureka
changed its name to Hell's Kitchen Systems, Inc., a Pennsylvania Corporation, in
conjunction with the transaction.
The transaction was accounted for as a purchase. At the Effective Date, each
share of common stock in HKS (690,950 shares) and each share of common stock in
Heureka (407,803 shares) converted into one share of the surviving corporation
(a total of 1,098,753 shares). The total purchase price paid by Heureka was
$746,762, including assumption of liabilities of HKS at the date of the
acquisition. In connection with the merger, approximately $43,000 in tangible
assets were acquired and $703,000 of goodwill was created, which will be
amortized over a period of 3 years.
During the period from March 10, 1999 to September 30, 1999, the Company
sold 243,345 shares common stock to a number of investors at prices ranging from
$1.00 to $1.50 per share.
10. STOCK OPTIONS AND WARRANTS
STOCK OPTIONS
During the period from March 10, 1999 to September 30, 1999 the Company
granted stock options for the purchase of a total of 74,500 shares to employees
at an exercise price of $1.00 and options for the purchase of a total of 5,500
shares to employees at an exercise price of $1.50. No options were granted prior
to March 10, 1999.
All options granted during the period from March 10, 1999 to September 30,
1999 were granted with an exercise price equal to or greater than the fair value
of the underlying common stock on the grant date, as determined by the board of
directors. All options granted were immediately vested. The fair value of each
option is estimated on the grant date using the minimum value method with the
following assumptions during the period ended September 30, 1999: risk free
interest of 5.63%, expected life of 2 years, dividend yield of 0%, and a
volatility factor 0%. The weighted average fair value of options granted during
the period from March 10, 1999 to September 30, 1999 was $0.11.
The following table summarizes information about the Company's stock options
outstanding at September 30, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ ------------------------
WEIGHTED
AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
OUTSTANDING LIFE PRICE EXERCISABLE PRICE
--------------------- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
74,500 5 $1.00 74,500 $1.00
5,500 5 $1.50 5,500 $1.50
</TABLE>
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTIONS AND WARRANTS (CONTINUED)
The Company applies APB No. 25 and related interpretations in accounting for
the options. Had compensation costs for the options been determined based on the
fair value at the grant dates for awards consistent with the methods of SFAS
No. 123, the Company's net loss would be $467,193 for the period from March 10,
1999 to September 30, 1999. The Company did not grant any stock options or
warrants during the year ended December 31, 1998 or the period from January 1,
1999 to March 9, 1999 and, therefore, no pro forma disclosure for these years is
provided.
11. COMMITMENTS AND CONTINGENCIES
As of September 30, 1999, the Company has leased office space and certain
equipment under various noncancelable operating and capital leases. Future
minimum payments required under the operating and capital leases at
September 30, 1999 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
---------- --------
<S> <C> <C>
Remaining 1999.............................................. $ 6,425 $ 591
2000........................................................ 28,838 2,362
2001........................................................ 2,438 2,362
2002........................................................ 813 2,362
2003........................................................ -- 2,075
------- ------
Total minimum lease payments................................ $38,514 9,752
=======
Less amount representing interest (at rates ranging from 14%
to 17.25%)................................................ 2,607
------
Present value of net minimum lease payments................. 7,145
Less current portion........................................ 1,267
------
Long-term portion........................................... $5,878
======
</TABLE>
Rent expense under operating leases during the year ended December 31, 1998,
the period from January 1, 1999 to March 9, 1999 and the period from March 10,
1999 to September 30, 1999 was $18,000, $5,000 and $13,000, respectively.
The gross amount of equipment and related accumulated depreciation recorded
under capital leases and included in property and equipment was as follows:
<TABLE>
DECEMBER 31, MARCH 9, SEPTEMBER 30,
1998 1999 1999
------ ------ ------
<S> <C> <C> <C>
Equipment........................................ $4,492 $6,303 $7,891
Less accumulated depreciation.................... -- (75) (1,857)
------ ------ ------
$4,492 $6,228 $6,034
====== ====== ======
</TABLE>
12. SUBSEQUENT EVENT (UNAUDITED)
In January 2000, HKS was acquired by Red Hat, Inc. ("Red Hat"). The Company
exchanged all their outstanding stock and stock options for up to 796,670 shares
of Red Hat's common stock. This acquisition was accounted for using the purchase
method of accounting in accordance with APB No. 16 as 318,668 of the shares to
be issued to the HKS shareholders is
<PAGE>
HELL'S KITCHEN SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. SUBSEQUENT EVENT (UNAUDITED) (CONTINUED)
contingent upon continued employment with Red Hat by certain employees of HKS
for a period of up to three years after the date of the acquisition and upon the
HKS business achieving certain performance targets.
<PAGE>
Exhibit 99.5
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Cygnus Solutions
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, shareholders' equity (deficit)
and cash flows present fairly, in all material respects, the financial
position of Cygnus Solutions and its subsidiaries at June 30, 1999 and 1998
and the results of their operations and their cash flows for the years then
ended, in conformity with accounting principles generally accepted in the
United States. 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 auditing standards generally accepted in the
United States 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 our
audits provide a reasonable basis for the opinion expressed above.
San Jose, California
September 23, 1999
<PAGE>
CYGNUS SOLUTIONS
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30,
------------------- SEPTEMBER 30,
1998 1999 1999
-------- -------- ---------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 3,701 $ 11,977 $ 10,155
Accounts receivable, net of allowance for doubtful
accounts of $94 and $193 at June 30, 1998 and 1999,
respectively and of $233 at September 30, 1999.......... 4,584 3,890 5,002
Unbilled receivables...................................... 585 755 --
Prepaid and other current assets.......................... 660 924 885
------- -------- --------
Total current assets.................................... 9,530 17,546 16,042
Property and equipment, net................................. 2,788 2,568 2,393
Intangibles, net of accumulated amortization of $162 and
$270 at June 30, 1998 and 1999, and $297 at
September 30, 1999, respectively.......................... 162 54 27
------- -------- --------
Total assets............................................ $12,480 $ 20,168 $ 18,462
======= ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 492 $ 587 $ 943
Accrued compensation...................................... 1,445 1,613 3,426
Other accrued liabilities................................. 892 1,254 --
Deferred revenue.......................................... 7,614 6,522 5,430
Notes payable, current.................................... -- 500 506
Current portion of capital lease obligations.............. 28 31 31
------- -------- --------
Total current liabilities............................... 10,471 10,507 10,336
Notes payable............................................... -- 792 667
Capital lease obligations, less current portion............. 87 56 48
------- -------- --------
Total liabilities....................................... 10,558 11,355 11,051
Commitments (Note 5)
Series B mandatorily redeemable convertible preferred stock;
$0.001 par value
Authorized: 1,042,000 shares
Issued and outstanding: 1,042,000 shares at June 30, 1998,
June 30, 1999 and September 30, 1999.................... 6,252 6,252 6,252
(Liquidation value: $18,756)
Shareholders' equity (deficit):
Series A convertible preferred stock; $0.001 par value
Authorized: 4,959,172 shares
Issued and outstanding: 3,828,290 shares at June 30, 1998,
4,018,005 shares at June 30, 1999 and September 30,
1999.................................................... 835 989 989
(Liquidation value: $19,648)
Series C convertible preferred stock; $0.001 par value
Authorized: 1,000,000 shares
Issued and outstanding: no shares at June 30, 1998,
784,570 shares at June 30, 1999 and September 30,
1999.................................................... -- 11,734 11,734
(Liquidation value: $11,769)
Common stock; $0.001 par value
Authorized: 40,000,000 shares
Issued and outstanding: 868 shares at June 30, 1998,
878,003 shares at June 30, 1999 and 878,850 shares at
September 30, 1999...................................... 108 5,000 5,809
Shareholder notes receivable................................ (114) (2,952) (2,851)
Unearned stock-based compensation........................... -- (981) (1,556)
Accumulated deficit......................................... (5,159) (11,229) (12,966)
------- -------- --------
Total shareholders' equity (deficit).................... (4,330) 2,561 1,159
------- -------- --------
Total liabilities, mandatorily redeemable convertible
preferred stock and shareholders'
equity (deficit)...................................... $12,480 $ 20,168 $ 18,462
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
CYGNUS SOLUTIONS
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
JUNE 30, SEPTEMBER 30,
----------------------- -----------------------------
1998 1999 1998 1999
-------- -------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues............................... $19,761 $21,773 $ 5,054 $ 6,263
Cost of revenues....................... 7,547 8,505 1,946 3,104
------- ------- ------- -------
Gross profit....................... 12,214 13,268 3,108 3,159
Operating expenses:
Sales and marketing.................. 8,319 8,108 1,584 2,760
General and administrative........... 3,925 3,487 1,777 998
Research and development............. 4,243 6,651 754 889
Stock-based compensation............. -- 476 -- 186
------- ------- ------- -------
Operating expenses................. 16,487 18,722 4,115 4,833
------- ------- ------- -------
Operating loss..................... (4,273) (5,454) (1,007) (1,674)
------- ------- ------- -------
Interest and other income.............. 438 405 51 185
Interest expense....................... (198) (453) (54) (108)
------- ------- ------- -------
Loss before provision for income
taxes............................ (4,033) (5,502) (1,010) (1,597)
Provision for (benefit from) income
taxes................................ 325 568 142 140
------- ------- ------- -------
Net loss........................... $(4,358) $(6,070) $(1,152) $(1,737)
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
CYGNUS SOLUTIONS
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY (DEFICIT)
YEARS ENDED JUNE 30, 1998 AND 1999
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK SHAREHOLDER UNEARNED
--------------------- -------------------- NOTES STOCK-BASED ACCUMULATED
SHARES AMOUNT SHARES AMOUNT RECEIVABLE COMPENSATION DEFICIT
(IN THOUSANDS, EXCEPT SHARE DATA) ---------- -------- --------- -------- ------------ -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, June 30, 1997.............. 3,731,290 $ 339 -- $ -- $ (201) $ -- $ (801)
Issuance of common stock from
options.......................... -- -- 868 2 -- -- --
Issuance of Series A preferred
stock from options............... 218,000 121 -- -- (1) -- --
Repurchase of restricted stock..... (121,000) (60) -- -- 102 -- --
Other shareholder receivable....... -- -- -- -- (14) -- --
Compensation expense related to
options.......................... -- 435 -- 106 -- -- --
Net loss........................... -- -- -- -- -- -- (4,358)
---------- -------- -------- ------ ------- -------- --------
Balances, June 30, 1998.............. 3,828,290 835 868 108 (114) -- (5,159)
Issuance of common stock from
options.......................... -- -- 760,135 3,195 (2,744) -- --
Issuance of Series A preferred
stock from options............... 311,403 183 -- -- -- -- --
Issuance of Series C preferred
stock, net....................... 784,570 11,734 -- -- -- -- --
Repurchase of restricted stock..... (4,688) (1) -- -- 1 -- --
Conversion and repurchase of
convertible preferred stock to
restricted Common Stock.......... (117,000) (28) 117,000 28 -- -- --
Repayment of shareholder
receivable....................... -- -- -- -- 5 -- --
Issuance of other shareholder
receivable....................... -- -- -- -- (100) -- --
Common stock options granted to
service providers................ -- -- -- 212 -- -- --
Unearned stock-based compensation.. -- -- -- 1,457 -- (1,457) --
Amortization of unearned stock-
based compensation............... -- -- -- -- -- 476 --
Net loss........................... -- -- -- -- -- -- (6,070)
---------- -------- -------- ------ ------- -------- --------
Balances, June 30, 1999.............. 4,802,575 12,723 878,003 5,000 (2,952) (981) (11,229)
Issuance of common stock from
options.......................... -- -- 847 48 -- -- --
Repayment of shareholder note
receivable....................... -- -- -- -- 101 -- --
Unearned stock-based compensation.. -- -- -- 761 -- (761) --
Amortization of unearned stock-
based compensation............... -- -- -- -- -- 186 --
Net loss........................... -- -- -- -- -- -- (1,737)
---------- -------- -------- ------ ------- -------- --------
Balances, September 30, 1999......... 4,802,575 $ 12,723 878,850 $5,809 $(2,851) $ (1,556) $(12,966)
(unaudited) ========== ======== ======== ====== ======= ======== ========
<CAPTION>
TOTAL
(IN THOUSANDS, EXCEPT SHARE DATA) --------
<S> <C>
Balances, June 30, 1997.............. $ (663)
Issuance of common stock from
options.......................... 2
Issuance of Series A preferred
stock from options............... 120
Repurchase of restricted stock..... 42
Other shareholder receivable....... (14)
Compensation expense related to
options.......................... 541
Net loss........................... (4,358)
-------
Balances, June 30, 1998.............. (4,330)
Issuance of common stock from
options.......................... 451
Issuance of Series A preferred
stock from options............... 183
Issuance of Series C preferred
stock, net....................... 11,734
Repurchase of restricted stock..... --
Conversion of convertible preferred
stock to Common Stock............ --
Repayment of shareholder
receivable....................... 5
Issuance of other shareholder
receivable....................... (100)
Common stock options granted to
service providers................ 212
Unearned stock-based compensation.. --
Amortization of unearned stock-
based compensation............... 476
Net loss........................... (6,070)
-------
Balances, June 30, 1999.............. 2,561
Issuance of common stock from
options.......................... 48
Repayment of shareholder note
receivable....................... 101
Unearned stock-based compensation.. --
Amortization of unearned stock-
based compensation............... 186
Net loss........................... (1,737)
-------
Balances, September 30, 1999......... $ 1,159
(unaudited) =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
CYGNUS SOLUTIONS
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
JUNE 30, SEPTEMBER 30,
------------------- -------------------
1998 1999 1998 1999
-------- -------- -------- --------
(unaudited)
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................... $(4,358) $(6,070) (1,152) (1,737)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 1,163 1,482 335 233
Provision for doubtful accounts........................... (113) 99 (1) 30
Loss on disposal of property and equipment................ 28 33 -- --
Stock-based compensation expense.......................... -- 476 -- 186
Stock-based compensation for services rendered............ 541 212 -- --
Changes in assets and liabilities:
Accounts receivable and unbilled receivables............ (604) 425 2,666 (302)
Prepaid and other current assets........................ (51) (264) (160) (45)
Accounts payable........................................ 193 95 (86) 355
Accrued liabilities..................................... (834) 530 1,480 212
Deferred revenue........................................ 1,667 (1,092) (2,863) (744)
------- ------- ------- --------
Net cash (used in) provided by operating activities... (2,368) (4,074) 219 (1,812)
------- ------- ------- --------
Cash flows from investing activities:
Acquisition of property and equipment..................... (2,098) (1,187) (324) (32)
Purchases of short-term investments....................... (4,735) -- -- --
Sales and maturities of short-term investments............ 7,921 -- -- --
------- ------- ------- --------
Net cash (used in) provided by investing activities... 1,088 (1,187) (324) (32)
------- ------- ------- --------
Cash flows from financing activities:
Proceeds from issuance of notes payable................... -- 1,500 1,500 --
Principal payments on notes payable....................... -- (208) (2) (120)
Principal payments on capital lease obligations........... (23) (28) (8) (7)
Proceeds from issuance of common stock, net of repurchases
and interest on shareholder note receivable............. 2 351 19 48
Proceeds from issuance of Series A preferred stock, net of
repurchases............................................. 148 183 82 --
Proceeds from issuance of Series C preferred stock, net of
issuance costs.......................................... -- 11,734 -- --
Proceeds from repayment of shareholder note receivable.... -- 5 1 101
------- ------- ------- --------
Net cash provided by financing activities............. 127 13,537 1,592 22
------- ------- ------- --------
Net increase (decrease) in cash and cash equivalents........ (1,153) 8,276 1,487 (1,822)
Cash and cash equivalents at beginning of period............ 4,854 3,701 3,701 11,977
------- ------- ------- --------
Cash and cash equivalents at end of period.................. $ 3,701 $11,977 $ 5,188 $ 10,155
======= ======= ======= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest.................................................. $ 10 $ 128 $ 8 $ 29
Income taxes.............................................. $ 2 $ 1 $ 3 $ 1
Supplemental disclosure of noncash investing and financing
activity:
Issuance of shareholder note receivable for restricted
stock, net of retirements for repurchases............... $ 15 $ 2,744 -- --
Property and equipment acquired under capital leases...... $ 21 $ -- -- --
Cancellation of shareholder note receivable for restricted
stock, net of retirements for repurchases............... $ 12 $ 1 -- --
Unearned stock based compensation related to stock option
grants.................................................. $ -- $ 1,457 -- $ 761
Issuance of options for common stock for services......... $ 541 $ 212 -- --
Conversion of Series A convertible preferred stock to
common stock............................................ $ -- $ 28 -- --
Issuance of shareholder note receivable for interest...... $ -- $ 100 -- --
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS OF THE COMPANY
Cygnus Solutions (the "Company"), formerly Cygnus Support, was incorporated
in California in 1989. The Company is an open source software technology leader
and an innovating force in internet software infrastructure. The Company
provides end-to-end software solutions, including leading embedded and desktop
software platforms, tools and real-time operating systems, and custom
engineering services and support. The Company maintains offices in Sunnyvale,
California; Atlanta, Georgia; Cambridge, England; Toronto, Canada; and Tokyo,
Japan. Sales are conducted world-wide through the Company's direct sales
force. The Company operates in only one business segment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant inter-company transactions
and balances have been eliminated on consolidation.
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 amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Investments and deposits with maturities of three months or less at the time
of purchase are considered cash equivalents. Cash and cash equivalents consist
primarily of money market deposits in major U.S. banks. Cash deposits are
also maintained in Japan, Germany, Canada and the United Kingdom.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method based upon the useful
life of the assets, ranging from three to five years. Disposals of property and
equipment are recorded by removing the costs and accumulated depreciation from
the accounts. Gains or losses are included in the results of operations.
INTANGIBLES
Goodwill, which is related to the acquisition of the Company's German
subsidiary during fiscal 1997, is stated at cost less accumulated amortization.
Amortization is computed on a straight-line basis over the estimated benefit
period of three years.
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LONG-LIVED ASSETS
The Company accounts for long-lived assets under Statement of Financial
Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of
Long-Lived Assets and for the Long-Lived Assets to Be Disposed Of", which
requires the Company to review for impairment of long-lived assets, whenever
events or changes in circumstances indicate that the carrying amounts of an
asset might not be recoverable. When such an event occurs, the Company estimates
the future cash flows expected to result from the use of the assets and its
eventual disposition. If the undiscounted expected future cash flows are less
than the carrying amount of the asset, an impairment loss is recognized. To
date, no impairment loss has been recognized.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The financial statements as of September 30, 1999 and for the three month
periods ended September 30, 1998 and 1999 are unaudited and reflect all
adjustments (consisting of normal recurring adjustments) which are, in the
opinion of the Company's management, necessary for the fair presentation of
financial position, results of operations and cash flows. All financial
statement disclosures related to the three month periods ended September 30,
1998 and 1999 are also unaudited.
REVENUE RECOGNITION
In fiscal 1999, the Company adopted the provisions of Statement of
Position ("SOP") 97-2, "Software Revenue Recognition", as amended by SOP
98-4, "Deferral of the Effective Date of Certain Provisions of SOP 97-2",
effective February 1, 1998. SOP 97-2 and SOP 98-4 provide guidance on
recognizing revenue on software transactions and supersede SOP 91-1,
"Software Revenue Recognition". The adoption of SOP 97-2 and SOP 98-4 did not
have a significant impact on the Company's revenue recognition practices
under SOP 91-1.
Product revenues consist of licensing fees from software development tools.
Service revenues are derived from software compiling, debugging and optimization
contracts ("Development Contracts"). In addition, service revenue also includes
support contracts which are generally initially sold with the services. The
Company's customers consist of end-users, distributors and original equipment
manufacturers.
Product revenues are recognized at the time of shipment or upon the sale by
distributors to their customers if no significant vendor obligations remain and
if collection of the resulting receivable is considered probable. The Company
grants distributors and resellers certain rights of return. Accordingly,
provisions for estimated future returns and exchanges are recognized upon
product shipment.
Service revenues are recognized on the percentage-of-completion method for
Development Contracts and ratably over the term of the agreement for support
contracts, provided that collection of the resulting receivable is probable, the
fee is fixed or determinable and vendor-specific objective evidence ("VSOE")
exists to allocate the total fee to all delivered and undelivered elements of
the contract.
In December 1998, the American Institute of Certified Public Accountants
("AICPA") released SOP 98-9, "Modification of SOP 97-2, "Software Revenue
Recognition with Respect to Certain Transactions". SOP 98-9 amends SOP 97-2
to require that an entity recognize revenue for multiple
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
element arrangements by means of the "residual method" when (1) there is VSOE of
the fair values of all the undelivered elements that are not accounted for by
means of long-term contract accounting, (2) VSOE of fair value does not exist
for one or more of the delivered elements, and (3) all revenue recognition
criteria of SOP 97-2 (other than the requirements for VSOE of the fair value of
each delivered element) are satisfied. The provisions of SOP 98-9 that extend
the deferral of certain paragraphs of SOP 97-2 became effective December 15,
1998. These paragraphs of SOP 97-2 and SOP 98-9 will be effective for
transactions that are entered into in fiscal years beginning after March 15,
1999. Retroactive application is prohibited. The adoption did not materially
impact the Company's revenue recognition policies.
ADVERTISING
The Company expenses the costs of advertising as the expenses are
incurred. The production costs of advertising consist primarily of magazine
advertisements, agency fees and other direct production costs. Advertising
costs were $382,000 and $322,000 during the fiscal years ended June 30, 1998
and 1999, respectively.
RESEARCH AND DEVELOPMENT
Research and development expenses, which primarily consist of salaries and
related benefits, are charged to operations as incurred. Under Statement of
Financial Accounting Standards No. 86, "Capitalization of Software Development
Costs" ("SFAS No. 86"), software development costs are capitalized beginning
when a product's technological feasibility has been established and ending when
a product is available for general release to customers. To date, the costs
incurred during this period have not been significant.
INCOME TAXES
Income taxes are accounted for under the liability method wherein deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. A valuation allowance is established to the extent that
there is uncertainty of realization of net deferred tax assets.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Carrying amounts of the Company's financial instruments including cash and
cash equivalents, accounts receivable and accounts payable approximate fair
values due to their short maturities. Based on borrowing rates currently
available to the Company for loans with similar terms, the carrying value of its
notes payable and capital lease obligations approximate fair value.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to a
concentration of credit risk principally consist of cash and cash equivalents
and trade accounts receivable.
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Cash and cash deposits are invested primarily in deposits with banks in the
United States, United Kingdom, Germany, Japan and Canada. Deposits in these
banks may exceed the amount of insurance, if any, provided on such deposits. The
Company has not experienced any losses on its cash and cash equivalents.
The Company's customer base is disbursed throughout the United States,
Europe and Asia, and consists principally of companies in the networking
equipment and computer systems industries. The Company maintains an allowance
for potential credit losses, but historically has not experienced any
significant losses related to individual customers or groups of customers in any
particular industry or geographic area. One customer individually accounted for
26% of accounts receivable at June 30, 1999 and certain customers accounted for
19%, 18%, and 16% of accounts receivable at June 30, 1998. For the year ended
June 30, 1998 certain customers accounted for 18% and 12% of revenues and for
the year ended June 30, 1999 one customer accounted for 22% of revenues.
FOREIGN CURRENCY TRANSLATION
Substantially all of the Company's sales are denominated in U.S. dollars and
the U.S. dollar is the functional currency for all foreign operations. Foreign
exchange gains and losses, which result from the process of remeasuring foreign
currency financial statements into U.S. dollars are included in the statement of
operations. The Company recorded net foreign currency translation losses of
$67,000 and $124,000 during the years ended June 30, 1998 and 1999,
respectively.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic value
method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees". Accordingly, compensation cost for stock options is measured as the
excess, if any, of the fair value of the Company's stock at the date of the
grant over the amount an employee must pay to acquire the stock. The Company has
adopted the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation".
COMPREHENSIVE INCOME (LOSS)
Effective July 1, 1998, the Company adopted the provisions of SFAS No. 130,
"Reporting Comprehensive Income". SFAS No. 130 establishes standards for
reporting comprehensive income (loss) and its components in financial
statements. Comprehensive income (loss), as defined, includes all changes in
equity during a period from non-owner sources. To date, the Company has not had
any transactions that are required to be reported as comprehensive income.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year financial statements
to conform to the current year's classifications.
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the Accounting Standards Executive Committee ("AcSEC") of
the AICPA issued Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", which
provides guidance on accounting for the cost of computer software developed
or obtained for internal use. SOP No. 98-1 is effective for financial
statements for fiscal years beginning after December 15, 1998. The Company
does not expect that the adoption of SOP No. 98-1 will have a material impact
on its financial statements.
In April 1998, AcSEC issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities". This SOP provides guidance on the financial reporting of start-up
costs and organization costs. It requires the costs of start-up activities and
organization costs to be expensed as incurred. The SOP is effective for
financial statements for fiscal years beginning after December 15, 1998. The
Company does not expect that the adoption of SOP No. 98-5 will have a material
impact on its financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, or SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS 133 establishes standards of
accounting and reporting for derivative instruments and hedging activities.
SFAS 133 requires that all derivatives be recognized at fair value in the
statement of financial position, and that the corresponding gains or losses be
reported either in the statement of operations or as a component of
comprehensive income, depending on the type of hedging relationship that exists.
SFAS 133, as amended, will be effective for fiscal quarters of fiscal years
beginning after June 15, 2000. The Company does not currently hold derivative
instruments or engage in hedging activities.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (IN THOUSANDS):
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30, SEPTEMBER 30,
------------------- --------------
1998 1999 1999
-------- -------- --------------
(UNAUDITED)
<S> <C> <C> <C>
Computer equipment....................... $ 3,459 $ 4,041 $ 4,083
Computer software........................ 433 553 565
Furniture and fixtures................... 670 821 799
------- ------- -------
4,562 5,415 5,447
Less accumulated depreciation and
amortization........................... (1,774) (2,847) (3,054)
------- ------- -------
$ 2,788 $ 2,568 $ 2,393
======= ======= =======
</TABLE>
Depreciation expense was approximately $928,000 and $1,383,000 for the years
ended June 30, 1998 and 1999, respectively, and $323,000 and $359,000 for the
three months ended September 30, 1998 and 1999, respectively.
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. PROPERTY AND EQUIPMENT (CONTINUED)
Property and equipment under capital leases included above comprise (IN
THOUSANDS):
<TABLE>
<CAPTION>
JUNE 30,
------------------- SEPTEMBER 30,
1998 1999 1999
-------- -------- --------------
(UNAUDITED)
<S> <C> <C> <C>
Computers and equipment....................... $144 $144 $144
Less accumulated depreciation and
amortization................................ (46) (87) (95)
---- ---- ----
$ 98 $ 57 $ 49
==== ==== ====
</TABLE>
4. LINE OF CREDIT
The Company has a line of credit agreement with a bank which provides the
Company the ability to borrow up to $4,000,000. The amount available is adjusted
for certain items, including outstanding letters of credit. The line of credit,
which is collateralized by the assets of the Company, matures on December 15,
1999 and requires the Company to maintain certain financial covenants.
Borrowings under the line of credit bear interest at the bank's prime rate
(7.75% at June 30, 1999) plus 0.5%. At June 30, 1999 and September 30, 1999, the
Company had no borrowings under the line of credit.
Additionally, the Agreement provides for equipment advances of $1,500,000
through January 17, 1999. During the year ended June 30, 1999, the Company
obtained an advance of $1,500,000 for capital acquisitions, with interest
accruing from the date of the advance at bank's prime rate plus 0.5%. The
advance is payable in 36 monthly installments of principal, plus accrued
interest, beginning February 17, 1999. At June 30, 1999, the outstanding
obligation was $1,292,000. Borrowings on the facility are due as follows (IN
THOUSANDS):
<TABLE>
<S> <C>
Year Ending June 30,
2000........................................................ $ 500
2001........................................................ 500
2002........................................................ 292
------
$1,292
======
</TABLE>
During the three months ended September 30, 1999, the Company received no
additional equipment advances and made principal payments of $120,000 on the
outstanding principal obligations under this facility.
5. COMMITMENTS
The Company leases its facilities and certain equipment under
noncancelable operating leases which require the Company to pay taxes,
insurance and maintenance. Rent expense for the three months ended September
30, 1998 and 1999 was $212,000 and $224,000 respectively and for the year
ended June 30, 1998 and June 30, 1999, totaled $847,000 and $897,000,
respectively. The Company recognizes rent expense on a straight-line basis
over the lease period and has recognized a deferred rent liability for rent
expenditures paid but not incurred.
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS (CONTINUED)
The Company leases certain of its computers and equipment and software under
capital leases. The capital leases expire at various dates through 2002. The
Company pays interest from 6% to 11% per annum on the leases.
At June 30, 1999, future minimum lease payments under noncancelable
operating and capital leases are as follows (IN THOUSANDS):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ----------
<S> <C> <C>
Year Ending June 30,
2000................................................... $ 37 $ 824
2001................................................... 36 623
2002................................................... 25 300
2003................................................... -- 5
---- ------
Total minimum payments................................. 98 $1,752
======
Less amount representing interest...................... (11)
----
87
Less current portion................................... (31)
----
Long-term portion...................................... $ 56
====
</TABLE>
6. PREFERRED STOCK
During fiscal 1999, the Company issued 784,570 shares of Series C
Preferred Stock at $15 per share.
The rights, preference and privileges of Series A, Series B and Series C
preferred stock are as follows:
REDEMPTION (SERIES B ONLY)
The holders of shares of Series B preferred stock could require the Company
to redeem, at any time after January 1, 2004 (the "Redemption Date") in two
annual installments equal to the then outstanding preferred stock, by paying
cash in exchange for the shares of preferred stock to be redeemed at a sum equal
to $6 per share plus all declared and unpaid dividends per share. The
redemption value equals the carrying value of the preferred stock.
DIVIDENDS
The holders of Series A, Series B and Series C preferred stock are entitled
to noncumulative dividends of $0.37, $0.45 and $1.125, respectively, per share
per annum, when and if declared by the Board of Directors. Such a dividend will
be declared or paid prior and in preference to any declaration or payment of any
dividend on the common stock, other than a common stock dividend payable solely
in shares of common stock. No dividends have been declared through June 30,
1999.
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. PREFERRED STOCK (CONTINUED)
LIQUIDATION
A consolidation or merger of the Company with or into any other corporation
in which the shareholders of the Company do not own a majority of the
outstanding shares of the surviving corporation is deemed a liquidation. The
assets and surplus funds of the Company shall be distributed in the following
order (all pro rata references assume conversion of the preferred stock into
common stock): i) to the holders of Series C preferred at an amount of $15.00
per share, plus any declared but unpaid dividends; ii) to the holders of
Series B preferred at an amount of $8.1118 per share plus an amount equal to any
declared but unpaid dividends on such shares; iii) to the holders of Series A
and Series B preferred stock at an amount of $4.89 per share plus, in the case
of Series A preferred stock, an amount equal to any declared but unpaid
dividends on such shares; iv) to the holders of Series B preferred stock and
common stock pro rata until the holders of Series B preferred stock have
received an aggregate of $18 per share; and v) to the holders of Series A and
Series B preferred stock and common stock pro rata. If the assets and funds to
be distributed at any level are insufficient to permit the payment to the
holders of the full amount, as calculated in (i) through (v) above, then the
entire assets and funds of the Company legally available for distribution shall
be distributed pro rata among the holders designated at such level.
CONVERSION AND REGISTRATION
The preferred stock is convertible at the option of the holder, according
to a conversion ratio, into such number of fully paid and nonassessable
shares of common stock calculated using the conversion ratio at the date of
conversion. Conversion of Series A and Series B preferred stock is automatic
upon the earlier of the closing date of a public offering of the Company's
common stock for which the aggregate proceeds equal or exceed $12,500,000 and
the per share Series A and B offering price is not less than $15, or upon
consent of two-thirds interest of the preferred stockholders. Conversion of
Series C preferred stock is automatic upon the earlier of the closing date of
a public offering of the Company's common stock for which the aggregate
proceeds equal or exceed $15,000,000 and the per share offering price is not
less than $30, or upon consent of the holders of at least 80% of the then
outstanding Series B and Series C preferred shares, including the holders of
at least 75% of the Series C preferred stock holders.
VOTING
Each share of Series A, B and C preferred stock is entitled to vote on an
"as converted" basis along with common shareholders. With respect to the
election of members of the Company's Board of Directors, as long as at least
500,000 shares of Series B preferred stock are outstanding, the holders of
Series B preferred stock shall have the right to elect two members and the
holders of Series A preferred stock and common stock shall have the right to
elect one member, voting as separate classes.
7. COMMON STOCK
The Company's Articles of Incorporation, as amended, authorize the Company
to issue 40,000,000 shares of $0.001 par value Common Stock. A portion of the
shares sold are subject to a right of repurchase by the Company subject to
vesting, which is generally over a four year period
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. COMMON STOCK (CONTINUED)
from the earlier of grant date or employee hire date, as applicable, until
vesting is complete. At June 30, 1999, there were 469,882 shares subject to
repurchase.
At June 30, 1999, the Company had reserved shares of common stock for future
issuances as follows:
<TABLE>
<S> <C>
Conversion of Series A convertible preferred stock.......... 4,018,005
Conversion of Series B mandatorily redeemable preferred
stock..................................................... 1,042,000
Conversion of Series C convertible preferred stock.......... 784,570
Exercise and conversion of options for Series A convertible
preferred stock........................................... 249,870
Exercise of common stock options............................ 1,469,061
---------
7,563,506
=========
</TABLE>
8. STOCK PLANS
1998 EXECUTIVE STOCK PLAN
In May 1998, the Company's Board of Directors adopted the 1998 Executive
Stock Plan (the 1998 Plan) and 609,882 shares of common stock were reserved for
issuance under the 1998 plan. Also in May 1998 the Company granted rights to
purchase 609,882 shares of common stock to the Chief Executive Officer of the
Company. The exercise price of the shares was $4.50. The Company has the right
to repurchase 469,882 shares of common stock at $4.50, which right shall lapse
at a rate of 1/48 of the shares at the end of each calendar month following the
Chief Executive Officer's commencement of employment with the Company. Subject
to other conditions, 140,000 shares are subject to repurchase by the Company at
a repurchase price of $4.50. In January 1999, the Company authorized an
additional 390,118 shares for issuance under this plan, for a total of 1,000,000
shares.
1997 AND 1995 STOCK PLANS
In March 1997, the Company's Board of Directors adopted the 1997 Stock Plan.
At the time of adoption, all of the remaining shares available under the 1995
Stock Plan were rolled into the 1997 Stock Plan and 610,000 shares of common
stock were reserved for issuance under the 1997 Stock Plan. The provisions of
the 1997 Stock Plan (the "Plan") provide for incentive stock options to be
issued to employees and nonstatutory stock options and stock purchase rights to
be issued to employees and consultants.
The exercise price of incentive stock options and nonstatutory stock
options granted under the Plan must be at least 100% and 85%, respectively,
of the fair value of the shares on the date of grant as determined by the
Company's Board of Directors. Options generally expire ten years from the
date of the grant or such shorter term as may be provided in the option
agreement. Options granted under the Plan typically vest over a four year
period at a rate of 25% after the first year and ratably each month
thereafter.
Stock Purchase Rights provide for issuance of common stock at not less than
85% of the fair market value of the stock. The Plan provides that the
Administrator of the Plan shall advise the offeree in writing of the terms,
conditions and restrictions related to the offer. Restricted stock
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK PLANS (CONTINUED)
purchases generally vest 25% after the first year and 1/48th each month
thereafter. Unvested shares are subject to repurchase upon termination of
employment.
Activity under the Plan is as follows:
<TABLE>
<CAPTION>
SERIES A
PREFERRED STOCK
---------------------------------
1995 PLAN WEIGHTED
OPTIONS OUTSTANDING AVERAGE
-------------------- EXERCISE
SHARES NUMBER PRICE
AVAILABLE OF SHARES PER SHARE
--------- -------------------- ----------
<S> <C> <C> <C>
Balances, July 1, 1997......................... -- 1,067,214 $0.85
Options exercised............................ -- (218,245) $0.55
Options returned to Plan..................... 168,849 (168,849) $1.80
Options transferred from 1995 Plan to 1997
Plan....................................... (168,849) --
-------- --------- -----
Balances, June 30, 1998........................ -- 680,120 $0.71
Options exercised............................ -- (311,403) $0.59
Options returned to Plan..................... 118,848 (118,848) $1.01
Options transferred from 1995 Plan to 1997
Plan....................................... (118,848) -- --
-------- --------- -----
Balances, June 30, 1999........................ -- 249,869 $0.71
Options returned to Plan..................... 1,823 (1,823) $1.58
Options transferred from 1995 Plan to 1997
Plan....................................... (1,823) -- --
-------- --------- -----
Balances, September 30, 1999
(unaudited).................................. -- 248,046 $0.70
======== ========= =====
</TABLE>
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK PLANS (CONTINUED)
Activity under the 1997 and 1998 Stock Plans is as follows:
<TABLE>
<CAPTION>
COMMON STOCK
-------------------------------------------------------------------------------
1997 PLAN OPTIONS WEIGHTED 1998 EXECUTIVE PLAN WEIGHTED
OUTSTANDING AVERAGE OPTIONS OUTSTANDING AVERAGE
------------------ EXERCISE -------------------- EXERCISE
SHARES NUMBER PRICE SHARES NUMBER PRICE
AVAILABLE OF SHARES PER SHARE AVAILABLE OF SHARES PER SHARE
---------- ------------------ ---------- --------- -------------------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balances, July 1, 1997............. 584,689 184,090 $ 1.55 -- -- --
Additional shares authorized..... 770,118 609,882 -- --
Options granted.................. (1,231,820) 1,231,820 $ 2.97 (609,882) 609,882 $4.50
Options exercised................ -- (868) $ 2.35 -- -- --
Options returned to plan......... 318,399 (318,399) $ 1.89 -- -- --
Options transferred to 1997 Plan
from 1995 Plan................. 168,849 -- -- -- --
---------- --------- -------- --------
Balances, June 30, 1998............ 610,235 1,096,643 $ 3.05 -- 609,882 $4.50
Options transferred to 1998 Plan
from 1997 Plan................. (390,118) -- -- 390,118 -- --
Options granted.................. (553,833) 553,833 $ 5.06 (425,000) 425,000 $4.85
Options exercised................ -- (112,753) $ 2.50 -- (647,382) $4.50
Options returned to plan......... 421,162 (421,162) $ 3.43 35,000 (35,000) $4.50
Options transferred to 1997 Plan
from 1995 Plan................. 118,848 -- -- -- --
---------- --------- -------- -----
Balances, June 30, 1999............ 206,294 1,116,561 $ 3.95 118 352,500 $4.93
---------- --------- -------- -------- -----
Options granted.................. (108,500) 108,500 $13.74 -- -- --
Options exercised................ -- (847) $56.67 -- -- --
Options returned to plan......... 22,335 (22,335) $ 3.93 -- -- --
Options transferred to 1997 Plan
from 1995 Plan................. 1,823 -- -- -- -- --
---------- --------- -------- -------- -----
Balances, September 30, 1999
(unaudited)...................... 121,952 1,201,879 $ 4.80 118 352,500 $4.93
========== ========= ====== ======== ======== =====
</TABLE>
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK PLANS (CONTINUED)
At June 30, 1998 and 1999, vested options to purchase 512,488 shares and
562,876 shares, respectively, of stock were unexercised.
The following summarizes information about fixed stock options outstanding
at June 30, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- --------------------------------------------------------------- ------------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AVERAGE WEIGHTED OUTSTANDING WEIGHTED
RANGE OF AT REMAINING AVERAGE AT AVERAGE
EXERCISE JUNE 30, CONTRACTUAL EXERCISE JUNE 30, EXERCISE
PRICES 1999 LIFE (YEARS) PRICE 1999 PRICE
- --------------------- ------------ ------------ --------- ------------ ---------
<S> <C> <C> <C> <C> <C>
$0.24 129,709 5.94 $0.24 123,195 $0.24
$1.00 52,701 7.00 $1.00 45,888 $1.00
$1.50-$2.00 291,351 7.84 $1.70 198,512 $1.67
$2.75-$3.25 193,175 8.39 $2.94 77,151 $2.92
$4.50 885,494 9.40 $4.50 118,130 $4.50
$6.50 41,500 9.79 $6.50 -- $6.50
$7.50 125,000 9.97 $7.50 -- $7.50
--------- ---- ----- ------- -----
1,718,930 8.75 $3.70 562,876 $2.07
========= ==== ===== ======= =====
</TABLE>
The weighted average fair value of those options granted in 1998 and 1999
was $0.43 and $2.25, respectively.
The fair value of each option grant is estimated on the date of grant using
the minimum value method with the following weighted average assumptions:
<TABLE>
<CAPTION>
1998 1999
---------- ----------
<S> <C> <C>
Risk-free interest rate............ 5.47-5.83% 4.23-5.66%
Expected life...................... 2.75 years 2.75 years
Dividend yield..................... -- --
</TABLE>
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation". Had compensation cost for the Stock Plans been determined based
on the fair value at the grant date for awards in 1998
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK PLANS (CONTINUED)
and 1999, consistent with the provisions of SFAS No. 123, the Company's net loss
for the years ended June 30, 1998 and 1999 would have increased as follows
(AMOUNTS IN THOUSANDS):
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30,
-------------------
1998 1999
-------- --------
<S> <C> <C>
Net loss--as reported.................... $(4,358) $(6,070)
Net loss--pro forma...................... $(4,470) $(7,035)
</TABLE>
OPTION AGREEMENTS
In October 1999, the Company granted 3,333 options to consultants in return
for recruiting consulting services and recorded an expense of $13,500
(unaudited).
In March 1998, the Company recorded an expense of $541,000 as a result of
changes in the terms of options granted to an employee.
STOCK-BASED COMPENSATION
In connection with certain stock grants to employees during the year
ended June 30, 1999 and the three months ended September 30, 1999, the
Company recorded unearned stock-based compensation totaling $1,457,000 and
$761,250, respectively which is being amortized over the four year vesting
period of the related options. Amortization of this stock-based compensation
recognized during the three months ended September 30, 1999 and the year
ended June 30, 1999 totaled $186,000 and $476,000 respectively.
RESTRICTED STOCK
The Company has the right under its stock option plans, to repurchase
unvested shares of restricted stock from employees which terminate employment
prior to the date at which such shares of restricted stock vest. The Company
repurchased 121,000 and 117,000 shares of restricted stock during the years
ended June 30, 1998 and 1999.
9. SHAREHOLDER NOTES RECEIVABLE
The Company has issued notes to certain Executive Officers in order for them
to purchase shares of the Company's common stock. The notes' principal is
collateralized by the shares of common stock and is due on the earlier of the
sale of the restricted stock, ten years from the date of issue or termination.
Under the terms of the notes, interest accrues at rates ranging from 5.46% and
6.72% per annum and is payable at least annually. The notes' interest is
collateralized by the shares of common stock and other assets of the Executive
Officers.
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS THREE MONTHS
JUNE 30, ENDED ENDED
------------------- SEPTEMBER 30, SEPTEMBER 30,
1998 1999 1998 1999
-------- -------- -------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Current:
Federal.................... $ -- $ -- $ -- $ --
State...................... 3 5 1 --
Foreign.................... 322 563 141 140
---- ---- ---- ----
325 568 142 140
---- ---- ---- ----
Deferred:
Federal.................... -- -- -- --
State...................... -- -- -- --
---- ---- ---- ----
-- -- -- --
---- ---- ---- ----
$325 $568 $142 $140
==== ==== ==== ====
</TABLE>
The provision for income taxes primarily relates to foreign withholding
taxes on foreign revenues earned by the Company. These withholding taxes paid
may be creditable against U.S. federal income taxes in future periods.
The federal and state tax effects of temporary differences as of June 30,
1998, and 1999 and the three months ended September 30, 1999, that give rise to
significant portions of the deferred tax assets, are presented below (IN
THOUSANDS):
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30, THREE MONTHS ENDED
------------------- SEPTEMBER 30,
1998 1999 1999
-------- -------- ---------------------
<S> <C> <C> <C>
Deferred tax assets:
Compensation related accruals.... $ 78 $ 181 $ 472
Other accrued liabilities and
reserves....................... 642 470 426
Property and equipment,
principally due to differences
in depreciation................ -- 149 148
Intangible assets................ 646 638 636
Research and development tax
credits........................ 486 809 809
Foreign tax credits.............. 323 886 886
Net operating losses............. 864 2,907 3,442
------- ------- -------
Total deferred tax assets...... 3,039 6,040 6,819
Valuation allowance................ (2,801) (6,040) (6,819)
------- ------- -------
Net deferred tax assets............ 238 -- --
------- ------- -------
Deferred tax liabilities:
Property and equipment,
principally due to differences
in depreciation................ (238) -- --
------- ------- -------
$ -- $ -- $ --
======= ======= =======
</TABLE>
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
The Company has established a valuation allowance against its deferred tax
assets due to uncertainty surrounding the realization of such assets. Management
evaluates annually the recoverability of the net deferred tax assets and the
level of valuation allowance.
At June 30, 1999, the Company has federal and state net operating loss
carryforwards ("NOLs") of approximately $7,484,083 and $5,976,820, respectively.
These NOLs expire in the years through 2019. Under the Tax Reform Act of 1986,
the amounts of and benefits from net operating loss carryforwards may be
impaired or limited in certain circumstances. Events which cause limitations in
the amount of net operating losses that the Company may utilize in any one year
include, but are not limited to, a cumulative ownership change of more than 50%,
as defined, over a three year period.
At June 30, 1999, the Company had paid $407,934 of foreign withholding taxes
which are recoverable against future taxable income in Japan. As these amounts
are unlikely to be recovered, they have been recorded as income tax expense.
As of September 30, 1999, the Company has federal and state net operating
loss carryforwards ("NOLs") of approximately $8,941,000 and $6,700,000,
respectively. These NOLs expire in varying amounts beginning in 2011 and 2001
for federal and state income tax purposes, respectively. Under the Tax Reform
Act of 1986, the amounts of and benefits from net operating loss carryforwards
may be impaired or limited in certain circumstances. Events which cause
limitations in the amount of net operating losses that the Company may utilize
in any one year include, but are not limited to, a cumulative ownership change
of more than 50%, as defined, over a three year period.
The Company has not provided taxes on undistributed earnings of foreign
subsidiaries because the Company assumes that the foreign subsidiaries will
reinvest the undistributed earnings indefinitely.
The Company's effective tax rate differs from the U.S. federal statutory
income tax rate as follows:
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30,
-----------------------
1998 1999
-------- --------
<S> <C> <C>
Income tax (benefit) provision at statutory rate........... (34.0)% (34.0)%
State income taxes......................................... -- 0.1
Foreign taxes.............................................. -- 10.4
Change in valuation allowance.............................. 48.3 --
NOL not benefitted......................................... -- 34.0
Other...................................................... (6.2) (0.2)
----- -----
Effective tax rate......................................... 8.1% 10.3%
===== =====
</TABLE>
11. RELATED PARTY TRANSACTIONS
Two investors who participated in the Company's Series C preferred stock
offerings are also customers of the Company. For the years ended June 30,
1998 and 1999, the Company had the
<PAGE>
CYGNUS SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RELATED PARTY TRANSACTIONS (CONTINUED)
following accounts receivable and deferred revenue balances, and earned revenue
from these related parties as follows (IN THOUSANDS):
<TABLE>
<CAPTION>
CUSTOMER A CUSTOMER B
------------------- ------------------
YEAR ENDED YEAR ENDED
JUNE 30, JUNE 30,
------------------- ------------------
1998 1999 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Accounts receivable......................................... $ 850 $ 90 $ -- $1,045
Deferred revenue............................................ $ 934 $310 $ -- $ 641
Revenue..................................................... $1,447 $889 $ -- $1,367
</TABLE>
12. EMPLOYEE BENEFIT PLAN
The Company maintains a 401(k) savings plan to provide retirement benefits
through tax deferred salary deductions for all its employees. The Company may
make discretionary matching contributions as determined by the Board of
Directors, which cannot exceed a percentage of the annual aggregate salaries of
those employees eligible to participate. No Company contributions have been made
to the plan to date.
13. SUBSEQUENT EVENT (UNAUDITED)
On January 2000, the Company completed a merger with Red Hat, Inc., whereby
all of the outstanding shares of common and preferred stock of the Company was
exchanged for 10,867,966 shares of Red Hat common stock plus all outstanding
options were exchanged for options to purchase Red Hat common stock at the
exchange ratio.
<PAGE>
Exhibit 99.6
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The unaudited pro forma combined balance sheet as of November 30, 1999
and the unaudited pro forma combined statements of operations for the year
ended February 28, 1999 and the nine months ended November 30, 1999 combine
the Red Hat, Cygnus and HKS balance sheet and statements of operations and
the historical balance sheets and historical statements of operations of Red
Hat, Cygnus and HKS as if the acquisition of Cygnus and HKS, which occurred
on January 7, 2000, had been completed on November 30, 1999 for purposes of
the presentation of the unaudited pro forma combined balance sheet and as of
March 1, 1998 and March 1, 1999 for purposes of the presentation of the
unaudited pro forma statements of operations.
We purchased all of the outstanding common stock of HKS on January 6,
2000 in exchange for the issuance of up to a maximum of 796,670 shares of our
common stock. The total purchase price of the HKS acquisition was
approximately $57.9 million and has been accounted for using the purchase
method of accounting. At closing, we issued 478,004 shares of our common
stock with a fair value of approximately $57.7 million to the stockholders of
HKS. We committed to issue up to 239,000 shares to certain HKS stockholders
over a three-year period contingent upon their continued employment with us.
Up to an additional 79,666 shares will be issued upon the achievement by the
HKS business of certain performance targets which shares are not reflected in
these pro forma combined financial statements due to uncertainty of whether
they will be issued. The unaudited pro forma combined financial statements
should be read together with the consolidated financial statements including
the notes to these statements of Red Hat and the historical financial
statements of HKS and Cygnus.
The pro forma adjustments reflecting the consummation of the HKS
acquisition are based on the purchase method of accounting, available
financial information and certain estimates and assumptions set forth in the
notes to the unaudited pro forma combined financial statements. The unaudited
pro forma combined financial statements reflects our best estimates; however,
the final purchase price allocation and the actual financial position and
results of operations may differ significantly from the pro forma amounts
reflected herein due to various factors, including, without limitation,
access to additional financial information and changes in value. The pro
forma adjustments do not reflect any operating efficiencies or cost savings
that may be achievable with respect to the combined businesses of Red Hat and
HKS.
The unaudited pro forma financial statements for the year ended February
28, 1999 and as of and for the nine months ended November 30, 1999, do not
purport to represent what the actual financial condition or results of
operations of the combined businesses would have been if the acquisition of
Cygnus and HKS had occurred on the dates indicated in these pro forma combined
financial statements nor does this information purport to project our results
or financial position for any future period.
25
<PAGE>
PRO FORMA COMBINED CONSOLIDATED
BALANCE SHEET
NOVEMBER 30, 1999
<TABLE>
<CAPTION>
CYGNUS POOLING
RED HAT, INC. SOLUTIONS RECLASSIFICATIONS
-------------- -------------- ----------------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents............... $ 11,997,157 $ 9,392,552
Short-term investments.................. 7,630,705 --
Accounts receivable, net................ 4,536,431 4,456,891
Inventory............................... 1,853,711 --
Prepaids and other current assets....... 736,580 794,247
Income tax receivable -- --
------------ ------------ -----------
Total current assets.................. 26,754,584 14,643,690 $ --
Property and equipment, net............... 5,095,166 2,545,731
Other Assets.............................. 1,814,781 9,008
Investments............................... 76,633,119 -- --
------------ ------------ -----------
Total assets.......................... $110,297,650 $ 17,198,429 $ --
Current liabilities
Accounts payable........................ $ 4,589,370 $ 910,740
Royalties Payable....................... 221,343 --
Accrued Expenses........................ 2,167,704 3,472,927
Deferred revenue........................ 4,123,853 5,459,149
Short-term notes payable................ -- 504,968
Current portion of capital lease
obligation............................ 457,581 32,491
------------ ------------ -----------
Total current liabilities............. 11,559,851 10,380,275 --
Long-term liabilities
Long-term notes payable................. -- 583,333
Long-term capital lease obligations..... 203,012 42,990
------------ ------------ -----------
Total long-term liabilities........... 203,012 626,323 --
Mandatorily redeemable preferred stock.. -- 6,252,000 --
Stockholders' equity:
Preferred stock......................... -- 12,659,883 86,351 (e)
Common stock............................ 13,758 5,406,952 (5,406,801)(e)
Additional paid-in capital.............. 115,142,628 761,250 5,320,450 (e)
Shareholder receivable.................. -- (2,824,908)
Deferred compensation................... (7,115,756) (1,358,901)
Accumulated other comprehensive loss.... (212,289) --
Accumulated deficit..................... (9,293,554) (14,704,445)
------------ ------------ -----------
Total stockholders'
equity.............................. 98,534,787 (60,169) --
------------ ------------ -----------
Total liabilities and stockholders'
equity.............................. $110,297,650 $ 17,198,429 $ --
============ ============ ===========
</TABLE>
<TABLE>
<CAPTION>
RED HAT/
CYGNUS
POOLED HKS
NOVEMBER 30, SEPTEMBER 30, PRO FORMA
1999 1999 COMBINED ADJUSTMENTS PRO FORMA
-------------- -------------- ------------- ------------- -------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents............... $ 21,389,709 $ 62,988 $ 21,452,697 $ 21,452,697
Short-term investments.................. 7,630,705 -- 7,630,705 7,630,705
Accounts receivable, net................ 8,993,322 -- 8,993,322 8,993,322
Inventory............................... 1,853,711 -- 1,853,711 1,853,711
Prepaids and other current assets....... 1,530,827 8,585 1,539,412 1,539,412
------------ -------- ------------ ------------ -------------
Total current assets.................. 41,398,274 71,573 41,469,847 41,469,847
Property and equipment, net............... 7,640,897 28,150 7,669,047 7,669,047
Other Assets.............................. 1,823,789 -- 1,823,789 1,823,789
Goodwill and other intangibles............ -- 575,721 575,721 $ (575,721)(c) 57,743,278
57,743,278 (a)
Investments............................... 76,633,119 -- 76,633,119 76,633,119
------------ -------- ------------ ------------ -------------
Total assets.......................... $127,496,079 $675,444 $128,171,523 $ 57,167,557 $ 185,339,080
============ ======== ============ ============ =============
Current liabilities
Accounts payable........................ $ 5,500,110 $108,322 $ 5,608,432 $ 5,608,432
Royalties Payable....................... 221,343 -- 221,343 221,343
Accrued Expenses........................ 5,640,631 48,131 5,688,762 5,688,762
Deferred revenue........................ 9,583,002 10,977 9,593,979 9,593,979
Short-term notes payable................ 504,968 -- 504,968 504,968
Current portion of capital lease
obligation............................ 490,072 1,267 491,339 491,339
------------ -------- ------------ ------------ -------------
Total current liabilities............. 21,940,126 168,697 22,108,823 22,108,823
Long-term liabilities
Long-term notes payable................. 583,333 -- 583,333 583,333
Long-term capital lease obligations..... 246,002 5,878 251,880 251,880
------------ -------- ------------ ------------ -------------
Total long-term liabilities........... 829,335 5,878 835,213 835,213
Mandatorily redeemable preferred stock.... 6,252,000 -- 6,252,000 6,252,000
Stockholders' equity:
Preferred stock......................... 12,746,234 -- 12,746,234 12,746,234
Common stock............................ 13,909 962,233 976,142 (962,233)(d) 13,957
48 (a)
Additional paid in capital.............. 121,224,328 -- 121,224,328 57,670,644 (a) 207,730,813
28,835,350 (b)
Shareholder receivable.................. (2,824,908) (2,757) (2,827,665) (2,827,665)
Deferred compensation................... (8,474,657) -- (8,474,657) (28,835,350)(b) (37,310,007)
Accumulated other comprehensive loss.... (212,289) -- (212,289) (212,289)
Accumulated deficit..................... (23,997,999) (458,607) (24,456,606) 458,607 (d) (23,997,999)
------------ -------- ------------ ------------ -------------
Total stockholders'
equity (deficit).................... 98,474,618 500,869 98,975,487 57,167,557 156,143,044
------------ -------- ------------ ------------ -------------
Total liabilities and stockholders'
equity (deficit).................... $127,496,079 $675,444 $128,171,523 $ 57,167,557 $ 185,339,080
============ ======== ============ ============ =============
</TABLE>
- ------------------------------
(a) Reflects the value of the 478,004 shares of our common stock issued to
acquire HKS on January 6, 2000, based on the average closing price of our
common stock of $120.65 for the three day period immediately preceding and
following the date of our announcement of the acquisition of HKS. The
following is a calculation of the goodwill and other intangibles recorded in
the HKS acquisition:
<TABLE>
<S> <C>
Market Value of Shares Issued $57,670,692
Net liabilities assumed 72,095
-----------
Goodwill and other intangibles $57,743,278
</TABLE>
(b) Reflects the value of the 239,000 shares of our common stock to be issued to
certain HKS stockholders contingent on their continued employment with us
for a period of three years after the date of the acquisition.
(c) Reflects the elimination of the existing goodwill on the books of HKS.
(d) Reflects the elimination of the stockholders' equity balances of HKS as this
acquisition is being accounted for using the purchase method of accounting.
(e) Reflects the reclassification of the stockholders' equity balances of
Cygnus for the exchange of Cygnus common stock for Red Hat common stock
at the exchange ratio.
26
<PAGE>
PRO FORMA COMBINED CONSOLIDATED
UNAUDITED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED FEBRUARY 28, 1999
<TABLE>
<CAPTION>
CYGNUS
RED HAT, INC. SOLUTIONS
------------- ---------
<S> <C> <C>
Revenue:
Software and related products..... $ 10,012,923 $ 1,127,468
Web advertising................... -- --
Services and other................ 776,996 21,114,295
------------ ------------
Total revenue................. 10,789,919 22,241,763
------------ ------------
Cost of revenue:
Software and related products..... 4,012,685 92,218
Web advertising................... -- --
Services and other................ 28,148 8,582,538
------------ ------------
Total cost of revenue........ 4,040,833 8,674,756
------------ ------------
Gross profit........................ 6,749,086 13,567,007
------------ ------------
Operating expense:
Sales and marketing............... 3,083,162 7,968,387
Research and development.......... 2,220,115 6,257,703
General and administrative........ 1,483,909 4,180,652
Stock-based compensation.......... -- 227,261
Merger and acquisitions........... -- --
Purchased in process research
and development................. -- --
Amortization of goodwill.......... -- --
------------ ------------
Total operating expense...... 6,787,186 18,634,003
------------ ------------
Income (loss) from operations....... (38,100) (5,066,996)
Other income (expense):
Interest income................... 171,181 204,858
Interest expense.................. (9,463) (327,209)
------------ ------------
Other income (expense), net..... 161,718 (122,351)
------------ ------------
Income (loss) before income taxes... 123,618 (5,189,347)
Provision for income taxes.......... 214,686 507,530
------------ ------------
Net income (loss)................... (91,068) (5,696,877)
Accretion for mandatorily redeemable
preferred stock................... (39,356) --
------------ ------------
Net income (loss) available to
common stockholders............... $ (130,424) $ (5,696,877)
============ ============
Net loss per share basic
and diluted....................... $ (0.00)
============
Weighted average shares outstanding. 47,100,101
============
</TABLE>
<TABLE>
<CAPTION>
RED HAT/
CYGNUS
POOLED HKS
YEAR ENDED YEAR ENDED
FEBRUARY 28, DECEMBER 31, PRO FORMA PRO FORMA
1999 1998 COMBINED ADJUSTMENTS COMBINED
-------------- ------------------- ------------ ------------ ------------
(AUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Software and related products.... $11,140,391 $ 33,694 $ 11,174,085 $ 11,174,085
Web.............................. -- -- -- --
Services and other............... 21,891,291 2,443 21,893,734 21,893,734
-- --
----------- --------- ------------ ------------ ------------
Total revenue................ 33,031,682 36,137 33,067,819 33,067,819
----------- --------- ------------ ------------ ------------
Cost of Revenue
Software and related
products..................... 4,104,903 23,364 4,128,267 4,128,267
Web............................ -- -- -- --
Services and other............. 8,610,686 21,238 8,631,924 8,631,924
----------- --------- ------------ ------------ ------------
Total cost of revenue........ 12,715,589 44,602 12,760,191 12,760,191
----------- --------- ------------ ------------ ------------
Gross profit (loss).............. 20,316,093 (8,465) 20,307,628 20,307,628
----------- --------- ------------ ------------ ------------
Operating expense:
Sales and marketing............ 11,051,549 28,048 11,079,597 11,079,597
Research and development....... 8,477,818 114,155 8,591,973 8,591,973
General and administrative..... 5,664,561 143,992 5,808,553 5,808,553
Stock-based compensation....... 227,261 -- 227,261 $ 9,611,783 (b) 9,839,044
Mergers and acquisitions....... -- -- -- --
Purchased in process research
and development.............. -- -- -- --
Amortization of goodwill......... -- -- -- 19,247,759(a) 19,247,759
----------- --------- ------------ ------------ ------------
Total operating expenses..... 25,421,189 286,195 25,707,384 28,859,543 54,566,927
----------- --------- ------------ ------------ ------------
Income (loss) from operations.... (5,105,096) (294,660) (5,399,756) (28,859,543) (34,259,299)
----------- --------- ------------ ------------ ------------
Other income (expense)
Interest income................ 376,039 -- 376,039 376,039
Interest expense............... (336,672) -- (336,672) (336,672)
----------- --------- ------------ ------------ ------------
Other income (expense), net.. 39,367 -- 39,367 39,367
----------- --------- ------------ ------------ ------------
Income (loss) before income
taxes.......................... (5,065,729) (294,660) (5,360,389) (28,859,543) (34,219,932)
Provision for (benefit from)
income taxes................... 722,216 -- 722,216 722,216
----------- --------- ------------ ------------ ------------
Net loss......................... (5,787,945) (294,660) (6,082,605) (28,859,543) (34,942,148)
Accretion on mandatorily
redeemable preferred stock..... (39,356) -- (39,356) (39,356)
----------- --------- ------------ ------------ ------------
Net loss available to common
stockholders................... $(5,827,301) $(294,660) $ (6,121,961) $(28,859,543) $(34,981,504)
=========== ========= ============ ============ ============
Net loss per share
basic and diluted.............. $ (0.12) $ (0.39)
============
Weighted average shares
outstanding..... 49,628,096 $ 88,865,644
============
</TABLE>
- ------------------------------
(a) Reflects amortization of goodwill and intangible assets recorded in the HKS
acquisition using a three year life assuming the acquisition occurred on
March 1, 1998.
(b) Reflects amortization of deferred compensation recorded as part of the HKS
acquisition over the required employment period of three years assuming the
acquisition occurred on March 1, 1998.
27
<PAGE>
PRO FORMA COMBINED CONSOLIDATED
UNAUDITED STATEMENT OF OPERATIONS DATA
FOR THE NINE MONTHS ENDED NOVEMBER 30, 1999
<TABLE>
<CAPTION>
CYGNUS
RED HAT, INC. SOLUTIONS
------------- ---------
<S> <C> <C>
Revenue:
Software and related products..... $ 8,559,330 $ 1,176,368
Web advertising................... 626,384 --
Services and other................ 3,409,967 15,839,482
------------ ------------
Total revenue................. 12,595,681 17,015,850
------------ ------------
Cost of revenue:
Software and related products..... 4,738,312 105,268
Web advertising................... 626,756 --
Services and other................ 2,048,770 8,510,344
------------ ------------
Total revenue................ 7,413,838 8,615,612
------------ ------------
Gross profit........................ 5,181,843 8,400,238
------------ ------------
Operating expense:
Sales and marketing............... 7,609,146 7,744,517
Research and development.......... 4,157,907 3,736,970
General and administrative........ 2,870,778 2,757,533
Stock-based compensation.......... 1,009,503 632,004
Merger and acquisitions........... 123,887 --
Purchased in process research
and development................. -- --
------------ ------------
Total operating expense...... 15,771,221 14,871,024
------------ ------------
Income (loss) from operations....... (10,589,378) (6,470,786)
Other income (expense):
Interest income................... 1,828,065 680,101
Interest expense.................. (15,140) (424,768)
------------ ------------
Other income (expense), net..... 1,812,925 255,333
------------ ------------
Income (loss) before income taxes... (8,776,453) (6,215,453)
Provision for income taxes.......... -- 240,981
------------ ------------
Net income (loss)................... (8,776,453) (6,456,434)
Accretion for mandatorily redeemable
preferred stock................... (82,473) --
------------ ------------
Net income (loss) available to
common stockholders............... $ (8,858,926) $ (6,456,434)
============ ============
Net loss per share basic
and diluted....................... $ (0.11)
============
Weighted Average shares outstanding. 84,354,922
</TABLE>
<TABLE>
<CAPTION>
HKS
RED HAT/ PERIOD HKS
CYGNUS FROM PERIOD FROM
POOLED JANUARY 1, MARCH 10,
NINE MONTHS 1999 1999
ENDED TO TO
NOVEMBER 30, MARCH 9, SEPTEMBER 30, PRO FORMA PRO FORMA
1999 1999 1999 COMBINED ADJUSTMENTS COMBINED
------------- ----------- -------------- ------------ ------------ ------------
(UNAUDITED) (AUDITED) (AUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Software and related products......... $ 9,735,698 $ 11,714 $ 84,578 $ 9,831,990 $ 9,831,990
Web................................... 626,384 -- -- 626,384 626,384
Services and other.................... 19,249,449 5,858 4,669 19,259,976 19,259,976
------------ -------- --------- ------------ ------------ ------------
Total revenue..................... 29,611,531 17,572 89,247 29,718,350 29,718,350
------------ -------- --------- ------------ ------------ ------------
Cost of Revenue
Software and related products....... 4,843,580 8,872 25,354 4,877,806 4,877,806
Web................................. 626,756 -- 15,025 641,781 641,781
Services and other.................. 10,559,114 5,258 -- 10,564,372 10,564,372
------------ -------- --------- ------------ ------------ ------------
Total cost of revenue............. 16,029,450 14,130 40,379 16,083,959 16,083,959
------------ -------- --------- ------------ ------------ ------------
Gross profit.......................... 13,582,081 3,442 48,868 13,634,391 13,634,391
------------ -------- --------- ------------ ------------ ------------
Operating expense:
Sales and marketing................. 15,353,663 -- 23,362 15,377,025 15,377,025
Research and development............ 7,894,877 29,703 87,826 8,012,406 8,012,406
General and administrative.......... 5,628,311 43,462 395,755 6,067,528 6,067,528
Stock-based compensation............ 1,641,507 -- -- 1,641,507 7,208,838(b) 8,850,345
Mergers and acquisitions............ 123,887 -- -- 123,887 123,887
Purchased in process research and
development....................... -- -- -- --
Amortization of Goodwill.......... -- -- -- -- 14,435,819(a) 14,435,819
------------ -------- --------- ------------ ------------ ------------
Total operating expenses.......... 30,642,245 73,165 506,943 31,222,353 21,644,657 52,867,010
------------ -------- --------- ------------ ------------ ------------
Income (loss) from operations......... (17,060,164) (69,723) (458,075) (17,587,962) (21,644,657) (39,232,619)
------------ -------- --------- ------------ ------------ ------------
Other income (expense)
Interest income..................... 2,508,166 -- -- 2,508,166 2,508,166
Interest expense.................... (439,908) (105) (532) (440,545) (440,545)
------------ -------- --------- ------------ ------------ ------------
Other income (expense), net....... 2,068,258 (105) (532) 2,067,621 2,067,621
------------ -------- --------- ------------ ------------ ------------
Income (loss) before income taxes..... (14,991,906) (69,828) (458,607) (15,520,341) (20,470,499) (37,164,988)
Provision for (benefit from) income
taxes............................... 240,981 -- -- 240,981 240,981
------------ -------- --------- ------------ ------------ ------------
Net loss.............................. (15,232,887) (69,828) (458,607) (15,761,322) (20,470,499) (36,924,017)
Accretion on mandatorily redeemable
preferred stock..................... (82,473) -- -- (82,473) (82,473)
------------ -------- --------- ------------ ------------ ------------
Net loss available to common
stockholders........................ $(15,315,360) $(69,828) $(458,607) $(15,843,795) $(20,470,499) $(37,006,490)
============ ======== ========= ============ ============ ============
Net loss per share--
basic and diluted................... $ (0.18) $ (0.29)
============
Weighted average shares outstanding... 85,691,876
============
</TABLE>
- ------------------------------
(a) Reflects amortization of goodwill and intangible assets recorded in the HKS
acquisition using a three year life assuming the acquisition occurred on
March 1, 1999.
(b) Reflects amortization of deferred compensation recorded as part of the HKS
acquisition over the required employment period of three years assuming the
acquisition occurred on March 1, 1999.
28
