<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 28, 2000
REGISTRATION NO. 333-94775
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
RED HAT, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 7375 06-1364380
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
------------------------------
2600 MERIDIAN PARKWAY
DURHAM, N.C. 27713
(919) 547-0012
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
------------------------------
MATTHEW SZULIK
PRESIDENT AND CHIEF EXECUTIVE OFFICER
RED HAT, INC.
2600 MERIDIAN PARKWAY
DURHAM, NC 27713
(919) 547-0012
(Name, address including zip code, and telephone number, including area code, of
agent for service)
------------------------------
COPIES TO:
<TABLE>
<S> <C>
WILLIAM J. SCHNOOR, JR., ESQ. MARK G. BORDEN, ESQ.
GREGG A. GRINER, ESQ. PATRICK J. RONDEAU, ESQ.
Testa, Hurwitz & Thibeault, LLP Hale and Dorr LLP
125 High Street 60 State Street
Boston, Massachusetts 02110 Boston, Massachusetts 02109
Telephone: (617) 248-7000 Telephone: (617) 526-6000
Telecopy: (617) 248-7100 Telecopy: (617) 526-5000
</TABLE>
------------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date hereof. If any of the securities being
registered on this form are to be offered on a delayed or continuous basis
pursuant to Rule 415 under the Securities Act of 1933, check the following
box. / /
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. / /
------------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED
MAXIMUM PROPOSED
AGGREGATE MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE PER AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED (1) SHARE OFFERING PRICE (2) FEE (3)
<S> <C> <C> <C> <C>
Common Stock, $.0001 par value............... 4,600,000 $124.345 $571,984,700 $0
</TABLE>
(1) Includes 600,000 shares of common stock which may be purchased by the
underwriters to cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act of 1933, as amended, on the
basis of the average high and low prices of the Registrant's common stock on
January 7, 2000, as reported by Nasdaq.
(3) A registration fee of $151,004 was paid at the time of the initial filing of
this registration statement based on an estimate of the aggregate offering
price.
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION. DATED JANUARY 24, 2000.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THESE
SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING OFFERS TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
4,000,000 Shares
[LOGO]
Common Stock
----------------
Red Hat, Inc. is offering 2,750,000 of the shares of common stock to be sold
in the offering. The selling stockholders identified in this prospectus are
offering an additional 1,250,000 shares of common stock. Red Hat will not
receive any of the proceeds from the sale of shares being sold by the selling
stockholders.
The common stock is quoted on the Nasdaq National Market under the symbol
"RHAT". The last reported sale price of the common stock on January 13, 2000 was
$131.3125 per share.
SEE "RISK FACTORS" BEGINNING ON PAGE 7 TO READ ABOUT CERTAIN FACTORS YOU
SHOULD CONSIDER BEFORE BUYING SHARES OF THE COMMON STOCK.
------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY
HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY OR
ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
<TABLE>
<CAPTION>
Per Share Total
---------- -----------
<S> <C> <C>
Initial price to public.................................. $ $
Underwriting discount.................................... $ $
Proceeds, before expenses, to Red Hat.................... $ $
Proceeds, before expenses, to the selling stockholders... $ $
</TABLE>
If the underwriters sell more than 4,000,000 shares of common stock, the
underwriters have the option to purchase up to an additional 600,000 shares from
Red Hat at the initial price to public less the underwriting discount.
------------------------
The underwriters expect to deliver the shares against payment in New York,
New York on , 2000.
GOLDMAN, SACHS & CO.
CHASE H&Q
THOMAS WEISEL PARTNERS LLC
J.P. MORGAN & CO.
----------------
Prospectus dated , 2000.
<PAGE>
DESCRIPTION OF INSIDE FRONT COVER:
[Graphic Description]
This inside front cover contains the following:
A picture of the shrink-wrapped Official Red Hat Linux 6.1 operating system
package. This picture is surrounded by an all black background.
<PAGE>
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION AND OUR FINANCIAL STATEMENTS AND NOTES TO THOSE STATEMENTS APPEARING
ELSEWHERE IN THIS PROSPECTUS.
RED HAT
OUR BUSINESS
We are a leading global developer and provider of open source software and
solutions. Unlike proprietary software, open source software has publicly
available source code and can be copied, modified and distributed with minimal
restrictions. Our software and solutions are provided for a variety of computing
systems, ranging from desktops, workstations and servers to special-purpose
computing devices such as wireless telephones, personal digital assistants,
routers and phone switches. Our principal product, Red Hat Linux, represented
approximately 56% of new license shipments of Linux-based server operating
systems in the U.S. in 1998 and was the most popular Linux-based system,
preferred by 68% of U.S. users, according to International Data Corporation.
We offer professional services for the Red Hat Linux operating system,
related tools and libraries and popular open source applications. Our services
include technical support and maintenance, developer support, custom
development, consulting, training and education and hardware certification.
Our web site, REDHAT.COM, is a leading destination for open source software
users and developers and serves as the primary delivery mechanism and customer
interface for many of our solutions. REDHAT.COM also offers extensive news and
content for the open source community, an important forum for open source
software development, a commerce site and priority access for software downloads
and upgrades.
We are committed to serving the interests and needs of open source software
users and developers and to sharing our product developments with the open
source community. We generated, on a pooled basis with Cygnus Solutions, which
we acquired in January 2000, approximately $29.6 million in revenue for the nine
months ended November 30, 1999. Companies with which we have strategic
relationships include Cisco, Compaq, Dell, Hewlett Packard, IBM, Intel, Nokia,
Nortel, Oracle, SAP, Silicon Graphics and Sony Computer Entertainment.
OUR MARKET OPPORTUNITY
We believe open source software offers many potential benefits for
customers, users and vendors. Customers and users are able to acquire the
software at little or no cost, install the software on as many computing devices
as they wish, and customize the software to suit their particular needs. Vendors
are able to leverage the community of open source developers, allowing them to
reduce development costs and decrease their time to market. Vendors are also
able to distribute their products freely over the internet, enabling them to
create large global user bases quickly.
We believe open source solutions are particularly well-suited for a new
category of computing devices that provide low-cost, easy access to the
internet. Open source solutions are flexible, modular, and robust, and can be
tailored to fit within resource-constrained environments, while still taking
advantage of common application programming interfaces from desktop programming
environments. This new category of computing platforms includes mobile devices
such as personal digital assistants, wireless telephones, television set top
boxes, kiosks and game consoles, as well as special-purpose server devices such
as routers, phone switches, and dedicated file and e-mail servers. The growth of
the internet has generated significant demand for these devices. For example,
IDC predicts that by 2002, there will be more than 55 million mobile computing
devices and that by 2005, shipment of these devices will exceed shipment of
personal computers.
3
<PAGE>
We believe there is a growing opportunity to provide extensive professional
services relating to the development and use of open source products across
computing platforms, particularly for the enterprise market. Furthermore, we
believe that we are well positioned to realize this opportunity, given our
comprehensive suite of open source offerings and the popularity of Linux-based
solutions. Open source operating systems based on the Linux kernel are some of
the better known open source products. Linux-based operating systems represented
17% of new license shipments of server operating systems in 1998, according to
IDC. In addition, Linux-based operating systems are now the most commonly used
operating systems for web servers, representing approximately 29% of all
installations, according to the December 1999 Netcraft Web Server Survey.
OUR STRATEGY
We seek to enhance our position as a leading provider of open source
software and solutions by:
- increasing the adoption of open source software across all computing
platforms from servers to mobile computing devices, particularly through
technology alliances and through the sharing of our development efforts
and resources with third-party developers;
- expanding our presence in the enterprise market by increasing our
professional services capabilities and providing comprehensive offerings
of open source systems, tools and applications;
- continuing to enhance and expand our web site to create the definitive
online destination for the open source community;
- continuing to pursue strategic acquisitions and alliances;
- furthering our penetration into international markets; and
- continuing to invest in the development of open source technology.
RECENT DEVELOPMENTS
Since our initial public offering in August 1999 we have:
- acquired Cygnus Solutions, a leading developer and provider of open source
development tools and custom engineering services, which we believe
positions us to be the open source leader in both operating systems and
development tools;
- acquired Hell's Kitchen Systems, Inc., a leading developer of Linux- and
UNIX- based credit card processing software;
- enhanced our REDHAT.COM web site by launching "Wide Open News", a news
site, and our "Developer Network," a collection of technical and business
resources for developing software that runs on Red Hat Linux;
- released Red Hat Linux 6.1 in October 1999, including localized versions
for the German, French and Japanese markets; and
- established subsidiaries in Japan and Australia.
OUR HISTORY
Red Hat, Inc. was incorporated in Connecticut in March 1993 as ACC
Corp., Inc. In September 1995, ACC Corp., Inc. changed its name to Red Hat
Software, Inc. In September 1998, Red Hat Software, Inc. reincorporated in
Delaware. In June 1999, Red Hat Software, Inc. changed its name to Red
Hat, Inc. We made an initial public offering of our common stock in
August 1999. Unless the context otherwise requires, any reference to "Red Hat",
"we", "our" and "us" in this prospectus refers to Red Hat, Inc., a Delaware
corporation, and its subsidiaries and predecessors; all references to "Cygnus"
in this prospectus refer to Cygnus Solutions, Inc., a wholly-owned subsidiary of
Red Hat; and all references to "HKS" in this prospectus refer to
4
<PAGE>
Hell's Kitchen Systems, Inc., a wholly-owned subsidiary of Red Hat. Our
principal executive offices are located at 2600 Meridian Parkway, Durham, N.C.
27713. Our telephone number is (919) 547-0012.
"Red Hat", the Red Hat "Shadow Man" logo, "RPM", "PowerTools", "Red Hat
Certified Engineer", "RHCE", "Wide Open", "Always Open", "Red Hat Ready" and the
"Red Hat Ready" logo are trademarks or service marks of Red Hat. "Cygnus
Solutions", "GNUPro", "eCos", "eCosystem", "Source Navigator", "EL/IX" and
"Cygwin" are trademarks or service marks of Cygnus. Other trademarks and
tradenames in this prospectus are the property of their respective owners.
Except as presented in the financial statements or as otherwise specified in
this prospectus, all information in this prospectus:
- assumes no exercise of the underwriters' over-allotment option;
- gives effect to a two-for-one stock split effected on January 7, 2000; and
- gives effect to our acquisitions of Cygnus and HKS, including our issuance
of common stock and assumption of options in connection with the Cygnus
acquisition.
THE OFFERING
<TABLE>
<S> <C>
Shares offered by Red Hat................... 2,750,000 shares
Shares offered by the selling 1,250,000 shares
stockholders................................
Shares to be outstanding after the 151,683,572 shares
offering....................................
Use of proceeds............................. To provide working capital and for other
general corporate purposes including
geographic expansion and possible strategic
acquisitions or alliances. See "Use of
Proceeds".
Nasdaq National Market symbol............... RHAT
</TABLE>
The number of shares of common stock to be outstanding after the offering is
based on the number of shares outstanding on December 31, 1999. This number
includes 11,345,970 shares issued in connection with our acquisitions of Cygnus
and HKS. This number does not include 12,827,622 shares of common stock issuable
upon the exercise of stock options outstanding under Red Hat's stock plans on
December 31, 1999 with a weighted average exercise price of $8.15 per share and
2,412,737 shares of common stock issuable upon exercise of options outstanding
under Cygnus's stock plans on December 31, 1999 with a weighted average exercise
price of $2.87 per share, or 4,814,900 shares of common stock issuable upon
exercise of warrants outstanding on December 31, 1999 with an exercise price of
$0.0001 per share. This number also does not include an aggregate of 13,224,110
shares reserved as of December 31, 1999 for future stock option grants and
purchases under Red Hat's equity compensation plans. See "Management Employee
Benefit Plans" and note 11 of notes to Red Hat's historical financial
statements.
5
<PAGE>
SUMMARY FINANCIAL DATA
The following table summarizes the historical financial data of our business
and supplementary pooled financial data reflecting our acquisition of Cygnus in
January 2000 in a merger accounted for using the pooling of interests method of
accounting. You should read this information with the discussion in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our financial statements and notes to those statements included
elsewhere in this prospectus.
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
----------------------------------------------------
1995 1996(1) 1997 1998 1999
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenue.................... $ 482 $ 930 $2,603 $5,156 $10,790
Net income (loss).......... (128) (155) 33 8 (91)
Net income (loss) available
to common stockholders... (128) (155) 33 8 (130)
Earnings (loss) per common
share:
Basic.................... $ 0.00 $ 0.00 $0.00 $0.00 $(0.01)
Diluted.................. 0.00 0.00 0.00 0.00 (0.01)
Weighted average common
shares outstanding:
Basic.................... 24,000 45,252 47,000 47,000 47,100
Diluted.................. 24,000 45,252 54,465 69,157 47,100
Pro forma earnings (loss)
per common share (2):
Basic.................... $ 0.00 $ 0.00 $ 0.00 $ 0.00 $0.00
Diluted.................. 0.00 0.00 0.00 0.00 0.00
Pro forma weighted average
common shares
outstanding (2):
Basic.................... 24,000 45,252 47,000 61,684 87,860
Diluted.................. 24,000 45,252 54,465 61,684 87,860
<CAPTION>
SUPPLEMENTAL
POOLED
SUPPLEMENTAL NINE MONTHS NINE MONTHS
POOLED ENDED ENDED
YEAR ENDED NOVEMBER 30, NOVEMBER 30,
FEBRUARY 28, ------------------- ---------------------
1999 1998 1999 1998 1999
-------------- -------- -------- --------- ---------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenue.................... $ 33,032 $ 7,113 $ 12,596 $ 23,590 $ 29,612
Net income (loss).......... (5,788) 200 (8,776) (4,564) (15,233)
Net income (loss) available
to common stockholders... (5,827) 184 (8,859) (4,580) (15,315)
Earnings (loss) per common
share:
Basic.................... $(0.12) $0.01 $(0.11) $(0.10) $ (0.18)
Diluted.................. (0.12) 0.00 $(0.11) (0.10) $ (0.18)
Weighted average common
shares outstanding:
Basic.................... 47,628 47,052 84,355 47,438 85,692
Diluted.................. 47,628 89,502 84,355 47,438 85,692
Pro forma earnings (loss)
per common share (2):
Basic.................... $(0.07) $0.00 $(0.06) $(0.05) $(0.12)
Diluted.................. (0.07) 0.00 0.06 (0.05) (0.12)
Pro forma weighted average
common shares
outstanding (2):
Basic.................... 88,388 81,577 151,880 81,984 127,048
Diluted.................. 88,388 89,502 151,880 81,984 127,048
</TABLE>
- ------------------------------
(1) Red Hat's fiscal year ended on February 29, 1996.
(2) These numbers are presented on a pro forma basis to reflect the conversion
of all of our outstanding preferred stock into our common stock at the
beginning of the period indicated or the date of issuance of the preferred
stock, if later.
The following table presents a summary of our unaudited balance sheet at
November 30, 1999:
- on an actual basis;
- on a pooled pro forma basis to reflect the consummation of our
acquisitions of Cygnus and HKS; and
- on a pooled pro forma as adjusted basis to reflect the sale by us of
2,750,000 shares of common stock in this offering at an estimated public
offering price of $131.3125 per share after deducting the estimated
underwriting discount and estimated offering expenses.
<TABLE>
<CAPTION>
NOVEMBER 30, 1999
--------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 11,997 $21,453 $364,812
Working capital............................................. 15,195 19,361 362,720
Total assets................................................ 110,298 185,339 528,698
Long-term liabilities....................................... 203 835 835
Total stockholders' equity.................................. 98,535 162,395 505,754
</TABLE>
6
<PAGE>
RISK FACTORS
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER
THE RISKS DESCRIBED BELOW AND THE OTHER INFORMATION IN THIS PROSPECTUS BEFORE
DECIDING TO INVEST IN THE SHARES OF COMMON STOCK.
RISKS RELATED TO OUR LINUX-BASED OPEN SOURCE BUSINESS MODEL
OUR BUSINESS MAY NOT SUCCEED BECAUSE OPEN SOURCE SOFTWARE BUSINESS MODELS ARE
UNPROVEN
We have not demonstrated the success of our open source business model,
which gives our customers the right freely to copy and distribute our software.
No other company has built a successful open source business. Few open source
software products have gained widespread commercial acceptance partly due to the
lack of viable open source industry participants to offer adequate service and
support on a long term basis. In addition, open source vendors are not able to
provide industry standard warranties and indemnities for their products, since
these products have been developed largely by independent parties over whom open
source vendors exercise no control or supervision. If open source software
should fail to gain widespread commercial acceptance, we would not be able to
sustain our revenue growth and our business could fail.
OUR RELIANCE ON THE SUPPORT OF LINUS TORVALDS AND OTHER PROMINENT LINUX
DEVELOPERS COULD IMPAIR OUR ABILITY TO RELEASE MAJOR PRODUCT UPGRADES AND
MAINTAIN MARKET SHARE
We may not be able to release major product upgrades of Red Hat Linux on a
timely basis because the core of Red Hat Linux, the Linux kernel, is maintained
by third parties. Linus Torvalds, the original developer of the Linux kernel and
a small group of independent engineers are primarily responsible for the
development and evolution of the Linux kernel. If this group of developers fails
to further develop the Linux kernel or if Mr. Torvalds or other prominent Linux
developers, such as Alan Cox, David Miller or Stephen Tweedie, were to join one
of our competitors or no longer work on the Linux kernel, we would have to
either rely on another party to further develop the kernel or develop it
ourselves. We cannot predict whether enhancements to the kernel would be
available from reliable alternative sources. We could be forced to rely to a
greater extent on our own development efforts, which would increase our
development expenses and may delay our product release and upgrade schedules. In
addition, any failure on the part of the kernel developers to further develop
and enhance the kernel could stifle the development of additional Linux-based
applications.
WE MAY NOT BE ABLE TO EFFECTIVELY ASSEMBLE AND TEST OUR SOFTWARE BECAUSE IT
CONSISTS LARGELY OF CODE DEVELOPED BY INDEPENDENT THIRD PARTIES OVER WHOM WE
EXERCISE NO CONTROL, WHICH COULD RESULT IN UNRELIABLE PRODUCTS AND DAMAGE TO
OUR REPUTATION
Red Hat Linux, in compressed form, consists of approximately 546 megabytes
of code. Of that total, approximately 500 megabytes have been developed by
independent third parties, including approximately 10 megabytes of code
contained in the Linux kernel. Included within the 546 megabytes of code are
over 700 distinct software components developed by thousands of individual
programmers which we must assemble and test before we can release a new version
of Red Hat Linux. If these components are not reliable, Red Hat Linux could
fail, resulting in serious damage to our reputation and potential litigation.
Although we attempt to assemble only the best available components, we cannot be
sure that we will be able to identify the highest quality and most reliable
components or to successfully assemble and test them. In addition, if these
components were no longer available, we would have to develop them ourselves,
which would significantly increase our development expenses.
7
<PAGE>
THE SCARCITY OF SOFTWARE APPLICATIONS FOR LINUX-BASED OPERATING SYSTEMS COULD
PREVENT COMMERCIAL ADOPTION OF OUR PRODUCTS
Our products will not gain widespread commercial adoption until there are
more third-party software applications designed to operate on Linux-based
operating systems. These applications include word processors, databases,
accounting packages, spreadsheets, e-mail programs, internet browsers,
presentation and graphics software and personal productivity applications. We
intend to encourage the development of additional applications that operate on
Linux-based operating systems by attracting third-party developers to the Linux
platform, by providing open source tools to create these applications and by
maintaining our existing developer relationships through marketing and technical
support for third-party developers. If we are not successful in achieving these
goals, however, our products will not gain widespread commercial acceptance and
we will not be able to maintain our product sales growth.
WE MAY NOT BE ABLE TO GENERATE REVENUE FROM SALES OF OFFICIAL RED HAT LINUX IF
USERS CAN MORE QUICKLY DOWNLOAD IT FROM THE INTERNET
Anyone can download a free copy of Red Hat Linux from the internet. However,
because this download can take up to 36 hours using a standard telephone
connection, many of our users choose to buy the shrink-wrapped version of
Official Red Hat Linux. If hardware and data transmission technology advances in
the future to the point where increased bandwidth allows users to more quickly
download our products from the internet, users may no longer choose to purchase
Official Red Hat Linux. This could lead to a significant loss of product
revenue.
WE MAY NOT SUCCEED IN SHIFTING OUR BUSINESS FOCUS FROM TRADITIONAL SHRINK-
WRAPPED SOFTWARE SALES TO OFFERING SUBSCRIPTION-BASED PRODUCT AND SERVICES
OFFERINGS
While we have historically relied solely on sales of shrink-wrapped
software, we continue to focus our sales and marketing efforts on providing
subscription-based products and services. This change has required us to expend
significant financial and managerial resources and may ultimately not prove
successful. The failure to successfully implement this transition of our sales
model could materially adversely affect our operating results.
OUR CUSTOMERS MAY FIND IT DIFFICULT TO INSTALL AND IMPLEMENT RED HAT LINUX,
WHICH COULD LEAD TO CUSTOMER DISSATISFACTION AND DAMAGE OUR REPUTATION
Installation and implementation of Red Hat Linux often involves a
significant commitment of resources, financial and otherwise, by our customers.
This process can be lengthy due to the size and complexity of our products and
the need to purchase and install new applications. The failure by us to attract
and retain services personnel to support our customers, the failure of companies
with which we have strategic alliances to commit sufficient resources towards
the installation and implementation of our products, or a delay in
implementation for any other reason could result in dissatisfied customers. This
could damage our reputation and the Red Hat brand, resulting in decreased
revenue.
WE MAY BE UNABLE TO PREDICT THE FUTURE COURSE OF OPEN SOURCE TECHNOLOGY
DEVELOPMENT, WHICH COULD REDUCE THE MARKET APPEAL OF OUR PRODUCTS AND DAMAGE
OUR REPUTATION
We do not exercise control over many aspects of the development of open
source technology. Historically at times different groups of open source
software programmers have competed with each other to develop new technology.
Typically one of those groups develops the technology that becomes more
8
<PAGE>
widely used than that developed by others. If we adopt new technology and
incorporate it into our products, and competing technology becomes more widely
used, the market appeal of our products may be reduced, which could harm our
reputation, diminish the Red Hat brand and result in decreased revenue.
NEGATIVE REACTION WITHIN THE OPEN SOURCE COMMUNITY TO OUR BUSINESS STRATEGY
COULD HARM OUR REPUTATION AND BUSINESS
Some members of the open source software community have criticized the
expansion of our strategic focus in online chat rooms, electronic bulletin
boards and articles posted on the web. These critics argue that our strategy
could fragment the Linux community into a variety of competing factions,
resulting in a less cohesive and cooperative development process. Others have
suggested that by expanding our focus, we are trying to dominate the market for
Linux-based operating systems and the open source community in the same way that
some companies have been able to dominate the traditional software markets. This
type of negative reaction, if widely shared by our customers, developers or the
rest of the open source community, could harm our reputation, diminish the Red
Hat brand and result in decreased revenue.
RISKS RELATED TO OUR FINANCIAL RESULTS AND CONDITION
OUR LIMITED OPERATING HISTORY IN THE DEVELOPING MARKET FOR OPEN SOURCE PRODUCTS
AND SERVICES MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS
Red Hat was formed in March 1993. We began offering Red Hat Linux in
October 1994. Our limited operating history makes it difficult to evaluate the
risks and uncertainties that we face. Our failure to address these risks and
uncertainties could cause our business results to suffer and result in the loss
of all or part of your investment.
WE HAVE NO COMBINED OPERATING HISTORY WITH CYGNUS AND MAY HAVE DIFFICULTY
INTEGRATING THIS BUSINESS
The successful integration of the operations, products, services and
personnel of Red Hat and Cygnus is important to the future financial performance
of the combined enterprise. The anticipated benefits of this acquisition may not
be achieved unless, among other things, the operations, products, services and
personnel of Cygnus are successfully combined with those of Red Hat in a timely
and efficient manner. Integration of these companies' operations, products,
services and personnel may be hampered because, among other things:
- the products and services offered by Red Hat and Cygnus are highly complex
and have been developed independently;
- integration of Red Hat and Cygnus product lines will require the
coordination of separate development and engineering teams from each
company; and
- Red Hat, which is headquartered in Durham, North Carolina, and Cygnus,
which is headquartered in Sunnyvale, California, are located in disparate
geographic regions.
In addition, the costs associated with integrating these operations, products,
services and personnel may be substantial and could include, among other things:
- employee redeployment or relocation; and
- the combination of research and development teams and processes.
Any of these difficulties and costs encountered in the transition process
could divert the attention of management, and could have an adverse impact on
the revenue and operating results of the combined enterprise. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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WE EXPECT TO INCUR SUBSTANTIAL LOSSES FOR THE FORESEEABLE FUTURE
We have incurred operating losses in four of our previous five fiscal years,
including our most recent fiscal year ended February 28, 1999, as well as in the
nine months ended November 30, 1999. We expect to incur significant losses for
the foreseeable future, as we substantially increase our sales and marketing,
research and development and administrative expenses. In addition, we are
investing considerable resources in our web initiatives and to expand our
professional services offerings. As a result, we cannot be certain when or if we
will achieve sustained profitability. Failure to become and remain profitable
may adversely affect the market price of our common stock and our ability to
raise capital and continue operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Overview", "--Results of
Operations" and "--Liquidity and Capital Resources".
YOU SHOULD NOT RELY ON OUR QUARTERLY RESULTS OF OPERATIONS AS AN INDICATION OF
OUR FUTURE RESULTS BECAUSE THEY FLUCTUATE SIGNIFICANTLY AND ARE DIFFICULT TO
FORECAST
Due to our limited combined operating history and the unpredictability of
our business, our revenue and operating results may fluctuate significantly from
quarter to quarter and are difficult to forecast. We base our current and
projected future expense levels in part on our estimates of future revenue. Our
expenses are to a large extent fixed in the short term. We may not be able to
adjust our spending quickly if our revenue falls short of our expectations.
Accordingly, a revenue shortfall in a particular quarter would have a
disproportionate adverse effect on our operating results for that quarter. You
should not rely on quarter-to-quarter comparisons of our results of operations
as an indication of our future performance. Our future operating results may
fall below expectations of securities analysts or investors, which would likely
cause the market price of our common stock to decline significantly. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Quarterly Results of Operations".
WE MAY NOT BE ABLE TO EFFECTIVELY ATTRACT ADDITIONAL ENTERPRISE CUSTOMERS AND
PRESERVE RELATIONSHIPS WITH CURRENT ENTERPRISE CUSTOMERS, WHICH COULD
ADVERSELY AFFECT REVENUE
Historically, we focused our sales and marketing efforts on product sales to
individuals. We have recently, however, begun to focus our efforts on expanding
our enterprise customer base. To this end, we have invested extensively to
attract enterprise customers. In addition, we have gained a significant number
of enterprise customers through our acquisition of Cygnus. These enterprise
customers expect diverse and extensive service offerings. If we are unable to
continue to successfully expand and enhance our service offerings, we may not be
able to meet these customers' needs or attract new customers, and, consequently,
our revenue would suffer.
OUR FAILURE TO UPDATE AND MODERNIZE OUR INTERNAL SYSTEMS, PROCEDURES AND
CONTROLS MAY PREVENT THE IMPLEMENTATION OF OUR BUSINESS STRATEGIES IN A
RAPIDLY EVOLVING MARKET AND MAY RETARD OUR FUTURE GROWTH
During this fiscal year, from March 1, 1999 to December 31, 1999, we have
substantially increased the number of our employees and corporate offices. To
accommodate this growth, we have evaluated our financial and operational
systems, procedures and controls. Although we have revised and updated most of
them, if we continue our rapid growth, we may not be able to improve our
transaction processing and reporting systems and procedures, or expand and train
our expanding workforce quickly enough to maintain a competitive position in our
markets. In addition, failure to quickly replace obsolete systems, procedures
and controls could impede our management's decision-making abilities. This, in
turn, may impair our ability to pursue business opportunities and may hamper
future growth.
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WE INTEND TO RECORD THE EXPENSES OF THE ACQUISITION OF CYGNUS AS A CURRENT
CHARGE WHICH WILL NEGATIVELY IMPACT OUR RESULTS OF OPERATIONS FOR THE PERIOD
IN WHICH THE MERGER CLOSES
Because our merger with Cygnus will be accounted for under the pooling of
interests method, we intend to record all of the expenses of the merger, which
are expected to be substantial, in the fiscal quarter ending February 29, 2000.
The reporting of expenses of the merger as a current charge will have a
significant adverse impact on the combined results of operations of Red Hat and
Cygnus and may cause the market price of our common stock to decline
significantly. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations".
BECAUSE OUR HEADQUARTERS ARE NOT LOCATED IN A MAJOR METROPOLITAN AREA, WE MAY
NOT BE ABLE TO RECRUIT AND RETAIN QUALIFIED PROFESSIONALS, WHO ARE CURRENTLY
IN HIGH DEMAND AND WHOSE NUMBERS ARE LIMITED
We compete intensely with other software companies nationwide to recruit and
hire from a limited pool of qualified personnel. Because our headquarters are
not located in a major metropolitan area, many qualified candidates may be
unwilling to relocate to North Carolina and work for Red Hat. If we cannot
attract and hire additional qualified sales and marketing, professional services
and software engineering and development personnel, our business results will
suffer.
WE MAY NOT BE ABLE TO GENERATE ENOUGH ADDITIONAL REVENUE FROM OUR PLANNED
INTERNATIONAL EXPANSION TO OFFSET THE COSTS ASSOCIATED WITH ESTABLISHING AND
MAINTAINING FOREIGN OPERATIONS
A key component of our growth strategy is to expand our presence in foreign
markets. We have recently established subsidiaries or offices in Ireland, the
UK, Germany, Japan and Australia, and are considering further expansion
worldwide. We may also enter other markets as opportunities arise. It will be
costly to establish international facilities and operations, promote our brand
internationally, and develop localized web sites and other systems. Revenue from
international activities may not offset the expense of establishing and
maintaining these foreign operations. In addition, because we have little
experience in marketing and distributing products or services for these markets,
we may not benefit from any first-to-market advantages.
OUR MANAGEMENT TEAM MAY NOT BE ABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS
STRATEGIES BECAUSE IT HAS ONLY RECENTLY BEGUN TO WORK TOGETHER
Our business is highly dependent on the ability of our management to work
together effectively to meet the demands of our growth. Several members of our
senior management, including our Chief Executive Officer and President, Matthew
Szulik, our Chief Operating Officer, Tim Buckley and our Chief Marketing
Officer, Tom Butta, have been employed by us for a relatively short period of
time. In addition, the members of our management team who have been with us
since 1997 or earlier have had only limited experience managing a rapidly
growing company on either a public or private basis. The failure of our
management team to work together effectively could prevent efficient
decision-making by our executive team, affecting product development and sales
and marketing efforts, which would negatively impact our operating results.
WE COULD LOSE ROBERT YOUNG, MATTHEW SZULIK AND TIM BUCKLEY OR OTHER KEY
PERSONNEL, WHICH COULD PREVENT US FROM EXECUTING OUR BUSINESS STRATEGIES
Our future success depends on the continued services of a number of key
directors and officers, including our Chairman, Robert Young, our Chief
Executive Officer and President, Matthew Szulik, and our Chief Operating
Officer, Tim Buckley. The loss of the technical knowledge and industry expertise
of any of these people could seriously impede our success. Moreover, the loss of
one or a
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group of our key employees, particularly to a competitor, and any resulting loss
of customers could reduce our market share and diminish the Red Hat brand.
WE MAY LACK THE FINANCIAL AND OPERATIONAL RESOURCES NEEDED TO INCREASE OUR
MARKET SHARE AND COMPETE EFFECTIVELY WITH MICROSOFT, OTHER ESTABLISHED
OPERATING SYSTEMS DEVELOPERS, SOFTWARE DEVELOPMENT TOOLS DEVELOPERS AND OTHER
SERVICE AND SUPPORT PROVIDERS
In the market for operating systems, we face significant competition from
larger companies with greater financial resources and name recognition than we
have. These competitors, which offer hardware-independent multi-user operating
systems for Intel platforms and/or UNIX-based operating systems, include AT&T,
Compaq, Hewlett-Packard, IBM, Microsoft, Novell, Olivetti, The Santa Cruz
Operation, Sun Microsystems and Unisys. Some of these competitors currently, or
may in the future, produce and market open source operating systems.
With our acquisition of Cygnus, we now face competition in the market for
software development tools and operating systems for special-purpose computing.
Our competitors in this market, some of which have greater market share than we
do, include Wind River Systems, Integrated Systems Incorporated, Green Hills
Software, and the Metrowerks subsidiary of Motorola. Some of these companies
currently produce or use open source software as part of their product
offerings. We may not be able to compete effectively in this market if customers
choose proprietary solutions. If the demand for open source solutions in this
market expands, however, we could lose market share as existing competitors
reposition or new companies emerge to address the opportunity.
As we increase our services offerings, we may face competition from larger
and more capable companies that currently service and support other operating
systems, particularly UNIX-based operating systems, due to the fact that Linux-
and UNIX-based operating systems share many common features. These companies may
be able to leverage their existing service organizations and provide higher
levels of support on a more cost-effective basis than we can. We may not be able
to compete successfully with these current or potential competitors. See
"Business--Competition".
WE MAY NOT BE ABLE TO MATCH THE PROMOTIONAL ACTIVITIES AND PRICING POLICIES
OFFERED BY OTHER SUPPLIERS OF LINUX-BASED AND OTHER OPEN SOURCE OPERATING
SYSTEMS, WHICH COULD RESULT IN A LOSS OF MARKET SHARE
In the new and rapidly-evolving market for Linux-based operating systems, we
face intense competition from a number of other suppliers of Linux-based
operating systems. We also face competition to a lesser extent from developers
of non-Linux-based open source operating systems such as BSD-based operating
systems. BSD-based operating systems such as FreeBSD, NetBSD and OpenBSD are
open source operating systems produced by communities of developers working
together via the internet, and which are published and distributed by Walnut
Creek CD-ROM, among others. We expect competition in broader open source
operating systems and the Linux-based operating systems markets to intensify. In
addition, companies like Sun Microsystems and Corel, which are more established
and have larger customer bases than we do, have indicated a growing interest in
the market for Linux-based operating systems. These companies may be able to
undertake more extensive promotional activities, adopt more aggressive pricing
policies, and offer more attractive terms to their customers than we can.
Furthermore, because Linux-based operating systems can be downloaded from the
internet for free or purchased at a nominal cost and modified and re-sold with
few restrictions, traditional barriers to entry are minimal. Accordingly, it is
possible that new competitors or alliances among existing competitors may emerge
and rapidly acquire significant market share. See "Business--Competition".
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IF WE FAIL TO ESTABLISH AND MAINTAIN STRATEGIC DISTRIBUTION AND OTHER
COLLABORATIVE RELATIONSHIPS WITH INDUSTRY-LEADING COMPANIES, WE MAY NOT BE
ABLE TO ATTRACT AND RETAIN A LARGER CUSTOMER BASE
Our success depends on our ability to continue to establish and maintain
strategic distribution and other collaborative relationships with
industry-leading hardware manufacturers, distributors, software vendors and
enterprise solutions providers. These relationships allow us to offer our
products and services to a much larger customer base than we would otherwise be
able to through our direct sales and marketing efforts. We may not be able to
maintain these relationships or replace them on attractive terms.
In addition, our existing strategic relationships do not, and any future
strategic relationships may not, afford us any exclusive marketing or
distribution rights. As a result, the companies with which we have strategic
alliances are free to pursue alternative technologies and to develop alternative
products and services in addition to or in lieu of our products and services,
either on their own or in collaboration with others, including our competitors.
Moreover, we cannot guarantee that the companies with which we have strategic
relationships will market our products effectively or continue to devote the
resources necessary to provide us with effective sales, marketing and technical
support. See "Business--Sales, Marketing and Distribution".
ANY DISRUPTION IN OUR RELATIONSHIPS WITH OUR TWO LARGEST DISTRIBUTORS, ON WHOM
WE RELY FOR A SIGNIFICANT PERCENTAGE OF OUR PRODUCT REVENUE, COULD CAUSE OUR
REVENUE TO DECLINE
We are highly dependent on revenue from sales to our two largest
distributors, Frank Kasper & Associates and Ingram Micro, who together accounted
for a significant percent of our total revenue for the fiscal year ended
February 28, 1999 and for the nine months ended November 30, 1999. These
distributors are not obligated to purchase products from us and the loss of one
or both of these distributors, or a reduction in the amount of product sales
generated by them, could significantly reduce our product revenue. See
"Business--Sales, Marketing and Distribution".
WE MAY NOT BE ABLE TO MEET THE OPERATIONAL AND FINANCIAL CHALLENGES THAT WE WILL
ENCOUNTER AS OUR INTERNATIONAL OPERATIONS EXPAND
As we expand our international operations, we will face a number of
additional challenges associated with the conduct of business overseas. For
example:
- we may have difficulty managing and administering a globally-dispersed
business;
- fluctuations in exchange rates may negatively affect our operating
results;
- we may not be able to repatriate the earnings of our foreign operations;
- we have to comply with a wide variety of foreign laws with which we are
not familiar;
- we may not be able to adequately protect our trademarks overseas due to
the uncertainty of laws and enforcement in certain countries relating to
the protection of intellectual property rights;
- reductions in business activity during the summer months in Europe and
certain other parts of the world could negatively impact the operating
results of our foreign operations;
- export controls could prevent us from shipping our products into and from
some markets;
- multiple and possibly overlapping tax structures could significantly
reduce the financial performance of our foreign operations;
- changes in import/export duties and quotas could affect the competitive
pricing of our products and services and reduce our market share in some
countries; and
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- economic or political instability in some international markets could
result in the forfeiture of some foreign assets and the loss of sums spent
developing and marketing those assets.
EXPANDING OUR SERVICES BUSINESS WILL BE COSTLY AND MAY NOT RESULT IN ANY BENEFIT
TO US
We have recently expanded our strategic focus to place additional emphasis
on technical support and maintenance, developer support, custom development,
consulting, training and education or hardware certification services, from
which we have historically derived an insignificant amount of revenue. We cannot
be certain that our customers will engage our professional services organization
to assist with any of these services. We also cannot be certain that we can
attract or retain a sufficient number of the highly qualified services personnel
that the expansion of our services business will need. In addition, this
expansion has required, and will continue to require, significant additional
expenses and development, financial and operational resources. The need for
these additional resources will place further strain on our management,
financial and operational resources and may make it more difficult for us to
achieve and maintain profitability.
ATTEMPTS TO EXPAND BY MEANS OF BUSINESS COMBINATIONS AND STRATEGIC ALLIANCES MAY
NOT BE SUCCESSFUL AND MAY HARM OUR OPERATIONAL EFFICIENCY, FINANCIAL
PERFORMANCE AND RELATIONSHIPS WITH EMPLOYEES AND THIRD PARTIES
We may continue to expand our operations or market presence by entering into
additional business combinations, investments, joint ventures or other strategic
alliances with hardware manufacturers, software vendors, internet companies,
open source software developers or other companies both in the United States and
internationally. Our ability to expand in this way may be limited due to the
many financial and operational risks accompanying these transactions. For
example:
- we may have difficulty assimilating the operations, technology and
personnel of the combined companies;
- our business may be disrupted by the allocation of resources to consummate
these transactions;
- we may have problems retaining key technical and managerial personnel from
acquired companies;
- we may experience one-time in-process research and development charges and
ongoing expenses associated with amortization of goodwill and other
purchased intangible assets;
- our stockholders will suffer dilution if we issue equity to fund these
transactions;
- acquired businesses may initially be unprofitable resulting in our
assumption of operating losses and increased expenses;
- our reputation may be harmed if the open source development community does
not approve of these transactions; and
- our relationships with existing employees, customers and business partners
may be weakened or terminated as a result of these transactions.
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RISKS RELATED TO OUR INTERNET STRATEGY
WE MAY FAIL TO PROMOTE AND ENHANCE OUR WEB SITE EFFECTIVELY, WHICH MAY PREVENT
US FROM ATTRACTING NEW VISITORS, ELECTRONIC COMMERCE PARTNERS OR ADVERTISERS
TO OUR WEB SITE AND FROM DELIVERING OUR SOLUTIONS THROUGH OUR WEB SITE
Enhancing the REDHAT.COM web site is critical to our ability to increase our
revenue. In order to attract and retain internet users, electronic commerce
partners and advertisers, we intend to substantially increase our expenditures
for enhancing and further developing our web site. Our success in promoting and
enhancing the REDHAT.COM web site will also depend on our ability to provide
high quality content, features and functionality. If we fail to promote our web
site successfully or if visitors to our web site, electronic commerce partners
or advertisers do not perceive our services to be useful, current or of high
quality, our ability to generate revenue from our web site will be significantly
impaired.
VISITORS TO OUR WEB SITE COULD EXPERIENCE DELAYS AND DECREASED PERFORMANCE
DURING PERIODS OF HEAVY TRAFFIC, WHICH COULD RESULT IN DISSATISFACTION WITH
OUR WEB SITE AND DAMAGE TO OUR REPUTATION
Our web site must accommodate a high volume of traffic and deliver
frequently updated information. Our web site has in the past experienced slower
response times or decreased traffic for a variety of reasons. These occurrences
have not had a material impact on our business. These types of occurrences in
the future, however, could materially adversely affect our reputation and brand
name and could cause users to perceive our web site as not functioning properly.
Under these circumstances, our users might choose another web site or other
methods to obtain Linux-based operating systems or Linux-related information.
BECAUSE THERE IS NO INDUSTRY STANDARD FOR THE MEASUREMENT OF THE EFFECTIVENESS
OF INTERNET ADVERTISING, ADVERTISERS MAY NOT INCREASE OR EVEN MAINTAIN THEIR
CURRENT LEVELS OF INTERNET ADVERTISING, WHICH WOULD PREVENT US FROM GENERATING
A SIGNIFICANT AMOUNT OF REVENUE FROM OUR WEB SITE
As we execute our internet strategy, we expect to derive an increasing
percentage of our total revenue from sponsorships and advertising on our web
site. We may not generate this revenue if advertisers do not maintain or
increase their current levels of internet advertising. As there is no industry
standard for the measurement of the effectiveness of internet advertising,
advertisers that currently advertise on the internet may reduce or eliminate
this form of advertising and advertisers that have traditionally relied upon
other advertising media may be reluctant to begin to advertise on the internet.
Moreover, widespread adoption of currently available software programs that
limit or prevent advertisements from being delivered to an internet user's
computer would negatively affect the commercial viability of internet
advertising and would further deter advertisers from increasing or maintaining
current levels of internet advertising. Our ability to successfully execute our
internet strategy will be adversely affected if the market for internet
advertising fails to develop or develops more slowly than expected.
WE MAY NOT BE ABLE TO RESPOND QUICKLY TO NEW PRICING MODELS FOR ADVERTISING,
WHICH COULD PREVENT US FROM ATTRACTING QUALITY SPONSORS TO OUR WEB SITE
Different pricing models are used to sell advertising on the internet. It is
difficult to predict which, if any, will emerge as the industry standard. If we
cannot quickly and successfully respond to changes in pricing models for
internet advertising, or identify and adopt any industry standards that may
emerge, we will not be able to attract a sufficient number of quality sponsors
and our internet advertising strategy will fail.
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WE MAY BE UNABLE TO ADEQUATELY MEASURE THE DEMOGRAPHICS OF VISITORS TO OUR WEB
SITE, WHICH IS CRITICAL TO OUR ABILITY TO ATTRACT ADVERTISING REVENUE
We expect that it will be important to our advertisers that we accurately
measure the demographics of the visitors to our web site. While we have not
committed significant resources to the measurement of demographics to date, we
are currently implementing systems designed to record demographic data on our
web site's visitors. This implementation may be costly, and if not done
effectively, may not permit us to accurately measure the demographic
characteristics of our web site's visitors. Until these new systems are
functional, we will continue to rely on third parties to provide some of these
measurement services. If these parties were unable to provide these services, we
would need to obtain them from other providers, which might not be readily
available. Companies may choose not to advertise on our web site or may pay less
for advertising if they do not perceive our measurements or measurements made by
third parties to be reliable.
OUR INTERNET STRATEGY WILL FAIL IF THE INFRASTRUCTURE OF THE INTERNET IS NOT
CONTINUALLY DEVELOPED AND MAINTAINED
The success of our internet strategy will depend in large part on the
continued development and maintenance of the infrastructure of the internet.
Because global commerce and the online exchange of information is new and
evolving, we cannot predict with any certainty that the internet will be a
viable commercial marketplace in the long term. The internet has experienced,
and we expect it to continue to experience, significant growth in the number of
users and amount of traffic. If the internet continues to experience an
increased number of users, frequency of use or increased bandwidth requirements
of users, it may not be able to support the demands placed upon it by this
growth, and its performance and reliability may suffer. Furthermore, the
internet has experienced a variety of outages and other delays as a result of
damage to portions of its infrastructure, and could face similar outages and
delays in the future. Any outage or delay could affect the level of internet
usage, as well as the volume of traffic on our web site. In addition, the
internet could lose its viability due to increased governmental regulation and
delays in the development or adoption of new standards and protocols to handle
increased levels of activity. If the necessary infrastructure, standards or
protocols or complementary products, services or facilities are not developed,
or if the internet does not become a viable commercial marketplace, our internet
strategy will not succeed.
WE ARE VULNERABLE TO UNEXPECTED NETWORK INTERRUPTIONS CAUSED BY SYSTEM FAILURES,
WHICH MAY RESULT IN REDUCED VISITOR TRAFFIC ON OUR WEB SITE, DECREASED REVENUE
AND HARM TO OUR REPUTATION
Substantially all of our communications hardware and other hardware related
to our web site is located at our facilities, although we have back-up and
co-location hardware for our web site located at third-party facitilies. Fire,
floods, hurricanes, tornadoes, earthquakes, power loss, telecommunications
failures, break-ins and similar events could damage these systems. In addition,
although we have implemented network security measures, our servers are
vulnerable to computer viruses, electronic break-ins, human error and other
similar disruptive problems which could adversely affect our systems and web
site. Although we try to prevent unauthorized access to our systems, we cannot
eliminate this risk entirely. We could lose revenue and suffer damage to our
reputation if our systems were affected by any of these occurrences. Our
insurance policies may not adequately compensate us for any losses that may
occur due to failures or interruptions in our systems. We do not presently have
a formal disaster recovery plan.
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RISKS RELATED TO LEGAL UNCERTAINTY
WE COULD BE PREVENTED FROM SELLING OR DEVELOPING OUR PRODUCTS IF THE GNU GENERAL
PUBLIC LICENSE AND SIMILAR LICENSES UNDER WHICH OUR PRODUCTS ARE DEVELOPED AND
LICENSED ARE NOT ENFORCEABLE
The Linux kernel, the Red Hat Linux operating system and our other open
source products have been developed and licensed under the GNU General Public
License and similar licenses. These licenses state that any program licensed
under them may be liberally copied, modified and distributed. We know of no
circumstance under which these licenses have been challenged or interpreted in
court. Accordingly, it is possible that a court would hold these licenses to be
unenforceable in the event that someone were to file a claim asserting
proprietary rights in a program developed and distributed under them. Any ruling
by a court that these licenses are not enforceable, or that Linux-based
operating systems, or significant portions of them, may not be liberally copied,
modified or distributed, would have the effect of preventing us from selling or
developing our products.
OUR PRODUCTS MAY CONTAIN DEFECTS THAT MAY BE COSTLY TO CORRECT, DELAY MARKET
ACCEPTANCE OF OUR PRODUCTS AND EXPOSE US TO LITIGATION
Despite testing by us and our customers, errors may be found in our products
after commencement of commercial shipments. This risk is exacerbated by the fact
that most of the code in our products is developed by independent parties over
whom we exercise no supervision or control. If errors are discovered, we may
have to make significant expenditures of capital to eliminate them and yet may
not be able to successfully correct them in a timely manner or at all. Errors
and failures in our products could result in a loss of, or delay in, market
acceptance of our products and could damage our reputation and our ability to
convince commercial users of the benefits of Linux-based operating systems and
other open source software products.
In addition, failures in our products could cause system failures for our
customers who may assert warranty and other claims for substantial damages
against us. Although our license agreements with our customers typically contain
provisions designed to limit our exposure to potential product liability claims,
it is possible that these provisions may not be effective or enforceable under
the laws of some jurisdictions. Our insurance policies may not adequately limit
our exposure to this type of claim. These claims, even if unsuccessful, could be
costly and time consuming to defend.
WE ARE VULNERABLE TO CLAIMS THAT OUR PRODUCTS INFRINGE THIRD-PARTY INTELLECTUAL
PROPERTY RIGHTS PARTICULARLY BECAUSE OUR PRODUCTS ARE COMPRISED OF MANY
DISTINCT SOFTWARE COMPONENTS DEVELOPED BY THOUSANDS OF INDEPENDENT PARTIES
We may be exposed to future litigation based on claims that our products
infringe the intellectual property rights of others. This risk is exacerbated by
the fact that most of the code in our products is developed by independent
parties over whom we exercise no supervision or control. Claims of infringement
could require us to reengineer our products or seek to obtain licenses from
third parties in order to continue offering our products. In addition, an
adverse legal decision affecting our intellectual property, or the use of
significant resources to defend against this type of claim, could place a
significant strain on our financial resources and harm our reputation.
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OUR EFFORTS TO PROTECT OUR TRADEMARKS MAY NOT BE ADEQUATE TO PREVENT THIRD
PARTIES FROM MISAPPROPRIATING OUR INTELLECTUAL PROPERTY RIGHTS
Our most valuable intellectual property is our collection of trademarks. The
protective steps we have taken in the past have been, and may in the future
continue to be, inadequate to deter misappropriation of our trademark rights.
Although we do not believe that we have suffered any material harm from
misappropriation to date, we may be unable to detect the unauthorized use of, or
take appropriate steps to enforce, our trademark rights. We have registered some
of our trademarks in the United States, Europe and Australia and have other
trademark applications pending in the United States, Europe, Australia, Canada,
Europe, Japan and many other countries. Effective trademark protection may not
be available in every country in which we offer or intend to offer our products
and services. Failure to adequately protect our trademark rights could damage or
even destroy the Red Hat brand and impair our ability to compete effectively.
Furthermore, defending or enforcing our trademark rights could result in the
expenditure of significant financial and managerial resources. See
"Business--Intellectual Property".
WE MAY BE SUED AS A RESULT OF INFORMATION PUBLISHED OR POSTED ON OR ACCESSIBLE
FROM OUR REDHAT.COM WEB SITE
We may be subjected to claims for defamation, negligence, copyright or
trademark infringement or other claims relating to the information we publish on
our web site. These types of claims have been brought, sometimes successfully,
against online services in the past, and can be costly to defend. We may also be
subjected to claims based on content that is accessible from our web site
through links to other web sites or through content and materials that may be
posted by visitors to our web site. We believe that the scope and amount of our
commercial and general liability insurance is appropriate, given our current
financial position. However, this insurance may not adequately protect us
against these types of claims. We have not been a party to any lawsuit of this
type to date.
OUR SOFTWARE PRODUCTS, AS WELL AS THOSE OF OUR CUSTOMERS AND SUPPLIERS, COULD
FAIL AS A RESULT OF THE YEAR 2000 PROBLEM
We have conducted a review of Red Hat Linux and our internal systems to
identify functions that need correction to be "Year 2000 compliant". We have
not, however, tested our other products and have not tested or sought
certifications from third parties bundling software applications and components
with Official Red Hat Linux. Although we have not experienced any failures to
date, any failure by our products or third-party software bundled with our
products to function in the Year 2000 may decrease the value of our products,
give rise to warranty claims and tarnish the Red Hat brand. Additionally, the
Year 2000 problem may affect us by causing disruptions in the business
operations of, or delay technology purchases by, companies with which we do
business, such as customers and suppliers, causing a decrease in our product
revenue. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000 Compliance".
RISKS RELATED TO THIS OFFERING
CONCENTRATION OF OWNERSHIP WILL LIMIT YOUR ABILITY TO INFLUENCE CORPORATE
MATTERS
Immediately following this offering, our directors, executive officers and
their affiliates will beneficially own approximately 48.8% of our outstanding
common stock. These stockholders could determine the outcome of actions taken by
us that require stockholder approval. For example, these stockholders could
elect all of our directors, delay or prevent a transaction in which stockholders
might receive a premium over the prevailing market price for their shares and
control changes in management.
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PROVISIONS OF OUR CHARTER AND BY-LAWS MAY DELAY OR PREVENT TRANSACTIONS THAT
MANY STOCKHOLDERS MAY FAVOR
Provisions of our certificate of incorporation and by-laws may discourage,
delay or prevent a merger or acquisition that stockholders may consider
favorable, including transactions in which you might otherwise receive a premium
for your shares. Some provisions of Delaware law may also discourage, delay or
prevent someone from acquiring us or merging with us. See "Description of
Capital Stock--Delaware Law and Certain Charter and By-Law Provisions and
Anti-Takeover Effects".
OUR STOCK PRICE HAS BEEN EXTREMELY VOLATILE AND YOU MAY NOT BE ABLE TO RESELL
YOUR SHARES AT OR ABOVE THE OFFERING PRICE
The trading price of our common stock has been and is likely to continue to
be highly volatile and could be subject to wide fluctuations in response to
factors such as:
- actual or anticipated variations in quarterly operating results;
- new products or services offered by Red Hat or our competitors;
- changes in financial estimates by securities analysts;
- conditions or trends in the internet, Linux and software industries;
- changes in the economic performance and/or market valuations of other
internet, Linux and software industries;
- announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
- additions or departures of key personnel;
- sales of common stock; and
- other events or factors, many of which are beyond our control.
In addition, the stock market in general, and the Nasdaq National Market and
the market for internet-related and technology companies in particular, has
experienced extreme price and volume fluctuations that have often been unrelated
or disproportionate to the operating performance of such companies. The trading
prices of many technology companies' stocks, including our common stock, are at
or near historical highs and these trading prices and multiples are
substantially above historical levels. These trading prices and multiples may
not be sustained. In addition, broad market and industry factors may materially
adversely affect the market price of our common stock, regardless of our actual
operating performance. In the past, following periods of volatility in the
market price of a company's securities, securities class-action litigation has
often been instituted against such companies. Such litigation, if instituted,
could result in substantial costs and a diversion of management's attention and
resources, which would materially adversely affect our business, financial
condition and operating results.
A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK COULD BE SOLD INTO THE PUBLIC
MARKET SOON AFTER THIS OFFERING, WHICH COULD DEPRESS OUR STOCK PRICE
Sales of significant amounts of our common stock in the public market after
this offering or the perception that such sales will occur could materially
adversely affect the market price of the common stock or our future ability to
raise capital through an offering of our equity securities.
Upon the completion of this offering, we will have outstanding 151,683,572
shares of common stock, based on the number of shares of common stock
outstanding as of December 31, 1999 and assuming no exercise of the
underwriters' overallotment option, no exercise of outstanding options or
warrants and the consummation of the Cygnus and HKS acquisitions. Of these
shares, the 6,900,000 shares sold in our initial public offering in
August 1999, the 4,000,000 shares sold in this offering and approximately
3,409,039 of the shares issued to stockholders of Cygnus will be freely tradable
without restriction and 3,980,000 shares will be
19
<PAGE>
tradeable under Rule 144(k) under the Securities Act, unless any of such shares
are purchased by an existing affiliate of Red Hat as that term is defined in
Rule 144 under the Securities Act. The remaining 133,394,533 shares of common
stock are restricted securities in that they may be sold in the public market
only if registered or if they qualify for an exemption from registration under
the Securities Act or Rule 144, or Rule 701 as promulgated under the Securities
Act. In addition, as of December 31, 1999, assuming the consummation of the
Cygnus and HKS acquisitions had been completed at such time, an additional
20,055,259 shares of common stock may be issued upon exercise of warrants and
exercisable options. Of these shares, the 4,814,900 shares issuable upon
exercise of these warrants will be restricted securities. The 15,240,359 shares
issuable upon exercise of these options will be freely tradeable.
More than 120,000,000 shares, or thirty times the number of shares sold in
this offering, are subject to transfer restrictions imposed by the underwriters
in connection with our initial public offering, which restrictions expire on
February 7, 2000. Of these shares, approximately 75,129,906 shares held by our
executive officers, directors and certain other stockholders are subject to
additional transfer restrictions imposed by contracts executed in connection
with the acquisition of Cygnus and approximately 46,361,648 shares are subject
to transfer restrictions imposed by the underwriters in connection with this
offering. The contractual restrictions imposed in connection with this offering
will expire 90 days after the effective date of the registration statement of
which this prospectus is a part. The contractual restrictions imposed in
connection with the acquisition of Cygnus will lapse two days after the
announcement of financial results covering 30 days of combined operations of Red
Hat and Cygnus. Upon expiration of these contractual obligations, these shares
will become eligible for resale in the public market in reliance on Rule 144 at
various dates.
YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION IN THE BOOK VALUE OF YOUR
INVESTMENT
Investors purchasing shares of common stock in this offering will incur
immediate and substantial dilution in the amount of $128.36 per share, based on
an estimated public offering price of $131.3125 per share. In the event that we
issue additional common stock in the future, including shares that may be issued
as consideration for acquisitions or upon exercise of warrants and options and
other rights granted under our employee benefit plans, purchasers of common
stock in this offering may experience further dilution.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary", "Risk Factors", "Management's
Discussion and Analysis of Financial Condition and Results of Operations",
"Business", and elsewhere in this prospectus constitute forward-looking
statements. In some cases, you can identify forward-looking statements by
terminology such as "may", "will", "should", "expects", "plans", "anticipates",
"believes", "estimated", "predicts", "potential", or "continue" or the negative
of such terms or other comparable terminology. These statements are only
predictions and involve known and unknown risks, uncertainties, and other
factors that may cause our or our industry's actual results, levels of activity,
performance, or achievements to be materially different from any future results,
levels of activity, performance, or achievements expressed or implied by such
forward-looking statements. These factors include, among other things, those
listed under "Risk Factors" and elsewhere in this prospectus.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future
20
<PAGE>
results, levels of activity, performance, or achievements. We are under no duty
to update any of the forward-looking statements after the date of this
prospectus to conform forward-looking statements to actual results.
USE OF PROCEEDS
We estimate the net proceeds to us from the sale of 2,750,000 shares of common
stock in this offering to be approximately $343,359,000 at the estimated public
offering price of $131.3125 per share and after deducting the underwriting
discount and estimated offering expenses. If the underwriters' over-allotment
option is exercised in full, we estimate net proceeds will be $418,602,000.
We will not receive any proceeds from the sale of shares being sold by the
selling stockholders.
The principal purposes of this offering are to increase our capitalization
and financial flexibility.
We expect to use the net proceeds for working capital and other general
corporate purposes, including geographic expansion. A portion of the net
proceeds may be used for possible future acquisitions of businesses, products
and technologies that are complementary to our own, or for strategic alliances.
We have not allocated any specific portion of the net proceeds to any particular
purpose, and our management will have the ability to allocate the proceeds at
its discretion. The net proceeds of this offering will be invested in
short-term, interest-bearing, investment-grade securities until allocated for
specific use.
PRICE RANGE OF OUR COMMON STOCK
Our common stock is listed on The Nasdaq National Market under the symbol
"RHAT". As of December 31, 1999, there were approximately 614 registered holders
of common stock. The following table sets forth, for the periods indicated, the
high and low split-adjusted sales prices per share as reported by Nasdaq.
The last reported sales price of our common stock on the Nasdaq National
Market on January 13, 2000 was $131.3125 per share.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
FISCAL YEAR ENDING FEBRUARY 29, 2000
Second Fiscal Quarter (commencing August 11,
1999)............................................. $ 42.625 $ 26.032
Third Fiscal Quarter................................ 105.000 37.594
Fourth Fiscal Quarter (through January 13, 2000).... 143.125 100.500
</TABLE>
DIVIDEND POLICY
We have never paid any cash dividends on our common stock and do not anticipate
paying any cash dividends in the foreseeable future. We presently intend to
retain future earnings, if any, to finance the expansion and growth of our
business. Payment of future dividends, if any, will be at the discretion of our
Board of Directors after taking into account various factors, including our
financial condition, operating results, current and anticipated cash needs and
plans for expansion.
21
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of Red Hat as of November 30,
1999:
- on an actual basis which reflects the two-for-one stock split as if it had
been in effect on November 30, 1999;
- on a pro forma basis to reflect the acquisitions of Cygnus and HKS in
January 2000 and the conversion of all Cygnus preferred stock into Cygnus
common stock and subsequently our common stock in connection with the
Cygnus acquisition; and
- on an as adjusted basis to reflect the sale of the 2,750,000 shares of
common stock offered by us in this offering at the estimated public
offering price of $131.3125 per share after deducting the estimated
underwriting discount and estimated offering expenses.
The outstanding share information excludes 12,493,976 shares of common stock
issuable upon the exercise of stock options outstanding on November 30, 1999,
4,814,900 shares of common stock issuable upon the exercise of warrants
outstanding on November 30, 1999 and 13,662,200 shares reserved as of
November 30, 1999 for future stock option grants and purchases under Red Hat's
equity compensation plans. See "Management--Employee Benefit Plans" and note 11
to notes to the Red Hat financial statements. The pro forma and as adjusted
outstanding share information excludes 2,412,737 shares of common stock issuable
upon the exercise of options assumed by Red Hat in connection with our
acquisition of Cygnus.
You should read this information together with Red Hat's financial
statements and the notes to those statements appearing elsewhere in this
prospectus.
<TABLE>
<CAPTION>
NOVEMBER 30, 1999
----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Long-term obligations...................................... $ 203 $ 835 $ 835
Stockholders' equity (deficit):
Preferred stock, par value $.0001; 5,000,000 shares
authorized and no shares issued or outstanding (actual,
pro forma and pro forma as adjusted)................... -- -- --
Common stock, par value $.0001; 225,000,000 shares
authorized, 137,589,208 shares issued and outstanding
(actual); 225,000,000 shares authorized, 148,935,188
shares issued and outstanding (pro forma); 225,000,000
shares authorized, 151,685,188 shares issued and
outstanding (pro forma as adjusted).................... 14 15 15
Additional paid-in capital................................. 115,143 226,728 570,087
Shareholder receivable..................................... -- (2,828) (2,828)
Deferred compensation...................................... (7,116) (37,310) (37,310)
Accumulated deficit........................................ (9,294) (23,998) (23,998)
Accumulated other comprehensive loss....................... (212) (212) (212)
------- -------- --------
Total stockholders' equity (deficit)....................... 98,535 162,395 505,754
------- -------- --------
Total capitalization....................................... $98,738 $163,230 $506,589
======= ======== ========
</TABLE>
22
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
The statement of operations data presented below for the fiscal years ended
February 28, 1997, February 28, 1998 and February 28, 1999, and the balance
sheet data as of February 28, 1998 and February 28, 1999, have been derived from
our audited financial statements included elsewhere in this prospectus. The
statement of operations data for the nine months ended November 30, 1998 and
November 30, 1999 and the balance sheet data as of November 30, 1999 have been
derived from our unaudited financial statements included elsewhere in this
prospectus. In our opinion, these unaudited interim financial statements include
all adjustments, consisting of normal recurring adjustments, necessary for the
fair presentation of financial position, results of operations and cash flows.
The balance sheet data as of February 28, 1997 have been derived from our
audited financial statements which are not included in this prospectus. The
statement of operations data for the fiscal years ended February 28, 1995 and
February 29, 1996, and the balance sheet data as of February 28, 1995 and
February 29, 1996 have been derived from our unaudited financial statements
which are not included in this prospectus. You should read the data presented
below together with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the financial statements and notes to those
statements appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED FEBRUARY 28, NOVEMBER 30,
---------------------------------------------------- ----------------------
1995 1996(2) 1997 1998 1999 1998 1999
-------- -------- -------- -------- -------- -------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
Software and related products................... $ 482 $ 930 $2,603 $5,132 $10,013 $ 6,505 $ 8,559
Web............................................. -- -- -- -- -- -- 626
Services and other.............................. -- -- -- 24 777 608 3,410
------ ------ ------ ------ ------- ------- --------
Total revenue..................................... 482 930 2,603 5,156 10,790 7,113 12,596
------ ------ ------ ------ ------- ------- --------
Cost of revenue:
Software and related products................... 352 432 1,205 2,211 4,013 2,647 4,738
Web............................................. -- -- -- -- -- -- 627
Services and other.............................. -- -- -- -- 28 -- 2,049
------ ------ ------ ------ ------- ------- --------
Total cost of revenue............................. 352 432 1,205 2,211 4,041 2,647 7,414
------ ------ ------ ------ ------- ------- --------
Gross profit...................................... 130 498 1,398 2,945 6,749 4,466 5,182
------ ------ ------ ------ ------- ------- --------
Operating expense:
Sales and marketing............................. 133 241 491 1,252 3,083 1,645 7,609
Research and development........................ 80 250 325 903 2,220 1,422 4,158
General and administrative...................... 44 140 526 799 1,484 1,046 2,871
Stock-based compensation........................ -- -- -- -- -- -- 1,009
Mergers and acquisitions........................ -- -- -- -- -- -- 124
------ ------ ------ ------ ------- ------- --------
Total operating expenses.......................... 257 631 1,342 2,954 6,787 4,113 15,771
------ ------ ------ ------ ------- ------- --------
Income (loss) from operations..................... (127) (133) 56 (9) (38) 353 (10,589)
Other income (expense), net....................... (1) (22) (23) 22 162 62 1,813
------ ------ ------ ------ ------- ------- --------
Income (loss) before income taxes................. (128) (155) 33 13 124 415 (8,776)
Provision for income taxes........................ -- -- -- 5 215 215 --
------ ------ ------ ------ ------- ------- --------
Net income (loss)................................. (128) (155) 33 8 (91) 200 (8,776)
Accretion on mandatorily redeemable preferred
stock........................................... -- -- -- -- (39) (16) (83)
------ ------ ------ ------ ------- ------- --------
Net income (loss) available to common
stockholders.................................... $ (128) $ (155) $ 33 $ 8 $ (130) $ 184 $ (8,859)
====== ====== ====== ====== ======= ======= ========
Earnings (loss) per common share (1):
Basic........................................... $(0.00) $(0.00) $ 0.00 $ 0.00 $ (0.01) $ 0.00 $ (0.11)
Diluted......................................... 0.00 0.00 0.00 0.00 (0.01) 0.00 (0.11)
Weighted average common shares outstanding:
Basic........................................... 24,000 45,252 47,000 47,000 47,100 47,052 84,355
Diluted......................................... 24,000 45,252 54,465 69,157 47,100 89,502 84,355
Pro forma net income (loss) per common share (1):
Basic........................................... $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.06
Diluted......................................... 0.00 0.00 0.00 0.00 0.00 0.00 0.06
Shares of common stock used in computing pro forma
net income (loss) per common share:
Basic........................................... 24,000 45,252 47,000 61,684 87,860 81,577 151,880
Diluted......................................... 24,000 45,252 54,465 69,157 87,860 89,502 151,880
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
FEBRUARY 28, NOVEMBER 30,
---------------------------------------------------- --------------
1995 1996(2) 1997 1998 1999 1999
-------- -------- -------- -------- -------- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ -- $ -- $ -- $1,293 $10,055 $11,997
Working capital (deficit)................................. (129) (160) (324) 1,541 11,100 15,195
Total assets.............................................. 106 245 670 3,131 15,276 110,298
Long term liabilities..................................... -- 30 145 65 420 203
Mandatorily redeemable preferred stock.................... -- -- -- 1,983 12,107 --
Total stockholders' equity (deficit)...................... (42) (79) (46) (38) (5) 98,535
</TABLE>
- ------------------------------
(1) See note 2 to notes to Red Hat's historical financial statements.
(2) Red Hat's fiscal year ended on February 29, 1996.
24
<PAGE>
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 pooled
balance sheet and supplemental pooled statements of operations of Red Hat and
the historical balance sheets and historical statements of operations of HKS as
if the acquisition of 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 supplemental pooled consolidated financial statements including the notes to
these statements of Red Hat and the historical financial statements of HKS and
Management's Discussion and Analysis of Financial Condition and Results of
Operations appearing elsewhere in this prospectus.
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 data. 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 as of and 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 HKS
had occurred on the dates indicated in these pro forma combined financial
statements nor does this information purport to project our results for any
future period.
25
<PAGE>
PRO FORMA COMBINED CONSOLIDATED
BALANCE SHEET
NOVEMBER 30, 1999
<TABLE>
<CAPTION>
RED HAT
SUPPLEMENTAL
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 $57,671,183
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.
26
<PAGE>
PRO FORMA COMBINED CONSOLIDATED
UNAUDITED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED FEBRUARY 28, 1999
<TABLE>
<CAPTION>
RED HAT
SUPPLEMENTAL
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)
=========== ========= ============ ============ ============
Pro forma combined loss per share
basic and diluted.............. $ (0.39)
============
Pro forma combined weighted
average shares outstanding..... $ 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>
HKS
RED HAT PERIOD HKS
SUPPLEMENTAL 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)
============ ======== ========= ============ ============ ============
Pro forma combined loss per share--
basic and diluted $ (0.29)
============
Pro forma combined weighted average
shares outstanding.................. 127,525,798
============
</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
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH RED
HAT'S FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS
PROSPECTUS. THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
INDICATED IN SUCH FORWARD-LOOKING STATEMENTS. SEE "SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS".
OVERVIEW
We are a leading global developer and provider of open source software and
solutions, and have built a comprehensive web site dedicated to the open source
software community. We were incorporated in Connecticut in March 1993 as ACC
Corp., Inc. In September 1995, we changed our name to Red Hat Software, Inc. In
September 1998, we reincorporated in Delaware. In June 1999, we changed our name
to Red Hat, Inc. We have financed our activities to date through proceeds from
the sale of equity securities and cash flow from operations.
In January 2000, we acquired Cygnus in a transaction accounted for as a
pooling of interests. As a result of this acquisition, our historical financial
statements will be restated, commencing with our first publication of financial
statements covering a period in which the acquisition was consummated (the
period ending February 29, 2000), to include the results of operations and
accounts of Cygnus for all periods presented. In January 2000, we acquired HKS
in a transaction accounted for in accordance with the purchase method of
accounting. As a result, our results of operations will include the results of
operations of HKS from the date of the acquisition. The discussion and analysis
which follows covers both:
- Red Hat's historical financial statements, without giving effect to the
pooling of interests with Cygnus, as those financial statements remain our
financial statements until we report results of operations for the period
ending February 29, 2000; and
- Red Hat's pooled financial statements, which give effect to the
acquisition of Cygnus, and which will become Red Hat's historical
financial statements at the time we report results of operations for the
period ending February 29, 2000.
Sales of Official Red Hat Linux have historically represented our principal
source of revenue. We derive our software and related products revenue primarily
from the sale of software products:
- through distributors to enterprise and retail accounts;
- directly to individual users and enterprises through our REDHAT.COM web
site and our call center; and
- from original equipment manufacturers which license our software directly.
We recognize revenue from software product sales to distributors and
original equipment manufacturers for which no technical support is provided at
the time our products are shipped, net of a reserve for estimated sales returns.
This reserve is recognized based on our historical experience with these
distributors' rates of sell-through to the end user. Revenue from the sale of
software products to individual users and enterprises for which no technical
support is provided is recognized on the date we ship the software products.
Upon the release of Version 6.0 of Red Hat Linux in May 1999, we began selling
Official Red Hat Linux and Red Hat Secure Web Server with 30 days of free
telephone technical support, 90 days of free e-mail technical support and
180 days of subscription services. In accordance with the provisions of
Statement of Opinion No. 97-2 ``Software Revenue Recognition", we are
recognizing all of the revenue from the sale of Versions 6.0 and 6.1 of Official
Red Hat Linux
29
<PAGE>
ratably over the period that the technical support and subscription services are
provided in proportion to the costs incurred to provide such technical support
and subscription services as compared to estimated total costs to be incurred.
Cygnus recognized revenue on the sale of its software products at the date
such products were shipped to the distributor or customer net of a reserve for
estimated sales returns. This reserve was recognized based on each individual
distributor's right of return under the distribution agreement and Cygnus's
historical experience of sales returns of its software products. Cygnus used the
same method of revenue recognition for product sales for which no technical
support is provided as we do, and we intend to continue to use this method for
these sales.
We have recently added new features to our REDHAT.COM web site and intend to
develop additional features which we believe will result in an increase in both
the number of visitors who access our web site and in revenue generated through
our web site, including through
- the sale of our own software and solutions;
- the sale of third-party products;
- the sale of products co-branded or bundled with third-party products; and
- the sale of advertising.
Web revenue is currently derived principally from short-term advertising
contracts in which we typically guarantee a minimum number of impressions to be
delivered to users over a specified period of time for a fixed fee. Advertising
rates are typically measured on a cost per thousand impressions basis.
Advertising revenue is recognized ratably in the period in which the
advertisement is displayed, provided that we have no significant remaining
obligations, at the lesser of the ratio of impressions delivered over total
guaranteed impressions or the straight line basis over the term of the contract.
If we do not meet minimum guaranteed impressions requirements, we defer
recognition of the corresponding revenue until the minimum number of guaranteed
impressions is achieved. We did not generate revenue from the sale of
advertising on our web site until the first quarter of the fiscal year ending
February 29, 2000.
Prior to March 1999, we provided only minimal service offerings to our
customers. In March 1999, we developed and expanded our service offerings to
include comprehensive technical support and maintenance, developer support,
custom development, consulting, training and education and hardware
certification services. Although these services generated only an insignificant
amount of revenue through February 28, 1999, we earned $3.4 million in service
revenue during the nine months ended November 30, 1999. We believe that the
expansion of our service offerings will cause our services revenue to continue
to increase significantly as a percentage of total revenue in the fiscal year
ending February 29, 2000. Revenue from technical support and maintenance
arrangements is deferred and recognized ratably over the term of the related
agreement, which is typically one year. Revenue from custom development,
consulting, training and education services, developer support and hardware
certification services, is recognized as the services are provided.
Cygnus provides custom development services for integrated device
manufacturers and also provides engineering services and developer support
services for microprocessor and product manufacturing companies. Cygnus
recognized revenue on its service arrangements on the percentage of completion
method over the term of the related development agreement. These custom
development arrangements generally have a term of three to six months. Support
and maintenance arrangements typically have terms of three months to two years.
Revenue from ongoing technical support and maintenance services was recognized
ratably over the term of the related technical support and maintenance
agreement. We intend to
30
<PAGE>
continue to use this method of revenue recognition for these services.
Our software products are sold worldwide. For the fiscal year ended
February 28, 1999, all of our revenue came from North America, except for less
than $50,000 in royalties received from international sources. In August 1999,
we established international operations, and we expect total revenue derived
from sales outside of North America to increase in the fiscal year ending
February 29, 2000 as we expand these operations.
We have historically experienced fluctuations in our results of operations
related to the release of new versions of Red Hat Linux. We believe our
customers' anticipation of the release of these new versions has historically
resulted in, and will continue to result in, a decline in sales for several
months prior to the release and an increase in sales immediately following the
release. Prior to our release of Version 6.0 of Official Red Hat Linux in
May 1999 and of Version 6.1 of Official Red Hat Linux in October 1999, software
product sales decreased, but after each release we experienced an immediate
significant increase in both the volume and dollar amount of software product
sales. In addition, we believe that revenue from the sale of Official Red Hat
Linux and related products will decline as a percentage of total revenue in the
future as we continue to expand our services offerings and execute our web
initiatives.
Sales of software products to distributors comprised $0.7 million or 26.1%
of total historical software and related products revenue in the fiscal year
ended February 28, 1997, $0.9 million or 17.3% of total historical software and
related products revenue in the fiscal year ended February 28, 1998,
$5.9 million or 58.2% of total historical software and related products revenue
in the fiscal year ended February 28, 1999 and $6.3 million or 73.7% of total
historical software and related products revenue for the nine months ended
November 30, 1999. Sales of software products to end users through our
REDHAT.COM web site and call center comprised $1.9 million or 73.9% of total
historical software and related products revenue in the fiscal year ended
February 28, 1997, $3.0 million or 58.8% of total historical software and
related products revenue in the fiscal year ended February 28, 1998,
$3.2 million or 29.6% of total historical software and related products revenue
in the fiscal year ended February 28, 1999 and $1.8 million or 20.5% of total
historical software and related products revenue for the nine months ended
November 30, 1999.
We plan to expand sales through distributors as well as direct sales through
our web site. We continue to expand our original equipment manufacturer
relationships and expect related revenue for the fiscal year ending
February 29, 2000 to increase as a percentage of total revenue as compared to
the fiscal year ended February 28, 1999.
Sales to Frank Kasper & Associates, one of our primary distributors,
constituted approximately 16.0% of total historical revenue in the fiscal year
ended February 28, 1997, and 26.0% of total historical revenue in the fiscal
year ended February 28, 1998. Sales to Frank Kasper & Associates and to Ingram
Micro, our two largest distributors in fiscal 1999, comprised 54.0% of total
historical revenue in the fiscal year ended February 28, 1999 and 62.0% of total
historical revenue in the nine months ended November 30, 1999. We provide our
distributors an advertising allowance on a quarterly basis, determined upon our
approval of the distributors' advertising plans. Distributors must then submit
to us a detailed list of expenses incurred by us. We pay all approved expenses
and recognize these costs as a component of sales and marketing expense as such
expenses are incurred.
We employed 233 people at December 31, 1999, compared to 103 at March 1,
1999. This increase in headcount resulted primarily from:
- an increase in services personnel associated with our efforts to develop
our services organization;
- an increase in research and development personnel;
- the commencement of international operations; and
31
<PAGE>
- an increase in administrative personnel as we recruited our management
team.
In addition, our acquisitions of Cygnus and HKS in January 2000 added
approximately 185 employees, resulting in total headcount in excess of
400 employees. We expect to continue to increase expenses associated with our
sales and marketing, research and development and general and administrative
groups in anticipation of continued growth and expansion. Given the expected
increase in headcount, we anticipate that we will need to either expand our
existing offices or lease additional office space at a separate location within
the next 12 months. We believe that this expansion will result in an increase in
total facilities costs.
HISTORICAL RESULTS OF OPERATIONS
The following table sets forth the historical results of operations for Red
Hat expressed as a percentage of total revenue. These historical results are not
necessarily indicative of results to be expected for any future period.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED FEBRUARY 28, NOVEMBER 30,
------------------------------ -----------------------
1997 1998 1999 1998 1999
-------- -------- -------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Software and related products.......................... 100.0% 99.5% 92.8% 91.5% 68.0%
Web.................................................... 0.0 0.0 0.0 0.0 5.0
Services and other..................................... 0.0 0.5 7.2 8.5 27.0
----- ----- ----- ----- -----
Total revenue............................................ 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- -----
Cost of revenue:
Software and related products.......................... 46.3 42.9 37.2 37.2 37.6
Web.................................................... 0.0 0.0 0.0 0.0 5.0
Services and other..................................... 0.0 0.0 0.2 0.0 16.3
----- ----- ----- ----- -----
Total cost of revenue.................................... 46.3 42.9 37.4 37.2 58.9
----- ----- ----- ----- -----
Gross profit............................................. 53.7 57.1 62.6 62.8 41.1
----- ----- ----- ----- -----
Operating expense:
Sales and marketing.................................... 18.8 24.3 28.6 23.1 60.4
Research and development............................... 12.5 17.5 20.6 20.0 33.0
General and administrative............................. 20.2 15.5 13.7 14.7 22.8
Stock-based compensation............................... 0.0 0.0 0.0 0.0 8.0
Mergers and acquisitions............................... 0.0 0.0 0.0 0.0 1.0
----- ----- ----- ----- -----
Total operating expense.................................. 51.5 57.3 62.9 57.8 125.2
----- ----- ----- ----- -----
Income (loss) from operations............................ 2.2 (0.2) (0.3) 5.0 (84.1)
Other income (expense), net.............................. (0.9) 0.4 1.5 0.8 14.4
----- ----- ----- ----- -----
Income (loss) before income taxes........................ 1.3 0.2 1.2 5.8 (69.7)
Provision for income taxes............................... 0.0 0.1 2.0 3.0 0.0
----- ----- ----- ----- -----
Net income (loss)........................................ 1.3 0.1 (0.8) 2.8 (69.7)
Accretion on mandatorily redeemable preferred stock...... 0.0 0.0 (0.4) (0.2) (0.7)
----- ----- ----- ----- -----
Net income (loss) available to common stockholders....... 1.3% 0.1% (1.2)% 2.6% (70.4)%
===== ===== ===== ===== =====
</TABLE>
32
<PAGE>
NINE MONTHS ENDED NOVEMBER 30, 1999 AND 1998
TOTAL REVENUE
Total revenue increased to $12.6 million in the nine months ended
November 30, 1999 from $7.1 million in the nine months ended November 30, 1998.
The majority of our revenue in the nine months ended November 30, 1999 came from
customers located in the United States. However, in August 1999, we established
international operations that began to generate revenue in the fiscal quarter
ended November 30, 1999. Our international revenue totalled $1.0 million in the
nine months ended November 30, 1999 as compared to less than $50,000 in the nine
months ended November 30, 1998, which consisted entirely of royalty revenue. We
expect that our revenue from international sources will increase in the future.
SOFTWARE AND RELATED PRODUCTS REVENUE
Software and related products revenue is comprised primarily of revenue from
sales of Official Red Hat Linux and related software products and sales of
publications about Linux-based operating systems. Software and related products
revenue increased to $8.6 million in the nine months ended November 30, 1999
from $6.5 million in the nine months ended November 30, 1998. In addition, we
generated software and related products revenue of $0.5 million from our
international operations in the nine months ended November 30, 1999 as compared
to zero in the nine months ended November 30, 1998. The increase in software and
related products revenue is primarily due to the release of Version 6.0 of
Official Red Hat Linux in May 1999 and the release of Version 6.1 of Official
Red Hat Linux in October 1999. As a percentage of total revenue, software and
related products revenue decreased to 68.0% in the nine months ended
November 30, 1999 from 91.5% in the nine months ended November 30, 1998. This
decrease was due to the increase in web revenue and services and other revenue.
Software and related products revenue was comprised almost entirely of revenue
from sale of software products in the nine months ended November 30, 1999.
WEB REVENUE
Web revenue is comprised primarily of fees generated from short-term
contracts with advertisers to display advertisements on our web site. Web
revenue increased to $0.6 million in the nine months ended November 30, 1999
from zero in the nine months ended November 30, 1998. As a percentage of total
revenue, web revenue increased to 5.0% in the nine months ended November 30,
1999. These increases were due to the commencement of our web initiatives during
the fiscal year ending February 29, 2000. We expect web revenue to increase as a
percentage of revenue in the future as advertising revenue and revenue from the
sale of third-party products and products co-branded or bundled with third-party
products continue to grow.
SERVICES AND OTHER REVENUE
Services and other revenue is primarily comprised of technical support and
maintenance fees, custom development fees, training and education fees and
royalties received from licensing our trademarks. Services and other revenue
increased to $3.4 million in the nine months ended November 30, 1999 from $0.6
in the nine months ended November 30, 1998. As a percentage of total revenue,
services and other revenue increased to 27.0% in the nine months ended
November 30, 1999 from 8.5% in the nine months ended November 30, 1998. These
increases resulted primarily from an increase in training and education revenue
earned in the nine months ended November 30, 1999 as we expanded our course
offerings, and, to a lesser extent, from an increase in technical support and
maintenance revenue as we began to sell technical support and maintenance
services during the second quarter of the fiscal year ending February 29, 2000.
In addition, we generated services and other revenue of $0.5 million from our
international operations in the nine months ended November 30, 1999 as compared
to
33
<PAGE>
zero in the nine months ended November 30, 1998.
COST OF REVENUE
COST OF SOFTWARE AND RELATED PRODUCTS
Cost of software and related products primarily consists of expenses we
incur to manufacture, package and distribute our products and related
documentation. These costs include expenses for physical media, literature and
packaging, fulfillment and shipping. Also included are royalties we paid for
licensing third-party applications included in our software products. Cost of
software and related products increased to $4.7 million in the nine months ended
November 30, 1999 from $2.6 million in the nine months ended November 30, 1998.
The increase in cost of software and related products was directly related to
the increase in sales of software and related products. As a percentage of
software and related products revenue, cost of software and related products
increased to 55.4% in the nine months ended November 30, 1999 from 40.7% in the
nine months ended November 30, 1998. This increase was due to the offering of
technical support and subscription services with the sale of Version 6.0 of
Offical Red Hat Linux in May 1999 and Version 6.1 of Official Red Hat Linux in
October 1999. This increase was also due to higher costs associated with the
initiation of product sales by our international operations in the fiscal
quarter ended November 30, 1999. We expect the cost of software and related
products revenue of our international operations to decrease as a percentage of
revenue in the future as sales volumes increase.
WEB COSTS
Web costs include the costs of developing advertising and supporting our web
site. Web costs increased to $0.6 million in the nine months ended November 30,
1999 from zero in the nine months ended November 30, 1998. As a percentage of
web revenue, web costs were 100.1% in the nine months ended November 30, 1999.
These increases were due to the development of our web advertising group and our
offering of web advertising for the first time during the fiscal year ending
February 29, 2000. We expect web costs to decrease as a percentage of web
revenue as this business becomes more established.
COST OF SERVICES AND OTHER
Cost of services and other was primarily comprised of salaries and other
related costs incurred for technical support and maintenance, custom
development, training and education and hardware certification services. We
incur no direct costs related to royalties received from the licensing of our
trademarks to third parties. Cost of services and other increased to
$2.0 million in the nine months ended November 30, 1999 from zero in the nine
months ended November 30, 1998. As a percentage of services and other revenue,
cost of services and other was 60.1% in the nine months ended November 30, 1999.
These increases were due to the addition of personnel to provide training and
education and hardware certification courses and the development of our services
organization.
We expect cost of services and other to continue to increase as we further
expand our service offerings and develop our services organization. Cost of
services and other as a percentage of services and other revenue is expected to
vary significantly from period to period depending upon:
- the mix of services we provide;
- whether such services are provided by us or third-party contractors; and
- the overall utilization rate of our services staff.
GROSS PROFIT
Gross profit increased to $5.2 million in the nine months ended
November 30, 1999 from $4.5 million in the nine months ended November 30, 1998.
As a percentage of total revenue, gross profit decreased to 41.1% in the nine
months ended November 30, 1999 from 62.8% in the nine months ended November 30,
1998. The increase in gross profit was due to the increased sales of our
34
<PAGE>
software products, which were primarily the result of the release of Version 6.0
of Official Red Hat Linux in May 1999 and Version 6.1 of Official Red Hat Linux
in October 1999. The decrease in gross profit as a percentage of revenue was the
result of the increase in costs related to the expansion, development and
marketing of our service offerings during the fiscal year ending February 29,
2000 and higher costs associated with our international operations which were
established in August 1999.
OPERATING EXPENSE
SALES AND MARKETING
Sales and marketing expense consists primarily of salaries and other related
costs for sales and marketing personnel, sales commissions, travel, public
relations and marketing materials and tradeshows. Sales and marketing expense
increased to $7.6 million in the nine months ended November 30, 1999 from
$1.6 million in the nine months ended November 30, 1998. As a percentage of
total revenue, sales and marketing expense increased to 60.4% in the nine months
ended November 30, 1999 from 23.1% in the nine months ended November 30, 1998.
These increases were due to higher advertising and promotional costs incurred to
promote the release of Versions 6.0 and 6.1 of Official Red Hat Linux during the
nine months ended November 30, 1999 and to promote REDHAT.COM and our service
offerings. In addition, we incurred a significant amount of sales and marketing
expense in the nine months ended November 30, 1999 related to our international
operations, which were established in August 1999. These increases were also due
to higher costs resulting from joint marketing arrangements with distributors.
We expect sales and marketing expense to continue to increase in dollar amount
as we promote the expansion of our services offerings and web site and expand
our international operations.
RESEARCH AND DEVELOPMENT
Research and development expense consists primarily of personnel and related
costs for development of our software products and web site. Research and
development expense increased to $4.2 million in the nine months ended
November 30, 1999 from $1.4 million in the nine months ended November 30, 1998.
As a percentage of total revenue, research and development expense increased to
33.0% in the nine months ended November 30, 1999 from 20.0% in the nine months
ended November 30, 1998. These increases resulted from increased spending
related to the development of our web initiatives and costs incurred to complete
the development of Versions 6.0 and 6.1 of Official Red Hat Linux. We expect
research and development expenses to continue to increase in dollar amount in
the future as we continue to develop our web site and create additional features
for Red Hat Linux.
GENERAL AND ADMINISTRATIVE
General and administrative expense consists primarily of personnel and
related costs for general corporate functions, including finance, accounting,
legal, human resources, facilities and information systems expenses. General and
administrative expense increased to $2.9 million in the nine months ended
November 30, 1999 from $1.0 million in the nine months ended November 30, 1998.
As a percentage of total revenue, general and administrative expense increased
to 22.8% in the nine months ended November 30, 1999 from 14.7% in the nine
months ended November 30, 1998. These increases resulted from:
- an increase in payroll costs due to an increase in the number of general
and administrative personnel to support the growth of our business;
- an increase in legal and accounting costs due to our initial public
offering and our geographic expansion; and
- an increase in insurance costs as a result of our becoming a public
company.
35
<PAGE>
We expect general and administrative expense to continue to increase in
dollar amount as we add administrative personnel to support our business
expansion.
STOCK-BASED COMPENSATION
Stock-based compensation expense consists of the amortization of deferred
compensation related to stock options granted to employees, primarily new
members of our management team that were recruited immediately prior to our
initial public offering in August 1999, with an exercise price below the fair
market value of our common stock at the date of grant. Deferred compensation is
amortized over the vesting period of the related stock options, which is
generally four years. Stock-based compensation expense increased to
$1.0 million in the nine months ended November 30, 1999 from zero in the nine
months ended November 30, 1998. As a percentage of total revenue, stock based
compensation expense increased to 8.0% in the nine months ended November 30,
1999. Stock-based compensation is expected to be approximately $2.3 million on
an annual basis through 2003.
MERGERS AND ACQUISITIONS
Mergers and acquistions expense consists of costs incurred in connection
with investigating potential acquisitions and acquisitions accounted for using
the pooling of interests method of accounting. Mergers and acquisitions expense
increased to $0.1 million in the nine months ended November 30, 1999 from zero
in the nine months ended November 30, 1998. As a percentage of total revenue,
mergers and acquisitions expense increased to 1.0% in the nine months ended
November 30, 1999. At November 30, 1999, we deferred $0.2 million in costs
related to the acquisition of Cygnus which will be expensed in the fiscal
quarter ending February 29, 2000.
OTHER INCOME (EXPENSE), NET
Other income (expense) consists of interest income earned on cash deposited
in money market accounts and other short-term investments, net of interest
expense incurred on capital leases. Other income (expense), net increased to
income of $1.8 million in the nine months ended November 30, 1999 from income of
$62,000 in the nine months ended November 30, 1998. As a percentage of total
revenue, other income (expense), net increased to 14.4% in the nine months ended
November 30, 1999 from 0.8% in the nine months ended November 30, 1998. These
increases resulted from higher average cash and investment balances in the nine
months ended November 30, 1999 as compared to the nine months ended
November 30, 1998 due to the receipt of proceeds from the sale of preferred
stock in September 1998 and in February, March and April 1999, and proceeds from
the sale of our common stock in our initial public offering in August 1999.
PROVISION FOR INCOME TAXES
Provision for income taxes decreased to zero for the nine months ended
November 30, 1999 from $0.2 million in the nine months ended November 30, 1998.
This decrease resulted from the decrease in our taxable income in the nine
months ended November 30, 1999 as compared to the nine months ended
November 30, 1998.
ACCRETION OF MANDATORILY REDEEMABLE PREFERRED STOCK
The increase in the accretion from mandatorily redeemable preferred stock to
$82,000 in the nine months ended November 30, 1999 from $16,000 for the nine
months ended November 30, 1998 was due to the fact that prior to September 1998
we had no outstanding mandatorily redeemable preferred stock. Accretion of
mandatorily redeemable preferred stock ceased with the completion of our initial
public offering in August 1999 when all outstanding mandatorily redeemable
preferred stock converted to common stock.
36
<PAGE>
FISCAL YEARS ENDED FEBRUARY 28, 1999 AND 1998
TOTAL REVENUE
Total revenue increased 109.3% to $10.8 million in the fiscal year ended
February 28, 1999 from $5.2 million in the fiscal year ended February 28, 1998.
SOFTWARE AND RELATED PRODUCTS REVENUE
Software and related products revenue increased 95.1% to $10.0 million, or
92.8% of total revenue, in the fiscal year ended February 28, 1999 from
$5.1 million, or 99.5% of total revenue, in the fiscal year ended February 28,
1998. The decrease in software and related products revenue as a percentage of
total revenue was due to the increase in services and other revenue.
Software products revenue increased to $9.0 million during the fiscal year
ended February 28, 1999 from $3.9 million for the fiscal year ended
February 28, 1998. The increase in software products revenue was due to higher
sales of Official Red Hat Linux. We met the higher demand for Official Red Hat
Linux by establishing a relationship with a major distributor in November 1998
and subsequently adding prominent national computer and software retailers.
Related products revenue decreased to $1.0 million during the fiscal year
ended February 28, 1999 compared to $1.2 million in the fiscal year ended
February 28, 1998. During the fiscal year ended February 28, 1999, we reduced
the number of publications that we published and distributed to focus our
efforts on our software products.
SERVICES AND OTHER REVENUE
Services and other revenue increased to $0.8 million in the fiscal year
ended February 28, 1999 from $24,000 in the fiscal year ended February 28, 1998.
As a percentage of total revenue, services and other revenue increased to 7.2%
in the fiscal year ended February 28, 1999 from 0.5% in the fiscal year ended
February 28, 1998.
Services and other revenue was comprised of $0.1 million in services revenue
and $0.7 million in royalties for the fiscal year ended February 28, 1999
compared to no services revenue and $24,000 in royalties for the fiscal year
ended February 28, 1998. The increase in services revenue resulted from the
introduction of our training and education and hardware certification program in
February 1999.
The increase in royalties resulted from the licensing of some of our
trademarks to third parties, nationally and internationally, as a way of
increasing our market share in markets or geographic locations important to our
business plan. This strategy allowed us to have a local presence without
incurring the costs associated with establishing separate operations in each of
these markets or geographic locations. During the fiscal year ended
February 28, 1999, we licensed some of our trademarks to publishers, who paid us
a royalty based on their sales.
COST OF REVENUE
COST OF SOFTWARE AND RELATED PRODUCTS
Cost of software and related products increased 81.5% to $4.0 million in the
fiscal year ended February 28, 1999 from $2.2 million in the fiscal year ended
February 28, 1998. The increase in cost of software and related products was
directly related to the increase in sales of software and related products. As a
percentage of software and related products revenue, cost of software and
related products decreased to 40.1% in the fiscal year ended February 28, 1999
from 43.1% in the fiscal year ended February 28, 1998. This decrease was due to
the decline in royalties paid to third parties because of the reduction in the
number of third-party applications included in our software products.
COST OF SERVICES AND OTHER
Cost of services for the fiscal year ended February 28, 1999 was primarily
comprised of salaries and other related costs incurred for our training and
education and hardware certification services which commenced in February 1999.
Cost of services and other
37
<PAGE>
increased to $28,000 in the fiscal year ended February 28, 1999 from zero in the
fiscal year ended February 28, 1998. As a percentage of services and other
revenue, cost of services and other increased to 3.6% in the fiscal year ended
February 28, 1999 from zero percent in the fiscal year ended February 28, 1998.
These increases were due to greater costs associated with our preparation to
expand our service offerings through the hiring of additional personnel.
GROSS PROFIT
Gross profit increased 129.2% to $6.7 million in the fiscal year ended
February 28, 1999 from $2.9 million in the fiscal year ended February 28, 1998.
As a percentage of total revenue, gross profit increased to 62.6% in the fiscal
year ended February 28, 1999 from 57.1% in the fiscal year ended February 28,
1998. These increases were primarily due to an increase in royalties received
for licensing our trademarks to third parties of $0.7 million in the fiscal year
ended February 28, 1999 for which we incurred no direct costs.
OPERATING EXPENSE
SALES AND MARKETING
Sales and marketing expense increased 146.2% to $3.1 million in the fiscal
year ended February 28, 1999 from $1.3 million in the fiscal year ended
February 28, 1998. Costs associated with joint marketing arrangements with
distributors totaled $0.1 million in the fiscal year ended February 28, 1999, as
compared to zero in the fiscal year ended February 28, 1998. As a percentage of
total revenue, sales and marketing expense increased to 28.6% in the fiscal year
ended February 28, 1999 from 24.3% in the fiscal year ended February 28, 1998.
These increases were due to greater costs attributable to cooperative marketing
arrangements with distributors, which were approximately $0.1 million in the
fiscal year ended February 28, 1999 and were zero in the fiscal year ended
February 28, 1998, and extensive public relations activities in the fiscal year
ended February 28, 1999 to promote our brand.
RESEARCH AND DEVELOPMENT
Research and development expense increased 145.9% to $2.2 million in the
fiscal year ended February 28, 1999 from $0.9 million in the fiscal year ended
February 28, 1998. As a percentage of total revenue, research and development
expense increased to 20.6% in the fiscal year ended February 28, 1999 from 17.5%
in the fiscal year ended February 28, 1998. These increases resulted from an
increase in the number of research and development personnel necessary to
support both expanded functionality and ease of use of Official Red Hat Linux,
costs of personnel involved in the GNOME graphical user interface project, and
increases in quality assurance and technical documentation projects.
GENERAL AND ADMINISTRATIVE
General and administrative expense increased 85.8% to $1.5 million in the
fiscal year ended February 28, 1999 from $0.8 million in the fiscal year ended
February 28, 1998. This increase resulted from:
- an increase in payroll costs of $0.3 million due to the increase in the
number of general and administrative personnel to 14 at February 28, 1999
from 5 at February 28, 1998;
- an increase in legal and accounting costs of $0.4 million in the fiscal
year ended February 28, 1999 incurred in connection with establishment of
new business activities; and
- to a lesser extent, due to approximately $60,000 in costs incurred
associated with relocating our offices in January 1999.
As a percentage of total revenue, general and administrative expense
decreased to 13.7% in the fiscal year ended February 28, 1999 from 15.5% in the
fiscal year ended February 28, 1998. This decrease was due
38
<PAGE>
primarily to revenue increasing at a higher rate than general and administrative
expense.
OTHER INCOME (EXPENSE), NET
Other income (expense), net increased 656.6% to income of $0.2 million in
the fiscal year ended February 28, 1999 from income of $20,000 in the fiscal
year ended February 28, 1998. As a percentage of total revenue, other income
(expense), net increased to 1.5% in the fiscal year ended February 28, 1999 from
0.4% in the fiscal year ended February 28, 1998. These increases resulted from
higher average cash and cash equivalents and short-term investment balances in
the fiscal year ended February 28, 1999 compared to fiscal 1998 due to receipt
of proceeds from the sale of preferred stock in September 1998 and the repayment
of outstanding notes payable during the fiscal year ended February 28, 1998.
PROVISION FOR INCOME TAXES
Provision for income taxes increased to $0.2 million in the fiscal year
ended February 28, 1999 from $5,000 in the fiscal year ended February 28, 1998.
Our effective tax rate increased to 173.6% of income before income taxes for the
fiscal year ended February 28, 1999 from 38.7% of income for the fiscal year
ended February 28, 1998. These increases resulted from the growth in our taxable
income and an increase in the valuation allowance on our net deferred tax assets
due to uncertainty of realization.
ACCRETION OF MANDATORILY REDEEMABLE PREFERRED STOCK
Accretion of mandatorily redeemable preferred stock of $39,000 in the fiscal
year ended February 28, 1999 was a result of the issuance of mandatorily
redeemable preferred stock in September 1998. Accretion of mandatorily
redeemable preferred stock ceased with the completion of our initial public
offering in August 1999 when all outstanding mandatorily redeemable preferred
stock converted to common stock.
FISCAL YEARS ENDED FEBRUARY 28, 1998 AND 1997
TOTAL REVENUE
Total revenue increased 98.1% to $5.1 million in the fiscal year ended
February 28, 1998 from $2.6 million in the fiscal year ended February 28, 1997.
SOFTWARE AND RELATED PRODUCTS REVENUE
Software and related products revenue increased by 97.1% to $5.1 million in
the fiscal year ended February 28, 1998 from $2.6 million in the fiscal year
ended February 28, 1997. The increase in software and related products revenue
resulted from increasing acceptance of Official Red Hat Linux by technical users
as a viable operating system.
SERVICES AND OTHER REVENUE
Services and other revenue increased to $24,000 in the fiscal year ended
February 28, 1998 from zero in the fiscal year ended February 28, 1997. This
increase resulted from royalty payments received from international publishers
of products bearing our trademarks in the fiscal year ended February 28, 1998.
COST OF REVENUE
COST OF SOFTWARE AND RELATED PRODUCTS
Cost of software and related products increased 83.5% to $2.2 million in the
fiscal year ended February 28, 1998 from $1.2 million in the fiscal year ended
February 28, 1997. The increase in cost of software and related products
resulted from increased sales of our software and related products. As a
percentage of software and related products revenue, cost of software and
related products decreased to 42.9% in the fiscal year ended February 28, 1998
from 46.3% in the fiscal year ended February 28, 1997. This decrease was due to
growing sales and declining costs on a per unit basis.
39
<PAGE>
GROSS PROFIT
Gross profit increased 110.6% to $2.9 million in the fiscal year ended
February 28, 1998 from $1.4 million in the fiscal year ended February 28, 1997.
As a percentage of total revenue, gross profit increased to 57.1% in the fiscal
year ended February 28, 1998 from 53.7% in the fiscal year ended February 28,
1997.
OPERATING EXPENSES
SALES AND MARKETING EXPENSE
Sales and marketing expense increased 154.8% to $1.3 million in the fiscal
year ended February 28, 1998 from $0.5 million in the fiscal year ended
February 28, 1997. As a percentage of total revenue, sales and marketing expense
increased to 24.3% in the fiscal year ended February 28, 1998 from 18.8% in the
fiscal year ended February 28, 1997. These increases resulted from additional
expense incurred due to the growth in the number of sales and marketing
personnel, increased costs attributable to cooperative marketing arrangements
with distributors, and higher advertising and tradeshows costs.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense increased 177.6% to $0.9 million in the
year ended February 28, 1998 from $0.3 million in the year ended February 28,
1997. As a percentage of total revenue, research and development expense
increased to 17.5% in the fiscal year ended February 28, 1998 from 12.5% in the
fiscal year ended February 28, 1997. These increases in research and development
expense were primarily due to the addition of software engineering and
development personnel in the fiscal year ended February 28, 1998.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense increased 51.8% to $0.8 million in the
fiscal year ended February 28, 1998 from $0.5 million in the fiscal year ended
February 28, 1997. The increase in general and administrative expense resulted
from the growth in the number of general and administrative personnel. As a
percentage of total revenue, general and administrative expense decreased to
15.5% in the fiscal year ended February 28, 1998 from 20.2% in the fiscal year
ended February 28, 1997. This decrease was due to total revenue increasing at a
higher rate than general and administrative expense.
OTHER INCOME (EXPENSE), NET
Other income (expense), net increased to income of $22,000 in the fiscal
year ended February 28, 1998 from expense of $23,000 in the fiscal year ended
February 28, 1997. This increase in other income (expense), net was due to an
increase in interest income resulting from higher average balances of cash and
cash equivalents and short-term investments and lower interest expense on our
notes payable which were repaid during the fiscal year ended February 28, 1997.
PROVISION FOR INCOME TAXES
Provision for income taxes increased to a provision of $5,000 in the fiscal
year ended February 28, 1998 from zero in the fiscal year ended February 28,
1997. For fiscal years ended February 28, 1998 and 1997, a full valuation
allowance was provided against net deferred tax assets due to uncertainty of
realization.
40
<PAGE>
POOLED RESULTS OF OPERATIONS
The following table sets forth the pooled results of operations for Red Hat
and Cygnus expressed as a percentage of total revenue as if they had been
combined since March 1, 1997. These pooled results are not necessarily
indicative of results to be expected for any future period. This table should be
read together with the pooled consolidated financial statements appearing
elsewhere in this prospectus.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED FEBRUARY 28, ENDED NOVEMBER 30,
--------------------------- -------------------------
1998 1999 1998 1999
------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
Revenue:
Software and related products............................ 22.7% 33.7% 31.7% 32.9%
Web...................................................... 0.0 0.0 0.0 2.1
Services and other....................................... 77.3 66.3 68.3 65.0
----- ----- ----- -----
Total revenue.............................................. 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenue:
Software and related products............................ 9.8 12.4 11.5 16.4
Web...................................................... 0.0 0.0 0.0 2.1
Services and other....................................... 27.5 26.1 26.5 35.6
----- ----- ----- -----
Total cost of revenue...................................... 37.3 38.5 38.0 54.1
----- ----- ----- -----
Gross profit............................................... 62.7 61.5 62.0 45.9
Operating expense:
Sales and marketing...................................... 39.8 33.5 31.9 51.9
Research and development................................. 20.4 25.7 27.1 26.7
General and administrative............................... 16.2 17.1 19.3 19.0
Stock-based compensation................................. 0.0 0.7 0.7 5.5
Mergers and acquisitions................................. 0.0 0.0 0.0 0.4
----- ----- ----- -----
Total operating expense.................................... 76.5 77.0 79.0 103.5
----- ----- ----- -----
Income (loss) from operations.............................. (13.8) (15.5) (16.8) (57.6)
Other income (expense), net................................ 1.6 0.1 0.2 7.0
----- ----- ----- -----
Income (loss) before income taxes.......................... (12.1) (15.3) (16.8) (50.6)
Provision for income taxes................................. 1.0 2.2 2.5 0.8
----- ----- ----- -----
Net income (loss).......................................... (13.1) (17.5) (19.3) (51.4)
Accretion on mandatorily redeemable preferred stock........ 0.0 (0.1) (0.1) (0.3)
----- ----- ----- -----
Net income (loss) available to common stockholders......... (13.1)% (17.6)% (19.4)% (51.7)%
===== ===== ===== =====
</TABLE>
41
<PAGE>
NINE MONTHS ENDED NOVEMBER 30, 1999 AND 1998
TOTAL REVENUE
Total revenue increased 25.5% to $29.6 million in the nine months ended
November 30, 1999 from $23.6 million in the nine months ended November 30, 1998.
Revenue from international operations totaled $13.1 million during the nine
months ended November 30, 1999. Prior to October 1999, our international revenue
was limited to revenue generated from custom development services performed for
international customers.
SOFTWARE AND RELATED PRODUCTS REVENUE
Software and related products revenue is comprised primarily of revenue from
sales of Official Red Hat Linux and related software products, sales of
publications about Linux-based operating systems and sales of software
development tools for use. Software and related products revenue increased 30.4%
to $9.7 million in the nine months ended November 30, 1999 from $7.5 million in
the nine months ended November 30, 1998. As a percentage of total revenue,
software and related products revenue increased to 32.9% in the nine months
ended November 30, 1999 from 31.7% in the nine months ended November 30, 1998.
These increases were primarily due to the release of Version 6.0 of Official Red
Hat Linux in May 1999, the release of Version 6.1 of Official Red Hat Linux in
October 1999 and, to a lesser extent, to the initial release of our software
development tools in July 1999. In addition, we generated $0.5 million in
revenue from sales of Official Red Hat Linux and related products by our
international operations in the nine months ended November 30, 1999 as compared
to zero in the nine months ended November 30, 1998. Software and related
products revenue was comprised almost entirely of revenue from sales of software
products in the nine months ended November 30, 1999.
WEB REVENUE
Web revenue is comprised primarily of fees generated from short-term
contracts with advertisers to display advertisements on our web site. Web
revenue increased to $0.6 million in the nine months ended November 30, 1999
from zero in the nine months ended November 30, 1998. As a percentage of total
revenue, web revenue increased to 2.1% in the nine months ended November 30,
1999. These increases were due to the commencement of our web initiatives during
the fiscal year ending February 29, 2000. We expect web revenue to increase as a
percentage of revenue in the future as advertising revenue and revenue from the
sale of third-party products and products co-branded or bundled with third-party
products continues to grow.
SERVICES AND OTHER REVENUE
Services and other revenue is primarily comprised of custom development
fees, technical support and maintenance fees, training and education fees and
royalties received from licensing our trademarks. Services and other revenue
increased to $19.3 million in the nine months ended November 30, 1999 from $16.1
in the nine months ended November 30, 1998. The increase in services and other
revenue resulted primarily from an increase in custom development revenue due to
an increase in the number, size and scope of custom development contracts, an
increase in training and education revenue as we began offering these services
in the first quarter of the fiscal year ended February 28, 1999 and an increase
in technical support and maintenance revenue as we began to sell technical
support and maintenance services for Official Red Hat Linux and related software
products in the nine months ended November 30, 1999. The increase in training
and education revenue was a result of the expansion of our course offerings in
the nine months ended November 30, 1999. As a percentage of total revenue,
services and other revenue decreased to 65.0% in the nine months ended
November 30, 1999 from 68.3% in the nine months ended November 30, 1998. The
42
<PAGE>
decrease in services and other revenue as a percentage of total revenue is
primarily the result of the increase in software and related products revenue.
COST OF REVENUE
COST OF SOFTWARE AND RELATED PRODUCTS
Cost of software and related products primarily consists of expenses we
incur to manufacture, package and distribute our products and related
documentation. These costs include expenses for physical media, literature and
packaging, fulfillment and shipping. Also included are royalties we paid for
licensing third-party applications included in our software products. Cost of
software and related products increased to $4.8 million in the nine months ended
November 30, 1999 from $2.7 million in the nine months ended November 30, 1998.
The increase in cost of software and related products was directly related to
the increase in sales of software and related products. As a percentage of
software and related products revenue, cost of software and related products
increased to 49.7% in the nine months ended November 30, 1999 from 36.5% in the
nine months ended November 30, 1998. This increase was due to the offering of
technical support and subscription services with the sale of Version 6.0 of
Official Red Hat Linux released in May 1999 and Version 6.1 of Official Red Hat
Linux released in October 1999. This increase was also due to higher costs
associated with the initiation of product sales by our international operations
in the fiscal quarter ended November 30, 1999. We expect the costs of software
and related products of our international operations to decrease as a percentage
of revenue in the future as sales volumes increase.
WEB COSTS
Web costs include the cost of developing advertising and supporting our web
site. Web costs increased to $0.6 million in the nine months ended November 30,
1999 from zero in the nine months ended November 30, 1998. As a percentage of
web revenue, web costs were 100.1% in the nine months ended November 30, 1999.
These increases were due to the development of our web advertising group and our
offering of web advertising for the first time during the fiscal year ending
February 29, 2000. We expect web costs to decrease as a percentage of revenue as
this business becomes more established.
COST OF SERVICES AND OTHER
Cost of services and other was primarily comprised of salaries and related
costs incurred for technical support and maintenance, custom development,
training and education and hardware certification services. We incur no direct
costs related to royalties received from the licensing of our trademarks to
third parties. Cost of services and other increased to $10.6 million in the nine
months ended November 30, 1999 from $6.2 million in the nine months ended
November 30, 1998. As a percentage of services and other revenue, cost of
services and other increased to 54.9% in the nine months ended November 30, 1999
from 38.7% in the nine months ended November 30, 1998. These increases are due
to the addition of personnel to provide custom development, training and
education and hardware certification services and the development of our
services organization.
We expect cost of services and other to continue to increase as we further
expand our service offerings. Cost of services and other as a percentage of
services and other revenue is expected to vary significantly from period to
period depending upon:
- the mix of services we provide;
- the number and scope of custom development contracts;
- whether such services are provided by us or third-party contractors; and
- the overall utilization rate of our services staff.
GROSS PROFIT
Gross profit decreased to $13.6 million in the nine months ended
November 30, 1999 from $14.6 million in the nine months ended November 30, 1998.
As a percentage of total revenue, gross profit decreased to 45.9% in the nine
months ended November 30, 1999 from 62.0% in the nine months ended
43
<PAGE>
November 30, 1998. These decreases were the result of the increase in costs
related to our custom development services, the expansion, development and
marketing of our technical support and maintenance offerings during the fiscal
year ending February 29, 2000 and higher costs associated with our international
software product revenue. These cost increases were partially offset by
increased sales of our software products, which were primarily a result of the
release of Version 6.0 in May 1999 and Version 6.1 of Official Red Hat Linux in
October 1999, and, to a lesser extent, increased revenue from sales of software
development tools.
OPERATING EXPENSE
SALES AND MARKETING
Sales and marketing expense consists primarily of salaries and other related
costs for sales and marketing personnel, sales commissions, travel, public
relations and marketing materials and tradeshows. Sales and marketing expense
increased to $15.4 million in the nine months ended November 30, 1999 from
$7.5 million in the nine months ended November 30, 1998. As a percentage of
total revenue, sales and marketing expense increased to 51.9% in the nine months
ended November 30, 1999 from 31.9% in the nine months ended November 30, 1998.
These increases were due to higher advertising and promotional costs incurred to
promote the release of Versions 6.0 and 6.1 of Official Red Hat Linux, our web
advertising and service offerings and, to a lesser extent, our new software
development tools. In addition, we incurred a significant amount of sales and
marketing expense related to our international operations which were established
in August 1999 and international promotion of Version 6.1 of Official Red Hat
Linux in the nine months ended November 30, 1999. These increases were also due
to higher costs resulting from joint marketing arrangements with distributors.
We expect sales and marketing expense to continue to increase in dollar amount
as we promote the expansion of our services offerings and web site and expand
our international operations.
RESEARCH AND DEVELOPMENT
Research and development expense consists primarily of personnel and related
costs for development of our software products and web site. Research and
development expense increased to $7.9 million in the nine months ended
November 30, 1999 from $6.4 million in the nine months ended November 30, 1998.
As a percentage of total revenue, research and development expense decreased to
26.7% in the nine months ended November 30, 1999 from 27.1% in the nine months
ended November 30, 1998. The increase in research and development expense
resulted from increased spending related to the development of our web
initiatives and costs incurred to complete the development of Versions 6.0 and
6.1 of Official Red Hat Linux, partially offset by a decrease in spending
related to the development of software development tools as these products were
completed during the nine months ended November 30, 1999. The decrease in
research and development expense as a percentage of revenue is primarily due to
the fact that revenue has increased at a faster rate than research and
development expense. We expect research and development expense to continue to
increase in dollar amount as we continue to develop our web site and create
additional features for Red Hat Linux.
GENERAL AND ADMINISTRATIVE
General and administrative expense consists primarily of personnel and
related costs for general corporate functions, including finance, accounting,
legal, human resources, facilities and information systems expenses. General and
administrative expense increased to $5.6 million in the nine months ended
November 30, 1999 from $4.5 million in the nine months ended November 30, 1998.
As a percentage of total revenue, general and administrative expense increased
to 21.0% in the nine months ended November 30, 1999 from 20.0% in the nine
months ended November 30, 1998. These increases resulted from:
- an increase in payroll costs due to an increase in the number of general
and
44
<PAGE>
administrative personnel to support the growth of our business;
- an increase in legal and accounting costs due to our initial public
offering and our geographic expansion; and
- an increase in insurance costs as a result of our becoming a public
company.
We expect general and administrative expense to continue to increase in
dollar amount as we add administrative personnel to support our business
expansion.
STOCK-BASED COMPENSATION
Stock-based compensation expense consists of the amortization of deferred
compensation related to stock options granted to employees, primarily new
members of our management team that were recruited immediately prior to our
initial public offering in August 1999, with an exercise price below the fair
market value of our common stock at the date of grant. Deferred compensation is
amortized over the vesting period of the related stock options, which is
generally four years. Stock-based compensation expense increased to
$1.6 million in the nine months ended November 30, 1999 from $0.2 million in the
nine months ended November 30, 1998. As a percentage of total revenue, stock
based compensation expense increased to 8.0% in the nine months ended
November 30, 1999. Stock-based compensation is expected to be approximately
$2.3 million on an annual basis through 2003.
MERGERS AND ACQUISITIONS
Mergers and acquisitions expense consists of costs incurred in connection
with investigating potential acquisitions and acquisitions accounted for using
the pooling of interests method of accounting. Mergers and acquisitions expense
increased to $0.1 million in the nine months ended November 30, 1999 from zero
in the nine months ended November 30, 1998. As a percentage of total revenue,
mergers and acquisitions expense increased to 1.0% in the nine months ended
November 30, 1999. We expect to incur approximately $10.0 million in merger and
acquisitions expense related to the acquisition of Cygnus, which includes
$0.2 million in costs related to this acquisition which were deferred at
November 30, 1999. These costs will be recognized in the fiscal quarter ending
February 29, 2000.
OTHER INCOME (EXPENSE), NET
Other income (expense) consists of interest income earned on cash deposited
in money market accounts and other short-term investments, net of interest
expense incurred on capital leases. Other income (expense), net increased to
income of $2.1 million in the nine months ended November 30, 1999 from income of
$42,000 in the nine months ended November 30, 1998. As a percentage of total
revenue, other income (expense), net increased to 7.0% in the nine months ended
November 30, 1999 from 0.2% in the nine months ended November 30, 1998. These
increases resulted from higher average cash and investment balances in the nine
months ended November 30, 1999 as compared to the nine months ended
November 30, 1998 due primarily to the receipt of proceeds from the sale of
preferred stock in September 1998 and in February, March, April and May 1999,
and proceeds from the sale of our common stock in our initial public offering in
August 1999.
PROVISION FOR INCOME TAXES
Provision for income taxes decreased to $0.2 million for the nine months
ended November 30, 1999 from $0.5 million in the nine months ended November 30,
1998. This decrease resulted from the decrease in our taxable income in the nine
months ended November 30, 1999 as compared to the nine months ended
November 30, 1998.
ACCRETION OF MANDATORILY REDEEMABLE PREFERRED STOCK
The increase in the accretion from mandatorily redeemable preferred stock to
$82,000 in the nine months ended November 30, 1999 from $16,000 for the nine
months ended November 30, 1998 was due to the fact that prior to September 1998
we had no outstanding mandatorily redeemable preferred stock. Accretion of
mandatorily redeemable preferred stock ceased with the
45
<PAGE>
completion of our initial public offering in August 1999 when all outstanding
mandatorily redeemable preferred stock converted to common stock.
FISCAL YEARS ENDED FEBRUARY 28, 1999 AND 1998
TOTAL REVENUE
Total revenue increased 46.0% to $33.0 million in the fiscal year ended
February 28, 1999 from $22.6 million in the fiscal year ended February 28, 1998.
Our international revenue totaled $10.6 million in the fiscal year ended
February 28, 1999.
SOFTWARE AND RELATED PRODUCTS REVENUE
Software and related products revenue increased 117% to $11.1 million, or
33.7% of total revenue, in the fiscal year ended February 28, 1999 from
$5.1 million, or 22.7% of total revenue, in the fiscal year ended February 28,
1998.
Software products revenue increased to $10.1 million during the fiscal year
ended February 28, 1999 from $3.9 million for the fiscal year ended
February 28, 1998. The increase in software products revenue was due to higher
sales of Official Red Hat Linux and, to a lesser extent, to the initial release
of our software development tools. We met the higher demand for Official Red Hat
Linux by establishing a relationship with a major distributor in November 1998
and subsequently adding prominent national computer and software retailers.
Related products revenue decreased to $1.0 million during the fiscal year
ended February 28, 1999 compared to $1.2 million in the fiscal year ended
February 28, 1998. During the fiscal year ended February 28, 1999, we reduced
the number of publications that we published and distributed to focus our
efforts on our software products.
SERVICES AND OTHER REVENUE
Services and other revenue increased to $21.9 million in the fiscal year
ended February 28, 1999 from $17.5 million in the fiscal year ended
February 28, 1998. This increase was the result of an increase in the number,
size and scope of our custom development arrangements and an increase in
technical support and maintenance revenue on custom development projects. As a
percentage of total revenue, services and other revenue decreased to 66.3% in
the fiscal year ended February 28, 1999 from 77.3% in the fiscal year ended
February 28, 1998. The decrease in services and other revenue as a percentage of
total revenue is primarily the result of the increase in software and related
products revenue.
COST OF REVENUE
COST OF SOFTWARE AND RELATED PRODUCTS
Cost of software and related products increased 85.7% to $4.1 million in the
fiscal year ended February 28, 1999 from $2.2 million in the fiscal year ended
February 28, 1998. The increase in cost of software and related products was
directly related to the increase in sales of software and related products. As a
percentage of software and related products revenue, cost of software and
related products decreased to 36.8% in the fiscal year ended February 28, 1999
from 43.1% in the fiscal year ended February 28, 1998. This decrease was due to
the decline in royalties paid to third parties because of the reduction in the
number of third-party applications included in our software products.
COST OF SERVICES AND OTHER
Cost of services for the fiscal year ended February 28, 1999 was primarily
comprised of salaries and other related costs incurred for our technical support
and maintenance, custom development, training and education and hardware
certification services. Cost of services and other increased to $8.6 million in
the fiscal year ended February 28, 1999 from $6.2 million in the fiscal year
ended February 28, 1998. This increase was due to greater costs associated with
the expansion of our service offerings through the hiring of additional
personnel and to increased costs related to our custom development and technical
support and maintenance services. As a percentage of services and other revenue,
cost of services and other decreased to 27.0% in the fiscal year ended
February 28, 1999
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from 35.6% in the fiscal year ended February 28, 1998. This decrease was
primarily due to services and other revenue increasing at a higher rate than the
cost of services and other.
GROSS PROFIT
Gross profit increased 43.1% to $20.3 million in the fiscal year ended
February 28, 1999 from $14.2 million in the fiscal year ended February 28, 1998.
This increase was primarily due to increased revenue from custom development and
technical support and maintenance services and an increase in royalties received
for licensing our trademarks to third parties of $0.7 million in the fiscal year
ended February 28, 1999 for which we incurred no direct costs. As a percentage
of total revenue, gross profit decreased to 61.5% in the fiscal year ended
February 28, 1999 from 62.7% in the fiscal year ended February 28, 1998. This
decrease was primarily the result of a decrease in gross profit on services and
other revenue.
OPERATING EXPENSE
SALES AND MARKETING
Sales and marketing expense increased 22.6% to $11.1 million in the fiscal
year ended February 28, 1999 from $9.0 million in the fiscal year ended
February 28, 1998. This increase was due to extensive public relations
activities in the fiscal year ended February 28, 1999 to promote our brand and
software products, costs of marketing our software development tools and greater
costs attributable to cooperative marketing arrangements with distributors. As a
percentage of total revenue, sales and marketing expense decreased to 33.5% in
the fiscal year ended February 28, 1999 from 39.8% in the fiscal year ended
February 28, 1998. This decrease was primarily due to a significant increase in
total revenue.
RESEARCH AND DEVELOPMENT
Research and development expense increased 83.4% to $8.5 million in the
fiscal year ended February 28, 1999 from $4.6 million in the fiscal year ended
February 28, 1998. As a percentage of total revenue, research and development
expense increased to 25.7% in the fiscal year ended February 28, 1999 from 20.4%
in the fiscal year ended February 28, 1998. These increases resulted from
expenditures incurred in the development of a software emulation product that
began in the fiscal year ended February 28, 1999, an increase in the number of
research and development personnel necessary to support both expanded
functionality and ease of use of Official Red Hat Linux, costs of personnel
involved in the GNOME graphical user interface project, and increases in quality
assurance and technical documentation projects.
GENERAL AND ADMINISTRATIVE
General and administrative expense increased 54.3% to $5.7 million in the
fiscal year ended February 28, 1999 from $3.7 million in the fiscal year ended
February 28, 1998. As a percentage of total revenue, general and administrative
expense increased to 17.1% in the fiscal year ended February 28, 1999 from 16.2%
in the fiscal year ended February 28, 1998. These increases resulted from:
- an increase in payroll costs due to an increase in the number of general
and administrative personnel at February 28, 1999 as compared to
February 28, 1998;
- an increase in legal and accounting costs in the fiscal year ended
February 28, 1999 incurred in connection with establishment of new
business activities; and
- to a lesser extent, due to costs incurred associated with relocating our
offices in January 1999.
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STOCK-BASED COMPENSATION
Stock-based compensation expense increased to $0.2 million in the nine
months ended November 30, 1999 from zero in the nine months ended November 30,
1998. As a percentage of total revenue, stock based compensation expense
increased to 0.7% in the nine months ended November 30, 1999 from zero in the
nine months ended November 30, 1998.
OTHER INCOME (EXPENSE), NET
Other income (expense), net decreased to income of $40,000 in the fiscal
year ended February 28, 1999 from income of $0.4 million in the fiscal year
ended February 28, 1998. As a percentage of total revenue, other income
(expense), net decreased to 0.1% in the fiscal year ended February 28, 1999 from
1.6% in the fiscal year ended February 28, 1998. These decreases resulted from
increased interest expense on our line of credit due to a higher average
outstanding balance in the fiscal year ended February 28, 1999 as compared to
the fiscal year ended February 28, 1998. This was partially offset by an
increase in interest income as a result of higher average cash and cash
equivalents and short term investment balances in the fiscal year ended
February 28, 1999 compared to the fiscal year ended February 28, 1998 due to
receipt of proceeds from the sale of preferred stock and the repayment of
outstanding notes payable during the fiscal year ended February 28, 1998.
PROVISION FOR INCOME TAXES
Provision for income taxes increased to $0.7 million in the fiscal year
ended February 28, 1999 from $0.2 million in the fiscal year ended February 28,
1998. This increase resulted from the growth in our taxable income in the United
States and withholding taxes on our foreign source income.
ACCRETION OF MANDATORILY REDEEMABLE PREFERRED STOCK
Accretion of mandatorily redeemable preferred stock of $39,000 in the fiscal
year ended February 28, 1999 was a result of the issuance of mandatorily
redeemable preferred stock in September 1998. Accretion of mandatorily
redeemable preferred stock ceased with the completion of our initial public
offering in August 1999 when all outstanding mandatorily redeemable preferred
shares converted into common stock.
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QUARTERLY RESULTS OF OPERATIONS
The following table sets forth Red Hat's unaudited historical quarterly
statement of operations data for each of the five fiscal quarters since
August 31, 1998 and an unaudited pooled quarterly statement of operations data
for the fiscal quarter ended November 30, 1999 to reflect our acquisition of
Cygnus. The historical quarterly information has been derived from unaudited
interim financial statements that, in the opinion of management, have been
prepared on a basis consistent with the financial statements contained elsewhere
in this prospectus and include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the financial
information for the periods presented. This information should be read in
conjunction with the financial statements and notes to those statements included
elsewhere in this prospectus.
<TABLE>
<CAPTION>
POOLED
THREE MONTHS
THREE MONTHS ENDED ENDED
NOV. 30, FEB. 28, MAY 31, AUG. 31, NOV. 30, NOV. 30,
1998 1999 1999 1999 1999 1999
-------- -------- -------- -------- -------- --------------
(IN THOUSANDS, UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Software and related products................ $2,964 $3,508 $ 1,936 $ 3,255 $ 3,369 $ 3,671
Web.......................................... -- -- 80 105 441 441
Services and other........................... 360 169 781 1,010 1,619 6,438
------ ------ ------- ------- ------- --------
Total revenue................................ 3,324 3,677 2,797 4,370 5,429 10,550
------ ------ ------- ------- ------- --------
Cost of revenue:
Software and related products................ 1,179 1,366 1,181 1,519 2,038 2,083
Web.......................................... -- -- 123 203 301 301
Services and other........................... -- 28 443 914 692 3,844
------ ------ ------- ------- ------- --------
Total cost of revenue........................ 1,179 1,394 1,747 2,636 3,031 6,288
------ ------ ------- ------- ------- --------
Gross profit................................. 2,145 2,283 1,050 1,734 2,398 4,322
------ ------ ------- ------- ------- --------
Operating expense:
Sales and marketing.......................... 781 1,438 1,629 2,331 3,650 6,390
Research and development..................... 624 797 826 1,511 1,821 2,819
General and administrative................... 502 437 824 959 1,187 2,094
Stock-based compensation..................... -- -- -- 377 532 580
Mergers and acquisitions..................... -- -- -- -- 124 124
------ ------ ------- ------- ------- --------
Total operating expense...................... 1,907 2,672 3,279 5,178 7,314 12,007
------ ------ ------- ------- ------- --------
Income (loss) from operations................ 238 (389) (2,229) (3,444) (4,916) (7,685)
Other income (expense), net.................. 34 100 140 336 1,337 1,426
------ ------ ------- ------- ------- --------
Income (loss) before income taxes............ 272 (289) (2,089) (3,108) (3,579) (6,259)
Provision for income taxes................... 153 -- -- -- -- 39
------ ------ ------- ------- ------- --------
Net income (loss)............................ 119 (289) (2,089) (3,108) (3,579) (6,298)
Accretion on mandatorily redeemable preferred
stock...................................... (16) (23) (43) (39) -- --
------ ------ ------- ------- ------- --------
Net income (loss) available to common
stockholders............................... $ 103 $ (312) $(2,132) $ 3,147 $(3,579) $ (6,298)
====== ====== ======= ======= ======= ========
</TABLE>
The operating results for any quarter are not necessarily indicative of the
operating results for any future period. In particular, due to our limited
operating history and the unpredictability of our industry, our revenue and net
income may fluctuate significantly from quarter to quarter and are difficult to
forecast. We base our current and future expense levels in part on our estimates
of future revenue. Our expenses are to a large extent fixed in the short term.
We may not be able to adjust our spending quickly if our revenue falls short of
our expectations. Accordingly, a revenue shortfall in a particular quarter would
have a disproportionate adverse effect on our net income for that quarter.
Furthermore, we may make pricing, purchasing, service, marketing, acquisition or
financing decisions that could adversely affect our business, operating results
and financial condition.
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Our quarterly operating results will fluctuate for many reasons, including:
- our ability to retain existing customers, attract new customers and
satisfy customer demand;
- changes in gross margins of our current and future products and services;
- the timing of our release of upgrade versions of our products;
- introduction of new products and services by us or our competitors;
- changes in the market acceptance of our open source solutions;
- changes in the usage of the internet and online services;
- timing of upgrades and developments in the Linux kernel and other open
source software products;
- the effects of acquisitions and other business combinations, including
one-time charges, goodwill amortization and integration expenses or
difficulties; and
- technical difficulties or system downtime affecting the internet or our
web site.
For these reasons, you should not rely on period-to-period comparisons of
our financial results to forecast our future performance. Our future operating
results may fall below expectations of securities analysts or investors, which
would likely cause the trading price of our common stock to decline
significantly.
HISTORICAL LIQUIDITY AND CAPITAL RESOURCES
We have historically derived a significant portion of our liquidity and
operating capital from the sale of equity securities, including private sales of
preferred stock and the sale of common stock in our initial public offering, and
from cash flows from operations.
At November 30, 1999, cash and cash equivalents totaled $12.0 million, an
increase of $1.9 million as compared to February 28, 1999. The increase in cash
and cash equivalents resulted from the receipt of $88.5 million in net proceeds
from our initial public offering in August 1999, $3.2 million in proceeds from
issuance of preferred stock in March and April 1999 and $2.8 million in proceeds
from exercise of stock options and warrants. This was partially offset by
purchase of net investments in debt securities of $82.5 million, cash used by
operations of $5.6 million and $4.3 million for the purchase of office and
computer equipment.
Cash used by operations of $5.6 million in the nine months ended
November 30, 1999, represented the net loss of $8.8 million, an increase in
accounts receivable of $3.5 million, an increase in inventories of $1.5 million
and an increase in other assets of $1.7 million, partially offset by an increase
in accounts payable of $2.5 million and an increase in deferred revenue of
$4.1 million. The increase in accounts receivable, accounts payable, accrued
expenses and deferred revenue resulted from the release of Versions 6.0 of
Official Red Hat Linux to our distributors in late April 1999 and Version 6.1 of
Official Red Hat Linux in early October 1999. These releases resulted in
increased sales which resulted in higher amounts of accounts receivable from
distributors at November 30, 1999.
Cash used in investing activities was comprised of the purchase of
investments in debt securities, net of maturities, of $82.5 million and
purchases of office and computer equipment totaling $4.3 million.
Cash from financing activities of $94.3 million for the nine months ended
November 30, 1999 was comprised of $3.2 million in net proceeds from the sale of
our preferred stock, $2.8 million in proceeds from the exercise of stock options
and warrants and $88.5 million in net proceeds from the sale of our common stock
in our initial public offering in August 1999.
At February 28, 1999, cash and cash equivalents totaled $10.0 million, an
increase of $8.7 million as compared to February 28, 1998. The increase in cash
and cash equivalents resulted primarily from $1.2 million in cash generated by
operations and $10.1 million of net proceeds from issuance of
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preferred stock during the fiscal year ended February 28, 1999. These amounts
were partially offset by $1.9 million of cash used to purchase short-term debt
securities, net of maturities, and $0.7 million of additions to property and
equipment.
Cash generated by operations of $1.2 million for the fiscal year ended
February 28, 1999 resulted primarily from an increase in accounts payable and
accrued liabilities of $1.5 million and net noncash charges to income of $0.6
million partially offset by our net loss of $0.1 million and an increase in
accounts receivable of $0.6 million.
Cash used in investing activities of $2.6 million was used to purchase
$1.9 million of short-term debt securities, net of maturities, and office and
computer equipment totaling $0.7 million.
Cash from financing activities totaled $10.1 million in the fiscal year
ended February 28, 1999 as a result of $6.9 million in net proceeds received
from sales of preferred stock in September 1998 and $3.2 million in net proceeds
received from sales of preferred stock in February 1999. We received an
additional $3.2 million in net proceeds from the sale of preferred stock
subsequent to February 28, 1999.
We have experienced a substantial increase in our operating expenses since
our inception in connection with the growth of our operations and staffing and
the expansion of our services operation and web initiatives. Our capital
requirements during the fiscal year ending February 29, 2000 depend on numerous
factors including the amount of resources we devote to:
- fund our domestic and international expansion;
- enhance our REDHAT.COM web site;
- improve and extend our service offerings;
- pursue strategic acquisitions and alliances;
- make possible investments in businesses, products and technologies; and
- expand our sales and marketing programs and conduct more aggressive brand
promotions.
We believe that the net proceeds from our initial public offering of common
stock in August 1999, together with the net proceeds from this offering and our
cash flow from operations, will be sufficient to meet our anticipated cash needs
for working capital and capital expenditures for at least the next 12 to
18 months. We may need to raise additional funds, however, in order to fund more
rapid expansion. We may seek to sell additional equity or debt securities or to
obtain a credit facility. The sale of additional equity or debt securities, if
convertible, could result in additional dilution to our stockholders. The
incurrence of indebtedness would result in increased fixed obligations and could
result in operating covenants that would restrict our operations. We cannot
guarantee that financing will be available in amounts or on terms acceptable to
us, if at all.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, ``Accounting for Derivative Instruments
and Hedging Activities". This statement establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. Statement of Financial
Accounting Standards No. 133 as amended by Statement of Financial Accounting
Standards No. 137, is effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000, with earlier application encouraged. We do not
currently nor do we intend in the future to use derivative instruments and
therefore do not expect that the adoption of Statement of Financial Accounting
Standards No. 133 will have any impact on our financial position or results of
operations.
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In December 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
No. 98-9, "Modification of Statement of Position No. 97-2, Software Revenue
Recognition, with Respect to Certain Transactions". Statement of Position
No. 98-9 amends Statement of Position No. 97-2 to require recognition of revenue
using the ``residual method" in circumstances outlined in Statement of Position
No. 98-9. Under the residual method, revenue is recognized as follows:
- the total fair value of undelivered elements, as indicated by vendor
specific objective evidence is deferred and subsequently recognized in
accordance with the relevant sections of Statement of Position No. 97-2;
and
- the difference between the total arrangement fee and the amount deferred
for the undelivered elements is recognized as revenue related to the
delivered elements.
Statement of Position No. 98-9 is effective for transactions entered into in
fiscal years beginning after March 15, 1999. Also, the provisions of Statement
of Position No. 97-2 that were deferred by Statement of Position No. 98-4 will
continue to be deferred until the date Statement of Position No. 98-9 becomes
effective. We do not expect that the adoption of Statement of Position No. 98-9
will have any impact on our financial position or results of operations.
YEAR 2000 COMPLIANCE
The "Year 2000 Issue" refers generally to the problems that some software
may have in determining the correct century for the year. For example, software
and computer systems with date-sensitive functions that is not Year 2000
compliant may not be able to distinguish whether "00" means 1900 or 2000, which
may result in failures or the creation of erroneous results.
We have defined "Year 2000 compliant" as the ability to:
- correctly handle date information needed for the December 31, 1999 to
January 1, 2000 date change;
- function according to the product documentation provided for this date
change, without changes in operation resulting from the advent of a new
century, assuming correct configuration;
- where appropriate, respond to two-digit date input in a way that resolves
the ambiguity as to century in a disclosed, defined, and predetermined
manner;
- if the date elements in interfaces and data storage specify the century,
store and provide output of date information in ways that are unambiguous
as to century; and
- recognize the year 2000 as a leap year.
In November 1998, we formed a committee consisting of our Chief Financial
Officer, our controller, a financial analyst and a systems administrator, as
part of our effort to perform a coordinated audit of:
- our products;
- the software components and applications with which our products are
bundled; and
- the systems upon which we rely for our internal operations.
PRODUCTS
The committee tested Version 4.2 and later versions of Red Hat Linux by
accelerating the date within these software programs to December 31, 1999 and
observed which software components failed as the date changed to January 1,
2000. These tests revealed that all of these versions of Red Hat Linux were Year
2000 compliant. In addition, in June 1999 we hired an independent contractor to
test Versions 5.2 and 6.0 of Red Hat Linux for Year 2000 readiness. The
independent contractor certified these products as Year 2000 compliant. In light
of the testing results
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<PAGE>
and certification, we do not plan to generate a contingency plan if either of
these products is later found not to be Year 2000 compliant. We have not tested,
however, and do not plan to test any products other than Red Hat Linux.
To date, we are aware of no Year 2000 problems with any of our products. If
it is later determined that products that we have not tested are not Year 2000
compliant, we believe that we have the resources, either in-house or within the
open source community, to quickly remedy any non-compliant products. If it is
necessary to remedy problems related to the Year 2000 issue, such efforts could
otherwise divert our resources from pursuing our business strategy. In addition,
known or unknown errors or defects in our products could result in the delay or
loss of revenue, diversion of development resources, damage to our reputation,
or increased service and warranty costs, any of which could materially adversely
affect our business, operating results or financial condition. Furthermore, some
commentators have predicted significant litigation regarding Year 2000
compliance issues, and we are aware of such claims and actions against other
software vendors. Because of the unprecedented nature of this litigation, it is
uncertain whether or to what extent we may be affected by it.
THIRD-PARTY PRODUCTS
We bundle third-party applications and software components with Official Red
Hat Linux. To date, the committee has made no assessment of and has no knowledge
of third-party Year 2000 readiness. We have not experienced any Year 2000
problems with these third-party applications to date, and we intend to remedy
any problems on a case-by-case basis if they arise. Because we believe that the
costs associated with the failure of third-party products will not be material
to our business, results of operations or financial condition, we do not intend
to expend resources to seek out and correct problems before they arise.
Accordingly, although our customers have not reported any Year 2000 problems to
date, it is possible that some of our customers may yet experience difficulties
related to third-party software, which may affect the performance of our
products and may lead to adverse results such as an unusually high number of
calls to our technical support department or other unusual requests for
information or assistance. Responding to these requests may divert resources
away from the execution of our business strategy. Moreover, failure of
applications bundled with our software may reduce the value of our products,
decrease or delay revenue, diminish our brand, give rise to breach of warranty
claims or divert resources, any of which could materially adversely affect our
business, results of operations and financial condition.
INTERNAL SYSTEMS
In August 1999, we evaluated our mission-critical internal systems for Year
2000 compliance, including computer hardware, software, web server, and other
related equipment and systems, such as phone systems and networking security
systems. Based on certifications from our information systems,
telecommunications and information technology vendors, such as Oracle, Sun
Microsystems, Veritas, Lucent, and Cisco regarding these systems, we believe
that their level of Year 2000 preparedness is sufficient to permit us to proceed
without any major disruptions to our internal equipment and systems.
Additionally, the majority of our computer hardware, telecommunications systems,
software, and networking hardware and software is new and all major systems are
covered under manufacturer service warranties and on-support contracts. We have
experienced no Year 2000 problems with our internal systems to date.
The lessor of our corporate headquarters has indicated that our offices are
Year 2000 compliant. We currently house substantially all of our communications
hardware and our other computer operations related to our web site on site at
our facilities, although we have back-up and co-location hardware for our web
site located at third-party facilities. The owners of facilities we plan to use
for that purpose have also certified to us that all of their systems and
facilities are Year 2000 compliant.
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Since we have just recently opened offices in Ireland, the United Kingdom,
Germany, Italy and Japan and may open additional offices in the future, the Year
2000 committee has begun to examine the global impact of Year 2000 issues, such
as telecommunications and networking interfaces with vendors in foreign
countries. Although we have tried to maintain a centralized approach to the
management of distributed computing by establishing a sole-source vendor
supplier policy worldwide, certain localizations and in-country implementations
of our communications systems may require piece-by-piece testing for Year 2000
compliance. Our international offices have not experienced any significant Year
2000 problems to date, and we intend to remedy any problems on a case-by-case
basis if they arise.
Based upon the foregoing, we do not believe that the costs involved in
continuing to make our internal information technology and non-information
technology systems Year 2000 compliant will be material, nor do we expect to
incur material costs to upgrade or replace any non-compliant systems.
WORST CASE SCENARIO
We have not tested any of our products other than Red Hat Linux and have not
tested software provided by, nor sought certifications from, third-parties
bundling software with Official Red Hat Linux. Our reasonably likely worst case
Year 2000 scenario would be that these products and bundled software from
third-parties fail in the year 2000, resulting in a decreased demand for our
products and damage to the Red Hat brand. In the event of a Year 2000 failure we
would devote resources to correct it. Because we have skilled in-house
developers and relationships with the open source community and third-parties
whose software we bundle with Red Hat Linux, we believe we will be able to
respond promptly to any failures that occur. The costs of such response and the
diversion of resources, however, could have a material adverse effect on our
business, results of operation and financial condition.
YEAR 2000 COMPLIANCE EXPENSES
To date, we have not expended a material amount of capital resources on Year
2000 compliance and do not anticipate future expenditures to be material to our
business, results of operations or financial condition. We have not hired
additional personnel to specifically address our Year 2000 compliance issues,
and presently, we do not expect to do so. Through December 31, 1999, we have
incurred approximately $300,000 in costs to make our internal systems Year 2000
compliant. These costs were primarily incurred to update our accounting and
financial management software and systems. The product and testing expenditures
to date relate primarily to on-going salary costs of personnel, including
committee members, participating at various levels in our compliance efforts, as
well as payments of approximately $30,000 to the independent contractor that
tested Versions 5.2 and 6.0 of Red Hat Linux. All costs related to achieving
Year 2000 readiness have been expensed as incurred, unless they related to the
cost of new software or hardware for our internal systems.
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BUSINESS
RED HAT
We are a leading global developer and provider of open source software and
solutions. Our software and solutions are provided for a variety of computing
systems, ranging from desktops, workstations and servers to special-purpose
computing devices such as wireless telephones, personal digital assistants,
routers and phone switches. We offer a wide range of professional services for
the Red Hat Linux operating system, related tools and libraries and popular open
source applications. Our services include technical support and maintenance,
developer support, custom development, consulting, training and education and
hardware certification. Our web site, REDHAT.COM, is a leading destination for
open source software users and developers and serves as the primary delivery
mechanism and customer interface for many of our offerings. REDHAT.COM also
offers extensive news and information for the open source community, an
important forum for open source software development, a commerce site and
priority access for software downloads and upgrades. We are committed to serving
the interests and needs of open source software users and developers and to
sharing our product developments with the open source community.
INDUSTRY BACKGROUND
GROWTH OF OPEN SOURCE SOFTWARE
The internet has accelerated the development of open source software. Open
source software has its origins in the academic and research environments and is
based on an open, collaborative approach to the development and distribution of
software, whereby multiple groups of developers collaborate on specific projects
from remote locations around the globe. Developers can write code alone or in
groups, make their code available over the internet, give and receive comments
on other developers' code and modify it accordingly. The growth of the internet
has greatly increased the scale and efficiency of open source development
through the availability of collaborative technologies such as e-mail lists,
news groups and web sites. These technologies have enabled increasingly large
communities of independent developers to collaborate on more complex open source
projects.
Open source software has emerged as a viable alternative to traditional
proprietary software. Under the proprietary model of software development, a
software developer generally licenses to the user only the object, or binary
code. Binary code consists of the 1's and 0's that only computers understand. By
contrast, under the open source development model, the software developer
provides the user with access to both the binary code and the source code.
Source code is the language used by the developers. As compared to the
proprietary model, the open source model:
- allows a company's in-house development team to collaborate with a global
community of independent developers;
- provides the user access to both binary and source code, and the rights to
copy, modify, alter and redistribute the software; and
- permits the user ongoing access to improvements made to the software by
others.
We believe open source software offers many potential benefits for software
customers, users and vendors. Customers and users are able to acquire the
software at little or no cost, install the software on as many computing devices
as they wish, and customize the software to suit their particular needs. In
addition, customers and users can obtain software updates, improvements and
support from multiple vendors, reducing reliance on any single vendor. Vendors
are able to leverage the community of open source developers, allowing them to
reduce development costs and decrease their time to market. Vendors are also
able to distribute
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their products freely over the internet, enabling them to create large global
user bases quickly.
Participants in open source development can generate revenue in a variety of
ways, including:
- making their own open source products widely available, and then offering
technical support, custom development, and related services to customers;
- meeting consumer demand for convenience and quality by selling their open
source products to customers in shrink-wrapped packaging accompanied by
user manuals and other related documentation and access to services and
technical support offerings;
- using open source products as a means of attracting visitors to their web
sites, which in turn can result in the sale of other products, services,
and advertising; and
- developing brand loyalty and a reputation for quality by providing
technically superior open source software products, which they can
leverage to sell additional products and services to customers.
Just as the open source model has benefited from the success of the
internet, it has also greatly contributed to the internet's success. Open source
software comprises much of the internet's infrastructure, from domain name
server software to web servers and e-mail router software. Open source software
is particularly well-suited to the internet. With access to the source code,
system administrators and developers can collaborate to debug, fix and optimally
configure their software on a real-time basis. This enables them to improve
performance and keep data flowing continually across the internet, minimizing
the disruptions and downtime common with proprietary software.
One of the better known open source products is the Linux kernel, the engine
of Linux-based operating systems. An operating system is the software that
allows a computer and its various hardware and software components to interact.
Operating systems based on the Linux kernel are robust and dynamic. Thousands of
developers worldwide continually collaborate on improving Linux-based operating
systems and update them on a regular basis.
Some of the benefits enjoyed by users of Linux-based operating systems
include:
- reduced licensing costs;
- flexibility resulting from access to and legal right to modify source
code;
- stability and high performance;
- comprehensive internet support;
- compliance with standards; and
- multi-platform capability.
Since 1991, the use of Linux-based operating systems has grown rapidly.
According to IDC, Linux-based operating systems represented 17% of all new
license shipments of server operating systems in 1998. Linux-based operating
systems are now the most commonly used operating system for web servers,
representing approximately 29% of all installations, according to the
December 1999 Netcraft Web Server Survey.
OPEN SOURCE OPPORTUNITIES BEYOND SERVERS AND DESKTOP COMPUTERS
The growth of the internet, together with the reduction in cost and increase
in performance of computing platforms, has also stimulated the demand for
computing devices that provide low-cost, easy access to the internet. These
devices include mobile computing devices, such as personal digital assistants,
wireless telephones, television set-top boxes, kiosks and game consoles, as well
as special-purpose server devices such as routers, switches and dedicated file
and e-mail servers. According to IDC, whereas in 1997 personal computers
accounted for 96% of internet access devices shipped in the U.S., by 2002 mobile
computing devices are expected to account for nearly 50% of unit shipments in
the U.S. In addition, IDC predicts that from
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1998 through 2002 shipments of these devices will increase 76% annually, that by
2002 there will be more than 55 million mobile computing devices, and that by
2005, shipment of these devices will exceed shipment of personal computers.
Manufacturers of mobile computing devices and other special-purpose server
devices need flexible, robust and sophisticated operating systems to power these
devices to take advantage of common application interfaces from desktop
computing environments. Many of these manufacturers have, therefore, turned to
open source solutions. In addition, many software developers rely upon open
source tools, such as libraries, compilers and debuggers, to create software for
these devices. Microprocessor vendors also use open source development tools and
real time operating systems to design reference platforms for integrated device
manufacturers.
CHALLENGES TO THE WIDESPREAD ADOPTION OF OPEN SOURCE
Despite a strong initial market acceptance of Linux-based operating systems
and other open source products, there exists a number of obstacles to widespread
adoption within the enterprise, including:
- lack of service and support;
- scarcity of applications supporting Linux-based operating systems; and
- lack of well-financed, viable open source industry participants.
The ability of a Linux-based operating system to penetrate large businesses
on an enterprise-wide basis and to gain widespread acceptance as a viable
alternative to operating systems developed under the proprietary software model,
depends, in large part, on the emergence of a proven leader in the open source
community. This open source leader must demonstrate to the business enterprise,
as well as to the community of application developers upon whom the business
enterprise relies, a successful business model and the ability to support and
service its products at a consistently high level.
THE RED HAT SOLUTION
To address the challenges facing the open source software market, our
products and services offer the following features and benefits:
SUPERIOR PRODUCT OFFERINGS
We engineer what we believe to be the most technically advanced open source
operating system, Red Hat Linux. Red Hat Linux is comprised of more than 700
separate software packages, including compilers and web servers, e-mail servers,
file transfer protocol servers and file servers. Red Hat Linux is:
- flexible and scalable--capable of running a single desktop machine or the
entire network of a large business enterprise;
- functional--able to handle discrete or multiple applications accessed by
multiple users;
- modular--allowing the user to install only those applications that are
desired by the user;
- adaptable--allowing the user to modify the software to meet particular
needs and requirements; and
- reliable--constantly monitored and fine-tuned by thousands of developers
worldwide.
As a result, Red Hat accounted for 56% of new license shipments of
Linux-based server operating systems in the U.S. in 1998 and was the most
popular system, preferred by 68% of U.S. users, according to IDC. In addition,
Red Hat Linux has won numerous awards, including "Operating System Product of
the Year" by InfoWorld Magazine in 1996, 1997 and 1998.
We also engineer superior software development tools. Our GNUPro and Code
Fusion software development tools are based
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on the leading open source GNU standards, and feature a compiler, debugger,
various additional libraries and utilities, including advanced source code
browsing and editing technology. We believe that Cygnus has been responsible for
over 75% of the changes in GNU compiler source code over the past two years. We
make regular, supported releases of our GNUPro software across a broad range of
computing platforms that support all significant operating system environments.
Consequently, these tools have won numerous awards including "Show Favorite" at
the August 1999 Linux World show and Linux Journal's 1999 award for "Best New
Application--Software Development".
COMPREHENSIVE OPEN SOURCE SOLUTIONS
Our market leadership in open source operating systems and development tools
enables us to deliver end-to-end solutions for software developers and
enterprise customers from servers to mobile computing devices. We employ many of
the top contributors to the development and maintenance of the Linux kernel and
GNU tools. With this expertise, we are better able to encourage software
developers to rapidly develop applications across a broad range of computing
platforms and port these applications for use on the Red Hat Linux operating
system. We are also positioned to attract enterprise customers and expand the
adoption of open source solutions within these companies.
EXTENSIVE PROFESSIONAL SERVICES
We also offer a broad range of professional services relating to the
development and use of open source products. These services include technical
support and maintenance, developer support, custom development, consulting,
training and education and hardware certification. We provide our customers and
the open source community with a respected and reliable technology partner, one
that is available to help with the purchase, deployment, customization and
maintenance of open source solutions. We also provide custom solutions for key
integrated device manufacturers and develop new technologies that meet their
business objectives. We provide engineering services and developer support to
microprocessor and product manufacturing partners to ensure that our development
tools provide functionality and flexibility that we believe are unmatched by any
proprietary tools vendor. We believe that providing these services and
establishing ourselves as our customers' technology development partner will
allow us to facilitate the widespread adoption of Red Hat Linux and other open
source solutions as full scale enterprise solutions.
LEADING ONLINE DESTINATION FOR THE OPEN SOURCE COMMUNITY
We are dedicated to serving the interests and needs of open source software
users and developers online. REDHAT.COM serves as our primary customer interface
and delivery mechanism for many of our solutions. REDHAT.COM also serves as a
comprehensive resource for the latest information related to open source
initiatives. It contains news of interest to open source users and developers,
features for the open source community, a commerce site and priority access for
software downloads and upgrades. Visitors to our site can organize and
participate in user groups, make available bug fixes and incremental code
improvements and share knowledge regarding the use and development of open
source software.
We estimate, based on our internal data, that our web site had approximately
959,000 unique visitors in November 1999 and approximately 34.8 million page
views in the fiscal quarter ended November 30, 1999. A unique visitor is an
individual visitor to our REDHAT.COM web site. We calculate unique visitors by
tracking the number of unique internet protocol addresses that access our web
site. Page views are the total number of complete pages retrieved and viewed by
visitors to REDHAT.COM. We calculate page views as the total successful requests
to access our web site pages less requests to view images.
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By acting as a clearinghouse of open source and Linux-related information
and by facilitating the interaction of developers, businesses and technology
enthusiasts, our web site has become a community center for the open source
movement.
COMMITMENT TO THE OPEN SOURCE MODEL
Red Hat has fully embraced the open source model. Whereas others have
incorporated certain aspects of this model into their businesses while retaining
various features of the proprietary model, our product offerings are true open
source offerings. We share our improvements to the Linux kernel and other open
source products with the development community. In this way, we benefit
independent developers by making our products more useful for them in their own
development projects. We have also sponsored the creation of the Red Hat Center
for Open Source, Inc., a non-profit foundation dedicated to the promotion of
open source activities and ideals. Furthermore, in addition to the open source
software we develop ourselves, we help fund a broad range of open source
software projects and organizations, including the XFree86 group, the linuxconf
open source software product and the Free Software Foundation.
STRATEGIC RELATIONSHIPS
In an effort to increase the market acceptance of open source software in
general, and the Red Hat Linux operating system in particular, we have
established development, marketing or distribution relationships with leading
technology companies, including Cisco, Compaq, Dell, Hewlett-Packard, IBM,
Intel, Nokia, Nortel, Oracle, SAP, Silicon Graphics and Sony Computer
Entertainment. Further, with our acquisition of Cygnus, we are positioned to
partner with many of the world's leading microprocessor companies to provide
open source software technologies on the latest computing platforms. In
addition, we share our development efforts with and commit resources to third
party developers and vendors in order to expand the number of applications
available for Linux-based and other open-source based operating systems. By
establishing and maintaining these relationships, we are able to increase market
awareness of open source software, gather industry support for our products and
penetrate new markets. See "--Sales, Marketing and Distribution".
STRATEGY
Our objective is to enhance our position as a leading worldwide developer
and provider of advanced, open source software and solutions, via both
traditional channels and the internet. The key elements of our strategy are:
INCREASE THE ADOPTION OF OPEN SOURCE SOFTWARE ACROSS ALL COMPUTING PLATFORMS
Although recent years have seen a substantial increase in the market
acceptance of Linux-based operating systems and other open source software, we
intend to promote further acceptance of open source software through a variety
of means, including strengthening our existing alliances with other information
technology companies, establishing new alliances and sharing our development
efforts with third-party developers. The strength of these relationships is
crucial to the expansion of the open source community, the technical advancement
and widespread distribution of open source products and the development of
third-party applications suitable for Linux-based operating systems.
By aligning ourselves with companies widely regarded as producing high
quality and highly reliable software developed under the traditional software
development model, we expect to bridge the gap between the open source community
and those customers who are currently skeptical or unaware of the benefits of
open source software.
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Our acquisition of Cygnus has broadened the market for our open source
products and solutions by permitting us to forge relationships with
manufacturers of mobile computing devices such as wireless phones and digital
personal organizers and special purpose server devices, such as routers and
phone switches. With our broad selection of open source products and our
comprehensive array of professional services, we believe that we can quickly and
effectively penetrate this market, expand our presence and increase the market
acceptance for open source solutions within it.
Additional means of increasing the market acceptance for Linux-based
operating systems and other open source software include maintaining and
improving our relationship with third-party developers and the open source
community, encouraging the development of open source applications and
publicizing success stories.
CONTINUE TO ENHANCE OUR WEB SITE
We are continuing to enhance our web site in an effort to create the
definitive online destination for open source software products, software
updates, news, and other content related to Linux-based operating systems and
other open source projects. At REDHAT.COM, people from around the world will be
able to obtain updates to open source software, purchase a wide array of open
source products and services, access and copy code for their own programming
efforts, read news related to topics of interest to the community and interact
with other community members. We have recently added such enhancements as
software update notification and automatic software updating for those who want
it. New features we anticipate adding to our web site include:
- registries and hosting of open source web sites and projects;
- open source classifieds (including products for sale and employment
listings);
- event calendars; and
- virtual trade shows.
By adding these features to our web site, we believe that our visitors will
continue to visit on a regular basis, and that we will attract an increasing
number of new visitors. In addition, we believe that these new features and
offerings will keep visitors on our site for longer periods of time.
EXPAND OUR PRESENCE IN THE ENTERPRISE MARKET
Historically, enterprise customers had to obtain open source operating
systems from one source and application development tools from another source.
With our acquisition of Cygnus, we are now positioned to provide comprehensive
open source solutions. We intend to expand our service offerings, including
training, consulting, custom development and web-based services that customers
have come to expect from information technology providers, which will increase
their confidence in open source products and providers. We are currently
expanding our professional services organization to enhance our ability to
provide such services. Between March 1, 1999 and December 31, 1999 we added 39
people to our professional services organization. With our acquisition of
Cygnus, we now have 90 people in our professional services organization. We
believe that as our user base grows, more of our customers, particularly our
larger customers, will look to us to help them customize their operating systems
and our development tools to perform optimally within their particular computing
environments across all of their computing platforms. We also expect that more
of our services will be provided as subscription services accessed through our
web site. We expect that many of our larger customers will also expect us to
assume the role of their technology partner and perform on-site consulting
services such as large-scale system assessments and enterprise-wide system
enhancements. We believe that by increasing our capacity to offer such services,
we will be able to significantly increase our services revenue and establish
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ourselves as the premier open source service provider.
CONTINUE TO PURSUE STRATEGIC ACQUISITIONS AND ALLIANCES
We intend to pursue a selective acquisition strategy as opportunities arise
to complement our product offerings, extend our service capabilities and expand
the features on our web site. We also intend to create strategic alliances where
it is beneficial to our business model. Our acquisition of Cygnus in
January 2000 allows us to expand the market for our products and foster the
rapid development of open source applications. In addition, we believe that our
strategic relationships with Cygnus's large corporate customers will encourage
the wide-spread acceptance of open source operating systems beyond the
traditional workstation and desktop computing environments. Our purchase of HKS
in January 2000 will help us expand our web site and provide open source
e-commerce solutions to our business partners.
INCREASE OUR PENETRATION INTO INTERNATIONAL MARKETS
We have only recently commenced operations in Europe, Asia and Australia,
but we are rapidly expanding worldwide. Since August 1999, we have established
subsidiaries in Japan and Australia. While we have a significant installed base
of international users, we intend to increase our overseas presence in the near
future by establishing additional foreign offices or subsidiaries. We offer Red
Hat Linux in English, French, German, Italian, and Japanese, and plan to
introduce it in other languages in the future.
CONTINUE TO INVEST IN THE DEVELOPMENT OF OPEN SOURCE TECHNOLOGY
We intend to continue to invest significant resources in the development of
new open source technology, capitalizing on our extensive experience working
within the open source model. We expect this continued investment to take the
form of increased expenditures on internal development efforts, including our
Red Hat Advanced Development Laboratory, as well as continued funding of
third-party open source projects. We also plan to continue our financial support
of the development efforts of many of the top-tier engineers in the open source
community. This support will be directed towards an array of projects, ranging
from:
- the development of ease-of-use features, which we believe will take Red
Hat Linux from the server to the desktop;
- the development of open source embedded operating systems and software,
which we believe will take Red Hat Linux from the personal computer to the
mobile computing device; and
- the design of new networking and scalability features, which are expected
to make Red Hat Linux more attractive as a server operating system.
In particular, we are going to sponsor a foundation which promotes open source
projects and ideals. We expect that, through our continued efforts, we will be
able not only to foster the advancement of open source technology, but also to
enhance our relationship with the open source community.
PRODUCTS AND SERVICES
We are a leading provider of open source software products and services. Our
product offerings include Red Hat Linux and related tools, open source software
applications, documentation, manuals and general merchandise. Our professional
services offerings, principally directed towards our larger corporate customers
and strategic partners, include technical support and maintenance, custom
development, consulting, training and education, developer support and hardware
certification.
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Our shrink-wrapped products come with a limited subscription service. Users
of these services are entitled to priority downloads of products, access to
developer pages on our web site and are e-mailed news relating to developments
within the open source community.
RED HAT LINUX AND RELATED SOFTWARE
OFFICIAL RED HAT LINUX 6.1. Official Red Hat Linux is our principal
product. We first released Official Red Hat Linux in October 1994, and began
shipping the latest release, Version 6.1, in October 1999. Official Red Hat
Linux is available for the Intel, Sun SPARC and Compaq Alpha platforms. We offer
the product in three versions:
- Standard--the basic collection of Red Hat Linux software includes a
printed user manual, limited installation technical support, and priority
access to software updates;
- Deluxe--includes the components of Standard, plus additional software
applications we license from third parties, an additional printed manual,
and limited telephone technical support; and
- Professional--includes the components of Deluxe, plus additional software
applications and technical support, and cryptography software we license
from RSA Data Security, Inc. used to create a secure web server suitable
for conducting secure transactions via the Internet. This is a successor
to our product previously known as the Red Hat Secure Web Server.
Official Red Hat Linux provides everything the user needs to perform a wide
variety of server functions, including setting-up a web, e-mail, file or print
server as well as using a computer as a general purpose desktop workstation to
perform virtually any computing function. Examples of the components included
within Red Hat Linux 6.1 are:
<TABLE>
<CAPTION>
COMPONENT FUNCTION
- --------- --------
<S> <C>
Linux Kernel (Version 2.2)................... Core of the operating system
X Windows System............................. Graphical layer
GNOME........................................ Graphical desktop user interface
Gtk.......................................... Graphical development libraries
Netscape Communicator........................ Web browser
Apache....................................... Web server
Sendmail..................................... E-mail routing software
Perl......................................... High-level programming language
Efax......................................... Fax utility
Pilot Link................................... Palm Pilot-Registered Trademark-
synchronization
GNOME PIM.................................... Personal Information Manager
Howto Greek (and other languages)............ Help files translated into Greek (and other
languages)
RPM.......................................... Manages the various software packages
All other components......................... Libraries, tools, games and other integrated
applications
</TABLE>
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Other Red Hat products include:
LINUX APPLICATIONS LIBRARY. The Linux Applications Library is a collection
of applications developed by third parties that are designed to run on Red Hat
Linux. These products do not include printed documentation or technical support.
RED HAT ROUGH CUTS. Red Hat Rough Cuts is a collection of unofficial
versions of Red Hat Linux designed to run on PowerPC, UltraSPARC, MIPS and M68K
processors. This product does not include technical support or printed
documentation.
RMS LINUX. RMS Linux is a special collection of Red Hat Linux operating
system and applications containing only open source software, and does not
include technical support or printed documentation. Red Hat donates a portion of
the proceeds from the sale of this product to the Free Software Foundation.
CCVS. Credit Card Verification System (CCVS) is transaction processing
software that is embeddable and portable to most UNIX and Linux systems. CCVS
may be used for credit card authorization and settlement, as well as check
verification. CCVS is certified with the major clearing house protocols and
supports e-commerce applications ranging from a single web page or billing
application, to a payment gateway server supporting thousands of merchants. We
acquired this product with our acquisition of HKS.
SOFTWARE FOR SPECIAL-PURPOSE CLIENT AND SERVER DEVICES
With our acquisition of Cygnus, we are now able to provide a wide array of
products that enable application scalability and portability across a range of
computing platforms. Cygnus engineers tools and operating systems which are used
for applications development and deployment across a broad range of computing
platforms. These products reduce the complexity of cross-platform application
development and deployment by allowing a single body of source code to be
developed on or targeted toward a wide range of computing platforms. These
products include:
GNUPRO TOOLSUITE. GNUPro Toolsuite is a collection of software development
tools based on the popular GNU standard. We intend to sell GNUPro bundled with a
subscription service that includes regular software upgrades and developer
support services for rapid response and resolution of technical questions or
problems.
GNUPRO DEV KIT FOR LINUX. GNUPro Dev Kit for Linux features GNU development
tools designed for users of Linux-based operating systems using computers based
on the Intel architecture. Unlike GNUPro Toolsuite, GNU Pro Dev Kit for Linux
does not come bundled with any support packages.
CODE FUSION. Code Fusion is an integrated development environment, or IDE,
for Linux developers. Code Fusion IDE enables developers familiar with UNIX or
Windows programming to quickly become productive in developing for Linux. This
complete Linux IDE tightly integrates the C, C++, and Java programming languages
with a robust graphical user interface to enhance developer productivity and
reduce software product time-to-market.
ECOS. eCos, the "embedded Cygnus operating system", is an
application-specific operating system targeted at special-purpose client device
environments such as consumer electronics, wireless telephones, set top boxes,
and internet appliances. This highly configurable and scalable product is
currently bundled with host tools that allow for rapid operating system
configuration.
EL/IX. EL/IX brings a consistent application programming interface to
developers who wish to target Linux as a host operating system, Linux as an
embedded operating system, or eCos as a deeply embedded operating system. Use of
EL/IX provides developers with the ease of developing Linux applications
natively and redeploying them to a variety of targets and applications,
including special-purpose server
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and client applications that are running any EL/IX-compliant operating system.
CYGWIN. Cygwin allows Linux/UNIX developers to compile their applications
easily for the Windows platform, without any substantial rewriting of the source
code.
SOURCE-NAVIGATOR 4.5. Source-Navigator 4.5 is a tool for software
developers, enabling them to quickly understand and re-engineer complex code.
PROFESSIONAL SERVICES
With our acquisition of Cygnus, we have significantly expanded the scope of
our service offerings and professional services staff, and currently offer the
following services:
TECHNICAL SUPPORT AND MAINTENANCE AND DEVELOPER SUPPORT. We offer technical
support and maintenance to a broad range of customers ranging from individual
users to large corporations. We deliver installation, incident-based and
developer support via our web site, e-mail and telephone. We have a
highly-trained and skilled staff of technical support engineers to provide these
services to our customers. In addition, we maintain relationships with several
third-party support providers in order to enhance and expand our technical
support and maintenance capabilities.
CUSTOM DEVELOPMENT AND CONSULTING. We offer consulting and custom
development services for enterprise customers seeking to deploy Red Hat Linux
and open source applications. We also offer advanced assistance to third-party
software developers working to develop applications that run on Red Hat Linux.
In addition, we offer specific consulting and custom development services for
key integrated device and microprocessor manufacturers seeking to utilize
embedded open source operating systems on their devices.
TRAINING AND EDUCATION. We provide training and educational programs to
those customers who want to learn how to optimize their use of Red Hat Linux.
The most popular of these programs is the "Red Hat Certified Engineer" course
that we offer at sites around the world. We also conduct on-site training for
customers. We work with third-party training and educational program providers
to develop and offer additional training courses on a variety of topics related
to Red Hat Linux, our open source tools and other open source software.
HARDWARE CERTIFICATION. We perform testing and certification services for
hardware vendors seeking to market their products to Red Hat Linux users.
Hardware vendors submit their products to us and, in exchange for a fee, we test
the hardware to determine whether it is compatible with Red Hat Linux. Products
meeting our performance criteria are certified as Red Hat Linux compatible.
PRODUCTION AND FULFILLMENT
We outsource the production, packaging and order fulfillment of our products
to third parties when it is cost effective to do so. To the extent possible, we
limit our internal production activities to such tasks as quality inspection and
testing. We currently have production arrangements with JVC Disc America Co.,
Webcom, Inc. and Brightstar Services, and order fulfillment arrangements with
JVC. We believe that our existing production arrangements are sufficient to
accommodate potential increases in sales volume for the foreseeable future.
REDHAT.COM
Our web site, REDHAT.COM, serves as the primary delivery mechanism and
customer interface for many of our offerings. We offer extensive resources for
the open source community, software updates and downloads and a commerce site
for our shrink-wrapped products and support offerings. REDHAT.COM also offers
users access to broad and authoritative content on open source software
including news, documentation, educational materials and case studies. Our web
site serves the interests and needs of a wide spectrum of open source software
users, from
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system administrators to developers to academics to mainstream technology users.
The REDHAT.COM audience is highly focused and technically sophisticated,
representing an attractive target market of computing professionals for
advertisers and merchants. We offer a number of advertising and sponsorship
programs to our partners and others seeking to reach this market.
Since August 1999, significant enhancements include:
- Red Hat Developer Network--The Red Hat Developer Network is a collection
of technical and business resources for developing software that runs on
Red Hat Linux. It includes news about recent open source software
developments, guidance on how to develop new applications that will run
optimally on Red Hat Linux, technical documentation and other resources,
and links to other resources that may be of interest to software
developers. It is targeted at a range of software developers, including
third parties that develop their own software application products,
enterprise developers, web application developers and open source software
developers. We plan to expand the Developer Network to include a variety
of partnership programs, co-marketing opportunities and specialized
support service offerings.
- Wide Open News--Wide Open News is a leading news and opinion forum for
open source solutions. It includes both original news and editorial
offerings, as well as content licensed from third parties, including
Industry Standard, Salon.com and The Register.
- Agent Update--We offer customers the ability to receive electronic
notification of the release of new open source products or product
upgrades. In addition, at their option, we can automatically download new
or upgraded products to the customers' computers when released.
- Red Hat Store--We intend to continue building the REDHAT.COM store into
the most comprehensive open source shopping resource for corporate
enterprise buyers. Offerings and upsell opportunities will be presented
throughout the site in a context-relevant manner.
CUSTOMERS AND APPLICATIONS
CUSTOMERS
Our customers range from individuals using our products for a wide variety
of personal and professional purposes to multinational Fortune 500 companies,
government agencies, and research and academic institutions. The following is a
partial list of customers which have purchased products and services from us in
the past, but which may not necessarily be ongoing customers. These customers
have purchased products and services ranging from one-time purchases of
approximately $2,000 to multi-year, multi-million dollar support, consulting and
custom development contracts:
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CORPORATE
<TABLE>
<S> <C>
American Airlines Inacom
America Online Intel
AT&T Lawrence Livermore National Laboratories
Autozone Nokia
Burlington Industries Nortel
Cisco Systems Oracle
Citrix Racal
Compaq Raytheon
Dell Sandia National Laboratories
Dreamworks SKG SAP
Fidelity Investments Siemens
Fujitsu (Amdahl) Silicon Graphics, Inc.
Gateway Sony Computer Entertainment
GTE Sprint
Hewlett-Packard Toshiba
IBM US Vision
</TABLE>
GOVERNMENT/ACADEMIC
<TABLE>
<S> <C>
Internal Revenue Service United States Department of the Army
Massachusetts Institute of Technology United States Marine Corps
National Weather Service United States Postal Service
Navy Surface Warfare Center Woods Hole Oceanographic Institution
</TABLE>
The following case studies provide examples of the manner in which our
products are used:
- The Exploration Department of Amerada Hess, a Fortune 500 global oil
company, was frustrated with the cost and difficulty of upgrading its
supercomputing hardware. In 1998, the Exploration Department replaced
approximately $2.5 million of its supercomputing hardware with a $420,000
cluster of more than 90 servers running Red Hat Linux. The department uses
this cluster to identify potential offshore oil and gas reservoirs using
three-dimensional modeling software.
- Garden Grove, California, a city with a population of 153,000, runs its
government and public services entirely on Red Hat Linux. Since 1994,
Garden Grove has not had a computer-related interruption in service for
any department, including its police department.
- Kenwood, a world leader in car audio and mobile electronics, is leveraging
Red Hat's affordability and flexibility to implement solutions for its
retail outlet store operations. Kenwood uses Red Hat Linux for mail relay,
print servers and file sharing. In addition, it serves as a firewall in
its outlet stores and selected branch offices.
- iCelebrate.com, an online provider of holiday and seasonal merchandise and
resources, purchased Red Hat's on-site consulting services to help create
its holiday shopping web site, quickly installing, integrating and tuning
Red Hat Linux on Oracle database software and Dell systems.
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THIRD-PARTY APPLICATIONS
The following is a partial list of the third-party applications that are
available today on Red Hat Linux:
<TABLE>
<S> <C>
Adobe Acrobat reader Lotus Domino
Apache Group Apache Web Server Netscape Communicator
Applix Applixware Netscape Messaging Server
Ardent UniData Oracle Oracle8i
Computer Associates Unicenter TNG Oracle Application Server
Corel Word Perfect Real Networks Real Server
Hewlett Packard Openmail SAP R/3
IBM DB2 Sendmail Sendmail
IBM Viavoice Sun Star Office
IBM Visual Age for Java for Linux Sybase Adaptive Server
IBM WebSphere
</TABLE>
The following is a partial list of the third-party applications that will be
available on Red Hat Linux in the near future:
<TABLE>
<S> <C>
American Power Conversion PowerChute Inprise C++Builder
Plus
Adobe Acrobat Creator Inprise Delphi
Adobe Framemaker Intershop Enterprise
Allaire Cold Fusion Intershop Hosting Product Line
Ardent UniVerse Intershop Enfinity
BEA Systems Tuxedo Knox Arkeia
BEA Systems Weblogic Netscape Directory Server
Computer Associates ArcServeIT Netscape Enterprise Server
Computer Associates InoculateIT Oracle Applications 11i
Checkpoint Firewall-1 Pervasive SQL
Citrix ICA Client Pervasive Tango
Citrix MetaFrame Progress AppServer
Digital Creations Zope Progress DataServers
EST BRU Progress WebSpeed Messenger
Hewlett Packard Openview Progress WebSpeed Transaction Server
IBM MQ Series Tivoli (all systems management
applications)
Informix Dynamic Server 2000 Tripwire Tripwire
Inprise JBuilder
</TABLE>
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The following represents a partial list of systems vendors that offer Red
Hat Linux on their servers and other systems:
<TABLE>
<S> <C>
SYSTEMS VENDOR RED HAT LINUX OFFERINGS
Cobalt All of Cobalt's server appliances use an
optimized version of Red Hat Linux.
Compaq Offers Red Hat Linux on its ProLiant, Prosignia
and AlphaServer series of servers and
workstations. Compaq also offers Red Hat Linux
bundled on its Deskpro EN and EP series upon
request.
Dell Offers Red Hat Linux factory-installed across
its entire line of Power-Edge servers and on
selected configurations of its workstations and
desktop personal computers.
Gateway Offers Red Hat Linux as an option on its Gateway
ALR servers (ALR 7000, 8000 and 9000).
Hewlett-Packard Offers Red Hat Linux on high end work stations
for the electronic design automation market and
has certified their Enterprise-ready LPR servers
on Red Hat Linux.
IBM Offers Red Hat Linux on the RS/6000 UNIX
systems, Netfinity server series, Intellistation
workstation and ThinkPad 600E.
Intel Offers Red Hat Linux tuned for its original
equipment manufacturer internet server
platforms.
Silicon Graphics Offers Red Hat Linux on the 1400L server
preloaded.
Sun Microsystems Offers Red Hat Linux as an option on its Deluxe
Sparc servers.
VA Linux Offers Red Hat Linux on all of its systems.
</TABLE>
SALES, MARKETING AND DISTRIBUTION
SOFTWARE PRODUCTS
We sell our products worldwide through direct marketing, telesales campaigns
and our web site, and indirectly through distributors, retailers, catalogs and
original equipment manufacturers. Our direct sales force of 18 individuals as of
December 31, 1999, is dedicated to increasing worldwide sales through our
retail, distribution and original equipment manufacturer channels. As of
December 31, 1999, our indirect distribution channel was composed of eight
distributors, over 100 retailers with thousands of locations and 50 original
equipment manufacturers. We have recently begun to focus our sales efforts more
aggressively on the business enterprise market.
Our two largest distributors are Ingram Micro and Frank Kasper & Associates.
Ingram Micro, which began distributing our products during the fiscal year ended
February 28, 1999, accounted for approximately 34% of our total historical
revenue during that fiscal year.
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Frank Kasper & Associates accounted for approximately 26% of our total
historical revenue in the fiscal year ended February 28, 1998, 20% for the
fiscal year ended February 28, 1999, and 12% in the nine months ended
November 30, 1999. Ingram Micro accounted for approximately 30% of our total
historical revenue in the nine months ended November 30, 1999.
Our agreements with our distributors typically are not exclusive, have no
stated minimum purchase or license obligations and may be terminated by either
party without cause. We believe that in the event of the termination of our
relationship with one or more of our indirect channel partners, we could enter
into replacement agreements with new partners. However, the failure to replace
these partners with distributors of equal marketing capabilities and reputation
could have a material adverse effect on our business, operating results and
financial condition.
We permit original equipment manufacturers to distribute Red Hat Linux with
their own hardware in exchange for royalty payments to us. We currently have
original equipment manufacturer agreements in place with Dell, Silicon Graphics
and others. These agreements are not exclusive, have no stated minimum purchase
or license obligations, and generally may not be terminated prior to the
expiration of their terms which, in the case of Dell, is one year and, in the
case of Silicon Graphics, is an initial term of one year, renewable for two
additional one-year terms.
SERVICES
We sell our service offerings worldwide directly to individuals and
companies through our sales force, direct marketing, telesales and our web site,
and indirectly through joint marketing alliances with companies such as Compaq,
IBM and Intel. Our direct sales force concentrates primarily on selling custom
development and technical support and maintenance contracts to our enterprise
customers worldwide. Our acquisition of Cygnus in January 2000 added 28 sales
professionals to our direct sales organization.
We have established joint marketing relationships with a number of leading
technology companies including Compaq, Hewlett-Packard, IBM, Intel and Oracle.
These agreements generally have one- or two-year terms and may be terminated
prior to the expiration of their terms by either party with prior notice.
Our direct marketing efforts support our sales and distribution efforts
through participation in industry trade shows, targeted advertising, channel
sales programs, public relations campaigns, retail promotions, customer surveys
and the promotion of our products through our web site. In addition, we offer
our software products for free download from REDHAT.COM and other internet sites
worldwide.
REDHAT.COM
We have a team of professionals dedicated to the development and maintenance
of our web site.
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<PAGE>
COMPETITION
In the market for operating systems, we compete with a limited number of
large and well-established companies that have significantly greater financial
resources, larger development staffs and more extensive marketing and
distribution capabilities. These competitors include Microsoft, Novell, IBM, Sun
Microsystems and The Santa Cruz Operation, all of which offer
hardware-independent multi-user operating systems for Intel platforms, and AT&T,
Compaq, Hewlett-Packard, Olivetti and Unisys, each of which, together with IBM
and Sun Microsystems, offers its own version of the UNIX operating system. Many
of these competitors bundle competitive operating systems with their own
hardware offerings, thereby making it more difficult for us to penetrate their
customer bases.
In the rapidly evolving open source- and Linux-based operating system
market, we compete with a number of well-respected vendors and development
projects. These competitors have established stable customer bases and continue
to attract new customers. We also compete for services revenue with a number of
companies that provide technical support and other professional services to
users of Linux-based operating systems, including some original equipment
manufacturers with which we have agreements. Many of these companies have larger
and more experienced services organizations than we do currently. In addition,
we face potential competition from several companies devoted to providing open
source-based products and services, such as VA Linux Systems, a provider of
hardware pre-installed with open source software, and Corel Corp., a developer
of open source applications, each of which has indicated a growing interest in
the Linux-based operating systems market.
With our acquisition of Cygnus, we now face competition in the market for
software development tools and operating systems for special-purpose computing.
Our main competitors in this market include Wind River Systems, Integrated
Systems Incorporated, Green Hills Software, and the Metrowerks subsidiary of
Motorola. These companies are well established and have greater financial
resources and a larger direct sales staff than we do. Some of these companies
currently produce or use open source software as part of their product
offerings.
The open source solutions market is not characterized by the traditional
barriers to entry that are found in most other markets, due to the nature of our
products. For example, anyone can copy, modify and redistribute Red Hat Linux
and most of our other open source products themselves. Accordingly, it is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share.
We believe that the major factors affecting the competitive landscape for
our products include:
- name and reputation of vendor;
- product performance, functionality and price;
- strength of relationships in the open source community;
- availability of user applications;
- ease of use;
- networking capability;
- breadth of hardware compatibility;
- quality of support and customer services;
- distribution strength; and
- alliances with industry partners.
Although we believe that we compete favorably with many of our competitors
in a number of respects, including product performance, functionality and price,
networking capability, and breadth of hardware compatibility, we believe that
many of our competitors have superior distribution capabilities and offer more
extensive support services than we currently do. In addition, there are
significantly more user applications available for competing operating systems,
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such as Windows NT and UNIX, than there are for Linux-based operating systems.
An integral part of our strategy in the near future, however, is to address
these shortcomings by, among other things, strengthening our existing strategic
relationships and entering into new ones in an effort to expand our distribution
capabilities, continuing to expand into the special-purpose computing device
market and attracting more attention to the open source movement, which in turn
should create additional incentives for software developers to write more
applications for Red Hat Linux.
In the market for advertising revenue, we will compete with other online
content providers and traditional forms of media such as newspapers, magazines,
radio and television. We believe that the principal competitive factors in
attracting advertisers include the amount of traffic on REDHAT.COM, brand
recognition, customer service and support, the demographics of our users and
visitors, our ability to offer targeted audiences and the overall
cost-effectiveness of the advertising medium that we offer.
SOFTWARE ENGINEERING AND DEVELOPMENT
We have invested, and intend to continue to invest, significant resources in
product and technology development. We focus and modify our product development
efforts based on the needs of users and changes in the marketplace. We are
currently focusing our development efforts on improving the Linux kernel, as
well as commercializing our software innovations into new products and product
enhancements that are easier to use and provide greater functionality. Our
software engineers collaborate with open source software development teams
working across the internet. This involvement enables us to remain abreast of
and lead technical advances, plans for development of new features and timing of
releases, as well as other information related to the development of the Linux
kernel and other open source projects.
Our software engineers have contributed to the development and maintenance
of some of the most important components of the Red Hat Linux operating system,
including the installation program and the package management program. The
installation program provides users with a single method to install the hundreds
of separate software programs that are included with Red Hat Linux so that from
the user's perspective, the hundreds of programs appear as one. This simplified
process sharply reduces the time and effort required to install a Linux-based
operating system, as compared to the alternative of gathering the hundreds of
programs one by one via the internet. The installation program provides default
settings for the user depending upon whether the user wishes to use Red Hat
Linux as a server operating system or as a workstation operating system. The
installation also provides advanced users with the ability to customize the
programs that are installed, allowing for significant flexibility and control
over the operating system. The installation also automatically detects the type
of hardware that comprises the user's computer, in order to ensure that all
programs necessary for Red Hat Linux to work on the hardware are properly
installed.
Our software development engineers perform extensive testing of Red Hat
Linux to ensure that it is properly assembled and works as a coherent whole from
the user's perspective. We use industry standard methods of quality assurance
testing to ensure that Red Hat Linux is solidly engineered and ready for use by
our customers when shipped. We also operate an extensive beta testing program
for Red Hat Linux. Under this beta testing program, we post a beta or test
version of the operating system on the internet. Developers and users around the
world then suggest improvements and identify bugs. Each suggestion is circulated
over the internet in an attempt to encourage others to assist in the programming
of a solution. In this way, Red Hat Linux users are treated as co-developers.
Bug fixes and enhancements are tested by other users and our engineers, and when
corrected, added to the next release. When the beta version is viewed as stable
and complete,
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<PAGE>
it becomes the next production version, and a new beta cycle begins.
Our web development team consists of engineers with considerable experience
in developing scalable web-based applications. We continue to develop
applications on REDHAT.COM for user registration, commerce, and content
management and publication. We rigorously test these programs and have built in
the software necessary to ensure high quality visits to our web site.
Most of our software engineering and development work takes place at our
headquarters. As of December 31, 1999, we employed 84 individuals in our
engineering group, consisting of 42 software engineers, including several of the
top Linux kernel developers in the world, 30 web design and development
professionals, 7 quality assurance engineers, 5 documentation specialists. With
our acquisitions of Cygnus and HKS, we added 114 people to our engineering
group.
INTELLECTUAL PROPERTY
Red Hat Linux and our other open source products have been developed and
made available for licensing under the GNU General Public License and similar
licenses. These licenses generally permit anyone to copy, modify and distribute
the software, subject only to the restriction that any resulting or derivative
work is made available to the public under the same terms. Therefore, although
we retain the copyrights to the code that we develop ourselves, due to the open
source nature of our software products and the licenses under which we develop
and distribute them, our most valuable intellectual property is our collection
of trademarks. We rely primarily on a combination of trademarks and copyrights
to protect our intellectual property. We also enter into confidentiality and
nondisclosure agreements with our employees and consultants, and generally
control access to and distribution of our documentation and other proprietary
information.
We pursue registration of some of our trademarks in the United States and in
other countries. We have registered the trademark "Red Hat" in the United
States, Australia, and the European Union, and have registrations pending in
many other countries, including Canada and Japan. We have registered the Red Hat
"Shadow Man" logo in the U.S., European Union and Australia and have
registrations pending for it in many other countries, including Canada and
Japan. Other trademarks we have registered or have registrations pending in the
United States include Red Hat Certified Engineer, RHCE, Wide Open, Always Open,
Red Hat Ready and the Red Hat Ready logo. Other trademarks Cygnus registered or
has registrations pending in the United States include Cygnus Solutions, GNUPro,
Code Fusion, eCos, eCosystem, SourceNavigator and Cygwin.
Despite our efforts to protect our trademark rights, unauthorized third
parties have in the past attempted and in the future may attempt to
misappropriate our trademark rights. We are currently investigating possible
infringement claims against a third party in France whom we believe has
misappropriated our tradename and trademarks. We cannot be certain that we will
succeed in preventing the continued misappropriation of our tradename and
trademarks in these circumstances or that we will be able to prevent this type
of unauthorized use in the future. The laws of some foreign countries do not
protect our trademark rights to the same extent as do the laws of the United
States. In addition, policing unauthorized use of our trademark rights is
difficult, expensive and time consuming. The loss of any material trademark or
trade name could have a material adverse effect on our business, operating
results and financial condition.
Although we do not believe that our products infringe the rights of third
parties, third parties have in the past asserted, and may in the future assert
infringement claims against us which may result in costly litigation or require
us to obtain a license to third-party intellectual rights. There can be no
assurance that such licenses will be available on reasonable terms or at all,
which could have a material adverse effect on our business, operating results
and financial condition.
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<PAGE>
EMPLOYEES
As of December 31, 1999, we had a total of 233 employees. Of the total
employees, 84 were in software engineering, 74 in sales and marketing, 45 in
customer service and technical support and 30 in finance and administration.
With our acquisitions of Cygnus and HKS, the number of employees in our software
engineering and customer service and technical support departments has almost
doubled. Our future success will depend in part on our ability to attract,
retain and motivate highly qualified technical and management personnel, for
whom competition is intense. From time to time we also employ independent
contractors to support our professional services, product development, sales,
marketing and business development organizations. Our employees are not
represented by any labor union and are not organized under a collective
bargaining agreement, and we have never experienced a work stoppage. We believe
our relations with our employees are good.
FACILITIES
Our headquarters are currently located in a leased facility in Durham, North
Carolina, consisting of approximately 51,800 square feet under a five year lease
that will expire on January 14, 2004. The annual rental expense under this lease
is approximately $900,000. We also have major offices in Sunnyvale, California
and in the United Kingdom. We believe that additional space will be required as
our business expands and will be available on acceptable terms.
LEGAL PROCEEDINGS
We are not a party to any material legal proceedings. We may from time to
time become a party to various legal proceedings arising in the ordinary course
of our business.
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<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth the executive officers, directors and key
employees of Red Hat, their ages and the positions held by them with Red Hat as
of December 31, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- -------- --------
<S> <C> <C>
EXECUTIVE OFFICERS AND DIRECTORS
Robert F. Young.............................. 45 Chairman of the Board of Directors
Matthew J. Szulik............................ 43 Chief Executive Officer, President and
Director
Michael Tiemann.............................. 35 Chief Technology Officer
Timothy J. Buckley........................... 48 Senior Vice President and Chief Operating
Officer
Manoj K. George.............................. 32 Chief Financial Officer, Director of
Administration and Treasurer
Tom Butta.................................... 43 Chief Marketing Officer
David G. Shumannfang......................... 31 Counsel and Secretary
Marc Ewing................................... 30 Director
Kevin Harvey (1)(2).......................... 35 Director
William S. Kaiser (1)(2)..................... 44 Director
Eric Hahn (1)(2)............................. 39 Director
Frank Battten, Jr. (3)....................... 40 Director
KEY EMPLOYEES
Erik W. Troan................................ 25 Director of Engineering, Red Hat Linux
Donald J. Barnes............................. 27 Director of Technical Projects
Dr. Charles A. Coleman, Jr................... 53 Director of Information Services
Matthew Butterick............................ 29 Director of Internet Strategy
Carolyn Sparano.............................. 37 Director of North American Services
Howard Jacobson.............................. 39 Director of Corporate Development
Walter McCormack............................. 31 Director of Corporate Development
Lawrence J. Weidman.......................... 46 Director of Business Development, e-Commerce
Paul F. McNamara............................. 38 Director of Sales, Enterprise Division
Don Langley.................................. 40 Director of Sales, Embedded and Tools Division
Tom Barton................................... 36 Director of Global Services
Kim Knuttilla................................ 42 Director of Engineering, Embedded Systems
Colin Tenwick................................ 39 General Manager for European Operations
Masanobu Hirano.............................. 47 General Manager for Japan Operations
Mark White................................... 31 General Manager for Asia/Pacific Operations
</TABLE>
- ------------------------
(1) Member of Compensation Committee.
(2) Member of Audit Committee.
(3) Resigned from the Board of Directors effective January 13, 2000.
ROBERT F. YOUNG co-founded Red Hat and served as its President and a
Director from its inception until November 1998. In November 1998, he was
elected as Chief Executive Officer and Chairman of the Board of Directors. In
November 1999, he resigned as Chief Executive Officer and currently serves as
the Chairman of the Board of Directors.
MATTHEW J. SZULIK has served as Chief Executive Officer of Red Hat since
November 1999, as President since November 1998 and as a Director since
April 1999. Mr. Szulik also served as Chief Operating Officer of Red Hat from
November 1998 to April 1999. Prior to joining Red Hat, from September 1997 to
October 1998, Mr. Szulik served as President of Relativity Technologies, a
computer software company. From February 1996 to May 1997, Mr. Szulik served as
President of Sapiens International, a computer software company. Prior to that,
from January 1993 to December 1995, he served as Senior Vice President in charge
of sales and marketing for MapInfo Corp., a computer software company.
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MICHAEL TIEMANN has served as Red Hat's Chief Technology Officer since
January 2000. Prior to joining Red Hat, he was a co-founder of Cygnus in 1989,
and held various positions with Cygnus, including President, Director of
Business Development and Director of Technical Marketing.
TIMOTHY J. BUCKLEY has served as Senior Vice President and Chief Operating
Officer of Red Hat since April 1999. Prior to joining Red Hat, from
October 1997 until April 1999, Mr. Buckley was Senior Vice President of
Worldwide Sales at Visio Corp., a business software company. Mr. Buckley joined
Visio in November 1993 and served as Visio's Vice President of Worldwide Sales
until his promotion in October 1997.
MANOJ K. GEORGE has served as Red Hat's Chief Financial Officer and
Treasurer since May 1998. From May 1997 to the present, he has held the position
of Director of Administration, and from May 1997 to May 1998 he served as Red
Hat's Controller. From November 1994 to May 1997, Mr. George, a certified public
accountant, served, first as a staff accountant, then as a senior accountant
with a regional accounting firm.
TOM BUTTA has served as Red Hat's Chief Marketing Officer since July 1999.
Prior to joining Red Hat, from July 1996 to July 1999, Mr. Butta served as Chief
Executive Officer of FGI, Inc., a marketing, consulting, research and
interactive communications firm. From January 1995 until June 1996, he served as
Chief Executive Officer of FGI New York, Inc., a marketing, consulting and
communications firm. Prior to that, Mr. Butta was a founder and Chief Executive
Officer of Christopher Vincent, Inc., an integrated and new media marketing
firm, from January 1989 to December 1994.
DAVID G. SHUMANNFANG has served as Counsel of Red Hat since October 1996 and
Secretary of Red Hat since April 1997. From August 1993 to May 1996,
Mr. Shumannfang earned his Juris Doctor from the University of North Carolina at
Chapel Hill School of Law. Mr. Shumannfang is a member of the North Carolina
State Bar.
MARC EWING co-founded Red Hat and has served as a Director of Red Hat since
its inception. He also served as its Executive Vice President and Chief
Technology Officer from inception until January 2000. Mr. Ewing participated in
the design and development of Red Hat Linux and founded Red Hat Advanced
Development Laboratories to develop open source graphical desktop applications
for Linux in cooperation with the open source development community. Prior to
founding Red Hat, for various periods from January 1991 to August 1992,
Mr. Ewing worked as a systems programmer for IBM.
KEVIN HARVEY has served as a Director of Red Hat since August 1999.
Mr. Harvey has been a Managing Member of the general partner of Benchmark
Capital Partners, a venture capital firm, since January 1995. From July 1993 to
January 1995, Mr. Harvey served as General Manager for Lotus Development
Corporation, a software company. Mr. Harvey is also a director of Silicon
Gaming, Inc., Critical Path, Inc. and several privately held companies.
WILLIAM S. KAISER has served as a Director of Red Hat since September 1998.
Mr. Kaiser has been employed by Greylock Management Corporation, a venture
capital firm, since May 1986 and has been a general partner of the Greylock
Limited Partnerships since January 1988. Mr. Kaiser is also a director of Open
Market Inc., Clarus Corporation and Student Advantage, Inc.
ERIC HAHN has served as a Director of Red Hat since April 1999. Mr. Hahn is
a founding partner of Inventures Group, a leading "mentor investment" venture
capital firm. He served as Executive Vice President and Chief Technology Officer
of Netscape from November 1996 until June 1998. Prior to serving as Netscape's
Chief Technology Officer, from November 1995 to November 1996, Mr. Hahn was
general manager of Netscape's Server Products Division, overseeing product
development for Netscape's enterprise, internet and extranet servers. Mr. Hahn
joined Netscape following its acquisition of Collabra Software, Inc., which
Mr. Hahn founded in February 1993.
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ERIK W. TROAN has served as Red Hat's Director of Engineering since
February 1999. Prior to that, between May 1995 and February 1999, he served as
Chief Developer at Red Hat. He is the co-author of LINUX APPLICATION
DEVELOPMENT, a book covering mid-level programming on the Linux operating system
and from 1995 to 1996, was a regular columnist for the X Journal Magazine,
covering free software topics.
DONALD J. BARNES has served Red Hat as Director of Technical Projects since
February 1999. From November 1997 to February 1999, he served as Red Hat's
Development Manager of Quality Assurance and from May 1995 to November 1997 he
served as a System's Engineer for Red Hat. From May 1994 to May 1995,
Mr. Barnes was a Systems Engineer for Northern Telecom Limited.
CHARLES A. COLEMAN has served as Red Hat's Director of Information Services
since April 1999. From February 1999 to March 1999, Mr. Coleman acted as a
consultant to Red Hat in connection with systems vendor evaluation, selection
and implementation. From April 1998 to January 1999, Mr. Coleman served as
President and Chief Information Officer at Critical Information Technologies,
LLC, a data modeling and systems integration firm. From September 1996 to
April 1998 he was employed by Ellora Software, Inc., a clinical data management
software developer, first as a consultant and then as a Vice President. From
February 1994 to September 1996, Mr. Coleman was Senior Vice President of
Inquiry Management and Database Systems for Computerworld, Inc. From
August 1983 to February 1994 he served as President and Chief Information
Officer of Response Technologies, Inc., a business processing reengineering
company.
MATTHEW BUTTERICK has served as Red Hat's Director of Internet Business
since May 1999. Prior to joining Red Hat, Mr. Butterick was founder and
President of Atomic Vision, a web site development company, from September 1994
until May 1999.
CAROLYN SPARANO has served as Red Hat's Business Unit Manager of Services
since June 1999. Prior to joining Red Hat, Ms. Sparano served in several
positions with INTERSOLV, including Vice President of Worldwide Training from
March 1999 to May 1999; Director of Consulting Services from August 1998 to
March 1999; Director of World Wide DataDirect Solutions from March 1997 to
August 1998; Director of DataDirect Technical Support from August 1995 to
March 1997; and Manager of Technical Support from January 1992 to August 1995.
HOWARD JACOBSON has served as Red Hat's Director of Corporate Development
since January 1999. Prior to joining Red Hat, Mr. Jacobson was an attorney at
the law firm of Moore & Van Allen from August 1995 to January 1999. He was an
attorney at Gibson, Dunn and Crutcher from 1988 to July 1995.
WALTER MCCORMACK has served as Red Hat's Director of Corporate Development
since September 1999. Prior to joining Red Hat, from August 1996 through
September 1999, Mr. McCormack was an investment banker in the High Technology
Group at Goldman, Sachs & Co. From August 1994 to 1996 he earned his Masters in
Management from the J.L. Kellogg Graduate School of Management at Northwestern
University.
LAWRENCE J. WEIDMAN has served as Red Hat's Director of Business
Development, eCommerce, since January 2000. Prior to joining Red Hat, from
November 1998 to January 2000, Mr. Weidman served as President, Chief Executive
Officer and a Director of HKS. From January 1997 to August 1998, he was
President of 6DOS, Inc., a developer of web-based collaboration software. From
April 1995 to January 1997, he was vice president of marketing at GALT
Technologies. From June 1991 to February 1995, he was President and General
Manager of Cisigraph Corporation.
PAUL F. MCNAMARA has served as Director of Sales, Enterprise Division, since
August 1999. From May 1998 to August 1999 he served as Red Hat's Vice President
of Business Development. Prior to joining Red Hat, from September 1994 to May
1998, he
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was President and Chief Operating Officer of Asset Management Technologies, a
computer software company.
DON LANGLEY has served as Red Hat's Director of Sales, Embedded and Tools
Division, since January 2000. Prior to joining Red Hat, from July 1998 to
January 2000 Mr. Langley served as Vice President of North American Sales for
Cygnus. From January 1998 to July 1998 he was Director of Sales for C-Cube
Microsystems. From January 1997 to January 1998 he was Director and General
Manager of the Mainstream and Removable Products Group at Adaptec. Prior to
that, he served at SGS-Thomson as Managing Director, Data Storage Business Unit
from March 1995 to January 1997 and as Director of Marketing, Computer Business
Unit from February 1994 to March 1995.
TOM BARTON has served as Red Hat's Director of Global Services since January
2000. Prior to joining Red Hat, Mr. Barton held several positions with Cygnus,
including Senior Vice President and General Manager of Client Services from
December 1998 to January 2000, Senior Vice President of Operations from July
1998 to December 1998, Acting Chief Executive Officer from December 1997 to
July 1998, Vice President and General Manager of Platform Products from
April 1997 to December 1997, Vice President of Business Development from
January 1997 to April 1997, and Director of Marketing from August 1996 to
January 1997. From July 1993 to August 1996 Mr. Barton was an Associate and then
an Engagement Manager with McKinsey & Co.
KIM KNUTTILLA has served as Red Hat's Director of Engineering, Embedded
Division, since January 2000. Prior to joining Red Hat, Mr. Knuttilla held
several positions with Cygnus, including Vice President of Engineering from
February 1999 to January 2000, Vice President of Client Services, Engineering
from September 1998 to February 1999, Director of Client Services, Engineering
from February 1998 to September 1998, Director of Engineering from October 1996
to February 1998, and GCC Engineer from May 1995 to October 1996. From
April 1994 to May 1995 he was Director of Engineering for Visible Decisions.
COLIN TENWICK has served as Red Hat's General Manager for European
Operations since June 1999. Prior to joining Red Hat, Mr. Tenwick held numerous
positions with Sybase, including Vice President and General Manager, European
Operations from October 1998 to June 1999; Vice President and Managing Director,
U.K. Operations from November 1995 to October 1998; and Vice President,
Marketing and Channel Sales, European Operations from April 1994 to
November 1995.
MASANOBU HIRANO has served as Red Hat's General Manager for Japan Operations
since August 1999. Prior to joining Red Hat, Mr. Hirano was President of
Hyperion Japan from June 1998 until July 1999, an independent management
consultant from June 1997 to June 1998, and held several positions with ASCII
Corporation in Japan, including Director of Software Division from January 1995
to June 1995 and Vice President of Software Division from June 1995 to
May 1997.
MARK WHITE has served as Red Hat's General Manager for Asia-Pacific
Operations since November 1999. Prior to joining Red Hat, Mr. White served as
Director of UNIX Marketing for Compaq Asia-Pacific from June 1998 through
October 1999. From January 1997 through June 1998, he was Manager of UNIX &
Telecomms Platforms for the Asia-Pacific Division of Tandem Computers Inc. and
was UNIX Product Manager for the same firm from April 1995 to December 1996.
From January 1994 through March 1995, Mr. White served as Projects Director for
Pacific Star Communications Pty Ltd., a Bell Atlantic International joint
venture company.
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ELECTION OF OFFICERS AND DIRECTORS
Red Hat's executive officers are elected by the Board of Directors on an
annual basis and serve until their successors are duly elected and qualified.
With the exception of Kevin Harvey, who was appointed to the Board in
August 1999, all of the current Directors were selected as Directors of Red Hat
under the First Amended and Restated Stockholder's Voting Agreement dated
February 25, 1999, as amended, between Red Hat and some of its stockholders,
which agreement terminated upon the closing of Red Hat's initial public
offering. There are no family relationships among any of the executive officers
or directors of Red Hat.
Red Hat's Board of Directors is divided into three classes, with the members
of each class of directors serving for staggered three-year terms.
Messrs. Ewing and Hahn serve in the class the term of which expires in 2000;
Messrs. Szulik and Harvey serve in the class the term of which expires in 2001;
and Messrs. Young and Kaiser serve in the class the term of which expires in
2002. At each annual meeting of stockholders, a class of directors will be
elected for a three-year term to succeed the directors of the same class whose
term is then expiring. Red Hat's adoption of a classified Board of Directors
could have the effect of increasing the length of time necessary to change the
composition of a majority of the Board of Directors. See "Description of Capital
Stock--Delaware Law and Certain Charter and By-Law Provisions and Anti-Takeover
Effects".
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has appointed a Compensation Committee consisting of
Messrs. Harvey, Kaiser and Hahn. The Compensation Committee reviews and
evaluates the compensation and benefits of all of Red Hat's officers, reviews
general policy matters relating to compensation and benefits of Red Hat's
employees and makes recommendations concerning these matters to the Board of
Directors. The Compensation Committee also administers Red Hat's stock option
and stock purchase plans. See "Employee Benefit Plans".
The Board of Directors has also appointed an Audit Committee consisting of
Messrs. Harvey, Kaiser and Hahn. The Audit Committee reviews, with Red Hat's
independent auditors, the scope and timing of the auditors' services, the
auditors' report on Red Hat's financial statements following completion of the
auditors' audit, and Red Hat's internal accounting and financial control
policies and procedures. In addition, the Audit Committee will make annual
recommendations to the Board of Directors for the appointment of independent
auditors for the ensuing year.
DIRECTOR COMPENSATION
Directors are reimbursed for reasonable out-of-pocket expenses incurred in
attending meetings of the Board of Directors and for meetings of any committees
of the Board of Directors on which they serve. Directors are also eligible to
participate in Red Hat's 1999 Stock Option and Incentive Plan. In accordance
with a policy approved by the Board of Directors in June 1999, upon initial
election or appointment to the Board of Directors, new non-employee Directors
will be granted non-qualified stock options to purchase 40,000 shares of common
stock at a price at least equal to the fair market value of Red Hat's common
stock on the date of grant. These options will vest 33 1/3% one year from grant
date and 8 1/3% at the end of each three-month period thereafter. Upon
re-election, non-employee directors will be granted non-qualified stock options
to purchase 20,000 shares of common stock to vest 33 1/3% one year from the date
of re-election and 8 1/3% at the end of each three-month period thereafter. Each
year of a non-employee director's tenure, the director will be granted
non-qualified stock options to purchase 10,000 shares of common stock which will
be fully vested upon grant. In accordance with this policy, in August 1999,
Frank Batten, who was re-elected as a director in August 1999 and resigned from
the Board of Directors in January 2000, and Mr. Kaiser, who was re-elected as a
director in August 1999, were granted non-qualified stock options to
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purchase 20,000 shares of common stock at the initial public offering price and
on August 25, 1999, Mr. Harvey was granted non-qualified stock options to
purchase 40,000 shares of common stock at a price of $36.75 per share. All of
these options will vest as provided above, except for options held by
Mr. Batten, which have been canceled. See "Employee Benefit Plans". In addition,
in April 1999, Mr. Hahn was granted a non-qualified stock option under the 1998
Stock Option Plan to purchase 343,104 shares of common stock at an exercise
price of $.78525 per share.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between the Board of Directors or
Compensation Committee and the board of directors or compensation committee of
any other company, nor has any interlocking relationship existed in the past.
EXECUTIVE COMPENSATION
The following table sets forth the compensation earned by Robert F. Young,
Red Hat's Chief Executive Officer, and Red Hat's only other executive officer
during the fiscal year ended February 28, 1999 whose salary and bonus exceeded
$100,000 for such fiscal year for services rendered in all capacities to Red Hat
during the fiscal year ended February 28, 1999. As of December 31, 1999, the
annualized base salaries of Red Hat's executive officers not listed in the table
below who, had they been employed by Red Hat for the full fiscal year ended
February 28, 1999, would have earned in excess of $100,000, were: Matthew J.
Szulik--$185,000; Timothy J. Buckley--$155,000; and Tom Butta--$175,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION ALL OTHER
NAME AND PRINCIPAL ANNUAL AWARDS COMPENSATION ($)
POSITION COMPENSATION --------------------- ------------------
- ------------------ --------------------- SECURITIES UNDERLYING
SALARY($) BONUS($) OPTIONS(#)
--------- --------- ---------------------
<S> <C> <C> <C> <C>
Robert F. Young(1)
Chairman...................................... 161,458 25,000 -- 41,141
Marc Ewing(1)
Director...................................... 145,125 20,000 -- --
</TABLE>
- ------------------------------
(1) During the fiscal year ended February 28, 1999, Mr. Young served as Red
Hat's President and Chief Executive Officer and Mr. Ewing served as Red
Hat's Executive Vice President and Chief Technology Officer.
Red Hat has never granted any stock options to Mr. Young or Mr. Ewing.
SEVERANCE AND CHANGE IN CONTROL ARRANGEMENTS
Matthew Szulik, Red Hat's Chief Executive Officer and President, is a party
to an incentive stock option agreement and a non-qualified stock option
agreement, which both provide for the lapsing of Red Hat's repurchase right as
to 33 1/3% of his option shares if he is terminated without cause on or before
March 13, 2000 and for the lapsing in full of Red Hat's repurchase right as to
any unvested option shares upon the termination of his employment, either by Red
Hat's successor without cause or by Mr. Szulik for good reason, following a
change in control of Red Hat.
Tim Buckley, Red Hat's Senior Vice President and Chief Operating Officer, is
a party to an incentive stock option agreement and a non-qualified stock option
agreement, which both provide for the lapsing of Red Hat's repurchase right as
to 33 1/3% of his option shares if he is terminated without cause on or before
April 12, 2000 and for the lapsing in full of Red Hat's repurchase right as to
any unvested option shares upon the termination of his employment, either by Red
Hat's successor
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without cause or by Mr. Buckley for good reason, following a change in control
of Red Hat.
Tom Butta, Red Hat's Chief Marketing Officer, is a party to a non-qualified
stock option agreement which provides for the lapsing of Red Hat's repurchase
right as to 50% of his unvested option shares upon the termination of his
employment by Red Hat without cause or by Mr. Butta for good reason. In
addition, pursuant to the terms of his employment offer letter, upon the
termination of Mr. Butta's employment by Red Hat without cause before July 20,
2000, Red Hat must pay Mr. Butta a severance amount equal to three month's
salary.
EMPLOYEE BENEFIT PLANS
RED HAT'S 1998 STOCK OPTION PLAN, AS AMENDED
Red Hat's 1998 Stock Option Plan, as amended, was adopted by the Board of
Directors and approved by Red Hat's stockholders in August 1998, and was amended
in November 1998, February 1999 and June 1999. In June 1999, the Board of
Directors and the stockholders voted to terminate the 1998 Stock Option Plan
effective upon the consummation of Red Hat's initial public offering of its
common stock in August 1999. Under the 1998 Stock Option Plan, Red Hat granted
incentive stock options and non-qualified stock options to employees,
consultants, directors and officers of Red Hat. The 1998 Stock Option Plan is
administered by the Board of Directors and the Compensation Committee. The 1998
Stock Option Plan provides that the Board of Directors and the Compensation
Committee each has the authority to select the participants and determine the
terms of the stock options, awards and purchase rights granted under the 1998
Stock Option Plan. Options granted under the 1998 Stock Option Plan are
immediately exercisable. Red Hat has a right of repurchase over all exercised
but unvested shares which lapses over a period of four years. An incentive stock
option is not transferable by the recipient except by will or by the laws of
descent and distribution. Non-qualified stock options and other awards are
transferable only to the extent provided in the agreement relating to such
option or award or in response to a valid domestic relations order. No incentive
stock options may be exercised more than three months following termination of
employment, and no stock option may be exercised following termination of
employment for cause. However, in the event that termination is due to death or
disability, the stock option is exercisable for a maximum of 180 days after such
termination. As of December 31, 1999, Red Hat had outstanding under the 1998
Stock Option Plan stock options for 11,551,732 shares of common stock.
RED HAT'S 1999 STOCK OPTION AND INCENTIVE PLAN
Red Hat's 1999 Stock Option and Incentive Plan was adopted by Red Hat's
Board of Directors and approved by its stockholders in June 1999. The 1999 Stock
Option and Incentive Plan provides for the grant of stock-based awards to
employees, officers and directors of, and consultants or advisors to, Red Hat
and its subsidiaries, including incentive stock options and non-qualified stock
options and other equity-based awards. Incentive stock options may be granted
only to employees of Red Hat. A total of 13,000,000 shares of common stock may
be issued upon the exercise of options or other awards granted under the 1999
Stock Option and Incentive Plan. The maximum number of shares that may be
granted to any employee under the 1999 Stock Option and Incentive Plan shall not
exceed 6,500,000 shares of common stock during any calendar year.
The 1999 Stock Option and Incentive Plan is administered by the Board of
Directors and the Compensation Committee. The 1999 Stock Option and Incentive
Plan provides that the Board of Directors and the Compensation Committee each
has the authority to select the persons to whom awards are granted and determine
the terms of each award, including the number of shares of common stock to be
granted. Payment of the exercise price of an award may be made in cash, shares
of
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common stock, a combination of cash or stock or by any other method approved by
the Board of Directors or Compensation Committee, consistent with Section 422 of
the Internal Revenue Code and Rule 16b-3 under the Exchange Act. Unless
otherwise permitted by Red Hat, awards are not assignable or transferable except
by will or the laws of descent and distribution.
Each of the Board of Directors or Compensation Committee may, in its sole
discretion, amend, modify or terminate any award granted or made under the 1999
Stock Option and Incentive Plan, so long as such amendment, modification or
termination would not materially and adversely affect the participant. Each of
the Board of Directors or Compensation Committee may also, in its sole
discretion, accelerate or extend the date or dates on which all or any
particular option or options granted under the 1999 Stock Option and Incentive
Plan may be exercised. As of December 31, 1999, Red Hat had outstanding under
the 1999 Stock Option and Incentive Plan stock options for 1,275,890 shares of
common stock.
RED HAT'S 1999 EMPLOYEE STOCK PURCHASE PLAN
The 1999 Employee Stock Purchase Plan was adopted by the Board of Directors
and approved by the stockholders in June 1999. The 1999 Employee Stock Purchase
Plan provides for the issuance of a maximum of 1,500,000 shares of common stock.
The 1999 Employee Stock Purchase Plan is administered by the Board of
Directors and the Compensation Committee. All employees of Red Hat whose
customary employment is for more than 20 hours per week and for more than three
months in any calendar year and who have completed more than 90 days of
employment with Red Hat on or before the first day of any six-month payment
period are eligible to participate in the 1999 Employee Stock Purchase Plan.
Outside directors and employees who would own 5% or more of the total combined
voting power of value of Red Hat's stock immediately after the grant may not
participate in the 1999 Employee Stock Purchase Plan. To participate in the 1999
Employee Stock Purchase Plan, an employee must authorize Red Hat to deduct an
amount not less than one percent nor more than 10 percent of a participant's
total cash compensation from his or her pay during six-month payment periods.
The first payment period commenced on October 1, 1999 and ends on March 31,
2000. Thereafter, the payment periods will commence on the first day of April
and October, and end on the last day of the following March and September,
respectively, of each year, but in no case shall an employee be entitled to
purchase more than 2,000 shares in any one payment period. The exercise price
for the option granted in each payment period is 85% of the lesser of the
average market price of the common stock on the first or last business day of
the payment period, in either event rounded up to the nearest cent. If an
employee is not a participant on the last day of the payment period, such
employee is not entitled to exercise his or her option, and the amount of his or
her accumulated payroll deductions will be refunded. Options granted under the
1999 Employee Stock Purchase Plan may not be transferred or assigned. An
employee's rights under the 1999 Employee Stock Purchase Plan terminate upon his
or her voluntary withdrawal from the plan at any time or upon termination of
employment. No options have been granted to date under the 1999 Employee Stock
Purchase Plan.
CYGNUS STOCK OPTION PLANS
In connection with the acquisition of Cygnus in January 1999, Red Hat
assumed all of Cygnus' obligations under the Cygnus 1995 Stock Plan, the Cygnus
1997 Stock Plan and the Cygnus 1998 Executive Stock Plan, and all options
granted thereunder are exercisable for Red Hat common stock. Upon the
consummation of the acquisition of Cygnus, all of these plans were terminated
and no further options may be granted under these plans. The Cygnus Stock Plans
shall be administered by Red Hat's Board of Directors and Compensation
Committee. Payment of the exercise price of an option under these Plans may be
made in cash, shares of common
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stock, promissory note or any combination of the foregoing or any other method
approved by the Board of Directors or the Compensation Committee consistent with
applicable law. Options under the Cygnus Plans are not assignable or
transferable except by will or the laws of descent and distribution. Red Hat
may, however, at any time and at its discretion offer to repurchase any option
previously granted under these plans on terms determined by the Board of
Directors or the Compensation Committee.
As of December 31, 1999 (giving effect to the Cygnus acquisition, which
closed on January 7, 2000), Red Hat had outstanding under the Cygnus stock plans
stock options for 2,412,737 shares of common stock.
401(K) PLAN
Red Hat has a Section 401(k) Profit Sharing Plan. The 401(k) plan is a
tax-qualified plan covering all full-time Red Hat employees who are over
21 years of age and who have completed three months of service with Red Hat. If,
however, an employee was employed by Red Hat prior to February 1999, the 401(k)
plan covers such employee regardless of age or length of service with Red Hat.
Under the 401(k) plan, participants may elect to defer a portion of their
compensation. In addition, at the discretion of the Board of Directors, Red Hat
may make matching contributions into the 401(k) plan for all eligible employees.
Red Hat has not made any contributions to the 401(k) plan to date.
Employees of Cygnus after the acquisition will continue to participate in
the Cygnus 401(k) plan. This plan is a tax-qualified plan covering all Cygnus
employees who are over 21 years of age and who have completed one month of
service with Cygnus. If, however, an employee was employed by Cygnus prior to
October 1, 1996, the 401(k) plan covers such employee regardless of age. Under
this plan, participants may elect to defer a portion of their compensation.
There is no provision for matching contributions.
LIMITATION OF LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
Red Hat's Third Amended and Restated Certificate of Incorporation and
Amended and Restated By-Laws provide that the directors and officers of Red Hat
shall be indemnified by Red Hat to the fullest extent permitted by Delaware law,
as it now exists or may in the future be amended, against all expenses and
liabilities reasonably incurred in connection with their service for or on
behalf of Red Hat. In addition, the Third Amended and Restated Certificate of
Incorporation provides that the directors of Red Hat will not be personally
liable for monetary damages to Red Hat for breaches of their fiduciary duty as
directors, unless they violated their duty of loyalty to Red Hat or its
stockholders, acted in bad faith, knowingly or intentionally violated the law,
authorized illegal dividends or redemptions or derived an improper personal
benefit from their action as directors. Red Hat has obtained insurance which
insures the directors and officers of Red Hat against certain losses and which
insures Red Hat against its obligations to indemnify the directors and officers.
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TRANSACTIONS WITH AFFILIATES
On August 15, 1997, Red Hat sold 6,801,400 shares of its Series A preferred
stock to Frank Batten, Jr., Frank Batten, Louis F. Ryan as trustees under a
trust agreement dated April 11, 1988, as amended in a private financing at a
price of $.294057 per share. The trust is a 5% stockholder of Red Hat.
On September 29, 1998, Red Hat sold an aggregate of 8,116,550 shares of its
Series B preferred stock in a private financing at a price of $.857 per share.
Among the purchasers in this financing were Frank Batten, Jr., Frank Batten,
Louis F. Ryan as trustees under a trust agreement dated April 11, 1988, as
amended, Intel Corporation, Greylock IX Limited Partnership and Benchmark
Capital Partners II, L.P., each a 5% stockholder of Red Hat.
From February 25, 1999 through April 1, 1999, Red Hat sold an aggregate of
2,054,776 shares of its Series C preferred stock in a private financing at a
price of $3,141 per share. Among the purchasers in this financing were Frank
Batten, Jr., Frank Batten, Louis F. Ryan as trustees under a trust agreement
dated April 11, 1988, as amended, Intel Corporation, Greylock IX Limited
Partnership and Benchmark Capital Partners II L.P., each a 5% stockholder of Red
Hat.
In January 2000, in connection with our acquisition of Cygnus, we issued
Greylock IX Limited Partnership, a stockholder of Cygnus and a 5% stockholder of
Red Hat, an aggregate of 621,013 shares of common stock and Greylock Equity
Limited Partnership, a stockholder of Cygnus, an aggregate of 621,010 shares of
common stock. William Kaiser, a general partner of the general partner of
Greylock IX Limited Partnership and a general partner of the general partner of
Greylock Equity Limited Partnership, is a director of Red Hat. Mr. Kaiser
abstained from voting with respect to the approval by Red Hat's Board of
Directors of the Cygnus acquisition.
Red Hat believes that all transactions set forth above were made on terms no
less favorable to it than would have been obtained from unaffiliated third
parties. Red Hat has adopted a policy providing that all future transactions
between Red Hat and any of its officers, directors and affiliates will be on
terms no less favorable to Red Hat than could be obtained from unaffiliated
thirds parties and will be approved by a majority of the disinterested members
of Red Hat's Board of Directors.
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PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information known to Red Hat regarding
beneficial ownership of Red Hat's common stock at December 31, 1999 (giving
effect to the stock split effected in January 2000 and the issuance of shares in
conncetion with our acquisitions of Cygnus and HKS in January 2000) and as
adjusted to reflect the sale of the shares of common stock in this offering by:
- each person known by Red Hat to be the beneficial owner of more than 5% of
Red Hat's common stock;
- Red Hat's Chief Executive Officer;
- each of Red Hat's directors;
- all other selling stockholders; and
- all executive officers and directors as a group.
Unless otherwise indicated, to the knowledge of Red Hat, each stockholder
possesses sole voting and investment power over the shares listed, except for
shares owned jointly with that person's spouse.
The number of shares of common stock deemed outstanding includes shares
issuable upon exercise of options and warrants held by the respective person or
group which may be exercised within 60 days after December 31, 1999. For
purposes of calculating each person's or group's percentage ownership, stock
options exercisable within 60 days after December 31, 1999 and warrants are
included for that person or group but not the stock options and warrants of any
other person or group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED SHARES TO OWNED
BEFORE THE OFFERING BE SOLD AFTER THE OFFERING
NAME AND ADDRESS OF ------------------------ ---------- ------------------------
BENEFICIAL OWNER (1) NUMBER PERCENTAGE NUMBER PERCENTAGE
-------------------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
5% STOCKHOLDERS
Greylock IX Limited Partnership....... 18,689,755 12.6% -- 18,689,755 12.2%
One Federal Street
Boston, MA 02110
Benchmark Capital Partners II, L.P.... 11,631,820 7.8 -- 11,631,820 7.6
2840 Sand Hill Road, Suite 2000
Menlo Park, CA 94025
EXECUTIVE OFFICERS AND DIRECTORS
Robert F. Young (2)................... 18,163,652 12.2 321,502 17,842,150 11.9
Marc Ewing (3)........................ 18,176,952 12.2 331,745 17,845,207 11.9
Matthew Szulik (4).................... 5,472,496 3.6 38,826 5,433,670 3.5
Frank Batten, Jr. (5)................. 30,011,776 20.2 547,739 29,464,037 19.6
c/o Landmark Communications
150 W. Brambleton Avenue
Norfolk, VA 23510-2075
William S. Kaiser (6)................. 18,689,755 12.6 -- 18,689,755 12.2
c/o Greylock IX Limited Partnership
One Federal Street
Boston, MA 02110
Eric Hahn............................. 343,104 * -- 343,104 *
c/o Inventures Group
465 Melville Avenue
Palo Alto, CA 94301
Kevin Harvey (7)...................... 11,631,820 7.8 -- 11,631,820 7.6
c/o Benchmark Capital Partner II,
L.P.
2840 Sand Hill Road, Suite 2000
Menlo Park, CA 94025
Manoj K. George (8)................... 478,204 * 7,998 470,206 *
David G. Shumannfang (9).............. 160,000 * 2,190 157,810 *
All executive officers and directors
as a group (11 persons) (10)........ 77,953,223 49.7 1,250,000 76,703,223 48.8
</TABLE>
- --------------------------
* Represents beneficial ownership of less than one percent of outstanding
common stock.
(1) Unless otherwise indicated, the address for each beneficial owner is c/o Red
Hat, Inc., 2600 Meridian Parkway, Durham, N.C. 27713.
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(2) Shares beneficially owned includes 6,445,492 shares held of record by Nancy
Young, Mr. Young's wife, 600,000 held by the Nancy R. Young GRAT dated
April 28, 1999, 400,000 shares held of record by the Young Family Trust
dated April 28, 1999 and 2,836,320 shares held of record by trusts for the
benefit of Mr. Young's children. Mr. Young disclaims beneficial ownership of
these shares. Also includes 600,000 shares held of record by the Robert F.
Young GRAT dated April 28, 1999. Of the shares to be sold by Mr. Young,
160,751 shares will be sold by Mr. Young and 160,751 shares will be sold by
Nancy Young.
(3) Shares beneficially owned includes 400,000 shares held of record by the
Ewing Family Trust dated April 28, 1999 and 2,025,440 shares held of record
by trusts for the benefit of Mr. Ewing's children. Mr. Ewing disclaims
beneficial ownership of these shares. Also includes 1,200,000 shares held of
record by the Marc Ewing GRAT dated April 28, 1999.
(4) Shares beneficially owned includes 72,000 shares held of record by trusts
for the benefit of Mr. Szulik's children. Mr. Szulik disclaims beneficial
ownership of these shares. Also includes 55,356 shares held of record by the
Matthew J. Szulik GRAT dated May 26, 1999. Also includes 3,345,140 shares of
common stock issuable upon exercise of stock options.
(5) Shares beneficially owned includes 2,515,753 shares held of record by the
1988 Batten Trust, 26,973,284 shares held of record by the 1998 Frank
Batten, Jr. Grantor Annuity Trust and 522,739 shares held of record by the
Aimee and Frank Batten, Jr. Foundation. Of the shares to be sold by
Mr. Batten, 25,000 shares will be sold by the 1998 Frank Batten, Jr. Grantor
Annuity Trust and 522,739 shares will be sold by the Aimee and Frank Batten,
Jr. Foundation.
(6) Shares beneficially owned includes shares held of record by Greylock IX
Limited Partnership and 621,010 shares held of record by Greylock Equity
Limited Partnership. Mr. Kaiser is a general partner of the general partner
of each of Greylock IX Limited Partnership and Greylock Equity Limited
Partnership. Mr. Kaiser disclaims beneficial ownership of all of these
shares. Also includes 20,000 shares of common stock issuable upon exercise
of stock options.
(7) Shares beneficially owned includes shares held by Benchmark Capital Partners
II, L.P. Mr. Harvey is a managing member of Benchmark Capital Management Co.
II, L.L.C., the general partner of Benchmark Capital Partners II, L.P.
Mr. Harvey disclaims beneficial ownership of these shares.
(8) Shares beneficially owned includes 40,000 shares of common stock issuable
upon exercise of stock options.
(9) Shares beneficially owned includes 40,000 shares of common stock issuable
upon exercise of stock options.
(10) Shares beneficially owned includes 6,762,380 shares of common stock
issuable upon exercise of stock options.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital stock of Red Hat consists of 225,000,000 shares of
common stock, par value $.0001 per share, and 5,000,000 shares of preferred
stock, par value $.0001 per share.
The following summary description of Red Hat's capital stock is not intended
to be complete and is qualified by reference to the provisions of applicable law
and to Red Hat's Third Amended and Restated Certificate of Incorporation and
Amended and Restated By-laws, filed as exhibits to the registration statement of
which this prospectus is a part.
COMMON STOCK
As of December 31, 1999, giving effect to the stock split effected in
January 2000 and the issuance of shares in connection with our acquisitions of
Cygnus and HKS in January 2000, there were 148,933,572 shares of common stock
outstanding held by approximately 775 stockholders of record. Based upon the
number of shares outstanding as of that date and giving effect to the issuance
of the 2,750,000 shares of common stock offered by Red Hat in this offering,
there will be 151,683,572 shares of common stock outstanding upon the closing of
this offering. In addition, as of December 31, 1999, giving effect to stock
split effected in January 2000 and the assumption of options in connection with
our acquisitions of Cygnus and HKS in January 2000, there were outstanding stock
options for the purchase of 15,240,359 shares of common stock and outstanding
warrants for the purchase of 4,814,900 shares of common stock.
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Directors are elected by a plurality of the votes of the shares present
in person or by proxy at the meeting and entitled to vote in such election.
Holders of common stock are entitled to receive ratably such dividends, if any,
as may be declared by the Board of Directors out of funds legally available
therefor, after provision has been made for any preferential dividend rights of
outstanding preferred stock. Upon the liquidation, dissolution or winding up of
Red Hat, the holders of common stock are entitled to receive ratably the net
assets of Red Hat available after the payment of all debts and other liabilities
of Red Hat, and after the satisfaction of the rights of any outstanding
preferred stock. Holders of the common stock have no preemptive, subscription,
redemption or conversion rights, nor are they entitled to the benefit of any
sinking fund. The outstanding shares of common stock are, and the shares offered
by Red Hat in this offering will be, when issued and paid for, validly issued,
fully paid and non-assessable. The rights, powers, preferences and privileges of
holders of common stock are subordinate to, and may be adversely affected by,
the rights of the holders of shares of any series of preferred stock which Red
Hat may designate and issue in the future.
PREFERRED STOCK
The Board of Directors will be authorized, without further stockholder
approval, to issue from time to time up to an aggregate of 5,000,000 shares of
preferred stock, in one or more series. Each series of preferred stock shall
have such number of shares, designations, preferences, voting powers,
qualifications and special or relative rights or privileges as shall be
determined by the Board of Directors, which may include, among others, dividend
rights, voting rights, redemption and sinking fund provisions, liquidation
preferences, conversion rights and preemptive rights.
The stockholders of Red Hat have granted the Board of Directors authority to
issue the preferred stock and to determine its rights and preferences in order
to eliminate delays associated with a stockholder vote on specific issuances.
The rights of the holders of common stock will be subordinate to the rights of
holders of any preferred stock issued in the future. The issuance of preferred
stock, while providing desirable flexibility in connection with
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<PAGE>
possible acquisitions and other corporate purposes, could adversely affect the
voting power or other rights of the holders of common stock, and could make it
more difficult for a third party to acquire, or discourage a third party from
attempting to acquire, a majority of the outstanding voting stock of Red Hat.
Red Hat has not, to date, issued any shares of such preferred stock and has no
present plans to issue any shares of preferred stock.
DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS AND ANTI-TAKEOVER EFFECTS
The provisions of Section 203 of the General Corporation Law of Delaware
prohibit Red Hat from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a prescribed manner. A "business combination"
includes mergers, asset sales and other transactions resulting in a financial
benefit to the interested stockholder. An "interested stockholder" is defined as
a person who, at the time of determination whether a person is an interested
stockholder,
- beneficially owns 15% or more of Red Hat's common stock; or
- is an affiliate or associate of Red Hat and beneficially owned 15% or more
of Red Hat's common stock at any time within three years of the date of
determination.
Red Hat's Third Amended and Restated Certificate of Incorporation provides
for the division of the Board of Directors into three classes as nearly equal in
size as possible with staggered three-year terms. See "Management--Election of
Officers and Directors". In addition, Red Hat's Third Amended and Restated
Certificate of Incorporation provides that directors may be removed only for
cause by the affirmative vote of the holders of 75% of the shares of capital
stock of Red Hat entitled to vote. Under Red Hat's Third Amended and Restated
Certificate of Incorporation, any vacancy on the Board of Directors, however
occurring, including a vacancy resulting from an enlargement of the Board, may
only be filled by vote of a majority of the directors then in office. The likely
effect of the classification of the Board of Directors and the limitations on
the removal of directors and filling of vacancies is an increase in the time
required for the stockholders to change the composition of the Board of
Directors. For example, because only two directors may be replaced by
stockholder vote at each annual meeting of stockholders, stockholders seeking to
replace a majority of the members of the Board of Directors will need at least
two annual meetings of stockholders to effect this change.
Red Hat's Third Amended and Restated Certificate of Incorporation also
provides that any action required or permitted to be taken by the stockholders
of Red Hat at an annual meeting or special meeting of stockholders may only be
taken if it is properly brought before the meeting and may not be taken by
written action in lieu of a meeting. Red Hat's Amended and Restated By-laws
provide that special meetings of the stockholders may only be called by the
Board of Directors, the Chairman of the Board of Directors, the Chief Executive
Officer or the President of Red Hat. Red Hat's Amended and Restated By-laws
further provide that in order for any matter to be considered "properly brought"
before a meeting, a stockholder must comply with requirements regarding advance
notice to Red Hat. The foregoing provisions could have the effect of delaying
until the next stockholders meeting stockholder actions which are favored by the
holders of a majority of the outstanding voting securities of Red Hat. These
provisions may also discourage another person or entity from making a tender
offer for Red Hat's common stock, because such person or entity, even if it
acquired a majority of the outstanding voting securities of Red Hat, would be
able to take action as a stockholder, such as electing new directors or
approving a merger, only at a duly called stockholders meeting, and not by
written consent.
87
<PAGE>
The General Corporation Law of Delaware provides that the affirmative vote
of a majority of the shares entitled to vote on any matter is required to amend
a corporation's certificate of incorporation or by-laws, unless a corporation's
certificate of incorporation or by-laws, as the case may be, requires a greater
percentage. Red Hat's Third Amended and Restated Certificate of Incorporation
requires the affirmative vote of the holders of at least 75% of the shares of
capital stock of Red Hat issued and outstanding and entitled to vote to amend or
repeal any of the foregoing provisions of the Restated Certificate of
Incorporation. Red Hat's Amended and Restated By-laws may be amended or repealed
by a majority vote of the Board of Directors except for provisions relating to
the Board of Directors which may only be amended or repealed by the affirmative
vote of the holders of at least 75% of the shares of capital stock issued and
outstanding and entitled to vote. The Amended and Restated By-laws may also be
amended or repealed by the affirmative vote of the holders of at least 75% of
the shares of capital stock of Red Hat issued and outstanding and entitled to
vote. The 75% stockholder vote would be in addition to any separate class vote
that might in the future be required in accordance with the terms of any series
of preferred stock that might be outstanding at the time any such amendments are
submitted to stockholders.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is ChaseMellon
Shareholder Services, LLC.
LEGAL MATTERS
The validity of the shares of common stock to be issued in this offering
will be passed upon for Red Hat by Testa, Hurwitz & Thibeault, LLP, Boston,
Massachusetts. Certain legal matters in connection with this offering will be
passed upon for the underwriters by Hale and Dorr LLP, Boston, Massachusetts. A
partner and three associates of Testa, Hurwitz & Thibeault, LLP own an aggregate
of 4,200 shares of Red Hat's common stock.
EXPERTS
The financial statements of Red Hat as of February 28, 1998 and 1999 and for
each of the three years in the period ended February 28, 1999 and the
supplemental pooled financial statements of Red Hat as of February 28, 1998 and
1999 and for each of the three years in the period ended February 28, 1999
included in this prospectus have been so included in reliance upon the report
(which contains an explanatory paragraph relating to the merger of Red Hat with
Cygnus) of PricewaterhouseCoopers LLP, independent accountants, given on the
authority of said firm as experts in auditing and accounting.
The financial statements of Hell's Kitchen Systems as of December 31, 1998,
March 9, 1999 and September 30, 1999 and 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 included in this prospectus have been so included in
reliance upon the report of PricewaterhouseCoopers LLP, independent accountants,
given on the authority of said firm as experts in auditing and accounting.
In addition, the supplementary pooled financial statements of Red Hat as of
February 28, 1998 and 1999 and for each of the three years in the period ended
February 28, 1999, included in this prospectus have been so included in reliance
upon the report of PricewaterhouseCoopers LLP, independent accountants, given on
the authority of said firm as experts in auditing and accounting.
88
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
Red Hat files reports and other information with the Securities and Exchange
Commission. Investors may inspect these reports and other information at the
public reference facilities maintained by the Commission at Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at its regional
offices located at Seven World Trade Center, New York, New York 10007 and 500
West Madison Street, Suite 1400, Chicago, Illinois 60661, and copies of all or
any part thereof may be obtained from such offices upon payment of the
prescribed fees. You may call the Commission at 1-800-SEC-0330 for further
information on the operation of the public reference rooms and you can request
copies of the documents upon payment of a duplicating fee, by writing to the
Commission. In addition, the Commission maintains a web site that contains
reports, proxy and information statements and other information regarding
registrants (including Red Hat) that file electronically with the Commission
which can be accessed at http://www.sec.gov.
In addition, Red Hat has filed with the Commission a registration statement
on Form S-1 under the Securities Act relating to the common stock to be sold in
this offering. As permitted by the rules and regulations of the Commission, this
prospectus omits certain information contained in the registration statement and
the exhibits and schedules filed as a part of the registration statement. For
further information concerning Red Hat and the common stock to be sold in this
offering, you should refer to the registration statement and to the exhibits and
schedules filed as part of the registration statement. Statements contained in
this prospectus regarding the contents of any agreement or other document filed
as an exhibit to the registration statement are not necessarily complete, and in
each instance reference is made to the copy of the agreement filed as an exhibit
to the registration statement each statement being qualified by this reference.
The registration statement, including the exhibits and schedules filed as a part
of the registration statement, as well as other documents filed by Red Hat with
the Commission, may be inspected by investors as provided above.
89
<PAGE>
UNDERWRITING
Red Hat, the selling stockholders and the underwriters named below have
entered into an underwriting agreement concerning the shares being offered. Each
underwriter has severally agreed to purchase the number of shares indicated in
the following table. Goldman, Sachs & Co., Hambrecht & Quist LLC, Thomas Weisel
Partners LLC and J.P. Morgan Securities Inc. are the representatives of the
underwriters.
<TABLE>
<CAPTION>
Number of
Shares
Underwriters -----------
<S> <C>
Goldman, Sachs & Co.........................................
Hambrecht & Quist LLC.......................................
Thomas Weisel Partners LLC..................................
J.P. Morgan Securities Inc..................................
---------
Total:...................................................... 4,000,000
=========
</TABLE>
If the underwriters sell more shares than the total number presented in the
table above, the underwriters have an option to buy up to an additional 600,000
shares from Red Hat to cover such sales. They may exercise that option for
30 days. If any shares are purchased upon exercise of this option, the
underwriters will severally purchase shares in approximately the same proportion
as presented in the table above.
The following tables show the per share and total underwriting discounts and
commissions to be paid to the underwriters by Red Hat and by the selling
stockholders. These amounts are shown assuming both no exercise and full
exercise of the underwriters' option to purchase 600,000 additional shares.
<TABLE>
<CAPTION>
Paid by Red Hat
---------------
No Exercise Full Exercise
------------- -------------
<S> <C> <C>
Per Share................................................... $ $
Total....................................................... $ $
</TABLE>
<TABLE>
<CAPTION>
Paid by the selling stockholders
--------------------------------
No Exercise Full Exercise
------------- -------------
<S> <C> <C>
Per Share................................................... $ $
Total....................................................... $ $
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial price to public presented on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $ per share from the initial price to public. Any of these
securities dealers may resell any shares purchased from the underwriters to
certain other brokers or dealers at a discount of up to $ per share from
the initial price to public. If all the shares are not sold at the initial price
to public, the representatives may change the offering price and the other
selling terms.
90
<PAGE>
Red Hat, its officers and directors, the selling stockholders and certain
other stockholders have agreed with the underwriters not to dispose of or hedge
shares of their common stock or securities convertible into or exchangeable for
shares of common stock during the period from the date of this prospectus
continuing through the date 90 days after the date of this prospectus, except
(i) for an aggregate of 850,000 shares held by officers, directors, selling
shareholders and other stockholders as a group, or (ii) with the prior written
consent of Goldman, Sachs & Co. The 850,000 shares are, however, subject to
transfer restrictions, which will lapse two days after the announcement of
financial results for the quarter ending February 29, 2000, imposed in
connection with the acquisition of Cygnus.
Thomas Weisel Partners LLC, one of the representatives of the underwriters,
was organized and registered as a broker-dealer in December 1998. Since
December 1998, Thomas Weisel Partners LLC has been named as a lead or co-manager
of 106 filed public offerings of equity securities, of which 79 have been
completed, and has acted as a syndicate member in an additional 54 public
offerings of equity securities. Thomas Weisel Partners LLC does not have any
material relationship with Red Hat or any of our officers, directors or other
controlling persons, except for its contractual relationship with Red Hat under
the terms of the underwriting agreement entered into in connection with this
offering.
In connection with this offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. Stabilizing
transactions consist of certain bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of that underwriter in stabilizing or short covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
As permitted by Rule 103 under the Exchange Act, certain underwriters and
selling group members that are passive market makers in the common stock may
make bids for or purchases of common stock on the Nasdaq National Market until a
stabilizing bid has been made. Rule 103 generally provides that:
- a passive market maker's net daily purchases of the common stock may not
exceed 30% of its average daily trading volume in such securities for the
two full consecutive calendar months, or any 60 consecutive days ending
within the 10 days, immediately preceding the filing date of the
registration statement of which this prospectus is a part;
- a passive market maker may not effect transactions or display bids for
common stock at a price that exceeds the highest independent bid for the
common stock by persons who are not passive market makers; and
- bids made by passive market makers must be identified as such.
Red Hat and the selling stockholders estimate that their share of the total
expenses of the offering, excluding underwriting commissions, will be
approximately $1,500,000.
Red Hat and the selling stockholders have agreed to indemnify the several
underwriters against certain liabilities, including liabilities under the
Securities Act.
91
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
RED HAT, INC. HISTORICAL CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants......................... F-2
Consolidated Balance Sheets at February 28, 1998 and 1999
and November 30, 1999 (unaudited)....................... F-3
Consolidated Statements of Operations for the years ended
February 28, 1997, 1998 and 1999 and the nine months
ended November 30, 1998 and 1999 (unaudited)............ F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended February 28, 1997, 1998 and 1999 and
the nine months ended November 30, 1999................. F-5
Consolidated Statements of Cash Flows for the years ended
February 28, 1997, 1998 and 1999 and the nine months
ended November 30, 1998 and 1999........................ F-6
Notes to Consolidated Financial Statements................ F-7
RED HAT, INC. SUPPLEMENTAL POOLED FINANCIAL STATEMENTS
Consolidated Balance Sheets at February 28, 1998 and 1999
and November 30, 1999 (unaudited)....................... F-26
Supplemental Pooled Consolidated Statements of Operations
for the years ended February 28, 1997, 1998 and 1999 and
the nine months ended November 30, 1998 and 1999
(unaudited)............................................. F-27
Supplemental Pooled Consolidated Statements of
Stockholders' Equity (Deficit) for the years ended
February 28, 1997, 1998 and 1999 and the nine months
ended November 30, 1999................................. F-28
Supplemental Pooled Consolidated Statements of Cash Flows
for the years ended February 28, 1997, 1998 and 1999 and
the nine months ended November 30, 1998 and 1999........ F-29
Notes to Supplemental Pooled Consolidated Financial
Statements.............................................. F-30
HELL'S KITCHEN SYSTEMS, INC. FINANCIAL STATEMENTS
Report of Independent Accountants......................... F-54
Consolidated Balance Sheets at February 28, 1998 and 1999
and November 30, 1999 (unaudited)....................... F-55
Consolidated Statements of Operations for the years ended
February 28, 1997, 1998 and 1999 and the nine months
ended November 30, 1998 and 1999 (unaudited)............ F-56
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended February 28, 1997, 1998 and 1999 and
the nine months ended November 30, 1999................. F-57
Consolidated Statements of Cash Flows for the years ended
February 28, 1997, 1998 and 1999 and the nine months
ended November 30, 1998 and 1999........................ F-58
Notes to Consolidated Financial Statements................ F-59
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders of Red Hat, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity (deficit), and of
cash flows present fairly, in all material respects, the consolidated financial
position of Red Hat, Inc. and subsidiaries at February 28, 1998 and 1999 and the
results of their operations and their cash flows for each of the three years in
the period ended February 28, 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.
As described in Note 15, on January 7, 2000, Red Hat merged with Cygnus
Solutions in a transaction accounted for as a pooling of interests. The
accompanying supplementary consolidated financial statements give retroactive
effect of the merger of Red Hat with Cygnus. Accounting principles generally
accepted in the United States proscribe giving effect to a consummated business
combination accounted for by the pooling of interests method in financial
statements that do not include the date of consummation. These financial
statements do not extend through the date of consummation; however, they will
become the historical consolidated financial statements of Red Hat and its
subsidiaries after financial statements covering the date of consummation of the
business combination are issued.
In our opinion, based upon our audits, the accompanying supplementary
consolidated balance sheets and the related supplementary consolidated
statements of operations, of stockholders' equity (deficit) and of cash flows
present fairly, in all material respects, the financial position of Red Hat and
its subsidiaries at February 28, 1998 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
February 28, 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.
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
April 30, 1999, except as to
Note 14 to the financial statements which is as of January 7, 2000, and the
pooling of interests with Cygnus which is as of January 7, 2000
F-2
<PAGE>
RED HAT, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
FEBRUARY 28,
------------------------------------------
NOVEMBER 30,
1998 1999 1999
---------- ----------- ---------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $1,292,562 $10,055,227 $ 11,997,157
Short-term investments.................................... 100,000 2,037,992 7,630,705
Accounts receivable, net.................................. 744,551 1,241,338 4,536,431
Inventory................................................. 141,176 345,630 1,853,711
Prepaid expenses.......................................... 383,830 173,730 736,580
---------- ----------- ------------
Total current assets.................................. 2,662,119 13,853,917 26,754,584
Property and equipment, net................................. 337,327 1,270,576 5,095,166
Other assets, net........................................... 81,188 151,310 1,814,781
Investments................................................. 50,000 -- 76,633,119
---------- ----------- ------------
Total assets.......................................... $3,130,634 $15,275,803 $110,297,650
========== =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 773,936 $ 2,087,305 $ 4,589,370
Royalties payable......................................... 247,323 144,074 221,343
Accrued expenses.......................................... 50,334 379,757 2,167,704
Deferred revenue.......................................... 26,207 33,352 4,123,853
Current portion of capital lease obligations.............. 22,797 108,897 457,581
---------- ----------- ------------
Total current liabilities............................. 1,120,597 2,753,385 11,559,851
Capital lease obligations................................. 65,032 419,778 203,012
Commitments and contingencies (Note 12)...................
Mandatorily redeemable preferred stock:
Series A, 6,801,400, 6,801,400 and 0 shares authorized,
issued and outstanding at February 28, 1998, February
28, 1999 and November 30, 1999, respectively............ 1,983,209 1,992,184 --
Series B, 0, 8,116,550 and 0, shares authorized, issued
and outstanding at February 28, 1998, February 28, 1999
and November 30, 1999, respectively..................... -- 6,919,644 --
Series C, 0, 1,797,929 and 0 shares authorized at February
28, 1998, February 28, 1999 and November 30, 1999,
respectively; 0, 1,027,388 and 0 shares issued and
outstanding at February 28, 1998, February 28, 1999 and
November 30, 1999, respectively......................... -- 3,195,591 --
Stockholders' equity (deficit):
Preferred stock, 5,000,000 shares authorized, none
outstanding -- -- --
Common stock, $.0001 par value, 225,000,000 shares
authorized; 47,000,000, 47,705,900 and 137,589,208
shares issued and outstanding at February 28, 1998,
February 28, 1999 and November 30, 1999, respectively... 4,700 4,770 13,758
Additional paid-in capital................................ 261,300 425,079 115,142,628
Deferred compensation..................................... -- -- (7,115,756)
Accumulated deficit....................................... (304,204) (434,628) (9,293,554)
Accumulated other comprehensive loss...................... -- -- (212,289)
---------- ----------- ------------
Total stockholders' equity (deficit).................. (38,204) (4,779) 98,534,787
---------- ----------- ------------
Total liabilities and stockholders' equity
(deficit)........................................... $3,130,634 $15,275,803 $110,297,650
========== =========== ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
RED HAT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED FEBRUARY 28, ENDED NOVEMBER 30,
--------------------------------------- ---------------------------
1997 1998 1999 1998 1999
----------- ----------- ----------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Software and related products.......... $ 2,603,131 $ 5,131,623 $10,012,923 $ 6,505,082 8,559,330
Web.................................... -- -- -- -- 626,384
Services and other..................... -- 24,000 776,996 607,985 3,409,967
----------- ----------- ----------- ----------- -------------
Total revenue........................ 2,603,131 5,155,623 10,789,919 7,113,067 12,595,681
----------- ----------- ----------- ----------- -------------
Cost of revenue:
Software and related products.......... 1,204,721 2,210,538 4,012,685 2,647,025 4,738,312
Web.................................... -- -- -- -- 626,756
Services and other..................... -- -- 28,148 -- 2,048,770
----------- ----------- ----------- ----------- -------------
Total cost of revenue................ 1,204,721 2,210,538 4,040,833 2,647,025 7,413,838
----------- ----------- ----------- ----------- -------------
Gross profit............................... 1,398,410 2,945,085 6,749,086 4,466,042 5,181,843
----------- ----------- ----------- ----------- -------------
Operating expense:
Sales and marketing.................... 491,473 1,252,362 3,083,162 1,644,838 7,609,146
Research and development............... 325,244 902,826 2,220,115 1,422,469 4,157,907
General and administrative............. 525,978 798,592 1,483,909 1,046,279 2,870,778
Stock-based compensation............... -- -- -- -- 1,009,503
Mergers and acquisitions............... -- -- -- -- 123,887
----------- ----------- ----------- ----------- -------------
Total operating expense.............. 1,342,695 2,953,780 6,787,186 4,113,586 15,771,221
----------- ----------- ----------- ----------- -------------
Income (loss) from operations.............. 55,715 (8,695) (38,100) 352,456 (10,589,378)
----------- ----------- ----------- ----------- -------------
Other income (expense):
Interest income........................ 200 34,410 171,181 68,208 1,828,065
Interest expense....................... (23,304) (13,036) (9,463) (6,396) (15,140)
----------- ----------- ----------- ----------- -------------
Other income (expense), net.......... (23,104) 21,374 161,718 61,812 1,812,925
----------- ----------- ----------- ----------- -------------
Income (loss) before income taxes.......... 32,611 12,679 123,618 414,268 (8,776,453)
Provision for income taxes................. -- 4,906 214,686 214,686 --
----------- ----------- ----------- ----------- -------------
Net income (loss).......................... 32,611 7,773 (91,068) 199,582 (8,776,453)
Accretion on mandatorily redeemable
preferred stock.......................... -- -- (39,356) (16,000) (82,473)
----------- ----------- ----------- ----------- -------------
Net income (loss) available to common
stockholders............................. $ 32,611 $ 7,773 $ (130,424) $ 183,582 $ (8,858,926)
=========== =========== =========== =========== =============
Net income (loss) per common share:
Basic.................................. $ 0.0007 $ 0.0002 $ (0.0028) $ 0.0039 $ (0.1050)
Diluted................................ $ 0.0006 $ 0.0001 $ (0.0028) $ 0.0021 $ (0.1050)
Weighted average common shares outstanding:
Basic.................................. 47,000,000 47,000,000 47,100,101 47,052,080 84,354,922
Diluted................................ 54,465,040 69,156,554 47,100,101 89,502,057 84,354,922
Pro forma net income (loss) per common
share (unaudited):
Basic.................................. $ (0.0010) $ 0.0025 $ (0.0578)
Diluted................................ $ (0.0010) $ 0.0022 $ (0.0578)
Pro forma weighted average common shares
outstanding (unaudited):
Basic.................................. 87,859,649 81,577,332 151,879,702
Diluted................................ 87,859,649 89,502,057 151,879,702
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
RED HAT, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
---------------------- PAID-IN DEFERRED ACCUMULATED COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT CAPITAL COMPENSATION DEFICIT INCOME (LOSS) EQUITY (DEFICIT)
----------- -------- ------------- -------------- ------------- --------------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at February
29, 1996............ 47,000,000 $ 4,700 $ 261,300 $ -- $ (344,588) $ -- $ (78,588)
Net income............ -- -- -- -- 32,611 -- 32,611
----------- ------- ------------ ----------- ----------- --------- -----------
Balance at February
28, 1997............ 47,000,000 4,700 261,300 -- (311,977) -- (45,977)
Net income............ -- -- -- -- 7,773 -- 7,773
----------- ------- ------------ ----------- ----------- --------- -----------
Balance at February
28, 1998............ 47,000,000 4,700 261,300 -- (304,204) -- (38,204)
Exercise of common
stock warrants...... 705,900 70 (52) -- -- -- 18
Tax benefit on
exercise of common
stock warrants...... -- -- 163,831 -- -- -- 163,831
Accretion of
mandatorily
redeemable preferred
stock............... -- -- -- -- (39,356) -- (39,356)
Net loss.............. -- -- -- -- (91,068) -- (91,068)
----------- ------- ------------ ----------- ----------- --------- -----------
Balance at February
28, 1999............ 47,705,900 4,770 425,079 -- (434,628) -- (4,779)
Net loss.............. -- -- -- -- (8,776,453) -- (8,776,453)
Other comprehensive
income:
Unrealized loss on
investments in
marketable
securities........ -- -- -- -- -- (244,513) --
Foreign currency
translation
adjustment........ -- -- -- -- -- 32,224 --
---------
Other comprehensive
income.............. (212,289) (212,289)
Conversion of
preferred stock into
common stock........ 67,890,904 6,789 15,363,731 -- -- -- 15,370,520
Proceeds from sale of
common stock in
initial public
offering, net of
offering costs...... 13,800,000 1,380 88,465,549 -- -- -- 88,466,929
Exercise of common
stock options and
warrants............ 8,192,404 819 2,763,010 -- -- 2,763,829
Deferred
compensation........ -- -- 8,125,259 (8,125,259) -- -- --
Amortization of
deferred
compensation........ -- -- -- 1,009,503 -- -- 1,009,503
Accretion of
mandatorily
redeemable preferred
stock............... -- -- -- -- (82,473) -- (82,473)
----------- ------- ------------ ----------- ----------- --------- -----------
Balance at November
30, 1999
(unaudited)......... 137,589,208 $13,758 $115,142,628 $(7,115,756) $(9,293,554) $(212,289) $98,534,787
=========== ======= ============ =========== =========== ========= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
RED HAT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED FEBRUARY 28, NOVEMBER 30,
------------------------------------- --------------------------
1997 1998 1999 1998 1999
---------- ---------- ----------- ---------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................. $ 32,611 $ 7,773 $ (91,068) $ 199,582 $ (8,776,453)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization............... 37,134 102,876 177,656 127,140 736,192
Tax benefit of stock options and warrants
exercised................................. -- -- 163,831 -- --
Deferred compensation....................... -- -- -- -- 1,009,503
Provision for doubtful accounts............. 38,986 38,141 185,092 55,558 212,085
Provision for inventory obsolescence........ -- -- 182,509 -- --
Deferred revenue............................ -- 26,207 7,145 (19,386) 4,090,501
Changes in operating assets and liabilities:
Accounts receivable....................... (251,774) (479,746) (681,879) (652,318) (3,507,178)
Inventory................................. (14,934) (84,507) (386,963) 22,045 (1,508,081)
Prepaid expenses.......................... (12,248) (370,571) 210,100 124,257 (562,850)
Other assets.............................. 1,613 (15,408) (75,478) (421,832) (1,668,710)
Accounts payable.......................... 282,453 290,253 1,313,369 556,242 2,502,065
Royalties payable......................... 57,477 189,846 (103,249) (49,682) 77,269
Accrued expenses.......................... (66,044) 19,019 329,423 863,301 1,787,947
---------- ---------- ----------- ---------- -------------
Net cash provided by (used in) operating
activities.............................. 105,274 (276,117) 1,230,488 804,907 (5,607,710)
---------- ---------- ----------- ---------- -------------
Cash flows from investing activities:
Purchase of investment securities............. -- (150,000) (1,966,600) -- (154,220,661)
Proceeds from sales and maturity of investment
securities.................................. -- -- 100,000 -- 71,750,316
Purchase of equipment......................... (201,322) (158,004) (654,235) (226,260) (4,285,391)
Proceeds from sale of equipment............... -- 24,272 -- -- --
---------- ---------- ----------- ---------- -------------
Net cash provided by (used in) investing
activities.............................. (201,322) (283,732) (2,520,835) (226,260) (86,755,736)
---------- ---------- ----------- ---------- -------------
Cash flows from financing activities:
Proceeds from borrowing from stockholders..... 50,000 -- -- -- --
Repayments of borrowings from stockholders.... -- (86,243) -- -- --
Proceeds from notes payable................... 46,048 239,214 -- -- --
Repayments of notes payable................... -- (279,019) -- 21,186 --
Proceeds from issuance of mandatorily
redeemable preferred stock, net............. -- 1,983,209 10,084,854 6,889,263 3,180,628
Proceeds from issuance of common stock, net... -- -- -- -- 88,466,929
Proceeds from exercise of common stock options
and warrants................................ -- -- 18 -- 2,763,829
Payments on capital lease obligations......... -- (4,750) (31,860) -- (138,234)
---------- ---------- ----------- ---------- -------------
Net cash provided by financing
activities.............................. 96,048 1,852,411 10,053,012 6,910,449 94,273,152
---------- ---------- ----------- ---------- -------------
Effect of exchange rate changes on cash and
cash equivalents............................ -- -- -- -- 32,224
Net increase in cash and cash equivalents..... -- 1,292,562 8,762,665 7,489,096 1,941,930
Cash and cash equivalents beginning of the
period...................................... -- -- 1,292,562 1,292,562 10,055,227
---------- ---------- ----------- ---------- -------------
Cash and cash equivalents end of period....... $ -- $1,292,562 $10,055,227 $8,781,658 $ 11,997,157
========== ========== =========== ========== =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
BUSINESS ACTIVITY
Red Hat, Inc. and subsidiaries ("Red Hat" or the "Company") is a leading
developer and global provider of open source software products and services, and
has built a comprehensive web site dedicated to the open source software
community. Red Hat, Inc. was incorporated in Connecticut in March 1993 as ACC
Corp., Inc. In September 1995 ACC Corp., Inc. changed its name to Red Hat
Software, Inc. In September 1998, Red Hat Software, Inc. reincorporated in
Delaware. In June 1999, Red Hat Software, Inc. changed its name to Red
Hat, Inc.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
UNAUDITED INTERIM FINANCIAL STATEMENTS
The consolidated financial statements as of November 30, 1999 and for the
nine month periods ended November 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 a fair presentation of
financial position, results of operations and cash flows. All financial
statement disclosures related to the nine month periods ended November 30, 1998
and 1999 are also unaudited.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers investments purchased with a maturity period of three
months or less at the date of purchase to be cash equivalents.
INVESTMENTS
The Company's investments at February 28, 1997, 1998 and 1999 were in debt
securities which were classified as held-to-maturity and were carried at
amortized cost in accordance with Statement of Financial Accounting Standards
No. 115 "Accounting for Certain Investments in Debt and Equity Securities"
("SFAS No. 115"), as the Company had both the positive intent and ability to
hold them to maturity. Investments with a maturity period of greater than one
year at date of purchase are recorded as long-term investments.
During the nine month period ended November 30, 1999, all of the Company's
investments matured or were sold and re-invested in new securities. The
Company's investments at November 30, 1999 are in debt and equity securities.
The Company has classified these investments as available for sale and is
carrying these investments at market value in accordance with SFAS No. 115. The
Company's investments are considered available for sale as these securities
could potentially be sold in response to needs for liquidity, changes in the
availability of and the yield on alternative instruments or changes in funding
sources or terms. At November 30, 1999, the Company has an unrealized loss of
$244,513 related to these investments which is
F-7
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
recorded as other comprehensive income which is a separate component of
stockholders' equity. The Company had an insignificant amount of net realized
losses on sales and maturities of investments during the nine months ended
November 30, 1999.
INVENTORY
The costs incurred for duplicating the computer software, documentation, and
training materials from the product masters and for packaging the product for
distribution are capitalized as inventory using the weighted average method and
charged to cost of sales when revenue from the sale of units is recognized.
Management periodically evaluates the realizability of inventory based on
planned release dates of product updates and records a reserve for obsolescence
when necessary. The reserve for inventory obsolescence was $0 and $182,509 at
February 28, 1998 and 1999, respectively. The reserve for inventory obsolescence
was $0 at November 30, 1999.
CAPITALIZED SOFTWARE COSTS
Capitalization of software development costs begins upon the establishment
of technological feasibility and ceases when the product is available for
general release. The establishment of technological feasibility and the ongoing
assessment of recoverability of capitalized software development costs require
considerable judgment by management concerning certain external factors
including, but not limited to, technological feasibility, anticipated future
gross revenue, estimated economic life and changes in software and hardware
technologies. As a result of the Company's practice of releasing source code
that it has developed on a weekly basis for unrestricted download on the
internet, there is generally no passage of time between achievement of
technological feasibility and the availability of the Company's product for
general release. Therefore, the Company has no capitalized software development
costs at February 28, 1998 and 1999 and November 30, 1999.
PROPERTY AND EQUIPMENT
Property and equipment is primarily comprised of furniture and computer
equipment which are recorded at cost and depreciated over their estimated useful
lives using the straight line method. Expenditures for maintenance and repairs
are charged to operations as incurred; major expenditures for renewals and
betterments are capitalized and depreciated. Property and equipment acquired
under capital leases are being depreciated over their estimated useful lives or
the respective lease term, if shorter. Depreciation periods used for property
and equipment are as follows:
<TABLE>
<S> <C>
Computer equipment.......................................... 3 years
Furniture and fixtures...................................... 7 years
Leasehold improvements...................................... 4 to 25 years
</TABLE>
OTHER ASSETS
Costs incurred for acquiring trademarks, copyrights and patents are
capitalized and amortized over their estimated useful lives, which range from 5
to 15 years, using the straight line method. Other assets also includes
investments in other companies accounted for using the cost method of
accounting, security deposits which are expected to be refunded to the Company
upon termination
F-8
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
of certain leases, deferred merger and acquisition costs related to the
Company's pending acquisition of Cygnus Solutions, Inc. (Cygnus) (see Note 3)
and the long term portion of the Company's prepaid directors' and officers'
insurance premium. The deferred merger and acquisition costs will be expensed at
the closing date of the Company's acquisition of Cygnus. Prepaid insurance will
be amortized over the term of the related policy.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates the recoverability of its property and equipment, and
other assets in accordance with Statement of Financial Accounting Standards
No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed of"
("SFAS 121"). SFAS 121 requires recognition of impairment of long-lived assets
in the event the net book value of such assets exceeds the estimated future
undiscounted cash flows attributable to such assets or the business to which
such intangible assets relate. No impairments were required to be recognized
during the years ended February 28, 1997, 1998 and 1999 or the nine months ended
November 30, 1999.
REVENUE RECOGNITION
Revenues from the sale of software products for which no technical support
is provided are generally recognized upon shipment of the products, net of
estimated returns. A reserve for sales returns is recognized for sales of
software products to distributors, who have a right of return, based on the
Company's historical experience of sell-through to the end user by the
distributor. The Company recognizes revenues from the sale of software products
to new distributors of its software products based upon sell-through to the end
user until the Company has sufficient historical experience with the distributor
to allow the accurate estimation of sales returns.
Upon the release of Version 6.0 of Official Red Hat Linux in May 1999, the
Company began providing certain telephone and e-mail technical support services
with Official Red Hat Linux and Red Hat Secure Web Server for a period of
90 days from the date of registration of the software products for no additional
fee. In June 1999, the Company also began to provide to purchasers of Official
Red Hat Linux and Red Hat Secure Web Server certain subscription services for a
period of six months from the date of registration of the software products. In
October 1999, the Company released Version 6.1 of Red Hat Linux and included the
Secure Web Server product in the "professional version" of Version 6.1 of
Official Red Hat Linux. In accordance with the provisions of Statement of
Opinion No. 97-2, "Software Revenue Recognition" ("SOP 97-2"), the Company is
recognizing all of the revenue from the sale of Versions 6.0 and 6.1 of Official
Red Hat Linux over the period that the technical support and subscription
services are provided as the Company does not sell these technical support and
subscription services separately and therefore does not have vendor specific
objective evidence of the fair value of these services. These revenues are
recognized ratably over the period that the technical support and subscription
services are provided in proportion to the costs incurred to provide such
technical support and subscription services as compared to estimated total costs
to be incurred. The Company currently does not provide support and maintenance
services as part of the fee for any of its software products, other than
Official Red Hat Linux.
Revenue for technical support and maintenance services, other than
installation support, is deferred and recognized ratably over the term of the
agreement, which is typically twelve months.
F-9
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue from customer training and education and other services is
recognized at the date the services are performed.
Royalty revenue, which is included in services and other revenue, is
comprised primarily of royalties received from the sale of rights to the
Company's brand and trademark and royalties received from international
distributors of the Company's products. Royalty revenue is recognized when
received. Revenue from sale of books, published by the Company, which is
included in software and related products revenue is recognized at the date of
shipment, net of a reserve for estimated returns.
Web revenue related to advertising is recognized ratably over the period in
which the advertisement is displayed, provided that the Company has no
significant remaining obligations, at the lesser of the ratio of impressions to
the advertiser's web site delivered over total guaranteed impressions to the
advertiser's web site or the straight line basis over the term of the contract.
If minimum guaranteed impressions are not met, the Company defers recognition of
the corresponding revenue until the guaranteed impressions are achieved. The
Company did not generate revenue from the sale of advertising on its web site
during the fiscal years ended February 28, 1997, 1998 and 1999. The Company
began selling advertising space on its web site in May 1999.
ROYALTY COSTS
Royalties that the Company is required to pay on applications licensed from
third parties that are a component of the software products sold by the Company
are expensed as cost of sales on a per unit basis as software products are sold.
Royalties paid in advance of the sale of the Company's software products are
included in prepaid expenses and recorded as expense when the related software
products are sold.
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. The Company recognized
$1,009,503 in non-cash compensation expense related to amortization of deferred
compensation during the nine months ended November 30, 1999. The Company did not
recognize any non-cash compensation expense in the years ended February 28, 1998
and 1999 as no options were granted at prices below fair value until
April 1999. The Company has adopted the disclosure requirements of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), which requires compensation expense to be disclosed
based on the fair value of the options granted at the date of the grant.
F-10
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SALES AND MARKETING EXPENSES
Sales and marketing expenses consist primarily of costs, including salaries
and sales commissions, of all personnel involved in the sales process and
related expenses. Sales and marketing expenses also include costs of advertising
and trade shows. All costs of advertising, including cooperative marketing
arrangements, the software products, books and related services offered by the
Company are expensed as incurred. Advertising expense totaled $69,109, $152,939
and $597,822 for the years ended February 28, 1997, 1998 and 1999, respectively.
RESEARCH AND DEVELOPMENT COSTS
Research and development expenses include all direct costs, primarily
salaries for Company personnel and outside consultants, related to the
development of new products and significant enhancements to existing products
and are charged to operations as incurred until such time as technological
feasibility is achieved.
INCOME TAXES
The Company accounts for income taxes using the liability method which
requires the recognition of deferred tax assets or liabilities for the temporary
differences between financial reporting and tax bases of the Company's assets
and liabilities and for tax carryforwards at enacted statutory tax rates in
effect for the years in which the differences are expected to reverse. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. In addition, valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be realized.
SIGNIFICANT CUSTOMERS AND CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash investments
and trade receivables. The Company primarily places its temporary cash
investments with high-credit quality financial institutions which invest
primarily in U.S. Government securities, commercial paper of prime quality and
certificates of deposit guaranteed by banks which are members of the FDIC. Cash
deposits are primarily in financial institutions in the United States, however,
cash for monthly operating costs of international operations are deposited with
financial institutions outside of the United States. The Company performs
ongoing credit evaluations to reduce credit risk and requires no collateral from
its customers. Management estimates the allowance for uncollectible accounts
based on their historical experience and credit evaluation. Sales to one
distributor comprised $416,501 or 16%, $1,340,462 or 26% and $2,135,733 or 20%
of total revenues for the years ended February 28, 1997, 1998 and 1999,
respectively. Sales to one other distributor comprised $3,719,162 or 34% of
total revenues for the year ended February 28, 1999. Receivables from two
distributors comprised 75% and 25%, respectively, of net accounts receivable at
February 28, 1999. Accounts receivable from one distributor comprised 42% of net
receivables at February 28, 1998.
F-11
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Prior to October 1999, all of the Company's software revenues were from
sales transactions originating in the United States, however, in October 1999,
the Company began making direct sales from its international subsidiaries to
customers located outside the United States. The Company has historically
received certain royalty payments from international sources; however, such
amounts have been insignificant to date.
CASH FLOWS
The Company made cash payments for interest of $23,304, $13,036 and $9,463
for the years ended February 28, 1997, 1998 and 1999, respectively. The Company
made no cash payments for income taxes during the years ended February 28, 1997
and 1998 and $163,831 during the year ended February 28, 1999.
The Company acquired property and equipment through the assumption of
capital lease obligations amounting to $22,466, $75,299 and $472,706 for the
years ended February 28, 1997, 1998 and 1999 respectively.
NET INCOME (LOSS) PER COMMON SHARE
HISTORICAL
The Company computes net income (loss) per common share in accordance with
Statement of Financial Accounting Standards No. 128, "Earnings Per Share,"
("SFAS 128") and SEC Staff Accounting Bulletin No. 98 ("SAB No. 98"). Under the
provisions of SFAS 128 and SAB No. 98, basic net income (loss) per common share
("Basic EPS") is computed by dividing net income (loss) available to common
stockholders by the weighted average number of common shares outstanding.
Diluted net income (loss) available to common stockholders per common share
("Diluted EPS") is computed by dividing net income (loss) by the weighted
average number of common shares and dilutive potential common share equivalents
then outstanding. Potential common shares consist of shares issuable upon the
exercise of stock options and warrants and shares issuable upon conversion of
outstanding mandatorily redeemable preferred stock. The calculation of the net
loss per share available to common stockholders for the fiscal year ended
February 28, 1999 does not include 48,598,142 potential shares of common stock
equivalents, as their impact would be antidilutive.
PRO FORMA (UNAUDITED)
Pro forma net income (loss) per common share is calculated assuming
conversion of all mandatorily redeemable preferred stock which converted
automatically upon the effectiveness of the Company's initial public offering on
August 11, 1999 into 67,890,904 shares of common stock (see Note 9) at March 1,
1999 or the date of issuance, if later.
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
F-12
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
areas and major customers. The Company adopted SFAS 131 effective for its fiscal
year ended February 28, 1998. The Company has determined that it did not have
any separately reportable operating segments as of February 28, 1997, 1998 or
1999 or as of November 30, 1999. See below for disclosure regarding the
Company's geographic segments.
The Company established international sales offices in the United Kingdom,
Germany, Ireland and Japan during the Company's fiscal quarter ended August 31,
1999. These operations did not begin to generate revenues until the Company's
fiscal quarter ended November 30, 1999. None of these international operations
are material on an individual basis for the nine month period ended
November 30, 1999, therefore, the following disclosure aggregates all the
Company's international operations:
<TABLE>
<CAPTION>
UNITED STATES INTERNATIONAL TOTAL
------------- ------------- -------------
<S> <C> <C> <C>
Revenues from external customers................ $ 11,594,274 $ 1,001,407 $ 12,595,681
Net loss........................................ $ (7,125,314) $(1,651,159) $ (8,776,453)
Total Assets.................................... $105,765,867 $ 4,531,783 $110,297,650
</TABLE>
INTERNAL USE SOFTWARE
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 March 1, 1999. The adoption of SOP
No. 98-1 did not have a material impact on the Company's financial position or
results of operations.
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 did not impact the Company's financial position, results of operations,
or cash flows as the Company had no items of other comprehensive income during
the three year period ended February 28, 1999. The Company's items of other
comprehensive income during the nine months ended November 30, 1999 are net
unrealized losses on investments in marketable securities of $244,513 and a
change in the cumulative translation adjustment of $32,224 for fiscal 1999
foreign currency gains and losses.
FOREIGN CURRENCY TRANSLATION
The majority of the Company's international sales are denominated in
currencies other than the U.S. dollar and most of the costs of the Company's
international operations are paid in currencies other than the U.S. dollar.
Foreign exchange gains and losses, which result from the translation of foreign
currency financial statements into U.S. dollars, are included as a separate
component of stockholders' equity.
F-13
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"). SFAS 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. SFAS 133 as amended by SFAS 137, is effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000, with earlier
application encouraged. The Company does not currently nor does it intend in the
future to use derivative instruments and therefore does not expect that the
adoption of SFAS 133 will have any impact on its financial position or results
of operations.
In December 1998, the AICPA issued Statement of Position No. 98-9,
"Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to
Certain Transactions" ("SOP No. 98-9"). SOP No. 98-9 amends SOP No. 97-2 to
require recognition of revenue using the "residual method" in circumstances
outlined in SOP 98-9. Under the residual method, revenue is recognized as
follows: (1) the total fair value of undelivered elements, as indicated by
vendor specific objective evidence, is deferred and subsequently recognized in
accordance with the relevant sections of SOP No. 97-2 and (2) the difference
between the total arrangement fee and the amount deferred for the undelivered
elements is recognized as revenue related to the delivered elements. SOP
No. 98-9 is effective for transactions entered into in fiscal years beginning
after March 15, 1999. Also, the provisions of SOP No. 97-2 that were deferred by
SOP No. 98-4 will continue to be deferred until the date SOP No. 98-9 becomes
effective. The Company does not expect that the adoption of SOP No. 98-9 will
have a significant impact on the Company's results of operations or financial
position.
3. ACCOUNTS RECEIVABLE
Accounts receivable, which are primarily from product sales, are presented
net of an allowance for doubtful accounts. The activity in the Company's
allowance for doubtful accounts for the years ended February 28, 1997, 1998 and
1999 is presented in the following table:
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
YEAR ENDED BEGINNING INCOME OR END OF
FEBRUARY 28, OF YEAR EXPENSE DEDUCTIONS (A) YEAR
- ------------ ----------- ----------- --------------- -----------
<S> <C> <C> <C> <C>
1997................. $ -- $ 38,986 $ (554) $ 38,432
1998................. 38,432 38,141 (27,829) 48,744
1999................. 48,744 185,092 (73,458) 160,378
</TABLE>
The Company's allowance for doubtful accounts totaled $134,162 at November 30,
1999. Bad debt expense for the nine month period ended November 30, 1999 was
$212,085
- ------------------------
(a) Represents amounts written-off as uncollectible accounts receivable.
F-14
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. PROPERTY AND EQUIPMENT
The Company's property and equipment consisted of the following:
<TABLE>
<CAPTION>
FEBRUARY 28,
---------------------- NOVEMBER 30,
1998 1999 1999
--------- ---------- --------------
<S> <C> <C> <C>
Computer equipment.................. $ 420,523 $ 818,676 $ 5,017,087
Furniture and fixtures.............. 69,256 583,175 744,016
Leasehold improvements.............. -- 214,868 412,813
--------- ---------- -----------
489,779 1,616,719 6,173,916
Less: accumulated depreciation...... (152,452) (346,143) (1,078,750)
--------- ---------- -----------
$ 337,327 $1,270,576 $ 5,095,166
========= ========== ===========
</TABLE>
5. OTHER ASSETS
Other assets were comprised of the following:
<TABLE>
<CAPTION>
FEBRUARY 28,
-------------------- NOVEMBER 30,
1998 1999 1999
-------- --------- --------------
<S> <C> <C> <C>
Cost basis investment................... $ -- $ -- $ 500,000
Prepaid insurance....................... -- -- 419,972
Security deposits....................... 11,900 78,130 92,442
Trademarks, patents and copyrights,
net................................... 69,288 73,180 121,745
Deferred merger and acquisition costs... -- -- 230,995
Other................................... -- -- 449,627
------- -------- ----------
$81,188 $151,310 $1,814,781
======= ======== ==========
</TABLE>
6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, accounts payable and
accounts receivable at February 28, 1998 and 1999 approximated their fair value
due to the short-term nature of these items.
The fair value of the Company's short-term and long-term investments at
February 28, 1998 and 1999 approximated their carrying values as these
investments were primarily in short-term U.S. Government obligations.
The Company's investments in debt and equity securities are considered as
available for sale at November 30, 1999 and are carried at their respective fair
values in accordance with SFAS
F-15
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
No. 115. Following is a summary of the historical cost, unrealized loss and fair
values of the Company's investments at November 30, 1999:
<TABLE>
<CAPTION>
COST UNREALIZED GAIN (LOSS) FAIR VALUE
----------- ---------------------- -----------
<S> <C> <C> <C>
Short-term investments... $ 7,630,705 $ -- $ 7,630,705
Long-term investments.... 76,877,622 (244,503) 76,633,119
----------- --------- -----------
$84,508,327 $(244,503) $84,263,824
=========== ========= ===========
</TABLE>
7. ACCRUED EXPENSES
Accrued expenses were comprised of the following:
<TABLE>
<CAPTION>
FEBRUARY 28,
-------------------- NOVEMBER 30,
1998 1999 1999
-------- --------- --------------
<S> <C> <C> <C>
Payroll................................. $ -- $212,608 $ 143,499
Vacation................................ 3,501 59,165 231,202
Taxes................................... 5,151 14,025 263,356
Trade................................... -- -- 1,414,196
Other................................... 41,682 93,959 115,451
------- -------- ----------
$50,334 $379,757 $2,167,704
======= ======== ==========
</TABLE>
8. INCOME TAXES
The components of the Company's provision for income taxes consisted of the
following:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED FEBRUARY 28, NOVEMBER 30,
------------------------------- --------------------
1997 1998 1999 1998 1999
-------- -------- --------- --------- --------
<S> <C> <C> <C> <C> <C>
Current tax provision:
Federal....................... $ -- $ -- $149,284 $149,284 $ --
State......................... -- 4,906 65,402 65,402 --
---- ------ -------- -------- ----
Current tax expense........... -- 4,906 214,686 214,686 --
---- ------ -------- -------- ----
Deferred tax benefit:
Federal....................... -- -- -- -- --
State......................... -- -- -- -- --
---- ------ -------- -------- ----
Deferred tax benefit.......... -- -- -- -- --
---- ------ -------- -------- ----
Net provision for income
taxes......................... $ -- $4,906 $214,686 $214,686 $ --
==== ====== ======== ======== ====
</TABLE>
F-16
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
at February 28, 1999 and 1998 consisted of the following:
<TABLE>
<CAPTION>
FEBRUARY 28,
--------------------- NOVEMBER 30,
1998 1999 1999
--------- --------- --------------
<S> <C> <C> <C>
Deferred Tax Assets:
Domestic net operating loss
carryforwards...................... $ 23,697 $ -- $ 2,414,970
Foreign net operating loss
carryforwards...................... -- -- 611,666
Accounts receivable.................. 21,818 217,777 54,591
Allowance for inventory
obsolescence....................... -- 70,785 --
Allowance for returns................ -- -- 138,297
Research and development credit...... 67,629 -- 73,810
Deferred compensation................ -- -- 339,046
Other accruals....................... 1,376 22,947 97,099
--------- --------- -----------
Total deferred tax assets.......... 114,520 311,509 3,729,479
Valuation allowance for deferred tax
assets............................. (109,040) (307,423) (3,725,192)
--------- --------- -----------
Net deferred tax assets: 5,480 4,086 4,287
--------- --------- -----------
Deferred Tax Liabilities:
Property and equipment............... (5,480) (4,086) (4,287)
--------- --------- -----------
Total deferred tax liabilities..... (5,480) (4,086) (4,287)
--------- --------- -----------
Net deferred taxes................. $ -- $ -- $ --
========= ========= ===========
</TABLE>
As of February 28, 1998 and 1999, and November 30, 1999 the Company provided
a full valuation allowance against its net deferred tax assets since realization
of these benefits cannot be reasonably assured. An increase in the valuation
allowance was recorded during fiscal 1999 and the nine months ended
November 30, 1999 to reserve the increase in total deferred tax assets at
February 28, 1999 and November 30, 1999 due to uncertainty of realizability.
As of February 28, 1998, the Company had federal and state net operating
loss carryforwards of approximately $70,000. This carryforward was fully
utilized during 1999. As of November 30, 1999, the Company had federal and state
net operating loss carryforwards of approximately $6,224,000. The use of federal
net operating loss carryforwards may be subject to limitation under the rules
regarding a change in stock ownership as determined by the Internal Revenue
Code. The federal and state net operating loss carryforwards will begin to
expire in 2020 and 2015, respectively. Additionally, the Company had net
operating loss carryforwards for tax purposes in various jurisdictions outside
the United States amounting to approximately $1,485,000. The majority of foreign
loss carryforwards will never expire under local country tax rules.
F-17
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Taxes computed at the statutory federal income tax rate of 34% are
reconciled to the provision for income taxes as follows:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED FEBRUARY 28, ENDED
----------------------------------- NOVEMBER 30,
1997 1998 1999 1999
-------- -------- --------- --------------
<S> <C> <C> <C> <C>
Effective rate.......... 0% 39% 174% 0%
-------- -------- -------- -----------
United States Federal
tax at statutory
rate.................. $ 12,214 $ 4,311 $ 42,030 $(2,966,404)
State taxes (net of
Federal benefit)...... 1,897 13,392 7,619 (336,889)
Foreign rate
differential.......... -- -- -- (106,629)
Change in valuation
reserves.............. (17,040) 28,993 198,477 3,417,768
Research and development
credit................ -- (67,629) (43,959) (73,810)
Non-deductible items.... 2,929 25,839 10,519 65,964
-------- -------- -------- -----------
Provision for income
taxes................. $ -- $ 4,906 $214,686 $ --
======== ======== ======== ===========
</TABLE>
9. MANDATORILY REDEEMABLE PREFERRED STOCK
At February 28, 1999, the Company had authorized 6,801,400, 8,116,550 and
2,054,776 shares of Series A, Series B and Series C mandatorily redeemable
preferred stock, respectively. The shares of Series A, Series B and Series C
mandatorily redeemable preferred stock had a par value of $0.0001 per share.
On August 15, 1997, the Company entered into a purchase agreement with an
investor (the "Series A Investor"). In connection with this agreement, the
Company issued 6,801,400 shares of Series A preferred stock to the Series A
Investor for $2,000,000 or $0.2941 per share, less related issuance costs of
$16,791. The Series A preferred stock became mandatorily redeemable with the
issuance of the Series B mandatorily preferred stock in September 1998.
On September 29, 1998, the Company entered into a purchase agreement with
several investors (the "Series B Investors"). In connection with this agreement,
the Company issued 8,116,550 shares of Series B mandatorily redeemable preferred
stock to the Series B Investors for $6,955,884, or $0.857 per share, less
related issuance costs of $66,621.
On February 25, 1999, the Company entered into a purchase agreement with
several investors (the "Series C Investors"). In connection with this agreement,
the Company issued 1,027,388 shares of Series C mandatorily redeemable preferred
stock to the Series C Investors for $3,227,026, or $3.141 per share.
The Company had additional closings of the Series C mandatorily redeemable
preferred stock financing subsequent to February 28, 1999. Additional Series C
Investors purchased 1,027,388
F-18
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. MANDATORILY REDEEMABLE PREFERRED STOCK (CONTINUED)
shares of Series C mandatorily redeemable preferred stock for $3,227,026, or
$3.141 per share in March and April of 1999. Total issuance costs related to
sales of Series C mandatorily redeemable preferred stock were $62,870.
CONVERSION
Each share of Series A, Series B and Series C mandatorily redeemable
preferred stock could be converted to common stock at the option of the Holders
at a two-to-one conversion rate, after certain adjustments. This conversion rate
could be adjusted upon the issuance by the Company of additional common shares
(with certain exceptions) for consideration per share less than $0.343 per
share, in the case of Series A mandatorily redeemable preferred stock, $0.996
per share, in the case of Series B mandatorily redeemable preferred stock and
$3.893 per share, in the case of Series C mandatorily redeemable preferred
stock. The conversion rate could also be adjusted for common stock splits,
reverse common stock splits, dividends and distributions.
All outstanding shares of Series A, Series B and Series C mandatorily
redeemable preferred stock automatically converted into 67,890,904 shares of
common stock, upon the effectiveness of the Company's initial public offering
("IPO") on August 11, 1999.
REDEMPTION
The Company could be required to redeem the Series A, Series B and Series C
mandatorily redeemable preferred stock from the Holders upon receipt of written
request from Holders of shares representing at least 66 2/3% of the aggregate
number of shares of common stock issuable upon conversion. Redemption could
first be made by the Holders on February 25, 2004 and on each of the first and
second anniversaries thereof. The redemption price was equal to $0.343 per share
in the case of Series A, $0.996 per share, in the case of Series B and $3.893
per share, in the case of Series C, after adjustment for certain events. The
carrying value of the Company's mandatorily redeemable preferred stock was
accreted to its redemption price over the redemption period using the effective
interest rate method. In conjunction with the sale of the Series B mandatorily
redeemable preferred stock in September 1998, the Series A mandatorily
redeemable preferred stock became mandatorily redeemable.
CARRYING VALUE
The Series A, Series B and Series C mandatorily redeemable preferred stock
were initially recorded at the total net proceeds received by the Company upon
issuance. The difference between the total net proceeds at issuance of
$12,068,063 and the total redemption price of $14,416,585 was to be charged to
accumulated deficit over the period from issuance until redemption first became
available. The amount of accretion recognized during each period was determined
by using the effective interest rate method. For the year ended February 28,
1999 the accretion was $39,356. The Company had no outstanding mandatorily
redeemable preferred stock prior to the fiscal year ended February 28, 1999. The
Company sold an additional 1,027,388 shares of Series C preferred stock for net
proceeds of $3,164,156 in March and April 1999 with a redemption value of
$4,004,758. Accretion on preferred stock was $82,473 for the nine months ended
November 30, 1999. Accretion on preferred stock ceased upon the effectiveness of
the Company's IPO.
F-19
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK
On September 28, 1998, the Company effected a 100 for 1 stock split for
holders of its common stock. Amounts presented for the periods prior to the
stock split have been restated to reflect the stock split on a retroactive
basis.
The Company has authorized 225,000,000 shares of common stock with a par
value of $0.0001 per share. Holders of these shares have one vote per share.
Upon the dissolution, liquidation or winding up of the Company, holders of
common stock will be entitled to receive the assets of the Company after
satisfaction of the preferential rights of any outstanding mandatorily
redeemable preferred stock or any other outstanding stock ranking on liquidation
senior to or on parity with the common stock.
On September 29, 1998, in connection with the above mentioned sale of
Series B mandatorily redeemable preferred stock, certain stockholders, primarily
comprised of officers of the Company, entered into a common stock purchase
agreement with the Series B Investors. In connection with this agreement, those
stockholders sold 5,251,000 shares of common stock to the Series B Investors for
$1,125,000 or $0.215 per share.
On February 25, 1999, in connection with the above mentioned sale of
Series C mandatorily redeemable preferred stock, certain stockholders, primarily
comprised of officers of the Company, entered into a common stock purchase
agreement with the Series C Investors. In connection with this agreement, those
stockholders sold 984,368 shares of common stock to the Series C Investors for
$772,975 or $0.786 per share. Upon additional closings of the Series C
mandatorily redeemable preferred stock financing in March and April of 1999, an
additional 984,368 shares of common stock were sold by certain stockholders,
primarily comprised of officers of the Company, to the additional Series C
Investors for $772,975 or $0.786 per share.
On August 16, 1999, the Company closed its initial public offering of
13,800,000 shares of its common stock at a price of $7.00 per share. The Company
received proceeds of $88,466,929 net of $8,133,071 in offering costs.
11. STOCK OPTIONS AND WARRANTS
STOCK OPTIONS
During September 1998, the Company's Board of Directors approved a stock
option plan. As of February 28, 1999, 14,929,600 shares of common stock were
reserved for issuance upon exercise of options granted to any employee, officer
or director or consultant of the Company at terms and prices to be determined by
the Board of Directors. In June 1999, the option pool was increased to
18,869,600 shares. At November 30, 1999, 12,423,976 shares of common stock are
reserved for issuance under the Company's stock option plan. The plan provides
that the exercise price per share and the purchase price per share for each
non-qualified option should be set by the Board on the date of grant. The price
for each Incentive Stock Option (ISO) shall not be less than the fair market
value of the common stock on the date of grant. The maximum term for an option
granted is ten years from the date of grant. The Company believes that all
options and warrants, granted through February 28, 1999, have been granted at
their fair values on their respective grant dates. Options granted under the
plan generally vest 25% upon completion of one full year of service and 6.25% on
the first day of each subsequent three-month period. All options are immediately
exercisable upon grant into restricted shares of the Company's common stock with
the same vesting provisions as the original option. The Company, at its option,
may repurchase these restricted shares at the original purchase price under
certain circumstances.
F-20
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS AND WARRANTS (CONTINUED)
The activity for the stock option plan for the year ended February 28, 1999
and for the period from March 1, 1999 to November 30, 1999 is presented in the
following table. Prior to March 1, 1998, the Company had granted no stock
options.
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVERAGE
UNDERLYING EXERCISE PRICE
OPTIONS PER SHARE
----------- --------------
<S> <C> <C>
Outstanding at February 28, 1998................. -- $ --
Granted.......................................... 8,645,140 0.18
Forfeited........................................ (40,000) 0.09
----------- -----
Outstanding at February 28, 1999................. 8,605,140 0.18
Granted (unaudited).............................. 10,316,140 3.68
Exercised (unaudited)............................ (6,232,404) 0.47
Forfeited (unaudited)............................ (178,900) 0.70
----------- -----
Outstanding at November 30, 1999 (unaudited)..... 12,509,976 $2.93
=========== =====
</TABLE>
The Company recorded deferred compensation of $8,125,259 during the nine
months ended November 30, 1999 to reflect the difference between the aggregate
fair market value and exercise price during this period of all stock options
granted with an exercise price below the fair market value of the Company's
common stock at the date of the grant. Amortization of deferred compensation
totaled $1,009,503 during the nine months ended November 30, 1999.
The following summarizes information about the Company's stock options at
February 28, 1999:
<TABLE>
<CAPTION>
FEBRUARY 28, 1999
- -------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- --------------------- ----------- ----------- -------- ----------- --------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
<S> <C> <C> <C> <C> <C>
0.09....$..... 2,400,000 9.58 $0.09 2,400,000 $0.09
$0.21 6,205,140 9.67 $0.21 6,205,140 $0.21
</TABLE>
<TABLE>
<CAPTION>
NOVEMBER 30, 1999
- -------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- --------------------- ----------- ----------- -------- ----------- --------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
<S> <C> <C> <C> <C> <C>
$ 0.09 729,000 8.77 $ 0.09 729,000 $ 0.09
$ 0.21 3,734,140 8.98 $ 0.21 3,734,140 $ 0.21
$ 0.79 3,282,240 9.36 $ 0.79 3,282,240 $ 0.79
$ 2.50 2,271,796 9.53 $ 2.50 2,271,796 $ 2.50
$ 5.00-$5.50 1,611,000 9.66 $ 5.21 1,611,000 $ 5.21
$ 7.00 40,000 9.70 $ 7.00 40,000 $ 7.00
$36.75-$42.94 41,800 9.86 $40.73 41,800 $40.73
</TABLE>
F-21
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS AND WARRANTS (CONTINUED)
STOCK WARRANTS
On October 10, 1995, the Company issued warrants (which are equivalent to
nonqualified stock options) to purchase 7,480,800 shares of common stock to
three of its employees with an exercise price of $0.0001 per share. The warrants
vest 25% annually on each May 1, beginning May 1, 1996 and ending May 1, 1999.
The warrants terminate upon death, permanent disability, termination of
employment or May 1, 2006. The Company and certain founding shareholders have a
right of first refusal to purchase the warrant shares on the same terms as a
proposed purchaser and a right to purchase the shares upon the death,
disability, or termination of employment of the employee. Upon the death,
disability, or termination without cause of the employee, the purchase price
shall be 80% of the fair market value of the Company's common stock as
determined by the board of directors. If the employee is terminated for cause,
the purchase price shall be 80% of the lesser of the book value or the fair
market value of the Company's common stock.
The activity for the stock warrants is presented in the following table:
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE
UNDERLYING PRICE UNDERLYING PRICE UNDERLYING PRICE
WARRANTS PER SHARE WARRANTS PER SHARE WARRANTS PER SHARE
---------- --------- ---------- --------- ---------- ---------
YEAR ENDED FEBRUARY 28,
1997 1998 1999
---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
year............................ 7,480,800 $0.0001 7,480,800 $ 0.0001 7,480,800 $ 0.0001
Exercised......................... -- -- -- -- (705,900) $ 0.0001
Outstanding at end of year........ 7,480,800 $0.0001 7,480,800 $ 0.0001 6,774,900 $ 0.0001
Exercisable at end of year........ 1,870,200 $0.0001 3,740,400 $ 0.0001 4,904,700 $ 0.0001
</TABLE>
During the nine month period ended November 30, 1999, 1,960,000 warrants to
purchase shares were exercised. At November 30, 1999, warrants to purchase
4,814,900 shares remained outstanding, all of which were exercisable.
SFAS 123 requires the Company to disclose pro forma information regarding
option grants made and warrants issued to its employees. SFAS 123 specifies
certain valuation techniques that produce estimated compensation charges that
are included in the pro forma results below. These amounts have not been
reflected in the Company's statement of operations, because APB No. 25 specifies
that no compensation charge arises when the exercise price of employees' stock
options and warrants equal the market value of the underlying stock at the grant
date, as in the case of options and warrants granted to the Company's employees.
The fair value of options and warrants was estimated using the following
assumptions for the year ended February 28, 1999 and the nine months ended
November 30, 1999:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
FEBRUARY 28, 1999 NOVEMBER 30, 1999
----------------- ------------------
EMPLOYEE EMPLOYEE
STOCK STOCK
OPTIONS OPTIONS
----------------- ------------------
<S> <C> <C>
Expected dividend yield................... 0.00% 0.00%
Risk-free interest rate................... 4.98% 5.01%
Expected volatility....................... 0.00% 134.41%
Expected life (in years).................. 6 5
</TABLE>
F-22
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS AND WARRANTS (CONTINUED)
SFAS 123 pro forma numbers are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
FEBRUARY 28, NINE MONTHS ENDED
1999 NOVEMBER 30, 1999
------------ -----------------
<S> <C> <C>
Net loss available to common stockholders as
reported
under APB No. 25............................ $130,424 $ 8,858,126
Pro forma net loss available to common
stockholders................................ $287,288 $11,906,767
</TABLE>
The Company did not grant any stock options or warrants in fiscal 1998 or
1997 and, therefore, no pro forma disclosure for these years is provided.
The weighted average estimated fair value of employee stock options granted
during the year ended February 28, 1999 was $0.14 per share and was $16.96
during the nine months ended November 30, 1999.
12. COMMITMENTS AND CONTINGENCIES
As of February 28, 1999, the Company leased office space and certain
equipment under various noncancelable operating and capital leases. Future
minimum lease payments required under the operating and capital leases at
February 28, 1999 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
---------- ---------
<S> <C> <C>
2000................................................. $ 945,612 $139,698
2001................................................. 934,208 136,901
2002................................................. 931,283 120,863
2003................................................. 932,200 112,089
2004................................................. 819,266 99,687
---------- --------
Total minimum lease payments................... $4,562,569 609,238
========== ========
Less amount representing interest (at rates ranging
from 8.2% to 9.6%)................................. (80,563)
--------
Present value of net minimum lease payments.......... 528,675
--------
Less current portion................................. (108,897)
--------
Long-term portion.................................... $419,778
========
</TABLE>
Rent expense under operating leases for the years ended February 28, 1997,
1998 and 1999 was $86,313, $171,191 and $308,973 respectively.
The Company has entered into an agreement with a bank to provide a letter of
credit pertaining to its building lease. The Company is required by the bank to
maintain a compensating balance of $65,000 which is equal to the amount of the
letter of credit. This amount is included in cash and cash equivalents.
The Company has executed licensing contracts to publish, bundle and
distribute software products developed by other companies in return for royalty
payments based on a percentage of
F-23
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
the revenues generated by the Company from the sale of these products. Prepaid
royalty payments are included in current assets and royalty payments due are
included in royalties payable.
In April 1999, the Company also contracted with a web support firm to
maintain its backup web site. The initial fee of $98,000 was due upon receipt
and installation of the hardware. The Company has agreed to pay a monthly
maintenance fee of $17,000 for a period of 36 months.
13. EMPLOYEE BENEFITS
The Company provides a retirement plan qualified under Section 401(k) of the
Internal Revenue Code ("IRC") of 1986, as amended. Participants may elect to
contribute a portion of their annual compensation to the plan, after complying
with certain limitations set by the IRC. Employees are eligible to participate
in the plan who are over 21 years of age and have completed three months of
service with Red Hat. If, however, an employee was employed by the Company prior
to February 1999, the 401(k) Plan covers such employee regardless of age or
length of service. The Company has the option to make contributions to the plan
but did not make any contributions to the plan for the years ended February 28,
1997, 1998 and 1999.
In June 1999, the Company established an employee stock purchase plan which
provides for the issuance of up to 1,500,000 shares of the Company's common
stock. Employees of the Company can elect to defer up to 10% of their total cash
compensation to purchase the Company's common stock under the terms of this
plan. No options have been granted to date under this plan.
14. STOCK SPLITS
On August 11, 1999, the Company effected a two-for-one common stock split
immediately prior to the effectiveness of the Company's initial public offering.
All share and per share information in the accompanying financial statements and
notes to the financial statements has been restated to reflect the effects of
this stock split.
In addition, an amendment to the Company's certificate of incorporation
became effective on August 11, 1999, to increase the authorized capital stock to
225,000,000 shares of common stock and 5,000,000 shares of preferred stock each
with a par value of $.0001 per share.
On January 7, 2000, the Company effected a two-for-one common stock split.
All share and per share information in the accompanying financial statements and
notes to the financial statements has been restated to reflect the effect of
this stock split.
15. EVENTS (UNAUDITED) SUBSEQUENT TO DATE OF ACCOUNTANTS' REPORT
On January 7, 2000, Red Hat completed a merger with Cygnus Solutions, Inc.
("Cygnus") by exchanging 10,867,966 shares of its common stock for all of the
outstanding common and preferred stock of Cygnus. In addition, approximately
1,514,168 outstanding Cygnus employee stock options were converted at the same
exchange factor into options to purchase approximately 2,380,722 shares of Red
Hat's common stock.
The merger constituted a tax-free reorganization and will be accounted for
using the pooling of interests method of accounting under Accounting Principles
Board Opinion No. 16 ("APB No. 16").
In addition, on January 4, 2000, the Company completed the acquisition of
all the outstanding common stock of Hells Kitchen Systems, Inc. ("HKS") in
exchange for the issuance of up to 798,670 shares of the Company's common stock
to the shareholders of HKS. The Company issued 478,000 shares of its common
stock to the stockholders of HKS at closing. The Company
F-24
<PAGE>
RED HAT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
15. EVENTS (UNAUDITED) SUBSEQUENT TO DATE OF ACCOUNTANTS' REPORT (CONTINUED)
committed to issue up to an additional 239,000 shares of its common stock to
certain HKS stockholders over a three year period contingent upon their
continued employment with the Company and the Company committed to issue up to
an additional 79,666 shares of its common stock to the HKS stockholders upon
achievement of certain performance targets by the HKS business. The acquisition
of HKS will be accounted for using the purchase method of accounting in
accordance with APB No. 16.
F-25
<PAGE>
RED HAT, INC.
SUPPLEMENTAL POOLED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
FEBRUARY 28,
--------------------------- NOVEMBER 30,
1998 1999 1999
------------ ------------ --------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 5,752,120 $19,485,586 $ 21,389,709
Short-term investments.................................... 1,065,526 2,037,992 7,630,705
Accounts receivable, net.................................. 5,660,949 5,895,173 8,993,322
Inventory................................................. 141,176 345,630 1,853,711
Prepaid expenses.......................................... 971,225 812,665 1,530,827
----------- ----------- ------------
Total current assets.................................... 13,590,996 28,577,046 41,398,274
Property and equipment, net................................. 2,969,855 3,921,798 7,640,897
Other assets, net........................................... 302,015 232,379 1,823,789
Investments................................................. 50,000 -- 76,633,119
----------- ----------- ------------
Total assets............................................ $16,912,866 $32,731,223 $127,496,079
=========== =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 1,584,898 $ 2,584,489 5,500,110
Royalties payable......................................... 247,323 144,074 221,343
Accrued expenses.......................................... 2,343,460 3,209,080 5,640,631
Deferred revenue.......................................... 7,592,784 6,096,465 9,583,002
Short term notes payable.................................. -- 1,509,936 504,968
Current portion of capital lease obligations.............. 45,110 139,112 490,072
----------- ----------- ------------
Total current liabilities............................... 11,813,575 13,683,156 21,940,126
Capital lease obligations................................... 144,488 482,796 246,002
Long term notes payable..................................... 49,345 916,667 583,333
Commitments and contingencies (Note 12)..................... -- -- --
Mandatorily redeemable preferred stock:
Series A, 6,801,400, 6,801,400 and 0 shares authorized,
issued and outstanding at February 28, 1998,
February 28, 1999 and November 30, 1999,
respectively............................................ 1,983,209 1,992,184 --
Series B, 0, 8,116,550 and 0 shares authorized, issued and
outstanding at February 28, 1998, February 28, 1999 and
November 30, 1999, respectively......................... -- 6,919,644 --
Series C, 0, 1,797,929 and 0 shares authorized at
February 28, 1998, February 28, 1999 and November 30,
1999, respectively; 0, 1,027,388 and 0 shares issued and
outstanding at February 28, 1998, February 28, 1999 and
November 30, 1999, respectively......................... -- 3,195,591 --
Series B Cygnus, 1,042,000 shares authorized and
outstanding at February 28, 1998, February 28, 1999 and
November 30, 1999....................................... 6,252,000 6,252,000 6,252,000
Stockholders' equity (deficit):
Preferred stock, 5,000,000 shares authorized, none
outstanding............................................. -- -- --
Preferred stock........................................... 411,691 7,728,094 12,746,234
Common stock, $.0001 par value, 225,000,000 shares
authorized, 47,000,000, 48,865,107 and 139,094,102
shares issued and outstanding at February 28, 1998,
February 28, 1999 and November 30, 1999, respectively... 4,700 4,887 13,909
Additional paid-in capital................................ 261,300 5,265,667 121,224,328
Shareholder receivables................................... (170,790) (2,857,355) (2,824,908)
Deferred compensation..................................... -- (1,188,155) (8,474,657)
Accumulated deficit....................................... (3,836,652) (9,663,953) (23,997,999)
Accumulated other comprehensive income (loss)............. -- -- (212,289)
----------- ----------- ------------
Total stockholders' equity (deficit).................... (3,329,751) (710,815) 98,474,618
----------- ----------- ------------
Total liabilities and stockholders' equity (deficit).... $16,912,866 $32,731,223 $127,496,079
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
F-26
<PAGE>
RED HAT, INC.
SUPPLEMENTAL POOLED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED FEBRUARY 28, ENDED NOVEMBER 30,
---------------------------------------- --------------------------
1997 1998 1999 1998 1999
----------- ----------- ------------ ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Software and related products................ $ 2,603,131 $ 5,131,623 $ 11,140,391 $ 7,466,845 $ 9,735,698
Web.......................................... -- -- -- -- 626,384
Services and other........................... 12,525,856 17,511,827 21,891,291 16,123,271 19,249,449
----------- ----------- ------------ ----------- ------------
Total revenue.............................. 15,128,987 22,643,450 33,031,682 23,590,116 29,611,531
----------- ----------- ------------ ----------- ------------
Cost of revenue:
Software and related products................ 1,204,721 2,210,538 4,104,903 2,725,627 4,843,580
Web.......................................... -- -- -- -- 626,756
Services and other........................... 4,574,535 6,237,612 8,610,686 6,246,651 10,559,114
----------- ----------- ------------ ----------- ------------
Total cost of revenue...................... 5,779,256 8,448,150 12,715,589 8,972,278 16,029,450
----------- ----------- ------------ ----------- ------------
Gross profit................................... 9,349,731 14,195,300 20,316,093 14,617,838 13,582,081
----------- ----------- ------------ ----------- ------------
Operating expense:
Sales and marketing.......................... 5,246,710 9,016,388 11,051,549 7,517,133 15,353,663
Research and development..................... 826,144 4,622,409 8,477,818 6,401,006 7,894,877
General and administrative................... 3,352,092 3,672,167 5,664,561 4,539,578 5,628,311
Stock-based compensation..................... -- -- 227,261 170,346 1,641,507
Mergers and acquisitions..................... -- -- -- -- 123,887
Purchased in process research and
development................................ 1,386,017 -- -- -- --
----------- ----------- ------------ ----------- ------------
Total operating expense.................... 10,810,963 17,310,964 25,421,189 18,628,063 30,642,245
----------- ----------- ------------ ----------- ------------
Loss from operations........................... (1,461,232) (3,115,664) (5,105,096) (4,010,225) (17,060,164)
----------- ----------- ------------ ----------- ------------
Other income (expense):
Interest income.............................. 196,771 509,558 376,039 254,426 2,508,166
Interest expense............................. (55,940) (144,392) (336,672) (212,440) (439,908)
----------- ----------- ------------ ----------- ------------
Other income (expense), net................ 140,831 365,166 39,367 41,986 2,068,258
----------- ----------- ------------ ----------- ------------
Loss before income taxes....................... (1,320,401) (2,750,498) (5,065,729) (3,968,239) (14,991,906)
Provision for income taxes..................... 191,094 215,348 722,216 595,334 240,981
----------- ----------- ------------ ----------- ------------
Net loss....................................... (1,511,495) (2,965,846) (5,787,945) (4,563,573) (15,232,887)
Accretion on mandatorily redeemable preferred
stock........................................ -- -- (39,356) (16,000) (82,473)
----------- ----------- ------------ ----------- ------------
Net loss available to common stockholders...... $(1,511,495) $(2,965,846) $ (5,827,301) $(4,579,573) $(15,315,360)
=========== =========== ============ =========== ============
Net loss per common share:
Basic........................................ (0.0322) (0.0631) (0.1224) (0.0965) (0.1787)
Diluted...................................... (0.0322) (0.0631) (0.1224) (0.0965) (0.1787)
Weighted average common shares outstanding:
Basic........................................ 47,000,000 47,000,000 47,628,096 47,437,780 85,691,876
Diluted...................................... 47,000,000 47,000,000 47,628,096 47,437,780 85,691,876
Pro forma net loss per common share
(unaudited):
Basic........................................ (0.0655) 0.0557 (0.1199)
Diluted...................................... (0.0655) 0.0557 (0.1199)
Pro forma weighted average common shares
outstanding (unaudited):
Basic........................................ 88,387,644 81,984,468 127,047,798
Diluted...................................... 88,387,644 81,984,468 127,047,798
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
F-27
<PAGE>
RED HAT, INC.
SUPPLEMENTAL POOLED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------------- ---------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
----------- ----------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C>
Balance at February 29, 1996........................ -- -- 52,571,284 $ 5,257 $ 420,459
Repurchase and retirement of preferred stock........ (37,124) (112,500) -- -- --
Issuance of common stock............................ -- -- 311,349 31 263,710
Conversion of common stock to Series A preferred.... 5,882,633 423,457 (5,882,633) (588) (422,869)
Net loss............................................ -- -- -- -- --
----------- ----------- ----------- ------- ------------
Balance at February 28, 1997........................ 5,845,509 310,957 47,000,000 4,700 261,300
Exercise of common stock options and warrants....... -- -- -- -- --
Issuance of Series A preferred stock from options... 288,455 117,555 -- -- --
Repurchase and retirement of preferred stock........ (48,884) (16,821) -- -- --
Net loss............................................ -- -- -- -- --
----------- ----------- ----------- ------- ------------
Balance at February 28, 1998........................ 6,085,080 411,691 47,000,000 4,700 261,300
Exercise of common stock options and warrants....... -- -- 1,865,107 187 3,121,860
Tax benefit on exercise of common stock warrants.... -- -- -- -- 163,831
Issuance of Series A preferred stock from options... 205,812 165,586 -- -- --
Issuance of Series C preferred stock, net........... 709,555 6,760,594 -- -- --
Repurchase and retirement of preferred stock........ (141,386) (44,357) -- -- --
Deferred compensation............................... -- -- -- -- 1,415,416
Amortization of deferred compensation............... -- -- -- -- --
Stock options issued for services................... -- 434,580 -- -- 303,260
Accretion of mandatorily redeemable preferred
stock............................................. -- -- -- -- --
Net (increase) decrease in shareholder notes
receivable........................................ -- -- --
Net loss............................................ -- -- -- -- --
----------- ----------- ----------- ------- ------------
Balance at February 28, 1999........................ 6,859,061 7,728,094 48,865,107 4,887 5,265,667
Net loss............................................ -- -- -- -- --
Adjustment for inclusion of Cygnus September 1999
net loss in results of operations twice........... -- -- -- -- --
Other comprehensive income:
Unrealized loss on investments in marketable
securities...................................... -- -- -- -- --
Foreign currency translation adjustment........... -- -- -- -- --
Other comprehensive income.......................... -- -- -- -- --
Conversion of preferred stock into common stock..... -- -- 67,890,904 6,789 15,363,730
Sale of common stock in initial public offering..... -- -- 13,800,000 1,380 88,465,549
Exercise of common stock options and warrants....... -- -- 8,354,111 835 3,159,934
Repurchase and retirement of preferred stock........ (7,372) (1,119) -- -- --
Issuance of Series A preferred stock from options... 420,225 73,311 -- -- --
Issuance of Series C preferred stock, net........... 524,160 4,973,882 -- -- --
Conversion of convertible preferred to common
stock............................................. (183,980) (27,934) 183,980 18 27,916
Deferred compensation............................... -- -- -- -- 8,928,009
Amortization of deferred compensation............... -- -- -- -- --
Stock options issued for services................... -- -- -- -- 13,523
Net (increase) decrease in shareholder notes
receivable........................................ -- -- -- -- --
Accretion of mandatorily redeemable preferred
stock............................................. -- -- -- -- --
----------- ----------- ----------- ------- ------------
Balance at November 30, 1999 (unaudited)............ 7,612,094 $12,746,234 139,094,102 $13,909 $121,224,328
=========== =========== =========== ======= ============
<CAPTION>
ACCUMULATED
SHAREHOLDER OTHER
DEFERRED NOTES ACCUMULATED COMPREHENSIVE
COMPENSATION RECEIVABLE DEFICIT INCOME/(LOSS)
-------------- ------------ ------------- ---------------
<S> <C> <C> <C> <C>
Balance at February 29, 1996........................ $ -- $ (65,530) $ 640,689 $ --
Repurchase and retirement of preferred stock........ -- 112,500 -- --
Issuance of common stock............................ -- (225,931) -- --
Conversion of common stock to Series A preferred.... -- -- -- --
Net loss............................................ -- -- (1,511,495) --
----------- ----------- ------------ ---------
Balance at February 28, 1997........................ -- (178,961) (870,806) --
Exercise of common stock options and warrants....... -- (22,500) -- --
Issuance of Series A preferred stock from options... -- -- -- --
Repurchase and retirement of preferred stock........ -- 30,671 -- --
Net loss............................................ -- -- (2,965,846) --
----------- ----------- ------------ ---------
Balance at February 28, 1998........................ -- (170,790) (3,836,652) --
Exercise of common stock options and warrants....... -- (2,745,901) -- --
Tax benefit on exercise of common stock warrants.... -- -- -- --
Issuance of Series A preferred stock from options... -- -- -- --
Issuance of Series C preferred stock, net........... -- -- -- --
Repurchase and retirement of preferred stock........ -- 72,877 -- --
Deferred compensation............................... (1,415,416) -- -- --
Amortization of deferred compensation............... 227,261 -- -- --
Stock options issued for services................... -- -- -- --
Accretion of mandatorily redeemable preferred
stock............................................. -- -- (39,356) --
Net (increase) decrease in shareholder notes
receivable........................................ -- (13,541) -- --
Net loss............................................ -- -- (5,787,945) --
----------- ----------- ------------ ---------
Balance at February 28, 1999........................ (1,188,155) (2,857,355) (9,663,953) --
Net loss............................................ -- -- (15,232,887) --
Adjustment for inclusion of Cygnus September 1999
net loss in results of operations twice........... -- -- 981,314 --
Other comprehensive income:
Unrealized loss on investments in marketable
securities...................................... -- -- -- (244,513)
Foreign currency translation adjustment........... -- -- -- 32,224
---------
Other comprehensive income.......................... -- -- -- (212,289)
Conversion of preferred stock into common stock..... -- -- -- --
Sale of common stock in initial public offering..... -- -- -- --
Exercise of common stock options and warrants....... -- 127,670 -- --
Repurchase and retirement of preferred stock........ -- -- -- --
Issuance of Series A preferred stock from options... -- -- -- --
Issuance of Series C preferred stock, net........... -- -- -- --
Conversion of convertible preferred to common
stock............................................. -- -- -- --
Deferred compensation............................... (8,928,009) -- -- --
Amortization of deferred compensation............... 1,641,507 -- -- --
Stock options issued for services................... -- -- -- --
Net (increase) decrease in shareholder notes
receivable........................................ -- (95,223) -- --
Accretion of mandatorily redeemable preferred
stock............................................. -- -- (82,473) --
----------- ----------- ------------ ---------
Balance at November 30, 1999 (unaudited)............ $(8,474,657) $(2,824,908) $(23,997,999) $(212,289)
=========== =========== ============ =========
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY/(DEFICIT)
----------------
<S> <C>
Balance at February 29, 1996........................ $ 1,000,875
Repurchase and retirement of preferred stock........ --
Issuance of common stock............................ 37,810
Conversion of common stock to Series A preferred.... --
Net loss............................................ (1,511,495)
------------
Balance at February 28, 1997........................ (472,810)
Exercise of common stock options and warrants....... (22,500)
Issuance of Series A preferred stock from options... 117,555
Repurchase and retirement of preferred stock........ 13,850
Net loss............................................ (2,965,846)
------------
Balance at February 28, 1998........................ (3,329,751)
Exercise of common stock options and warrants....... 376,146
Tax benefit on exercise of common stock warrants.... 163,831
Issuance of Series A preferred stock from options... 165,586
Issuance of Series C preferred stock, net........... 6,760,594
Repurchase and retirement of preferred stock........ 28,520
Deferred compensation............................... --
Amortization of deferred compensation............... 227,261
Stock options issued for services................... 737,840
Accretion of mandatorily redeemable preferred
stock............................................. (39,356)
Net (increase) decrease in shareholder notes
receivable........................................ (13,541)
Net loss............................................ (5,787,945)
------------
Balance at February 28, 1999........................ (710,815)
Net loss............................................ (15,232,887)
Adjustment for inclusion of Cygnus September 1999
net loss in results of operations twice........... 981,314
Other comprehensive income:
Unrealized loss on investments in marketable
securities......................................
Foreign currency translation adjustment...........
Other comprehensive income.......................... (212,289)
Conversion of preferred stock into common stock..... 15,370,519
Sale of common stock in initial public offering..... 88,466,929
Exercise of common stock options and warrants....... 3,288,439
Repurchase and retirement of preferred stock........ (1,119)
Issuance of Series A preferred stock from options... 73,311
Issuance of Series C preferred stock, net........... 4,973,882
Conversion of convertible preferred to common
stock............................................. --
Deferred compensation............................... --
Amortization of deferred compensation............... 1,641,507
Stock options issued for services................... 13,523
Net (increase) decrease in shareholder notes
receivable........................................ (95,223)
Accretion of mandatorily redeemable preferred
stock............................................. (82,473)
------------
Balance at November 30, 1999 (unaudited)............ $ 98,474,618
============
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
F-28
<PAGE>
RED HAT, INC.
SUPPLEMENTAL POOLED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED FEBRUARY 28, ENDED NOVEMBER 30,
---------------------------------------- ----------------------------
1997 1998 1999 1998 1999
----------- ----------- ------------ ------------ -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)................................. $(1,511,495) $(2,965,846) $ (5,787,945) $ (4,563,573) $ (15,232,887)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Effect on net loss of inclusion of Cygnus
September 1999 results of operation twice....... -- -- -- -- 981,314
Depreciation and amortization..................... 599,166 1,085,106 1,600,919 728,566 1,365,645
Amortization of deferred compensation............. 227,261 170,346 1,641,507
Tax benefit of stock options and warrants
exercised....................................... -- -- 163,831 -- --
Noncash management compensation expense........... -- -- 737,840 737,840 13,523
Provision for doubtful accounts................... 38,986 38,141 185,092 148,662 362,060
Provision for inventory obsolescence.............. -- -- 182,509 -- --
(Gain) loss on sale of property and equipment..... -- 116,063 46,058 -- --
Deferred revenue.................................. 1,735,705 2,731,660 (1,496,319) (2,085,583) 3,486,537
Changes in operating assets and liabilities:
Accounts receivable............................... (806,429) (2,302,497) (419,316) 633,163 (3,460,209)
Inventory......................................... (14,934) (84,507) (386,963) 22,045 (1,508,081)
Prepaid expenses.................................. (362,904) 53,402 18,801 (100,552) (718,162)
Other assets...................................... (442,201) 242,021 64,280 (421,832) (1,668,710)
Accounts payable.................................. 695,832 500,200 999,591 249,865 2,915,621
Royalties payable................................. 770,001 (785,649) (103,249) (49,682) 77,269
Accrued expenses.................................. (23,044) 526,848 865,620 1,798,982 2,431,551
----------- ----------- ------------ ------------ -------------
Net cash provided by (used in) operating
activities...................................... 678,683 (845,058) (3,101,990) (2,731,753) (9,313,022)
Cash flows from investing activities:
Purchase of investment securities................... (7,419,959) (150,000) (1,966,600) -- (154,220,661)
Proceeds from sales and maturity of investment
securities........................................ -- 5,769,921 1,065,526 965,526 71,750,316
Purchase of equipment............................... (1,336,769) (2,139,445) (1,986,887) (785,028) (4,737,292)
Proceeds from sale of equipment..................... -- 24,272 -- -- --
----------- ----------- ------------ ------------ -------------
Net cash provided by (used in) investing
activities.................................... (8,756,728) 3,504,748 (2,887,961) 180,498 (87,207,637)
----------- ----------- ------------ ------------ -------------
Cash flows from financing activities:
Proceeds from borrowing from stockholders........... 50,000 -- -- -- --
(Increase) decrease in stockholder receivable....... -- 13,850 14,978 (13,541) (95,223)
Repayments of borrowings from stockholders.......... -- (86,243) -- -- --
Issuance of restricted stock........................ 37,810 -- -- 28,520 --
Proceeds from notes payable......................... 1,096,048 239,214 2,416,667 2,416,667
Repurchase of restricted stock...................... (1,119)
Repayments of notes payable......................... (25,160) (279,019) (39,409) (933,028) (1,338,302)
Proceeds from issuance of mandatorily redeemable
preferred stock, net.............................. 6,252,000 1,983,209 10,084,854 6,889,263 3,180,628
Proceeds from issuance of preferred stock........... -- -- 6,760,594 -- 4,973,881
Proceeds from issuance of common stock.............. -- -- -- 88,466,929
Proceeds from exercise of stock options and
warrants.......................................... -- 95,055 541,731 193,207 3,361,750
Payments on capital lease obligations............... (34,708) (22,569) (55,998) (16,370) (155,986)
----------- ----------- ------------ ------------ -------------
Net cash provided by financing activities....... 7,375,990 1,943,497 19,723,417 8,564,718 98,392,558
----------- ----------- ------------ ------------ -------------
Effect of foreign currency exchange rates on cash
and cash equivalents.............................. -- -- -- -- 32,224
Net increase (decrease) in cash and cash
equivalents....................................... (702,055) 4,603,187 13,733,466 6,013,463 1,904,123
Cash and cash equivalents at beginning of period.... 1,850,988 1,148,933 5,752,120 5,752,120 19,485,586
----------- ----------- ------------ ------------ -------------
Cash and cash equivalents at end of period.......... $ 1,148,933 $ 5,752,120 $ 19,485,586 11,765,583 21,389,709
=========== =========== ============ ============ =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-29
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
BUSINESS ACTIVITY
Red Hat, Inc. and its subsidiaries ("Red Hat" or the "Company") is a leading
developer and global provider of open source software products and services, and
has built a comprehensive web site dedicated to the open source software
community. Red Hat, Inc. was incorporated in Connecticut in March 1993 as ACC
Corp., Inc. In September 1995 ACC Corp., Inc. changed its name to Red Hat
Software, Inc. In September 1998, Red Hat Software, Inc. reincorporated in
Delaware. In June 1999, Red Hat Software, Inc. changed its name to Red
Hat, Inc. On January 7, 2000, Red Hat acquired Cygnus Solutions, Inc. in a
transaction accounted for using the pooling of interests method of accounting
(See Note 3). All prior period financial statements of Red Hat have been
restated to reflect this combination as if it had occurred March 1, 1996.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
UNAUDITED INTERIM FINANCIAL STATEMENTS
The consolidated financial statements as of November 30, 1998 and 1999 and
for the nine month period then ended are unaudited and reflect all adjustments
(consisting of normal recurring adjustments) which are, in the opinion of the
Company's management, necessary for a fair presentation of financial position,
results of operations and cash flows. All financial statement disclosures
related to the nine month period ended November 30, 1998 and 1999 are unaudited.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers investments purchased with a maturity period of three
months or less at the date of purchase to be cash equivalents.
INVESTMENTS
The Company's investments at February 28, 1997, 1998 and 1999 were in debt
securities which were classified as held-to-maturity and are carried at
amortized cost in accordance with Statement of Financial Accounting Standards
No. 115 "Accounting for Certain Investments in Debt and Equity Securities ("SFAS
No. 115")", as the Company had both the positive intent and ability to hold them
to maturity.
During the nine month period ended November 30, 1999, all of the Company's
investments matured or were sold and reinvested in new securities. The Company's
investments at November 30, 1999 are in debt and equity securities. The Company
has classified these investments as available for sale and is carrying these
investments at market value in accordance with SFAS No. 115. The Company's
investments are considered as available for sale as these securities could
potentially be sold in response to needs for liquidity, changes in the
availability of
F-30
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
and the yield on alternative instruments or changes in funding sources or terms.
At November 30, 1999, the Company's investments are carried at fair value in
accordance with SFAS No. 115. The Company has an unrealized loss of $244,513
related to these investments at November 30, 1999 which is recorded as other
comprehensive income which is a separate component of stockholders' equity at
November 30, 1999.
INVENTORY
The costs incurred for duplicating the computer software, documentation, and
training materials from the product masters and for packaging the product for
distribution are capitalized as inventory using the weighted average method and
charged to cost of sales when revenue from the sale of units is recognized.
Management periodically evaluates the realizability of inventory based on
planned release dates of product updates and records a reserve for obsolescence
when necessary. The reserve for inventory obsolescence was $0 and $182,509 at
February 28, 1998 and 1999, respectively. The reserve for inventory obsolescence
was $0 at November 30, 1999.
CAPITALIZED SOFTWARE COSTS
Capitalization of software development costs begins upon the establishment
of technological feasibility and ceases when the product is available for
general release. The establishment of technological feasibility and the ongoing
assessment of recoverability of capitalized software development costs require
considerable judgment by management concerning certain external factors
including, but not limited to, technological feasibility, anticipated future
gross revenue, estimated economic life and changes in software and hardware
technologies. As a result of the Company's practice of releasing source code
that it has developed on a weekly basis for unrestricted download on the
internet, there is generally no passage of time between achievement of
technological feasibility and the availability of the Company's product for
general release. Therefore, the Company has no capitalized software development
costs at February 28, 1998, February 28, 1999 and November 30, 1999.
PROPERTY AND EQUIPMENT
Property and equipment is primarily comprised of furniture and computer
equipment which are recorded at cost and depreciated over their estimated useful
lives using the straight line method. Expenditures for maintenance and repairs
are charged to operations as incurred; major expenditures for renewals and
betterments are capitalized and depreciated. Property and equipment acquired
under capital leases are being depreciated over their estimated useful lives or
the respective lease term, if shorter. Depreciation periods used for property
and equipment are as follows:
<TABLE>
<S> <C>
Computer equipment.......................................... 3 years
Furniture and fixtures...................................... 7 years
Leasehold improvements...................................... 4 to 25 years
</TABLE>
F-31
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER ASSETS
Costs incurred for acquiring trademarks, copyrights and patents are
capitalized and amortized over their estimated useful lives, which range from 5
to 15 years, using the straight line method. Other assets also includes security
deposits which are expected to be refunded to the Company upon termination of
certain leases, deferred merger and acquisition costs, goodwill, a cost-basis
investment in another company accounted for using the cost method and the
long-term portion of the Company's prepaid directors' and officers' insurance
premiums. Deferred merger and acquisition costs will be expensed upon the
closing of the merger between Red Hat and Cygnus.
Goodwill is included in other assets at cost less accumulated amortization.
Goodwill is amortized over the estimated useful life which is three years.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates the recoverability of its property and equipment, and
other assets in accordance with Statement of Financial Accounting Standards
No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed of"
("SFAS 121"). SFAS 121 requires recognition of impairment of long-lived assets
in the event the net book value of such assets exceeds the estimated future
undiscounted cash flows attributable to such assets or the business to which
such intangible assets relate. No impairments were required to be recognized
during the years ended February 28, 1997, 1998 and 1999 or the nine months ended
November 30, 1999.
REVENUE RECOGNITION
Revenues from the sale of software products for which no technical support
is provided are generally recognized upon shipment of the products, net of
estimated returns. A reserve for sales returns is recognized for sales of
software products to distributors, who have a right of return, based on the
Company's historical experience of sell-through to the end user by the
distributor. The Company recognizes revenues from the sale of software products
to new distributors of its software products based upon sell-through to the end
user until the Company has sufficient historical experience with the distributor
to allow the accurate estimation of sales returns.
Upon the release of Version 6.0 of Official Red Hat Linux in May 1999, the
Company began providing certain telephone and e-mail technical support services
with Official Red Hat Linux and Red Hat Secure Web Server for a period of 90
days from the date of registration of the software products for no additional
fee. In June 1999, the Company also began to provide to purchasers of Official
Red Hat Linux and Red Hat Secure Web Server subscription services for a period
of six months from the date of registration of the software products. In October
1999, the Company released Version 6.1 of Red Hat Linux and included the Secure
Web Server product in the "professional" version of Version 6.1 of Official Red
Hat Linux. In accordance with the provisions of Statement of Opinion ("SOP")
No. 97-2, "Software Revenue Recognition" ("SOP 97-2") as amended by SOP
No. 98-4 and SOP No. 98-9, the Company is recognizing all of the revenue from
the sale of Versions 6.0 and 6.1 Official Red Hat Linux over the period that the
technical support and subscription services are provided as the Company does not
sell these technical support and subscription services separately and therefore
does not have vendor specific objective evidence of the fair value of these
services. These revenues are recognized ratably over the period that the
F-32
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
technical support and subscription services are provided in proportion to the
costs incurred to provide such technical support and subscription services as
compared to estimated total costs to be incurred. The Company currently does not
provide support and maintenance services as part of the fee for any of its
software products, other than Official Red Hat Linux.
Service revenues consist of revenue for technical support and maintenance
services, other than installation support and revenue for software compiling,
debugging and optimization contracts ("Development Contracts"). Revenue for
technical support and maintenance services, other than installation support, is
deferred and recognized ratably over the term of the agreement, which is
typically twelve months.
Revenues for custom development services are recognized on the percentage of
completion method provided that the fee for such engineering services is fixed
or determinable and the collection of the resulting receivable is probable.
Revenue from customer training and education and other services is
recognized at the date the services are performed.
Royalty revenue, which is included in services and other revenue, is
comprised primarily of royalties received from the sale of rights to the
Company's brand and trademark and royalties received from international
distributors of the Company's products. Royalty revenue is recognized when
received. Revenue from sale of books, which is include in software and related
products revenue, published by the Company, is recognized at the date of
shipment, net of estimated returns.
Web revenue related to advertising is recognized ratably in the period in
which the advertisement is displayed, provided that the Company has no
significant remaining obligations, at the lesser of the ratio of connections to
the advertiser's website delivered over total guaranteed connections to the
advertiser's website or the straight line basis over the term of the contract.
If minimum guaranteed connections are not met, the Company defers recognition of
the corresponding revenue until the guaranteed connections are achieved. The
Company did not generate revenue from the sale of advertising on its web site
during the fiscal years ended February 28, 1997, 1998 and 1999. The Company
began selling advertising space on its web site in the three months ended
May 31, 1999.
ROYALTY COSTS
Royalties that the Company is required to pay on applications licensed from
third parties that are a component of the software products sold by the Company
are expensed as cost of sales on a per unit basis as software products are sold.
Royalties paid in advance of the sale of the Company's software products are
included in prepaid expenses and recorded as expense when the related software
products are sold.
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
F-33
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 market value of the Company's common stock at the grant date,
the difference between the fair market 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. The Company recognized $170,346 and $1,641,507 in
non-cash compensation expense related to amortization of deferred compensation
during the nine months ended November 30, 1998 and 1999, respectively. The
Company has adopted the disclosure requirements of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), which requires compensation expense to be disclosed based on the
fair value of the options granted at the date of the grant.
SALES AND MARKETING EXPENSES
Sales and marketing expenses consist primarily of costs, including salaries
and sales commissions, of all personnel involved in the sales process and
related expenses. Sales and marketing expenses also include costs of advertising
and trade shows. All costs of advertising, including cooperative marketing
arrangements, the software products, books and related services offered by the
Company are expensed as incurred. Advertising expense totaled $113,964, $434,094
and $1,003,517 for the years ended February 28, 1997, 1998 and 1999,
respectively.
RESEARCH AND DEVELOPMENT COSTS
Research and development expenses include all direct costs, primarily
salaries for Company personnel and outside consultants, related to the
development of new products and significant enhancements to existing products
and are charged to operations as incurred until such time as technological
feasibility is achieved and ending when a product is available for general
release to customers. To date, such costs have been insignificant.
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.
FOREIGN CURRENCY TRANSLATION
The majority of the Company's international sales are currently denominated
in U.S. dollars. The U.S. dollar has been determined to be the functional
currency for the Company's European operations and local currencies have been
determined to be the functional currencies for the Company's Asian 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
statements of
F-34
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
operations. Foreign exchange gains and losses which result from the translation
of foreign currency financial statements into U.S. dollars where the local
currency is the functional currency is included as a separate component of
stockholders' equity.
SIGNIFICANT CUSTOMERS AND CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash investments
and trade receivables. The Company primarily places its temporary cash
investments with high-credit quality financial institutions which invest
primarily in U.S. Government instrumentalities, commercial paper of prime
quality and certificates of deposit guaranteed by banks which are members of the
FDIC. Cash deposits are primarily in financial institutions in the United
States, however, cash from monthly operating costs of international operations
are deposited in banks outside the United States. The Company performs ongoing
credit evaluations to reduce credit risk and requires no collateral from its
customers. Management estimates the allowance for uncollectible accounts based
on their historical experience and credit evaluation. Sales to one distributor
comprised $416,501 or 16%, $1,340,462 or 26% and $2,135,733 or 19% of software
and related product revenue for the years ended February 28, 1997, 1998 and
1999, respectively. Sales to one other distributor comprised $3,719,162 or 33%
of total revenues for the year ended February 28, 1999. In addition, the Company
generated services and other revenue from a single customer which comprised 12%,
13% and 16% of total revenue for the years ended February 28, 1997, 1998 and
1999, respectively. Receivables from one distributor and one other customer
comprised 14% and 10%, respectively, of net accounts receivable at February 28,
1999. Accounts receivable from one customer comprised 14% of net receivables at
February 28, 1998.
All of the Company's software revenues are from sales transactions
originating in the United States. The Company has received certain royalty
payments from international sources; however, such amounts have been
insignificant to date.
CASH FLOWS
The Company made cash payments for interest of $23,304, $22,941, and
$103,121 for the years ended February 28, 1997, 1998, and 1999, respectively.
The Company made cash payments for income taxes during the years ended
February 28, 1997 and 1998 and February 28, 1999 of $305,235, $3,117 and
$164,461 respectively.
The Company acquired property and equipment through the assumption of
capital lease obligations amounting to $102,935, $122,541 and $488,310 for the
years ended February 28, 1997, 1998, and 1999 respectively.
NET INCOME (LOSS) PER COMMON SHARE
HISTORICAL
The Company computes net income (loss) per common share in accordance with
Statement of Financial Accounting Standards No. 128, "Earnings Per Share,"
("SFAS 128") and SEC Staff Accounting Bulletin No. 98 ("SAB No. 98"). Under the
provisions of SFAS 128 and SAB No. 98, basic net income (loss) per common share
("Basic EPS") is computed by dividing net income
F-35
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(loss) available to common stockholders by the weighted average number of common
shares outstanding. Diluted net income (loss) available to common stockholders
per common share ("Diluted EPS") is computed by dividing net income (loss) by
the weighted average number of common shares and dilutive potential common share
equivalents then outstanding. Potential common shares consist of shares issuable
upon the exercise of stock options and warrants and shares issuable upon
conversion of outstanding mandatorily redeemable preferred stock.
PRO FORMA (UNAUDITED)
Pro forma net income (loss) per common share is calculated assuming
conversion of all mandatorily redeemable preferred stock which converted
automatically upon the effectiveness of the Company's initial public offering on
August 11, 1999 into 67,890,904 shares of common stock (see Note 11) at
February 28, 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 fiscal year ended
February 28, 1998. Required segment disclosures are presented below:
The Company has international sales offices in the United Kingdom, Ireland,
Germany, Switzerland and Japan. The following disclosure aggregates individually
immaterial international operations and separately discloses the significant
international operations at and for the year ended February 28, 1999.
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28, 1999
-------------------------------------------------------------------
UNITED UNITED OTHER
STATES KINGDOM IRELAND INTERNATIONAL TOTAL
----------- --------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Revenues from
external
customers.......... $19,885,561 $334,579 $10,592,689 $2,218,853 $33,031,682
Net Income (Loss).... $(6,474,777) $134,523 $ (471,207) $ 984,360 $(5,827,301)
Total Assets......... $31,769,839 $287,879 $ 106,726 $ 566,779 $37,731,223
</TABLE>
INTERNAL USE SOFTWARE
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 March 1, 1999. The adoption of SOP No. 98-1 did
not have a material impact on the Company's financial position or results of
operations.
F-36
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. SFAS 130 is effective for
financial statements for fiscal years beginning after December 15, 1997. Its
adoption did not impact the Company's financial position, results of operations,
or cash flows as the Company had no items of other comprehensive income during
the three year period ended February 28, 1999. The Company's only item of other
comprehensive income during nine months ended November 30, 1999 is an unrealized
loss on investments in marketable securities of $244,503.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"). SFAS 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. SFAS 133 as amended by SFAS 137, is effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000, with earlier
application encouraged. The Company does not currently nor does it intend in the
future to use derivative instruments and therefore does not expect that the
adoption of SFAS 133 will have any impact on its financial position or results
of operations.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AICPA"), issued Statement of
Position No. 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP No. 98-1"), which provides guidance regarding
when software developed or obtained for internal use should be capitalized. SOP
No. 98-1 is effective for fiscal years beginning after December 15, 1998. The
adoption of SOP No. 98-1 in the three months ended May 31, 1999, did not have a
material impact on its financial position or results of operations.
3. BUSINESS COMBINATION
In January 2000, Red Hat completed a merger with Cygnus Solutions, Inc.
("Cygnus") by exchanging 10,867,966 shares of its common stock for all of the
outstanding common and preferred stock of Cygnus. In addition, approximately
1,574,168 outstanding Cygnus employee stock options were converted at the same
exchange factor into options to purchase approximately 2,380,722 shares of Red
Hat's common stock.
The merger constituted a tax-free reorganization and has been accounted for
using the pooling of interests method of accounting under Accounting Principles
Board Opinion No. 16. Accordingly, all prior period financial statements have
been restated to include the results of operations, financial position and cash
flows of Cygnus as though it had always been a part of Red Hat.
Prior to the merger, Cygnus' fiscal year ended on June 30. In recording the
business combination, Cygnus' prior period financial statements have been
restated to a year ended March 31, to be within a 90-day period of Red Hat's
fiscal year end. In order to fully conform Cygnus'
F-37
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. BUSINESS COMBINATION (CONTINUED)
period end with the fiscal quarter end of Red Hat, in preparing the results of
operations for Cygnus for the nine month period ended November 30, 1999, the
results of operations of Cygnus for the month of September 1999, have been
included twice. Cygnus' net loss for the month of September 1999 was $981,314. A
credit to accumulated deficit has been recorded to remove the effect of
including the net loss of Cygnus for the month of September 1999, in the results
of operations of the Company more than once.
The results of operations for the separate companies and the combined
amounts presented in the consolidated financial statements are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED FEBRUARY 28, NINE MONTHS
--------------------------------------------- ENDED
1997 1998 1999 NOVEMBER 30, 1999
----------- ----------- ----------- -----------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Total revenue
Red Hat.................... $ 2,603,131 $ 5,155,623 $10,789,919 $ 12,595,681
Cygnus..................... 12,525,856 17,487,827 22,241,763 17,015,850
----------- ----------- ----------- ------------
Combined................... $15,128,987 $22,643,450 $33,031,682 $ 29,611,531
=========== =========== =========== ============
Net income (loss) available
to common stockholders
Red Hat.................... $ 32,611 $ 7,733 $ (130,424) $ (8,858,926)
Cygnus..................... (1,544,457) (2,973,619) (5,696,877) (6,408,857)
----------- ----------- ----------- ------------
Combined................... $(1,511,846) $(2,965,846) $(5,827,301) $(15,267,783)
=========== =========== =========== ============
</TABLE>
Immaterial adjustments were made to conform Red Hat and Cygnus' accounting
policies. Certain reclassifications were made to Cygnus' financial statements to
conform to Red Hat's presentation.
In connection with the merger, the Company will record a charge of
approximately $10.0 million to operating expenses for costs incurred related to
the merger at the date of the merger is completed. Merger costs totaling
$230,995 are deferred and included in prepaids and other assets in the
accompanying consolidated balance sheet at November 30, 1999 until the merger is
completed. These merger costs consist primarily of $6,000,000 in investment
banking fees and costs of attorneys, accountants, and other directly related
costs.
F-38
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ACCOUNTS RECEIVABLE
Accounts receivable, which are primarily from product sales, are presented
net of an allowance for doubtful accounts. The activity in the Company's
allowance for doubtful accounts for the years ended February 28, 1997, 1998 and
1999 is presented in the following table:
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING INCOME OR END OF
YEAR ENDED FEBRUARY 28, OF PERIOD EXPENSE DEDUCTIONS (A) PERIOD
- ----------------------- ---------- ---------- -------------- ----------
<S> <C> <C> <C> <C>
1997................................. $207,000 $ 39,455 $ (1,304) $245,151
1998................................. $245,151 $ 38,141 $(152,904) $130,388
1999................................. $130,388 $185,092 $ (61,999) $253,481
</TABLE>
The Company's allowance for doubtful accounts at November 30, 1999 is $377,245.
Bad debt expense for the nine months ended November 30, 1999 was $362,060.
- ------------------------
(a) Represents amounts written-off as uncollectible accounts receivable.
5. PROPERTY AND EQUIPMENT
The Company's property and equipment consisted of the following:
<TABLE>
<CAPTION>
FEBRUARY 28, NOVEMBER 30,
------------------------- ------------
1998 1999 1999
----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Computer equipment................ $ 4,169,343 $ 4,847,833 $9,376,163
Furniture and fixtures............ 666,933 1,388,118 1,616,664
Leasehold improvements............ -- 214,868 412,813
Software.......................... 220,293 540,125 594,401
----------- ----------- ----------
5,056,569 6,990,944 12,000,041
Less: accumulated depreciation.... (2,086,714) (3,069,146) (4,359,144)
----------- ----------- ----------
$ 2,969,855 $ 3,921,798 $7,640,897
=========== =========== ==========
</TABLE>
F-39
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. OTHER ASSETS
Other assets were comprised of the following:
<TABLE>
<CAPTION>
FEBRUARY 28, NOVEMBER 30,
------------------- ------------
<S> <C> <C> <C>
1998 1999 1999
-------- -------- ----------
(UNAUDITED)
Security deposits...................... $ 11,900 $ 78,130 $ 92,442
Trademarks, patents and copyrights,
net.................................. 69,288 73,180 121,745
Deferred merger and acquisition
costs................................ -- -- 230,995
Goodwill............................... 189,160 81,069 437,863
Prepaid directors' and officers'
insurance............................ -- -- 419,972
Cost basis investment.................. -- -- 500,000
Other.................................. 31,667 -- 20,772
-------- -------- ----------
$302,015 $232,379 $1,823,789
======== ======== ==========
</TABLE>
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, accounts payable and
accounts receivable at February 28, 1998 and 1999 approximated their fair value
due to the short-term nature of these items.
The fair value of the Company's short-term and long-term investments at
February 28, 1998 and 1999 approximated their carrying values as these
investments were primarily in short-term U.S. Government obligations.
The fair value of the Company's short-term and long-term investments at
November 30, 1999, differed from their historical cost by $244,503. Following is
a summary of the historical cost, unrealized gain (loss) and fair values of the
Company's investments at December 30, 1999:
<TABLE>
<CAPTION>
UNREALIZED GAIN
COST (LOSS) FAIR VALUE
----------------- ----------------- -----------------
<S> <C> <C> <C>
Short-term........... $ 7,630,705 $ -- $ 7,630,705
76,877,622 (244,503) 76,633,119
----------- --------- -----------
$84,508,327 $(244,503) $84,263,824
=========== ========= ===========
</TABLE>
F-40
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. ACCRUED EXPENSES
Accrued expenses were comprised of the following:
<TABLE>
<CAPTION>
FEBRUARY 28, NOVEMBER 30,
----------------------- ------------
1998 1999 1999
---------- ---------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Payroll............................ $ 977,929 $1,220,403 $ 874,033
Vacation........................... 330,501 563,197 870,595
Commissions........................ 225,643 160,926 55,422
Trade.............................. 151,314 232,304 1,792,909
Taxes.............................. 357,753 255,824 976,698
Other.............................. 300,320 776,426 1,070,974
---------- ---------- ----------
$2,343,460 $3,209,080 $5,640,631
========== ========== ==========
</TABLE>
9. 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
(8.26% at February 28, 1999) plus 0.5%. At February 28, 1999 and November 30,
1999, the Company had no borrowings under the line of credit.
Additionally, the Agreement provided for equipment advances of $1,500,000
through January 17, 1999. During the year ended February 28, 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 February 28, 1999, the outstanding
obligation was approximately $1,417,000. Borrowings on the facility are due as
follows (IN THOUSANDS):
<TABLE>
<S> <C>
YEAR ENDING FEBRUARY 28,
2000................................................. $ 500
2001................................................. 500
2002................................................. 417
------
$1,417
======
</TABLE>
At November 30, 1999, the outstanding obligation on this facility was
$1,083,339.
F-41
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES
The components of the Company's provision for income taxes consisted of the
following:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED FEBRUARY 28, NOVEMBER 30,
--------------------------------- ---------------------
1997 1998 1999 1998 1999
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Current tax provision:
Federal.................. $ 20,594 $(34,500) $149,284 $149,284 $ --
State.................... 2,000 (1,950) 69,820 68,715 --
Foreign.................. 28,500 251,798 503,112 377,335 240,981
-------- -------- -------- -------- --------
Current tax expense...... 51,094 215,348 722,216 595,334 240,981
-------- -------- -------- -------- --------
Deferred tax provision:
Federal.................. 115,500 -- -- -- --
State.................... 24,500 -- -- -- --
-------- -------- -------- -------- --------
Deferred tax benefit..... 140,000 -- -- -- --
-------- -------- -------- -------- --------
Net provision for income
taxes.................... $191,094 $215,348 $722,216 $595,334 $240,981
======== ======== ======== ======== ========
</TABLE>
The provision for income taxes in all periods primarily relates to foreign
withholding taxes on foreign revenues earned by a U.S. Company. These
withholding taxes paid may be creditable against U.S. federal income taxes in
future periods.
F-42
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
at February 28, 1999, February 28, 1998 and November 30, 1999, consisted of the
following:
<TABLE>
<CAPTION>
FEBRUARY 28,
------------------------- NOVEMBER 30,
1998 1999 1999
----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Deferred Tax Assets:
Domestic net operating loss
carryforwards..................... $ 746,988 $ 2,906,601 7,688,907
Foreign net operating loss
carryforwards..................... -- -- 611,666
Accounts receivable................. 70,620 284,957 151,482
Allowance for inventory
obsolescence...................... -- 70,785 --
Other accruals and liabilities...... 431,574 92,090 538,571
Property and equipment.............. -- 146,048 142,880
Intangibles......................... 742,398 673,125 660,120
Research and development credit..... 553,154 809,258 1,120,400
Foreign tax credit.................. 322,730 885,730 886,302
Compensation-related accruals....... 86,399 98,582 926,334
----------- ----------- ------------
Total deferred tax assets......... 2,953,863 5,967,176 12,726,662
Valuation allowance for deferred tax
assets............................ (2,709,945) (5,967,176) (12,726,662)
----------- ----------- ------------
Deferred Tax Liabilities:
Deferred tax assets............... 243,918 -- --
----------- ----------- ------------
Property and equipment.............. (243,918) -- --
----------- ----------- ------------
Total deferred tax liabilities.... (243,918) -- --
----------- ----------- ------------
Net deferred taxes................ $ -- $ -- $ --
=========== =========== ============
</TABLE>
As of February 28, 1998 and 1999, and November 30, 1999 the Company provided
a full valuation allowance against its net deferred tax assets since realization
of these benefits can not be reasonably assured. An increase in the valuation
allowance was recorded during fiscal 1999 and the nine months ended
November 30, 1999 to reserve the increase in total deferred tax assets at
February 28, 1999 and November 30, 1999 due to uncertainty of realizability.
As of November 30, 1999, the Company had Federal and state net operating
loss carryforwards of approximately $19,112,000 and 12,222,000 respectively.
These net operating loss carryforwards expire in varying amounts beginning in
2011 and 2001 for Federal and state income tax purposes, respectively. The
utilization of the Federal net operating loss carryforwards 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 utilization, the Company would incur a
Federal income tax liability even though its net operating loss carryforwards
exceed its taxable income.
F-43
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
Additionally, the Company had net operating loss carryforwards for taxes
purposes in various jurisdictions outside the United States amounting to
approximately $1,485,000. The majority of the foreign loss carryforwards will
never expire under local country tax rules. 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.
Taxes computed at the statutory federal income tax rate of 34% are
reconciled to the provision for income taxes as follows:
<TABLE>
<CAPTION>
1997 1998 1999
--------- ----------- ----------
<S> <C> <C> <C>
Effective rate......................................... (14.5)% (7.9)% (14.3)%
--------- ----------- ----------
United States Federal tax at statutory rate............ $(448,936) $ (935,169) (1,722,348)
State taxes (net of Federal benefit)................... (127,920) (81,845) (440,355)
Foreign taxes.......................................... 28,500 250,798 422,680
Charge in valuation reserves........................... 897,084 1,812,861 3,257,231
Research and development credit........................ -- (553,154) (256,104)
Foreign tax credit..................................... -- (322,730) (563,000)
Refund due to credits.................................. (169,106) -- --
Nondeductible items.................................... 11,472 44,587 24,112
--------- ----------- ----------
Provision for income taxes............................. $ 191,094 $ 215,348 $ 722,216
========= =========== ==========
</TABLE>
11. MANDATORILY REDEEMABLE PREFERRED STOCK
At November 30, 1999, the Company has authorized 5,000,000 shares of
preferred stock with a par value of $0.0001 per share. The Company has no
outstanding shares of preferred stock at November 30, 1999.
At February 28,1999, the Company had authorized 6,801,400, 8,116,550 and
2,054,776 shares of Series A, Series B and Series C mandatorily redeemable
preferred stock, respectively. The shares of Series A, Series B and Series C
mandatorily redeemable preferred stock have a par value of $0.0001 per share.
On August 15, 1997, the Company entered into a purchase agreement with an
investor (the "Series A Investor"). In connection with this agreement, the
Company issued 6,801,400 shares of Series A preferred stock to the Series A
Investor for $2,000,000 or $0.2941 per share, less related issuance costs of
$16,791. The Series A preferred stock became mandatorily redeemable with the
issuance of the Series B mandatorily preferred stock in September 1998.
On September 29, 1998, the Company entered into a purchase agreement with
several investors (the "Series B Investors"). In connection with this agreement,
the Company issued 8,116,550 shares of Series B mandatorily redeemable preferred
stock to the Series B Investors for $6,955,884, or $0.857 per share, less
related issuance costs of $66,621.
On February 25, 1999, the Company entered into a purchase agreement with
several investors (the "Series C Investors"). In connection with this agreement,
the Company issued 1,027,388
F-44
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. MANDATORILY REDEEMABLE PREFERRED STOCK (CONTINUED)
shares of Series C mandatorily redeemable preferred stock to the Series C
Investors for $3,227,026, or $3.141 per share.
The Company had additional closings of the Series C mandatorily redeemable
preferred stock financing subsequent to February 28, 1999. Additional Series C
Investors purchased 1,027,388 shares of Series C mandatorily redeemable
preferred stock for $3,227,026, or $3.141 per share in March and April of 1999.
Total issuance costs related to sales of Series C mandatorily redeemable
preferred stock were $62,870.
CONVERSION
Each share of Series A, Series B and Series C mandatorily redeemable
preferred stock can be converted to common stock at the option of the Holders at
a two-to-one conversion rate, after certain adjustments. This conversion rate
could be adjusted upon the issuance by the Company of additional common shares
(with certain exceptions) for consideration per share less than $0.343 per
share, in the case of Series A mandatorily redeemable preferred stock, $0.996
per share, in the case of Series B mandatorily redeemable preferred stock and
$3.893 per share, in the case of Series C mandatorily redeemable preferred
stock. The conversion rate shall also be adjusted for common stock splits,
reverse common stock splits, dividends and distributions.
All outstanding shares of Series A, Series B and Series C mandatorily
redeemable preferred stock automatically converted into 67,890,904 shares of
common stock, at the then effective conversion rate, upon the closing of a sale
of the common stock of the Company in a qualified public offering.
REDEMPTION
The Company could be required to redeem the Series A, Series B and Series C
mandatorily redeemable preferred stock from the Holders upon receipt of written
request from Holders of shares representing at least 66 2/3% of the aggregate
number of shares of common stock issuable upon conversion. Redemption may first
be made by the Holders on February 25, 2004 and on each of the first and second
anniversaries thereof. Redemption is limited to 33% and 50% of the Series A,
Series B and Series C shares outstanding on February 25, 2004 and the first
anniversary thereof, respectively. There is no limitation on the number of
shares on February 25, 2006. The redemption price is equal to $0.343 per share
in the case of Series A, $0.996 per share, in the case of Series B and $3.893
per share, in the case of Series C, after adjustment for certain events. The
carrying value of the Company's mandatorily redeemable preferred stock is being
accreted to its redemption price over the redemption period using the effective
interest rate method. In conjunction with the sale of the Series B mandatorily
redeemable preferred stock in September 1998, the Series A mandatorily
redeemable preferred stock became mandatorily redeemable.
CARRYING VALUE
The Series A, Series B and Series C mandatorily redeemable preferred stock
were initially recorded at the total net proceeds received by the Company upon
issuance. The difference between the total net proceeds at issuance of
$12,068,063 and the total redemption price of $14,416,585 is charged to
accumulated deficit over the period from issuance until redemption first
F-45
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. MANDATORILY REDEEMABLE PREFERRED STOCK (CONTINUED)
becomes available. The amount of accretion recognized during each period is
determined by using the effective interest rate method. For the year ended
February 28, 1999 the accretion was $39,356. The Company had no outstanding
mandatorily redeemable preferred stock prior to the fiscal year ended
February 28, 1999. The Company sold an additional 1,027,388 shares of Series C
preferred stock for net proceeds of $3,164,156 in March and April 1999 with a
redemption value of $4,004,758. Accretion on preferred stock was $43,080 for the
three months ended May 31, 1999.
CYGNUS SERIES B MANDATORILY REDEEMABLE PREFERRED STOCK
Cygnus had authorized 1,042,000 shares of Series B mandatorily redeemable
preferred stock at February 28, 1998, February 28, 1999 and November 30, 1999.
On January 27, 1997, Cygnus entered into a purchase agreement with several
investors (the "Cygnus Series B Investors"). In connection with this agreement,
the Company issued 1,042,000 shares of Series B preferred stock for $6,252,000
or $6.00 per share.
The holders of the Cygnus Series B preferred stock could require Cygnus to
redeem, at any time after January 1, 2004, in two equal annual installments, the
holders' outstanding Series B preferred stock at a redemption price of $6 per
share or a total of $6,252,000.
The Cygnus Series B preferred stock was convertible at the option of the
holder into the number of shares of common stock of Cygnus as is determined by
dividing $6 by the conversion price in effect at the date of conversion. The
Cygnus Series B preferred stock converted into 1,638,520 shares of Red Hat stock
on January 7, 2000, the closing date of the merger with Red Hat.
12. COMMON AND PREFERRED STOCK
COMMON STOCK
On September 28, 1998, the Company effected a 100 for 1 stock split for
holders of its common stock. Amounts presented for the periods prior to the
stock split have been restated to reflect the stock split on a retroactive
basis.
The Company has authorized 125,000,000 shares of common stock with a par
value of $0.0001 per share. Holders of these shares have one vote per share.
Upon the dissolution, liquidation or winding up of the Company, holders of
common stock will be entitled to receive the assets of the Company after
satisfaction of the preferential rights of the outstanding Series A, Series B
and Series C mandatorily redeemable preferred stock or any other outstanding
stock ranking on liquidation senior to or on parity with the common stock.
On September 29, 1998, in connection with the above mentioned sale of
Series B mandatorily redeemable preferred stock, certain stockholders, primarily
comprised of officers of the Company, entered into a common stock purchase
agreement with the Series B Investors. In connection with this agreement, those
stockholders sold 5,251,000 shares of common stock to the Series B Investors for
$1,125,000 or $0.215 per share.
On February 25, 1999, in connection with the above mentioned sale of
Series C mandatorily redeemable preferred stock, certain stockholders, primarily
comprised of officers of the Company, entered into a common stock purchase
agreement with the Series C Investors. In connection with
F-46
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. COMMON AND PREFERRED STOCK (CONTINUED)
this agreement, those stockholders sold 984,368 shares of common stock to the
Series C Investors for $772,975 or $0.786 per share. Upon additional closings of
the Series C mandatorily redeemable preferred stock financing in March and April
of 1999, an additional 984,368 shares of common stock were sold by certain
stockholders, primarily comprised of officers of the Company, to the additional
Series C Investors for $772,975 or $0.786 per share.
On August 16, 1999, the Company closed its initial public offering of
13,800,000 shares of its common stock at a price of $7.00 per share. The Company
received proceeds from this offering of $88,466,929 net of $8,133,107 in
offering costs.
CYGNUS PREFERRED STOCK
Cygnus had authorized 7,798,180 shares of Series A preferred stock at
February 28, 1998, February 28, 1999 and November 30, 1999. On January 15, 1997,
Cygnus converted 5,882,633 outstanding shares of common stock to Series A
preferred stock. In addition, 914,493 Series A preferred shares were issued from
exercise of options by employees to purchase Cygnus Series A preferred stock.
The Cygnus Series A preferred stock was convertible, at the option of the
holder, into the number of common shares of Cygnus common stock determined by
dividing $3.11 by the conversion price in effect at the date of conversion. All
outstanding Cygnus Series A preferred stock was converted into 6,318,219 shares
of Red Hat common stock on January 7, 2000, the closing date of the merger
between Red Hat and Cygnus.
Cygnus had authorized 1,572,476 shares of Series C preferred stock at
February 28, 1999 and November 30, 1999. In March and June 1999, Cygnus entered
into purchase agreements with several investors, whereby, 1,233,715 shares of
Cygnus Series C preferred stock were sold for $9.50 per share, or net proceeds
of $11,734,476.
The Cygnus Series C preferred stock was convertible into Cygnus common
stock, at the option of the holder, into the number of common shares determined
by dividing $9.50 by the conversion price in effect at the date of conversion.
All outstanding Cygnus Series C preferred stock was converted into 1,233,715
shares of Red Hat common stock on January 7, 2000.
13. STOCK OPTIONS AND WARRANTS
STOCK OPTIONS
During September 1998, the Company's Board of Directors approved a stock
option plan. As of February 28, 1999, 14,929,600 shares of common stock were
reserved for issuance upon exercise of options granted to any employee, officer
or director or consultant of the Company at terms and prices to be determined by
the Board of Directors. In June 1999, the option pool was increased to
18,929,600 shares. The plan provides that the exercise price per share and the
purchase price per share for each non-qualified option should be set by the
Board on the date of grant. The price for each Incentive Stock Option (ISO)
shall not be less than the fair market value of the common stock on the date of
grant. The maximum term for an option granted is ten years from the date of
grant. The Company believes that all options and warrants, granted through
February 28, 1999, have been granted at their fair values on their respective
grant dates. Options
F-47
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTIONS AND WARRANTS (CONTINUED)
granted under the plan generally vest 25% upon completion of one full year of
service and 6.25% on the first day of each subsequent three-month period. All
options are immediately exercisable upon grant into restricted shares of the
Company's common stock with the same vesting provisions as the original option.
The Company, at its option, may repurchase these restricted shares at the
original purchase price under certain circumstances.
CYGNUS STOCK OPTION PLANS
In March 1997, Cygnus's Board of Directors adopted the 1997 Cygnus Stock
Plan. At the time of adoption, all of the remaining shares available under the
1995 Cygnus Stock Plan were rolled into the 1997 Cygnus Stock Plan and 959,210
shares of common stock were reserved for issuance under the 1997 Cygnus Stock
Plan. The provisions of the 1997 Cygnus Stock Plan provided 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 1997 Cygnus Stock Plan was required to be at least 100% and
85%, respectively, of the fair market value of the shares on the date of grant.
Options issued under the Cygnus 1997 Stock Plan generally expired ten years from
the date of the grant or such shorter term as may be provided in the option
agreement. Options granted under the 1997 Cygnus Stock 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 1997 Cygnus Stock Plan provides
that the Administrator of the 1997 Cygnus Stock Plan shall advise the offeree in
writing of the terms, conditions and restrictions related to the offer.
Restricted stock purchases generally vest 25% after the first year and 1/48th
each month thereafter. Unvested shares are subject to repurchase upon
termination of employment.
In May 1998, Cygnus's Board of Directors adopted the 1998 Cygnus Executive
Stock Plan (the 1998 Plan) and 959,025 shares of common stock were reserved for
issuance under the 1998 plan. Also in May 1998 Cygnus granted rights to purchase
959,025 shares of common stock to the Chief Executive Officer of Cygnus. The
exercise price of the shares was $2.86. The Company has the right to repurchase
738,878 shares of common stock at $2.86, 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 Cygnus. Subject to other
conditions, 220,147 shares are subject to repurchase by Cygnus at a repurchase
price of $2.86. In January 1999, Cygnus authorized an additional 613,451 shares
for issuance under this plan, for a total of 1,572,476 shares.
F-48
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTIONS AND WARRANTS (CONTINUED)
The activity for the stock option plans for the year ended February 28, 1999
and for the period from March 1, 1999 to November 30, 1999 is presented in the
following table and includes common stock options of Red Hat and both common and
preferred stock options of Cygnus.
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVERAGE
UNDERLYING EXERCISE PRICE
OPTIONS PER SHARE
----------- --------------
<S> <C> <C>
Outstanding at February 28, 1998............................ 2,156,560 $0.95
Granted..................................................... 11,442,215 0.84
Exercised................................................... (1,365,019) 2.41
Forfeited................................................... (702,267) 2.06
----------- -----
Outstanding at February 28, 1999............................ 11,531,488 0.60
Granted (unaudited)......................................... 10,756,433 3.81
Exercised (unaudited)....................................... (6,900,337) 0.50
Forfeited (unaudited)....................................... (448,257) 1.59
----------- -----
Outstanding at November 30, 1999 (unaudited)................ 14,939,328 $2.92
=========== =====
</TABLE>
Options outstanding at November 30, 1999 include 342,320 options to purchase
Cygnus' Series preferred stock. These preferred stock options converted into
options to purchase Red Hat's common stock on the closing of the merger between
Red Hat and Cygnus (see Note 3).
The Company recorded deferred compensation of $8,886,509 during the nine
months ended November 30, 1999 to reflect the difference between the aggregate
fair value and exercise price during this period of all stock options granted
with an exercise price below the fair value of the Company's common stock at the
date of the grant. Amortization of deferred compensation totaled $737,840 and
$1,023,026 during the year ended February 28, 1999 and the nine months ended
November 30, 1999, respectively.
The following summarizes information about the Company's stock options at
February 28, 1999:
FEBRUARY 28, 1999
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTURAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ----------- ----------- ------------ -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 0.09 2,400,000 9.58 $0.09 2,400,000 $0.09
$ 0.15 510,487 6.20 $0.15 145,291 $0.15
$ 0.22 6,205,140 9.67 $0.22 6,205,140 $0.22
$ 0.64 204,502 7.25 $0.64 54,118 $0.64
$0.95-$1.27 460,114 8.09 $1.04 234,117 $1.02
$1.75-$2.07 349,739 8.64 $1.79 90,989 $1.78
$ 2.86 1,401,506 9.69 $2.86 139,317 $2.86
</TABLE>
F-49
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTIONS AND WARRANTS (CONTINUED)
STOCK WARRANTS
On October 10, 1995, the Company issued warrants (which are equivalent to
nonqualified stock options) to purchase 7,480,800 shares of common stock to
three of its employees with an exercise price of $0.0001 per share. The warrants
vest 25% annually on each May 1, beginning May 1, 1996 and ending May 1, 1999.
The warrants terminate upon death, permanent disability, termination of
employment or May 1, 2006. The Company and certain founding shareholders have a
right of first refusal to purchase the warrant shares on the same terms as a
proposed purchaser and a right to purchase the shares upon the death,
disability, or termination of employment of the employee. Upon the death,
disability, or termination without cause of the employee, the purchase price
shall be 80% of the fair market value of the Company's common stock as
determined by the board of directors. If the employee is terminated for cause,
the purchase price shall be 80% of the lesser of the book value or the fair
market value of the Company's common stock.
The activity for the stock warrants is presented in the following table:
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
------------------------------------------------------------------------
1997 1998 1999
---------------------- ---------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE
UNDERLYING PRICE UNDERLYING PRICE UNDERLYING PRICE
WARRANTS PER SHARE WARRANTS PER SHARE WARRANTS PER SHARE
---------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year................ 7,480,800 $.00005 7,480,800 $.00005 7,480,800 $.00005
--------- ------- --------- ------- --------- -------
Exercised................ -- -- -- -- (705,900) $.00005
Outstanding at end of
year................... 7,480,800 $.00005 7,480,800 $.00005 6,774,900 $.00005
Exercisable at end of
year................... 1,870,200 $.00005 3,740,400 $.00005 4,908,700 $.00005
</TABLE>
During the nine month period ended November 30, 1999, warrants to purchase
1,960,000 shares were exercised. At May 31, 1999, warrants to purchase 4,814,900
shares remained outstanding. Amounts as of November 30, 1999 are unaudited.
SFAS 123 requires the Company to disclose pro forma information regarding
option grants made and warrants issued to its employees. SFAS 123 specifies
certain valuation techniques that produce estimated compensation charges that
are included in the pro forma results below. These amounts have not been
reflected in the Company's statement of operations, because APB No. 25 specifies
that no compensation charge arises when the exercise price of employees' stock
options and warrants equal the market value of the underlying stock at the grant
date, as in the case of options and warrants granted to the Company's employees.
The fair value of options and warrants
F-50
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTIONS AND WARRANTS (CONTINUED)
was estimated using the following assumptions for the year ended February 28,
1999 and the nine months ended November 30, 1999:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
FEBRUARY 28, 1999 NOVEMBER 30, 1999
------------------ ------------------
EMPLOYEE EMPLOYEE
STOCK STOCK
OPTIONS OPTIONS
------------------ ------------------
(UNAUDITED)
<S> <C> <C>
Expected dividend yield............ 0.00% 0.00%
Risk-free interest rate............ 4.98% 5.01%
Expected volatility................ 0.00% 134.41%
Expected life (in years)........... 6 5
</TABLE>
SFAS 123 pro forma numbers are as follows:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
FEBRUARY 28, NOVEMBER 30,
1999 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
Net loss available to common stockholders as
reported
under APB No. 25............................ $5,827,301 $15,315,360
Pro forma net loss available to common
stockholders................................ $6,565,864 $19,016,808
</TABLE>
The weighted average estimated fair value of employee stock options granted
during the year ended February 28, 1999 was $0.41 per share and was $16.14
during the nine months ended November 30, 1999. The weighted average estimated
fair value of the warrants at the time of grant was $0.0001 per share.
14. STOCK SPLIT
On August 11, 1999, the Company effected a two-for-one stock split
immediately prior to the effectiveness of the Company's initial public offering.
All share and per share information have been restated to reflect the effects of
this stock split.
On January 7, 2000, the Company effected a two-for-one stock split. All
share and per share information has been restated to reflect the effects of this
stock split.
F-51
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. COMMITMENTS AND CONTINGENCIES
As of February 28, 1999, the Company leased office space and certain
equipment under various noncancelable operating and capital leases. Future
minimum lease payments required under the operating and capital leases at
February 28, 1999 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
---------- --------
<S> <C> <C>
2000................................................. $1,794,633 $176,833
2001................................................. 1,618,642 173,313
2002................................................. 1,394,975 151,072
2003................................................. 982,742 113,729
Thereafter........................................... 899,291 99,687
---------- --------
Total minimum lease payments....................... $6,690,283 714,634
==========
Less amount representing interest (at rates ranging
from 8.2% to 9.6%)................................. (92,726)
--------
Present value of net minimum lease payments.......... 621,908
Less current portion................................. (139,112)
--------
Long-term portion.................................. $482,796
========
</TABLE>
Rent expense under operating leases for the years ended February 28, 1997,
1998 and 1999 was $642,313, $1,018,191 and $1,205,973 respectively.
The Company has entered into an agreement with a bank to provide a letter of
credit pertaining to its building lease. The Company is required by the bank to
maintain a compensating balance of $65,000 which is equal to the amount of the
letter of credit. This amount is included in cash and cash equivalents.
The Company has executed licensing contracts to publish, bundle and
distribute software products developed by other companies in return for royalty
payments based on a percentage of the revenues generated by the Company from the
sale of these products. Prepaid royalty payments are included in current assets
and royalty payments due are included in royalties payable.
In April 1999, the Company also contracted with a web support firm to
maintain its backup web site. The initial fee of $98,000 was due upon receipt
and installation of the hardware. The Company has agreed to pay a monthly
maintenance fee of $17,000 for a period of 36 months.
16. EMPLOYEE BENEFIT PLAN
The Company provides a retirement plan qualified under Section 401(k) of the
Internal Revenue Code ("IRC") of 1986, as amended. Participants may elect to
contribute a portion of their annual compensation to the plan, after complying
with certain limitations set by the IRC. Employees are eligible to participate
in the plan who are over 21 years of age and have completed three months of
service with Red Hat. If, however, an employee was employed by the Company prior
to February 1999, the 401(k) Plan covers such employee regardless of age or
length of service. The Company has the option to make contributions to the plan
but did not make any contributions to the plan for the years ended February 28,
1997, 1998 and 1999.
F-52
<PAGE>
RED HAT, INC.
NOTES TO SUPPLEMENTAL POOLED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. ACQUISITIONS (UNAUDITED)
In January 2000, the Company completed the acquisition of all of the
outstanding common stock of Hells Kitchen Systems, Inc. ("HKS") in exchange for
the issuance of 769,670 shares of the Company's common stock to the shareholders
of HKS. The acquisition of HKS will be accounted for using the purchase method
of accounting in accordance with APB No. 16.
F-53
<PAGE>
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
F-54
<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.
F-55
<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.
F-56
<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>
F-57
<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.
F-58
<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.
F-59
<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
F-60
<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.
F-61
<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.
F-62
<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.
F-63
<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.
F-64
<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>
F-65
<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 a portion of the shares to
be issued to the HKS shareholders (318,668 shares) is
F-66
<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.
F-67
<PAGE>
DESCRIPTION OF INSIDE BACK COVER
This inside back cover contains the following:
A picture of the Red Hat "Shadow Man" logo. This picture is surrounded by an
all white background.
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is an offer to
sell only the shares offered hereby, but only under circumstances and in
jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
--------
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 7
Special Note Regarding Forward-
Looking Statements.................. 20
Use of Proceeds....................... 21
Price Range of our Common Stock....... 21
Dividend Policy....................... 21
Capitalization........................ 22
Selected Financial Data............... 23
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 29
Business.............................. 55
Management............................ 74
Transactions with Affiliates.......... 83
Principal and Selling Stockholders.... 84
Description of Capital Stock.......... 86
Legal Matters......................... 88
Experts............................... 88
Where You Can Find More Information... 89
Underwriting.......................... 90
Index to Financial Statements......... F-1
</TABLE>
4,000,000 Shares
RED HAT
Common Stock
--------------------
[LOGO]
--------------------
GOLDMAN, SACHS & CO.
CHASE H&Q
THOMAS WEISEL PARTNERS LLC
J.P. MORGAN & CO.
Representatives of the Underwriters
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Estimated expenses payable in connection with the sale of the common stock
in this offering are as follows:
<TABLE>
<S> <C>
SEC registration fee................. 151,004
NASD filing fee...................... 57,700
Nasdaq National Market listing fee... 17,500
Printing and engraving expenses...... 125,000
Legal fees and expenses.............. 500,000
Accounting fees and expenses......... 375,000
Transfer agent and registrar fees and
expenses........................... 10,000
Miscellaneous........................ 263,796
---------
Total................................ 1,500,000
</TABLE>
The registrant will bear all of the expenses shown above.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Delaware General Corporation Law, the registrant's charter and by-laws
provide for indemnification of the registrant's directors and officers for
liabilities and expenses that they may incur in such capacities. In general,
directors and officers are indemnified with respect to actions taken in good
faith in a manner reasonably believed to be in, or not opposed to, the best
interests of the registrant, and with respect to any criminal action or
proceeding, actions that the indemnitee had no reasonable cause to believe were
unlawful. Reference is made to the registrant's corporate charter filed as
Exhibit 3.1 hereto and the registrants by-laws filed as Exhibit 3.2 hereto.
The underwriting agreements executed in connection with this offering and
with our initial public offering each provide that the underwriters are
obligated, under certain circumstances, to indemnify directors, officers and
controlling persons of the registrant against certain liabilities, including
liabilities under the Securities Act. Reference is made to the form of
underwriting agreement filed as Exhibit 1.1 to our Registration Statement on
Form S-1 (File No. 333-80051) and to the form of underwriting agreement filed as
Exhibit 1.1 hereto.
The registrant currently has in place and maintains a directors' and
officers' insurance policy.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
In the three years preceding the filing of this registration statement, the
registrant has sold the following securities that were not registered under the
Securities Act:
On August 15, 1997, the registrant sold an aggregate of 6,801,400 shares of
its Series A convertible preferred stock to one investor at a price of $.294057
per share.
On September 29, 1998, the registrant sold an aggregate of 8,116,550 shares
of its Series B convertible preferred stock to five investors at a price of
$.857 per share.
During the period between February 25, 1999 and April 1, 1999, the
registrant sold an aggregate of 2,054,776 shares of its Series C convertible
preferred stock to ten investors at a price of $3.141 per share.
II-1
<PAGE>
On October 10, 1995, the registrant issued warrants to certain employees
exercisable for an aggregate of 4,814,900 shares of common stock with an
exercise price per share of $.0001.
From September 4, 1998 through August 11, 1999, the registrant granted
options to purchase an aggregate of 11,656,176 shares of common stock under the
1998 Stock Option Plan, as amended, exercisable at a weighted average price of
$1.542 per share.
From August 11, 1999 through December 31, 1999, the registrant granted
options to purchase an aggregate of 837,800 shares of common stock under the
1999 Stock Option and Incentive Plan, exercisable at a weighted average exercise
price of $41.72 per share.
On January 6, 2000, in connection with the acquisition of Hell's Kitchen
Systems, Inc., the registrant issued shares of its common stock to 30
shareholders of HKS. The registrant issued 478,004 shares to such shareholders
upon the closing of the acquisition and 318,666 shares may be issued at certain
dates over a period of three years based upon continued employment with the
registrant and designated performance targets.
Such sales were made in reliance upon the exemption provided by
Section 4(2) of the Securities Act for transactions not involving a public
offering and/or Rule 701 under the Securities Act.
On January 7, 2000, in connection with the acquisition of Cygnus, the
registrant issued an aggregate of 10,867,966 shares of common stock. These
shares do not include 2,412,737 shares of common stock outstanding under the
Cygnus 1995 Stock Plan, the Cygnus 1997 Stock Plan and the Cygnus 1998 Executive
Stock Plan, which options have been assumed by Red Hat. The offering and sale of
the shares in the transaction were made in reliance upon the exemption provided
by Section 3(a)(10) of the Securities Act for transactions not involving a
public offering.
On January 17, 2000 the registrant issued 3,781 shares of its common stock
as part of the purchase price for the entire stock capital of Sistemi Research
Laboratories s.r.l., a limited liability company organized under the laws of
Italy. The registrant issued such shares pursuant to the exemption from
registration provided by Regulation S promulgated under the Securities Act. The
registrant issued such shares to a single non-U.S. person in an offshore
transaction in which no directed selling efforts were made by the registrant.
The offering restrictions specified under Rule 903 of Regulation S were
implemented in connection with the issuance of such shares. The registrant also
agreed to issue an additional 1,512 of its shares of common stock on
December 31, 2000 if sales of Red Hat Linux products and services in the Italian
market prior to that date exceed a specified dollar target and the individual to
whom the shares were issued is still employed by the registrant or one of its
affiliates.
No underwriters were involved in the foregoing sales of securities.
II-2
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(A) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT INDEX
- --------------------- -------------
<C> <S>
1.1* Form of Underwriting Agreement
2.1 Agreement and Plan of Reorganization by and among the
registrant, Cygnus Solutions, Miami Acquisition Corp. and
Michael Tiemann, as Securityholder Agent, dated as of
November 5, 1999 (incorporated by reference from Exhibit 2.1
to the registrant's Quarterly Report on Form 10-Q for the
fiscal quarter ended November 1999)
2.2* Agreement and Plan of Merger by and among the registrant,
HKS Acquisition Corp., Hell's Kitchen Systems, Inc. and
certain shareholders of Hell's Kitchen Systems, Inc., dated
as of January 4, 2000
3.1* Third Amended and Restated Certificate of Incorporation, as
amended, of the registrant
3.2* Amended and Restated By-laws, as amended, of the registrant
4.1 Specimen certificate representing the common stock
(incorporated by reference from Exhibit 4.1 to the
registrant's Registration Statement on Form S- 1 (File no.
333-80051))
5.1* Opinion of Testa, Hurwitz & Thibeault, LLP
10.1 Red Hat, Inc. 1998 Stock Option Plan, as amended
(incorporated by reference from Exhibit 10.1 to the
registrant's Registration Statement on Form S- 1 (File no.
333-80051))
10.2 Red Hat, Inc. 1999 Stock Option and Incentive Plan
(incorporated by reference from Exhibit 10.2 to the
registrant's Registration Statement on Form S- 1 (File no.
333-80051))
10.3 Red Hat, Inc. 1999 Employee Stock Purchase Plan
(incorporated by reference from Exhibit 10.3 to the
registrant's Registration Statement on Form S- 1 (File no.
333-80051))
10.4* Cygnus Solutions 1995 Stock Plan
10.5* Cygnus Solutions 1997 Stock Plan
10.6* Cygnus Solutions 1998 Executive Stock Plan
10.7* Amended and Restated Warrant Agreement by and among the
registrant, Robert F. Young, Nancy R. Young, Marc Ewing and
Erik Troan, dated as of October 21, 1999
10.8* Amended and Restated Warrant Agreement, by and among the
registrant, Robert F. Young, Nancy R. Young, Marc Ewing and
Donald Barnes, dated as of October 21, 1999
10.9* Amended and Restated Warrant Agreement by and among the
registrant, Robert F. Young, Nancy R. Young, Marc Ewing and
Lisa Sullivan, dated as of October 21, 1999
10.10 First Amended and Restated Investor Rights Agreement by and
among the registrant and the Investors and Founders listed
therein, dated as of February 25, 1999, as amended
(incorporated by reference from Exhibit 10.7 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.11* Registration Rights Agreement by and among the registrant
and the sellers listed therein, dated as of January 6, 2000
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT INDEX
- --------------------- -------------
<C> <S>
10.12* Asset Purchase Agreement by and among the registrant and
Open Source, Inc., dated as of December 14, 1999
10.13 Escrow Agreement by and among the registrant, Miami
Acquisition Corp., Cygnus Solutions, Inc., Michael Tiemann,
as Securityholder Agent, and First Union National Bank, as
Escrow Agent, dated as of January 7, 2000 (incorporated by
reference from Exhibit 10.1 to the registrant's Quarterly
Report on Form 10-Q for the fiscal quarter ended
November 30, 1999)
10.14 Office Lease by and between the registrant and CMD
Properties, Inc., dated November 13, 1998 (incorporated by
reference from Exhibit 10.8 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.15 Non-Qualified Stock Option Agreement by and between the
registrant and Matthew Szulik (incorporated by reference
from Exhibit 10.9 to the registrant's Registration Statement
on Form S-1 (File no. 333-80051))
10.16 Incentive Stock Option Agreement by and between the
registrant and Matthew Szulik (incorporated by reference
from Exhibit 10.10 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.17 Non-Qualified Stock Option Agreement by and between the
registrant and Timothy Buckley (incorporated by reference
from Exhibit 10.11 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.18 Incentive Stock Option Agreement by and between the
registrant and Timothy Buckley (incorporated by reference
from Exhibit 10.12 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.19* Non-Qualified Stock Option Agreement by and between the
registrant and Tom Butta
10.20 GNU General Public License (incorporated by reference from
Exhibit 10.13 to the registrant's Registration Statement on
Form S-1 (File no. 333-80051))
10.21+ Distribution Agreement by and between the registrant and
Ingram Micro Inc. dated as of October 15, 1998, as amended
(incorporated by reference from Exhibit 10.14 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.22+ Red Hat Product Distribution Agreement by and between the
registrant and Frank Kasper Associates, Inc., dated as of
April 30, 1999 (incorporated by reference from Exhibit 10.15
to the registrant's Registration Statement on Form S-1 (File
no. 333-80051))
10.23+ Software Distribution Agreement between Tech Data Product
Management, Inc. and the registrant, dated as of April 29,
1999 (incorporated by reference from Exhibit 10.16 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.24+ Independent Contractor Agreement by and between the
registrant and Ingo Molnar, dated as of August 18, 1998
(incorporated by reference from Exhibit 10.18 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.25 Escrow Agreement by and among the registrant and Lawrence
Weidman, as Shareholder Representative, dated January 6,
2000 (incorporated by reference from Exhibit 99.3 to the
registrant's Current Report on Form 8-K dated January 6,
2000)
21.1* Subsidiaries of the registrant
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT INDEX
- --------------------- -------------
<C> <S>
23.1* Consent of Testa, Hurwitz & Thibeault, LLP (included in
Exhibit 5.1)
23.2 Consent of PricewaterhouseCoopers LLP
24.1* Power of Attorney
27.1* Financial Data Schedule
</TABLE>
- ------------------------
* Previously filed
+ Confidential materials omitted and filed separately with the Securities and
Exchange Commission
(B) FINANCIAL STATEMENTS SCHEDULES:
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions, the required information is disclosed in the notes to the
financial statements or the schedules are inapplicable, and therefore have been
omitted.
ITEM 17. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to provisions described in Item 14 above, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The registrant hereby undertakes that for purposes of determining any
liability under the Securities Act, the information omitted from the form of
prospectus filed as part of a registration statement in reliance upon Rule 430A
and contained in the form of prospectus filed by the registrant pursuant to
Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be
part of this registration statement as of the time it was declared effective;
and (3) that for the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this amendment no. 1 to the registration statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in Durham, North
Carolina on January 28, 2000.
<TABLE>
<S> <C> <C>
RED HAT, INC.
BY: /S/ MATTHEW SZULIK
-----------------------------------------
Matthew Szulik
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
POWER OF ATTORNEY AND SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, this amendment
no. 1 to the registration statement has been signed below by the following
persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ MATTHEW J. SZULIK Chief Executive Officer, President and
------------------------------- Director (principal executive officer) January 28, 2000
Matthew J. Szulik
* Chief Financial Officer
------------------------------- (principal financial and accounting January 28, 2000
Manoj K. George officer)
* Director
------------------------------- January 28, 2000
Robert F. Young
* Director
------------------------------- January 28, 2000
Marc Ewing
* Director
------------------------------- January 28, 2000
William S. Kaiser
* Director
------------------------------- January 28, 2000
Kevin Harvey
* Director
------------------------------- January 28, 2000
Eric Hahn
</TABLE>
<TABLE>
<S> <C>
/s/ MATTHEW SZULIK
-------------------------------
Matthew Szulik
By: ATTORNEY-IN-FACT
</TABLE>
II-6
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT INDEX
- --------------------- -------------
<C> <S>
1.1* Form of Underwriting Agreement
2.1 Agreement and Plan of Reorganization by and among the
registrant, Cygnus Solutions, Miami Acquisition Corp. and
Michael Tiemann, as Securityholder Agent, dated as of
November 5, 1999 (incorporated by reference from Exhibit 2.1
to the registrant's Quarterly Report on Form 10-Q for the
fiscal quarter ended November 1999)
2.2* Agreement and Plan of Merger by and among the registrant,
HKS Acquisition Corp., Hell's Kitchen Systems, Inc. and
certain shareholders of Hell's Kitchen Systems, Inc., dated
as of January 4, 2000
3.1* Third Amended and Restated Certificate of Incorporation, as
amended, of the registrant
3.2* Amended and Restated By-laws, as amended, of the registrant
4.1 Specimen certificate representing the common stock
(incorporated by reference from Exhibit 4.1 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
5.1* Opinion of Testa, Hurwitz & Thibeault, LLP
10.1 Red Hat, Inc. 1998 Stock Option Plan, as amended
(incorporated by reference from Exhibit 10.1 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.2 Red Hat, Inc. 1999 Stock Option and Incentive Plan
(incorporated by reference from Exhibit 10.2 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.3 Red Hat, Inc. 1999 Employee Stock Purchase Plan
(incorporated by reference from Exhibit 10.3 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.4* Cygnus Solutions 1995 Stock Plan
10.5* Cygnus Solutions 1997 Stock Plan
10.6* Cygnus Solutions 1998 Executive Stock Plan
10.7* Amended and Restated Warrant Agreement by and among the
registrant, Robert F. Young, Nancy R. Young, Marc Ewing and
Erik Troan, dated as of October 21, 1999
10.8* Amended and Restated Warrant Agreement, by and among the
registrant, Robert F. Young, Nancy R. Young, Marc Ewing and
Donald Barnes, dated as of October 21, 1999
10.9* Amended and Restated Warrant Agreement by and among the
registrant, Robert F. Young, Nancy R. Young, Marc Ewing and
Lisa Sullivan, dated as of October 21, 1999
10.10 First Amended and Restated Investor Rights Agreement by and
among the registrant and the Investors and Founders listed
therein, dated as of February 25, 1999, as amended
(incorporated by reference from Exhibit 10.7 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.11* Registration Rights Agreement by and among the registrant
and the sellers listed therein, dated as of January 6, 2000
10.12* Asset Purchase Agreement by and among the registrant and
Open Source, Inc., dated as of December 14, 1999
10.13 Escrow Agreement by and among the registrant, Miami
Acquisition Corp., Cygnus Solutions, Inc., Michael Tiemann,
as Securityholder Agent, and First Union National Bank, as
Escrow Agent, dated as of January 7, 2000 (incorporated by
reference from Exhibit 10.1 to the registrant's Quarterly
Report on Form 10-Q for the fiscal quarter ended
November 30, 1999)
</TABLE>
II-7
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT INDEX
- --------------------- -------------
<C> <S>
10.14 Office Lease by and between the registrant and CMD
Properties, Inc., dated November 13, 1998 (incorporated by
reference from Exhibit 10.8 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.15 Non-Qualified Stock Option Agreement by and between the
registrant and Matthew Szulik (incorporated by reference
from Exhibit 10.9 to the registrant's Registration Statement
on Form S-1 (File no. 333-80051))
10.16 Incentive Stock Option Agreement by and between the
registrant and Matthew Szulik (incorporated by reference
from Exhibit 10.10 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.17 Non-Qualified Stock Option Agreement by and between the
registrant and Timothy Buckley (incorporated by reference
from Exhibit 10.11 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.18 Incentive Stock Option Agreement by and between the
registrant and Timothy Buckley (incorporated by reference
from Exhibit 10.12 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.19* Non-Qualified Stock Option Agreement by and between the
registrant and Tom Butta
10.20 GNU General Public License (incorporated by reference from
Exhibit 10.13 to the registrant's Registration Statement on
Form S-1 (File no. 333-80051))
10.21+ Distribution Agreement by and between the registrant and
Ingram Micro Inc. dated as of October 15, 1998, as amended
(incorporated by reference from Exhibit 10.14 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.22+ Red Hat Product Distribution Agreement by and between the
registrant and Frank Kasper Associates, Inc., dated as of
April 30, 1999 (incorporated by reference from Exhibit 10.15
to the registrant's Registration Statement on Form S-1 (File
no. 333-80051))
10.23+ Software Distribution Agreement between Tech Data Product
Management, Inc. and the registrant, dated as of April 29,
1999 (incorporated by reference from Exhibit 10.16 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.24+ Independent Contractor Agreement by and between the
registrant and Ingo Molnar, dated as of August 18, 1998
(incorporated by reference from Exhibit 10.18 to the
registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.25 Escrow Agreement by and among the registrant and Lawrence
Weidman, as Shareholder Representative, dated January 6,
2000 (incorporated by reference from Exhibit 99.3 to the
registrant's Current Report on Form 8-K dated January 6,
2000)
21.1* Subsidiaries of the registrant
23.1* Consent of Testa, Hurwitz & Thibeault, LLP (included in
Exhibit 5.1)
23.2 Consent of PricewaterhouseCoopers LLP
24.1* Power of Attorney
27.1* Financial Data Schedule
</TABLE>
- ------------------------
* Previously filed
+ Confidential materials omitted and filed separately with the Securities and
Exchange Commission
II-8
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in this Registration Statement on Form
S-1 of our report dated April 30, 1999, except as to Note 14 which is as of
January 7, 2000 and except as to the pooling of interests with Cygnus which is
as of January 7, 2000, relating to the financial statements of Red Hat,
Inc., which appears in such Registration Statement. We also consent to the
use in this Registration Statement on Form S-1 of our report dated December
16, 1999 relating to the financial statements of Hell's Kitchen Systems, Inc.,
which appears in such Registration Statement. We also consent to the
references to us under the heading "Experts" in such Registration Statement.
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
January 28, 2000
