<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 8, 1999
REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
VA LINUX SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
CALIFORNIA
(PRIOR TO REINCORPORATION)
DELAWARE
(AFTER REINCORPORATION) 3571 77-0399299
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
1382 BORDEAUX DRIVE
SUNNYVALE, CALIFORNIA 94089
(408) 542-8600
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
LARRY M. AUGUSTIN
PRESIDENT AND CHIEF EXECUTIVE OFFICER
1382 BORDEAUX DRIVE
SUNNYVALE, CALIFORNIA 94089
(408) 542-8600
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
------------------------
COPIES TO:
<TABLE>
<S> <C>
JUDITH M. O'BRIEN, ESQ. WILLIAM D. SHERMAN, ESQ.
BRUCE M. MCNAMARA, ESQ. STEPHEN J. SCHRADER, ESQ.
BRET M. DIMARCO, ESQ. JUSTIN L. BASTIAN, ESQ.
DAVID I. FRAZEE, ESQ. ROCHELLE A. KRAUSE, ESQ.
WILSON SONSINI GOODRICH & ROSATI BRIAN MCALLISTER, ESQ.
PROFESSIONAL CORPORATION MORRISON & FOERSTER LLP
650 PAGE MILL ROAD 755 PAGE MILL ROAD
PALO ALTO, CALIFORNIA 94304 PALO ALTO, CALIFORNIA 94304
(650) 493-9300 (650) 813-5600
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
- ---------------
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
- ---------------
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
- ---------------
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED OFFERING PRICE(1) REGISTRATION FEE
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Common Stock, $0.001 par value.............................. $70,000,000 $19,460
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Estimated pursuant to Rule 457(o) of the Securities Act of 1933 solely for
the purpose of computing the amount of the registration fee.
------------------------
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 HEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SUCH SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED OCTOBER 8, 1999
SHARES
[VA LINUX SYSTEMS LOGO]
COMMON STOCK
------------------------
Prior to this offering, there has been no public market for our common
stock. The initial public offering price of our common stock is expected to be
between $ and $ per share. We have applied to list our common stock on
The Nasdaq Stock Market's National Market under the symbol "LNUX."
The underwriters have an option to purchase a maximum of
additional shares to cover over-allotments of shares.
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" ON PAGE 7.
<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS VA LINUX SYSTEMS
----------------- ----------------- -----------------
<S> <C> <C> <C>
Per Share..................................... $ $ $
Total......................................... $ $ $
</TABLE>
Delivery of the shares of common stock will be made on or about ,
1999.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
CREDIT SUISSE FIRST BOSTON
DEUTSCHE BANC ALEX. BROWN
HAMBRECHT & QUIST
LEHMAN BROTHERS
The date of this prospectus is , 1999.
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUMMARY.................... 3
RISK FACTORS.......................... 7
SPECIAL NOTE REGARDING FORWARD-
LOOKING STATEMENTS.................. 23
USE OF PROCEEDS....................... 24
DIVIDEND POLICY....................... 24
CAPITALIZATION........................ 25
DILUTION.............................. 26
SELECTED FINANCIAL DATA............... 27
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS....................... 28
BUSINESS.............................. 37
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
MANAGEMENT............................ 50
CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS........................ 59
PRINCIPAL STOCKHOLDERS................ 61
DESCRIPTION OF CAPITAL STOCK.......... 63
SHARES ELIGIBLE FOR FUTURE SALE....... 65
UNDERWRITING.......................... 67
NOTICE TO CANADIAN RESIDENTS.......... 69
LEGAL MATTERS......................... 70
EXPERTS............................... 70
ADDITIONAL INFORMATION................ 70
INDEX TO FINANCIAL STATEMENTS......... F-1
</TABLE>
------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO
WHICH WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH
INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL
TO SELL THESE SECURITIES. THE INFORMATION IN THIS DOCUMENT MAY ONLY BE ACCURATE
ON THE DATE OF THIS DOCUMENT.
DEALER PROSPECTUS DELIVERY OBLIGATION
UNTIL , 2000 (25 DAYS AFTER THE COMMENCEMENT OF THIS
OFFERING), ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR
NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE DEALER'S OBLIGATION TO DELIVER A PROSPECTUS WHEN
ACTING AS AN UNDERWRITER AND WITH RESPECT TO UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
<PAGE> 4
PROSPECTUS SUMMARY
This summary highlights information described more fully elsewhere in this
prospectus. This summary is not complete and may not contain all the information
you should consider before investing in our common stock. You should read the
entire prospectus, including the Financial Statements and related Notes, before
making an investment decision.
VA LINUX SYSTEMS, INC.
We are a leading provider of Linux-based solutions, integrating systems,
software and services.
Linux has emerged as one of the most popular operating systems used by
companies deploying or expanding their Internet infrastructures. The use of the
Internet to communicate and conduct business is increasing rapidly. According to
International Data Corporation, the number of worldwide Internet users is
expected to grow from 159 million in 1998 to 510 million in 2003. Because of
this rapid growth, companies doing business on the Internet require enterprise
computing environments to be scalable, reliable and cost effective.
Linux offers businesses seeking to rapidly establish or significantly
expand their Internet presence a solution that is generally more reliable and
scalable than proprietary software solutions and often costs less. Linux is
gaining market share quickly. A March 1999 International Data Corporation report
estimated that, in 1998, Linux compact disc units sold represented 14.7% of all
new server operating system license units sold worldwide. According to an April
1999 survey conducted by the Internet Operating System Counter, Linux ran on
approximately 31% of the Internet servers polled, more than any other single
operating system.
As an open source operating system, the source code for Linux is available
to the user. As a result, Linux is being rapidly customized for a wide range of
functions and applications. This customizability poses a challenge for
traditional business models that separate systems providers from software
expertise providers. We believe successful Linux vendors must combine in-depth
knowledge of Linux and other open source software with system design expertise
and close ties with the open source developer community in order to maximize the
benefits of Linux for customers.
We offer a single point of contact for all Linux-based product, service and
support needs. Our broad-based technical expertise in system and software design
enables us to provide high-quality Linux-based solutions.
A majority of our systems are sold to customers deploying or expanding
Internet infrastructure environments. Our largest customers in fiscal 1999
included Akamai Technologies, Inc., eToys Inc., StarMedia Network, Inc. and 24/7
Media, Inc.
Our strategy is to enhance our position as a leading developer and provider
of advanced Linux and other open source solutions by:
- continuing to demonstrate technical leadership in Linux and other open
source technologies;
- utilizing our direct distribution model;
- continuing to leverage the Internet and our linux.com Internet site;
- accelerating development of the open source market and community;
- continuing to apply open source practices within our business and
products; and
- increasing our brand awareness.
We are firmly committed to supporting the continued growth and success of
the open source model and developer community. We believe that our integrated
approach and our close ties to the open source developer community enable us to
offer a superior solution to our customers.
3
<PAGE> 5
We were incorporated in January 1995 in California. We intend to
reincorporate in Delaware prior to the completion of this offering. Our
principal executive offices are located at 1382 Bordeaux Drive, Sunnyvale,
California 94089, and our telephone number is (408) 542-8600. Our corporate web
site is located at valinux.com. Information contained on this web site, our
other web sites or any other web site referenced elsewhere in this prospectus
does not constitute a part of this prospectus.
------------------
CLUSTER CITY, FULLON, GOFULLON, LINUX HARDWARE SOLUTIONS the Linux Hardware
Solutions logo, SERVICE TLC, STARTX, SUPPORT TLC, TOTAL LINUX COVERAGE, VA TLC,
VA LINUX SYSTEMS, and our logo are trademarks, trade names or service marks that
we use. We have applied for federal trademark registration only for FULLON,
GOFULLON, SERVICE TLC, STARTX, SUPPORT TLC LINUX HARDWARE SOLUTIONS and VA TLC.
This prospectus contains other trademarks and trade names of other companies.
4
<PAGE> 6
THE OFFERING
<TABLE>
<S> <C>
Common stock offered.................................... shares
Common stock to be outstanding after this offering...... shares
Use of proceeds......................................... For general corporate purposes, including
working capital and expansion of
professional services and sales and
marketing efforts.
Proposed Nasdaq National Market symbol.................. LNUX
</TABLE>
SUMMARY FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 9,
1995
(INCEPTION) YEAR ENDED JULY 31,
TO --------------------------------------------
JULY 31, 1995 1996 1997 1998 1999
------------- ----------- ------ ------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net revenues......................... $ 1,135 $ 2,257 $2,743 $ 5,556 $ 17,710
Cost of revenues..................... 747 1,991 2,562 4,494 17,766
------- ------- ------ ------- --------
Gross margin......................... 388 266 181 1,062 (56)
Income (loss) from operations........ 111 (169) (462) 73 (14,531)
Net income (loss).................... 111 (170) (474) 84 (14,512)
Basic net income (loss) per share.... $ 0.01 $ (0.01) $(0.05) $ 0.02 $ (2.62)
======= ======= ====== ======= ========
Diluted net income (loss) per
share............................. $ 0.01 $ (0.01) $(0.05) $ 0.01 $ (2.62)
======= ======= ====== ======= ========
Shares used in computing basic net
income (loss) per share........... 15,000 15,000 9,467 5,100 5,530
======= ======= ====== ======= ========
Shares used in computing diluted net
income (loss) per share........... 15,000 15,000 9,467 12,249 5,530
======= ======= ====== ======= ========
Pro forma basic net loss per share
(unaudited)....................... $ (1.01)
========
Shares used in computing pro forma
basic net loss per share
(unaudited)....................... 14,317
========
</TABLE>
<TABLE>
<CAPTION>
JULY 31, 1999
----------------------
ACTUAL AS ADJUSTED
------- -----------
(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $18,653 $
Working capital........................................... 16,230
Total assets.............................................. 27,595
Long-term obligations, less current portion............... 424
Total stockholders' equity................................ 18,363
</TABLE>
5
<PAGE> 7
The total number of outstanding shares of our common stock above are based on:
- 15,444,860 shares of our common stock outstanding as of July 31, 1999; and
- automatic conversion of all outstanding shares of preferred stock as of July
31, 1999 upon completion of this offering into 18,651,914 additional shares
of common stock.
See Note 2 of Notes to Financial Statements for an explanation of the
determination of the number of shares used in computing per share data.
The as adjusted amounts above give effect to the sale of the
shares of common stock offered hereby at an assumed public
offering price of $ per share (less estimated underwriting discounts and
commissions and estimated offering expenses).
The above information excludes:
- 6,667,976 shares of common stock issuable upon exercise of options
outstanding as of July 31, 1999 at a weighted average exercise price of
$0.45 per share;
- 6,552,640 shares of common stock available for issuance at July 31, 1999
under our 1998 Stock Plan, and an additional 4,000,000 shares reserved
for issuance by our Board of Directors in October 1999; and
- 1,500,000 additional shares of common stock available for issuance under
our 1999 Employee Stock Purchase Plan and 1999 Director Option Plan
immediately following the offering.
Unless otherwise specifically stated, information throughout this
prospectus:
- reflects the conversion of all outstanding shares of preferred stock as
of July 31, 1999 into 18,651,914 shares of common stock automatically
upon the closing of this offering;
- assumes no exercise of the underwriters' over-allotment option;
- reflects the various stock splits since inception through the date of
this prospectus (all share and per share amounts have been retroactively
restated to reflect the stock splits), see Notes 2 and 10 of Notes to
Financial Statements regarding these stock splits; and
- our reincorporation in Delaware before the effectiveness of this offering
and the filing of our amended and restated certificate of incorporation
upon completion of this offering.
6
<PAGE> 8
RISK FACTORS
Any investment in our common stock involves a high degree of risk. The
risks described below are intended to highlight risks that are specific to us
and are not the only ones we face. Additional risks and uncertainties, such as
those that generally apply to our industry or to companies undertaking initial
public offerings, may also impair our business operations. You should carefully
consider the risks described below and all of the information contained in this
prospectus, including the discussions in "Special Note Regarding Forward-Looking
Statements," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business," as well as our Financial Statements and
the related Notes, before deciding whether to purchase our common stock. If any
of the following risks actually occur, our business, financial condition and
results of operations could be harmed. In such a case, the trading price of our
common stock could decline, and you may lose all or part of your investment in
our common stock.
RISKS RELATED TO OUR FINANCIAL RESULTS
OUR LIMITED OPERATING HISTORY AND THE FACT THAT WE OPERATE IN A NEW INDUSTRY
MAKES EVALUATING OUR BUSINESS PROSPECTS AND RESULTS OF OPERATIONS DIFFICULT.
Our company was founded in January 1995. During the second quarter of
fiscal 1999, we began to expand our operations significantly. For example, we
grew from 15 employees at July 31, 1998 to 153 employees at July 31, 1999, and
only two members of our current management team were employed by us at the end
of fiscal 1998. Furthermore, we participate in the Linux industry, which has
only recently exhibited significant growth. According to PC Data, sales of Linux
operating system units in retail stores grew from 4,305 in June 1998 to 35,963
in June 1999. You should consider the risks and difficulties we may encounter as
an early stage company in the new and rapidly evolving Linux products and
services market. Some of the factors that may affect us include:
- the evolving and unpredictable nature of our business model;
- the uncertain rate of growth in usage and acceptance of the Linux
operating system and other open source software;
- the uncertain demand for our products;
- the need to expand our sales, professional services and customer support
organizations;
- the need to expand our Internet operations;
- increased competition in the Linux industry as well as the competition we
face from general purpose computer systems manufacturers; and
- our ability to attract and retain qualified management personnel.
Our business strategy may not be successful and we may not successfully
manage these risks. If we fail to address any of these risks or difficulties
adequately, our business will suffer.
WE HAVE A HISTORY OF LOSSES AND MAY EXPERIENCE LOSSES IN THE FUTURE.
We incurred losses of $14.5 million in fiscal 1999 primarily due to
expansion of our operations, and we had an accumulated deficit of $15.0 million
as of July 31, 1999. We expect to continue to incur significant product
development, sales and marketing and administrative expenses, particularly as a
result of expanding our direct sales force. In addition, we are investing
considerable resources in our professional services organization and our
Internet operations. We do not expect to generate sufficient revenues to achieve
profitability and, therefore, we expect to continue to incur net losses for at
least the foreseeable future. If we do achieve profitability, we may not be able
to sustain it.
OUR NET REVENUES MAY NOT CONTINUE TO GROW AT THE SAME RATE IN THE FUTURE AS THEY
HAVE IN THE PAST.
Although our net revenues have grown substantially in recent quarters, we
do not expect our net revenues to grow at such a rapid rate in the future and
they could decline. Our net revenues have grown
7
<PAGE> 9
from $2.4 million in the quarter ended October 31, 1998 to $7.8 million in the
quarter ended July 31, 1999. This growth rate reflects increases in customers
and average order size, as well as the introduction of our 3.5 inch, or 2u,
rackmount servers in the third quarter of fiscal 1999. As our business matures,
it is unlikely that our net revenues will continue to grow at the same pace. We
believe that our future growth rates will depend on the success of our sales and
marketing efforts, which will require significant expenditures that we may not
have sufficient resources to undertake, as well as the success of our
professional services organization. In addition, increased competition and
slower than anticipated growth in our market could also affect our revenue
growth. If our net revenues do not increase at or above the rate analysts
expect, the trading price for our common stock may decline.
QUARTERLY FLUCTUATIONS IN OUR NET REVENUES AND RESULTS OF OPERATIONS MAY RESULT
IN VOLATILITY IN OUR STOCK PRICE.
Our ability to accurately forecast our quarterly sales and revenues is made
difficult by our limited operating history and the new and rapidly evolving
market for Linux-based systems in general, and our products in particular. In
addition, most of our operating costs are fixed and based on our revenue
expectations. Therefore, if we have a shortfall in revenues, we may be unable to
reduce our expenses quickly enough to avoid lower quarterly operating results.
During fiscal 1999, we hired 138 employees, moved into significantly larger
facilities and greatly increased our operating expenses. We do not know whether
our business will grow rapidly enough to absorb these costs. As a result, our
quarterly operating results could fluctuate, and such fluctuation could
adversely affect the market price of our common stock.
Our quarterly net revenues and results of operations may vary significantly
in the future due to a number of additional factors, many of which are outside
of our control. The primary factors that may cause our quarterly net revenues
and results of operations to fluctuate include the following:
- demand for and market acceptance of Linux-based systems and our products
and services;
- increases in manufacturing costs, including the prices of components we
purchase;
- reductions in the sales price of systems offered by us or our
competitors;
- our ability to develop, introduce and market new products and product
enhancements that meet customer requirements in a timely manner;
- our contract manufacturer's ability to manufacture sufficient quantities
of systems and maintain the quality of our systems;
- our ability to obtain sufficient supplies of sole or single source
components, including power supplies and chassis;
- the introduction of competing products by larger companies which market
general or limited purpose servers and computers;
- the failure of Linux developers to enhance and develop the Linux
operating system;
- economic conditions generally and in the specific industries in which our
customers operate; and
- costs related to acquisitions of complementary technologies or
businesses.
Accordingly, you should not rely on the results of any past periods as an
indication of our future performance. It is likely that in some future periods,
our operating results may be below expectations of public market analysts or
investors. If this occurs, the price of our common stock may drop.
OUR FUTURE NET REVENUES DEPEND ON CONTINUED SALES OF OUR SERVERS.
Historically, we have derived a large percentage of our net revenues from
sales of our servers. Sales of our servers represented approximately 59% of our
net revenues in fiscal 1999 and approximately 85% of our net revenues in the
quarter ended July 31, 1999. We expect sales of these servers to continue to
account for a substantial majority of our net revenues for the foreseeable
future. Any factors adversely affecting the pricing
8
<PAGE> 10
of, or demand for, these servers, including increased competition or decreased
market acceptance of Linux systems, could cause our net revenues to decline and
our business to suffer.
OUR SUCCESS DEPENDS ON DEVELOPING NEW SYSTEMS THAT ACHIEVE MARKET ACCEPTANCE AND
ON THE SUCCESS OF OUR PROFESSIONAL SERVICES ORGANIZATION.
We develop systems that are optimized to run the Linux operating system,
particularly for use in Internet-related applications. Developing new products
that meet the needs of emerging market segments requires us to incur significant
research and development expenses and commit substantial engineering resources.
For example, in the third quarter of fiscal 1999, we introduced our first
rackmount server model to meet growing Internet infrastructure needs. These
products have accounted for an increasing portion of our net revenues. If we
fail to introduce new products that address the needs of emerging market
segments, our future growth and profitability could suffer. Any new systems that
we develop may not achieve market acceptance, which may harm our business. Our
success also depends on customers choosing our professional consulting services
and support over those of our competitors. If customers do not select our
services, our business will be harmed.
FAILURE TO MAINTAIN OR INCREASE OUR GROSS MARGIN WILL HARM OUR RESULTS OF
OPERATIONS.
Our gross margin may be affected by decreases in the average selling prices
of our systems or increased manufacturing costs. We have experienced
fluctuations in the average selling prices of our products to date. We
anticipate that as the market for Linux systems grows, the average unit price of
our products will continue to fluctuate and may decrease. The average unit price
of our products may also decrease in response to changes in product mix,
competitive pricing pressures, new product introductions by us or our
competitors or other factors. If we are unable to offset a decrease in the
average selling prices of our existing products by developing and introducing
products and services with higher margins or by reducing our product and
manufacturing costs, our gross margins will suffer.
To maintain or increase our gross margin, we also must continue to reduce
the manufacturing cost of our products. Our products incorporate a significant
number of commodity components and our gross margin will fluctuate as a result
of changes in the cost of these components. Component prices can increase for a
number of reasons, including temporary or extended supply shortages. For
example, the recent earthquake in Taiwan resulted in increased prices of memory
and other components due to market concerns over supply interruptions. In fiscal
1999, our gross margin was adversely affected by higher component costs, our
decision to outsource our manufacturing and our subsequent decision to terminate
our first contract manufacturer and move our outsourced manufacturing operations
to another contract manufacturer. Increases in our manufacturing costs, whether
due to increase component costs or other factors, could seriously harm our
business.
RISKS RELATED TO GROWTH OF OUR MARKET AND ACCEPTANCE OF LINUX
OUR SUCCESS DEPENDS ON THE SUCCESS OF THE LINUX OPERATING SYSTEM.
For the foreseeable future, we expect that substantially all of our
revenues will be derived from sales of systems that run the Linux operating
system and the provision of services and support for these systems. The Linux
operating system has only recently gained broad market acceptance. This
acceptance has been mostly limited to Internet infrastructure applications and
scientific research environments. Our success depends on the continued and
increased rate of adoption of Linux in these and other markets. If this does not
occur, our business would suffer.
Even if Linux is widely accepted, the Linux operating system is an open
source software product, which users are licensed to freely copy, use, modify
and distribute. Accordingly, anyone may download the Linux operating system and
numerous related software applications from the Internet, or otherwise copy,
without cost and run it on an existing Linux compatible product. Our success
depends on customers purchasing new systems which integrate and are optimized to
run Linux.
9
<PAGE> 11
IF LINUX DEVELOPERS DO NOT CONTINUE TO ENHANCE THE LINUX KERNEL AND DEVELOP
LINUX-BASED APPLICATIONS, OUR BUSINESS WILL BE HARMED.
We may not be able to introduce new products or product enhancements on a
timely basis because our products run the Linux operating system. The heart of
the Linux operating system, or 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. Mr. Torvalds is not our employee. If Mr. Torvalds
and other third-party developers fail to further develop the Linux kernel or if
the development community does not continue to improve the functionality of the
operating system or introduce new open source software or software enhancements,
our ability to market our existing and future Linux products would suffer. In
this event, we may also be forced to rely to a greater extent on our own
development efforts or the development efforts of third-party consultants, which
would significantly increase our costs. Any failure on the part of the kernel
developers to further develop and enhance the kernel could stifle the
development of additional Linux-based applications for use with our products,
which would harm our product sales.
Because the Linux operating system currently lacks some functionalities, we
cannot sell our systems in markets which require those software capabilities.
For example, Linux cannot support some database applications which precludes our
selling our products to entities which require those types of database
applications. If these efforts to expand the functionality of the Linux
operating system are not successful on a timely basis, our ability to continue
to grow our business will be impeded.
IF ADDITIONAL SOFTWARE APPLICATIONS COMPATIBLE WITH LINUX ARE NOT DEVELOPED, OUR
BUSINESS AND RESULTS OF OPERATIONS WILL BE HARMED.
Our products are currently purchased primarily for Internet-related
applications and by research facilities. For Linux, in general, and our
products, in particular, to gain acceptance in mainstream business and consumer
markets, more third-party software applications designed to operate on
Linux-based operating systems must be introduced and achieve market acceptance.
Many widely used applications, such as Microsoft Office, Intuit Quicken, Adobe
Photoshop and others, cannot run natively on Linux operating systems. Many
available Linux applications, such as word processors, databases, accounting
packages, spreadsheets, e-mail programs, Internet browsers, presentation and
graphics software and personal productivity applications, have not achieved
mainstream market acceptance. We intend to encourage the development of
additional applications that operate on Linux-based operating systems by
attracting third-party developers to the Linux platform and by maintaining our
existing relationships with open source developers. If we are not successful in
achieving these goals, however, our products will not gain mainstream business
and consumer acceptance and we may not be able to maintain our product sales
growth.
IF MULTIPLE AND INCOMPATIBLE COLLECTIONS OF LINUX ACHIEVE SUFFICIENT MARKET
ACCEPTANCE, OUR OPERATING EXPENSES COULD INCREASE AND DEMAND FOR OUR PRODUCTS
COULD DECLINE.
We sell systems that come pre-installed with collections of Linux, or
distributions, that have been optimized for our systems. Although there are many
different distributions of Linux in use, presently most distributions are
compatible and Linux applications can operate across these distributions. If
multiple, incompatible versions of Linux are developed, however, customers may
become less likely to purchase Linux products and our sales would suffer. In
addition, should multiple and incompatible versions of Linux achieve sufficient
market acceptance, we may be required to offer and support more distributions of
Linux. This would result in increased operating expenses. Alternatively, if we
sold and supported a single Linux distribution that was not the predominant
Linux distribution, our sales and revenue growth would suffer.
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IF THE LINUX DEVELOPER COMMUNITY FAILS TO SUPPORT US OR REACTS NEGATIVELY TO OUR
BUSINESS STRATEGY, OUR BUSINESS WILL BE HARMED.
A majority of the software we use is developed and maintained by third
parties in the open source software community. We participate in a number of
open source projects that are designed to improve Linux and Linux applications
for the markets we target. If these third parties fail to support us for any
reason, including because of negative reactions to our product promotions or
disapproval of our corporate or operating decisions, we would be forced to rely
to a significantly greater extent on our own development efforts. This would
require us to hire additional developers and increase our development expenses
and could adversely impact product release schedules. Some members of the open
source software community have criticized companies that profit from open source
software. This type of negative reaction could harm our reputation, diminish our
brand and result in lower net revenues.
RISKS RELATED TO OUR PRODUCT MANUFACTURING
IF OUR SINGLE SOURCE CONTRACT MANUFACTURER IS UNABLE TO MEET OUR MANUFACTURING
NEEDS, OUR RESULTS OF OPERATIONS WILL BE HARMED.
We rely on Synnex Information Technologies, Inc. to produce substantially
all of our products and do not currently intend to qualify any other contract
manufacturer. With the exception of a small internal systems integration and
prototyping facility, we have relocated our internal manufacturing organization
to Synnex's manufacturing facility in Fremont, California. Presently, all of our
manufacturing is done at this one site and, in the event of a natural disaster,
our business could be harmed. Under our agreement with Synnex, Synnex is not
obligated to supply products to us for any specific period, or in any specific
quantity, except as may be provided in a particular purchase order which has
been accepted by Synnex. If Synnex experiences delays, disruptions, capacity
constraints or quality control problems in its manufacturing operations, then
product shipments to our customers could be delayed, which would negatively
impact our net revenues and our competitive position and reputation. Moreover,
our contract with Synnex may be terminated for any reason at any time by either
party upon 120 days advance notice. Synnex subleases to us space in its
facilities for our manufacturing operations. If our sublease with Synnex
terminates, we will need to lease additional space for our manufacturing
operations, which may not be available to us on commercially reasonable terms,
if at all. In addition, we may need to qualify a new contract manufacturer and
may be unable to find a contract manufacturer that meets our needs or that can
source components as cost-effectively as our current contract manufacturer.
Additionally, qualifying a new contract manufacturer and commencing volume
production is expensive and time consuming. In fiscal 1999, we transferred all
of our manufacturing operations to our initial contract manufacturer and
subsequently to Synnex. This process was time consuming and expensive and
adversely affected our gross margin. Transferring manufacturing operations can
significantly disrupt product supply. If we are required or choose to change
contract manufacturers, we may lose sales and may experience increased
manufacturing or component costs, and our customer relationships may suffer.
IF WE EXPAND OUR MANUFACTURING OPERATIONS INTERNATIONALLY, WE WILL FACE
ADDITIONAL RISKS, WHICH COULD HARM OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
To date, substantially all of our net revenues have been derived from sales
of our products in North America. However, we intend to begin selling our
products overseas during fiscal 2000, initially in Europe. We anticipate that as
we expand our international sales, we will fulfill orders through international
facilities operated by Synnex. We could experience difficulties and disruptions
in the manufacture of our products while we transition some manufacturing
operations to these new facilities. Our inability to scale manufacturing of our
products in foreign facilities, and any manufacturing delays or disruptions that
occur, could prevent us from increasing international sales and achieving the
timely delivery of products to
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customers located in foreign jurisdictions. This could result in lost revenues
and slower revenue growth. Additional risks associated with international
manufacturing operations include:
- currency fluctuations;
- the need to comply with regulatory requirements and unexpected changes in
these requirements;
- legal uncertainties regarding liability, tariffs and other trade
barriers;
- greater incidence of shipping delays;
- limited oversight of manufacturing operations; and
- potential political and economic instability.
Any of these factors could significantly impair our ability to source our
contract manufacturing requirements internationally.
SYNNEX DEPENDS ON SINGLE AND LIMITED SOURCE SUPPLIERS FOR KEY COMPONENTS, WHICH
MAKES US SUSCEPTIBLE TO SUPPLY SHORTAGES OR PRICE FLUCTUATIONS THAT COULD
ADVERSELY AFFECT OUR OPERATING RESULTS.
Synnex, our contract manufacturer, depends on single source suppliers for a
number of key components for our products, such as industry standard processors,
power supplies, custom printed circuit boards, chassis and sheet metal parts. It
also depends on limited sources to supply several other industry standard
components. For fiscal 2000, we have a single source for power supplies used in
our FullOn product. It would be difficult for us to identify another source of
supply if this supplier were unable to meet our requirements for any reason. In
the past, Synnex has experienced, and may in the future experience, shortages
of, or difficulties in, acquiring these components. If Synnex is unable to buy
these components in adequate quantities at the times required, we may not be
able to manufacture our products on a timely basis, which would harm our
operating results. In addition, if Synnex is required to pay higher prices for
these single or limited source components and we are required to pay higher
prices for products, our gross margin would be harmed. Furthermore, overall
market conditions affecting supply and pricing for key commodity components are
known to fluctuate significantly at times. Recently, the price of memory chips
has increased significantly. Increases in the costs of key components could harm
our business.
IF WE FAIL TO ACCURATELY PREDICT OUR MANUFACTURING REQUIREMENTS, WE COULD INCUR
ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS.
We provide Synnex with five month rolling forecasts of our product
requirements based on anticipated orders. Our contract manufacturer uses these
forecasts to purchase components for our products. As a result, our component
requirement forecasts may not be accurate. If we overestimate our component
requirements, Synnex may have excess inventory, which would increase our costs.
Also, because lead times for materials and components that we require vary
significantly and depend on a variety of factors, if we underestimate our
requirements, Synnex may have inadequate inventory, which could interrupt their
manufacturing of our products and result in delays in system shipments. Any of
these events could harm our business and results of operations.
RISKS RELATED TO COMPETITION WITHIN OUR INDUSTRY
WE MAY NOT BE ABLE TO COMPETE WITH MORE ESTABLISHED COMPANIES.
In the market for computer systems, we face significant competition from
larger companies who market general-purpose computers and have greater financial
resources, more established direct and indirect sales channels and greater name
recognition than we do. These companies include Compaq Computer, Dell, Fujitsu,
Hewlett Packard Company, IBM and Sun Microsystems, Inc. In most cases, these
companies primarily sell systems that run proprietary operating systems, such as
Microsoft Windows and variants of UNIX, including Solaris. These companies also
have larger and more established service
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organizations to support these products and operating systems. These companies
may be able to leverage their existing organizations, including their service
organizations, and provide a wider offering of products and 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. In addition,
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.
We also face competition in narrow, vertical markets from limited purpose
computer vendors that offer products that are carefully tailored for specific
applications which better address the needs of these customers.
WE MAY NOT BE ABLE TO EFFECTIVELY COMPETE AGAINST OTHER PROVIDERS OF LINUX-BASED
COMPUTER PRODUCTS OR NEW MARKET ENTRANTS.
Many large, general-purpose computer vendors, such as Compaq, Dell,
Gateway, Hewlett-Packard and IBM, have recently introduced Linux-based systems.
The systems offered by these companies may have greater functionality and lower
prices than those we currently provide, making our systems less attractive to
our customers. Even if the functionality of the standard features of these
products is equivalent to ours, we face a substantial risk that a significant
number of customers will choose not to purchase products from a less well-known
vendor regardless of the competitiveness of our solutions. Furthermore, because
Linux 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.
FAILURE TO PROVIDE HIGH-QUALITY LINUX CUSTOMER SUPPORT AND PROFESSIONAL SERVICES
WILL HARM OUR REPUTATION AND REDUCE OUR PRODUCT SALES.
Due to the customizability and versatility of Linux, and the critical
business applications for which it is employed, we believe that high-quality
services and hardware and software expertise represents a significant
competitive advantage. For our business to succeed, we must effectively market
our integrated system and service solution. If our service organization fails to
compete effectively with these organizations, we face an increased risk that
customers will purchase systems from other integrated solution providers or
purchase systems from one vendor and services from a Linux specialist.
As an open source solution provider, our ability to offer customers
high-quality products and services is dependent to a large degree on our ability
to leverage the talents of open source community members. In order to foster and
expand existing ties with the open source community, we have established the
linux.com web site to provide a neutral forum for Linux information and links to
other web sites frequented by members of the open source community. We have also
developed other special purpose web sites, such as themes.org. In attracting
open source community members to our sites, we face competition from a number of
web sites that cater to the same community. Some of these sites, such as
Andover.net's web site, slashdot.org, have a larger following than linux.com and
themes.org. Since the quality of our brand promotion is tied to the
effectiveness and focus of linux.com and themes.org, our failure to increase
traffic on these sites could weaken our ties to the community and our efforts to
promote our brand and connect it to Linux and the open source movement. If our
web site strategy fails, our brand could be diluted, which would harm our
ability to market our products and services.
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IF WE FAIL TO RETAIN AND EXPAND OUR CUSTOMER BASE, OUR REVENUES COULD DECLINE
SUBSTANTIALLY.
We face competition from different sources, and we must compete effectively
against other current and future competitors to retain and expand our customer
base. We believe the principal factors on which we compete include:
- product functionality;
- quality and availability of professional services;
- quality of product and product support;
- total cost of ownership;
- system performance at different price points;
- reusability for multiple applications;
- sales and distribution efficiency; and
- brand name recognition.
To be competitive, we must respond promptly and effectively to the
challenges of technological change, evolving standards and our competitors'
innovations by continuing to enhance our products and grow our sales and
professional services organizations. Any pricing pressures or loss of potential
customers resulting from our failure to compete effectively would reduce our
revenues.
COMPUTER SYSTEMS PRODUCTS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND OUR
PRODUCTS COULD BE RENDERED OBSOLETE BY NEW TECHNOLOGIES.
The computer systems market is characterized by rapid technological change,
frequent new product enhancements, uncertain product life cycles, changes in
customer demands and evolving industry standards. Our products could be rendered
obsolete if products based on new technologies are introduced or new industry
standards emerge.
Enterprise computing environments are inherently complex. As a result, we
cannot accurately estimate the life cycles of our products. New products and
product enhancements can require long development and testing periods, which
requires us to hire and retain increasingly scarce, technically competent
personnel. Significant delays in new product releases or significant problems in
installing or implementing new products could seriously damage our business. We
have, on occasion, experienced delays in the scheduled introduction of new and
enhanced products and may experience similar delays in the future.
Our future success depends upon our ability to enhance existing products,
develop and introduce new products, satisfy customer requirements and achieve
market acceptance. This process is made more challenging by the fact that much
of the software development for our products is done by the open source
community and we must work with a large number of developers who are not our
employees in this process. We may not successfully identify new product
opportunities and develop and bring new products to market in a timely and
cost-effective manner.
RISKS RELATED TO OUR PRODUCTS' DEPENDENCE ON
INTELLECTUAL PROPERTY AND OUR USE OF OUR BRAND
WE COULD BE PREVENTED FROM SELLING OR DEVELOPING OUR PRODUCTS IF THE GNU GENERAL
PUBLIC LICENSE (GPL) AND SIMILAR LICENSES UNDER WHICH THE OPERATING SYSTEM
INCORPORATED INTO OUR PRODUCTS IS DEVELOPED AND LICENSED ARE NOT ENFORCEABLE, OR
ARE NOT EFFECTIVELY ENFORCED.
The Linux kernel and the Linux operating system incorporated into our
products have been developed and licensed under the GPL and similar open source
licenses. These licenses require that any software program licensed under them
may be copied, used, modified and distributed freely, so long as all
modifications are also freely made available and licensed under the same
conditions. We know of no
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instance in which a party has challenged the validity of these licenses or in
which these licenses have been interpreted in a legal proceeding. To date, all
compliance with these licenses has been voluntary.
It is possible that parties may refuse to comply with the terms of these
licenses. One resulting risk is that entities with the legal right to enforce
these licenses against non-complying parties might not be able to enforce these
licenses effectively, because of a lack of financial resources or otherwise.
Even with vigorous enforcement action, it is possible that a court would hold
one or more of 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 copied, modified, or distributed freely, would have the effect
of preventing us from selling or developing our products, unless we are able to
negotiate a license for the use of the software or replace the affected
portions. In the event that we obtain this license, we would likely be required
to make royalty payments with respect to sale of our products covered by the
license. Any royalty payments would harm our operating results. We may not be
able to obtain this license. In the event that we have to replace portions of
the software code ourselves, which could be time consuming and result in higher
development costs, our operating results would be harmed.
IF WE ARE PROHIBITED FROM USING THE LINUX TRADEMARK, OUR BUSINESS COULD BE
ADVERSELY AFFECTED.
Like many other companies, we market Linux-based products, systems and
services. We do not own the trademark to "Linux." The owner has consented to our
use of the word Linux in our company name and in the title of our web sites. We
believe that the continued efficacy and use of the "Linux" trademark is
important to our business. If the "Linux" trademark is invalidated through a
legal action, or we are no longer permitted to use it, our business could
suffer. In addition, we cannot control the use of this trademark, and use by
others may lead to confusion about the source, quality, reputation and
dependability of Linux, which may harm our business.
OUR BUSINESS WILL BE HARMED IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL
PROPERTY RIGHTS FROM MISUSE BY THIRD PARTIES.
Our collection of trademarks is important to our business. The protective
steps we take or have taken may be inadequate to deter misappropriation of our
trademark rights. We have filed applications for registration of some of our
trademarks in the United States. Effective trademark protection may not be
available in every country in which we offer or intend to offer our products and
services. Failure to protect our trademark rights adequately could damage our
brand identity 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.
WE ARE VULNERABLE TO CLAIMS THAT OUR PRODUCTS INFRINGE THIRD-PARTY INTELLECTUAL
PROPERTY RIGHTS, ESPECIALLY BECAUSE OUR SYSTEMS INCORPORATE MANY DISTINCT
SOFTWARE COMPONENTS DEVELOPED BY THOUSANDS OF INDEPENDENT THIRD PARTIES. ANY
RESULTING CLAIMS AGAINST US COULD BE COSTLY TO DEFEND OR SUBJECT US TO
SIGNIFICANT DAMAGES.
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 and who, themselves,
might not have the same financial resources as us to pay damages to a successful
litigant. For example, developers may incorporate code into the Linux operating
system under the GPL without proper third party consents. In addition, these
developers are unlikely to perform patent searches and may therefore unwittingly
infringe third party patent rights. Although most of the software incorporated
into our systems is open source, nothing in open source licenses can prevent
current or future patent holders or other owners of intellectual property from
suing us and others in seeking monetary damages or an injunction against
shipment of our systems. A patent holder may deny us a license or force us to
pay royalties. In either event, our operating results could be seriously harmed.
In addition, employees hired from
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competitors might utilize proprietary and trade secret information from their
former employers without our knowledge, even though our employment agreements
and policies clearly prohibit such practices. Any litigation, with or without
merit, could be time consuming to defend, result in high litigation costs,
divert our management's attention and resources, or cause product shipment
delays. We also could be required to remove or replace infringing technology. We
are not aware that the technology employed in our systems infringes any
proprietary rights of third parties.
WE MAY NOT BE ABLE TO USE INTELLECTUAL PROPERTY TO PROTECT OURSELVES FROM
COMPETITION.
Our systems consist primarily of commodity hardware components in
combination with the Linux operating system. While we have developed some
proprietary techniques and expertise, most of our activities and systems are not
protectable as proprietary intellectual property. To protect our intellectual
property, we generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners. We have also recently commenced a
patent program and to date have filed one patent application. In general,
however, we have taken only limited steps to protect our intellectual property.
Accordingly, we may be unable to use intellectual property to prevent other
companies from competing with us. In addition, we may be unable to prevent third
parties from developing techniques that are similar or superior to our
technology, or from designing around our copyrights, patents and trade secrets.
WE MAY BE SUBJECT TO CLAIMS AS A RESULT OF INFORMATION PUBLISHED ON, POSTED ON
OR ACCESSIBLE FROM OUR INTERNET SITES.
We may be subject to claims for defamation, negligence, copyright or
trademark infringement (including contributory infringement) or other claims
relating to the information contained on our Internet sites, whether written by
us or third parties. These types of claims have been brought against online
services in the past and can be costly to defend regardless of the merit of the
lawsuit. Although recent federal legislation protects online services from some
claims when the material is written by third parties, this protection is
limited. Furthermore, the law in this area remains in flux and varies from state
to state. While no claims have been made against us to date, our business could
be seriously harmed if one were asserted.
OTHER RISKS RELATED TO OUR BUSINESS
DEVELOPING OUR BRAND IS CRITICAL TO OUR SUCCESS.
We believe that we need a strong brand to compete successfully. In order to
promote and maintain our brand identity and to attract and retain customers, we
plan to increase our spending on advertising and promotions and to implement new
marketing campaigns. These strategies may not be successful. If we are unable to
design and implement effective marketing campaigns or otherwise fail to promote
and maintain our brand, our sales could decline. Our business may also be harmed
if we incur significant expenses in an attempt to promote and maintain our brand
without a corresponding increase in revenues. Linus Torvalds owns the trademark
to "Linux." Mr. Torvalds has consented to our use of the word Linux in our
company name and in the title of our web sites. This consent may be revoked in
the future, however, and we may no longer be able to use this trademark in our
brand or in the title of our web sites. In this event, our business would be
harmed.
OUR FUTURE GROWTH DEPENDS ON EXPANSION OF OUR SALES EFFORTS.
To date, we have relied primarily on our direct sales force to generate
demand for our products. Many of our products require a sophisticated sales
effort targeted at our prospective customers' information technology
departments. In order to increase market awareness and sales of our products, we
will need to substantially expand our direct sales operations, both domestically
and internationally. Competition for qualified sales personnel is intense, and
we might not be able to hire the quality and number of sales people we require.
In addition, we have devoted significant resources to implementing e-commerce
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solutions, such as our valinux.com web site, that broaden our market reach and
intend to deploy more e-commerce solutions. If we fail to effectively expand our
direct sales operations or strengthen our e-commerce initiatives, our growth
will be limited.
OUR MANAGEMENT TEAM IS NEW AND, IF THEY ARE UNABLE TO WORK TOGETHER EFFECTIVELY,
OUR BUSINESS COULD BE SERIOUSLY HARMED.
Our business is highly dependent on the ability of our management team to
work together effectively to meet the demands of our growth. We grew from 15
employees at July 31, 1998 to 153 employees at July 31, 1999. Only two members
of our current management team were employed by us at the end of fiscal 1998.
These individuals have not previously worked together as a management team and
have had only limited experience managing a rapidly growing company on either a
public or private basis. We are also actively searching for a new Chief
Operating Officer and Vice President, International Sales and expect to hire
people for those positions within the next few months. Our productivity and the
quality of the products and services we render may be adversely affected if we
do not integrate and train our new employees quickly and effectively.
EXPANDING OUR SERVICES BUSINESS WILL BE COSTLY AND MAY NOT RESULT IN ANY BENEFIT
TO US.
We believe that the expansion of both our business and the acceptance of
Linux are dependent upon the availability of high quality professional services
to assist customers in designing and implementing Linux-based systems. If we are
unable to successfully provide these services, our business will be harmed. We
have recently expanded our strategic focus to place additional emphasis on
providing professional services, from which we have historically derived an
insignificant amount of revenue. Our customers may not engage our professional
services organization to render services such as architecture and planning,
system integration, open source product implementation and security consulting
services. We may not attract or retain a sufficient number of the highly
qualified service personnel we need to support the expansion of our professional
services organization. This expansion has required, and will continue to
require, significant additional expenses and resources. We may not generate
sufficient services revenues to offset these expenses. In addition, the need for
these resources will place further strain on our management and operational
resources.
OUR REVENUE GROWTH DEPENDS ON OUR ABILITY TO HIRE AND RETAIN STAFF.
We intend to hire a significant number of additional support, sales,
marketing, research and development, and other personnel during fiscal 2000.
Competition for these individuals is intense, and we may not be able to attract,
assimilate or retain highly qualified personnel. Our future success and ability
to sustain our revenue growth also depend upon the continued service of our
executive officers and other key engineering, sales, marketing and support
personnel. Competition for qualified personnel in our industry and in the San
Francisco Bay Area, as well as the other geographic markets in which we recruit,
is extremely intense and characterized by rapidly increasing salaries, which may
increase our operating expenses or hinder our ability to recruit qualified
candidates.
ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR FINANCIAL
CONDITION.
We may make investments in complementary companies, products or
technologies. While we have no current agreements or negotiations underway, we
may buy businesses, products or technologies in the future. In the event of any
future purchases, we will face additional financial and operational risks,
including:
- difficulty in assimilating the operations, technology and personnel of
acquired companies;
- disruption in our business because of the allocation of resources to
consummate these transactions and the diversion of management's attention
from our core business;
- difficulty in retaining key technical and managerial personnel from
acquired companies;
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- dilution of our stockholders, if we issue equity to fund these
transactions;
- assumption of operating losses, increased expenses and liabilities;
- harm to our reputation, if the open source development community does not
approve of these transactions;
- our relationships with existing employees, customers and business
partners may be weakened or terminated as a result of these transactions;
and
- we may experience one-time in-process research and development charges
and ongoing expenses associated with amortization of goodwill and other
purchased intangible assets.
IF WE DO NOT SUCCESSFULLY MANAGE OUR EXPANSION, OUR BUSINESS COULD BE HARMED.
We have recently experienced a period of rapid growth. At July 31, 1998, we
had a total of 15 employees, and at July 31, 1999, we had a total of 153
employees. We plan to continue to hire new employees to expand our operations
significantly to pursue existing and potential market opportunities. This growth
will place a significant demand on our management and our operational resources.
In order to manage growth effectively, in the past six months, we have
implemented or updated our operational and financial systems, procedures and
controls, including the implementation of an enterprise resource planning system
and a web-based ordering system. Our systems will continue to require additional
modifications and improvements to respond to future changes in our business. Our
key personnel have limited experience managing this type of growth. If we cannot
manage our growth effectively or if we fail to timely implement appropriate
internal systems, procedures, controls and necessary modifications and
improvements to these systems, our business will suffer.
IF WE EXPAND OUR INTERNATIONAL OPERATIONS, WE WILL FACE ADDITIONAL RISKS, WHICH
COULD HARM OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
We plan to expand our international operations and enter new international
markets. It will be costly to establish international facilities and operations,
promote our brand internationally and develop localized web sites and other
systems. In addition, we may be required to develop foreign language
translations of software incorporated into our systems. Revenue from
international sales may not offset the expense of establishing and maintaining
these foreign operations. We have no previous experience with any of these
matters. 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 encounter greater difficulty in collecting accounts receivable
resulting in longer collection periods;
- we may not be able to repatriate the earnings of our foreign operations;
- we will have to comply with a wide variety of foreign laws and regulatory
environments with which we are not familiar;
- we may not be able to adequately protect our trademarks and other
intellectual property overseas due to the uncertainty of laws and
enforcement in certain countries relating to the protection of
intellectual property rights;
- difficulty in building close relationships with international open source
developers;
- 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;
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- 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
- 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.
ANY YEAR 2000 PROBLEMS WITH OUR PRODUCTS OR OUR INTERNAL SYSTEMS COULD RESULT IN
THIRD-PARTY CLAIMS. IF WE, OUR KEY SUPPLIERS, OR OUR CUSTOMERS FAIL TO BE READY
FOR THE YEAR 2000 CALENDAR CHANGE, OUR BUSINESS MAY BE DISRUPTED AND OUR
BUSINESS WOULD BE ADVERSELY AFFECTED.
The Year 2000 issue refers to the potential for disruption to business
activities caused by system failures or miscalculations which are triggered by
advancement of date records past the year 1999. For example, if software that
uses the calendar year in computations is not ready for the millennial calendar
change, it may interpret a 21(st) century date as a 20(th) century date (for
example, mistaking 2001 for 1901).
We have completed our assessment of Year 2000 readiness with respect to our
products and believe that all of our products manufactured since early calendar
1997 are Year 2000 compliant in all material respects. However, our products
operate in complex system environments and directly and indirectly interact with
a number of other hardware and software systems. We are unable to predict to
what extent our products may be affected if other products in the systems in
which our products operate experience a material Year 2000 failure. Known or
unknown errors or defects that affect the operation of our products could result
in:
- delay or loss of revenues;
- cancellation of customer contracts;
- diversion of development resources;
- damage to our reputation;
- increased maintenance and warranty costs; or
- litigation costs.
Any of these results could harm our business and financial condition.
Despite investigation and testing by us, our internal systems may contain
errors or defects associated with the Year 2000 issue. We are unable to predict
to what extent our core business functions may be affected if our internal
systems or software experience a material Year 2000 failure. See "Management's
Discussion and Analysis of Financial Condition and Results of Operation -- Year
2000 Readiness" for a description of our Year 2000 vulnerability.
Our customers' purchasing plans could be affected by Year 2000 issues if
they need to expend significant resources to fix their existing systems. This
situation could divert funds and resources otherwise available for new product
purchase. In addition, some customers may wait to purchase our products until
after the Year 2000, which may reduce our revenues in the near future.
We are unable to determine at this time whether these or other Year 2000
failures will occur and if they will have a material impact on our business,
results of operations, or financial condition. This inability is particularly
acute due to the potential scope of the Year 2000 problem on, and the inability
to assure the readiness of, external service providers, including utilities,
government entities and other vendors. We have not developed, and we have no
current plans to develop in the near future, a contingency plan to deal with
Year 2000 failures.
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WE DEPEND ON THE CONTINUED SERVICES OF OUR FOUNDERS AND OTHER KEY ENGINEERING
PERSONNEL, WHOSE KNOWLEDGE OF OUR BUSINESS AND TECHNICAL EXPERTISE WOULD BE
DIFFICULT TO REPLACE.
Our products and technologies are complex, and we are substantially
dependent upon the continued services of our existing engineering personnel and
executive management, especially Larry Augustin, our President and Chief
Executive Officer. The loss of any, or a group of, our key engineering
personnel, particularly to a competitor, could adversely affect our business,
reduce our market share, slow our product development processes and diminish our
brand identity.
OUR PRODUCTS MAY CONTAIN DEFECTS THAT COULD 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. We buy almost all of our
component hardware parts from third parties. These parts may fail, cause
unexpected electrical or mechanical problems or otherwise not function properly.
In addition, most of the software 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 correct them in a timely manner, if 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 products incorporating
Linux-based operating systems and other open source software products.
Failures in our products could also cause system failures, including in
critical business systems, for our customers who may assert warranty and other
claims for substantial damages against us. Although our warranties 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 provide
sufficient coverage to adequately limit our exposure to this type of claim.
These claims, even if unsuccessful, could be costly and time consuming to
defend.
WE COULD FACE ADDITIONAL BURDENS ASSOCIATED WITH GOVERNMENT REGULATION OF, AND
LEGAL UNCERTAINTIES SURROUNDING, THE INTERNET.
We are significantly dependent on the Internet to process the sale of our
products. In August 1999, over 80% of our sales were processed through our
valinux.com web site. We are also planning on deploying enhanced e-commerce
applications to foster closer relationships with our customers, facilitate
Internet-based ordering and tracking, and sales processing. As the use of the
Internet continues to evolve, increased regulation by federal, state or foreign
agencies in areas including user privacy, pricing, content, and quality of
products and services becomes more likely. Our e-commerce activities might
subject us to the jurisdiction of the legal systems of other countries. Taxation
of Internet commerce, or other charges imposed by government agencies or by
private organizations, may also be imposed. Laws and regulations applying to the
solicitation, collection, processing of personal or consumer information could
also be enacted. Any of these regulations could result in a decline in the use
or popularity of the Internet as a medium for commerce, which could have an
adverse effect on our future business.
RISKS RELATED TO THIS OFFERING
WE MAY APPLY THE PROCEEDS OF THIS OFFERING TO USES THAT DO NOT INCREASE OUR
PROFITS OR MARKET VALUE.
We have broad discretion in the use of the net proceeds of this offering
and could spend the net proceeds in ways that do not yield a favorable return or
to which stockholders object. We may also use the proceeds to acquire
complementary businesses or technologies, although no such acquisitions are
currently planned. Until we need to use the proceeds of this offering, we may
place them in investments that do not produce income or that lose value. See
"Use of Proceeds" for a more complete discussion of our planned use of the net
proceeds from this offering.
20
<PAGE> 22
INSIDERS WILL CONTINUE TO HAVE SUBSTANTIAL CONTROL OVER US AFTER THIS OFFERING
AND COULD DELAY OR PREVENT A CHANGE IN OUR CONTROL.
After this offering, we anticipate that our officers, directors and five
percent or greater stockholders will beneficially own or control, directly or
indirectly, approximately 27,642,343 shares of common stock, which in the
aggregate will represent approximately % of the outstanding shares of common
stock. These stockholders, if acting together, will have the ability to control
all matters submitted to our stockholders for approval, including the election
and removal of directors and the approval of any business combinations. See
"Description of Capital Stock" for a more complete discussion of the voting
rights of our stockholders.
PROVISIONS OF OUR CHARTER DOCUMENTS MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD
PREVENT A CHANGE IN OUR CONTROL.
Provisions of our amended and restated certificate of incorporation and
bylaws in effect after completion of this offering, and Delaware law, could make
it more difficult for a third party to acquire us, even if doing so would be
beneficial to our stockholders. See "Description of Capital Stock" for a more
complete discussion of these provisions of our charter documents and the effects
of Delaware law.
OUR STOCK PRICE MAY BE VOLATILE AND YOU MAY NOT BE ABLE TO RESELL YOUR SHARES AT
OR ABOVE THE INITIAL PUBLIC OFFERING PRICE.
Prior to this offering there was no public market for our common stock. The
initial public offering price for our common stock will be determined through
negotiations between the underwriters and us. This initial public offering price
may vary from the market price of our common stock after the offering. If you
purchase shares of common stock, you may not be able to resell those shares at
or above the initial public offering price. The market price of our common stock
may fluctuate significantly in response to factors, some of which are beyond our
control, include the following:
- actual or anticipated fluctuations in our operating results;
- changes in market valuations of other technology companies;
- announcements by us or our competitors of significant technical
innovations, contracts, acquisitions, strategic partnerships, joint
ventures or capital commitments;
- additions or departures of key personnel;
- future sales of common stock;
- any deviations in net revenues or in losses from levels expected by
securities analysts; and
- volume fluctuations, which are particularly common among highly volatile
securities of Internet-related companies.
You should read the "Underwriting" section for a more complete discussion
of the factors which were considered in determining the initial public offering
price of our common stock.
OUR GROWTH AND OPERATING RESULTS WOULD BE IMPAIRED IF WE WERE UNABLE TO MEET OUR
FUTURE CAPITAL REQUIREMENTS.
We believe that the net proceeds of this offering, together with our
current cash balances and cash generated from our current and future debt
financings, will be sufficient to meet our operating and capital requirements
for at least the next 12 months. However, we may be required, or could elect to
seek additional funding prior to that time, particularly if we elect to acquire
complementary businesses or technologies. In the event we are required to raise
additional funds we may not be able to do so on favorable terms, if at all.
Further, if we issue new equity securities, stockholders may experience
additional dilution or the new equity securities may have rights, preferences or
privileges senior to those of existing holders of common stock. If we cannot
raise funds on acceptable terms, we may be unable to develop or
21
<PAGE> 23
enhance our products, develop our professional services organization, take
advantage of future opportunities or respond to competitive pressures or
unanticipated requirements. For additional information on our anticipated future
capital requirements, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
SUBSTANTIAL FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET MAY DEPRESS
OUR STOCK PRICE.
Our current stockholders hold a substantial number of shares, which they
will be able to sell in the public market in the near future. Sales of a
substantial number of shares of our common stock after this offering could cause
our stock price to fall. In addition, the sale of these shares could impair our
ability to raise capital through the sale of additional stock. You should read
"Shares Eligible for Future Sale" for a full discussion of shares that may be
sold in the public market in the future.
YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION IN THE BOOK VALUE OF YOUR
SHARES.
The initial public offering price is substantially higher than the book
value per share of our outstanding common stock immediately after the offering.
Accordingly, if you purchase common stock in the offering, you will incur
immediate dilution of approximately in the book value per share of our
common stock from the price you pay for our common stock. For additional
information on this calculation, see "Dilution."
22
<PAGE> 24
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus, including the sections entitled "Prospectus Summary,"
"Risk Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and "Business," contains forward-looking statements.
These statements relate to future events or our future financial performance and
involve known and unknown risks, uncertainties and other factors that may cause
our or our industry's actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by the forward-
looking statements. These risks and other factors include those listed under
"Risk Factors" and elsewhere in this prospectus. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," "continue" or the negative of these terms or other comparable
terminology. These statements are only predictions. In evaluating these
statements, you should specifically consider various factors, including the
risks outlined under "Risk Factors."
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of these
forward-looking statements. We are under no duty to update any of the
forward-looking statements after the date of this prospectus or to conform our
prior statements to actual results.
23
<PAGE> 25
USE OF PROCEEDS
We expect to receive net proceeds from the sale of the shares of
common stock in this offering of approximately $ million (approximately
$ million if the underwriters' over-allotment option is exercised in full),
at an assumed initial public offering price of $ per share, after deducting
estimated underwriting discounts and commissions and estimated offering
expenses.
We intend to use the net proceeds from this offering primarily for working
capital and general corporate purposes, including the expansion of our sales and
marketing efforts and our professional services organization, as well as for
capital expenditures. The amounts that we actually expend will vary
significantly, depending on a number of factors, including future revenue
growth, if any, and the amount of cash we generate from operations. As a result,
we will retain broad discretion in the allocation of the net proceeds of this
offering. In addition, we may use a portion of the net proceeds to acquire
complementary products, technologies or businesses. We currently have no
commitments or agreements and are not involved in any negotiations with respect
to any such transactions. Pending use of the net proceeds of this offering, we
intend to invest the net proceeds in interest bearing, investment-grade
securities.
DIVIDEND POLICY
We have never declared or paid any dividends on our capital stock. We
currently expect to retain future earnings, if any, for use in the operation and
expansion of our business and do not anticipate paying any cash dividends in the
foreseeable future. In addition, our existing bank line of credit prohibits the
payment of cash dividends without our bank's consent.
24
<PAGE> 26
CAPITALIZATION
The following table sets forth our capitalization as of July 31, 1999:
- on an actual basis;
- on a pro forma basis to give effect to the conversion of all outstanding
shares of preferred stock to 18,651,914 shares of common stock
automatically upon completion of this offering; and
- on an as adjusted basis to give effect to the sale of shares of
common stock in this offering at an assumed initial offering price of
$ per share (less estimated underwriting discounts and commissions
and estimated offering expenses) and the application of the net proceeds.
You should read this table in conjunction with our Financial Statements and
the related Notes, Selected Financial Data and Management's Discussion and
Analysis of Financial Condition and Results of Operations included elsewhere in
this prospectus.
<TABLE>
<CAPTION>
JULY 31, 1999
-------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE AND
PER SHARE DATA)
<S> <C> <C> <C>
Long-term obligations, less current portion............... $ 424 $ 424 $ 424
Stockholders' equity:
Preferred stock, $0.001 par value: 20,149,322 authorized
(actual and pro forma), 18,651,914 outstanding
(actual), no shares outstanding (pro forma),
10,000,000 authorized, no shares outstanding (pro
forma as adjusted)................................... 19 -- --
Common stock, $0.001 par value: 250,000,000 authorized
(actual, pro forma and pro forma as adjusted),
15,444,860 outstanding (actual), 34,096,774
outstanding (pro forma), outstanding (pro forma
as adjusted)......................................... 15 34
Additional paid-in capital................................ 45,461 45,461
Stockholder note receivable............................... (50) (50) (50)
Deferred stock compensation............................... (12,121) (12,121) (12,121)
Accumulated deficit....................................... (14,961) (14,961) (14,961)
--------- -------- --------
Total stockholders' equity........................... 18,363 18,363
--------- -------- --------
Total capitalization................................. $ 18,787 $ 18,787 $
========= ======== ========
</TABLE>
The data in the table above excludes:
- 6,667,976 shares of common stock issuable upon exercise of options
outstanding as of July 31, 1999 at a weighted average exercise price of
$0.45 per share;
- 6,552,640 shares of common stock available for issuance at July 31, 1999
under our 1998 Stock Plan and 4,000,000 shares reserved for issuance by
our Board of Directors in October 1999; and
- 1,500,000 additional shares of common stock available for issuance under
our 1999 Employee Stock Purchase Plan and 1999 Director Option Plan
immediately following the offering.
For additional information regarding these shares, see "Management -- Stock
Plans," "Certain Transactions," "Description of Capital Stock" and Notes 7 and 8
of Notes to Financial Statements.
25
<PAGE> 27
DILUTION
If you invest in our common stock, your interest will be diluted to the
extent of the difference between the public offering price per share of our
common stock and the pro forma as adjusted net tangible book value per share of
common stock after this offering. Our pro forma net tangible book value as of
July 31, 1999 was $17,718,000 or $0.52 per share of common stock. Net tangible
book value per share represents the amount of our total tangible assets less
total liabilities, divided by the pro forma number of shares of common stock
outstanding. Dilution in net tangible book value per share represents the
difference between the amount per share paid by purchasers of shares of common
stock in this offering and the net tangible book value per share of common stock
immediately after the completion of this offering. After giving effect to the
sale of the shares of common stock in this offering at an assumed public
offering price of $ per share (less estimated underwriting discounts and
commissions and estimated offering expenses), our pro forma as adjusted net
tangible book value as of July 31, 1999 would have been $ or approximately
$ per share. This represents an immediate increase in net tangible book
value of $ per share to existing stockholders and an immediate dilution in
net tangible book value of $ per share to new investors, or approximately
% of the initial public offering price of $ per share. The following
table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $
Pro forma net tangible book value per share at July 31,
1999................................................... $ 0.52
Increase per share attributable to this offering.......... $
--------
Pro forma as adjusted net tangible book value per share
after this offering....................................... $
--------
Dilution per share to new investors......................... $
========
</TABLE>
The following table shows, on a pro forma basis as of July 31, 1999, and
after giving effect to this offering, the differences between the existing
holders of common stock and the new investors with respect to the number of
shares of common stock purchased from us, the total consideration paid to us and
the average price per share paid (based on an assumed initial public offering
price of $ per share, before deducting estimated underwriting discounts and
commissions and estimated offering expenses):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
--------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders...... 34,096,774 % $30,871,000 % $0.91
New investors.............. $
---------- ----- ----------- -----
Total................. 100.0% $ 100.0%
========== ===== =========== =====
</TABLE>
The foregoing discussion and table are based on actual shares outstanding
on July 31, 1999. The foregoing discussion assumes no exercise of any stock
options outstanding as of July 31, 1999. As of July 31, 1999, there were options
outstanding to purchase 6,667,976 shares of common stock at a weighted average
exercise price of $0.45 per share. To the extent any of these options are
exercised, there will be further dilution to investors. See "Capitalization,"
"Management -- Stock Plans," "Description of Capital Stock" and Notes 7 and 8 of
Notes to Financial Statements.
26
<PAGE> 28
SELECTED FINANCIAL DATA
You should read the selected financial data set forth below in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our Financial Statements and the related Notes included
elsewhere in this prospectus. The statement of operations data for the years
ended July 31, 1997, 1998 and 1999 and the balance sheet data as of July 31,
1998 and 1999 are derived from, and are qualified by reference to, the audited
Financial Statements and related Notes appearing elsewhere in this prospectus.
The statements of operations data for the period from January 9, 1995, the date
of our inception, to July 31, 1995 and the year ended July 31, 1996 and the
balance sheet data as of July 31, 1995 and 1996 are derived from unaudited
financial statements not appearing in this prospectus. Historical results are
not necessarily indicative of results that may be expected for any future
period.
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 9, 1995 YEAR ENDED JULY 31,
(INCEPTION) TO ------------------------------------
JULY 31, 1995 1996 1997 1998 1999
---------------- ------- ------ ------ --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net revenues............................... $ 1,135 $ 2,257 $2,743 $5,556 $ 17,710
Cost of revenues........................... 747 1,991 2,562 4,494 17,766
------- ------- ------ ------ --------
Gross margin............................ 388 266 181 1,062 (56)
Operating expenses:
Sales and marketing..................... 21 27 310 382 5,183
Research and development................ 86 144 115 180 3,189
General and administrative.............. 170 264 218 427 3,791
Amortization of deferred stock
compensation.......................... -- -- -- -- 2,312
------- ------- ------ ------ --------
Total operating expenses........... 277 435 643 989 14,475
------- ------- ------ ------ --------
Income (loss) from operations.............. 111 (169) (462) 73 (14,531)
Interest and other income (expense), net... -- (1) (12) 11 19
------- ------- ------ ------ --------
Net income (loss).......................... $ 111 $ (170) $ (474) $ 84 $(14,512)
======= ======= ====== ====== ========
Basic net income (loss) per share.......... $ 0.01 $ (0.01) $(0.05) $ 0.02 $ (2.62)
======= ======= ====== ====== ========
Diluted net income (loss) per share........ $ 0.01 $ (0.01) $(0.05) $ 0.01 $ (2.62)
======= ======= ====== ====== ========
Shares used in computing basic net income
(loss) per share........................ 15,000 15,000 9,467 5,100 5,530
======= ======= ====== ====== ========
Shares used in computing diluted net income
(loss) per share........................ 15,000 15,000 9,467 12,249 5,530
======= ======= ====== ====== ========
Pro forma basic net loss per share
(unaudited)............................. $ (1.01)
========
Shares used in computing pro forma basic
net loss per share (unaudited).......... 14,317
========
</TABLE>
<TABLE>
<CAPTION>
JULY 31,
----------------------------------------------------
1995 1996 1997 1998 1999
------------- ------- ------- ------ -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents..................... $ 21 $ 147 $ 20 $ 62 $18,653
Working capital............................... 341 129 12 (214) 16,230
Total assets.................................. 380 304 591 1,195 27,595
Long-term obligations, less current portion... 50 -- -- 275 424
Total stockholders' equity (deficit).......... 319 149 45 (420) 18,363
</TABLE>
See Note 2 of Notes to Financial Statements for an explanation of the
determination of the shares used in computing basic and diluted net income
(loss) per share and pro forma basic net loss per share.
27
<PAGE> 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Financial Data" and our Financial Statements and the related Notes
included elsewhere in this prospectus. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from those anticipated in the forward-looking statements as a result
of certain factors including the risks discussed in "Risk Factors" and elsewhere
in this prospectus.
OVERVIEW
We are a leading provider of Linux-based solutions, integrating systems,
software and services. Our broad-based technical expertise in systems and
software design, as well as our focus on the Linux operating system and other
open source solutions, enables us to provide high-quality Linux-based systems
designed for optimal performance, reliability and scalability. To further expand
our service offerings, we recently established a professional services
organization.
We were founded in January 1995, and grew very modestly until the end of
fiscal 1998. Since July 31, 1998, however, we have experienced significant
growth and have invested in hiring engineers with Linux expertise, growing our
direct sales force to better penetrate the market for Linux products and
marketing our brand. To further implement these strategies, we expanded our
operations, customer support and administration infrastructure. As a result, our
employee base grew from 15 at July 31, 1998 to 153 on July 31, 1999, and our
operating expenses grew significantly. At July 31, 1999, we had an accumulated
deficit of $15.0 million. This rapid growth has placed significant demands on
our management and operational resources.
During fiscal 1999, our quarterly revenues increased rapidly, growing from
$2.4 million in the quarter ended October 31, 1998 to $7.8 million in the
quarter ended July 31, 1999. To date, substantially all of our revenues have
been derived from sales of systems and related customer support. Sales of our
servers accounted for approximately 59% of our net revenues in fiscal 1999, and
approximately 85% in the quarter ended July 31, 1999. While we expect sales of
our desktop and storage products to increase, current and future generations of
our server product families will continue to represent a significant majority of
our net revenues through fiscal 2000. We recognize revenues from product sales
upon shipment. We also provide allowances for warranty costs and estimated
future returns at the time of shipment. Customer support fees are recognized
ratably over the term of the service contract.
In September 1999, we established our professional services organization to
expand our existing customer service and support offerings to better address the
demand for Linux expertise from our customers. This organization offers a number
of services, including systems architecture and planning, deployment and
installation, system integration, open source product implementation,
performance analysis and security consulting services. Although revenues from
our professional services organization have been insignificant to date, we
expect these revenues to account for a more significant portion of revenues in
the future. Professional services revenues are recognized upon completion of a
project. Any payments made prior to completion are recorded as deferred revenue.
Prior to January 1999, we sold our products to customers primarily in
response to telephone inquiries. During the third quarter of fiscal 1999, we
began implementing our direct sales strategy. The number of employees engaged in
direct sales activities grew from four at January 31, 1999, to 34 at July 31,
1999. Our direct sales organization consists of field sales, telesales and sales
support personnel. Although indirect sales have been insignificant to date, we
may pursue selective channel opportunities to supplement our direct sales
efforts. In addition, our valinux.com web site permits customers to configure
and order products online, allowing us to more efficiently sell products and
facilitate order processing. In August 1999, over 80% of our sales were
processed through this web site. We intend to continue to enhance our e-commerce
solutions to foster closer relationships with our customers and improve the
efficiency of our sales process.
28
<PAGE> 30
To date, substantially all of our sales have been in North America. We
expect to launch sales and marketing efforts internationally during fiscal 2000,
initially focusing on Europe. However, we expect international revenues to
represent a relatively small percent of our revenues, if any, in fiscal 2000.
We outsource a significant portion of our manufacturing and supply chain
management operations, including inventory management and component procurement,
to Synnex, our contract manufacturer. We provide Synnex with five month rolling
forecasts based on anticipated product orders. Synnex uses these forecasts to
purchase components for our products. If we overestimate our component
requirements, Synnex may have excess inventory, which would increase our costs.
If we underestimate our component requirements, Synnex may have inadequate
inventory, which could interrupt their manufacturing of our products and result
in delays in system shipments. Any of these events could harm our business and
results of operations. Our agreement with Synnex may be terminated for any
reason at any time on delivery of 120 days advanced notice. A substantial
majority of our cost of revenues currently consists of payments to Synnex. Cost
of revenues also includes costs associated with our customer support and
professional services. Customer support costs include payments made to
DecisionOne, which provides call-center and onsite service functions to our
customers. We expect revenues from professional services to carry a higher gross
margin than our product revenues. We believe that future gross margin will
primarily be affected by:
- changes in components and manufacturing costs;
- the volume and mix of products and services sold;
- new product introductions both by us and our competitors;
- changes in our pricing policies and those of our competitors;
- the size of customer orders; and
- the mix of domestic and international sales.
Prior to October 1998, we operated as a small closely-held company. As
such, we did not have the kinds of operational and financial controls normally
implemented by growing enterprises. During the second half of fiscal 1999, we
have implemented or updated our operational and financial systems, procedures
and controls, including the implementation of an enterprise resource planning
system and a Internet-based ordering system. Our systems will continue to
require additional modifications and improvements, and possibly new systems, to
respond to future changes in our business. Implementation of these modifications
and improvements or new systems could be disruptive to our business.
In connection with the grant of stock options to employees during fiscal
1999, we recorded deferred stock compensation of $14.4 million, representing the
difference between the deemed fair market value of the common stock for
accounting purposes and the exercise price of these options as of the date of
grant. Deferred compensation is presented as a reduction of stockholders' equity
and is amortized on an accelerated basis over the vesting period of the
applicable options. We expensed $2.3 million of deferred compensation during
fiscal 1999. Based on option grant activity through September 30, 1999, we
expect to amortize deferred stock compensation of $7.2 million during fiscal
2000, $3.8 million in fiscal 2001, $2.0 million in fiscal 2002 and approximately
$730,000 in fiscal 2003. See Note 8 of Notes to Financial Statements.
29
<PAGE> 31
RESULTS OF OPERATIONS
Although we have included a discussion of our results of operations for
each of the three fiscal years ended July 31, 1999, our significant growth
during the last fiscal year makes period-to-period comparisons involving periods
prior to the fiscal year ended July 31, 1998 less meaningful than an analysis of
more recent annual and quarterly operating results. Accordingly, this discussion
and analysis of our operating results is primarily focused on comparisons
between fiscal 1998 and 1999. The following table sets forth financial data for
the fiscal years indicated as a percent of net revenues:
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
----------------------
1997 1998 1999
----- ---- -----
<S> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net revenues.............................................. 100% 100% 100%
Cost of revenues.......................................... 93.4 80.9 100.3
----- ---- -----
Gross margin.............................................. 6.6 19.1 (0.3)
----- ---- -----
Operating expenses:
Sales and marketing..................................... 11.3 6.9 29.3
Research and development................................ 4.2 3.2 18.0
General and administrative.............................. 7.9 7.7 21.4
Amortization of deferred stock compensation............. -- -- 13.0
----- ---- -----
Total operating expenses........................... 23.4 17.8 81.7
----- ---- -----
Income (loss) from operations............................. (16.8) 1.3 (82.0)
Interest and other income (expense), net.................. (0.5) 0.2 0.1
----- ---- -----
Net income (loss)......................................... (17.3)% 1.5% (81.9)%
===== ==== =====
</TABLE>
YEARS ENDED JULY 31, 1998 AND 1999
Net Revenues
Net revenues increased from $2.7 million in fiscal 1997, to $5.6 million in
fiscal 1998, to $17.7 million in fiscal 1999. Net revenues for each period
increased primarily due to an increase in the number of customers and an
increase in average order size. Growth of net revenues from fiscal 1998 to
fiscal 1999 was also attributable to sales of our server products, which we
introduced late in the second quarter of fiscal 1999. In the fourth quarter of
fiscal 1999, sales of this product accounted for approximately 85% of net
revenues. We also believe this increase in sales reflected the growing market
acceptance of Linux and other open source software. A majority of our systems
are sold to customers deploying or expanding Internet infrastructure
environments. We believe that sales of our Internet infrastructure solutions
will represent an increasing portion of our revenues.
Cost of Revenues
Cost of revenues increased from $2.6 million in fiscal 1997, to $4.5
million in fiscal 1998, to $17.8 million in fiscal 1999. Gross margin increased
as a percent of net revenues from 6.6% in fiscal 1997, to 19.1% in fiscal 1998,
primarily due to increased sales volume and the introduction of new products. In
fiscal 1999, gross margin declined to negative 0.3%. This decline was primarily
due to costs associated with establishing and moving our manufacturing
activities to our initial contract manufacturer in the third quarter of fiscal
1999, and the establishment of our customer support organization. In addition to
these costs, we experienced significant increases in component costs due to our
transitioning to more dependable component suppliers and the lack of purchasing
power of our initial contract manufacturer. To become more competitive, we
transferred our manufacturing operations to Synnex in July 1999. While we
incurred additional expenses in connection with this move, we believe that
Synnex's position as a distributor of Intel architecture components and other
subsystems, its focus on build-to-order processes and its expertise in material
management will reduce our future product costs. In addition, we anticipate that
our gross margins will improve if unit volume increases and we successfully
market our professional services.
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<PAGE> 32
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of salaries, commissions and
related expenses for personnel engaged in marketing, sales and sales support
functions, as well as costs associated with trade shows, advertising and
promotional activities. Sales and marketing expenses were approximately $300,000
in fiscal 1997, approximately $400,000 in fiscal 1998 and increased to $5.2
million in fiscal 1999. Sales and marketing expenses as a percent of net
revenues were 11.3% in fiscal 1997, 6.9% in fiscal 1998 and 29.3% in fiscal
1999. The increase in absolute dollars from fiscal 1998 to fiscal 1999 was
primarily due to an increase in sales and marketing personnel from two at the
end of fiscal 1998 to 66 at the end of fiscal 1999. Of these 66 employees, 34
were engaged in sales and 32 were engaged in marketing. In addition, sales and
marketing expenses increased primarily due to the launch and ongoing
implementation of our branding and other marketing campaigns. We intend to
expand our sales and marketing activities substantially, both domestically and
internationally, in order to increase market awareness and sales of our
products. Accordingly, we expect our sales and marketing expenses to continue to
increase in absolute dollars.
Research and Development Expenses
Research and development expenses consist primarily of payroll and related
expenses for software and hardware engineers and cost of materials for
prototyping and testing units. We expense all of our research and development
costs as they are incurred. Research and development expenses were approximately
$100,000 in fiscal 1997, approximately $200,000 in fiscal 1998 and increased to
$3.2 million in fiscal 1999. Research and development expenses as a percent of
net revenues were 4.2% in fiscal 1997, 3.2% in fiscal 1998, and 18.0% in fiscal
1999. The increase in absolute dollars from fiscal 1998 to fiscal 1999 was
primarily due to an increase in research and development personnel from two at
the end of fiscal 1998, to 29 at the end of fiscal 1999, and other costs
associated with the development of new products. We believe that a significant
level of investment in system design, open source software development and other
research and development initiatives is required to remain competitive.
Accordingly, we expect research and development expenses to continue to increase
in absolute dollars on an annual basis.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries and
related expenses for finance and administrative personnel, professional fees and
costs associated with implementing and expanding our information systems.
General and administrative expenses were approximately $200,000 in fiscal 1997,
approximately $400,000 in fiscal 1998 and increased to $3.8 million in fiscal
1999. General and administrative expenses as a percent of net revenues were 7.9%
in fiscal 1997, 7.7% in fiscal 1998 and 21.4% in fiscal 1999. The increase in
absolute dollars from fiscal 1998 to fiscal 1999 was primarily due to an
increase in administrative personnel from six at the end of fiscal 1998 to 28 at
the end of fiscal 1999 and expenses necessary to support our increased
operations, including the implementation of a new management information system.
We intend to add personnel to expand our information infrastructure and to
support our operation as a public company. As a result, we expect general and
administrative expenses to increase in absolute dollars on an annual basis.
Amortization of Deferred Stock Compensation
In connection with the grant of stock options to employees during fiscal
1999, we recorded amortized deferred stock compensation of $14.4 million. We
recorded no amortization of deferred stock compensation in fiscal 1997 or fiscal
1998. We recorded $2.3 million of amortized deferred stock compensation in
fiscal 1999.
Interest and Other Income (Expense), Net
Interest and other income, net includes income from our cash investments
net of other expenses. We had net interest and other expense of approximately
$12,000 in fiscal 1997, and net interest and other
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<PAGE> 33
income of approximately $11,000 in fiscal 1998 and approximately $19,000 in
fiscal 1999. The increase from fiscal 1998 to fiscal 1999 was primarily due to
an increase in interest income earned on proceeds from issuances of convertible
preferred stock.
Income Taxes
As of July 31, 1999, we had $10.8 million of federal and $5.2 million of
state net operating loss carryforwards for tax reporting purposes available to
offset future taxable income. The federal net operating loss carryforwards
expire at various dates through 2019 to the extent that they are not utilized.
We have not recognized any benefit from these net operating loss carryforwards
because of uncertainty surrounding their realization. The amount of net
operating losses that we can utilize is limited under tax regulations since we
have experienced a cumulative stock ownership change of more than 50% over the
last three years.
QUARTERLY RESULTS OF OPERATIONS
The following table presents our operating results for each of the four
quarters ended July 31, 1999. The information for each of these quarters is
unaudited and has been prepared on the same basis as our audited financial
statements appearing elsewhere in this prospectus. In the opinion of management,
all necessary adjustments, consisting only of normal recurring adjustments, have
been included to present fairly the unaudited quarterly results when read in
conjunction with our audited Financial Statements and related Notes. We have
experienced, and expect to continue to experience, fluctuations in operating
results from quarter to quarter. Historical operating results are not
necessarily indicative of the results that may be expected for any future
period.
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------
OCTOBER 31, JANUARY 31, APRIL 30, JULY 31,
1998 1999 1999 1999
----------- ----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net revenues.................................. $2,435 $ 3,170 $ 4,270 $ 7,835
Cost of revenues.............................. 2,053 3,324 4,295 8,094
------ ------- ------- -------
Gross margin................................ 382 (154) (25) (259)
------ ------- ------- -------
Operating expenses:
Sales and marketing......................... 177 406 1,326 3,274
Research and development.................... 48 216 410 2,515
General and administrative.................. 136 654 1,146 1,855
Amortization of deferred stock
compensation............................. 118 371 505 1,318
------ ------- ------- -------
Total operating expenses............ 479 1,647 3,387 8,962
------ ------- ------- -------
Loss from operations.......................... (97) (1,801) (3,412) (9,221)
Interest and other income (expense), net...... -- (14) -- 33
------ ------- ------- -------
Net loss...................................... $ (97) $(1,815) $(3,412) $(9,188)
====== ======= ======= =======
</TABLE>
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<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------
OCTOBER 31, JANUARY 31, APRIL 30, JULY 31,
1998 1999 1999 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
AS A PERCENT OF NET REVENUES:
Net revenues.................................. 100.0% 100.0% 100.0% 100.0%
Cost of revenues.............................. 84.3 104.9 100.6 103.3
------ ------- ------- -------
Gross margin............................. 15.7 (4.9) (0.6) (3.3)
------ ------- ------- -------
Operating expenses:
Sales and marketing......................... 7.3 12.8 31.1 41.8
Research and development.................... 2.0 6.8 9.6 32.1
General and administrative.................. 5.6 20.6 26.8 23.7
Amortization of deferred stock
compensation............................. 4.8 11.7 11.8 16.8
------ ------- ------- -------
Total operating expenses............ 19.7 51.9 79.3 114.4
------ ------- ------- -------
Loss from operations.......................... (4.0) (56.8) (79.9) (117.7)
Interest and other income (expense), net...... -- (0.4) -- 0.4
------ ------- ------- -------
Net loss...................................... (4.0)% (57.2)% (79.9)% (117.3)%
====== ======= ======= =======
</TABLE>
Gross margin decreased from 15.7% in the quarter ended October 31, 1998 to
negative 4.7% in the quarter ended July 31, 1999. This decline was primarily due
to an increase in component costs due to our transitioning to more dependable
component suppliers and costs associated with the establishment of our customer
support organization. While our research and development and general and
administrative expenses increased each quarter during fiscal 1999, we expect
these expenses to stabilize during fiscal 2000. We expect sales and marketing
expenses to continue to increase in absolute dollars on a quarterly basis
through fiscal 2000 as we continue to hire additional sales and marketing
personnel. Our operating expenses are largely fixed and are based on anticipated
revenue trends. As a result, a delay in generating or recognizing revenue could
cause significant variations in our operating results from quarter to quarter
and could result in substantially greater operating losses. In addition, we
intend to broaden our professional service organization and begin manufacturing
products internationally, both of which will increase our cost of revenues.
Our net revenues and operating results will vary significantly from quarter
to quarter due to a number of factors, many of which are outside of our control
and any of which may cause our stock price to fluctuate. The primary factors
that could affect our quarterly operating results include:
- demand for and market acceptance of Linux-based systems and our products
and services;
- increases in manufacturing costs, including the prices of components we
purchase;
- reductions in the sales price of systems offered by us or our
competitors;
- our ability to develop, introduce and market new products and product
enhancements that meet customer requirements in a timely manner;
- our contract manufacturer's ability to manufacture sufficient quantities
of systems and maintain the quality of our systems;
- our ability to obtain sufficient supplies of sole or single source
components, including power supplies and chassis;
- the introduction of competing products by larger companies which market
general or limited purpose servers and computers;
- the failure of Linux developers to enhance and develop the Linux
operating system;
- economic conditions generally and in the specific industries in which our
customers operate; and
- costs related to acquisitions of complementary technologies or
businesses.
Although we grew sequentially each quarter during fiscal 1999, we may
experience some seasonality in our operating results. It is difficult for us to
evaluate the degree to which this seasonality may affect our
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<PAGE> 35
business because of our limited operating history and the fact that our recent
growth may have overshadowed seasonality in recent periods. In addition, if our
international sales grow, we may experience lower sales in Europe or other
international locations during the summer months. Concerns regarding year 2000
compliance issues may also adversely affect the demand for our products in the
next few quarters.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through private
sales of convertible preferred stock, net revenues generated from product sales
and borrowings under an equipment loan and a line of credit. As of July 31,
1999, we had cash and cash equivalents of $18.7 million, an accumulated deficit
of $15.0 million and working capital of $16.2 million.
In February 1999, we entered into a $4.0 million line of credit with a
bank. In connection with this line of credit, we also entered into a $500,000
equipment loan. At July 31, 1999, $500,000 was outstanding under the equipment
loan and no amounts were outstanding under the line of credit. Amounts
outstanding under each facility bear interest at a variable rate equal to the
bank's prime rate plus 0.75% per annum (8.75% as of July 31, 1999) and are
secured by substantially all of our assets. At July 31, 1999, we were not in
compliance with certain covenants set forth in these facilities, which
compliance violations were subsequently waived by the bank.
We used approximately $300,000 of cash in operating activities in fiscal
1997 and $10.2 million in fiscal 1999. We generated approximately $86,000 in
cash from operations in fiscal 1998. Cash used in operating activities for
fiscal 1997 and 1999 was primarily attributable to net losses of approximately
$500,000 and $14.5 million, respectively. In fiscal 1998, we generated cash
primarily from an increase in accounts payable of approximately $400,000 and net
income of approximately $84,000, offset in part by an increase in accounts
receivable. In fiscal 1999, cash used in operating activities was also
attributable to increases in accounts receivable and inventories of $3.3 million
and $1.7 million, respectively, offset in part by increases in accounts payable
of $5.4 million and accrued expenses of $1.4 million, as well as depreciation
and amortization of stock compensation.
We used cash in investing activities of approximately $25,000 in fiscal
1997, approximately $44,000 in fiscal 1998 and $2.3 million in fiscal 1999. Our
investing activities primarily reflect purchases of computer equipment and other
fixed assets. While we have no outstanding commitments, we expect to make
capital expenditures of approximately $2.0 million during fiscal 2000. Our
capital expenditures may increase over the next several years as we expand our
facilities and acquire equipment to support expansion of our sales and marketing
and research and development activities.
Our financing activities provided cash of approximately $400,000 in fiscal
1997 and $31.0 million in fiscal 1999. We had no financing activities in fiscal
1998. The increase in fiscal 1999 resulted primarily from the net proceeds from
the issuances of convertible preferred stock and borrowings under lending
facilities.
Our future liquidity and capital requirements will depend upon numerous
factors, including the costs associated with the expansion of our sales and
marketing activities and product development efforts, the level and timing of
product and service revenues, available borrowings under line of credit
arrangements and other factors. We believe that the net proceeds from this
offering, together with our current cash and investment balances and any cash
generated from current or future debt financing, will be sufficient to meet our
operating and capital requirements for at least the next 12 months. However, it
is possible that we may require additional financing within this period,
particularly if we elect to acquire complementary businesses or technologies.
The factors described in this paragraph will affect our future capital
requirements and the adequacy of our available funds. As a result, we may be
required to raise additional funds through public or private financings,
strategic relationships or other arrangements. We cannot assure you that
additional funding, if needed, will be available on terms attractive to us, or
at all. Furthermore, any additional equity financing may be dilutive to
stockholders, and debt financing, if available, may involve restrictive
covenants. Our inability to raise capital when needed could seriously harm our
business.
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RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the AICPA issued SOP No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," (SOP No. 98-1). SOP
No. 98-1 requires entities to capitalize certain costs related to internal-use
software once certain criteria have been met. SOP No. 98-1 was adopted by the
Company in fiscal 1999. The adoption of SOP No. 98-1 did not have a material
impact on the Company's financial position or results of operations.
In June 1998, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133). SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
SFAS No. 133, as recently amended, is effective for fiscal years beginning after
June 15, 2000. Management believes the adoption of SFAS No. 133 will not have a
material effect on the Company's financial position or results of operations.
In December 1998, the AICPA issued SOP 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 and SOP No. 98-4 by extending the
deferral of the application of certain provisions of SOP No. 97-2 amended by SOP
No. 98-4 through fiscal years beginning on or before March 15, 1999. All other
provisions of SOP No. 98-9 are effective for transactions entered into in fiscal
years beginning after March 15, 1999. The Company has not had significant
software sales to date and management does not expect the adoption of SOP No.
98-9 to have a significant effect on the financial position or results of
operations.
YEAR 2000 READINESS
The Year 2000 Issue
The Year 2000 issue refers to the potential for disruption to business
activities caused by system failures or miscalculations which are triggered by
advancement of date records past the year 1999. For example, if software that
uses the calendar year in computations is not ready for the millennial calendar
change, it may interpret a 21(st) century date as a 20(th) century date (for
example, mistaking 2001 for 1901).
Readiness of Our Products
We have completed our assessment of Year 2000 readiness with respect to our
products and believe that all of our products manufactured since early calendar
1997 are Year 2000 compliant in all material respects. However, our products
operate in complex system environments and directly and indirectly interact with
a number of other hardware and software systems. We are unable to predict to
what extent our products may be affected if other products in the systems in
which our products operate experience a material Year 2000 failure.
Readiness of Our Systems and Facilities
Our business may be affected by Year 2000 issues. We are completing our
systems updates, upgrades, and replacements of non-ready systems. Systems
include internal hardware and software as well as external services provided by
other companies, including contract manufacturing, product development, customer
support, information processing, and facility services. We are not currently
aware of any unresolved Year 2000 problems relating to any of our internal
systems. We do not believe that we have any significant systems that are not
Year 2000 compliant. The majority of our software, hardware and operating
systems have been acquired as new products in the last two years. We acquired
the software as original product and it is supported by existing vendors. We do
not believe that we have any significant systems that contain embedded chips
that are not Year 2000 compliant. We are not using legacy hardware or software
that would be more likely to have Year 2000 issues because of its age.
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<PAGE> 37
Cost of Product and Internal Systems Preparation
Based on our assessment to date, we do not expect the total cost of Year
2000 preparation and remediation to be material to our business. To date, our
preparation and remediation costs have not been material.
Year 2000 Risk
Failures of our internal systems to be Year 2000 compliant could
temporarily prevent us from processing orders, issuing invoices and developing
products, and could require us to devote significant resources to correcting the
problems.
If our suppliers, vendors, customers or service providers fail to correct
their Year 2000 problems, these failures could result in an interruption in, or
a failure of, our normal business activities or operations. If a Year 2000
problem occurs, it may be difficult to determine which party's products have
caused the problem. These failures could interrupt our operations and damage our
relationships with our customers.
An internal or external business disruption caused by the Year 2000 issue
could interrupt our operations and damage our relationships with our customers.
An internal disruption unique to us could give a comparative advantage to our
competitors. Failure of our internal systems and critical external services to
be ready for the Year 2000 could delay order processing, issuing invoices or
development and shipment of products. The cost of recovery from failures could
be significant.
Our customers' purchasing plans could be affected by Year 2000 issues if
they need to expend significant resources to fix their existing systems. This
situation could divert funds and resources otherwise available for new product
purchases. In addition, some customers may wait to purchase our products until
after the Year 2000, which may reduce our revenues in the near future.
We are unable to determine at this time whether these or other Year 2000
failures will occur and if they will have a material impact on our business,
results of operations, or financial condition. This inability is particularly
acute due to the potential scope of the Year 2000 problem and the inability to
ascertain the readiness of external service providers, including utilities,
government entities and other vendors. We have not developed, and we have no
current plans to develop in the near future, a contingency plan to deal with the
effects of this worst case scenario.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we may invest
in may be subject to market risk. This means that a change in prevailing
interest rates may cause the principal amount of the investment to fluctuate.
For example, if we hold a security that was issued with a fixed interest rate at
the then-prevailing rate and the prevailing interest rate later rises, the
principal amount of our investment will probably decline. To minimize this risk
in the future, we intend to maintain our portfolio of cash equivalents and
short-term investments in a variety of securities, including commercial paper,
money market funds and government and non-government debt securities. In
general, money market funds are not subject to market risk because the interest
paid on such funds fluctuates with the prevailing interest rate. As of July 31,
1999, all of our cash and cash equivalents were in money market and checking
funds.
We have operated primarily in the United States and all sales have been
made in U.S. dollars. Accordingly, we have not had any material exposure to
foreign currency rate fluctuations.
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BUSINESS
VA LINUX OVERVIEW
We are a leading provider of Linux-based solutions, integrating systems,
software and services. Our broad-based technical expertise in systems and
software design, as well as our focus on the Linux operating system and other
open source solutions, enables us to provide high-quality Linux-based systems
designed for optimal performance, reliability and scalability. Through our staff
of Linux system and software engineers, we also offer comprehensive customer
service and support. To further expand our service offerings, we recently
established a professional services organization to provide a broad range of
services including system architecture design, system integration and security
consulting.
Our products are primarily sold through a direct sales organization to
customers deploying or expanding Internet infrastructure environments. Our
largest customers in fiscal 1999 included Akamai Technologies, eToys, StarMedia
Network and 24/7 Media. In fiscal 1999, we had over 50 customers who each
purchased at least $50,000 of our Linux-based systems. These customers accounted
for 47.2% of our total net revenues in fiscal 1999.
INDUSTRY BACKGROUND
The Internet Build-Out
The Internet is rapidly becoming a critical resource for business.
Companies that successfully build an online presence can more efficiently
conduct business with partners and suppliers, communicate with customers and
employees, and address the rapidly growing, global base of online consumers.
According to International Data Corporation, or IDC, the number of worldwide
Internet users is expected to grow from 159 million in 1998 to 510 million in
2003, and worldwide e-commerce revenues will increase from approximately $50
billion to more than $1.3 trillion, during the same period.
To remain competitive, companies are being forced to offer more
sophisticated Internet services more rapidly. As a result, their computing
environments are becoming more complex and their demand for Internet
infrastructure is growing. According to IDC, businesses will spend approximately
$56 billion on Internet infrastructure and will deploy approximately six million
servers in 2003.
The Growth of the Internet is Fueling Demand for Linux and other Open Source
Solutions
In seeking cost-effective, reliable and secure infrastructure for
Internet-based solutions, companies are increasingly implementing open source
software, such as the Linux Operating System, the Apache web server and the
Sendmail email server.
The term "open source" applies to software which can be copied, modified
and distributed without any associated fee and with few restrictions. Popular
open source software like Linux is continuously maintained and improved by large
communities of developers who share information, code and suggestions. This
collaborative environment has been facilitated and enhanced by the growth of the
Internet and the availability of low-cost computing resources. These market
trends have fueled significant increases in the number of developers in open
source projects, the frequency of software releases and the speed of feature
development and error correction.
The nature of open source software makes it very easy for multiple groups,
commercial and non-commercial, to create "distributions," or collections, of
this software. The best known distributions of Linux, for example, include those
from Caldera, Debian, Red Hat and S.u.S.E. In most cases, there are only minor
technical variations among distributions and software applications designed for
Linux run consistently across all of them. When variations among distributions
occur, they are generally market-based. For example, some distributions are
localized for different languages, or optimized for different hardware systems.
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The following points illustrate some of the benefits consumers receive by
implementing the Linux operating system and other open source software
solutions:
Rapid Development and High Quality. Traditional proprietary software
vendors rely on a limited pool of software engineers to correct software
errors and develop new software or software enhancements. In contrast, any
end-user can access the source code to develop new features and
applications or suggest fixes and improvements to open source software. As
a result, businesses are not dependent on a single third party vendor and
can rely on a larger pool of software engineers and service providers. In
addition, open source software projects promote independent peer review.
This system of peer review is designed to ensure the quality of all
submissions and changes to the code. Furthermore, we believe that opening
source code to the public ensures that security flaws are quickly
identified and eliminated, making open source software more secure than
proprietary software.
Customer-Focused Solutions. The lack of access to the source code of
proprietary software makes it more difficult and costly to integrate into
existing systems than open source software. In addition, in an open source
environment, internal development personnel in an organization can leverage
the efforts of a broad community consisting of other information technology
specialists and independent programmers to develop customized solutions
more rapidly and at a significantly lower cost. The ability to modify open
source software by end users also results in open source software
implementations that are tailored to meet customer needs.
Lower Cost of Ownership. Consumers can significantly decrease the
cost of owning and servicing their computing systems in an open source
environment. According to Gartner Group, the sale price of a system
typically accounts for approximately 10% of the total cost of owning that
system. The remaining 90% is attributable to services such as training,
support and maintenance. These are largely software support-related
activities. Therefore, in addition to having the ability to install an
unlimited number of copies for free, consumers can reduce their costs by
sourcing services from more than one party, avoiding the significant
margins that proprietary software vendors can charge as a result of their
exclusive knowledge of the product. Open source software solutions create a
competitive multi-source market for these software support services.
The benefits of open source applications have accelerated the market
penetration of open source software, especially in environments such as the
Internet where highly reliable, secure, low-cost and customizable solutions are
essential. For example, in September 1999, Apache, an open source web server,
commanded a 55% market share according to the Netcraft Web Server Survey
(netcraft.com/survey), as compared to 22% for Microsoft's Internet Information
Server.
Linux is the Leading Internet Operating System
Linux has emerged as the leading operating system for the Internet.
According to an April 1999 survey conducted by the Internet Operating System
Counter (leb.net/hzo/ioscount), which polls web sites for operating system
information, Linux ran on approximately 31% of the servers polled. According to
an IDC report dated March 1999, the use of Linux grew at an annual rate of 181%
in 1998. In its report, IDC also projected that the use of Linux will grow
faster than the use of any other operating system through 2003. We believe that
this growth was largely attributable to decisions by information technology
managers to deploy Linux as a highly cost-effective and reliable way to support
web services. According to the IDC report, in 1998, Linux compact disc units
sold represented 14.7% of all server operating system license units sold
worldwide. We believe that the reliability, security and continuous improvement
of open source software, complemented by its low cost, will continue to make
Linux a preferred solution for delivering Internet services.
The Challenge in Delivering Open Source Solutions
As companies adopt open source software solutions in their critical
business operations, they face new challenges. To help maximize the advantages
of open source software and address these challenges, consumers require the
assistance of vendors that have significant Linux expertise and are able to
provide
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timely and qualified Linux professional services and customer support. The rapid
evolution of open source software requires open source vendors and support
providers to:
- continuously develop knowledge of the ongoing changes in open source
software distributions;
- actively engage in research and development with the open source
development community; and
- leverage the expertise of this community to deliver customized solutions.
In addition, as open source software becomes more complex, its interactions
with a diverse range of commodity hardware platforms become more difficult to
support. Supporting too broad a set of hardware platforms and software offerings
can overwhelm many service and support organizations. As a result, vendors must
maintain a thorough understanding of the interoperability of open source
software distributions and hardware platforms and tailor their offerings to
provide the best available hardware and software products.
Traditional server, workstation and personal computer vendors depend on
highly controlled and scheduled releases of software from major proprietary
software developers. This regimented software environment enables the
disaggregation of hardware, service and support delivery among multiple
companies, while keeping systems and service offerings tied to new proprietary
software releases. Given the rapid rate of development in commodity hardware
markets, systems vendors have become reliant on this controlled software release
process to coordinate the development and create the demand for new products and
services. As open source software gains market acceptance, its rapid and
relatively unconstrained pace of development disrupts these well-defined
processes and poses significant challenges for traditional systems vendors and
service providers. To effectively deliver enterprise-class open source
solutions, vendors will need to simultaneously:
- capitalize on the rapid pace of open source software development;
- manage the high rate of change in commodity hardware markets; and
- integrate the best available open source software and system components
to produce the highest-quality solutions for particular customer needs.
We believe that, in order to satisfy these market requirements, open source
vendors must deliver integrated system, software and support solutions to
customers.
The Market Opportunity for Open Source Vendors
We believe that open source solutions will continue to gain market
acceptance as the limitations of more expensive and less customizable
proprietary applications become more pronounced. To date, no large Intel
processor-based systems vendors have focused their businesses on delivering
high-quality systems optimized for Linux and other open source software. These
vendors are primarily dependent on proprietary operating systems and
applications from vendors such as Microsoft. Alternatively, some systems
vendors, such as Sun Microsystems, offer their own proprietary software. In
neither case do these vendors maintain expertise in open source systems nor do
they have extensive ties to the open source community. Linux software and
service vendors, on the other hand, have little experience in developing and
supporting systems that are optimized for Linux.
SOLUTION
We are a leading provider of Linux-based solutions, integrating systems,
software and services. We offer high-quality Linux-based systems that are
designed for optimal performance, reliability and scalability in business and
Internet-based computing environments. We also offer comprehensive service and
customer support. Our products and services offer the following benefits:
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Integrated Linux Solution
We offer a single point of contact for all Linux-based product, service and
support needs. Our Linux systems are deployed in a variety of computing
environments, ranging from small desktops to complex, high-performance,
clustered server installations and are differentiated to meet the price,
performance and scalability requirements of our customers. For example, for the
Internet server markets, we offer high-storage density servers that we engineer
for deployment in optimized space configurations. We also offer professional
services, consisting of planning, deployment, installation and integration,
security audits and performance analysis, as well as 24-hour toll-free telephone
support and onsite services by Linux professionals.
Depth of Technical Expertise in Linux and other Open Source Software
We focus on Linux-based solutions and have developed a comprehensive
understanding of our customers' Linux needs. In addition, by cultivating close
ties with the open source community, we have assembled a world-class team of
Linux software engineers and community professionals who collaborate on open
source development projects. As of July 31, 1999, we employed 31 Linux and
open-source hardware and software professionals. Many of our current employees
are leading contributors to open source projects, such as the Linux kernel, the
XFree86 window system, the Enlightenment window manager and cluster management
software. Notably, Intel has contracted with us to port the Linux operating
system to the IA-64 architecture. We believe that our involvement in these
projects and our investment in Linux expertise helps position us as an integral
member of the Linux development community. This also helps enable us to remain
abreast of technical advances and react quickly to new developments.
High-Quality, Cost-Effective Solutions
We offer high-quality systems that provide our customers with significantly
lower total costs of system ownership. The Linux expertise of our engineers
enables us to design servers, workstations and desktops that are tuned for
optimal performance, reliability and scalability in Linux environments. Our
engineers work with engineers of major component vendors such as Mylex and
Matrox to improve the performance of their subsystems and components and ensure
interoperability with Linux and other open source products. We integrate widely
available commodity hardware components, popular Linux distributions and Linux
service and support to deliver comprehensive low-cost, high-quality
industry-standard systems to our customers. By contrast, customers of other
vendors are required to purchase Linux service and support separately from their
system provider, which adds significantly to the total cost of their system.
Support for Multiple Linux Distributions
We maintain Linux distribution neutrality by offering our customers a
variety of Linux distributions. This enables us to offer customers an optimal
distribution for their system or customize a publicly available distribution to
meet their specific needs. By remaining neutral, we believe we offer the best
open source software for our customers' needs and can support specialized
distributions which meet the requirements of different geographic or vertical
markets more rapidly and effectively than vendors of single, general purpose
distributions. In addition, we believe our neutrality is well aligned with the
goals of a broad section of the open source developer community, thus improving
our ability to recruit and retain the best community talent.
Extensive Internet Services
As a Linux vendor, it is imperative that we maintain close relationships
with the open source developer community and offer a forum where our customers
and open source community members can
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interact. We currently maintain several web sites that serve our customers and
the open source community, including linux.com, our flagship open source portal.
linux.com offers a central place for sharing ideas and receiving information
related to Linux and other open source software, creating a conduit for customer
and community exchange and providing technical support. Our commitment to the
open source community has attracted significant support from its members which,
in turn, keeps linux.com up to date and content-rich through continuous
contributions. linux.com and our other web sites received more than five million
page views in September 1999.
STRATEGY
Our objective is to enhance our position as a leading developer and
provider of advanced Linux and other open source solutions. Key elements of our
strategy are to:
Continue to Demonstrate Technical Leadership in Linux and Other Open Source
Technologies
As an open source technology leader, we will enhance our position in the
marketplace and reinforce our ability to bring high-quality solutions and
support to our customers. We intend to continue to recruit experts who are fully
engaged in open source development projects. We intend to remain at the
forefront of high-end Linux systems and software development, as demonstrated by
our development of high-density Linux-based servers and cluster management
software. Further, we intend to leverage our business agreements with leading
technology companies to reduce the time-to-market for Linux support for emerging
hardware technologies, such as the porting of Linux to Intel's IA-64
architecture.
Utilize Our Direct Distribution Model
We intend to gain immediate feedback from customers on our designs and
product quality by using a direct sales and distribution model. We believe this
will enable us to improve our solutions much faster and more precisely than if
we utilized a traditional reseller-distributor model. By communicating our
users' critiques on open source software reliability, usability and scalability
to the open source community, we believe we will facilitate improvements in the
quality of open source software. Furthermore, we intend to use the direct
distribution model to expand our build-to-order fulfillment capability, minimize
inventory costs, increase margin and lower prices to our customers. We believe
the direct model is the most effective means of reaching customers and
establishing long-term customer relationships.
Continue to Leverage the Internet
As a company that specializes in Linux-based solutions, Internet strategies
are central to our operations. We intend to continue to strengthen our brand and
our Internet presence through expansion of our commercial web site and our
sponsorship of community-oriented sites like linux.com. We also plan to use the
Internet to enhance our relationship with our customers and suppliers by
delivering highly customized order and account information and offering creative
self-service programs. Currently, over 80% of all orders are placed through our
web site. In addition, we will continue to engage in Internet-based strategies
which promote closer ties between our customers and the open source community.
We intend to build strong community relationships by providing Internet
resources to open source community members who want to lead or contribute to
open source projects. Finally, we intend to continue to use the Internet as a
research and development resource by involving the network of open source
engineers on the Internet in our engineering projects.
Accelerate Development of the Open Source Market and Community
We intend to continue to invest resources for the development of open
source technologies and the open source community. We intend to increase the
variety and quality of open source applications by encouraging our customers to
join with members of the open source community in application development. By
promoting successes in deploying open source solutions, we believe we will raise
awareness of open source software capabilities. We intend to increase the
credibility of open source
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solutions and educate customers who are currently unaware of its benefits by
partnering with established technology companies such as database developers and
Internet software providers.
Continue to Apply Open Source Practices Within Our Business and Products
The popularity of Linux and other open source products demonstrates the
success of innovative, highly collaborative software development models. These
models have been made possible only in recent years through the widespread
availability of the Internet. We seek opportunities to apply similar models of
Internet community collaboration across our business, in such areas as market
research, product development and ongoing customer support. For example, we are
collaborating with more than 100 members of the open source community to help
develop a more secure version of Linux for use in university computing
environments. We will continue to embrace the open source model not only in the
creation of new products and services, but also in the overall execution of our
business model.
Increase Brand Awareness
We believe that continuing to build our brand is vital to our success in
providing Linux-based solutions and strengthening our presence in the Linux and
open source communities. We have established a reputation for providing
high-quality Linux systems and support and for promoting open source community
involvement. We intend to continue to promote our brand through a variety of
campaigns, including promotion of linux.com and related sites, public relations
activities, and tightly-focused advertising campaigns in computer-related
publications and general business media. We also intend to continue to
contribute engineering resources, leadership, systems and other services to open
source development projects and to community-wide support organizations, such as
Linux International and the Linux Standard Base.
PRODUCTS AND SERVICES
We offer an end-to-end Linux solution for our customers that includes
systems, software and services. Our systems are designed to meet the reliability
and scalability requirements of Internet infrastructure and other computing
intensive markets. Unlike traditional systems vendors, we design our products
exclusively around the Linux operating system. All our systems and components
are tested and configured for optimal Linux compatibility and include support
and service as a standard feature. In addition to system support, we offer
professional service capabilities that provide in-depth Linux and other open
source software expertise to our customers.
Computing Systems
We sell a broad line of Linux desktop and server systems. Our Linux systems
are built to customer specifications and can be optimized for a wide range of
applications and environments. We build our products with standard components
that adhere to the Intel processor architecture and are carefully selected and
tested for optimal performance in Linux environments. We believe our
comprehensive testing methodology, combined with our significant expertise in
solving hardware and software integration issues in Linux environments, assures
our customers that our systems will not suffer from incompatibility problems.
Our design decisions reflect the benefit of our direct channel sales strategy
which provides us with early and frequent customer feedback on product
improvements.
All our systems come pre-installed with a version of a popular Linux
distribution which we customize to enhance quality and performance for our
customer's particular application requirements. All improvements to popular
distributions are posted to the Internet in open source form immediately,
enabling us to maintain our standing as an active open source community
participant.
We have devoted significant engineering efforts to design our servers for
Internet-related applications. For example, we have focused on reducing the
height of our server designs to facilitate high-density, rackmount deployments.
This reduces our customers' space requirements which can, among other things,
lower the costs of deployment in co-location facilities. Our recently introduced
FullOn server offers one of
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the highest disk storage densities of any 3.5 inch rackmount system in the
industry for any operating system. In addition, our FullOn servers feature
support for redundant arrays of independent disks, or RAID, configurations.
FullOn's dual processor configuration, for example, allows up to five 1.6 inch
10,000 revolution per minute disk drives, any of which can be swapped while the
system is running.
We offer a broad range of desktop configurations, from value-priced to
high-end models. Our high-end desktops are designed for computing-intensive
applications, such as Linux development. Most of these products feature RAID
support and external storage, which positions them as very cost-effective
departmental file and database servers.
Our customers benefit from a single point of contact for complete system
support. All our system sales include six software support calls for the first
12 months, along with two day return-to-depot hardware service. By contrast,
customers of other vendors are often required to purchase Linux service and
support separately from their system provider, which adds significantly to the
total cost.
We introduce new configurations frequently. The following table details our
server and desktop configurations available as of September 1999:
<TABLE>
<CAPTION>
MODEL PROCESSOR MEMORY INTERNAL DISC TARGET MARKET
----- --------- ------ ------------- -------------
<S> <C> <C> <C> <C>
DESKTOP TOWERS
StartX SP Intel Celeron (500MHz) 64-256MB 6.4GB Linux community developers
Students
StartX MP Intel Pentium III (Dual 600MHz) 128MB-1GB 6.4-36.4GB Software developers
Local serving
StartX ZP Intel Pentium III XEON (Dual 128MB-1GB 9.1-36.4GB Technical applications
500MHz) Local serving
RACKMOUNT SERVERS
501 (2u) Intel Pentium III (Dual 600MHz) 128MB-1GB 9.1-144.0GB Internet and web serving
Compute clustering
FullOn 2X2 (2u) Intel Pentium III (Dual 600MHz) 256MB-2GB 6.4-180.0GB High-performance, high-density
Internet and web serving
High-performance clustering
700 (4u) Intel Pentium III (Dual 600MHz) 128MB-1GB 9.1-144.0GB Internet serving
I/O expansion
3500 (7u) Intel Pentium III XEON (Quad 1-2GB 9.1GB-3.2TB High-performance computer
550MHz) serving databases
</TABLE>
Service and Support
We believe that in an open source computing environment an integrated
product and service organization is essential for the delivery of effective and
low-cost solutions. Because of the variability of open source software and the
challenges associated with integrating this continuously evolving software with
standard hardware packages, we believe only a vendor that has expertise with
both can maintain a strong standing with the open source community and be in a
position to select the best available software and hardware products to provide
high-quality, low-cost solutions to customers.
Open Source Community Relationship. The quality of our services is
dependent on the efforts and the expertise of members of the open source
community. It is imperative, therefore, that we continue to work productively
with these community members. We do so by actively sponsoring, contributing to
or otherwise supporting dozens of open source projects. In addition, unlike some
vendors of Linux distributions which act as intermediaries between Linux users
and developers, we help establish direct communication between our customers and
members of the development community.
Professional Services. We have recently established a professional service
organization that offers a comprehensive suite of services that reduce our
customers' time to implement Linux-based infrastructure solutions and improve
the scalability and security of these solutions. These services include
planning,
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deployment and installation, systems integration, performance analysis and
security consulting of Linux-based solutions.
Technical Support. We offer a broad range of Linux technical support
products under the product family "Total Linux Coverage" or "VA TLC." For our
commercial customers, we offer 24-hour, seven-days-a-week access to our
technical support specialists by telephone and the Internet. For smaller
customers or end users, we also offer per-incident technical support products
and upgrades through a toll-free telephone number and our web site. All products
include comprehensive support for our systems and Linux software.
Extended Warranties and Onsite Maintenance. As part of our Total Linux
Coverage product family, we offer customers a broad range of warranty and onsite
maintenance services. Our standard service options include next business day
onsite response for systems maintenance throughout North America and three year
warranties for systems and components. For our commercial customers, we offer
same day priority onsite response, with assigned technical support specialists
for their specific Linux configuration.
Customer Service. Our customers can access phone and onsite support across
the United States and Canada 24 hours a day, seven days a week. We have
partnered with DecisionOne, a leading provider of computer maintenance and
support services, for the provision of call center and onsite service functions
to our customers. We have trained DecisionOne employees who are dedicated to
Linux support and who do not support any other systems vendors.
INTERNET OPERATIONS
A central component of our business strategy is to leverage the Internet to
enhance our ties with the open source development community and promote market
acceptance of Linux solutions. The Internet is the primary communication medium
for open source community vendors and developers. In addition, information about
Linux is widely dispersed on the Internet. Therefore, prominent web sites are
important mechanisms for attracting open source community members, providing a
forum to link customers with other community members, facilitating the
initiation of open source projects and promoting the growth of Linux-based
solutions.
In addition to our support of numerous open source web sites through the
donation of systems, hosting and systems administration support, we own and
manage several sites that are widely used by the open source community and our
customer base.
- linux.com is our flagship web site which contains news, links and
articles of interest to open source community members. Its focus is on
corporate Linux usage, customization and support.
- themes.org is a repository of desktop themes. Desktop themes are
background images, icons and other graphic customizations for the window
systems used in Linux and popular Unix operating systems.
- valinux.com is our e-commerce site which provides company and product
information and allows customers to order customized systems as well as
to access professional and customer support online.
linux.com and themes.org are continually updated and enhanced with
significant content contributions from the open source community.
ENGINEERING
We offer our customers a broad range of technical expertise in Linux-based
systems and software design. As of July 31, 1999, our engineering organization
consisted of 29 employees. Our organization combines extensive knowledge of
desktop, server and cluster hardware architectures with in-depth expertise on
how to optimize the performance of Linux for these architectures.
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Software Engineering
As of July 31, 1999, we had 20 software engineers. These engineers
primarily work to advance Linux technology and customize popular Linux
distributions for our customers. We participate in the development of Linux and
our team includes many recognized technologists who have made significant
contributions to the Linux code base. As a result, our software engineers enjoy
an in-depth understanding of the capabilities of the Linux operating system. Our
software engineers concentrate their efforts on several Linux disciplines,
including kernel and driver development; distribution and product releases; and
advanced projects, such as desktop and graphics applications and the VACM
cluster management software.
Systems Engineering
As of July 31, 1999, we had a staff of five engineers dedicated to systems
engineering and mechanical design. These engineers design our printed circuit
boards, sheet metal chassis and molded plastic parts and have significant
expertise in designing high-density Intel processor-based systems, including
backplane and high-performance input/output design. We believe our designs are
industry leaders in storage density, clustering technology, thermal management
capabilities, manufacturability, reliability, serviceability and low cost.
Open Source Development Projects
We devote some of our resources to, and encourage our employees to be
actively involved in, open source development projects. By contributing to these
projects, our employees expand our relationships with open source community
members, assist in improving open source software and remain current with all
developments in the open source community. Our employees actively contribute to
a variety of significant and ongoing Linux projects. The following table
highlights some of these efforts:
<TABLE>
<CAPTION>
PROJECT DESCRIPTION PARTICIPATING EMPLOYEES
- ------- ----------- -----------------------
<S> <C> <C>
Linux Kernel Linux operating Ted T'so
system-related development San "nettwerk" Mehat
Leonard Zubkoff
Walt Drummond
H. J. Lu
XFree86 Xwindow system Mark Vojkovich
Brad Grantham
Enlightenment Window manager Geoff "mandrake" Harrison
Carsten "rasterman" Haitzler
VACM Cluster management system Michael Jennings
San Mehat
Perl Scripting language Chip Salzenberg
Debian Debian distribution Sean Perry
Joey Hess
Linux International Linux advocacy Jon "maddog" Hall
</TABLE>
CUSTOMERS
Our Linux products and services are targeted primarily at Internet
infrastructure and scientific computing applications that demand highly scalable
and reliable solutions. We believe that sales related to Internet infrastructure
solutions will represent an increasing portion of our revenues. In addition, as
Linux becomes more widely deployed, we see a significant opportunity to increase
sales of Linux desktops. The
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following is a representative list of our customers, each from which we derived
more than $50,000 in revenues in fiscal 1999:
Akamai Technologies, Inc.
Amteva Technologies, Inc.
Argonne National Laboratory
Brookhaven National Laboratory
Cavalier Telephone
Cisco Systems, Inc.
CNET, Inc.
Connect Innovations, Inc.
Cox Interactive Media, Inc.
Donald Danforth Plant Sciences Center
Dartmouth College
eCollege.com
El Camino Resources International, Inc.
EMC Corporation
eToys Inc.
Exodus Communications, Inc.
Forman Interactive Corp.
France Telecom
Global Proximity Corporation
GTE Corporation
Hyseq, Inc.
Inabata America Corporation
Integral Access, Inc.
IX Development Laboratories Inc.
Linuxcare, Inc.
Lucent Technologies Inc.
Massachusetts Inst. of Tech.
Music Connection Corporation
NaviSite, Inc.
NeoPlanet, Inc.
Powerize.com, Inc.
Rainmaker Digital Inc.
Rhone-Poulenc Rorer Inc.
Sandia National Laboratories
Sarnoff Corporation
Stanford University
StarMedia Network, Inc.
Telestor SARL
TIBCO Software Inc.
Tucows.Com Inc.
24/7 Media, Inc.
Universidade Estadual Paulista
ViaNet Communications
Virtual Networks, Inc.
WinStar Communications, Inc.
Customer Case Studies
Akamai Technologies, Inc. Akamai provides a global Internet content
delivery service that improves web site speed and reliability. Akamai required
their own Linux distribution and a solution tightly integrated with networking
products. Akamai purchased a large number of servers from us to help support the
anticipated traffic load of NetAid, a live multi-media Internet based
entertainment event. Akamai purchased our 501 servers. Akamai selected us for
their web caching requirements due to our expertise in Linux development and
customization, our ability to manufacture a large number of systems quickly and
our ability to provide high-quality systems integration and implementation
service. We configured, shipped and installed over 300 servers in less than 30
days.
Blue Mountain Arts. Blue Mountain Arts is an electronic greeting card
publisher based in San Diego, California which offers free electronic animated
and musical greeting cards that can be emailed to anyone in the world.
Bluemountain.com is among the most heavily trafficked web sites in the world.
Blue Mountain required a system that could support their architecture for heavy
internet traffic loads in a very cost-effective implementation. Blue Mountain
selected us after deciding that Linux on Intel Architecture was significantly
better for their needs, and that our quality was superior to that provided by
other Linux solutions.
Donald Danforth Plant Sciences Center. Donald Danforth Plant Sciences
Center is a non-profit laboratory dedicated to furthering the knowledge of plant
sciences. Research at this laboratory includes computational genomics,
bioinformatics, protein function prediction, elucidation of metabolic pathways
and development and implementation of algorithms for large-scale computer
simulations of proteins. Danforth required a large group of small form-factor
systems for this processing, and they were particularly concerned about support
of Sun Microsystems' network file system, or NFS. Danforth selected us after a
review of Linux and Linux vendors. In addition to the cost effective performance
and quality of our systems, they were also pleased to find that we employ one of
the leading open source NFS contributors, H.J. Lu.
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SALES AND MARKETING
We sell our products and services primarily through our direct sales
organization in the United States and Canada. We are in the process of entering
into an agreement with a reseller who will market our products to the U.S.
government. As of July 31, 1999, we had 34 sales professionals located in
Arizona, California, Colorado, Illinois, Massachusetts, Michigan, Minnesota, New
York, Texas, Washington, Washington D.C., and Toronto, Ontario. We intend to
expand our sales operations into Europe in the future.
Our sales personnel rely on our commercial web site, valinux.com, to
expedite and process sales. valinux.com incorporates an advanced ordering system
that offers customers and the company a single point of order entry. In August
1999, over 80% of all our sales were processed through our web-based ordering
system. Most of these orders resulted from the efforts of our direct sales
personnel. We believe that, as we build brand name recognition and as market
acceptance of Linux solutions increases, a larger percent of sales will occur
without direct salesperson support.
We continuously strive to associate our brand with Linux and the open
source community in general. We market our products and services aggressively
through online advertising campaigns, traditional media advertising programs,
trade shows, Internet-based video seminars and through our own Internet portals.
Our marketing efforts are both broad-based and focused on specific market
segments that represent significant short-term lead-generation opportunities,
such as the Internet infrastructure and scientific computing markets. Our
Internet infrastructure marketing includes joint-marketing programs with co-
location facilities, such as Abovenet.
MANUFACTURING
We outsource substantially all of our volume manufacturing, materials
procurement, assembly, functional testing, and packaging and distribution to
Synnex of Fremont, California. Synnex will own approximately % of our
common stock immediately following this offering. While all current volume
manufacturing is conducted in Fremont, we intend to initiate contract
manufacturing and distribution activities internationally with Synnex in the
United Kingdom, Japan and Taiwan should sales in those geographic regions grow
sufficiently. We selected Synnex for its technical expertise in build-to-order
production and distribution, large scale component purchasing and distribution
capabilities and international operations. Our relationship with Synnex has
enabled us to reduce our manufacturing and component costs significantly. We
also operate a small internal systems integration and prototyping facility in
Sunnyvale, California.
Substantially all of our functional test, quality assurance and software
loading software utilized by Synnex in the manufacturing process have been
developed and is owned by us. Testing and quality control processes are also
applied to components, parts and subassemblies. Synnex's build-to-order process
enables us to rapidly manufacture customized computer systems and to achieve
high inventory turnover rates and reduced inventory levels, which lessens
exposure to the risk of declining inventory values. This flexible manufacturing
process also enables us to quickly incorporate new technologies and components
into our process quickly while mitigating the risk of excess and obsolete
inventories.
By maintaining rigorous quality control processes, we are able to supply
high quality products. We test components, parts and subassemblies at various
stages in the manufacturing process. We also conduct on-going production
reliability audits and defect tracking for early identification of workmanship
and component problems.
Although most of our components and subassemblies are standard products
sold by multiple vendors, some are available only from one source. For fiscal
2000, we have a single source for power supplies used in our FullOn product. It
would be difficult for us to identify another source of supply if this supplier
were unable to meet our requirements for any reason. Therefore, we are
susceptible to supply shortages and interruptions that could harm our operating
results. Furthermore, overall market conditions affecting supply and pricing for
key commodity components are known to fluctuate significantly at times. Recently
the
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price of memory chips has increased significantly. Increases in costs of key
components could harm our results of operations.
We continuously seek to improve our manufacturing operating efficiencies
through the use of new technologies. For example, to facilitate rapid and
accurate ordering, manufacturing and fulfillment of products, we have
implemented a complete end-to-end e-commerce solution. We intend to continue
integrating additional order fulfillment, tracking and related functionality
into our back-office systems.
COMPETITION
We compete in markets that are new, intensely competitive, highly
fragmented and rapidly changing. We face competition primarily from computer
vendors that provide solutions for distributed computing systems.
Companies offering competitive products vary in scope and breadth of
products and services offered and include:
- general purpose computer systems manufacturers such as Compaq Computer,
Dell Computer, Hewlett-Packard, IBM and Sun Microsystems, all of which,
except Sun Microsystems, have recently introduced Linux-based systems;
and
- Linux service and software vendors.
We believe we compete favorably on the principal factors that will draw end
users to a Linux-based systems, which include:
- product functionality;
- quality of product and product support;
- total cost of ownership;
- system performance at different price points;
- reusability for multiple applications;
- sales and distribution efficiency;
- brand name recognition; and
- quality and availability of professional services.
To be competitive, we must respond promptly and effectively to the
challenges of technological change, evolving standards and our competitors'
innovations by continuing to enhance our products and grow our sales and
professional services organizations. Any pricing pressures or loss of potential
customers resulting from our failure to compete effectively would reduce our
revenues.
We expect competition in the computer systems market to increase
significantly as new companies enter the market and current competitors expand
their product lines and services. Many of these potential competitors are likely
to have substantial competitive advantages including:
- greater resources that can be devoted to the development, promotion and
sale of their products;
- more established sales forces and channels;
- greater software development experience; and
- greater name recognition.
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INTELLECTUAL PROPERTY RIGHTS
Our systems consist primarily of commodity hardware components in
combination with the Linux operating system. While we have developed some
proprietary techniques and know how, most of our activities and systems are not
protectable as proprietary intellectual property. To protect our proprietary
intellectual property, we generally enter into confidentiality or license
agreements with our employees, consultants, and corporate partners. We have also
recently commenced a patent program and to date have filed one patent
application. In general, however, we have taken only limited steps to protect
our intellectual property, and most of our activities and systems are not
protectable as proprietary intellectual property.
The measures we do undertake may not be adequate to protect our proprietary
technology, and these measures may not preclude competitors from independently
developing products with functionality or features similar to our products.
There can be no assurance that the precautions we take will prevent
misappropriation or infringement of our technology. Failure to protect our
intellectual property could materially harm our business.
Furthermore, we are committed to open source software. In the future, to
the extent that we develop internal software projects that we could make
proprietary, we may instead choose to develop them under open source licenses.
To date, we have licensed almost all of our software development projects under
open source licenses.
Litigation may be necessary in the future to enforce our intellectual
property rights, to protect our trade secrets, or to determine the validity and
scope of the proprietary rights of others. Litigation could result in
substantial costs and diversion of our resources and could materially harm our
business. From time to time, we have received, and may receive in the future,
notice of claims of infringement of third parties' proprietary rights.
Infringement or other claims could be asserted against us in the future, and it
is possible that past or future assertions or prosecutions could harm our
business. Any such claims, with or without merit, could be time-consuming,
result in costly litigation and diversion of technical and management personnel,
cause delays in the development and release of our products, or require us to
develop non-infringing technology or enter into royalty or licensing
arrangements. Such royalty or licensing arrangements, if required, may not be
available on terms acceptable to us, or at all. For these reasons, infringement
claims could materially harm our business.
EMPLOYEES
At July 31, 1999 we had a total of 153 employees, all of whom were based in
the United States and Canada. Of the total, 29 were in research and development,
66 were engaged in sales and marketing, 10 were engaged in customer and
professional services activities and 48 were in administration, finance and
operations. None of our employees are subject to a collective bargaining
agreement and we believe that our relations with our employees are good.
FACILITIES
Our corporate headquarters facility, of approximately 29,326 square feet,
is located in Sunnyvale, California. We occupy our corporate headquarters
facility pursuant to a sublease that expires on September 30, 2000. We expect to
require additional space to meet our needs in the next 12 months. We are
currently evaluating additional space in the local area. We believe that
suitable additional facilities will be available as needed on commercially
reasonable terms.
LEGAL PROCEEDINGS
We are not currently a party to any material legal proceedings.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information with respect to our
executive officers and directors as of September 30, 1999.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Larry M. Augustin......................... 37 President, Chief Executive Officer and Director
Brian D. Biles............................ 41 Vice President, Marketing
Gregory B. Chabrier....................... 45 Vice President, Sales
John T. Hall.............................. 27 Vice President, Support and Professional Services
Todd B. Schull............................ 41 Vice President, Finance and Chief Financial Officer
Daniel R. Shore........................... 35 Vice President, Operations
Gregg E. Zehr............................. 46 Vice President, Engineering
Leonard N. Zubkoff........................ 41 Chief Technical Officer
Jeffry R. Allen(1)........................ 48 Director
Carol A. Bartz(2)......................... 51 Director
Douglas Leone(2).......................... 42 Director
Thomas F. Mendoza(1)...................... 49 Director
Eric S. Raymond........................... 42 Director
Carl Redfield(1).......................... 52 Director
</TABLE>
- ---------------
(1) Member of the audit committee.
(2) Member of the compensation committee.
Larry M. Augustin, one of our founders, has served as our President and
Chief Executive Officer and as a member of our Board of Directors since March
1995. From September 1989 through December 1995, Mr. Augustin was a Consultant
for Fintronic USA, Inc., a provider of high performance EDA tools, and was a
Research Associate at Stanford University. Mr. Augustin is a director of Linux
International, a Linux vendor and advocacy association. Mr. Augustin received a
B.S. degree in Electrical Engineering from the University of Notre Dame, and a
M.S.E.E. and a Ph.D. in Electrical Engineering from Stanford University.
Brian D. Biles has served as our Vice President, Marketing since March
1999. He was a consultant to various companies from June 1998 to March 1999.
Prior to that, Mr. Biles was Director of Marketing, Enterprise Network Products
Group at Sun Microsystems, where he worked from September 1987 to April 1998.
Mr. Biles received a B.A. degree in Computer Information Sciences from the
University of California at Santa Cruz.
Gregory B. Chabrier has served as our Vice President, Sales since January
1999. Mr. Chabrier was President at Vendre, a maker of web-based sales tools,
from June 1998 to December 1998. From May 1997 to May 1998, he was Vice
President of Sales at Selectica, a developer of configuration software. Mr.
Chabrier was Vice President of Sales at Calico Technology, a maker of sales
configuration software, from March 1996 through April 1997. Mr. Chabrier was
Vice President of Field Operations at HAL Computer Systems, the producer of the
Fujitsu Ultra SPARC based SMP server series, where he worked from October 1991
to March 1996. Mr. Chabrier received a B.S. degree in Physics from the
University of California at Davis and an M.B.A. degree from the University of
Santa Clara.
John T. Hall has served as our Vice President, Support and Professional
Services since August 1998. He was our Vice President, Finance from August 1997
through August 1998. Prior to that, Mr. Hall was Chief Executive Officer and a
founder of Stanford Student Enterprises, a student-managed company that provides
campus services through its subsidiaries, from August 1996 through June 1997.
From May 1995 to June 1997, Mr. Hall was the head counselor at the Bridge, a
suicide prevention and counseling center in Palo Alto, California.
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<PAGE> 52
Todd B. Schull has served as our Vice President, Finance and Chief
Financial Officer since June 1999. He was Vice President and Chief Financial
Officer at Repeater Technologies, Inc, a wireless infrastructure company, from
January 1997 through May 1999. Mr. Schull held various positions, most recently
Vice President of Finance, North America and Corporate Controller at Solectron
Corporation, from December 1987 through December 1996. Mr. Schull received a
B.S. degree in Accounting from the University of Utah, and is a Certified Public
Accountant.
Daniel R. Shore has served as our Vice President, Operations since November
1998. He was Director of Operations, Digital Video Group at Philips Consumer
Electronics from November 1997 through October 1998. Mr. Shore held various
positions, including Business Unit General Manager and Product Marketing Manager
for AccuTouch and TouchMonitor Business Unit, at Elo TouchSystems, a leading
supplier of touch screen computers, from June 1990 through November 1997. Mr.
Shore received a B.S. degree in Mechanical Engineering from the University of
Tennessee College of Engineering and an M.A. degree in Economics from the
University of Tennessee Graduate School of Business.
Gregg E. Zehr has served as our Vice President of Engineering since
December 1998. He was a founder and Executive Vice President, Engineering at
Ridge Technologies, a company that provides external RAID storage for NT
servers, from July 1997 to May 1998. Mr. Zehr was Director, Desktop Hardware
Engineering, then Vice President, PowerBook Engineering at Apple Computer, Inc.
from October 1988 to July 1997. Mr. Zehr received a B.S. degree in Electrical
Engineering and an M.S.E.E. from the University of Illinois.
Leonard N. Zubkoff has served as our Chief Technical Officer since July
1998. He was a member of the principal technical staff at Oracle Corporation
from December 1993 to June 1998. Prior to that, he held various technical
positions, most recently Principal Scientist, at Lucid, Incorporated, a LISP and
C/C++ software company, from February 1985 through September 1993. Mr. Zubkoff
received a B.A. degree in Mathematics and Physics from the University of
Rochester and an M.S. degree in Computer Science from Carnegie-Mellon
University.
Jeffry R. Allen has served on our Board of Directors since October 1998. He
has been with Network Appliance, Inc., a leading provider of network data access
solutions, since December 1996, where he currently serves as Senior Vice
President, Finance and Operations, Chief Financial Officer and Secretary. Prior
to December 1996, Mr. Allen served in various capacities, including Senior Vice
President of Operations and Vice President and Controller of Bay Networks, Inc.,
a networking company, from October 1994 to December 1996. Mr. Allen received a
B.S. degree from San Diego State University.
Carol A. Bartz has served on our Board of Directors since July 1999. She
has served as Chief Executive Officer and Chairman of the Board of Autodesk Inc.
since May 1992. Ms. Bartz served as President of Autodesk from May 1992 through
September 1996, and from June 1999 to the present. Ms. Bartz is a director of
Network Appliance, Inc., a leading provider of network data access solutions,
BEA Systems, Inc., a provider of software that allows cross-platform middleware
solutions from enterprise business applications, Cadence Design Systems, Inc., a
leading electronic design firm, and Cisco Systems, Inc. Ms. Bartz received a
B.S. degree in Computer Science from the University of Wisconsin.
Douglas Leone has served on our Board of Directors since October 1998. He
has been at Sequoia Capital, a venture capital firm, since July 1988 and has
been a General Partner since 1993. He is a member of the board of directors of
Scient Corporation and several other private corporations. Mr. Leone received a
B.S. degree in Mechanical Engineering from Cornell University, a M.S. degree in
Industrial Engineering from Columbia University and an M.S. degree in Management
from Massachusetts Institute of Technology, Sloan School of Management.
Thomas F. Mendoza has served on our Board of Directors since July 1999. He
has served as Vice President, Worldwide Sales of Network Appliance, Inc., a
leading provider of network data access solutions, since May 1994 and Senior
Vice President, Marketing and Sales since May 1998. Mr. Mendoza received a B.S.
degree in Economics from the University of Notre Dame.
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<PAGE> 53
Eric S. Raymond has served on our Board of Directors since October 1998. He
has served as Technical Director at Chester County InterLink, a nonprofit
Internet service provider, since September 1993. Prior to that, Mr. Raymond was
an independent consultant from May 1985 through October 1993.
Carl Redfield has served on our Board of Directors since October 1998. He
has served as Senior Vice President, Manufacturing and Logistics of Cisco
Systems, Inc. since February 1997. From September 1993 through February 1997,
Mr. Redfield was Vice President of Manufacturing of Cisco Systems. Mr. Redfield
serves on the boards of CTC Communications, Inc. and iBASIS Inc., both of which
are competitive local exchange carriers. Mr. Redfield received a B.S. degree in
Materials Engineering from Rensselaer Polytechnic Institute and an M.B.A. degree
from Harvard Business School.
BOARD OF DIRECTORS
Our Board of Directors currently consists of seven members. Each director
holds office until his or her term expires or until his or her successor is duly
elected and qualified. Upon completion of this offering, our amended and
restated certificate of incorporation and bylaws will provide for a classified
Board of Directors. In accordance with the terms of our certificate, our Board
of Directors will be divided into three classes whose terms will expire at
different times. The three classes will be comprised of the following directors:
- Class I consists of Messrs. Augustin and Leone, who will serve until the
annual meeting of stockholders to be held in 2000;
- Class II consists of Messrs. Raymond and Redfield, who will serve until
the annual meeting of stockholders to be held in 2001; and
- Class III consists of Messrs. Allen and Mendoza and Ms. Bartz, who will
serve until the annual meeting of stockholders to be held in 2002.
At each annual meeting of stockholders beginning with the 2000 annual
meeting, the successors to directors whose terms will then expire will be
elected to serve from the time of election and qualification until the third
annual meeting following election and until their successors have been duly
elected and qualified. Any additional directorships resulting from an increase
in the number of directors will be distributed among the three classes so that,
as nearly as possible, each class will consist of an equal number of directors.
Committees
Our Board of Directors has an audit committee and a compensation committee.
The audit committee consists of Messrs. Allen, Mendoza and Redfield. The audit
committee reviews our internal accounting procedures, consults with and reviews
the services provided by our independent accountants and makes recommendations
to the Board of Directors regarding the selection of independent accountants.
The compensation committee consists of Ms. Bartz and Mr. Leone. The compensation
committee reviews and recommends to the Board of Directors the salaries,
incentive compensation and benefits of our officers and employees and
administers our stock plans and employee benefit plans.
Compensation Committee Interlocks and Insider Participation
Our Board of Directors established the compensation committee in October
1999. Prior to establishing the compensation committee, our Board of Directors
as a whole performed the functions delegated to the compensation committee. Ms.
Bartz, a member of our compensation committee, serves as a member of the board
of directors and compensation committee of Network Appliance, Inc. of which
Messrs. Allen and Mendoza are executive officers. No other member of our
compensation committee has served as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving as a member of our Board of Directors or compensation committee. Since
the formation of our compensation committee, none of its members has been our
officer or employee.
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<PAGE> 54
Compensation
We reimburse our directors who are not officers or employees for expenses
incurred in attending any Board of Directors or committee meeting. Directors who
are also our officers or employees are not reimbursed for expenses incurred in
attending Board of Directors or committee meetings.
Effective upon the closing of this offering, our non-employee directors
also will be eligible to participate in our 1999 Director Option Plan. Each
non-employee director who joins our Board of Directors after this offering will
automatically receive a grant of an option to purchase 40,000 shares of our
common stock on the date on which such person becomes a director. The shares
subject to each of these options will vest over a four year period following the
date of grant with 1/4 vesting one year from the date of grant and 1/48 vesting
each month thereafter. Additionally, beginning at our annual meeting of
stockholders to be held in 2000 and at each successive annual stockholder
meeting, each non-employee director who has previously served at least six
consecutive months prior thereto (including our current non-employee directors)
will receive an option to purchase 16,000 shares of our common stock which will
also vest over four years. The vesting of these options will automatically
accelerate upon a change of control of our company. The exercise price per share
for all options automatically granted to directors under our 1999 Director
Option Plan will be equal to the market price of our common stock on the date of
grant and will have a ten year term, but will generally terminate within a
specified time, as defined in the 1999 Director Option Plan, following the date
the option holder ceases to be a director or consultant.
Employee directors, including Mr. Augustin, are eligible to participate in
our 1999 Employee Stock Purchase Plan and to receive discretionary grants under
our 1998 Stock Plan.
EXECUTIVE OFFICERS
Our executive officers are appointed by our Board of Directors and serve
until their successors are elected or appointed.
Compensation
The following table sets forth all compensation paid or accrued during
fiscal 1999 to our President and Chief Executive Officer, and each of our four
other most highly compensated officers whose annual compensation exceeded
$100,000 for the period. Messrs. Hall, Shore and Zehr joined us during fiscal
1999 and therefore their annual compensation does not reflect their full base
salary.
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
ANNUAL COMPENSATION SECURITIES ------------
------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITIONS SALARY BONUS OPTIONS COMPENSATION
- ---------------------------- -------- ------- ------------ ------------
<S> <C> <C> <C> <C>
Larry M. Augustin............................. $ 96,133 $ 6,199 1,155,000 $13,294(1)
President and Chief Executive Officer
Gregg E. Zehr................................. 116,667 31,250 665,910 --
Vice President, Engineering
Daniel R. Shore(2)............................ 94,225 45,500 499,434 37,836(2)
Vice President, Operations
John T. Hall.................................. 99,100 7,967 2,919,000 --
Vice President, Support and Professional
Services
Leonard N. Zubkoff............................ 98,200 2,200 2,376,000 --
Chief Technology Officer
</TABLE>
- ---------------
(1) We forgave and wrote off a loan in the principal amount of $13,294 to Mr.
Augustin.
(2) We paid $37,836 in premiums for a life insurance policy payable to Mr.
Shore's wife.
Option Grants in Fiscal 1999
The following table sets forth information concerning grants of stock
options to each of the executive officers named in the compensation table above
during fiscal year 1999. All options granted to these
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<PAGE> 55
executive officers in the last fiscal year were granted under the 1998 Stock
Plan. One-quarter of the shares subject to each option vests and becomes
exercisable on the first anniversary of the date of grant, and an additional
1/48 of the shares subject to each option vests each month thereafter. In
addition, options granted to each of the individuals set forth below may be
early exercised, provided that such individual enters into a restricted stock
purchase agreement. The shares thus acquired remain subject to a right of
repurchase by us. The percent of the total options set forth below is based on
an aggregate of 15,962,180 options granted to employees during fiscal 1999. All
options were granted at a fair market value as determined by our Board of
Directors on the date of grant.
Potential realizable value represents hypothetical gains that could be
achieved for the options if exercised at the end of the option term assuming
that the fair market value of the common stock on the date of grant appreciates
at 5% and 10% over the option term (ten years) and that the option is exercised
and sold on the last day of its option term for the appreciated stock price. The
assumed 5% and 10% rates of stock price appreciation are provided in accordance
with rules of the Securities and Exchange Commission and do not represent our
estimate or projection of our future common stock price. Actual gains, if any,
on stock option exercises will depend on the future performance of our common
stock.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
------------------------------------------------------ VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF
SECURITIES OPTIONS STOCK APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM
OPTIONS EMPLOYEES PRICE EXPIRATION --------------------
NAME GRANTED DURING PERIOD PER SHARE DATE 5% 10%
- ---- ---------- ------------- --------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Larry M. Augustin(1).... 1,155,000 7.24% $0.020 09/30/08 $14,527 $36,815
Gregg E. Zehr(1)........ 665,910 4.17 0.043 02/24/09 18,008 45,635
Daniel R. Shore......... 499,434 3.13 0.043 12/08/08 13,506 34,227
John T. Hall(1)......... 2,919,000 18.29 0.020 09/30/08 36,715 93,043
Leonard N. Zubkoff(1)... 2,376,000 14.89 0.020 09/30/08 29,885 75,735
</TABLE>
- ---------------
(1) These options are subject to a change of control provision. One-fourth of
the shares originally granted vest and become immediately exercisable upon
the occurrence of both a change of control and the involuntary termination
of service with us or the termination of service with us without cause.
Aggregate Option Exercises in Fiscal Year 1999 and Values at July 31, 1999
The following table sets forth information concerning option exercises in
fiscal 1999 and exercisable and unexercisable stock options held by the
executive officers named in the summary compensation table at July 31, 1999. The
value of unexercised in-the-money options is based on a value of $1.00 per
share, the fair market value of our common stock as of July 31, 1999, as
determined by our board of directors, minus the actual per share exercise
prices, multiplied by the number of shares underlying the option. All options
were granted under our 1998 Stock Plan.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS IN-THE-MONEY OPTIONS
AT JULY 31, 1999 AT JULY 31, 1999
SHARES ACQUIRED VALUE --------------------------- ---------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- --------------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Larry M. Augustin....... -- -- 1,155,000 -- $1,131,900 --
Gregg E. Zehr........... 665,910 -- -- -- -- --
Daniel R. Shore......... 249,750 -- 249,684 -- 244,274 --
John T. Hall............ 2,919,000 $4,865 -- -- -- --
Leonard N. Zubkoff...... 2,376,000 3,960 -- -- -- --
</TABLE>
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<PAGE> 56
CHANGE OF CONTROL AND EMPLOYMENT AGREEMENTS
In March 1995, we entered into a five year employment agreement with Mr.
Augustin that provides for annual salary and benefits. This agreement has been
terminated.
In October 1998 with each of Messrs. Augustin, Hall, Zehr and Zubkoff, we
entered into stock option agreements under our 1998 Stock Plan, that include
change of control provisions. Each of these agreements provides that if the
officer is terminated without cause or involuntarily terminated upon a change of
control, he will receive one year accelerated vesting of all of his stock
options (or an accelerated lapsing of the repurchase right applicable for the
common stock issued upon an early exercise of the option). If the officer
voluntarily resigns, is terminated for cause or is terminated for any other
reason, he is not entitled to this acceleration.
In October 1998, we entered into a Founder's Stock Repurchase Agreement
with Mr. Augustin. Pursuant to this agreement, we have the right to repurchase
shares from Mr. Augustin that have not been released from our repurchase option.
Sixty percent of Mr. Augustin's 4,950,000 shares were released from the
repurchase option upon execution of the agreement; 1/24 of the remaining shares
are released each month starting in November 1998. This agreement provides that
if Mr. Augustin is terminated without cause or involuntarily terminated, 50% of
the remaining unreleased shares will be released from our repurchase right. If
Mr. Augustin voluntarily resigns, is terminated for cause or is terminated for
any other reason, he is not entitled to this release of shares.
In October 1998, we entered into an employment agreement with Mr. Shore
that provides that if he is involuntarily terminated for any reason, he will
receive a severance package equal to the higher of either one month's salary for
every year of service or three month's salary. In December 1998, we entered into
an employment agreement with Mr. Zehr that provides that if he is involuntarily
terminated for any reason, he will receive a severance package equal to his
salary for six months. These amounts will be paid monthly following the
termination of either officer's employment. We will pay these amounts on a
salary continuation basis with medical benefits coverage during the severance
period.
LIMITATIONS ON DIRECTORS' AND OFFICERS' LIABILITY AND INDEMNIFICATION
Our amended and restated certificate of incorporation to be filed upon
completion of this offering limits the liability of our directors to the maximum
extent permitted by Delaware law. Delaware law provides that directors of a
corporation will not be personally liable for monetary damages for breach of
their fiduciary duties as directors, except liability associated with any of the
following:
- any breach of their duty of loyalty to the corporation or its
stockholders;
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- unlawful payments of dividends or unlawful stock repurchases or
redemption; or
- any transaction from which the director derived an improper personal
benefit.
The limitation of our director's liability does not apply to liabilities
arising under the federal securities laws and does not affect the availability
of equitable remedies such as injunctive relief or rescission.
Our amended and restated certificate of incorporation and bylaws also
provide that we shall indemnify our directors and executive officers and may
indemnify our other officers and employees and other agents to the fullest
extent permitted by law. We believe that indemnification under our bylaws covers
at least negligence and gross negligence on the part of indemnified parties. Our
bylaws also permit us to secure insurance on behalf of any officer, director,
employee or other agent for any liability arising out of his or her actions in
such capacity, regardless of whether our bylaws would permit indemnification.
We are entering into indemnification agreements with each of our officers
and directors containing provisions that require us to, among other things,
indemnify our officers and directors against liabilities that may arise by
reason of their status or service as directors or officers (other than
liabilities arising from willful misconduct of a culpable nature), to advance
their expenses incurred as a result of any proceeding against them as to which
they could be indemnified, and to cover our directors and officers under any of
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<PAGE> 57
our liability insurance policies applicable to our directors and officers. We
believe that these provisions and agreements are necessary to attract and retain
qualified persons as directors and executive officers.
STOCK PLANS
1998 Stock Plan
Our 1998 Stock Plan was originally approved by our Board of Directors and
stockholders in October 1998. On October 7, 1999 our Board of Directors amended
the 1998 Stock Plan, to be effective upon the completion of this offering. We
expect our stockholders will approve this amended plan in November 1999. The
1998 Stock Plan, as amended, provides for the granting to our employees of
incentive stock options within the meaning of Section 422 of the United States
tax code, and for the granting to employees, including officers and directors,
non-employee directors and consultants of non-statutory stock options and stock
purchase rights. We have reserved an aggregate of 27,257,144 shares of common
stock for issuance under this plan. The number of shares reserved for issuance
under this plan will be subject to an annual increase on the first day of each
fiscal year equal to the lesser of (a) 4,000,000 shares, (b) 4.9% of the
outstanding shares on that date, or (c) a lesser amount as determined by our
Board of Directors. As of July 31, 1999, options to purchase 6,482,976 shares of
common stock were outstanding under this plan; 10,221,528 shares had been issued
upon exercise of options, net of repurchases, and 6,552,640 shares were
available for future grant. On October 7, 1999, an additional 4,000,000 shares
of common stock was reserved for issuance under this plan. Unless terminated
sooner, the 1998 Stock Plan will terminate automatically in 2008.
Our 1998 Stock Plan is administered by our Board of Directors who determine
the terms of the options or stock purchase rights granted, including the
exercise price, the number of shares subject to each option or stock purchase
right, the vesting and the form of consideration payable upon such exercise. In
addition, the Board of Directors has the authority to amend, suspend or
terminate the plan, provided that no such action may affect any share of common
stock previously issued and sold or any option previously granted and then
outstanding under the plan. The Board of Directors has the exclusive authority
to interpret and apply the provisions of the 1998 Stock Plan.
Options and stock purchase rights granted under our 1998 Stock Plan are not
generally transferable by the optionee, and each option and stock purchase right
is exercisable during the lifetime of the optionee only by the optionee. Options
granted under the 1998 Stock Plan must generally be exercised within three
months of the end of optionee's status as our employee or consultant (or such
shorter time as may be specified in the option agreement), or within twelve
months after his or her termination by death or disability, but in no event
later than the expiration of the option's ten year term. In the case of stock
purchase rights, unless the Board of Directors determines otherwise, the
agreement evidencing the grant shall provide that we have a repurchase option
exercisable upon the voluntary or involuntary termination of his or her
employment for any reason (including death or disability). In this event, the
purchase price per share will be equal to the original price and may be paid by
cancellation of his or her outstanding indebtedness to us, if any. Our
repurchase option shall lapse at a rate determined by the Board of Directors.
The exercise price of any incentive stock options granted under the 1998 Stock
Plan and any non-statutory stock options intended to qualify as
"performance-based compensation" within the meaning of Section 162(m) of the
United States tax code, must be at least equal to the fair market value of our
common stock on the date of grant. With respect to any participant who owns
stock possessing more than 10% of the voting power of all classes of our
outstanding capital stock, the exercise price of any incentive stock option
granted must equal at least 110% of the fair market value on the grant date and
the term of such incentive stock option must not exceed five years. The term of
all other options granted under the 1998 Stock Plan may not exceed ten years.
Options granted under our 1998 Stock Plan, as amended, will accelerate and
become fully vested in the event we are acquired, unless the successor
corporation assumes or substitutes other options in their place.
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<PAGE> 58
1999 Employee Stock Purchase Plan
Our 1999 Employee Stock Purchase Plan was adopted by our Board of Directors
in October 1999 and we expect stockholder approval in November 1999. A total of
1,000,000 shares of common stock have been reserved for issuance under our 1999
Employee Stock Purchase Plan. This plan provides for annual increases equal to
the lesser of (a) 500,000 shares, (b) 1% of the outstanding shares on the last
day of our fiscal year, or (c) a lesser amount determined by our Board of
Directors.
Our 1999 Employee Stock Purchase Plan, which is intended to qualify under
Section 423 of the United States tax code, contains consecutive six month
offering and purchase periods. The offering periods generally start on the first
trading day on or after September 1 and March 1 of each year, except for the
first such offering period which commences on the first trading day on or after
the effective date of this offering and ends on the last trading day on or
before August 31, 2000.
Employees are eligible to participate if they are customarily employed by
us or any participating subsidiary for at least 20 hours per week and more than
five months in any calendar year. However, any employee who immediately after
grant owns stock possessing 5% or more of the total combined voting power or
value of all classes of our capital stock, or whose rights to purchase stock
under all of our employee stock purchase plans accrues at a rate which exceeds
$25,000 worth of stock for each calendar year may not be granted an option to
purchase stock under this plan. The 1999 Employee Stock Purchase Plan permits
participants to purchase common stock through payroll deductions of up to 10% of
the participant's "compensation." Compensation is defined as the participant's
base straight time gross earnings and commissions, but is exclusive of payments
for overtime, shift premium payments, incentive compensation, incentive
payments, bonuses and other compensation.
Amounts deducted and accumulated by the participant are used to purchase
shares of common stock at the end of each purchase period. The price of stock
purchased under the 1999 Employee Stock Purchase Plan is generally 85% of the
lower of the fair market value of the common stock at the beginning of the
offering period, or at the end of the purchase period. Participants may end
their participation at any time during an offering period, and they will be paid
their payroll deductions to date. Participation ends automatically upon
termination of employment with us.
Rights granted under the 1999 Employee Stock Purchase Plan are not
transferable by a participant other than by will, the laws of descent and
distribution, or as otherwise provided under the plan. The 1999 Employee Stock
Purchase Plan provides that, in the event of our merger with or into another
corporation or a sale of substantially all our assets, each outstanding option
may be assumed or substituted for a new option by the successor corporation. If
the successor corporation refuses to assume or substitute a new option for the
outstanding options, the offering period then in progress will be shortened and
a new exercise date will be set. The 1999 Employee Stock Purchase Plan will
terminate automatically in 2009, unless terminated earlier. The Board of
Directors has the authority to amend or terminate the purchase plan, except that
no such action may adversely affect any outstanding rights to purchase stock
under the purchase plan. The Board of Directors has the exclusive authority to
interpret and apply the provisions of the purchase plan.
1999 Director Option Plan
Our 1999 Director Option Plan was approved by our Board of Directors in
October 1999 and we expect our stockholders to approve it in November 1999. A
total of 500,000 shares of our common stock have been reserved for issuance
under our 1999 Director Option Plan. This plan provides for annual increases
equal to the lesser of (a) 250,000 shares, (b) 0.5% of the outstanding shares on
the last day of our fiscal year, or (c) a lesser amount determined by our Board
of Directors. No awards will be made under the 1999 Director Option Plan until a
new non-employee director is elected after the completion of this offering. The
purpose of the 1999 Director Option Plan is to attract and retain the best
available non-employee directors, to provide them additional incentives and,
therefore, to promote the success of our business.
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<PAGE> 59
The 1999 Director Option Plan establishes an automatic grant of 40,000
shares of common stock to each non-employee director who is elected after the
completion of this offering. The 1999 Director Option Plan also provides that
upon the date of each annual stockholders' meeting, each non-employee director
who has been a member of our Board of Directors for at least six months prior to
the date of the stockholders' meeting (including our current non-employee
directors) will receive automatic annual grants of options to acquire 16,000
shares of our common stock.
Each automatic grant will have an exercise price per share equal to the
fair market value of our common stock at the date of grant and will vest as to
1/4 of the shares subject to the option one year after the date of grant and
1/48 each month thereafter. Each automatic grant will have a term of ten years.
The 1999 Director Option Plan is administered by our Board of Directors or by a
committee designated by our Board of Directors constituted to permit
non-employee director awards to be exempt from Section 16(b) of the Exchange Act
in accordance with Rule 16(b)-3 thereunder. The administrator shall approve
forms of award agreements for use under the plan, determine the terms and
conditions of awards pursuant to the 1999 Director Option Plan and construe and
interpret the terms of the plan and awards granted under it.
In the event of our merger with another corporation or the sale of
substantially all of our assets, each non-employee director's outstanding option
will become fully vested and exercisable. Options granted under the 1999
Director Option Plan must be exercised within 3 months of the end of the
non-employee director's tenure as a member of our Board of Directors, or within
12 months after a non-employee director's termination by death or disability,
provided that the option does not terminate by its terms earlier.
Unless terminated sooner, our 1999 Director Option Plan terminates
automatically in 2009. Our Board of Directors has the authority to amend,
suspend or terminate the plan, subject to stockholder approval of some
amendments and provided no amendment, suspension or termination may affect
awards to non-employee directors previously granted under the plan, unless
agreed to by the affected non-employee director.
401(k) Plan
In September 1998, we adopted a 401(k) Profit Sharing Plan and Trust
covering our employees who are age 21 as of the 401(k) Profit Sharing Plan and
Trust effective date, and/or have at least 1,000 hours of service credited as of
their anniversary hire date with us and for every plan year thereafter. The
401(k) Profit Sharing Plan and Trust excludes nonresident alien employees. The
401(k) Profit Sharing Plan and Trust is intended to qualify under Section 401(k)
of the United States tax code, so that contributions to the 401(k) Profit
Sharing Plan and Trust by employees or by us and the investment earnings thereon
are not taxable to the employees until withdrawn. If our 401(k) Profit Sharing
Plan and Trust qualifies under Section 401(k) of the United States tax code, our
contributions will be deductible by us when made. Our employees may elect to
reduce their current compensation by up to the statutorily prescribed annual
limit of $10,000 in 1999 and to have those funds contributed to the 401(k)
Profit Sharing Plan and Trust. The 401(k) Profit Sharing Plan and Trust permits
us, but does not require us, to make additional matching contributions on behalf
of all participants. To date, we have not made any contributions to the 401(k)
Profit Sharing Plan and Trust.
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<PAGE> 60
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PREFERRED STOCK.
On October 30, 1998 and February 19, 1999, we sold an aggregate of
8,623,773 shares and 3,525,549 shares, respectively, of our series A preferred
stock at a purchase price of $0.4567 per share. On July 16, 1999 and September
24, 1999, we sold an aggregate of 6,502,592 shares and 1,256,454 shares,
respectively, of our series B preferred stock at a purchase price of $3.86 per
share. On August 1, 1999, we issued 12,954 shares of our series B preferred
stock in consideration for certain assets. The following officer, directors and
5% stockholders purchased shares in these financings:
<TABLE>
<CAPTION>
SHARES OF SHARES OF
PURCHASER SERIES A STOCK SERIES B STOCK
- --------- -------------- --------------
<S> <C> <C>
Sequoia Entities:
Sequoia Capital VIII................................... 7,299,666 469,586
Sequoia International Technology Partners VIII(Q)...... 483,261 31,088
CMS Partners LLC....................................... 161,088 10,362
Sequoia International Technology Partners VIII......... 92,625 5,958
Sequoia 1997........................................... 17,718 1,140
Sequoia Capital Franchise Fund......................... -- 419,690
Sequoia Capital Franchise Partners..................... -- 46,632
Intel Corporation........................................ 3,284,673 259,068
Larry M. Augustin........................................ 109,488 --
</TABLE>
CMS Partners LLC, Sequoia International Technology Partners VIII(Q),
Sequoia Capital VIII, Sequoia International Technology Partners VIII and Sequoia
1997 are affiliated entities and together are considered a 5% stockholder. Mr.
Leone, one of our directors, is the managing member of the general partner of
Sequoia International Technology Partners VIII(Q), Sequoia Capital VIII and
Sequoia International Technology Partners VIII, and has signature authority for
CMS Partners LLC and Sequoia 1997. Mr. Leone disclaims beneficial ownership of
the securities held by such entities, except for his proportional interest in
the entities. Larry M. Augustin is our President, Chief Executive Officer, one
of our directors and a 5% stockholder.
INVESTOR RIGHTS AGREEMENT.
We have entered into an agreement with the preferred stockholders described
above pursuant to which these and other preferred stockholders will have
registration rights with respect to their shares of common stock following this
offering. For a description of these registration rights, see "Description of
Capital Stock." Upon the completion of this offering, all shares of our
outstanding preferred stock will be automatically converted into an equal number
of shares of common stock.
STOCK OPTION GRANTS TO OFFICERS AND DIRECTORS.
During fiscal 1999, we granted the following options to purchase our common
stock to our officers, directors and stockholders who beneficially own 5% or
more of our common stock. In order to comply with the closing conditions of the
investors for the sale of the series A preferred stock, on October 1, 1998,
options previously granted to Messrs. Augustin, Hall and Zubkoff were cancelled
and exchanged for options to purchase the same number of shares of common stock
under our 1998 Stock Plan. These new options had vesting and pricing terms
consistent with the prior grants.
59
<PAGE> 61
<TABLE>
<CAPTION>
EXERCISE PRICE
NAME DATE OF GRANT OPTIONS PER SHARE
- ---- ---------------- --------- --------------
<S> <C> <C> <C>
Larry M. Augustin............................... October 1, 1998 1,155,000 $0.02
John T. Hall.................................... October 1, 1998 2,919,000 0.02
Leonard N. Zubkoff.............................. October 1, 1998 2,376,000 0.02
Jeffry R. Allen................................. October 13, 1998 150,000 0.043
Eric S. Raymond................................. October 13, 1998 150,000 0.043
Carl Redfield................................... October 13, 1998 150,000 0.043
Daniel R. Shore................................. December 9, 1998 499,434 0.043
Gregory B. Chabrier............................. February 25, 499,434 0.043
1999
Gregg E. Zehr................................... February 25, 665,910 0.043
1999
Brian D. Biles.................................. April 13, 1999 499,434 0.50
Todd B. Schull.................................. June 1, 1999 499,434 0.50
Carol A. Bartz.................................. July 14, 1999 150,000 1.00
Thomas F. Mendoza............................... July 14, 1999 150,000 1.00
</TABLE>
INDEMNIFICATION, CHANGE OF CONTROL AND EMPLOYMENT AGREEMENTS.
We are entering into indemnification agreements with each of our directors
and officers. Such indemnification agreements will require us to indemnify our
directors and officers to the fullest extent permitted by Delaware law. See
"Limitation on Directors' Liability and Indemnification."
For a description of an employment agreement we entered into with Mr.
Augustin and change of control agreements entered into with Messrs. Augustin,
Hall, Zehr and Zubkoff, see "Management -- Change of Control and Employment
Agreements."
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<PAGE> 62
PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of July 31, 1999 and as adjusted to
reflect the sale of common stock offered hereby by:
- each stockholder known by us to own beneficially more than 5% of our
common stock;
- each of our executive officers named in the compensation table above;
- each of our directors; and
- all current directors and executive officers as a group.
Except as otherwise indicated, we believe that the beneficial owners of the
common stock listed below, on the information furnished by such owners, have
sole voting power and investment power with respect to such shares. Beneficial
ownership is determined in accordance with the rules of the Securities and
Exchange Commission. In computing the number of shares beneficially owned by a
person and the percent ownership of that person, shares of common stock subject
to options or warrants held by that person that are currently exercisable or
will become exercisable within 60 days after July 31, 1999 are deemed
outstanding, while such shares are not deemed outstanding for purposes of
computing percent ownership of any other person. Percent of beneficial ownership
is based upon 34,096,774 shares of our common stock outstanding prior to this
offering and shares of common stock outstanding after this
offering. Unless otherwise indicated in the footnotes below, the persons and
entities named in the table have sole voting and investment power with respect
to all shares beneficially owned, subject to community property laws where
applicable. The address for those individuals for which an address is not
otherwise indicated is VA Linux Systems, Inc., 1382 Bordeaux Drive, Sunnyvale,
California 94089.
<TABLE>
<CAPTION>
PERCENT OF SHARES
OUTSTANDING
SHARES --------------------------
BENEFICIALLY PRIOR
OWNED PRIOR TO
NAME OR GROUP OF BENEFICIAL OWNERS TO OFFERING OFFERING AFTER OFFERING
- ---------------------------------- ------------ -------- --------------
<S> <C> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS
Jeffry R. Allen(1)........................................ 259,488 * *
2770 San Tomas
Santa Clara, CA 95051
Larry M. Augustin(2)...................................... 6,598,488 19.4% %
1382 Bordeaux Drive
Sunnyvale, CA 94089
Carol A. Bartz(3)......................................... 150,000 * *
82 Isabella Avenue
Atherton, CA 94027
Douglas Leone(4).......................................... 8,572,492 25.1
Sequoia Capital
3000 Sand Hill Road, Bldg. 4, Ste. 280
Menlo Park, CA 94025
Thomas F. Mendoza(5)...................................... 150,000 * *
79 Selby Lane
Atherton, CA 94027
Eric S. Raymond(1)........................................ 150,000 * *
6 Karen Drive
Malvern, PA 19355
Carl Redfield(1).......................................... 259,488 * *
1669 Cowper Street
Palo Alto, CA 94301
John T. Hall(6)........................................... 2,919,000 8.6 *
Daniel R. Shore(7)........................................ 499,434 1.5 *
</TABLE>
61
<PAGE> 63
<TABLE>
<CAPTION>
PERCENT OF SHARES
OUTSTANDING
SHARES --------------------------
BENEFICIALLY PRIOR
OWNED PRIOR TO
NAME OR GROUP OF BENEFICIAL OWNERS TO OFFERING OFFERING AFTER OFFERING
- ---------------------------------- ------------ -------- --------------
<S> <C> <C> <C>
Gregg E. Zehr(8).......................................... 665,910 2.0 *
Leonard N. Zubkoff(9)..................................... 2,376,000 7.0 *
All directors and officers as a group (14 persons)(10).... 24,098,602 70.7
5% STOCKHOLDERS
Entities affiliated with Sequoia Capital Funds(4)......... 8,572,492 25.1
3000 Sand Hill Road, Building 4, Suite 280
Menlo Park, California 94025
Intel Corporation......................................... 3,543,741 10.4
2200 Mission College Blvd. Mail Stop RN6-46
Santa Clara, CA 95052
Attn: M&A Portfolio Manager
</TABLE>
- ---------------
(1) Includes 150,000 shares subject to our right of repurchase, which lapses
over time.
(2) Includes 1,237,500 shares subject to our right of repurchase, which lapses
over time, and an option exercisable for 1,155,000 shares, of which all
1,155,000 shares may be exercised by Mr. Augustin and upon exercise will
become subject to our right of repurchase, which lapses over time. Also
includes 384,000 shares owned by Alice Kitsuta Augustin, Mr. Augustin's
wife.
(3) Includes an option exercisable for 150,000 shares, of which all 150,000
shares may be exercised by Ms. Bartz and upon exercise will become subject
to our right of repurchase, which lapses over time.
(4) Includes 7,769,252 shares held by Sequoia Capital VIII, 514,349 shares held
by Sequoia International Technology Partners VIII (Q), 171,450 shares held
by CMS Partners LLC, 98,583 shares held by Sequoia International Technology
Partners VIII, and 18,858 shares held by Sequoia 1997. Mr. Leone is the
managing member of Sequoia International Technology Partners VIII, Sequoia
Capital VIII, and Sequoia International Technology Partners VIII (Q), and
has signature authority for CMS Partners LLC and Sequoia 1997. Mr. Leone
disclaims beneficial ownership of shares held by these entities except to
the extent of his pecuniary interest in these entities.
(5) Includes an option exercisable for 150,000 shares, of which all 150,000
shares may be exercised by Mr. Mendoza and upon exercise will become
subject to our right of repurchase, which lapses over time.
(6) Includes 2,919,000 shares subject to our right of repurchase, which lapses
over time.
(7) Includes an option exercisable for 249,684 shares, of which all 249,684
shares may be exercised by Mr. Shore and upon exercise will become subject
to our right of repurchase, which lapses over time.
(8) Includes 665,910 shares subject to our right of repurchase, which lapses
over time.
(9) Includes 2,376,000 shares subject to our right of repurchase, which lapses
over time.
(10) Includes the shares beneficially owned by the persons and entities
described in footnotes (1) - (9).
- ---------------
* Less than 1% of the outstanding shares of common stock.
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<PAGE> 64
DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, we will be authorized to issue
260,000,000 shares, $0.001 par value per share, to be divided into two classes
to be designated common stock and preferred stock. Of the shares authorized,
250,000,000 shares shall be designated as common stock and 10,000,000 shares
shall be designated as preferred stock. The following description of our capital
stock is only a summary. You should refer to our certificate of incorporation
and bylaws as in effect upon the closing of this offering, which are included as
exhibits to the registration statement of which this prospectus forms a part,
and by the provisions of applicable Delaware law.
COMMON STOCK
As of July 31, 1999, and assuming the conversion of all outstanding shares
of preferred stock into common stock, there were 34,096,774 shares of common
stock outstanding which were held of record by approximately 71 stockholders.
There will be shares of common stock outstanding (assuming no exercise
of the underwriters' over-allotment option and no exercise of outstanding
options after July 31, 1999) after giving effect to the sale of our common stock
in this offering. There are outstanding options to purchase a total of 6,667,976
shares of our common stock.
The holders of our common stock are entitled to one vote per share held of
record on all matters submitted to a vote of the stockholders. Our amended and
restated certificate of incorporation to be filed concurrently with completion
of this offering, does not provide for cumulative voting in the election of
directors. Subject to preferences that may be applicable to any outstanding
preferred stock, the holders of common stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by our Board of
Directors out of funds legally available for that purpose. In the event of our
liquidation, dissolution or winding up, holders of our common stock are entitled
to share ratably in all assets remaining after payment of liabilities, subject
to prior distribution rights of preferred stock, if any, then outstanding.
Holders of our common stock have no preemptive or other subscription or
conversion rights. There are no redemption or sinking fund provisions applicable
to our common stock.
PREFERRED STOCK
Upon the completion of this offering and filing of our amended and restated
certificate of incorporation, our Board of Directors will be authorized, without
action by the stockholders, to issue 10,000,000 shares of preferred stock in one
or more series and to fix the rights, preferences, privileges and restrictions
thereof. These rights, preferences and privileges may include dividend rights,
conversion rights, voting rights, terms of redemption, liquidation preferences,
sinking fund terms and the number of shares constituting any series or the
designation of any series, all or any of which may be greater than the rights of
the common stock. It is not possible to state the actual effect of the issuance
of all shares of preferred stock upon the right of holders of our common stock
until our Board of Directors determines the specific rights of the holders of
any preferred stock that may be issued. However, the effect might include, among
other things: (a) restricting dividends on the common stock, (b) diluting the
voting power of the common stock, (c) impairing the liquidation rights of the
common stock and (d) delaying or preventing a change in our control without
further action by the stockholders. Upon the closing of this offering, no shares
of preferred stock will be outstanding and we have no present plans to issue any
shares of preferred stock.
REGISTRATION RIGHTS
Pursuant to a registration rights agreement we entered into with holders of
18,651,914 shares of our common stock (assuming conversion of all outstanding
shares of preferred stock), the holders of these shares are entitled to certain
registration rights regarding these shares. The registration rights provide that
if we propose to register any securities under the Securities Act, either for
our own account or for the account of other security holders exercising
registration rights, they are entitled to notice of the registration and are
entitled to include shares of their common stock in the registration. This right
is subject to conditions and limitations, including the right of the
underwriters in an offering to limit the number of
63
<PAGE> 65
shares included in the registration. The holders of these shares may also
require us to file up to two registration statements under the Securities Act at
our expense with respect to their shares of common stock. We are required to use
our best efforts to effect these registrations, subject to conditions and
limitations. Furthermore, the holders of these shares may require us to file
additional registration statements on Form S-3, subject to conditions and
limitations. These rights terminate on the earlier of five years after the
effective date of this offering, the date on which all shares subject to these
registration rights have been sold to the public, or when a holder is able to
sell all its shares pursuant to Rule 144 under the Securities Action in any
90-day period.
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER AND BYLAW PROVISIONS
Certain provisions of Delaware law and our certificate of incorporation and
bylaws could make our acquisition more difficult by means of a tender offer, a
proxy contest or otherwise and could also make the removal of incumbent officers
and directors more difficult. These provisions, summarized below, are expected
to discourage certain types of coercive takeover practices and inadequate
takeover bids and to encourage persons seeking to acquire control of us to first
negotiate with us. We believe that the benefits of increased protection of our
potential ability to negotiate with the proponent of an unfriendly or
unsolicited proposal to acquire or restructure us outweighs the disadvantages of
discouraging such proposals because, among other things, negotiation of such
proposals could result in an improvement of their terms.
We are subject to Section 203 of the Delaware General Corporation Law, an
anti-takeover law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years following the date the person became an
interested stockholder, unless (with certain exceptions) the "business
combination" or the transaction in which the person became an interested
stockholder is approved in a prescribed manner. Generally, a "business
combination" includes a merger, asset or stock sale, or other transaction
resulting in a financial benefit to the interested stockholder. Generally, an
"interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years prior to the determination of interested
stockholder status, did own) 15% or more of a corporation's voting stock. The
existence of this provision would be expected to have an anti-takeover effect
with respect to transactions not approved in advance by the board of directors,
including discouraging attempts that might result in a premium over the market
price for the shares of common stock held by stockholders.
Our certificate of incorporation eliminates the right of stockholders to
act by written consent without a meeting and limits the ability of stockholders
to call a special meeting. The certificate of incorporation and bylaws do not
provide for cumulative voting in the election of directors. The authorization of
undesignated preferred stock makes it possible for the board of directors to
issue preferred stock with voting or other rights or preferences that could
impede the success of any attempt to change control of our company. These and
other provisions may have the effect of deterring hostile takeovers or delaying
changes in control or management of our company. The amendment of any of these
provisions would require approval by holders of at least 66 2/3 of our
outstanding common stock.
Our Board of Directors will be divided into three classes, each with
staggered three-year terms. As a result, only one class of directors will be
elected at each annual meeting of our stockholders, with the other classes
continuing for the remainder of their respective three-year terms.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is EquiServe.
NASDAQ STOCK MARKET NATIONAL MARKET LISTING
We have applied to list our common stock on The Nasdaq Stock Market's
National Market under the symbol "LNUX."
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<PAGE> 66
SHARES ELIGIBLE FOR FUTURE SALE
Immediately prior to this offering, there was no public market for our
common stock. Future sales of substantial amounts of our common stock in the
public market could adversely affect the market price of our common stock.
Upon completion of this offering, based on shares outstanding as of July
31, 1999, we will have outstanding shares of common stock, assuming
(1) the issuance of shares of common stock in this offering, (2) no
exercise of the underwriters' over-allotment option, and (3) no exercise of
options after July 31, 1999. All of the shares sold in this offering
will be freely tradable without restriction or further registration under the
Securities Act. However, the sale of any of these share if purchased by
"affiliates" as that term is defined in Rule 144 are subject to certain
limitations and restrictions that are described below.
The remaining 34,096,774 shares of common stock held by existing
stockholders were issued and sold by us in reliance on exemptions from the
registration requirements of the Securities Act. These shares are "restricted
shares" as that term is defined in Rule 144 and therefore may not be sold
publicly unless they are registered under the Securities Act or are sold
pursuant to Rule 144 or another exemption from registration. In addition, our
directors and officers as well as other stockholders and optionholders have
entered into "lock-up agreements" with the underwriters. These lock-up
agreements provide that, except under limited exceptions, the stockholder may
not offer, sell, contract to sell, pledge or otherwise dispose of any of our
common stock or securities that are convertible into or exchangeable for, or
that represent the right to receive, our common stock for a period of 180 days
after the date of this prospectus. Credit Suisse First Boston, however, may in
its sole discretion, at any time without notice, release all or any portion of
the shares subject to lock-up agreements. Accordingly, of the remaining
34,096,774 shares, shares will become eligible for sale 180 days
after the effective date subject to Rules 144 and 701.
As of July 31, 1999, there were a total of 6,667,976 shares of common stock
subject to outstanding options, 814,010 of which were vested, and nearly all of
which are subject to lock-up agreements. Immediately after the completion of the
offering, we intend to file registration statements on Form S-8 under the
Securities Act to register all of the shares of common stock issued or reserved
for future issuance under our 1998 Stock Plan, our 1999 Employee Stock Purchase
Plan and our 1999 Director Option Plan. On the date 180 days after the effective
date of the offering, the date that the lock-up agreements expire, a total of
shares of our common stock subject to outstanding options will be
vested. After the effective dates of the registration statements on Form S-8,
shares purchased upon exercise of options granted pursuant to our 1998 Stock
Plan, our 1999 Employee Stock Purchase Plan and our 1999 Director Option Plan
generally would be available for resale in the public market.
Rule 144
In general, under Rule 144 as currently in effect beginning 90 days after
the date of this prospectus, a person who has beneficially owned shares of our
common stock for at least one year would be entitled to sell, within any
three-month period, a number of shares that does not exceed the greater of:
- 1% of the number of shares of common stock then outstanding, which will
equal approximately shares immediately after this offering; or
- the average weekly trading volume of the common stock on the Nasdaq Stock
Market's National Market during the four calendar weeks preceding the
filing of a notice on Form 144 with respect to such sale.
Sales under Rule 144 are also subject to certain other requirements
regarding the manner of sale, notice filing and the availability of current
public information about us.
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<PAGE> 67
Rule 144(K)
Under Rule 144(k), a person who is not deemed to have been one of our
"affiliates" at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years,
generally including the holding period of any prior owner other than an
"affiliate," is entitled to sell such shares without complying with the manner
of sale, notice filing, volume limitation or notice provisions of Rule 144.
Therefore, unless otherwise restricted, "144(k) shares" may be sold immediately
upon the completion of this offering.
Rule 701
In general, under Rule 701, any of our employees, directors, officers,
consultants or advisors who purchase shares from us in connection with a
compensatory stock or option plan or other written agreement before the
effective date of this offering is entitled to resell such shares 90 days after
the effective date of this offering in reliance on Rule 144, without having to
comply with certain restrictions, including the holding period, contained in
Rule 144.
The SEC has indicated that Rule 701 will apply to typical stock options
granted by an issuer before it becomes subject to the reporting requirements of
the Securities Exchange Act of 1934, along with the shares acquired upon
exercise of such options (including exercises after the date of this
prospectus). Securities issued in reliance on Rule 701 are restricted securities
and, subject to the contractual restrictions described above, beginning 90 days
after the date of this prospectus, may be sold by persons other than
"affiliates," as defined in Rule 144, subject only to the manner of sale
provisions of Rule 144. Securities issued in reliance on Rule 701 may be sold by
"affiliates" under Rule 144 without compliance with its one year minimum holding
period requirement.
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<PAGE> 68
UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement dated , 1999 we have agreed to sell to the underwriters
named below, for whom Credit Suisse First Boston Corporation, Deutsche Banc
Alex. Brown, Hambrecht & Quist LLC and Lehman Brothers Inc. are acting as
representatives, the following respective numbers of shares of common stock:
<TABLE>
<CAPTION>
Number
Underwriter of Shares
----------- ---------
<S> <C>
Credit Suisse First Boston Corporation......................
Deutsche Banc Alex. Brown...................................
Hambrecht & Quist LLC.......................................
Lehman Brothers Inc. .......................................
--------
Total.............................................
========
</TABLE>
The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of common stock in the offering if any are purchased,
other than those shares covered by the over-allotment option described below.
The underwriting agreement also provides that if an underwriter defaults, the
purchase commitments of non-defaulting underwriters may be increased or the
offering of common stock may be terminated.
We have granted to the underwriters a 30-day option to purchase on a pro
rata basis up to additional shares at the initial public offering price less
the underwriting discounts and commissions. The option may be exercised only to
cover any over-allotments of common stock.
The underwriters propose to offer the shares of common stock initially at
the public offering price on the cover page of this prospectus and to selling
group members at that price less a concession of $ per share. The underwriters
and selling group members may allow a discount of $ per share on sales to other
broker/dealers. After the initial public offering, the public offering price and
concession and discount to broker/dealers may be changed by the representatives.
The following table summarizes the compensation and estimated expenses we
will pay.
<TABLE>
<CAPTION>
Per Share Total
---------------------- ----------------------
Without With Without With
Over- Over- Over- Over-
allotment allotment allotment allotment
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Underwriting Discounts and
Commissions paid by us................ $ $ $ $
Expenses payable by us.................. $ $ $ $
</TABLE>
The underwriters have informed us that they do not expect discretionary
sales to exceed 5% of the shares of common stock being offered.
We and our executive officers, directors and other of our security holders
have agreed that we will not offer, sell, contract to sell, pledge or otherwise
dispose of, directly or indirectly, or file with the Securities and Exchange
Commission a registration statement under the Securities Act relating to, any
shares of common stock or securities convertible into or exchangeable or
exercisable for any common stock, or publicly disclose the intention to make an
offer, sale, pledge, disposition or filing, without the prior written consent of
Credit Suisse First Boston Corporation for a period of 180 days after the date
of this prospectus. We can, however, issue stock pursuant to the exercise of
currently outstanding options.
The underwriters have reserved for sale, at the initial public offering
price up to shares of the common stock for employees, directors, other persons
associated with us and a number of open source developers who have expressed an
interest in purchasing common stock in this offering. The number of
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<PAGE> 69
shares available for sale to the general public in this offering will be reduced
to the extent these persons purchase the reserved shares. Any reserved shares
not so purchased will be offered by the underwriters to the general public on
the same terms as the other shares.
We have agreed to indemnify the underwriters against liabilities under the
Securities Act, or contribute to payments which the underwriters may be required
to make in that respect.
We have applied to list the shares of common stock on The Nasdaq Stock
Market's National Market under the symbol "LNUX."
In June 1999, we sold shares of our Series B preferred stock in a private
placement at a purchase price of $3.86 per share. In this private placement,
Lehman Brothers VC Partners, L.P. purchased 640,354 shares of Series B preferred
stock for approximately $2.5 million. Lehman Brothers Venture Partners L.P.
purchased 571,856 shares of Series B preferred stock for approximately $2.2
million. Lehman Brothers Venture Capital Partners I, L.P. purchased 342,194
shares of Series B preferred stock for approximately $1.3 million. These funds
purchased these shares of Series B preferred stock on the same terms as the
other investors in the private placement. These funds are affiliated entities of
Lehman Brothers Inc., a representative of the underwriters in this offering.
Pursuant to the regulations of the National Association of Securities Dealers,
Inc., subject to limited exceptions, these funds may not sell or otherwise
transfer any shares of our capital stock that they hold for 90 days following
the completion of this offering. This restriction is in addition to the 180-day
lock-up agreed to by these funds with the underwriters.
Prior to this offering, there has been no public market for our common
stock. The initial public offering price will be determined by negotiation
between us and the underwriters. The principal factors to be considered in
determining the public offering price include: the information in this
prospectus and otherwise available to the underwriters; the history and the
prospects for the industry in which we will compete; the ability of our
management; the prospects for our future earnings; the present state of our
development and our current financial condition; the general condition of the
securities markets at the time of this offering; and the recent market prices
of, and the demand for, publicly traded common stock of generally comparable
companies.
The representatives may engage in over-allotment, stabilizing transactions,
syndicate covering transactions, and penalty bids in accordance with Regulation
M under the Exchange Act.
- Over-allotment involves syndicate sales in excess of the offering size,
which creates a syndicate short position.
- Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.
- Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions.
- Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member is purchased in a syndicate covering transaction to
cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions and penalty bids
may cause the price of the common stock to be higher than it would otherwise be
in the absence of these transactions. These transactions may be effected on The
Nasdaq National Market or otherwise and, if commenced, may be discontinued at
any time.
68
<PAGE> 70
NOTICE TO CANADIAN RESIDENTS
RESALE RESTRICTIONS
The distribution of the common stock in Canada is being made only on a
private placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of common stock are effected. Accordingly, any resale of the common stock
in Canada must be made in accordance with applicable securities laws which will
vary depending on the relevant jurisdiction, and which may require resales to be
made in accordance with available statutory exemptions or pursuant to a
discretionary exemption granted by the applicable Canadian securities regulatory
authority. Purchasers are advised to seek legal advice prior to any resale of
the common stock.
REPRESENTATIONS OF PURCHASERS
Each purchaser of common stock in Canada who receives a purchase
confirmation will be deemed to represent to us and the dealer from whom the
purchase confirmation is received that (i) the purchaser is entitled under
applicable provincial securities laws to purchase the common stock without the
benefit of a prospectus qualified under the securities laws, (ii) where required
by law, that the purchaser is purchasing as principal and not as agent, and
(iii) the purchaser has reviewed the text above under "Resale Restrictions."
RIGHTS OF ACTION (ONTARIO PURCHASERS)
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.
ENFORCEMENT OF LEGAL RIGHTS
All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be possible
for Canadian purchasers to effect service of process within Canada upon the
issuer or these persons. All or a substantial portion of the assets of the
issuer and these persons may be located outside of Canada and, as a result, it
may not be possible to satisfy a judgment against the issuer or these persons in
Canada or to enforce a judgment obtained in Canadian courts against the issuer
or these persons outside of Canada.
NOTICE TO BRITISH COLUMBIA RESIDENTS
A purchaser of common stock to whom the Securities Act (British Columbia)
applies is advised that the purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
common stock acquired by such purchaser in this offering. This report must be in
the form attached to British Columbia Securities Commission Blanket Order BOR
#95/17, a copy of which may be obtained from us. Only one report must be filed
in respect of common stock acquired on the same date and under the same
prospectus exemption.
TAXATION AND ELIGIBILITY FOR INVESTMENT
Canadian purchasers of common stock should consult with their own legal and
tax advisors with respect to the tax consequences of an investment in the common
stock in their particular circumstances and with respect to the eligibility of
the common stock for investment by the purchaser under relevant Canadian
legislation.
69
<PAGE> 71
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us
by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California. Legal matters will be passed upon for the underwriters by Morrison &
Foerster LLP, Palo Alto, California. As of the date of this prospectus, WS
Investment Company 98B, WS Investment Company 99A and WS Investment Company 99B,
each an investment partnership composed of certain current and former members of
and persons associated with Wilson Sonsini Goodrich & Rosati, Professional
Corporation, in addition to certain current individual members of Wilson Sonsini
Goodrich & Rosati, Professional Corporation, beneficially own an aggregate of
102,584 of VA Linux Systems, Inc. preferred stock.
EXPERTS
The audited financial statements and schedule included in this prospectus
and elsewhere in the registration statement have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their reports with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in giving said reports.
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission, Washington,
D.C., a registration statement on Form S-1 under the Securities Act with respect
to the shares of common stock offered hereby. This prospectus does not contain
all the information set forth in the registration statement and the exhibits and
schedules thereto. For further information with respect to us and our common
stock, reference is made to the registration statement and to the exhibits and
schedules filed therewith. Statements contained in this prospectus as to the
contents of any contract or other document referred to are not necessarily
complete, and in each instance reference is made to the copy of the contract or
other document filed as an exhibit to the registration statement, each statement
being qualified in all respects by this reference. A copy of the registration
statement may be inspected by anyone without charge at the Public Reference
Section of the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of all or any portion of the registration
statement may be obtained from the Public Reference Section of the Commission,
450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of prescribed fees.
The Commission maintains a Web site at http://www.sec.gov that contains reports,
proxy and information statements and other information regarding registrants
that file electronically with the Commission.
70
<PAGE> 72
VA LINUX SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... F-2
Balance Sheets.............................................. F-3
Statements of Operations.................................... F-4
Statements of Stockholders' (Deficit) Equity................ F-5
Statements of Cash Flows.................................... F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE> 73
After the stock splits and reincorporation discussed in Note 10 to VA Linux
Systems, Inc.'s financial statements, we expect to be in a position to render
the following audit report:
ARTHUR ANDERSEN LLP
San Jose, California
September 30, 1999
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To The Board of Directors and Stockholders of
VA Linux Systems, Inc.:
We have audited the accompanying balance sheets of VA Linux Systems, Inc.
(a Delaware corporation) as of July 31, 1998 and 1999, and the related
statements of operations, stockholders' (deficit) equity and cash flows for each
of the three years in the period ended July 31, 1999. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of VA Linux Systems, Inc. as of
July 31, 1998 and 1999, and the results of its operations and its cash flows for
each of the three years in the period ended July 31, 1999 in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Jose, California
September 30, 1999 (except with respect to the matters referred to
in Note 10, as to which the date is , 1999)
F-2
<PAGE> 74
VA LINUX SYSTEMS, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
JULY 31,
1999
PRO FORMA
JULY 31, STOCKHOLDERS'
------------------ EQUITY
1998 1999 (NOTE 7)
------ -------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 62 $ 18,653
Accounts receivable, net of allowances of $39 and $207,
respectively........................................... 746 4,033
Inventories............................................... 315 1,971
Prepaid expenses and other assets......................... 3 381
------ --------
Total current assets.............................. 1,126 25,038
Property and equipment, net................................. 55 1,759
Other assets................................................ 14 798
------ --------
$1,195 $ 27,595
====== ========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Equipment loan............................................ $ -- $ 500
Current portion of notes payable.......................... 275 259
Accounts payable.......................................... 820 6,243
Accrued warranty.......................................... 167 239
Accrued liabilities and other............................. 78 1,567
------ --------
Total current liabilities......................... 1,340 8,808
------ --------
Notes payable and other, net of current portion............. 275 424
------ --------
Commitments (Note 5)
Stockholders' (deficit) equity:
Convertible preferred stock, $0.001 par value; aggregate
liquidation preference of $30,648 as of July 31, 1999
Authorized -- 20,149,322;
Outstanding -- 0 shares at July 31, 1998, 18,651,914
shares at July 31, 1999 and none pro forma........... -- 19 $ --
Common stock, $0.001 par value
Authorized -- 250,000,000;
Outstanding -- 5,100,000 shares at July 31, 1998,
15,444,860 shares at July 31, 1999 and 34,096,774
shares pro forma..................................... 5 15 34
Additional paid-in capital................................ 24 45,461 45,461
Stockholder note receivable............................... -- (50) (50)
Deferred stock compensation............................... -- (12,121) (12,121)
Accumulated deficit....................................... (449) (14,961) (14,961)
------ -------- --------
Total stockholders' (deficit) equity.............. (420) 18,363 $ 18,363
------ -------- ========
$1,195 $ 27,595
====== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 75
VA LINUX SYSTEMS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
-----------------------------
1997 1998 1999
------ ------- --------
<S> <C> <C> <C>
Net revenues................................................ $2,743 $ 5,556 $ 17,710
Cost of revenues............................................ 2,562 4,494 17,766
------ ------- --------
Gross margin........................................... 181 1,062 (56)
------ ------- --------
Operating expenses:
Sales and marketing....................................... 310 382 5,183
Research and development.................................. 115 180 3,189
General and administrative................................ 218 427 3,791
Amortization of deferred stock compensation............... -- -- 2,312
------ ------- --------
Total operating expenses.......................... 643 989 14,475
------ ------- --------
Income (loss) from operations............................... (462) 73 (14,531)
Interest and other income (expense), net.................... (12) 11 19
------ ------- --------
Net income (loss)........................................... $ (474) $ 84 $(14,512)
====== ======= ========
Basic net income (loss) per share........................... $(0.05) $ 0.02 $ (2.62)
====== ======= ========
Diluted net income (loss) per share......................... $(0.05) $ 0.01 $ (2.62)
====== ======= ========
Shares used in computing basic net income (loss) per
share..................................................... 9,467 5,100 5,530
====== ======= ========
Shares used in computing diluted net income (loss) per
share..................................................... 9,467 12,249 5,530
====== ======= ========
Pro forma basic net loss per share (unaudited).............. $ (1.01)
========
Shares used in computing pro forma basic net loss per share
(unaudited)............................................... 14,317
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 76
VA LINUX SYSTEMS, INC.
STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL STOCKHOLDER DEFERRED
------------------- ------------------- PAID-IN NOTE STOCK
SHARES AMOUNT SHARES AMOUNT CAPITAL RECEIVABLE COMPENSATION
---------- ------ ---------- ------ ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JULY 31, 1996............. -- $-- 15,000,000 $15 $ 69 $ -- $ --
Issuance of convertible preferred
stock for cash................... 1,734,000 2 -- -- 498 -- --
Repurchase of common stock for
cash............................. -- -- (9,900,000) (10) (45) -- --
Net loss........................... -- -- -- -- -- -- --
---------- -- ---------- --- ------- ---- --------
BALANCE AT JULY 31, 1997............. 1,734,000 2 5,100,000 5 522 -- --
Repurchase of convertible preferred
stock in exchange for note
payable.......................... (1,734,000) (2) -- -- (498) -- --
Net income......................... -- -- -- -- -- -- --
---------- -- ---------- --- ------- ---- --------
BALANCE AT JULY 31, 1998............. -- -- 5,100,000 5 24 -- --
Issuance of Series A convertible
preferred stock for cash and note
receivable, net.................. 12,149,322 12 -- -- 5,482 (50) --
Exercise of stock options and stock
purchase rights for cash and
services rendered................ -- -- 10,304,860 10 308 -- --
Issuance of Series B convertible
preferred stock for cash, net.... 6,502,592 7 -- -- 25,084 -- --
Issuance of common stock for assets
acquired......................... -- -- 40,000 -- 20 -- --
Fair value of options and stock
purchase rights granted for
services rendered and assets
acquired......................... -- -- -- -- 110 -- --
Deferred stock compensation........ -- -- -- -- 14,433 -- (14,433)
Amortization of deferred stock
compensation..................... -- -- -- -- -- -- 2,312
Net loss........................... -- -- -- -- -- -- --
---------- -- ---------- --- ------- ---- --------
BALANCE AT JULY 31, 1999............. 18,651,914 $19 15,444,860 $15 $45,461 $(50) $(12,121)
========== == ========== === ======= ==== ========
<CAPTION>
RETAINED
EARNINGS TOTAL
(ACCUMULATED STOCKHOLDERS'
DEFICIT) (DEFICIT) EQUITY
------------ ----------------
<S> <C> <C>
BALANCE AT JULY 31, 1996............. $ 66 $ 150
Issuance of convertible preferred
stock for cash................... -- 500
Repurchase of common stock for
cash............................. (75) (130)
Net loss........................... (474) (474)
-------- --------
BALANCE AT JULY 31, 1997............. (483) 46
Repurchase of convertible preferred
stock in exchange for note
payable.......................... (50) (550)
Net income......................... 84 84
-------- --------
BALANCE AT JULY 31, 1998............. (449) (420)
Issuance of Series A convertible
preferred stock for cash and note
receivable, net.................. -- 5,444
Exercise of stock options and stock
purchase rights for cash and
services rendered................ -- 318
Issuance of Series B convertible
preferred stock for cash, net.... -- 25,091
Issuance of common stock for assets
acquired......................... -- 20
Fair value of options and stock
purchase rights granted for
services rendered and assets
acquired......................... -- 110
Deferred stock compensation........ -- --
Amortization of deferred stock
compensation..................... -- 2,312
Net loss........................... (14,512) (14,512)
-------- --------
BALANCE AT JULY 31, 1999............. $(14,961) $ 18,363
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 77
VA LINUX SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
--------------------------
1997 1998 1999
----- ----- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $(474) $ 84 $(14,512)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization.......................... 9 18 449
Loss on disposal of assets............................. -- -- 75
Amortization of deferred stock compensation............ -- -- 2,312
Non-cash compensation expense.......................... -- -- 64
Changes in assets and liabilities:
Accounts receivable.................................. (149) (449) (3,287)
Inventories.......................................... (102) (76) (1,656)
Prepaid expenses and other assets.................... (1) (11) (517)
Accounts payable..................................... 279 403 5,423
Accrued liabilities and other........................ 74 (12) 1,426
Accrued warranty..................................... 39 129 72
----- ----- --------
Net cash provided by (used in) operating
activities...................................... (325) 86 (10,151)
----- ----- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment........................ (25) (44) (2,139)
Purchase of other long-lived assets....................... -- -- (154)
----- ----- --------
Net cash used in investing activities............. (25) (44) (2,293)
----- ----- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable................................. -- -- (275)
Proceeds from borrowings on equipment loan and line of
credit................................................. -- -- 700
Repayments of borrowings on equipment loan and line of
credit................................................. -- -- (200)
Proceeds from issuance of convertible preferred stock,
net.................................................... 500 -- 30,535
Proceeds from issuance of common stock.................... -- -- 275
Repurchase of common stock................................ (130) -- --
----- ----- --------
Net cash provided by financing activities......... 370 -- 31,035
----- ----- --------
Net increase in cash and cash equivalents................... 20 42 18,591
Cash and cash equivalents, beginning of year................ -- 20 62
----- ----- --------
Cash and cash equivalents, end of year...................... $ 20 $ 62 18,653
===== ===== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Repurchase of convertible preferred stock pursuant to
notes payable.......................................... $ -- $ 550 $ --
Issuance of convertible preferred stock for note
receivable............................................. $ -- $ -- $ 50
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 78
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED JULY 31, 1997, 1998 AND 1999
1. ORGANIZATION AND OPERATIONS OF THE COMPANY:
VA Linux Systems, Inc. ("the Company"), formerly known as VA Research,
Inc., was incorporated in California in January 1995 and is a provider of
Linux-based computer systems and services. Additionally, the Company has
recently established a professional services organization to provide other
services including system architecture design, system integration and security
consulting.
The Company is subject to certain risks including the emergence of the
Linux industry, dependence on a key supplier for manufacturing, competition from
larger, more established companies, short product life cycles, the Company's
ability to develop and bring to market new products on a timely basis,
dependence on key employees, the ability to attract and retain additional
qualified personnel and the ability to obtain adequate financing to support
growth.
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 period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments or money-market
type funds with an original maturity of three months or less to be cash
equivalents. Cash and cash equivalents consist principally of cash deposited in
money market and checking accounts.
Inventories
Inventories are stated at the lower of cost or market and consist of the
following (in thousands):
<TABLE>
<CAPTION>
JULY 31,
--------------
1998 1999
---- ------
<S> <C> <C>
Raw materials............................................... $256 $1,813
Finished goods.............................................. 59 158
---- ------
Total....................................................... $315 $1,971
==== ======
</TABLE>
Provisions, when required, are made to reduce excess and obsolete
inventories to their estimated net realizable values. Due to competitive
pressures and technological innovation, it is possible that estimates of net
realizable value could change in the near term.
Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives (three to five years) of
the assets. Leasehold improvements are amortized over the corresponding lease
term.
F-7
<PAGE> 79
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
JULY 31,
--------------
1998 1999
---- ------
<S> <C> <C>
Computer and office equipment............................... $ 22 $1,314
Furniture and fixtures...................................... 76 110
Leasehold improvements...................................... -- 572
Software.................................................... -- 125
---- ------
Total property and equipment........................... 98 2,121
Less: Accumulated depreciation and amortization............. (43) (362)
---- ------
Property and equipment, net............................ $ 55 $1,759
==== ======
</TABLE>
The Company periodically evaluates the carrying amount of its long-lived
assets and applies the provisions of SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
("SFAS No. 121"). SFAS No. 121 requires that long-lived assets and certain
identifiable intangibles to be held and used or disposed of by an entity be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.
Revenue Recognition
Product revenues from the sale of Linux-based servers and desktop computers
are recognized upon shipment of goods. The Company provides allowances for
warranty costs and estimated future returns at the time of shipment. Revenue
from customer support services are recognized pro-rata over the contract term.
For the years ended July 31, 1997, 1998 and 1999, revenues from customer support
services have not been material.
Stock Split
Effective October 15, 1998 and March 30, 1999, the Company completed a
2-for-1 and 3-for-2 split, respectively, of its common stock. As a result of the
stock splits, outstanding and reserved common shares increased. The rights of
the holders of these securities were not otherwise modified. Subsequent to July
31, 1999, the Board of Directors approved, subject to stockholder approval,
additional stock splits (see Note 10).
Stock-Based Compensation and Equity Instruments Exchanged for Services and
Assets
The Financial Accounting Standards Board issued SFAS No. 123, "Accounting
for Stock-Based Compensation" ("SFAS No. 123"), in October 1995. SFAS No. 123
permits the use of either a fair value based method or the method defined in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25"), to account for stock-based compensation arrangements.
Companies that elect to employ the valuation method provided in APB No. 25 are
required to disclose the pro forma net income (loss) that would have resulted
from the use of the fair value based method. The Company has elected to continue
to determine the value of stock-based compensation arrangements under the
provisions of APB No. 25 and, accordingly, it has included the pro forma
disclosures required under SFAS No. 123 in the financial statements (see Note
8).
The value of options, stock purchase rights and stock exchanged for
services rendered or assets acquired are valued using the Black-Scholes option
pricing model. To calculate the expense or asset value,
F-8
<PAGE> 80
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
the Company uses either the fair value of the consideration received or the fair
value of the equity instruments issued, whichever is more reliably measurable.
Software Development Costs
In accordance with SFAS No. 86, "Accounting for the Cost of Computer
Software to be Sold, Leased, or Otherwise Marketed", development costs incurred
in the research and development of new software products are expensed as
incurred until technological feasibility in the form of a working model has been
established. To date, the Company's software development has been completed
concurrent with the establishment of technological feasibility and, accordingly,
all software development costs have been charged to research and development
expense in the accompanying statements of operations.
Computation of Per Share Amounts
Basic net income (loss) per common share and diluted net income (loss) per
common share are presented in conformity with SFAS No. 128, "Earnings Per Share"
("SFAS No. 128") for all periods presented. Pursuant to Securities and Exchange
Commission Staff Accounting Bulletin No. 98, common stock and convertible
preferred stock issued or granted for nominal consideration prior to the
anticipated effective date of the initial public offering must be included in
the calculation of basic and diluted net income (loss) per common share as if
such stock had been outstanding for all periods presented. To date, the Company
has not had any issuances or grants for nominal consideration.
In accordance with SFAS No. 128, basic net income (loss) per common share
has been calculated using the weighted-average number of shares of common stock
outstanding during the period, less shares subject to repurchase. For the years
ended July 31, 1997 and 1999, the Company has excluded all convertible preferred
stock and outstanding stock options from the calculation of diluted net loss per
common share because all such securities are antidilutive for those periods. The
total number of shares excluded from the calculations of diluted net loss per
common share were 3,245,000 and 25,320,000 for the years ended July 31, 1997 and
1999, respectively. Pro forma basic net loss per common share has been
calculated assuming the conversion of the convertible preferred stock using the
if-converted method into an equivalent number of common shares as if the shares
had been converted on the dates of issuance.
F-9
<PAGE> 81
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
The following table presents the calculation of basic, diluted and pro
forma basic net income (loss) per share (in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
-----------------------------
1997 1998 1999
------- ------ --------
<S> <C> <C> <C>
Net income (loss)..................................... $ (474) $ 84 $(14,512)
------- ------ --------
Basic:
Weighted average shares of common stock
outstanding...................................... 9,467 5,100 8,268
Less: Weighted average shares subject to
repurchase....................................... -- -- (2,738)
------- ------ --------
Shares used in computing basic net income (loss) per
share............................................ 9,467 5,100 5,530
======= ====== ========
Basic net income (loss)
per share........................................ $ (0.05) $ 0.02 $ (2.62)
======= ====== ========
Diluted:
Shares used above................................... 9,467 5,100 5,530
Add: Weighted average dilutive convertible preferred
stock and stock options.......................... -- 7,149 --
------- ------ --------
Shares used in computing diluted net income per
share............................................ 9,467 12,249 5,530
======= ====== ========
Diluted net income (loss) per share................. $ (0.05) $ 0.01 $ (2.62)
======= ====== ========
Pro forma basic net loss per share:
Shares used above................................... 5,530
Pro forma adjustment to reflect weighted effect of
assumed conversion of convertible preferred stock
(unaudited)...................................... 8,787
--------
Shares used in computing pro forma basic net loss
per share (unaudited)............................ 14,317
========
Pro forma basic net loss per share (unaudited)...... $ (1.01)
========
</TABLE>
Comprehensive Income (Loss)
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," ("SFAS No. 130") which establishes standards
for reporting and presentation of comprehensive income. SFAS No. 130 was adopted
by the Company in 1998. This standard defines comprehensive income as the
changes in equity of an enterprise except those resulting from stockholder
transactions. Comprehensive income (loss) for the years ended July 31, 1997,
1998 and 1999 equaled net income (loss).
Segment Reporting
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information" ("SFAS No.
131"). SFAS No. 131 establishes standards for disclosures about operating
segments, products and services, geographic areas and major customers. The
Company is organized and operates as one operating segment, the provision of
Linux-based products and services. The Company markets its products in the
United States through its direct sales force. Revenues for each of the years
ended July 31, 1997, 1998 and 1999 were primarily generated from sales to end
users in the United States.
F-10
<PAGE> 82
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
Recent Accounting Pronouncements
In March 1998, the AICPA issued SOP No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP No. 98-1"). SOP
No. 98-1 requires entities to capitalize certain costs related to internal-use
software once certain criteria have been met. SOP No. 98-1 was adopted by the
Company in fiscal 1999. The adoption of SOP No. 98-1 did not have a material
impact on the Company's financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133").
SFAS No. 133 establishes accounting and reporting standards requiring that every
derivative instrument be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS No. 133, as recently amended, is
effective for fiscal years beginning after June 15, 2000. Management believes
the adoption of SFAS No. 133 will not have a material effect on the Company's
financial position or results of operations.
In December 1998, the AICPA issued SOP 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 and SOP No. 98-4 by extending the
deferral of the application of certain provisions of SOP No. 97-2 amended by SOP
No. 98-4 through fiscal years beginning on or before March 15, 1999. All other
provisions of SOP No. 98-9 are effective for transactions entered into in fiscal
years beginning after March 15, 1999. The Company has not had significant
software sales to date and management does not expect the adoption of SOP No.
98-9 to have a significant effect on the financial position or results of
operations.
Supplier Concentration
The Company is dependent on a single contract manufacturer for
substantially all of its manufacturing and supply chain management, including
component procurement and inventory management. The contract manufacturer is
also an investor in the Company. The inability of the manufacturer to fulfill
the production requirements of the Company or make distributions of the
Company's products on a timely basis could negatively impact future results.
Although there are other contract manufactures that could provide similar
services, a change in the contract manufacturer could cause delays in
manufacturing and distribution of the Company's products and possible loss of
sales.
Concentrations of Credit Risk and Significant Customers
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of trade receivables. The
Company provides credit, in the normal course of business, to a number of
companies and performs ongoing credit evaluations of its customers. As of July
31, 1999, approximately 37% of gross accounts receivable was concentrated with
one customer. As of July 31, 1998, approximately 32% of gross accounts
receivable was concentrated with five customers. No single customer accounted
for more than 10% of net revenues in fiscal 1997, 1998 and 1999.
3. NOTES PAYABLE:
UMAX Data Systems
In April 1998, the Company entered into a note payable arrangement with
UMAX Data Systems ("UMAX") for the repurchase of 1,734,000 shares of the
Company's Series A preferred stock held by UMAX. The note payable was for
$550,000, of which $275,000 was paid in November 1998. The remaining note
payable bears no interest and is to be repaid in 12 equal monthly installments
of approximately $23,000, beginning in February 2000 and ending in January 2001.
As of July 31, 1999,
F-11
<PAGE> 83
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
principal maturities under the note payable are $115,000 and $160,000 in fiscal
2000 and fiscal 2001, respectively. For the period during fiscal 1998 when UMAX
was a significant shareholder, the Company purchased approximately $395,000 of
computer components from UMAX.
Acquisition of Rights
In connection with the acquisition of certain Internet properties and
rights during fiscal 1999, the Company entered into an obligation to pay a total
of $396,000 in cash. The obligation bears no interest and is repayable in 33
equal monthly installments of $12,000 beginning in April 1999 and ending
December 2001. As of July 31, 1999, principal maturities under the obligation
are $144,000 in fiscal 2000, $144,000 in fiscal 2001 and $60,000 in fiscal 2002.
4. LINE OF CREDIT AND EQUIPMENT LOAN:
In February 1999, the Company entered into a loan and security agreement
with a bank for maximum borrowings of $4,000,000 under a revolving line of
credit ("Line of Credit") and $500,000 under an equipment loan ("Equipment
Loan"). The interest rate for both the Line of Credit and the Equipment Loan is
the bank's base rate plus 0.75% (8.75% at July 31, 1999). The amount available
for borrowing under the Line of Credit is limited to an amount equal to 80% of
the Company's eligible accounts receivable, less any outstanding letters of
credit issued under the Line of Credit. The Company can borrow $500,000 under
the Line of Credit without limitation to eligible accounts receivable. The
amount available for borrowing under the Equipment Loan can only be utilized to
acquire equipment that the bank approves. Advances under the Equipment Loan can
only be made through December 31, 1999. Borrowings under the Equipment Loan are
repayable in 36 equal monthly installments of principal and interest beginning
on a date no later than January 1, 2000. Borrowings under the Line of Credit
mature in February 2000 and borrowings under the Equipment Loan mature in July
2002. As of July 31, 1999, the Company had $0 outstanding on the Line of Credit
and $500,000 outstanding on the Equipment Loan. The Equipment Loan and Line of
Credit require that the Company maintain certain financial and non-financial
ratios and covenants. As of July 31, 1999, the Company was not in compliance
with all of the ratios and covenants. The Company obtained a waiver from the
bank to waive this non-compliance as of July 31, 1999.
5. COMMITMENTS:
The Company leases its facilities under operating leases that expire at
various dates through April 30, 2004. Future minimum rental payments as of July
31, 1999 are as follows (in thousands):
<TABLE>
<S> <C>
2000................................................ $ 639
2001................................................ 514
2002................................................ 496
2003................................................ 107
2004................................................ 25
------
$1,781
======
</TABLE>
Rent expense for the years ended July 31, 1997, 1998 and 1999 was
approximately $42,000, $55,000 and $344,000, respectively.
F-12
<PAGE> 84
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
6. RETIREMENT SAVINGS PLAN:
The Company maintains an employee savings and retirement plan which is
intended to be qualified under Section 401(k) of the Internal Revenue Code and
is available to substantially all full-time employees of the Company. The plan
provides for tax deferred salary deductions and after-tax employee
contributions. Contributions include employee salary deferral contributions and
discretionary employer contributions. To date, there have been no employer
discretionary contributions.
7. CONVERTIBLE PREFERRED STOCK:
Series A convertible preferred stock ("Series A") and Series B convertible
preferred stock ("Series B") consists of the following, net of issuance costs,
(in thousands, except share information):
<TABLE>
<CAPTION>
JULY 31,
---------------
1998 1999
---- -------
<S> <C> <C>
Series A:
Authorized -- 12,149,322;
Outstanding -- 0 and 12,149,322 shares, respectively...... $-- $ 5,494
Series B:
Authorized -- 8,000,000;
Outstanding -- 0 and 6,502,592 shares, respectively....... -- 25,091
--- -------
$-- $30,585
=== =======
</TABLE>
During fiscal 1999, the Company issued 12,149,322 shares of Series A at
$0.4567 per share. In June 1999, the Company issued 6,502,592 shares of Series B
at $3.86 per share and an additional 1,256,454 shares of Series B at $3.86 per
share in September 1999. Also in September 1999, the Company issued 12,954
shares of Series B in exchange for assets acquired. The rights, restrictions and
preferences of the Series A and Series B (collectively, "Preferred Stock") are
as follows:
- The holders of Series A and Series B are entitled to receive
non-cumulative cash dividends, at the rate of $0.0228 and $0.1930,
respectively, when and as declared by the Board of Directors, prior and
in preference to any cash dividend declarations or distributions to
holders of common stock.
- In the event of any liquidation, dissolution or winding up of the
Company, the holders of Series A and Series B are entitled to receive
proceeds equal to $0.4567 per share and $3.86 per share, respectively,
plus all declared but unpaid dividends, prior and in preference to any
distribution to holders of common stock. If the assets available for
distribution are insufficient to pay the preferred stockholders in full,
the assets will be distributed ratably among the preferred stockholders.
- Each share of Preferred Stock is convertible at the option of the holder
into one share of common stock. Each share of Preferred Stock converts
automatically into common stock at the earlier of (1) the closing of an
underwritten public offering of the Company's common stock at an
aggregate offering price of greater than $15,000,000 or (2) the date
specified by affirmative vote of a majority of the holders of Preferred
Stock outstanding.
- The holder of each share of Preferred Stock is entitled to one vote for
each share of common stock into which it is convertible.
F-13
<PAGE> 85
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
Unaudited Pro Forma Stockholders' Equity
The Company's Board of Directors has authorized the filing of a
registration statement with the Securities and Exchange Commission to register
shares of its common stock in connection with a proposed initial public offering
(the "IPO"). If the IPO is consummated under the terms presently anticipated,
all of the outstanding shares of convertible preferred stock as of July 31, 1999
will be converted into 18,651,914 shares of common stock upon the closing of the
IPO. The effect of the conversion of the preferred stock outstanding at July 31,
1999 has been reflected as unaudited pro forma stockholders' equity in the
accompanying balance sheet. In addition, the shares of Series B issued in
September 1999 will be converted into 1,269,408 shares of common stock upon the
closing of the IPO.
8. COMMON STOCK:
As of July 31, 1999, the Company had reserved shares of its common stock
for future issuance as follows:
<TABLE>
<S> <C>
Conversion of Series A preferred stock...................... 12,149,322
Conversion of Series B preferred stock...................... 6,502,592
1998 Stock Option Plan...................................... 13,035,616
Non-Plan Stock Options and Stock Purchase Rights............ 185,000
----------
31,872,530
==========
</TABLE>
Founder's Stock Repurchase Agreement
In October 1998, a founder of the Company holding 4,950,000 shares of
common stock entered into a Stock Repurchase Agreement ("Agreement") with the
Company. Under the terms of the Agreement, in the event of any voluntary or
involuntary termination of the founder's employment with the Company, the
Company shall have an irrevocable, exclusive option, for a period of 90 days
from termination, to repurchase any shares of common stock held by the founder,
at $0.02 per share. The founder's shares of common stock are released from the
repurchase option as follows: 2,970,000 are not subject to repurchase as of
October 30, 1998 and 1/24 of the remaining shares are released from the
repurchase option each month after October 1998 until all shares have been
released. As of July 31, 1999, 1,237,500 shares are subject to repurchase by the
Company.
Stock Option Plan
In fiscal 1997, the Company adopted and the Board of Directors approved the
1996 Stock Option Plan ("1996 Plan"), under which a total of 4,650,000 shares
were reserved for issuance. The 1996 Plan permitted options to be granted to
employees, consultants and directors to purchase shares of the Company's common
stock at a price determined by the Board. The Company granted 4,650,000 options
under the 1996 Plan during fiscal 1997 and 1998. In fiscal 1998, the Company
granted options to purchase 4,026,000 shares of common stock outside of the 1996
Plan at an exercise price of $0.02 per share. In October 1998, the Company
cancelled all stock options outstanding under the 1996 Plan and the 4,026,000
options that had been issued in fiscal 1998 outside of the 1996 Plan. The
cancelled options were replaced with options under the 1998 Plan that had
vesting and exercise prices consistent with the terms of the cancelled options.
The 1996 Plan was terminated in October 1998.
In fiscal 1999, the Company adopted and the Board of Directors approved the
1998 Stock Plan (the "1998 Plan"). The number of shares reserved for issuance
under the 1998 Plan is 23,257,144. Under the 1998 Plan, the Board of Directors
may grant to employees and consultants options and/or stock purchase
F-14
<PAGE> 86
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
rights to purchase the Company's common stock at terms and prices determined by
the Board of Directors. As of July 31, 1999, the number of shares that remain
available to be granted under the 1998 Plan is 6,552,640. The Plan will
terminate in 2008. Nonqualified options granted under the 1998 Plan must be
issued at a price equal to at least 85% of the fair market value of the
Company's common stock at the date of grant. All options may be exercised at any
time within 10 years of the date of grant or within three months of termination
of employment, or such shorter time as may be provided in the stock option
agreement, and vest over a vesting schedule determined by the Board of
Directors.
During fiscal 1999, the Company also issued to non-employees options and
stock purchase rights to purchase 268,332 shares of common stock outside of the
1998 Plan. The Company recorded stock based compensation or an asset, as
applicable, based upon the fair value at the date of issuance calculated in
accordance with SFAS No. 123.
A summary of the option activity under the 1996 and 1998 Plans and related
information for the years ended July 31 follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-----------------------------
WEIGHTED
OPTIONS AVERAGE
AVAILABLE SHARES EXERCISE PRICE
----------- ----------- --------------
<S> <C> <C> <C>
Balance, July 31, 1996...................... -- -- $ --
Authorized................................ 4,650,000 -- --
Granted................................... (3,021,000) 3,021,000 0.02
Cancelled................................. 55,800 (55,800) 0.02
----------- -----------
Balance, July 31, 1997...................... 1,684,800 2,965,200 0.02
Granted................................... (2,644,800) 2,644,800 0.02
Cancelled................................. 960,000 (960,000) 0.02
----------- -----------
Balance, July 31, 1998...................... -- 4,650,000 0.02
Authorized................................ 23,257,144 -- --
Granted................................... (16,781,146) 16,781,146 0.20
Exercised................................. -- (10,221,528) 0.03
Cancelled................................. 76,642 (4,726,642) 0.31
----------- -----------
Balance, July 31, 1999...................... 6,552,640 6,482,976 $0.46
=========== =========== =====
</TABLE>
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------
WEIGHTED-
NUMBER AVERAGE WEIGHTED-
RANGE OF OUTSTANDING REMAINING AVERAGE
EXERCISE AT JULY 31, CONTRACTUAL EXERCISE
PRICES 1999 LIFE PRICE
- ----------- ----------- ----------- ---------
<S> <C> <C> <C>
$0.02-$0.04 1,857,684 9.33 $0.02
$0.50-$1.00 4,625,292 9.81 0.64
---------
6,482,976 $0.46
========= =====
</TABLE>
As of July 31, 1999, there were 1,292,708 shares issuable upon the exercise
of fully vested options under the 1998 Plan at a weighted average exercise price
of $0.02 per share. As of July 31, 1999, 185,000 options and stock purchase
rights that had been granted outside of the 1998 Plan were exercisable at a
weighted average exercise price of $0.04 per share.
F-15
<PAGE> 87
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
The Company accounts for stock options issued to employees under APB
Opinion No. 25 whereby the difference between the exercise price and the fair
value at the date of grant is recognized as compensation expense. Had
compensation expense been determined consistent with SFAS No. 123, net income
(loss) would have decreased and losses would have increased to the following pro
forma amounts (in thousands except per share data):
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
---------------------------
1997 1998 1999
------ ----- --------
<S> <C> <C> <C>
Net income (loss) as reported........................... $ (474) $ 84 $(14,512)
Pro forma net income (loss)............................. (474) 84 (14,683)
Basic and diluted net income (loss) per share........... (0.05) 0.02 (2.62)
Pro forma net income (loss) per share................... (0.05) 0.02 (2.66)
</TABLE>
The weighted average fair value of options granted during fiscal 1999 was
$0.03. The Company did not grant any options in fiscal 1997 and 1998. Pursuant
to the provisions of SFAS No. 123, the compensation cost associated with options
granted in fiscal 1999 was estimated on the grant date using the Black-Scholes
model and the following assumptions:
<TABLE>
<S> <C>
Risk free interest rate..................................... 5.75%
Average expected life of option............................. 3 years
Dividend yield.............................................. 0%
Volatility of common stock.................................. 0.01%
</TABLE>
Deferred Stock Compensation
In connection with the grant of certain stock options to employees during
fiscal 1999, the Company recorded deferred stock compensation within
stockholders' equity of approximately $14.4 million, representing the difference
between the estimated fair value of the common stock for accounting purposes and
the option exercise price of these options at the date of grant. The Company
recorded amortization of deferred compensation of approximately $2.3 million
during fiscal 1999. The deferred stock compensation expense is being amortized
on an accelerated basis over the vesting period of the individual award,
generally four years. The method is in accordance with Financial Accounting
Standards Board Interpretation No. 28. Accordingly, at July 31, 1999, the
remaining deferred compensation of approximately $12.1 million will be amortized
as follows: $6.4 million during fiscal 2000, $3.4 million during fiscal 2001,
$1.7 during fiscal 2002 and $625,000 during fiscal 2003. The amortization
expense relates to options awarded to employees in all operating expense
categories. The amortization of deferred compensation has not been separately
allocated to these categories. The amount of deferred compensation expense to be
recorded in future periods could decrease if options for which accrued but
unvested compensation has been recorded are forfeited. In August 1999, the
Company recorded additional deferred stock compensation of $1.6 million related
to the grant of options to acquire 222,000 shares of common stock.
F-16
<PAGE> 88
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
9. INCOME TAXES:
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes" ("SFAS No. 109"). Due to the Company's loss
position in fiscal 1997 and 1999, and availablity of loss carryforwards in
fiscal 1998, there was no provision for income taxes for the years ended July
31, 1997, 1998 or 1999. A valuation allowance has been recorded for the total
deferred tax assets as a result of uncertainties regarding realization of the
assets based upon the limited operating history of the Company, the lack of
consistent profitability to date and the uncertainty of future profitability.
The components of the net deferred tax assets are as follows (in thousands):
<TABLE>
<CAPTION>
JULY 31,
----------------
1998 1999
----- -------
<S> <C> <C>
Net operating loss carryforwards.......................... $ 73 $ 3,970
Other reserves and accruals............................... 141 638
----- -------
214 4,608
Valuation allowance....................................... (214) (4,608)
----- -------
Net deferred income tax asset............................. $ -- $ --
===== =======
</TABLE>
As of July 31, 1999, the Company has net operating loss carryforwards of
approximately $10.8 million to offset future federal taxable income, which
expire at various dates through the year 2019. The Company also has California
net operating loss carryforwards of approximately $5.2 million to offset future
California taxable income, which expire in the year 2004. The operating loss
carryforwards to be used in future years is limited in accordance with the
provisions of the Tax Reform Act of 1986 as the Company has experienced a
cumulative stock ownership change of more than 50% over the last three years.
10. SUBSEQUENT EVENTS:
On October 7, 1999, the Board of Directors approved, subject to stockholder
approval, the following:
- amendment of the 1998 Stock Plan to increase the number of authorized
shares by 4,000,000 and provide for an automatic annual increase in the
number of shares authorized under the 1998 Stock Plan. Such increase is
to be added on the first day of the Company's fiscal year beginning in
2000 and will be equal to the lesser of (i) 4,000,000 shares, (ii) 4.9%
of the then outstanding common stock shares, or (iii) a lesser amount
determined by the Board.
- adoption of the 1999 Employee Stock Purchase Plan under which 1,000,000
shares of common stock have been reserved for issuance initially, subject
to an annual increase of the lesser of 500,000 shares or 1% of the then
outstanding common stock. The plan allows employees to purchase shares of
common stock at a 15% discount.
- adoption of the 1999 Director Option Plan under which 500,000 shares of
common stock have been reserved, subject to an annual increase of the
lesser of 250,000 shares or 0.5% of the then outstanding common stock.
Under the plan, options will be granted when a non-employee director
joins the Board following the IPO and at each annual meeting where the
director continues to serve on the Board.
- reincorporation into Delaware by way of a merger with a newly-formed
Delaware subsidiary, and the associated issuance of one share of common
stock of the subsidiary for each one share of common stock of the Company
held by the stockholders of record. Additionally, stockholders of record
of Series A and Series B of the Company will be entitled to receive one
share of Series A and Series B preferred stock of the subsidiary.
F-17
<PAGE> 89
VA LINUX SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JULY 31, 1997, 1998 AND 1999
- an increase in the authorized shares of common stock to 250,000,000 and
the creation of newly undesignated preferred stock totaling 10,000,000,
contingent upon the reincorporation of the Company in Delaware and the
closing of the IPO.
- a 3-for-1 split of the outstanding shares of Series A
- a 2-for-1 split of the outstanding shares of common and Series B
preferred stock.
- an amendment to the conversion ratios of the Series A and Series B to
provide that each share of preferred stock will convert into one share of
common stock.
All share and per share amounts in these financial statements have been
adjusted to give effect to the reincorporation and all stock splits.
F-18
<PAGE> 90
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by VA Linux Systems, Inc. in
connection with the sale of Common Stock being registered. All amounts are
estimates except the SEC registration fee and the NASD filing fee.
<TABLE>
<S> <C>
SEC registration fee........................................ $19,460
NASD filing fee............................................. $ 7,500
Nasdaq National Market listing fee.......................... *
Printing and engraving costs................................ *
Legal fees and expenses..................................... *
Accounting fees and expenses................................ *
Blue Sky fees and expenses.................................. *
Transfer Agent and Registrar fees........................... *
Miscellaneous expenses...................................... *
-------
Total............................................. $ *
=======
</TABLE>
- ------------------------
* To be filed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law permits a corporation
to include in its charter documents, and in agreements between the corporation
and its directors and officers, provisions expanding the scope of
indemnification beyond that specifically provided by the current law.
The Eighth Article of the Registrant's Amended and Restated Certificate of
Incorporation provides for the indemnification of directors to the fullest
extent permissible under Delaware law.
Article VI of the Registrant's Amended and Restated Bylaws provides for the
indemnification of officers, directors and third parties acting on behalf of the
Registrant if such person acted in good faith and in a manner reasonably
believed to be in and not opposed to the best interest of the Registrant, and,
with respect to any criminal action or proceeding, the indemnified party had no
reason to believe his or her conduct was unlawful.
The Registrant has entered into indemnification agreements with its
directors and executive officers, in addition to indemnification provided for in
the Registrant's Amended and Restated Bylaws, and intends to enter into
indemnification agreements with any new directors and executive officers in the
future.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since August 1, 1996, we have issued unregistered securities to a limited
number of persons as described below: (all share numbers and exercise prices in
this Item 15 are adjusted for our splits.)
(a) From October 1, 1998 through September 30, 1999, we sold an
aggregate of 10,221,528 shares of our common stock at exercise prices
ranging from $0.02 to $1.00 per share to employees, consultants, directors
and other service providers pursuant to our 1998 Stock Plan, as amended.
(b) On October 30, 1998 and February 19, 1999, we sold 8,623,774 and
3,525,548 shares of Series A Preferred Stock, respectively, at a price of
$0.4567 per share to a group of private investors for an aggregate purchase
price of $5,548,190.
(c) On December 9, 1998, we granted an option to purchase 30,000
shares of our common stock to an outside service provider at a purchase
price of $0.0433.
II-1
<PAGE> 91
(d) On January 19, 1999 and March 1, 1999, we sold a total of 83,332
shares of our common stock, having a value of $22,817, to an outside
service provider in consideration for past services rendered.
(e) On February 25, 1999, we granted a right to purchase 135,000
shares of our common stock at a purchase price of $0.0433 per share in
connection with an asset purchase.
(f) On May 13, 1999, we granted a right to purchase 5,000 shares of
our common stock, having a value of $2,500, to an outside service provider
in consideration for past services rendered.
(g) On May 13, 1999, we granted a right to purchase 15,000 shares of
our common stock to an outside service provider at a purchase price of
$0.50 per share.
(h) On May 25, 1999, we sold 40,000 shares of our common stock in
connection with an asset purchase for an aggregate purchase price of
$20,000.
(i) On June 16, 1999 and September 24, 1999, we sold 6,502,592 and
1,256,454 shares of our Series B Preferred Stock, respectively, for $3.86
per share to a group of private investors for an aggregate purchase price
of $29,949,918.
(j) On August 1, 1999 we sold 12,954 shares of our Series B Preferred
Stock in connection with an asset purchase for an aggregate purchase price
of $50,002.
(k) On October 6, 1999, we sold 13,000 shares of our common stock for
$1.00 per share to a group of private investors for an aggregate purchase
price of $13,000.
For additional information concerning these equity investment transactions,
reference is made to the information contained under the caption "Certain
Transactions" in the form of prospectus included herein. The sales of the above
securities were deemed to be exempt from registration in reliance on Rule 701
promulgated under Section 3(b) under the Securities Act as transactions pursuant
to a compensatory benefit plan or a written contract relating to compensation,
or in reliance on Section 4(2) of the Securities Act or Regulation D promulgated
thereunder as transactions by an issuer not involving any public offering. The
recipients of securities in each such transaction represented their intention to
acquire the securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed to
the share certificates and other instruments issued in such transactions. All
recipients either received adequate information about VA Linux or had access,
through employment or other relationships, to such information.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<C> <S>
1.1* Form of Underwriting Agreement
3.1* Certificate of Incorporation of the Registrant, as currently
in effect
3.2* Amended and Restated Certificate of Incorporation of the
Registrant to be filed upon completion of this offering
3.3* Bylaws of the Registrant, as currently in effect
3.4* Amended and Restated Bylaws to be in effect upon completion
of this offering
4.1* Specimen Common Stock Certificate
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional
Corporation
10.1* Form of Indemnification Agreement between the Registrant and
each of its directors and officers
10.4* 1998 Stock Plan and forms of agreement thereunder
10.5* 1999 Employee Stock Purchase Plan
10.6* 1999 Director Option Plan
</TABLE>
II-2
<PAGE> 92
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<C> <S>
10.7* Sublease between Registrant and Boca Global, Inc.
10.8* First Amended and Restated Registration Rights Agreement
between Registrant and certain holders of preferred stock
10.9* Founder's Stock Repurchase Agreement
10.10* Manufacturing Agreement between the Registrant and Synnex
Information Technologies, Inc.
10.11* Loan and Security Agreement between Registrant and Comerica
Bank-California
23.1 Consent of Arthur Andersen, LLP, Independent Public
Accountants
23.2* Consent of Counsel (see Exhibit 5.1)
24.1 Power of Attorney (see page II-4)
27.1 Financial Data Schedules
</TABLE>
- ---------------
+ Certain portions of this exhibit have been granted confidential treatment by
the Commission. The omitted portions have been separately filed with the
Commission.
* To be filed by amendment
(b) FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
SCHEDULE PAGE
-------- ----
<S> <C>
II -- Valuation and Qualifying Accounts S-2
</TABLE>
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification by the Registrant for liabilities arising under
the Securities Act may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the provisions referenced in Item 14 of
this Registration Statement or otherwise, the Registrant has been advised that
in the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act, and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer, or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by a director,
officer or controlling person in connection with the securities being registered
hereunder, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of Prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, 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-3
<PAGE> 93
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Sunnyvale,
State of California, on the 8th day of October, 1999.
VA Linux Systems, Inc.
By: /s/ LARRY M. AUGUSTIN
------------------------------------
Larry M. Augustin, President and
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Larry M. Augustin and Todd B. Schull and
each of them, his attorneys-in-fact, each with the power of substitution, for
him and in his name, place and stead, in any and all capacities, to sign any and
all amendments (including post-effective amendments) to this Registration
Statement, and to sign any registration statement for the same offering covered
by this Registration Statement that is to be effective upon filing pursuant to
Rule 462(b) promulgated under the Securities Act of 1933, as amended, and all
post-effective amendments thereto, and to file the same, with all exhibits
thereto and all documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that such attorneys-in-fact and agents or any of them, or his or
their substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<C> <S> <C>
/s/ LARRY M. AUGUSTIN President and Chief Executive October 8, 1999
- --------------------------------------------------- Officer and Director
Larry M. Augustin (Principal Executive Officer)
/s/ TODD B. SCHULL Vice President, Finance and October 8, 1999
- --------------------------------------------------- Chief Financial Officer
Todd B. Schull (Principal Financial and
Accounting Officer)
/s/ JEFFRY R. ALLEN Director October 8, 1999
- ---------------------------------------------------
Jeffry R. Allen
/s/ CAROL BARTZ Director October 8, 1999
- ---------------------------------------------------
Carol Bartz
/s/ DOUGLAS LEONE Director October 8, 1999
- ---------------------------------------------------
Douglas Leone
</TABLE>
II-4
<PAGE> 94
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<C> <S> <C>
/s/ THOMAS F. MENDOZA Director October 8, 1999
- ---------------------------------------------------
Thomas F. Mendoza
/s/ ERIC S. RAYMOND Director October 8, 1999
- ---------------------------------------------------
Eric S. Raymond
/s/ CARL REDFIELD Director October 8, 1999
- ---------------------------------------------------
Carl Redfield
</TABLE>
II-5
<PAGE> 95
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
To VA Linux Systems, Inc.:
We have audited, in accordance with generally accepted auditing standards,
the financial statements of VA Linux Systems, Inc. included in this Registration
Statement and have issued our report thereon dated September 30, 1999. Our
audits were made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The accompanying schedule is the responsibility of
the Company's management and is presented for the purpose of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth herein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
San Jose, California
September 30, 1999
S-1
<PAGE> 96
VA LINUX SYSTEMS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO
BEGINNING OF COSTS AND BALANCE AT
DESCRIPTION PERIOD EXPENSES DEDUCTIONS END OF PERIOD
----------- ------------ ---------- ---------- -------------
<S> <C> <C> <C> <C>
Year Ended July 31, 1997
Allowance for doubtful accounts........... $ -- $ -- $ -- $ --
Year Ended July 31, 1998
Allowance for doubtful accounts........... $ -- $ 39 $ -- $ 39
Year Ended July 31, 1999
Allowance for doubtful accounts........... $ 39 $168 $ -- $207
</TABLE>
S-2
<PAGE> 97
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<C> <S>
1.1* Form of Underwriting Agreement
3.1* Certificate of Incorporation of the Registrant, as currently
in effect
3.2* Amended and Restated Certificate of Incorporation of the
Registrant to be filed upon completion of this offering
3.3* Bylaws of the Registrant, as currently in effect
3.4* Amended and Restated Bylaws to be in effect upon completion
of this offering
4.1* Specimen Common Stock Certificate
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional
Corporation
10.1* Form of Indemnification Agreement between the Registrant and
each of its directors and officers
10.4* 1998 Stock Plan and forms of agreement thereunder
10.5* 1999 Employee Stock Purchase Plan
10.6* 1999 Director Option Plan
10.7* Sublease between Registrant and Boca Global, Inc.
10.8* First Amended and Restated Registration Rights Agreement
between Registrant and certain holders of preferred stock
10.9* Founder's Stock Repurchase Agreement
10.10* Manufacturing Agreement between the Registrant and Synnex
Information Technologies, Inc.
10.11* Loan and Security Agreement between Registrant and Comerica
Bank-California
23.1 Consent of Arthur Andersen, LLP, Independent Public
Accountants
23.2* Consent of Counsel (see Exhibit 5.1)
24.1 Power of Attorney (see page II-4)
27.1 Financial Data Schedules
</TABLE>
- ---------------
+ Certain portions of this exhibit have been granted confidential treatment by
the Commission. The omitted portions have been separately filed with the
Commission.
* To be filed by amendment
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our reports
(and to all references to our Firm) included in or made a part of this
registration statement.
ARTHUR ANDERSEN LLP
San Jose, California
October 8, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> JUL-31-1998 JUL-31-1999
<PERIOD-START> AUG-01-1997 AUG-01-1998
<PERIOD-END> JUL-31-1998 JUL-31-1999
<CASH> 62 18,653
<SECURITIES> 0 0
<RECEIVABLES> 785 4,240
<ALLOWANCES> 39 207
<INVENTORY> 315 1,971
<CURRENT-ASSETS> 1,126 25,038
<PP&E> 98 2,121
<DEPRECIATION> 43 362
<TOTAL-ASSETS> 1,195 27,595
<CURRENT-LIABILITIES> 1,340 8,808
<BONDS> 0 0
0 0
0 19
<COMMON> 5 15
<OTHER-SE> (425) 18,329
<TOTAL-LIABILITY-AND-EQUITY> 1,195 27,595
<SALES> 5,556 17,710
<TOTAL-REVENUES> 5,556 17,710
<CGS> 4,494 17,766
<TOTAL-COSTS> 4,494 17,766
<OTHER-EXPENSES> 562 10,684
<LOSS-PROVISION> 39 168
<INTEREST-EXPENSE> 1 67
<INCOME-PRETAX> 84 (14,512)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 84 (14,512)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 84 (14,512)
<EPS-BASIC> 0.02 (2.62)
<EPS-DILUTED> 0.01 (2.62)
</TABLE>
