<PAGE> 1
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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended October 27, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from __________ to __________.
Commission File Number: 000-28369
VA LINUX SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 77-0399299
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
</TABLE>
47071 BAYSIDE PARKWAY, FREMONT, CA 94538
(Address of principal executive offices) (Zip code)
(687) 687-7000
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
<TABLE>
<S> <C>
TITLE OF CLASS OUTSTANDING AT NOVEMBER 30, 2000
--------------------------------- ----------------------------------
Common Stock, $0.001 par value 53,115,088
</TABLE>
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VA Linux Systems, Inc.
and Subsidiaries
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
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PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements 3
Condensed Consolidated Balance Sheets at October
27, 2000 and July 28, 2000 3
Condensed Consolidated Statements of Operations for
the three months ended October 27, 2000 and 4
October 29, 1999
Condensed Consolidated Statements of Cash Flows for
the three months ended October 27, 2000 and 5
October 29, 1999
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 27
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 29
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VA LINUX SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
OCTOBER 27, JULY 28,
2000 2000
--------- ---------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 92,511 $ 123,849
Short-term investments 64,855 52,433
Accounts receivable, net 38,434 31,842
Inventories 1,438 1,018
Prepaid expenses and other current assets 3,382 2,156
--------- ---------
Total current assets 200,620 211,298
Property and equipment, net 18,367 10,316
Goodwill and intangible assets, net 342,928 362,744
Other assets 659 741
--------- ---------
$ 562,574 $ 585,099
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 27,608 $ 26,715
Accrued liabilities and other 13,610 11,285
Current portion of notes payable 1,508 1,568
--------- ---------
Total current liabilities 42,726 39,568
Notes payable, net of current portion 1,068 1,104
Other long-term liabilities 730 552
Stockholders' equity:
Common stock 53 52
Additional paid-in capital 775,485 763,128
Deferred stock compensation (96,522) (109,686)
Accumulated deficit (160,966) (109,619)
--------- ---------
Total stockholders' equity 518,050 543,875
--------- ---------
$ 562,574 $ 585,099
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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VA LINUX SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------
OCTOBER 27, OCTOBER 29,
2000 1999
---------- ----------
(Unaudited)
<S> <C> <C>
Net revenues $ 56,062 $ 14,848
Cost of revenues 43,450 12,887
-------- --------
Gross profit 12,612 1,961
Operating expenses:
Sales and marketing 11,547 5,064
Research and development 4,730 2,774
General and administrative 5,554 1,496
Amortization of deferred stock
compensation 2,694 2,855
Amortization of compensation
expense related to acquisitions 18,189 --
Amortization of goodwill and
intangible assets 23,424 --
-------- --------
Total operating expenses 66,138 12,189
-------- --------
Loss from operations (53,526) (10,228)
Interest and other income, net 2,179 173
-------- --------
Net loss $(51,347) $(10,055)
======== ========
Dividend related to convertible
preferred stock -- (4,900)
-------- --------
Net loss attributable to common
stockholders $(51,347) $(14,955)
======== ========
Basic and diluted net loss per share $ (1.12) $ (2.00)
Shares used in computing basic and
diluted net loss per share 45,978 7,483
</TABLE>
The accompanying notes are an integral part of these financial statements.
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VA LINUX SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------
OCTOBER 27, OCTOBER 29,
2000 1999
---------- ----------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (51,347) $ (10,055)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 23,899 236
Amortization of deferred compensation 20,883 2,855
Non-cash compensation expense -- 441
Other, net (61) --
Changes in assets and liabilities:
Accounts receivable (6,151) (3,254)
Inventories (420) (9)
Prepaid expenses and other assets (1,097) 27
Accounts payable 783 1,254
Accrued liabilities and other 1,237 421
Other long-term liabilities 178 --
--------- ---------
Net cash used in operating activities (12,096) (8,084)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (8,415) (701)
Purchase of short-term investments (12,422) --
Businesses acquired, net of cash acquired (951) --
Other, net (420) --
--------- ---------
Net cash used in investing activities (22,208) (701)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable (160) (16)
Proceeds from issuance of convertible preferred
stock, net -- 4,834
Proceeds from issuance of common stock, net 3,159 29
Repurchase of common stock (33) (25)
--------- ---------
Net cash provided by financing activities 2,966 4,822
--------- ---------
Net decrease in cash and cash equivalents (31,338) (3,963)
Cash and cash equivalents, beginning of period 123,849 18,653
--------- ---------
Cash and cash equivalents, end of period $ 92,511 $ 14,690
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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VA LINUX SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - Basis of Presentation
The condensed consolidated financial statements included herein have
been prepared by VA Linux Systems, Inc. ("VA Linux" or the "Company"), without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. The unaudited condensed consolidated financial statements should be
read in conjunction with the financial statements and the notes thereto included
in VA Linux's 2000 Annual Report included on Form 10-K and Form 10-K/A filed by
the Company with the Securities and Exchange Commission. The condensed
consolidated balance sheet as of July 28, 2000 has been derived from the audited
financial statements as of that date, but does not include all disclosures
required by generally accepted accounting principles.
The condensed consolidated financial statements at October 27, 2000, and
for the three months ended October 27, 2000 and October 29, 1999, include all
normal recurring adjustments which the management of VA Linux believes to be
necessary for fair presentation of the periods presented. The results of
operations for the three months ended October 27, 2000 are not necessarily
indicative of the results that may be expected for future quarters or the year
ending July 27, 2001.
NOTE 2 - Significant Accounting Policies
Use of Estimates in Preparation of Financial Statements
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 the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the period.
Actual results could differ from those estimates.
Principals of Consolidation
These consolidated financial statements include the accounts of VA Linux
and its wholly and majority owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Inventories
Inventories consisted of:
<TABLE>
<CAPTION>
OCTOBER 27, JULY 28,
2000 2000
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<S> <C> <C>
Raw materials $1,421 $ 387
Work-in-process -- 86
Finished goods 17 545
------ ------
Total $1,438 $1,018
====== ======
</TABLE>
Revenue Recognition
Product revenues from the sale of Linux-based servers, components, and
desktop computers are recognized upon shipment of goods. The Company generally
does not grant its customers any rights to return products. The Company provides
allowances for warranty costs at the time of shipment. Revenues from customer
support services, including on-site maintenance and technical support, are
recognized pro-rata over the term of the related service agreement. Revenues
from professional service contracts are recognized as revenue upon completion of
the project, or using the percentage of completion method of the project where
project costs can be reasonably estimated. Any payments received prior to
revenue recognition are recorded as deferred revenue. For the three
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months ended October 27, 2000 and October 29, 1999, revenues from customer
support services and professional service contracts were not material.
The Company generates advertising revenues as a result of its
acquisition of Andover.Net. Advertising revenues are derived from the sale of
advertising space on the Company's various websites. Advertising revenues are
recognized over the period in which the advertisements are displayed, provided
that no significant obligations remain and collection of the receivable is
reasonably assured. The Company's obligations typically include guarantees of a
minimum number of "impressions" (time that an advertisement is viewed by users
of the Company's online services over a specified period of time). To the extent
that minimum guaranteed impressions are not met, the Company does not recognize
the corresponding revenues until the guaranteed impressions are achieved.
Net Loss Per Share
Basic and diluted net loss per share is calculated using the
weighted-average number of common shares outstanding during the period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------
OCTOBER 27, OCTOBER 29,
2000 1999
---------- ----------
(In thousands, except per
share data)
<S> <C> <C>
Net loss attributable to common stockholders $(51,347) $(14,955)
Basic and diluted net loss per share $ (1.12) $ (2.00)
Weighted-average shares of common stock outstanding 50,164 15,166
Less: Weighted average shares subject to repurchase (4,186) (7,683)
-------- --------
Shares used in computing basic and diluted net loss per share 45,978 7,483
======== ========
</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. This standard
defines comprehensive income as the changes in equity of an enterprise except
those resulting from stockholder transactions. Comprehensive loss for the three
months ended October 27, 2000 and October 29, 1999 approximated net loss.
Segment Reporting
The Company has two reportable business segments: Systems and Services,
and through the acquisition of Andover.Net, the Open Source Development Network
("OSDN"). The Systems and Services segment consists of a broad line of Linux
systems and Open Source services including system architecture design and
integration, development of Open Source software and managed services. The OSDN
segment helps people develop, distribute and discuss Open Source software
development. The Company currently allocates resources to and evaluates the
performance of its segments based on each segment's revenue. For the three
months ended October 27, 2000 and October 29, 1999, revenue from its Systems and
Services segment was $51.6 million and $14.8 million, respectively. For the
three months ended October 27, 2000 and October 29, 1999, revenue from OSDN was
$4.5 million and zero, respectively. The Company may change, add or amend its
segments in future periods. The accounting policies of these segments are the
same as those described in the summary of significant accounting policies in the
Company's Annual Report on Form 10-K for the fiscal year ended July 28, 2000.
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 manufacturer's inability to fulfill the
Company's production requirements or make timely distributions of the Company's
products could negatively impact future results. Although there are other
contract manufacturers 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.
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NOTE 3 - Acquisitions
Brave New Worlds, Inc.
On September 26, 2000, in an acquisition accounted for under the
purchase method of accounting, VA Linux acquired all of the outstanding shares
of Brave New Worlds, Inc. ("BNW") for approximately $2.5 million. BNW offers
e-commerce deployment services and a range of professional services for
planning, development and integration to support mission critical Internet
e-business infrastructure. The consideration included approximately 35,000
shares of VA Linux common stock valued at $1.7 million and cash of approximately
$750,000. The purchase agreement contained additional payments to be made in
common stock contingent upon the continued employment of certain key employees
for a period of four years. Maximum future payments contingent on employment of
the key employees is $4.8 million in stock (approximately 97,000 shares) and is
payable after 12 months, 24 months, 36 months and 48 months. The contingent
payments will be accounted for as compensation expense on a pro-rata basis over
the term of the employment condition and not as purchase price. Upon
consummation of the acquisition, VA established an escrow for these contingent
payments. The disclosures of the allocation of purchase price and pro forma data
have been omitted as the amounts are not material.
Life BVBA
On September 29, 2000, in an acquisition accounted for under the
purchase method of accounting, VA Linux acquired all of the outstanding shares
of Life BVBA ("Life") for approximately $860,000. Life is a Belgium company that
provides 24x7 Linux support services and training. The consideration included
approximately 14,000 shares of VA Linux common stock valued at $660,000 and cash
of approximately $200,000. The purchase agreement contained additional payments
to be made in common stock contingent upon the continued employment of certain
key employees for a period of four years. Maximum future payments contingent on
employment of the key employees is $2.0 million in stock (approximately 42,000
shares) and is payable after 12 months, 24 months, 36 months and 48 months. The
contingent payments will be accounted for as compensation expense on a pro-rata
basis over the term of the employment condition and not as purchase price. Upon
consummation of the acquisition, VA established an escrow for these contingent
payments. The disclosures of the allocation of purchase price and pro forma data
have been omitted as the amounts are not material.
Pro Forma Information
On March 28, 2000, in an acquisition accounted for under the purchase
method of accounting, VA Linux acquired all of the outstanding shares of
TruSolutions, Inc. ("TruSolutions") for approximately $72.9 million.
TruSolutions is a manufacturer of rackmount servers based on the Pentium III,
Xeon and UltraSPARC processors specializing in low profile, high performance
systems designed for the Internet Data Center, ISP, ASP and OEM. On April 5,
2000, in an acquisition accounted for under the purchase method of accounting,
VA Linux acquired all of the outstanding shares of NetAttach, Inc. ("NetAttach")
for approximately $37.3 million. NetAttach provides high-availability
data-appliances for mission-critical deployment in corporate services or
engineering environments. On June 7, 2000, in an acquisition accounted for under
the purchase method of accounting, VA Linux acquired all of the outstanding
shares of OSDN (previously Andover.Net, Inc.) for approximately $342.0 million
(including acquisition costs of approximately $5.0 million). OSDN provides
products, online tools, news and other services for programmers, software
developers, web site designers, technology managers and corporate buyers. The
following unaudited pro forma information represents the results of operations
of VA Linux, NetAttach, TruSolutions and OSDN as if the acquisitions had been
consummated as of the beginning of the period presented. The pro forma
information does not purport to be indicative of what would have occurred had
the acquisitions been made as of those dates or of results that may occur in the
future. The information below does not include $9.0 million of purchased
in-process research and development that was expensed at the time of
acquisition. The unaudited pro forma information is as follows (in thousands,
except per share data):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
----------
OCTOBER 29,
1999
----------
<S> <C>
Total revenues $ 20,286
Loss from operations $(54,777)
Net loss attributable to common stockholders $(59,677)
Basic and diluted net loss per share $ (3.92)
</TABLE>
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NOTE 4 -- Sublease Agreement
In October 2000, the Company entered into an agreement to sublease its
previous headquarters located in Sunnyvale, California. The sublease expires in
2005 upon the expiration of the original lease with the landlord.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Special Note Regarding Forward Looking Statements
This quarterly report on Form 10-Q contains forward looking statements,
including, without limitation, statements regarding future financial performance
and results of our operations; technological trends in the computer industry;
our future product and service offerings, costs and features; the ultimate
success of our product and service offerings; anticipated domestic and
international revenue; future gross margin on products and services;
management's strategy, plans and objectives for future operations, including
additional offices in foreign markets, pursuing a broader account base and new
sales channels; demand for VA Linux's products and service plans; the future
functionality, business potential, demand for, and adoption of build-to-order
software, the Build-to-Order Software Selector (BOSS(TM)), and the Open Source
Development Network (OSDN(TM)); growth in adoption of and support for the Open
Source development model; and the expansion of the range of Open Source software
applications. Actual results may differ materially from those projected in such
forward-looking statements due to various factors, including, without
limitation: VA Linux's quarterly sales cycle and fluctuation in demand for our
products and services, with increased fluctuation due to VA Linux's
concentration of customers in the Internet infrastructure industry; the rate of
growth and acceptance of Linux and the Open Source software development model;
VA Linux's ability to continue to introduce new products and services, and to
expand its business and operations, particularly internationally and by pursuing
a broader account base; the fact that VA Linux has incurred and expects to
continue to incur substantial losses; VA Linux's dependence upon an Open Source
business model, independent third-party Linux developers, and its single source
contract manufacturer and suppliers; VA Linux's reliance on sales of server
products and expanding its services business; VA Linux's reliance upon strategic
relationships with other companies and its ability to negotiate and implement
specific terms relating to them; the scarcity of Linux-based applications;
competition with, and pricing pressures from, larger, more established
companies, and smaller, general purpose manufacturers; VA Linux's dependence on
its Internet-based businesses; the enforceability of the GNU General Public
License; VA Linux's ability to attract and retain qualified personnel,
especially in professional services and overseas; VA Linux's acquisition
strategy and its ability to successfully integrate Andover.Net and other
acquired companies into its operations; market acceptance of Linux and Open
Source software generally; rapid technological and market change; manufacturing
and sourcing risks; the impact of rapid evolution of the Linux market on our
ability to forecast demand and results; claims and potential damages resulting
from information or postings on our Internet sites; and risks associated with
the Internet infrastructure and regulation.
The following discussion and analysis should be read in conjunction with
the condensed consolidated financial statements and the notes thereto included
in Item 1 in this Quarterly Report and our 2000 Annual Report included as an
exhibit to our Form 10-K and Form 10-K/A filed by the Company with the
Securities and Exchange Commission.
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 related
open source solutions, enables us to provide high-quality Linux systems designed
for optimal performance, reliability and scalability. To further expand our
service offerings, we recently established a professional service organization
and the Open Source Development Network.
We were incorporated 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 personnel 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, administration infrastructure, and acquired
companies. As a result, our employee base grew from 153 at July 31, 1999 to 525
on October 27, 2000, and our operating expenses grew significantly. At October
27, 2000, we had an accumulated deficit of $161.0 million.
Net revenue in the first quarter of fiscal 2001 grew sequentially by
10.7% to $56.1 million compared to $50.7 million for the fourth quarter of
fiscal 2000. Our revenue is derived primarily from sales of systems and related
customer support, with a smaller portion derived from services and web
advertising. Sales of our systems accounted for approximately 87% of our net
revenue in the first quarter of fiscal 2001 and approximately 92% of our net
revenues in the fourth quarter of fiscal 2000. While we expect sales from
services and web advertising to increase, our sales from systems will continue
to represent a significant majority of our net revenues through fiscal 2001. We
recognize revenues from product sales upon shipment. We generally do not grant
any rights to our
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customers to return products. We also provide allowances for warranty costs 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 service organization
and acquired Precision Insight, Inc., Brave New Worlds, and Life to expand our
existing customer service and support offerings to better address the demand for
Linux and Open Source software expertise from our customers. This organization
provides Internet infrastructure and Open Source software services including
system architecture design and integration, development of Open Source software
including the porting of software to Linux, and managed services. We believe
that the computer industry is generally characterized by significant demand for
professional services. Although revenues from our professional services
organization have not been material to date, we are aggressively marketing these
services and believe that these services will address this significant demand.
Accordingly, we expect these revenues to account for a more significant portion
of revenues in the future. Revenues from professional service contracts are
recognized as revenue upon completion of the project, or using the percentage of
completion method of the project where project costs can be reasonably
estimated. Any payments received prior to revenue recognition are recorded as
deferred revenue.
With the acquisition of Andover.Net in June 2000 and in conjunction with
our other Open Source Web sites, we established the Open Source Development
Network (OSDN), which supplies Open Source information to a wide audience. OSDN
helps people develop Open Source software with tools like SourceForge, helps
them to distribute their work through Freshmeat and other Web sites, and helps
them discuss Open Source development on Slashdot and many of our other sites.
Although Web revenues have not been material to date, we are aggressively
marketing these services and we expect these revenues to account for a more
significant portion of revenues in the future. Advertising revenues are
recognized over the period in which the advertisements are displayed, provided
that no significant obligations remain and collection of the receivable is
reasonably assured.
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 35 at fiscal year end 1999 to over 100 at
October 27, 2000. Our direct sales organization consists of field sales,
telesales and sales support personnel. Although indirect sales have not been
material 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 and software via the Internet,
allowing us to more efficiently sell products and facilitate order processing.
Since October 1999, substantially all 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.
Although we have established our European and Japanese operations, to
date, substantially all of our sales have been in North America. We expect
international revenues to represent a larger percentage of our revenues during
fiscal 2001.
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 90 day 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 advance 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 a third
party service organization, 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
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- 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 types of operational and financial controls normally
implemented by growing enterprises. During the second half of fiscal 1999, we
implemented or updated our operational and financial systems, procedures and
controls, including the implementation of an enterprise resource planning system
and an 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.
RESULTS OF OPERATIONS
The following table sets forth financial data for the periods indicated
as a percentage of net revenue.
<TABLE>
<CAPTION>
PERCENTAGE OF NET REVENUE
THREE MONTHS ENDED
-------------------------
OCTOBER 27, OCTOBER 29,
2000 1999
---------- ----------
<S> <C> <C>
Net revenues 100.0% 100.0%
Cost of revenues 77.5 86.8
----- -----
Gross margin 22.5 13.2
Operating expenses:
Sales and marketing 20.6 34.1
Research and development 8.4 18.7
General and administrative 9.9 10.1
Amortization of deferred
Compensation 4.8 19.2
Amortization of compensation
expense related to acquisitions 32.5 --
Amortization of goodwill
and intangible assets 41.8 --
----- -----
Total operating expenses 118.0 82.1
----- -----
Loss from operations (95.5) (68.9)
Interest and other income, net 3.9 1.2
----- -----
Net loss (91.6) (67.7)
===== =====
Dividend related to
convertible preferred stock -- (33.0)
----- -----
Net loss attributable to
common stockholders (91.6%) (100.7%)
===== =====
</TABLE>
THREE MONTHS ENDED OCTOBER 27, 2000 AND OCTOBER 29, 1999
NET REVENUES
The Company has two reportable business segments for revenue: Systems
and Services, and OSDN. The Company allocates resources to and evaluates
performance of its segments based on revenue. Net revenues for the three months
ended October 27, 2000 grew to $56.1 million from $14.8 million for the three
months ended October 29, 1999, which represents an increase of 278%. Sales
growth was primarily attributable to the strength of our server products
designed for the Internet market and an increase in our customer base.
Substantially all of our sales is to customers in the United States and Canada.
In the three months ended October 27, 2000, systems and services revenue
contributed $51.6 million, representing 92.0% of total net revenue, as compared
to $14.8 million, or approximately 100% of total revenue, for the three months
ended October 29, 1999. The sales growth was primarily due to higher demand for
our Internet server products and increased revenue from our professional service
contracts.
In the three months ended October 27, 2000, revenue from OSDN
contributed $4.5 million, representing 8.0% of total net revenue, as compared to
zero revenue for the three months ended October 29, 1999.
For the first three months in fiscal 2001, our top ten customers
accounted for approximately 44.6% of net revenues. For the same period in fiscal
2000, our top ten customers accounted for 50.3% of net revenues. The only
customer to account for more than 10% of
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net revenues in the first three months of fiscal 2001 and fiscal 2000 was Akamai
Technologies, which represented 28.0% and 16.9% of net revenues, respectively.
No other customer accounted for more than 10% of net revenues during any of the
periods presented.
Net revenues for the three months ended October 27, 2000 were below the
Company's expectations, primarily due to slower-than-expected sales growth as
new customer opportunities in the venture-funded "Dot-com" sector declined
faster than anticipated. In the near future, we expect this slower sales growth
to continue because many venture-funded "Dot-com" companies are experiencing a
lack of funding and have delayed systems deployments to conserve capital or pull
in profitability.
Repeat business with our existing customers remained strong during the
first fiscal quarter and, in the future, we expect to benefit from our strategy
of pursuing a broader account base, including business from larger corporate and
enterprise accounts. However, because larger corporate and enterprise customers
require longer sales cycles, we did not receive significant contribution to
revenue from that sector in the fiscal first quarter.
COST OF REVENUES
Cost of revenues increased to $43.5 million for the three months ended
October 27, 2000, as compared to $12.9 million during the same period ended
October 29, 1999. The gross margin percentage was 22.5% for the three months
ended October 27, 2000, as compared to 13.2% for the three months ended October
29, 1999. The improved margins were due to lower component costs as we benefited
from our relationship with our contract manufacturer, Synnex, continued leverage
of our manufacturing and customer support infrastructure as unit volumes
increased and contribution from professional services and OSDN to gross margins
during this fiscal quarter. We expect continued sequential improvement in our
gross margins going forward due to increased revenues from our professional
services, increased unit volumes which allow us to gain certain cost advantages,
and the introduction of new products.
SALES AND MARKETING EXPENSES
In absolute dollars, sales and marketing expenses increased to $11.5
million for the three months ended October 27, 2000 from $5.1 million for the
three months ended October 29, 1999. For the first quarter of fiscal 2001 the
increase reflects expenses associated with sales growth and increased marketing
infrastructure and branding activities. Sales and marketing expenses were 20.6%
of net revenues for the first quarter of fiscal 2001, a decrease of 13.5
percentage points when compared to the same period of fiscal 2000. The decrease
as a percentage of net revenues was due to leveraging our investment in
infrastructure as revenues significantly increased. We expect that sales and
marketing expense will increase in absolute dollars in the future but is
expected to decline as a percentage of net revenues.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist 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, as a percentage of net
revenues, was 8.4% for the three month period ended October 27, 2000 and 18.7%
for the three month period ended October 29, 1999. In absolute dollars, R&D
expenses increased to $4.7 million for the three months ended October 27, 2000
from $2.8 million for the three months ended October 29, 1999. The increase in
absolute dollars was due to an increase in engineering personnel and spending
for prototyping material for new product development. The decrease as a
percentage of net revenues was due to leveraging our investment in
infrastructure as revenues significantly increased. We believe that a
significant level of investment in system design, open source software 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 but to decline as a percentage of net revenues in the
future.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses consist 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, as a percentage of net revenues, were 9.9% in the first
quarter of fiscal 2001, a decrease of 0.2 percentage points when compared to the
first quarter of the prior fiscal year. In absolute dollars, general and
administrative expenses increased to $5.6 million for the three months ended
October 27, 2000 from $1.5 million for the three months ended October 29, 1999.
The increase in absolute dollars was due to an increase in administrative
personnel and the associated costs to support our increased operations. 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, but decrease as a
percentage of net revenues in the future.
AMORTIZATION OF DEFERRED COMPENSATION
In connection with the grant of stock options to employees during fiscal
1999 and prior to our initial public offering in fiscal 2000, we expensed
deferred stock compensation of $2.7 million for the first quarter of fiscal
2001. We expensed $2.9 million of deferred stock compensation in the first
quarter of fiscal 2000.
In connection with the acquisitions of TruSolutions, Inc., Precision
Insight, Inc., NetAttach, Inc., Andover.Net, Brave New Worlds, and Life, we
amortized $18.2 million of compensation expense in the first quarter of fiscal
2001.
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AMORTIZATION OF GOODWILL AND INTANGIBLE ASSETS
In connection with the acquisitions of TruSolutions, Inc., Precision
Insight, Inc., NetAttach, Inc., Andover.Net, Brave New Worlds, and Life, we
amortized $23.4 million of goodwill and intangibles in the first quarter of
fiscal 2001.
INTEREST AND OTHER INCOME, NET
Interest and other income net includes income from our cash investments
net of other expenses. Net interest and other income of $2.2 million in the
first quarter of fiscal 2001 increased from $0.2 million when compared to the
same period in the prior year. The increase was due to an increase in interest
income earned on proceeds from the issuance of common stock as a result of our
initial public offering.
INCOME TAXES
As of October 27, 2000, we had federal and 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 because we have experienced a
cumulative stock ownership change of more than 50% over the last three years.
LIQUIDITY AND CAPITAL RESOURCES
At October 27, 2000, cash and cash equivalents were $92.5 million, as
compared to $14.7 million at October 29, 1999. The increase in cash was due to
proceeds from the sale of common stock in our initial public offering, offset by
investments in working capital and capital expenditures to support operations
growth, and the purchase of short-term marketable securities.
Cash used in operations of $12.1 million for the first three months of
fiscal 2001 consisted primarily of the net loss and increase in accounts
receivable partially offset by depreciation and amortization. The increase in
accounts receivable for the first three months of fiscal 2001 was principally
due to the increase in sales.
Cash used in investing activities of $22.2 million for the first three
months of fiscal 2001 consisted of the purchase of marketable securities, the
purchase of computer and facilities related assets, and the remaining was used
for the acquisition related activities.
Cash from financing activities of $3.0 million for the first three
months of fiscal 2001 was primarily from the exercise of employee stock options
and options exercised from the employee stock purchase plan.
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, continued establishment of
our professional services group, the level and timing of product and service
revenues, the amount of working capital required, possible future acquisitions,
the level of fixed asset investment required, and available borrowings under our
line of credit arrangements. We believe that the net proceeds from our initial
public 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 and other factors which may arise
subsequently, 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 financings, strategic relationships or other arrangements. We
cannot assure you that additional funding, if needed, will be available on
reasonable terms, or at all. Furthermore, any additional equity financing may be
dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. Our inability to raise capital when needed could
seriously harm our business.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No.
133 establishes accounting and reporting standards requiring that every
derivative instrument be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS No. 133, as recently amended, is
effective for fiscal years beginning after June 15, 2000. Management believes
the adoption of SFAS No. 133 will not have a material effect on the Company's
financial position or results of operations.
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In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition". In June 2000, the
SEC deferred the adoption date for SAB No. 101 until the fourth quarter of
fiscal 2001. SAB No. 101 summarizes certain areas of the Staff's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. The Company has not quantified the effect of SAB No. 101
on its financial position or results of operations and has not yet determined
the timing and method of adoption.
In March 2000, the FASB issued Financial Standards Board Interpretation
("FIN") No. 44, "Accounting for Certain Transactions Involving Stock
Compensation--an Interpretation of APB Opinion No. 25". FIN No. 44 addresses the
application of APB No. 25 to clarify, among other issues, (a) the definition of
employee for purposes of applying APB No. 25, (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. FIN No. 44 is effective July 1, 2000, but
certain conclusions cover specific events that occurred after either December
15, 1998 or January 12, 2000. To the extent FIN No. 44 covers events occurring
during the period after December 15, 1998 or January 12, 2000, but before the
effective date of July 1, 2000, the effects of applying the interpretation have
been recognized on a prospective basis from July 1, 2000. VA Linux Systems
adopted FIN No. 44 in July of 2000. The adoption did not have a material effect
on the Company's financial position or results of operations.
RISK FACTORS
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 Corporation, Dell Computer
Corporation, Fujitsu International, Inc., Hewlett-Packard Company, International
Business Machines Corporation and Sun Microsystems, Inc. Although these
companies primarily sell systems that run proprietary operating systems, such as
Microsoft Windows and variants of UNIX, including Sun's Solaris, these companies
have also implemented Linux-based computer businesses.
The systems offered by these companies may have greater functionality and lower
prices than those we currently provide, making our systems less attractive to
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. This is especially true as
we complete for sales from large customers, which may have long-standing
relationships with our more established competitors. These companies also have
larger and more established service 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. 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. These vendors offer products that are carefully tailored for
specific applications, which may better address the needs of these customers.
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 market entry are minimal. Accordingly, it is possible
that new competitors or alliances among existing competitors may emerge and
rapidly acquire significant market share. Any pricing pressures or loss of
potential customers resulting from our failure to compete effectively would
reduce our revenues. We may not be able to compete successfully with these
current or potential competitors.
WE MAY NOT BE ABLE TO COMPETE WITH SMALLER COMPETITORS WHO ARE FOCUSED ON
MANUFACTURING UNITS THAT COMPETE WITH OUR PRODUCTS ON THE BASIS OF PRICE, USING
COMMODITY PARTS. Small, general purpose computer manufacturers that are focused
on a small number of products can often assemble and offer systems comprised of
off-the-shelf, commodity components, and compete with us primarily on the basis
of price. These "white-box" makers may be able to build systems more
inexpensively than we can because they have little or no research and
development expenses, and no investment in relationships with the Open Source
community, thereby giving them lower overhead expenses than us. Such companies
may also be able to compete effectively with us on personalized, local service,
as these companies generally target a small portion of the market. Technology
standardization in recent years has helped these smaller manufacturers overcome
incompatibility problems that affected
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some manufacturers in the past. If customers place less emphasis on our
branding, differentiated design and software expertise and, instead, focus on
price and a comparison of some of the component parts in our systems versus
these "white box" systems, we could suffer a loss of revenues and our business
may be harmed.
IF WE DO NOT INTRODUCE NEW PRODUCTS AND SERVICES IN A TIMELY MANNER, OUR
PRODUCTS AND SERVICES WILL BECOME OBSOLETE, AND OUR OPERATING RESULTS WILL
SUFFER. 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 the
Open Source community does much of the software development for our products and
we must work with, and rely upon, a large number of developers who are not our
employees. We may not successfully identify new product opportunities and
develop and bring new products to market in a timely and cost-effective manner.
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. Our strategy to broaden our customer base includes
pursuing business opportunities from larger corporate and enterprise accounts,
which may fail to generate sufficient revenue to offset the substantial demands
that this strategy will place on our business, in particular the longer sales
cycles, higher levels of service and support and volume pricing and terms that
larger corporate and enterprise accounts often demand. 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.
IF WE ARE UNABLE TO PROVIDE HIGH-QUALITY CUSTOMER SUPPORT AND SERVICES, WE WILL
BE UNABLE TO MEET THE NEEDS OF OUR CUSTOMERS. IN ADDITION, OUR PRODUCTS AND
SERVICES ARE DEPENDENT UPON THE EFFORTS OF MEMBERS OF THE OPEN SOURCE COMMUNITY.
For our business to succeed, we must effectively market our integrated system
and service solutions. If our service organization does not meet the needs or
expectations of customers, 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.
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The quality of our products and services is dependent on the efforts and the
expertise of members of the Open Source community. If we do not continue to work
productively with these members, our ability to provide product enhancement and
quality services will be harmed, which would harm our revenues and compromise
our reputation in the Open Source community and with customers.
RISKS RELATED TO OUR FINANCIAL RESULTS
BECAUSE WE HAVE A LIMITED OPERATING HISTORY AND THE MARKET FOR LINUX-BASED
SYSTEMS IS RAPIDLY EVOLVING, WE MAY NOT ACCURATELY FORECAST OUR SALES AND
REVENUES, WHICH WILL CAUSE QUARTERLY FLUCTUATIONS IN OUR NET REVENUES AND
RESULTS OF OPERATIONS AND 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. In fiscal 2000, we
continued to add a significant number of new employees. In early fiscal 2001, we
again relocated to larger facilities. 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:
- economic conditions generally and in the specific industries in
which our customers operate;
- demand for and market acceptance of Linux-based systems and our
products and services;
- increases in manufacturing costs, including the prices of
components that are used in our products; - reductions in the sales
price of our systems or those offered by 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 contract manufacturer's ability to obtain sufficient supplies
of sole or single source components, including power supplies, disk
controller cards, backplane circuit boards, motherboards and
central processing units;
- the introduction of competing products by companies which market
general or limited purpose servers and computers;
- the failure of Linux developers to enhance and develop the Linux
operating system; 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.
FAILURE TO MAINTAIN OR INCREASE OUR GROSS MARGIN WILL HARM OUR RESULTS OF
OPERATIONS. Our gross margin may be adversely affected by decreases in the
average selling prices of our systems, increased manufacturing costs or
increased costs of providing service revenues. 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
margin will suffer.
To maintain or increase our gross margin, we also must continue to reduce the
manufacturing cost of our products and the costs of providing professional
services. Our products incorporate a significant number of commodity components
and our gross margin will
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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. Increases in our manufacturing costs, whether due to increased
component costs or other factors, could seriously harm our business. We intend
to increase the amount of revenues we derive from professional services. As a
result, we continue to hire additional staff to provide these services. If we
are unable to increase professional services revenues quickly enough, gross
margins on these revenues may decline and may adversely affect our overall gross
margins. For more information related to our costs associated with
manufacturing, see "Management's Discussion and Analysis of Financial Conditions
and Results of Operations -- Results of Operations."
OUR QUARTERLY SALES CYCLE MAKES PLANNING AND OPERATIONAL EFFICIENCIES DIFFICULT.
The timing and amount of our revenues are subject to a number of factors that
make estimation of revenues and operating results prior to the end of a quarter
extremely uncertain. We have operated historically with little or no backlog. As
a result, our revenues in any quarter are dependent on orders booked and shipped
in that quarter. In addition, our customers generally have a long lead-time and
sales cycle, which increases the risk of quarter-to-quarter fluctuations and the
uncertainty of estimating quarterly operating results. We, like other computer
companies, generally sell more of our products in the third month of each
quarter than in the first and second months. This sales pattern places pressure
on our logistics system based on internal forecasts and on our ability to timely
notify our contract manufacturer of our precise manufacturing needs. As a
result, our quarterly sales cycle may adversely affect our ability to predict
our financial results accurately.
Our operating expenses are based on projected annual and quarterly revenue
levels and are incurred approximately ratably throughout each quarter. As a
result, if projected revenues were not realized in the expected period, our
operating results for that period would be adversely affected and could result
in an operating loss. Failure to achieve revenue, earnings, and other operating
and financial results as forecast or anticipated by brokerage firm and industry
analysts has in the past resulted, and could in the future result, in an
immediate and adverse effect on the market price of our common stock.
Additionally, developments late in the quarter, such as lower-than-anticipated
product demand, a systems failure at our facilities or at our contract
manufacturer, or component pricing movements, can adversely impact cash and
related gross profitability, in a manner that is disproportionate to the number
of days in the quarter affected.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE
FORESEEABLE FUTURE. We incurred a loss of $51.3 million for the Company's fiscal
first quarter ended October 27, 2000, primarily due to expansion of our
operations, and we had an accumulated deficit of $161.0 million as of October
27, 2000. 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. Failure to
become and remain profitable may materially and adversely affect the market
price of our common stock and our ability to raise capital and continue
operations.
AS OUR BUSINESS MATURES, WE DO NOT EXPECT OUR NET REVENUES TO CONTINUE TO GROW
AT THE SAME RATE 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. This growth rate
reflects an increased number of customers, introductions of new server models,
an increased focus on professional services beginning in the second quarter of
fiscal 2000 and the acquisition of TruSolutions in the third quarter of fiscal
2000. As our business matures, it is unlikely that our net revenues will
continue to grow at the same rate. 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, which to date
has not represented a significant portion of our revenues. 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.
SALES IN THE INTERNET INFRASTRUCTURE MARKET ARE SUBJECT TO FLUCTUATION. Although
sales to the Internet infrastructure market have grown historically, this market
is characterized by large and often sporadic purchases. In addition, recently,
we and other companies in this market, as well as in the computer market
generally, have warned of lower than expected revenue and declines or delays in
sales orders from customers in the Internet infrastructure market. Sales
activity in this industry depends upon the stage of completion of expanding
network infrastructures, the availability of funding, and the extent that
service providers are affected by regulatory and business conditions in the
locale of operations. A decline or delay in sales orders from this industry
could have a material adverse effect on our business, operating results, and
financial condition.
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OUR LIMITED OPERATING HISTORY AND THE FACT THAT WE OPERATE IN A NEW INDUSTRY
MAKE EVALUATING OUR BUSINESS PROSPECTS AND RESULTS OF OPERATIONS DIFFICULT. Our
company was incorporated in January 1995. We have recently expanded our
operations significantly. For example, we grew from 33 employees at January 31,
1999 to 525 employees at October 27, 2000. 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. In addition, we
employed only two members of our current management team 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.
Furthermore, we participate in the Linux industry, which has only recently
exhibited significant growth. 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 difficulties often associated with acquiring businesses and
technologies;
- 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, particularly from
larger, more established companies that are entering into the Linux
market, as well as the competition we face from general purpose
computer systems manufacturers; and
- our ability to attract and retain qualified management and
professional services personnel.
If we fail to address any of these risks or difficulties adequately, our
business strategy may not be successful and our revenues may not grow and may
decline.
AS WE EXPAND OUR INTERNATIONAL OPERATIONS, 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 began selling our products overseas
during fiscal 2000, initially in Europe. In the first quarter of fiscal 2000, we
established a subsidiary in Japan. 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 customers located in foreign jurisdictions. This could
result in lost revenues and slower revenue growth. Additionally, it will be
costly to establish international facilities and operations, promote our brand
internationally and develop localized websites and other systems. We may be
required to develop foreign language translations of software incorporated into
our systems. Revenues 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
international business. 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 requirements with which we are not familiar and
unexpected changes in these laws and requirements;
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- 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;
- some or all of our domain names may already be in use in countries
where we expect to sell and/or establish operations;
- we could face 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;
- multiple and possibly overlapping tax structures could
significantly reduce the financial performance of our foreign
operations;
- changes in import/export duties and quotas, tariffs and other tax
barriers 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 of these factors could significantly impair our ability to source our
contract manufacturing requirements internationally, which could harm our
business and results of operations.
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 to this
effort. If we fail to introduce new products that address the needs of emerging
market segments, or if our new systems do not achieve market acceptance, our
future growth and profitability could suffer. Our success also depends on
customers choosing our professional consulting services and support over those
of our competitors, and our ability to attract and retain qualified personnel in
the area of professional services. If customers do not select our services, or
if we are unable to meet customer demand for such services, our revenues may not
grow and may decline, and our business will be harmed.
OUR FUTURE NET REVENUES DEPEND ON CONTINUED SALES OF OUR SYSTEMS, AND OUR
BUSINESS WILL SUFFER IF DEMAND FOR, OR REVENUES FROM, OUR SYSTEMS DECLINES.
Historically, we have derived a large percentage of our net revenues from Linux
systems sales. Systems sales represented approximately 100% of our net revenues
in fiscal 1999, approximately 95% of our net revenues in fiscal 2000 and
approximately 87% of our net revenues in the first quarter of fiscal 2001. We
expect systems sales to continue to account for a substantial majority of our
net revenues for the foreseeable future. Any factors adversely affecting the
pricing of, or demand for, these Linux systems, including increased competition
or decreased market acceptance, could cause our net revenues to decline and our
business to suffer.
RISKS RELATED LINUX AND OPEN SOURCE SOFTWARE
IF THE LINUX OPERATING SYSTEM DOES NOT CONTINUE TO GAIN MARKET ACCEPTANCE, WE
WILL NOT BE ABLE TO SUSTAIN OUR REVENUE GROWTH AND OUR BUSINESS COULD FAIL. 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
providing 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. 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 will 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 it,
without cost, and run it on an existing Linux compatible product. Our success
depends on customers purchasing new systems that integrate and are optimized to
run the Linux operating system.
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OUR ABILITY TO INTRODUCE NEW PRODUCTS OR PRODUCT ENHANCEMENTS WOULD BE IMPAIRED
IF LINUX DEVELOPERS DO NOT CONTINUE TO ENHANCE THE CORE SOURCE CODE OF THE LINUX
OPERATING SYSTEM AND DEVELOP LINUX-BASED APPLICATIONS. We may not be able to
introduce new products or product enhancements on a timely basis unless efforts
by Linux developers to expand the functionality of the Linux operating system
continue and are successful. We cannot guarantee that these efforts will
continue, or be successful, because third parties maintain the core of the Linux
operating system, the Linux kernel. 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 Linux kernel developers to
further develop and enhance the Linux kernel could stifle the development of
additional Linux-based applications for use with our products, which would harm
our product sales.
IF ADDITIONAL SOFTWARE APPLICATIONS COMPATIBLE WITH LINUX ARE NOT DEVELOPED, THE
MARKET FOR OUR PRODUCTS WILL NOT GROW, AND OUR PRODUCT SALES WILL BE HARMED. Our
products are currently purchased primarily for Internet-related applications.
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. If third parties
do not introduce more software applications designed to operate on the Linux
operating system and achieve market acceptance, 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 DISTRIBUTIONS OF LINUX ACHIEVE SUFFICIENT MARKET
ACCEPTANCE, OUR OPERATING EXPENSES COULD INCREASE AND DEMAND FOR OUR PRODUCTS
COULD DECLINE. If multiple, incompatible versions of Linux are developed,
customers may become less likely to purchase Linux products, and our sales would
suffer. In addition, we may be required to offer and support more distributions
of Linux.
This would result in increased operating expenses. Alternatively, if VA Linux
sold and supported a single Linux distribution that was not the predominant
Linux distribution, VA Linux's sales and revenue growth would suffer.
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 include with our server products is developed and maintained by third parties
in the Open Source software community. The third parties in the Linux developer
community, upon whom we rely to develop and maintain a majority of our software,
may not continue to support us, our product promotions or our corporate or
operating decisions. If these third parties fail to support us for any reason,
we would be forced to rely to a significantly greater extent on our own
development efforts, which 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 community have criticized the commercialization
of the Open Source movement through activities such as licensing proprietary
versions of Open Source software, providing services to the users of Open Source
software and selling advertisements to companies that seek access to the user
group that visits websites dedicated to Open Source software. We provide
services to the users of Open Source software and sell advertisements on our
websites. A negative reaction to our actions, if widely shared by our visitors
or the rest of the Open Source community, could harm our reputation and diminish
our brand. Our business, results of operations and financial condition could
suffer accordingly.
RISKS RELATED TO OUR PRODUCT MANUFACTURING
WE RELY ON SYNNEX AS OUR SINGLE SOURCE CONTRACT MANUFACTURER. IF SYNNEX IS
UNABLE TO MEET OUR MANUFACTURING NEEDS OR OUR RELATIONSHIP TERMINATES, WE MAY
LOSE REVENUES AND DAMAGE OUR CUSTOMER RELATIONSHIPS. We rely on Synnex to
produce substantially all of our products at its Fremont, California facility on
a purchase order basis, and Synnex is our sole 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. 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
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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 that 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 space in its facilities to us 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. Qualifying a new contract manufacturer and commencing volume
production is expensive and time consuming. 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.
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 a limited
number of sources to supply several other industry standard components. For
fiscal 2001, Converter Concepts, Inc. is our single source for power supplies
used in our FullOn model of server product, Tyco International is our single
source for backplane circuit boards, motherboards and central processing units
in our server products, and Mylex Corporation is our single source for our RAID
hard disk controller cards. It would be difficult for us to identify another
source of supply if any of these suppliers were unable to meet our requirements
for any reason. In addition, we do not have a long-term binding agreement with
Converter Concepts, Inc., Tyco International or Mylex Corporation. 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, and increases in the costs of key components, or shortages of supply,
could harm our business.
IF WE FAIL TO ACCURATELY PREDICT OUR MANUFACTURING REQUIREMENTS, WE COULD INCUR
ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS. Because we currently do not
have a long-term supply contract with Synnex, it is not obligated to supply
products to us for any specific period, in any specific quantity or at any
certain price, except as may be provided in a particular purchase order. We
provide forecasts of our demand to Synnex up to 90 days prior to scheduled
delivery of products to our customers. If we overestimate our requirements,
Synnex may have excess inventory, which would increase our costs. If we
underestimate our requirements, Synnex may have an inadequate inventory, which
could interrupt manufacturing of our products and result in delays in shipments
and revenues. In addition, lead times for materials and components we order vary
significantly and depend on factors such as the specific supplier, contract
terms and demand for each component at a given time. We also may experience
shortages of certain components from time to time, which also could delay the
manufacturing of our products.
RISKS RELATED TO OUR PRODUCTS' DEPENDENCE ON INTELLECTUAL PROPERTY AND THE USE
OF OUR BRAND
WE COULD BE PREVENTED FROM SELLING OR DEVELOPING OUR PRODUCTS IF THE GNU GENERAL
PUBLIC LICENSE 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 GNU
General Public License (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
made freely available and licensed under the same conditions. We know of no
instance in which a party has challenged the validity of these licenses or in
which these licenses have been interpreted in a legal proceeding. 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
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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 the 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 websites. 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 and
internationally. 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 we do 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 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 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 and may be used by competitors,
harming our market share and product revenues. 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 three patent applications. 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.
IF WE FAIL TO ADEQUATELY PROMOTE AND MAINTAIN OUR BRAND NAME OR ARE UNABLE TO
CONTINUE USING "LINUX" AS PART OF OUR BRAND NAME, OUR PRODUCT SALES WOULD
DECLINE, AND WE WOULD INCUR SIGNIFICANT COSTS TO PROMOTE A NEW BRAND NAME. 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
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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 websites. 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 websites. In this event, our product sales would
decline, and we would incur significant costs to promote a new brand name, which
takes time and may not be successful.
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 of
defamation, negligence, copyright or trademark infringement (including
contributory infringement) or other claims relating to the information contained
on our Internet sites, whether written by third parties or us. 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 third parties write
the material, this protection is limited. Furthermore, the law in this area
remains in flux and varies from state to state. We receive notification from
time to time of potential claims, but have not been named as a party to
litigation involving such claims. While no formal complaints have been made
against us to date, our business could be seriously harmed if one were asserted.
OTHER RISKS RELATED TO OUR BUSINESS
OUR REVENUE GROWTH DEPENDS ON OUR ABILITY TO HIRE AND RETAIN QUALIFIED
PERSONNEL. During fiscal 2000 we hired, and going forward we intend to continue
to hire, a significant number of additional research and development, support,
sales and marketing and other personnel. 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.
OUR ACQUISITION OF ANDOVER.NET COULD CAUSE US TO LOSE CUSTOMERS OR STRATEGIC
PARTNERS. Some of Andover.Net's existing customers or strategic partners may
view themselves as competitors of some of our customers or of us and therefore
determine that our acquisition of Andover.Net is competitively disadvantageous
to them. As a result, the acquisition may have adversely affected our
relationship with these customers or strategic partners, and could result in
termination of their relationships as a result.
WE HAVE RECENTLY ACQUIRED SEVERAL COMPANIES AND WE MAY NOT BE ABLE TO
SUCCESSFULLY INTEGRATE AND MANAGE THESE COMPANIES. In the third quarter of
fiscal 2000, we acquired TruSolutions, Inc., Net Attach, Inc., and Precision
Insight, Inc. and in the fourth quarter of fiscal 2000, we acquired Andover.Net.
In the first quarter of 2001, we acquired Brave New Worlds, Inc. and Life BVBA.
These six companies had a total of 202 employees, whom we are integrating with
our other employees.
The ongoing integration of these employees and the operations of these companies
into our business requires significant resources, including significant
attention of our management. We cannot assure you that we will be able to
successfully integrate the employees and other operations of these companies
into our business or that we will be successful in managing the operations of
these companies. If we are not able to successfully integrate and manage the
operations of these operations of these companies, our business may be
materially harmed. Further, we may never realize any of the anticipated benefits
of these acquisitions.
IF WE ARE UNABLE TO IMPLEMENT APPROPRIATE SYSTEMS, PROCEDURES AND CONTROLS TO
MANAGE OUR EXPECTED GROWTH, WE MAY NOT BE ABLE TO SUCCESSFULLY OFFER OUR
SERVICES AND GROW OUR BUSINESS. Our ability to successfully offer our services
and grow our business requires an effective planning and management process.
Since we began operations, we have significantly increased the size of our
operations. This growth has placed, and we expect that any future growth we
experience will continue to place, a significant strain on our management,
systems and resources. In order to manage growth effectively, in the past
fifteen months we have implemented or updated our operations 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.
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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 M. Augustin, our President
and Chief Executive Officer. Aside from certain individuals from Andover.Net, we
do not have employment contracts with any of our key engineering personnel, so
that the employment of any key engineer may be terminated "at will" by such
individual. 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.
WE MAY NOT BE ABLE TO GENERATE ENOUGH ADDITIONAL REVENUE FROM OUR INTERNATIONAL
EXPANSION TO OFFSET THE COSTS ASSOCIATED WITH ESTABLISHING AND MAINTAINING
FOREIGN OPERATIONS. A key component of our growth strategy is to expand our
presence in foreign markets. It has been, and will continue to be, costly to
establish international facilities and operations, promote our brand
internationally and develop localized websites and other systems. Revenue from
international activities may not offset the expense of establishing and
maintaining these foreign operations. In addition, because we have little
experience in marketing and distributing products or services for these markets,
we may not benefit from any first-to-market advantages.
IF WE DO NOT SUBSTANTIALLY EXPAND OUR DIRECT SALES OPERATIONS AND E-COMMERCE
INITIATIVES, OUR SALES AND MARKET SHARE WILL NOT GROW. 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 solutions, such as our
valinux.com website, that broaden our market reach and we 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 PRODUCTS MAY CONTAIN DEFECTS THAT COULD BE COSTLY TO CORRECT, DELAY MARKET
ACCEPTANCE OF OUR PRODUCTS AND EXPOSE US TO LITIGATION. Despite testing our
customers and us, 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. We have not achieved regulatory
compliance in all countries into which we expect to sell and/or establish
operations. In addition, independent parties over whom we exercise no
supervision or control develop most of the software code in our products. 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 products. Failures in our
products could also cause system failures, including 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.
FURTHER ACQUISITIONS COULD RESULT IN DILUTION TO OUR STOCKHOLDERS, OPERATING
DIFFICULTIES AND OTHER HARMFUL CONSEQUENCES FOR US. We are currently seeking to
acquire, and expect that we will continue to seek to acquire or invest in,
additional businesses, products, services and technologies that complement or
augment our service and product offerings and customer base. We are currently
engaged in discussions with a number of other companies regarding strategic
acquisitions or investments. Although these discussions are ongoing, we have not
signed any definitive agreements and cannot assure you that any of these
discussions will result in actual acquisitions.
To be successful, we will need to identify suitable acquisition candidates. In
the event of future acquisitions, we will face additional financial and
operational risks, including:
- difficulty in assimilating the operations, technology and personnel
of acquired companies;
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- 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;
- 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.
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 and
we may lose customers seeking quality professional services. 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 and, therefore, we may not generate sufficient
services revenues to offset the expenses of this organization. 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. In addition, this expansion will place further strain on
our management and operational resources.
WE MAY FAIL TO DEVELOP AND PROMOTE OUR NETWORK EFFECTIVELY, WHICH MAY PREVENT US
FROM ATTRACTING NEW VISITORS AND ADVERTISERS TO OUR NETWORK. Enhancing our
network will allow us to increase our revenues because a segment of our business
is to deliver services and content to users through our network, and we display
advertisements on our network. We have recently enhanced, and intend to continue
to enhance, our network by internally creating and externally acquiring
additional complementary websites. We develop some of the content currently
provided on our websites. Other content is developed by third parties and posted
on our network. In order to attract and retain Internet users and advertisers,
we intend to substantially increase our expenditures to further promote and
develop our network. Our success in developing and promoting our network will
also depend on our ability to provide high quality content, features and
functionality. If we fail to promote our network successfully or if visitors to
our network or advertisers do not perceive our services to be useful, current or
of high quality, our business, results of operations and financial condition
could suffer.
WE ARE VULNERABLE TO UNEXPECTED NETWORK INTERRUPTIONS CAUSED BY SYSTEM FAILURES,
WHICH MAY RESULT IN REDUCED VISITOR TRAFFIC ON OUR NETWORK, DECREASED REVENUE
AND HARM TO OUR REPUTATION. Substantially all of our communications hardware and
other hardware related to our websites will be located in two locations. Fire,
floods, hurricanes, tornadoes, earthquakes, power loss, telecommunications
failures, break-ins and similar events could damage these systems. In addition,
our servers are vulnerable to computer viruses, electronic break-ins, human
error and other similar disruptive problems, which could adversely affect our
systems and websites. We could lose revenue and suffer damage to our reputation
if any of these occurrences affected our systems because we would have decreased
visitor traffic on our network. Our insurance policies may not adequately
compensate us for any losses that may occur due to failures or interruptions in
our systems.
OUR SYSTEMS MAY FAIL OR EXPERIENCE A SLOWDOWN AND OUR USERS DEPEND ON OTHERS FOR
ACCESS TO OUR NETWORK. Our network must accommodate a high volume of traffic and
deliver frequently updated information. Our network has experienced, and may in
the future experience, slower response times or decreased traffic for a variety
of reasons. Slower response times can result from general Internet problems,
routing and equipment problems by third-party Internet access providers,
problems with third-party advertising servers and increased traffic to our
servers. Our network could experience interruptions in service due to the
failure or delay in the transmission or receipt of this information. In
addition, our community of Internet users depends on Internet service providers,
online service providers and other websites' operators for access to our
network. Those providers have experienced outages in the past, and may
experience outages or delays in the future. Moreover, our Internet
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infrastructure might not be able to support continued growth of our network. If
we experience any of these problems, our reputation and brand name could suffer,
users might perceive our network as not functioning properly and our business,
results of operations and financial condition could suffer.
REGULATION AND THIRD-PARTY OWNERSHIP COULD REDUCE THE VALUE OF OUR DOMAIN NAMES,
WHICH WOULD HARM OUR BRAND RECOGNITION. We own numerous domain names, both in
the United States and internationally. These domain names are important because
they allow visitors to locate our websites and build brand recognition. Internet
regulatory bodies regulate domain names. The regulation of domain names in the
United States and in foreign countries is subject to change. Regulatory bodies
could establish additional top-level domains, appoint additional domain name
registrars or modify the requirements for holding domain names. Because of this,
and as a result of third parties acquiring our domain names in other
jurisdictions, we might not acquire or maintain our domain names in all the
countries in which we conduct business, which could harm our business.
Furthermore, the relationship between regulations governing domain names and
laws protecting trademarks and similar proprietary rights is unclear and still
evolving. Therefore, we might be unable to prevent third parties from acquiring
domain names that infringe or otherwise decrease the value of our trademarks and
other proprietary rights. If this occurs, our business, results of operations
and financial condition would suffer.
OUR PRODUCT SALES AND REVENUE GROWTH DEPEND ON THE CONTINUED POPULARITY AND
ACCEPTANCE OF THE INTERNET, WHICH MAY DECLINE IF NEW LAWS AND GOVERNMENT
REGULATIONS SURROUNDING THE INTERNET ARE APPLIED. If the popularity and
acceptance of the Internet as an effective medium of commerce does not continue
to grow or declines, our product sales and revenue growth will be harmed. We are
significantly dependent on the Internet to process the sale of our products. In
July 2000, substantially all of our sales were processed through our valinux.com
website. 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 sales and revenue growth.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have operated primarily in the United States, and virtually all sales have
been made in U.S. dollars. Accordingly, we have not had any material exposure to
foreign currency rate fluctuations. 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. There were
no significant changes in our market risk exposures during the first quarter of
2001. For further discussion of our market risk exposures, refer to Part II,
Item 7A., "Quantitative and Qualitative Disclosures About Market Risk" in our
Annual Report on Form 10-K and Form 10-KA for the fiscal year ended July 28,
2000.
PART II. OTHER INFORMATION
ITEM 2. Changes in Securities and Use of Proceeds
During the quarter ended October 27, 2000, we issued an aggregate of
approximately 189,000 shares of VA Linux common stock (including shares held in
escrow) in exchange for the outstanding shares of Brave New Worlds, Inc. and
Life BVBA. The shares were issued pursuant to an exemption by reason of Section
4(2) of the Securities Act of 1933. These sales were made without general
solicitation or advertising. Each purchaser was an accredited investor or a
sophisticated investor (either alone or through its representative) with access
to all relevant information necessary.
ITEM 6. Exhibits and Reports on Form 8-K
(b) Reports on Form 8-K
(i) Report on Form 8-K, dated November 9, 2000, containing a
November 6, 2000 news release announcing the Registrant's
anticipated financial results for its first fiscal quarter ended
October 27, 2000.
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(ii) Report on Form 8-K, dated November 21, 2000, containing a
November 16, 2000 news release announcing the Registrant's
actual financial results for its first fiscal quarter ended
October 27, 2000.
(c) Exhibit index
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NUMBER
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27.1 Financial Data Schedules
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VA Linux Systems, Inc.
October 27, 2000
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LINUX SYSTEMS, INC.
DATE: December 8, 2000 BY: /s/ Larry M. Augustin
------------------ ---------------------------------------
Larry M. Augustin
President and Chief Executive Officer
DATE: December 8, 2000 BY: /s/ Todd B. Schull
------------------ ---------------------------------------
Todd B. Schull
Vice President and Chief Financial Officer
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EXHIBIT INDEX
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NUMBER
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27.1 Financial Data Schedules
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