<PAGE> 1
================================================================================
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 April 28, 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)
DELAWARE 77-0399299
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1382 BORDEAUX DRIVE, SUNNYVALE, CALIFORNIA 94089
(Address of principal executive offices) (Zip code)
(408) 542-8600
(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.
TITLE OF CLASS OUTSTANDING AT MAY 31, 2000
------------------------------ ---------------------------
Common Stock, $0.001 par value 44,271,199
================================================================================
<PAGE> 2
VA Linux Systems, Inc.
and Subsidiaries
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C> <C>
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements 3
Condensed Consolidated Balance Sheets at April 28, 2000
and July 31, 1999 3
Condensed Consolidated Statements of Operations for the
three and nine months ended April 28, 2000 and April 30, 1999 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended April 28, 2000 and April 30, 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 28
PART II. OTHER INFORMATION 28
Item 2. Changes in Securities and Use of Proceeds 28
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VA LINUX SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
APRIL 28, JULY 31,
2000 1999
--------- ---------
(UNAUDITED)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 125,364 $ 18,653
Accounts receivable, net 18,433 4,033
Inventories 699 1,971
Prepaid expenses and other assets 968 381
--------- ---------
Total current assets 145,464 25,038
Property and equipment, net 4,425 1,759
Goodwill and intangible assets, net 110,528 645
Other assets 256 153
--------- ---------
$ 260,673 $ 27,595
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of loans and notes payable $ 2,598 $ 759
Accounts payable 17,665 6,243
Accrued warranty 1,086 239
Accrued liabilities and other 7,038 1,567
--------- ---------
Total current liabilities 28,387 8,808
--------- ---------
Loans and notes payable, net of current portion 621 424
--------- ---------
Stockholders' equity:
Convertible preferred stock - 19
Common stock 44 15
Additional paid-in capital 424,966 45,461
Stockholder note receivable - (50)
Deferred stock compensation (131,240) (12,121)
Accumulated deficit (62,105) (14,961)
--------- ---------
Total stockholders' equity 231,665 18,363
--------- ---------
$ 260,673 $ 27,595
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 4
VA LINUX SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------- -----------------------
APRIL 28, APRIL 30, APRIL 28, APRIL 30,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues $ 34,595 $ 4,270 $ 69,634 $ 9,874
Cost of revenues 28,439 4,295 58,682 9,671
-------- -------- -------- --------
Gross profit 6,156 (25) 10,952 203
Operating expenses:
Sales and marketing 7,593 1,326 19,769 1,909
Research and development 2,985 410 8,191 674
General and administrative 2,071 1,146 5,224 1,934
Amortization of deferred
stock compensation 4,586 505 11,699 994
Amortization of
compensation expense
related to acquisitions 5,656 - 5,656 -
Amortization of goodwill and
intangible assets 1,889 - 1,889 -
Write-off of in-process
research and development 4,000 - 4,000 -
-------- -------- -------- --------
Total operating expenses 28,780 3,387 56,428 5,511
-------- -------- -------- --------
Loss from operations (22,624) (3,412) (45,476) (5,308)
Interest and other income
(expense), net 1,996 - 3,233 (18)
-------- -------- -------- --------
Net loss (20,628) (3,412) (42,243) (5,326)
======== ======== ======== ========
Dividend related to
convertible preferred stock - - (4,900) -
-------- -------- -------- --------
Net loss attributable to
common stockholders $(20,628) $ (3,412) $(47,143) $ (5,326)
======== ======== ======== ========
Basic and diluted net loss
per share $ (0.58) $ (0.58) $ (2.14) $ (1.14)
Pro forma basic net loss per
share N/A $ (0.20) $ (1.50) $ (0.43)
Weighted-average shares
outstanding:
Basic and diluted 35,313 5,869 22,029 4,674
Pro forma basic N/A 17,266 31,367 12,452
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 5
VA LINUX SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-------------------------
APRIL 28, APRIL 30,
2000 1999
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (42,243) $ (5,326)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 8,475 162
Loss on disposal of assets 177 94
Amortization of deferred stock
compensation 11,699 994
Non-cash compensation expense 1,429 49
Write-off of in-process research and
development 4,000 -
Other, net (37) -
Changes in assets and liabilities:
Accounts receivable (10,436) (1,167)
Inventories 2,511 (210)
Prepaid expenses and other assets (1,036) (248)
Accounts payable 8,383 1,192
Accrued liabilities and other 3,812 522
Accrued warranty 802 (39)
Other long-term liabilities - 60
--------- ---------
Net cash used in operating activities (12,464) (3,917)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (3,113) (1,384)
Business acquired, net of cash acquired (21,608) -
Purchase of other long-lived assets - (130)
--------- ---------
Net cash used in investing activities (24,721) (1,514)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on loans and notes payable (1,170) (275)
Proceeds from borrowings on equipment loan
and line of credit - 700
Proceeds from stockholder note receivable 50 -
Proceeds from issuance of convertible
preferred stock, net 4,834 5,445
Proceeds from issuance of common stock, net 140,207 271
Repurchase of common stock (25) -
--------- ---------
Net cash provided by financing
activities 143,896 6,141
--------- ---------
Net increase in cash and cash equivalents 106,711 710
Cash and cash equivalents, beginning of period 18,653 62
--------- ---------
Cash and cash equivalents, end of period $ 125,364 $ 772
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 6
VA LINUX SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
APRIL 28, 2000
(UNAUDITED)
NOTE 1 - Basis of Presentation
The condensed consolidated financial statements included herein have
been prepared by VA Linux Systems, Inc. ("VA Linux"), 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 condensed
balance sheet as of July 31, 1999 has been derived from the audited financial
statements as of that date, but does not include all disclosures required by
generally accepted accounting principles. VA Linux believes the disclosures
included in the unaudited condensed consolidated financial statements when read
in conjunction with the financial statements and the notes thereto included in
VA Linux's Registration Statement on Form S-1 declared effective by the
Securities Exchange Commission on December 9, 1999 are adequate to make the
information presented not misleading.
The information presented in the accompanying condensed consolidated
financial statements at April 28, 2000, and for the three and nine months ended
April 28, 2000 and April 30, 1999, is unaudited, but includes 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 and nine months ended April 28, 2000 are not necessarily indicative of
the results that may be expected for future quarters or the year ending July 28,
2000.
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.
Principles of Consolidation
These consolidated financial statements include the accounts of VA Linux
Systems, Inc. and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Inventories
Inventories consisted of (in thousands):
<TABLE>
<CAPTION>
APRIL 28, JULY 31,
2000 1999
--------- --------
<S> <C> <C>
Raw materials $ 192 $1,813
Work in process 451 -
Finished goods 56 158
------ ------
Total $ 699 $1,971
====== ======
</TABLE>
Revenue Recognition
Product revenues from the sale of Linux-based servers and desktop
computers are recognized upon shipment of goods. The Company generally does not
grant to 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, including planning, deployment and
installation, systems integration, performance analysis and security consulting
of Linux-based solutions, are recognized as revenue
6
<PAGE> 7
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.
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.
Pro forma basic net loss per share includes the conversion of the
Company's convertible preferred stock using the if-converted method into an
equivalent number of common shares as if the shares had been converted on the
dates of issuance.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
APRIL 28, APRIL 30, APRIL 28, APRIL 30,
2000 1999 2000 1999
------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net loss attributable to common
stockholders $(20,628) $ (3,412) $(47,143) $ (5,326)
======== ======== ======== ========
Basic and diluted net loss
per share $ (0.58) $ (0.58) $ (2.14) $ (1.14)
Pro forma basic net loss
per share $ N/A $ (0.20) $ (1.50) $ (0.43)
Weighted-average shares
outstanding:
Basic and diluted 35,313 5,869 22,029 4,674
Pro forma basic N/A 17,266 31,367 12,452
</TABLE>
Excluding non-cash compensation of $10.2 million and other non-cash
charges of $5.9 million and calculated on a pro forma basis, basic and diluted
net loss per share for the three months ended April 28, 2000 would have been
$(0.13) compared to $(0.20) for the three months ended April 30, 1999.
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. The Company adopted SFAS No. 130
in 1998. Comprehensive income (loss) for the three and nine months ended April
28, 2000 and April 30, 1999 equaled net income (loss).
Segment Reporting
In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information"
("SFAS No. 131"). SFAS No. 131 establishes standards for disclosures about
operating segments, products and services, geographic areas and major customers.
The Company is organized and operates as one operating segment, the provision of
Linux-based products and services. The Company markets its products in the
United States through its direct sales force. Revenues for the three and nine
months ended April 28, 2000 and April 30, 1999 were primarily generated from
sales to end users in the United States.
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.
NOTE 3 - Initial Public Offering
In December 1999, the Company completed an initial public offering of
common stock whereby the Company issued 4,400,000 shares of common stock with an
initial public offering price of $30.00 per share. Upon closing of the initial
public offering, all of the
7
<PAGE> 8
outstanding shares of convertible preferred stock were automatically converted
into 19,921,322 shares of common stock. In conjunction with the initial public
offering, the underwriters exercised their option to purchase 660,000 additional
shares to cover the over-allotments of shares at the $30.00 per share offering
price. The initial public offering raised approximately $141 million after
underwriting fees and $139 million after all other direct costs.
NOTE 4 - Common Stock
Effective October 1998 and March 1999, the Company completed a 2-for-1
and 3-for-2 split, respectively, of its common stock. A 2-for-1 split of the
outstanding shares of common stock and Series B preferred stock and a 3-for-1
split of the outstanding shares of Series A preferred stock was approved by VA
Linux's Board of Directors in October 1999. All share and per share information
included in these financial statements have been retroactively adjusted to
reflect these stock splits.
As of April 28, 2000 there were 44,146,944 shares of common stock issued
and outstanding. This share number assumes the conversion of 19,921,322
outstanding shares of preferred stock into equal shares of common stock. The
conversion was effectuated in December 1999 upon the closing of the Company's
initial public offering. VA Linux is authorized to issue 250,000,000 shares of
common stock, $0.001 par value and 10,000,000 shares of preferred stock, $0.001
par value.
NOTE 5 - Acquisitions
TruSolutions, Inc.
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 (including
acquisition costs of $400,000). 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. The consideration included 767,000 shares of VA Linux common
stock valued at $56.7 million, cash of approximately $10.0 million and the
assumption of outstanding options to purchase TruSolutions common stock valued
at $5.8 million using the Black Scholes option pricing model. 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 three
years. Maximum future payments contingent on employment of the key employees is
$96.3 million in stock (approximately 1,303,000 shares) and is payable after 12
months, 24 months and 36 months (approximately 501,000 shares, 501,000 shares
and 301,000 shares, respectively). The contingent payments will be accounted for
as compensation expense over the term of the employment condition and not as
part of the purchase price. Upon consummation of the merger, VA Linux
established an escrow for these contingent payments. The allocations of the
purchase price to the assets acquired and liabilities assumed based on
preliminary estimates of fair value, which are subject to final adjustment, are
as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Current assets $ 4,871
Property and equipment 381
Other assets 9
Acquired in-process research and development 4,000
Goodwill 62,153
Other intangible assets 7,700
-----------
79,114
Less: Liabilities assumed (6,214)
-----------
$ 72,900
-----------
</TABLE>
At the time of acquisition, VA Linux expensed $4.0 million of purchased
in-process research and development. Other purchased intangible assets,
including goodwill, developed technology and other intangible assets of
approximately $69.9 million are being amortized over their estimated useful
lives of three to five years on a straight-line basis. Beginning on March 28,
2000, TruSolutions' operating results were included with those of the Company.
8
<PAGE> 9
The $4.0 million expensed as in-process research and development
represented 5% of the purchase price and was attributed and supported by a
discounted cash flow analysis that identified revenue and costs on a project by
project basis. The value assigned to purchased in-process technology, based on a
discounted cash flow method, was determined by identifying research projects in
areas for which technological feasibility has not been established. In-process
projects existed at TruSolutions as of the acquisition date for 1/2U, 1U, 2U,
and 4U server products. The value of in-process research and development was
determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net cash
flows from such projects and discounting the net cash flows back to their
present value. The discount rate includes a risk adjusted discount rate to take
into account the uncertainty surrounding the successful development of the
purchased in-process technology. The risk-adjusted discount rate applied to the
projects' cash flows was 45% for the in-process technology. Based upon
assessment of each in-process project's development stage, including relative
difficulty of remaining development milestones, it was determined that
application of a 45% discount rate was appropriate for all acquired in-process
projects. Consideration was also given to the weighted average cost of capital
and various analyses of venture capital rates of return. The valuation includes
cash inflows from in-process technology through 2009 with revenues commencing in
2000 for the 1U, 2U and 4U servers, and in 2001 for the 1/2U server. The
projected total revenue of TruSolutions was broken down to revenue attributable
to the in-process technologies, existing technologies, core technology and
future technology. The revenue attributable to core technology was determined
based on the extent to which the in-process technologies rely on the already
developed intellectual property. At the time of the merger, TruSolutions'
remaining tasks that were substantially incomplete included: developing
additional server features as well as proving out the in-process products'
electrical designs, testing for compatibility with other systems common in
server farms, and testing for Linux performance. Finally, TruSolutions needed to
conduct shock, vibration and performance testing. The percentage complete
calculations for all projects were estimated based on research and development
expenses incurred to date and management estimates of remaining development
costs. Significant remaining development efforts must be completed in the next
six months in order for the respective projects to become implemented in a
commercially viable timeframe. Management's cash flow and other assumptions
utilized at the time of acquisition do not materially differ from historical
pricing, margin, and expense levels prior to acquisition.
NetAttach, Inc.
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 $37.4 million (including
acquisition costs of approximately $300,000). NetAttach provides
high-availability data-appliances for mission-critical deployment in corporate
services or engineering environments. The purchase price included 396,000 shares
of VA Linux common stock valued at $24.6 million, cash of $10.0 million and the
assumption of outstanding options to acquire NetAttach common stock valued at
$2.5 million using the Black Scholes option pricing model. The purchase
agreement also contained additional payments to be made in common stock. These
payments are solely contingent upon the continued employment of certain key
employees for a period of two years. Maximum future payments contingent on
employment of the key employees are $5.4 million in stock (approximately 86,000
shares of VA Linux common stock) and are payable on the two-year anniversary
date of the merger. The contingent payments will be accounted for as
compensation expense over the term of the employment condition and not as part
of the purchase price. Upon consummation of the merger, VA Linux established an
escrow for these contingent payments. The allocations of the purchase price to
the assets acquired and liabilities assumed based on preliminary estimates of
fair value which are subject to final adjustment are as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Current assets $ 376
Property and equipment 55
Other assets 3
Goodwill 33,067
Other intangible assets 4,800
-----------
38,301
Less: Liabilities assumed (944)
-----------
$ 37,357
-----------
</TABLE>
Purchased intangible assets, including goodwill and developed technology
of approximately $37.9 million are being amortized over their estimated useful
lives of five years on a straight-line basis. Beginning on April 5, 2000,
NetAttach's operating results were included with those of the Company.
9
<PAGE> 10
Precision Insight, Inc.
On April 14, 2000, in an acquisition accounted for under the purchase
method of accounting, VA Linux acquired all of the outstanding shares of
Precision Insight, Inc. ("Precision Insight") for approximately $4.1 million.
Precision Insight is an engineering and project management team with significant
expertise in the Linux kernel and multimedia infrastructure development. The
consideration included approximately 32,000 shares of VA Linux common stock
valued at $2.3 million and cash of approximately $1.8 million. 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
$11.5 million in stock (approximately 157,000 shares of VA Linux common stock)
and is payable after 24 months, 36 months and 48 months (approximately 52,300
shares each year). The contingent payments will be accounted for as compensation
expense over the term of the employment condition and not as purchase price.
Upon consummation of the merger, VA Linux established an escrow for these
contingent payments. The disclosures of the allocation of purchase price and pro
forma data have been omitted due to materiality.
The following unaudited pro forma information represents the results of
operations of VA Linux, NetAttach and TruSolutions as if the acquisitions had
been consummated as of the beginning of the periods 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 $4.0 million of purchased
in-process research and development that was expensed at the time of the
TruSolutions acquisition. The unaudited pro forma information is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------- -------------------------
APRIL 28, APRIL 30, APRIL 28, APRIL 30,
2000 1999 2000 1999
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Total revenues $ 39,204 $ 5,598 $ 84,148 $ 13,646
Income from operations $(11,546) $ (4,066) $(34,013) $ (6,227)
Net loss attributable to common stockholders $(11,546) $ (4,066) $(38,913) $ (6,227)
Basic and diluted net loss per share $ (0.32) $ (0.58) $ (1.69) $ (1.07)
</TABLE>
NOTE 6 - Subsequent Events
Acquisition of Andover.Net
VA Linux entered into an agreement and plan of reorganization with
Andover.Net, Inc. ("Andover.Net") to acquire all of the outstanding shares of
Andover.Net pursuant to a triangular merger with its wholly owned subsidiary.
This acquisition was closed on June 7, 2000. A copy of the definitive agreement
related to this acquisition was filed with the Securities and Exchange
Commission on Form 8-K on February 14, 2000. An amendment to this agreement was
filed with the Securities and Exchange Commission on Form 8-K on May 9, 2000.
Lease Agreement
On May 2, 2000, VA Linux entered into an agreement to lease
approximately 139,000 square feet of office space in Fremont, California. The
lease commences on June 1, 2000. VA Linux expects to relocate its headquarters
from Sunnyvale, California to Fremont during its first fiscal quarter of 2001
and intends to sublease its Sunnyvale facilities subsequent to the relocation.
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Factors That May Affect Future Results
This report contains certain forward-looking statements (as such term is
defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) and information relating to VA Linux that are
based on the beliefs of the management of VA Linux as well as assumptions made
by and information currently available to its management of the Company
including statements related to the growth of VA Linux's business, the
performance of its contract manufacturer, Synnex. In addition, when used in this
report, the words "likely," "will," "suggests," "target," "may," "would,"
"could," "anticipate," "believe," "estimate," "expect," "intend," "plan,"
"predict" and similar expressions and their variants, as they relate to VA Linux
or its management, may identify forward-looking statements. Such statements
reflect the judgment of the Company as of the date of this quarterly report on
Form 10-Q with respect to future events, the outcome of which is subject to
certain risks, including the factors set forth in "Risk Factors," which may have
a significant impact on VA Linux's business, operating results or financial
condition. Investors are cautioned that these forward-looking statements are
inherently uncertain. Should one or more of these risks or uncertainties
materialize, or should underlying assumptions prove incorrect, actual results or
outcomes may vary materially from those described herein. Although we believe
that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. Moreover, VA Linux does not assume responsibility for the
accuracy and completeness of these forward-looking statements. VA Linux
undertakes no obligation to update forward-looking statements.
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 registration statement on Form S-1
declared effective by the Securities Exchange Commission on December 9, 1999.
OVERVIEW
We are a leading provider of complete Linux-based solutions, integrating
systems, software and professional 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.
We were founded in January 1993, and grew very modestly until the end of
fiscal 1998. Since July 31, 1998, however, we have experienced significant
growth and have invested in hiring engineers with Linux expertise, growing our
direct sales force to better penetrate the market for Linux products and
marketing our brand. To further implement these strategies, we expanded our
operations, customer support and administrative infrastructure. As a result, our
employee base has grown from 15 at July 31, 1998 to 345 on April 28, 2000, and
our operating expenses have grown significantly. This rapid growth has placed
significant demands on our management and operational resources. Since our
inception, we have incurred significant losses. At April 28, 2000, we had an
accumulated deficit of $62.1 million.
During the quarter ended April 28, 2000, we completed the acquisitions
of TruSolutions Inc. ("TruSolutions"), NetAttach Inc. ("NetAttach"), and
Precision Insight, Inc. ("Precision Insight"). 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. NetAttach provides high-availability
data-appliances for mission-critical deployment in corporate services or
engineering environments. Precision Insight is an engineering and project
management team with significant expertise in the Linux kernel and multimedia
infrastructure development. The effect of the acquisition of Precision Insight
on the quarter ended and nine months ended was not material.
Our prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets. These
risks for VA Linux include the emerging market for Linux products and our
ability to successfully manage our growth. To address these risks, we must:
- develop and increase our customer base;
- implement and successfully execute our business and marketing
strategy;
- continue to develop, introduce, market and sell new products and
services;
- successfully respond to competitive developments; and
- attract, retain and motivate quality personnel.
Net revenue in the quarter ended April 28, 2000 grew by 710% to $34.6
million compared to $4.3 million for the quarter ended April 30, 1999. The net
revenue was based primarily on increased sales of our server products. To date,
substantially all of our revenues have been derived from sales of systems,
professional services and related customer support. Sales of our servers
accounted for approximately 59% of our net revenues in fiscal 1999,
approximately 88% in the quarter ended October 29, 1999, 91% in the quarter
ended January 28, 2000 and 89% in the quarter ended April 28, 2000. While we
expect sales of our desktop and storage products to increase, current and future
generations of our server product families will continue to represent a
significant majority of our net revenues through fiscal 2000.
VA Linux has targeted the Internet market for strategic emphasis. This
segment includes customers in the ISP, ASP, web caching and e-tailing
businesses. In the third quarter of fiscal 2000, sales to customers in this
segment represented 77% of our revenue. We expect this market segment will
continue to be the central focus of our sales efforts.
We recognize revenues from product sales upon shipment. We generally do
not grant any rights to our 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.
We sell Linux expertise. This expertise is based upon our knowledge of
Linux and other open source software and is delivered through sales and support
of our hardware and through the delivery of professional services. Professional
services were $1.5 million or 4.2% of our net revenue for the quarter ended
April 28, 2000 as compared to zero dollars or 0% of our net revenue for the
quarter ended April 30, 1999.
We believe that the computer industry is generally characterized by
significant demand for professional services. In September 1999, we established
our professional services organization to expand our existing customer service
and support offerings to better address the demand for Linux expertise from our
customers. This organization offers a number of services, including systems
11
<PAGE> 12
architecture and planning, deployment and installation, system integration, open
source product implementation, performance analysis and security consulting
services.
Professional services revenues are recognized upon completion of the
project, or using the percentage of completion method where project costs can be
reasonably estimated. Any payments made prior to revenue recognition are
recorded as deferred revenue.
Prior to January 1999, we sold our products to customers primarily in
response to telephone inquiries. During the third quarter of fiscal 1999, we
began implementing our direct sales strategy. Our direct sales organization
consists of field sales, telesales and sales support personnel. Although
indirect sales have been insignificant to date, we may pursue selective channel
opportunities to supplement our direct sales efforts. In addition, our
valinux.com web site permits customers to configure and order products online,
allowing us to more efficiently sell products and facilitate order processing.
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.
To date, substantially all of our sales have been in North America. We
expect to launch sales and marketing efforts internationally during the fourth
quarter of fiscal 2000, initially focusing on Europe. In addition we expect to
establish a subsidiary in Japan during calendar year 2000. However, we expect
international revenues to represent a relatively small percent of our revenues,
if any, in fiscal 2000.
We outsource virtually all of our manufacturing and supply chain
management operations, including inventory management and component procurement,
to Synnex, our contract manufacturer. We provide Synnex with five month rolling
forecasts based on anticipated product orders. Synnex uses these forecasts to
purchase components for our products. If we overestimate our component
requirements, Synnex may have excess inventory, which would increase our costs.
If we underestimate our component requirements, Synnex may have inadequate
inventory, which could interrupt their manufacturing of our products and result
in delays in system shipments. Any of these events could harm our business and
results of operations. Our agreement with Synnex may be terminated for any
reason at any time on delivery of 120 days advanced notice. A substantial
majority of our cost of revenues currently consists of payments to Synnex. Cost
of revenues also includes costs associated with our customer support and
professional services. Customer support costs include payments made to
DecisionOne, which provides call-center and onsite service functions to our
customers. We expect revenues from professional services to carry a higher gross
margin than our product revenues. We believe that future gross margin will
primarily be affected by:
- changes in components and manufacturing costs;
- the volume and mix of products and services sold;
- new product introductions both by us and our competitors;
- changes in our pricing policies and those of our competitors;
- the size of customer orders; and
- the mix of domestic and international sales.
Prior to October 1998, we operated as a small closely-held company. As
such, we did not have the 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.
In connection with the grant of stock options to employees during fiscal
1999 and the first nine months of fiscal 2000, we recorded deferred stock
compensation of $14.4 million and $23.4 million, respectively, representing the
difference between the deemed fair market value of the common stock for
accounting purposes and the exercise price of these options as of the date of
grant. Deferred compensation is presented as a reduction of stockholders' equity
and is amortized on an accelerated basis over the vesting period of the
applicable options, generally four years. We expensed $4.6 million and $11.7
million of deferred compensation during the three and
12
<PAGE> 13
nine months ended April 28, 2000. Based on option grant activity through April
28, 2000, we expect to amortize deferred stock compensation of $4.6 million
during the fourth quarter of fiscal 2000.
In addition, in connection with the acquisitions of TruSolutions and
NetAttach, we recorded deferred stock compensation of $113.1 million during the
third quarter of fiscal 2000, representing the value of common stock issued into
an escrow account that will only be issued to certain employees of the acquired
companies if they continue to be employed by VA Linux for a set period of time.
We expensed $5.7 million of this deferred compensation related to acquisitions
during the three months ended April 28, 2000 and expect to amortize $17.0
million during the fourth quarter of fiscal 2000.
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 NINE MONTHS ENDED
----------------------- -----------------------
APRIL 28, APRIL 30, APRIL 28, APRIL 30,
2000 1999 2000 1999
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 82.2 100.6 84.3 97.9
-------- --------- --------- ---------
Gross margin 17.8 (0.6) 15.7 2.1
Operating expenses:
Sales and marketing 21.9 31.1 28.4 19.3
Research and development 8.6 9.6 11.8 6.8
General and administrative 6.0 26.8 7.5 19.6
Amortization of deferred
stock compensation 13.3 11.8 16.8 10.1
Amortization of
compensation expense
related to acquisitions 16.3 - 8.1 -
Amortization of goodwill
and intangible assets 5.5 - 2.7 -
Write-off of in-process
research and development 11.6 - 5.7 -
-------- --------- --------- ---------
Total operating
expenses 83.2 79.3 81.0 55.8
-------- --------- --------- ---------
Loss from operations (65.4) (79.9) (65.3) (53.7)
Interest and other income
(expense), net 5.8 -- 4.6 (0.2)
-------- --------- --------- ---------
Net loss (59.6) (79.9) (60.7) (53.9)
======== ========= ========= =========
Dividend related to
convertible preferred
stock - - (7.0) -
-------- --------- --------- ---------
Net loss attributable to
common stockholders (59.6%) (79.9%) (67.7%) (53.9%)
======== ========= ========= =========
</TABLE>
13
<PAGE> 14
THREE AND NINE MONTHS ENDED APRIL 28, 2000 AND APRIL 30, 1999
NET REVENUES
Net revenues for the three months ended April 28, 2000 grew to $34.6
million from $4.3 million for the three months ended April 30, 1999, which
represents an increase of 710%. Net revenues increased by 605% to $69.6 million
for the first nine months in fiscal 2000 compared to $9.9 million for the first
nine months of fiscal 1999. Sales growth was primarily attributable to the
strength of our server products designed for the Internet market and an increase
in our customer base. Virtually all of our sales are to customers in the United
States and Canada.
For the first nine months in fiscal 2000, our top ten customers
accounted for approximately 34.0% of net revenues. For the same period in fiscal
1999, our top ten customers accounted for 21.3% of net revenues. Akamai
Technologies, which represented 16.1% of net revenues, was the only customer to
account for more than 10% of net revenues in the first nine months of fiscal
2000. No other customer accounted for more than 10% of net revenues during any
of the periods presented.
In the three months ended April 28, 2000, professional services revenue
contributed $1.5 million, representing 4.2% of total revenue, as compared to
zero revenue for the three months ended April 30, 1999. For the nine months
ended April 28, 2000, revenue from professional services was $1.8 million,
compared to zero revenue for the nine months ended April 30, 1999.
COST OF REVENUES
Cost of revenues increased to $28.4 million for the three months ended
April 28, 2000, as compared to $4.3 million during the same period ended April
30, 1999. Cost of revenues for the first nine months of fiscal 2000 increased to
$58.7 million from $9.7 million for the same period of fiscal 1999. Gross margin
was 17.8% and 15.7% for the three months and nine months, respectively, ended
April 28, 2000, as compared to (0.6%) and 2.1% for the three months and nine
months, respectively, ended April 30, 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 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 $7.6
million for the three months ended April 28, 2000 and $19.8 million for the
first nine months of fiscal 2000 from $1.3 million and $1.9 million,
respectively, for the three months and nine months ended April 30, 1999. For the
third quarter of fiscal 2000 the increase reflects expenses associated with
sales growth and increased marketing infrastructure and branding activities. For
the first nine months of fiscal 2000, the increase also reflects non-recurring
non-cash charges associated with stock options issued for recruiting and
marketing services incurred prior to our initial public offering. Sales and
marketing expenses were 21.9% of net revenues for the third quarter of fiscal
2000 and 28.4% of net revenues for the first nine months of fiscal 2000, a
decrease of 9.2 percentage points and an increase of 9.1 percentage points,
respectively, when compared to the same periods of fiscal 1999. The decrease as
a percentage of net revenues was due to leveraging our investment in
infrastructure as revenues increased significantly. Excluding the one-time
non-cash charges, sales and marketing expense would have been 27.0% of net
revenues for the first nine months of fiscal 2000. 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 8.6% and 11.8%, respectively for the three month and nine month
periods ended April 28, 2000 and were 9.6% and 6.8% for the three month and nine
month periods ended April 30, 1999. In absolute dollars, R&D expenses increased
to $3.0 million for the three months ended April 28, 2000 and $8.2 million for
the first nine months of fiscal 2000 from $0.4 million and $0.7 million for the
three and nine months ended April 30, 1999. The increase in absolute dollars was
due to an increase in engineering personnel and spending for prototyping
material for new product development. We believe that a significant level of
investment in system design, open source software and other research and
14
<PAGE> 15
development initiatives is required to remain competitive. Accordingly, we
expect research and development expenses to continue to increase in absolute
dollars and decrease 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 6.0% and 7.5% in
the third quarter and first nine months of fiscal 2000, a decrease of 20.8
percentage points and 12.1 percentage points when compared to the third quarter
and first nine months of the prior fiscal year. In absolute dollars, general and
administrative expenses increased to $2.1 million for the three months ended
April 28, 2000 and $5.2 million for the first nine months of fiscal 2000 from
$1.1 million and $1.9 million, respectively, for the three and nine months ended
April 30, 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 and 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 STOCK COMPENSATION
In connection with the grant of stock options to employees during fiscal
1999 and the contingent shares in escrow from our acquisitions of TruSolutions
and NetAttach during fiscal 2000, we expensed deferred stock compensation of
$10.2 million for the third quarter and $17.4 million for the first nine months
of fiscal 2000. We expensed $1.0 million of deferred stock compensation in the
first nine months of fiscal 1999. We expect to expense $21.6 million of deferred
stock compensation in the fourth quarter of fiscal 2000.
AMORTIZATION OF OTHER NON-CASH EXPENSES
In connection with the acquisitions of TruSolutions and NetAttach we
recorded approximately $107 million of goodwill and intangibles and expensed
$1.9 million of goodwill and intangibles for the third quarter of fiscal 2000.
We expect to expense $5.7 million of goodwill and intangibles in the fourth
quarter of fiscal 2000.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
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. The
consideration included 767,000 shares of common stock valued at $56.7 million,
cash of approximately $10.0 million and the assumption of outstanding options
to purchase TruSolutions common stock valued at $5.8 million using the Black
Scholes option pricing model.
At the time of acquisition, VA Linux expensed $4.0 million of purchased
in-process research and development. Other purchased intangible assets,
including goodwill, developed technology and other intangible assets of
approximately $69.9 million are being amortized over their estimated useful
lives of three to five years on a straight-line basis.
The $4.0 million expensed as in-process research and development
represented 5% of the purchase price and was attributed and supported by a
discounted cash flow analysis that identified revenue and costs on a project by
project basis. The value assigned to purchased in-process technology, based on
a discounted cash flow method, was determined by identifying research projects
in areas for which technological feasibility has not been established.
In-process projects existed at TruSolutions as of the acquisition date for
1/2U, 1U, 2U and 4U server products. The value of in-process research and
development was determined by estimating the costs to develop the purchased
in-process technology into commercially viable products, estimating the
resulting net cash flows from such projects and discounting the net cash flows
back to their present value. The discount rate includes a risk adjusted
discount rate to take into account the uncertainty surrounding the successful
development of the purchased in-process technology. The risk-adjusted discount
rate applied to the projects' cash flows was 45% for the in-process technology.
Based upon assessment of each in-process project's development stage, including
relative difficulty of remaining development milestones, it was determined that
application of a 45% discount rate was appropriate for all acquired in-process
projects. Consideration was also given to the weighted average cost of capital
and various analyses of venture capital rates of return. The valuation includes
cash inflows from in-process technology through 2009 with revenues commencing
in 2000 for the 1U, 2U and 4U servers, and in 2001 for the 1/2U server. The
projected total revenue of TruSolutions was broken down to revenue attributable
to the in-process technologies, existing technologies, core technology and
future technology. The revenue attributable to core technology was determined
based on the extent to which the in-process technologies rely on the already
developed intellectual property. At the time of the merger, TruSolutions'
remaining tasks that were substantially incomplete included: developing
additional server features as well as proving out the in-process projects'
electrical designs, testing for compatibility with other systems common in
server farms, and testing for Linux performance. Finally, TruSolutions needed
to conduct shock, vibration and performance testing. The percentage complete
calculations for all projects were estimated based on research and development
expenses incurred to date and management estimates of remaining development
costs. Significant remaining development efforts must be completed in the next
six months in order for the respective projects to become implemented in a
commercially viable timeframe. Management's cash flow and other assumptions
utilized at the time of acquisition do not materially differ from historical
pricing, margin, and expense levels prior to acquisition.
INTEREST AND OTHER INCOME (EXPENSE), NET
Interest and other income (expense) net includes income from our cash
investments net of other expenses. Net interest and other income (expense) of
$2.0 million in the third quarter and $3.2 million in the first nine months of
fiscal 2000 increased from virtually zero when compared to the same periods 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 April 28, 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
Since inception, our operations have been financed through private sales
of convertible preferred stock and the sale of common stock in our initial
public offering, and from cash flows from operations.
At April 28, 2000, cash and cash equivalents were $125.4 million, as
compared to $18.7 million at July 31, 1999. During the same period working
capital increased to $117.1 million from $16.2 million. The increase in cash was
due to proceeds from the sale of common stock in our initial public offering,
partially offset by investments in working capital and capital expenditures to
support operations growth.
15
<PAGE> 16
Cash used in operations of $12.5 million for the first nine months of
fiscal 2000 represented the net loss of $42.2 million, an increase in accounts
receivable of $10.4 million, offset by the add back of the amortization of
deferred stock compensation expense of $11.7 million, the add back of in-process
research and development of $4.0 million, the increase in accounts payable of
$8.4 million, and the increase in inventory of $2.5 million. The increase in
accounts receivable and accounts payable for the first nine months of fiscal
2000 was principally due to the increase in sales, and the increase in inventory
was due to the inventory on-hand that was acquired from TruSolutions.
Cash used in investing activities was $24.7 million for the nine months
ended April 28, 2000, of which $22.0 million was used for the acquisition of
TruSolutions, NetAttach and the remaining was used for purchasing computer and
facilities related assets.
Cash from financing activities of $143.9 million for the first nine
months of fiscal 2000 was from the sale of our common stock from our initial
public offering in December 1999 and from the proceeds from the issuance of
convertible preferred stock.
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 financing, 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 March 1998, the American Institute of Certified Public Accountants
issued SOP No. 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," ("SOP No. 98-1"). SOP No. 98-1 requires entities to
capitalize certain costs related to internal-use software once certain criteria
have been met. VA Linux adopted SOP No. 98-1 in fiscal 1999. The adoption of SOP
No. 98-1 did not have a material impact on the Company's financial position or
results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes
accounting and reporting standards requiring that every derivative instrument be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS No. 133, as recently amended, is effective for fiscal years
beginning after June 15, 2000. Management believes the adoption of SFAS No. 133
will not have a material effect on the Company's financial position or results
of operations.
In December 1998, the American Institute of Certified Public Accountants
issued SOP No. 98-9, "Modification of SOP No. 97-2, Software Revenue
Recognition, With Respect to Certain Transactions," ("SOP No. 98-9"). SOP No.
98-9 amends SOP No. 97-2 and SOP No. 98-4 by extending the deferral of the
application of certain provisions of SOP No. 97-2 amended by SOP No. 98-4
through fiscal years beginning on or before March 15, 1999. All other provisions
of SOP No. 98-9 are effective for transactions entered into in fiscal years
beginning after March 15, 1999. VA Linux has not had significant software sales
to date and management does not expect the adoption of SOP No. 98-9 to have a
significant effect on the financial position or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition" ("SAB 101"). SAB 101
summarizes certain areas of the Staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. Management
believes that the adoption of SAB 101 will not have a material effect on the
Company's financial position or results of operations.
YEAR 2000 COMPLIANCE
Many existing computer programs use only two digits to identify a year.
These programs were designed and developed without addressing the impact of the
change in the century. If not corrected, many computer software applications
could fail or create
16
<PAGE> 17
erroneous results by, at or beyond the year 2000. As a result, the networks,
which incorporate our products and our own internal networks, could fail leading
to disruptions in operations and our business activities.
To date, we have not experienced any year 2000 issues with any of our
internal systems or our products, and we do not expect to experience any in the
future. To date, we have not experienced any year 2000 issues related to any of
our key third party suppliers, vendors, customers or service providers nor do we
expect to experience any in the future. Costs associated with remediating our
internal systems have not been material to date.
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. In most
cases, these companies primarily sell systems that run proprietary operating
systems, such as Microsoft Windows and variants of UNIX, including Solaris.
However, some of them, notably IBM, Compaq, Dell, and H-P have announced and are
implementing Linux-based computer businesses. 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
that offer products that are carefully tailored for specific applications which
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 also may not be able to
compete successfully with these current or potential competitors.
WE MAY NOT BE ABLE TO EFFECTIVELY COMPETE AGAINST OTHER PROVIDERS OF LINUX-BASED
COMPUTER PRODUCTS OR NEW MARKET ENTRANTS.
Many large, general-purpose computer vendors, such as Compaq, Dell,
Gateway, Hewlett-Packard and IBM, have recently introduced Linux-based systems.
The systems offered by these companies may have greater functionality and lower
prices than those we currently provide, making our systems less attractive to
our customers. Even if the functionality of the standard features of these
products is equivalent to ours, we face a substantial risk that a significant
number of customers will choose not to purchase products from a less well-known
vendor, regardless of the competitiveness of our solutions.
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 solution. 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.
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.
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.
17
<PAGE> 18
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 a large number of developers who are not our
employees in this process. We may not successfully identify new product
opportunities and develop and bring new products to market in a timely and
cost-effective manner.
IF WE FAIL TO RETAIN AND EXPAND OUR CUSTOMER BASE, OUR REVENUES COULD DECLINE
SUBSTANTIALLY.
We face competition from different sources, and we must compete
effectively against other current and future competitors to retain and expand
our customer base. We believe the principal factors on which we compete include:
- product functionality;
- quality and availability of professional services;
- quality of product and product support;
- total cost of ownership;
- system performance at different price points;
- reusability for multiple applications;
- sales and distribution efficiency; and
- brand name recognition.
To be competitive, we must respond promptly and effectively to the
challenges of technological change, evolving standards and our competitors'
innovations by continuing to enhance our products and grow our sales and
professional services organizations. Any pricing pressures or loss of potential
customers resulting from our failure to compete effectively would reduce our
revenues.
RISKS RELATED TO OUR FINANCIAL RESULTS
OUR LIMITED OPERATING HISTORY AND THE FACT THAT WE OPERATE IN A NEW INDUSTRY
MAKES EVALUATING OUR BUSINESS PROSPECTS AND RESULTS OF OPERATIONS DIFFICULT.
Our company was founded in January 1993. We have recently expanded our
operations significantly. For example, we grew from 33 employees at January 31,
1999 to 345 employees at April 28, 2000, and only two members of our current
management team were employed by us at the end of fiscal 1998. Furthermore, we
participate in the Linux industry, which has only recently exhibited significant
growth. 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;
18
<PAGE> 19
- the uncertain rate of growth in usage and acceptance of the Linux
operating system and other open source software;
- 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.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE
FORESEEABLE FUTURE.
We incurred losses of $47.1 million for the first nine months of fiscal
2000 primarily due to expansion of our operations, and we had an accumulated
deficit of $62.1 million as of April 28, 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 increases in customers and average
order size, as well as the introduction of a new server model and an increased
focus on professional services 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.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY AND BECAUSE 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 its 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 have
continued to add a significant number of new employees and are relocating 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:
- demand for and market acceptance of Linux-based systems and our
products and services;
- increases in manufacturing costs, including the prices of
components which 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 manufacturers' 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,
backplane circuit boards, motherboards and central processing units;
- the introduction of competing products by larger companies which
market general or limited purpose servers and computers;
- the failure of Linux developers to enhance and develop the Linux
operating system;
- economic conditions generally and in the specific industries in
which our customers operate; and
- costs related to acquisitions of complementary technologies or
businesses.
Accordingly, you should not rely on the results of any past periods as
an indication of our future performance. It is likely that in some future
periods, our operating results may be below expectations of public market
analysts or investors. If this occurs, the price of our common stock may drop.
You should not rely on the results of any past periods as an indication
of our future net revenues or results of operations because 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,
during fiscal 1999 and the first two quarters of fiscal 2000, we greatly
increased our operating expenses. We do not know whether our business will grow
rapidly enough to absorb these costs. As a result, we expect our quarterly
operating results to fluctuate and they may be below expectations of public
market analysts or investors. If this occurs, the price of our common stock may
drop.
19
<PAGE> 20
OUR FUTURE NET REVENUES DEPEND ON CONTINUED SALES OF OUR SERVERS, AND OUR
BUSINESS WILL SUFFER IF DEMAND FOR, OR REVENUES FROM, OUR SERVERS DECLINES.
Historically, we have derived a large percentage of our net revenues
from sales of our servers. Sales of our servers represented approximately 59% of
our net revenues in fiscal 1999 and approximately 91% of our net revenues in the
quarter ended April 28, 2000. We expect sales of these servers to continue to
account for a substantial majority of our net revenues for the foreseeable
future. Any factors adversely affecting the pricing of, or demand for, these
servers, including increased competition or decreased market acceptance of Linux
systems, could cause our net revenues to decline and our business to suffer.
OUR SUCCESS DEPENDS ON DEVELOPING NEW SYSTEMS THAT ACHIEVE MARKET ACCEPTANCE AND
ON THE SUCCESS OF OUR PROFESSIONAL SERVICES ORGANIZATION.
We develop systems that are optimized to run the Linux operating system,
particularly for use in Internet-related applications. Developing new products
that meet the needs of emerging market segments requires us to incur significant
research and development expenses and commit substantial engineering resources.
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.
FAILURE TO MAINTAIN OR INCREASE OUR GROSS MARGIN WILL HARM OUR RESULTS OF
OPERATIONS.
Our gross margin may be affected by decreases in the average selling
prices of our systems or increased manufacturing costs 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 margins 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 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 recently announced our intention to
increase the amount of revenues we derive from professional services. As a
result, we have begun 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."
RISKS RELATED TO LINUX AND OPEN SOURCE SOFTWARE
IF THE LINUX OPERATING SYSTEM DOES NOT CONTINUE TO GAIN MARKET ACCEPTANCE, WE
WOULD 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 provision of services and support for these systems. The Linux
operating system has only recently gained broad market acceptance. This
acceptance has been mostly limited to Internet infrastructure applications and
scientific research environments. Our success depends on the continued and
increased rate of adoption of Linux in these and other markets. If this does not
occur, our business 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.
20
<PAGE> 21
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 the core of the Linux
operating system, or the Linux kernel, is maintained by third parties. Linus
Torvalds, the original developer of the Linux kernel, and a small group of
independent engineers are primarily responsible for the development and
evolution of the Linux kernel. Mr. Torvalds is not our employee. If Mr. Torvalds
and other third-party developers fail to further develop the Linux kernel or if
the development community does not continue to improve the functionality of the
operating system or introduce new open source software or software enhancements,
our ability to market our existing and future Linux products would suffer. In
this event, we may also be forced to rely to a greater extent on our own
development efforts or the development efforts of third-party consultants, which
would significantly increase our costs. Any failure on the part of the 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 and by research facilities. For Linux, in general, and our
products, in particular, to gain acceptance in mainstream business and consumer
markets, more third-party software applications designed to operate on
Linux-based operating systems must be introduced and achieve market acceptance.
Many widely used applications, such as Microsoft Office, Intuit Quicken, Adobe
PhotoShop and others, cannot run natively on Linux operating systems. Many
available Linux applications, such as word processors, databases, accounting
packages, spreadsheets, e-mail programs, Internet browsers, presentation and
graphics software and personal productivity applications, have not achieved
mainstream market acceptance. 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. In addition, negative reactions of
third parties in the Linux developer community could harm our reputation,
diminish our brand and result in lower net revenues.
NEGATIVE REACTION WITHIN THE OPEN SOURCE COMMUNITY TO OUR BUSINESS STRATEGY
COULD HARM OUR REPUTATION AND BUSINESS.
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 web sites dedicated to open source
software. We provide services to the users of open source software and sell
advertisements on our web sites. 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 Information Technologies, Inc. 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 with
Synnex, Synnex is not obligated to supply products to us for any specific
period, or in any specific quantity, except as may be provided in a particular
purchase order which has been accepted by Synnex. If Synnex experiences delays,
disruptions, capacity constraints or quality control problems in its
manufacturing operations, then product shipments to our customers could be
delayed, which would negatively impact our net revenues and our competitive
position and reputation. Moreover, our contract with Synnex may be terminated
for any reason at any time by either party upon 120 days advance notice. Synnex
subleases space in its facilities to us for our manufacturing operations. If our
sublease with Synnex terminates, we will need to lease additional space for its
manufacturing operations, which may not be available to us on commercially
reasonable terms, if at all. In addition, we may need to qualify a new contract
manufacturer and may be unable to find a contract manufacturer that meets our
needs or that can source components as cost-effectively as our current contract
manufacturer. Additionally, qualifying a new contract manufacturer and
commencing volume production is expensive and time consuming. Transferring
manufacturing operations can significantly disrupt product supply. If we are
required or chooses 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 2000, Converter Concepts, Inc. is
our single source for power supplies used in its FullOn model of server product,
Tyco International is our single source for backplane circuit boards,
motherboards and central processing units in its server products, and Network
Engines, Inc. is our single source for our "full featured" 1U product. It would
be difficult for us to identify another source of supply if either of these
suppliers were unable to meet our requirements for any reason. In addition, we
do not have a long-term binding agreement with either Converter Concepts, Inc.
or Tyco International. In the past, Synnex has experienced, and may in the
future experience, shortages of, or difficulties in, acquiring these components.
If Synnex is unable to buy these components in adequate quantities at the times
required, we may not be able to manufacture our products on a timely basis,
which would harm our operating results. In addition, if Synnex is required to
pay higher prices for these single or limited source components and we are
required to pay higher prices for products, our gross margin would be harmed.
Furthermore, overall market conditions affecting supply and pricing for key
commodity components are known to fluctuate significantly at times, and
increases in the costs of key components could harm our business.
21
<PAGE> 22
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
five months 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.
IF 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 intend to begin selling our
products overseas during fiscal 2000, initially in Europe. We anticipate that as
we expand our international sales, we will fulfill orders through international
facilities operated by Synnex. We could experience difficulties and disruptions
in the manufacture of our products while we transition some manufacturing
operations to these new facilities. Our inability to scale manufacturing of our
products in foreign facilities, and any manufacturing delays or disruptions that
occur, could prevent us from increasing international sales and achieving the
timely delivery of products to 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 web sites 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;
- 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
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 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.
Additional risks associated with international manufacturing operations include:
- currency fluctuations;
- the need to comply with regulatory requirements and unexpected
changes in these requirements;
- legal uncertainties regarding liability, tariffs and other trade
barriers;
- greater incidence of shipping delays;
- limited oversight of manufacturing operations; and
- potential political and economic instability.
22
<PAGE> 23
Any of these factors could significantly impair our ability to source
our contract manufacturing requirements internationally.
RISKS RELATED TO OUR PRODUCTS' DEPENDENCE ON
INTELLECTUAL PROPERTY AND OUR USE OF OUR BRAND
WE COULD BE PREVENTED FROM SELLING OR DEVELOPING OUR PRODUCTS IF THE GNU GENERAL
PUBLIC LICENSE 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 freely made 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 significant portions of
them, may not be copied, modified, or distributed freely, would have the effect
of preventing us from selling or developing our products, unless we are able to
negotiate a license for the use of the software or replace the affected
portions. In the event that we obtain this license, we would likely be required
to make royalty payments with respect to sale of our products covered by the
license. Any royalty payments would harm our operating results. We may not be
able to obtain this license. In the event that we have to replace portions of
the software code ourselves, which could be time consuming and result in higher
development costs, our operating results would be harmed.
IF WE ARE PROHIBITED FROM USING THE LINUX TRADEMARK, OUR BUSINESS COULD BE
ADVERSELY AFFECTED.
Like many other companies, we market Linux-based products, systems and
services. We do not own the trademark to "Linux." The owner has consented to our
use of the word Linux in our company name and in the title of our web sites. We
believe that the continued efficacy and use of the "Linux" trademark is
important to our business. If the "Linux" trademark is invalidated through a
legal action, or we are no longer permitted to use it, our business could
suffer. In addition, we cannot control the use of this trademark, and use by
others may lead to confusion about the source, quality, reputation and
dependability of Linux, which may harm our business.
OUR BUSINESS WILL BE HARMED IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL
PROPERTY RIGHTS FROM MISUSE BY THIRD PARTIES.
Our collection of trademarks is important to our business. The
protective steps we take or have taken may be inadequate to deter
misappropriation of our trademark rights. We have filed applications for
registration of some of our trademarks in the United States. Effective trademark
protection may not be available in every country in which we offer or intend to
offer our products and services. Failure to protect our trademark rights
adequately could damage our brand identity and impair our ability to compete
effectively. Furthermore, defending or enforcing our trademark rights could
result in the expenditure of significant financial and managerial resources.
WE ARE VULNERABLE TO CLAIMS THAT OUR PRODUCTS INFRINGE THIRD-PARTY INTELLECTUAL
PROPERTY RIGHTS, ESPECIALLY BECAUSE OUR SYSTEMS INCORPORATE MANY DISTINCT
SOFTWARE COMPONENTS
23
<PAGE> 24
DEVELOPED BY THOUSANDS OF INDEPENDENT THIRD PARTIES. ANY RESULTING CLAIMS
AGAINST US COULD BE COSTLY TO DEFEND OR SUBJECT US TO SIGNIFICANT DAMAGES.
We may be exposed to future litigation based on claims that our products
infringe the intellectual property rights of others. This risk is exacerbated by
the fact that most of the code in our products is developed by
independent parties over whom we exercise no supervision or control and who,
themselves, might not have the same financial resources as us to pay damages to
a successful litigant. For example, developers may incorporate code into the
Linux operating system under the GPL without proper third party consents. In
addition, these developers are unlikely to perform patent searches and may
therefore unwittingly infringe third party patent rights. Although most of the
software incorporated into our systems is open source, nothing in open source
licenses can prevent current or future patent holders or other owners of
intellectual property from suing us and others in seeking monetary damages or an
injunction against shipment of our systems. A patent holder may deny us a
license or force us to pay royalties. In either event, our operating results
could be seriously harmed. In addition, employees hired from 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 one patent application. In general,
however, we have taken only limited steps to protect our intellectual property.
Accordingly, we may be unable to use intellectual property to prevent other
companies from competing with us. In addition, we may be unable to prevent third
parties from developing techniques that are similar or superior to our
technology, or from designing around our copyrights, patents and trade secrets.
WE MAY BE SUBJECT TO CLAIMS AS A RESULT OF INFORMATION PUBLISHED ON, POSTED ON
OR ACCESSIBLE FROM OUR INTERNET SITES.
We may be subject to claims 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
us or third parties. These types of claims have been brought against online
services in the past and can be costly to defend regardless of the merit of the
lawsuit. Although recent federal legislation protects online services from some
claims when the material is written by third parties, this protection is
limited. Furthermore, the law in this area remains in flux and varies from state
to state. We receive notification from time to time of potential claims, but
have not been named as a party to litigation involving such claims. In the event
that a claim is made against us in the future, our business could be seriously
harmed if one were asserted. While no claims have been made against us to date,
our business could be seriously harmed if one were asserted.
OTHER RISKS RELATED TO OUR BUSINESS
OUR REVENUE GROWTH DEPENDS ON OUR ABILITY TO HIRE AND RETAIN STAFF.
We intend to hire a significant number of additional research and
development, support, sales and marketing and other personnel during fiscal
2000. Competition for these individuals is intense, and we may not be able to
attract, assimilate or retain highly qualified personnel. Our future success and
ability to sustain our revenue growth also depend upon the continued service of
our executive officers and other key engineering, sales, marketing and support
personnel. Competition for qualified personnel in our industry and in the San
Francisco Bay Area, as well as the other geographic markets in which we recruit,
is extremely intense and characterized by rapidly increasing salaries, which may
increase our operating expenses or hinder our ability to recruit qualified
candidates.
WE MAY NOT BE ABLE TO INTEGRATE ANDOVER.NET SUCCESSFULLY.
Achieving the anticipated benefits of our merger with Andover.Net will
depend in part on the integration of the two businesses in an efficient manner,
and there can be no assurance that this will occur. A successful combination of
VA Linux and Andover.Net will require substantial effort. The difficulty of the
integration may be increased by the geographical separation of the two companies
and their employees. For example, we may not be able to retain key executives
and employees of Andover.Net after the merger. Diversion of our management's
attention from ongoing operations and any difficulties encountered in the
transition and integration process could have a material adverse effect on our
revenues, expenses and operating results. There can be no assurance that we will
realize any of the anticipated benefits of the merger.
WE HAVE RECENTLY ACQUIRED SEVERAL COMPANIES AND WE MAY NOT BE ABLE TO
SUCCESSFULLY INTEGRATE AND MANAGE THESE COMPANIES.
We have recently acquired TruSolutions, Net Attach, and Precision
Insights. These three companies will have 91 employees which must be integrated
with our employees. The integration of these employees and the operations of
these companies into our business may also require significant resources,
including 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 ACQUISITIONS COULD RESULT IN DILUTION TO OUR STOCKHOLDERS, OPERATING
DIFFICULTIES AND OTHER HARMFUL CONSEQUENCES FOR US.
We expect that we will acquire or invest in additional businesses,
products, services and technologies that complement or augment our service and
product offerings and customer base. We have recently acquired Andover.Net,
TruSolutions, Net Attach and Precision Insight. We are currently engaged in
discussions with a number of 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:
24
<PAGE> 25
- difficulty in assimilating the operations, technology and personnel
of acquired companies;
- disruption in our business because of the allocation of resources to
consummate these transactions and the diversion of management's
attention from our core business;
- difficulty in retaining key technical and managerial personnel from
acquired companies;
- 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.
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 could adversely affect our relationship
with these customers or strategic partners, and they could terminate their
relationships as a result.
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 twelve 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.
25
<PAGE> 26
WE MAY NOT BE ABLE TO GENERATE ENOUGH ADDITIONAL REVENUE FROM OUR PLANNED
INTERNATIONAL EXPANSION TO OFFSET THE COSTS ASSOCIATED WITH ESTABLISHING AND
MAINTAINING FOREIGN OPERATIONS.
A key component of our growth strategy is to expand our presence in
foreign markets. It will be costly to establish international facilities and
operations, promote our brand internationally and develop localized web sites
and other systems. Revenue from international activities may not offset the
expense of establishing and maintaining these foreign operations. In addition,
because we have little experience in marketing and distributing products or
services for these markets, we may not benefit from any first-to-market
advantages.
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.
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 design and implement effective marketing campaigns or otherwise fail
to
26
<PAGE> 27
promote and maintain our brand, our sales could decline. Our business may also
be harmed if we incur significant expenses in an attempt to promote and maintain
our brand without a corresponding increase in revenues. Linus Torvalds owns the
trademark to "Linux." Mr. Torvalds has consented to our use of the word Linux in
our company name and in the title of our web sites. This consent may be revoked
in the future, however, and we may no longer be able to use this trademark in
our brand or in the title of our web sites. In this event, our product sales
would decline, and we would incur significant costs to promote a new brand name,
which takes time and may not be successful.
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 web site, 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 MANAGEMENT TEAM IS NEW AND, IF THEY ARE UNABLE TO WORK TOGETHER EFFECTIVELY,
OUR BUSINESS COULD BE SERIOUSLY HARMED.
Our business is highly dependent on the ability of our management team
to work together effectively to meet the demands of our growth. We grew from 33
employees at January 31, 1999 to 345 employees at April 28, 2000. 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. Our productivity and the quality of the products and
services we render may be adversely affected if we do not integrate and train
our new employees quickly and effectively.
EXPANDING OUR SERVICES BUSINESS WILL BE COSTLY AND MAY NOT RESULT IN ANY BENEFIT
TO US.
We believe that the expansion of both our business and the acceptance of
Linux are dependent upon the availability of high quality professional services
to assist customers in designing and implementing Linux-based systems. If we are
unable to successfully provide these services, our business will be harmed 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 such as architecture and planning, system
integration, open source product implementation and security consulting
services. 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.
OUR PRODUCTS MAY CONTAIN DEFECTS THAT COULD BE COSTLY TO CORRECT, DELAY MARKET
ACCEPTANCE OF OUR PRODUCTS AND EXPOSE US TO LITIGATION.
Despite testing by us and our customers, errors may be found in our
products after commencement of commercial shipments. We buy almost all of our
component hardware parts from third parties. These parts may fail, cause
unexpected electrical or mechanical problems or otherwise not function properly.
We have not achieved regulatory compliance in all countries into which we sell,
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 in
critical business systems, for our customers who may assert warranty and other
claims for substantial damages against us. Although our warranties typically
contain provisions designed to limit our exposure to potential product liability
claims, it is possible that these provisions may not be effective or enforceable
under the laws
27
<PAGE> 28
of some jurisdictions. Our insurance policies may not provide sufficient
coverage to adequately limit our exposure to this type of claim. These claims,
even if unsuccessful, could be costly and time consuming to defend.
WE RELY ON THE GROWTH OF THE LINUX/OPEN SOURCE MOVEMENT.
Our business relies on growth in the use of Linux and other open source
operating systems. Generally, this software is provided for free or for less
than $100. If the open source community of third-party software developers does
not continue to improve the functionality of the Linux operating system, or
fails to introduce new open source software or software enhancements, or
develops predominantly expensive, proprietary software, the use of these
operating systems may not increase and our business, results of operations and
financial condition will suffer.
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 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 intend to enhance our network
by internally creating and externally acquiring additional complementary web
sites. Some of the content currently on our web sites is developed by us. 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 web sites 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 web sites. 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 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 web sites' 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 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 web sites 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 April 2000, substantially all of our sales were
processed through our valinux.com web site. We are also planning on deploying
enhanced e-commerce applications to foster closer relationships with our
customers, facilitate Internet-based ordering and tracking, and sales
processing. As the use of the Internet continues to evolve, increased regulation
by federal, state or foreign agencies in areas including user privacy, pricing,
content, and quality of products and services becomes more likely. Our
e-commerce activities might subject us to the jurisdiction of the legal systems
of other countries. Taxation of Internet commerce, or other charges imposed by
government agencies or by private organizations, may also be imposed. Laws and
regulations applying to the solicitation, collection, processing of personal or
consumer information could also be enacted. Any of these regulations could
result in a decline in the use or popularity of the Internet as a medium for
commerce, which could have an adverse effect on our future sales and revenue
growth.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we may invest in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the principal amount of our investment will probably decline. To minimize
this risk in the future, we intend to maintain our portfolio of cash equivalents
and short-term investments in a variety of securities, including commercial
paper, money market funds and government and non-government debt securities. In
general, money market funds are not subject to market risk because the interest
paid on such funds fluctuates with the prevailing interest rate. As of April 28,
2000, all of our cash and cash equivalents were in money market and checking
funds.
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.
PART II. OTHER INFORMATION
ITEM 2. Changes in Securities and Use of Proceeds
During the quarter ended April 28, 2000, we issued an aggregate of
approximately 2.7 million shares of VA Linux common stock (including shares held
in escrow) in exchange for the outstanding shares of TruSolutions, NetAttach,
and Precision Insight. 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
(a) Exhibits
<TABLE>
<S> <C>
10.19 Supplier Agreement between VA Linux Systems, Inc. and
Network Engines, Inc. dated March 1, 2000*
27.1 Financial Data Schedule.
* Confidential treatment has been requested as to certain
portions of this exhibit. The omitted portions have been
separately filed with the Commission.
</TABLE>
(b) Reports on Form 8-K
VA Linux filed four reports on Form 8-K during the quarter ended
April 28, 2000. Information regarding the items reported is as follows.
<TABLE>
<CAPTION>
Date Item Reported On
---- ----------------
<S> <C>
February 14, 2000 VA Linux announced the execution of a definitive
acquisition agreement with Andover.Net.
March 2, 2000 VA Linux announced financial results for the fiscal
quarter ended January 28, 2000.
April 12, 2000 VA Linux announced the acquisition of NetAttach, Inc.
April 12, 2000 VA Linux announced the acquisition of TruSolutions, Inc.
</TABLE>
28
<PAGE> 29
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.
VA LINUX SYSTEMS, INC.
DATE: June 12, 2000 BY: /s/ Larry M. Augustin
------------------------- -------------------------------------
Larry M. Augustin
President and Chief Executive Officer
DATE: June 12, 2000 BY: /s/ Todd B. Schull
------------------------- -------------------------------------
Todd B. Schull
Vice President and Chief Financial Officer
29
<PAGE> 30
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<S> <C>
10.19 Supplier Agreement between VA Linux Systems, Inc. and
Network Engines, Inc.*
27.1 Financial Data Schedule
</TABLE>
--------------
* Confidential treatment has been requested as to certain portions of this
exhibit. The omitted portions have been separately filed with the Commission.
30