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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended February 28, 2001
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: 0-26281
RED HAT, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State of Incorporation)
06-1364387
(I.R.S. Employer Identification No.)
2600 Meridian Parkway, Durham, North Carolina 27713
(Address of principal executive offices, including Zip Code)
(919) 547-0012
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.0001 par value
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
Aggregate market value of the voting stock held by non-affiliates of the
Registrant as of February 28, 2001 was approximately $758,772,733, based on the
closing price of $6.4375 for our common stock as reported by The Nasdaq National
Market on February 28, 2001. There were 168,485,899 shares of common stock
outstanding as of February 28, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
Registrant intends to file a definitive Proxy Statement pursuant to Regulation
14A within 120 days of the end of the fiscal year ended February 28, 2001.
Portions of such Proxy Statement are incorporated by reference in Part III
hereof.
PART I
ITEM 1 - BUSINESS
General
We are the leader in open source solutions for Internet computing, delivering on
the promise of open source from small embedded devices to the most prodigious
enterprise. We apply our technological leadership to create open source
solutions for Internet infrastructure and post-PC environments, offer services
backed by the best understanding of open source and the most comprehensive
resources, deliver the brand of a widely trusted open source leader and
corporate partner, and persist in our commitment to the virtues of open source
to lead a revolution in the computing industry. We provide custom engineering
services to develop end-to-end software solutions primarily for use in the UNIX
and Linux markets and then provide ongoing support and maintenance services for
these custom developed software solutions. In addition, we have developed a
suite of software development tools that are sold through our web site. In late
February 2001, we initiated the Red Hat Network monthly subscription services
for personal users of Red Hat Linux. Through Red Hat Network, we are able to
remotely deploy and manage over the web open source software solutions on
servers using Red Hat Linux as their operating system. We will initiate an
enterprise level version of Red Hat Network in the second half of fiscal 2002
and are committed to providing additional services through Red Hat Network to
users of Red Hat Linux and other open source solutions.
Our web site, redhat.com, is a leading destination for open source software
users and developers and serves as the primary delivery mechanism and customer
interface for many of our offerings. redhat.com also offers extensive news and
information for the open source community, an important forum for open source
software development, a commerce site and priority access for software downloads
and upgrades. We are committed to serving the interests and needs of open source
software users and developers and continuing to share our product developments
with the open source community.
Red Hat, Inc. was incorporated in Connecticut in March 1993 as ACC Corp., Inc.
In September 1995, ACC Corp., Inc. changed its name to Red Hat Software, Inc. In
September 1998, Red Hat Software, Inc. reincorporated in Delaware. In June 1999,
Red Hat Software, Inc. changed its name to Red Hat, Inc. In August 1999 we sold
13,800,000 shares of common stock to the public in our initial public offering.
In January 2000 and February 2001, we acquired Cygnus Solutions ("Cygnus") and
Planning Technologies, Inc. ("PTI"), respectively, in transactions accounted for
as a pooling of interests. As a result of these acquisitions, our historical
financial statements have been restated to include the results of operations and
accounts of both Cygnus and PTI for all periods presented.
In January, March, May, July and September 2000, we acquired Hells Kitchen
Systems Inc. ("HKS"), Enterprise Network Services ("ENS"), Bluecurve, WireSpeed
and C2Net, respectively, in transactions accounted for in accordance with the
purchase method of accounting. In January 2001, we acquired Akopia, Inc., in a
transaction accounted for in accordance with the purchase method of accounting.
As a result, our results of operations include the results of operations of
these entities from the date of the acquisition.
We have international sales offices in the United Kingdom, Ireland, Germany,
Hong Kong, India, Australia, and Japan. Information regarding the international
segments of our business is included in NOTE 2 to our consolidated financial
statements which appear elsewhere in this report.
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Industry Background
Growth of open source software
The Internet has accelerated the development of open source software. Open
source software has its origins in the academic and research environments and is
based on an open, collaborative approach to the development and distribution of
software, whereby multiple groups of developers collaborate on specific projects
from remote locations around the globe. Developers can write code alone or in
groups, make their code available over the Internet, give and receive comments
on other developers' code and modify it accordingly. The growth of the Internet
has greatly increased the scale and efficiency of open source development
through the availability of collaborative technologies such as e-mail lists,
news groups and web sites. These technologies have enabled increasingly large
communities of independent developers to collaborate on more complex open source
projects.
Open source software has emerged as a viable alternative to traditional
proprietary software. Under the proprietary model of software development, a
software developer generally licenses to the user only the object, or binary
code. Binary code consists of the 1's and 0's that only computers understand. By
contrast, under the open source development model, the software developer
provides the user with access to both the binary code and the source code.
Source code is the language used by the developers. As compared to the
proprietary model, the open source model:
. allows a company's in-house development team to collaborate with a
global community of independent developers;
. provides the user access to both binary and source code, and the
rights to copy, modify, alter and redistribute the software; and
. permits the user ongoing access to improvements made to the software
by others.
We believe open source software offers many potential benefits for software
customers, users and vendors. Customers and users are able to acquire the
software at little or no cost, install the software on as many computing devices
as they wish, and customize the software to suit their particular needs. In
addition, customers and users can obtain software updates, improvements and
support from multiple vendors, reducing reliance on any single vendor. Vendors
are able to leverage the community of open source developers, allowing them to
reduce development costs and decrease their time to market. Vendors are also
able to distribute their products freely over the Internet, enabling them to
create large global user bases quickly.
Participants in open source development can generate revenue in a variety of
ways, including:
. making their own open source products widely available, and then
offering technical support, custom development, and related services
to customers;
. meeting consumer demand for convenience and quality by selling their
open source products to customers in shrink-wrapped packaging
accompanied by user manuals and other related documentation and access
to services and technical support offerings;
. using open source products as a means of attracting visitors to their
web sites, which in turn can result in the sale of other products,
services, and advertising; and
. developing brand loyalty and a reputation for quality by providing
technically superior open source software products, which they can
leverage to sell additional products and services to customers.
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Just as the open source model has benefited from the success of the Internet, it
has also greatly contributed to the Internet's success. Open source software
comprises much of the Internet's infrastructure, from domain name server
software to web servers and e-mail router software. Open source software is
particularly well-suited to the Internet. With access to the source code, system
administrators and developers can collaborate to debug, fix and optimally
configure their software on a real-time basis. This enables them to improve
performance and keep data flowing continually across the Internet, minimizing
the disruptions and downtime common with proprietary software.
One of the better known open source products is the Linux kernel, the engine of
Linux-based operating systems. An operating system is the software that allows a
computer and its various hardware and software components to interact. Operating
systems based on the Linux kernel are robust and dynamic. Thousands of
developers worldwide continually collaborate on improving Linux-based operating
systems and update them on a regular basis.
Some of the benefits enjoyed by users of Linux-based operating systems include:
. reduced licensing costs;
. flexibility resulting from access to and legal right to modify source
code;
. stability and high performance;
. comprehensive Internet support;
. compliance with standards; and
. multi-platform capability.
Since 1991, the use of Linux-based operating systems has grown rapidly.
According to International Data Corporation, ("IDC"), Linux-based operating
systems represented 27% of all new license shipments of server operating systems
in 2000. Linux-based operating systems are now the most commonly used operating
system for web sites, representing approximately 33% of all installations,
according to the April 2000 Netcraft Web Server Survey.
Open source opportunities beyond servers
The growth of the Internet, together with the reduction in cost and increase in
performance of computing platforms, has also stimulated the demand for computing
devices that provide low-cost, easy access to the Internet. These devices
include mobile computing devices, such as personal digital assistants, wireless
telephones, television set-top boxes, kiosks and game consoles, as well as
special-purpose server devices such as routers, switches and dedicated file and
e-mail servers. According to IDC, whereas in 1997 personal computers accounted
for 96% of Internet access devices shipped in the U.S., by 2002 mobile computing
devices are expected to account for nearly 50% of unit shipments in the U.S. In
addition, IDC predicts that from 1998 through 2002 shipments of these devices
will increase 76% annually, that by 2002 there will be more than 55 million
mobile computing devices, and that, by 2005, shipments of these devices will
exceed shipments of personal computers.
Manufacturers of mobile computing devices and other special-purpose server
devices need flexible, robust and sophisticated operating systems to power these
devices to take advantage of common application interfaces from desktop
computing environments. Many of these manufacturers have, therefore, turned to
open source solutions and specifically Red Hat Linux. We believe significant
opportunity exists for us to be a major contributor to the growth in the use of
open source solutions embedded in mobile computing devices. In fact, in the
fourth quarter of fiscal 2001 over 40% of our custom development contracts
related to embedded Linux applications as compared to none in the fourth
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quarter of fiscal 2000. In addition, many software developers rely upon open
source tools, such as libraries, compilers and debuggers, to create software for
these devices. Microprocessor vendors also use open source development tools and
real time operating systems to design reference platforms for integrated device
manufacturers.
Challenges to the widespread adoption of open source
Despite a strong initial market acceptance of Linux-based operating systems and
other open source products, there exists a number of obstacles to widespread
adoption within the enterprise, including:
. few providers of high quality service and support;
. relative scarcity of applications supporting Linux-based operating
systems; and
. limited number of well-financed, viable open source industry
participants.
The ability of a Linux-based operating system to penetrate large businesses on
an enterprise-wide basis and to gain widespread acceptance as a viable
alternative to operating systems developed under the proprietary software model,
depends, in large part, on the emergence of a proven leader in the open source
community. This open source leader must demonstrate to the business enterprise,
as well as to the community of application developers upon whom the business
enterprise relies, a successful business model and the ability to support and
service its products at a consistently high level.
The Red Hat Solution
To address the challenges facing the open source software market, our products
and services offer the following features and benefits:
Superior product offerings
We engineer what we believe to be the most technically advanced open source
operating system, Red Hat Linux. Red Hat Linux is comprised of more than 700
separate software packages, including compilers and web servers, e-mail servers,
file transfer protocol servers and file servers. Red Hat Linux is:
. flexible and scalable - capable of running a single desktop machine or
the entire network of a large business enterprise;
. functional - able to handle discrete or multiple applications accessed
by multiple users;
. modular - allowing the user to install only those applications that
are desired by the user;
. adaptable - allowing the user to modify the software to meet
particular needs and requirements; and
. reliable - constantly monitored and fine-tuned by thousands of
developers worldwide.
As a result, Red Hat accounted for 48% of new license shipments of Linux-based
server operating systems in the U.S. in 1999. In addition, Red Hat Linux has won
numerous awards, including Info World Magazine's "Operating System Product of
the Year" four years in a row in 1996, 1997, 1998 and 1999.
We also engineer superior software development tools. Our GNUPro software
development tools are based on the leading open source GNU standards and feature
a compiler, debugger, various additional libraries and utilities, including
advanced source code browsing and editing technology. We believe that
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Cygnus has been responsible for over 75% of the changes in GNU compiler source
code over the past three years. We make regular, supported releases of our
GNUPro software across a broad range of computing platforms that support all
significant operating system environments. Consequently, these tools have won
numerous awards including "Show Favorite" at the August 1999 Linux World show
and Linux Journal's 1999 award for "Best New Application-Software Development".
Comprehensive open source solutions
Our market leadership in open source operating systems, e-commerce solutions and
development tools enables us to deliver end-to-end solutions for software
developers and enterprise customers from servers to mobile computing devices. We
employ many of the top contributors to the development and maintenance of the
Linux kernel, Apache and GNU tools. With this expertise, we are better able to
encourage software developers to rapidly develop applications across a broad
range of computing platforms and port these applications for use on the Red Hat
Linux operating system. We are also positioned to work with enterprise customers
and are expanding the adoption of open source solutions within these companies.
Extensive professional services
We also offer a broad range of professional services relating to the development
and use of open source products. These services include technical support and
maintenance, developer support, custom development, consulting, training and
education and hardware certification. We provide our customers and the open
source community with a respected and reliable technology partner, one that is
available to help with the planning, purchase, deployment, customization and
maintenance of open source solutions. We also provide custom embedded Linux
solutions for key integrated device manufacturers, such as Ericsson and
Motorola, and develop new technologies that meet their business objectives. We
provide engineering services and developer support to microprocessor and mobile
computing device manufacturing partners to ensure that our development tools
provide functionality and flexibility that we believe are unmatched by any
proprietary tools vendor. We believe that providing these services and
establishing ourselves as our customers' technology development, deployment and
management partner will allow us to facilitate the widespread adoption of Red
Hat Linux and other open source solutions as full scale enterprise solutions.
Through our acquisition of PTI, we are now able to provide an end-to-end
solution from initial planning of network based computing infrastructure to
development and deployment of open source solutions and support and management
of these solutions.
A leading online destination for the open source community
We are dedicated to serving the interests and needs of open source software
users and developers online. redhat.com serves as our primary customer interface
and delivery mechanism for many of our solutions. redhat.com also serves as a
comprehensive resource for the latest information related to open source
initiatives. It contains news of interest to open source users and developers,
features for the open source community, a commerce site and priority access for
software downloads and upgrades. Visitors to our site can organize and
participate in user groups, make available bug fixes and incremental code
improvements and share knowledge regarding the use and development of open
source software.
By acting as a clearinghouse of open source and Linux-related information and by
facilitating the interaction of developers, businesses and technology
enthusiasts, our web site has become a community center for the open source
movement.
Commitment to the open source model
Red Hat has fully embraced the open source model in its products and services.
Whereas others have incorporated certain aspects of this model into their
businesses while retaining various features of the proprietary model, our
product offerings are true open source offerings. We share our improvements to
the Linux kernel and other open source products with the development community.
In this way, we benefit
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independent developers by making our products more useful for them in their own
development projects. We have also sponsored the creation of the Red Hat Center
for Open Source, Inc., a non-profit foundation dedicated to the promotion of
open source activities and ideals. In addition to the open source software we
develop ourselves, we help fund a broad range of open source software projects
and organizations, including the XFree86 group, the linuxconf open source
software product and the Free Software Foundation.
Strategic relationships
In an effort to increase the market acceptance of open source software in
general, and the Red Hat Linux operating system and other open source solutions
that we develop in particular, we have established development, marketing or
distribution relationships with leading technology companies, including Cisco,
Compaq, Computer Associates, Dell, Hewlett-Packard, IBM, Intel, Nokia, Nortel,
Oracle, SAP, and Sony Computer Entertainment. Further, we are partnering with
many of the world's leading microprocessor companies and mobile computing device
manufacturers to provide open source software technologies on the latest
computing platforms. In addition, we share our development efforts with and
commit resources to third party developers and vendors in order to expand the
number of applications available for Linux-based and other open source-based
operating systems. By establishing and maintaining these relationships, we are
able to increase market awareness of open source software, gather industry
support for our products and penetrate new markets.
Business Strategy
Our objective is to enhance our position as the leader in open source solutions
for Internet computing, via both traditional channels and the Internet. The key
elements of our strategy are:
Increase the adoption of open source solutions across all computing platforms
Although the past year has seen a substantial increase in the market acceptance
of Linux-based operating systems and other open source solutions, we intend to
promote further acceptance of open source solutions through a variety of means,
including continuing to strengthen our existing alliances with other information
technology companies, establishing new alliances and sharing our development
efforts with third-party developers. The strength of these relationships is
crucial to the continued expansion of the open source community, the technical
advancement and widespread distribution of open source solutions and the
development of third-party applications suitable for Linux-based operating
systems.
By aligning ourselves with companies widely regarded as producing high quality
and highly reliable software developed under the traditional software
development model, we expect to bridge the gap between the open source community
and those customers who are currently skeptical or unaware of the benefits of
open source software.
We have and will continue to focus on forging relationships with manufacturers
of mobile computing devices such as wireless phones, digital personal organizers
and special purpose server devices, such as routers and phone switches. With our
broad selection of open source products and our comprehensive array of
professional services, we believe that we can quickly and effectively penetrate
this market, expand our presence and increase the market acceptance for open
source solutions within it.
Additional means of increasing the market acceptance for Linux-based operating
systems and solutions and other open source solutions include maintaining and
improving our relationship with third-party developers and the open source
community, encouraging the development of open source applications and
publicizing success stories.
Expand our presence in the enterprise market
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Historically, enterprise customers had to obtain open source operating systems
from one source and application development tools from another source. With our
acquisitions of Cygnus and Planning Technologies, we are now positioned to
provide comprehensive open source solutions. We intend to continue to expand our
service offerings, including training, consulting, custom development and web-
based services that customers have come to expect from information technology
providers, which will increase their confidence in open source products and
providers. We are currently expanding our professional services organization, as
a result of the acquisition of Planning Technologies, to enhance our ability to
provide such services. We believe that as our user base grows, more of our
customers, particularly our larger customers, will look to us to help them
customize their operating systems and our development tools to perform optimally
within their particular computing environments across all of their computing
platforms. We also expect that more of our services will be provided as
subscription services accessed through our web site. We believe that many of our
larger customers will also expect us to assume the role of their technology
partner and perform on-site consulting services such as large-scale system
assessments and enterprise-wide system enhancements. We believe that by
increasing our capacity to offer such services, through our acquisition of
Planning Technologies, we will be able to significantly increase our services
revenue and establish ourselves as the premier open source service provider.
Continue to pursue strategic acquisitions and alliances
We intend to continue to pursue a selective acquisition strategy as
opportunities arise to complement our product offerings, extend our service
capabilities and expand the features on our web site. We also intend to create
strategic alliances where it is beneficial to our business model. Our
acquisition of Cygnus and Planning Technologies allows us to expand the market
for our products and foster the rapid development of open source applications.
In addition, we believe that our strategic relationships with Cygnus' and
Planning Technologies' large corporate customers will encourage the wide-spread
acceptance of open source operating systems beyond the traditional workstation
and desktop computing environments. Our acquisition of HKS in January 2000,
C2Net in September 2000, and Akopia in January 2001 has helped and will continue
to help us provide comprehensive open source e-commerce solutions to our
business partners.
Increase our penetration into international markets
We have only recently commenced operations in Europe, Asia and Australia, but we
are rapidly expanding worldwide. Since August 1999, we have established
subsidiaries in France, Italy, Japan and Australia. While we have a significant
installed base of international users, we intend to increase our overseas
presence in the near future by establishing additional foreign offices or
subsidiaries. We offer Red Hat Linux in English, French, German, Italian, and
Japanese, and plan to introduce it in other languages in the future.
Continue to invest in the development of open source technology
We intend to continue to invest significant resources in the development of new
open source technology, capitalizing on our extensive experience working within
the open source model. We expect this continued investment to take the form of
increased expenditures on internal development efforts, including our Red Hat
Advanced Development Laboratory, as well as continued funding of third-party
open source projects. We also plan to continue our financial support of the
development efforts of many of the top-tier engineers in the open source
community. This support will be directed towards an array of projects, ranging
from:
. the development of open source embedded operating systems and software
which began with our acquisition of Wirespeed, an embedded Linux
engineering Company, in July 2000, which we believe will take Red Hat
Linux from the personal computer to the mobile computing device; and
. the design of new networking and scalability features, which are
expected to make Red Hat Linux more attractive as a server operating
system.
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In particular, we have sponsored the Red Hat Center for Open Source, Inc., a
foundation which promotes open source projects and ideals. We expect that,
through our continued efforts, we will be able not only to foster the
advancement of open source technology, but also to enhance our relationship with
the open source community.
Products and Services
Our product offerings include Red Hat Linux and related tools, open source
software applications, documentation, manuals and general merchandise. Our
professional services offerings, principally directed towards our larger
corporate customers and strategic partners, include technical support and
maintenance, custom development, consulting, training and education, developer
support and hardware certification.
Our shrink-wrapped products come with a limited subscription service. Users of
these services are entitled to access to Red Hat Network Software, access to
developer pages on our web site and are e-mailed news relating to developments
within the open source community.
Red Hat Linux Open Source Solutions
Official Red Hat Linux. We first released Official Red Hat Linux in October
1994, and began shipping the latest release, Version 7.1, in April 2001.
Official Red Hat Linux is available for the Intel and Alpha platforms. We offer
the product in three versions:
. Standard - the basic collection of Red Hat Linux software including
printed installation guide, limited installation technical support,
and 30 day access to Red Hat Network Software Manager;
. Deluxe - includes the components of Standard, additional software
applications we license from third parties, an additional printed
manual, limited telephone technical support, and 60 day access to Red
Hat Network Software Manager for multiple systems; and
. Professional - includes the components of Deluxe, plus additional
server applications and technical support, and 90 day access to Red
Hat Network Software Manager for multiple systems.
Official Red Hat Linux provides everything the user needs to perform a wide
variety of server functions, including setting-up a web, e-mail, file or print
server as well as using a computer as a general purpose desktop workstation to
perform virtually any computing function.
Interchange. Red Hat introduced Interchange in early 2001 as an e-business
software solution targeted at small and medium businesses. Interchange offers a
complete solution for business-to-business and business-to-consumer electronic
commerce for Red Hat Linux and the Stronghold Secure Apache web server. Though
Interchange is designed to be easy to implement and use, Red Hat offers services
to facilitate rapid deployment and customization of Interchange.
Stronghold. Stronghold is a highly secure Apache web server for Red Hat Linux
and other operating systems. Stronghold complements Red Hat's high-speed Tux
web-serving capability, which is built into the operating system kernel, and
comprises an important component of Red Hat's Internet infrastructure solution.
Red Hat Network. With the release of Red Hat Linux 7, Red Hat introduced the Red
Hat Network, which is an Internet-based service to assure the security,
availability and reliability of Red Hat Linux, Stronghold, Interchange and other
Red Hat software. Today, Red Hat Network allows Red Hat's customers to learn
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about, receive and install updates to Red Hat's software on many computers from
any device connected to the Internet.
Other Red Hat products include:
Red Hat Linux Enterprise Edition. As part of our enterprise product strategy, we
work with top software vendors to provide tested and integrated total Red Hat
Linux solutions for business critical, high-volume, e-business and enterprise
environments. The Red Hat Linux Enterprise Edition product line features
enterprise-class support from Red Hat's worldwide support solutions centers.
Linux Applications Library. The Linux Applications Library is a collection of
applications developed by third parties that are designed to run on Red Hat
Linux. These products do not include printed documentation or technical support.
RMS Linux. RMS Linux is a special collection of Red Hat Linux operating system
and applications containing only open source software, and does not include
technical support or printed documentation. Red Hat donates a portion of the
proceeds from the sale of this product to the Free Software Foundation.
CCVS. Credit Card Verification System (CCVS) is transaction-processing software
that is embeddable and portable to most UNIX and Linux systems. CCVS may be used
for credit card authorization and settlement, as well as check verification.
CCVS is certified with the major clearing house protocols and supports
e-commerce applications ranging from a single web page or billing application,
to a payment gateway server supporting thousands of merchants. We acquired this
product with our acquisition of HKS.
Software for special-purpose client and server devices
Red Hat's product solution offers a common platform for developing, deploying,
and managing open source across Internet infrastructure and devices that connect
to the Internet, ranging from small embedded devices to high availability
clusters. Red Hat has experience in providing runtime solutions for residential
gateways, information appliances, set top boxes and more. In addition, Red Hat
GNUPro tools are relied on by many of the major semiconductor manufacturers
including Altera, Fujitsu, Hitachi, IBM, Intel, MIPS, Mitsubishi, Motorola, NEC,
and Toshiba. These products include:
GNUPro Tools. Red Hat provides a commercial grade toolsuite, GNUPro, based on
the GNU standard. This toolsuite is built on a standard reference base and
delivered with pre-configured binaries. GNUPro features a graphical interface,
compiler, debugger, linker, loader, utilities and more and can be purchased with
various levels of support packages.
Red Hat Embedded Linux. Red Hat Embedded Linux operating system features source
code and drivers, system boot code, POSIX compliant API, file system support,
networking support, and is ideally suited for Internet Appliances, residential
gateways, information appliances, set top boxes and other devices not requiring
real-time.
eCos. eCos, the embedded Configurable operating system, is an open source
real-time operating system for deeply embedded applications. It meets the
requirements of the embedded space that Linux cannot yet reach. Customers using
eCos include Delphi Automatics and iObjects HipZip.
EL/IX. EL/IX is an application programming interface (API) based on a subset of
the POSIX.1 and ISO C standards plus extensions from Linux/GNU and BSD sockets
that are applicable to embedded applications. EL/IX provides an interface that
ensures application portability for any EL/IX compliant operating systems, such
as Linux or eCos. With EL/IX, developers have the tools and framework that
ensure applications maintain compatibility between different underlying
implementations of the operating system.
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RedBoot. RedBoot is a firmware solution designed to aid the development,
deployment and management of embedded devices. It is used by OEM's to support
application development on both commercial development boards and their own
prototype hardware, providing a straightforward migration path to deploy and
manage the final product.
Cygwin. Cygwin allows Linux/UNIX developers to compile their applications easily
for the Windows platform, without any substantial rewriting of the source code.
Professional services
With our acquisition of PTI, we have significantly expanded the scope of our
service offerings and professional services staff, and currently offer the
following services:
Technical support and maintenance and developer support. We offer technical
support and maintenance to a broad range of customers ranging from individual
users to large corporations. We deliver installation, incident-based and
developer support via our web site, e-mail and telephone. We have a
highly-trained and skilled staff of technical support engineers to provide these
services to our customers. In addition, we maintain relationships with several
third-party support providers in order to enhance and expand our technical
support and maintenance capabilities.
Custom development and consulting. We offer consulting and custom development
services for enterprise customers seeking to deploy Red Hat Linux and open
source applications. We also offer advanced assistance to third-party software
developers working to develop applications that run on Red Hat Linux. In
addition, we offer specific consulting and custom development services for key
integrated device and microprocessor manufacturers seeking to utilize embedded
open source operating systems on their devices.
Training and education. We provide training and educational programs to those
customers who want to learn how to optimize their use of Red Hat Linux,
Stronghold Apache and Interchange. The most popular of these programs is the
"Red Hat Certified Engineer" course that we offer at sites around the world. We
also conduct on-site training for customers and e-learning classes through the
Internet. We work with third-party training and educational program providers to
develop and offer additional training courses on a variety of topics related to
Red Hat Linux, our open source tools and other open source software.
Hardware certification. We perform testing and certification services for
hardware vendors seeking to market their products to Red Hat Linux users.
Hardware vendors submit their products to us and, in exchange for a fee, we test
the hardware to determine whether it is compatible with Red Hat Linux. Products
meeting our performance criteria are certified as Red Hat Linux compatible.
Production and fulfillment
We outsource the physical production, packaging and order fulfillment of our
products to third parties when it is cost effective to do so. To the extent
possible, we limit our internal production activities to such tasks as
scheduling, quality inspection and testing.
redhat.com
Our web site, redhat.com, serves as the primary delivery mechanism and customer
interface for many of our offerings. We offer extensive resources for the open
source community, software updates and downloads and a commerce site for our
shrink-wrapped products and support offerings. redhat.com also offers users
access to broad and authoritative content on open source software including
news, documentation, educational materials and case studies. Our web site serves
the interests and needs of a
11
wide spectrum of open source software users, from system administrators to
developers to academics to mainstream technology users.
Since August 1999, significant enhancements include:
. Red Hat Developer Network - The Red Hat Developer Network is a
collection of technical and business resources for developing
software that runs on Red Hat Linux. It includes news about
recent open source software developments, guidance on how to
develop new applications that will run optimally on Red Hat
Linux, technical documentation and other resources, and links to
other resources that may be of interest to software developers.
It is targeted at a range of software developers, including third
parties that develop their own software application products,
enterprise developers, web application developers and open source
software developers. We plan to expand the Developer Network to
include a variety of partnership programs, co-marketing
opportunities and specialized support service offerings.
. Red Hat Store - We intend to continue building the redhat.com
store into the most comprehensive open source shopping resource
for corporate enterprise buyers. Offerings and upsell
opportunities will be presented throughout the site in a context-
relevant manner.
Sales, Marketing and Distribution
Software Solutions
We sell our solutions worldwide through direct sales, inside sales, telesales
campaigns and our web site, and indirectly through distributors, value-added
resellers, retailers, catalogs and original equipment manufacturers. Our sales
force is dedicated to increasing worldwide sales through our retail,
distribution and original equipment manufacturer channels. As of February 28,
2001, our indirect distribution channel was comprised of three distributors,
over 100 retailers with thousands of locations and 50 original equipment
manufacturers. We have recently begun to focus our sales efforts more
aggressively on the business enterprise market.
Our agreements with our distributors typically are not exclusive, have no stated
minimum purchase or license obligations and may be terminated by either party
without cause. We believe that in the event of the termination of our
relationship with one or more of our indirect channel partners, we could enter
into replacement agreements with new partners.
We permit original equipment manufacturers to distribute Red Hat Linux with
their own hardware in exchange for royalty payments to us. We currently have
original equipment manufacturer agreements in place with Dell, Compaq, IBM,
Motorola and others. These agreements are not exclusive, have no stated minimum
purchase or license obligations, and generally may not be terminated prior to
the expiration of their terms.
Services
We sell our service offerings worldwide directly to individuals and companies
through our sales force, direct sales, telesales and our web site, and
indirectly through joint marketing alliances with companies such as Dell,
Compaq, IBM and Intel and Motorola. Our direct sales force concentrates
primarily on selling custom development, network consulting, e-commerce
implementation and technical support and
12
maintenance contracts to our enterprise customers worldwide. Our acquisition of
Cygnus added 28 sales professionals to our direct sales organization.
We have established joint marketing relationships with a number of leading
technology companies including Dell, Compaq, IBM, Intel and Motorola. These
agreements generally have one- or two-year terms and may be terminated prior to
the expiration of their terms by either party with prior notice.
Our direct sales efforts support our sales and distribution efforts through
participation in industry trade shows, targeted advertising, channel sales
programs, public relations campaigns, retail promotions, customer surveys and
the promotion of our products through our web site. In addition, we offer our
software products for free download from redhat.com and other Internet sites
worldwide.
Competition
In the market for operating systems, we compete with a limited number of large
and well-established companies that have significantly greater financial
resources, larger development staffs and more extensive marketing and
distribution capabilities. These competitors include Microsoft, Novell, IBM, Sun
Microsystems and The Santa Cruz Operation, all of which offer hardware-
independent, multi-user operating systems for Intel platforms, and AT&T, Compaq,
Hewlett-Packard, Olivetti and Unisys, each of which, together with IBM and Sun
Microsystems, offers its own version of the UNIX operating system. Many of these
competitors bundle competitive operating systems with their own hardware
offerings, thereby making it more difficult for us to penetrate their customer
bases.
In the rapidly evolving open source and Linux-based operating system market, we
compete with a number of well-respected vendors and development projects. These
competitors have established stable customer bases and continue to attract new
customers. We also compete for services revenue with a number of companies that
provide technical support and other professional services to users of Linux-
based operating systems, including some original equipment manufacturers with
which we have agreements. Many of these companies have larger and more
experienced services organizations than we do currently. In addition, we face
potential competition from several companies devoted to providing open source-
based products and services, such as VA Linux Systems, a provider of hardware
pre-installed with open source software, and Corel Corp., a developer of open
source applications, each of which has indicated a growing interest in the
Linux-based operating systems market.
We face competition in the market for software development tools and operating
systems for special-purpose computing. Our main competitors in this market
include Wind River Systems, Integrated Systems Incorporated, Green Hills
Software, and the Metrowerks subsidiary of Motorola. These companies are well
established and have greater financial resources and larger direct sales staffs
than we do. Some of these companies currently produce or use open source
software as part of their product offerings.
With the acquisition of PTI, we now face competition in the market for network
consulting. Our competitors in this market include Predictive Systems, IBM
Global Services and a large number of small private network consulting
companies.
The open source solutions market is not characterized by the traditional
barriers to entry that are found in most other markets, due to the nature of our
products. For example, anyone can copy, modify and redistribute Red Hat Linux
and most of our other open source products themselves. Accordingly, it is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share.
We believe that the major factors affecting the competitive landscape for our
products include:
13
. name and reputation of vendor;
. product performance, reliability, functionality and price;
. strength of relationships in the open source community;
. availability of user applications;
. ease of use;
. networking capability;
. breadth of hardware compatibility;
. quality of support and customer services;
. distribution strength; and
. alliances with industry partners.
Although we believe that we compete favorably with many of our competitors in a
number of respects, including product performance, functionality and price,
networking capability, and breadth of hardware compatibility, we believe that
many of our competitors have superior distribution capabilities and offer more
extensive support services than we currently do. In addition, there are
significantly more user applications available for competing operating systems,
such as Windows NT and UNIX, than there are for Linux-based operating systems.
An integral part of our strategy in the near future, however, is to address
these shortcomings by, among other things, strengthening our existing strategic
relationships and entering into new ones in an effort to expand our distribution
capabilities, continuing to expand into the special-purpose computing device
market and attracting more attention to the open source movement, which in turn
should create additional incentives for software developers to write more
applications for Red Hat Linux.
In the market for advertising revenue, we compete with other online content
providers and traditional forms of media such as newspapers, magazines, radio
and television. We believe that the principal competitive factors in attracting
advertisers include the amount of traffic on redhat.com, brand recognition,
customer service and support, the demographics of our users and visitors, our
ability to offer targeted audiences and the overall cost-effectiveness of the
advertising medium that we offer.
Software Engineering and Development
We have invested, and intend to continue to invest, significant resources in
product and technology development. We focus and modify our product development
efforts based on the needs of users and changes in the marketplace. We are
currently focusing our development efforts on improving the Linux kernel, as
well as commercializing our software innovations into new products and product
enhancements that are easier to use and provide greater functionality. Our
software engineers collaborate with open source software development teams
working across the Internet. This involvement enables us to remain abreast of
and lead technical advances, plans for development of new features and timing of
releases, as well as other information related to the development of the Linux
kernel and other open source projects.
Our software engineers have contributed to the development and maintenance of
some of the most important components of the Red Hat Linux operating system,
including the installation program and the package management program. The
installation program provides users with a single method to install the hundreds
of separate software programs that are included with Red Hat Linux so that from
the user's
14
perspective, the hundreds of programs appear as one. This simplified process
sharply reduces the time and effort required to install a Linux-based operating
system, as compared to the alternative of gathering the hundreds of programs one
by one via the Internet. The installation program provides default settings for
the user depending upon whether the user wishes to use Red Hat Linux as a server
operating system or as a workstation operating system. The installation also
provides advanced users with the ability to customize the programs that are
installed, allowing for significant flexibility and control over the operating
system. The installation also automatically detects the type of hardware that
comprises the user's computer, in order to ensure that all programs necessary
for Red Hat Linux to work on the hardware are properly installed.
Our software development engineers perform extensive testing of Red Hat Linux,
Stronghold Apache, CCVS and Interchange to ensure that they are properly
assembled and work as a coherent whole from the user's perspective. We use
industry standard methods of quality assurance testing to ensure that Red Hat
Linux, Stronghold Apache, CCVS and Interchange are solidly engineered and ready
for use by our customers when shipped. We also operate an extensive beta testing
program for Red Hat Linux, Stronghold Apache, CCVS and Interchange. Under this
program, we post a beta or test version of the operating system on the Internet.
Developers and users around the world then suggest improvements and identify
bugs. Each suggestion is circulated over the Internet in an attempt to encourage
others to assist in the programming of a solution. In this way, Red Hat Linux,
Stronghold Apache, CCVS and Interchange users are treated as co-developers. Bug
fixes and enhancements are tested by other users and our engineers, and when
corrected, added to the next release. When the beta version is viewed as stable
and complete, it becomes the next production version, and a new beta cycle
begins.
Intellectual Property
Red Hat Linux, Stronghold Apache, CCVS and Interchange and our other open source
products have been developed and made available for licensing under the GNU
General Public License and similar licenses. These licenses generally permit
anyone to copy, modify and distribute the software, subject only to the
restriction that any resulting or derivative work is made available to the
public under the same terms. Therefore, although we retain the copyrights to the
code that we develop ourselves, due to the open source nature of our software
products and the licenses under which we develop and distribute them, our most
valuable intellectual property is our collection of trademarks. We rely
primarily on a combination of trademarks and copyrights to protect our
intellectual property. We also enter into confidentiality and nondisclosure
agreements with our employees and consultants, and generally control access to
and distribution of our documentation and other proprietary information.
We pursue registration of some of our trademarks in the United States and in
other countries. We have registered the trademark "Red Hat" in the United
States, Australia, and the European Union, and have registrations pending in
many other countries, including Canada and Japan. We have registered the Red Hat
"Shadow Man" logo in the U.S., European Union and Australia and have
registrations pending for it in many other countries, including Canada and
Japan. Other trademarks we have registered or have registrations pending in the
United States include Red Hat Certified Engineer, RHCE, Wide Open, Always Open,
Red Hat Ready and the Red Hat Ready logo. Other trademarks Cygnus registered or
for which it has registrations pending in the United States include Cygnus
Solutions, GNUPro, Code Fusion, eCos, eCosystem, SourceNavigator and Cygwin.
Despite our efforts to protect our trademark rights, unauthorized third parties
have in the past attempted and in the future may attempt to misappropriate our
trademark rights. We cannot be certain that we will succeed in preventing the
continued misappropriation of our tradename and trademarks in these
circumstances or that we will be able to prevent this type of unauthorized use
in the future. The laws of some foreign countries do not protect our trademark
rights to the same extent as do the laws of the United States. In addition,
policing unauthorized use of our trademark rights is difficult, expensive and
time
15
consuming. The loss of any material trademark or trade name could have a
material adverse effect on our business, operating results and financial
condition.
Although we do not believe that our products infringe the rights of third
parties, third parties have in the past asserted, and may in the future assert
infringement claims against us which may result in costly litigation or require
us to obtain a license to third-party intellectual rights. There can be no
assurance that such licenses will be available on reasonable terms or at all,
which could have a material adverse effect on our business, operating results
and financial condition.
Employees
As of March 31, 2001, we had a total of 735 employees. From time to time we also
employ independent contractors to support our professional services, product
development, sales, marketing and business development organizations. Our
employees are not represented by any labor union and are not organized under a
collective bargaining agreement, and we have never experienced a work stoppage.
We believe our relations with our employees are good.
16
Executive Officers of Red Hat
The following table sets forth the name, age, and position of each of the
persons who are serving as executive officers and directors of Red Hat as of
March 31, 2001:
Name Age Position
- ---- --- --------
Executive Officers and Directors
Robert F. Young........................... 46 Chairman of the Board of Directors
Matthew J. Szulik......................... 44 Chief Executive Officer, President and Director
Timothy J. Buckley........................ 49 Executive Vice President and Chief Operating Officer
Kevin B. Thompson......................... 35 Executive Vice President and Chief Financial Officer
Michael Tiemann........................... 36 Chief Technology Officer
James J. Neiser........................... 50 Sr. Vice President and Chief Marketing Officer
Howard A. Jacobson........................ 40 Sr. Vice President, Corporate Development
Mark H. Webbink........................... 50 Sr. Vice President, General Counsel and Secretary
Eugene McDonald(2)........................ 68 Director
F. Selby Wellman.......................... 59 Director
Kevin Harvey (1)(2)....................... 36 Director
William S. Kaiser (1)(2).................. 45 Director
Eric Hahn (1)............................. 40 Director
_____________
(1) Member of Compensation Committee.
(2) Member of Audit Committee.
Robert F. Young co-founded Red Hat and served as its President and a Director
from its inception until November 1998. In November 1998, he was elected as
Chief Executive Officer and Chairman of the Board of Directors. In November
1999, he resigned as Chief Executive Officer and currently serves as the
Chairman of the Board of Directors.
Matthew J. Szulik has served as Chief Executive Officer of Red Hat since
November 1999, as President since November 1998 and as a Director since April
1999. Mr. Szulik also served as Chief Operating Officer of Red Hat from November
1998 to April 1999. Prior to joining Red Hat, from September 1997 to October
1998, Mr. Szulik served as President of Relativity Technologies, a computer
software company. From February 1996 to May 1997, Mr. Szulik served as President
of Sapiens International, a computer software company. Prior to that, from
January 1993 to December 1995, he served as Senior Vice President in charge of
sales and marketing for MapInfo Corp., a computer software company.
Timothy J. Buckley has served as Senior Vice President and Chief Operating
Officer of Red Hat since April 1999. Prior to joining Red Hat, from October 1997
until April 1999, Mr. Buckley was Senior Vice President of Worldwide Sales at
Visio Corp., a business software company. Mr. Buckley joined Visio in November
1993 and served as Visio's Vice President of Worldwide Sales until his promotion
in October 1997.
Kevin B. Thompson has served as Red Hat's Chief Financial Officer since November
2000. Mr. Thompson formerly served as a partner in the Global Technology
Industry Group of
17
PricewaterhouseCoopers LLP. Prior to his position at PricewaterhouseCoopers, Mr.
Thompson served as a senior manager for Arthur Andersen LLP for 10 years. Mr.
Thompson is a certified public accountant and holds a bachelor of science degree
in business administration from the University of Oklahoma.
Michael Tiemann has served as Red Hat's Chief Technology Officer since January
2000. Prior to joining Red Hat, he was a co-founder of Cygnus in 1989, and held
various positions including President, Director of Business Development and
Director of Technical Marketing. Mr. Tiemann holds a B.S.C.S.E. from the Moore
School of Engineering at the University of Pennsylvania. Mr. Tiemann serves on
the governing boards of a number of not-for-profit open source organizations,
including the Open Source Initiative, the Embedded Linux Consortium, and the
GNOME Foundation.
James J. Neiser has served as Red Hat's Chief Marketing Officer since December
2000. Mr. Neiser formerly served as the Vice President of Worldwide Distribution
Channel Marketing and Customer Set marketing for the IBM Software Group. Mr.
Neiser has over 19 years of experience in a variety of software and packaged
goods companies including Ashton-Tate and Carnation. Mr. Neiser holds a Ph.D. in
Cognitive Psychology from Oklahoma State University specializing in memory and
information processing along with five years of teaching experience.
Howard A. Jacobson has served as Red Hat's head of Corporate Development since
September 2000. Previously at Red Hat, he was Director of Internet Business and
Manager of Business Development. Before joining Red Hat, Mr. Jacobson was a
partner at the law firm of Moore & Van Allen PLLC in Raleigh, North Carolina.
Mr. Jacobson received his law degree from Georgetown, magna cum laude in 1987
and his bachelors degree with honors from Haverford College in 1982.
Mark H. Webbink has served as Red Hat's General Counsel since May 2000. Prior to
joining Red Hat, Mr. Webbink was in private practice with Moore & Van Allen PLLC
where he was a member of the firm's intellectual property practice team. Prior
to entering the practice of law, Mr. Webbink spent 20 years in corporate
finance, holding positions of Chief Financial Officer, Vice President - Finance
and Corporate Controller with several Research Triangle area companies. Mr.
Webbink received his law degree from North Carolina Central University, magna
cum laude, in 1994, and he also holds an MPA from the University of North
Carolina at Chapel Hill and a BA from Purdue University.
Eugene McDonald has served as Director of Red Hat since August 2000. Mr.
McDonald is President of Duke Management Company, the asset management division
of Duke University, and Executive Vice President of Duke University. McDonald
has held several positions at Duke University in Durham, North Carolina since he
joined in 1977 as University Counsel and Vice President. For six years Mr.
McDonald served as Executive Vice President of the university, discharging the
responsibilities of Chief Financial Officer and Chief Non-academic
Administrative Officer. Prior to his tenure at Duke, Mr. McDonald served as an
international business executive in London, a practicing attorney in San
Francisco and a faculty member at Georgetown University Law Center.
F. Selby Wellman has served as Director of Red Hat since January 2001. Prior to
becoming a Director, Mr. Wellman was employed by Cisco Systems Inc., where he
served most recently as Senior Vice President and General Manager of the
InterWorks Business Division. Mr. Wellman also held the position of Research
Triangle Park, N.C. Corporate Site Executive at Cisco and served as Senior Vice
President of Business Units in San Jose, Calif. and Senior Executive for
Corporate Marketing. Prior to his tenure at Cisco, Mr. Wellman held positions as
Vice President of Sales, Marketing and Operations at FiberCom and Corporate Vice
President of Sales at Paradyne, a Florida-based networking company.
Kevin Harvey has served as a Director of Red Hat since August 1999. Mr. Harvey
has been a Managing Member of the general partner of Benchmark Capital Partners,
a venture capital firm, since January 1995. From July 1993 to January 1995, Mr.
Harvey served as General Manager for Lotus Development Corporation, a software
company. Mr. Harvey is also a director of Silicon Gaming, Inc., Critical Path,
Inc. and several privately held companies.
18
William S. Kaiser has served as a Director of Red Hat since September 1998. Mr.
Kaiser has been employed by Greylock Management Corporation, a venture capital
firm, since May 1986 and has been a general partner of the Greylock Limited
Partnerships since January 1988. Mr. Kaiser is also a director of Open Market
Inc., Clarus Corporation and Student Advantage, Inc.
Eric Hahn has served as a Director of Red Hat since April 1999. Mr. Hahn is a
founding partner of Inventures Group, a leading "mentor investment" venture
capital firm. He served as Executive Vice President and Chief Technology Officer
of Netscape from November 1996 until June 1998. Prior to serving as Netscape's
Chief Technology Officer, from November 1995 to November 1996, Mr. Hahn was
general manager of Netscape's Server Products Division, overseeing product
development for Netscape's enterprise, Internet and extranet servers. Mr. Hahn
joined Netscape following its acquisition of Collabra Software, Inc., which Mr.
Hahn founded in February 1993.
ITEM 2 - PROPERTIES
Our headquarters are currently located in a leased facility in Durham, North
Carolina, consisting of approximately 65,600 square feet under a five year lease
that will expire on January 14, 2004. The annual rental expense under this lease
is approximately $1,200,000. We also lease offices in Sunnyvale, California;
Atlanta, Georgia; Seattle, Washington; Reston, Virginia; Pittsburgh,
Pennsylvania; Huntsville, Alabama; and in the United Kingdom. We believe that
additional space will be required as our business expands and will be available
on acceptable terms.
ITEM 3 - LEGAL PROCEEDINGS
Subsequent to the end of fiscal 2001, the Company and certain of its officers
and directors were named as defendants in a class action suit. The plaintiff
contends that the defendants violated federal securities laws by issuing a
Registration Statement and Prospectus that contained materially false and
misleading information and failed to disclose material information. The
Prospectus was issued in connection with the Company's initial public offering
in August 1999. The Company is reviewing the suit and believes that the
complaints are without merit. No assurance can be given, however, that this
matter will be resolved in the Company's favor.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's stockholders, through the
solicitation of proxies or otherwise, during the fourth quarter of fiscal year
2001.
19
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
The Company's common stock is traded on The Nasdaq National Market under the
symbol "RHAT". The chart below sets forth the high and low bid information for
the quarters of the fiscal years ended February 28, 2001 and February 29, 2000
in which the Company was publicly traded.
FY 2001 FY 2000
---------------------- ----------------------
Quarter High Low High Low
------- ---------- ---------- ----------- ---------
First.............................................. $75.81 $15.75 N/A N/A
Second............................................. $34.19 $17.94 $ 45.34 $20.00
Third.............................................. $27.19 $ 6.25 $127.00 $36.00
Fourth............................................. $ 9.34 $ 5.13 $151.31 $60.50
The closing price for our common stock as reported by The Nasdaq National Market
on February 28, 2001 was $6.44 per share.
Holders
As of February 28, 2001 the Company estimates there were 100,133 registered
stockholders of record of the Company's common stock.
Dividends
The Company has never declared or paid any cash dividends on its common stock.
In February 2001, the Company completed the acquisition of Planning
Technologies, Inc ("PTI"), which was accounted for as a pooling of interests.
Prior to the acquisition, PTI paid dividends of $3,850,000 to its shareholders
in connection with the acquisition of a division of another company. The Company
anticipates that all of its earnings will be retained for the operation and
expansion of the Company's business and does not anticipate paying any cash
dividends in the foreseeable future.
Sales of Unregistered Securities
On January 17, 2001, in connection with the acquisition of Akopia, Inc.
("Akopia"), the Company issued an aggregate of 722,009 shares of common stock to
the seven shareholders of Akopia.
On February 23, 2001, in connection with the acquisition of PTI, the Company
issued an aggregate of 6,319,704 shares of common stock to the 20 shareholders
of PTI.
These shares were offered and sold in reliance upon the exemption provided by
Section 4(2) of the Securities Act for transactions not involving a public
offering. No underwriters were involved in the foregoing sales of securities.
Use of Proceeds
On August 11, 1999 the Securities and Exchange Commission declared effective the
Company's Registration Statement on Form S-1 (File number 333-80051), relating
to the initial public offering of the Company's Common Stock, $.0001 par value.
The offering commenced on August 11, 1999 and all
20
shares covered by the Registration Statement were sold. The proceeds to the
Company, net of underwriting discounts and costs, was approximately $88.5
million. The following are the uses of such proceeds from the effective date of
the registration statement (August 11, 1999) through February 28, 2001:
Cash and cash equivalents: $21,998,198
Working capital: $66,468,731
None of the net proceeds from the IPO were used to pay, directly or indirectly,
directors, officers, persons owning ten percent or more of the Company's equity
securities, or affiliates of the Company.
21
ITEM 6 - SELECTED FINANCIAL DATA
The following selected financial data is derived from the Consolidated Financial
Statements of the Company and has been restated to reflect the acquisition of
Planning Technologies, Inc. in February 2001 which was accounted for using the
pooling of interests method of accounting. The data should be read in
conjunction with the Consolidated Financial Statements, related notes, and other
financial information included herein.
Year Ended
----------
(in thousands, except per share data)
-------------------------------------
February February February February February
-------- -------- -------- -------- --------
28, 2001 29, 2000 28, 1999 28, 1998 28, 1997
-------- -------- -------- -------- --------
SELECTED STATEMENT OF OPERATIONS DATA
Subscription and services revenue.............. $ 102,652 $ 52,823 $37,828 $22,847 $15,129
Hardware resale revenue........................ 777 11,954 25,601 34,550 73,481
Gross profit................................... 54,784 25,670 24,546 17,594 15,216
Loss from operations........................... (107,481) (46,689) (5,656) (4,511) (1,027)
Net loss....................................... (86,716) (42,427) (6,388) (3,738) (1,318)
Net income (loss) per common share (a):
Basic..................................... (0.53) (0.41) (0.13) (0.08) (0.03)
Diluted................................... (0.53) (0.41) (0.13) (0.08) (0.03)
Number of weighted average shares outstanding
(a):
Basic..................................... 164,659 102,465 49,578 48,948 48,948
Diluted................................... 164,659 102,465 49,578 48,948 48,948
BALANCE SHEET DATA
Working capital................................ $ 138,990 $257,365 $14,521 $ 1,737 $ 5,459
Total cash and investments in debt and equity
securities..................................... 302,681 349,497 21,985 7,818 9,498
Total assets................................... 505,251 434,861 39,158 23,498 30,924
Long-term debt, net of current maturities...... 277 231 1,399 370 1,399
Mandatorily redeemable preferred stock......... - - 18,359 8,235 -
Stockholders' equity (deficit)................. 464,283 401,167 (166) (2,916) 564
______________________
(a) All share and per share information has been retroactively restated to
reflect the two-for-one splits of common stock on each of August 11, 1999
and January 7, 2000. See Note 13 of Notes to Consolidated Financial
Statements.
22
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-looking statements in this Annual Report on Form 10-K are made pursuant
to the safe harbor provisions of Section 21E of the Securities Exchange Act of
1934. Investors are cautioned that statements in this Annual Report on Form 10-K
that are not strictly historical statements, including, without limitation,
statements regarding current or future financial performance, management's plans
and objectives for future operations, product plans and performance,
management's assessment of market factors, and statements regarding the strategy
and plans of Red Hat and its strategic partners, constitute forward-looking
statements. These forward-looking statements are not guarantees of Red Hat's
future performance and are subject to a number of risks and uncertainties that
could cause Red Hat's actual results in the future to differ materially from the
forward-looking statements. These risks and uncertainties include, without
limitation, the risks detailed below and in Red Hat's other filings with the
Securities and Exchange Commission, copies of which may be accessed through the
SEC's web site at http://www.sec.gov.
------------------
Overview
Red Hat offers users a single, trusted point of contact and a common platform
for developing, deploying and managing open source software across Internet
infrastructure and devices that connect to the Internet, ranging from small
embedded devices to high-availability clusters and integrated web
server/e-commerce operating systems. The Red Hat Network, Red Hat's unique
management technology, helps companies worldwide efficiently manage their
networks and systems by delivering open source products, services, support and
information on-line, in real-time.
In January 2000 and February 2001, we acquired Cygnus Solutions ("Cygnus") and
Planning Technologies, Inc. ("PTI"), respectively, in transactions accounted for
as a pooling of interests. As a result of these acquisitions, our historical
financial statements have been restated to include the results of operations and
accounts of both Cygnus and PTI for all periods presented.
In January, March, May, July and September 2000, we acquired Hells Kitchen
Systems Inc. ("HKS"), Enterprise Network Services ("ENS"), Bluecurve, Inc.,
Wirespeed Communications Corporation ("Wirespeed") and C2Net Software, Inc.
("C2Net"), respectively, in transactions accounted for in accordance with the
purchase method of accounting. In January 2001, we acquired Akopia, Inc.
("Akopia"), in a transaction accounted for in accordance with the purchase
method of accounting. As a result, our results of operations include the results
of operations of these entities from the date of the acquisition.
We derive our subscription revenue primarily from the sale of open source
software solutions, technical support contracts, and web advertising revenue:
. through distributors to enterprise and retail accounts;
. directly to individual users and enterprises through our redhat.com
web site, our call center, and our direct sales force; and
. from original equipment manufacturers which license our software and
support services directly.
Revenues from the sale of software products for which no technical support is
provided are generally recognized upon shipment of the products, net of a
reserve for estimated returns. A reserve for sales returns is recognized for
sales of software products to distributors, who have a right of return, based on
the Company's historical experience of sell-through to the end user by the
distributor.
23
The Company provides certain support and subscription services with Official Red
Hat Linux for a period of time, not exceeding six months, from the date of
registration of the software products for no additional fee. In accordance with
the provisions of Statement of Position No. 97-2, "Software Revenue Recognition"
("SOP 97-2") as amended by SOP 98-4 and SOP 98-9, the Company is recognizing all
of the revenue from the sale of Official Red Hat Linux ratably over the period
that the support and subscription services are provided.
Revenue for technical support and maintenance services, other than installation
support, is deferred and recognized ratably over the term of the agreement,
which is typically twelve months.
Web advertising revenue, which is included in subscription revenue, is
recognized ratably over the period in which the advertisement is displayed,
provided that the Company has no significant remaining obligations, at the
lesser of the ratio of connections to the advertiser's web site delivered over
total guaranteed connections to the advertiser's web site or the straight-line
basis over the term of the contract. If minimum guaranteed connections are not
met, the Company defers recognition of the corresponding revenue until the
guaranteed connections are achieved.
Service revenues consist of revenue for customer training and education, revenue
for software compiling, debugging and optimization contracts and revenues for
network infrastructure consulting services and engineering services. Revenues
for development contracts are recognized on the percentage-of-completion method
provided that the fee for such engineering services is fixed or determinable and
the collection of the resulting receivable is probable. Revenue from customer
training and education and other services is recognized at the date the services
are performed. Revenues for network consulting and engineering services is
recognized on a time and materials basis as our consultants provide services.
Revenue from technical support and maintenance arrangements is deferred and
recognized ratably over the term of the related agreement, which is typically
one year. Revenue from custom development, consulting, training and education
services, developer support and hardware certification services, is recognized
as the services are provided.
We provide custom development services for integrated device manufacturers and
also provide engineering services and developer support services for
microprocessor and product manufacturing companies. We recognize revenue on
these service arrangements on the percentage-of-completion method over the term
of the related development agreement. These custom development arrangements
generally have a term of three to six months. Support and maintenance
arrangements typically have terms of three months to two years. Revenue from
ongoing technical support and maintenance services is recognized ratably over
the term of the related technical support and maintenance agreement.
The Company provides network consulting and engineering services to a wide array
of corporate and government enterprises. These short and long-term service
projects include network business consulting, internetworking, network
management and network security services. Professional service revenue is
recognized as our consultants provide services, based on hourly rates billed to
our customers.
PTI acted as a value-added reseller of certain hardware products and
peripherals. Revenue from the sale of such products has been recognized upon
delivery to the customer. PTI customized certain features of the hardware
products it purchased so that the products would support the unique solutions
and services provided by PTI's network consultants to each of its customers. In
accordance with EITF 99-19, Accounting for Revenue Gross as a Principal versus
Net as an Agent ("EITF No. 99-19"), revenues from the sale of such hardware
products are recorded on a gross basis. Beginning in fiscal year 2000, PTI
discontinued its practice of reselling hardware products.
We have historically experienced fluctuations in our results of operations
related to the release of new versions of Official Red Hat Linux. We believe our
customers' anticipation of the release of these new versions has historically
resulted in, and will continue to result in, a decline in sales for several
months
24
prior to the release and an increase in sales immediately following the release.
Our software products and service offerings are sold worldwide. International
revenues for the fiscal years ended February 28, 2001, February 29, 2000 and
February 28, 1999, were $20.0 million, $10.7 million and $13.1 million,
respectively.
Results of Operations
The following table sets forth the results of operations for Red Hat expressed
as a percentage of total revenue:
Year Ended
----------------------------------------------------------
February 28, February 29, February 28,
2001 2000 1999
-------------- -------------- ---------------
Subscription and services revenue:
Subscription 44.0% 39.0% 34.8%
Services 55.3% 42.5% 24.8%
-------------- ------------- --------------
Total subscription and services revenue 99.3% 81.5% 59.6%
-------------- ------------- --------------
Cost of subscription and services:
Subscription 14.2% 21.2% 10.5%
Services 32.3% 22.4% 13.6%
Stock-based services (income) expense -0.1% 0.3% 0.0%
Total cost of subscription and services revenue 46.4% 43.9% 24.1%
-------------- ------------- --------------
Gross profit on subscription and services revenue 52.9% 37.6% 35.5%
-------------- ------------- --------------
Hardware resale revenue 0.7% 18.5% 40.4%
Cost of hardware resale 0.6% 16.5% 37.2%
-------------- ------------- --------------
Gross profit on hardware resale revenue 0.1% 2.0% 3.2%
-------------- ------------- --------------
Operating expense:
Sales and marketing 47.4% 43.4% 21.8%
Research and development 15.2% 16.9% 13.2%
General and administrative 29.6% 36.4% 11.1%
Stock-based sales and marketing expense 6.6% 4.6% 1.1%
Stock-based research and development expense 3.0% 1.8% 0.4%
Stock-based general and administrative expense 7.0% 3.8% 0.0%
Amortization of goodwill and intangibles 48.1% 4.8% 0.0%
--------------- ------------- --------------
Total operating expense 156.9% 111.7% 47.6%
---------------- ------------- --------------
Loss from operations -103.9% -72.1% -8.9%
--------------- ------------- --------------
Other income (expense), net 20.3% 6.8% 0.1%
--------------- ------------- --------------
Loss before income taxes -83.6% -65.3% -8.8%
Provision for income taxes 0.2% 0.2% 1.3%
--------------- ------------- --------------
Net loss -83.8% -65.5% -10.1%
Accretion of mandatorily redeemable preferred stock 0.0% -0.1% 0.0%
--------------- ------------- --------------
Net loss available to common stockholders -83.8% -65.6% -10.1%
=============== ============= ==============
25
Years Ended February 28, 2001 and February 29, 2000
Total revenue
Total revenue increased 60% to $103.4 million in the year ended February 28,
2001 from $64.8 million in the year ended February 29, 2000. Revenue from
international operations totaled $20.0 million and $10.7 million during the
years ended February 28, 2001 and February 29, 2000, respectively. We
established international operations for sale of our software products in August
1999. Prior to August 1999, our international revenue was limited to revenue
generated from custom development services performed for international
customers.
Subscription revenue
Subscription revenue is comprised primarily of revenue from sales of Official
Red Hat Linux and related software solutions, sales of software development
tools, technical support and maintenance fees, and web advertising revenue.
Subscription revenue increased 80.0% to $45.5 million in the year ended February
28, 2001 from $25.3 million in the year ended February 29, 2000. This increase
was primarily due to the release of two new versions of Official Red Hat Linux
during fiscal 2001, rapid growth of our international operations, introduction
of new open source solutions during fiscal 2001 and an increase in technical
support and maintenance revenue as a result of our increased focus on providing
these services in fiscal year 2001 as compared to fiscal year 2000. As a
percentage of total revenue, subscription revenue increased to 44.0% in the year
ended February 28, 2001 from 39.0% in the year ended February 29, 2000. The
increase in subscription revenue as a percentage of total revenue is primarily a
result of the timing of our product releases, sales of new open source solutions
and the growth in the sales of our technical support and maintenance offerings.
Services revenue
Services revenue is primarily comprised of custom development fees, network
consulting and engineering fees, training and education fees, and short-term
consulting contracts. Services revenue increased 107.0% to $57.2 million in the
year ended February 28, 2001 from $27.6 million in the year ended February 29,
2000. As a percentage of total revenue, services revenue increased to 55.3% in
the year ended February 28, 2001 from 42.5% in the year ended February 29, 2000.
The increase in services revenue in total and as a percentage of total revenue
resulted primarily from an increase in custom development revenue due to an
increase in the number, size and scope of custom development contracts, an
increase in the number of network consulting engagements and expansion of the
Company's network consulting and engineering offerings, and an increase in
training and education revenue due to the expansion of our course offerings in
the year ended February 28, 2001.
Hardware resale revenue
Hardware resale revenue is primarily comprised of PTI's resale of computer
hardware and peripherals. Hardware resale revenue decreased 93.5% to $0.8
million in the year ended February 28, 2001 from $12.0 million in the year ended
February 29, 2001. As a percentage of total revenue, hardware resale revenue
decreased to 0.7% in the year ended February 28, 2001 from 18.5% in the year
ended February 29, 2000. The decrease in hardware resale revenue in total and as
a percentage of total revenue resulted primarily from PTI's migration from a
value added reseller to a pure professional services company.
Cost of revenue
Cost of subscription revenue
Cost of subscription revenue primarily consists of expenses we incur to
manufacture, package and
26
distribute our products and related documentation. These costs include expenses
for physical media, literature and packaging, fulfillment and shipping, and
labor related costs to provide technical support and maintenance. Also included
are the cost of developing advertising on our web site and royalties we pay for
licensing third-party applications included in our software products. Cost of
subscription revenue increased 6.5% to $14.7 million in the year ended February
28, 2001 from $13.8 million in the year ended February 29, 2000. This increase
was directly related to the increase in costs to provide telephone support and
subscription services upon the release of Version 6.2 of Official Red Hat Linux
and the increase in sales volumes as a result of the release of Version 7 of
Official Red Hat Linux in September 2000 and costs incurred to provide technical
support and maintenance services. As a percentage of subscription revenue, cost
of subscription revenue decreased to 32.2% in the year ended February 28, 2001
from 54.5% in the year ended February 29, 2000. This decrease was due to an
increase in sales volumes, which resulted in a decrease in cost per unit, and
use of the internet as a delivery mechanism for the technical support and
maintenance of our products in the year ended February 28, 2001.
Cost of services revenue
Cost of services revenue is primarily comprised of salaries and related costs --
including non-cash, stock-based compensation charges -- incurred for our
personnel to deliver custom development, network consulting and engineering,
training and education, and hardware certification services. We incur no direct
costs related to royalties received from the licensing of our trademarks to
third parties. Cost of services revenue increased 127.3% to $33.3 million in the
year ended February 28, 2001 from $14.7 million in the year ended February 29,
2000. This increase was primarily due to the addition of personnel to provide
custom development, network consulting and engineering, training and education,
and hardware certification services, and the development of our services
organization. As a percentage of services revenue, cost of services revenue
increased to 58.3% in the year ended February 28, 2001 from 53.2% in the year
ended February 29, 2000. This increase was primarily due to the increased use of
third-party partners and contractors to deliver our training and education
courses and due to an increase in the salaries and related costs of our delivery
personnel.
We expect cost of services to increase as we further expand our service
offerings. Cost of services as a percentage of services revenue is expected to
vary significantly from period to period depending upon:
. the mix of services we provide;
. the number and scope of custom development contracts;
. whether such services are provided by us or third-party partners and
contractors;
. the overall utilization rate of our services staff; and
. the use of our redhat.com web site to deliver these services
Cost of Hardware Resale
Cost of hardware resale revenue primarily consists of the cost to purchase
computer hardware and peripherals and related sub-contactor costs. Cost of
hardware resale revenue decreased 93.9% to $0.6 million in the year ended
February 28, 2001 from $10.7 million in the year ended February 29, 2000. This
decrease was directly related to PTI's migration from a value added reseller to
a pure professional services company. As a percentage of hardware resale
revenue, cost of hardware resale revenue decreased to 83.1% in the year ended
February 28, 2001 from 89.3% in the year ended February 29, 2000.
Gross Profit
27
Gross profit increased 113.4% to $54.8 million in the year ended February 28,
2001 from $25.7 million in the year ended February 29, 2000. As a percentage of
total revenue, gross profit increased to 52.9% in the year ended February 28,
2001 from 39.6% in the year ended February 29, 2000. These increases were
primarily the result of the increases in sales of software products, due to the
release of Version 6.2 of Official Red Hat Linux in March 2000, the release of
Version 7 of Official Red Hat Linux in September 2000, and web advertisements
which were at a higher proportion relative to the associated cost of revenue.
The increase in gross profit as a percentage of total revenue is also due to
PTI's decreasing reliance upon hardware resale revenues, as these revenues
generate significantly lower margins than do the Company's other sources of
revenues. These revenue increases were partially offset by increased costs of
services resulting from the addition of personnel to provide custom development,
network consulting and engineering, training and education, and hardware
certification services, and the development of our services organization.
Operating expense
Sales and marketing
Sales and marketing expense consists primarily of salaries and other related
costs -- including non-cash, stock-based compensation charges -- for sales and
marketing personnel, sales commissions, travel, public relations and marketing
materials and tradeshows. Sales and marketing expense increased 79.4% to $55.8
million in the year ended February 28, 2001 from $31.1 million in the year ended
February 29, 2000. As a percentage of total revenue, sales and marketing expense
increased to 53.9% in the year ended February 28, 2001 from 48.0% in the year
ended February 29, 2000. This increase was due primarily to higher advertising
and promotional costs incurred to promote the release of Version 7 and 6.2 of
Official Red Hat Linux, our web advertising and service offerings and, to a
lesser extent, our new software development tools. This increase was also due to
higher costs resulting from joint marketing arrangements with distributors and
to increased stock-based compensation charges. We expect sales and marketing
expense to continue to increase in dollar amount as we promote the expansion of
our services offerings and web site and expand our international subscription
operations.
Research and development
Research and development expense consists primarily of personnel and related
costs -- including non-cash, stock-based compensation charges -- for development
of our software products and web site. Research and development expense
increased 54.9% to $18.8 million in the year ended February 28, 2001 from $12.1
million in the year ended February 29, 2000. As a percentage of total revenue,
research and development expense decreased to 18.2% in the year ended February
28, 2001 from 18.7% in the year ended February 29, 2000. The increase in
research and development expense resulted from increased spending related to the
development of our web initiatives and costs incurred to complete the
development of Version 7 and 6.2 of Official Red Hat Linux and an increase in
stock-based compensation expense, partially offset by a decrease in spending
related to the development of software development tools as these products were
completed during the year ended February 29, 2000.
General and administrative
General and administrative expense consists primarily of merger and acquisition
costs and personnel and related costs -- including non-cash, stock-based
compensation charges -- for general corporate functions, including finance,
accounting, legal, human resources, facilities and information systems expenses.
General and administrative expense increased 45.4% to $37.9 million in the year
ended February 28, 2001 from $26.1 million in the year ended February 29, 2000.
This increase resulted from:
. a decrease in merger and acquisition expenses to $9.2 million for the
year ended February 28, 2001 from $12.4 million for the year ended
February 29, 2000.
. an increase in payroll costs, due to an increase in the number of
general and administrative personnel to support the growth of our
business;
28
. an increase in stock-based compensation expense;
. an increase in legal and accounting costs as a result of our becoming a
public company and our geographic expansion; and
. an increase in insurance costs as a result of our becoming a public
company.
As a percentage of total revenue, general and administrative expense decreased
to 36.6% in the year ended February 28, 2001 from 40.2% in the year ended
February 29, 2000. We expect general and administrative expense to continue to
increase in dollar amount as we add administrative personnel to support our
business expansion.
Amortization of goodwill and intangibles
Amortization of goodwill and intangibles expense consists of the amortization of
goodwill and other intangible assets. Goodwill, which represents the excess of
acquisition cost over the net assets acquired in business combinations, is
amortized over its estimated useful life, which is three years. Costs incurred
for acquiring trademarks, copyrights and patents are capitalized and amortized
using the straight-line method over their estimated useful lives, which range
from three to five years. Amortization of goodwill and intangibles expense
increased to $49.8 million in the year ended February 28, 2001 from $3.1 million
in the year ended February 29, 2000. As a percentage of total revenue,
amortization of goodwill and intangibles expense increased to 48.1% in the year
ended February 28, 2001 from 4.8% in the year ended February 29, 2000. These
increases were primarily due to the acquisition of HKS, ENS, Bluecurve,
WireSpeed, C2Net, and Akopia during the year ended February 28, 2001.
Other income (expense), net
Other income (expense), net consists of interest income earned on cash deposited
in money market accounts and invested in short- and long-term fixed income
instruments, net of interest expense incurred on short-term debt and capital
leases. Interest income, net, increased to $21.0 million in the year ended
February 28, 2001 from interest income, net, of $4.4 million in the year ended
February 29, 2000. These amounts are net of interest expense of $0.4 million in
the year ended February 28, 2001 and $0.7 million in the year ended February 29,
2000. As a percentage of total revenue, other income (expense), net increased to
20.3% in the year ended February 28, 2001 from 6.8% in the year ended February
29, 2000. These increases resulted from higher average cash and investment
balances in the year ended February 28, 2001 as compared to the year ended
February 29, 2000 due primarily to the receipt of proceeds from the sale of
common stock in our initial and secondary public offerings in August 1999 and
February 2000, respectively.
Provision for income taxes
Provision for income taxes increased to $0.3 million for the year ended February
28, 2001 from $0.2 million in the year ended February 29, 2000. Our taxes for
the year ended February 28, 2001 were related to certain foreign income tax
expenses.
Accretion of mandatorily redeemable preferred stock
Accretion of mandatorily redeemable preferred stock decreased to zero in the
year ended February 28, 2001 from $82,000 for the year ended February 29, 2000.
Accretion of mandatorily redeemable preferred stock ceased with the completion
of our initial public offering in August 1999 when all outstanding mandatorily
redeemable preferred stock converted to common stock.
29
Years Ended February 29, 2000 and February 28, 1999
Total revenue
Total revenue increased 2.1% to $64.8 million in the year ended February 29,
2000 from $63.4 million in the year ended February 28, 1999. Our international
revenue totaled $13.1 million in the year ended February 28, 1999.
Subscription revenue
Subscription revenue increased 14.3% to $25.3 million in the year ended February
29, 2000 from $22.1 million in the year ended February 28, 1999. As a percentage
of total revenue, subscription revenue increased to 39.0% in the year ended
February 29, 2000 from 34.8% in the year ended February 28, 1999. This increase
was primarily due to the release of Version 6.0 of Official Red Hat Linux in May
1999, the release of Version 6.1 of Official Red Hat Linux in October 1999 and,
to a lesser extent, to the initial release of our software development tools in
July 1999.
Services revenue
Services revenue increased 75.2% to $27.6 million in the year ended February 29,
2000 from $15.7 million in the year ended February 28, 1999. As a percentage of
total revenue, services revenue increased to 42.5% in the year ended February
29, 2000 from 24.8% in the year ended February 28, 1999. The increase in
services revenue in total and as a percentage of total revenue resulted
primarily from an increase in custom development and network consulting and
engineering revenues due to an increase in the number, size and scope of custom
development and network consulting and engineering contracts.
Hardware resale revenue
Hardware resale revenue decreased 53.3% to $12.0 million in the year ended
February 29, 2000 from $25.6 million in the year ended February 28, 1999. As a
percentage of total revenue, hardware resale revenue decreased to 18.5% in the
year ended February 29, 2000 from 40.4% in the year ended February 28, 1999. The
decrease in hardware resale revenue in total and as a percentage of total
revenue resulted primarily from PTI's migration from a value added reseller to a
pure professional services company that began during calendar 1998.
Cost of revenue
Cost of subscription revenue
Cost of subscription revenue increased 106.8% to $13.8 million in the year ended
February 29, 2000 from $6.7 million in the year ended February 28, 1999. This
increase was directly related to the increase in costs to provide telephone
support and subscription services upon the release of Version 6.0 of Official
Red Hat Linux and the increase in sales volumes. As a percentage of subscription
revenue, cost of subscription revenue increased to 54.5% in the year ended
February 29, 2000 from 30.1% in the year ended February 28, 1999. This increase
was due to the offering of technical support and subscription services with the
sale of Version 6.0 of Official Red Hat Linux released in May 1999 and Version
6.1 of Official Red Hat Linux released in October 1999. This increase was also
due to higher costs associated with the initiation of product sales by our
international operations in the fiscal quarter ended November 30, 1999. We
expect the costs of subscription revenue of our international operations to
decrease as a percentage of revenue in the future as sales volumes increase.
30
Cost of services revenue
Cost of services revenue is primarily comprised of salaries and related costs,
including non-cash stock based compensation expense, incurred for custom
development, network consulting and engineering, training and education, and
hardware certification services. We incur no direct costs related to royalties
received from the licensing of our trademarks to third parties. Cost of services
revenue increased 69.5% to $14.7 million in the year ended February 29, 2000
from $8.7 million in the year ended February 28, 1999. This increase was
primarily due to the addition of personnel to provide custom development,
network consulting and engineering, training and education, and hardware
certification services. As a percentage of services revenue, cost of services
revenue decreased to 53.2% in the year ended February 29, 2000 from 55.0% in the
year ended February 28, 1999. This decrease was primarily due to the increase in
services revenue and higher utilization of staff resources.
Cost of Hardware Resale
Cost of hardware resale revenue primarily consists of the cost to purchase
computer hardware and peripherals and related sub-contactor costs. Cost of
hardware resale revenue decreased 54.7% to $10.7 million in the year ended
February 29, 2000 from $23.6 million in the year ended February 28, 1999. This
decrease was directly related to PTI's migration from a value add reseller to a
pure professional services company as a result of PTI's decision to discontinue
the hardware resale business in late fiscal 1999. As a percentage of hardware
resale revenue, cost of hardware resale revenue decreased to 89.3% in the year
ended February 29, 2000 from 92.0% in the year ended February 28, 1999.
Gross profit
Gross profit increased 4.6% to $25.7 million in the year ended February 29, 2000
from $24.5 million in the year ended February 28, 1999. As a percentage of total
revenue, gross profit increased to 39.6% in the year ended February 29, 2000
from 38.7% in the year ended February 28, 1999. These increases were primarily a
result of the release of Version 6.0 in May 1999 and Version 6.1 of Official Red
Hat Linux in October 1999, and due to an increase in higher margin service
revenues and a decrease in lower margin hardware resale revenues.
Operating expense
Sales and marketing
Sales and marketing expense consists primarily of salaries and other related
costs -- including non-cash, stock-based compensation charges -- for sales and
marketing personnel, sales commissions, travel, public relations, marketing
materials and trade shows. Sales and marketing expense increased 113.8% to $31.1
million in the year ended February 29, 2000 from $14.5 million in the year ended
February 28, 1999. As a percentage of total revenue, sales and marketing expense
increased to 48.0% in the year ended February 29, 2000 from 22.9% in the year
ended February 28, 1999. These increases were due primarily to higher
advertising and promotional costs incurred to promote the release of Versions
6.0 and 6.1 of Official Red Hat Linux, our web advertising and service offerings
and, to a lesser extent, our new software development tools. In addition, we
incurred a significant amount of sales and marketing expense related to our
international subscription operations which were established in August 1999 and
international promotion of Version 6.1 of Official Red Hat Linux in the year
ended February 29, 2000. These increases were also due to higher costs resulting
from joint marketing arrangements with distributors and higher non-cash stock
based compensation expense as a result of deferred compensation recorded during
our initial public offering in August 1999.
Research and development
Research and development expense consists primarily of personnel and related
costs, including non-
31
cash, stock-based compensation charges, for development of our software products
and web site. Research and development expense increased 41.1% to $12.1 million
in the year ended February 29, 2000 from $8.6 million in the year ended February
28, 1999. As a percentage of total revenue, research and development expense
increased to 18.7% in the year ended February 29, 2000 from 13.5% in the year
ended February 28, 1999. The increase in research and development expense
resulted from increased spending related to the development of our web
initiatives and costs incurred to complete the development of Versions 6.0 and
6.1 of Official Red Hat Linux and increased non-cash stock based compensation
expense, partially offset by a decrease in spending related to the development
of software development tools as these products were completed during the year
ended February 29, 2000.
General and administrative
General and administrative expense, including non-cash stock based compensation
expense, consists primarily of personnel and related costs for general corporate
functions, including finance, accounting, legal, human resources, facilities and
information systems expenses. General and administrative expense increased
268.9% to $26.1 million in the year ended February 29, 2000 from $7.1 million in
the year ended February 28, 1999. This increase resulted from:
. an increase in payroll costs due to an increase in the number of general
and administrative personnel to support the growth of our business;
. an increase in non-cash stock-based compensation expense;
. an increase in the cost of completing and integrating mergers and
acquisitions to $12.7 million from 0 in the years ended February 29,
2000 and February 28, 1999, respectively;
. an increase in legal and accounting costs due to our initial public
offering and our geographic expansion; and
. an increase in insurance costs as a result of our becoming a public
company.
As a percentage of total revenue, general and administrative expense, including
non-cash stock based compensation expense, increased to 40.2% in the year ended
February 29, 2000 from 11.1% in the year ended February 28, 1999.
Amortization of goodwill and intangibles
Amortization of goodwill and intangibles expense consists of the amortization of
goodwill and other intangible assets. Goodwill, which represents the excess of
acquisition cost over the net assets acquired in business combinations, is
amortized over its estimated useful life which is three years. Costs incurred
for acquiring trademarks, copyrights and patents are capitalized and amortized
using the straight line method over their estimated useful lives, which range
from five to 15 years. Amortization of goodwill and intangibles expense
increased to $3.1 million in the year ended February 29, 2000 from zero in the
year ended February 28, 1999. As a percentage of total revenue, amortization of
goodwill and intangibles expense was 4.8% in the year ended February 29, 2000.
These increases were primarily due to the acquisition of HKS in January 2000.
Other income (expense), net
Other income (expense), net consists of interest income earned on cash deposited
in money market accounts and invested in short and long term fixed income other
short-term investments, net of interest expense incurred on capital leases.
Other income (expense), net increased to income of $4.4 million in the year
ended February 29, 2000 from income of $0.1 million in the year ended February
28, 1999. As a percentage of total revenue, other income (expense), net
increased to 6.8% in the year ended February
32
29, 2000 from 0.1% in the year ended February 28, 1999. These increases resulted
from higher average cash and investment balances in the year ended February 29,
2000 as compared to the year ended February 28, 1999 due primarily to the
receipt of proceeds from the sale of preferred stock in September 1998 and in
February, March, April and May 1999, and proceeds from the sale of common stock
in our initial and secondary public offerings in August 1999 and February 2000,
respectively.
Provision for income taxes
Provision for income taxes decreased to $0.2 million for the year ended February
29, 2000 from $0.8 million in the year ended February 28, 1999. This decrease
resulted from the decrease in our taxable income in the year ended February 29,
2000 as compared to the year ended February 28, 1999. Our taxes, for the year
ended February 29, 2000, were related to certain foreign income tax expenses.
Accretion of mandatorily redeemable preferred stock
Accretion of mandatorily redeemable preferred stock increased to $82,000 in the
year ended February 29, 2000 from $39,000 for the year ended February 28, 1999
due to the fact that, prior to September 1998, we had no outstanding mandatorily
redeemable preferred stock. Accretion of mandatorily redeemable preferred stock
ceased with the completion of our initial public offering in August 1999 when
all outstanding mandatorily redeemable preferred stock converted to common
stock.
Liquidity and Capital Resources
We have historically derived a significant portion of our liquidity and
operating capital from the sale of equity securities, including private sales of
preferred stock and the sale of common stock in our initial and secondary public
offerings, and from cash flows from operations. At February 28, 2001, we had
total cash and investments of $302.7 million, which is comprised of $85.2
million in cash and cash equivalents, $62.9 million of short-term, fixed-income
investments and $154.6 million of long-term, fixed-income investments.
At February 28, 2001, cash and cash equivalents totaled $85.2 million, a
decrease of $164.5 million as compared to February 29, 2000. The decrease in
cash and cash equivalents resulted primarily from the purchase of net
investments in debt and equity securities of $115.8 million, cash used by
operations of $39.6 million, including $9.2 million of merger and acquisition
costs, and $11.1 million for the purchase of office and computer equipment.
Cash used in operations of $39.6 million in the year ended February 28, 2001,
represented the net loss of $86.7 million, an increase in accounts receivable of
$22.0 million, an increase in inventory of $1.0 million, an increase in
intangibles and other assets of $4.2 million and a decrease in accounts payable
of $3.6 million, partially offset by an increase in accrued expenses of $7.6
million and net non cash charges of $73.3 million. The increase in accounts
receivable, resulted primarily from the release of Version 7 of Official Red Hat
Linux to our distributors in September 2000 and to increased services performed
by our network consulting and engineers during the year ended February 28, 2001
as a result of contracts acquired in the acquisition of ENS. Cash used in
operations includes $9.2 million representing costs incurred related to merger
and acquisition activities.
Cash used in investing activities of $122.2 million was comprised of the
purchase of investments in debt securities, net of maturities, of $115.8 million
and purchases of property and equipment totaling $11.1 million, net of $4.7
million acquired through acquisitions.
Cash used in financing activities of $1.5 million for the year ended February
28, 2001 was comprised of $6.4 million for the purchase of treasury stock, $3.9
million for the payment of dividends by PTI related to its acquisition of ENS in
April 2000, and $3.6 million of repayments of notes payable. This was partially
offset by of $5.5 million in net proceeds from borrowings by PTI, $5.2 million
in proceeds from the exercise of stock options and warrants, $1.2 million in
proceeds from the sale of common stock and $0.6 million in
33
proceeds from the sale of common stock under our employee stock purchase plan
At February 29, 2000, cash and cash equivalents totaled $249.7 million, an
increase of $229.7 million as compared to February 28, 1999. The increase in
cash and cash equivalents resulted from the receipt of $337.1 million in net
proceeds from the issuance of common stock in August 1999 and February 2000,
$16.0 million in proceeds from issuance of preferred stock in March, April, and
June 1999, $2.7 million in proceeds from receipt of repayment of stockholders'
notes receivable, $0.4 million in proceeds from line of credit, and $3.9 million
in proceeds from exercise of stock options and warrants. This was partially
offset by the purchase of net investments in debt and equity securities of
$101.9 million, cash used by operations of $18.2 million, repayments of notes
payable of $2.4 million, and $7.1 million for the purchase of office and
computer equipment.
Cash used by operations of $18.2 million in the year ended February 29, 2000,
represented the net loss of $42.4 million, an increase in accounts receivable of
$0.9 million, an increase in intangibles and other assets of $1.7 million and an
increase in prepaid expenses of $1.0 million, partially offset by an increase in
accounts payable and accrued expenses of $9.5 million, an increase in deferred
revenue of $4.9 million, and net non-cash charges of $14.3 million. The increase
in accounts receivable, accounts payable, accrued expenses and deferred revenue
resulted from the release of Versions 6.0 of Official Red Hat Linux to our
distributors in late April 1999 and Version 6.1 of Official Red Hat Linux in
early October 1999. These releases resulted in increased sales which resulted in
higher amounts of accounts receivable from distributors and deferred revenues at
February 29, 2000.
Cash used in investing activities in the year ended February 29, 2000, was
comprised of the purchase of investments in debt securities, net of maturities,
of $101.9 million and purchase of office and computer equipment totaling $7.1
million.
Cash from financing activities of $357.4 million for the year ended February 29,
2000 was comprised of $16.0 million in net proceeds from the sale of preferred
stock, $3.9 million in proceeds from the exercise of stock options and warrants,
$2.7 million in proceeds from receipt of repayment of stockholders' notes
receivable, $0.4 million in proceeds from line of credit, and $337.1 million in
net proceeds from the sale of our common stock in August 1999 and February 2000.
This was partially offset by repayments of notes payable of $2.4 million.
We have experienced a substantial increase in our operating expenses since our
inception in connection with the growth of our operations and staffing and the
expansion of our services operation and acquisition activity. Our capital
requirements during the year ending February 28, 2002 will depend on numerous
factors including the amount of resources we devote to:
. fund our domestic and international expansion;
. enhance our redhat.com web site;
. expanding our product offerings;
. improve and extend our service offerings;
. pursue strategic acquisitions and alliances;
. make possible investments in businesses, products and technologies;
and
. expand our sales and marketing programs and conduct more aggressive
brand promotions.
34
We believe that the net proceeds from our public offerings of common stock in
August 1999 and February 2000, together with cash flow from operations, will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for the foreseeable future. We may need to raise additional funds,
however, in order to fund more rapid expansion. We may seek to sell additional
equity or debt securities or to obtain a credit facility. The sale of additional
equity or debt securities, if convertible, could result in additional dilution
to our stockholders. The incurrence of indebtedness would result in increased
fixed obligations and could result in operating covenants that would restrict
our operations. We cannot guarantee that financing will be available in amounts
or on terms acceptable to us, if at all.
Recent Accounting Pronouncements
The FASB recently issued Statement of Financial Accounting Standards No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
Effective Date of FASB Statement No. 133" ("SFAS137"). The Statement defers for
one year the effective date of FASB Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities". The rule now will apply to all
fiscal quarters of all fiscal years beginning after June 15, 2000. In June 1998,
the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"), which is required to be adopted in years beginning
after June 15, 1999. The Statement permits early adoption as of the beginning of
any fiscal quarter after its issuance. The adoption of SFAS 137 and SFAS 133 is
not expected to have a material impact on the consolidated financial position or
results of operations.
Year 2000 Compliance
Year 2000 Readiness Disclosure
By the end of 1999, we had evaluated our Year 2000 readiness in preparation for
issues that could result from computer programs being written using two digits
to define the applicable year rather than four to define the applicable year and
century. We believe that we were prepared for the transition to the Year 2000
and did not experience any significant Year 2000 problems with respect to our
products, third party products that we bundle with official Red Hat Linux or our
internal management information systems or other systems, applications or
infrastructure.
Since January 1, 2000, our internal management information systems and
non-information systems have functioned properly. In addition, we have not
experienced any material Year 2000 issues related to our interaction with third
parties. We have not experienced any material disruption in our ability to
provide our products and services to our customers, collect payments or report
accurate data to management or any other business interruptions due to Year 2000
issues. We will continue to monitor our products and systems and those of third
parties with whom we have material business relationships to ensure that no
unexpected Year 2000 issues develop.
35
Factors Affecting Future Results
Risks Related to our Linux-based Open Source Business Model
Our open source software business model is unproven.
We have not demonstrated the success of our open source business model, which
gives our customers the right to freely copy and distribute our software. No
other company has built a successful open source business. Few open source
software products have gained widespread commercial acceptance partly due to the
lack of viable open source industry participants to offer adequate service and
support on a long term basis. In addition, open source vendors are not able to
provide industry standard warranties and indemnities for their products, since
these products have been developed largely by independent parties over whom open
source vendors exercise no control or supervision. If open source software
should fail to gain widespread commercial acceptance, we would not be able to
sustain our revenue growth and our business could fail.
We depend on the support of Linux developers not employed by the us to release
major product upgrades and maintain market share.
We may not be able to release major product upgrades of Official Red Hat Linux
on a timely basis because the heart of Official Red Hat Linux, the Linux kernel,
is maintained by third parties. Linus Torvalds, the original developer of the
Linux kernel, and a small group of independent engineers are primarily
responsible for the development and evolution of the Linux kernel. If this group
of developers fails to further develop the Linux kernel or if Mr. Torvalds or
other prominent Linux developers, such as Alan Cox, David Miller or Stephen
Tweedie, were to join one of our competitors or no longer work on the Linux
kernel, we would have to either rely on another party to further develop the
kernel or develop it ourselves. We cannot predict whether enhancements to the
kernel would be available from reliable alternative sources. We could be forced
to rely to a greater extent on our own development efforts, which would increase
our development expenses and may delay our product release and upgrade
schedules. In addition, any failure on the part of the kernel developers to
further develop and enhance the kernel could stifle the development of
additional Linux-based applications.
We may not be able to effectively assemble and test our software because it
consists largely of code developed by independent third parties over whom we
exercise no control, which could result in unreliable products and damage to our
reputation.
Official Red Hat Linux, in compressed form, consists of approximately 1.1
gigabytes of code. Of that total, in excess of 1,000 megabytes have been
developed by independent third parties, including approximately 10 megabytes of
code contained in the Linux kernel. Included within the 1.1 gigabytes of code
are more than 800 distinct software components developed by thousands of
individual programmers which we must assemble and test before we can release a
new version of Official Red Hat Linux. If these components are not reliable,
Official Red Hat Linux could fail, resulting in serious damage to our reputation
and potential litigation. Although we attempt to assemble only the best
available components, we cannot be sure that we will be able to identify the
highest quality and most reliable components or successfully assemble and test
them. In addition, if these components were no longer available, we would have
to develop them ourselves, which would significantly increase our development
expenses.
The scarcity of software applications for Linux-based operating systems could
prevent commercial adoption of our products.
Our products will not gain widespread commercial adoption until there are more
third-party software applications designed to operate on Linux-based operating
systems. These applications include word processors, databases, accounting
packages, spreadsheets, e-mail programs, Internet browsers,
36
presentation and graphics software and personal productivity applications. We
intend to encourage the development of additional applications that operate on
Linux-based operating systems by attracting third-party developers to the Linux
platform, by providing open source tools to create these applications and by
maintaining our existing developer relationships through marketing and technical
support for third-party developers. If we are not successful in achieving these
goals, however, our products will not gain widespread commercial acceptance and
we will not be able to maintain our product sales growth.
We may not be able to generate revenue from sales of Official Red Hat Linux if
users can more quickly download it from the Internet.
Anyone can download a free copy of official Red Hat Linux from the Internet.
However, because this download can take up to 36 hours using a standard
telephone connection, many of our users choose to buy the shrink-wrapped version
of Official Red Hat Linux. If hardware and data transmission technology advances
in the future to the point where increased bandwidth allows users to more
quickly download our products from the Internet, users may no longer choose to
purchase Official Red Hat Linux. This could lead to a significant loss of
product revenue.
We may not succeed in shifting our business focus from traditional
shrink-wrapped software sales to offering subscription-based product and
services offerings.
We are focusing our sales and marketing efforts on providing subscription-based
products and services as opposed to relying on sales of shrink-wrapped software.
This change has required us to expend significant financial and managerial
resources and may ultimately prove unsuccessful. The failure to successfully
implement this transition of our sales model could materially adversely affect
our operating results.
Our customers may find it difficult to install and implement Official Red Hat
Linux, which could lead to customer dissatisfaction and damage our reputation.
Installation and implementation of Official Red Hat Linux often involves a
significant commitment of resources, financial and otherwise, by our customers.
This process can be lengthy due to the size and complexity of our products and
the need to purchase and install new applications. The failure by us to attract
and retain services personnel to support our customers, the failure of companies
with which we have strategic alliances to commit sufficient resources towards
the installation and implementation of our products, or a delay in
implementation for any other reason could result in dissatisfied customers. This
could damage our reputation and the Red Hat brand and result in decreased
revenue.
We may be unable to predict the future course of open source technology
development, which could reduce the market appeal of our products and damage our
reputation.
We do not exercise control over many aspects of the development of open source
technology. Historically, different groups of open source software programmers
have competed with each other to develop new technology. Typically one of those
groups develops the technology that becomes more widely used than that developed
by others. If we adopt new technology and incorporate it into our products, and
competing technology becomes more widely used, the market appeal of our products
may be reduced, which could harm our reputation, diminish the Red Hat brand and
result in decreased revenue.
Risks Related to our Financial Results and Condition
Our limited operating history in the new and developing market for Linux-based
operating systems makes it difficult to evaluate our business.
Red Hat was formed in March 1993. We began offering Official Red Hat Linux in
October 1994. Our
37
limited operating history and the developing market for Linux-based operating
systems makes it difficult to evaluate the risks and uncertainties that we face.
Our failure to address these risks and uncertainties could cause our business
results to suffer and result in the loss of all or part of your investment.
We have limited combined operating history with the companies we have acquired
since our initial public offering and may have difficulty integrating these
businesses.
The successful integration of the operations, products, services and personnel
of Red Hat and the seven companies we have acquired since our initial public
offering -- Cygnus Solutions, Hell's Kitchen Systems, Inc., Bluecurve, Inc.,
WireSpeed Communications Corporation, C2Net Software, Inc. Akopia, Inc., and
Planning Technologies, Inc. -- is important to the future financial performance
of the combined enterprise. The anticipated benefits of these acquisitions may
not be achieved unless, among other things, the operations, products, services
and personnel of the acquired companies are successfully combined with those of
Red Hat in a timely and efficient manner. Integration of these companies'
operations, products, services and personnel may be hampered because, among
other things:
. the products and services offered by each of the acquired companies and Red
Hat are highly complex and have been developed independently;
. integration of the product lines of Red Hat and each of the acquired
companies will require the coordination of separate development and
engineering teams from each company; and
. the employees and management of the acquired companies and Red Hat are
located in disparate geographical regions.
In addition, the costs associated with integrating these companies' operations,
products, services and personnel may be substantial and could include, among
other things:
. employee redeployment or relocation; and
. the combination of research and development teams and processes.
Any of these difficulties and costs encountered in the transition process, could
divert the attention of management, and could have an adverse impact on the
revenues and operating results of the combined enterprise.
We expect to incur substantial losses on a GAAP basis for the foreseeable
future.
We have incurred operating losses in six of our previous seven fiscal years,
including our most recent fiscal year ended February 28, 2001. We expect to
incur significant losses for the foreseeable future, as we substantially
increase our sales and marketing, research and development and administrative
expenses. In addition, we are investing considerable resources in our Red Hat
Network initiative and to expand our professional services offerings. As a
result, we cannot be certain when or if we will achieve sustained profitability.
Failure to become and remain profitable may adversely affect the market price of
our common stock and our ability to raise capital and continue operations.
You should not rely on our quarterly results of operations as an indication of
our future results because they fluctuate significantly and are difficult to
forecast.
Due to our limited combined operating history and the unpredictability of our
business, our revenue and operating results may fluctuate significantly from
quarter to quarter and are difficult to forecast. We base our current and
projected future expense levels in part on our estimates of future revenue. Our
expenses are, to a large extent, fixed in the short term. We may not be able to
adjust our spending quickly if our revenue falls short of our expectations.
Accordingly, a revenue shortfall in a particular quarter would have
38
a disproportionate adverse effect on our operating results for that quarter. You
should not rely on quarter-to-quarter comparisons of our results of operations
as an indication of our future performance. Our future operating results may
fall below expectations of securities analysts or investors, which would likely
cause the market price of our common stock to decline significantly.
We may not be able to effectively attract additional enterprise customers and
preserve relationships with current enterprise customers, which could adversely
affect revenue.
Historically, we focused our sales and marketing efforts on product sales to
individuals. We have recently, however, begun to focus our efforts on expanding
our enterprise customer base. To this end, we have invested extensively to
attract enterprise customers. These enterprise customers expect diverse and
extensive service programs, and if we are unable to continue to successfully
expand and enhance our service offerings, we may not be able to meet these
customers' needs or attract new customers, and, consequently, our revenue would
suffer.
Our failure to update and modernize our internal systems, procedures and
controls may prevent the implementation of our business strategies in a rapidly
evolving market and may constrain our future growth.
Our operational and financial systems, procedures and controls, which were
adequate for a small private company, are becoming outdated as we grow. Since
March 1, 1999 we have increased the number of employees more than tenfold. To
accommodate this growth, we have evaluated our financial and operational
systems, procedures and controls. Although we have revised or are in the process
of revising and updating most of them, if we continue our rapid growth, we may
not be able to improve our transaction processing and reporting systems and
procedures, or expand and train our expanding workforce quickly enough to
maintain a competitive position in our markets. In addition, failure to quickly
replace obsolete systems, procedures and controls could impede our management's
decision-making abilities. This, in turn, may impair our ability to pursue
business opportunities and may hamper future growth.
We may not be able to generate enough additional revenue from our international
expansion to offset the costs associated with establishing and maintaining
foreign operations.
A key component of our growth strategy is to expand our presence in foreign
markets. We have recently established subsidiaries or offices in Canada,
Ireland, the United Kingdom, Germany, Italy, Japan, France, Singapore and
Australia, and are considering further expansion worldwide. We may also enter
other markets as opportunities arise. It will be costly to establish
international facilities and operations, promote our brand internationally, and
develop localized web sites and other systems. Revenue from international
activities may not offset the expense of establishing and maintaining these
foreign operations. In addition, because we have little experience in marketing
and distributing products or services for these markets, we may not benefit from
any first-to-market advantages.
Our management team may not be able to successfully implement our business
strategies because it has only recently begun to work together.
Our business is highly dependent on the ability of our management to work
together effectively to meet the demands of our growth. Several members of our
senior management have been employed by us for a relatively short period of
time. These individuals have not previously worked together as a management
team. The failure of our management team to work together effectively could
prevent efficient decision-making by our executive team, affecting product
development and sales and marketing efforts, which would negatively impact our
operating results.
We depend on our key personnel.
Our future success depends on the continued services of a number of key
officers, including our Chief
39
Executive Officer and President, Matthew J. Szulik, our Chief Operating Officer,
Timothy J. Buckley, our Chief Technical Officer, Michael Tiemann, our Chief
Financial Officer, Kevin B. Thompson, and our Chief Marketing Officer, James
Neiser. The loss of the technical knowledge and industry expertise of any of
these people could seriously impede our success. Moreover, the loss of one or a
group of our key employees, particularly to a competitor, and any resulting loss
of customers could reduce our market share and diminish the Red Hat brand.
With our declining stock price we may have increased difficulty in attracting
and retaining highly skilled employees.
As with most technology companies, a key component of our compensation package
for our employees is stock options. With the decline in our stock price, many of
the options granted in the last 18 months are now out of the money. In order to
retain our highly skilled workforce, we may be compelled to grant new options.
If such new options are granted, they are likely to have a dilutive effect on
our stockholders.
We may lack the financial and operational resources needed to increase our
market share and compete effectively with Microsoft, other established operating
systems developers, software development tools developers and other service and
support providers.
In the market for operating systems, we face significant competition from larger
companies with greater financial resources and name recognition than we have.
These competitors, which offer hardware-independent multi-user operating systems
for Intel platforms and/or UNIX-based operating systems, include Microsoft,
Novell, IBM, Sun Microsystems, The Santa Cruz Operation, AT&T, Compaq,
Hewlett-Packard, Olivetti and Unisys. Some of these competitors currently, or
may in the future, produce and market open source operating systems.
We also face competition in the market for software development tools and
operating systems for special purpose computing, including embedded systems. Our
competitors in this market, some of which have greater market share than we do,
include Wind River Systems, Integrated Systems Incorporated, Green Hills
Software, and the Metrowerks subsidiary of Motorola. Some of these companies
currently produce or use open source software as part of their product
offerings. We may not be able to compete effectively in this market if customers
choose proprietary solutions. If the demand for open source solutions in this
market expands, however, we could lose market share as existing competitors
reposition or new companies emerge to address the opportunity.
As we increase our services offerings, we may face competition from larger and
more capable companies that currently service and support the Linux operating
system as well as other operating systems, particularly UNIX-based operating
systems, due to the fact that Linux-and UNIX-based operating systems share many
common features. These companies, including IBM and Hewlett-Packard, may be able
to leverage their existing service organizations and provide higher levels of
support on a more cost-effective basis than we can. We may not be able to
compete successfully with these current or potential competitors.
We may not be able to match the promotional activities and pricing policies
offered by other suppliers of Linux-based and other open source operating
systems, which could result in a loss of market share.
In the new and rapidly evolving market for Linux-based operating systems, we
face intense competition from a number of other suppliers of Linux-based
operating systems. We also face competition to a lesser extent from developers
of non-Linux-based open source operating systems such as BSD-based operating
systems. BSD-based operating systems such as FreeBSD, NetBSD and OpenBSD are
open source operating systems produced by communities of developers working
together via the Internet, and which are published and distributed by Walnut
Creek CD-ROM, among others. We expect competition in broader open source
operating systems and the Linux-based operating systems market to intensify. In
40
addition, companies like Sun Microsystems and IBM, which are more established
and have larger customer bases than we do, have indicated a growing interest in
the market for Linux-based operating systems. With the recent acquisition of
BSDi by Wind River Systems, we will face increased competition in providing open
source solutions in the embedded space. These companies may be able to undertake
more extensive promotional activities, adopt more aggressive pricing policies,
and offer more attractive terms to their customers than we can. Furthermore,
because Linux-based operating systems can be downloaded from the Internet for
free or purchased at a nominal cost and modified and re-sold with few
restrictions, traditional barriers to entry are minimal. Accordingly, it is
possible that new competitors or alliances among existing competitors may emerge
and rapidly acquire significant market share.
If we fail to establish and maintain strategic distribution and other
collaborative relationships with industry-leading companies, we may not be able
to attract and retain a larger customer base.
Our success depends on our ability to continue to establish and maintain
strategic distribution and other collaborative relationships with
industry-leading hardware manufacturers, distributors, software vendors and
enterprise solutions providers. These relationships allow us to offer our
products and services to a much larger customer base than we would otherwise be
able to through our direct sales and marketing efforts. We may not be able to
maintain these relationships or replace them on attractive terms. In addition,
our existing strategic relationships do not, and any future strategic
relationships may not, afford us any exclusive marketing or distribution rights.
As a result, the companies with which we have strategic alliances are free to
pursue alternative technologies and to develop alternative products and services
in addition to or in lieu of our products and services, either on their own or
in collaboration with others, including our competitors. Moreover, we cannot
guarantee that the companies with which we have strategic relationships will
market our products effectively or continue to devote the resources necessary to
provide us with effective sales, marketing and technical support.
We may not be able to meet the operational and financial challenges that we will
encounter as our international operations expand.
As we expand our international operations, we will face a number of additional
challenges associated with the conduct of business overseas. For example:
. we may have difficulty managing and administering a globally-dispersed
business;
. fluctuations in exchange rates may negatively affect our operating results;
. we may not be able to repatriate the earnings of our foreign operations;
. we have to comply with a wide variety of foreign laws with which we are not
familiar;
. we may not be able to adequately protect our trademarks overseas due to the
uncertainty of laws and enforcement in certain countries relating to the
protection of intellectual property rights;
. reductions in business activity during the summer months in Europe and
certain other parts of the world could negatively impact the operating
results of our foreign operations;
. export controls could prevent us from shipping our products into and from
some markets;
. multiple and possibly overlapping tax structures could significantly reduce
the financial performance of our foreign operations;
. changes in import/export duties and quotas could affect the competitive
pricing of our products and services and reduce our market share in some
countries; and
41
. economic or political instability in some international markets could result
in the forfeiture of some foreign assets and the loss of sums spent
developing and marketing those assets.
Expanding our services business will be costly and may not result in any benefit
to us.
We have expanded our strategic focus to place additional emphasis on consulting,
custom engineering and development, education and support services. We cannot be
certain that our customers will engage our professional services organization to
assist with support, consulting, custom development, training and implementation
of our products. We also cannot be certain that we can attract or retain a
sufficient number of the highly qualified services personnel that the expansion
of our services business will need. In addition, this expansion has required,
and will continue to require, significant additional expenses and development,
financial and operational resources. The need for these additional resources
will place further strain on our management, financial and operational resources
and may make it more difficult for us to achieve and maintain profitability.
Attempts to expand by means of business combinations and strategic alliances may
not be successful and may harm our operational efficiency, financial performance
and relationships with employees and third parties.
We may continue to expand our operations or market presence by entering into
additional business combinations, investments, joint ventures or other strategic
alliances with hardware manufacturers, software vendors, Internet companies,
open source software developers or other companies both in the United States and
internationally. Our ability to expand in this way may be limited due to the
many financial and operational risks accompanying these transactions. For
example:
. we may have difficulty assimilating the operations, technology and personnel
of the combined companies;
. our business may be disrupted by the allocation of resources to consummate
these transactions;
. we may have problems retaining key technical and managerial personnel from
acquired companies;
. we may experience one-time in-process research and development charges and
ongoing expenses associated with amortization of goodwill and other purchased
intangible assets;
. our stockholders will suffer dilution if we issue equity to fund these
transactions;
. acquired businesses may initially be unprofitable resulting in our assumption
of operating losses and increased expenses;
. our reputation may be harmed if the open source development community does
not approve of these transactions;
. our relationships with existing employees, customers and business partners
may be weakened or terminated as a result of these transactions; and
. our investment activities, particularly with respect to emerging-growth
technology companies, are inherently risky and we may not realize any benefit
from such activities.
Risks Related to our Internet Strategy
We may fail to promote and enhance our web site effectively, which may prevent
us from attracting new visitors, advertisers or electronic commerce partners to
our web site.
42
In order to attract and retain Internet users, service customers, and electronic
commerce partners, we intend to substantially increase our expenditures for
enhancing and further developing our web site. Our success in promoting and
enhancing the redhat.com web site will also depend on our ability to provide
high quality service delivery, content, features and functionality. If we fail
to promote our web site successfully or if visitors to our web site or customers
do not perceive our services to be useful, current or of high quality, our
ability to generate revenue from our web site will be significantly impaired.
Visitors to our web site could experience delays and decreased performance
during periods of heavy traffic, which could result in dissatisfaction with our
web site and damage to our reputation.
Our web site must accommodate a high volume of traffic and deliver frequently
updated information. Our web site has in the past experienced slower response
times or decreased traffic for a variety of reasons. These occurrences have not
had a material impact on our business. These types of occurrences in the future,
however, could materially adversely affect our reputation and brand name and
could cause users to perceive our web site as not functioning properly. Under
these circumstances, our users might choose another web site or other methods to
obtain Linux-based operating systems, services, or Linux-related information.
Our Internet strategy will fail if the infrastructure of the Internet is not
continually developed and maintained.
The success of our Internet strategy will depend in large part on the continued
development and maintenance of the infrastructure of the Internet. Because
global commerce and the online exchange of information is new and evolving, we
cannot predict with any certainty that the Internet will be a viable commercial
marketplace in the long term. The Internet has experienced, and we expect it to
continue to experience, significant growth in the number of users and amount of
traffic. If the Internet continues to experience an increased number of users,
frequency of use or increased bandwidth requirements of users, it may not be
able to support the demands placed upon it by this growth, and its performance
and reliability may suffer. Furthermore, the Internet has experienced a variety
of outages and other delays as a result of damage to portions of its
infrastructure, and could face similar outages and delays in the future. Any
outage or delay could affect the level of Internet usage, as well as the volume
of traffic on our web site. In addition, the Internet could lose its viability
due to increased governmental regulation and delays in the development or
adoption of new standards and protocols to handle increased levels of activity.
If the necessary infrastructure, standards or protocols or complementary
products, services or facilities are not developed, or if the Internet does not
become a viable commercial marketplace, our Internet strategy will not succeed.
We are vulnerable to unexpected network interruptions caused by system failures,
which may result in reduced visitor traffic on our web site, decreased revenue
and harm to our reputation.
Substantially all of our communications hardware and other hardware related to
our web site is located at our facilities, although we have back-up and
co-location hardware for our web site located at third-party facilities. Fire,
floods, hurricanes, tornadoes, earthquakes, power loss, telecommunications
failures, break-ins and similar events could damage these systems. In addition,
although we have implemented network security measures, our servers are
vulnerable to computer viruses, electronic break-ins, human error and other
similar disruptive problems which could adversely affect our systems and web
site. Although we try to prevent unauthorized access to our systems, we cannot
eliminate this risk entirely. We could lose revenue and suffer damage to our
reputation if our systems were affected by any of these occurrences. Our
insurance policies may not adequately compensate us for any losses that may
occur due to failures or interruptions in our systems. We do not presently have
any secondary "off-site" systems or a formal disaster recovery plan.
43
Risks Related to Legal Uncertainty
We could be prevented from selling or developing our products if the GNU General
Public License and similar licenses under which our products are developed and
licensed are not enforceable.
The Linux kernel and the official Red Hat Linux operating system have been
developed and licensed under the GNU General Public License and similar
licenses. These licenses state that any program licensed under them may be
liberally copied, modified and distributed. We know of no circumstance under
which these licenses have been challenged or interpreted in court. Accordingly,
it is possible that a court would hold these licenses to be unenforceable in the
event that someone were to file a claim asserting proprietary rights in a
program developed and distributed under them. Any ruling by a court that these
licenses are not enforceable, or that Linux-based operating systems, or
significant portions of them, may not be liberally copied, modified or
distributed, would have the effect of preventing us from selling or developing
our products.
Our products may contain defects that may be costly to correct, delay market
acceptance of our products and expose us to litigation.
Despite testing by us and our customers, errors have been and may continue to be
found in our products after commencement of commercial shipments. This risk is
exacerbated by the fact that most of the code in our products is developed by
independent parties over whom we exercise no supervision or control. If errors
are discovered, we may have to make significant expenditures of capital to
eliminate them and yet may not be able to successfully correct them in a timely
manner or at all. Errors and failures in our products could result in a loss of,
or delay in, market acceptance of our products and could damage our reputation
and our ability to convince commercial users of the benefits of Linux-based
operating systems and other open source software products.
In addition, failures in our products could cause system failures for our
customers who may assert warranty and other claims for substantial damages
against us. Although our license agreements with our customers typically contain
provisions designed to limit our exposure to potential product liability claims,
it is possible that these provisions may not be effective or enforceable under
the laws of some jurisdictions. Our insurance policies may not adequately limit
our exposure to this type of claim. These claims, even if unsuccessful, could be
costly and time consuming to defend.
We are vulnerable to claims that our products infringe third-party intellectual
property rights particularly because our products are comprised of many distinct
software components developed by thousands of independent parties.
We may be exposed to future litigation based on claims that our products
infringe the intellectual property rights of others. This risk is exacerbated by
the fact that most of the code in our products is developed by independent
parties over whom we exercise no supervision or control. Claims of infringement
could require us to reengineer our products or seek to obtain licenses from
third parties in order to continue offering our products. In addition, an
adverse legal decision affecting our intellectual property, or the use of
significant resources to defend against this type of claim, could place a
significant strain on our financial resources and harm our reputation.
Our efforts to protect our trademarks may not be adequate to prevent third
parties from misappropriating our intellectual property rights.
Our most valuable intellectual property is our collection of trademarks. The
protective steps we have taken in the past have been, and may in the future
continue to be, inadequate to deter misappropriation of our trademark rights.
Although we do not believe that we have suffered any material harm from
misappropriation to date, we may be unable to detect the unauthorized use of, or
take appropriate steps to enforce, our trademark rights. We have registered some
of our trademarks in the United States, Europe
44
and Australia and have other trademark applications pending in the United
States, Europe, Australia, Canada, Europe and Japan. Effective trademark
protection may not be available in every country in which we offer or intend to
offer our products and services. Failure to adequately protect our trademark
rights could damage or even destroy the Red Hat brand and impair our ability to
compete effectively. Furthermore, defending or enforcing our trademark rights
could result in the expenditure of significant financial and managerial
resources.
We may be sued as a result of information published or posted on or accessible
from our redhat.com web site.
We may be subjected to claims for defamation, negligence, copyright or trademark
infringement or other claims relating to the information we publish on our web
site. These types of claims have been brought, sometimes successfully, against
online services in the past, and can be costly to defend. We may also be
subjected to claims based on content that is accessible from our web site
through links to other web sites or through content and materials that may be
posted by visitors to our web site. We believe that the scope and amount of our
commercial and general liability insurance is appropriate, given our current
financial position. However, this insurance may not adequately protect us
against these types of claims. We have not been a party to any lawsuit of this
type to date.
Risks Related to the Market for Our Common Stock
Our stock price has been extremely volatile and you may not be able to resell
your shares at or above your purchase price.
The trading price of our common stock has been and is likely to continue to be
highly volatile and could be subject to wide fluctuations in response to factors
such as:
. actual or anticipated variations in quarterly operating results;
. new products or services offered by Red Hat or our competitors;
. changes in financial estimates by securities analysts;
. conditions or trends in the Internet, Linux and software industries;
. changes in the economic performance and/or market valuations of other
Internet, Linux and software industries;
. announcements by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;
. additions or departures of key personnel;
. sales of common stock; and
. other events or factors, many of which are beyond our control.
In addition, the stock market in general, and the NASDAQ National Market and the
market for Internet-related and technology companies in particular, has
experienced extreme price and volume fluctuations that have often been unrelated
or disproportionate to the operating performance of such companies. In addition,
broad market and industry factors may materially adversely affect the market
price of our common stock, regardless of our actual operating performance. In
the past, following periods of volatility in the market price of a company's
securities, securities class-action litigation has often been instituted
45
against such companies. Such litigation, if instituted, could result in
substantial costs and a diversion of management's attention and resources, which
would materially adversely affect our business, financial condition and
operating results.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
The primary objective of Red Hat's investment activities is to preserve
principal and liquidity while at the same time maximizing yields without
significantly increasing risk. To achieve this objective, the Company maintains
its portfolio of cash equivalents, short-term and long-term investments in a
variety of fixed-income securities, including both government and corporate
obligations and money market funds. The following table presents the fair value
balances of the Company's cash equivalents and short-term and long-term
investments that are subject to interest rate risk by year of expected maturity
and average interest rates as of February 28, 2001:
Year Ended
(in thousands)
February 28, February 28, February 29,
------------ ------------ ------------
2002 2003 2004 Total
---- ---- ---- -----
Cash equivalents................ 85,213 85,213
Average interest rate........... 5.55%
Investments..................... 62,912 58,429 96,127 217,468
Average interest rates.......... 6.45% 6.63% 6.32%
Red Hat did not hold derivative financial instruments as of February 28, 2001,
and has never held such investments in the past.
Foreign Currency Risk
Approximately 19.3% of the Company's fiscal 2001 revenues were generated by
sales outside the United States. The Company is exposed to significant risks of
foreign currency fluctuation primarily from receivables denominated in foreign
currency and are subject to transaction gains and losses, which are recorded as
a component in determining net income. Additionally, the assets and liabilities
of the Company's non-U.S. operations are translated into U.S. dollars at
exchange rates in effect as of the applicable balance sheet dates, and revenue
and expense accounts of these operations are translated at average exchange
rates during the month the transactions occur. Unrealized translation gains and
losses will be included as an adjustment to stockholders' equity.
46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Financial Statements:
Report of Independent Accountants 48
Consolidated Balance Sheets at February 28, 2001 and February 29, 2000 49
Consolidated Statements of Operations for the years ended February 28, 2001,
February 29, 2000 and February 28, 1999 50
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
February 28, 2001, February 29, 2000 and February 28, 1999 51
Consolidated Statements of Cash Flows for the years ended February 28, 2001,
February 29, 2000 and February 28, 1999 52
Notes to Consolidated Financial Statements 53
47
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Red Hat, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity (deficit), and of
cash flows present fairly, in all material respects, the financial position of
Red Hat, Inc. and its subsidiaries at February 28, 2001 and February 29, 2000,
and the results of their operations and their cash flows for each of the three
years in the period ended February 28, 2001, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
/s/ PRICEWATERHOUSECOOPERS LLP
Raleigh, North Carolina
March 16, 2001
48
RED HAT, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
February 28, February 29,
2001 2000
------------- --------------
Current assets:
Cash and cash equivalents $ 85,212,830 $ 249,682,724
Investments in debt and equity securities 62,911,634 27,460,222
Accounts receivable, net 25,203,635 11,077,873
Subcontractor receivable 3,441,394 -
Inventory 739,960 488,977
Prepaid expenses and other current assets 2,171,721 2,119,147
------------- --------------
Total current assets 179,681,174 290,828,943
Property and equipment, net 14,591,510 8,532,718
Goodwill and intangibles, net 147,396,649 58,267,419
Investments in debt and equity securities 154,556,684 72,354,212
Other assets, net 9,025,138 4,877,713
------------- --------------
Total assets $ 505,251,155 $ 434,861,005
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 9,681,174 $ 13,250,547
Royalties payable - 115,117
Accrued expenses 15,915,682 8,351,760
Deferred revenue 12,150,549 11,030,337
Short term payable 2,750,000 350,000
Current portion of capital lease obligations 193,895 366,062
------------- --------------
Total current liabilities 40,691,300 33,463,823
Capital lease obligations 277,338 230,516
Commitments and contingencies (Note 16) - -
Stockholders' equity:
Preferred stock, 5,000,000 shares authorized, none outstanding - -
Preferred stock - 7,900,000
Common stock, $.0001 par value, 225,000,0000 shares authorized,
168,485,899 and 155,144,022 shares issued and outstanding
at February 28, 2001 and February 29, 2000, respectively 16,849 15,514
Additional paid-in capital 643,712,385 480,696,614
Shareholder notes receivable - (66,899)
Deferred compensation (36,051,412) (35,484,582)
Accumulated deficit (143,588,767) (51,378,113)
Accumulated other comprehensive income (loss) 193,462 (515,868)
------------- --------------
Total stockholders' equity 464,282,517 401,166,666
------------- --------------
Total liabilities and stockholders' equity $ 505,251,155 $ 434,861,005
============= ==============
The accompanying notes are an integral part of these consolidated
financial statements.
49
RED HAT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended
-------------------------------------------------------------
February 28, February 29, February 28,
2001 2000 1999
----------------- ----------------- -----------------
Subscription and services revenue:
Subscription $ 45,498,605 $ 25,266,825 $ 22,102,923
Services 57,152,952 27,555,626 15,725,039
----------------- ----------------- -----------------
Total subscription and services revenue 102,651,557 52,822,451 37,827,962
----------------- ----------------- -----------------
Cost of subscription and services revenue:
Subscription 14,660,496 13,766,090 6,655,685
Services 33,402,199 14,479,301 8,655,792
Stock-based services (income) expense (63,872) 188,835 -
----------------- ----------------- -----------------
Total cost of subscription and services revenue 47,998,823 28,434,226 15,311,477
------------------ ------------------ ------------------
Gross profit on subscription and services revenue 54,652,734 24,388,225 22,516,485
----------------- ----------------- -----------------
Hardware resale revenue 777,070 11,954,084 25,600,950
Cost of hardware resale revenue 645,813 10,672,141 23,571,474
----------------- ----------------- -----------------
Gross profit on hardware resale revenue 131,257 1,281,943 2,029,476
----------------- ----------------- -----------------
Operating expense:
Sales and marketing 48,979,339 28,108,035 13,821,961
Research and development 15,713,563 10,929,815 8,363,087
General and administrative 30,643,630 23,579,984 7,063,726
Stock-based sales and marketing expense 6,815,976 2,992,800 726,268
Stock-based research and development expense 3,068,977 1,191,810 227,261
Stock-based general and administrative expense 7,238,929 2,482,318 -
Amortization of goodwill and intangibles 49,804,415 3,074,307 -
----------------- ----------------- -----------------
Total operating expense 162,264,829 72,359,069 30,202,303
----------------- ----------------- -----------------
Loss from operations (107,480,838) (46,688,901) (5,656,342)
----------------- ----------------- -----------------
Interest income (expense):
Interest income 21,386,959 5,145,673 442,756
Interest expense (354,874) (720,573) (338,410)
----------------- ----------------- -----------------
Other income (expense), net 21,032,085 4,425,100 104,346
----------------- ----------------- -----------------
Loss before income taxes (86,448,753) (42,263,801) (5,551,996)
Provision for income taxes 266,857 163,012 836,394
----------------- ----------------- -----------------
Net loss (86,715,610) (42,426,813) (6,388,390)
Accretion of mandatorily redeemable preferred stock - (82,473) (39,356)
----------------- ----------------- -----------------
Net loss available to common stockholders $ (86,715,610) $ (42,509,286) $ (6,427,746)
================= ================= =================
Net loss per common share:
Basic ($0.53) ($0.41) ($0.13)
Diluted ($0.53) ($0.41) ($0.13)
Weighted average shares outstanding:
Basic 164,659,004 102,464,684 49,577,764
Diluted 164,659,004 102,464,684 49,577,764
The accompanying notes are an integral part of these consolidated financial
statements.
50
RED HAT, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Preferred Stock Common Stock
------------------------------- -------------------------------
Shares Amount Shares Amount
------------- --------------- ---------------- -----------
Balance at February 28, 1998 6,085,080 $ 411,691 48,948,402 $ 4,895
Net loss - - - -
Exercise of common stock options and warrants - - 1,869,014 187
Tax benefit on exercise of common stock warrants - - - -
Issuance of Series A preferred stock from options 205,812 165,586 - -
Issuance of Series C preferred stock, net 709,555 6,760,594 - -
Repurchase and retirement of preferred stock (141,386) (44,357) - -
Deferred compensation - - - -
Amortization of deferred compensation - - - -
Stock options issued for services - 434,580 - -
Accretion of mandatorily redeemable preferred stock - - - -
Net increase in shareholder notes receivable - - - -
------------- --------------- ----------------- -----------
Balance at February 28, 1999 6,859,061 7,728,094 50,817,416 5,082
Net loss - - - -
Adjustment for inclusion of Cygnus September 1999 net
loss in results of operations twice - - - -
Other comprehensive income:
Unrealized loss on investments in marketable
securities - - - -
Foreign currency translation adjustment - - - -
Other comprehensive income - - - -
Conversion of preferred stock into common stock - - 67,890,904 6,789
Sale of common stock in public offerings, net - - 16,550,000 1,655
Exercise of common stock options and warrants - - 10,084,673 1,008
Repurchase and retirement of preferred stock (7,372) (1,119) - -
Issuance of Series A preferred stock from exercise of options 530,357 93,899 - -
Issuance of Series C preferred stock, net 524,160 4,973,882 - -
Conversion of common stock into preferred stock 2,000,000 (194,840) (20)
Issuance of Series A convertible preferred stock 8,000,000 7,900,000
Conversion of convertible preferred stock to common stock (7,906,206) (12,794,756) 9,500,084 950
Common stock issued for acquisitions - - 495,785 50
Deferred compensation related to acquisitions - - - -
Deferred compensation related to stock options - - - -
Amortization of deferred compensation - - - -
Stock options issued for services - - - -
Net decrease in shareholder notes receivable - - - -
Accretion of mandatorily redeemable preferred stock - - - -
------------- --------------- ---------------- -----------
Balance at February 29, 2000 10,000,000 7,900,000 155,144,022 15,514
Net loss - - - -
Adjustment for exclusion of PTI January and February 2000
results of operations - - 253 -
Other comprehensive income:
Unrealized gain on investments in marketable
securities - - - -
Foreign currency translation adjustment - - - -
Other comprehensive income - - - -
Conversion of PTI Series A convertible preferred stock to
common stock (10,000,000) (7,900,000) 974,201 97
Exercise of common stock options and warrants - - 5,388,908 539
Issuance of common stock under Employee Stock Purchase Plan - - 36,714 4
Issuance of PTI common stock, net - - 296,117 30
Common stock issued for acquisitions - - 6,645,684 665
Deferred compensation related to acquisitions - - - -
Deferred compensation related to stock options - - - -
Amortization of deferred compensation - - - -
Dividends paid to PTI shareholders in April 2000 - - - -
Decrease in shareholder notes receivable - - - -
------------- --------------- ---------------- -----------
Balance at February 28, 2001 - $ - 168,485,899 $ 16,849
============= =============== ================ ===========
Additional Shareholder
Paid-In Notes Deferred Accumulated
Capital Receivable Compensation Deficit
-------------- ------------- -------------- --------------
Balance at February 28, 1998 $ 261,205 $ (170,790) $ - $ (3,422,395)
Net loss - - - (6,388,390)
Exercise of common stock options and warrants 3,125,910 (2,745,901) - -
Tax benefit on exercise of common stock warrants 163,831 - - -
Issuance of Series A preferred stock from options - - - -
Issuance of Series C preferred stock, net - - - -
Repurchase and retirement of preferred stock - 72,877 - -
Deferred compensation 2,415,416 - (2,415,416) -
Amortization of deferred compensation - - 953,529 -
Stock options issued for services 303,260 - - -
Accretion of mandatorily redeemable preferred stock - - - (39,356)
Net increase in shareholder notes receivable - (13,541) - -
------------- ------------- ------------- --------------
Balance at February 28, 1999 6,269,622 (2,857,355) (1,461,887) (9,850,141)
Net loss - - - (42,426,813)
Adjustment for inclusion of Cygnus September 1999 net
loss in results of operations twice - - - 981,314
Other comprehensive income:
Unrealized loss on investments in marketable
securities - - - -
Foreign currency translation adjustment - - - -
Other comprehensive income - - - -
Conversion of preferred stock into common stock 15,363,730 - - -
Sale of common stock in public offerings, net 337,051,328 - - -
Exercise of common stock options and warrants 3,675,018 127,670 - -
Repurchase and retirement of preferred stock - - - -
Issuance of Series A preferred stock from exercise of options - - - -
Issuance of Series C preferred stock, net - - - -
Conversion of common stock into preferred stock 20
Issuance of Series A convertible preferred stock
Conversion of convertible preferred stock to common stock 19,045,806 - - -
Common stock issued for acquisitions 59,658,465 - - -
Deferred compensation related to acquisitions 32,869,109 - (32,869,109) -
Deferred compensation related to stock options 6,749,993 - (6,749,993) -
Amortization of deferred compensation - - 5,596,407 -
Stock options issued for services 13,523 - - -
Net decrease in shareholder notes receivable - 2,662,786 - -
Accretion of mandatorily redeemable preferred stock - - - (82,473)
------------- ------------- ------------- --------------
Balance at February 29, 2000 480,696,614 (66,899) (35,484,582) (51,378,113)
Net loss - - - (86,715,610)
Adjustment for exclusion of PTI January and February 2000
results of operations (7,234) - 78,759 (1,645,044)
Other comprehensive income:
Unrealized gain on investments in marketable
securities - - - -
Foreign currency translation adjustment - - - -
Other comprehensive income - - - -
Conversion of PTI Series A convertible preferred stock to common
stock 7,899,903 - - -
Exercise of common stock options and warrants 5,220,718 - - -
Issuance of common stock under Employee Stock Purchase Plan 590,106 - - -
Issuance of PTI common stock, net 1,208,108 - - -
Common stock issued for acquisitions 147,862,054 - (15,905,002) -
Deferred compensation related to acquisitions 689,437 - (689,437) -
Deferred compensation related to stock options (447,321) - 447,321 -
Amortization of deferred compensation - - 15,501,529 -
Dividends paid to PTI shareholders in April 2000 - - - (3,850,000)
Decrease in shareholder notes receivable - 66,899 - -
------------- ------------- ------------- --------------
Balance at February 28, 2001 $ 643,712,385 $ - $ (36,051,412) $ (143,588,767)
============= ============= ============= ==============
Accumulated
Other Total
Comprehensive Stockholders'
Income (Loss) Equity (Deficit)
------------- -----------------
Balance at February 28, 1998 $ - $ (2,915,394)
Net loss - (6,388,390)
Exercise of common stock options and warrants - 380,196
Tax benefit on exercise of common stock warrants - 163,831
Issuance of Series A preferred stock from options - 165,586
Issuance of Series C preferred stock, net - 6,760,594
Repurchase and retirement of preferred stock - 28,520
Deferred compensation - -
Amortization of deferred compensation - 953,529
Stock options issued for services - 737,840
Accretion of mandatorily redeemable preferred stock - (39,356)
Net increase in shareholder notes receivable - (13,541)
------------- ---------------
Balance at February 28, 1999 - (166,585)
Net loss - (42,426,813)
Adjustment for inclusion of Cygnus September 1999 net
loss in results of operations twice - 981,314
Other comprehensive income:
Unrealized loss on investments in marketable
securities (575,647)
Foreign currency translation adjustment 59,779
-------------
Other comprehensive income (515,868) (515,868)
Conversion of preferred stock into common stock - 15,370,519
Sale of common stock in public offerings, net - 337,052,983
Exercise of common stock options and warrants - 3,803,696
Repurchase and retirement of preferred stock - (1,119)
Issuance of Series A preferred stock from exercise of options - 93,899
Issuance of Series C preferred stock, net - 4,973,882
Conversion of common stock into preferred stock -
Issuance of Series A convertible preferred stock 7,900,000
Conversion of convertible preferred stock to common stock - 6,252,000
Common stock issued for acquisitions - 59,658,515
Deferred compensation related to acquisitions - -
Deferred compensation related to stock options - -
Amortization of deferred compensation - 5,596,407
Stock options issued for services - 13,523
Net decrease in shareholder notes receivable - 2,662,786
Accretion of mandatorily redeemable preferred stock - (82,473)
------------- ---------------
Balance at February 29, 2000 (515,868) 401,166,666
Net loss - (86,715,610)
Adjustment for exclusion of PTI January and February 2000
results of operations - (1,573,519)
Other comprehensive income:
Unrealized gain on investments in marketable
securities 1,853,321
Foreign currency translation adjustment (1,143,991)
-------------
Other comprehensive income 709,330 709,330
Conversion of PTI Series A convertible preferred stock to common
stock - -
Exercise of common stock options and warrants - 5,221,257
Issuance of common stock under Employee Stock Purchase Plan - 590,110
Issuance of PTI common stock, net - 1,208,138
Common stock issued for acquisitions - 131,957,717
Deferred compensation related to acquisitions - -
Deferred compensation related to stock options - -
Amortization of deferred compensation - 15,501,529
Dividends paid to PTI shareholders in April 2000 - (3,850,000)
Decrease in shareholder notes receivable - 66,899
------------- ---------------
Balance at February 28, 2001 $ 193,462 $ 464,282,517
============= ===============
The accompanying notes are an integral part of these consolidated financial
statements.
51
RED HAT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
February 28, February 29, February 28,
2001 2000 1999
------------- ------------- ------------
Cash flows from operating activities:
Net loss $ (86,715,610) $ (42,426,813) $ (6,388,390)
Adjustments to reconcile net loss to net cash used in operating activities:
Effect on cash of exclusion of PTI January and February
2000 net loss (1,252,762) - -
Effect on net loss of inclusion of Cygnus September
1999 results of operations twice - 981,314 -
Depreciation and amortization 54,997,258 6,190,781 1,807,723
Deferred income taxes - (131,313) 11,891
Stock-based compensation expense 15,564,029 5,596,407 953,529
Tax benefit on exercise of common stock options and warrants - - 163,831
Noncash management compensation expense - 13,523 737,840
Provision for doubtful accounts 2,689,444 768,521 185,092
Provision for inventory obsolescence 746,072 481,280 182,509
Loss on sale of property and equipment 71,576 131,629 46,058
Deferred revenue 611,330 4,921,154 (1,496,319)
Forgiveness of notes receivable from PTI stockholders - 285,598 -
Changes in operating assets and liabilities:
Accounts receivable (22,030,406) (938,395) (1,249,260)
Inventory (997,055) (624,627) (331,067)
Prepaid expenses 228,175 (1,028,082) (6,735)
Intangibles and other assets (4,206,311) (1,741,680) 61,881
Refundable income taxes 92,311 (92,311) 416,158
Accounts payable (3,568,493) 5,264,693 592,707
Royalties payable (115,117) (28,957) (103,249)
Accrued expenses 7,585,221 4,205,252 1,029,510
Payment of liabilities assumed in acquisitions (3,329,669) - -
------------- ------------- ------------
Net cash used in operating activities (39,630,007) (18,172,026) (3,386,291)
------------- ------------- ------------
Cash flows from investing activities:
Purchase of investment securities (264,764,884) (275,926,085) (1,966,600)
Proceeds from sales and maturities of investment securities 148,964,320 174,073,991 1,065,526
Acquisitions of businesses, net of cash acquired 4,677,934 (600,000) -
Purchase of property and equipment (11,137,641) (7,092,330) (2,195,013)
Proceeds from sale of equipment 29,528 - -
------------- ------------- ------------
Net cash used in investing activities (122,230,743) (109,544,424) (3,096,087)
------------- ------------- ------------
Cash flows from financing activities:
Decrease in stockholders' notes receivable 66,899 2,662,786 14,978
Proceeds from notes payable 5,500,000 350,000 2,416,667
Repayments of notes payable (3,607,291) (2,426,603) (39,409)
Repurchase of PTI restricted stock - (1,119) -
Proceeds from issuance of mandatorily redeemable preferred stock, net - 3,180,628 10,084,854
Proceeds from issuance of preferred stock - 12,862,507 6,760,594
Proceeds from sale of common stock by PTI 1,208,138 - -
Proceeds from issuance of common stock under Employee Stock Purchase Plan 590,110 - -
Proceeds from issuance of common stock in public offerings, net - 337,052,983 -
Proceeds from exercise of common stock options and warrants 5,221,257 3,908,969 545,781
Purchase of treasury stock (6,439,738) - -
Payment of dividends to PTI shareholders (3,850,000) - -
Payment of capital lease obligations (154,528) (198,161) (55,998)
------------- ------------- ------------
Net cash (used in) provided by financing activities (1,465,153) 357,391,990 19,727,467
------------- ------------- ------------
Effect of foreign currency exchange rates on cash and cash equivalents (1,143,991) 59,779 -
Net (decrease) increase in cash and cash equivalents (164,469,894) 229,735,319 13,245,089
Cash and cash equivalents at beginning of year 249,682,724 19,947,405 6,702,316
------------- ------------- ------------
Cash and cash equivalents at end of year $ 85,212,830 $ 249,682,724 $ 19,947,405
============= ============= ============
The accompanying notes are an integral part of these consolidated
financial statements.
52
NOTE 1-Organization
Red Hat, Inc. and its subsidiaries ("Red Hat" or the "Company") offer users one
single, trusted point of contact and a common platform for developing, deploying
and managing open source software across Internet infrastructure and devices
that connect to the Internet, ranging from small embedded devices to high
availability clusters and integrated web server/e-commerce operating systems.
The Red Hat Network, Red Hat's unique web based system management technology,
helps companies worldwide easily manage all of their Red Hat Linux servers and
appliances by delivering open source products, service, support and information
on-line in real-time. Red Hat was incorporated in Connecticut in March 1993 as
ACC Corp., Inc. In September 1995, the Company changed its name to Red Hat
Software, Inc. In September 1998, the Company reincorporated in Delaware. In
June 1999, the Company changed its name to Red Hat, Inc. In January 2000, the
Company acquired Cygnus Solutions, Inc. ("Cygnus") in a transaction accounted
for using the pooling of interests method of accounting (see NOTE 3). In
February 2001, the Company acquired Planning Technologies, Inc. ("PTI") in a
transaction accounted for using the pooling of interests method of accounting
(see NOTE 3). All prior period financial statements of the Company have been
restated to reflect these combinations.
NOTE 2-Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and all of its wholly-owned subsidiaries. All significant intercompany
accounts and transactions are eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers investments purchased with a maturity period of three
months or less at the date of purchase to be cash equivalents.
Accounts Receivable
The Company's accounts receivable include $3,378,074 and $2,433,095 in unbilled
receivables at February 28, 2001 and February 29, 2000, respectively. Unbilled
receivables arise as revenues for custom development services are recognized
under the percentage-of-completion method. These amounts are billable at
specified dates, which do not necessarily coincide with timing of revenue
recognition. In addition, accounts receivable include a subcontractor
receivable, which represents amounts due from a customer of PTI for services
performed by a subcontractor of PTI. Accounts receivable are presented net of an
allowance for doubtful accounts (see NOTE 4).
Investments
The Company's investments at February 28, 2001 and February 29, 2000 are in debt
and equity securities which are classified as available for sale and carried at
market value in accordance with Statement of Financial Accounting Standards No.
115 "Accounting for Certain Investments in Debt and Equity
53
Securities" ("SFAS 115"). The Company's investments are considered available for
sale as these securities could potentially be sold in response to needs for
liquidity, changes in the availability of and the yield on alternative
instruments or changes in funding sources or terms. The Company has an
unrealized gain (loss) of $1,277,674 and ($575,647) related to these investments
at February 28, 2001 and February 29, 2000, respectively, which is recorded as
other comprehensive income (loss), a separate component of stockholders' equity.
Inventory
The costs incurred for duplicating the computer software, documentation, and
training materials sold by the Company from the product masters and for
packaging the product for distribution are capitalized as inventory at the lower
of cost or market using the weighted average method and charged to cost of sales
when revenue from the sale of units is recognized. Management periodically
evaluates the realizability of inventory based on planned release dates of
product updates and records a reserve for obsolescence when necessary. The
reserve for inventory obsolescence was approximately $322,000 and $335,000 at
February 28, 2001 and February 29, 2000, respectively.
Internal Use Software
The Company capitalized $1,738,888 and $0 in costs related to the development of
internal use software during the years ended February 28, 2001 and February 29,
2000, respectively. The Company amortizes the costs of computer software
developed for internal use on a straight-line basis over its estimated useful
life which ranges from five to seven years. The carrying value of internal use
software is included in property and equipment on the Consolidated Balance
Sheets.
Capitalized Software Costs
Capitalization of software development costs begins upon the establishment of
technological feasibility and ceases when the product is available for general
release. The establishment of technological feasibility and the ongoing
assessment of recoverability of capitalized software development costs requires
considerable judgment by management concerning certain external factors
including, but not limited to, technological feasibility, anticipated future
gross revenue, estimated economic life and changes in software and hardware
technologies. As a result of the Company's practice of releasing source code
that it has developed on a weekly basis for unrestricted download on the
Internet, there is generally no passage of time between achievement of
technological feasibility and the availability of the Company's product for
general release. Therefore, the Company has no capitalized software development
costs at February 28, 2001 and February 29, 2000.
Property and Equipment
Property and equipment is primarily comprised of furniture and computer
equipment which are recorded at cost and depreciated using the straight-line
method over their estimated useful lives as follows: furniture and fixtures,
seven years; computer equipment, three years; computer software, three years;
leasehold improvements, over the lesser of the remaining useful life of the
asset or the remaining term of the lease. Expenditures for maintenance and
repairs are charged to operations as incurred; major expenditures for renewals
and betterments are capitalized and depreciated. Property and equipment acquired
under capital leases are being depreciated over their estimated useful lives or
the respective lease term, if shorter.
Goodwill and Intangibles
Goodwill, which represents the excess of acquisition cost over the tangible net
assets acquired in business combinations, is amortized over its estimated useful
life of three years. Costs incurred for
54
acquiring certain intangible assets such as trademarks, copyrights and patents
are capitalized and amortized using the straight-line method over their
estimated useful lives, which range from three to 15 years.
Other Assets
Other assets includes security deposits which are expected to be refunded to the
Company upon termination of certain leases, investments in other companies
accounted for using the cost method of accounting, and the long-term portion of
the Company's prepaid directors' and officers' insurance premiums, which is
amortized to general and administrative expense over the term of the insurance
policy.
Impairment of Long-Lived Assets
The Company evaluates the recoverability of its property and equipment and other
assets in accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets to be Disposed of" ("SFAS
121"). SFAS 121 requires that assets be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. An impairment loss is recognized when the net book value of
such assets exceeds the estimated future undiscounted cash flows attributable to
the assets or the business to which the assets relate. Impairment losses are
measured as the amount by which the carrying value exceeds the fair value of the
assets. No impairments were required to be recognized during the years ended
February 28, 2001, February 29, 2000 and February 28, 1999.
Revenue Recognition
Revenue from the sale of software products for which no technical support is
provided is generally recognized upon shipment of the products, net of a reserve
for estimated returns. A reserve for sales returns is recognized for sales of
software products to distributors, who have a right of return, based on the
Company's historical experience of sell-through to the end user by the
distributor. The Company recognizes revenue from the sale of software products
to new distributors of its software products based upon sell-through to the end
user until the Company has sufficient historical experience with the distributor
to allow the accurate estimation of sales returns.
The Company provides certain support and subscription services with Official Red
Hat Linux for a period of time, not exceeding six months, from the date of
registration of the software products for no additional fee. In accordance with
the provisions of Statement of Position No. 97-2, "Software Revenue Recognition"
("SOP 97-2") as amended by SOP 98-4 and SOP 98-9, the Company is recognizing all
of the revenue from the sale of Official Red Hat Linux ratably over the period
that the support and subscription services are provided.
Service revenue consists of revenue for technical support and maintenance
services, other than installation support, and customer training and education,
revenue for software compiling, debugging and optimization contracts
("Development Contracts") and royalty revenue. Revenue for technical support and
maintenance services, other than installation support, is deferred and
recognized ratably over the term of the agreement, which is typically twelve
months. Revenue for development contracts is recognized on the
percentage-of-completion method provided that the fee for such engineering
services is fixed or determinable and the collection of the resulting receivable
is probable. Revenue from customer training and education and other services is
recognized at the date the services are performed.
Professional consulting revenue, which is also included in services revenue, is
recognized as the consultants provide services. At February 28, 2001 and
February 29, 2000 all consultants services were billed. Provisions for estimated
losses on uncompleted contracts are made in the period in which such losses are
determined.
55
Web advertising revenue, which is included in subscription revenue, is
recognized ratably in the period in which the advertisement is displayed,
provided that the Company has no significant remaining obligations, at the
lesser of the ratio of connections to the advertiser's website delivered over
total guaranteed connections to the advertiser's website or the straight line
basis over the term of the contract. If minimum guaranteed connections are not
met, the Company defers recognition of the corresponding revenue until the
guaranteed connections are achieved.
Hardware resale revenue is recognized based on the shipping terms of the
product. Effective January 1, 2000, the Company began migrating from a value
added reseller to a pure professional services company. Therefore, an immaterial
amount of hardware resale revenue was generated in fiscal 2001.
Stock-Based Compensation
56
The Company accounts for stock-based compensation based on the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), which states that no compensation expense is recorded for
stock options or other stock-based awards to employees that are granted with an
exercise price equal to or above the estimated fair value per share of the
Company's common stock on the grant date. In the event that stock options are
granted with an exercise price below the estimated fair market value of the
Company's common stock at the grant date, the difference between the fair market
value of the Company's common stock and the exercise price of the stock option
is recorded as deferred compensation. In addition, PTI's stock option plan (see
NOTE 14) provides the Company with the right of first refusal, for a period of
six months from the exercise date, to repurchase shares if the employee ceases
to be employed for any reason. Accordingly, the options are accounted for under
the provisions of variable plan accounting as set forth in APB 25 whereby the
Company recognizes adjustments to deferred compensation for changes in the
difference between the exercise price of the stock options granted and the fair
market value of the stock at each balance sheet date. Deferred compensation is
amortized to compensation expense over the vesting period of the stock option.
Stock-based compensation also includes the amortization of deferred compensation
related to the value of certain shares of common stock to be issued to certain
HKS shareholders contingent on their continued employment with the Company for a
period of three years after the date of acquisition (see NOTE 3). The Company
recognized $15,501,529, $5,596,407 and $953,529 in non-cash compensation expense
related to amortization of deferred compensation during the years ended February
28, 2001, February 29, 2000 and February 28, 1999, respectively. In addition,
the Company classifies the employer portion of tax liabilities paid upon
exercise of non-qualified stock options and warrants as stock-based
compensation. The Company paid $1,495,981 and $1,259,356 in tax liabilities
related to stock options and warrants exercised during the years ended February
28, 2001 and February 29, 2000, respectively. No tax liabilities related to
stock options and warrants were paid during the year ended February 28, 1999.
The Company complies with the disclosure requirements of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), which requires compensation expense to be disclosed based on the fair
value of the options granted at the date of the grant.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of costs, including salaries and
sales commissions, of all personnel involved in the sales process and related
expenses. Sales and marketing expenses also include costs of advertising and
trade shows. All costs of advertising, including cooperative marketing
arrangements, the software products, books and related services offered by the
Company are expensed as incurred. Advertising expense totaled $3,361,698,
$3,156,061 and $1,003,517 for the years ended February 28, 2001, February 29,
2000 and February 28, 1999, respectively.
Research and Development Expenses
Research and development expenses include all direct costs, primarily salaries
for Company personnel and outside consultants, related to the development of new
software products, significant enhancements to existing software products, and
the portion of costs of development of internal use software required to be
expensed, and are charged to operations as incurred until such time as
technological feasibility is achieved and ending when a product is available for
general release to customers.
Income Taxes
The Company accounts for income taxes using the liability method which requires
the recognition of deferred tax assets or liabilities for the temporary
differences between financial reporting and tax bases of the Company's assets
and liabilities and for tax carryforwards at enacted statutory tax rates in
effect for the years in which the differences are expected to reverse. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. In addition, valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be
57
realized.
Foreign Currency Translation
The majority of the Company's international sales are currently denominated in
U.S. Dollars. The Euro has been determined to be the functional currency for the
Company's European operations and local currencies have been determined to be
the functional currencies for the Company's Asian operations. Foreign exchange
gains and losses, which result from the process of remeasuring foreign currency
financial statements into U.S. Dollars, are included in the Consolidated
Statements of Operations. Foreign exchange gains and losses which result from
the translation of foreign currency financial statements into U.S. Dollars where
the local currency is the functional currency are included in other
comprehensive income, which is a separate component of stockholders' equity.
Foreign exchange gains and losses were not material for the years ended February
28, 2001, February 29, 2000 and February 28, 1999.
Significant Customers and Credit Risk
Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally of temporary cash investments and trade
receivables. The Company primarily places its temporary cash investments with
high-credit quality financial institutions which invest predominantly in U.S.
Government instruments, commercial paper of prime quality and certificates of
deposit guaranteed by banks which are members of the FDIC. Cash deposits are
primarily in financial institutions in the United States, however, cash from
monthly operating costs of international operations are deposited in banks
outside the United States.
The Company performs ongoing credit evaluations to reduce credit risk and
requires no collateral from its customers. Management estimates the allowance
for uncollectible accounts based on their historical experience and credit
evaluation. Accounts receivable from one customer comprised 25% of net
receivables as of February 28, 2001. As of February 29, 2000, approximately 19%
of accounts receivable, representing hardware resale, were concentrated in the
8(a) federal program and other federal contracts. Due to the credit worthiness
of the federal government, the Company does not require collateral and does not
expect any loss from nonpayment of these receivables.
Sales to one distributor comprised 10% and 17% of total revenue for the years
ended February 28, 2001 and February 29, 2000, respectively. Hardware resales to
the federal government comprised 11% and 28% of total revenue for the years
ended February 29, 2000 and February 28, 1999, respectively.
Cash Flows
The Company made cash payments for interest of $66,253, $148,595 and $104,859
for the years ended February 28, 2001, February 29, 2000 and February 28, 1999,
respectively. The Company made cash payments of $0, $121,137 and $243,559 for
income taxes during the years ended February 28, 2001, February 29, 2000 and
February 28, 1999, respectively.
The Company acquired property and equipment through the assumption of capital
lease obligations amounting to $195,225, $309,132 and $488,310 for the years
ended February 28, 2001, February 29, 2000 and February 28, 1999, respectively.
Net Loss Per Common Share
The Company computes net loss per common share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings Per Share," ("SFAS 128") and
SEC Staff Accounting Bulletin No. 98 ("SAB 98"). Under the provisions of SFAS
128 and SAB 98, basic net loss per common share ("Basic EPS") is computed by
dividing net loss available to common stockholders by the weighted average
number of common shares outstanding. Diluted net loss available to common
stockholders per common
58
share ("Diluted EPS") is computed by dividing net loss available to common
stockholders by the weighted average number of common shares and dilutive
potential common share equivalents then outstanding. Potential common shares
consist of shares issuable upon the exercise of stock options and warrants and
shares issuable upon conversion of outstanding mandatorily redeemable preferred
stock. The calculation of net loss per share available to common stockholders
does not include 2,604,357, 51,336,842, and 49,379,463 potential shares of
common stock equivalents for the years ended February 28, 2001, February 29,
2000 and February 28, 1999, respectively, as their impact would be antidilutive.
Segment Reporting
Management identifies its operating segments primarily based on differences in
the nature of its products and services and on geographical location. The
Company's operating segments are subscription, services, hardware resale, and
web advertising. Performance of these segments is evaluated based on their
respective gross margins. Web advertising revenues and costs are included in
subscription revenues and costs, respectively, on the Company's Consolidated
Statement of Operations. The following table presents the revenues, costs and
gross margins of subscription and web advertising sales for the years ended
February 28, 2001 and February 29, 2000, respectively. No web advertising
revenues were generated in the year ended February 28, 1999.
Year Ended Year Ended
---------- ----------
February 28, February 29,
------------ ------------
2001 2000
---- ----
Subscription revenue................................... $40,848,679 $23,960,187
Cost of subscription revenue........................... 14,396,251 13,069,831
----------- -----------
Gross margin........................................... 26,452,428 10,890,356
Web advertising revenue................................ 4,649,926 1,306,638
Cost of web advertising revenue........................ 264,245 696,259
----------- -----------
Gross margin........................................... $ 4,385,681 $ 610,379
Information on the services and hardware resale segments is presented on the
Consolidated Statement of Operations.
Management evaluates the Company's assets on a consolidated basis only.
Accordingly, no information has been provided and no allocations have been made
related to segment assets. There were no transactions entered into between the
Company's operating segments.
59
The Company has international sales offices in the United Kingdom, Ireland,
Germany, Hong Kong, Australia, and Japan. The following disclosure aggregates
individually immaterial international operations and separately discloses the
significant international operations at and for the years ended February 28,
2000, February 29, 2000 and February 28, 1999.
North Asia Pacific
America Europe and Japan Total
------- ------ --------- -----
Year Ended February 28, 2001
----------------------------
Revenues from unaffiliated customers................. $ 83,417,438 $10,727,225 $ 9,283,964 $103,428,627
Net loss available to common stockholders............ $(79,399,823) $(4,389,075) $(2,926,712) $(86,715,610)
Total assets......................................... $493,540,764 $ 7,333,793 $ 4,376,598 $505,251,155
Year Ended February 29, 2000
----------------------------
Revenues from unaffiliated customers................. $ 54,113,347 $ 4,230,213 $ 6,432,975 $ 64,776,535
Net loss available to common stockholders............ $(38,712,698) $(2,203,242) $(1,510,873) $(42,509,286)
Total assets......................................... $427,641,695 $ 5,642,561 $ 1,576,749 $434,861,005
Year Ended February 28, 1999
----------------------------
Revenues from unaffiliated customers................. $ 50,282,791 $ 334,579 $12,811,542 $ 63,428,912
Net income (loss) available to common stockholders... $ (7,075,422) $ 134,523 $ 513,153 $ (6,427,746)
Total assets......................................... $ 38,196,952 $ 287,879 $ 673,505 $ 39,158,336
60
Comprehensive Income
The Company's items of other comprehensive income (loss) are comprised of an
unrealized gain (loss) on investments in marketable securities of $1,853,321 and
($575,647) and a foreign currency translation adjustment of ($1,143,991) and
$59,779 during years ended February 28, 2001 and February 29, 2000,
respectively. The Company had no items of other comprehensive income during the
year ended February 28, 1999.
Recent Accounting Pronouncements
The FASB recently issued Statement of Financial Accounting Standards No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
Effective Date of FASB Statement No. 133" ("SFAS 137"). The Statement defers for
one year the effective date of FASB Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities". The rule now will apply to all
fiscal quarters of all fiscal years beginning after June 15, 2000. In June 1998,
the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"), which is required to be adopted in years beginning
after June 15, 1999. The Statement permits early adoption as of the beginning of
any fiscal quarter after its issuance. The adoption of SFAS 137 and SFAS 133
will not have a material impact on the consolidated financial position or
results of operations of the Company.
NOTE 3-Business Combinations
In late February 2001, the Company completed a merger with PTI by exchanging
6,319,704 shares of its common stock for all of the outstanding common stock of
PTI. In addition, approximately 2,414,927 outstanding PTI employee stock options
were converted at the same exchange factor into options to purchase
approximately 253,219 shares of the Company's common stock.
The merger constituted a tax-free reorganization and has been accounted for
using the pooling of interests method of accounting under Accounting Principles
Board Opinion No. 16 ("APB 16"). Accordingly, all prior period financial
statements have been restated to include the results of operations, financial
position and cash flows of PTI as though it had always been a part of the
Company.
Prior to the merger, PTI's fiscal year ended on December 31. In order to conform
PTI's year end with the fiscal year end of the Company, PTI's results of
operations for the months of January and February 2000 have been excluded from
all periods presented. PTI's net loss for the months of January and February
2000 was $1,645,044. A debit to accumulated deficit has been recorded to account
for the effect of excluding the net loss of PTI for the months of January and
February 2000, in the results of operations of the Company. Immaterial
adjustments were made to conform PTI and the Company's accounting policies.
Certain reclassifications were made to PTI's financial statements to conform to
the Company's presentation.
In connection with the merger, the Company recorded a charge of approximately
$1.7 million to operating expenses for costs incurred related to the merger at
the date the merger was completed. These merger costs consist primarily of $1.0
million in investment banking and filing fees and $0.7 million in costs of
attorneys and accountants. Subsequent to February 28, 2001, the Company recorded
an additional charge of approximately $1.4 million to operating expenses for
costs incurred related to the merger. These additional merger costs consist
primarily of $0.9 million in severance and other employee related costs, and
$0.5 million in costs to merge the information and accounting systems of Red Hat
and PTI.
61
The results of operations for the separate companies and the consolidated
amounts presented in the consolidated financial statements are as follows:
Year ended Year ended Year ended
February 28, February 29, February 28,
2001 2000 1999
----------------------------------------------------------
Subscription and services revenue
Red Hat.................................... $ 77,950,553 $ 42,427,503 $ 33,031,682
PTI........................................ 24,701,004 10,394,948 4,796,280
Hardware resale revenue
PTI........................................ $ 777,070 $ 11,954,084 $ 25,600,950
Net loss available to common stockholders
Red Hat.................................... $(72,277,422) $(39,924,839) $ (5,827,301)
PTI........................................ (14,438,188) (2,584,447) (600,445)
Consolidated............................... $(86,715,610) $(42,509,286) $ (6,427,746)
As a result of the fact that PTI was acquired in late February 2001, the results
of operations above represent PTI's results of operations prior to the date of
the acquisition.
In January 2000, the Company completed a merger with Cygnus Solutions, Inc.
("Cygnus") by exchanging 10,867,966 shares of its common stock for all of the
outstanding common and preferred stock of Cygnus. In addition, approximately
1,514,168 outstanding Cygnus employee stock options were converted at the same
exchange factor into options to purchase approximately 2,380,722 shares of the
Company's common stock.
The merger constituted a tax-free reorganization and was accounted for using the
pooling of interests method of accounting under APB 16. Accordingly, all
financial statements for periods prior to January 2000 have been restated to
include the results of operations, financial position and cash flows of Cygnus
as though it had always been a part of the Company. Immaterial adjustments were
made to conform the Company and Cygnus' accounting policies. Certain
reclassifications were made to Cygnus' financial statements to conform to the
Company's presentation.
Prior to the merger, Cygnus' fiscal year ended on June 30. In recording the
business combination, Cygnus' prior period financial statements have been
restated to a year ended March 31, to be within a 90-day period of the Company's
fiscal year end. In order to fully conform Cygnus' period end with the fiscal
quarter end of the Company, in preparing the consolidated results of operations
of the Company for the year ended February 29, 2000, the results of operations
of Cygnus for the month of September 1999, have been included twice. Cygnus' net
loss for the month of September 1999 was $981,314. A credit to accumulated
deficit has been recorded to remove the effect of including the net loss of
Cygnus for the month of September 1999, in the results of operations of the
Company more than once.
In connection with the merger, the Company recorded a charge of approximately
$9.4 million to operating expenses for costs incurred related to the merger at
the date the merger was completed. These merger costs consist primarily of $5.9
million in investment banking and filing fees, $1.1 million in costs of
attorneys and accountants, $0.8 million in severance and other employee related
costs, $0.7 million in infrastructure reconfiguration to improve overall
business efficiency, and $0.2 million in facilities closure costs and other
directly related costs.
62
In January 2000, the Company completed the acquisition of all of the outstanding
common stock of Hell's Kitchen Systems, Inc. ("HKS") in exchange for the
issuance of 478,004 shares of the Company's common stock valued at $57,671,183.
The acquisition of HKS has been accounted for using the purchase method of
accounting in accordance with APB 16 and, accordingly, the excess of purchase
price over the fair values of the net assets acquired of $57,771,183 has been
recorded as goodwill, which is being amortized on a straight-line basis over
three years. Goodwill amortization is expected to be $19,257,061 on an
annualized basis. An additional 239,000 shares valued at $28,835,350 may be
issued to certain shareholders contingent upon their continued employment with
the Company for a period of three years after the date of the acquisition. As of
February 28, 2001, 104,146 shares were issued under this portion of the
agreement. This amount has been recorded as deferred compensation and is being
amortized on a straight-line basis over three years. In addition to the above,
79,666 shares may be issued if certain performance objectives are met. The value
of these shares will be determined and recorded as goodwill as the performance
objectives are met. As of February 28, 2001, no shares were issued under this
portion of the agreement.
In March 2000, PTI acquired Enterprise Network Systems, Inc. ("ENS"), an
indirect wholly-owned subsidiary of iGate Capital Corporation, an unrelated
corporation, in a transaction accounted for as a purchase. In connection with
this transaction, PTI issued 3,156,036 shares of its common stock valued at
$32,279,094 in exchange for certain ENS assets with a fair value of
approximately $175,000 and $5,500,000 in cash. PTI recorded intangible assets of
$26,604,094, which represented the excess of the purchase price over the fair
value of the assets acquired. Goodwill amortization is expected to be $8,868,031
on an annualized basis.
In May 2000, the Company acquired all of the outstanding common stock of
Bluecurve, Inc. ("Bluecurve") in exchange for the issuance of 972,083 shares of
the Company's common stock and the assumption of all of the outstanding
Bluecurve stock options valued, in the aggregate, at $33,223,303, plus the
assumption of $1,021,544 in net liabilities. The acquisition of Bluecurve has
been accounted for using the purchase method of accounting in accordance with
APB 16 and, accordingly, the excess of purchase price over the fair values of
the net assets acquired of $34,244,847 has been recorded as goodwill, which is
being amortized on a straight-line basis over three years. Goodwill amortization
is expected to be $11,414,949 on an annualized basis.
In July 2000, the Company completed the acquisition of all of the outstanding
common stock of WireSpeed Communications Corporation, Inc. ("WireSpeed") in
exchange for the issuance of 1,461,119 shares of the Company's common stock, and
the assumption of all of the outstanding WireSpeed stock options valued, in the
aggregate, at $35,832,638, plus the assumption of $741,525 in net liabilities.
The acquisition of WireSpeed has been accounted for using the purchase method of
accounting in accordance with APB 16 and, accordingly, the excess of purchase
price over the fair values of the net assets acquired of $36,574,163 has been
recorded as goodwill, which is being amortized on a straight-line basis over
three years. An additional $4,042,902 in goodwill was recorded during the year
ended February 28, 2001 upon satisfaction of certain performance objectives. In
addition to the above, additional shares may be issued, with a maximum value of
$33,000,000, if certain performance objectives are met. The number and value of
these shares will be determined and recorded as goodwill as the performance
objectives are met.
63
In September 2000, the Company completed the acquisition of all of the
outstanding common stock of C2Net Software, Inc. ("C2Net") in exchange for the
issuance of 954,357 shares of the Company's common stock, and the assumption of
all of the outstanding C2Net stock options. The fair value of the shares and
stock options issued for vested stock options of C2Net, together with the
intrinsic value of stock options issued for unvested stock options of C2Net
amounted to $42,798,154, plus the assumption of $1,810,325 in net liabilities.
The acquisition of C2Net has been accounted for using the purchase method of
accounting in accordance with APB 16 and, accordingly, the excess of purchase
price over the fair values of the net assets acquired of $28,703,477 has been
recorded as goodwill, which is being amortized on a straight-line basis over
three years, and $15,905,002 has been recorded as deferred compensation in
accordance with FASB Interpretation No. 44, "Accounting for Certain Transactions
Involving Stock Compensation--an interpretation of APB Opinion No. 25" ("FIN
44"), which is being amortized over the remaining vesting period of the related
stock options, which averages approximately three years. Goodwill amortization
is expected to be $9,567,825 on an annualized basis. In addition to the above,
additional shares may be issued, with a market value as defined in the
agreement, if certain performance objectives are met. The number and value of
these shares will be determined and recorded as goodwill as the performance
objectives are met.
In January 2001, the Company completed the acquisition of all of the outstanding
common stock of Akopia, Inc. ("Akopia") in exchange for $500,000 in cash and
722,009 shares of the Company's common stock, which were purchased at a cost of
$6,439,738 as treasury stock and immediately reissued in conjunction with the
acquisition, and the assumption of all of the outstanding Akopia stock options.
Treasury stock issued in this transaction is netted in common stock issued for
acquisitions on the Consolidated Statements of Stockholders' Equity (Deficit).
The fair value of the cash, shares and stock options issued for vested stock
options of Akopia, together with the intrinsic value of stock options issued for
unvested stock options of Akopia amounted to $7,629,175, plus the assumption of
$691,364 in net liabilities. The acquisition of Akopia has been accounted for
using the purchase method of accounting in accordance with APB 16 and,
accordingly, the excess of purchase price over the fair values of the net assets
acquired of $7,631,102 has been recorded as goodwill, which is being amortized
on a straight-line basis over three years, and $689,437 has been recorded as
deferred compensation in accordance with FIN 44, which is being amortized over
the remaining vesting period of the related stock options, which averages
approximately three years. Goodwill amortization is expected to be $2,543,700 on
an annual basis.
The following unaudited pro forma consolidated financial information reflects
the results of operations of the Company for the years ended February 28, 2001
and February 29, 2000 as if the acquisitions of HKS, Bluecurve, WireSpeed, C2Net
and Akopia had occurred on March 1, 2000 and March 1, 1999, respectively, after
giving effect to certain purchase accounting adjustments. These pro forma
results are not necessarily indicative of what the Company's operating results
would have been had the acquisition actually taken place on March 1, 2000 and
March 1, 1999 and may not be indicative of future operating results.
Year ended Year ended
February 28, February 29,
2001 2000
----------------- -------------------
Revenue......................................... $ 104,839,552 $ 66,504,403
Net loss........................................ $(103,019,159) $ (103,243,469)
Net loss per common share, basic and diluted.... $ (0.62) $ (0.96)
64
NOTE 4-Accounts Receivable
Accounts receivable are presented net of an allowance for doubtful accounts. The
activity in the Company's allowance for doubtful accounts for the years ended
February 28, 2001, February 29, 2000 and February 28, 1999 is presented in the
following table:
Balance at Charged to Balance at
beginning income or end of
of period expense (b) Deductions (a) period
--------- ----------- -------------- ------
1999..................................... $210,388 $ 185,092 $ (105,613) $ 289,867
2000..................................... $289,867 $ 768,521 $ (310,936) $ 747,452
2001..................................... $847,452 $2,689,444 $(1,701,604) $1,835,292
______________________________
(a) Represents amounts written-off as uncollectible accounts receivable.
(b) Excludes $100,000 charged to expense by PTI during January and February
2000.
NOTE 5-Property and Equipment
The Company's property and equipment consisted of the following:
February 28, February 29,
2001 2000
---- ----
Computer equipment................................ $13,119,425 $9,138,669
Software, including software developed for internal
use............................................ 7,034,016 3,183,310
Furniture and fixtures............................ 1,647,978 1,848,189
Leasehold improvements............................ 2,142,515 259,485
23,943,934 14,429,653
Less: accumulated depreciation................... (9,352,424) (5,896,935)
$14,591,510 $8,532,718
Depreciation expense was $5,192,843, $3,096,775, and $1,675,234 for the years
ended February 28, 2001, February 29, 2000 and February 28, 1999, respectively.
65
NOTE 6-Goodwill and Intangible Assets
Goodwill and intangible assets were comprised of the following:
February 28, February 29,
2001 2000
---- ----
Goodwill and intangibles - Akopia.................... $ 7,631,102
Goodwill and intangibles - C2Net..................... 28,703,477
Goodwill and intangibles - WireSpeed................. 40,617,065
Goodwill and intangibles - Bluecurve................. 34,244,847
Goodwill and intangibles - ENS....................... 26,604,094
Goodwill and intangibles - HKS....................... 57,771,183 57,771,183
Goodwill and intangibles - other acquisitions........ 1,810,804 1,305,291
Web site domain names................................ 2,015,961 1,594,000
Other................................................ 876,838 671,252
200,275,371 61,341,726
Less: accumulated amortization....................... (52,878,722) (3,074,307)
$147,396,649 $ 58,267,419
Amortization expense was $49,804,415, $3,074,307, and $0 for the years ended
February 28, 2001, February 29, 2000 and February 28, 1999, respectively.
NOTE 7-Other Assets
Other assets were comprised of the following:
February 28, February 29,
2001 2000
---- -----
Cost basis investments............................... $8,000,005 $3,500,005
Notes receivable..................................... 578,499 1,000,000
Other................................................ 446,634 377,708
$9,025,138 $4,877,713
66
NOTE 8-Fair Value of Financial Instruments
The carrying value of cash and cash equivalents, accounts receivable, and
accounts payable at February 28, 2001 and February 29, 2000 approximated their
fair value due to the short-term nature of these items.
The fair value of the Company's short-term and long-term investments at February
28, 2001 and February 29, 2000, differed from their historical cost by
$1,277,674 and $(575,647), respectively. The Company had realized gains (losses)
on investments of approximately $58,000, $0, and $0 during the years ended
February 28, 2001, February 29, 2000 and February 28, 1999, respectively.
Following is a summary of the historical cost, unrealized gain (loss) and fair
values of the Company's investments at February 28, 2001 and February 29, 2000:
February 28, 2001
-----------------
Unrealized
----------
Cost Gain Fair Value
---- ---- -----------
Short-term corporate debt and equity securities........ $ 31,104,303 $ 168,357 $ 31,272,660
Short-term government debt and equity securities....... 31,592,476 46,498 31,638,974
-----------------------------------------------
62,696,779 214,855 62,911,634
Long-term corporate debt and equity securities......... 86,506,676 910,581 87,417,257
Long-term government debt and equity securities........ 66,987,189 152,238 67,139,427
-----------------------------------------------
153,493,865 1,062,819 154,556,684
-----------------------------------------------
$216,190,644 $1,277,674 $217,468,318
-----------------------------------------------
February 29, 2000
-----------------
Unrealized
----------
Cost Loss Fair Value
---- ---- ----------
Short-term government debt and equity securities....... $27,595,639 $(135,417) $27,460,222
------------------------------------------------
Long-term corporate debt and equity securities......... 57,626,040 (358,350) 57,267,690
Long-term government debt and equity securities........ 15,168,402 (81,880) 15,086,522
------------------------------------------------
72,794,442 (440,230) 72,354,212
------------------------------------------------
$100,390,081 $(575,647) $99,814,434
------------------------------------------------
67
NOTE 9-Accrued Expenses
Accrued expenses were comprised of the following:
February 28, February 29,
2001 2000
---- ----
Wages and other compensation........................... $ 6,968,687 $ 3,539,616
Trade.................................................. 4,921,820 3,189,536
Taxes.................................................. 808,655 572,067
Merger-related......................................... 1,932,315
Other.................................................. 1,284,205 1,050,541
$15,915,682 $ 8,351,760
NOTE 10-Income Taxes
The components of the Company's provision for income taxes consisted of
the following:
February February February
-------- -------- ---------
28, 2001 29, 2000 28, 1999
-------- -------- ---------
Current:
Foreign............................. $266,857 $271,826 $ 503,112
Federal............................. 458,791
State............................... 22,499 105,963
Current tax expense................. 266,857 294,325 1,067,866
Deferred:
Foreign.............................
Federal............................. (117,702) (207,320)
State............................... (13,611) (24,152)
Deferred tax expense................ (131,313) (231,472)
Net provision for income taxes......... $266,857 $163,012 $ 863,394
The provision for income taxes in all periods primarily relates to foreign
withholding taxes on foreign revenues earned by a U.S. Company. These
withholding taxes paid may be creditable against U.S. federal income taxes in
future periods.
68
Significant components of the Company's deferred tax assets and liabilities at
February 28, 2001 and February 29, 2000, consisted of the following:
February 28, February 29,
----------- -----------
2001 2000
---- ----
Deferred Tax Assets:
Domestic net operating loss carryforwards....... $11,552,885 $ 8,396,328
Foreign net operating loss carryforwards........ 3,496,618 1,104,295
Accounts receivable............................. 1,074,856 2,030,857
Allowance for inventory obsolescence............ 104,918 129,930
Other accruals and liabilities.................. 387,090 441,909
Intangibles..................................... 640,068 640,068
Research and development credit................. 1,452,415 1,127,415
Foreign tax credit.............................. 1,053,422 1,053,422
Compensation-related accruals................... 9,304,925 2,380,402
Total deferred tax assets....................... 29,067,197 17,304,626
Valuation allowance for deferred tax assets..... (28,531,930) (16,903,284)
Deferred tax assets............................. 535,267 401,342
Deferred Tax Liabilities:
Fixed and intangible assets..................... 535,267 401,342
Total deferred tax liabilities.................. 535,267 401,342
Net deferred taxes.............................. $ $
As of February 28, 2001 and February 29, 2000, the Company provided a full
valuation allowance against its net deferred tax assets since realization of
these benefits cannot be reasonably assured. An increase in the valuation
allowance was recorded during the years ended February 28, 2001 and February 29,
2000 to reserve the increase in total deferred tax assets during such periods
due to uncertainty of realizability.
As of February 28, 2001, the Company had Federal and state net operating loss
carryforwards of approximately $31,097,000 and $20,481,000, respectively. These
net operating loss carryforwards expire in varying amounts beginning in 2011 and
2002 for Federal and state income tax purposes, respectively. The utilization of
the Federal net operating loss carryforwards may be subject to limitation under
the rules regarding a change in stock ownership as determined by the Internal
Revenue Code. If the Company's utilization of its net operating loss
carryforwards is limited and the Company has taxable income which exceeds the
permissible yearly net operating loss utilization, the Company would incur a
Federal income tax liability even though its net operating loss carryforwards
exceed its taxable income.
The Company's foreign net operating loss carryforwards expire in varying amounts
beginning in 2005. The Company's research and development credits begin to
expire in varying amounts beginning in 2009.
69
Taxes computed at the statutory federal income tax rate of 34% are reconciled to
the provision for income taxes for the years ended February 28, 2001, February
29, 2000 and February 28, 1999 as follows:
Year Ended Year Ended Year Ended
February 28, February 29, February 28,
2001 2000 1999
-------------------------------------------------
Effective rate................................................... 0.0% 0.0% (15.0)%
United States Federal tax benefit at statutory rate.............. $(29,392,576) $(14,369,692) $(1,887,679)
State tax benefit (net of Federal tax)........................... (987,383) (1,124,992) (459,806)
Foreign taxes.................................................... 370,727 325,805 422,680
Change in valuation reserves..................................... 11,628,646 10,936,080 3,257,231
Research and development tax credit.............................. (325,000) (318,157) (255,104)
Foreign tax credit............................................... (167,692) (563,000)
Acquisition related expenses..................................... 18,237,862 4,113,793
Nondeductible items.............................................. 734,581 767,867 322,072
-------------------------------------------------
Provision for income taxes....................................... $ 266,857 $ 163,012 $ 836,394
NOTE 11-Short Term Payable
PTI had a $750,000 line of credit with a financial institution that expired on
May 31, 2000. The financial institution had been extending the terms of the loan
on a monthly basis and amounts outstanding under this note were due upon demand
and thus are classified as a current liability. Borrowings under the line of
credit bear interest at the 30 day commercial paper rate plus 3.15% (8.91% at
February 29, 2000) and were collateralized by certain assets of PTI. At February
28, 2001 and February 29, 2000, $0 and $350,000, respectively, were outstanding
under this line of credit.
In connection with the acquisition of ENS (see NOTE 3), PTI obtained a line of
credit from ENS's former parent. Under the terms of the line of credit, PTI
could borrow up to $10,000,000. Borrowings under this line of credit bear
interest at the rate obtained by the lender to secure these funds plus 0.25%
(8.82% at February 28, 2001) and are collateralized by certain assets of PTI.
During the year ended February 28, 2001, PTI made borrowings totaling
$5,500,000. At February 28, 2001, $2,750,000 was outstanding under this line of
credit, all of which was repaid subsequent to this date.
NOTE 12-Mandatorily Redeemable Preferred Stock
At February 28, 1999, the Company had authorized and issued 6,801,400, 8,116,550
and 1,027,388 shares of Series A, Series B and Series C mandatorily redeemable
preferred stock, respectively. In March and April 1999, the Company had
additional closings of the Series C mandatorily redeemable preferred stock
financing in which the Series C Investors purchased 1,027,388 shares of Series C
mandatorily redeemable preferred stock for $3,227,026, or $3.141 per share. The
shares of Series A, Series B and Series C mandatorily redeemable preferred stock
had a par value of $0.0001 per share.
All outstanding shares of Series A, Series B and Series C mandatorily redeemable
preferred stock automatically converted into 67,890,904 shares of common stock,
at the then effective conversion rate, upon the closing of the Company's initial
public offering of common stock in August 1999.
The Series A, Series B and Series C mandatorily redeemable preferred stock were
initially recorded at the total net proceeds received by the Company upon
issuance. The difference between the total net proceeds at issuance of
$12,068,063 and the total redemption price of $14,416,585 was being charged to
70
accumulated deficit over the period from issuance until redemption was to first
become available. The amount of accretion recognized during each period was
determined by using the effective interest rate method. The Company recognized
$82,473 and $39,356 in accretion for the years ended February 29, 2000 and
February 28, 1999, respectively. The Company had no outstanding mandatorily
redeemable preferred stock prior to the year ended February 28, 1999.
Cygnus Series B Mandatorily Redeemable Preferred Stock
Cygnus had authorized 1,042,000 shares of Series B mandatorily redeemable
preferred stock at February 28, 1999. On January 27, 1997, Cygnus entered into a
purchase agreement with several investors (the "Cygnus Series B Investors"). In
connection with this agreement, the Company issued 1,042,000 shares of Series B
preferred stock for $6,252,000 or $6.00 per share. On January 7, 2000,
simultaneous with the closing of the merger between the Company and Cygnus, the
Cygnus Series B preferred stock converted into 1,638,520 shares of the Company's
common stock.
NOTE 13-Common and Preferred Stock
Common Stock
The Company has authorized 225,000,000 shares of common stock with a par value
of $0.0001 per share. Holders of these shares have one vote per share. Upon the
dissolution, liquidation or winding up of the Company, holders of common stock
will be entitled to receive the assets of the Company after satisfaction of the
preferential rights of the outstanding preferred stock or any other outstanding
stock ranking on liquidation senior to or on parity with the common stock.
On each of August 11, 1999 and January 7, 2000, the Company effected two-for-one
stock splits of its common stock. All common share and per common share
information in the accompanying consolidated financial statements and related
notes have been restated to reflect these stock splits.
On August 16, 1999, the Company closed its initial public offering of 13,800,000
shares of its common stock at a price of $7.00 per share. The Company received
proceeds from this offering of $88,466,929, net of $8,133,071 in offering costs.
On February 9, 2000, the Company closed a secondary public offering of 2,750,000
shares of its common stock at a price of $95.00 per share. The Company received
proceeds from this offering of $248,586,054, net of $12,663,946 in offering
costs.
In January 2001, the Company purchased 722,009 shares of its common stock at a
total cost of $6,439,738. These shares were all reissued in the acquisition of
Akopia on January 17, 2001.
Preferred Stock
At February 28, 2001, the Company has authorized 5,000,000 shares of preferred
stock with a par value of $0.0001 per share. No shares of preferred stock were
outstanding at February 28, 2001 and February 29, 2000.
Cygnus Preferred Stock
Cygnus had authorized 7,798,180 shares of Series A preferred stock at February
28, 1999. On January 15, 1997, Cygnus converted 5,882,633 outstanding shares of
common stock to Series A preferred stock. In addition, 914,493 Series A
preferred shares were issued from exercise of options by employees to purchase
Cygnus Series A preferred stock. All outstanding Cygnus Series A preferred stock
was converted into 6,318,219 shares of the Company's common stock on January 7,
2000, the closing
71
date of the merger between Red Hat and Cygnus.
In March and June 1999, Cygnus entered into purchase agreements with several
investors, whereby, 1,233,715 shares of Cygnus Series C preferred stock were
sold for $9.50 per share, or net proceeds of $11,734,476. All outstanding Cygnus
Series C preferred stock was converted into 1,233,715 shares of the Company's
common stock on the closing date of the merger between the Company and Cygnus.
PTI Preferred Stock
PTI had authorized 10,000,000 shares of Series A Convertible Preferred Stock
("PTI Preferred Stock"). Each share of PTI Preferred Stock was convertible into
one share of PTI common stock or .0974021 shares of the Company's common stock
after adjustment for the exchange ratio. On June 22, 1999, PTI sold 4,761,905
shares of PTI Preferred Stock at $1.68 per share for net proceeds of $7,900,000,
to certain investors, pursuant to a Stock Purchase Agreement ("Agreement"). In
conjunction with the Agreement, certain shareholders of PTI also exchanged
1,190,476 shares of PTI common stock for an equal number of shares of PTI
Preferred Stock and subsequently sold these shares to the investors. Under the
terms of the Agreement, an additional 4,047,619 shares of PTI Preferred Stock
were placed in an escrow account. These shares would be released to the
investors if PTI did not achieve certain revenue levels. In March 2000,
3,632,346 of these shares were released to the investors. At the time of PTI's
acquisition of ENS, all shares of PTI Preferred Stock converted into 10,000,000
shares of PTI's common stock.
NOTE 14-Stock Options and Warrants
Stock Options
The Company has two stock options plans that provide for the granting of either
incentive stock options or non-qualified stock options (1998 and 1999 plans). As
of February 28, 2001, 23,636,525 shares of common stock were reserved for
issuance upon exercise of options granted to any employee, officer or director
or consultant of the Company at terms and prices to be determined by the Board
of Directors. The plans provide that the purchase price per share for each
non-qualified option should be set by the Board of Directors on the date of
grant. The purchase price per share for each Incentive Stock Option (ISO) shall
not be less than the fair market value of the common stock on the date of grant.
The maximum term for an option granted is ten years from the date of grant.
Options granted under the plans generally vest 25% upon completion of one full
year of service and 6.25% on the first day of each subsequent three-month
period. Under the 1998 plan, all options are immediately exercisable upon grant
into restricted shares of the Company's common stock with the same vesting
provisions as the original option. The Company, at its option, may repurchase
these restricted shares at the original purchase price under certain
circumstances. No additional options may be granted under the 1998 plan.
PTI Stock Option Plans
Effective August 7, 1997 and June 1, 1998, PTI implemented two incentive stock
option plans (the "Plans"). Under the Plans, the exercise price of incentive
stock options granted to key employees was required to be not less than the fair
market value of the shares on the grant date. The options are exercisable
ratably from a vesting start date designated by the Board of Directors over a
three to four year vesting period. The Plans also provide for stock appreciation
rights and stock bonus awards. No such awards have been granted under the Plans.
In addition, the Plans provide the Company the right of first refusal, with no
time restrictions, to repurchase shares if the employee ceases to be employed
for any reason. Accordingly, the Company recognizes adjustments to deferred
compensation for changes in the difference between the exercise prices of the
stock options granted and the fair market value of the common stock at each
balance sheet date. Deferred compensation is presented as a component of
stockholders' equity in the accompanying Consolidated Balance Sheets and is
amortized over the vesting period of the stock options.
72
Cygnus Stock Option Plans
In March 1997, Cygnus's Board of Directors adopted the 1997 Cygnus Stock Plan.
The provisions of the 1997 Cygnus Stock Plan provided for incentive stock
options to be issued to employees and nonstatutory stock options and stock
purchase rights to be issued to employees and consultants.
The exercise price of incentive stock options and nonstatutory stock options
granted under the 1997 Cygnus Stock Plan was required to be at least 100% and
85%, respectively, of the fair market value of the shares on the date of grant.
Stock options issued under the Cygnus 1997 Stock Plan generally expired ten
years from the date of the grant or such shorter term as may be provided in the
stock option agreement. Stock options granted under the 1997 Cygnus Stock Plan
typically vest over a four year period at a rate of 25% after the first year and
ratably each month thereafter.
Stock Purchase Rights provide for issuance of common stock at not less than 85%
of the fair market value of the stock. The 1997 Cygnus Stock Plan provides that
the Administrator of the 1997 Cygnus Stock Plan shall advise the offeree in
writing of the terms, conditions and restrictions related to the offer.
Restricted stock purchases generally vest 25% after the first year and 1/48th
each month thereafter. Unvested shares are subject to repurchase upon
termination of employment.
In May 1998, Cygnus's Board of Directors adopted the 1998 Cygnus Executive Stock
Plan (the "1998 Plan") and 959,025 shares of common stock were reserved for
issuance under the 1998 Plan. In January 1999, Cygnus authorized an additional
613,451 shares for issuance under this plan, for a total of 1,572,476 shares.
All of Cygnus outstanding stock options were converted into 2,380,772 options to
purchase the Company's common stock on the closing date of the merger between
the Company and Cygnus.
The activity for the stock option plans for the years ended February 28, 2001,
February 29, 2000 and February 28, 1999 is presented in the following table:
Weighted
Shares Average
Underlying Exercise Price
Options Per Share
------- ---------
Outstanding at February 28, 1998........ 2,400,065 $ 0.96
Granted................................. 11,674,621 0.63
Exercised............................... (1,368,926) 2.41
Forfeited............................... (672,606) 2.05
Outstanding at February 28, 1999........ 12,033,154 0.64
Granted................................. 11,737,975 11.26
Exercised............................... (7,455,030) 0.51
Forfeited............................... (1,208,867) 3.63
Outstanding at February 29, 2000........ 15,107,232 8.97
Granted................................. 8,173,849 18.91
Exercised............................... (2,743,908) 1.94
Forfeited............................... (3,147,859) 23.02
Outstanding at February 28, 2001........ 17,389,314 $12.08
73
The Company recorded deferred compensation of $(447,321), $6,749,993, and
$2,415,416 during the years ended February 28, 2001, February 29, 2000 and
February 28, 1999, respectively, to reflect the difference between the aggregate
fair value and exercise price during this period of all stock options granted
with an exercise price below the fair value of the Company's common stock at the
date of the grant and stock options granted under PTI stock option plans.
Amortization of deferred compensation totaled $15,501,529, $5,596,407 and
$953,529 during the years ended February 28, 2001, February 29, 2000 and
February 28, 1999, respectively.
The following summarizes information about the Company's stock options at
February 28, 2001:
Exercise Number Weighted Weighted Number Weighted
Prices Outstanding Average Average Exercisable Average
------ ----------- Contractual Exercise ----------- Exercise
Life Price Price
---- ----- -----
Options Outstanding Options Exercisable
------------------- -------------------
$ 0.00-$ 13.40 11,864,002 8.1 $ 2.39 9,360,292 $ 1.33
$ 13.40-$ 26.79 3,045,963 9.2 $ 20.65 7,148 $ 17.25
$ 26.79-$ 40.19 1,548,616 9.3 $ 27.86 36,520 $ 36.89
$ 40.19-$ 53.59 347,909 8.4 $ 42.84 94,267 $ 42.94
$ 53.59-$ 66.98 16,100 9.0 $ 55.75 0 $ 55.75
$ 66.98-$ 80.38 157,200 9.0 $ 73.44 39,298 $ 73.44
$ 80.38-$ 93.78 19,400 8.9 $ 92.50 4,850 $ 92.50
$ 93.78-$107.18 32,815 7.5 $ 101.79 9,677 $101.79
$107.18-$120.57 181,000 8.8 $ 108.50 47,749 $108.50
$120.57-$133.97 176,309 8.6 $ 133.97 45,383 $133.97
--------------------------------------------------------------------------
17,389,314 8.4 $ 12.08 9,645,184 $ 3.48
Stock Warrants
On October 10, 1995, the Company issued warrants, which are equivalent to
nonqualified stock options, to purchase 7,480,800 shares of common stock to
three of its employees with an exercise price of $0.0001 per share. The warrants
vested 25% annually on each May 1, beginning May 1, 1996 and ending May 1, 1999.
The warrants terminate upon death, permanent disability, termination of
employment or May 1, 2006. The Company and certain founding shareholders have a
right of first refusal to purchase the warrant shares on the same terms as a
proposed purchaser and a right to purchase the shares upon the death,
disability, or termination of employment of the employee. Upon the death,
disability, or termination without cause of the employee, the purchase price
shall be 80% of the fair market value of the Company's common stock as
determined by the Board of Directors. If the employee is terminated for cause,
the purchase price shall be 80% of the lesser of the book value or the fair
market value of the Company's common stock.
74
The activity for the stock warrants is presented in the following table:
Shares Weighted Shares Weighted Shares Weighted
Underlying Average Underlying Average Underlying Average
Warrants Exercise Warrants Exercise Warrants Exercise
-------- Price -------- Price -------- Price
Per Share Per Share Per Share
--------- --------- ---------
Year Ended February 28, 2001 Year Ended February 29, 2000 Year Ended February 28, 1999
---------------------------- ---------------------------- ----------------------------
Outstanding at beginning of year..... 3,614,900 $.0001 6,774,900 $.0001 7,480,800 $.0001
Exercised............................ (2,645,000) $.0001 (3,160,000) $.0001 (705,900) $.0001
Outstanding at end of year........... 969,900 $.0001 3,614,900 $.0001 6,774,900 $.0001
Exercisable at end of year........... 969,900 $.0001 3,614,900 $.0001 4,908,700 $.0001
SFAS 123 requires the Company to disclose pro forma information regarding
stock option grants and warrants issued to its employees. SFAS 123
specifies certain valuation techniques that produce estimated compensation
charges that are included in the pro forma results below. These amounts
have not been reflected in the Company's Consolidated Statement of
Operations, because APB 25 specifies that no compensation charge arises
when the exercise price of employees' stock options and warrants equal the
market value of the underlying stock at the grant date, as in the case of
options and warrants granted to the Company's employees. The fair value of
options and warrants was estimated using the following assumptions for the
years ended February 28, 2001, February 29, 2000 and February 28, 1999:
Year Ended Year Ended Year Ended
February 28, February 29, February 28,
----------- ----------- -----------
2001 2000 1999
---- ---- ----
Expected divided yield 0.00% 0.00% 0.00%
Risk-free interest rate 5.75% 5.85% 4.98%
Expected volatility 120.02% 129.96% 0.00%
Expected Life (in years) 5 5 6
Had the Company accounted for its stock option plan and stock warrants by
recording compensation expense based on the fair value at the grant date on
a straight-line basis over the vesting period, stock-based compensation
costs would have increased net loss available to common stockholders by
$89,712,040, $106,895,916 and $13,329,510 for the years ended February 28,
2001, February 29, 2000 and February 28, 1999, respectively. The pro forma
effect on basic and diluted earnings per common share would have been a
reduction of $0.54, $1.04 and $0.27 for the years ended February 28, 2001,
February 29, 2000 and February 28, 1999, respectively.
The weighted average estimated fair value of employee stock options granted
was $18.20, $10.31, and $0.41 per share during the years ended February 28,
2001, February 29, 2000 and February 28, 1999, respectively. The weighted
average estimated fair value of the warrants at the time of grant was
$0.0001 per share.
75
NOTE 15-Related-Party Transactions
At February 29, 2000, the Company held a $1,000,000 interest bearing promissory
note receivable with an officer of the Company. The promissory note was repaid
to the Company during fiscal 2001 upon termination of employment of the officer.
NOTE 16-Commitments and Contingencies
As of February 28, 2001, the Company leased office space and certain equipment
under various non-cancelable operating and capital leases. Future minimum lease
payments required under the operating and capital leases at February 28, 2001
are as follows:
Operating Capital
Leases Leases
------ ------
2002......................................................................... $ 3,159,795 $ 222,840
2003......................................................................... 3,109,948 204,708
2004......................................................................... 2,233,607 101,422
2005......................................................................... 611,431 145
2006......................................................................... 458,309
Thereafter................................................................... 1,685,264
Total minimum lease payments.............................................. $11,258,354 529,115
Less amount representing interest (at rates ranging from 8.2% to 9.6%)....... (57,882)
Present value of net minimum lease payments.................................. 471,233
Less current portion......................................................... (193,895)
Long-term portion......................................................... $ 277,338
Rent expense under operating leases was $3,731,568, $2,115,814 and $1,377,552
for the years ended February 28, 2001, February 29, 2000 and February 28, 1999,
respectively.
The Company is involved in certain legal proceedings as a part of its normal
course of business. Management does not believe that the ultimate resolution of
these matters will have a material impact on the Company's results of operations
or financial position in any quarterly or annual period.
NOTE 17-Employee Benefit Plans
401(k) Plan
The Company provides a retirement plan qualified under Section 401(k) of the
Internal Revenue Code ("IRC") of 1986, as amended. Participants may elect to
contribute a portion of their annual compensation to the plan, after complying
with certain limitations set by the IRC. Employees are eligible to participate
in the plan who are over 21 years of age and have completed three months of
service with Red Hat. If, however, an employee was employed by the Company prior
to February 1999, the 401(k) plan covers such employee regardless of age or
length of service. The Company has the option to make contributions to the plan
but did not make any contributions to the plan for the years ended February 28,
2001, February 29, 2000 and February 28, 1999.
76
Employee Stock Purchase Plan
In 1999, the Company's stockholders approved the 1999 Employee Stock Purchase
Plan (the "Plan"), under which 1,500,000 shares of the Company's common stock
could be sold to employees. All full-time U.S. and certain non-U.S. employees
are eligible to participate in the Plan. The Plan provides that participants may
authorize the Company to withhold up to 10% of their earnings, on a semi-annual
basis, to purchase shares of stock at a price equal to the lesser of 85% of the
fair value of the stock as of the first business day of the period or the last
business day of the period. The Plan will terminate at the earlier of the date
that all 1,500,000 shares have been sold or at June 2, 2009. During the years
ended February 28, 2001, February 29, 2000 and February 28, 1999, 36,714, 0 and
0 shares, respectively, of the Company's common stock were sold under the Plan.
NOTE 18-Subsequent Event (Unaudited)
Subsequent to the end of fiscal 2001, the Company and certain of its officers
and directors were named as defendants in a class action suit. The plaintiff
contends that the defendants violated federal securities laws by issuing a
Registration Statement and Prospectus that contained materially false and
misleading information and failed to disclose material information. The
Prospectus was issued in connection with the Company's initial public offering
in August 1999. The Company is reviewing the suit and believes that the
complaints are without merit and intends to vigorously defend itself and its
officers and directors.
NOTE 19-Unaudited Quarterly Results
Year Ended February 28, 2001
----------------------------
(in thousands, except per share data)
-------------------------------------
4/th/ 3/rd/ 2/nd/ 1/st/
---- ----- ----- -----
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Subscription revenue........................... $ 11,790 $ 13,250 $ 10,690 $ 9,769
Services revenue............................... 15,230 15,718 14,264 11,941
Gross profit on subscription and services
revenue........................................ 15,206 15,976 12,540 10,867
Hardware resale revenue (a).................... 0 228 100 449
Gross profit on hardware resale revenue........ 0 35 8 88
Loss from operations........................... (28,817) (30,229) (25,595) (22,839)
Net loss....................................... (24,220) (25,068) (20,006) (17,422)
Net loss per common share (b) (c):
Basic..................................... (0.14) (0.15) (0.12) (0.11)
Diluted................................... (0.14) (0.15) (0.12) (0.11)
Number of weighted average shares outstanding
(b):
Basic..................................... 168,156 167,144 163,976 159,464
Diluted................................... 168,156 167,144 163,976 159,464
77
Year Ended February 29, 2000
----------------------------
(in thousands, except per share data)
------------------------------------
4/th/ 3/rd/ 2/nd/ 1/st/
----- ----- ----- -----
Quarter Quarter Quarter Quarter
------- ------- ------ -------
Subscription revenue........................... $ 8,138 $ 6,735 $ 5,993 $ 4,402
Services revenue............................... 7,839 6,601 7,271 5,844
Gross profit on subscription and services 7,414 5,686 6,231 5,246
revenue........................................
Hardware resale revenue (a).................... 2,353 3,429 3,042 3,130
Gross profit on hardware resale revenue........ 237 426 235 384
Loss from operations........................... (26,922) (7,737) (7,823) (4,207)
Net loss....................................... (24,084) (6,468) (7,739) (4,136)
Net loss per common share (b) (c):
Basic..................................... (0.16) (0.05) (0.11) (0.08)
Diluted................................... (0.16) (0.05) (0.11) (0.08)
Number of weighted average shares outstanding
(b):
Basic..................................... 147,503 140,840 70,583 51,878
Diluted................................... 147,503 140,840 70,583 51,878
_________________
NOTE: The quarterly financial data for the quarters presented above has been
restated to reflect the acquisition of PTI, which was accounted for as a pooling
of interests.
(a) Hardware resale revenue represents PTI's resale of computer hardware,
software and peripherals. Beginning in fiscal year 2000, PTI discontinued
its practice of reselling hardware products.
(b) Earnings per common share are computed independently for each of the
quarters presented. Therefore, the sum of the quarterly per common share
information may not equal the annual earnings per common share.
(b) All share and per share information has been retroactively restated to
reflect the two-for-one splits of common stock (see NOTE 13).
78
(c) ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information under the Sections "Election of Directors," "Occupations of
Directors and Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" from the registrant's definitive proxy statement for the
annual meeting of stockholders to be held on August 2, 2001 (the "Proxy
Statement"), which is to be filed with the Securities and Exchange Commission
not later than 120 days after the close of the registrant's fiscal year ended
February 28, 2001, is hereby incorporated by reference.
Item 11. EXECUTIVE COMPENSATION
The information under the Sections "Compensation and Other Information
Concerning Directors and Officers" and "Stock Performance Graph" from the Proxy
Statement is hereby incorporated by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the Section "Securities Ownership of Certain Beneficial
Owners and Management" from the Proxy Statement is hereby incorporated by
reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the Sections "Compensation and Other Information
Concerning Directors and Officers" and "Certain Relationships and Related
Transactions" from the Proxy Statement is hereby incorporated by reference.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this Report under "Item
8-Financial Statements and Supplementary Data":
1. Financial Statements:
Report of Independent Accountants 48
Consolidated Balance Sheets at February 28, 2001 and February 29, 2000 49
Consolidated Statements of Operations for the years ended February 28, 2001,
February 29, 2000 and February 28, 1999 50
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
February 28, 2001, February 29, 2000 and February 28, 1999 51
Consolidated Statements of Cash Flows for the years ended February 28, 2001,
February 29, 2000 and February 28, 1999 52
79
Notes to Consolidated Financial Statements 53
2. Financial Statement Schedules:
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission
are not required under the related instructions or are
inapplicable and therefore have been omitted.
3. List of Exhibits:
Exhibit Description of Exhibit
----------------------
No.
---
2.1 Agreement and Plan of Merger by and among the registrant, HKS
Acquisition Corp., Hell's Kitchen Systems, Inc., and certain
shareholders of Hell's Kitchen Systems, Inc. dated as of January
4, 2000 (incorporated by reference from Exhibit 2.2 to the
registrant's Registration Statement on Form S-1 (File no. 333-
94775))
2.2 Stock Purchase Agreement, dated June 13, 2000, by and among Red
Hat, Inc., WireSpeed Communications Corporation and Andrew Bailey,
as Securityholder Agent (incorporated by reference from Exhibit
2.1 to the registrant's Current Report on Form 8K dated July 27,
2000)
2.3 Amendment to Stock Purchase Agreement, dated July 27, 2000, by and
among Red Hat, Inc., WireSpeed Communications Corporation and
Andrew Bailey, as Securityholder Agent (incorporated by reference
from registrant's Current Report on Form 8K dated August 11, 2000)
3.1 Third Amended and Restated Certificate of Incorporation, as
amended, of the registrant (incorporated by reference from Exhibit
3.1 to the registrant's Registration Statement on Form S-1 (File
no. 333-94775))
3.2 Amended and Restated By-laws, as amended, of the registrant
(incorporated by reference from Exhibit 3.2 to the registrant's
Registration Statement on Form S-1 (File no. 333-94775))
4.1 Specimen certificate representing the common stock (incorporated
by reference from Exhibit 4.1 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.1* Red Hat, Inc. 1998 Stock Option Plan, as amended (incorporated by
reference from Exhibit 10.1 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.2* Red Hat, Inc. 1999 Stock Option and Incentive Plan (incorporated
by reference from Exhibit 10.2 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.3* Red Hat, Inc. 1999 Employee Stock Purchase Plan (incorporated by
reference from Exhibit 10.3 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.4 First Amended and Restated Investor Rights Agreement by and among
the registrant and the Investors and Founders listed therein,
dated as of February 25, 1999, as amended (incorporated by
reference from Exhibit 10.7 to the registrant's Registration
Statement on Form S-1 (File no. 333-80051))
10.5* Non-Qualified Stock Option Agreement by and between the registrant
and Matthew Szulik (incorporated by reference from Exhibit 10.9 to
the registrant's Registration Statement on Form S-1 (File no.
333-80051))
80
10.6* Incentive Stock Option Agreement by and between the registrant and
Matthew Szulik (incorporated by reference from Exhibit 10.10 to
the registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.7* Non-Qualified Stock Option Agreement by and between the registrant
and Timothy Buckley (incorporated by reference from Exhibit 10.11
to the registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.8* Incentive Stock Option Agreement by and between the registrant and
Timothy Buckley (incorporated by reference from Exhibit 10.12 to
the registrant's Registration Statement on Form S-1 (File no.
333-80051))
10.9 GNU General Public License (incorporated by reference from Exhibit
10.13 to the registrant's Registration Statement on Form S-1 (File
no. 333-80051))
10.10** Escrow Agreement by and among the registrant and Lawrence Weidman,
as Shareholder Representative, dated January 6, 2000 (incorporated
by reference from Exhibit 99.3 to the registrant's Current Report
on Form 8-K dated January 6, 2000)
21.1 Subsidiaries of Red Hat, Inc.
23.2 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney (included on signature page of Annual Report)
* Indicates a management contract or compensatory plan, contract or
management.
** Confidential materials omitted and filed separately with the
Securities and Exchange Commission
(b) Reports on Form 8-K:
The registrant filed a Current Report on Form 8-K with the Securities
and Exchange Commission on March 5, 2001 to disclose the acquisition by
the registrant on February 26, 2001 of substantially all of the capital
stock of Planning Technologies, Inc., a Georgia corporation ("PTI"), by
means of a merger (the "PTI Merger") of Coke Acquisition Corp., a North
Carolina corporation and wholly owned subsidiary of Red Hat ("PTI
Merger Sub"), with and into PTI, pursuant to the Agreement and Plan of
Reorganization dated as of February 23, 2001 (the "PTI Merger
Agreement") by and among Red Hat, PTI Merger Sub, PTI and the majority
shareholders of PTI. As a result of the PTI Merger, PTI became a wholly
owned subsidiary of Red Hat and will continue to operate as a wholly-
owned subsidiary of Red Hat.
81
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
RED HAT, INC.
By: /s/ MATTHEW J. SZULIK
Matthew J. Szulik
President and Chief Executive Officer
Date: April 19, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ MATTHEW J.SZULIK Chief Executive Officer, President and Director (principal executive April 19, 2001
- --------------------
Matthew J. Szulik officer)
/s/ KEVIN B. THOMPSON Chief Financial Officer April 19, 2001
- ---------------------
Kevin B. Thompson (principal financial and accounting officer)
/s/ ROBERT F. YOUNG Director April 19, 2001
- -------------------
Robert F. Young
/s/ EUGENE MCDONALD Director April 19, 2001
- -------------------
Eugene McDonald
/s/ F. SELBY WELLMAN Director April 19, 2001
- --------------------
F. Selby Wellman
/s/ WILLIAM S. KAISER Director April 19, 2001
- ---------------------
William S. Kaiser
/s/ KEVIN HARVEY Director April 19, 2001
- ----------------
Kevin Harvey
/s/ ERIC HAHN Director April 19, 2001
- -------------
Eric Hahn