Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| (Mark One) |
|
|
| X |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| |
| |
|
For the quarter ended May 31, 2002 |
| |
| |
|
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)
06-1364380
(I.R.S. Employer Identification No.)
1801 Varsity Drive,
Raleigh, North Carolina 27606
(Address of principal executive offices, including Zip Code)
(919) 754-3700
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
As of May 31, 2002, there were 169,891,464 shares of common stock outstanding.
TABLE OF CONTENTS
| |
|
Page
|
| PART I—FINANCIAL INFORMATION: |
|
|
| |
| |
|
3 |
| |
| |
|
3 |
| |
| |
|
4 |
| |
| |
|
5 |
| |
| |
|
6 |
| |
| |
|
13 |
| |
| |
|
20 |
| |
| PART II—OTHER INFORMATION: |
|
|
| |
| |
|
20 |
| |
| |
|
21 |
2
PART I—FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(In thousands-except share amounts)
ASSETS
| |
|
May 31, 2002
(unaudited)
|
|
|
February 28, 2002
|
|
| Assets: |
|
|
|
|
|
|
|
|
| Cash and cash equivalents |
|
$ |
40,431 |
|
|
$ |
55,468 |
|
| Investments in debt securities |
|
|
62,079 |
|
|
|
40,928 |
|
| Accounts receivable, net |
|
|
15,336 |
|
|
|
12,919 |
|
| Costs and estimated earnings in excess of billings |
|
|
5,991 |
|
|
|
5,727 |
|
| Inventory |
|
|
1,201 |
|
|
|
885 |
|
| Prepaid expenses and other assets |
|
|
3,296 |
|
|
|
2,642 |
|
| |
|
|
|
|
|
|
|
|
| Total current assets |
|
|
128,334 |
|
|
|
118,569 |
|
| Property and equipment, net |
|
|
20,251 |
|
|
|
20,399 |
|
| Goodwill and intangibles, net |
|
|
36,242 |
|
|
|
35,459 |
|
| Investments in debt securities |
|
|
184,047 |
|
|
|
190,581 |
|
| Other assets, net |
|
|
4,737 |
|
|
|
4,857 |
|
| |
|
|
|
|
|
|
|
|
| Total assets |
|
$ |
373,611 |
|
|
$ |
369,865 |
|
| |
|
|
|
|
|
|
|
|
| |
| LIABILITIES AND STOCKHOLDERS’ EQUITY |
| Liabilities: |
|
|
|
|
|
|
|
|
| Accounts payable |
|
$ |
6,630 |
|
|
$ |
6,267 |
|
| Accrued expenses |
|
|
10,321 |
|
|
|
11,035 |
|
| Deferred revenue |
|
|
9,359 |
|
|
|
8,624 |
|
| Short term payable |
|
|
15,003 |
|
|
|
10,000 |
|
| Current portion of capital lease obligations |
|
|
822 |
|
|
|
1,049 |
|
| |
|
|
|
|
|
|
|
|
| Total current liabilities |
|
|
42,135 |
|
|
|
36,975 |
|
| Deferred lease credits |
|
|
4,223 |
|
|
|
3,778 |
|
| Capital lease obligations |
|
|
1,675 |
|
|
|
1,563 |
|
| Commitments and contingencies |
|
|
— |
|
|
|
— |
|
| Stockholders’ equity: |
|
|
|
|
|
|
|
|
| Noncontrolling interest in subsidiary |
|
|
82 |
|
|
|
74 |
|
| Preferred stock, 5,000,000 shares authorized, none outstanding |
|
|
— |
|
|
|
— |
|
| Common stock, $0.0001 par value, 300,000,000 shares authorized, 171,829,364 and 171,659,334 shares issued, and
169,891,464 and 169,721,434 shares outstanding at May 31, 2002 and February 28, 2002, respectively |
|
|
17 |
|
|
|
17 |
|
| Additional paid-in capital |
|
|
627,650 |
|
|
|
626,633 |
|
| Deferred compensation |
|
|
(5,506 |
) |
|
|
(5,984 |
) |
| Accumulated deficit |
|
|
(288,393 |
) |
|
|
(283,805 |
) |
| Treasury stock, 1,937,900 shares at cost |
|
|
(6,672 |
) |
|
|
(6,672 |
) |
| Accumulated other comprehensive income (loss) |
|
|
(1,600 |
) |
|
|
(2,714 |
) |
| |
|
|
|
|
|
|
|
|
| Total stockholders’ equity |
|
|
325,578 |
|
|
|
327,549 |
|
| |
|
|
|
|
|
|
|
|
| Total liabilities and stockholders’ equity |
|
$ |
373,611 |
|
|
$ |
369,865 |
|
| |
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these consolidated financial
statements.
3
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands—except per share amounts)
| |
|
Three Months Ended
|
|
| |
|
May 31, 2002
|
|
|
May 31, 2001
|
|
| |
|
(Unaudited) |
|
| Subscription and services revenue: |
|
|
|
|
|
|
|
|
| Subscription: |
|
|
|
|
|
|
|
|
| Enterprise |
|
$ |
9,615 |
|
|
$ |
9,747 |
|
| Embedded |
|
|
1,041 |
|
|
|
1,607 |
|
| |
|
|
|
|
|
|
|
|
| Total subscription revenue |
|
|
10,656 |
|
|
|
11,354 |
|
| |
|
|
|
|
|
|
|
|
| Services: |
|
|
|
|
|
|
|
|
| Enterprise |
|
|
7,817 |
|
|
|
5,435 |
|
| Embedded development |
|
|
1,049 |
|
|
|
4,572 |
|
| |
|
|
|
|
|
|
|
|
| Total services revenue |
|
|
8,866 |
|
|
|
10,007 |
|
| |
|
|
|
|
|
|
|
|
| Total subscription and services revenue |
|
|
19,522 |
|
|
|
21,361 |
|
| |
|
|
|
|
|
|
|
|
| Cost of subscription and services revenue: |
|
|
|
|
|
|
|
|
| Subscription: |
|
|
|
|
|
|
|
|
| Enterprise |
|
|
1,868 |
|
|
|
2,751 |
|
| Embedded |
|
|
121 |
|
|
|
374 |
|
| |
|
|
|
|
|
|
|
|
| Total cost of subscription revenue |
|
|
1,989 |
|
|
|
3,125 |
|
| |
|
|
|
|
|
|
|
|
| Services: |
|
|
|
|
|
|
|
|
| Enterprise |
|
|
4,119 |
|
|
|
2,995 |
|
| Embedded development |
|
|
1,161 |
|
|
|
2,424 |
|
| Stock-based enterprise (income) expense |
|
|
— |
|
|
|
(32 |
) |
| |
|
|
|
|
|
|
|
|
| Total cost of services revenue |
|
|
5,280 |
|
|
|
5,387 |
|
| |
|
|
|
|
|
|
|
|
| Total cost of subscription and services revenue |
|
|
7,269 |
|
|
|
8,512 |
|
| |
|
|
|
|
|
|
|
|
| Gross profit enterprise |
|
|
11,445 |
|
|
|
9,468 |
|
| Gross profit embedded |
|
|
808 |
|
|
|
3,381 |
|
| |
|
|
|
|
|
|
|
|
| Total gross profit |
|
|
12,253 |
|
|
|
12,849 |
|
| Operating expense: |
|
|
|
|
|
|
|
|
| Sales and marketing |
|
|
7,806 |
|
|
|
9,861 |
|
| Research and development |
|
|
4,787 |
|
|
|
4,297 |
|
| General and administrative |
|
|
3,375 |
|
|
|
3,293 |
|
| General and administrative—mergers and acquisitions |
|
|
522 |
|
|
|
3,491 |
|
| Lease buyout costs |
|
|
285 |
|
|
|
— |
|
| Stock-based sales and marketing expense |
|
|
128 |
|
|
|
1,091 |
|
| Stock-based research and development expense |
|
|
356 |
|
|
|
1,549 |
|
| Stock-based general and administrative expense |
|
|
451 |
|
|
|
1,068 |
|
| Amortization of goodwill |
|
|
— |
|
|
|
18,211 |
|
| Amortization of intangibles |
|
|
399 |
|
|
|
339 |
|
| Restructuring charges |
|
|
1,357 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
| Total operating expense |
|
|
19,466 |
|
|
|
43,200 |
|
| |
|
|
|
|
|
|
|
|
| Loss from operations |
|
|
(7,213 |
) |
|
|
(30,351 |
) |
| |
|
|
|
|
|
|
|
|
| Other income (expense), net |
|
|
2,886 |
|
|
|
4,480 |
|
| |
|
|
|
|
|
|
|
|
| Loss from continuing operations |
|
|
(4,327 |
) |
|
|
(25,871 |
) |
| Discontinued operations: |
|
|
|
|
|
|
|
|
| Loss from discontinued operations |
|
|
— |
|
|
|
(1,689 |
) |
| Extraordinary item—loss on disposal of discontinued operations |
|
|
(261 |
) |
|
|
— |
|
| |
|
|
|
|
|
|
|
|
| Net loss |
|
$ |
(4,588 |
) |
|
$ |
(27,560 |
) |
| |
|
|
|
|
|
|
|
|
| Earnings Per Share Data Basic and Diluted |
|
|
|
|
|
|
|
|
| Net income (loss) from continuing operations |
|
$ |
(0.03 |
) |
|
$ |
(0.15 |
) |
| Discontinued operations: |
|
|
|
|
|
|
|
|
| Loss from discontinued operations |
|
|
|
|
|
$ |
(0.01 |
) |
| Extraordinary item—loss on disposal of discontinued operations |
|
$ |
(0.00 |
) |
|
|
|
|
| |
|
|
|
|
|
|
|
|
| Net loss per common share |
|
$ |
(0.03 |
) |
|
$ |
(0.16 |
) |
| |
|
|
|
|
|
|
|
|
| Weighted average shares outstanding |
|
|
169,826 |
|
|
|
169,003 |
|
The accompanying notes are an integral part of these consolidated financial
statements.
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
| |
|
Three Months Ended
|
|
| |
|
May 31, 2002
|
|
|
May 31, 2001
|
|
| |
|
(Unaudited) |
|
| Cash flows from operating activities: |
|
|
|
|
|
|
|
|
| Net loss |
|
$ |
(4,588 |
) |
|
$ |
(27,560 |
) |
| Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
| Depreciation and amortization |
|
|
1,796 |
|
|
|
18,008 |
|
| Non-cash restructuring charges |
|
|
1,359 |
|
|
|
— |
|
| Write-down of investments |
|
|
— |
|
|
|
4,250 |
|
| Stock-based compensation expense |
|
|
935 |
|
|
|
3,514 |
|
| Noncontrolling interest in subsidiary |
|
|
8 |
|
|
|
38 |
|
| Non-cash interest expense |
|
|
27 |
|
|
|
— |
|
| Provision for doubtful accounts |
|
|
396 |
|
|
|
225 |
|
| Provision for inventory obsolescence |
|
|
27 |
|
|
|
— |
|
| Loss on sale/abandonment of property and equipment |
|
|
290 |
|
|
|
— |
|
| Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
| Accounts receivable |
|
|
(3,596 |
) |
|
|
7,545 |
|
| Inventory |
|
|
(344 |
) |
|
|
(618 |
) |
| Prepaid expenses |
|
|
(654 |
) |
|
|
(115 |
) |
| Intangibles and other assets |
|
|
128 |
|
|
|
(592 |
) |
| Accounts payable |
|
|
152 |
|
|
|
(5,772 |
) |
| Accrued expenses |
|
|
(2,463 |
) |
|
|
(1,657 |
) |
| Deferred revenue |
|
|
735 |
|
|
|
488 |
|
| Deferred lease credits |
|
|
445 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
| Net cash used in operating activities |
|
|
(5,347 |
) |
|
|
(2,246 |
) |
| |
|
|
|
|
|
|
|
|
| Cash flows from investing activities: |
|
|
|
|
|
|
|
|
| Purchase of investment securities |
|
|
(30,727 |
) |
|
|
(87,048 |
) |
| Proceeds from sales and maturities of investment securities |
|
|
16,889 |
|
|
|
82,565 |
|
| Acquisitions of businesses, net of cash acquired |
|
|
— |
|
|
|
(994 |
) |
| Purchase of property and equipment |
|
|
(1,459 |
) |
|
|
(2,626 |
) |
| |
|
|
|
|
|
|
|
|
| Net cash used in investing activities |
|
|
(15,297 |
) |
|
|
(8,103 |
) |
| |
|
|
|
|
|
|
|
|
| Cash flows from financing activities: |
|
|
|
|
|
|
|
|
| Proceeds from short term notes payable |
|
|
18,745 |
|
|
|
— |
|
| Repayments of short term notes payable |
|
|
(13,770 |
) |
|
|
(2,750 |
) |
| Proceeds from exercise of common stock options and warrants |
|
|
559 |
|
|
|
801 |
|
| Payments on capital lease obligations |
|
|
(263 |
) |
|
|
22 |
|
| |
|
|
|
|
|
|
|
|
| Net cash provided by (used in) financing activities |
|
|
5,271 |
|
|
|
(1,927 |
) |
| |
|
|
|
|
|
|
|
|
| Effect of foreign currency exchange rates on cash and cash equivalents |
|
|
336 |
|
|
|
(478 |
) |
| Net decrease in cash and cash equivalents |
|
|
(15,037 |
) |
|
|
(12,754 |
) |
| Cash and cash equivalents at beginning of the period |
|
|
55,468 |
|
|
|
85,213 |
|
| |
|
|
|
|
|
|
|
|
| Cash and cash equivalents at end of period |
|
$ |
40,431 |
|
|
$ |
72,459 |
|
| |
|
|
|
|
|
|
|
|
The accompanying notes are an
integral part of these consolidated financial statements.
5
Red Hat, Inc. together with its subsidiaries (“Red Hat” or the
“Company”) is the recognized global technology and brand leader in providing open source solutions to the large enterprise for its information technology infrastructure. Red Hat delivers a single open source operating platform from the
mainframe to the Intel server to the embedded device. The Company applies its technology leadership to create open source solutions that meet the functionality requirements and performance demands of the information technology infrastructure of the
large enterprise and those software applications or products that are critical to the large enterprise, such as the Oracle Database. In April 2002, the Company launched the first in what will be a series of Enterprise product offerings, Red Hat
Advanced Server, that reflects its commitment to providing an Enterprise class infrastructure platform based on open source technology. The Company has developed a complete set of engineering, consulting, and managed services offerings to enable the
large enterprise to capture the significant cost, performance and scalability benefits of its Enterprise platform, Red Hat Advanced Server.
Red Hat, Inc. is incorporated in Delaware. During January, 2002, the Company adopted a formal plan to discontinue its network consulting operations. Accordingly, the Consolidated Statement of Operations have been restated to present
the results of the network consulting operations separately from continuing operations (see NOTE 4).
NOTE 2—Summary of
Significant Accounting Policies
Unaudited Interim Financial Information
The interim consolidated financial statements as of and for the quarter ended May 31, 2002 have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. These consolidated statements are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring
adjustments and accruals) necessary to present fairly the consolidated balance sheets, consolidated operating results, and consolidated cash flows for the periods presented in accordance with generally accepted accounting principles. The
consolidated balance sheet at February 28, 2002 has been derived from the audited consolidated financial statements at that date. Operating results for the three month period ended May 31, 2002 are not necessarily indicative of the results that may
be expected for the year ending February 28, 2003. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been omitted in accordance
with the rules and regulations for interim reporting of the SEC. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended February 28, 2002.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. Entities which are not wholly-owned, but for which a controlling financial interest is
maintained by the Company, are consolidated. The non-controlling interest is presented as a separate component of stockholders’ equity. All significant intercompany accounts and transactions are eliminated in consolidation.
6
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.
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. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 requires that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation
of discontinued operations to include more disposal transactions. 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.
Revenue Recognition
The Company recognizes revenue in accordance with Statement of Position No. 97-2,
“Software Revenue Recognition” (“SOP
97-2”), as amended by SOP 98-4 and SOP 98-9, and SEC Staff Accounting Bulletin No. 101 (“SAB 101”).
Subscription Revenue
Subscription revenue is comprised of enterprise and embedded revenues.
Enterprise subscription revenue is comprised
primarily of revenue from sales of Red Hat Linux and related software solutions, software development tools, technical support and maintenance fees. Red Hat Linux was released in October 1994. The Company’s current release is Red Hat 7.3, which
was first shipped in May 2002. Red Hat sells Red Hat Linux software solutions through three channels: retail distributors, direct sales, and original equipment manufacturers (“OEMs”). Revenue recognition varies for each channel.
Through its retail distributors, Red Hat sells Red Hat Linux products to its enterprise customers. The product is offered in two
versions Standard and Professional. Each version has various levels of Red Hat support and software applications provided. During the three months ended May 31, 2002, Red Hat had sales of different versions of Red Hat Linux. Red Hat also provides
certain support and subscription services with Red Hat Linux for a period of time, not exceeding two months, from the date of registration of the software products for no additional fee. As the Company’s technologies are all open source and
freely available for download and use by others, its value proposition is in the ability to provide the customer certain subscription services (primarily on-line updates and management of these technologies) that enhance the value of the technology.
In accordance with the provisions of SOP 97-2, the Company recognizes all of the revenue from the sale of Red Hat Linux ratably over the period that the subscription services are provided. 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 return rate experienced by the Company over its last three product releases has
averaged 18.0%. The fee is fixed and determinable, collection of the resulting receivable is probable and product returns are reasonably estimable. Enterprise customers do not receive the right to future upgrades or new versions of technology.
7
Subscription relationships with large enterprise customers typically involve contracts with multiple
elements (i.e., delivered and undelivered products, maintenance and other services). The Company allocates revenue to each component of the contract based on objective evidence of its fair value, which is specific to the Company. The fair value of
each element is based on the price if sold separately. The Company recognizes revenue allocated to undelivered products when the criteria for product revenue set forth above have been met. Subscription revenue also includes revenue from large Unix
to Linux migration arrangements. Revenue from these arrangements has generally been recognized ratably over the term of the arrangement as no other pattern of performance is discernible nor has there been specific evidence of the fair value of the
elements of these arrangements.
Web-based software sales are recognized over the period beginning when shipped, as these customers
purchase on the Company’s website. Revenue from OEM arrangements is recognized over the subscription period beginning on the date the Company is notified sales have been made.
In addition, enterprise subscription revenue is partially derived from sales of Stronghold and Red Hat Network. Stronghold is a secure enterprise-ready web server based on Apache and OpenSSL.
Stronghold is available to complement Red Hat Linux Advanced Server as well as other operating systems. Red Hat Network is an internet-based service designed to assure the security, availability and reliability of Red Hat Linux, Stronghold,
Database, E-Commerce and other Red Hat software. Stronghold is the only software for which there is vendor specific evidence of fair value. The Company recognizes revenue separately related to the delivered software and the support subscription
agreement. The Company is able to estimate the value of Stronghold as the initial copy of the software is purchased with a support subscription and any additional support subscriptions are purchased separately. Red Hat Network is sold in the form of
a monthly subscription and revenue is recognized ratably over the subscription period.
Embedded subscription consists of revenue for
technical support and maintenance services provided pursuant to software compiling, debugging, and optimization agreements. Revenue is deferred and recognized ratably over the term of the agreement, which is typically twelve months.
Services Revenue
Services
revenue is comprised of embedded development and enterprise services.
Embedded development services are contracts for software
compiling, debugging, and optimization. Revenue is recognized on the percentage-of-completion method, provided that the Company has the ability to make reliable estimates of progress towards completion, the fee for such services is fixed and
determinable and collection of the resulting receivable is probable. Interchange is an e-business software solution for business to business and business to customer commerce.
Enterprise services are comprised of revenue for open source consulting and engineering services and customer training and education. Open source consulting services are agreements where customers are
paying the Company on a fixed fee or hourly basis to assist in the deployment of open source technologies. The Company recognizes revenue related to enterprise services on a percentage of completion or time and materials basis, as applicable. Custom
development arrangements generally have a term of three to six months. Payments for technical support and maintenance services are generally made in advance and are non-refundable. 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. Revenue from customer training and education is recognized at the
date the services are performed.
8
Net Loss Per Share
The Company computes net loss per 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 share (“Basic EPS”) is computed by dividing net loss by the weighted average number of common shares outstanding. Diluted net loss per share
(“Diluted EPS”) is computed by dividing net loss by the weighted average number of common shares outstanding and dilutive potential common share equivalents. Potential common shares consist of shares issuable upon the exercise of stock
options. The calculation of net loss per share does not include 9,037,395 and 7,434,777 potential shares of common stock equivalents for the three month periods ended May 31, 2002 and 2001, respectively, as their impact would be antidilutive.
Segment Reporting
Management identifies the Company’s operating segments primarily based on differences in the nature of its products and services and on geographic location. The Company’s operating segments are enterprise and embedded.
These segments reflect the Company’s change in focus to two primary areas, UNIX to Linux migration opportunities in large enterprises and delivering complete solutions for the embedded system market. All previous periods have been revised to
reflect this change. Performance of these segments is evaluated based on their respective gross margins as disclosed in the Company’s Consolidated Statements 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.
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 three month periods
ended May 31, 2002 and 2001, respectively.
(In thousands)
| |
|
North America
|
|
|
Europe
|
|
|
Asia Pacific and Japan
|
|
Total
|
|
| |
| |
|
Three Months Ended May 31, 2002 |
|
| Revenues from unaffiliated customers |
|
$ |
13,949 |
|
|
$ |
3,292 |
|
|
$ |
2,281 |
|
$ |
19,522 |
|
| Net loss |
|
$ |
(6,587 |
) |
|
$ |
1,555 |
|
|
$ |
705 |
|
$ |
(4,327 |
) |
| Total assets |
|
$ |
359,219 |
|
|
$ |
9,959 |
|
|
$ |
4,433 |
|
$ |
373,611 |
|
| |
| |
|
Three Months Ended May 31, 2001 |
|
| Revenues from unaffiliated customers |
|
$ |
15,708 |
|
|
$ |
3,106 |
|
|
$ |
2,547 |
|
$ |
21,361 |
|
| Net loss |
|
$ |
(26,847 |
) |
|
$ |
(803 |
) |
|
$ |
90 |
|
$ |
(27,560 |
) |
| Total assets |
|
$ |
460,093 |
|
|
$ |
7,238 |
|
|
$ |
3,788 |
|
$ |
471,119 |
|
9
General and Administrative—Mergers and Acquisition Expense
General and administrative—mergers and acquisition expense primarily consists of severance and related expenses incurred in connection with redundancies identified pursuant to mergers and
acquisitions completed by the Company, as well as the compensation and related costs of employees who are dedicated to seeking out and identifying potential acquisition candidates. In addition to this, general and administrative—mergers and
acquisition expense includes in the first quarter of fiscal 2002 legal costs incurred related to acquisitions accounted for under the pooling of interests method of accounting.
Comprehensive Income
The Company’s items of accumulated other
comprehensive income (loss) during the three months ended May 31, 2002 totaled $1.1 million and are comprised of an unrealized gain on investments in marketable debt securities of $778,000 and a foreign currency translation adjustment of $336,000.
The Company’s items of other comprehensive income (loss) during the three months ended May 31, 2001 totaled ($301,000) and are comprised of an unrealized gain on investments in marketable debt securities of $177,000 and a foreign currency
translation adjustment of ($478,000).
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141, “Business
Combinations” (“SFAS 141”), and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). These standards become effective for fiscal years beginning after December
15, 2001. Beginning in the first quarter of fiscal 2003, goodwill was no longer amortized but will be subject to annual impairment tests. All other intangible assets continue to be amortized over their estimated useful lives. The new rules also
require business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting and goodwill acquired after June 30, 2001 will not be amortized. Goodwill existing at June 30, 2001, has been amortized through
the end of the Company’s fiscal 2002. Through the end of fiscal 2002, the Company tested goodwill for impairment using the current method, which uses an undiscounted cash flow test. During fiscal 2003, the Company will begin to test goodwill
for impairment under the new rules, applying a fair-value-based test.
NOTE 3—Supplemental Reconciliation of Change in Total Cash
and Investments in Debt Securities
| |
|
Three Months Ended
|
|
| |
|
May 31, 2002
|
|
|
May 31, 2001
|
|
| |
|
(Unaudited) |
|
| Net cash used in operating activities |
|
$ |
(5,347 |
) |
|
$ |
(2,246 |
) |
| Net cash used in investing activities excluding purchases and sales of investments in marketable debt
securities |
|
|
(1,459 |
) |
|
|
(3,620 |
) |
| Net cash provided by (used in) financing activities |
|
|
5,271 |
|
|
|
(1,927 |
) |
| Unrealized gain (loss) on investments in marketable debt securities |
|
|
779 |
|
|
|
177 |
|
| Effect of foreign currency exchange rates on cash and cash equivalents |
|
|
336 |
|
|
|
(478 |
) |
| |
|
|
|
|
|
|
|
|
| Net decrease in cash and investments in marketable debt securities |
|
|
(420 |
) |
|
|
(8,094 |
) |
| Cash and investments in marketable debt securities at beginning of period |
|
|
286,977 |
|
|
|
302,681 |
|
| |
|
|
|
|
|
|
|
|
| Cash and investments in marketable debt securities at end of period |
|
$ |
286,557 |
|
|
$ |
294,587 |
|
| |
|
|
|
|
|
|
|
|
10
NOTE 4—Discontinued Operations
During January 2002, the Company adopted a formal plan to discontinue its network consulting operations. Accordingly, the network consulting operations were accounted for as a discontinued
operation beginning with the fiscal year 2000 consolidated financial statements. The Company completed the disposal of the network consulting operations in February 2002 through termination of associated employees. Loss on disposal of discontinued
operations of $10.3 million in fiscal year 2002 included the write-off of goodwill recorded in the acquisition of ENS of $9.6 million, severance and related costs of $0.4 million, and a provision against accounts receivable of $0.3 million. An
additional provision against accounts receivable of $261,000 was recorded during the three months ended May 31, 2002. Network consulting revenues were $4.2 million during the three months ended May 31, 2001. The net assets of the network consulting
operations included in the accompanying Consolidated Balance Sheets as of May 31, 2002 were primarily comprised of $593,000 of accounts receivable.
NOTE 5—Restructuring Charges
In the three months ended May 31, 2002, the Company recorded restructuring
charges of $1.4 million. This restructuring charge was primarily due to a sharpening of the Company’s focus on UNIX to Linux migration opportunities in large enterprises. As a result, the Company terminated 60 employees. Restructuring charges
consist of various facility closings, and $1.1 million in severance and related expenses.
With the exception of continued lease payments
for certain of the closed facilities and severance to be paid to certain individuals winding down restructured elements of the business, all restructuring actions were substantially completed during the three months ended May 31, 2002.
Details of the restructuring charge are as follows (in thousands):
| |
|
Restructuring Reserve at February 28, 2002
|
|
2003 Restructuring Charges
|
|
2003 Cash Payments
|
|
Restructuring Reserve at May
31, 2002
|
| Employee severance and termination benefits |
|
$ |
1,623 |
|
$ |
1,129 |
|
$ |
1,076 |
|
$ |
1,676 |
| Facility exit costs |
|
|
123 |
|
|
228 |
|
|
227 |
|
|
124 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Total |
|
$ |
1,746 |
|
$ |
1,357 |
|
$ |
1,303 |
|
$ |
1,800 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
11
NOTE 6—Legal Proceedings
Planning Technologies, Inc. (“PTI”), a wholly-owned subsidiary of the Company acquired in February, 2001, along with its former directors and some of its former principal shareholders is a
defendant in a suit brought by a former employee. The plaintiff asserts, among other things, breach of various employment agreements. PTI has filed an answer, affirmative defenses and counterclaims denying all liability and has filed a motion to
dismiss which remains pending. All discovery in the matter is complete. The Company has been indemnified in this matter by the former PTI shareholders and further believes that that likelihood of a material loss is remote.
Commencing on or about March 29, 2001, the Company and certain of its officers and directors were named as defendants in a series of purported class action suits
arising out of the Company’s initial public offering and secondary offering. On August 8, 2001, Chief Judge Mukasey of the federal district court for the Southern District of New York issued an order that transferred all of the so-called IPO
allocation actions, including the complaints involving the Company, to one judge for coordinated pre-trial proceedings. The court has consolidated the actions by issuer, and the Red Hat actions have been consolidated into a single action. The
plaintiffs contend that the defendants violated federal securities laws by issuing Registration Statements and Prospectuses that contained materially false and misleading information and failed to disclose material information. Plaintiffs also
challenge certain IPO allocation practices by underwriters and the lack of disclosure thereof in initial public offering documents. No discovery has occurred to date, and no dispositive motions have been filed. On April 19, 2002, plaintiffs filed
amended complaints in each of the 310 consolidated actions, including the Red Hat action. The relief sought consists of unspecified damages. The Company believes these complaints are without merit and will defend itself vigorously in this matter. No
assurance can be given, however, that this matter will be resolved in the Company’s favor.
This Company is a defendant in a
trademark litigation case related to the use of certain fonts in its software products. At the time of this filing, no claim amount has been made by the plaintiff in this case. The Company intends to vigorously defend itself in this matter. The
outcome of this matter cannot currently be determined, however, it is not expected that it will materially impact the Company’s financial position.
12
ITEM 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve known and unknown risks and uncertainties, including statements regarding Red Hat’s
strategy, financial performance, and revenue sources. These risks and uncertainties may cause Red Hat’s actual results to differ materially from any 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 (the “SEC”), 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. Red Hat Network, our unique management technology, helps companies efficiently manage their networks and systems by delivering open source products, services, support
and information on-line, in real-time. Open source software is an alternative to proprietary software. There are no licensing fees associated with open source software. Therefore, we do not recognize any separate distinguishable value from the sale
of the code itself. We derive the value from the sale of our open source solutions by the value we add through the integration and testing of open source technology and by the managed services we provide for our technologies through the Red Hat
Network. We recognize our technology based revenue over the period of the technology subscription relationships with our customers.
Critical Accounting Policies
Our critical accounting policies include the following:
| |
• |
|
Revenue recognition; and |
| |
• |
|
Impairment of long-lived assets |
Revenue Recognition
We recognize revenue in accordance with Statement of Position No. 97-2, “Software
Revenue Recognition” (“SOP 97-2”), as amended by SOP 98-4 and SOP 98-9, and SEC Staff Accounting Bulletin No. 101 (“SAB 101”). Revenue recognition in accordance with these pronouncements can be complex due to the nature and
variability of our sales transactions.
Subscription Revenue
Subscription revenue is comprised of enterprise and embedded revenues.
Enterprise
subscription revenue is comprised primarily of revenue from sales of Red Hat Linux and related software solutions, software development tools, technical support and maintenance fees. Official Red Hat Linux was released in October 1994. Our current
release is Red Hat 7.3, which was first shipped in May 2002. We sell Red Hat Linux software solutions through three channels: retail distributors, direct sales, and original equipment manufacturers (“OEMs”). Revenue recognition periods
vary for each channel based on the end purchaser’s subscription period with Red Hat.
13
Through our retail distributors, we sell Red Hat Linux products to enterprise customers. The product is
currently offered in two versions: standard and professional. Various levels of Red Hat support and software applications are provided with each version. During the three months ended May 31, 2002, we sold two different releases of Red Hat Linux
(7.2 and 7.3). We also provide certain support and subscription services with Red Hat Linux for a period of time, not exceeding two months, from the date of registration of the software products for no additional fee. As our technologies are all
open source and freely available for download and use by others, a part of our value proposition is in the ability to provide the customer certain subscription services (primarily on-line updates and management of these technologies) that enhance
the value of the technology. In accordance with the provisions of SOP 97-2, we recognize all of the revenue from the sale of Red Hat Linux ratably over the period that the subscription services are provided. 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 return rate experienced by the Company over its last three
product releases has averaged 18.0%. The fee is fixed and determinable, collection of the resulting receivable is probable and product returns are reasonably estimable. Our enterprise customers do not receive the right to future upgrades or new
versions of our technology.
Our subscription relationships with large enterprise customers typically have contracts with multiple
elements (i.e., delivered and undelivered products, maintenance and other services). We allocate revenue to each component of the contract based on objective evidence of its fair value, which is specific to us. The fair value of each element is
based on the price if sold separately. Subscription revenue also includes revenue from several large Unix to Linux migration arrangements. Revenue from these arrangements has generally been recognized ratably over the term of the arrangement as no
other pattern of performance has been discernible nor has there been specific evidence of the fair value of the elements of these arrangements. With the release of Red Hat Advanced Server in May 2002, we believe that we will begin to have specific
evidence of the fair value of the elements of these larger enterprise arrangements.
Web-based software sales are recognized over the
subscription period beginning when shipped, as these customers purchase on the Company’s website. Revenue from our OEM arrangements are recognized over the subscription period beginning on the date we are notified that sales have been made.
In addition, our enterprise subscription revenue is partially derived from sales of Stronghold and Red Hat Network. Stronghold is a
secure enterprise-ready web server based on Apache and OpenSSL. Stronghold is available to complement Red Hat Linux Advanced Server as well as other operating systems. Red Hat Network is an internet-based service designed to assure the security,
availability and reliability of Red Hat Linux, Stronghold, Database, E-Commerce and other Red Hat software solutions. Stronghold is the only software for which there is vendor specific evidence of fair value. Revenue from delivered software is
recognized separately from revenue associated with the support subscription agreement. We are able to estimate the value of Stronghold as the initial copy of the software is purchased with a support subscription and any additional support
subscriptions are purchased separately. Red Hat Network is sold in the form of a monthly subscription and revenue is recognized ratably over the subscription period.
Embedded subscription consists of revenue for technical support and maintenance services provided pursuant to software compiling, debugging, and optimization agreements. Revenue is deferred and
recognized ratably over the term of the agreement, which is typically 12 months.
Services Revenue
Services revenue is comprised of embedded development and enterprise services.
Embedded development services are contracts for compiling, debugging, and optimization of various open source software technologies. Revenue is recognized on the percentage-of-completion method,
provided that we have the ability to make reliable estimates of progress towards completion, the fee for such services is fixed and determinable and collection of the resulting receivable is probable.
14
Enterprise services are comprised of revenue for open source consulting and engineering services and
customer training and education. Open source consulting services are agreements where customers are paying the Company on a fixed fee or hourly basis to assist in the deployment of open source technologies. The Company recognizes revenue related to
enterprise services on a percentage of completion or time and materials basis, as applicable. Custom development arrangements generally have a term of three to six months. Payments for technical support and maintenance services are generally made in
advance and are non-refundable. 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. Revenue from customer training and education is recognized at the date the services are performed.
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. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 requires that one accounting model be used for
long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operations to include more disposal transactions. 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.
RESULTS OF OPERATIONS
Three Months Ended May 31, 2002 and May 31, 2001
Total revenue
Total revenue decreased 8.6% to $19.5 million for the three months ended May 31, 2002 from $21.4 million in the three months ended
May 31, 2001. This decrease is primarily attributable to the decrease in embedded revenue of 66.2% to $2.1 million in the three months ended May 31, 2002 from $6.2 million in the three months ended May 31, 2001, partially offset by an increase in
subscription revenue of 14.8% to $17.4 million in the three months ended May 31, 2002 from $15.2 million in the three months ended May 31, 2001 resulting from the strong market for Red Hat product offerings in the enterprise market. Revenue from
international operations totaled $5.6 million and $5.7 million during the three months ended May 31, 2002 and May 31, 2001, respectively.
Subscription revenue
Subscription revenue is comprised of revenue from enterprise and embedded customers.
Enterprise revenue primarily relates to sales of subscriptions to Red Hat Linux and related software solutions. Enterprise subscription revenue decreased slightly to $9.6 million for the three months ended May 31, 2002 from $9.7 million for the
three months ended May 31, 2001. This small decline represents a reduction in web advertising revenue of $636,000 to $81,000 in the three months ended May 31, 2002 from $717,000 in the three months ended May 31, 2001, offset by an increase in
enterprise subscription revenue of $504,000 primarily attributable to a continued sharpening of our efforts to focus on large enterprise customers. This decline also reflects the restructuring of our embedded business which was completed in the
first quarter of fiscal 2003. We expect that enterprise subscription revenue will be positively impacted in future periods by our introduction of new managed services products such as Advanced Server and Red Hat Network.
15
Embedded subscription revenue decreased 35.2% to $1.0 million for the three months ended May 31, 2002 from $1.6 million for the three months
ended May 31, 2001. The decrease in embedded subscription revenue is primarily due to the continued weak performance of the semiconductor and telecommunications industries which has impacted research and development spending.
Services revenue
Services
revenue is comprised of enterprise services and embedded development services. Enterprise services includes fees received from enterprise customers for deployment, management and support of Red Hat solutions, and customer training and education
fees. Enterprise services revenue increased 43.8% to $7.8 million in the three months ended May 31, 2002 from $5.4 million in the three months ended May 31, 2001. The increase in enterprise services revenue is primarily due to revenues earned from
relationships with companies included in the Global 2000 index (the “Global 2000”) as a result of the increasing level of interest and adoption by large enterprises of Red Hat Linux as an enterprise computing platform. Customer training
and education services revenue also increased 13.4% to $4.3 million in the three months ended May 31, 2002 from $3.7 million in the three months ended May 31, 2001. The increase is the direct result of the migration of larger enterprises to the Red
Hat platform, increasing the need to train system administrators and developers.
Embedded services revenue decreased 77.1% to $1.0
million in the three months ended May 31, 2002 from $4.6 million in the three months ended May 31, 2001. This decrease is primarily due to the continued weak performance of the semiconductor and telecommunications industries which has impacted
research and development spending and the impact of our restructuring of the embedded business which was completed in the first quarter of fiscal 2003.
Cost of revenue
Cost of subscription revenue
Cost of enterprise subscription revenue primarily consists of expenses we incur to manufacture, package, distribute and support our solutions. These costs include expenses for physical
media, literature and packaging, fulfillment and shipping, labor related costs to provide technical support and maintenance and bandwidth costs for Red Hat Network. Cost of subscription revenue decreased 36.4% to $2.0 million in the three months
ended May 31, 2002 from $3.1 million in the three months ended May 31, 2001. This decrease was directly related to a reduction in expenses incurred for physical media, literature, packaging and fulfillment, as well as efficiencies gained in
providing technical support and maintenance of our products on-line, global consolidation of our support and maintenance function and benefits of Red Hat Network in reducing support costs of Red Hat Linux based systems.
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, open source consulting 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 decreased 2.0% to $5.3 million in the three months ended May 31, 2002 from $5.4
million in the three months ended May 31, 2001. This decrease was primarily due to the reduction in number of personnel dedicated to providing custom development services to semiconductor companies and device manufacturers.
16
Gross Profit
Gross
profit decreased 4.6% to $12.3 million in the three months ended May 31, 2002 from $12.8 million in the three months ended May 31, 2001. As a percentage of revenue, gross profit increased 2.6% to 62.8% for the three months ended May 31, 2002 from
60.2% for the three months ended May 31, 2001. The increase in gross profit as a percentage of revenue was primarily the result of our focus on operational efficiency, continuing to migrate the services we provide with our technology to be
technology-based services not people-based services, and in selling more strategic, higher margin subscription solutions to large enterprise customers.
Operating expenses
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 decreased 27.6% to $7.9 million in the three months ended May 31, 2002 from $11.0 million in the three months ended May 31, 2001. This decrease was due
primarily to reduction in redundant sales and marketing personnel and other variable costs. These personnel came from acquisitions completed in late fiscal 2001. This decrease was partially offset by an increase in large enterprise sales costs as we
began to increase the size of our direct outside sales force which sells to companies in the Global 2000 in the fourth quarter of fiscal 2002.
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 decreased 12.0% to $5.1 million in the three months ended May 31, 2002 from $5.8 million in
the three months ended May 31, 2001. The decrease in research and development expense resulted from a decrease in stock based compensation charges of $1.2 million to $356,000 in the three months ended May 31, 2002 from $1.5 million in the three
months ended May 31, 2001, partially offset by increased spending related to the development of our first enterprise-class operating platform, Red Hat Advanced Server, costs incurred to complete the aggregation, development and testing of Version
7.3 of Red Hat Linux, and an increase in spending related to the development of software development tools for the enterprise.
General and administrative
General and administrative expense consists primarily of 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. Mergers and acquisition expense primarily
consists of severance and related expenses incurred in connection with redundancies identified pursuant to mergers and acquisitions completed by the Company. In addition, mergers and acquisition expense in the first quarter of the prior year
includes legal costs incurred related to acquisitions accounted for under the pooling of interests method of accounting. General and administrative expense decreased 44.6% to $4.3 million in the three months ended May 31, 2002 from $7.9 million in
the three months ended May 31, 2001. This decrease resulted from:
| |
• |
|
a significant decrease in merger and acquisition activity in the three months ended May 31, 2002 resulting in a decrease in merger and acquisition expenses to
$522,000 in the three months ended May 31, 2002 from $3.5 million in the three months ended May 31, 2001; and |
17
| |
• |
|
a decrease in stock-based compensation expense primarily due to reductions in deferred compensation to record the termination of employees prior to the complete
vesting of stock options for which deferred compensation was originally recorded, as well as reductions to record the termination of employees prior to satisfaction of employment requirements pursuant to certain acquisitions.
|
Amortization of goodwill and intangibles
Amortization of goodwill and intangibles expense consists of the amortization of goodwill and other intangible assets. Pursuant to the adoption of SFAS 141 in the first quarter of fiscal 2003,
goodwill, which represents the excess of acquisition cost over the net assets acquired in business combinations, is no longer being amortized as of March 1, 2002, but is subject to annual impairment tests. 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 decreased to $399,000 in the three months
ended May 31, 2002 from $18.6 million ($339,000 excluding goodwill amortization) in the three months ended May 31, 2001. This decrease was primarily due to the adoption of SFAS 141 in the first quarter of fiscal 2003, which, as noted above,
precludes the amortization of goodwill as of March 1, 2002. We are required to complete step one of the transitional impairment test for goodwill pursuant to SFAS 142 by the end of the second quarter of fiscal 2003. Under the transitional impairment
test, we will allocate the net book value of all goodwill to identified reporting units and determine the fair value of those reporting units. If the book value of those reporting units exceeds its fair value, we will then be required to complete
step two of the transitional test by the end of fiscal 2003 to determine the amount of goodwill impairment to be recorded. We are in the process of completing the transitional test and have not yet determined the outcome. Completion of the tests may
result in an impairment that may be material to our fiscal 2003 financial statements.
Restructuring Charges
Restructuring charges consist of various facility closings, and $1.1 million in severance and related expenses. These restructuring charges were
primarily due to a sharpening of the Company’s focus on UNIX to Linux migration opportunities in significant enterprises. As a result, the Company terminated 60 employees. In the fourth quarter of fiscal 2002, we completed the re-allocation of
our resources to focus on customers included in the Global 2000, which resulted in discontinuing our network consulting business.
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, decreased to $2.9 million in the three months ended May 31, 2002 from
$4.5 million in the three months ended May 31, 2001. The decrease resulted from reductions in short-term interest rates due to the actions taken by the Federal Reserve Board and lower average cash and investment balances in the three months ended
May 31, 2002 as compared to the three months ended May 31, 2001 due primarily to the use of cash to partially fund operations and to pay merger and acquisition and restructuring costs.
18
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 borrowings under our working capital line of credit. At May 31, 2002, we had total cash and investments of $286.5 million, which is comprised of $40.4 million in cash and cash equivalents, $62.1
million of short-term, fixed-income investments and $184.0 million of long-term, fixed-income investments.
At May 31, 2002, cash and
cash equivalents totaled $40.4 million, a decrease of $15.0 million as compared to February 28, 2002. The decrease in cash and cash equivalents resulted primarily from the purchase of long- and short-term fixed-income investments of $30.7 million,
offset by sales and maturities of long- and short-term fixed-income investments of $16.9 million, cash used in operations of $5.3 million, and $1.5 million used to purchase equipment. These uses of cash were offset by $5.0 million in net borrowings
under our working capital line of credit.
Cash used in operations of $5.3 million in the three months ended May 31, 2002, include the
net loss of $4.3 million, adjusted to exclude the impact of non-cash revenues and expenses, which totaled $4.8 million. Changes in working capital items were a net use of cash of $5.9 million and include increases in accounts receivable ($3.6
million), prepaid expenses ($0.7 million) and inventory ($0.3 million) and a decrease in accrued expenses ($2.7 million). These were offset by increases in deferred revenue ($0.7 million) and deferred lease credits ($0.4 million). Our accounts
receivable increased during the quarter ended May 31, 200 due to the shipment of our Red Hat Linux 7.3 product just prior to the end of the quarter. At time of shipment, we recognize a receivable from our distributors. Our days sales outstanding
decreased from approximately 89 days during the quarter ended May 31, 2001 to approximately 72 days during the quarter ended May 31, 2002. The increase in inventory resulted from the build-up of our Red Hat Linux 7.3 product, which was released for
sale in May 2002. We expect cash flow from operations to improve significantly during the quarter ending August 31, 2002.
Cash used in
operations includes $2.4 million of costs related to merger and acquisition activities and cash paid for restructuring charges that were expensed in prior periods. Excluding these costs, our cash flows from recurring operations used $2.9 million of
cash during the three months ended May 31, 2002. Cash flows from recurring operations is a non-GAAP measure and excludes cash payments made in connection with restructuring activities and costs incurred related to completed acquisitions. Non-GAAP
information is not prepared in accordance with GAAP and is not intended to be superior to GAAP information.
Cash used in investing
activities of $15.3 million for the three months ended May 31, 2002 was comprised of the purchase of fixed-income investments, net of sales and maturities, of $13.8 million and purchases of property and equipment totaling $1.5 million.
Cash provided by financing activities of $5.3 million for the three months ended May 31, 2002 was primarily comprised of $5.0 million in net
borrowings under our working capital line of credit. The $5.0 million of net borrowings is comprised of $18.7 million in proceeds from borrowings, net of $13.7 million in repayments of notes payable.
In August 2001, we entered into a $10.0 million line of credit, referred to previously as the working capital line of credit, with a financial institution. This
line of credit is secured by certain of our fixed-income investments. The line bears interest at monthly LIBOR plus 1%. This line is available to the Company for up to 12 months and is to be used to provide additional working capital liquidity. On
May 15, 2002, we increased the working capital line of credit to $15.0 million, all of which was outstanding at May 31, 2002. We intend to renew this working capital line of credit upon maturity.
19
Factors Affecting Future Results
There are numerous factors that affect the Company’s future results. For a discussion of these and other factors affecting the Company’s business, see
“Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors Affecting Future Results” in the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2002.
ITEM 3: 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.
Red Hat did not hold derivative financial instruments as of May 31, 2002, and has not held
such investments in the past.
Foreign Currency Risk
Approximately 29% of the Company’s revenues for the three months ended May 31, 2002 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 is 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.
PART II—OTHER INFORMATION
ITEM 5: OTHER INFORMATION
On September 17, 2001, the Board of Directors authorized a stock
repurchase program covering up to the lesser of 10% of Red Hat’s outstanding common shares or $10.0 million. The timing and amount of shares actually repurchased during the 12 month duration of the program will be determined by
management’s discretion and will depend on market conditions. The Company has purchased a total of 1,937,900 shares of its common stock at a total cost of $6.7 million under this program. No shares were purchased during the three months ended
May 31, 2002.
20
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: July 12, 2002
| RED HAT, INc. |
| |
| By: |
|
/S/ MATTHEW J.
SZULIK
|
| |
|
Matthew J. Szulik President and Chief Executive Officer
(Officer on behalf of the Registrant) |
| |
| By: |
|
/S/ KEVIN B.
THOMPSON
|
| |
|
Kevin B. Thompson Chief Financial Officer (Principal Financial Officer) |
21