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<SEC-DOCUMENT>/in/edgar/work/0001095811-00-004100/0001095811-00-004100.txt : 20001027
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ACCESSION NUMBER: 0001095811-00-004100
CONFORMED SUBMISSION TYPE: 10-K405
PUBLIC DOCUMENT COUNT: 5
CONFORMED PERIOD OF REPORT: 20000728
FILED AS OF DATE: 20001026
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: VA LINUX SYSTEMS INC
CENTRAL INDEX KEY: 0001096199
STANDARD INDUSTRIAL CLASSIFICATION: [3571
] IRS NUMBER: 770399299
STATE OF INCORPORATION: DE
FISCAL YEAR END: 0731
</COMPANY-DATA>
FILING VALUES:
FORM TYPE: 10-K405
SEC ACT:
SEC FILE NUMBER: 000-28369
FILM NUMBER: 746566
</FILING-VALUES>
BUSINESS ADDRESS:
STREET 1: 1382 BORDEAUX DR
CITY: SUNNYVALE
STATE: CA
ZIP: 94089
BUSINESS PHONE: 4085428000
</BUSINESS-ADDRESS>
MAIL ADDRESS:
STREET 1: 1382 BORDEAUX DR
CITY: SUNNYVALE
STATE: CA
ZIP: 94089
</MAIL-ADDRESS>
</FILER>
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K405
<SEQUENCE>1
<FILENAME>f66473e10-k405.txt
<DESCRIPTION>FORM 10-K405 FISCAL YEAR ENDED JULY 28,2000
<TEXT>
<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended July 28, 2000 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from __________ to __________.
Commission File Number: 000-28369
VA LINUX SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0399299
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
47071 BAYSIDE PARKWAY, FREMONT, CALIFORNIA, 94538
(Address, including zip code, of principal executive offices)
(510) 687-7000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
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 Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10K or any amendment to this
Form 10-K. [X]
As of September 30, 2000, there were 52,647,849 shares of the Registrant's
Common Stock outstanding. The aggregate market value of the Common Stock held by
non-affiliates of the Registrant as of September 30, 2000 (based on the closing
price for the Common Stock on the Nasdaq National Market on September 29, 2000)
was approximately $1,563,528,379.
DOCUMENTS INCORPORATED BY REFERENCE
Specified portions of the Registrant's Annual Report to Stockholders for the
fiscal year ended July 28, 2000 are incorporated by reference into Parts II and
III of this Form 10-K.
Specified portions of the Registrant's definitive Proxy Statement to be issued
in conjunction with Registrant's Annual Meeting of Stockholders are incorporated
by reference into Part III of this Form 10-K.
================================================================================
<PAGE> 2
PART I
ITEM 1. BUSINESS
The following description of our business contains forward looking statements,
including, without limitation, statements regarding future financial performance
and results of our operations; technological trends in the computer industry;
our future product and service offerings, costs and features; the ultimate
success of our product and service offerings; anticipated domestic and
international revenue; future gross margin on products and services;
management's strategy, plans and objectives for future operations, including
additional offices in foreign markets; demand for our products and service
plans; the future functionality, business potential, demand for, and adoption of
build-to-order software, the Build-to-Order Software Selector (BOSS(TM)), and
the Open Source Development Network (OSDN(TM)); growth in adoption of and
support for the Open Source development model; use of the OSDN and the expansion
of the range of Open Source software applications. Actual results may differ
materially from those projected in such forward-looking statements due to
various factors, including, without limitation: competition with, and pricing
pressures from, larger, more established companies and smaller, general purpose
and highly specialized manufacturers; the rate of growth and acceptance of Linux
and the Open Source software development model; our ability to continue to
introduce new products and services, and to expand its business and operations,
particularly internationally; the fact that we have incurred and expect to
continue to incur substantial losses; our dependence upon an Open Source
business model, independent third-party Linux developers, and its single source
contract manufacturer and suppliers; our reliance on sales of systems and its
success in expanding its services business; our reliance upon strategic
relationships with other companies and its ability to negotiate and implement
specific terms relating to them; the scarcity of Linux-based applications; our
dependence on its Internet-based businesses; the enforceability of the GNU
General Public License; our ability to attract and retain qualified personnel,
especially in professional services and overseas; our acquisition strategy and
its ability to successfully integrate Andover.Net and other acquired companies
into its operations; market acceptance of Linux and Open Source software
generally; rapid technological and market change; manufacturing and sourcing
risks; the impact of rapid evolution of the Linux market on our ability to
forecast demand and results; our quarterly sales cycle and fluctuation in demand
for our products and services, with increased fluctuation due to our
concentration of customers in the Internet infrastructure industry; claims and
potential damages resulting from information or postings on our Internet sites;
and risks associated with the Internet infrastructure and regulation. The
following business description should also be read in conjunction with the Risk
Factors contained in the section entitled "Management's Discussion and Analysis
of Financial Condition and Results of Operations" in our Annual Report for the
fiscal year ended July 28, 2000.
We are a leading provider of expertise in Linux and Open Source software,
delivered through build-to-order systems, professional services, and the OSDN
online network. Since our inception, we have focused exclusively on developing
and selling Linux-based solutions. We have over five years of experience serving
commercial Linux-based customers. This experience, combined with our broad base
of technical expertise in Linux systems and software and our close ties to the
Open Source development community, enable us to develop Linux-based solutions
that we believe are generally more reliable, scalable and cost-effective than
those based on proprietary software solutions.
Our solutions offer the following:
o Systems -- We offer a broad line of Linux systems built to customer
specifications and optimized for use in a variety of computing
environments. In particular, we have devoted significant engineering
efforts to design servers for Internet-related applications. According
to statistics released by International Data Corporation's Worldwide
Quarterly Server Tracker in September 2000, in the second calendar
quarter of 2000, VA Linux ranked as the number two vendor of Linux
servers in the United States, based on factory revenue, with 20% market
share, and number three worldwide.
o Software -- We develop and pre-install on our systems customized
versions of the Linux operating system designed to enhance the
performance and reliability of our solutions for our customers' needs.
o Services -- We provide a full range of technical and professional
services centered around Linux and Open Source software. Professional
services can consist of Open Source software community-building; Linux
porting; planning, implementation, installation, support and integration
of Linux systems; and security audits. Technical and support services
can include 24 hour a day, seven day a week, toll-free telephone support
and onsite services by Linux professionals.
o OSDN -- We communicate directly with our customers and the Open Source
community through our OSDN web sites, including our flagship web site
sourceforge.net, an online development center for Open Source, which, as
of October 2000, is
<PAGE> 3
the home for more than 10,000 projects and has more than 70,000
registered developers. The OSDN includes properties such as
slashdot.org and freshmeat.net, which we acquired with Andover.Net,
Inc. in June 2000.
A majority of our Linux-based solutions are sold to customers implementing
or expanding their Internet infrastructures. Linux has emerged as one of the
most popular operating systems used by companies for this purpose. One of the
factors contributing to the popularity of Linux is that it is an Open Source
operating system. The term Open Source applies to software that can be copied,
modified and distributed, generally without any associated fee and with few
restrictions. As such, the source code for Linux can be downloaded from the
Internet free of cost. Popular Open Source software like Linux is continuously
maintained and improved by large communities of developers who share
information, code and suggestions. This collaborative environment has been
facilitated and enhanced by the growth of the Internet and the availability of
low-cost computing resources. These market trends have fueled significant
increases in the number of developers working on Open Source projects, the
frequency of software releases and the speed of feature development and error
correction.
Our strategy is to enhance our position as a leading developer and provider
of advanced Linux and related Open Source solutions by:
o continuing to demonstrate technical leadership in Linux and related Open
Source technologies that run on the Linux operating system and provide
additional business software applications for our customers. These
software applications include the Apache web server (which allows for the
service of web pages), the Samba file server (which provides file
services) and the Sendmail electronic mail server (which allows the
exchange of e-mail messages). We have demonstrated technical leadership
in the Linux community by being the first company to introduce several
Linux features for Intel-based systems, in areas such as memory, device
support and data storage;
o utilizing direct sales and distribution of our systems over the Internet
to reduce the cost of delivering our solutions by improving the
efficiency of order processing;
o continuing to leverage the Internet and our OSDN web sites to accelerate
the development of new Open Source software and communicate with our
customers and the Linux community in a cost effective way;
o speeding development of the Open Source market and community;
o continuing to apply Open Source practices, such as encouraging
community involvement within our business and products; and
o increasing our brand awareness.
Cultivating close ties with the Open Source community has enabled us to
recruit members of this community and thereby assemble a team of software
engineers and community professionals who have significant expertise relating to
the Linux operating system and applications and collaborate on Open Source
development projects. We believe that involvement in these various development
projects and the close ties fostered by participation in these projects allows
us to remain abreast of technical advances, react more quickly to new
developments in the Linux operating system and hire knowledgeable software
engineers to develop products responsive to the evolving Linux market. As a
Linux vendor, it is imperative that we maintain close relationships with the
Open Source developer community and offer a forum where our customers and Open
Source community members can interact. We are firmly committed to supporting the
continued growth and success of the Open Source model and developer community.
We were incorporated in January 1995 in California as VA Research, Inc. In
June 1999 we changed our name to VA Linux Systems, Inc., and in December 1999 we
reincorporated in Delaware. In December 1999, we sold 4,400,000 shares of common
stock to the public in our initial public offering. Our principal executive
offices are located at 47071 Bayside Parkway, Fremont, California, 94538, and
our telephone number is (510) 687-7000. Our corporate web site is located at
valinux.com.
---------------
CLUSTER CITY, FULLON, GOFULLON, LINUX HARDWARE SOLUTIONS, the Linux Hardware
Solutions logo, SERVICE TLC, STARTX, SUPPORT TLC, SOURCEFORGE, TOTAL LINUX
COVERAGE, VA TLC, BOSS, OSDN, VA LINUX SYSTEMS and our logo are trademarks,
trade names or service marks that we use. We have applied for federal trademark
registration only for the VA logo, FULLON, STARTX, the Linux Hardware Solutions
design orb, SOURCEFORGE and VA TLC. This Form 10-K contains other trademarks and
trade names of other companies.
<PAGE> 4
INDUSTRY BACKGROUND
The Internet Build-Out
The Internet is rapidly becoming a critical resource for business. Companies
that successfully build an online presence can more efficiently conduct business
with partners and suppliers, communicate with customers and employees and
address the rapidly growing, global base of online consumers. To remain
competitive, companies are being forced to offer more sophisticated Internet
services more rapidly. As a result, their computing environments are becoming
more complex and their demand for Internet infrastructure is growing.
The Growth of the Internet is Fueling Demand for Linux and Other Open Source
Solutions
In seeking cost-effective, reliable and secure infrastructure for their
Internet services, companies are increasingly implementing Open Source software.
Popular examples of Open Source software include the Linux operating system, the
Apache web server, the Samba file server and the Sendmail e-mail server.
The nature of Open Source software makes it easy for multiple groups,
commercial and non-commercial, to create "distributions," or collections, of
this software. The most well known distributions of Linux, for example, include
those from Caldera Systems, Inc., Debian, Red Hat, Inc., and S.u.S.E. In most
cases, there are only minor technical variations among distributions and
software applications designed for Linux can run consistently across all of
them. When variations among distributions occur, they are generally
market-based. For example, some distributions are localized for different
languages or optimized for different hardware systems.
The following points illustrate some of the benefits we believe consumers
receive by implementing the Linux operating system and related Open Source
solutions:
Rapid Development and High Quality. Traditional software vendors that
create proprietary software programs rely on a limited pool of software
engineers to correct software errors and develop new software or software
enhancements. In contrast, any end user can access the source code to
develop new features and applications or suggest fixes and improvements to
Open Source software. As a result, businesses are not dependent on a single
third party vendor and can rely on a larger pool of software engineers and
service providers. In addition, these software projects promote independent
peer review. This system of peer review is designed to ensure the quality of
all submissions and changes to the code. Furthermore, we believe that
opening source code to the public ensures that security flaws are quickly
identified and eliminated, often making Open Source software more secure
than proprietary software.
Customer-Focused Solutions. The lack of access to the source code of
proprietary software often makes it more difficult and, usually, more costly
to integrate into existing systems than Open Source software. In addition,
in an environment where anyone can access and modify the source code,
internal development personnel in an organization can leverage the efforts
of a broad community consisting of other information technology specialists
and independent programmers to develop customized solutions more rapidly and
at a significantly lower cost. End users' ability to modify Open Source
software also results in Open Source software implementations that are
tailored to meet customer needs.
Lower Cost of Ownership. Consumers can significantly decrease the cost
of owning and servicing their computing systems in an Open Source
environment. This is because the sale price of the computing system
typically accounts for only a small portion of the total cost of owning a
system, whereas the bulk of the costs are attributable to services such as
training, support and maintenance, which are largely software
support-related activities. Therefore, in addition to having the ability to
install an unlimited number of copies for free, we believe that consumers
can further reduce their costs by sourcing services from more than one
party, avoiding the significant margins that proprietary software vendors
can charge as a result of their exclusive knowledge of the product. Open
Source software solutions create a competitive, multi-source market for
these software support services.
The benefits of Open Source initiatives have accelerated the market
penetration of Open Source software, especially in environments such as the
Internet where highly reliable, secure, low-cost and customizable solutions are
essential. For example, in June 2000, Apache, an Open Source web server,
commanded a 62% share of the Internet server market, according to the July 2000
Netcraft Web Server Survey (netcraft.com/survey), as compared to 20% for
Microsoft Corporation's Internet Information Server.
<PAGE> 5
Linux is the Leading Internet Operating System
Linux has emerged as the leading operating system for the Internet.
According to the July 2000 Netcraft Web Server Survey (netcraft.com/survey),
almost 30% of all active web sites run on Linux as of June 2000, making Linux
the most popular operating system for public web sites. We believe that this
growth is largely attributable to decisions by information technology managers
to deploy Linux as a highly cost-effective and reliable way to support web
services. We believe that the reliability, security and continuous improvement
of Open Source software, complemented by its low cost, will continue to make
Linux a preferred solution for delivering Internet services.
The Challenge in Delivering Open Source Solutions
As companies adopt software solutions that are created in an Open Source
environment as part of their critical business operations, they face new
challenges. To help maximize the advantages of these software solutions and
address these challenges, consumers require the assistance of vendors that have
significant Open Source expertise and are able to provide timely and qualified
Open Source professional services and customer support. The rapid evolution of
Open Source software requires Open Source vendors and support providers to:
o continuously develop knowledge of the ongoing changes in popular Open
Source software;
o actively engage in research and development with the Open Source
development community; and
o leverage the expertise of this community to deliver customized
solutions.
In addition, as Open Source software becomes more complex, its interactions
with a diverse range of commodity hardware platforms become more difficult to
support. Supporting too broad a set of hardware platforms and software offerings
can overwhelm many service and support organizations. As a result, vendors must
maintain a thorough understanding of the interoperability of Open Source
software and hardware platforms and tailor their offerings to provide the best
available hardware and software products.
Traditional server, workstation and personal computer vendors primarily
depend on highly controlled and scheduled releases of software from major
proprietary software developers. This regimented software environment enables
the disaggregation of hardware, service and support delivery among multiple
companies, while keeping systems and service offerings tied to new proprietary
software releases. Given the rapid rate of development in commodity hardware
markets, systems vendors have become reliant on this controlled software release
process to coordinate the development and create the demand for new products and
services. As Open Source software gains market acceptance, its rapid and
relatively unconstrained pace of development disrupts these well-defined
processes and poses significant challenges for traditional systems vendors and
service providers. To effectively deliver Open Source solutions to large
companies, vendors will need to simultaneously:
o capitalize on the rapid pace of Open Source software development;
o manage the high rate of change in commodity hardware markets; and
o integrate the best available Open Source software and system components
to produce the highest-quality solutions for particular customer needs.
We believe that, in order to satisfy these market requirements, Open Source
vendors must deliver integrated system, software and support solutions to
customers.
The Market Opportunity for Open Source Vendors
We believe that Open Source solutions will continue to gain market
acceptance as the limitations of more expensive and less customizable
proprietary applications become more pronounced. To date, few large Intel
processor-based systems vendors have focused their businesses solely on
delivering high-quality systems optimized for Linux and other Open Source
software, despite their announcements of product support for Linux. These
vendors primarily utilize proprietary operating systems and applications from
vendors such as Microsoft. Alternatively, some systems vendors, such as Sun
Microsystems, Inc., offer their own proprietary software. Few such vendors
maintain significant expertise in creating and implementing Open Source systems,
nor do they have extensive ties
<PAGE> 6
to the Open Source community. Linux software and service vendors, on the other
hand, have little experience in developing and supporting systems that are
optimized for Linux.
SOLUTION
We are a leading provider of expertise in Linux and Open Source software,
delivered through build-to-order systems, professional services, and the OSDN.
We offer high-quality Linux systems that are designed for optimal performance,
reliability and scalability in business and Internet-based computing
environments. We offer comprehensive professional services and customer support.
And we manage the OSDN, the leading Open Source online development network. Our
products and services offer the following:
Integrated Linux-Based Solution
We offer a single point of contact for all Linux product, service and
support needs. Our Linux systems are used in a variety of computing
environments, ranging from small desktops to complex, high-performance, groups
of servers and are differentiated to meet the price, performance and scalability
requirements of our customers. For example, for the Internet server markets, we
offer compact servers with high storage capabilities that we engineer for use by
companies with physical space constraints. We also offer professional services,
consisting of planning, implementation, installation and integration, security
audits and performance analysis, as well as 24-hour toll-free telephone support
and onsite services by Linux professionals. We also offer Open Source specific
services. For example, we have worked with the Hewlett-Packard Company on
improving the quality and availability of Open Source printing software.
Depth of Technical Expertise in Linux and Other Open Source Software
We focus on Linux-based solutions and have developed a comprehensive
understanding of our customers' Linux needs. In addition, by cultivating close
ties with the Open Source community, we have assembled a world-class team of
Linux and Open Source software engineers and community professionals who
collaborate on Open Source development projects. Many of our current employees
are leading contributors to Open Source projects. Notably, Intel Corporation has
contracted with us to port the Linux operating system to its next generation
series of microprocessors that are used in computers. We believe that our
involvement in these projects and our investment in Linux expertise helps
position us as an integral member of the Linux development community. This also
helps enable us to remain abreast of technical advances and react quickly to new
developments.
High-Quality, Cost-Effective Solutions
We offer high-quality systems that we believe provide our customers with
significantly lower total costs of system ownership. The Linux expertise of our
engineers enables us to design servers, storage devices, and workstations that
are tuned for optimal performance, reliability and scalability in Linux
environments. Our engineers work with engineers of major component vendors, such
as IBM/Mylex and Matrox Electronic Systems, to improve the performance of their
subsystems and components and attain interoperability with Linux and other Open
Source products. We integrate widely available commodity hardware components,
popular Linux distributions and Linux service and support to deliver
comprehensive low-cost, high-quality industry-standard systems to our customers.
By contrast, customers of other vendors are required to purchase Linux service
and support separately from their systems providers, which adds significantly to
the total cost of their systems.
Build-to-Order Software
We pioneered the idea of build-to-order software. In this model, our
customers make decisions about what software packages are loaded on their
systems at the time of purchase. This capability offers many benefits. First, in
the server market, it offers the replicability and single-purpose server
software environment that customers have enjoyed from "server appliance"
vendors, but without any of the inflexibility; server appliances are
fixed-function servers. Second, build-to-order software is ideally suited to
Open Source, where there are no proprietary operating system vendor restrictions
compelling OEMs to load software packages purely in the proprietary operating
system vendors' interest. Over time, we intend to link this system with the OSDN
to allow integration of the latest packages on the web. In addition, we believe
this software neutrality, by freeing us from specific alignment with a
particular Linux distribution, resonates with the goals of a broad section of
the Open Source community, thus improving our ability to recruit and retain the
best community talent.
<PAGE> 7
OSDN
As a Linux vendor, it is imperative that we maintain close relationships
with the Open Source community and offer a forum where our customers and Open
Source community members can interact. We manage the Open Source Development
Network (OSDN) to serve our customers and the Open Source community. The OSDN
includes Sourceforge.net, our flagship Open Source development center.
Sourceforge offers developers a complete on-line development environment for
updating, downloading, and discussing Open Source projects. From its inception
in January 2000 through October 2000, Sourceforge has attracted more than 10,000
projects, which we have estimated to be more than two-thirds of the total known
Open Source projects, and more than 70,000 registered developers. More than
three million unique users view the OSDN every month, making it one of the top
100 web destinations in the world.
STRATEGY
Our objective is to enhance our position as a leading developer and
provider of advanced Linux and related Open Source solutions. Key elements of
our strategy are to:
Continue to Demonstrate Technical Leadership in Linux and Related Open Source
Technologies
As an Open Source technology leader, we will enhance our position in the
marketplace and reinforce our ability to bring high-quality solutions and
support to our customers. We expect to continue to recruit experts who are fully
engaged in Open Source development projects. We intend to remain at the
forefront of high-performance Linux systems and software development, as
demonstrated by our development of high-density Linux servers and our software
to manage groups of servers. Further, we intend to leverage our business
agreements with leading technology companies to reduce the time-to-market for
Linux support for emerging hardware technologies, such as the porting of Linux
to Intel's future 64-bit processor family. In addition, we intend to extend our
model into support of more specialized servers, such as our recently announced
network attached storage (NAS) products.
Utilize Our Direct Distribution Model
We intend to gain immediate feedback from customers on our designs and
product quality by using a direct sales and distribution model. We believe this
will enable us to improve our solutions much faster and more precisely than if
we were to utilize a traditional reseller-distributor model. By communicating
our users' critiques on Open Source software reliability, usability and
scalability to the Open Source community, we believe we will facilitate
improvements in the quality of Open Source software. Furthermore, we intend to
use the direct distribution model to expand our build-to-order fulfillment
capability, which we have recently expanded to include BOSS(TM) (Build to Order
Software Selector), the world's first build-to-order software methodology,
designed to minimize inventory costs, increase margin and lower prices to our
customers. We believe the direct model is the most effective means of reaching
customers and establishing long-term customer relationships.
Continue to Leverage the Internet
As a company that specializes in Linux solutions, Internet strategies are
central to our operations. We intend to continue to strengthen the range of
available Open Source software, the tools available to the Open Source
community, our brand and our Internet presence through expansion of our
commercial web site and our management of community-oriented sites in the OSDN.
We also plan to use the Internet to enhance our relationship with our customers
and suppliers by delivering highly customized order and account information and
offering creative self-service programs. Currently, substantially all system
orders are placed through our valinux.com web site. In addition, we intend to
continue to engage in Internet-based strategies, which promote closer ties
between our customers and the Open Source community. We intend to build strong
community relationships by providing Internet resources to Open Source community
members who want to lead or contribute to Open Source projects.
Accelerate Development of the Open Source Market and Community
We intend to continue to invest resources for the development of Open Source
technologies and the Open Source community. We intend to increase the variety
and quality of Open Source applications by encouraging our customers to join
with members of the Open Source community in application development. By
promoting Open Source solutions, we believe we will raise awareness of Open
Source software capabilities. We intend to increase the credibility of Open
Source solutions and educate customers who are currently unaware of its benefits
by collaborating with established technology companies such as database
developers and Internet software providers.
<PAGE> 8
Continue to Apply Open Source Practices Within Our Business and Products
The popularity of Linux and other Open Source products demonstrates the
success of innovative, highly collaborative software development models. These
models have been made possible only in recent years through the widespread
availability of the Internet. We seek opportunities to apply similar models of
Internet community collaboration across our business, in such areas as market
research, product development and ongoing customer support. For example, we are
collaborating with members of the Open Source community to help develop a more
secure version of Linux for use in university computing environments. We will
continue to embrace the Open Source model not only in the creation of new
products and services, but also in the overall execution of our business model.
Increase Brand Awareness
We believe that continuing to build our brand is vital to our success in
providing Linux-based solutions and strengthening our presence in the Linux and
Open Source communities. We have established a reputation for providing
high-quality Linux systems and support and for promoting Open Source community
involvement. We intend to continue to promote our brand through a variety of
campaigns, including promotion of the OSDN, public relations activities, and
tightly focused advertising campaigns in computer-related publications and
general business media. We also intend to continue to contribute engineering
resources, leadership, systems and other services to Open Source development
projects and to community-wide support organizations, such as Linux
International and the Linux Standard Base.
PRODUCTS, SERVICES AND THE OSDN
We offer an end-to-end Linux-based solution for our customers, including
systems, software, services, and on-line development centers. Our systems are
designed to meet the reliability and scalability requirements of Internet
infrastructure and other computing intensive markets. Sales of our systems
accounted for approximately 95% of our net revenues in fiscal 2000 and all of
our sales in fiscal 1999. Generally, we do not grant our customers any rights to
return products. We provide allowances for warranty costs at the time of
shipment.
Unlike traditional systems vendors, we design our products exclusively
around the Linux operating system. All our systems and components are tested and
configured for optimal Linux compatibility and include support and service as a
standard feature. In addition to system support, we offer professional service
capabilities that provide in-depth Linux and other Open Source software
expertise to our customers. Finally, through the OSDN, we offer tools and
services for the Open Source development community that we believe help create
better software faster.
Computing Systems
We sell a broad line of Linux desktop and server systems. Our Linux systems
are built to customer specifications and can be optimized for a wide range of
applications and environments. We build our products with standard components
that adhere to the Intel processor architecture and are carefully selected and
tested for optimal performance in Linux environments. We believe our
comprehensive testing methodology, combined with our significant expertise in
solving hardware and software integration issues in Linux environments, assures
our customers that our systems will not suffer from incompatibility problems.
Our design decisions reflect the benefit of our direct channel sales strategy,
which provides us with early and frequent customer feedback on product
improvements.
All our systems come pre-installed with a version of a popular Linux
distribution, which we and our clients can customize, using BOSS, to enhance
quality and performance for our customers' particular application requirements.
We immediately post all improvements to popular distributions to the Internet in
Open Source form, enabling us to maintain our standing as an active Open Source
community participant.
We have devoted significant engineering efforts to design our servers for
Internet-related applications. For example, we have focused on reducing the
height of our server designs to facilitate high-density installation. This
reduces our customers' space requirements, which can, among other things, lower
the costs of implementing our systems in co-location facilities. Our 2250 model
server product offers one of the highest disk storage densities of any similar
server system in the industry for any operating system. In addition, the 2250
server product features support for a configuration of multiple disks, which
provide back-up in the event of a
<PAGE> 9
system failure. The 2250 model server product features a dual processor
configuration, which allows up to five 1.6 inch 10,000 revolutions per minute
disk drives, any of which can be swapped while the system is running.
We offer a broad range of desktop configurations, from value-priced to
high-performance models. Our high-performance desktops are designed for
computing-intensive applications, such as Linux development. Most of these
products feature a configuration of multiple disks, which provide back-up in the
event of a system failure, and external storage, which positions these products
as departmental file and database servers.
Our customers benefit from a single point of contact for complete system
support. All our system sales include six software support calls for the first
12 months, along with two day return-to-depot hardware service. By contrast,
customers of other vendors are often required to purchase Linux service and
support separately from their system provider, which can add significantly to
their total cost.
We frequently introduce new configurations. The following table details our
server and desktop configurations available as of September 2000:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
PRODUCT MODELS PROCESSOR MEMORY INTERNAL DISK TARGET MARKET
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
420 Intel Celeron or Pentium III 64-256MB 6.4GB Linux community developers
- -----------------------------------------------------------------------------------------------------------------------
StartX MP Intel Pentium III (dual) 128MB-1GB 10.2 - 36.4 GB Software developers
- -----------------------------------------------------------------------------------------------------------------------
1150 (1U) Intel Pentium III up to 2GB 9.1-72GB Internet and web serving
- -----------------------------------------------------------------------------------------------------------------------
1000 (1U) Intel Pentium III (dual) up to 2GB 20 - 36.4 GB Internet and web serving
- -----------------------------------------------------------------------------------------------------------------------
2130 (2U) Intel Pentium III up to 512MB 10 - 60 GB Internet and web serving
- -----------------------------------------------------------------------------------------------------------------------
2200 (2U) Intel Pentium III (dual) 256MB-2GB 6.4 - 365 GB Internet and web serving
- -----------------------------------------------------------------------------------------------------------------------
4450 (4U) Intel Pentium III Xeon (quad) up to 4GB 9.1 - 180 GB Application & data serving
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
SERVICE AND SUPPORT
We believe that in an Open Source computing environment an integrated
product and service organization is essential for the delivery of effective and
low-cost solutions. Because of the variability of Open Source software and the
challenges associated with integrating this continuously evolving software with
standard hardware packages, we believe only a vendor that has expertise with
both can maintain a strong standing in the Open Source community and be in a
position to select the best available software and hardware products to provide
high-quality, low-cost solutions to customers.
Open Source Community Relationship. The quality of our services is dependent
on the efforts and the expertise of members of the Open Source community. It is
imperative, therefore, that we continue to work productively with these
community members. We do so by actively sponsoring, contributing to or otherwise
supporting dozens of Open Source projects. We established the OSDN web sites to
provide a neutral forum for Linux and Open Source development, software
distribution, and information and links to other members of the Open Source
community. In addition, unlike some vendors of Linux distributions that act as
intermediaries between Linux users and developers, we help establish direct
communication between our customers and members of the development community.
Professional Services. We have established a professional service
organization that offers a comprehensive suite of services designed to reduce
our customers' time to implement Linux-based infrastructure solutions and
improve the scalability and security of these solutions. These services include
planning, installation, systems integration, support and security consulting
with respect to Linux solutions. We have worked with companies such as
Hewlett-Packard and Cadence Design Systems, Inc. on assignments to help them
bring their software to Linux and the Open Source community. We have also begun
working with companies who are interested in putting OSDN site technology, such
as the infrastructure behind sourceforge.net and slashdot.org, into private use
behind corporate firewalls.
Technical Support. We offer a broad range of Linux technical support
products under the product family "Total Linux Coverage" or "VA TLC." For our
commercial customers, we offer 24 hour per day, seven day per week access to our
technical support specialists by telephone and the Internet. For smaller
customers or end users, we also offer per-incident technical support products
and upgrades through a toll-free telephone number and our web site. All products
include comprehensive support for our systems and Linux software.
<PAGE> 10
Extended Warranties and Onsite Maintenance. As part of our Total Linux
Coverage product family, we offer customers a broad range of warranty and
on-site maintenance services. Our standard service options include next business
day on-site response for systems maintenance throughout North America and three
year warranties for systems and components. For our commercial customers, we
offer same day priority on-site response, with assigned technical support
specialists for their specific Linux configuration.
Customer Service. Our customers can access 24 hour per day, seven day per
week phone and on-site support across the United States and Canada. We
collaborate with DecisionOne, a leading provider of computer maintenance and
support services, for the provision of call center and onsite service functions
to our customers. We have trained certain DecisionOne employees, who are
dedicated to Linux support and who do not support any other systems vendors, to
provide these services.
OSDN
A central component of our business strategy is to leverage the Internet to
enhance our ties with the Open Source development community and promote market
acceptance of Linux solutions. The Internet is the primary communication medium
for Open Source community vendors and developers. In addition, information about
Linux is widely dispersed on the Internet. Therefore, prominent web sites are
important to attract Open Source community members, providing a forum to link
customers with other community members, facilitating the initiation of Open
Source projects and promoting the growth of Linux-based solutions.
In addition to our support of numerous Open Source web sites through the
donation of systems, hosting and systems administration support, we own and
manage several sites that are widely used by the Open Source community and our
customer base. This network is known as the Open Source Development Network
(OSDN). Per month, the OSDN receives more than 75 million page views and more
than three million unique visitors.
On June 7, 2000, in an acquisition accounted for under the purchase method
of accounting, we acquired all of the outstanding shares of Andover.Net, Inc.
for approximately $342,000,000 (including acquisition costs of approximately
$5,000,000). Andover.Net provides products, online tools, news and other
services for programmers, software developers, web site designers, technology
managers and corporate buyers. The purchase price included 6,986,000 shares of
our common stock valued at $315,000,000 and the assumption of outstanding
options to purchase our common stock valued at approximately $22,000,000. The
former Andover.Net web sites are now part of the OSDN, which includes:
o sourceforge.net, our flagship web site and development center. As of October
2000, Sourceforge is the development home for more than 10,000 Open Source
projects and has more than 70,000 registered developers. We believe that
this represents more than two-thirds of the known Open Source projects in
the world.
o slashdot.org, our most popular site. A "village pub" for the Open Source
community, Slashdot carries news and interactive commentary on topics of
interest to the community.
o freshmeat.net, the world's leading Open Source index and is the most popular
update notification service for Open Source developers.
o linux.com, which contains news, links and articles of interest to Open
Source community members. Its focus is on corporate Linux usage,
customization and support.
o themes.org, a repository of desktop themes. Desktop themes are background
images, icons and other graphic customizations for the window systems used
in Linux and popular Unix operating systems.
o questionexchange.com, a brokerage service between Open Source users and the
Open Source community for support questions.
o valinux.com, our e-commerce site, which provides company and product
information and allows customers to order customized systems as well as to
access professional and customer support online.
ENGINEERING
We offer our customers a broad range of technical expertise in Linux-based
systems and software design. Our organization combines extensive knowledge of
hardware architecture with in-depth expertise on how to optimize the performance
of Linux for these architectures.
In fiscal years 2000, 1999 and 1998, we recognized research and development
expenses of $12.4 million, $3.2 million and $180,000, respectively.
<PAGE> 11
Software Engineering
Our software engineers primarily work to advance Linux and related Open
Source software technology and customize popular Linux distributions for our
customers. We participate in the development of Linux and our team includes many
recognized technologists who have made significant contributions to the Linux
code base. As a result, our software engineers enjoy an in-depth understanding
of the capabilities of the Linux operating system. Our software engineers
concentrate their efforts on several Linux disciplines, including kernel, file
system and driver development; distribution and product releases; and advanced
projects, such as desktop and graphics applications and software to manage
groups of servers.
Systems Engineering
Our systems and mechanical design engineers design our printed circuit
boards, sheet metal chassis and molded plastic parts and have significant
expertise in designing high-density Intel processor-based systems, including
backplane and high-performance input/output design. We believe our designs are
industry leaders in storage density, clustering technology, thermal management
capabilities, manufacturability, reliability, serviceability and low cost.
Open Source Development Projects
We devote some of our resources to, and encourage our employees to be
actively involved in, Open Source development projects. By contributing to these
projects, our employees expand our relationships with Open Source community
members, assist in improving Open Source software and remain current with all
developments in the Open Source community. Our employees actively contribute to
a variety of significant and on-going Linux projects. The following table
highlights some of these efforts:
<TABLE>
<CAPTION>
PROJECT DESCRIPTION PARTICIPATING EMPLOYEES
- ------- ----------- -----------------------
<S> <C> <C>
Linux Kernel The core of the Linux Ted T'so
operating system San "nettwerk" Mehat
Leonard Zubkoff
Walt Drummond
H. J. Lu
XFree86 A server for the Xwindow Mark Vojkovich
system that runs on Unix and Brad Grantham
Unix-like systems David Dawes
Enlightenment Window manager for the Geoff "mandrake" Harrison
Xwindow system Carsten "rasterman" Haitzler
VACM Software to manage groups, or Michael Jennings
clusters, of servers San "nettwerk" Mehat
Samba A file server Jeremy Allison
Perl A programming language Chip Salzenberg
Debian A Linux operating system Sean Perry
distribution Joey Hess
Linux International A Linux advocacy group Jon "maddog" Hall
</TABLE>
CUSTOMERS
Our Linux products and services are targeted primarily at Internet
infrastructure and scientific computing applications that demand highly scalable
and reliable solutions. We believe that sales related to Internet infrastructure
solutions will represent an increasing portion of our revenues. In addition, as
Linux becomes more widely used, we believe that there could be a significant
opportunity to increase sales of Linux desktops. In fiscal 1998 and 1999, no
customer accounted for more than 10% of net revenues. In fiscal 2000, only
Akamai Technologies, Inc. accounted for more than 10% of net revenues, at 18.3%.
SALES AND MARKETING
We sell our products and services primarily through our direct sales
organization in the United States, Canada, France, the United Kingdom, Germany,
the Netherlands, and Switzerland. We recently established a majority-owned
subsidiary in Japan.
Our sales personnel rely on our commercial web site, valinux.com, to
expedite and process sales. valinux.com incorporates an advanced ordering system
that offers customers and the company a single point of order entry. Since
October 1999, substantially all our sales have been processed through our
web-based ordering system. Most of these orders resulted from the efforts of our
direct
<PAGE> 12
sales personnel. We believe that, as we build brand name recognition and as
market acceptance of Linux solutions increases, a larger percent of sales will
occur without direct salesperson support.
We continuously strive to associate our brand with Linux and the Open Source
community in general. We market our products and services aggressively through
on-line advertising campaigns, traditional media advertising programs, trade
shows, Internet-based video seminars and through our own Internet portals. Our
marketing efforts are both broad-based and focused on specific market segments
that represent significant short-term lead-generation opportunities, such as the
Internet infrastructure and scientific computing markets. Our Internet
infrastructure marketing includes joint-marketing programs with managed hosting
and co-location facilities, such as Exodus and SiteSmith.
MANUFACTURING
With the exception of a small internal systems integration and prototyping
facility, we have relocated our internal manufacturing organization to Synnex
Information Technology, Inc.'s manufacturing facility in Fremont, California.
While all current volume manufacturing is conducted in Fremont, California, we
expect to initiate contract manufacturing and distribution activities
internationally with Synnex in Europe and Asia should sales in those geographic
regions grow sufficiently. We selected Synnex for its technical expertise in
build-to-order production and distribution, large scale component purchasing and
distribution capabilities and international operations. Our relationship with
Synnex has enabled us to reduce our manufacturing and component costs
significantly.
Substantially all of our functional test, quality assurance and software
loading software utilized by Synnex in the manufacturing process has been
developed and is owned by us. Testing and quality control processes are also
applied to components and parts. Synnex's build-to-order process enables us to
rapidly manufacture customized computer systems and to achieve high inventory
turnover rates and reduced inventory levels, which lessens exposure to the risk
of declining inventory values. This flexible manufacturing process also enables
us to quickly incorporate new technologies and components into our process while
mitigating the risk of excess and obsolete inventories. Our inventories are
stated at the lower of cost or market, using the first-in, first-out method, and
are comprised of materials component costs from vendors.
By maintaining rigorous quality control processes, we are able to supply
high quality products. We test components, parts and subassemblies at various
stages in the manufacturing process. We also conduct on-going production
reliability audits and defect tracking for early identification of workmanship
and component problems.
Although most of our components are standard products sold by multiple
vendors, some are available only from one source. For fiscal 2000, we had a
single source for power supplies used in our 2100 and 2200 model server
products, MicroEnergy Inc. For fiscal 2001, MicroEnergy, Inc. is our single
source for power supplies used in our 2100 and 2200 model server products;
Converter Concepts, Inc. is our single source for power supplies used in our
FullOn model of server product; Tyco International is our single source for
backplane circuit boards, motherboards and central processing units in our
server products; and Mylex Corporation is our single source for our RAID hard
disk controller cards. It would be difficult for us to identify another source
of supply if any of these suppliers were unable to meet our requirements for any
reason. We do not have a binding long-term agreement with MicroEnergy, Converter
Concepts Inc., Tyco International or Mylex Corporation. Therefore, we are
susceptible to supply shortages and interruptions that could harm our operating
results. Furthermore, overall market conditions affecting supply and pricing for
key commodity components are known to fluctuate significantly at times.
Recently, for example, the price of memory chips has increased significantly.
Increases in costs of key components could harm our results of operations.
We continuously seek to improve our manufacturing operating efficiencies
through the use of new technologies. For example, to facilitate rapid and
accurate ordering, manufacturing and fulfillment of products, we have
implemented a complete end-to-end e-commerce solution. We intend to continue
integrating additional order fulfillment, tracking and related functionality
into our back-office systems.
COMPETITION
We compete in markets that are new, intensely competitive, highly fragmented
and rapidly changing. We face competition primarily from computer vendors that
provide solutions for distributed computing systems.
Companies offering competitive products vary in scope and breadth of
products and services offered and include:
o computer systems manufacturers such as Compaq Computer Corporation, Dell
Computer Corporation, Hewlett-Packard, IBM and Sun Microsystems, all of
which, have qualified their systems for Linux; and
o small, general purpose computer manufacturers that offer a small number
of products, and compete with us primarily on the basis of price.
o Linux service and software vendors.
<PAGE> 13
We believe we compete favorably on the principal factors that will draw end
users to Linux systems, which include:
o product functionality;
o quality of product and product support;
o total cost of ownership;
o system performance at different price points;
o reusability for multiple applications;
o sales and distribution efficiency;
o brand name recognition; and
o quality and availability of professional services.
To be competitive, we must respond promptly and effectively to the
challenges of technological change, evolving standards and our competitors'
innovations by continuing to enhance our products and grow our sales and
professional services organizations. Any pricing pressures or loss of potential
customers resulting from our failure to compete effectively would reduce our
revenues.
We expect competition in the computer systems market to increase
significantly as new companies enter the market and current competitors expand
their product lines and services. Many of these potential competitors are likely
to have substantial competitive advantages including:
o greater resources that can be devoted to the development, promotion and
sale of their products;
o more established sales forces and channels;
o greater software development experience; and
o greater name recognition.
In the OSDN, our customers are typically high technology product, service
and network companies that seek access to the demographic we target, Open Source
developers. Here, we compete with other on-line networks for sponsorship. These
networks include Internet.com Corporation, CNET Networks, Inc. and Tucows, Inc.
We compete on the basis of our focused coverage of Open Source development,
which is unique. We have achieved significant audience share through this focus,
and much of the content generated on our network is from developers themselves.
To stay competitive, we need to update the network with the most pertinent
news and tools for the Open Source community on a regular basis.
We expect aggressive competition as Open Source takes a larger role in the
software market. IBM and Collab.net are both potential competitors in this
space, with greater resources or more specific application of a network to a
particular large Open Source project.
SEASONALITY
Historically, sales in our second fiscal quarter have been lower than sales
in the other three fiscal quarters due to the holiday season.
BACKLOG
We have operated historically with little or no backlog. Our backlog at July
28, 2000 was approximately $10.4 million, as compared to immaterial backlog
amounts for the comparable periods in 1999 and 1998. Our customers typically
purchase products on an as-needed basis and require different levels of
customization, all of which affect the amount of unfilled orders. In our
experience, the actual amount of unfilled orders at any particular time is not a
meaningful indication of our future business prospects.
INTELLECTUAL PROPERTY RIGHTS
Our systems consist primarily of commodity hardware components in
combination with the Linux operating system and incorporate many distinct
software components developed by thousands of independent third parties. While
we have developed some proprietary techniques and know how, most of our
activities and systems are not protectable as proprietary intellectual property.
To
<PAGE> 14
protect our proprietary intellectual property, we generally enter into
confidentiality or license agreements with our employees, consultants, and
corporate partners. We have also recently commenced a patent program and to date
have filed two patent applications. To date, we have licensed almost all of our
software development projects under Open Source licenses.
EMPLOYEES
At July 28, 2000, we had a total of 515 employees. None of our employees are
subject to a collective bargaining agreement and we believe that our relations
with our employees are good.
ITEM 2. PROPERTIES
In September 2000, we relocated our corporate headquarters to Fremont,
California from Sunnyvale, California. Our Fremont facility consists of
approximately 140,000 square feet, which is occupied pursuant to a lease that
expires in May 2010. We have subleased our Sunnyvale facility pursuant to an
agreement that expires in 2005, upon the expiration of our lease with the
landlord.
ITEM 3. LEGAL PROCEEDINGS
We are not currently a party to any material legal proceedings. We may in
the future be party to litigation arising in the course of our business. These
claims, even if not meritorious, could result in the expenditure of significant
financial and managerial resources.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The information in the section entitled "Quarterly Financial Data
(unaudited)" in the Registrant's Annual Report to Stockholders for the fiscal
year ended July 28, 2000 (the "Annual Report") regarding market, market price
range, dividend information and registered holders of record is incorporated
herein by this reference. The Annual Report is included herein as Exhibit 13.1
to this Form 10-K.
Prior to the effective date of our initial public offering and during our
last fiscal year, we issued 642,374 shares of our common stock upon the exercise
of stock grants under our 1998 Stock Plan. The shares were issued pursuant to an
exemption either by reason of Section 4(2) or Rule 701 under the Securities Act
of 1933. These sales were made without general solicitation or advertising. For
purposes of qualifying for such exemptions, each purchaser either was an
accredited investor, a sophisticated investor (either alone or through its
representative) or a natural person satisfying the requirements of Rule 701,
with access to all relevant information necessary to make an investment
decision.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is in the section entitled "Selected
Financial Data" in the Annual Report and is incorporated herein by this
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this item is in the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Annual Report and is incorporated herein by this reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is in the section entitled
"Quantitative and Qualitative Disclosures About Market Risk" in the Annual
Report and is incorporated herein by this reference.
<PAGE> 15
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is in the section entitled "Financial
Statements" in the Annual Report and is incorporated herein by this reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this section is in the Registrant's definitive
proxy statement to be issued in conjunction with the Registrant's 2000 Annual
Meeting of Stockholders (the "Proxy Statement") and is incorporated herein by
this reference.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this item is incorporated by reference to the
section entitled "Compensation of Directors and Executive Officers" in the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this item is incorporated by reference to the
sections entitled "Certain Beneficial Owners" and "Security Ownership of
Directors and Executive Officers" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this item is incorporated by reference to the
section entitled "Certain Relationships and Related Transactions" in the Proxy
Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following financial statements are included in the Annual Report and
are incorporated herein by this reference.
<TABLE>
<CAPTION>
PAGE
<S> <C>
Report of Independent Public Accountants.............................32
Consolidated Balance Sheets..........................................33
Consolidated Statements of Operations................................34
Consolidated Statements of Stockholders' (Deficit) Equity............35
Consolidated Statements of Cash Flows................................36
Notes to Consolidated Financial Statements...........................37
</TABLE>
2. Index to Financial Statement Schedules
The following Schedule is filed as part of this Form 10-K:
II Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable, not
required, or because the required information is included in the consolidated
financial statements or notes thereto.
<PAGE> 16
(b) Reports on Form 8-K.
(i) Report on Form 8-K dated May 9, 2000, containing an April 26, 2000 news
release announcing the amendment and restatement of the Registrant's
Agreement and Plan of Reorganization, pursuant to which the Registrant
acquired Andover.Net, Inc.
(ii) Report on Form 8-K, dated June 16, 2000, containing a May 23, 2000 news
release announcing the Registrant's financial results for its third
fiscal quarter ended April 28, 2000.
(iii) Report on Form 8-K, dated June 22, 2000, containing a June 7, 2000
news release announcing the closing of the Registrant's acquisition of
Andover.Net, Inc.
(c) Exhibit index
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
<S> <C>
2.1** Amended and Restated Agreement and Plan of Reorganization between the
Registrant, Atlanta Acquisition Corp. and Andover.Net, Inc.
3.1* Amended and Restated Certificate of Incorporation of the Registrant
3.2* Bylaws of the Registrant
4.1* Specimen Common Stock Certificate
10.1* Form of Indemnification Agreement between the Registrant and each of
its directors and officers
10.2* 1998 Stock Plan and forms of agreement thereunder
10.3* 1999 Employee Stock Purchase Plan
10.4* 1999 Director Option Plan
10.5* Sublease between Registrant and Boca Global, Inc.
10.6* First Amended and Restated Registration Rights Agreement between
Registrant and certain holders of preferred stock
10.7* Founder's Stock Repurchase Agreement
10.8* Manufacturing Agreement between the Registrant and Synnex
Information Technologies, Inc.
10.9* Loan and Security Agreement between Registrant and Comerica
Bank-California
10.10* Master Subcontracted Maintenance Service Provider Agreement between
Registrant and DecisionOne Corporation
10.11* VA Research Linux IA-64 Porting License Agreement between Registrant
and Intel Corporation
10.12* GNU General Public License, version 2
10.13+*** Master Lease Agreement between Boca Global, Inc. and Bordeaux
Partners LLC
10.14+ Master Lease Agreement between Registrant and Renco Investment
Company
10.15**** Consent of Linus Torvalds
13.1 Annual Report to Stockholders for the Fiscal Year Ended July 28, 2000
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants (see
page 19)
23.2 Consent of IDC
24.1 Power of Attorney (see signature page)
27.1 Financial Data Schedules
</TABLE>
- ----------
+ Confidential treatment has been requested by the Registrant as to certain
portions of this exhibit. The omitted portions have been separately filed
with the Commission.
* Incorporated by reference to the corresponding exhibit of Registrant's form
S-1 and the amendments thereto (Commission registration no. 333-88687).
** Incorporated by reference to the corresponding exhibit of Registrant's form
S-4 and the amendment thereto (Commission registration no. 333-35704).
*** Incorporated by reference from Exhibit 10.16 of Registrant's form S-1 and
the amendments thereto (Commission registration no. 333-88687).
**** Incorporated by reference from Exhibit 10.18 of Registrant's Quarterly
Report on Form 10-Q for the period ended January 28, 2000 filed on March
13, 2000 (Commission file number 000-28369).
<PAGE> 17
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.
Date: October 24, 2000
VA Linux Systems, Inc.
By: /s/ LARRY M. AUGUSTIN
--------------------------
Larry M. Augustin
President and Chief Executive Officer
<PAGE> 18
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Larry M. Augustin and Todd B. Schull, and
each of them, his true and lawful attorneys-in-fact, each with full power of
substitution, for him and all capacities, to sign any amendments to this report
on Form 10-K and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission and does
hereby ratify and confirm all that each of said attorneys-in-fact or their
substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirement 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.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ Larry M. Augustin President, Chief Executive Officer and October 24, 2000
- ------------------------------- Director (Principal Executive Officer)
Larry M. Augustin
/s/ Todd B. Schull Vice President, Finance and October 24, 2000
- ------------------------------- Chief Financial Officer
Todd B. Schull (Principal Financial and Accounting
Officer)
/s/ Jeffry R. Allen Director October 24, 2000
- -------------------------------
Jeffry R. Allen
/s/ Carol A. Bartz Director October 24, 2000
- -------------------------------
Carol A. Bartz
/s/ Douglas Leone Director October 24, 2000
- -------------------------------
Douglas Leone
/s/ Eric S. Raymond Director October 24, 2000
- -------------------------------
Eric S. Raymond
/s/ Carl Redfield Director October 24, 2000
- -------------------------------
Carl Redfield
</TABLE>
<PAGE> 19
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
reports included (or incorporated by reference) in this Form 10-K into the
Company's previously filed Registration Statement File Nos. 333-38874,
333-38768, 333-38766, 333-92391 and 333-92409.
/s/ Arthur Andersen LLP
San Jose, California
October 24, 2000
<PAGE> 20
VA LINUX SYSTEMS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO ADDITIONS
BEGINNING COSTS AND DUE TO BALANCE AT
DESCRIPTION OF PERIOD EXPENSES ACQUISITIONS DEDUCTIONS END OF PERIOD
----------- --------- -------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C>
Year Ended July 31, 1998
Allowance for doubtful accounts................ $ -- $ 39 $ -- $ -- $ 39
Year Ended July 31, 1999
Allowance for doubtful accounts................ $ 39 $ 168 $ -- $ -- $ 207
Year Ended July 28, 2000
Allowance for doubtful accounts................ $207 $1,328 $150 $210 $1,475
</TABLE>
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-10.14
<SEQUENCE>2
<FILENAME>f66473ex10-14.txt
<DESCRIPTION>EXHIBIT 10.14
<TEXT>
<PAGE> 1
SINGLE TENANT LEASE FORM*
(NET FORM)
THIS LEASE, dated April 6, 2000 for reference purposes only, is made by and
between RENCO INVESTMENT COMPANY ("Landlord") and VA LINUX SYSTEMS CORPORATION,
a Delaware Corporation ("Tenant"), to be effective and binding upon the parties
as of the date the last of the designated signatories to this Lease shall have
executed this Lease (the "Effective Date of this Lease").
ARTICLE 1
REFERENCES
1.1 REFERENCES: All references in this Lease (subject to any further
clarifications contained in this Lease) to the following terms shall have the
following meaning or refer to the respective address, person, date, time
period, amount, percentage, calendar year or fiscal year as below set forth:
A. Tenant's Address for Notices: VA LINUX SYSTEMS, INCORPORATED
B. Tenant's Representative: Mr. Todd Schull
Business Phone Number: _________________________________
Home Phone Number: _________________________________
Home Address: _________________________________
C. Landlord's Address for Notices: 1285 Oakmead Parkway,
Sunnyvale, CA 94086
D. Landlord's Representative: Gerald E. Hodnefield
Phone Number: (408) 730-5500
E. Lease Commencement Date: June 1, 2000
F. Lease Term: Ten (10) Years
G. Lease Expiration Date: May 31, 2010
H. Tenant's Punchlist Period: Thirty calendar days from
delivery of The Premises to
Tenant
I. First Month's Prepaid Rent: *
J. Last Month's Prepaid Rent: None
K. Tenant's Security Deposit: *
L. Late Charge Amount: Six (6%) Percent of the late
amount(s)
M. Tenants Liability Coverage: Three Million ($3,000,000)
Dollar Single Limit
N. Parking Spaces: All spaces provided within the
Project
O. Leased Premises: That certain space which is a combination of
buildings containing 139,311 square feet of leasable area referred to as Renco
42 and Renco 47 (the "Project" or the "Property"), which space is shown outlined
in red on the Floor Plan attached hereto as Exhibit "B" consisting of
approximately 139,311 square feet of leasable area measuring to the outside edge
of the outside walls and drip lines, but not including the connecting hallway,
and, for purposes of this Lease, agreed between Landlord and Tenant to contain
said number of square feet. The Leased Premises are commonly known by address as
follows: 47071 and 46939 Bayside Parkway, Fremont, California, 94538.
P. Base Monthly Rent: The term "Base Monthly Rent" shall mean the
amount of rent due and payable on the first day of each month of the Lease Term
which for purposes of this Lease is agreed to be the monthly sum of * for each
full month of the first year of the Lease Term, * for each full month of the
second year of the Lease Term, * for each full month of the third year of the
Lease Term, * for each full month of the fourth year of the Lease Term, * for
each full month of the fifth year of the Lease Term, * for each full month of
the sixth year of the Lease Term, * for each full month of the seventh year of
the Lease Term, * for each full month of the eighth year of the Lease Term, *
for each full month of the ninth year of the Lease Term, and * for each full
month of the tenth year of the Lease Term. Any partial month shall be prorated
on the basis of a 30 day month.
Q. Permitted Use: The term "Permitted Use" shall mean that Landlord
and Tenant agree that Tenant shall use the Premises for: manufacture, assembly,
repair, sales, marketing and distribution of electronic parts and components,
internet services, and related office and support functions and for no other
use.
R. Exhibits: The term "Exhibits" shall mean the Exhibits to this
Lease which are described as follows:
Exhibit "A" -- Site Plan showing the "Project" (or "Property")
and delineating the Building in which the Leased
Premises are located.
Exhibit "B" -- Floor Plan outlining the Leased Premises.
Exhibit "C" -- Tenant Improvements Agreement.
S. Addenda: The term "Addenda" shall mean the Addendum (or Addenda)
to this Lease which is (or are) described as follows:
Signage Criteria
Option to Renew Lease
Letter of Credit securitizing Lease costs
ARTICLE 2
LEASED PREMISES, TERM AND POSSESSION
2.1 LEASE OF PREMISES: Landlord hereby leases to Tenant and Tenant hereby
leases from Landlord that certain interior space described above as the Leased
Premises (or "Premises"). Landlord reserves the right to install, maintain, use
and replace ducts, wires, conduits and pipes leading through the Leased
Premises in locations which will not materially interfere with Tenant's use of
the Leased Premises. Tenant's use of the Leased Premises, together with the
appurtenant right to use the Common Areas shall be conditioned upon and be
subject to the continuing compliance by Tenant with (i) all the terms and
conditions of the Lease, (ii) all Laws governing the use of the Leased Premises
and the Project, (iii) all Private Restrictions, easements and other matters
now of public record respecting the use of the Leased Premises and the Project,
and (iv) all reasonable rules and regulations from time to time established by
Landlord.
- -------
* Portions of this exhibit have been redacted pursuant to a confidential
treatment request filed with the Commission.
-1-
<PAGE> 2
2.2 RIGHT TO USE COMMON AREAS: As an appurtenant right to Tenant's right
to the use of the Leased Premises, Tenant shall have the exclusive right, except
to the extent noted elsewhere herein, to use the Common Areas.
2.3 LEASE COMMENCEMENT DATE AND LEASE TERM: The term of this Lease shall
begin, and the Lease Commencement Date shall be deemed to have occurred, on the
Commencement Date (as set forth in Article 1.1. The term of the Lease shall
expire on the Lease Expiration Date, subject, however, to the Option to Renew
Lease attached hereto.
2.4 DELIVERY OF POSSESSION: Landlord shall deliver to Tenant possession of
the Leased Premises on the business day subsequent to the delivery of all fully
executed lease documents, lease exhibits, and lease addenda, together with all
monies required thereof from Tenant to Landlord.
2.5 ACCEPTANCE OF POSSESSION: Upon the expiration of Tenant's Punchlist
Period, Tenant shall be conclusively deemed to have accepted the condition of
the Leased Premises in their then-existing condition as so delivered by Landlord
to Tenant, except as to those items reasonably set forth in the punchlist
submitted to Landlord prior to the expiration of said period. Landlord agrees to
correct all items reasonably set forth in Tenant's punchlist, at Landlord's sole
cost and expense, provided that such punchlist was submitted to Landlord within
Tenant's Punchlist Period. The punchlist items shall consist of making the
repairs and effecting the service as noted below, and shall be limited to such.
Landlord agrees to place in good working order all existing plumbing, lighting,
ceiling tiles, skylights (including replacing cracked or duct-taped skylights),
elevator, electrical systems, heating, ventilating and air conditioning systems
within the Leased Premises and all man doors and roll-up truck doors serving the
Leased Premises to the extent that such systems and/or items are not in good
operating condition as of the date Tenant accepts possession of the Leased
Premises, or as quickly thereafter as can be reasonably accomplished, provided
that, and only if, Tenant notifies Landlord in writing of such failures or
deficiencies within thirty calendar days from the date Tenant so accepts
possession of the Leased Premises. Notwithstanding the foregoing, Landlord
warrants and represents that the Leased Premises shall comply with all Laws,
(including, without limitation, the ADA) as of the Lease Execution Date.
2.6 SURRENDER OF POSSESSION: Immediately prior to the expiration or sooner
termination of this Lease, Tenant shall remove all of Tenant's signs from the
exterior of the Building and shall remove all of Tenant's equipment, trade
fixtures, furniture, supplies, wall decorations and other personal property from
the Leased Premises, and shall vacate and surrender the Leased Premises to
Landlord in the same condition, broom clean, as existed at the Lease
Commencement Date, reasonable wear and tear, damage from casualty and
condemnation, and the Initial Tenant Improvements excepted. Landlord, at
Tenant's expense, shall retain a mechanical contractor to service all heating,
ventilation and air conditioning equipment, and Tenant shall pay the cost to
restore (or replace as required), said equipment to good working order. Tenant
shall repair all damage to the Leased Premises caused by Tenant or by Tenant's
removal of Tenant's property and all damage to the exterior of the Building
caused by Tenant's removal of Tenant's signs. Tenant shall patch and refinish,
to Landlord's reasonable satisfaction, all penetrations made by Tenant or its
employees to the floor, walls or ceiling of the Leased Premises, whether such
penetrations were made with Landlord's approval or not. Tenant shall replace all
stained or damaged ceiling tiles and shall repair or replace, as necessary, all
wall coverings and clean or replace, as may be required, floor coverings to the
reasonable satisfaction of Landlord. Tenant shall replace all burned out light
bulbs and damaged or stained light lenses. Tenant shall repair all damage caused
by Tenant to the exterior surface of the Building and the paved surfaces of the
outside areas adjoining the Leased Premises and, where necessary, replace or
resurface same. Additionally, Tenant shall, prior to the expiration or sooner
termination of this Lease, remove any improvements constructed or installed by
Tenant, (other than the Initial Tenant Improvements), which Landlord requests,
at the time of consent to such improvements, be so removed by Tenant and repair
all damage caused by such removal. If the Leased Premises are not surrendered to
Landlord in the condition required by this Article at the expiration or sooner
termination of this Lease, Landlord may, at Tenant's expense, so remove Tenant's
signs, property and/or improvements not so removed and make such repairs and
replacements not so made or hire, at Tenant's expense, independent contractors
to perform such work. Tenant shall be liable to Landlord for all costs incurred
by Landlord in returning the Leased Premises to the required condition and
Tenant shall be deemed to have impermissibly held over until such time as such
required work is completed. Tenant shall pay Base Monthly Rent and Additional
Rent in accordance with the terms of Section 13.2 (Holding Over) until such work
is completed.
ARTICLE 3
RENT, LATE CHARGES AND SECURITY DEPOSITS
3.1 BASE MONTHLY RENT: Commencing on the Lease Commencement Date and
continuing throughout the Lease Term, Tenant shall pay to Landlord, without
prior written or oral demand in advance on the first day of each calendar month,
as base monthly rent, the amount set forth as "Base Monthly Rent" in Article 1.
3.2 ADDITIONAL RENT: Commencing on the Lease Commencement Date and
continuing throughout the Lease Term, in addition to the Base Monthly Rent,
Tenant shall pay to Landlord as additional rent (the "Additional Rent") all
Building Operating Expenses (as defined in Article 13). Payment shall be made by
one of the following methods: Landlord may bill to Tenant, on a periodic basis
not more frequently than monthly, such expenses (or group of expenses) as paid
or incurred by Landlord, and Tenant shall pay such expenses within ten days
after receipt of a written bill therefore from Landlord; and/or Landlord may
budget the annual projected expenses and bill to Tenant on a monthly basis,
one-twelfth of the annual amount. If Landlord elects the latter of the
alternatives, Landlord shall reconcile the budgeted amounts with the actual
amounts on an annual basis during the first quarter of the subsequent year and
bill Tenant for any additional amounts or credit Tenant any overpayments against
future Additional Rent amounts.
3.3 LATE CHARGE AND INTEREST ON RENT IN DEFAULT: Tenant acknowledges that
the late payment by Tenant of any monthly installment of Base Monthly Rent or
any Additional Rent will cause Landlord to incur certain costs and expense not
contemplated under this Lease, the exact amounts of which are extremely
difficult or impractical to fix. Such costs and expenses will include, without
limitation, administration and collection costs and processing and accounting
expenses. If any installment of Base Monthly Rent or Additional Rent is not
received
-2-
<PAGE> 3
by Landlord from Tenant within six calendar days after the same becomes due,
Tenant shall immediately pay to Landlord a late charge in an amount equal to
six percent of the amounts due and not so paid. Landlord and Tenant agree that
this late charge represents a reasonable estimate of such costs and expenses
and is fair compensation to Landlord for the anticipated loss Landlord would
suffer by reason of Tenant's failure to make timely payment. In no event shall
this provision for a late charge be deemed to grant to Tenant a grace period or
extension of time within which to pay any rental installment or prevent
Landlord from exercising any right or remedy available to Landlord upon
Tenant's failure to pay each rental installment due under this Lease when due.
If any rent remains delinquent for a period in excess of six calendar days,
then, in addition to such late charge, Tenant shall pay to Landlord interest on
any rent that is not so paid from said six day at the then maximum rate of
interest not prohibited by Law until paid. Notwithstanding the foregoing, no
such late charge shall be payable on the first such failure to pay Base Monthly
Rent or Additional Rent in any twelve (12) month period unless Landlord shall
have given Tenant notice of such failure to pay and Tenant fails to pay such
Base Monthly Rent or Additional Rent within five (5) days of such notice.
3.4 PAYMENT OF RENT: All rent shall be paid without any abatement,
deduction or offset for any reason whatsoever, to Landlord at such address as
Landlord may designate from time to time. Tenant's obligation to pay Base
Monthly Rent and all Additional Rent shall be prorated at the commencement and
expiration of the Lease Term. The failure by Tenant to pay any Additional Rent
as required pursuant to this Lease when due shall be treated the same as a
failure by Tenant to pay Base Monthly Rent when due, and Landlord shall have
the same rights and remedies against Tenant as Landlord would have if Tenant
failed to pay the Base Monthly Rent when due.
3.5 SECURITY DEPOSIT: Upon signing this Lease, Tenant shall immediately
deposit with Landlord the amount set forth in Article 1 as the "Security
Deposit" as security for the performance by Tenant of the terms of this Lease
and not as prepayment of rent. Landlord may apply such portion or portions of
the Security Deposit as are reasonably necessary for the following purposes:
(i) to remedy any default (beyond applicable notice and cure periods) by Tenant
in the payment of Base Monthly Rent or Additional Rent or a late charge or
interest on defaulted rent; (ii) to repair damage to the Leased Premises caused
by Tenant; (iii) to clean and repair the Leased Premises following their
surrender to Landlord if not surrendered in the condition required pursuant to
the provisions of Article 2; and (iv) to remedy any other default of Tenant to
the extent permitted by Law including, without limitation, paying in full on
Tenant's behalf any sums claims by materialmen or contractors or Tenant to be
owing to them by Tenant for work done or improvements made at Tenant's request
to the Leased Premises. Tenant shall not be entitled to any interest on the
Security Deposit. If Landlord transfers the Building during the Lease Term,
Landlord may pay the Security Deposit to any subsequent owner in conformity
with the California Civil Code, in which event the transferring landlord shall
be released from all liability for the return of the Security Deposit. In no
event shall the Security Deposit, or any portion thereof, be considered prepaid
rent.
3.6 LETTER OF CREDIT: As additional consideration for Landlord's entering
into this Lease and performing under its terms and conditions, Tenant agrees to
provide Landlord with an irrevocable letter of credit in a form reasonably
satisfactory to Landlord in the amount of Two Million, Two Hundred and Fifty
Thousand ($2,250,000.00) Dollars. Such Letter of Credit shall be annually
renewed and Tenant shall provide Landlord with such Letter of Credit for a
minimum period of Five years commencing with the Commencement Date and Expiring
at the end of the Sixtieth month thereafter if, and only if, Tenant has not been
in material default of the Lease or its terms beyond applicable notice and cure
periods. Such Letter of Credit shall be reduced by Twenty (20%) Percent of its
original face amount ($450,000.00) on each anniversary date of the Commencement
Date such that by the end of the sixtieth month of the Lease Term, the remaining
amount of the Letter of Credit shall be cancelled. In the event of a material
default beyond applicable notice and cure periods on the part of Tenant during
the term of the Letter of Credit, the Letter of Credit amount shall be renewed
at the level existing at the time of said material default and shall be renewed
each year of the Lease Term at such level during the remainder of the Lease
Term. The Letter of Credit shall have the following provisions:
1) In the event a material default beyond applicable notice and
cure periods by Tenant has occurred and is continuing, Landlord shall be
entitled to make a draw for the sum of the face amount of the Letter of Credit,
or any portion thereof.
2) Landlord shall be entitled to make a draw for the sum of the
face amount of the Letter of Credit in the event Tenant fails, within 30 days
prior to the expiration of the existing Letter of Credit, to deliver a new
Letter of Credit to Landlord in the amount agreed upon under the terms of this
Lease.
3) The Letter of Credit shall be transferable in whole but not in
part to a new owner and Landlord.
4) Partial drawing shall be allowed.
5) The Letter of Credit shall be subject to the Uniform Customs and
Practice for Documentary Credits (1993 Revision), International Chamber of
Commerce Publication 500.
6) The Letter of Credit shall be from a US National Bank
(reasonably acceptable to Landlord) with a branch located in the Greater San
Francisco Bay Area.
It is hereby agreed between Landlord and Tenant that any amounts drawn on the
Letter of Credit by Landlord shall be used by Landlord to satisfy Tenant's
breach of the Lease and/or to reimburse Landlord for damages occasioned by a
breach of the Lease which may include, without limitation, the following: (a)
Landlord's brokerage commissions with respect to the Lease; (b) Landlord's
Tenant Improvement Costs pursuant to Exhibit C of the Lease; and (c) Landlord's
legal expenses occasioned by the breach. It is expressly agreed, however, that
the foregoing shall not in any way modify the Letter of Credit nor create any
defense or excuse for the bank paying all or any portion of the Letter of
Credit upon Landlord complying with the draw requirements set forth in the
Letter of Credit. Should Landlord inadvertently draw down the Letter of Credit
more than is necessary to cure such Lease breaches, such excess shall be added
to the Security Deposit under Article 3.5 above.
ARTICLE 4
USE OF LEASED PREMISES AND COMMON AREAS
4.1 PERMITTED USE: Tenant shall be entitled to use the Leased Premises
solely for the "Permitted Use" as set forth in Article 1 and for no other
purpose whatsoever. Subject to the limitations contained in this Article 4,
Tenant shall have the right to use the Common Areas, solely for the purposes
for which they were intended and for
-3-
<PAGE> 4
no other purposes whatsoever. Tenant shall not have the right to use the
exterior surfaces of exterior walls without the prior written consent of
Landlord.
4.2 GENERAL LIMITATIONS ON USE: Tenant shall not do or permit anything to
be done in or about the Leased Premises, the Building, the Common Areas or the
Project which does or could (i) interfere with the rights of neighboring
tenants, (ii) jeopardize the structural integrity of the Building or the
Project, or (iii) cause damage to any part of the Building or the Project.
Tenant shall not operate any equipment within the Leased Premises which does or
could (i) injure, vibrate or shake the Leased Premises or the Building, (ii)
damage, overload, corrode, or impair the efficient operation of any electrical,
plumbing, sewer, heating, ventilating or air conditioning systems within or
servicing the Leased Premises or the Building or (iii) damage or impair the
efficient operation of the sprinkler system within or servicing the Leased
Premises or the Building. Tenant shall not install any equipment or antennas on
or make any penetrations of the exterior walls or roof of the Building. Tenant
shall not affix any equipment to or make any penetrations or cuts in the
floor, ceiling or walls of the Leased Premises. Tenant shall not place any
loads upon the floors, walls, ceiling or roof systems which could endanger the
structural integrity of the Building or damage its floors, foundations or
supporting structural components. Tenant shall not place any explosive,
flammable or harmful fluids, including Hazardous Materials in any sanitary or
storm sewer or place any waste materials in the storm drainage systems of the
Building or the Project. Tenant shall not drain or discharge any fluids in the
landscaped areas or across the paved areas of the Project. Tenant shall not use
any area located outside the Leased Premises for the storage of its materials,
supplies, inventory or equipment, and all such materials, supplies, inventory
and equipment shall at all times be stored within the Leased Premises. Tenant
shall not commit nor permit to be committed any waste in or about the Leased
Premises, the Common Areas or the Project.
4.3 NOISE AND EMISSIONS: All noise generated by Tenant in its use of the
Leased Premises shall be confined or muffled so that it does not interfere with
the businesses of or annoy neighboring tenants. All dust, fumes, odors and
other emissions generated by Tenant's use of the Leased Premises shall be
sufficiently dissipated in accordance with sound environmental practices and
exhausted from the Leased Premises in such a manner so as not to interfere with
the businesses of or annoy neighboring tenants, or cause any damage to the
Leased Premises or the Building or any component part thereof or the property
of neighboring tenants.
4.4 TRASH DISPOSAL: Tenant shall provide trash and garbage disposal
facilities inside the Leased Premises for all of its trash, garbage and waste
requirements unless Landlord shall have provided fenced areas for "dumpsters"
and shall cause such trash, garbage and waste to be regularly removed from the
Leased Premises at Tenant's sole cost. Tenant shall keep all areas outside the
Leased Premises and all fire corridors and mechanical equipment rooms in or
about the Leased Premises free and clear of all trash, garbage, waste and boxes
containing same at all times.
4.5 PARKING. Tenant and its employees and invitees shall have the exclusive
right to use all of the parking spaces provided within the Project. In the
event Landlord is required by any Law to limit or control parking within the
Project, whether by validation of parking tickets or any other method, Tenant
agrees to participate in such validation or other program as reasonably
established by Landlord. Tenant shall not, at any time, park or permit to be
parked any trucks or vehicles adjacent to entryways or loading areas within the
Project so as to interfere in any way with the use of such areas, nor shall
Tenant, at any time, park or permit the parking of Tenant's trucks or other
vehicles, or the trucks and vehicles of Tenant's suppliers or others, in any
portion of the Common Areas not designated by Landlord for such use. Tenant
shall not, at any time, park or permit to be parked any recreational vehicles,
inoperative vehicles or equipment on any portion of the common parking area or
other Common Areas of the Project. Tenant agrees to assume responsibility for
compliance by its employees and invitees with the parking provisions contained
herein. Tenant hereby authorizes Landlord, at Tenant's sole expense, to tow
away from the Project and store until redeemed by its owner any vehicle
belonging to Tenant or Tenant's employees parked in violation of these
provisions.
4.6 SIGNS: Tenant shall not place or install on or within any portion of the
Leased Premises, the Building, the Common Areas or the Project any sign (other
than a business identification sign first approved by Landlord in accordance
with this Article), advertisements, banners, placards or pictures which are
visible from the exterior of the Leased Premises. Tenant shall not place or
install on or within any portion of the Leased Premises, the Building, the
Common Areas or the Project any business identification sign which is visible
from the exterior of the Leased Premises until Landlord shall have first
approved in writing the location, size, content, design, method of attachment
and material to be used in the making of such sign. Any signs, once approved by
Landlord, shall be installed only in strict compliance with Landlord's approval,
at Tenant's expense, using a person first approved by Landlord to install same.
Landlord may remove any signs (not first approved in writing by Landlord),
advertisements, banners, placards or pictures so placed by Tenant on or within
the Leased Premises, the Building, the Common Areas or the Project and charge to
Tenant the cost of such removal, together with any costs incurred by Landlord to
repair any damage caused thereby, including any cost incurred to restore the
surface upon which such sign was so affixed to its original condition. Tenant
shall remove any such signs, repair any damage caused thereby, and restore the
surface upon which the sign was affixed to its original condition, all to
Landlord's reasonable satisfaction, upon the termination of this Lease.
Notwithstanding the foregoing, however, Tenant shall be allowed to place its
identification signs and logos in the areas which were previously used by
Syquest Technologies, Inc. on the same buildings and upon the same monuments.
4.7 LANDLORD'S RIGHT TO ENTER: Landlord and its agents shall have the right
to enter the Leased Premises during normal business hours upon at least twenty
four (24) hours prior notice (except in the event of an emergency) and subject
to Tenant's reasonable security measures for the purpose of (i) inspecting the
same; (ii) supplying any services to be provided by Landlord to Tenant; (iii)
showing the Leased Premises to prospective purchasers, mortgagees or tenants;
(iv) making necessary alterations, additions or repairs; (v) performing any of
Tenant's obligations when Tenant has failed to do so after giving Tenant
reasonable written notice of its intent to do so; and (vi) posting notices of
non-responsibility or "For Lease" or "For Sale" signs. Additionally, Landlord
shall have the right to enter the Leased Premises without notice to Tenant at
times of emergency. Notwithstanding the foregoing, Landlord shall not show the
Leased Premises to tenants or post "For Lease" signs except during the last six
(6) months of the Lease Term (including extensions thereof).
4.8 CONTROL OF COMMON AREAS: Landlord shall at all times have the
administrative control of the
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<PAGE> 5
Common Areas including without limitation, the right to prohibit mobile food
and beverage or other vendors from entering the Property.
4.9 RULES AND REGULATIONS: Landlord shall have the right from time to
time to establish reasonable rules and regulations regarding the use of the
Common Areas. Upon delivery to Tenant of a copy of such reasonable rules and
regulations, Tenant shall comply with such rules and regulations.
4.10 OUTSIDE AREAS: No materials, pallets, supplies, tanks or containers
whether above or below ground level, equipment, finished products or
semi-finished products, raw materials, inoperable vehicles or articles of any
nature shall be stored upon or permitted to remain outside of the Leased
Premises except in fully fenced and screened areas outside the Building which
have been designed for such purpose and have been approved in writing by
Landlord for such use by Tenant.
4.11 HAZARDOUS MATERIALS: Landlord and Tenant agree that with respect to the
existence or use of Hazardous Materials (as defined as such under current laws
or regulations as may be amended from to time) on the Property, any handling,
transportation, storage, treatment, disposal or use of Hazardous Materials
(other than the use of ordinary office and janitorial products), in any amount,
by Tenant, Tenant's agents, or any other party associated with Tenant must be
absolutely and completely disclosed to and approved in writing by Landlord prior
to its arrival in the Premises. Landlord may uncontestably withhold Landlord's
approval at Landlord's sole discretion. Any withholding from Landlord of
information relating to Hazardous Materials used or stored by Tenant shall
constitute a material default under the terms of the Lease and shall be cause
for lease termination at Landlord's option. Any use or storage of any disclosed
Hazardous Materials in or about the Property, which use or storage shall have
been approved by Landlord, shall strictly comply with all applicable Hazardous
Materials laws. Tenant shall, upon request by Landlord, provide proof of
approvals by the governing authorities. Landlord's consent or approval once
given shall not constitute approval for any subsequent bringing of Hazardous
Materials onto the Premises or Project. Tenant shall indemnify, defend upon
demand with counsel reasonably acceptable to Landlord, and hold harmless
Landlord from and against any and all liabilities, losses, claims, damages, lost
profits, consequential damages, interest, penalties, fines, court costs,
remediation costs, investigation costs, and other expenses which result from or
arise in any manner whatsoever out of the use, storage, treatment,
transportation, release, or disposal of Hazardous Materials on or about the
Leased Premises or the Property by Tenant, Tenant's agents, permittees, or
invitees. If the presence of Hazardous Materials on the Leased Premises, the
Building, or the Project caused or permitted by Tenant, Tenant's agents,
permittees, or invitees result in contamination or deterioration to any extent
of water, soil, or any part of the Lease Premises, the Building, or the Project,
then Tenant shall promptly take any and all action necessary to remove said
Hazardous Materials and to return the Project (and any other property of
whatever nature) to their condition existing prior to the appearance of such
Hazardous Materials. Landlord may at any time and at Tenant's sole cost perform
any tests or investigations (including the installation of testing wells), it
deems appropriate to determine the presence of Hazardous Materials on the
Project. The terms of this clause shall survive the expiration or sooner
termination of this Lease. To the best knowledge of Landlord, (a) no Hazardous
Material is present on the Project or the soil, surface water or groundwater
thereof, (b) no underground storage leaks are present on the Project, and (c) no
action, proceeding or claim is pending or threatened regarding the Project
concerning any Hazardous Material or pursuant to any environmental law. Under no
circumstance shall Tenant be liable for, and Landlord shall indemnify, defend,
protect and hold harmless Tenant, its agents, contractors, stockholders,
directors, successors, representatives, and assigns from and against all losses,
costs, claims, liabilities and damages (including reasonable attorneys' and
consultants' fees) of every type and nature, directly or indirectly arising out
of or in connection with any Hazardous Material present at any time on or about
the Project, or the soil, air, improvements, groundwater or surface water
thereof, or the violation of any laws, orders or regulations, relating to any
such Hazardous Material except to the extent that any of the foregoing actually
results from the release or emission of Hazardous Material by Tenant or its
agents or employees in violation of applicable environmental laws.
ARTICLE 5
REPAIRS, MAINTENANCE, SERVICES AND UTILITIES
5.1 REPAIRED AND MAINTENANCE: The parties shall have the following
obligations and responsibilities with respect to the repair and maintenance of
the Leased Premises, the Building and the Common Areas.
A. Tenant's Obligation: Tenant shall, at all times during the Lease
Term and at its sole cost and expense, regularly clean and continuously keep
and maintain in good order, condition and repair the Leased Premises and every
part thereof and all appurtenances thereto, including, without limiting the
generality of the foregoing, (i) all interior walls, floors and ceilings, (ii)
all windows, doors and skylights, (iii) all electrical wiring, conduits,
connectors and fixtures, (iv) all plumbing, pipes, sinks, toilets, faucets and
drains, (v) all lighting fixtures, bulbs and lamps, (vi) all heating,
ventilating and air conditioning equipment located within the Leased Premises
or located outside the Leased Premises (e.g. rooftop compressors) and serving
the Leased Premises and (vii) all entranceways to the Leased Premises. Tenant,
if requested to do so by Landlord, shall hire, at Tenant's sole cost and
expense, a licensed heating, ventilating and air conditioning contractor to
regularly, and periodically inspect (not less frequently than every three
months) and perform required maintenance on the heating, ventilating and air
conditioning equipment and systems serving the Leased Premises, or
alternatively, Landlord may, at its election, contract in its own name for such
regular and periodic inspections of and maintenance on such heating,
ventilating and air conditioning equipment and systems and charge to Tenant, as
Additional Rent, the cost thereof. Tenant shall, at its sole cost and expense,
repair all damage to the Building, the Common Areas or the Project caused by
the activities of Tenant, its employees, invitees or contractors promptly
following written notice from Landlord to so repair such damage. If Tenant
shall fail to perform the required maintenance or fail to make repairs required
of it pursuant to this Article within a reasonable period of time following
notice from Landlord to do so, then Landlord may, at its election and without
waiving any other remedy it may otherwise have under this Lease or at Law,
perform such maintenance or make such repairs and charge to Tenant, as
Additional Rent, the costs so incurred by Landlord for same. All glass within
or a part of the Leased Premises, both interior and exterior, is at the sole
risk of Tenant and any broken glass shall promptly be replaced by Tenant at
Tenant's expense with glass of the same kind, size and quality.
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B. Landlord's Obligation: Landlord shall, during the Lease
Term or any extensions thereof, and at Landlord's sole cost and expense, repair
the exterior structural parts of the Building (including the foundation,
concrete walls, and roof structure) (the "Structural Portions"). In addition,
Landlord, at Tenant's sole cost and expense, shall be responsible for
maintaining in good and servicable repair, the roof membrane, the glazing, the
Common Area, the paved areas (including driving surfaces, curbs and gutters and
landscaping. During the time that Renco Investment Company owns the Project,
Landlord shall, also maintain in good condition and repair: the exterior
finishes including paint, and the electrical and plumbing systems located
outside the Leased Premises which service the Building, all heating, ventilating
and air conditioning equipment located within the Leased Premises or located
outside the Leased Premises (e.g. rooftop compressors). Landlord shall charge
Tenant, as Additional Rent, the costs incurred by Landlord in making such
non-structural repairs and maintenance. In the event that Landlord elects to
replace the roof membrane or elects to replace the parking and driveway areas,
(as opposed to repairing such items) such cost shall be paid for by Landlord and
the cost of such replacement(s) shall be amortized at the interest rate of Ten
(10%) Percent per annum over the useful life of the replacement. The monthly
amortized amount shall become a Building Operating Expense and Tenant shall pay
such amortized portions of such Building Operating Expense as provided in
Section 13.11.G.
5.2 SERVICES AND UTILITIES: The parties shall have the following
responsibilities and obligations with respect to obtaining and paying the cost
of providing the following utilities and other services to the Leased Premises.
A. Gas and Electricity: Tenant shall arrange, at its sole
cost and expense and in its own name, for the supply of gas and electricity to
the Leased Premises. Tenant shall be responsible for determining if the local
supplier of gas and/or electricity can supply the needs of Tenant and whether
or not the existing gas and/or electrical distribution systems within the
Building and the Leased Premises are adequate for Tenant's needs. Tenant shall
pay all charges for gas and electricity as so supplied to the Leased Premises.
B. Water: Tenant shall arrange, at its sole cost and expense
and in its own name, for the supply of water to the Leased Premises.
C. Security Service: Tenant acknowledges that Landlord is
not responsible for the security of the Leased Premises or the protection of
Tenant's property or Tenant's employees, invitees or contractors, and that to
the extent Tenant determines that such security or protection services are
advisable or necessary, Tenant shall arrange for and pay the costs of providing
same.
D. Trash Disposal: Tenant acknowledges that Landlord is not
responsible for the disposal of Tenant's waste, garbage or trash and that Tenant
shall arrange, in its own name and at its sole cost, for the regular and
periodic removal of such waste, garbage, or trash from the Leased Premises. In
no event shall Landlord be required to provide trash bins for the disposal of
Tenant's waste, garbage or trash.
5.3 LIMITATION OF LANDLORD'S LIABILITY: Landlord shall not be liable to
Tenant for injury to Tenant, its employees, agents, invitees or contractors,
damage to Tenant's property or loss of Tenant's business or profits, nor shall
Tenant be entitled to terminate this lease or to any reduction in or abatement
of rent by reason of (i) any failure, interruption, rationing or other
curtailment in the supply of water, electric current, gas or other utility
service to the Leased Premises, the Building or the Project from whatever cause
(other than Landlord's active negligence or willful misconduct), or (ii) the
unauthorized intrusion or entry into the Leased Premises by third parties.
ARTICLE 6
ALTERATIONS AND IMPROVEMENTS
6.1 BY TENANT: Tenant shall not make any alterations to or modifications of
the Leased Premises or construct any improvements to or within the Leased
Premises without Landlord's prior written approval, and then not until Landlord
shall have first approved, in writing, the plans and specifications therefore,
which approval shall not be unreasonably withheld. Tenant may, however, make
nonstructural alterations without Landlord's consent to the extent the cost of
any particular project is less than twenty-five thousand dollars ($25,000). All
such modifications, alterations or improvements, once so approved, shall be
made, constructed or installed by Tenant at Tenant's expense, using a licensed
contractor first approved by Landlord, in substantial compliance with the
Landlord-approved plans and specifications therefore. All work undertaken by
Tenant shall be done in accordance with all Laws and in a good and workmanlike
manner using new materials of good quality that match or complement the original
improvements existing as of the Lease Commencement Date. Tenant shall not
commence the making of any such modifications or alterations or the construction
of any such improvements until (i) all required governmental approvals and
permits shall have been obtained, (ii) all requirements regarding insurance
imposed by this Lease have been satisfied, (iii) Tenant shall have given
Landlord at least five business days prior written notice of its intention to
commence such work so that Landlord may post and file notices of
non-responsibility, and (iv) if requested by Landlord, Tenant shall have
obtained contingent liability and broad form builder's risk insurance in an
amount satisfactory to Landlord to cover any perils relating to the proposed
work not covered by insurance carried by Tenant pursuant to Article 9. In no
event shall Tenant make any modifications, alterations or improvements to the
Common Areas or any areas outside of the Leased Premises. As used in this
Article, the term "modifications, alterations and/or improvements" shall
include, without limitation, the installation of additional electrical outlets,
overhead lighting fixtures, drains, sinks, partitions, doorways, or the like.
Tenant shall pay Landlord's reasonable costs to inspect the construction of
Tenant's alterations or modifications and to have Landlord's architect revise
Landlord's drawings to show the work performed by Tenant. Notwithstanding the
above provisions, however, Landlord and Tenant acknowledge that as a part of the
consideration of Tenant and Landlord having entered into this Lease Agreement,
that Tenant intends to modify the interior of the Leased Premises. By the terms
of Exhibit "C" hereof, Landlord agrees to reimburse Tenant for a portion of the
expense in the modification of said interior (the "Initial Tenant
Improvements").
6.2 OWNERSHIP OF IMPROVEMENTS: All modifications, alterations or
improvements made or added to the Leased Premises by Tenant (other than
Tenant's inventory, equipment, movable furniture, wall decorations and trade
fixtures) shall be deemed real property and a part of the Leased Premises, but
shall remain the property of Tenant during the Lease Term. Any such
modifications, alterations or improvements, once completed, shall not be
altered or removed from the Leased Premises during the Lease Term without
Landlord's written approval first obtained in accordance with the provisions of
the Article above. At the expiration or sooner termination of the Lease, all
such modifications, alterations and improvements (other than Tenant's inventory,
equipment, movable furniture, wall decorations and trade fixtures) shall
automatically become the property of Landlord and shall be surrendered to
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Landlord as a part of the Leased Premise as required pursuant to Article 2,
unless Landlord shall require Tenant to remove any of such modifications,
alterations or improvements by giving Tenant written notice of such requirement
at the time of consent, in which case Tenant shall so remove same on or before
the expiration of the Lease Term (including extensions thereof). Landlord shall
not require Tenant to remove any of the Initial Tenant Improvements. Landlord
shall have no obligations to reimburse to Tenant all or any portion of the cost
or value of any such modifications, alterations or improvements so surrendered
to Landlord. All modifications, alterations or improvements which are installed
or constructed on or attached to the Leased Premises by Landlord at Landlord's
expense shall be deemed real property, and a part of the Leased Premises and
shall be the property of Landlord. All lighting, plumbing, electrical, heating,
ventilating and air conditioning fixtures, partitioning, window coverings, wall
coverings and floor coverings installed by Tenant shall be deemed improvements
to the Leased Premises and not trade fixtures of Tenant.
6.3 ALTERATIONS: Throughout the terms of this Lease or any extensions
thereof, at its sole cost, Tenant shall make all modifications, alterations and
improvements to the Leased Premises that are required by any Law for any
reason. Notwithstanding the foregoing, in no event shall Tenant be required to
cause the Structural Portions of the Buildings (concrete walls, foundations,
and the structural portions of the roof) to comply with Laws unless such
requirement is due solely to Tenant's particular use.
6.4 LIENS: Tenant shall keep the Leased Premises, the Building and the
Property free from any liens and shall pay when due all bills arising out of
any work performed, materials furnished, or obligations incurred by Tenant, its
agents, employees or contractors relating to the Leased Premises.
ARTICLE 7
ASSIGNMENT AND SUBLETTING BY TENANT
7.1 BY TENANT: Tenant shall not sublet the Leased Premises (or any portion
thereof) or assign or encumber its interest in this Lease, whether voluntarily
or by operation of Law, without Landlord's prior written consent first obtained
in accordance with the provisions of this Article 7. Any attempted subletting,
assignment or encumbrance without Landlord's prior written consent, at
Landlord's election, shall constitute a default by Tenant under the terms of
this Lease. The acceptance of rent by Landlord from any person or entity other
than Tenant, or the acceptance of rent by Landlord from Tenant with knowledge
of a violation of the provisions of this Article, shall not be deemed to be a
waiver by Landlord of any provision of this Article or this Lease or to be a
consent to any subletting by Tenant or any assignment or encumbrance of
Tenant's interest in this Lease. Notwithstanding the foregoing, however,
Landlord hereby gives its consent to sublet the premises commonly known and
referred to as Renco 47 consisting of approximately 51,767 square feet of space
for only the initial period of 36 months from the Commencement Date, without
Landlord's participation in Assignment Consideration and Excess Rentals and
without being subject to any recapture or termination rights under Section
7.3. Such subletting shall be to a reasonable subtenant and Landlord shall have
the same rights as described in this Article 7 saving and excepting therefrom
only the provision that Tenant share with the Landlord, Assignment
Consideration and Excess Rentals. Notwithstanding anything to the contrary
herein, Tenant may, without Landlord's prior written consent, sublet the Leased
Premises or assign the Lease to (a) a subsidiary, affiliate, division or
corporation controlling, controlled by or under common control with Tenant, (b)
a successor corporation related to Tenant by merger, consolidation,
non-bankruptcy reorganization, or government action, or (c) a purchaser of
substantially all of Tenant's assets located in the Premises. A sale or
transfer of Tenant's capital stock shall not be deemed an assignment, subletting
or any other transfer of the Lease or the Leased Premises.
7.2 INTENTIONALLY DELETED
7.3 LANDLORD'S ELECTION: If Tenant or Tenant's successors shall desire to
assign its interest under this Lease or to sublet the Leased Premises, Tenant
and Tenant's successors must first notify Landlord, in writing, of its intent to
so assign or sublet, at least thirty days in advance of the date it intends to
so assign its interest in this Lease or sublet the Leased Premises but not
sooner than sixty days in advance of such date, specifying in detail the terms
of such proposed assignment or subletting, including the name of the proposed
assignee or sublessee, the proposed assignee's or Sublessee's intended use of
the Leased Premises, a current financial statement of such proposed assignee or
sublessee and the form of documents to be used in effectuating such assignment
or subletting. Landlord shall have a period of fifteen days following receipt of
such notice and receipt of all information reasonably requested by Landlord
regarding the proposed assignee or sublessee within which to do one of the
following: (a) in the event of an assignment or sublease of more than fifty
(50%) percent of an entire Building for substantially the remaining Lease Term,
to terminate the Lease as to that part of the Leased Premises proposed to be so
sublet, or assigned or (b) if Landlord shall not have elected to or does not
have the option to cancel and terminate this Lease, to either (i) consent to
such requested assignment or subletting subject to Tenant's and Tenant's
successors' compliance with the conditions set forth in Article 7.4 below or
(ii) refuse to so consent to such requested assignment or subletting, provided
that such consent shall not be unreasonably refused. It shall not be
unreasonable for Landlord to withhold its consent to any proposed assignment or
subletting if (i) the proposed assignee's or subtenant's anticipated use of the
Premises involves the storage, use or disposal of a Hazardous Material; (ii) if
the proposed assignee or subtenant has been required by any prior landlord,
lender or governmental authority to clean up Hazardous Materials unlawfully
discharged by the proposed assignee or subtenant; or (iii) if the proposed
assignee or subtenant is subject to investigation or enforcement order or
proceeding by any governmental authority in connection with the use, disposal or
storage of a Hazardous Material. Tenant and Tenant's successors covenant and
agree to supply to Landlord, upon request, with all necessary or relevant
information which Landlord may reasonably request respecting such proposed
assignment or subletting and/or the proposed assignee or sublessee. Landlord's
review period shall not commence until Landlord has received all information
requested by Landlord.
7.4 CONDITIONS TO LANDLORD'S CONSENT: If Landlord elects to consent, or
shall have been ordered to so consent by a court of competent jurisdiction, to
such requested assignment, subletting or encumbrance, such consent shall be
expressly conditioned upon the occurrence of each of the conditions below set
forth. The conditions are as follows:
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A. Landlord having approved in form and substance the assignment or
sublease agreement (or the encumbrance agreement), which approval shall not be
unreasonably withheld by Landlord if the requirements of this Article 7 are
otherwise complied with.
B. Each such sublessee or assignee having agreed, in writing
satisfactory to Landlord and its counsel and for the benefit of Landlord, to
assume, to be bound by, and to perform the obligations of this Lease to be
performed by Tenant (or, in the case of an encumbrance, each such encumbrancer
having similarly agreed to assume, be bound by and to perform Tenant's
obligations upon a foreclosure or transfer in lieu thereof).
C. Tenant being in full compliance, having cured any defaults under
the terms of this Lease through and including the date of the requested consent,
as well as through and including the date such assignment or subletting is to
become effective.
D. Tenant having reimbursed to Landlord all reasonable costs and
attorneys fees incurred by Landlord in conjunction with the processing and
documentation of any such requested subletting, assignment or encumbrance.
E. Tenant having delivered to Landlord a complete and fully-executed
duplicate original of such sublease agreement, assignment or encumbrance (as
applicable) and all related agreements.
F. Tenant having paid, or having agreed in writing to pay as to future
payments, to Landlord fifty percent of all assignment consideration or excess
rentals to be paid to Tenant or to any other on Tenant's behalf or for Tenant's
benefit for such assignment or subletting as follows:
(1) If Tenant assigns its interest under the Lease and if all or a
portion of the consideration for such assignment is to be paid by the assignee
at the time of the assignment, that Tenant shall have paid to Landlord and
Landlord shall have received an amount equal to fifty percent of the assignment
consideration so paid or to be paid (whichever is the greater) at the time of
the assignment by the assignee after subtracting Tenant's reasonable costs in
connection therewith (including, without limitation reasonable brokerage
commissions and attorneys' fees and the unamortized portion of Tenant
Improvements paid for solely by Tenant ("Assignment/Subletting Costs"), all
reduced to a monthly amount to be allocated over the remaining term of the
Lease; or
(2) If Tenant assigns its interest under this Lease and if Tenant is
to receive all or a portion of the consideration for such assignment in future
installments, that Tenant and Tenant's assignee shall have entered into a
written agreement with and for the benefit of Landlord satisfactory to Landlord
and its counsel whereby Tenant and Tenant's assignee jointly agree to pay to
Landlord an amount equal fifty percent of all such future assignment
consideration installments to be paid by such assignee as and when such
assignment consideration is so paid after subtracting Tenant's
Assignment/Subletting Costs.
(3) If Tenant subleases the Leased Premises, that Tenant and Tenant's
sublessee shall have entered into a written agreement with and for the benefit
of Landlord satisfactory to Landlord and its counsel whereby Tenant and Tenant's
sublessee jointly agree to pay to Landlord fifty percent of all excess rentals
to be paid by such sublessee as and when such excess rentals are so paid after
subtracting Tenant's Assignment/Subletting Costs.
7.5 ASSIGNMENT CONSIDERATION AND EXCESS RENTALS DEFINED: For purposes of
this article, the term "Assignment Consideration" shall mean all consideration
to be paid by the Assignee as consideration for such assignment, and the term
"Excess Rentals" shall mean all consideration to be paid by the Sublessee in
excess of the rent to be paid by said Sublessee/Sublessor for the premises
subleased for the same period. It is specifically intended and agreed that this
provision is intended to be a fifty percent profit sharing clause, such that
Tenant and Landlord shall share and share alike in any profits (after
reasonable costs of subletting or assignment) as a result of any transfer of an
interest in the Lease or the Leased Premises or any other property, as more
particularly described herein. In the event Tenant or Tenant's successors
sublease a portion of the Leased Premises, "Excess Rentals" shall be calculated
by subtracting the rent payable by the Sublessor for the portion of the Leased
Premises so sublet from all consideration to be paid by such Sublessee. Rent
payable by the Sublessor for the portion of the Leased Premises so sublet shall
be calculated by multiplying the Base Monthly Rent payable by the Sublessor for
the Leased Premises leased by such Sublessor by a fraction, the numerator of
which is the area in square fee subleased and the denominator of which is the
total floor area of the Leased Premises leased by such Sublessor also in square
feet. Tenant and Tenant's Successors agree that fifty percent of any Assignment
Consideration and/or Excess Rentals hereunder after subtracting Tenant's
Assignment/Subletting Costs shall be the property of Landlord and fifty percent
of such shall be the property of Tenant.
7.6 PAYMENTS: All payments required by this Article to be made to Landlord
shall be made in cash in full as and when they become due. At the time Tenant,
Tenant's assignee or sublessee makes each such payment to Landlord, Tenant or
Tenant's assignee or sublessee, as the case may be, shall deliver to Landlord
an itemized statement in reasonable detail showing the method by which the
amount due Landlord was calculated and certified by the party making such
payment as true and correct. Landlord may require that all payments of Excess
Rentals and/or Assignment Consideration to be made hereunder be made directly
to Landlord by such Transferee.
7.7 GOOD FAITH: The rights granted to Tenant by this Article are granted
in consideration of Tenant's express covenant that all pertinent allocations
which are made by Tenant between the rental value of the Leased Premises and
the value of any of Tenant's personal property which may be conveyed or leased
concurrently with and which may reasonably be considered a part of the same
transaction as the permitted assignment or subletting shall be made fairly,
honestly and in good faith. If Tenant shall breach this Covenant of Good Faith,
Landlord may immediately declare Tenant to be in default under the terms of
this Lease and terminate this Lease and/or exercise any other rights and
remedies Landlord would have under the terms of this Lease in the case of a
material default by Tenant under this Lease.
7.8 EFFECT OF LANDLORD'S CONSENT: No subletting, assignment or encumbrance,
even with the consent of Landlord, shall relieve Tenant of its personal and
primary obligation to pay rent and to perform all of the obligations to be
performed by Tenant hereunder. Consent by Landlord to one or more assignments or
encumbrances of Tenant's interest in this Lease or to one or more sublettings of
the Leased Premises shall not be deemed to be a consent to any subsequent
assignment, encumbrance or subletting. If Landlord shall have been ordered by a
court of competent jurisdiction to consent to a requested assignment or
subletting, or such an assignment or subletting shall have been ordered over the
objection of Landlord, such assignment or subletting shall not be binding
between the assignee (or sublessee) and Landlord until such time as all
conditions set forth in Article 7.4 above have been fully satisfied (to the
extent not then satisfied) by the assignee or sublessee, including, without
limitation, the payment to Landlord of all agreed assignment considerations
and/or excess rentals then due Landlord.
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ARTICLE 8
LIMITATIONS ON LANDLORD'S LIABILITY AND INDEMNITY
8.1 LIMITATION ON LANDLORD'S LIABILITY AND RELEASE: Except to the extent
of the active negligence or willful misconduct of Landlord or its agents or
contractors or a breach of Landlord's obligations under the Lease, Landlord
shall not be liable to Tenant for, and Tenant hereby releases Landlord and its
partners and officers from, any and all liability, whether in contract, tort or
on any other basis, for any injury to or any damage sustained by Tenant, its
agents, employees, contractors or invitees; any damage to Tenant's property; or
any loss to Tenant's business, loss of Tenant's profits or other financial loss
of Tenant resulting from or attributable to the condition of, the management of,
the maintenance of, or the protection of the Leased Premises or the failure of
any component of the Premises, the Building, the Project or the Common Areas,
including, without limitation, any such injury, damage or loss resulting from
(i) the failure, interruption, rationing or other curtailment or cessation in
the supply of electricity, water, gas or other utility service to the Project,
the Building or the Leased Premises; (ii) the vandalism or forcible entry into
the Building or the Leased Premises; (iii) the penetration of water into or onto
any portion of the Leased Premises through roof leaks or otherwise; (iv) the
failure to provide security and/or adequate lighting in or about the Project,
the Building or the Leased Premises; (v) the existence of any design or
construction defects within the Project, the Building or the Leased Premises;
(vi) the failure of any mechanical systems to function properly (such as the
HVAC systems); or (vii) the blockage of access to any portion of the Project,
the Building or the Leased Premises.
8.2 TENANT'S INDEMNIFICATION OF LANDLORD: Except to the extent of the
active negligence or willful misconduct of Landlord or its agents or contractors
or a breach of Landlord's obligations under the Lease, Tenant shall defend
Landlord, with competent counsel reasonably satisfactory to Landlord, against
and claims made or legal actions filed or threatened by third parties against
Landlord which result from the death, bodily injury, personal injury, damage to
property or interference with contractual or other rights suffered by any third
party, (including other Tenants within the Project) which (i) occurred within
the Leased Premises or the Common Areas or (ii) resulted from Tenant's use or
occupancy of the Leased Premises or the Common Areas or (iii) resulted from
Tenant's activities in or about the Leased Premises, the Building or the
Project, and Tenant shall indemnify and hold Landlord, Landlord's principals,
employees and agents harmless from any loss (including loss of rents by reason
of vacant space which otherwise would have been leased but for such
activities), liabilities, penalties, or expense whatsoever (including all legal
fees incurred by Landlord with respect to defending such claims) resulting
therefrom. The terms of his indemnity agreement pertain to events which shall
have occurred during the term of this Lease but the indemnity shall survive the
expiration or sooner termination of this Lease.
ARTICLE 9
INSURANCE
9.1 TENANT'S INSURANCE: Tenant shall maintain insurance complying with
all of the following:
A. Tenant shall procure, pay for and keep in force and effect, at
all times during the Lease Term, the following:
(1) Commercial General Liability insurance insuring Tenant
against liability for bodily injury, death, property damage and personal injury
occurring at the Leased Premises, or resulting from Tenant's use or occupancy of
the Leased Premises or the Building, Outside Areas, Property, or Common Areas or
resulting from Tenant's activities in or about the Leased Premises. Such
insurance shall be on an occurrence basis with a combined single limit of
liability of not less than the amount of Tenant's Required Liability Coverage
(as set forth in Article 1). The policy or policies shall be endorsed to name
Landlord and such others as are designated by Landlord as additional insureds
and shall contain the following additional endorsement: "The insurance afforded
to the additional insureds is primary insurance. If the additional insureds have
other insurance which is applicable to the loss on a contributing, excess or
contingent basis, the amount of this insurance company's liability under this
policy shall not be reduced by the existence of such other insurance. Any
insurance carried by the additional insureds shall be excess and non
contributing with the insurance provided by the Tenant." The policy shall not be
canceled or reduced without at least 30 days written notice to additional
insureds. If the policy insures more than one location, it shall be endorsed to
show that the limits and aggregate apply per location. Tenant's policy shall
also contain the severability of interest and cross-liability endorsement or
clauses.
(2) Fire and property damage insurance in so-called Special
Form insuring Tenant against loss from physical damage to Tenant's personal
property, inventory, stock, trade fixtures and improvements within the Leased
Premises with coverage for the full actual replacement cost thereof;
(3) Plate-glass insurance, at actual replacement cost;
(4) Product Liability insurance shall not be required by
Landlord.
(5) Workers' compensation insurance and any other employee
benefit insurance sufficient to comply with all Laws which policy shall be
endorsed to provide thirty (30) days written notice of cancellation to Landlord.
(6) Comprehensive Auto Liability insurance with a combined
single limit coverage of not less than the amount of Tenant's Required
Liability Coverage (as set forth in Article 1.1 M. Each policy of liability
insurance required to be carried by Tenant pursuant to this Article or actually
carried by Tenant with respect to the Leased Premises or the Property (i) shall
be in a form satisfactory to Landlord, (ii) Shall be provided by carriers
admitted to do business in the State of California, with a Best rating of
"A/VI" or better and/or acceptable to Landlord. Property insurance shall
contain a waiver and/or a permission to waive by the insurer any right of
subrogation against Landlord, its principals, employees, agents and contractors
which might arise by reason of any payment under such policy or by reason of
any act or omission of Landlord, its principals, employees, agents or
contractors.
(7) Business Interruption Insurance which shall adequately
compensate Tenant for any losses incurred due to Tenant's inability to use the
Premises whether caused by the act or failure to act by Landlord or any other
reason Tenant shall have been denied the full and normal use of the Premises or
any portion thereof.
C. Prior to the time Tenant or any of its contractors enters the
Leased Premises, Tenant shall deliver to the Landlord with respect to each
policy of insurance required to be carried by Tenant pursuant to this Article,
a certificate of the insurer certifying, in a form reasonably satisfactory to
the Landlord, that the policy has been issued and premium paid providing the
coverage required by this Article and containing the provisions herein.
Attached to
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such a certificate shall be endorsements naming Landlord as additional insured,
and including the wording under primary insurance above. Landlord may at any
time and from time-to-time inspect and/or copy any and all insurance policies
required to be carried by Tenant pursuant to this article.
D. The Commercial General Liability insurance carried by Tenant shall
specifically insure the performance by Tenant of the Indemnification provisions
set forth in Article 8.2 of this lease provided, however, nothing contained in
this Article 9 shall be construed to limit the liability of Tenant under the
Indemnification provisions set forth in said Article 8.2.
E. Notwithstanding anything contained herein to the contrary, all
insurance policies and coverages required under the terms of this Lease shall
require a minimum notice to Landlord of Thirty (30) days prior to a
cancellation, of such coverages or providers.
F. In the event that Tenant shall not have acquired all of the insurance
coverages and policies as required above, by the Lease Commencement Date,
Landlord shall have the right but not the obligation to acquire such coverages
and policies on behalf of Tenant at Tenant's sole cost and expense, and Tenant
shall, upon demand by Landlord, reimburse to Landlord, all costs associated
with the premiums, acquisition, and administration of such coverages and
policies, and such costs shall be a Building Operating Expense.
9.2 LANDLORD'S INSURANCE: With respect to insurance maintained by Landlord:
A. Landlord shall maintain, as the minimum coverage required of it by
this Lease, property insurance insuring Landlord (and such others as Landlord
may designate) against loss from physical damage to the Building with coverage
of not less than one hundred percent of the full actual replacement cost thereof
and against loss of rents for a period of not less than twelve months. Such
property damage insurance, at Landlord's election but without any requirement on
Landlord's behalf to do so, (i) may be written in so-called Special Form,
excluding only those perils commonly excluded from such coverage by Landlord's
then property damage insurer; (ii) may provide coverage for physical damage to
the improvements so insured for up to the entire full actual replacement cost
thereof; (iii) may be endorsed to include (or separate policies which may be
carried to cover) loss or damage caused by any additional perils against which
Landlord may elect to insure, including earthquake and/or flood; (iv) may
provide coverage for loss of rents for a period of up to twelve months; and/or
(v) may contain "deductibles" per occurrence in an amount reasonably acceptable
to Landlord. Landlord shall not be required to cause such insurance to cover any
of Tenant's personal property, inventory and trade fixtures, or any
modifications, alterations or improvements made or constructed by Tenant to or
within the Leased Premises.
B. Landlord shall maintain Commercial General Liability insurance
insuring Landlord (and such others as are designated by Landlord) against
liability for personal injury, bodily injury, death, and damage to property
occurring in, on or about, or resulting from the use or occupancy of the
Project, or any portion thereof, with combined single limit coverage of at least
Two Million Dollars. Landlord may carry such greater coverage as Landlord or
Landlord's Lender, insurance broker or advisor or counsel may from time to time
determine is reasonably necessary for the adequate protection of Landlord and
the Project.
C. Landlord may maintain any other insurance which in the opinion of its
lender, insurance broker or advisor, or legal counsel is reasonably prudent to
carry under the given circumstances.
9.3 MUTUAL WAIVER OF SUBROGATION: Notwithstanding anything to the contrary in
the Lease, Landlord hereby releases Tenant, and Tenant hereby releases Landlord
and its respective partners and officers, agents, employees and servants, from
any and all liability for loss, damage or injury to the property of the other
in or about the Leased Premises which is caused by or results from a peril or
event or happening which would be covered by insurance required to be carried
under the terms of this Lease, or is covered by insurance actually carried and
in force at the time of the loss, by the party sustaining such loss.
ARTICLE 10
DAMAGE TO LEASED PREMISES
10.1 LANDLORD'S DUTY TO RESTORE: If the Leased Premises are damaged by any
peril after the Effective Date of this Lease, Landlord shall restore the Leased
Premises, as and when required by this Article, unless this Lease is terminated
by Landlord pursuant to Article 10.2 or by Tenant pursuant to Article 10.3. All
insurance proceeds available from the fire and property damage insurance
carried by Landlord shall be paid to and become the property of Landlord. If
this Lease is terminated pursuant to either Article 10.2 or 10.3, all insurance
proceeds available from insurance carried by Tenant which cover loss to
property that is Landlord's property or would become Landlord's property on
termination of this Lease shall be paid to and become the property of Landlord
(except to the extent such property was installed at Tenant's sole cost) and
the remainder of such proceeds shall be paid to and become the property of
Tenant. If this Lease is not terminated pursuant to either Article 10.2 or
10.3, all insurance proceeds available from insurance carried by Tenant which
cover loss to property that is Landlord's property shall be paid to and become
the property of Landlord, and all proceeds available which cover loss to
property which would become the property of Landlord upon the termination of
this Lease shall be paid to and remain the property of Tenant provided that
Tenant agrees to restore such property. If this Lease is not so terminated,
then upon receipt of the insurance proceeds (if the loss is covered by
insurance) and the issuance of all necessary governmental permits, Landlord
shall commence and diligently prosecute to completion the restoration of the
Leased Premises, to the extent then allowed by Law, to substantially the same
condition in which the Leased Premises existed as of the time just prior to
such damage or destruction. Landlord's obligation to restore shall be limited
to the Leased Premises and interior improvements constructed by Landlord.
Landlord shall have no obligation to restore any other improvements to the
Leased Premises or any of Tenant's personal property, inventory or trade
fixtures. Upon completion of the restoration by Landlord, Tenant shall
forthwith replace or fully repair all of Tenant's personal property, inventory,
trade fixtures and other improvements constructed by Tenant to like or similar
condition as existed at the time of such damage or destruction.
10.2 LANDLORD'S RIGHT TO TERMINATE: Landlord shall have the option to terminate
this Lease in the event any of the following occurs, which option may be
exercised only by delivery to Tenant of a written notice of election to
terminate within thirty days after the date of such damage or destruction:
A. The Building is damaged by any peril covered by valid and collectible
insurance actually carried by Landlord and in force at the time of such damage
or destruction (an "insured peril") to such an extent that the estimated cost
to restore the Building exceeds the lesser of (i) the insurance proceeds
(including deductibles) available
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from insurance carried by Landlord, or (ii) seventy-five percent of the then
actual estimated replacement cost thereof;
B. The Building is damaged by an uninsured peril.
D. The Building is damaged by any peril and, because of the Laws
then in force, the Building (i) can not be restored at reasonable cost or (ii)
if restored, can not be used for the same use being made thereof before such
damage. Notwithstanding the foregoing, in the event of either A or B above,
Tenant may but is not required to elect to contribute the shortfall of proceeds
within thirty (30) days of Landlord's written notice of such shortfall, in which
event Landlord shall restore the Leased Premises and shall not have the right to
terminate the Lease. In no event shall Landlord have the right to terminate the
Lease if the damage to the Leased Premises is relatively minor (e.g. repair or
restoration which would cost less than ten (10%) percent of the replacement cost
of the Leased Premises.
10.3 TENANT'S RIGHT TO TERMINATE: If the Leased Premises are damaged by any
peril and Landlord does not elect to terminate this Lease or is not entitled to
terminate this Lease pursuant to this Article, then as soon as reasonably
practicable, Landlord shall furnish Tenant with the written opinion of
Landlord's architect or construction consultant as to when the restoration work
required of Landlord may be complete. Tenant shall have the option to terminate
this Lease in the event any of the following occurs, which option may be
exercised in the case of A or B below only by delivery to Landlord of a written
notice of election to terminate with seven days after Tenant receives from
Landlord the estimate of the time needed to complete such restoration:
A. The Leased Premises are damaged by any peril and, in the
reasonably opinion of Landlord's architect or construction consultant, the
restoration of the Leased Premises cannot be substantially completed within
nine (9) months after the date of such notice from Landlord; or
B. The Leased Premises are damaged by any peril within nine
months of the last day of the Lease Term and, in the reasonable opinion of
Landlord's architect or construction consultant, the restoration of the Leased
Premises cannot be substantially completed within ninety days after the date
such restoration is commenced.
10.4 TENANT'S WAIVER: Landlord and Tenant agree that the provisions of
Article 10.3 above, captioned "Tenant's Right to Terminate", are intended to
supersede and replace the provisions contained in California Civil Code, Section
1932, Subdivision 2, and California Civil Code, Section 1934, and accordingly,
Tenant hereby waives the provisions of said Civil Code Sections and the
provisions of any successor Code Sections or similar Laws hereinafter enacted.
10.5 ABATEMENT OF RENT: In the event of damage to the Leased Premises which
does not result in the termination of this Lease, the Base Monthly Rent (and any
Additional Rent) shall be temporarily abated during the period of restoration
in proportion to the degree to which Tenant's use of the Leased Premises is
impaired by such damage.
ARTICLE 11
CONDEMNATION
11.1 RIGHT TO TERMINATE: Subject to Article 11.3, Tenant and Landlord each
shall have the option to terminate this Lease, if, as a result of a taking by
means of the exercise of the power of eminent domain, a portion greater than
thirty three (33%) percent of the Leased Premises are so taken.
11.2 INTENTIONALLY LEFT BLANK
11.3 TEMPORARY TAKING: If any portion of the Leased Premises is temporarily
taken for one year or less, this Lease shall remain in effect. If more than 33%
of the Leased Premises is temporarily taken for a period which either exceeds
one year or which extends beyond the natural expiration of the Lease Term, then
Landlord and Tenant shall each independently have the option to terminate this
Lease, effective on the date possession is taken by the condemnor.
11.4 RESTORATION AND ABATEMENT OF RENT: If any part of the Leased Premises
is taken by condemnation and this Lease in not terminated, then Landlord shall
repair any damage occasioned thereby to the remainder of the Leased Premises to
a condition reasonably suitable for Tenant's continued operations, to the extent
practicable. As of the date possession is taken by the condemning authority, (i)
the Base Monthly Rent shall be reduced in the same proportion that the area of
that part of the Leased Premises so taken bears to the area of the Leased
Premises immediately prior to such taking, and (ii) Tenant's Proportionate Share
shall be appropriately adjusted.
11.5 DIVISION OF CONDEMNATION AWARD: Any award made for any condemnation
of the Project, the Building, the Common Areas or the Lease Premises, or any
portion thereof, shall belong to and be paid to Landlord, and Tenant hereby
assigns to Landlord all of its right, title and interest in any such award.
Tenant shall, however, be entitled to made a claim for a separate award for
Tenant's fixtures and equipment, moving expenses, loss of goodwill and the
unamortized portion of improvements paid for by Tenant.
ARTICLE 12
DEFAULT AND REMEDIES
12.1 EVENTS OF TENANT'S DEFAULT: The occurrence of any of the following
shall constitute a default by Tenant: (a) failure to pay rent or other charges
when due where such failure is not cured within five days after written notice
of nonpayment; (b) failure to perform any other provision of this Lease within
the time periods provided where such failure is not cured within thirty (30)
days after written notice of such failure or such longer period as is reasonably
necessary to effect such cure.
12.2 LANDLORD'S REMEDIES: Landlord shall have the following remedies (which
are cumulative and not exclusive and are in addition to any remedies now or
later allowed by law) if Tenant is in default beyond applicable notice and cure
periods. Landlord may terminate Tenant's right to possession of the Premises at
any time. No act by Landlord other than giving notice to Tenant shall terminate
this Lease. Acts of maintenance, efforts to relet the Premises, or the
appointment of a receiver on Landlord's initiative to protect Landlord's
interest under the terms of
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<PAGE> 12
this Lease shall not constitute a termination of Tenants right to possession.
Upon termination of Tenant's right to possession, Landlord has the right to
recover from Tenant: (1) the worth of the unpaid rent that had been earned at
the time of termination of Tenant's right to possession; (2) the worth of the
amount of the unpaid rent that would have been earned after the date of
termination of Tenant's right to possession after subtracting the amount Tenant
reasonably proves could reasonably be avoided by Landlord; (3) any other
amount, including but not limited to expenses incurred to relet the premises,
court, attorney and collection costs, necessary to compensate Landlord for any
all losses caused by Tenant's default. "The worth," as used in this article, is
to be computed by allowing interest at the maximum legal interest rate
permitted by law.
12.3 LANDLORD'S DEFAULT AND TENANT'S REMEDIES: In the event Landlord fails
to perform any of its obligations under this Lease, Landlord shall nevertheless
not be in default under the terms of this Lease until such time as Tenant shall
have first given Landlord written notice specifying the nature of such failure
to perform its obligations, and then only after Landlord shall have had a
reasonable period of time following its receipt of such notice within which to
perform such obligations. In the event of Landlord's default as above set
forth, then, and only then, Tenant may then proceed at law to compel Landlord
to perform its obligations and/or to recover damages proximately caused by such
failure to perform. In the event Landlord fails to perform any of its
obligations herein or under the Lease within such reasonable time period
(except in case of emergency posing an immediate threat to persons or property,
in which case no prior notice shall be required), then Tenant shall have the
right but not the obligation to cure such default and to demand reimbursement
by Landlord for the reasonable cost of such cure with interest thereon at the
rate of ten (10%) percent per annum or the highest rate allowed by law,
whichever is less, from the date of the expenditure until repaid. Nothing in
this Article 12.3 shall entitle Tenant to offset rent or deduct such amounts
from the Base Monthly Rent or Additional Rent due under the terms of this Lease.
12.4 LIMITATION ON TENANT'S RECOURSE: Tenant agrees that the obligations
of Landlord under this Lease shall not constitute personal obligations of the
officers, directors, trustees, partners, joint venturers, members, owners,
stockholders, or other principals of any business entity which holds title to
the Project. Tenant shall have recourse only to the assets of the Project (as
shown on the Site Plan) for the satisfaction of such obligations and not to the
other assets of any individual owner such officers, directors, trustees,
partners, joint venturers, members, owners, stockholders or principals.
Additionally, if Landlord is a corporation, partnership or limited liability
corporation, then Tenant covenants and agrees:
A. No partner, stockholder, or officer of Landlord shall be sued
or named as a party in any suit or action brought by Tenant with respect to any
alleged breach of this Lease (except to the extent necessary to secure
jurisdiction over the entity and then only for that sole purpose);
B. No service of process shall be made against any partner,
stockholder, or officer of Landlord except for the sole purpose of securing
jurisdiction over the entity; and
C. No writ of execution shall be levied against the assets of
any partner or officer of Landlord other than to the extent of his interest in
the assets of the Project. Tenant further agrees that each of the foregoing
covenants and agreements shall be enforceable by Landlord and by any partner or
officer of Landlord and shall be applicable to any actual or alleged
misrepresentation or non-disclosure made respecting this Lease or the Leased
Premises or any actual or alleged failure, default or breach of any covenant or
agreement either expressly or implicitly contained in this Lease or imposed by
statute or at common law.
12.5 TENANT'S WAIVER: Landlord and Tenant agree that the provisions of
Article 12.3 above are intended to supersede and replace the provisions of
California Civil Code 1932(1), 1941 and 1942, and accordingly, Tenant hereby
waives the provisions of Section 1932(1), 1941 and 1942 of the California Civil
Code and/or any similar or successor Law regarding Tenant's right to terminate
this Lease or to make repairs and deduct the expenses of such repairs from the
rent due under this Lease. Tenant hereby waives any right of redemption or
relief from forfeiture under the Laws of the State of California, or under any
other present or future Law, in the event Tenant is evicted or Landlord takes
possession of the Leased Premises by reason of any default by Tenant.
ARTICLE 13
GENERAL PROVISIONS
13.1 TAXES ON TENANT'S PROPERTY: Tenant shall pay before delinquency any
and all taxes, assessments, license fees, use fees, permit fees and public
charges of whatever nature or description levied, assessed or imposed against
Tenant or Landlord by a governmental agency arising out of, caused by reason of
or based upon Tenant's estate in this Lease, Tenant's ownership of property,
improvements made by Tenant to the Leased Premises, improvements made by
Landlord for Tenant's use within the Leased Premises, Tenant's use (or
estimated use) of public facilities or services or Tenant's consumption (or
estimated consumption) of public utilities, energy, water or other resources.
On demand by Landlord, Tenant shall furnish Landlord with satisfactory evidence
of these payments. If any such taxes, assessments, fees or public charges are
levied against Landlord, Landlord's property, the Building or the Project, or
if the assessed value of the Building or the Project is increased by the
inclusion therein of a value placed upon same, then Landlord, after giving
written notice to Tenant, shall have the right, regardless of the validity
thereof, to pay such taxes, assessment, fee or public charge and bill Tenant,
as Additional Rent, the amount of such taxes, assessment, fee or public charge
so paid on Tenant's behalf. Tenant shall, within ten days from the date it
receives an invoice from Landlord setting forth the amount of such taxes,
assessment, fee or public charge so levied, pay to Landlord, as Additional
Rent, the amount set forth in said invoice. Failure by Tenant to pay the amount
so invoiced within said ten day period shall be conclusively deemed a default
by Tenant under this Lease. Tenant shall have the right, and with Landlord's
full cooperation if Tenant is not then in default under the terms of this
Lease, to bring suit in any court of competent jurisdiction to recover from the
taxing authority the amount of any such taxes, assessment, fee or public charge
so paid.
13.2 HOLDING OVER: This Lease shall terminate without further notice on
the Lease Expiration Date (as set forth in Article 1) as the same may be
extended pursuant to the terms of the Lease. Any holding over after the
expiration of the Lease shall be deemed an unlawful detainer of the Leased
Premises unless Landlord has consented to same in writing. Any holding over by
Tenant with written permission of Landlord shall be construed to be a tenancy
from month to month, on the same terms and conditions herein specified insofar
as applicable, except that the Base Monthly Rent shall be increased to an
amount equal to one hundred fifty percent of the Base Monthly Rent payable
during the last full month immediately preceding such period of holding over.
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13.3 SUBORDINATION TO MORTGAGES: This Lease is subject and subordinate to
all underlying ground leases and to all mortgages and deeds of trust which
affect the Building and are of public record as of the Effective Date of this
Lease, and to all renewals, modifications, consolidations, replacements and
extensions thereof. However, if the lessor under any such ground lease or any
Lender holding any such mortgage or deed of trust shall advise Landlord that it
desires or requires this Lease to be made prior and superior thereto, then, upon
written request of Landlord to Tenant, Tenant shall promptly execute,
acknowledge and deliver any and all documents or instruments which Landlord and
such lessor or Lender deem necessary or desirable to make this Lease prior
thereto. Tenant hereby consents to Landlord's ground leasing the land underlying
the Building and/or encumbering the Building as security for future loans on
such terms as Landlord shall desire, all of which future ground leases,
mortgages or deeds of trust shall be subject and subordinate to this Lease.
However, if any lessor under any such future ground lease or any Lender holding
such future mortgage or deed of trust shall desire or require that this Lease be
made subject and subordinate to such future ground lease, mortgage or deed of
trust, then Tenant agrees, within twenty (20) days after Landlord's written
request therefore, to execute, acknowledge and deliver to Landlord any and all
documents or as requested by Landlord or such lessor or Lender as may be
necessary or proper to assure the subordination of this Lease to such future
ground lease, mortgage or deed of trust; but only if such lessor or Lender
agrees to recognize Tenant's rights under this Lease and not to disturb Tenant's
quiet possession of the Leased Premises so long as Tenant is not in default
under this Lease. Tenant's failure to execute and deliver such subordination
agreement within twenty (20) days after Landlord's request therefore (after the
passage of an additional five (5) day cure period after written notice to Tenant
of such failure) shall be a material default by Tenant under this Lease, and
Landlord shall have all of the rights and remedies available to Landlord as
Landlord would otherwise have in the case of any other material default by
Tenant, including the right to terminate this Lease and sue for damages
proximately caused thereby, it being agreed and understood by Tenant that
Tenant's failure to so deliver such subordination agreement in a timely manner
could result in Landlord being unable to perform committed obligations to other
third parties which were made by Landlord in reliance upon this covenant of
Tenant. Landlord and Tenant intend that any statement delivered pursuant to this
Article may be relied upon by any Lender or purchaser or prospective Lender or
purchaser of the Building, the Project, or any interest therein. Landlord shall,
within ninety (90) days of written request by Tenant following full execution of
this Lease, use its best efforts to cause all mortgagees, lenders, and other
parties currently holding a security interest affecting the Leased Premises to
execute a recognition and non-disturbance agreement which (i) provides that this
Lease shall not be terminated so long as Tenant is not in default under this
Lease and (ii) recognizes all of Tenant's rights hereunder.
13.4 TENANT'S ATTORNMENT UPON FORECLOSURES: Tenant shall, upon request,
attorn (i) to any purchaser of the Building at any foreclosure sale or private
sale conducted pursuant to any security instrument encumbering the Building,
(ii) to any grantee or transferee designated in any deed given in lieu of
foreclosure of any security interest encumbering the Building, or (iii) to the
lessor under any underlying ground lease of the land underlying the Building,
should such ground lease be terminated; provided that such purchaser, grantee
or lessor recognizes Tenant's rights under this Lease.
13.5 MORTGAGEE PROTECTION: In the event of any default on the part of
Landlord, Tenant will give notice by registered mail to any Lender or lessor
under any underlying ground lease who shall have requested, in writing, to
Tenant that it be provided with such notice, and Tenant shall offer such Lender
or lessor a reasonable opportunity to cure the default, including time to
obtain possession of the Leased Premises by power of sale or judicial
foreclosure or other appropriate legal proceedings if reasonably necessary to
effect a cure.
13.6 ESTOPPEL CERTIFICATES: Tenant will, following any request(s) by
Landlord, promptly execute and deliver to Landlord an estoppel certificate (i)
certifying that this Lease is unmodified and in full force and effect, or, if
modified, stating the nature of such modification and certifying that this
Lease, as so modified, is in full force and effect, (ii) stating the date to
which the rent and other charges are paid in advance, if any, (iii)
acknowledging that there are not, to Tenant's knowledge, any uncured defaults
on the part of Landlord hereunder, or specifying such defaults if any are
claimed, and (iv) certifying such other information about this Lease as may be
reasonably requested by Landlord. Tenant's failure to execute and deliver such
estoppel certificate within ten days after Landlord's request therefore (after
the passage of an additional five (5) day cure period after written notice to
Tenant of such failure) shall be a material default by Tenant under this Lease,
and Landlord shall have all of the rights and remedies available to Landlord as
Landlord would otherwise have in the case of any other material default by
Tenant, including the right to terminate this Lease and sue for damages
proximately caused thereby, it being agreed and understood by Tenant that
Tenant's failure to so deliver such estoppel certificate in a timely manner
could result in Landlord being unable to perform committed obligations to
other third parties which were made by Landlord in reliance upon this covenant
of Tenant. Landlord and Tenant intend that any statement delivered pursuant to
this Article may be relied upon by any Lender or purchaser or prospective
Lender or purchaser of the Building, the Project, or any interest therein.
13.7 TENANT'S FINANCIAL INFORMATION: Tenant shall, within ten business days
after Landlord's request therefore, deliver to Landlord a copy of Tenant's most
recent, publicly disclosed, audited financial statement certified by Tenant in
writing as to its accuracy) including a publicly disclosed income statement and
balance sheet.
13.8 FORCE MAJEURE: The obligations of each of the parties under this Lease
(other than the obligation to pay money) shall be temporarily excused if such
party is prevented or delayed in performing such obligation by reason of any
strikes, lockouts or labor disputes; inability to obtain labor, materials,
fuels or reasonable substitutes therefore; governmental restrictions,
regulations, controls, action or inaction; civil commotion; inclement weather,
fire or other acts of God; or other causes (except financial inability) beyond
the reasonable control of the party obligated to perform (including acts or
omissions of the other party for a period equal to the period of any such
prevention, delay or stoppage.
13.9 NOTICES: Any notice required or desired to be given by a party
regarding this Lease shall be in writing and shall be personally served, or in
lieu of personal service may be given by depositing such notice in the United
States mail, postage prepaid, addressed to the other party at the address
specified in Article 1.1 above. Any notice required under the Lease that is
sent by mail shall be deemed received if properly addressed, three (3) business
days after any such notice is deposited in the United States mail certified,
postage prepaid, return-receipt requested.
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13.10 ATTORNEYS' FEES: In the event any party shall bring any action,
arbitration proceeding or legal proceeding alleging a breach of any provision
of this Lease to recover rent, to terminate this Lease, or to enforce, protect,
determine or establish any term or covenant of this Lease or rights or duties
hereunder of either party, the prevailing party shall be entitled to recover
from the non-prevailing party as a part of such action or proceeding, or in a
separate action for that purpose brought within one year from the determination
of such proceeding, all reasonable expenses incurred by the prevailing party.
In the event that Landlord shall be required to retain counsel to enforce any
provision of this Lease; or if Tenant defaults under this Lease and thereafter
cures (or desires to cure) such default with Landlord's consent, Tenant shall
pay to Landlord all reasonable expenses so incurred by Landlord promptly upon
demand. Landlord may enforce this provision by requiring Tenant to pay such
fees and costs as a condition to curing its default.
13.11 DEFINITIONS: Any term that is given a special meaning by any
provision in this Lease shall, unless otherwise specifically stated, have such
meaning whenever used in this Lease or in any Addenda or amendment hereto. In
addition to the terms defined in Article 1, the following terms shall have the
following meanings:
A. REAL PROPERTY TAXES: The term "Real Property Tax" or "Real Property
Taxes" shall each mean (i) all taxes, assessments, levies and other charges of
any kind or nature whatsoever, general and special (including all installments
of principal and interest required to pay any general or special assessments for
public improvements and any increases resulting from reassessments caused by any
change in ownership or new construction), now or hereafter imposed by any
governmental or quasi-governmental authority or special district having the
direct or indirect power to tax or levy assessments, which are levied or
assessed for whatever reason against the Project or any portion thereof, or
Landlord's interest therein, or the fixtures, equipment and other property of
Landlord that is an integral part of the Project and located thereon, or
Landlord's business of owning, leasing or managing the Project or the gross
receipts, income or rentals from the Project; (ii) all charges, levies or fees
imposed by any governmental authority against Landlord by reason of or based
upon the use of or number of parking spaces within the project, the amount of
public services or public utilities used or consumed (e.g. water, gas,
electricity, sewage or surface water disposal) at the Project, the number of
persons employed by tenants of the Project, the size (whether measured in area,
volume or number of tenants) or the value of the Project, or the type of use or
uses conducted within the Project; and (iii) all costs and fees (including
reasonable attorneys' fees) incurred by Landlord in contesting any Real Property
Tax and in negotiating with public authorities as to any Real Property Tax. If,
at any time during the Lease Term, the taxation or assessment of the Project
prevailing as of the Effective Date of this Lease shall be altered so that in
lieu of or in addition to any Real Property Tax described above there shall be
levied, assessed or imposed (whether by reason of a change in the method of
taxation or assessment, creation of a new tax or charge, or any other cause) an
alternate, substitute, or additional tax or charge (i) on the value, size, use
or occupancy of the Project or Landlord's interest therein or (ii) on or
measured by the gross receipts, income or rentals from the Project, or on
Landlord's business of owning, leasing or managing the Project or (iii) computed
in any manner with respect to the operation of the Project, then any such tax or
charge, however designated, shall be included within the meaning of the terms
"Real Property Taxes" for purposes of this Lease. If any Real Property Tax is
partly based upon property or rents unrelated to the Project, then only that
part of such Real Property Tax that is fairly allocable to the Project shall be
included within the meaning of the terms "Real Property Taxes". Notwithstanding
the foregoing, the term "Real Property Taxes" shall not include estate,
inheritance, transfer, gift or franchise taxes of Landlord or the federal or
state income tax imposed on Landlord's income from all sources. "Real Property
Taxes" shall not include and Tenant shall not be required to pay any portion of
any tax or assessment expense or any increase therein in excess of the amount
which would be payable if such tax or assessment expense were paid in
installments over the longest term allowed by the assessing or taxing authority.
B. LANDLORD'S INSURANCE COSTS: The term "Landlord's Insurance Costs"
shall mean the costs to Landlord to carry and maintain the policies of fire and
property damage insurance, including earthquake and flood, for the Project and
Landlord's general liability insurance carried by Landlord pursuant to Article
9, together with any deductible amounts paid by Landlord upon the occurrence of
any insured casualty or loss.
C. PROJECT MAINTENANCE COSTS: The term "Project Maintenance Costs"
shall mean all costs and expenses (except Landlord's Insurance Costs and Real
Property Taxes) paid or incurred by Landlord in protecting, operating,
maintaining, repairing and preserving the Project and all parts thereof,
including without limitation, (i) professional management fees equal to three
percent of the annualized Base Monthly Rent, (ii) the amortizing portion of any
costs incurred by Landlord in the making of any modifications, alterations or
improvements which are so amortized during the Lease Term, (iii) costs of
complying with ADA standards imposed upon Landlord, governmental regulations
governing Tenant's use of Hazardous Materials, and Landlord's costs of
monitoring Tenant's use of Hazardous Materials including fees charged by
Landlord's consultants to periodically inspect the Premises and the Property,
all costs associated with the maintaining and repairing of the parts of the
drainage district, and (v) such other costs as may be paid or incurred with
respect to operating, maintaining and preserving the Project, such as repairing
replacing and resurfacing the exterior surfaces of the buildings (including
roof membranes but not the structural portions of the roof), repairing,
replacing portions of and resurfacing paved areas, cleaning, maintaining,
repairing, or replacing the interior of the Leased Premises both during the
Lease Term and upon the termination of the Lease, and maintaining, repairing or
replacing, when necessary electrical, plumbing, sewer, drainage, heating,
ventilating and air conditioning systems serving the buildings, providing
utilities to the common areas, maintenance, repair, replacement or installation
of lighting fixtures, directional or other signs and signals, irrigation or
drainage systems, trees, shrubs, materials, maintenance of all landscaped
areas, and any rental paid for machinery and equipment (if leased).
D. READY FOR OCCUPANCY: The term "Ready for Occupancy" shall mean the
date upon which all of the Lease documents have been fully executed and
delivered to the respective parties and all monies required by the terms of the
Lease have been paid. Notwithstanding the Ready For Occupancy provision of this
Lease, and the definition thereof, the Base Monthly Rent and the Additional
Rent shall not commence until June 1, 2000.
E. TENANT'S PROPORTIONATE SHARE: The term "Tenant's Proportionate
Share" or "Tenant's Share", as used with respect to an item pertaining to the
Building, shall each mean one hundred percent of the square footage of the
Leased Premises and of the Project.
F. BUILDING'S PROPORTIONATE SHARE: Not applicable in this Single
Tenant Lease wherein Tenant is leasing both buildings.
G. BUILDING OPERATING EXPENSES: The term "Building Operating Expenses"
shall mean and include all of the of all Real Property Taxes, all Insurance
Costs, including Landlord's general liability costs and any insurance costs
relating to Article [9.1 F] herein contained, all Project Maintenance Costs, and
an accounting fee equal to three percent of the combined total of all such
costs. Notwithstanding anything to the
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<PAGE> 15
contrary in the Lease, "Building Operating Expenses" shall not include and
Tenant shall not have any obligation to perform or to pay for the following
(collectively, "Costs"): (a) Costs occasioned by the act omission or violation
of any law by Landlord; (b) Costs occasioned by a casualty or by the exercise of
the power of eminent domain; (c) Costs to correct any construction defect as
certified by a licensed architect with at least 10 years experience in the
design and construction of industrial type concrete tilt-up buildings in Santa
Clara County, in the Leased Premises or the Project on the Lease execution date;
(d) Costs incurred in connection with the presence of any Hazardous Material in,
on, under, or about the Project except to the extent caused by the release or
emission of the Hazardous Material in question by Tenant, Tenant's agents or
Tenant's employees; (e) interest, charges and fees incurred on debt; (f) Costs
of repair, maintenance and replacement of the Structural Portions of the
Buildings (concrete walls, foundations, and the structural portions of the roof)
and costs to cause such structural portions to comply with Laws.
H. LAW: The term "Law" shall mean any judicial decision and any
statute, constitution, ordinance, resolution, regulation, rule, administrative
order, or other requirement of any municipal, county, state, federal, or other
governmental agency or authority having jurisdiction over the parties to this
Lease, the Leased Premises, the Building or the Project, or any of them in
effect either at the Effective Date of this Lease or at any time during the
Lease Term, including, without limitation, any regulation, order, or policy of
any quasi-official entity or body (e.g. a board of fire examiners or a public
utility or special district).
I. LENDER: The term "Lender" shall mean the holder of any note
or other evidence of indebtedness secured by the Project or any portion thereof.
J. PRIVATE RESTRICTIONS: The term "Private Restrictions" shall
mean all recorded covenants, conditions and restrictions, private agreements,
easements, and any other recorded instruments affecting the use of the Project,
as they may exist from time to time.
K. RENT: The term "rent" shall mean collectively Base Monthly
Rent and all Additional Rent, and all other amounts owed by Tenant to Landlord.
L. COMMON AREAS: Those areas surrounded the enclosed Leased
Premises upon which exists landscaping areas, parking areas, driveway and
access areas, trash enclosures, sidewalks, and so forth which areas compose a
portion of The Project.
13.12 GENERAL WAIVERS: One party's consent to or approval of any act by
the other party, requiring the first party's consent or approval shall not be
deemed to waive or render unnecessary the first party's consent to or approval
of any subsequent similar act by the other party. No waiver of any provision
hereof shall be effective unless in writing and signed by the waiving party. The
receipt by Landlord of any rent or payment with or without knowledge of the
breach of any provision hereof shall not be deemed a waiver of any such breach.
No waiver of any provision of this Lease shall be deemed a continuing waiver
unless such waiver specifically states so in writing and is signed by both
Landlord and Tenant. No delay or omission in the exercise of any right or remedy
accruing to either party upon any breach by the other party under this Lease
shall impair such right or remedy or be construed as a waiver of any such breach
theretofore or thereafter occurring. The waiver by either party of any breach of
any provision of this Lease shall not be deemed to be a waiver of any subsequent
breach of the same or any other provisions herein contained.
13.13 MISCELLANEOUS: Should any provision of this Lease prove to be
invalid or illegal, such invalidity or illegality shall in no way affect, impair
or invalidate any other provision hereof, and such remaining provisions shall
remain in full force and effect. Time is of the essence with respect to the
performance of every provision of this Lease in which time or performance is a
factor. Any copy of this Lease which is executed by the parties shall be deemed
an original for all purposes. This Lease shall, subject to the provisions
regarding assignment, apply to and bind the respective heirs, successors,
executors, administrators and assigns of Landlord and Tenant. The term "party"
shall mean Landlord or Tenant as the context implies. If Tenant consists of more
than one person or entity, then all members of Tenant shall be jointly and
severally liable hereunder. This Lease shall be construed and enforced in
accordance with the Laws of the State of California. The language in all parts
of this Lease shall in all cases be construed as a whole according to its fair
meaning, and not strictly for or against either Landlord or Tenant. The captions
used in this Lease are for convenience only and shall not be considered in the
construction or interpretation of any provision hereof. When the context of this
Lease requires, the neuter gender includes the masculine, the feminine, a
partnership or corporation or joint venture, and the singular includes the
plural. The terms "must", "shall", "will" and "agree" are mandatory. The term
"may" is permissive. When a party is required to do something by this Lease, it
shall do so at its sole cost and expense without right of reimbursement from the
other party unless specific provision is made therefore. Where Tenant is
obligated not to perform any act or is not permitted to perform any act, Tenant
is also obligated to restrain any others reasonably within its control,
including agents, invitees, contractors, subcontractors and employees, from
performing said act. Landlord shall not become or be deemed a partner or a joint
venturer with Tenant by reason of any of the provisions of this Lease.
13.14 REASONABLE EXPENSES: Any expenditure by a party permitted or
required under the Lease, for which such party is entitled to demand and does
demand reimbursement from the other party, shall be limited to the fair market
value of the goods and services involved, shall be reasonably incurred, and
shall be substantiated by documentary evidence available for inspection and
review by the other party or its representative during normal business hours.
13.15 APPROVALS: Whenever the Lease requires an approval, consent,
designation, determination, selection or judgment by either Landlord or Tenant,
such approval, consent, designation, determination, selection or judgment and
any conditions imposed thereby shall be reasonable and shall not be unreasonably
withheld or delayed and, in exercising any right or remedy hereunder, each party
shall at all times act reasonably and in good faith.
ARTICLE 14
CORPORATE AUTHORITY
14.1 CORPORATE AUTHORITY: If Tenant is a corporation, each individual
executing this Lease on behalf of said corporation represents and warrants that
Tenant is validly formed and duly authorized and existing, that Tenant is
qualified to do business in the State of California, that Tenant has the full
right and legal authority to enter into this Lease, that he or she is duly
authorized to execute and deliver this Lease on behalf of Tenant in accordance
with the bylaws and/or a board of directors' resolution of Tenant, and that
this Lease is binding upon Tenant in accordance with its terms.
5/2/00
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<PAGE> 16
14.2 ENTIRE AGREEMENT: This Lease, the Exhibits (as described in Article 1) and
the Addenda (as described in Article 1), which Exhibits and Addenda are by this
reference incorporated herein, constitute the entire agreement between the
parties, and there are no other agreements, understandings or representations
between the parties relating to the lease by Landlord of the Leased Premises to
Tenant, except as expressed herein. No subsequent changes, modifications or
additions to this Lease shall be binding upon the parties unless in writing and
signed by both Landlord and Tenant.
14.3 LANDLORD'S REPRESENTATIONS: Tenant acknowledges that neither Landlord nor
any of its agents made any representations or warranties respecting the
Project, the Building or the Leased Premises, upon which Tenant relied in
entering into this Lease, which are not expressly set forth in this Lease.
Tenant further acknowledges that neither Landlord nor any of its agents made
any representations as to (i) whether the Leased Premises may be used for
Tenant's intended use under existing Law or (ii) the suitability of the Leased
Premises for the conduct of Tenant's business or (iii) the exact square footage
of the Leased Premises, that Tenant relied solely upon its own investigations
respecting said matters and that upon its execution of this Lease, accepts the
leasable area as specified herein. Tenant expressly waives any and all claims
for damage by reason of any statement, representation, warranty, promise or
other agreement of Landlord or Landlord's agent(s), if any, not contained in
this Lease or in any Addenda hereto.
IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as of the
respective dates below set forth with the intent to be legally bound thereby as
of the Effective Date of this Lease.
AS LANDLORD: AS TENANT:
RENCO INVESTMENT COMPANY VA LINUX SYSTEMS, INCORPORATED
BY: /s/ GERALD E. HODNEFIELD BY: /s/ BRIAN BILES
---------------------------------- ---------------------------------
Gerald E. Hodnefield, General Partner Brian Biles, VP Mktg
BY: /s/ DONALD E. VERMEIL BY: /s/ TODD SCHULL
---------------------------------- ---------------------------------
Donald E. Vermeil, General Partner Todd Schull, CFO
BY: /s/ RICHARD PEERY
----------------------------------
Richard Peery, General Partner
TITLE:
-------------------------------
DATE: 5/2/00 DATE: 5/2/00
-------------------------------- --------------------------------
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<PAGE> 17
EXHIBIT A
BAYSIDE TECHNOLOGY PARK
46393-47071 BAYSIDE PARKWAY
[MAP]
<PAGE> 18
EXHIBIT "B"
SYQUEST TECHNOLOGY INTERIOR
47911 BAYSIDE PARKWAY FREMONT CA
[INTERIOR MAP]
<PAGE> 19
EXHIBIT "B"
SYQUEST TECHNOLOGY INTERIOR
47911 BAYSIDE PARKWAY FREMONT CA
[INTERIOR MAP]
<PAGE> 20
EXHIBIT "B"
SYQUEST TECHNOLOGY INTERIOR
[INTERIOR MAP]
<PAGE> 21
EXHIBIT "C"
TENANT IMPROVEMENT ALLOWANCE LETTER
INTERIOR ALLOWANCE
1. Landlord agrees that it will provide tenant improvement money for the
improvement of the interior of the Leased Premises as follows:
Subject to Landlord's reasonable approval Tenant shall have the flexibility to
design a floor plan that suits Tenant's needs so long as Tenant's plan
preserves the general purpose nature of the building and the interior.
The term "general purpose improvements" is intended to mean those improvements
(and the configuration of such improvements) that can be used by a majority of
users who have or are likely to locate in electronic manufacturing or support
type industrial or office buildings or for mandated upgrades due to ADA
requirements. Special purpose improvements include but are not limited to the
following: raised computer floors, compressed air systems, gas or liquid
distribution systems, haylon fire extinguishing systems, excess or redundant
HVAC equipment or distribution systems, flammable or solvent storage or waste
systems, special electrical systems, lighting levels in excess of Title 24
limitations, redundant or backup electrical power, telephone systems, alarm
systems, public address systems, fire sprinkler monitoring equipment, computer
cabling, burn in rooms, sound insulated rooms, plumbing other than for domestic
use, clean rooms, window covering, moveable partitions, equipment used in
eating or food handling facilities, materials (or the arrangement of materials)
that are unique to one segment of users, the connection of Tenant's equipment
to building HVAC, electric, or plumbing systems ("fit up"), and the like.
Subject to Landlord's approval, Tenant at its sole cost and expense shall
install all required improvements and fixtures to provide for any Hazardous
Materials which have been approved in writing by Landlord.
Landlord reimburse Tenant for the cost of general purpose Tenant Improvements up
to a maximum of *. Tenant agrees to pay in cash the entire cost of construction
(if any) of Tenant Improvements in excess of the above amount.
Tenant shall provide to Landlord a Conceptual Plan (Conceptual Plan) for the
Tenant Improvements showing Tenant's preference for the location of: doors,
partitions, ceilings, air conditioned areas, restrooms, offices, conference
areas, entries, assembly or manufacturing areas, storage and distribution
areas, and any proposed alterations to existing improvements in Landlord's
Building. Landlord shall be allowed 3 business days to approve or make
suggestions as to changes in the Conceptual Plan. Landlord's approval shall not
be unreasonably withheld. Tenant shall pay the costs of such special purpose
improvements at Tenants sole costs and expense.
Tenant shall also be solely responsible for the design, approval, and payment
of the costs of construction for any and all work, fixtures, or materials
required for the construction of Tenant's interior improvements as shown on
Construction Drawings approved by Landlord and Tenant. Landlord shall reimburse
Tenant for construction costs as specified above, with the exceptions noted,
upon the following terms and conditions:
1) Provide Landlord with a Conceptual Plan as noted above and as
approved by Landlord.
2) Complete construction by December 31, 2000
3) Comply with the provisions of Article 6 of the Lease
*redacted, confidential treatment requested
<PAGE> 22
Tenant Improvement Agreement
Interior Allowance
Page 2
4) Use materials and construction techniques (where appropriate) which
match, complement, or exceed the quality of those used by Landlord
in the construction of the existing improvements
5) Provide Landlord with reproducible drawings showing the construction
performed by Tenant
The funds that Landlord has agreed to spend specifically exclude any and all
fees charged by governmental agencies for Tenant's use of Hazardous Materials
(approved in writing by Landlord) or Tenant's service of food which fees
include but are not limited to: sewer or sanitary district fees, health
department fees, air quality fees, excess water usage fees, and the like. Any
and all such fees shall be paid by Tenant to the appropriate governmental
agency.
Upon being presented with evidence reasonably satisfactory to Landlord that all
the construction bills have been paid and that the dates for any liens have
expired or lien rights waived by materialmen, suppliers, contractors and
subcontractors, Landlord shall reimburse Tenant to Tenant's construction costs
as provided above.
<PAGE> 23
OPTION TO RENEW LEASE
This Option to Renew Lease ("Option") is entered into by and between RENCO
INVESTMENT COMPANY, a California General Partnership ("Landlord") and VA LINUX
SYSTEMS, INCORPORATED, A Delaware Corporation ("Tenant") to be effective as of
the date the last of the designated signatories to this Option shall have
executed this Option, with respect to the following described Lease (the
"Lease") for the following described premises (the "Leased Premises"):
"That certain Lease dated as of April 6, 2000, by and between Landlord
and Tenant for the lease of approximately 139,311 square feet in those certain
buildings consisting of 87,544 and 51,767 square feet, more or less, located at
46939 and 47071 Bayside Parkway, Fremont, CA 94538.
1. For and in consideration of Tenant entering into the Lease and other
valuable consideration, Landlord hereby grants to Tenant an option to renew the
Lease for an additional term of Five (5) years (the "Renewal Term") commencing
on the expiration of the Lease (the "Renewal Commencement Date") and ending
Five) years thereafter (Renewal Expiration Date").
2. The lease of the Leased Premises for the Renewal Term shall be on the
same terms and conditions as set forth in the Lease, except:
A. That the rental for the Leased Premises during the Renewal Term
shall be as set forth below in Paragraph 5, and
B. That the Security Deposit shall be increased to the rental
amount determined in Paragraph 5 (the "Increased Security Deposit Amount") plus
the sum of Five Hundred ($500) Dollars.
C. Exhibit "C" shall be inoperative in that there shall be no
Tenant Improvement Allowance for the modification of the interior of the Leased
Premises for the option period.
3. Provided that Tenant shall not have been in default under the Lease
prior to the exercise of this Option as defaults are defined in Section 4
below, Tenant shall notify Landlord of Tenant's exercise of its right to renew
the Lease for Renewal Term only by giving to Landlord written notice not sooner
than seven (7) months prior to the Renewal Commencement Date and not later than
five (5) months prior to the Renewal Commencement Date (time is expressly of
the essence to Landlord). Any attempted exercise of this Option made other than
within the time period stated or in the manner stated shall be void and of no
force or effect.
4. This Option to Renew Lease is expressly conditioned upon Tenant
having performed each and every of its covenants under the Lease at all times
during the entire Lease Term in a timely fashion (time being made expressly of
the essence), with the full and complete understanding that if, at any time
during the Lease Term, Tenant shall fail to perform any of its covenants or
obligations under the Lease in a timely fashion, this Option shall terminate
without notice and be of no further effect irrespective of whether or not
Tenant shall have cured such breach.
<PAGE> 24
Tenant acknowledges that Tenant's promise to faithfully perform each of its
covenants and obligations under the Lease in a timely fashion was material
inducement to Landlord in granting to Tenant this Option to Renew Lease.
For purposes of this Option to Renew Lease, Tenant shall be deemed to
have paid the Base Monthly Rent according to the terms of the Lease if Tenant
shall have paid such monthly rental within six (6) days of being notified by
Landlord of such rental being due and unpaid.
With respect to matters other than monies due Landlord, Tenant shall be
deemed to have performed according to the terms and conditions of the Lease if
Tenant shall have commenced a cure within ten (10) days of having been notified
of a default under such Lease and shall have completed such cure within thirty
(30) days thereafter or, in the event such a default is not curable within said
30 day period, Tenant shall have diligently pursued such cure to the reasonable
satisfaction of Landlord.
5. If Tenant shall properly and timely exercised its right to extend the term
of the Lease and provided that Tenant shall not have been in default under the
terms of the Lease as of the Renewal Commencement Date, the term of the Lease
shall be so extended for such Renewal Term on the same terms and conditions
contained in the Lease; provided, however, there shall be no Tenant Improvement
Allowance Letter and the Base Monthly Rent for each month of the first Twelve
(12) months Renewal Term shall be calculated as follows: The new Base Monthly
Rent of the Renewal Term shall be the greater of: (i) the Base Monthly Rent
being paid by Tenant to Landlord during the final full month of the initial
Lease Term, or (ii) the Then Market Rental Rate for the Lease Premises.
6. For purposes of this Option to Renew Lease, the term "Then Monthly
Market Rental Rate" shall be determined by mutual agreement between Landlord
and Tenant or, in the event such agreement cannot be made within ten (10) days
from the date Tenant shall have exercised this Option, Landlord and Tenant
shall each appoint a real estate appraiser with at least five (5) years
full-time commercial/industrial appraisal experience in Santa Clara County to
appraise and determine the fair market monthly rental rate the Lease Premises,
in their then existing condition for the use specified in the Lease could be
leased for, on the same terms and conditions set forth in the Lease, to a
qualified tenant ready, willing and able to lease the Leased Premises for a
term equal to the Renewal Term. Notwithstanding the above, however, the
appraisers shall take into consideration the value of the Tenant in place, and
the avoided costs of retaining an existing Tenant in His/Her efforts to
determine a fair and representative "Then Monthly Market Rental Rate. If either
party does not appoint an appraiser within ten (10) days after the other party
has given notice of the name of its appraiser, the other party can then apply
to the President of the Santa Clara County Real Estate Board or the presiding
Judge of the Superior Court of that County for the selection of a second
appraiser who meets the qualifications stated above. The failing party shall
bear the cost of appointing the second appraiser and of paying the second
appraiser's fee. The two appraisers shall attempt to establish the Then Monthly
Market Rental Rate for the Leased Premises. If the two appraisers are unable to
agree on the Then Monthly Market Rental Rate for the Leased Premises within ten
(10) days after the second appraiser has been selected or appointed, then the
two appraisers shall attempt to select a third appraiser meeting the
qualifications stated above. If they
<PAGE> 25
fail to agree on a third appraiser, either party can follow the above procedure
for having an appraiser appointed by the Real Estate Board or a judiciary. Each
of the parties shall bear one-half (1/2) of the cost of appointing the third
appraiser and of paying the third appraiser's fee. Unless the three appraisers
are able to agree on the Then Monthly Market Rental Rate for the Leased
Premises within ten (10) days after the selection or appointment of the third
appraiser, the two appraisal amounts being calculated most closely together,
after having discarded the appraisal amount which most greatly varies from the
other two appraisal amounts, shall be added together then divided by two (2).
The resulting rental amount shall be defined as the Then Monthly Market Rental
Rate for the Leased Premises. In no event, however, shall the resulting Then
Monthly Market Rental Rate be less than the Base Monthly Rent paid during the
final full month of the Initial Lease Term. If the Then Monthly Market Rental
is determined by appraisal and if Tenant does not, in Tenant's sole discretion,
approve the rental amount established thereby, then Tenant may rescind its
exercise of the renewal option by giving Landlord written notice of such
election to rescind within ten (10) days after the Then Monthly Rental has been
established. If Tenant rescinds its exercise of the renewal option, then (i)
the Lease shall terminate on the date the Lease Term would otherwise have
expired absent Tenant's exercise of the renewal option, or at Landlord's
option, may be extended by ninety (90) days, and (ii) Tenant shall pay all
costs and expenses of all appraisals.
The Base Monthly Rent shall be adjusted upward (increased) at the
anniversary of each year of the extended lease term commencing with the
beginning of the Thirteenth Month of the extended lease term, by the amount of
Three Percent of the Base Monthly Rent calculated for the prior Twelve Month
period. Such increased rental amount shall be effective during the subsequent
Twelve (12) month period of the extended term.
7. This Option to renew is subject and subordinate to any underlying ground
leases and to all mortgages and deeds of trust which affect the Building and
are of public record as of the Effective Date of this Option to Renew Lease,
and to all renewals, modifications, consolidations, replacements and extensions
thereof. However, if the lessor under any such ground lease or any Lender
holding any such mortgage or deed of trust shall advise Landlord that it
desires or requires this Option to Renew Lease to be made prior and superior
thereto, then, upon written request of Landlord to Tenant, Tenant shall
promptly execute, acknowledge and deliver any and all documents or instruments
which Landlord and such lessor or Lender deem necessary or desirable to make
this Option to Renew Lease prior thereto. Tenant hereby consents to Landlord's
ground leasing the land underlying the Building and/or encumbering the Building
as security for future loans on such terms as Landlord shall desire, all of
which future ground leases, mortgages or deeds of trust shall be subject and
subordinate to this Option to Renew Lease. However, if any lessor under any
such future ground lease or any Lender holding such future mortgage or deed of
trust shall desire or require that this Option to Renew Lease by made subject
and subordinate to such future ground lease, mortgage or deed of trust, then
Tenant agrees, within twenty (20) days after Landlord's written request
therefore, to execute, acknowledge and deliver to Landlord any and all
documents or instruments requested by Landlord or such lessor or Lender as may
be necessary or proper to assure the subordination of this Option to Renew
Lease to such future ground
<PAGE> 26
lease, mortgage or deed of trust; but only if such lessor or Lender agrees to
recognize Tenant's rights under this Option to Renew Lease so long as Tenant is
not in default under the Lease, or this Option to Renew Lease.
IN WITNESS WHEREOF, the parties have executed this Option to Renew Lease on the
dates below set forth to be effective as of the date referenced above.
AS LANDLORD: AS TENANT:
RENCO INVESTMENT COMPANY VA LINUX SYSTEMS, INCORPORATED
A California General Partnership A Delaware Corporation
By /s/ [Signature Illegible] By /s/ BRIAN BILES
------------------------------- -------------------------------
General Partner Brian Biles
Title: VP Marketing
---------------------------
By /s/ [Signature Illegible] By /s/ TODD SCHULL
------------------------------- -------------------------------
General Partner Todd Schull
Title: Chief Financial Officer
---------------------------
By /s/ [Signature Illegible]
-------------------------------
General Partner
DATE: 5/2/00 DATE: 5/2/00
---------------------------- -----------------------------
<PAGE> 27
BAYSIDE TECHNOLOGY PARK
EXTERIOR SIGNAGE STANDARDS
In an effort to encourage and maintain High Quality Architectural Signage
Standards and to also provide for good Tenant visibility, this Exterior Sign
Program has been adopted.
BUILDING MOUNTED SIGNAGE
MULTI-TENANT BUILDINGS
Exterior Wall signs are not permitted unless the building is designed to
accommodate signage in the design of the elevations. At this time there are no
Multi-Tenant buildings with this design feature.
SINGLE TENANT BUILDINGS
Custom Logos, Type styles and Colors can be recommended for approval if the
following criteria is observed.
Scale Plans showing the dimensioned sizes, square footage used, placement,
colors, materials and finishes must be submitted to RENCO PROPERTIES, INC. for
approval by the review board prior to acquiring City Sign Permits.
The overall look of the building elevation must be considered when selecting
size, colors, materials and finishes. Since there are many creative building
designs, what may look good on one building may not necessarily be appropriate
on another.
Buildings can be allowed One Sign Location facing each different street
frontage.
Bayside Technology Park is not a Retail environment, and only High Quality
Corporate Images are desired. However, your Custom Image is welcome as long as
it can be adopted to the building exterior as a Identification Mark and NOT a
BIG SIGN. Sign design, fabrication and installation should look clean and
contemporary, with attempts made to hide bolts, rivets and other fasteners.
The content of the Wall Sign is limited to the Corporate or Company Name, Logo,
Trademark, and/or Division Name. No description of Products or Services,
Slogans, Phone Numbers, Banners, or any other type of sign is permitted.
Shipping & Receiving Hours Signs located on the back of the building are exempt.
<PAGE> 28
Bayside Technology Park
Exterior Signage Standards
Page 2
Illuminated Individual Channel Letters are permitted. The letters can have
transparent faces which illuminate or solid opaque faces which create a halo
effect back illuminated against the building wall. Electrical raceways should
be hidden whenever possible. Exposed Neon is not desired in signage. However,
it could be used if incorporated with the building architectural design such as
in as restaurant exterior.
The following Square Footage GUIDELINES will help your designer. Define the
area by using eight or fewer perimeter lines and figure the Square Footage Area.
VERY SHORT NAMES (5 Letters & Logo) can use 40 Square Feet.
SHORT NAMES (10 Letters & Logo) can use 50 Square Feet.
MEDIUM NAMES (15 Letters & Logo) can use 70 Square Feet.
LONG NAMES (20 Letters & Logo) can use 70 Square Feet.
These guidelines are for signs on building walls that face into Bayside
Technology Park.
Signs that directly face Freeway 880 may be up to 35% larger than these
guidelines, with a maximum of 75 Square Feet.
INFORMATIONAL & DIRECTIONAL SIGNAGE
MULTI-TENANT BUILDINGS
Informational signs are not permitted unless the building is designed to
accommodate this kind of signage in the design of the site plans. At this time
there are no Multi-Tenant buildings with this design feature. If a
Shipping/Receiving sign is necessary at a driveway entrance, it will be a sign
that is in keeping with the building design, with address numbers and arrows as
needed, but not a listing of tenants names.
INFORMATIONAL SIGNS BY THE STREET (15' SETBACK IS STILL REQUIRED)
Maximum panel size is 18" tall x 32" wide, (which is 4 square feet), with the
overall height 42" maximum. The signs should be made from painted aluminum and
not plywood, as it not as durable.
SINGLE TENANT BUILDINGS
April 16, 1996
<PAGE> 29
Bayside Technology Park
Exterior Signage Standards
Page 3
Informational signs are permitted at the building driveways. The signs will be
in keeping with the building design, with address numbers and arrows as needed,
and can include the Corporate Name & Logo, and be in the corporate colors.
INFORMATIONAL SIGNS BY THE STREET (15' SETBACK IS STILL REQUIRED) Maximum panel
size is 18" tall x 32" wide, (which is 4 sq. feet), with the overall height 42"
maximum.
DIRECTIONAL SIGNS WITHIN THE PARKING AREAS Standard panel size is 18" tall x
32" wide, (which is 4 sq. feet), with the overall height 42". A Multi-Building
Campus with a single tenant may have larger directional signs up to 10 square
feet, like 40" tall x 36- wide, with the overall height 60- maximum. These
signs m- not be located within 50 feet from any street frontage.
GENERAL NOTES ON INFORMATIONAL & DIRECTIONAL SIGNS
Informational & Directional Signs are not intended to be advertising signs, so
if there is heavy directional copy, the name and/or logo may have to be left
off, or kept small.
Directional signs with changeable or switchable panels can be approved if the
directory is recessed into the main sign face with screws showing.
These signs should be fabricated from aluminum and not plywood, as it not as
durable. Acrylic Polyurethane finishes in Semi-gloss finishes will provide 7 to
12 years of paint.
Informational & Directional Signs can be 2-sided as required.
Scale Plans showing the dimensioned sizes, square footage used, placement,
colors, materials and finishes must be submitted to RENCO PROPERTIES, INC. for
approval by the review board prior to acquiring City Sign Permits.
After the review board has given written approval, contact Fred Broumand at the
City of Fremont, (415) 790-6642. He is responsible for Exterior Sign Permits.
All exterior signs must be approved by the City of Fremont Planning & Building
Department and have a valid Sign Permit. This can be a 4-5 week approval
process if the sign is visible from Highway 880, Fremont Avenue or West Warren
Avenue. The planning staff may require these major street locations to go
through their SPAR review process. On smaller streets within the park the
approval process can sometimes take just a few days. The City of Fremont
requires that all electrical signs have a UL label, a permit label and a
manufacturers' label.
April 16, 1996
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13.1
<SEQUENCE>3
<FILENAME>f66473ex13-1.txt
<DESCRIPTION>EXHIBIT 13.1
<TEXT>
<PAGE> 1
[GRAPHIC OF PHRASE "OPEN UP." WITHIN THE LETTER "O"]
VA LINUX SYSTEMS ANNUAL REPORT
2000
<PAGE> 2
[GRAPHIC OF PHRASE "OPEN LEADERS." WITHIN THE LETTER "O"]
[BAR CHART SHOWING NET REVENUE OF $5.6 MILLION, $17.7 MILLION AND $120.3
MILLION FOR FISCAL YEARS 1998, 1999 AND 2000, RESPECTIVELY]
<PAGE> 3
CORPORATE PROFILE. VA Linux Systems provides integrated Linux and Open Source
solutions for Internet infrastructure applications. We offer our customers a
single point of contact for Linux-based server and storage systems, enhanced
Linux and Open Source software, professional consulting services, and support.
Our integrated Linux and Open Source solutions enable businesses to
rapidly build and scale their Internet infrastructure, while leveraging the Open
Source model to accelerate software development, reduce costs, and increase
competitiveness.
We design, manufacture and market the industry's most complete family of
ultra-dense Linux-based servers and storage systems, all of which are available
on a build-to-order basis via the online VA Store and our direct sales force. We
offer our servers and systems with the industry's first build-to-order software.
The Build-to-Order Software Selector (BOSS(TM)) located in the VA Store
currently offers customers a selection of more than 700 Linux OS and Open Source
applications that can be pre-loaded on their systems and servers.
Our Professional Services Group offers vast expertise in Linux and Open
Source Internet infrastructure and business solutions. We assist our customers
in everything from Internet systems design and the development of Open Source
strategies to the integration of Linux and Open Source solutions with their
existing environments. All our solutions, both hardware and software, are backed
by our Total Linux Coverage (TLC) 24/7 support programs.
In addition, we own and operate the Open Source Development Network
(OSDN(TM)), an integrated network of the leading Open Source Internet sites
providing tools for Open Source software distribution, development, and
discussion. The OSDN infrastructure is used by tens of thousands of developers
on the Internet for the collaborative development of the Open Source software
that forms the backbone of the solutions we offer our customers. It enables us
to better leverage the Open Source model to accelerate software development,
reduce costs, and increase competitiveness.
VA Linux Systems is headquartered in Fremont, California, with offices
throughout North America, Europe, and Japan. Our stock is traded on NASDAQ under
the symbol LNUX. As of September 2000, VA Linux Systems had approximately 40,000
stockholders of record.
1
<PAGE> 4
[GRAPHIC OF PHRASE "OPEN LETTER."]
TO OUR STOCKHOLDERS. VA Linux Systems' first year as a publicly traded company
has been a tremendous success. And it's only the beginning.
First of all, I would like to thank all of you who have contributed to our
successful beginning. Thank you to our stockholders for believing in our vision,
our people, and our business model. Thank you to our customers, suppliers and
employees who have all contributed to our strong financial results. And thank
you, especially, to our friends in the Open Source community for your
enthusiasm, your support, your good will, and most importantly, your efforts in
developing Linux and other Open Source software. Without the success of the Open
Source development community we would not be here today. Continuing to nurture
the growth of Open Source is critical to our success. Our mission at VA Linux
Systems is to make our customers successful by providing them with complete
integrated solutions based on Linux and Open Source technologies and
methodologies. If our customers are successful, our company and our stockholders
will be successful as well.
We are delivering on that mission. In fiscal 2000, we have succeeded in growing
our business dramatically. We have succeeded in creating the leading destination
for Open Source software development on the Internet. We have succeeded in
growing our share of the Linux server market to become the number two vendor of
Linux servers in the United States.(1) We have succeeded in becoming a leading
center for Linux and Open Source expertise. And we are aggressively building an
infrastructure for continued growth and success.
For the full fiscal year 2000, which ended July 28, 2000, our revenues totaled
$120.3 million, representing an increase of 579% over fiscal year 1999 revenues
of $17.7 million. Additionally, our gross profits in fiscal year 2000 soared to
$22.1 million.
Moreover, we have demonstrated, quarter after quarter, strong revenue growth and
improved financial results. In the fourth fiscal quarter, our revenues were
$50.7 million, an increase of 547% compared to the same period of fiscal 1999
and an increase of 46% compared to the prior fiscal quarter.
We improved our gross margin and reduced our net loss in each quarter in fiscal
2000.
(1) IDC, Worldwide Quarterly Server Tracker, Q2 2000 (Based on factory revenue)
2
<PAGE> 5
The fourth quarter gross margin was 22% and our net loss, excluding non-cash
charges, was 8.1% of revenue. Our goal is to reach profitability, excluding
non-cash charges, no later than the end of calendar 2001. Our financial success
derives directly from our differentiation as the expert provider of integrated
Linux and Open Source solutions for Internet infrastructure applications. We
provide our customers a single point of contact for Linux-based server and
storage systems, enhanced Linux and Open Source software, professional
consulting services, and support. In fiscal 2000, we have made strategic
acquisitions and investments in people, products, processes and technologies -
all with the goal of sharpening our differentiation as the best source for
expert Linux and Open Source solutions. During the course of the year, we
upgraded and expanded the industry's broadest line of high-density
build-to-order Linux servers and storage systems. We expanded our Professional
Services Group, our expert team of Linux and Open source consultants. In August
2000, we introduced the industry's first build-to-order software, which enables
our customers to order systems with custom-configured software.
In June 2000, we completed the acquisition of Andover.net, giving us the
leading network of Internet sites devoted to the development, distribution, and
discussion of Open Source software. Launched as the Open Source Development
Network in August 2000, OSDN is home to over 9,600 Linux and Open Source
software development projects. Our acquisitions of TruSolutions and NetAttach
enabled us to broaden both our product line and our expertise. From TruSolutions
we gained an entry-level server product and custom hardware engineering
expertise. From NetAttach, we gained expertise and technology that led to our
Network Attached Storage (NAS) products, providing us new opportunities in the
burgeoning Internet storage market. Our goals with storage are simple: build
storage solutions using Open Source in the same way we have built Web server and
other Internet infrastructure solutions using Open Source. In the future, we
expect to continue to grow our products and services around that same theme:
solutions built on Open Source, including more and more targeted appliance
markets like NAS. In our ten months as a publicly traded company, we have been
very successful and positioned ourselves for greater success in the future.
[PHOTOGRAPH OF LARRY AUGUSTIN]
/s/ LARRY AUGUSTIN
- -----------------------------
Larry Augustin - President and Chief Executive Officer
3
<PAGE> 6
[GRAPHIC OF PHRASE "OPEN SOURCE" WITHIN THE LETTER "O".]
<PAGE> 7
"REVOLUTIONS NEVER GO BACKWARDS."
- -Wendell Phillips, American Reformer, 1861
THE POWER OF OPEN SOURCE IS BETTER SOLUTIONS FASTER.
So what exactly is Open Source software? At its most basic, Open Source software
is software for which the underlying source code is freely distributed for
others to use, modify, improve and redistribute.
Its roots extend at least back to the development of UNIX at Bell Labs
in the late 1960s, and the development of Open Source tools to support UNIX
development. It entered its current phase of rapid expansion in 1991, when Linus
Torvalds developed Linux and released it on the Internet for others to use and
improve as they saw fit.
From that beginning has grown a movement - a community of thousands of
developers, as well as companies large and small, all dedicated to developing
better software faster and cheaper through open collaboration.
COLLABORATION VS. COMPETITION.
The Open Source movement is fundamentally changing the way software is
developed. Unlike proprietary software that's developed by in-house programmers
behind closed doors, Open Source software is developed, tested, improved and
evolved in the open light of day, collaboratively. Unlike proprietary software
which is upgraded when market conditions are right, Open Source software is
continually upgraded.
For businesses, the Open Source community is the army of developers they
can't afford to hire. And Open Source software is the highly evolved, stable and
highly reliable software they need to compete.
SOLUTIONS IN INTERNET TIME.
The advent of the Internet has provided the medium for Open Source software
collaboration. It is the Internet that provides the capability for thousands of
people worldwide to collaborate in real time to create better software faster.
Not coincidentally, it is the Internet with its insatiable appetite for
rapid and constant innovation that has used the fruits of Open Source
collaboration to innovate. Nearly 30%(2) of the world's web servers run the
Linux OS, helping to make the Linux OS the world's fastest growing operating
system. The Open Source software Apache web server runs on 61%(3) of all
Websites. The Open Source software Samba enables the integration of Linux, UNIX
and VMS with Windows. And those are a but a few examples. Today, there are
literally thousands of Linux and Open Source applications and tools in use or in
development throughout the world.
[PIE CHART OF INTERNET SERVER OS MARKET SHARE(2) SHOWING 30%, 28%, 26% AND 16%
MARKET SHARE FOR LINUX, MICROSOFT, OTHER AND SOLARIS, RESPECTIVELY]
VA LINUX AND OPEN SOURCE.
VA Linux Systems was founded on the belief that Open Source development produces
better software faster than does proprietary software development.
We have been ardent supporters of and participants in the Open Source
community since before we were a company. Many of our people come from the Open
Source community. And they believe fervently in its power to, through open
collaboration and communication, create legendary software.
Today, we are succeeding by delivering to our customers better Open
Source-based solutions faster. Our Professional Services Group both develops
Open Source solutions for our customers, and helps our customers become active
members of the Open Source community. Additionally, through our Open Source
Development Network (OSDN), we provide the primary resources for Open Source
collaboration and communication. (Read more about Professional Services and OSDN
later in our Annual Report.)
[PIE CHART OF LINUX SERVER MARKET SHARE (U.S.)(4) SHOWING 30%, 20%, 19%, 7%, 4%
AND 20% MARKET SHARE FOR COMPAQ, VA LINUX, DELL, IBM, HP AND OTHER,
RESPECTIVELY]
(2) July 2000 Netcraft Web Server Survey, www.netcraft.com/survey/
(3) September 2000 Netcraft Web Server Survey, www.netcraft.com/survey/
(4) IDC, Worldwide Quarterly Server Tracker, Q2 2000 (Based on factory revenue)
5
<PAGE> 8
COMPLETE LINUX/OPEN SOURCE SOLUTIONS.
VA Linux Systems provides complete integrated Linux and Open
Source solutions for the Web. From the broadest selection of
high-density, rackmount server and storage systems to the
industry's first build-to-order software. From our expert Linux
and Open Source Professional Services team to our close
collaboration with the Open Source development community.
[GRAPHIC OF PHRASE "OPEN SOLUTIONS." OVER A BLUE CIRCLE]
"The movement to Open Source is inevitable. The company that
best supports, nurtures, and leverages Open Source will lead the
next generation of computing."
-Larry Augustin, President and CEO, VA Linux Systems
6
<PAGE> 9
[PHOTOGRAPH OF A SERVER RACK]
[GRAPHIC OF A "CUSTOMIZE" POINT AND CLICK ICON]
LINUX SERVERS TO POWER THE INTERNET. At the heart of most VA Linux
solutions is a system. In fiscal 2000, 95% of our revenues came from the sales
of systems, primarily rackmount server systems, to the Internet infrastructure
market, Internet service providers, application service providers, web caching,
streaming and e-tailing businesses.
In the course of fiscal 2000 (and in the first days of fiscal 2001), we
have significantly strengthened and broadened our product lines. We now offer
the broadest range of build-to-order high-density Linux server products, from
entry level models to ultra-dense models, in 1U, 2U and 4U rackmountable
enclosures.
As they have been since our inception, all our servers are built on
Intel(R) processor technology, from entry-level servers featuring a single
Intel Celeron(R) processor to high-powered servers featuring up to 4 Intel
Pentium III Xeon(R) processors. All offer high availability and scalability.
They are specially architected and tuned to maximize Linux performance. And they
are highly configurable servers. Building on the technologies we gained in the
NetAttach acquisition, we have introduced (and continue to introduce) our first
network-attached storage (NAS) servers, which will quickly evolve into a
complete line of storage servers. Early market acceptance of those products has
been positive, and we expect them to make an important contribution to revenues
in fiscal 2001.
POINT. CLICK. BUILD-TO-ORDER SOFTWARE. Unlike traditional hardware vendors,
however, it is not systems alone that drive our business. It is our expertise in
Linux OS and Open Source software. To date, that expertise has been our
competitive advantage. In the months and years ahead, we expect that advantage
to grow significantly.
Throughout fiscal 2000, we have developed the world's first
Build-to-Order Software Selector (BOSS(TM)). While hardware vendors - including
VA Linux Systems - also offer customers the opportunity to custom configure
hardware, we now present customers the opportunity to custom configure the
software on their VA Linux systems online before they buy them. The initial BOSS
selection, launched in August 2000, consists of over 700 Linux OS and Open
Source applications.
Build-to-order software is particularly important to our customers,
because BOSS enables them to configure ideal Web servers, application servers,
database servers and other specific application servers. And their systems
arrive ready to run (as opposed to ready to configure). The time a customer
saves by using BOSS can be an hour or more per server (extrapolate that to a
data center installation of, for example, 250 servers and the potential savings
to a customer are significant). Moreover, a systems administrator can use BOSS
to ship software-configured systems to multiple data centers in multiple
geographies, where they can be plugged in and brought on line rapidly.
In the months ahead, we intend to broaden BOSS to include even more
applications and integrate BOSS with the development resources of our Open
Source Development Network.
BOSS, in other words, provides us a large competitive advantage now,
which we believe is going to grow.
<PAGE> 10
[PHOTOGRAPH OF CHIP SALZENBERG, PERL]
[PHOTOGRAPH OF DAVID HINDS, PCMCIA, LINUX KERNEL]
[PHOTOGRAPH OF JEREMY ALLISON, SAMBA]
[GRAPHIC OF THE PHRASE "OPEN EXPERTS." OVER A FIRING RANGE BULLS-EYE]
"Our company, like our Linux servers, is built from the ground up to
deliver the power of Linux and Open Source solutions to our customers."
- John T. Hall
Vice President, Strategic Planning,
VA Linux Systems
[PHOTOGRAPH OF GEOFF "MANDRAKE" HARRISON, ENLIGHTENMENT, CLUSTERING]
[PHOTOGRAPH OF SAN "NETTWERK" MEHAT, VACM, LINUX KERNEL]
[PHOTOGRAPH OF TED T'SO, LINUX KERNEL, EXT2 FILE SYSTEM]
8
<PAGE> 11
[PHOTOGRAPH H.J. LU, NFS, LINUX KERNEL]
[PHOTOGRAPH JON "MADDOG" HALL, LINUX INTERNATIONAL]
EXPERTISE OUR CUSTOMERS CAN BUILD ON. Throughout this Annual Report we have
talked about our Linux and Open Source expertise.
We have built that expertise through a focus and a passion for Open
Source. We have forged strong links to the Open Source community (and its
incredible knowledge base). And we are of the Open Source community. Many of us
have been involved in the Open Source movement (a movement that is gaining
momentum by the hour) almost since the beginning.
Many of the premier developers in the Linux and Open Source arena, are
on staff at VA Linux. Why? Because they believe VA Linux has the wherewithal to
lead Linux and Open Source to a position of prominence. And because they know
that we care too much about the ultimate success of Linux and Open Source to
turn either one into something proprietary and stagnant. As WR Hambrecht noted
in an August 2000 report, over 85% of all changes to the Linux kernel have come
from employees of VA Linux and Red Hat.
There is, of course, more to us than a bunch of Linux luminaries. We are
also savvy business people. Our founding team developed our breakthrough
business model - a solutions company that utilizes Open Source methodologies -
and has guided the company through a successful beginning. And in the past two
years, we've built a strong leadership team of industry veterans from companies
including Amdahl, Apple, EDS, Philips, Oracle, SGI, Solectron, Sun and Synopsys.
It is a team with the experience to run and grow a successful company. And the
impact they've made can be seen in our impressive results.
[GROUP PHOTOGRAPH OF PAUL PAPAGEORGE, LARRY M. AUGUSTIN, JOHN T. HALL, ROBERT
RUSSO, DANIEL R. SHORE, BRIAN D. BILES, TODD B. SCHULL, LEONARD N. ZUBKOFF,
GREGG E. ZEHR, ALI JENAB AND STEVE WESTMORELAND]
THE POWER OF PROFESSIONAL SERVICES. While our Open Source expertise is designed
into our systems, our Professional Services Group offers our customers direct
access to that expertise, so they can extend the Open Source model and a
knowledge of Linux into their own enterprises.
By the close of fiscal 2000, the Professional Services Group had grown
to 47 professional staff members, and they directly generated over 4% of our
total revenue in the fourth quarter of fiscal 2000. While that direct
contribution to revenue is important, the Group's impact on our overall business
is much greater. Many of our customers choose our systems specifically because
of the solutions that only our Professional Services Group can provide.
The Group consists of an impressive roster of business and IT experts,
as well as many pioneers in Linux development and the integration of Open Source
solutions in corporate environments. And it offers valuable expertise in Linux
and Open Source Internet infrastructure and business solutions. We assist our
customers in everything from Internet systems design and the development of Open
Source strategies to the integration of Linux and Open Source solutions with
their existing environments. We, for instance, recently assisted in the largest
deployment of Oracle on Linux Internet servers.
As we said earlier, Open Source development and methodology enable the
delivery of better solutions faster. Our Professional Services Group helps our
customers make that happen.
[PHOTOGRAPH OF LEONARD ZUBKOFF, LINUX KERNEL, RAID]
[PHOTOGRAPH OF CARSTEN "RASTERMAN" HAITZFER, ENLIGHTENMENT, CLUSTERING]
9
<PAGE> 12
[GRAPHIC OF THE PHRASE "OPEN COLLABORATION." OVER FOUR LINKED LETTERS "O"].
<PAGE> 13
"WHERE ARE THE PEOPLE GOING? I AM THEIR LEADER AND I MUST FOLLOW THEM."
- Mahatma Gandhi
OPEN SOURCE DEVELOPMENT IS THE INTERNET REVOLUTION. AND VICE VERSA.
The growth of the Open Source movement has roughly paralleled the growth of the
Internet. Why? Because they fuel one another. Open Source software provides the
rapid innovation and high reliability that the Internet demands. And the
Internet provides the high-speed, geography-spanning communications forum that
Open Source developers need to develop, distribute and discuss new software. The
Internet is, in other words, the medium of Open Source development.
At VA Linux Systems, we not only understand the symbiotic relationship
between Open Source and the Internet, we're doing everything in our power to
nurture it.
In January 2000, we launched SourceForge,(TM) a website that hosts Open
Source development and provides a variety of resources, tools and administration
to developers. When the site launched it hosted about 300 development projects
and almost 7,000 developers. Now, less than nine months later (September 2000),
SourceForge hosts over 9,600 development projects and more than 67,000
developers.
"I cannot adequately express how
useful the many resources provided
by SourceForge have been, or how
grateful I am to have them.
Without SourceForge, I doubt my
Open Source project would
be nearly as successful."
G.W. LUCAS,
Administrator, The Rossum Project
[OPEN SOURCE DEVELOPMENT NETWORK LOGO]
[GRAPHIC OF THE WORLD]
OSDN. THINK OF IT AS THE WORLD DEVELOPMENT CENTER FOR OPEN SOURCE SOFTWARE.
In August 2000, with the goal of making Open Source the dominant model for
software development we launched the Open Source Development Network (OSDN), a
new division of VA Linux Systems. OSDN is the premier online resource for Open
Source development, distribution and discussion. It links all our Open Source
Internet resources - SourceForge, Linux.com and Themes.org, as well as the Web
properties we gained in our acquisition of Andover.net, Freshmeat.net,
Slashdot.org, Question Exchange and ThinkGeek.com.
The result? The world's most complete environment for Open Source
developer communication and collaboration.
In the fourth quarter of fiscal 2000, our Web properties contributed 4%
of our revenues. More important than revenue contribution, however, is the
contribution OSDN will make to the growth of Open Source development and the
Open Source community, which we firmly believe will ultimately fuel the growth
of VA Linux Systems.
11
<PAGE> 14
[GRAPHIC OF THE PHRASE "OPEN ENTHUSIASM." NEXT TO A STYLIZED EXCLAMATION POINT]
AND NOW FOR A WORD FROM OUR CUSTOMERS.
At the outset of this annual report we said VA Linux Systems
provides integrated Linux and Open Source solutions for Internet
infrastructure applications. And that our solutions enable
businesses to rapidly build and scale their Internet
infrastructure, while leveraging the Open Source model to
accelerate software development, reduce costs and increase
competitiveness. We would like to share with you how our
customers think we're succeeding. We think their enthusiasm for
VA Linux Systems speaks volumes. And that it is a very good way
to assess our future prospects.
"VA Linux offers a complete solution, providing
NetLedger with the tools, the method and the
support to launch and operate our data center
virtually maintenance free. As a result, our
network can handle millions of end users."
DAVE DURKEE,
Chief Information Officer,
NetLedger
[PHOTOGRAPH OF DAVE DURKEE]
12
<PAGE> 15
"Through our partnership with VA Linux and our commitment to Open
Source development models, we are able to provide
support for our customers using Linux.
Additionally, our customers can participate in developing
successful printing solutions that will best serve
their specific needs."
GEORGE MULHERN,
Vice President and General Manager
HP Department LaserJet Printing
[PHOTOGRAPH OF JOHN SELLENS]
"SourceForge is a great resource
and a tremendous help, and certainly
makes me want to buy some VA Linux machines."
JOHN SELLENS,
General Manager,
Certaintysolutions
[PHOTOGRAPH OF TED ROBERTS]
"VA Linux allows us to focus on our company's core competency of forging a new
global Point-to-Point delivery network.
With VA, we deal with just one company, a quality
product and the highest levels of service and
expertise from Professional Services."
TED ROBERTS,
Chief Technology Officer,
Avienda Technologies
[PHOTOGRAPH OF RIC O'CONNELL]
"Once you decide to utilize Linux as your operating system, VA Linux is the
obvious choice. There isn't another vendor remotely close to offering the Linux
resources that VA Linux provides."
RIC O'CONNELL,
Chief Technology Officer,
1stUp.com
[PHOTOGRAPH OF ALLAN TEAR]
"As broadband use becomes more widespread,
the ability to scale our network to handle large
numbers of users will be vital to Incanta's success.
VA Linux's responsiveness and flexibility to problems
and opportunities help us quickly expand our services
and respond to new market opportunities on short notice."
ALLAN TEAR,
Chief Operating Officer,
Incanta, Inc.
13
<PAGE> 16
[GRAPHIC OF THE PHRASE "OPEN BOOKS." INSIDE A CIRCLE WITHIN A SQUARE]
<PAGE> 17
FY 2000 FINANCIAL STATEMENTS
Selected Financial Data 16
Management's Discussion and Analysis
of Financial Condition and Results of Operations 17
Factors That May Affect Future Results 22
Report of Independent Public Accountants 32
Consolidated Balance Sheets 33
Consolidated Statements of Operations 34
Consolidated Statements of Stockholders'
(Deficit) Equity 35
Consolidated Statements of Cash Flows 36
Notes to Consolidated Financial Statements 37
Report of Management 47
Special Note Regarding Forward-Looking Statements 47
Board of Directors and Executive Officers 48
Corporate Information 49
15
<PAGE> 18
SELECTED FINANCIAL DATA
(in thousands, except per share data)
You should read the selected financial data set forth below in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our financial statements and the related notes included
elsewhere in this Annual Report. The statement of operations data for the years
ended July 28, 2000 and July 31, 1999 and 1998 and the balance sheet data as of
July 28, 2000 and July 31, 1999 are derived from, and are qualified by reference
to, the audited financial statements and related notes appearing elsewhere in
this Annual Report. The statement of operations data for the year ended July 31,
1997 and the balance sheet data as of July 31, 1998 and 1997 are derived from
audited financial statements not appearing in this Annual Report. The statement
of operations data for the year ended July 31, 1996 and the balance sheet data
as of July 31, 1996 are derived from unaudited financial statements not
appearing in this Annual Report. Historical results are not necessarily
indicative of results that may be expected for any future period.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JULY 28, JULY 31,
--------- ------------------------------------------------
2000 1999 1998 1997 1996
--------- --------- --------- --------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net revenues $ 120,296 $ 17,710 $ 5,556 $ 2,743 $ 2,257
Cost of revenues 98,181 17,766 4,494 2,562 1,991
--------- --------- --------- --------- ---------
Gross profit 22,115 (56) 1,062 181 266
Income (loss) from operations (95,387) (14,531) 73 (462) (169)
Net income (loss) (89,758) (14,512) 84 (474) (170)
Dividend related to convertible preferred stock (4,900) -- -- -- --
Net income (loss) attributable to common stockholders (94,658) (14,512) 84 (474) (170)
Basic net income (loss) per share $ (3.52) $ (2.62) $ 0.02 $ (0.05) $ (0.01)
Diluted net income (loss) per share $ (3.52) $ (2.62) $ 0.01 $ (0.05) $ (0.01)
Shares used in computing basic net income (loss) per share 26,863 5,530 5,100 9,467 15,000
Shares used in computing diluted net income (loss) per share 26,863 5,530 12,249 9,467 15,000
BALANCE SHEET DATA AT YEAR-END:
Cash and cash equivalents $ 123,849 $ 18,653 $ 62 $ 20 $ 147
Working capital 171,730 16,230 (214) 12 129
Total assets 585,099 27,595 1,195 591 304
Long-term obligations, less current portion 1,656 424 275 -- --
Total stockholders' equity (deficit) 543,875 18,363 (420) 45 149
</TABLE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition
and results of operations together with "Selected Financial Data" and our
consolidated financial statements and the related notes appearing elsewhere in
this Annual Report. This discussion and analysis contains forward-looking
statements that involve risks, uncertainties and assumptions. Our actual results
may differ materially from those anticipated in these forward-looking statements
as a result of certain factors, including, but not limited to, those presented
under "Factors That May Affect Future Results" and elsewhere in this Annual
Report. Please read our "Special Note Regarding Forward Looking Statements" set
forth on page 47 of this Annual Report.
OVERVIEW
We are a leading provider of Linux-based solutions, integrating systems,
software and services. Our broad-based technical expertise in systems and
software design, as well as our focus on the Linux operating system and related
Open Source solutions, enable us to provide high-quality Linux systems designed
for optimal performance, reliability and scalability. To further expand our
service offerings, we recently established a professional service organization
and the Open Source Development Network (OSDN).
We were incorporated in January 1995, and grew very modestly until the end of
fiscal 1998. Since July 31, 1998, however, we have experienced significant
growth and have invested in hiring personnel with Linux expertise, growing our
direct sales force to better penetrate the market for Linux products and
marketing our brand. To further implement these strategies, we expanded our
operations, customer support, administration infrastructure, and acquired
companies. As a result, our employee base grew from 153 at July 31, 1999 to 515
on July 28, 2000, and our operating expenses grew significantly. At July 28,
2000, we had an accumulated deficit of $109.6 million.
During fiscal 2000, our quarterly revenues increased rapidly, growing from $14.8
million in the first quarter ended October 29, 1999 to $50.7 million in the
fourth quarter ended July 28, 2000. Our revenue is derived primarily from sales
of systems and related customer support, with a smaller portion derived from
services and web advertising. While we expect sales from services and web
advertising to increase, our sales from systems will continue to represent a
significant majority of our net revenues through fiscal 2001. We recognize
revenues from product sales upon shipment. We generally do not grant any rights
to our customers to return products. We also provide allowances for warranty
costs at the time of shipment. Customer support fees are recognized ratably over
the term of the service contract.
Sales of our systems accounted for approximately 95% of our net revenues in
fiscal 2000 and all of our sales in fiscal 1999. Only one customer represented
more than 10% of our net revenue for fiscal 2000. Akamai Technologies, Inc.
represented approximately 18% of net revenue for fiscal 2000 and approximately
8% of net revenue for fiscal 1999. We acquired TruSolutions, Inc. in March 2000
to expand our server product lines and acquired NetAttach, Inc. in April 2000 to
help establish our new storage product lines.
In September 1999, we established our professional service organization and
acquired Precision Insight, Inc. in April 2000 to expand our existing customer
service and support offerings to better address the demand for Linux and Open
Source software expertise from our customers. This organization provides
Internet infrastructure and Open Source software services including system
architecture design and integration, development of Open Source software
including the porting of software to Linux, and managed services. We believe
that the computer industry is generally characterized by significant demand for
professional services. Although revenues from our professional services
organization have not been material to date, we are aggressively marketing these
services and believe that these services will address this significant demand.
Accordingly, we expect these revenues to account for a more significant portion
of revenues in the future. Revenues from professional service contracts are
recognized as revenue upon completion of the project, or using the percentage of
completion method of the project where project costs can be reasonably
estimated. Any payments received prior to revenue recognition are recorded as
deferred revenue.
With the acquisition of Andover.Net in June 2000, and in conjunction with our
other Open Source websites, we established the Open Source Development Network
(OSDN), which supplies Open Source information to a wide audience. OSDN helps
people develop Open Source software with tools like SourceForge, helps them to
distribute their work through Freshmeat and other websites, and helps them
discuss Open Source development on Slashdot and many of our other sites.
Although Web revenues have not been material to date, we are aggressively
marketing these services and we expect these revenues to account for a more
significant portion of revenues in the future. Advertising revenues are
recognized over the period in which the advertisements are displayed, provided
that no significant obligations remain and collection of the receivable is
reasonably assured. The financial impact of Andover.Net was not material to the
fiscal 2000 consolidated financial information unless specifically noted within
the Results of Operations section.
Prior to January 1999, we sold our products to customers primarily in response
to telephone inquiries. During the third quarter of fiscal 1999, we began
implementing our direct sales strategy. The number of employees engaged in
direct sales activities grew from 35 at fiscal year end 1999 to 103 at fiscal
year end 2000. Our direct sales organization consists of field sales, telesales
and sales support personnel. Although indirect sales have not been material to
date, we may pursue selective channel opportunities to supplement our direct
sales efforts. In addition, our valinux.com website permits customers to
configure and order products and software via the Internet, allowing us to more
efficiently sell products and facilitate order processing. Since October 1999,
substantially all of our sales have been processed through this website. We
intend to continue to enhance our e-commerce solutions to foster closer
relationships with our customers and improve the efficiency of our sales
process.
Although we have established our European operations, to date, substantially all
of our sales have been in North America. We expect international revenues to
represent a larger percentage of our revenues in fiscal 2001.
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<PAGE> 20
We outsource a significant portion of our manufacturing and supply chain
management operations, including inventory management and component procurement,
to Synnex, our contract manufacturer. We provide Synnex with 90 day rolling
forecasts based on anticipated product orders. Synnex uses these forecasts to
purchase components for our products. If we overestimate our component
requirements, Synnex may have excess inventory, which would increase our costs.
If we underestimate our component requirements, Synnex may have inadequate
inventory, which could interrupt their manufacturing of our products and result
in delays in system shipments. Any of these events could harm our business and
results of operations. Our agreement with Synnex may be terminated for any
reason at any time on delivery of 120 days advance notice. A substantial
majority of our cost of revenues currently consists of payments to Synnex. Cost
of revenues also includes costs associated with our customer support and
professional services. Customer support costs include payments made to a
third-party service organization, which provides call-center and onsite service
functions to our customers. We expect revenues from professional services to
carry a higher gross margin than our product revenues. We believe that future
gross margin will primarily be affected by:
- changes in components and manufacturing costs;
- the volume and mix of products and services sold;
- new product introductions both by us and our competitors;
- changes in our pricing policies and those of our competitors;
- the size of customer orders; and
- the mix of domestic and international sales.
Prior to October 1998, we operated as a small closely-held company. As such, we
did not have the types of operational and financial controls normally
implemented by growing enterprises. During the second half of fiscal 1999, we
implemented or updated our operational and financial systems, procedures and
controls, including the implementation of an enterprise resource planning system
and an Internet-based ordering system. Our systems will continue to require
additional modifications and improvements, and possibly new systems, to respond
to future changes in our business. Implementation of these modifications and
improvements or new systems could be disruptive to our business.
In connection with the grant of stock options to employees during fiscal 1999
and 2000, we recorded deferred stock compensation of $14.4 million and $23.4
million, respectively, representing the difference between the deemed fair
market value of the common stock for accounting purposes and the exercise price
of these options as of the date of grant. Deferred compensation is presented as
a reduction of stockholders' equity and is amortized on an accelerated basis
over the vesting period of the applicable options. We expensed $2.3 million and
$16.3 million of deferred compensation during fiscal 1999 and fiscal 2000,
respectively.
RESULTS OF OPERATIONS
The following table sets forth for the years indicated certain financial data as
a percentage of net revenue:
<TABLE>
<CAPTION>
FOR YEARS ENDED JULY 28, JULY 31,
-------- --------------------
2000 1999 1998
-------- ------ ------
<S> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 81.6 100.3 80.9
----- ----- -----
Gross margin 18.4 (0.3) 19.1
----- ----- -----
Operating expenses:
Sales and marketing 24.5 29.3 6.9
Research and development 10.3 18.0 3.2
General and administrative 7.5 21.4 7.7
Amortization of deferred
stock compensation 32.8 13.0 --
Amortization of goodwill
and intangible assets 15.1 -- --
Write-off of in-process
research and development 7.5 -- --
----- ----- -----
Total operating expenses 97.7 81.7 17.8
----- ----- -----
Income (loss) from operations (79.3) (82.0) 1.3
Interest and other income
(expense), net 4.7 0.1 0.2
----- ----- -----
Net income (loss) (74.6)% (81.9)% 1.5%
===== ===== =====
Dividend related to
convertible preferred stock (4.1)% -- --
===== ===== =====
Net income (loss) applicable to
common stockholders (78.7)% (81.9)% 1.5%
===== ===== =====
</TABLE>
NET REVENUES
Net revenues increased from $17.7 million in fiscal 1999 to $120.3 million in
fiscal 2000, an increase of $102.6 million. Net revenues increased primarily due
to the high demand for our web based server products and the introduction of our
new 1U and 2U server products in the third and second quarters of fiscal 2000,
respectively. All of our net revenue in fiscal 1999 was derived from sales of
our systems and in fiscal 2000 sales of our systems were approximately 95% of
net revenue. In fiscal 2000, approximately 71% of our net revenues were sales to
companies in the Internet infrastructure market.
Net revenues increased from $5.6 million in fiscal 1998 to $17.7 million in
fiscal 1999. The growth of net revenues was due to the introduction of our new
server product designed for the Internet market late in the second quarter of
fiscal 1999.
Export sales for fiscal 2000, 1999 and 1998 were not material.
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<PAGE> 21
COST OF REVENUES
Cost of revenues increased from $17.8 million in fiscal 1999 to $98.2 million in
fiscal 2000, an increase of $80.4 million. Gross margin increased as a percent
of net revenues from a negative 0.3% in fiscal 1999, to 18.4% in fiscal 2000,
primarily due to increased sales volume from our server products, reductions in
component costs, improved manufacturing efficiencies as a result of outsourcing
our manufacturing to Synnex, and the introduction of new products.
Cost of revenues increased from $4.5 million in fiscal 1998 to $17.8 million in
fiscal 1999, an increase of $13.3 million. Gross margin declined to negative
0.3% in fiscal 1999 from 19.1% in fiscal 1998. This decline was due to three
factors. The largest factor was costs associated with establishing and moving
our manufacturing activities to our initial contract manufacturer. This
represented approximately 50% of the decline. The second factor was the
establishment of our technical support organization and increased headcount in
our manufacturing operations, which represented approximately 30% of the
decline. The third factor was increased component costs due to our transitioning
to more dependable component suppliers. To become more competitive, we
transferred our manufacturing operations to Synnex in July 1999. While we
incurred additional expenses in connection with this move, we believe that
Synnex's position as a distributor of Intel architecture components and other
subsystems, its focus on build-to-order processes and its expertise in material
management will reduce our future product costs.
SALES AND MARKETING EXPENSES
Sales and marketing expenses increased from $5.2 million in fiscal 1999 to $29.5
million in fiscal 2000, an increase of $24.3 million. This increase was due to
an increase in sales and marketing personnel, tradeshow and branding expenses,
and increased commission expenses resulting from higher revenue. Sales and
marketing expenses as a percent of net revenues decreased from 29.3% in fiscal
1999 to 24.5% in fiscal 2000 as a result of higher revenue.
Sales and marketing expenses increased from approximately $382,000 in fiscal
1998 to $5.2 million in fiscal 1999, an increase of $4.8 million. This increase
was due to an increase of sales and marketing personnel and increased expenses
from the launch of our branding and other marketing campaigns. Sales and
marketing expenses as a percent of net revenues increased from 6.9% in fiscal
1998 to 29.3% in fiscal 1999.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased from $3.2 million in fiscal 1999 to
$12.4 million in fiscal 2000, an increase of $9.2 million. This increase was due
to an increase in research and development personnel and increased spending for
material for new product development. Research and development expenses as a
percent of net revenues decreased from 18.0% in fiscal 1999 to 10.3% in fiscal
2000 as a result of higher revenue. We expense all of our research and
development costs as they are incurred.
Research and development expenses increased from approximately $180,000 in
fiscal 1998 to $3.2 million in fiscal 1999, an increase of $3.0 million. This
increase was due to an increase in research and development personnel and
increased spending for material for new product development. Research and
development expenses as a percent of net revenues increased from 3.2% in fiscal
1998 to 18.0% in fiscal 1999.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased from $3.8 million in fiscal 1999
to $9.0 million in fiscal 2000, an increase of $5.2 million. This increase was
due to an increase in administrative personnel and increased expenses relating
to the support of our increased operations. General and administrative expenses
as a percent of net revenues decreased from 21.4% in fiscal 1999 to 7.5% in
fiscal 2000 as a result of higher revenue.
General and administrative expenses increased from approximately $427,000 in
fiscal 1998 to $3.8 million in fiscal 1999, an increase of $3.4 million. This
increase was due to an increase in administrative personnel and increased
expenses to support our increased operations, including the implementation of a
new management information system. General and administrative expenses as a
percent of net revenues increased from 7.7% in fiscal 1998 to 21.4% in fiscal
1999.
AMORTIZATION OF DEFERRED STOCK COMPENSATION
In connection with the grant of stock options to employees during fiscal 1999
and 2000, we recorded deferred stock compensation of $14.4 million and $23.4
million, respectively. We amortized $2.3 million and $16.9 million of deferred
stock compensation in fiscal 1999 and 2000, respectively. We did not record any
deferred stock compensation or amortization in fiscal 1998.
In connection with the acquisitions of TruSolutions, Inc., Precision Insight,
Inc., and NetAttach, Inc. we recorded $113.1 million of deferred stock
compensation during fiscal 2000. We amortized $22.6 million of compensation
expense in fiscal 2000. See further discussion in Notes to the Consolidated
Financial Statements.
AMORTIZATION OF GOODWILL AND INTANGIBLES
In connection with the acquisitions of TruSolutions, Inc., Precision Insight,
Inc., NetAttach, Inc., and Andover.Net, we recorded $381.3 million of goodwill
and intangibles during fiscal 2000. We amortized $18.2 million of goodwill and
intangibles in fiscal 2000. See further discussion in Notes to the Consolidated
Financial Statements.
WRITE-OFF OF IN-PROCESS RESEARCH AND DEVELOPMENT
TRUSOLUTIONS, INC. In connection with the acquisition of TruSolutions, Inc., we
expensed $4.0 million of purchased in-process research and development. The
value assigned to purchased in-process technology, based on the income method
prepared by an independent third-party, was determined by identifying research
projects in areas for which technological feasibility had not been established.
TruSolutions' in-process projects included the research and development
associated with the 1/2U, 1U, 2U, and 4U server products. The value of
in-process research and development was determined by estimating the costs to
develop the purchased in-process technology into commercially viable products,
estimating the resulting net cash flows from such projects and discounting the
net cash flows back to their present value. The discount rate includes a
risk-adjusted discount rate to take into account the uncertainty surrounding the
successful development
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<PAGE> 22
of the purchased in-process technology. The risk-adjusted discount rate applied
to the projects' cash flows was 45% for the in-process technology. We believe
that the estimated in-process technology amounts represent fair value and do not
exceed the amount a third-party would pay for the projects. The valuation
includes cash inflows from in-process technology through 2003 with revenues
commencing in 2000 for the 1U, 2U and 4U servers, and in 2001 for the 1/2U
server. Where appropriate, we allocated anticipated cash flows from an
in-process research and development project to reflect contributions of the core
technology. At the time of the acquisition, TruSolutions' remaining tasks that
were substantially incomplete included: developing additional server features as
well as proving out the in-process products' electrical designs, testing for
compatibility with other systems common in server farms, and testing for Linux
performance. Finally, TruSolutions needed to conduct shock, vibration and
performance testing. We estimate that it will cost approximately $400,000 to
complete the projects with significant remaining development efforts, which are
expected to be completed in the next three to fifteen months. If the projects
are not successful or completed in a timely manner, management's product pricing
and growth rates may not be achieved and we may not realize the financial
benefits expected from the projects.
Andover.Net In connection with the acquisition of Andover.Net, we expensed $5.0
million of purchased in-process research and development. The value assigned to
purchased in-process technology, based on the income method prepared by an
independent third-party, was determined by identifying research projects in
areas for which technological feasibility had not been established. Andover's
in-process projects included next-generation website management tools, online
web applications, and other technologies which will support our vast network of
websites. The value of in-process research and development was determined by
estimating the costs to develop the purchased in-process technology into
commercially viable products, estimating the resulting net cash flows from such
projects and discounting the net cash flows back to their present value. The
discount rate includes a risk-adjusted discount rate to take into account the
uncertainty surrounding the successful development of the purchased in-process
technology. The risk-adjusted discount rate applied to the projects' cash flows
was 30% for the in-process technology. We believe that the estimated in-process
technology amounts represent fair value and do not exceed the amount a
third-party would pay for the projects. The valuation includes cash inflows from
in-process technology through 2005 with revenues commencing in 2001. Where
appropriate, the Company allocated anticipated cash flows from an in-process
research and development project to reflect contributions of the core
technology. At the time of the merger, Andover's remaining tasks that were
substantially incomplete included certain planning, designing, coding,
prototyping, and testing activities that are necessary to establish that the
developmental technologies can be produced to meet their design specifications
including functional, technical, and economic performance requirements. The
Company estimates that it will cost approximately $1,000,000 to complete the
projects with significant remaining development efforts, which are expected to
be completed in the next 9 to 12 months. If the projects are not successful or
completed in a timely manner, management's product pricing and growth rates may
not be achieved and VA Linux may not realize the financial benefits expected
from the projects.
INTEREST AND OTHER INCOME (EXPENSE), NET
Interest and other income, net includes income from our cash investments net of
other expenses. We had net interest and other expenses of approximately $11,000
in fiscal 1998, approximately $19,000 in fiscal 1999, and $5.6 million in fiscal
2000. The increase from fiscal 1999 to fiscal 2000 was primarily due to an
increase in interest income earned on proceeds from our initial public offering
in December 1999. The increase from fiscal 1998 to fiscal 1999 was primarily due
to an increase in interest income earned on proceeds from the issuance of
convertible preferred stock.
INCOME TAXES
As of July 28, 2000, we had $84.9 million of federal and $25.8 million of state
net operating loss carryforwards for tax reporting purposes available to offset
future taxable income. The federal and state net operating loss carry-forwards
expire at various dates through 2020 and 2005, respectively, to the extent that
they are not utilized. We have not recognized any benefit from these net
operating loss carryforwards because of uncertainty surrounding their
realization. The amount of net operating losses that we can utilize is limited
under tax regulations because we have experienced a cumulative stock ownership
change of more than 50% over the last three years.
PREFERRED STOCK DIVIDEND
During the quarter ended October 29, 1999, we recorded a preferred stock
dividend of $4.9 million representing the value of the beneficial conversion
feature on the issuance of convertible preferred stock in September 1999. The
beneficial conversion feature was calculated at the commitment date based on the
difference between the conversion price of $3.86 per share and the estimated
fair value of the common stock at that date. The amount of the beneficial
conversion feature was limited to the amount of the gross proceeds received from
the issuance of convertible preferred stock. The excess of the beneficial
conversion feature over the gross proceeds received was $4.2 million.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased from $18.7 million at July 31, 1999 to
$123.8 million at July 28, 2000, an increase of $105.1 million. This increase is
primarily a result of our initial public offering of common stock in December
1999, which generated net proceeds of $138.7 million and the cash we assumed
from Andover.Net as a result of their initial public offering of common stock in
December 1999, which generated net proceeds of $77.4 million. We used $10.2
million of cash in operating activities in fiscal 1999 and $24.6 million in
fiscal 2000. This increase in cash used was primarily due to increases in
operating losses and accounts receivable, offset by depreciation, amortization
of stock compensation, increases in accounts payable, write-off of in-process
research and development, and lower inventories. We expect accounts receivables
to continue to grow as revenues increase.
Investing activities used cash of $13.2 million in fiscal 2000 due to purchases
of short-term investments of $52.4 million, capital equipment of $7.6 million,
offset by the net amount of cash acquired as a result of acquisitions of $46.9
million. We used cash in investing activities of $2.3 million in fiscal 1999 due
to purchases of computer equipment and other fixed assets. Our capital
expenditures may increase over the next several years as we expand our
facilities and acquire equipment to support expansion of our sales and marketing
and research and development activities.
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<PAGE> 23
Our financing activities provided cash of $143.0 million in fiscal 2000,
generated from the proceeds of our issuance of common stock with our initial
public offering and the sale of convertible preferred stock in September 1999,
partially offset by payments on notes payables and capital lease obligations.
Financing activities provided cash of $31.0 million in fiscal 1999, resulting
almost entirely from the net proceeds from the issuance of convertible preferred
stock.
During fiscal 2000 we entered into a $10.0 million line of credit with a bank.
In connection with this line of credit, we also entered into a $500,000
equipment loan. At July 28, 2000, we had $375,000 outstanding under the
equipment loan and $2.3 million issued under a letter of credit for lease
obligations. Amounts outstanding under each facility bear interest at a variable
rate equal to the bank's prime rate plus 0.75% per annum (9.5% at July 28, 2000)
and are secured by substantially all of our assets. This agreement requires that
we maintain certain financial and non-financial ratios and covenants. As of July
28, 2000 we were in compliance with these covenants.
In June 2000, we agreed to lease a 140,000 square foot complex in Fremont,
California. The related cost of this lease is expected to be approximately
$284,000 per month. The lease has a term of 120 months.
Our future liquidity and capital requirements will depend upon numerous factors,
including the costs associated with the expansion of our sales and marketing
activities and product development efforts, the level and timing of product and
service revenues, the amount of working capital required, and the level of fixed
asset investment required. We believe that the net proceeds from our initial
public offering, together with our current cash and investment balances and any
cash generated from current or future debt financing, will be sufficient to meet
our operating and capital requirements for at least the next 12 months. However,
it is possible that we may require additional financing within this period,
particularly if we elect to acquire complementary businesses or technologies.
The factors described in this paragraph will affect our future capital
requirements and the adequacy of our available funds. As a result, we may be
required to raise additional funds through the sale of equity or convertible
debt or other arrangements. Furthermore, any additional equity financing may be
dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. Our inability to raise capital when needed could
seriously harm our business.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. SFAS No. 133, as recently amended, is effective for
fiscal years beginning after June 15, 2000. Management believes the adoption of
SFAS No. 133 will not have a material effect on the Company's financial position
or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition". In June 2000, the SEC deferred
the adoption date for SAB No. 101 until the fourth quarter of fiscal 2001. SAB
No. 101 summarizes certain areas of the Staff's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
The Company has not quantified the effect of SAB No. 101 on its financial
position or results of operations and has not yet determined the timing and
method of adoption.
In March 2000, the FASB issued Financial Standards Board Interpretation ("FIN")
No. 44, "Accounting for Certain Transactions Involving Stock Compensation--an
Interpretation of APB Opinion No. 25." FIN No. 44 addresses the application of
APB No. 25 to clarify, among other issues, (a) the definition of employee for
purposes of applying APB No. 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. FIN No. 44 is effective July 1, 2000, but certain conclusions cover
specific events that occurred after either December 15, 1998 or January 12,
2000. To the extent FIN No. 44 covers events occurring during the period after
December 15, 1998 or January 12, 2000, but before the effective date of July 1,
2000, the effects of applying the interpretation have been recognized on a
prospective basis from July 1, 2000. Management believes the adoption of FIN No.
44 will not have a material effect on the Company's financial position or
results of operations.
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<PAGE> 24
FACTORS THAT MAY AFFECT FUTURE RESULTS
RISKS RELATED TO COMPETITION WITHIN OUR INDUSTRY
WE MAY NOT BE ABLE TO COMPETE WITH MORE ESTABLISHED COMPANIES.
In the market for computer systems, we face significant competition from larger
companies who market general-purpose computers and have greater financial
resources, more established direct and indirect sales channels and greater name
recognition than we do. These companies include Compaq Computer Corporation,
Dell Computer Corporation, Fujitsu International Inc., Hewlett-Packard Company,
International Business Machines Corporation and Sun Microsystems, Inc. In most
cases, these companies primarily sell systems that run proprietary operating
systems, such as Microsoft Windows and variants of UNIX, including Sun's
Solaris. However, some of them, notably IBM, Compaq, Dell, Sun and H-P, have
also implemented Linux-based computer businesses.
The systems offered by these companies may have greater functionality and lower
prices than those we currently provide, making our systems less attractive to
customers. Even if the functionality of the standard features of these products
is equivalent to ours, we face a substantial risk that a significant number of
customers will choose not to purchase products from a less well-known vendor,
regardless of the competitiveness of our solutions. These companies also have
larger and more established service organizations to support these products and
operating systems. These companies may be able to leverage their existing
organizations, including their service organizations, and provide a wider
offering of products and higher levels of support on a more cost-effective basis
than we can. In addition, these companies may be able to undertake more
extensive promotional activities, adopt more aggressive pricing policies and
offer more attractive terms to their customers than we can.
We also face competition in narrow, vertical markets from limited purpose
computer vendors that offer products that are carefully tailored for specific
applications, which may better address the needs of these customers.
Furthermore, because Linux can be downloaded from the Internet for free or
purchased at a nominal cost and modified and re-sold with few restrictions,
traditional barriers to market entry are minimal. Accordingly, it is possible
that new competitors or alliances among existing competitors may emerge and
rapidly acquire significant market share. Any pricing pressures or loss of
potential customers resulting from our failure to compete effectively would
reduce our revenues. We may not be able to compete successfully with these
current or potential competitors.
WE MAY NOT BE ABLE TO COMPETE WITH SMALLER COMPETITORS WHO ARE FOCUSED ON
MANUFACTURING UNITS THAT COMPETE WITH OUR PRODUCTS ON THE BASIS OF PRICE, USING
COMMODITY PARTS. Small, general purpose computer manufacturers that are focused
on a small number of products can often assemble and offer systems comprised of
off-the-shelf, commodity components, and compete with us primarily on the basis
of price. These "white-box makers" may be able to build systems more
inexpensively than we can because they have little or no research and
development expenses, and no investment in relationships with the Open Source
community, thereby giving them lower overhead expenses than us. Such companies
may also be able to compete effectively with us on personalized, local service,
as these companies generally target a small portion of the market. Technology
standardization in recent years has helped these smaller manufacturers overcome
incompatibility problems that affected some manufacturers in the past. If
customers place less emphasis on our branding, differentiated design and
software expertise and, instead, focus on price and a comparison of some of the
component parts in our systems versus these "white box" systems, we could suffer
a loss of revenues and our business may be harmed.
IF WE DO NOT INTRODUCE NEW PRODUCTS AND SERVICES IN A TIMELY MANNER, OUR
PRODUCTS AND SERVICES WILL BECOME OBSOLETE, AND OUR OPERATING RESULTS WILL
SUFFER. The computer systems market is characterized by rapid technological
change, frequent new product enhancements, uncertain product life cycles,
changes in customer demands and evolving industry standards. Our products could
be rendered obsolete if products based on new technologies are introduced or new
industry standards emerge.
Enterprise computing environments are inherently complex. As a result, we cannot
accurately estimate the life cycles of our products. New products and product
enhancements can require long development and testing periods, which requires us
to hire and retain increasingly scarce, technically competent personnel.
Significant delays in new product releases or significant problems in installing
or implementing new products could seriously damage our business. We have, on
occasion, experienced delays in the scheduled introduction of new and enhanced
products and may experience similar delays in the future.
Our future success depends upon our ability to enhance existing products,
develop and introduce new products, satisfy customer requirements and achieve
market acceptance. This process is made more challenging by the fact that the
Open Source community does much of the software development for our products and
we must work with, and rely upon, a large number of developers who are not our
employees. We may not successfully identify new product opportunities and
develop and bring new products to market in a timely and cost-effective manner.
IF WE FAIL TO RETAIN AND EXPAND OUR CUSTOMER BASE, OUR REVENUES COULD DECLINE
SUBSTANTIALLY. We face competition from different sources, and we must compete
effectively against other current and future competitors to retain and expand
our customer base. We believe the principal factors on which we compete include:
- product functionality;
- quality and availability of professional services;
- quality of product and product support;
- total cost of ownership;
- system performance at different price points;
- reusability for multiple applications;
- sales and distribution efficiency; and
- brand name recognition.
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To be competitive, we must respond promptly and effectively to the challenges of
technological change, evolving standards and our competitors' innovations by
continuing to enhance our products and grow our sales and professional services
organizations. Any pricing pressures or loss of potential customers resulting
from our failure to compete effectively would reduce our revenues.
IF WE ARE UNABLE TO PROVIDE HIGH-QUALITY CUSTOMER SUPPORT AND SERVICES, WE WILL
BE UNABLE TO MEET THE NEEDS OF OUR CUSTOMERS. IN ADDITION, OUR PRODUCTS AND
SERVICES ARE DEPENDENT UPON THE EFFORTS OF MEMBERS OF THE OPEN SOURCE COMMUNITY.
For our business to succeed, we must effectively market our integrated system
and service solutions. If our service organization does not meet the needs or
expectations of customers, we face an increased risk that customers will
purchase systems from other integrated solution providers or purchase systems
from one vendor and services from a Linux specialist.
The quality of our products and services is dependent on the efforts and the
expertise of members of the Open Source community. If we do not continue to work
productively with these members, our ability to provide product enhancement and
quality services will be harmed, which would harm our revenues and compromise
our reputation in the Open Source community and with customers.
RISKS RELATED TO OUR FINANCIAL RESULTS
BECAUSE WE HAVE A LIMITED OPERATING HISTORY AND THE MARKET FOR LINUX-BASED
SYSTEMS IS RAPIDLY EVOLVING, WE MAY NOT ACCURATELY FORECAST OUR SALES AND
REVENUES, WHICH WILL CAUSE QUARTERLY FLUCTUATIONS IN OUR NET REVENUES AND
RESULTS OF OPERATIONS AND MAY RESULT IN VOLATILITY IN OUR STOCK PRICE. Our
ability to accurately forecast our quarterly sales and revenues is made
difficult by our limited operating history and the new and rapidly evolving
market for Linux-based systems in general, and our products in particular. In
addition, most of our operating costs are fixed and based on our revenue
expectations. Therefore, if we have a shortfall in revenues, we may be unable to
reduce our expenses quickly enough to avoid lower quarterly operating results.
During fiscal 1999, we hired 138 employees, moved into significantly larger
facilities and greatly increased our operating expenses. In fiscal 2000, we
continued to add a significant number of new employees. In early fiscal 2001, we
again relocated to larger facilities. We do not know whether our business will
grow rapidly enough to absorb these costs. As a result, our quarterly operating
results could fluctuate, and such fluctuation could adversely affect the market
price of our common stock. Our quarterly net revenues and results of operations
may vary significantly in the future due to a number of additional factors, many
of which are outside of our control. The primary factors that may cause our
quarterly net revenues and results of operations to fluctuate include the
following:
- economic conditions generally and in the specific industries in
which our customers operate;
- demand for and market acceptance of Linux-based systems and our
products and services;
- increases in manufacturing costs, including the prices of
components that are used in our products;
- reductions in the sales price of our systems or those offered by
our competitors;
- our ability to develop, introduce and market new products and
product enhancements that meet customer requirements in a timely
manner;
- our contract manufacturer's ability to manufacture sufficient
quantities of systems and maintain the quality of our systems;
- our contract manufacturer's ability to obtain sufficient supplies
of sole or single source components, including power supplies, disk
controller cards, backplane circuit boards, motherboards and
central processing units;
- the introduction of competing products by companies which market
general or limited purpose servers and computers;
- the failure of Linux developers to enhance and develop the Linux
operating system; and
- costs related to acquisitions of complementary technologies or
businesses.
Accordingly, you should not rely on the results of any past periods as an
indication of our future performance. It is likely that in some future periods,
our operating results may be below expectations of public market analysts or
investors. If this occurs, the price of our common stock may drop.
FAILURE TO MAINTAIN OR INCREASE OUR GROSS MARGIN WILL HARM OUR RESULTS OF
OPERATIONS. Our gross margin may be adversely affected by decreases in the
average selling prices of our systems, increased manufacturing costs or
increased costs of providing service revenues. We have experienced fluctuations
in the average selling prices of our products to date. We anticipate that, as
the market for Linux systems grows, the average unit price of our products will
continue to fluctuate and may decrease. The average unit price of our products
may also decrease in response to changes in product mix, competitive pricing
pressures, new product introductions by us or our competitors or other factors.
If we are unable to offset a decrease in the average selling prices of our
existing products by developing and introducing products and services with
higher margins or by reducing our product and manufacturing costs, our gross
margin will suffer.
To maintain or increase our gross margin, we also must continue to reduce the
manufacturing cost of our products and the costs of providing professional
services. Our products incorporate a significant number of commodity components
and our gross margin will fluctuate as a result of changes in the cost of these
components. Component prices can increase for a number of reasons, including
temporary or extended supply shortages. Increases in our manufacturing costs,
whether due to increased component costs or other factors, could seriously harm
our business. We intend to increase the amount of revenues we derive from
professional services. As a result, we continue to hire additional staff to
provide these services. If we are unable
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to increase professional services revenues quickly enough, gross margins on
these revenues may decline and may adversely affect our overall gross margins.
For more information related to our costs associated with manufacturing, see
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations -- Results of Operations."
OUR QUARTERLY SALES CYCLE MAKES PLANNING AND OPERATIONAL EFFICIENCIES DIFFICULT.
The timing and amount of our revenues are subject to a number of factors that
make estimation of revenues and operating results prior to the end of a quarter
extremely uncertain. We have operated historically with little or no backlog. As
a result, our revenues in any quarter are dependent on orders booked and shipped
in that quarter. In addition, our customers generally have a long lead-time and
sales cycle, which increases the risk of quarter-to-quarter fluctuations and the
uncertainty of estimating quarterly operating results. We, like other computer
companies, generally sell more of our products in the third month of each
quarter than in the first and second months. This sales pattern places pressure
on our logistics system based on internal forecasts and on our ability to timely
notify our contract manufacturer of our precise manufacturing needs. As a
result, our quarterly sales cycle may adversely affect our ability to predict
our financial results accurately.
Our operating expenses are based on projected annual and quarterly revenue
levels and are incurred approximately ratably throughout each quarter. As a
result, if projected revenues are not realized in the expected period, our
operating results for that period would be adversely affected and could result
in an operating loss. Failure to achieve revenue, earnings, and other operating
and financial results as forecast or anticipated by brokerage firm and industry
analysts has in the past resulted, and could in the future result, in an
immediate and adverse effect on the market price of our common stock.
Additionally, developments late in the quarter, such as lower-than- anticipated
product demand, a systems failure at our facilities or at our contract
manufacturer, or component pricing movements, can adversely impact cash and
related gross profitability, in a manner that is disproportionate to the number
of days in the quarter affected.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE
FORESEEABLE FUTURE. We incurred losses of $89.8 million for the Company's fiscal
year ended July 28, 2000, primarily due to expansion of our operations, and we
had an accumulated deficit of $109.6 million as of July 28, 2000. We expect to
continue to incur significant product development, sales and marketing and
administrative expenses, particularly as a result of expanding our direct sales
force. In addition, we are investing considerable resources in our professional
services organization and our Internet operations. We do not expect to generate
sufficient revenues to achieve profitability and, therefore, we expect to
continue to incur net losses for at least the foreseeable future. If we do
achieve profitability, we may not be able to sustain it. Failure to become and
remain profitable may materially and adversely affect the market price of our
common stock and our ability to raise capital and continue operations.
AS OUR BUSINESS MATURES, WE DO NOT EXPECT OUR NET REVENUES TO CONTINUE TO GROW
AT THE SAME RATE AS THEY HAVE IN THE PAST. Although our net revenues have grown
substantially in recent quarters, we do not expect our net revenues to grow at
such a rapid rate in the future and they could decline. This growth rate
reflects an increased number of customers, introductions of new server models,
an increased focus on professional services beginning in the second quarter of
fiscal 2000 and the acquisition of TruSolutions in the third quarter of fiscal
2000. As our business matures, it is unlikely that our net revenues will
continue to grow at the same rate. We believe that our future growth rates will
depend on the success of our sales and marketing efforts, which will require
significant expenditures that we may not have sufficient resources to undertake,
as well as the success of our professional services organization, which to date
has not represented a significant portion of our revenues. In addition,
increased competition and slower than anticipated growth in our market could
also affect our revenue growth. If our net revenues do not increase at or above
the rate analysts expect, the trading price for our common stock may decline.
SALES IN THE INTERNET INFRASTRUCTURE MARKET ARE SUBJECT TO FLUCTUATION. Although
sales to the Internet infrastructure market have grown historically, this market
is characterized by large and often sporadic purchases. In addition, recently,
several of the companies in this market, as well as in the computer market
generally, have warned of lower than expected earnings, which could result in a
decline or delay in sales orders from our customers in the Internet
infrastructure market. Sales activity in this industry depends upon the stage of
completion of expanding network infrastructures, the availability of funding,
and the extent that service providers are affected by regulatory and business
conditions in the locale of operations. A decline or delay in sales orders from
this industry could have a material adverse effect on our business, operating
results, and financial condition.
OUR LIMITED OPERATING HISTORY AND THE FACT THAT WE OPERATE IN A NEW INDUSTRY
MAKE EVALUATING OUR BUSINESS PROSPECTS AND RESULTS OF OPERATIONS DIFFICULT. Our
company was incorporated in January 1995. We have recently expanded our
operations significantly. For example, we grew from 33 employees at January 31,
1999 to 515 employees at July 28, 2000, and only two members of our current
management team were employed by us at the end of fiscal 1998. Further more, we
participate in the Linux industry, which has only recently exhibited significant
growth. You should consider the risks and difficulties we may encounter as an
early stage company in the new and rapidly evolving Linux products and services
market. Some of the factors that may affect us include:
- the evolving and unpredictable nature of our business model;
- the uncertain rate of growth in usage and acceptance of the Linux
operating system and other Open Source software;
- the difficulties often associated with acquiring businesses and
technologies;
- the uncertain demand for our products;
- the need to expand our sales, professional services and customer
support organizations;
- the need to expand our Internet operations;
- increased competition in the Linux industry, particularly from
larger, more established companies that are entering into the Linux
market, as well as the competition we face from general purpose
computer systems manufacturers; and
- our ability to attract and retain qualified management and
professional services personnel.
If we fail to address any of these risks or difficulties adequately, our
business strategy may not be successful and our revenues may not grow and may
decline.
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AS WE EXPAND OUR INTERNATIONAL OPERATIONS, WE WILL FACE ADDITIONAL RISKS, WHICH
COULD HARM OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. To date,
substantially all of our net revenues have been derived from sales of our
products in North America. However, we began selling our products overseas
during fiscal 2000, initially in Europe. We anticipate that as we expand our
international sales, we will fulfill orders through international facilities
operated by Synnex. We could experience difficulties and disruptions in the
manufacture of our products while we transition some manufacturing operations to
these new facilities. Our inability to scale manufacturing of our products in
foreign facilities, and any manufacturing delays or disruptions that occur,
could prevent us from increasing international sales and achieving the timely
delivery of products to customers located in foreign jurisdictions. This could
result in lost revenues and slower revenue growth. Additionally, it will be
costly to establish international facilities and operations, promote our brand
internationally and develop localized websites and other systems. We may be
required to develop foreign language translations of software incorporated into
our systems. Revenues from international sales may not offset the expense of
establishing and maintaining these foreign operations. We have no previous
experience with any of these matters. As we expand our international operations,
we will face a number of additional challenges associated with the conduct of
international business. For example:
- we may have difficulty managing and administering a globally-
dispersed business;
- fluctuations in exchange rates may negatively affect our operating
results;
- we may encounter greater difficulty in collecting accounts
receivable resulting in longer collection periods;
- we may not be able to repatriate the earnings of our foreign
operations;
- we will have to comply with a wide variety of foreign laws and
regulatory requirements with which we are not familiar and
unexpected changes in these laws and requirements;
- we may not be able to adequately protect our trademarks and other
intellectual property overseas due to the uncertainty of laws and
enforcement in certain countries relating to the protection of
intellectual property rights;
- some or all of our domain names may already be in use in countries
where we expect to sell and/or establish operations;
- we could face difficulty in building close relationships with
international Open Source developers;
- reductions in business activity during the summer months in Europe
and certain other parts of the world could negatively impact the
operating results of our foreign operations;
- export controls could prevent us from shipping our products into
and from some markets;
- multiple and possibly overlapping tax structures could
significantly reduce the financial performance of our foreign
operations;
- changes in import/export duties and quotas, tariffs and other tax
barriers could affect the competitive pricing of our products and
services and reduce our market share in some countries; and
- economic or political instability in some international markets
could result in the forfeiture of some foreign assets and the loss
of sums spent developing and marketing those assets.
Any of these factors could significantly impair our ability to source our
contract manufacturing requirements internationally, which could harm our
business and results of operations.
OUR SUCCESS DEPENDS ON DEVELOPING NEW SYSTEMS THAT ACHIEVE MARKET ACCEPTANCE AND
ON THE SUCCESS OF OUR PROFESSIONAL SERVICES ORGANIZATION. We develop systems
that are optimized to run the Linux operating system, particularly for use in
Internet-related applications. Developing new products that meet the needs of
emerging market segments requires us to incur significant research and
development expenses and commit substantial engineering resources to this
effort. If we fail to introduce new products that address the needs of emerging
market segments, or if our new systems do not achieve market acceptance, our
future growth and profitability could suffer. Our success also depends on
customers choosing our professional consulting services and support over those
of our competitors, and our ability to attract and retain qualified personnel in
the area of professional services. If customers do not select our services, or
if we are unable to meet customer demand for such services, our revenues may not
grow and may decline, and our business will be harmed.
OUR FUTURE NET REVENUES DEPEND ON CONTINUED SALES OF OUR SYSTEMS, AND OUR
BUSINESS WILL SUFFER IF DEMAND FOR, OR REVENUES FROM, OUR SYSTEMS DECLINES.
Historically, we have derived a large percentage of our net revenues from Linux
systems sales. Systems sales represented approximately 100% of our net revenues
in fiscal 1999 and approximately 95% of our net revenues in fiscal 2000. We
expect systems sales to continue to account for a substantial majority of our
net revenues for the foreseeable future. Any factors adversely affecting the
pricing of, or demand for, these Linux systems, including increased competition
or decreased market acceptance, could cause our net revenues to decline and our
business to suffer.
RISKS RELATED LINUX AND OPEN SOURCE SOFTWARE
IF THE LINUX OPERATING SYSTEM DOES NOT CONTINUE TO GAIN MARKET ACCEPTANCE, WE
WILL NOT BE ABLE TO SUSTAIN OUR REVENUE GROWTH AND OUR BUSINESS COULD FAIL. For
the foreseeable future, we expect that substantially all of our revenues will be
derived from sales of systems that run the Linux operating system and the
providing of services and support for these systems. The Linux operating system
has only recently gained broad market acceptance. This acceptance has been
mostly limited to Internet infrastructure applications. Our success depends on
the continued and increased rate of adoption of Linux in these and other
markets. If this does not occur, our business will suffer.
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Even if Linux is widely accepted, the Linux operating system is an Open Source
software product, which users are licensed to freely copy, use, modify and
distribute. Accordingly, anyone may download the Linux operating system and
numerous related software applications from the Internet, or otherwise copy it,
without cost, and run it on an existing Linux compatible product. Our success
depends on customers purchasing new systems that integrate and are optimized to
run the Linux operating system.
OUR ABILITY TO INTRODUCE NEW PRODUCTS OR PRODUCT ENHANCEMENTS WOULD BE IMPAIRED
IF LINUX DEVELOPERS DO NOT CONTINUE TO ENHANCE THE CORE SOURCE CODE OF THE LINUX
OPERATING SYSTEM AND DEVELOP LINUX-BASED APPLICATIONS. We may not be able to
introduce new products or product enhancements on a timely basis unless efforts
by Linux developers to expand the functionality of the Linux operating system
continue and are successful. We cannot guarantee that these efforts will
continue or be successful because the core of the Linux operating system, or the
Linux kernel, is maintained by third parties. Linus Torvalds, the original
developer of the Linux kernel, and a small group of independent engineers are
primarily responsible for the development and evolution of the Linux kernel. Mr.
Torvalds is not our employee. If Mr. Torvalds and other third-party developers
fail to further develop the Linux kernel or if the development community does
not continue to improve the functionality of the operating system or introduce
new Open Source software or software enhancements, our ability to market our
existing and future Linux products would suffer. In this event, we may also be
forced to rely to a greater extent on our own development efforts or the
development efforts of third-party consultants, which would significantly
increase our costs. Any failure on the part of the Linux kernel developers to
further develop and enhance the Linux kernel could stifle the development of
additional Linux-based applications for use with our products, which would harm
our product sales.
IF ADDITIONAL SOFTWARE APPLICATIONS COMPATIBLE WITH LINUX ARE NOT DEVELOPED, THE
MARKET FOR OUR PRODUCTS WILL NOT GROW, AND OUR PRODUCT SALES WILL BE HARMED. Our
products are currently purchased primarily for Internet-related applications.
For Linux, in general, and our products, in particular, to gain acceptance in
mainstream business and consumer markets, more third-party software applications
designed to operate on Linux-based operating systems must be introduced and
achieve market acceptance. Many widely used applications, such as Microsoft
Office, Intuit Quicken, Adobe PhotoShop and others, cannot run natively on Linux
operating systems. Many available Linux applications, such as word processors,
databases, accounting packages, spreadsheets, e-mail programs, Internet
browsers, presentation and graphics software and personal productivity
applications, have not achieved mainstream market acceptance. If third parties
do not introduce more software applications designed to operate on the Linux
operating system and achieve market acceptance, our products will not gain
mainstream business and consumer acceptance, and we may not be able to maintain
our product sales growth.
IF MULTIPLE AND INCOMPATIBLE DISTRIBUTIONS OF LINUX ACHIEVE SUFFICIENT MARKET
ACCEPTANCE, OUR OPERATING EXPENSES COULD INCREASE AND DEMAND FOR OUR PRODUCTS
COULD DECLINE. If multiple, incompatible versions of Linux are developed,
customers may become less likely to purchase Linux products, and our sales would
suffer. In addition, we may be required to offer and support more distributions
of Linux.
This would result in increased operating expenses. Alternatively, if VA Linux
sold and supported a single Linux distribution that was not the predominant
Linux distribution, VA Linux's sales and revenue growth would suffer.
IF THE LINUX DEVELOPER COMMUNITY FAILS TO SUPPORT US, OR REACTS NEGATIVELY TO
OUR BUSINESS STRATEGY, OUR BUSINESS WILL BE HARMED. A majority of the software
we include with our server products is developed and maintained by third parties
in the Open Source software community. The third parties in the Linux developer
community, upon whom we rely to develop and maintain a majority of our software,
may not continue to support us, our product promotions or our corporate or
operating decisions. If these third parties fail to support us for any reason,
we would be forced to rely to a significantly greater extent on our own
development efforts, which would require us to hire additional developers and
increase our development expenses and could adversely impact product release
schedules.
Some members of the Open Source community have criticized the commercialization
of the Open Source movement through activities such as licensing proprietary
versions of Open Source software, providing services to the users of Open Source
software and selling advertisements to companies that seek access to the user
group that visits websites dedicated to Open Source software. We provide
services to the users of Open Source software and sell advertisements on our
websites. A negative reaction to our actions, if widely shared by our visitors
or the rest of the Open Source community, could harm our reputation and diminish
our brand. Our business, results of operations and financial condition could
suffer accordingly.
RISKS RELATED TO OUR PRODUCT MANUFACTURING
WE RELY ON SYNNEX AS OUR SINGLE SOURCE CONTRACT MANUFACTURER. IF SYNNEX IS
UNABLE TO MEET OUR MANUFACTURING NEEDS OR OUR RELATIONSHIP TERMINATES, WE MAY
LOSE REVENUES AND DAMAGE OUR CUSTOMER RELATIONSHIPS. We rely on Synnex to
produce substantially all of our products at its Fremont, California facility on
a purchase order basis, and Synnex is our sole manufacturer. With the exception
of a small internal systems integration and prototyping facility, we have
relocated our internal manufacturing organization to Synnex's manufacturing
facility. Presently, all of our manufacturing is done at this one site and, in
the event of a natural disaster, our business could be harmed. Under our
agreement with Synnex, Synnex is not obligated to supply products to us for any
specific period, or in any specific quantity, except as may be provided in a
particular purchase order that has been accepted by Synnex. If Synnex
experiences delays, disruptions, capacity constraints or quality control
problems in its manufacturing operations, then product shipments to our
customers could be delayed, which would negatively impact our net revenues and
our competitive position and reputation. Moreover, our contract with Synnex may
be terminated for any reason at any time by either party upon 120 days advance
notice. Synnex subleases space in its facilities to us for our manufacturing
operations. If our sublease with Synnex terminates, we will need to lease
additional space for our manufacturing operations, which may not be available to
us on commercially reasonable terms, if at all. In addition, we may need to
qualify a new contract manufacturer and may be unable to find a contract
manufacturer that meets our needs or that can source components as
cost-effectively as our current contract manufacturer. Qualifying a new contract
manufacturer and commencing volume production is expensive and time consuming.
Transferring manufacturing opera-
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tions can significantly disrupt product supply. If we are required or choose to
change contract manufacturers, we may lose sales and may experience increased
manufacturing or component costs, and our customer relationships may suffer.
SYNNEX DEPENDS ON SINGLE AND LIMITED SOURCE SUPPLIERS FOR KEY COMPONENTS, WHICH
MAKES US SUSCEPTIBLE TO SUPPLY SHORTAGES OR PRICE FLUCTUATIONS THAT COULD
ADVERSELY AFFECT OUR OPERATING RESULTS. Synnex, our contract manufacturer,
depends on single source suppliers for a number of key components for our
products, such as industry standard processors, power supplies, custom printed
circuit boards, chassis and sheet metal parts. It also depends on a limited
number of sources to supply several other industry standard components. For
fiscal 2001, Converter Concepts, Inc. is our single source for power supplies
used in our FullOn model of server product, Tyco International is our single
source for backplane circuit boards, motherboards and central processing units
in our server products, and Mylex Corporation is our single source for our RAID
hard disk controller cards. It would be difficult for us to identify another
source of supply if any of these suppliers were unable to meet our requirements
for any reason. In addition, we do not have a long-term binding agreement with
Converter Concepts, Inc., Tyco International or Mylex Corporation. Synnex has
experienced, and may in the future experience, shortages of, or difficulties in,
acquiring these components. If Synnex is unable to buy these components in
adequate quantities at the times required, we may not be able to manufacture our
products on a timely basis, which would harm our operating results. In addition,
if Synnex is required to pay higher prices for these single or limited source
components and we are required to pay higher prices for products, our gross
margin would be harmed. Furthermore, overall market conditions affecting supply
and pricing for key commodity components are known to fluctuate significantly at
times, and increases in the costs of key components, or shortages of supply,
could harm our business.
IF WE FAIL TO ACCURATELY PREDICT OUR MANUFACTURING REQUIREMENTS, WE COULD INCUR
ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS. Because we currently do not
have a long-term supply contract with Synnex, it is not obligated to supply
products to us for any specific period, in any specific quantity or at any
certain price, except as may be provided in a particular purchase order. We
provide forecasts of our demand to Synnex up to 90 days prior to scheduled
delivery of products to our customers. If we overestimate our requirements,
Synnex may have excess inventory, which would increase our costs. If we
underestimate our requirements, Synnex may have an inadequate inventory, which
could interrupt manufacturing of our products and result in delays in shipments
and revenues. In addition, lead times for materials and components we order vary
significantly and depend on factors such as the specific supplier, contract
terms and demand for each component at a given time. We also may experience
shortages of certain components from time to time, which also could delay the
manufacturing of our products.
RISKS RELATED TO OUR PRODUCTS' DEPENDENCE ON
INTELLECTUAL PROPERTY AND THE USE OF OUR BRAND
WE COULD BE PREVENTED FROM SELLING OR DEVELOPING OUR PRODUCTS IF THE GNU GENERAL
PUBLIC LICENSE AND SIMILAR LICENSES UNDER WHICH THE OPERATING SYSTEM
INCORPORATED INTO OUR PRODUCTS IS DEVELOPED AND LICENSED, ARE NOT ENFORCEABLE,
OR ARE NOT EFFECTIVELY ENFORCED. The Linux kernel and the Linux operating system
incorporated into our products have been developed and licensed under the GNU
General Public License (the "GPL"), and similar Open Source licenses. These
licenses require that any software program licensed under them may be copied,
used, modified and distributed freely, so long as all modifications are also
made freely available and licensed under the same conditions. We know of no
instance in which a party has challenged the validity of these licenses or in
which these licenses have been interpreted in a legal proceeding. To date, all
compliance with these licenses has been voluntary.
It is possible that parties may refuse to comply with the terms of these
licenses. One resulting risk is that entities with the legal right to enforce
these licenses against non-complying parties might not be able to enforce these
licenses effectively, because of a lack of financial resources or otherwise.
Even with vigorous enforcement action, it is possible that a court would hold
one or more of these licenses to be unenforceable in the event that someone were
to file a claim asserting proprietary rights in a program developed and
distributed under them. Any ruling by a court that these licenses are not
enforceable, or that Linux-based operating systems, or significant portions of
them, may not be copied, modified, or distributed freely, would have the effect
of preventing us from selling or developing our products, unless we are able to
negotiate a license for the use of the software or replace the affected
portions. In the event that we obtain this license, we would likely be required
to make royalty payments with respect to the sale of our products covered by the
license. Any royalty payments would harm our operating results. We may not be
able to obtain this license. In the event that we have to replace portions of
the software code ourselves, which could be time consuming and result in higher
development costs, our operating results would be harmed.
IF WE ARE PROHIBITED FROM USING THE LINUX TRADEMARK, OUR BUSINESS COULD BE
ADVERSELY AFFECTED. Like many other companies, we market Linux-based products,
systems and services. We do not own the trademark to "Linux." The owner has
consented to our use of the word Linux in our company name and in the title of
our websites. We believe that the continued efficacy and use of the "Linux"
trademark is important to our business. If the "Linux" trademark is invalidated
through a legal action, or we are no longer permitted to use it, our business
could suffer. In addition, we cannot control the use of this trademark, and use
by others may lead to confusion about the source, quality, reputation and
dependability of Linux, which may harm our business.
OUR BUSINESS WILL BE HARMED IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL
PROPERTY RIGHTS FROM MISUSE BY THIRD PARTIES. Our collection of trademarks is
important to our business. The protective steps we take or have taken may be
inadequate to deter misappropriation of our trademark rights. We have filed
applications for registration of some of our trademarks in the United States and
internationally. Effective trademark protection may not be available in every
country in which we offer or intend to offer our products and services. Failure
to protect our trademark rights adequately could damage our brand identity and
impair our ability to compete effectively. Furthermore, defending or enforcing
our trademark rights could result in the expenditure of significant financial
and managerial resources.
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WE ARE VULNERABLE TO CLAIMS THAT OUR PRODUCTS INFRINGE THIRD-PARTY INTELLECTUAL
PROPERTY RIGHTS, ESPECIALLY BECAUSE OUR SYSTEMS INCORPORATE MANY DISTINCT
SOFTWARE COMPONENTS DEVELOPED BY THOUSANDS OF INDEPENDENT THIRD PARTIES. ANY
RESULTING CLAIMS AGAINST US COULD BE COSTLY TO DEFEND OR SUBJECT US TO
SIGNIFICANT DAMAGES. We may be exposed to future litigation based on claims that
our products infringe the intellectual property rights of others. This risk is
exacerbated by the fact that most of the code in our products is developed by
independent parties over whom we exercise no supervision or control and who,
themselves, might not have the same financial resources as we do to pay damages
to a successful litigant. For example, developers may incorporate code into the
Linux operating system under the GPL without proper third-party consents. In
addition, these developers are unlikely to perform patent searches and may
therefore unwittingly infringe third-party patent rights. Although most of the
software incorporated into our systems is Open Source, nothing in Open Source
licenses can prevent current or future patent holders or other owners of
intellectual property from suing us and others seeking monetary damages or an
injunction against shipment of our systems. A patent holder may deny us a
license or force us to pay royalties. In either event, our operating results
could be seriously harmed. In addition, employees hired from competitors might
utilize proprietary and trade secret information from their former employers
without our knowledge, even though our employment agreements and policies
clearly prohibit such practices. Any litigation, with or without merit, could be
time consuming to defend, result in high litigation costs, divert our
management's attention and resources, or cause product shipment delays. We also
could be required to remove or replace infringing technology. We are not aware
that the technology employed in our systems infringes any proprietary rights of
third parties.
WE MAY NOT BE ABLE TO USE INTELLECTUAL PROPERTY TO PROTECT OURSELVES FROM
COMPETITION. Our systems consist primarily of commodity hardware components in
combination with the Linux operating system. While we have developed some
proprietary techniques and expertise, most of our activities and systems are not
protectable as proprietary intellectual property and may be used by competitors,
harming our market share and product revenues. To protect our intellectual
property, we generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners. We have also recently commenced a
patent program and to date have filed two patent applications. In general,
however, we have taken only limited steps to protect our intellectual property.
Accordingly, we may be unable to use intellectual property to prevent other
companies from competing with us. In addition, we may be unable to prevent third
parties from developing techniques that are similar or superior to our
technology, or from designing around our copyrights, patents and trade secrets.
IF WE FAIL TO ADEQUATELY PROMOTE AND MAINTAIN OUR BRAND NAME OR ARE UNABLE TO
CONTINUE USING "LINUX" AS PART OF OUR BRAND NAME, OUR PRODUCT SALES WOULD
DECLINE, AND WE WOULD INCUR SIGNIFICANT COSTS TO PROMOTE A NEW BRAND NAME. We
believe that we need a strong brand to compete successfully. In order to promote
and maintain our brand identity and to attract and retain customers, we plan to
increase our spending on advertising and promotions and to implement new
marketing campaigns. These strategies may not be successful. If we are unable to
design and implement effective marketing campaigns or otherwise fail to promote
and maintain our brand, our sales could decline. Our business may also be harmed
if we incur significant expenses in an attempt to promote and maintain our brand
without a corresponding increase in revenues. Linus Torvalds owns the trademark
to "Linux." Mr. Torvalds has consented to our use of the word Linux in our
company name and in the title of our websites. This consent may be revoked in
the future, however, and we may no longer be able to use this trademark in our
brand or in the title of our websites. In this event, our product sales would
decline, and we would incur significant costs to promote a new brand name, which
takes time and may not be successful
WE MAY BE SUBJECT TO CLAIMS AS A RESULT OF INFORMATION PUBLISHED ON, POSTED ON
OR ACCESSIBLE FROM OUR INTERNET SITES. We may be subject to claims of
defamation, negligence, copyright or trademark infringement (including
contributory infringement) or other claims relating to the information contained
on our Internet sites, whether written by us or third parties. These types of
claims have been brought against online services in the past and can be costly
to defend regardless of the merit of the lawsuit. Although recent federal
legislation protects online services from some claims when the material is
written by third parties, this protection is limited. Furthermore, the law in
this area remains in flux and varies from state to state. We receive
notification from time to time of potential claims, but have not been named as a
party to litigation involving such claims. While no formal complaints have been
made against us to date, our business could be seriously harmed if one were
asserted.
OTHER RISKS RELATED TO OUR BUSINESS
OUR REVENUE GROWTH DEPENDS ON OUR ABILITY TO HIRE AND RETAIN QUALIFIED
PERSONNEL. During fiscal 2000 we hired, and going forward we intend to continue
to hire, a significant number of additional research and development, support,
sales and marketing and other personnel. Competition for these individuals is
intense, and we may not be able to attract, assimilate or retain highly
qualified personnel. Our future success and ability to sustain our revenue
growth also depend upon the continued service of our executive officers and
other key engineering, sales, marketing and support personnel. Competition for
qualified personnel in our industry and in the San Francisco Bay Area, as well
as the other geographic markets in which we recruit, is extremely intense and
characterized by rapidly increasing salaries, which may increase our operating
expenses or hinder our ability to recruit qualified candidates.
OUR ACQUISITION OF ANDOVER.NET COULD CAUSE US TO LOSE CUSTOMERS OR STRATEGIC
PARTNERS. Some of Andover.Net's existing customers or strategic partners may
view themselves as competitors of some of our customers or of us and therefore
determine that our acquisition of Andover.Net is competitively disadvantageous
to them. As a result, the acquisition may have adversely affected our
relationship with these customers or strategic partners, and could result in
termination of their relationships as a result.
WE HAVE RECENTLY ACQUIRED SEVERAL COMPANIES AND WE MAY NOT BE ABLE TO
SUCCESSFULLY INTEGRATE AND MANAGE THESE COMPANIES. In the third quarter of
fiscal 2000, we acquired TruSolutions, Inc. Net Attach, Inc., and Precision
Insight, Inc. and in the fourth quarter of fiscal 2000, we acquired Andover.Net.
In the first quarter of 2001, we acquired Brave New Worlds, Inc. and Life BVBA.
These six companies had a total of 202 employees, whom we are integrating with
our other employees.
28
<PAGE> 31
The ongoing integration of these employees and the operations of these companies
into our business requires significant resources, including significant
attention of our management. We cannot assure you that we will be able to
successfully integrate the employees and other operations of these companies
into our business or that we will be successful in managing the operations of
these companies. If we are not able to successfully integrate and manage the
operations of these operations of these companies, our business may be
materially harmed. Further, we may never realize any of the anticipated benefits
of these acquisitions.
IF WE ARE UNABLE TO IMPLEMENT APPROPRIATE SYSTEMS, PROCEDURES AND CONTROLS TO
MANAGE OUR EXPECTED GROWTH, WE MAY NOT BE ABLE TO SUCCESSFULLY OFFER OUR
SERVICES AND GROW OUR BUSINESS. Our ability to successfully offer our services
and grow our business requires an effective planning and management process.
Since we began operations, we have significantly increased the size of our
operations. This growth has placed, and we expect that any future growth we
experience will continue to place, a significant strain on our management,
systems and resources. In order to manage growth effectively, in the past
fifteen months we have implemented or updated our operations and financial
systems, procedures and controls, including the implementation of an enterprise
resource planning system and a web-based ordering system. Our systems will
continue to require additional modifications and improvements to respond to
future changes in our business. Our key personnel have limited experience
managing this type of growth. If we cannot manage our growth effectively or if
we fail to timely implement appropriate internal systems, procedures, controls
and necessary modifications and improvements to these systems, our business will
suffer.
WE DEPEND ON THE CONTINUED SERVICES OF OUR FOUNDERS AND OTHER KEY ENGINEERING
PERSONNEL, WHOSE KNOWLEDGE OF OUR BUSINESS AND TECHNICAL EXPERTISE WOULD BE
DIFFICULT TO REPLACE. Our products and technologies are complex, and we are
substantially dependent upon the continued services of our existing engineering
personnel and executive management, especially Larry M. Augustin, our President
and Chief Executive Officer. Aside from certain individuals from Andover.Net, we
do not have employment contracts with any of our key engineering personnel, so
that the employment of any key engineer may be terminated "at will" by such
individual. The loss of any, or a group of, our key engineering personnel,
particularly to a competitor, could adversely affect our business, reduce our
market share, slow our product development processes and diminish our brand
identity.
WE MAY NOT BE ABLE TO GENERATE ENOUGH ADDITIONAL REVENUE FROM OUR INTERNATIONAL
EXPANSION TO OFFSET THE COSTS ASSOCIATED WITH ESTABLISHING AND MAINTAINING
FOREIGN OPERATIONS. A key component of our growth strategy is to expand our
presence in foreign markets. It has been, and will continue to be, costly to
establish international facilities and operations, promote our brand
internationally and develop localized websites and other systems. Revenue from
international activities may not offset the expense of establishing and
maintaining these foreign operations. In addition, because we have little
experience in marketing and distributing products or services for these markets,
we may not benefit from any first-to-market advantages.
IF WE DO NOT SUBSTANTIALLY EXPAND OUR DIRECT SALES OPERATIONS AND E-COMMERCE
INITIATIVES, OUR SALES AND MARKET SHARE WILL NOT GROW. To date, we have relied
primarily on our direct sales force to generate demand for our products. Many of
our products require a sophisticated sales effort targeted at our prospective
customers' information technology departments. In order to increase market
awareness and sales of our products, we will need to substantially expand our
direct sales operations, both domestically and internationally. Competition for
qualified sales personnel is intense, and we might not be able to hire the
quality and number of sales people we require. In addition, we have devoted
significant resources to implementing e-commerce solutions, such as our
valinux.com website, that broaden our market reach and we intend to deploy more
e-commerce solutions. If we fail to effectively expand our direct sales
operations or strengthen our e-commerce initiatives, our growth will be limited.
OUR PRODUCTS MAY CONTAIN DEFECTS THAT COULD BE COSTLY TO CORRECT, DELAY MARKET
ACCEPTANCE OF OUR PRODUCTS AND EXPOSE US TO LITIGATION. Despite testing by us
and our customers, errors may be found in our products after commencement of
commercial shipments. We buy almost all of our component hardware parts from
third parties. These parts may fail, cause unexpected electrical or mechanical
problems or otherwise not function properly. We have not achieved regulatory
compliance in all countries into which we expect to sell and/or establish
operations. In addition, independent parties over whom we exercise no
supervision or control develop most of the software code in our products. If
errors are discovered, we may have to make significant expenditures of capital
to eliminate them and yet may not be able to correct them in a timely manner, if
at all. Errors and failures in our products could result in a loss of, or delay
in, market acceptance of our products and could damage our reputation and our
ability to convince commercial users of the benefits of products incorporating
Linux-based operating systems and other Open Source products. Failures in our
products could also cause system failures, including critical business systems,
for our customers who may assert warranty and other claims for substantial
damages against us. Although our warranties typically contain provisions
designed to limit our exposure to potential product liability claims, it is
possible that these provisions may not be effective or enforceable under the
laws of some jurisdictions. Our insurance policies may not provide sufficient
coverage to adequately limit our exposure to this type of claim. These claims,
even if unsuccessful, could be costly and time consuming to defend.
OUR MANAGEMENT TEAM IS NEW AND, IF THEY ARE UNABLE TO WORK TOGETHER EFFECTIVELY,
OUR BUSINESS COULD BE SERIOUSLY HARMED. Our business is highly dependent on the
ability of our management team to work together effectively to meet the demands
of our growth. We grew from 33 employees at January 31, 1999 to 515 employees at
July 28, 2000. We employed only two members of our current management team at
the end of fiscal 1998. Additionally, we have recently added two additional
senior executives. These individuals have not previously worked together as a
management team and have had only limited experience managing a rapidly growing
company on either a public or private basis. Our productivity and the quality of
the products and services we render may be adversely affected if we do not
integrate and train our new employees quickly and effectively.
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<PAGE> 32
FURTHER ACQUISITIONS COULD RESULT IN DILUTION TO OUR STOCKHOLDERS, OPERATING
DIFFICULTIES AND OTHER HARMFUL CONSEQUENCES FOR US. We are currently seeking to
acquire, and expect that we will continue to seek to acquire or invest in,
additional businesses, products, services and technologies that complement or
augment our service and product offerings and customer base. We are currently
engaged in discussions with a number of other companies regarding strategic
acquisitions or investments. Although these discussions are ongoing, we have not
signed any definitive agreements and cannot assure you that any of these
discussions will result in actual acquisitions.
To be successful, we will need to identify suitable acquisition candidates. In
the event of future acquisitions, we will face additional financial and
operational risks, including:
- difficulty in assimilating the operations, technology and personnel
of acquired companies;
- disruption in our business because of the allocation of resources
to consummate these transactions and the diversion of management's
attention from our core business;
- difficulty in retaining key technical and managerial personnel from
acquired companies;
- dilution of our stockholders, if we issue equity to fund these
transactions;
- assumption of operating losses, increased expenses and liabilities;
- harm to our reputation, if the Open Source development community
does not approve of these transactions;
- our relationships with existing employees, customers and business
partners may be weakened or terminated as a result of these
transactions; and
- we may experience one-time in-process research and development
charges and ongoing expenses associated with amortization of
goodwill and other purchased intangible assets.
EXPANDING OUR SERVICES BUSINESS WILL BE COSTLY AND MAY NOT RESULT IN ANY BENEFIT
TO US. We believe that the expansion of both our business and the acceptance of
Linux are dependent upon the availability of high quality professional services
to assist customers in designing and implementing Linux-based systems. If we are
unable to successfully provide these services, our business will be harmed and
we may lose customers seeking quality professional services. We have recently
expanded our strategic focus to place additional emphasis on providing
professional services, from which we have historically derived an insignificant
amount of revenue. Our customers may not engage our professional services
organization to render services and, therefore, we may not generate sufficient
services revenues to offset the expenses of this organization. We may not
attract or retain a sufficient number of the highly qualified service personnel
we need to support the expansion of our professional services organization. This
expansion has required, and will continue to require, significant additional
expenses and resources. In addition, this expansion will place further strain on
our management and operational resources.
WE MAY FAIL TO DEVELOP AND PROMOTE OUR NETWORK EFFECTIVELY, WHICH MAY PREVENT US
FROM ATTRACTING NEW VISITORS AND ADVERTISERS TO OUR NETWORK. Enhancing our
network will allow us to increase our revenues because a segment of our business
is to deliver services and content to users through our network, and we display
advertisements on our network. We have recently enhanced, and intend to continue
to enhance, our network by internally creating and externally acquiring
additional complementary websites. Some of the content currently provided on our
websites is developed by us. Other content is developed by third parties and
posted on our network. In order to attract and retain Internet users and
advertisers, we intend to substantially increase our expenditures to further
promote and develop our network. Our success in developing and promoting our
network will also depend on our ability to provide high quality content,
features and functionality. If we fail to promote our network successfully or if
visitors to our network or advertisers do not perceive our services to be
useful, current or of high quality, our business, results of operations and
financial condition could suffer.
WE ARE VULNERABLE TO UNEXPECTED NETWORK INTERRUPTIONS CAUSED BY SYSTEM FAILURES,
WHICH MAY RESULT IN REDUCED VISITOR TRAFFIC ON OUR NETWORK, DECREASED REVENUE
AND HARM TO OUR REPUTATION. Substantially all of our communications hardware and
other hardware related to our websites will be located in two locations. Fire,
floods, hurricanes, tornadoes, earthquakes, power loss, telecommunications
failures, break-ins and similar events could damage these systems. In addition,
our servers are vulnerable to computer viruses, electronic break-ins, human
error and other similar disruptive problems, which could adversely affect our
systems and websites. We could lose revenue and suffer damage to our reputation
if any of these occurrences affected our systems because we would have decreased
visitor traffic on our network. Our insurance policies may not adequately
compensate us for any losses that may occur due to failures or interruptions in
our systems.
OUR SYSTEMS MAY FAIL OR EXPERIENCE A SLOWDOWN AND OUR USERS DEPEND ON OTHERS FOR
ACCESS TO OUR NETWORK. Our network must accommodate a high volume of traffic and
deliver frequently updated information. Our network has experienced, and may in
the future experience, slower response times or decreased traffic for a variety
of reasons. Slower response times can result from general Internet problems,
routing and equipment problems by third-party Internet access providers,
problems with third-party advertising servers and increased traffic to our
servers. Our network could experience interruptions in service due to the
failure or delay in the transmission or receipt of this information. In
addition, our community of Internet users depends on Internet service providers,
online service providers and other websites' operators for access to our
network. Those providers have experienced outages in the past, and may
experience outages or delays in the future. Moreover, our Internet
infrastructure might not be able to support continued growth of our network. If
we experience any of these problems, our reputation and brand name could suffer,
users might perceive our network as not functioning properly and our business,
results of operations and financial condition could suffer.
REGULATION AND THIRD-PARTY OWNERSHIP COULD REDUCE THE VALUE OF OUR DOMAIN NAMES,
WHICH WOULD HARM OUR BRAND RECOGNITION. We own numerous domain names, both in
the United States and internationally.
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<PAGE> 33
These domain names are important because they allow visitors to locate our
websites and build brand recognition. Internet regulatory bodies regulate domain
names. The regulation of domain names in the United States and in foreign
countries is subject to change. Regulatory bodies could establish additional
top-level domains, appoint additional domain name registrars or modify the
requirements for holding domain names. Because of this, and as a result of third
parties acquiring our domain names in other jurisdictions, we might not acquire
or maintain our domain names in all the countries in which we conduct business,
which could harm our business. Furthermore, the relationship between regulations
governing domain names and laws protecting trademarks and similar proprietary
rights is unclear and still evolving. Therefore, we might be unable to prevent
third parties from acquiring domain names that infringe or otherwise decrease
the value of our trademarks and other proprietary rights. If this occurs, our
business, results of operations and financial condition would suffer.
OUR PRODUCT SALES AND REVENUE GROWTH DEPEND ON THE CONTINUED POPULARITY AND
ACCEPTANCE OF THE INTERNET, WHICH MAY DECLINE IF NEW LAWS AND GOVERNMENT
REGULATIONS SURROUNDING THE INTERNET ARE APPLIED. If the popularity and
acceptance of the Internet as an effective medium of commerce does not continue
to grow or declines, our product sales and revenue growth will be harmed. We are
significantly dependent on the Internet to process the sale of our products. In
July 2000, substantially all of our sales were processed through our valinux.com
website. We are also planning on deploying enhanced e-commerce applications to
foster closer relationships with our customers, facilitate Internet-based
ordering and tracking, and sales processing. As the use of the Internet
continues to evolve, increased regulation by federal, state or foreign agencies
in areas including user privacy, pricing, content, and quality of products and
services becomes more likely. Our e-commerce activities might subject us to the
jurisdiction of the legal systems of other countries. Taxation of Internet
commerce, or other charges imposed by government agencies or by private
organizations, may also be imposed. Laws and regulations applying to the
solicitation, collection, processing of personal or consumer information could
also be enacted. Any of these regulations could result in a decline in the use
or popularity of the Internet as a medium for commerce, which could have an
adverse effect on our future sales and revenue growth.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we may invest
in may be subject to market risk. This means that a change in prevailing
interest rates may cause the principal amount of the investment to fluctuate.
For example, if we hold a security that was issued with a fixed interest rate at
the then-prevailing rate and the prevailing interest rate later rises, the
principal amount of our investment will probably decline. To minimize this risk
in the future, we intend to maintain our portfolio of cash equivalents and
short-term investments in a variety of securities, including commercial paper,
money market funds and government and non-government debt securities. In
general, money market funds are not subject to market risk because the interest
paid on such funds fluctuates with the prevailing interest rate. The following
table presents the amount of our cash equivalents and short-term investment that
are subject to market risk by range of expected maturity and weighted-average
interest rate as of July 28, 2000. This table does not include money market
funds because those funds are not subject to market risk.
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
(IN THOUSANDS) OR LESS TO ONE YEAR
- ------------------------------------- ---------- ----------
<S> <C> <C>
Included in cash and cash equivalents $ 50,517
Weighted-average interest rate 6.70%
Included in short-term investments $ 52,433
Weighted-average interest rate 7.03%
</TABLE>
We have operated primarily in the United States, and virtually all sales have
been made in U.S. dollars. Accordingly, we have not had any material exposure to
foreign currency rate fluctuations.
31
<PAGE> 34
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To The Board of Directors and Stockholders of
VA Linux Systems, Inc.:
We have audited the accompanying consolidated balance sheets of VA Linux
Systems, Inc. (a Delaware corporation) as of July 28, 2000 and July 31, 1999,
and the related consolidated statements of operations, stockholders' (deficit)
equity and cash flows for each of the three years in the period ended July 28,
2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VA Linux Systems, Inc. as of
July 28, 2000 and July 31, 1999, and the results of its operations and its cash
flows for each of the three years ended July 28, 2000, in conformity with
accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
/s/ ARTHUR ANDERSEN LLP
- -----------------------------------
San Jose, California
August 21, 2000
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<PAGE> 35
CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
<TABLE>
<CAPTION>
JULY 28, 2000 JULY 31, 1999
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 123,849 $ 18,653
Short-term investments 52,433 --
Accounts receivable, net of allowances of $1,475 and $207, respectively 31,842 4,033
Inventories 1,018 1,971
Prepaid expenses and other assets 2,156 381
--------- ---------
Total current assets 211,298 25,038
Property and equipment, net 10,316 1,759
Goodwill and intangibles 362,744 645
Other assets 741 153
--------- ---------
$ 585,099 $ 27,595
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 26,715 $ 6,243
Accrued liabilities and other 11,285 1,806
Current portion of notes payable 1,568 759
--------- ---------
Total current liabilities 39,568 8,808
--------- ---------
Notes payable, net of current portion 1,104 160
Other long-term liabilities 552 264
Commitments (Note 6)
Stockholders' equity:
Convertible preferred stock, $0.001 par value
Authorized -- 10,000,000;
Outstanding-- None in 2000 and 18,651,914 shares in 1999 -- 19
Common stock, $0.001 par value
Authorized -- 250,000,000;
Outstanding-- 51,903,850 shares in 2000 and 15,444,860 shares in 1999 52 15
Additional paid-in capital 763,128 45,461
Stockholder note receivable -- (50)
Deferred stock compensation (109,686) (12,121)
Accumulated deficit (109,619) (14,961)
--------- ---------
Total stockholders' equity 543,875 18,363
--------- ---------
$ 585,099 $ 27,595
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
33
<PAGE> 36
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED JULY 28, YEARS ENDED JULY 31,
------------------ --------------------------
2000 1999 1998
------------------ --------- ---------
<S> <C> <C> <C>
Net revenues $ 120,296 $ 17,710 $ 5,556
Cost of revenues 98,181 17,766 4,494
--------- --------- ---------
Gross margin 22,115 (56) 1,062
--------- --------- ---------
Operating expenses:
Sales and marketing 29,479 5,183 382
Research and development 12,363 3,189 180
General and administrative 8,985 3,791 427
Amortization of deferred stock compensation 39,500 2,312 --
Amortization of goodwill and intangible assets 18,175 -- --
Write-off of in-process research and development 9,000 -- --
--------- --------- ---------
Total operating expenses 117,502 14,475 989
--------- --------- ---------
Income (loss) from operations (95,387) (14,531) 73
Interest and other income, net 5,629 19 11
--------- --------- ---------
Net income (loss) $ (89,758) $ (14,512) $ 84
========= ========= =========
Dividend related to convertible preferred stock $ (4,900) $ -- $ --
========= ========= =========
Net income (loss) attributable to common stockholders $ (94,658) $ (14,512) $ 84
========= ========= =========
Basic net income (loss) per share $ (3.52) $ (2.62) $ 0.02
========= ========= =========
Diluted net income (loss) per share $ (3.52) $ (2.62) $ 0.01
========= ========= =========
Shares used in computing basic net income (loss) per share 26,863 5,530 5,100
========= ========= =========
Shares used in computing diluted net income (loss) per share 26,863 5,530 12,249
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
34
<PAGE> 37
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
(in thousands)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL
-------------------------- -------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
-------- --------- -------- --------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE AT JULY 31, 1997 1,734 $ 2 5,100 $ 5 $ 522
Repurchase of convertible
preferred stock in exchange
for note payable (1,734) (2) -- -- (498)
Net income -- -- -- -- --
--------- --------- --------- --------- ---------
BALANCE AT JULY 31, 1998 -- -- 5,100 5 24
Issuance of Series A
convertible preferred stock
for cash and note
receivable, net 12,149 12 -- -- 5,482
Exercise of stock options and
stock purchase rights for
cash and services rendered -- -- 10,305 10 308
Issuance of Series B convertible
preferred stock for cash, net 6,503 7 -- -- 25,084
Issuance of common stock for
assets acquired -- -- 40 -- 20
Fair value of options and
stock purchase rights
granted for services rendered
and assets acquired -- -- -- -- 110
Deferred stock compensation -- -- -- -- 14,433
Amortization of deferred
stock compensation -- -- -- -- --
Net loss -- -- -- -- --
--------- --------- --------- --------- ---------
BALANCE AT JULY 31, 1999 18,652 19 15,445 15 45,461
Issuance of Series B
convertible preferred stock
for assets acquired 13 -- -- -- 50
Issuance of Series B
convertible preferred stock
for cash, net 1,256 1 -- -- 4,833
Exercise of stock options and
stock purchase rights for cash
and services rendered -- -- 2,140 2 3,333
Dividend related to
convertible preferred stock -- -- -- -- 4,900
Issuance of common stock
for cash and services rendered -- -- 203 -- 530
Issuance of common stock
from initial public offering, net -- -- 5,060 5 138,724
Repurchase of common stock
for cash -- -- (593) -- (55)
Proceeds received from
stockholders -- -- -- -- --
Conversion of preferred stock
to common stock (19,921) (20) 19,921 20 --
Issuance of common stock
to acquire businesses -- -- 9,728 10 541,983
Deferred stock compensation -- -- -- -- 23,369
Amortization of deferred stock
compensation and compensation
expense related to acquisitions -- -- -- -- --
Net loss -- -- -- -- --
--------- --------- --------- --------- ---------
BALANCE AT JULY 28, 2000 -- $ -- 51,904 $ 52 $ 763,128
========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
STOCKHOLDER DEFERRED TOTAL
NOTE STOCK ACCUMULATED STOCKHOLDERS'
RECEIVABLE COMPENSATION DEFICIT (DEFICIT) EQUITY
----------- ------------ ----------- ----------------
<S> <C> <C> <C> <C>
BALANCE AT JULY 31, 1997 $ -- $ -- $ (483) $ 46
Repurchase of convertible
preferred stock in exchange
for note payable -- -- (50) (550)
Net income -- -- 84 84
--------- --------- --------- ---------
BALANCE AT JULY 31, 1998 -- -- (449) (420)
Issuance of Series A
convertible preferred stock
for cash and note
receivable, net (50) -- -- 5,444
Exercise of stock options and
stock purchase rights for
cash and services rendered -- -- -- 318
Issuance of Series B convertible
preferred stock for cash, net -- -- -- 25,091
Issuance of common stock for
assets acquired -- -- -- 20
Fair value of options and
stock purchase rights
granted for services rendered
and assets acquired -- -- -- 110
Deferred stock compensation -- (14,433) -- --
Amortization of deferred
stock compensation -- 2,312 -- 2,312
Net loss -- -- (14,512) (14,512)
--------- --------- --------- ---------
BALANCE AT JULY 31, 1999 (50) (12,121) (14,961) 18,363
Issuance of Series B
convertible preferred stock
for assets acquired -- -- -- 50
Issuance of Series B
convertible preferred stock
for cash, net -- -- -- 4,834
Exercise of stock options and
stock purchase rights for cash
and services rendered -- -- -- 3,335
Dividend related to
convertible preferred stock -- -- (4,900) --
Issuance of common stock
for cash and services rendered -- -- -- 530
Issuance of common stock
from initial public offering, net -- -- -- 138,729
Repurchase of common stock
for cash -- -- -- (55)
Proceeds received from
stockholders 50 -- -- 50
Conversion of preferred stock
to common stock -- -- -- --
Issuance of common stock
to acquire businesses -- (113,106) -- 428,887
Deferred stock compensation -- (23,369) -- --
Amortization of deferred stock
compensation and compensation
expense related to acquisitions -- 38,910 -- 38,910
Net loss -- -- (89,758) (89,758)
--------- --------- --------- ---------
BALANCE AT JULY 28, 2000 $ -- $(109,686) $(109,619) $ 543,875
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
35
<PAGE> 38
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED JULY 28, YEARS ENDED JULY 31,
------------------ --------------------------
2000 1999 1998
------------------ --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (89,758) $ (14,512) $ 84
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization 19,588 449 18
Loss on disposal of assets 177 75 --
Amortization of deferred stock compensation 39,500 2,312 --
Non-cash compensation expense 1,429 64 --
Write-off of in-process research and development 9,000 -- --
Other, net (47) -- --
Changes in assets and liabilities:
Accounts receivable (22,140) (3,287) (449)
Inventories 3,069 (1,656) (76)
Prepaid expenses and other assets (2,098) (517) (11)
Accounts payable 11,902 5,423 403
Accrued liabilities and other 4,768 1,498 117
--------- --------- ---------
Net cash provided by (used in) operating activities (24,610) (10,151) 86
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (7,601) (2,139) (44)
Purchase of marketable securities (52,433) -- --
Businesses acquired, net of cash acquired 46,870 -- --
Purchase of other long-lived assets -- (154) --
--------- --------- ---------
Net cash used in investing activities (13,164) (2,293) (44)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable (3,363) (275) --
Proceeds from borrowings on equipment loan and line of credit -- 500 --
Proceeds from stockholder note receivable 50 -- --
Proceeds from issuance of convertible preferred stock, net 4,834 30,535 --
Proceeds from issuance of common stock 141,504 275 --
Repurchase of common stock (55) -- --
--------- --------- ---------
Net cash provided by financing activities 142,970 31,035 --
--------- --------- ---------
Net increase in cash and cash equivalents 105,196 18,591 42
Cash and cash equivalents, beginning of year 18,653 62 20
--------- --------- ---------
Cash and cash equivalents, end of year $ 123,849 $ 18,653 $ 62
========= ========= =========
Supplemental cash flow information:
Repurchase of convertible preferred stock pursuant to notes payable $ -- $ -- $ 550
Issuance of convertible preferred stock for note receivable $ -- $ 50 $ --
Issuance of convertible preferred stock for assets $ 50 $ -- $ --
Dividends on convertible preferred stock $ 4,900 $ -- $ --
Conversion of preferred stock to common stock at par $ 20 $ -- $ --
</TABLE>
The accompanying notes are an integral part of these financial statements
36
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS OF THE COMPANY
VA Linux Systems, Inc. (the "Company"), formerly known as VA Research, Inc., was
incorporated in California in January 1995 and is a provider of Linux-based
computer systems and services. Additionally, the Company has recently
established a professional services organization to provide Internet
infrastructure and Open Source software services, including system architecture
design and integration, development of Open Source software including the
porting of software to Linux and managed services. The Company also offers OSDN,
the Open Source Development Network, which provides members of the Open Source
community with the web-based means to discuss, develop and deploy Open Source
software. Effective August 1, 1999, the Company began operating on a 52-53 week
year ending the Friday before July 31. Fiscal year ending July 28, 2000 was a 52
week year.
The Company is subject to certain risks including the emergence of the Linux
industry, dependence on a key supplier for manufacturing, competition from
larger, more established companies, short product life cycles, the Company's
ability to develop and bring to market new products on a timely basis,
dependence on key employees, the ability to attract and retain additional
qualified personnel and the ability to obtain adequate financing to support
growth.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the period. Actual results
could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the accounts of VA Linux
Systems, Inc. and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents. Cash and cash equivalents consist
principally of cash deposited in money market and checking accounts.
The Company accounts for its investments under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Investments in highly liquid
financial instruments with original maturities greater than three months but
less than one year are classified as short-term investments. All short-term
investments are deemed by management to be available-for-sale and are reported
at fair value with net unrealized gains (losses) reported, net of tax, as other
comprehensive loss in stockholders' equity. To date the unrealized gains
(losses) have not been material. The fair value of the Company's
available-for-sale securities is based on quoted market prices at the balance
sheet dates.
Cash equivalents and short-term investments are all due within one year and
consist of the following (in thousands):
<TABLE>
<CAPTION>
JULY 28, 2000
-------------
<S> <C>
Government obligations $ 30,013
Corporate obligations 72,937
--------
Total 102,950
Included in cash and cash equivalents 50,517
--------
Included in short-term investments $ 52,433
========
</TABLE>
There were no investments in debt and equity securities at July 31, 1999.
INVENTORIES
Inventories are stated at the lower of cost or market, using the first-in
first-out method, and are comprised of materials. Inventories consist of the
following (in thousands):
<TABLE>
<CAPTION>
JULY 28, 2000 JULY 31, 1999
------------- -------------
<S> <C> <C>
Raw materials $ 387 $1,813
Work-in-process 86 --
Finished goods 545 158
------ ------
$1,018 $1,971
====== ======
</TABLE>
Provisions, when required, are made to reduce excess and obsolete inventories to
their estimated net realizable values. Due to competitive pressures and
technological innovation, it is possible that estimates of net realizable value
could change.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives (three to five years) of
the assets. Leasehold improvements are amortized over the corresponding lease
term. Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
JULY 28, 2000 JULY 31, 1999
------------- -------------
<S> <C> <C>
Computer and office equipment $ 9,796 $ 1,314
Furniture and fixtures 1,075 110
Leasehold improvements 1,074 572
Software 629 125
-------- --------
Total property and equipment 12,574 2,121
Less: Accumulated depreciation
and amortization (2,258) (362)
-------- --------
Property and equipment, net $ 10,316 $ 1,759
======== ========
</TABLE>
The Company periodically evaluates the carrying amount of its long-lived assets
and applies the provisions of SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS No. 121
requires that long-lived assets and certain identifiable intangibles to be held
and used or disposed of by an entity be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable.
37
<PAGE> 40
GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangibles are being amortized on a straight-line basis over
three to five years. Subsequent to its acquisitions, the Company continually
evaluates whether later events and circumstances have occurred that indicate the
remaining estimated useful lives of goodwill and other intangibles may warrant
revision or that the remaining balance of goodwill and other intangibles may not
be recoverable. When factors indicate that goodwill and other intangibles should
be evaluated for possible impairment, the Company uses an estimate of the
related business segment's undiscounted net income over the remaining life of
the goodwill and other intangibles in measuring whether they are recoverable. To
date, the Company has not recorded any impairment losses on long-lived assets.
REVENUE RECOGNITION
Product revenues from the sale of Linux-based servers, components, and desktop
computers are recognized upon shipment of goods. The Company generally does not
grant to its customers any rights to return products. The Company provides
allowances for warranty costs at the time of shipment. Revenues from customer
support services, including on-site maintenance and technical support, are
recognized pro-rata over the term of the related service agreement. Revenues
from professional service contracts are recognized as revenue upon completion of
the project, or using the percentage of completion method of the project where
project costs can be reasonably estimated. Any payments received prior to
revenue recognition are recorded as deferred revenue. For the years ended July
28, 2000 and July 31, 1999 and 1998, revenues from customer support services and
professional service contracts have not been material.
The Company generates advertising revenues as a result of the acquisition of
Andover.Net. Advertising revenues are derived from the sale of advertising space
on the Company's various websites. Advertising revenues are recognized over the
period in which the advertisements are displayed, provided that no significant
obligations remain and collection of the receivable is reasonably assured. The
Company's obligations typically include guarantees of a minimum number of
"impressions" (times that an advertisement is viewed by users of the Company's
online services over a specified period of time). To the extent that minimum
guaranteed impressions are not met, the Company does not recognize the
corresponding revenues until the guaranteed impressions are achieved.
STOCK SPLIT
Effective October 15, 1998 and March 30, 1999, the Company completed a
two-for-one and three-for-two split, respectively, of its common stock. A
two-for-one split of the outstanding shares of common stock and Series B
preferred stock and a three-for-one split of the outstanding shares of Series A
preferred stock was effective November 1999. All share and per share information
included in these financial statements have been retroactively adjusted to
reflect these stock splits.
STOCK-BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation" permits the use of
either a fair value based method or the method defined in Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" to
account for stock-based compensation arrangements. Companies that elect to
employ the valuation method provided in APB No. 25 are required to disclose the
pro forma net income (loss) that would have resulted from the use of the fair
value based method. The Company has elected to continue to determine the value
of stock-based compensation arrangements under the provisions of APB No. 25 and,
accordingly, it has included the pro forma disclosures required under SFAS No.
123 in the financial statements (see Note 9).
The value of options, stock purchase rights and stock exchanged for services
rendered or assets acquired are valued using the Black-Scholes option pricing
model. To calculate the expense or asset value, the Company uses either the fair
value of the consideration received or the fair value of the equity instruments
issued, whichever is more reliably measurable.
SOFTWARE DEVELOPMENT COSTS
In accordance with SFAS No. 86, "Accounting for the Cost of Computer Software to
be Sold, Leased, or Otherwise Marketed", development costs incurred in the
research and development of new software products are expensed as incurred until
technological feasibility in the form of a working model has been established.
To date, the Company's software development has been completed concurrent with
the establishment of technological feasibility and, accordingly, all software
development costs have been charged to research and development expense in the
accompanying statements of operations.
COMPUTATION OF PER SHARE AMOUNTS
Basic net income (loss) per common share and diluted net income (loss) per
common share are presented in conformity with SFAS No. 128, "Earnings Per Share"
for all periods presented.
In accordance with SFAS No. 128, basic net income (loss) per common share has
been calculated using the weighted-average number of shares of common stock
outstanding during the period, less shares subject to repurchase. For the years
ended July 28, 2000 and July 31, 1999, the Company has excluded all convertible
preferred stock and outstanding stock options from the calculation of diluted
net loss per common share because all such securities are antidilutive for those
periods. The total number of shares excluded from the calculations of diluted
net loss per common share were 14,514,563 and 25,320,000 for the years ended
July 28, 2000 and July 31, 1999, respectively.
38
<PAGE> 41
The following table presents the calculation of basic and diluted net income
(loss) per share (in thousands, except per share data):
<TABLE>
<CAPTION>
JULY 28, JULY 31,
-------- ---------------------------
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Net income (loss) attributable
to common stockholders $(94,658) $(14,512) $ 84
-------- -------- --------
Basic:
Weighted average shares
of common stock outstanding 33,398 8,268 5,100
Less: Weighted average shares
subject to repurchase (6,535) (2,738) --
-------- -------- --------
Shares used in computing
basic net income (loss) per share 26,863 5,530 5,100
======== ======== ========
Basic net income (loss) per share $ (3.52) $ (2.62) $ 0.02
======== ======== ========
Diluted:
Shares used above 26,863 5,530 5,100
Add: Weighted average dilutive
convertible preferred stock
and stock options -- -- 7,149
-------- -------- --------
Shares used in computing
diluted net income (loss)
per share 26,863 5,530 12,249
======== ======== ========
Diluted net income (loss) per share $ (3.52) $ (2.62) $ 0.01
======== ======== ========
</TABLE>
COMPREHENSIVE INCOME (LOSS)
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting and
presentation of comprehensive income. SFAS No. 130 defines comprehensive income
as the changes in equity of an enterprise except those resulting from
stockholder transactions. Comprehensive income (loss) for the years ended July
28, 2000, July 31, 1999 and 1998 approximated net income (loss).
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. SFAS No. 133, as recently amended, is effective for
fiscal years beginning after June 15, 2000. Management believes the adoption of
SFAS No. 133 will not have a material effect on the Company's financial position
or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition." In June 2000, the SEC deferred
the adoption date for SAB No. 101 until the fourth quarter of fiscal 2001. SAB
No. 101 summarizes certain areas of the Staff's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
The Company has not quantified the effect of SAB No. 101 on its financial
position or results of operations and has not yet determined the timing and
method of adoption.
In March 2000, the FASB issued Financial Standards Board Interpretation ("FIN")
No. 44, "Accounting for Certain Transactions Involving Stock Compensation--an
Interpretation of APB Opinion No. 25." FIN No. 44 addresses the application of
APB No. 25 to clarify, among other issues, (a) the definition of employee for
purposes of applying APB No. 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. FIN No. 44 is effective July 1, 2000, but certain conclusions cover
specific events that occurred after either December 15, 1998 or January 12,
2000. To the extent FIN No. 44 covers events occurring during the period after
December 15, 1998 or January 12, 2000, but before the effective date of July 1,
2000, the effects of applying the interpretation have been recognized on a
prospective basis from July 1, 2000. Management believes the adoption of FIN No.
44 will not have a material effect on the Company's financial position or
results of operations.
SUPPLIER CONCENTRATION
The Company is dependent on a single contract manufacturer for substantially all
of its manufacturing and supply chain management, including component
procurement and inventory management. The contract manufacturer is also an
investor in the Company. The inability of the manufacturer to fulfill the
production requirements of the Company or make distributions of the Company's
products on a timely basis could negatively impact future results. Although
there are other contract manufacturers that could provide similar services, a
change in the contract manufacturer could cause delays in manufacturing and
distribution of the Company's products and possible loss of sales.
CONCENTRATIONS OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of trade receivables. The Company provides credit,
in the normal course of business, to a number of companies and performs ongoing
credit evaluations of its customers. As of July 28, 2000, approximately 28% of
gross accounts receivable were concentrated with one customer. As of July 31,
1999, approximately 37% of gross accounts receivables were concentrated with one
customer. No single customer accounted for more than 10% of net revenues in
fiscal 1999 and 1998. For the fiscal year ended July 28, 2000, one customer
accounted for approximately 18% of net revenues.
3. ACQUISITIONS
TRUSOLUTIONS, INC. On March 28, 2000, in an acquisition accounted for under the
purchase method of accounting, VA Linux acquired all of the outstanding shares
of TruSolutions, Inc. ("TruSolutions") for approximately $72,900,000 (including
acquisition costs of approximately $400,000). TruSolutions is a manufacturer of
rackmount servers based on the Pentium III, Xeon and UltraSPARC processors
specializing in low profile, high performance systems designed for the Internet
Data Center, ISP, ASP and OEM. The consideration included 767,000 shares of VA
Linux common stock valued at $56,700,000, cash of approximately $10,000,000 and
the assumption of outstanding options to purchase TruSolutions common stock
valued at $5,800,000 using the Black Scholes option pricing model and the
following assumptions: risk free interest rate of 6.34%, average expected
39
<PAGE> 42
life of 4 years, dividend yield of 0%, and volatility of 70%. The purchase
agreement contained additional payments to be made in common stock contingent
upon the continued employment of certain key employees for a period of three
years. Maximum future payments, contingent on employment of the key employees,
is $96,300,000 payable in stock (approximately 1,303,000 shares) and is payable
after 12 months, 24 months and 36 months (approximately 501,000 shares, 501,000
shares and 301,000 shares, respectively). The contingent payments will be
accounted for as compensation expense over the term of the employment condition
and not as part of the purchase price. Upon consummation of the acquisition, VA
Linux established an escrow for these contingent payments. The allocation of the
purchase price to the assets acquired and liabilities assumed based on
preliminary estimates of fair value, which are subject to final adjustment, are
as follows (in thousands):
<TABLE>
<S> <C>
Current assets $ 4,871
Property and equipment 381
Other assets 9
Acquired in-process
research and development 4,000
Goodwill 62,153
Other intangible assets 7,700
--------
79,114
Less: Liabilities assumed (6,214)
--------
$ 72,900
========
</TABLE>
At the time of acquisition, VA Linux expensed $4,000,000 of purchased in-
process research and development. Other purchased intangible assets, including
goodwill, developed technology and other intangible assets of approximately
$69,900,000 are being amortized over their estimated useful lives of three to
five years on a straight-line basis. Beginning on March 28, 2000,
TruSolutions' operating results were included with those of the Company.
The value assigned to purchased in-process technology, based on the income
method prepared by an independent third-party was determined by identifying
research projects in areas for which technological feasibility had not been
established. TruSolutions' in-process projects included the research and
development associated with the 1/2U, 1U, 2U, and 4U server products. The value
of in-process research and development was determined by estimating the costs to
develop the purchased in-process technology into commercially viable products,
estimating the resulting net cash flows from such projects and discounting the
net cash flows back to their present value. The discount rate includes a
risk-adjusted discount rate to take into account the uncertainty surrounding the
successful development of the purchased in-process technology. The risk-adjusted
discount rate applied to the projects' cash flows was 45% for the in-process
technology. The Company believes that the estimated in-process technology
amounts represent fair value and do not exceed the amount a third-party would
pay for the projects. The valuation includes cash inflows from in-process
technology through 2003 with revenues commencing in 2000 for the 1U, 2U and 4U
servers, and in 2001 for the 1/2U server. Where appropriate, the Company
allocated anticipated cash flows from an in-process research and development
project to reflect contributions of the core technology. At the time of the
acquisition, TruSolutions' remaining tasks that were substantially incomplete
included: developing additional server features as well as proving out the
in-process products' electrical designs, testing for compatibility with other
systems common in server farms, and testing for Linux performance. Finally,
TruSolutions needed to conduct shock, vibration and performance testing. The
Company estimates that it will cost approximately $400,000 to complete the
projects with significant remaining development efforts, which are expected to
be completed in the next three to fifteen months. If the projects are not
successful or completed in a timely manner, management's product pricing and
growth rates may not be achieved and VA Linux may not realize the financial
benefits expected from the projects.
NETATTACH, INC. On April 5, 2000, in an acquisition accounted for under the
purchase method of accounting, VA Linux acquired all of the outstanding shares
of NetAttach, Inc. ("NetAttach") for approximately $37,400,000 (including
acquisition costs of approximately $300,000). NetAttach provides
high-availability data-appliances for mission-critical deployment in corporate
services or engineering environments. The purchase price included 396,000 shares
of VA Linux common stock valued at $24,600,000, cash of $10,000,000 and the
assumption of outstanding options valued at $2,500,000 using the Black-Scholes
option pricing model and the following assumptions: risk free interest rate of
6.34%, average expected life of 4 years, dividend yield of 0%, and volatility of
70%. The purchase agreement also contained additional payments to be made in
common stock. These payments are solely contingent upon the continued employment
of certain key employees for a period of two years. Maximum future payments,
contingent on employment of the key employees, are $5,400,000 payable in stock
(approximately 86,000 shares of VA Linux common stock) and are payable on the
two-year anniversary date of the acquisition. The contingent payments will be
accounted for as compensation expense over the term of the employment condition
and not as part of the purchase price. Upon consummation of the acquisition, VA
Linux established an escrow for these contingent payments. The allocations of
the purchase price to the assets acquired and liabilities assumed, based on
preliminary estimates of fair value which are subject to final adjustment are as
follows (in thousands):
<TABLE>
<S> <C>
Current assets $ 376
Property and equipment 55
Other assets 3
Goodwill 33,067
Other intangible assets 4,800
--------
38,301
Less: Liabilities assumed (944)
--------
$ 37,357
========
</TABLE>
Purchased intangible assets, including goodwill and developed technology of
approximately $37,900,000 are being amortized over their estimated useful lives
of five years on a straight-line basis. Beginning on April 5, 2000, NetAttach's
operating results were included with those of the Company.
40
<PAGE> 43
PRECISION INSIGHT, INC. On April 14, 2000, in an acquisition accounted for under
the purchase method of accounting, VA Linux acquired all of the outstanding
shares of Precision Insight, Inc. ("Precision Insight") for approximately
$4,100,000. Precision Insight is an engineering and project management team with
expertise in the Linux kernel and multimedia infrastructure development. The
consideration included approximately 32,000 shares of VA Linux common stock
valued at $2,300,000 and cash of approximately $1,800,000. The purchase
agreement contained additional payments to be made in common stock contingent
upon the continued employment of certain key employees for a period of four
years. Maximum future payments, contingent on employment of the key employees,
is $11,500,000 in stock (approximately 157,000 shares of VA Linux common stock)
and is payable after 24 months, 36 months and 48 months (approximately 52,300
shares each year). The contingent payments will be accounted for as compensation
expense over the term of the employment condition and not as purchase price.
Upon consummation of the acquisition, VA Linux established an escrow for these
contingent payments. The disclosures of the allocation of purchase price and pro
forma data have not been disclosed as the amounts are not material.
ANDOVER.NET, INC. On June 7, 2000, in an acquisition accounted for under the
purchase method of accounting, VA Linux acquired all of the outstanding shares
of Andover.Net, Inc. ("Andover") for approximately $342,000,000 (including
acquisition costs of approximately $5,000,000). Andover provides products,
online tools, news and other services for programmers, software developers,
website designers, technology managers and corporate buyers. The purchase price
included 6,986,000 shares of VA Linux common stock valued at $315,000,000 and
the assumption of outstanding options to purchase VA Linux common stock valued
at approximately $22,000,000 using the Black-Scholes option pricing model using
the following assumptions: risk-free interest rate ranging from 6.1%-6.6%;
expected dividend yields of zero; expected volatility factor of the market price
of the common stock of 70%; and an expected life of the options of 7 years from
the vesting date. The allocation of the purchase price to the assets acquired
and liabilities assumed based on the fair value at the effective date, which are
subject to final adjustment, are as follows:
<TABLE>
<S> <C>
Current assets $ 72,495
Property and equipment 2,400
Other assets 120
Acquired in-process
research and development 5,000
Goodwill 229,683
Other intangible assets 38,400
---------
348,098
Less: Liabilities assumed (6,098)
---------
$ 342,000
=========
</TABLE>
At the time of acquisition, VA Linux expensed $5,000,000 of purchased in-process
research and development. Other purchased intangible assets, including goodwill,
developed technology and other intangible assets of approximately $240,900,000
are being amortized over their estimated useful lives of three to five years on
a straight-line basis.
The value assigned to purchased in-process technology, based on the income
method prepared by an independent third-party, was determined by identifying
research projects in areas for which technological feasibility had not been
established. Andover's in-process projects included next-generation website
management tools, online web applications, and other technologies which will
support the Company's vast network of websites. The value of in-process
research and development was determined by estimating the costs to develop the
purchased in-process technology into commercially viable products, estimating
the resulting net cash flows from such projects and discounting the net cash
flows back to their present value. The discount rate includes a risk-adjusted
discount rate to take into account the uncertainty surrounding the successful
development of the purchased in-process technology. The risk-adjusted discount
rate applied to the projects' cash flows was 30% for the in-process technology.
The Company believes that the estimated in-process technology amounts represent
fair value and do not exceed the amount a third-party would pay for the
projects.
The valuation includes cash inflows from in-process technology through 2005 with
revenues commencing in 2001. Where appropriate, the Company allocated
anticipated cash flows from an in-process research and development project to
reflect contributions of the core technology. At the time of the acquisition,
Andover's remaining tasks that were substantially incomplete included certain
planning, designing, coding, prototyping, and testing activities that are
necessary to establish that the developmental technologies can be produced to
meet their design specifications including functional, technical, and economic
performance requirements. The Company estimates that it will cost approximately
$1,000,000 to complete the projects with significant remaining development
efforts, which are expected to be completed in the next 9 to 12 months. If the
projects are not successful or completed in a timely manner, management's
product pricing and growth rates may not be achieved and VA Linux may not
realize the financial benefits expected from the projects.
The following unaudited pro forma information represents the results of
operations of VA Linux, NetAttach, TruSolutions and Andover as if the
acquisitions had been consummated as of the beginning of the periods presented.
The pro forma information does not purport to be indicative of what would have
occurred had the acquisitions been made as of those dates or of results that may
occur in the future. The information below does not include $9,000,000 of
purchased in-process research and development that was expensed at the time of
the acquisitions of TruSolutions and Andover. The unaudited pro forma
information is as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED JULY 28, 2000 JULY 31, 1999
------------- -------------
<S> <C> <C>
Revenues $ 142,634 $ 26,347
Loss from operations $(157,947) $(152,128)
Net loss attributable
to common stockholders $(163,107) $(152,482)
Basic and diluted net loss per share $ (4.89) $ (11.48)
</TABLE>
41
<PAGE> 44
4. NOTES PAYABLE
UMAX DATA SYSTEMS
In April 1998, the Company entered into a note payable arrangement with UMAX
Data Systems ("UMAX") for the repurchase of 1,734,000 shares of the Company's
Series A preferred stock held by UMAX. The note payable was for $550,000, of
which $275,000 was paid in November 1998. The remaining note payable bears no
interest and is to be repaid in 12 equal monthly installments of approximately
$23,000, beginning in February 2000 and ending in January 2001.
ACQUISITION OF RIGHTS
In connection with the acquisition of certain Internet properties and rights
during fiscal 1999, the Company entered into an obligation to pay a total of
$396,000 in cash. The obligation bears no interest and is repayable in 33 equal
monthly installments of $12,000 beginning in April 1999 and ending December
2001. As of July 28, 2000, principal maturities under the obligation are
$144,000 in fiscal 2001 and $60,000 in fiscal 2002.
ANDOVER NOTES PAYABLE
As part of the Andover.Net acquisition, the Company assumed three note payable
agreements (the "Notes"). The Notes bear interest rates of 9.0% to 9.75%
totaling $2,043,000 and mature through fiscal year 2003. As of July 28, 2000,
principal maturities under the note payables are $1,200,000, $750,000, and
$93,000 in fiscal 2001, 2002, and 2003, respectively.
5. LINE OF CREDIT AND EQUIPMENT LOAN
In February 1999, the Company entered into a loan and security agreement with a
bank which was last amended in May 2000 for maximum borrowings of $10,000,000
under a revolving line of credit ("Line of Credit") and $500,000 under an
equipment loan ("Equipment Loan"). The interest rate for both the Line of Credit
and the Equipment Loan is the bank's base rate plus 0.75% (9.5% at July 28,
2000). The amount available for borrowing under the Line of Credit is limited to
the committed revolving line, less any outstanding letters of credit issued
under the Line of Credit, which is not to exceed $5,000,000. The amount
available for borrowing under the Equipment Loan can only be utilized to acquire
equipment that the bank approves. The Equipment Loan was fully drawn in July
1999. Borrowings under the Equipment Loan are repayable in 36 equal monthly
installments of principal and interest beginning October 31, 1999. Borrowings
under the Line of Credit mature in May 31, 2001 and borrowings under the
Equipment Loan mature in July 2002. As of July 28, 2000, the Company had no
borrowings outstanding under the Line of Credit and $375,000 outstanding under
the Equipment Loan, of which $167,000 is current and $208,000 is non-current.
The Equipment Loan and Line of Credit require that the Company maintain certain
financial and non-financial ratios and covenants. As of July 28, 2000, the
Company was in compliance with all of the ratios and covenants.
As of July 28, 2000, the Company has outstanding letters of credit issued under
the Line of Credit of approximately $2,300,000, primarily related to the
construction of a new corporate facility.
As part of the TruSolutions acquisition, the Company assumed a $1,500,000
revolving line of credit with IBM Global Financing. During fiscal 2000, all
amounts outstanding under the line of credit were paid and the line was
cancelled.
6. COMMITMENTS
The Company leases its facilities under operating leases that expire at various
dates through 2010. As part of the acquisitions, the Company also assumed
various non-cancelable office equipment leases, which expire through November
2002. Future minimum lease payments under non-cancelable operating leases as of
July 28, 2000 are as follows (in thousands):
<TABLE>
<CAPTION>
OPERATING LEASES
----------------
<S> <C>
2001 $ 5,753
2002 5,705
2003 5,528
2004 5,465
2005 5,060
Thereafter 17,944
-------
Total minimum lease payments $45,455
=======
</TABLE>
Effective June 1, 2000, the Company entered into a ten-year lease agreement for
a new corporate facility. The Company's current facility will be subleased for
at least the net book value of the leasehold improvements that will remain in
the facility.
Rent expense for the years ended July 28, 2000 and July 31, 1999 and 1998 was
approximately $2,163,000, $344,000 and $55,000, respectively.
7. RETIREMENT SAVINGS PLAN
The Company maintains an employee savings and retirement plan, which is intended
to be qualified under Section 401(k) of the Internal Revenue Code and is
available to substantially all full-time employees of the Company. The plan
provides for tax deferred salary deductions and after-tax employee
contributions. Contributions include employee salary deferral contributions and
discretionary employer contributions. To date, there have been no employer
discretionary contributions.
8. CONVERTIBLE PREFERRED STOCK
During fiscal 1999, the Company issued 12,149,322 shares of Series A Preferred
Stock at $0.4567 per share and 6,502,592 shares of Series B Preferred Stock at
$3.86 per share. An additional 1,256,454 shares of Series B Preferred Stock at
$3.86 per share were issued in September 1999. Prior to the initial public
offering of VA Linux common stock ("IPO") on December 9, 1999, the Company
issued 12,954 shares of Series B Preferred Stock in exchange for assets
acquired. The Company has recorded a preferred stock dividend of $4,900,000
representing the value of the beneficial conversion feature on the issuance of
Series B Preferred Stock in September 1999. The beneficial conversion feature
was calculated at the commitment date based on the difference between the
conversion price of $3.86 per share and the estimated fair value of the common
stock
42
<PAGE> 45
at that date. The amount of the beneficial conversion feature was limited to the
amount of the gross proceeds received from the issuance of Series B Preferred
Stock. The excess of the beneficial conversion feature over the gross proceeds
received was $4,200,000. Upon completion of the IPO in December 1999, all
19,921,322 shares of preferred stock were converted to an equal number of shares
of common stock.
In October 1999, the Company's board of directors authorized 10,000,000 shares
of a newly undesignated series of preferred stock, with a par value of $0.001,
after the reincorporation of the Company in Delaware and the closing of the IPO
(see Note 9). As of July 28, 2000, no shares of preferred stock are outstanding.
9. COMMON STOCK
In October 1999, the Company's board of directors approved the reincorporation
into Delaware by way of a merger with a newly-formed Delaware subsidiary in
connection with the Company's IPO. In conjunction with the IPO, the Company
issued 4,400,000 shares of common stock with an initial public offering price of
$30.00 per share. Upon closing of the initial public offering, all of the
outstanding shares of convertible preferred stock were automatically converted
into 19,921,322 shares of common stock. In addition, the underwriters exercised
their option to purchase 660,000 additional shares to cover the over-allotments
of shares at the $30.00 per share offering price. The IPO raised approximately
$141,000,000 after underwriting fees and $139,000,000 after all other direct
costs.
As of July 28, 2000 there were 51,903,850 shares of common stock issued and
outstanding. VA Linux is authorized to issue 250,000,000 shares of common stock,
$0.001 par value.
As of July 28, 2000, the Company had reserved shares of its common stock for
future issuance as follows:
<TABLE>
<S> <C>
1998 Stock Option Plan and Assumed Plans 17,043,203
1999 Director Option Plan 500,000
1999 Employee Stock Purchase Plan 1,000,000
----------
18,543,203
==========
</TABLE>
STOCK REPURCHASE AGREEMENTS
In October 1998, a founder of the Company holding 4,950,000 shares of common
stock entered into a Stock Repurchase Agreement ("Agreement") with the Company.
Under the terms of the Agreement, in the event of any voluntary or involuntary
termination of the founder's employment with the Company, the Company shall have
an irrevocable, exclusive option, for a period of 90 days from termination, to
repurchase any shares of common stock held by the founder, at $0.02 per share.
The founder's shares of common stock are released from the repurchase option as
follows: 2,970,000 are not subject to repurchase as of October 30, 1998 and 1/24
of the remaining shares are released from the repurchase option each month after
October 1998 until all shares have been released. As of July 28, 2000, 247,500
shares are subject to repurchase by the Company.
In connection with the exercise of options pursuant to the Company's Stock
Option Plan, employees entered into restricted stock purchase agreements with
the Company. Under the terms of these agreements, the Company has a right to
repurchase any unvested shares at the original exercise price of the shares upon
termination of the employee. The repurchase right lapses ratably over the
vesting term of the original option grant. As of July 28, 2000, 4,385,068 shares
were subject to repurchase by the Company.
STOCK OPTION PLAN
In fiscal 1997, the Company adopted and the board of directors approved the 1996
Stock Option Plan ("1996 Plan"), under which a total of 4,650,000 shares were
reserved for issuance. The 1996 Plan permitted options to be granted to
employees, consultants and directors to purchase shares of the Company's common
stock at a price determined by the board of directors. The Company granted
4,650,000 options under the 1996 Plan during fiscal 1997 and 1998. In fiscal
1998, the Company granted options to purchase 4,026,000 shares of common stock
outside of the 1996 Plan at an exercise price of $0.02 per share. In October
1998, the Company cancelled all stock options outstanding under the 1996 Plan
and the 4,026,000 options that had been issued in fiscal 1998 outside of the
1996 Plan. The cancelled options were replaced with options under the 1998 Stock
Plan ("1998 Plan") that had vesting and exercise prices consistent with the
terms of the cancelled options. The 1996 Plan was terminated in October 1998.
In fiscal 1999, the Company adopted and the board of directors approved the 1998
Plan. The number of shares reserved for issuance under the 1998 Plan is
23,257,144. Subsequent to July 31, 1999, the board of directors approved an
amendment to the 1998 Plan to increase the number of authorized shares by the
lesser of 4,000,000 shares, 4.9% of the outstanding shares on that date or a
lesser amount as determined by the board of directors. Under the 1998 Plan, the
board of directors may grant to employees and consultants options and/or stock
purchase rights to purchase the Company's common stock at terms and prices
determined by the board of directors. The Plan will terminate in 2008.
Nonqualified options granted under the 1998 Plan must be issued at a price equal
to at least 85% of the fair market value of the Company's common stock at the
date of grant. All options may be exercised at any time within 10 years of the
date of grant or within three months of termination of employment, or such
shorter time as may be provided in the stock option agreement, and vest over a
vesting schedule determined by the board of directors.
The Company's 1999 Directors Option Plan (the "Directors' Plan") was adopted by
the Company's board of directors in October 1999. A total of 500,000 shares of
common stock have been reserved for issuance under the Directors' Plan, subject
to an annual increase of the lesser of 250,000 shares, 0.5% of the then
outstanding common stock or an amount determined by the board of directors.
Through July 28, 2000, no options have been granted under the Directors' Plan.
Under the Directors' Plan, options will be granted when a non-employee director
joins the board of directors following the IPO and at each annual meeting where
the director continues to serve on the board of directors. The Directors' Plan
establishes an automatic grant of 40,000 shares of common stock to each
non-employee director who is elected after the completion of the IPO. The
Directors' Plan also
43
<PAGE> 46
provides that upon the date of each annual stockholders' meeting, each
non-employee director who has been a member of the board of directors for at
least six months prior to the date of the stockholders' meeting will receive
automatic annual grants of options to acquire 16,000 shares of common stock.
Each automatic grant will have an exercise price per share equal to the fair
market value of the common stock at the date of grant and will vest as to 1/4 of
the shares subject to the option one year after the date of grant and 1/48 each
month thereafter. Each automatic grant will have a term of ten years. In the
event of a merger with another corporation or the sale of substantially all of
its assets, each non-employee director's outstanding option will become fully
vested and exercisable. Options granted under the Directors' Plan must be
exercised within 3 months of the end of the non-employee director's tenure as a
member of the board of directors, or within 12 months after a non-employee
director's termination by death or disability, provided that the option does not
terminate by its terms earlier. Unless terminated sooner, the Directors' Plan
terminates automatically in 2009.
The Company has assumed certain option plans and the underlying options of
companies which the Company has acquired (the "Assumed Plans"). Options under
the Assumed Plans have been converted into the Company's options and adjusted to
effect the appropriate conversion ratio as specified by the applicable
acquisition agreement, but are otherwise administered in accordance with the
terms of the Assumed Plans. Options under the Assumed Plans generally vest over
four years and expire ten years from the date of grant. No additional options
will be granted under the Assumed Plans.
A summary of the option activity under all of the stock option plans for the
three years ended July 28, 2000 follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-------------------------------------------------------
OPTIONS WEIGHTED
AVAILABLE NUMBER OF AVERAGE
FOR GRANT SHARES EXERCISE PRICE
----------- ----------- --------------
<S> <C> <C> <C>
BALANCE AT JULY 31, 1997: 1,684,800 2,965,200 $ 0.02
Granted (2,644,800) 2,644,800 0.02
Cancelled 960,000 (960,000) 0.02
----------- -----------
BALANCE AT JULY 31, 1998: -- 4,650,000 0.02
Authorized 23,257,144 -- --
Granted (16,757,146) 16,757,146 0.20
Exercised -- (10,221,528) 0.03
Cancelled 52,642 (4,702,642) 0.31
----------- -----------
BALANCE AT JULY 31, 1999: 6,552,640 6,482,976 0.46
Authorized 4,000,000 -- --
Granted and assumed (3,911,088) 5,465,563 20.89
Exercised -- (2,139,936) 1.12
Cancelled 275,085 (275,085) 9.26
Repurchases 593,048 -- --
----------- -----------
BALANCE AT JULY 28, 2000: 7,509,685 9,533,518 $ 11.77
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS OPTIONS EXERCISABLE
------------------------------------------------ ----------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER LIFE EXERCISE EXERCISE
EXERCISE PRICES OUTSTANDING (IN YEARS) PRICE SHARES PRICE
- --------------- ----------- ---------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
$0.020-$1.000 4,971,696 8.60 $ 0.406 1,844,774 $ 0.207
$2.000-$12.000 2,531,769 9.23 $ 6.366 90,022 $ 4.301
$16.660-$64.118 1,809,653 9.73 $ 40.138 106,308 $ 33.411
$91.780-$156.125 220,400 9.64 $ 97.200 -- $ 0.000
--------- ---------
$0.020-$156.125 9,533,518 9.00 $ 11.769 2,041,104 $ 3.216
========= ========= =========
</TABLE>
During fiscal 1999, the Company also granted to non-employees options and stock
purchase rights to acquire 268,332 shares of common stock outside of the 1998
Plan at a weighted average exercise price of $0.15 and a weighted average fair
value of $0.57. These equity instruments were either granted in exchange for
certain assets, including certain Internet properties and rights, or for
consulting services rendered. During fiscal 2000 and 1999, 185,000 and 83,332
options and stock purchase rights, with weighted average exercise prices of
$0.09 and $0.26, were exercised respectively.
As of July 28, 2000, there were no options or stock purchase rights granted
outside of the 1998 Plan outstanding. The compensation expense recorded in
connection with these grants is not material.
The Company accounts for stock options issued to employees under APB Opinion No.
25 whereby the difference between the exercise price and the fair value at the
date of grant is recognized as compensation expense. Had compensation expense
been determined consistent with SFAS No. 123, net income (loss) would have
decreased or increased to the following pro forma amounts (in thousands, except
per share data):
<TABLE>
<CAPTION>
JULY 28, JULY 31,
---------- -------------------------------
2000 1999 1998
---------- ---------- ----------
<S> <C> <C> <C>
Net income (loss) as reported $ (94,658) $ (14,512) $ 84
Pro forma net income (loss) (98,971) (14,683) 84
Basic net income (loss) per share (3.52) (2.62) 0.02
Diluted net income (loss) per share (3.52) (2.62) 0.01
Pro forma basic and diluted net income
(loss) per share (3.68) (2.66) 0.02
</TABLE>
44
<PAGE> 47
The weighted average fair value of options granted during fiscal 2000 and 1999
was $10.28 and $0.03, respectively. The fair value of options granted in fiscal
1998 is not material. Pursuant to the provisions of SFAS No. 123, the
compensation cost associated with options granted in fiscal 2000 and 1999 were
estimated on the grant date using the Black-Scholes model and the following
assumptions:
<TABLE>
<CAPTION>
YEAR ENDED JULY 28, 2000 JULY 31, 1999
------------- -------------
<S> <C> <C>
Risk free interest rate 6.9% 5.8%
Average expected life of option 5.3 years 3 years
Dividend yield 0% 0%
Volatility of common stock 60% 0.01%
</TABLE>
EMPLOYEE STOCK PURCHASE PLAN
The Company's 1999 Employee Stock Purchase Plan ("ESPP") was adopted by the
Company's board of directors in October 1999. Through July 28, 2000, the Company
has 1,000,000 shares of the common stock reserved for issuance under the ESPP,
subject to an annual increase of the lesser of 500,000 shares, 1% of the then
outstanding common stock or an amount determined by the board of directors. The
plan allows employees to purchase shares of common stock at a 15% discount.
Through July 28, 2000, the Company did not issue any shares to its employees
under the ESPP.
DEFERRED STOCK COMPENSATION
In connection with the grant of certain stock options to employees during fiscal
2000 and 1999, the Company recorded deferred stock compensation within
stockholders' equity of approximately $37,800,000, representing the difference
between the estimated fair value of the common stock for accounting purposes and
the option exercise price of these options at the date of grant. The Company
recorded amortization of deferred compensation of approximately $16,900,000,
$2,300,000, and $0 during fiscal 2000, 1999, and 1998, respectively. The
deferred stock compensation expense is being amortized on an accelerated basis
over the vesting period of the individual award, generally four years. The
method is in accordance with Financial Accounting Standards Board Interpretation
No. 28. Accordingly, at July 28, 2000, the remaining deferred compensation of
approximately $19,200,000 will be amortized as follows: $10,800,000 during
fiscal 2001, $5,700,000 during fiscal 2002, $2,500,000 during fiscal 2003 and
$200,000 during fiscal 2004. The amortization expense relates to options awarded
to employees in all operating expense categories. The amortization of deferred
compensation has not been separately allocated to these categories. The amount
of deferred compensation expense to be recorded in future periods could decrease
if options for which accrued but unvested compensation has been recorded are
forfeited.
WARRANT AGREEMENTS
As part of the NetAttach acquisition, the Company assumed certain warrant
agreements in association with the purchase. The fair market value of the
warrants at the date of grant was not material.
10. INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes". Due to the Company's loss position in fiscal 2000
and 1999, and availability of loss carryforwards in fiscal 1998, there was no
provision for income taxes for the years ended July 28, 2000 and July 31, 1999
and 1998. A valuation allowance has been recorded for the total deferred tax
assets as a result of uncertainties regarding realization of the assets based
upon the limited operating history of the Company, the lack of consistent
profitability to date and the uncertainty of future profitability.
The components of the net deferred tax assets are as follows (in thousands):
<TABLE>
<CAPTION>
JULY 28, 2000 JULY 31, 2000
------------- -------------
<S> <C> <C>
Net operating loss carryforwards $ 34,578 $ 3,970
Other reserves and accruals 2,901 638
-------- --------
37,479 4,608
Valuation allowance (37,479) (4,608)
-------- --------
Net deferred income tax asset $ -- $ --
======== ========
</TABLE>
As of July 28, 2000, the Company has net operating loss carryforwards of
approximately $84,900,000 to offset future federal taxable income, which expire
at various dates through the year 2020. This amount includes approximately
$33,800,000 of net operating loss carryforwards from the acquisition of Andover.
The deferred tax assets related to the acquisition of Andover, approximately
$11,800,000 as of June 7, 2000, if and when realized, will be used to reduce the
amount of goodwill and intangibles recorded at the date of acquisition. The
Company also has California net operating loss carryforwards of approximately
$25,800,000 to offset future California taxable income, which expire in the year
2005. The net operating loss carryforward also includes approximately $9,100,000
resulting from employee exercises of non-qualified stock options or
disqualifying dispositions, the tax benefits of which, when realized, will be
recorded as an addition to additional paid-in capital rather than a reduction of
the provision for income taxes. The operating loss carryforwards to be used in
future years is limited in accordance with the provisions of the Tax Reform Act
of 1986 as the Company has experienced a cumulative stock ownership change of
more than 50% over the last three years. The net operating loss carryforwards
stated above are reflective of various federal and state tax limitations.
11. SEGMENT AND GEOGRAPHIC INFORMATION
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", establishes standards for reporting information regarding
operating segments in annual financial statements and requires selected
information for those segments to be presented in interim financial reports
issued to stockholders. SFAS No. 131 also establishes standards for related
disclosures about products and services and geographic areas. Operating segments
are identified as components of an enterprise about which separate discrete
financial information is available for evaluation by the chief operating
decision-maker, or decision-making group, in making decisions how to allocate
resources and assess performance. The Company's chief decision-maker, as defined
under SFAS No. 131, is the Chief Executive Officer and the executive team. For
the period up to the acquisition of Andover.Net on June 7, 2000, VA Linux viewed
its operations as one operating segment, the provision of Linux-based products
and services.
45
<PAGE> 48
VA Linux currently views the operations of Andover.Net as a second segment. The
accounting policies of each segment are the same as those described in the
summary of significant accounting policies. The Company has no intersegment
sales and transfers, and does not allocate assets or expenses to the operating
segments. The Company may change, add or amend segments in future periods.
Cash, cash equivalents and short-term investments are maintained by the
Company's corporate headquarters. Total assets of Andover.Net as of July 28,
2000, excluding cash, cash equivalents, short-term investments and goodwill and
other intangibles, were not material in relation to consolidated total assets.
In addition, revenues for the period from June 7, 2000 to July 28, 2000 were
also not material in relation to consolidated revenues. Excluding all
acquisition related expenses, net loss recorded by Andover.Net for the period
from June 7, 2000 to July 28, 2000 was not material.
The Company markets its products in the United States through its direct sales
force. Revenues for each of the years ended July 28, 2000 and July 31, 1999 and
1998 were primarily generated from sales to end users in the United States.
12. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
2000
------------------------------------------------------------------
FOR THE THREE MONTHS ENDED OCTOBER 29 JANUARY 28 APRIL 28 JULY 28
---------- ---------- -------- --------
<S> <C> <C> <C> <C>
Net revenues $ 14,848 $ 20,191 $ 34,595 $ 50,662
Cost of revenues 12,887 17,356 28,439 39,499
-------- -------- -------- --------
Gross profit 1,961 2,835 6,156 11,163
Loss from operations (10,228) (12,623) (22,624) (49,912)
Net loss $(10,055) $(11,561) $(20,628) $(47,514)
======== ======== ======== ========
Dividend related to
convertible
preferred stock $ (4,900) $ -- $ -- $ --
======== ======== ======== ========
Net loss attributable
to common
stockholders $(14,955) $(11,561) $(20,628) $(47,514)
======== ======== ======== ========
Per share amounts:
Basic and diluted
net loss per share $ (2.00) $ (0.50) $ (0.58) $ (1.15)
======== ======== ======== ========
Shares used in
computing basic
and diluted net
loss per share 7,483 23,325 35,313 41,172
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
1999
--------------------------------------------------------------
FOR THE THREE MONTHS ENDED OCTOBER 31 JANUARY 31 APRIL 30 JULY 31
---------- ---------- -------- -------
<S> <C> <C> <C> <C>
Net revenues $ 2,435 $ 3,170 $ 4,270 $ 7,835
Cost of revenues 2,053 3,324 4,295 8,094
------- ------- ------- -------
Gross profit 382 (154) (25) (259)
Loss from operations (97) (1,801) (3,412) (9,221)
Net loss $ (97) $(1,815) $(3,412) $(9,188)
======= ======= ======= =======
Dividend related
to convertible
preferred stock $ -- $ -- $ -- $ --
======= ======= ======= =======
Net loss attributable
to common
stockholders $ (97) $(1,815) $(3,412) $(9,188)
======= ======= ======= =======
Per share amounts:
Basic and diluted
net loss per share $ (0.02) $ (0.57) $ (0.58) $ (1.17)
======= ======= ======= =======
Shares used in
computing basic
and diluted net
loss per share 5,100 3,203 5,869 7,845
======= ======= ======= =======
</TABLE>
The common stock of VA Linux Systems, Inc. is traded in the NASDAQ National
Market System under the symbol LNUX. As of October 10, 2000, there were
approximately 41,000 holders of record of VA Linux common stock. The Company has
declared no cash dividends since its inception and does not expect to pay any
dividends in the foreseeable future. The quarterly high and low closing sales
price, as reported by Nasdaq, of VA Linux common stock since the initial public
offering on December 9, 1999 are as follows:
<TABLE>
<CAPTION>
HIGH LOW
---------- ----------
<S> <C> <C>
Initial public offering to January 28, 2000 $ 242.88 $ 122.63
Quarter ended April 28, 2000 $ 136.88 $ 28.94
Quarter ended July 28, 2000 $ 64.38 $ 31.13
</TABLE>
46
<PAGE> 49
REPORT OF MANAGEMENT
Responsibility for the integrity and objectivity of the financial information
presented in this Annual Report rests with VA Linux management. The accompanying
financial statements have been prepared in conformity with generally accepted
accounting principles, applying certain estimates and judgments as required.
VA Linux maintains an effective internal control structure. It consists, in
part, of organizational arrangements with clearly defined lines of
responsibility and delegation of authority, and comprehensive systems and
control procedures. We believe this structure provides reasonable assurance that
transactions are executed in accordance with management authorization, and that
they are appropriately recorded, in order to permit preparation of financial
statements in conformity with generally accepted accounting principles and to
adequately safeguard, verify and maintain accountability of assets.
To assure the effective administration of internal control, we carefully select
and train our employees, develop and disseminate written policies and
procedures, provide appropriate communication channels, and foster an
environment conducive to the effective functioning of controls. We believe that
it is essential for the company to conduct its business affairs in accordance
with the highest ethical standards.
Arthur Andersen LLP, independent accountants, is retained to examine VA Linux's
financial statements. Its accompanying report is based on an examination
conducted in accordance with generally accepted auditing standards, including a
review of the internal control structure and tests of accounting procedures and
records.
The Audit Committee of the Board of Directors is composed solely of outside
directors, and is responsible for recommending to the Board the independent
accounting firm to be retained for the coming year, subject to stockholder
approval. The Audit Committee meets periodically and privately with the
independent accountants, as well as with VA Linux management, to review
accounting, auditing, internal control structure and financial reporting
matters.
/s/ LARRY M. AUGUSTIN /s/ TODD B. SCHULL
- --------------------------------- ----------------------------------
Larry M. Augustin Todd B. Schull
President and Vice President, Finance and
Chief Executive Officer Chief Financial Officer
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report contains forward looking statements (some of which may be
graphical representations), including, without limitation, statements regarding
future financial performance and results of our operations; technological trends
in the computer industry; our future product and service offerings, costs and
features; the ultimate success of our product and service offerings; anticipated
domestic and international revenue; future gross margin on products and
services; management's strategy, plans and objectives for future operations,
including additional offices in foreign markets and new sales channels; demand
for VA Linux's products and service plans; the future functionality, business
potential, demand for, and adoption of build-to-order software, the
Build-to-Order Software Selector (BOSS(TM)), and the Open Source Development
Network (OSDN(TM)); growth in adoption of and support for the Open Source
development model; and the expansion of the range of Open Source software
applications. Actual results may differ materially from those projected in such
forward-looking statements due to various factors, including, without
limitation: the rate of growth and acceptance of Linux and the Open Source
software development model; VA Linux's ability to continue to introduce new
products and services, and to expand its business and operations, particularly
internationally; the fact that VA Linux has incurred and expects to continue to
incur substantial losses; VA Linux's dependence upon an Open Source business
model, independent third-party Linux developers, and its single source contract
manufacturer and suppliers; VA Linux's reliance on sales of server products and
its success in expanding its services business; VA Linux's reliance upon
strategic relationships with other companies and its ability to negotiate and
implement specific terms relating to them; the scarcity of Linux-based
applications; competition with, and pricing pressures from, larger, more
established companies, and smaller, general purpose manufacturers; VA Linux's
dependence on its Internet-based businesses; the enforceability of the GNU
General Public License; VA Linux's ability to attract and retain qualified
personnel, especially in professional services and overseas; VA Linux's
acquisition strategy and its ability to successfully integrate Andover.Net and
other acquired companies into its operations; market acceptance of Linux and
Open Source software generally; rapid technological and market change;
manufacturing and sourcing risks; the impact of rapid evolution of the Linux
market on our ability to forecast demand and results; VA Linux's quarterly sales
cycle and fluctuation in demand for our products and services, with increased
fluctuation due to VA Linux's concentration of customers in the Internet
infrastructure industry; claims and potential damages resulting from information
or postings on our Internet sites; and risks associated with the Internet
infrastructure and regulation.
47
<PAGE> 50
BOARD OF DIRECTORS AND EXECUTIVE OFFICERS
EXECUTIVE OFFICERS
LARRY M. AUGUSTIN
President and Chief Executive Officer
ROBERT RUSSO
General Manager and Senior Vice President,
Worldwide Field Operations
ALI JENAB
General Manager and Senior Vice President,
Systems Division
BRIAN D. BILES
Vice President, Business Development
JOHN T. HALL
Vice President, Strategic Planning
MCKINLEY LITTLEJOHN
Vice President, Human Resources
GREG ORZECH
Vice President, North American Sales
PAUL PAPAGEORGE
Vice President, Worldwide Marketing
TODD B. SCHULL
Vice President, Finance and Chief Financial Officer
DANIEL R. SHORE
Vice President, Operations
BRUCE TWICKLER
President,
Open Source Development Network (OSDN)
GREGG E. ZEHR
Vice President, Engineering
STEVE WESTMORELAND
Chief Information Officer
LEONARD N. ZUBKOFF
Chief Technical Officer
WILLIAM C. COBERT
Managing Director, European Operations
DIRECTORS
LARRY M. AUGUSTIN
President and Chief Executive Officer
VA Linux Systems, Inc.
JEFFRY R. ALLEN(1)
Executive Vice President, Finance and Operations
Network Appliance, Inc.
CAROL A. BARTZ(2)
Chief Executive Officer and Chairman of the Board
Autodesk Inc.
DOUGLAS LEONE(2)
General Partner
Sequoia Capital
ERIC S. RAYMOND
Technical Director
Chester County InterLink
CARL REDFIELD(1)
Senior Vice President, Manufacturing and Logistics
Cisco Systems, Inc.
[GROUP PHOTOGRAPH OF PAUL PAPAGEORGE, LARRY M. AUGUSTIN, JOHN T. HALL, ROBERT
RUSSO, DANIEL R. SHORE, BRIAN D. BILES, TODD B. SCHULL, LEONARD N. ZUBKOFF,
GREGG E. ZEHR, ALI JENAB AND STEVE WESTMORELAND]
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
48
<PAGE> 51
CORPORATE INFORMATION
CORPORATE HEADQUARTERS
47071 Bayside Parkway
Fremont, CA 94538
(510) 687-7000
http://www.valinux.com
INDEPENDENT AUDITORS
Arthur Andersen LLP
San Jose, CA
CORPORATE COUNSEL
Wilson, Sonsini, Goodrich & Rosati, P.C.
Palo Alto, CA
TRANSFER AGENT & REGISTRAR
Equiserve
P.O. Box 8040
Boston, MA 02266-8040
www.equiserve.com
STOCKHOLDER'S MEETING
The annual meeting of stockholders will be held on Wednesday, December 6, 2000
at 9:00 am at The Westin Santa Clara, 5101 Great America Parkway, Santa Clara,
CA 95054
INVESTOR RELATIONS A COPY OF THE 2000 ANNUAL REPORT ON FORM 10-K IS AVAILABLE
FREE OF CHARGE UPON WRITTEN REQUEST TO THE DIRECTOR, INVESTOR RELATIONS, 47071
BAYSIDE PARKWAY, FREMONT, CA 94538. For further information about VA Linux
Systems please contact Investor Relations at the above address, via e-mail at
ir@valinux.com, or at 510-687-7000. Additional information about the company is
available on our website at http://www.valinux.com.
The VA logo, VA Linux Systems, SourceForge, OSDN and BOSS are trademarks of VA
Linux Systems,Inc., and may be registered in certain jurisdictions. Linux is a
registered trademark of Linus Torvalds. All other trademarks are the property of
their respective holders. (C)2000 VA Linux Systems, Inc. All rights reserved.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23.2
<SEQUENCE>4
<FILENAME>f66473ex23-2.txt
<DESCRIPTION>EXHIBIT 23.2
<TEXT>
<PAGE> 1
EXHIBIT 23.2
[INTERNATIONAL DATA CORPORATION LETTERHEAD]
October 23, 2000
Eureka Endo
Public Relations Manager
VA Linux Systems, Inc.
47071 Bayside Parkway
Fremont, CA 94538
Dear Ms. Endo,
Per our discussion, you have permission to include the following statistic
stated below in VA Linux's Form 10-K filing with Securities Exchange Commission,
for your fiscal year ended July 28, 2000:
According to statistics released by International Data Corporation's
Worldwide Quarterly Server Tracker in September 2000, in the second calendar
quarter of 2000, VA Linux ranked as the number two vendor of Linux servers
in the United States, based on factory revenue, with 20% market share, and
number three worldwide.
Sincerely,
/s/ Vernon Turner
- ----------------------------
Vernon Turner
Vice President, Worldwide Commercial Systems and Servers
International Data Corporation
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-27.1
<SEQUENCE>5
<FILENAME>f66473ex27-1.txt
<DESCRIPTION>FINANCIAL DATA SCHEDULE
<TEXT>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUL-28-2000
<PERIOD-START> AUG-01-1999
<PERIOD-END> JUL-28-2000
<CASH> 123,849
<SECURITIES> 52,433
<RECEIVABLES> 33,317
<ALLOWANCES> 1,475
<INVENTORY> 1,018
<CURRENT-ASSETS> 211,298
<PP&E> 12,574
<DEPRECIATION> 2,258
<TOTAL-ASSETS> 585,099
<CURRENT-LIABILITIES> 39,568
<BONDS> 0
<PREFERRED-MANDATORY> 0
<PREFERRED> 0
<COMMON> 52
<OTHER-SE> 543,823
<TOTAL-LIABILITY-AND-EQUITY> 585,099
<SALES> 120,296
<TOTAL-REVENUES> 120,296
<CGS> 98,181
<TOTAL-COSTS> 98,181
<OTHER-EXPENSES> 108,517
<LOSS-PROVISION> 1,328
<INTEREST-EXPENSE> 144
<INCOME-PRETAX> (89,758)
<INCOME-TAX> 0
<INCOME-CONTINUING> (89,758)
<DISCONTINUED> 0
<EXTRAORDINARY> (4,900)
<CHANGES> 0
<NET-INCOME> (94,658)
<EPS-BASIC> (3.52)
<EPS-DILUTED> (3.52)
</TABLE>
</TEXT>
</DOCUMENT>
</SEC-DOCUMENT>
-----END PRIVACY-ENHANCED MESSAGE-----