-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JtNtoHpWQ+mjI1CELjJbl8VaUyxxsvOfWCshmTGZQc6CDB0Z1WmKAhQO25ppjW3o M6ftsKe1cghYX3qeDysrzQ== 0001047469-99-023237.txt : 19990607 0001047469-99-023237.hdr.sgml : 19990607 ACCESSION NUMBER: 0001047469-99-023237 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 26 FILED AS OF DATE: 19990604 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RED HAT INC CENTRAL INDEX KEY: 0001087423 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 061364380 STATE OF INCORPORATION: DE FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-80051 FILM NUMBER: 99640973 BUSINESS ADDRESS: STREET 1: 2600 MERIDIAN PARKWAY CITY: DURHAM STATE: NC ZIP: 27713 BUSINESS PHONE: 9195470012 MAIL ADDRESS: STREET 1: 2600 MERIDIAN PARKWAY CITY: DURHAM STATE: NC ZIP: 27713 S-1 1 S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 4, 1999 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ RED HAT, INC. (Exact name of registrant as specified in its charter) DELAWARE 7375 06-1364380 (State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer of incorporation or organization) Classification Code Number) Identification Number)
------------------------ 2600 MERIDIAN PARKWAY DURHAM, N.C. 27713 (919) 547-0012 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ------------------------------ ROBERT F. YOUNG Chairman and Chief Executive Officer Red Hat, Inc. 2600 Meridian Parkway Durham, NC 27713 (919) 547-0012 (Name, address including zip code, and telephone number, including area code, of agent for service) ------------------------------ COPIES TO: WILLIAM J. SCHNOOR, JR., ESQ. MARK G. BORDEN, ESQ. GREGG A. GRINER, ESQ. PATRICK J. RONDEAU, ESQ. Testa, Hurwitz & Thibeault, LLP Hale and Dorr LLP 125 High Street 60 State Street Boston, Massachusetts 02110 Boston, Massachusetts 02109 Telephone: (617) 248-7000 Telephone: (617) 526-6000 Telecopy: (617) 248-7100 Telecopy: (617) 526-5000
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date hereof. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. / / If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. / / ------------------------------ CALCULATION OF REGISTRATION FEE
TITLE OF EACH CLASS OF PROPOSED MAXIMUM AMOUNT OF SECURITIES TO BE REGISTERED AGGREGATE OFFERING PRICE(1) REGISTRATION FEE Common Stock, $.0001 par value........................................ $96,600,000 $26,855
(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended. ------------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Subject To Completion. Dated June 4, 1999. THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PRELIMINARY PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. Shares [LOGO] Common Stock ------------------ This is an initial public offering of shares of Red Hat, Inc. All of the shares of common stock are being sold by Red Hat. It is currently estimated that the initial public offering price per share will be between $ and $ . Prior to this offering, there has been no public market for the common stock. Application has been made for quotation of the common stock on the Nasdaq National Market under the symbol "RHAT". SEE "RISK FACTORS" BEGINNING ON PAGE 6 TO READ ABOUT CERTAIN FACTORS YOU SHOULD CONSIDER BEFORE BUYING SHARES OF THE COMMON STOCK. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------
Per Share Total -------------------- -------------------- Initial public offering price................... $ $ Underwriting discount........................... $ $ Proceeds, before expenses, to Red Hat........... $ $
To the extent that the underwriters sell more than shares of common stock, the underwriters have the option to purchase up to an additional shares from Red Hat at the initial public offering price less the underwriting discount. ------------------------ The underwriters expect to deliver the shares against payment in New York, New York on , 1999. GOLDMAN, SACHS & CO. THOMAS WEISEL PARTNERS LLC E*TRADE SECURITIES, INC. ------------------------ Prospectus dated , 1999. DESCRIPTION OF INSIDE BACK COVER: [Graphic Description] This inside back cover contains the following: Awards Red Hat has won in the last three years with the graphical representations or logos of each award. The presentation of the awards is surrounded by the words "And the Winner is... Red Hat Linux". The Red Hat "Shadow Man" logo appears above the award presentation. DESCRIPTION OF INSIDE FRONT COVER: [Graphic Description] This inside front cover contains the following: A picture of the shrink-wrapped Official Red Hat Linux 6.0 operating system package. This picture is surrounded by the names of entities which are OEM, distribution or marketing partners of Red Hat. The Red Hat "Shadow Man" logo appears in the lower right corner of the page. PROSPECTUS SUMMARY YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED INFORMATION AND OUR FINANCIAL STATEMENTS AND NOTES TO THOSE STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS. RED HAT OUR BUSINESS We are a leading developer and provider of open source software and services, including the Red Hat Linux operating system. Our Web site, REDHAT.COM, is a leading online source of information and news about open source software and one of the largest online communities of open source software users and developers. In addition to offering extensive content for the open source community, REDHAT.COM serves as an important forum for open source software development and offers software downloads and a shopping site. Our broad range of professional services includes technical support, training and education, custom development, consulting and hardware certification. We are committed to serving the interests and needs of open source software users and developers and to sharing all of our product developments with the open source community. Red Hat Linux is our principal product. Since its introduction in 1994, Red Hat Linux has emerged as the most popular Linux-based operating system in the world. Red Hat Linux represented approximately 56% of new license shipments of Linux-based server operating systems in 1998, according to International Data Corporation (IDC). Our Web site had over 265,000 unique visitors and approximately 2.5 million page views during March 1999. A unique visitor is an individual visitor to our REDHAT.COM Web site. Page views are the total number of complete pages retrieved and viewed by visitors to REDHAT.COM. We generated approximately $10.8 million in revenue for the fiscal year ended February 28, 1999, primarily from the sale of Official Red Hat Linux. Our products are also generally available via free download from REDHAT.COM and other sites across the Internet, but do not include technical support or printed user documentation in these instances. Companies with which we have strategic alliances or investment relationships include Compaq, Dell, IBM, Intel, Netscape, Novell, Oracle and SAP. OUR MARKET OPPORTUNITY The rapid growth of the Internet in recent years has accelerated the development of open source software. Unlike proprietary software, open source software has publicly available source code and can be copied, modified and distributed with minimal restrictions. Under the open source software model, software is created through the collaborative efforts of large communities of independent developers. Developers work alone or in groups to write code, make it available over the Internet, solicit feedback on it from other developers, then modify and share it with others for general use. This continuous process results in the rapid evolution and improvement of open source software. We believe open source software offers many potential benefits for software customers, users and vendors. Customers and users are able to acquire the software at little or no cost, install the software on as many computers as they wish, and customize the software to suit their particular needs. In addition, customers and users can obtain software updates, improvements and support from multiple vendors, reducing reliance on any single vendor. Vendors are able to leverage the community of open source developers, allowing them to reduce development costs and decrease their time to market. Vendors are also able to distribute their products freely over the Internet, enabling them to create large global user bases quickly. Open source software is particularly well-suited to the Internet and includes the 2 following leading Internet software and server products: - Apache Web Server--the most common Web server in use today; - Perl--the de facto standard scripting language for Apache servers; and - Sendmail--an e-mail routing tool that handles a majority of all e-mail traffic. Operating systems based on the Linux kernel are some of the better known open source products. Linux-based operating systems represented 17% of new license shipments of server operating systems in 1998, according to IDC. Despite strong initial market acceptance, these operating systems have been slow to penetrate large corporations at the enterprise level due in part to the lack of viable open source industry participants to offer technical support and other services on a long-term basis. OUR STRATEGY We seek to enhance our position as a leading provider of open source software and services by: - continuing to enhance our Web site to create the definitive online destination for the open source community; - expanding our professional services capabilities to capture large corporate business on an enterprise basis; - increasing market acceptance of open source software, particularly through technology alliances and sharing our development efforts and resources with third-party developers; - continuing to invest in the development of open source technology; and - enhancing the Red Hat brand through targeted advertising and public relations campaigns. OUR HISTORY Red Hat, Inc. was incorporated in Connecticut in March 1993 as ACC Corp., Inc. In September 1995, ACC Corp., Inc. changed its name to Red Hat Software, Inc. In September 1998, Red Hat Software, Inc. reincorporated in Delaware. In June 1999, Red Hat Software, Inc. changed its name to Red Hat, Inc. Unless the context otherwise requires, any reference to "Red Hat", "we", "our" and "us" in this prospectus refers to Red Hat, Inc., a Delaware corporation, and its subsidiaries and predecessors. Our principal executive offices are located at 2600 Meridian Parkway, Durham, N.C. 27713. Our telephone number is (919) 547-0012. "Red Hat", the Red Hat "Shadow Man" logo, "RPM", and "PowerTools" are trademarks or service marks of Red Hat, Inc. Other trademarks and tradenames in this prospectus are the property of their respective owners. Except as set forth in the financial statements or as otherwise specified in this prospectus, all information in this prospectus: - assumes no exercise of the underwriters' over-allotment option; - reflects a 2-for-1 stock split of the common stock which will occur prior to the closing of this offering; and - reflects the automatic conversion of all outstanding shares of our preferred stock at February 28, 1999 into a total of 31,890,676 shares of common stock upon the closing of this offering. 3 THE OFFERING Shares offered by Red Hat.................... shares Shares to be outstanding after the shares offering..................................... Use of proceeds.............................. To provide working capital and for other general corporate purposes including geographic expansion. See "Use of Proceeds". Proposed Nasdaq National Market symbol....... RHAT
The number of shares of common stock to be outstanding after the offering is based on the number of shares outstanding on May 31, 1999. This number does not include 5,418,088 shares of common stock issuable upon the exercise of stock options outstanding on May 31, 1999 with a weighted average exercise price of $1.23 per share or 3,197,450 shares of common stock issuable upon exercise of warrants outstanding on May 31, 1999 with an exercise price of $.0001 per share. This number also does not include an aggregate of 9,235,160 shares reserved for future stock option grants and purchases under Red Hat's equity compensation plans. See "Management-- Employee Benefit Plans" and note 11 of notes to financial statements. 4 SUMMARY FINANCIAL DATA The following table summarizes the financial data of our business. You should read this information with the discussion in "Management Discussion and Analysis of Financial Condition and Results of Operations" and our financial statements and notes to those statements included elsewhere in this prospectus.
YEAR ENDED FEBRUARY 28, ------------------------------------------------------------------------- 1995 1996(1) 1997 1998 1999 ------------- ------------- ------------- ------------- ------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenue............................... $ 482 $ 930 $ 2,603 $ 5,156 $ 10,790 Net income (loss)..................... (128) (155) 33 8 (91) Net income (loss) available to common stockholders........................ (128) (155) 33 8 (130) Earnings (loss) per common share: Basic............................... $ (0.0107) $ (0.0069) $ 0.0014 $ 0.0003 $ (0.0055) Diluted............................. (0.0107) (0.0069) 0.0012 0.0002 (0.0055) Weighted average common shares outstanding:() Basic............................... 12,000 22,626 23,500 23,500 23,550 Diluted............................. 12,000 22,626 27,233 34,578 23,550 Pro forma earnings (loss) per common share: Basic............................... $ (0.0107) $ (0.0069) $ 0.0014 $ 0.0003 $ (0.0021) Diluted............................. (0.0107) (0.0069) 0.0012 0.0002 (0.0021) Pro forma weighted average common shares outstanding: Basic............................... 12,000 22,626 23,500 30,842 43,930 Diluted............................. 12,000 22,626 27,233 34,578 43,930
- ------------------------ (1) Red Hat's fiscal year ended on February 29, 1996. The following table presents a summary of our balance sheet at February 28, 1999: - on an actual basis; - on a pro forma basis to reflect conversion of all outstanding shares of our preferred stock at February 28, 1999 into a total of 31,890,676 shares of common stock, which will occur upon closing of this offering; and - on a pro forma as adjusted basis to reflect the sale of shares of common stock in this offering at an assumed initial public offering price of $ per share after deducting the estimated underwriting discount and offering expenses. - the pro forma and pro forma as adjusted amounts do not reflect the conversion of 1,027,388 shares of Series C preferred stock into 2,054,776 shares of common stock. We issued these shares of Series C preferred stock in March and April 1999 for net proceeds of approximately $3.2 million. If these shares were reflected, our pro forma total stockholders' equity would be $15.3 million and our pro forma, as adjusted stockholders' equity would be $ . 5
FEBRUARY 28, 1999 ------------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED --------- ----------- ------------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents............................. $ 10,055 $ 10,055 $ Working capital....................................... 11,100 11,100 Total assets.......................................... 15,276 15,276 Long-term liabilities................................. 420 420 Mandatorily redeemable preferred stock................ 12,107 -- Total stockholders' equity (deficit).................. (5) 12,102
6 RISK FACTORS THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW AND THE OTHER INFORMATION IN THIS PROSPECTUS BEFORE DECIDING TO INVEST IN THE SHARES OF COMMON STOCK. RISKS RELATED TO THE OPEN SOURCE BUSINESS MODEL THE MARKET FOR LINUX-BASED OPERATING SYSTEMS IS STILL DEVELOPING, AND OPEN SOURCE SOFTWARE BUSINESS MODELS ARE UNPROVEN The markets for Red Hat's products and services have only recently begun to develop. Demand and market acceptance for software products developed under the open source development model and services relating to these products are subject to a high level of uncertainty and risk. Few open source software products have gained widespread commercial acceptance. This is partly due to the lack of viable open source industry participants to offer adequate service and support on a long term basis. In addition, open source vendors are not able to provide industry standard warranties and indemnities for their products, since these products have been developed largely by independent parties over whom open source vendors exercise no control or supervision. Finally, there are currently few widely available commercial applications built for use with open source operating systems such as those based on the Linux kernel. If open source software should fail to gain widespread commercial acceptance, our business, operating results and financial condition would be materially adversely affected. WE RELY ON THE SUPPORT OF LINUS TORVALDS AND OTHER PROMINENT LINUX DEVELOPERS Our ability to release major upgrades of Red Hat Linux is largely dependent upon the release of new versions of the Linux kernel by Linus Torvalds, the original developer of the kernel. The Linux kernel is the heart of the operating system. Mr. Torvalds and a small group of engineers are primarily responsible for the development and evolution of the kernel. If this group of developers fails to further develop the Linux kernel, we will have to either develop it ourselves or rely on another party to develop it. This development effort could be costly and time consuming, and could delay our product release and upgrade schedule. Furthermore, there is no guarantee that the kernel would be available from a reliable alternative source. In addition, any failure on the part of the kernel developers to further develop the kernel could also stifle the development of additional Linux-based applications. Moreover, if Mr. Torvalds or other prominent Linux developers, such as Alan Cox, David Miller or Stephen Tweedie, were to join one of our competitors, or if they were to decide to no longer support us and our products in particular, or Linux in general, our business, operating results and financial condition could be materially adversely affected. OUR SOFTWARE CONSISTS LARGELY OF CODE DEVELOPED BY INDEPENDENT THIRD PARTIES, WHICH MAKES IT DIFFICULT TO ASSEMBLE AND TEST Red Hat Linux, in compressed form, consists of approximately 573 megabytes of code. Of that total, approximately 500 megabytes have been developed by independent third parties, including approximately 10 megabytes of code contained in the Linux kernel. Included within the 573 megabytes of code are approximately 645 distinct software components developed by thousands of individual programmers which we must assemble and test before we can release a new version of Red Hat Linux. Although we attempt to assemble only the best available components, we cannot be sure that we will be able to identify the best components or to successfully assemble and test them. Moreover, if these components are no longer independently developed or are not reliable, 7 our business, operating results and financial condition could be materially adversely affected. BECAUSE LINUX-BASED OPERATING SYSTEMS ARE STILL EMERGING AND RELATIVELY NEW, MOST SOFTWARE COMPANIES HAVE NOT YET DEVELOPED APPLICATIONS FOR THEM Demand and market acceptance for Linux-based operating systems in general, and Red Hat Linux in particular, will significantly depend on the availability of an increasing number of third party applications that operate on the Linux platform. These applications include word processors, databases, accounting packages, spreadsheets, e-mail programs, Internet browsers, presentation and graphics software and personal productivity applications. We intend to encourage the development of additional applications that operate on Linux-based operating systems by attracting third party developers to the Linux platform and by maintaining our existing developer relationships through marketing and technical support for third party developers. However, third party developers are generally under no obligation to develop applications for Linux-based operating systems. A developer's decision to write applications for these operating systems depends, in large part, on the developer's perception and analysis of the relative technical, financial and other benefits of developing applications for Linux-based operating systems as compared to writing applications for more widely accepted operating systems such as Windows NT or UNIX. If we cannot attract a sufficient number of application developers to write and market successful applications for Linux-based operating systems, our business, operating results and financial condition will be materially adversely affected. OUR ABILITY TO GENERATE REVENUE FROM SALES MAY BE ADVERSELY AFFECTED IF USERS CAN QUICKLY DOWNLOAD RED HAT LINUX FROM THE INTERNET Red Hat's historical business has been based on the sale of Official Red Hat Linux. Using a standard telephone connection, a user can download Red Hat Linux from the Internet free of charge in approximately 36 hours. To avoid this significant download time, users can purchase the shrink-wrapped version of Official Red Hat Linux. If hardware and data transmission technology advances in the future to the point where increased bandwidth allows Red Hat Linux to be more quickly downloaded from the Internet, users may no longer choose to purchase Official Red Hat Linux. Any resulting decrease in product revenue, if significant, could have a material adverse effect on our business, operating results and financial condition. DIFFICULTIES IN DEPLOYING OUR PRODUCTS MAY LEAD TO CUSTOMER DISSATISFACTION Deployment of our products often involves a significant commitment of resources, financial and otherwise, by our customers. The deployment process can be lengthy due to the size and complexity of our products and the need to purchase and install new applications. The failure by us to attract and retain services personnel, the failure of companies with which we have strategic alliances to commit sufficient resources towards deploying our products, or a delay in deployment for any other reason could result in dissatisfied customers. This could have a material adverse effect on our reputation and the Red Hat brand, which in turn could materially adversely affect our business, operating results and financial condition. THE OPEN SOURCE COMMUNITY MAY REACT NEGATIVELY TO OUR BUSINESS STRATEGY Some members of the open source software community have criticized the expansion of our strategic focus as encouraging the fragmentation of the Linux community. Others have suggested that by expanding our focus, we are trying to dominate the market for Linux-based operating systems and the open source community in the same way that some companies have been able to dominate the traditional software markets. This type of negative reaction, if widely shared by our customers, developers or the rest of the open source community, could harm our reputation, diminish the Red Hat brand and adversely affect our business, operating results and financial condition. 8 RISKS RELATED TO OUR FINANCIAL RESULTS AND CONDITION WE HAVE A LIMITED OPERATING HISTORY AND ARE SUBJECT TO RISKS FREQUENTLY ENCOUNTERED BY EARLY STAGE COMPANIES Red Hat was founded in March 1993. We began offering our Red Hat Linux operating system software for sale in October 1994. Accordingly, we have a relatively limited operating history upon which you can evaluate our business and prospects. You must consider our prospects in light of the risks and difficulties frequently encountered by early stage companies in new and rapidly evolving markets. WE EXPECT TO INCUR SUBSTANTIAL LOSSES IN THE FUTURE We have incurred operating losses in three of our previous five fiscal years. We expect to substantially increase our sales and marketing, research and development and administrative expenses in the immediate future. In addition, we are investing considerable resources in our Web initiative. As a result, we expect to incur significant losses for the foreseeable future and cannot be certain when or if we will achieve profitability. Failure to become and remain profitable within the timeframe expected by investors may adversely affect the market price of our common stock and our ability to raise capital and continue operations. OUR QUARTERLY RESULTS OF OPERATIONS MAY FLUCTUATE SIGNIFICANTLY AND ARE DIFFICULT TO FORECAST Due to our limited operating history and the unpredictability of our industry, our revenue and net income (loss) may fluctuate significantly from quarter to quarter and are difficult to forecast. We base our current and projected future expense levels in part on our estimates of future revenue. Our expenses are to a large extent fixed in the short term. We may not be able to adjust our spending quickly if our revenue falls short of our expectations. Accordingly, a revenue shortfall in a particular quarter would have a disproportionate adverse effect on our net income (loss) for that quarter. Further, we may make pricing, purchasing, service, marketing, acquisition or financing decisions that could adversely affect our business, operating results and financial condition. Our quarterly operating results will fluctuate for many reasons, including: - our ability to retain existing customers, attract new customers and satisfy our customers' demand; - changes in gross margins of our current and future products and services; - the timing of our release of upgraded versions of our products; - introduction of new products and services by us or our competitors; - changes in the market acceptance of Linux-based operating systems; - changes in the usage of the Internet and online services; - timing of upgrades and developments in the Linux kernel and other open source software products; - the effects of acquisitions and other business combinations, including one-time charges, goodwill amortization and integration expenses or difficulties; and - technical difficulties or system downtime affecting the Internet or our Web site. For these reasons, you should not rely on period-to-period comparisons of our financial results to forecast our future performance. Our future operating results may fall below expectations of securities analysts or investors, which would likely cause the trading price of our common stock to decline significantly. WE HAVE EXPERIENCED RAPID GROWTH, WHICH HAS PLACED A SIGNIFICANT STRAIN ON OUR RESOURCES Since March 1, 1998 we have experienced a period of rapid growth and expansion which 9 has placed, and continues to place, a significant strain on all of our resources. Our total revenue increased significantly during the last fiscal year, and from March 1, 1998 to May 31, 1999, the number of our employees increased from 36 to 127. We expect our anticipated growth to further strain our management, operational and financial resources. Our management team has had limited experience managing a rapidly growing company on either a public or private basis. To accommodate our anticipated growth we must: - improve existing and implement new operational and financial systems, procedures and controls; - hire, train and manage additional qualified personnel, including sales and marketing, professional services and software engineering and development personnel; and - effectively manage multiple relationships with our customers, suppliers and other third parties. We may not be able to install and implement adequate operational and financial systems, procedures and controls in an efficient and timely manner, and our current or planned systems, procedures and controls may not be adequate to support our future operations. The difficulties associated with installing and implementing these new systems, procedures and controls may place a significant burden on our management and our internal resources. In addition, if we grow internationally, as we intend, we will have to expand our worldwide operations and enhance our communications infrastructure. Any delay in the implementation of, or any disruption in the transition to, new or enhanced systems, procedures or controls could adversely affect our ability to accurately forecast sales demand, manage our supply chain, and record and report financial and management information on a timely and accurate basis. Our inability to manage growth effectively could have a material adverse effect on our business, operating results and financial condition. SEVERAL MEMBERS OF OUR SENIOR MANAGEMENT HAVE ONLY RECENTLY JOINED RED HAT Several members of our senior management joined us in 1998 and 1999, including our President and our Chief Operating Officer. We also plan to hire a new Chief Financial Officer in the near future. These individuals have not previously worked together and are becoming integrated as a management team. As a result, our senior managers may not be able to work together effectively to successfully manage our growth. WE MAY BE ADVERSELY AFFECTED IF WE LOSE ROBERT YOUNG, MATTHEW SZULIK, TIM BUCKLEY, MARC EWING OR OTHER KEY PERSONNEL Our future success depends on the continued services of a number of key officers, including our Chairman and Chief Executive Officer, Robert Young; our President, Matthew Szulik; our Chief Operating Officer, Tim Buckley; and our Executive Vice President and Chief Technology Officer, Marc Ewing. The loss of the technical knowledge and industry expertise of any of these officers could seriously impede our success. Moreover, the loss of one or a group of our key employees, particularly to a competitor, and any resulting loss of customers to a competitor could materially adversely affect our business, operating results and financial condition. WE FACE INTENSE COMPETITION FROM MICROSOFT AND OTHER ESTABLISHED OPERATING SYSTEMS DEVELOPERS The market for operating systems is intensely competitive and rapidly changing. We face significant competition from larger companies with greater financial resources and name recognition than we have. These competitors include Microsoft, Novell, IBM, Sun Microsystems and The Santa Cruz Operation, which offer hardware-independent multi-user operating systems for Intel platforms, as well as OEMs such as AT&T, Compaq, Hewlett-Packard, IBM, Olivetti, Sun Microsystems and Unisys, which offer UNIX-based operating systems. Many of these companies bundle 10 competitive operating systems with their own hardware offerings, making it more difficult for us to penetrate their customer base. If we are not able to compete successfully with current or future competitors, our business, operating results and financial condition will be materially adversely affected. WE FACE INTENSE COMPETITION FROM OTHER SUPPLIERS OF LINUX-BASED OPERATING SYSTEMS, AND NEW COMPETITORS MAY ENTER OUR MARKETS EASILY The market for Linux-based operating systems is new, rapidly evolving and intensely competitive. We expect competition to persist and intensify in the future. We estimate that there are currently over 23 suppliers of Linux-based operating systems worldwide and expect this number to grow as Linux-based operating systems gain increased market share from competing operating systems such as Microsoft Windows NT and the various UNIX-based operating systems. In addition, there are a number of companies with large customer bases and greater financial resources and name recognition, such as Sun Microsystems, Corel and Cygnus Solutions, that have indicated a growing interest in the market for Linux-based operating systems. These companies may be able to undertake more extensive promotional activities, adopt more aggressive pricing policies, and offer more attractive terms to their customers than we can. Furthermore, because Linux-based operating systems are open source software (i.e., they can be downloaded from the Internet for free or purchased at a nominal cost and modified and re-sold with few restrictions), traditional barriers to entry are minimal. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition, we may face competition for services revenue from larger and more capable companies that service and support other operating systems, particularly those that service and support the UNIX-based operating systems, due to the fact that Linux- and UNIX-based operating systems share many common features. These companies may be able to leverage their existing service organizations and provide higher levels of support on a more cost-effective basis than we can. If we are not able to compete successfully with current or future competitors, our business, operating results and financial condition will be materially adversely affected. WE MUST ESTABLISH AND MAINTAIN STRATEGIC RELATIONSHIPS IN ORDER TO OFFER PRODUCTS AND SERVICES TO A LARGER CUSTOMER BASE Our success depends on our ability to continue to establish and maintain strategic distribution and other collaborative relationships with industry-leading hardware manufacturers, distributors, software vendors and enterprise solutions providers in order to offer products and services to a larger customer base than we could otherwise reach through our direct sales and marketing efforts. We must develop and expand our indirect distribution channels through relationships with original equipment manufacturers (OEMs) and value-added resellers (VARs). Our largest distributor accounted for approximately 26% of our total revenue for the fiscal year ended February 28, 1998. Our two largest distributors accounted for 53% of our total revenue for the fiscal year ended February 28, 1999. If we are unable to maintain our existing strategic relationships or enter into additional strategic relationships, we will have to devote substantially more resources to the distribution, sale and marketing of our products and services than we would otherwise intend to, and our business, operating results and financial condition would be materially adversely affected. Our existing strategic relationships do not, and any future strategic relationships may not, afford us any exclusive marketing or distribution rights. The companies with which we have strategic alliances are free to pursue alternative technologies and to develop alternative products and services in addition to or in lieu of our products and services, either on their own or in collaboration with others, including our competitors. We cannot guarantee that our OEMs and distributors will 11 market our products effectively or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. In order to support and develop leads for our indirect distribution channels, we plan to expand our field sales and support staff significantly. We cannot guarantee that we will be able to successfully complete this internal expansion, that the revenue generated from this expansion will exceed its cost or that our expanded sales and support staff will be able to compete successfully against the significantly more extensive and better-funded sales and marketing operations of many of our current or potential competitors. Our inability to effectively manage the expansion of our sales and support staff would materially adversely affect our business, operating results and financial condition. OUR PLANNED INTERNATIONAL EXPANSION AND OPERATIONS EXPOSE US TO BUSINESS RISKS We plan to expand our presence in foreign markets. We have little experience in marketing and distributing products or services for these markets and may not benefit from any first-to-market advantages. It will be costly to establish international facilities and operations, promote our brand internationally, and develop localized Web sites and other systems. We may not succeed in our efforts in these countries. If revenue from international activities does not offset the expense of establishing and maintaining foreign operations, our business, operating results and financial condition will suffer. As we expand our international operations, we will face a number of additional risks associated with the conduct of business overseas, including: - difficulties relating to the management and administration of a globally- dispersed business; - fluctuations in exchange rates; - limitations on repatriation of earnings of our foreign operations; - the burdens of complying with a wide variety of foreign laws; - the uncertainty of laws and enforcement in certain countries relating to the protection of intellectual property rights; - reductions in business activity during the summer months in Europe and certain other parts of the world; - export controls; - multiple and possibly overlapping tax structures; - changes in import/export duties and quotas; and - economic or political instability in some international markets. WE MAY NOT REALIZE ANY BENEFIT FROM THE PLANNED EXPANSION OF OUR SERVICES BUSINESS We have recently begun to expand our strategic focus to place additional emphasis on consulting, custom development, education and support services. Historically, we have derived virtually all of our revenue from software product sales. Although we intend to continue to develop and sell Official Red Hat Linux, we anticipate that product sales will represent a declining percentage of our total revenue if our strategy is successful. We cannot be certain that our customers will engage our professional services organization to assist with support, consulting, custom development, training and implementation of our products. We also cannot be certain that we can attract or retain a sufficient number of the highly qualified services personnel that the expansion of our services business will need. In addition, this expansion has required, and will continue to require, significant additional expenses and development, financial and operational resources. These additional resources will place further strain on our management, financial and operational resources and may make it more difficult for us to achieve and maintain profitability. WE MAY ENTER INTO BUSINESS COMBINATIONS AND STRATEGIC ALLIANCES WHICH WILL PRESENT US WITH ADDITIONAL CHALLENGES We may expand our operations or market presence by entering into business combinations, investments, joint ventures or other strategic alliances with other companies. These transactions create risks such as: - difficulty assimilating the operations, technology and personnel of the combined companies; 12 - disruption of our ongoing business; - problems retaining key technical and managerial personnel; - one-time in-process research and development charges and ongoing expenses associated with amortization of goodwill and other purchased intangible assets; - potential dilution to our stockholders; - additional operating losses and expenses of acquired businesses; and - impairment of relationships with existing employees, customers and business partners. Our inability to address these risks could have a material adverse effect on our business, operating results and financial condition. COMPETITION FOR SKILLED TECHNICAL PERSONNEL IN OUR INDUSTRY IS INTENSE Our future performance also depends upon our ability to attract and retain highly qualified programming, technical, sales, marketing and managerial personnel. There is intense competition for skilled personnel, particularly in the field of software engineering. If we do not succeed in retaining our personnel or in attracting new employees, our business could suffer significantly. RISKS RELATED TO OUR INTERNET STRATEGY IF WE FAIL TO ATTRACT VISITORS TO OUR WEB SITE, OUR BUSINESS WILL SUFFER Enhancing the REDHAT.COM Web site is critical to our ability to increase our revenue. In order to attract and retain Internet users, advertisers and electronic commerce partners, we intend to substantially increase our expenditures for enhancing and further developing our Web site. Our success in promoting and enhancing the REDHAT.COM Web site will also depend on our success in providing high quality content, features and functionality. If we fail to promote our Web site successfully or if visitors to our Web site or advertisers do not perceive our services to be useful, current or of high quality, our ability to generate revenue from our Web site would be diminished. This could materially adversely affect our business, operating results and financial condition. WE MAY NOT GENERATE THE ADVERTISING REVENUE WE EXPECT As we execute our Internet strategy, we expect to derive an increasing amount of our revenue from sponsorships and advertising on our Web site. Demand and market acceptance for Internet advertising is uncertain. There are currently no standards for the measurement of the effectiveness of Internet advertising, and the industry may need to develop standard measurements to support and promote Internet advertising as a significant advertising medium. If standards do not develop, existing advertisers may not continue their levels of Internet advertising. Furthermore, advertisers that have traditionally relied on other advertising media may be reluctant to advertise on the Internet. Our ability to successfully execute our Internet strategy will be adversely affected if the market for Internet advertising fails to develop or develops more slowly than expected. In addition, different pricing models are used to sell advertising on the Internet. It is difficult to predict which, if any, will emerge as the industry standard. This makes it difficult to project our future advertising rates and revenue. Our advertising revenue could be adversely affected if we are unable to adapt to new forms of Internet advertising pricing models. Moreover, software programs that limit or prevent advertisements from being delivered to an Internet user's computer are available. Widespread adoption of this software could adversely affect the commercial viability of Internet advertising, and could materially adversely affect our business, operating results and financial condition. 13 THE SUCCESSFUL EXECUTION OF OUR INTERNET STRATEGY DEPENDS UPON THE CONTINUED DEVELOPMENT AND MAINTENANCE OF THE INFRASTRUCTURE OF THE INTERNET AND THE INTEGRITY OF OUR SYSTEMS The success of our Internet strategy will depend in large part on the continued development and maintenance of the infrastructure of the Internet. Because global commerce and the online exchange of information is new and evolving, we cannot predict with any certainty that the Internet will be a viable commercial marketplace in the long term. The Internet has experienced, and we expect it to continue to experience, significant growth in number of users and amount of traffic. To the extent that the Internet continues to experience an increased number of users, frequency of use or increased bandwidth requirements of users, it may not be able to support the demands placed upon it by such growth, and its performance and reliability may suffer. Furthermore, the Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure, and could face similar outages and delays in the future. Any outage or delay could affect the level of Internet usage, as well as the level of traffic on our Web site. In addition, the Internet could lose its viability due to delays in the development or adoption of new standards and protocols to handle increased levels of activity or due to increased governmental regulation. If the necessary infrastructure, standards or protocols or complementary products, services or facilities are not developed, or if the Internet does not become a viable commercial marketplace, our business, operating results and financial condition could be materially adversely affected. Substantially all of our communications hardware and our other computer hardware operations related to our Web site are located in Herndon, Virginia. Fire, floods, hurricanes, tornadoes, earthquakes, power loss, telecommunications failures, break-ins and similar events could damage these systems. In addition, although we have implemented network security measures, our servers are vulnerable to computer viruses, electronic break-ins, human error and other similar disruptive problems which could adversely affect our systems and Web site. Although we try to prevent unauthorized access to our systems, we cannot eliminate this risk entirely. Our business could be adversely affected if our systems were affected by any of these occurrences. Our insurance policies may not adequately compensate us for any losses that may occur due to failures or interruptions in our systems. We do not presently have any secondary "off-site" systems or a formal disaster recovery plan. Our Web site must accommodate a high volume of traffic and deliver frequently updated information. Our Web site has in the past experienced slower response times or decreased traffic for a variety of reasons. These occurrences have not had a material impact on our business. These types of occurrences in the future, however, could materially adversely affect our reputation and brand name and could cause users to perceive our Web site as not functioning properly. Under these circumstances, our customers could choose another Web site or other methods to obtain Linux-based operating systems or Linux-related information. WE MAY BE UNABLE TO ADEQUATELY MEASURE THE DEMOGRAPHICS OF VISITORS TO OUR WEB SITE We expect that it will be important to our advertisers that we accurately measure the demographics of the visitors to and the delivery of advertisements on our Web site. We have not committed significant resources to the measurement of demographics. We depend on third parties to provide some of these measurement services. If these parties were unable to provide these services in the future, we would need to perform them ourselves or obtain them from other providers. This could cause us to incur additional costs or cause interruptions in our Internet business during the time we were replacing these services. We are currently implementing additional systems designed to record demographic data on our Web site's visitors, 14 which will require us to incur additional costs. If we do not implement these systems successfully, we may not be able to accurately evaluate the demographic characteristics of visitors to our Web site. Companies may choose not to advertise on our Web site or may pay less for advertising if they do not perceive our measurements or measurements made by third parties to be reliable. RISKS RELATED TO LEGAL UNCERTAINTY OUR PRODUCTS ARE DEVELOPED AND LICENSED UNDER THE GNU GENERAL PUBLIC LICENSE WHICH MAY NOT BE ENFORCEABLE The Linux kernel and the Red Hat Linux operating system have been developed under, and licensed pursuant to, the GNU General Public License (GPL). The GPL states that any program licensed under it may be liberally copied, modified and distributed. We know of no circumstance under which the GPL has been challenged or interpreted in court. Accordingly, it is possible that a court would hold the GPL to be unenforceable in the event that someone were to file a claim asserting proprietary rights in a program developed and distributed in accordance with the GPL. Any ruling by a court that the GPL is not enforceable, or that Linux-based operating systems, or significant portions of them, may not be liberally copied, modified or distributed, would have the effect of preventing us from selling or developing our products. This would have a material adverse effect on our business, operating results and financial condition. OUR PRODUCTS MAY CONTAIN DEFECTS THAT MAY HARM OUR REPUTATION, BE COSTLY TO CORRECT, DELAY REVENUE AND EXPOSE US TO LITIGATION Despite testing by us and our customers, errors may be found in our products after commencement of commercial shipments. This risk is exacerbated by the fact that most of the code in our products is developed by independent parties over whom we exercise no supervision or control. If errors are discovered, we may not be able to successfully correct them in a timely manner or at all. Errors and failures in our products could result in a loss of, or delay in, market acceptance of our products and could damage our reputation and our ability to convince commercial users of the benefits of Linux-based operating systems and other open source software products. In addition, we may need to make significant expenditures of capital resources in order to eliminate errors and failures. If our products fail, our customers' systems may fail and they may assert warranty and other claims for substantial damages against us. Although our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims, it is possible that these provisions may not be effective or enforceable under the laws of some jurisdictions. In addition, our insurance policies may not adequately limit our exposure with respect to this type of claim. A product liability claim, even if unsuccessful, could be costly and time consuming. Claims related to the occurrence or discovery of these types of errors or failures could have a material adverse effect on our business, operating results and financial condition. OTHERS COULD CLAIM THAT WE INFRINGE THEIR INTELLECTUAL PROPERTY RIGHTS We may be subject to future litigation based on claims that our products infringe the intellectual property rights of others. This risk is exacerbated by the fact that most of the code in our products is developed by independent parties over whom we exercise no supervision or control. Claims of infringement could require us to reengineer our products or seek to obtain licenses from third parties in order to continue offering our products. In addition, an adverse legal decision affecting our intellectual property, or the use of significant resources to defend against this type of claim, could materially adversely affect our business, operating results and financial condition. 15 FAILURE TO PROTECT OUR TRADEMARKS COULD HARM OUR BRAND BUILDING EFFORTS AND OUR ABILITY TO COMPETE EFFECTIVELY Our most valuable intellectual property is our collection of trademarks. The protective steps we have taken in the past have been, and may continue to be inadequate to deter misappropriation of our trademark rights. We may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our trademark rights. We have registered some of our trademarks in the United States and Australia and have other trademark applications pending in Australia, Canada and Europe. Effective trademark protection may not be available in every country in which we offer or intend to offer our products and services. Failure to adequately protect our trademark rights could harm or even destroy the Red Hat brand and impair our ability to compete effectively. Furthermore, defending or enforcing our trademark rights could result in the expenditure of significant financial and managerial resources, which could materially adversely affect our business, operating results and financial condition. WE MAY BE SUED AS A RESULT OF INFORMATION RETRIEVED FROM OUR WEB SITE We may be subjected to claims for defamation, negligence, copyright or trademark infringement or other claims relating to the information we publish on our Web site. These types of claims have been brought, sometimes successfully, against online services in the past. We could also be subjected to claims based on content that is accessible from our Web site through links to other Web sites or through content and materials that may be posted by visitors to our Web site. Our insurance, which covers commercial general liability, may not adequately protect us against these types of claims. WE MAY BE ADVERSELY IMPACTED BY THE YEAR 2000 PROBLEM We have conducted a software review to identify functions that need correction to be "Year 2000 compliant". We are taking corrective actions in an effort to ensure that software systems used in our business or sold by us will continue to function properly in the year 2000. However, if compliance costs significantly exceed our estimate or if the corrective actions are unsuccessful or not completed in time, we may encounter Year 2000 problems with our products or business operations. Our exposure to Year 2000 problems 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. Additionally, the Year 2000 problem may affect us by causing disruptions in the business operations of, or delay technology purchases by, companies with which we do business, such as customers and suppliers. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Year 2000 Compliance". RISKS RELATED TO THIS OFFERING WE WILL HAVE BROAD DISCRETION AS TO THE USE OF THE PROCEEDS FROM THIS OFFERING The primary purposes of this offering are to obtain additional capital, create a public market for our common stock and facilitate future access to public markets. We expect to use the net proceeds from this offering for working capital and other general corporate purposes, including geographic expansion. We have not designated the proceeds for any particular purpose. Accordingly, we will have broad discretion as to the application of the proceeds. Our failure to apply the proceeds effectively could have a material adverse effect on our business, operating results and financial condition. THE PRICE OF OUR COMMON STOCK AFTER THIS OFFERING MAY BE LOWER THAN THE PRICE YOU PAY Before this offering, there was no public market for our common stock. Together with 16 the underwriters, we will determine the initial public offering price of our common stock based on an assessment of the valuation of our common stock. The public market may not agree with or accept this valuation. After this offering, therefore, you may not be able to resell your shares at or above the initial public offering price. FUTURE SALES BY EXISTING STOCKHOLDERS COULD DEPRESS THE MARKET PRICE OF OUR COMMON STOCK Once a trading market develops for our common stock, many of our stockholders will have an opportunity to sell their common stock for the first time. Sales of a substantial number of shares of common stock in the public market, or the threat that substantial sales might occur, could cause the market price of the common stock to decrease. These factors could also make it difficult for us to raise capital by selling stock. See "Shares Eligible for Future Sale". OUR EXISTING STOCKHOLDERS WILL EXERCISE SIGNIFICANT CONTROL OVER RED HAT Upon completion of this offering, our directors, executive officers and their affiliates will beneficially own approximately % of our outstanding common stock. These stockholders could determine the outcome of actions taken by us that require stockholder approval. For example, these stockholders could elect all of our directors, delay or prevent a transaction in which stockholders might receive a premium over the prevailing market price for their shares and control changes in management. See "Management" and "Principal Stockholders". ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD PREVENT OR DELAY A CHANGE IN CONTROL OF OUR COMPANY Provisions of our charter and bylaws may discourage, delay or prevent a merger or acquisition that stockholders may consider favorable. These provisions include: - authorizing the issuance of "blank check" preferred stock; - providing for a classified board of directors with staggered three-year terms; - requiring supermajority voting to effect certain amendments to our certificate of incorporation and bylaws; - limiting the ability to call special meetings of stockholders; - prohibiting stockholder action by written consent; and - establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings. Some provisions of Delaware law may also discourage, delay or prevent someone from acquiring us or merging with us. See "Description of Capital Stock--Delaware Law and Certain Charter and By-Law Provisions and Anti-Takeover Effects". YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION IN THE BOOK VALUE OF YOUR INVESTMENT The net tangible book value per share of the common stock immediately after this offering will be substantially less than the initial public offering price. Furthermore, in the event that we issue additional shares of common stock in the future, including shares that may be issued upon exercise of warrants and options and other rights granted under our employee benefit plans, purchasers of common stock in this offering will experience further dilution. See "Dilution". 17 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Some of the statements under "Prospectus Summary", "Risk Factors", "Management's Discussion and Analysis of Financial Condition and Results of Operations", "Business", and elsewhere in this prospectus constitute forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "may", "will", "should", "expects", "plans", "anticipates", "believes", "estimated", "predicts", "potential", or "continue" or the negative of such terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause our or our industry's actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. These factors include, among other things, those listed under "Risk Factors" and elsewhere in this prospectus. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of the forward-looking statements after the date of this prospectus to conform forward-looking statements to actual results. USE OF PROCEEDS We estimate the net proceeds to us from the sale of shares of common stock in this offering to be approximately $ , after deducting the estimated underwriting discount and offering expenses. If the underwriters' over-allotment option is exercised in full, we estimate net proceeds to be $ . The principal purposes of this offering are to increase our capitalization and financial flexibility, to provide a public market for the common stock and to facilitate access to public equity markets. We expect to use the net proceeds for working capital and other general corporate purposes, including geographic expansion. We have not allocated any specific portion of the net proceeds to any particular purpose, and our management will have the ability to allocate the proceeds at its discretion. A portion of the net proceeds may be used for the acquisition of businesses, products and technologies that are complementary to our own. Currently, we do not have any understandings, commitments or agreements with respect to acquisitions. The net proceeds of this offering will be invested in short-term, interest-bearing, investment-grade securities until allocated for specific use. DIVIDEND POLICY We have never paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We presently intend to retain future earnings, if any, to finance the expansion and growth of our business. Payment of future dividends, if any, will be at the discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion. 18 CAPITALIZATION The following table sets forth the capitalization of Red Hat as of February 28, 1999: - on an actual basis; - on a pro forma basis after giving effect to the conversion of our outstanding preferred stock at February 28, 1999 into common stock which will occur upon the closing of this offering; and - on a pro forma as adjusted basis to reflect the sale of the shares of common stock offered in this offering at an assumed initial public offering price of $ per share after deducting the estimated underwriting discount and offering expenses. The outstanding share information excludes 4,302,570 shares of common stock issuable upon the exercise of stock options outstanding on February 28, 1999, 3,387,450 shares of common stock issuable upon the exercise of warrants outstanding on February 28, 1999 and 7,434,800 shares reserved for future stock option grants and purchases under Red Hat's equity compensation plans. See "Management--Employee Benefit Plans" and note 11 to notes to financial statements. You should read this information together with Red Hat's financial statements and the notes to those statements appearing elsewhere in this prospectus.
FEBRUARY 28, 1999 ------------------------------------ PRO FORMA PRO AS ACTUAL FORMA(1) ADJUSTED(1) --------- ----------- ------------ (IN THOUSANDS) Long-term obligations......................................................... $ 420 $ 420 $ Stockholders' equity (deficit): Preferred stock: Series A preferred stock, par value $.0001; 6,801,400 shares authorized, issued and outstanding (actual); no shares authorized, issued or outstanding (pro forma and pro forma as adjusted)......................... 1,992 -- -- Series B preferred stock, par value $.0001; 8,116,550 shares authorized, issued and outstanding (actual); no shares authorized, issued or outstanding (pro forma and pro forma as adjusted)......................... 6,920 -- -- Series C preferred stock, par value $.0001; 1,797,929 shares authorized, 1,027,388 issued and outstanding (actual); no shares authorized, issued or outstanding (pro forma and pro forma as adjusted)......................... 3,195 -- -- Preferred stock, par value $0.0001; no shares authorized, issued or outstanding (actual); 5,000,000 shares authorized and no shares issued or outstanding (pro forma and pro forma as adjusted)......................... -- -- -- Common stock, par value $.0001; 225,000,000 shares authorized, 23,852,950 shares issued and outstanding (actual); 225,000,000, shares authorized, 55,743,626 shares issued and outstanding (pro forma); 225,000,000 shares authorized, shares issued and outstanding (pro forma as adjusted).... 2 5 -- Additional paid-in capital.................................................. 428 12,532 -- Accumulated deficit......................................................... (435) (435) -- --------- ----------- Total stockholders' equity (deficit)........................................ (5) 12,102 -- --------- ----------- ------------ Total capitalization........................................................ $ 12,522 $ 12,522 $ --------- ----------- ------------ --------- ----------- ------------
- ------------------------ (1) The pro forma and pro forma as adjusted amounts do not reflect the conversion of 1,027,388 shares of Series C preferred stock into 2,054,776 shares of common stock upon the completion of the offering. We issued these shares of Series C preferred stock in March and April 1999 for net proceeds of approximately $3.2 million. If such conversion were reflected, our pro forma total capitalization would be $15.7 million and our pro forma, as adjusted capitalization would be $ . 19 DILUTION Red Hat's net tangible book value per share immediately after this offering will be substantially less than the assumed initial public offering price. Red Hat's pro forma net tangible book value as of February 28, 1999 was $ million, or $ per share. Pro forma net tangible book value per share represents the pro forma amount of total tangible assets less total liabilities, divided by the number of pro forma shares of common stock outstanding. After giving effect to the sale by us of shares of common stock in this offering at an assumed initial public offering price of $ per share, after deducting the estimated underwriting discount and offering expenses, the pro forma as adjusted net tangible book value of Red Hat as of February 28, 1999 would have been $ million, or $ per share. This represents an immediate increase in pro forma as adjusted net tangible book value of $ per share to existing stockholders and an immediate dilution of $ per share to investors purchasing common stock in this offering. The following table illustrates this per share dilution: Assumed initial public offering price......................................... $ Pro forma net tangible book value per share prior to this offering.......... $ Increase per share attributable to this offering............................ --------- Adjusted pro forma net tangible book value per share after this offering...... --------- Dilution per share to new investors........................................... $ --------- ---------
Assuming the exercise in full of the underwriters' over-allotment option, Red Hat's pro forma as adjusted net tangible book value at February 28, 1999 would have been approximately $ per share, representing an immediate increase in the pro forma net tangible book value of $ per share to Red Hat's existing stockholders and an immediate decrease in net tangible book value of $ per share to new investors. The following table summarizes, on a pro forma as adjusted basis, as of February 28, 1999, the difference between the number of shares of common stock purchased from Red Hat, the total consideration paid to Red Hat, and the average price per share paid by existing stockholders and by new investors at an assumed initial public offering price of $ per share, before deducting the estimated underwriting discounts and offering expenses.
SHARES PURCHASED TOTAL CONSIDERATION ---------------------------- ---------------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE --------------- ----------- --------------- ----------- --------------- Existing stockholders..................... 55,743,626 % $ 13,573,961 % $ 0.24 New investors............................. $ --------------- ----- --------------- ----- Total................................. 100.0% $ 100.0% --------------- ----- --------------- ----- --------------- ----- --------------- -----
------------------------ The discussion and the tables above assume no exercise of stock options or warrants outstanding on February 28, 1999 and no issuance of shares reserved for future issuance under Red Hat's equity plans. As of February 28, 1999, there were options outstanding to purchase 4,302,570 shares of common stock at a weighted average exercise price of $0.36 per share and warrants outstanding to purchase 3,387,450 shares of common stock at an exercise price of $.0001 per share. To the extent that any of these options or warrants are exercised, there will be further dilution to new investors. In addition, the discussion and the tables above do not reflect the conversion of 1,027,388 shares of Series C preferred stock into 2,054,776 shares of common stock upon the completion of the offering. We issued these shares of Series C preferred stock in March and April 1999 for net proceeds of approximately $3.2 million. See "Capitalization" and "Management--Employee Benefit Plans". 20 SELECTED FINANCIAL DATA The statement of operations data set forth below for the fiscal years ended February 28, 1997, February 28, 1998 and February 28, 1999, and the balance sheet data as of February 28, 1998 and February 28, 1999, have been derived from our financial statements which have been audited by PricewaterhouseCoopers LLP, independent accountants, and are included elsewhere in this prospectus. The balance sheet data as of February 28, 1997 have been derived from our audited financial statements which are not included in this prospectus. The statement of operations data for the fiscal years ended February 28, 1995 and February 29, 1996, and the balance sheet data as of February 28, 1995 and February 29, 1996 have been derived from our unaudited financial statements which are not included in this prospectus. You should read the data set forth below in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and notes thereto appearing elsewhere in this prospectus.
YEAR ENDED FEBRUARY 28, ----------------------------------------------------- 1995 1996(2) 1997 1998 1999 --------- --------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenue: Software and related products................................ $ 482 $ 930 $ 2,603 $ 5,132 $ 10,013 Services and other........................................... -- -- -- 24 777 --------- --------- --------- --------- --------- Total revenue.............................................. 482 930 2,603 5,156 10,790 Cost of revenue: Software and related products................................ 352 432 1,205 2,211 4,013 Services and other........................................... -- -- -- -- 28 --------- --------- --------- --------- --------- Total cost of revenue...................................... 352 432 1,205 2,211 4,041 --------- --------- --------- --------- --------- Gross profit................................................... 130 498 1,398 2,945 6,749 --------- --------- --------- --------- --------- Operating expense: Sales and marketing.......................................... 133 241 491 1,252 3,083 Research and development..................................... 80 250 325 903 2,220 General and administrative................................... 44 140 526 799 1,484 --------- --------- --------- --------- --------- Total operating expenses................................... 257 631 1,342 2,954 6,787 --------- --------- --------- --------- --------- Income (loss) from operations................................ (127) (133) 56 (9) (38) Other income (expense), net.................................... (1) (22) (23) 22 162 --------- --------- --------- --------- --------- Income (loss) before income taxes.............................. (128) (155) 33 13 124 Provision for income taxes..................................... -- -- -- 5 215 --------- --------- --------- --------- --------- Net income (loss).............................................. (128) (155) 33 8 (91) Accretion on mandatorily redeemable preferred stock............ -- -- -- -- (39) --------- --------- --------- --------- --------- Net income (loss) available to common stockholders............. $ (128) $ (155) $ 33 $ 8 $ (130) --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Earnings (loss) per common share (1): Basic........................................................ (0.0107) (0.0069) 0.0014 0.0003 (0.0055) Diluted...................................................... (0.0107) (0.0069) 0.0012 0.0002 (0.0055) Weighted average common shares outstanding: Basic........................................................ 12,000 22,626 23,500 23,500 23,550 Diluted...................................................... 12,000 22,626 27,233 34,578 23,550 Pro forma net income (loss) per common share (1): Basic........................................................ (0.0107) (0.0069) 0.0014 0.0003 (0.0021) Diluted...................................................... (0.0107) (0.0069) 0.0012 0.0002 (0.0021) Shares of common stock used in computing pro forma net income (loss) per share: Basic........................................................ 12,000 22,626 23,500 30,842 43,930 Diluted...................................................... 12,000 22,626 27,233 34,578 43,930
21
FEBRUARY 28, ----------------------------------------------------- 1995 1996(2) 1997 1998 1999 --------- --------- --------- --------- --------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents...................................... $ -- $ -- $ -- $ 1,293 $ 10,055 Working capital (deficit)...................................... (129) (160) (324) 1,541 11,100 Total assets................................................... 106 245 670 3,131 15,276 Long term liabilities.......................................... -- 30 145 65 420 Mandatorily redeemable preferred stock......................... -- -- -- 1,983 12,107 Total stockholders' equity (deficit)........................... (42) (79) (46) (38) (5)
- -------------------------- (1) See note 2 to notes to financial statements. (2) Our fiscal year ended on February 29, 1996. 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH RED HAT'S FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS PROSPECTUS. THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE INDICATED IN SUCH FORWARD-LOOKING STATEMENTS. SEE "SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS". OVERVIEW Red Hat, Inc. is a leading developer and provider of open source software products and services, and has built a comprehensive Web site dedicated to the open source software community. Red Hat, Inc. was incorporated in Connecticut in March 1993 as ACC Corp., Inc. In September 1995, ACC Corp., Inc. changed its name to Red Hat Software, Inc. In September 1998, Red Hat Software, Inc. reincorporated in Delaware. In June 1999, Red Hat Software, Inc. changed its name to Red Hat, Inc. We have financed our activities to date through proceeds from the private sale of equity securities and cash flow from operations. Sales of Official Red Hat Linux have represented our principal source of revenue since its introduction in October 1994. We derive our software and related products revenue primarily from the sale of software products: - through distributors to enterprise and retail accounts; - directly to individual users and enterprises through our REDHAT.COM Web site and our call center; and - from OEMs which license our software directly. We recognize revenue from software product sales to distributors and OEMs at the time our products are shipped, net of a reserve for estimated sales returns. This reserve is recognized for the sale of software products to distributors, who have the right of return, based on our historical experience of sell-through to the end user by the distributor. Revenue from the sale of software products to individual users and enterprises is recognized on the date we ship the software products. Upon the release of Version 6.0 of Red Hat Linux in May 1999, we began selling Official Red Hat Linux with 30 days of free telephone technical support. An amount equal to the value of the support and maintenance services is recorded as a support and maintenance fee and recognized, as a component of services and other revenue, over the period the services are provided. The remainder of the purchase price for Official Red Hat Linux is recognized as software products revenue. We have recently added new features to our REDHAT.COM Web site. We intend to develop additional features for our Web site which we believe will result in both a substantial increase in the number of visitors who access our Web site and increased advertising revenue. Advertising revenue is derived principally from short-term advertising contracts in which we typically guarantee a minimum number of impressions to be delivered to users over a specified period of time for a fixed fee. Advertising rates are typically measured on a cost per thousand impressions basis. Advertising revenue is recognized ratably in the period in which the advertisement is displayed, provided that we have no significant remaining obligations, at the lesser of the ratio of impressions delivered over total guaranteed impressions or the straight line basis over the term of the contract. To the extent that minimum guaranteed impressions are not met, we defer recognition of the corresponding revenue until the guaranteed impressions are achieved. We did not generate revenue from the sale of advertising on our Web site until the first quarter of the fiscal year ending February 29, 2000. However, we believe that the expected increase in traffic on our Web site, along with our focus on marketing our 23 advertising services, will generate significant advertising revenue in the future. In March 1999, we expanded our service offerings to include comprehensive support and maintenance, custom development, consulting and education services. Although these services generated only an insignificant amount of revenue through February 28, 1999, we believe that our services revenue will increase significantly as a percentage of total revenue beginning in the fiscal year ending February 29, 2000. Revenue from support and maintenance agreements is deferred and recognized ratably over the term of the related agreement, which is typically one year. Revenue from custom development, consulting and education services, which includes offering training courses and hardware certification services, is recognized as the services are provided. Our software products are sold worldwide, with substantially all of our total revenue coming from North America. We expect that total revenue derived from sales outside of North America will increase beginning in the fiscal year ending February 29, 2000. We have historically experienced fluctuations in our results of operations related to the release of major upgrades to Official Red Hat Linux. We believe that the anticipation by our customers of the release of major upgrades to our software products has resulted in, and will continue to result in, a decline in sales for several months prior to the release of the major upgrade and an increase in sales immediately following the release. In May 1999, we released Version 6.0 of Official Red Hat Linux and experienced an immediate significant increase in both the volume and dollar amount of software product sales. In addition, we believe that revenue from the sale of Official Red Hat Linux and related products will decline as a percentage of total revenue in the future as we continue to expand our services offerings and execute our Web initiative. Sales of software products to distributors comprised $0.7 million or 26.1% of total software and related products revenue in the fiscal year ended February 28, 1997, $0.9 million or 17.3% of total software and related products revenue in the fiscal year ended February 28, 1998, and $5.9 million or 58.2% of total software and related products revenue in the fiscal year ended February 28, 1999. Sales of software products to end users through our REDHAT.COM Web site and call center comprised $1.9 million or 73.9% of total software and related products revenue in the fiscal year ended February 28, 1997, $3.0 million or 58.8% of total software and related products revenue in the fiscal year ended February 28, 1998 and $3.2 million or 29.6% of total software and related products revenue in the fiscal year ended February 28, 1999. Sales to our largest distributor constituted approximately 16.0% of total revenue in the fiscal year ended February 28, 1997, and 26.0% of total revenue in the fiscal year ended February 28, 1998. Sales to our two largest distributors comprised 54.3% of total revenue in the fiscal year ended February 28, 1999. During the fiscal year ended February 28, 1999, approximately 69.2% of our total revenue was attributable to sales to retail channel accounts through distributors. We plan to expand our OEM relationships in the fiscal year ending February 29, 2000 and therefore expect that our OEM-related revenue for this fiscal year will increase significantly as a percentage of total revenue as compared to the fiscal year ended February 28, 1999. We employed 127 people at May 31, 1999, compared to 36 at March 1, 1998. This increase in headcount resulted primarily from an increase in administrative personnel as we recruited our management team; an increase in support, maintenance, consulting and education personnel associated with our efforts to develop the infrastructure of our services organization; and an increase in research and development personnel. We expect to continue to increase expenses associated with our sales and marketing, research and development and general and administrative groups in anticipation of continued growth and expansion. Given the expected increase in headcount, we anticipate that we will need to 24 either expand our existing offices or lease additional office space at a separate location within the next 12 to 18 months. We believe that this expansion will result in an increase in total facilities costs. RESULTS OF OPERATIONS The following table sets forth the results of operations for Red Hat expressed as a percentage of total revenues. The historical results are not necessarily indicative of results to be expected for any future period.
YEAR ENDED FEBRUARY 28, ------------------------------- 1997 1998 1999 --------- --------- --------- Revenue: Software and related products........................................ 100.0% 99.5% 92.8% Services and other................................................... 0.0 0.5 7.2 --------- --------- --------- Total revenue...................................................... 100.0 100.0 100.0 Cost of revenue: Software and related products........................................ 46.3 42.9 37.2 Services and other................................................... 0.0 0.0 0.2 --------- --------- --------- Total cost of revenue.............................................. 46.3 42.9 37.4 Gross profit........................................................... 53.7 57.1 62.6 Operating expense: Sales and marketing.................................................. 18.8 24.3 28.6 Research and development............................................. 12.5 17.5 20.6 General and administrative........................................... 20.2 15.5 13.7 --------- --------- --------- Total operating expense............................................ 51.5 57.3 62.9 Income (loss) from operations.......................................... 2.2 (0.2) (0.3) Other income (expense), net............................................ (0.9) 0.4 1.5 Income before income taxes............................................. 1.3 0.2 1.2 Provision for income taxes............................................. 0.0 0.1 2.0 --------- --------- --------- Net income (loss)...................................................... 1.3 0.1 (0.8) Accretion on mandatorily redeemable preferred stock.................... 0.0 0.0 (0.4) --------- --------- --------- Net income (loss) available to common stockholders..................... 1.3% 0.1% (1.2)% --------- --------- --------- --------- --------- ---------
25 FISCAL YEARS ENDED FEBRUARY 28, 1999 AND 1998 TOTAL REVENUE Total revenue increased 109.3% to $10.8 million in the fiscal year ended February 28, 1999 from $5.2 million in the fiscal year ended February 28, 1998. SOFTWARE AND RELATED PRODUCTS REVENUE Software and related products revenue is comprised primarily of sales of Official Red Hat Linux and related software products and sales of publications about Linux-based operating systems. Software and related products revenue increased 95.1% to $10.0 million, or 92.8% of total revenue, in the fiscal year ended February 28, 1999 from $5.1 million, or 99.5% of total revenue, in the fiscal year ended February 28, 1998. The decrease in software and related products revenue as a percentage of total revenue was due to the increase in services and other revenue. Software products revenue increased to $9.0 million during the fiscal year ended February 28, 1999 from $3.9 million for the fiscal year ended February 28, 1998. The increase in software products revenue was due to higher sales of Official Red Hat Linux, which, along with other Linux-based operating systems, continues to emerge as a viable software platform in the end user, educational and enterprise arenas. We met the higher demand for Official Red Hat Linux by establishing a relationship with a major distributor in November 1998 and subsequently adding prominent national computer and software retailers. Related products revenue, which is comprised of revenue from sales of books and other products, decreased to $1.0 million during the fiscal year ended February 28, 1999 compared to $1.2 million in the fiscal year ended February 28, 1998. During the fiscal year ended February 28, 1999, we reduced the number of publications that we published and distributed to focus our efforts on our software products. SERVICES AND OTHER REVENUE Services and other revenue is comprised of support and maintenance fees, custom development fees, consulting and education fees and royalties received from licensing our trademarks. Services and other revenue increased to $0.8 million in the fiscal year ended February 28, 1999 from $24,000 in the fiscal year ended February 28, 1998. As a percentage of total revenue, services and other revenue increased to 7.2% in the fiscal year ended February 28, 1999 from 0.5% in the fiscal year ended February 28, 1998. Services and other revenue was comprised of $0.1 million in services revenue and $0.7 million in royalties for the fiscal year ended February 28, 1999 as compared to no services revenue and $24,000 in royalties for the fiscal year ended February 28, 1998. The increase in services revenue resulted from the introduction of our training and certification program during February 1999. We expect services revenue to increase significantly in dollar amount and as a percentage of our total revenue in the fiscal year ending February 29, 2000 as we develop and expand our support and maintenance, custom development and consulting and education services. The increase in royalties resulted from the licensing of some of our trademarks to third parties, nationally and internationally, as a way of increasing our market share in markets or geographic locations important to our business plan. This strategy allowed us to have a local presence without incurring the costs associated with establishing separate operations in each of these markets or geographic locations. During the fiscal year ended February 28, 1999, we licensed some of our trademarks to publishers, who paid us a royalty based on their sales. We expect to discontinue some of these agreements during the fiscal year ending February 29, 2000 due to our geographic expansion plans. 26 COST OF REVENUE COST OF SOFTWARE AND RELATED PRODUCTS Cost of software and related products primarily consists of expenses we incur to manufacture, package and distribute our products and related documentation. These costs include expenses for physical media, literature, packaging, fulfillment and shipping. Also included are royalties paid by us for licensing third-party applications included in software products and third-party publications. Cost of software and related products increased 81.5% to $4.0 million in the fiscal year ended February 28, 1999 from $2.2 million in the fiscal year ended February 28, 1998. The increase in cost of software and related products was directly related to the increase in sales of software and related products. As a percentage of software and related products revenue, cost of software and related products decreased to 40.1% in the fiscal year ended February 28, 1999 from 43.1% in the fiscal year ended February 28, 1998. This decrease was due to the decline in royalties paid to third parties because of the reduction in the number of third-party applications included in our software products. COST OF SERVICES AND OTHER Cost of services and other includes salaries of support and maintenance, custom development, consulting and education personnel and other related costs. Cost of services for the fiscal year ended February 28, 1999 was primarily comprised of salaries and other related costs incurred for our training and certification program which commenced in February 1999. We incur no direct costs related to royalties received for licensing our trademarks to third parties. Cost of services and other increased to $28,000 in the fiscal year ended February 28, 1999 from zero in the fiscal year ended February 28, 1998. As a percentage of services and other revenue, cost of services and other increased to 3.6% in the fiscal year ended February 28, 1999 from zero percent in the fiscal year ended February 28, 1998. We expect cost of services and other to increase in the fiscal year ending February 29, 2000, as we expand our service offerings, which will include the costs associated with providing technical support and maintenance, custom development, consulting and education. We expect these costs to be high in dollar amount and as a percentage of services and other revenue due to costs that we will incur in connection with developing and expanding our services organization. Cost of services and other as a percentage of services and other revenue is expected to vary significantly from period to period depending upon the mix of services we provide, whether such services are provided by us or third-party contractors, and the overall utilization rate of our services staff. GROSS PROFIT Gross profit increased 129.2% to $6.7 million in the fiscal year ended February 28, 1999 from $2.9 million in the fiscal year ended February 28, 1998. As a percentage of total revenue, gross profit increased to 62.6% in the fiscal year ended February 28, 1999 from 57.1% in the fiscal year ended February 28, 1998. These increases were primarily due to an increase in royalties received for licensing our trademarks to third parties of $0.7 million in the fiscal year ended February 28, 1999 for which we incurred no direct costs. OPERATING EXPENSE SALES AND MARKETING Sales and marketing expense consists primarily of salaries and other related costs for sales and marketing personnel, sales commissions, travel, public relations, marketing materials and tradeshows. Sales and marketing expense increased 146.2% to $3.1 million in the fiscal year ended February 28, 1999 from $1.3 million in the fiscal year ended February 28, 1998. As a percentage of total revenue, sales and marketing expense increased to 28.6% in the fiscal year ended February 28, 1999 from 24.3% in the fiscal year ended February 28, 1998. These increases 27 were due to greater costs attributable to cooperative marketing arrangements with distributors and extensive public relations activities in the fiscal year ended February 28, 1999 to promote our brand. We expect sales and marketing expense to increase in the forseeable future as we promote the expansion of our services offerings and Web site and expand our international operations. RESEARCH AND DEVELOPMENT Research and development expense consists primarily of personnel and related costs for our software products and Web development efforts. Also included in research and development expense are payments to outside consultants for development related services and expenses. Research and development expense increased 145.9% to $2.2 million in the fiscal year ended February 28, 1999 from $0.9 million in the fiscal year ended February 28, 1998. As a percentage of total revenue, research and development expense increased to 20.6% in the fiscal year ended February 28, 1999 from 17.5% in the fiscal year ended February 28, 1998. These increases resulted from an increase in the number of research and development personnel necessary to support both expanded functionality and ease of use of Official Red Hat Linux, costs of personnel involved in the GNOME graphical user interface project, and increases in quality assurance and technical documentation projects. We expect research and development expenses to continue to increase in the fiscal year ending February 29, 2000 as we develop our Web site and expand features in Red Hat Linux. GENERAL AND ADMINISTRATIVE General and administrative expense consists primarily of personnel and related costs for general corporate functions, including finance, accounting, legal, human resources, facilities and information system expenses. General and administrative expense increased 85.8% to $1.5 million in the fiscal year ended February 28, 1999 from $0.8 million in the fiscal year ended February 28, 1998. The increase in general and administrative expense resulted from an increase in the number of general and administrative personnel, from legal and accounting costs incurred in connection with establishment of new business activities and, to a lesser extent, from costs associated with relocating our offices in January 1999. As a percentage of total revenue, general and administrative expense decreased to 13.7% in the fiscal year ended February 28, 1999 from 15.5% in the fiscal year ended February 28, 1998. This decrease was due primarily to revenue increasing at a higher rate than general and administrative expense. We expect general and administrative expense to continue to increase in the fiscal year ending February 29, 2000 as we complete the formation of our management team and expand our international operations. OTHER INCOME (EXPENSE), NET Other income (expense), net consists of interest income earned on cash deposited in money market accounts and other short-term investments and interest expense incurred on capital leases. Other income (expense), net increased 656.6% to income of $0.2 million in the fiscal year ended February 28, 1999 from income of $20,000 in the fiscal year ended February 28, 1998. As a percentage of total revenue, other income (expense), net increased to 1.5% in the fiscal year ended February 28, 1999 from 0.4% in the fiscal year ended February 28, 1998. These increases resulted from higher average cash and cash equivalents and short-term investment balances in the fiscal year ended February 28, 1999 as compared to fiscal 1998 due to receipt of proceeds from the sale of preferred stock in September 1998 and the repayment of outstanding notes payable during the fiscal year ended Feburary 28, 1998. PROVISION FOR INCOME TAXES Provision for income taxes increased to $0.2 million in the fiscal year ended February 28, 1999 from $5,000 in the fiscal year ended February 28, 1998. The increase resulted from the growth in our taxable income and an increase in the valuation allowance on 28 our net deferred tax assets due to uncertainty of realization. ACCRETION OF MANDATORILY REDEEMABLE PREFERRED STOCK Accretion of mandatorily redeemable preferred stock of $39,000 in the fiscal year ended February 28, 1999 was a result of the issuance of mandatorily redeemable preferred stock in September 1998. All of the outstanding preferred stock will convert into common stock upon the closing of this offering. FISCAL YEARS ENDED FEBRUARY 28, 1998 AND 1997 TOTAL REVENUE Total revenue increased 98.1% to $5.1 million in the fiscal year ended February 28, 1998 from $2.6 million in the fiscal year ended February 28, 1997. SOFTWARE AND RELATED PRODUCTS REVENUE Software and related products revenue increased by 97.1% to $5.1 million in the fiscal year ended February 28, 1998 from $2.6 million in the fiscal year ended February 28, 1997. The increase in software and related products revenue resulted from increasing acceptance of Official Red Hat Linux by technical users as a viable operating system. SERVICES AND OTHER REVENUE Services and other revenue increased to $24,000 in the fiscal year ended February 28, 1998 from zero in the fiscal year ended February 28, 1997. This increase resulted from royalty payments received from international publishers of products bearing our trademarks in the fiscal year ended February 28, 1998. COST OF REVENUE COST OF SOFTWARE AND RELATED PRODUCTS Cost of software and related products increased 83.5% to $2.2 million in the fiscal year ended February 28, 1998 from $1.2 million in the fiscal year ended February 28, 1997. The increase in cost of software and related products resulted from increased sales of our software and related products. As a percentage of software and related products revenue, cost of software and related products decreased to 42.9% in the fiscal year ended February 28, 1998 from 46.3% in the fiscal year ended February 28, 1997. This decrease was due to growing sales and declining costs on a per unit basis. GROSS PROFIT Gross profit increased 110.6% to $2.9 million in the fiscal year ended February 28, 1998 from $1.4 million in the fiscal year ended February 28, 1997. As a percentage of total revenue, gross profit increased to 57.1% in the fiscal year ended February 28, 1998 from 53.7% in the fiscal year ended February 28, 1997. OPERATING EXPENSES SALES AND MARKETING EXPENSE Sales and marketing expense increased 154.8% to $1.3 million in the fiscal year ended February 28, 1998 from $0.5 million in the fiscal year ended February 28, 1997. As a percentage of total revenue, sales and marketing expense increased to 24.3% in the fiscal year ended February 28, 1998 from 18.8% in the fiscal year ended February 28, 1997. These increases resulted from additional expense incurred due to significantly increasing the number of sales and marketing personnel, increased costs attributable to cooperative marketing arrangements with distributors, and higher advertising and tradeshows costs. 29 RESEARCH AND DEVELOPMENT EXPENSE Research and development expense increased 177.6% to $0.9 million in the year ended February 28, 1998 from $0.3 million in the year ended February 28, 1997. As a percentage of total revenue, research and development expense increased to 17.5% in the fiscal year ended February 28, 1998 from 12.5% in the fiscal year ended February 28, 1997. These increases in research and development expense were primarily due to the addition of software engineering and development personnel in the fiscal year ended February 28, 1998. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense increased 51.8% to $0.8 million in the fiscal year ended February 28, 1998 from $0.5 million in the fiscal year ended February 28, 1997. The increase in general and administrative expense resulted from the growth in the number of general and administrative personnel. As a percentage of total revenue, general and administrative expense decreased to 15.5% in the fiscal year ended February 28, 1998 from 20.2% in the fiscal year ended February 28, 1997. This decrease was due to total revenue increasing at a higher rate than general and administrative expense. OTHER INCOME (EXPENSE), NET Other income (expense), net increased to income of $22,000 in the fiscal year ended February 28, 1998 from expense of $23,000 in the fiscal year ended February 28, 1997. This increase in other income (expense), net was due to an increase in interest income resulting from higher average balances of cash and cash equivalents and short-term investments and lower interest expense on our notes payable which were repaid during the fiscal year ended February 28, 1997. PROVISION FOR INCOME TAXES Provision for income taxes increased to a provision of $5,000 in the fiscal year ended February 28, 1998 from zero in the fiscal year ended February 28, 1997. For fiscal years ended February 28, 1998 and 1997, a full valuation allowance was provided against net deferred tax assets due to uncertainty of realization. QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited quarterly statement of operations data for each of the four quarters in the period ended February 28, 1999. This information has been derived from unaudited interim financial statements that, in the opinion of management, have been prepared on a basis consistent with the financial statements contained elsewhere in this prospectus and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial information for the periods presented. This information should be read in conjunction with the financial statements and notes thereto included elsewhere in this prospectus. 30
THREE MONTHS ENDED -------------------------------------------------- MAY 31, AUG. 31, NOV. 30, FEB. 28, 1998 1998 1998 1999 ----------- ----------- ----------- ----------- (IN THOUSANDS, UNAUDITED) Revenue: Software and related products........................................ $ 1,374 $ 2,167 $ 2,964 $ 3,508 Services and other................................................... 177 71 360 169 ----------- ----------- ----------- ----------- Total revenue...................................................... 1,551 2,238 3,324 3,677 ----------- ----------- ----------- ----------- Cost of revenue: Software and related products........................................ 683 785 1,179 1,366 Services and other................................................... -- -- -- 28 ----------- ----------- ----------- ----------- Total cost of revenue.............................................. 683 785 1,179 1,394 ----------- ----------- ----------- ----------- Gross profit....................................................... 868 1,453 2,145 2,283 ----------- ----------- ----------- ----------- Operating expense: Sales and marketing.................................................. 382 482 781 1,438 Research and development............................................. 341 458 624 797 General and administrative........................................... 214 331 502 437 ----------- ----------- ----------- ----------- Total operating expense............................................ 937 1,271 1,907 2,672 ----------- ----------- ----------- ----------- Income (loss) from operations.......................................... (69) 182 238 (389) ----------- ----------- ----------- ----------- Other income (expense), net............................................ 15 13 34 100 ----------- ----------- ----------- ----------- Income (loss) before income taxes...................................... (54) 195 272 (289) Provision for income taxes............................................. -- 62 153 -- ----------- ----------- ----------- ----------- Net income (loss)...................................................... (54) 133 119 (289) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Accretion on mandatorily redeemable preferred stock.................... -- -- (16) (23) ----------- ----------- ----------- ----------- Net income (loss) available to common stockholders..................... $ (54) $ 133 $ 103 $ (312) ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
The operating results for any quarter are not necessarily indicative of the operating results for any future period. In particular, due to our limited operating history and the unpredictability of our industry, our revenue and net income may fluctuate significantly from quarter to quarter and are difficult to forecast. We base our current and future expense levels in part on our estimates of future revenue. Our expenses are to a large extent fixed in the short term. We may not be able to adjust our spending quickly if our revenue falls short of our expectations. Accordingly, a revenue shortfall in a particular quarter would have a disproportionate adverse effect on our net income for that quarter. Furthermore, we may make pricing, purchasing, service, marketing, acquisition or financing decisions that could adversely affect our business, operating results and financial condition. Our quarterly operating results will fluctuate for many reasons, including: - our ability to retain existing customers, attract new customers and satisfy our customers' demand; - changes in gross margins of our current and future products and services; - the timing of our release of upgrade versions of our products; - introduction of new products and services by us or our competitors; - changes in the market acceptance of Linux-based operating systems; - changes in the usage of the Internet and online services; - timing of upgrades and developments in the Linux kernel and other open source software products; - the effects of acquisitions and other business combinations, including one-time charges, goodwill amortization and integration expenses or difficulties; and - technical difficulties or system downtime affecting the Internet or our Web site. For these reasons, you should not rely on period-to-period comparisons of our financial 31 results to forecast our future performance. Our future operating results may fall below expectations of securities analysts or investors, which would likely cause the trading price of our common stock to decline significantly. LIQUIDITY AND CAPITAL RESOURCES We have historically derived a significant portion of our liquidity and operating capital from sales of preferred stock and from cash flow from operations. At February 28, 1999, cash and cash equivalents totaled $10.0 million, an increase of $8.7 million as compared to February 28, 1998. The increase in cash and cash equivalents resulted primarily from $1.2 million in cash generated by operations and $10.1 million of net proceeds from issuance of preferred stock during the fiscal year ended February 28, 1999. These amounts were partially offset by $1.9 million of cash used to purchase short-term debt securities, net of maturities, and $0.7 million of additions to property and equipment. Cash generated by operations of $1.2 million for the fiscal year ended February 28, 1999 resulted primarily from an increase in accounts payable and accrued liabilities of $1.5 million and net noncash charges to income of $0.6 million partially offset by our net loss of $0.1 million and an increase in accounts receivable of $0.6 million. Cash used in investing activities of $2.5 million was used to purchase $1.8 million of short-term debt securities, net of maturities, and office and computer equipment totaling $0.7 million. Cash from financing activities totaled $10.1 million in the fiscal year ended February 28, 1999 as a result of $6.9 million in net proceeds received from sales of Series B preferred stock in September 1998 and $3.2 million in net proceeds received from sales of Series C preferred stock in February 1999. We received an additional $3.2 million in net proceeds from the sale of Series C preferred stock subsequent to February 28, 1999. We have experienced a substantial increase in our operating expenses since our inception in connection with the growth of our operations and staffing and the expansion of our services operation and Web site. We anticipate that this will continue for the foreseeable future. Additionally, we will continue to evaluate possible investments in businesses, products and technologies, and plan to expand our sales and marketing programs and conduct more aggressive brand promotions. We believe that the net proceeds from this offering, together with our cash and cash equivalents and short-term investments, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for the foreseeable future. If cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or to obtain a credit facility. The sale of additional equity or debt securities; if convertible could result in additional dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations. We cannot guarantee that financing will be available in amounts or on terms acceptable to us, if at all. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. As issued, SFAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999, with earlier application encouraged. In May 1999, the FASB delayed the effective date of SFAS 133 for one year, to fiscal years beginning after June 15, 2000. We do not currently nor do we intend in the future to use derivative instruments and therefore do 32 not expect that the adoption of SFAS 133 will have any impact on our financial position or results of operations. In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants ("AICPA"), issued Statement of Position No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP No. 98-1"), which provides guidance regarding when software developed or obtained for internal use should be capitalized. SOP No. 98-1 is effective for transactions entered into in fiscal years beginning after December 15, 1998. We do not expect that the adoption of SOP No. 98-1 will have a material impact on our financial position or results of operations. In December 1998, the AICPA issued Statement of Position No. 98-9, "Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions" ("SOP No. 98-9"). SOP No. 98-9 amends SOP No. 97-2 to require recognition of revenue using the "residual method" in circumstances outlined in the SOP. Under the residual method, revenue is recognized as follows: - the total fair value of undelivered elements, as indicated by vendor specific objective evidence is deferred and subsequently recognized in accordance with the relevant sections of SOP No. 97-2; and - the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements. SOP No. 98-9 is effective for transactions entered into in fiscal years beginning after March 15, 1999. Also, the provisions of SOP No. 97-2 that were deferred by SOP No. 98-4 will continue to be deferred until the date SOP No. 98-9 becomes effective. The Company does not expect that the adoption of SOP No. 98-9 will have a significant impact on our results of operations or financial position. YEAR 2000 COMPLIANCE The "Year 2000 Issue" refers generally to the problems that some software may have in determining the correct century for the year. For example, software and computer systems with date-sensitive functions that are not Year 2000 compliant may not be able to distinguish whether "00" means 1900 or 2000, which may result in failures or the creation of erroneous results. We have defined "Year 2000 compliant" as the ability to: - correctly handle date information needed for the December 31, 1999 to January 1, 2000 date change; - function according to the product documentation provided for this date change, without changes in operation resulting from the advent of a new century, assuming correct configuration; - where appropriate, respond to two-digit date input in a way that resolves the ambiguity as to century in a disclosed, defined, and predetermined manner; - if the date elements in interfaces and data storage specify the century, store and provide output of date information in ways that are unambiguous as to century; and - recognize the year 2000 as a leap year. In November 1998, we formed a committee consisting of our Chief Financial Officer, our controller, a financial analyst and a systems administrator, as part of our effort to perform a coordinated audit of: - our products; - the software components and applications with which our products are bundled; and - the systems upon which we rely for our internal operations. 33 PRODUCTS The committee has tested Version 4.2 and later versions of Red Hat Linux by accelerating the date within these software programs to December 31, 1999 and observing which software components failed as the date changed to January 1, 2000. In addition, we recently hired an independent contractor to test Versions 5.2 and 6.0 of Red Hat Linux for Year 2000 readiness. We expect this testing to be complete by June 30, 1999. If it is determined that older versions of Red Hat Linux are not Year 2000 compliant, we plan to recommend that users of such products download Version 6.0 of Red Hat Linux from our Web site for free. We have not yet generated a contingency plan if Version 6.0 is found not to be Year 2000 compliant. We believe, however, that we have the resources, either in-house or within the open source community, to quickly remedy any non-compliant products. If it is necessary to remedy problems related to the Year 2000 issue, such efforts could otherwise divert our resources from pursuing our business strategy. In addition, known or unknown errors or defects in our products could result in delay or loss of revenue, diversion of development resources, damage to our reputation, or increased service and warranty costs, any of which could materially adversely affect our business, operating results or financial condition. Furthermore, some commentators have predicted significant litigation regarding Year 2000 compliance issues, and we are aware of such claims and actions against other software vendors. Because of the unprecedented nature of this litigation, it is uncertain whether or to what extent we may be affected by it. THIRD-PARTY PRODUCTS We bundle third-party applications and software components with Official Red Hat Linux. To date, the committee has made no assessment of and has no knowledge of third party Year 2000 readiness. We intend to contact these third parties and remedy problems on a case-by-case basis, as we deem appropriate. Accordingly, it is possible that some of our customers may experience difficulties related to third-party software, which may affect the performance of our products and may lead to adverse results such as an unusually high number of calls to our technical support department or other unusual requests for information or assistance. Although we do not anticipate that the costs related to responding to any increased volume of support or other calls will be material, responding to these calls may divert resources from pursuing our business strategy. Moreover, failure of applications bundled with our software may reduce the value of our products, decrease or delay revenues, tarnish our brand, give rise to breach of warranty claims or divert resources, any of which could materially adversely affect our business, results of operations and financial condition. INTERNAL SYSTEMS We are in the process of identifying and evaluating the Year 2000 compliance of systems upon which we rely for internal operations such as our computer hardware, software, Web server and other related equipment and systems, such as phone systems and security systems. We are presently unable to estimate the costs involved in making our internal systems Year 2000 compliant, although we do not expect such costs to have a material adverse affect on our business, results of operations and financial condition. We have recently installed new financial application software that has been certified as Year 2000 compliant. We use Red Hat Linux and its bundled applications for our internal operations. Our hardware is mostly new, but if our desktop stations malfunction, we plan to replace them. We do not expect to incur material costs to replace any such defective hardware. The majority of non-information technology systems on which we rely for our internal operations are owned and managed by the lessor of our office building, who has indicated that the offices are Year 2000 compliant. In addition, the owners of the facility in Herndon, Virginia, which houses substantially all of our communications hardware and our other computer hardware 34 operations related to our Web site, have certified to us that all of their systems and facilities are Year 2000 compliant. CONTINGENCY PLANS AND EXPECTED COSTS The committee is in the process of developing further checklists of software applications to test and systems upon which we rely and, as we deem appropriate, we will seek certification documents from the developers and providers regarding Year 2000 compliance of their systems and products. The committee will develop contingency plans based on the responses regarding its critical systems that it receives, or does not receive, from its providers and developers. We presently expect that we will complete this effort in the fall of 1999. To date, we have not expended a material amount of capital resources on Year 2000 compliance and do not anticipate future expenditures to be material to our business, results of operations and financial condition. We have not hired additional personnel or made material purchases of products to specifically address our Year 2000 compliance issues, and presently, we do not expect to do so. The expenditures to date relate primarily to on-going salary costs of personnel, including committee members, participating at various levels in our compliance efforts, as well as payments to the third-party tester of our software which will be approximately $30,000. All costs related to achieving Year 2000 readiness are being expensed as incurred. 35 BUSINESS RED HAT We are a leading developer and provider of open source software and services, including the Red Hat Linux operating system. Our Web site, REDHAT.COM, is a leading online source of information and news about open source software and one of the largest online communities of open source software users and developers. In addition to offering extensive content for the open source community, REDHAT.COM serves as an important forum for open source software development and offers software downloads and a shopping site. Our broad range of professional services includes custom development and consulting, technical support, training and education and hardware certification. We are committed to serving the interests and needs of open source software users and developers and to sharing all of our product developments with the open source community. INDUSTRY BACKGROUND IMPACT OF THE INTERNET The Internet has emerged as a global communications medium, enabling millions of people to gather information, communicate and conduct business electronically. International Data Corporation estimates that there were approximately 142 million users of the Internet at the end of 1998 and that the number of users will grow to almost 400 million by the end of 2002. In addition, IDC estimates that worldwide Internet commerce revenue will increase from approximately $50 billion in 1998 to more than $730 billion in 2002. The Internet's ability to empower customers, reduce transaction costs and product development times and accelerate the pace of business transactions has dramatically transformed the competitive landscape of a wide range of industries. The Internet provides customers with a broader selection, increased purchasing power and unparalleled convenience while enabling businesses to reach a global audience, increase economies of scale and operate with minimal infrastructure. The Internet has facilitated the emergence of new competitors and is increasingly affecting the methods by which incumbent competitors sell goods and services and manage relationships with customers. For example, in the software industry, the Internet is profoundly changing the way that software is developed and distributed. The Internet has enabled multiple groups of developers to collaborate on specific projects from remote locations around the globe. Developers can write code alone or in groups, make their code available over the Internet, give and receive comments on other developers' code and modify it accordingly. The Internet has also provided an avenue not only for less expensive and speedier delivery of code, but also for support and other online services. OPEN SOURCE SOFTWARE MOVEMENT The Internet has accelerated the development of open source software. Open source software has its origins in the academic and research environments and is based on an open, collaborative approach to the development and distribution of software. The growth of the Internet has greatly increased the scale and efficiency of open source development through the availability of collaborative technologies such as e-mail lists, news groups and Web sites. These technologies have enabled increasingly large communities of independent developers to collaborate on more complex open source projects. An early example of open source development is the X Windows system, a graphical user interface developed by the X Consortium. The members of the X Consortium, originally Digital, Hewlett-Packard, IBM and Sun Microsystems, wanted a common user interface for their own proprietary operating systems. By openly sharing development ideas and coding efforts, these companies were able to quickly and cost-effectively develop a superior user interface, which we estimate is currently 36 installed on more than 20 million computers worldwide. Open source software has emerged as a viable alternative to traditional proprietary software. Under the proprietary model of software development, a software developer generally licenses to the user only the object or binary code. Binary code consists of the 1s and 0s that only the computer understands. By contrast, under the open source development model, the software developer provides to the user access to both the binary code and the source code. Source code is the language used by the developers. The principal differentiating points of open source software include: - development process--open source software allows a company's in-house development team to collaborate with a community of independent developers; - license terms--under open source licenses, the user has access to both binary and source code, and the rights to copy, modify, alter and redistribute the software; and - shared improvements--under the open source model, the user has ongoing access to improvements made to the software by others. We believe open source software offers many potential benefits for software customers, users and vendors. Customers and users are able to acquire the software at little or no cost, install the software on as many computers as they wish, and customize the software to suit their particular needs. In addition, customers and users can obtain software updates, improvements and support from multiple vendors, reducing reliance on any single vendor. Vendors are able to leverage the community of open source developers, allowing them to reduce development costs and decrease their time to market. Vendors are also able to distribute their products freely over the Internet, enabling them to create large global user bases quickly. Just as the open source model has benefited from the success of the Internet, it has also greatly contributed to the Internet's success. Open source software comprises much of the Internet's infrastructure, from domain name server software to Web servers and e-mail router software. Open source software is particularly well-suited to the Internet. With access to the source code, system administrators and developers can collaborate to debug, fix and optimally configure their software on a real-time basis. This enables them to improve performance and keep data flowing continually across the Internet, minimizing the disruptions and downtime common with proprietary software. The following examples demonstrate the prevalence of open source software on the Internet: - Apache Web server--based on code originally written at the National Center for Supercomputing Applications at the University of Illinois at Champaign-Urbana, is the most common Web server in use today according to a survey conducted by Netcraft. - Perl--the de facto standard scripting language for Apache servers. - Sendmail--the Internet's standard e-mail routing tool, which we believe handles a majority of the Internet's e-mail traffic. One of the better known open source products is the Linux kernel, the engine of Linux-based operating systems. An operating system is the software that allows a computer and its various hardware and software components to interact. An initial goal of the open source software movement was to develop an operating system that was better, faster and more reliable than the proprietary operating systems then available. Viewing UNIX as the best commercially-available operating system, the open source community decided to incorporate the best design ideas from UNIX. Open source developers rewrote all of the underlying source code so that it could not be controlled by a single corporation or individual. By the early 1990s, these efforts had resulted in a number of significant software initiatives but had fallen short of building a 37 complete operating system. Still missing from the project was the engine upon which the new operating system was to run, known as the kernel. In 1991, Linus Torvalds, a young Finnish developer, supplied a stable and powerful open source kernel, known as Linux, to run the operating system. Operating systems based on the Linux kernel are robust and dynamic. Thousands of developers worldwide continually collaborate on improving Linux-based operating systems and update them on a regular basis. Since 1991, the use of Linux-based operating systems has rapidly grown. According to IDC, Linux-based operating systems represented 17% of all new license shipments of server operating systems in 1998. Beginning in 1998, a number of major technology industry leaders, including IBM, Intel and Hewlett-Packard, announced support for Linux-based operating systems. The Linux kernel and the standards around which it is developed remain under the close supervision of Linus Torvalds and a small group of kernel developers working under his leadership. Some of the benefits enjoyed by users of Linux-based operating systems include: - reduced licensing costs; - flexibility resulting from access to and legal right to modify source code; - stability and high performance; - comprehensive Internet support; - compliance with standards; and - multi-platform capability. Despite a strong initial market acceptance of Linux-based operating systems and other open source products, there exists a number of obstacles to widespread adoption within the enterprise, including: - lack of service and support; - scarcity of applications supporting Linux-based operating systems; and - lack of well-financed, viable open source industry participants. The ability of a Linux-based operating system to penetrate large businesses on an enterprise-wide basis and to gain widespread acceptance as a viable alternative to operating systems developed under the proprietary software model, depends, in large part, on the emergence of a proven leader in the open source community. This open source leader must demonstrate to the business enterprise, as well as to the community of application developers upon whom the business enterprise relies, a successful business model and the ability to support and service its products at a consistently high level. THE RED HAT SOLUTION To address the challenges facing the open source software market, our products and services offer the following features and benefits: SUPERIOR OPEN SOURCE PRODUCT OFFERINGS We engineer what we believe to be the most technically advanced open source operating system, Red Hat Linux. Our software engineers collaborate with critical open source software development teams working across the Internet. This involvement enables us to remain abreast of technical advances, plans for development of new features and timing of releases, as well as other information related to the development of the Linux kernel and other open source projects. As a participant in these processes, we are able to react quickly to new developments and to contribute to the future direction of the Linux kernel and the open source development paradigm. We compile and integrate more than 640 separate software packages into Red Hat Linux, consisting of some of the most technically advanced software products available, including compilers and Web, e-mail, ftp and file servers. Red Hat Linux is: - flexible and scalable--capable of running a single desktop machine or the 38 entire network of a large business enterprise; - functional--able to handle discrete or multiple applications being accessed by multiple users; - adaptable--allowing the user to modify the software to meet particular needs and requirements; and - reliable--constantly monitored and fine-tuned by thousands of developers worldwide. These benefits have led many industry analysts to identify Red Hat Linux as a superior operating system. This recognition has accelerated the deployment of Red Hat Linux within the business enterprise. According to IDC, Red Hat Linux accounted for approximately 56% of new license shipments of Linux-based server operating systems in 1998, or roughly 9% of total new server license shipments. In addition to offering technically advanced products, we provide purchasers of our Official Red Hat Linux with extensive written documentation and limited installation support. Our team of technical writers works closely with our software development engineers to prepare manuals and other documentation that accurately and clearly describe the many features of Red Hat Linux and advise the user on how to exploit these features. In addition, we make Red Hat Linux available to users via free download from our Web site and other sites across the Internet. LEADING ONLINE DESTINATION FOR THE OPEN SOURCE COMMUNITY We have established our Web site as a leading online destination related to the open source movement. We are dedicated to serving the interests and needs of open source software users and developers online. Our Web site is a comprehensive resource for the latest information related to Linux and other open source projects. It contains news of interest to open source users and developers, features for the open source community, software updates and downloads, a shopping center for our shrink-wrapped products and support offerings, and a wealth of technical information related to open source products, including Red Hat Linux. Visitors to our site can organize and participate in user groups, make available bug fixes and incremental code improvements and share knowledge regarding the use and development of open source software. Our Web site had more than 265,000 unique visitors and approximately 2.5 million page views during March 1999. By acting as a clearinghouse of open source and Linux-related information, and facilitating the interaction of developers, businesses and technology enthusiasts, our Web site has become a community center for the open source movement. COMMITMENT TO THE OPEN SOURCE MODEL Red Hat has fully embraced the open source model. Whereas others have incorporated certain aspects of the open source software model into their businesses while retaining various features of the proprietary model, our product offerings are true open source offerings. We share all of our developments on and improvements to the Linux kernel and other open source products with the development community. In this way, we benefit independent developers by making our products more useful for them in their own development projects. In addition, we have aggressively promoted and distributed our products in the marketplace by making them available free of charge by download from our Web site and other Internet sites worldwide, by issuing thousands of free CD-ROMs containing Red Hat Linux at trade shows and through direct mailing campaigns, and by providing copies to academic and research institutions. Furthermore, in addition to the open source software we develop ourselves, we fund a broad range of open source software projects and organizations, including the XFree86 group, the linuxconf open source software product, and the Free Software Foundation. 39 EXTENSIVE PROFESSIONAL SERVICES We also offer a broad range of professional services relating to the development and use of open source products. These services include technical support, custom development, consulting, training, education and hardware certification. By servicing Red Hat Linux, we provide our customers and the open source community with a respected and reliable technology partner, one that is available to help with the purchase, deployment, customization and maintenance of open source software solutions. We believe that providing these services and establishing ourselves as our customers' technology development partner will allow us to facilitate the widespread adoption of Red Hat Linux as a full scale enterprise solution. STRATEGIC ALLIANCES In an effort to increase the market acceptance of open source software in general, and the Red Hat Linux operating system in particular, we have established development, marketing or distribution relationships with leading technology companies, including Compaq, Dell, Hewlett-Packard, IBM, Intel, Novell, Oracle and SAP. In addition, we share our development efforts with and commit resources to third party developers and vendors in order to expand the number of applications available for Linux-based operating systems. By establishing and maintaining these relationships, we are able to increase market awareness of open source software, gather industry support for our products and penetrate new markets. STRATEGY Our objective is to enhance our position as a leading worldwide developer and provider of advanced, open source products and services, both via traditional channels and the Internet. The key elements of our strategy are: CONTINUE TO ENHANCE OUR WEB SITE We are continuing to enhance our Web site in an effort to create the definitive online destination for open source software products, software updates, news, and other information related to Linux-based operating systems and other open source projects, and to provide advertisers with a large and technically sophisticated audience. At REDHAT.COM, people from around the world will be able to obtain updates to open source software, purchase a wide array of open source products and services, access and copy code for their own programming efforts, read news related to topics of interest to the community and interact with other community members. New features we anticipate adding to our Web site include: - software update notification; - automatic software updating for those who want it; - registries and hosting of open source Web sites and projects; - open source classifieds (including products for sale and employment listings); - event calendars; and - virtual trade shows. By adding these features to our Web site, we believe that our visitors will continue to visit on a regular basis, and that we will attract an increasing number of new visitors. In addition, we believe that these new features and offerings will keep visitors on our site for longer periods of time, which we believe will be crucial to our ability to generate significant advertising revenue. EXPAND SERVICE CAPABILITIES TO ADDRESS THE ENTERPRISE NEEDS OF LARGE CORPORATIONS We believe that we must expand our services capabilities to address the market need for quality custom engineering and development. We are currently expanding our professional services organization to enhance our ability to provide such services. Between March 1, 1998 and May 31, 1999 we added 22 people to our professional services organization. We believe that as our user base grows, more of our customers, particularly our larger customers, will look to us to help them 40 customize their operating systems to perform optimally within their particular computing environments. We expect that many of our larger customers will also expect us to assume the role of their technology partner, and perform on-site consulting services such as large-scale system assessments and enterprise-wide system enhancements. We believe that by increasing our capacity to offer such services, we will be able to significantly increase our services revenue and establish ourselves as the premier open source service provider. INCREASE MARKET ACCEPTANCE OF OPEN SOURCE SOFTWARE Although recent years have seen a substantial increase in the market acceptance of Linux-based operating systems and other open source software, we intend to promote further acceptance of open source software through a variety of means, including strengthening our existing alliances with other information technology companies and by establishing new alliances. The strength of these alliances is crucial to the expansion of the open source community, the technical advancement and widespread distribution of open source products and the development of third party applications suitable for Linux-based operating systems. By aligning ourselves with companies widely regarded as producing high quality and highly reliable software developed under the traditional software development model, we expect to bridge the gap between the open source community and those customers who are currently skeptical or unaware of the benefits of open source software. We believe that by continuing to collaborate with industry-leading information technology companies, we will be able to further improve the performance and features of Red Hat Linux and other open source software products. Although we intend to increase our own engineering and development efforts, we believe that by entering into and maintaining strategic relationships with other market-leading companies, we will ensure that Red Hat Linux continues to develop technically, and that such development is compatible with the technological innovations of other key vendors in our industry. By entering into additional strategic distribution relationships with major distributors, retail outlets, OEMs, and VARs worldwide, we intend to make Red Hat Linux and other open source products more widely available. In addition, we expect to continue to share our development efforts with and commit additional resources to applications developers and vendors in an effort to increase the third party applications offerings that will run on Red Hat Linux. Third party applications currently available for Linux-based operating systems include desktop office productivity tools from Applix, Corel and Star Division and enterprise software applications from IBM, Oracle and SAP. Additional means of increasing the market acceptance for Linux-based operating systems and other open source software include expanding our international presence, broadening our services offerings, and publicizing success stories. While we have a significant installed base of international users, we intend to increase our overseas presence in the near future by establishing foreign offices or subsidiaries. In addition, we intend to expand our services offerings, including training, consulting and related services that customers have come to expect from information technology providers, which will increase their confidence in open source products and providers. Finally, we will continue to publicize, to the extent possible, success stories of customers who have found open source products to be more valuable than restrictive, proprietary products. CONTINUE TO INVEST IN THE DEVELOPMENT OF OPEN SOURCE TECHNOLOGY We intend to continue to invest significant resources in the development of new open source technology, capitalizing on our extensive experience working within the open source model. We expect this continued investment to take the form of increased expenditures on internal development efforts, 41 including our Red Hat Advanced Development Laboratory, as well as continued funding of third party open source projects. We also plan to continue our financial support of the development efforts of many of the top-tier engineers in the open source community. In particular, we are currently exploring the possibility of establishing a foundation to support the development of open source software. We would fund this foundation with cash, stock or a combination thereof. This support will be directed towards an array of projects, ranging from the development of ease of use features, which we believe will take Red Hat Linux from the server to the desktop, to the design of new networking and scalability features, which are expected to make Red Hat Linux more attractive as a server operating system. We expect that, through these efforts, we will be able not only to foster the advancement of open source technology, but also to enhance and maintain our relationships within the open source community. MAINTAIN AND CONTINUE TO ENHANCE RED HAT BRAND We believe that continuing to build the Red Hat brand is vital to the expansion of our customer base and the maintenance of the energy of the current open source community. We intend to continue to aggressively promote our Web site as the definitive source for open source products, services, resources and other information. Another component of our brand enhancement strategy is to expand our use of aggressive public relations campaigns by continuing to work with the media to educate the public on the benefits of open source software. In addition, we expect to continue our pursuit of tightly-focused advertising campaigns, both in computer related publications and in general purpose media, in order to attract new users to Red Hat Linux and open source software. Moreover, we also intend to continue to devote substantial engineering resources to open source development projects and to otherwise demonstrate our commitment to the open source philosophy. Through these measures, we intend to build the Red Hat brand into the preeminent symbol of quality for open source software. PRODUCTS AND SERVICES We are a leading provider of open source software products and services. Our product offerings include Red Hat Linux and related tools, documentation, manuals and general merchandise. Our professional services offerings, principally directed towards our larger corporate customers and strategic partners, include technical support, training and education, consulting and custom development and hardware certification. RED HAT LINUX AND RELATED SOFTWARE OFFICIAL RED HAT LINUX 6.0. Official Red Hat Linux is our principal product. We first released Official Red Hat Linux in October 1994, and began shipping the latest release, Version 6.0, in May 1999. Official Red Hat Linux is available for the Intel, Sun SPARC and Compaq Alpha platforms. Official Red Hat Linux provides everything the user needs to perform a wide variety of server functions, including setting-up a Web, e-mail, file or print server as well as using his computer as a general purpose desktop workstation to perform virtually any computing function. Official Red Hat Linux comes with a number of third party applications including office productivity and e-commerce applications, as well as comprehensive user manuals and limited installation support. The suggested retail price for Official Red Hat Linux is $79.95. Examples of the components included within the 573 megabytes of code that comprise Red Hat Linux 6.0 are: 42
COMPONENT FUNCTION - --------------------------------------------- --------------------------------------------- Linux Kernel (Version 2.2)................... Core of the operating system X Windows System............................. Graphical layer Gnome........................................ Graphical desktop user interface Gtx.......................................... Graphical development libraries Netscape Communicator........................ Web browser Apache....................................... Web server Sendmail..................................... E-mail routing software Perl......................................... High-level programming language Efax......................................... Fax utility Pilot Link................................... Palm Pilot-Registered Trademark- synchronization Gnome PIM.................................... Personal Information Manager Howto Greek (and other languages)............ Help files translated into Greek RPM.......................................... Manages the various software packages All other components......................... Libraries, tools, games and other integrated applications
RED HAT POWERTOOLS: Red Hat Powertools is a collection of open source tools and applications that run on top of Red Hat Linux. The suggested retail price for Powertools is $39.95. RED HAT LINUX CORE: Red Hat Linux Core, consisting of Official Red Hat Linux 6.0 and the Official Red Hat Linux Installation Guide, is designed for developers and experienced users of Linux-based operating systems. Red Hat Linux Core does not include installation support or third party applications. The suggested retail price for Red Hat Linux Core is $39.95. EXTREME LINUX: Extreme Linux, popular among students and researchers, is designed to run on multiple computers using parallel processing. The open source software included in this product was developed in part by the National Aeronautics and Space Administration (NASA). Extreme Linux does not include user manuals or installation support. The suggested retail price for Extreme Linux is $29.95. RED HAT SECURE WEB SERVER: Red Hat Secure Web Server combines the Apache open source Web server with certain cryptography software we licensed from RSA Data Security, Inc. to create a secure Web server suitable for conducting secure transactions via the Internet. Red Hat Secure Web Server won a "Best of Show" award at the 1998 Networld + Interop conference. Red Hat Secure Web Server cannot be downloaded from our Web site and is available only in the U.S. and Canada due to export controls on encryption software. The suggested retail price for Secure Web Server is $99.95. Our products are generally also available for free download via the Internet from REDHAT.COM and other Web sites worldwide. We encourage our customers to download Red Hat Linux and our other software products. By allowing users to download our software free of charge, we are able to strengthen the Red Hat brand and increase our installed base of users, at no incremental cost to us. Customers who obtain Red Hat Linux in this way receive substantially the same operating system software as is included in our shrink-wrapped packages, but do not receive installation support, documentation and other additional features. REDHAT.COM We have 20 professionals focused on the development and maintenance of our REDHAT.COM Web site. REDHAT.COM offers users access to broad and authoritative content on open source software including news, documentation, educational materials and case studies. This content is directed at a wide spectrum of open source software users, from 43 system administrators to developers to academics. We also offer extensive features for the open source community, software updates and downloads and a shopping center for our shrink-wrapped products and support offerings. We intend to also offer the following benefits via our Web site to our partners and users: - Personalization: users will be able to register on the site and select custom presentations of information that are specifically tailored to their needs. These presentations, which will be known as MY.REDHAT.COM, will filter news and information (according to user-specified criteria), promote various features of the site likely to be of interest to a specific user and notify the user by e-mail of new content and upgrades. - Advertising and Sponsorships: the REDHAT.COM audience is highly focused and technically sophisticated, representing an attractive target market of computing professionals for advertisers. We offer a number of advertising and sponsorship programs to our partners and others wanting to reach this market. - Content Subscriptions: we intend to make special market reports and data and access to real-time support available to our users on an annual subscription basis. By subscribing to our site, our customers will also be able to purchase additional features and services such as online training and certification and remote software maintenance packages. - Commerce: we intend to build the REDHAT.COM store into the most comprehensive open source shopping resource for corporate enterprise buyers. Offerings and upsell opportunities will be presented throughout the site in a context-relevant manner. - Licensing: we intend to license our content to other content providers, thereby generating additional traffic, extending the Red Hat brand and increasing revenue. PROFESSIONAL SERVICES Although we have not generated significant revenue to date from our professional services, we have recently significantly expanded the scope of our service offerings and expect them to generate significant revenue in the future. SUPPORT AND MAINTENANCE. Customers who purchase our Official Red Hat Linux Version 6.0 product are entitled to 30 days of telephone installation support or 90 days of e-mail installation support at no additional charge. Customers seeking additional technical support may purchase telephone support agreements from us ranging in price from $995 for up to three incidents to $60,000 for 24 hour a day unlimited support for one year. We have a highly-trained and skilled staff of technical support engineers to provide these services to our customers. In addition, we maintain relationships with several third party support providers in order to enhance and expand our technical support capabilities. TRAINING AND EDUCATION. We provide training and educational programs to those customers who want to learn how to optimize their use of Red Hat Linux. The most popular of these programs is the "Red Hat Certified Engineer" course that we offer at our corporate offices. This week-long course, taught by Red Hat instructors and priced at approximately $2,500, gives a comprehensive overview of the use of Red Hat Linux. We also conduct on-site training for customers. We anticipate that we will work with third party training and educational program providers to develop and offer additional training courses on a variety of topics related to Red Hat Linux and open source software. CONSULTING AND CUSTOM DEVELOPMENT. We offer specific consulting and custom development services on an individualized basis. We have performed such services related to the optimization of Red Hat Linux when used in conjunction with certain 44 hardware products. We intend to expand our consulting and custom development capabilities in the near future. HARDWARE CERTIFICATION. We perform testing and certification services for hardware vendors seeking to market their products to Red Hat Linux users. Hardware vendors submit their products to us and, in exchange for a fee, we test the hardware to determine whether it is compatible with Red Hat Linux. Products meeting our performance criteria are certified as Red Hat Linux compatible. Companies for which we have performed such services include Dell, IBM and Toshiba. PRODUCT AWARDS Official Red Hat Linux has won numerous awards, including: - Operating System Product of the Year, InfoWorld magazine, 1996, 1997 and 1998 - Product Excellence Award, SD Magazine, May 1999 - "Jolt" Productivity Award, Software Development Conference, 1997 and 1998 - Reader's Choice Award, Linux Journal, 1998 - Best Linux Distribution, Australian Personal Computing Magazine, 1998 - Environment/Desktop finalist, Ziff-Davis European Excellence awards, 1997 - Editor's Choice Award, Australian Personal Computing Magazine, 1998 PRODUCTION AND FULFILLMENT We outsource the production, packaging and order fulfillment of our products to third parties when it is cost effective to do so. To the extent possible, we limit our internal production activities to such tasks as quality inspection and testing. We currently have production arrangements with JVC Disc America Co., Webcom, Inc., and Brightstar Services and order fulfillment arrangements with JVC. We believe that our existing production arrangements are sufficient to accommodate potential increases in sales volume for the foreseeable future. 45 CUSTOMERS AND APPLICATIONS CUSTOMERS Our customers range from individuals using our products for a wide variety of personal and professional purposes to multinational Fortune 500 companies, government agencies, and research and academic institutions. The following is a partial list of our customers:
CORPORATE GOVERNMENT RESEARCH / ACADEMIC - --------------------------- ------------------------ ------------------------- Angelfire.com Canadian Department of Carnegie Mellon University Boeing Human Resources Burlington Coat Factory Cern Laboratories Cisco Systems City of Garden Grove, CA Deutsche Bank Fermi National Accelerator Digital Domain Internal Revenue Service Laboratory Global One Google.com NASA Harvard-Smithsonian GTE Astrophysical Observatory Hewlett-Packard Waco Public Schools Hughes Telecommunications University of North Carolina IKEA Intel University of Rochester Nationwide Insurance New York Life Nortel Southwestern Bell Suzuki
The following case studies describe the manner in which some of our customers employ our products: - Angelfire.com provides free Web hosting services to thousands of customers who generate millions of page views each day. Angelfire.com runs all of its Web servers on Red Hat Linux and was the fastest growing Web site, measured by number of unique users, during the period from December 1997 to June 1998, according to Media Metrix. - Cisco Systems relies on Red Hat Linux to run 100 networked printer servers which are connected to 3,000 printers and support the network's 20,000 users. - Burlington Coat Factory runs Red Hat Linux on 1,250 customized Dell OptiPlex PCs with Oracle databases in its 264 stores nationwide. The PCs administer Baby Registry, Burlington's service to register baby gifts, and facilitate back office functions, such as shipping and receiving. - Garden Grove, California, a city with a population of 153,000, runs its government and public services entirely on Red Hat Linux. Since 1994, Garden Grove has not had a computer-related interruption in service for any department, including its police department. THIRD PARTY APPLICATIONS Some of the third party applications that are included in Red Hat Linux are: - Apache Web Server; - Netscape Navigator and Communicator Internet browsers; - ftp servers; - e-mail routing software; 46 - GNU C and C++ compilers and debugger; - editors; - databases; and - games. Some of the stand-alone third party applications that are currently available to users of Linux-based operating systems are: - Oracle, Informix and IBM databases; - Computer Associates UNICENTER network control software; - Lotus Domino Notes Server; - Corel WordPerfect; - Applixware Office Suite; - Star Office Suite; - NEXS Spreadsheet; and - MetroWerks Rapid Application Development tools. SALES, MARKETING AND DISTRIBUTION SOFTWARE PRODUCTS AND SERVICES We sell our products and services worldwide through direct marketing and telesales campaigns and our Web site, and indirectly through our distributors, retailers, catalogs and OEMs. Our direct sales force of eight individuals as of May 31, 1999, is dedicated to increasing worldwide sales through our retail, distribution and OEM channels. As of May 31, 1999, our indirect distribution channel was composed of five distributors, over 500 retailers and 11 OEMs. We have recently begun to focus our sales efforts more aggressively on the business enterprise market. Our two largest distributors are Ingram Micro and Frank Kasper & Associates. Ingram Micro, which began distributing our products during the fiscal year ended February 28, 1999, accounted for approximately 34% of our total revenue during that fiscal year. Frank Kasper & Associates accounted for approximately 26% of our total revenue for the fiscal year ended February 28, 1998 and 20% for the fiscal year ended February 28, 1999. Our OEM agreements generally license the OEMs to include Red Hat Linux with their own products in exchange for royalty payments to us. We currently have OEM agreements in place with Dell, ASL Workstations, CPU Micromart and others. Our agreements with our distributors and OEMs typically are not exclusive, have no stated minimum purchase or license obligations and may be terminated by either party without cause. We believe that in the event of the termination of our relationship with one or more of our indirect channel partners, we could enter into replacement agreements with new partners. However, the failure to replace these partners with distributors or OEMs of equal marketing capabilities and reputation could have a material adverse effect on our business, operating results and financial condition. Our marketing efforts support our sales and distribution efforts through participation in industry trade shows, targeted advertising, channel sales programs, public relations campaigns, retail promotions, customer surveys and the promotion of our products through our Web site. In addition, we have entered into joint marketing relationships with Compaq, IBM, Intel and Oracle, among others. Furthermore, we offer our software products for free download from REDHAT.COM and other Internet sites worldwide. REDHAT.COM We have a team of professionals dedicated to selling advertising on our Web site. Though these sales have been insignificant to date, we expect to generate significant revenue from the sale of advertising and sponsorships in the future. COMPETITION In the broader market for operating systems, we compete with a limited number of large and well-established companies that have significantly greater financial resources, 47 larger development staffs and more extensive marketing and distribution capabilities. These competitors include Microsoft, Novell, IBM, Sun Microsystems and The Santa Cruz Operation, all of which offer hardware-independent multi-user operating systems for Intel platforms, and AT&T, Compaq, Hewlett-Packard, Olivetti and Unisys, each of which, together with IBM and Sun Microsystems, offers its own version of the UNIX operating system. Many of these competitors bundle competitive operating systems with their own hardware offerings, thereby making it more difficult for us to penetrate their customer bases. In the newer and rapidly evolving Linux-based operating system market, we compete with a number of well-respected vendors and development projects. These competitors have established and stable customer bases and continue to attract new customers. We also compete for services revenue with a number of companies that provide technical support and other professional services to users of Linux-based operating systems, including some of our OEMs. Many of these companies have larger and more experienced services organizations than we do currently. In addition, we face potential competition from several companies with larger customer bases and greater financial resources and name recognition than we have, such as Sun Microsystems, Corel Corp. and Cygnus Solutions, each of which has indicated a growing interest in the Linux-based operating systems market. The Linux-based operating systems market is not characterized by the traditional barriers to entry that are found in most other markets, due to the open source nature of our products. For example, anyone can copy, modify and redistribute Red Hat Linux themselves. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We believe that the major factors affecting the competitive landscape for our products include: - name and reputation of vendor; - product performance, functionality and price; - strength of relationships in the open source community; - availability of user applications; - ease of use; - networking capability; - breadth of hardware compatibility; - quality of support and customer services; - distribution strength; and - alliances with industry partners. Although we believe that we compete favorably with many of our competitors in a number of respects, including product performance, functionality and price, networking capability, and breadth of hardware compatibility, we believe that many of our competitors enjoy greater name recognition, have superior distribution capabilities and offer more extensive support services than we currently do. In addition, there are significantly more user applications available for competing operating systems, such as Windows NT and UNIX, than there are for Linux-based operating systems. An integral part of our strategy in the near future, however, is to address these shortcomings by, among other things, strengthening our existing strategic relationships and entering into new ones in an effort to enhance our name recognition, expand our distribution capabilities and attract more attention to the open source movement, which in turn should create additional incentives for software developers to write more applications for Red Hat Linux. In the market for advertising revenue, we will compete with other online content providers and traditional forms of media such as newspapers, magazines, radio and television. We believe that the principal competitive factors in attracting advertisers include the amount of traffic on REDHAT.COM, brand recognition, customer service and support, the demographics of our users and visitors, our ability to offer targeted audiences 48 and the overall cost-effectiveness of the advertising medium that we offer. SOFTWARE ENGINEERING AND DEVELOPMENT We have invested, and intend to continue to invest, significant resources in product and technology development. We focus and modify our product development efforts based on the needs of users and changes in the marketplace. We are currently focusing our development efforts on improving the Linux kernel, as well as commercializing our software innovations into new products and product enhancements that are easier to use and provide greater functionality. Our software engineers have contributed to the development and maintenance of some of the most important components of the Red Hat Linux operating system, including the installation program and the package management program. The installation program provides users with a single method to install the hundreds of separate software programs that are included with Red Hat Linux so that from the user's perspective, the hundreds of programs appear as one. This simplified process sharply reduces the time and effort required to install a Linux-based operating system, as compared to the alternative of gathering the hundreds of programs one by one via the Internet. The installation program provides default settings for the user depending upon whether the user wishes to use Red Hat Linux as a server operating system or as a workstation operating system. The installation also provides advanced users with the ability to customize the programs that are installed, allowing for significant flexibility and control over the operating system. The installation also automatically detects the type of hardware that comprises the user's computer, in order to ensure that all programs necessary for Red Hat Linux to work on the hardware are properly installed. Our software development engineers perform extensive testing of Red Hat Linux to ensure that it is properly assembled and works as a coherent whole from the user's perspective. We use industry standard methods of quality assurance testing to ensure that Red Hat Linux is solidly engineered and ready for use by our customers when shipped. We also operate an extensive beta testing program for Red Hat Linux. Under this beta testing program, we post a beta or test version of the operating system on the Internet. Developers and users around the world then suggest improvements and identify bugs. Each suggestion is circulated over the Internet in an attempt to encourage others to assist in the programming of a solution. In this way, Red Hat Linux users are treated as co-developers. Bug fixes and enhancements are tested by other users and our engineers, and when corrected, added to the next release. When the beta version is viewed as stable and complete, it becomes the next production version, and a new beta cycle begins. Our Web development team consists of engineers with considerable experience in developing scalable Web-based applications. We continue to develop applications on REDHAT.COM for user registration, commerce, and content management and publication. We rigorously test these programs and have built in the software necessary to ensure high quality visits to our Web site. As of May 31, 1999, we employed 52 individuals in our engineering group, consisting of 22 software engineers, including several of the top Linux kernel developers in the world, 20 Web design and development professionals, five quality assurance engineers and five documentation specialists. INTELLECTUAL PROPERTY Red Hat Linux has been developed and made available for licensing under the GNU General Public License (GPL), pursuant to which anyone generally may copy, modify and distribute the software, subject only to the restriction that any resulting or derivative work is made available to the public under the same terms. Therefore, although we retain the copyrights to the code that we develop ourselves, due to the GPL and the open source nature of our software products, our 49 most valuable intellectual property is our collection of trademarks. We rely primarily on a combination of trademarks and copyrights to protect our intellectual property. We also enter into confidentiality and nondisclosure agreements with our employees and consultants, and generally control access to and distribution of our documentation and other proprietary information. We pursue registration of some of our trademarks in the U.S. and in other countries. We have registered the trademark "Red Hat" in the U.S. and have registrations pending in the Australian, Canadian and European Union trademark offices. We have registered the Red Hat "Shadow Man" logo in the U.S. and in Australia and have registrations pending for it in the Canadian and European Union trademark offices. Despite our efforts to protect our trademark rights, unauthorized third parties have in the past attempted and in the future may attempt to misappropriate our trademark rights. We are currently investigating possible infringement claims against a third party in France whom we believe has misappropriated our tradename and trademarks. We cannot be certain that we will succeed in preventing the continued misappropriation of our tradename and trademarks in these circumstances or that we will be able to prevent this type of unauthorized use in the future. The laws of some foreign countries do not protect our trademark rights to the same extent as do the laws of the United States. In addition, policing unauthorized use of our trademark rights is difficult, expensive and time-consuming. The loss of any material trademark or trade name could have a material adverse effect on our business, operating results and financial condition. Although we do not believe that our products infringe the rights of third parties, there can be no assurance that third parties will not assert infringement claims against us in the future or that any such assertion will not result in costly litigation or require us to obtain a license to third party intellectual rights. In addition, there can be no assurance that such licenses will be available on reasonable terms or at all, which could have a material adverse effect on our business, operating results and financial condition. EMPLOYEES As of May 31, 1999, we had a total of 127 employees. Of the total employees, 52 were in software engineering, 30 in sales and marketing, 28 in customer service and technical support and 17 in finance and administration. Our future success will depend in part on our ability to attract, retain and motivate highly qualified technical and management personnel, for whom competition is intense. From time to time we also employ independent contractors to support our professional services, product development, sales, marketing and business development organizations. Our employees are not represented by any labor union and are not subject to a collective bargaining agreement, and we have never experienced a work stoppage. We believe our relations with our employees are good. FACILITIES Our headquarters are currently located in a leased facility in Durham, North Carolina, consisting of approximately 51,800 square feet under a five year lease that will expire on January 14, 2004. The annual rental expense under this lease is approximately $900,000. We believe that additional space will be required as our business expands and will be available on acceptable terms. LEGAL PROCEEDINGS We are not a party to any material legal proceedings. We may from time to time become a party to various legal proceedings arising in the ordinary course of our business. 50 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth the executive officers, directors and key employees of Red Hat, their ages and the positions held by them with Red Hat as of May 31, 1999:
NAME AGE POSITION - ---------------------------------------------------- --------- ---------------------------------------------------- EXECUTIVE OFFICERS AND DIRECTORS Robert F. Young..................................... 45 Chief Executive Officer and Chairman of the Board of Directors Matthew J. Szulik................................... 42 President and Director Marc Ewing.......................................... 30 Executive Vice President, Chief Technology Officer and Director Timothy J. Buckley.................................. 48 Senior Vice President and Chief Operating Officer Manoj K. George..................................... 32 Chief Financial Officer, Director of Administration and Treasurer David G. Shumannfang................................ 31 Counsel and Secretary Frank Batten, Jr. (1)(2)............................ 40 Director William S. Kaiser (1)(2)............................ 43 Director Eric Hahn (1)(2).................................... 39 Director KEY EMPLOYEES Erik W. Troan....................................... 25 Director of Engineering Lisa F. Sullivan.................................... 26 Director of Marketing Donald J. Barnes.................................... 26 Director of Technical Projects Paul F. McNamara.................................... 37 Business Unit Leader--Business Development Howard Jacobson..................................... 38 Director of Internet Business Theresa A. Williams-Spangler........................ 41 Business Unit Leader--Sales Dr. Charles A. Coleman, Jr.......................... 53 Director of Information Services
- ------------------------ (1) Member of Compensation Committee. (2) Member of Audit Committee. ROBERT F. YOUNG co-founded Red Hat and served as its President and a Director from its inception until November 1998. In November 1998, he was elected to his current positions as Chief Executive Officer and Chairman of the Board of Directors. MATTHEW J. SZULIK has served as President of Red Hat since November 1998 and a Director since April 1999. Mr. Szulik also served as Chief Operating Officer of Red Hat from November 1998 to April 1999. Prior to joining Red Hat, from September 1997 to October 1998 Mr. Szulik served as President of Relativity Technologies, a computer software company. From February 1996 to May 1997, Mr. Szulik served as President of Sapiens International, a computer software company. Prior to that, from January 1993 to December 1995, he served as Senior Vice President in charge of sales and marketing for MapInfo Corp., a computer software company. MARC EWING co-founded Red Hat and has served as its Executive Vice President and Chief Technology Officer and as a Director since its inception. Mr. Ewing participated in the design and development of Red Hat Linux and founded Red Hat Advanced Development Laboratories to develop open source graphical desktop applications for Linux in cooperation with the open source development community. 51 Prior to founding Red Hat, for various periods from January 1991 to August 1992, Mr. Ewing worked as a systems programmer for IBM. TIMOTHY J. BUCKLEY has served as Senior Vice President and Chief Operating Officer of Red Hat since April 1999. Prior to joining Red Hat, from October 1997 until April 1999, Mr. Buckley was Senior Vice President of Worldwide Sales at Visio Corp., a business software company. Mr. Buckley joined Visio in November 1993 and served as Visio's Vice President of Worldwide Sales until his promotion in October 1997. MANOJ K. GEORGE has served as Red Hat's Chief Financial Officer and Treasurer since May 1998. From May 1997 to the present he has held the position of Director of Administration, and from May 1997 to May 1998 he served as Red Hat's Controller. From November 1994 to May 1997, Mr. George, a certified public accountant, served, first as a staff accountant, then as a senior accountant with a regional accounting firm. DAVID G. SHUMANNFANG has served as Counsel of Red Hat since October 1996 and Secretary of Red Hat since April 1997. From August 1993 to May 1996, Mr. Shumannfang earned his Juris Doctor from the University of North Carolina at Chapel Hill School of Law. Mr. Shumannfang is a member of the North Carolina State Bar. FRANK BATTEN, JR. has served as a Director of Red Hat since August 1997. Mr. Batten is currently Chairman of Landmark Communications Inc., a media company, and has served in that position since January 1998. Prior to that, Mr. Batten served Landmark Communications as its Executive Vice President, Corporate Development from October 1995 to January 1998. From June 1991 to October 1995, Mr. Batten was President and Publisher of the Virginian Pilot, a newspaper division of Landmark Communications. WILLIAM S. KAISER has served as a Director of Red Hat since September 1998. Mr. Kaiser has been employed by Greylock Management Corporation, a venture capital firm, since May 1986 and has been a general partner of the Greylock Limited Partnerships since January 1988. Mr. Kaiser is also a director of Open Market Inc. and Clarus Corporation. ERIC HAHN has served as a Director of Red Hat since April 1999. Mr. Hahn is a founding partner of Inventures Group, a leading "mentor investment" venture capital firm. He served as Executive Vice President and Chief Technology Officer of Netscape from November 1996 until June 1998. Prior to serving as Netscape's Chief Technology Officer, from November 1995 to November 1996, Mr. Hahn was general manager of Netscape's Server Products Division, overseeing product development for Netscape's enterprise, Internet and extranet servers. Mr. Hahn joined Netscape following its acquisition of Collabra Software, Inc., which Mr. Hahn founded in February 1993. ERIK W. TROAN has served as Red Hat's Director of Engineering since February 1999. Prior to that, between May 1995 and February 1999, he served as Chief Developer at Red Hat. He is the co-author of LINUX APPLICATION DEVELOPMENT, a book covering mid-level programming on the Linux operating system and from 1995 to 1996, was a regular columnist for the X Journal Magazine, covering free software topics. LISA F. SULLIVAN has served as Director of Marketing for Red Hat since June 1997. Prior to that, from October 1996 to June 1997, she served as a Product and Distribution Manager and from September 1994 to September 1996 as a Sales Office Manager for Red Hat. DONALD J. BARNES has served Red Hat as Director of Technical Projects since February 1999. From November 1997 to February 1999, he served as Red Hat's Development Manager of Quality Assurance and from May 1995 to November 1997 he served as a System's Engineer for Red Hat. From May 1994 to May 1995, Mr. Barnes was a Systems Engineer for Northern Telecom Limited. 52 PAUL F. MCNAMARA has served as Red Hat's Business Unit Leader--Business Development since June 1999. From February 1999 to June 1999, he served as Red Hat's Vice President of Business Development. From May 1998 to February 1999, he served as Red Hat's Vice President of Strategic Relationships. Prior to joining Red Hat, from September 1994 to May 1998, Mr. McNamara served as President and Chief Operating Officer of Asset Management Technologies, Inc., a developer of wireless communications and global positioning system software. Prior to his tenure with Asset Management, Mr. McNamara served IBM from September 1993 to September 1994 as Senior Manager, Product and Business Development. HOWARD JACOBSON has served as Red Hat's Director of Internet Business since April 1999. He served as Business Development Manager for Red Hat from January 1999 to April 1999. Prior to joining Red Hat, from August 1995 to January 1999, Mr. Jacobson was a partner at the law firm of Moore & Van Allen, and from July 1985 to July 1998 was an associate at the law firm of Gibson Dunn & Crutcher specializing in intellectual property law. THERESA SPANGLER has served as Business Unit Leader--Sales for Red Hat since February 1999. Prior to joining Red Hat, from October 1997 to February 1999, she served as Vice President of Sales and Marketing at Technauts, Inc., a software company. From December 1991 to March 1997, Ms. Spangler served as Senior Territory Manager for PictureTel Corp., a video conferencing equipment manufacturer. CHARLES A. COLEMAN has served as Red Hat's Director of Information Services since April 1999. From February 1999 to March 1999, Mr. Coleman acted as a consultant to Red Hat in connection with ERP vendor evaluation and selection and ERP implementation. From April 1998 to January 1999, Mr. Coleman served as President and Chief Information Officer at Critical Information Technologies, LLC, a data modeling and systems integration firm. From September 1996 to April 1998 he was employed by Ellora Software, Inc., a clinical data management software developer, first as a consultant and then as a Vice President. From February 1994 to September 1996, Mr. Coleman was Senior Vice President of Inquiry Management and Database Systems for Computerworld, Inc. From August 1983 to February 1994 he served as President and Chief Information Officer of Response Technologies, Inc., a business processing reengineering company. ELECTION OF OFFICERS AND DIRECTORS Red Hat's executive officers are elected by the Board of Directors on an annual basis and serve until their successors are duly elected and qualified. All of the current Directors were selected as Directors of Red Hat pursuant to the First Amended and Restated Stockholder's Voting Agreement dated February 25, 1999, as amended, between Red Hat and some of its stockholders, which agreement will automatically terminate upon the closing of this offering. There are no family relationships among any of the executive officers or directors of Red Hat. Upon the closing of this offering, Red Hat's Board of Directors will be divided into three classes, with the members of each class of directors serving for staggered three-year terms. Messrs. Ewing and Hahn will serve in the class the term of which expires in 2000; Messrs. Szulik and Batten will serve in the class the term of which expires in 2001; and Messrs. Young and Kaiser will serve in the class the term of which expires in 2002. At each annual meeting of stockholders, a class of directors will be elected for a three-year term to succeed the directors of the same class whose term is then expiring. Red Hat's adoption of a classified Board of Directors could have the effect of increasing the length of time necessary to change the composition of a majority of the Board of Directors. See "Description of Capital Stock--Delaware Law and Certain Charter and By-Law Provisions; Anti-Takeover Effects". 53 COMMITTEES OF THE BOARD OF DIRECTORS The Board of Directors has appointed a Compensation Committee consisting of Messrs. Batten, Kaiser and Hahn. The Compensation Committee reviews and evaluates the compensation and benefits of all of Red Hat's officers, reviews general policy matters relating to compensation and benefits of Red Hat's employees and makes recommendations concerning these matters to the Board of Directors. The Compensation Committee also administers Red Hat's stock option and stock purchase plans. See "--Employee Benefit Plans". The Board of Directors has also appointed an Audit Committee consisting of Messrs. Batten, Kaiser and Hahn. The Audit Committee reviews, with Red Hat's independent auditors, the scope and timing of the auditors' services, the auditors' report on Red Hat's financial statements following completion of the auditors' audit, and Red Hat's policies and procedures with respect to internal accounting and financial controls. In addition, the Audit Committee will make annual recommendations to the Board of Directors for the appointment of independent auditors for the ensuing year. DIRECTOR COMPENSATION Directors are reimbursed for reasonable out-of-pocket expenses incurred in attending meetings of the Board of Directors and for meetings of any committees of the Board of Directors on which they serve. Directors are also eligible to participate in Red Hat's 1999 Stock Option and Incentive Plan. Pursuant to a policy approved by the Board of Directors, upon initial election or appointment to the Board of Directors, new non-employee Directors will be granted non-qualified stock options to purchase 20,000 shares of common stock at a price at least equal to the fair market value of Red Hat's common stock on the date of grant. These options will vest 33 1/3% one year from grant date and 8.33% at the end of each three-month period thereafter. Upon re-election, non-employee directors will be granted non-qualified stock options to purchase 10,000 shares of common stock to vest 33 1/3% one year from the date of re-election and 8.33% each three-month period thereafter. Each year of a non-employee director's tenure, the director will be granted non-qualified stock options to purchase 5,000 shares of common stock which will be fully vested upon grant. Upon the effectiveness of the registration statement of which this prospectus is a part, according to the policy established by the Board of Directors, Messrs. Batten and Kaiser will each be granted non-qualified stock options to purchase 10,000 shares of common stock at the initial public offering price. These options will vest as provided above. See "--Employee Benefit Plans". In addition, in April 1999, Mr. Hahn was granted a non-qualified stock option under the 1998 Stock Option Plan to purchase 171,552 shares of common stock at an exercise price of $1.5705 per share. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION No interlocking relationship exists between the Board of Directors or Compensation Committee and the board of directors or compensation committee of any other company, nor has any interlocking relationship existed in the past. 54 EXECUTIVE COMPENSATION The following table sets forth the compensation earned by Robert F. Young, Red Hat's Chief Executive Officer, and Red Hat's only other executive officer during the fiscal year ended February 28, 1999 whose salary and bonus exceeded $100,000 for such fiscal year (together with the Chief Executive Officer, the "Named Executive Officers") for services rendered in all capacities to Red Hat during the fiscal year ended February 28, 1999. As of May 31, the annualized base salaries of Red Hat's executive officers not listed in the table below who, had they been employed by Red Hat for the full fiscal year ended February 28, 1999, would have earned in excess of $100,000, were: Matthew J. Szulik -- $185,000 and Timothy J. Buckley -- $155,000. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ANNUAL COMPENSATION AWARDS --------------------------- ------------------------ SECURITIES UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION SALARY($) BONUS($) OPTIONS(#) COMPENSATION ($) - --------------------------- ----------- ----------- --------------------------- ------------------- Robert F. Young Chairman and Chief Executive Officer........ 161,458 25,000 -- 41,141 Marc Ewing Executive Vice President and Chief Technology Officer.................. 145,125 20,000 -- --
Red Hat has never granted any stock options to the Named Executive Officers. CHANGE IN CONTROL ARRANGEMENTS Matthew Szulik, Red Hat's President, is a party to an incentive stock option agreement and a non-qualified stock option agreement, which both provide for the lapsing of Red Hat's repurchase right as to 33 1/3% of his option shares if he is terminated without cause within sixteen months of his date of hire (November 13, 1998) and for the lapsing in full of Red Hat's repurchase right as to any unvested option shares upon the termination of his employment (either by Red Hat's successor without cause or by Mr. Szulik for good reason) following a change in control of Red Hat. Tim Buckley, Red Hat's Chief Operating Officer, is a party to an incentive stock option agreement and a non-qualified stock option agreement, which both provide for the lapsing of Red Hat's repurchase right as to 33 1/3% of his option shares if he is terminated without cause within one year of his date of hire (April 12, 1999) and for the lapsing in full of Red Hat's repurchase right as to any unvested option shares upon the termination of his employment (either by Red Hat's successor without cause or by Mr. Buckley for good reason) following a change in control of Red Hat. EMPLOYEE BENEFIT PLANS 1998 STOCK OPTION PLAN, AS AMENDED Red Hat's 1998 Stock Option Plan, as amended (the "1998 Plan"), was adopted by the Board of Directors and approved by Red Hat's stockholders in August 1998, and was amended in November 1998, February 1999 and April 1999. The aggregate number of shares of common stock which may be issued under the 1998 Plan is 9,235,160. Under the 1998 Plan, Red Hat is authorized to grant incentive stock options ("ISOs") and non-qualified stock options ("NQSOs"), as well as awards of common stock and opportunities 55 to make direct purchases of common stock to employees, consultants, directors and officers of Red Hat. The 1998 Plan is administered by the Compensation Committee of the Board of Directors. Subject to the provisions of the 1998 Plan, the Compensation Committee has the authority to select the participants and determine the terms of the stock options, awards and purchase rights granted under the 1998 Plan. Options granted under the 1998 Plan are immediately exercisable, subject to a right of repurchase in favor of Red Hat for all exercised but unvested shares. Red Hat's right of repurchase lapses over a period of four years. An ISO is not transferable by the recipient except by will or by the laws of descent and distribution. NQSOs and other awards are transferable only to the extent set forth in the agreement relating to such option or award or pursuant to a valid domestic relations order. Generally, no ISO may be exercised more than three months following termination of employment, and no stock option may be exercised following termination of employment for cause. However, in the event that termination is due to death or disability, the stock option is exercisable for a maximum of 180 days after such termination. In June 1999, the Board of Directors and the stockholders voted to terminate the 1998 Plan effective on, and subject to the consummation of the offering. As of May 31, 1999 Red Hat had outstanding under the 1998 Plan ISOs exercisable for 2,936,058 shares of common stock and NQSOs exercisable for 2,482,030 shares of common stock. 1999 STOCK OPTION AND INCENTIVE PLAN Red Hat's 1999 Stock Option and Incentive Plan (the "1999 Stock Plan") was adopted by Red Hat's Board of Directors and approved by its stockholders in June 1999. The 1999 Stock Plan provides for the grant of stock-based awards to employees, officers and directors of, and consultants or advisors to, Red Hat and its subsidiaries, including ISOs and NQSOs and other equity-based awards. ISOs may be granted only to employees of Red Hat. A total of 6,500,000 shares of common stock may be issued upon the exercise of options or other awards granted under the 1999 Stock Plan. The maximum number of shares with respect to which awards may be granted to any employee under the 1999 Stock Plan shall not exceed 3,250,000 shares of common stock during any calendar year. The 1999 Stock Plan is administered by the Board of Directors and the Compensation Committee. Subject to the provisions of the 1999 Stock Plan, the Board of Directors and the Compensation Committee each has the authority to select the persons to whom awards are granted and determine the terms of each award, including the number of shares of common stock subject to the award. Payment of the exercise price of an award may be made in cash, shares of common stock, a combination of cash or stock or by any other method approved by the Board or Compensation Committee, consistent with Section 422 of the Internal Revenue Code and Rule 16b-3 under the Exchange Act. Unless otherwise permitted by Red Hat, awards are not assignable or transferable except by will or the laws of descent and distribution. Each of the Board of Directors or Compensation Committee may, in its sole discretion, amend, modify or terminate any award granted or made under the 1999 Stock Plan, so long as such amendment, modification or termination would not materially and adversely affect the participant. Each of the Board or Compensation Committee may also, in its sole discretion, accelerate or extend the date or dates on which all or any particular option or options granted under the 1999 Stock Plan may be exercised. 1999 EMPLOYEE STOCK PURCHASE PLAN The 1999 Employee Stock Purchase Plan (the "1999 Purchase Plan") was adopted by the Board of Directors and approved by the stockholders in June 1999. The 1999 Purchase Plan provides for the issuance of a maximum of 750,000 shares of common stock. The 1999 Purchase Plan is administered by the Compensation Committee of the Board of Directors. All employees of Red Hat whose 56 customary employment is for more than 20 hours per week and for more than three months in any calendar year and who have completed more than 90 days of employment with Red Hat on or before the first day of any Payment Period (as defined below) are eligible to participate in the 1999 Purchase Plan. Outside directors and employees who would own 5% or more of the total combined voting power of value of Red Hat's stock immediately after the grant may not participate in the 1999 Purchase Plan. To participate in the 1999 Purchase Plan, an employee must authorize Red Hat to deduct an amount (not less than one percent nor more than 10 percent of a participant's total cash compensation) from his or her pay during six-month payment periods (each, a "Payment Period"). The first Payment Period will commence on a date to be determined by the Board of Directors and end on February 29, 2000. Thereafter, the Payment Periods will commence on the six-month periods beginning on the first day of April and October, respectively, and ending on the last day of the following March and September, respectively, of each year, but in no case shall an employee be entitled to purchase more than 1,000 shares in any one Payment Period. The exercise price for the option granted in each Payment Period is 85% of the lesser of the average market price of the common stock on the first or last business day of the Payment Period, in either event rounded up to the nearest cent. If an employee is not a participant on the last day of the Payment Period, such employee is not entitled to exercise his or her option, and the amount of his or her accumulated payroll deductions will be refunded. Options granted under the 1999 Purchase Plan may not be transferred or assigned. An employee's rights under the 1999 Purchase Plan terminate upon his or her voluntary withdrawal from the plan at any time or upon termination of employment. No options have been granted to date under the 1999 Purchase Plan. 401(K) PLAN Red Hat has a Section 401(k) Profit Sharing Plan (the "401(k) Plan"). The 401(k) Plan is a tax-qualified plan covering all full-time Red Hat employees who are over 21 years of age and who have completed three months of service with Red Hat. If, however, an employee was employed by Red Hat prior to February 1999, the 401(k) Plan covered such employee regardless of age or length of service with Red Hat. Under the 401(k) Plan, participants may elect to defer a portion of their compensation, subject to certain limitations. In addition, at the discretion of the Board of Directors, Red Hat may make matching contributions into the 401(k) Plan for all eligible employees. During the fiscal year ended February 28, 1999, Red Hat did not make any contributions to the 401(k) Plan. LIMITATION OF LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS Red Hat's Third Amended and Restated Certificate of Incorporation and Amended and Restated By-Laws provide that the directors and officers of Red Hat shall be indemnified by Red Hat to the fullest extent permitted by Delaware law, as it now exists or may in the future be amended, against all expenses and liabilities reasonably incurred in connection with their service for or on behalf of Red Hat. In addition, the Third Amended and Restated Certificate of Incorporation provides that the directors of Red Hat will not be personally liable for monetary damages to Red Hat for breaches of their fiduciary duty as directors, unless they violated their duty of loyalty to Red Hat or its stockholders, acted in bad faith, knowingly or intentionally violated the law, authorized illegal dividends or redemptions or derived an improper personal benefit from their action as directors. Red Hat intends to obtain insurance which insures the directors and officers of Red Hat against certain losses and which insures Red Hat against certain of its obligations to indemnify such directors and officers. 57 CERTAIN TRANSACTIONS On August 15, 1997, Red Hat sold 6,801,400 shares of its Series A preferred stock to Frank Batten, Jr., Frank Batten, Louis F. Ryan as trustees under a trust agreement dated April 11, 1988, as amended (the "1988 Batten Trust") in a private financing at a price of $.294057 per share. The 1988 Batten Trust is a 5% stockholder of Red Hat. On September 29, 1998, Red Hat sold an aggregate of 8,116,550 shares of its Series B preferred stock in a private financing at a price of $.857 per share. Among the purchasers in this financing were the 1988 Batten Trust, Intel Corporation, Greylock IX Limited Partnership and Benchmark Capital Partners II, L.P., each a 5% stockholder of Red Hat. From February 25, 1999 through April 1, 1999, Red Hat sold an aggregate of 2,054,776 shares of its Series C preferred stock in a private financing at a price of $3.141 per share. Among the purchasers in this financing were the 1988 Batten Trust, Intel Corporation, Greylock IX Limited Partnership and Benchmark Capital Partners II, L.P., each a 5% stockholder of Red Hat. Red Hat believes that all transactions set forth above were made on terms no less favorable to it than would have been obtained from unaffiliated third parties. Red Hat has adopted a policy whereby all future transactions between Red Hat and any of its officers, directors and affiliates will be on terms no less favorable to Red Hat than could be obtained from unaffiliated third parties and will be approved by a majority of the disinterested members of Red Hat's Board of Directors. 58 PRINCIPAL STOCKHOLDERS The following table sets forth certain information known to Red Hat regarding beneficial ownership of Red Hat's common stock as May 31, 1999 and as adjusted to reflect the sale of the shares of common stock in this offering by: - each person known by Red Hat to be the beneficial owner of more than 5% of Red Hat's common stock; - each of Red Hat's directors; - each Named Executive Officer; and - all executive officers and directors as a group. Unless otherwise indicated, to the knowledge of Red Hat, each stockholder possesses sole voting and investment power with respect to the shares listed, except to the extent an individual stockholder's shares are owned jointly with that person's spouse. The number of shares of common stock deemed outstanding includes shares issuable pursuant to options and warrants held by the respective person or group which may be exercised within 60 days after May 31, 1999. For purposes of calculating each person's or group's percentage ownership, stock options exercisable within 60 days after May 31, 1999 and warrants are included for that person or group but not the stock options and warrants of any other person or group.
PERCENTAGE OF SHARES BENEFICIALLY OWNED ------------------------ NAME AND ADDRESS OF BEFORE AFTER BENEFICIAL OWNER (1) SHARES BENEFICIALLY OWNED OFFERING OFFERING - ---------------------------------------- -------------------------- ----------- ----------- 5% STOCKHOLDERS Greylock IX Limited Partnership......... 8,723,866 14.5% One Federal Street Boston, MA 02110 Benchmark Capital Partners II, L.P...... 5,815,910 9.7 2840 Sand Hill Road, Suite 2000 Menlo Park, CA 94025 Intel Corporation....................... 3,005,058 5.0 2200 Mission College Blvd. RN6-46 Santa Clara, CA 95052 EXECUTIVE OFFICERS AND DIRECTORS Robert F. Young (2)..................... 9,081,826 15.1 Marc Ewing (3).......................... 9,088,476 15.1 Matthew Szulik (4)...................... 2,736,248 4.4 Frank Batten, Jr. (5)................... 15,005,888 25.0 c/o Landmark Communications 150 W. Brambleton Avenue Norfolk, VA 23510-2075 William S. Kaiser (6)................... 8,723,866 14.5 c/o Greylock IX Limited Partnership One Federal Street Boston, MA. 02110 Eric Hahn............................... 171,552 * All executive officers and directors as a group (9 persons) (7)................. 46,436,268 74.4%
- ------------------------ * Represents beneficial ownership of less than one percent of outstanding common stock. 59 (1) Unless otherwise indicated, the address for each beneficial owner is c/o Red Hat, Inc., 2600 Meridian Parkway, Durham, N.C. 27713. (2) Includes 3,222,746 shares held of record by Nancy Young, Mr. Young's wife, 300,000 held by the Nancy R. Young GRAT dated April 28, 1999, 200,000 shares held of record by the Young Family Trust dated April 28, 1999 and 1,418,160 shares held of record by trusts for the benefit of Mr. Young's children. Mr. Young disclaims beneficial ownership of such shares. Also includes 300,000 shares held of record by the Robert F. Young GRAT dated April 28, 1999. (3) Includes 200,000 shares held of record by the Ewing Family Trust dated April 28, 1999 and 1,412,720 shares held of record by trusts for the benefit of Mr. Ewing's children. Mr. Ewing disclaims beneficial ownership of such shares. Also includes 600,000 shares held of record by the Marc Ewing GRAT dated April 28, 1999. (4) Includes 36,000 shares held of record by trusts for the benefit of Mr. Szulik's children. Mr. Szulik disclaims beneficial ownership of such shares. Also includes 27,678 shares held of record by the Matthew J. Szulik GRAT dated May 26, 1999. Also includes 1,672,570 shares of common stock issuable pursuant to stock options. (5) Includes 1,519,246 shares held of record by the 1988 Batten Trust and 13,486,642 shares held of record by the 1998 Frank Batten, Jr. Grantor Annuity Trust. (6) Includes shares held by Greylock IX Limited Partnership. Mr. Kaiser is a general partner of Greylock IX GP Limited Partnership, the general partner of Greylock IX Limited Partnership. Mr. Kaiser disclaims beneficial ownership of these shares. (7) Includes 4,582,742 shares of common stock issuable pursuant to stock options. DESCRIPTION OF CAPITAL STOCK GENERAL Effective upon the closing of this offering and the filing of Red Hat's Third Amended and Restated Certificate of Incorporation, the authorized capital stock of Red Hat will consist of 225,000,000 shares of common stock, par value $.0001 per share, and 5,000,000 shares of preferred stock, par value $.0001 per share. Prior to the effectiveness of the registration statement of which this prospectus is a part, and in accordance with Red Hat's Second Amended and Restated Certificate of Incorporation, as amended and currently in effect, Red Hat is authorized to issue up to 70,620,652 shares of common stock, par value $.0001 per share, of which 26,114,502 shares are issued and outstanding as of May 31, 1999 and 16,972,726 shares of preferred stock, par value $.0001 per share, of which as of May 31, 1999 16,972,726 shares are issued and outstanding. Upon the closing of this offering, all shares of preferred stock will be converted into 33,945,452 shares of common stock. The following summary description of Red Hat's capital stock is not intended to be complete and is qualified by reference to the provisions of applicable law and to Red Hat's Third Amended and Restated Certificate of Incorporation (the "Restated Certificate of Incorporation") and Amended and Restated Bylaws (the "Restated By-laws"), filed as exhibits to the registration statement of which this prospectus is a part. COMMON STOCK As of May 31, 1999, there were 26,114,502 shares of common stock outstanding held by 41 stockholders of record. Based upon the number of shares outstanding as of that date and giving effect to the issuance of the shares of common stock offered by Red Hat in this offering and the conversion of the outstanding shares of preferred stock, there will be shares of common stock outstanding upon the closing of this offering. In addition, as of May 31, 1999, there were outstanding stock options for the purchase of 5,418,088 shares of common stock and outstanding warrants for 60 the purchase of 3,197,450 shares of common stock. Holders of common stock are entitled to one vote for each share held on all matters submitted to a vote of stockholders and do not have cumulative voting rights. Directors are elected by a plurality of the votes of the shares present in person or by proxy at the meeting and entitled to vote in such election. Holders of common stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of funds legally available therefor, subject to any preferential dividend rights of outstanding preferred stock. Upon the liquidation, dissolution or winding up of Red Hat, the holders of common stock are entitled to receive ratably the net assets of Red Hat available after the payment of all debts and other liabilities of Red Hat, subject to the prior rights of any outstanding preferred stock. Holders of the common stock have no preemptive, subscription, redemption or conversion rights, nor are they entitled to the benefit of any sinking fund. The outstanding shares of common stock are, and the shares offered by Red Hat in this offering will be, when issued and paid for, validly issued, fully paid and nonassessable. The rights, powers, preferences and privileges of holders of common stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of preferred stock which Red Hat may designate and issue in the future. PREFERRED STOCK The Board of Directors will be authorized, subject to any limitations prescribed by law, without further stockholder approval, to issue from time to time up to an aggregate of 5,000,000 shares of preferred stock, in one or more series. Each such series of preferred stock shall have such number of shares, designations, preferences, voting powers, qualifications and special or relative rights or privileges as shall be determined by the Board of Directors, which may include, among others, dividend rights, voting rights, redemption and sinking fund provisions, liquidation preferences, conversion rights and preemptive rights. The stockholders of Red Hat have granted the Board of Directors authority to issue the preferred stock and to determine its rights and preferences in order to eliminate delays associated with a stockholder vote on specific issuances. The rights of the holders of common stock will be subject to the rights of holders of any preferred stock issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could adversely affect the voting power or other rights of the holders of common stock, and could make it more difficult for a third party to acquire, or discourage a third party from attempting to acquire, a majority of the outstanding voting stock of Red Hat. Red Hat has not, to date, issued any shares of such preferred stock and has no present plans to issue any shares of preferred stock. DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS AND ANTI-TAKEOVER EFFECTS Upon completion of this offering, Red Hat will be subject to the provisions of Section 203 of the General Corporation Law of Delaware, Section 203 prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, 15% or more of the corporation's voting stock. The Restated Certificate of Incorporation provides for the division of the Board of Directors into three classes as nearly equal in size as possible with staggered three-year terms. See "Management--Election of Officers and Directors". In addition, the Restated 61 Certificate of Incorporation provides that directors may be removed only for cause by the affirmative vote of the holders of 75% of the shares of capital stock of Red Hat entitled to vote. Under the Restated Certificate of Incorporation, any vacancy on the Board of Directors, however occurring, including a vacancy resulting from an enlargement of the Board, may only be filled by vote of a majority of the directors then in office. The likely effect of the classification of the Board of Directors and the limitations on the removal of directors and filling of vacancies is an increase in the time required for the stockholders to change the composition of the Board of Directors. For example, in general, at least two annual meetings of the stockholders will be necessary for stockholders to effect a change in a majority of the members of the Board of Directors. The Restated Certificate of Incorporation also provides that after the closing of this offering, any action required or permitted to be taken by the stockholders of Red Hat at an annual meeting or special meeting of stockholders may only be taken if it is properly brought before the meeting and may not be taken by written action in lieu of a meeting. The Restated By-laws provide that special meetings of the stockholders may only be called by the Board of Directors, the Chairman of the Board of Directors, the Chief Executive Officer or the President of Red Hat. The Restated By-laws further provide that in order for any matter to be considered "properly brought" before a meeting, a stockholder must comply with requirements regarding advance notice to Red Hat. The foregoing provisions could have the effect of delaying until the next stockholders meeting stockholder actions which are favored by the holders of a majority of the outstanding voting securities of Red Hat. These provisions may also discourage another person or entity from making a tender offer for Red Hat's common stock, because such person or entity, even if it acquired a majority of the outstanding voting securities of Red Hat, would be able to take action as a stockholder (such as electing new directors or approving a merger) only at a duly called stockholders meeting, and not by written consent. The General Corporation Law of Delaware provides generally that the affirmative vote of a majority of the shares entitled to vote on any matter is required to amend a corporation's certificate of incorporation or bylaws, unless a corporation's certificate of incorporation or by-laws, as the case may be, requires a greater percentage. The Restated Certificate of Incorporation requires the affirmative vote of the holders of at least 75% of the shares of capital stock of Red Hat issued and outstanding and entitled to vote to amend or repeal any of the foregoing provisions of the Restated Certificate of Incorporation. The Restated By-laws also may be amended or repealed by a majority vote of the Board of Directors subject to any limitations set forth in the Restated By-laws and amendment by stockholders of provisions described above requires the affirmative vote of the holders of at least 75% of the shares of capital stock of Red Hat issued and outstanding and entitled to vote. The 75% stockholder vote would be in addition to any separate class vote that might in the future be required pursuant to the terms of any series of preferred stock that might be outstanding at the time any such amendments are submitted to stockholders. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the common stock is Chase Mellon Shareholder Services, LLC. 62 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no market for Red Hat's common stock. Future sales of substantial amounts of common stock in the public market could adversely affect prevailing market prices from time to time. Furthermore, since only a limited number of shares will be available for sale shortly after this offering because of certain contractual and legal restrictions on resale described below, sales of substantial amounts of Red Hat's common stock in the public market after the restrictions lapse could adversely affect the prevailing market price and Red Hat's the ability to raise equity capital in the future. SALES OF RESTRICTED SHARES Based on shares outstanding at May 31, 1999 upon completion of this offering, Red Hat will have outstanding an aggregate of shares of common stock, assuming no exercise of the underwriters' over-allotment option and no exercise of outstanding options or warrants. Of these shares, the shares sold in this offering will be freely tradable without restrictions or further registration under the Securities Act, unless such shares are purchased by an existing affiliate of Red Hat as that term is defined in Rule 144 under the Securities Act. The remaining 60,059,954 shares of common stock held by existing stockholders are restricted shares or are subject to the contractual restrictions described below. Restricted shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rule 144, 144(k) or 701 promulgated under the Securities Act, which are summarized below. Of these restricted shares, 1,990,000 shares will be available for resale in the public market in reliance on Rule 144(k), all of which shares are subject to lock-up agreements described below. An additional 31,773,102 shares will be available for resale in the public market in reliance on Rule 144, substantially all of which are subject to lock-up agreements. The remaining 26,296,852 shares become eligible for resale in the public market at various dates thereafter, substantially all of which shares are subject to lock-up agreements. In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned restricted shares for at least one year would be entitled to sell a certain number of shares within any three-month period. That number of shares cannot exceed the greater of one percent of the number of shares of common stock then outstanding, which will equal approximately shares immediately after this offering, or the average weekly trading volume of the common stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a notice on Form 144 with respect to such sale. Sales under Rule 144 are also subject to certain manner of sale provisions, notice requirements and the availability of current public information about Red Hat. Rule 144 also provides that affiliates of Red Hat who are selling shares of common stock that are not restricted shares must nonetheless comply with the same restrictions applicable to restricted shares with the exception of the holding period requirement. Under Rule 144(k), a person who is not deemed to have been an affiliate of Red Hat at any time during the 90 days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, is entitled to sell such shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Accordingly, unless otherwise restricted, these shares may therefore be sold immediately upon the completion of this offering. OPTIONS Rule 701 provides that the shares of common stock acquired upon the exercise of currently outstanding options or pursuant to other rights granted under Red Hat's stock plans may be resold (to the extent not subject 63 to the Lock-up Agreements) by persons, other than Affiliates, beginning 90 days after the date of this prospectus, subject only to the manner of sale provisions of Rule 144, and by affiliates under Rule 144, without compliance with its one-year minimum holding period, subject to certain limitations. As of May 31, 1999, the Board of Directors has authorized an aggregate of up to 16,684,800 shares of common stock for issuance pursuant to Red Hat's stock option and stock purchase plans. As of May 31, 1999, options to purchase a total of 5,418,088 shares of common stock were outstanding, all of which options are exercisable subject to Red Hat's right to repurchase unvested shares under certain circumstances. Of these options, 508,675 shares are no longer subject to Red Hat's right of repurchase and will be eligible for sale (to the extent not subject to the lock-up agreements) in the public market in accordance with Rule 701 under the Securities Act beginning 90 days after the date of this prospectus. Of the total shares issuable pursuant to these options, 238,050 shares are subject to lock-up agreements. Red Hat intends to file one or more registration statements on Form S-8 under the Securities Act following this offering to register all shares of common stock which are subject to outstanding stock options or other rights granted pursuant to Red Hat's stock plan(s) and common stock issuable pursuant to Red Hat's stock option and stock purchase plans. These registration statements are expected to become effective upon filing. Shares covered by these registration statements will thereupon be eligible for sale in the public markets, subject to the lock-up agreements, to the extent applicable. WARRANTS As of May 31, 1999, Red Hat had outstanding warrants exercisable for a total of 3,197,450 shares of common stock, all of which are currently exercisable. All of these shares are subject to lock-up agreements. LOCK-UP AGREEMENTS Except for sales of common stock to the underwriters pursuant to the underwriting agreement Red Hat, the executive officers, directors, stockholders and substantially all optionholders have agreed not to sell or otherwise dispose of, directly or indirectly, any shares of common stock (or any security convertible into or exchangeable or exercisable for common stock) without the prior written consent of Goldman, Sachs & Co. for a period of 180 days from the date of this prospectus. In addition, for a period of 180 days from the date of this prospectus, except as required by law, Red Hat has agreed that its Board of Directors will not consent to any offer for sale, sale or other disposition, or any transaction which is designed or could be expected to result in the disposition by any person, directly or indirectly, of any shares of common stock without the prior written consent of Goldman Sachs. See "Underwriting". Goldman Sachs in its sole discretion at any time or from time to time and without notice may release for sale in the public market all or any portion of the shares subject to the lock-up agreements. REGISTRATION RIGHTS Upon the expiration of the contractual lock-up period, certain securityholders of Red Hat (the "Rights Holders") will be entitled to require Red Hat to register under the Securities Act up to a total of 55,725,622 shares of outstanding common stock (the "Registrable Shares") under the terms of an investor rights agreement between Red Hat and the Rights Holders (the "Investor Rights Agreement"). The Investor Rights Agreement provides that if Red Hat proposes to register in a firm commitment underwritten offering any of its securities under the Securities Act at any time or times, the Investor Rights Holders, subject to certain exceptions, shall be entitled to include Registrable Shares in such registration. However, the managing underwriter of any such offering may exclude for marketing reasons some or all of such Registrable Shares from such registration. Some of the Rights Holders also have, subject to certain conditions and limitations, the right to require 64 Red Hat, on no more than five occasions, to prepare and file a registration statement under the Securities Act with respect to their Registrable Shares. Red Hat is generally required to bear the expenses of all such registrations, except underwriting discounts and commissions. The Investor Rights Agreement terminates in 2002 on the third anniversary of the offering. EFFECTS OF SALES OF SHARES Prior to this offering, there has been no public market for the common stock of Red Hat, and no predictions can be made as to the effect, if any, that market sales of shares of common stock prevailing from time to time, or the availability of shares for future sale, may have on the market price for the common stock. Sales of substantial amounts of common stock, or the perception that such sales could occur, could adversely effect prevailing market prices for the common stock and could impair Red Hat's future ability to obtain capital through an offering of equity securities. LEGAL MATTERS The validity of the shares of common stock to be issued in this offering will be passed upon for Red Hat by Testa, Hurwitz & Thibeault, LLP, Boston, Massachusetts. Certain legal matters in connection with this offering will be passed upon for the underwriters by Hale and Dorr LLP, Boston, Massachusetts. EXPERTS The financial statements as of February 28, 1998 and 1999 and for each of the three years in the period ended February 28, 1999 included in this prospectus have been so included in reliance upon the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. WHERE YOU CAN FIND MORE INFORMATION Red Hat has filed with the Commission a registration statement on Form S-1 (including all amendments and exhibits thereto, the "Registration Statement") under the Securities Act with respect to the common stock to be sold in this offering. As permitted by the rules and regulations of the Commission, this prospectus omits certain information contained in the Registration Statement. For further information with respect to Red Hat and the common stock to be sold in this offering, you should refer to the Registration Statement and to the exhibits and schedules filed as part of the Registration Statement. Statements contained in this prospectus regarding the contents of any agreement or other document filed as an exhibit to the Registration Statement are not necessarily complete, and in each instance reference is made to the copy of such agreement filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. The Registration Statement, including the exhibits and schedules thereto, may be inspected at the public reference facilities maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at its regional offices located at Seven World Trade Center, New York, New York 10007 and 500 West Madison Street, Suite 1400, Chicago, Illinois 60661, and copies of all or any part thereof may be obtained from such offices upon payment of the prescribed fees. You may call the Commission at 1-800-SEC-0330 for further information on the operation of the public reference rooms and you can request copies of the documents upon payment of a duplicating fee, by writing to the Commission. In addition, the Commission maintains a Web site that contains reports, proxy and information statements and other information regarding registrants (including Red Hat) that file electronically with the Commission which can be accessed at http://www.sec.gov. 65 RED HAT, INC. INDEX TO FINANCIAL STATEMENTS
PAGE ----- Report of Independent Accountants.................................................... F-2 Balance Sheets at February 28, 1998 and 1999......................................... F-3 Statements of Operations for the years ended February 28, 1997, 1998 and 1999........ F-4 Statements of Stockholders' Equity (Deficit) for the years ended February 28, 1997, 1998 and 1999...................................................................... F-5 Statements of Cash Flows for the years ended February 28, 1997, 1998 and 1999........ F-6 Notes to Financial Statements........................................................ F-7
F-1 REPORT OF INDEPENDENT ACCOUNTANTS The Board of Directors and Stockholders of Red Hat, Inc. The two-for-one stock split discussed in note 14 to the financial statements has not been consummated at June 4, 1999. When it has been consummated, we will be in a position to furnish the following audit report: "In our opinion, the accompanying balance sheets and the related statements of operations, of stockholders' equity (deficit), and of cash flows present fairly, in all material respects, the financial position of Red Hat, Inc. at February 28, 1998 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended February 28, 1999, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above." /s/ PricewaterhouseCoopers LLP Raleigh, North Carolina April 30, 1999 F-2 RED HAT, INC. BALANCE SHEETS
FEBRUARY 28, ------------------------------------- PRO FORMA 1999 1998 1999 UNAUDITED ----------- ----------- ----------- ASSETS Current assets: Cash and cash equivalents......................... $ 1,292,562 $10,055,227 $10,055,227 Short-term investments............................ 100,000 2,037,992 2,037,992 Accounts receivable, net.......................... 744,551 1,127,193 1,127,193 Inventory......................................... 141,176 345,630 345,630 Prepaid expenses.................................. 383,830 173,730 173,730 Income tax receivable............................. -- 114,145 114,145 ----------- ----------- ----------- Total current assets............................ 2,662,119 13,853,917 13,853,917 Property and equipment, net......................... 337,327 1,270,576 1,270,576 Other assets, net................................... 81,188 151,310 151,310 Investments......................................... 50,000 -- -- ----------- ----------- ----------- Total assets.................................... $ 3,130,634 $15,275,803 $15,275,803 ----------- ----------- ----------- ----------- ----------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable.................................. $ 773,936 $ 2,087,305 $ 2,087,305 Royalties payable................................. 247,323 144,074 144,074 Accrued expenses.................................. 50,334 379,757 379,757 Deferred revenue.................................. 26,207 33,352 33,352 Current portion of capital lease obligations...... 22,797 108,897 108,897 ----------- ----------- ----------- Total current liabilities....................... 1,120,597 2,753,385 2,753,385 Capital lease obligations........................... 65,032 419,778 419,778 Commitments and contingencies (Note 12)............. Mandatorily redeemable preferred stock: Series A, 6,801,400 shares authorized, issued and outstanding; none pro forma..................... 1,983,209 1,992,184 -- Series B, 8,116,550 shares authorized, issued and outstanding; none pro forma..................... -- 6,919,644 -- Series C, 1,797,929 shares authorized, 1,027,388 issued and outstanding; none pro forma.......... -- 3,195,591 -- Stockholders' equity (deficit): Common stock, $.0001 par value, 225,000,000 shares authorized, 23,500,000 and 23,852,950 shares issued and outstanding at February 28, 1998 and 1999, respectively (55,743,626 shares issued and outstanding pro forma at February 28, 1999)..... 2,350 2,385 5,574 Additional paid-in capital........................ 263,650 427,464 12,531,694 Accumulated deficit............................... (304,204) (434,628) (434,628) ----------- ----------- ----------- Total stockholders' equity (deficit)............ (38,204) (4,779) 12,102,640 ----------- ----------- ----------- Total liabilities and stockholders' equity (deficit)..................................... $ 3,130,634 $15,275,803 $15,275,803 ----------- ----------- ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these financial statements. F-3 RED HAT, INC. STATEMENTS OF OPERATIONS
YEAR ENDED FEBRUARY 28, ----------------------------------- 1997 1998 1999 ---------- ---------- ----------- Revenue: Software and related products....................... $2,603,131 $5,131,623 $10,012,923 Services and other.................................. -- 24,000 776,996 ---------- ---------- ----------- Total revenue..................................... 2,603,131 5,155,623 10,789,919 ---------- ---------- ----------- Cost of revenue: Software and related products....................... 1,204,721 2,210,538 4,012,685 Services and other.................................. -- -- 28,148 ---------- ---------- ----------- Total cost of revenue............................. 1,204,721 2,210,538 4,040,833 ---------- ---------- ----------- Gross profit.......................................... 1,398,410 2,945,085 6,749,086 ---------- ---------- ----------- Operating expense: Sales and marketing................................. 491,473 1,252,362 3,083,162 Research and development............................ 325,244 902,826 2,220,115 General and administrative.......................... 525,978 798,592 1,483,909 ---------- ---------- ----------- Total operating expense........................... 1,342,695 2,953,780 6,787,186 ---------- ---------- ----------- Income (loss) from operations......................... 55,715 (8,695) (38,100) ---------- ---------- ----------- Other income (expense): Interest income..................................... 200 34,410 171,181 Interest expense.................................... (23,304) (13,036) (9,463) ---------- ---------- ----------- Other income (expense), net....................... (23,104) 21,374 161,718 ---------- ---------- ----------- Income (loss) before income taxes..................... 32,611 12,679 123,618 Provision for income taxes............................ -- 4,906 214,686 ---------- ---------- ----------- Net income (loss)..................................... 32,611 7,773 (91,068) Accretion on mandatorily redeemable preferred stock... -- -- (39,356) ---------- ---------- ----------- Net income (loss) available to common stockholders.... $ 32,611 $ 7,773 $ (130,424) ---------- ---------- ----------- ---------- ---------- ----------- Net income (loss) per common share: Basic............................................... 0.0014 0.0003 (0.0055) Diluted............................................. 0.0012 0.0002 (0.0055) Weighted average common shares outstanding: Basic............................................... 23,500,000 23,500,000 23,550,050 Diluted............................................. 27,232,520 34,578,277 23,550,050 Pro forma net income (loss) per common share (unaudited): Basic............................................... 0.0014 0.0003 (0.0021) Diluted............................................. 0.0012 0.0002 (0.0021) Pro forma weighted average common shares outstanding: Basic............................................... 23,500,000 30,841,785 43,929,824 Diluted............................................. 27,232,520 34,578,277 43,929,824
The accompanying notes are an integral part of these financial statements. F-4 RED HAT, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
COMMON STOCK ADDITIONAL TOTAL ----------------------- PAID-IN ACCUMULATED STOCKHOLDERS' SHARES AMOUNT CAPITAL DEFICIT EQUITY (DEFICIT) ---------- ----------- ----------- ------------- ---------------- Balance at February 29, 1996................... 23,500,000 $ 2,350 $ 263,650 $ (344,588) $ (78,588) Net income............... -- -- -- 32,611 32,611 ---------- ----------- ----------- ------------- -------- Balance at February 28, 1997................... 23,500,000 2,350 263,650 (311,977) (45,977) Net income............... -- -- -- 7,773 7,773 ---------- ----------- ----------- ------------- -------- Balance at February 28, 1998................... 23,500,000 2,350 263,650 (304,204) (38,204) Exercise of common stock warrants............... 352,950 35 (17) -- 18 Tax benefit on exercise of common stock warrants............... -- -- 163,831 -- 163,831 Accretion of mandatorily redeemable preferred stock.................. -- -- -- (39,356) (39,356) Net loss................. -- -- -- (91,068) (91,068) ---------- ----------- ----------- ------------- -------- Balance at February 28, 1999................... 23,852,950 $ 2,385 $ 427,464 $ (434,628) $ (4,779) ---------- ----------- ----------- ------------- -------- ---------- ----------- ----------- ------------- --------
The accompanying notes are an integral part of these financial statements. F-5 RED HAT, INC. STATEMENTS OF CASH FLOWS
YEAR ENDED FEBRUARY 28, ---------------------------------- 1997 1998 1999 --------- ---------- ----------- Cash flows from operating activities: Net income (loss)...................................... $ 32,611 $ 7,773 $ (91,068) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization........................ 37,134 102,876 177,656 Provision for doubtful accounts...................... 38,986 38,141 185,092 Provision for inventory obsolescence................. -- -- 182,509 Deferred revenue..................................... -- 26,207 7,145 Changes in operating assets and liabilities: Accounts receivable................................ (251,774) (479,746) (567,734) Inventory.......................................... (14,934) (84,507) (386,963) Prepaid expenses................................... (12,248) (370,571) 210,100 Income tax receivable.............................. -- -- 49,686 Other assets....................................... 1,613 (15,408) (75,478) Accounts payable................................... 282,453 290,253 1,313,369 Royalties payable.................................. 57,477 189,846 (103,249) Accrued expenses................................... (66,044) 19,019 329,423 --------- ---------- ----------- Net cash provided by (used in) operating activities..................................... 105,274 (276,117) 1,230,488 --------- ---------- ----------- Cash flows from investing activities: Purchase of investment securities...................... -- (150,000) (1,966,600) Proceeds from sale of investment securities............ -- -- 100,000 Purchase of equipment.................................. (201,322) (158,004) (654,235) Proceeds from sale of equipment........................ -- 24,272 -- --------- ---------- ----------- Net cash used in investing activities............ (201,322) (283,732) (2,520,835) --------- ---------- ----------- Cash flows from financing activities: Proceeds from borrowing from stockholders.............. 50,000 -- -- Repayments of borrowings from stockholders............. -- (86,243) -- Proceeds from notes payable............................ 46,048 239,214 -- Repayments of notes payable............................ -- (279,019) -- Proceeds from issuance of mandatorily redeemable preferred stock, net................................. -- 1,983,209 10,084,854 Proceeds from exercise of common stock warrants........ -- -- 18 Payments on capital lease obligations.................. -- (4,750) (31,860) --------- ---------- ----------- Net cash provided by financing activities........ 96,048 1,852,411 10,053,012 --------- ---------- ----------- Net increase in cash and cash equivalents.............. -- 1,292,562 8,762,665 Cash and cash equivalents beginning of the year........ -- -- 1,292,562 --------- ---------- ----------- Cash and cash equivalents end of year.................. $ -- $1,292,562 $10,055,227 --------- ---------- ----------- --------- ---------- -----------
The accompanying notes are an integral part of these financial statements. F-6 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS 1. NATURE OF BUSINESS BUSINESS ACTIVITY Red Hat, Inc. ("Red Hat" or the "Company") is a leading developer and global provider of open source software products and services, and has built a comprehensive Web site dedicated to the open source software community. Red Hat, Inc. was incorporated in Connecticut in March 1993 as ACC Corp., Inc. In September 1995 ACC Corp., Inc. changed its name to Red Hat Software, Inc. In September 1998, Red Hat Software, Inc. reincorporated in Delaware. In June 1999, Red Hat Software, Inc. changed its name to Red Hat, Inc. The Linux operating system ("Linux") is copyrighted under the terms of the GNU General Public License (the "GPL") which states that the source code must be freely distributable. The Company develops and publishes software applications that are sold as shrink-wrapped software and releases freely-redistributable software available for unrestricted download on the Internet. In addition, the Company publishes and sells reference books on the Linux operating system. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES UNAUDITED PRO FORMA BALANCE SHEET The Board of Directors has authorized the Company to file a Registration Statement with the Securities and Exchange Commission permitting the Company to sell shares of common stock in an initial public offering ("IPO"). If the IPO is consummated as presently anticipated, each share of the Series A, Series B, and Series C mandatorily redeemable preferred stock will automatically convert into two shares of common stock. The unaudited pro forma balance sheet reflects the subsequent conversion of Series A, Series B, and Series C preferred shares into common stock at a 2 for 1 conversion ratio as if such conversion has occurred as of February 28, 1999. The unaudited pro forma balance sheet does not include the conversion of 1,027,388 shares of Series C preferred stock which were sold in March and April 1999 for net proceeds of $3,227,026 (see Note 9) into 2,054,776 shares of common stock. Had such amount been included, total stockholders' equity on a pro forma basis would have been $15,329,666. 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 reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS The Company considers investments purchased with a maturity period of three months or less at the date of purchase to be cash equivalents. INVESTMENTS The Company's investments are all in debt securities which are classified as held-to-maturity and are carried at amortized cost in accordance with Statement of Financial Accounting Standards F-7 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) No. 115 "Accounting for Investments in Debt and Equity Securities", as the Company has both the positive intent and ability to hold them to maturity. INVENTORY The costs incurred for duplicating the computer software, documentation, and training materials from the product masters and for packaging the product for distribution are capitalized as inventory using the weighted average method and charged to cost of sales when revenue from the sale of units is recognized. Management periodically evaluates the realizability of inventory based on planned release dates of product updates and records a reserve for obsolescence when necessary. The reserve for inventory obsolescence was $0 and $182,509 at February 28, 1998 and 1999, respectively. CAPITALIZED SOFTWARE COSTS Capitalization of software development costs begins upon the establishment of technological feasibility and ceases when the product is available for general release. The establishment of technological feasibility and the ongoing assessment of recoverability of capitalized software development costs require considerable judgment by management with respect to certain external factors including, but not limited to, technological feasibility, anticipated future gross revenue, estimated economic life and changes in software and hardware technologies. As a result of the Company's practice of releasing source code that it has developed on a weekly basis for unrestricted download on the Internet, there is generally no passage of time between achievement of technological feasibility and the availability of the Company's product for general release. Therefore, the Company has no capitalized software development costs at February 28, 1998 and 1999. PROPERTY AND EQUIPMENT Property and equipment is primarily comprised of furniture and computer equipment which are recorded at cost and depreciated over their estimated useful lives using the straight line method. Expenditures for maintenance and repairs are charged to operations as incurred; major expenditures for renewals and betterments are capitalized and depreciated. Property and equipment acquired under capital leases are being depreciated over their estimated useful lives or the respective lease term, if shorter. Depreciation periods used for property and equipment are as follows: Computer equipment........................................... 3 years Furniture and fixtures....................................... 7 years 4 to 25 Leasehold improvements....................................... years
OTHER ASSETS Costs incurred for acquiring trademarks, copyrights and patents are capitalized and amortized over their estimated useful lives, which range from 5 to 15 years, using the straight line method. Other assets also includes security deposits which are expected to be refunded to the Company upon termination of certain leases. F-8 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) IMPAIRMENT OF LONG-LIVED ASSETS The Company evaluates the recoverability of its property and equipment, and other assets in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed of" ("SFAS 121"). SFAS 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the estimated future undiscounted cash flows attributable to such assets or the business to which such intangible assets relate. No impairments were required to be recognized during the years ended February 28, 1997, 1998 and 1999. REVENUE RECOGNITION Revenues from the sale of software products are generally recognized upon shipment of the products, net of estimated returns. A reserve for sales returns is recognized for sales of software products to distributors, who have a right of return based on the Company's historical experience of sell-through to the end user by the distributor. Revenue for maintenance and support services is deferred and recognized ratably over the term of the agreement, which is typically twelve months. Such revenues have been insignificant to date. In instances where the fee for support and maintenance services is included in the fee for the software products, revenue is allocated to each element based on their respective fair values with these fair values determined using the price charged when that element is sold separately. Revenue from customer training, and other services is recognized as the service is performed. Royalty revenue, which is included in services and other revenue, is comprised primarily of royalties received from the sale of rights to the Company's brand and trademark and royalties received from international distributors of the Company's products. Royalty revenue is recognized when received. Revenue from sale of books, which is include in software and related products revenue, published by the Company, is recognized at the date of shipment, net of estimated returns. Advertising revenue is recognized ratably in the period in which the advertisement is displayed, provided that we have no significant remaining obligations, at the lesser of the ratio of impressions delivered over total guaranteed impressions delivered over total guaranteed impressions or the straight line basis over the term of the contract. To the extent that minimum guaranteed impressions are not met, the Company defers recognition of the corresponding revenue until the guaranteed impressions are achieved. The Company did not generate revenue from the sale of advertising on our Web site during the fiscal years ended February 28, 1997, 1998 and 1999. ROYALTY COSTS Royalties that the Company is required to pay on applications licensed from third parties that are a component of the software products sold by the Company are expensed as cost of sales on a per unit basis as software products are sold. Royalties paid in advance of the sale of the Company's software products are included in prepaid expenses and recorded as expense when the related software products are sold. F-9 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SIGNIFICANT CUSTOMERS AND CREDIT RISK The Company performs ongoing credit evaluations to reduce credit risk and requires no collateral from its customers. Management estimates the allowance for uncollectible accounts based on their historical experience and credit evaluation. Sales to one distributor comprised $416,501 or 16%, $1,340,462 or 26% and $2,135,733 or 20% of total revenues for the years ended February 28, 1997, 1998 and 1999, respectively. Sales to one other distributor comprised $3,719,162 or 34% of total revenues for the year ended February 28, 1999. All of the Company's software revenues are from sales transactions originating in the United States. The Company has received certain royalty payments from international sources; however, such amounts have been insignificant to date. STOCK BASED COMPENSATION The Company accounts for stock based compensation based on the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), which states that no compensation expense is recorded for stock options or other stock-based awards to employees that are granted with an exercise price equal to or above the estimated fair value per share of the Company's common stock on the grant date. The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), which requires compensation expense to be disclosed based on the fair value of the options granted at the date of the grant. SALES AND MARKETING EXPENSES Sales and marketing expenses consist primarily of costs, including salaries and sales commissions, of all personnel involved in the sales process and related expenses. Sales and marketing expenses also include costs of advertising and trade shows. All costs of advertising the software products, books and related services offered by the Company are expensed as incurred. Advertising expense totaled $69,109, $152,939 and $597,822 for the years ended February 28, 1997, 1998 and 1999, respectively. RESEARCH AND DEVELOPMENT COSTS Research and development expenses include all direct costs, primarily personnel and outside consultants, related to the development of new products and significant enhancements to existing products and are charged to operations as incurred until such time as technological feasibility is achieved. INCOME TAXES The Company accounts for income taxes using the liability method which requires the recognition of deferred tax assets or liabilities for the temporary differences between financial reporting and tax bases of the Company's assets and liabilities and for tax carryforwards at enacted statutory tax rates in effect for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the F-10 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) enactment date. In addition, valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. CASH FLOWS The Company made cash payments for interest of $23,304, $13,036, and $9,463 for the years ended February 28, 1997, 1998, and 1999, respectively. The Company made no cash payments for income taxes during the years ended February 28, 1997 and 1998 and $163,831 during the year ended February 28, 1999. The Company acquired property and equipment through the assumption of capital lease obligations amounting to $22,466, $75,299 and $472,706 for the years ended February 28, 1997, 1998, and 1999 respectively. NET INCOME (LOSS) PER COMMON SHARE HISTORICAL The Company computes net income (loss) per common share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share," ("SFAS 128") and SEC Staff Accounting Bulletin No. 98 ("SAB No. 98"). Under the provisions of SFAS 128 and SAB No. 98, basic net income (loss) per common share ("Basic EPS") is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding. Diluted net income (loss) available to common stockholders per common share ("Diluted EPS") is computed by dividing net income (loss) by the weighted average number of common shares and dilutive potential common share equivalents then outstanding. Potential common shares consist of shares issuable upon the exercise of stock options and warrants and shares issuable upon conversion of outstanding mandatorily redeemable preferred stock. The calculation of the net loss per share available to common stockholders for the fiscal year ended February 28, 1999 does not include 24,299,071 potential shares of common stock equivalents, as their impact would be antidilutive. PRO FORMA (UNAUDITED) Pro forma net income (loss) per common share is calculated assuming conversion of all mandatorily redeemable preferred stock which converts automatically upon the completion of the initial public offering into 31,890,676 shares of common stock (see Note 9). Therefore, accretion of mandatorily redeemable preferred stock of $39,356 for the year ended February 28, 1999 is excluded from the calculation of pro forma net income (loss) per common share. The calculation of pro forma net loss per common share for the fiscal year ended February 28, 1999 does not include 3,919,297 potential shares of common stock equivalents, as their impact would be anti-dilutive. SEGMENT REPORTING In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). This statement requires companies to report information about operating segments in interim and annual F-11 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) financial statements. It also requires segment disclosures about products and services, geographic areas and major customers. The Company adopted SFAS 131 effective for its fiscal year ended February 28, 1998. The Company has determined that it did not have any separately reportable operating segments as of February 28, 1997, 1998 or 1999. COMPREHENSIVE INCOME In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS 130 is effective for financial statements for fiscal years beginning after December 15, 1997. Its adoption did not impact the Company's financial position, results of operations, or cash flows as the Company had no items of other comprehensive income during the three year period ended February 28, 1999. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. As issued, SFAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999, with earlier application encouraged. In May 1999, the FASB delayed the effective date of SFAS 133 for one year, to fiscal quarters of all fiscal years beginning after June 15, 2000. The Company does not currently nor does it intend in the future to use derivative instruments and therefore does not expect that the adoption of SFAS 133 will have any impact on its financial position or results of operations. In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants ("AICPA"), issued Statement of Position No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP No. 98-1"), which provides guidance regarding when software developed or obtained for internal use should be capitalized. SOP No. 98-1 is effective for fiscal years beginning after December 15, 1998. The Company does not expect that the adoption of SOP No. 98-1 will have a material impact on its financial position or results of operations. In December 1998, the AICPA issued Statement of Position No. 98-9, "Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions" ("SOP No. 98-9"). SOP No. 98-9 amends SOP No. 97-2 to require recognition of revenue using the "residual method" in circumstances outlined in the SOP. Under the residual method, revenue is recognized as follows: (1) the total fair value of undelivered elements, as indicated by vendor specific objective evidence, is deferred and subsequently recognized in accordance with the relevant sections of SOP No. 97-2 and (2) the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements. SOP No. 98-9 is effective for transactions entered into in fiscal years beginning after March 15, 1999. Also, the provisions of SOP No. 97-2 that were deferred by SOP No. 98-4 will continue to be deferred until F-12 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) the date SOP No. 98-9 becomes effective. The Company does not expect that the adoption of SOP No. 98-9 will have a significant impact on the Company's results of operations or financial position. 3. ACCOUNTS RECEIVABLE Accounts receivable, which are primarily from product sales, are presented net of an allowance for doubtful accounts. The activity in the Company's allowance for doubtful accounts for the years ended February 28, 1997, 1998 and 1999 is presented in the following table:
BALANCE AT CHARGED TO BALANCE AT BEGINNING INCOME OR END OF YEAR ENDED FEBRUARY 28, OF PERIOD EXPENSE DEDUCTIONS (A) PERIOD - ------------------------------------- ----------- ----------- --------------- ----------- 1997................................. $ -- $ 38,986 $ (554) $ 38,432 1998................................. 38,432 38,141 (27,829) 48,744 1999................................. 48,744 185,092 (73,458) 160,378
- ------------------------ (a) Represents amounts written-off as uncollectible accounts receivable. 4. PROPERTY AND EQUIPMENT The Company's property and equipment consisted of the following:
FEBRUARY 28, --------------------- 1998 1999 --------- ---------- Computer equipment.................................. $ 420,523 $ 818,676 Furniture and fixtures.............................. 69,256 583,175 Leasehold improvements.............................. -- 214,868 --------- ---------- 489,779 1,616,719 Less: accumulated depreciation...................... (152,452) (346,143) --------- ---------- $ 337,327 $1,270,576 --------- ---------- --------- ----------
5. OTHER ASSETS Other assets were comprised of the following:
FEBRUARY 28, -------------------- 1998 1999 --------- --------- Security deposits....................................... $ 11,900 $ 78,130 Trademarks, patents and copyrights, net................. 69,288 73,180 --------- --------- $ 81,188 $ 151,310 --------- --------- --------- ---------
F-13 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying value of cash and cash equivalents, accounts payable and accounts receivable at February 28, 1998 and 1999 approximated their fair value due to the short-term nature of these items. The fair value of the Company's short-term and long-term investments at February 28, 1998 and 1999 approximated their carrying values as these investments were primarily in short-term US Government obligations and certificates of deposit. 7. ACCRUED EXPENSES Accrued expenses were comprised of the following:
FEBRUARY 28, -------------------- 1998 1999 --------- --------- Payroll................................................. $ -- $ 212,608 Vacation................................................ 3,501 59,165 Taxes................................................... 5,151 14,025 Other................................................... 41,682 93,959 --------- --------- $ 50,334 $ 379,757 --------- --------- --------- ---------
8. INCOME TAXES The components of the Company's provision for income taxes consisted of the following:
YEAR ENDED FEBRUARY 28, ------------------------------- 1997 1998 1999 --------- --------- --------- Current tax provision: Federal....................................... $ -- $ -- $ 149,284 State......................................... -- 4,906 65,402 --------- --------- --------- Current tax expense........................... -- 4,906 214,686 --------- --------- --------- Deferred tax benefit: Federal....................................... -- -- -- State......................................... -- -- -- --------- --------- --------- Deferred tax benefit.......................... -- -- -- --------- --------- --------- Net provision for income taxes.............. $ -- $ 4,906 $ 214,686 --------- --------- --------- --------- --------- ---------
F-15 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES (CONTINUED) Significant components of the Company's deferred tax assets and liabilities at February 28, 1999 and 1998 consisted of the following:
1998 1999 --------- --------- Domestic net operating loss carryforwards............ $ 23,697 $ -- Accounts receivable.................................. 21,818 217,777 Allowance for inventory obsolescence................. -- 70,785 Research and development credit...................... 67,629 -- Other accruals....................................... 1,376 22,947 --------- --------- Total deferred tax assets.......................... 114,520 311,509 Valuation allowance for deferred tax assets.......... (109,040) (307,423) --------- --------- Deferred tax assets................................ 5,480 4,086 --------- --------- Property and equipment............................... (5,480) (4,086) --------- --------- Total deferred tax liabilities..................... (5,480) (4,086) --------- --------- Net deferred tax assets............................ $ -- $ -- --------- --------- --------- ---------
As of February 28, 1998 and 1999, the Company provided a full valuation allowance against its net deferred tax assets since realization of these benefits can not be reasonably assured. An increase in the valuation allowance was recorded during fiscal 1999 to reserve the increase in total deferred tax assets at February 28, 1999 due to uncertainty of realizability. As of February 28, 1998, the Company had federal and state net operating loss carryforwards of approximately $70,000. This carryforward was fully utilized during 1999. Taxes computed at the statutory federal income tax rate of 34% are reconciled to the provision for income taxes as follows:
1997 1998 1999 --------- --------- --------- Effective rate............................... 0% 39% 174% --------- --------- --------- United States Federal tax at statutory rate....................................... $ 12,214 $ 4,311 $ 42,030 State taxes (net of Federal benefit)......... 1,897 13,392 7,619 Change in valuation reserves................. (17,040) 28,993 198,477 Research and development credit.............. -- (67,629) (43,959) Non-deductible items......................... 2,929 25,839 10,519 --------- --------- --------- Provision for income taxes................... $ -- $ 4,906 $ 214,686 --------- --------- --------- --------- --------- ---------
9. MANDATORILY REDEEMABLE PREFERRED STOCK The Company has authorized 6,801,400, 8,116,550 and 2,054,776 shares of Series A, Series B and Series C mandatorily redeemable preferred stock, respectively. The shares of Series A, Series B and Series C mandatorily redeemable preferred stock have a par value of $0.0001 per share. F-16 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. MANDATORILY REDEEMABLE PREFERRED STOCK (CONTINUED) On August 15, 1997, the Company entered into a purchase agreement with an investor (the "Series A Investor"). In connection with this agreement, the Company issued 6,801,400 shares of Series A preferred stock to the Series A Investor for $2,000,000 or $0.2941 per share, less related issuance costs of $16,791. The Series A preferred stock became mandatorily redeemable with the issuance of the Series B mandatorily preferred stock in September 1998. On September 29, 1998, the Company entered into a purchase agreement with several investors (the "Series B Investors"). In connection with this agreement, the Company issued 8,116,550 shares of Series B mandatorily redeemable preferred stock to the Series B Investors for $6,955,884, or $0.857 per share, less related issuance costs of $66,621. On February 25, 1999, the Company entered into a purchase agreement with several investors (the "Series C Investors"). In connection with this agreement, the Company issued 1,027,388 shares of Series C mandatorily redeemable preferred stock to the Series C Investors for $3,227,026, or $3.141 per share. The Company had additional closings of the Series C mandatorily redeemable preferred stock financing subsequent to February 28, 1999. Additional Series C Investors purchased 1,027,388 shares of Series C mandatorily redeemable preferred stock for $3,227,026, or $3.141 per share in March and April of 1999. Total issuance costs related to sales of Series C mandatorily redeemable preferred stock were $62,870. DIVIDENDS The Series A, Series B and Series C stockholders (the "Holders") are not entitled to dividends unless dividends are declared on shares of common stock, in which case the Holders shall receive a distribution on each outstanding share of Series A, Series B and Series C mandatorily redeemable preferred stock on an as if converted basis. CONVERSION Each share of Series A, Series B and Series C mandatorily redeemable preferred stock can be converted to common stock at the option of the Holders at a two-to-one conversion rate, subject to certain adjustments. This conversion rate shall be adjusted upon the issuance by the Company of additional common shares (with certain exceptions) for consideration per share less than $0.343 per share, in the case of Series A mandatorily redeemable preferred stock, $0.996 per share, in the case of Series B mandatorily redeemable preferred stock and $3.893 per share, in the case of Series C mandatorily redeemable preferred stock. The conversion rate shall also be adjusted for common stock splits, reverse common stock splits, dividends and distributions. Each share of Series A, Series B and Series C mandatorily redeemable preferred stock will be automatically converted into shares of common stock, at the then effective conversion rate, upon the closing of a sale of the common stock of the Company in a qualified public offering. VOTING RIGHTS Holders of Series A, Series B and Series C mandatorily redeemable preferred stock have the right to one vote for each common share into which such shares could then be converted, as described above. F-17 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. MANDATORILY REDEEMABLE PREFERRED STOCK (CONTINUED) LIQUIDATION In the event of the liquidation, dissolution or winding up of the Company, Holders shall be entitled to receive, prior to any distributions to common stockholders, an amount in cash equal to the greater of (i) $0.343 per share, in the case of Series A, $0.996 per share, in the case of Series B, and $3.893 per share, in the case of Series C, plus any dividends declared but unpaid, or (ii) such amount per share as would have been payable had each such share been converted into common stock immediately prior to liquidation, dissolution or winding up, as described above. In the event that assets of the Company are insufficient to permit payment of the above mentioned amounts, the Holders shall share ratably in any distribution of the remaining assets and funds of the Company in proportion to the respective amounts which would otherwise be payable pursuant to the above. REDEMPTION The Company could be required to redeem the Series A, Series B and Series C mandatorily redeemable preferred stock from the Holders upon receipt of written request from Holders of shares representing at least 66 2/3% of the aggregate number of shares of common stock issuable upon conversion. Redemption may first be made by the Holders on February 25, 2004 and on each of the first and second anniversaries thereof. Redemption is limited to 33% and 50% of the Series A, Series B and Series C shares outstanding on February 25, 2004 and the first anniversary thereof, respectively. There is no limitation on the number of shares on February 25, 2006. The redemption price is equal to $0.343 per share in the case of Series A, $0.996 per share, in the case of Series B and $3.893 per share, in the case of Series C, subject to adjustment for certain events. The carrying value of the Company's mandatorily redeemable preferred stock is being accreted to its redemption price over the redemption period using the effective interest rate method. In conjunction with the sale of the Series B mandatorily redeemable preferred stock, the Series A mandatorily redeemable preferred stock became mandatorily redeemable. CARRYING VALUE The Series A, Series B and Series C mandatorily redeemable preferred stock were initially recorded at the total net proceeds received by the Company upon issuance. The difference between the total net proceeds at issuance of $12,068,063 and the total redemption price of $14,416,585 is charged to retained earnings over the period from issuance until redemption first becomes available. The amount of accretion recognized during each period is determined by using the effective interest rate method. For the year ended February 28, 1999 the accretion was $39,356. The Company had no outstanding mandatoriily redeemable preferred stock prior to the fiscal year ended February 28, 1999. 10. COMMON STOCK On September 28, 1998, the Company effected a 100 for 1 stock split for holders of its common stock. Amounts presented for the periods prior to the stock split have been restated to reflect the stock split on a retroactive basis. The Company has authorized 68,620,652 shares of common stock with a par value of $0.0001 per share. Holders of these shares have one vote per share. Upon the dissolution, liquidation or F-18 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. COMMON STOCK (CONTINUED) winding up of the Company, holders of common stock will be entitled to receive the assets of the Company subject to the preferential rights of the outstanding Series A, Series B and Series C mandatorily redeemable preferred stock or any other outstanding stock ranking on liquidation senior to or on parity with the common stock. On September 29, 1998, in connection with the above mentioned sale of Series B mandatorily redeemable preferred stock, certain stockholders, primarily comprised of officers of the Company, entered into a common stock purchase agreement with the Series B Investors. In connection with this agreement, those stockholders sold 2,625,500 shares of common stock to the Series B Investors for $1,125,000 or $0.429 per share. On February 25, 1999, in connection with the above mentioned sale of Series C mandatorily redeemable preferred stock, certain stockholders, primarily comprised of officers of the Company, entered into a common stock purchase agreement with the Series C Investors. In connection with this agreement, those stockholders sold 492,184 shares of common stock to the Series C Investors for $772,975 or $1.571 per share. Upon additional closings of the Series C mandatorily redeemable preferred stock financing in March and April of 1999, an additional 492,184 shares of common stock were sold by certain stockholders primarily comprised of officers of the Company to the additional Series C Investors for $772,975 or $1.571 per share. 11. STOCK OPTIONS AND WARRANTS STOCK OPTIONS During September 1998, the Company's Board of Directors approved a stock option plan whereby 5,834,800 shares of common stock have been reserved for issuance pursuant to grants of options to any employee, officer or director or consultant of the Company at terms and prices to be determined by the Board of Directors. In April 1999, the Board increased the pool to 7,434,800 shares. The plan provides that the exercise price per share and the purchase price per share for each non-qualified option should be set by the Board on the date of grant. The price for each Incentive Stock Option (ISO) shall not be less than the fair market value of the common stock on the date of grant. The maximum term for an option granted is ten years from the date of grant. The Company believes that all options and warrants, granted through February 28, 1999, have been granted at their fair values on their respective grant dates. Options granted under the plan generally vest 25% upon completion of one full year of service and 6.25% on the first day of each subsequent three-month period. All options are immediately exercisable upon grant into restricted shares of the Company's common stock, subject to repurchase, with the same vesting provisions as the original option. F-19 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. STOCK OPTIONS AND WARRANTS (CONTINUED) The activity for the stock option plan for the year ended February 28, 1999 and for the period from March 1, 1999 to May 31, 1999 is presented in the following table:
WEIGHTED SHARES AVERAGE UNDERLYING EXERCISE PRICE OPTIONS PER SHARE ----------- ----------------- Outstanding at February 28, 1998............................... -- $ -- Granted........................................................ 4,322,570 0.36 Forfeited...................................................... (20,000) 0.18 ----------- Outstanding at February 28, 1999............................... 4,302,570 0.36 Granted (unaudited)............................................ 3,207,070 2.17 Exercised (unaudited).......................................... (2,071,552) 0.88 Forfeited (unaudited).......................................... (20,000) 1.57 ----------- Outstanding at May 31, 1999 (unaudited)........................ 5,418,088 $ 1.23
Prior to February 28, 1998, the Company had granted no stock options. The following summarizes information about the Company's stock options at February 28, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------ ------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE NUMBER CONTRACTURAL EXERCISE NUMBER EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE - ----------- ------------ --------------- ----------- ------------ ----------- $ 0.18 1,200,000 9.58 $ 0.18 1,200,000 $ 0.18 $ 0.43 3,102,570 9.67 $ 0.43 3,102,570 $ 0.43
The following summarizes certain information regarding stock option grants during the period from March 1, 1999 to May 31, 1999 (unaudited):
EXERCISE NUMBER OF DATE OF GRANT PRICE SHARES - ----------------------------------------------------- ----------- ----------- March 1999........................................... $ 1.57 212,000 April 1999........................................... $ 1.57 2,393,972 May 3, 1999.......................................... $ 1.57 40,000 May 10, 1999......................................... $ 5.00 561,098 ----------- 3,207,070
STOCK WARRANTS On October 10, 1995, the Company issued warrants (which are equivalent to nonqualified stock options) to purchase 3,740,400 shares of common stock to three of its employees with an exercise price of $.0001 per share. The warrants vest 25% annually on each May 1, beginning May 1, 1996 F-20 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. STOCK OPTIONS AND WARRANTS (CONTINUED) and ending May 1, 1999. The warrants terminate upon death, permanent disability, termination of employment or May 1, 2006. The Company and certain founding shareholders have a right of first refusal to purchase the warrant shares on the same terms as a proposed purchaser and a right to purchase the shares upon the death, disability, or termination of employment of the employee. Upon the death, disability, or termination without cause of the employee, the purchase price shall be 80% of the fair market value of the Company's common stock as determined by the board of directors. If the employee is terminated for cause, the purchase price shall be 80% of the lesser of the book value or the fair market value of the Company's common stock. The activity for the stock warrants is presented in the following table:
YEAR ENDED FEBRUARY 28, ---------------------------------------------------------------------------- 1997 1998 1999 ------------------------ ------------------------ ------------------------ WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE UNDERLYING PRICE UNDERLYING PRICE UNDERLYING PRICE WARRANTS PER SHARE WARRANTS PER SHARE WARRANTS PER SHARE ----------- ----------- ----------- ----------- ----------- ----------- Outstanding at beginning of year................ 3,740,400 $ 0.0001 3,740,400 $ 0.0001 3,740,400 $ 0.0001 ----------- ----------- ----------- ----------- ----------- ----------- Exercised................ -- -- -- -- (352,950) $ 0.0001 Outstanding at end of year................... 3,740,400 $ 0.0001 3,740,400 $ 0.0001 3,387,450 $ 0.0001 Exercisable at end of year................... 935,100 $ 0.0001 1,870,200 $ 0.0001 2,452,350 $ 0.0001
During the three month period ended May 31, 1999, 190,000 warrants were exercised. At May 31, 1999, 3,197,450 warrants remained outstanding. Amounts as of May 31, 1999 are unaudited. SFAS 123 requires the Company to disclose pro forma information regarding option grants made and warrants issued to its employees. SFAS 123 specifies certain valuation techniques that produce estimated compensation charges that are included in the pro forma results below. These amounts have not been reflected in the Company's statement of operations, because APB No. 25 specifies that no compensation charge arises when the exercise price of employees' stock options and warrants equal the market value of the underlying stock at the grant date, as in the case of options and warrants granted to the Company's employees. The fair value of options and warrants was estimated using the minimum value method with the following assumptions:
EMPLOYEE EMPLOYEE STOCK STOCK OPTIONS WARRANTS ------------- ------------- Expected dividend yield............................. 0.00% 0.00% Risk-free interest rate............................. 4.98% 5.81% Expected volatility................................. 0.00% 0.00% Expected life (in years)............................ 6 6
F-21 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. STOCK OPTIONS AND WARRANTS (CONTINUED) SFAS 123 pro forma numbers are as follows:
1999 --------- Net loss available to common stockholders as reported under APB No. 25............................................... $ 130,424 Pro forma net loss available to common stockholders.............. $ 287,288
The Company did not grant any stock options or warrants in fiscal 1998 or 1997 and, therefore, no pro forma disclosure for these years is provided. The weighted average estimated fair value of employee stock options granted during the year ended February 28, 1999 was $0.27 per share. The weighted average estimated fair value of the warrants at the time of grant was $0.0001 per share. 12. COMMITMENTS AND CONTINGENCIES As of February 28, 1999, the Company leased office space and certain equipment under various noncancelable operating and capital leases. Future minimum lease payments required under the operating and capital leases at February 28, 1999 are as follows:
OPERATING CAPITAL LEASES LEASES ---------- --------- 2000................................................. $ 945,612 $ 139,698 2001................................................. 934,208 136,901 2002................................................. 931,283 120,863 2003................................................. 932,200 112,089 2004................................................. 819,266 99,687 ---------- --------- Total minimum lease payments....................... $4,562,569 609,238 ---------- ---------- Less amount representing interest (at rates ranging from 8.2% to 9.6%)................................. 80,563 --------- Present value of net minimum lease payments.......... 528,675 Less current portion................................. 108,897 --------- Long-term portion.................................. $ 419,778 --------- ---------
Rent expense under operating leases for the years ended February 28, 1997, 1998 and 1999 was $86,313, $171,191 and $308,973 respectively. The Company has entered into an agreement with a bank to provide a letter of credit pertaining to its building lease. The Company is required by the bank to maintain a compensating balance of $65,000 which is equal to the amount of the letter of credit. This amount is included in cash and cash equivalents. The Company has executed licensing contracts to publish, bundle and distribute software products developed by other companies in return for royalty payments based on a percentage of the revenues generated by the Company from the sale of these products. Prepaid royalty payments are included in current assets and royalty payments due are included in royalties payable. F-22 RED HAT, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 12. COMMITMENTS AND CONTINGENCIES (CONTINUED) In April 1999, the Company also contracted with a Web support firm to maintain its backup web site. The initial fee of $98,000 was due upon receipt and installation of the hardware. The Company has agreed to pay a monthly maintenance fee of $17,000 for a period of 36 months. 13. EMPLOYEE BENEFIT PLAN The Company provides a retirement plan qualified under Section 401(k) of the Internal Revenue Code ("IRC") of 1986, as amended. Participants may elect to contribute a portion of their annual compensation to the plan, subject to certain limitations set by the IRC. Employees are eligible to participate in the plan who are over 21 years of age and have completed three months of service with Red Hat. If, however, an employee was employed by the Company prior to February 1999, the 401(k) Plan covers such employee regardless of age or length of service. The Company has the option to make contributions to the plan but did not make any contributions to the plan for the years ended February 28, 1997, 1998 and 1999. 14. SUBSEQUENT EVENTS On June 2, 1999, the Board of Directors approved a two-for-one common stock split to be effective upon the closing of the Company's IPO. All share and per share information in the accompanying financial statements and notes to the financial statements has been retroactively restated to reflect the effect of this stock split. In addition, the Board of Directors approved, as of the effective date of the IPO, that the authorized capital stock will consist of 225,000,000 shares of common stock and 5,000,000 shares of preferred stock each with a par value of $.0001 per share. F-23 UNDERWRITING Red Hat and the underwriters named below (the "Underwriters")will enter into an underwriting agreement with respect to the shares being offered. Subject to certain conditions, each underwriter will severally agree to purchase the number of shares indicated in the following table. Goldman, Sachs & Co., Thomas Weisel Partners LLC and E*TRADE Securities, Inc. are the representatives of the underwriters.
Number of Underwriters Shares ----------- ----------- Goldman, Sachs & Co. ........................................... Thomas Weisel Partners LLC...................................... E*TRADE Securities, Inc......................................... ----------- Total................................................... ----------- -----------
If the Underwriters sell more shares than the total number set forth in the table above, the Underwriters have an option to buy up to an additional shares from Red Hat to cover such sales. They may exercise that option for 30 days. If any shares are purchased pursuant to this option, the Underwriters will severally purchase shares in approximately the same proportion as set forth in the table above. The following table shows the per share and total underwriting discounts to be paid to the Underwriters by Red Hat. These amounts are shown assuming both no exercise and full exercise of the Underwriters' option to purchase additional shares. Paid by Red Hat
No Full Exercise Exercise ----------- ----------- Per Share...... $ $ Total.......... $ $
Shares sold by the Underwriters to the public will initially be offered at the initial public offering price set forth on the cover of this prospectus. Any shares sold by the Underwriters to securities dealers may be sold at a discount of up to $ per share from the initial public offering price. Any of these securities dealers may resell any shares purchased from the Underwriters to certain other brokers or dealers at a discount of up to $ per share from the initial public offering price. If all the shares are not sold at the initial offering price, the representatives may change the offering price and the other selling terms. Red Hat and its officers, directors, stockholders and optionholders have agreed with the Underwriters not to dispose of or hedge any of its common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus continuing through the date 180 days after the date of this prospectus, except with the prior written consent of Goldman Sachs. This agreement does not apply to any existing employee benefit plan. See "Shares Eligible for Future Sale" for a discussion of certain transfer restrictions. At the request of Red Hat, the Underwriters have reserved up to shares of common stock for sale, at the initial public offering price, to directors, officers, employees and friends of Red Hat through a directed share program. There can be no assurance that any of the reserved shares will be so purchased. The number of shares of common stock available for sale to the general public in the public offering will be reduced to the extent these persons purchase these reserved shares. Any reserved shares not so purchased will be offered to the general public on the same basis as the other shares offered hereby. Thomas Weisel Partners LLC, one of the representatives of the underwriters, was organized and registered as a broker-dealer in U-1 December 1998. Since December 1998, Thomas Weisel Partners has been named as a lead or co-manager of 37 filed public offerings of equity securities, of which 17 have been completed, and has acted as a syndicate member in an additional 10 public offerings of equity securities. Thomas Weisel Partners does not have any material relationship with us or any of our officers, directors or other controlling persons, except with respect to its contractual relationship with us pursuant to the underwriting agreement entered into in connection with this offering. Prior to this offering, there has been no public market for the shares. The initial public offering price will be negotiated among Red Hat and the representatives. Among the factors to be considered in determining the initial public offering price of the shares, in addition to prevailing market conditions, will be Red Hat's historical performance, estimates of the business potential and earnings prospects of Red Hat, an assessment of Red Hat's management and the consideration of the above factors in relation to market valuation of companies in related businesses. Red Hat has applied to list the common stock on the Nasdaq National Market under the symbol "RHAT". In connection with this offering, the Underwriters may purchase and sell shares of common stock in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the Underwriters of a greater number of shares than they are required to purchase in the offering. Stabilizing transactions consist of certain bids or purchases made for the purpose of preventing or retarding a decline in the market price of the common stock while the offering is in progress. The Underwriters also may impose a penalty bid. This occurs when a particular underwriter repays to the Underwriters a portion of the underwriting discount received by it because the representatives have repurchased shares sold by or for the account of that underwriter in stabilizing or short covering transactions. These activities by the Underwriters may stabilize, maintain or otherwise affect the market price of the common stock. As a result, the price of the common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the underwriters at any time. These transactions may be effected on the Nasdaq National Market, in the over-the-counter market or otherwise. The Underwriters do not expect sales to discretionary accounts to exceed five percent of the total number of shares offered. Red Hat estimates that its share of the total expenses of the offering, excluding underwriting commissions, will be approximately $ . Red Hat has agreed to indemnify the several underwriters against certain liabilities, including liabilities under the Securities Act. U-2 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date. ------------------------ TABLE OF CONTENTS
Page ---- Prospectus Summary........................................................ 2 Risk Factors.............................................................. 7 Special Note Regarding Forward-Looking Statements......................... 18 Use of Proceeds........................................................... 18 Dividend Policy........................................................... 18 Capitalization............................................................ 19 Dilution.................................................................. 20 Selected Financial Data................................................... 21 Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................................. 23 Business.................................................................. 36 Management................................................................ 51 Certain Transactions...................................................... 58 Principal Stockholders.................................................... 59 Description of Capital Stock.............................................. 60 Shares Eligible for Future Sale........................................... 63 Legal Matters............................................................. 65 Experts................................................................... 65 Where You Can Find More Information....................................... 65 Index to Financial Statements............................................. F-1 Underwriting.............................................................. U-1
------------------------ Through and including , 1999 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer's obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription. Shares Red Hat Common Stock ------------------ [LOGO] ------------------ GOLDMAN, SACHS & CO. THOMAS WEISEL PARTNERS LLC E*TRADE SECURITIES, INC. Representatives of the Underwriters - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. Estimated expenses payable in connection with the sale of the common stock in this offering are as follows: SEC registration fee.............................................. $ 26,855 NASD filing fee................................................... 10,160 Nasdaq National Market listing fee................................ 95,000 Printing and engraving expenses................................... Legal fees and expenses........................................... Accounting fees and expenses...................................... Transfer agent and registrar fees and expenses.................... Directors' and officers' insurance................................ Miscellaneous..................................................... --------- Total....................................................... $ --------- ---------
The registrant will bear all of the expenses shown above. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The Delaware General Corporation Law, the registrant's charter and by-laws provide for indemnification of the registrant's directors and officers for liabilities and expenses that they may incur in such capacities. In general, directors and officers are indemnified with respect to actions taken in good faith in a manner reasonably believed to be in, or not opposed to, the best interests of the registrant, and with respect to any criminal action or proceeding, actions that the indemnitee had no reasonable cause to believe were unlawful. Reference is made to the registrant's corporate charter and by-laws filed as Exhibits 3.1 and 3.2 hereto, respectively. The Underwriting Agreement provides that the underwriters are obligated, under certain circumstances, to indemnify directors, officers and controlling persons of the registrant against certain liabilities, including liabilities under the Securities Act. Reference is made to the form of underwriting agreement filed as Exhibit 1.1 hereto. The registrant intends to apply for a directors' and officers' insurance policy. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. In the three years preceding the filing of this registration statement, the registrant has sold the following securities that were not registered under the Securities Act: On August 15, 1997, the registrant sold an aggregate of 6,801,400 shares of its Series A convertible preferred stock to one investor at a price of $.294057 per share. On September 29, 1998, the registrant sold an aggregate of 8,116,550 shares of its Series B convertible preferred stock to five investors at a price of $.857 per share. During the period between February 25, 1999 and April 1, 1999, the registrant sold an aggregate of 2,054,776 shares of its Series C convertible preferred stock to ten investors at a price of $3.141 per share. On October 10, 1995, the registrant issued warrants to certain employees exercisable for an aggregate of 3,740,400 shares of common stock with an exercise price per share of $.0001. II-1 Since September 4, 1998, the registrant has granted options to purchase an aggregate of 7,338,088 shares of common stock under the 1998 Stock Option Plan, as amended, exercisable at a weighted average price of $1.23 per share. No underwriters were involved in the foregoing sales of securities. Such sales were made in reliance upon the exemption provided by Section 4(2) of the Securities Act for transactions not involving a public offering and/or Rule 701 under the Securities Act. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (A) EXHIBITS:
EXHIBIT NO. EXHIBIT INDEX - ----------- ----------------------------------------------------------------------------------- 1.1+ Form of Underwriting Agreement 3.1 Second Amended and Restated Certificate of Incorporation, as amended, of the registrant (currently in effect) 3.2 Form of Third Amended and Restated Certificate of Incorporation of the registrant to be filed upon the effectiveness of the registration statement 3.3+ Form of Certificate of Amendment to the Third Amended and Restated Certificate of Incorporation to be filed upon the closing of the offering 3.4 By-laws of the registrant 3.5 Form of Amended and Restated By-laws to take effect as of the effective date of the registration statement 4.1+ Specimen certificate representing the common stock 5.1+ Opinion of Testa, Hurwitz & Thibeault, LLP 10.1 1998 Stock Option Plan, as amended 10.2 1999 Stock Option and Incentive Plan 10.3 1999 Employee Stock Purchase Plan 10.4 Warrant Agreement by and among the registrant, Robert F. Young, Nancy R. Young, Marc Ewing and Erik Troan, dated as of September 29, 1998, as amended 10.5 Warrant Agreement, by and among the registrant, Robert F. Young, Nancy R. Young, Marc Ewing and Donald Barnes, dated as of September 29, 1998, as amended 10.6 Warrant Agreement by and among the registrant, Robert F. Young, Nancy R. Young, Marc Ewing and Lisa Sullivan, dated as of September 29, 1998, as amended 10.7 First Amended and Restated Investor Rights Agreement by and among the registrant and the Investors and Founders listed therein, dated as of February 25, 1999, as amended 10.8 Office Lease by and between the registrant and CMD Properties, Inc., dated November 13, 1998 10.9 Non-Qualified Stock Option Agreement by and between the registrant and Matthew Szulik 10.10 Incentive Stock Option Agreement by and between the registrant and Matthew Szulik
II-2
EXHIBIT NO. EXHIBIT INDEX - ----------- ----------------------------------------------------------------------------------- 10.11 Non-Qualified Stock Option Agreement by and between the registrant and Timothy Buckley 10.12 Incentive Stock Option Agreement by and between the registrant and Timothy Buckley 10.13 GNU General Public License 10.14* Distribution Agreement by and between the registrant and Ingram Micro Inc. dated as of October 15, 1998, as amended 10.15* Red Hat Product Distribution Agreement by and between the registrant and Frank Kasper Associates, Inc., dated as of April 30, 1999 10.16* Software Distribution Agreement between Tech Data Product Management, Inc. and the registrant, dated as of April 29, 1999 10.17* Agreement by and between the registrant and Building Number Three, Ltd., dated as of June 10, 1998 10.18* Independent Contractor Agreement by and between the registrant and Ingo Molnar, dated as of August 18, 1998 10.19* Software License and Shipment Agreement by and among the registrant, Dell Products L.P. and Dell Computer Corporation, dated as of February 25, 1999 23.1 Consent of Testa, Hurwitz & Thibeault, LLP (included in Exhibit 5.1) 23.2 Consent of PricewaterhouseCoopers LLP 24.1 Power of Attorney (see page II-5) 27.1 Financial Data Schedule
- ------------------------ * Confidential materials omitted and filed separately with the Securities and Exchange Commission. + To be filed by amendment. (B) FINANCIAL STATEMENTS SCHEDULES: All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, the required information is disclosed in the notes to the financial statements or the schedules are inapplicable, and therefore have been omitted. ITEM 17. UNDERTAKINGS. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to provisions described in Item 14 above, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has II-3 been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The registrant hereby undertakes (1) to provide to the underwriters at the closing specified in the underwriting agreement certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser; (2) that for purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of a registration statement in reliance upon Rule 430A and contained in the form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective; and (3) that for the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Durham, North Carolina on June 4, 1999. RED HAT, INC. BY: /S/ ROBERT F. YOUNG ----------------------------------------- Robert F. Young CHAIRMAN AND CHIEF EXECUTIVE OFFICER POWER OF ATTORNEY AND SIGNATURES The undersigned officers and directors of Red Hat, Inc. hereby constitute and appoint Robert F. Young and Matthew Szulik, and each of them singly, with full power of substitution, our true and lawful attorneys-in-fact and agents to take any actions to enable Red Hat, Inc. to comply with the Securities Act, and any rules, regulations and requirements of the Securities and Exchange Commission, in connection with this registration statement, including the power and authority to sign for us in our names in the capacities indicated below any and all amendments to this registration statement and any other registration statement filed pursuant to the provisions of Rule 462 under the Securities Act. Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed below by the following persons in the capacities and on the dates indicated. SIGNATURE TITLE DATE - ------------------------------ --------------------------- ------------------- Chairman and Chief /s/ ROBERT F. YOUNG Executive Officer - ------------------------------ (principal executive June 4, 1999 Robert F. Young officer) /s/ MANOJ GEORGE Chief Financial Officer - ------------------------------ (principal financial and June 4, 1999 Manoj George accounting officer) /s/ MARC EWING Director - ------------------------------ June 4, 1999 Marc Ewing /s/ FRANK BATTEN, JR. Director - ------------------------------ June 4, 1999 Frank Batten, Jr. /s/ WILLIAM S. KAISER Director - ------------------------------ June 4, 1999 William S. Kaiser /s/ MATTHEW SZULIK Director - ------------------------------ June 4, 1999 Matthew Szulik /s/ ERIC HAHN Director - ------------------------------ June 4, 1999 Eric Hahn II-5
EXHIBIT NO. EXHIBIT INDEX - ----------- ----------------------------------------------------------------------------------- 1.1+ Form of Underwriting Agreement 3.1 Second Amended and Restated Certificate of Incorporation, as amended, of the registrant (currently in effect) 3.2 Form of Third Amended and Restated Certificate of Incorporation of the registrant to be filed upon the effectiveness of the registration statement 3.3+ Form of Certificate of Amendment to the Third Amended and Restated Certificate of Incorporation to be filed upon the closing of the offering 3.4 By-laws of the registrant 3.5 Form of Amended and Restated By-laws to take effect as of the effective date of the registration statement 4.1+ Specimen certificate representing the common stock 5.1+ Opinion of Testa, Hurwitz & Thibeault, LLP 10.1 1998 Stock Option Plan, as amended 10.2 1999 Stock Option and Incentive Plan 10.3 1999 Employee Stock Purchase Plan 10.4 Warrant Agreement by and among the registrant, Robert F. Young, Nancy R. Young, Marc Ewing and Erik Troan, dated as of September 29, 1998, as amended 10.5 Warrant Agreement, by and among the registrant, Robert F. Young, Nancy R. Young, Marc Ewing and Donald Barnes, dated as of September 29, 1998, as amended 10.6 Warrant Agreement by and among the registrant, Robert F. Young, Nancy R. Young, Marc Ewing and Lisa Sullivan, dated as of September 29, 1998, as amended 10.7 First Amended and Restated Investor Rights Agreement by and among the registrant and the Investors and Founders listed therein, dated as of February 25, 1999, as amended 10.8 Office Lease by and between the registrant and CMD Properties, Inc., dated November 13, 1998 10.9 Non-Qualified Stock Option Agreement by and between the registrant and Matthew Szulik 10.10 Incentive Stock Option Agreement by and between the registrant and Matthew Szulik 10.11 Non-Qualified Stock Option Agreement by and between the registrant and Timothy Buckley 10.12 Incentive Stock Option Agreement by and between the registrant and Timothy Buckley 10.13 GNU General Public License 10.14* Distribution Agreement by and between the registrant and Ingram Micro Inc. dated as of October 15, 1998, as amended 10.15* Red Hat Product Distribution Agreement by and between the registrant and Frank Kasper Associates, Inc., dated as of April 30, 1999 10.16* Software Distribution Agreement between Tech Data Product Management, Inc. and the registrant, dated as of April 29, 1999 10.17* Agreement by and between the registrant and Building Number Three, Ltd., dated as of June 10, 1998
EXHIBIT NO. EXHIBIT INDEX - ----------- ----------------------------------------------------------------------------------- 10.18* Independent Contractor Agreement by and between the registrant and Ingo Molnar, dated as of August 18, 1998 10.19* Software License and Shipment Agreement by and among the registrant, Dell Products L.P. and Dell Computer Corporation, dated as of February 25, 1999 23.1 Consent of Testa, Hurwitz & Thibeault, LLP (included in Exhibit 5.1) 23.2 Consent of PricewaterhouseCoopers LLP 24.1 Power of Attorney (see page II-5) 27.1 Financial Data Schedule
- ------------------------ * Confidential materials omitted and filed separately with the Securities and Exchange Commission. + To be filed by amendment. EX-3.1 2 EXHIBIT 3.1 Exhibit 3.1 SECOND AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF RED HAT SOFTWARE, INC. -------------------------------------------- Pursuant to Sections 228, 242 and 245 of the General Corporation Law of the State of Delaware -------------------------------------------- Red Hat Software, Inc. (the "Corporation"), a corporation organized and existing under the General Corporation Law of the State of Delaware, does hereby certify as follows: 1. The name of the Corporation is Red Hat Software, Inc. The Corporation was originally incorporated under such name. The original certificate of incorporation of the Corporation was filed with the office of the Secretary of State of Delaware on September 17, 1998. An amended and restated certificate of incorporation of the Corporation was filed with the office of the Secretary of State of Delaware on September 29, 1998. 2. This Second Amended and Restated Certificate of Incorporation was recommended to the stockholders for approval as being advisable and in the best interests of the Corporation by written action of the Board of Directors on February 24, 1999. 3. That in lieu of a meeting and vote of stockholders, consents in writing have been signed by holders of outstanding stock having not less than the minimum number of votes that is necessary to consent to this amendment and restatement, and, if required, prompt notice of such action shall be given in accordance with the provisions of Section 228 of the General Corporation Law of the State of Delaware. 4. This Second Amended and Restated Certificate of Incorporation restates and integrates and further amends the certificate of incorporation of the Corporation, as heretofore amended or supplemented. The text of the Corporation's amended and restated certificate of incorporation is amended and restated in its entirety as follows FIRST. That the name of the Corporation is Red Hat Software, Inc. (the "Corporation"). SECOND. The address of the registered office of the Corporation in the State of Delaware is 1209 Orange Street, in the City of Wilmington, New Castle County, Delaware 19801. The name of its registered agent at such address is The Corporation Trust Company. -2- THIRD. The nature of the business or purposes to be conducted or promoted by the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware. FOURTH. The total number of shares of all classes of capital stock which the Corporation shall have authority to issue is 50,769,358 shares, consisting of 34,053,479 shares of Common Stock with a par value of $.0001 per share (the "Common Stock"), and 16,715,879 shares of Preferred Stock with a par value of $.0001 per share (the "Preferred Stock"), of which 6,801,400 shares are designated as Series A Convertible Preferred Stock, 8,116,550 shares are designated as Series B Convertible Preferred Stock and 1,797,929 shares are designated as Series C Convertible Preferred Stock A description of the respective classes of stock and a statement of the designations, preferences, voting powers (or no voting powers), relative, participating, optional or other special rights and privileges and the qualifications, limitations and restrictions of the Preferred Stock and the Common Stock are as follows: COMMON STOCK 1. General. The voting, dividend and liquidation rights of the holders of the Common Stock are subject to and qualified by the rights of the holders of the Preferred Stock (and any other class or series of capital stock of the Corporation) at the time outstanding having prior rights as to voting, dividends or liquidation. 2. Voting. The holders of Common Stock are entitled to one vote for each share held at all meetings of stockholders (and written actions in lieu of meetings) with respect to any and all matters presented to the stockholders of the Corporation for their action or consideration. Except as provided by law, holders of Common Stock shall vote together as a single class on all matters with the holders of Preferred Stock (and any other class or series of voting capital stock of the Corporation). 3. Dividends. The holders of the Common Stock shall be entitled to receive, when and as declared by the Board of Directors, out of any assets of the Corporation legally available therefor, such dividends as may be declared from time to time by the Board of Directors, subject to any preferential rights of any then outstanding Preferred Stock (and any other class or series of capital stock of the Corporation which may have preferential rights). 4. Liquidation. Upon the dissolution, liquidation or winding up of the Corporation, holders of Common Stock will be entitled to receive the assets of the Corporation subject to any preferential rights of any then outstanding Preferred Stock or other then outstanding stock ranking on liquidation senior to or on a parity with the Common Stock. -3- SERIES A, SERIES B AND SERIES C CONVERTIBLE PREFERRED STOCK 1. Dividends. The Corporation shall not declare or pay any dividends on shares of Common Stock (except for dividends payable solely in the form of Common Stock) until the holders of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock then outstanding shall have first received, or simultaneously receive, a distribution on each outstanding share of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock in an amount at least equal to the product of (i) the per share amount, if any, of the dividends to be declared, paid or set aside for the Common Stock, multiplied by (ii) the number of whole shares of Common Stock into which such share of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock is then convertible. The Corporation shall not declare or pay any dividends on any shares of Preferred Stock unless, at the same time, a dividend in a like amount per share shall be paid upon, or declared and set apart for, all shares of Preferred Stock then outstanding. 2. Liquidation, Dissolution or Winding Up; Certain Mergers, Consolidations and Asset Sales. (a) In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock then outstanding shall be entitled to be paid out of the assets of the Corporation available for distribution to its stockholders, before any payment shall be made to the holders of Common Stock or any other class or series of stock ranking on liquidation junior to the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock (such Common Stock and other stock being collectively referred to as "Junior Stock") by reason of their ownership thereof, an amount equal to the greater of (i) $.343 per share, in the case of Series A Preferred Stock, $.996 per share, in the case of Series B Preferred Stock, and $3.893 per share in the case of the Series C Preferred Stock (each subject to appropriate adjustment in the event of any stock dividend, stock split, combination or other similar recapitalization affecting such shares), plus any dividends declared but unpaid thereon, or (ii) such amount per share as would have been payable had each such share been converted into Common Stock pursuant to Section 4 immediately prior to such liquidation, dissolution or winding up. If upon any such liquidation, dissolution or winding up of the Corporation the remaining assets of the Corporation available for distribution to its stockholders shall be insufficient to pay the holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock the full amount to which they shall be entitled, the holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock and any class or series of stock ranking on liquidation on a parity with the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall share ratably in any distribution of the remaining assets and funds of the Corporation in proportion to the respective amounts which would otherwise be payable pursuant to clause (i) above in respect of the shares held by them upon such distribution. The Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock of the Corporation shall be deemed to rank on a parity with each other with respect to the liquidation, dissolution or winding-up of the Corporation. -4- (b) After the payment of all preferential amounts required to be paid to the holders of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock and any other class or series of stock of the Corporation ranking on liquidation on a parity with the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, upon the dissolution, liquidation or winding up of the Corporation, the holders of shares of Junior Stock then outstanding shall be entitled to receive the remaining assets and funds of the Corporation available for distribution to its stockholders. (c) Any (i) merger or consolidation of the Corporation or a subsidiary of the Corporation into or with another corporation (except one in which the holders of capital stock of the Corporation immediately prior to such merger or consolidation continue to hold at least 50% by voting power of the capital stock of the Corporation or the surviving or acquiring corporation), (ii) acquisition, in one transaction or a series of related transactions by a person or group of affiliated persons, of 50% or more of the outstanding voting stock of the Company or (iii) sale of all or substantially all the assets of the Corporation, shall be deemed to be a liquidation of the Corporation for purposes of this Section 2 unless the holders of a majority of the then outstanding Preferred Stock elect in writing not to treat such merger, consolidation or sale as a liquidation, and any agreement or plan of merger or consolidation to which the Company is a party shall provide that the consideration payable to the stockholders of the Corporation (in the case of a merger or consolidation), or consideration payable to the Corporation, together with all other available assets of the Corporation (in the case of an asset sale), shall be distributed to the holders of capital stock of the Corporation in accordance with Subsections 2(a) and 2(b) above. The amount deemed distributed to the holders of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock upon any such merger, consolidation or sale shall be the cash or the value of the property, rights or securities distributed to such holders by the Corporation or the acquiring person, firm or other entity. The value of such property, rights or other securities shall be determined in good faith by the Board of Directors of the Corporation. 3. Voting. (a) Each holder of outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall be entitled to the number of votes equal to the number of whole shares of Common Stock into which the shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock held by such holder are then convertible (as adjusted from time to time pursuant to Section 4 hereof), at each meeting of stockholders of the Corporation (and written actions of stockholders in lieu of meetings) with respect to any and all matters presented to the stockholders of the Corporation for their action or consideration. Except as provided by law, by the provisions of Subsection 3(b) below or by the provisions establishing any other series of Preferred Stock, holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock and any other outstanding series of Preferred Stock shall vote together with the holders of Common Stock as a single class. -5- (b) The Corporation shall not amend, alter or repeal the preferences, special rights or other powers of the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock so as to affect adversely the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, without the written consent or affirmative vote of the holders of a majority of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be, given in writing or by vote at a meeting, consenting or voting (as the case may be) separately as a class. For this purpose, without limiting the generality of the foregoing, the authorization of any shares of capital stock with preference or priority over the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock as to the right to receive either dividends or amounts distributable upon liquidation, dissolution or winding up of the Corporation shall be deemed to affect adversely the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, and the authorization of any shares of capital stock on a parity with Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock as to the right to receive either dividends or amounts distributable upon liquidation, dissolution or winding up of the Corporation shall not be deemed to affect adversely the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock. 4. Optional Conversion. The holders of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall have conversion rights as follows (the "Conversion Rights"): (a) (i) Series A Right to Convert. Each share of Series A Preferred Stock shall be convertible, at the option of the holder thereof, at any time and from time to time, and without the payment of additional consideration by the holder thereof, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing $.343 by the Series A Conversion Price (as defined below) in effect at the time of conversion. The "Series A Conversion Price" shall initially be $.343. Such initial Series A Conversion Price, and the rate at which shares of Series A Preferred Stock may be converted into shares of Common Stock, shall be subject to adjustment as provided below. (ii) Series B Right to Convert. Each share of Series B Preferred Stock shall be convertible, at the option of the holder thereof, at any time and from time to time, and without the payment of additional consideration by the holder thereof, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing $.996 by the Series B Conversion Price (as defined below) in effect at the time of conversion. The "Series B Conversion Price" shall initially be $.996. Such initial Series B Conversion Price, and the rate at which shares of Series B Preferred Stock may be converted into shares of Common Stock, shall be subject to adjustment as provided below. (iii) Series C Right to Convert. Each share of Series C Preferred Stock shall be convertible, at the option of the holder thereof, at any time and from time to time, and without the payment of additional consideration by the holder thereof, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing $3.893 by the Series C Conversion Price (as defined below) in effect at the time of conversion. The "Series C Conversion Price" shall initially be $3.893. Such initial Series C Conversion Price, and the rate -6- at which shares of Series C Preferred Stock may be converted into shares of Common Stock, shall be subject to adjustment as provided below. (iv) In the event of a notice of redemption of any shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock pursuant to Section 6 hereof, the Conversion Rights of the shares designated for redemption shall terminate at the close of business on the fifth full day preceding the date fixed for redemption, unless the redemption price is not paid when due, in which case the Conversion Rights for such shares shall continue until such price is paid in full. In the event of a liquidation of the Corporation, the Conversion Rights shall terminate at the close of business on the first full day preceding the date fixed for the payment of any amounts distributable on liquidation to the holders of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock. (b) Fractional Shares. No fractional shares of Common Stock shall be issued upon conversion of the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock. In lieu of any fractional shares to which the holder would otherwise be entitled, the Corporation shall pay cash equal to such fraction multiplied by the then effective Series A Conversion Price, Series B Conversion Price or Series C Conversion Price. (c) Mechanics of Conversion. (i) In order for a holder of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock to convert its shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock into shares of Common Stock, such holder shall surrender the certificate or certificates for such shares of Preferred Stock, at the office of the transfer agent for the Preferred Stock (or at the principal office of the Corporation if the Corporation serves as its own transfer agent), together with written notice (a "Conversion Notice") that such holder elects to convert all or any number of the shares of the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock represented by such certificate or certificates. The Conversion Notice shall state such holder's name or the names of the nominees in which such holder wishes the certificate or certificates for shares of Common Stock to be issued. If required by the Corporation, certificates surrendered for conversion shall be endorsed or accompanied by a written instrument or instruments of transfer, in form satisfactory to the Corporation, duly executed by the registered holder or his or its attorney duly authorized in writing. The date of receipt of such certificates and Conversion Notice by the transfer agent (or by the Corporation if the Corporation serves as its own transfer agent) shall be the conversion date ("Conversion Date"). The Corporation shall, as soon as practicable after the Conversion Date, issue and deliver at such office to such holder of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, or to his or its nominees, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled, together with cash in lieu of any fraction of a share. -7- (ii) The Corporation shall at all times when the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock shall be outstanding, reserve and keep available out of its authorized but unissued stock, for the purpose of effecting the conversion of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, such number of its duly authorized shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock. Before taking any action which would cause an adjustment reducing the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price below the then par value of the shares of Common Stock issuable upon conversion of the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, the Corporation will take any corporate action which may, in the opinion of its counsel, be necessary in order that the Corporation may validly and legally issue fully paid and nonassessable shares of Common Stock at such adjusted Series A Conversion Price, Series B Conversion Price or Series C Conversion Price. (iii) Upon any such conversion, no adjustment to the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price shall be made for any declared but unpaid dividends on the Series A Preferred Stock, Series B Preferred Stock or Series C Conversion Price, as applicable, surrendered for conversion or on the Common Stock delivered upon such conversion. (iv) All shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock which shall have been surrendered for conversion as herein provided shall no longer be deemed to be outstanding and all rights with respect to such shares, including the rights, if any, to receive notices and to vote, shall immediately cease and terminate on the Conversion Date, except only the right of the holders thereof to receive shares of Common Stock in exchange therefor and payment of any dividends declared but unpaid thereon. Any shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock so converted shall be retired and cancelled and shall not be reissued, and the Corporation (without the need for stockholder action) may from time to time take such appropriate action as may be necessary to reduce the authorized number of shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock accordingly. (v) The Corporation shall pay any and all issue and other taxes that may be payable in respect of any issuance or delivery of shares of Common Stock upon conversion of shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock pursuant to this Section 4. The Corporation shall not, however, be required to pay any tax which may be payable in respect of any transfer involved in the issuance and delivery of shares of Common Stock in a name other than that in which the shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock so converted were registered, and no such issuance or delivery shall be made unless and until the person or entity requesting such issuance has paid to the Corporation the amount of any such tax or has established, to the satisfaction of the Corporation, that such tax has been paid. -8- (d) Adjustments to Series A Conversion Price, Series B Conversion Price or Series C Conversion Price for Diluting Issues: (i) Special Definitions. For purposes of this Subsection 4(d), the following definitions shall apply: (A) "Option" shall mean rights, options or warrants to subscribe for, purchase or otherwise acquire Common Stock or Convertible Securities. (B) "Series A Original Issue Date" shall mean the date on which the first share of Series A Preferred Stock was issued. (C) "Series B Original Issue Date" shall mean the date on which the first share of Series B Preferred Stock was issued. (D) "Series C Original Issue Date" shall mean the date on which the first share of Series C Preferred Stock was issued. (E) "Convertible Securities" shall mean any evidences of indebtedness, shares or other securities directly or indirectly convertible into or exchangeable for Common Stock. (F) "Additional Shares of Common Stock" shall mean all shares of Common Stock issued (or, pursuant to Subsection 4(d)(iii) below, deemed to be issued) by the Corporation after the Series C Original Issue Date, other than: (I) shares of Common Stock issued or issuable upon conversion of any shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock; (II) shares of Common Stock issued or issuable upon conversion of any Convertible Securities (other than shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock) or exercise of any warrants outstanding on the Series C Original Issue Date; (III) shares of Common Stock issued or issuable as a dividend or distribution on Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock; (IV) shares of Common Stock issued or issuable by reason of a dividend, stock split, split-up or other distribution on shares of Common Stock that is covered by Subsection 4(e) or 4(f) below; (V) up to 3,717,400 shares of Common Stock (including issuances prior to the Series C Original Issue Date) (subject to appropriate adjustment in the event of any stock dividend, stock split, combination or other similar recapitalization affecting such shares), plus such additional number of shares of Common Stock as may be approved by -9- the Board of Directors of the Corporation and by a majority of the members of the Board of Directors who are not employees of the Company or any of its subsidiaries, issued or issuable to employees or directors of, or consultants to, the Corporation pursuant to employer stock option plans; (VI) securities issued pursuant to any equipment leasing arrangement or debt financing from a bank or similar financial institution approved by the Board of Directors of the Corporation and by a majority of the members of the Board of Directors who are not employees of the Corporation or any of its subsidiaries; or (VII) securities issued in connection with strategic transactions approved by the Board of Directors of the Corporation and by a majority of the members of the Board of Directors who are not employees of the Corporation or any of its subsidiaries involving the Company and other entities, including (a) joint ventures, manufacturing, marketing or distribution arrangements or (b) technology transfer or development arrangements. (ii) No Adjustment of Conversion Price. (A) No adjustment in the number of shares of Common Stock into which the Series A Preferred Stock is convertible shall be made, by adjustment in the applicable Series A Conversion Price thereof: (a) unless the consideration per share (determined pursuant to Subsection 4(d)(v)) for an Additional Share of Common Stock issued or deemed to be issued by the Corporation is less than the applicable Series A Conversion Price in effect immediately prior to the issue of such Additional Shares, or (b) if prior to such issuance, the Corporation receives written notice from the holders of at least 66-2/3% of the then outstanding shares of Series A Preferred Stock agreeing that no such adjustment shall be made as the result of the issuance of Additional Shares of Common Stock. (B) No adjustment in the number of shares of Common Stock into which the Series B Preferred Stock is convertible shall be made, by adjustment in the applicable Series B Conversion Price thereof: (a) unless the consideration per share (determined pursuant to Subsection 4(d)(v)) for an Additional Share of Common Stock issued or deemed to be issued by the Corporation is less than the applicable Series B Conversion Price in effect immediately prior to the issue of such Additional Shares, or (b) if prior to such issuance, the Corporation receives written notice from the holders of at least 66-2/3% of the then outstanding shares of Series B Preferred Stock agreeing that no such adjustment shall be made as the result of the issuance of Additional Shares of Common Stock. (C) No adjustment in the number of shares of Common Stock into which the Series C Preferred Stock is convertible shall be made, by adjustment in the applicable Series C Conversion Price thereof: (a) unless the consideration per share (determined pursuant to Subsection 4(d)(v)) for an Additional Share of Common Stock issued or deemed to be issued by the Corporation is less than the applicable Series C Conversion Price in effect immediately prior to the issue of such Additional Shares, or (b) if prior to such issuance, the Corporation receives written notice from the holders of at least 66-2/3% of the then outstanding -10- shares of Series C Preferred Stock agreeing that no such adjustment shall be made as the result of the issuance of Additional Shares of Common Stock. (iii) Issue of Securities Deemed Issue of Additional Shares of Common Stock. If the Corporation at any time or from time to time after the Series A Original Issue Date, Series B Original Issue Date or Series C Original Issue Date, as applicable, shall issue any Options (excluding Options covered by Subsection 4(d)(i)(F)(IV) above) or Convertible Securities or shall fix a record date for the determination of holders of any class of securities entitled to receive any such Options or Convertible Securities, then the maximum number of shares of Common Stock (as set forth in the instrument relating thereto without regard to any provision contained therein for a subsequent adjustment of such number) issuable upon the exercise of such Options or, in the case of Convertible Securities and Options therefor, the conversion or exchange of such Convertible Securities, shall be deemed to be Additional Shares of Common Stock issued as of the time of such issue or, in case such a record date shall have been fixed, as of the close of business on such record date, provided that (x) for the purposes of adjusting the Series A Conversion Price, Additional Shares of Common Stock shall not be deemed to have been issued unless the consideration per share (determined pursuant to Subsection 4(d)(v) hereof) of such Additional Shares of Common Stock would be less than the applicable Series A Conversion Price in effect on the date of and immediately prior to such issue, or such record date, as the case may be, (y) for the purposes of adjusting the Series B Conversion Price, Additional Shares of Common Stock shall not be deemed to have been issued unless the consideration per share (determined pursuant to Subsection 4(d)(v) hereof) of such Additional Shares of Common Stock would be less than the applicable Series B Conversion Price in effect on the date of and immediately prior to such issue, or such record date, as the case may be, and (z) for the purposes of adjusting the Series C Conversion Price, Additional Shares of Common Stock shall not be deemed to have been issued unless the consideration per share (determined pursuant to Subsection 4(d)(v) hereof) of such Additional Shares of Common Stock would be less than the applicable Series C Conversion Price in effect on the date of and immediately prior to such issue, or such record date, as the case may be, and provided further that in any such case in which Additional Shares of Common Stock are deemed to be issued: (A) No further adjustment in the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price shall be made upon the subsequent issue of Convertible Securities or shares of Common Stock upon the exercise of such Options or conversion or exchange of such Convertible Securities; (B) If such Options or Convertible Securities by their terms provide, with the passage of time or otherwise, for any increase or decrease in the consideration payable to the Corporation, upon the exercise, conversion or exchange thereof, the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price computed upon the original issue thereof (or upon the occurrence of a record date with respect thereto), and any subsequent adjustments based thereon, shall, upon any such increase or decrease becoming effective, be recomputed to reflect such increase or decrease insofar as it affects such Options or the rights of conversion or exchange under such Convertible Securities; -11- (C) Upon the expiration or termination of any such unexercised Option, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price shall be readjusted, to the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price as would have been in effect at the time of such expiration or termination had such Option never been issued; (D) In the event of any change in the number of shares of Common Stock issuable upon the exercise, conversion or exchange of any such Option or Convertible Security, including, but not limited to, a change resulting from the anti-dilution provisions thereof, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price then in effect shall forthwith be readjusted to such Series A Conversion Price, Series B Conversion Price or Series C Conversion Price as would have obtained had the adjustment which was made upon the issuance of such Option or Convertible Security not exercised or converted prior to such change been made upon the basis of such change; and (E) No readjustment pursuant to clauses (B) or (D) above shall have the effect of increasing the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price to an amount which exceeds the lower of (i) the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price on the original adjustment date, or (ii) the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price, as the case may be, that would have resulted from any issuances of Additional Shares of Common Stock between the original adjustment date and such readjustment date. In the event the Corporation, after the Series A Original Issue Date, the Series B Original Issue Date or the Series C Original Issue Date, amends the terms of any such Options or Convertible Securities (whether such Options or Convertible Securities were outstanding on such respective original issue date or were issued after such respective original issue date), then such Options or Convertible Securities, as so amended, shall be deemed to have been issued after such respective original issue date and the provisions of this Subsection 4(d)(iii) shall apply. (iv) Adjustment of Conversion Price Upon Issuance of Additional Shares of Common Stock. (A) In the event the Corporation shall at any time after the Series A Original Issue Date issue Additional Shares of Common Stock (including Additional Shares of Common Stock deemed to be issued pursuant to Subsection 4(d)(iii), but excluding shares issued as a stock split or combination as provided in Subsection 4(e) or upon a dividend or distribution as provided in Subsection 4(f)), without consideration or for a consideration per share less than the applicable Series A Conversion Price in effect immediately prior to such issue, then and in such event, such Series A Conversion Price shall be reduced, concurrently with such issue, to a price (calculated to the nearest cent) determined by multiplying such Series A Conversion Price by a fraction, (A) the numerator of which shall be (1) the number of shares of Common Stock outstanding immediately prior to such issue plus (2) the number of shares of Common Stock which the aggregate consideration received or to be received by the Corporation for the total number of Additional Shares of Common Stock so issued would purchase at such -12- Series A Conversion Price; and (B) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issue plus the number of such Additional Shares of Common Stock so issued; provided that, (i) for the purpose of this Subsection 4(d)(iv), all shares of Common Stock issuable upon exercise or conversion of vested Options or Convertible Securities outstanding immediately prior to such issue shall be deemed to be outstanding, and (ii) the number of shares of Common Stock deemed issuable upon exercise or conversion of such outstanding vested Options and Convertible Securities shall not give effect to any adjustments to the conversion price or conversion rate of such Options or Convertible Securities resulting from the issuance of Additional Shares of Common Stock that is the subject of this calculation. (B) In the event the Corporation shall at any time after the Series B Original Issue Date issue Additional Shares of Common Stock (including Additional Shares of Common Stock deemed to be issued pursuant to Subsection 4(d)(iii), but excluding shares issued as a stock split or combination as provided in Subsection 4(e) or upon a dividend or distribution as provided in Subsection 4(f)), without consideration or for a consideration per share less than the applicable Series B Conversion Price in effect immediately prior to such issue, then and in such event, such Series B Conversion Price shall be reduced, concurrently with such issue, to a price (calculated to the nearest cent) determined by multiplying such Series B Conversion Price by a fraction, (A) the numerator of which shall be (1) the number of shares of Common Stock outstanding immediately prior to such issue plus (2) the number of shares of Common Stock which the aggregate consideration received or to be received by the Corporation for the total number of Additional Shares of Common Stock so issued would purchase at such Series B Conversion Price; and (B) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issue plus the number of such Additional Shares of Common Stock so issued; provided that, (i) for the purpose of this Subsection 4(d)(iv), all shares of Common Stock issuable upon exercise or conversion of vested Options or Convertible Securities outstanding immediately prior to such issue shall be deemed to be outstanding, and (ii) the number of shares of Common Stock deemed issuable upon exercise or conversion of such outstanding vested Options and Convertible Securities shall not give effect to any adjustments to the conversion price or conversion rate of such Options or Convertible Securities resulting from the issuance of Additional Shares of Common Stock that is the subject of this calculation. (C) In the event the Corporation shall at any time after the Series C Original Issue Date issue Additional Shares of Common Stock (including Additional Shares of Common Stock deemed to be issued pursuant to Subsection 4(d)(iii), but excluding shares issued as a stock split or combination as provided in Subsection 4(e) or upon a dividend or distribution as provided in Subsection 4(f)), without consideration or for a consideration per share less than the applicable Series C Conversion Price in effect immediately prior to such issue, then and in such event, such Series C Conversion Price shall be reduced, concurrently with such issue, to a price (calculated to the nearest cent) determined by multiplying such Series C Conversion Price by a fraction, (A) the numerator of which shall be (1) the number of shares of Common Stock outstanding immediately prior to such issue plus (2) the number of shares of Common Stock which the aggregate consideration received or to be received by the Corporation for the total number of Additional Shares of Common Stock so issued would purchase at such -13- Series C Conversion Price; and (B) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issue plus the number of such Additional Shares of Common Stock so issued; provided that, (i) for the purpose of this Subsection 4(d)(iv), all shares of Common Stock issuable upon exercise or conversion of vested Options or Convertible Securities outstanding immediately prior to such issue shall be deemed to be outstanding, and (ii) the number of shares of Common Stock deemed issuable upon exercise or conversion of such outstanding vested Options and Convertible Securities shall not give effect to any adjustments to the conversion price or conversion rate of such Options or Convertible Securities resulting from the issuance of Additional Shares of Common Stock that is the subject of this calculation. (v) Determination of Consideration. For purposes of this Subsection 4(d), the consideration received by the Corporation for the issue of any Additional Shares of Common Stock shall be computed as follows: (A) Cash and Property: Such consideration shall: (I) insofar as it consists of cash, be computed at the aggregate of cash received by the Corporation, excluding amounts paid or payable for accrued interest; (II) insofar as it consists of property other than cash, be computed at the fair market value thereof at the time of such issue, as determined in good faith by the Board of Directors; and (III) in the event Additional Shares of Common Stock are issued together with other shares or securities or other assets of the Corporation for consideration which covers both, be the proportion of such consideration so received, computed as provided in clauses (I) and (II) above, as determined in good faith by the Board of Directors. (B) Options and Convertible Securities. The consideration per share received by the Corporation for Additional Shares of Common Stock deemed to have been issued pursuant to Subsection 4(d)(iii), relating to Options and Convertible Securities, shall be determined by dividing (x) the total amount, if any, received or receivable by the Corporation as consideration for the issue of such Options or Convertible Securities, plus the minimum aggregate amount of additional consideration (as set forth in the instruments relating thereto, without regard to any provision contained therein for a subsequent adjustment of such consideration) payable to the Corporation upon the exercise of such Options or the conversion or exchange of such Convertible Securities, or in the case of Options for Convertible Securities, the exercise of such Options for Convertible Securities and the conversion or exchange of such Convertible Securities, by (y) the maximum number of shares of Common Stock (as set forth in the instruments relating thereto, without regard to any provision contained therein -14- for a subsequent adjustment of such number) issuable upon the exercise of such Options or the conversion or exchange of such Convertible Securities. (vi) Multiple Closing Dates. In the event the Corporation shall issue on more than one date Additional Shares of Common Stock which are comprised of shares of the same series or class of Preferred Stock, and such issuance dates occur within a period of no more than 120 days, then, upon the final such issuance, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price shall be adjusted to give effect to all such issuances as if they occurred on the date of the final such issuance (and without giving effect to any adjustments as a result of such prior issuances within such period). (e) Adjustment for Stock Splits and Combinations. If the Corporation shall at any time or from time to time after the Series C Original Issue Date effect a subdivision of the outstanding Common Stock, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price then in effect immediately before that subdivision each shall be proportionately decreased. If the Corporation shall at any time or from time to time after the Series C Original Issue Date combine the outstanding shares of Common Stock, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price then in effect immediately before the combination each shall be proportionately increased. Any adjustment under this paragraph shall become effective at the close of business on the date the subdivision or combination becomes effective. (f) Adjustment for Certain Dividends and Distributions. In the event the Corporation at any time, or from time to time after the Series C Original Issue Date, as the case may be, shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price then in effect immediately before such event each shall be decreased as of the time of such issuance or, in the event such a record date shall have been fixed, as of the close of business on such record date, by multiplying the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price, as the case may be, then in effect by a fraction: (1) the numerator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, and (2) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date plus the number of shares of Common Stock issuable in payment of such dividend or distribution; provided, however, if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price each shall be recomputed accordingly as of the close of business on such record date and thereafter the Series A Conversion Price, -15- Series B Conversion Price and Series C Conversion Price, as the case may be, shall be adjusted pursuant to this paragraph as of the time of actual payment of such dividends or distributions; and provided further, however, that no such adjustment shall be made if the holders of Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock simultaneously receive (i) a dividend or other distribution of shares of Common Stock in a number equal to the number of shares of Common Stock as they would have received if all outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock had been converted into Common Stock on the date of such event or (ii) a dividend or other distribution of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock which are convertible, as of the date of such event, into such number of shares of Common Stock as is equal to the number of additional shares of Common Stock being issued with respect to each share of Common Stock in such dividend or distribution. (g) Adjustments for Other Dividends and Distributions. In the event the Corporation at any time or from time to time after the Series C Original Issue Date shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in securities of the Corporation other than shares of Common Stock, then and in each such event provision shall be made so that the holders of the Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of Series C Preferred Stock shall receive upon conversion thereof in addition to the number of shares of Common Stock receivable thereupon, the amount of securities of the Corporation that they would have received had the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be, been converted into Common Stock on the date of such event and had they thereafter, during the period from the date of such event to and including the conversion date, retained such securities receivable by them as aforesaid during such period, giving application to all adjustments called for during such period under this paragraph with respect to the rights of the holders of the Series A Preferred Stock, the rights of the holders of the Series B Preferred Stock and the rights of the holders of the Series C Preferred Stock, as the case may be; and provided further, however, that no such adjustment shall be made if the holders of Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock, as the case may be, simultaneously receive a dividend or other distribution of such securities in an amount equal to the amount of such securities as they would have received if all outstanding shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be, had been converted into Common Stock on the date of such event. -16- (h) Adjustment for Reclassification, Exchange, or Substitution. If the Common Stock issuable upon the conversion of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall be changed into the same or a different number of shares of any class or classes of stock, whether by capital reorganization, reclassification, or otherwise (other than a subdivision or combination of shares or stock dividend provided for above, or a reorganization, merger, consolidation, or sale of assets provided for below), then and in each such event the holders of each such share of Series A Preferred Stock, the holders of each such share of Series B Preferred Stock and the holders of each such share of Series C Preferred Stock shall have the right thereafter to convert such share into the kind and amount of shares of stock and other securities and property receivable, upon such reorganization, reclassification, or other change, by holders of the number of shares of Common Stock into which such shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be, might have been converted immediately prior to such reorganization, reclassification, or change, all subject to further adjustment as provided herein. (i) Adjustment for Merger or Reorganization, etc. In case of any consolidation or merger of the Corporation with or into another corporation or the sale of all or substantially all of the assets of the Corporation to another corporation (other than a consolidation, merger or sale which is covered by Subsection 2(c)), each share of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall thereafter be convertible (or shall be converted into a security which shall be convertible) into the kind and amount of shares of stock or other securities or property to which a holder of the number of shares of Common Stock of the Corporation deliverable upon conversion of such Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, as the case may be, would have been entitled upon such consolidation, merger or sale; and, in such case, appropriate adjustment (as determined in good faith by the Board of Directors) shall be made in the application of the provisions in this Section 4 set forth with respect to the rights and interest thereafter of the holders of the Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock, to the end that the provisions set forth in this Section 4 (including provisions with respect to changes in and other adjustments of the Series A Conversion Price, Series B Conversion Price and the Series C Conversion Price) shall thereafter be applicable, as nearly as reasonably may be, in relation to any shares of stock or other property thereafter deliverable upon the conversion of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, as the case may be. (j) No Impairment. The Corporation will not, by amendment of its Certificate of Incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Corporation, but will at all times in good faith assist in the carrying out of all the provisions of this Section 4 and in the taking of all such action as may be necessary or appropriate in order to protect the Conversion Rights of the holders of the Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock against impairment. (k) Certificate as to Adjustments. Upon the occurrence of each adjustment or readjustment of the Series A Conversion Price, the Series B Conversion Price or the Series C -17- Conversion Price pursuant to this Section 4, the Corporation at its expense shall promptly compute such adjustment or readjustment in accordance with the terms hereof and furnish to each holder of Series A Preferred Stock, each holder of the Series B Preferred Stock and each holder of the Series C Preferred Stock a certificate setting forth such adjustment or readjustment and showing in detail the facts upon which such adjustment or readjustment is based. The Corporation shall, upon the written request at any time of any holder of Series A Preferred Stock, any holder of Series B Preferred Stock or any holder of Series C Preferred Stock, furnish or cause to be furnished to such holder a similar certificate setting forth (i) such adjustments and readjustments, (ii) the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price, as applicable, then in effect, and (iii) the number of shares of Common Stock and the amount, if any, of other property which then would be received upon the conversion of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be. (l) Notice of Record Date. In the event: (i) that the Corporation declares a dividend (or any other distribution) on its Common Stock payable in Common Stock or other securities of the Corporation; (ii) that the Corporation subdivides or combines its outstanding shares of Common Stock; (iii) of any reclassification of the Common Stock of the Corporation (other than a subdivision or combination of its outstanding shares of Common Stock or a stock dividend or stock distribution thereon), or of any consolidation or merger of the Corporation into or with another corporation, or of the sale of all or substantially all of the assets of the Corporation; or (iv) of the involuntary or voluntary dissolution, liquidation or winding up of the Corporation; then the Corporation shall cause to be filed at its principal office or at the office of the transfer agent of the Preferred Stock, and shall use its best efforts to cause to be mailed to the holders of the Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock at their last addresses as shown on the records of the Corporation or such transfer agent, prior to the dates specified in (A) and (B) below, a notice stating (A) the record date of such dividend, distribution, subdivision or combination, or, if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distribution, subdivision or combination are to be determined, or -18- (B) the date on which such reclassification, consolidation, merger, sale, dissolution, liquidation or winding up is expected to become effective, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities or other property deliverable upon such reclassification, consolidation, merger, sale, dissolution or winding up. 5. Mandatory Conversion. (a) Upon (i) the closing of the sale of shares of Common Stock, at a price to the public of at least $4.75 per share (subject to appropriate adjustment for stock splits, stock dividends, combinations and other similar recapitalizations affecting such shares), in a public offering pursuant to an effective registration statement under the Securities Act of 1933, as amended, resulting in at least $15,000,000 of net proceeds to the Corporation (a "Qualified IPO") or (ii) the delivery to the Corporation of a Conversion Notice or Notices covering at least 75% of the outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock (the "Mandatory Conversion Date"), (A) all outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall automatically be converted into shares of Common Stock, at the then effective applicable conversion rate and (B) the number of authorized shares of Preferred Stock shall be automatically reduced by the number of shares of Preferred Stock that had been designated as Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock and all references to the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall be deleted and shall be of no further force or effect. (b) All holders of record of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall be given written notice of the Mandatory Conversion Date and the place designated for mandatory conversion of all such shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock pursuant to this Section 5 . Such notice need not be given in advance of the occurrence of the Mandatory Conversion Date. Such notice shall be sent by first class or registered mail, postage prepaid, to each record holder of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock at such holder's address last shown on the records of the transfer agent for the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be (or the records of the Corporation, if it serves as its own transfer agent). Upon receipt of such notice, each holder of shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock shall surrender his or its certificate or certificates for all such shares to the Corporation at the place designated in such notice, and shall thereafter receive certificates for the number of shares of Common Stock to which such holder is entitled pursuant to this Section 5. On the Mandatory Conversion Date, all rights with respect to the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock so converted, including the rights, if any, to receive notices and vote (other than as a holder of Common Stock) will terminate, except only the rights of the holders thereof, upon surrender of their certificate or certificates therefor, to receive certificates for the number of shares of Common Stock into which such Series A Preferred Stock, Series B -19- Preferred Stock and Series C Preferred Stock has been converted, and payment of any declared but unpaid dividends thereon. If so required by the Corporation, certificates surrendered for conversion shall be endorsed or accompanied by written instrument or instruments of transfer, in form satisfactory to the Corporation, duly executed by the registered holder or by his or its attorney duly authorized in writing. As soon as practicable after the Mandatory Conversion Date and the surrender of the certificate or certificates for Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, the Corporation shall cause to be issued and delivered to such holder, or on his or its written order, a certificate or certificates for the number of full shares of Common Stock issuable on such conversion in accordance with the provisions hereof and cash as provided in Subsection 4(b) in respect of any fraction of a share of Common Stock otherwise issuable upon such conversion. (c) All certificates evidencing shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock which are required to be surrendered for conversion in accordance with the provisions hereof shall, from and after the Mandatory Conversion Date, be deemed to have been retired and cancelled and the shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock represented thereby converted into Common Stock for all purposes, notwithstanding the failure of the holder or holders thereof to surrender such certificates on or prior to such date. Such converted Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock may not be reissued, and the Corporation may thereafter take such appropriate action (without the need for stockholder action) as may be necessary to reduce the authorized number of shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, accordingly. 6. Redemption. (a) The Corporation will, subject to the conditions set forth below, on February 25, 2004 and on each of the first and second anniversaries thereof (each such date being referred to hereinafter as a "Mandatory Redemption Date"), upon receipt not less than 60 nor more than 120 days prior to the applicable Mandatory Redemption Date of written request(s) for redemption from holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock representing at least 66-2/3% of the aggregate number of shares of Common Stock issuable upon conversion of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock (a "Redemption Request"), redeem from each holder of shares of Series A Preferred Stock, Series B Preferred Stock and/or Series C Preferred Stock that requests redemption pursuant to the Redemption Request or pursuant to a subsequent election made in accordance with this Section 6(a) (a "Requesting Holder"), at a price equal to $.343 per share, in the case of the Series A Preferred Stock, $.996 per share, in the case of the Series B Preferred Stock, and $3.893 in the case of the Series C Preferred Stock, plus in each case any dividends declared but unpaid thereon, subject to appropriate adjustment in the event of any stock dividend, stock split, combination or other similar recapitalization affecting such shares (the "Mandatory Redemption Price"), the number of shares of Series A Preferred Stock, Series B Preferred Stock and/or Series C Preferred Stock requested to be redeemed by each Requesting Holder, but not more than the following respective portions of the number of shares each series of Preferred Stock held by such Requesting Holder on the applicable Mandatory Redemption Date. -20-
Maximum Mandatory Portion of Shares of Series of Redemption Date Preferred Stock To Be Redeemed - --------------- ------------------------------ February 25, 2004 33% February 25, 2005 50% February 25, 2006 All shares of Series
The Corporation shall provide notice of its receipt of Redemption Request, specifying the time, manner and place of redemption and the Mandatory Redemption Price (a "Redemption Notice"), by first class or registered mail, postage prepaid, to each holder of record of Series A Preferred Stock, to each holder of Series B Preferred Stock and to each holder of Series C Preferred Stock at the address for such holder last shown on the records of the transfer agent therefor (or the records of the Corporation, if it serves as its own transfer agent), not less than 45 days prior to the applicable Mandatory Redemption Date. Each holder of Series A Preferred Stock, each holder of Series B Preferred Stock and each holder of Series C Preferred Stock (other than a holder who has made the Redemption Request) may elect to become a Requesting Holder on such Mandatory Redemption Date by so indicating in a written notice mailed to the Company, by first class or registered mail, postage prepaid, at least 30 days prior to the applicable Mandatory Redemption Date. Except as provided in Section 6(b) below, each Requesting Holder shall surrender to the Corporation on the applicable Mandatory Redemption Date the certificate(s) representing the shares to be redeemed on such date, in the manner and at the place designated in the Redemption Notice. Thereupon, the Mandatory Redemption Price shall be paid to the order of each such Requesting Holder and each certificate surrendered for redemption shall be cancelled. (b) If the funds of the Corporation legally available for redemption of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock on any Mandatory Redemption Date are insufficient to redeem the number of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock required under this Section 6 to be redeemed on such date from Requesting Holders, those funds which are legally available will be used to redeem the maximum possible number of each such shares ratably on the basis of the number of each such series which would be redeemed on such date if the funds of the Corporation legally available therefor had been sufficient to redeem all shares required to be redeemed on such date. At any time thereafter when additional funds of the Corporation become legally available for the redemption of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, such funds will be used, at the end of the next succeeding fiscal quarter, to redeem the balance of the shares which the Corporation was theretofore obligated to redeem, ratably on the basis set forth in the preceding sentence. (c) Unless there shall have been a default in payment of the Mandatory Redemption Price, on the applicable Mandatory Redemption Date, all rights of the holder of each share redeemed on such date as a stockholder of the Corporation by reason of the ownership of such share will cease, except the right to receive such Mandatory Redemption Price of such share, without interest, upon presentation and surrender of the certificate representing such share, -21- and such share will not from and after such Mandatory Redemption Date be deemed to be outstanding. (d) Any shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock redeemed pursuant to this Section 6 will be cancelled and will not under any circumstances be reissued, sold or transferred and the Corporation may from time to time take such appropriate action as may be necessary to reduce the authorized shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock accordingly. 7. Waiver. Any of the respective rights of the holders of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock set forth herein may be waived by the affirmative vote of the holders of not less than 66-2/3% of the shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, then outstanding, voting together as a separate class; provided, however, that any waiver which does not affect all series of Preferred Stock in the same manner may only be waived by the holders of not less than 66-2/3% of the shares of Preferred Stock so affected. 8. Negative Covenants. So long as at least 25% of the shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock outstanding on the Series C Original Issue Date (such numbers to be proportionately adjusted in the event of any stock splits, stock dividends, recapitalizations or similar events) are outstanding, the Corporation shall not, without the prior written consent of the holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock representing not less than 66-2/3% of the shares of Common Stock into which all outstanding shares of such Preferred Stock are then convertible: (a) merge or consolidate into or with another corporation (except a merger or consolidation in which the holders of capital stock of the Corporation immediately prior to such merger or consolidation continue to hold at least 50% by voting power of the capital stock of the surviving or acquiring corporation), or sell all or substantially all the assets of the Corporation; (b) acquire (whether by merger, stock purchase, asset purchase or otherwise) all or substantially all of the properties, assets or stock of any other corporation or entity; (c) amend the Certificate of Incorporation (including through the filing of a Certificate of Designation) of the Corporation to authorize any additional shares of Common Stock or Preferred Stock or to authorize or designate any other class or series of stock in addition to Common Stock and Preferred Stock; (d) declare or pay any dividends or distributions on Common Stock (other than dividends payable solely in Common Stock and repurchases of Common Stock for a price equal to its original purchase price pursuant to restricted stock agreements); (e) voluntarily liquidate or dissolve; (f) incur any indebtedness for borrowed money or purchase money financing in excess of the greater of (i) $1.5 million or (ii) 25% of the amount, if any, by which the -22- Corporation's total assets exceeds its total liabilities (as reflected in the Corporation's most recent balance sheet); (g) guarantee directly or indirectly, any indebtedness or obligations (except for guarantees of trade accounts of any subsidiary arising in the ordinary course of business); (h) make any loan or advance to any person or entity, except advances and similar expenditures in the ordinary course of business or under the terms of an employee stock or option plan approved by the Board of Directors; or (i) engage in any strategic transaction in which securities of the Company are issued, including (a) joint ventures, manufacturing, marketing or distribution agreements, or (b) technology transfer or development agreements. FIFTH. The Corporation is to have perpetual existence. SIXTH. In furtherance and not in limitation of the powers conferred by the laws of the State of Delaware: A. The Board of Directors of the Corporation is expressly authorized to adopt, amend or repeal the By-Laws of the Corporation. B. Elections of directors need not be by written ballot unless the By-Laws of the Corporation shall so provide. C. The books of the Corporation may be kept at such place within or without the State of Delaware as the By-Laws of the Corporation may provide or as may be designated from time to time by the Board of Directors of the Corporation. SEVENTH. The Corporation eliminates the personal liability of each member of its Board of Directors to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided, however, that, to the extent provided by applicable law, the foregoing shall not eliminate the liability of a director (i) for any breach of such director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of Title 8 of the Delaware Code or (iv) for any transaction from which such director derived an improper personal benefit. No amendment to or repeal of this provision shall apply to or have any effect on the liability or alleged liability of any director for or with respect to any acts or omissions of such director occurring prior to such amendment or repeal. EIGHTH. The Corporation reserves the right to amend or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon a stockholder herein are granted subject to this reservation. NINTH. Whenever a compromise or arrangement is proposed between this Corporation and its creditors or any class of them and/or between this Corporation and its -23- stockholders or any class of them, any court of equitable jurisdiction within the State of Delaware may, on the application in a summary way of this Corporation or of any creditor or stockholder thereof or on the application of any receiver or receivers appointed for this Corporation under the provisions of Section 291 of Title 8 of the Delaware Code or on the application of trustees in dissolution or of any receiver or receivers appointed for this Corporation under the provisions of Section 279 of Title 8 of the Delaware Code, order a meeting of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this Corporation, as the case may be, to be summoned in such manner as the said court directs. If a majority in number representing three-fourths in value of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this Corporation, as the case may be, agree to any compromise or arrangement and to any reorganization of this Corporation as consequence of such compromise or arrangement, the said compromise or arrangement and the said reorganization shall, if sanctioned by the court to which the said application has been made, be binding on all the creditors or class of creditors, and/or on all the stockholders or class of stockholders, of this Corporation, as the case may be, and also on this Corporation. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -24- IN WITNESS WHEREOF, the undersigned has executed, signed, and acknowledged this Second Amended and Restated Certificate of Incorporation this 25th day of February, 1999. RED HAT SOFTWARE, INC. By: /s/ Robert F. Young ---------------------------------------- Name: Robert F. Young Title: Chief Executive Officer [SEAL] Attest: By: /s/ David Shumannfang --------------------- David Shumannfang Secretary CERTIFICATE OF AMENDMENT OF SECOND AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF RED HAT SOFTWARE, INC. Red Hat Software, Inc. (the "Corporation"), a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, does hereby certify as follows: FIRST: That the Board of Directors of the Corporation, by unanimous written consent, duly adopted resolutions setting forth a proposed amendment to the Corporation's Second Amended and Restated Certificate of Incorporation, declaring said amendment to be advisable and directing consideration thereof by the stockholders of the Corporation. The resolution setting forth the proposed amendment is as follows: RESOLVED: That, subject to stockholder approval, the first paragraph Article FOURTH of the Corporation's Second Amended and Restated Certificate of Incorporation be amended by deleting such paragraph in its entirety and replacing it with the following: "FOURTH: The total number of shares of all classes of capital stock which the Corporation shall have authority to issue is 51,283,052 shares, consisting of 34,310,326 shares of Common Stock with a par value of $.0001 per share (the "Common Stock") and 16,972,726 shares of Preferred Stock with a par value of $.0001 per share, (the "Preferred Stock"), of which 6,801,400 shares are designated as Series A Convertible Preferred Stock, 8,116,550 shares are designated as Series B Convertible Preferred Stock and 2,054,776 shares are designated as Series C Convertible Preferred Stock." SECOND: The Board of Directors of the Corporation directed that such amendment be submitted to the stockholders of the Corporation for their consent and approval and, in lieu of a meeting and vote of stockholders, the stockholders have given written consent to said amendment in accordance with the provisions of Section 228 of the DGCL. THIRD: That said amendment was duly adopted in accordance with the provisions of Sections 242 and 228 of the DGCL. -2- IN WITNESS WHEREOF, the undersigned has executed, signed and acknowledged this Certificate of Amendment this 31st day of March, 1999. RED HAT SOFTWARE, INC. By: /s/ Robert F. Young ---------------------------------------- Name: Robert F. Young Title: CEO [SEAL] Attest: By: /s/ David Shumannfang --------------------- David Shumannfang Secretary CERTIFICATE OF AMENDMENT OF SECOND AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF RED HAT SOFTWARE, INC. Red Hat Software, Inc. (the "Corporation"), a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, does hereby certify as follows: FIRST: That the Board of Directors of the Corporation, by unanimous written consent, duly adopted resolutions setting forth a proposed amendment to the Corporation's Second Amended and Restated Certificate of Incorporation, as amended, declaring said amendment to be advisable and directing consideration thereof by the stockholders of the Corporation. The resolutions setting forth the proposed amendment are as follows: RESOLVED: That, subject to stockholder approval, the Article FIRST of the Corporation's Second Amended and Restated Certificate of Incorporation, as amended, be amended by deleting such paragraph in its entirety and replacing it with the following: "FIRST. That the name of the Corporation is Red Hat, Inc. (the "Corporation")." RESOLVED: That, subject to stockholder approval, the first paragraph Article FOURTH of the Corporation's Second Amended and Restated Certificate of Incorporation be amended by deleting such paragraph in its entirety and replacing it with the following: "FOURTH: The total number of shares of all classes of capital stock which the Corporation shall have authority to issue is 52,283,052 shares, consisting of 35,310,326 shares of Common Stock with a par value of $.0001 per share (the "Common Stock") and 16,972,726 shares of Preferred Stock with par value of $.0001 per share (the "Preferred Stock"), of which 6,801,400 shares are designated as Series A Convertible Preferred Stock, 8,116,550 shares are designated as Series B Convertible Preferred Stock and 2,054,776 shares are designated as Series C Convertible Preferred Stock." -2- SECOND: The Board of Directors of the Corporation directed that such amendment be submitted to the stockholders of the Corporation for their consent and approval and, in lieu of a meeting and vote of stockholders, stockholders having not less than the minimum number of votes that is necessary to consent to this amendment have given written consent to said amendment in accordance with the provisions of Section 228 of the DGCL. THIRD: That said amendment was duly adopted in accordance with the provisions of Sections 242 and 228 of the DGCL. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -3- IN WITNESS WHEREOF, the undersigned has executed, signed and acknowledged this Certificate of Amendment this 4th day of June, 1999. RED HAT SOFTWARE, INC. By: /s/ Robert F. Young ----------------------- Name: Robert F. Young Title: Chief Executive Officer [SEAL] Attest: By: /s/ David Shumannfang ------------------------- David Shumannfang Secretary EX-3.2 3 EXHIBIT 3.2 THIRD AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF RED HAT, INC. -------------------------------------------- Pursuant to Sections 228, 242 and 245 of the General Corporation Law of the State of Delaware -------------------------------------------- Red Hat, Inc. (the "Corporation"), a corporation organized and existing under the General Corporation Law of the State of Delaware, does hereby certify as follows: 1. The name of the Corporation is Red Hat, Inc. The Corporation was originally incorporated under the name Red Hat Software, Inc. The original certificate of incorporation of the Corporation was filed with the office of the Secretary of State of Delaware on September 17, 1998. An amended and restated certificate of incorporation of the Corporation was filed with the office of the Secretary of State of Delaware on September 29, 1998. A Second Amended and Restated Certificate was filed with the office of the Secretary of the State of Delaware on February 24, 1999, and amended on March 31, 1999 and June 4, 1999. 2. This Third Amended and Restated Certificate of Incorporation was recommended to the stockholders for approval as being advisable and in the best interests of the Corporation by written action of the Board of Directors on June 2, 1999. 3. That in lieu of a meeting and vote of stockholders, consents in writing have been signed by holders of outstanding stock having not less than the minimum number of votes that is necessary to consent to this amendment and restatement, and, if required, prompt notice of such action shall be given in accordance with the provisions of Section 228 of the General Corporation Law of the State of Delaware. 4. This Third Amended and Restated Certificate of Incorporation restates and integrates and further amends the certificate of incorporation of the Corporation, as heretofore amended or supplemented. The text of the Corporation's second amended and restated certificate of incorporation is amended and restated in its entirety as follows: FIRST. The name of the Corporation is Red Hat, Inc. SECOND. The address of the registered office of the Corporation in the State of Delaware is 1209 Orange Street, Wilmington, County of New Castle, Delaware 19801. The name of its registered agent at such address is The Corporation Trust Company. -2- THIRD. The nature of the business or purposes to be conducted or promoted is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware. FOURTH. The total number of shares of all classes of capital stock which the Corporation shall have authority to issue is 246,972,726 shares consisting of 225,000,000 shares of Common Stock with a par value of $.0001 per share (the "Common Stock") and 21,972,726 shares of Preferred Stock with a par value of $.0001 per share, (the "Preferred Stock"), of which 5,000,000 are undesignated, 6,801,400 shares are designated as Series A Convertible Preferred Stock, 8,116,550 shares are designated as Series B Convertible Preferred Stock and 2,054,776 shares are designated as Series C Convertible Preferred Stock. A description of the respective classes of stock and a statement of the designations, powers, preferences and rights, and the qualifications, limitations and restrictions of the Preferred Stock and Common Stock are as follows: A. COMMON STOCK 1. GENERAL. All shares of Common Stock will be identical and will entitle the holders thereof to the same rights, powers and privileges. The rights, powers and privileges of the holders of the Common Stock are subject to and qualified by the rights of holders of the Preferred Stock. 2. DIVIDENDS. Dividends may be declared and paid on the Common Stock from funds lawfully available therefor as and when determined by the Board of Directors and subject to any preferential dividend rights of any then outstanding Preferred Stock. 3. DISSOLUTION, LIQUIDATION OR WINDING UP. In the event of any dissolution, liquidation or winding up of the affairs of the Corporation, whether voluntary or involuntary, each issued and outstanding share of Common Stock shall entitle the holder thereof to receive an equal portion of the net assets of the Corporation available for distribution to the holders of Common Stock, subject to any preferential rights of any then outstanding Preferred Stock. 4. VOTING RIGHTS. Except as otherwise required by law or this Third Amended and Restated Certificate of Incorporation, each holder of Common Stock shall have one vote in respect of each share of stock held of record by such holder on the books of the Corporation for the election of directors and on all matters submitted to a vote of stockholders of the Corporation. Except as otherwise required by law or provided herein, holders of Common Stock shall vote together with holders of the Preferred Stock as a single class, subject to any special or preferential voting rights of any then outstanding Preferred Stock. There shall be no cumulative voting. -3- B. PREFERRED STOCK The Preferred Stock may be issued in one or more series at such time or times and for such consideration or considerations as the Board of Directors of the Corporation may determine. Each series shall be so designated as to distinguish the shares thereof from the shares of all other series and classes. Except as otherwise provided in this Third Amended and Restated Certificate of Incorporation, different series of Preferred Stock shall not be construed to constitute different classes of shares for the purpose of voting by classes. C. UNDESIGNATED PREFERRED STOCK The Board of Directors is expressly authorized to provide for the issuance of all or any shares of the undesignated Preferred Stock in one or more series, each with such designations, preferences, voting powers (or special, preferential or no voting powers), relative, participating, optional or other special rights and privileges and such qualifications, limitations or restrictions thereof as shall be stated in the resolution or resolutions adopted by the Board of Directors to create such series, and a certificate of said resolution or resolutions (a "Certificate of Designation") shall be filed in accordance with the General Corporation Law of the State of Delaware. The authority of the Board of Directors with respect to each such series shall include, without limitation of the foregoing, the right to provide that the shares of each such series may be: (i) subject to redemption at such time or times and at such price or prices; (ii) entitled to receive dividends (which may be cumulative or non-cumulative) at such rates, on such conditions, and at such times, and payable in preference to, or in such relation to, the dividends payable on any other class or classes or any other series; (iii) entitled to such rights upon the dissolution of, or upon any distribution of the assets of, the Corporation; (iv) convertible into, or exchangeable for, shares of any other class or classes of stock, or of any other series of the same or any other class or classes of stock of the Corporation at such price or prices or at such rates of exchange and with such adjustments, if any; (v) entitled to the benefit of such limitations, if any, on the issuance of additional shares of such series or shares of any other series of Preferred Stock; or (vi) entitled to such other preferences, powers, qualifications, rights and privileges, all as the Board of Directors may deem advisable and as are not inconsistent with law and the provisions of this Third Amended and Restated Certificate of Incorporation. D. SERIES A, SERIES B AND SERIES C CONVERTIBLE PREFERRED STOCK 1. DIVIDENDS. The Corporation shall not declare or pay any dividends on shares of Common Stock (except for dividends payable solely in the form of Common Stock) until the holders of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock then outstanding shall have first received, or simultaneously receive, a distribution on each outstanding share of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock in an amount at least equal to the product of (i) the per share amount, if any, of the dividends to be declared, paid or set aside for the Common Stock, multiplied by (ii) the number of whole shares of Common Stock into which such share of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock is then convertible. The Corporation shall not declare or pay any dividends on any shares of Preferred Stock unless, at the same -4- time, a dividend in a like amount per share shall be paid upon, or declared and set apart for, all shares of Preferred Stock then outstanding. 2. LIQUIDATION, DISSOLUTION OR WINDING UP; CERTAIN MERGERS, CONSOLIDATIONS AND ASSET SALES. (a) In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock then outstanding shall be entitled to be paid out of the assets of the Corporation available for distribution to its stockholders, before any payment shall be made to the holders of Common Stock or any other class or series of stock ranking on liquidation junior to the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock (such Common Stock and other stock being collectively referred to as "Junior Stock") by reason of their ownership thereof, an amount equal to the greater of (i) $.343 per share, in the case of Series A Preferred Stock, $.996 per share, in the case of Series B Preferred Stock, and $3.893 per share in the case of the Series C Preferred Stock (each subject to appropriate adjustment in the event of any stock dividend, stock split, combination or other similar recapitalization affecting such shares), plus any dividends declared but unpaid thereon, or (ii) such amount per share as would have been payable had each such share been converted into Common Stock pursuant to Section 4 immediately prior to such liquidation, dissolution or winding up. If upon any such liquidation, dissolution or winding up of the Corporation the remaining assets of the Corporation available for distribution to its stockholders shall be insufficient to pay the holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock the full amount to which they shall be entitled, the holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock and any class or series of stock ranking on liquidation on a parity with the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall share ratably in any distribution of the remaining assets and funds of the Corporation in proportion to the respective amounts which would otherwise be payable pursuant to clause (i) above in respect of the shares held by them upon such distribution. The Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock of the Corporation shall be deemed to rank on a parity with each other with respect to the liquidation, dissolution or winding-up of the Corporation. (b) After the payment of all preferential amounts required to be paid to the holders of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock and any other class or series of stock of the Corporation ranking on liquidation on a parity with the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, upon the dissolution, liquidation or winding up of the Corporation, the holders of shares of Junior Stock then outstanding shall be entitled to receive the remaining assets and funds of the Corporation available for distribution to its stockholders. (c) Any (i) merger or consolidation of the Corporation or a subsidiary of the Corporation into or with another corporation (except one in which the holders of capital stock of the Corporation immediately prior to such merger or consolidation continue to hold at least -5- 50% by voting power of the capital stock of the Corporation or the surviving or acquiring corporation), (ii) acquisition, in one transaction or a series of related transactions by a person or group of affiliated persons, of 50% or more of the outstanding voting stock of the Company or (iii) sale of all or substantially all the assets of the Corporation, shall be deemed to be a liquidation of the Corporation for purposes of this Section 2 unless the holders of a majority of the then outstanding Preferred Stock elect in writing not to treat such merger, consolidation or sale as a liquidation, and any agreement or plan of merger or consolidation to which the Company is a party shall provide that the consideration payable to the stockholders of the Corporation (in the case of a merger or consolidation), or consideration payable to the Corporation, together with all other available assets of the Corporation (in the case of an asset sale), shall be distributed to the holders of capital stock of the Corporation in accordance with Subsections 2(a) and 2(b) above. The amount deemed distributed to the holders of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock upon any such merger, consolidation or sale shall be the cash or the value of the property, rights or securities distributed to such holders by the Corporation or the acquiring person, firm or other entity. The value of such property, rights or other securities shall be determined in good faith by the Board of Directors of the Corporation. 3. VOTING. (a) Each holder of outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall be entitled to the number of votes equal to the number of whole shares of Common Stock into which the shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock held by such holder are then convertible (as adjusted from time to time pursuant to Section 4 hereof), at each meeting of stockholders of the Corporation (and written actions of stockholders in lieu of meetings) with respect to any and all matters presented to the stockholders of the Corporation for their action or consideration. Except as provided by law, by the provisions of Subsection 3(b) below or by the provisions establishing any other series of Preferred Stock, holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock and any other outstanding series of Preferred Stock shall vote together with the holders of Common Stock as a single class. (b) The Corporation shall not amend, alter or repeal the preferences, special rights or other powers of the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock so as to affect adversely the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, without the written consent or affirmative vote of the holders of a majority of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be, given in writing or by vote at a meeting, consenting or voting (as the case may be) separately as a class. For this purpose, without limiting the generality of the foregoing, the authorization of any shares of capital stock with preference or priority over the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock as to the right to receive either dividends or amounts distributable upon liquidation, dissolution or winding up of the Corporation shall be deemed to affect adversely the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, and the authorization of any shares of capital stock on a parity with Series A Preferred Stock, -6- Series B Preferred Stock and Series C Preferred Stock as to the right to receive either dividends or amounts distributable upon liquidation, dissolution or winding up of the Corporation shall not be deemed to affect adversely the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock. 4. OPTIONAL CONVERSION. The holders of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall have conversion rights as follows (the "Conversion Rights"): (a) (i) SERIES A RIGHT TO CONVERT. Each share of Series A Preferred Stock shall be convertible, at the option of the holder thereof, at any time and from time to time, and without the payment of additional consideration by the holder thereof, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing $.343 by the Series A Conversion Price (as defined below) in effect at the time of conversion. The "Series A Conversion Price" shall initially be $.343. Such initial Series A Conversion Price, and the rate at which shares of Series A Preferred Stock may be converted into shares of Common Stock, shall be subject to adjustment as provided below. (ii) SERIES B RIGHT TO CONVERT. Each share of Series B Preferred Stock shall be convertible, at the option of the holder thereof, at any time and from time to time, and without the payment of additional consideration by the holder thereof, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing $.996 by the Series B Conversion Price (as defined below) in effect at the time of conversion. The "Series B Conversion Price" shall initially be $.996. Such initial Series B Conversion Price, and the rate at which shares of Series B Preferred Stock may be converted into shares of Common Stock, shall be subject to adjustment as provided below. (iii) SERIES C RIGHT TO CONVERT. Each share of Series C Preferred Stock shall be convertible, at the option of the holder thereof, at any time and from time to time, and without the payment of additional consideration by the holder thereof, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing $3.893 by the Series C Conversion Price (as defined below) in effect at the time of conversion. The "Series C Conversion Price" shall initially be $3.893. Such initial Series C Conversion Price, and the rate at which shares of Series C Preferred Stock may be converted into shares of Common Stock, shall be subject to adjustment as provided below. (iv) In the event of a notice of redemption of any shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock pursuant to Section 6 hereof, the Conversion Rights of the shares designated for redemption shall terminate at the close of business on the fifth full day preceding the date fixed for redemption, unless the redemption price is not paid when due, in which case the Conversion Rights for such shares shall continue until such price is paid in full. In the event of a liquidation of the Corporation, the Conversion Rights shall terminate at the close of business on the first full day preceding the date fixed for the payment of any amounts distributable on liquidation to the holders of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock. -7- (b) FRACTIONAL SHARES. No fractional shares of Common Stock shall be issued upon conversion of the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock. In lieu of any fractional shares to which the holder would otherwise be entitled, the Corporation shall pay cash equal to such fraction multiplied by the then effective Series A Conversion Price, Series B Conversion Price or Series C Conversion Price. (c) MECHANICS OF CONVERSION. (i) In order for a holder of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock to convert its shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock into shares of Common Stock, such holder shall surrender the certificate or certificates for such shares of Preferred Stock, at the office of the transfer agent for the Preferred Stock (or at the principal office of the Corporation if the Corporation serves as its own transfer agent), together with written notice (a "Conversion Notice") that such holder elects to convert all or any number of the shares of the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock represented by such certificate or certificates. The Conversion Notice shall state such holder's name or the names of the nominees in which such holder wishes the certificate or certificates for shares of Common Stock to be issued. If required by the Corporation, certificates surrendered for conversion shall be endorsed or accompanied by a written instrument or instruments of transfer, in form satisfactory to the Corporation, duly executed by the registered holder or his or its attorney duly authorized in writing. The date of receipt of such certificates and Conversion Notice by the transfer agent (or by the Corporation if the Corporation serves as its own transfer agent) shall be the conversion date ("Conversion Date"). The Corporation shall, as soon as practicable after the Conversion Date, issue and deliver at such office to such holder of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, or to his or its nominees, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled, together with cash in lieu of any fraction of a share. (ii) The Corporation shall at all times when the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock shall be outstanding, reserve and keep available out of its authorized but unissued stock, for the purpose of effecting the conversion of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, such number of its duly authorized shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock. Before taking any action which would cause an adjustment reducing the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price below the then par value of the shares of Common Stock issuable upon conversion of the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, the Corporation will take any corporate action which may, in the opinion of its counsel, be necessary in order that the Corporation may validly and legally issue fully paid and nonassessable shares of Common Stock at such adjusted Series A Conversion Price, Series B Conversion Price or Series C Conversion Price. -8- (iii) Upon any such conversion, no adjustment to the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price shall be made for any declared but unpaid dividends on the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as applicable, surrendered for conversion or on the Common Stock delivered upon such conversion. (iv) All shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock which shall have been surrendered for conversion as herein provided shall no longer be deemed to be outstanding and all rights with respect to such shares, including the rights, if any, to receive notices and to vote, shall immediately cease and terminate on the Conversion Date, except only the right of the holders thereof to receive shares of Common Stock in exchange therefor and payment of any dividends declared but unpaid thereon. Any shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock so converted shall be retired and cancelled and shall not be reissued, and the Corporation (without the need for stockholder action) may from time to time take such appropriate action as may be necessary to reduce the authorized number of shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock accordingly. (v) The Corporation shall pay any and all issue and other taxes that may be payable in respect of any issuance or delivery of shares of Common Stock upon conversion of shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock pursuant to this Section 4. The Corporation shall not, however, be required to pay any tax which may be payable in respect of any transfer involved in the issuance and delivery of shares of Common Stock in a name other than that in which the shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock so converted were registered, and no such issuance or delivery shall be made unless and until the person or entity requesting such issuance has paid to the Corporation the amount of any such tax or has established, to the satisfaction of the Corporation, that such tax has been paid. (d) ADJUSTMENTS TO SERIES A CONVERSION PRICE, SERIES B CONVERSION PRICE OR SERIES C CONVERSION PRICE FOR DILUTING ISSUES: (i) SPECIAL DEFINITIONS. For purposes of this Subsection 4(d), the following definitions shall apply: (A) "OPTION" shall mean rights, options or warrants to subscribe for, purchase or otherwise acquire Common Stock or Convertible Securities. (B) "SERIES A ORIGINAL ISSUE DATE" shall mean the date on which the first share of Series A Preferred Stock was issued. (C) "SERIES B ORIGINAL ISSUE DATE" shall mean the date on which the first share of Series B Preferred Stock was issued. -9- (D) "SERIES C ORIGINAL ISSUE DATE" shall mean the date on which the first share of Series C Preferred Stock was issued. (E) "CONVERTIBLE SECURITIES" shall mean any evidences of indebtedness, shares or other securities directly or indirectly convertible into or exchangeable for Common Stock. (F) "ADDITIONAL SHARES OF COMMON STOCK" shall mean all shares of Common Stock issued (or, pursuant to Subsection 4(d)(iii) below, deemed to be issued) by the Corporation after the Series C Original Issue Date, other than: (I) shares of Common Stock issued or issuable upon conversion of any shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock; (II) shares of Common Stock issued or issuable upon conversion of any Convertible Securities (other than shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock) or exercise of any warrants outstanding on the Series C Original Issue Date; (III) shares of Common Stock issued or issuable as a dividend or distribution on Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock; (IV) shares of Common Stock issued or issuable by reason of a dividend, stock split, split-up or other distribution on shares of Common Stock that is covered by Subsection 4(e) or 4(f) below; (V) up to 3,717,400 shares of Common Stock (including issuances prior to the Series C Original Issue Date) (subject to appropriate adjustment in the event of any stock dividend, stock split, combination or other similar recapitalization affecting such shares), plus such additional number of shares of Common Stock as may be approved by the Board of Directors of the Corporation and by a majority of the members of the Board of Directors who are not employees of the Company or any of its subsidiaries, issued or issuable to employees or directors of, or consultants to, the Corporation pursuant to employer stock option plans; (VI) securities issued pursuant to any equipment leasing arrangement or debt financing from a bank or similar financial institution approved by the Board of Directors of the Corporation and by a majority of the members of the Board of Directors who are not employees of the Corporation or any of its subsidiaries; or (VII) securities issued in connection with strategic transactions approved by the Board of Directors of the Corporation and by a majority of the members of the Board of Directors who are not employees of the Corporation or any of its subsidiaries involving the Company and other entities, including (a) joint ventures, -10- manufacturing, marketing or distribution arrangements or (b) technology transfer or development arrangements. (ii) NO ADJUSTMENT OF CONVERSION PRICE. (A) No adjustment in the number of shares of Common Stock into which the Series A Preferred Stock is convertible shall be made, by adjustment in the applicable Series A Conversion Price thereof: (a) unless the consideration per share (determined pursuant to Subsection 4(d)(v)) for an Additional Share of Common Stock issued or deemed to be issued by the Corporation is less than the applicable Series A Conversion Price in effect immediately prior to the issue of such Additional Shares, or (b) if prior to such issuance, the Corporation receives written notice from the holders of at least 66-2/3% of the then outstanding shares of Series A Preferred Stock agreeing that no such adjustment shall be made as the result of the issuance of Additional Shares of Common Stock. (B) No adjustment in the number of shares of Common Stock into which the Series B Preferred Stock is convertible shall be made, by adjustment in the applicable Series B Conversion Price thereof: (a) unless the consideration per share (determined pursuant to Subsection 4(d)(v)) for an Additional Share of Common Stock issued or deemed to be issued by the Corporation is less than the applicable Series B Conversion Price in effect immediately prior to the issue of such Additional Shares, or (b) if prior to such issuance, the Corporation receives written notice from the holders of at least 66-2/3% of the then outstanding shares of Series B Preferred Stock agreeing that no such adjustment shall be made as the result of the issuance of Additional Shares of Common Stock. (C) No adjustment in the number of shares of Common Stock into which the Series C Preferred Stock is convertible shall be made, by adjustment in the applicable Series C Conversion Price thereof: (a) unless the consideration per share (determined pursuant to Subsection 4(d)(v)) for an Additional Share of Common Stock issued or deemed to be issued by the Corporation is less than the applicable Series C Conversion Price in effect immediately prior to the issue of such Additional Shares, or (b) if prior to such issuance, the Corporation receives written notice from the holders of at least 66-2/3% of the then outstanding shares of Series C Preferred Stock agreeing that no such adjustment shall be made as the result of the issuance of Additional Shares of Common Stock. -11- (iii) ISSUE OF SECURITIES DEEMED ISSUE OF ADDITIONAL SHARES OF COMMON STOCK. If the Corporation at any time or from time to time after the Series A Original Issue Date, Series B Original Issue Date or Series C Original Issue Date, as applicable, shall issue any Options (excluding Options covered by Subsection 4(d)(i)(F)(IV) above) or Convertible Securities or shall fix a record date for the determination of holders of any class of securities entitled to receive any such Options or Convertible Securities, then the maximum number of shares of Common Stock (as set forth in the instrument relating thereto without regard to any provision contained therein for a subsequent adjustment of such number) issuable upon the exercise of such Options or, in the case of Convertible Securities and Options therefor, the conversion or exchange of such Convertible Securities, shall be deemed to be Additional Shares of Common Stock issued as of the time of such issue or, in case such a record date shall have been fixed, as of the close of business on such record date, provided that (x) for the purposes of adjusting the Series A Conversion Price, Additional Shares of Common Stock shall not be deemed to have been issued unless the consideration per share (determined pursuant to Subsection 4(d)(v) hereof) of such Additional Shares of Common Stock would be less than the applicable Series A Conversion Price in effect on the date of and immediately prior to such issue, or such record date, as the case may be, (y) for the purposes of adjusting the Series B Conversion Price, Additional Shares of Common Stock shall not be deemed to have been issued unless the consideration per share (determined pursuant to Subsection 4(d)(v) hereof) of such Additional Shares of Common Stock would be less than the applicable Series B Conversion Price in effect on the date of and immediately prior to such issue, or such record date, as the case may be, and (z) for the purposes of adjusting the Series C Conversion Price, Additional Shares of Common Stock shall not be deemed to have been issued unless the consideration per share (determined pursuant to Subsection 4(d)(v) hereof) of such Additional Shares of Common Stock would be less than the applicable Series C Conversion Price in effect on the date of and immediately prior to such issue, or such record date, as the case may be, and provided further that in any such case in which Additional Shares of Common Stock are deemed to be issued: (A) No further adjustment in the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price shall be made upon the subsequent issue of Convertible Securities or shares of Common Stock upon the exercise of such Options or conversion or exchange of such Convertible Securities; (B) If such Options or Convertible Securities by their terms provide, with the passage of time or otherwise, for any increase or decrease in the consideration payable to the Corporation, upon the exercise, conversion or exchange thereof, the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price computed upon the original issue thereof (or upon the occurrence of a record date with respect thereto), and any subsequent adjustments based thereon, shall, upon any such increase or decrease becoming effective, be recomputed to reflect such increase or decrease insofar as it affects such Options or the rights of conversion or exchange under such Convertible Securities; -12- (C) Upon the expiration or termination of any such unexercised Option, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price shall be readjusted, to the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price as would have been in effect at the time of such expiration or termination had such Option never been issued; (D) In the event of any change in the number of shares of Common Stock issuable upon the exercise, conversion or exchange of any such Option or Convertible Security, including, but not limited to, a change resulting from the anti-dilution provisions thereof, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price then in effect shall forthwith be readjusted to such Series A Conversion Price, Series B Conversion Price or Series C Conversion Price as would have obtained had the adjustment which was made upon the issuance of such Option or Convertible Security not exercised or converted prior to such change been made upon the basis of such change; and (E) No readjustment pursuant to clauses (B) or (D) above shall have the effect of increasing the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price to an amount which exceeds the lower of (i) the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price on the original adjustment date, or (ii) the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price, as the case may be, that would have resulted from any issuances of Additional Shares of Common Stock between the original adjustment date and such readjustment date. In the event the Corporation, after the Series A Original Issue Date, the Series B Original Issue Date or the Series C Original Issue Date, amends the terms of any such Options or Convertible Securities (whether such Options or Convertible Securities were outstanding on such respective original issue date or were issued after such respective original issue date), then such Options or Convertible Securities, as so amended, shall be deemed to have been issued after such respective original issue date and the provisions of this Subsection 4(d)(iii) shall apply. (iv) ADJUSTMENT OF CONVERSION PRICE UPON ISSUANCE OF ADDITIONAL SHARES OF COMMON STOCK. (A) In the event the Corporation shall at any time after the Series A Original Issue Date issue Additional Shares of Common Stock (including Additional Shares of Common Stock deemed to be issued pursuant to Subsection 4(d)(iii), but excluding shares issued as a stock split or combination as provided in Subsection 4(e) or upon a dividend or distribution as provided in Subsection 4(f)), without consideration or for a consideration per share less than the applicable Series A Conversion Price in effect immediately prior to such issue, then and in such event, such Series A Conversion Price shall be reduced, concurrently with such issue, to a price (calculated to the nearest cent) determined by multiplying such Series A Conversion Price by a fraction, (A) the numerator of which shall be (1) the number of shares of Common Stock outstanding immediately prior to such issue plus (2) the number of -13- shares of Common Stock which the aggregate consideration received or to be received by the Corporation for the total number of Additional Shares of Common Stock so issued would purchase at such Series A Conversion Price; and (B) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issue plus the number of such Additional Shares of Common Stock so issued; PROVIDED THAT, (i) for the purpose of this Subsection 4(d)(iv), all shares of Common Stock issuable upon exercise or conversion of vested Options or Convertible Securities outstanding immediately prior to such issue shall be deemed to be outstanding, and (ii) the number of shares of Common Stock deemed issuable upon exercise or conversion of such outstanding vested Options and Convertible Securities shall not give effect to any adjustments to the conversion price or conversion rate of such Options or Convertible Securities resulting from the issuance of Additional Shares of Common Stock that is the subject of this calculation. (B) In the event the Corporation shall at any time after the Series B Original Issue Date issue Additional Shares of Common Stock (including Additional Shares of Common Stock deemed to be issued pursuant to Subsection 4(d)(iii), but excluding shares issued as a stock split or combination as provided in Subsection 4(e) or upon a dividend or distribution as provided in Subsection 4(f)), without consideration or for a consideration per share less than the applicable Series B Conversion Price in effect immediately prior to such issue, then and in such event, such Series B Conversion Price shall be reduced, concurrently with such issue, to a price (calculated to the nearest cent) determined by multiplying such Series B Conversion Price by a fraction, (A) the numerator of which shall be (1) the number of shares of Common Stock outstanding immediately prior to such issue plus (2) the number of shares of Common Stock which the aggregate consideration received or to be received by the Corporation for the total number of Additional Shares of Common Stock so issued would purchase at such Series B Conversion Price; and (B) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issue plus the number of such Additional Shares of Common Stock so issued; PROVIDED THAT, (i) for the purpose of this Subsection 4(d)(iv), all shares of Common Stock issuable upon exercise or conversion of vested Options or Convertible Securities outstanding immediately prior to such issue shall be deemed to be outstanding, and (ii) the number of shares of Common Stock deemed issuable upon exercise or conversion of such outstanding vested Options and Convertible Securities shall not give effect to any adjustments to the conversion price or conversion rate of such Options or Convertible Securities resulting from the issuance of Additional Shares of Common Stock that is the subject of this calculation. (C) In the event the Corporation shall at any time after the Series C Original Issue Date issue Additional Shares of Common Stock (including Additional Shares of Common Stock deemed to be issued pursuant to Subsection 4(d)(iii), but excluding shares issued as a stock split or combination as provided in Subsection 4(e) or upon a dividend or distribution as provided in Subsection 4(f)), without consideration or for a consideration per share less than the applicable Series C Conversion Price in effect immediately prior to such issue, then and in such event, such Series C Conversion Price shall be reduced, concurrently with such issue, to a price (calculated to the nearest cent) determined by multiplying such Series C Conversion Price by a fraction, (A) the numerator of which shall be (1) the number of -14- shares of Common Stock outstanding immediately prior to such issue plus (2) the number of shares of Common Stock which the aggregate consideration received or to be received by the Corporation for the total number of Additional Shares of Common Stock so issued would purchase at such Series C Conversion Price; and (B) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issue plus the number of such Additional Shares of Common Stock so issued; PROVIDED THAT, (i) for the purpose of this Subsection 4(d)(iv), all shares of Common Stock issuable upon exercise or conversion of vested Options or Convertible Securities outstanding immediately prior to such issue shall be deemed to be outstanding, and (ii) the number of shares of Common Stock deemed issuable upon exercise or conversion of such outstanding vested Options and Convertible Securities shall not give effect to any adjustments to the conversion price or conversion rate of such Options or Convertible Securities resulting from the issuance of Additional Shares of Common Stock that is the subject of this calculation. (V) DETERMINATION OF CONSIDERATION. For purposes of this Subsection 4(d), the consideration received by the Corporation for the issue of any Additional Shares of Common Stock shall be computed as follows: (A) CASH AND PROPERTY: Such consideration shall: (I) insofar as it consists of cash, be computed at the aggregate of cash received by the Corporation, excluding amounts paid or payable for accrued interest; (II) insofar as it consists of property other than cash, be computed at the fair market value thereof at the time of such issue, as determined in good faith by the Board of Directors; and (III) in the event Additional Shares of Common Stock are issued together with other shares or securities or other assets of the Corporation for consideration which covers both, be the proportion of such consideration so received, computed as provided in clauses (I) and (II) above, as determined in good faith by the Board of Directors. (B) OPTIONS AND CONVERTIBLE SECURITIES. The consideration per share received by the Corporation for Additional Shares of Common Stock deemed to have been issued pursuant to Subsection 4(d)(iii), relating to Options and Convertible Securities, shall be determined by dividing (x) the total amount, if any, received or receivable by the Corporation as consideration for the issue of such Options or Convertible Securities, plus the minimum aggregate amount of additional consideration (as set forth in the instruments relating thereto, without regard to any provision contained therein for a subsequent adjustment of such consideration) payable to the Corporation upon the exercise of such Options or the conversion or exchange of such Convertible Securities, or in the case of Options for -15- Convertible Securities, the exercise of such Options for Convertible Securities and the conversion or exchange of such Convertible Securities, by (y) the maximum number of shares of Common Stock (as set forth in the instruments relating thereto, without regard to any provision contained therein for a subsequent adjustment of such number) issuable upon the exercise of such Options or the conversion or exchange of such Convertible Securities. (vi) MULTIPLE CLOSING DATES. In the event the Corporation shall issue on more than one date Additional Shares of Common Stock which are comprised of shares of the same series or class of Preferred Stock, and such issuance dates occur within a period of no more than 120 days, then, upon the final such issuance, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price shall be adjusted to give effect to all such issuances as if they occurred on the date of the final such issuance (and without giving effect to any adjustments as a result of such prior issuances within such period). (e) ADJUSTMENT FOR STOCK SPLITS AND COMBINATIONS. If the Corporation shall at any time or from time to time after the Series C Original Issue Date effect a subdivision of the outstanding Common Stock, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price then in effect immediately before that subdivision each shall be proportionately decreased. If the Corporation shall at any time or from time to time after the Series C Original Issue Date combine the outstanding shares of Common Stock, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price then in effect immediately before the combination each shall be proportionately increased. Any adjustment under this paragraph shall become effective at the close of business on the date the subdivision or combination becomes effective. (f) ADJUSTMENT FOR CERTAIN DIVIDENDS AND DISTRIBUTIONS. In the event the Corporation at any time, or from time to time after the Series C Original Issue Date, as the case may be, shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price then in effect immediately before such event each shall be decreased as of the time of such issuance or, in the event such a record date shall have been fixed, as of the close of business on such record date, by multiplying the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price, as the case may be, then in effect by a fraction: (1) the numerator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, and -16- (2) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date plus the number of shares of Common Stock issuable in payment of such dividend or distribution; provided, however, if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price each shall be recomputed accordingly as of the close of business on such record date and thereafter the Series A Conversion Price, Series B Conversion Price and Series C Conversion Price, as the case may be, shall be adjusted pursuant to this paragraph as of the time of actual payment of such dividends or distributions; and provided further, however, that no such adjustment shall be made if the holders of Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock simultaneously receive (i) a dividend or other distribution of shares of Common Stock in a number equal to the number of shares of Common Stock as they would have received if all outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock had been converted into Common Stock on the date of such event or (ii) a dividend or other distribution of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock which are convertible, as of the date of such event, into such number of shares of Common Stock as is equal to the number of additional shares of Common Stock being issued with respect to each share of Common Stock in such dividend or distribution. (g) ADJUSTMENTS FOR OTHER DIVIDENDS AND DISTRIBUTIONS. In the event the Corporation at any time or from time to time after the Series C Original Issue Date shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in securities of the Corporation other than shares of Common Stock, then and in each such event provision shall be made so that the holders of the Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of Series C Preferred Stock shall receive upon conversion thereof in addition to the number of shares of Common Stock receivable thereupon, the amount of securities of the Corporation that they would have received had the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be, been converted into Common Stock on the date of such event and had they thereafter, during the period from the date of such event to and including the conversion date, retained such securities receivable by them as aforesaid during such period, giving application to all adjustments called for during such period under this paragraph with respect to the rights of the holders of the Series A Preferred Stock, the rights of the holders of the Series B Preferred Stock and the rights of the holders of the Series C Preferred Stock, as the case may be; and provided further, however, that no such adjustment shall be made if the holders of Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock, as the case may be, simultaneously receive a dividend or other distribution of such securities in an amount equal to the amount of such securities as they would have received if all outstanding shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be, had been converted into Common Stock on the date of such event. -17- (h) ADJUSTMENT FOR RECLASSIFICATION, EXCHANGE, OR SUBSTITUTION. If the Common Stock issuable upon the conversion of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall be changed into the same or a different number of shares of any class or classes of stock, whether by capital reorganization, reclassification, or otherwise (other than a subdivision or combination of shares or stock dividend provided for above, or a reorganization, merger, consolidation, or sale of assets provided for below), then and in each such event the holders of each such share of Series A Preferred Stock, the holders of each such share of Series B Preferred Stock and the holders of each such share of Series C Preferred Stock shall have the right thereafter to convert such share into the kind and amount of shares of stock and other securities and property receivable, upon such reorganization, reclassification, or other change, by holders of the number of shares of Common Stock into which such shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be, might have been converted immediately prior to such reorganization, reclassification, or change, all subject to further adjustment as provided herein. (i) ADJUSTMENT FOR MERGER OR REORGANIZATION, ETC. In case of any consolidation or merger of the Corporation with or into another corporation or the sale of all or substantially all of the assets of the Corporation to another corporation (other than a consolidation, merger or sale which is covered by Subsection 2(c)), each share of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall thereafter be convertible (or shall be converted into a security which shall be convertible) into the kind and amount of shares of stock or other securities or property to which a holder of the number of shares of Common Stock of the Corporation deliverable upon conversion of such Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, as the case may be, would have been entitled upon such consolidation, merger or sale; and, in such case, appropriate adjustment (as determined in good faith by the Board of Directors) shall be made in the application of the provisions in this Section 4 set forth with respect to the rights and interest thereafter of the holders of the Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock, to the end that the provisions set forth in this Section 4 (including provisions with respect to changes in and other adjustments of the Series A Conversion Price, Series B Conversion Price and the Series C Conversion Price) shall thereafter be applicable, as nearly as reasonably may be, in relation to any shares of stock or other property thereafter deliverable upon the conversion of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, as the case may be. (j) NO IMPAIRMENT. The Corporation will not, by amendment of its Certificate of Incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Corporation, but will at all times in good faith assist in the carrying out of all the provisions of this Section 4 and in the taking of all such action as may be necessary or appropriate in order to protect the Conversion Rights of the holders of the Series A Preferred -18- Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock against impairment. (k) CERTIFICATE AS TO ADJUSTMENTS. Upon the occurrence of each adjustment or readjustment of the Series A Conversion Price, the Series B Conversion Price or the Series C Conversion Price pursuant to this Section 4, the Corporation at its expense shall promptly compute such adjustment or readjustment in accordance with the terms hereof and furnish to each holder of Series A Preferred Stock, each holder of the Series B Preferred Stock and each holder of the Series C Preferred Stock a certificate setting forth such adjustment or readjustment and showing in detail the facts upon which such adjustment or readjustment is based. The Corporation shall, upon the written request at any time of any holder of Series A Preferred Stock, any holder of Series B Preferred Stock or any holder of Series C Preferred Stock, furnish or cause to be furnished to such holder a similar certificate setting forth (i) such adjustments and readjustments, (ii) the Series A Conversion Price, Series B Conversion Price or Series C Conversion Price, as applicable, then in effect, and (iii) the number of shares of Common Stock and the amount, if any, of other property which then would be received upon the conversion of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be. (l) NOTICE OF RECORD DATE. In the event: (i) that the Corporation declares a dividend (or any other distribution) on its Common Stock payable in Common Stock or other securities of the Corporation; (ii) that the Corporation subdivides or combines its outstanding shares of Common Stock; (iii) of any reclassification of the Common Stock of the Corporation (other than a subdivision or combination of its outstanding shares of Common Stock or a stock dividend or stock distribution thereon), or of any consolidation or merger of the Corporation into or with another corporation, or of the sale of all or substantially all of the assets of the Corporation; or (iv) of the involuntary or voluntary dissolution, liquidation or winding up of the Corporation; then the Corporation shall cause to be filed at its principal office or at the office of the transfer agent of the Preferred Stock, and shall use its best efforts to cause to be mailed to the holders of the Series A Preferred Stock, the holders of the Series B Preferred Stock and the holders of the Series C Preferred Stock at their last addresses as shown on the records of the Corporation or such transfer agent, prior to the dates specified in (A) and (B) below, a notice stating -19- (A) the record date of such dividend, distribution, subdivision or combination, or, if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distribution, subdivision or combination are to be determined, or (B) the date on which such reclassification, consolidation, merger, sale, dissolution, liquidation or winding up is expected to become effective, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities or other property deliverable upon such reclassification, consolidation, merger, sale, dissolution or winding up. 5. MANDATORY CONVERSION. (a) Upon (i) the closing of the sale of shares of Common Stock, at a price to the public of at least $4.75 per share (subject to appropriate adjustment for stock splits, stock dividends, combinations and other similar recapitalizations affecting such shares), in a public offering pursuant to an effective registration statement under the Securities Act of 1933, as amended, resulting in at least $15,000,000 of net proceeds to the Corporation (a "Qualified IPO") or (ii) the delivery to the Corporation of a Conversion Notice or Notices covering at least 75% of the outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock (the "Mandatory Conversion Date"), (A) all outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall automatically be converted into shares of Common Stock, at the then effective applicable conversion rate and (B) the number of authorized shares of Preferred Stock shall be automatically reduced by the number of shares of Preferred Stock that had been designated as Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock and all references to the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall be deleted and shall be of no further force or effect. (b) All holders of record of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall be given written notice of the Mandatory Conversion Date and the place designated for mandatory conversion of all such shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock pursuant to this Section 5 . Such notice need not be given in advance of the occurrence of the Mandatory Conversion Date. Such notice shall be sent by first class or registered mail, postage prepaid, to each record holder of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock at such holder's address last shown on the records of the transfer agent for the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, as the case may be (or the records of the Corporation, if it serves as its own transfer agent). Upon receipt of such notice, each holder of shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock shall surrender his or its certificate or certificates for all such shares -20- to the Corporation at the place designated in such notice, and shall thereafter receive certificates for the number of shares of Common Stock to which such holder is entitled pursuant to this Section 5. On the Mandatory Conversion Date, all rights with respect to the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock so converted, including the rights, if any, to receive notices and vote (other than as a holder of Common Stock) will terminate, except only the rights of the holders thereof, upon surrender of their certificate or certificates therefor, to receive certificates for the number of shares of Common Stock into which such Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock has been converted, and payment of any declared but unpaid dividends thereon. If so required by the Corporation, certificates surrendered for conversion shall be endorsed or accompanied by written instrument or instruments of transfer, in form satisfactory to the Corporation, duly executed by the registered holder or by his or its attorney duly authorized in writing. As soon as practicable after the Mandatory Conversion Date and the surrender of the certificate or certificates for Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, the Corporation shall cause to be issued and delivered to such holder, or on his or its written order, a certificate or certificates for the number of full shares of Common Stock issuable on such conversion in accordance with the provisions hereof and cash as provided in Subsection 4(b) in respect of any fraction of a share of Common Stock otherwise issuable upon such conversion. (c) All certificates evidencing shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock which are required to be surrendered for conversion in accordance with the provisions hereof shall, from and after the Mandatory Conversion Date, be deemed to have been retired and cancelled and the shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock represented thereby converted into Common Stock for all purposes, notwithstanding the failure of the holder or holders thereof to surrender such certificates on or prior to such date. Such converted Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock may not be reissued, and the Corporation may thereafter take such appropriate action (without the need for stockholder action) as may be necessary to reduce the authorized number of shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, accordingly. 6. REDEMPTION. (a) The Corporation will, subject to the conditions set forth below, on February 25, 2004 and on each of the first and second anniversaries thereof (each such date being referred to hereinafter as a "Mandatory Redemption Date"), upon receipt not less than 60 nor more than 120 days prior to the applicable Mandatory Redemption Date of written request(s) for redemption from holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock representing at least 66-2/3% of the aggregate number of shares of Common Stock issuable upon conversion of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock (a "Redemption Request"), redeem from each holder of shares of Series A Preferred Stock, Series B Preferred Stock and/or Series C Preferred Stock that requests redemption pursuant to the Redemption Request or pursuant to a subsequent election made in accordance with this Section -21- 6(a) (a "Requesting Holder"), at a price equal to $.343 per share, in the case of the Series A Preferred Stock, $.996 per share, in the case of the Series B Preferred Stock, and $3.893 in the case of the Series C Preferred Stock, plus in each case any dividends declared but unpaid thereon, subject to appropriate adjustment in the event of any stock dividend, stock split, combination or other similar recapitalization affecting such shares (the "Mandatory Redemption Price"), the number of shares of Series A Preferred Stock, Series B Preferred Stock and/or Series C Preferred Stock requested to be redeemed by each Requesting Holder, but not more than the following respective portions of the number of shares each series of Preferred Stock held by such Requesting Holder on the applicable Mandatory Redemption Date. Maximum Mandatory Portion of Shares of Series of REDEMPTION DATE PREFERRED STOCK TO BE REDEEMED - --------------- ------------------------------ February 25, 2004 33% February 25, 2005 50% February 25, 2006 All shares of Series The Corporation shall provide notice of its receipt of Redemption Request, specifying the time, manner and place of redemption and the Mandatory Redemption Price (a "Redemption Notice"), by first class or registered mail, postage prepaid, to each holder of record of Series A Preferred Stock, to each holder of Series B Preferred Stock and to each holder of Series C Preferred Stock at the address for such holder last shown on the records of the transfer agent therefor (or the records of the Corporation, if it serves as its own transfer agent), not less than 45 days prior to the applicable Mandatory Redemption Date. Each holder of Series A Preferred Stock, each holder of Series B Preferred Stock and each holder of Series C Preferred Stock (other than a holder who has made the Redemption Request) may elect to become a Requesting Holder on such Mandatory Redemption Date by so indicating in a written notice mailed to the Company, by first class or registered mail, postage prepaid, at least 30 days prior to the applicable Mandatory Redemption Date. Except as provided in Section 6(b) below, each Requesting Holder shall surrender to the Corporation on the applicable Mandatory Redemption Date the certificate(s) representing the shares to be redeemed on such date, in the manner and at the place designated in the Redemption Notice. Thereupon, the Mandatory Redemption Price shall be paid to the order of each such Requesting Holder and each certificate surrendered for redemption shall be cancelled. (b) If the funds of the Corporation legally available for redemption of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock on any Mandatory Redemption Date are insufficient to redeem the number of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock required under this Section 6 to be redeemed on such date from Requesting Holders, those funds which are legally available will be used to redeem the maximum possible number of each such shares ratably on the basis of the number of each such series which would be redeemed on such date if the funds of the Corporation legally available therefor had been sufficient to redeem all shares required to be redeemed on such date. At any time thereafter when additional funds of the Corporation -22- become legally available for the redemption of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, such funds will be used, at the end of the next succeeding fiscal quarter, to redeem the balance of the shares which the Corporation was theretofore obligated to redeem, ratably on the basis set forth in the preceding sentence. (c) Unless there shall have been a default in payment of the Mandatory Redemption Price, on the applicable Mandatory Redemption Date, all rights of the holder of each share redeemed on such date as a stockholder of the Corporation by reason of the ownership of such share will cease, except the right to receive such Mandatory Redemption Price of such share, without interest, upon presentation and surrender of the certificate representing such share, and such share will not from and after such Mandatory Redemption Date be deemed to be outstanding. (d) Any shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock redeemed pursuant to this Section 6 will be cancelled and will not under any circumstances be reissued, sold or transferred and the Corporation may from time to time take such appropriate action as may be necessary to reduce the authorized shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock accordingly. 7. WAIVER. Any of the respective rights of the holders of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock set forth herein may be waived by the affirmative vote of the holders of not less than 66-2/3% of the shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, then outstanding, voting together as a separate class; PROVIDED, HOWEVER, that any waiver which does not affect all series of Preferred Stock in the same manner may only be waived by the holders of not less than 66-2/3% of the shares of Preferred Stock so affected. 8. NEGATIVE COVENANTS. So long as at least 25% of the shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock outstanding on the Series C Original Issue Date (such numbers to be proportionately adjusted in the event of any stock splits, stock dividends, recapitalizations or similar events) are outstanding, the Corporation shall not, without the prior written consent of the holders of shares of Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock representing not less than 66-2/3% of the shares of Common Stock into which all outstanding shares of such Preferred Stock are then convertible: (a) merge or consolidate into or with another corporation (except a merger or consolidation in which the holders of capital stock of the Corporation immediately prior to such merger or consolidation continue to hold at least 50% by voting power of the capital stock of the surviving or acquiring corporation), or sell all or substantially all the assets of the Corporation; (b) acquire (whether by merger, stock purchase, asset purchase or otherwise) all or substantially all of the properties, assets or stock of any other corporation or entity; -23- (c) amend the Certificate of Incorporation (including through the filing of a Certificate of Designation) of the Corporation to authorize any additional shares of Common Stock or Preferred Stock or to authorize or designate any other class or series of stock in addition to Common Stock and Preferred Stock; (d) declare or pay any dividends or distributions on Common Stock (other than dividends payable solely in Common Stock and repurchases of Common Stock for a price equal to its original purchase price pursuant to restricted stock agreements); (e) voluntarily liquidate or dissolve; (f) incur any indebtedness for borrowed money or purchase money financing in excess of the greater of (i) $1.5 million or (ii) 25% of the amount, if any, by which the Corporation's total assets exceeds its total liabilities (as reflected in the Corporation's most recent balance sheet); (g) guarantee directly or indirectly, any indebtedness or obligations (except for guarantees of trade accounts of any subsidiary arising in the ordinary course of business); (h) make any loan or advance to any person or entity, except advances and similar expenditures in the ordinary course of business or under the terms of an employee stock or option plan approved by the Board of Directors; or (i) engage in any strategic transaction in which securities of the Company are issued, including (a) joint ventures, manufacturing, marketing or distribution agreements, or (b) technology transfer or development agreements. FIFTH. The Corporation is to have perpetual existence. SIXTH. The following provisions are included for the management of the business and the conduct of the affairs of the Corporation, and for further definition, limitation and regulation of the powers of the Corporation and of its Board of Directors and stockholders: 1. The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors of the Corporation. 2. The Board of Directors of the Corporation is expressly authorized to adopt, amend or repeal the by-laws of the Corporation, subject to any limitation thereof contained in the by-laws. The stockholders shall also have the power to adopt, amend or repeal the by-laws of the Corporation; PROVIDED, however, that, in addition to any vote of the holders of any class or series of stock of the Corporation required by law or by this Third Amended and Restated Certificate of Incorporation, the affirmative vote of the holders of at least seventy-five percent (75%) of the voting power of all of the then outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single -24- class, shall be required to adopt, amend or repeal any provision of the by-laws of the Corporation. 3. Stockholders of the Corporation may not take any action by written consent in lieu of a meeting. 4. Special meetings of stockholders may be called at any time only by the Chief Executive Officer, the President, the Chairman of the Board of Directors (if any) or a majority of the Board of Directors. Business transacted at any special meeting of stockholders shall be limited to matters relating to the purpose or purposes stated in the notice of meeting. 5. The books of the Corporation may be kept at such place within or without the State of Delaware as the by-laws of the Corporation may provide or as may be designated from time to time by the Board of Directors of the Corporation. SEVENTH. 1. NUMBER OF DIRECTORS. The number of directors which shall constitute the whole Board of Directors shall be determined by resolution of a majority of the Board of Directors, but in no event shall the number of directors be less than three. The number of directors may be decreased at any time and from time to time by a majority of the directors then in office, but only to eliminate vacancies existing by reason of the death, resignation, removal or expiration of the term of one or more directors. The directors shall be elected at the annual meeting of stockholders by such stockholders as have the right to vote on such election. Directors need not be stockholders of the Corporation. 2. CLASSES OF DIRECTORS. The Board of Directors shall be and is divided into three classes: Class I, Class II and Class III. No one class shall have more than one director more than any other class. 3. ELECTION OF DIRECTORS. Elections of directors need not be by written ballot except as and to the extent provided in the by-laws of the Corporation. 4. TERMS OF OFFICE. Each director shall serve for a term ending on the date of the third annual meeting following the annual meeting at which such director was elected; provided, however, that each initial director in Class I shall serve for a term ending on the date of the annual meeting next following the end of the Corporation's fiscal year ending February 29, 2000; each initial director in Class II shall serve for a term ending on the date of the annual meeting next following the end of the Corporation's fiscal year ending February 28, 2001; and each initial director in Class III shall serve for a term ending on the date of the annual meeting next following the end of the Corporation's fiscal year ending February 28, 2002. 5. ALLOCATION OF DIRECTORS AMONG CLASSES IN THE EVENT OF INCREASES OR DECREASES IN THE NUMBER OF DIRECTORS. In the event of any increase or decrease in the authorized number of directors, (i) each director then serving as such shall nevertheless continue as director of the class of which he or she is a member until the expiration of such director's current term or his or -25- her prior death, removal or resignation and (ii) the newly created or eliminated directorships resulting from such increase or decrease shall be apportioned by the Board of Directors among the three classes of directors so as to ensure that no one class has more than one director more than any other class. To the extent possible, consistent with the foregoing rule, any newly created directorships shall be added to those classes whose terms of office are to expire at the earliest dates following such allocation, unless otherwise provided for from time to time by resolution adopted by a majority of the directors then in office, though less than a quorum. No decrease in the number of directors constituting the whole Board of Directors shall shorten the term of an incumbent director. 6. TENURE. Notwithstanding any provisions to the contrary contained herein, each director shall hold office until his or her successor is elected and qualified, or until his or her earlier death, resignation or removal. 7. VACANCIES. Unless and until filled by the stockholders, any vacancy in the Board of Directors, however occurring, including a vacancy resulting from an enlargement of the Board of Directors, may be filled only by vote of a majority of the directors then in office, even if less than a quorum, or by a sole remaining director. A director elected to fill a vacancy shall be elected for the unexpired term of his or her predecessor in office, if applicable, and a director chosen to fill a position resulting from an increase in the number of directors shall hold office until the next election of the class for which such director shall have been chosen and until his or her successor is elected and qualified, or until his or her earlier death, resignation or removal. 8. QUORUM. A majority of the total number of the whole Board of Directors shall constitute a quorum at all meetings of the Board of Directors. In the event one or more of the directors shall be disqualified to vote at any meeting, then the required quorum shall be reduced by one for each such director so disqualified; provided, however, that in no case shall less than one-third (1/3) of the number so fixed constitute a quorum. In the absence of a quorum at any such meeting, a majority of the directors present may adjourn the meeting from time to time without further notice other than announcement at the meeting, until a quorum shall be present. 9. ACTION AT MEETING. At any meeting of the Board of Directors at which a quorum is present, the vote of a majority of those present shall be sufficient to take any action, unless a different vote is specified by law or the Corporation's by-laws. 10. REMOVAL. Any one or more or all of the directors may be removed with cause only by the holders of at least seventy-five percent (75%) of the shares then entitled to vote at an election of directors. Directors may not be removed without cause. 11. STOCKHOLDER NOMINATIONS AND INTRODUCTION OF BUSINESS, ETC. Advance notice of stockholder nominations for election of directors and other business to be brought by stockholders before a meeting of stockholders shall be given in the manner provided in the by-laws of the Corporation. 12. RIGHTS OF PREFERRED STOCK. The provisions of this Article are subject to the rights of the holders of any series of Preferred Stock from time to time outstanding. -26- EIGHTH. No director (including any advisory director) of the Corporation shall be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director notwithstanding any provision of law imposing such liability; provided, however, that, to the extent provided by applicable law, this provision shall not eliminate the liability of a director (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the General Corporation Law of the State of Delaware, or (iv) for any transaction from which the director derived an improper personal benefit. No amendment to or repeal of this provision shall apply to or have any effect on the liability or alleged liability of any director for or with respect to any acts or omissions of such director occurring prior to such amendment or repeal. NINTH. The Board of Directors of the Corporation, when evaluating any offer of another party (a) to make a tender or exchange offer for any equity security of the Corporation or (b) to effect a business combination, shall, in connection with the exercise of its judgment in determining what is in the best interests of the Corporation as whole, be authorized to give due consideration to any such factors as the Board of Directors determines to be relevant, including, without limitation: (i) the interests of the Corporation's stockholders, including the possibility that these interests might be best served by the continued independence of the Corporation; (ii) whether the proposed transaction might violate federal or state laws; (iii) not only the consideration being offered in the proposed transaction, in relation to the then current market price for the outstanding capital stock of the Corporation, but also to the market price for the capital stock of the Corporation over a period of years, the estimated price that might be achieved in a negotiated sale of the Corporation as a whole or in part or through orderly liquidation, the premiums over market price for the securities of other corporations in similar transactions, current political, economic and other factors bearing on securities prices and the Corporation's financial condition and future prospects; and (iv) the social, legal and economic effects upon employees, suppliers, customers, creditors and others having similar relationships with the Corporation, upon the communities in which the Corporation conducts its business and upon the economy of the state, region and nation. In connection with any such evaluation, the Board of Directors is authorized to conduct such investigations and engage in such legal proceedings as the Board of Directors may determine. TENTH. The Corporation reserves the right to amend or repeal any provision contained in this Third Amended and Restated Certificate of Incorporation in the manner prescribed by the laws of the State of Delaware and all rights conferred upon stockholders are granted subject to this reservation, PROVIDED, HOWEVER, that in addition to any vote of the holders of any class or series of stock of the Corporation required by law, this Third Amended and -27- Restated Certificate of Incorporation or a Certificate of Designation with respect to a series of Preferred Stock, the affirmative vote of the holders of shares of voting stock of the Corporation representing at least seventy-five percent (75%) of the voting power of all of the then outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to (i) reduce or eliminate the number of authorized shares of Common Stock or the number of authorized shares of Preferred Stock set forth in Article FOURTH or (ii) amend or repeal, or adopt any provision inconsistent with, Parts A and B of Article FOURTH and Articles FIFTH, SIXTH, SEVENTH, EIGHTH, NINTH and this Article TENTH of this Third Amended and Restated Certificate of Incorporation. [REMAINDER OF PAGE LEFT INTENTIONALLY BLANK] -28- IN WITNESS WHEREOF, the undersigned has hereunto signed his name and affirms that the statements made in this Third Amended and Restated Certificate of Incorporation are true under the penalties of perjury this ____ day of _____, 1999. By: ----------------------------------- Name: Robert F. Young Title: Chief Executive Officer [SEAL] Attest: By: ------------------------ David Shummanfang Secretary EX-3.4 4 EXHIBIT 3.4 Exhibit 3.4 BY-LAWS OF RED HAT SOFTWARE, INC. A DELAWARE CORPORATION Dated: September 17, 1998 ARTICLE I.........................................................................................................1 MEETINGS OF STOCKHOLDERS..........................................................................................1 Section 1. Place of Meetings...................................................................................1 Section 2. Annual Meeting......................................................................................1 Section 3. Special Meetings....................................................................................1 Section 4. Notice of Meetings..................................................................................1 Section 5. Voting List.........................................................................................1 Section 6. Quorum..............................................................................................2 Section 7. Adjournments........................................................................................2 Section 8. Action at Meetings..................................................................................2 Section 9. Voting and Proxies..................................................................................2 Section 10. Action Without Meeting.............................................................................3 ARTICLE II........................................................................................................3 DIRECTORS.........................................................................................................3 Section 1. Number, Election, Tenure and Qualification..........................................................3 Section 2. Enlargement.........................................................................................3 Section 3. Vacancies...........................................................................................3 Section 4. Resignation and Removal.............................................................................4 Section 5. General Powers......................................................................................4 Section 6. Chairman of the Board...............................................................................4 Section 7. Place of Meetings...................................................................................4 Section 8. Regular Meetings....................................................................................4 Section 9. Special Meetings....................................................................................4 Section 10. Quorum, Action at Meeting, Adjournments............................................................4 Section 11. Action by Consent..................................................................................5 Section 12. Telephonic Meetings................................................................................5 Section 13. Committees.........................................................................................5 Section 14. Compensation.......................................................................................5 ARTICLE III.......................................................................................................6 OFFICERS..........................................................................................................6 Section 1. Enumeration.........................................................................................6 Section 2. Election............................................................................................6 Section 3. Tenure..............................................................................................6 Section 4. President...........................................................................................6 Section 5. Vice-Presidents.....................................................................................7 Section 6. Secretary...........................................................................................7 Section 7. Assistant Secretaries...............................................................................7 Section 8. Treasurer...........................................................................................7 Section 9. Assistant Treasurers................................................................................8 Section 10. Bond...............................................................................................8 ARTICLE IV........................................................................................................8 NOTICES...........................................................................................................8 Section 1. Delivery............................................................................................8 Section 2. Waiver of Notice....................................................................................8 ARTICLE V.........................................................................................................9 INDEMNIFICATION...................................................................................................9 Section 1. Actions other than by or in the Right of the Corporation............................................9 Section 2. Actions by or in the Right of the Corporation.......................................................9 Section 3. Success on the Merits..............................................................................10 (i) Section 4. Specific Authorization.............................................................................10 Section 5. Advance Payment....................................................................................10 Section 6. Non-Exclusivity....................................................................................10 Section 7. Insurance..........................................................................................10 Section 8. Continuation of Indemnification and Advancement of Expenses........................................10 Section 9. Severability.......................................................................................10 Section 10. Intent of Article.................................................................................11 ARTICLE VI.......................................................................................................11 CAPITAL STOCK....................................................................................................11 Section 1. Certificates of Stock..............................................................................11 Section 2. Lost Certificates..................................................................................11 Section 3. Transfer of Stock..................................................................................11 Section 4. Record Date........................................................................................11 Section 5. Registered Stockholders............................................................................12 ARTICLE VII......................................................................................................12 CERTAIN TRANSACTIONS.............................................................................................12 Section 1. Transactions with Interested Parties...............................................................12 Section 2. Quorum.............................................................................................13 ARTICLE VIII.....................................................................................................13 GENERAL PROVISIONS...............................................................................................13 Section 1. Dividends..........................................................................................13 Section 2. Reserves...........................................................................................13 Section 3. Checks.............................................................................................13 Section 4. Fiscal Year........................................................................................13 Section 5. Seal...............................................................................................14 ARTICLE IX.......................................................................................................14 AMENDMENTS.......................................................................................................14
Addendum Register of Amendments to the By-Laws (ii) * * * * * BY-LAWS * * * * * ARTICLE I MEETINGS OF STOCKHOLDERS Section 1. Place of Meetings. All meetings of the stockholders shall be held at such place within or without the State of Delaware as may be fixed from time to time by the Board of Directors or the Chief Executive Officer, or if not so designated, at the registered office of the Corporation. Section 2. Annual Meeting. Unless directors are elected by written consent in lieu of an annual meeting as permitted by law and these By-Laws, an annual meeting of stockholders shall be held at such date and time as shall be designated from time to time by the Board of Directors or the Chief Executive Officer, at which meeting the stockholders shall elect by a plurality vote a board of directors and shall transact such other business as may be properly brought before the meeting. If no annual meeting is held in accordance with the foregoing provisions, the Board of Directors shall cause the meeting to be held as soon thereafter as convenient, which meeting shall be designated a special meeting in lieu of annual meeting. Section 3. Special Meetings. Special meetings of the stockholders, for any purpose or purposes, may, unless otherwise prescribed by statute or by the certificate of incorporation, be called by the Board of Directors or the Chief Executive Officer and shall be called by the Chief Executive Officer or Secretary at the request in writing of a majority of the Board of Directors, or at the request in writing of stockholders owning a majority in amount of the entire capital stock of the Corporation issued and outstanding and entitled to vote. Such request shall state the purpose or purposes of the proposed meeting. Business transacted at any special meeting shall be limited to matters relating to the purpose or purposes stated in the notice of meeting. Section 4. Notice of Meetings. Except as otherwise provided by law, written notice of each meeting of stockholders, annual or special, stating the place, date and hour of the meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be given not less than ten (10) or more than sixty (60) days before the date of the meeting, to each stockholder entitled to vote at such meeting. Section 5. Voting List. The officer who has charge of the stock ledger of the Corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, -2- and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city or town where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. Section 6. Quorum. The holders of a majority of the stock issued and outstanding and entitled to vote thereat, present in person or represented by proxy, shall constitute a quorum at all meetings of the stockholders for the transaction of business, except as otherwise provided by statute, the certificate of incorporation or these By-Laws. Where a separate vote by a class or classes is required, a majority of the outstanding shares of such class or classes, present in person or represented by proxy, shall constitute a quorum entitled to take action with respect to that vote on that matter. If no quorum shall be present or represented at any meeting of stockholders, such meeting may be adjourned in accordance with Section 7 hereof, until a quorum shall be present or represented. Section 7. Adjournments. Any meeting of stockholders may be adjourned from time to time to any other time and to any other place at which a meeting of stockholders may be held under these By-Laws, which time and place shall be announced at the meeting, by a majority of the stockholders present in person or represented by proxy at the meeting and entitled to vote (whether or not a quorum is present), or, if no stockholder is present or represented by proxy, by any officer entitled to preside at or to act as Secretary of such meeting, without notice other than announcement at the meeting. At such adjourned meeting, any business may be transacted which might have been transacted at the original meeting, provided that a quorum either was present at the original meeting or is present at the adjourned meeting. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. Section 8. Action at Meetings. When a quorum is present at any meeting, the affirmative vote of the holders of a majority of the stock present in person or represented by proxy, entitled to vote and voting on the matter (or where a separate vote by a class or classes is required, the affirmative vote of the majority of shares of such class or classes present in person or represented by proxy at the meeting) shall decide any matter (other than the election of Directors) brought before such meeting, unless the matter is one upon which by express provision of law, the certificate of incorporation or these By-Laws, a different vote is required, in which case such express provision shall govern and control the decision of such matter. The stock of holders who abstain from voting on any matter shall be deemed not to have been voted on such matter. Directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at the meeting, entitled to vote and voting on the election of Directors. -3- Section 9. Voting and Proxies. Unless otherwise provided in the certificate of incorporation, each stockholder shall at every meeting of the stockholders be entitled to one vote for each share of capital stock having voting power held of record by such stockholder. Each stockholder entitled to vote at a meeting of stockholders, or to express consent or dissent to corporate action in writing without a meeting, may authorize another person or persons to act for him by proxy, but no such proxy shall be voted or acted upon after three years from its date, unless the proxy provides for a longer period. Section 10. Action Without Meeting. Any action required to be taken at any annual or special meeting of stockholders, or any action which may be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action so taken, shall be (1) signed and dated by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and (2) delivered to the Corporation within sixty days of the earliest dated consent by delivery to its registered office in the State of Delaware (in which case delivery shall be by hand or by certified or registered mail, return receipt requested), its principal place of business, or an officer or agent of the Corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. ARTICLE II DIRECTORS Section 1. Number, Election, Tenure and Qualification. The number of Directors which shall constitute the whole board shall be not less than one. Within such limit, the number of Directors shall be determined by resolution of the Board of Directors or by the stockholders at the annual meeting or at any special meeting of stockholders. The directors shall be elected at the annual meeting or at any special meeting of stockholders, or by written consent in lieu of an annual or special meeting of the stockholders (provided, however, that if such consent is less than unanimous, such action by written consent may be in lieu of holding an annual meeting only if all of the directorships to which directors could be elected at an annual meeting held at the effective time of such action are vacant and are filled by such action), except as provided in section 3 of this Article, and each director elected shall hold office until his successor is elected and qualified, unless sooner displaced. Directors need not be stockholders. Section 2. Enlargement. The number of the Board of Directors may be increased at any time by vote of a majority of the Directors then in office. -4- Section 3. Vacancies. Vacancies and newly created Directorships resulting from any increase in the authorized number of Directors may be filled by a majority of the Directors then in office, though less than a quorum, or by a sole remaining director, and the Directors so chosen shall hold office until the next annual election and until their successors are duly elected and shall qualify, unless sooner displaced. If there are no Directors in office, then an election of Directors may be held in the manner provided by statute. In the event of a vacancy in the Board of Directors, the remaining Directors, except as otherwise provided by law or these By-Laws, may exercise the powers of the full board until the vacancy is filled. Section 4. Resignation and Removal. Any director may resign at any time upon written notice to the Corporation at its principal place of business or to the Chief Executive Officer or Secretary. Such resignation shall be effective upon receipt unless it is specified to be effective at some other time or upon the happening of some other event. Any director or the entire Board of Directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of Directors, unless otherwise specified by law or the certificate of incorporation. Section 5. General Powers. The business and affairs of the Corporation shall be managed by its Board of Directors, which may exercise all powers of the Corporation and do all such lawful acts and things as are not by statute or by the certificate of incorporation or by these By-Laws directed or required to be exercised or done by the stockholders. Section 6. Chairman of the Board. If the Board of Directors appoints a chairman of the board, he shall, when present, preside at all meetings of the stockholders and the Board of Directors. He shall perform such duties and possess such powers as are customarily vested in the office of the chairman of the board or as may be vested in him by the Board of Directors. Section 7. Place of Meetings. The Board of Directors may hold meetings, both regular and special, either within or without the State of Delaware. Section 8. Regular Meetings. Regular meetings of the Board of Directors may be held without notice at such time and at such place as shall from time to time be determined by the board; provided that any director who is absent when such a determination is made shall be given prompt notice of such determination. A regular meeting of the Board of Directors may be held without notice immediately after and at the same place as the annual meeting of stockholders. Section 9. Special Meetings. Special meetings of the board may be called by the Chief Executive Officer, Secretary, or on the written request of two (2) or more Directors, or by one director in the event that there is only one director in office. Two (2) days' notice to each director, either personally or by telegram, cable, telecopy, commercial delivery service, telex or similar means sent to his business or home address, or three (3) days' notice by written notice deposited in the mail, shall be given to each director by the Secretary or by the officer or one of the Directors calling the meeting. A notice or waiver of notice of a meeting of the Board of Directors need not specify the purposes of the meeting. -5- Section 10. Quorum, Action at Meeting, Adjournments. At all meetings of the board a majority of Directors then in office, but in no event less than one third of the entire board, shall constitute a quorum for the transaction of business and the act of a majority of the Directors present at any meeting at which there is a quorum shall be the act of the Board of Directors, except as may be otherwise specifically provided by law or by the certificate of incorporation. For purposes of this section, the term "entire board" shall mean the number of Directors last fixed by the stockholders or Directors, as the case may be, in accordance with law and these By-Laws; provided, however, that if less than all the number so fixed of Directors were elected, the "entire board" shall mean the greatest number of Directors so elected to hold office at any one time pursuant to such authorization. If a quorum shall not be present at any meeting of the Board of Directors, a majority of the Directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. Section 11. Action by Consent. Unless otherwise restricted by the certificate of incorporation or these By-Laws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if all members of the board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the board or committee. Section 12. Telephonic Meetings. Unless otherwise restricted by the certificate of incorporation or these By-Laws, members of the Board of Directors or of any committee thereof may participate in a meeting of the Board of Directors or of any committee, as the case may be, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting. Section 13. Committees. The Board of Directors may designate one or more committees, each committee to consist of one or more of the Directors of the Corporation. The board may designate one or more Directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. Any such committee, to the extent provided in the resolution of the Board of Directors, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; but no such committee shall have the power or authority in reference to (a) adopting, amending or repealing the By-Laws of the Corporation or any of them or (b) approving or adopting, or recommending to the stockholders any action or matter expressly required by law to be submitted to stockholders for approval. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board of Directors. Each committee shall keep regular minutes of its meetings and make such reports to the Board of Directors as the Board of Directors may request. Except as the Board of Directors may otherwise determine, any committee may make rules for the conduct of its business, but unless otherwise provided by the Directors or in such rules, its business shall be conducted as nearly as possible in the same manner as is provided in these By-Laws for the conduct of its business by the Board of Directors. -6- Section 14. Compensation. Unless otherwise restricted by the certificate of incorporation or these By-Laws, the Board of Directors shall have the authority to fix from time to time the compensation of Directors. The Directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and the performance of their responsibilities as Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors and/or a stated salary as director. No such payment shall preclude any director from serving the Corporation or its parent or subsidiary corporations in any other capacity and receiving compensation therefor. The Board of Directors may also allow compensation for members of special or standing committees for service on such committees. ARTICLE III OFFICERS Section 1. Enumeration. The officers of the Corporation shall be chosen by the Board of Directors and shall be a President, a Secretary and a Treasurer and such other officers with such titles, terms of office and duties as the Board of Directors may from time to time determine, including a chairman of the board, one or more Vice-Presidents, and one or more Assistant Secretaries and assistant Treasurers. If authorized by resolution of the Board of Directors, the Chief Executive Officer may be empowered to appoint from time to time Assistant Secretaries and assistant Treasurers. Any number of offices may be held by the same person, unless the certificate of incorporation or these By-Laws otherwise provide. Section 2. Election. The Board of Directors at its first meeting after each annual meeting of stockholders shall choose a President, a Secretary and a Treasurer. Other officers may be appointed by the Board of Directors at such meeting, at any other meeting, or by written consent. Section 3. Tenure. The officers of the Corporation shall hold office until their successors are chosen and qualify, unless a different term is specified in the vote choosing or appointing him, or until his earlier death, resignation or removal. Any officer elected or appointed by the Board of Directors or by the Chief Executive Officer may be removed at any time, with or without cause, by the affirmative vote of a majority of the Board of Directors or a committee duly authorized to do so, except that any officer appointed by the Chief Executive Officer may also be removed at any time, with or without cause, by the Chief Executive Officer. Any vacancy occurring in any office of the Corporation may be filled by the Board of Directors, at its discretion. Any officer may resign by delivering his written resignation to the Corporation at its principal place of business or to the Chief Executive Officer or the Secretary. Such resignation shall be effective upon receipt unless it is specified to be effective at some other time or upon the happening of some other event. Section 4. President. The President shall be the Chief Operating Officer of the Corporation. He shall also be the Chief Executive Officer unless the Board of Directors -7- otherwise provides. If no Chief Executive Officer shall have been appointed by the Board of Directors, all references herein to the "Chief Executive Officer" shall be to the President. The President shall, unless the Board of Directors provides otherwise in a specific instance or generally, preside at all meetings of the stockholders and the Board of Directors, have general and active management of the business of the Corporation and see that all orders and resolutions of the Board of Directors are carried into effect. The President shall execute bonds, mortgages, and other contracts requiring a seal, under the seal of the Corporation, except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the Board of Directors to some other officer or agent of the Corporation. Section 5. Vice-Presidents. In the absence of the President or in the event of his or her inability or refusal to act, the Vice-President, or if there be more than one Vice-President, the Vice-Presidents in the order designated by the Board of Directors or the Chief Executive Officer (or in the absence of any designation, then in the order determined by their tenure in office) shall perform the duties of the President, and when so acting, shall have all the powers of and be subject to all the restrictions upon the President. The Vice-Presidents shall perform such other duties and have such other powers as the Board of Directors or the Chief Executive Officer may from time to time prescribe. Section 6. Secretary. The Secretary shall have such powers and perform such duties as are incident to the office of Secretary. The Secretary shall maintain a stock ledger and prepare lists of stockholders and their addresses as required and shall be the custodian of corporate records. The Secretary shall attend all meetings of the Board of Directors and all meetings of the stockholders and record all the proceedings of the meetings of the Corporation and of the Board of Directors in a book to be kept for that purpose and shall perform like duties for the standing committees when required. The Secretary shall give, or cause to be given, notice of all meetings of the stockholders and special meetings of the Board of Directors, and shall perform such other duties as may be from time to time prescribed by the Board of Directors or Chief Executive Officer, under whose supervision the Secretary shall be. The Secretary shall have custody of the corporate seal of the Corporation and the Secretary, or an assistant Secretary, shall have authority to affix the same to any instrument requiring it and when so affixed, it may be attested by his or her signature or by the signature of such assistant Secretary. The Board of Directors may give general authority to any other officer to affix the seal of the Corporation and to attest the affixing by his or her signature. Section 7. Assistant Secretaries. The assistant Secretary, or if there be more than one, the assistant secretaries in the order determined by the Board of Directors, the Chief Executive Officer or the Secretary (or if there be no such determination, then in the order determined by their tenure in office), shall, in the absence of the Secretary or in the event of his or her inability or refusal to act, perform the duties and exercise the powers of the Secretary and shall perform such other duties and have such other powers as the Board of Directors, the Chief Executive Officer or the Secretary may from time to time prescribe. In the absence of the Secretary or any assistant Secretary at any meeting of stockholders or Directors, the person -8- presiding at the meeting shall designate a temporary or acting Secretary to keep a record of the meeting. Section 8. Treasurer. The Treasurer shall perform such duties and shall have such powers as may be assigned to him or her by the Board of Directors or the Chief Executive Officer. In addition, the Treasurer shall perform such duties and have such powers as are incident to the office of Treasurer. The Treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. He shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the Chief Executive Officer and the Board of Directors, when the Chief Executive Officer or Board of Directors so requires, an account of all his or her transactions as Treasurer and of the financial condition of the Corporation. Section 9. Assistant Treasurers. The assistant Treasurer, or if there shall be more than one, the assistant Treasurers in the order determined by the Board of Directors, the Chief Executive Officer or the Treasurer (or if there be no such determination, then in the order determined by their tenure in office), shall, in the absence of the Treasurer or in the event of his or her inability or refusal to act, perform the duties and exercise the powers of the Treasurer and shall perform such other duties and have such other powers as the Board of Directors, the Chief Executive Officer or the Treasurer may from time to time prescribe. Section 10. Bond. If required by the Board of Directors, any officer shall give the Corporation a bond in such sum and with such surety or sureties and upon such terms and conditions as shall be satisfactory to the Board of Directors, including without limitation a bond for the faithful performance of the duties of his office and for the restoration to the Corporation of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control and belonging to the Corporation. ARTICLE IV NOTICES Section 1. Delivery. Whenever, under the provisions of law, or of the certificate of incorporation or these By-Laws, written notice is required to be given to any director or stockholder, such notice may be given by mail, addressed to such director or stockholder, at his address as it appears on the records of the Corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. Unless written notice by mail is required by law, written notice may also be given by telegram, cable, telecopy, commercial delivery service, telex or similar means, addressed to such director or stockholder at his address as it appears on the records of the corporation, in which case such notice shall be deemed to be given when delivered into the control of the -9- persons charged with effecting such transmission, the transmission charge to be paid by the Corporation or the person sending such notice and not by the addressee. Oral notice or other in-hand delivery (in person or by telephone) shall be deemed given at the time it is actually given. Section 2. Waiver of Notice. Whenever any notice is required to be given under the provisions of law or of the certificate of incorporation or of these By-Laws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto. ARTICLE V INDEMNIFICATION Section 1. Actions other than by or in the Right of the Corporation. The corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that such person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceedings, had no reasonable cause to believe such person's conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which such person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that such person's conduct was unlawful. Section 2. Actions by or in the Right of the Corporation. The corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he or she is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by such person in connection with the defense or settlement of such action or suit if such person acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the Corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable unless and only to the extent that the Court of Chancery of the State of Delaware or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of -10- all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery of the State of Delaware or such other court shall deem proper. Section 3. Success on the Merits. To the extent that any person described in Section 1 or 2 of this Article V has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in said Sections, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. Section 4. Specific Authorization. Any indemnification under Section 1 or 2 of this Article V (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of any person described in said Sections is proper in the circumstances because he has met the applicable standard of conduct set forth in said Sections. Such determination shall be made (1) by the Board of Directors by a majority vote of Directors who were not parties to such action, suit or proceeding (even though less than a quorum), or (2) if there are no disinterested Directors or if a majority of disinterested Directors so directs, by independent legal counsel (who may be regular legal counsel to the Corporation) in a written opinion, or (3) by the stockholders of the Corporation. Section 5. Advance Payment. Expenses incurred in defending a pending or threatened civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of any person described in said Section to repay such amount if it shall ultimately be determined that he or she is not entitled to indemnification by the Corporation as authorized in this Article V. Section 6. Non-Exclusivity. The indemnification and advancement of expenses provided by, or granted pursuant to, the other Sections of this Article V shall not be deemed exclusive of any other rights to which those provided indemnification or advancement of expenses may be entitled under any By-Law, agreement, vote of stockholders or disinterested Directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office. Section 7. Insurance. The Board of Directors may authorize, by a vote of the majority of the full board, the Corporation to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this Article V. Section 8. Continuation of Indemnification and Advancement of Expenses. The indemnification and advancement of expenses provided by, or granted pursuant to, this Article V -11- shall continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. Section 9. Severability. If any word, clause or provision of this Article V or any award made hereunder shall for any reason be determined to be invalid, the provisions hereof shall not otherwise be affected thereby but shall remain in full force and effect. Section 10. Intent of Article. The intent of this Article V is to provide for indemnification and advancement of expenses to the fullest extent permitted by Section 145 of the General Corporation Law of Delaware. To the extent that such Section or any successor section may be amended or supplemented from time to time, this Article V shall be amended automatically and construed so as to permit indemnification and advancement of expenses to the fullest extent from time to time permitted by law. ARTICLE VI CAPITAL STOCK Section 1. Certificates of Stock. Every holder of stock in the Corporation shall be entitled to have a certificate, signed by, or in the name of the Corporation by, the chairman or Vice-chairman of the Board of Directors, or the President or a Vice-President and the Treasurer or an assistant Treasurer, or the Secretary or an assistant Secretary of the Corporation, certifying the number of shares owned by such holder in the Corporation. Any or all of the signatures on the certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue. Certificates may be issued for partly paid shares and in such case upon the face or back of the certificates issued to represent any such partly paid shares, the total amount of the consideration to be paid therefor, and the amount paid thereon shall be specified. Section 2. Lost Certificates. The Board of Directors may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the Corporation alleged to have been lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or his legal representative, to give reasonable evidence of such loss, theft or destruction, to advertise the same in such manner as it shall require and/or to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen or destroyed or the issuance of such new certificate. Section 3. Transfer of Stock. Upon surrender to the Corporation or the transfer agent of the Corporation of a certificate for shares, duly endorsed or accompanied by proper evidence -12- of succession, assignment or authority to transfer, and proper evidence of compliance with other conditions to rightful transfer, it shall be the duty of the Corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. Section 4. Record Date. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, the Board of Directors may fix a record date, which shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which shall not be more than sixty days nor less then ten days before the date of such meeting. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. If no record date is fixed, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day before the day on which notice is given, or, if notice is waived, at the close of business on the day before the day on which the meeting is held. In order that the Corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the Board of Directors may fix a record date, which shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which shall not be more than ten days after the date upon which the resolution fixing the record date is adopted by the Board of Directors. If no record date is fixed, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the Board of Directors is required by statute, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the Corporation as provided in Section 10 of Article I. If no record date is fixed and prior action by the Board of Directors is required, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be at the close of business on the date on which the Board of Directors adopts the resolution taking such prior action. In order that the Corporation may determine the stockholders entitled to receive payment of any dividend or other distribution or allotment of any rights or the stockholders entitled to exercise any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action, the Board of Directors may fix a record date, which shall not precede the date upon which the resolution fixing the record date is adopted, and which shall be not more than sixty days prior to such action. If no record date is fixed, the record date for determining stockholders for any such purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating to such purpose. Section 5. Registered Stockholders. The Corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and to hold liable for calls and assessments a person registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware. -13- ARTICLE VII CERTAIN TRANSACTIONS Section 1. Transactions with Interested Parties. No contract or transaction between the Corporation and one or more of its Directors or officers, or between the Corporation and any other corporation, partnership, association, or other organization in which one or more of its Directors or officers are Directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee thereof which authorizes the contract or transaction or solely because his or their votes are counted for such purpose, if: (a) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the Board of Directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested Directors, even though the disinterested Directors be less than a quorum; or (b) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or (c) The contract or transaction is fair as to the Corporation as of the time it is authorized, approved or ratified, by the Board of Directors, a committee thereof, or the stockholders. Section 2. Quorum. Common or interested Directors may be counted in determining the presence of a quorum at a meeting of the Board of Directors or of a committee which authorizes the contract or transaction. ARTICLE VIII GENERAL PROVISIONS Section 1. Dividends. Dividends upon the capital stock of the corporation, if any, may be declared by the Board of Directors at any regular or special meeting or by written consent, pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the certificate of incorporation. Section 2. Reserves. The Directors may set apart out of any funds of the Corporation available for dividends a reserve or reserves for any proper purpose and may abolish any such reserve. -14- Section 3. Checks. All checks or demands for money and notes of the Corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate. Section 4. Fiscal Year. The fiscal year of the Corporation shall be fixed by resolution of the Board of Directors. Section 5. Seal. The Board of Directors may, by resolution, adopt a corporate seal. The corporate seal shall have inscribed thereon the name of the Corporation, the year of its organization and the word "Delaware." The seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise. The seal may be altered from time to time by the Board of Directors. ARTICLE IX AMENDMENTS These By-Laws may be altered, amended or repealed or new By-Laws may be adopted by the stockholders or by the Board of Directors, when such power is conferred upon the Board of Directors by the certificate of incorporation, at any regular meeting of the stockholders or of the Board of Directors or at any special meeting of the stockholders or of the Board of Directors provided, however, that in the case of a regular or special meeting of stockholders, notice of such alteration, amendment, repeal or adoption of new By-Laws be contained in the notice of such meeting. Register of Amendments to the By-Laws Date Section Affected Change - ---- ---------------- ------ EX-3.5 5 EXHIBIT 3.5 Exhibit 3.5 AMENDED AND RESTATED BY-LAWS OF RED HAT, INC. BY-LAWS TABLE OF CONTENTS
Page ---- ARTICLE 1 - STOCKHOLDERS.................................................................................1 1.1 PLACE OF MEETINGS.................................................................................1 1.2 ANNUAL MEETING....................................................................................1 1.3 SPECIAL MEETINGS..................................................................................1 1.4 NOTICE OF MEETINGS................................................................................1 1.5 VOTING LIST.......................................................................................1 1.6 QUORUM............................................................................................2 1.7 ADJOURNMENTS......................................................................................2 1.8 VOTING AND PROXIES................................................................................2 1.9 ACTION AT MEETING.................................................................................3 1.10 INTRODUCTION OF BUSINESS AT MEETINGS.............................................................3 1.11 ACTION WITHOUT MEETING...........................................................................6 ARTICLE 2 - DIRECTORS....................................................................................6 2.1 GENERAL POWERS....................................................................................6 2.2 NUMBER; ELECTION AND QUALIFICATION................................................................7 2.3 CLASSES OF DIRECTORS..............................................................................7 2.4 TERMS IN OFFICE...................................................................................7 2.5 ALLOCATION OF DIRECTORS AMONG CLASSES IN THE EVENT OF INCREASES OR DECREASES IN THE NUMBER OF DIRECTORS......................................................................................7 2.6 TENURE............................................................................................8 2.7 VACANCIES.........................................................................................8 2.8 RESIGNATION.......................................................................................8 2.9 REGULAR MEETINGS..................................................................................8 2.10 SPECIAL MEETINGS.................................................................................8 2.11 NOTICE OF SPECIAL MEETINGS.......................................................................8 2.12 MEETINGS BY TELEPHONE CONFERENCE CALLS...........................................................9 2.13 QUORUM...........................................................................................9 2.14 ACTION AT MEETING................................................................................9 2.15 ACTION BY WRITTEN CONSENT........................................................................9 2.16 REMOVAL..........................................................................................9 2.17 COMMITTEES.......................................................................................9 2.18 COMPENSATION OF DIRECTORS.......................................................................10 2.19 AMENDMENTS TO ARTICLE...........................................................................10
-ii- ARTICLE 3 - OFFICERS....................................................................................10 3.1 ENUMERATION......................................................................................10 3.2 ELECTION.........................................................................................10 3.3 QUALIFICATION....................................................................................10 3.4 TENURE...........................................................................................10 3.5 RESIGNATION AND REMOVAL..........................................................................11 3.6 VACANCIES........................................................................................11 3.7 CHAIRMAN OF THE BOARD AND VICE-CHAIRMAN OF THE BOARD.............................................11 3.8 PRESIDENT........................................................................................11 3.9 VICE PRESIDENTS..................................................................................11 3.10 SECRETARY AND ASSISTANT SECRETARIES.............................................................12 3.11 TREASURER AND ASSISTANT TREASURERS..............................................................12 3.12 SALARIES........................................................................................13 3.13 ACTION WITH RESPECT TO SECURITIES OF OTHER CORPORATIONS.........................................13 ARTICLE 4 - CAPITAL STOCK...............................................................................13 4.1 ISSUANCE OF STOCK................................................................................13 4.2 CERTIFICATES OF STOCK............................................................................13 4.3 TRANSFERS........................................................................................13 4.4 LOST, STOLEN OR DESTROYED CERTIFICATES...........................................................14 4.5 RECORD DATE......................................................................................14 ARTICLE 5 - GENERAL PROVISIONS..........................................................................14 5.1 FISCAL YEAR......................................................................................14 5.2 CORPORATE SEAL...................................................................................14 5.3 NOTICES..........................................................................................14 5.4 WAIVER OF NOTICE.................................................................................15 5.5 EVIDENCE OF AUTHORITY............................................................................15 5.6 FACSIMILE SIGNATURES.............................................................................15 5.7 RELIANCE UPON BOOKS, REPORTS AND RECORDS.........................................................15 5.8 TIME PERIODS.....................................................................................15 5.9 CERTIFICATE OF INCORPORATION.....................................................................15 5.10 TRANSACTIONS WITH INTERESTED PARTIES............................................................15 5.11 SEVERABILITY....................................................................................16 5.12 PRONOUNS........................................................................................16 ARTICLE 6 - AMENDMENTS..................................................................................16 6.1 BY THE BOARD OF DIRECTORS........................................................................16 6.2 BY THE STOCKHOLDERS..............................................................................16
-iii- ARTICLE 7 - INDEMNIFICATION.............................................................................17 7.1 ACTIONS OTHER THAN BY OR IN THE RIGHT OF THE CORPORATION........................................17 7.2 ACTIONS BY OR IN THE RIGHT OF THE CORPORATION...................................................17 7.3 SUCCESS ON THE MERITS...........................................................................18 7.4. AUTHORIZATION..................................................................................18 7.5 EXPENSE ADVANCE.................................................................................18 7.6 NONEXCLUSIVITY..................................................................................18 7.7 INSURANCE.......................................................................................18 7.8 "THE CORPORATION"...............................................................................18 7.9 OTHER INDEMNIFICATION...........................................................................19 7.10 OTHER DEFINITIONS..............................................................................19 7.11 CONTINUATION OF INDEMNIFICATION................................................................19
AMENDED AND RESTATED BY-LAWS OF RED HAT, INC. (the "Corporation") ARTICLE 1 - STOCKHOLDERS 1.1 PLACE OF MEETINGS. All meetings of stockholders shall be held at such place within or without the State of Delaware as may be designated from time to time by the Chairman of the Board (if any), the board of directors of the Corporation (the "Board of Directors") or the President or, if not so designated, at the registered office of the Corporation. 1.2 ANNUAL MEETING. The annual meeting of stockholders for the election of directors and for the transaction of such other business as may properly be brought before the meeting shall be held on a date to be fixed by the Chairman of the Board (if any), Board of Directors, the Chief Executive Officer or the President (which date shall not be a legal holiday in the place where the meeting is to be held) at the time and place to be fixed by the Chairman of the Board, the Board of Directors, the Chief Executive Officer or the President and stated in the notice of the meeting. 1.3 SPECIAL MEETINGS. Special meetings of stockholders may be called at any time by the Chairman of the Board (if any), a majority of the Board of Directors, the Chief Executive Officer or the President and shall be held at such place, on such date and at such time as shall be fixed by the Board of Directors or the person calling the meeting. Business transacted at any special meeting of stockholders shall be limited to matters relating to the purpose or purposes stated in the notice of meeting. 1.4 NOTICE OF MEETINGS. Except as otherwise provided by law, written notice of each meeting of stockholders, whether annual or special, shall be given not less than 10 nor more than 60 days before the date of the meeting to each stockholder entitled to vote at such meeting. The notices of all meetings shall state the place, date and hour of the meeting. The notice of a special meeting shall state, in addition, the purpose or purposes for which the meeting is called. If mailed, notice is given when deposited in the United States mail, postage prepaid, directed to the stockholder at his or her address as it appears on the records of the Corporation. 1.5 VOTING LIST. The officer who has charge of the stock ledger of the Corporation shall prepare, at least 10 days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least 10 days prior to the meeting, -2- either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time of the meeting, and may be inspected by any stockholder who is present. This list shall presumptively determine the identity of the stockholders entitled to vote at the meeting and the number of shares held by each of them. 1.6 QUORUM. Except as otherwise provided by law, the Corporation's Certificate of Incorporation, as such may be amended from time to time, or these Amended and Restated By-Laws, as such may be amended from time to time (the "Restated By-Laws"), the holders of a majority of the shares of the capital stock of the Corporation issued and outstanding and entitled to vote at the meeting, present in person or represented by proxy, shall constitute a quorum for the transaction of business. Shares held by brokers which such brokers are prohibited from voting (pursuant to their discretionary authority on behalf of beneficial owners of such shares who have not submitted a proxy with respect to such shares) on some or all of the matters before the stockholders, but which shares would otherwise be entitled to vote at the meeting ("Broker Non-Votes") shall be counted, for the purpose of determining the presence or absence of a quorum, both (a) toward the total voting power of the shares of capital stock of the Corporation and (b) as being represented by proxy. If a quorum has been established for the purpose of conducting the meeting, a quorum shall be deemed to be present for the purpose of all votes to be conducted at such meeting, provided that where a separate vote by a class or classes, or series thereof, is required, a majority of the voting power of the shares of such class or classes, or series, present in person or represented by proxy shall constitute a quorum entitled to take action with respect to that vote on that matter. If a quorum shall fail to attend any meeting, the chairman of the meeting or the holders of a majority of the voting power of the shares of stock entitled to vote who are present, in person or by proxy, may adjourn the meeting to another place, date, or time. 1.7 ADJOURNMENTS. Any meeting of stockholders may be adjourned to any other time and to any other place at which a meeting of stockholders may be held under these Restated By-Laws by the stockholders present or represented at the meeting and entitled to vote, although less than a quorum, or, if no stockholder is present, by any officer entitled to preside at or to act as Secretary of such meeting. It shall not be necessary to notify any stockholder of any adjournment of less than 30 days if the time and place of the adjourned meeting are announced at the meeting at which adjournment is taken, unless after the adjournment a new record date is fixed for the adjourned meeting. At the adjourned meeting, the Corporation may transact any business which might have been transacted at the original meeting. 1.8 VOTING AND PROXIES. At any meeting of the stockholders, each stockholder shall have one vote for each share of stock entitled to vote at such meeting held of record by such stockholder and a proportionate vote for each fractional share so held, unless otherwise provided in the Certificate of Incorporation. Each stockholder of record entitled to vote at a meeting of stockholders, or to express consent or dissent to corporate action in writing without a meeting (to the extent not otherwise prohibited by the Certificate of Incorporation or these By-laws), may vote or express such consent or dissent in person or may authorize another person or persons to vote or act for such stockholder by written proxy executed by such stockholder or his or her -3- authorized agent or by a transmission permitted by law and delivered to the Secretary of the Corporation. No such proxy shall be voted or acted upon after three years from the date of its execution, unless the proxy expressly provides for a longer period. Any copy, facsimile telecommunication or other reliable reproduction of the writing or transmission created pursuant to this Section 1.8 may be substituted or used in lieu of the original writing or transmission for any and all purposes for which the original writing or transmission could be used, provided that such copy, facsimile telecommunication or reproduction shall be a complete reproduction of the entire original writing or transmission. In the election of directors, voting shall be by written ballot, and for any other action, voting need not be by ballot. The Corporation may, and to the extent required by law or the Certificate of Incorporation, shall, in advance of any meeting of stockholders, appoint one or more inspectors to act at such meeting and make a written report thereof. The Corporation may designate one or more persons as alternate inspectors to replace any inspector who fails to act. If no inspector or alternate is able to act at a meeting of stockholders, the person presiding at such meeting may, and to the extent required by law or the Certificate of Incorporation, shall, appoint one or more inspectors to act at such meeting. Each inspector, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his or her ability. 1.9 ACTION AT MEETING. When a quorum is present at any meeting of stockholders, the holders of a majority of the stock present or represented and voting on a matter (or if there are two or more classes of stock entitled to vote as separate classes, then in the case of each such class, the holders of a majority of the stock of that class present or represented and voting on such matter) shall decide any matter to be voted upon by the stockholders at such meeting (other than the election of directors), except when a different vote is required by express provision of law, the Certificate of Incorporation or these Restated By-Laws. Any election of directors by the stockholders shall be determined by a plurality of the votes cast by the stockholders entitled to vote at such election, except as otherwise provided by the Certificate of Incorporation. For the purposes of this paragraph, Broker Non-Votes represented at the meeting but not permitted to vote on a particular matter shall not be counted, with respect to the vote on such matter, in the number of (a) votes cast, (b) votes cast affirmatively, or (c) votes cast negatively. 1.10 INTRODUCTION OF BUSINESS AT MEETINGS. A. ANNUAL MEETINGS OF STOCKHOLDERS. (1) Nominations of persons for election to the Board of Directors and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders (a) pursuant to the Corporation's notice of meeting, (b) by or at the direction of the Board of Directors or (c) by any stockholder of the Corporation who was a stockholder of record at the time of giving of notice provided for in this Section 1.10, who is entitled to vote at the meeting and who complies with the notice procedures set forth in this Section 1.10. -4- (2) For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (c) of paragraph (A)(1) of this Section 1.10, the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation and such other business must otherwise be a proper matter for stockholder action. To be timely, a stockholder's notice shall be delivered to the Secretary at the principal executive offices of the Corporation not later than the close of business on the one hundred twentieth (120th) day nor earlier than the close of business on the one hundred fiftieth (150th) day prior to the first anniversary of the date of the proxy statement delivered to stockholders in connection with the preceding year's annual meeting; provided, however, that if either (i) the date of the annual meeting is more than thirty (30) days before or more than sixty (60) days after such an anniversary date or (ii) no proxy statement was delivered to stockholders in connection with the preceding year's annual meeting, notice by the stockholder to be timely must be so delivered not earlier than the close of business on the ninetieth (90th) day prior to such annual meeting and not later than the close of business on the later of the sixtieth (60th) day prior to such annual meeting or the close of business on the tenth (10th) day following the day on which public announcement of the date of such meeting is first made by the Corporation. Such stockholder's notice shall set forth (a) as to each person whom the stockholder proposes to nominate for election or reelection as a director, all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act") (including such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (b) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and the beneficial owner, if any, on whose behalf the proposal is made; and (c) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (i) the name and address of such stockholder, as they appear on the Corporation's books, and of such beneficial owner and (ii) the class and number of shares of capital stock of the Corporation that are owned beneficially and held of record by such stockholder and such beneficial owner. (3) Notwithstanding anything in the second sentence of paragraph (A)(2) of this Section 1.10 to the contrary, in the event that the number of directors to be elected to the Board of Directors of the Corporation is increased and there is no public announcement by the Corporation naming all of the nominees for director or specifying the size of the increased Board of Directors at least seventy (70) days prior to the first anniversary of the preceding year's annual meeting (or, if the annual meeting is held more than thirty (30) days before or sixty (60) days after such anniversary date, at least seventy (70) days prior to such annual meeting), a stockholder's notice required by this Section 1.10 shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it -5- shall be delivered to the Secretary at the principal executive office of the Corporation not later than the close of business on the tenth (10th) day following the day on which such public announcement is first made by the Corporation. B. SPECIAL MEETINGS OF STOCKHOLDERS. Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the Corporation's notice of meeting. Nominations of persons for election to the Board of Directors may be made at a special meeting of stockholders at which directors are to be elected pursuant to the Corporation's notice of meeting (a) by or at the direction of the Board of Directors or (b) provided that the Board of Directors has determined that directors shall be elected at such meeting, by any stockholder of the Corporation who is a stockholder of record at the time of giving of notice of the special meeting, who shall be entitled to vote at the meeting and who complies with the notice procedures set forth in this Section 1.10. If the Corporation calls a special meeting of stockholders for the purpose of electing one or more directors to the Board of Directors, any such stockholder may nominate a person or persons (as the case may be), for election to such position(s) as specified in the Corporation's notice of meeting, if the stockholder's notice required by paragraph (A)(2) of this Section 1.10 shall be delivered to the Secretary at the principal executive offices of the Corporation not earlier than the ninetieth (90th) day prior to such special meeting nor later than the later of (x) the close of business on the sixtieth (60th) day prior to such special meeting or (y) the close of business on the tenth (10th) day following the day on which public announcement is first made of the date of such special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting. C. GENERAL. (1) Only such persons who are nominated in accordance with the procedures set forth in this Section 1.10 shall be eligible to serve as directors and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with the procedures set forth in this Section 1.10. Except as otherwise provided by law, the Certificate of Incorporation or these Restated By-Laws, the chairman of the meeting shall have the power and duty to determine whether a nomination or any business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with the procedures set forth in this Section 1.10 and, if any proposed nomination or business is not in compliance herewith, to declare that such defective proposal or nomination shall be disregarded. (2) For purposes of this Section 1.10, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service or in a document publicly filed by the Corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act. -6- (3) Notwithstanding the foregoing provisions of this Section 1.10, a stockholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth herein. Nothing in this Section 1.10 shall be deemed to affect any rights (i) of stockholders to request inclusion of proposals in the Corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act or (ii) of the holders of any series of Preferred Stock to elect directors under specified circumstances. 1.11 ACTION WITHOUT MEETING. Stockholders of the Corporation may not take any action by written consent in lieu of a meeting. Notwithstanding any other provision of law, the Certificate of Incorporation or these Restated By-Laws, and notwithstanding the fact that a lesser percentage may be specified by law, the affirmative vote of the holders of at least seventy-five percent (75%) of the votes which all the stockholders would be entitled to cast at any annual election of directors or class of directors shall be required to amend or repeal, or to adopt any provision inconsistent with, this Section 1.11. ARTICLE 2 - DIRECTORS 2.1 GENERAL POWERS. The business and affairs of the Corporation shall be managed by or under the direction of a Board of Directors, who may exercise all of the powers of the Corporation except as otherwise provided by law or the Certificate of Incorporation. In the event of a vacancy in the Board of Directors, the remaining directors, except as otherwise provided by law or the Certificate of Incorporation, may exercise the powers of the full Board of Directors until the vacancy is filled. Without limiting the foregoing, the Board of Directors may: (a) declare dividends from time to time in accordance with law; (b) purchase or otherwise acquire any property, rights or privileges on such terms as it shall determine; (c) authorize the creation, making and issuance, in such form as it may determine, of written obligations of every kind, negotiable or non-negotiable, secured or unsecured, to borrow funds and guarantee obligations, and to do all things necessary in connection therewith; (d) remove any officer of the Corporation with or without cause, and from time to time to devolve the powers and duties of any officer upon any other person for the time being; (e) confer upon any officer of the Corporation the power to appoint, remove and suspend subordinate officers, employees and agents; (f) adopt from time to time such stock option, stock purchase, bonus or other compensation plans for directors, officers, employees, consultants and agents of the Corporation and its subsidiaries as it may determine; -7- (g) adopt from time to time such insurance, retirement, and other benefit plans for directors, officers, employees, consultants and agents of the Corporation and its subsidiaries as it may determine; and (h) adopt from time to time regulations, not inconsistent herewith, for the management of the Corporation's business and affairs. 2.2 NUMBER; ELECTION AND QUALIFICATION. The number of directors which shall constitute the whole Board of Directors shall be determined by resolution of the Board of Directors, but in no event shall be less than three. The number of directors may be decreased at any time and from time to time by a majority of the directors then in office, but only to eliminate vacancies existing by reason of the death, resignation, removal or expiration of the term of one or more directors. The directors shall be elected at the annual meeting of stockholders (or, if so determined by the Board of Directors pursuant to Section 10 hereof, at a special meeting of stockholders), by such stockholders as have the right to vote on such election. Directors need not be stockholders of the Corporation. 2.3 CLASSES OF DIRECTORS. The Board of Directors shall be and is divided into three classes: Class I, Class II and Class III. No one class shall have more than one director more than any other class. 2.4 TERMS IN OFFICE. Each director shall serve for a term ending on the date of the third annual meeting following the annual meeting at which such director was elected; provided, however, that each initial director in Class I shall serve for a term ending on the date of the annual meeting next following the end of the Corporation's fiscal year ending February 29, 2000; each initial director in Class II shall serve for a term ending on the date of the annual meeting next following the end of the Corporation's fiscal year ending February 28, 2001; and each initial director in Class III shall serve for a term ending on the date of the annual meeting next following the end of the Corporation's fiscal year ending February 28, 2002. 2.5 ALLOCATION OF DIRECTORS AMONG CLASSES IN THE EVENT OF INCREASES OR DECREASES IN THE NUMBER OF Directors. In the event of any increase or decrease in the authorized number of directors, (i) each director then serving as such shall nevertheless continue as a director of the class of which he or she is a member until the expiration of such director's current term or his or her prior death, removal or resignation and (ii) the newly created or eliminated directorships resulting from such increase or decrease shall be apportioned by the Board of Directors among the three classes of directors, subject to the second sentence of Section 2.3. To the extent possible, consistent with the foregoing rule, any newly created directorships shall be added to those classes whose terms of office are to expire at the earliest dates following such allocation, unless otherwise provided for from time to time by resolution adopted by a majority of the directors then in office, although less than a quorum. No decrease in the number of directors constituting the whole Board of Directors shall shorten the term of an incumbent Director. -8- 2.6 TENURE. Notwithstanding any provisions to the contrary contained herein, each director shall hold office until his or her successor is elected and qualified, or until his or her earlier death, resignation or removal. 2.7 VACANCIES. Unless and until filled by the stockholders, any vacancy in the Board of Directors, however occurring, including a vacancy resulting from an enlargement thereof, may be filled by vote of a majority of the directors then in office, although less than a quorum, or by a sole remaining director. A director elected to fill a vacancy shall be elected for the unexpired term of his or her predecessor in office, if any, and a director chosen to fill a position resulting from an increase in the number of directors shall hold office until the next election of directors of the class for which such director was chosen and until his or her successor is elected and qualified, or until his or her earlier death, resignation or removal. 2.8 RESIGNATION. Any director may resign by delivering his or her written resignation to the Corporation at its principal office or to the President or Secretary. Such resignation shall be effective upon receipt unless it is specified to be effective at some other time or upon the happening of some other event. 2.9 REGULAR MEETINGS. Regular meetings of the Board of Directors may be held without notice at such time and place, either within or without the State of Delaware, as shall be determined from time to time by the Board of Directors; provided that any director who is absent when such a determination is made shall be given notice of the determination. 2.10 SPECIAL MEETINGS. Special meetings of the Board of Directors may be held at any time and place, within or without the State of Delaware, designated in a call by the Chairman of the Board (if any), the Chief Executive Officer, the President, two or more directors, or by one director in the event that there is only a single director in office. 2.11 NOTICE OF SPECIAL MEETINGS. Notice of any special meeting of directors shall be given to each director by the Secretary or by the officer or one of the directors calling the meeting. Notice shall be duly given to each director (i) by giving notice to such director in person or by telephone at least 48 hours in advance of the meeting, (ii) by sending a telegram or delivering written notice by facsimile transmission or by hand, to his or her last known business or home address at least 48 hours in advance of the meeting, or (iii) by mailing written notice to his or her last known business or home address at least 72 hours in advance of the meeting. A notice or waiver of notice of a meeting of the Board of Directors need not specify the purposes of the meeting. 2.12 MEETINGS BY TELEPHONE CONFERENCE CALLS. Directors or any members of any committee designated by the Board of Directors may participate in a meeting of the Board of Directors or such committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation by such means shall be deemed to constitute presence in person at such meeting. 2.13 QUORUM. A majority of the total number of the whole Board of Directors shall constitute a quorum at all meetings of the Board of Directors. In the event one or more of the -9- directors shall be disqualified to vote at any meeting, then the required quorum shall be reduced by one for each such director so disqualified; provided, however, that in no case shall less than one-third (1/3) of the total number of the whole Board of Directors constitute a quorum. In the absence of a quorum at any such meeting, a majority of the directors present may adjourn the meeting from time to time without further notice other than announcement at the meeting, until a quorum shall be present. 2.14 ACTION AT MEETING. At any meeting of the Board of Directors at which a quorum is present, the vote of a majority of those present shall be sufficient to take any action, unless a different vote is specified by law, the Certificate of Incorporation or these Restated By-Laws. 2.15 ACTION BY WRITTEN CONSENT. Any action required or permitted to be taken at any meeting of the Board of Directors or of any committee of the Board of Directors may be taken without a meeting, if all members of the Board of Directors or committee, as the case may be, consent to such action in writing, and the written consents are filed with the minutes of proceedings of the Board of Directors or committee. 2.16 REMOVAL. Unless otherwise provided in the Certificate of Incorporation, any one or more or all of the directors may be removed with cause only by the holders of at least seventy-five percent (75%) of the shares then entitled to vote at an election of directors. Directors may not be removed without cause. 2.17 COMMITTEES. The Board of Directors may, by resolution passed by a majority of the whole Board, designate one or more committees, each committee to consist of one or more of the directors of the Corporation. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of such committee. In the absence or disqualification of a member of a committee, the member or members of such committee present at any meeting and not disqualified from voting, whether or not such member or members constitute a quorum, may unanimously appoint another member of the Board of Directors to act at such meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the Board of Directors and subject to the provisions of the General Corporation Law of the State of Delaware, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the Corporation and may authorize the seal of the Corporation to be affixed to all papers which may require it. Each such committee shall keep minutes and make such reports as the Board of Directors may from time to time request. Except as the Board of Directors may otherwise determine or as provided herein, any committee may make rules for the conduct of its business, but unless otherwise provided by the directors or in such rules, its business shall be conducted as nearly as possible in the same manner as is provided in these Restated By-Laws for the Board of Directors. Adequate provisions shall be made for notice to members of all meeting of committees. One-third (1/3) of the members of any committee shall constitute a quorum unless the committee shall consist of one (1) or two (2) members, in which event one (1) member shall constitute a quorum; and all matters shall be determined by a majority vote of the members present. Action may be taken by any committee without a meeting if all members thereof consent thereto in writing, and the writing or writings are filed with the minutes of the proceedings of such committee. -10- 2.18 COMPENSATION OF DIRECTORS. Directors may be paid such compensation for their services and such reimbursement for expenses of attendance at meetings as the Board of Directors may from time to time determine. No such payment shall preclude any director from serving the Corporation or any of its parent or subsidiary corporations in any other capacity and receiving compensation for such service. 2.19 AMENDMENTS TO ARTICLE. Notwithstanding any other provisions of law, the Certificate of Incorporation or these Restated By-Laws, and notwithstanding the fact that a lesser percentage may be specified by law, the affirmative vote of the holders of a least seventy-five percent (75%) of the votes which all the stockholders would be entitled to cast at any annual election of directors or class of directors shall be required to amend or repeal, or to adopt any provision inconsistent with, this Article 2. ARTICLE 3 - OFFICERS 3.1 ENUMERATION. The officers of the Corporation shall consist of a President, a Secretary, a Treasurer and such other officers with such other titles as the Board of Directors shall determine, including, but not limited to, a Chairman of the Board, a Vice-Chairman of the Board, and one or more Vice Presidents, Assistant Treasurers and Assistant Secretaries. The Board of Directors may appoint such other officers as it may deem appropriate. 3.2 ELECTION. The President, Treasurer and Secretary shall be elected annually by the Board of Directors at its first meeting following the annual meeting of stockholders. Other officers may be appointed by the Board of Directors at such meeting or at any other meeting. 3.3 QUALIFICATION. No officer need be a stockholder. Any two or more offices may be held by the same person. 3.4 TENURE. Except as otherwise provided by law, by the Certificate of Incorporation or by these Restated By-Laws, each officer shall hold office until his or her successor is elected and qualified, unless a different term is specified in the vote choosing or appointing such officer, or until his or her earlier death, resignation or removal. 3.5 RESIGNATION AND REMOVAL. Any officer may resign by delivering his or her written resignation to the Chairman of the Board (if any), to the Board of Directors at a meeting thereof, to the Corporation at its principal office or to the President or Secretary. Such resignation shall be effective upon receipt unless it is specified to be effective at some other time or upon the happening of some other event. Any officer may be removed at any time, with or without cause, by vote of a majority of the entire number of directors then in office. -11- Except as the Board of Directors may otherwise determine, no officer who resigns or is removed shall have any right to any compensation as an officer for any period following his or her resignation or removal, or any right to damages on account of such removal, whether his or her compensation be by the month or by the year or otherwise, unless such compensation is expressly provided in a duly authorized written agreement with the Corporation. 3.6 VACANCIES. The Board of Directors may fill any vacancy occurring in any office for any reason and may, in its discretion, leave unfilled for such period as it may determine any offices other than those of President, Treasurer and Secretary. Each such successor shall hold office for the unexpired term of his predecessor and until his or her successor is elected and qualified, or until his or her earlier death, resignation or removal. 3.7 CHAIRMAN OF THE BOARD AND VICE-CHAIRMAN OF THE BOARD. The Chairman of the Board, if any, shall preside at all meetings of the Board of Directors and stockholders at which he or she is present and shall perform such duties and possess such powers as are designated by the Board of Directors. If the Board of Directors appoints a Vice-Chairman of the Board, he or she shall, in the absence or disability of the Chairman of the Board, perform the duties and exercise the powers of the Chairman of the Board and shall perform such other duties and possess such other powers as may from time to time be designated by the Board of Directors. 3.8 PRESIDENT. The President shall, subject to the direction of the Board of Directors, have general charge and supervision of the business of the Corporation. Unless otherwise provided by the Board of Directors, and provided that there is no Chairman of the Board or that the Chairman and Vice-Chairman, if any, are not available, the President shall preside at all meetings of the stockholders, and, if a director, at all meetings of the Board of Directors. Unless the Board of Directors has designated another officer as the Chief Executive Officer, the President shall be the Chief Executive Officer of the Corporation. The President shall perform such other duties and shall have such other powers as the Board of Directors may from time to time prescribe. The President shall have the power to enter into contracts and otherwise bind the Corporation in matters arising in the ordinary course of the Corporation's business. 3.9 VICE PRESIDENTS. Any Vice President shall perform such duties and possess such powers as the Board of Directors or the President may from time to time prescribe. In the event of the absence, inability or refusal to act of the President, the Vice President (or if there shall be more than one, the Vice Presidents in the order determined by the Board of Directors) shall perform the duties of the President and, when so performing, shall have all the powers of and be subject to all the restrictions upon the President. The Board of Directors may assign to any Vice President the title of Executive Vice President, Senior Vice President or any other title selected by the Board of Directors. Unless otherwise determined by the Board of Directors, any Vice President shall have the power to enter into contracts and otherwise bind the Corporation in matters arising in the ordinary course of the Corporation's business. 3.10 SECRETARY AND ASSISTANT SECRETARIES. The Secretary shall perform such duties and shall have such powers as the Board of Directors or the President may from time to time prescribe. In addition, the Secretary shall perform such duties and have such powers as are incident to the office of secretary, including without limitation the duty and power to give notices -12- of all meetings of stockholders and special meetings of the Board of Directors, to attend all meetings of stockholders and the Board of Directors and keep a record of the proceedings, to maintain a stock ledger and prepare lists of stockholders and their addresses as required, to be custodian of corporate records and the corporate seal and to affix and attest to the same on documents. Any Assistant Secretary shall perform such duties and possess such powers as the Board of Directors, the President or the Secretary may from time to time prescribe. In the event of the absence, inability or refusal to act of the Secretary, the Assistant Secretary (or if there shall be more than one, the Assistant Secretaries in the order determined by the Board of Directors) shall perform the duties and exercise the powers of the Secretary. In the absence of the Secretary or any Assistant Secretary at any meeting of stockholders or directors, the person presiding at the meeting shall designate a temporary secretary to keep a record of the meeting. 3.11 TREASURER AND ASSISTANT TREASURERS. The Treasurer shall perform such duties and shall have such powers as the Board of Directors or the President may from time to time prescribe. In addition, the Treasurer shall perform such duties and have such powers as are incident to the office of treasurer, including without limitation the duty and power to keep and be responsible for all funds and securities of the Corporation, to deposit funds of the Corporation in depositories selected in accordance with these Restated By-Laws, to disburse such funds as ordered by the Board of Directors, to make proper accounts for such funds, and to render as required by the Board of Directors statements of all such transactions and of the financial condition of the Corporation. The Assistant Treasurers shall perform such duties and possess such powers as the Board of Directors, the President or the Treasurer may from time to time prescribe. In the event of the absence, inability or refusal to act of the Treasurer, the Assistant Treasurer (or if there shall be more than one, the Assistant Treasurers in the order determined by the Board of Directors) shall perform the duties and exercise the powers of the Treasurer. 3.12 SALARIES. Officers of the Corporation shall be entitled to such salaries, compensation or reimbursement as shall be fixed or allowed from time to time by the Board of Directors. 3.13 ACTION WITH RESPECT TO SECURITIES OF OTHER CORPORATIONS. Unless otherwise directed by the Board of Directors, the President or any officer of the Corporation authorized by the President shall have power to vote and otherwise act on behalf of the Corporation, in person or by proxy, at any meeting of stockholders of or with respect to any action of stockholders of any other corporation in which the Corporation may hold securities and otherwise to exercise any and all rights and powers which this Corporation may possess by reason of its ownership of securities in such other corporation. ARTICLE 4 - CAPITAL STOCK -13- 4.1 ISSUANCE OF STOCK. Unless otherwise voted by the stockholders and subject to the provisions of the Certificate of Incorporation, the whole or any part of any unissued balance of the authorized capital stock of the Corporation or the whole or any part of any issued, authorized capital stock of the Corporation held in its treasury may be issued, sold, transferred or otherwise disposed of by vote of the Board of Directors in such manner, for such consideration and on such terms as the Board of Directors may determine. 4.2 CERTIFICATES OF STOCK. Every holder of stock of the Corporation shall be entitled to have a certificate, in such form as may be prescribed by law and by the Board of Directors, certifying the number and class of shares owned by such stockholder in the Corporation. Each such certificate shall be signed by, or in the name of the Corporation by, the Chairman or Vice-Chairman, if any, of the Board of Directors, or the President or a Vice President, and the Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary of the Corporation. Any or all of the signatures on such certificate may be a facsimile. Each certificate for shares of stock which are subject to any restriction on transfer pursuant to the Certificate of Incorporation, the Restated By-Laws, applicable securities laws or any agreement among any number of shareholders or among such holders and the Corporation shall have conspicuously noted on the face or back of such certificate either the full text of such restriction or a statement of the existence of such restriction. 4.3 TRANSFERS. Except as otherwise established by rules and regulations adopted by the Board of Directors, and subject to applicable law, shares of stock may be transferred on the books of the Corporation by the surrender to the Corporation or its transfer agent of the certificate representing such shares, properly endorsed or accompanied by a written assignment or power of attorney properly executed, and with such proof of authority or the authenticity of signature as the Corporation or its transfer agent may reasonably require. Except as may be otherwise required by law, by the Certificate of Incorporation or by these Restated By-Laws, the Corporation shall be entitled to treat the record holder of stock as shown on its books as the owner of such stock for all purposes, including the payment of dividends and the right to vote with respect to such stock, regardless of any transfer, pledge or other disposition of such stock, until the shares have been transferred on the books of the Corporation in accordance with the requirements of these Restated By-Laws. 4.4 LOST, STOLEN OR DESTROYED CERTIFICATES. The Corporation may issue a new certificate of stock in place of any previously issued certificate alleged to have been lost, stolen, or destroyed, upon such terms and conditions as the President may prescribe, including the presentation of reasonable evidence of such loss, theft or destruction and the giving of such indemnity as the President may require for the protection of the Corporation or any transfer agent or registrar. 4.5 RECORD DATE. The Board of Directors may fix in advance a date as a record date for the determination of the stockholders entitled to notice of or to vote at any meeting of stockholders or, to the extent permitted by the Certificate of Incorporation and these By-laws, to express consent (or dissent) to corporate action in writing without a meeting, or entitled to -14- receive payment of any dividend or other distribution or allotment of any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action. Such record date shall not be more than 60 nor less than 10 days before the date of such meeting, nor more than 60 days prior to any other action to which such record date relates. If no record date is fixed, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day before the day on which notice is given, or, if notice is waived, at the close of business on the day before the day on which the meeting is held. The record date for determining stockholders entitled to express consent to corporate action in writing without a meeting (to the extent permitted by the Certificate of Incorporation and these By-laws) when no prior action by the Board of Directors is necessary, shall be the day on which the first written consent is expressed. The record date for determining stockholders for any other purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating to such purpose. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. ARTICLE 5 - GENERAL PROVISIONS 5.1 FISCAL YEAR. The fiscal year of the Corporation shall be fixed by resolution of the Board of Directors. 5.2 CORPORATE SEAL. The corporate seal shall be in such form as shall be approved by the Board of Directors. 5.3 NOTICES. Except as otherwise specifically provided herein or required by law or the Certificate of Incorporation, all notices required to be given to any stockholder, director, officer, employee or agent of the Corporation shall be in writing and may in every instance be effectively given by hand delivery to the recipient thereof, by depositing such notice in the mails, postage paid, or by sending such notice by prepaid telegram or facsimile transmission. Any such notice shall be addressed to such stockholder, director, officer, employee or agent at his or her last known address as the same appears on the books of the Corporation. The time when such notice is received shall be deemed to be the time of the giving of the notice. 5.4 WAIVER OF NOTICE. Whenever any notice whatsoever is required to be given by law, by the Certificate of Incorporation or by these Restated By-Laws, a waiver of such notice either in writing signed by the person entitled to such notice or such person's duly authorized attorney, or by telegraph, facsimile transmission or any other available method, whether before, at or after the time stated in such waiver, or the appearance of such person or persons at such meeting in person or by proxy, shall be deemed equivalent to such notice. 5.5 EVIDENCE OF AUTHORITY. A certificate by the Secretary, or an Assistant Secretary, or a temporary Secretary, as to any action taken by the stockholders, directors, a committee or -15- any officer or representative of the Corporation shall, as to all persons who rely on the certificate in good faith, be conclusive evidence of such action. 5.6 FACSIMILE SIGNATURES. In addition to the provisions for use of facsimile signatures elsewhere specifically authorized in these Restated By-Laws, facsimile signatures of any officer or officers of the Corporation may be used whenever and as authorized by the Board of Directors or a committee thereof. 5.7 RELIANCE UPON BOOKS, REPORTS AND RECORDS. Each director, each member of any committee designated by the Board of Directors, and each officer of the Corporation shall, in the performance of his or her duties, be fully protected in relying in good faith upon the books of account or other records of the Corporation and upon such information, opinions, reports or statements presented to the Corporation by any of its officers or employees or committees of the Board of Directors so designated, or by any other person as to matters which such director or committee member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the Corporation. 5.8 TIME PERIODS. In applying any provision of these Restated By-Laws that requires that an act be done or not be done a specified number of days prior to an event or that an act be done during a period of a specified number of days prior to an event, calendar days shall be used, the day of the doing of the act shall be excluded, and the day of the event shall be included. 5.9 CERTIFICATE OF INCORPORATION. All references in these Restated By-Laws to the Certificate of Incorporation shall be deemed to refer to the Third Amended and Restated Certificate of Incorporation of the Corporation, as amended and in effect from time to time. 5.10 TRANSACTIONS WITH INTERESTED PARTIES. No contract or transaction between the Corporation and one or more of the directors or officers, or between the Corporation and any other corporation, partnership, association, or other organization in which one or more of the directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because such director or officer is present at or participates in the meeting of the Board of Directors or a committee of the Board of Directors which authorizes the contract or transaction or solely because his, her or their votes are counted for such purpose, if: (1) The material facts as to his or her relationship or interest and as to the contract or transaction are disclosed or are known to the Board of Directors or the committee, and the Board or committee in good faith authorizes the contract or transaction by the affirmative vote of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; (2) The material facts as to his or her relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or -16- (3) The contract or transaction is fair as to the Corporation as of the time it is authorized, approved or ratified, by the Board of Directors, a committee of the Board of Directors, or the stockholders. Common or interested directors may be counted in determining the presence of a quorum at a meeting of the Board of Directors or of a committee which authorizes the contract or transaction. 5.11 SEVERABILITY. Any determination that any provision of these Restated By-Laws is for any reason inapplicable, illegal or ineffective shall not affect or invalidate any other provision of these Restated By-Laws. 5.12 PRONOUNS. All pronouns used in these Restated By-Laws shall be deemed to refer to the masculine, feminine or neuter, singular or plural, as the identity of the persons or persons so designated may require. ARTICLE 6 - AMENDMENTS 6.1 BY THE BOARD OF DIRECTORS. Except as is otherwise set forth in these Restated By-Laws, these Restated By-Laws may be altered, amended or repealed, or new by-laws may be adopted, by the affirmative vote of a majority of the directors present at any regular or special meeting of the Board of Directors at which a quorum is present. 6.2 BY THE STOCKHOLDERS. Except as otherwise set forth in these Restated By-Laws, these Restated By-Laws may be altered, amended or repealed or new by-laws may be adopted by the affirmative vote of the holders of seventy-five percent (75%) of the shares of the capital stock of the Corporation issued and outstanding and entitled to vote at any regular meeting of stockholders, or at any special meeting of stockholders, provided notice of such alteration, amendment, repeal or adoption of new by-laws shall have been stated in the notice of such special meeting. ARTICLE 7 - INDEMNIFICATION 7.1 ACTIONS OTHER THAN BY OR IN THE RIGHT OF THE CORPORATION. The Corporation shall indemnify and hold harmless, to the fullest extent permitted by applicable law as it presently exists or may hereafter be amended, any person who was or is a party or is threatened to be made a party or is otherwise involved in any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that such person, or a person for whom such person is the legal representative, is or was a director, trustee, partner, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise or non-profit entity, against all liability, losses, expenses (including attorneys' fees), judgments, fines, and amounts paid in settlement actually and reasonably incurred by such person in -17- connection with such action, suit or proceeding if such person acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interest of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that such person did not act in good faith and in a manner which he or she reasonably believed to be in or not opposed to the best interest of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his or her conduct was unlawful. 7.2 ACTIONS BY OR IN THE RIGHT OF THE CORPORATION. The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he or she is or was a director, trustee, partner, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise or non-profit entity against expenses (including attorneys' fees) actually and reasonably incurred by him or her in connection with the defense or settlement of such action or suit if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the Corporation; except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation unless and only to the extent that the Court of Chancery of the State of Delaware or the court in which such action or suit was brought shall determine upon application that despite the adjudication of liability but in view of all the circumstances of the case, such person fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery of the State of Delaware or such other court shall deem proper. 7.3 SUCCESS ON THE MERITS. To the extent that any person referred to in Sections 7.1 or 7.2 has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to therein, or in defense of any claim, issue or matter therein, he or she shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him or her in connection therewith. 7.4. AUTHORIZATION. Any indemnification under Sections 7.1, 7.2 or 7.3 (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the director, trustee, partner, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Sections 7.1 and 7.2. Such determination shall be made: (a) by the Board of Directors, by a majority vote of directors who are not parties to such action, suit or proceeding (whether or not a quorum), or (b) if there are no disinterested directors or if a majority of disinterested directors so directs, by independent legal counsel (who may be regular legal counsel to the corporation) in a written opinion, or (c) by the stockholders. 7.5 EXPENSE ADVANCE. Expenses (including attorneys' fees) incurred by an officer or director of the Corporation in defending any pending or threatened civil, criminal, administrative -18- or investigative action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding as authorized by the Board of Directors in the manner provided in Section 7.4 of this Article upon receipt of an undertaking by or on behalf of such officer or director to repay such amount, if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation as authorized in this Article. Such expenses (including attorneys' fees) incurred by other employees or agents of the Corporation may be so paid upon such terms and conditions, if any, as the Board of Directors deems appropriate. 7.6 NONEXCLUSIVITY. The indemnification and advancement of expenses provided by, or granted pursuant to, the other Sections of this Article shall not be deemed exclusive of any other rights to which any person seeking indemnification or advancement of expenses may be entitled under any statute, by-law, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his or her official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. 7.7 INSURANCE. The Corporation shall have power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, trustee, partner, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise or non-profit entity against any liability asserted against and incurred by such person in any such capacity, or arising out of his or her status as such, whether or not the Corporation would have the power to indemnify such person against such liability under the provisions of this Article or Section 145 of the Delaware General Corporation Law. 7.8 "THE CORPORATION" For the purposes of this Article, references to "the Corporation" shall include the resulting corporation and, to the extent that the Board of Directors of the resulting corporation so decides, all constituent corporations (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers and employees or agents so that any person who is or was a director, officer, employee or agent of such a constituent corporation or is or was serving at the request of such constituent corporation as director, trustee, partner, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise or non-profit entity shall stand in the same position under the provisions of this Article with respect to the resulting or surviving corporation as he or she would have with respect to such constituent corporation if its separate existence had continued. 7.9 OTHER INDEMNIFICATION. The Corporation's obligation, if any, to indemnify any person who was or is serving at its request as a director, trustee, partner, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise or non-profit entity shall be reduced by any amount such person may collect as indemnification from such other corporation, partnership, joint venture, trust or other enterprise or non-profit entity or from insurance. 7.10 OTHER DEFINITIONS. For purposes of this Article, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed -19- on a person with respect to an employee benefit plan; and references to "serving at the request of the Corporation" shall include any service as a director, trustee, officer, employee or agent of the Corporation which imposes duties on, or involves services by, such director, trustee, officer, employee, or agent with respect to an employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the Corporation" as referred to in this Article. 7.11 CONTINUATION OF INDEMNIFICATION. The indemnification and advancement of expenses provided by, or granted pursuant to, this Article shall, unless otherwise provided when authorized or ratified, continue as a person who has ceased to be a director, trustee, partner, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. EX-10.1 6 EXHIBIT 10.1 Exhibit 10.1 RED HAT SOFTWARE, INC. 1998 STOCK OPTION PLAN ---------------------- 1. Purpose. The purpose of the Red Hat Software, Inc. 1998 Stock Option Plan (the "Plan") is to encourage key employees of Red Hat Software, Inc., a Delaware corporation (the "Company") and of any present or future parent or subsidiary of the Company (collectively, "Related Corporations") and other individuals who render services to the Company or a Related Corporation, by providing opportunities to participate in the ownership of the Company and its future growth through (a) the grant of options which qualify as "incentive stock options" ("ISOs") under Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code"); (b) the grant of options which do not qualify as ISOs ("Non-Qualified Options"); (c) awards of stock in the Company ("Awards"); and (d) opportunities to make direct purchases of stock in the Company ("Purchases"). Both ISOs and Non-Qualified Options are referred to hereafter individually as an "Option" and collectively as "Options." Options, Awards and authorizations to make Purchases are referred to hereafter collectively as "Stock Rights." As used herein, the terms "parent" and "subsidiary" mean "parent corporation" and "subsidiary corporation," respectively, as those terms are defined in Section 424 of the Code. 2. Administration of the Plan. A. Board or Committee Administration. The Plan shall be administered by the Board of Directors of the Company (the "Board") or, subject to paragraph 2(D) (relating to compliance with Section 162(m) of the Code), by a committee appointed by the Board (the "Committee"). Hereinafter, all references in this Plan to the "Committee" shall mean the Board if no Committee has been appointed. Subject to ratification of the grant or authorization of each Stock Right by the Board (if so required by applicable state law), and subject to the terms of the Plan, the Committee shall have the authority to (i) determine to whom (from among the class of employees eligible under paragraph 3 to receive ISOs) ISOs shall be granted, and to whom (from among the class of individuals and entities eligible under paragraph 3 to receive Non-Qualified Options and Awards and to make Purchases) Non-Qualified Options, Awards and authorizations to make Purchases may be granted; (ii) determine the time or times at which Options or Awards shall be granted or Purchases made; (iii) determine the purchase price of shares subject to each Option or Purchase, which prices shall not be less than the minimum price specified in paragraph 6; (iv) determine whether each Option granted shall be an ISO or a Non-Qualified Option; (v) determine (subject to paragraph 7) the time or times when each Option shall become exercisable and the duration of the exercise period; (vi) extend the period during which outstanding Options may be exercised; (vii) determine whether restrictions such as repurchase -2- options are to be imposed on shares subject to Options, Awards and Purchases and the nature of such restrictions, if any, and (viii) interpret the Plan and prescribe and rescind rules and regulations relating to it. If the Committee determines to issue a Non-Qualified Option, it shall take whatever actions it deems necessary, under Section 422 of the Code and the regulations promulgated thereunder, to ensure that such Option is not treated as an ISO. The interpretation and construction by the Committee of any provisions of the Plan or of any Stock Right granted under it shall be final unless otherwise determined by the Board. The Committee may from time to time adopt such rules and regulations for carrying out the Plan as it may deem advisable. No member of the Board or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any Stock Right granted under it. B. Committee Actions. The Committee may select one of its members as its chairman, and shall hold meetings at such time and places as it may determine. A majority of the Committee shall constitute a quorum and acts of a majority of the members of the Committee at a meeting at which a quorum is present, or acts reduced to or approved in writing by all the members of the Committee (if consistent with applicable state law), shall be the valid acts of the Committee. From time to time the Board may increase the size of the Committee and appoint additional members thereof, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies however caused, or remove all members of the Committee and thereafter directly administer the Plan. C. Grant of Stock Rights to Board Members. Stock Rights may be granted to members of the Board. All grants of Stock Rights to members of the Board shall in all respects be made in accordance with the provisions of this Plan applicable to other eligible persons. Members of the Board who either (i) are eligible to receive grants of Stock Rights pursuant to the Plan or (ii) have been granted Stock Rights may vote on any matters affecting the administration of the Plan or the grant of any Stock Rights pursuant to the Plan, except that no such member shall act upon the granting to himself or herself of Stock Rights, but any such member may be counted in determining the existence of a quorum at any meeting of the Board during which action is taken with respect to the granting to such member of Stock Rights. D. Performance-Based Compensation. The Board, in its discretion, may take such action as may be necessary to ensure that Stock Rights granted under the Plan qualify as "qualified performance-based compensation" within the meaning of Section 162(m) of the Code and applicable regulations promulgated thereunder ("Performance-Based Compensation"). Such action may include, in the Board's discretion, some or all of the following (i) if the Board determines that Stock Rights granted under the Plan generally shall constitute Performance-Based Compensation, the Plan shall be administered, to the extent required for such Stock Rights to constitute Performance-Based Compensation, by a -3- Committee consisting solely of two or more "outside directors" (as defined in applicable regulations promulgated under Section 162(m) of the Code), (ii) if any Non-Qualified Options with an exercise price less than the fair market value per share of Common Stock are granted under the Plan and the Board determines that such Options should constitute Performance-Based Compensation, such options shall be made exercisable only upon the attainment of a pre-established, objective performance goal established by the Committee, and such grant shall be submitted for, and shall be contingent upon shareholder approval and (iii) Stock Rights granted under the Plan may be subject to such other terms and conditions as are necessary for compensation recognized in connection with the exercise or disposition of such Stock Right or the disposition of Common Stock acquired pursuant to such Stock Right, to constitute Performance-Based Compensation. 3. Eligible Employees and Others. ISOs may be granted only to employees of the Company or any Related Corporation. Non-Qualified Options, Awards and authorizations to make Purchases may be granted to any employee, officer or director (whether or not also an employee) or consultant of the Company or any Related Corporation. The Committee may take into consideration a recipient's individual circumstances in determining whether to grant a Stock Right. The granting of any Stock Right to any individual or entity shall neither entitle that individual or entity to, nor disqualify such individual or entity from, participation in any other grant of Stock Rights. 4. Stock. The stock subject to Stock Rights shall be authorized but unissued shares of Common Stock of the Company, $.0001 par value per share (the "Common Stock"), or shares of Common Stock reacquired by the Company in any manner. The aggregate number of shares which may be issued pursuant to the Plan is 1,000,000, subject to adjustment as provided in paragraph 13. If any Option granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part or shall be repurchased by the Company, the unpurchased shares of Common Stock subject to such Option shall again be available for grants of Stock Rights under the Plan. In addition, if any shares of Common Stock issued upon the exercise of any Option shall be repurchased by the Company at cost pursuant to the terms of the option agreement evidencing such Option, such repurchased shares shall also again be available for grants of Stock Rights under the Plan. No employee of the Company or any Related Corporation may be granted Options to acquire, in the aggregate, more than 500,000 shares of Common Stock under the Plan during any fiscal year of the Company. If any Option granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part or shall be repurchased by the Company, the shares subject to such Option shall be included in the determination of the aggregate number of shares of Common Stock deemed to have been granted to such employee under the Plan. In addition, if any shares of Common Stock issued upon the exercise of any Option shall be repurchased by the Company at cost pursuant to the terms of the option agreement evidencing such Option, such repurchased shares shall also be included in the determination of the aggregate number of shares of Common Stock deemed to have been granted to such employee under the Plan. -4- 5. Granting of Stock Rights. Stock Rights may be granted under the Plan at any time on or after August 31, 1998 and prior to August 31, 2008. The date of grant of a Stock Right under the Plan will be the date specified by the Committee at the time it grants the Stock Right; provided, however, that such date shall not be prior to the date on which the Committee acts to approve the grant. 6. Minimum Option Price; ISO Limitations. A. Price for Non-Qualified Options, Awards and Purchases. Subject to paragraph 2(D) (relating to compliance with Section 162(m) of the Code), the exercise price per share specified in the agreement relating to each Non-Qualified Option granted, and the purchase price per share of stock granted in any Award or authorized as a Purchase, under the Plan may be less than the fair market value of the Common Stock of the Company on the date of grant; provided that, in no event shall such exercise price or such purchase price be less than the minimum legal consideration required therefor under the laws of any jurisdiction in which the Company or its successors in interest may be organized. B. Price for ISOs. The exercise price per share specified in the agreement relating to each ISO granted under the Plan shall not be less than the fair market value per share of Common Stock on the date of such grant. In the case of an ISO to be granted to an employee owning stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Related Corporation, the price per share specified in the agreement relating to such ISO shall not be less than one hundred ten percent (110%) of the fair market value per share of Common Stock on the date of grant. For purposes of determining stock ownership under this paragraph, the rules of Section 424(d) of the Code shall apply. C. $100,000 Annual Limitation on ISO Vesting. Each eligible employee may be granted Options treated as ISOs only to the extent that, in the aggregate under this Plan and all incentive stock option plans of the Company and any Related Corporation, ISOs do not become exercisable for the first time by such employee during any calendar year with respect to stock having a fair market value (determined at the time the ISOs were granted) in excess of $100,000. The Company intends to designate any Options granted in excess of such limitation as Non-Qualified Options, and the Company shall issue separate certificates to the optionee with respect to Options that are Non-Qualified Options and Options that are ISOs. D. Determination of Fair Market Value. If, at the time an Option is granted under the Plan, the Company's Common Stock is publicly traded, "fair market value" shall be determined as of the date of grant or, if the prices or quotes discussed in this sentence are unavailable for such date, the last business day for which such prices or quotes are available prior to the date of grant and shall mean -5- (i) the average (on that date) of the high and low prices of the Common Stock on the principal national securities exchange on which the Common Stock is traded, if the Common Stock is then traded on a national securities exchange; or (ii) the last reported sale price (on that date) of the Common Stock on the Nasdaq National Market, if the Common Stock is not then traded on a national securities exchange; or (iii) the closing bid price (or average of bid prices) last quoted (on that date) by an established quotation service for over-the-counter securities, if the Common Stock is not reported on the Nasdaq National Market. If the Common Stock is not publicly traded at the time an Option is granted under the Plan, "fair market value" shall mean the fair value of the Common Stock as determined by the Committee after taking into consideration all factors which it deems appropriate, including, without limitation, recent sale and offer prices of the Common Stock in private transactions negotiated at arm's length. 7. Option Duration. Subject to earlier termination as provided in paragraphs 9 and 10 or in the agreement relating to such Option, each Option shall expire on the date specified by the Committee, but not more than (i) ten years from the date of grant in the case of Options generally and (ii) five years from the date of grant in the case of ISOs granted to an employee owning stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Related Corporation, as determined under paragraph 6(B). Subject to earlier termination as provided in paragraphs 9 and 10, the term of each ISO shall be the term set forth in the original instrument granting such ISO, except with respect to any part of such ISO that is converted into a Non-Qualified Option pursuant to paragraph 16. 8. Exercise of Option. Subject to the provisions of paragraphs 9 through 12, each Option granted under the Plan shall be exercisable as follows: A. Vesting. The Option shall either be fully exercisable on the date of grant or shall become exercisable thereafter in such installments as the Committee may specify. B. Full Vesting of Installments. Once an installment becomes exercisable, it shall remain exercisable until expiration or termination of the Option, unless otherwise specified by the Committee. C. Partial Exercise. Each Option or installment may be exercised at any time or from time to time, in whole or in part, for up to the total number of shares with respect to which it is then exercisable. D. Acceleration of Vesting. The Committee shall have the right to accelerate the date that any installment of any Option becomes exercisable; provided that the Committee shall not, without the consent of an optionee, accelerate the permitted exercise date of any installment of any Option granted to any employee as an ISO (and not previously converted into a Non-Qualified Option pursuant to paragraph 16) if such acceleration would violate the annual -6- vesting limitation contained in Section 422(d) of the Code, as described in paragraph 6(C). 9. Termination of Employment. Unless otherwise specified in the agreement relating to such ISO, if an ISO optionee ceases to be employed by the Company and all Related Corporations other than by reason of death or disability as defined in paragraph 10, no further installments of his or her ISOs shall become exercisable, and his or her ISOs shall terminate on the earlier of (a) three months after the date of termination of his or her employment, or (b) their specified expiration dates, except to the extent that such ISOs (or unexercised installments thereof) have been converted into Non-Qualified Options pursuant to paragraph 16. For purposes of this paragraph 9, employment shall be considered as continuing uninterrupted during any bona fide leave of absence (such as those attributable to illness, military obligations or governmental service) provided that the period of such leave does not exceed 90 days or, if longer, any period during which such optionee's right to reemployment is guaranteed by statute or by contract. A bona fide leave of absence with the written approval of the Committee shall not be considered an interruption of employment under this paragraph 9, provided that such written approval contractually obligates the Company or any Related Corporation to continue the employment of the optionee after the approved period of absence. ISOs granted under the Plan shall not be affected by any change of employment within or among the Company and Related Corporations, so long as the optionee continues to be an employee of the Company or any Related Corporation. Nothing in the Plan shall be deemed to give any grantee of any Stock Right the right to be retained in employment or other service by the Company or any Related Corporation for any period of time. 10. Death; Disability. A. Death. If an ISO optionee ceases to be employed by the Company and all Related Corporations by reason of his or her death, any ISO owned by such optionee may be exercised, to the extent otherwise exercisable on the date of death, by the estate, personal representative or beneficiary who has acquired the ISO by will or by the laws of descent and distribution, until the earlier of (i) the specified expiration date of the ISO or (ii) 180 days from the date of the optionee's death. B. Disability. If an ISO optionee ceases to be employed by the Company and all Related Corporations by reason of his or her disability, such optionee shall have the right to exercise any ISO held by him or her on the date of termination of employment, for the number of shares for which he or she could have exercised it on that date, until the earlier of (i) the specified expiration date of the ISO or (ii) 180 days from the date of the termination of the optionee's employment. For the purposes of the Plan, the term "disability" shall mean "permanent and total disability" as defined in Section 22(e)(3) of the Code or any successor statute. 11. Assignability. No ISO shall be assignable or transferable by the optionee except by will or by the laws of descent and distribution, and during the lifetime of the optionee shall be -7- exercisable only by such optionee. Stock Rights other than ISOs shall be transferable to the extent set forth in the agreement relating to such Stock Right. 12. Terms and Conditions of Options. Options shall be evidenced by instruments (which need not be identical) in such forms as the Committee may from time to time approve. Such instruments shall conform to the terms and conditions set forth in paragraphs 6 through 11 hereof and may contain such other provisions as the Committee deems advisable which are not inconsistent with the Plan, including restrictions applicable to shares of Common Stock issuable upon exercise of Options. The Committee may specify that any Non-Qualified Option shall be subject to the restrictions set forth herein with respect to ISOs, or to such other termination and cancellation provisions as the Committee may determine. The Committee may from time to time confer authority and responsibility on one or more of its own members and/or one or more officers of the Company to execute and deliver such instruments. The proper officers of the Company are authorized and directed to take any and all action necessary or advisable from time to time to carry out the terms of such instruments. 13. Adjustments. Upon the occurrence of any of the following events, an optionee's rights with respect to Options granted to such optionee hereunder shall be adjusted as hereinafter provided, unless otherwise specifically provided in the written agreement between the optionee and the Company relating to such Option: A. Stock Dividends and Stock Splits. If the shares of Common Stock shall be subdivided or combined into a greater or smaller number of shares or if the Company shall issue any shares of Common Stock as a stock dividend on its outstanding Common Stock, the number of shares of Common Stock deliverable upon the exercise of Options shall be appropriately increased or decreased proportionately, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, combination or stock dividend. B. Consolidations or Mergers. If (i) the Company is a party to a consolidation or merger (other than a merger in which the Company is the continuing corporation), (ii) the Company sells all or substantially all of its assets, or (iii) a person or group (as defined in Rule 13d-5(b)(1) of the Securities Exchange Act of 1934, as amended) acquires in a transaction or a series of related transactions of at least sixty-six and two-thirds percent (66 2/3%) of the outstanding voting stock of the Company (an "Organic Change"), the Committee or the board of directors of any entity assuming the obligations of the Company hereunder (the "Successor Board"), shall, as to outstanding Options, make appropriate provision for the continuation of such Options by substituting on an equitable basis for the shares then subject to such Options either (a) the consideration payable with respect to the outstanding shares of Common Stock in connection with the Organic Change, (b) shares of stock of a surviving or successor corporation or (c) such other securities as the Successor Board deems appropriate, the fair market value of which, at the time of the Organic Change, -8- shall equal the fair market value of the shares of Common Stock subject to such Options immediately preceding the Organic Change. C. Recapitalization or Reorganization. In the event of a recapitalization or reorganization of the Company (other than a transaction described in subparagraph B above) pursuant to which securities of the Company or of another corporation are issued with respect to the outstanding shares of Common Stock, an optionee upon exercising an Option shall be entitled to receive for the purchase price paid upon such exercise the securities he or she would have received if he or she had exercised such Option prior to such recapitalization or reorganization. D. Modification of ISOs. Notwithstanding the foregoing, any adjustments made pursuant to subparagraphs A, B or C with respect to ISOs shall be made only after the Committee, after consulting with counsel for the Company, determines whether such adjustments would constitute a "modification" of such ISOs (as that term is defined in Section 424 of the Code) or would cause any adverse tax consequences for the holders of such ISOs. If the Committee determines that such adjustments made with respect to ISOs would constitute a modification of such ISOs or would cause adverse tax consequences to the holders, it may refrain from making such adjustments. E. Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, then the Committee shall, as to outstanding Options, at its discretion provide, upon written notice to the optionees, (i) that all Options must be exercised, to the extent then exercisable, within a specified number of days of the date of such notice, at the end of which period the Options shall terminate or (ii) that such Options (including those which have not yet vested) shall be exercisable within a specified number of days of such notice, at the end of which period the Options shall terminate. F. Issuances of Securities. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares subject to Options. No adjustments shall be made for dividends paid in cash or in property other than securities of the Company. G. Fractional Shares. No fractional shares shall be issued under the Plan and the optionee shall receive from the Company cash in lieu of such fractional shares. H. Adjustments. Upon the happening of any of the events described in subparagraphs A, B, C above, the class and aggregate number of shares set forth in paragraph 4 hereof that are subject to Stock Rights which previously have been or subsequently may be granted under the Plan shall also be appropriately -9- adjusted to reflect the events described in such subparagraphs. The Committee or the Successor Board shall determine the specific adjustments to be made under this paragraph 13 and, subject to paragraph 2, its determination shall be conclusive. 14. Means of Exercising Options; Restriction on Issuance of Shares. A. An Option (or any part or installment thereof) shall be exercised by giving written notice to the Company at its principal office address, or to such transfer agent as the Company shall designate. Such notice shall identify the Option being exercised and specify the number of shares as to which such Option is being exercised, accompanied by full payment of the purchase price therefor either (a) in United States dollars in cash or by check, (b) at the discretion of the Committee, through delivery of shares of Common Stock having a fair market value equal as of the date of the exercise to the cash exercise price of the Option (provided such shares of Common Stock have been held by the optionee free of any substantial risk of forfeiture for at least six (6) months), (c) at the discretion of the Committee, by delivery of the grantee's personal recourse note bearing interest payable not less than annually at no less than 100% of the lowest applicable Federal rate, as defined in Section 1274(d) of the Code, (d) at the discretion of the Committee and consistent with applicable law, through the delivery of an assignment to the Company of a sufficient amount of the proceeds from the sale of the Common Stock acquired upon exercise of the Option and an authorization to the broker or selling agent to pay that amount to the Company, which sale shall be at the participant's direction at the time of exercise, or (e) at the discretion of the Committee, by any combination of (a), (b), (c) and (d) above. If the Committee exercises its discretion to permit payment of the exercise price of an ISO by means of the methods set forth in clauses (b), (c), (d) or (e) of the preceding sentence, such discretion shall be exercised in writing at the time of the grant of the ISO in question. The holder of an Option shall not have the rights of a shareholder with respect to the shares covered by such Option until the date of issuance of a stock certificate to such holder for such shares. Except as expressly provided above in paragraph 13 with respect to changes in capitalization and stock dividends, no adjustment shall be made for dividends or similar rights for which the record date is before the date such stock certificate is issued. 15. Term and Amendment of Plan. This Plan was adopted by the Board on August 31, 1998, subject, with respect to the validation of ISOs granted under the Plan, to approval of the Plan by the stockholders of the Company at the next Meeting of Stockholders or, in lieu thereof, by written consent. If the approval of stockholders is not obtained prior to August 31, 1999, any grants of ISOs under the Plan made prior to that date will be rescinded. The Plan shall expire at the end of the day on August 31, 2008 (except as to Options outstanding on that date). Subject to the provisions of paragraph 5 above, Options may be granted under the Plan prior to the date of stockholder approval of the Plan. The Board may terminate or amend the Plan in any respect at any time, except that, without the approval of the stockholders obtained within 12 months before or after the Board adopts a resolution authorizing any of the following -10- actions: (a) the total number of shares that may be issued under the Plan may not be increased (except by adjustment pursuant to paragraph 13); (b) the provisions of paragraph 3 regarding eligibility for grants of ISOs may not be modified; (c) the provisions of paragraph 6(B) regarding the exercise price at which shares may be offered pursuant to ISOs may not be modified (except by adjustment pursuant to paragraph 13); and (d) the expiration date of the Plan may not be extended. Except as otherwise provided in this paragraph 15, in no event may action of the Board or stockholders alter or impair the rights of a grantee, without such grantee's consent, under any Stock Right previously granted to such grantee. 16. Modifications of ISOs; Conversion of ISOs into Non-Qualified Options. Subject to paragraph 13(D), without the prior written consent of the holder of an ISO, the Committee shall not alter the terms of such ISO (including the means of exercising such ISO) if such alteration would constitute a modification (within the meaning of Section 424(h)(3) of the Code). The Committee, at the written request or with the written consent of any optionee, may in its discretion take such actions as may be necessary to convert such optionee's ISOs (or any installments or portions of installments thereof) that have not been exercised on the date of conversion into Non-Qualified Options at any time prior to the expiration of such ISOs, regardless of whether the optionee is an employee of the Company or a Related Corporation at the time of such conversion. Such actions may include, but shall not be limited to, extending the exercise period or reducing the exercise price of the appropriate installments of such ISOs. At the time of such conversion, the Committee (with the consent of the optionee) may impose such conditions on the exercise of the resulting Non-Qualified Options as the Committee in its discretion may determine, provided that such conditions shall not be inconsistent with this Plan. Nothing in the Plan shall be deemed to give any optionee the right to have such optionee's ISOs converted into Non-Qualified Options, and no such conversion shall occur until and unless the Committee takes appropriate action. Upon the taking of such action, the Company shall issue separate certificates to the optionee with respect to Options that are Non-Qualified Options and Options that are ISOs. 17. Application Of Funds. The proceeds received by the Company from the sale of shares pursuant to Options granted and Purchases authorized under the Plan shall be used for general corporate purposes. 18. Notice to Company of Disqualifying Disposition. By accepting an ISO granted under the Plan, each optionee agrees to notify the Company in writing immediately after such optionee makes a Disqualifying Disposition (as described in Sections 421, 422 and 424 of the Code and regulations thereunder) of any stock acquired pursuant to the exercise of ISOs granted under the Plan. A Disqualifying Disposition is generally any disposition occurring on or before the later of (a) the date two years following the date the ISO was granted or (b) the date one year following the date the ISO was exercised. 19. Withholding of Additional Income Taxes. Upon the exercise of a Non-Qualified Option, the transfer of a Non-Qualified Stock Option pursuant to an arm's-length transaction, the grant of an Award, the making of a Purchase of Common Stock for less than its fair market value, the making of a Disqualifying Disposition (as defined in paragraph 18), the -11- vesting or transfer of restricted stock or securities acquired on the exercise of an Option hereunder, or the making of a distribution or other payment with respect to such stock or securities, the Company may withhold taxes in respect of amounts that constitute compensation includible in gross income. The Committee in its discretion may condition (i) the exercise of an Option, (ii) the transfer of a Non-Qualified Stock Option, (iii) the grant of an Award, (iv) the making of a Purchase of Common Stock for less than its fair market value, or (v) the vesting or transferability of restricted stock or securities acquired by exercising an Option, on the grantee's making satisfactory arrangement for such withholding. Such arrangement may include payment by the grantee in cash or by check of the amount of the withholding taxes or, at the discretion of the Committee, by the grantee's delivery of previously held shares of Common Stock or the withholding from the shares of Common Stock otherwise deliverable upon exercise of a Option shares having an aggregate fair market value equal to the amount of such withholding taxes. 20. Purchase for Investment; Rights of Holder on Subsequent Registration. Unless the shares to be issued upon exercise of an Option granted under the Plan have been effectively registered under the Securities Act of 1933, as now in force or hereafter amended, the Company shall be under no obligation to issue any shares covered by any option unless the person who exercised such Option, in whole or in part, shall give a written representation and undertaking to the Company which is satisfactory in form and scope to counsel for the Company and upon which, in the opinion of such counsel, the Company may reasonably rely, that he or she is acquiring the shares issued pursuant to such exercise of the Option for his or her own account as an investment and not with a view to, or for sale in connection with, the distribution of any such shares, and that he or she will make no transfer of the same except in compliance with any rules and regulations in force at the time of such transfer under the Securities Act of 1933, or any other applicable law, and that if shares are issued without such registration, a legend to this effect may be endorsed upon the securities so issued. In the event that the Company shall, nevertheless, deem it necessary or desirable to register under the Securities Act of 1933 or other applicable statutes any shares with respect to which an Option shall have been exercised, or to qualify any such shares for exemption from the Securities Act of 1933 or other applicable statutes, then the Company may take such action and may require from each optionee such information in writing for use in any registration statement, supplementary registration statement, prospectus, preliminary prospectus or offering circular as is reasonably necessary for such purpose and may require reasonable indemnity to the Company and its officers and directors and controlling persons from such holder against all losses, claims, damages and liabilities arising from such use of the information so furnished and caused by any untrue statement of any material fact therein or caused by the omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances under which they were made. 21. Governmental Regulation. The Company's obligation to sell and deliver shares of the Common Stock under this Plan is subject to the approval of any governmental authority required in connection with the authorization, issuance or sale of such shares. Government regulations may impose reporting or other obligations on the Company with respect to the Plan. For example, the Company may be required to send tax information statements to employees and former employees that exercise ISOs under the Plan, and the -12- Company may be required to file tax information returns reporting the income received by grantees of Options in connection with the Plan. 22. Governing Law. The validity and construction of the Plan and the instruments evidencing Stock Rights shall be governed by the laws of Delaware, or the laws of any jurisdiction in which the Company or its successors in interest may be organized. -13- AMENDMENT NO. 1 TO THE RED HAT SOFTWARE, INC. 1998 STOCK OPTION PLAN Pursuant to a Written Consent of the Board of Directors of Red Hat Software, Inc. (the "Company") dated as of September 28, 1998 and a Written Consent of the Stockholders of the Company dated as of September 29, 1998, the Company's 1998 Stock Option Plan (the "Plan") is amended by increasing the number of shares reserved for issuance under the Plan by 1,917,400 shares so that an aggregate of 2,917,400 shares may be issued under the Plan. -14- AMENDMENT NO. 2 TO THE RED HAT SOFTWARE, INC. 1998 STOCK OPTION PLAN Pursuant to a Written Consent of the Board of Directors of Red Hat Software, Inc. (the "Company") dated as of February 4, 1999, the Company's 1998 Stock Option Plan, as amended (the "Plan"), is further amended by increasing the maximum number of Options that may be granted to any employee of the Company or any Related Corporation under the Plan during any fiscal year of the Company by 1,000,000 shares to 2,000,000 shares. -15- AMENDMENT NO. 3 TO THE RED HAT SOFTWARE, INC. 1998 STOCK OPTION PLAN Pursuant to a Written Consent of the Board of Directors of Red Hat Software, Inc. (the "Company") dated as of February 24, 1999 and a Written Consent of the Stockholders of the Company dated as of February 24, 1999, the Company's 1998 Stock Option Plan, as amended (the "Plan"), is further amended by increasing the number of shares reserved for issuance under the Plan by 800,000 shares so that an aggregate of 3,717,400 shares may be issued under the Plan. -16- AMENDMENT NO. 4 TO THE RED HAT SOFTWARE, INC. 1998 STOCK OPTION PLAN Pursuant to a Written Consent of the Board of Directors of Red Hat Software, Inc. (the "Company") dated as of June 2, 1999 and a Written Consent of the Stockholders of the Company dated as of June 3, 1999, the Company's 1998 Stock Option Plan, as amended (the "Plan"), is further amended by increasing the number of shares reserved for issuance under the Plan by 1,000,000 shares so that an aggregate of 4,717,400 shares may be issued under the Plan. EX-10.2 7 EXHIBIT 10.2 Exhibit 10.2 RED HAT, INC. 1999 STOCK OPTION AND INCENTIVE PLAN 1. PURPOSE AND ELIGIBILITY The purpose of this 1999 Stock Option and Incentive Plan (the "PLAN") of Red Hat, Inc. (the "COMPANY") is to provide stock options and other equity interests in the Company (each an "AWARD") to employees, officers, directors, consultants and advisors of the Company and its Subsidiaries, all of whom are eligible to receive Awards under the Plan. Any person to whom an Award has been granted under the Plan is called a "PARTICIPANT." Additional definitions are contained in Section 8. 2. ADMINISTRATION a. ADMINISTRATION BY BOARD OF DIRECTORS. The Plan will be administered by the Board of Directors of the Company (the "BOARD"). The Board, in its sole discretion, shall have the authority to grant and amend Awards, to adopt, amend and repeal rules relating to the Plan and to interpret and correct the provisions of the Plan and any Award. All decisions by the Board shall be final and binding on all interested persons. Neither the Company nor any member of the Board shall be liable for any action or determination relating to the Plan. b. APPOINTMENT OF COMMITTEES. To the extent permitted by applicable law, the Board may delegate any or all of its powers under the Plan to one or more committees or subcommittees of the Board (a "COMMITTEE"). All references in the Plan to the "BOARD" shall mean such Committee or the Board. c. DELEGATION TO EXECUTIVE OFFICERS. To the extent permitted by applicable law, the Board may delegate to one or more executive officers of the Company the power to grant Awards and exercise such other powers under the Plan as the Board may determine, PROVIDED THAT the Board shall fix the maximum number of Awards to be granted and the maximum number of shares issuable to any one Participant pursuant to Awards granted by such executive officers. 3. STOCK AVAILABLE FOR AWARDS a. NUMBER OF SHARES. Subject to adjustment under Section 3(c), the aggregate number of shares of Common Stock, $.0001 par value, of the Company (the "COMMON STOCK") that may be issued pursuant to the Plan is 6,500,000 shares. If any Award expires, or is terminated, surrendered or forfeited, in whole or in part, the unissued Common Stock covered by such Award shall again be available for the grant of Awards under the Plan. b. PER-PARTICIPANT LIMIT. Subject to adjustment under Section 3(c), no Participant may be granted Awards during any one fiscal year to purchase more than 3,250,000 shares of Common Stock. -2- C. ADJUSTMENT TO COMMON STOCK. In the event of any stock split, stock dividend, extraordinary cash dividend, recapitalization, reorganization, merger, consolidation, combination, exchange of shares, liquidation, spin-off, split-up, or other similar change in capitalization or event (not including the Company's stock dividend approved by the Board of Directors on June 2, 1999), (i) the number and class of securities available for Awards under the Plan and the per-Participant share limit, (ii) the number and class of securities, vesting schedule and exercise price per share subject to each outstanding Option, (iii) the repurchase price per security subject to repurchase, and (iv) the terms of each other outstanding stock-based Award shall be adjusted by the Company (or substituted Awards may be made) to the extent the Board shall determine, in good faith, that such an adjustment (or substitution) is appropriate. 4. STOCK OPTIONS a. GENERAL. The Board may grant options to purchase Common Stock (each, an "OPTION" and determine the number of shares of Common Stock to be covered by each Option, the exercise price of each Option and the conditions and limitations applicable to the exercise of each Option and the Common Stock issued upon the exercise of each Option, including vesting provisions, repurchase provisions and restrictions relating to applicable federal or state securities laws, as it considers advisable. b. INCENTIVE STOCK OPTIONS. An Option that the Board intends to be an "incentive stock option" as defined in Section 422 of the Code (an "INCENTIVE STOCK OPTION") shall be granted only to employees of the Company and shall be subject to and shall be construed consistently with the requirements of Section 422 of the Code. The Board and the Company shall have no liability if an Option or any part thereof that is intended to be an Incentive Stock Option does not qualify as such. An Option or any part thereof that does not qualify as an Incentive Stock Option is referred to herein as a "NONSTATUTORY STOCK OPTION". c. EXERCISE PRICE. The Board shall establish the exercise price (or determine the method by which the exercise price shall be determined) at the time each Option is granted and specify it in the applicable option agreement. d. DURATION OF OPTIONS. Each Option shall be exercisable at such times and subject to such terms and conditions as the Board may specify in the applicable option agreement. e. EXERCISE OF OPTION. Options may be exercised only by delivery to the Company of a written notice of exercise signed by the proper person together with payment in full as specified in Section 4(f) for the number of shares for which the Option is exercised. f. PAYMENT UPON EXERCISE. Common Stock purchased upon the exercise of an Option shall be paid for by one or any combination of the following forms of payment: (i) by check payable to the order of the Company; (ii) except as otherwise explicitly provided in the applicable option agreement, and only if the Common Stock is then publicly traded, delivery of an irrevocable and -3- unconditional undertaking by a creditworthy broker to deliver promptly to the Company sufficient funds to pay the exercise price, or delivery by the Participant to the Company of a copy of irrevocable and unconditional instructions to a creditworthy broker to deliver promptly to the Company cash or a check sufficient to pay the exercise price; or (iii) to the extent explicitly provided in the applicable option agreement, by (x) delivery of shares of Common Stock owned by the Participant valued at fair market value (as determined by the Board or as determined pursuant to the applicable option agreement), (y) delivery of a promissory note of the Participant to the Company (and delivery to the Company by the Participant of a check in an amount equal to the par value of the shares purchased), or (z) payment of such other lawful consideration as the Board may determine. 5. RESTRICTED STOCK A. GRANTS. The Board may grant Awards entitling recipients to acquire shares of Common Stock, subject to (i) delivery to the Company by the Participant of a check in an amount at least equal to the par value of the shares purchased, and (ii) the right of the Company to repurchase all or part of such shares at their issue price or other stated or formula price from the Participant in the event that conditions specified by the Board in the applicable Award are not satisfied prior to the end of the applicable restriction period or periods established by the Board for such Award (each, a "RESTRICTED STOCK AWARD"). B. TERMS AND CONDITIONS. The Board shall determine the terms and conditions of any such Restricted Stock Award. Any stock certificates issued in respect of a Restricted Stock Award shall be registered in the name of the Participant and, unless otherwise determined by the Board, deposited by the Participant, together with a stock power endorsed in blank, with the Company (or its designee). After the expiration of the applicable restriction periods, the Company (or such designee) shall deliver the certificates no longer subject to such restrictions to the Participant or, if the Participant has died, to the beneficiary designated by a Participant, in a manner determined by the Board, to receive amounts due or exercise rights of the Participant in the event of the Participant's death (the "DESIGNATED BENEFICIARY"). In the absence of an effective designation by a Participant, Designated Beneficiary shall mean the Participant's estate. 6. OTHER STOCK-BASED AWARDS The Board shall have the right to grant other Awards based upon the Common Stock having such terms and conditions as the Board may determine, including, without limitation, the grant of shares based upon certain conditions, the grant of securities convertible into Common Stock and the grant of stock appreciation rights, phantom stock awards or stock units. 7. GENERAL PROVISIONS APPLICABLE TO AWARDS a. TRANSFERABILITY OF AWARDS. Except as the Board may otherwise determine or provide in an Award, Awards shall not be sold, assigned, transferred, pledged or otherwise encumbered by the person to whom they are granted, either voluntarily or by operation of law, except by will or the laws of descent and distribution, and, during the life of the Participant, shall -4- be exercisable only by the Participant. References to a Participant, to the extent relevant in the context, shall include references to authorized transferees. b. DOCUMENTATION. Each Award under the Plan shall be evidenced by a written instrument in such form as the Board shall determine or as executed by an officer of the Company pursuant to authority delegated by the Board. Each Award may contain terms and conditions in addition to those set forth in the Plan PROVIDED THAT such terms and conditions do not contravene the provisions of the Plan. c. BOARD DISCRETION. The terms of each type of Award need not be identical, and the Board need not treat Participants uniformly. d. TERMINATION OF STATUS. The Board shall determine the effect on an Award of the disability, death, retirement, authorized leave of absence or other change in the employment or other status of a Participant and the extent to which, and the period during which, the Participant, or the Participant's legal representative, conservator, guardian or Designated Beneficiary, may exercise rights under the Award. e. ACQUISITION OF THE COMPANY (i) CONSEQUENCES OF AN ACQUISITION. Unless otherwise expressly provided in the applicable Option or Award, upon the occurrence of an Acquisition, the Board or the board of directors of the surviving or acquiring entity (as used in this Section 7(e)(i), also the "BOARD", shall, as to outstanding Awards (on the same basis or on different bases, as the Board shall specify), make appropriate provision for the continuation of such Awards by the Company or the assumption of such Awards by the surviving or acquiring entity and by substituting on an equitable basis for the shares then subject to such Awards either (a) the consideration payable with respect to the outstanding shares of Common Stock in connection with the Acquisition, (b) shares of stock of the surviving or acquiring corporation or (c) such other securities as the Board deems appropriate, the fair market value of which (as determined by the Board in its sole discretion) shall not materially differ from the fair market value of the shares of Common Stock subject to such Awards immediately preceding the Acquisition. In addition to or in lieu of the foregoing, with respect to outstanding Options, the Board may, upon written notice to the affected optionees, provide that one or more Options must be exercised, to the extent then exercisable or to be exercisable as a result of the Acquisition, within a specified number of days of the date of such notice, at the end of which period such Options shall terminate; or terminate one or more Options in exchange for a cash payment equal to the excess of the fair market value (as determined by the Board in its sole discretion) of the shares subject to such Options (to the extent then exercisable or to be exercisable as a result of the Acquisition) over the exercise price thereof. (ii) ACQUISITION DEFINED. An "Acquisition" shall mean: (x) any merger or consolidation after which the voting securities of the Company outstanding immediately prior thereto represent (either by remaining outstanding or by being converted into voting securities of the surviving or acquiring entity) less than 50% of the combined voting power of the voting securities of the Company or such surviving or acquiring entity outstanding immediately after -5- such event; or (y) any sale of all or substantially all of the assets or capital stock of the Company (other than in a spin-off or similar transaction) or (z) any other acquisition of the business of the Company, as determined by the Board. (iii) ASSUMPTION OF OPTIONS UPON CERTAIN EVENTS. In connection with a merger or consolidation of an entity with the Company or the acquisition by the Company of property or stock of an entity, the Board may grant Awards under the Plan in substitution for stock and stock-based awards issued by such entity or an affiliate thereof. The substitute Awards shall be granted on such terms and conditions as the Board considers appropriate in the circumstances. (iv) POOLING-OF INTERESTS-ACCOUNTING. If the Company proposes to engage in an Acquisition intended to be accounted for as a pooling-of-interests, and in the event that the provisions of this Plan or of any Award hereunder, or any actions of the Board taken in connection with such Acquisition, are determined by the Company's or the acquiring company's independent public accountants to cause such Acquisition to fail to be accounted for as a pooling-of-interests, then such provisions or actions shall be amended or rescinded by the Board, without the consent of any Participant, to be consistent with pooling-of-interests accounting treatment for such Acquisition. (v) PARACHUTE AWARDS. If, in connection with an Acquisition, a tax under Section 4999 of the Code would be imposed on the Participant (after taking into account the exceptions set forth in Sections 280G(b)(4) and 280G(b)(5) of the Code), then the number of Awards which shall become exercisable, realizable or vested as provided in such section shall be reduced (or delayed), to the minimum extent necessary, so that no such tax would be imposed on the Participant (the Awards not becoming so accelerated, realizable or vested, the "PARACHUTE AWARDS"; PROVIDED, HOWEVER, that if the "AGGREGATE PRESENT VALUE" of the Parachute Awards would exceed the tax that, but for this sentence, would be imposed on the Participant under Section 4999 of the Code in connection with the Acquisition, then the Awards shall become immediately exercisable, realizable and vested without regard to the provisions of this sentence. For purposes of the preceding sentence, the "AGGREGATE PRESENT VALUE" of an Award shall be calculated on an after-tax basis (other than taxes imposed by Section 4999 of the Code) and shall be based on economic principles rather than the principles set forth under Section 280G of the Code and the regulations promulgated thereunder. All determinations required to be made under this Section 7(e)(v) shall be made by the Company. f. WITHHOLDING. Each Participant shall pay to the Company, or make provisions satisfactory to the Company for payment of, any taxes required by law to be withheld in connection with Awards to such Participant no later than the date of the event creating the tax liability. The Board may allow Participants to satisfy such tax obligations in whole or in part by transferring shares of Common Stock, including shares retained from the Award creating the tax obligation, valued at their fair market value (as determined by the Board or as determined pursuant to the applicable option agreement). The Company may, to the extent permitted by law, deduct any such tax obligations from any payment of any kind otherwise due to a Participant. -6- g. AMENDMENT OF AWARDS. The Board may amend, modify or terminate any outstanding Award including, but not limited to, substituting therefor another Award of the same or a different type, changing the date of exercise or realization, and converting an Incentive Stock Option to a Nonstatutory Stock Option, PROVIDED THAT, except as otherwise provided in Section 7(e)(iv), the Participant's consent to such action shall be required unless the Board determines that the action, taking into account any related action, would not materially and adversely affect the Participant. h. CONDITIONS ON DELIVERY OF STOCK. The Company will not be obligated to deliver any shares of Common Stock pursuant to the Plan or to remove restrictions from shares previously delivered under the Plan until (i) all conditions of the Award have been met or removed to the satisfaction of the Company, (ii) in the opinion of the Company's counsel, all other legal matters in connection with the issuance and delivery of such shares have been satisfied, including any applicable securities laws and any applicable stock exchange or stock market rules and regulations, and (iii) the Participant has executed and delivered to the Company such representations or agreements as the Company may consider appropriate to satisfy the requirements of any applicable laws, rules or regulations. i. ACCELERATION. The Board may at any time provide that any Options shall become immediately exercisable in full or in part, that any Restricted Stock Awards shall be free of some or all restrictions, or that any other stock-based Awards may become exercisable in full or in part or free of some or all restrictions or conditions, or otherwise realizable in full or in part, as the case may be, despite the fact that the foregoing actions may (i) cause the application of Sections 280G and 4999 of the Code if a change in control of the Company occurs, or (ii) disqualify all or part of the Option as an Incentive Stock Option. 8. MISCELLANEOUS a. DEFINITIONS. (i) "COMPANY" for purposes of eligibility under the Plan, shall include any present or future subsidiary corporations of Red Hat, Inc., as defined in Section 424(f) of the Code (a "SUBSIDIARY"), and any present or future parent corporation of Red Hat, Inc., as defined in Section 424(e) of the Code. For purposes of Awards other than Incentive Stock Options, the term "COMPANY" shall include any other business venture in which the Company has a direct or indirect significant interest, as determined by the Board in its sole discretion. (ii) "CODE" means the Internal Revenue Code of 1986, as amended, and any regulations promulgated thereunder. (iii) "EMPLOYEE" for purposes of eligibility under the Plan shall include a person to whom an offer of employment has been extended by the Company. b. NO RIGHT TO EMPLOYMENT OR OTHER STATUS. No person shall have any claim or right to be granted an Award, and the grant of an Award shall not be construed as giving a Participant the right to continued employment or any other relationship with the Company. -7- The Company expressly reserves the right at any time to dismiss or otherwise terminate its relationship with a Participant free from any liability or claim under the Plan. c. NO RIGHTS AS STOCKHOLDER. Subject to the provisions of the applicable Award, no Participant or Designated Beneficiary shall have any rights as a stockholder with respect to any shares of Common Stock to be distributed with respect to an Award until becoming the record holder thereof. d. EFFECTIVE DATE AND TERM OF PLAN. The Plan shall become effective upon adoption by the Board. No Awards shall be granted under the Plan after the completion of ten years from the date on which the Plan was adopted by the Board, but Awards previously granted may extend beyond that date. e. AMENDMENT OF PLAN. The Board may amend, suspend or terminate the Plan or any portion thereof at any time. f. GOVERNING LAW. The provisions of the Plan and all Awards made hereunder shall be governed by and interpreted in accordance with the laws of Delaware, without regard to any applicable conflicts of law. Adopted by the Board of Directors on June 2, 1999. Approved by the stockholders on June 3, 1999. EX-10.3 8 EXHIBIT 10.3 Exhibit 10.3 RED HAT, INC. 1999 EMPLOYEE STOCK PURCHASE PLAN ARTICLE 1 - PURPOSE. This 1999 Employee Stock Purchase Plan (the "Plan") is intended to encourage stock ownership by all eligible employees of Red Hat, Inc. a Delaware corporation, (the "Company"), and its participating subsidiaries (as defined in Article 17) so that they may share in the growth of the Company by acquiring or increasing their proprietary interest in the Company. The Plan is designed to encourage eligible employees to remain in the employ of the Company and its participating subsidiaries. The Plan is intended to constitute an "employee stock purchase plan" within the meaning of Section 423(b) of the Internal Revenue Code of 1986, as amended (the "Code"). ARTICLE 2 - ADMINISTRATION OF THE PLAN. The Plan may be administered by a committee appointed by the Board of Directors of the Company (the "Committee"). The Committee shall consist of not less than two members of the Company's Board of Directors. The Board of Directors may from time to time remove members from, or add members to, the Committee. Vacancies on the Committee, howsoever caused, shall be filled by the Board of Directors. The Committee may select one of its members as Chairman, and shall hold meetings at such times and places as it may determine. Acts by a majority of the Committee, or acts reduced to or approved in writing by a majority of the members of the Committee, shall be the valid acts of the Committee. The interpretation and construction by the Committee of any provisions of the Plan or of any option granted under it shall be final, unless otherwise determined by the Board of Directors. The Committee may from time to time adopt such rules and regulations for carrying out the Plan as it may deem best, provided that any such rules and regulations shall be applied on a uniform basis to all employees under the Plan. No member of the Board of Directors or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any option granted under it. In the event the Board of Directors fails to appoint or refrains from appointing a Committee, the Board of Directors shall have all power and authority to administer the Plan. In such event, the word "Committee" wherever used herein shall be deemed to mean the Board of Directors. ARTICLE 3 - ELIGIBLE EMPLOYEES. All employees of the Company or any of its participating subsidiaries whose customary employment is more than 20 hours per week and for more than five months in any calendar year and who have completed 90 days employment with the Company shall be eligible to receive options under the Plan to purchase common stock of the Company, and all eligible employees shall have the same rights and privileges hereunder. Persons who are eligible employees on the first business day of any Payment Period (as defined in Article 5) shall receive their options as of such day. Persons who become eligible employees after any date on which options are granted under the Plan shall be granted options on the first day of the next succeeding Payment Period on which options are granted to eligible employees under the -2- Plan. In no event, however, may an employee be granted an option if such employee, immediately after the option was granted, would be treated as owning stock possessing five percent or more of the total combined voting power or value of all classes of stock of the Company or of any parent corporation or subsidiary corporation, as the terms "parent corporation" and "subsidiary corporation" are defined in Section 424(e) and (f) of the Code. For purposes of determining stock ownership under this paragraph, the rules of Section 424(d) of the Code shall apply, and stock which the employee may purchase under outstanding options shall be treated as stock owned by the employee. ARTICLE 4 - STOCK SUBJECT TO THE PLAN. The stock subject to the options under the Plan shall be shares of the Company's authorized but unissued common stock, par value $.0001 per share (the "Common Stock"), or shares of Common Stock reacquired by the Company, including shares purchased in the open market. The aggregate number of shares which may be issued pursuant to the Plan is 750,000, subject to adjustment as provided in Article 12. If any option granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part, the unpurchased shares subject thereto shall again be available under the Plan. ARTICLE 5 - PAYMENT PERIOD AND STOCK OPTIONS. The first Payment Period during which payroll deductions will be accumulated under the Plan shall commence on a date determined by the Board of Directors and shall end on March 31, 2000. For the remainder of the duration of the Plan, Payment Periods shall consist of the six-month periods commencing on April 1 and October 1 and ending on March 31st and on September 30th of each calendar year. Twice each year, on the first business day of each Payment Period, the Company will grant to each eligible employee who is then a participant in the Plan an option to purchase on the last day of such Payment Period, at the Option Price hereinafter provided for, a maximum of 1,000 shares, on condition that such employee remains eligible to participate in the Plan throughout the remainder of such Payment Period. The participant shall be entitled to exercise the option so granted only to the extent of the participant's accumulated payroll deductions on the last day of such Payment Period. If the participant's accumulated payroll deductions on the last day of the Payment Period would enable the participant to purchase more than 1,000 shares except for the 1,000-share limitation, the excess of the amount of the accumulated payroll deductions over the aggregate purchase price of the 1,000 shares shall be promptly refunded to the participant by the Company, without interest. The Option Price per share for each Payment Period shall be the lesser of (i) 85% of the average market price of the Common Stock on the first business day of the Payment Period and (ii) 85% of the average market price of the Common Stock on the last business day of the Payment Period, in either event rounded up to the nearest cent. The foregoing limitation on the number of shares subject to option and the Option Price shall be subject to adjustment as provided in Article 12. For purposes of the Plan, the term "average market price" on any date means (i) the average (on that date) of the high and low prices of the Common Stock on the principal national securities exchange on which the Common Stock is traded, if the Common Stock is then traded on a national securities exchange; or (ii) the last reported sale price (on that date) of the Common Stock on the Nasdaq National Market, if the Common Stock is not then traded on a national securities exchange; or (iii) the average of the closing bid and asked prices last quoted (on that date) by an established quotation service for over- -3- the-counter securities, if the Common Stock is not reported on the Nasdaq National Market; or (iv) if the Common Stock is not publicly traded, the fair market value of the Common Stock as determined by the Committee after taking into consideration all factors which it deems appropriate, including, without limitation, recent sale and offer prices of the Common Stock in private transactions negotiated at arm's length. For purposes of the Plan, the term "business day" means a day on which there is trading on the Nasdaq National Market or the aforementioned national securities exchange, whichever is applicable pursuant to the preceding paragraph; and if neither is applicable, a day that is not a Saturday, Sunday or legal holiday in the State of North Carolina. No employee shall be granted an option which permits the employee's right to purchase stock under the Plan, and under all other Section 423(b) employee stock purchase plans of the Company and any parent or subsidiary corporations, to accrue at a rate which exceeds $25,000 of fair market value of such stock (determined on the date or dates that options on such stock were granted) for each calendar year in which such option is outstanding at any time. The purpose of the limitation in the preceding sentence is to comply with Section 423(b)(8) of the Code. If the participant's accumulated payroll deductions on the last day of the Payment Period would otherwise enable the participant to purchase Common Stock in excess of the Section 423(b)(8) limitation described in this paragraph, the excess of the amount of the accumulated payroll deductions over the aggregate purchase price of the shares actually purchased shall be promptly refunded to the participant by the Company, without interest. ARTICLE 6 - EXERCISE OF OPTION. Each eligible employee who continues to be a participant in the Plan on the last day of a Payment Period shall be deemed to have exercised his or her option on such date and shall be deemed to have purchased from the Company such number of full shares of Common Stock reserved for the purpose of the Plan as the participant's accumulated payroll deductions on such date will pay for at the Option Price, subject to the 1,000-share limit of the option and the Section 423(b)(8) limitation described in Article 5. If the individual is not a participant on the last day of a Payment Period, the he or she shall not be entitled to exercise his or her option. Only full shares of Common Stock may be purchased under the Plan. Unused payroll deductions remaining in a participant's account at the end of a Payment Period by reason of the inability to purchase a fractional share shall be carried forward to the next Payment Period. ARTICLE 7 - AUTHORIZATION FOR ENTERING THE PLAN. An employee may elect to enter the Plan by filling out, signing and delivering to the Company an authorization: A. Stating the percentage to be deducted regularly from the employee's pay; B. Authorizing the purchase of stock for the employee in each Payment Period in accordance with the terms of the Plan; and C. Specifying the exact name or names in which stock purchased for the employee is to be issued as provided under Article 11 hereof. -4- Such authorization must be received by the Company at least ten days before the first day of the next succeeding Payment Period and shall take effect only if the employee is an eligible employee on the first business day of such Payment Period. Unless a participant files a new authorization or withdraws from the Plan, the deductions and purchases under the authorization the participant has on file under the Plan will continue from one Payment Period to succeeding Payment Periods as long as the Plan remains in effect. The Company will accumulate and hold for each participant's account the amounts deducted from his or her pay. No interest will be paid on these amounts. ARTICLE 8 - MAXIMUM AMOUNT OF PAYROLL DEDUCTIONS. An employee may authorize payroll deductions in an amount (expressed as a whole percentage) not less than one percent (1%) but not more than ten percent (10%) of the employee's total compensation, including base pay or salary and any overtime, bonuses or commissions. ARTICLE 9 - CHANGE IN PAYROLL DEDUCTIONS. Deductions may not be increased or decreased during a Payment Period. However, a participant may withdraw in full from the Plan. ARTICLE 10 - WITHDRAWAL FROM THE PLAN. A participant may withdraw from the Plan (in whole but not in part) at any time prior to the last day of a Payment Period by delivering a withdrawal notice to the Company. To re-enter the Plan, an employee who has previously withdrawn must file a new authorization at least ten days before the first day of the next Payment Period in which he or she wishes to participate. The employee's re-entry into the Plan becomes effective at the beginning of such Payment Period, provided that he or she is an eligible employee on the first business day of the Payment Period. ARTICLE 11 - ISSUANCE OF STOCK. Certificates for stock issued to participants shall be delivered as soon as practicable after each Payment Period by the Company's transfer agent. Stock purchased under the Plan shall be issued only in the name of the participant, or if the participant's authorization so specifies, in the name of the participant and another person of legal age as joint tenants with rights of survivorship. ARTICLE 12 - ADJUSTMENTS. Upon the happening of any of the following described events, a participant's rights under options granted under the Plan shall be adjusted as hereinafter provided: A. In the event that the shares of Common Stock shall be subdivided or combined into a greater or smaller number of shares or if, upon a reorganization, split-up, liquidation, recapitalization or the like of the Company, the shares of Common Stock shall be exchanged for -5- other securities of the Company, each participant shall be entitled, subject to the conditions herein stated, to purchase such number of shares of Common Stock or amount of other securities of the Company as were exchangeable for the number of shares of Common Stock that such participant would have been entitled to purchase except for such action, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, combination or exchange; and B. In the event the Company shall issue any of its shares as a stock dividend upon or with respect to the shares of stock of the class which shall at the time be subject to option hereunder, each participant upon exercising such an option shall be entitled to receive (for the purchase price paid upon such exercise) the shares as to which the participant is exercising his or her option and, in addition thereto (at no additional cost), such number of shares of the class or classes in which such stock dividend or dividends were declared or paid, and such amount of cash in lieu of fractional shares, as is equal to the number of shares thereof and the amount of cash in lieu of fractional shares, respectively, which the participant would have received if the participant had been the holder of the shares as to which the participant is exercising his or her option at all times between the date of the granting of such option and the date of its exercise. Upon the happening of any of the foregoing events, the class and aggregate number of shares set forth in Article 4 hereof which are subject to options which have been or may be granted under the Plan and the limitations set forth in the second paragraph of Article 5 shall also be appropriately adjusted to reflect the events specified in paragraphs A and B above. Notwithstanding the foregoing, any adjustments made pursuant to paragraphs A or B shall be made only after the Committee, based on advice of counsel for the Company, determines whether such adjustments would constitute a "modification" (as that term is defined in Section 424 of the Code). If the Committee determines that such adjustments would constitute a modification, it may refrain from making such adjustments. If the Company is to be consolidated with or acquired by another entity in a merger, a sale of all or substantially all of the Company's assets or otherwise (an "Acquisition"), the Committee or the board of directors of any entity assuming the obligations of the Company hereunder (the "Successor Board") shall, with respect to options then outstanding under the Plan, either (i) make appropriate provision for the continuation of such options by arranging for the substitution on an equitable basis for the shares then subject to such options either (a) the consideration payable with respect to the outstanding shares of the Common Stock in connection with the Acquisition, (b) shares of stock of the successor corporation, or a parent or subsidiary of such corporation, or (c) such other securities as the Successor Board deems appropriate, the fair market value of which shall not materially exceed the fair market value of the shares of Common Stock subject to such options immediately preceding the Acquisition; or (ii) terminate each participant's options in exchange for a cash payment equal to the excess of (a) the fair market value on the date of the Acquisition, of the number of shares of Common Stock that the participant's accumulated payroll deductions as of the date of the Acquisition could purchase, at an option price determined with reference only to the first business day of the applicable Payment Period and subject to the 1,000-share, Code Section 423(b)(8) and fractional-share limitations on the amount of stock a participant would be entitled to purchase, over (b) the result of multiplying such number of shares by such option price. The Committee or Successor Board shall determine the adjustments to be made under this Article 12, and its determination shall be conclusive. -6- ARTICLE 13 - NO TRANSFER OR ASSIGNMENT OF EMPLOYEE'S RIGHTS. An option granted under the Plan may not be transferred or assigned and may be exercised only by the participant. ARTICLE 14 - TERMINATION OF EMPLOYEE'S RIGHTS. Whenever a participant ceases to be an eligible employee because of retirement, voluntary or involuntary termination, resignation, layoff, discharge, death or for any other reason, his or her rights under the Plan shall immediately terminate, and the Company shall promptly refund, without interest, the entire balance of his or her payroll deduction account under the Plan. Notwithstanding the foregoing, eligible employment shall be treated as continuing intact while a participant is on military leave, sick leave or other bona fide leave of absence, for up to 90 days, or for so long as the participant's right to re-employment is guaranteed either by statute or by contract, if longer than 90 days. If a participant's payroll deductions are interrupted by any legal process, a withdrawal notice will be considered as having been received from the participant on the day the interruption occurs. ARTICLE 15 - TERMINATION AND AMENDMENTS TO PLAN. Unless terminated sooner as provided below, the Plan shall terminate on June 2, 2009. The Plan may be terminated at any time by the Company's Board of Directors but such termination shall not affect options then outstanding under the Plan. It will terminate in any case when all or substantially all of the unissued shares of stock reserved for the purposes of the Plan have been purchased. If at any time shares of stock reserved for the purpose of the Plan remain available for purchase but not in sufficient number to satisfy all then unfilled purchase requirements, the available shares shall be apportioned among participants in proportion to the amount of payroll deductions accumulated on behalf of each participant that would otherwise be used to purchase stock, and the Plan shall terminate. Upon such termination or any other termination of the Plan, all payroll deductions not used to purchase stock will be refunded, without interest. The Committee or the Board of Directors may from time to time adopt amendments to the Plan provided that, without the approval of the stockholders of the Company, no amendment may (i) increase the number of shares that may be issued under the Plan; (ii) change the class of employees eligible to receive options under the Plan, if such action would be treated as the adoption of a new plan for purposes of Section 423(b) of the Code; or (iii) cause Rule 16b-3 under the Securities Exchange Act of 1934 to become inapplicable to the Plan. ARTICLE 16 - LIMITS ON SALE OF STOCK PURCHASED UNDER THE PLAN. The Plan is intended to provide shares of Common Stock for investment and not for resale. The Company does not, however, intend to restrict or influence any employee in the conduct of his or her own affairs. An employee may, therefore, sell stock purchased under the Plan at any time the employee chooses, subject to compliance with any applicable federal or state securities laws and subject to any restrictions imposed under Article 21 to ensure that tax withholding obligations are satisfied. THE EMPLOYEE ASSUMES THE RISK OF ANY MARKET FLUCTUATIONS IN THE PRICE OF THE STOCK. -7- ARTICLE 17 - PARTICIPATING SUBSIDIARIES. The term "participating subsidiary" shall mean any present or future subsidiary of the Company, as that term is defined in Section 424(f) of the Code, which is designated from time to time by the Board of Directors to participate in the Plan. The Board of Directors shall have the power to make such designation before or after the Plan is approved by the stockholders. ARTICLE 18 - OPTIONEES NOT STOCKHOLDERS. Neither the granting of an option to an employee nor the deductions from his or her pay shall constitute such employee a stockholder of the shares covered by an option until such shares have been actually purchased by the employee. ARTICLE 19 - APPLICATION OF FUNDS. The proceeds received by the Company from the sale of Common Stock pursuant to options granted under the Plan will be used for general corporate purposes. ARTICLE 20 - NOTICE TO COMPANY OF DISQUALIFYING DISPOSITION. By electing to participate in the Plan, each participant agrees to notify the Company in writing immediately after the participant transfers Common Stock acquired under the Plan, if such transfer occurs within two years after the first business day of the Payment Period in which such Common Stock was acquired. Each participant further agrees to provide any information about such a transfer as may be requested by the Company or any subsidiary corporation in order to assist it in complying with the tax laws. Such dispositions generally are treated as "disqualifying dispositions" under Sections 421 and 424 of the Code, which have certain tax consequences to participants and to the Company and its participating subsidiaries. ARTICLE 21 - WITHHOLDING OF ADDITIONAL INCOME TAXES. By electing to participate in the Plan, each participant acknowledges that the Company and its participating subsidiaries are required to withhold taxes with respect to the amounts deducted from the participant's compensation and accumulated for the benefit of the participant under the Plan, and each participant agrees that the Company and its participating subsidiaries may deduct additional amounts from the participant's compensation, when amounts are added to the participant's account, used to purchase Common Stock or refunded, in order to satisfy such withholding obligations. Each participant further acknowledges that when Common Stock is purchased under the Plan the Company and its participating subsidiaries may be required to withhold taxes with respect to all or a portion of the difference between the fair market value of the Common Stock purchased and its purchase price, and each participant agrees that such taxes may be withheld from compensation otherwise payable to such participant. It is intended that tax withholding will be accomplished in such a manner that the full amount of payroll deductions elected by the participant under Article 7 will be used to purchase Common Stock. However, if amounts sufficient to satisfy applicable tax withholding obligations have not been withheld from compensation otherwise payable to any participant, then, notwithstanding any other provision of the Plan, the Company may withhold such taxes from the participant's accumulated payroll deductions and apply the net amount to the purchase of Common Stock, unless the participant pays to the Company, prior to the exercise date, an amount sufficient to satisfy such withholding obligations. Each participant further acknowledges that the Company and its participating subsidiaries -8- may be required to withhold taxes in connection with the disposition of stock acquired under the Plan and agrees that the Company or any participating subsidiary may take whatever action it considers appropriate to satisfy such withholding requirements, including deducting from compensation otherwise payable to such participant an amount sufficient to satisfy such withholding requirements or conditioning any disposition of Common Stock by the participant upon the payment to the Company or such subsidiary of an amount sufficient to satisfy such withholding requirements. ARTICLE 22 - GOVERNMENTAL REGULATIONS. The Company's obligation to sell and deliver shares of Common Stock under the Plan is subject to the approval of any governmental authority required in connection with the authorization, issuance or sale of such shares. Government regulations may impose reporting or other obligations on the Company with respect to the Plan. For example, the Company may be required to identify shares of Common Stock issued under the Plan on its stock ownership records and send tax information statements to employees and former employees who transfer title to such shares. ARTICLE 23 - GOVERNING LAW. The validity and construction of the Plan shall be governed by the laws of Delaware, without giving effect to the principles of conflicts of law thereof. ARTICLE 24 - APPROVAL OF BOARD OF DIRECTORS AND STOCKHOLDERS OF THE COMPANY. The Plan was adopted by the Board of Directors on June 2, 1999 and was approved by the stockholders of the Company on June 3, 1999. EX-10.4 9 EXHIBIT 10.4 Exhibit 10.4 AGREEMENT THIS AGREEMENT, made as of the 29th day of September 1998, by and between ROBERT F. YOUNG, NANCY R. YOUNG and MARC EWING (individually and collectively, the "Founders"); ERIK WILLIAM TROAN ("Employee," and collectively with the Founders, the "Individual Parties"); and RED HAT SOFTWARE, INC., a Delaware corporation with offices in Research Park, North Carolina (the "Corporation"); W I T N E S S E T H: WHEREAS, as of the date of this Agreement the Founders own and hold of record shares of the Corporation's common stock as follows: Founder Number of Shares ------- ---------------- Robert F. Young 2,030,000 Nancy R. Young 1,820,913 Marc Ewing 4,044,238 WHEREAS, as of the date of this Agreement Employee has been granted warrants (the "Warrants") to purchase shares of the Corporation's common stock pursuant to an Employment Agreement by and between the Corporation and Employee commencing May 1, 1995 and executed October 10, 1995 (the "Employment Agreement") and desires to enter into this Agreement to bind Employee and the Corporation to its terms for the Warrants and for any and all shares of the Corporation issued to Employee upon exercise of the Warrants (the "Warrant Shares") in accordance with the terms hereof; and WHEREAS, pursuant to the Warrants, the Employee, if such Employee exercises all Warrants available pursuant to such Employee's Employment Agreement prior to the termination of such Warrants pursuant to the terms of this Agreement, may own and hold of record, upon exercise of all Warrants, total shares of the Corporation's common stock as follows: Employee Number of Warrant -------- Option Shares ------------- Erik William Troan 770,200; and WHEREAS, the Employee acknowledges that there are shares of the Corporation issued and outstanding to other shareholders and stock options for shares of the Corporation issued and outstanding to other employees of the Corporation which are not subject to this Agreement and that the Corporation, in its sole discretion, will issue shares of common and preferred stock from time to time to other shareholders and pursuant to stock options which will not be subject to this Agreement; and WHEREAS, the Corporation also anticipates that it may in the future issue additional stock options to employees, directors, consultants or other service providers of the Corporation pursuant to a plan or plans established by the Corporation's Board of Directors (the "Plan") and that the Corporation, in its sole discretion, may, but shall not be obligated to, subject any such stock options authorized under the -2- Plan and any shares of the Corporation's stock purchased pursuant to such stock options to terms and conditions similar to those contained in this Agreement; and WHEREAS, the Individual Parties and the Corporation recognize that the Warrants are granted to the Employee as an incentive to promote the success of the business and to encourage the Employee to remain in the Corporation's employ; and WHEREAS, the Individual Parties and the Corporation desire to set forth and confirm the terms and conditions upon which the Warrants may be exercised and terminated and the terms and conditions under which they Warrant Shares will be held; and WHEREAS, the Individual Parties and the Corporation agree that it is in their best interest to agree upon the terms and conditions set forth herein and that such terms and conditions reflect the full understanding of the Individual Parties and the Corporation. NOW, THEREFORE, in consideration of the premises and of the mutual covenants and conditions herein contained, the Individual Parties and the Corporation agree, for themselves, their successors and assigns, as follows: ARTICLE I WARRANTS 1.1 Warrant. The Corporation and the Employee hereby agree that the Employee's rights to purchase Warrant Shares pursuant to the Employment Agreement, and the exercise of the Warrants, shall be governed by the terms of this Article I. Employee agrees that the provisions in this Agreement pertaining to the exercise and termination of Warrants and the vesting and purchase of Warrant Shares represents the understanding of the parties and shall control and shall supersede over any provisions to the contrary in such Employee's Employment Agreement. Employee acknowledges that the only options or warrants to purchase or receive shares of the Corporation's stock to which the Employee is entitled are the Warrants described in this Article I, that no profit sharing plan has been implemented by the Corporation, and that the Employee waives any rights under Section 3c of the Employment Agreement to demand "warrants" pursuant to a profit sharing plan unless a profit sharing plan expressly granting the right to Employee to "warrants" is hereinafter implemented by the Corporation and authorized by its Board of Directors. 1.2 Vesting. Employee has the option to purchase the following number of Warrant Shares on the dates (the "Vesting Dates") set forth on the following schedule:
Vesting Dates ------------- Employee 5/1/96 5/1/97 5/1/98 5/1/99 - -------- --------- --------- ---------- --------- 183,400 183,400 183,400 220,000
However, if the Employee does not purchase the full number of Warrant Shares to which the Employee is entitled on or before the Vesting Dates, the Employee is permitted to purchase those remaining Warrant Shares at a later period (unless terminated) in addition to those Warrant Shares which the Employee may otherwise be entitled to purchase. No partial exercise of such Warrant may be for less than one hundred (100) full Warrant Shares. In no event shall the Corporation be required to transfer fractional shares to the Employee. The Individual Parties and the Corporation acknowledge and confirm that as of the April 22, 1999, the Employee has exercised 101,975 of his Warrants and that, after selling 76,975 Warrant Shares, the Employee owns 25,000 Warrant Shares. -3- 1.3 Purchase Price. The purchase price for each Warrant Share shall be $.0001 per Warrant Share. 1.4 Exercise of Warrants. The respective number of Warrants shall be exercisable from time to time after the applicable Vesting Dates by ten (10) days written notice to the Corporation and the payment in cash to the Corporation of the purchase price of the Warrant Shares which the Employee may and elects to purchase. The Corporation shall make immediate delivery of such Warrant Shares, provided that if any law or regulation requires the Corporation to take any action with respect to the Warrant Shares specified in such notice before the issuance thereof, the date of delivery of such Warrant Shares shall be extended for the period necessary to take such action. 1.5 Termination of Warrants. The Warrants, to the extent not heretofore exercised, shall terminate on the first to occur of the following dates: (a) If the Employee's employment with the Corporation terminates because of his death, any Warrants held by the Employee on the date of his death may be exercised only within thirty (30) days after his death and only to the extent that the Warrants could have been exercised immediately before the Employee's death; (b) If the Employee's employment with the Corporation terminates because of Total Disability (as hereinafter defined) after at least one (1) year of continuous employment with the Corporation immediately following the date on which Warrants were originally granted in the Employment Agreement, the Employee may exercise the Warrant to the extent that it could be exercised upon such termination of employment at any time within thirty (30) days after the employment shall terminate; (c) If the Employee's employment with the Corporation terminates because of his retirement after at least one (1) year of continuous employment with the Corporation immediately following the date on which the Warrants were granted, the Employee may exercise the Warrant to the extent that the Warrants can be exercised upon such termination of employment at any time within thirty (30) days after retirement. Retirement means retirement from the Corporation pursuant to the provisions of the Corporation's policy as may be implemented by the Board of Directors from time to time.; (d) If the Employee's employment with the Corporation is terminated by the Corporation without cause, the Employee may exercise the Warrants to the extent that the Warrants can be exercised upon such termination of employment at any time within thirty (30) days after such termination; provided, however, that any Option Shares so acquired shall be subject to the rights of the Corporation or the Founders to purchase such shares in accordance with the provisions of Section 2.6 of this Agreement; (e) Termination of the Employee's employment with the Corporation for any reason other than death, disability, retirement, or without cause; (f) The happening of any event resulting in the termination of this Agreement pursuant to Section 3.14 hereof; (g) May 1, 2006. 1.6 Rights Prior to Exercise of Warrant. The Warrants granted to the Employee are nontransferable by the Employee and are exercisable only by the Employee. The Employee shall have no -4- right as a shareholder with respect to the Warrant Shares until payment of the warrrantprice and delivery to the Employee of such Warrant Shares as herein provided. 1.7 Restrictions. All Warrant Shares acquired by Employee pursuant to the Warrants shall be subject to the restrictions on sale, encumbrance, and other dispositions contained in Article II of this Agreement. 1.8 Time is of the Essence. Time is of the essence in exercising the Warrants under this Agreement. ARTICLE II RESTRICTIONS ON WARRANT SHARES 2.1 Restriction on Share Transfer. Employee shall not sell, assign, transfer, pledge, or otherwise dispose of or in any way alienate any of his respective Warrant Shares in the Corporation by operation of law or otherwise except as provided in this Agreement. 2.2 Offer to Purchase All Warrant Shares. If any one or more of the Founders receives a third party offer to purchase fifty percent (50%) or more of all of the shares of the Corporation owned collectively by the Founders plus all of the Warrant Shares and Warrants and the Founders desire to accept the third party offer, then the Founders have the right to deliver a notice (the "Bring Along Notice") with respect to such third party offer to the Corporation and the Employee stating that the Founders propose to effect such transaction, the name and address of the third party offeror, and the purchase price under the third party offer, together with a copy of all writings, if any, between the Founders and the third party offeror or such other person necessary to establish the terms of such third party offer. Employee agrees that upon receipt of the Bring Along Notice, Employee shall be obligated to sell all Warrants and Warrant Shares held by him to the third party offeror upon the terms and conditions (including, without limitation, purchase price) of the third party offeror (and otherwise take all necessary action to cause the Corporation to consummate the proposed transaction). The rights of first refusal in Section 2.3 of this Agreement shall not apply to this Section 2.2. Notwithstanding anything in this Section 2.2 to the contrary, Employee acknowledges and agrees that the rights and obligations hereunder are subject to (and, where applicable, subordinate to the rights of the Investor, as hereinafter defined) the terms and conditions of a Co-Sale Agreement between the Founding Shareholders, the Corporation and the Frank Batten, Jr. Trust, a copy of which is attached hereto as Exhibit A (the "Co-Sale Agreement"), and that the number of Warrants and Warrant Shares sold by the Employee to the third party offeror may be reduced by the participation rights of the Investor as defined and provided in the Co-Sale Agreement. For purposes of this Section 2.2, the term "Investor" shall have the same meaning as set forth in the Co-Sale Agreement. 2.3 Transfers During Employee's Lifetime. Except as otherwise set forth in this Agreement, no Warrant Shares owned by Employee shall be transferred, sold, assigned, pledged or otherwise disposed of during Employee's lifetime except in accordance with the following provisions: (a) Offer to Corporation. Employee (hereinafter referred to as "Offeror") intending to transfer any Warrant Shares (the "Offered Shares") shall first submit to the Corporation a written offer to sell the Offered Shares to the Corporation at the price offered by the proposed purchaser, on the terms of such offer. Every written offer submitted to the Corporation in accordance with the provisions of this Section 2.3(a) shall continue to be a binding offer to sell until expressly rejected by an officer or director of the Corporation acting pursuant to a resolution adopted in accordance with Section 2.7 of this Agreement or until the expiration of a period of sixty (60) days after the delivery of such offer to the Corporation, whichever time is earlier. Upon delivery to the Corporation of any written offer submitted -5- in accordance with the provisions of this Section 6(a), any officer or director of the Corporation, acting before the termination of the offer and pursuant to a resolution adopted in accordance with Section 2.7 of this Agreement may bind the Corporation to purchase all or any part of the Offered Shares. (b) Offer to Founders. Upon termination of the offer referred to in subparagraph (a) above, the Offeror shall then submit to the Founders a written offer to sell, at the price offered by the proposed purchaser, on the terms of such offer, any of the Offered Shares not previously purchased by the Corporation under the aforesaid offer to it (the "Excess Offered Shares"). Each Founder shall then have the right to purchase up to his Founder Percentage of the Excess Offered Shares. Each Founder's right to purchase the Excess Offered Shares shall be exercisable by written notices to the Offeror, the Corporation and the other Founders given within thirty (30) days of the Offeror's written offer to the Founders. Each Founder has the right and may indicate in such notice, his election to purchase the balance of such Excess Offered Shares if any other Founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Offered Shares. The failure of a Founder to exercise his right to purchase Excess Offered Shares within the thirty (30) day notice period shall be regarded as a waiver of his right to participate in the purchase of the Excess Offered Shares. For purposes of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Offeror's written offer to the Founders. (c) Contents of Offer and Subsequent Transfer. Every written offer submitted in accordance with this Section 2.3 shall specifically name the person or persons to whom the Offeror intends to transfer the shares, the number of shares that he intends to so transfer to each person, and the price per share and other terms upon which each intended transfer is to be made, and shall include copies of the written offer and pertinent documentation. Upon the termination of the written offer to the Founders, the Offeror shall, for a period of thirty (30) days thereafter, be free to transfer any unpurchased shares to the person or persons so named at the price per share and upon the other terms so named as stated in the Offeror's written offer to the Corporation; provided that any such transferee of those shares shall thereafter be bound by and subject to all of the provisions and restrictions of this Agreement and shall agree in writing to be so bound. However, if the Offeror fails to make such transfer within such thirty (30) days, such shares shall again be subject to all the restrictions and provisions of this Agreement. (d) Consideration for Shares. If any consideration to be received by the Offeror for the Warrant Shares offered is property other than cash, then the price per share shall be measured to that extent by the fair market value of such noncash consideration. Fair market value for the purposes of this Section 6(d) shall mean the sum of (i) the fair market value of any noncash consideration offered for the shares as determined by the Board of Directors of the Corporation (the "Board"), plus (ii) the value of any special benefits to the Offeror of such noncash consideration to the extent they can be reasonably identified and valued, plus (iii) the amount of any additional expense or cost (including additional taxes) incurred by the Offeror in accepting cash instead of such noncash consideration, in each case based upon a realistic appraisal of such noncash consideration, special benefits, expense or cost agreed upon by the Offeror and the Corporation or by two independent qualified appraisers, one being selected and paid for by the Offeror and the other by the Corporation. If the two appraisers are unable to agree, they shall select a third, and the determination of the third appraiser shall be final and conclusive. The cost of the third appraiser shall be divided equally between the Offeror and the Corporation. (e) Closing. The closing of the sale of the Warrant Shares shall be sixty (60) days following the last timely delivery of notice of election to purchase any of the shares. (f) Involuntary Transfer. The provisions of this Section 2.3 shall also be applicable to Involuntary Transfers of Warrant Shares. "Involuntary Transfer" means any transfer, proceeding or -6- action by or in which Employee shall be deprived or divested of any right, title or interest in or to any of his Warrant Shares, including, without limitation, any seizure under levy of attachment or execution, any transfer in connection with bankruptcy or other court proceeding to a debtor-in-possession, trustee or receiver or other officer or agency, or any transfer pursuant to a separation agreement or entry of a final court order in a divorce proceeding. In such event, the Corporation and the Founders shall have the right to purchase from either the Employee or the transferee on the Stipulated Terms (as hereinafter defined) all of the Warrant Shares of the Corporation owned by the Employee at the lesser of (i) 80% of the book value of the Warrant Shares as determined by the Board, (ii) 80% of the fair market value of the Warrant Shares based on the Corporation as a going concern as determined by the Board, or (iii) the amount of the indebtedness which resulted in the involuntary transfer of Warrant Shares. Notice to the Corporation by any person or in any manner of an Involuntary Transfer shall be deemed a written offer to sell the Warrant Shares and the Corporation and the Founders shall have the right to purchase the Warrant Shares in accordance with the procedures as set forth in this Section 2.2. 2.4 Option to Purchase Upon Permanent Disability. If Employee becomes totally disabled for a period of three (3) months (the "Disabled Employee"), the Corporation and the Founders shall each have the option to purchase all or any of the Disabled Employee's Warrant Shares upon the following terms: (a) Exercise of Option. Such option of the Corporation shall commence on the date three (3) months after such disability commences and shall be exercised by written notice by the Corporation within ninety (90) days after such right commences. The purchase price of the Warrant Shares shall be the Stipulated Price and shall be payable upon the Stipulated Term (as hereinafter defined), which shall be paid in cash to the extent of proceeds of insurance received by the Corporation as the result of such permanent disability, if any, with the balance of the purchase price payable pursuant to the Stipulated Terms (as hereinafter defined). (b) Exercise of Option by Founders. In the event the Corporation does not elect to exercise its option to purchase all or any of the Warrant Shares under Section 2.4(a) above (the "Excess Warrant Shares"), then each Founder shall have the option to purchase up to his Founder Percentage of the Excess Warrant Shares. Each Founder's right to purchase the Excess Warrant Shares shall be exercisable by written notice to the Disabled Employee, the Corporation and the other Founders given within thirty (30) days of the termination of the Corporation's option. Each Founder has the right and may indicate in such notice his election to purchase the balance of such Excess Warrant Shares if any other Founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Warrant Shares. The failure of a Founder to exercise his right to purchase Excess Warrant Shares within the thirty (30) day notice period, shall be regarded as a waiver of his right to participate in the purchase of the Excess Warrant Shares. For purposes of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Disabled Employee's Total Disability. (c) Determination of Disability. "Totally Disabled" shall mean the inability by reason of a physical or mental condition, or both, of the Disabled Employee to perform satisfactorily his usual duties for the Corporation, as determined by the Board. The Total Disability shall be deemed to have commenced on the date of the determination by the Board. (d) Closing. The closing of the sale of the Warrant Shares shall be sixty (60) days after delivery of the Corporation's or the Founder's, as the case may be, notice of election to purchase the Warrant Shares. -7- 2.5 Option to Purchase Upon Death. Upon the death of Employee (the "Decedent"), all of the Warrant Shares of the Corporation which had been owned by the Decedent and all Warrant Shares owned by the Decedent's representative if Warrants are exercised within thirty (30) days after the Decedent's death and to which he or his personal representatives shall be entitled shall be sold and purchased as herein provided at the option of the Corporation. (a) Option of the Corporation to Purchase. The Corporation has the option to purchase from Decedent's estate, and, if the option is exercised, Decedent's estate shall sell to the Corporation, all the Warrant Shares of the Corporation owned by Decedent at the Stipulated Price and upon the Stipulated Terms (as hereinafter defined). The Corporation shall exercise its option by giving written notice to the Decedent's personal representative within one hundred twenty (120) days after the Decedent's death. (b) Option of the Founders to Purchase. In the event the Corporation does not elect to exercise its option to purchase all or any of the Warrant Shares under Section 2.5(a) above (the "Excess Warrant Shares"), then each Founder shall have the option to purchase up to his Founder Percentage of the Excess Warrant Shares at the Stipulated Price and upon the Stipulated Terms (as hereinafter defined). Each Founder's right to purchase the Excess Warrant Shares shall be exercisable by written notice to the Decedent's Estate, the Corporation and the other Founders given within thirty (30) days of the termination of the Corporation's option. Each Founder has the right and may indicate in such notice his election to purchase the balance of such Excess Warrant Shares if nay other Founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Warrant Shares. The failure of a Founder to exercise his right to purchase Excess Warrant Shares within the thirty (30) day notice period, shall be regarded as a waiver of his right to participate in the purchase of the Excess Warrant Shares. For purposes of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Decedent's death. (c) Insurance. The Corporation may, but is not obligated to, obtain insurance on the life of Employee for a sum determined by the Corporation, naming itself as beneficiary of the policies The Corporation shall pay all premiums on the insurance policies. The Corporation shall be the sole owner of the insurance policies and may apply to the payment of premiums any dividends declared and paid on the policies. (d) Closing. The Closing of the purchase of the Warrant Shares shall be ninety (90) days after the Corporation or the Founders, as the case may be, exercises their option to purchase the Warrant Shares. 2.6 Purchase Upon Termination of Employment. In the event that Employee's employment with the Corporation is terminated by the Corporation or such Employee for any reason whatsoever, with or without cause, or at any time (the "Terminated Employee"), the Corporation and the Founders shall each have the option to purchase all or any of the Warrant Shares owned by the Terminated Employee upon the following terms: (a) Option to Purchase by Corporation. The Corporation shall have the option to purchase from the Terminated Employee all of the Warrant Shares owned by the Terminated Employee at the Stipulated Price and upon the Stipulated Terms (as hereinafter defined), which option the corporation may exercise by notice in writing to the Terminated Employee within (90) days of the effective date of termination; provided, however, in the event the Employee's terminated for cause, then the option to purchase under this Section 2.6(a) and 2.6(b) shall be at the lesser of eighty percent (80%) of book value of the Warrant Shares as determined by the Board or eighty percent (80%) of the value of the Warrant -8- Shares based on the Corporation as a going concern as determined by the Board, and on the Stipulated Terms. (b) Option to Purchase by Founders. In the event the Corporation does not elect to exercise its option to purchase all or any of the Warrant Shares under 2.6(a) above (the "Excess Warrant Shares"), then each Founder shall have the option to purchase up to his Founder Percentage of the Excess Warrant Shares at the price and under the terms provided in Section 2.6(a) above. Each Founder's right to purchase the Excess Warrant Shares shall be exercisable by written notice to the Terminated Employee, the corporation and the other Founders given within thirty (30) days of the termination of the Corporation's option. Each Founder has the right and may indicate in such notice his election to purchase the balance of such Excess Warrant Shares if any other founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Warrant Shares. The failure of a Founder to exercise his right to purchase Excess Warrant Shares within the thirty (30) day notice period, shall be regarded as a waiver of his right to participate in the purchase of the Excess Warrant Shares. For purpose of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Employee's termination of employment. (c) Closing. The closing of the purchase of the Warrant Shares shall be ninety (90) days after the Corporation or the Founders, as the case may be, exercise their option to purchase the Warrant Shares. 2.7 Vote on Option to Purchase. Whenever, under the terms of this Agreement, the Corporation has an option to purchase Warrant Shares, action on such option may be taken by the holders of a majority of the voting shares of the Corporation (or such other percentage as may be required by the Corporation's Articles of Incorporation as may be amended and/or restated from time to time if such redemption of stock under this Agreement is not excluded from such greater percentage), exclusive of the Warrant Shares held by the Offeror, the Decedent, the Disabled Employee or the Terminated Employee, as the case may be. 2.8 Non-Exercise of Option. Whenever, under the terms of this Agreement, the Corporation and Founders have an option to purchase Warrant Shares and elects not to exercise the option, said Warrant Shares shall nevertheless remain subject to all of the terms of this Agreement. 2.9 Dates for Determination of Purchase Price. This Section sets the various dates from which the purchase price for Warrant Shares purchased pursuant to this Agreement shall be determined. The price shall be determined in each case as of the following valuation dates: (a) upon the death of Employee, as of the date of death; (b) upon the Total Disability of Employee, as of the date of determination of Total Disability by the Board; (c) upon a termination of employment of Employee, upon the effective date of the termination; and (d) upon an Involuntary Transfer, upon the effective date of the Involuntary Transfer. 2.10 Payment of Purchase Price. The manner of payment of the purchase price for any Warrant Shares pursuant to this Agreement, with the exception of a purchase upon the terms offered by a proposed third-party purchaser or as otherwise provided in this Agreement, shall be determined by this Section. (a) Stipulated Price. The "Stipulated Price" shall be that price per share of the Corporation as a going concern equal to eighty percent (80%) of the fair market value for such shares as determined by the Board. -9- (b) Stipulated Terms. The purchase price for any Warrant Shares purchased pursuant to this Agreement shall be paid either in cash or by a cash down payment and the delivery of a secured promissory note, at the option of the purchaser. If the purchase is made for any reason other than the death of the Employee, the down payment shall equal at least twenty percent (20%) of the purchase price. If the purchase is made because of the death of Employee, the down payment shall equal not less than the greater of twenty percent (20%) of the purchase price or the full amount of the net proceeds from any insurance policies maintained by the Corporation on the life of the Employee. Any promissory note shall provide for equal quarterly installments of principal over a term not to exceed five (5) years, and shall bear interest at the rate of seven (7%) percent. Accrued interest shall be payable quarterly commencing with the first installment of principal. The note shall be subject to prepayment in whole or in part at any time and without penalty. In the event of default in payment of any installment when due, the whole sum of the principal and interest shall become immediately due and payable at the option of the holder. Notwithstanding anything herein to the contrary, if the purchase price is less than $10,000.00 the entire purchase price shall be paid in cash at closing. (c) Delivery of Warrant Shares. At such time as the cash and promissory note, if applicable, have been delivered to the Employee or his estate, the Warrant Shares of the Employee shall be transferred to the purchaser or purchasers. (d) Security. If part of the purchase price is paid by delivery of the purchaser's promissory note, then, as security for payments due under the terms of the note, the purchaser shall grant to the Employee a security interest in the Shares by executing a pledge and escrow agreement and whatever additional documents may be reasonably necessary to perfect the security interest of the Employee or his estate. The security documents shall provide that the Corporation or other purchaser shall deposit the shares it is purchasing with an escrow agent and that, if the purchaser defaults under the terms of the promissory note or the security documents, the Employee or his estate shall have the right to receive possession of the shares and to exercise all other rights of a secured party under the North Carolina Uniform Commercial Code. (e) Insufficient Corporate Surplus. If, at the time the Corporation is required to make payment of the purchase price for shares pursuant to this Agreement and/or to issue its promissory notes therefor, its surplus is insufficient for such purposes under applicable law, then the Corporation shall promptly take all action necessary and proper under applicable law to increase, to the extent possible, the surplus of the Corporation to permit such payment and/or the issuance of such promissory note. Employee or his personal representative shall perform such acts, execute such instruments, and vote the respective shares in such a manner as may be required to increase the available surplus to an amount sufficient to authorize the purchase of the shares, including, but not limited to, a recapitalization to reduce the capital of the Corporation and increase its surplus or a reappraisal of the assets of the Corporation for the purpose of reflecting the market value. ARTICLE III GENERAL PROVISIONS 3.1 Corporate Action and Articles of Incorporation. The Corporation and the Individual Parties shall take all action required pursuant to this Agreement to effectuate the provisions herein. The Corporation shall become a party to this Agreement. 3.2 Share Certificates. Every certificate representing Warrant Shares of the Corporation shall bear the following legend prominently displayed: -10- "The shares represented by this certificate, and the transfer thereof, are subject to the provisions of that certain Agreement, dated as of September 29, 1998, among ROBERT F. YOUNG, NANCY R. YOUNG, MARC EWING, ERIK WILLIAM TROAN and RED HAT SOFTWARE, INC., a Delaware corporation, a copy of which is on file in, and may be examined at, the principal office of the Corporation." 3.3 Warrant Shares. All references to Warrant Shares owned by Employee shall mean any outstanding shares of the Corporation hereafter owned by Employee and any shares distributed with respect to any such shares in a stock split, stock dividend, recapitalization, reorganization or otherwise. 3.4 Necessary Acts. Each party hereto agrees that they will do any act or thing and will execute any and all instruments necessary and/or proper to make effective the provisions of this Agreement. 3.5 Severability. Should any provision of this Agreement be declared to be invalid for any reason or to have ceased to be binding on the parties hereto, such provision shall be severed, and all other provisions herein shall continue to be effective and binding. 3.6 Governing Law. This Agreement shall be subject to and governed by the laws of the State of Delaware. 3.7 Entire Agreement. This Agreement contains the entire agreement between the parties hereto with respect to the subject matter hereof, and no change, amendment or modification of this Agreement shall be valid unless the same be in writing and signed by all the parties hereto. No waiver of any of the terms of this Agreement shall be valid unless signed by the party against whom such waiver is asserted. This Agreement supersedes and nullifies the terms of any other agreement setting forth the rights of the Employee previously entered into by Employee with respect to the subject matter hereof. The Employee acknowledges that his ownership of Warrants and Warrant Shares in the Corporation gives him no rights or expectations except those embodied in this Agreement. 3.8 Specific Performance. The parties acknowledge that the actual damage which would be sustained upon the breach of this Agreement by any of the parties or to a personal representative of a Decedent aggrieved by the breach or threatened breach of any of its provisions shall be entitled to seek from any court of competent jurisdiction an order for specific performance of all of the terms and conditions of this agreement. This provision does not limit the parties from seeking any other available remedies at law or equity. 3.9 Prohibited Transfers Void. Any purported transfer in violation of this Agreement shall be void and shall not transfer any interest or title to the purported transferee. The Corporation shall not be required to transfer on its books any Warrant Shares sold or transferred in violation of any of the provisions set forth in this Agreement or to treat as owner of those Warrant Shares or to pay dividends to any transferee to whom any of those Warrant Shares shall have been so sold or transferred. 3.10 Representation as to Attorney. The Individual Parties (and the Corporation) acknowledge that a conflict may exist among their respective interests, and that the Individual Parties should seek the advice of independent counsel. The parties hereby waive any claim they may have as to any conflict which may exist in connection with the preparation of this Agreement. 3.11 New Parties. The Corporation shall not record a transfer of Warrant Shares from Employee to any person not a party hereto unless said person shall execute an acknowledgment of the -11- terms hereof and agreement to be bound hereby, except for a transfer of Warrant Shares to a third party pursuant to Section 2.2 of this Agreement. 3.12 Agreement Binding. This Agreement shall insure to the benefit of and be binding upon the parties hereto and their respective next-of-kin, legatees, administrators, executors, legal representatives, successors and permitted assigns (including remote, as well as immediate, successors to and assignees of said parties), except this Agreement shall not be binding on a third-party purchaser in the event of a transfer of Warrant Shares to such third party pursuant to Section 2.2 of this Agreement. 3.13 Pronouns and Headings. In this Agreement the masculine shall include the feminine and the singular shall include the plural as the context of this Agreement shall clearly require. The article and section headings in this Agreement are inserted for convenience only and are not part of the Agreement. 3.14. Termination. This Agreement shall commence as of the date hereof and shall continue in full force and effect until terminated (i) by the mutual agreement of the parties hereto, (ii) by the dissolution or bankruptcy of the Corporation, (iii) upon the effectiveness of a merger, consolidation or other acquisition of substantially all of the Corporation's assets, if the Corporation is not the surviving corporation, except that a merger or consolidation with a subsidiary which effects a mere change in the form or domicile of the Corporation without changing the respective shareholdings of the Individual Parties shall not terminate the agreement, even if the Corporation is not the surviving corporation, (iv) upon the issuance of any of the Corporation's shares sold by means of a public offering that is required to be registered under the federal securities laws, or (v) upon the sale of all of the issued and outstanding shares of the Corporation. 3.15 Transferability. Any rights or interests of the parties set forth in this Agreement are personal and nontransferable. 3.16 Notices. Any notice or offer required hereunder shall be deemed to have been validly given if delivered by certified mail, return receipt requested, postage prepaid, addressed, or by federal express overnight delivery (or other nationally recognized service) with receipt confirmed, in the case of the Corporation, to its principal office, and in the case of the Individual Parties, to their address appearing on the stock records of the Corporation or to such other address as he may designate. Notices hereunder shall be deemed given seven (7) business days after deposit in the United States Mail or the next business day, if delivered by Federal Express overnight delivery (or other nationally recognized service). 3.17 Jurisdiction and Venue. The parties agree that any action brought in any court whether federal or state shall be brought within the State of North Carolina in the judicial district of Durham, Durham County and do hereby waive all questions of personal jurisdiction or venue for the purpose of carrying out this provision. 3.18 Counterparts. This Agreement may be executed in one or more counterparts, each of which will be deemed to be an original copy of this Agreement and all of which, when taken together, will be deemed to constitute one and the same agreements. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -12- IN WITNESS WHEREOF, the Corporation has caused this Agreement to be signed by its duly authorized officers and its corporate seal to be affixed hereto, and the Individual Parties have hereunto set their hands, all as of the day and year first above written. RED HAT SOFTWARE, INC. By: /s/ Robert F. Young ---------------------- Title: CEO ATTEST: /s/ David Schumannfang - ------------------------ Secretary [CORPORATE SEAL] /s/ Robert F. Young -------------------------- Robert F. Young /s/ Nancy R. Young -------------------------- Nancy R. Young /s/ Marc Ewing -------------------------- Marc Ewing EMPLOYEE /s/ Erik Troan -------------------------- Erik Troan -13- SPOUSAL CONSENT The undersigned, being the spouse of Employee who has signed this Agreement, hereby acknowledges that she has read and is familiar with its provisions and agrees to be bound thereby and to join therein to the extent, if any, that her joinder may be necessary. The undersigned hereby agrees that her spouse may join in the future amendment or modification of this Agreement without any further signature, acknowledgment, agreement or consent on her part; and further agrees that any interest which she may have in the Warrants and Warrant Shares (as defined in this Agreement) owned directly or beneficially by her spouse shall be subject to the provisions of this Agreement. /s/ [Illegible] -------------------------- Name: -14- AMENDMENT AMENDMENT, made as of May 24, 1999, by and among Red Hat Software, Inc. (the "Company"), Robert F. Young, Nancy R. Young and Marc Ewing (collectively, the "Founders") and Erik Troan (the "Warrantholder"). WHEREAS, the Company, the Founders and the Warrantholder are parties to that certain Warrant, dated as of August 12, 1997 (the "Warrant"), which by its terms, terminates on the issuance of any of the Company's shares sold by means of a public offering that is required to be registered under the federal securities laws; and WHEREAS, the Company, the Founders and the Warrantholder wish to amend the Warrant to prevent it from terminating under such circumstances and to remove certain restrictions on exercised Warrant Shares upon the closing of the Company's initial public offering. NOW THEREFORE, the parties hereto agree as follows: 1. Capitalized terms not defined herein shall have the meaning set forth in the Warrant. 2. Section 3.14 of the Warrant shall be amended and restated as follows: "3.14. Termination. This Agreement shall commence as of the date hereof and shall continue in full force and effect until terminated (i) by the mutual agreement of the parties hereto, (ii) by the dissolution or bankruptcy of the Corporation, (iii) upon the effectiveness of a merger, consolidation or other acquisition of substantially all of the Corporation's assets, if the Corporation is not the surviving corporation, except that a merger or consolidation with a subsidiary which effects a mere change in the form or domicile of the Corporation without changing the respective shareholdings of the Individual Parties shall not terminate the agreement, even if the Corporation is not the surviving corporation, or (iv) upon the sale of all of the issued and outstanding shares of the Corporation. Notwithstanding the foregoing, the provisions of Article II hereof shall cease and have no further force or effect with respect to any Warrant Shares upon the issuance of any of the Corporation's shares sold by means of a public offering that is required to be registered under the federal securities laws." 3. Continuing Effect. Except as otherwise set forth herein, all terms and conditions of the Warrant shall remain in full force and effect, and this Amendment shall not constitute a modification, acceptance or waiver of any other provision of the Warrant. 4. Counterparts. This Amendment may be executed in two or more counterparts, each of which shall constitute an original, but all of which, when taken together, shall constitute but one instrument. -15- IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first written above. RED HAT SOFTWARE, INC. By: /s/ Robert F. Young - -------------------------- Title: COE /s/ Marc Ewing - -------------------------- Marc Ewing /s/ Robert F. Young - -------------------------- Robert F. Young /s/ Nancy R. Young - -------------------------- Nancy R. Young /s/ Erik Troan - -------------------------- Erik Troan EX-10.5 10 EXHIBIT 10.5 Exhibit 10.5 AGREEMENT THIS AGREEMENT, made as of the 29th day of September 1998, by and between ROBERT F. YOUNG, NANCY R. YOUNG and MARC EWING (individually and collectively, the "Founders"); DONALD J. BARNES ("Employee," and collectively with the Founders, the "Individual Parties"); and RED HAT SOFTWARE, INC., a Delaware corporation with offices in Research Park, North Carolina (the "Corporation"); W I T N E S S E T H: WHEREAS, as of the date of this Agreement the Founders own and hold of record shares of the Corporation's common stock as follows: Founder Number of Shares ------- ---------------- Robert F. Young 2,030,000 Nancy R. Young 1,820,913 Marc Ewing 4,044,238 WHEREAS, as of the date of this Agreement Employee has been granted warrants (the "Warrants") to purchase shares of the Corporation's common stock pursuant to an Employment Agreement by and between the Corporation and Employee commencing May 1, 1995 and executed October 10, 1995 (the "Employment Agreement") and desires to enter into this Agreement to bind Employee and the Corporation to its terms for the Warrants and for any and all shares of the Corporation issued to Employee upon exercise of the Warrants (the "Warrant Shares") in accordance with the terms hereof; and WHEREAS, pursuant to the Warrants, the Employee, if such Employee exercises all Warrants available pursuant to such Employee's Employment Agreement prior to the termination of such Warrants pursuant to the terms of this Agreement, may own and hold of record, upon exercise of all Warrants, total shares of the Corporation's common stock as follows: Employee Number of Warrant -------- Option Shares ------------- Donald J. Barnes 550,000; and WHEREAS, the Employee acknowledges that there are shares of the Corporation issued and outstanding to other shareholders and stock options for shares of the Corporation issued and outstanding to other employees of the Corporation which are not subject to this Agreement and that the Corporation, in its sole discretion, will issue shares of common and preferred stock from time to time to other shareholders and pursuant to stock options which will not be subject to this Agreement; and WHEREAS, the Corporation also anticipates that it may in the future issue additional stock options to employees, directors, consultants or other service providers of the Corporation pursuant to a plan or plans established by the Corporation's Board of Directors (the "Plan") and that the Corporation, in its sole discretion, may, but shall not be obligated to, subject any such stock options authorized under the Plan and any shares of the Corporation's stock purchased pursuant to such stock options to terms and conditions similar to those contained in this Agreement; and -2- WHEREAS, the Individual Parties and the Corporation recognize that the Warrants are granted to the Employee as an incentive to promote the success of the business and to encourage the Employee to remain in the Corporation's employ; and WHEREAS, the Individual Parties and the Corporation desire to set forth and confirm the terms and conditions upon which the Warrants may be exercised and terminated and the terms and conditions under which they Warrant Shares will be held; and WHEREAS, the Individual Parties and the Corporation agree that it is in their best interest to agree upon the terms and conditions set forth herein and that such terms and conditions reflect the full understanding of the Individual Parties and the Corporation. NOW, THEREFORE, in consideration of the premises and of the mutual covenants and conditions herein contained, the Individual Parties and the Corporation agree, for themselves, their successors and assigns, as follows: ARTICLE I WARRANTS 1.1 Warrant. The Corporation and the Employee hereby agree that the Employee's rights to purchase Warrant Shares pursuant to the Employment Agreement, and the exercise of the Warrants, shall be governed by the terms of this Article I. Employee agrees that the provisions in this Agreement pertaining to the exercise and termination of Warrants and the vesting and purchase of Warrant Shares represents the understanding of the parties and shall control and shall supersede over any provisions to the contrary in such Employee's Employment Agreement. Employee acknowledges that the only options or warrants to purchase or receive shares of the Corporation's stock to which the Employee is entitled are the Warrants described in this Article I, that no profit sharing plan has been implemented by the Corporation, and that the Employee waives any rights under Section 3c of the Employment Agreement to demand "warrants" pursuant to a profit sharing plan unless a profit sharing plan expressly granting the right to Employee to "warrants" is hereinafter implemented by the Corporation and authorized by its Board of Directors. 1.2 Vesting. Employee has the option to purchase the following number of Warrant Shares on the dates (the "Vesting Dates") set forth on the following schedule:
Vesting Dates ------------- Employee 5/1/96 5/1/97 5/1/98 5/1/99 - -------- ---------- ---------- ---------- ---------- 137,500 137,500 137,500 137,500
However, if the Employee does not purchase the full number of Warrant Shares to which the Employee is entitled on or before the Vesting Dates, the Employee is permitted to purchase those remaining Warrant Shares at a later period (unless terminated) in addition to those Warrant Shares which the Employee may otherwise be entitled to purchase. No partial exercise of such Warrant may be for less than one hundred (100) full Warrant Shares. In no event shall the Corporation be required to transfer fractional shares to the Employee. The Individual Parties and the Corporation acknowledge and confirm that as of April 22, 1999, the Employee has exercised 75,000 of his Warrants and that, after selling 50,000 Warrant Shares, the Employee owns 25,000 Warrant Shares. -3- 1.3 Purchase Price. The purchase price for each Warrant Share shall be $.0001 per Warrant Share. 1.4 Exercise of Warrants. The respective number of Warrants shall be exercisable from time to time after the applicable Vesting Dates by ten (10) days written notice to the Corporation and the payment in cash to the Corporation of the purchase price of the Warrant Shares which the Employee may and elects to purchase. The Corporation shall make immediate delivery of such Warrant Shares, provided that if any law or regulation requires the Corporation to take any action with respect to the Warrant Shares specified in such notice before the issuance thereof, the date of delivery of such Warrant Shares shall be extended for the period necessary to take such action. 1.5 Termination of Warrants. The Warrants, to the extent not heretofore exercised, shall terminate on the first to occur of the following dates: (a) If the Employee's employment with the Corporation terminates because of his death, any Warrants held by the Employee on the date of his death may be exercised only within thirty (30) days after his death and only to the extent that the Warrants could have been exercised immediately before the Employee's death; (b) If the Employee's employment with the Corporation terminates because of Total Disability (as hereinafter defined) after at least one (1) year of continuous employment with the Corporation immediately following the date on which Warrants were originally granted in the Employment Agreement, the Employee may exercise the Warrant to the extent that it could be exercised upon such termination of employment at any time within thirty (30) days after the employment shall terminate; (c) If the Employee's employment with the Corporation terminates because of his retirement after at least one (1) year of continuous employment with the Corporation immediately following the date on which the Warrants were granted, the Employee may exercise the Warrant to the extent that the Warrants can be exercised upon such termination of employment at any time within thirty (30) days after retirement. Retirement means retirement from the Corporation pursuant to the provisions of the Corporation's policy as may be implemented by the Board of Directors from time to time.; (d) If the Employee's employment with the Corporation is terminated by the Corporation without cause, the Employee may exercise the Warrants to the extent that the Warrants can be exercised upon such termination of employment at any time within thirty (30) days after such termination; provided, however, that any Option Shares so acquired shall be subject to the rights of the Corporation or the Founders to purchase such shares in accordance with the provisions of Section 2.6 of this Agreement; (e) Termination of the Employee's employment with the Corporation for any reason other than death, disability, retirement, or without cause; (f) The happening of any event resulting in the termination of this Agreement pursuant to Section 3.14 hereof; (g) May 1, 2006. 1.6 Rights Prior to Exercise of Warrant. The Warrants granted to the Employee are nontransferable by the Employee and are exercisable only by the Employee. The Employee shall have no -4- right as a shareholder with respect to the Warrant Shares until payment of the warrrantprice and delivery to the Employee of such Warrant Shares as herein provided. 1.7 Restrictions. All Warrant Shares acquired by Employee pursuant to the Warrants shall be subject to the restrictions on sale, encumbrance, and other dispositions contained in Article II of this Agreement. 1.8 Time is of the Essence. Time is of the essence in exercising the Warrants under this Agreement. ARTICLE II RESTRICTIONS ON WARRANT SHARES 2.1 Restriction on Share Transfer. Employee shall not sell, assign, transfer, pledge, or otherwise dispose of or in any way alienate any of his respective Warrant Shares in the Corporation by operation of law or otherwise except as provided in this Agreement. 2.2 Offer to Purchase All Warrant Shares. If any one or more of the Founders receives a third party offer to purchase fifty percent (50%) or more of all of the shares of the Corporation owned collectively by the Founders plus all of the Warrant Shares and Warrants and the Founders desire to accept the third party offer, then the Founders have the right to deliver a notice (the "Bring Along Notice") with respect to such third party offer to the Corporation and the Employee stating that the Founders propose to effect such transaction, the name and address of the third party offeror, and the purchase price under the third party offer, together with a copy of all writings, if any, between the Founders and the third party offeror or such other person necessary to establish the terms of such third party offer. Employee agrees that upon receipt of the Bring Along Notice, Employee shall be obligated to sell all Warrants and Warrant Shares held by him to the third party offeror upon the terms and conditions (including, without limitation, purchase price) of the third party offeror (and otherwise take all necessary action to cause the Corporation to consummate the proposed transaction). The rights of first refusal in Section 2.3 of this Agreement shall not apply to this Section 2.2. Notwithstanding anything in this Section 2.2 to the contrary, Employee acknowledges and agrees that the rights and obligations hereunder are subject to (and, where applicable, subordinate to the rights of the Investor, as hereinafter defined) the terms and conditions of a Co-Sale Agreement between the Founding Shareholders, the Corporation and the Frank Batten, Jr. Trust, a copy of which is attached hereto as Exhibit A (the "Co-Sale Agreement"), and that the number of Warrants and Warrant Shares sold by the Employee to the third party offeror may be reduced by the participation rights of the Investor as defined and provided in the Co-Sale Agreement. For purposes of this Section 2.2, the term "Investor" shall have the same meaning as set forth in the Co-Sale Agreement. 2.3 Transfers During Employee's Lifetime. Except as otherwise set forth in this Agreement, no Warrant Shares owned by Employee shall be transferred, sold, assigned, pledged or otherwise disposed of during Employee's lifetime except in accordance with the following provisions: (a) Offer to Corporation. Employee (hereinafter referred to as "Offeror") intending to transfer any Warrant Shares (the "Offered Shares") shall first submit to the Corporation a written offer to sell the Offered Shares to the Corporation at the price offered by the proposed purchaser, on the terms of such offer. Every written offer submitted to the Corporation in accordance with the provisions of this Section 2.3(a) shall continue to be a binding offer to sell until expressly rejected by an officer or director of the Corporation acting pursuant to a resolution adopted in accordance with Section 2.7 of this Agreement or until the expiration of a period of sixty (60) days after the delivery of such offer to the Corporation, whichever time is earlier. Upon delivery to the Corporation of any written offer submitted -5- in accordance with the provisions of this Section 6(a), any officer or director of the Corporation, acting before the termination of the offer and pursuant to a resolution adopted in accordance with Section 2.7 of this Agreement may bind the Corporation to purchase all or any part of the Offered Shares. (b) Offer to Founders. Upon termination of the offer referred to in subparagraph (a) above, the Offeror shall then submit to the Founders a written offer to sell, at the price offered by the proposed purchaser, on the terms of such offer, any of the Offered Shares not previously purchased by the Corporation under the aforesaid offer to it (the "Excess Offered Shares"). Each Founder shall then have the right to purchase up to his Founder Percentage of the Excess Offered Shares. Each Founder's right to purchase the Excess Offered Shares shall be exercisable by written notices to the Offeror, the Corporation and the other Founders given within thirty (30) days of the Offeror's written offer to the Founders. Each Founder has the right and may indicate in such notice, his election to purchase the balance of such Excess Offered Shares if any other Founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Offered Shares. The failure of a Founder to exercise his right to purchase Excess Offered Shares within the thirty (30) day notice period shall be regarded as a waiver of his right to participate in the purchase of the Excess Offered Shares. For purposes of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Offeror's written offer to the Founders. (c) Contents of Offer and Subsequent Transfer. Every written offer submitted in accordance with this Section 2.3 shall specifically name the person or persons to whom the Offeror intends to transfer the shares, the number of shares that he intends to so transfer to each person, and the price per share and other terms upon which each intended transfer is to be made, and shall include copies of the written offer and pertinent documentation. Upon the termination of the written offer to the Founders, the Offeror shall, for a period of thirty (30) days thereafter, be free to transfer any unpurchased shares to the person or persons so named at the price per share and upon the other terms so named as stated in the Offeror's written offer to the Corporation; provided that any such transferee of those shares shall thereafter be bound by and subject to all of the provisions and restrictions of this Agreement and shall agree in writing to be so bound. However, if the Offeror fails to make such transfer within such thirty (30) days, such shares shall again be subject to all the restrictions and provisions of this Agreement. (d) Consideration for Shares. If any consideration to be received by the Offeror for the Warrant Shares offered is property other than cash, then the price per share shall be measured to that extent by the fair market value of such noncash consideration. Fair market value for the purposes of this Section 6(d) shall mean the sum of (i) the fair market value of any noncash consideration offered for the shares as determined by the Board of Directors of the Corporation (the "Board"), plus (ii) the value of any special benefits to the Offeror of such noncash consideration to the extent they can be reasonably identified and valued, plus (iii) the amount of any additional expense or cost (including additional taxes) incurred by the Offeror in accepting cash instead of such noncash consideration, in each case based upon a realistic appraisal of such noncash consideration, special benefits, expense or cost agreed upon by the Offeror and the Corporation or by two independent qualified appraisers, one being selected and paid for by the Offeror and the other by the Corporation. If the two appraisers are unable to agree, they shall select a third, and the determination of the third appraiser shall be final and conclusive. The cost of the third appraiser shall be divided equally between the Offeror and the Corporation. (e) Closing. The closing of the sale of the Warrant Shares shall be sixty (60) days following the last timely delivery of notice of election to purchase any of the shares. (f) Involuntary Transfer. The provisions of this Section 2.3 shall also be applicable to Involuntary Transfers of Warrant Shares. "Involuntary Transfer" means any transfer, proceeding or -6- action by or in which Employee shall be deprived or divested of any right, title or interest in or to any of his Warrant Shares, including, without limitation, any seizure under levy of attachment or execution, any transfer in connection with bankruptcy or other court proceeding to a debtor-in-possession, trustee or receiver or other officer or agency, or any transfer pursuant to a separation agreement or entry of a final court order in a divorce proceeding. In such event, the Corporation and the Founders shall have the right to purchase from either the Employee or the transferee on the Stipulated Terms (as hereinafter defined) all of the Warrant Shares of the Corporation owned by the Employee at the lesser of (i) 80% of the book value of the Warrant Shares as determined by the Board, (ii) 80% of the fair market value of the Warrant Shares based on the Corporation as a going concern as determined by the Board, or (iii) the amount of the indebtedness which resulted in the involuntary transfer of Warrant Shares. Notice to the Corporation by any person or in any manner of an Involuntary Transfer shall be deemed a written offer to sell the Warrant Shares and the Corporation and the Founders shall have the right to purchase the Warrant Shares in accordance with the procedures as set forth in this Section 2.2. 2.4 Option to Purchase Upon Permanent Disability. If Employee becomes totally disabled for a period of three (3) months (the "Disabled Employee"), the Corporation and the Founders shall each have the option to purchase all or any of the Disabled Employee's Warrant Shares upon the following terms: (a) Exercise of Option. Such option of the Corporation shall commence on the date three (3) months after such disability commences and shall be exercised by written notice by the Corporation within ninety (90) days after such right commences. The purchase price of the Warrant Shares shall be the Stipulated Price and shall be payable upon the Stipulated Term (as hereinafter defined), which shall be paid in cash to the extent of proceeds of insurance received by the Corporation as the result of such permanent disability, if any, with the balance of the purchase price payable pursuant to the Stipulated Terms (as hereinafter defined). (b) Exercise of Option by Founders. In the event the Corporation does not elect to exercise its option to purchase all or any of the Warrant Shares under Section 2.4(a) above (the "Excess Warrant Shares"), then each Founder shall have the option to purchase up to his Founder Percentage of the Excess Warrant Shares. Each Founder's right to purchase the Excess Warrant Shares shall be exercisable by written notice to the Disabled Employee, the Corporation and the other Founders given within thirty (30) days of the termination of the Corporation's option. Each Founder has the right and may indicate in such notice his election to purchase the balance of such Excess Warrant Shares if any other Founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Warrant Shares. The failure of a Founder to exercise his right to purchase Excess Warrant Shares within the thirty (30) day notice period, shall be regarded as a waiver of his right to participate in the purchase of the Excess Warrant Shares. For purposes of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Disabled Employee's Total Disability. (c) Determination of Disability. "Totally Disabled" shall mean the inability by reason of a physical or mental condition, or both, of the Disabled Employee to perform satisfactorily his usual duties for the Corporation, as determined by the Board. The Total Disability shall be deemed to have commenced on the date of the determination by the Board. (d) Closing. The closing of the sale of the Warrant Shares shall be sixty (60) days after delivery of the Corporation's or the Founder's, as the case may be, notice of election to purchase the Warrant Shares. -7- 2.5 Option to Purchase Upon Death. Upon the death of Employee (the "Decedent"), all of the Warrant Shares of the Corporation which had been owned by the Decedent and all Warrant Shares owned by the Decedent's representative if Warrants are exercised within thirty (30) days after the Decedent's death and to which he or his personal representatives shall be entitled shall be sold and purchased as herein provided at the option of the Corporation. (a) Option of the Corporation to Purchase. The Corporation has the option to purchase from Decedent's estate, and, if the option is exercised, Decedent's estate shall sell to the Corporation, all the Warrant Shares of the Corporation owned by Decedent at the Stipulated Price and upon the Stipulated Terms (as hereinafter defined). The Corporation shall exercise its option by giving written notice to the Decedent's personal representative within one hundred twenty (120) days after the Decedent's death. (b) Option of the Founders to Purchase. In the event the Corporation does not elect to exercise its option to purchase all or any of the Warrant Shares under Section 2.5(a) above (the "Excess Warrant Shares"), then each Founder shall have the option to purchase up to his Founder Percentage of the Excess Warrant Shares at the Stipulated Price and upon the Stipulated Terms (as hereinafter defined). Each Founder's right to purchase the Excess Warrant Shares shall be exercisable by written notice to the Decedent's Estate, the Corporation and the other Founders given within thirty (30) days of the termination of the Corporation's option. Each Founder has the right and may indicate in such notice his election to purchase the balance of such Excess Warrant Shares if nay other Founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Warrant Shares. The failure of a Founder to exercise his right to purchase Excess Warrant Shares within the thirty (30) day notice period, shall be regarded as a waiver of his right to participate in the purchase of the Excess Warrant Shares. For purposes of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Decedent's death. (c) Insurance. The Corporation may, but is not obligated to, obtain insurance on the life of Employee for a sum determined by the Corporation, naming itself as beneficiary of the policies The Corporation shall pay all premiums on the insurance policies. The Corporation shall be the sole owner of the insurance policies and may apply to the payment of premiums any dividends declared and paid on the policies. (d) Closing. The Closing of the purchase of the Warrant Shares shall be ninety (90) days after the Corporation or the Founders, as the case may be, exercises their option to purchase the Warrant Shares. 2.6 Purchase Upon Termination of Employment. In the event that Employee's employment with the Corporation is terminated by the Corporation or such Employee for any reason whatsoever, with or without cause, or at any time (the "Terminated Employee"), the Corporation and the Founders shall each have the option to purchase all or any of the Warrant Shares owned by the Terminated Employee upon the following terms: (a) Option to Purchase by Corporation. The Corporation shall have the option to purchase from the Terminated Employee all of the Warrant Shares owned by the Terminated Employee at the Stipulated Price and upon the Stipulated Terms (as hereinafter defined), which option the corporation may exercise by notice in writing to the Terminated Employee within (90) days of the effective date of termination; provided, however, in the event the Employee's terminated for cause, then the option to purchase under this Section 2.6(a) and 2.6(b) shall be at the lesser of eighty percent (80%) of book value of the Warrant Shares as determined by the Board or eighty percent (80%) of the value of the Warrant -8- Shares based on the Corporation as a going concern as determined by the Board, and on the Stipulated Terms. (b) Option to Purchase by Founders. In the event the Corporation does not elect to exercise its option to purchase all or any of the Warrant Shares under 2.6(a) above (the "Excess Warrant Shares"), then each Founder shall have the option to purchase up to his Founder Percentage of the Excess Warrant Shares at the price and under the terms provided in Section 2.6(a) above. Each Founder's right to purchase the Excess Warrant Shares shall be exercisable by written notice to the Terminated Employee, the corporation and the other Founders given within thirty (30) days of the termination of the Corporation's option. Each Founder has the right and may indicate in such notice his election to purchase the balance of such Excess Warrant Shares if any other founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Warrant Shares. The failure of a Founder to exercise his right to purchase Excess Warrant Shares within the thirty (30) day notice period, shall be regarded as a waiver of his right to participate in the purchase of the Excess Warrant Shares. For purpose of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Employee's termination of employment. (c) Closing. The closing of the purchase of the Warrant Shares shall be ninety (90) days after the Corporation or the Founders, as the case may be, exercise their option to purchase the Warrant Shares. 2.7 Vote on Option to Purchase. Whenever, under the terms of this Agreement, the Corporation has an option to purchase Warrant Shares, action on such option may be taken by the holders of a majority of the voting shares of the Corporation (or such other percentage as may be required by the Corporation's Articles of Incorporation as may be amended and/or restated from time to time if such redemption of stock under this Agreement is not excluded from such greater percentage), exclusive of the Warrant Shares held by the Offeror, the Decedent, the Disabled Employee or the Terminated Employee, as the case may be. 2.8 Non-Exercise of Option. Whenever, under the terms of this Agreement, the Corporation and Founders have an option to purchase Warrant Shares and elects not to exercise the option, said Warrant Shares shall nevertheless remain subject to all of the terms of this Agreement. 2.9 Dates for Determination of Purchase Price. This Section sets the various dates from which the purchase price for Warrant Shares purchased pursuant to this Agreement shall be determined. The price shall be determined in each case as of the following valuation dates: (a) upon the death of Employee, as of the date of death; (b) upon the Total Disability of Employee, as of the date of determination of Total Disability by the Board; (c) upon a termination of employment of Employee, upon the effective date of the termination; and (d) upon an Involuntary Transfer, upon the effective date of the Involuntary Transfer. 2.10 Payment of Purchase Price. The manner of payment of the purchase price for any Warrant Shares pursuant to this Agreement, with the exception of a purchase upon the terms offered by a proposed third-party purchaser or as otherwise provided in this Agreement, shall be determined by this Section. (a) Stipulated Price. The "Stipulated Price" shall be that price per share of the Corporation as a going concern equal to eighty percent (80%) of the fair market value for such shares as determined by the Board. -9- (b) Stipulated Terms. The purchase price for any Warrant Shares purchased pursuant to this Agreement shall be paid either in cash or by a cash down payment and the delivery of a secured promissory note, at the option of the purchaser. If the purchase is made for any reason other than the death of the Employee, the down payment shall equal at least twenty percent (20%) of the purchase price. If the purchase is made because of the death of Employee, the down payment shall equal not less than the greater of twenty percent (20%) of the purchase price or the full amount of the net proceeds from any insurance policies maintained by the Corporation on the life of the Employee. Any promissory note shall provide for equal quarterly installments of principal over a term not to exceed five (5) years, and shall bear interest at the rate of seven (7%) percent. Accrued interest shall be payable quarterly commencing with the first installment of principal. The note shall be subject to prepayment in whole or in part at any time and without penalty. In the event of default in payment of any installment when due, the whole sum of the principal and interest shall become immediately due and payable at the option of the holder. Notwithstanding anything herein to the contrary, if the purchase price is less than $10,000.00 the entire purchase price shall be paid in cash at closing. (c) Delivery of Warrant Shares. At such time as the cash and promissory note, if applicable, have been delivered to the Employee or his estate, the Warrant Shares of the Employee shall be transferred to the purchaser or purchasers. (d) Security. If part of the purchase price is paid by delivery of the purchaser's promissory note, then, as security for payments due under the terms of the note, the purchaser shall grant to the Employee a security interest in the Shares by executing a pledge and escrow agreement and whatever additional documents may be reasonably necessary to perfect the security interest of the Employee or his estate. The security documents shall provide that the Corporation or other purchaser shall deposit the shares it is purchasing with an escrow agent and that, if the purchaser defaults under the terms of the promissory note or the security documents, the Employee or his estate shall have the right to receive possession of the shares and to exercise all other rights of a secured party under the North Carolina Uniform Commercial Code. (e) Insufficient Corporate Surplus. If, at the time the Corporation is required to make payment of the purchase price for shares pursuant to this Agreement and/or to issue its promissory notes therefor, its surplus is insufficient for such purposes under applicable law, then the Corporation shall promptly take all action necessary and proper under applicable law to increase, to the extent possible, the surplus of the Corporation to permit such payment and/or the issuance of such promissory note. Employee or his personal representative shall perform such acts, execute such instruments, and vote the respective shares in such a manner as may be required to increase the available surplus to an amount sufficient to authorize the purchase of the shares, including, but not limited to, a recapitalization to reduce the capital of the Corporation and increase its surplus or a reappraisal of the assets of the Corporation for the purpose of reflecting the market value. ARTICLE III GENERAL PROVISIONS 3.1 Corporate Action and Articles of Incorporation. The Corporation and the Individual Parties shall take all action required pursuant to this Agreement to effectuate the provisions herein. The Corporation shall become a party to this Agreement. 3.2 Share Certificates. Every certificate representing Warrant Shares of the Corporation shall bear the following legend prominently displayed: -10- "The shares represented by this certificate, and the transfer thereof, are subject to the provisions of that certain Agreement, dated as of September 29, 1998, among ROBERT F. YOUNG, NANCY R. YOUNG, MARC EWING, DONALD J. BARNES and RED HAT SOFTWARE, INC., a Delaware corporation, a copy of which is on file in, and may be examined at, the principal office of the Corporation." 3.3 Warrant Shares. All references to Warrant Shares owned by Employee shall mean any outstanding shares of the Corporation hereafter owned by Employee and any shares distributed with respect to any such shares in a stock split, stock dividend, recapitalization, reorganization or otherwise. 3.4 Necessary Acts. Each party hereto agrees that they will do any act or thing and will execute any and all instruments necessary and/or proper to make effective the provisions of this Agreement. 3.5 Severability. Should any provision of this Agreement be declared to be invalid for any reason or to have ceased to be binding on the parties hereto, such provision shall be severed, and all other provisions herein shall continue to be effective and binding. 3.6 Governing Law. This Agreement shall be subject to and governed by the laws of the State of Delaware. 3.7 Entire Agreement. This Agreement contains the entire agreement between the parties hereto with respect to the subject matter hereof, and no change, amendment or modification of this Agreement shall be valid unless the same be in writing and signed by all the parties hereto. No waiver of any of the terms of this Agreement shall be valid unless signed by the party against whom such waiver is asserted. This Agreement supersedes and nullifies the terms of any other agreement setting forth the rights of the Employee previously entered into by Employee with respect to the subject matter hereof. The Employee acknowledges that his ownership of Warrants and Warrant Shares in the Corporation gives him no rights or expectations except those embodied in this Agreement. 3.8 Specific Performance. The parties acknowledge that the actual damage which would be sustained upon the breach of this Agreement by any of the parties or to a personal representative of a Decedent aggrieved by the breach or threatened breach of any of its provisions shall be entitled to seek from any court of competent jurisdiction an order for specific performance of all of the terms and conditions of this agreement. This provision does not limit the parties from seeking any other available remedies at law or equity. 3.9 Prohibited Transfers Void. Any purported transfer in violation of this Agreement shall be void and shall not transfer any interest or title to the purported transferee. The Corporation shall not be required to transfer on its books any Warrant Shares sold or transferred in violation of any of the provisions set forth in this Agreement or to treat as owner of those Warrant Shares or to pay dividends to any transferee to whom any of those Warrant Shares shall have been so sold or transferred. 3.10 Representation as to Attorney. The Individual Parties (and the Corporation) acknowledge that a conflict may exist among their respective interests, and that the Individual Parties should seek the advice of independent counsel. The parties hereby waive any claim they may have as to any conflict which may exist in connection with the preparation of this Agreement. 3.11 New Parties. The Corporation shall not record a transfer of Warrant Shares from Employee to any person not a party hereto unless said person shall execute an acknowledgment of the -11- terms hereof and agreement to be bound hereby, except for a transfer of Warrant Shares to a third party pursuant to Section 2.2 of this Agreement. 3.12 Agreement Binding. This Agreement shall insure to the benefit of and be binding upon the parties hereto and their respective next-of-kin, legatees, administrators, executors, legal representatives, successors and permitted assigns (including remote, as well as immediate, successors to and assignees of said parties), except this Agreement shall not be binding on a third-party purchaser in the event of a transfer of Warrant Shares to such third party pursuant to Section 2.2 of this Agreement. 3.13 Pronouns and Headings. In this Agreement the masculine shall include the feminine and the singular shall include the plural as the context of this Agreement shall clearly require. The article and section headings in this Agreement are inserted for convenience only and are not part of the Agreement. 3.14. Termination. This Agreement shall commence as of the date hereof and shall continue in full force and effect until terminated (i) by the mutual agreement of the parties hereto, (ii) by the dissolution or bankruptcy of the Corporation, (iii) upon the effectiveness of a merger, consolidation or other acquisition of substantially all of the Corporation's assets, if the Corporation is not the surviving corporation, except that a merger or consolidation with a subsidiary which effects a mere change in the form or domicile of the Corporation without changing the respective shareholdings of the Individual Parties shall not terminate the agreement, even if the Corporation is not the surviving corporation, (iv) upon the issuance of any of the Corporation's shares sold by means of a public offering that is required to be registered under the federal securities laws, or (v) upon the sale of all of the issued and outstanding shares of the Corporation. 3.15 Transferability. Any rights or interests of the parties set forth in this Agreement are personal and nontransferable. 3.16 Notices. Any notice or offer required hereunder shall be deemed to have been validly given if delivered by certified mail, return receipt requested, postage prepaid, addressed, or by federal express overnight delivery (or other nationally recognized service) with receipt confirmed, in the case of the Corporation, to its principal office, and in the case of the Individual Parties, to their address appearing on the stock records of the Corporation or to such other address as he may designate. Notices hereunder shall be deemed given seven (7) business days after deposit in the United States Mail or the next business day, if delivered by Federal Express overnight delivery (or other nationally recognized service). 3.17 Jurisdiction and Venue. The parties agree that any action brought in any court whether federal or state shall be brought within the State of North Carolina in the judicial district of Durham, Durham County and do hereby waive all questions of personal jurisdiction or venue for the purpose of carrying out this provision. 3.18 Counterparts. This Agreement may be executed in one or more counterparts, each of which will be deemed to be an original copy of this Agreement and all of which, when taken together, will be deemed to constitute one and the same agreements. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -12- IN WITNESS WHEREOF, the Corporation has caused this Agreement to be signed by its duly authorized officers and its corporate seal to be affixed hereto, and the Individual Parties have hereunto set their hands, all as of the day and year first above written. RED HAT SOFTWARE, INC. By: /s/ Robert F. Young ---------------------- Title: CEO ATTEST: /s/ David Schumannfang - ------------------------ Secretary [CORPORATE SEAL] /s/ Robert F. Young -------------------------- Robert F. Young /s/ Nancy R. Young -------------------------- Nancy R. Young /s/ Marc Ewing -------------------------- Marc Ewing EMPLOYEE /s/ Donald J. Barnes -------------------------- Donald J. Barnes -13- SPOUSAL CONSENT The undersigned, being the spouse of Employee who has signed this Agreement, hereby acknowledges that she has read and is familiar with its provisions and agrees to be bound thereby and to join therein to the extent, if any, that her joinder may be necessary. The undersigned hereby agrees that her spouse may join in the future amendment or modification of this Agreement without any further signature, acknowledgment, agreement or consent on her part; and further agrees that any interest which she may have in the Warrants and Warrant Shares (as defined in this Agreement) owned directly or beneficially by her spouse shall be subject to the provisions of this Agreement. /s/ Ashley S. Barnes -------------------------- Name: AMENDMENT AMENDMENT, made as of May 24, 1999, by and among Red Hat Software, Inc. (the "Company"), Robert F. Young, Nancy R. Young and Marc Ewing (collectively, the "Founders") and Donald Barnes (the "Warrantholder"). WHEREAS, the Company, the Founders and the Warrantholder are parties to that certain Warrant, dated as of August 12, 1997 (the "Warrant"), which by its terms, terminates on the issuance of any of the Company's shares sold by means of a public offering that is required to be registered under the federal securities laws; and WHEREAS, the Company, the Founders and the Warrantholder wish to amend the Warrant to prevent it from terminating under such circumstances and to remove certain restrictions on exercised Warrant Shares upon the closing of the Company's initial public offering. NOW THEREFORE, the parties hereto agree as follows: 1. Capitalized terms not defined herein shall have the meaning set forth in the Warrant. 2. Section 3.14 of the Warrant shall be amended and restated as follows: "3.14. Termination. This Agreement shall commence as of the date hereof and shall continue in full force and effect until terminated (i) by the mutual agreement of the parties hereto, (ii) by the dissolution or bankruptcy of the Corporation, (iii) upon the effectiveness of a merger, consolidation or other acquisition of substantially all of the Corporation's assets, if the Corporation is not the surviving corporation, except that a merger or consolidation with a subsidiary which effects a mere change in the form or domicile of the Corporation without changing the respective shareholdings of the Individual Parties shall not terminate the agreement, even if the Corporation is not the surviving corporation, or (iv) upon the sale of all of the issued and outstanding shares of the Corporation. Notwithstanding the foregoing, the provisions of Article II hereof shall cease and have no further force or effect with respect to any Warrant Shares upon the issuance of any of the Corporation's shares sold by means of a public offering that is required to be registered under the federal securities laws." 3. Continuing Effect. Except as otherwise set forth herein, all terms and conditions of the Warrant shall remain in full force and effect, and this Amendment shall not constitute a modification, acceptance or waiver of any other provision of the Warrant. 4. Counterparts. This Amendment may be executed in two or more counterparts, each of which shall constitute an original, but all of which, when taken together, shall constitute but one instrument. -2- IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first written above. RED HAT SOFTWARE, INC. By: /s/ Robert F. Young ---------------------- Title: CEO /s/ Marc Young - -------------------------- Marc Ewing /s/ Robert F. Young - -------------------------- Robert F. Young /s/ Nancy R. Young - -------------------------- Nancy R. Young /s/ Donald Barnes - -------------------------- Donald Barnes EX-10.6 11 EXHIBIT 10.6 Exhibit 10.6 AGREEMENT THIS AGREEMENT, made as of the 29th day of September 1998, by and between ROBERT F. YOUNG, NANCY R. YOUNG and MARC EWING (individually and collectively, the "Founders"); LISA F. SULLIVAN ("Employee," and collectively with the Founders, the "Individual Parties"); and RED HAT SOFTWARE, INC., a Delaware corporation with offices in Research Park, North Carolina (the "Corporation"); W I T N E S S E T H: WHEREAS, as of the date of this Agreement the Founders own and hold of record shares of the Corporation's common stock as follows: Founder Number of Shares ------- ---------------- Robert F. Young 2,030,000 Nancy R. Young 1,820,913 Marc Ewing 4,044,238 WHEREAS, as of the date of this Agreement Employee has been granted warrants (the "Warrants") to purchase shares of the Corporation's common stock pursuant to an Employment Agreement by and between the Corporation and Employee commencing May 1, 1995 and executed October 10, 1995 (the "Employment Agreement") and desires to enter into this Agreement to bind Employee and the Corporation to its terms for the Warrants and for any and all shares of the Corporation issued to Employee upon exercise of the Warrants (the "Warrant Shares") in accordance with the terms hereof; and WHEREAS, pursuant to the Warrants, the Employee, if such Employee exercises all Warrants available pursuant to such Employee's Employment Agreement prior to the termination of such Warrants pursuant to the terms of this Agreement, may own and hold of record, upon exercise of all Warrants, total shares of the Corporation's common stock as follows: Employee Number of Warrant -------- Option Shares ------------- Lisa F. Sullivan 550,000; and WHEREAS, the Employee acknowledges that there are shares of the Corporation issued and outstanding to other shareholders and stock options for shares of the Corporation issued and outstanding to other employees of the Corporation which are not subject to this Agreement and that the Corporation, in its sole discretion, will issue shares of common and preferred stock from time to time to other shareholders and pursuant to stock options which will not be subject to this Agreement; and WHEREAS, the Corporation also anticipates that it may in the future issue additional stock options to employees, directors, consultants or other service providers of the Corporation pursuant to a plan or plans established by the Corporation's Board of Directors (the "Plan") and that the Corporation, in its sole discretion, may, but shall not be obligated to, subject any such stock options authorized under the Plan and any shares of the Corporation's stock purchased pursuant to such stock options to terms and conditions similar to those contained in this Agreement; and -2- WHEREAS, the Individual Parties and the Corporation recognize that the Warrants are granted to the Employee as an incentive to promote the success of the business and to encourage the Employee to remain in the Corporation's employ; and WHEREAS, the Individual Parties and the Corporation desire to set forth and confirm the terms and conditions upon which the Warrants may be exercised and terminated and the terms and conditions under which they Warrant Shares will be held; and WHEREAS, the Individual Parties and the Corporation agree that it is in their best interest to agree upon the terms and conditions set forth herein and that such terms and conditions reflect the full understanding of the Individual Parties and the Corporation. NOW, THEREFORE, in consideration of the premises and of the mutual covenants and conditions herein contained, the Individual Parties and the Corporation agree, for themselves, their successors and assigns, as follows: ARTICLE I WARRANTS 1.1 Warrant. The Corporation and the Employee hereby agree that the Employee's rights to purchase Warrant Shares pursuant to the Employment Agreement, and the exercise of the Warrants, shall be governed by the terms of this Article I. Employee agrees that the provisions in this Agreement pertaining to the exercise and termination of Warrants and the vesting and purchase of Warrant Shares represents the understanding of the parties and shall control and shall supersede over any provisions to the contrary in such Employee's Employment Agreement. Employee acknowledges that the only options or warrants to purchase or receive shares of the Corporation's stock to which the Employee is entitled are the Warrants described in this Article I, that no profit sharing plan has been implemented by the Corporation, and that the Employee waives any rights under Section 3c of the Employment Agreement to demand "warrants" pursuant to a profit sharing plan unless a profit sharing plan expressly granting the right to Employee to "warrants" is hereinafter implemented by the Corporation and authorized by its Board of Directors. 1.2 Vesting. Employee has the option to purchase the following number of Warrant Shares on the dates (the "Vesting Dates") set forth on the following schedule:
Vesting Dates ------------- Employee 5/1/96 5/1/97 5/1/98 5/1/99 - -------- ---------- ---------- ---------- ---------- 137,500 137,500 137,500 137,500
However, if the Employee does not purchase the full number of Warrant Shares to which the Employee is entitled on or before the Vesting Dates, the Employee is permitted to purchase those remaining Warrant Shares at a later period (unless terminated) in addition to those Warrant Shares which the Employee may otherwise be entitled to purchase. No partial exercise of such Warrant may be for less than one hundred (100) full Warrant Shares. In no event shall the Corporation be required to transfer fractional shares to the Employee. The Individual Parties and the Corporation acknowledge and confirm that as of April 26, 1999, the Employee has exercised 94,500 of her Warrants and that, after selling 49,500 Warrant Shares, Employee owns 45,000 Warrant Shares. -3- 1.3 Purchase Price. The purchase price for each Warrant Share shall be $.0001 per Warrant Share. 1.4 Exercise of Warrants. The respective number of Warrants shall be exercisable from time to time after the applicable Vesting Dates by ten (10) days written notice to the Corporation and the payment in cash to the Corporation of the purchase price of the Warrant Shares which the Employee may and elects to purchase. The Corporation shall make immediate delivery of such Warrant Shares, provided that if any law or regulation requires the Corporation to take any action with respect to the Warrant Shares specified in such notice before the issuance thereof, the date of delivery of such Warrant Shares shall be extended for the period necessary to take such action. 1.5 Termination of Warrants. The Warrants, to the extent not heretofore exercised, shall terminate on the first to occur of the following dates: (a) If the Employee's employment with the Corporation terminates because of her death, any Warrants held by the Employee on the date of her death may be exercised only within thirty (30) days after her death and only to the extent that the Warrants could have been exercised immediately before the Employee's death; (b) If the Employee's employment with the Corporation terminates because of Total Disability (as hereinafter defined) after at least one (1) year of continuous employment with the Corporation immediately following the date on which Warrants were originally granted in the Employment Agreement, the Employee may exercise the Warrant to the extent that it could be exercised upon such termination of employment at any time within thirty (30) days after the employment shall terminate; (c) If the Employee's employment with the Corporation terminates because of her retirement after at least one (1) year of continuous employment with the Corporation immediately following the date on which the Warrants were granted, the Employee may exercise the Warrant to the extent that the Warrants can be exercised upon such termination of employment at any time within thirty (30) days after retirement. Retirement means retirement from the Corporation pursuant to the provisions of the Corporation's policy as may be implemented by the Board of Directors from time to time.; (d) If the Employee's employment with the Corporation is terminated by the Corporation without cause, the Employee may exercise the Warrants to the extent that the Warrants can be exercised upon such termination of employment at any time within thirty (30) days after such termination; provided, however, that any Option Shares so acquired shall be subject to the rights of the Corporation or the Founders to purchase such shares in accordance with the provisions of Section 2.6 of this Agreement; (e) Termination of the Employee's employment with the Corporation for any reason other than death, disability, retirement, or without cause; (f) The happening of any event resulting in the termination of this Agreement pursuant to Section 3.14 hereof; (g) May 1, 2006. 1.6 Rights Prior to Exercise of Warrant. The Warrants granted to the Employee are nontransferable by the Employee and are exercisable only by the Employee. The Employee shall have no -4- right as a shareholder with respect to the Warrant Shares until payment of the warrrantprice and delivery to the Employee of such Warrant Shares as herein provided. 1.7 Restrictions. All Warrant Shares acquired by Employee pursuant to the Warrants shall be subject to the restrictions on sale, encumbrance, and other dispositions contained in Article II of this Agreement. 1.8 Time is of the Essence. Time is of the essence in exercising the Warrants under this Agreement. ARTICLE II RESTRICTIONS ON WARRANT SHARES 2.1 Restriction on Share Transfer. Employee shall not sell, assign, transfer, pledge, or otherwise dispose of or in any way alienate any of her respective Warrant Shares in the Corporation by operation of law or otherwise except as provided in this Agreement. 2.2 Offer to Purchase All Warrant Shares. If any one or more of the Founders receives a third party offer to purchase fifty percent (50%) or more of all of the shares of the Corporation owned collectively by the Founders plus all of the Warrant Shares and Warrants and the Founders desire to accept the third party offer, then the Founders have the right to deliver a notice (the "Bring Along Notice") with respect to such third party offer to the Corporation and the Employee stating that the Founders propose to effect such transaction, the name and address of the third party offeror, and the purchase price under the third party offer, together with a copy of all writings, if any, between the Founders and the third party offeror or such other person necessary to establish the terms of such third party offer. Employee agrees that upon receipt of the Bring Along Notice, Employee shall be obligated to sell all Warrants and Warrant Shares held by her to the third party offeror upon the terms and conditions (including, without limitation, purchase price) of the third party offeror (and otherwise take all necessary action to cause the Corporation to consummate the proposed transaction). The rights of first refusal in Section 2.3 of this Agreement shall not apply to this Section 2.2. Notwithstanding anything in this Section 2.2 to the contrary, Employee acknowledges and agrees that the rights and obligations hereunder are subject to (and, where applicable, subordinate to the rights of the Investor, as hereinafter defined) the terms and conditions of a Co-Sale Agreement between the Founding Shareholders, the Corporation and the Frank Batten, Jr. Trust, a copy of which is attached hereto as Exhibit A (the "Co-Sale Agreement"), and that the number of Warrants and Warrant Shares sold by the Employee to the third party offeror may be reduced by the participation rights of the Investor as defined and provided in the Co-Sale Agreement. For purposes of this Section 2.2, the term "Investor" shall have the same meaning as set forth in the Co-Sale Agreement. 2.3 Transfers During Employee's Lifetime. Except as otherwise set forth in this Agreement, no Warrant Shares owned by Employee shall be transferred, sold, assigned, pledged or otherwise disposed of during Employee's lifetime except in accordance with the following provisions: (a) Offer to Corporation. Employee (hereinafter referred to as "Offeror") intending to transfer any Warrant Shares (the "Offered Shares") shall first submit to the Corporation a written offer to sell the Offered Shares to the Corporation at the price offered by the proposed purchaser, on the terms of such offer. Every written offer submitted to the Corporation in accordance with the provisions of this Section 2.3(a) shall continue to be a binding offer to sell until expressly rejected by an officer or director of the Corporation acting pursuant to a resolution adopted in accordance with Section 2.7 of this Agreement or until the expiration of a period of sixty (60) days after the delivery of such offer to the Corporation, whichever time is earlier. Upon delivery to the Corporation of any written offer submitted -5- in accordance with the provisions of this Section 6(a), any officer or director of the Corporation, acting before the termination of the offer and pursuant to a resolution adopted in accordance with Section 2.7 of this Agreement may bind the Corporation to purchase all or any part of the Offered Shares. (b) Offer to Founders. Upon termination of the offer referred to in subparagraph (a) above, the Offeror shall then submit to the Founders a written offer to sell, at the price offered by the proposed purchaser, on the terms of such offer, any of the Offered Shares not previously purchased by the Corporation under the aforesaid offer to it (the "Excess Offered Shares"). Each Founder shall then have the right to purchase up to her Founder Percentage of the Excess Offered Shares. Each Founder's right to purchase the Excess Offered Shares shall be exercisable by written notices to the Offeror, the Corporation and the other Founders given within thirty (30) days of the Offeror's written offer to the Founders. Each Founder has the right and may indicate in such notice, her election to purchase the balance of such Excess Offered Shares if any other Founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Offered Shares. The failure of a Founder to exercise her right to purchase Excess Offered Shares within the thirty (30) day notice period shall be regarded as a waiver of her right to participate in the purchase of the Excess Offered Shares. For purposes of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Offeror's written offer to the Founders. (c) Contents of Offer and Subsequent Transfer. Every written offer submitted in accordance with this Section 2.3 shall specifically name the person or persons to whom the Offeror intends to transfer the shares, the number of shares that he intends to so transfer to each person, and the price per share and other terms upon which each intended transfer is to be made, and shall include copies of the written offer and pertinent documentation. Upon the termination of the written offer to the Founders, the Offeror shall, for a period of thirty (30) days thereafter, be free to transfer any unpurchased shares to the person or persons so named at the price per share and upon the other terms so named as stated in the Offeror's written offer to the Corporation; provided that any such transferee of those shares shall thereafter be bound by and subject to all of the provisions and restrictions of this Agreement and shall agree in writing to be so bound. However, if the Offeror fails to make such transfer within such thirty (30) days, such shares shall again be subject to all the restrictions and provisions of this Agreement. (d) Consideration for Shares. If any consideration to be received by the Offeror for the Warrant Shares offered is property other than cash, then the price per share shall be measured to that extent by the fair market value of such noncash consideration. Fair market value for the purposes of this Section 6(d) shall mean the sum of (i) the fair market value of any noncash consideration offered for the shares as determined by the Board of Directors of the Corporation (the "Board"), plus (ii) the value of any special benefits to the Offeror of such noncash consideration to the extent they can be reasonably identified and valued, plus (iii) the amount of any additional expense or cost (including additional taxes) incurred by the Offeror in accepting cash instead of such noncash consideration, in each case based upon a realistic appraisal of such noncash consideration, special benefits, expense or cost agreed upon by the Offeror and the Corporation or by two independent qualified appraisers, one being selected and paid for by the Offeror and the other by the Corporation. If the two appraisers are unable to agree, they shall select a third, and the determination of the third appraiser shall be final and conclusive. The cost of the third appraiser shall be divided equally between the Offeror and the Corporation. (e) Closing. The closing of the sale of the Warrant Shares shall be sixty (60) days following the last timely delivery of notice of election to purchase any of the shares. (f) Involuntary Transfer. The provisions of this Section 2.3 shall also be applicable to Involuntary Transfers of Warrant Shares. "Involuntary Transfer" means any transfer, proceeding or -6- action by or in which Employee shall be deprived or divested of any right, title or interest in or to any of her Warrant Shares, including, without limitation, any seizure under levy of attachment or execution, any transfer in connection with bankruptcy or other court proceeding to a debtor-in-possession, trustee or receiver or other officer or agency, or any transfer pursuant to a separation agreement or entry of a final court order in a divorce proceeding. In such event, the Corporation and the Founders shall have the right to purchase from either the Employee or the transferee on the Stipulated Terms (as hereinafter defined) all of the Warrant Shares of the Corporation owned by the Employee at the lesser of (i) 80% of the book value of the Warrant Shares as determined by the Board, (ii) 80% of the fair market value of the Warrant Shares based on the Corporation as a going concern as determined by the Board, or (iii) the amount of the indebtedness which resulted in the involuntary transfer of Warrant Shares. Notice to the Corporation by any person or in any manner of an Involuntary Transfer shall be deemed a written offer to sell the Warrant Shares and the Corporation and the Founders shall have the right to purchase the Warrant Shares in accordance with the procedures as set forth in this Section 2.2. 2.4 Option to Purchase Upon Permanent Disability. If Employee becomes totally disabled for a period of three (3) months (the "Disabled Employee"), the Corporation and the Founders shall each have the option to purchase all or any of the Disabled Employee's Warrant Shares upon the following terms: (a) Exercise of Option. Such option of the Corporation shall commence on the date three (3) months after such disability commences and shall be exercised by written notice by the Corporation within ninety (90) days after such right commences. The purchase price of the Warrant Shares shall be the Stipulated Price and shall be payable upon the Stipulated Term (as hereinafter defined), which shall be paid in cash to the extent of proceeds of insurance received by the Corporation as the result of such permanent disability, if any, with the balance of the purchase price payable pursuant to the Stipulated Terms (as hereinafter defined). (b) Exercise of Option by Founders. In the event the Corporation does not elect to exercise its option to purchase all or any of the Warrant Shares under Section 2.4(a) above (the "Excess Warrant Shares"), then each Founder shall have the option to purchase up to her Founder Percentage of the Excess Warrant Shares. Each Founder's right to purchase the Excess Warrant Shares shall be exercisable by written notice to the Disabled Employee, the Corporation and the other Founders given within thirty (30) days of the termination of the Corporation's option. Each Founder has the right and may indicate in such notice her election to purchase the balance of such Excess Warrant Shares if any other Founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Warrant Shares. The failure of a Founder to exercise her right to purchase Excess Warrant Shares within the thirty (30) day notice period, shall be regarded as a waiver of her right to participate in the purchase of the Excess Warrant Shares. For purposes of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Disabled Employee's Total Disability. (c) Determination of Disability. "Totally Disabled" shall mean the inability by reason of a physical or mental condition, or both, of the Disabled Employee to perform satisfactorily her usual duties for the Corporation, as determined by the Board. The Total Disability shall be deemed to have commenced on the date of the determination by the Board. (d) Closing. The closing of the sale of the Warrant Shares shall be sixty (60) days after delivery of the Corporation's or the Founder's, as the case may be, notice of election to purchase the Warrant Shares. -7- 2.5 Option to Purchase Upon Death. Upon the death of Employee (the "Decedent"), all of the Warrant Shares of the Corporation which had been owned by the Decedent and all Warrant Shares owned by the Decedent's representative if Warrants are exercised within thirty (30) days after the Decedent's death and to which he or her personal representatives shall be entitled shall be sold and purchased as herein provided at the option of the Corporation. (a) Option of the Corporation to Purchase. The Corporation has the option to purchase from Decedent's estate, and, if the option is exercised, Decedent's estate shall sell to the Corporation, all the Warrant Shares of the Corporation owned by Decedent at the Stipulated Price and upon the Stipulated Terms (as hereinafter defined). The Corporation shall exercise its option by giving written notice to the Decedent's personal representative within one hundred twenty (120) days after the Decedent's death. (b) Option of the Founders to Purchase. In the event the Corporation does not elect to exercise its option to purchase all or any of the Warrant Shares under Section 2.5(a) above (the "Excess Warrant Shares"), then each Founder shall have the option to purchase up to her Founder Percentage of the Excess Warrant Shares at the Stipulated Price and upon the Stipulated Terms (as hereinafter defined). Each Founder's right to purchase the Excess Warrant Shares shall be exercisable by written notice to the Decedent's Estate, the Corporation and the other Founders given within thirty (30) days of the termination of the Corporation's option. Each Founder has the right and may indicate in such notice her election to purchase the balance of such Excess Warrant Shares if nay other Founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Warrant Shares. The failure of a Founder to exercise her right to purchase Excess Warrant Shares within the thirty (30) day notice period, shall be regarded as a waiver of her right to participate in the purchase of the Excess Warrant Shares. For purposes of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Decedent's death. (c) Insurance. The Corporation may, but is not obligated to, obtain insurance on the life of Employee for a sum determined by the Corporation, naming itself as beneficiary of the policies The Corporation shall pay all premiums on the insurance policies. The Corporation shall be the sole owner of the insurance policies and may apply to the payment of premiums any dividends declared and paid on the policies. (d) Closing. The Closing of the purchase of the Warrant Shares shall be ninety (90) days after the Corporation or the Founders, as the case may be, exercises their option to purchase the Warrant Shares. 2.6 Purchase Upon Termination of Employment. In the event that Employee's employment with the Corporation is terminated by the Corporation or such Employee for any reason whatsoever, with or without cause, or at any time (the "Terminated Employee"), the Corporation and the Founders shall each have the option to purchase all or any of the Warrant Shares owned by the Terminated Employee upon the following terms: (a) Option to Purchase by Corporation. The Corporation shall have the option to purchase from the Terminated Employee all of the Warrant Shares owned by the Terminated Employee at the Stipulated Price and upon the Stipulated Terms (as hereinafter defined), which option the corporation may exercise by notice in writing to the Terminated Employee within (90) days of the effective date of termination; provided, however, in the event the Employee's terminated for cause, then the option to purchase under this Section 2.6(a) and 2.6(b) shall be at the lesser of eighty percent (80%) of book value of the Warrant -8- Shares as determined by the Board or eighty percent (80%) of the value of the Warrant Shares based on the Corporation as a going concern as determined by the Board, and on the Stipulated Terms. (b) Option to Purchase by Founders. In the event the Corporation does not elect to exercise its option to purchase all or any of the Warrant Shares under 2.6(a) above (the "Excess Warrant Shares"), then each Founder shall have the option to purchase up to her Founder Percentage of the Excess Warrant Shares at the price and under the terms provided in Section 2.6(a) above. Each Founder's right to purchase the Excess Warrant Shares shall be exercisable by written notice to the Terminated Employee, the corporation and the other Founders given within thirty (30) days of the termination of the Corporation's option. Each Founder has the right and may indicate in such notice her election to purchase the balance of such Excess Warrant Shares if any other founder or Founders fail to exercise this right to purchase up to the full amount of their Founder Percentage of the Excess Warrant Shares. The failure of a Founder to exercise her right to purchase Excess Warrant Shares within the thirty (30) day notice period, shall be regarded as a waiver of her right to participate in the purchase of the Excess Warrant Shares. For purpose of this Section, Founder Percentage for each Founder shall be determined by dividing the total number of shares of the Corporation owned by the Founders into the total number of shares owned by each Founder at the time of the Employee's termination of employment. (c) Closing. The closing of the purchase of the Warrant Shares shall be ninety (90) days after the Corporation or the Founders, as the case may be, exercise their option to purchase the Warrant Shares. 2.7 Vote on Option to Purchase. Whenever, under the terms of this Agreement, the Corporation has an option to purchase Warrant Shares, action on such option may be taken by the holders of a majority of the voting shares of the Corporation (or such other percentage as may be required by the Corporation's Articles of Incorporation as may be amended and/or restated from time to time if such redemption of stock under this Agreement is not excluded from such greater percentage), exclusive of the Warrant Shares held by the Offeror, the Decedent, the Disabled Employee or the Terminated Employee, as the case may be. 2.8 Non-Exercise of Option. Whenever, under the terms of this Agreement, the Corporation and Founders have an option to purchase Warrant Shares and elects not to exercise the option, said Warrant Shares shall nevertheless remain subject to all of the terms of this Agreement. 2.9 Dates for Determination of Purchase Price. This Section sets the various dates from which the purchase price for Warrant Shares purchased pursuant to this Agreement shall be determined. The price shall be determined in each case as of the following valuation dates: (a) upon the death of Employee, as of the date of death; (b) upon the Total Disability of Employee, as of the date of determination of Total Disability by the Board; (c) upon a termination of employment of Employee, upon the effective date of the termination; and (d) upon an Involuntary Transfer, upon the effective date of the Involuntary Transfer. 2.10 Payment of Purchase Price. The manner of payment of the purchase price for any Warrant Shares pursuant to this Agreement, with the exception of a purchase upon the terms offered by a proposed third-party purchaser or as otherwise provided in this Agreement, shall be determined by this Section. (a) Stipulated Price. The "Stipulated Price" shall be that price per share of the Corporation as a going concern equal to eighty percent (80%) of the fair market value for such shares as determined by the Board. -9- (b) Stipulated Terms. The purchase price for any Warrant Shares purchased pursuant to this Agreement shall be paid either in cash or by a cash down payment and the delivery of a secured promissory note, at the option of the purchaser. If the purchase is made for any reason other than the death of the Employee, the down payment shall equal at least twenty percent (20%) of the purchase price. If the purchase is made because of the death of Employee, the down payment shall equal not less than the greater of twenty percent (20%) of the purchase price or the full amount of the net proceeds from any insurance policies maintained by the Corporation on the life of the Employee. Any promissory note shall provide for equal quarterly installments of principal over a term not to exceed five (5) years, and shall bear interest at the rate of seven (7%) percent. Accrued interest shall be payable quarterly commencing with the first installment of principal. The note shall be subject to prepayment in whole or in part at any time and without penalty. In the event of default in payment of any installment when due, the whole sum of the principal and interest shall become immediately due and payable at the option of the holder. Notwithstanding anything herein to the contrary, if the purchase price is less than $10,000.00 the entire purchase price shall be paid in cash at closing. (c) Delivery of Warrant Shares. At such time as the cash and promissory note, if applicable, have been delivered to the Employee or her estate, the Warrant Shares of the Employee shall be transferred to the purchaser or purchasers. (d) Security. If part of the purchase price is paid by delivery of the purchaser's promissory note, then, as security for payments due under the terms of the note, the purchaser shall grant to the Employee a security interest in the Shares by executing a pledge and escrow agreement and whatever additional documents may be reasonably necessary to perfect the security interest of the Employee or her estate. The security documents shall provide that the Corporation or other purchaser shall deposit the shares it is purchasing with an escrow agent and that, if the purchaser defaults under the terms of the promissory note or the security documents, the Employee or her estate shall have the right to receive possession of the shares and to exercise all other rights of a secured party under the North Carolina Uniform Commercial Code. (e) Insufficient Corporate Surplus. If, at the time the Corporation is required to make payment of the purchase price for shares pursuant to this Agreement and/or to issue its promissory notes therefor, its surplus is insufficient for such purposes under applicable law, then the Corporation shall promptly take all action necessary and proper under applicable law to increase, to the extent possible, the surplus of the Corporation to permit such payment and/or the issuance of such promissory note. Employee or her personal representative shall perform such acts, execute such instruments, and vote the respective shares in such a manner as may be required to increase the available surplus to an amount sufficient to authorize the purchase of the shares, including, but not limited to, a recapitalization to reduce the capital of the Corporation and increase its surplus or a reappraisal of the assets of the Corporation for the purpose of reflecting the market value. ARTICLE III GENERAL PROVISIONS 3.1 Corporate Action and Articles of Incorporation. The Corporation and the Individual Parties shall take all action required pursuant to this Agreement to effectuate the provisions herein. The Corporation shall become a party to this Agreement. 3.2 Share Certificates. Every certificate representing Warrant Shares of the Corporation shall bear the following legend prominently displayed: -10- "The shares represented by this certificate, and the transfer thereof, are subject to the provisions of that certain Agreement, dated as of September 29, 1998, among ROBERT F. YOUNG, NANCY R. YOUNG, MARC EWING, LISA F. SULLIVAN and RED HAT SOFTWARE, INC., a Delaware corporation, a copy of which is on file in, and may be examined at, the principal office of the Corporation." 3.3 Warrant Shares. All references to Warrant Shares owned by Employee shall mean any outstanding shares of the Corporation hereafter owned by Employee and any shares distributed with respect to any such shares in a stock split, stock dividend, recapitalization, reorganization or otherwise. 3.4 Necessary Acts. Each party hereto agrees that they will do any act or thing and will execute any and all instruments necessary and/or proper to make effective the provisions of this Agreement. 3.5 Severability. Should any provision of this Agreement be declared to be invalid for any reason or to have ceased to be binding on the parties hereto, such provision shall be severed, and all other provisions herein shall continue to be effective and binding. 3.6 Governing Law. This Agreement shall be subject to and governed by the laws of the State of Delaware. 3.7 Entire Agreement. This Agreement contains the entire agreement between the parties hereto with respect to the subject matter hereof, and no change, amendment or modification of this Agreement shall be valid unless the same be in writing and signed by all the parties hereto. No waiver of any of the terms of this Agreement shall be valid unless signed by the party against whom such waiver is asserted. This Agreement supersedes and nullifies the terms of any other agreement setting forth the rights of the Employee previously entered into by Employee with respect to the subject matter hereof. The Employee acknowledges that her ownership of Warrants and Warrant Shares in the Corporation gives her no rights or expectations except those embodied in this Agreement. 3.8 Specific Performance. The parties acknowledge that the actual damage which would be sustained upon the breach of this Agreement by any of the parties or to a personal representative of a Decedent aggrieved by the breach or threatened breach of any of its provisions shall be entitled to seek from any court of competent jurisdiction an order for specific performance of all of the terms and conditions of this agreement. This provision does not limit the parties from seeking any other available remedies at law or equity. 3.9 Prohibited Transfers Void. Any purported transfer in violation of this Agreement shall be void and shall not transfer any interest or title to the purported transferee. The Corporation shall not be required to transfer on its books any Warrant Shares sold or transferred in violation of any of the provisions set forth in this Agreement or to treat as owner of those Warrant Shares or to pay dividends to any transferee to whom any of those Warrant Shares shall have been so sold or transferred. 3.10 Representation as to Attorney. The Individual Parties (and the Corporation) acknowledge that a conflict may exist among their respective interests, and that the Individual Parties should seek the advice of independent counsel. The parties hereby waive any claim they may have as to any conflict which may exist in connection with the preparation of this Agreement. 3.11 New Parties. The Corporation shall not record a transfer of Warrant Shares from Employee to any person not a party hereto unless said person shall execute an acknowledgment of the -11- terms hereof and agreement to be bound hereby, except for a transfer of Warrant Shares to a third party pursuant to Section 2.2 of this Agreement. 3.12 Agreement Binding. This Agreement shall insure to the benefit of and be binding upon the parties hereto and their respective next-of-kin, legatees, administrators, executors, legal representatives, successors and permitted assigns (including remote, as well as immediate, successors to and assignees of said parties), except this Agreement shall not be binding on a third-party purchaser in the event of a transfer of Warrant Shares to such third party pursuant to Section 2.2 of this Agreement. 3.13 Pronouns and Headings. In this Agreement the masculine shall include the feminine and the singular shall include the plural as the context of this Agreement shall clearly require. The article and section headings in this Agreement are inserted for convenience only and are not part of the Agreement. 3.14. Termination. This Agreement shall commence as of the date hereof and shall continue in full force and effect until terminated (i) by the mutual agreement of the parties hereto, (ii) by the dissolution or bankruptcy of the Corporation, (iii) upon the effectiveness of a merger, consolidation or other acquisition of substantially all of the Corporation's assets, if the Corporation is not the surviving corporation, except that a merger or consolidation with a subsidiary which effects a mere change in the form or domicile of the Corporation without changing the respective shareholdings of the Individual Parties shall not terminate the agreement, even if the Corporation is not the surviving corporation, (iv) upon the issuance of any of the Corporation's shares sold by means of a public offering that is required to be registered under the federal securities laws, or (v) upon the sale of all of the issued and outstanding shares of the Corporation. 3.15 Transferability. Any rights or interests of the parties set forth in this Agreement are personal and nontransferable. 3.16 Notices. Any notice or offer required hereunder shall be deemed to have been validly given if delivered by certified mail, return receipt requested, postage prepaid, addressed, or by federal express overnight delivery (or other nationally recognized service) with receipt confirmed, in the case of the Corporation, to its principal office, and in the case of the Individual Parties, to their address appearing on the stock records of the Corporation or to such other address as he may designate. Notices hereunder shall be deemed given seven (7) business days after deposit in the United States Mail or the next business day, if delivered by Federal Express overnight delivery (or other nationally recognized service). 3.17 Jurisdiction and Venue. The parties agree that any action brought in any court whether federal or state shall be brought within the State of North Carolina in the judicial district of Durham, Durham County and do hereby waive all questions of personal jurisdiction or venue for the purpose of carrying out this provision. 3.18 Counterparts. This Agreement may be executed in one or more counterparts, each of which will be deemed to be an original copy of this Agreement and all of which, when taken together, will be deemed to constitute one and the same agreements. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -12- IN WITNESS WHEREOF, the Corporation has caused this Agreement to be signed by its duly authorized officers and its corporate seal to be affixed hereto, and the Individual Parties have hereunto set their hands, all as of the day and year first above written. RED HAT SOFTWARE, INC. By: /s/ Robert F. Young ---------------------- Title: CEO ATTEST: /s/ David Schumannfang - ------------------------ Secretary [CORPORATE SEAL] /s/ Robert F. Young -------------------------- Robert F. Young /s/ Nancy R. Young -------------------------- Nancy R. Young /s/ Marc Ewing -------------------------- Marc Ewing EMPLOYEE /s/ Lisa F. Sullivan -------------------------- Lisa F. Sullivan AMENDMENT AMENDMENT, made as of May 24, 1999, by and among Red Hat Software, Inc. (the "Company"), Robert F. Young, Nancy R. Young and Marc Ewing (collectively, the "Founders") and Lisa Sullivan (the "Warrantholder"). WHEREAS, the Company, the Founders and the Warrantholder are parties to that certain Warrant, dated as of August 12, 1997 (the "Warrant"), which by its terms, terminates on the issuance of any of the Company's shares sold by means of a public offering that is required to be registered under the federal securities laws; and WHEREAS, the Company, the Founders and the Warrantholder wish to amend the Warrant to prevent it from terminating under such circumstances and to remove certain restrictions on exercised Warrant Shares upon the closing of the Company's initial public offering. NOW THEREFORE, the parties hereto agree as follows: 1. Capitalized terms not defined herein shall have the meaning set forth in the Warrant. 2. Section 3.14 of the Warrant shall be amended and restated as follows: "3.14. Termination. This Agreement shall commence as of the date hereof and shall continue in full force and effect until terminated (i) by the mutual agreement of the parties hereto, (ii) by the dissolution or bankruptcy of the Corporation, (iii) upon the effectiveness of a merger, consolidation or other acquisition of substantially all of the Corporation's assets, if the Corporation is not the surviving corporation, except that a merger or consolidation with a subsidiary which effects a mere change in the form or domicile of the Corporation without changing the respective shareholdings of the Individual Parties shall not terminate the agreement, even if the Corporation is not the surviving corporation, or (iv) upon the sale of all of the issued and outstanding shares of the Corporation. Notwithstanding the foregoing, the provisions of Article II hereof shall cease and have no further force or effect with respect to any Warrant Shares upon the issuance of any of the Corporation's shares sold by means of a public offering that is required to be registered under the federal securities laws." 3. Continuing Effect. Except as otherwise set forth herein, all terms and conditions of the Warrant shall remain in full force and effect, and this Amendment shall not constitute a modification, acceptance or waiver of any other provision of the Warrant. 4. Counterparts. This Amendment may be executed in two or more counterparts, each of which shall constitute an original, but all of which, when taken together, shall constitute but one instrument. -2- IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first written above. RED HAT SOFTWARE, INC. By: /s/ Robert F. Young --------------------- Title: CEO /s/ Marc Ewing - --------------------- Marc Ewing /s/ Robert F. Young - --------------------- Robert F. Young /s/ Nancy R. Young - --------------------- Nancy R. Young /s/ Lisa Sullivan - --------------------- Lisa Sullivan EX-10.7 12 EXHIBIT 10.7 Exhibit 10.7 RED HAT SOFTWARE, INC. FIRST AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT This First Amended and Restated Investors Rights Agreement dated as of February 25, 1999 (the "Agreement") is entered into by and among Red Hat Software, Inc., a Delaware corporation (the "Company"), the entities listed on the signature pages hereto under the heading "Existing Investor" (the "Existing Investors"), the entities listed on the signature pages hereto under the heading "New Investor" (the "New Investors"), the entities who execute a counterpart signature page to this Agreement (the "Additional Investors," and together with the Existing Investors and the New Investors, the "Investors") and the persons listed on the signature pages hereto under the heading "Founders" (the "Founders"). Recitals A. The Company, the Founders and certain Investors are parties to that certain Investor Rights Agreement dated as of September 29, 1998 (the "Investor Rights Agreement"); B. Certain Investors are purchasing, concurrently herewith, shares of capital stock of the Company pursuant to the Series C Convertible Preferred Stock Purchase Agreement of even date herewith (the "Purchase Agreement"); C. The execution and delivery of this Agreement is a condition to the execution and delivery of the Purchase Agreement; and D. The parties to the Investor Rights Agreement desire to amend and restate the Investor Rights Agreement on the terms and conditions set forth herein. Agreement In consideration of the mutual covenants contained herein and the consummation of the sale and purchase of shares of capital stock of the Company pursuant to the Purchase Agreement, and for other valuable consideration, receipt of which is hereby acknowledged, the parties hereto agree as follows: 1. Certain Definitions. As used in this Agreement, the following terms shall have the following respective meanings: "Batten Trust" means Frank Batten, Jr., Frank Batten, Louis F. Ryan, trustees of the Frank Batten, Jr., Trust under a Trust Agreement dated April 11, 1988, as amended. "Batten GRAT" means the 1998 Frank Batten, Jr. Grantor Annuity Trust. -2- "Batten Affiliates" means the Batten GRAT, the Batten Trust, Frank Batten, Jr., his wife and issue, any trust of which Frank Batten, Jr. is the trustee or which is created for the benefit of Frank Batten, Jr., his wife or issue, or any entity or person controlled by Frank Batten, Jr. "Commission" means the Securities and Exchange Commission, or any other federal agency at the time administering the Securities Act. "Common Stock" means the common stock, $.0001 par value per share, of the Company. "Exchange Act" means the Securities Exchange Act of 1934, as amended, or any successor federal statute, and the rules and regulations of the Commission issued under such Act, as they each may, from time to time, be in effect. "Founder Shares" means all shares of Common Stock held by the Founders, whether now owned or subsequently acquired. "Initiating Holders" means the Stockholders initiating a request for registration pursuant to Section 2(a) or 2(b), as the case may be. "Initial Public Offering" means the initial firm-commitment underwritten public offering of shares of Common Stock pursuant to an effective Registration Statement. "Other Holders" shall have the meaning set forth in Section 2.1(d). "Prospectus" means the prospectus included in any Registration Statement, as amended or supplemented by an amendment or prospectus supplement, including post-effective amendments, and all material incorporated by reference or deemed to be incorporated by reference in such Prospectus. "Registration Statement" means a registration statement filed by the Company with the Commission for a public offering and sale of securities of the Company (other than a registration statement on Form S-8 or Form S-4, or their successors, or any other form for a similar limited purpose, or any registration statement covering only securities proposed to be issued in exchange for securities or assets of another corporation). "Registration Expenses" means the expenses described in Section 2.4. "Registrable Shares" means (i) the shares of Common Stock issued or issuable upon conversion of the Shares, (ii) any shares of Common Stock, and any shares of Common Stock issued or issuable upon the conversion or exercise of any other securities acquired by the Investors, (iii) the Founder Shares, (iv) the shares of Common Stock acquired by certain Investors pursuant to a Common Stock Purchase Agreement dated as of September 29, 1998, (v) the shares of Common Stock acquired by certain Investors pursuant to a Common Stock Purchase Agreement dated as of the date hereof and (vi) any other shares of Common Stock -3- issued in respect of such shares (because of stock splits, stock dividends, reclassifications, recapitalizations, or similar events); provided, however, that shares of Common Stock which are Registrable Shares shall cease to be Registrable Shares upon (i) any sale pursuant to a Registration Statement or Rule 144 under the Securities Act or (ii) any sale in any manner to a person or entity unless, by virtue of Section 4 of this Agreement, such person or entity is entitled to the rights provided by this Agreement. Wherever reference is made in this Agreement to a request or consent of holders of a certain percentage of Registrable Shares, the determination of such percentage shall include shares of Common Stock issuable upon conversion of the Shares even if such conversion has not been effected. "Securities Act" means the Securities Act of 1933, as amended, or any successor federal statute, and the rules and regulations of the Commission issued under such Act, as they each may, from time to time, be in effect. "Selling Stockholder" means any Stockholder owning Registrable Shares included in a Registration Statement. "Shares" means (a) the 6,801,400 outstanding shares of Series A Convertible Preferred Stock of the Company; (b) the 8,116,550 outstanding shares of Series B Convertible Preferred Stock of the Company; and (c) the shares of Series C Convertible Preferred Stock issued pursuant to the Purchase Agreement. "Stockholders" means (i) the Investors (including any persons or entities to whom the rights granted under this Agreement are transferred by the Investors, their successors or assigns pursuant to Section 4 hereof) and (ii) the Founders. 2. Registration Rights 2.1 Required Registrations. (a) At any time after the earlier of (x) February 25, 2002 or (y) six months after the closing of the Initial Public Offering, a Stockholder or Stockholders (excluding the Founders) holding in the aggregate at least 35% of the Registrable Shares (excluding the Registrable Shares held by the Founders) may request, in writing, that the Company effect the registration on Form S-1 or Form S-2 (or any successor form) of Registrable Shares owned by such Stockholder or Stockholders having an aggregate value of at least $5,000,000 (based on the then current market price or fair value). (b) At any time after the Company becomes eligible to file a Registration Statement on Form S-3 (or any successor form relating to secondary offerings), a Stockholder or Stockholders (excluding the Founders) holding in the aggregate at least 20% of the Registrable Shares (excluding the Registrable Shares held by the Founders) may request, in writing, that the Company effect the registration on Form S-3 (or such successor form), of Registrable Shares having an aggregate value of at least $1,000,000 (based on the then current public market price). -4- (c) Upon receipt of any request for registration pursuant to this Section 2, the Company shall promptly give written notice of such proposed registration to all other Stockholders (including the Founders). Such Stockholders shall have the right, by giving written notice to the Company within 30 days after the Company provides its notice, to elect to have included in such registration such of their Registrable Shares as such Stockholders may request in such notice of election, subject in the case of an underwritten offering to the approval of the managing underwriter as provided in Section 2(d) below. Thereupon, the Company shall, as expeditiously as possible, use its best efforts to effect the registration on an appropriate registration form of all Registrable Shares which the Company has been requested to so register (provided, however, that in the case of a registration requested under Section 2.1(b), the Company will only be obligated to effect such registration on Form S-3 (or any successor form)). (d) If the Initiating Holders intend to distribute the Registrable Shares covered by their request by means of an underwriting, they shall so advise the Company as a part of their request made pursuant to Section 2.1(a) or (b), as the case may be, and the Company shall include such information in its written notice referred to in Section 2.1(c). The right of any other Stockholder to include its Registrable Shares in such registration pursuant to Section 2.1(a) or (b), as the case may be, shall be conditioned upon such other Stockholder's participation in such underwriting on the terms set forth herein. If the Company desires that any officers or directors of the Company holding securities of the Company be included in any registration for an underwritten offering requested pursuant to Section 2.1(d) or if other holders of securities of the Company who are entitled, by contract with the Company, to have securities included in such a registration (the "Other Holders") request such inclusion, the Company may include the securities of such officers, directors and Other Holders in such registration and underwriting on the terms set forth herein. The Company shall (together with all Stockholders, officers, directors and Other Holders proposing to distribute their securities through such underwriting) enter into an underwriting agreement in customary form (including, without limitation, customary indemnification and contribution provisions on the part of the Company) with the managing underwriter; provided that such underwriting agreement shall not provide for indemnification or contribution obligations on the part of Stockholders materially greater than the obligations of the Stockholders pursuant to Section 2.5. Notwithstanding any other provision of this Section 2.1(d), if the managing underwriter advises the Company that the inclusion of all shares requested to be registered would adversely affect the offering, the securities of the Company held by officers or directors of the Company (other than Registrable Shares) and the securities held by Other Holders (other than Registrable Shares) shall be excluded from such registration and underwriting to the extent deemed advisable by the managing underwriter, and if a further limitation of the number of shares is required, the number of shares that may be included in such registration and underwriting shall be allocated among all holders of Registrable Shares requesting registration in proportion, as nearly as practicable, to the respective number of Registrable Shares held by them at the time of the request for registration made by the Initiating Holders pursuant to Section 2.1(a) or (b), as the case may be. If any holder of Registrable Shares, officer, director or Other Holder who has requested inclusion in such registration as provided above disapproves of the terms of the underwriting, such person may elect to withdraw therefrom by written notice to the Company, and the securities so withdrawn shall also be -5- withdrawn from registration. If the managing underwriter has not limited the number of Registrable Shares or other securities to be underwritten, the Company may include securities for its own account in such registration if the managing underwriter so agrees and if the number of Registrable Shares and other securities which would otherwise have been included in such registration and underwriting will not thereby be limited. (e) The Initiating Holders shall have the right to select the managing underwriter(s) for any underwritten offering requested pursuant to Section 2.1(a) or (b), subject to the approval of the Company, which approval will not be unreasonably withheld. (f) The Company shall not be required to effect more than two registrations pursuant to Section 2.1(a). In addition, the Company shall not be required to effect more than three registrations pursuant to Section 2.1(b) in any 12-month period. Moreover, the Company shall not be required to effect any registration (other than on Form S-3 or any successor form relating to secondary offerings) within six months after the effective date of any other Registration Statement of the Company. For purposes of this Section 2.1(f), a Registration Statement shall not be counted until such time as such Registration Statement has been declared effective by the Commission (unless the Initiating Holders withdraw their request for such registration (other than as a result of information concerning the business or financial condition of the Company which is made known to the Stockholders after the date on which such registration was requested) and elect not to pay the Registration Expenses therefor pursuant to Section 2.4). (g) If at the time of any request to register Registrable Shares by Initiating Holders pursuant to this Section 2.1, the Company is engaged or has plans to engage in a registered public offering or is engaged in any other activity which, in the good faith determination of the Company's Board of Directors, would be adversely affected by the requested registration, then the Company may at its option direct that such request be delayed for a period not in excess of 90 days from the date of such request, such right to delay a request to be exercised by the Company not more than once in any 12-month period. 2.2 Incidental Registration. (a) Whenever the Company proposes to file a Registration Statement (other than a Registration Statement filed pursuant to Section 2.1) at any time and from time to time, it will, prior to such filing, give written notice to all Stockholders of its intention to do so; provided, that no such notice need be given if no Registrable Shares are to be included therein as a result of a determination of the managing underwriter pursuant to Section 2.2(b). Upon the written request of a Stockholder or Stockholders given within 20 days after the Company provides such notice (which request shall state the intended method of disposition of such Registrable Shares), the Company shall use its best efforts to cause all Registrable Shares which the Company has been requested by such Stockholder or Stockholders to register to be registered under the Securities Act to the extent necessary to permit their sale or other disposition in accordance with the intended methods of distribution specified in the request of such Stockholder or Stockholders; provided that the Company shall have the right to postpone or withdraw any registration effected pursuant to this Section 2.2 without obligation to any Stockholder. -6- (b) If the registration for which the Company gives notice pursuant to Section 2.2(a) is a registered public offering involving an underwriting, the Company shall so advise the Stockholders as a part of the written notice given pursuant to Section 2.2(a). In such event, the right of any Stockholder to include its Registrable Shares in such registration pursuant to Section 2.2 shall be conditioned upon such Stockholder's participation in such underwriting on the terms set forth herein. All Stockholders proposing to distribute their securities through such underwriting shall (together with the Company, Other Holders, and any officers or directors distributing their securities through such underwriting) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for the underwriting by the Company. Notwithstanding any other provision of this Section 2.2, if the managing underwriter determines that the inclusion of all shares requested to be registered would adversely affect the offering, the Company may limit the number of Registrable Shares to be included in the registration and underwriting. The Company shall so advise all holders of Registrable Shares requesting registration, and the number of shares that are entitled to be included in the registration and underwriting shall be allocated in the following manner. The securities of the Company held by officers and directors of the Company (other than Registrable Shares) shall be excluded from such registration and underwriting to the extent deemed advisable by the managing underwriter; and, if a further limitation on the number of shares is required, the Registrable Shares held by the Founders shall be excluded from such registration and underwriting to the extent deemed advisable by the managing underwriter; and, if a further limitation on the number of shares is required, the number of shares that may be included in such registration and underwriting shall be allocated among all Stockholders (other than the Founders) and Other Holders requesting registration in proportion, as nearly as practicable, to the respective number of shares of Common Stock (on an as-converted basis) which they held at the time the Company gives the notice specified in Section 2.2(a). If any Stockholder or Other Holder would thus be entitled to include more securities than such holder requested to be registered, the excess shall be allocated among other requesting Stockholders and Other Holders pro rata in the manner described in the preceding sentence. If any holder of Registrable Shares or any officer, director or Other Holder disapproves of the terms of any such underwriting, such person may elect to withdraw therefrom by written notice to the Company, and any Registrable Shares or other securities excluded or withdrawn from such underwriting shall be withdrawn from such registration. (c) Notwithstanding the foregoing, the Company shall not be required, pursuant to this Section 2.2, to include any Registrable Shares in a Registration Statement (other than in the Initial Public Offering) if such Registrable Shares can then be sold pursuant to Rule 144(k) under the Securities Act and represent less than 1% of the then outstanding shares of Common Stock. 2.3 Registration Procedures. (a) If and whenever the Company is required by the provisions of this Agreement to use its best efforts to effect the registration of any Registrable Shares under the Securities Act, the Company shall: -7- (i) file with the Commission a Registration Statement with respect to such Registrable Shares and use its best efforts to cause that Registration Statement to become and remain effective for 120 days from the effective date or such lesser period until all such Registrable Shares are sold; (ii) as expeditiously as possible prepare and file with the Commission any amendments and supplements to the Registration Statement and the prospectus included in the Registration Statement as may be necessary to comply with the provisions of the Securities Act (including the anti-fraud provisions thereof) and to keep the Registration Statement effective for 120 days from the effective date or such lesser period until all such Registrable Shares are sold; (iii) as expeditiously as possible furnish to each Selling Stockholder such reasonable numbers of copies of the Prospectus, including any preliminary Prospectus, in conformity with the requirements of the Securities Act, and such other documents as such Selling Stockholder may reasonably request in order to facilitate the public sale or other disposition of the Registrable Shares owned by such Selling Stockholder; (iv) as expeditiously as possible use its best efforts to register or qualify the Registrable Shares covered by the Registration Statement under the securities or Blue Sky laws of such states as the Selling Stockholders shall reasonably request, and do any and all other acts and things that may be necessary or desirable to enable the Selling Stockholders to consummate the public sale or other disposition in such states of the Registrable Shares owned by the Selling Stockholder; provided, however, that the Company shall not be required in connection with this paragraph (iv) to qualify as a foreign corporation or execute a general consent to service of process in any jurisdiction; (v) as expeditiously as possible, cause all such Registrable Shares to be listed on each securities exchange or automated quotation system on which similar securities issued by the Company are then listed; (vi) promptly provide a transfer agent and registrar for all such Registrable Shares not later than the effective date of such registration statement; (vii) promptly make available for inspection by the Selling Stockholders, any managing underwriter participating in any disposition pursuant to such Registration Statement, and any attorney or accountant or other agent retained by any such underwriter or selected by the Selling Stockholders, all financial and other records, pertinent corporate documents and properties of the Company and cause the Company's officers, directors, employees and independent accountants to supply all information reasonably requested by any such seller, underwriter, attorney, accountant or agent in connection with such Registration Statement; (viii) as expeditiously as possible, notify each Selling Stockholder, promptly after it shall receive notice thereof, of the time when such Registration Statement has become effective or a supplement to any Prospectus forming a part of such -8- Registration Statement has been filed; and (ix) furnish, at the request of any Selling Stockholder, on the date that such Registrable Shares are delivered to the underwriter(s) for sale, if such securities are being sold through underwriters, or, if such securities are not being sold through underwriters, on the date that the registration statement with respect to such securities becomes effective, (A) an opinion, dated as of such date, of the counsel representing the Company for the purposes of such registration, in form and substance as is customarily given to underwriters in an underwritten public offering and reasonably satisfactory to a majority in interest of the Selling Stockholders, addressed to the underwriters, if any, and to the Selling Stockholders and (B) a "comfort" letter dated as of such date, from the independent certified public accountants of the Company, in form and substance as is customarily given by independent certified public accountants to underwriters in an underwritten public offering and reasonably satisfactory to a majority in interest of the Selling Stockholders, addressed to the underwriters, if any, and to the Selling Stockholders. (b) If the Company has delivered a Prospectus to the Selling Stockholders and after having done so the Prospectus is amended to comply with the requirements of the Securities Act, the Company shall promptly notify the Selling Stockholders and, if requested, the Selling Stockholders shall immediately cease making offers of Registrable Shares and return all Prospectuses to the Company. The Company shall promptly provide the Selling Stockholders with revised Prospectuses and, following receipt of the revised Prospectuses, the Selling Stockholders shall be free to resume making offers of the Registrable Shares. (c) In the event that, in the judgment of the Company, it is advisable to suspend use of a Prospectus included in a Registration Statement due to pending material developments or other events that have not yet been publicly disclosed and as to which the Company believes public disclosure would be detrimental to the Company, the Company shall notify all Selling Stockholders to such effect, and, upon receipt of such notice, each such Selling Stockholder shall immediately discontinue any sales of Registrable Shares pursuant to such Registration Statement until such Selling Stockholder has received copies of a supplemented or amended Prospectus or until such Selling Stockholder is advised in writing by the Company that the then current Prospectus may be used and has received copies of any additional or supplemental filings that are incorporated or deemed incorporated by reference in such Prospectus. Notwithstanding anything to the contrary herein, the Company shall not exercise its rights under this Section 2.3(c) to suspend sales of Registrable Shares for a period in excess of 90 days in any 365-day period. -9- 2.4 Allocation of Expenses. The Company will pay all Registration Expenses for all registrations under this Agreement; provided, however, that if a registration under Section 2.1(a) is withdrawn at the request of the Initiating Holders (other than as a result of information concerning the business or financial condition of the Company which is made known to the Stockholders after the date on which such registration was requested) and if the Initiating Holders elect not to have such registration counted as a registration requested under Section 2.1, the requesting Stockholders shall pay the Registration Expenses of such registration pro rata in accordance with the number of their Registrable Shares included in such registration. For purposes of this Section, the term "Registration Expenses" shall mean all expenses incurred by the Company in complying with this Agreement, including, without limitation, all registration and filing fees, exchange listing fees, printing expenses, fees and expenses of counsel for the Company and the fees and expenses of one counsel selected by the Selling Stockholders to represent the Selling Stockholders (not to exceed $10,000 in the aggregate), state Blue Sky fees and expenses, and the expense of any special audits incident to or required by any such registration, but excluding underwriting discounts, selling commissions and the fees and expenses of Selling Stockholders' own counsel (other than the counsel selected to represent all Selling Stockholders). 2.5 Indemnification and Contribution. (a) In the event of any registration of any of the Registrable Shares under the Securities Act pursuant to this Agreement, the Company will indemnify and hold harmless the seller of such Registrable Shares, each underwriter of such Registrable Shares, and each other person, if any, who controls such seller or underwriter within the meaning of the Securities Act or the Exchange Act against any losses, claims, damages or liabilities, joint or several, to which such seller, underwriter or controlling person may become subject under the Securities Act, the Exchange Act, state securities or Blue Sky laws or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any Registration Statement under which such Registrable Shares were registered under the Securities Act, any preliminary prospectus or final prospectus contained in the Registration Statement, or any amendment or supplement to such Registration Statement, or arise out of or are based upon the omission or alleged omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading; and the Company will reimburse such seller, underwriter and each such controlling person for any legal or any other expenses reasonably incurred by such seller, underwriter or controlling person in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon any untrue statement or omission made in such Registration Statement, preliminary prospectus or prospectus, or any such amendment or supplement, in reliance upon and in conformity with information furnished to the Company, in writing, by or on behalf of such seller, underwriter or controlling person specifically for use in the preparation thereof. -10- (b) In the event of any registration of any of the Registrable Shares under the Securities Act pursuant to this Agreement, each seller of Registrable Shares, severally and not jointly, will indemnify and hold harmless the Company, each of its directors and officers and each underwriter (if any) and each person, if any, who controls the Company or any such underwriter within the meaning of the Securities Act or the Exchange Act, against any losses, claims, damages or liabilities, joint or several, to which the Company, such directors and officers, underwriter or controlling person may become subject under the Securities Act, Exchange Act, state securities or Blue Sky laws or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement under which such Registrable Shares were registered under the Securities Act, any preliminary prospectus or final prospectus contained in the Registration Statement, or any amendment or supplement to the Registration Statement, or arise out of or are based upon any omission or alleged omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, if the statement or omission was made in reliance upon and in conformity with information relating to such seller furnished in writing to the Company by or on behalf of such seller specifically for use in connection with the preparation of such Registration Statement, prospectus, amendment or supplement; provided, however, that the obligations of a Stockholder hereunder shall be limited to an amount equal to the net proceeds to such Stockholder of Registrable Shares sold in connection with such registration. (c) Each party entitled to indemnification under this Section (the "Indemnified Party") shall give notice to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has actual knowledge of any claim as to which indemnity may be sought, and shall permit the Indemnifying Party to assume the defense of any such claim or any litigation resulting therefrom; provided, that counsel for the Indemnifying Party, who shall conduct the defense of such claim or litigation, shall be approved by the Indemnified Party (whose approval shall not be unreasonably withheld); and, provided, further, that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations under this Section except to the extent that the Indemnifying Party is adversely affected by such failure. The Indemnified Party may participate in such defense at such party's expense; provided, however, that the Indemnifying Party shall pay such expense if representation of such Indemnified Party by the counsel retained by the Indemnifying Party would be inappropriate due to actual or potential differing interests between the Indemnified Party and any other party represented by such counsel in such proceeding; provided further that in no event shall the Indemnifying Party be required to pay the expenses of more than one law firm per jurisdiction as counsel for the Indemnified Party. The Indemnifying Party also shall be responsible for the expenses of such defense if the Indemnifying Party does not elect to assume such defense. No Indemnifying Party, in the defense of any such claim or litigation shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect of such claim or litigation, and no Indemnified Party shall consent to entry of any judgment or settle such claim or litigation without the prior written consent of the Indemnifying Party, which consent shall not be unreasonably withheld. -11- (d) In order to provide for just and equitable contribution in circumstances in which the indemnification provided for in this Section 2.5 is due in accordance with its terms but for any reason is held to be unavailable to an Indemnified Party in respect to any losses, claims, damages and liabilities referred to herein, then the Indemnifying Party shall, in lieu of indemnifying such Indemnified Party, contribute to the amount paid or payable by such Indemnified Party as a result of such losses, claims, damages or liabilities to which such party may be subject in such proportion as is appropriate to reflect the relative fault of the Company on the one hand and the Stockholders on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities, as well as any other relevant equitable considerations. The relative fault of the Company and the Stockholders shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of material fact related to information supplied by the Company or the Stockholders and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Stockholders agree that it would not be just and equitable if contribution pursuant to this Section 2.5 were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to above. Notwithstanding the provisions of this paragraph of Section 2.5, (i) in no case shall any one Stockholder be liable or responsible for any amount in excess of the net proceeds received by such Stockholder from the offering of Registrable Shares and (ii) the Company shall be liable and responsible for any amount in excess of such proceeds; provided, however, that no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. Any party entitled to contribution will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim for contribution may be made against another party or parties under this Section, notify such party or parties from whom contribution may be sought, but the omission so to notify such party or parties from whom contribution may be sought shall not relieve such party from any other obligation it or they may have thereunder or otherwise under this Section. No party shall be liable for contribution with respect to any action, suit, proceeding or claim settled without its prior written consent, which consent shall not be unreasonably withheld. 2.6 Other Matters with Respect to Underwritten Offerings. In the event that Registrable Shares are sold pursuant to a Registration Statement in an underwritten offering pursuant to Section 2.1, the Company agrees to (a) enter into an underwriting agreement containing customary representations and warranties with respect to the business and operations of the Company and customary covenants and agreements to be performed by the Company, including without limitation customary provisions with respect to indemnification by the Company of the underwriters of such offering; (b) use its best efforts to cause its legal counsel to render customary opinions to the underwriters with respect to the Registration Statement; and (c) use its best efforts to cause its independent public accounting firm to issue customary "cold comfort letters" to the underwriters with respect to the Registration Statement. -12- 2.7 Information by Holder. Each holder of Registrable Shares included in any registration shall furnish to the Company such information regarding such holder and the distribution proposed by such holder as the Company may reasonably request in writing and as shall be required in connection with any registration, qualification or compliance referred to in this Agreement. 2.8 "Stand-Off" Agreement; Confidentiality of Notices. Each Stockholder, except Intel, if requested by the Company and the managing underwriter of an offering by the Company of Common Stock or other securities of the Company, agrees not to sell or otherwise transfer or dispose of any Registrable Shares or other securities of the Company held by such Stockholder for a period of 180 days following the effective date of a Registration Statement; provided, that: (a) such agreement shall only apply to the initial public offering of Common Stock of the Company sold in an underwritten offering; and (b) all stockholders of the Company then holding at least 1% of the outstanding Common Stock (on an as-converted basis) and all officers and directors of the Company enter into similar agreements or are otherwise bound by similar provisions. The Company may impose stop-transfer instructions with respect to the Registrable Shares, other than those held by Intel, or other securities subject to the foregoing restriction until the end of such 180-day period. Intel agrees that, if requested by the Company and the managing underwriter of an offering by the Company of Common Stock or other securities of the Company, it will enter into a customary market "Stand Off" agreement for a period of 180 days following the effective date of a Registration Statement. Any Stockholder receiving any written notice from the Company regarding the Company's plans to file a Registration Statement shall treat such notice confidentially and shall not disclose such information to any person other than as necessary to exercise its rights under this Agreement. 2.9 Limitations on Subsequent Registration Rights. The Company shall not, without the prior written consent of the Founders holding at least 66-2/3% of the Registrable Shares then held by all Founders and Stockholders (excluding the Founders) holding at least 66-2/3% of the Registrable Shares then held by all Stockholders (excluding the Registrable Shares held by the Founders), enter into any agreement (other than this Agreement) with any holder or prospective holder of any securities of the Company which grant such holder or prospective holder rights to include securities of the Company in any Registration Statement, unless (a) such rights to include securities in a registration initiated by the Company or by Stockholders are not more favorable than the rights granted to Other Holders under Sections 2.1 and 2.2 of this Agreement, and (b) any such rights to initiate a registration provide that Stockholders are entitled to include Registrable Shares on a pro rata basis with such holders based on the number of shares of Common Stock (on an as-converted basis) owned by Stockholders and such holders. -13- 2.10 Rule 144 Requirements. After the earliest of (i) the closing of the sale of securities of the Company pursuant to a Registration Statement, (ii) the registration by the Company of a class of securities under Section 12 of the Exchange Act, or (iii) the issuance by the Company of an offering circular pursuant to Regulation A under the Securities Act, the Company agrees to: (a) make and keep current public information about the Company available, as those terms are understood and defined in Rule 144; (b) use its best efforts to file with the Commission in a timely manner all reports and other documents required of the Company under the Securities Act and the Exchange Act (at any time after it has become subject to such reporting requirements); and (c) furnish to any holder of Registrable Shares upon request (i) a written statement by the Company as to its compliance with the reporting requirements of Rule 144 and of the Securities Act and the Exchange Act (at any time after it has become subject to such reporting requirements), (ii) a copy of the most recent annual or quarterly report of the Company, and (iii) such other reports and documents of the Company as such holder may reasonably request to avail itself of any similar rule or regulation of the Commission allowing it to sell any such securities without registration. 2.11 Termination. All of the Company's obligations to register Registrable Shares under Sections 2.1 and 2.2 of this Agreement shall terminate three years after the closing of the Initial Public Offering. 3. Right Of First Refusal 3.1 Rights of Investors (a) The Company shall not issue, sell or exchange, agree to issue, sell or exchange, or reserve or set aside for issuance, sale or exchange, (i) any shares of its Common Stock, (ii) any other equity securities of the Company, including, without limitation, shares of preferred stock, (iii) any option, warrant or other right to subscribe for, purchase or otherwise acquire any equity securities of the Company, or (iv) any debt securities convertible into capital stock of the Company (collectively, the "Offered Securities"), unless in each such case the Company shall have first complied with this Section 3.1. The Company shall deliver to each Investor a written notice of any proposed or intended issuance, sale or exchange of Offered Securities (the "Offer"), which Offer shall (i) identify and describe the Offered Securities, (ii) describe the price and other terms upon which they are to be issued, sold or exchanged, and the number or amount of the Offered Securities to be issued, sold or exchanged, (iii) identify the persons or entities (if known) to which or with which the Offered Securities are to be offered, issued, sold or exchanged and (iv) offer to issue and sell to or exchange with such Investor (A) a pro rata portion of the Offered Securities determined by dividing the aggregate number of shares of Common Stock then held by such Investor (giving effect to the conversion of all shares of convertible preferred stock then held) by the total number of shares of Common Stock then -14- outstanding (giving effect to the conversion of all outstanding shares of convertible preferred stock and the exercise of all vested options) (the "Basic Amount"), and (B) any additional portion of the Offered Securities attributable to the Basic Amounts of other Investors as such Investor shall indicate it will purchase or acquire should the other Investors subscribe for less than their Basic Amounts (the "Undersubscription Amount"). For purposes of the foregoing paragraph, the number of shares of Common Stock (on an as-converted basis) held by the Batten Trust and the Batten GRAT shall be aggregated with each other and all shares held by the other Batten Affiliates, and the Batten Affiliates may assign, inter se, the purchase rights provided under this section. (b) To accept an Offer, in whole or in part, an Investor must deliver a written notice to the Company prior to the end of the 30-day period of the Offer, setting forth the portion of the Investor's Basic Amount that such Investor elects to purchase and, if such Investor shall elect to purchase all of its Basic Amount, the Undersubscription Amount (if any) that such Investor elects to purchase (the "Notice of Acceptance"). If the Basic Amounts subscribed for by all Investors are less than the total of all of the Basic Amounts available for purchase, then each Investor who has set forth an Undersubscription Amount in its Notice of Acceptance shall be entitled to purchase, in addition to the Basic Amounts subscribed for, the Undersubscription Amount it has subscribed for; provided, however, that if the Undersubscription Amounts subscribed for exceed the difference between the total of all of the Basic Amounts available for purchase and the Basic Amounts subscribed for (the "Available Undersubscription Amount"), each Investor who has subscribed for any Undersubscription Amount shall be entitled to purchase only that portion of the Available Undersubscription Amount as the Undersubscription Amount subscribed for by such Investor bears to the total Undersubscription Amounts subscribed for by all Investors, subject to rounding by the Board of Directors to the extent it deems reasonably necessary. (c) The Company shall have 90 days from the expiration of the period set forth in Section 3.1(b) above to issue, sell or exchange all or any part of such Offered Securities as to which a Notice of Acceptance has not been given by the Investors (the "Refused Securities"), but only to the offerees or purchasers described in the Offer (if so described therein) and only upon terms and conditions (including, without limitation, unit prices and interest rates) which are not more favorable, in the aggregate, to the acquiring person or persons or less favorable to the Company than those set forth in the Offer. (d) In the event the Company shall propose to sell less than all the Refused Securities (any such sale to be in the manner and on the terms specified in Section 3.1(c) above), then each Investor may, at its sole option and in its sole discretion, reduce the number or amount of the Offered Securities specified in its Notice of Acceptance to an amount that shall be not less than the number or amount of the Offered Securities that the Investor elected to purchase pursuant to Section 3.1(b) above multiplied by a fraction, (i) the numerator of which shall be the number or amount of Offered Securities the Company actually proposes to issue, sell or exchange (including Offered Securities to be issued or sold to Investors pursuant to Section 3.1(b) above prior to such reduction) and (ii) the denominator of which shall be the original amount of the Offered Securities. In the event that any Investor so elects to reduce the number or amount of Offered Securities specified in its Notice of Acceptance, the Company may not issue, -15- sell or exchange more than the reduced number or amount of the Offered Securities unless and until such securities have again been offered to the Investors in accordance with Section 3.1(a) above. (e) Upon the closing of the issuance, sale or exchange of all or less than all of the Refused Securities, the Investors shall acquire from the Company, and the Company shall issue to the Investors, the number or amount of Offered Securities specified in the Notices of Acceptance, as reduced pursuant to Section 3.1(d) above if the Investors have so elected, upon the terms and conditions specified in the Offer. The purchase by the Investors of any Offered Securities is subject in all cases to the preparation, execution and delivery by the Company and the Investors of a purchase agreement relating to such Offered Securities reasonably satisfactory in form and substance to the Investors and their respective counsel. (f) Any Offered Securities not acquired by the Investors or other persons in accordance with Section 3.1(c) above may not be issued, sold or exchanged until they are again offered to the Investors under the procedures specified in this Agreement. (g) The rights of the Investors under this Section 3 shall not apply to: (i) any shares of the Company's Series C Convertible Preferred Stock issued pursuant to the Purchase Agreement; (ii) Common Stock issued as a stock dividend to holders of Common Stock or upon any subdivision or combination of shares of Common Stock; (iii) the issuance of any shares of Common Stock upon conversion of shares of convertible preferred stock; (iv) the issuance of up to 3,717,400 shares of Common Stock, or such greater number as is approved by vote of not less than a majority of the non-employee directors of the Company, or the grant of options therefor, including shares issued upon exercise of options outstanding on the date of this Agreement (such number to be proportionately adjusted in the event of any stock splits, stock dividends, recapitalizations or similar events occurring on or after the date of this Agreement) issuable to officers, directors, consultants and employees of the Company or any subsidiary pursuant to any plan, agreement or arrangement approved by a vote of not less than a majority of the Board of Directors of the Company (it being understood that any shares subject to options that expire or terminate unexercised shall not count towards the maximum number set forth in this clause (iii)); (v) securities issued solely in consideration for the acquisition (whether by merger or otherwise) by the Company or any of its subsidiaries of all or substantially all of the stock or assets of any other entity; (vi) shares of Common Stock sold by the Company in an underwritten public offering pursuant to an effective registration statement under the Securities Act; -16- (vii) securities issued pursuant to any equipment leasing arrangement, or debt financing from a bank or similar financial institution, in each case approved by a vote of not less than a majority of the non-employee members of the Board of Directors of the Company; or (viii) securities issued in connection with strategic transactions involving the Company and other entities, including (A) joint ventures, manufacturing, marketing or distribution arrangements or (B) technology transfer or development arrangements, in each case approved by a vote of not less than a majority of the non-employee members of the Board of Directors of the Company. 3.2 Termination. This Section 3 shall terminate upon the earlier of the following events: (a) The sale of all or substantially all of the assets or business of the Company, by merger, sale of assets or otherwise; or (b) The closing of the Initial Public Offering. 4. Transfers of Rights. This Agreement, and the rights and obligations of each Investor, may be assigned by such Investor to any person or entity to which at least 25% of the Shares owned by such Investor as of the date hereof are transferred, and such transferee shall be deemed an "Investor" for purposes of this Agreement; provided that the transferee provides written notice of such assignment to the Company and agrees in writing to be bound by the terms hereof. No such transfer shall be permitted by any Investor pursuant to this Section 4 to any person or entity that a majority of the non-employee members of the Board of Directors deem to be a competitor of the Company. The foregoing notwithstanding, the rights and obligations of a Batten Affiliates hereunder may be assigned to any Batten Affiliate without regard to the number of Shares transferred. 5. General. 5.1 Severability. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement. 5.2 Specific Performance. In addition to any and all other remedies that may be available at law in the event of any breach of this Agreement, each Investor shall be entitled to specific performance of the agreements and obligations of the Company hereunder and to such other injunctive or other equitable relief as may be granted by a court of competent jurisdiction. -17- 5.3 Governing Law. This Agreement shall be governed by and construed in accordance with the internal laws of the Commonwealth of Massachusetts (without reference to the conflicts of law provisions thereof). 5.4 Notices. All notices, requests, consents, and other communications under this Agreement shall be in writing and shall be deemed delivered (a) two business days after being sent by registered or certified mail, return receipt requested, postage prepaid or (b) one business day after being sent via a reputable nationwide overnight courier service guaranteeing next business day delivery, in each case to the intended recipient as set forth below: If to the Company, by mail to: P. O. Box 13588, Research Triangle Park, NC 27709, Attention: President, or by overnight courier to: 2600 Meridian Parkway, Durham, NC 27713, Attention: President, or at such other address or addresses as may have been furnished in writing by the Company to the Purchasers, with a copy to Testa, Hurwitz & Thibeault LLP, 125 High Street, Boston, MA 02110, Attn: William J. Schnoor, Jr., Esq.; If to an Investor, at the address set forth on the signature page hereto, or at such other address or addresses as may have been furnished to the Company in writing by such Investor; or If to a Founder, at the address set forth below such Founder's signature to this Agreement. Any party may give any notice, request, consent or other communication under this Agreement using any other means (including, without limitation, personal delivery, messenger service, telecopy, first class mail or electronic mail), but no such notice, request, consent or other communication shall be deemed to have been duly given unless and until it is actually received by the party for whom it is intended. Any party may change the address to which notices, requests, consents or other communications hereunder are to be delivered by giving the other parties notice in the manner set forth in this Section. 5.5 Complete Agreement. (a) This Agreement constitutes the entire agreement and understanding of the parties hereto with respect to the subject matter hereof and supersedes all prior agreements and understandings relating to such subject matter. (b) The Investor Rights Agreement dated September 29, 1998 by and among the Company, the Founders certain Investors is hereby terminated and is superseded in all respects by this Agreement. Each party to such terminated agreement hereby waives any right it may have had under such agreement with respect to the issuance and sale by the Company of the shares of Series C Convertible Preferred Stock pursuant to the Purchase Agreement. -18- 5.6 Amendments and Waivers. Any term of this Agreement may be amended or terminated and the observance of any term of this Agreement may be waived (either generally or in a particular instance and either retroactively or prospectively), with the written consent of the Company and the holders of at least 66-2/3% of the Registrable Shares held by all of the Stockholders; provided, that Section 3 hereof may be amended or waived with the written consent of the Stockholders (excluding the Founders) holding at least 66-2/3% of the Registrable Shares held by the Stockholders (excluding the Registrable Shares held by the Founders); provided further that this Agreement may be amended with the consent of the holders of less than all Registrable Shares only in a manner which affects all such holders in the same fashion. Any such amendment, termination or waiver effected in accordance with this Section 5.6 shall be binding on all parties hereto, even if they do not execute such consent. No waivers of or exceptions to any term, condition or provision of this Agreement, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such term, condition or provision. 5.7 Pronouns. Whenever the context may require, any pronouns used in this Agreement shall include the corresponding masculine, feminine or neuter forms, and the singular form of nouns and pronouns shall include the plural, and vice versa. 5.8 Counterparts; Facsimile Signatures. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original, and all of which together shall constitute one and the same document. This Agreement may be executed by facsimile signatures. Each purchaser of shares of the Company's Series C Convertible Preferred Stock shall become a party to this Agreement upon the closing of its purchase of such shares and its execution of a counterpart signature page to this Agreement. 5.9 Section Headings. The section headings are for the convenience of the parties and in no way alter, modify, amend, limit or restrict the contractual obligations of the parties. 5.10 Board Observer. (a) So long as Intel Corporation ("Intel"), together with its majority owned subsidiaries, holds twenty-five percent (25%) of the Registrable Shares purchased by Intel on September 29, 1998 (such number to be proportionately adjusted for stock splits, stock dividends, and similar events), the Company will permit a representative of Intel (the "Observer"), to attend all meetings of the Company's Board of Directors and all committees thereof (whether in person, telephonic or other) in a non-voting, observer capacity and shall provide to Intel or the Observer, concurrently with the members of the Board of Directors and in the same manner, notice of such meeting and a copy of all materials provided to such members, except for Intel Restricted Information, as defined in Section 5(j)(iii) below. The Company acknowledges that Intel will likely have, from time to time, information that may be of interest to the Company ("Information") regarding a wide variety of matters including, by way of example only, (i) Intel's technologies, plans and services, and plans -19- and strategies relating thereto, (ii) current and future investments Intel has made, may make, may consider or may become aware of with respect to other companies and other technologies, products and services, including, without limitation, technologies, products and services that may be competitive with the Company's, and (iii) developments with respect to the technologies, products and services, and plans and strategies relating thereto, of other companies, including, without limitation, companies that may be competitive with the Company. The Company recognizes that a portion of such Information may be of interest to the Company. Such Information may or may not be known by the Observer. The Company, as a material part of the consideration for this Agreement, agrees that Intel and its Observer shall have no duty to disclose any Information to the Company or permit the Company to participate in any projects or investment based on any Information, or to otherwise take advantage of any opportunity that may be of interest to the Company if it were aware of such Information, and hereby waives, to the extent permitted by law, any claim based on the corporate opportunity doctrine or otherwise that could limit Intel's ability to pursue opportunities based on such Information or that would require Intel or Observer to disclose any such Information to the Company or offer any opportunity relating thereto to the Company. (b) Notwithstanding anything to the contrary in the foregoing, the right to attend Board of Directors meetings and receive the information described herein shall not apply to any portion of any such meeting or information involving: (i) the presentation or discussion at Board of Director meetings of Intel Restricted Information and (ii) the presentation of information or discussion at Board of Directors meetings involving material matters which, if provided to or attended by Intel, would, in the reasonable opinion of the Company's Board of Directors, jeopardize the attorney client privilege that would otherwise be afforded to such information or meeting. (c) Intel Restricted Information as used herein shall be defined as information or analysis involving any topic with respect to which, in the reasonable judgment of a majority of the members of the Company's Board of Directors, present and acting throughout, the presence of the Observer or the provision of any such information or analysis to the Observer would inhibit deliberations by the Company's Board of Directors on a material matter or would otherwise be materially injurious to the Company in such circumstances. (d) Exchanges of confidential and proprietary information between the Company and the Intel Board Observer shall be governed by the terms of the Corporate Non-Disclosure Agreement No. 72897, dated April 27, 1998, executed by the Company and Intel, and a blanket Confidential Information Transmittal Record (the "CITR") in the form attached hereto as Exhibit A, which CITR need only be executed once, and shall govern all such exchanges of confidential and proprietary information. 5.11 Confidentiality. The parties hereto agree to be bound by the confidentiality and non-disclosure provisions set forth in Section 7 of the Purchase Agreement. -20- 5.12 Effectiveness. This Agreement shall become effective upon its execution by the Company, the New Investors and the holders of 66-2/3% of the Registrable Shares held, immediately prior to the execution of the Purchase Agreement, by the Founders and the Existing Investors. Upon the effectiveness of this Agreement, any Existing Investor who has not executed this Agreement shall be entitled to all benefits conferred upon the Investors hereunder as an intended third party beneficiary. [The remainder of this page intentionally left blank] -First Amended and Restated Investors Rights Agreement- IN WITNESS WHEREOF, this Agreement has been executed by the parties hereto as of the date first written above. COMPANY: RED HAT SOFTWARE, INC. By: /s/ Robert F. Young ------------------------------------ Name: Robert F. Young ---------------------------------- Title: Chief Executive Officer --------------------------------- -First Amended and Restated Investors Rights Agreement- EXISTING INVESTOR: GREYLOCK IX LIMITED PARTNERSHIP One Federal Street Boston, MA 02110 By: Greylock IX GP Limited Partnership By: /s/ William S. Kaiser ------------------------------------ Title: General Partner with copies of notices to: Patrick J. Rondeau, Esq. Hale & Dorr LLP 60 State Street Boston, MA 02109 -First Amended and Restated Investors Rights Agreement- EXISTING INVESTOR: BENCHMARK CAPITAL PARTNERS II, L.P. as nominee for Benchmark Capital Partners, II, L.P. Benchmark Founders' Fund II, L.P. Benchmark Founders' Fund II-A, L.P. Benchmark Members' Fund II, L.P. 2480 Sand Hill Road, Suite 2000 Menlo Park, CA 94025 By: Benchmark Capital Management Co. II, L.L.C., its general partner By: /s/ Kevin Harvey ------------------------------------ Title: Managing Member with copies of notices to: Patrick J. Rondeau, Esq. Hale & Dorr LLP 60 State Street Boston, MA 02109 -First Amended and Restated Investors Rights Agreement- EXISTING INVESTOR: INTEL CORPORATION Attn: M&A Portfolio Manager 2200 Mission College Blvd., SC4-210 Santa Clara, CA 95052 By: /s/ Arvind Sodhani ------------------------------------ Name: Arvind Sodhani ---------------------------------- Title: Vice President and Treasurer --------------------------------- with copies of notices to: Intel Corporation Attn: General Counsel 2200 Mission College Blvd. Santa Clara, CA 95052 -First Amended and Restated Investors Rights Agreement- EXISTING INVESTOR: NETSCAPE COMMUNICATIONS CORPORATION 501 E. Middlefield Road Mountain View, CA 94043 By: /s/ Peter L.S. Currie ------------------------------------ Name: Peter L.S. Currie ---------------------------------- Title: EVP and CAO --------------------------------- -First Amended and Restated Investors Rights Agreement- EXISTING INVESTOR: THE 1998 FRANK BATTEN, JR., GRANTOR ANNUITY TRUST c/o Frank Batten, Jr. Landmark Communications 150 Brambleton Avenue Norfolk, VA 23510-2075 By: /s/ Frank Batten, Jr. ------------------------------------ Title: Trustee with copies of notices to: Guy R. Friddell, III, Esq. Willcox & Savage, P.C. 1800 Nationsbank Center One Commercial Place Norfolk, VA 23510-2197 FRANK BATTEN, JR., FRANK BATTEN, LOUIS F. RYAN, TRUSTEES OF THE FRANK BATTEN, JR. TRUST UNDER A TRUST AGREEMENT DATED APRIL 11, 1988, AS AMENDED c/o Frank Batten, Jr. Landmark Communications 150 Brambleton Avenue Norfolk, VA 23510-2075 By: /s/ Frank Batten, Jr. ------------------------------------ Title: Trustee with copies of notices to: Guy R. Friddell, III, Esq. Willcox & Savage, P.C. 1800 Nationsbank Center One Commercial Place Norfolk, VA 23510-2197 -First Amended and Restated Investors Rights Agreement- NEW INVESTOR: INTERNATIONAL BUSINESS MACHINES CORPORATION Attn: Mr. Robert Dutton Route 100 Somers, NY 10589 By: /s/ Alfred W. Zollar ------------------------------------ Name: Alfred W. Zollar ---------------------------------- Title: General Manager, NCSD --------------------------------- with copies of notices to: Neil Abrams, Esq. Attn: IBM Associate General Counsel Route 100 Somers, NY 10559 -First Amended and Restated Investors Rights Agreement- FOUNDERS: /s/ Robert F. Young ---------------------------------------- Robert F. Young 208 Veranda Court Raleigh, NC 2615 /s/ Nancy R. Young ---------------------------------------- Nancy R. Young 208 Veranda Court Raleigh, NC 2615 /s/ Marc Ewing ---------------------------------------- Marc Ewing 221 High Hickory Road Chapel Hill, NC 27516 HENRY LEE EWING TRUST DATED SEPTEMBER 11, 1998 c/o Dan Ewing 721 SE 39th Avenue Portland, OR 97214 By: /s/ Dan Ewing ------------------------------------ Title: Trustee EWING CHILDREN'S TRUST DATED SEPTEMBER 11, 1998 c/o Dan Ewing 721 SE 39th Avenue Portland, OR 97214 By: /s/ Dan Ewing ------------------------------------ Title: Trustee -First Amended and Restated Investors Rights Agreement- ZOE E. YOUNG TRUST DATED SEPTEMBER 11, 1998 c/o William T. Jahnke 271 Colonial Drive Fairfield, CT 06430 By: /s/ William Jahnke ------------------------------------ Title: Trustee MARGAUX A. F. YOUNG TRUST DATED SEPTEMBER 11, 1998 c/o William T. Jahnke 271 Colonial Drive Fairfield, CT 06430 By: /s/ William Jahnke ------------------------------------ Title: Trustee VICTORIA C. B. YOUNG TRUST DATED SEPTEMBER 11, 1998 c/o William T. Jahnke 271 Colonial Drive Fairfield, CT 06430 By: /s/ William Jahnke ------------------------------------ Title: Trustee -First Amended and Restated Investors Rights Agreement- ADDITIONAL INVESTOR COUNTERPART SIGNATURE PAGE The undersigned hereby executes this First Amended and Restated Investor Rights Agreement, authorizes that this signature page be attached as a counterpart to said Agreement and agrees to be bound as an Investor to said Agreement. NOVELL INC. Attn: Mr. Blake Modersitzki 1555 N. Technology Way Orem, UT 84097 By: /s/ Christopher Stone ------------------------------------ Name: Christopher Stone ---------------------------------- Title: SVP --------------------------------- Date: March 19,1999 ---------------------------------- -First Amended and Restated Investors Rights Agreement- ADDITIONAL INVESTOR COUNTERPART SIGNATURE PAGE The undersigned hereby executes this First Amended and Restated Investor Rights Agreement, authorizes that this signature page be attached as a counterpart to said Agreement and agrees to be bound as an Investor to said Agreement. ORACLE CORPORATION Attn: Mr. Gene Frantz 500 Oracle Parkway Redwood Shores, CA 94065 By: /s/ Gary L. Bloom ------------------------------------ Name: Gary L. Bloom ---------------------------------- Title: EVP --------------------------------- with copies of notices to: Oracle Corporation Attn: General Counsel 500 Oracle Parkway Redwood Shores, CA 94065 -First Amended and Restated Investors Rights Agreement- ADDITIONAL INVESTOR COUNTERPART SIGNATURE PAGE The undersigned hereby executes this First Amended and Restated Investor Rights Agreement, authorizes that this signature page be attached as a counterpart to said Agreement and agrees to be bound as an Investor to said Agreement. CPQ HOLDINGS, INC. Attn: Office of the General Counsel Compaq Computer Corporation 20555 State Highway 249 Houston, TX 77070 By: /s/ John T. Rose ------------------------------------ Name: John T. Rose ---------------------------------- Title: Vice President --------------------------------- Date: 3/11/99 ---------------------------------- with copies of notices to: Compaq Computer Corporation Attn: Mr. Tim Yeaton 110 Spit Brook Road MS ZK03-3W20 Nashua, NH 03062 -First Amended and Restated Investors Rights Agreement- ADDITIONAL INVESTOR COUNTERPART SIGNATURE PAGE The undersigned hereby executes this First Amended and Restated Investor Rights Agreement, authorizes that this signature page be attached as a counterpart to said Agreement and agrees to be bound as an Investor to said Agreement. SAP AMERICA, INC. Attn: Legal Dept./Venture Investments 3999 West Chester Pike New Town Square, PA 19073 By: /s/ Kevin S. McKay ------------------------------------ Name: Kevin S. McKay ---------------------------------- Title: President and CEO --------------------------------- Date: 3/26/99 ---------------------------------- with copies of notices to: SAP LABS, INC. Attention: Exec. Vice President, Venture Fund 3475 Deer Creek Road Palo Alto, CA -First Amended and Restated Investors Rights Agreement- ADDITIONAL INVESTOR COUNTERPART SIGNATURE PAGE The undersigned hereby executes this First Amended and Restated Investor Rights Agreement, authorizes that this signature page be attached as a counterpart to said Agreement and agrees to be bound as an Investor to said Agreement. DELL USA L.P. Attn: Business Development One Dell Way Round Rock Texas 78682 By: /s/ Alex C. Smith ------------------------------------ Name: Alex C. Smith ---------------------------------- Title: Alex C. Smith ------------------------------------ Date: 4/1/99 ---------------------------------- with copies of notices to: Dell Computer Corporation Attn: General Corporate Counsel One Dell Way Round Rock, Texas 78682 AMENDMENT NO. 1 TO FIRST AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT This Amendment No. 1 to First Amended and Restated Investor Rights Agreement is entered into as of April 1, 1999 by and among Red Hat Software, Inc., a Delaware corporation (the "Company"), the several investors (each an "Investor" and collectively, the "Investors") named in that certain First Amended and Restated Investor Rights Agreement dated as of February 25, 1999 (the "Rights Agreement") and the several founders (each a "Founder" and collectively, the "Founders") named in the Rights Agreement. Capitalized terms used herein, unless otherwise defined herein, shall have the meanings assigned to them in the Rights Agreement. Recitals A. The Company and certain of the Investors are parties to that certain Series C Convertible Preferred Stock Purchase Agreement dated as of February 25, 1999 (the "Purchase Agreement"). B. The Company and certain of the Investors are amending, as of the date hereof, the Purchase Agreement in order to increase the number of shares of the Company's Series C Convertible Preferred Stock ("Series C Preferred") that may be sold pursuant to the Purchase Agreement. C. The Company, the Investors and the Founders desire to amend the Rights Agreement in order to allow the proposed purchaser of such additional Series C Preferred to receive the benefit of the rights granted to the Investors in the Rights Agreement. D. Pursuant to Section 5.6 thereof, the Rights Agreement may be amended with the written consent of the Company and the holders of at least 66-2/3% of the Registrable Shares held by all Stockholders. Agreement 1. Amendments. The Rights Agreement shall be amended as follows: 1.1 Recital B. shall be amended and restated in its entirety as follows: "B. Certain Investors are purchasing, concurrently herewith, shares of capital stock of the Company pursuant to the Series C Convertible Preferred Stock Purchase Agreement of even date herewith, as amended from time to time (the "Purchase Agreement"). 2. Amendment Limited. Except as provided herein, each of the provisions of the Rights Agreement shall remain in full force and effect following the consummation of the transactions contemplated hereby and this Amendment No. 1 shall not constitute a modification, acceptance or waiver of any other provision of the Rights Agreement. Each of the parties hereto hereby confirms and ratifies all of its obligations under the Rights Agreement, as amended by this Amendment No. 1. This Amendment No. 1 shall be governed and construed in accordance with the terms of the Rights Agreement. 3. Counterparts. This Amendment No. 1 may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - IN WITNESS WHEREOF, the Company, the Investors and the Founders have executed and delivered this Amendment No. 1 as of the date first above written. COMPANY: RED HAT SOFTWARE, INC. By: /s/ Robert F. Young ------------------------------------ Name: Robert F. Young Title: CEO - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: GREYLOCK IX LIMITED PARTNERSHIP By: Greylock IX GP Limited Partnership By: /s/ William Kaiser ------------------------------------ Title: General Partner - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: BENCHMARK CAPITAL PARTNERS II, L.P. as nominee for Benchmark Capital Partners, II, L.P. Benchmark Founders' Fund II, L.P. Benchmark Founders' Fund II-A, L.P. Benchmark Members' Fund II, L.P. By: Benchmark Capital Management Co. II, L.L.C., its general partner By: /s/ Kevin Harvey ------------------------------------ Title: Managing Member - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: FRANK BATTEN, JR., FRANK BATTEN, LOUIS F. RYAN, TRUSTEES OF THE FRANK BATTEN, JR. TRUST UNDER A TRUST AGREEMENT DATED APRIL 11, 1988, AS AMENDED By: /s/ Frank Batten, Jr. ------------------------------------ Title: Trustee INVESTOR: 1998 FRANK BATTEN, JR. GRANTOR ANNUITY TRUST By: /s/ Frank Batten, Jr. ------------------------------------ Title: Trustee - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: INTEL CORPORATION By: /s/ Arvind Sodhani ------------------------------------ Name: Arvind Sodhani ---------------------------------- Title: Vice President and Treasurer --------------------------------- - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: SAP AMERICA, INC. By: /s/ Brad Brubaker ------------------------------------ Name: Brad Brubaker ---------------------------------- Title: Vice President --------------------------------- - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: NOVELL INC. By: /s/ Christopher Stone ------------------------------------ Name: Christopher Stone ---------------------------------- Title: SVP --------------------------------- - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: ORACLE CORPORATION By: /s/ Daniel Cooperman ------------------------------------ Name: Daniel Cooperman ---------------------------------- Title: Senior VP, Gen. Counsel and Secretary --------------------------------- - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: INTERNATIONAL BUSINESS MACHINES CORPORATION By: /s/ J.E. Newman ------------------------------------ Name: J.E. Newman ---------------------------------- Title: VP Business Development --------------------------------- - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: Dell USA L.P. By: Dell Gen. P. Corp, General Partner By: /s/ Alex C. Smith ------------------------------------ Name: Alex C. Smith ---------------------------------- Title: Vice Presicent --------------------------------- - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - INVESTOR: NETSCAPE COMMUNICATIONS CORPORATION By: /s/ Kent Walker ------------------------------------ Name: Kent Walker ---------------------------------- Title: Assistant Secretary --------------------------------- - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - FOUNDERS: /s/ Robert F. Young ---------------------------------------- Robert F. Young /s/ Nancy F. Young ---------------------------------------- Nancy R. Young /s/ Marc Ewing ---------------------------------------- Marc Ewing HENRY LEE EWING TRUST DATED SEPTEMBER 11, 1998 By: /s/ Dan Ewing ------------------------------------ Title: Trustee EWING CHILDREN'S TRUST DATED SEPTEMBER 11, 1998 By: /s/ Dan Ewing ------------------------------------ Title: Trustee ZOE E. YOUNG TRUST DATED SEPTEMBER 11, 1998 By: /s/ William Jahnke ------------------------------------ Title: Trustee - Amendment No. 1 to First Amended and Restated Investor Rights Agreement - MARGAUX A. F. YOUNG TRUST DATED SEPTEMBER 11, 1998 By: /s/ William Jahnke ------------------------------------ Title: Trustee VICTORIA C. B. YOUNG TRUST DATED SEPTEMBER 11, 1998 By: /s/ William Jahnke ------------------------------------ Title: Trustee EX-10.8 13 EXHIBIT 10.8 Exhibit 10.8 CMD 103A (8/98) Base Years OFFICE LEASE WITH RED HAT SOFTWARE, INC. SUITE(S): 100 BUILDING: 2600 Meridian Parkway Durham, North Carolina 27713 TABLE OF CONTENTS ARTICLE 1: BASIC PROVISIONS.................................................................... ARTICLE 2: TERM AND COMMENCEMENT............................................................... ARTICLE 3: BASE RENT AND ADDITIONAL RENT....................................................... ARTICLE 4: CONDITION OF PREMISES............................................................... ARTICLE 5: QUIET ENJOYMENT..................................................................... ARTICLE 6: UTILITIES AND SERVICES.............................................................. ARTICLE 7: USE, COMPLIANCE WITH LAWS, AND RULES................................................ ARTICLE 8: MAINTENANCE AND REPAIRS............................................................. ARTICLE 9: ALTERATIONS AND LIENS............................................................... ARTICLE 10: INSURANCE, SUBROGATION, AND WAIVER OF CLAIMS........................................ ARTICLE 11: CASUALTY DAMAGE..................................................................... ARTICLE 12: CONDEMNATION........................................................................ ARTICLE 13: ASSIGNMENT AND SUBLETTING........................................................... ARTICLE 14: PERSONAL PROPERTY, RENT AND OTHER TAXES............................................. ARTICLE 15: LANDLORD'S REMEDIES................................................................. ARTICLE 16: SECURITY DEPOSIT.................................................................... ARTICLE 17: ATTORNEYS' FEES AND VENUE........................................................... ARTICLE 18: SUBORDINATION, ATTORNMENT AND LENDER PROTECTION..................................... ARTICLE 19: ESTOPPEL CERTIFICATES............................................................... ARTICLE 20: RIGHTS RESERVED BY LANDLORD......................................................... ARTICLE 21: RIGHT TO CURE....................................................................... ARTICLE 22: INDEMNIFICATION..................................................................... ARTICLE 23: RETURN OF POSSESSION................................................................ ARTICLE 24: HOLDING OVER........................................................................ ARTICLE 25: NOTICES............................................................................. ARTICLE 26: REAL ESTATE BROKERS................................................................. ARTICLE 27: NO WAIVER........................................................................... ARTICLE 28: TELECOMMUNICATION LINES............................................................. ARTICLE 29: HAZARDOUS MATERIALS................................................................. ARTICLE 30: DEFINITIONS......................................................................... ARTICLE 31: OFFER............................................................................... ARTICLE 32: MISCELLANEOUS....................................................................... ARTICLE 33: ENTIRE AGREEMENT.................................................................... EXHIBITS .................................................................Listed in Article 1.P
i OFFICE LEASE THIS OFFICE LEASE ("Lease") is made and entered into as of the 13th day of November, 1998, by and between CMD PROPERTIES, INC. ("Landlord"), an Illinois corporation, and RED HAT SOFTWARE, INC. ("Tenant"), a Delaware corporation. ARTICLE 1: BASIC PROVISIONS This Article contains the basic lease provisions between Landlord and Tenant. A. Building: Located at 2600 Meridian Parkway, Durham, North Carolina (the "Property", as further described in Article 30). B. Premises: Those three (3) certain spaces designated as "Space A," "Space B" and "Space C," to be collectively known as "Suite 100,"located on the 1st floor of the Building as outlined or crosshatched on EXHIBIT A hereto. C. Commencement Date: January 15, 1999, subject to Articles 2 and 4 (including later Possession bates for Space B and Space C per Article 2.D). D. Expiration Date: January 14, 2004, subject to Articles 2 and 4. E. Rentable Area: The rentable area of: (i) Space A shall be deemed to be 25,000 square feet (as further described in Article 2D), (ii) Space B shall be deemed to be 18,737 square feet, and (iii) Space C shall be deemed to be 8,124 square feet, such that the rentable area of the total Premises shall be deemed to be 51,861 square feet, and the rentable area of the Property shall be deemed to be 65,401 square feet, for purposes of this Lease, subject to Article 30. The preceding measurements were made using the BOMA/ANSI Standards as of June 7, 1996 and shall not be subject to remeasurement except as provided in Article 30 and in Article 2F. F. Tenant's Share: Sixty-six and 88/100 percent (66.88%) until the Space C Possession Date; and thereafter, Seventy-nine and 30/100 percent (79.30%), subject to Articles 3 and 30. G. Base Rent: Tenant shall pay monthly Base Rent pursuant to the following schedule and as described in Article 3:
Period Monthly Base Rent Commencement Date - 3/31/99 $39,804.08 4/l/99 - 1/14/00 $65,957.81 1/15/00 - 1/14/01 $74,922.94 1/15/01 - 1/14/02 $77,545.24 1/15/02 - 1/14/03 $80,259.32
1 1/15/03 - 1/14/04 $83,068.40
H. Additional Rent: Tenant shall pay Tenant's Share of Taxes and Expenses in excess of the amounts respectively for 1999 ("Base Tax Year") and 1999 ("Base Expense Year"), as further described in Article 3. I. Permitted Use: General office use, which shall be deemed to include, as related uses, a telephone call center (i.e., a computer "help desk"), sales and service, research and development, and a training center, which uses shall be in connection with Tenant's business and for its customers and employees, subject to Article 7. J. Security Deposit: $65,957.81, subject to Article 16 and Exhibit 1. K. Broker (if any): Corporate Realty Advisors and Park City Developments, Inc., subject to Article 26. L. Guarantor(s): N/A. M. Landlord's Notice Address (subject to Article 25): c/o CMD Realty Investors, Inc., Suite 135, 2500 Meridian Parkway, Durham, North Carolina 27713, Attn.: Regional Manager; with copies c/o CMD Realty Investors, Inc., 227 West Monroe Street, Suite 3900, Chicago, Illinois 60606, Attn.: General Counsel and Attn: National Leasing Manager. N. Tenant's Notice Address (subject to Article 25): Until the Commencement Date: Red Hat Software, Inc., 4201 Research Commons, Suite 100, Research Triangle Park, North Carolina 27709. Attn: Manoj George, CFO On the Commencement Date: Red Hat Software, Inc., 2600 Meridian Parkway, Suite 100, Durham, North Carolina 27713, Attn: Chief Financial Officer With a copy to: Steven 1. Reinhard, Esq., Ragsdale, Liggett & Foley, CrossPointe Plaza, 2840 Plaza Place, Suite 400, Raleigh, North Carolina 27612. 0. Rent Payments: Rent shall be paid to Landlord c/o The First National Bank of Chicago, P.O. Box 93150, Chicago, Illinois 60673-3150, or such other parties and addresses as to which Landlord shall provide with thirty (30) days' advance notice. P. Exhibits: This Lease includes, and incorporates by this reference: EXHIBIT A: Premises EXHIBIT B: Rules EXHIBIT C: Work Letter 2 EXHIBIT D: Parking EXHIBIT E: Tenant Exterior Sign EXHIBIT F: Option to Expand EXHIBIT G: Extension Option EXHIBIT H: Antenna EXHIBIT H-1: Area of Roof or Other Structure Identified EXHIBIT I: Letter of Credit Requirements EXHIBIT I-1: Form of Letter of Credit EXHIBIT J: Cleaning Specifications EXHIBIT K: Storage Space EXHIBIT L: Right of First Offer The foregoing provisions shall be interpreted and applied in accordance with the other provisions of this Lease. The terms of this Article, and the terms defined in Article 30 and other Articles, shall have the meanings specified therefor when used as capitalized terms in other provisions of this Lease or related documentation (except as expressly provided to the contrary therein). 3 ARTICLE 2: TERM AND COMMENCEMENT A. TERM. Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the Premises for the Term, subject to the other provisions of this Lease, including the provisions of Paragraph D below respecting later possession dates for Space B and Space C. The term ("Term") of this Lease shall commence on the Commencement Date and end on the Expiration Date set forth in Article 1, unless sooner terminated as provided in this Lease, subject to adjustment as provided below and the other provisions of this Lease. B. EARLY COMMENCEMENT. The Commencement Date, Rent and Tenant's other obligations shall be advanced to such earlier date Tenant, with Landlord's written permission, commences occupying the Premises for the operation and conduct of business. If such event occurs with respect to a portion of the Premises, the Commencement Date, Rent and Tenant's other obligations shall be so advanced with respect to such portion (and fairly prorated based on the rentable square footage involved). During any period that Tenant shall be permitted to enter the Premises prior to the Commencement Date other than to occupy the same for the operation and conduct of business (e.g., to perform alterations or improvements), Tenant shall comply with all terms and provisions of this Lease, except those provisions requiring the payment of Rent. Landlord shall permit early entry, so long as the Premises are legally available, Landlord has completed any work required to be performed by Landlord under this Lease (or can reasonably accommodate the scheduling of minor work Tenant desires to perform, such as cabling, without delaying any such Landlord work), and Tenant is in compliance with the other provisions of the Lease, including the insurance requirements. C. COMMENCEMENT DELAYS. The Commencement Date (or the Space B Possession Date or Space C Possession Date, as the case may be), and Rent and Tenant's other obligations relating thereto shall be postponed to the extent Tenant is not reasonably able to occupy Space A (or Space B or Space C, as the case may be) for the operation and conduct of business because Landlord fails, by the Commencement Date set forth in Article 1 (or the Space B Possession Date or Space C Possession Date, as the case may be) to: (i) deliver possession and (ii) substantially complete the improvements required to be performed by Landlord under Exhibit C to this Lease with respect to the applicable space, except to the extent that Tenant, its space planners, architects, contractors, agents or employees in any way contribute to such failure. The substantial completion referred to in subsection (ii) above, Section 4B of the Lease and in Exhibit C shall be deemed to have occurred when evidenced by the city of Durham inspector's issuance of a temporary certificate of occupancy and a certificate of substantial completion issued by the Architect (as defined in Exhibit C). If such failure occurs with respect to a portion of the subject space, the Commencement Date (or the Space B Possession Date or Space C Possession Date, as the case may be), Rent and Tenant's other obligations shall be so postponed with respect to such portion (and fairly prorated based on the rentable square footage involved). Any such delay in the Commencement Date shall not subject Landlord to liability for loss or damage resulting therefrom, and Tenant's sole recourse with respect thereto shall be the postponement of Rent and other obligations described herein, except as follows: (1) If the Commencement Date has not occurred by January 25, 1999 then beginning on January 25, 1999 and continuing until the Commencement Date has occurred, the commencement of Base Rent shall be delayed as provided above and Tenant shall also be entitled one (1) day of Base Rent abatement for each day of delay of the Commencement Date; and (2) If the Commencement Date has not occurred by May 17, 1999, Tenant shall have the right to terminate this Lease by written notice to Landlord given no later than May 27, 1999; provided, however, that the dates set forth in subsections (1) and (2) immediately above shall 4 be extended by the number of days of delay in the Commencement Date to which Tenant or its space planners, architects, contractors, agents or employees have in any way contributed. In the event that Tenant elects not to terminate the Lease, then the one (1) day of Rent abatement per day of delay as set forth in subsection (1) above shall cease as of May 17, 1999, and Tenant's only remedy for further delays in delivery of possession of the Premises shall be the delay in the commencement of Rent. D. SPACE B AND SPACE C POSSESSION DATES. Notwithstanding anything to the contrary contained in this Lease: (i) Tenant shall not be entitled to use or occupy Space B until April 1, 1999 ("SPACE B POSSESSION DATE"), unless (a) Tenant elects to accelerate the Space B Possession Date by written notice to Landlord, (b) Landlord has substantially completed the Work to Space B as defined in EXHIBIT C attached hereto, and (c) Tenant shall pay to Landlord additional Base Rent in the amount of $26,153.73 per month (as and when the Base Rent for Space A is due for the applicable month provided that Base Rent for any partial month with respect to Space B shall be paid no later that the date of Tenant's occupancy of Space B) for the period from the date of occupancy of Space B through March 31, 1999 (prorated on a per diem basis). It is understood and agreed that Space B is not a fixed block of space but rather, consists of 18,737 rentable square feet within (i.e. approximately 43% of) the area designated as "Space A and B" in Exhibit A and which Tenant has agreed not to occupy until the Space B Possession Date. Tenant agrees to act in good faith in observing the preceding distinction between Spaces A and B. (ii) Tenant shall not be entitled to use or occupy Space C until January 15, 2000 ("SPACE C POSSESSION DATE"), unless (a) Tenant elects to accelerate the Space C Possession Date by written notice to Landlord, (b) Landlord has substantially completed the Work to Space C as defined in EXHIBIT C attached hereto, and (c) Tenant shall pay to Landlord additional Base Rent in the amount of $6,431.50 per month (as and when the Base Rent for Space A is due for the applicable month provided that Base Rent for any partial month with respect to Space C shall be paid no later that the date of Tenant's occupancy of Space C) for the period from the date of occupancy of Space C through January 14, 2000 (prorated on a per diem basis). (iii) Until the Space B Possession Date and Space C Possession Date occur, the Base Rent and Additional Rent under this Lease shall be deemed to constitute rent with respect to Space A, and additional consideration for Landlord's agreement not to lease Space B or Space C to any other party, and instead to include Space B and Space C in the Premises, subject to staged possession dates as provided herein. E. ADJUSTMENTS TO DATES, RENTABLE AREAS AND OTHER MATTERS; CONFIRMATION. If the Commencement Date is advanced to an earlier date as provided above, the Expiration Date shall not be changed. If the Commencement Date is postponed as provided above, the Expiration Date shall be extended by the same length of time and all other specific dates within this Lease (including Base Rent increases and dates contained within options) shall likewise be postponed. If the Commencement Date occurs other than on the first day of a calendar month, then the Term shall be extended so that the Expiration Date is the last day of the calendar month in which it would otherwise occur, and the dates for any fixed increases in the Base Rent shall be adjusted so that they occur on the first day of the calendar month following the month in which they would otherwise occur. Tenant shall execute a confirmation of any dates and/or remeasurements and adjustments based on such remeasurements, as adjusted herein, in such 5 form as Landlord may reasonably request; any failure to respond within thirty (30) days after requested shall be deemed an acceptance of the matters set forth in Landlord's confirmation. If Tenant disagrees with Landlord's adjustment of such dates, and/or Landlord's remeasurements and adjustments based on such remeasurements under Paragraph F below, then Tenant shall pay Rent and perform all other obligations, in the amounts and on the dates set forth in Article 1, subject to retroactive and prospective adjustment between the parties promptly after the matter is resolved. F. REMEASUREMENT OF PREMISES. Within ten (10) business days after the substantial completion of the Building, Landlord shall cause the Building, the Premises and the combined Spaces A and B to be remeasured by a architect selected by Landlord ("Landlord's Architect"). The remeasurement shall be performed in accordance with BOMA/ANSI Standards as of June 7, 1996. Landlord shall provide the results of such remeasurement to Tenant, together with the architect's calculations therefor with three (3) business days after the completion of such remeasurement. The results of the remeasurement shall be provided to Tenant as follows: (1) total rentable square footage of the Building, (2) total rentable square footage of the Premises, (3) total rentable square footage of the combined Spaces A and B, (4) total rentable square footage of Space C, calculated by subtracting (3) above from (2) above. For the purposes of the Lease, the numbers for rentable square feet to be used for the Building, the Premises and the various parts thereof shall be as determined by Landlord's Architect. If Tenant disputes the results of such remeasurement, Landlord and Tenant shall select an architect (whose fees and costs shall be shared equally by Landlord and Tenant) mutually and reasonably agreeable to both parties who shall releaser the various areas set forth above and such architect's decision shall be final and binding on the parties. If square footages of the Building, Premises or Spaces A, B or C changes as the result of remeasurement as provided herein, all relevant square footage numbers and terms of this Lease relating to such square footage numbers (including without limitation, Rent, Tenant's Share and Allowances) shall be appropriately adjusted. ARTICLE 3: BASE RENT AND ADDITIONAL RENT A. BASE RENT. Tenant shall pay Landlord the monthly Base Rent set forth in Article 1 in advance on or before the first day of each calendar month during the Term; provided, Tenant shall pay Base Rent for the first full calendar month for which Base Rent shall be due (and any initial partial month) when Tenant executes this Lease. B. TAXES AND EXPENSES. Tenant shall pay Landlord Tenant's Share of Taxes and Expenses in excess of the amounts of Taxes and Expenses respectively for the Base Tax Year and Base Expense Year in the manner described below. The foregoing capitalized terms shall have the meanings specified therefor in Articles 1 and 30. 6 C. PAYMENTS. (i) Landlord may reasonably estimate in advance the amounts Tenant shall owe for Taxes and Expenses for any full or partial calendar year of the Term; such estimate shall be made by Landlord in good faith and shall contain a listing in reasonable detail for categories of Expenses. In such event, Tenant shall pay such estimated amounts, on a monthly basis, on or before the first day of each calendar month, together with Tenant's payment of Base Rent. Such estimate may be reasonably adjusted from time to time by Landlord, but not more than once per calendar year. (ii) Within 120 days after the end of each calendar year, or as soon thereafter as practicable, Landlord shall provide a statement (the "Statement") to Tenant showing: (a) the amount of actual Taxes and Expenses for such calendar year, with a listing in reasonable detail of amounts for categories of Expenses, (b) any amount paid by Tenant towards Taxes and Expenses during such calendar year on an estimated basis, and (c) any further revised estimate of Tenant's obligations for Taxes and Expenses for the current calendar year. (iii) If the Statement shows that Tenant's estimated payments were less than Tenant's actual obligations for Taxes and Expenses for such year, Tenant shall pay the difference within thirty (30) days after Landlord sends the Statement. If the Statement shows that Tenant's estimated payments exceeded Tenant's actual obligations for Taxes and Expenses, Landlord shall credit the difference against the payment of Rent next due. If the Term shall have expired or been terminated and no further Rent shall be due, Landlord shall provide a refund of such difference at the time Landlord sends the Statement. (iv) If the Statement shows a further increase in Tenant's estimated payments for the current calendar year, Tenant shall: (a) thereafter pay the new estimated amount until Landlord further revises such estimated amount, and (b) pay the difference between the new and former estimates for the period from January 1 of the current calendar year through the month in which the Statement is sent within thirty (30) days after Landlord sends the Statement, provided that Landlord has sent the Statement by April 30 of the calendar following the calendar year to which the Statement relates. If Landlord sends the Statement after April 30 of the calendar following the calendar year to which the Statement relates, then Tenant's payments shall be as follows: (1) within thirty (30) days after Landlord sends the Statement, Tenant shall pay the difference between the new and former estimates for the months of January through April of the current year, (2) within sixty (60) after Landlord sends the Statement, Tenant shall pay the difference between the new and former estimates for the month of May through the month in which Landlord sends the Statement. (v) Intentionally omitted. D. TAX REFUNDS, PROTEST COSTS, FISCAL YEARS AND SPECIAL ASSESSMENTS. Landlord shall each year: (i) credit against Taxes any refunds received during such year, whether or not for a prior year, (ii) include in Taxes any additional amount paid during such year involving an adjustment to Taxes for a prior year due to error by the taxing authority, supplemental assessment, or other reason, (iii) for Taxes payable in installments over more than one year, include only the minimum amounts payable each year and any interest thereon, and (iv) include, in either Taxes or Expenses, any fees for attorneys, consultants and experts, and other costs paid during such year in attempting to protest, appeal or otherwise seek to reduce or minimize Taxes, whether or not successful. Notwithstanding anything to the contrary contained in this Lease, if any taxing authority, at any time, uses a fiscal year other than a current calendar 7 year, Landlord may elect to require payments by Tenant based on: (a) amounts paid or payable during each calendar year without regard to such fiscal years, or (b) amounts paid or payable for or during each fiscal tax year. E. GROSSING UP VARIABLE EXPENSES; TAXES. In order to allocate variable Expenses (i.e. those items that vary based on occupancy levels, such as janitorial and utility costs) among those parties who are incurring such Expenses when the Property is not fully occupied during all or a portion of any calendar year, Landlord may, in accordance with sound accounting and management practices, determine the amount of such variable Expenses that would have been paid had the Property been fully occupied, and the amount so determined shall be deemed to have been the amount of Expenses for such year (rather than adjusting Tenant's Share by subtracting vacant space from the denominator); if Landlord makes such an adjustment to Expenses for any year following the Base Expense Year, Landlord shall also make such an adjustment to Expenses for the Base Expense Year. If Landlord adds a new type of expense in a subsequent year that was not included in the Base Year (e.g. an annual HVAC maintenance contract that was not needed during the Base Expense Year because of an HVAC warranty), then Landlord shall make an appropriate adjustment to the Base Expense Year by adding thereto a reasonable amount to reflect the expense that would have been incurred if such new type of expense (e.g. such annual HVAC maintenance contract) had been incurred in the Base Expense Year. Similarly, if Landlord is not furnishing any particular utility or service (the cost of which, if performed by Landlord, would be included in Expenses) to a tenant during any period, Landlord may for such period: (i) adjust Expenses to reflect the additional amount that would reasonably have been incurred during such period had Landlord furnished such utility or service to such tenant, or (ii) exclude the rentable area of such tenant from the rentable area of the Property in computing Tenant's Share of the component of Expenses for such utility or service. Landlord shall adjust the Taxes for the Base Tax Year to the amount that the Taxes would have been for the Base Tax Year if the Building had been fully occupied and fully improved. F. PRORATIONS; PAYMENTS AFTER TERM ENDS. If the Term commences on a day other than the first day of a calendar month or ends on a day other than the last day of a calendar month, the Base Rent and any other amounts payable on a monthly basis shall be prorated on a per diem basis for such partial calendar months. If the Base Rent is scheduled to increase under Article 1 other than on the first day of a calendar month, the amount for such month shall be prorated on a per them basis to reflect the number of days of such month at the then current and increased rates, respectively. If the Term commences other than on January 1, or ends other than on December 31, Tenant's obligations to pay amounts towards Taxes and Expenses for such first or final calendar years shall be prorated on a per diem basis to reflect the portion of such years included in the Term. Tenant's and Landlord's obligations regarding Taxes and Expenses (or any other amounts) accruing during, or relating to, the period prior to expiration or earlier termination of this Lease, shall survive such expiration or termination. G. LANDLORD'S ACCOUNTING PRACTICES AND RECORDS. Landlord shall maintain records respecting Taxes and Expenses and determine the same in accordance with sound accounting and management practices consistently applied in accordance with this Lease. Although this Lease contemplates the general computation of Taxes and Expenses on a cash basis, Landlord shall make reasonable and appropriate accrual adjustments to ensure that each calendar year includes substantially the same recurring items. Landlord reserves the right to apply a full accrual system of accounting so long as the same is consistently applied and 8 Tenant's obligations are not materially adversely affected, and further provided that Landlord shall continue to pay Expenses and Taxes on a timely basis. Tenant or its representative (acting on a noncontingent fee basis) shall have the right to review such records by sending notice to Landlord no later than ninety (90) days following the furnishing of the Statement specifying such records as Tenant reasonably desires to review. Such review shall be subject to the continuing condition that Tenant not be in Default, and subject to reasonable scheduling by Landlord during normal business hours at the place or places where such records are normally kept provided that such records shall be kept within the 48 continental United States. No later than ninety (90) days after Landlord makes such records available for review, Tenant shall send Landlord notice specifying any exceptions that Tenant takes to matters included in such Statement, Tenant's detailed reasons for each exception which support a conclusion that such exception properly identifies an error in such Statement, and a complete copy of the review report. Such Statement shall be considered final and binding on Tenant, except as to matters to which exception is taken after review of Landlord's records in the foregoing manner and within the foregoing times. The foregoing times for sending Tenant's notices hereunder are critical to Landlord's budgeting process, and are therefore of the essence of this Paragraph. If Tenant takes timely exception as provided herein, Landlord may seek certification from an independent certified public accountant or financial consultant (who shall be subject to Tenant's reasonable approval) as to the proper amount of Taxes and Expenses or the items as to which Tenant has taken exception. In such case: (i) such certification shall be considered final and binding on both parties (except as to additional amounts not then known or omitted by error), and (ii) Tenant shall pay Landlord for the cost of such certification, unless it shows that Tenant's Share of Taxes and Expenses were overstated by a net amount of three percent (3%) or more, in which event Landlord shall pay the reasonable cost of such certification provided that such reasonable cost does not exceed the amount of the overstatement. Pending review of such records and resolution of any exceptions, Tenant shall pay Tenant's Share of Taxes and Expenses in the amounts shown on such Statement, subject to credit, refund or additional payment after any such exceptions are resolved. H. BASE YEAR ADJUSTMENTS. If Taxes for the Base Tax Year are reduced as the result of protest or otherwise, Landlord may use the final reduced amount of Taxes for the Base Tax Year to compute Tenant's obligations for increases in Taxes during the Term. In such case, Tenant shall pay Landlord, within fifteen (15) days after notice, any additional amount of Taxes required by such computation for any period that has theretofore occurred during the Term following the Base Tax Year. Landlord may exclude from Base Year Expenses any nonrecurring items, including capital expenditures otherwise permitted under Article 30 (and shall only include the amortization of such expenditures in subsequent year Expenses to the extent permitted under Article 30). If Landlord eliminates from any subsequent year Expenses a recurring category of Expenses previously included in Base Year Expenses, Landlord may subtract such category from Base Year Expenses commencing with such subsequent year. I. GENERAL PAYMENT MATTERS. Base Rent, Taxes, Expenses and any other amounts which Tenant is or becomes obligated to pay Landlord under this Lease or other agreement entered in connection herewith are sometimes herein referred to collectively as "Rent," and all remedies applicable to the nonpayment of rent shall be applicable thereto. Tenant shall pay Rent in good funds and legal tender of the United States of America, together with any applicable sales tax or other taxes on Rent as further described in Article 14. Tenant shall pay Rent without any deduction, recoupment, setoff or counterclaim, and without relief from any valuation or appraisement laws, except as may be expressly provided in this Lease. No delay by Landlord in providing the Statement shall be deemed a default by Landlord or, unless Landlord fails to provide the Statement within one (1) calendar year following the close of 9 the calendar year to which the Statement relates, a waiver of Landlord's right to require payment of Tenant's obligations for actual or estimated Taxes or Expenses. In no event shall a decrease in Taxes or Expenses serve to decrease Base Rent. Landlord may apply payments received from Tenant to any obligations of Tenant then accrued, without regard to such obligations as may be designated by Tenant. ARTICLE 4: CONDITION OF PREMISES A. GENERAL CONDITION OF PREMISES. Tenant has inspected, or had an opportunity to inspect, the Premises (and portions of the Property, Systems and Equipment providing access to or serving the Premises), and agrees to accept the same "as is" without any agreements, representations, understandings or obligations on the part of Landlord to perform any alterations, repairs or improvements, except as may be expressly provided under this Lease (which term includes any Exhibit hereto). To the extent that Landlord has expressly agreed to perform any improvements to the Premises under this Lease, the following provisions shall apply. Landlord warrants and represents that, as of the date that Landlord delivers possession of the Premises to Tenant: (1) the Systems and Equipment serving the Property and the systems and equipment serving the Premises (to the extent that the same are part of the Work under Exhibit C) shall be in good working order, (2) the Building and the Premises have been constructed in a good and workmanlike manner, so as to be free of defects, and (3) the common areas of the Building shall comply with all Laws, including, but not limited to, the Americans with Disabilities Act. Landlord's sole liability for breach of any of the foregoing warranties shall be the obligation to make such repairs or alterations to the Property and the Premises as are necessary to cure the violation of the warranty. B. IMPROVEMENTS. With respect to the improvements to the Premises that Landlord is required to perform under EXHIBIT C to this Lease: (i) Landlord shall use diligent, good faith efforts to substantially complete any such improvements to an extent that Tenant can reasonably occupy the Premises for the operation and conduct of business by the Commencement Date set forth in Article 1, subject to Article 2 and the other provisions of this Lease, (ii) Tenant shall use diligent, good faith efforts to cooperate, and to cause its space planners, architects, contractors, agents and employees to cooperate, diligently and in good faith with Landlord and any space planners, architects, contractors or other parties designated by Landlord, such that any such improvements to the Premises can be planned, permits can be obtained, and the work can be substantially completed by the Commencement Date set forth in Article 1, and (ii) the Commencement Date, Rent and Tenant's other obligations shall be subject to postponement as further described in Article 2. In the event of any dispute as to whether any such improvements have been substantially completed, Landlord shall refer the matter to a third party mutually and reasonably agreeable to both Landlord and Tenant whose decision shall be final and binding on the parties. ARTICLE 5: QUIET ENJOYMENT Landlord agrees that, if Tenant timely pays the Rent and performs the terms and provisions hereunder, Tenant shall hold and enjoy the Premises during the Term free of lawful claims by any party acting by or through Landlord, subject to all other terms and provisions of this Lease. 10 ARTICLE 6: UTILITIES AND SERVICES A. STANDARD LANDLORD UTILITIES AND SERVICES. Landlord shall provide the following utilities and services (the cost of which shall be included in Expenses): (i) Heat and air-conditioning to provide a temperature required, in Landlord's reasonable opinion and in accordance with applicable Law, for occupancy of the Premises as offices during Building Hours (as defined in Article 30). (ii) Water from city mains for drinking, lavatory and toilet purposes only, at those points of supply provided for nonexclusive general use of tenants at the Property, or points of supply in the Premises installed by or with Landlord's written consent for such purposes. (iii) Cleaning and trash removal in and about the Premises substantially in accordance with the specifications attached hereto as Exhibit J. (iv) Passenger elevator service at all times (if the Property has such equipment serving the Premises, and subject to changes in the number of elevators in service after Building Hours or at other times), and freight elevator service (if the Property has such equipment serving the Premises, and subject to scheduling by Landlord), in common with Landlord and other parties. (v) Electricity for building standard overhead office lighting fixtures, and equipment and accessories customary for offices, where: (a) Tenant uses an amount of electricity that is generally consistent with average office use at the Property, as reasonably determined by Landlord, (b) the Systems and Equipment are suitable, and the safe and lawful capacity thereof is not exceeded, and (c) sufficient capacity remains at all times for other existing and future tenants, as reasonably determined by Landlord. Landlord shall include in Expenses the cost of replacement of lamps, starters and ballasts for Building standard lighting fixtures within the Premises; Tenant shall pay such costs for non-Building standard lighting fixtures within the Premises. (vi) Sprinklering of the Building in accordance with applicable Laws. (vii) Landscaping and snow removal services comparable to those provided as standard services by landlords for office space in comparable buildings in the vicinity. B. ADDITIONAL UTILITIES AND SERVICES. Landlord shall seek to provide such extra utilities. or services as Tenant may from time to time request, if the same are reasonable and feasible for Landlord to provide and do not involve modifications or additions to the Property or existing Systems and Equipment, and if Landlord shall receive Tenant's request within a reasonable period prior to the time such extra utilities or services are required. Landlord may comply with written or oral requests by any officer or employee of Tenant, unless Tenant shall notify Landlord of, or Landlord shall request, the names of authorized individuals (up to 3 for each floor on which the Premises are located) and procedures for written requests. Tenant shall pay for the actual cost to Landlord of any extra utilities or services, including Landlord's actual, reasonable out-of-pocket costs for architects, engineers, consultants and other parties relating to such extra utilities or services, and a fee equal to five percent (5%) of such costs. All payments for such extra utilities or services shall be due at the same time as the installment of 11 Base Rent with which the same are billed, or if billed separately, shall be due within fifteen (15) days after such billing. Landlord shall not be responsible for inadequate air-conditioning or ventilation whenever the use or occupancy of the Premises exceeds the normal capacity or design loads of, affects the temperature or humidity otherwise maintained by, or otherwise adversely affects the operation of, the Systems and Equipment for the Property, whether due to items of equipment or machinery generating heat, above normal concentrations of personnel or equipment, or alterations to the Premises made by or through Tenant without balancing the air or installing supplemental HVAC equipment. In any such case, Landlord may elect to balance the air and/or install, operate, maintain and replace such supplemental HVAC equipment during the Term, at Tenant's expense, as an extra utility or service (or require that Tenant arrange for the same as Work under Article 9). Notwithstanding the foregoing to the contrary, in lieu of charging separately for additional utilities and services, Landlord may reasonably elect from time to time to expand the amounts of services and utilities available without separate charge, in which case the costs thereof shall be included in Expenses, subject to the following sentence. In the event that, in any calendar year, any increase in Expenses resulting from the expansion of the amounts of services and utilities included in Expenses pursuant to the preceding sentence is estimated to exceed $0.50 per rentable square foot in the aggregate in any calendar year, then Landlord shall be required to obtain Tenant's approval (which shall not be unreasonably withheld, conditioned or delayed) of any amounts exceeding $0.50 per rentable square foot, provided that this sentence shall not apply to: (1) any increase in Expenses due to a reasonable increase in normal Building hours, and (2) any increase in Expenses due to changes in how a service or utility already included in Expenses is furnished. Notwithstanding anything to the contrary contained herein, it is understood and agreed by the parties that, due to the size and manner of design of the Building, HVAC services shall be available at all times without additional charge therefor (other than as part of Expenses), except that Landlord reserves the right pursuant to Article 6A(v) above to determine in a reasonable manner and charge Tenant for the cost of electricity used by Tenant in excess of average office use. If Tenant disputes the excess electricity charges as determined by Landlord, Tenant shall have the right, at Tenant's expense, to engage a consultant to provide another determination of such charges and Landlord agrees to reasonably and in good faith consider the merit and accuracy of such alternative determination in making its final determination of the excess electricity charges. C. MONITORING. Landlord may install and operate meters, submeters or any other reasonable system for monitoring or estimating any services or utilities used by Tenant in excess of those required to be provided by Landlord under this Article (including a system for Landlord's engineer to reasonably estimate any such excess usage). If such system indicates such excess services or utilities, Tenant shall pay Landlord's charges and fees as described in Paragraph B above for installing and operating such system and any supplementary air-conditioning, ventilation, heat, electrical or other systems or equipment (or adjustments or modifications to the existing Systems and Equipment) which Landlord may make, and Landlord's charges for such amount of excess services or utilities used by Tenant. D. INTERRUPTIONS AND CHANGES. Landlord shall have no liability for interruptions, variations, shortages, failures, changes in quality, quantity, character or availability of any utilities or services caused by repairs, maintenance, replacements, alterations (including any freon retrofit work), labor controversies, accidents, inability to obtain services, utilities or supplies, governmental or utility company acts or omissions, requirements, guidelines or requests, or other causes beyond Landlord's reasonable control (or under any circumstances with respect to utilities or services not required to be provided by Landlord hereunder). Under 12 no circumstances whatsoever shall any of the foregoing be deemed an eviction or disturbance of Tenant's use and possession of the Premises or any part thereof, serve to abate Rent, or relieve Tenant from performance of Tenant's obligations under this Lease; provided, however, after Landlord's receipt of notice, Landlord shall act reasonably and in good faith to cure the interruption or curtailment of services or utilities as soon as practicable thereafter. E. ABATEMENT OF RENT. Notwithstanding Paragraph D above to the contrary, if (a) any services or utilities required to be provided by Landlord hereunder are interrupted or discontinued as a result of Landlord's negligence (and not caused by Tenant or its employees, agents or contractors), and Tenant is unable to and does not use, the Premises as a result of such interruption or discontinuance, and (b) Tenant shall have given written notice respecting such interruption or discontinuance to Landlord, and Landlord shall have failed to cure such interruption or discontinuance within five (5) consecutive business days after receiving such notice, Base Rent hereunder shall thereafter be abated until such time as such services or utilities are restored or Tenant begins using, the Premises again, whichever shall first occur. Notwithstanding anything to the contrary contained herein, if Tenant, or its contractors, or their respective officers, employees, contractors, invitees or agents, delay Landlord in restoring the utilities or services, Landlord shall have additional time to complete the restoration equal to such delay and Tenant shall pay Landlord all Rent for the period of such delay. ARTICLE 7: USE, COMPLIANCE WITH LAWS, AND RULES A. USE OF PREMISES. Tenant shall use the Premises only for the permitted use identified in Article 1, and no other purpose whatsoever, subject to the other provisions of this Article and this Lease. Unless expressly permitted in Article 1. Tenant shall not use or permit the Premises to be used as a: (1) social welfare office, (ii) medical, dental, psychology, psychiatry, or science office or laboratory, (iii) multiparty "executive" or "legal" suite type offices, (iv) data processing, telecommunications or telemarketing center, (v) school, educational or training facility, (vi) employment, placement, recruiting or clerical support agency, (vii) computerized vehicle sales, loan or "findee" service, (viii) governmental, quasi-governmental trade association or union office or activities, (ix) travel agency or reservation center, (x) radio or television studio or broadcasting or recording facility, or (xi) retail real estate brokerage, retail stock brokerage, retail bank or other retail financial institution, loan office, depository, check-cashing or wire transferring service. B. COMPLIANCE WITH LAWS. Subject to Section 4A and except to the extent that such compliance is allocated to Landlord elsewhere under this Lease, the Tenant shall comply with all Laws relating to the Premises and Tenant's use of the Premises and Property, and shall promptly reimburse (within thirty (30) days after Tenant's receipt of Landlord's invoice) Landlord for any expenses Landlord incurs for work or other matters relating to areas outside of the Premises in order to comply with Laws as a result of Tenant's use of the Premises or Property; provided, Tenant shall not be required by this provision to perform structure or capital improvements to the Premises unless required by a Law pertaining to, (i) Tenant's particular use of the Premises (as opposed to a Law that applies to office tenants in general), (ii) work performed by or for Tenant or any Transferee (i.e. excluding any improvements in work that Landlord is required to perform under this Lease), or (iii) other acts or omissions of Tenant or any Transferee. Landlord shall comply with all Laws affecting the structure or common areas of the Property (the cost of which shall be included in Expenses, but only to the extent permitted in the definition thereof in Article 30), except to the extent that such compliance is Tenant's 13 responsibility under this Lease or is the responsibility of another occupant of the Property. To best of Landlord's actual knowledge as of the date of this Lease and as of the Commencement Date, there are no current violations of Laws affecting the Premises or Tenant's use of the Property. C. RULES. Tenant shall comply with the Rules set forth in EXHIBIT B attached hereto (the "Rules"). Landlord shall have the right, by notice to Tenant, to reasonably amend such Rules and supplement the same with other reasonable Rules relating to the Property, or the promotion of safety, care, efficiency, cleanliness or good order therein provided that such amended Rules are not contrary to this Lease. Although Landlord shall not discriminate against Tenant in the enforcement of the Rules, nothing herein shall be construed to give Tenant or any other Person any claim, demand or cause of action against Landlord arising out of the violation of Laws or the Rules by any other tenant or visitor of the Property, or out of the enforcement, modification or waiver of the Rules by Landlord in any particular instance. D. OTHER REQUIREMENTS. So long as Tenant receives written notification of the applicable requirements, Tenant shall not use or permit the Premises or Property to be used in a way that will: (i) violate the requirements of Landlord's insurers, the American Insurance Association, or any board of underwriters, (ii) cause a cancellation of Landlord's policies, impair the insurability of the Property, or increase Landlord's premiums (any such increase shall be paid by Tenant without such payment being deemed permission to continue such activity or a waiver of any other remedies of Landlord), or (iii) violate the requirements of any certificates of occupancy issued for the Premises or the Property, or any other requirements, covenants, conditions or restrictions affecting the Property at any time (provided none of the foregoing shall prohibit or materially impair use of the Premises as set forth in Article 1 in compliance with the other provisions of this Lease and the enjoyment of the other rights accorded to Tenant under this Lease). Landlord hereby warrants that the Plans for initial construction of the Property have been approved under that certain Declaration of Covenants, Conditions, Restrictions and Easements of the Meridian Business Campus filed with the Durham County Register of Deeds in Book 1235, pages 404 through 437 and Book 2285, pages 810-815. E. ANTENNA. Landlord agrees that Tenant shall have the right to install an antenna on the roof of the Building provided that the parties enter into an amendment to the Lease substantially in the form of Exhibits H and H-1 which are