| RED HAT INC ITEM 1A RISK FACTORS Set forth below are certain risks and cautionary statements, which supplement other disclosures in this Annual Report on Form 10-K Moreover, certain statements contained in this Annual Report on Form 10-K, including in Management’s Discussion and Analysis of Financial Condition and Results of Operations, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 |
| Forward-looking 14 ______________________________________________________________________ statements provide current expectations of future events based on certain assumptions and include any statement that is not strictly an historical statement (for example, statements regarding current or future financial performance, management’s plans and objectives for future operations, product plans and performance, management’s expectations regarding market risk and market penetration, management’s assessment of market factors or strategies, objectives and plans of Red Hat and its partners) |
| Words such as “anticipates,” “believes,” “expects,” “estimates,” “intends,” “plans,” “projects,” and similar expressions, may also identify such forward-looking statements |
| Investors are cautioned that these forward looking statements are not guarantees of Red Hat’s future performance and are subject to a number of risks and uncertainties that could cause Red Hat’s actual results to differ materially from those found in the forward looking statements and from historical trends |
| These risks and uncertainties include the risks and cautionary statements detailed below and elsewhere in this Annual Report on Form 10-K as well as in Red Hat’s other filings with the Securities and Exchange Commission (SEC), copies of which may be accessed through the SEC’s web site at http://www |
| Readers are urged to carefully review these risks and cautionary statements |
| The forward-looking statements included in this Annual Report represent our views as of the date of this Annual Report |
| We specifically disclaim any obligation to update these forward-looking statements in the future |
| These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Annual Report |
| RISKS RELATED TO BUSINESS UNCERTAINTY If we fail to continue to establish and maintain strategic distribution and other collaborative relationships with industry-leading companies, we may not be able to attract and retain a larger customer base |
| Our success depends in part 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 such as Dell, Hewlett-Packard, IBM, SUN, Oracle, Fujitsu and others |
| These relationships allow us to offer our products and services to a much larger customer base than we would otherwise be able to through our direct sales and marketing efforts |
| We may not be able to maintain these relationships or replace them on attractive terms |
| In addition, our existing strategic relationships do not, and any future strategic relationships may not, afford us any exclusive marketing or distribution rights |
| As a result, many of the companies with which we have strategic alliances pursue alternative technologies and develop alternative products and services in addition to or in lieu of our products and services, either on their own or in collaboration with others, including our competitors |
| Moreover, we cannot guarantee that the companies with which we have strategic relationships will market our products effectively or continue to devote the resources necessary to provide us with effective sales, marketing, and technical support |
| We have entered into and may continue to enter into or seek to enter into business combinations and acquisitions, which may be difficult to complete, integrate, disrupt our business, dilute stockholder value or divert management attention |
| As part of our business strategy, we have in the past and, in the future, may enter into business combinations and acquisitions |
| We have limited experience in making acquisitions, and acquisitions present significant challenges and risks, including: · The difficulty of integrating the operations, systems and personnel of the acquired companies; · The difficulty of gathering full information regarding the target business prior to the acquisition; · The maintenance of acceptable standards, controls, procedures and policies; · The potential disruption of our ongoing business and distraction of management; · The impairment of relationships with employees and customers as a result of any integration of new management and other personnel; · The inability to maintain a relationship with customers of the acquired business; 15 ______________________________________________________________________ · Challenges in maintaining good and effective relations with existing business partners or of those of the acquired business, including as a result of the changes in the competitive landscape effected by the acquisition; · The difficulty of incorporating acquired technology and rights into our products and services and of maintaining quality standards consistent with the Red Hat brand; · The potential failure to achieve the expected benefits of the combination or acquisition; · Expenses related to the acquisition; · Potential unknown liabilities associated with the acquired businesses; and · Unanticipated expenses related to acquired technology and its integration into existing technology |
| There can be no assurance that we will manage these challenges and risks successfully |
| Moreover, if we are not successful in completing acquisitions that we have or may pursue, our business may be adversely affected, and we may incur substantial expenses and divert significant management time and resources |
| In addition, in pursuing such acquisitions, we could use substantial portions of our available cash as all or a portion of the purchase price |
| We could also issue additional securities as consideration for these acquisitions, which could cause our stockholders to suffer significant dilution, or we may incur substantial debt |
| Any acquisition may not generate additional revenue or profit for us, which may adversely affect our operating results |
| If we fail to effectively manage our growth, our operations and financial results could be adversely affected |
| We have expanded our operations rapidly in recent years |
| For example, our total revenues increased from approximately dlra196dtta5 million for the year ended February 28, 2005 to approximately dlra278dtta3 million for the year ended February 28, 2006 |
| Moreover, the total number of our employees increased significantly over that year |
| In addition, we continue to explore ways to extend our product and service offerings, and geographic reach |
| Our growth has placed and will likely continue to place a strain on our management systems, information systems, resources and internal controls |
| Our ability to successfully offer products and services and implement our business plan requires adequate information systems and resources and oversight from our senior management |
| As we grow, we must also continue to hire, train, supervise and manage new employees |
| As we grow and expand globally, controls and oversight functions will become more complex and distributed and may in part be outsourced |
| We may not be able to adequately screen and hire or adequately train, supervise and manage sufficient personnel or develop management, or effectively manage and develop our controls and oversight functions and information systems to adequately manage our expansion effectively |
| If we are unable to adequately manage our growth and expansion, our operations and financial results could be materially adversely affected |
| We rely, to a significant degree, on an indirect sales channel for distribution of our products and services, and disruption of any part of this channel could adversely affect the sales of our products |
| We use a variety of different distribution methods to sell our products and services, including indirect channel partners, such as third party OEMs, resellers and distributors |
| A number of these partners in turn distribute via their own networks of channel partners (eg, distributors and resellers), with whom we have no direct relationship |
| We rely, to a significant degree, on our channel partners to, among other activities, select, screen and maintain relationships with our distribution network and for the distribution of our products and services in a manner that is consistent with Red Hat’s quality standards |
| Our indirect distribution channel could be affected by disruptions in the relationships of and with our channel partners and their networks, including their customers or suppliers |
| We cannot guarantee that our channel partners will market our products effectively |
| Disruptions in our distribution channel or poor marketing support by channel partners could lead to decreased sales or slower than expected growth |
| 16 ______________________________________________________________________ We may not be able to continue to attract capable management personnel Our ability to retain key management personnel or hire capable new management personnel as we grow may be challenged to the extent the technology sector performs well and/or if companies with more generous compensation packages or greater perceived growth opportunities compete for the same personnel |
| In addition, historically we have used stock options as a key component of our compensation packages |
| Changes in the accounting for equity compensation, including stock options, could adversely affect our earnings or force us to use more cash compensation to attract and retain capable personnel |
| Volatility in the stock market may reduce the value of our equity awards to the recipient |
| Such events, or if we are unable to secure shareholder approval for increases in the number of shares eligible for equity compensation grants, could adversely affect our ability to successfully attract and retain key management personnel |
| We depend on our key personnel that we employ |
| Our future success depends on the continued services of a number of key officers and employees |
| The loss of the technical knowledge and industry expertise of any of these individuals could seriously impede our success |
| Moreover, the loss of these individuals, particularly to a competitor, and any resulting loss of customers could reduce our market share and diminish the Red Hat brand and adversely affect our business or stock price |
| Our CEO and other key employees have become, or will soon become vested in a significant amount of their equity compensation awards |
| Employees may be more likely to leave us after a significant portion of their equity compensation awards fully vest, especially if the shares underlying the options have significantly appreciated in value |
| The subscription agreement used for many of our products, including Enterprise Linux, requires customers to agree to a subscription for our services for each installed system on which they deploy our subscription based products |
| At the same time, the subscription agreement places no restriction on the customer’s right to redistribute the products |
| While we believe this practice complies with the requirements of the GNU General Public License, and while we have reviewed this practice with the Free Software Foundation, the organization that maintains and provides interpretations of the GNU General Public License, we may still encounter customer resistance to this distribution model |
| To the extent we are unsuccessful in promoting or defending this distribution model, our business and operating results could be materially and adversely affected |
| If our current and future customers do not renew their subscription agreements with us, our revenue and operating results may be adversely impacted |
| Our customers may not renew their subscriptions for our service after the expiration of their subscription agreements and in fact, some customers elect not to do so |
| In addition, our customers may opt for a lower priced edition of our service or for fewer subscriptions |
| We have limited historical data with respect to rates of customer subscription renewals, so we cannot accurately predict customer renewal rates |
| Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their level of satisfaction with our service and their ability to continue their operations and spending levels |
| If we experience a decline in the renewal rates for our customers or they opt for lower priced editions of our offerings or fewer subscriptions, our revenue and operating results may be adversely impacted |
| If open source software programmers, most of whom we do not employ, do not continue to develop and enhance open source technologies, we may be unable to develop new products or adequately enhance our existing products |
| We rely to a significant degree on several largely informal communities of independent open source software programmers to develop and enhance our products |
| For example, Linus Torvalds, a prominent open source software developer, and a relatively small group of software engineers, many of whom are not employed 17 ______________________________________________________________________ by us, are primarily responsible for the development and evolution of the Linux kernel, which is the heart of the Enterprise Linux operating system |
| If these groups of programmers fail to adequately further develop and enhance open source technologies, we would have to rely on other parties to develop and enhance our products or we would need to develop and enhance our products with our own resources |
| We cannot predict whether further developments and enhancements to these technologies would be available from reliable alternative sources |
| In either event, our development expenses could be increased and our product release and upgrade schedules could be delayed |
| Moreover, if third party software programmers fail to adequately further develop and enhance open source technologies, the development and adoption of these technologies could be stifled and our products could become less competitive |
| If third-party enterprise software application providers do not continue to make their applications compatible with our Linux-based operating system offerings, our software will cease to be competitive |
| Our products will not be competitive unless enterprise software applications are compatible with our Linux-based operating system offerings |
| We intend to encourage the development of additional applications that operate on both current and new versions of our Linux-based operating systems by, among other means, attracting third-party developers to the Linux platform, providing open source tools to create these applications and maintaining our existing developer relationships through marketing and technical support |
| If we are not successful in achieving these goals, however, our products will not be competitive and our sales growth will be adversely affected |
| We may be unable to predict the future course of open source technology development, which could reduce the market appeal of our products and damage our reputation |
| We do not exercise control over many aspects of the development of open source technology |
| Different groups of open source software programmers compete with one another to develop new technology |
| Typically, the technology developed by one group will become more widely used than that developed by others |
| If we acquire or adopt new technology and incorporate it into our products but competing technology becomes more widely used or accepted, the market appeal of our products may be reduced and that could harm our reputation, diminish the Red Hat brand and result in decreased revenue |
| Because of the characteristics of open source software, there are few technology barriers to entry in the open source market by new competitors and it may be relatively easy for new competitors with greater resources than we have to enter our markets and compete with us |
| One of the characteristics of open source software is that anyone can modify the existing software or develop new software that competes with existing open source software |
| Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies |
| It is possible for new competitors with greater resources than ours to develop their own open source solutions, potentially reducing the demand for our solutions |
| In addition, some competitors make their open source software available for free download and use on an ad hoc basis or may position their open source software as a loss leader |
| We cannot guarantee that we will be able to compete successfully against current and future competitors or that competitive pressure and/or the availability of open source software will not result in price reductions, reduced operating margins and loss of market share, any one of which could seriously harm our business |
| Our continued success depends on our ability to adapt to a rapidly changing industry as well as maintaining a strong brand |
| Investment in new business strategies and initiatives could disrupt our ongoing business and may present risks not originally contemplated |
| We must continue to invest significant resources in research and development in order to enhance our existing products and services and introduce new high-quality products and services and technology infrastructure |
| If we are unable to ensure that our users and customers have a high quality experience with our products and services, then they may become dissatisfied and move to competitors’ products and services |
| In 18 ______________________________________________________________________ addition, if we are unable to predict user preferences or industry changes, or if we are unable to modify our products and services on a timely basis, we may lose customers |
| Our future success will depend on our ability to adapt to rapidly changing technologies, to adapt our services to evolving industry standards and to improve the performance and reliability of our services |
| In addition, the widespread adoption of other technological changes could require substantial expenditures to modify or adapt our services or infrastructure |
| Moreover, we believe that our continued success depends on our investing in new business strategies or initiatives that complement our strategic direction and product road map |
| Such endeavors may involve significant risks and uncertainties, including distraction of management’s attention away from other business operations; insufficient revenue generation to offset liabilities and expenses undertaken with such strategies and initiatives |
| Because these endeavors may be inherently risky, no assurance can be given that such endeavors will not materially adversely affect our business, operating results or financial condition |
| Security and privacy breaches may expose us to liability and cause us to lose clients |
| Our security and testing measures may not prevent security breaches that could harm our business |
| For example, a significant number of our users provide us with credit card and other confidential information and authorize us to bill their credit card accounts directly for our products and services |
| Typically, we rely on encryption and authentication technology licensed from third parties to enhance transmission security of confidential information |
| Advances in computer capabilities, new discoveries in the field of cryptography, inadequate facility security or other developments may result in a compromise or breach of the technology used by us to protect customer data |
| Any compromise of our security could harm our reputation or financial condition and, therefore, our business |
| In addition, a party who is able to circumvent our security measures could, among other effects, misappropriate proprietary information, cause interruptions in our operations or expose customers to computer viruses or other disruptions |
| Actual or perceived vulnerabilities may lead to claims against us |
| While our customer agreements typically contain provisions that seek to limit our liability, there is no assurance these provisions will be enforceable and effective under applicable law |
| We are vulnerable to system failures, which could harm our business |
| We rely on our technology infrastructure to, among other functions, sell our products and services, support our partners and to fulfill orders |
| Our systems are vulnerable to damage or interruption from natural disasters, power loss, telecommunication failures, terrorist attacks, computer viruses, computer denial-of-service attacks and other events |
| A significant number of our systems are not redundant, and our disaster recovery planning is not sufficient for every eventuality |
| Our systems are also subject to break-ins, sabotage and intentional acts of vandalism by internal employees and contractors as well as third parties |
| Despite any precautions we may take, such problems could result in interruptions in our services, which could harm our reputation and financial condition |
| We do not carry business interruption insurance sufficient to compensate us for losses that may result from interruptions in our service as a result of system failures |
| Any interruption in the availability of our websites would create a large volume of user questions and complaints that would need to be addressed by our customer support personnel rather than by self-help over our website |
| If our customer support personnel cannot meet this demand, customer satisfaction levels may fall, which in turn could cause additional claims or reduced revenues |
| RISKS RELATED TO LEGAL UNCERTAINTY If our products are found to infringe third-party intellectual property rights, we could be required to redesign our products, replace components of our products or enter into license agreements with third parties |
| We have committed to our subscription customers that if any portion of our enterprise products are found to infringe any third party intellectual property rights we will, at our expense and option: (i) obtain the right for the 19 ______________________________________________________________________ customer to continue to use the product consistent with their subscription agreement with us; (ii) modify the product so that it is non-infringing; or (iii) replace the infringing component with a non-infringing component |
| Although we cannot predict whether we will need to satisfy this commitment, satisfying the commitment could be costly and time consuming and could materially and adversely affect our financial results |
| In addition, our insurance policies may not adequately cover our exposure to this type of claim |
| Moreover, from time to time, we indemnify customers against certain claims that our products infringe upon the intellectual property rights of others |
| In the event that claims for indemnification are brought for intellectual property infringement, we could incur significant expense reimbursing customers for their legal costs and, in the event those claims are successful, for damages |
| We are vulnerable to claims that our products infringe third-party intellectual property rights because our products are comprised of software components, many of which are developed by numerous independent parties, and an adverse legal decision affecting our intellectual property could materially harm our business |
| We are vulnerable to claims that our products infringe third-party intellectual property rights including patent, copyright and trade secrets because our products are comprised of software components, many of which are developed by numerous independent parties |
| Moreover, because the scope of software patent protection is often not well defined, patent applications in the United States are not publicly disclosed at the time of filing, and the number of software parents that are issued each year is significant and growing, we may be unable to assess the relevance of patents to our products, or take appropriate responsive action, in a timely or economic manner |
| We expect that our products could increasingly be subject to intellectual property infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps |
| Defending patent infringement, copyright infringement and/or trade secret claims, even claims without significant merit, can be expensive |
| An adverse legal decision regarding the intellectual property in and to our technology and other offerings could harm our business and may do so materially |
| In addition, SCO Group, Inc |
| (“SCO”) has publicly alleged that certain Linux kernels contain unauthorized UNIX code or derivative works |
| As noted below, SCO has also filed suit against IBM based on allegations including that certain Linux kernels wrongfully include SCO’s intellectual property |
| Uncertainty concerning SCO’s allegations, regardless of their merit, could adversely affect sales of our products |
| If SCO were to prevail in this or other actions related to their claims regarding Linux, our business could be materially and adversely affected |
| We could be prevented from selling or developing our software if the GNU General Public License and similar licenses under which our products are developed and licensed are not enforceable |
| A number of our offerings, including RHEL, have been developed and licensed under the GNU General Public License and similar open source licenses |
| These licenses state that any program licensed under them may be liberally copied, modified and distributed |
| The GNU General Public License is a subject of litigation in the case of The SCO Group, Inc |
| It is possible that a court would hold these licenses to be unenforceable in that litigation or that someone could assert a claim for proprietary rights in a program developed and distributed under them |
| Any ruling by a court that these licenses are not enforceable, or that open source components of our product offerings, may not be liberally copied, modified or distributed, would have the effect of preventing us from selling or developing all or a portion of our products |
| Our products may contain defects that may be costly to correct, delay market acceptance of our products and expose us to litigation |
| Despite our testing procedures, errors have been and will continue to be found in our products after commencement of commercial shipments |
| This risk is exacerbated by the fact that much of the code in our products is developed by independent parties over whom we exercise no supervision or control |
| If errors are 20 ______________________________________________________________________ discovered, we may have to make significant expenditures of capital to eliminate them and may not be able to successfully correct them in a timely manner or at all |
| Errors and failures in our products could result in a loss of, or delay in, market acceptance of our products and could damage our reputation and our ability to convince commercial users of the benefits of Linux-based operating systems and other open source software products |
| In addition, failures in our products could cause system or other failures for our customers who may assert warranty and other claims for substantial damages against us |
| Although our license agreements with our customers often contain provisions which seek 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 to this type of claim |
| These claims, even if unsuccessful, could be costly and time consuming to defend and could materially harm our business |
| Our efforts to protect our trademarks may not be adequate to prevent third parties from misappropriating our intellectual property rights in our trademarks |
| Our most valuable intellectual property is our collection of trademarks |
| The protective steps we have taken in the past have been, and may in the future continue to be, inadequate to protect, and deter misappropriation of, our trademark rights |
| Although we do not believe that we have suffered material harm from misappropriation to date, we may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our trademark rights in a timely manner |
| We have registered some of our trademarks in the Americas, Europe, Asia and Australia and have other trademark applications pending in each of those regions |
| Effective trademark protection may not be available in every country in which we offer or intend to offer our products and services |
| Failure to adequately protect our trademark rights could damage or even destroy the Red Hat brand and impair our ability to compete effectively |
| Furthermore, defending or enforcing our trademark rights could result in the expenditure of significant financial and managerial resources |
| In connection with our restatement of historical financial statements, class action lawsuits have been filed against us and additional lawsuits may be filed |
| Following our announcement in July 2004 of our intention to restate certain historical financial statements, 14 class action lawsuits were commenced against us and certain of our current and former directors and officers, by or on behalf of persons claiming to be our stockholders and persons claiming to have purchased or otherwise acquired our securities at specified dates beginning as early as June 19, 2001 and continuing through July 13, 2004 |
| The 14 class action lawsuits have since been consolidated into a single lawsuit |
| Additional lawsuits or legal proceedings may be commenced against us |
| Regardless of the outcome, it is likely that we will incur substantial defense costs and these matters may cause a diversion of our management’s time and attention |
| If we do not prevail in these matters, we could be required to pay substantial damages or settlement costs, which could have a material adverse affect on our financial condition or results of operations |
| We are unable at this time to assess the validity of the claims or estimate the possible range of damages that might be incurred as a result of the lawsuits |
| We have not yet established any financial reserves relating to any of these lawsuits |
| We may suffer material adverse consequences if we are deemed to be an investment company and may incur significant costs to avoid investment company status |
| We may be deemed to be an investment company under the Investment Company Act of 1940 (the “1940 Act”), if we own investment securities with a value of exceeding 40prca of our total assets, unless a particular exclusion or safe harbor provision applies |
| A large portion of our assets has been invested in investment grade interest-bearing securities, many of which constitute “investment securities” under the 1940 Act |
| As of February 28, 2006, our “investment securities” exceeded 40prca of our total assets |
| We believe that we are otherwise excluded from the definition of investment company and the registration requirements of the 1940 Act, but, absent an exemptive order from the SEC, this result cannot be assured |
| Investment companies are subject to registration under the 1940 Act and compliance with a variety of restrictions and requirements imposed under the 21 ______________________________________________________________________ 1940 Act |
| If we were to be deemed an investment company, we would become subject to these restrictions and requirements of the 1940 Act and the consequences of having been an investment company without registering there under, could have a material adverse impact on our business |
| In addition, we may incur significant costs to avoid or eliminate investment company status if an exclusion from the 1940 Act were to be considered unavailable to use at a time when the value of our investments that constitute “investment securities” exceeds 40prca of our total assets |
| If we were required to change the allocation of our assets to reduce our ownership of securities that constitute “investment securities,” and acquire non-investment security assets, this could result in transaction costs, the realization of losses on investment securities sold, and or a reduction in the rate of return on our liquid assets |
| Our business is subject to a variety of US and international laws regarding data protection |
| Our business is subject to federal, state and international laws regarding privacy and protection of user data |
| We post, on our website, our privacy policies and practices concerning the use and disclosure of user data |
| Any failure by us to comply with our posted privacy policies or other federal, state or international privacy-related or data protection laws and regulations could result in proceedings against us by governmental entities or others which could potentially have an adverse effect on our business, results of operations and financial condition |
| It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data practices |
| If so, in addition to the possibility of fines and penalties, this could result in an order requiring that we change our data practices, which in turn could have a material effect on our business |
| Compliance with these regulations may involve significant costs or require changes in business practices that result in reduced revenue |
| Noncompliance could result in penalties being imposed on us or orders that we cease conducting the noncompliant activity |
| RISKS RELATED TO FINANCIAL UNCERTAINTY You should not rely on our quarterly results of operations as an indication of our future results |
| Due to the unpredictability of the technology spending environment, our revenue and operating results have fluctuated and may continue to fluctuate |
| We base our current and projected future expense levels, in part, on our estimates of future revenue |
| We may not be able to adjust our spending quickly enough to protect our projected operating results for a quarter if our revenue in that quarter falls short of our expectations |
| If, among other considerations, our future operating results fall below expectations of securities analysts or investors or we are unable to increase or maintain profitability, the market price of our common stock may decline |
| Our stock price has been volatile historically and may continue to be volatile |
| Further, the sale of our common stock by significant stockholders may cause the price of our common stock to decrease |
| The trading price of our common stock has been and may continue to be subject to wide fluctuations |
| Our stock price may fluctuate in response to a number of events and factors, such as quarterly variations in operating results, announcements of technological innovations or new products by us or our competitors, announcements relating to strategic decisions, changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies that investors may deem comparable to us, and news reports relating to trends in our markets or general economic conditions |
| In addition, several of our stockholders own significant portions of our common stock |
| If these stockholders were to sell all or a portion of their holdings of our common stock, then the market price of our common stock could be negatively impacted |
| The effect of such sales, or of significant portions of our stock being offered or 22 ______________________________________________________________________ made available for sale, could result in strong downward pressure on our stock price |
| Investors should be aware that they could experience significant short-term volatility in our stock if such stockholders decide to sell all or a portion of their holdings of our common stock at once or within a short period of time |
| We may lack the financial and operational resources needed to increase our market share and compete effectively |
| In the market for operating systems and applications, we face significant competition from larger companies with greater financial resources and name recognition than we have |
| Competitors, which offer hardware-independent multi-user operating systems for Intel platforms and/or Linux and UNIX-based operating systems, include Microsoft, Novell, IBM, Sun and HP We may lack the financial and operational resources needed to compete successfully with our current competitors as well as potential new competitors |
| Moreover, we compete in certain areas with our strategic partners and potential strategic partners, and this may adversely impact our relationship with an individual partner or a number of partners |
| Competitive pressures could affect prices or demand for our products and services, resulting in reduced profit margins and loss of market opportunity |
| We may have to lower the prices of our products and services to stay competitive, which could affect our margins and financial condition |
| In addition, if our pricing and other factors are not sufficiently competitive, we may lose market share |
| Industry consolidation may also effect competition by creating larger and potentially stronger competitors in the markets in which we compete, which may have an adverse effect on our business |
| In the market for services offerings, we face significant competition from larger companies, including those that currently provide service and training related to the Linux operating system as well as other operating systems, particularly UNIX-based operating systems, due to the fact that Linux-and UNIX-based operating systems share many common features |
| These larger companies, including IBM, Novell and HP, may be able to leverage their existing service organizations and provide higher levels of consulting and training on a more cost-effective basis than we can |
| We may not be able to compete successfully with our current or potential competitors |
| We may not be able to meet the financial and operational challenges that we will encounter as our international operations, which represented 35dtta5prca of our total revenue for the year ended February 28, 2006, continue to expand |
| Our international operations accounted for 35dtta5prca of total revenue for the year ended February 28, 2006 |
| As we expand our international operations, we may have difficulty managing and administering a globally-dispersed business and we may need to expend additional funds to, among other activities, reorganize our sales force and technical support services team, outsource general and administrative functions, staff key management positions, obtain additional informational technology infrastructure and successfully localize software products for a significant number of international markets, which may negatively affect our operating results |
| Additional challenges associated with the conduct of our business overseas that may negatively affect our operating results include: · Fluctuations in exchange rates; · Longer payment cycles and less financial stability of customers; · Compliance with a wide variety of foreign laws; · Difficulty selecting and monitoring channel partners outside of the United States; · Difficulty protecting our intellectual property rights overseas, due among other reasons, to the uncertainty of laws and enforcement in certain countries relating to the protection of intellectual property rights; · Difficulty maintaining quality standards in local activities consistent with the Red Hat brand; · Export controls and times of crisis could prevent us from shipping our products into and out of certain markets; 23 ______________________________________________________________________ · Changes in import/export duties, quotas or other trade barriers could affect the competitive pricing of our products and service and reduce our market share in some countries; and · Economic or political instability or terrorist acts in some international markets could result in the loss or forfeiture of some foreign assets and the loss of sums spent developing and marketing those assets |
| Moreover, in many foreign countries, particularly in certain developing economies, it is not uncommon to engage in business practices that are prohibited by regulations applicable to us, such as the Foreign Corrupt Practices Act and similar laws |
| Although we have policies and procedures designed to promote compliance with these laws, our employees, contractors and agents, as well as those companies to which we outsource certain of our business operations, may take actions in violation of our policies and procedures |
| Any such violation, even if prohibited by our policies and procedures, could have a material adverse effect on our business |
| Any failure by us to effectively manage the challenges associated with the international expansion of our operations could adversely affect our business, operating results and financial condition |
| Because we recognize revenue from subscriptions for our service over the term of the subscription, downturns or upturns in sales may not be immediately reflected in our operating results |
| We generally recognize subscription revenue from customers ratably over the term of their subscription agreements, which are typically 12 to 36 months |
| As a result, much of the revenue we report in each quarter is deferred revenue from subscription agreements entered into during previous quarters |
| Consequently, a decline in subscriptions in any one quarter will not necessarily be fully reflected in the revenue in that quarter and will negatively affect our revenue in future quarters |
| In addition, we may be unable to adjust our cost structure to reflect these reduced revenues |
| Accordingly, the effect of significant downturns in sales and market acceptance of our service may not be fully reflected in our results of operations until future periods |
| Our subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, as revenue from new customers must be recognized over the applicable subscription term |
| If our goodwill or amortizable intangible assets become impaired we may be required to record a significant charge to earnings |
| Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable |
| Goodwill is required to be tested for impairment at least annually |
| Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization, future cash flows, and slower growth rates in our industry |
| We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined resulting in an adverse impact on our results of operations |
| We may be exposed to potential risks if we do not have an effective system of disclosure controls or internal controls or fail on an on-going basis to properly address Section 404 of Sarbanes-Oxley |
| We must comply, on an on-going basis, with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”), including those provisions that establish the requirements for both management and auditors of public companies with respect to reporting on internal control over financial reporting |
| These requirements first became applicable to us on February 28, 2005 |
| We cannot be certain that measures we have taken, and will take, will be sufficient or timely completed to meet the Section 404 requirements on an on-going basis, or that we will be able to implement and maintain adequate disclosure controls and controls over our financial processes and reporting in the future, particularly in light of our rapid growth, international expansion and changes in our products and services, which are expected to result in on-going changes to our control systems and areas of potential risk |
| 24 ______________________________________________________________________ If we fail to maintain an effective system of disclosure controls or internal control over financial reporting, including satisfaction of the requirements of Section 404 of SOX, we may not be able to accurately or timely report on our financial results or adequately identify and reduce fraud |
| As a result, the financial position of our business could be harmed; current and potential future shareholders could lose confidence in us and/or our reported financial results, which may cause a negative effect on our trading price; and we could be exposed to litigation or regulatory proceedings, which may be costly or divert management attention |