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Lineo Inc – IPO: ‘S-1’ on 5/18/00

On:  Thursday, 5/18/00, at 5:11pm ET   ·   Accession #:  912057-0-25509   ·   File #:  333-37346

Previous ‘S-1’:  None   ·   Next & Latest:  ‘S-1/A’ on 10/13/00

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 5/18/00  Lineo Inc                         S-1                   34:1.9M                                   Merrill Corp/FA

Initial Public Offering (IPO):  Registration Statement (General Form)   —   Form S-1
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: S-1         Registration Statement (General Form)                187    945K 
 2: EX-3.1      Articles of Incorporation/Organization or By-Laws     51    177K 
 3: EX-3.1(A)   Articles of Incorporation/Organization or By-Laws      5     24K 
 4: EX-3.2      Articles of Incorporation/Organization or By-Laws     31    129K 
 5: EX-10.1     Material Contract                                     18     80K 
14: EX-10.10    Material Contract                                     18     94K 
15: EX-10.11    Material Contract                                     20     77K 
16: EX-10.12    Material Contract                                     55    112K 
17: EX-10.13    Material Contract                                     50    253K 
18: EX-10.14    Material Contract                                     48    246K 
19: EX-10.15    Material Contract                                     53    171K 
20: EX-10.16    Material Contract                                     19     81K 
21: EX-10.17    Material Contract                                     17     70K 
22: EX-10.18    Material Contract                                     23     89K 
23: EX-10.19    Material Contract                                     10     61K 
 6: EX-10.2     Material Contract                                      5     30K 
24: EX-10.20    Material Contract                                      8     32K 
25: EX-10.21    Material Contract                                      7     31K 
26: EX-10.22    Material Contract                                      8     49K 
 7: EX-10.3     Material Contract                                     17     90K 
 8: EX-10.4     Material Contract                                     26    116K 
 9: EX-10.5     Material Contract                                      6     22K 
10: EX-10.6     Material Contract                                      3     14K 
11: EX-10.7     Material Contract                                     17     73K 
12: EX-10.8     Material Contract                                     16     80K 
13: EX-10.9     Material Contract                                     15     81K 
27: EX-21.1     Subsidiaries of the Registrant                         1      9K 
28: EX-23.2     Consent of Experts or Counsel                          1     10K 
29: EX-23.3     Consent of Experts or Counsel                          1     10K 
30: EX-23.4     Consent of Experts or Counsel                          1     10K 
31: EX-23.5     Consent of Experts or Counsel                          1     10K 
32: EX-23.6     Consent of Experts or Counsel                          1     10K 
33: EX-23.7     Consent of Experts or Counsel                          1     10K 
34: EX-27.1     Financial Data Schedule (Pre-XBRL)                     2     17K 


S-1   —   Registration Statement (General Form)
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
3Underwriting
5Prospectus Summary
7The Offering
10Risk Factors
20Special Note About Forward-Looking Statements
"Use of proceeds
"Dividend Policy
21Capitalization
22Dilution
23Selected Actual and Pro Forma Financial Data
25Management's Discussion and Analysis of Financial Condition and Results of Operations
28Revenue
34Business
44Management
51Related-Party Transactions
53Principal Stockholders
55Description of Capital Stock
58Shares Eligible for Future Sale
62Notice to Canadian Residents
"Resale Restrictions
63Legal Matters
"Experts
"Where to Find Additional Documents
65Index to Unaudited Pro Forma Condensed Consolidated Financial Statements
67Unaudited Pro Forma Condensed Consolidated Balance Sheet as of April 30, 2000
74Index to Financial Statements
76Consolidated Balance Sheets
78Consolidated Statements of Operations and Comprehensive Loss
81Consolidated Statements of Cash Flows
83Notes to Consolidated Financial Statements
85Foreign Currency Translation
98Caldera Systems
100Zentropic
101Inup
106Consolidated Statements of Members' Capital
118Balance Sheets
119Statements of Operations and Comprehensive Income (Loss)
121Statements of Cash Flows
123Notes to Financial Statements
137Statements of Operations and Comprehensive Loss
138Statements of Stockholders' Deficit
147Statements of Operations
148Statements of Stockholders' Equity
157Statements of Revenue and Expenses and Comprehensive Loss
163Disclosures about Segments of an Enterprise and Related Information
169Statements of Shareholders' Equity (Deficit)
180Item 13. Other Expenses of Issuance and Distribution
"Item 14. Indemnification of Directors and Officers
181Item 15. Recent Sales of Unregistered Securities
182Item 16. Exhibits and Financial Statement Schedules
184Item 17. Undertakings
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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 18, 2000 REGISTRATION NO. 333- -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ LINEO, INC. (Name of issuer in its charter) [Enlarge/Download Table] DELAWARE 7371 87-0617792 (State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer Incorporation or Organization) Classification Code Number) Identification Number) 390 SOUTH 400 WEST LINDON, UTAH 84042 (801) 426-5001 (Address and telephone number of principal executive offices and principal place of business) BRYAN W. SPARKS PRESIDENT, CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD 390 SOUTH 400 WEST LINDON, UTAH 84042 (801) 426-5001 (Name, address and telephone number of agent for service) -------------------------- COPIES OF ALL COMMUNICATIONS TO BE SENT TO: [Download Table] LAURA A. BERTIN, ESQ. LAURIE A. SMILEY, ESQ. MICHAEL J. ERICKSON, ESQ. REED W. TOPHAM, ESQ. MARK F. WORTHINGTON, ESQ. MARC S. MARCHIEL, ESQ. Summit Law Group, PLLC Stoel Rives LLP 1505 Westlake Avenue North, Suite 300 600 University Street, Suite 3600 Seattle, Washington 98109 Seattle, Washington 98101 (206) 281-9881 (206) 624-0900 ------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. -------------------------- 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 [Enlarge/Download Table] TITLE OF EACH CLASS OF PROPOSED MAXIMUM AMOUNT OF SECURITIES TO BE REGISTERED AGGREGATE OFFERING PRICE(1) REGISTRATION FEE Common Stock, $0.001 par value.............................. $60,000,000 $15,840 (1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act. Includes proceeds from the sale of shares which the Underwriters have the option to purchase to cover over-allotments, if any. ------------------------------ 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 THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. -------------------------------------------------------------------------------- --------------------------------------------------------------------------------
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SUBJECT TO COMPLETION, DATED MAY 18, 2000 THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
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Shares [LOGO] Common Stock ----------- Prior to this offering, there has been no public market for our common stock. The initial public offering price of our common stock is expected to be between $ and $ per share. We have applied to list our common stock on The Nasdaq Stock Market's National Market under the symbol "LNEO." The underwriters have an option to purchase a maximum of additional shares to cover over-allotment of shares. Investing in the common stock involves risks. See "Risk Factors" on page 8. [Enlarge/Download Table] Underwriting Price to Discounts and Proceeds to Public Commissions Lineo ------------------- ------------------- ------------------- Per Share............................................ $ $ $ Total................................................ $ $ $ Delivery of the shares of common stock will be made on or about , 2000. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Credit Suisse First Boston Lehman Brothers Dain Rauscher Wessels Wit SoundView The date of this prospectus is , 2000.
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-------------- TABLE OF CONTENTS [Download Table] PAGE -------- PROSPECTUS SUMMARY.................... 3 RISK FACTORS.......................... 8 SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS.......................... 18 USE OF PROCEEDS....................... 18 DIVIDEND POLICY....................... 18 CAPITALIZATION........................ 19 DILUTION.............................. 20 SELECTED ACTUAL AND PRO FORMA FINANCIAL DATA...................... 21 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS....................... 23 BUSINESS.............................. 32 [Download Table] PAGE -------- MANAGEMENT............................ 42 RELATED-PARTY TRANSACTIONS............ 49 PRINCIPAL STOCKHOLDERS................ 53 DESCRIPTION OF CAPITAL STOCK.......... 53 SHARES ELIGIBLE FOR FUTURE SALE....... 56 UNDERWRITING.......................... 58 NOTICE TO CANADIAN RESIDENTS.......... 60 LEGAL MATTERS......................... 61 EXPERTS............................... 61 WHERE TO FIND ADDITIONAL DOCUMENTS.... 61 INDEX TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS... P-1 INDEX TO FINANCIAL STATEMENTS......... F-1 -------------- YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO WHICH WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL TO SELL THESE SECURITIES. THE INFORMATION IN THIS DOCUMENT MAY BE ACCURATE ONLY ON THE DATE OF THIS DOCUMENT. DEALER PROSPECTUS DELIVERY OBLIGATION UNTIL , 2000 (25 DAYS AFTER THE COMMENCEMENT OF THIS OFFERING), ALL DEALERS THAT EFFECT 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 UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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PROSPECTUS SUMMARY THE FOLLOWING SUMMARY HIGHLIGHTS INFORMATION THAT WE PRESENT MORE FULLY ELSEWHERE IN THIS PROSPECTUS. YOU SHOULD READ THIS ENTIRE PROSPECTUS CAREFULLY. UNLESS OTHERWISE STATED, INFORMATION IN THIS PROSPECTUS ASSUMES NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION. LINEO, INC. We provide a broad range of embedded operating system products and services through a combination of our experience with embedded operating systems, expertise in Linux operating systems and involvement in the open source community. Our embedded Linux technologies and services enable microprocessor companies and original equipment manufacturers to quickly and cost-effectively develop, optimize and integrate unique embedded systems that feature high functionality, performance and reliability and ease of use. We also develop and license complete customized embedded system solutions for our customers according to their specifications. We sell our Linux products and services to original equipment manufacturers such as Bast, Inc., CIS Technology, Inc., DaiShin Information & Communications Co. and MiTAC International Corp. To further promote our technologies, we have also entered into strategic relationships with microprocessor companies such as Hitachi, Ltd., Motorola Computer Group and Samsung Electro-Mechanics Co., Ltd. Rapid technological advancements have dramatically increased the number, type and capabilities of products and systems that enable organizations and individuals to collaborate, access information and conduct business more effectively. This proliferation is largely fueled by innovations in microprocessors, which are hidden, or embedded, in a variety of products and systems. These advancements in microprocessor technology have created demand for robust, reliable and powerful embedded operating systems to manage the interaction between the various hardware and software components. Historically, most companies seeking embedded operating systems have either used internal resources to develop their own or have purchased proprietary operating systems from third parties. Open source operating systems have emerged as a compelling alternative to internally developed and third-party proprietary operating systems. The term open source applies to software that can be copied, modified and distributed without any associated fee and few restrictions. Popular open source software is continuously maintained and improved by worldwide communities of developers who share information, code and suggestions, primarily over the Internet. Linux has emerged as the leading open source operating system, enjoying acceptance by both commercial and academic communities due to its high performance and stability, low cost and broad developer support. Until recently, the growth in the use of Linux operating systems has primarily been in the server and desktop computer markets. Microprocessor companies are now promoting, and original equipment manufacturers are now adopting, Linux in the embedded systems market. However, many of these manufacturers have limited experience working with Linux, and may lack developers with the specialized skills and relationships in the open source community necessary to identify and take advantage of the many enhancements and extensions to Linux that are continuously under development. We design our embedded Linux operating systems to address the requirements of the embedded products and systems market. Our offerings are designed to be adaptable to performance, memory and storage capacity limitations, support a broad range of hardware devices and allow for rapid development and deployment of products. Our products include Embedix Linux, Embedix Software Development Kit and Embedix Browser. Embedix Linux, a combination of open source Linux and internally developed technologies, is a powerful and reliable Linux operating system that is designed specifically for embedded products and systems. We have enhanced and extended open source Linux with new technologies and advancements to enable embedded systems developers to adapt Linux to a wide range of highly customized embedded products and systems. Embedix Software Development Kit, expected to begin commercial shipment in 3
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June 2000, is a package of our proprietary software and open source development tools designed to help systems developers accelerate the design, development, error detection and correction, implementation and maintenance of their embedded systems. Embedix Browser is our proprietary compact, Linux-based graphical Web browser for embedded products and systems that interact with the Internet. In addition, we provide comprehensive professional Embedix Services to our embedded systems customers. These services include customized engineering, education and technical support services. Our objective is to become the leading provider of embedded operating system products and services. We intend to enhance our technology leadership by developing technologies internally and by acquiring proprietary technologies or other companies. We are currently implementing this strategy and have recently acquired six companies with technologies complementary to our own. We also intend to continue developing strategic relationships with microprocessor companies and original equipment manufacturers to promote our offerings and plan our future product development. We plan to continue expanding sales efforts internationally by growing our internal sales force and through additional strategic acquisitions. We will also continue to enhance our operating system solutions by incorporating additional software products of independent software vendors. We began operations as a part of Caldera, Inc. in July 1996. We were incorporated as a separate entity in the State of Utah in August 1998 as Caldera Thin Clients, Inc., changed our name to Lineo, Inc. in July 1999 and reincorporated in the State of Delaware in January 2000. Our principal executive offices are located at 390 South 400 West, Lindon, Utah 84042, and our telephone number is (801) 426-5001. Our World Wide Web address is www.lineo.com. Information on our Web site does not constitute a part of this prospectus. -------------- LINEO-TM-, LINEO PARTNER CONNECT-TM-, the Lineo logo and EMBEDIX-TM- are our trademarks. We will continue to pursue registration of these and other marks. This prospectus also contains trademarks and trade names of other companies. 4
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THE OFFERING [Enlarge/Download Table] Common stock offered...................... shares Common stock to be outstanding after this offering................................ shares Use of proceeds........................... For general corporate purposes, including working capital. See "Use of Proceeds." Proposed Nasdaq National Market Symbol.... LNEO The number of outstanding shares after this offering above is based on: - 20,148,985 shares of our common stock outstanding on April 30, 2000; - issuance of 1,333,333 shares of our common stock, 83,334 shares of our Series C preferred stock and 1,430,482 shares of our Series D preferred stock in connection with the acquisition of material businesses subsequent to April 30, 2000; and - automatic conversion of all Series A, Series B and Series C preferred stock outstanding on April 30, 2000 and the Series C and Series D preferred stock issued subsequent to April 30, 2000 into 16,763,813 shares of our common stock upon completion of this offering. This number excludes the following: - 4,583 shares issued subsequent to April 30, 2000 upon exercise of outstanding stock options; - 1,786,326 shares issuable upon exercise of stock options outstanding on April 30, 2000 at a weighted average exercise price of $1.71 per share, excluding 4,583 shares issued subsequent to April 30, 2000 upon exercise of stock options, and 1,266,396 shares issuable upon exercise of stock options granted subsequent to April 30, 2000 through May 15, 2000 at a weighted average exercise price of $3.20 per share; and - 1,277,373 shares reserved for future issuance under our stock option plan. 5
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SUMMARY ACTUAL AND PRO FORMA FINANCIAL DATA The following financial data should be read in conjunction with "Selected Actual and Pro Forma Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Unaudited Pro Forma Condensed Consolidated Financial Statements and related Notes and our Consolidated Financial Statements and related Notes included elsewhere in this prospectus. Our actual operating results for the six months ended April 30, 2000 include the operating results of Zentropic Computing, LLC, which we acquired on April 3, 2000, for the period from the acquisition date through April 30, 2000. The unaudited pro forma statement of operations data for the fiscal year ended October 31, 1999 and the six months ended April 30, 2000: - give effect to our acquisitions of Zentropic, United System Engineers, Inc., or USE, Fireplug Computers Inc., Inup S.A., Moreton Bay Ventures Pty Ltd and RT-Control, Inc. as if they had occurred on November 1, 1998; and - reflect the amortization of goodwill and other intangibles related to the acquisitions, as well as adjustments for acquired in-process research and development in connection with the Zentropic acquisition and intercompany transactions. The unaudited pro forma balance sheet data as of April 30, 2000 give effect to the acquisitions as if they occurred on April 30, 2000, except for Zentropic, which is included in our historical April 30, 2000 balance sheet. The unaudited pro forma balance sheet data: - reflect the issuance of 1,333,333 shares of our common stock, 83,334 shares of our Series C preferred stock, 1,430,482 shares of our Series D preferred stock and options to purchase 673,596 shares of our common stock in connection with the acquisitions; and - give effect to the automatic conversion of our Series A, Series B and Series C preferred stock outstanding on April 30, 2000 and the Series C and Series D preferred stock issued subsequent to April 30, 2000 into 16,763,813 shares of our common stock upon completion of this offering. The pro forma as adjusted data as of April 30, 2000 give effect to the pro forma adjustments, as well as to the receipt of the proceeds from this offering, after deducting estimated underwriting discounts and commissions and estimated offering expenses. The unaudited pro forma financial data are presented for illustrative purposes only and are not necessarily indicative of the operating results or financial position that would have resulted if these acquisitions had been in effect during the periods presented or of future operating results. 6
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[Enlarge/Download Table] FISCAL YEAR ENDED OCTOBER 31, PERIOD FROM -------------------------------------------- JULY 23, 1996 1999 (INCEPTION) TO ---------------------- OCTOBER 31, 1996 1997 1998 ACTUAL PRO FORMA ----------------- -------- -------- -------- ----------- (UNAUDITED) (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenue....................... $ 62 $ 945 $ 1,376 $ 2,801 $ 4,640 Cost of revenue............... 67 247 361 185 1,380 Gross margin.................. (5) 698 1,015 2,616 3,260 Loss from operations.......... (49) (827) (2,005) (891) (9,731) Net loss...................... (61) (877) (2,186) (1,054) (9,950) Basic and diluted net loss per common share................ $(0.00) $(0.05) $ (0.12) $ (0.06) $ (0.47) Basic and diluted weighted average common shares outstanding................. 18,000 18,000 18,000 18,000 21,079 Basic and diluted supplemental pro forma net loss per common share................ $ (0.44) Basic and diluted supplemental pro forma weighted average common shares outstanding... 22,592 SIX MONTHS ENDED APRIL 30, --------------------------------------- 1999 2000 ----------- ------------------------- ACTUAL ACTUAL PRO FORMA ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenue....................... $ 806 $ 1,751 $ 2,814 Cost of revenue............... 37 84 838 Gross margin.................. 769 1,667 1,976 Loss from operations.......... (1,033) (4,287) (8,724) Net loss...................... (1,076) (4,103) (8,515) Basic and diluted net loss per common share................ $ (0.06) $ (0.21) $ (0.38) Basic and diluted weighted average common shares outstanding................. 18,000 19,660 22,478 Basic and diluted supplemental pro forma net loss per common share................ $ (0.30) Basic and diluted supplemental pro forma weighted average common shares outstanding... 28,277 [Enlarge/Download Table] APRIL 30, 2000 ----------------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED ----------- ------------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents................................... $30,464 $30,355 $ Working capital............................................. 31,284 30,407 Total assets................................................ 41,202 62,021 Long-term liabilities....................................... 115 936 Total stockholders' equity.................................. 39,511 57,514 7
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RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND ALL OTHER INFORMATION CONTAINED IN THIS PROSPECTUS BEFORE PURCHASING OUR COMMON STOCK. INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. ANY OF THE FOLLOWING RISKS COULD HARM OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION AND COULD RESULT IN A COMPLETE LOSS OF YOUR INVESTMENT. RISKS RELATED TO OUR OPERATIONS OUR LIMITED OPERATING HISTORY AND THE RECENT FOCUS OF OUR BUSINESS STRATEGY ON LINUX-BASED PRODUCTS MAY MAKE IT DIFFICULT FOR YOU TO EVALUATE AN INVESTMENT IN OUR COMPANY. We began operations as a separate entity in September 1998 and consequently have only a limited operating history on which you can rely in evaluating an investment in our company. Moreover, prior to January 1999, the focus of our business was on our embedded disk operating system, or DR DOS. In January 1999, we began focusing our strategy on developing embedded operating systems based on Linux and other open source technologies and commercially released the first version of our embedded Linux operating system in January 2000. Nonetheless, to date, a significant portion of our revenue has been generated from sales of DR DOS. We expect to generate substantially all of our future revenue from sales of our Linux-based operating systems and related products and services. As a result, we believe that our financial history to date is not indicative of our future performance. WE HAVE A HISTORY OF LOSSES AND EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE FORESEEABLE FUTURE. We have incurred losses since our inception. At April 30, 2000, we had an accumulated deficit of $10.2 million. We expect to continue to incur losses for at least the next 15 months as we incur significant expenses in connection with developing our products, hiring and training employees and building awareness of our brand. If our revenue declines or grows at a slower rate than we anticipate, or if our expenses exceed our expectations or cannot be adjusted to respond to slower revenue growth, we may not be able to achieve or sustain profitability or generate positive cash flow within our expected timeframe, if at all. WE MAY NOT BE ABLE TO INTEGRATE OUR RECENT ACQUISITIONS SUCCESSFULLY, WHICH COULD ADVERSELY IMPACT OUR OPERATING RESULTS. Since March 2000, we have acquired six companies. We may not successfully integrate the operations, technologies and personnel of these acquired companies. Specifically, we may experience difficulty in integrating acquired technologies with our Embedix products. Moreover, we may have difficulty retaining key technical and managerial personnel from the acquired companies. In addition, there may be a disruption in our business because of the allocation of resources necessary to integrate these companies and the resulting diversion of management's attention. Further, these acquisitions may have a negative impact on our business and financial condition as we are required to assume their ongoing expenses and liabilities. IF WE ARE UNABLE TO IMPLEMENT APPROPRIATE SYSTEMS, PROCEDURES AND CONTROLS, WE MAY NOT BE ABLE TO OFFER OUR SERVICES AND GROW OUR BUSINESS AS CURRENTLY ANTICIPATED. Our ability to offer our products and services and grow our business as currently anticipated requires an effective planning and management process. Since July 1999, we have significantly increased the size of our operations. This growth has placed, and we expect that any future growth we experience will continue to place, a significant strain on our management, systems and resources. Our key personnel have limited experience managing this type of growth. In addition, five of our ten executive officers have only recently joined us, and they have limited experience working together as a team to date, which may make it more difficult for them to manage our growth. To manage growth effectively, 8
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we will need to continue to implement or update our operational and financial systems, procedures and controls. Any failure to manage this growth could harm our business. WE EXPECT TO ENGAGE IN FUTURE ACQUISITIONS, WHICH COULD HARM OUR OPERATING RESULTS, DILUTE OUR STOCKHOLDERS AND CAUSE US TO INCUR DEBT OR ASSUME CONTINGENT LIABILITIES. In addition to our recent acquisitions, as part of our business strategy we expect to continue to make investments in or acquire complementary companies, products or technologies. If we acquire a company, we could have difficulty integrating that company's technologies or products into our operations or integrating and retaining its key personnel. These difficulties could disrupt our ongoing business, distract our management and employees and increase our expenses. Furthermore, we may issue equity securities to pay for any future acquisitions, which could be dilutive to our existing stockholders. We may also incur debt, assume contingent liabilities or incur charges associated with amortization of goodwill and other assets in connection with future acquisitions, which could harm our operating results. OUR REVENUE MAY DECREASE IF WE LOSE ANY OF OUR SIGNIFICANT CUSTOMERS. There are a limited number of original equipment manufacturers with a significant share of the embedded system market. Because of their strong market position, these original equipment manufacturers are typically able to secure favorable terms, including favorable pricing, in their technology licensing and service agreements. If we are not able to secure contracts on profitable terms with these original equipment manufacturers, our operating results may suffer. Moreover, the loss of any significant customer could cause our revenue to decline. Historically, a relatively small number of customers have accounted for a significant portion of our total revenue. In the fiscal year ended October 31, 1999, our three largest customers accounted for 48% of our total revenue, with Sun Microsystems, Inc. accounting for 23%, Brooktrout Inc. accounting for 13% and Symbol Technologies, Inc. accounting for 12%. In the six months ended April 30, 2000, our seven largest customers accounted for 77% of our total revenue, with DaiShin accounting for 34%. We anticipate that sales of our products and services to relatively few customers will continue to account for a significant portion of our total revenue. We generally do not enter into long-term purchase commitments with our significant customers. Therefore, these customers could cease purchasing our products and services with limited notice and with little or no penalty. WE MAY EXPERIENCE QUARTERLY FLUCTUATIONS IN OUR REVENUE AND RESULTS OF OPERATIONS, WHICH COULD RESULT IN VOLATILITY IN OUR STOCK PRICE. Our quarterly revenue and results of operations may vary significantly in the future due to a number of factors, many of which are outside of our control. Factors that may affect our quarterly results include: - the development, introduction, competitive pricing and market acceptance of our products and services as well as those of our competitors; - adverse changes in general economic conditions, such as recessions, that could affect capital expenditures and recruiting efforts in the software industry in general and specifically in the embedded operating systems market; - our ability to forecast revenue accurately, which is constrained by our limited operating experience selling our embedded Linux-based products and services; - changes in the length of our sales cycle due to factors such as our customers' budgetary constraints and changing product evaluation processes; 9
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- our ability to integrate and retain the additional personnel, operations, technologies and products of the six companies we recently acquired; - acceptance of Linux as a viable embedded operating system alternative to other competing operating systems; - the development and maintenance of our strategic relationships with microprocessor and original equipment manufacturers and independent software vendors; - the difficulties associated with attracting, retaining and training key personnel; and - our ability to manage our anticipated growth and expansion. If our quarterly operating results fluctuate due to these or any other factors, we may not meet the expectations of public market analysts or investors, and the price of our common stock could decline. RISKS RELATED TO LINUX AND OUR INTELLECTUAL PROPERTY IF THE LINUX OPERATING SYSTEM DOES NOT CONTINUE TO GAIN MARKET ACCEPTANCE, WE MAY NOT BE ABLE TO GENERATE REVENUE AND OUR BUSINESS COULD FAIL. We expect that substantially all of our future revenue will be derived from sales of Linux-based embedded operating systems and related products and professional services. The Linux operating system has only recently begun to gain broad market acceptance, and its use has been mostly limited to servers, desktop computers, Internet infrastructure applications and scientific research environments. Our success depends on the continued and increased rate of adoption of Linux in these and other markets, and especially the market for embedded operating systems, and the continued development of Linux-compatible products, applications and utilities. If this does not occur, our business will suffer. Moreover, if multiple incompatible versions of Linux are developed, customers may become less likely to purchase Linux products, and our sales could suffer. OUR BUSINESS MODEL, WHICH RELIES ON A COMBINATION OF OPEN SOURCE SOFTWARE AND PROPRIETARY TECHNOLOGIES, IS UNPROVEN. Our business model relies on a combination of open source software, proprietary technologies and commercial products. We know of no company that has built a profitable business based on open source software. In addition, because Linux is open source software, customers may be unwilling to pay royalties to license our Linux-based products. By incorporating open source software in our offerings, we cannot provide our customers with the same or similar warranties on products and services that customers of proprietary systems may typically receive. In addition, by developing products based on proprietary technology that is not freely available, we may alienate the open source community. Because we rely on our relationships within the open source community, negative reaction to our use of the Linux operating system could harm our reputation, impair our ability to capitalize on the development efforts of the open source community, diminish our brand and harm our business. OUR ABILITY TO INTRODUCE NEW PRODUCTS OR PRODUCT ENHANCEMENTS WOULD BE IMPAIRED IF LINUX DEVELOPERS DO NOT CONTINUE TO ENHANCE THE SOURCE CODE OF LINUX AND DEVELOP LINUX-BASED UTILITIES AND APPLICATIONS. As open source software, the Linux source code is open to the public and can be copied, modified and distributed without an associated fee. Our success depends in part on the continued efforts of the open source development community to enhance the source code of Linux and Linux-based utilities and applications to make Linux compatible for use across multiple software and hardware platforms. If Linus Torvalds, the initial developer of Linux, and other third-party developers fail to further develop or improve the functionality of Linux or to introduce new open source software or software 10
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enhancements, our ability to market our existing and future Linux products and services would suffer. In this event, we may be forced to rely to a greater extent on our own development efforts or the development efforts of third-party consultants, which would significantly increase our costs. WE COULD BE PREVENTED FROM SELLING OR DEVELOPING OUR PRODUCTS IF THE GNU GENERAL PUBLIC LICENSE AND SIMILAR LICENSES ARE NOT ENFORCEABLE OR IF WE ARE DEEMED TO BE IN VIOLATION OF THESE LICENSES. The Linux-based components of our products have been developed and licensed under the GNU General Public License and similar licenses. These licenses state that any program licensed under them may be liberally copied, used, modified and distributed freely, so long as all modifications are also freely made available and licensed under the same conditions. We know of no instance in which a party has challenged the validity of these licenses or in which these licenses have been interpreted in a legal proceeding. To date, compliance with these licenses has been voluntary. It is possible that a court would hold one or more of these licenses to be unenforceable. Any ruling by a court that these licenses are not enforceable, or that the Linux operating system may not be liberally copied, modified or distributed freely, would have the effect of preventing us from selling or developing our Linux products and services, unless we are able to negotiate a license to use the software. Any licenses could be expensive, which could impair our ability to price our offerings competitively. Moreover, it is possible that a party may argue that the GNU General Public License places restrictions on the types of fees that can be charged in connection with the distribution and licensing of derivative Linux programs. Because some of our products include both open source and proprietary technologies, we charge our customers a fee to license our products from us. These fees could be deemed to be a violation of the GNU General Public License, which could result in the termination of this license. Without this license, we could be subject to claims for infringement of copyrights and other intellectual property rights covered by the GNU General Public License, which could subject us to damages and impact our ability to market our existing and future Linux-based products. WE ARE VULNERABLE TO CLAIMS THAT OUR PRODUCTS INFRINGE THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS, PARTICULARLY BECAUSE OUR PRODUCTS ARE COMPRISED OF MANY DISTINCT SOFTWARE COMPONENTS DEVELOPED BY A BROAD COMMUNITY OF INDEPENDENT PARTIES. We may be exposed to future litigation based on claims that our products infringe the intellectual property rights of others. This risk is magnified by the fact that a significant portion of the software code in our products is developed by a community of independent parties over whom we exercise no supervision or control and who might not have the same financial resources as us to pay damages to a successful litigant. Claims of infringement could require us to re-engineer our products or seek to obtain licenses from third parties in order to continue offering our products. Moreover, we have agreed in many cases to provide our customers with protection from third-party infringement claims. An adverse legal decision affecting our intellectual property, or the use of significant resources to defend against this type of claim, could place a significant strain on our financial resources and harm our reputation. FAILURE TO ADEQUATELY PROTECT INTELLECTUAL PROPERTY RIGHTS THAT ARE KEY TO OUR BUSINESS COULD RESULT IN SIGNIFICANT HARM TO OUR OPERATING RESULTS. Although our Embedix platform is based on open source Linux, many aspects of our products include intellectual property that is proprietary to us. Our success depends significantly on our ability to protect our trademarks, trade secrets and the internally developed proprietary technologies contained in our products. We rely on a combination of patent, copyright, trademark and trade secret laws and on confidentiality and other contractual provisions to protect our proprietary rights. These measures afford only limited protection. Effective intellectual property protection may not be available in every country in which we intend to offer our products and services. Our means of protecting our proprietary rights 11
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and technologies in the United States or abroad may not be adequate, and competitors may independently develop similar technologies or unauthorized parties may copy aspects of our products or obtain and use trade secrets or other information that we regard as proprietary. In addition, a third party could attempt to interpret the GNU General Public License in a manner that could put the protection of our intellectual property at risk because of the interaction between our intellectual property and the intellectual property covered by the GNU General Public License. Moreover, because we rely in part on open source intellectual property, we may find it necessary to defend the open source community from attempts by others to misappropriate, whether by patent, copyright or otherwise, technology which belongs to the open source community. Legal proceedings to enforce our intellectual property rights or the rights of the open source community could be burdensome and expensive and involve a high degree of uncertainty. These legal proceedings may also divert management's attention from our core business. If we do not enforce and protect intellectual property rights important to our business, our business may be harmed. BECAUSE WE DO NOT OWN THE LINUX TRADEMARK, WE MAY BE PROHIBITED FROM USING IT IN CONNECTION WITH OUR PRODUCTS, WHICH COULD DAMAGE OUR BRAND AWARENESS. We use the term "Linux" in our advertising and marketing materials, in our product documentation and for other commercial uses. Mr. Torvalds owns the Linux trademark, however, and we do not have any ownership of, or contractual right to use, this trademark. If the Linux trademark is invalidated through legal action, or if we are otherwise prohibited from using it, our reputation and brand awareness could suffer. Also, the use by others of the Linux trademark could lead to confusion about the source, quality, reputation and dependability of Linux in general, which could negatively affect the market for Linux products. RISKS RELATED TO COMPETITION WITHIN OUR INDUSTRY WE FACE INTENSE COMPETITION IN THE EMBEDDED OPERATING SYSTEMS MARKET, WHICH MAY RESULT IN PRICE REDUCTIONS AND LOWER PROFIT MARGINS. The market for embedded operating systems products and services is becoming increasingly competitive. Failure to compete successfully with current or potential competitors would harm our business. We face competition from: - our current and potential customers' internal research and development departments that may seek to develop their own proprietary embedded operating systems; - established companies that have developed proprietary embedded operating systems, such as Mentor Graphics Corporation, Microsoft Corporation, Microware Systems Corporation, Palm Computing, Inc., QNX Software Systems Ltd., Sun Microsystems, Inc., Symbian, PLC and Wind River Systems, Inc.; - companies that have developed, or may in the future develop, Linux embedded operating systems, such as Caldera Systems, Inc., Coollogic, Inc., Information Storage Devices, Inc., LynuxWorks, Inc., MontaVista Software, Inc., Red Hat Software, Inc., SuSE Inc. and TurboLinux Inc.; and - companies that have developed Web browsers, such as Microsoft, Netscape Communications Corporation and Spyglass, Inc. (which recently announced its merger with OpenTV, Inc.). Many of these competitors are larger companies that have greater financial resources, more established direct and indirect sales channels and greater name recognition than we do. These companies also have larger and more established service organizations to support these products and operating systems. These companies may be able to leverage their existing organizations and provide a wider offering of products and higher levels of support on a more cost-effective basis than we can. In 12
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addition, these companies may be able to undertake more extensive promotional activities, adopt more aggressive pricing policies and offer more attractive terms to their customers than we can. Any pricing pressures or loss of potential customers resulting from our failure to compete effectively would reduce our revenue. Furthermore, because Linux distributions can be downloaded from the Internet for free or purchased at a nominal cost, modified and resold with few restrictions, some traditional barriers to market entry are minimized. Accordingly, it is possible that new competitors or alliances among existing competitors may emerge and acquire significant market share. In addition, to the extent that competing proprietary operating systems companies make their source code available to the public, software developers will be able to customize these systems and solutions more quickly and easily than if these technologies remain proprietary, which could harm our ability to compete. IF WE DO NOT INTRODUCE NEW OR UPDATED PRODUCTS AND SERVICES IN A TIMELY MANNER, OUR OFFERINGS MAY BECOME OBSOLETE, AND OUR OPERATING RESULTS WILL SUFFER. The embedded operating systems market is characterized by rapid technological change, frequent new product enhancements, uncertain product life cycles, changes in customer demands and evolving industry standards. Our products could be rendered obsolete if products based on new technologies are introduced or new industry standards emerge. Moreover, computing environments are inherently complex, and, as a result, we cannot accurately estimate the life cycles of our products. New products and product enhancements can require long development and testing periods, which requires us to hire and retain increasingly scarce, technically competent personnel. Significant delays in new product releases or significant problems in installing or implementing new products could seriously damage our business. In addition, our future success depends upon our ability to enhance existing products, develop and introduce new products, satisfy customer requirements and achieve market acceptance. This process is made more challenging by the fact that much of the software development for our products is done by the open source community, and we must work with a large number of developers who are not our employees in this process. We may not be able to successfully identify new product opportunities and develop and bring new products to market in a timely and cost-effective manner. Moreover, we may be required to license technologies from third parties to remain competitive, which could increase our expenses and harm our operating results. OTHER RISKS RELATED TO OUR BUSINESS WE FACE OPERATIONAL AND FINANCIAL RISKS AS WE MAINTAIN AND EXPAND OUR INTERNATIONAL OPERATIONS, ANY OF WHICH COULD HARM OUR RESULTS OF OPERATIONS. In the six months ended April 30, 2000, over 65% of our revenue was generated from customers located outside the United States, principally in South Korea and Taiwan. As we maintain and expand our international operations, we face a number of challenges, including: - difficulties in managing and administering a globally-dispersed business; - fluctuations in exchange rates that may negatively affect our operating results; - difficulties in collecting accounts receivable resulting in longer collection periods; - compliance with a wide variety of foreign laws and regulatory environments with which we have limited familiarity; - protecting our trademarks and other intellectual property due to the uncertainty of laws and enforcement in certain countries relating to the protection of intellectual property rights; 13
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- seasonality in business activity in certain parts of the world, which could negatively impact the operating results of our foreign operations; - multiple and possibly overlapping tax structures, which could reduce the financial performance of our foreign operations; - changes in import and export duties and quotas, which could affect the competitive pricing of our products and services and reduce our market share in some countries; and - economic or political instability in some international markets, including political instability in South Korea and Taiwan, the threat of hostilities in Taiwan and economic fluctuations in other Asian markets, which could negatively affect our operating results, especially given the concentration of our customers in this region. THE LOSS OF KEY EMPLOYEES OR OUR INABILITY TO ATTRACT, TRAIN AND RETAIN OTHER QUALIFIED PERSONNEL COULD HARM OUR BUSINESS. Our products and technologies are complex, and we depend upon the continued services of our existing software engineering personnel and executive management, especially Bryan Sparks, our president, chief executive officer and chairman of the board. Although we have employment agreements with Mr. Sparks and a limited number of our key software engineering personnel, their employment may nonetheless be terminated by them or us at any time. The loss of Mr. Sparks or any of our key software engineering personnel, especially to a competitor, could adversely affect our business, slow our product development and diminish our brand identity. We depend on our ability to attract, train and retain qualified personnel, specifically those with management, Linux and embedded systems development skills. Competition for such personnel is intense, particularly for qualified developers of Linux and embedded systems. We may not be able to attract, train or retain additional qualified personnel in the future, which could require us to use outside contractors, a more costly alternative. OUR PRODUCTS MAY CONTAIN DEFECTS THAT COULD BE COSTLY TO CORRECT, DELAY MARKET ACCEPTANCE OF OUR PRODUCTS AND EXPOSE US TO LITIGATION. Despite testing by us and our customers, errors may be found in our products. A portion of the software code in our products is developed by independent parties over whom we exercise no supervision or control. If errors are discovered, we may have to make significant capital expenditures to eliminate them and yet may not be able to correct them in a timely manner, if at all. Errors and failures in our products could result in a loss of, or delay in, market acceptance of our products and could damage our reputation. Failures in our products could also cause system failures, including failures in critical business systems, and our customers may assert common law warranty or other claims for substantial damages against us. Our insurance policies may not provide sufficient coverage to adequately limit our exposure to these types of claims. These claims, even if unsuccessful, could be costly and time consuming to defend. 14
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WE MAY NOT BE ABLE TO RAISE SUFFICIENT FUNDS TO EXECUTE OUR BUSINESS STRATEGY. We believe that the net proceeds from this offering, together with our current cash and cash equivalents, will be sufficient to fund our current working capital and capital expenditure requirements for at least the next 15 months. We may need to raise additional funds, however, to support more rapid expansion, respond to competitive pressures, acquire complementary businesses or technologies or respond to unanticipated developments. Additional funding may not be available to us in amounts, or on terms, acceptable to us. If sufficient funds are not available or are not available on acceptable terms, our ability to fund our expansion, execute our strategy, take advantage of acquisition opportunities, develop or enhance our services or products, or otherwise respond to competitive pressures would be significantly limited. RISKS RELATED TO THIS OFFERING A SMALL NUMBER OF OUR EXISTING STOCKHOLDERS CAN EXERT CONTROL OVER US AND THEIR INTERESTS MAY CONFLICT WITH THOSE OF OUR OTHER STOCKHOLDERS. Our executive officers, directors and principal stockholders holding more than 5% of our common stock, consisting of 9 persons and the several entities affiliated with these persons, together hold approximately 61.1% of our outstanding common stock before this offering and will together hold % of our outstanding common stock after completion of this offering. As a result, these stockholders, if they act together, will be able to control our management and affairs and all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. Moreover, of these stockholders, Mr. Yarro beneficially holds 46.7% of our outstanding common stock, or % after this offering, and Mr. Noorda beneficially holds 44.4% of our outstanding common stock, % after this offering. The concentration of ownership among our existing stockholders may have the effect of delaying or preventing a change in our control and might reduce the market price of our common stock. IT MIGHT BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US EVEN IF DOING SO WOULD BE BENEFICIAL TO OUR STOCKHOLDERS. Certain provisions of our certificate of incorporation and Delaware law may discourage, delay or prevent a change in our control or a change in our management even if doing so would be beneficial to our stockholders. Our board of directors has the authority under our certificate of incorporation to issue preferred stock without stockholder approval with rights superior to the rights of the holders of common stock. As a result, preferred stock could be issued quickly and easily with terms calculated to delay or prevent a change in control of our company or make removal of our management more difficult. In addition, as of the first annual meeting of stockholders following the closing of this offering, our board of directors will be divided into three classes. The directors in each class will serve for three-year terms, one class being elected each year by our stockholders. This system of electing and removing directors may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of our company because it generally makes it more difficult for stockholders to replace a majority of our directors. AN ACTIVE TRADING MARKET MAY NOT DEVELOP FOR OUR SHARES, WHICH MAY HAVE A NEGATIVE IMPACT ON THE PRICE OF OUR COMMON STOCK AND INHIBIT YOUR ABILITY TO SELL YOUR SHARES AT A PROFIT OR AT ALL. Prior to this offering, investors could not buy or sell our common stock publicly. An active public market for our common stock may not develop or be sustained after the offering. The initial public offering price will be determined by negotiations between us and the representatives of the underwriters. The market price of our common stock may decline below the initial public offering price after this offering. 15
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THE MARKET FOR OUR SHARES OF COMMON STOCK MAY EXPERIENCE EXTREME PRICE AND VOLUME FLUCTUATIONS, WHICH COULD RESULT IN LEGAL CLAIMS AGAINST US. The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including: - variations in quarterly operating results; - changes in market valuations of technology companies, especially companies focusing on embedded systems; - our or our competitors' announcements of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; - additions or departures of key personnel; - active "day" trading in our stock; - future issuances of our capital stock or the effect of the substantial number of shares that will be eligible for sale in the public market in the future; and - changes in financial estimates by public market analysts. In the past, securities class action litigation has often been brought against companies following periods of volatility in the market price of their common stock. In the future, we may be the target of similar litigation. Such claims, even if unsuccessful, could result in substantial costs and divert management's attention and resources. OUR MANAGEMENT WILL HAVE BROAD DISCRETION IN THE USE OF THE PROCEEDS OF THIS OFFERING, AND OUR FAILURE TO APPLY SUCH FUNDS EFFECTIVELY COULD HARM OUR BUSINESS. We have not designated any specific use for the net proceeds from this offering. We intend to use the net proceeds primarily for general corporate purposes, including working capital. In addition, we may use a portion of the proceeds for potential acquisitions. Management will have significant flexibility in applying the net proceeds of the offering. Our failure to apply such funds effectively could harm our business. THE SUBSTANTIAL NUMBER OF SHARES THAT WILL BE ELIGIBLE FOR SALE IN THE FUTURE MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK. Sales of a substantial number of shares of our common stock in the public market following this offering could adversely affect the market price of the common stock. As additional shares of our common stock become available for resale in the public market, the supply of our common stock will increase, which could decrease the price of our common stock. The number of shares of common stock available for sale in the public market is limited by restrictions under the federal securities laws and under agreements that some of our stockholders, directors and employees have entered into with the 16
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underwriters. The following table shows the timing of when shares outstanding on May 15, 2000 first become eligible for resale in the public market: [Enlarge/Download Table] NUMBER OF SHARES COMMENT --------------------- --------------------------------- - upon effectiveness of this prospectus..................... - Freely tradable shares sold in this offering - 90 days after date of this prospectus..................... 669,905 - Shares eligible for sale under Rules 144 and 701 and not previously registered on Form S-8 or locked up - 181 days after date of this prospectus..................... 18,000,000 - Freely tradable upon expiration of lock-up agreements, subject to the provisions of Rule 144 - at various times thereafter upon expiration of one-year holding periods................ 19,580,809 - Freely tradable, subject to the provisions of Rule 144 17
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SPECIAL NOTE ABOUT 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. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms and other comparable terminology. These statements involve known and unknown risks, uncertainties and factors, including those listed under "Risk Factors," that may cause our 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. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot and do not guarantee future results, levels of activity, performance or achievements. This prospectus also contains citations to industry sources on which our market projections are based. These projections are based in part on assumptions about technological developments and preferences of microprocessor companies and original equipment manufacturers, among other things, and are subject to change due to a number of factors, including economic and market conditions, technological advancements and changes in customer preferences. As a result, we cannot assure you that these market projections will actually be realized. USE OF PROCEEDS We expect to receive approximately $ million in net proceeds from the sale of shares of common stock in this offering, or $ if the underwriters exercise their over-allotment option in full, based upon an assumed initial public offering price of $ per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses. We expect to use the net proceeds from this offering for general corporate purposes, including working capital. Pending such uses, we intend to invest the net proceeds of this offering in investment grade, interest-bearing securities. We may also use a portion of the net proceeds to acquire additional businesses, products and technologies that we believe will complement our current or future business. We have no specific agreements or commitments to do so, however, and are not currently engaged in any negotiations with respect to any acquisition. DIVIDEND POLICY We have never paid cash dividends on our common stock. We currently intend to retain any future earnings to fund the development and growth of our business. Therefore, we do not anticipate paying any cash dividends in the foreseeable future. 18
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CAPITALIZATION The following table sets forth our capitalization as of April 30, 2000: - on an actual basis; - on a pro forma basis to reflect: (1) issuance of 1,333,333 shares of our common stock, 83,334 shares of our Series C preferred stock, 1,430,482 shares of our Series D preferred stock and options to purchase 673,596 shares of our common stock in connection with the acquisition of material businesses subsequent to April 30, 2000 and (2) automatic conversion of all Series A, Series B and Series C preferred stock outstanding on April 30, 2000 and the Series C and Series D preferred stock issued subsequent to April 30, 2000 into 16,763,813 shares of our common stock upon completion of this offering; and - on a pro forma as adjusted basis to reflect the pro forma adjustments, as well as the sale of shares of common stock in this offering at an assumed initial public offering price of $ per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses. The capitalization information set forth in the table below is qualified by and should be read in conjunction with our Consolidated Financial Statements and related Notes, the Unaudited Pro Forma Condensed Consolidated Financial Statements and related Notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this prospectus. [Enlarge/Download Table] APRIL 30, 2000 --------------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (IN THOUSANDS) Long-term debt, net of current maturities................... $ -- $ 821 $ 821 -------- ------- ------- Stockholders' equity: Preferred stock, $0.001 par value: 30,000,000 shares authorized (actual, pro forma and pro forma as adjusted); 15,249,997 shares outstanding (actual); no shares outstanding (pro forma and pro forma as adjusted)............................................... 15 -- -- Common stock, $0.001 par value: 100,000,000 shares authorized (actual, pro forma and pro forma as adjusted); 20,148,985 shares outstanding (actual); 38,246,131 outstanding (pro forma); shares outstanding (pro forma as adjusted)..................... 20 38 Additional paid-in capital................................ 52,612 72,673 Deferred compensation..................................... (2,911) (2,911) Accumulated deficit....................................... (10,225) (12,286) -------- ------- ------- Total stockholders' equity.............................. 39,511 57,514 -------- ------- ------- Total capitalization.................................. $ 39,511 $58,335 $ ======== ======= ======= The share information in this table does not include the following: - 4,583 shares issued subsequent to April 30, 2000 upon exercise of outstanding stock options; - 1,786,326 shares issuable upon exercise of stock options outstanding on April 30, 2000 at a weighted average price of $1.71 per share, excluding 4,583 shares issued subsequent to April 30, 2000 upon exercise of stock options, and 1,266,396 shares issuable upon exercise of stock options granted subsequent to April 30, 2000 through May 15, 2000 at a weighted average price per share of $3.20 per share; and - 1,277,373 shares reserved for future issuance under our stock option plan. 19
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DILUTION If you invest in our common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering. At April 30, 2000, our pro forma net tangible book value was $32.6 million, or $0.85 per share of common stock. We calculate pro forma net tangible book value per share by dividing the pro forma net tangible book value, which equals total assets less intangible assets and total liabilities, by the number of pro forma outstanding shares of common stock. After giving effect to the sale of the shares of common stock in this offering at an assumed initial public offering price of $ per share, less estimated underwriting discounts and commissions and estimated offering expenses, our pro forma as adjusted net tangible book value at April 30, 2000 would have been $ million, or $ per share. This represents an immediate increase in the pro forma as adjusted net tangible book value of $ per share to existing stockholders and an immediate dilution of $ per share to new investors, or approximately % of the assumed offering price of $ per share. The following table illustrates this dilution on a per share basis: [Download Table] Assumed initial public offering price per share......... $ Pro forma net tangible book value per share at April 30, 2000.................................................. $ 0.85 Increase per share attributable to new investors........ -------- Pro forma as adjusted net tangible book value per share after this offering................................... -------- Dilution per share to new investors..................... $ The following table shows on a pro forma as adjusted basis at April 30, 2000, after giving effect to the conversion of all outstanding preferred stock as of April 30, 2000 and shares of preferred stock issued subsequent to April 30, 2000 into 16,763,813 shares of common stock upon completion of this offering, the number of shares of common stock purchased from us, the aggregate effective cash consideration paid to us and the average price paid per share by existing stockholders and by new investors purchasing common stock in this offering, before deducting estimated underwriting discounts and commissions and estimated offering expenses: [Enlarge/Download Table] SHARES PURCHASED TOTAL CONSIDERATION --------------------- ---------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ---------- -------- ----------- -------- ------------- Existing stockholders.................... 38,246,131 % $66,380,977 % $1.81 New investors............................ $ ---------- ---- ----------- ---- Total.................................. 100% 100% ========== ==== =========== ==== The above computations assume no exercise of options after April 30, 2000. The number of shares outstanding at April 30, 2000 excludes 1,790,909 shares of common stock issuable upon exercise of options outstanding as of April 30, 2000, having a weighted average exercise price of $1.71 per share, and 1,266,396 shares issuable upon exercise of stock options granted subsequent to April 30, 2000 through May 15, 2000 having a weighted average price of $3.20 per share. To the extent the option holders exercise these outstanding options, or any options we grant in the future, or the underwriters exercise their over-allotment option, there will be further dilution to new investors. For a more detailed discussion of our stock option plan and outstanding options to purchase common stock, see Note 6 of Notes to our Consolidated Financial Statements. 20
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SELECTED ACTUAL AND PRO FORMA FINANCIAL DATA You should read the selected financial data set forth below in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Unaudited Pro Forma Condensed Consolidated Financial Statements and related Notes and our Consolidated Financial Statements and related Notes included elsewhere in this prospectus. The statements of operations data for the fiscal years ended October 31, 1997, 1998 and 1999 and the balance sheet data as of October 31, 1998 and 1999 are derived from, and are qualified by reference to, the audited Consolidated Financial Statements and related Notes included in this prospectus. The statement of operations data for the period from July 23, 1996 (inception) to October 31, 1996 and the balance sheet data as of October 31, 1996 and 1997 are derived from unaudited financial statements not included in this prospectus. The statements of operations data for the six months ended April 30, 1999 and 2000 and the balance sheet data as of April 30, 2000 are derived from unaudited financial statements included in this prospectus. Our actual operating results for the six months ended April 30, 2000 include the operating results of Zentropic, which we acquired on April 3, 2000, for the period from the acquisition date through April 30, 2000. The unaudited pro forma statement of operations data for the fiscal year ended October 31, 1999 and the six months ended April 30, 2000: - give effect to our acquisitions of Zentropic, USE, Fireplug, Inup, Moreton Bay and RT-Control as if they had occurred on November 1, 1998; and - reflect the amortization of goodwill and other intangibles related to the acquisitions, as well as adjustments for acquired in-process research and development in connection with the Zentropic acquisition and intercompany transactions. The unaudited pro forma balance sheet data as of April 30, 2000 give effect to the acquisitions as if they occurred on April 30, 2000, except for Zentropic, which is included in our historical April 30, 2000 balance sheet. The unaudited pro forma balance sheet data: - reflect the issuance of 1,333,333 shares of our common stock, 83,334 shares of our Series C preferred stock, 1,430,482 shares of our Series D preferred stock and options to purchase 673,596 shares of our common stock in connection with the acquisitions; and - give effect to the automatic conversion of our Series A, Series B and Series C preferred stock outstanding on April 30, 2000 and the Series C and Series D preferred stock issued subsequent to April 30, 2000 into 16,763,813 shares of our common stock upon completion of this offering. The pro forma as adjusted data as of April 30, 2000 give effect to the pro forma adjustments, as well as to the receipt of the proceeds from this offering, after deducting estimated underwriting discounts and commissions and estimated offering expenses. The unaudited pro forma financial data are presented for illustrative purposes only and are not necessarily indicative of the operating results or financial position that would have resulted if these acquisitions had been in effect during the periods presented or of future operating results. 21
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[Enlarge/Download Table] YEAR ENDED OCTOBER 31, PERIOD FROM -------------------------------------------- JULY 23, 1996 1999 (INCEPTION) TO ---------------------- OCTOBER 31, 1996 1997 1998 ACTUAL PRO FORMA ----------------- -------- -------- -------- ----------- (UNAUDITED) (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenue......................... $ 62 $ 945 $ 1,376 $ 2,801 $ 4,640 Cost of revenue................. 67 247 361 185 1,380 ------- ------- ------- ------- -------- Gross margin (deficit).......... (5) 698 1,015 2,616 3,260 ------- ------- ------- ------- -------- Operating expenses: Research and development...... -- 655 1,357 1,304 1,784 Sales and marketing........... 13 663 1,024 729 1,036 General and administrative.... 31 207 639 1,224 2,664 Non-cash stock-related compensation*............... -- -- -- 250 382 Amortization of goodwill and other intangibles........... -- -- -- -- 7,125 Acquired in-process research and development............. -- -- -- -- -- ------- ------- ------- ------- -------- Total operating expenses.... 44 1,525 3,020 3,507 12,991 ------- ------- ------- ------- -------- Loss from operations............ (49) (827) (2,005) (891) (9,731) Other income (expense), net..... (12) (50) (181) (163) (236) ------- ------- ------- ------- -------- Loss before income taxes........ (61) (877) (2,186) (1,054) (9,967) Benefit for income taxes........ -- -- -- -- 17 ------- ------- ------- ------- -------- Net loss........................ $ (61) $ (877) $(2,186) (1,054) $ (9,950) ======= ======= ======= ======= ======== Basic and diluted net loss per common share.................. $ (0.00) $ (0.05) $ (0.12) $ (0.06) $ (0.47) ======= ======= ======= ======= ======== Basic and diluted weighted average common shares outstanding................... 18,000 18,000 18,000 18,000 21,079 ======= ======= ======= ======= ======== Basic and diluted supplemental pro forma net loss per common share (unaudited)............. $ (0.44) ======== Basic and diluted supplemental pro forma weighted average common shares outstanding (unaudited)................... 22,592 ======== SIX MONTHS ENDED APRIL 30, --------------------------------------- 1999 2000 ----------- ------------------------- ACTUAL ACTUAL PRO FORMA ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenue......................... $ 806 $ 1,751 $ 2,814 Cost of revenue................. 37 84 838 ------- ----------- ------- Gross margin (deficit).......... 769 1,667 1,976 ------- ----------- ------- Operating expenses: Research and development...... 786 1,736 1,968 Sales and marketing........... 321 1,098 1,419 General and administrative.... 695 1,108 2,288 Non-cash stock-related compensation*............... -- 1,046 1,462 Amortization of goodwill and other intangibles........... -- 166 3,563 Acquired in-process research and development............. -- 800 -- ------- ----------- ------- Total operating expenses.... 1,802 5,954 10,700 ------- ----------- ------- Loss from operations............ (1,033) (4,287) (8,724) Other income (expense), net..... (43) 45 19 ------- ----------- ------- Loss before income taxes........ (1,076) (4,242) (8,705) Benefit for income taxes........ -- 139 190 ------- ----------- ------- Net loss........................ $(1,076) $ (4,103) $(8,515) ======= =========== ======= Basic and diluted net loss per common share.................. $ (0.06) $ (0.21) $ (0.38) ======= =========== ======= Basic and diluted weighted average common shares outstanding................... 18,000 19,660 22,478 ======= =========== ======= Basic and diluted supplemental pro forma net loss per common share (unaudited)............. $ (0.30) ======= Basic and diluted supplemental pro forma weighted average common shares outstanding (unaudited)................... 28,277 ======= [Enlarge/Download Table] OCTOBER 31, APRIL 30, 2000 ----------------------------------------------- ------------------------- 1996 1997 1998 1999 ACTUAL PRO FORMA ----------- ----------- -------- -------- ----------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents........................... $ 5 $ 44 $ 117 $ 68 $ 30,464 $30,355 Working capital (deficit)........................... 31 (380) (1,354) (2,157) 31,284 30,407 Total assets........................................ 521 363 465 1,134 41,202 62,021 Long-term liabilities............................... -- -- -- -- 115 936 Total stockholders' equity (deficit)................ 364 (129) (1,184) (1,983) 39,511 57,514 [Enlarge/Download Table] SIX MONTHS ENDED YEAR ENDED OCTOBER 31, 1999 APRIL 30, 2000 ------------------------------- ------------------------- ACTUAL PRO FORMA ACTUAL PRO FORMA -------------- -------------- ----------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (IN THOUSANDS) (*) NON-CASH STOCK-RELATED COMPENSATION HAS BEEN EXCLUDED FROM THE FOLLOWING EXPENSES: Research and development.............................. $ 16 $ 60 $ 67 $ 156 Sales and marketing................................... 26 85 23 117 General and administrative............................ 208 237 956 1,189 22
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES AND THE PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES, INCLUDED ELSEWHERE IN THIS PROSPECTUS. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. SEE "SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS" FOR MORE INFORMATION ABOUT THESE STATEMENTS. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS, INCLUDING THOSE SET FORTH UNDER "RISK FACTORS." OVERVIEW We provide a broad range of embedded operating system products and services through a combination of our experience with embedded operating systems, expertise in Linux operating systems and involvement in the open source community. Our offerings enable microprocessor companies and original equipment manufacturers to develop and optimize unique embedded systems and integrate those systems into their products. We began operations as part of Caldera, Inc. in July 1996 when Caldera purchased assets relating to a disk operating system, known as DR DOS. Caldera marketed DR DOS technology primarily as an embedded operating system for microprocessors to be used in products and systems other than desktop personal computers. In August 1998, we were incorporated as a separate entity, and in September 1998, Caldera transferred to us licensing rights and assets relating to the DR DOS and embedded system businesses. At the same time, Caldera transferred certain assets not related to those businesses to a separate entity, Caldera Systems. Starting in January 1999, we began focusing our strategy on developing embedded operating systems based on Linux. We commercially released the first version of our embedded Linux operating system, Embedix Linux, in January 2000. Since March 2000, we have acquired businesses with technologies that are complementary to our own, including Zentropic, USE, Fireplug, Inup, Moreton Bay and RT-Control. In connection with these acquisitions, we issued an aggregate of 3,078,559 shares of our common stock, 1,513,816 shares of our preferred stock and paid an aggregate of $1.3 million, including direct expenses of approximately $418,000. We also granted to employees of the acquired companies options to purchase an aggregate of 673,596 shares of common stock at a weighted average exercise price of $2.82 per share. With these acquisitions, we currently have established development groups both domestically and in Australia, Canada, France, Japan, Taiwan and the United Kingdom. SOURCES OF REVENUE Historically, we have generated revenue primarily from licenses of DR DOS-based embedded operating systems. With the commercial release of the first version of Embedix Linux in January 2000, we began generating revenue from licenses of Linux-based products and the provision of related professional services. Sales of our Linux-based products and services accounted for 69% of total revenue in the six months ended April 30, 2000. We expect that the majority of our future revenue will be derived from the licensing of our embedded Linux operating system and related software products, in particular Embedix Browser. A relatively small number of customers account for a significant portion of our total revenue. Sales to our seven largest customers accounted for approximately 77% of total revenue in the six months ended April 30, 2000, with DaiShin accounting for approximately 34% of total revenue. During that same period, no other customer accounted for more than 10% of total revenue. Through fiscal 2001, we expect that revenue from our ten largest customers will continue to account for a majority of our revenue. We market and sell our operating system and related software products and services both domestically and internationally. Revenue from sales to customers outside the United States 23
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represented 68% of our total revenue in the six months ended April 30, 2000. To date, all revenue transactions have been denominated in U.S. dollars. We expect revenue from sales to customers outside the United States to remain a significant percentage of our total revenue in the future. We generate a majority of our revenue from licenses of our operating system and related software products to original equipment manufacturers. We recognize this revenue when an agreement has been executed, the product has been delivered, no significant implementation obligations remain, the fee is fixed and determinable and collection is probable. Through April 30, 2000, some of our license agreements were bundled with maintenance and support services. Because we had not established the necessary vendor specific objective evidence until the second quarter of fiscal 2000, we could not recognize separately the service revenue. Accordingly, revenue for these licenses was deferred and recognized over the term of the support and maintenance services. As we have now established this evidence, we intend to unbundle service revenue components on our future contracts and to report separately service revenue in the future. We had no material service revenue in the six months ended April 30, 2000. We have recently begun to give our customers the option of entering into separate service contracts for maintenance and support. We recognize revenue from maintenance and support services over the term of the agreement. If maintenance and support services offered in connection with a software license agreement are provided for a period of one year or less, the estimated cost of the services is insignificant and there is no commitment to provide upgrades or enhancements, we recognize this service revenue upon our delivery of the software and accrue the estimated costs of providing these services. If the service period is greater than one year, or if upgrades or enhancements are included, we defer the revenue and recognize it either over the period that the services are to be provided or when no significant performance obligations remain. In addition, we have recently begun to enter into engineering and training contracts with our customers. Under our engineering contracts, we offer custom engineering services to customers purchasing our embedded operating system, or we may develop and license a complete custom embedded software solution at a customer's request. Under our training contracts, we offer instructor-led training to provide developers access to information and resources to assist with design and implementation. We recognize revenue from engineering and training services as the services are performed. RECENT ACQUISITIONS AND PRO FORMA RESULTS OF OPERATIONS From April 3, 2000 to May 12, 2000, we acquired six businesses with technologies that are complementary to our own. Each acquisition was accounted for using purchase accounting. On April 3, 2000, we acquired Zentropic for total consideration of $6.7 million, consisting of 1,745,226 shares of our common stock, and including $112,000 in costs directly associated with the acquisition. Zentropic provides Linux software for industrial and other time-sensitive applications, that it refers to as real-time technology. Zentropic is headquartered in Herndon, Virginia and also has an engineering office located in the United Kingdom. For the fiscal year ended October 31, 1999, Zentropic had revenue of approximately $85,000 and an operating loss of approximately $752,000. For the period from November 1, 1999 to April 2, 2000, Zentropic had revenue of approximately $256,000 and an operating loss of approximately $390,000. As of April 3, 2000, Zentropic had assets of approximately $276,000 and liabilities of approximately $160,000. The value assigned to the in-process research and development acquired in the Zentropic acquisition of $800,000 was determined by an independent valuation which included, but was not limited to, an analysis of estimating the costs to develop the purchased in-process research and development into commercially viable products, the market for the developed products and technologies, and discounting the resulting net cash flows related to these projects and technologies. The valuation was based upon assumptions management 24
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believed to be reasonable at the time of the valuation. However, the underlying assumptions used to estimate expected revenue, development costs or profitability, or the events associated with such projects, may not transpire as estimated. At the date of the acquisition of Zentropic, management estimated that the acquired in-process research and development projects of Zentropic were approximately 60% complete and that an additional $150,000 would be required to develop these projects and technologies to commercial viability. At the date of the acquisition, the acquired in-process research and development had not yet reached technological feasibility and had no alternative future uses. On May 1, 2000, we acquired all of the outstanding capital stock of USE, in connection with which we paid approximately $373,000 in cash, including $50,000 in estimated costs directly associated with the acquisition. We also granted to employees of USE options to purchase 682,335 shares of common stock at an exercise price of $3.00 per share. USE is a custom systems engineering company and is based in Shiojiri, Nagano, Japan. For the year ended December 31, 1999, USE had revenue of $1.5 million and an operating loss of approximately $509,000. For the six months ended March 31, 2000, USE had revenue of approximately $764,000 and an operating loss of approximately $557,000. As of March 31, 2000, USE had assets of $1.4 million and liabilities of $2.1 million. On May 1, 2000, we acquired all of the outstanding capital stock of Fireplug, in connection with which we issued 69,998 shares of our Series D convertible preferred stock and paid approximately $581,000 in cash, including $81,000 in estimated costs directly associated with the acquisition. We also granted to employees of Fireplug options to purchase 62,220 shares of our common stock at an exercise price of $1.50 per share. Fireplug develops embedded Linux network systems and tools and is based in Vancouver, Canada. For the year ended December 31, 1999, Fireplug had revenue of approximately $145,000 and an operating loss of approximately $33,000. For the six months ended March 31, 2000, Fireplug had revenue of approximately $128,000 and an operating loss of approximately $110,000. As of March 31, 2000, Fireplug had assets of approximately $51,000 and liabilities of approximately $122,000. On May 1, 2000, we acquired all of the outstanding capital stock of Inup, in connection with which we issued 1,333,333 shares of our common stock and 83,334 shares of our Series C preferred stock and paid approximately $60,000 in cash, including $50,000 in estimated costs directly associated with the acquisition. Inup develops Linux-based software that compensates for hardware failures and is based in Saint-Ouen, France. For the year ended December 31, 1999, Inup had revenue of approximately $8,000 and an operating loss of approximately $125,000. For the six months ended March 31, 2000, Inup had revenue of approximately $8,000 and an operating loss of approximately $306,000. As of March 31, 2000, Inup had assets of approximately $776,000 and liabilities of approximately $139,000. On May 10, 2000, we acquired all of the outstanding capital stock of Moreton Bay, in connection with which we issued 956,315 shares of our Series D preferred stock and paid approximately $60,000 in cash, including $50,000 in estimated costs directly associated with the acquisition. We also granted to employees of Moreton Bay options to purchase 209,474 shares of our common stock at an exercise price of $3.00 per share. Moreton Bay develops embedded virtual private network solutions for Internet appliances and provides engineering development services for the Motorola ColdFire microprocessor platform. Moreton Bay is based in Brisbane, Australia and has a sales and service office in San Jose, California. Prior to the acquisition, Moreton Bay transferred the assets, liabilities and operations of one of its unrelated product lines to a separate legal entity. For the year ended October 31, 1999, the acquired operations of Moreton Bay had no revenue and an operating loss of approximately $200,000. For the six months ended April 30, 2000, the acquired operations of Moreton Bay had revenue of approximately $27,000 and an operating loss of approximately $230,000. As of April 30, 2000, Morton Bay had assets of approximately $609,000 and liabilities of approximately $151,000. On May 12, 2000, we acquired all of the outstanding capital stock of RT-Control, in connection with which we issued 404,169 shares of our Series D preferred stock and paid approximately $90,000 in 25
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cash, including $75,000 in estimated costs directly associated with the acquisition. We also granted to employees of RT-Control options to purchase 16,667 shares of our common stock at an exercise price of $1.50 per share. RT-Control was the principal developer of the mcLinux version of Linux for microcontrollers and is based in Toronto, Canada. For the period from its inception (June 30, 1999) to December 31, 1999, RT-Control had revenue of approximately $67,000 and an operating loss of approximately $96,000. For the six months ended March 31, 2000, RT-Control had revenue of approximately $79,000 and an operating loss of approximately $246,000. As of March 31, 2000, RT-Control had assets of approximately $130,000 and liabilities of approximately $206,000. The unaudited pro forma condensed consolidated statements of operations for the fiscal year ended October 31, 1999 and for the six months ended April 30, 2000 are included elsewhere in this prospectus and reflect our acquisitions of Zentropic, USE, Fireplug, Inup, Moreton Bay, and RT-Control as if these transactions had occurred on November 1, 1998. Pro forma revenues were $4.6 million in the fiscal year ended October 31, 1999 and $2.8 million in the six months ended April 30, 2000. Pro forma losses from operations were $9.7 million in the fiscal year ended October 31, 1999 and $8.7 million in the six months ended April 30, 2000. The pro forma statements of operations reflect the amortization of goodwill and other intangibles related to the acquisitions and adjustments for acquired in-process research and development as part of the Zentropic acquisition and intercompany transactions. Pro forma amortization of goodwill and other intangibles was $7.1 million in the fiscal year ended October 31, 1999 and $3.6 million in the six months ended April 30, 2000. Acquired in-process research and development expense in connection with the Zentropic acquisition on April 3, 2000 was $800,000 in the six months ended April 30, 2000, and is not included in the pro forma results of operations for that period. Intercompany revenue, net of the cost of that revenue, between Zentropic and us prior to the acquisition was approximately $118,000 in the six months ended April 30, 2000, and is not included in the pro forma results of operations for that period. HISTORICAL RESULTS OF OPERATIONS We have included a discussion of our results of operations for the fiscal years ended October 31, 1997, 1998 and 1999 and the six months ended April 30, 1999 and 2000. As a result of focusing our strategy on Linux-based embedded systems starting in January 1999, commercially releasing the first version of Embedix Linux in January 2000 and our six recent acquisitions, we believe that period-to-period comparisons of our historical results are not indicative of our future performance. COMPARISON OF THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 REVENUE AND COST OF REVENUE REVENUE. Revenue increased 117% from approximately $806,000 in the six months ended April 30, 1999 to $1.8 million in the six months ended April 30, 2000. This increase was due to additional licensing revenue from the sale of our Linux-based operating system and related software products. We began selling Linux-based products and services in the six months ended April 30, 2000, and those sales accounted for 69% of total revenue in that period. We believe that sales of our Linux-based operating system and related software products and services will represent an increasing portion of our total revenue. COST OF REVENUE. Cost of revenue consists of our costs of production, fulfillment and shipment of our operating system software products, as well as salaries, benefits and related expenses of systems engineers. Also included in cost of revenue are any royalties paid to third parties for inclusion of their software products in our product offerings. Cost of revenue was approximately $37,000 in the six months ended April 30, 1999 and approximately $84,000 in the six months ended April 30, 2000. This increase was due to additional costs associated with an increase in the number of customer support personnel together with increased costs of production, fulfillment and shipping. As we begin to report 26
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service revenue separately, we will report the costs associated with those services separately as well. As our service offerings increase in the future, we expect total cost of revenue as a percentage of total revenue to increase. OPERATING EXPENSES RESEARCH AND DEVELOPMENT. Research and development expenses consist of payroll and related expenses for software engineers, technical writers and quality assurance and management personnel and the costs of materials used by these employees in the development of new or enhanced product offerings. We expense all of our research and development costs as they are incurred. Research and development expenses were approximately $786,000 in the six months ended April 30, 1999 and $1.7 million in the six months ended April 30, 2000. This increase was due to our hiring of additional research and development personnel in connection with the development of our Linux-based products and services. We believe that a significant level of investment in Linux-based product development and other research and development initiatives will be required as we integrate and complete the development of the technologies we recently acquired. Accordingly, we expect research and development expenses to continue to increase in absolute dollars. SALES AND MARKETING. Sales and marketing expenses consist of salaries, commissions and related expenses for personnel engaged in marketing, sales and sales support functions, as well as costs associated with trade shows, advertising and promotional activities. Sales and marketing expenses were approximately $321,000 in the six months ended April 30, 1999 and $1.1 million in the six months ended April 30, 2000. This increase was due to our hiring of additional sales and marketing personnel and increased expenses incurred in connection with our branding efforts following the commercial release of our Embedix Linux product in January 2000. We intend to continue to expand our sales and marketing activities, both domestically and internationally, to increase market awareness and sales of our products and services. Accordingly, we expect our sales and marketing expenses to continue to increase in absolute dollars. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist of professional fees, salaries and related costs for accounting, administrative, finance, human resources, information systems and legal personnel, as well as expenses associated with implementing and expanding our internal information and management reporting systems. General and administrative expenses were approximately $695,000 in the six months ended April 30, 1999 and $1.1 million in the six months ended April 30, 2000. This increase was due to our hiring of additional general and administrative personnel and additional expenses associated with improving our corporate infrastructure. We expect general and administrative expenses to continue to increase in absolute dollars as we add administrative personnel to support our business expansion. NON-CASH STOCK-RELATED COMPENSATION. Non-cash stock-related compensation reflects the amortized portion of the difference between the deemed fair market value of the common stock for accounting purposes and the sales price or exercise price of the stock or stock options as of the date of sale or grant. Deferred compensation is presented as a reduction of stockholders' equity and is amortized over the vesting period of the applicable options. In connection with stock option grants, we recorded deferred compensation of $3.0 million in the six months ended April 30, 2000. We amortized approximately $157,000 of deferred compensation in the six months ended April 30, 2000 and recorded $825,000 of compensation expense related to the sale of our common stock to our officers. There were no non-cash stock-related compensation amounts in the six months ended April 30, 1999. Based on option grant activity through May 15, 2000, we expect to expense $1.1 million of deferred compensation in the remainder of fiscal 2000, $1.8 million in fiscal 2001, approximately $886,000 in fiscal 2002, approximately $434,000 in fiscal 2003 and approximately $108,000 in fiscal 2004. 27
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AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Amortization of goodwill and other intangibles occurs when the purchase price of an acquired company exceeds the net assets and any in-process research and development costs. Our acquisition of Zentropic on April 3, 2000 resulted in $6.0 million of goodwill and other intangibles, which is being amortized over the expected lives of the assets, ranging from two to five years. We recorded amortization expense of approximately $166,000 for the six months ended April 30, 2000. ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. Acquired in-process research and development expense relates to the portion of the purchase price of an acquired company that is attributable to in-process technology that has not reached the requirements of technological feasibility at the closing date. In connection with our acquisition of Zentropic on April 3, 2000 we expensed $800,000 of acquired in-process research and development in the six months ended April 30, 2000. OTHER INCOME (EXPENSE), NET Other income (expense), net consists primarily of interest income from our cash investments offset by interest expense on borrowings. Other expense, net was approximately $43,000 in the six months ended April 30, 1999, and other income, net was approximately $45,000 in the six months ended April 30, 2000. The net increase was due to an increase in interest income of approximately $91,000 as a result of increased cash balances, offset by an increase in interest expense of approximately $9,000. On April 30, 2000, we repaid all outstanding principal and interest due under a borrowing arrangement with one of our principal stockholders, The Canopy Group. This repayment resulted in a decreased borrowing level in the six months ended April 30, 2000 compared to the same period in 1999. INCOME TAX BENEFIT In connection with the acquisition of Zentropic, we recorded a deferred income tax liability of approximately $717,000 related to acquired intangible assets that are not deductible for income tax purposes and we reduced the valuation allowance on our deferred income tax assets as of the date of the acquisition by approximately $575,000. As a result of the remaining deferred income tax liability of approximately $142,000, we recorded a benefit for income taxes of approximately $134,000 during the six months ended April 30, 2000 principally due to the net operating loss generated from the date of the Zentropic acquisition through April 30, 2000. See Note 7 of Notes to our Consolidated Financial Statements. COMPARISON OF THE FISCAL YEARS ENDED OCTOBER 31, 1997, 1998 AND 1999 REVENUE AND COST OF REVENUE REVENUE. Revenue increased from approximately $945,000 in fiscal 1997, to $1.4 million in fiscal 1998, to $2.8 million in fiscal 1999. Historically, we generated revenue primarily from licenses of DR DOS-based embedded operating systems. The increase in revenue in each year was due to increased market acceptance of these products. COST OF REVENUE. Cost of revenue was approximately $248,000 in fiscal 1997, approximately $361,000 in fiscal 1998 and approximately $185,000 in fiscal 1999. As a percentage of total revenue, these costs were 26% in each of fiscal 1997 and fiscal 1998 and 7% in fiscal 1999. The increase in absolute dollars from fiscal 1997 to fiscal 1998 was due to additional costs incurred as a result of additional license sales. During each of fiscal 1997 and fiscal 1998, cost of revenue included the amortization expense associated with the acquisition of the DR DOS assets. The decrease from fiscal 1998 to fiscal 1999 was due to these amounts being fully amortized at the end of fiscal 1998. 28
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OPERATING EXPENSES RESEARCH AND DEVELOPMENT. Research and development expenses were approximately $655,000 in fiscal 1997, $1.4 million in fiscal 1998 and $1.3 million in fiscal 1999. The increase from fiscal 1997 to fiscal 1998 was due to our hiring of software developers and quality assurance personnel to expand our DR DOS offerings and to support development and testing activities. This increase was also the result of the separation of our business from Caldera. The decrease from fiscal 1998 to fiscal 1999 was due to our decreased spending on DR DOS-based development offsetting any increases in research and development costs associated with Linux-based products. SALES AND MARKETING. Sales and marketing expenses were approximately $663,000 in fiscal 1997, $1.0 million in fiscal 1998 and approximately $729,000 in fiscal 1999. The increase from fiscal 1997 to fiscal 1998 was due to additional expenditures related to selling and marketing DR DOS-based products and the separation of our business from Caldera. The decrease from fiscal 1998 to fiscal 1999 was due to our decreased spending on selling and marketing DR DOS-based products offsetting any increases in costs associated with selling and marketing Linux-based products. GENERAL AND ADMINISTRATIVE. General and administrative expenses were approximately $208,000 in fiscal 1997, approximately $640,000 in fiscal 1998 and $1.2 million in fiscal 1999. The increase from fiscal 1997 to fiscal 1998 was due to significant costs incurred in connection with our separation from Caldera. The increase from fiscal 1998 to fiscal 1999 was due to the hiring of additional administrative, executive and finance personnel. NON-CASH STOCK-RELATED COMPENSATION. In connection with grants of stock options to employees and directors, we recorded approximately $311,000 of deferred compensation in the last six months of fiscal 1999, of which approximately $250,000 was expensed. We did not grant any options, and had no deferred stock compensation, in fiscal 1997 or 1998. OTHER INCOME (EXPENSE), NET Other expense, net, which consists principally of interest expense, was approximately $50,000 in fiscal 1997, approximately $181,000 in fiscal 1998 and approximately $163,000 in fiscal 1999. The increase from fiscal 1997 to fiscal 1998 was the result of increased borrowings to fund the carved-out operations of Caldera. Subsequent to our incorporation in August 1998, we funded our operations through borrowings from Canopy. The decrease from fiscal 1998 to fiscal 1999 was due to an overall reduction in borrowings resulting from the separation of our business from Caldera. LIQUIDITY AND CAPITAL RESOURCES Since our establishment as a separate entity in August 1998, we have funded our operations primarily through loans from Canopy and through sales of our common and preferred stock. As of April 30, 2000, we had $30.5 million of cash. This represents an increase of $30.4 million over October 31, 1999. Our working capital at April 30, 2000 was $31.3 million compared to a working capital deficit of $2.2 million at October 31, 1999. The increase in cash and working capital from October 31, 1999 is primarily a result of the sale of our common and preferred stock and the exercise of stock options. During the six months ended April 30, 2000, we received proceeds of: - $1.2 million from the sale of 1,500,000 shares of our common stock at a purchase price of $0.80 per share; - $532,000 from the exercise of outstanding stock options; 29
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- $3.7 million from the sale of 2,500,000 shares of Series A Class 2 preferred stock at a purchase price of $1.50 per share; - $14.5 million from the sale of 4,833,331 shares of Series B preferred stock at a purchase price of $3.00 per share; and - $17.5 million from the sale of 2,916,666 shares of Series C preferred stock at a purchase price of $6.00 per share, including a $1.5 million stock subscription receivable, which was paid subsequent to April 30, 2000. During the six months ended April 30, 2000, we used approximately $2.5 million of the proceeds from these stock sales to repay in full a convertible promissory note and accrued interest payable to Canopy. Net cash used in operating activities during the six months ended April 30, 2000 was $1.7 million. Cash used in operating activities was primarily attributed to the net loss of $4.1 million during that period, offset by non-cash expenses associated with acquired in-process research and development of $800,000, amortization of intangible assets of approximately $166,000 and amortization of deferred compensation of $1.0 million. Net cash used in operating activities was approximately $185,000 in fiscal 1997, $1.2 million in fiscal 1998 and $1.8 million in fiscal 1999. Cash used in operating activities was primarily attributed to the net loss of approximately $877,000 in fiscal 1997, $2.2 million in fiscal 1998 and $1.1 million in fiscal 1999, each offset by non-cash expenses and changes in working capital. Our investing activities have historically consisted of purchases of equipment. Purchases of equipment totaled approximately $108,000 in fiscal 1997, approximately $72,000 in fiscal 1998, approximately $190,000 in fiscal 1999 and approximately $284,000 in the six months ended April 30, 2000. During the six months ended April 30, 2000, we sold office equipment for $75,000. In addition, during the second quarter of fiscal 2000, we purchased Zentropic, acquiring net assets of approximately $116,000, including cash of approximately $113,000. Subsequent to April 30, 2000, we acquired net assets of approximately $335,000, including cash of $1.1 million, from USE, Fireplug, Inup, Moreton Bay and Rt-Control. In connection with the acquisition of USE we assumed aggregate loans payable of $1.9 million, of which $1.1 million is a current liability. The loans bear interest that is payable monthly, at rates ranging from 2.3% to 3.2%. The aggregate purchase price for these acquisitions consisted of 1,333,333 shares of our common stock, 83,334 shares of our Series C preferred stock, 1,430,482 shares of our Series D preferred stock, options to purchase 673,596 shares of our common stock and cash of $1.2 million, including approximately $306,000 in estimated costs directly associated with the acquisitions. We currently anticipate that we will continue to experience significant increases in our operating expenses for the foreseeable future as we enter new markets for our products and services, increase research and development activities and sales and marketing activities, develop new distribution channels and broaden our professional service capabilities. Our operating expenses will consume a material amount of our capital resources, including a portion of the net proceeds of this offering. We believe that the net proceeds of this offering, together with our existing cash, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 15 months. Although we believe that we will be able to meet our anticipated cash needs after that time from cash generated from operations and do not currently anticipate the need to raise additional capital, if we do seek to raise additional capital, additional financing may not be available on acceptable terms, if at all. We currently intend to use the net proceeds of this offering for general corporate purposes and working capital. We may also use a portion of the net proceeds to acquire additional businesses, products and technologies that we believe will complement our current or future business, although we have no specific plans, agreements or commitments to do so, and are not currently engaged in any 30
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negotiations for any acquisition. Pending these uses, we will invest the net proceeds of this offering in government securities and other short-term, investment grade, interest-bearing instruments. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as a part of a hedge transaction and, if it is, the type of hedge transaction. This statement is effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. We do not use derivative instruments, therefore the adoption of this statement will not have any effect on our results of operations or financial position. In December 1999, the SEC staff issued Staff Accounting Bulletin No. 101, or SAB No. 101, "Revenue Recognition in Financial Statements." This pronouncement summarizes certain of the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. We are required to adopt SAB No. 101 during the first quarter of fiscal year 2001. Although management is currently evaluating the impact, if any, of SAB No. 101, management does not presently believe it will have a material impact on our results of operations, financial position or liquidity. In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44 "Accounting for Certain Transactions involving Stock Compensation, an interpretation of Accounting Principles Board Opinion No. 25," or APB No. 25. This interpretation clarifies the definition of employee for purposes of applying APB No. 25, the criteria for determining whether a plan qualifies as a noncompensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and the accounting for an exchange of stock compensation awards in a business combination. This interpretation is effective July 1, 2000, but some conclusions in this interpretation cover specific events that occur after either December 15, 1998 or January 12, 2000. To the extent that this interpretation covers events occurring during the period after December 15, 1998 or January 12, 2000, but before the effective date of July 1, 2000, the effects of applying this interpretation are recognized on a prospective basis from July 1, 2000. Although we are currently evaluating the impact, if any, of this interpretation, we do not presently believe it will have a material impact on our results of operations, financial position or liquidity. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK As we maintain and expand our international operations, our financial results will be affected by factors such as changes in foreign currency rates or weak economic conditions in foreign markets. Because all of our revenue is currently denominated in U.S. dollars, a strengthening of the dollar could make our products and services less competitive in international markets. With our recent acquisitions of Zentropic, USE, Fireplug, Inup, Moreton Bay and RT-Control, we currently have operations both domestically and in Australia, Canada, France, Japan, Taiwan and the United Kingdom. To date, foreign currency fluctuations have had little effect on our business. In the future, more of our sales transactions may be denominated in local currencies. As we expand operations internationally, we will continue to evaluate our foreign currency exposures and risks and develop appropriate hedging or other strategies to manage those risks. We have not revised our current business practices or modified any of our products to conform to Europe's conversion to the euro. 31
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BUSINESS OVERVIEW We provide a broad range of embedded operating system products and services through a combination of our experience with embedded operating systems, expertise in Linux operating systems and involvement in the open source community. Our offerings enable microprocessor companies and original equipment manufacturers to develop and optimize unique embedded operating systems and integrate those technologies into their products and systems. We also develop and license complete customized embedded systems solutions for our customers according to their specifications. Our products and services are designed to reduce the time and expense associated with the development of embedded systems and to assist our customers in creating systems that feature high functionality, performance and reliability and ease of use. We offer embedded Linux operating system solutions, called Embedix, including an operating system, a software development kit and a compact graphical Web browser. Our products feature proprietary extensions of the Linux open source software. In addition, we offer comprehensive professional services, or Embedix Services, including customized engineering, training and technical support services. We sell our Linux products and services to original equipment manufacturers such as Bast, CIS Technology, DaiShin and MiTAC International. To further promote our technologies, we have also entered into strategic relationships with microprocessor companies such as Hitachi, Motorola and Samsung. INDUSTRY BACKGROUND Rapid technological advancements have dramatically increased the number, type and capabilities of products and systems that enable organizations and individuals to collaborate, access information and conduct business more effectively. This proliferation is largely fueled by innovations in microprocessors, which are hidden, or embedded, in a variety of products and systems. Complex tasks, such as Internet access, network traffic routing and graphics display, require a high level of computing power, which is currently delivered by 16-, 32- and 64-bit embedded microprocessors. Based on information provided by an industry research firm, worldwide unit shipments of 16-, 32- and 64-bit embedded microprocessors will grow from approximately 390 million in 1998 to approximately 1.2 billion in 2003. Products and systems containing embedded microprocessors play a role in virtually every aspect of modern life and include: - Internet and communications infrastructure equipment such as routers, modems and switches; - consumer-oriented devices such as personal digital assistants, smart cellular phones, entertainment systems, Internet-enabled television set-top boxes, home automation systems, automated teller machines and Internet kiosks; - retail business products such as handheld point-of-sale terminals, bar code scanners, smart cash registers, credit card readers and other systems that provide real-time inventory tracking and automate procurement processes; - transportation-related systems such as automobile and aviation navigation and safety systems; and - industrial control and automation systems such as manufacturing equipment and components as well as maintenance and repair machinery. Microprocessors require an operating system to manage the interaction between various hardware and software components. The growth in products and systems with embedded microprocessors has created demand for more robust, reliable and customizable embedded operating systems that are adaptable to product memory and storage limitations. In addition, as the development of embedded 32
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operating systems has significantly increased in complexity, software developers often require specialized software tools to customize and integrate these embedded operating systems. Many original equipment manufacturers use internal resources to develop their own operating systems for their embedded microprocessor projects. We believe that these internal development efforts have generally not proven to be cost-effective, in part because the programmers of these systems may not possess the requisite operating system expertise. Alternatively, manufacturers seeking more sophisticated operating systems for their embedded microprocessors have purchased proprietary operating systems from third parties. However, because of the proprietary nature of these operating systems, they typically cannot be easily and cost-effectively customized to meet the unique requirements of specific embedded systems. In addition, both internally developed and third-party proprietary operating systems are frequently designed for use with a limited set of applications and devices, and, as a result, we believe the companies that create these proprietary systems have largely been unable to achieve cost-saving economies of scale in production. Because many of these operating systems were originally created several years ago, and are therefore based on earlier microprocessor technology, the ability of companies using these operating systems to take full advantage of increasing microprocessor functionality may be limited. Further, because the companies that create these proprietary operating systems may be limited by the cost, expertise and availability of the developers that they employ, it is difficult for them to keep pace with innovations in microprocessor technology. Open source operating systems have emerged as a compelling alternative to internally developed or third-party proprietary operating systems. The term open source applies to software that can be copied, modified and distributed without any associated fee and with few restrictions. As such, the source code for these operating systems is open to the public and can be customized for a specific application or use. The growth of the Internet has greatly increased the scale and efficiency of open source software development through the availability of collaborative technologies such as e-mail lists, news groups and Web sites. Popular open source software is continuously maintained and improved by worldwide communities of developers who share information, code and suggestions, primarily over the Internet, increasing the frequency of software releases and the speed of feature development and error correction. Linux has emerged as the leading open source operating system, enjoying acceptance by both commercial and academic communities due to its high performance and stability, low cost and broad developer support. Until recently, the growth in the use of the Linux operating system has primarily been in the server and desktop computer markets. Microprocessor companies are now promoting, and original equipment manufacturers are now adopting, Linux in the embedded systems market. However, many of these manufacturers have only limited experience working with Linux, and may lack developers with the specialized skills and relationships in the open source community necessary to identify and take advantage of the many enhancements and extensions to Linux that are continuously under development. In addressing the increased complexity and functionality of products and systems with embedded microprocessors, microprocessor and original equipment manufacturers are faced with a number of challenges. As a result, we believe that there is a significant market opportunity for an embedded operating system that: - is powerful, reliable and full-featured, yet minimizes product memory and storage requirements; - can easily be customized across a variety of platforms to support a broad range of hardware devices; - allows for rapid development and deployment of the original equipment manufacturer's products, thereby reducing time-to-market; 33
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- provides increased functionality, connectivity and performance, including real-time capabilities, consistent with ongoing technological innovation; - is supported by a broad developer base; and - is complemented by a sophisticated set of development tools to enable integration, support services and value-added applications. THE LINEO SOLUTION We provide a broad range of embedded operating system software products and services through a combination of our experience with embedded operating systems, expertise in Linux operating systems and involvement in the open source community. Our offerings enable microprocessor companies and original equipment manufacturers to develop and optimize unique embedded systems and integrate those technologies into their products. We also develop and license complete customized embedded systems for our customers according to their specifications. Our products and services are designed to reduce the time and expense associated with the development of embedded systems and to assist our customers in creating systems with greater functionality, enhanced performance, improved reliability and greater ease of use as compared to currently available internally developed or third-party proprietary systems. The key benefits of our solution include: FULL-FEATURED EMBEDDED OPERATING SYSTEM. Embedix Linux, our embedded Linux operating system, not only provides the capabilities currently offered by existing embedded operating systems but also leverages the numerous advantages of Linux. Our proprietary process for identifying and customizing modular components of Linux enables the development of unique, reliable, full-featured embedded Linux variations with reduced memory and storage requirements and attributes appropriate for each customer's needs. In addition, our experience and long-standing relationships with the open source community allow us to combine its broad development and support resources with our internal expertise to fix errors and develop enhancements to our Linux-based products across various platforms in a quick and cost-effective manner. BROAD PLATFORM COMPATIBILITY. We work closely with microprocessor companies and original equipment manufacturers in developing our embedded Linux operating system solutions. As a result, these solutions are designed to operate on a broad range of embedded system platforms and meet diverse functionality requirements. Each embedded system has its own spectrum of performance, size and memory requirements. We offer solutions appropriate for products and systems ranging from small industrial components, to handheld consumer devices, to large networking infrastructure equipment. VALUE-ADDED DEVELOPMENT TOOLS AND APPLICATIONS. Our Embedix Software Development Kit, or SDK, is a package of proprietary software development tools designed to facilitate the design, development, error detection and correction, implementation and maintenance of embedded systems. Embedix SDK has been released as a beta version and is being tested by several of our key customers. We currently expect to begin commercial shipments of Embedix SDK in June 2000. We also offer our Embedix Linux customers our proprietary Embedix Browser, a compact, Linux-based graphical Web browser that provides a user interface for embedded products and systems that interact with the Internet. In addition, by incorporating third-party software applications from independent software vendors into our products, we can expand the functionality and features of products and systems that include our operating system. PROFESSIONAL ENGINEERING AND SUPPORT SERVICES. We offer our original equipment manufacturer customers and microprocessor companies a broad range of engineering, implementation, deployment and support services. Our engineers have significant experience with embedded systems, participate actively in the Linux community and contribute enhancements and additions to the Linux open source technology. In addition, we offer professional engineering, training and education services and technical 34
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support. Because we leverage the expertise of the extensive open source community, we believe that our services enable our customers to reduce their cost to implement, maintain and support embedded systems. THE LINEO STRATEGY Our objective is to become the leading provider of embedded operating system software products and services. To achieve this objective, we are implementing the following strategies: ENHANCE OUR TECHNOLOGY LEADERSHIP AND MARKET AWARENESS. We intend to continue to introduce technology that is compatible with existing embedded operating system software and to develop solutions specific to selected vertical markets. To support this effort, we plan both to develop technologies internally and to acquire proprietary technologies or other companies. For example, we are currently developing an extension to our Embedix Linux that is designed to enable applications originally written to run on Microsoft's Windows CE operating system to be modified, or ported, to run on our Embedix Linux operating system. In addition, through acquisitions, we have acquired a number of other technologies such as hard real-time operating system technology, proprietary high-availability extensions to Linux and Linux technology for microcontrollers. We also intend to enhance our brand awareness and increase the demand for our products through targeted advertising and will continue our active involvement in, and support of, the open source community to further enhance our reputation as one of the leading providers of embedded Linux solutions. CONTINUE TO DEVELOP STRATEGIC RELATIONSHIPS WITH MICROPROCESSOR COMPANIES. We intend to expand our strategic relationships with microprocessor companies to establish our brand of Linux-based software and services with the customers of these companies. We plan to continue to develop close relationships with microprocessor companies through our research and development efforts and by educating the employees of these companies about our products so that they may promote our products and be able to provide more comprehensive solutions to their customers. Through these relationships, we intend to further enhance our understanding of microprocessor and embedded circuit board configurations and to continue to understand future technology developments. EXPAND STRATEGIC RELATIONSHIPS WITH ORIGINAL EQUIPMENT MANUFACTURERS. We intend to continue to develop, strengthen and expand our relationships with original equipment manufacturers of products and systems that require embedded operating systems. By establishing close relationships with these manufacturers, we are better able to understand their future product development plans. Through these collaborative efforts, original equipment manufacturers can help ensure that their future products will have embedded Linux operating system support and we are able to integrate their requirements into our future product plans. EXPAND SALES EFFORTS INTERNATIONALLY. We intend to continue to expand our sales efforts internationally by growing our internal sales force and through additional strategic acquisitions. We believe that as the proliferation of digital consumer devices and other electronic products and systems continues, significant international demand for our embedded operating system solutions will develop. We currently have a sales or marketing presence in Australia, Canada, France, Japan, Taiwan and the United Kingdom. CONTINUE TO EXPAND OUR OFFERINGS BY INCORPORATING PRODUCTS FROM INDEPENDENT SOFTWARE VENDORS AND DEVELOPING A LIBRARY OF EMBEDDED OPERATING SYSTEM SOLUTIONS. We will continue to enhance the value of our operating system solutions by incorporating additional software products of independent software vendors. As part of our independent software vendor program, software vendors may include their products within our embedded software development kit, allowing us to introduce our customers to the benefits of these products when they are used in the embedded environment with our operating system. Original equipment manufacturers may incorporate these third-party technologies into their products under licenses obtained through us, for which we receive royalties, or under licenses obtained directly 35
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from the software vendors. In addition, our experience in providing professional support services to our customers enables us to maintain a library of common problems and their resolutions. We intend to continue to develop this library to be used in conjunction with our development tools and integrated in future products. PRODUCTS AND SERVICES We offer a wide range of embedded Linux technologies and services to enable our customers to develop, optimize and implement embedded products and systems. SOFTWARE PRODUCTS Our embedded Linux products, called Embedix, includes Embedix Linux, Embedix SDK and Embedix Browser. Embedix Linux Logo Embedix Linux is a powerful and reliable Linux operating system that is designed specifically for embedded products and systems. Embedix Linux is a combination of open source Linux and internally developed technologies. We have enhanced and extended open source Linux, traditionally designed for desktop/server implementation, with new technologies and advancements to enable developers and original equipment manufacturers to utilize Linux within highly customized embedded products and systems. We have developed a proprietary process for identifying and modifying Linux source code modules, which allows us to assemble and integrate a full-feature set of customizable components. By separating Linux into components, our customers can use those specific components that their unique embedded system products and systems require. We believe this decreases costs by allowing customers to build a wide range of embedded products and systems that use less memory and less storage. Embedix Linux not only provides the features currently offered by existing proprietary embedded operating systems, but it also leverages the numerous advantages of open source software development. We are able to combine the broad development and support resources of the Linux open source community with our own engineering expertise to develop enhancements across various platforms quickly and cost-effectively. Further, we test the components that we provide both individually and as an integrated whole to maintain the quality of our products. Embedix SDK Logo Embedix SDK is a package of proprietary software and open source development tools designed to help microprocessor companies and original equipment manufacturers accelerate the design, development, error detection and correction, implementation and maintenance of embedded systems. Embedix SDK has been released as a beta version and is being tested by several of our key customers. We currently expect to begin commercial shipment of Embedix SDK in June 2000. Embedix SDK provides developers with an assortment of tools designed to manage the complex tasks of building and configuring an embedded Linux operating system. It will allow system developers to construct customized versions of Embedix Linux for a range of microprocessors and add specialized functions and services such as Internet protocol routing and mobile computing. Further, Embedix SDK allows the customization process to be automated to reduce the possibility of defects and to enhance duplication efforts. 36
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One of the key features of Embedix SDK is the "Target Wizard," a tool that provides information about available system options and the effect that each component and configuration will have on the resulting product or system. It also identifies and shows interdependencies among different components, enabling our customers to select those software components necessary to achieve the functions and capabilities of their unique embedded systems and products, thereby decreasing memory and storage requirements and reducing time to market. Through our independent software vendor program, we will include in Embedix SDK a variety of third-party Linux-based software applications and components. These third-party technologies enable our original equipment manufacturer customers to enhance their embedded systems with features such as voice command-and-control, embedded databases and network management tools. Original equipment manufacturers can incorporate these third-party technologies into their products under licenses obtained through us, for which we receive royalties, or under licenses obtained directly from the software vendors. We test and certify these independent software vendors' technologies for interoperability with Embedix, providing our customers with a single source of compatible embedded system operating systems, components and third-party software technologies. Embedix Browser Logo The Embedix Browser is a compact, Linux-based graphical Web browser that provides a user interface for embedded products and systems that interact with the Internet. The Embedix Browser can be easily customized and has low memory and storage requirements. Because it has low system resource requirements and is easily adapted to meet diverse customer needs, it is well suited for a number of products and systems, including handheld devices, set-top boxes, kiosks and point-of-sale terminals. Embedix PDA Logo We are currently developing Embedix Personal Digital Assistant, or PDA. Embedix PDA is being designed as an extension to our Embedix Linux to enable applications that were originally written to run on Microsoft's Windows CE operating system to be modified, or ported, to run on our Embedix Linux operating system. We currently intend to release a commercial version of Embedix PDA in the first calendar quarter of 2001. OTHER TECHNOLOGIES In addition to our embedded Linux technologies and products, we continue to sell our embedded disk operating system, called DR DOS. Although we no longer actively develop DR DOS, this technology is sufficient for some embedded system requirements, and we continue to sell this technology to original equipment manufacturers that request it or who extend existing DR DOS contracts with us. SERVICES We provide comprehensive professional services, or Embedix Services, to our embedded systems customers, including customized engineering, training and technical support services. As of May 15, 2000, we employed approximately 33 professional services personnel. Our professional services personnel have significant experience with embedded systems, participate actively in the open source community and contribute enhancements and additions to the Linux open source technology. We 37
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believe that our services enable our customers to reduce their cost to implement, maintain and support their embedded systems. ENGINEERING. We offer custom engineering services to those embedded systems customers that require assistance. Alternatively, we may develop and license a complete custom embedded system solution at a customer's request. We typically offer these services on a per-project basis, although we also may offer these services on a time-and-expense basis. Each project is reviewed by our research and development, product marketing and sales groups to determine whether we should include the resulting custom technology development in our future product line. Our contracts for custom work generally provide that all intellectual property resulting from the work is either owned by us or is contributed to the open source community. EDUCATION. We recently began offering instructor-led training on our products to assist with design and implementation of embedded products and systems. We intend to also offer Web-based and computer-based training programs in the future. TECHNICAL SUPPORT. We provide technical support by e-mail, over the telephone and onsite at our customer locations worldwide. We are also implementing a database to capture our experience from prior projects. Our customers will have access to the database through our Web site. In addition, our products include comprehensive online documentation and support materials. A basic level of technical support is provided complimentary to our customers via the Web and e-mail, and fee-based support options are also available. TECHNOLOGY Our technology is based on a combination of open source software code and internally developed and third-party proprietary technology. Embedix Linux is designed to operate on various microprocessor platforms and is currently available for the Intel and Intel-compatible x86 and Motorola PowerPC platforms. We are developing customized versions of Embedded Linux for additional microprocessors including: - various ARM microprocessor cores; - Hitachi SuperH microprocessors; - various MIPS microprocessor designs; and - Motorola's ColdFire, DragonBall and MCORE microprocessors. Key features of Embedix Linux include industry-standard communication protocols for accessing the Internet as well as routing and multi-tasking capabilities. Another key feature of Embedix Linux is that it has execute-in-place capabilities from read-only memory, which conserves memory resources, thus lowering the cost of an embedded product or system. Embedix SDK consists of a combination of proprietary and open source software tools and utilities that allows an engineer to custom configure Embedded Linux to the specific requirements of an embedded product or system. It also allows developers to create and modify applications in a wide variety of computer languages, including C, C++, Java and other scripting languages, and to incorporate third-party applications. Key features of Embedix SDK include a complete Linux development platform, graphical configuration tools and integrated development environment, and other tools for writing software code and applications. Embedix Browser, our proprietary Internet browser, runs in conjunction with Embedix Linux. Embedix Browser is compatible with industry-standard Web-based programming protocols and Javascript support and features a customizable user interface and automatic software updates. It also includes television output software to support Internet set-top boxes and standard encryption 38
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technologies to enable secure electronic commerce transactions. Original equipment manufacturers can also pre-configure Embedix Browser for specific service providers to provide their customers with quicker and easier Internet access. As a result of our recent acquisitions, we are currently integrating hard real-time capabilities into our Embedix product line. Hard real-time allows applications to schedule time-critical tasks and obtain guaranteed response times. Hard real-time capabilities are critical to many embedded systems markets, including markets for medical, avionics and industrial control systems. We are also integrating high-availability embedded Linux technologies into our Embedix product line for high-end hardware and software systems. High-availability solutions are critical to embedded systems featuring significantly limited down-time tolerance, including telecommunications, aerospace and financial services systems. STRATEGIC RELATIONSHIPS INDEPENDENT SOFTWARE VENDOR PROGRAM As part of our independent software vendor program, which we call Lineo Partner Connect, software vendors may include their products within our embedded software development kit, allowing us to introduce our customers to the benefits of these products when they are used in the embedded environment with our operating systems. Current participants in this program include Jabber, Inc., NewMonics Inc. and Solid Information Technology. Original equipment manufacturers may incorporate these third-party technologies into their products under licenses obtained through us, for which we receive royalties, or under licenses obtained directly from the software vendors. Through this program, we believe that we are able to increase the appeal of our products and services by acting as a single source of Linux-based applications and components. As a result, our customers may streamline the complexity of their licensing requirements and reduce the time-to-market for any specific solution. At the same time, under this program, the independent software vendors benefit by expanding their marketing channels to a range of original equipment manufacturers. MICROPROCESSOR COMPANIES We have entered into a variety of strategic relationships with microprocessor companies to establish our brand of Linux products and services to the customers of these companies. Through these relationships, we intend to further enhance our understanding of microprocessor embedded circuit board configurations and their future technology developments. Currently, we have relationships with Hitachi, MIPS Technologies, Inc., Motorola and Samsung. We intend to develop strategic relationships with additional microprocessor companies. CUSTOMERS Our primary customers for our Linux products and services are original equipment manufacturers. As of April 30, 2000, we had generated revenue from licenses of our Linux products and services to several original equipment manufacturers, such as Bast, CIS Technology, DaiShin, and MiTAC International. In the fiscal year ended October 31, 1999, our three largest customers accounted for 48% of our total revenue, with Sun Microsystems accounting for 23%, Brooktrout accounting for 13% and Symbol Technologies accounting for 12%. In the six months ended April 30, 2000, our seven largest customers accounted for 77% of our total revenue, with DaiShin accounting for 34%. SALES AND MARKETING We market our Linux products and services to original equipment manufacturers through our direct sales force. We have a sales or marketing presence both domestically and in Australia, Canada, 39
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France, Japan, Taiwan and the United Kingdom. Key elements of our sales and marketing strategy include direct advertising, event marketing, active public relations, customer and strategic alliance partner programs, co-marketing programs and a comprehensive Web site. We are also currently developing indirect sales channels, including third-party distributors and systems integrators. We believe that these additional channels will further increase our brand awareness and promote the development of Linux-based software applications and solutions for embedded systems. We intend to use these channels to educate engineers on the benefits of our products. RESEARCH AND DEVELOPMENT As of May 15, 2000, we had 108 software engineers engaged in research and development. We have invested and will continue to invest in the development of innovative new product features and technologies in response to the evolving market for embedded Linux operating systems and input from original equipment manufacturer customers and microprocessor companies. Our engineers have significant experience with embedded systems, participate actively in the Linux community and contribute enhancements and additions to the Linux open source technology. We believe our contributions to the Linux community will facilitate the development of industry standards and encourage industry cooperation. We also analyze and incorporate the development and support efforts of the Linux open source community into our products on a continual basis. COMPETITION The market for embedded operating systems products and services is becoming increasingly competitive. We compete principally on the basis of the following: - product performance and functionality; - price; - quality of support and customer services; - breadth of embedded platform support; - availability of third-party software applications; - time-to-market; - relationships with original equipment manufacturers and microprocessor companies; - distribution penetration; and - technical and financial resources. Although we believe we compete favorably in each of these areas, failure to compete successfully in any of these areas against current or potential competitors could harm our business. We face competition from: - our current and potential customers' internal research and development departments that may seek to develop their own proprietary embedded operating systems; - established companies that have developed proprietary embedded operating systems, such as Mentor Graphics, Microsoft, Microware Systems, Palm Computing, QNX Software Systems, Sun Microsystems, Symbian and Wind River Systems; - companies that have developed, or may in the future develop, embedded Linux operating systems, such as Caldera Systems, Coollogic, Information Storage Devices, LynuxWorks, MontaVista Software, Red Hat, SuSE and TurboLinux; and 40
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- companies that have developed Web browsers, such as Microsoft, Netscape and Spyglass. INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS Intellectual property is critical to our success. Although our Embedix platform is based on open source Linux, many aspects of our products are based on intellectual property that is proprietary to us. This proprietary technology includes software development tools and other development resources to configure and implement Embedix Linux. We have also developed a graphical development environment that facilitates the creation and customization of embedded Linux solutions, and we have a proprietary Linux-based browser specifically for embedded systems. We take steps to protect our intellectual property rights through copyright, trademark and trade secret laws and contractual confidentiality arrangements. At the same time, because we rely in part on open source intellectual property, we may find it necessary to defend the open source community from attempts by others to misappropriate, whether by copyright or otherwise, technology which belongs to the open source community. We generally enter into confidentiality or noncompete agreements with our employees, consultants and corporate partners and generally control access to and distribution of our technologies, documentation and other proprietary information. Despite our efforts to protect our proprietary rights from unauthorized use or disclosure, parties may attempt to disclose, obtain or use our processes or technologies. The steps we have taken may not prevent misappropriation of our processes or technologies, particularly in foreign countries where the laws or law enforcement may not protect our proprietary rights as fully as in the United States. We have licensed, and may license in the future, elements of our trademarks, trade dress and similar proprietary right to third parties. While we attempt to ensure that the quality of our brand is maintained by these third parties, they may take actions that could harm the value of our proprietary rights or reputation. EMPLOYEES As of May 15, 2000, we had 200 employees, excluding independent contractors and other temporary employees, including 119 employees in engineering, 43 employees in sales and marketing and 38 employees in general and administrative services. Of these employees, 128 were in the United States, 15 were in Australia, 14 were in Canada, 7 were in France, 25 were in Japan, 6 were in Taiwan and 5 were in the United Kingdom. In addition, from time to time, we employ temporary employees and consultants. None of our employees is represented by a labor union, and we consider our relations with our employees to be good. FACILITIES Our principal executive office is located in Lindon, Utah, where we sublease a total of 20,000 square feet under two separate leases, with one lease expiring in February 2002 and the other expiring in March 2001. We also lease office space in Brighton, United Kingdom; Brisbane, Australia; Herndon, Virginia; Nagano, Japan; Saint-Ouen, France; San Jose, California; Seattle, Washington; Taipei, Taiwan; Toronto, Ontario, Canada and Vancouver, British Columbia, Canada. We believe that our existing facilities are adequate for our current requirements and that additional space can be obtained on commercially reasonable terms to meet our future requirements. 41
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MANAGEMENT EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES The following table sets forth certain information regarding our executive officers, directors and key employees as of May 15, 2000: [Enlarge/Download Table] NAME OF EXECUTIVE OFFICER OR DIRECTOR AGE POSITION ------------------------------------- -------- ------------------------------------------ Bryan W. Sparks........................... 38 Chairman of the Board, President and Chief Executive Officer Gregory C. Hill........................... 50 Senior Vice President, Chief Financial Officer and Treasurer Timothy R. Bird........................... 37 Senior Vice President, Chief Technology Officer Matthew R. Harris......................... 39 Senior Vice President, Business Development, Secretary and General Counsel Bradley J. Walters........................ 35 Senior Vice President, Sales Raymond J. Noorda......................... 75 Director Ralph J. Yarro III........................ 35 Director John R. Egan.............................. 42 Director William P. Barnett........................ 41 Director NAME OF KEY EMPLOYEE ------------------------------------------ Kim D. Clark.............................. 41 Vice President, Engineering Lyle S. Ball.............................. 31 Vice President, Communications Nathan S. Hatch........................... 37 Vice President, Marketing Allan C. Smart............................ 40 Vice President, Professional Services Christy A. Omohundro...................... 40 Vice President, Human Resources and Integration BRYAN W. SPARKS, has been our chairman of the board, president and chief executive officer since our incorporation in August 1998. Prior to that, Mr. Sparks was president and chief executive officer of Caldera, Inc., an operating systems company and predecessor of us and Caldera Systems, Inc., which he founded in January 1995. From 1986 to 1994, Mr. Sparks was employed at Novell, Inc., a network solutions company, holding a variety of engineering and management positions during his tenure there. Mr. Sparks received a bachelor's degree in computer science from Brigham Young University. He is also a member of the board of directors of Edgemail Technologies, Inc., a provider of high performance Web-based server technology. GREGORY C. HILL has been our senior vice president, chief financial officer and treasurer since January 2000. Prior to joining us, Mr. Hill was an independent financial consultant and, before that, the chief financial officer of Sensorium Software, Incorporated, a business intelligence software company, from December 1997 to June 1998. From July 1995 to May 1997, Mr. Hill served as the corporate treasurer of Quark, Inc., a developer of professional desktop publishing applications. From July 1993 to July 1995, Mr. Hill was vice president and treasurer of Tyco Toys, Inc., a publicly held toy and entertainment company. Mr. Hill received a bachelor's degree in humanities and science from the Massachusetts Institute of Technology and a master's degree in business administration from Harvard Business School. TIMOTHY R. BIRD has been our senior vice president, chief technology officer since May 1999. Prior to joining us, from July 1995 to September 1998, Mr. Bird was a senior developer at Caldera, Inc., where he worked on numerous open source Linux projects. From January 1988 to July 1995, Mr. Bird was a software engineer at Novell. Mr. Bird became a lead engineer at Novell in November 1991. 42
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Mr. Bird is the co-author of "Special Edition: Using OpenLinux" by MacMillan Publishing. Mr. Bird received both his bachelor's and master's degrees in computer science from Brigham Young University. MATTHEW R. HARRIS has been our senior vice president, business development, secretary and general counsel since January 2000. Prior to joining us, from March 1997 to January 2000, Mr. Harris was a founding partner at Summit Law Group, PLLC, a Seattle-based law firm. From October 1992 to March 1997, Mr. Harris was an attorney at Heller Ehrman White and McAuliffe, a San Francisco-based law firm. Prior to that time, Mr. Harris was a law clerk to the Honorable Eugene Wright, United States Court of Appeals for the Ninth Circuit. From 1983 to 1988, Mr. Harris worked as a software development engineer. Mr. Harris received a bachelor's degree in business administration from the University of Washington and a juris doctorate from the University of Michigan Law School. BRADLEY J. WALTERS has been our senior vice president, sales since July 1999. Prior to joining us, Mr. Walters worked at Caldera, Inc. from November 1997 to July 1999 as a regional sales manager and then director of sales. From May 1996 to November 1997, Mr. Walters worked as a regional sales manager at Engineering Geometry Systems, a computer aided design and manufacturing software company. Prior to that, from February 1996 to May 1996, Mr. Walters was employed at TurboLinux Inc., formerly Pacific HiTech, Inc., a distributor of Linux software, where he was the director of marketing and sales. From October 1995 to February 1996, Mr. Walters served as an independent consultant for sales of retail software. Prior to that, from April 1994 to October 1995, Mr. Walters was employed with LearnFrame, Inc., formerly known as Pinnacle Multimedia Inc., an online employment training and education company, where he was director of sales and later vice president. Mr. Walters received an associate's degree from Ricks College. RAYMOND J. NOORDA has served as a member of our board of directors since our incorporation in August 1998. Mr. Noorda currently serves as chairman of the board of directors of MTI Technology Corporation, a data storage and management company, and The Canopy Group, Inc., a holding company that beneficially owns 44.4% of our outstanding common stock prior to this offering, and is a member of the board of directors of Caldera Systems. From 1983 to 1994, Mr. Noorda served as president, chief executive officer and chairman of the board of Novell. He received a bachelor's degree in electrical engineering from the University of Utah. RALPH J. YARRO III has served as a member of our board of directors since our incorporation in August 1998. Mr. Yarro has served as the president and chief executive officer of The Canopy Group since April 1995 and currently serves as chairman of the board of directors of Caldera Systems. Mr. Yarro also is a member of the board of directors of MTI Technology Corporation. Mr. Yarro received a bachelor's degree in political science from Brigham Young University. JOHN R. EGAN has served as a member of our board of directors since January 2000. He currently serves as a managing partner of Egan-Managed Capital, a venture capital firm that owns 6.1% of our outstanding common stock prior to this offering, a position he has held since February 1997. Mr. Egan is also a member of the board of directors of Caldera Systems, EMC Corporation, a provider of storage-related hardware, software and service products, and several private technology companies. From April 1983 to September 1998, Mr. Egan has served in various capacities at EMC Corporation, including responsibility for developing and managing EMC's sales force and most recently as an executive vice president. He received a bachelor's degree in computer science from Boston College. WILLIAM P. BARNETT has served as a member of our board of directors since March 2000. Mr. Barnett is currently an associate professor at the Stanford Graduate School of Business, a position he has held since July 1991. Prior to joining Stanford, from 1988 to 1991, Mr. Barnett was an assistant professor of management at the University of Wisconsin at Madison. He received his bachelor's degrees in economics and political science and his Ph.D. in business administration from the University of California, Berkeley. 43
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KIM D. CLARK has been our vice president, engineering since March 2000. Prior to joining us, Mr. Clark worked at Novell, from September 1988 to March 2000, in a variety of positions, most recently as the director of engineering. While at Novell, Mr. Clark was also responsible for the engineering team developing the NetWare operating system. Mr. Clark received a bachelor's degree in electrical engineering from Utah State University. LYLE S. BALL has been our vice president, communications since our incorporation in August 1998. Prior to joining us, from November 1995 to April 1998, Mr. Ball was the director of communications at Caldera, Inc. From June 1993 to October 1995, Mr. Ball worked at Novell as a corporate communications manager. Mr. Ball received a bachelor's degree in business communications from Brigham Young University. NATHAN S. HATCH has been our vice president, marketing since March 2000. Prior to joining us, from June 1998 to March 2000 Mr. Hatch served as enterprise accounts marketing manager at Novell, Inc. From June 1996 to April 1998, Mr. Hatch served as director and then vice president of marketing at Caldera, Inc. From December 1995 to June 1996, Mr. Hatch was the director of marketing at Allen Communications, a multimedia software company, and from March 1988 to November 1995, Mr. Hatch was the marketing manager for UNIX products at WordPerfect, which was acquired by Novell. Mr. Hatch received a bachelor's degree in business management from the University of Phoenix. ALLAN C. SMART has been our vice president, professional services since March 2000, and prior to that was our director of business development since September 1999. Prior to joining us, from September 1998 to September 1999, Mr. Smart served as director, education services at Caldera Systems, Inc. From July 1995 to September 1998, Mr. Smart served as director, technical services at Caldera, Inc. Mr. Smart received a bachelor's degree in computer science from Utah State University and a master's degree in business administration from the Marriott School of Management at Brigham Young University. CHRISTY A. OMOHUNDRO has been our vice president, human resources and integration since April 2000. Prior to joining us, from April 1998 to April 2000, Ms. Omohundro was the director of regulatory policy at Puget Sound Energy, an electric and gas utility corporation. From April 1997 to April 1998, Ms. Omohundro was the vice president, client services at Bright Horizons, formerly known as CorporateFamily Solutions, a work/life consulting firm. Prior to that, Ms. Omohundro was employed by Puget Sound Energy as director of strategic planning from February 1997 to April 1997 and as director of rates from February 1995 to February 1997. Ms. Omohundro received her bachelor's degree in accounting and liberal arts from Spring Hill College and her master's degree in business administration from Vanderbilt University. BOARD OF DIRECTORS We currently have authorized five directors. Currently all directors hold office until the next annual meeting of stockholders or until their successors are duly elected, and will continue to do so following the completion of this offering. However, our certificate of incorporation will provide that as of the first annual meeting of stockholders after the completion of this offering, our board of directors will be divided into three classes, each with staggered three-year terms. As a result, only one class of directors will be elected at each annual meeting of our stockholders, with the other classes continuing for the remainder of their respective three-year terms. Prior to completion of this offering, we intend to increase the size of our board to seven directors and appoint two additional independent directors. COMMITTEES Our board of directors currently has an audit committee and a compensation committee. The audit committee consists of Messrs. Barnett, Egan and Yarro, and Mr. Barnett currently serves as its chairman. The audit committee makes recommendations to our board of directors regarding the 44
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selection of independent auditors, reviews the scope of audit and other services by our independent auditors, reviews the accounting principles and auditing practices and procedures to be used for our financial statements and reviews the results of our audits. The compensation committee consists of Messrs. Barnett and Egan. The compensation committee reviews and approves the compensation and benefits for our executive officers, grants stock options under our stock option plan and makes recommendations to our board of directors on compensation matters. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION No interlocking relationship exists between any member of our board of directors or compensation committee and any member of the board of directors or compensation committee of any other company, nor has any such interlocking relationship existed in the past. In January 2000, we entered into a stock purchase and sale agreement with Caldera Systems, Inc. to purchase 1,250,000 shares of Caldera Systems' common stock in exchange for 3,238,437 shares of our common stock. One of the members of our compensation committee, Mr. Egan, is a member of the board of directors of Caldera Systems. In February 2000, we sold 2,000,000 shares, out of a total of 2,500,000 shares, of Series A Class 2 preferred stock at a per share price of $1.50 to Egan-Managed Capital, L.P. for aggregate consideration of $3.0 million, and in March 2000, we sold 326,667 shares, out of a total of 4,833,331 shares, of Series B preferred stock at a per share price of $3.00 to Egan-Managed Capital for aggregate consideration of $980,000. Mr. Egan is a managing partner of Egan-Managed Capital, which holds 6.1% of our outstanding common stock prior to this offering. In connection with the sale of the preferred stock, Egan-Managed Capital, along with other investors, were granted registration rights, and we may therefore become obligated to effect a registration under the Securities Act of 1933 of shares of common stock held by these investors upon the conversion of the preferred stock. See "Description of Capital Stock" on page 53 for a more complete explanation of these registration rights. We have also granted to each of Mr. Barnett, one of the members of our compensation committee, and Egan-Managed Capital, on behalf of Mr. Egan, options to purchase up to 80,000 shares of common stock at exercise prices of $0.80 and $1.50 per share, respectively, under our stock option plan. COMPENSATION Our directors are reimbursed for expenses incurred in connection with attending board and committee meetings but are not otherwise compensated for their services as board members. 45
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EXECUTIVE OFFICERS Our executive officers are elected by, and serve at the discretion of, our board of directors. There are no family relationships among our directors and officers. COMPENSATION The following table sets forth information concerning compensation for services rendered to us in all capacities during the fiscal year ended October 31, 1999 by our chief executive officer and all of our other executive officers who earned or received salary and bonus in fiscal 1999 in excess of $100,000. [Enlarge/Download Table] ANNUAL LONG TERM ALL OTHER COMPENSATION COMPENSATION COMPENSATION ------------------- ------------ ---------------------- SECURITIES HEALTH LIFE AND UNDERLYING INSURANCE DISABILITY NAME AND PRINCIPAL POSITION SALARY BONUS OPTIONS (#S) PREMIUMS PREMIUMS --------------------------- -------- -------- ------------ --------- ---------- Bryan W. Sparks .......................... $121,218 $4,800 600,000 $6,674 $360 CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER Timothy R. Bird .......................... 101,863 4,000 55,000 6,322 308 SENIOR VICE PRESIDENT, CHIEF TECHNOLOGY OFFICER Bradley J. Walters ....................... 103,675 2,343 70,000 6,176 203 SENIOR VICE PRESIDENT, SALES OPTION GRANTS IN FISCAL YEAR 1999 The following table sets forth certain information with respect to stock options granted to each of our named executive officers during the fiscal year ended October 31, 1999. All options granted to these executive officers in the last fiscal year were granted under our stock option plan. In connection with the rules of the Securities and Exchange Commission, also shown below is the potential realizable value over the term of the option, the period from the grant date to the expiration date, based on assumed rates of stock appreciation of 5% and 10%, compounded annually. These amounts are mandated by the Securities and Exchange Commission and do not represent our estimate of future stock price. Actual gains, if any, on stock option exercises will depend on the future performance of our common stock. In fiscal year 1999, we granted options to acquire up to an aggregate of 955,700 shares of our common stock to employees and directors. [Enlarge/Download Table] POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL RATE OF PERCENT OF TOTAL STOCK PRICE APPRECIATION NUMBER OF OPTIONS GRANTED EXERCISE FOR OPTION TERM SECURITIES UNDERLYING TO EMPLOYEES PRICE EXPIRATION ------------------------- NAME OPTIONS GRANTED # IN FISCAL 1999 PER SHARE DATE 5% ($) 10% ($) ---- --------------------- ---------------- --------- ---------- ---------- ------------ Bryan W. Sparks...... 600,000 62.8% $0.80 9/23/09 $776,576 $1,429,938 Timothy R. Bird...... 55,000 5.8 0.80 9/23/09 71,186 131,078 Bradley J. Walters... 70,000 7.3 0.80 9/23/09 90,601 166,826 AGGREGATE OPTION EXERCISES IN FISCAL 1999 AND FISCAL YEAR-END OPTION VALUES None of our named executive officers exercised any options in fiscal 1999. With respect to our named executive officers, the following table sets forth information concerning exercisable and unexercisable options held as of October 31, 1999. The "Value of Unexercised In-the-Money Options at 46
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October 31, 1999" is based upon an assumed initial public offering price of $ per share minus the per share exercise price multiplied by the number of shares underlying the options. [Enlarge/Download Table] NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT OCTOBER 31, 1999 OCTOBER 31, 1999 ($) ----------------------------- --------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ------------ -------------- ----------- ------------- Bryan W. Sparks................................ 600,000 -- -- Timothy R. Bird................................ 14,895 40,105 Bradley J. Walters............................. 18,958 51,042 EMPLOYEE BENEFIT PLANS STOCK OPTION PLAN Our board of directors adopted and our stockholders approved our stock option plan in June 1999. As of May 15, 2000, we had reserved a total of 5,000,000 shares of common stock for issuance under the stock option plan. The stock option plan provides for the granting to our employees, including officers and directors, of incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986 and for the granting to employees, consultants and non-employee directors of nonstatutory stock options. If an optionee would have the right in any calendar year to exercise for the first time incentive stock options for shares having an aggregate fair market value, determined for each share as of the date the option to purchase the shares was granted, in excess of $100,000, any such excess options shall be treated as nonstatutory stock options. Unless terminated earlier by our board of directors, the plan will terminate in June 2009. As of May 15, 2000, options to purchase 3,052,722 shares of common stock were outstanding under this plan and 669,905 shares had been issued upon exercise of options. The stock option plan may be administered by our board of directors or by a committee appointed by our board and is currently administered by our compensation committee. The plan administrator determines the terms of each option granted under the stock option plan, including the number of shares subject to an option, exercise price, vesting schedule and duration. The exercise price of all incentive stock options granted under the stock option plan cannot be less than the fair market value of the common stock on the date of grant and, in the case of incentive stock options granted to holders of more than 10% of our voting power, not less than 110% of the fair market value. Generally, options granted under the stock option plan have a term of ten years, vest over a four-year period and are nontransferable. Payment of the exercise price of options may be made in cash or other consideration as determined by the plan administrator. Our board of directors has the authority to amend or terminate the stock option plan as long as such action does not adversely affect any outstanding options and provided that stockholder approval for any amendments to the stock option plan shall be obtained to the extent required by applicable law. 401(k) PLAN In May 2000 our board of directors ratified the adoption of a tax-qualified employee savings and retirement plan for eligible U.S. employees, which is currently sponsored by The Canopy Group, one of our principal stockholders. Eligible employees may elect to defer a percentage of their eligible compensation in the 401(k) plan, subject to the statutorily prescribed annual limit. We make matching contributions on behalf of all participants in the 401(k) plan in the amount equal to one-half of the first 6% of an employee's contributions. Matching contributions are subject to a vesting schedule; all other contributions are at all times fully vested. We intend the 401(k) plan to qualify under Sections 401(k) and 501 of the Internal Revenue Code so that contributions by employees or us to the 47
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401(k) plan, and income earned, if any, on plan contributions, are not taxable to employees until withdrawn from the 401(k) plan, and so that we will be able to deduct our contributions when made. The trustee of the 401(k) plan, at the direction of each participant, invests the assets of the 401(k) plan in any of a number of investment options. EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS In May 2000, we entered into an employment agreement with Mr. Sparks for a term of 24 months, subject to renewal thereafter. Under his employment agreement, Mr. Sparks is entitled to receive an annual salary of $150,000, as adjusted from time to time, and is eligible to receive bonuses as determined by us. If Mr. Sparks is terminated without cause, as defined in his employment agreement, he is entitled to receive his salary for a period of 12 months. Mr. Sparks has agreed not to compete, directly or indirectly, with us during his employment and for a period of 12 months thereafter. We currently do not have any employment agreements with any of our other executive officers. Our stock option plan provides that in the event a third party acquires us through the purchase of all or substantially all of our assets, a merger or other business combination, unless otherwise provided in applicable stock option agreements, the unexercised portion of outstanding options will vest and become immediately exercisable unless the options are assumed by the third party or are replaced with comparable options. DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY Our certificate of incorporation limits the liability of directors and officers to the fullest extent currently permitted by Delaware law or as it may be amended in the future. Consequently, subject to Delaware law, no director will be personally liable to us or our stockholders for monetary damages resulting from his conduct as our director, except liability for: - acts or omissions involving intentional misconduct or knowing violations of law; - unlawful distributions; or - transactions from which the director personally receives a benefit in money, property or services to which the director is not legally entitled. Our certificate of incorporation also provides that we shall indemnify any individual made a party to a proceeding because that individual is or was one of our directors or officers and shall advance or reimburse reasonable expenses incurred by such individual in advance of the final disposition of the proceeding to the fullest extent permitted by applicable law. Any repeal of or modification to our certificate of incorporation may not adversely affect any right of any of our directors who is or was a director at the time of such repeal or modification. We intend to enter into indemnification agreements with each of our officers and directors. In addition, our bylaws provide that we shall indemnify our directors and officers and may indemnify our employees and agents to the fullest extent permitted by law. Finally, we intend to purchase and maintain a liability insurance policy, pursuant to which our directors and officers will be indemnified against liability they may incur for serving in their capacities as our directors and officers. We believe that the indemnification and limitation of liability provisions in our certificate of incorporation, bylaws, indemnification agreements and the liability insurance policy will facilitate our ability to continue to attract and retain qualified individuals to serve as our directors and officers. To the extent the provisions of our certificate of incorporation, bylaws or indemnification agreements provide for indemnification of directors for liabilities arising under the Securities Act, those provisions are, in the opinion of the Securities and Exchange Commission, against public policy as expressed in the Securities Act and are therefore unenforceable. 48
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RELATED-PARTY TRANSACTIONS TECHNOLOGY In September 1998, we entered into a DR DOS License Agreement with Caldera, Inc., a company founded by Mr. Sparks, our president, chief executive officer and chairman of the board. In December 1999, we entered into a Technology Assignment Agreement with The Canopy Group with respect to software technology. SALES OF COMMON STOCK In fiscal 1998 and 1999, we borrowed an aggregate of $2,290,000 from The Canopy Group, of which approximately $337,000 was repaid in January 2000 and the balance of approximately $1,953,000 was repaid in March 2000. Two of our directors, Messrs. Noorda and Yarro, are members of The Canopy Group, which holds approximately 44.4% of our outstanding common stock prior to completion of this offering. In December 1999, we sold 750,000 shares of common stock at a per share price of $0.80 to each of MRH Investments, LLC and Dry Canyon Holdings, LLC. One of our executive officers, Mr. Harris, is a member of MRH Investments, and Mr. Sparks is a member of Dry Canyon Holdings. In January 2000, we entered into a stock purchase and sale agreement with Caldera Systems to purchase 1,250,000 shares of Caldera Systems' common stock in exchange for 3,238,437 shares of our common stock. Three of our directors, Messrs. Egan, Noorda and Yarro, are also members of the board of directors of Caldera Systems. Caldera Systems holds approximately 13.1% of our outstanding common stock prior to completion of this offering. SALES OF PREFERRED STOCK In February 2000, we sold an aggregate of 7,500,000 shares of Series A preferred stock at a per share price of $1.50 to four investors. Three of the purchasers of Series A preferred stock included: - The Canopy Group, which exchanged 5,000,000 shares of our common stock for 5,000,000 shares of Series A Class 1 preferred stock pursuant to a recapitalization agreement between us and The Canopy Group. - Dry Canyon Holdings, which purchased 166,667 shares of Series A Class 2 preferred stock for total consideration of $250,000. - Egan-Managed Capital, L.P., which purchased 2,000,000 shares of Series A Class 2 preferred stock for total consideration of $3,000,000. One of our directors, Mr. Egan, is a managing partner of Egan-Managed Capital, which holds 6.1% of our outstanding common stock prior to this offering. In March 2000, we sold 326,667 shares, out of a total of 4,833,331 shares, of Series B preferred stock at a per share price of $3.00 to Egan-Managed Capital. In April 2000, we sold 83,333 shares, out of a total of 3,000,000 shares, of Series C preferred stock at a per share price of $6.00 to Angel Partners. One of our directors, Mr. Yarro, is president, chairman and a trustee of Angel Partners. In connection with the sale of the preferred stock, the investors, other than Dry Canyon Holdings, were granted registration rights, and we may therefore become obligated to effect a registration under the Securities Act of 1933 of shares of common stock held by these investors upon the conversion of the preferred stock. See "Description of Capital Stock" on page 53 for a more complete description of these registration rights. 49
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STOCK OPTIONS We granted options to purchase shares of common stock to the following executive officers and directors on the date, for the number of shares and with an exercise price indicated opposite each person's name: [Enlarge/Download Table] NUMBER OF SHARES NAME GRANT DATE UNDERLYING OPTION EXERCISE PRICE ---- ---------- ----------------- -------------- Bryan W. Sparks...................................... 09/24/99 600,000 $0.80 04/25/00 160,000 $3.00 Gregory C. Hill...................................... 12/30/99 200,000 $0.80 Timothy R. Bird...................................... 09/24/99 55,000 $0.80 Matthew R. Harris.................................... 12/30/99 150,000 $0.80 Bradley J. Walters................................... 09/24/99 70,000 $0.80 Ralph J. Yarro III................................... 09/24/99 60,000 $0.80 02/29/00 20,000 $1.50 Egan-Managed Capital, L.P.*.......................... 02/29/00 80,000 $1.50 William P. Barnett................................... 02/29/00 80,000 $0.80 ------------------------ * On behalf of one of our directors, Mr. Egan. OTHER MATTERS Our 401(k) plan is currently sponsored by The Canopy Group. The Canopy Group is a venture capital company that invests primarily in start-up technology companies that encourage the adoption, deployment and promotion of Linux. The Canopy Group currently holds equity interests in companies in fields including data storage and protection, Linux operating systems, data satellites, universal voice messaging and electronic commerce. We have entered into transactions with a number of these companies and the Canopy Group including with respect to product sales and purchases, joint insurance coverage and rent. See Note 9 of Notes to our Consolidated Financial Statements. 50
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PRINCIPAL STOCKHOLDERS The following table sets forth certain information regarding the beneficial ownership of our common stock as of May 15, 2000, and as adjusted to reflect the sale of the common stock offered hereby, by: - each stockholder known by us to own beneficially more than 5% of our outstanding common stock; - each of our directors; - each of our named executive officers; and - all current executive officers and directors as a group. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. For purposes of calculating the number of shares beneficially owned by a stockholder and the percentage ownership of that stockholder, shares of common stock subject to options that are currently exercisable or exercisable within 60 days of May 15, 2000 by that stockholder are deemed outstanding. These options are listed below under the heading "Number of Shares Underlying Options" and are not treated as outstanding for the purpose of computing the percentage ownership of any other stockholder. Percentage ownership is based 38,250,714 shares of common stock outstanding on May 15, 2000 and shares outstanding upon completion of this offering. Unless otherwise noted below, the address for each stockholder below is: c/o Lineo, Inc., 390 South 400 West Lindon, Utah 84042. Unless otherwise noted, we believe that each of the stockholders has sole investment and voting power with respect to the common stock indicated, except to the extent shared by spouses under applicable law. [Enlarge/Download Table] PERCENTAGE OF NUMBER OF SHARES OUTSTANDING SHARES ------------------- NUMBER OF UNDERLYING BEFORE AFTER NAME AND ADDRESS OF BENEFICIAL OWNER SHARES OPTIONS OFFERING OFFERING ------------------------------------ ---------- ---------- -------- -------- Ralph J. Yarro III(1)................................. 17,843,886 60,000 46.7% % Raymond J. Noorda(2).................................. 17,010,585 -- 44.4 The Canopy Group, Inc.(3) ............................ 17,010,585 -- 44.4 240 West Center Street Orem, UT 84057 Caldera Systems, Inc.(4) ............................. 5,000,000 -- 13.1 240 West Center Street Orem, UT 84057 Dry Canyon Holdings, LLC.............................. 3,147,441 -- 8.2 Bryan W. Sparks(5).................................... 3,147,441 -- 8.2 Egan-Managed Capital, L.P. ........................... 2,326,667 -- 6.1 c/o Michael H. Shanahan 30 Federal Street Boston, MA 02110 John R. Egan(6)....................................... 2,326,667 -- 6.1 Bradley J. Walters.................................... 23,532 8,750 * Timothy R. Bird....................................... 19,479 5,729 * William P. Barnett.................................... -- -- -- All executive officers and directors as a group (9 persons)(7)...................................... 23,361,005 74,479 61.1 ------------------------ * Less than 1% 51
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(1) Includes 12,010,585 shares of common stock held by The Canopy Group, of which Mr. Yarro is the president and chief executive officer, 5,000,000 shares of common stock held by Caldera Systems, of which Mr. Yarro is chairman of the board of directors, and 83,333 shares of common stock held by Angel Partners, of which Mr. Yarro is president, chairman and a trustee. Mr. Yarro disclaims beneficial ownership of the shares owned by The Canopy Group, Caldera Systems and Angel Partners. (2) Includes 12,010,585 shares of common stock held by The Canopy Group, of which Mr. Noorda is chairman and a member of the board of directors, and 5,000,000 shares of common stock held by Caldera Systems, of which Mr. Noorda is a member of the board of directors. Mr. Noorda disclaims beneficial ownership of the shares owned by The Canopy Group and Caldera Systems, except to the extent of his pecuniary interest therein. (3) Includes 5,000,000 shares of common stock held by Caldera Systems, of which The Canopy Group is a majority stockholder. (4) Includes 1,761,563 shares of common stock acquired from The Canopy Group in May 2000. (5) Includes 3,147,441 shares of common stock held by Dry Canyon Holdings, LLC, of which Mr. Sparks is a member. (6) Includes 2,326,667 shares of common stock held by Egan-Managed Capital, of which Mr. Egan is a managing partner. Mr. Egan disclaims beneficial ownership of the shares owned by Egan-Managed Capital, except to the extent of his pecuniary interest therein. (7) Includes 750,000 shares of common stock held by MRH Investments, LLC, of which Matthew R. Harris is a member. See also footnotes 1, 2, 5 and 6 above. 52
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DESCRIPTION OF CAPITAL STOCK GENERAL Upon completion of this offering, we will be authorized to issue up to 100,000,000 shares of common stock, $0.001 par value, and 30,000,000 shares of preferred stock, $0.001 par value. The following summary of certain provisions of our common stock and preferred stock is not complete and may not contain all the information you should consider before investing in the common stock. This description is subject to and qualified in its entirety by provisions of our certificate of incorporation and bylaws, which are included as exhibits to the registration statement of which this prospectus is a part, and by provisions of applicable Delaware law. COMMON STOCK As of May 15, 2000, assuming conversion of all outstanding shares of preferred stock, there were 38,250,714 shares of common stock outstanding that were held of record by 176 stockholders. After giving effect to the sale of common stock offered in this offering, there will be shares of common stock outstanding, assuming no exercise of outstanding stock options. As of May 15, 2000, there were outstanding options to purchase a total of 3,052,722 shares of common stock. The holders of common stock are entitled to one vote per share on all matters to be voted on by the stockholders. Subject to preferences that may be granted to any outstanding shares of preferred stock, the holders of common stock are entitled to receive ratably only those dividends our board of directors declares out of funds legally available for the payment of dividends as well as any other distributions to the stockholders. If we are liquidated, dissolved or wound-up, the holders of common stock are entitled to share pro rata all of our assets remaining after payment of our liabilities and liquidation preferences of any then-outstanding shares of preferred stock. Holders of common stock have no preemptive rights or rights to convert their common stock into any other securities. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and non-assessable, and the shares of common stock to be issued in this offering will be fully paid and non-assessable. PREFERRED STOCK Upon completion of this offering, all outstanding shares of preferred stock will be converted into 16,763,813 shares of common stock. Thereafter, pursuant to our certificate of incorporation, our board of directors will have the authority, without further action by the stockholders, to issue up to 30,000,000 shares of preferred stock in one or more series and to fix the relative designations, powers, preferences and privileges of the preferred stock, any or all of which may be greater than the rights of the common stock. Our board of directors, without stockholder approval, can issue preferred stock with voting, conversion or other rights that could adversely affect the voting power and other rights of the holders of common stock. Preferred stock could thus be issued quickly with terms that could delay or prevent a change in control of us or make removal of our management more difficult. Additionally, the issuance of preferred stock may decrease the market price of the common stock and may adversely affect the voting and other rights of the holders of common stock. We have no present plans to issue any preferred stock. 53
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REGISTRATION RIGHTS After this offering, the holders of 15,166,664 shares of common stock will be entitled to rights with respect to the registration of those shares under the Securities Act pursuant to an investor rights agreement among those holders and us dated February 17, 2000, as amended. Under the terms of this agreement, if we propose to register any of our securities under the Securities Act, either for our own account or for the account of other security holders exercising registration rights, the holders of these shares are entitled to notice of the registration and to include their shares of common stock in the registration at our expense. Additionally, the holders of these shares are entitled to demand registration rights pursuant to which they may require us to file a registration statement under the Securities Act at our expense with respect to their shares of common stock. Further, the holders of these shares may require us to file additional registration statements on Form S-3 at our expense. All of these registration rights are subject to the right of the underwriters of an offering to limit the number of shares included in such registration. These registration rights terminate when the holder can transfer his or her registrable shares pursuant to Rule 144. Holders of these registration rights have entered into lock-up agreements and waived their registration rights until 180 days following the closing of this offering. ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW Our board of directors, without stockholder approval, has the authority under our certificate of incorporation to issue preferred stock with rights superior to the rights of the holders of common stock. As a result, preferred stock could be issued quickly and easily, could adversely affect the rights of holders of common stock and could be issued with terms calculated to delay or prevent a change in control of us or make removal of our management more difficult. In addition, as of the first annual meeting of stockholders following the closing of this offering, our board of directors will be divided into three classes. The directors in each class will serve for three-year terms, one class being elected each year by our stockholders, and directors can only be removed for cause. This system of electing and removing directors may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of our company because it generally makes it more difficult for stockholders to replace a majority of the directors. Upon completion of this offering, our certificate of incorporation will also permit the stockholders to adopt, amend or repeal our bylaws only upon the affirmative vote of the holders of at least two-thirds of the outstanding shares of voting stock entitled to vote at an election of directors. In addition, directors will be removable for cause only by stockholders holding a majority of the then outstanding shares of stock entitled to vote. Vacancies on the board of directors resulting from death, resignation, removal or other reason shall be filled by a majority of the directors then in office, even if less than a quorum. Upon completion of this offering, our bylaws will require that all stockholder actions must be effected at a duly called annual or special meeting and not by a consent in writing. Our bylaws will not permit stockholders to call a special meeting. In addition, our bylaws will establish an advance notice procedure for matters to be brought before an annual or special meeting of our stockholders, including the election of directors. Business permitted to be conducted at any annual meeting or special meeting of stockholders will be limited to business properly brought before the meeting. Our bylaws will also provide that we will indemnify officers and directors against losses that they may incur in investigations and legal proceedings resulting from their services to us, which may include services in connection with takeover defense measures. These provisions may have the effect of preventing changes in our management. In addition, section 203 of the Delaware General Corporation Law prohibits certain "business combination" transactions between a Delaware corporation and any "interested stockholder" owning 54
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15% or more of the corporation's outstanding voting stock for a period of three years after the date on which such stockholder became an interested stockholder, unless: - the board of directors approves, prior to such date, either the proposed business combination or the proposed acquisition of stock which resulted in the stockholder becoming an interested stockholder; - upon consummation of the transaction in which the stockholder becomes an interested stockholder, the interested stockholder owned at least 85% of those shares of the voting stock of the corporation which are not held by the directors, officers or certain employee stock plans; or - on or subsequent to the date on which such stockholder became an interested stockholder, the business combination with the interested stockholder is approved by the board of directors and also approved at a stockholders' meeting by the affirmative vote of the holders of at least two-thirds of the outstanding shares of the corporation's voting stock other than shares held by the interested stockholder. Under Delaware law, a "business combination" includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder. Section 203 does not apply, however, to those stockholders who own 15% or more of our voting stock prior to this offering. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common stock is ChaseMellon Shareholder Services, L.L.C. The transfer agent's address is 520 Pike Street, Suite 1220, Seattle, Washington 98101, and its telephone number is (206) 292-3795. NATIONAL MARKET LISTING We have applied to list our common stock on The Nasdaq Stock Market's National Market under the symbol "LNEO." 55
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SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this offering, we will have shares of common stock outstanding, assuming no exercise of options after May 15, 2000. Of these shares, the shares sold in this offering will be freely tradable in the public market without restriction under the Securities Act, unless such shares are held by our "affiliates," as that term is defined in Rule 144 under the Securities Act. The remaining 38,250,714 shares of common stock that will be outstanding after this offering will be restricted shares because they were sold in private transactions in reliance on exemptions from registration under the Securities Act. The following table shows the timing of when shares outstanding on May 15, 2000 first become eligible for resale in the public market: [Enlarge/Download Table] NUMBER OF SHARES COMMENT --------------------- --------------------------------- - upon effectiveness of this prospectus..................... - Freely tradable shares sold in this offering - 90 days after the date of this prospectus..................... 669,905 - Shares eligible for sale under Rules 144 and 701 and not previously registered on Form S-8 or locked up - 181 days after the date of this prospectus..................... 18,000,000 - Freely tradable upon expiration of lock-up agreements, subject to the provisions of Rule 144 - at various times thereafter upon expiration of one-year holding periods................ 19,580,809 - Freely tradable, subject to the provisions of Rule 144 S-8 REGISTRATION STATEMENTS As of May 15, 2000, there were a total of 3,052,722 shares of common stock subject to outstanding options under our stock option plan. Following effectiveness of this offering, we intend to file a registration statement on Form S-8 under the Securities Act to register certain of the shares of common stock issued or reserved for future issuance under our stock option plan. After the effective date of the registration statement on Form S-8, shares purchased upon exercise of options granted pursuant to our stock option plan generally would be available for resale in the public market without restriction. RULE 144 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 in any three-month period up to the greater of: - 1% of the then-outstanding shares of common stock, or approximately shares immediately after this offering; and - the average weekly trading volume of the common stock during the four calendar weeks preceding the filing of a Form 144 with respect to such sale. 56
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Sales under Rule 144 are also subject to certain manner of sale and notice requirements and to the availability of current public information about us. RULE 701 Any of our employees, directors, officers, consultants or advisors who purchased shares from us in connection with a written stock or option plan before the effective date of this offering is entitled to rely on the resale provisions of Rule 701, subject to the lock-up agreements described above. In general, Rule 701 permits non-affiliates to sell their Rule 701 shares 90 days after the effectiveness of a registration statement relating to a company's initial public offering without having to comply with the public information, holding period, volume limitation or notice provisions of Rule 144 and permits affiliates to sell their Rule 701 shares without having to comply with the holding period of Rule 144. RULE 144(k) Under Rule 144(k), a person who has not been one of our affiliates during the preceding 90 days and who has beneficially owned the restricted shares for at least two years is entitled to sell them without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. LOCK-UP AGREEMENTS Pursuant to certain "lock-up" agreements, our executive officers, directors and certain of our other stockholders have agreed not to offer, sell, contract to sell, announce an intention to sell, pledge or otherwise dispose of, directly or indirectly, or file with the SEC a registration statement under the Securities Act relating to, any shares of common stock or securities convertible into or exchangeable or exercisable for any common stock without the prior written consent of Credit Suisse First Boston Corporation for a period of 180 days after the date of this prospectus. 57
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UNDERWRITING Under the terms and subject to the conditions contained in an underwriting agreement dated , 2000, we have agreed to sell to the underwriters named below, for whom Credit Suisse First Boston Corporation, Lehman Brothers Inc., Dain Rauscher Incorporated and Wit SoundView Corporation are acting as representatives, the following respective numbers of shares of common stock: [Download Table] NUMBER UNDERWRITER OF SHARES ----------- --------- Credit Suisse First Boston Corporation...................... Lehman Brothers Inc......................................... Dain Rauscher Incorporated.................................. Wit SoundView Corporation................................... --------- Total................................................... ========= The underwriting agreement provides that the underwriters are obligated to purchase all the shares of common stock in the offering if any are purchased, other than those shares covered by the over-allotment option described below. The underwriting agreement also provides that if an underwriter defaults, the purchase commitments of non-defaulting underwriters may be increased or the offering of common stock may be terminated. We have granted to the underwriters a 30-day option to purchase on a pro rata basis up to additional shares from us at the initial public offering price less the underwriting discounts and commissions. The option may be exercised only to cover any over-allotments of common stock. The underwriters propose to offer the shares of common stock initially at the public offering price on the cover page of this prospectus and to selling group members at that price less a concession of $ per share. The underwriters and selling group members may allow a discount of $ per share on sales to other broker/dealers. After the initial public offering, the public offering price and concession and discount to broker/dealers may be changed by the representatives. The following table summarizes the compensation and estimated expenses we will pay. [Enlarge/Download Table] PER SHARE TOTAL ------------------------------- ------------------------------- WITHOUT WITH WITHOUT WITH OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT -------------- -------------- -------------- -------------- Underwriting discounts and commissions paid by us................ $ $ $ $ Expenses payable by us.................. $ $ $ $ The underwriters have informed us that they do not expect discretionary sales to exceed 5% of the shares of common stock being offered. We have agreed not to offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, or file with the SEC a registration statement under the Securities Act relating to, any shares of our common stock or securities convertible into or exchangeable or exercisable for any shares of common stock, or publicly disclose the intention to make any such offer, sale, pledge, disposition or filing, without the prior written consent of Credit Suisse First Boston Corporation for a period of 180 days after the date of this prospectus. 58
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Our officers, directors and certain of our other stockholders have agreed that they will not offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any shares of our common stock or securities convertible into or exchangeable or exercisable for any shares of our common stock, enter into a transaction which would have the same effect, or enter into swap, hedge or other arrangement that transfers, in whole or part, any of the economic consequences of ownership of our common stock, whether any such aforementioned transaction is to be settled by delivery of our common stock or such other securities, in cash or otherwise, or publicly disclose the intention to make any such offer, sale, pledge or disposition, or to enter into any such transaction, swap, hedge or other arrangement, without, in each case, the prior written consent of Credit Suisse First Boston Corporation for a period of 180 days after the date of this prospectus. The underwriters have reserved for sale, at the initial public offering price, up to shares of common stock for employees, directors and certain other person associated with us, who have expressed an interest in purchasing common stock in the offering. The number of shares available for sale to the general public in this offering will be reduced to the extent such persons purchase such reserved shares. Any reserved shares not so purchased will be offered by the underwriters to the general public on the same terms as the other shares. We have agreed to indemnify the underwriters against liabilities under the Securities Act, or contribute to payments which the underwriters may be required to make in that respect. We have applied to list our common stock on The Nasdaq Stock Market's National Market under the symbol "LNEO." Prior to this offering, there has been no public market for our common stock. The initial public offering price will be determined by negotiation between us and the underwriters and will not necessarily reflect the market price of the common stock following the offering. The principal factors that will be considered in determining the public offering price will include: - the information in this prospectus and otherwise available to the underwriters; - market conditions for initial public offerings; - the history and the prospects for the industry in which we will compete; - the ability of our management; - the prospects for our future earnings; - the present state of our development and our current financial condition; - the recent market prices of, and the demand for, publicly traded common stock of generally comparable companies; and - the general condition of the securities markets at the time of this offering. We can offer no assurances that the initial public offering price will correspond to the price at which the common stock will trade in the public market subsequent to the offering or that an active trading market for the common stock will develop and continue after the offering. The representatives may engage in over-allotment, stabilizing transactions, syndicate covering transactions and penalty bids in accordance with Regulation M under the Securities Exchange Act of 1934. - Over-allotment involves syndicate sales in excess of the offering size, which creates a syndicate short position. - Stabilizing transactions permit bids to purchase the underlying security so long as the stabilizing bids do not exceed a specified maximum. 59
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- Syndicate covering transactions involve purchases of the common stock in the open market after the distribution has been completed in order to cover syndicate short positions. - Penalty bids permit the representatives to reclaim a selling concession from a syndicate member when the common stock originally sold by the syndicate member is purchased in a syndicate covering transaction to cover syndicate short positions. These stabilizing transactions, syndicate covering transactions and penalty bids may cause the price of the common stock to be higher than it would otherwise be in the absence of these transactions. These transactions may be effected on The Nasdaq Stock Market's National Market or otherwise and, if commenced, may be discontinued at any time. A prospectus in electronic format will be made available on the Web sites maintained by one or more of the underwriters participating in this offering. The representatives may agree to allocate a number of shares to the underwriters for sale to their online brokerage account holders. Internet distributions will be allocated by the underwriters that will make Internet distributions on the same basis as other allocations. Wit Capital Corporation is an online broker/dealer that has received an allocation of shares of common stock through its affiliate Wit SoundView Corporation. In April 2000, DRW Venture Partners L.P., an affiliate of Dain Rauscher Wessels, one of the representatives, purchased 125,000 shares of our Series C preferred stock at a purchase price of $6.00 per share for a total purchase price of $750,000. NOTICE TO CANADIAN RESIDENTS RESALE RESTRICTIONS The distribution of the common stock in Canada is being made only on a private placement basis exempt from the requirement that we prepare and file a prospectus with the securities regulatory authorities in each province where trades of common stock are effected. Accordingly, any resale of the common stock in Canada must be made in accordance with applicable securities laws which will vary depending on the relevant jurisdiction, and which may require resales to be made in accordance with available statutory exemptions or pursuant to a discretionary exemption granted by the applicable Canadian securities regulatory authority. Purchasers are advised to seek legal advice prior to any resale of the common stock. REPRESENTATIONS OF PURCHASERS Each purchaser of common stock in Canada who receives a purchase confirmation will be deemed to represent to us and the dealer from whom such purchase confirmation is received that (i) such purchaser is entitled under applicable provincial securities laws to purchase such common stock without the benefit of a prospectus qualified under such securities laws, (ii) where required by law, that such purchaser is purchasing as principal and not as agent, and (iii) such purchaser has reviewed the text above under "Resale Restrictions." RIGHTS OF ACTION (ONTARIO PURCHASERS) The securities being offered are those of a foreign issuer and Ontario purchasers will not receive the contractual right of action prescribed by Ontario securities law. As a result, Ontario purchasers must rely on other remedies that may be available, including common law rights of action for damages or rescission or rights of action under the civil liability provisions of the U.S. federal securities laws. 60
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ENFORCEMENT OF LEGAL RIGHTS All of the issuer's directors and officers as well as the experts named may be located outside of Canada and, as a result, it may not be possible for Canadian purchasers to effect service of process within Canada upon the issuer or such persons. All or a substantial portion of the assets of the issuer and such persons may be located outside of Canada and, as a result, it may not be possible to satisfy a judgment against the issuer or such persons in Canada or to enforce a judgment obtained in Canadian courts against such issuer or persons outside of Canada. NOTICE TO BRITISH COLUMBIA RESIDENTS A purchaser of common stock to whom the SECURITIES ACT (British Columbia) applies is advised that such purchaser is required to file with the British Columbia Securities Commission a report within ten days of the sale of any common stock acquired by such purchaser pursuant to this offering. Such report must be in the form attached to British Columbia Securities Commission Blanket Order BOR # 95/17, a copy of which may be obtained from us. Only one such report must be filed in respect of common stock acquired on the same date and under the same prospectus exemption. TAXATION AND ELIGIBILITY FOR INVESTMENT Canadian purchasers of common stock should consult their own legal and tax advisors with respect to the tax consequences of an investment in the common stock in their particular circumstances and with respect to the eligibility of the common stock for investment by the purchaser under relevant Canadian legislation. LEGAL MATTERS The validity of the common stock in this offering will be passed upon for the company by Summit Law Group, PLLC, Seattle, Washington. Certain legal matters will be passed upon for the underwriters by Stoel Rives LLP, Seattle, Washington. As of the date of this prospectus, Summit Law Group beneficially owns 80,000 shares of our common stock, and certain members of Summit Law Group are affiliated with both Rainier Investors, LLC, which beneficially holds 86,666 shares of our common stock, and MRH Investments, LLC, which beneficially holds 750,000 shares of our common stock. EXPERTS The financial statements and schedules included in this prospectus and elsewhere in the registration statement, to the extent and for the periods indicated in their reports, have been audited by Arthur Andersen and BEFEC - Price Waterhouse, independent public accountants, and are included herein in reliance upon the authority of said firms as experts in giving said reports. WHERE TO FIND ADDITIONAL DOCUMENTS We have filed with the SEC a registration statement on Form S-1. This prospectus, which forms a part of the registration statement, does not contain all the information included in the registration statement. Certain information is omitted and you should refer to the registration statement and its exhibits. With respect to references made in this prospectus to any of our contracts or other documents, such references are not necessarily complete and you should refer to the exhibits attached to the registration statement for copies of the actual contract or document. You may read and copy the registration statement, including exhibits and schedules filed with it, at the SEC's public reference facilities in Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the SEC's public reference facilities by calling the SEC at 61
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1-800-SEC-0330. The SEC maintains a Web site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants, such as us, that file electronically with the SEC. Upon completion of this offering, we will become subject to the information and periodic reporting requirements under the Exchange Act and, in accordance with this law, will file periodic reports, proxy statements and other information with the SEC. These periodic reports, proxy statements and other information will be available for inspection and copying at the SEC's public reference facilities and the Web site of the SEC referred to above. 62
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INDEX TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS [Download Table] Unaudited Pro Forma Condensed Consolidated Balance Sheet as of April 30, 2000......................................... P-3 Unaudited Pro Forma Condensed Consolidated Statement of Operations for the year ended October 31, 1999............ P-4 Unaudited Pro Forma Condensed Consolidated Statement of Operations for the six months ended April 30, 2000........ P-5 Notes to Pro Forma Condensed Consolidated Financial Statements................................................ P-6 P-1
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LINEO, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The following unaudited pro forma condensed consolidated financial statements are based on the historical consolidated financial statements of Lineo, Inc. included elsewhere in this prospectus adjusted to give effect to the acquisition of Zentropic Computing, LLC ("Zentropic") completed by the Company on April 3, 2000 and the acquisitions of United System Engineers ("USE"), Fireplug Computers Inc. ("Fireplug"), Inup S.A. ("Inup"), Moreton Bay Ventures Pty Ltd ("Moreton Bay") and RT-Control, Inc. ("RT-Control"), completed subsequent to April 30, 2000. The accompanying unaudited pro forma condensed consolidated financial statements should be read in conjunction with the audited financial statements, including the notes thereto, of these entities included elsewhere in this prospectus. The unaudited pro forma condensed consolidated financial statements have been prepared using the purchase method of accounting for the acquisitions. The unaudited pro forma condensed consolidated balance sheet as of April 30, 2000 reflects the effect of the Company's acquisition of USE, Fireplug, Inup, Moreton Bay and RT-Control as if they had occurred on April 30, 2000. The unaudited pro forma condensed consolidated statements of operations for the year ended October 31, 1999 and the six months ended April 30, 2000 reflect the effect of all of the acquisitions as if they had occurred on November 1, 1998. The pro forma adjustments are based on preliminary estimates, available information and certain assumptions that management believes are reasonable. The unaudited pro forma condensed consolidated financial statements included in this prospectus are for illustrative purposes only. Such information does not purport to represent what the Company's financial position or results of operations actually would have been had the acquisitions in fact occurred when assumed, nor is it indicative of actual or future operating results or financial position that may occur. P-2
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LINEO, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET AS OF APRIL 30, 2000 [Enlarge/Download Table] HISTORICAL ------------------------------------------------------------------------------- LINEO USE FIREPLUG INUP MORETON BAY RT-CONTROL ------------ ----------- ---------- ---------- ----------- ---------- APRIL 30, MARCH 31, MARCH 31, MARCH 31, APRIL 30, MARCH 31, PRO FORMA 2000 2000 2000 2000 2000 2000 ADJUSTMENTS ------------ ----------- ---------- ---------- ----------- ---------- ----------- ASSETS Current assets: Cash....................... $ 30,464,362 $ 307,000 $ 537 $ 519,815 $214,848 $ 12,229 $(1,164,179)(a) Accounts receivable, net... 690,631 113,000 25,189 95,259 8,603 331 -- Marketable securities...... -- 499,000 -- -- 271,446 -- -- Other receivables.......... 1,531,236 -- -- -- 48,204 12,905 -- Prepaid expenses and other.................... 173,960 35,000 -- 5,176 58,613 54,609 -- ------------ ----------- --------- --------- -------- --------- ----------- Total current assets..... 32,860,189 954,000 25,726 620,250 601,714 80,074 (1,164,179) ------------ ----------- --------- --------- -------- --------- ----------- Property and equipment, net...................... 379,999 473,000 25,636 155,877 7,162 49,639 -- Goodwill and other intangibles, net......... 5,804,109 -- -- -- -- -- 19,071,626 (a) Other assets............... 2,157,885 19,000 -- -- -- -- (100,000)(b) ------------ ----------- --------- --------- -------- --------- ----------- Total assets............. $ 41,202,182 $ 1,446,000 $ 51,362 $ 776,127 $608,876 $ 129,713 $17,807,447 ============ =========== ========= ========= ======== ========= =========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Notes payable and current maturities of long-term debt..................... $ -- $ 1,107,000 $ -- $ -- $ -- $ 1,821 $ -- Accounts payable........... 515,151 -- 27,051 103,681 80,787 21,237 -- Accrued liabilities........ 599,610 120,000 32,157 35,342 49,334 53,506 239,132 (a) Deferred revenue........... 303,953 18,000 -- -- 20,682 605 -- Related party payables..... 157,755 -- 62,476 -- -- 121,942 (100,000)(b) ------------ ----------- --------- --------- -------- --------- ----------- Total current liabilities............ 1,576,469 1,245,000 121,684 139,023 150,803 199,111 139,132 ------------ ----------- --------- --------- -------- --------- ----------- Deferred income tax liability.................. 115,059 -- -- -- -- -- -- ------------ ----------- --------- --------- -------- --------- ----------- Long-term debt, net of current maturities......... -- 814,000 -- -- -- 7,286 -- ------------ ----------- --------- --------- -------- --------- ----------- Stockholders' equity (deficit): Convertible preferred stock.................... 15,250 -- -- -- -- -- 1,514 (a) Common stock............... 20,149 781,000 134,074 188,363 -- 181,439 (1,283,543)(a) Additional paid-in capital.................. 52,611,663 -- -- 738,577 -- -- 19,322,892 (a) Retained earnings (accumulated deficit).... (10,225,164) (1,671,000) (199,394) (252,124) 458,073 (258,045) (138,340)(a) Accumulated other comprehensive income (loss)................... -- 277,000 (5,002) (37,712) -- (78) (234,208)(a) Deferred compensation...... (2,911,244) -- -- -- -- -- -- ------------ ----------- --------- --------- -------- --------- ----------- Total stockholders' equity (deficit)....... 39,510,654 (613,000) (70,322) 637,104 458,073 (76,684) 17,668,315 ------------ ----------- --------- --------- -------- --------- ----------- Total liabilities and stockholders' equity... $ 41,202,182 $ 1,446,000 $ 51,362 $ 776,127 $608,876 $ 129,713 $17,807,447 ============ =========== ========= ========= ======== ========= =========== PRO FORMA ------------ ASSETS Current assets: Cash....................... $ 30,354,612 Accounts receivable, net... 933,013 Marketable securities...... 770,446 Other receivables.......... 1,592,345 Prepaid expenses and other.................... 327,358 ------------ Total current assets..... 33,977,774 ------------ Property and equipment, net...................... 1,091,313 Goodwill and other intangibles, net......... 24,875,735 Other assets............... 2,076,885 ------------ Total assets............. $ 62,021,707 ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Notes payable and current maturities of long-term debt..................... $ 1,108,821 Accounts payable........... 747,907 Accrued liabilities........ 1,129,081 Deferred revenue........... 343,240 Related party payables..... 242,173 ------------ Total current liabilities............ 3,571,222 ------------ Deferred income tax liability.................. 115,059 ------------ Long-term debt, net of current maturities......... 821,286 ------------ Stockholders' equity (deficit): Convertible preferred stock.................... 16,764 Common stock............... 21,482 Additional paid-in capital.................. 72,673,132 Retained earnings (accumulated deficit).... (12,285,994) Accumulated other comprehensive income (loss)................... -- Deferred compensation...... (2,911,244) ------------ Total stockholders' equity (deficit)....... 57,514,140 ------------ Total liabilities and stockholders' equity... $ 62,021,707 ============ P-3
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LINEO, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED OCTOBER 31, 1999 [Enlarge/Download Table] HISTORICAL ----------------------------------------------------------------------------------------------- LINEO ZENTROPIC USE FIREPLUG INUP ---------------- ---------------- ----------------- ----------------- ----------------- YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED OCTOBER 31, 1999 OCTOBER 31, 1999 DECEMBER 31, 1999 DECEMBER 31, 1999 DECEMBER 31, 1999 ---------------- ---------------- ----------------- ----------------- ----------------- Revenue.......................... $ 2,800,584 $ 85,474 $1,534,000 $ 144,778 $ 8,355 Cost of revenue.................. 184,857 38,364 1,024,000 88,996 1,785 ----------- ---------- ---------- ---------- ---------- Gross margin................. 2,615,727 47,110 510,000 55,782 6,570 ----------- ---------- ---------- ---------- ---------- Operating expenses: Research and development....... 1,303,347 320,828 48,000 -- -- Sales and marketing............ 729,066 249,898 -- 32,382 -- General and administrative..... 1,223,578 150,132 971,000 56,787 131,556 Non-cash stock-related compensation(*).............. 250,265 78,708 -- -- -- Amortization of goodwill and other intangibles............ -- -- -- -- -- ----------- ---------- ---------- ---------- ---------- Total operating expenses..... 3,506,256 799,566 1,019,000 89,169 131,556 ----------- ---------- ---------- ---------- ---------- Loss from operations............. (890,529) (752,456) (509,000) (33,387) (124,986) Other expense, net............... (163,146) -- (69,000) -- (50) ----------- ---------- ---------- ---------- ---------- Loss before income taxes......... (1,053,675) (752,456) (578,000) (33,387) (125,036) Income tax (provision) benefit... -- 4,117 (2,000) -- 14,718 ----------- ---------- ---------- ---------- ---------- Net loss......................... $(1,053,675) $ (748,339) $ (580,000) $ (33,387) $ (110,318) =========== ========== ========== ========== ========== Basic and diluted net loss per common share................... $ (0.06) =========== Basic and diluted weighted average common shares outstanding.................... 18,000,000 1,745,226 (d) 1,333,333 (d) =========== ========== ========== Basic and diluted supplemental net loss per common share...... $ (0.06) =========== Basic and diluted supplemental weighted average common shares outstanding.................... 18,000,000 1,745,226 (e) 69,998 (e) 1,416,667 (e) =========== ========== ========== ========== ------------------------------ * Non-cash stock-related compensation has been excluded from the following expenses: Research and development..... $ 15,935 $ 850 Sales and marketing.......... 26,376 58,393 General and administrative... 207,954 19,465 HISTORICAL -------------------------------------- MORETON BAY RT-CONTROL ---------------- ------------------- INCEPTION (JUNE 30, YEAR ENDED 1999) TO PRO FORMA OCTOBER 31, 1999 DECEMBER 31, 1999 ADJUSTMENTS PRO FORMA ---------------- ------------------- ----------- ------------ Revenue.......................... $ -- $ 66,951 $ -- $ 4,640,142 Cost of revenue.................. -- 42,392 -- 1,380,394 --------- -------- ----------- ------------ Gross margin................. -- 24,559 -- 3,259,748 --------- -------- ----------- ------------ Operating expenses: Research and development....... 37,839 74,468 -- 1,784,482 Sales and marketing............ 17,114 7,324 -- 1,035,784 General and administrative..... 92,038 38,446 -- 2,663,537 Non-cash stock-related compensation(*).............. 53,201 -- -- 382,174 Amortization of goodwill and other intangibles............ -- -- 7,125,248 (c) 7,125,248 --------- -------- ----------- ------------ Total operating expenses..... 200,192 120,238 7,125,248 12,991,225 --------- -------- ----------- ------------ Loss from operations............. (200,192) (95,679) (7,125,248) (9,731,477) Other expense, net............... -- (2,764) -- (234,960) --------- -------- ----------- ------------ Loss before income taxes......... (200,192) (98,443) (7,125,248) (9,966,437) Income tax (provision) benefit... -- -- -- 16,835 --------- -------- ----------- ------------ Net loss......................... $(200,192) $(98,443) $(7,125,248) $ (9,949,602) ========= ======== =========== ============ Basic and diluted net loss per common share................... $ (0.47) ============ Basic and diluted weighted average common shares outstanding.................... 21,078,559 ============ Basic and diluted supplemental net loss per common share...... $ (0.44) ============ Basic and diluted supplemental weighted average common shares outstanding.................... 956,315 (e) 404,169 (e) 22,592,375 ========= ======== ============ ------------------------------ * Non-cash stock-related compensa has been excluded from the foll expenses: Research and development..... $ 43,097 $ 59,882 Sales and marketing.......... -- 84,769 General and administrative... 10,104 237,523 P-4
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LINEO, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED APRIL 30, 2000 [Enlarge/Download Table] HISTORICAL ------------------------------------------------------------------------------------- LINEO ZENTROPIC USE FIREPLUG INUP -------------- ----------------- -------------- -------------- -------------- SIX MONTHS PERIOD FROM SIX MONTHS SIX MONTHS SIX MONTHS ENDED NOVEMBER 1, 1999 ENDED ENDED ENDED APRIL 30, 2000 TO APRIL 2, 2000 MARCH 31, 2000 MARCH 31, 2000 MARCH 31, 2000 -------------- ----------------- -------------- -------------- -------------- Revenue........................ $ 1,751,094 $ 256,491 $ 764,000 $ 128,238 $ 8,355 Cost of revenue................ 84,382 102,035 650,000 35,455 1,785 ----------- ---------- --------- --------- ---------- Gross margin............... 1,666,712 154,456 114,000 92,783 6,570 ----------- ---------- --------- --------- ---------- Operating expenses: Research and development..... 1,736,209 81,406 48,000 -- -- Sales and marketing.......... 1,098,284 223,870 -- 72,087 -- General and administrative... 1,108,174 72,108 623,000 16,652 313,025 Non-cash stock-related compensation(*)............ 1,045,621 167,354 -- 114,500 -- Amortization of goodwill and other intangibles.......... 165,829 -- -- -- -- Acquired in-process research and development............ 800,000 -- -- -- -- ----------- ---------- --------- --------- ---------- Total operating expenses... 5,954,117 544,738 671,000 203,239 313,025 ----------- ---------- --------- --------- ---------- Loss from operations........... (4,287,405) (390,282) (557,000) (110,456) (306,455) Other income (expense), net.... 45,105 -- (31,000) -- 443 ----------- ---------- --------- --------- ---------- Loss before income taxes....... (4,242,300) (390,282) (588,000) (110,456) (306,012) Income tax (provision) benefit...................... 139,715 (1,942) (1,000) -- 53,888 ----------- ---------- --------- --------- ---------- Net loss....................... $(4,102,585) $ (392,224) $(589,000) $(110,456) $ (252,124) =========== ========== ========= ========= ========== Basic and diluted net loss per common share................. $ (0.21) =========== Basic and diluted weighted average common shares outstanding.................. 19,659,910 1,484,888 (i) 1,333,333 (i) =========== ========== ========== Basic and diluted supplemental net loss per common share.... $ (0.17) =========== Basic and diluted supplemental weighted average common shares outstanding........... 23,945,361 (j) 1,484,888 (k) 69,998 (k) 1,416,667 (k) =========== ========== ========= ========== ------------------------------ * Non-cash stock-related compensation has been excluded from the following expenses: Research and development... $ 66,931 $ 29,454 $ -- Sales and marketing........ 22,966 94,242 -- General and administrative........... 955,724 43,658 114,500 HISTORICAL -------------------------------- MORETON BAY RT-CONTROL --------------- -------------- SIX MONTHS SIX MONTHS ENDED ENDED PRO FORMA APRIL 30, 2000 MARCH 31, 2000 ADJUSTMENTS PRO FORMA --------------- -------------- ----------- ----------- Revenue........................ $ 26,558 $ 79,083 $ (200,000)(f) $ 2,813,819 Cost of revenue................ 13,691 32,330 (81,933)(f) 837,745 --------- --------- ----------- ----------- Gross margin............... 12,867 46,753 (118,067) 1,976,074 --------- --------- ----------- ----------- Operating expenses: Research and development..... 94,456 125,679 (118,067)(f) 1,967,683 Sales and marketing.......... 13,583 11,528 -- 1,419,352 General and administrative... 75,381 80,149 -- 2,288,489 Non-cash stock-related compensation(*)............ 59,365 75,000 -- 1,461,840 Amortization of goodwill and other intangibles.......... -- -- 3,396,793 (g) 3,562,622 Acquired in-process research and development............ -- -- (800,000)(h) -- --------- --------- ----------- ----------- Total operating expenses... 242,785 292,356 2,478,726 10,699,986 --------- --------- ----------- ----------- Loss from operations........... (229,918) (245,603) (2,596,793) (8,723,912) Other income (expense), net.... -- 4,123 -- 18,671 --------- --------- ----------- ----------- Loss before income taxes....... (229,918) (241,480) (2,596,793) (8,705,241) Income tax (provision) benefit...................... -- -- -- 190,661 --------- --------- ----------- ----------- Net loss....................... $(229,918) $(241,480) $(2,596,793) $(8,514,580) ========= ========= =========== =========== Basic and diluted net loss per common share................. $ (0.38) =========== Basic and diluted weighted average common shares outstanding.................. 22,478,131 =========== Basic and diluted supplemental net loss per common share.... $ (0.30) =========== Basic and diluted supplemental weighted average common shares outstanding........... 956,315 (k) 404,169 (k) 28,277,398 ========= ========= =========== ------------------------------ * Non-cash stock-related compensation has been excluded from the following expenses: Research and development... $ 59,365 $ -- $ 155,750 Sales and marketing........ -- -- 117,208 General and administrative........... -- 75,000 1,188,882 P-5
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LINEO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION The unaudited pro forma condensed consolidated financial statements are based on adjustments to the historical consolidated financial statements of Lineo, Inc. to give effect to the acquisitions described in Note 2 using the purchase method of accounting. The unaudited pro forma condensed consolidated balance sheet assumes the acquisitions of USE, Fireplug, Inup, Moreton Bay and RT-Control were consummated on April 30, 2000. The unaudited pro forma condensed consolidated statements of operations assume all acquisitions described in Note 2 were consummated as of November 1, 1998. The unaudited pro forma condensed consolidated statements of operations are not necessarily indicative of results that would have occurred had the acquisitions been consummated as of November 1, 1998 or that might be attained in the future. The pro forma condensed consolidated financial statements should be read in conjunction with the historical consolidated financial statements of the Company, the historical financial statements of the acquired companies and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this prospectus. USE and Inup have not separately classified sales and marketing expenses from general and administrative expenses in their historical financial statements. As a result, for purposes of the accompanying unaudited pro forma condensed consolidated statements of operations the selling, general and administrative expense of USE and Inup have been classified as general and administrative expense. (2) ACQUISITIONS The following table sets forth the consideration paid in cash, including estimated direct expenses to be paid in connection with each acquisition, and through the issuance of shares of common stock, shares of Series C and Series D convertible preferred stock and options to acquire shares of common stock. For purposes of computing the estimated purchase price, the value of the common stock was determined using an estimated fair value of $3.80 per share for the Zentropic acquisition and a value of $6.00 per share for the shares of Series C and Series D convertible preferred shares and common shares issued for the acquisition of all other entities, which represents the estimated fair value based upon equity transactions with independent parties at or near the dates the acquisitions were consummated. The estimated fair values of the options to purchase common stock issued in connection with the acquisitions were determined using the Black-Scholes option pricing model with the following assumptions: expected exercise lives of five years, risk free interest rate of 5.65 percent, expected dividend yield of zero percent and volatility of 60.7 percent. The estimated purchase price for the acquisitions is based on preliminary estimates and is subject to certain purchase price adjustments following closing. However, management does not expect the final purchase price allocation to be P-6
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LINEO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (2) ACQUISITIONS (CONTINUED) materially different from the preliminary allocation nor does it expect there to be any material post closing adjustments. [Enlarge/Download Table] OPTIONS TO SHARES OF SHARES OF PURCHASE SERIES C SERIES D SHARES OF SHARES OF CONVERTIBLE CONVERTIBLE COMMON COMMON PREFERRED PREFERRED CASH STOCK STOCK STOCK STOCK ---------- --------- ---------- ----------- ----------- Zentropic.............................. $ 111,867 1,745,226 -- -- -- USE.................................... 372,829 -- 507,335 -- -- Fireplug............................... 581,350 -- 62,220 -- 69,998 Inup................................... 60,000 1,333,333 -- 83,334 -- Moreton Bay............................ 60,000 -- 87,374 -- 956,315 RT-Control............................. 90,000 -- 16,667 -- 404,169 ---------- --------- ------- ------ --------- Total................................ $1,276,046 3,078,559 673,596 83,334 1,430,482 ========== ========= ======= ====== ========= Zentropic was acquired effective April 3, 2000. The acquisitions of USE, Fireplug, Inup, Moreton Bay and RT-Control are effective subsequent to April 30, 2000 through May 12, 2000. Management of the Company anticipates, based on its preliminary analysis, that the historical carrying value of the acquired companies' assets and liabilities will approximate fair value. The estimated purchase prices have been allocated to each of the acquired companies as follows based on preliminary independent appraisals: [Enlarge/Download Table] ZENTROPIC USE FIREPLUG INUP MORETON BAY RT-CONTROL TOTAL ---------- ---------- ---------- ---------- ----------- ---------- ----------- Net assets (liabilities)...... $ 115,765 $ (613,000) $ (70,322) $ 637,104 $ 218,941 $ (76,684) $ 211,804 Deferred income tax liability.......... (141,977) -- -- -- -- -- (141,977) Acquired in-process research and development........ 800,000 -- -- 800,000 900,000 400,000 2,900,000 Assembled workforce.......... 610,000 475,000 130,000 210,000 320,000 -- 1,745,000 Core technology...... 1,301,000 466,000 600,000 -- 2,600,000 280,000 5,247,000 Non-competition agreements......... -- -- 400,000 -- -- -- 400,000 Goodwill............. 4,058,938 2,249,787 254,565 6,912,898 2,138,690 1,995,516 17,610,394 ---------- ---------- ---------- ---------- ---------- ---------- ----------- $6,743,726 $2,577,787 $1,314,243 $8,560,002 $6,177,631 $2,598,832 $27,972,221 ========== ========== ========== ========== ========== ========== =========== The valuation of the in-process research and development included, but was not limited to, an analysis by independent appraisers of (1) the market for the acquired companies products and technologies; (2) the completion costs for the projects; (3) the expected cashflows attributed to the projects; and (4) the risks associated with achieving such cash flows. The assumptions used in valuing the in-process research and development were based upon assumptions the Company believed to be P-7
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LINEO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (2) ACQUISITIONS (CONTINUED) reasonable but which are inherently uncertain and unpredictable. For these reasons, actual results may vary from projected results. (3) PRO FORMA ADJUSTMENTS UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET ADJUSTMENTS (a) In each of the acquisitions, the Company purchased 100 percent of the outstanding equity of each entity. With respect to Moreton Bay, certain net assets and operations not acquired were split-out to a separate entity by Moreton Bay prior to the acquisition and accordingly were carved-out from Moreton Bay's historical financial statements. This pro forma adjustment as summarized in the table below reflects the following: (1) the consideration paid in connection with the acquisitions including the issuance of common stock, options to purchase common stock, Series C and Series D convertible preferred stock, and cash payments, (2) the elimination of the acquired companies historical equity accounts, (3) the impact of the write-off of acquired in-process research and development on the accumulated deficit, and (4) the potential repayment obligation of research and development grant reimbursements totaling $239,132 received by Moreton Bay. [Enlarge/Download Table] TOTAL PRO FORMA USE FIREPLUG INUP MORETON BAY RT-CONTROL ADJUSTMENT ----------- ---------- ----------- ----------- ----------- ------------ Cash............... $ (372,829) $ (581,350) $ (60,000) $ (60,000) $ (90,000) $ (1,164,179) Goodwill and other intangibles...... 3,190,787 1,384,565 7,122,898 5,058,690 2,275,516 19,032,456 Accrued liabilities...... -- -- (239,132) -- (239,132) Convertible preferred stock............ -- (70) (84) (956) (404) (1,514) Common stock....... 781,000 134,074 187,030 -- 181,439 1,283,543 Additional paid-in capital.......... (2,204,958) (732,823) (7,760,008) (6,116,675) (2,508,428) (19,322,892) Retained earnings (accumulated deficit)......... (1,671,000) (199,394) 547,876 1,358,073 141,955 177,510 Accumulated other comprehensive income (loss).... 277,000 (5,002) (37,712) -- (78) 234,208 ----------- ---------- ----------- ----------- ----------- ------------ $ -- $ -- $ -- $ -- $ -- $ -- =========== ========== =========== =========== =========== ============ (b) To eliminate an intercompany advance from Lineo to RT-Control. P-8
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LINEO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (3) PRO FORMA ADJUSTMENTS (CONTINUED) UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS ADJUSTMENTS YEAR ENDED OCTOBER 31, 1999 (c) To reflect the amortization of goodwill and other intangibles related to the acquisitions. The amortization periods for intangible assets are as follows: [Download Table] PERIOD ----------- Goodwill.................................................... 3 - 5 years Core technology............................................. 3 - 5 years Assembled workforce......................................... 2 - 5 years Non-competition agreements.................................. 2 years (d) Reflects the additional shares of common stock that would have been outstanding had the acquisition of Zentropic been effective as of November 1, 1998 and to reflect the shares of common stock issued in connection with the acquisition of Inup. All other acquisitions were completed through the issuance of options to purchase common stock and the issuance of Series C and Series D convertible preferred stock. The options and preferred stock are considered anti-dilutive and accordingly, have not been included in the calculation of pro forma weighted average common shares outstanding. (e) Reflects the additional shares of common stock to be issued upon conversion of the preferred shares issued as consideration in connection with the acquisitions, which will occur upon completion of this offering. SIX MONTHS ENDED APRIL 30, 2000 (f) To eliminate intercompany revenues and expenses between Lineo and Zentropic earned and incurred prior to April 3, 2000 (the effective date of the acquisition). (g) To reflect the amortization of goodwill and other intangibles related to the acquisitions. (h) To eliminate the impact of the acquired in-process research and development expensed as part of the acquisition of Zentropic. (i) Reflects the additional shares of common stock that would have been outstanding had the acquisition of Zentropic been effective as of November 1, 1998 and to reflect the shares of common stock issued in the acquisition of Inup. All other acquisitions were completed through the issuance of options to purchase common stock and the issuance of Series C and Series D convertible preferred stock. The options and preferred stock are considered anti-dilutive and accordingly, have not been included in the calculation of pro forma weighted average common shares outstanding. (j) Reflects the additional shares of common stock to be issued upon conversion of the preferred shares outstanding as of April 30, 2000 which will occur upon completion of this offering. (k) Reflects the additional shares of common stock to be issued upon conversion of the preferred shares issued as consideration in connection with the acquisitions, which will occur upon completion of this offering. P-9
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INDEX TO FINANCIAL STATEMENTS [Download Table] LINEO, INC. Report of Independent Public Accountants.................. F-2 Consolidated Balance Sheets............................... F-3 Consolidated Statements of Operations and Comprehensive Loss.................................................... F-5 Consolidated Statements of Stockholders' Equity (Deficit)............................................... F-6 Consolidated Statements of Cash Flows..................... F-8 Notes to Consolidated Financial Statements................ F-10 ZENTROPIC COMPUTING, LLC Report of Independent Public Accountants.................. F-30 Consolidated Balance Sheets............................... F-31 Consolidated Statements of Operations and Comprehensive Loss.................................................... F-32 Consolidated Statements of Members' Capital............... F-33 Consolidated Statements of Cash Flows..................... F-34 Notes to Consolidated Financial Statements................ F-36 UNITED SYSTEM ENGINEERS, INC. Report of Independent Public Accountants.................. F-44 Balance Sheets............................................ F-45 Statements of Operations and Comprehensive Income (Loss).................................................. F-46 Statements of Stockholders' Deficit....................... F-47 Statements of Cash Flows.................................. F-48 Notes to Financial Statements............................. F-50 FIREPLUG COMPUTERS INC. Report of Independent Public Accountants.................. F-62 Balance Sheets............................................ F-63 Statements of Operations and Comprehensive Loss........... F-64 Statements of Stockholders' Deficit....................... F-65 Statements of Cash Flows.................................. F-66 Notes to Financial Statements............................. F-67 INUP Report of Independent Accountants......................... F-72 Balance Sheets............................................ F-73 Statements of Operations.................................. F-74 Statements of Stockholders' Equity........................ F-75 Statements of Cash Flows.................................. F-76 Notes to Financial Statements............................. F-77 MORETON BAY VENTURES PTY LTD Report of Independent Public Accountants.................. F-82 Statements of Assets, Liabilities, and Equity (Deficit) of the Acquired Operations................................. F-83 Statements of Revenue and Expenses and Comprehensive Loss.................................................... F-84 Statements of Changes in Equity (Deficit) of the Acquired Operations.............................................. F-85 Statements of Cash Flows.................................. F-86 Notes to Financial Statements............................. F-87 RT-CONTROL, INC. Report of Independent Public Accountants.................. F-93 Balance Sheets............................................ F-94 Statements of Operations and Comprehensive Loss........... F-95 Statements of Shareholders' Equity (Deficit).............. F-96 Statements of Cash Flows.................................. F-97 Notes to Financial Statements............................. F-98 F-1
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Lineo, Inc.: We have audited the accompanying consolidated balance sheets of Lineo, Inc. (a Delaware corporation), the carved-out portion of Caldera, Inc. (a Utah corporation) and their subsidiary as of October 31, 1998 and 1999, and the related consolidated statements of operations and comprehensive loss, stockholders' equity (deficit) and cash flows for each of the three years in the period ended October 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lineo, Inc., the carved-out portion of Caldera, Inc. and their subsidiary as of October 31, 1998 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 1999 in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Salt Lake City, Utah May 15, 2000 F-2
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY CONSOLIDATED BALANCE SHEETS ASSETS [Enlarge/Download Table] OCTOBER 31, --------------------- APRIL 30, 1998 1999 2000 -------- ---------- ----------- (UNAUDITED) Current assets: Cash.................................................... $117,058 $ 67,794 $30,464,362 Accounts receivable, net of allowance for doubtful accounts of approximately $13,000, $68,000 and $68,000, respectively................................. 135,632 854,796 690,631 Stock subscription receivable........................... -- -- 1,500,000 Related party receivables............................... 29,884 32,116 31,236 Deferred income tax assets.............................. -- -- 107,319 Other current assets.................................... 11,941 5,623 66,641 -------- ---------- ----------- Total current assets.................................. 294,515 960,329 32,860,189 -------- ---------- ----------- Property and equipment: Computer equipment...................................... 124,934 115,920 382,980 Furniture and fixtures.................................. 55,881 117,897 89,483 Leasehold improvements.................................. -- 5,396 9,306 -------- ---------- ----------- 180,815 239,213 481,769 Less accumulated depreciation and amortization.......... (95,610) (65,420) (101,770) -------- ---------- ----------- Net property and equipment............................ 85,205 173,793 379,999 -------- ---------- ----------- Investment in affiliate................................... -- -- 531,402 -------- ---------- ----------- Intangibles, net of accumulated amortization of $165,829................................................ -- -- 5,804,109 -------- ---------- ----------- Advances to companies subsequently acquired............... -- -- 578,607 -------- ---------- ----------- Other assets.............................................. 85,000 -- 1,047,876 -------- ---------- ----------- $464,720 $1,134,122 $41,202,182 ======== ========== =========== See accompanying notes to consolidated financial statements. F-3
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) [Enlarge/Download Table] OCTOBER 31, ------------------------- APRIL 30, 1998 1999 2000 ----------- ----------- ------------ (UNAUDITED) Current liabilities: Accounts payable......................................... $ 314,444 $ 65,084 $ 515,151 Accrued liabilities...................................... 142,780 290,579 599,610 Deferred revenue......................................... 782,075 293,155 303,953 Related party payables................................... 5,538 35,745 157,755 Convertible promissory note payable to majority stockholder and related accrued interest............... 403,542 2,432,387 -- ----------- ----------- ------------ Total current liabilities.............................. 1,648,379 3,116,950 1,576,469 ----------- ----------- ------------ Deferred income tax liability.............................. -- -- 115,059 ----------- ----------- ------------ Commitments and contingencies (Notes 1, 8 and 13) Stockholders' equity (deficit): Preferred stock, $0.001 par value; 30,000,000 shares authorized: Series A Class 1 convertible preferred stock, 5,000,000 shares designated and outstanding as of April 30, 2000................................................. -- -- 5,000 Series A Class 2 convertible preferred stock, 2,500,000 shares designated and outstanding as of April 30, 2000................................................. -- -- 2,500 Series B convertible preferred stock, 4,850,000 shares designated and 4,833,331 shares outstanding as of April 30, 2000....................................... -- -- 4,833 Series C convertible preferred stock, 3,000,000 shares designated and 2,916,666 shares outstanding as of April 30, 2000....................................... -- -- 2,917 Series D convertible preferred stock, 2,000,000 shares designated and no shares outstanding................. -- -- -- Common stock, $0.001 par value; 100,000,000 shares authorized, 18,000,000, 18,000,000 and 20,148,985 shares outstanding, respectively....................... 18,000 18,000 20,149 Additional paid-in capital............................... (719,002) (408,399) 52,611,663 Deferred compensation.................................... -- (60,338) (2,911,244) Cumulative translation adjustments....................... (4,241) -- -- Accumulated deficit...................................... (478,416) (1,532,091) (10,225,164) ----------- ----------- ------------ Total stockholders' equity (deficit)................... (1,183,659) (1,982,828) 39,510,654 ----------- ----------- ------------ $ 464,720 $ 1,134,122 $ 41,202,182 =========== =========== ============ See accompanying notes to consolidated financial statements. F-4
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS [Enlarge/Download Table] YEAR ENDED OCTOBER 31, SIX MONTHS ENDED APRIL 30, --------------------------------------- --------------------------- 1997 1998 1999 1999 2000 ----------- ----------- ----------- ------------ ------------ (UNAUDITED) (UNAUDITED) Revenue...................................... $ 945,414 $ 1,376,209 $ 2,800,584 $ 805,838 $ 1,751,094 Cost of revenue.............................. 247,694 360,727 184,857 36,722 84,382 ----------- ----------- ----------- ----------- ----------- Gross margin............................... 697,720 1,015,482 2,615,727 769,116 1,666,712 ----------- ----------- ----------- ----------- ----------- Operating expenses: Research and development (exclusive of non- cash stock-related compensation of $15,935 in fiscal year 1999 and $66,931 in the six months ended April 30, 2000).................................... 655,122 1,357,190 1,303,347 785,937 1,736,209 Sales and marketing (exclusive of non-cash stock-related compensation of $26,376 in fiscal year 1999 and $22,966 in the six months ended April 30, 2000)............. 662,811 1,023,759 729,066 320,582 1,098,284 General and administrative (exclusive of non-cash stock-related compensation of $207,954 in fiscal year 1999 and $955,724 in the six months ended April 30, 2000).................................... 207,084 639,667 1,223,578 695,124 1,108,174 Non-cash stock-related compensation........ -- -- 250,265 -- 1,045,621 Amortization of goodwill and other intangibles.............................. -- -- -- -- 165,829 Acquired in-process research and development.............................. -- -- -- -- 800,000 ----------- ----------- ----------- ----------- ----------- Total operating expenses................. 1,525,017 3,020,616 3,506,256 1,801,643 5,954,117 ----------- ----------- ----------- ----------- ----------- Loss from operations......................... (827,297) (2,005,134) (890,529) (1,032,527) (4,287,405) ----------- ----------- ----------- ----------- ----------- Other income (expense): Interest expense........................... (51,048) (186,904) (138,542) (49,166) (57,769) Interest income............................ -- 669 14,245 5,761 96,506 Other income (expense), net................ 1,439 5,098 (38,849) -- 6,368 ----------- ----------- ----------- ----------- ----------- Other income (expense), net.............. (49,609) (181,137) (163,146) (43,405) 45,105 ----------- ----------- ----------- ----------- ----------- Loss before income tax benefit............... (876,906) (2,186,271) (1,053,675) (1,075,932) (4,242,300) Income tax benefit........................... -- -- -- -- 139,715 ----------- ----------- ----------- ----------- ----------- Net loss..................................... $ (876,906) $(2,186,271) $(1,053,675) $(1,075,932) $(4,102,585) =========== =========== =========== =========== =========== Basic and diluted net loss per common share...................................... $ (0.05) $ (0.12) $ (0.06) $ (0.06) $ (0.21) =========== =========== =========== =========== =========== Weighted average common shares outstanding... 18,000,000 18,000,000 18,000,000 18,000,000 19,659,910 =========== =========== =========== =========== =========== Comprehensive loss: Net Loss................................... $ (876,906) $(2,186,271) $(1,053,675) $(1,075,932) $(4,102,585) Foreign currency translation adjustments... (11,463) 7,222 4,241 4,241 -- ----------- ----------- ----------- ----------- ----------- $ (888,369) $(2,179,049) $(1,049,434) $(1,071,691) $(4,102,585) =========== =========== =========== =========== =========== See accompanying notes to consolidated financial statements. F-5
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) [Enlarge/Download Table] PREFERRED STOCK COMMON STOCK ADDITIONAL ACCUMULATED --------------------- --------------------- PAID-IN DEFERRED COMPREHENSIVE SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION INCOME (LOSS) ---------- -------- ---------- -------- ----------- ------------- -------------- Balance, October 31, 1996.................... -- $ -- -- $ -- $ -- $ -- $ -- Debt funding and related accrued interest applicable to carved-out operations of Caldera, Inc..................... -- -- -- -- -- -- -- Foreign currency translation adjustment.............. -- -- -- -- -- -- (11,463) Net loss applicable to carved-out operations of Caldera, Inc............ -- -- -- -- -- -- -- ---------- ------- ---------- ------- ----------- ----------- -------- Balance, October 31, 1997.................... -- -- -- -- -- -- (11,463) Debt funding and related accrued interest applicable to carved-out operations of Caldera, Inc..................... -- -- -- -- -- -- -- Net loss applicable to carved-out operations of Caldera, Inc. through August 31, 1998......... -- -- -- -- -- -- -- Incorporation of Lineo, Inc. and issuance of common shares to Caldera, Inc. in exchange for certain net liabilities recorded at carryover basis......... -- -- 18,000,000 18,000 (719,002) -- -- Foreign currency translation adjustment.............. -- -- -- -- -- -- 7,222 Net loss for the period subsequent to incorporation........... -- -- -- -- -- -- -- ---------- ------- ---------- ------- ----------- ----------- -------- Balance, October 31, 1998.................... -- -- 18,000,000 18,000 (719,002) -- (4,241) Deferred compensation related to stock option grants.................. -- -- -- -- 310,603 (310,603) -- Amortization of deferred compensation............ -- -- -- -- -- 250,265 -- Foreign currency translation adjustment.............. -- -- -- -- -- -- 4,241 Net loss.................. -- -- -- -- -- -- -- ---------- ------- ---------- ------- ----------- ----------- -------- Balance, October 31, 1999.................... -- -- 18,000,000 18,000 (408,399) (60,338) -- CALDERA, INC.'S EQUITY (DEFICIT) IN ACCUMULATED CARVED-OUT DEFICIT OPERATIONS ------------ --------------- Balance, October 31, 1996.................... $ -- $ 364,189 Debt funding and related accrued interest applicable to carved-out operations of Caldera, Inc..................... -- 394,816 Foreign currency translation adjustment.............. -- -- Net loss applicable to carved-out operations of Caldera, Inc............ -- (876,906) ------------ ----------- Balance, October 31, 1997.................... -- (117,901) Debt funding and related accrued interest applicable to carved-out operations of Caldera, Inc..................... -- 1,124,754 Net loss applicable to carved-out operations of Caldera, Inc. through August 31, 1998......... -- (1,707,855) Incorporation of Lineo, Inc. and issuance of common shares to Caldera, Inc. in exchange for certain net liabilities recorded at carryover basis......... -- 701,002 Foreign currency translation adjustment.............. -- -- Net loss for the period subsequent to incorporation........... (478,416) -- ------------ ----------- Balance, October 31, 1998.................... (478,416) -- Deferred compensation related to stock option grants.................. -- -- Amortization of deferred compensation............ -- -- Foreign currency translation adjustment.............. -- -- Net loss.................. (1,053,675) -- ------------ ----------- Balance, October 31, 1999.................... (1,532,091) -- F-6
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)(CONTINUED) [Enlarge/Download Table] PREFERRED STOCK COMMON STOCK ADDITIONAL ACCUMULATED --------------------- --------------------- PAID-IN DEFERRED COMPREHENSIVE SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION INCOME (LOSS) ---------- -------- ---------- -------- ----------- ------------- -------------- Conversion of common shares to Series A Class 1 convertible preferred shares and distribution to majority stockholder for fair value of preferred shares issued in excess of common shares converted (unaudited)............. 5,000,000 5,000 (5,000,000) (5,000) 750,000 -- -- Issuance of Series A Class 2 convertible preferred shares for cash, net of offering costs of $47,322 (unaudited)..... 2,500,000 2,500 -- -- 3,700,178 -- -- Issuance of Series B convertible preferred shares for cash and services, net of offering costs of $37,751 (unaudited)..... 4,833,331 4,833 -- -- 14,457,416 -- -- Issuance of Series C convertible preferred shares for cash and services, net of offering costs of $9,996 (unaudited)............. 2,916,666 2,917 -- -- 17,487,083 -- -- Issuance of common shares in exchange for investment in Caldera Systems, Inc. and distribution to majority stockholder for fair value of shares issued in excess of the carryover basis of investment (unaudited)............. -- -- 3,238,437 3,238 4,368,652 -- -- Issuance of common shares for cash and services (unaudited)............. -- -- 1,500,000 1,500 2,023,500 -- -- Issuance of common shares upon exercise of stock options (unaudited)..... -- -- 665,322 666 531,592 -- -- Grant of common stock option by majority stockholder for services (unaudited)............. -- -- -- -- 63,374 -- -- Deferred compensation related to stock option grants (unaudited)...... -- -- -- -- 3,008,153 (3,008,153) -- Amortization of deferred compensation (unaudited)............. -- -- -- -- -- 157,247 -- Issuance of common shares related to purchase of Zentropic Computing, LLC (unaudited)............. -- -- 1,745,226 1,745 6,630,114 -- -- Net loss (unaudited)...... -- -- -- -- -- -- -- ---------- ------- ---------- ------- ----------- ----------- -------- Balance, April 30, 2000 (unaudited)............. 15,249,997 $15,250 20,148,985 $20,149 $52,611,663 $(2,911,244) $ -- ========== ======= ========== ======= =========== =========== ======== CALDERA, INC.'S EQUITY (DEFICIT) IN ACCUMULATED CARVED-OUT DEFICIT OPERATIONS ------------ --------------- Conversion of common shares to Series A Class 1 convertible preferred shares and distribution to majority stockholder for fair value of preferred shares issued in excess of common shares converted (unaudited)............. (750,000) -- Issuance of Series A Class 2 convertible preferred shares for cash, net of offering costs of $47,322 (unaudited)..... -- -- Issuance of Series B convertible preferred shares for cash and services, net of offering costs of $37,751 (unaudited)..... -- -- Issuance of Series C convertible preferred shares for cash and services, net of offering costs of $9,996 (unaudited)............. -- -- Issuance of common shares in exchange for investment in Caldera Systems, Inc. and distribution to majority stockholder for fair value of shares issued in excess of the carryover basis of investment (unaudited)............. (3,840,488) -- Issuance of common shares for cash and services (unaudited)............. -- -- Issuance of common shares upon exercise of stock options (unaudited)..... -- -- Grant of common stock option by majority stockholder for services (unaudited)............. -- -- Deferred compensation related to stock option grants (unaudited)...... -- -- Amortization of deferred compensation (unaudited)............. -- -- Issuance of common shares related to purchase of Zentropic Computing, LLC (unaudited)............. -- -- Net loss (unaudited)...... (4,102,585) -- ------------ ----------- Balance, April 30, 2000 (unaudited)............. $(10,225,164) $ -- ============ =========== See accompanying notes to consolidated financial statements. F-7
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH [Enlarge/Download Table] YEAR ENDED SIX MONTHS ENDED OCTOBER 31, APRIL 30, ------------------------------------- ------------------------- 1997 1998 1999 1999 2000 --------- ----------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) Cash flows from operating activities: $(1,075,932) Net loss................................................. $(876,906) $(2,186,271) $(1,053,675) $(4,1 Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.......................... 191,307 237,635 101,217 66,425 48,216 Amortization of intangibles............................ -- -- -- -- 165,829 Acquired in-process research and development........... -- -- -- -- 800,000 Non-cash stock related compensation.................... -- -- 250,265 -- 1,045,621 Gain on disposition of assets.......................... -- -- -- -- (6,368) Deferred income tax benefit............................ -- -- -- -- (134,237) Accrued interest applicable to funding of carved-out operations of Caldera, Inc........................... 51,048 183,362 -- -- -- Accrued interest on convertible note payable to majority stockholder................................. -- 3,542 138,845 49,137 57,769 Changes in operating assets and liabilities, net of effect of acquisition of Zentropic Computing, LLC: Accounts receivable, net............................. 150,764 (103,896) (719,164) (162,844) 270,216 Related party receivables............................ -- (29,884) (2,232) 13,270 880 Other current assets................................. (36,853) 24,912 6,318 6,286 (47,196) Other assets......................................... -- (85,000) 85,000 -- (504,061) Accounts payable..................................... 113,515 200,929 (249,360) (228,962) 403,455 Accrued liabilities.................................. 25,652 117,128 147,799 15,298 303,901 Deferred revenue..................................... 196,817 428,615 (488,920) (89,387) 4,756 Related party payables............................... -- 5,538 30,207 25,026 19,747 --------- ----------- ----------- ----------- ----------- Net cash used in operating activities.............. (184,656) (1,203,390) (1,753,700) (1,381,683) (1,674,057) --------- ----------- ----------- ----------- ----------- Cash flows from investing activities: Purchase of property and equipment....................... (108,473) (72,342) (189,805) (155,479) (284,424) Proceeds from sale of property and equipment............. -- -- -- -- 75,000 Advances to companies subsequently acquired.............. -- -- -- -- (578,607) Net cash acquired in acquisition of Zentropic Computing, LLC.................................................... -- -- -- -- 1,627 --------- ----------- ----------- ----------- ----------- Net cash used in investing activities.............. (108,473) (72,342) (189,805) (155,479) (786,404) --------- ----------- ----------- ----------- ----------- Cash flows from financing activities: Borrowings from majority stockholder under convertible promissory note........................................ -- 400,000 1,890,000 1,890,000 -- Repayment of borrowings from majority stockholder........ -- -- -- -- (2,490,156) Borrowings from majority stockholder prior to reorganization......................................... 343,768 941,392 -- -- -- Net proceeds from issuance of preferred stock............ -- -- -- -- 33,614,927 Proceeds from the sale of common stock................... -- -- -- -- 1,200,000 Proceeds from the exercise of common stock options....... -- -- -- -- 532,258 --------- ----------- ----------- ----------- ----------- Net cash provided by financing activities.......... 343,768 1,341,392 1,890,000 1,890,000 32,857,029 --------- ----------- ----------- ----------- ----------- Net increase (decrease) in cash............................ 50,639 65,660 (53,505) 352,838 30,396,568 Foreign currency translation adjustments................... (11,463) 7,222 4,241 4,241 -- Cash, beginning of the period.............................. 5,000 44,176 117,058 117,058 67,794 --------- ----------- ----------- ----------- ----------- Cash, end of the period.................................... $ 44,176 $ 117,058 $ 67,794 $ 474,137 $30,464,362 ========= =========== =========== =========== =========== See accompanying notes to consolidated financial statements. F-8
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) INCREASE (DECREASE) IN CASH [Enlarge/Download Table] YEAR ENDED SIX MONTHS ENDED OCTOBER 31, APRIL 30, ------------------------------------- ------------------------- 1997 1998 1999 1999 2000 --------- ----------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) Supplemental disclosure of cash flow information: Cash paid for interest................................... $ -- $ -- $ -- $ -- $ 200,156 Supplemental schedule of noncash investing and financing activities: Acquisition of Zentropic Computing, LLC: Fair value of assets acquired.......................... $ -- $ -- $ -- $ -- $ 7,045,750 Liabilities assumed.................................... $ -- $ -- $ -- $ -- $ 302,024 Fair value of common stock issued...................... $ -- $ -- $ -- $ -- $ 6,631,859 Issuance of common stock in connection with the acquisition of certain net assets from Caldera, Inc. recorded at carryover basis............................ $ -- $ 701,002 $ -- $ -- $ -- Issuance of common stock in exchange for investment in Caldera Systems, Inc. recorded at carryover basis...... $ -- $ -- $ -- $ -- $ 531,402 Distribution to majority stockholder for fair value of shares issued in excess of the carryover basis of the investment in Caldera Systems, Inc..................... $ -- $ -- $ -- $ -- $ 3,840,488 Conversion of 5,000,000 shares of common stock to 5,000,000 shares of Series A Class 1 convertible preferred stock........................................ $ -- $ -- $ -- $ -- $ 5,000 Distribution to majority stockholder for fair value of preferred shares issued in excess of common shares converted.............................................. $ -- $ -- $ -- $ -- $ 750,000 Issuance of Series B and Series C convertible preferred stock for services..................................... $ -- $ -- $ -- $ -- $ 540,000 See accompanying notes to consolidated financial statements. F-9
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (1) ORGANIZATION AND DESCRIPTION OF BUSINESS Lineo, Inc. ("Lineo") was originally incorporated as a Utah corporation on August 26, 1998 as Caldera Thin Clients, Inc. and was reincorporated as a Delaware corporation on January 21, 2000. Lineo began operations in July 1996 as part of Caldera, Inc. ("Caldera"). Prior to July 1996, Caldera was developing and marketing Linux operating system software and related products for desktop personal computers and servers. On July 23, 1996, through an asset purchase, Caldera acquired certain rights related to a DOS-based operating system, which was marketed primarily as an embedded operating system in non-desktop microprocessors. Caldera continued the development of the DOS-based operating system for embedded applications. Caldera subsequently made the strategic determination to separate its two business lines into separate entities and, effective September 1, 1998, transferred certain of the assets relating to the DOS-based operating system to Lineo in exchange for 18,000,000 shares of common stock. Also effective September 1, 1998, Caldera sold certain assets not related to the DOS-based operating system to Caldera Systems, Inc. ("Caldera Systems"). Prior to the reorganization of Caldera, The Canopy Group ("Canopy") was the majority shareholder of Caldera and continued to be the majority shareholder of Lineo and was the sole shareholder of Caldera Systems. Since Caldera was the sole shareholder of Lineo, the transfer of the DOS-based operations from Caldera to Lineo has been treated as a reorganization of entities under common control with the assets and liabilities reflected at carry-over basis in a manner similar to a pooling of interests. The accompanying consolidated financial statements include the carved-out operations of Caldera related to the DOS-based operations through September 1, 1998. The revenue of the carved-out operations of Caldera reflect actual revenue derived from sales of DOS-based operating system products and the expenses of the carved-out operations reflect actual expenses associated with the DOS-based business and an allocated portion of common expenses. The allocated common expenses consist primarily of rent, depreciation, interest and personnel benefits. Rent, depreciation and personnel benefits were allocated based upon actual personnel expense. Interest was allocated based upon borrowings related to the carved-out operations of Caldera. Management believes that the allocation methods used are reasonable. Prior to the reorganization, the net losses of Caldera were funded through loans and equity contributions from Canopy. The funding applicable to the carved-out operations has been reflected as a component of Caldera Inc.'s Equity (Deficit) in Carved-out Operations included in the accompanying consolidated statements of stockholders' equity (deficit). This funding has been offset by the accumulated losses applicable to the carved-out operations. The resulting deficit balance as of the date of reorganization, September 1, 1998, of $701,002 has been reflected as a deemed distribution to Caldera and charged to equity. In connection with the reorganization, Lineo acquired a wholly owned subsidiary of Caldera, located in England, Caldera (UK) Limited ("Caldera Ltd"), which performed research and development activities. The operations of Caldera Ltd were terminated in February 1999. As discussed in Note 13, effective April 3, 2000, Lineo acquired Zentropic Computing, LLC ("Zentropic"), a Virginia limited liability company. Zentropic provides Linux solutions for time-sensitive processing functions, referred to as real-time technology. Zentropic's operations are included in the accompanying F-10
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (1) ORGANIZATION AND DESCRIPTION OF BUSINESS (CONTINUED) financial statements from the date of the acquisition, April 3, 2000. Lineo, the carved-out operations of Caldera, Caldera Ltd and Zentropic are collectively referred to as the "Company." Historically, the Company developed, marketed and supported DOS-based operating system products for the embedded systems market. Starting in January 1999, the Company focused its strategy on developing embedded operating systems based on Linux. In January 2000, the Company commercially released the first version of its embedded Linux operating system. The Company sells and distributes its software products through license agreements principally with original equipment manufacturers ("OEMs"). These sales occur throughout the United States and in certain international locations. The Company is subject to certain risks including the uncertainty of market acceptance and demand for Linux-based products and services, competition from larger, more established companies, short product life cycles, the Company's ability to develop and bring to market new products on a timely basis, dependence on key employees, the ability to attract and retain additional qualified personnel and the ability to obtain adequate financing to support growth. (2) SIGNIFICANT ACCOUNTING POLICIES UNAUDITED INTERIM FINANCIAL DATA The unaudited interim financial statements as of April 30, 2000 and for the six months ended April 30, 1999 and 2000 have been prepared on the same basis as the audited financial statements and, in the opinion of management, reflect all normal recurring adjustments necessary to present fairly the financial information set forth therein, in accordance with accounting principles generally accepted in the United States. The results of operations for the six months ended April 30, 2000 are not necessarily indicative of the results to be expected for the entire fiscal year ending October 31, 2000. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS 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 revenue and expenses during the reporting period. Actual results could differ from these estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the accompanying consolidated financial statements for cash, accounts receivable and accounts payable approximate fair values because of the immediate or short-term maturities of these financial instruments. The carrying amounts of the Company's debt obligations approximate fair value based on current interest rates. F-11
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the carved-out operations of Caldera prior to Lineo's incorporation, Lineo, Caldera Ltd and Zentropic, after elimination of intercompany accounts and transactions. FOREIGN CURRENCY TRANSLATION For purposes of consolidating the Caldera Ltd operations, the Company determined the functional currency for the Caldera Ltd operations to be the British Pound. Accordingly, translation gains and losses are included as a component of comprehensive loss. PROPERTY AND EQUIPMENT Property and equipment are stated at cost, less accumulated depreciation and amortization. Computer equipment and furniture and fixtures are depreciated using the straight-line method over the estimated useful life of the asset, typically three to five years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the improvement or the remaining term of the lease agreement. Expenditures for repairs and maintenance are charged to expense when incurred. Expenditures for major renewals and betterments that extend the useful lives of existing equipment are capitalized and depreciated. On retirement or disposition of property and equipment, the cost and related accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is recognized in the statement of operations. CAPITALIZED SOFTWARE COSTS In accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," development costs incurred in the research and development of new software products to be sold, leased or otherwise marketed are expensed as incurred until technological feasibility in the form of a working model has been established. Internally generated capitalizable software development costs have not been material for the years ended October 31, 1997, 1998 and 1999 and the six months ended April 30, 2000. The Company has charged its software development costs to research and development expense in the accompanying consolidated statements of operations. OTHER ASSETS As of October 31, 1998, other assets consisted of prepaid software license fees of $85,000. During the year ended October 31, 1999, as a result of the Company focusing its strategy on Linux-based products for the embedded market, the determination was made that the remaining balance of prepaid software license fees was impaired and was therefore expensed as part of cost of revenue. As of April 30, 2000, other assets consisted primarily of legal and accounting fees capitalized in connection with the Company's anticipated initial public offering and deferred acquisition costs associated with the F-12
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) subsequent acquisitions discussed in Note 13. Capitalized offering costs will be netted against the actual offering proceeds and deferred acquisition costs will be included as part of the total purchase price. INTANGIBLE ASSETS Intangible assets include work force, core technology and goodwill associated with the acquisition of Zentropic (see Note 13). Work force is being amortized using the straight-line method over a period of two years. Other intangibles are amortized using the straight-line method over a period of three years. IMPAIRMENT OF LONG-LIVED ASSETS The Company reviews its long-lived assets, including intangibles, for impairment when events or changes in circumstances indicate that the book value of an asset may not be recoverable. The Company evaluates, at each balance sheet date, whether events and circumstances have occurred which indicate possible impairment. The Company uses an estimate of future undiscounted net cash flows of the related asset or group of assets over the remaining life in measuring whether the assets are recoverable. As of October 31, 1999 and April 30, 2000, the Company does not consider any of its long-lived assets to be impaired. REVENUE RECOGNITION The Company recognizes revenue in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue Recognition." Revenue from the sale of software is recognized upon delivery of the product when persuasive evidence of an arrangement exists, the price is fixed or determinable, collection is probable and no significant post-delivery obligations exist. Certain of the Company's software sales agreements include post-contract maintenance and support ("PCS") services. If these PCS services are to be provided for a period of one year or less, the estimated cost of providing the PCS is insignificant and there is no commitment to provide upgrades or enhancements, revenue is recognized upon delivery and the estimated costs of providing the PCS are accrued. If the PCS services are to be provided for a period greater than one year, or if the PCS includes upgrades or enhancements, software revenue is deferred and recognized over the PCS period or deferred until no significant obligations exist. As of October 31, 1998 and 1999 and April 30, 2000, the Company had deferred revenue of $782,075, $293,155 and $303,953, respectively. The Company has historically generated a majority of its revenue from software products sold directly to OEMs. Through April 30, 2000, some of the Company's license agreements have included bundled maintenance and support services. Because the Company had not established the necessary vendor specific objective evidence until the second quarter of fiscal year 2000, the Company could not recognize separately the service revenue. Accordingly, revenue for these licenses was deferred and recognized over the term of the maintenance and support services. F-13
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) During the six months ended April 30, 2000, the Company has begun to enter into multiple-element arrangements including software products, maintenance and support, engineering and training services. In these multiple-element arrangements, revenue is allocated to each element based on vendor-specific objective evidence of fair value for each element. Software license revenue under a multiple-element arrangement is recognized as described above. Service revenue is recognized as the services are performed. If any services to be provided are essential to the functionality of the software product, the software revenue is deferred and recognized over the period the services are provided. 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 98-9"). SOP 98-9 amended SOP 97-2 to require recognition of revenue using a "residual method" in certain circumstances. SOP 98-9 is effective for transactions entered into by the Company beginning in its fiscal year 2000. The Company does not believe that the adoption of this statement will have a material effect on the Company's current revenue recognition policies. INCOME TAXES Prior to January 6, 2000, the Company was not directly subject to income taxes as the Company's operations were consolidated with those of Caldera for income tax reporting purposes. The Company was not an income tax reporting entity nor did it have a tax-sharing agreement with Caldera. As a result, Caldera allocated no income tax expense or related current or deferred income tax assets or liabilities to the Company and the liabilities or benefits attributable to the Company's operations were recorded by Caldera. Had Caldera allocated income taxes to the Company as if it were a separate taxable entity, no income tax expense or benefit would have been recorded due to the Company's net operating loss position and the uncertainty of future realization of any deferred income tax assets. A full valuation allowance would have been recorded against the Company's net deferred income tax assets. On January 6, 2000, as a result of the issuance of common stock by the Company to Caldera Systems (see Note 5), the Company could no longer be consolidated with Caldera for income tax reporting purposes and it became a separate taxable entity. Accordingly, the Company began to account for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, the Company recognizes a liability or asset for the deferred income tax consequences of all temporary differences between the income tax bases of assets and liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years when the reported amounts of the assets and liabilities are recovered or settled. These deferred income tax assets or liabilities are measured using the enacted income tax rates that will be in effect when the differences are expected to reverse. Deferred income tax assets are reviewed periodically for recoverability and valuation allowances are provided, as necessary. CONCENTRATION OF CREDIT RISK The Company offers credit terms on the sale of its software products to OEMs and other customers. The Company performs ongoing credit evaluations of its customers' financial condition and F-14
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) requires no collateral from its customers. The Company maintains an allowance for uncollectable accounts receivable based upon the expected collectibility of all accounts receivable. As of October 31, 1998 and 1999 and April 30, 2000, the allowance for bad debts was $13,000, $68,000 and $68,000, respectively. As of October 31, 1999, two customers accounted for approximately 73 percent of the gross accounts receivable balance. As of April 30, 2000, five customers accounted for approximately 78 percent of the gross accounts receivable balance. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" was issued. SFAS No. 133 establishes new accounting and reporting standards for companies to report information about derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. This statement is effective for financial statements issued for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not expect this statement to have a material impact on the Company's results of operations, financial position or liquidity. In December 1999, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in Financial Statements." This pronouncement summarizes certain of the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. The Company is required to adopt SAB No. 101 during the first quarter of fiscal year 2001. Although management is currently evaluating the impact, if any, of SAB No. 101, management does not presently believe it will have a material impact on the Company's results of operations, financial position or liquidity. In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44 "Accounting for Certain Transactions involving Stock Compensation, an interpretation of Accounting Principles Board Opinion No. 25 ("APB No. 25")." This interpretation clarifies the definition of employee for purposes of applying APB No. 25, the criteria for determining whether a plan qualifies as a noncompensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and the accounting for an exchange of stock compensation awards in a business combination. This interpretation is effective July 1, 2000, but certain conclusions in this interpretation cover specific events that occur after either December 15, 1998, or January 12, 2000. To the extent that this interpretation covers events occurring during the period after December 15, 1998, or January 12, 2000, but before the effective date of July 1, 2000, the effects of applying this interpretation are recognized on a prospective basis from July 1, 2000. Although management is currently evaluating the impact, if any, of this interpretation, management does not presently believe it will have a material impact on the Company's results of operations, financial position or liquidity. NET LOSS PER COMMON SHARE The Company computes net loss per share in accordance with SFAS No. 128, "Earnings Per Share", and SEC Staff Accounting Bulletin No. 98 ("SAB 98"). Under the provisions of SFAS No. 128 and SAB 98, basic net loss per common share ("Basic EPS") is computed by dividing net loss available F-15
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) to common stockholders by the weighted average number of common shares outstanding. Diluted net loss per common share ("Diluted EPS") is computed by dividing net loss by the sum of the weighted average number of common shares and the dilutive common share equivalents then outstanding. Common share equivalents consist of shares issuable upon the exercise of stock options, shares issuable upon the conversion of the convertible note payable to majority stockholder and related accrued interest, and shares issuable upon conversion of convertible preferred stock. As of October 31, 1998 and 1999 and April 30, 1999 and 2000, there were 403,542, 3,388,087, 2,342,679 and 17,040,906 outstanding common share equivalents, respectively, that were not included in the computation of diluted net loss per common share as their effect would have been anti-dilutive, thereby decreasing the net loss per common share. There were no common share equivalents outstanding as of October 31, 1997. For the years ended October 31, 1997 and 1998, the 18,000,000 shares of common stock issued in the initial capitalization of the Company were treated as outstanding for the entire period. (3) CONVERTIBLE PROMISSORY NOTE PAYABLE TO MAJORITY STOCKHOLDER On September 11, 1998, Lineo and Canopy entered into a Secured Convertible Promissory Note Agreement (the "Note Agreement") pursuant to which the Company could borrow up to $2,290,000 to fund ongoing operations. Borrowings under the Note Agreement accrued interest at a rate of 7.25 percent per year, were due 30 days after demand and were secured by essentially all assets of the Company. At Canopy's option, borrowings under the Note Agreement, together with accrued interest thereon, were convertible into shares of the Company's common stock at $1.00 per share, which was deemed to be equal to or greater than the estimated fair market value of the Company's common stock on September 11, 1998. Under the Note Agreement, the Company borrowed $400,000, $1,890,000 during the years ended October 31, 1998 and 1999, respectively. Additionally, the Company accrued interest on borrowings under the Note Agreement of $3,542, $138,845 and $57,769 during the years ended October 31, 1998 and 1999 and the six months ended April 30, 2000, respectively. On January 12, 2000, the Company repaid $500,000 of principal and interest under the Note Agreement. Concurrently, the Note Agreement was amended to delete the conversion provision. No principal or interest was converted to common stock prior to the deletion of the conversion provision. The Company repaid all outstanding principal and interest due under the Note Agreement on March 22, 2000 and the Note Agreement was cancelled. (4) PREFERRED STOCK The Company's articles of incorporation provide for the issuance of up to 30,000,000 shares of $.001 par value preferred stock in one or more series. The Company's Board of Directors is authorized, without shareholder approval, to designate and determine the preferences, limitations and relative rights granted to or imposed upon any series of preferred stock or increase or decrease the number of shares constituting any series of preferred stock. The Company's Board of Directors designated 7,500,000 shares as Series A Convertible Preferred Stock ("Series A"), 5,000,000 of which were designated as Series A Class 1 Convertible Preferred Stock F-16
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (4) PREFERRED STOCK (CONTINUED) ("Series A Class 1") and 2,500,000 of which were designated as Series A Class 2 Convertible Preferred Stock ("Series A Class 2), 4,850,000 shares as Series B Convertible Preferred Stock ("Series B"), 3,000,000 shares as Series C Convertible Preferred Stock ("Series C") and 2,000,000 shares as Series D Convertible Preferred Stock ("Series D"). RIGHTS AND PREFERENCES The Series A, B and C shares have priority over any other class or series of outstanding capital stock of the Company with respect to dividend rights and liquidation, winding up or dissolution rights. The Series D shares rank junior to the Series A, B and C shares in all respects but have priority over the common stock of the Company with respect to liquidation, winding up or dissolution rights. The Series A, B, C and D shares are entitled to receive, when, as and if declared by the Board of Directors, dividends at the same rate as dividends are paid with respect to the Company's common stock. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company, each holder of Series A, B and C shares then outstanding shall be entitled to receive, on a PARI PASSU basis, out of the assets available for distribution to stockholders an amount equal to the greater of (i) the sum of (1) the respective stated value per share plus (2) an amount equal to all unpaid accruing dividends (whether or not declared) plus (3) any other dividends declared but unpaid, and (ii) the amount that such holder of Series A, B or C shares would hold had all Series A, B and C shares been converted to common immediately prior to the liquidation, dissolution, or winding up after giving consideration to the amounts to be received by the holders of Series D shares. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company, each holder of Series D shares then outstanding shall be entitled to receive out of the assets available for distribution to stockholders an amount equal to the sum of (1) the respective stated value per share plus (2) any dividends declared but unpaid. After payment of the full liquidation preference to the Series A, B, C and D shares and any other preferences payable to preferred stockholders, any remaining assets of the Company then available are to be distributed ratably among the holders of Series A, B, C and common shares. A share exchange, merger or sale of substantially all of the assets of the Company, as defined, is to be regarded as a liquidation, dissolution or winding up of the affairs of the Company and the Series A, B, C and D shares would be entitled to the preference payment described above. Each share of Series A, B, C and D is entitled to one vote for each share of common stock that would be issuable upon conversion of such share. All but one holder of Series A, B and C shares has certain rights with respect to registration of the common shares issued or issuable upon conversion of their shares. Additionally, the holders of Series A, B or C shares have demand rights that require the Company to use its best efforts to register the requested shares in accordance with the Securities Exchange Act of 1933. The Company has agreed to bear all expenses in connection with any registration. F-17
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (4) PREFERRED STOCK (CONTINUED) CONVERTIBILITY Any holder of Series A, B, C or D shares may convert all or any shares of Series A, B, C or D shares into common stock at any time. Each share of Series A, B and C automatically converts into common stock (i) immediately prior to the closing of a firm commitment underwritten public offering of common stock of the Company at a minimum price of $10 per share and gross proceeds of at least $15,000,000 (a "Qualified Offering"), (ii) upon approval of at least two-thirds of the then outstanding shares of the respective series or (iii) upon the cumulative conversion of at least two-thirds of the then outstanding shares of the respective series. Each share of Series D automatically converts into common stock (i) immediately prior to the closing of a firm commitment underwritten public offering of common stock of the Company at a minimum price of $7.50 per share and gross proceeds of at least $7,500,000 (a "Qualified Offering"), (ii) upon a share exchange or merger of the Company into or with another entity resulting in a change in control or (iii) upon the approval of at least two-thirds of the then outstanding shares of preferred stock. Each Series A, B, C and D share initially converts into one share of common stock. The conversion ratio is adjusted upon the happening of certain events, including the issuance of additional shares of common stock as a dividend or other distribution or changes resulting from a stock split. CONVERSION OF COMMON STOCK INTO SERIES A CLASS 1 On February 17, 2000, the Company entered into a recapitalization agreement with Canopy whereby 5,000,000 shares of common stock owned by Canopy were exchanged for 5,000,000 shares of Series A Class 1. In connection with the exchange, the Company recorded a deemed distribution to Canopy of $750,000 representing the difference between the estimated fair value of the shares of Series A Class 1 of $1.50 per share based on the offering price of Series A Class 2 shares and the estimated fair value of the shares of common stock of $1.35 per share on February 17, 2000. ISSUANCE OF SERIES A CLASS 2 On February 17, 2000, the Company sold 2,500,000 shares of Series A Class 2 at $1.50 per share for cash proceeds of $3,750,000. The Company incurred $47,322 of direct offering expenses in connection with the sale of the Series A Class 2 shares which have been netted against the total proceeds. ISSUANCE OF SERIES B On March 15, 2000, the Company issued 4,833,331 shares of Series B at $3.00 per share for cash proceeds of $14,260,000 and services of $240,000. The Company incurred $37,751 of direct offering expenses in connection with the sale of the Series B shares which have been netted against the proceeds. F-18
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (4) PREFERRED STOCK (CONTINUED) ISSUANCE OF SERIES C On April 28, 2000, the Company issued 2,916,666 shares of Series C at $6.00 per share for cash proceeds of $17,199,996 (of which $1,500,000 was received subsequent to April 30, 2000) and services of $300,000. On May 1, 2000, the Company issued 83,334 shares of Series C in conjunction with the acquisition of Inup S.A. (see Note 13). The Company incurred $9,996 of direct offering expenses in connection with the sale of the Series C shares which have been netted against the total proceeds. ISSUANCE OF SERIES D Subsequent to April 30, 2000, the Company has issued 1,430,482 shares of Series D in connection with the acquisitions discussed in Note 13. (5) COMMON STOCK STOCK SPLIT On September 24, 1999, the Company's Board of Directors approved a two-for-one stock split for holders of common stock. This stock split has been retroactively reflected in the accompanying consolidated financial statements for all periods presented. REINCORPORATION AS A DELAWARE CORPORATION On January 21, 2000, Lineo was reincorporated in Delaware. The reincorporation was effected by way of a merger with a newly-formed Delaware subsidiary, and the associated issuance of one share of common stock of the subsidiary for each share of common stock of the Company held by the stockholders of record. All share and per share amounts in the accompanying consolidated financial statements have been adjusted to retroactively reflect the reincorporation. COMMON STOCK TRANSACTIONS As discussed in Note 1, on September 1, 1998, in connection with the initial capitalization of Lineo, the Predecessor was issued 18,000,000 shares of common stock in exchange for certain net assets associated with the DOS-based operations of the Predecessor. The net assets acquired from the Predecessor were recorded at the Predecessor's carryover basis, which was a deficit of $701,002. F-19
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (5) COMMON STOCK (CONTINUED) On December 29, 1999, the Company's Board of Directors authorized the issuance of 1,500,000 shares of common stock to two officers of the Company at $0.80 per share. The estimated fair value of the common shares on December 29, 1999 for financial statement purposes was deemed to be $1.35 per share. The difference between the estimated fair value and the purchase price of $0.55 per share, or $825,000 in aggregate, has been recorded as non-cash stock-related compensation expense by the Company. STOCK EXCHANGE AGREEMENT WITH CALDERA SYSTEMS On January 6, 2000, the Company and Caldera Systems entered into a stock purchase and sale agreement. Pursuant to the stock purchase agreement, the Company agreed to purchase 1,250,000 shares of common stock of Caldera Systems (approximately 3.5 percent of Caldera Systems' then outstanding common stock) in exchange for 3,238,437 shares of the Company's common stock. Because Caldera Systems is also majority owned by Canopy, the investment in Caldera Systems has been accounted for as a transaction between entities under common control with the transfer being reflected in the accompanying financial statements at Caldera Systems' carry over basis. At the date of the agreement, Caldera Systems had stockholders' equity of approximately $15,113,000, of which approximately $530,000 relates to the 3.5 percent interest acquired by Lineo. Accordingly, the investment in Caldera Systems common stock was recorded at $531,402. Additionally, the Company recorded the estimated fair value of the shares of its common stock issued to Caldera Systems of $1.35 per share, or $4,371,890 in aggregate, with the difference between the $4,371,890 and the $531,402 investment recorded as a deemed distribution to Canopy. The Company currently intends to hold the shares of Caldera Systems indefinitely. Subsequent to April 30, 2000, Canopy transferred 1,761,563 shares of the Company's common stock which were held by Canopy to Caldera Systems. As a result of this transaction, Caldera Systems currently holds a total of 5,000,000 shares of the Company's common stock. In management's opinion, the transfer between Canopy and Caldera Systems was a transaction between stockholders from which the Company received no benefit. (6) STOCK OPTION PLAN THE 1999 STOCK OPTION PLAN During fiscal year 1999, the Company adopted the 1999 Stock Option Plan (the "1999 Plan") that provides for the granting of incentive or nonqualified stock options to purchase shares of common stock. The 1999 Plan is administered by the compensation committee (the "Committee") of Company's Board of Directors (the "Board"). Under the 1999 Plan, the Board can grant up to 5,000,000 options to employees, directors and to such other persons as the Board selects. Options granted under the 1999 Plan are subject to expiration and vesting terms as determined by the Board. No options can expire more than ten years from the date of grant. The exercise price for the options may be paid in cash or, as approved by the Board, in shares of the Company's common stock valued at fair market value on F-20
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (6) STOCK OPTION PLAN (CONTINUED) the exercise date. As of April 30, 2000, the Board had not authorized the exercise price of any of the options to be paid in shares of the Company's common stock. A summary of stock option activity under the 1999 Plan for the year ended October 31, 1999 and the six months ended April 30, 2000 is as follows: [Download Table] WEIGHTED AVERAGE OPTIONS PRICE RANGE EXERCISE PRICE --------- ------------ ---------------- Balance, October 31, 1998............. -- $ -- $ -- Granted............................... 955,700 0.80 0.80 --------- Balance, October 31, 1999............. 955,700 0.80 0.80 Granted (unaudited)................... 1,500,531 0.80--3.00 1.88 Exercised (unaudited)................. (665,322) 0.80 0.80 --------- Balance, April 30, 2000 (unaudited)... 1,790,909 $ 0.80--3.00 $1.71 ========= As of October 31, 1999, the 955,700 outstanding options had a remaining contractual life of ten years and 677,469 of the options were exercisable. As of April 30, 2000, the 1,790,909 outstanding options had a remaining contractual life of 9.8 years and 95,171 of the options were exercisable. As discussed in Note 13, in connection with the acquisitions, subsequent to April 30, 2000, the Company has granted options to purchase an additional 673,596 shares of common stock at a weighted average exercise price of $2.82 per share. Additionally, the Company has subsequently granted additional options to employees as discussed below. STOCK-BASED COMPENSATION The Company accounts for its stock options issued to directors, officers and employees under APB No. 25 and related interpretations. Under APB No. 25, compensation expense is recognized if an option's exercise price on the measurement date is below the intrinsic fair value of the Company's common stock. During the year ended October 31, 1999 and the six months ended April 30, 2000, the Company granted 955,700 and 1,500,531 options, respectively, with exercises prices below the estimated fair market value on the measurement date as determined for financial reporting purposes resulting in $310,603 and $3,008,153, respectively, in deferred compensation. This deferred compensation has been recorded as a component of stockholders' equity and will be amortized as non-cash stock-related compensation over the vesting period of the underlying stock options. Amortization of deferred compensation amounted to $250,265 for the year ended October 31, 1999 and $157,247 for the six months ended April 30, 2000. Between April 30 and May 15, 2000, the Company has granted options to purchase an additional 652,800 shares of common stock to employees, officers and directors at a weighted average exercise price per share of $3.85, resulting in approximately $1,402,100 of additional deferred compensation. SFAS No. 123 "Accounting for Stock-Based Compensation", requires pro forma information regarding net loss as if the Company had accounted for its stock options granted under the fair value F-21
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (6) STOCK OPTION PLAN (CONTINUED) method. The fair market value of the stock options is estimated on the date of grant using the Black-Scholes pricing model with the following weighted-average assumptions for grants during the year ended October 31, 1999: risk-free interest rate of 5.65 percent; expected dividend yield of 0 percent; volatility of 0 percent and an expected exercise life of five years. For purposes of the pro forma disclosures, the estimated fair market value of the stock options is amortized over the vesting periods of the respective stock options. The following is the pro forma disclosure and the related impact on net loss for the year ended October 31, 1999: [Download Table] Net loss as reported........................................ $(1,053,675) Pro forma net loss.......................................... (1,205,304) (7) INCOME TAXES As described in Note 2, prior to January 6, 2000, the Company was not directly subject to income taxes as the Company's operations were consolidated with those of Caldera for income tax reporting purposes. On January 6, 2000, as a result of sales of common stock by the Company, the Company could no longer be consolidated with Caldera for income tax reporting purposes and became a separate taxable entity. The loss before income tax benefit consisted of the following components for the period from January 6, 2000 through April 30, 2000: [Download Table] Domestic U.S. operations.................................... $(2,553,885) Foreign operations.......................................... (19,849) ----------- $(2,573,734) =========== F-22
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (7) INCOME TAXES (CONTINUED) The components of the benefit for income taxes for the period from January 6, 2000 through April 30, 2000 are as follows: [Download Table] Current: U.S. Federal.............................................. $ -- U.S. State................................................ -- Non-U.S................................................... (5,478) --------- (5,478) ========= Deferred: U.S. Federal.............................................. (608,695) U.S. State................................................ (100,189) Non-U.S................................................... -- Increase in valuation allowance........................... 574,647 --------- (134,237) --------- Total income tax benefit.................................... $(139,715) ========= In connection with the acquisition of Zentropic (see Note 13), the Company recorded a deferred income tax liability of $716,625 related to the acquired intangible assets other than goodwill that are not deductible for income tax purposes. As a result of the deferred income tax liability, the Company reduced the valuation allowance against its deferred income tax assets by $574,647 on the date of the acquisition. This reduction was included as a component of the purchase accounting in accordance with SFAS No. 109. The significant components of the Company's deferred income tax assets and liabilities as of April 30, 2000 are as follows: [Download Table] Deferred income tax assets: Net operating loss carryforward........................... $ 509,085 Reserves and accrued expenses............................. 107,319 Deferred revenue.......................................... 72,998 --------- Total deferred income tax assets.......................... 689,402 --------- Deferred income tax liabilities: Non-deductible intangibles................................ (696,719) Tax depreciation in excess of book........................ (423) --------- Total deferred income tax liabilities..................... (697,142) --------- Net deferred income tax liability....................... $ (7,740) ========= As of April 30, 2000, the Company had a net operating loss carryforward for federal income tax reporting purposes totaling approximately $1,358,000, which expires in 2020. F-23
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (7) INCOME TAXES (CONTINUED) The Internal Revenue Code contains provisions that likely could reduce or limit the availability and utilization of net operating loss carryforwards if certain changes in ownership have taken place or will take place. The Company has not performed an analysis to determine whether any such limitations have occurred. (8) COMMITMENTS AND CONTINGENCIES OPERATING AGREEMENTS The Company leases certain foreign and domestic facilities used in its operations under operating lease agreements. The aggregate commitments under non-cancelable operating leases in effect at October 31, 1999 were as follows: [Download Table] YEAR ENDING OCTOBER 31, ----------------------- 2000........................................................ $78,926 2001........................................................ 2,202 ------- $81,128 ======= The Company incurred expenses of approximately $12,796, $36,466 and $137,536 in connection with operating leases during the years ended October 31, 1997, 1998 and 1999, respectively. During the six months ended April 30, 2000, the Company has entered into additional operating lease arrangements for additional facilities. The future minimum rental payments on this premises for the years ending October 31, 2000, 2001 and 2002 total approximately $283,000, 267,000 and $50,000, respectively. LEGAL The Company may become party to certain legal proceedings arising in the ordinary course of business. Management believes, after consultation with legal counsel, that as of October 1, 1999 and April 30, 2000, no pending or threatened legal proceedings exist which would have a material adverse effect on the Company's financial position, liquidity or results of operations. (9) RELATED PARTY TRANSACTIONS CANOPY AND AFFILIATED COMPANIES A member of the Company's Board of Directors is the president and chief executive officer and a director of Canopy. Additionally, another director of the Company is the chairman of Canopy's Board of Directors. As discussed in Note 1, Canopy was the majority stockholder of Caldera. Canopy advanced $400,000 and $1,890,000 under a secured convertible promissory note agreement during the years ended October 31, 1998 and 1999, respectively (see Note 3). As discussed in Note 10, the Company participates in a 401(k) plan sponsored by Canopy. F-24
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (9) RELATED PARTY TRANSACTIONS (CONTINUED) The Company has entered into certain transactions with Canopy and other entities that are majority-owned by Canopy. These transactions consist mainly of participating in rent, joint insurance coverage and product sales and purchases. The Company believes that the terms of these related party transactions are no less favorable than the terms that could have been obtained from an unaffiliated third party in similar transactions. During the years ended October 31, 1997, 1998 and 1999 and the six months ended April 30, 2000, transactions with these related parties were as follows: [Enlarge/Download Table] YEAR ENDED OCTOBER 31, SIX MONTHS -------------------------------- ENDED APRIL 30, 1997 1998 1999 2000 -------- -------- ---------- --------------- Transactions: Revenue....................................... $14,717 $ 42,302 $ 106,637 $ -- Purchases..................................... -- -- 1,700 26,246 Rent.......................................... 12,796 12,296 82,174 56,995 Insurance..................................... 2,076 2,321 14,955 5,796 Interest expense.............................. 51,048 186,904 138,542 57,769 Balances: Convertible note payable together with accrued interest.................................... -- 403,542 2,432,387 -- Accounts payable.............................. -- 5,538 35,745 51,019 Accounts receivable........................... -- 29,884 32,116 31,236 The Company's related-party receivables and payables are non-interest bearing and provide for settlement through cash payments in the normal course of business. As a result of an option agreement between Canopy and its chief executive officer, who is also a director of the Company, the Company has recorded a one-time compensation charge of $63,374 during the six months ended April 30, 2000. The option agreement, which granted options to purchase Lineo common shares directly from Canopy was subsequently rescinded. No shares were purchased under the agreement. CALDERA SYSTEMS As discussed in Note 5, in January 2000, the Company acquired an ownership interest in Caldera Systems. Three members of the Company's Board of Directors are also directors of Caldera Systems, one of which is also the chairman of the Board of Directors of Caldera Systems. ADVANCED SIMULATION TECHNOLOGY, INC. On April 3, 2000, the Company acquired Zentropic (see Note 13). The former principal members of Zentropic, who became stockholders of the Company as a result of the acquisition, are also majority stockholders of Advanced Simulation Technology, inc. ("ASTi"). Prior to the acquisition, Zentropic and ASTi entered into an informal agreement whereby ASTi paid substantially all operating expenses of Zentropic. As of April 3, 2000, Zentropic had a payable of $102,263 to ASTi. During the period from F-25
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (9) RELATED PARTY TRANSACTIONS (CONTINUED) acquisition (April 3, 2000) to April 30, 2000, the Company incurred $4,473 in expenses that were paid by ASTi on behalf of the Company. As of April 30, 2000, the Company had a related party payable of $106,736 to ASTi. (10) EMPLOYEE BENEFIT PLANS The Company has adopted a 401(k) plan sponsored by Canopy in which all eligible employees are entitled to make pre-tax contributions. All full-time employees become eligible for participation in the plan once they have reached the age of 21. Eligible participants are able to contribute up to 15 percent of annual compensation to the plan, subject to certain IRS limitations. As of October 31, 1999, the Company has not made any contributions to the plan, however, the Board of Directors of Canopy has approved a discretionary matching program allowing the Company to annually match up to 50 percent of each dollar contributed by employees up to six percent of the employee's salary. This matching program went in effect beginning January 1, 2000. During the four months ended April 30, 2000, the Company contributed $17,177 to the plan. (11) SIGNIFICANT CUSTOMERS During the years ended October 31, 1997, 1998 and 1999, the Company had sales to one, one and three customer(s), respectively, that accounted for 74 percent, 22 percent and 48 percent of revenue, respectively. During the six months ended April 30, 1999 and 2000, the Company has sales to two and one customer(s), respectively, that accounted for 28 percent and 34 percent of revenue, respectively. No other customers accounted for more than ten percent of revenue during the years ended October 31, 1997, 1998 and 1999 and the six months ended April 30, 1999 and 2000. (12) SEGMENT INFORMATION In June 1998, SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" was issued. SFAS No. 131 establishes disclosures related to components of a company for which separate financial information is available and evaluated regularly by the company's chief operating decision makers in deciding how to allocate resources and in assessing performance. It also requires segment disclosures about products and services as well as geographic areas. The Company has determined that it did not have any separately reportable operating segments as of October 31, 1997, 1998 and 1999 and April 30, 2000. However, the Company does generate revenue in geographic locations outside of the United States. Revenue attributable to individual countries based on the F-26
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (12) SEGMENT INFORMATION (CONTINUED) location of sales to unaffiliated customers for the years ended October 31, 1997, 1998 and 1999 and the six months ended April 30, 2000 is as follows: [Enlarge/Download Table] YEAR ENDED OCTOBER 31, SIX MONTHS ---------------------------------- ENDED APRIL 30, 1997 1998 1999 2000 -------- ---------- ---------- --------------- United States................................ $895,341 $ 904,722 $2,100,599 $ 536,470 -------- ---------- ---------- ---------- Foreign: China...................................... 25,000 302,273 272,727 3,500 South Korea................................ -- -- -- 606,075 Taiwan..................................... -- 19,250 64,350 462,600 Other...................................... 25,073 149,964 362,908 124,654 -------- ---------- ---------- ---------- Total foreign............................ 50,073 471,487 699,985 1,196,829 -------- ---------- ---------- ---------- $945,414 $1,376,209 $2,800,584 $1,751,094 ======== ========== ========== ========== No other individual countries accounted for more than ten percent of revenue during the years ended October 31, 1997, 1998 and 1999 and the six months ended April 30, 2000. (13) ACQUISITIONS ZENTROPIC Effective April 3, 2000, the Company, through a wholly owned subsidiary, acquired 100 percent of the membership interest of Zentropic in exchange for 1,745,226 shares of the Company's common stock. The value of the common shares was determined using an estimated fair value of $3.80 per share based on the Company's preferred stock offerings near the date of the acquisition (see Note 4). The acquisition was accounted for as a purchase and Zentropic's results of operations have been included in the accompanying April 30, 2000 unaudited consolidated financial statements from the acquisition date. The purchase price was allocated as follows, including legal and accounting fees associated with the acquisition: [Download Table] Current assets.............................................. $ 233,367 Property and equipment...................................... 38,630 Other assets................................................ 3,815 Goodwill.................................................... 4,058,938 Core technology and assembled workforce..................... 1,911,000 Acquired in-process research and development................ 800,000 Current liabilities......................................... (160,047) Net deferred income tax liability........................... (141,977) ---------- Purchase price.............................................. $6,743,726 ========== F-27
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (13) ACQUISITIONS (CONTINUED) The value assigned to acquired in-process research and development was determined by an independent valuation which included, but was not limited to, an analysis of estimating the costs to develop the purchased in-process research and development into commercially viable products, the market for the developed products and technologies, and discounting the resulting net cash flows related to these projects and technologies. The valuation was based upon assumptions management believed to be reasonable at the time of the valuation. However, the underlying assumptions used to estimate expected revenue, development costs or profitability, or the events associated with such projects, may not transpire as estimated. At the date of the acquisition of Zentropic, management estimated that the acquired in-process research and development projects of Zentropic were approximately 60 percent complete and that an additional $150,000 would be required to develop these projects and technologies to commercial viability. At the date of the acquisition, the acquired in-process research and development had not yet reached technological feasibility and had no alternative future uses. UNITED SYSTEM ENGINEERS On April 13, 2000, the Company entered into an agreement with United System Engineers, Inc. ("USE"), a Japanese corporation. USE is a custom systems engineering company with experience in embedded operating systems. Pursuant to the agreement, the Company acquired, effective May 1, 2000, all of the outstanding stock of USE in exchange for $322,829 in cash and options to purchase 507,335 shares of the Company's common stock. The options have a vesting period of one year, an exercise price of $3.00 per share and expire ten years from the date of grant. The acquisition will be accounted for as a purchase. The excess of the purchase price over the estimated fair value of the acquired tangible assets will be allocated to goodwill and other intangible assets. FIREPLUG COMPUTERS INC. On May 1, 2000, the Company entered into an agreement with Fireplug Computers Inc. ("Fireplug"), a Canadian corporation. Fireplug is a developer of embedded Linux network application software solutions and embedded Linux tools. Pursuant to the agreement, the Company acquired all of the outstanding stock of Fireplug in exchange for $500,000 in cash, 69,998 shares of Series D and options to purchase 62,220 shares of common stock of the Company. The options have a vesting period of one year, an exercise price of $1.50 per share and expire ten years from the date of grant. The acquisition will be accounted for as a purchase. The excess of the purchase price over the estimated fair value of the acquired tangible assets will be allocated to goodwill and other intangible assets. INUP On May 1, 2000, the Company entered into an agreement with Inup S.A. ("Inup"), a French corporation. Inup develops Linux-based solutions for embedded devices that provide software backup in the event of hardware failures. Pursuant to the agreement, the Company acquired all of the outstanding stock of Inup in exchange for $10,000 in cash, 83,334 shares of Series C and 1,333,333 shares of common stock of the Company. The acquisition will be accounted for as a purchase. The F-28
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (13) ACQUISITIONS (CONTINUED) excess of the purchase price over the estimated fair value of the acquired tangible assets will be allocated to acquired in-process research and development, goodwill and other intangible assets. MORETON BAY VENTURES PTY LTD. On May 12, 2000, the Company entered into an agreement with Moreton Bay Ventures Pty Ltd. ("Moreton Bay"), an Australian corporation. Moreton Bay develops embedded virtual private network solutions for Internet appliances and provides engineering development for the Motorola ColdFire microprocessor platform. Moreton Bay's historical operations include two product lines, RAStel multimodem cards ("RAStel") and NETtel Internet routers ("NETtel"). Pursuant to the agreement, the Company acquired all of the outstanding stock of Moreton Bay in exchange for $10,000 in cash, 956,315 shares of Series D and options to purchase 87,374 shares of the Company's common stock. The options have a vesting period of one year, an exercise price of $3.00 per share and expire ten years from the date of grant. The acquisition will be accounted for as a purchase. The excess of the purchase price over the estimated fair value of the acquired tangible assets will be allocated to acquired in-process research and development, goodwill and other intangible assets. Prior to the acquisition, Moreton Bay transferred the RAStel assets, liabilities and operations, which the Company did not acquire, to a separate legal entity. F-29
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Zentropic Computing, LLC: We have audited the accompanying consolidated balance sheets of Zentropic Computing, LLC (a Virginia limited liability company), the carved-out portion of Advanced Simulation Technology, inc. (a Virginia corporation) and their subsidiary as of October 31, 1998 and 1999, and the related consolidated statements of operations and comprehensive loss, members' capital and cash flows for each of the two years in the period ended October 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Zentropic Computing, LLC, the carved-out portion of Advanced Simulation Technology, inc. and their subsidiary as of October 31, 1998 and 1999, and the results of their operations and their cash flows for each of the two years in the period ended October 31, 1999 in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Salt Lake City, Utah April 3, 2000 F-30
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY CONSOLIDATED BALANCE SHEETS [Enlarge/Download Table] OCTOBER 31, --------------------- JANUARY 31, 1998 1999 2000 --------- --------- ----------- (UNAUDITED) ASSETS Current assets: Cash...................................................... $ 63,678 $ 120,037 $ 170,864 Accounts receivable, net of allowance for doubtful accounts of $0.......................................... -- 25,667 22,500 Value added tax and income tax receivables................ 7,053 4,280 4,945 Prepaid expenses.......................................... 2,426 11,534 16,141 --------- --------- --------- Total current assets.................................... 73,157 161,518 214,450 --------- --------- --------- Property and equipment: Computer equipment........................................ 3,385 10,764 12,752 Furniture and fixtures.................................... 3,059 9,368 9,352 --------- --------- --------- 6,444 20,132 22,104 Less accumulated depreciation............................. (1,084) (6,106) (6,779) --------- --------- --------- Net property and equipment.............................. 5,360 14,026 15,325 --------- --------- --------- Other assets, net........................................... 461 4,345 4,027 --------- --------- --------- $ 78,978 $ 179,889 $ 233,802 ========= ========= ========= LIABILITIES AND MEMBERS' CAPITAL Current liabilities: Accounts payable.......................................... $ 36,252 $ 6,810 $ 32,938 Accrued warranty.......................................... -- 5,000 5,000 Deferred revenue.......................................... -- 30,667 10,417 Related party payable..................................... -- 40,580 76,861 --------- --------- --------- Total current liabilities............................... 36,252 83,057 125,216 --------- --------- --------- Commitments and contingencies (Notes 1 and 4) Members' capital: Contributed capital....................................... 275,669 787,852 955,206 Member capital contributions receivable................... -- (137,900) -- Accumulated comprehensive income (loss)................... 446 96 (39) Accumulated deficit....................................... (23,910) (271,702) (566,071) Net deficit of carved-out operations...................... (209,479) (281,514) (280,510) --------- --------- --------- Total members' capital.................................. 42,726 96,832 108,586 --------- --------- --------- $ 78,978 $ 179,889 $ 233,802 ========= ========= ========= See accompanying notes to consolidated financial statements. F-31
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS [Enlarge/Download Table] THREE MONTHS ENDED YEAR ENDED OCTOBER 31, JANUARY 31, ----------------------- ------------------------- 1998 1999 1999 2000 ---------- ---------- ----------- ----------- (UNAUDITED) (UNAUDITED) Revenue: Software....................................... $ -- $ 26,141 $ -- $ 7,461 Services....................................... -- 59,333 -- 35,250 --------- --------- --------- --------- Total revenue................................ -- 85,474 -- 42,711 --------- --------- --------- --------- Cost of revenue: Software....................................... -- 20,725 -- 2,687 Services....................................... -- 17,639 -- 10,886 --------- --------- --------- --------- Total cost of revenue........................ -- 38,364 -- 13,573 --------- --------- --------- --------- Gross margin................................. -- 47,110 -- 29,138 --------- --------- --------- --------- Operating expenses: Research and development (exclusive of non-cash compensation of $0, $850, $0 and $29,454, respectively)................................ 208,539 320,828 70,300 76,826 Sales and marketing (exclusive of non-cash compensation of $0, $58,393, $0 and $94,242, respectively)................................ 130,314 249,898 57,849 79,700 General and administrative (exclusive of non-cash compensation of $0, $19,465, $0 and $43,658, respectively)....................... 90,674 150,132 36,123 71,733 Non-cash compensation.......................... -- 78,708 -- 167,354 --------- --------- --------- --------- Total operating expenses..................... 429,527 799,566 164,272 395,613 --------- --------- --------- --------- Loss before income taxes......................... (429,527) (752,456) (164,272) (366,475) Provision (benefit) for income taxes............. 2,482 (4,117) 4,907 3,479 --------- --------- --------- --------- Net loss......................................... $(432,009) $(748,339) $(169,179) $(369,954) ========= ========= ========= ========= Comprehensive loss: Net loss....................................... $(432,009) $(748,339) $(169,179) $(369,954) Foreign currency translation adjustments....... 446 (350) (454) (135) --------- --------- --------- --------- $(431,563) $(748,689) $(169,633) $(370,089) ========= ========= ========= ========= See accompanying notes to consolidated financial statements. F-32
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY CONSOLIDATED STATEMENTS OF MEMBERS' CAPITAL [Enlarge/Download Table] MEMBER CAPITAL ACCUMULATED NET DEFICIT OF CONTRIBUTED CONTRIBUTIONS COMPREHENSIVE ACCUMULATED CARVED-OUT CAPITAL RECEIVABLE INCOME (LOSS) DEFICIT OPERATIONS ----------- -------------- ------------- ----------- -------------- Balance, October 31, 1997...... $ -- $ -- $ -- $ -- $ -- Member capital contributions... 58,295 -- -- -- -- ASTi funding of carved-out operations and contribution to members' capital.......... 217,374 -- -- -- 198,620 Net loss applicable to carved-out operations........ -- -- -- -- (408,099) Cumulative translation adjustment................... -- -- 446 -- -- Net loss....................... -- -- -- (23,910) -- -------- --------- ----- --------- --------- Balance, October 31, 1998...... 275,669 -- 446 (23,910) (209,479) Member capital contributions... 361,440 (137,900) -- -- -- ASTi funding of carved-out operations and contribution to members' capital.......... 72,035 -- -- -- 428,512 Net loss applicable to carved-out operations........ -- -- -- -- (500,547) Issuance of member interests for services................. 78,708 -- -- -- -- Cumulative translation adjustment................... -- -- (350) -- -- Net loss....................... -- -- -- (247,792) -- -------- --------- ----- --------- --------- Balance, October 31, 1999...... 787,852 (137,900) 96 (271,702) (281,514) ASTi funding of carved-out operations (unaudited)....... -- -- -- -- 76,589 Net loss applicable to carved-out operations (unaudited).................. -- -- -- -- (75,585) Cash received related to member capital contributions receivable (unaudited)....... -- 137,900 -- -- -- Issuance of member interests for services (unaudited)..... 167,354 -- -- -- -- Cumulative translation adjustment (unaudited)....... -- -- (135) -- -- Net loss (unaudited)........... -- -- -- (294,369) -- -------- --------- ----- --------- --------- Balance, January 31, 2000 (unaudited).................. $955,206 $ -- $ (39) $(566,071) $(280,510) ======== ========= ===== ========= ========= See accompanying notes to consolidated financial statements. F-33
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH [Enlarge/Download Table] THREE MONTHS ENDED YEAR ENDED OCTOBER 31, JANUARY 31, ----------------------- ------------------------- 1998 1999 1999 2000 ---------- ---------- ----------- ----------- (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net loss....................................... $(432,009) $(748,339) $(169,179) $(369,954) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization................ 7,272 7,007 362 991 Non-cash compensation expense................ -- 78,708 -- 167,354 Changes in operating assets and liabilities, excluding effects of acquisition: Accounts receivable........................ 11,527 (25,667) -- 3,167 VAT and income tax receivables............. (6,021) 2,773 (3,932) (665) Prepaid expenses........................... (2,426) (9,108) (3,794) (4,607) Accounts payable........................... 24,465 (29,442) (20,512) 26,128 Deferred revenue........................... -- 30,667 -- (20,250) Accrued warranty........................... -- 5,000 -- -- Related party payable...................... -- 40,580 -- 36,281 --------- --------- --------- --------- Net cash used in operating activities.... (397,192) (647,821) (197,055) (161,555) --------- --------- --------- --------- Cash flows from investing activities: Purchase of property and equipment............. (3,683) (13,688) -- (1,972) Acquisition of Autospan Limited, net of cash acquired..................................... (9,692) -- -- -- Purchase of other long-term assets............. (490) (5,869) -- -- --------- --------- --------- --------- Net cash used in operating activities.... (13,865) (19,557) -- (1,972) --------- --------- --------- --------- Cash flows from financing activities: Members' capital contributions................. 275,669 295,575 72,025 137,900 ASTi funding of carved-out operations not contributed to members' capital.............. 198,620 428,512 127,288 76,589 --------- --------- --------- --------- Net cash provided by financing activities............................. 474,289 724,087 199,313 214,489 --------- --------- --------- --------- Net increase in cash............................. 63,232 56,709 2,258 50,962 Cumulative translation adjustment................ 446 (350) (454) (135) Cash, beginning of period........................ -- 63,678 63,678 120,037 --------- --------- --------- --------- Cash, end of period.............................. $ 63,678 $ 120,037 $ 65,482 $ 170,864 ========= ========= ========= ========= See accompanying notes to consolidated financial statements. F-34
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) INCREASE (DECREASE) IN CASH SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: [Enlarge/Download Table] THREE MONTHS YEAR ENDED ENDED OCTOBER 31, JANUARY 31, -------------------- -------------------- 1998 1999 1998 1999 --------- -------- --------- -------- Cash paid for income taxes....................... $ -- $2,482 $ -- $9,441 SUPPLEMENTAL DISCLOSURE OF NON CASH INVESTING AND FINANCING ACTIVITIES: During fiscal 1998, in connection with the acquisition of Autospan Limited, Advanced Simulation Technology, inc. received $15,308 of cash, $12,559 of receivables, $8,920 of equipment and other assets and assumed $11,787 of accounts payable and accrued liabilities in exchange for $25,000 in cash. See accompanying notes to consolidated financial statements. F-35
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (INFORMATION AS OF JANUARY 31, 2000 AND FOR THE THREE MONTHS ENDED JANUARY 31, 1999 AND 2000 IS UNAUDITED) (1) ORGANIZATION AND DESCRIPTION OF BUSINESS Zentropic Computing, LLC's subsidiary, Zentropic Computing Ltd ("Ltd"), began operations in the United Kingdom during November 1994 as Autospan Limited ("Autospan"). Autospan developed and marketed tools, related products and utilities for real time ("RT") Linux operating system software. Advanced Simulation Technology, inc. ("ASTi") acquired Autospan on February 1, 1998 for $25,000 in cash. Three individuals, together with ASTi, created a separate entity to market and sell Ltd's tools and products in the United States and certain other locations. These individuals, together with ASTi, organized Zentropic Computing, LLC, a Virginia limited liability company doing business as Zentropix ("Zentropix"), and became its founding members on January 5, 1998. Effective May 12, 1999, ASTi transferred its ownership interest in Ltd to Zentropix. As a result of the transfer, Ltd became a subsidiary of Zentropix (collectively referred to as the "Company"). ASTi's majority shareholder was one of the founding members of Zentropix. Since ASTi was the sole shareholder of Ltd and together with its majority shareholder was the majority owner of Zentropix, this transaction has been accounted for as a reorganization of entities under common control with the assets and liabilities reflected at carryover basis in a manner similar to a pooling of interests. Subsequent to the acquisition of Ltd and the reorganization of Zentropix, ASTi has paid substantially all operating expenses on behalf of the Company (see Note 5). These expenses were not recorded by the Company. Accordingly, the accompanying consolidated financial statements include the expenses paid by ASTi on behalf of the Company during the years ended October 31, 1998 and 1999 and the three months ended January 31, 2000 (referred to as the carved-out operations of ASTi). The expenses of the carved-out portion of ASTi reflect actual direct expenses associated with the Company's business and an allocated portion of common expenses. The allocated common expenses consist primarily of facilities rent and legal and accounting expenses and were allocated based on the percentage of ASTi payroll expense allocated to the Company. Management believes that the allocation methods used are reasonable and reflect their best estimate of the expenses that would have been incurred by the Company as a standalone entity. ASTi has funded the net losses of the Company by paying substantially all operating expenses of the Company. The funding applicable to the carved-out operations has been reflected as a component of equity entitled "Net Deficit of Carved-out Operations" in the accompanying consolidated balance sheets. This funding has been offset by the accumulated losses applicable to the carved-out operations of ASTi and the contributions to members' capital made by ASTi. The Company continues to develop, market and support operating system products primarily for the RT Linux and embedded Linux markets. The Company sells and distributes its software and related products through license agreements directly to end-users. These sales occur throughout the United States and in certain international locations. The Company is subject to certain risks including the uncertainty of market acceptance and demand for Linux-related products and services, competition from larger, more established companies, short product life cycles, the Company's ability to develop and bring to market new products on a F-36
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JANUARY 31, 2000 AND FOR THE THREE MONTHS ENDED JANUARY 31, 1999 AND 2000 IS UNAUDITED) (1) ORGANIZATION AND DESCRIPTION OF BUSINESS (CONTINUED) timely basis, dependence on key employees, the ability to attract and retain additional qualified personnel and the ability to obtain adequate financing to support growth. During the years ended October 31, 1998 and 1999 and the three months ended March 31, 2000, the Company has suffered net losses of $432,009, $748,339 and $369,954, respectively. As discussed in Note 8, subsequent to March 31, 2000 the Company has been acquired by Lineo, Inc. ("Lineo") and Lineo has committed to provide funding to the Company as required. (2) SIGNIFICANT ACCOUNTING POLICIES UNAUDITED INTERIM FINANCIAL STATEMENTS The unaudited interim financial statements as of January 31, 2000 and for the three months ended January 31, 1999 and 2000 have been prepared on the same basis as the audited financial statements and, in the opinion of management, reflect all normal recurring adjustments necessary to present fairly the financial information set forth therein in accordance with accounting principles generally accepted in the United States. The results of operations for the three months ended January 31, 2000 are not necessarily indicative of the results to be expected for the entire fiscal year ending October 31, 2000. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the accompanying consolidated financial statements for cash, accounts receivable, value added tax and income tax receivables and accounts payable approximate fair values because of the immediate or short-term maturities of these financial instruments. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Zentropix, the carved-out operations of ASTi and their wholly owned subsidiary, Ltd, after elimination of intercompany accounts and transactions. FOREIGN CURRENCY TRANSLATION For purposes of consolidating the operations of Ltd, the Company has determined the functional currency for Ltd's operations to be the British Pound. Accordingly, translation gains and losses are included as a component of comprehensive loss. F-37
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JANUARY 31, 2000 AND FOR THE THREE MONTHS ENDED JANUARY 31, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment are stated at cost, less accumulated depreciation. Computer equipment and furniture and fixtures are depreciated using the straight-line method over the estimated useful life of the asset, typically three years. Expenditures for repairs and maintenance are charged to expense when incurred. Expenditures for major renewals and betterments that extend the useful lives of existing equipment are capitalized and depreciated. On retirement or disposition of property and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in the statement of operations. CAPITALIZED SOFTWARE COSTS In accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," development costs incurred in the research and development of new software products to be sold, leased or otherwise marketed are expensed as incurred until technological feasibility in the form of a working model has been established. Internally generated capitalizable software development costs have not been material for the years ended October 31, 1998 and 1999 and the three months ended January 31, 2000. The Company has charged its software development costs to research and development expense in the accompanying consolidated statements of operations. OTHER ASSETS Other assets consist of legal and other direct costs incurred to obtain the Company's trademarks. The trademarks are being amortized using the straight-line method over a period of five years. IMPAIRMENT OF LONG-LIVED ASSETS The Company reviews its long-lived assets, including intangibles, for impairment when events or changes in circumstances indicate that the book value of an asset may not be recoverable. The Company evaluates, at each balance sheet date, whether events and circumstances have occurred which indicate possible impairment. The Company uses an estimate of future undiscounted net cash flows of the related asset or group of assets over the remaining life in measuring whether the assets are recoverable. As of October 31, 1999 and January 31, 2000, the Company does not consider any of its long-lived assets to be impaired. REVENUE RECOGNITION The Company generates revenue from software sold directly to end-users. The Company also generates service revenue from training fees, consulting fees, and customer support fees. F-38
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JANUARY 31, 2000 AND FOR THE THREE MONTHS ENDED JANUARY 31, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company recognizes revenue in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue Recognition." Revenue from the sale of software products is recognized upon delivery when persuasive evidence of an arrangement exists, the price is fixed or determinable and collection is probable. Direct sales to end-users are evidenced by a binding purchase order for the product and are governed by a license agreement. Generally, the only multiple element arrangement of the Company's initial software sales are training and technical support services the Company provides at additional charge to the end-user. None of the post contract maintenance and support services extend for more than a year following the date of the sale. These services do not include product update or upgrade rights. After the initial support period, customers can elect to enter into separate support agreements. Revenue from the extended support agreements are deferred and recognized over the period of the contract or as the services are provided. If other significant post-delivery vendor obligations exist or if a product is subject to customer acceptance, revenues are deferred until no significant obligations remain or acceptance has occurred. To date, the Company has not shipped any software subject to acceptance terms or subject to other post-delivery vendor obligations. Additionally, the Company has not recognized revenue on any contract with customers that may include customer cancellation or termination clauses that indicate a demonstration period or otherwise incomplete transaction. The Company also offers it customers consulting, training and other services separate from the software sale. This service revenue is recognized as the services are performed. SALES AND MARKETING EXPENSES Sales and marketing expenses consist of the following: advertising, promotional activities, public relations, trade shows and the salaries, commissions and related expenses of all personnel in the sales process. The Company expenses the cost of advertising the first time the advertising takes place. Advertising expenses totaled $0 and $7,990 for the years ended October 31, 1998 and 1999, respectively, and $0 and $2,921 for the three-month periods ended January 31, 1999 and 2000, respectively. INCOME TAXES Historically, the Company has not recorded any income tax assets or liabilities related to its United States operations due to its treatment as a partnership for Federal income tax purposes. However, effective January 15, 2000, the Company elected to be taxed as a corporation rather than a partnership for Federal income tax purposes. The Company's subsidiary, Ltd, does recognize income tax assets and liabilities due to its classification as a Private Company Limited by Shares in the United Kingdom. The Company's policy was to make distributions to its members in amounts at least equal to the member's income taxes that were attributable to the net earnings of the Company. Due to its history of losses in the United States, the Company has not made any distributions to members for the payment of income taxes. F-39
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JANUARY 31, 2000 AND FOR THE THREE MONTHS ENDED JANUARY 31, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS The Company offers credit terms on the sale of its software products to its customers. The Company performs ongoing credit evaluations of its customers' financial condition and requires no collateral from its customers. The Company continually evaluates the need for an allowance for uncollectable accounts receivable based upon the expected collectibility of all accounts receivable. As of October 31, 1999, two customers accounted for 100 percent of the gross accounts receivable balance which the Company deemed to be entirely collectible. During the year ended October 31, 1999, the Company's sales to three customers accounted for 45, 23 and 19 percent of revenue. No other customer accounted for more than ten percent of net revenue during the year ended October 31, 1999. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes new accounting and reporting standards for companies to report information about derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. This statement is effective for financial statements issued for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not expect this statement to have a material impact on the Company's results of operations, financial position or liquidity. In December 1999, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in Financial Statements." This pronouncement summarizes certain of the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. The Company is required to adopt SAB No. 101 during the first quarter of fiscal year 2001. Although management is currently evaluating the impact, if any, of SAB No. 101, management does not presently believe it will have a material impact on the Company's results of operations, financial position or liquidity. (3) MEMBERS' CAPITAL CONTRIBUTED CAPITAL On January 5, 1998, Zentropix was organized with capital of $25,100 contributed by ASTi and three other founding members. During the period from January 5, 1998 through October 31, 1998, these members contributed an additional $33,195. On May 12, 1999, additional members were admitted to Zentropix. Together with the founding members, these members agreed to contribute additional capital of $336,440. As of October 31, 1999, the Company had member capital contributions receivable of $137,900. As of January 31, 2000, all amounts receivable from members had been collected. As discussed in Note 1, ASTi has funded the net losses of the Company by paying substantially all operating expenses of the Company. During fiscal 1999, ASTi and the other members agreed that a F-40
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JANUARY 31, 2000 AND FOR THE THREE MONTHS ENDED JANUARY 31, 1999 AND 2000 IS UNAUDITED) (3) MEMBERS' CAPITAL (CONTINUED) portion of ASTi's funding would be deemed as contributed capital. During the years ended October 31, 1998 and 1999, the funding which was deemed to be contributed capital by the members totaled $217,374 and $72,035, respectively. TRANSFER OF MEMBER INTERESTS On May 12, 1999, the Company granted three founding members an additional 5.6 percent interest in the Company for services rendered. The Company valued this interest at $78,708 based upon the sale of member interests to third parties for cash at that same date. On December 7, 1999, three principal members of Zentropix transferred a portion of their membership interests in Zentropix to four key employees as compensation for services rendered by the employees. These three principal members transferred 7.1 percent of the total outstanding membership interest in the Company to these four employees. In accordance with Interpretation No. 1 to Accountings Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," the Company recorded the $167,354 estimated fair value related to the member interests transferred as non-cash compensation expense in the accompanying statement of operations for the quarter ended January 31, 2000. The fair value of the member interests transferred was based upon other equity transactions in fiscal 1999 and fiscal 2000 and in the opinion of management, is a reasonable estimate of fair value. (4) COMMITMENTS AND CONTINGENCIES OPERATING AGREEMENTS The Company shares its corporate office facilities with ASTi, which pays for all rent expense associated with corporate facilities. Historically no formal agreement between ASTi and the Company governed this arrangement. However, after the merger with Lineo (see Note 8), the Company expects to move its corporate offices and assume direct responsibility for its rent obligations. A portion of the rent expense paid by ASTi has been included in the carved-out operations of ASTi. The Company leases office space in Brighton, U.K. The current lease expires in March 2002. The Company is obligated to pay rent of approximately $5,100 per year plus annual VAT. Rent expense was approximately $800 for the year ended October 31, 1998 under a prior lease arrangement. Rent expense was approximately $5,000 (including VAT) for the year ended October 31, 1999 under the current and prior lease arrangements. Future minimum lease obligations related to this lease are $5,100 in fiscal 2000, $5,100 in fiscal 2001 and $1,200 in fiscal 2002. LIMITATION OF MEMBERS' LIABILITY None of the members are obligated to contribute capital to restore any negative capital account, nor is any member liable for any of the debts, losses, liabilities or obligations of the Company beyond such member's capital contributions as governed by the provisions of the Virginia Limited Liability Company Act and other applicable laws of the Commonwealth of Virginia. F-41
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JANUARY 31, 2000 AND FOR THE THREE MONTHS ENDED JANUARY 31, 1999 AND 2000 IS UNAUDITED) (5) RELATED PARTY TRANSACTIONS The Company had an informal agreement whereby ASTi paid substantially all operating expenses of the Company. The expenses paid on behalf of the Company by ASTi consisted of the following: [Download Table] THREE MONTHS ENDED YEAR ENDED OCTOBER 31, JANUARY 31, ----------------------- ------------------- 1998 1999 1999 2000 ---------- ---------- -------- -------- Payroll.............................. $332,551 $446,862 $106,886 $66,766 Contract research and development.... 37,500 -- -- -- Facilities rent...................... 17,795 33,693 8,423 7,500 Legal and accounting fees and other general operating expenses......... 8,083 17,971 4,493 2,323 Marketing expenses................... 20,065 2,021 505 -- -------- -------- -------- ------- Total expenses..................... $415,994 $500,547 $120,307 $76,589 ======== ======== ======== ======= The Company had a related party payable to ASTi of $40,580 as of October 31, 1999 and $76,861 at January 31, 2000 related to expenses paid by ASTi on behalf of the Company. The agreement between ASTi and the Company relating to these expenses is informal. Consequently, the Company has classified the related party payable as a current liability. (6) INCOME TAXES As described in Note 2, Zentropix was treated as a partnership for Federal income tax purposes prior to January 15, 2000 at which time it elected to be treated as a taxable entity. Ltd has been treated as a taxable entity under the laws of the United Kingdom since it's inception. The carved-out portion of ASTi was included in the U.S. tax return of ASTi for all periods presented. Had these carved-out expenses been paid by Zentropix, the tax benefit would have flowed through to the members and would not have been reflected in the accompanying financial statements for all periods prior to January 15, 2000. The net loss before income taxes consisted of the following components: [Enlarge/Download Table] YEAR ENDED OCTOBER 31 THREE MONTHS --------------------- ENDED JANUARY 31, 1998 1999 2000 --------- --------- ------------------ Domestic U.S. operations............................... $(428,380) $(742,434) $(383,804) Operations of foreign subsidiary, Zentropic Computing Ltd.................................................. (1,147) (10,022) 17,329 --------- --------- --------- Net loss before income taxes......................... $(429,527) $(752,456) $(366,475) ========= ========= ========= The provision (benefit) for income taxes for the years ended October 31, 1998 and 1999 consisted entirely of taxes related to Ltd. F-42
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ZENTROPIC COMPUTING, LLC, THE CARVED-OUT PORTION OF ADVANCED SIMULATION TECHNOLOGY, INC. AND THEIR SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JANUARY 31, 2000 AND FOR THE THREE MONTHS ENDED JANUARY 31, 1999 AND 2000 IS UNAUDITED) (6) INCOME TAXES (CONTINUED) The Company determines its deferred tax assets and liabilities based on the differences between the financial reporting and tax bases of assets and liabilities. They are measured by applying the enacted tax rates and laws in effect for the years in which such differences are expected to reverse. As of January 15, 2000 (the date Zentropix became a taxable entity in the U.S.) the Company had approximately $6,000 of deferred income tax assets related to deferred revenue and accruals. As of January 31, 2000, the Company had approximately $29,000 of deferred income tax assets related to net operating losses, deferred revenue and accruals. The amount of and ultimate realization of the deferred income tax assets is dependent, in part, upon the tax laws in effect, the Company's future earnings, and other future events, the effects of which cannot be determined. The Company has established a valuation allowance against its deferred income tax assets because the available objective evidence creates sufficient uncertainty regarding their realizability. (7) SEGMENT INFORMATION In June 1998, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 establishes disclosures related to components of a company for which separate financial information is available and evaluated regularly by a company's chief operating decision makers in deciding how to allocate resources and in assessing performance. It also requires segment disclosures about products and services as well as geographic areas. The Company has determined that it did not have any separately reportable operating segments as of October 31, 1998 and 1999 and January 31, 2000. However, the Company does sell software and related services in geographic locations outside the United States. Revenues attributed to individual countries based on the location of sales to unaffiliated customers were as follows: [Enlarge/Download Table] YEAR ENDED OCTOBER 31, THREE MONTHS -------------------- ENDED JANUARY 31, 1998 1999 2000 --------- -------- ------------------ Revenue: United States............................... $ -- $47,141 $36,461 France...................................... -- 38,333 6,250 --------- ------- ------- Total revenue................................. $ -- $85,474 $42,711 ========= ======= ======= (8) SUBSEQUENT EVENT On January 21, 2000, the Company signed a letter of intent to merge with Lineo. The Company agreed to exchange 100 percent of its members' capital for 1,745,226 shares of Lineo's common stock. On March 28, 2000, the Company and Lineo signed a definitive Agreement and Plan of Merger and on April 3, 2000, the Company finalized its merger with Lineo in accordance with the terms specified above. F-43
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To United System Engineers, Inc.: We have audited the accompanying balance sheets of United System Engineers, Inc. (a Japanese corporation) as of December 31, 1998 and 1999, and the related statements of operations and comprehensive income (loss), stockholders' deficit and cash flows for the years then ended, expressed in Japanese yen. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of United System Engineers, Inc. as of December 31, 1998 and 1999, and the results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles in the United States of America (see Note 1). Also, in our opinion, the amounts translated into U.S. dollars in the accompanying financial statements have been computed on the basis set forth in Note 1. ARTHUR ANDERSEN Tokyo, Japan April 14, 2000 F-44
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UNITED SYSTEM ENGINEERS, INC. BALANCE SHEETS [Enlarge/Download Table] THOUSANDS OF YEN ------------------------------------------------------ THOUSANDS OF U.S. DOLLARS DECEMBER 31, -------------------------- ----------------------------------- MARCH 31, DECEMBER 31, MARCH 31, 1998 1999 2000 1999 2000 ---------------- ---------------- ---------------- ------------ ----------- (UNAUDITED) (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................. Y 55,422 Y 40,091 Y 31,430 $ 391 $ 307 Time deposits............................. 9,104 9,124 9,130 89 89 Accounts receivable....................... 14,127 10,979 11,541 107 113 Unbilled revenue.......................... 5,979 13,790 -- 135 -- Prepaid expenses.......................... 12,732 13,857 1,357 135 13 Investment in marketable security......... -- -- 41,990 -- 410 Other current assets...................... 1,160 1,212 2,259 12 22 ---------------- ---------------- ---------------- ------- ------- Total current assets.................... 98,524 89,053 97,707 869 954 ---------------- ---------------- ---------------- ------- ------- Property and equipment, at cost: Buildings and improvements................ 99,039 99,039 99,039 967 967 Equipment................................. 17,294 17,793 17,945 174 175 Less accumulated depreciation............. (61,345) (67,275) (68,541) (657) (669) ---------------- ---------------- ---------------- ------- ------- 54,988 49,557 48,443 484 473 ---------------- ---------------- ---------------- ------- ------- Other assets................................ 2,375 1,994 1,942 20 19 ---------------- ---------------- ---------------- ------- ------- Y 155,887 Y 140,604 Y 148,092 $ 1,373 $ 1,446 ================ ================ ================ ======= ======= LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable.......................... Y -- Y 8,500 Y -- $ 83 $ -- Customer advances and deferred revenue.... 193 182 1,839 1 18 Short-term debt........................... 69,735 78,284 81,846 764 799 Current maturities of long-term debt...... 19,920 31,094 31,484 304 308 Accrued vacation payable.................. 5,528 6,191 6,191 60 60 Other accrued liabilities................. 3,780 4,304 1,958 42 19 Income taxes payable...................... 206 206 51 2 -- Other current liabilities................. 2,044 7,903 4,153 78 41 ---------------- ---------------- ---------------- ------- ------- Total current liabilities............... 101,406 136,664 127,522 1,334 1,245 ---------------- ---------------- ---------------- ------- ------- Long-term debt, net of current maturities... 107,970 76,876 83,440 751 814 ---------------- ---------------- ---------------- ------- ------- Commitments and contingencies (Notes 1 and 5) Stockholders' deficit: Common stock, Y500 par value per share; Authorized--160,000 shares; Outstanding--80,000 shares as of December 31, 1998, 160,000 shares as of December 31, 1999 and March 31, 2000.... 40,000 80,000 80,000 781 781 Accumulated deficit......................... (93,489) (152,936) (171,185) (1,493) (1,671) Accumulated other comprehensive income...... -- -- 28,315 -- 277 ---------------- ---------------- ---------------- ------- ------- Total stockholders' deficit............. (53,489) (72,936) (62,870) (712) (613) ---------------- ---------------- ---------------- ------- ------- Y155,887 Y140,604 Y148,092 $ 1,373 $ 1,446 ================ ================ ================ ======= ======= See accompanying notes to financial statements. F-45
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UNITED SYSTEM ENGINEERS, INC. STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) [Enlarge/Download Table] THOUSANDS OF U.S. DOLLARS THOUSANDS OF YEN -------------------------- --------------------------------------------------------------------- THREE YEAR ENDED THREE MONTHS ENDED MONTHS DECEMBER 31, MARCH 31, YEAR ENDED ENDED --------------------------------- --------------------------------- DECEMBER 31, MARCH 31, 1998 1999 1999 2000 1999 2000 --------------- --------------- --------------- --------------- ------------ ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) Revenues: Services................... Y 202,408 Y 146,117 Y 34,050 Y 23,101 $1,427 $ 225 Software................... -- 10,990 -- 8,628 107 85 --------------- --------------- --------------- --------------- ------ ----- Total revenue............ Y202,408 Y157,107 Y 34,050 Y 31,729 $1,534 $ 310 Cost of revenue.............. 91,778 104,879 27,716 34,432 1,024 336 --------------- --------------- --------------- --------------- ------ ----- Gross profit (loss)...... 110,630 52,228 6,334 (2,703) 510 (26) --------------- --------------- --------------- --------------- ------ ----- Operating expenses: Research and development... 25,560 4,934 4,934 -- 48 -- Selling, general and administrative........... 82,495 99,506 14,296 13,890 971 136 --------------- --------------- --------------- --------------- ------ ----- Total operating expenses............... 108,055 104,440 19,230 13,890 1,019 136 --------------- --------------- --------------- --------------- ------ ----- Income (loss) from operations................. 2,575 (52,212) (12,896) (16,593) (509) (162) --------------- --------------- --------------- --------------- ------ ----- Other income (expense): Interest expense, net...... (6,134) (7,119) (1,639) (1,515) (69) (15) Other income (expense), net...................... 81 90 55 (90) -- (1) --------------- --------------- --------------- --------------- ------ ----- Other expense, net....... (6,053) (7,029) (1,584) (1,605) (69) (16) --------------- --------------- --------------- --------------- ------ ----- Loss before income taxes..... (3,478) (59,241) (14,480) (18,198) (578) (178) Provision for income taxes... 206 206 51 51 2 -- --------------- --------------- --------------- --------------- ------ ----- Net loss..................... Y (3,684) Y (59,447) Y (14,531) Y (18,249) $ (580) $(178) =============== =============== =============== =============== ====== ===== Comprehensive income (loss): Net loss................... Y (3,684) Y (59,447) Y (14,531) Y (18,249) $ (580) $(178) Unrealized gain on marketable security...... -- -- -- 28,315 -- 277 --------------- --------------- --------------- --------------- ------ ----- Y (3,684) Y (59,447) Y (14,531) Y 10,066 $ (580) $ 99 =============== =============== =============== =============== ====== ===== See accompanying notes to financial statements. F-46
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UNITED SYSTEM ENGINEERS, INC. STATEMENTS OF STOCKHOLDERS' DEFICIT [Enlarge/Download Table] THOUSANDS OF YEN THOUSANDS OF U.S. DOLLARS ----------------------------------------------------- -------------------------- DECEMBER 31, ---------------------------------- MARCH 31, DECEMBER 31, MARCH 31, 1998 1999 2000 1999 2000 --------------- ---------------- ---------------- ------------ ----------- (UNAUDITED) (UNAUDITED) Common stock: Beginning balance.................... Y 30,000 Y 40,000 Y 80,000 $ 391 $ 781 Shares issued: 20,000 shares in December 1998..... 10,000 -- -- -- -- 80,000 shares in December 1999..... -- 40,000 -- 390 -- --------------- ---------------- ---------------- ------- ------- Ending balance....................... Y 40,000 Y 80,000 Y 80,000 $ 781 $ 781 =============== ================ ================ ======= ======= Accumulated deficit: Beginning balance.................... Y(89,805) Y (93,489) Y(152,936) $ (913) $(1,493) Net loss............................. (3,684) (59,447) (18,249) (580) (178) --------------- ---------------- ---------------- ------- ------- Ending balance....................... Y(93,489) Y(152,936) Y(171,185) $(1,493) $(1,671) =============== ================ ================ ======= ======= Accumulated other comprehensive income: Beginning balance.................... Y -- Y -- Y -- $ -- $ -- Unrealized gain on investment in marketable security................ -- -- 28,315 -- 277 --------------- ---------------- ---------------- ------- ------- Ending balance....................... Y -- Y -- Y 28,315 $ -- $ 277 =============== ================ ================ ======= ======= See accompanying notes to financial statements. F-47
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UNITED SYSTEM ENGINEERS, INC. STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS [Enlarge/Download Table] THOUSANDS OF YEN THOUSANDS OF U.S. DOLLARS --------------------------------------------------------------------- ---------------------------- YEAR ENDED THREE MONTHS ENDED THREE MONTHS DECEMBER 31, MARCH 31, YEAR ENDED ENDED --------------------------------- --------------------------------- DECEMBER 31, MARCH 31, 1998 1999 1999 2000 1999 2000 --------------- --------------- --------------- --------------- ------------ ------------- (UNAUDITED) (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net loss................. Y (3,684) Y(59,447) Y(14,531) Y(18,249) $(580) $(178) Adjustments to reconcile net loss to net cash provided by (used in) operating activities-- Depreciation and amortization......... 6,144 6,180 1,454 1,266 60 12 Changes in assets and liabilities-- Accounts receivable......... 11,420 3,148 (5,025) (562) 31 (6) Unbilled revenue..... (5,103) (7,811) 5,979 115 (76) 2 Prepaid expenses..... (11,192) (1,125) 11,498 12,500 (11) 122 Other current assets............. (799) (52) 1,058 (1,047) (1) (10) Other assets......... (1,319) 131 52 52 1 1 Accounts payable..... (5,882) 8,500 -- (8,500) 83 (83) Customer advances and deferred revenue... 54 (11) 14 1,657 -- 17 Accrued vacation payable............ 908 663 (1) -- 6 -- Other accrued liabilities........ (2,970) 524 (1,999) (2,346) 5 (23) Income tax payable... -- -- (155) (155) -- (2) Other current liabilities........ (2,813) 5,859 2,950 (3,750) 57 (37) --------------- --------------- --------------- --------------- ----- ----- Net cash provided by (used in) operating activities......... (15,236) (43,441) 1,294 (19,019) (425) (185) =============== =============== =============== =============== ===== ===== Cash flows from investing activities: Purchases of buildings and improvements, and equipment.............. (1,529) (499) -- (152) (4) (1) Increase in time deposits............... (3,635) (20) (11) (6) -- -- --------------- --------------- --------------- --------------- ----- ----- Net cash used in investing activities........... (5,164) (519) (11) (158) (4) (1) --------------- --------------- --------------- --------------- ----- ----- Cash flows from financing activities: Proceeds from long term debt................... 85,200 -- -- 15,000 -- 146 Repayments of long term debt................... (22,780) (19,920) (4,800) (8,046) (194) (79) Increase (decrease) in short term debt, net... (21,186) 8,549 (600) 3,562 83 35 Sale of common shares.... 10,000 40,000 -- -- 390 -- --------------- --------------- --------------- --------------- ----- ----- Net cash provided by (used in) financing activities........... 51,234 28,629 (5,400) 10,516 279 102 =============== =============== =============== =============== ===== ===== Net increase (decrease) in cash and cash equivalents.............. 30,834 (15,331) (4,117) (8,661) (150) (84) Cash and cash equivalents: Beginning of period...... 24,588 55,422 55,422 40,091 541 391 --------------- --------------- --------------- --------------- ----- ----- End of period............ Y 55,422 Y 40,091 Y 51,305 Y 31,430 $ 391 $ 307 =============== =============== =============== =============== ===== ===== See accompanying notes to financial statements. F-48
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UNITED SYSTEM ENGINEERS, INC. STATEMENTS OF CASH FLOWS (CONTINUED) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS [Enlarge/Download Table] THOUSANDS OF YEN THOUSANDS OF U.S. DOLLARS --------------------------------------------------------------------- ---------------------------- YEAR ENDED THREE MONTHS ENDED THREE MONTHS DECEMBER 31, MARCH 31, YEAR ENDED ENDED --------------------------------- --------------------------------- DECEMBER 31, MARCH 31, 1998 1999 1999 2000 1999 2000 --------------- --------------- --------------- --------------- ------------ ------------- (UNAUDITED) (UNAUDITED) (UNAUDITED) Supplemental disclosure of cash flow information: Cash paid for interest... Y 7,219 Y 6,959 Y 1,658 Y 1,640 $ 67 $ 16 Cash paid for income taxes.................. Y 206 Y 206 Y 206 Y 206 $ 2 $ 2 Supplemental schedule of noncash investing and financing activities: Receipt of investment in marketable security as payment for services... Y -- Y -- Y -- Y 13,675 $ -- $ 134 See accompanying notes to financial statements. F-49
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (1) ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND DESCRIPTION OF BUSINESS United System Engineers, Inc. (the "Company") was founded on October 24, 1984. Since its founding, the Company has specialized in providing engineering and software development services. A majority of the Company's services have been provided to computer system vendors and integrators in Japan. The Company's experience has been concentrated in embedded systems development. In November 1997, the Company began to develop its proprietary Linux-based server application software product named WebMart. In March 1999, the Company began to generate revenues from the sale of WebMart directly through the Company's Internet homepage and is negotiating with other vendors and system integrators for indirect sales. The Company's revenues are generated from two sources: contract engineering services and sales of WebMart, including technical support of WebMart. The commercial success of WebMart is subject to certain risks including the uncertainty of market acceptance and life cycles. The Company is yet to recover the research and development costs of WebMart, which was financed primarily by bank borrowings. During the years ended December 31, 1998 and 1999 and the three months ended March 31, 2000, the Company suffered net losses and as March 31, 2000, the Company had a working capital deficit of Y71,805,000 ($701,000) and a stockholders' deficit of Y62,870,000 ($613,000). As discussed in Note 11, subsequent to March 31, 2000 the Company's shares of common stock have been acquired by Lineo, Inc. and Lineo, Inc. has committed to provide funding to the Company as required. BASIS OF PRESENTING FINANCIAL STATEMENTS The Company maintains its accounts and prepares its financial statements in conformity with Japanese income tax laws and accounting practices. However, the accompanying financial statements differ from those issued for domestic purposes in Japan. They reflect certain adjustments necessary to present the financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The principal adjustments necessary to conform to U.S. GAAP relate to accounting for costs of computer software to be sold, leased or otherwise marketed, certain accrued liabilities, comprehensive income and differences related to accounting for income taxes. The Company's functional currency is the Japanese yen and the accompanying financial statements are presented in yen. Additionally, as a convenience, the balance sheets as of December 31, 1999 and March 31, 2000 and the related statements of operations and comprehensive income (loss), stockholders' deficit and cash flows for the year and three months then ended are also presented in U.S. dollars by arithmetically translating all Japanese yen amounts at Y102.40 to US$1, which was the exchange rate at December 31, 1999. UNAUDITED INTERIM FINANCIAL STATEMENTS The unaudited interim financial statements as of March 31, 2000 and for the three months ended March 31, 1999 and 2000 have been prepared on the same basis as the audited financial statements F-50
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (1) ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) and, in the opinion of management, reflect all normal recurring adjustments necessary to present fairly the financial information set forth therein in accordance with U.S. GAAP. All financial statement disclosures related to the interim financial statements are unaudited. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with U.S. GAAP 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. TRANSLATION OF FOREIGN CURRENCIES In accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation", certain transactions entered into by the Company which are denominated in foreign currencies are translated into Japanese yen using the prevailing exchange rates as of the transaction dates. Assets and liabilities denominated in the foreign currencies are translated using exchange rates in effect at the balance sheet date. Exchange gains and losses relating to these assets and liabilities are included in the determination of net income (loss). STATEMENTS OF CASH FLOWS For purposes of the statements of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Cash equivalents consist principally of amounts in time deposits. MARKETABLE SECURITY The Company's investment in a marketable security has been categorized as available for sale, as defined by SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Unrealized holding gains and losses are reflected as a component of stockholders' deficit until realized. CONCENTRATION OF CREDIT RISK The Company offers credit terms on the sale of its software products to certain customers. The Company performs ongoing credit evaluations of its customers' financial condition and requires no collateral from its customers. The Company continually evaluates the need for an allowance for uncollectible accounts receivable based upon the expected collectibility of all accounts receivable. As of December 31, 1998 and 1999 and March 31, 2000, no allowance was recognized as the Company deemed its accounts receivable to be entirely collectible. DEPRECIATION Depreciation of buildings and equipment is computed by using the declining-balance method at rates based on the estimated useful lives of the assets, which range from 20 to 26 years for buildings (including improvements) and from two to ten years for equipment. Depreciation expense was F-51
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (1) ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Y5,668,000 ($55,000) and Y5,930,000 ($58,000) for the years ended December 31, 1998 and 1999, respectively. Amortization of intangible assets is computed by using the straight-line method based on a useful life of five years. Amortization expense was Y459,000 ($4,000) and Y250,000 ($2,000) for the years ended December 31,1998 and 1999, respectively. REVENUE Deferred revenue primarily relates to support agreements, which have been paid for by customers prior to the performance of the related services. REVENUE RECOGNITION In October 1997, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2"). Additionally, 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 98-9"). SOP 98-9 amends SOP 97-2 to require recognition of revenue using a "residual method" in certain circumstances. The Company has adopted SOP 97-2 and SOP 98-9 for all transactions entered into during the periods included in the accompanying financial statements. The Company generates revenue from software products sold directly to computer device manufacturers and end-users. The Company also generates services revenue from engineering, training and customer support fees. Revenue from contracted engineering services is recognized based upon the percentage completion method. The Company also provides training services to its customers and the related revenue is recognized as the services are performed. Revenue from the sale of software products is recognized upon delivery of the product when persuasive evidence of an arrangement exists, the price is fixed or determinable and collection is probable. All sales into the distribution channel require a binding purchase order. Direct sales to end-users are evidenced by concurrent payment for the product by transfer of funds and are governed by a license agreement. The sale of software products does not include product update or upgrade rights. If other significant post-delivery vendor obligations exist or if a product is subject to customer acceptance, revenue is deferred until no significant obligations remain or acceptance has occurred. To date, the Company has not shipped any software products subject to acceptance terms or subject to other post-delivery vendor obligations. Additionally, the Company has not recognized revenue on any contracts with customers that may include customer cancellation or termination clauses that indicate a demonstration period or otherwise incomplete transaction. The Company also offers its customers training and other services separate from the software sale. The services are not integral to the functionality of the software and are available from other vendors. This service revenue is generally recognized over the period during which the applicable service is to be performed or on a services-performed basis. F-52
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (1) ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) CAPITALIZED SOFTWARE COSTS In accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," development costs incurred in the research and development of new software products to be sold, leased or otherwise marketed are expensed as incurred until technological feasibility in the form of a working model has been established. Internally generated capitalizable software development costs have not been material for the years ended December 31, 1998 and 1999 and the three months ended January 31, 2000. The Company has charged its software development costs to research and development expense in the accompanying statements of operations. INCOME TAXES The Company recognizes a liability or asset for the deferred tax consequences of all temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years when the reported amounts of the assets and liabilities are recovered or settled. These deferred tax assets or liabilities are measured using the enacted tax rates that will be in effect when the differences are expected to reverse. Deferred tax assets are reviewed periodically for recoverability and valuation allowances are provided, as necessary. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," was issued. SFAS No. 133 establishes new accounting and reporting standards for companies to report information regarding derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. This statement is effective for all fiscal quarters of all fiscal years beginning after June 15, 2000 (or June 1, 2001 for the Company). The Company does not expect that SFAS No. 133 will have a material impact on the financial condition or results of the operations of the Company. In December 1999, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 101 ("SAB No. 1"), "Revenue Recognition in Financial Statements." This pronouncement summarizes certain of the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. The Company is required to adopt SAB No. 101 during the second quarter of 2000. Although management is currently evaluating the impact, if any, of SAB No. 101, management does not presently believe it will have a material impact on the Company's results of operations, financial position or liquidity. (2) MARKETABLE SECURITY As discussed in Note 5, the Company received 16,833 shares of Caldera Systems, Inc.'s common stock in exchange for services. This investment has been classified as an available-for-sale security in F-53
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (2) MARKETABLE SECURITY (CONTINUED) the accompanying financial statements. The cost, gross unrealized holding gain, and estimated fair value of the marketable security as of March 31, 2000 is as follows: [Download Table] THOUSANDS OF THOUSANDS OF YEN U.S. DOLLARS ---------------- ------------ Cost............................................. Y13,675 $134 Gross unrealized holding gain.................... 28,315 276 -------------- ---- Estimated fair value............................. Y41,990 $410 ============== ==== (3) SHORT-TERM AND LONG-TERM DEBT Short-term debt consisted primarily of short-term bank loans due to banks, shareholders and directors. The weighted-average annual interest rates applicable to short-term debt outstanding at December 31, 1998 and 1999, were 2.9 percent and 2.3 percent, respectively. The weighted-average borrowings during the years ended December 31, 1998 and 1999 were Y82,952,000 ($810,000) and Y69,055,000 ($674,000), respectively. F-54
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (3) SHORT-TERM AND LONG-TERM DEBT (CONTINUED) Long-term debt at December 31, 1998 and 1999, consisted of the following: [Enlarge/Download Table] THOUSANDS OF YEN --------------------------------------------------- THOUSANDS OF U.S. DOLLARS DECEMBER 31, ------------------------- --------------------------------- MARCH 31, DECEMBER 31, MARCH 31, 1998 1999 2000 1999 2000 --------------- --------------- --------------- ------------ ---------- Long-term loan from 82 Bank: interest at 2.8 percent per annum payable monthly, principal due in monthly installments through 2003; secured by building; guaranteed by directors and stockholder........................... Y 47,216 Y 34,520 Y 31,346 $ 338 $ 306 --------------- --------------- --------------- ----- ----- Long-term loan from Ina Shinkin Bank: interest at 3.2 percent per annum payable monthly, principal due in monthly installments through 2003; secured by building and time deposit; guaranteed by directors and stockholder........................... 68,674 63,370 73,978 619 722 --------------- --------------- --------------- ----- ----- Long-term loan from People's Finance Corporation: interest at 2.3 percent per annum payable monthly, principal due in monthly installments through 2003; secured by building; guaranteed by directors and stockholder.......... 12,000 10,080 9,600 98 94 --------------- --------------- --------------- ----- ----- Less current maturities................. (19,920) (31,094) (31,484) (304) (308) --------------- --------------- --------------- ----- ----- Long-term debt.......................... Y107,970 Y 76,876 Y 83,440 $ 751 $ 814 =============== =============== =============== ===== ===== As is customary in Japan, substantially all bank loans are made under agreements which provide that the banks may require, under certain conditions, the borrower to provide collateral or guarantors for its loans. Lending banks have a right to offset cash deposited with them against any debt or obligation that becomes due and, in the case of default and certain other specified events, against all other debt payable to the banks. The Company paid guarantee fees and pledged a building with a book value of Y1,896,000 ($18,000) as of December 31, 1999 as security to the credit guarantee company. Additionally, another building with a book value of Y43,494,000 ($424,000) as of December 31, 1999 and a time deposit of Y20,024,000 ($195,000) are pledged as security to the banks. Furthermore all loans are guaranteed by the Company's directors and stockholders. F-55
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (3) SHORT-TERM AND LONG-TERM DEBT (CONTINUED) Annual maturities of long-term debt as of December 31, 1999 are as follows: [Download Table] THOUSANDS OF YEAR ENDING DECEMBER 31 THOUSANDS OF YEN U.S. DOLLARS ----------------------- ---------------- ------------ 2000......................................... Y 31,094 $ 304 2001......................................... 27,744 271 2002......................................... 27,744 271 2003......................................... 21,388 209 --------------- ------ Total........................................ Y107,970 $1,055 =============== ====== (4) RETIREMENT BENEFIT PLANS The Company has defined contribution benefit plans, which provide retirement benefits to qualified employees. The Company makes discretionary contributions principally based on individual technical skills and experience. The Company's contributions are expensed as incurred and totaled Y2,472,000 ($24,000) and Y2,252,000 ($22,000) for the years ended December 31, 1998 and 1999, respectively. (5) COMMITMENTS AND CONTINGENCIES SOFTWARE LOCALIZATION AGREEMENT On October 1, 1999, the Company entered into an agreement with Caldera Systems, Inc. ("Caldera") to localize certain of Caldera's software products for the Japanese market. As consideration, Caldera agreed to pay $250,000 in cash or issue to the Company shares of Caldera's common stock with a market value of $202,000, based on Caldera's initial public offering price per share. On January 4, 2000, the Company and Caldera amended the agreement pursuant to which Caldera agreed to issue 33,667 shares of common stock to the Company for the services, of which 16,833 were to be issued immediately for services previously rendered and the remaining 16,834 are to be issued upon completion of the localization services. In the event that the localized software is not accepted by Caldera under the agreement prior to December 31, 2001, then the Company shall pay $100,000 to Caldera. However, the Company shall have no obligation to pay such amount if the localized software is not accepted by Caldera prior to December 31, 2001 because Caldera unreasonably withheld or delayed such acceptance. Based on the performance commitment, the date of the amended contract has been determined to be the measurement date and the estimated fair value of Caldera's common stock on that date was $269,336, or $8 per share. As of December 31,1999, the Company recognized Y13,790,000 ($135,000) of revenue based upon the percentage completion method (see Note 1). OPERATING LEASE AGREEMENTS The Company leases land for operating facilities and equipment under cancelable and non-cancelable operating lease agreements. Rent expense under these lease agreements amounted to F-56
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (5) COMMITMENTS AND CONTINGENCIES (CONTINUED) Y2,432,000 ($23,000) and Y2,084,000 ($20,000) for the years ended December 31, 1998 and 1999, respectively. As of December 31, 1999, the future minimum lease payments under these operating leases were as follows: [Download Table] YEAR ENDING DECEMBER 31, THOUSANDS OF YEN THOUSANDS OF U.S. DOLLARS ------------------------ ---------------- ------------------------- 2000................................ Y 2,052 $ 20 2001................................ 2,052 20 2002................................ 2,052 20 2003................................ 2,052 20 2004................................ 2,052 20 Thereafter.......................... 12,312 120 -------------- ---- Total............................... Y22,572 $220 ============== ==== (6) STOCKHOLDERS' DEFICIT The Japanese Commercial Code (the "Code") provides that at least one-half of the issue price of new shares, with a minimum of the par value thereof, be included in common stock. The issue price is the price determined by the Board of Directors of a company. In December 1998 and 1999, the Company issued 20,000 and 40,000 shares of Common Stock at par value, Y 500 ($4.88) per share. As of December 31, 1999, the Company had received Y20,000,000 ($195,312) in exchange for 40,000 shares of common stock to be issued. The shares were not actually issued until February 2000; however, they have been reflected as issued and outstanding in the accompanying balance sheet as of December 31, 1999. At December 31, 1998 and 1999, the Company had an accumulated deficit and had no amounts legally available for distribution to stockholders. F-57
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (7) INCOME TAXES The significant components of the Company's net deferred income tax assets at December 31, 1998 and 1999 are as follows: [Enlarge/Download Table] THOUSANDS OF THOUSANDS OF YEN U.S. DOLLARS --------------------------------- ------------ DECEMBER 31, --------------------------------- DECEMBER 31, 1998 1999 1999 --------------- --------------- ------------ Deferred income tax assets: Net operating loss carryforwards.......... Y 36,686 Y 62,882 $ 614 Research and development expenses......... 11,860 -- -- Deferred expenses......................... -- 8,982 87 Accrued vacation pay...................... 2,564 2,569 25 Other..................................... 980 977 9 Deferred revenue.......................... (2,775) (6,245) (60) Prepaid bonus............................. (5,096) (5,025) (49) --------------- --------------- ----- Net deferred income tax assets.......... 44,219 64,140 626 Valuation allowance......................... (44,219) (64,140) (626) --------------- --------------- ----- Net deferred income tax assets.......... Y -- Y -- $ -- =============== =============== ===== The amount of and ultimate realization of the net deferred income tax assets is dependent, in part, upon the tax laws in effect, the Company's future earnings, and other future events, the effects of which cannot be determined. The Company has established a valuation allowance against its deferred income tax assets because the available objective evidence creates sufficient uncertainty regarding their realizability. Under Japanese tax regulation, the Company can carry forward net operating losses for five years. The net operating loss carryforwards as of December 31, 1999 will expire as follows: [Download Table] THOUSANDS OF YEAR OF EXPIRATION THOUSANDS OF YEN U.S. DOLLARS ------------------ ---------------- ------------ 2000......................................... Y 21,455 $ 209 2001......................................... 57,610 563 2004......................................... 72,457 707 --------------- ------ Total........................................ Y151,522 $1,479 =============== ====== F-58
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (7) INCOME TAXES (CONTINUED) The differences between the statutory tax rates and the effective tax rates for the years ended December 31, 1998 and 1999 are summarized as follows: [Download Table] DECEMBER 31, ------------------- 1998 1999 -------- -------- Statutory tax rate.......................................... (49.7)% (46.4)% Effect of tax rate change................................... 90.7 12.8 Change in valuation allowance............................... (40.8) 33.6 Minimum inhabitant tax...................................... (5.9) (0.3) Other....................................................... (0.2) -- ----- ----- Effective tax rate.......................................... (5.9)% (0.3)% ===== ===== Effective April 1, 1999, the statutory tax rate was reduced to approximately 41.5 percent and such rate has been used in calculating the future expected tax effects of temporary differences as of December 31, 1999. The provision for income taxes in the statements of operations reflects only the minimum inhabitant tax due to the Company's loss from operations. (8) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the accompanying financial statements for cash and cash equivalents, time deposits, accounts receivables, short-term debt, and accounts payable approximate fair values because of the immediate or short-term maturity of these financial instruments. The carrying amount of the Company's marketable security also approximates fair value because the investment has been classified as available for sale and recorded at the quoted market price. The estimated fair values of the Company's long-term debt obligations have been determined based on the present value of future cash flows associated with each instrument discounted using the current borrowing rate for similar debt of comparable maturity. As of December 31, 1999, the Company's long-term debt, which had a carrying amount of Y107,970,000 ($1,055,000), had an estimated fair value of Y110,525,000 ($1,079,000). (9) SEGMENT INFORMATION In June 1998, SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" was issued. SFAS 131 establishes disclosures related to components of a company for which separate financial information is available and evaluated regularly by a company's chief operating decision makers in deciding how to allocate resources and in assessing performance. It also requires segment disclosures about products and services as well as geographic areas. The Company has determined that it did not have any separately reportable operating segments as of December 31, 1998 and 1999. F-59
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (9) SEGMENT INFORMATION (CONTINUED) However, the Company generates revenue in geographic locations outside of Japan. Revenue attributable to individual countries based on the location of sales is as follows: [Enlarge/Download Table] THOUSANDS OF YEN THOUSANDS OF U.S. DOLLARS ------------------------------------------------------------------- --------------------------- YEAR ENDED THREE MONTHS ENDED THREE MONTHS DECEMBER 31, MARCH 31, YEAR ENDED ENDED --------------------------------- ------------------------------- DECEMBER 31, MARCH 31, 1998 1999 1999 2000 1999 2000 --------------- --------------- -------------- -------------- ------------ ------------ (UNAUDITED) (UNAUDITED) (UNAUDITED) Japan....................... Y202,408 Y143,317 Y34,050 Y31,729 $1,399 $ 310 Other countries............. -- 13,790 -- -- 135 -- --------------- --------------- -------------- -------------- ------ ----- Total revenue............. Y202,408 Y157,107 Y34,050 Y31,729 $1,534 $ 310 =============== =============== ============== ============== ====== ===== Sales to significant customers as a percentage of total revenue are as follows: [Download Table] YEAR ENDED DECEMBER 31, ----------------------- CUSTOMER 1998 1999 -------- -------- -------- Seiko Epson................................................. 40.0% 44.6% Mikuni Industry............................................. 9.0 20.3 (10) RELATED PARTY TRANSACTIONS The Company's stockholders and directors have made short-term loans to the Company from time to time. Certain of the loans are non-interest bearing. The Company has imputed interest on the loans, which has been reflected as additional capital contributions. The Company has also agreed to pay consulting fees to certain stockholders in connection with the Caldera transaction discussed in Note 5. The following table summarizes the amounts due from (due to) stockholders and the related interest expense and other transactions as of and for the years ended December 31, 1998 and 1999, and as of and for the three months ended March 31, 2000. [Enlarge/Download Table] THOUSANDS OF YEN THOUSANDS OF U.S. DOLLARS -------------------------------------------------- -------------------------- DECEMBER 31, DECEMBER 31, MARCH 31, DECEMBER 31, MARCH 31, 1998 1999 2000 1999 2000 -------------- --------------- --------------- ------------ ----------- (UNAUDITED) (UNAUDITED) Interest bearing short-term debt..... Y(8,600) Y(15,550) Y(15,550) $(151) $(151) Non-interest bearing short-term debt............................... (3,135) (734) (334) (7) (3) Consulting fees...................... -- 8,500 -- 83 -- Consulting fees payable.............. -- (8,500) -- (83) -- F-60
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UNITED SYSTEM ENGINEERS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000 IS UNAUDITED) (10) RELATED PARTY TRANSACTIONS (CONTINUED) The weighted average amount of non-interest short-term loans from stockholders and directors for the years ended December 31, 1998 and 1999 and for the three months ended March 31, 2000 were as follows: [Enlarge/Download Table] THOUSANDS OF YEN THOUSANDS OF U.S. DOLLARS ----------------------------------------------------------- ------------------------------ DECEMBER 31, DECEMBER 31, MARCH 31, DECEMBER 31, MARCH 31, 1998 1999 2000 1999 2000 --------------- --------------- --------------- ------------ ----------- (UNAUDITED) (UNAUDITED) Y(18,031) Y(14,392) Y(16,083) $(140) $(157) (11) SUBSEQUENT STOCK PURCHASE AGREEMENT On April 13, 2000, the Company's stockholders and Lineo, Inc. ("Lineo") entered into a stock purchase agreement pursuant to which Lineo agreed to purchase all of the issued and outstanding capital stock of the Company for $322,829 of cash and 507,333 options to purchase shares of Lineo common stock at $3.00 per share. The stock purchase agreement is effective May 1, 2000. In addition, Lineo agreed to grant 175,000 additional options to purchase shares of Lineo's common stock to the employees of the Company who will become employees of Lineo for future services. F-61
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Fireplug Computers Inc: We have audited the accompanying balance sheets of Fireplug Computers Inc. (a British Columbia, Canada company) as of December 31, 1998 and 1999, and the related statements of operations and comprehensive loss, stockholders' deficit and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Fireplug Computers Inc. as of December 31, 1998 and 1999, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN Vancouver, British Columbia May 15, 2000 F-62
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FIREPLUG COMPUTERS INC. BALANCE SHEETS (U.S. DOLLARS) [Enlarge/Download Table] DECEMBER 31, ------------------- MARCH 31, 1998 1999 2000 -------- -------- ----------- (UNAUDITED) ASSETS Current assets: Cash...................................................... $ 2,462 $ 9,334 $ 537 Accounts receivable, net of allowance for doubtful accounts of $0, $0, and $9,803, respectively............ 304 1,008 25,189 -------- -------- --------- Total current assets.................................... 2,766 10,342 25,726 -------- -------- --------- Property and equipment: Computer equipment........................................ 43,485 50,406 61,924 Furniture and fixtures.................................... 5,394 5,394 8,063 -------- -------- --------- 48,879 55,800 69,987 Less accumulated depreciation............................. (19,944) (40,777) (44,351) -------- -------- --------- Net property and equipment.............................. 28,935 15,023 25,636 -------- -------- --------- $ 31,701 $ 25,365 $ 51,362 ======== ======== ========= LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable.......................................... $ 6,714 $ 19,113 $ 27,051 Accrued liabilities....................................... -- 6,103 32,157 Deferred revenue.......................................... -- 3,465 -- Advances from stockholders................................ 72,951 82,015 62,476 -------- -------- --------- Total current liabilities............................... 79,665 110,696 121,684 -------- -------- --------- Commitments and contingencies (Note 6) Stockholders' deficit: Class C redeemable preferred stock, CDN$1.00 par value; 2,000,000 shares designated, none outstanding........... -- -- -- Class A voting shares, no par value; 2,000,000 shares designated, 412, 412 and 463 shares outstanding, respectively............................................ 288 288 134,074 Class B non-voting shares, no par value; 2,000,000 shares designated, none outstanding............................ -- -- -- Accumulated deficit....................................... (49,930) (83,317) (199,394) Cumulative translation adjustments........................ 1,678 (2,302) (5,002) -------- -------- --------- Total stockholders' deficit............................. (47,964) (85,331) (70,322) -------- -------- --------- $ 31,701 $ 25,365 $ 51,362 ======== ======== ========= See accompanying notes to financial statements. F-63
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FIREPLUG COMPUTERS INC. STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (U.S. DOLLARS) [Enlarge/Download Table] YEAR ENDED THREE MONTHS ENDED DECEMBER 31, MARCH 31, ------------------- ------------------------- 1998 1999 1999 2000 -------- -------- ----------- ----------- (UNAUDITED) (UNAUDITED) Revenue............................................ $ 33,025 $144,778 $16,618 $ 69,186 Cost of revenue.................................... 34,128 88,996 10,008 24,733 -------- -------- ------- --------- Gross margin................................... (1,103) 55,782 6,610 44,453 -------- -------- ------- --------- Operating expenses: Sales and marketing.............................. 15,052 32,382 6,280 27,794 General and administrative (exclusive of non-cash stock-related compensation of $114,500 in the three months ended March 31, 2000)............. 32,003 56,787 5,184 18,236 Non-cash stock related compensation.............. -- -- -- 114,500 -------- -------- ------- --------- Total operating expenses....................... 47,055 89,169 11,464 160,530 -------- -------- ------- --------- Net loss........................................... $(48,158) $(33,387) $(4,854) $(116,077) ======== ======== ======= ========= Comprehensive loss: Net loss......................................... $(48,158) $(33,387) $(4,854) $(116,077) Foreign currency translation adjustments......... 1,629 (3,980) (788) (2,700) -------- -------- ------- --------- $(46,529) $(37,367) $(5,642) $(118,777) ======== ======== ======= ========= See accompanying notes to financial statements. F-64
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FIREPLUG COMPUTERS, INC. STATEMENTS OF STOCKHOLDERS' DEFICIT (U.S. DOLLARS) [Enlarge/Download Table] CLASS A VOTING CUMULATIVE TOTAL ------------------- ACCUMULATED TRANSLATION STOCKHOLDERS' SHARES AMOUNT DEFICIT ADJUSTMENTS DEFICIT -------- -------- ----------- ----------- ------------- Balance, December 31, 1997.............. 412 $ 288 $ (1,772) $ 49 $ (1,435) Foreign currency translation adjustments........................... -- -- -- 1,629 1,629 Net loss................................ -- -- (48,158) -- (48,158) --- -------- --------- ------- --------- Balance, December 31, 1998.............. 412 288 (49,930) 1,678 (47,964) Foreign currency translation adjustments........................... -- -- -- (3,980) (3,980) Net loss................................ -- -- (33,387) -- (33,387) --- -------- --------- ------- --------- Balance, December 31, 1999.............. 412 288 (83,317) (2,302) (85,331) Issuance of Class A voting shares for services (unaudited).................. 43 114,500 -- -- 114,500 Issuance of Class A voting shares upon conversion of advance from stockholder (unaudited)........................... 8 19,286 -- -- 19,286 Foreign currency translation adjustments (unaudited)........................... -- -- -- (2,700) (2,700) Net loss (unaudited).................... -- -- (116,077) -- (116,077) --- -------- --------- ------- --------- Balance, March 31, 2000 (unaudited)..... 463 $134,074 $(199,394) $(5,002) $ (70,322) === ======== ========= ======= ========= See accompanying notes to financial statements. F-65
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FIREPLUG COMPUTERS INC. STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH [Enlarge/Download Table] YEAR ENDED DECEMBER 31, THREE MONTHS ENDED MARCH 31, ------------------------ ----------------------------- 1998 1999 1999 2000 ---------- ----------- ------------- ------------- (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net loss................................ $(48,158) $(33,387) $(4,854) $(116,077) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation.......................... 19,944 20,833 4,893 3,574 Non-cash stock related compensation... -- -- -- 114,500 Changes in operating assets and liabilities: Accounts receivable................. (304) (704) 260 (24,181) Accounts payable.................... 6,883 12,399 (5,393) 7,938 Accrued liabilities................. -- 6,103 6,737 26,054 Deferred revenue.................... -- 3,465 -- (3,465) -------- -------- ------- --------- Net cash provided by (used in) operating activities............ (21,635) 8,709 1,643 8,343 -------- -------- ------- --------- Cash flows from investing activities: Purchase of property and equipment...... -- (6,921) (462) (14,187) -------- -------- ------- --------- Cash flows from financing activities: Advances from stockholders.............. 22,468 9,064 1,558 (253) -------- -------- ------- --------- Net increase (decrease) in cash........... 833 10,852 2,739 (6,097) Foreign currency translation adjustments............................. 1,629 (3,980) (788) (2,700) Cash, beginning of period................. -- 2,462 2,462 9,334 -------- -------- ------- --------- Cash, end of period....................... $ 2,462 $ 9,334 $ 4,413 $ 537 ======== ======== ======= ========= Supplemental disclosure of non-cash investing and financing activities: Conversion of advance from stockholder to Class A voting shares.............. $ -- $ -- $ -- $ 19,286 See accompanying notes to financial statements. F-66
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FIREPLUG COMPUTERS INC. NOTES TO FINANCIAL STATEMENTS (INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) (1) ORGANIZATION AND DESCRIPTION OF BUSINESS Fireplug Computers Inc. (the "Company") was incorporated under the laws of British Columbia on April 11, 1997. The Company is a developer of embedded Linux network application software solutions and embedded Linux tools. On May 1, 2000, the Company's stockholders entered into an agreement with Lineo, Inc. ("Lineo"), a United States corporation. Pursuant to the agreement, Lineo acquired all of the outstanding stock of the Company in exchange for $500,000 in cash, 69,998 shares of Lineo's series D convertible preferred stock and options to purchase 62,220 shares of Lineo's common stock. The options have a vesting period of one year, an exercise price of $1.50 per share and expire ten years from the date of grant. Lineo has committed to provide funding to the Company as required. (2) SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States. UNAUDITED INTERIM FINANCIAL STATEMENTS The unaudited interim financial statements as of March 31, 2000 and for the three months ended March 31, 1999 and 2000 have been prepared on the same basis as the audited financial statements and, in the opinion of management, reflect all normal recurring adjustments necessary to present fairly the financial information set forth therein in accordance with accounting principles generally accepted in the United States. The results of operations for the three months ended March 31, 2000 are not necessarily indicative of the results to be expected for the entire year ending December 31, 2000. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the accompanying financial statements for cash, accounts receivable and accounts payable approximate fair values because of the immediate or short-term maturities of these financial instruments. FOREIGN CURRENCY TRANSLATION The Company prepares its statements in Canadian dollars since its functional currency is the Canadian dollar. As a result of the acquisition discussed in Note 1, the accompanying financial statements are denominated in U.S. dollars. The Company has translated its Canadian dollar financial F-67
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FIREPLUG COMPUTERS INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) statements into U.S. dollars using the current method. Under this method, monetary and non-monetary items are translated at the rate of exchange in effect at the balance sheet date and revenue and expenses are translated at the average exchange rate for the periods. Depreciation of assets is translated at the same exchange rate as the assets to which they relate. PROPERTY AND EQUIPMENT Property and equipment are stated at cost, less accumulated depreciation and amortization. Computer equipment and furniture and fixtures are depreciated using the straight-line method over the estimated useful life of the asset, typically three years. Expenditures for repairs and maintenance are charged to expense when incurred. Expenditures for major renewals and betterments that extend the useful lives of existing equipment are capitalized and depreciated. On retirement or disposition of property and equipment, the cost and related accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is recognized in the statement of operations. IMPAIRMENT OF LONG-LIVED ASSETS Long-lived assets are comprised principally of equipment and fixtures. The Company reviews its long-lived assets for impairment when events or changes in circumstances indicate that the book value of an asset may not be recoverable. The Company evaluates, at each balance sheet date, whether events and circumstances have occurred which indicate possible impairment. The Company uses an estimate of future undiscounted net cash flows of the related asset or group of assets over the remaining life in measuring whether the assets are recoverable. As of December 31, 1999 and March 31, 2000, the Company does not consider any of its long-lived assets to be impaired. REVENUE RECOGNITION The Company generates revenue from engineering services. Revenue is recognized as services are performed. Amounts received in advance of services being performed are recorded as deferred revenue. INCOME TAXES The Company recognizes a current tax liability or asset for current taxes payable or refundable and a deferred income tax liability or asset for the estimated future tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting and their tax basis and loss carry forwards to the extent they are realizable. A deferred income tax valuation allowance is required if it is "more likely than not" that all or a portion of recorded future tax assets will not be realized. CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS The Company offers credit terms on the sale of its consulting services to its customers. The Company performs ongoing credit evaluations of its customers' financial condition and requires no F-68
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FIREPLUG COMPUTERS INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) collateral from its customers. The Company continually evaluates the need for an allowance for uncollectable accounts receivable based upon the expected collectability of all accounts receivable. As of March 31, 2000, one customer accounted for 97 percent of gross accounts receivable. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes new accounting and reporting standards for companies to report information about derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. This statement is effective for financial statements issued for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not expect this statement to have a material impact on the Company's results of operations, financial position or liquidity. In December 1999, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in Financial Statements." This pronouncement summarizes certain of the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. The Company is required to adopt SAB No. 101 during the second quarter of 2000. Although management is currently evaluating the impact, if any, of SAB No. 101, management does not presently believe it will have a material impact on the Company's results of operations, financial position or liquidity. (3) STOCKHOLDERS' DEFICIT AUTHORIZED SHARES The Company's articles of incorporation provide for the issuance of Class A, B and C shares and sets forth the preferences, limitations and relative rights granted or imposed upon each class of preferred stock. Dividends may be declared on the Class A, B and C shares at the discretion of the Board of Directors. The Class C shares are redeemable and have priority over Class A and B shares with respect to liquidation, winding up or dissolution. The Class B shares have no voting rights. CLASS A ISSUANCES During the three months ended March 31, 2000, the Company issued 43 shares of Class A stock to employees and consultants for services rendered. The estimated fair value of the Class A shares on the date of issuance was deemed to be $114,500, based on the consideration paid by Lineo to acquire the Company on May 1, 2000. The $114,500 has been reflected as non-cash stock-related compensation in the accompanying statement of operations for the three months ended March 31, 2000. During the three months ending March 31, 2000, the Company issued 8 shares of Class A stock in connection with a conversion of $19,826 of advances from stockholders (See Note 4). F-69
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FIREPLUG COMPUTERS INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) (4) RELATED PARTY TRANSACTIONS During the year ended December 31, 1998, certain stockholders of the Company transferred $48,879 of property and equipment to the Company. The Company recorded the carry-over basis of these assets as advances from stockholders. Advances from stockholders represent amounts owed to stockholders for property and equipment transferred to the Company and for expenses incurred on behalf of the Company. The advances are non-interest bearing and have no fixed repayment terms. During the three months ended March 31, 2000, advances from stockholders of $19,826 were converted into 8 shares of Class A stock (see Note 3). (5) INCOME TAXES The components of the Company's income tax provision computed at the combined statutory Canadian federal and provincial income tax rate for the years ended December 31, 1998 and 1999 are as follows: [Download Table] 1998 1999 -------- -------- Income tax benefit at statutory rates...................... $9,632 $ 6,677 Change in valuation allowance.............................. (9,632) (6,677) ------ ------- $ -- $ -- ====== ======= The deferred income tax assets resulting from differences in the timing of the recognition of certain income and expense items for income tax and financial accounting purposes at December 31, 1998 and 1999 are as follows: [Download Table] 1998 1999 -------- -------- Net operating loss carryforwards......................... $ 8,575 $ 12,741 Depreciation............................................. 1,105 3,616 ------- -------- 9,680 16,357 Less: valuation allowance................................ (9,680) (16,357) ------- -------- Net deferred income taxes................................ $ -- $ -- ======= ======== The ultimate realization of the deferred income tax assets is dependent, in part, upon the tax laws in effect, the Company's future earnings, and other future events, the effects of which cannot be determined. The Company has established a valuation allowance against its deferred income tax assets because the available objective evidence creates sufficient uncertainty regarding their realizability. At December 31, 1999, the Company's net operating loss carryforwards totaled $64,000 and expire as follows: $43,000 in 2004 and $21,000 in 2005. F-70
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FIREPLUG COMPUTERS INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) (6) COMMITMENTS AND CONTINGENCIES The Company may become party to certain legal proceedings arising in the ordinary course of business. Management believes, after consultation with legal counsel, that as of December 31, 1999 and March 31, 2000, no pending or threatened legal proceedings exist which would have a material adverse effect on the Company's financial position, liquidity or results of operations. F-71
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REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders of INUP S.A. In our opinion, the accompanying balance sheet and the related statement of operations, stockholders' equity, and cash flows present fairly, in all material respects, the financial position of INUP S.A. (a development stage company) (the "Company") at December 31, 1999, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. 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 audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States 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 audit provides a reasonable basis for the opinion expressed above. THE STATUTORY AUDITOR Befec -- Price Waterhouse Member of PricewaterhouseCoopers Paris, France April 28, 2000, except as to Notes 3 and 8 which are as of May 1, 2000 F-72
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INUP S.A. (A DEVELOPMENT STAGE COMPANY) BALANCE SHEETS (U.S. DOLLARS) [Enlarge/Download Table] DECEMBER 31, MARCH 31, 1999 2000 ------------ ----------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 757,603 $ 519,815 Accounts receivable....................................... 62,992 95,259 Prepaid expenses.......................................... 9,666 3,146 Other current assets...................................... 1,623 2,030 --------- --------- Total current assets.................................... 831,884 620,250 --------- --------- Property and equipment, net................................. 148,243 155,877 --------- --------- Total assets............................................ $ 980,127 $ 776,127 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 152,487 $ 103,681 Accrued liabilities....................................... 10,021 35,342 --------- --------- Total liabilities....................................... 162,508 139,023 --------- --------- Commitments and contingencies (Note 6) Stockholders' Equity: Common stock, $0.25 par value, 750,000 shares authorized, issued and outstanding.................................. 188,363 188,363 Additional paid-in capital................................ 738,577 738,577 Accumulated other comprehensive (loss) income............. 997 (37,712) Deficit accumulated during the development stage.......... (110,318) (252,124) --------- --------- Total stockholders' equity.............................. 817,619 637,104 --------- --------- Total liabilities and stockholders' equity.............. $ 980,127 $ 776,127 ========= ========= The accompanying notes are an integral part of these financial statements. F-73
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INUP S.A. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF OPERATIONS (U.S. DOLLARS) [Enlarge/Download Table] PERIOD FROM INCEPTION YEAR ENDED THREE MONTHS (JANUARY 1, 1999) DECEMBER 31, ENDED MARCH 31, THROUGH 1999 2000 MARCH 31, 2000 ------------ --------------- ----------------- (UNAUDITED) (UNAUDITED) Revenue.......................................... $ 8,355 $ -- $ 8,355 Cost of revenue.................................. 1,785 -- 1,785 --------- --------- --------- Gross profit................................... 6,570 6,570 Sales, general and administrative expenses....... 131,556 181,469 313,025 --------- --------- --------- Loss from operations............................. (124,986) (181,469) (306,455) --------- --------- --------- Other income (expense)........................... Interest income (expense)...................... (60) 494 434 Other non-operating income (expense)........... 10 (1) 9 --------- --------- --------- Other income (expense), net.................. (50) 493 443 --------- --------- --------- Loss before income taxes......................... (125,036) (180,976) (306,012) Income tax credit................................ 14,718 39,170 53,888 --------- --------- --------- Net loss......................................... $(110,318) $(141,806) $(252,124) ========= ========= ========= The accompanying notes are an integral part of these financial statements. F-74
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INUP S.A. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF STOCKHOLDERS' EQUITY (U.S. DOLLARS) [Enlarge/Download Table] DEFICIT ACCUMULATED ACCUMULATED COMMON STOCK ADDITIONAL DURING THE OTHER STOCKHOLDERS' ------------------- PAID-IN DEVELOPMENT COMPREHENSIVE EQUITY COMPREHENSIVE SHARES AMOUNT CAPITAL STAGE INCOME (LOSS) TOTAL LOSS -------- -------- ---------- ------------ -------------- ------------- -------------- Common stock issued for cash on January 1, 1999 at $0.25 per share................... 32,000 $ 8,037 $ -- -- $ -- $ 8,037 -- Common stock issued for cash on November 3, 1999 at $1.28 per share................... 718,000 180,326 738,577 -- -- 918,903 -- Comprehensive loss: Net loss.................... -- -- -- $(110,318) -- (110,318) $(110,318) Other comprehensive income: Foreign currency translation adjustment.............. -- -- -- -- 997 997 997 Comprehensive loss........ -- -- -- -- -- -- $(109,321) ------- -------- -------- --------- -------- --------- ========= Balances, December 31, 1999... 750,000 188,363 738,577 (110,318) 997 817,619 Comprehensive loss: Net loss (unaudited)........ -- -- -- (141,806) -- (141,806) $(141,806) Other comprehensive loss: Foreign currency translation adjustment (unaudited)............. -- -- -- -- (38,709) (38,709) (38,709) --------- Comprehensive loss (unaudited)........... -- -- -- -- -- -- $(180,515) ------- -------- -------- --------- -------- --------- --------- Balances, March 31, 2000 (unaudited)................. 750,000 $188,363 $738,577 $(252,124) $(37,712) $ 637,104 ======= ======== ======== ========= ======== ========= The accompanying notes are an integral part of these financial statements. F-75
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INUP S.A. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF CASH FLOWS (U.S. DOLLARS) [Enlarge/Download Table] THREE PERIOD FROM MONTHS INCEPTION YEAR ENDED ENDED (JANUARY 1, 1999) DECEMBER 31, MARCH 31, THROUGH 1999 2000 MARCH 31, 2000 ------------- ----------- ------------------ (UNAUDITED) (UNAUDITED) Cash flows from operations: Net loss............................................ $(110,318) $(141,806) $(252,124) Adjustments to reconcile net loss to net cash used in operations: Depreciation...................................... 11,280 29,680 40,960 Changes in operating assets and liabilities: Accounts receivable............................. (62,992) (32,267) (95,259) Prepaid expenses................................ (9,666) 6,520 (3,146) Other current assets............................ (1,623) (407) (2,030) Accounts payable................................ 152,487 (48,806) 103,681 Accrued liabilities............................. 10,021 25,321 35,342 --------- --------- --------- Net cash used in operating activities............. (10,811) (161,765) (172,576) --------- --------- --------- Cash flows from investing activities: Purchase of property and equipment................ (159,523) (37,314) (196,837) --------- --------- --------- Net cash used in investing activities............. (159,523) (37,314) (196,837) --------- --------- --------- Cash flows from financing activities: Proceeds from issuance of common stock............ 926,940 -- 926,940 --------- --------- --------- Net cash provided by financing activities......... 926,940 -- 926,940 --------- --------- --------- Effect of exchange rate changes on cash and cash equivalents....................................... 997 (38,709) (37,712) --------- --------- --------- Net increase (decrease) in cash and cash equivalents....................................... 757,603 (237,788) 519,815 Cash and cash equivalents beginning of period....... -- 757,603 -- --------- --------- --------- Cash and cash equivalents end of period............. $ 757,603 $ 519,815 $ 519,815 ========= ========= ========= The accompanying notes are an integral part of these financial statements. F-76
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INUP S.A. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (U.S. DOLLARS) 1. ORGANIZATION OF THE COMPANY AND NATURE OF OPERATIONS INUP S.A. ("the Company") was formed on January 1, 1999 pursuant to French articles of incorporations as SOCIETE A RESPONSABILITE LIMITE (Limited Liability Company). The Company subsequently changed its corporate structure to that of a SOCIETE ANONYME (Corporation) on November 30, 1999. The Company seeks to produce and sell services and products associated with computer systems, electronics and telecommunications. Specifically, the Company currently aims to produce and sell suites for embedded and scalable Linux-based computer systems. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF ACCOUNTING AND PRESENTATION The Company maintains its accounting records and prepares its statutory financial statements in conformity with generally accepted accounting principles in France. The financial statements and notes are representations of the Company's management, who is responsible for their integrity and objectivity. These financial statements have been translated into US Dollars according to the guidance of Statement of Financial Accounting Standards No. 52, "Foreign Currency Translation" ("SFAS 52") and include certain adjustments, not recorded in the Company's accounting records, to present these financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") and conform to the standards applicable to development stage companies. The Company's functional currency is the European Currency Unit ("Euro"). FOREIGN CURRENCY TRANSLATION Under the provisions of SFAS 52, the accompanying financial statements have been translated from Euros to US Dollars as follows: - All assets and liabilities have been translated into US Dollars using the current exchange rate at the balance sheet date. Equity accounts have been translated using historical exchange rates. - Income statement accounts have been translated into US Dollars using the average exchange rate over the period presented. - The adjustment from translation of the Company's financial statements into US Dollars is reported as a separate component of other comprehensive income. UNAUDITED INTERIM FINANCIAL STATEMENTS The unaudited interim financial statements as of March 31, 2000 and for the three months then ended have been prepared on the same basis as the audited financial statements and, in the opinion of management, reflect all normal recurring adjustments necessary to present fairly the financial information set forth therein in accordance with U.S. GAAP. All financial statement disclosures related to the interim financial statements are unaudited. F-77
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INUP S.A. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) (U.S. DOLLARS) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Although the Company was formed on January 1, 1999, the Company's operations did not begin until the fourth quarter of 1999. Accordingly, there is no comparative financial information for the three months ended March 31, 1999 to be included in the accompanying financial statements. DEVELOPMENT STAGE ENTERPRISE From the date of inception (January 1, 1999) through December 31, 1999, the Company was a development stage company, as planned principal operations had not yet begun to generate significant revenue. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from these 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. REVENUE RECOGNITION Revenues in 1999 resulted from a one-time resale of acquired software and consulting services provided by the Company. Through December 31, 1999, and March 31, 2000 (unaudited), the Company has not recognized revenue from other product sales. CONCENTRATION OF CREDIT RISK The Company primarily places its temporary cash investments with high-credit quality financial institutions which invest primarily in French Government securities and commercial paper of prime quality. Cash deposits are held in financial institutions in France. FAIR VALUE OF FINANCIAL INSTRUMENTS Carrying amounts of certain of the Company's financial instruments including cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to their short maturities. PROPERTY AND EQUIPMENT Property and equipment are stated at cost and depreciated on a straight-line basis over the estimated useful lives of the related assets, generally two to ten years. Leased assets are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or the lease term. F-78
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INUP S.A. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) (U.S. DOLLARS) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Expenditures for maintenance and repairs are charged to operations as incurred; major expenditures for renewals and betterments are capitalized and depreciated. When an asset is sold or otherwise disposed of, the cost of the asset and the related accumulated depreciation are removed from the accounts and the related gain or loss is recognized in the statement of operations. Depreciation periods used for property and equipment are as follows: [Download Table] Computer equipment.......................................... 2 years Furniture and fixtures...................................... 10 years Leasehold improvements...................................... 10 years LONG-LIVED ASSETS The Company evaluates the recoverability of its long-lived 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 future undiscounted cash flows attributed to such assets. 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 the financial reporting and tax bases of the Company's assets and liabilities and for tax carryforwards at enacted statutory tax rates in effect for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. In addition, a valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized. ADVERTISING The Company expenses advertising costs as incurred. For the three-month period ended March 31, 2000 (unaudited) and for the year ended December 31, 1999, the Company incurred $6,582 and $7,341 of advertising costs, respectively. INTERNAL USE SOFTWARE COSTS Effective January 1, 1999, the Company adopted Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Through December 31, 1999, the only costs required to be capitalized under the provisions of this standard relate to purchased software. F-79
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INUP S.A. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) (U.S. DOLLARS) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECENT ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission staff released Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB No. 101), which provides guidance on the recognition, presentation and disclosure of revenues in financial statements. The Company does not expect this guidance to materially impact the financial statements. 3. LIQUIDITY The Company incurred a net loss of $110,318 for the year ended December 31, 1999. The Company anticipates revenues generated from its continuing operations will not be sufficient to fund ongoing operations during the year ending December 31, 2000. As discussed in Note 8, the Company was acquired by Lineo, Inc. ("Lineo"). Lineo has represented its intent to fund the on-going operations of the Company. 4. PROPERTY AND EQUIPMENT Property and equipment consist of the following: [Enlarge/Download Table] DECEMBER 31, MARCH 31, 1999 2000 ------------ ----------- (UNAUDITED) Purchased computer software and equipment................... $138,871 $171,236 Furniture and fixtures...................................... 9,833 11,350 Leasehold improvements...................................... 10,819 14,251 -------- -------- 159,523 196,837 Less accumulated depreciation............................... (11,280) (40,960) -------- -------- $148,243 $155,877 ======== ======== 5. INCOME TAXES The Company is subject to income taxes levied by the governments of France. As of December 31, 1999, no income taxes have been generated or paid by the Company. Income tax credits of $14,718 and $39,170 have been earned by the Company for the year ended December 31, 1999 and for the three months ended March 31, 2000 (unaudited), respectively, and will be received by the Company in a future period. 6. COMMITMENTS AND CONTINGENCIES During the year ended December 31, 1999, the Company entered into a contract to purchase certain software. Included in the contract are terms that require the Company to pay royalties of 2% of gross income earned on the sale of licenses of this software. Furthermore, the Company must pay royalties of 30% upon the sale of licenses of this software which include the right to modify the source code. This royalty agreement will terminate on October 19, 2006. F-80
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INUP S.A. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) (U.S. DOLLARS) 6. COMMITMENTS AND CONTINGENCIES (CONTINUED) Royalties that the Company is required to pay per the above contract will be expensed as cost of sales. Also, as of December 31, 1999, the Company leased office space under a cancelable operating lease. The contractual term of the lease is nine years, with a right to cancel at the third and sixth anniversary dates. The portion of future minimum lease payments required under this lease that are not cancelable at December 31, 1999, are as follows: [Download Table] 2000........................................................ $11,822 2001........................................................ 11,822 2002........................................................ 4,147 ------- Total minimum lease payments................................ $27,791 ======= 7. STOCKHOLDERS' EQUITY Effective November 30, 1999, the par value of the common stock of the Company was changed from $25 per share to $0.25 per share. All references to number of shares and per share amounts have been restated to reflect the effect of this change. 8. SUBSEQUENT EVENTS On May 1, 2000, the Company's stockholders and Lineo entered into a stock purchase agreement pursuant to which Lineo agreed to purchase all of the issued and outstanding capital stock of the Company for 83,334 shares of the unregistered Series C convertible preferred stock and 1,333,333 shares of the unregistered common stock of Lineo and $10,000 of cash. F-81
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Moreton Bay Ventures Pty Ltd: We have audited the accompanying statements of assets, liabilities, and equity (deficit) of the acquired operations of Moreton Bay Ventures Pty Ltd as of October 31, 1998 and 1999 and the related statements of revenue and expenses and comprehensive loss, changes in equity (deficit) of the acquired operations and cash flows for each of the two years in the period ended October 31, 1999. These statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The accompanying financial statements were prepared for the purpose of complying with the rules and regulations of the United States Securities and Exchange Commission and, as described in Note 1, are not intended to be a complete presentation of Moreton Bay Ventures Pty Ltd's assets, liabilities, revenues, expenses and cash flows. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the acquired operations of Moreton Bay Ventures Pty Ltd as of October 31, 1998 and 1999, and the results of its operations and its cash flows for each of the two years in the period ended October 31, 1999 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the amounts translated into U.S. dollars in the accompanying financial statements have been computed on the basis set forth in Note 2. ARTHUR ANDERSEN Brisbane, Australia May 12, 2000 F-82
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD STATEMENTS OF ASSETS, LIABILITIES AND EQUITY (DEFICIT) OF THE ACQUIRED OPERATIONS [Enlarge/Download Table] AUSTRALIAN DOLLARS U.S. DOLLARS --------------------------------- ------------------------- OCTOBER 31, ------------------- APRIL 30, OCTOBER 31, APRIL 30, 1998 1999 2000 1999 2000 -------- -------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) ASSETS Current assets: Cash................................... $ -- $ -- $332,427 $ -- $214,848 Accounts receivable.................... -- -- 13,311 -- 8,603 Inventory.............................. -- -- 90,690 -- 58,613 Research grant receivable.............. 17,368 46,378 74,584 29,974 48,204 Marketable security, at fair value..... -- -- 420,000 -- 271,446 -------- -------- -------- -------- -------- Total current assets................. 17,368 46,378 931,012 29,974 601,714 ======== ======== ======== ======== ======== Property and equipment: Computer equipment..................... 17,684 34,930 38,437 22,575 24,842 Furniture and fixtures................. 2,178 6,291 6,291 4,066 4,066 -------- -------- -------- -------- -------- 19,862 41,221 44,728 26,641 28,908 Less accumulated depreciation.......... (12,520) (27,418) (33,647) (17,721) (21,746) -------- -------- -------- -------- -------- Net property and equipment........... 7,342 13,803 11,081 8,920 7,162 -------- -------- -------- -------- -------- $ 24,710 $ 60,181 $942,093 $ 38,894 $608,876 ======== ======== ======== ======== ======== LIABILITIES AND EQUITY (DEFICIT) OF THE ACQUIRED OPERATIONS Current liabilities: Accounts payable....................... $ -- $ 29,014 $124,999 $ 18,751 $ 80,787 Accrued liabilities.................... 7,078 36,947 76,333 23,879 49,334 Deferred revenue....................... -- -- 32,000 -- 20,682 -------- -------- -------- -------- -------- Total current liabilities............ 7,078 65,961 233,332 42,630 150,803 ======== ======== ======== ======== ======== Commitments and contingencies (Notes 1 and 6) Equity (deficit) of the acquired operations............................. 17,632 (5,780) 708,761 (3,736) 458,073 -------- -------- -------- -------- -------- $ 24,710 $ 60,181 $942,093 $ 38,894 $608,876 ======== ======== ======== ======== ======== See accompanying notes to financial statements. F-83
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD STATEMENTS OF REVENUE AND EXPENSES AND COMPREHENSIVE LOSS [Enlarge/Download Table] AUSTRALIAN DOLLARS U.S. DOLLARS ------------------------------------------------- ------------------------------ YEAR ENDED SIX MONTHS ENDED OCTOBER 31, APRIL 30, YEAR ENDED SIX MONTHS ENDED --------------------- ------------------------- OCTOBER 31, APRIL 30, 1998 1999 1999 2000 1999 2000 --------- --------- ----------- ----------- ----------- ---------------- (UNAUDITED) (UNAUDITED) (UNAUDITED) Revenue....................... $ -- $ -- $ -- $ 41,093 $ -- $ 26,558 Cost of revenue............... -- -- -- 21,184 -- 13,691 --------- --------- -------- --------- --------- --------- Gross margin.............. -- -- -- 19,909 -- 12,867 --------- --------- -------- --------- --------- --------- Operating expenses: General and administrative (exclusive of non-cash compensation expense of AUS$0, AUS$15,633, AUS$0, AUS$0, US$10,104 and US$0, respectively)............. 81,964 142,408 76,794 116,634 92,038 75,381 Research and development (exclusive of non-cash compensation expense of AUS$0, AUS$66,683, AUS$0, AUS$91,854, US$43,097 and US$59,365, respectively)............. 81,595 58,547 8,554 146,148 37,839 94,456 Sales and marketing......... -- 26,481 6,972 21,017 17,114 13,583 Non-cash compensation expense................... -- 82,316 -- 91,854 53,201 59,365 --------- --------- -------- --------- --------- --------- Total operating expenses.... 163,559 309,752 92,320 375,653 200,192 242,785 --------- --------- -------- --------- --------- --------- Expenses in excess of revenue................... $(163,559) $(309,752) $(92,320) $(355,744) $(200,192) $(229,918) ========= ========= ======== ========= ========= ========= Comprehensive loss: Expenses in excess of revenue................... $(163,559) $(309,752) $(92,320) $(355,744) $(200,192) $(229,918) Unrealized loss on marketable security....... -- -- -- (380,000) -- (245,594) --------- --------- -------- --------- --------- --------- $(163,559) $(309,752) $(92,320) $(735,744) $(200,192) $(475,512) ========= ========= ======== ========= ========= ========= See accompanying notes to financial statements. F-84
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD CHANGES IN EQUITY (DEFICIT) OF THE ACQUIRED OPERATIONS [Enlarge/Download Table] AUSTRALIAN DOLLARS U.S. DOLLARS ----------------------------------------- ----------------------------- YEAR ENDED OCTOBER 31, SIX MONTHS YEAR ENDED SIX MONTHS ----------------------- ENDED APRIL 30, OCTOBER 31, ENDED APRIL 30, 1998 1999 2000 1999 2000 ---------- ---------- --------------- ----------- --------------- (UNAUDITED) (UNAUDITED) Balance, beginning of period..... $ -- $ 17,632 $ (5,780) $ 11,396 $ (3,736) Expenses in excess of revenue.... (163,559) (309,752) (355,744) (200,192) (229,918) Unrealized loss on marketable security....................... -- -- (380,000) -- (245,594) Issuance of stock options by Moreton Bay Venture Pty Ltd.... -- 82,316 91,854 53,201 59,365 Funding provided by Moreton Bay Ventures Pty Ltd............... 181,191 204,024 1,358,431 131,859 877,956 --------- --------- ---------- --------- --------- Balance, end of period........... $ 17,632 $ (5,780) $ 708,761 $ (3,736) $ 458,073 ========= ========= ========== ========= ========= See accompanying notes to financial statements. F-85
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH [Enlarge/Download Table] AUSTRALIAN DOLLARS U.S. DOLLARS ------------------------------------------------- ----------------------------- YEAR ENDED SIX MONTHS ENDED OCTOBER 31, APRIL 30, YEAR ENDED SIX MONTHS --------------------- ------------------------- OCTOBER 31, ENDED APRIL 30, 1998 1999 1999 2000 1999 2000 --------- --------- ----------- ----------- ----------- --------------- (UNAUDITED) (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Expenses in excess of revenue............. $(163,559) $(309,752) $(92,320) $(355,744) $(200,192) $(229,918) Adjustments to reconcile expenses in excess of revenue to net cash used in operating activities: Depreciation............................ 8,000 14,898 5,085 6,229 9,629 4,025 Non-cash compensation................... -- 82,316 -- 91,854 53,201 59,365 Changes in operating assets and liabilities: Accounts receivable................... -- -- -- (13,311) -- (8,603) Inventory............................. -- -- -- (90,690) -- (58,613) Research grant receivable............. (17,368) (29,010) 17,368 (28,206) (18,749) (18,230) Accounts payable...................... -- 29,014 4,670 95,985 18,751 62,036 Accrued liabilities................... 7,078 29,869 16,906 39,386 19,305 25,455 Deferred revenue...................... -- -- -- 32,000 -- 20,682 --------- --------- -------- --------- --------- --------- Net cash used in operating activities........................ (165,849) (182,665) (48,291) (222,497) (118,055) (143,801) --------- --------- -------- --------- --------- --------- Cash flows from investing activities: Purchase of property and equipment........ (7,979) (21,359) (15,190) (3,507) (13,804) (2,267) --------- --------- -------- --------- --------- --------- Cash flows from financing activities: Funding provided by Moreton Bay Pty Ltd... 173,828 204,024 63,481 558,431 131,859 360,916 --------- --------- -------- --------- --------- --------- Net increase in cash........................ -- -- -- 332,427 -- 214,848 Cash, beginning of period................... -- -- -- -- -- -- --------- --------- -------- --------- --------- --------- Cash, end of period......................... $ -- $ -- $ -- $ 332,427 $ -- $ 214,848 ========= ========= ======== ========= ========= ========= Supplemental disclosure of non-cash investing and financing activities: Allocation of property and equipment by Moreton Bay Ventures Pty Ltd.......... $ 7,363 $ -- $ -- $ -- $ -- $ -- Issuance of common stock for marketable security.............................. $ -- $ -- $ -- $ 800,000 $ -- $ 517,040 See accompanying notes to financial statements. F-86
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD NOTES TO FINANCIAL STATEMENTS (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (1) ORGANIZATION AND DESCRIPTION OF BUSINESS Moreton Bay Pty Ltd ("Moreton Bay"), incorporated as an Australia corporation on April 24, 1995, develops embedded virtual private network solutions for Internet appliances and provides engineering development for the Motorola ColdFire microprocessor platform. Moreton Bay's historical operations include two product lines, RAStel multimodem cards ("RAStel") and NETtel Internet routers ("NETtel"). Moreton Bay LLC, a United States limited liability corporation, is a wholly owned subsidiary of Moreton Bay. On May 12, 2000, the Moreton Bay's stockholders entered into an agreement with Lineo, Inc. ("Lineo"), a United States corporation. Pursuant to the agreement, Lineo acquired all of the outstanding stock of Moreton Bay in exchange for US$10,000 in cash, 956,315 shares of series D convertible preferred stock and options to purchase 87,374 shares of Lineo's common stock. The options have a vesting period of one year, an exercise price of US$3.00 per share and expire ten years from the date of grant. Prior to the acquisition, Moreton Bay transferred the RAStel assets, liabilities and operations, which Lineo did not acquire, to a separate legal entity. The accompanying financial statements have been prepared for the purpose of complying with the rules and regulations of the United States Securities and Exchange Commission. The accompanying financial statements include Moreton Bay's NETtel operations (the "Company") acquired by Lineo. The statements of revenue and expenses reflect the revenue and direct expenses of the NETtel operations and allocations of common expenses. The common expenses consist primarily of the cost of shared facilities, employees and certain other costs. Such common expenses have been allocated to the acquired operations based upon actual usage or other methods that approximate actual usage. Management believes that the allocation methods used are reasonable. The accompanying financial information may not necessarily reflect the financial position, results of operations or cash flows of the acquired operations in the future, nor what the financial position, results of operations or cash flows would have been had it been a separate, stand-alone company throughout the periods presented. During the years ended October 31, 1998 and 1999 and the six months ended April 30, 2000, the expenses of the acquired operations exceeded revenue by AUS$163,559 (US$105,708), AUS$309,752 (US$200,192) and AUS$355,744 (US$229,918), respectively, and as of April 30, 2000, the acquired operations had equity of of AUS$708,761 (US$458,073). As discussed above, subsequent to April 30, 2000, Lineo acquired certain operations of Moreton Bay and Lineo has committed to provide funding to the Company as required. (2) SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION Moreton Bay maintains its accounting records and prepares its financial statements in accordance with accounting principles generally accepted in Australia. However, the accompanying financial statements reflect all material adjustments necessary to present the financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The Company's functional currency is the Australian dollar and the accompanying financial statements are presented in Australian dollars. Additionally, as a convenience, the balance sheets as of F-87
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) October 31, 1999 and April 30, 2000 and the related statements of revenue and expenses, changes in equity (deficit) of the acquired operations and cash flows for the respective year and six months then ended are also presented in U.S. dollars by arithmetically translating all Australian dollar amounts at AUS$1 to US$0.6463, which was the exchange rate at October 31, 1999. UNAUDITED INTERIM FINANCIAL STATEMENTS The unaudited interim financial statements as of April 30, 2000 and for the six months ended April 30, 1999 and 2000 have been prepared on the same basis as the audited financial statements, and, in the opinion of management, reflect all normal recurring adjustments necessary to present fairly the financial information set forth therein in accordance with U.S. GAAP. All financial statement disclosures related to the interim financial statements are unaudited. The results of the interim periods are not necessarily indicative of the results to be expected for the year ending October 31, 2000. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with U.S. GAAP 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 these estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the accompanying financial statements for accounts receivable, research grant receivable and accounts payable approximate fair values because of the immediate or short-term maturities of these financial instruments. RESEARCH AND DEVELOPMENT GRANT The Company has a research and development grant related to the development of the NETtel products from AusIndustry, a division of the Australian government. The grant reimburses the Company for incurred costs. Grant reimbursements are not recognized until the costs have been incurred and there is reasonable assurance that the Company will comply with the grant's conditions and that the reimbursements will be received (see Note 6). The Company has elected to include reimbursements as a reduction of the related expenses. The Company recorded grant reimbursements of AUS$17,368 (US$11,225) and AUS$220,049 (US$142,218) during the years ended October 31, 1998 and 1999, respectively, and AUS$102,848 (US$66,471) and AUS$132,584 (US$85,689) during the six months ended April 30, 1999 and 2000, respectively. INVENTORY Inventories consist primarily of completed products. Inventories are stated at the lower of cost (using the first-in, first-out method) or market value. Provisions, when required, are made to reduce excess and obsolete inventories to their estimated net realizable values. Due to competitive pressures F-88
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) and technological innovation, it is possible that estimates of net realizable value could change in the near term. MARKETABLE SECURITY The Company's investment in a marketable security has been categorized as available for sale, as defined by Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Unrealized holding gains and losses are reflected as a component of equity (deficit) of the acquired operations until realized. PROPERTY AND EQUIPMENT Property and equipment are stated at cost, less accumulated depreciation. Computer equipment and furniture and fixtures are depreciated using the straight-line method over the estimated useful life of the asset, typically three to five years. Expenditures for repairs and maintenance are charged to expense when incurred. Expenditures for major renewals and betterments that extend the useful lives of existing equipment are capitalized and depreciated. On retirement or disposition of property and equipment, the cost and related accumulated depreciation is removed from the accounts and any resulting gain or loss is recognized. CAPITALIZED SOFTWARE COSTS In accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," development costs incurred in the research and development of new software products to be sold, leased or otherwise marketed are expensed as incurred until technological feasibility in the form of a working model has been established. Internally generated capitalizable software development costs have not been material for the years ended October 31, 1998 and 1999 and the six months ended April 30, 2000. The Company has charged its software development costs to research and development expense in the accompanying statements of revenues and expenses. IMPAIRMENT OF LONG-LIVED ASSETS The Company reviews its long-lived assets for impairment when events or changes in circumstances indicate that the book value of an asset may not be recoverable. The Company evaluates, at each balance sheet date, whether events and circumstances have occurred which indicate possible impairment. The Company uses an estimate of future undiscounted net cash flows of the related asset or group of assets over the remaining life in measuring whether the assets are recoverable. As of October 31, 1999 and April 30, 2000, the Company does not consider any of its long-lived assets to be impaired. REVENUE RECOGNITION The accompanying statements of revenue and expenses reflect revenue in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position No. 97-2 F-89
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) ("SOP 97-2"), "Software Revenue Recognition." Revenue from the sale of software has been recognized upon delivery of the product when persuasive evidence of an arrangement exists, the price is fixed or determinable, collection is probable and no significant post-delivery obligations exist. 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 98-9"). SOP 98-9 amended SOP 97-2 to require recognition of revenue using a "residual method" in certain circumstances. The Company does not believe that the adoption of this statement will have a material effect on the Company's current revenue recognition policies. INCOME TAXES For all periods presented, the Company was not directly subject to income taxes as the acquired operations were included with those of Moreton Bay for income tax reporting purposes. The Company was not an income tax reporting entity nor did it have a tax-sharing agreement with Moreton Bay. As a result, no income tax expense or related current or deferred income tax assets or liabilities have been allocated to the acquired operations and the liabilities or benefits attributable to the acquired operations were recorded by Moreton Bay. Had Moreton Bay allocated income taxes to the acquired operations as if it were a separate taxable entity, no income tax expense or benefit would have been recorded due to the net operating loss position of the acquired operations and the uncertainty of future realization of any deferred tax assets. The Company has recorded a valuation allowance against the net deferred tax assets of the acquired operations. EQUITY (DEFICIT) OF ACQUIRED OPERATIONS Cash remitted to or transferred from Moreton Bay has been reflected as a decrease or increase in the equity (deficit) of acquired operations. DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION The acquired operations consist of one segment, NETtel operations. Substantially all of the acquired assets, liabilities and operations have been derived from and are located in Australia. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" was issued. SFAS No. 133 establishes new accounting and reporting standards for companies to report information about derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. This statement is effective for financial statements issued for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not expect this statement to have a material impact on the Company's results of operations, financial position or liquidity. In December 1999, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in Financial Statements." This F-90
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) pronouncement summarizes certain of the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. The Company is required to adopt SAB No. 101 during the first quarter of fiscal year 2001. Although management is currently evaluating the impact, if any, of SAB No. 101, management does not presently believe it will have a material impact on the Company's results of operations, financial position or liquidity. (3) MARKETABLE SECURITY On November 12, 1999, Moreton Bay entered into a stock exchange agreement with Netcomm Ltd ("Netcomm") whereby 206,868 shares of Moreton Bay's common stock were exchanged for 2,000,000 shares of common stock of Netcomm. The Company recorded the shares of Netcomm's common stock based upon the quoted market price on the date of exchange. The cost, gross unrealized loss and fair value of the marketable security as of April 30, 2000 is as follows: [Download Table] AUSTRALIAN DOLLARS U.S. DOLLARS ---------- ------------ Cost.................................................. $ 800,000 $ 517,040 Gross unrealized loss................................. (380,000) (245,594) --------- --------- Fair value............................................ $ 420,000 $ 271,446 ========= ========= (4) STOCK OPTIONS During the year ended October 31, 1999 and the six months ended April 30, 2000, Moreton Bay agreed to grant options to purchase 26,250 and 20,000 shares of common stock, respectively, to consultants and an employee of the Company for services rendered. The committed exercise price is less than the estimated fair value of Moreton Bay's common stock on the commitment date. Accordingly, the Company recorded its allocated portion of the estimated expense related to these option commitments of AUS$82,316 (US$53,201) and AUS$91,854 (US$59,365) during the year ended October 31, 1999 and the six months ended April 30, 2000, respectively. As of April 30, 2000, the options had not yet been formally granted. (5) RELATED PARTY TRANSACTIONS As discussed in Note 3, Moreton Bay entered into a share exchange agreement with Netcomm. Pursuant to the share exchange, Netcomm acquired approximately 20 percent of Moreton Bay's then outstanding common stock and Moreton Bay acquired approximately 4 percent of Netcomm's then outstanding common stock. The managing director of Moreton Bay was appointed to Netcomm's Board of Directors on March 9, 2000. On November 12, 1999, Moreton Bay entered into a Technology Manufacturing and Marketing Agreement with Netcomm. This agreement granted Netcomm a non-exclusive license to use Moreton Bay's licensed intellectual property and the non-exclusive right to all general development products and software products developed by or available to Moreton Bay. In consideration for the rights granted, F-91
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THE ACQUIRED OPERATIONS OF MORETON BAY VENTURES PTY LTD NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF APRIL 30, 2000 AND FOR THE SIX MONTHS ENDED APRIL 30, 1999 AND 2000 IS UNAUDITED) (5) RELATED PARTY TRANSACTIONS (CONTINUED) Netcomm agreed to pay a royalty on Netcomm product sales outside Australia and New Zealand which incorporate Moreton Bay's intellectual property or products. To date, no royalties have been received or are due. On November 12, 1999, Moreton Bay entered into a Contract Manufacturing agreement with Netcomm. The agreement specified that Netcomm would be the preferred supplier for Moreton Bay. Transactions under this agreement are conducted under terms that would be reasonable for entity's dealing at arm's length in similar circumstances. During the six months ended April 30, 2000, Moreton Bay purchased no products from Netcomm. As of April 30, 2000, the Company had no amounts due to Netcomm. (6) COMMITMENTS AND CONTINGENCIES OPERATING AGREEMENTS Rent expense included in the accompanying statements of revenues and expenses was AUS$8,610 (US$5,565) and AUS$14,225 (US$9,194) for the years ended October 31, 1998 and 1999, respectively, and AUS$5,675 (US$3,668) and AUS$8,550 (US$5,526) for the six months ended April 30, 1999 and 2000, respectively. Moreton Bay has entered into non-cancelable operating lease agreements for premises in the United States with terms of 6 months to 12 months. The future minimum rental payments under these leases for the years ending October 31, 2000 and 2001 total AUS$31,180 (US$20,152) and AUS$905 (US$585), respectively. Moreton Bay currently leases its Australian premises on a month-to-month basis. Current monthly rent is AUS$700 (US$452). RESEARCH AND DEVELOPMENT GRANT In October 1998, Moreton Bay was awarded a research and development grant related to the NETtel products from AusIndustry, a division of the Australian government. The grant criteria include certain restrictions, including ownership changes, as defined. If an ownership change is deemed to have occurred, the grant may be cancelled and proceeds previously received by Moreton Bay may be required to be repaid. The Company has not determined whether the acquisition by Lineo will constitute an ownership change. Through April 30, 2000, the Company has recorded approximately AUS$390,000 (US$239,132) in reimbursements from this grant. Total funding available under the grant is approximately AUS$614,000 (US$397,000). LITIGATION The Company is a party to certain legal proceedings from time to time arising in the ordinary course of business. Management believes, after consultation with legal counsel, that as of October 31, 1999 and April 30, 2000, no pending or threatened legal proceedings exist which would have a material adverse effect on the Company's financial position, liquidity or results of operations. F-92
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To RT-Control Inc.: We have audited the accompanying balance sheet of RT-Control Inc., a Canada Corporation, as of December 31, 1999 and the related statements of operations and comprehensive loss, shareholders' equity and cash flows for the period from inception (June 30, 1999) to December 31, 1999. 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 audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of RT-Control Inc. as of December 31, 1999 and the results of its operations and its cash flows for the period from inception to December 31, 1999 in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN Toronto, Canada May 15, 2000 F-93
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RT-CONTROL INC. BALANCE SHEETS (U.S. DOLLARS) [Enlarge/Download Table] DECEMBER 31, 1999 MARCH 31, 2000 ----------------- -------------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 37,860 $ 12,229 Accounts receivable....................................... -- 331 Prepaid expenses.......................................... -- 5,769 Inventory................................................. 21,307 48,840 Goods and services tax recoverable........................ 7,037 12,905 --------- --------- Total current assets.................................... 66,204 80,074 --------- --------- Computer and office equipment, net of accumulated depreciation of $461.................................... -- 49,639 --------- --------- $ 66,204 $ 129,713 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable.......................................... $ 36,451 $ 21,237 Accrued liabilities....................................... -- 53,506 Deferred revenue.......................................... -- 605 Advances from shareholders................................ 10,434 21,942 Notes payable to shareholders............................. 11,120 -- Note payable to Lineo, Inc................................ -- 100,000 Current portion of capital lease obligation............... -- 1,821 --------- --------- Total current liabilities............................... 58,005 199,111 --------- --------- Capital lease obligation, net of current portion............ -- 7,286 --------- --------- Shareholders' equity (deficit): Common shares, no par value, unlimited shares authorized, 291 and 300 shares outstanding, respectively............ 106,439 181,439 Accumulated deficit....................................... (98,443) (258,045) Cumulative translation adjustment......................... 203 (78) --------- --------- Total shareholders equity (deficit)..................... 8,199 (76,684) --------- --------- $ 66,204 $ 129,713 ========= ========= See accompanying notes to financial statements. F-94
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RT-CONTROL INC. STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (U.S. DOLLARS) [Enlarge/Download Table] PERIOD FROM INCEPTION THREE MONTHS (JUNE 30, 1999) TO ENDED DECEMBER 31, 1999 MARCH 31, 2000 ------------------ -------------- (UNAUDITED) Revenue..................................................... $ 66,951 $ 10,224 Cost of revenue............................................. 42,392 6,455 -------- --------- Gross margin.............................................. 24,559 3,769 -------- --------- Operating expenses: Research and development.................................. 74,468 52,870 General and administrative (exclusive of non-cash share-related compensation of $0 and $75,000, respectively)........................................... 38,446 27,690 Sales and marketing....................................... 7,324 6,475 Non-cash share-related compensation....................... -- 75,000 -------- --------- 120,238 162,035 -------- --------- Loss from operations........................................ (95,679) (158,266) Interest expense, net..................................... (2,764) (1,336) -------- --------- Net loss.................................................... $(98,443) $(159,602) ======== ========= Comprehensive loss: Net loss.................................................. $(98,443) $(159,602) Foreign currency translation adjustments.................. 203 (281) -------- --------- $(98,240) $(159,883) ======== ========= See accompanying notes to financial statements. F-95
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RT-CONTROL INC. STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (U.S. DOLLARS) [Enlarge/Download Table] COMMON SHARES CUMULATIVE TOTAL ------------------- ACCUMULATED TRANSLATION SHAREHOLDERS' SHARES AMOUNT DEFICIT ADJUSTMENT EQUITY (DEFICIT) -------- -------- ----------- ----------- ---------------- Issuance of common shares for cash at inception............................. 291 $ 20 $ -- $ -- $ 20 Contribution of services................ -- 106,419 -- -- 106,419 Foreign currency translation adjustments........................... -- -- -- 203 203 Net loss................................ -- -- (98,443) -- (98,443) --- -------- --------- ----- --------- Balance, December 31, 1999.............. 291 106,439 (98,443) 203 8,199 Issuance of common shares for services (unaudited)........................... 9 75,000 -- -- 75,000 Foreign currency translation adjustments (unaudited)........................... -- -- -- (281) (281) Net loss (unaudited).................... -- -- (159,602) -- (159,602) --- -------- --------- ----- --------- Balance, March 31, 2000 (unaudited)..... 300 $181,439 $(258,045) $ (78) $ (76,684) === ======== ========= ===== ========= See accompanying notes to financial statements. F-96
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RT-CONTROL INC. STATEMENTS OF CASH FLOWS (U.S. DOLLARS) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS [Enlarge/Download Table] PERIOD FROM INCORPORATION THREE (JUNE 30, 1999) TO MONTHS ENDED DECEMBER 31, 1999 MARCH 31, 2000 ------------------------- ------------------------- (UNAUDITED) Cash flows from operating activities: Net loss.................................................. $ (98,443) $ (159,602) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation.......................................... -- 461 Contribution of services.............................. 106,419 -- Non-cash share-related compensation................... -- 75,000 Changes in operating assets and liabilities: Accounts receivable................................. -- (331) Prepaid expenses.................................... -- (5,769) Inventory........................................... (21,307) (27,533) Goods and services tax recoverable.................. (7,037) (5,868) Accounts payable.................................... 36,451 (15,214) Accrued liabilities................................. -- 53,506 Deferred revenue.................................... -- 605 ------------------------- ------------------------- Net cash provided by (used in) operating activities........................................ 16,083 (84,745) ------------------------- ------------------------- Cash flows from investing activities: Purchase of property and equipment........................ -- (40,993) ------------------------- ------------------------- Cash flows from financing activities: Advances from shareholders................................ 10,434 11,508 Proceeds from (repayments of) notes payable to shareholders............................................ 11,120 (11,120) Proceeds from the sale of common shares upon incorporation........................................... 20 -- Proceeds from note payable to Lineo, Inc.................. -- 100,000 ------------------------- ------------------------- Net cash provided by financing activities........... 21,574 100,388 ------------------------- ------------------------- Net increase (decrease) in cash and cash equivalents........ 37,657 (25,350) Foreign currency translation adjustments.................... 203 (281) Cash and cash equivalents, beginning of period.............. -- 37,860 ------------------------- ------------------------- Cash and cash equivalents, end of period.................... $ 37,860 $ 12,229 ========================= ========================= Supplemental disclosure of cash flow information: Cash paid for interest.................................... $ 1,048 $ 907 Supplemental disclosure of noncash investing and financing activities: Acquisition of assets under capital lease arrangement..... $ -- $ 9,107 See accompanying notes to financial statements. F-97
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RT-CONTROL INC. NOTES TO FINANCIAL STATEMENTS (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) 1. ORGANIZATION AND NATURE OF OPERATIONS RT-Control Inc. (the "Company") was incorporated under the Canada Business Corporations Act on June 30, 1999. The Company develops and markets the mcLinux version of Linux for microcontrollers. On May 12, 2000, the Company's shareholders entered into an agreement with Lineo, Inc. ("Lineo"), a United States corporation. Pursuant to the agreement, Lineo acquired all of the outstanding common shares of RT-Control in exchange for $15,000 in cash, 404,169 shares of Lineo's series D convertible preferred stock and options to purchase 16,667 shares of Lineo's common stock. The options have a vesting period of one year, an exercise price of $1.50 per share and expire ten years from the date of grant. During the three months ended March 31, 2000, the Company received $100,000 from Lineo through the issue of a promissory note. The Company received an additional $100,000 on April 3, 2000 from Lineo under similar terms (see Note 6). Lineo has committed to provide funding to the Company as required. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States. UNAUDITED INTERIM FINANCIAL STATEMENTS The unaudited interim financial statements as of March 31, 2000 and for the three months then ended have been prepared on the same basis as the audited financial statements and, in the opinion of management, reflect all normal recurring adjustments necessary to present fairly the financial information set forth therein in accordance with accounting principles generally accepted in the United States. The results of operations for the three months ended March 31, 2000 are not necessarily indicative of the results to be expected for the entire year ending December 31, 2000. USE OF ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the accompanying financial statements for cash and cash equivalents, accounts receivable, goods and services tax recoverable, and accounts payable approximate fair values because of the immediate or short-term maturities of these financial instruments. The F-98
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RT-CONTROL INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) carrying amounts of the Company's debt obligations approximate fair value based on current interest rates. FOREIGN CURRENCY TRANSLATION The Company prepares its statements in Canadian dollars since its functional currency is the Canadian dollar. As a result of the acquisition discussed in Note 1, the accompanying financial statements are denominated in U.S. dollars. As a result, the Company has translated its Canadian dollar financial statements into U.S. dollars using the current method. Under this method, monetary and non-monetary items are translated at the rate of exchange in effect at the balance sheet date and revenue and expenses are translated at the average exchange rate for the periods. Depreciation of assets is translated at the same exchange rate as the assets to which they relate. CASH AND CASH EQUIVALENTS For purposes of the balance sheet and statement of cash flows, the Company considers all short-term deposits with original maturities of 90 days or less to be cash equivalents. Cash equivalents consist of short-term low risk commercial paper and guaranteed investment certificates. INVENTORY Inventory consists primarily of raw materials. Inventory is stated at the lower of cost (using the first-in, first-out method) or market value. Provisions, when required, are made to reduce excess and obsolete inventory to its estimated net realizable value. Due to competitive pressures and technological innovation, it is possible that estimates of net realizable value could change in the near term. RESEARCH AND DEVELOPMENT EXPENSES In accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed", development costs incurred in the research and development of new software products to be sold, leased or otherwise marketed are expensed as incurred until technological feasibility in the form of a working model has been established. Due to continuing technological changes and changing customer needs, the Company has concluded that it cannot determine technological feasibility of its various products until the development phase of the project is nearly complete. The time period during which costs could be capitalized from the point of reaching technological feasibility until the time of general product release is very short and, consequently, the amounts that could be capitalized are not material to the Company's financial position or results of operations. Therefore, the Company charges all research and development expenses to operations in the period incurred. F-99
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RT-CONTROL INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) REVENUE RECOGNITION The Company generates revenue from the sale of its products, which primarily takes place through the Company's internet site. The Company has recognized software revenue in accordance with the provisions of Statement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2"). Under SOP 97-2, software revenue is recognized upon execution of a contract and delivery of software, provided that the license fee is fixed and determinable, no significant production, modification or customization of the software is required and collection is considered probable by management. Hardware sales are recognized when title passes, which coincides with shipment and customer acceptance. INCOME TAXES The Company recognizes a current tax liability or asset for current taxes payable or refundable and a deferred tax liability or asset for the estimated future tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting and their tax basis and loss carry forwards to the extent they are realizable. A deferred tax valuation allowance is required if it is "more likely than not" that all or a portion of recorded future tax assets will not be realized. GOODS AND SERVICES TAX RECOVERABLE Goods and services tax ("GST") is a Canadian value added tax. GST recoverable represents input tax credits received by the Company on GST paid or payable for certain goods and services purchased during the period. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" was issued. SFAS No. 133 establishes new accounting and reporting standards for companies to report information about derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. This statement is effective for financial statements issued for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not expect this statement to have a material impact on the Company's results of operations, financial position or liquidity. In December 1999, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in Financial Statements." This pronouncement summarizes certain of the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. The Company is required to adopt SAB No. 101 during the second quarter of 2000. Although management is currently evaluating the impact, if any, of SAB No. 101, management does not presently believe it will have a material impact on the Company's results of operations, financial position or liquidity. F-100
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RT-CONTROL INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) 3. EQUITY AND RELATED PARTY TRANSACTIONS During the period ended December 31 1999, certain shareholders and employees of the Company rendered services without receiving any consideration amounting to approximately $90,400 and $16,000, respectively. The Company recorded the fair value of these services as a capital contribution. The fair value of these services was based on management's estimates. At December 31, 1999 and March 31, 2000, the Company had advances from shareholders of $10,434 and $21,942, respectively, representing amounts owed to shareholders for expenses incurred on behalf of the Company. The advances do not have any fixed repayment terms and bear interest charges only to the extent the shareholders incur interest charges. At December 31, 1999, the Company had $11,120 in notes due to shareholders representing cash advances made by the shareholders to the Company. The notes did not carry any fixed repayment terms and bore interest at prime (6.5 percent at December 31, 1999) plus 3.7 percent. Subsequent to December 31, 1999, the Company repaid these notes together with the related interest. On January 27, 2000, the Company issued 261 common shares to its existing shareholders on a pro-rata basis. This issuance has been accounted for as a stock split and retroactively reflected in the accompanying financial statements for all periods presented. During January 2000, the Company issued 9 common shares to an employee and a consultant for services rendered. The estimated fair value of the common shares on the date of issuance was deemed to be $75,000, based on the consideration paid by Lineo to acquire the Company on May 9, 2000. The $75,000 has been reflected as non-cash share-related compensation in the accompanying statement of operations for the three months ended March 31, 2000. 4. INCOME TAXES The components of the Company's income tax provision computed at the combined statutory Canadian federal and provincial income tax rate for the period from inception (June 30, 1999) to December 31, 1999 is as follows: [Download Table] Income tax benefit at statutory rates.............................. $22,267 Change in valuation allowance........ (22,267) ------- $ -- ======= The deferred income tax assets resulting from differences in the timing of the recognition of certain income and expense items for income tax and financial accounting purposes at December 31, 1999 are as follows: [Download Table] Net operating loss carryforward...... $ 22,267 Less: valuation allowance............ (22,267) -------- Net deferred income taxes.......... $ -- ======== F-101
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RT-CONTROL INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) 4. INCOME TAXES (CONTINUED) The ultimate realization of the net operating loss carryforward is dependent, in part, upon the tax laws in effect, the Company's future earnings, and other future events, the effects of which cannot be determined. The Company has established a valuation allowance against its net operating loss carryforward because the available objective evidence creates sufficient uncertainty regarding its realizability. At December 31, 1999, the Company's net operating loss carryforward totaled $98,443 and expires in 2006. 5. COMMITMENTS AND CONTINGENCIES LEGAL The Company may become party to certain legal proceedings arising in the ordinary course of business. Management believes, after consultation with legal counsel, that as of December 31, 1999 and March 31, 2000, no pending or threatened legal proceedings exist which would have a material adverse effect on the Company's financial position, liquidity or results of operations. LEASES The Company leases its operating facilities under an operating lease arrangement. The lease term is 29 months commencing on March 1, 2000. The future minimum rental payments under the arrangement are as follows: [Download Table] YEAR ENDING DECEMBER 31, ------------------------ 2000................................. $17,914 2001................................. 23,885 2002................................. 9,952 ------- $51,751 ======= F-102
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RT-CONTROL INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 IS UNAUDITED) (U.S. DOLLARS) 5. COMMITMENTS AND CONTINGENCIES (CONTINUED) The Company has acquired certain office equipment under a capital lease agreement. The lease term is for 60 months commencing on April 1, 2000. The future minimum lease payments on this lease are as follows: [Download Table] YEAR ENDING DECEMBER 31, ------------------------ 2000................................. $1,739 2001................................. 2,318 2002................................. 2,318 2003................................. 2,318 2004................................. 2,318 Thereafter........................... 580 ------ 11,591 Less: amounts representing interest........................... (2,484) ------ Capital lease obligation............. 9,107 Less: current portion................ (1,821) ------ $7,286 ====== 6. NOTE PAYABLE TO LINEO On February 25, 2000, the Company received proceeds of $100,000 from Lineo in consideration for issuing an unsecured promissory note. On April 3, 2000, the Company received an additional $100,000 from Lineo in consideration for issuing an unsecured promissory note. The notes bear interest at a rate of 7.25 percent per annum and are due 30 days after demand. F-103
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE TO LINEO, INC.: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Lineo, Inc., the carved-out portion of Caldera, Inc. and their subsidiary included in this registration statement and have issued our report thereon dated May 15, 2000. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II--Valuation and Qualifying Accounts is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Salt Lake City, Utah May 15, 2000
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LINEO, INC., THE CARVED-OUT PORTION OF CALDERA, INC. AND THEIR SUBSIDIARY SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED OCTOBER 31, 1997, 1998 AND 1999 [Enlarge/Download Table] BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END OF DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(A) PERIOD -------------------------------------------------- ---------- ---------- ------------- ---------- Allowance of doubtful accounts: Year ended October 31, 1997..................... $ -- $ -- $ -- $ -- Year ended October 31, 1998..................... -- 13,500 -- 13,500 Year ended October 31, 1999..................... 13,500 163,500 (95,168) 68,332 ------------------------ (a) Represents write-offs of uncollectable accounts receivable
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PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table sets forth the costs and expenses, other than the underwriting discounts and commissions, payable by the registrant in connection with the sale of the securities being registered. All amounts are estimates except the Securities and Exchange Commission registration fee, the NASD filing fee and The Nasdaq National Market listing fee. [Download Table] Securities and Exchange Commission Registration Fee......... $ 15,840 NASD Filing Fee............................................. 6,500 Nasdaq National Market Filing Fee........................... 90,000 Printing Costs.............................................. 200,000 Legal Fees and Expenses..................................... 400,000 Accounting Fees and Expenses................................ 950,000 Directors' and Officers' Insurance Policy Premium........... 525,000 Blue Sky Fees and Expenses.................................. 5,000 Transfer Agent and Registrar Fees........................... 5,000 Miscellaneous............................................... 52,660 ---------- Total................................................... $2,250,000 ========== ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The registrant is a Delaware corporation. In its restated certificate of incorporation, the registrant has adopted the provisions of Section 102(b)(7) of the Delaware General Corporation Law (the "Delaware Law"), which enables a corporation in its original certificate of incorporation or an amendment thereto to eliminate or limit the personal liability of a director for monetary damages for breach of the director's fiduciary duty, except (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 Delaware Law (providing for liability of directors for unlawful payment of dividends or unlawful stock purchases or redemptions) or (iv) for any transaction from which a director will personally receive a benefit in money, property or services to which the director is not legally entitled. The registrant has also adopted indemnification provisions in its restated certificate of incorporation and bylaws pursuant to Section 145 of the Delaware Law, which provides that a corporation may indemnify any persons, including officers and directors, who are, or are threatened to be made, parties to any threatened, pending or completed legal action, suit or proceedings, 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 was an officer, director, employee or agent of the corporation, or is or was serving at the request of such corporation as a director, officer, employee or agent of another corporation or enterprise. The indemnity may include 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, provided such officer, director, employee or agent acted in good faith and in a manner he reasonably believed to be in or not opposed to the corporation's best interests and, with respect to criminal proceedings, had no reasonable cause to believe that his conduct was unlawful. A Delaware corporation may indemnify officers or directors in an action by or in the right of the corporation under the same conditions, except that no indemnification is permitted without judicial approval if the officer or director is adjudged to be liable to the corporation. Where an officer or director is successful on the merits or otherwise in the II-1
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defense of any action referred to above, the corporation must indemnify him against expenses (including attorneys' fees) that such officer or director actually and reasonably incurred. The registrant intends to enter into indemnification agreements with each of the registrant's officers and directors. The Underwriting Agreement (Exhibit 1.1 hereto) provides for indemnification between the underwriters and the registrant from and against certain liabilities arising in connection with the offering which is the subject of this registration statement. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. The following is a description of all securities that the registrant has sold within the past three years without registering the securities under the Securities Act: On September 1, 1998, the registrant issued 18,000,000 shares of its common stock to Caldera, Inc. in exchange for a contribution of assets. This issuance was exempt from registration pursuant to 4(2) of the Securities Act. On December 29, 1999, the registrant sold 1,500,000 shares of its common stock at a price of $.80 per share to two accredited investors for an aggregate offering price of $1,200,000. This issuance was exempt from registration pursuant to 4(2) of the Securities Act. On February 17, 2000, the registrant sold 2,500,000 shares of its Series A Class 2 convertible preferred stock at a price of $1.50 per share to three accredited investors for an aggregate offering price of $3,750,000. This issuance was exempt from registration pursuant to Rule 506 of Regulation D under Section 4(2) of the Securities Act. On February 17, 2000, the registrant exchanged 5,000,000 shares of its Series A Class 1 convertible preferred stock to one accredited investor in exchange for 5,000,000 shares of our common stock. This exchange was exempt from registration pursuant to Rule 506 of Regulation D under Section 4(2) of the Securities Act. On March 15, 2000, the registrant sold 4,833,331 shares of its Series B convertible preferred stock at a price of $3.00 per share to 15 accredited investors for an aggregate offering price of $14,499,973. This issuance was exempt from registration pursuant to Rule 506 of Regulation D under Section 4(2) of the Securities Act. On April 3, 2000, the registrant issued 1,745,226 shares of its common stock to 23 individuals pursuant to a merger agreement between the registrant and Zentropic Computing, LLC, a Virginia limited liability company. This exchange was exempt from registration pursuant to Rule 506 of Regulation D under Section 4(2) of the Securities Act. On April 28, 2000, the registrant sold 3,000,000 shares of its Series C convertible preferred stock at a price of $6.00 per share to 21 accredited investors for an aggregate offering price of $18,000,000. This issuance was exempt from registration pursuant to Rule 506 of Regulation D under Section 4(2) of the Securities Act. On May 1, 2000, the registrant issued 69,998 shares of its Series D convertible preferred stock to five individuals pursuant to a share purchase agreement between the registrant and certain shareholders of Fireplug Computers Inc., a British Columbia, Canada company. This transaction was exempt from registration pursuant to Regulation S and/or Rule 506 of Regulation D under Section 4(2) of the Securities Act. On May 1, 2000, the registrant issued 1,333,333 shares of its common stock to 21 individuals and 83,334 shares of our Series C convertible preferred stock to one corporate entity pursuant to a stock purchase agreement between the registrant and certain shareholders of Inup S.A., a French II-2
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corporation. This transaction was exempt from registration pursuant to Regulation S and/or Rule 506 of Regulation D under Section 4(2) of the Securities Act. On May 10, 2000, the registrant issued 956,315 shares of its Series D convertible preferred stock to 14 individuals pursuant to a stock purchase agreement between the registrant and certain shareholders of Moreton Bay Ventures Pty Ltd, an Australian corporation. This transaction was exempt from registration pursuant to Regulation S and/or Rule 506 of Regulation D under Section 4(2) of the Securities Act. On May 12, 2000, the registrant issued 404,169 shares of its Series D convertible preferred stock to three individuals pursuant to a stock purchase agreement between the registrant and certain shareholders of RT-Control, Inc., a Canadian corporation. This transaction was exempt from registration pursuant to Regulation S and/or Rule 506 of Regulation D under Section 4(2) of the Securities Act. From June 1999 to May 15, 2000, options to purchase 3,722,627 shares of the registrant's common stock were granted to 136 individuals at a weighted average exercise price of $2.05 per share. These grants were exempt from registration pursuant to Rule 701 under the Securities Act. From June 1999 to May 15, 2000, 669,905 shares of the registrant's common stock were issued to eight individuals upon the exercise of stock options granted pursuant to the registrant's stock option plan at a weighted average exercise price of $0.80 per share. These issuances were exempt from registration pursuant to Rule 701 under the Securities Act. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (A) EXHIBITS. [Download Table] NUMBER DESCRIPTION --------------------- ----------- 1.1* Form of Underwriting Agreement 3.1# Certificate of Incorporation and all amendments thereto 3.1(a)# Form of Restated Certificate of Incorporation 3.2# Bylaws and all amendments thereto 4.1 See Exhibits 3.1 and 3.2 for provisions defining the rights of the holders of common stock 5.1* Opinion of Summit Law Group, PLLC regarding legality of shares 10.1# 1999 Stock Option Plan 10.2# GNU General Public License 10.3#+ OEM License Agreement No. LNO201 (Amended and Restated 3/20/2000) by and between Lineo Inc. and DaiShin Information and Communications Company dated February 17, 2000 10.4# Stock Purchase and Sale Agreement dated as of January 6, 2000, by and between Lineo, Inc. and Caldera Systems, Inc. 10.5# DR DOS License Agreement dated as of September 1, 1998, by and between Caldera, Inc. and Caldera Thin Clients, Inc. 10.6# Technology Assignment Agreement dated as of December 29, 1999, by and between The Canopy Group and Lineo, Inc. 10.7# Recapitalization Agreement dated February 17, 2000, by and between Lineo, Inc. and The Canopy Group, Inc. II-3
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[Download Table] NUMBER DESCRIPTION --------------------- ----------- 10.8# Form of Lineo, Inc. Series A Stock Purchase Agreement 10.9# Form of Lineo, Inc. Series B Stock Purchase Agreement 10.10# Form of Lineo, Inc. Series C Stock Purchase Agreement 10.11# Stock Purchase Agreement dated as of April 13, 2000, by and among Lineo, Inc., United System Engineers, Inc., and the shareholders named therein 10.12# Share Purchase Agreement dated as of May 1, 2000, by and among Lineo, Inc., Fireplug Computers Inc. and the shareholders named therein 10.13# Stock Purchase Agreement dated as of May 10, 2000, by and among Moreton Bay Ventures Pty Ltd, Lineo, Inc. and the Sellers named therein 10.14# Stock Purchase Agreement dated as of May 1, 2000, by and among Lineo, Inc., Inup S.A. and the Sellers named therein 10.15# Share Purchase Agreement dated as of May 10, 2000, by and among Lineo, Inc., RT-Control, Inc. and the Shareholders named therein 10.16# Form of Lineo, Inc. Investor Rights Agreement 10.17# Form of Lineo, Inc. Amendment No. 1 to Investor Rights Agreement 10.18# Form of Lineo, Inc. Amendment No. 2 to Investor Rights Agreement 10.19# Form of Indemnification Agreement 10.20# Sublease dated January 31, 2000 by and between SwitchSoft Systems, Inc. and Lineo, Inc. 10.21# Sublease 380 South 400 West, Suite C dated February 21, 2000 by and between VPNX.com and Lineo, Inc. 10.22# Employment Agreement dated May 16, 2000 by and between Bryan W. Sparks and Lineo, Inc. 21.1# Subsidiaries of the registrant 23.1 Consent of Summit Law Group, PLLC (contained in the opinion filed as Exhibit 5.1 hereto) 23.2# Consent of Arthur Andersen LLP, Independent Public Accountants 23.3# Consent of Arthur Andersen, Independent Public Accountants 23.4# Consent of Arthur Andersen, Independent Public Accountants 23.5# Consent of Befec -- Price Waterhouse, Independent Accountants 23.6# Consent of Arthur Andersen, Independent Public Accountants 23.7# Consent of Arthur Andersen, Independent Public Accountants 24.1 Power of Attorney (See Page II-6) 27.1# Financial Data Schedule ------------------------ # Filed herewith + Confidential treatment requested * To be filed by amendment II-4
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(B) FINANCIAL STATEMENT SCHEDULES. Schedule II -- Valuation and Qualifying Accounts for the Years Ended October 31, 1997, 1998 and 1999 Schedules not listed above have been omitted because they are inapplicable or the requested information is shown in the consolidated financial statements of the registrant or related notes thereto. ITEM 17. UNDERTAKINGS. The undersigned registrant hereby undertakes 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. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, 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 been settled by controlling precedent, submit to a court of appropriate jurisdiction the questions 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 undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a 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 a part of this registration statement as of the time it was declared effective. (2) 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-5
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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 the City of Lindon, State of Utah, on the 18(th) day of May, 2000. [Download Table] LINEO, INC. By: /s/ BRYAN W. SPARKS ----------------------------------------- Bryan W. Sparks PRESIDENT, CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD POWER OF ATTORNEY Each person whose individual signature appears below hereby authorizes and appoints Bryan W. Sparks and Matthew R. Harris, and each of them, with full power of substitution and resubstitution and full power to act without the other, as his true and lawful attorney-in-fact and agent to act in his name, place and stead and to execute in the name and on behalf of each person, individually and in each capacity stated below, and to file, any and all amendments to this registration statement, including any and all post-effective amendments thereto and any registration statement relating to the same offering as this registration statement that is to be effective upon filing pursuant to Rule 462(b) under the Securities Act of 1933, as amended, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in fact and agents, and each of them, full power and authority to do and perform each and every act and thing, ratifying and confirming all that said attorneys-in-fact and agents or any of them or their or his substitute or substitutes may lawfully do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities indicated below on the 18(th) day of May, 2000. [Enlarge/Download Table] SIGNATURE TITLE --------- ----- /s/ BRYAN W. SPARKS President, Chief Executive Officer and ------------------------------------------- Chairman of the Board (Principal Executive Bryan W. Sparks Officer) /s/ GREGORY C. HILL Senior Vice President, Chief Financial Officer ------------------------------------------- and Treasurer (Principal Financial and Gregory C. Hill Accounting Officer) /s/ RAYMOND J. NOORDA ------------------------------------------- Director Raymond J. Noorda /s/ RALPH J. YARRO ------------------------------------------- Director Ralph J. Yarro /s/ JOHN R. EGAN ------------------------------------------- Director John R. Egan /s/ WILLIAM P. BARNETT ------------------------------------------- Director William P. Barnett II-6
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EXHIBIT INDEX [Download Table] NUMBER DESCRIPTION --------------------- ------------------------------------------------------------ 1.1* Form of Underwriting Agreement 3.1# Certificate of Incorporation and all amendments thereto 3.1(a)# Form of Restated Certificate of Incorporation 3.2# Bylaws and all amendments thereto 4.1 See Exhibits 3.1 and 3.2 for provisions defining the rights of the holders of common stock 5.1* Opinion of Summit Law Group, PLLC regarding legality of shares 10.1# 1999 Stock Option Plan 10.2# GNU General Public License 10.3#+ OEM License Agreement No. LNO201 (Amended and Restated 3/2/00) by and between Lineo Inc. and DaiShin Information and Communications Company dated February 17, 2000 10.4# Stock Purchase and Sale Agreement dated as of January 6, 2000, by and between Lineo, Inc. and Caldera Systems, Inc. 10.5# DR DOS License Agreement dated as of September 1, 1998, by and between Caldera, Inc. and Caldera Thin Clients, Inc. 10.6# Technology Assignment Agreement dated as of December 29, 1999, by and between The Canopy Group and Lineo, Inc. 10.7# Recapitalization Agreement dated February 17, 2000, by and between Lineo, Inc. and The Canopy Group, Inc. 10.8# Form of Lineo, Inc. Series A Stock Purchase Agreement 10.9# Form of Lineo, Inc. Series B Stock Purchase Agreement 10.10# Form of Lineo, Inc. Series C Stock Purchase Agreement 10.11# Stock Purchase Agreement dated as of April 13, 2000, by and among Lineo, Inc., United System Engineers, Inc., and the shareholders named therein 10.12# Share Purchase Agreement dated as of May 1, 2000, by and among Lineo, Inc., Fireplug Computers Inc. and the shareholders named therein 10.13# Stock Purchase Agreement dated as of May 10, 2000, by and among Moreton Bay Ventures Pty Ltd, Lineo, Inc. and the Sellers named therein 10.14# Stock Purchase Agreement dated as of May 1, 2000, by and among Lineo, Inc., Inup S.A. and the Sellers named therein 10.15# Share Purchase Agreement dated as of May 10, 2000, by and among Lineo, Inc., RT-Control, Inc. and the Shareholders named therein 10.16# Form of Lineo, Inc. Investor Rights Agreement 10.17# Form of Lineo, Inc. Amendment No. 1 to Investor Rights Agreement 10.18# Form of Lineo, Inc. Amendment No. 2 to Investor Rights Agreement 10.19# Form of indemnification agreement 10.20# Sublease dated January 31, 2000 by and between SwitchSoft Systems, Inc. and Lineo, Inc. II-7
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[Download Table] NUMBER DESCRIPTION --------------------- ------------------------------------------------------------ 10.21# Sublease 380 South 400 West, Suite C dated February 21, 2000 by and between VPNX.com and Lineo, Inc. 10.22# Employment Agreement dated May 16, 2000 by and between Bryan Sparks and Lineo, Inc. 21.1# Subsidiaries of the registrant 23.1 Consent of Summit Law Group, PLLC (contained in the opinion filed as Exhibit 5.1 hereto) 23.2# Consent of Arthur Andersen LLP, Independent Public Accountants 23.3# Consent of Arthur Andersen, Independent Public Accountants 23.4# Consent of Arthur Andersen, Independent Public Accountants 23.5# Consent of Befec -- Price Waterhouse, Independent Accountants 23.6# Consent of Arthur Andersen, Independent Public Accountants 23.7# Consent of Arthur Andersen, Independent Public Accountants 24.1 Power of Attorney (See Page II-6) 27.1# Financial Data Schedule ------------------------ # Filed herewith + Confidential treatment requested * To be filed by amendment II-8

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