Set forth below are certain risks and cautionary statements, which
supplement other disclosures in this report. Please carefully consider the following risks and cautionary statements. If any event related to the following risk factors occurs, our business, financial condition, operating results and cash flows
could be materially adversely affected.
RISKS RELATED TO BUSINESS UNCERTAINTY
We face intense competition.
The
enterprise software industry is rapidly evolving and intensely competitive, and is subject to changing technologies, shifting customer needs, and frequent introductions of new products and services. We compete based on our ability to provide our
customers with enterprise software and related service offerings that best meet their needs at a compelling price. We expect that competition will continue to be intense, and there is a risk that our competitors products may provide better
performance or include additional features when compared to our offerings. Competitive pressures could also affect the prices we may charge or the demand for our offerings, resulting in reduced profit margins and loss of market share.
Our current and potential competitors range from large and well-established companies to emerging start-ups. Some of our competitors have
significantly greater financial resources and name recognition, larger development and sales staffs and more extensive marketing and distribution capabilities. Certain competitors also bundle hardware and software offerings, making it more difficult
for us to penetrate their customer bases. As the enterprise software industry evolves, the competitive pressure for us to innovate encompasses a wider range of products and services, including new offerings that require different expertise than our
current offerings. Some competitors may be able to innovate and provide products and services faster than we can. Moreover, if we are unable to effectively communicate the value of our subscription model, we may not compete effectively in attracting
new, and maintaining existing, customers.
Given the rapid evolving nature of the enterprise software industry, the competitive landscape
and the nature of the competition is constantly changing. Industry consolidation may affect competition by creating larger and potentially stronger competitors in the markets in which we compete. Moreover, other companies may currently be planning
to or are under pressure by stockholders to divest businesses. These divestitures may result in additional competitors that may have an advantage by focusing on a single product or service. We also compete in certain areas with our partners and
potential partners, and this may adversely impact our relationship with an individual partner or a number of partners.
Our efforts to
compete effectively may not be sufficient, which may adversely affect our business, financial condition, operating results and cash flows.
Our
continued success depends on our ability to adapt to a rapidly changing industry. Investment in new offerings, business strategies and initiatives could disrupt our ongoing business and may present risks not originally contemplated.
We operate in highly competitive markets that are characterized by rapid technological change, such as the transition of many of our enterprise
customers to cloud computing environments and frequent new product and
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service announcements. Our continued success will depend on our ability to adapt to rapidly changing technologies and user preferences, to adapt our offerings to evolving industry standards, to
predict user preferences and industry changes and to improve the performance and reliability of our offerings. Our failure to adapt to such changes could harm our business, and our efforts to adapt to such changes could require substantial
expenditures on our part to modify our offerings or infrastructure. Delays in developing, completing or delivering new or enhanced offerings and technologies could result in delayed or reduced revenue for those offerings and could also adversely
affect customer acceptance of those offerings and technologies. The success of new and enhanced offering introductions depends on several factors, including our ability to invest significant resources in research and development in order to enhance
our existing offerings and introduce new offerings in a timely manner, successfully promote the offerings, manage the risks associated with the offerings, make sufficient resources available to support the offerings and address any quality or other
defects in the early stages of introduction. Even if we are able to enhance our existing offerings or introduce new offerings that are well perceived by the market, if our marketing or sales efforts do not generate interest in or sales for these
offerings they may be unsuccessful.
Moreover, we believe that our continued success depends on our investing in new business strategies
or initiatives that complement our strategic direction and technology road map. Such endeavors may involve significant risks and uncertainties, including distraction of managements attention away from other business operations, and
insufficient revenue generation to offset liabilities and expenses undertaken with such strategies and initiatives. Because these endeavors may be inherently risky, no assurance can be given that such endeavors will not adversely affect our
business, financial condition, operating results and cash flows.
If we fail to continue to establish and maintain strategic relationships with
industry-leading companies, we may not be able to attract and retain a larger customer base.
Our success depends in part on our
ability to continue to establish and maintain strategic relationships with industry-leading cloud service providers, hardware original equipment manufacturers, independent software vendors (ISVs) and system integrators, such as
Amazon.com, Inc., Cisco Systems, Inc., Dell Inc., Fujitsu Limited, Hewlett Packard Enterprise Company, International Business Machines Corporation, Microsoft Corporation, NEC Corporation, Oracle Corporation, SAP AG and others. Many of these
strategic partners have engineered and certified that their technologies run on or with our offerings and, in some cases, have built their products and solutions using our offerings. We may not be able to maintain these relationships or replace them
on attractive terms in the future. Some of our strategic partners offer competing products and services. As a result of these factors, many of the companies with which we have strategic alliances may choose to pursue alternative technologies and
develop alternative products and services in addition to or in lieu of our offerings, either on their own or in collaboration with others, including our competitors. Moreover, we cannot guarantee that the companies with which we have strategic
relationships will market our offerings effectively or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. As our agreements with strategic partners terminate or expire, we may be unable to
renew or replace these agreements on comparable terms, or at all.
We rely, to a significant degree, on indirect sales channels for the distribution of
our offerings, and disruption within these channels could adversely affect our business, financial condition, operating results and cash flows.
We use a variety of different indirect distribution methods for our offerings, including channel partners, such as certified cloud service
providers, distributors, embedded technology partners, hardware original equipment manufacturers, ISVs, system integrators and value added resellers. A number of these partners in turn distribute via their own networks of channel partners with whom
we have no direct relationship. These relationships allow us to offer our technologies to a much larger customer base than we would otherwise be able through our direct sales and marketing efforts.
We rely, to a significant degree, on each of our channel partners to select, screen and maintain relationships with its distribution network
and to distribute our offerings in a manner that is consistent with applicable law and
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regulatory requirements and our quality standards. If our channel partners or a partner in its distribution network violate applicable law or regulatory requirements or misrepresent the
functionality of our offerings, our reputation could be damaged and we could be subject to potential liability. Furthermore, our channel partners may offer their own products and services or the products and services of other companies that compete
with our offerings or may not distribute and market our offerings effectively. Moreover, our existing channel partner relationships do not, and any future channel partner relationships may not, provide for any exclusivity regarding marketing or
distribution. In addition, if a channel partner is acquired by a competitor, its business units are reorganized or divested or its financial conditions were to weaken, our revenue derived from that partner may be adversely impacted.
Recruiting and retaining qualified channel partners and training them in the use of our enterprise technologies requires significant time and
resources. If we fail to devote sufficient resources to support and expand our network of channel partners, our business may be adversely affected. In addition, because we rely on channel partners for the indirect distribution of our enterprise
technologies, we may have little or no contact with the ultimate end-users of our technologies, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our software, support ongoing customer
requirements, estimate end-user demand, respond to evolving customer needs and obtain subscription renewals from end-users.
A portion of
our sales to government entities have been made indirectly through our channel partners. Government entities may have statutory, contractual, or other legal rights to terminate contracts with our channel partners for convenience or due to a default,
and any such termination may adversely impact our future operating results. Governments routinely investigate and audit government contractors administrative processes, and any unfavorable audit could result in the government refusing to
continue buying our offerings, a reduction of revenue or fines or civil or criminal liability if the audit uncovers improper or illegal activities.
If our indirect distribution channel is disrupted, we may be required to devote more resources to distribute our offerings directly and
support our customers, which may not be as effective and could lead to higher costs, reduced revenue and growth that is slower than expected.
The
duration and extent of economic downturns, regional financial instability, and economic and market conditions in general could adversely affect our business, financial condition, operating results and cash flows.
Economic weakness and uncertainty, tightened credit markets and constrained IT spending from time to time contribute to slowdowns in the
technology industry, as well as in the industries of our customers and the geographic regions in which we operate, which may result in reduced demand and increased price competition for our offerings. Our operating results in one or more geographic
regions or customer industries may also be affected by uncertain or changing economic conditions within that region or industry. Continuing uncertainty about future economic conditions may, among other things, negatively impact our current and
prospective customers and result in delays or reductions in technology purchases or lengthen our sales cycle. Adverse economic conditions also may negatively impact our ability to obtain payment for outstanding debts owed to us by our customers or
other parties with whom we do business. In addition, such conditions may impact our investment portfolio, and we could determine that some of our investments have experienced an other-than-temporary decline in fair value, requiring an impairment
charge that could adversely impact our financial condition and operating results. Also, such conditions may make it more difficult to forecast operating results. If global economic conditions, or economic conditions in the U.S., Europe, Asia or in
other key geographic regions or customer industries, were to remain uncertain or persist, spread or deteriorate further, current and prospective customers may delay or reduce their IT spending, which could adversely affect our business, financial
condition, operating results and cash flows.
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We have entered into and may continue to enter into or seek to enter into business combinations and
acquisitions, which may be difficult to complete and integrate, disrupt our business, divert managements attention, adversely affect our business, financial condition, operating results and cash flows or dilute stockholder value.
As part of our business strategy, we have in the past entered into business combinations and acquisitions, and we may continue to do so in the
future. These types of transactions can increase the expense of running our business and present significant challenges and risks, including:
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identifying acquisition targets that complement our strategic direction and technology road map;
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integrating the acquired business accounting, financial reporting, management, information and information security, human resource and other administrative systems to permit effective management and reporting,
and the lack of control if such integration is delayed or not implemented;
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gathering full information regarding a business or technology prior to a transaction, including the identification and assessment of liabilities, claims or other circumstances that could result in litigation or
regulatory exposure, unfavorable accounting treatment, unexpected tax implications and other adverse effects on our business;
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increasing or additional operating expenses related to the acquired business or technology;
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maintaining or establishing acceptable standards, controls, procedures and policies;
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disrupting of our ongoing business and distraction of management;
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impairing relationships with our employees, partners or customers as a result of any integration of new management and other personnel, products or technology or as a result of the changes in the competitive landscape
affected by the transaction;
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maintaining good relationships with customers or business partners of the acquired business;
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effectively evaluating talent at an acquired business or cultural challenges associated with integrating employees from the acquired business into our organization;
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losing key employees of the acquired business;
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incorporating and further developing acquired products or technology into our offerings and maintaining quality standards consistent with our brands;
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achieving the expected benefits of the transaction, which may include generating greater market acceptance of our technologies, increasing our revenues or integrating the assets acquired into one or more of our current
offerings;
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incurring expenses related to the transaction;
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assuming claims and liabilities from the acquired business or technology, or that are otherwise related to the transaction
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entering into new markets in which we have little or no experience or in which competitors may have stronger market positions;
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impairing of intangible assets and goodwill acquired in transactions; and
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for foreign transactions, managing additional risks related to the integration of operations across different cultures and languages, and the economic, political, compliance and regulatory risks associated with specific
countries.
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There can be no assurance that we will manage these challenges and risks successfully. Moreover, if we are not
successful in completing transactions that we have pursued or may pursue, our business may be adversely affected, and we may incur substantial expenses and divert significant management time and resources. In addition, in pursuing and completing
such transactions, we could use substantial portions of our available cash as all or a portion of the purchase price for these transactions or as retention incentives to employees of the acquired
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business, or we may incur substantial debt. We could also issue additional securities as all or a portion of the purchase price for these transactions or as retention incentives to employees of
the acquired business, which could cause our stockholders to suffer significant dilution. Any transaction may not generate additional revenue or profit for us, or may take longer to do so than expected, which may adversely affect our business,
financial condition, operating results and cash flows.
If we fail to effectively manage our growth, our business, financial condition, operating
results and cash flows could be adversely affected.
We have expanded our operations rapidly in recent years. For example, our total
revenue increased from $1.79 billion for the fiscal year ended February 28, 2015 to $2.05 billion for the fiscal year ended February 29, 2016. Moreover, the total number of our employees increased from approximately 7,300 as of
February 28, 2015 to approximately 8,800 as of February 29, 2016. In addition, we continue to explore ways to extend our offerings and geographic reach. Our growth has placed and will likely continue to place a strain on our management
systems, information systems, resources and internal controls. Our ability to successfully provide our offerings and implement our business plan requires adequate information systems and resources, internal controls and oversight from our senior
management. As we expand in international markets, these challenges increase as a result of the need to support a growing business in an environment of multiple languages, cultures, customs, legal systems, dispute resolution systems, regulatory
systems and commercial practices. As we grow, (i) we may not be able to adequately screen and hire or adequately train, supervise, manage or develop sufficient personnel, and (ii) we may not be able to develop or effectively manage our
controls, oversight functions or information systems. If we are unable to effectively manage our growth, our business, financial condition, operating results and cash flows could be adversely affected.
Industry consolidation and divestitures may lead to increased competition and may adversely affect our business, financial condition, operating results and
cash flows.
There has been a trend of both consolidation and divestitures in the technology industry. We expect these trends to
continue as companies attempt to strengthen or hold their market positions in an evolving industry. For example, as the computing, networking, storage, and software technologies that comprise the enterprise data center converge, many companies seek
to position themselves as key or single-source vendors providing end-to-end technology solutions for the data center. Also, some of our current and potential competitors have made acquisitions or announced new strategic alliances designed to
position them as a key or single-source vendor. As a result of these developments, we face greater competition, including competition from entities that are among our key business partners. This increased competition could adversely affect our
business, financial condition, operating results and cash flows.
We depend on our key non-management employees, and our inability to attract and
retain such employees could adversely affect our business or diminish our brands.
Competition in our industry for qualified employees,
especially technical employees, is intense and our competitors directly target our employees. Our inability to attract and retain key employees could hinder our influence in open source projects and seriously impede our success. Moreover, the loss
of these individuals, particularly to a competitor, some of which may be in a position to offer greater compensation, and any resulting loss of customers could reduce our market share and diminish our brands. We have from time to time in the past
experienced, and we may experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. Also, to the extent we hire personnel from competitors, we may be subject to allegations that they have
been improperly solicited, that they have divulged proprietary or other confidential information, or that their former employers own their inventions or other work product.
A number of our key employees have become, or will become, vested in a significant amount of their equity compensation awards. Employees may
be more likely to leave us after a significant portion of their equity compensation awards fully vest, especially if the shares underlying the equity awards have significantly appreciated in value. Additionally, as we grow, there may be less equity
compensation to award per employee. If
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we do not succeed in attracting and retaining key personnel, our business, financial performance, operating results and cash flows may be adversely affected.
We may not be able to continue to attract and retain capable management.
Our future success depends on the continued services and effectiveness of a number of key management personnel. The loss of these individuals,
particularly to a competitor, some of which may be in a position to offer greater compensation, could adversely affect our business or stock price.
Our ability to retain key management personnel or hire capable new management personnel as we grow may be challenged to the extent that other
companies are able to offer more attractive opportunities to the individuals we seek to hire or retain. In addition, historically we have used share-based compensation as a key component of our compensation packages. Changes in the accounting for
share-based compensation could adversely affect our earnings or make it more beneficial for us to use more cash compensation to attract and retain capable personnel. If the price of our common stock falls, the value of our share-based awards to
recipients is reduced. Such events, or if we are unable to secure stockholder approval for increases in the number of shares eligible for share-based compensation grants, could adversely affect our ability to successfully attract and retain key
management personnel. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key management personnel could hinder our strategic planning and
execution.
Because of the characteristics of open source software, there are few technology barriers to entry into the open source market by new
competitors and it may be relatively easy for competitors, some of which may have greater resources than we have, to enter our markets and compete with us.
One of the characteristics of open source software is that anyone may modify and redistribute the existing open source software and use it to
compete with us. Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies. It is possible for competitors with greater resources than ours to develop their own open source
solutions or acquire a smaller business that has developed open source offerings that compete with our offerings, potentially reducing the demand for, and putting price pressure on, our offerings. In addition, some competitors make their open source
software available for free download and use on an ad hoc basis or may position their open source software as a loss leader. We cannot guarantee that we will be able to compete successfully against current and future competitors or that competitive
pressure and/or the availability of open source software will not result in price reductions, reduced operating margins and loss of market share. Additionally, any failure by us to provide high-quality technical support, or the perception that we do
not provide high-quality technical support, could harm our reputation and negatively impact our ability to sell subscriptions for our open source offerings to existing and prospective customers. If we are unable to differentiate our open source
offerings from those of our competitors or compete effectively with other open source offerings, our business, financial condition, operation results and cash flows could be adversely affected.
Our corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the innovation, creativity and
collaboration fostered by our culture, and our business may be adversely affected.
We believe that a critical contributor to our
success has been our corporate culture, which we believe fosters innovation, creativity and collaboration. As our organization grows, our employees (including remote workers) and our resources become more globally dispersed and our organizational
management structures become more complex, we may find it increasingly difficult to maintain these beneficial aspects of our corporate culture. If we are unable to maintain our corporate culture, we may find it difficult to attract and retain
motivated employees, continue to perform at current levels or execute on our business strategy. As a result, our business, financial condition, operating results and cash flows could be adversely affected.
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Our emerging technology offerings are based on developing technologies and business models, and the potential
market for these offerings remains uncertain.
Our emerging technology offerings, which include our cloud, mobile and storage
offerings, are based on developing technologies and business models, the success of which will depend on the technological and operational benefits and cost savings associated with the adoption of these technologies. These technologies are rapidly
evolving, and their development is a complex and uncertain process requiring high levels of innovation and investment as well as the accurate anticipation of technology trends, market demand and customer needs. We expect competition to remain
intense and, as with many emerging IT sectors, these technologies may be subject to a first mover effect pursuant to which certain product offerings rapidly capture a significant portion of market share and developer attention. Moreover,
we may make errors in reacting to relevant business trends and predicting which technologies are successful or otherwise develop into industry standards.
Adoption of emerging technologies may occur more slowly or less pervasively than we expect and the revenue growth associated with these
offerings may be slower than currently expected. Moreover, even if emerging technologies are adopted widely by enterprises, our offerings in these areas may not attract a sufficient number of users or generate attractive financial results. We incur
expenses associated with these offerings in advance of our ability to generate associated revenue. Demand for our emerging technology offerings may unfavorably impact demand for our other offerings, including software subscriptions and related
professional services. If the market for our emerging technologies offerings fails to develop adequately, it could have an adverse effect on our business, financial condition, operating results and cash flows.
Our business model may encounter customer resistance or we may experience a decline in the demand for our offerings.
We provide Red Hat enterprise technologies primarily under annual or multi-year subscriptions. A subscription generally entitles a customer to,
among other things, a specified level of support, as well as security updates, fixes, functionality enhancements, upgrades to the technologies, each, if and when available, and compatibility with an ecosystem of certified hardware and software.
While we believe this practice complies with the requirements of the GNU General Public License, and while we have reviewed this practice with the Free Software Foundation, the organization that maintains and provides interpretations of the GNU
General Public License, customers may fail to honor the terms of our subscription agreements.
Demand for our offerings depends
substantially on the general demand for enterprise software, which fluctuates based on numerous factors, including the spending levels and growth of our current and prospective customers, and general economic conditions. In addition, our customers
generally undertake a significant evaluation process that may result in a lengthy sales cycle. We spend substantial time, effort, and money on our sales efforts, including developing and implementing appropriate go-to-market strategies and training
our sales force and channel partners in order to effectively market new offerings, without any assurance that our efforts will produce any sales. The purchase of our offerings may be discretionary and can involve significant expenditures. If our
current and prospective customers cut costs, then they may significantly reduce their enterprise software expenditures.
As technologies
and the markets for our enterprise offerings change, our annual or multi-year subscription-based business model may no longer meet the needs of our customers. For example, a business model based on annual or multi-year subscriptions may no longer be
competitive in an environment where disruptive technologies (such as cloud computing) enable customers to consume computing resources on an hourly basis or for free. We also develop and offer these disruptive technologies with consumption-based
pricing, which may have an effect on the demand for our subscription-based offerings.
An increased focus on developing and providing
emerging technology offerings may require a greater focus on marketing more holistic solutions, rather than individual offerings. Consequently, we may need to develop appropriate marketing and pricing strategies for our offerings, our
customers purchasing decisions may become more complex and require additional levels of approval and the duration of sales cycles for our offerings may increase.
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If we are unable to adapt our business model to changes in the marketplace or if demand for our
offerings declines, our business, financial condition, operating results and cash flows could be adversely affected.
If our customers do not renew
their subscription agreements with us, or if they renew on less favorable terms, our business, financial results, operating results and cash flows may be adversely affected.
Our customers may not renew their subscriptions after the expiration of their subscription agreements and in fact some customers elect not to
do so. In addition, our customers may opt for a lower-priced edition of our offerings or for fewer subscriptions. We have limited historical data with respect to rates of customer subscription renewals, so we cannot accurately predict customer
renewal rates. Our customers renewal rates may decline or fluctuate as a result of a number of factors, including their level of satisfaction with our services and their ability to continue their operations and spending levels. Government
contracts could be subject to future funding that may affect the extension or termination of programs and generally are subject to the right of the government to terminate for convenience or non-appropriation. If we experience a decline in the
renewal rates for our customers or they opt for lower-priced editions of our offerings or fewer subscriptions, our business, financial condition, operating results and cash flows may be adversely affected.
If third-party enterprise hardware and software providers do not continue to make their products and services compatible with our offerings, our software
may cease to be competitive and our business, financial condition, operating results and cash flows may be adversely affected.
The
competitive position of our offerings is dependent on their compatibility with products and services of third-party enterprise hardware and software companies. To the extent that a hardware or software vendor might have or develop products and
services that compete with ours, the vendor may have an incentive to seek to limit the performance, functionality or compatibility of our offerings when used with one or more of the vendors offerings. In addition, these vendors may fail to
support or issue statements of compatibility or certification of our offerings when used with their offerings. We intend to encourage the development of additional applications that operate on both current and new versions of our offerings by, among
other means, attracting third-party developers to our offerings, providing open source tools to create these applications and maintaining our existing developer relationships through marketing and technical support. We intend to encourage the
compatibility of our software with various third-party hardware and software offerings by maintaining and expanding our relationships, both business and technical, with relevant independent hardware and software vendors. If we are not successful in
achieving these goals, however, our offerings may not be competitive and our business, financial condition, operating results and cash flows may be adversely affected.
If open source software programmers, most of whom we do not employ, do not continue to develop and enhance open source technologies, we may be unable to
develop new technologies, adequately enhance our existing technologies or meet customer requirements for innovation, quality and price.
We rely to a significant degree on a number of largely informal communities of independent open source software programmers to develop and
enhance our enterprise technologies. For example, Linus Torvalds, a prominent open source software developer, and a relatively small group of software engineers, many of whom are not employed by us, are primarily responsible for the development and
evolution of the Linux kernel, which is the heart of the Red Hat Enterprise Linux operating system. If these groups of programmers fail to adequately further develop and enhance open source technologies, we would have to rely on other parties to
develop and enhance our offerings or we would need to develop and enhance our offerings with our own resources. We cannot predict whether further developments and enhancements to these technologies would be available from reliable alternative
sources. In either event, our development expenses could be increased and our technology release and upgrade schedules could be delayed. Moreover, if third-party software programmers fail to adequately further develop and enhance open source
technologies, the development and adoption of these technologies could be stifled and our offerings could become less competitive. Delays in developing, completing or delivering new or enhanced offerings could result in delayed or reduced revenue
for those offerings and could also adversely affect customer acceptance of those offerings.
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Our offerings may contain defects that may be costly to correct, delay market acceptance of our enterprise
technologies and expose us to claims and litigation.
Despite our testing procedures, errors have been and may continue to be found in
our offerings after deployment. This risk is increased by the fact that much of the code in our offerings is developed by independent parties over whom we exercise no supervision or control. If errors are discovered, we may have to make significant
expenditures of capital and devote significant technical resources to analyze, correct, eliminate or work around them, and we may not be able to successfully do so in a timely manner or at all. Errors and failures in our offerings could result in a
loss of, or delay in, market acceptance of our enterprise technologies, loss of existing or potential customers and delayed or lost revenue and could damage our reputation and our ability to convince enterprise users of the benefits of our
technologies.
In addition, errors in our technologies could cause system failures, loss of data or other adverse effects for our
customers who may assert warranty and other claims for substantial damages against us. Although our agreements with our customers often contain provisions which seek to limit our exposure to potential product liability claims, it is possible that
these provisions may not be effective or enforceable under the laws of some jurisdictions. While we seek to insure against these types of claims, our insurance policies may not adequately limit our exposure to such claims. These claims, even if
unsuccessful, could be costly and time-consuming to defend and could adversely affect our business, financial conditions, operating results and cash flows.
Our continued success depends on our ability to maintain and enhance strong brands.
We believe that the brand identities that we have developed have contributed significantly to the success of our business. We also believe that
maintaining and enhancing our brands is important to expanding our customer and partner base and attracting talented employees. In order to maintain and enhance our brands, we may be required to make further investments that may not be successful.
Maintaining our brands will depend in part on our ability to remain a leader in open source technology and our ability to continue to provide high-quality offerings. If we fail to promote and maintain our brands, or if we incur excessive costs in
doing so, our business, financial condition, operating results and cash flows may be adversely affected.
Security breaches and data loss may expose us
to liability, harm our reputation and adversely affect our business.
Our business involves the production and distribution of
enterprise software technologies, as well as hosting applications. As part of our business, we (or third parties with whom we contract) receive, store and process our data, as well as our customers and partners data. While we take
security and testing measures relating to our offerings and operations, those measures may not prevent security breaches and data loss that could harm our business or the businesses of our customers and partners. Advances in computer capabilities,
new discoveries in the field of cryptography, inadequate technology or facility security measures or other factors may result in data loss or a compromise or breach of our systems and the data we receive, store and process (or systems and the data
received, stored and processed by third parties with whom we contract). These security measures may be breached or data lost as a result of actions by third parties, employee error (such as weak passwords or unencrypted devices), malfeasance or
vulnerabilities or security bugs found in software code. A party who is able to circumvent security measures or exploit inadequacies in security measures, could, among other things, misappropriate proprietary information (including information about
our employees, customers and partners, our customers information, financial data and data that others could use to compete against us), cause the loss or disclosure of some or all of this information, cause interruptions or denial of service
in our or our customers operations, cause delays in development efforts or expose customers (and their customers) to computer viruses or other disruptions or vulnerabilities. A compromise to these systems could remain undetected for an
extended period of time, exacerbating the impact of that compromise. These risks may increase as we continue to grow our cloud, mobile and services offerings and as we receive, store and process more of our customers data. Actual or perceived
vulnerabilities may lead to regulatory investigations, claims against us by customers, partners or other third parties, or costs, such as those related to providing customer notifications and fraud monitoring. While our
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customer agreements typically contain provisions that seek to limit our liability, there is no assurance these provisions will be enforceable and effective under applicable law. In addition, the
cost and operational consequences of implementing further data protection measures could be significant. Moreover, because the techniques used to obtain unauthorized access, disable or degrade service or sabotage systems change frequently and often
are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any loss of data or compromise of our systems or the data we receive, store or process (or systems
and the data received, stored and processed by third parties with whom we contract) could result in a loss of confidence in the security of our offerings, damage our reputation, loss of channel or strategic partners, lead to legal liability and
adversely affect our business, financial condition, operating results and cash flows.
We are vulnerable to technology infrastructure failures, which
could harm our reputation and adversely affect our business.
We rely on our technology infrastructure, and the technology
infrastructure of third parties, for many functions, including selling our offerings, supporting our partners, fulfilling orders and billing, and collecting and making payments. This technology infrastructure may be vulnerable to damage or
interruption from natural disasters, power loss, telecommunication failures, terrorist attacks, computer intrusions, vulnerabilities and viruses, software errors, computer denial-of-service attacks and other events. A significant number of the
systems making up this infrastructure are not redundant, and our disaster recovery planning may not be sufficient for every eventuality. This technology infrastructure may fail or be vulnerable to damage or interruption because of actions by third
parties or employee error or malfeasance. We may not carry business interruption insurance sufficient to protect us from all losses that may result from interruptions in our services as a result of technology infrastructure failures or to cover all
contingencies. Any interruption in the availability of our websites and on-line interactions with customers or partners may cause a reduction in customer or partner satisfaction levels, which in turn could cause additional claims, reduced revenue or
loss of customers or partners. Despite any precautions we may take, such problems could result in, among other consequences, a loss of data, loss of confidence in the stability and reliability of our offerings, damage to our reputation, and legal
liability, all of which may adversely affect our business, financial condition, operating results and cash flows interruptions.
A decline in or
reprioritization of funding in the U.S. or foreign government budgets or delays in the budget process could adversely affect our business, financial condition, operating results and cash flows.
We derive, and expect to continue to derive, a portion of our revenue from U.S. and foreign governments. Government deficit reduction and
austerity measures, along with continued economic challenges, continue to place pressure on U.S. and foreign government spending. The termination of, or delayed or reduced funding for, government-sponsored programs and contracts from which we derive
revenue could adversely affect our business, financial condition, operating results and cash flows.
We may be unable to predict the future course of
open source technology development, which could reduce the market appeal of our offerings, damage our reputation and adversely affect our business, financial condition, operating results and cash flows.
We do not exercise control over many aspects of the development of open source technology. Different groups of open source software programmers
compete with one another to develop new technology. Typically, the technology developed by one group will become more widely used than that developed by others. If we acquire or adopt new technology and incorporate it into our offerings but
competing technology becomes more widely used or accepted, the market appeal of our offerings may be reduced and that could harm our reputation, diminish our brands and adversely affect our business, financial condition, operating results and cash
flows.
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We include software licensed from other parties in our offerings, the loss of which could increase our costs
and delay availability of our offerings.
We utilize various types of software licensed from unaffiliated third parties in our
offerings. Aspects of our business could be disrupted if any of the software we license from others or functional equivalents of this software were no longer available to us, no longer offered to us on commercially reasonable terms or changed in
ways or included defects that make the third-party software unsuitable for our use. In these cases, we would be required to either redesign our technologies to function with software available from other parties, develop these components ourselves
or eliminate the functionality, which could result in increased costs, the need to mitigate customer issues, delays in delivery of our offerings and the release of new offerings and limit the features available in our current or future offerings.
RISKS RELATED TO LEGAL UNCERTAINTY
If our technologies are found or alleged to infringe third-party intellectual property rights, we may be required to take costly and time-consuming actions
to meet our commitments to customers.
We regularly commit to our subscription customers that if portions of our offerings are found to
infringe third-party intellectual property rights we will, at our expense and option: (i) obtain the right for the customer to continue to use the technology consistent with their subscription agreement with us; (ii) modify the technology
so that its use is non-infringing; or (iii) replace the infringing component with a non-infringing component, and defend them against specified infringement claims. Although we cannot predict whether we will need to satisfy these commitments
and we often have limitations on these commitments, satisfying these commitments could be costly, be time-consuming, divert the attention of technical and management personnel, and adversely affect our business, financial condition, operating
results and cash flows. In addition, our insurance policies would likely not adequately cover our exposure to this type of claim. Finally, because we have agreed to defend our subscription customers against specified infringement claims arising from
the use of our offerings, we could become involved in litigation brought against such customers if our services and technology are allegedly implicated.
We are vulnerable to claims that our technologies infringe third-party intellectual property rights and an unfavorable legal decision affecting our
intellectual property could adversely affect our business.
We are vulnerable to claims that our technologies infringe third-party
intellectual property rights, including patents, copyrights, trademarks and trade secrets, because our technologies are comprised of software components, many of which are developed by numerous independent parties. We are also unlikely to be able to
assess adequately the relevance of patents to our technologies, and may be unable to take appropriate responsive action in a timely or economic manner because, among other reasons, the scope of software patent protection is often not well defined or
readily determinable, patent applications in the U.S. are not publicly disclosed at the time of filing, and the number of software patents that are issued each year is significant and growing. Our exposure to risks associated with the use of
intellectual property may increase as a result of acquisitions. In addition, third parties may make infringement and similar or related claims after we have acquired technology that had not been asserted prior to our acquisition of such technology.
In the past, our technologies have been subject to intellectual property infringement claims. Some of these claims have been brought by
entities that do not design, manufacture, or distribute products or services or that acquire intellectual property like patents for the sole purpose of monetizing their acquired intellectual property through asserting claims of infringement. As
these entities do not have operating businesses of their own and therefore have limited risk of counterclaims for damages or injunctive relief, it may be difficult to deter them from bringing intellectual property infringement claims. We expect to
face the possibility of more intellectual property infringement claims as our prominence increases, business activities expand, market share and revenue grow, the number of products and competitors in our industry grows and the functionality of
products in different portions of the industry overlap. We may not be able to accurately assess the risk related to these suits, and we may be unable to accurately assess our level of exposure.
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Defending patent and other intellectual property claims, even claims without significant merit,
can be time-consuming, costly and can divert the attention of technical and management personnel. We may receive unfavorable preliminary or interim rulings in the course of litigation, and there can be no assurances that favorable final outcomes
will be obtained in all cases. We may decide to settle certain lawsuits and disputes on terms that are disadvantageous to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment
that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease offering certain of our technologies or pay substantial amounts to the other party. In addition, we may have to seek a license to continue
offering technologies found to be in violation of a third partys rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to
develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense or may not be feasible.
An unfavorable legal decision regarding the intellectual property in and to our technology and other offerings could adversely affect our
business, financial condition, operating results and cash flows. See Part II, Item 1, Legal Proceedings for additional information.
Our activities, or the activities of our partners, may violate anti-corruption laws and regulations that apply to us.
In many foreign countries, particularly in certain developing economies, it is not uncommon to engage in business practices that are prohibited
by regulations that may apply to us, such as the U.S. Foreign Corrupt Practices Act and similar laws. Although we have policies and procedures designed to help promote compliance with these laws, our employees, contractors, partners and agents, as
well as those companies to which we outsource certain of our business operations, may take actions in violation of our policies and procedures. Any violation of these laws and regulations could result in fines, criminal sanctions against us, our
officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation.
Governmental regulations affecting the import
or export of software could adversely impact our business.
Due to the global nature of our business, we are subject to import and
export restrictions and regulations, including the Export Administration Regulations administered by the U.S. Commerce Departments Bureau of Industry and Security (BIS) and the trade and economic sanctions regulations administered
by the U.S. Treasury Departments Office of Foreign Assets Control (OFAC). The U.S., through the BIS and OFAC, places restrictions on the sale or export of certain products and services to certain countries and persons (denied
parties). Violators of these export control and sanctions laws may be subject to significant penalties, which may include significant monetary fines, criminal proceedings against them and their officers and employees, a denial of export
privileges, and suspension or debarment from selling products or services to the federal government. Any such penalties could have an adverse effect on our business, financial condition, operating results and cash flows. In addition, the political
and media scrutiny surrounding any governmental investigation of us could cause us significant expense and reputational harm and distract senior executives from managing our normal day-to-day operations.
Our products could also be shipped to denied parties by third parties, including our channel partners. Even though we take precautions to
ensure that our channel partners comply with all relevant import and export regulations, any failure by our channel partners to comply with such regulations could have negative consequences for us, including reputational harm, government
investigations and penalties.
We could be prevented from selling or developing our software if the GNU General Public License and similar licenses
under which our technologies are developed and licensed are not enforceable or are modified so as to become incompatible with other open source licenses.
A number of our offerings, including Red Hat Enterprise Linux, have been developed and licensed under the GNU General Public License and
similar open source licenses. These licenses state that any program licensed
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under them may be liberally copied, modified and distributed. It is possible that a court would hold these licenses to be unenforceable or that someone could assert a claim for proprietary rights
in a program developed and distributed under them. Additionally, if any of the open source components of our offerings may not be liberally copied, modified or distributed, then our ability to distribute or develop all or a portion of our offerings
could be adversely impacted. In addition, licensors of open source software employed in our offerings may, from time to time, modify the terms of their license agreements in such a manner that those license terms may become incompatible with other
open source licenses in our offerings or our end user license agreement, and thus could, among other consequences, prevent us from distributing the software code subject to the modified license.
Our efforts to protect our trademarks may not be adequate to prevent third parties
from misappropriating our intellectual property rights in our trademarks.
Our collection of trademarks is valuable and important
to our business. The protective steps we have taken in the past may have been, and may in the future continue to be, inadequate to protect and deter misappropriation of our trademark rights. We may be unable to detect the unauthorized use of, or
take appropriate steps to enforce, our trademark rights in a timely manner. We have registered some of our trademarks in countries in North America, South America, Europe, Asia, Africa and Australia and have other trademark applications pending
in various countries around the world. Effective trademark protection may not be available in every country in which we offer or intend to distribute our offerings. We may be unable to prevent third parties from acquiring domain names that are
similar to, infringe upon, or diminish the value of our trademarks and other proprietary rights. Failure to adequately protect our trademark rights could damage or even destroy one or more of our brands and impair our ability to compete effectively.
Furthermore, defending or enforcing our trademark rights could result in the expenditure of significant financial and managerial resources.
Efforts to
assert intellectual property ownership rights in our technologies could impact our standing in the open source community, which could limit our technology innovation capabilities and adversely affect our business.
When we undertake actions to protect and maintain ownership and control over our intellectual property, including patents, copyrights and
trademark rights, our standing in the open source community could be adversely affected as the community supports the ability to write and share code freely. This in turn could limit our ability to continue to rely on this community, upon which we
are dependent, as a resource to help develop and improve our technologies and further our research and development efforts, and could adversely affect our business.
Our Patent Promise on software patents limits our ability to enforce our patent rights in certain circumstances.
As part of our commitment to the open source community, we provide our Patent Promise on software patents. Under our Patent Promise, we
agree, subject to certain limitations, to not enforce our patent rights against users of open source software covered by certain open source licenses, including the GNU General Public License version 2.0 and version 3.0, GNU Lesser General Public
License version 2.1 and version 3.0, IBM Public License version 1.0, Common Public License version 1.0, Q Public License version 1.0, Open Software License version 3.0 and any other open source license granted by Red Hat. While we may be able
to claim protection of our intellectual property under other rights, such as trade secrets or contractual rights, our Patent Promise effectively limits our ability to assert our patent rights against these third parties (even if we were to conclude
that their use infringes our patents with competing offerings), unless any such third party asserts its patent rights against us. This limitation on our ability to assert our patent rights against others could harm our business and ability to
compete.
We are, and may become, involved in disputes and lawsuits that could adversely affect our business.
Lawsuits or legal proceedings may be commenced against us. These disputes and proceedings may involve significant expense and divert the
attention of management and other employees. If we do not prevail in these
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matters, we could be required to pay substantial damages or settlement costs, which could adversely affect our business, financial condition, operating results and cash flows. See Part II,
Item 1, Legal Proceedings for additional information.
If we fail to comply with laws and regulations regarding data privacy and
protection, our business could be adversely affected.
Our business is subject to a variety of federal, state and international laws
and regulations that apply to the collection, use, retention, protection, disclosure, transfer and processing of personal data. These data privacy- and protection-related laws and regulations are evolving, with new or modified laws and regulations
proposed and implemented frequently and existing laws and regulations subject to new or different interpretations. For example, in October 2015, the European Court of Justice invalidated the U.S.-EU Safe Harbor Framework. The Safe Harbor Framework
had established a lawful method for the transfer of personal data from the European Economic Area (EEA) to the U.S. The decision of the European Court of Justice has resulted in increased uncertainty and greater complexity and risk
relating to transfers of personal data from the EEA to the U.S.
Any failure by us to comply with data privacy- and protection-related
laws and regulations could result in enforcement actions, significant penalties or other legal actions against us or our customers or suppliers. An actual or alleged failure to comply, which could result in negative publicity, reduce demand for our
offerings, increase the cost of compliance, require changes in business practices that result in reduced revenue, restrict our ability to provide our offerings in certain locations, result in our customers inability to use our offerings and
prohibit data transfers or result in other claims, liabilities or sanctions, including fines, could have an adverse effect on our business, financial condition, operating results and cash flows.
If we fail to comply with our customer contracts or government contracting regulations, our business could be adversely affected.
Our contracts with our customers may include specialized performance requirements. In particular, our contracts with federal, state, provincial
and local governmental customers are subject to various government certification requirements, procurement regulations, contract provisions and other requirements relating to their formation, administration and performance. Any failure by us or our
channel partners to comply with the specific provisions in our customer contracts or any violation of government contracting regulations by us or our channel partners could result in the imposition of various civil and criminal penalties, which may
include termination of contracts, forfeiture of profits, suspension of payments and, in the case of our government contracts, fines and suspension from future government contracting. In addition, we may be subject to
qui tam
litigation, the
process by which a private individual sues or prosecutes on behalf of the government relating to government contracts and shares in the proceeds of any successful litigation or settlement, which could include claims for up to treble damages.
Further, any negative publicity related to our customer contracts or any proceedings surrounding them, regardless of its accuracy, may damage our business and affect our ability to compete for new contracts. There is increased pressure for
governments and their agencies, both domestically and internationally, to reduce spending. If our customer contracts are terminated, if we are suspended from government work, if we are unable to meet government certification requirements, or if our
ability to compete for new contracts is adversely affected, we could suffer an adverse effect on our business, financial condition, operating results and cash flows.
We may be subject to legal liability associated with providing online services or content.
We provide offerings, such as OpenShift by Red Hat, that enable users to exchange information, advertise products and services, conduct
business, and engage in various online activities. The law relating to the liability of providers of these online offerings for activities of their users is relatively unsettled and still developing both in the U.S. and internationally and may be
significantly different from jurisdiction to jurisdiction. Claims could be brought against us based on the nature and content of information that we publish or to which we provide links or that may be posted online or generated by us or by third
parties, including our customers. In addition, we could be subject to domestic or international actions alleging that certain content we have generated or third-party content that we have made available within our services violates applicable law.
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RISKS RELATED TO FINANCIAL UNCERTAINTY
Our quarterly and annual operating results may not be a reliable indicator of our future financial performance.
Due to the unpredictability of the IT spending environment, among other reasons, our revenue and operating results have fluctuated and may
continue to fluctuate. We base our current and projected future expense levels, in part, on our estimates of future revenue. Our expenses are, to a large extent, fixed in the short term. Accordingly, we may not be able to adjust our spending quickly
enough to protect our projected operating results for a quarter if our revenue in that quarter falls short of our expectations. Additionally, a significant portion of our quarterly sales typically occur during the last weeks of the quarter and our
revenue and operating results may be adversely impacted if we are unable to process an increasing number of transactions by the end of the quarter. If, among other considerations, our future financial performance falls below the expectations of
securities analysts or investors or we are unable to increase or maintain profitability, the market price of our common stock may decline.
We may not
be able to meet the financial and operational challenges that we will encounter as our international operations, which represented approximately 40.9% of our total revenue for the fiscal year ended February 29, 2016, continue to expand.
Our international operations accounted for approximately 40.9% of total revenue for the fiscal year ended February 29, 2016. As
we expand our international operations, we may have difficulty managing and administering a globally dispersed business and we may need to expend additional funds to, among other activities, reorganize our sales force and technical support services
team, outsource or supplement general and administrative functions, staff key management positions, obtain additional information technology infrastructure and successfully localize offerings for a significant number of international markets, which
may adversely affect our operating results. Additional challenges associated with the conduct of our business globally that may adversely affect our operating results include:
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longer payment cycles and less financial stability of customers;
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economic, political, compliance and regulatory risks associated with specific countries;
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laws and policies of the U.S. and other jurisdictions affecting trade, foreign investment, loans, and taxes;
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difficulty selecting and monitoring channel partners;
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differing technology standards and customer requirements;
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lower levels of availability or use of the Internet, through which our software is often delivered;
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difficulty protecting our intellectual property rights globally due to, among other reasons, the uncertainty of laws and enforcement in certain countries relating to the protection of intellectual property rights;
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difficulty in staffing, developing and managing foreign operations as a result of distance, language, legal, cultural and other differences;
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different employee/employer relationships and the existence of works councils and labor unions;
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difficulty maintaining quality standards consistent with the our brands;
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export and import laws and regulations that could prevent us from delivering our offerings into and from certain countries;
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public health risks and natural disasters, particularly in areas in which we have significant operations;
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limitations on the repatriation and investment of funds and foreign currency exchange restrictions;
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changes in import/export duties, quotas or other trade barriers that could affect the competitive pricing of our offerings and reduce our market share in some countries; and
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economic or political instability or terrorist acts in some international markets that could adversely affect our business in those markets or result in the loss or forfeiture of some foreign assets and the loss of sums
spent developing and marketing those assets and the revenue associated with them.
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Any failure by us to effectively manage
the challenges associated with the international expansion of our operations could adversely affect our business, financial condition, operating results and cash flows.
On June 23, 2016, the United Kingdom (the U.K.) held a referendum in which voters approved an exit from the European Union
(the E.U.), commonly referred to as Brexit. As a result of the referendum, it is expected that the British government will begin negotiating the terms of the U.K.s withdrawal from the E.U. A withdrawal could, among
other outcomes, disrupt the free movement of goods, services and people between the U.K. and the E.U., undermine bilateral cooperation in key policy areas and significantly disrupt trade between the U.K. and the E.U. In addition, Brexit could lead
to legal uncertainty and potentially divergent national laws and regulations as the U.K. determines which E.U. laws to replace or replicate. Given the lack of comparable precedent, it is unclear what financial, political and legal implications the
withdrawal of the U.K. from the E.U. would have and how such withdrawal would affect us.
The announcement of Brexit caused significant
volatility in global stock markets and currency exchange rate fluctuations that resulted in the strengthening of the U.S. dollar against foreign currencies in which we conduct business. The strengthening of the U.S. dollar relative to other
currencies may adversely affect our operating results. The announcement of Brexit and the withdrawal of the U.K. from the E.U. may also create global economic uncertainty, which may cause our customers to closely monitor their costs and reduce their
spending budgets. Any of these effects of Brexit, among others, could adversely affect our business, financial condition, operating results and cash flows.
A substantial portion of our revenue is derived from our Red Hat Enterprise Linux platform.
During our fiscal year ended February 29, 2016, a substantial portion of our subscription revenue was derived from our Red Hat Enterprise
Linux offerings. Although we are continuing to develop other offerings, we expect that revenue from Red Hat Enterprise Linux will constitute a majority of our revenue for the foreseeable future. Declines and variability in demand for Red Hat
Enterprise Linux could occur as a result of:
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competitive products and pricing;
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failure to release new or enhanced versions of Red Hat Enterprise Linux on a timely basis, or at all;
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technological change that we are unable to address with Red Hat Enterprise Linux; or
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future economic conditions.
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Additionally, as more customers and potential customers
virtualize their data centers and move computing projects to cloud environments, demand for operating systems such as Red Hat Enterprise Linux may decline. Moreover, as data centers become more virtualized and move to cloud environments, we may
experience a decline in growth if we are unsuccessful in adapting our business model and offerings accordingly. Due to the concentration of our revenue from Red Hat Enterprise Linux, our business, financial condition, operating results and cash
flows could be adversely affected by a decline in demand for Red Hat Enterprise Linux.
We are subject to risks of currency fluctuations and related
hedging operations.
A portion of our business is conducted in currencies other than the U.S. dollar. Changes in exchange rates among
other currencies and the U.S. dollar may affect our revenue, operating expenses and operating margins,
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which are reported in U.S. dollars. We cannot predict the impact of future exchange rate fluctuations. As we expand international operations, our exposure to exchange rate fluctuations may
increase. We use financial instruments, primarily forward purchase contracts, to economically hedge currency commitments arising from trade accounts receivable, trade accounts payable and fixed purchase obligations. If these hedging activities are
not successful or we change or reduce these hedging activities in the future, we may experience significant unexpected expenses from fluctuations in exchange rates. For information regarding our hedging activity, see Part I, Item 3,
Quantitative and Qualitative Disclosures About Market Risk.
If our growth rate slows, our stock price could be adversely affected.
As the markets for our offerings mature and the scale of our business increases, our rate of revenue, deferred revenue and operating
cash flow growth may be lower than the growth rates we experienced in earlier periods. In addition, to the extent that the adoption of our offerings occurs more slowly or is less pervasive than we expect, our growth rates may slow or decline, which
could adversely affect our stock price. Historical period-to-period comparisons of our revenue, deferred revenue and operating cash flow may not be meaningful and are not guarantees of our future performance.
We may be subject to greater tax liabilities.
We are subject to income and other taxes in the U.S. and in numerous foreign jurisdictions. Our domestic and foreign tax liabilities are
subject to the allocation of revenue and expenses in different jurisdictions. Additionally, the amount of taxes paid is subject to our interpretation of applicable tax laws in the jurisdictions in which we operate. Changes in tax laws, or in
judicial or administrative interpretations of tax laws, could have an adverse effect on our business, financial condition, operating results and cash flows. Significant judgment is required in determining our worldwide provision for income taxes. In
the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We are regularly subject to audits by tax authorities. Although we believe our tax estimates are reasonable, the
final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. Economic and political pressures to increase tax revenue in various jurisdictions may make resolving
tax disputes more difficult. The results of an audit or litigation could adversely affect our financial statements in the period or periods for which that determination is made.
We earn a significant amount of our operating income from outside the U.S., and any repatriation of funds currently held in foreign
jurisdictions may result in higher effective tax rates for the company. In addition, there have been proposals to change U.S. tax laws that would significantly impact how U.S. multinational corporations are taxed on foreign earnings. Although we
cannot predict whether or in what form this proposed legislation may pass, if enacted it could adversely affect our operating results and cash flows.
Because we recognize revenue from subscriptions for our service over the term of the subscription, downturns or upturns in sales may not be immediately
reflected in our operating results.
We generally recognize subscription revenue from customers ratably over the term of their
subscription agreements, which are generally 12 to 36 months. As a result, much of the revenue we report in each quarter is deferred revenue from subscription agreements entered into during previous quarters. Consequently, a decline in subscriptions
in any one quarter will not necessarily be fully reflected in the revenue in that quarter and will negatively affect our revenue in future quarters. In addition, we may be unable to adjust our cost structure to reflect this reduced revenue.
Accordingly, the effect of significant downturns in sales and market acceptance of our service, and potential changes in our rate of renewals, may not be fully reflected in our operating results until future periods. Our subscription model also
makes it difficult for us to rapidly increase our revenue through additional sales in any period, as revenue from new customers must be recognized over the applicable subscription term.
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If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant
charge to earnings.
Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when
events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of
our goodwill or amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization, reduced future cash flow estimates and slower growth rates in our industry. We may be required to record a significant
charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, which could adversely affect our operating results.
We may be exposed to potential risks if we do not have an effective system of disclosure controls or internal controls.
We must comply, on an on-going basis, with the requirements of the Sarbanes-Oxley Act of 2002, including those provisions that establish the
requirements for both management and auditors of public companies with respect to reporting on internal control over financial reporting. We cannot be certain that measures we have taken, and will take, will be sufficient or timely completed to meet
these requirements on an on-going basis, or that we will be able to implement and maintain adequate disclosure controls and controls over our financial processes and reporting in the future, particularly in light of our rapid growth, international
expansion and changes in our offerings, which are expected to result in on-going changes to our control systems and areas of potential risk.
If we fail to maintain an effective system of disclosure controls or internal control over financial reporting, including satisfaction of the
requirements of the Sarbanes-Oxley Act, we may not be able to accurately or timely report on our financial results or adequately identify and reduce fraud. As a result, the financial condition of our business could be adversely affected; current and
potential future stockholders could lose confidence in us and/or our reported financial results, which may cause a negative effect on our trading price; and we could be exposed to litigation or regulatory proceedings, which may be costly or divert
management attention.
Changes in accounting principles and guidance, or their interpretation, could result in unfavorable accounting charges or
effects, including changes to previously filed financial statements, which could cause our stock to decline.
We prepare our
consolidated financial statements in accordance with accounting principles generally accepted in the U.S. These principles are subject to interpretation by the Securities and Exchange Commission and various bodies formed to interpret and create
appropriate accounting principles and guidance. A change in these principles or guidance, or in their interpretations, may have a significant effect on our reported results and may retroactively affect previously reported results.
Our investment portfolio is subject to credit and liquidity risks and fluctuations in the market value of our investments and interest rates. These risks
may result in an impairment of, or the loss of all or a portion of, the value of our investments, an inability to sell our investments or a decline in interest income.
We maintain an investment portfolio of various holdings, types and maturities. Our portfolio as of February 29, 2016 consisted primarily
of money market funds, U.S. government and agency securities, European sovereign and agency securities with a rating of AA or higher, certificates of deposit, and corporate securities. Although we follow an established investment policy and seek to
minimize the risks associated with our investments by investing primarily in investment grade, highly liquid securities and by limiting the amounts invested with any one institution, type of security or issuer, we cannot give assurances that the
assets in our investment portfolio will not lose value or become impaired, or that our interest income will not decline.
A significant
part of our investment portfolio consists of U.S. government and agency securities. If global credit and equity markets experience prolonged periods of decline, or if there is a default or downgrade of U.S.
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government or agency debt, our investment portfolio may be adversely impacted and we could determine that some of our investments have experienced an other-than-temporary decline in fair value,
requiring impairment charges that could adversely affect our financial condition and operating results.
Future fluctuations and
uncertainty in economic and market conditions could adversely affect the market value of our investments, and we could record additional impairment charges and lose some or all of the principal value of investments in our portfolio. A total loss of
an investment or a significant decline in the value of our investment portfolio could adversely affect our financial condition and operating results. For information regarding the sensitivity of and risks associated with the market value of
portfolio investments and interest rates, see Part I, Item 3, Quantitative and Qualitative Disclosures About Market Risk.
Our investments in private companies are subject to risk of loss of investment capital. Some of these investments may have been made to
further our strategic objectives and support our key business initiatives. Our investments in private companies are inherently risky because the markets for the technologies they have under development are typically in the early stages and may never
materialize. We could lose the value of our entire investment in these companies.
Epidemics, geo-political events, Internet and power outages or
natural disasters could adversely affect our business, financial condition, operating results and cash flows.
The occurrence of one or
more epidemics, geo-political events (such as civil unrest or terrorist attacks), Internet and power outages or natural disasters in a country in which we operate or in which technology industry suppliers or our customers are located, could
adversely affect our business, financial condition, operating results and cash flows. Such events could result in physical damage to, or the complete loss of, one or more of our facilities, the lack of an adequate work force in a market, the
inability of our customers to access our offerings, the inability of our associates to reach or have transportation to our facilities or our customers facilities directly affected by such events, the evacuation of the populace from areas in
which our facilities are located, changes in the purchasing patterns of our customers, the temporary or long-term disruption in the supply of computer hardware and related components, the disruption or delay in the manufacture and transport of goods
globally, the disruption of utility services to our facilities or to suppliers, partners or customers, or disruption in our communications with our customers.
RISKS RELATED TO THE CONVERTIBLE NOTES
The convertible notes are effectively subordinated to any secured debt we incur in the future and to any liabilities of our subsidiaries.
In October 2014, we issued $805.0 million of 0.25% Convertible Senior Notes due 2019 (the convertible notes). The convertible notes
will rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the convertible notes; equal in right of payment to any of our existing and future indebtedness and other liabilities that are not
so subordinated; effectively junior in right of payment to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness and other liabilities of
our subsidiaries (including trade payables). In the event of our bankruptcy, liquidation, reorganization or other winding up, our assets that secure debt ranking senior in right of payment to the convertible notes will be available to pay
obligations on the convertible notes only after the secured debt has been repaid in full from these assets, and the assets of our subsidiaries will be available to pay obligations on the convertible notes only after all claims senior to the
convertible notes have been repaid in full. There may not be sufficient assets remaining to pay amounts due on any or all of the convertible notes then outstanding.
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We may still incur substantially more debt or take other actions that could diminish our ability to make
payments on the convertible notes.
We and our subsidiaries may be able to incur substantial additional debt in the future, subject to
the restrictions contained in our future debt instruments, some of which may be secured debt. We are not restricted under the terms of the indenture governing the convertible notes from incurring additional debt, securing existing or future debt,
recapitalizing our debt or taking a number of other actions that are not limited by the terms of the indenture governing the convertible notes that could have the effect of diminishing our ability to make payments on the convertible notes when due.
We may not have the ability to raise the funds necessary to settle conversions of the convertible notes in cash, repay the convertible notes at
maturity or repurchase the convertible notes upon a fundamental change, and our future debt may contain limitations on our ability to pay cash upon conversion or repurchase of the convertible notes.
Holders of the convertible notes will have the right to require us to repurchase all or a portion of their convertible notes upon the
occurrence of a fundamental change at a repurchase price equal to 100% of the principal amount of the convertible notes to be repurchased, plus accrued and unpaid interest, if any. In addition, upon conversion of the convertible notes, unless we
elect to deliver solely shares of our common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the convertible notes being converted. However,
we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of the convertible notes surrendered therefor or pay cash with respect to the convertible notes being converted or at their
maturity.
In addition, our ability to repurchase or to pay cash upon conversions of the convertible notes may be limited by law,
regulatory authority or agreements governing our future indebtedness and is dependent on our future performance, which is subject to economic, financial, competitive and other factors beyond our control. Our failure to repurchase the convertible
notes at a time when the repurchase is required by the indenture or to pay any cash payable on future conversions of the convertible notes as required by the indenture would constitute a default under the indenture. A fundamental change under the
indenture or a default under the indenture could also lead to a default under agreements governing our future indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not
have sufficient funds to repay the indebtedness and repurchase the convertible notes or make cash payments upon conversions thereof.
The conditional
conversion feature of the convertible notes, if triggered, may adversely affect our financial condition and operating results.
In the
event the conditional conversion feature of the convertible notes is triggered, holders of the convertible notes will be entitled to convert the convertible notes at any time during specified periods at their option. If one or more holders elect to
convert their convertible notes, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share), we would be required to settle a portion or
all of our conversion obligation through the payment of cash, which could adversely affect our liquidity. In addition, even if holders do not elect to convert their convertible notes, we could be required under applicable accounting rules to
reclassify all or a portion of the outstanding principal of the convertible notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.
The accounting method for convertible debt securities that may be settled in cash, such as the convertible notes, could have a material effect on our
reported financial results.
Accounting Standards Codification Subtopic 470-20, Debt with Conversion and Other Options (ASC
470-20), requires an entity to separately account for the liability and equity components of convertible debt instruments (such as the convertible notes) that may be settled entirely or partially in cash upon conversion in a
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manner that reflects the issuers non-convertible debt interest rate. Accordingly, the equity component of the convertible notes is required to be included in the additional paid-in capital
section of stockholders equity on our consolidated balance sheet, and the value of the equity component is treated as original issue discount for purposes of accounting for the debt component of the convertible notes. As a result, we are
required to recognize a greater amount of non-cash interest expense in our consolidated income statements in the current and future periods presented as a result of the amortization of the discounted carrying value of the convertible notes to their
principal amount over the term of the convertible notes. We will report lower net income (or greater net losses) in our consolidated financial results because ASC 470-20 will require interest to include both the current periods amortization of
the original issue discount and the instruments non-convertible interest rate. This could adversely affect our reported or future consolidated financial results, the trading price of our common stock and the trading price of the convertible
notes.
In addition, under certain circumstances, in calculating earnings per share, convertible debt instruments (such as the convertible
notes) that may be settled entirely or partly in cash are currently accounted for utilizing the treasury stock method, the effect of which is that the shares of common stock issuable upon conversion of the convertible notes, if any, are not included
in the calculation of diluted earnings per share except to the extent that the conversion value of the convertible notes exceeds their principal amount. Under the treasury stock method, diluted earnings per share is calculated as if the number of
shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, were issued. We cannot be sure that the accounting standards in the future will continue to permit the use of the treasury stock
method. If we are unable to use the treasury stock method in accounting for the shares issuable upon conversion of the convertible notes, if any, then our diluted consolidated earnings per share would be adversely affected.
The convertible note hedge and warrant transactions may affect the value of our common stock.
In connection with the sale of the convertible notes, we entered into convertible note hedge transactions with institutions that we refer to as
the option counterparties. We also entered into warrant transactions with the option counterparties pursuant to which we sold warrants for the purchase of our common stock. The convertible note hedge transactions are expected to offset the potential
dilution to our common stock upon any conversion of convertible notes and/or offset any cash payments we are required to make in excess of the principal amount upon conversion of any convertible notes. The warrant transactions could separately have
a dilutive effect to the extent that the market price per share of our common stock exceeds the strike price of the relevant warrants, unless, subject to certain conditions, we elect to settle the warrants in cash.
The option counterparties or their respective affiliates may modify their hedge positions by entering into or unwinding various derivatives
with respect to our common stock and/or purchasing or selling our common stock or other securities of ours in secondary market transactions prior to the maturity of the convertible notes (and are likely to do so during any observation period related
to a conversion of convertible notes or following any repurchase of convertible notes by us in connection with any fundamental change repurchase date or otherwise). This activity could suppress or inflate the market price of our common stock.
We do not make any representation or prediction as to the direction or magnitude of any potential effect that the transactions described above
may have on the price of the convertible notes or our common stock. In addition, we do not make any representation that the option counterparties or their respective affiliates will engage in these transactions or that these transactions, once
commenced, will not be discontinued without notice.
We are subject to counterparty risk with respect to the convertible note hedge transactions.
The option counterparties are financial institutions or affiliates of financial institutions, and we will be subject to the risk that
these option counterparties may default under the convertible note hedge transactions. Our exposure to the credit risk of the option counterparties will not be secured by any collateral. If one or more of the option counterparties to one or more of
our convertible note hedge transactions becomes subject to insolvency proceedings, we will become an unsecured creditor in those proceedings with a claim equal to our exposure at the
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time under those transactions. Our exposure will depend on many factors but, generally, the increase in our exposure will be correlated to the increase in the market price of our common stock and
in the volatility of the market price of our common stock. In addition, upon a default by one of the option counterparties, we may suffer dilution with respect to our common stock as well as adverse financial consequences. We can provide no
assurances as to the financial stability or viability of any of the option counterparties.
RISKS RELATED TO OWNERSHIP OF OUR COMMON
STOCK
Our stock price has been volatile historically and may continue to be volatile.
The trading price of our common stock has been and may continue to be subject to wide fluctuations. Our stock price may fluctuate in response
to a number of events and factors, such as quarterly variations in operating results, announcements of technological innovations or new offerings by us or our competitors, announcements relating to strategic decisions, announcements related to key
personnel, customer purchase delays, service disruptions, changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies that investors may deem comparable to us, news reports
relating to trends in our markets, the commencement or termination of any share repurchase program, general economic conditions and other risks listed herein.
The sale of our common stock by significant stockholders may cause the price of our common stock to decrease.
Several of our stockholders own significant portions of our common stock. If these stockholders were to sell all or a portion of their holdings
of our common stock, then the market price of our common stock could be negatively impacted. The effect of such sales, or of significant portions of our stock being offered or made available for sale, could result in strong downward pressure on our
stock price. Investors should be aware that they could experience significant short-term volatility in our stock if such stockholders decide to sell all or a portion of their holdings of our common stock at once or within a short period of time.
We may issue additional shares of our common stock or instruments convertible into shares of our common stock and thereby materially and adversely
affect the market price of our common stock.
We are not restricted from issuing additional shares of our common stock or other
instruments convertible into, or exchangeable or exercisable for, shares of our common stock. If we issue additional shares of our common stock or instruments convertible into shares of our common stock, it may materially and adversely affect the
market price of our common stock.
In addition, a substantial number of shares of our common stock is reserved for instruments issued
under our equity compensation plans, including for the issuance upon the exercise of stock options and the vesting of performance share units, restricted stock, restricted stock units and deferred stock units, upon conversion of the convertible
notes, and in relation to the convertible note hedge and warrant transactions entered into in connection with the convertible notes. We may not be able to predict the size of future issuances or the effect, if any, that they may have on the market
price for our common stock. The issuance and sale of substantial amounts of common stock, or the perception that such issuances and sales may occur, could adversely affect the market price of our common stock and impair our ability to raise capital
through the sale of equity or equity-linked securities.
We do not currently expect to pay dividends on our common stock, so any returns may be limited
to changes in the value of our common stock.
We have never declared or paid any cash dividends on our common stock. We currently
anticipate that we will retain future earnings for the development, operation and expansion of our business and do not anticipate declaring or paying any cash dividends for the foreseeable future. In addition, our ability to pay cash dividends on
our common stock may be prohibited or limited by the terms of any future debt financing arrangement. Any return to stockholders will therefore be limited to the increase, if any, of our stock price.
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Conversion of the convertible notes may dilute the ownership interest of existing stockholders, including
holders who had previously converted their convertible notes, or may otherwise depress the price of our common stock.
The conversion
of the convertible notes into shares of our common stock, to the extent that we choose not to deliver all cash for the conversion value, will dilute the ownership interests of existing stockholders. Any sales in the public market of the common stock
issuable upon conversion of the convertible notes could adversely affect prevailing market prices of our common stock. In addition, the existence of the convertible notes may encourage short selling by market participants due to this dilution or may
facilitate trading strategies involving the convertible notes and our common stock.
Provisions of our certificate of incorporation, by-laws, Delaware
law and the convertible notes may have anti-takeover effects that could prevent a change in control even if the change in control would be beneficial to our stockholders.
Provisions of our certificate of incorporation, by-laws and Delaware law could make it more difficult for a third party to acquire us, even if
doing so would be beneficial to our stockholders. These provisions include:
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our Board of Directors has the right to elect directors to fill a vacancy created by the expansion of the Board of Directors or the resignation, death or removal of a director, which prevents stockholders from being
able to fill vacancies on our Board of Directors;
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stockholders must provide advance notice to nominate individuals for election to the Board of Directors or to propose matters that can be acted upon at a stockholders meeting; such provisions may discourage or
deter a potential acquirer from conducting a solicitation of proxies to elect the acquirers own slate of directors or otherwise attempting to obtain control of our company; and
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our Board of Directors may issue, without stockholder approval, shares of undesignated preferred stock; the ability to issue undesignated preferred stock makes it possible for our Board of Directors to issue preferred
stock with voting or other rights or preferences that could impede the success of any attempt to acquire us.
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Further, as a
Delaware corporation, we are also subject to certain Delaware law anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the
stock for three years or, among other things, the Board of Directors has approved the transaction. Our Board of Directors could rely on Delaware law to prevent or delay an acquisition of us. Additionally, certain provisions of the convertible notes
could make it more difficult or more expensive for a third party to acquire us or could also have the effect of delaying or reducing the likelihood of a change in control of us even if such acquisition or change of control may be favorable to our
stockholders.
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