<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): JUNE 21, 1999
Commission File No. 000-24409
INTERNATIONAL INTEGRATION INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 04-3169145
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
101 Main Street 02142
Cambridge, Massachusetts (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (617) 250-2500
<PAGE> 2
Item 5. OTHER EVENTS.
On May 25, 1999, International Integration Incorporated ("i-Cube" or the
"Company") acquired all of the outstanding common stock of Tomorrow's Technology
Today, Inc., ("T3") in exchange for 89,640 shares of i-Cube common stock. On
June 21, 1999, the Company acquired all of the outstanding common stock of
Reportsent, Ltd. and its majority-owned subsidiary Conduit Communications Ltd.,
(collectively, "Conduit") in exchange for approximately 2.4 million shares of
i-Cube common stock.
The supplemental consolidated financial statements filed herewith have been
prepared accounting for the above acquisitions using the pooling of interests
method of accounting. Upon publication, these supplemental consolidated
financial statements will become the historical financial statements of the
Company.
Item 7. FINANCIAL STATEMENTS AND EXHIBITS
EXHIBIT NUMBER TITLE
- -------------- -----
Exhibit 23.1 Consent of Independent Accountants
Exhibit 99.1 Supplemental Consolidated Financial Statements of
International Integration, Inc. as of December 31, 1998 and
1997 and for each of the three years in the period ended
December 31, 1998, and Report of Independent Accountants
thereon (Previously filed on Form 10-K on March 31, 1999)
Exhibit 99.2 Management's Discussion and Analysis of Supplemental
Financial Condition and Results of Operations
(Previously filed on Form 10-K on March 31, 1999)
Exhibit 99.3 Selected Supplemental Consolidated Financial Data (Previously
filed on Form 10-K on March 31, 1999)
Exhibit 99.4 Supplemental Consolidated Interim Financial Statements of
International Integration, Inc. as of March 31, 1999 and
December 31, 1998 and for the three month periods ended March
31, 1999 and March 31, 1998 (Previously filed on Form 10-Q on
May 17, 1999)
Exhibit 99.5 Management's Discussion and Analysis of Supplemental
Financial Condition and Results of Operations
(Previously filed on Form 10-Q on May 17, 1999)
1
<PAGE> 3
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: September 10, 1999
INTERNATIONAL INTEGRATION INCORPORATED
By: /s/ Lawrence P. Begley
-----------------------------
Lawrence P. Begley
Executive Vice President
& Chief Financial Officer
(Principal Financial Officer)
2
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
International Integration Incorporated on Form S-8 (File No. 333-69269) of our
report dated September 7, 1999 on our audits of the supplemental consolidated
financial statements of International Integration Incorporated as of December
31, 1998 and 1997, and for each of the three years in the period ended December
31, 1998, which report is included in this current report on Form 8-K.
PricewaterhouseCoopers LLP
Boston, Massachusetts
September 10, 1999
<PAGE> 1
Exhibit 99.1
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
INDEX TO SUPPLEMENTAL CONSOLIDATED FINANCIAL
STATEMENTS (Previously filed on Form 10-K on March 31, 1999)
Report of Independent Accountants A-1
Supplemental Consolidated Balance Sheets A-2
Supplemental Consolidated Statements of Income A-3
Supplemental Consolidated Statements of Stockholders' Equity A-4
Supplemental Consolidated Statements of Cash Flows A-6
Notes to Supplemental Consolidated Financial Statements A-7
<PAGE> 2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of International Integration
Incorporated:
In our opinion, the accompanying supplemental consolidated balance sheets and
related supplemental consolidated statements of income, stockholders' equity and
cash flows present fairly, in all material respects, the financial position of
International Integration Incorporated at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These supplemental consolidated financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these supplemental consolidated financial statements based on our
audits. We conducted our audits of these statements in accordance with generally
accepted auditing standards which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion expressed above.
As described in Note 1, on May 25, 1999 and June 21, 1999, International
Integration Incorporated acquired Tomorrow's Technology Today, Inc. ("T3") and
Reportsent, Ltd. ("Conduit"), respectively, in transactions accounted for as
poolings of interests. The accompanying supplemental consolidated financial
statements give retroactive effect to these acquisitions. Generally accepted
accounting principles proscribe giving effect to a consummated business
combination accounted for by the pooling of interests method in financial
statements that do not include the date of consummation. These financial
statements do not extend through the date of consummation; however, they will
become the historical consolidated financial statements of the Company after
financial statements covering the date of consummation of the business
combination are issued.
PricewaterhouseCoopers LLP
Boston, Massachusetts
September 7, 1999
A-1
<PAGE> 3
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31,
1998 1997
------- -------
ASSETS
Current assets:
Cash and cash equivalents $36,010 $11,609
Short-term investments 8,302 --
Accounts receivable, net of reserve of $255
and $180, respectively 6,380 7,754
Unbilled revenues 1,988 708
Prepaid expenses and other current assets 1,100 960
Deferred income taxes 157 812
------- -------
Total current assets 53,937 21,843
Property and equipment, at cost:
Computers and equipment 5,721 4,022
Building 1,944 1,935
Furniture and fixtures 1,841 1,147
------- -------
Total property and equipment, at cost 9,506 7,104
Less- accumulated depreciation (2,674) (1,365)
------- -------
Total property and equipment, net 6,832 5,739
Other assets 273 144
------- -------
Total assets $61,042 $27,726
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,244 $ 1,781
Accrued expenses 6,590 4,917
Current portion of long-term obligations 384 317
Accrued income taxes 545 3
Deferred revenues 4,859 8,423
------- -------
Total current liabilities 14,622 15,441
Long-term obligations 2,222 2,393
Stockholders' equity:
Preferred stock $0.01 par value; 1,000,000 shares
authorized; no shares issued or outstanding -- --
Common stock $0.01 par value; 100,000,000 shares
authorized; 18,758,111 and 15,408,798 shares
issued and outstanding at December 31, 1998
and 1997, respectively 188 154
Additional paid-in capital 30,551 1,903
Treasury stock, 0 and 3,001 shares at cost at
December 31, 1998 and 1997, respectively -- (8)
Note receivable from stockholder (533) (533)
Retained earnings 13,914 8,368
Accumulated other comprehensive income 78 8
------- -------
Total stockholders' equity 44,198 9,892
------- -------
Total liabilities and stockholders' equity $61,042 $27,726
======= =======
The accompanying notes are an integral part of these supplemental consolidated
financial statements
A-2
<PAGE> 4
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
1998 1997 1996
------- ------- -------
Net revenues $56,793 $38,850 $19,659
Project personnel and software costs 27,562 17,630 7,961
------- ------- -------
Gross profit 29,231 21,220 11,698
Operating expenses:
Selling and marketing 5,178 3,819 1,913
General and administrative 14,551 9,997 6,844
Restructuring costs 786 -- --
------- ------- -------
Total operating expenses 20,515 13,816 8,757
------- ------- -------
Operating income 8,716 7,404 2,941
Other income (expense):
Interest income 1,430 460 85
Interest expense (212) (208) (30)
------- ------- -------
Income before income taxes 9,934 7,656 2,996
Provision for income taxes 4,388 2,978 1,086
------- ------- -------
Net income $ 5,546 $ 4,678 $ 1,910
======= ======= =======
Earnings per share:
Basic $ 0.32 $ 0.31 $ 0.13
======= ======= =======
Diluted $ 0.26 $ 0.26 $ 0.12
======= ======= =======
Weighted average shares outstanding:
Basic 17,363 15,113 14,911
Diluted 21,325 17,743 16,196
The accompanying notes are an integral part of these supplemental consolidated
financial statements
A-3
<PAGE> 5
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
SERIES A COMMON STOCK SERIES B COMMON STOCK COMMON STOCK
NUMBER OF NO PAR NUMBER OF NO PAR NUMBER OF PAR ADDITIONAL
SHARES VALUE SHARES VALUE SHARES VALUE PAID-IN CAPITAL
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 12,020,025 $ 8 327,499 $ 2
Pooling of interests with Conduit -- -- -- -- 2,352,269 $ 23 $ 388
Pooling of interests with T3 -- -- -- -- 89,640 1 (1)
---------- --- ------- --- ---------- ---- -------
Balance at December 31, 1995, as restated 12,020,025 8 327,499 2 2,441,909 24 387
Conversion (12,020,025) (8) (327,499) (2) 12,347,524 123
Exercise of stock options -- -- -- -- 145,688 2 250
Net income -- -- -- -- -- -- --
Translation adjustments -- -- -- -- -- -- --
Comprehensive income -- -- -- -- -- -- --
---------- --- ------- --- ---------- ---- -------
Balance at December 31, 1996 -- -- -- -- 14,935,121 149 637
Exercise of stock options -- -- -- -- 473,677 5 676
Acquisition of treasury stock -- -- -- -- -- -- --
Tax benefit due to stock option
exercise -- -- -- -- -- -- 590
Net income -- -- -- -- -- -- --
Translation adjustments -- -- -- -- -- -- --
Comprehensive income -- -- -- -- -- -- --
---------- --- ------- --- ---------- ---- -------
Balance at December 31, 1997 -- -- -- -- 15,408,798 154 1,903
Exercise of stock options -- -- -- -- 744,313 8 455
Proceeds from initial public
offering -- -- -- -- 2,605,000 26 27,851
Tax benefit due to stock option
exercise -- -- -- -- -- -- 342
Net income -- -- -- -- -- -- --
Translation adjustments -- -- -- -- -- -- --
Comprehensive income -- -- -- -- -- -- --
---------- --- ------- --- ---------- ---- -------
Balance at December 31, 1998 -- $-- -- $-- 18,758,111 $188 $30,551
========== === ======= === ========== ==== =======
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements
A-4
<PAGE> 6
<TABLE>
<CAPTION>
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
TREASURY STOCK
NOTE ACCUMULATED
RECEIVABLE OTHER TOTAL STATEMENT OF
NUMBER FROM RETAINED COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE
OF SHARES COST STOCKHOLDER EARNINGS INCOME EQUITY INCOME
--------- ---- ----------- -------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 -- -- -- $ 2,685 -- $ 2,695 --
Pooling of interests with Conduit -- -- -- (792) -- (381) --
Pooling of interests with T3 -- -- -- -- -- -- --
----- --- ----- ------- --- ------- ------
Balance at December 31, 1995, as restated -- -- -- 1,893 -- 2,314 --
Conversion -- -- -- (113) -- -- --
Exercise of stock options -- -- -- -- -- 252 --
Net income -- -- -- 1,910 -- 1,910 $1,910
Translation adjustments -- -- -- -- $ 6 6 6
------
Comprehensive income -- -- -- -- -- -- 1,916
----- --- ----- ------- --- ------- ======
Balance at December 31, 1996 -- -- -- 3,690 6 4,482 --
Exercise of stock options -- -- $(533) -- -- 148 --
Acquisition of treasury stock (3,001) $(8) -- -- -- (8) --
Tax benefit due to stock option
exercise -- -- -- -- -- 590 --
Net income -- -- -- 4,678 4,678 4,678
Translation adjustments -- -- -- -- 2 2 2
------
Comprehensive income -- -- -- -- -- -- 4,680
----- --- ----- ------- --- ------- ======
Balance at December 31, 1997 (3,001) (8) (533) 8,368 8 9,892 --
Exercise of stock options 3,001 8 -- -- -- 471 --
Proceeds from initial public
offering -- -- -- -- -- 27,877 --
Tax benefit due to stock option
exercise -- -- -- -- -- 342 --
Net income 5,546 5,546 5,546
------
Translation adjustments -- -- -- -- 70 70 70
------
Comprehensive income -- -- -- -- -- -- $5,616
----- --- ----- ------- --- ------- ======
Balance at December 31, 1998 -- $-- $(533) $13,914 $78 $44,198
===== === ===== ======= === =======
The accompanying notes are an integral part of these supplemental consolidated
financial statements
</TABLE>
A-5
<PAGE> 7
<TABLE>
<CAPTION>
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
1998 1997 1996
------- ------- ------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income $ 5,546 $ 4,678 $1,910
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,307 725 283
Provision for doubtful accounts (84) 82 73
Loss on disposal of fixed assets -- 97 --
Deferred income taxes 655 (17) 163
Tax benefit due to stock option exercise 342 590 --
Changes in operating assets and liabilities:
Accounts receivable 1,467 (2,130) (2,792)
Unbilled revenues (1,280) (486) 191
Prepaid expenses and other current assets (138) (353) (222)
Accounts payable 457 780 651
Accrued expenses 1,694 2,302 (247)
Accrued income taxes 543 (191) (916)
Deferred revenues (3,570) 2,997 2,835
Other (129) 23 14
------- ------- ------
Net cash provided by operating activities 6,810 9,097 1,943
Cash flows from investing activities:
Purchases of available for sale securities (10,802) -- --
Sale and maturities of available for sale securities 2,500 -- --
Purchases of property and equipment (2,002) (4,196) (708)
Proceeds from sale of fixed assets -- 25 --
------- ------- ------
Net cash used in investing activities (10,304) (4,171) (708)
Cash flows from financing activities:
Repayment of long-term obligations (1,784) (177) --
Repayments on line of credit (66) (66) (33)
Proceeds from long-term obligations 1,380 1,180 86
Proceeds from equipment line of credit -- 500 --
Purchase of treasury stock -- (8) --
Proceeds from exercise of stock options 471 148 251
Proceeds from initial public offering 27,877 -- --
Decrease in due from related parties -- -- 396
Decrease in due from officer/stockholder -- -- 30
------- ------- ------
Net cash provided by financing activities 27,878 1,577 730
Effect of exchange rates on cash and cash equivalents 17 (44) 47
------- ------- ------
Net increase in cash and cash equivalents 24,401 6,459 2,012
Cash and cash equivalents, beginning of period 11,609 5,150 3,138
-------- -------- -------
Cash and cash equivalents, end of period $ 36,010 $ 11,609 $ 5,150
======== ======== =======
The accompanying notes are an integral part of these supplemental consolidated
financial statements
</TABLE>
A-6
<PAGE> 8
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) ORGANIZATION AND SIGNIFICANT POLICIES
International Integration Incorporated, commonly known as i-Cube (the
"Company"), is an IT solutions provider specializing in consulting, electronic
business, and transformation services for the complex IT environments inherent
in the world's leading organizations. Since 1992, i-Cube has helped clients
leverage their current business processes and technology infrastructure to
create competitive advantage. Utilizing a fixed-time/fixed-price model and a
unique client teaming approach, i-Cube delivers solutions rapidly and with full
knowledge transfer. i-Cube's innovative solutions are based on open standards
and architectures that are independent of any single vendor's hardware, software
or middleware. i-Cube uses i-Structure, a set of methodologies and tools which
embody best practices in application development, project management, testing,
and deployment. During 1998, the Company expanded its operations by opening its
European headquarters in Mannheim, Germany, bringing to three the number of
locations from which the Company provides its services.
On May 25, 1999, the Company acquired all of the outstanding common stock of
Tomorrow's Technology Today, Inc., ("T3"), an IT solutions provider, in exchange
for 89,640 shares of i-Cube common stock.
On June 21, 1999, the Company acquired all of the outstanding common stock of
Reportsent, Ltd. and its majority-owned subsidiary Conduit Communications Ltd.,
(collectively, "Conduit"), an IT solutions provider, in exchange for
approximately 2.4 million shares of i-Cube common stock.
These transactions have been accounted for as poolings of interests and
accordingly, the Supplemental Consolidated Financial Statements reflect the
combined financial position and results of operations and cash flows of i-Cube,
Conduit, and T3 for all periods presented. Upon publication of the Company's
financial statements for a period which includes May 25, 1999 and June 21, 1999,
the Supplemental Consolidated Financial Statements will become the historical
consolidated financial statements of the Company.
A summary of the Company's significant accounting policies follows:
(a) Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
(b) Principles of Consolidation
The consolidated financial statements reflect the operations of the Company and
its wholly-owned subsidiaries. All significant intercompany transactions and
accounts have been eliminated.
(c) Foreign Currency Translation
Assets and liabilities of the Company's foreign operations are translated into
United States dollars at exchange rates prevailing at the balance sheet date.
Revenues and expenses for the year are translated at the average exchange rates
in effect during the year. The resulting translation adjustments are accumulated
as a separate component of stockholders' equity.
(d) Revenue Recognition
The Company derives substantially all of its revenues from technology consulting
services. Revenues from contracts are recognized on the percentage-of-completion
basis. The cumulative impact of any revision in estimates of the cost to
complete and losses on projects in process are reflected in the period in which
they become known. Net revenues exclude reimbursable expenses charged to
customers. Revenues from maintenance contracts are deferred and recognized
ratably over the contractual periods during which services are performed.
Deferred revenues consist principally of amounts billed in advance for
technology consulting contracts that will be recognized upon performance and
amounts billed to clients in excess of revenues recognized to-date. Unbilled
revenues on contracts represent revenues recognized on contracts in excess of
contractual billings to-date.
A-7
<PAGE> 9
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) ORGANIZATION AND SIGNIFICANT POLICIES (CONTINUED)
(e) Significant Customers and Concentration of Credit Risk
During the year ended December 31, 1998, revenues from two clients accounted for
12% and 11% of the Company's net revenues. During the year ended December 31,
1997, revenues from three clients accounted for 20%, 13%, and 10% of the
Company's net revenues. During the year ended December 31, 1996, revenues from
four clients accounted for 16%, 12%, 11% and 10% of the Company's net revenues.
Financial instruments that subject the company to credit risks consist primarily
of trade accounts receivable. As of December 31, 1998 and 1997, approximately
29% and 65% of the Company's accounts receivable are due from two and four
customers, respectively.
(f) Cash, Cash Equivalents, and Short-term Investments
Cash equivalents consist of highly liquid investments with a maturity of less
than three months when purchased. At December 31, 1998 and 1997, cash and cash
equivalents include overnight repurchase agreements of $12,525 and $10,800,
respectively. Due to the short-term nature of these agreements, the Company does
not take possession of the underlying collateral, U.S. Government Agency notes,
which are held by the bank.
The Company invests in only high quality, short-term investments, all of which
are classified as available for sale at December 31, 1998. Short-term
investments are recorded at fair market value, which approximates cost. The cost
of securities sold is based on the specific identification method. Gross
realized and unrealized gains or losses were not significant as of December 31,
1998. All available for sale securities have maturities of less than one year.
(g) Depreciation
The Company provides for depreciation of fixed assets over their estimated
useful lives, using the straight-line method, as follows:
ASSET CLASSIFICATION ESTIMATED USEFUL LIFE
-------------------- ---------------------
Building........................................... 20 years
Computers and equipment............................ 3-5 years
Furniture and fixtures............................. 5 years
Depreciation and amortization expense relating to total fixed assets was $1,307,
$725, and $283 for the years ended December 31, 1998, 1997, and 1996,
respectively. As of December 31, 1998 and 1997, the cost of furniture and
fixtures recorded under capital leases was $473, and the related accumulated
amortization was $150 and $147, respectively. As of December 31, 1998 and 1997,
the cost of computers and equipment recorded under capital leases was $398 and
$43, respectively, and the related accumulated amortization was $70 and $30,
respectively. Upon retirement or disposal, the cost of the disposed asset and
the related accumulated depreciation are removed from the accounts and any gain
or loss is reflected in income.
(h) Accounting for Stock-Based Compensation
The Company accounts for stock-based awards to its employees using the intrinsic
value based method as prescribed by Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," and related Interpretations
and has adopted the provisions of Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation," through disclosure
only (Note 9).
(i) Earnings Per Share
Basic earnings per share ("EPS") is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted EPS
is computed using the weighted average number of common shares outstanding plus
the dilutive effect of common stock equivalents using the treasury stock method.
(j) Income Taxes
Deferred income taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities, as measured by the
enacted tax rates assumed to be in effect when these differences reverse.
A-8
<PAGE> 10
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) ORGANIZATION AND SIGNIFICANT POLICIES (CONTINUED)
(k) Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
130, "Reporting Comprehensive Income." This Statement requires that all items
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. SFAS No. 130 does not require a specific format for
the financial statement in which comprehensive income is reported, but does
require that an amount representing total comprehensive income be reported in
that statement. The components of comprehensive income for the Company generally
include foreign currency translation and unrealized gains or losses on
short-term investments classified as available for sale.
The Company has adopted SFAS No. 130 in the accompanying financial statements.
(l) Segment Reporting
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, superseding SFAS No. 14, Financial Reporting
for Segments of a Business Enterprise. SFAS No. 131 establishes standards for
the way public business enterprises report information about operating segments
in annual financial statements, and requires those enterprises to report
selected information about operating segments in interim financial statements.
It also requires disclosures about products and services, geographic areas, and
major customers.
The Company is in the business of providing specialized IT solutions in
consulting, electronic business, and transformation services for the complex IT
environments inherent in the world's leading organizations. The Company
evaluated its business activities that are regularly reviewed by the Executive
Management team and Board of Directors for which discrete financial information
is available. As a result of this evaluation, the Company determined that it has
one operating segment. The adoption of SFAS 131 did not affect the results of
operations, financial position, or require the disclosure of segment information
since the Company has one reportable segment.
(m) Computer Software Developed or Obtained for Internal Use
In March 1998, Statement of Position ("SOP") 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use," was issued which
provides guidance in addressing whether and under what conditions the costs of
internal-use software should be capitalized. SOP 98-1 is effective for
transactions entered into in fiscal years beginning after December 15, 1998,
however earlier adoption is encouraged. The Company adopted the guidelines of
SOP 98-1 as of January 1, 1998, and the impact of such adoption was not material
to results of operations or of cash flows for the year ended December 31, 1998.
(n) Reclassifications
Certain prior year amounts have been reclassified to conform to current year
presentation.
(2) ACQUISITIONS
On May 25, 1999, the Company acquired all of the outstanding common stock of
Tomorrow's Technology Today, Inc., ("T3") in exchange for 89,640 shares of
i-Cube common stock.
On June 21, 1999, the Company acquired all of the outstanding capital stock of
Conduit in exchange for approximately 2.4 million shares of the Company's common
stock. The Company assumed the existing Conduit stock options which are
transferable into approximately 0.5 million shares of the Company's common
stock upon exercise.
A-9
<PAGE> 11
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(2) ACQUISITIONS (CONTINUED)
The results of operations for i-Cube and Conduit and the combined amounts
presented in the accompanying Supplemental Consolidated Financial Statements are
summarized below (in thousands):
YEARS ENDED DECEMBER 31,
1998 1997 1996
------- ------- -------
Net revenues:
i - Cube $41,587 $26,859 $14,479
Conduit 15,206 11,991 5,180
------- ------- -------
Combined $56,793 $38,850 $19,659
Net income (loss):
i - Cube $ 6,936 $ 4,245 $ 1,615
Conduit (1,390) 433 295
------- ------- -------
Combined $ 5,546 $ 4,678 $ 1,910
======= ======= =======
Revenue and net income for T3 for the years ended December 31, 1998, 1997, and
1996 were nominal and have been included in the respective i-Cube amounts in the
above table.
On August 10, 1999, the Company announced that it had signed a definitive
agreement to merge with Razorfish, a New York City-based information technology
firm that provides Digital Change Management(SM) solutions. Under terms of the
agreement, approved by each company's board of directors, each share of the
Company will be exchanged for 0.875 shares of Razorfish, and Razorfish will be
the surviving entity. The Company anticipates that the transaction will be
accounted for as a pooling of interests.
(3) SHORT-TERM INVESTMENTS
The following is a summary of investments at cost which approximates fair value
classified as current assets at December 31, 1998:
Corporate debt securities.............................. $1,236
U.S. Government securities............................. 7,066
------
Total................................................ $8,302
======
(4) LONG-TERM OBLIGATIONS AND CREDIT ARRANGEMENTS
The Company has a working capital line of credit ("working capital line") with a
financial institution under which the Company may borrow the lesser of $5,000 or
75% of eligible accounts receivable, as defined in the agreement. The interest
rate on all borrowings under the working capital line is prime (7.75% at
December 31, 1998). The unsecured line of credit expires in September 1999. The
Company is required to comply with certain operational and financial covenants
under the agreement if there are borrowings under the credit line. At December
31, 1998, the Company is in compliance with all such covenants. The agreement
also provides for a $4,000 sublimit for foreign exchange transactions and the
issuance of letters of credit of up to $4,000. There were no borrowings under
this line of credit at December 31, 1998 or 1997.
In July 1997, the Company obtained an equipment line of credit ("equipment
line") with the same financial institution from which the Company could borrow
up to $500 for qualified capital expenditures, as defined in the agreement. The
interest rate on all borrowings under the equipment line was prime plus 3/4%
(9.25% at December 31, 1997) and was reduced to prime upon the Company's
successful completion of its Initial Public Offering ("IPO"). The Company was
able to borrow against this equipment line until January 31, 1998 (the "draw
period"). During the draw period, the Company was required to make payments of
interest only on all outstanding borrowings. At the conclusion of the draw
period, the Company was required to make 36 equal monthly principal payments
plus interest. The Company was required to comply with certain operational and
financial covenants under the agreement if there were borrowings under the
equipment line. The outstanding balance under the equipment line was paid in
full in July 1998.
In May 1998, Conduit entered into a loan agreement with a major financial
institution for $1.4 million for the purchase of a building currently occupied
by Conduit. The principal balance is payable over 12 years in quarterly
installments and bears interest at LIBOR +2% (8.18% at December 31, 1998). These
quarterly installments increase throughout the term of the loan. The Company is
required to comply with certain financial covenants under this loan agreement.
At December 31, 1998, the Company was in compliance with these requirements. At
December 31, 1998, $1.4 million was outstanding under the loan agreement which
is collateralized by the building.
A-10
<PAGE> 12
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(4) LONG-TERM OBLIGATIONS AND CREDIT ARRANGEMENTS (CONTINUED)
The Company assumed $230 of Conduit's convertible employee loans which are
transferable into the Company's common stock upon conversion. These loans bear
no interest and are due in full on the 20th anniversary of the date of the loan,
provided they have not been converted. As of December 31, 1998 and 1997, $230
was outstanding under these loan notes.
Long-term obligations consist of the following at December 31, 1998 and 1997:
1998 1997
------ ------
Capital lease obligations........................... $ 750 $ 483
Loan agreements..................................... 1,856 1,727
Equipment line...................................... -- 500
------ ------
2,606 2,710
Less-current maturities............................. 384 317
------ ------
$2,222 $2,393
====== ======
Maturities of long-term obligations are as follows:
1999.......................................................... $ 524
2000.......................................................... 519
2001.......................................................... 363
2002.......................................................... 164
2003.......................................................... 108
Thereafter.................................................... 1,140
------
2,818
Less-amount representing interest............................. 212
------
$2,606
======
(5) ACCRUED EXPENSES
Accrued expenses consist of the following at December 31, 1998 and 1997:
1998 1997
------ ------
Accrued payroll and other payroll expenses................ $2,992 $1,796
Accrued marketing......................................... 245 214
Accrued other............................................. 3,353 2,907
------ ------
$6,590 $4,917
====== ======
A-11
<PAGE> 13
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(6) INCOME TAXES
The provision for income taxes consists of the following for the years ended
December 31, 1998, 1997, and 1996:
1998 1997 1996
------ ------ ------
Current
Federal................... $2,902 $2,118 $ 692
State..................... 831 659 196
Foreign................... -- 218 36
------ ------ ------
3,733 2,995 924
Deferred
Federal................... 504 (13) 124
State..................... 151 (4) 38
------ ------ ------
655 (17) 162
------ ------ ------
$4,388 $2,978 $1,086
====== ====== ======
A reconciliation of the Company's income tax provision to the U.S. statutory
income tax rate is as follows:
1998 1997 1996
---- ---- ----
U.S. federal statutory tax rate.................... 34.0% 34.0% 34.0%
State income taxes, net of federal benefit......... 6.5 5.8 5.6
Foreign income taxes............................... 4.8 -- (2.6)
Research and development credits................... (0.9) (0.9) (0.9)
Other, net......................................... -- -- 0.1
---- ---- ----
Effective tax rate............................... 44.4% 38.9% 36.2%
==== ==== ====
Significant components of the deferred tax asset as of December 31, 1998 and
1997 are as follows:
1998 1997
---- ----
Net operating loss carryforwards....................... $533
Nondeductible accruals and reserves.................... 284 $835
Depreciation........................................... (283) (23)
---- ----
534 812
Valuation allowance.................................... (377) --
---- ----
Total net deferred tax asset................ $157 $812
==== ====
The Company has net operating loss carryforwards as of December 31, 1998 of
$577, expiring at various dates through 2013.
A-12
<PAGE> 14
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(7) STOCKHOLDERS' EQUITY
On May 25, 1999, the Company acquired all of the outstanding common stock of
Tomorrow's Technology Today, Inc., ("T3") in exchange for 89,640 shares of
i-Cube common stock. The Company's supplemental financial statements have been
restated for all prior periods presented to reflect the acquisition of T3, which
was accounted for as a pooling of interests.
On June 21, 1999, the Company acquired all of the outstanding capital stock of
Conduit in exchange for approximately 2.4 million shares of the Company's common
stock. The Company's supplemental financial statements have been restated for
all prior periods presented to reflect the acquisition of Conduit, which was
accounted for as a pooling of interests.
Until February 1996, the Company had authorized 12,020,025 and 2,979,975 of
Series A and Series B common shares, respectively, at no par value.
In February 1996, each share of Series A common stock and Series B common stock,
without par value, was converted into one share of common stock, $0.01 par
value, with the same voting rights. The Company has authorized 101,000,000
shares consisting of 100,000,000 shares of common stock, $0.01 par value, and
1,000,000 shares of preferred stock, $0.01 par value.
In February 1997, i-Cube's Board of Directors voted a three-for-two stock split
of the Company's common stock, payable as a stock dividend, which became
effective the same day. All share and per share data, except common stock par
value, have been retroactively adjusted to reflect these changes.
In April 1998, i-Cube's Board of Directors voted, and i-Cube's stockholders
approved, an increase in the authorized shares of Common Stock, $0.01 par value,
to 100,000,000.
The Company completed an IPO of 2,500,000 shares of its common stock on June 23,
1998. Additionally, the underwriters elected to exercise their option to
purchase 105,000 shares of common stock from the Company to cover
over-allotments. The net proceeds to the Company from the subscribed and
over-allotment shares were $27,877, after deduction of offering expenses of
$3,383.
(8) EARNINGS PER SHARE
The following table reconciles the denominator of the diluted earnings per share
computation as shown on the Consolidated Statements of Income.
DILUTED EPS COMPUTATION 1998 1997 1996
---------- ---------- ----------
Basic common shares outstanding.............. 17,363,000 15,113,000 14,911,000
Stock options................................ 3,962,000 2,630,000 1,285,000
---------- ---------- ----------
Diluted common and common equivalent shares.. 21,325,000 17,743,000 16,196,000
========== ========== ==========
Options to purchase shares of the Company's common stock of 172,371, 297,780,
and 253,979 for the years ended December 31, 1998, 1997, and 1996, respectively,
were outstanding during the respective periods but were not included in the
computation of diluted EPS because the exercise price of the options was greater
than or equal to the average market price of the common stock for the periods
reported.
A-13
<PAGE> 15
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(9) STOCK PLANS
(a) 1993 Stock Plan
The Company has a 1993 Stock Plan (the "1993 Plan"), pursuant to which the
Company may grant to employees, directors, and consultants of the Company
statutory and nonstatutory stock options to purchase shares of Series B common
stock. Under the 1993 Plan, incentive stock options may be granted at an
exercise price not less than the fair market value of the Company's common stock
on the date of the grant, as determined by the Board of Directors. Nonqualified
options may be granted on terms determined by the Board of Directors, but at a
price of no less than the book value per share or 50% of the fair market value
on the date of grant, whichever is lower. The maximum term of the options is ten
years from date of grant. Upon the adoption of the 1996 Plan, shares remaining
ungranted under the 1993 Plan were authorized to be granted under the 1996 Plan,
and the 1993 Plan was then terminated.
(b) 1996 Stock Plan
On January 15, 1996, the Company's Board of Directors adopted the 1996 Stock
Plan (the "1996 Plan"), pursuant to which the Company may grant to employees,
directors, and consultants of the Company stock options, rights or awards to
purchase shares of common stock. Under the 1996 Plan, incentive stock options
("ISOs") may be granted at an exercise price not less than the fair market value
of the Company's common stock on the date of the grant (110% of fair market
value for ISOs granted to holders of more than 10% of the voting stock of the
Company), as determined by the Board of Directors. Stock options under the 1996
Plan are non-transferable and generally vest over a four-year period. The
maximum term of any option is ten years. Upon the adoption of the 1998 Plan,
shares remaining ungranted under the 1996 Plan were authorized to be granted
under the 1998 Plan, and the 1996 Plan was then terminated.
(c) 1998 Stock Plan
On April 23, 1998, the Company's Board of Directors adopted the 1998 Stock
Incentive Plan (the "1998 Plan"), pursuant to which the Company may grant to
employees, officers, directors, and advisors of the Company stock options,
restricted stock, or other stock-based awards to purchase up to 3,432,078 shares
of common stock plus the number of shares of Common Stock granted under the 1993
Plan or the 1996 Plan which are not actually issued because the grants have
expired, have resulted in shares not being issued, or have been repurchased by
the Company. Under the 1998 Plan, incentive stock options ("ISOs") may be
granted at an exercise price not less than the fair market value of the
Company's common stock on the date of the grant (110% of fair market value for
ISOs granted to holders of more than 10% of the voting stock of the Company), as
determined by the Board of Directors. However, it is the Company's intent to
grant only Non-statutory Stock Options in the future. Stock options under the
1998 Plan are non-transferable and generally vest over a four-year period. The
maximum term of any option is ten years. The Company's intent is to grant all
future stock options under the 1998 Plan.
(d) 1998 Employee Stock Purchase Plan
On April 23, 1998, the Company's Board of Directors adopted the 1998 Employee
Stock Purchase Plan (the "ESPP"). The ESPP allows eligible employees the right
to purchase up to 300,000 shares of Common Stock on an annual basis at the lower
of 85% of the market price at the beginning or end of the 12-month offering
period. The offering period began on January 1, 1999. A liability will be
recorded for ESPP withholdings not yet applied toward the purchase of Common
Stock.
A-14
<PAGE> 16
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(9) STOCK PLANS (CONTINUED)
Information related to all stock options granted by the Company is as follows:
<TABLE>
<CAPTION>
Weighted
Weighted- average
average exercise price
Number of exercise Options of options
shares price exercisable exercisable
--------- ----- ----------- -----------
<S> <C> <C> <C> <C>
Outstanding, December 31, 1995................ 2,388,648 $0.86 1,223,437 $0.57
Granted...................................... 3,033,690 2.00
Exercised.................................... (145,688) 1.72
Forfeited/canceled........................... (479,550) 1.99
--------- -----
Outstanding, December 31, 1996................ 4,797,100 1.44 1,866,176 0.79
Granted...................................... 2,252,050 3.31
Exercised.................................... (473,677) 1.44
Forfeited/canceled........................... (429,323) 2.17
--------- -----
Outstanding, December 31, 1997................ 6,146,150 2.08 2,275,440 1.08
Granted...................................... 1,209,515 11.32
Exercised.................................... (744,313) 0.63
Forfeited/canceled........................... (250,914) 4.98
--------- -----
Outstanding, December 31, 1998................ 6,360,438 $3.90 3,225,828 $2.03
========= =====
</TABLE>
The following table summarizes information about fixed stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------- -------------------
Number Weighted- Weighted- Number Weighted-
Range of outstanding average average Exerciseable average
exercise at December 31, remaining exercise at December 31, exercise
prices 1998 contractual life price 1998 price
----------- ---------- ---------------- ----- --------------- -----
<S> <C> <C> <C> <C> <C>
$ 0.01-0.67 591,124 5.78 years $0.14 558,501 $0.11
1.00-1.99 210,856 3.82 1.60 208,148 1.61
2.00-2.99 2,854,061 7.32 2.03 1,694,227 2.02
3.00-4.99 1,184,058 8.58 3.06 609,563 3.11
5.00-5.99 750,139 8.55 5.06 151,575 5.11
7.00-12.00 260,000 9.33 9.91 3,814 12.00
14.00-17.00 307,100 9.77 16.16 -- --
17.13-18.50 203,100 9.79 17.71 -- --
----------- --------- ---- ----- --------- -----
$0.01-18.50 6,360,438 7.72 years $3.90 3,225,828 $2.03
=========== ========= ========== ===== ========= =====
</TABLE>
The exercise price for each of the above grants was determined by the Board of
Directors of the Company to be equal to the fair market value of the common
stock on the day of grant (110% of the fair market value for grants to holders
of more than 10% of the voting stock of the Company). Prior to the IPO, in
reaching this determination at the time of each such grant, the Board considered
a broad range of factors including the illiquid nature of an investment in the
Company's common stock, the Company's historical financial performance, and the
Company's future prospects. Subsequent to the IPO, the exercise prices are equal
to the closing prices of the Company's stock as reported by Nasdaq exchange on
the date of grant. Pursuant to the required pro forma disclosure under the fair
value method of estimating compensation cost, the Company has estimated the fair
value of its stock option grants by using the Black-Scholes option pricing
method with the following weighted-average assumptions:
1998 1997 1996
----- ----- -----
Expected option term (years)......................... 7.0 7.0 7.0
Risk-free interest rate (%).......................... 5.3 6.4 6.6
Expected volatility (%).............................. 43.3 -- --
Dividend yield (%)................................... -- -- --
Weighted average fair value of
options granted.................................... $6.78 $1.04 $0.70
A-15
<PAGE> 17
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(9) STOCK PLANS (CONTINUED)
The Company applies APB Opinion No. 25 and the related Interpretations.
Accordingly, no compensation cost has been recognized for option grants. Had
compensation cost for these awards been determined based on the fair value at
the grant dates consistent with the method prescribed by SFAS No. 123, the
Company's net income would have been adjusted to the pro forma amounts indicated
below:
1998 1997 1996
------ ------ ------
Net income
As reported................................... $5,546 $4,678 $1,910
Compensation expense for stock options........ 1,342 609 272
------ ------ ------
Pro forma net income.......................... $4,204 $4,069 $1,638
====== ====== ======
Basic earnings per share as reported............ $ 0.32 $ 0.31 $ 0.13
Pro forma basic earnings per share.............. $ 0.24 $ 0.27 $ 0.11
Diluted earnings per share as reported.......... $ 0.26 $ 0.26 $ 0.12
Pro forma diluted earnings per share............ $ 0.20 $ 0.23 $ 0.10
(10) COMMITMENTS
The Company leases its facilities under operating lease agreements that expire
through October 2002. The following are the future minimum lease payments under
operating leases as of December 31, 1998:
1999........................................ $1,343
2000........................................ 1,338
2001........................................ 1,140
2002........................................ 45
------
Total minimum lease payments................ $3,866
======
Rent expense was approximately $1,304, $1,282, and $619 for the years ended
December 31, 1998, 1997, and 1996, respectively.
(11) RELATED PARTY TRANSACTIONS
During 1995, the Company provided certain management, administrative, and
support services and subleased a portion of its facilities to a related entity.
The Company charged the entity $102 during 1995, which was offset against
operating expenses of the Company. The amount charged was included in due from
related party in the Company's balance sheets. During 1996 all amounts were paid
in full.
In 1996, the Company was paid $317 for IT services provided to a company of
which a principal stockholder and a former director of the Company was a
significant shareholder. The Company also purchases approximately $400 in annual
telephone services from a company which is owned by principal stockholders.
During 1997, the Company received a note for $533 from a stockholder for the
exercise of 400,000 stock options. The note is due in October 2000. Interest
accrues at 8.5%, is payable at maturity, and the associated interest receivable
is included in other assets in the Supplemental Consolidated Balance Sheets.
In 1997, the Company received notes for $230 from stockholders due in April
2002. These notes carry interest at a rate of 5% per annum. The notes were for
the sale of a property occupied by a tenant unrelated to the Company.
In 1998, the Company granted an option to acquire one of its subsidiaries to
parties related to three of its directors. The subsidiary's sole activity is the
ownership of property together with a non-recourse bank loan of approximately
$1,400. The exercise price of the option was set at the fair market value of
approximately $403 and expires in May 2001.
A-16
<PAGE> 18
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(12) 401(k) PLAN
During April 1995, the Company adopted a defined contribution plan (the "401k
Plan") under Section 401(k) of the Internal Revenue Code. The 401k Plan allows
eligible employees to make contributions up to a specified annual maximum
contribution. Under the 401k Plan, the Company may, but is not obligated to,
match a portion of the employees' contributions up to a defined maximum. The
Company did not contribute to the 401k Plan during 1996 or 1997. The Company
contributed $129 to the 401k Plan during 1998.
(13) SUPPLEMENTARY INFORMATION
During 1998, 1997, and 1996, the Company paid interest of $208, $229, and $74,
respectively.
During 1998, 1997, and 1996, the Company paid $3,811, $2,267, and $1,906,
respectively, for income taxes.
The Company entered into obligations under capital leases of $398 and $660
during the periods ended December 31, 1998 and 1997, respectively.
During 1997, the Company disposed of various fixed assets with an original cost
of $199.
During 1997 and 1996, the Company paid $249 and $1,150 for executive signing
bonuses, respectively. These amounts are included in general and administrative
expenses.
A-17
<PAGE> 1
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF SUPPLEMENTAL FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Introduction
The following discussion and analysis relates to the Supplemental Consolidated
Financial Statements of International Integration Incorporated ("i-Cube" or the
"Company") as of December 31, 1998 and 1997 and for each of the three years in
the period ending December 31, 1998.
On June 21, 1999, the Company acquired all of the outstanding common stock of
Reportsent, Ltd. and its majority-owned subsidiary Conduit Communications Ltd.,
(collectively, "Conduit"), in exchange for approximately 2.4 million shares of
i-Cube common stock. On May 25, 1999, the Company acquired all of the
outstanding common stock of Tomorrow's Technology Today, Inc., ("T3"), in
exchange for 89,640 shares of i-Cube common stock.
These transactions have been accounted for as poolings of interests and
accordingly, the Supplemental Consolidated Financial Statements reflect the
combined financial position and results of operations and cash flows of i-Cube,
Conduit, and T3 for all periods presented. Upon publication of the Company's
financial statements for a period which includes May 25, 1999 and June 21, 1999,
the Supplemental Consolidated Financial Statements will become the historical
consolidated financial statements of the Company.
Overview
The Company is an IT solutions provider specializing in consulting, electronic
business, and transformation services for the complex IT environments inherent
in the world's leading organizations. Since 1992, the Company has helped clients
leverage their current business processes and technology infrastructure to
create competitive advantage. The Company's solutions are based on open
standards and architectures that are independent of any single vendor's
hardware, software, or middleware. The Company makes use of i-Structure, a set
of methodologies and tools which embody "best" practices in application
development, project management, testing, and deployment. Utilizing a
fixed-time/fixed-price model and a unique client teaming approach, the Company
delivers solutions quickly, with full knowledge transfer to the client.
The Company derives substantially all of its revenues from consulting,
electronic business and transformation services. The Company's services are
principally provided on a fixed-time/fixed-price basis; however, as a result of
the Conduit acquisition, a portion of the Company's revenues are derived from
time and materials based contracts. In developing the fixed price of a project,
the Company follows a process that assesses the technical complexity of the
project, the nature of the work, the functions to be performed, the resources
required to complete the engagement, and the extent to which the Company will
deploy its internally-developed software tools to deliver the solution. The
Company recognized revenues from fixed-time/fixed-price and time and
materials-based contracts on the percentage-of-completion method of accounting.
For its fixed time/fixed price and larger projects, the Company's contracts
typically call for an advance payment from its customers upon signing, with
additional payments required upon the attainment of project milestones. For its
time and materials and smaller projects, the Company typically receives payment
ratably over the duration of the engagement. Deferred revenues consist
principally of amounts billed in advance for the Company's technology consulting
contracts that will be recognized upon performance and amounts billed to
customers in excess of revenues recognized to-date.
During 1998, the Company expanded its operations by opening its European
headquarters in Mannheim, Germany, bringing to three the number of locations
from which the Company provides its services.
The Company has traditionally depended upon a few major clients for a majority
of its revenues. During the year ended December 31, 1998, revenues from two
clients accounted for 12% and 11% of the Company's net revenues. During the
comparable period in 1997, revenues from three clients accounted for 20%, 13%,
and 10% of the Company's net revenues. The percentage of revenues coming from
the top five clients declined to 49% in 1998 from 58% in 1997. The loss of one
or more major customers could have a material adverse effect on the Company's
business, financial condition, and results of operations. Although the Company's
strategy is to broaden its customer base, there can be no assurance that such
customer concentration will actually diminish, and the Company anticipates that
its results of operations in any given period will continue to depend to a
significant extent upon contracts with a small number of customers. See "Certain
Factors That May Affect Future Results".
<PAGE> 2
The Company's revenues and earnings may fluctuate from quarter to quarter based
on the number, size, and scope of projects in which the Company is engaged, the
contractual terms and degree of completion of such projects, any delays incurred
in connection with a project, the accuracy of estimates of resources required to
complete ongoing projects, general economic conditions, and other factors. See
"Certain Factors That May Affect Future Results".
Recent Developments
On August 10, 1999, the Company announced that it had signed a definitive
agreement to merge with Razorfish, a New York City-based information technology
firm that provides Digital Change Management(sm) solutions. Under terms of the
agreement, approved by each company's board of directors, each share of the
Company will be exchanged for 0.875 shares of Razorfish, and Razorfish will be
the surviving entity. The Company anticipates that the transaction will be
accounted for as a pooling of interests.
The Company completed the initial public offering of 2,605,000 shares of its
Common Stock on June 23, 1998 (including shares purchased by the underwriters
pursuant to their over-allotment option). The net proceeds to the Company from
these shares were approximately $27.9 million.
Results of Operations
The following table sets forth certain items included in the Company's
Consolidated Statements of Income as a percentage of net revenues for the
periods indicated:
PERCENTAGE OF TOTAL REVENUES
YEARS ENDED DECEMBER 31,
1998 1997 1996
---- ---- ----
STATEMENT OF INCOME DATA
Net revenues 100% 100% 100%
Project personnel and software costs 49 45 40
--- --- ---
Gross profit 51 55 60
Operating expenses:
Selling and marketing 9 10 10
General and administrative 26 26 35
Restructuring costs 1 -- --
--- --- ---
Total operating expenses 36 36 45
--- --- ---
Operating income 15 19 15
Other income, net 2 1 --
--- --- ---
Income before income taxes 17 20 15
Provision for income taxes 7 8 5
--- --- ---
Net income 10% 12% 10%
=== === ===
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Net Revenues
The Company's net revenues increased by $17.9 million, or 46%, to $56.8 million
for the year ended December 31, 1998 from $38.9 million for the year ended
December 31, 1997. This increase in net revenues was primarily attributable to
an increased volume of projects from new customers and the leveraging of
existing client relationships to obtain repeat business. During the year ended
December 31, 1998, the Company's five largest customers accounted for 49% of net
revenues as compared to 58% for the year ended December 31, 1997. In the years
ended December 31, 1998 and 1997, the Company had two and three customers,
respectively, that each accounted for 10% or more of net revenues.
<PAGE> 3
Project Personnel and Software Costs
Project personnel and software costs consist primarily of compensation and
related costs of personnel dedicated to customer assignments and personnel
assigned to developing and enhancing the Company's methodologies and
technologies deployed during the project delivery process. Project personnel and
software costs also include fees paid to subcontractors for work performed in
connection with projects and non-reimbursed project travel expenses. Project
personnel and software costs increased 56%, to $27.6 million, for the year ended
December 31, 1998 from $17.6 million for the comparable period in 1997. As a
percentage of net revenues, these costs were 49% in 1998 and 45% in 1997. The
absolute dollar and percentage increases in project personnel and software costs
in 1998 were primarily attributable to the hiring of additional and more
experienced personnel required to deliver the Company's services and increases
in per person compensation costs. Project personnel headcount, which includes
contractors and employees working over 20 hours per week, increased to 286 at
December 31, 1998 from 190 at December 31, 1997.
Selling and Marketing
Selling and marketing costs consist primarily of compensation and related costs
of sales and marketing personnel, travel expenses, and marketing programs and
promotion costs. Selling and marketing costs increased 36%, to $5.2 million, for
the year ended December 31, 1998 from $3.8 million for the comparable period in
1997. As a percentage of net revenues, these costs were 9% in 1998 and 10% in
1997. The increase in selling and marketing costs in absolute dollars was
primarily attributable to increased spending on promotional activities and
increases in selling and marketing personnel. Selling and marketing personnel,
which includes contractors and employees working over 20 hours per week,
increased to 28 at December 31, 1998 from 26 at December 31, 1997.
General and Administrative
General and administrative costs consist primarily of compensation and related
costs of the Company's management and administrative functions, including
finance and accounting, human resources, internal information technology, and
the costs of the Company's facilities and other general corporate expenses.
General and administrative costs increased 46%, to $14.6 million, for the year
ended December 31, 1998 from $10.0 million for the comparable period in 1997. As
a percentage of net revenues, these costs were 26% in both years. The increase
in general and administrative costs in absolute dollars was primarily
attributable to an increase in general and administrative personnel and costs
related to the opening of the Company's European headquarters. General and
administrative employees, which include contractors and employees working over
20 hours per week, increased to 56 at December 31, 1998 from 44 at December 31,
1997.
Restructuring Costs
Restructuring costs in 1998 consist primarly of severance related costs at
Conduit and were fully spent in the year ended December 31, 1998.
Other Income, Net
Other income, net consists primarily of interest income from the Company's cash,
cash equivalents, and short-term investment balances and interest expense
associated with fixed asset purchases made under the Company's equipment line of
credit, obligations under capital leases and bank loans. Other income, net was
$1.2 million and $0.3 million for the years ended December 31, 1998 and 1997,
respectively. The increase in other income, net was principally due to the
increase in cash, cash equivalents, and short-term investments which included
net proceeds from the Company's initial public offering in the second quarter of
1998. The Company invests its cash, cash equivalents, and short-term investments
primarily in overnight repurchase agreements, short-term U.S. Treasury and
Agency bonds, and short-term commercial paper.
Provision for Income Taxes
The Company's combined effective rate for federal and state income taxes was 44%
and 39% for 1998 and 1997, respectively.
<PAGE> 4
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Net Revenues
The Company's net revenues increased by $19.2 million, or 98%, to $38.9 million
for the year ended December 31, 1997 from $19.7 million for the comparable
period in 1996. This increase in net revenues represents an increase in the
number of customer projects from both new and existing customers plus an
increase in the average size of projects. During the year ended December 31,
1997, the Company's five largest customers accounted for 58% of net revenues as
compared to 55% for the comparable period in 1996.
Project Personnel and Software Costs
Project personnel and software costs increased 121%, to $17.6 million, for the
year ended December 31, 1997 from $8.0 million for the comparable period in
1996. As a percentage of net revenues, these costs were 45% in 1997 and 40% in
1996. The increase in project personnel and software costs in absolute dollars
was primarily attributable to an increase in the number of personnel required to
deliver projects and increased per person compensation costs. The increase in
project personnel and software costs as a percentage of net revenues was
primarily attributable to an increase in compensation on both an absolute and
per employee basis. Project personnel headcount, which includes contractors and
employees working over 20 hours per week, increased to 190 at December 31, 1997
from 117 at December 31, 1996.
Selling and Marketing
Selling and marketing costs increased 100%, to $3.8 million, for the year ended
December 31, 1997 from $1.9 million for the comparable period in 1996. As a
percentage of net revenues, these costs were 10% in both years. The increase in
selling and marketing costs in absolute dollars was primarily attributable to
increased spending on promotional activities and increases in selling and
marketing personnel. Selling and marketing personnel, which includes contractors
and employees working over 20 hours per week, increased to 26 at December 31,
1997 from 17 at December 31, 1996.
General and Administrative
General and administrative costs increased 46%, to $10.0 million, for the year
ended December 31, 1997 from $6.8 million for the comparable period in 1996. As
a percentage of net revenues, these costs were 26% in 1997 and 35% in 1996. In
1996, the Company paid $1.2 million in bonuses to secure the services of certain
executive officers of the Company. General and administrative personnel, which
includes contractors and employees working over 20 hours per week, increased to
44 at December 31, 1997 from 23 at December 31, 1996.
Other Income, Net
Other income, net consists primarily of interest income from the Company's cash,
cash equivalents, and short-term investment balances and interest expense
associated with fixed asset purchases made under the Company's equipment line of
credit, obligations under capital leases and bank loans. Other income, net was
$0.3 million and $55,000 for the years ended December 31, 1997 and 1996,
respectively.
Provision for Income Taxes
The Company's combined effective rate for federal and state income taxes was 39%
and 36% for 1997 and 1996, respectively.
Liquidity and Capital Resources
Prior to its initial public offering, the Company met its working capital
requirements through cash generated from operations. In June 1998, the Company
completed its initial public offering of common stock resulting in net proceeds
to the Company of approximately $27.9 million. The Company also maintains a $5.0
million revolving line of credit (the "Line") with Silicon Valley Bank, which
expires in September 1999. Under the Line, the Company may borrow the lesser of
$5.0 million or 75% of eligible accounts receivable, as defined in the loan
agreement. The Company is required to comply with certain operational and
financial covenants under the Line if there are borrowings under the Line. At
December 31, 1998 the Company was in compliance with these requirements and no
borrowings have been made under the Line.
In May 1998, Conduit entered into a loan agreement with a major financial
institution for $1.4 million for the purchase of a building currently occupied
by Conduit. The principal balance is payable over 12 years in quarterly
installments and bears interest at LIBOR +2% (8.18% at December 31, 1998). These
quarterly installments increase throughout the term of the loan. The Company is
required to comply with certain financial covenants under this loan agreement.
At December 31, 1998, the Company was in compliance with these requirements. At
December 31, 1998, $1.4 million was outstanding under the loan agreement which
is collateralized by the building.
<PAGE> 5
The Company's cash and cash equivalents balances increased to $36.0 million at
December 31, 1998 from $11.6 million at December 31, 1997. The increase in cash
was primarily due to proceeds from the Company's initial public offering and
cash generated from operations. The Company's cash and cash equivalents balances
increased to $11.6 million at December 31, 1997 from $5.2 million at December
31, 1996. This increase in cash was primarily the result of cash generated from
operations. The Company's working capital was $39.3 million at December 31, 1998
as compared to $6.4 million at December 31, 1997 and $3.1 million at December
31, 1996.
The Company's operating activities provided cash from operations of $6.8 million
for the year ended December 31, 1998 as compared to $9.1 million provided from
operations for the comparable period in 1997 and $1.9 million in 1996. The
decrease in cash provided from operations in 1998 as compared to 1997 was due
principally to a decrease in deferred revenues which was partially offset by a
decrease in accounts receivable and an increase in accrued expenses. The
decrease in deferred revenues in 1998 was the result of the timing of milestone
billings on some of the Company's fixed-price contracts. The increase in cash
from operations in 1997 as compared to 1996 was primarily the result of
increases in net income, deferred revenues and accrued expenses.
The Company used cash of $10.3 million for investing activities for the year
ended December 31, 1998 as compared to $4.2 million and $0.7 million used in the
comparable periods of 1997 and 1996, respectively. Cash used for investing
activities consisted primarily of purchases of short-term investments and
purchases of property and equipment used to support the growing base of
employees.
The Company's financing activities provided cash of $27.9 million for the year
ended December 31, 1998 as compared to $1.6 million and $0.8 million provided by
financing activities in the comparable periods of 1997 and 1996, respectively.
The increase in cash provided by financing activities in 1998 mainly represents
the net proceeds of $27.9 million from its initial public offering of common
stock in June 1998.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
130, "Reporting Comprehensive Income." This Statement requires that all items
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. SFAS No. 130 does not require a specific format for
the financial statement in which comprehensive income is reported, but does
require that an amount representing total comprehensive income be reported in
that statement. The components of comprehensive income for the Company generally
include foreign currency translation and unrealized gains or losses on
short-term investments classified as available for sale.
These components are not material for the years presented.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, superseding SFAS No. 14, Financial Reporting
for Segments of a Business Enterprise. SFAS No. 131 establishes standards for
the way public business enterprises report information about operating segments
in annual financial statements, and requires those enterprises to report
selected information about operating segments in interim financial statements.
It also requires disclosures about products and services, geographic areas, and
major customers. The Company has determined that it has one reportable segment.
In March 1998, Statement of Position ("SOP") 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use," was issued which
provides guidance in addressing whether and under what conditions the costs of
internal-use software should be capitalized. SOP 98-1 is effective for
transactions entered into in fiscal years beginning after December 15, 1998;
however, earlier adoption is encouraged. The Company adopted the guidelines of
SOP 98-1 as of January 1, 1998, and the impact of such adoption was not material
to results of operations or of cash flows for the year ended December 31, 1998.
Year 2000
In the past, many information technology products were designed with two digit
year codes that did not recognize century and millennium fields. As a result,
these hardware and software products may not function or may give incorrect
results with respect to dates after December 31, 1999. This problem is generally
referred to as the "Year 2000" problem or issue. Substantially every company in
the computer or information technology industries, as well as every company
which relies on computer systems or which utilizes products which include
embedded technology face the Year 2000 issue.
The Company is currently in the process of assessing its exposure to the Year
2000 problem. Generally, the Company is assessing its Year 2000 exposure in four
major areas: (i) problems arising from systems previously developed for
customers; (ii) delays in existing projects by the Company's customers as they
shift internal resources to complete their Year 2000 mitigation, and delays in
the purchasing patterns of clients and potential clients with respect to new
projects; (iii) Year 2000 problems faced by the Company's
<PAGE> 6
material suppliers which could have an impact on the Company's business, results
of operations or financial condition; and (iv) Year 2000 problems existent in
the Company's internal information technology ("IT") systems and non-IT systems.
The Company is in the process of assessing systems previously developed for
customers and believes that they are Year 2000 compliant. However, there can be
no assurances that the Company's systems do not contain undetected errors or
defects associated with Year 2000 compliance issues, or that third party
software included in the systems developed by the Company do not contain Year
2000 problems. Certain of the Company's agreements with its customers contain
warranties that the systems developed by the Company will not experience Year
2000 problems. To the extent that a problem arises, the Company may be required
to expend funds to remedy the problem or, if asserted, to pay damages incurred
by the customer as a result of such failure. In addition, to the extent that a
Year 2000 problem is identified in a system developed under a contract without a
Year 2000 warranty, the Company may nevertheless expend resources to remedy the
problem, in certain circumstances, at its own cost. Although the Company's
contracts with its customers generally contain provisions which seek to insulate
the Company from, or limit the amount of, any liability arising from claims
asserted against the Company, there can be no assurance that any such
limitations would be upheld in favor of the Company. The Company is aware of a
growing number of lawsuits against other providers of IT services. Because of
the unprecedented nature of such litigation, it is uncertain to what extent the
Company may be affected by such litigation. Due to the complexity of the Year
2000 issue, upon any failure of critical client systems or processes that may be
directly or indirectly connected or related to systems or software designed,
developed, customized, or implemented by the Company as described above, the
Company may be subjected to claims regardless of whether the failure is related
to the services provided by the Company. If asserted, such claims (including the
associated defense costs) could have a material adverse effect on the Company's
business, operating results, and financial condition.
The Company is in the process of conducting a survey of its major customers to
determine their Year 2000 readiness and the likelihood that the customers will
delay scheduled or in-process contracts, or defer future contracts with the
Company, in order to allocate more IT resources to solving their Year 2000
problems. In addition, the Company continually seeks feedback from its
salespersons as to the impact that the Year 2000 readiness of prospective
customers may have on the Company's future revenues. There can be no assurance
that the Company's customers and prospective customers will not delay scheduled,
in-process, or future projects as a result of their own Year 2000 remediation
efforts. Any such delays could have a material adverse impact on the Company's
business, operating results, and financial condition.
The Company has completed the process of determining the nature and extent of
the work required, if any, to make its internal IT systems Year 2000 compliant.
The Company's internal IT systems consist principally of its accounting and
human resources software. The licensor of the software has indicated to the
Company in writing that the products are Year 2000 compliant. Based on currently
available information, the Company believes the expense associated with these
efforts will be immaterial and has provided for the enhancement of these systems
in its operating and capital budgets for the current fiscal year. However, if
Year 2000 issues of which the Company is not currently aware arise and are not
remediated on time, or if the Company is required to pay for any required
updating, modification or replacement of the Company's information systems, the
Year 2000 issue could have a material adverse impact on the Company's business,
operating results, and financial condition. The Company is also assessing its
utilization of non-IT systems which contain embedded technology such as
microcontrollers. Following its determination of such utilization, the Company
expects to contact the providers of any material non-IT systems to determine
whether the systems are Year 2000 compliant, and if not, whether such systems
will be remediated or will need to be replaced. In addition to the Company's
internal systems, the Company relies on third party vendors in the conduct of
its business. The Company is in the process of seeking assurances from its
material vendors and suppliers that there will be no interruption of service as
a result of the Year 2000 issue and to the extent such assurances are not given,
the Company intends to devise contingency plans to ameliorate the negative
effects on the Company in the event the Year 2000 issue results in the
unavailability of services. There can be no assurance that any contingency plans
developed by the Company will prevent any such service interruption on the part
of one or more of the Company's third party vendors or suppliers from having a
material adverse effect on the Company. In addition, the failure on the part of
the accounting systems of the Company's clients due to the Year 2000 issue could
result in a delay in the payment of invoices issued by the Company for services
and expenses. A failure of the accounting systems of a significant number of the
Company's clients would have a material adverse effect on the Company.
Through December 31, 1998, the Company had not incurred material costs directly
relating to the remediation of Year 2000 problems. Pending further progress in
its assessment of its exposure to the Year 2000 problem, as described in the
preceding paragraphs, the Company is unable to estimate the costs of remediating
the Year 2000 problem that it may incur in the future.
The Securities and Exchange Commission has asked publicly-traded companies to
include a reasonable description of their most reasonably likely worst case Year
2000 scenario. As of the date of this report, the Company is uncertain as to
such scenario, although the Company believes that it may include a situation
where one of the Company's significant clients asks the Company to delay or
<PAGE> 7
stop work on an ongoing project due to the client's internal Year 2000 issues.
The Company intends to address this uncertainty by continuing to assess its
exposure to the Year 2000 problem, as described above. The Company intends to
consider this scenario in its financial and strategic planning for 1999 and
2000, including in its projected personnel needs and other areas. As of December
31, 1998, the Company is not able to estimate revenue lost due to Year 2000
issues.
The Company has not yet established a contingency plan for addressing the most
reasonably likely worst case Year 2000 scenario. The Company intends to
establish such a plan to the extent the Company believes it necessary to do so,
based on the impact that such scenario is expected to have on the Company's
business, operating results, and financial condition.
Safe Harbor Provision
This Form 8-K includes forward-looking statements (statements that are not
historical facts) such as statements about future net revenues and profits,
capital expenditures, liquidity sources and needs, working capital needs,
increases in personnel and related costs, opening additional offices, general
and administrative expenses, sales and marketing expenses, issues arising out of
the Year 2000 problem and other costs, both in absolute terms and as a
percentage of net revenues. These forward-looking statements are subject to
several risks and uncertainties and the Company's actual future results may
differ significantly from those stated in any forward looking statements for a
variety of reasons, including those set forth in "Certain Factors That May
Affect Future Results". The Company makes no commitments to disclose any
revisions to forward-looking statements, or any facts, events or circumstances
that may occur after the date of this Form 8-K that may have an impact on the
forward-looking statements.
Certain Factors That May Affect Future Results
The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Annual Report on Form 8-K and presented elsewhere by management from time
to time.
The Company has entered into a Merger Agreement with Razorfish, Inc. and a
subsidiary of Razorfish, Inc., pursuant to which, subject to the terms and
conditions of the Merger Agreement, the Company would become a wholly-owned
subsidiary of Razorfish. There can be no assurance that the Merger will be
consummated. If the Merger is not consummated, there can be no assurance that
the Company's results of operations and financial condition will not have been
adversely affected by the Merger negotiations or the announcement of the Merger,
by the passage of time following the signing of the Merger Agreement, or by
other factors. If the Merger is consummated, stockholders of the Company will
become stockholders of Razorfish, and as such will have the risks associated
with an investment in that company.
The Company has completed, and may in the future pursue, acquisitions of
companies, technologies or assets that complement the Company's business. The
successful integration of acquired companies, technologies and assets, including
Conduit and T3, is important to the future financial performance of the Company.
The anticipated benefits of such acquisitions may not be achieved unless, among
other things, the operations of acquired companies,
technologies and assets, are successfully combined with those
of the Company in a timely manner. The diversion of the attention of management,
and any difficulties encountered in the transition process, could have an
adverse impact on the revenues and operating results of the combined enterprise.
There can be no assurance that the Company will be able to successfully
integrate such acquisitions into the operations of the Company.
The Company's results of operations have varied significantly in the past and
may vary significantly in the future, on a quarterly and annual basis, as a
result of a variety of factors, many of which are outside the Company's control.
The Company's expense levels are based, in significant part, on anticipated
contract requirements and on other expectations of future revenues and are
relatively fixed in the short-term. Consequently, if revenue levels are below
expectations, including without limitation as a result of an unanticipated delay
in or termination of a customer engagement, expense levels could be
disproportionately high as a percentage of net revenues, and the Company's
business, financial condition, and results of operations would be materially
adversely affected.
The Company has historically derived, and may in the future derive, a
significant amount of its net revenues from major engagements with a relatively
small number of customers. Although the Company's largest customers have varied
from period to period, the Company anticipates that its results of operations in
any given period will continue to depend to a significant extent upon large
contracts with a small number of customers. The loss of or a reduction in the
level of services provided to one or more major customers would have a material
adverse effect on the Company's business, financial condition, and results of
operations. Furthermore, if a major customer were unable or unwilling to proceed
with a project or to pay the Company for its services on a timely basis, the
Company's business, financial condition, and results of operations could be
materially adversely affected.
Many of the Company's projects are large, complex engagements that are performed
by the Company over extended periods of time.
<PAGE> 8
The Company is generally paid for these projects in installments, based on the
achievement of certain milestones. The Company's ability to successfully
complete these projects and to earn the milestone payments is based on factors
within and outside the Company's control. Furthermore, because of the
significant numbers of IT professionals assigned by the Company to these large
projects, unexpected early terminations of any of such engagements could result
in underutilization of project personnel until such persons can be redeployed to
other projects. Conversely, an unexpected delay in the completion of a major
engagement could result in a delay in the redeployment of project personnel to
new assignments for which the Company is contractually committed to achieve
milestones on a timely basis. The Company's failure or inability to meet a
customer's expectations in the performance of its services could give rise to
claims against the Company or damage the Company's reputation and adversely
affect its ability to attract new business.
The Company generally undertakes projects on a fixed-time/fixed-price basis, and
warrants defined project deliverables as specified in mutually agreed upon
statements of work. In making proposals for fixed-time/fixed-price contracts,
the Company relies on its estimated costs and timing for completing the project.
Any increased or unexpected costs or unanticipated delays in connection with the
performance of fixed-time/fixed-price contracts, including delays caused by
factors outside the Company's control, could affect the profitability of these
contracts and have a material adverse effect on the Company's business,
financial condition, and results of operations.
The Company's business, financial condition, and results of operations may be
adversely affected by the Year 2000 problems described above.
The Company has experienced growth in net revenues and expansion of its
operations which have placed, and are expected to continue to place, significant
demands on the Company's managerial, operational, and financial resources. If
the Company's management is unable to manage growth effectively, the Company's
business, financial condition, and results of operations would be materially
adversely affected.
The Company's success depends to a significant extent on its ability to attract,
train, motivate, and retain highly-skilled IT professionals, particularly
project managers, software engineers, and other senior technical personnel.
There is currently a shortage of, and significant competition for, software
development and other IT professionals with the advanced technological skills
necessary to perform the services offered by the Company. This shortage has
caused wages for such professionals to increase, which increases operating costs
to IT service providers such as the Company. An inability to hire a sufficient
number of qualified employees or an inability to retain employees could have a
material adverse effect on the Company's business, financial condition, and
results of operations. In addition, even if the Company is able to expand its
team of highly-skilled IT professionals, the resources required to attract and
retain such employees may adversely affect the Company's operating margins.
The time between the date of initial contact with a potential customer and the
execution of a contract with that customer is often lengthy, typically ranging
from six weeks for smaller engagements to nine months or more for the Company's
larger engagements, and is subject to delays over which the Company has little
or no control, including customers' budgetary constraints, customers' internal
acceptance reviews, the success and continued internal support of customers' own
development efforts, and the possibility of cancellation or delay of projects by
customers. During such sales cycle, the Company may expend substantial funds and
management resources and yet not obtain project awards or revenues.
The market for the Company's services is characterized by innovation and rapid
technological change, evolving industry standards, and changing customer
preferences. Both the needs of potential customers and the technologies
available for meeting those needs can change significantly within a short period
of time. The Company has derived a significant portion of its revenues from
projects based primarily on client/server architectures. These technologies are
continuing to develop and are subject to rapid change. Any factors negatively
affecting the acceptance of such technologies could have a material adverse
effect on the Company's business, financial condition, and results of
operations.
The Company's future will depend, in part, on its ability to continually enhance
its services, to develop services that address the needs of its customers and
potential customers, and to continue to improve its i-Structure methodologies
and technologies. There can be no assurance that the Company will be successful
in developing and marketing services that respond to technological changes, that
the Company will enhance its i-Structure methodologies and technologies on a
timely or cost-effective basis, or that the Company's services, methodologies,
and technologies will adequately meet the requirements of the marketplace.
The Company's future success depends to a significant extent on its executive
officers. The loss of the services of any one or more of these individuals could
have a material adverse effect on the Company's business, financial condition,
and results of operations.
<PAGE> 9
The Company operates in a highly competitive and rapidly changing market and
competes with a variety of organizations that offer services similar to those
offered by the Company. Many of these competitors have significantly greater
financial, technical, sales and marketing resources and greater name recognition
than the Company. There can be no assurance that the Company will be able to
continue to compete successfully with its existing competitors or that it will
be able to compete successfully with new competitors.
The Company's success and its ability to compete is dependent, in part, upon its
proprietary rights, including its rights in i-Structure methodologies and
technologies. The Company relies primarily on a combination of copyright,
trademark, and trade secret laws to establish and protect its proprietary
rights. There can be no assurance that such measures will be adequate to protect
the Company's proprietary rights. Although the Company believes that its
services and technologies do not infringe on the intellectual property rights of
others, there can be no assurance that infringement claims will not be asserted
against the Company in the future.
The Company's agreements with its customers typically contain provisions
designed to limit the Company's exposure to claims relating to the Company's
professional services and the applications developed by it. However, it is
possible that the limitation of liability provisions contained in the Company's
agreements may not adequately protect the Company or be effective under the laws
of certain jurisdictions. A liability claim brought against the Company could
have a material adverse effect on the Company's business, financial condition,
and results of operations.
Software applications as complex as those developed by the Company frequently
contain errors or defects, especially when first implemented. Any such defects
or errors could result in delayed or lost revenues, adverse customer reaction,
negative publicity regarding the Company and its services, and harm to the
Company's reputation, or could require expensive corrections, any of which could
have a material adverse effect on the Company's business, financial condition,
and results of operations.
The Company is subject to a number of risks that can adversely affect its
international operations, including difficulties administering its business
globally, managing foreign operations, currency fluctuations, restrictions
against the repatriation of earnings, the burdens of complying with a wide
variety of foreign laws, the uncertainty of laws and enforcement in certain
jurisdictions relating to the protection of intellectual property rights and
multiple and possibly overlapping tax structures.
Quantitative and Qualitative Disclosures About Market Risk
The Company does not believe that there is any material market risk exposure
with respect to derivative or other financial instruments that would require
disclosure under this item.
<PAGE> 1
Exhibit 99.3
SELECTED SUPPLEMENTAL CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of the Company for the five
years ended December 31, 1998 are derived from the Company's supplemental
consolidated financial statements and notes thereto. The information set forth
below should be read in conjunction with "Management's Discussion and Analysis
of Supplemental Financial Condition and Results of Operations" and the
supplemental financial statements and related footnotes included in this Form
8-K.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(in thousands, except per share data)
STATEMENT OF INCOME DATA
<S> <C> <C> <C> <C> <C>
Net revenues $56,793 $38,850 $19,659 $12,622 $5,112
Project personnel and software costs 27,562 17,630 7,961 4,408 2,627
------- ------- ------- ------- ------
Gross profit 29,231 21,220 11,698 8,214 2,485
Operating expenses:
Selling and marketing 5,178 3,819 1,913 1,128 564
General and administrative 14,551 9,997 6,844 3,389 658
Restructuring costs 786 -- -- -- --
------- ------- ------- ------- ------
Total operating expenses 20,515 13,816 8,757 4,517 1,222
------- ------- ------- ------- ------
Operating income 8,716 7,404 2,941 3,697 1,263
Other income, net 1,218 252 55 92 11
------- ------- ------- ------- ------
Income before income taxes 9,934 7,656 2,996 3,789 1,274
Provision for income taxes 4,388 2,978 1,086 1,440 508
------- ------- ------- ------- ------
Net income $ 5,546 $ 4,678 $ 1,910 $ 2,349 $ 766
======= ======= ======= ======= ======
Earnings per share:
Basic $ 0.32 $ 0.31 $ 0.13 $ 0.16 $ 0.05
======= ======= ======= ======= ======
Diluted $ 0.26 $ 0.26 $ 0.12 $ 0.15 $ 0.05
======= ======= ======= ======= ======
Weighted average shares outstanding:
Basic 17,363 15,113 14,911 14,809 14,600
Diluted 21,325 17,743 16,196 15,955 14,600
DECEMBER 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(in thousands)
BALANCE SHEET DATA
Cash, cash equivalents, and short term
investments $44,312 $11,609 $ 5,150 $ 3,138 $ 1,183
Working capital 39,315 6,402 3,109 1,405 (570)
Total assets 61,042 27,726 14,374 9,591 3,218
Long-term obligations 2,222 2,393 512 477 321
Total stockholders' equity 44,198 9,892 4,474 2,337 (127)
</TABLE>
<PAGE> 1
Exhibit 99.4
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
INDEX TO SUPPLEMENTAL CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(PREVIOUSLY FILED ON FORM 10-Q ON MAY 17, 1999)
Supplemental Consolidated Balance Sheets B-1
Supplemental Consolidated Statements of Income B-2
Supplemental Consolidated Statements of Cash Flows B-3
Notes to Supplemental Consolidated Financial Statements B-4
<PAGE> 2
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
MARCH 31, DECEMBER 31,
1999 1998
----------- -------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $32,444 $36,010
Short-term investments 5,483 8,302
Accounts receivable, net of reserve of $255 12,188 6,380
Unbilled revenues 2,964 1,988
Prepaid expenses and other current assets 1,294 1,100
Deferred income taxes 156 157
------- -------
Total current assets 54,529 53,937
Property and equipment, at cost:
Computers and equipment 5,969 5,721
Building 1,954 1,944
Furniture and fixtures 1,865 1,841
------- -------
Total property and equipment, at cost 9,788 9,506
Less- accumulated depreciation (3,255) (2,674)
-------- --------
Total property and equipment, net 6,533 6,832
Other assets 508 273
------- -------
Total assets $61,570 $61,042
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,169 $ 2,244
Accrued expenses 5,144 6,590
Current portion of long-term obligations 403 384
Accrued income taxes 1,530 545
Deferred revenues 3,122 4,859
------- -------
Total current liabilities 12,368 14,622
Long-term obligations 2,032 2,222
Stockholders' equity:
Preferred stock $0.01 par value; 1,000,000 shares
authorized; no shares issued or outstanding -- --
Common stock $0.01 par value; 100,000,000 shares
authorized; 19,254,729 and 18,758,111 shares
issued and outstanding at 193 188
March 31, 1999 and December 31, 1998, respectively
Additional paid-in capital 31,067 30,551
Note receivable from stockholder (533) (533)
Retained earnings 16,342 13,914
Accumulated other comprehensive income 101 78
------- -------
Total stockholders' equity 47,170 44,198
------- -------
Total liabilities and stockholders' equity $61,570 $61,042
======= =======
The accompanying notes are an integral part of these supplemental consolidated
financial statements
B-1
<PAGE> 3
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS
ENDED
MARCH 31,
-----------------
1999 1998
------- -------
Net revenues $16,895 $12,825
Project personnel and software costs 7,594 6,329
------- -------
Gross profit 9,301 6,496
Operating expenses:
Selling and marketing 1,581 1,067
General and administrative 4,295 3,471
------- -------
Total operating expenses 5,876 4,538
------- -------
Operating income 3,425 1,958
Other income, net 421 115
------- -------
Income before income taxes 3,846 2,073
Provision for income taxes 1,418 877
------- --------
Net income $ 2,428 $ 1,196
======= =======
Earnings per share:
Basic $ 0.13 $ 0.08
======== ========
Diluted $ 0.11 $ 0.06
======== ========
Weighted average shares outstanding:
Basic 18,996 15,730
Diluted 23,021 18,699
The accompanying notes are an integral part of these supplemental consolidated
financial statements
B-2
<PAGE> 4
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31,
----------------------
1999 1998
------- -------
Cash flows from operating activities:
<S> <C> <C>
Net income $ 2,428 $ 1,196
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 603 366
Provision for doubtful accounts 60 --
Deferred income taxes 1 (66)
Changes in operating assets and liabilities:
Accounts receivable (5,924) (628)
Unbilled revenues (976) 232
Prepaid expenses and other current assets (205) (245)
Accounts payable (56) 497
Accrued expenses (1,410) 327
Accrued income taxes 996 935
Deferred revenues (1,676) (3,501)
Other (232) (16)
------- -------
Net cash used in operating activities (6,391) (903)
Cash flows from investing activities:
Purchases of property and equipment (481) (524)
Purchases of available for sale securities (3,488) --
Sale and maturities of available for sale securities 6,307 --
------- -------
Net cash provided by (used in) investing activities 2,338 (524)
Cash flows from financing activities:
Repayment of long-term obligations (18) (58)
Repayments on line of credit (16) (7)
Proceeds from exercise of stock options 519 55
------- -------
Net cash provided by (used in) financing activities 485 (10)
Effect of exchange rates on cash and cash equivalents 2 13
------- -------
Net decrease in cash and cash equivalents (3,566) (1,424)
Cash and cash equivalents, beginning of period 36,010 11,609
------- -------
Cash and cash equivalents, end of period $32,444 $10,185
======= =======
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements
B-3
<PAGE> 5
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited supplemental consolidated financial statements have
been prepared by International Integration Incorporated ("i-Cube" or the
"Company") pursuant to the rules and regulations of the Securities and Exchange
Commission for interim reporting. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements and should be read in conjunction with the
Company's supplemental consolidated financial statements and notes thereto on
this Form 8-K for the year ended December 31, 1998. The accompanying
supplemental consolidated financial statements reflect all normal and recurring
adjustments which are, in the opinion of management, necessary for a fair
presentation of results for these interim periods presented. The results of
operations for the three month period ended March 31, 1999 are not necessarily
indicative of results to be expected for the full year.
2. ACQUISITIONS
On May 25, 1999, the Company acquired all of the outstanding common stock of
Tomorrow's Technology Today, Inc., ("T3") in exchange for 89,640 shares of
i-Cube common stock.
On June 21, 1999, the Company acquired all of the outstanding capital stock of
Conduit in exchange for approximately 2.4 million shares of the Company's
common stock. The Company assumed the existing Conduit stock options which are
transferable into approximately 0.5 million shares of the Company's common stock
upon exercise.
These transactions have been accounted for as poolings of interests and
accordingly, the Supplemental Consolidated Financial Statements reflect the
combined financial position and results of operations and cash flows of i-Cube,
Conduit, and T3 for all periods presented. Upon publication of the Company's
financial statements for a period which includes May 25, 1999 and June 31,
1999, the Supplemental Consolidated Financial Statements will become the
historical consolidated financial statements of the Company.
The results of operations for i-Cube and Conduit and the combined amounts
presented in the accompanying Supplemental Consolidated Financial Statements
are summarized below (in thousands):
THREE MONTHS ENDED MARCH 31,
1999 1998
------- -------
Net revenues:
i-Cube $12,941 $ 8,925
Conduit 3,954 3,900
------- -------
Combined $16,895 $12,825
Net income (loss):
i-Cube $ 2,126 $ 1,376
Conduit 302 (180)
------- -------
Combined $ 2,428 $ 1,196
======= =======
Revenue and net income for T3 for the three months ended March 31, 1999 and
1998 were nominal and have been included in the respective i-Cube amounts in
the above table.
On August 10, 1999, the Company announced that it had signed a definitive
agreement to merge with Razorfish, a New York City-based information
technology firm that provides Digital Change Management(sm) solutions. Under
terms of the agreement, approved by each company's board of directors, each
share of the Company will be exchanged for 0.875 shares of Razorfish, and
Razorfish will be the surviving entity. The Company anticipates that the
transaction will be accounted for as a pooling of interests.
3. EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted EPS
is computed using the weighted average number of common shares outstanding plus
the dilutive effect of common stock equivalents (using the treasury stock
method).
The following table reconciles the denominator of the basic and diluted earnings
per share computation as shown on the Consolidated Statements of Income (in
thousands):
THREE MONTHS
ENDED
MARCH 31,
-----------------
1999 1998
------ ------
(UNAUDITED)
Basic common shares outstanding.............. 18,996 15,730
Stock options................................ 4,025 2,969
------ ------
Diluted common and common equivalent shares.. 23,021 18,699
====== ======
4. COMPREHENSIVE INCOME
The components of other comprehensive income for the Company generally include
foreign currency translation adjustments and unrealized gains and losses on
marketable securities classified as available-for-sale. The computation of
comprehensive income is as follows (in thousands):
THREE MONTHS
ENDED
MARCH 31,
-----------------
1999 1998
------ ------
(UNAUDITED)
Net income................................ $2,428 $1,196
Other comprehensive income................ 23 31
------ ------
Total comprehensive income................ $2,451 $1,227
====== ======
5. RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to current period
presentation.
B-4
<PAGE> 1
Exhibit 99.5
INTERNATIONAL INTEGRATION INCORPORATED ("i-Cube")
MANAGEMENT'S DISCUSSION AND ANALYSIS OF SUPPLEMENTAL FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion and analysis relates to the Supplemental Interim
Consolidated Financial Statements of International Integration Incorporated
("i-Cube" or the "Company") as of March 31, 1999 and December 31, 1998 and for
the three month periods ending March 31, 1999 and March 31, 1998.
On June 21, 1999, the Company acquired all of the outstanding common stock of
Reportsent, Ltd. and its majority-owned subsidiary Conduit Communications Ltd.,
(collectively, "Conduit"), in exchange for approximately 2.4 million shares of
i-Cube common stock. On May 25, 1999, the Company acquired all of the
outstanding common stock of Tomorrow's Technology Today, Inc., ("T3"), in
exchange for 89,640 shares of i-Cube common stock.
These transactions have been accounted for as poolings of interests and
accordingly, the Supplemental Consolidated Financial Statements reflect the
combined financial position and results of operations and cash flows of i-Cube,
Conduit, and T3 for all periods presented. Upon publication of the Company's
financial statements for a period which includes May 25, 1999 and June 21,
1999, the Supplemental Consolidated Financial Statements will become the
historical consolidated financial statements of the Company.
OVERVIEW
The Company is an information technology ("IT") solutions provider specializing
in consulting, electronic business, and transformation services for the complex
IT environments inherent in the world's leading organizations. Since 1992, the
Company has helped clients leverage their current business processes and
technology infrastructure to create competitive advantage. The Company's
solutions are based on open standards and architectures that are independent of
any single vendor's hardware, software, or middleware. The Company makes use of
i-Structure, a set of methodologies and tools which embody "best" practices in
application development, project management, testing, and deployment. Utilizing
a fixed-time/fixed-price model and a unique client teaming approach, the Company
delivers solutions quickly, with full knowledge transfer to the client.
The Company derives substantially all of its revenues from consulting,
electronic business and transformation services. The Company's services are
principally provided on a fixed-time/fixed-price basis; however, as a result of
the Conduit acquisition, a portion of the Company's revenues are derived from
time and materials based contracts. In developing the fixed price of a project,
the Company follows a process that assesses the technical complexity of the
project, the nature of the work, the functions to be performed, the resources
required to complete the engagement, and the extent to which the Company will
deploy its internally-developed software tools to deliver the solution. The
Company recognized revenues from fixed-time/fixed-price and time and
materials-based contracts on the percentage-of-completion method of accounting.
For its fixed time/fixed price and larger projects, the Company's contracts
typically call for an advance payment from its customers upon signing, with
additional payments required upon the attainment of project milestones. For its
time and materials and smaller projects, the Company typically receives payment
ratably over the duration of the engagement. Deferred revenues consist
principally of amounts billed in advance for the Company's technology consulting
contracts that will be recognized upon performance and amounts billed to
customers in excess of revenues recognized to-date.
The Company has traditionally depended upon a few major clients for a majority
of its revenues. During the three months ended March 31, 1999, revenues from
three clients each accounted for 10% of the Company's net revenues. During the
comparable period in 1998, revenues from four clients accounted for 16%, 12%,
11%, and 11% of the Company's net revenues. The percentage of revenues coming
from the top five clients decreased from 57% for the period ended March 31, 1998
to 46% during the comparable period in 1999. The loss of one or more major
customers could have a material adverse effect on the Company's business,
financial condition, and results of operations. Although the Company's strategy
is to broaden its customer base, there can be no assurance that such customer
concentration will actually diminish, and the Company anticipates that its
results of operations in any given period will continue to depend to a
significant extent upon contracts with a small number of customers. See "Certain
Factors That May Affect Future Results".
The Company's revenues and earnings may fluctuate from quarter to quarter based
on the number, size, and scope of projects in which the Company is engaged, the
contractual terms and degree of completion of such projects, any delays incurred
in connection with a project, the accuracy of estimates of resources required to
complete ongoing projects, general economic conditions, and other factors. See
"Certain Factors That May Affect Future Results".
RECENT DEVELOPMENTS
On August 10, 1999, the Company announced that it had signed a definitive
agreement to merge with Razorfish, a New York City-based information technology
firm that provides Digital Change Management(sm) solutions. Under terms of the
agreement, approved by each company's board of directors, each share of the
Company will be exchanged for 0.875 shares of Razorfish, and Razorfish will be
accounted for as a pooling of interests.
17
<PAGE> 2
RESULTS OF OPERATIONS
The following table sets forth certain items included in the Company's
Consolidated Statements of Income as a percentage of net revenues for the
periods indicated:
THREE MONTHS
ENDED
MARCH 31,
-----------------
1999 1998
------ ------
(unaudited)
Net revenues.................... 100% 100%
Project personnel and software
costs........................... 45 49
--- ---
Gross profit............... 55 51
Operating expenses:
Selling and marketing......... 9 9
General and administrative.... 26 27
--- ---
Total operating
expenses............. 35 36
--- ---
Operating income................ 20 15
Other income, net............... 2 1
--- ---
Income before income taxes. 22 16
Provision for income taxes...... 8 7
--- ---
Net income................. 14% 9%
=== ===
NET REVENUES
The Company's net revenues increased by $4.1 million, or 32%, to $16.9 million
in the three months ended March 31, 1999 from $12.8 million for the comparable
period in 1998. This increase in net revenues was primarily attributable to an
increased volume of projects from new customers and the leveraging of existing
client relationships to obtain repeat business. During the period ended March
31, 1999, the Company's five largest customers accounted for 46% of net revenues
as compared to 57% for the period ended March 31, 1998. In the periods ended
March 31, 1999 and 1998, the Company had three and four customers, respectively,
that each accounted for 10% or more of net revenues.
PROJECT PERSONNEL AND SOFTWARE COSTS
Project personnel and software costs consist primarily of compensation and
related costs of personnel dedicated to customer assignments and personnel
assigned to developing and enhancing the Company's methodologies and
technologies deployed during the project delivery process. Project personnel and
software costs also include fees paid to subcontractors for work performed in
connection with projects and non-reimbursed project travel expenses. Project
personnel and software costs increased 20% to $7.6 million for the period ended
March 31, 1999 from $6.3 million for the comparable period in 1998. As a
percentage of net revenues, these costs were 45% for the period ended March 31,
1999 and 49% for the comparable period in 1998. The absolute dollar increase in
project personnel and software costs for the period in 1999 was primarily
attributable to the hiring of additional and more experienced personnel required
to deliver the Company's services and increases in per person compensation
costs. Project personnel headcount, which includes contractors and employees
working over 20 hours per week, increased to 307 at March 31, 1999 from 233 at
March 31, 1998.
SELLING AND MARKETING
Selling and marketing costs consist primarily of compensation and related costs
of sales and marketing personnel, travel expenses, and marketing programs and
promotion costs. Selling and marketing costs increased 48%, to $1.6 million, for
the period ended March 31, 1999 from $1.1 million for the comparable period in
1998. As a percentage of net revenues, these costs were 9% for each of the
periods ended March 31, 1999 and 1998. The absolute dollar increase in selling
and marketing costs was primarily attributable to increased spending on
promotional activities and increases in selling and marketing personnel. Selling
and marketing personnel, which includes contractors and employees working over
20 hours per week, increased to 29 at March 31, 1999 from 23 at March 31, 1998.
GENERAL AND ADMINISTRATIVE
General and administrative costs consist primarily of compensation and related
costs of the Company's management and administrative functions, including
finance and accounting, human resources, internal information technology, and
the costs of the Company's facilities and other general corporate expenses.
General and administrative costs increased 24%, to $4.3 million, for the
<PAGE> 3
period ended March 31, 1999 from $3.5 million for the comparable period in 1998.
As a percentage of net revenues, these costs were 26% and 27% for the periods
ended March 31, 1999 and 1998, respectively. The decline in general and
administrative costs as a percentage of net revenues reflects slower relative
hiring of and more efficient utilization of administrative staff as well as more
efficient space utilization of the Company's facilities in 1999. The increase in
general and administrative costs in absolute dollars was primarily attributable
to an increase in general and administrative personnel. General and
administrative employees, which include contractors and employees working over
20 hours per week, increased to 57 at March 31, 1999 from 50 at March 31, 1998.
OTHER INCOME, NET
Other income, net consists primarily of interest income from the Company's cash,
cash equivalents, and short-term investment balances and interest expense
associated with fixed asset purchases made under the Company's equipment line of
credit and obligations under capital leases and bank loans. Other income, net
was $0.4 million and $0.1 million for the periods ended March 31, 1999 and 1998,
respectively. The increase in other income, net was principally due to the
increase in cash, cash equivalents, and short-term investments, which included
net proceeds from the Company's initial public offering in the second quarter of
1998. The Company invests its cash, cash equivalents, and short-term investments
primarily in overnight repurchase agreements, short-term U.S.
Treasury and Agency bonds, and short-term commercial paper.
PROVISION FOR INCOME TAXES
The Company's effective rate for federal and state income taxes was 37% and 42%
for the periods ended March 31, 1999 and 1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Prior to its initial public offering, the Company met its working capital
requirements through cash generated from operations. In June 1998, the Company
completed its initial public offering of common stock resulting in net proceeds
to the Company of approximately $27.9 million. The Company also maintains a $5.0
million revolving line of credit (the "Line") with Silicon Valley Bank, which
expires in September 1999. Under the Line, the Company may borrow the lesser of
$5.0 million or 75% of eligible accounts receivable, as defined in the loan
agreement. The Company is required to comply with certain operational and
financial covenants under the Line if there are borrowings under the Line. At
March 31, 1999 the Company was in compliance with these requirements and no
borrowings have been made under the Line.
In May 1998, Conduit entered into a loan agreement with a major financial
institution for $1.4 million for the purchase of a building currently occupied
by Conduit. The principal balance is payable over 12 years in quarterly
installments and bears interest at LIBOR +2% (8.18% at December 31, 1998). These
quarterly installments increase throughout the term of the loan. The Company is
required to comply with certain financial covenants under this loan agreement.
At March 31, 1999, the Company was in compliance with these requirements. At
March 31, 1999, $1.4 million was outstanding under the loan agreement which is
collateralized by the building.
The Company's cash and cash equivalents balances decreased to $32.4 million at
March 31, 1999 from $36.0 million at December 31, 1998. The decrease in cash was
primarily due to cash used in operations. The Company's working capital was
$42.2 million at March 31, 1999 as compared to $39.3 million at December 31,
1998.
The Company's operating activities used cash from operations of $6.4 million for
the period ended March 31, 1999 as compared to $0.9 million for the comparable
period in 1998. The increase in cash used in operations was due principally to
an increase in accounts receivable of $5.3 million as compared to the comparable
period in 1998, an increase in unbilled revenues of $1.2 million as compared to
the comparable period in 1998, and a decrease in accrued expenses of $1.7
million as compared to the comparable period in 1998. The increases in cash used
in operations for the period ended March 31, 1999 as compared to the period
ended March 31, 1998 were partially offset by a decrease in deferred revenues of
$1.8 million from the prior year period and an increase in net income of $1.2
million from the prior year period. The increase in accounts receivable and
unbilled revenues and the decrease in deferred revenues from December 31, 1998
to March 31, 1999 resulted from the timing of milestone billings on some of the
Company's large fixed-price contracts and billings from a number of new
engagements that were started near the end of the first quarter of 1999.
The Company's investing activities provided cash of $2.3 million for the period
ended March 31, 1999 as compared to having used cash of $0.5 million in the
comparable period of 1998. Cash provided by investing activities during the
period ended March 31, 1999 consisted of maturities of short-term investments
and was partially offset by purchases of short-term investments and purchases of
property and equipment used to support the growing base of employees. Cash used
for investing activities during the period ended March 31, 1998 consisted of
purchases of property and equipment.
The Company's financing activities provided cash of $0.5 million for the period
ended March 31, 1999 which mainly represents the proceeds from the exercise of
stock options.
<PAGE> 4
YEAR 2000
In the past, many information technology products were designed with two digit
year codes that did not recognize century and millennium fields. As a result,
these hardware and software products may not function or may give incorrect
results with respect to dates after December 31, 1999. This problem is generally
referred to as the "Year 2000" problem or issue. Substantially every company in
the computer or information technology industries, as well as every company
which relies on computer systems or which utilizes products which include
embedded technology face the Year 2000 issue.
The Company is completing the process of assessing its exposure to the Year 2000
problem. Generally, the Company is assessing its Year 2000 exposure in four
major areas: (i) problems arising from systems previously developed for
customers; (ii) delays in existing projects by the Company's customers as they
shift internal resources to complete their Year 2000 mitigation, and delays in
the purchasing patterns of clients and potential clients with respect to new
projects; (iii) Year 2000 problems faced by the Company's material suppliers
which could have an impact on the Company's business, results of operations or
financial condition; and (iv) Year 2000 problems existent in the Company's
internal information technology ("IT") systems and non-IT systems.
The Company has completed the assessment of systems previously developed for
customers and believes that they are Year 2000 compliant. However, there can be
no assurances that the Company's systems do not contain undetected errors or
defects associated with Year 2000 compliance issues, or that third party
software included in the systems developed by the Company do not contain Year
2000 problems. Certain of the Company's agreements with its customers contain
warranties that the systems developed by the Company will not experience Year
2000 problems. To the extent that a problem arises, the Company may be required
to expend funds to remedy the problem or, if asserted, to pay damages incurred
by the customer as a result of such failure. In addition, to the extent that a
Year 2000 problem is identified in a system developed under a contract without a
Year 2000 warranty, the Company may nevertheless expend resources to remedy the
problem, in certain circumstances, at its own cost. Although the Company's
contracts with its customers generally contain provisions which seek to insulate
the Company from, or limit the amount of, any liability arising from claims
asserted against the Company, there can be no assurance that any such
limitations would be upheld in favor of the Company. The Company is aware of a
growing number of lawsuits against other providers of IT services. Because of
the unprecedented nature of such litigation, it is uncertain to what extent the
Company may be affected by such litigation. Due to the complexity of the Year
2000 issue, upon any failure of critical client systems or processes that may be
directly or indirectly connected or related to systems or software designed,
developed, customized, or implemented by the Company as described above, the
Company may be subjected to claims regardless of whether the failure is related
to the services provided by the Company. If asserted, such claims (including the
associated defense costs) could have a material adverse effect on the Company's
business, operating results, and financial condition.
The Company is continually monitoring its major customers to determine their
Year 2000 readiness and the likelihood that the customers will delay scheduled
or in-process contracts, or defer future contracts with the Company, in order to
allocate more IT resources to solving their Year 2000 problems. In addition, the
Company continually seeks feedback from its salespersons as to the impact that
the Year 2000 readiness of prospective customers may have on the Company's
future revenues. There can be no assurance that the Company's customers and
prospective customers will not delay scheduled, in-process, or future projects
as a result of their own Year 2000 remediation efforts. Any such delays could
have a material adverse impact on the Company's business, operating results, and
financial condition.
The Company has completed the process of determining the nature and extent of
the work required, if any, to make its internal IT systems Year 2000 compliant.
The Company's internal IT systems consist principally of its accounting and
human resources software. The licensor of the software has indicated to the
Company in writing that the products are Year 2000 compliant. Based on currently
available information, the Company believes the expense associated with making
its internal IT systems Year 2000 compliant will be immaterial and has provided
for the enhancement of these systems in its operating and capital budgets for
the current fiscal year. However, if Year 2000 issues of which the Company is
not currently aware arise and are not remediated on time, or if the Company is
required to pay for any required updating, modification or replacement of the
Company's information systems, the Year 2000 issue could have a material adverse
impact on the Company's business, operating results, and financial condition.
The Company has also completed the assessment of its utilization of non-IT
systems which contain embedded technology such as microcontrollers. Based upon
currently available information, the Company believes the expense associated
with making its non-IT systems Year 2000 compliant will be immaterial and has
provided for the enhancement of these systems in its operating and capital
budgets for the current fiscal year. In addition to the Company's internal
systems, the Company relies on third party vendors in the conduct of its
business. The Company has received assurances from its material vendors and
suppliers that there will be no interruption of service as a result of the Year
2000 issue. However, there can be no assurance that we will not experience
interruptions of service due to the Year 2000 issue resulting in a material
adverse effect on the Company. In addition, the failure on the part of the
accounting systems of
<PAGE> 5
the Company's clients due to the Year 2000 issue could result in a delay in the
payment of invoices issued by the Company for services and expenses. A failure
of the accounting systems of a significant number of the Company's clients would
have a material adverse effect on the Company.
Through March 31, 1999, the Company had not incurred material costs directly
relating to the remediation of Year 2000 problems. Pending further progress in
its assessment of its exposure to the Year 2000 problem, as described in the
preceding paragraphs, the Company is unable to estimate the costs of remediating
the Year 2000 problem that it may incur in the future.
The Securities and Exchange Commission has asked publicly-traded companies to
include a reasonable description of their most reasonably likely worst case Year
2000 scenario. As of the date of this report, the Company is uncertain as to
such scenario, although the Company believes that it may include a situation
where one of the Company's significant clients asks the Company to delay or stop
work on an ongoing project due to the client's internal Year 2000 issues. The
Company intends to address this uncertainty by continuing to assess its exposure
to the Year 2000 problem, as described above. The Company intends to consider
this scenario in its financial and strategic planning for 1999 and 2000,
including in its projected personnel needs and other areas. As of March 31,
1999, the Company is not able to estimate revenue lost due to Year 2000 issues.
The Company has not yet established a contingency plan for addressing the most
reasonably likely worst case Year 2000 scenario. The Company intends to
establish such a plan to the extent the Company believes it necessary to do so,
based on the impact that such scenario is expected to have on the Company's
business, operating results, and financial condition.
SAFE HARBOR PROVISION
This Form 8-K includes forward-looking statements (statements that are not
historical facts) such as statements about future net revenues and profits,
capital expenditures, liquidity sources and needs, working capital needs,
increases in personnel and related costs, opening additional offices, general
and administrative expenses, sales and marketing expenses, issues arising out of
the Year 2000 problem and other costs, in qualitative terms, as a percentage of
net revenues, and in qualitative terms. These forward-looking statements are
subject to several risks and uncertainties and the Company's actual future
results may differ significantly from those stated in any forward looking
statements for a variety of reasons, including those set forth below in "Certain
Factors That May Affect Future Results". The Company makes no commitments to
disclose any revisions to forward-looking statements, or any facts, events or
circumstances that may occur after the date of this Form 8-K that may have an
impact on the forward-looking statements.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
The following important factors, among others, could cause actual results to
differ materially from those indicated in forward-looking statements made in
this Form 8-K and presented elsewhere by management from time to time.
The Company has entered into a Merger Agreement with Razorfish, Inc. and a
subsidiary of Razorfish, Inc., pursuant to which, subject to the terms and
conditions of the Merger Agreement, the Company would become a wholly-owned
subsidiary of Razorfish. There can be no assurance that the Merger will be
consummated. If the Merger is not consummated, there can be no assurance that
the Company's results of operations and financial condition will not have been
adversely affected by the Merger negotiations or the announcement of the
Merger, by the passage of time following the signing of the Merger Agreement,
or by other factors. If the Merger is consummated, stockholders of the Company
will become stockholders of Razorfish, and as such will have the risks
associated with an investment in that company.
The Company has completed, and may in the future pursue, acquisitions of
companies, technologies or assets that complement the Company's business. The
successful integration of acquired companies, technologies and assets,
including Conduit and T3, is important to the future financial performance of
the Company. The anticipated benefits of such acquisitions may not be achieved
unless, among other things, the operations of acquired companies, technologies
and assets, are successfully combined with those of the Company in a timely
manner. The diversion of the attention of management, and any difficulties
encountered in the transition process, could have an adverse impact on the
revenues and operating results of the combined enterprise. There can be no
assurance that the Company will be able to successfully integrate such
acquisitions into the operations of the Company.
The Company's results of operations have varied significantly in the past and
may vary significantly in the future, on a quarterly and annual basis, as a
result of a variety of factors, many of which are outside the Company's control.
The Company's expense levels are based, in significant part, on anticipated
contract requirements and on other expectations of future revenues and are
relatively fixed in the short-term. Consequently, if revenue levels are below
expectations, including without limitation as a result of an unanticipated delay
in or termination of a customer engagement, expense levels could be
disproportionately high as a percentage of net revenues, and the Company's
business, financial condition, and results of operations would be materially
adversely affected.
The Company has historically derived, and may in the future derive, a
significant amount of its net revenues from major engagements with a relatively
small number of customers. Although the Company's largest customers have varied
from period to period, the Company anticipates that its results of operations in
any given period will continue to depend to a significant extent upon large
contracts with a small number of customers. The loss of or a reduction in the
level of services provided to one or more major customers would have a material
adverse effect on the Company's business, financial condition, and results of
operations. Furthermore, if a major customer were unable or unwilling to proceed
with a project or to pay the Company for its services on a timely basis, the
Company's business, financial condition, and results of operations could be
materially adversely affected.
Many of the Company's projects are large, complex engagements that are performed
by the Company over extended periods of time. The Company is generally paid for
these projects in installments, based on the achievement of certain milestones.
The Company's ability to successfully complete these projects and to earn the
milestone payments is based on factors within and outside the Company's control.
Furthermore, because of the significant numbers of IT professionals assigned by
the Company to these large projects, unexpected early terminations of any of
such engagements could result in underutilization of project personnel until
such persons can be redeployed to other projects. Conversely, an unexpected
delay in the completion of a major engagement could result in
<PAGE> 6
a delay in the redeployment of project personnel to new assignments for which
the Company is contractually committed to achieve milestones on a timely basis.
The Company's failure or inability to meet a customer's expectations in the
performance of its services could give rise to claims against the Company or
damage the Company's reputation and adversely affect its ability to attract new
business.
The Company generally undertakes projects on a fixed-time/fixed-price basis, and
warrants defined project deliverables as specified in mutually agreed upon
statements of work. In making proposals for fixed-time/fixed-price contracts,
the Company relies on its estimated costs and timing for completing the project.
Any increased or unexpected costs or unanticipated delays in connection with the
performance of fixed-time/fixed-price contracts, including delays caused by
factors outside the Company's control, could affect the profitability of these
contracts and have a material adverse effect on the Company's business,
financial condition, and results of operations.
The Company's business, financial condition, and results of operations may be
adversely affected by the Year 2000 problems described above.
The Company has experienced growth in net revenues and expansion of its
operations which have placed, and are expected to continue to place, significant
demands on the Company's managerial, operational, and financial resources. If
the Company's management is unable to manage growth effectively, the Company's
business, financial condition, and results of operations would be materially
adversely affected.
The Company's success depends to a significant extent on its ability to attract,
train, motivate, and retain highly-skilled IT professionals, particularly
project managers, software engineers, and other senior technical personnel.
There is currently a shortage of, and significant competition for, software
development and other IT professionals with the advanced technological skills
necessary to perform the services offered by the Company. This shortage has
caused wages for such professionals to increase, which increases operating costs
to IT service providers such as the Company. An inability to hire a sufficient
number of qualified employees or an inability to retain employees could have a
material adverse effect on the Company's business, financial condition, and
results of operations. In addition, even if the Company is able to expand its
team of highly-skilled IT professionals, the resources required to attract and
retain such employees may adversely affect the Company's operating margins.
The time between the date of initial contact with a potential customer and the
execution of a contract with that customer is often lengthy, typically ranging
from six weeks for smaller engagements to nine months or more for the Company's
larger engagements, and is subject to delays over which the Company has little
or no control, including customers' budgetary constraints, customers' internal
acceptance reviews, the success and continued internal support of customers' own
development efforts, and the possibility of cancellation or delay of projects by
customers. During such sales cycle, the Company may expend substantial funds and
management resources and yet not obtain project awards or revenues.
The Company's success may depend on its ability to make strategic acquisitions
from time to time. The competition to acquire appropriate companies is fierce,
with the result that the acquisition prices for these Companies may be high. In
addition, the high stock prices of publicly traded technology companies, that
are comparables for companies the Company may wish to acquire, have further
driven up the prices of potential acquisition candidates. As a result, there can
be no assurances that the Company will be able to make strategic acquisitions at
favorable prices, if at all.
The market for the Company's services is characterized by innovation and rapid
technological change, evolving industry standards, and changing customer
preferences. Both the needs of potential customers and the technologies
available for meeting those needs can change significantly within a short period
of time. The Company has derived a significant portion of its revenues from
projects based primarily on client/server architectures. These technologies are
continuing to develop and are subject to rapid change. Any factors negatively
affecting the acceptance of such technologies could have a material adverse
effect on the Company's business, financial condition, and results of
operations.
The Company's future will depend, in part, on its ability to continually enhance
its services, to develop services that address the needs of its customers and
potential customers, and to continue to improve its i-Structure methodologies
and technologies. There can be no assurance that the Company will be successful
in developing and marketing services that respond to technological changes, that
the Company will enhance its i-Structure methodologies and technologies on a
timely or cost-effective basis, or that the Company's services, methodologies,
and technologies will adequately meet the requirements of the marketplace.
The Company's future success depends to a significant extent on its executive
officers. The loss of the services of any one or more of these individuals could
have a material adverse effect on the Company's business, financial condition,
and results of operations.
<PAGE> 7
The Company operates in a highly competitive and rapidly changing market and
competes with a variety of organizations that offer services similar to those
offered by the Company. Many of these competitors have significantly greater
financial, technical, sales and marketing resources and greater name recognition
than the Company. There can be no assurance that the Company will be able to
continue to compete successfully with its existing competitors or that it will
be able to compete successfully with new competitors.
The Company's success and its ability to compete is dependent, in part, upon its
proprietary rights, including its rights in i-Structure methodologies and
technologies. The Company relies primarily on a combination of copyright,
trademark, and trade secret laws to establish and protect its proprietary
rights. There can be no assurance that such measures will be adequate to protect
the Company's proprietary rights. Although the Company believes that its
services and technologies do not infringe the intellectual property rights of
others, there can be no assurance that infringement claims will not be asserted
against the Company in the future.
The Company's agreements with its customers typically contain provisions
designed to limit the Company's exposure to claims relating to the Company's
professional services and the applications developed by it. However, it is
possible that the limitation of liability provisions contained in the Company's
agreements may not adequately protect the Company or be effective under the laws
of certain jurisdictions. A liability claim brought against the Company could
have a material adverse effect on the Company's business, financial condition,
and results of operations.
Software applications as complex as those developed by the Company frequently
contain errors or defects, especially when first implemented. Any such defects
or errors could result in delayed or lost revenues, adverse customer reaction,
negative publicity regarding the Company and its services, and harm to the
Company's reputation, or could require expensive corrections, any of which could
have a material adverse effect on the Company's business, financial condition,
and results of operations.
The Company is subject to a number of risks that can adversely affect its
international operations, including difficulties administering its business
globally, managing foreign operations, currency fluctuations, restrictions
against the repatriation of earnings, the burdens of complying with a wide
variety of foreign laws, the uncertainty of laws and enforcement in certain
jurisdictions relating to the protection of intellectual property rights and
multiple and possibly overlapping tax structures.
