<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the quarterly period ended September 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from _________________ to ________________
Commission File No. 0-24833
FUTURELINK CORP.
--------------------------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
Delaware 95-4763404
--------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2 South Pointe Drive, Lake Forest , CA 92630
--------------------------------------------------------------------------------
(Address of principal executive offices)
(949) 672-3000
--------------------------------------------------------------------------------
(Issuer's telephone number)
6 Morgan, Suite 100
Irvine, CA 92618
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(Former name, former address and former fiscal year,
if changed since last report)
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: as of October 31, 2000, 68,104,789
shares of the issuer's common stock, par value $.0001 per share, were
outstanding.
--------------------
Transitional Small Business Disclosure Format (check one): Yes No X
---- ---
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FUTURELINK CORP.
INDEX TO QUARTERLY REPORT ON FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of September 30, 2000
(unaudited) and December 31, 1999................................. 4
Condensed Consolidated Statements of Operations for the three
and nine month periods ended September 30, 1999 and 2000
(unaudited)....................................................... 5
Condensed Consolidated Statements of Cash Flows for the nine
month periods ended September 30, 1999 and 2000 (unaudited)....... 6
Notes to Condensed Consolidated Financial Statements ............. 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS ....... 13
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES............................................. 27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.................................. 29
SIGNATURES ............................................................... 30
2
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FORWARD LOOKING INFORMATION
This Quarterly Report on Form 10-QSB contains forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended, and Section 27A of the Securities Act of 1933, as amended,
reflecting management's current expectations. Examples of such forward-looking
statements include the expectations of the Company with respect to its strategy.
Although the Company believes that its expectations are based upon reasonable
assumptions, there can be no assurances that the Company's financial goals will
be realized. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Numerous factors may affect the Company's
actual results and may cause results to differ materially from those expressed
in forward-looking statements made by or on behalf of the Company. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words, "believes," "anticipates," "plans," "expects" and similar
expressions are intended to identify forward-looking statements. Additionally,
statements concerning future matters such as the development of new products,
enhancements or technologies, possible changes in legislation and other
statements regarding matters that are not historical facts are forward-looking
statements. The important factors discussed in Part I, Item 2, "Management's
Discussion and Analysis or Plan of Operations - Factors That May Affect Future
Results", herein, among others, could cause actual results to differ materially
from those indicated by forward-looking statements made herein and presented
elsewhere by management. Such forward-looking statements represent management's
current expectations and are inherently uncertain. Investors are warned that
actual results may differ from management's expectations. The Company assumes no
obligation to update the forward-looking information to reflect actual results
or changes in the factors affecting such forward-looking information.
3
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PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
FUTURELINK CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 21,877 $ 19,185
Restricted cash 562 3,099
Accounts receivable, net 25,309 14,284
Inventory 5,018 4,964
Prepaid expenses and other current assets 2,791 536
--------- ---------
Total current assets 55,557 42,068
Property and equipment, net 29,108 10,972
Goodwill and other intangibles, net 254,112 186,866
Deferred offering and acquisition costs -- 543
Other assets 950 229
--------- ---------
Total assets $ 339,727 $ 240,678
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit $ 5,464 $ 1,657
Accounts payable and accrued liabilities 28,417 15,811
Settlement payable -- 5,000
Current portion of long-term debt 6,875 8,554
Deferred revenue 1,380 1,330
--------- ---------
Total current liabilities 42,136 32,352
Long term debt, net of current portion 11,764 4,116
Convertible debentures, net -- 874
Deferred taxes 588 588
--------- ---------
Total liabilities 54,488 37,930
Stockholders' equity:
Preferred stock, no par value; 20,000,000 shares
authorized; 2,571,428 shares of Series A Preferred
Stock authorized and 1,428,571 shares of Series A
Preferred Stock, issued and outstanding at
September 30, 2000 3,394 --
Common stock, $0.0001 par value, 300,000,000 shares
authorized,68,104,789 and 52,743,169, issued and
outstanding at September 30, 2000 and December 31,
1999, respectively 8 7
Common stock issuable; 2,199,965 and 1,639,850 shares
at September 30, 2000 and December 31, 1999,
respectively 16,369 42,636
Additional paid-in capital 393,369 146,150
Warrants -- 60,000
Deferred compensation (1,752) (1,393)
Loan receivable from officer -- (1,500)
Accumulated other comprehensive loss (1,127) (77)
Accumulated deficit (125,022) (43,075)
--------- ---------
Total stockholders' equity 285,239 202,748
--------- ---------
Total liabilities and stockholders' equity $ 339,727 $ 240,678
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
4
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FUTURELINK CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2000 1999 2000 1999
------------ ----------- ------------ -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenue:
Hardware and software $ 23,867 $ 576 $ 66,043 $ 1,460
Service delivery 11,282 1,006 25,321 3,577
------------ ----------- ------------ -----------
35,149 1,582 91,364 5,037
Expenses:
Cost of hardware and software 20,306 511 55,009 1,333
Cost of service delivery 7,732 2,237 17,546 5,460
Selling, general and administration 18,623 3,655 51,428 6,627
Goodwill amortization 15,620 461 42,071 1,421
Depreciation and other amortization 2,152 172 5,393 522
------------ ----------- ------------ -----------
64,433 7,036 171,447 15,363
------------ ----------- ------------ -----------
Loss from operations (29,284) (5,454) (80,083) (10,326)
Interest expense 825 2,341 2,057 11,214
Interest income (367) (59) (701) (59)
------------ ----------- ------------ -----------
Loss before income taxes and extraordinary item (29,742) (7,736) (81,439) (21,481)
Provision (benefit) for income taxes 2 (119) 27 (357)
------------ ----------- ------------ -----------
Loss before extraordinary item (29,744) (7,617) (81,466) (21,124)
Extraordinary item -- -- -- (845)
------------ ----------- ------------ -----------
Net loss (29,744) (7,617) (81,466) (21,969)
Other Comprehensive Income/(Loss)
Foreign currency translation adjustment (308) (27) (1,050) 87
------------ ----------- ------------ -----------
Comprehensive loss $ (30,052) $ (7,617) $ (82,516) $ (21,882)
============ =========== ============ ===========
Net loss before Series A Preferred Stock dividends (29,744) (7,617) (81,466) (21,969)
Dividends for Series A Preferred Stock (437) -- (437) --
------------ ----------- ------------ -----------
Net loss applicable to common stock (30,181) (7,617) (81,903) (21,969)
============ =========== ============ ===========
Basic and diluted loss per common share $ (0.43) $ (1.00) $ (1.32) $ (3.36)
============ =========== ============ ===========
Weighted average shares -- basic and diluted 69,737,487 7,594,083 62,054,083 6,534,575
============ =========== ============ ===========
</TABLE>
See notes to condensed consolidated financial statements.
5
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FUTURELINK CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------
2000 1999
---------- ---------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (81,466) $(21,968)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 47,464 1,943
Loss on sale of assets 106 --
Deferred income taxes -- (357)
Extinguishment of debt -- 433
Amortization of deferred compensation 1,899 250
Amortization of finance fees -- 3,335
Common stock, warrants and options issued for services 250 1,144
Non-cash interest expense -- 6,903
Change in operating assets and liabilities,
net of effect of business acquisitions:
Accounts receivable (1,686) (298)
Inventory 1,479 (47)
Prepaid expenses and other current assets (2,067) (94)
Deferred offering and acquisition costs 543 --
Other assets (598) (58)
Accounts payable and accrued expenses 3,781 (881)
Settlement payable (5,000) --
Other current liabilities -- 552
Deferred revenue (733) --
--------- --------
NET CASH USED IN OPERATING ACTIVITIES (36,028) (9,143)
--------- --------
INVESTING ACTIVITIES
Purchases of property and equipment (5,380) (1,863)
Business acquisitions, net of cash balances acquired (18,100) (3,304)
Repayment of acquisition notes (18,356) --
Decrease in restricted cash 2,537 --
--------- --------
NET CASH USED IN INVESTING ACTIVITIES (39,299) (5,167)
--------- --------
FINANCING ACTIVITIES
Net cash advanced (paid) under lines of credit 307 (819)
Proceeds from issuance of common shares, net 52,280 (5)
Proceeds from issuance of preferred shares, net 10,000 --
Proceeds from exercise of employee stock options 1,762 100
Proceeds from exercise of warrants 18,108 65
Repayment of capital lease obligation (3,215) (68)
Issuance of convertible debentures, net of costs -- 24,771
Exchange of shares in settlement of employee advance (129) --
Repayment of convertible debentures and promissory notes -- (1,839)
--------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 79,113 22,205
--------- --------
Effect of currency rate changes (1,094) (87)
--------- --------
Increase in cash 2,692 7,808
Cash at beginning of period 19,185 7
--------- --------
CASH AT END OF PERIOD $ 21,877 $ 7,815
========= ========
NON-CASH INVESTING AND FINANCING ACTIVITIES
Acquisition of businesses:
Assets acquired $ 120,852 $ 42
Liabilities assumed 11,462 --
Notes payable issued 11,671 --
Common stock and options issued 79,619 42
--------- --------
Cash paid for acquisitions 18,100 --
Capital lease obligations 15,567 66
Conversion of convertible debt to equity 874 4,455
</TABLE>
See notes to condensed consolidated financial statements.
6
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FUTURELINK CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE-MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
reflect the results of operations for FutureLink Corp. (the "Company")and its
wholly owned subsidiaries and have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-QSB and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals and
adjustments) considered necessary for a fair presentation have been included.
Operating results for the three-month and nine-month periods ended September 30,
2000 are not necessarily indicative of the results that may be expected for the
year ended December 31, 2000. For further information, refer to the consolidated
financial statements and footnotes thereto included in Annual Report on Form
10-KSB for the year ended December 31, 1999 filed with the Securities and
Exchange Commission (SEC) on March 30, 2000. Current and future financial
statements may not be directly comparable to the Company's historical financial
statements.
The Company is a Delaware corporation headquartered in Lake Forest,
California. The Company is an application services provider, or ASP, and is in
the business of corporate ASP integration (previously known as server-based
computing). The Company's services enable software applications to be deployed,
managed, supported and upgraded from centrally located servers, rather than on
individual desktop computers. For its corporate ASP integration business, the
Company installs and integrates software applications on customers' servers. For
its ASP customers, the Company hosts software applications on servers at data
centers, and rents computing services to customers for a monthly fee. The
Company also provides remote management and maintenance of customers' servers
from its network operation centers. ASP customers connect to facilities over the
Internet, through a dedicated telecommunications line or by wireless connection.
The Company introduced its ASP services in March 1999.
The Company has experienced net losses over the past two years and has
an accumulated deficit of approximately $125.0 million at September 30, 2000.
Such losses are attributable to cash losses resulting from costs incurred in the
development of the Company's services and infrastructure, interest expense and
non-cash charges. The Company expects operating losses to continue for the
foreseeable future as it continues to develop and promote its services.
NOTE 2. ACQUISITIONS
Vertical Software, Inc.
On January 31, 2000, the Company acquired Vertical Software, Inc.
("VSI"), a U.S. mid-Atlantic regional provider of system integration and
information technology services. To complete the acquisition, VSI was merged
with a subsidiary of the Company such that all of VSI's outstanding stock was
sold to the Company in exchange for consideration of $27.6 million consisting of
$8.1 million cash and 1,026,316 common shares of the Company's common stock
valued at $19.5 million. The acquisition was accounted for by the purchase
method of accounting. The excess purchase price of $26.7 million over the
estimated fair value of net assets acquired was allocated to goodwill and is
being amortized over five years.
7
<PAGE> 8
MicroLAN Systems, Inc.
On February 29, 2000, the Company acquired MicroLAN Systems, Inc., that
was doing business as Madison Technology Group, Madison Consulting Resources,
Inc. and Madison Consulting Resources NJ, Inc. The companies were acquired for
total consideration of $57.5 million, consisting of $6.5 million cash, a note
payable in the amount of $7.3 million that was subsequently paid, and 1,975,170
shares of common stock valued at $43.7 million. The acquisition was accounted
for by the purchase method of accounting. In connection therewith, $12.4 million
of the purchase price was allocated to assembled workforce and is being
amortized over three years, and $45.2 million of the excess purchase price over
the estimated fair value of net assets acquired was allocated to goodwill and is
being amortized over five years.
Charon Systems Inc.
On June 19, 2000, the Company acquired Charon Systems Inc. ("Charon")
for total consideration of $21.5 million, consisting of $0.7 million cash, a
note payable in the amount of $4.4 million which was paid on July 11, 2000 and
exchangeable shares convertible into 2,199,965 shares of the Company's common
stock valued at $16.4 million. The acquisition was accounted for by the purchase
method of accounting. The excess purchase price of $20.7 million over the
estimated fair value of net assets acquired was allocated to goodwill and is
being amortized over five years.
Summary Pro Forma Results of Operations
The following pro forma results of operations give effect to all of the
Company's acquisitions in 2000 and 1999 as if the transactions had occurred on
January 1, 1999 (dollars in thousands):
Three Months Nine Months
Ended Ended
September 30, September 30,
----------------------- ------------------------
2000 1999 2000 1999
-------- -------- --------- --------
(Unaudited) (Unaudited)
Revenue........... $ 35,149 $ 34,982 $ 103,804 $ 78,792
Net loss.......... (29,744) (23,737) (89,096) (51,330)
Loss per share.... $ (0.43) $ (0.86) $ (1.37) $ (1.92)
8
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NOTE 3. GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangible assets are comprised of the following at
September 30, 2000 and December 31, 1999 (in thousands):
September 30, 2000 December 31, 1999
------------------ ------------------
(Unaudited)
Goodwill $287,010 $189,699
Assembled workforce 15,166 3,200
-------- --------
Total 302,176 192,899
Less accumulated amortization (48,064) (6,033)
-------- --------
Goodwill and other intangibles $254,112 $186,866
======== ========
NOTE 4. LINE OF CREDIT AGREEMENTS
The Company has a credit facility agreement with a bank that allows
borrowings up to a maximum of $10 million based upon the Company meeting certain
performance criteria. Borrowings under the credit agreement at September 30,
2000 were $4.3 million and the Company had utilized an additional $0.7 million
to secure an outstanding letter of credit. The facility bears interest at rates
that vary from prime (9.5% at September 30, 2000) plus 1% to prime plus 3% per
annum based upon the Company maintaining certain operating performance levels,
and is payable on demand. The facility is secured by receivables and other
assets of certain subsidiaries of the Company, and guarantees and a pledge of a
percentage of the shares of those subsidiaries. The agreement contains certain
financial and other covenants or restrictions, including the maintenance of
certain financial ratios, limitations on the incurrence of indebtedness and
restrictions on dividends paid by the Company. As of September 30, 2000, the
Company was either in compliance with all covenants, limitations and
restrictions or had obtained waivers thereto.
The Company maintains two additional lines of credit at other banks
that allow borrowings of $1.7 million, of which $1.2 million was borrowed at
September 30, 2000. The lines bear interest at various rates ranging from prime
plus 1% to prime plus 3% per annum, and mature at various dates through November
30, 2000. The lines are secured by certain working capital assets of the
Company's United Kingdom subsidiary and a certificate of deposit of $0.6 million
(reflected as restricted cash on the accompanying consolidated balance sheet at
September 30, 2000). On October 30, 2000, the Company paid off its $0.6 million
line and the certificate of deposit that was held as security by the bank was
returned.
9
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NOTE 5. LONG-TERM DEBT
Long-term debt consists of the following at September 30, 2000 and
December 31, 1999 (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------ -----------
(Unaudited)
<S> <C> <C>
Capital lease obligations, net of original issue
discount of $662 and $727, respectively ...... $ 18,639 $ 5,985
Notes payable to former KNS stockholders ....... -- 6,685
-------- --------
18,639 12,670
Less current portion of long-term debt ......... (6,875) (8,554)
-------- --------
Long-term debt ................................. $ 11,764 $ 4,116
======== ========
</TABLE>
Capital lease obligations are for the lease of up to $25.9 million of
computer hardware and related infrastructure costs. Aggregate monthly payments
are currently $758,000 and are based upon twenty-four to sixty month
amortization periods, including interest implicit in the leases at rates ranging
from 9% to 14% per annum. As of September 30, 2000, the Company had available
borrowings of $11.8 million under the various lease lines. In addition to the
lease payments, the Company issued to certain of the lessors warrants valued at
$833,000 to acquire 72,599 shares of common stock. The value of the warrants has
been reflected as a discount of the related debt, and is being amortized to
interest expense over the life of the debt.
Notes payable to former KNS stockholders consisted of a note of $2.7
million, which was paid in May 2000, and a note of $4.0 million, of which $1.0
million was paid in June 2000 and the remainder of the note was paid in July
2000.
NOTE 6. STOCKHOLDERS' EQUITY
Issuance of Common Stock and Warrants for Cash
On April 28, 2000, the Company completed a private placement of common
equity with institutional private equity investors for approximately $15
million. A total of 1,764,704 restricted shares of the Company's common stock
and warrants to purchase 441,176 shares of its common stock at an exercise price
of $9.25 per share were issued. The warrants expire at the end of April 2003.
In July 2000, the Company completed a public offering of 6,250,000
shares of its common stock at a price of $7 per share, resulting in net proceeds
of $37.4 million after deducting underwriting discounts and commissions and
offering costs.
Issuance of Preferred Stock and Warrants for Cash
On July 6, 2000, the Company sold to Microsoft Corporation, for
proceeds of $10 million, 1,428,571 shares of FutureLink Series A Redeemable
Convertible Preferred Stock ("Series A
10
<PAGE> 11
Preferred Stock") for a price of $7.00 per share. The Company also issued to
Microsoft a warrant with a five-year term to purchase up to an additional
1,142,857 shares of Series A Preferred Stock at an exercise price of $7.00 per
share. The shares of outstanding Series A Preferred Stock and the warrant to
purchase additional shares of Series A Preferred Stock are each subject to
provisions which provide anti-dilution protection. Each share of Series A
Preferred Stock is initially convertible into 1 share of common stock.
Additionally, each share of Series A Preferred Stock is entitled to a
preferential distribution on liquidation of the greater of $7.00 per share or
their pro rata value, as if converted into common stock, of the assets to be
distributed, a cumulative preference on dividends of $0.56 per annum and certain
redemption rights. Both of these preferential amounts are paid prior to any
payment to the holders of common stock. The Series A Preferred Stock is entitled
to vote on all matters presented to the holders of common stock as if the Series
A Preferred Stock were converted into common stock. Additionally, certain
actions which impact the rights of the holders of Series A Preferred Stock,
require a 2/3 approval of all holders of Series A Preferred Stock voting as a
class. In addition, Microsoft has the right to nominate one director for
election to FutureLink's Board of Directors.
Cumulative annual dividends at a rate of 8% per annum are payable in
cash or shares of the Company's Series A Preferred Stock in an amount to be
based on the then current market price of the Company's common stock. Subject to
the application of anti-dilution provisions, Microsoft shall have the right to
convert all or a portion of the Series A Preferred Stock into common stock of
the Company on a one-for-one basis. If at any time, the common stock of the
Company trades at or above $25.50 per share for twenty consecutive days, the
Series A Preferred Stock shall automatically convert to common stock. Upon any
such automatic conversion, any warrants that remain outstanding, shall become
warrants to acquire common stock. After four years, the Company will redeem the
Series A Preferred Stock for either (i) cash or (ii) if the Company's common
stock is traded on a national exchange, in shares of the Company's common stock,
at the Company's option, at a redemption price per share equal to the original
purchase price of the Series A Preferred Stock plus all unpaid dividends. It's
the Company's intent to redeem stock for shares of Company's common stock. The
value of the shares used for repayment shall be the average price of the
Company's common stock over the ten trading days prior to the redemption date,
but no lower than $5.50 per share.
Issuance of Common Stock upon Exercise of Warrants
During the nine months ended September 30, 2000, warrant holders
exercised their rights to acquire 2,704,223 shares of the Company's common stock
at an average effective price of $7.50 per share for aggregate net proceeds to
the Company of $18.2 million. The warrants had an adjusted (for anti-dilution)
conversion price of $8.40 per share and the holders of these warrants
effectively paid $7.50 per share after adjustment for a warrant exercise fee of
$0.90 for each warrant.
Issuance of Common Stock upon Conversion of Convertible Debt
On March 30, 2000, certain holders of convertible notes converted
approximately $217,000 of debt and accrued interest thereon into 189,160 shares
of common stock. On August 30, 2000, these note holders converted their
remaining notes in the aggregate amount of $94,000 into 81,558 shares of the
Company's common stock.
11
<PAGE> 12
On April 29, 2000, certain holders of convertible debt converted
$621,000 of debt and accrued interest thereon into 676,408 shares of the
Company's common stock in accordance with the terms contained in the convertible
debt agreement. The Company incurred approximately $96,000 of costs in
connection with the conversion.
Issuance and Exercise of Stock Options
On May 26, 2000, Glen Holmes, the Company's President and Chief
Operating Officer and one of its directors, granted to the Company an option to
purchase 600,000 shares of the Company's common stock at $5.50 per share, the
fair market value at the date of grant. The Company may only exercise this
option to the extent employees to whom the Company granted reciprocal options
exercise those options. On the same date, Mr. Holmes also granted to two of the
Company's employees options to purchase 2,400,000 shares of the Company's common
stock at $5.50 per share, the fair market value at the date of grant. The
options were granted covering shares personally owned by Mr. Holmes to employees
who were formerly employed at Executive LAN Management, Inc.
During the nine months ended September 30, 2000, the Company recorded
approximately $2.3 million in deferred compensation representing the difference
between the exercise price of certain of the Company's stock options and
warrants that were granted during the period and the fair market value of the
underlying common stock. Such amount has been presented as a reduction to
stockholders' equity and is being amortized ratably over the vesting period of
the applicable options. The Company amortized an aggregate of $1.9 million of
deferred compensation during the nine months ended September 30, 2000.
Loan Receivable from Officer
On August 1, 1999, the Company loaned $2.0 million to an executive with
recourse, which was then used by the executive to purchase 232,829 common shares
of the Company. The loan receivable was recorded as a reduction of stockholders'
equity and $250,000 of the principal amount of the loan was to be forgiven on a
quarterly basis. The shares were deposited in escrow, to be released on
quarterly basis commencing January 1, 2000. During the nine months ended
September 30, 2000, the Company recognized $250,000 as salary expense relating
to the services received from such executive in relation to the loan agreement.
On June 30, 2000 the Company and the executive terminated the loan agreement and
canceled the issuance of any further shares. Through June 30, 2000, the Company
released 87,349 of the escrowed shares to the executive. In addition, the
employee returned 14,212 of these shares to the Company valued at the then
current market price of $129,000 in settlement of an advance made to the
executive.
12
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN 0F OPERATIONS
We are an application services provider, or ASP, and is in the business
of corporate ASP integration. Our services enable software applications to be
deployed, managed, supported and upgraded from centrally located servers, rather
than on individual desktop computers. For our ASP integration customers, we
install and integrate software applications on our customers' servers. For our
ASP customers, we host software applications on our servers at our data centers,
and rent computing services to our customers for a monthly fee. The Company also
provides remote management and maintenance of customers' servers from our
network operation centers. Our ASP customers connect to our facilities over the
Internet, through a dedicated telecommunications line or by wireless connection.
Our goal is to provide our ASP services with the speed, simplicity and
reliability of a utility service.
We introduced our ASP services in March 1999 and launched our sales
program for ASP services in July 1999. Since then, we have built our
server-based computing business through seven acquisitions that we closed
between October 15, 1999, and June 19, 2000, as follows:
- On October 15, 1999, we acquired Executive LAN Management, Inc. for
total consideration of $86.0 million.
- On November 5, 1999, we acquired CN Networks, Inc. for total
consideration of $19.9 million.
- On November 26, 1999, we acquired Async Technologies, Inc. for total
consideration of $35.0 million.
- On December 22, 1999, we acquired KNS Holdings Limited, for total
consideration of $44.0 million.
- On January 31, 2000, we acquired Vertical Software, Inc. for total
consideration of $27.6 million.
- On February 29, 2000, we acquired MicroLAN Systems, Inc., doing
business as Madison Technology Group, Madison Consulting Resources,
Inc. and Madison Consulting Resources N.J., Inc. for total
consideration of $57.5 million.
- On June 19, 2000, we acquired Charon Systems Inc. for total
consideration of $21.5 million.
Our acquisitions reflect our strategy to rapidly expand our market
penetration and our ability to deliver ASP services. All of the companies we
have acquired to date offer their customers information technology services,
specializing in server-based applications relying on software from Citrix
Systems, Inc. The Citrix Systems software interacts with Windows NT Terminal
Server software from Microsoft, the same software used by us to run our ASP
servers. The acquisitions have allowed us to enter other major markets through
an established market participant, with local sales and marketing teams now able
to offer both server-based integration and outsourcing services and ASP, while
allowing us to leverage the talents of additional technical staff to deliver ASP
as well as the more traditional server-based computing solutions to a wider
range of clients.
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The acquisitions resulted in approximately $302 million of purchase
price in excess of net assets acquired that we have allocated to goodwill and
assembled workforce. We believe that we will be able to realize the value of the
goodwill acquired through the overall expansion of our ASP business based on our
strategic business plan. We will periodically evaluate the goodwill based upon
the future undiscounted cash flows using the forecasts in our strategic business
plan. If our estimate of future undiscounted cash flows should change or our
strategic business plan is not achieved, future analyses may indicate
insufficient future undiscounted cash flows to recover the carrying value of the
goodwill, in which case the goodwill would be written down to fair value.
Our historical financial statements for the three and nine month
periods ended September 30, 1999 reflect FutureLink's historical Canadian
business and Canadian ASP operations and do not reflect any United States ASP
integration or ASP business until the effective dates of the acquisitions listed
previously. These acquired businesses now represent a significant portion of our
revenue, operations and employees.
Our discussion of operations for the three and nine month periods ended
September 30, 2000 and 1999 focuses on activities in each respective period
because our significant acquisition activity in late 1999 and 2000 distorts
period to period comparisons.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
Revenue
The components of our revenue for the three months ended September 30,
2000 and 1999 were as follows (in millions):
September 30,
------------------
2000 1999
----- -----
Sale of hardware and software........................ $23.9 $ 0.6
Service delivery..................................... 11.2 1.0
----- -----
Total............................................. $35.1 $ 1.6
===== =====
Revenue for the three months ended September 30, 2000 consisted of
$11.2 million of information technology outsourcing revenue, a portion of which
related to delivery of ASP services. The purchase and resale of hardware and
software to our customers accounted for $23.9 million of revenue for the three
months ended September 30, 2000.
Revenue for the three months ended September 30, 1999 consisted of $1.0
million of information technology outsourcing revenue, a portion of which
related to delivery of ASP services. The resale of hardware and software to our
customers accounted for $0.6 million of revenue for the three months ended
September 30, 1999.
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<PAGE> 15
Cost of Goods Sold
Cost of goods sold reflects costs of hardware and software purchased
for resale to customers. Cost of goods sold for the three months ended September
30, 2000 was $20.3 million, or 85 % of hardware and software sales.
Our cost of goods sold for the three months ended September 30, 1999
was $0.5 million, or 83 % of related hardware and software sales.
Cost of Service Delivery
Our cost of service delivery for the three months ended September 30,
2000 was $7.7 million, or 68% of service delivery revenue. Our cost of service
delivery reflects payroll and benefit costs for our outsourcing consultants who
support the information technology activities of our clients, and payroll,
benefit, and operational costs related to testing and operating our data centers
and installing and supporting software applications related to our ASP and
information technology outsourcing businesses.
Our cost of service delivery for the three months ended September 30,
1999 was $2.2 million, or 220 % of service delivery revenue. This includes
amounts related to the cost of service delivery of information technology
outsourcing and the direct cost related to the development of our ASP services,
including operating a "beta test" data center for early customers.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses include travel,
payroll, advertising and marketing expenses to secure customers and to develop
business partnerships, as well as for meeting and developing relationships with
industry analysts and financiers.
Selling, general and administrative expenses for the three months ended
September 30, 2000 increased $14.9 million to $18.6 million, from $3.7 million
in the comparable period in 1999. This amount includes $0.6 million of non-cash
compensation charges relating to the issuance of our common stock, options and
warrants. The increase results from the expansion of our ASP business which
resulted in increased payroll and operating costs, additional costs for our
financing and marketing activities, and the additional selling, general and
administrative costs of the subsidiaries that we acquired during 1999 and 2000.
Our selling, general and administrative expenses for the three months
ended September 30, 1999 were $3.7 million. The 1999 amount also included $0.7
million of non-cash compensation charges relating to the issuance of our common
stock, options and warrants.
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<PAGE> 16
Depreciation and Amortization of Goodwill and Other Intangible Assets
Our depreciation and amortization costs for the three months ended
September 30, 2000 and 1999 are comprised of the following (in millions):
September 30,
----------------
2000 1999
----- ----
Goodwill amortization....................................... $15.6 $0.5
Depreciation and other amortization......................... 2.2 0.2
----- ----
$17.8 $0.7
===== ====
Amortization of goodwill for the three months ended September 30, 2000
relates to the acquisitions made during 1999 and 2000. Our depreciation and
other amortization expense for the three months ended September 30, 2000
includes depreciation on the expansion of our data centers, software user
licenses, office and leasehold improvements, and amortization of amounts
capitalized for assembled workforce.
Our amortization of intangible assets for the three months ended
September 30, 1999 relates to the amortization of the amounts capitalized for
assembled workforce.
Interest Expense
Interest expense of $0.8 million for the three months ended September
30, 2000 relates mainly to interest on outstanding bank indebtedness and lines
of credit, capital lease obligations and convertible debt.
Interest expense of $2.3 million for the three months ended September
30, 1999 includes a non-cash $1.8 million charge related to amortization of the
intrinsic value of conversion features related to convertible debenture
financing and $0.5 million related to interest on outstanding bank indebtedness
and lines of credit, capital lease obligations and convertible debt.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
Revenue
The components of our revenue for the nine months ended September 30,
2000 and 1999 were as follows (in millions):
September 30,
-----------------
2000 1999
----- ----
Sale of hardware and software............................... $66.0 $1.5
Service delivery............................................ 25.3 3.6
----- ----
Total.................................................. $91.3 $5.1
===== ====
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Revenue for the nine months ended September 30, 2000 consisted of $25.3
million of information technology outsourcing revenue, a portion of which
related to delivery of ASP services. We also purchase and resell hardware and
software to our customers as part of our services, which accounted for $66.0
million of revenue for the nine months ended September 30, 2000.
Revenue for the nine months ended September 30, 1999 consisted of $3.6
million of information technology outsourcing revenue, a portion of which
related to delivery of ASP services. The resale of hardware and software to our
customers accounted for $1.5 million of revenue for the nine months ended
September 30, 1999.
Cost of Goods Sold
Cost of goods sold reflects costs of hardware and software purchased
for resale to customers. Cost of goods sold for the nine months ended September
30, 2000 was $55.0 million, or 83 % of hardware and software sales.
Our cost of goods sold for the nine months ended September 30, 1999 was
$1.3 million, or 87% of related hardware and software sales.
Cost of Service Delivery
Our cost of service delivery for the nine months ended September 30,
2000 was $17.5 million, or 69% of service delivery revenue. Our cost of service
delivery reflects payroll and benefit costs for our outsourcing consultants who
support the information technology activities of our clients, and payroll,
benefit, and operational costs related to testing and operating our data centers
and installing and supporting software applications related to our ASP and
information technology outsourcing businesses.
Our cost of service delivery for the nine months ended September 30,
1999 was $5.5 million, or 153% of service delivery revenue. This includes
amounts related to the cost of service delivery of information technology
outsourcing and the direct cost related to the development of our ASP services,
including operating a "beta test" data center for early customers.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses include travel,
payroll, advertising and marketing expenses to secure customers and to develop
business partnerships, as well as for meeting and developing relationships with
industry analysts and financiers.
Selling, general and administrative expenses for the nine months ended
September 30, 2000 increased $44.8 million to $51.4 million, from $6.6 million
in the comparable period in 1999. This amount includes $2.2 million of non-cash
compensation charges relating to the issuance of our common stock, options and
warrants. The increase in such costs results from the expansion of our ASP
business which resulted in increased payroll and operating costs, additional
costs for our financing and marketing activities, and the additional selling,
general and administrative costs of the subsidiaries that we acquired during
1999 and 2000.
Our selling, general and administrative expenses for the nine months
ended September 30, 1999 were $6.6 million. The 1999 amount also includes $1.7
million of non-cash compensation charges relating to the issuance of our common
stock, options and warrants.
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<PAGE> 18
Depreciation and Amortization of Goodwill and Other Intangible Assets
Our depreciation and amortization costs for the nine months ended
September 30, 2000 and 1999 are comprised of the following (in millions):
September 30,
-----------------
2000 1999
------ -----
Goodwill amortization...................................... $42.1 $1.4
Depreciation and other amortization........................ 5.4 0.5
----- ----
$47.5 $1.9
===== ====
Amortization of goodwill for the nine months ended September 30, 2000
relates to the acquisitions made during 1999 and the nine months ended September
30, 2000. Our depreciation and other amortization expense for the nine months
ended September 30, 2000 includes depreciation on the expansion of our data
centers, software user licenses, office and leasehold improvements, and
amortization of amounts capitalized for assembled workforce.
Our amortization of intangible assets for the nine months ended
September 30, 1999 relates to the amortization of the amounts capitalized for
assembled workforce. \
Interest Expense
Interest expense of $2.0 million for the nine months ended September
30, 2000 relates mainly to interest on outstanding bank indebtedness and lines
of credit, capital lease obligations and convertible debt.
Interest expense of $11.2 million for the nine months ended September
30, 1999 includes a non-cash $3.3 million charge related to amortization of the
intrinsic value of conversion features related to convertible debenture
financing and $7.9 million related to interest on outstanding bank indebtedness
and lines of credit, capital lease obligations and convertible debt.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 2000, we had net cash
outflows from operating activities of $36.0 million and utilized another $36.5
million for acquisitions and repayment of acquisition notes. These outflows
related mainly to the expansion of our ASP business, our significant acquisition
activity and a payment of $5.0 million to SmallCaps Online Group LLC relating to
the settlement of a litigation matter. In addition, during the nine months ended
September 30, 2000 we invested $5.4 million in property and equipment, primarily
in expanding our data centers, and for the acquisition of software, hardware and
other infrastructure costs necessary to host our ASP customers. These net cash
outflows are significantly greater than net cash outflows for the same period in
1999.
During the nine months ended September 30, 2000, we acquired three
companies. The total consideration for these acquisitions was $106.5 million,
consisting of $15.2 million cash, 5,201,459 shares of our common stock valued at
$79.6 million, and notes payable of $11.7 million, all of which have been paid.
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<PAGE> 19
We used the following sources of financing to fund operations, our
acquisitions, expansion of our ASP business, our expansion into the United
States and the United Kingdom, investments in property and equipment, and for
the acquisition of software, hardware and other infrastructure costs necessary
to host our ASP customers:
Issuance of common stock and warrants - During 1999, we completed a
private placement of $50.0 million of common equity with institutional private
equity investors and received net proceeds of approximately $46.1 million after
deducting commissions and fees. As part of this placement, we issued warrants to
acquire 2,401,041 shares of common stock to the investors and the placement
agent. The holders exercised these warrants in February 2000, resulting in net
proceeds to the Company of $18.0 million. On April 28, 2000, we completed a
private placement of approximately $15 million common equity with institutional
private equity investors. As part of this placement, we issued to the investors
1,764,706 shares of our common stock and warrants to purchase 441,176 shares of
our common stock at an exercise price of $9.25 per share. On July 10, 2000, we
issued to Microsoft Corporation, for proceeds of $10.0 million, 1,428,571 shares
of our Series A Preferred Stock for a price of $7.00 per share. The Company also
issued to Microsoft a warrant with a five-year term to purchase up to an
additional 1,142,857 shares of our Series A Preferred Stock at an exercise price
of $7.00 per share. In July 2000, we completed a public offering of 6,250,000
shares of our common stock at a price of $7.00 per share. We received net
proceeds of $37.3 million from this offering after deducting underwriting
discounts, commissions and offering costs.
Lease Financing - During the nine months ended September 30, 2000, we
utilized several capital asset lease lines with financial lenders and computer
hardware vendors. These lines allow us to lease up to $25.9 million of computer
hardware and related infrastructure. As of September 30, 2000, we have used
$14.1 million of these lines. Aggregate monthly payments under these lines are
currently $0.8 million, including interest implicit in the leases at rates
ranging from 9% to 14% per annum. We had available borrowings of $11.8 million
under the various lease lines as of September 30, 2000. These lines have been
partially used to build and expand our United States, Canadian and United
Kingdom data centers.
Bank Financing - We have a credit facility agreement with a bank that
allows borrowings up to a maximum of $10.0 million. The amount that we are
permitted to borrow at any given time depends on the extent to which we have met
certain performance criteria. Borrowings under the credit agreement at September
30, 2000 were $4.3 million and we utilized an additional $0.7 million to secure
an outstanding letter of credit. The facility bears interest at rates that vary
from prime (9.5% at September 30, 2000) plus 1% to prime plus 3% per annum based
upon the Company maintaining certain operating performance levels, and is
payable on demand. The facility is secured by receivables and other assets of
certain of our subsidiaries, and guarantees and a pledge of a percentage of the
shares of those subsidiaries. The agreement contains certain financial and other
covenants or restrictions, including the maintenance of certain financial
ratios, limitations on the incurrence of indebtedness and restrictions on
dividends paid by us. As of September 30, 2000, we had borrowed the maximum
amount permitted based on the performance criteria and we were either in
compliance with, or had obtained waivers for, all covenants, limitations and
restrictions.
We also maintain two additional lines of credit at two other banks that
allowed borrowings of an aggregate amount of $1.7 million, of which $1.2 million
was borrowed at September 30, 2000. The lines bear interest at various rates
ranging from prime plus 1% to prime plus 3% per annum, and mature at various
intervals through November 30, 2000. The lines are secured by certain working
capital assets of our United Kingdom subsidiary and a certificate of deposit of
$0.6 million (reflected as restricted cash on the Company's consolidated balance
sheet at September 30, 2000). On October 30, 2000, we paid off the $0.6 million
line and the certificate of deposit that was held as security by the bank was
returned.
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<PAGE> 20
We believe that our available cash, cash equivalents and available
borrowings under our lease and bank credit facilities, together with any income
generated from operations, will be sufficient to meet our anticipated cash needs
to fund our operating losses, working capital and capital expenditures through
at least June 2001. Notwithstanding the foregoing, our cash needs could be
adversely affected in the event that we are unable to comply with, or in the
alternative, obtain waivers of certain covenants, limitations and restrictions
contained in our bank financing agreements. In that event, we would require
additional capital in order to fund our operating losses, working capital and
capital expenditures. Under those circumstances, if we are unable to secure
additional capital and we are unable to curtail our operating losses, our
current operations could be materially adversely affected.
In connection with our ASP integration business, we purchase hardware
and software for resale to our customers. These purchases account for a
significant demand on our available resources and, at times, create liquidity
concerns which impact the use of our available funds. Although these hardware
and software costs are invoiced to our customers in connection with the delivery
of our ASP integration business services, receipt of payment for such services
often occurs several months after we have acquired the related hardware and
software. To address our need to continue to purchase hardware and software
prior to, and in connection with, the performance of services to our clients
and, at the same time, to enable us to address our short-term and long-term
liquidity needs in a more predictable manner, on August 21, 2000, we entered
into a letter of intent with a nationally recognized financial institution
relating to a revolving credit facility that will allow maximum borrowings up to
$30 million, based upon eligible accounts receivables, and secured by
substantially all of our assets. The funds available from this credit facility
will be used to refinance all our Bank financing under the existing credit
facilities described above, provide the necessary financing for working capital
(including the funding of hardware and software purchases related to the
performance of our ASP Integration services), acquisitions and capital
expenditures. Our current capital asset lease lines of credit with financial
lenders and computer hardware vendors, described above, will remain in effect.
Advances under the new facility will be subject to a sub-limit of $5 million for
each of our Canadian and United Kingdom subsidiaries. The facility will mature
in three years and will contain prepayment penalties. The credit facility will
bear interest at prime, or prime plus 1.5% per annum, depending on the amount of
our available unrestricted cash; however, at no time will the interest rate
charged by the lender be less than 8% per annum. The credit facility contains
certain financial and other covenants and restrictions. In connection with
entering into the new credit facility, we agreed to grant to the financial
institution a warrant to purchase 100,000 shares of our common stock at an
exercise price of $8.40 per share with related registration rights. We expect to
have the facility in place by November 30, 2000. The letter of intent contains
usual and customary conditions to closing, including the satisfactory completion
of the financial institution's due diligence, the absence of a material adverse
change in our business and the execution of final documents. Accordingly, we
cannot give any assurance that the credit facility will be consummated. To the
extent that it is not consummated, we will continue to pursue other similar
credit financing options. We cannot assure you that comparable alternative
financing will be available to us on commercially reasonable terms or at all.
Our future liquidity will also depend on our ability to restructure our
operations to reduce our operating loss. In October 2000, consistent with our
plan to integrate our recently acquired companies and to achieve more efficient
operations, we closed 6 branch offices and eliminated an aggregate of 75
positions company-wide through a combination of reduction in force and
attrition. As a result of these actions, the Company expects to realize
annualized cost savings of approximately $12 million by the end of the fourth
quarter 2000. We will continue to evaluate all aspects of our operations with a
view to reducing our operating losses. If we are unable to secure additional
financing and we are unable to curtail our operating losses, our current
operations could be materially adversely affected for the period beyond the
second quarter of fiscal 2001.
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In order to fund our expansion, we will require additional capital.
This financing may involve incurring additional debt (beyond the $30 million
credit facility described above) and/or selling equity securities. We cannot
assure you that such additional financing will be available to us on
commercially reasonable terms or at all. As we incur debt (including the debt
which is subject to the August 21, 2000 letter of intent), the risks associated
with our business and with owning our common stock should increase. If we raise
capital through the sale of equity securities, the percentage ownership of our
stockholders will be diluted. In addition, any new equity securities may have
rights, preferences or privileges senior to those of our common stock. If we are
unable to obtain additional financing, our ability to meet our current plans for
expansion could be materially adversely affected.
Foreign Currency Translation and Hedging
We are exposed to foreign currency fluctuations through our operations
in Canada and the United Kingdom. At September 30, 2000, approximately 11% of
our revenue and 17% of our receivables are in Canadian dollars and approximately
22% of our revenue and 21% of our receivables are in British pounds. We do not
enter into forward exchange contracts or any derivative financial investments
for trading purposes. Thus, we do not currently hedge our foreign currency
exposure.
FACTORS THAT MAY AFFECT FUTURE RESULTS
WE INTEND THAT OUR ASP SERVICES WILL BECOME AN INCREASING PERCENTAGE OF OUR
OVERALL BUSINESS. IF WE ARE NOT SUCCESSFUL IN GROWING OUR ASP BUSINESS, OUR
PROSPECTS WILL BE ADVERSELY AFFECTED.
To date, most of our revenues have come from computer consulting,
software integration, hardware installation and training services. Our ASP
services were introduced in March 1999 and are therefore a relatively new line
of business for us. Our business strategy includes the expansion of our ASP
services. In the future, we expect that revenue from ASP services will comprise
a greater portion of our revenue. However, our business plan may not be
successful and we may not be able to increase our ASP revenues. We may not be
successful in addressing these risks, and if we are not successful, our
business, results of operations and financial condition will be materially
adversely affected.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY AND OUR BUSINESS MODEL IS STILL
EVOLVING, WE MAY NOT BE ABLE TO SUCCESSFULLY MANAGE OUR BUSINESS OR ACHIEVE
PROFITABILITY.
Our business is new, evolving and unproven, and our range of services
continues to change. In order to achieve our business plan we must:
- convince customers to purchase our ASP services,
- increase awareness and market penetration of our brand,
- attract, retain and motivate qualified personnel,
- maintain our existing, and develop new, relationships with software
providers and vendors,
- raise additional capital, and
- convince customers that we can provide reliable and cost-effective
services.
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<PAGE> 22
If we are not successful in the foregoing areas, our business, results
of operations and financial condition may be materially adversely affected.
WE HAVE A HISTORY OF SUBSTANTIAL LOSSES AND NEGATIVE CASH FLOWS. WE EXPECT THESE
LOSSES AND NEGATIVE CASH FLOWS TO CONTINUE AND INCREASE IN THE FUTURE.
We have experienced net losses and negative cash flows since we began
implementing our current business plan. We expect that the ongoing
implementation of our current business plan will increase our net losses and our
negative cash flows for the foreseeable future as we invest in personnel,
technology and other assets to support our expected growth. In addition, our
business plan includes expansion through acquisitions. As of September 30, 2000,
we had approximately $254.1 million in goodwill and assembled work force as a
result of our acquisitions. The respective amount from each acquisition will be
amortized over a five year period and will substantially increase our net
losses. In addition, acquisitions are likely to increase our cash needs. We may
not be able to operate profitably in the future or generate positive cash flows.
If we cannot operate profitably or generate positive cash flows, our business,
results of operations and financial condition will be materially adversely
affected.
IN ORDER TO EXECUTE OUR BUSINESS PLAN, WE WILL NEED TO RAISE ADDITIONAL CAPITAL.
We need to raise additional funds through public or private debt or
equity financings to be able to fully execute our business plan. Any additional
capital raised through the sale of equity may dilute our stockholders' ownership
interest. We may not be able to raise additional funds on favorable terms, or at
all. If we are unable to obtain additional funds, we will be unable to execute
our business plan, and our business, results of operations and financial
condition will be materially adversely affected.
THE GROWTH IN DEMAND FOR OUR ASP SERVICES IS HIGHLY UNCERTAIN. THE ASP MARKET
MAY NOT DEVELOP AS WE ANTICIPATE AND, ACCORDINGLY, WE MAY NOT BE ABLE TO EXPAND
OUR BUSINESS OR OPERATE IT PROFITABLY.
The market for ASP services has only recently begun to develop and is
evolving rapidly. Future demand for these services is highly uncertain. We
believe that many of our potential customers are not fully aware of the benefits
of ASP services. We must educate potential customers regarding these benefits
and convince them of our ability to provide complete and reliable services. The
market for ASP services may never become viable or grow further. If the market
for our ASP services does not grow or grows more slowly than we currently
anticipate, our business, financial condition and operating results will be
materially adversely affected.
WE ARE INVOLVED AND MAY BECOME INVOLVED IN LEGAL PROCEEDINGS WITH FORMER
EMPLOYEES, CONSULTANTS AND SERVICE PROVIDERS WHICH, IF DETERMINED AGAINST US,
COULD CAUSE US TO PAY A SIGNIFICANT AMOUNT OF DAMAGES.
We are party to one lawsuit by a former consultant to one of our
subsidiaries who seeks damages of approximately $2 million which includes
approximately 50,000 stock options and monetary damages.
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<PAGE> 23
In the past, we have entered into contracts with third parties in the
normal course of business and with advisors and consultants based on business
plans that we are no longer pursuing. We believe that those contracts are no
longer effective. However, it is possible that the other parties to those
contracts could claim that we did not fulfill our obligations under the
contracts. If a court found that we are obligated under any of those contracts
we could be liable for an undeterminable amount of compensation.
All of these legal proceedings are likely to be expensive for us. If
such suits are determined against us and a court awards a material amount of
cash damages, our business, results of operations and financial condition will
be materially adversely affected. In addition, any such litigation could divert
management's attention and resources.
OUR ABILITY TO SUCCESSFULLY INTEGRATE COMPLETED ACQUISITIONS OR IDENTIFY,
ACQUIRE AND SUCCESSFULLY INTEGRATE FUTURE ACQUISITIONS INTO OUR OWN OPERATIONS,
MAY AFFECT OUR GROWTH AND OUR OPERATING RESULTS.
We have made a number of significant acquisitions in 1999 and 2000.
These acquisitions have increased our revenue from $2.4 million for the year
ended December 31, 1998 to $115.0 million for the year ended December 31, 1999,
on a pro forma basis after giving effect to our completed acquisitions as if
each had occurred as of January 1, 1999. We have not yet fully integrated any of
these companies. We may not be able to successfully integrate these acquisitions
into our business. Our failure to acquire suitable companies or to successfully
integrate any acquired companies into our operations could have a material
adverse effect upon our business, operating results and financial condition.
OUR INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGY WITH CONTINUOUS
IMPROVEMENTS IN BOTH COMPUTER HARDWARE AND SOFTWARE.
We must continually buy or lease new computer hardware and license new
computer software systems to effectively compete in our industry. In addition,
our software delivery applications must be able to support changes in the
underlying software applications that are delivered to our customers. The rapid
development of new technologies increases the risk that current or new
competitors could develop products or services that would reduce the
competitiveness of our products or services. We rely on software providers to
produce software applications that keep pace with our customers' demands. We may
not successfully develop or adopt new technologies, introduce new services or
enhance our existing services on a timely basis and new technologies, new
services or enhancements we use or develop may never achieve market acceptance.
If we fail to address these developments, we will lose sales to our competitors
and our business, operating results and financial condition will be materially
adversely affected.
OUR CURRENT DATA CENTERS ARE LOCATED IN ONLY FOUR LOCATIONS, IRVINE, CALIFORNIA,
CALGARY AND TORONTO, CANADA, AND NEWBURY, UNITED KINGDOM, WHICH LEAVES US
VULNERABLE TO DISRUPTIONS THAT AFFECT OUR DATA CENTERS.
Our ASP business strategy depends on the consistent performance of our
four data centers located in Irvine, California, Calgary and Toronto, Canada,
and Newbury, United Kingdom. We offer back-up storage of data for customers in
the United States and Canada that elect this service, but do not yet offer this
service for European customers. We plan to develop additional data centers in
the eastern United States and in Europe. However, our current data centers are
vulnerable to interruption from fire, earthquake, flood, power loss,
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<PAGE> 24
telecommunications failure, break-ins and other events beyond our control. If a
data center is damaged, a customer storing its data on that data center may lose
its data if it is not backed up. If one of our data centers was damaged, the
loss of data may affect a significant portion of our customers. We have
experienced periodic systems disruptions in the past and anticipate that such
disruptions will occur in the future. In the event that we experience
significant disruptions that affect one or more of our data centers, we could
lose customers and fail to attract new customers, and our business, results of
operations and financial condition would be materially adversely affected.
WE RELY ON SOFTWARE APPLICATION AND SOFTWARE SYSTEMS INTEGRATION COMPANIES TO
REFER MANY OF OUR CLIENTS TO US.
We rely on referrals from software application and technology
integrators for a portion of our business. These software application and
technology integrators refer their customers to us because we can provide an
array of services which complement the products and services they offer.
However, these software application and technology integrators may stop or
substantially diminish referring business to us or they may decide to cooperate
with our competitors and thereby adversely impact or eliminate the amount of
referrals made to us. If these third-party referrals cease or materially
decline, our sales will materially decline and our business, results of
operations and financial condition will be materially adversely affected.
WE MUST LICENSE THE SOFTWARE APPLICATIONS WE PROVIDE TO OUR CUSTOMERS FROM THIRD
PARTIES.
We depend on third-party software manufacturers agreeing to allow their
software applications to be hosted or run at our data centers and provided to
our customers. We have entered into non-exclusive agreements with Microsoft,
Onyx, Great Plains, SalesLogix and others that allow us to host some of their
software applications at our data centers or re-license their software
applications to our customers. Under most of these agreements, the software
manufacturer can terminate its relationship with us for any reason by giving us
as little as 30 days notice. In these instances, the software manufacturer is
not liable to us or our customers for any damages resulting from termination. If
our relationships with these software manufacturers are terminated or if these
or other software manufacturers do not allow our customers to obtain a license
to operate the software application on our data centers, our business, operating
results and financial condition could be materially adversely affected.
IF WE ARE UNABLE TO OBTAIN CITRIX OR MICROSOFT PRODUCTS, AS WELL AS OTHER KEY
HARDWARE COMPONENTS AND SOFTWARE APPLICATIONS FROM OTHER VENDORS, WE WOULD BE
UNABLE TO DELIVER OUR SERVICES.
We depend on third-party suppliers to provide us with key hardware
components and software applications for our infrastructure and with sufficient
communications lines to allow our customers to access their software
applications. Some components or applications are only available from limited
sources. Citrix Systems, Inc. and Microsoft Corporation are our key suppliers of
software that we utilize to connect our customers to software applications.
Although there are other competing software applications on the market, we
believe that Citrix software, deployed with Windows NT Terminal Server software
from Microsoft, is currently best suited to serve this function. If we are
unable to obtain these products or services such as telecommunications services
from other vendors, in a timely manner, at an acceptable cost or at all, we
would be unable to deliver our services. Until we replace these products, our
business, results from operations and financial condition will be materially
adversely affected.
24
<PAGE> 25
IF THE SOFTWARE WE UTILIZE CONTAINS DEFECTS, OUR CUSTOMERS' SERVICE COULD BE
DISRUPTED AND THEIR DATA COULD BE LOST.
Our service offerings depend on complex software which may contain
defects, particularly when first introduced or when new versions are released.
Although we test software applications prior to deployment, we may not discover
software defects that affect our new or current services or enhancements until
after they are deployed. These defects could cause service interruptions or data
loss which could damage our reputation or increase our service costs, cause us
to lose revenue, delay market acceptance or divert our development resources.
Any software modifications we perform as part of our integration services could
cause problems in application delivery. Also, because we offer a one-source
solution to our customers, they are likely to hold us accountable for any
problems associated with their software, even if the problem results from
software defects the manufacturer causes. Typically, software manufacturers
disclaim liability for any damages suffered as a result of software defects or
provide only limited warranties. As a result, we may have no recourse against
the providers of defective software applications.
BREACHES OF OUR SECURITY COULD DISRUPT THE OPERATION OF OUR DATA CENTERS AND
JEOPARDIZE OUR SECURE TRANSMISSION OF CONFIDENTIAL INFORMATION.
The growth of our business depends upon our ability to securely
transmit confidential information to and from our data centers or the servers of
our customers. Despite our design and implementation of a variety of delivery
system security measures, unauthorized access, computer viruses and accidental
or intentional disturbances could occur. We may need to devote substantial
capital and resources to protect against the threat of unauthorized penetration
of our delivery system or to remedy any problems that the penetration of our
delivery system security creates. The occurrence of any of these events could
cause us to lose customers and expose us to liability, all of which could have a
material adverse effect on us.
OUR ASP SERVICE CONTRACTS GUARANTEE CERTAIN SERVICE LEVELS.
Our ASP contracts contain service level guarantees which obligate us to
provide our hosted applications at a guaranteed level of performance. To the
extent we fail to meet those service levels, we may be obligated to provide our
customers credit for free service. If we continue to fail to meet these service
levels, our ASP customers have the right to cancel their contracts with us.
These credits or cancellations will cost us money, damage our reputation with
our customers and prospective customers and could materially adversely affect
our business, results of operations and financial condition.
WE OPERATE IN AN INDUSTRY WHERE IT IS DIFFICULT TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL.
Our success depends in significant part on the continued services of
our key employees. Losing one or more of our key personnel will seriously impair
our ability or could cause us to fail to successfully implement our business
plan. This will have a material adverse effect on our business, results of
operations and financial condition.
Our business is labor-intensive, and our success depends in large part
upon our ability to attract, develop, motivate and retain highly skilled
personnel. We have grown from over 100 employees as of December 31, 1998 to 683
as of October 19, 2000. We believe that we will need to hire additional
qualified technical employees and experienced sales personnel. These employees
are in great demand and are likely to remain a limited resource for the
foreseeable future. We may not be able to engage the services of such personnel
or retain our current personnel. If we do not succeed in attracting new,
qualified personnel or successfully retain our current personnel, our business
could suffer.
25
<PAGE> 26
MANY COMPANIES USE THE NAME "FUTURELINK".
We are aware that other companies have claimed prior use of the name
"FutureLink" for products or services similar to our own. We are in the process
of investigating the rights, if any, others may have to the name. In addition,
we are attempting to register "FutureLink" as a service mark in the United
States, Canada and the United Kingdom. However, we may not be able to obtain
proprietary rights to the use of this name. We will incur expenses if called to
defend our use of the "FutureLink" name. Any litigation, even if without merit,
may be time consuming and expensive to defend. It also could divert management's
attention and resources and require us to enter into costly royalty or licensing
agreements. In addition, if any company in our industry is able to establish a
use of the "FutureLink" name that is prior to our use, we could be liable for
damages and could be forced to stop using the name unless we are able to buy the
right to use the name. If we are unable to buy the right to use our name after
we lose an infringement claim, we would have to change our name, which may
require us to spend money to build new brand recognition and incur other costs.
Third parties may assert other infringement claims against us. Any of these
events could have a material adverse effect on our business, financial condition
and results of operations.
WE MAY BE EXPOSED TO UNKNOWN ENVIRONMENTAL LIABILITY.
We merged with a publicly-traded company that prior to 1992 was engaged
in the natural resource exploration and development business, including mining
and oil and gas. The mining, mineral processing and oil and gas industries are
subject to extensive governmental regulations for the protection of the
environment, including regulations relating to air and water quality, site
reclamation, solid and hazardous waste handling and disposal and the promotion
of occupational safety. We could be held responsible for any liabilities
relating to our previous involvement in mining or oil and gas exploration and
development, which liabilities would result in our spending our cash resources
and could have a material adverse effect on our business, financial condition
and results of operations.
26
<PAGE> 27
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES.
USE OF PROCEEDS
On June 29, 2000, the effective date of the Company's Registration
Statement on Form SB-2 (Registration No. 333-30178), the Company completed a
public offering of 6,000,000 shares of its common stock, par value $.0001 per
share, for $7.00, netting proceeds to the Company after underwriting discounts
and expenses of approximately $39.1 million. Bear, Stearns & Co. Inc. acted as
the lead underwriter of the offering and C.E. Unterberg, Towbin acted as
co-manager of the offering. The closing of the offering occurred on July 5,
2000. The Company granted the underwriters an over-allotment option to purchase
up to an additional 250,000 shares of its common stock (all of which were
included in the above-referenced registration statement). The underwriters
partially exercised their over-allotment option on July 18, 2000 resulting in
the purchase of an additional 250,000 shares of the Company's common stock for
$7.00 per share, netting proceeds to the Company after underwriting discounts
and expenses of approximately $1.5 million. The over-allotment option and the
offering terminated prior to the sale of the remaining 650,000 shares of the
Company's common stock. The closing of the shares related to the over-allotment
option occurred on July 18, 2000. In connection with the offering, a reasonable
estimate of the amount of expenses incurred for the Company's account were as
follows: $3.2 million attributable to underwriting discounts and commissions,
and $3.2 million attributable to other costs. No expenses were attributable to
finder's fees or expenses paid to or for underwriters. All such expenses were
direct or indirect payment to others (as opposed to payments to directors,
officers, general partners of the Company or their associates, 10% or more
shareholders or affiliates of the Company). The total net offering proceeds to
the Company after deducting the total expenses was approximately $37.4 million.
From the effective date to September 30, 2000, the Company utilized
$37,400,000 as set forth in the table below:
<TABLE>
<CAPTION>
Direct or Indirect Payments
to Directors, Officers, General Partners
of the Issuer or their Associates, to Persons
Owning Ten Percent or More of any Class
of Equity Securities of the Issuer, and to Direct or Indirect
Affiliates of the Issuer Payment to Others
--------------------------------------------- ------------------
<S> <C> <C>
Construction of plant,
building and facilities........... 0 0
Purchase and installation
of machinery and equipment........ 0 0
Purchase of real estate........... 0 0
Acquisition of other
business(es)/assets............... 0 0
Repayment of indebtedness......... 0 $13,088,000
Working capital................... $1,612,000(1)(2) $13,400,000
Temporary investment (3).......... 0 $ 9,300,000
/assets
</TABLE>
(1) On December 22, 1999 we acquired KNS Holdings Limited for total
consideration of $44.0 million. As part of the purchase price we paid Mr.
Yuri Pasea $316,000. Mr. Pasea is now Managing Director, Europe.
(2) On June 19, 2000, we acquired Charon Systems Inc. for total consideration
of $21.5 million. As part of the purchase price we paid Mr. David Fung
$1,296,000. Mr. Fung is now President and Chief Operating Officer, Canada.
(3) On deposit with a financial institution.
27
<PAGE> 28
SALES OF UNREGISTERED SECURITIES DURING THE QUARTER
On July 10, 2000, we issued 1,428,591 shares of Series A Preferred
Stock and warrants to purchase up to 1,142,857 shares of Series A Preferred
Stock to Microsoft Corporation. In exchange for the issuances, we received total
consideration of $10.0 million. We issued these securities under an exemption
provided by Rule 506 of Regulation D promulgated under the Securities Act of
1933, as amended ("Regulation D"). The purchaser of these securities certified
that it was an "accredited investor" as defined in Rule 501 of Regulation D,
acquired the securities as an investment and not with a view to distribution,
and has agreed to not resell the securities unless they became registered or
another exemption from registration was available. The securities issued were
appropriately legended to reflect these restrictions.
On July 11, 2000, we issued warrants to purchase up to 5,143 shares of
its common stock to TBCC Funding Trust. The issuance was made in connection with
a lease financing arrangement with Transamerica Business Credit Corporation. We
issued these securities under an exemption provided by Rule 506 of Regulation D.
TBCC Funding Trust certified that it was an "accredited investor" as defined in
Rule 501 of Regulation D, was acquiring the securities as an investment and not
with a view to distribution, and would not resell the securities unless they
became registered or another exemption from registration was available. The
securities were appropriately legended to reflect these restrictions.
On July 28, 2000 and August 18, 2000, we issued warrants to acquire up
to, 20,000 and 4,903 shares of our common stock to EMC 2 Corporation. The
issuances were made as partial consideration for an equipment financing
arrangement. We issued these securities under an exemption provided by Rule 506
of Regulation D. EMC 2 Corporation certified that it was an "accredited
investor" as defined in Rule 501 of Regulation D, was acquiring the securities
as an investment and not with a view to distribution, and would not resell the
securities unless they became registered or another exemption from registration
was available. The securities were appropriately legended to reflect these
restrictions.
On August 15, 2000, we issued warrants to acquire up to, 10,000 shares
of our common stock to Magnus Diversified Inc. and issued warrants to acquire up
to 5,000 shares of our common
28
<PAGE> 29
stock to Cyber Asylum Inc. These issuances were made as partial consideration
for settlement of a claim made by Magnus Diversified Inc. and Cyber Asylum Inc.
The Company issued these securities under an exemption provided by Rule 903 of
Regulation S promulgated under the Securities Act of 1933. We made no directed
selling efforts of these securities within the United States. The purchasers of
the securities certified that they were not U.S. persons, were not acquiring the
securities for the account or benefit of any U.S. person and would not resell
the securities in the U.S. for at least one year. The securities issued by us
were appropriately legended to reflect these restrictions and we have the right
to refuse to register any transfer of these securities not made in accordance
with Regulation S.
On August 30, 2000, we issued 81,558 shares of common stock to a
non-U.S. entity upon conversion of the remaining principal plus interest of a
10% convertible debenture held by the entity. On the same date, we also issued
an additional 36,558 shares of our common stock to this non-U.S. entity upon a
"cashless" exercise of a warrant held by the entity. These securities were
issued under an exemption provided by Rule 903 of Regulation S promulgated under
the Securities Act of 1933, as amended. The common stock issued to this non-U.S.
entity was legended to reflect these restrictions and we have the right to
refuse to register any transfer of these securities not made in accordance with
Regulation S.
Between July 1 and September 30, 2000, we issued 40,692 shares of our
common stock upon the "cashless" exercise of 46,773 warrants, that we originally
issued between April 29 and May 7 1999. We issued these shares of common stock
pursuant to an exemption from the registration requirements provided by Rule 506
of Regulation D. The recipients of these shares of common stock had previously
certified that they were "accredited investors" as defined in Rule 501 of
Regulation D, were acquiring the securities as an investment and not with a view
to distribution, and would not resell the securities unless they became
registered or another exemption from registration is available. The common stock
issued was appropriately legended to reflect these restrictions.
On August 28, 2000, we issued 19,612 shares of our common stock to the
trustee of our employee 401K plan to meet our contribution obligations for the
period January 1 through June 30, 2000. We issued these shares of common stock
pursuant to an exemption from the registration requirements provided by Rule 506
of Regulation D. The recipient of these shares of common stock had previously
certified that it was an "accredited investor" as defined in Rule 501 of
Regulation D, it was acquiring the securities as an investment and not with a
view to distribution, and would not resell the securities unless it became
registered or another exemption from registration is available. The common stock
issued was appropriately legended to reflect these restrictions.
Except as otherwise set forth above, no underwriters were engaged in
the sales of securities described above.
29
<PAGE> 30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a)
The exhibits listed below are hereby filed with the U.S. Securities and Exchange
Commission (the "Commission") as part of this Report.
EXHIBIT
NUMBER DESCRIPTION
-------- -----------
3.1 Amended Certificate of Incorporation of FutureLink Corp. (1)
10.1 First Amendment to Loan Agreement dated November 15, 1999 between
FutureLink Corp. and Vincent L. Romano (1)
10.2 Loan Termination Agreement dated June 30, 2000 between FutureLink
Corp. and Vincent L. Romano (1)
10.3 First Amendment to Employment Agreement dated November 15, 2000
between Vincent L. Romano and FutureLink Corp. (1)
10.4 Termination of Employment Agreement dated July 31, 2000 between
Vincent L. Romano and FutureLink Corp. (1)
10.5 Lease Agreement dated April 27, 2000 between Olen Commercial Realty
Corp. and FutureLink Micro Visions Corporation for 2 South Pointe Dr.,
Lake Forest, Ca. 92630 (1)
10.6 Lease Agreement dated August 8, 2000 between Transwestern Lexington,
LLC and FutureLink Corp. for 360 Lexington Avenue, New York (1)
10.7 Securities Purchase Agreement dated June 29, 2000 between FutureLink
Corp. and Microsoft Corporation (1)
21.0 List of Subsidiaries (1)
27.0 Financial Data Schedule
--------------
* Filed herewith.
(1) Included as an Exhibit to FutureLink's Registration Statement on Form SB-2
filed with the Commission on September 28, 2000 (Registration No.
333-46778), and is incorporated by reference herein.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed with the Commission during the quarter for
which this Report is filed.
30
<PAGE> 31
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
FUTURELINK CORP.
Date: November 13, 2000 By: /s/ R. Kilambi
--------------------------------
Raghu N. Kilambi,
Executive Vice-President
& Chief Financial Officer
(Authorized Signatory and
Principal Financial Officer)
31
<PAGE> 32
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
---------- -----------
<S> <C>
3.1 Amended Certificate of Incorporation of FutureLink Corp. (1)
10.1 First Amendment to Loan Agreement dated November 15, 1999 between
FutureLink Corp. and Vincent L. Romano (1)
10.2 Loan Termination Agreement dated June 30, 2000 between FutureLink
Corp. and Vincent L. Romano (1)
10.3 First Amendment to Employment Agreement dated November 15, 2000
between Vincent L. Romano and FutureLink Corp. (1)
10.4 Termination of Employment Agreement dated July 31, 2000 between
Vincent L. Romano and FutureLink Corp. (1)
10.5 Lease Agreement dated April 27, 2000 between Olen Commercial Realty
Corp. and FutureLink Micro Visions Corporation for 2 South Pointe Dr.,
Lake Forest, Ca. 92630 (1)
10.6 Lease Agreement dated August 8, 2000 between Transwestern Lexington,
LLC and FutureLink Corp. for 360 Lexington Avenue, New York (1)
10.7 Securities Purchase Agreement dated June 29, 2000 between FutureLink
Corp. and Microsoft Corporation (1)
21.0 List of Subsidiaries (1)
27.0 Financial Data Schedule
</TABLE>
----------
(1) Included as an Exhibit to FutureLink's Registration Statement on Form SB-2
filed with the Commission on September 28, 2000 (Registration No.
333-46778), and is incorporated by reference herein.
