<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For The Quarterly Period Ended September 30, 1999
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For The Transition Period From _____ To _____
Commission File Number 0-26115
INTERLIANT, INC.
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(Exact Name Of Registrant As Specified In Its Charter)
DELAWARE 13-3978980
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(State of Incorporation) (IRS Employer Identification No.)
Two Manhattanville Road, Purchase, New York 10577
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(Address of Principal Executive Offices) (Zip Code)
(914) 640-9000
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(Registrant's Telephone Number, Including Area Code)
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(Former Name, Former Address and Former Fiscal Year, if Changed Since
Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) Yes X No ___, and (2) has been
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subject to such filing requirements for the past 90 days. Yes X No __.
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The number of shares outstanding of the Registrant's Common Stock as of
November 3, 1999 was 43,675,575.
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INTERLIANT, INC.
INDEX
PAGE NO.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of
September 30, 1999 and December 31, 1998 1
Condensed Consolidated Statements of Operations for the
Three Months and Nine Months Ended September 30, 1999 and 1998 2
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
PART II. OTHER INFORMATION 17
Item 2. Changes in Securities and Use of Proceeds
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
<PAGE>
PART I. FINANCIAL INFORMATION
INTERLIANT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
--------------- ---------------
(unaudited)
<S> <C> <C>
Assets Note 2
Current assets:
Cash and cash equivalents $ 52,614,768 $ 6,813,360
Cash-restricted 1,259,122
Accounts receivable, net of allowance of $1,166,690 and
$320,000 at September 30, 1999 and December 31, 1998, respectively 6,033,334 806,322
Prepaid and other current assets 2,271,395 639,662
--------------- ---------------
Total current assets 62,178,619 8,259,344
--------------- ---------------
Furniture, fixtures and equipment, net 15,296,477 5,103,123
Intangibles, net 75,299,085 12,612,228
Other assets 1,200,801 222,172
--------------- ---------------
Total assets $153,974,982 $ 26,196,867
=============== ===============
Liabilities and stockholders' equity
Current liabilities:
Notes payable and current portion of long-term debt $ 591,952
Accounts payable 3,875,553 $ 787,412
Accrued expenses 5,843,949 2,301,507
Deferred revenue 4,683,841 1,414,969
--------------- ---------------
Total current liabilities 14,995,295 4,503,888
--------------- ---------------
Long-term debt, less current portion 1,663,834
Stockholders' equity:
Preferred stock, $.01 par value; 1,000,000 shares authorized; 0 shares
issued and outstanding
Common stock, $.01 par value; 200,000,000 and 100,000,000
shares authorized; 43,627,658, and 19,217,197 shares
issued and outstanding, respectively 436,277 192,172
Additional paid-in capital 185,249,256 34,160,334
Deferred compensation (66,741) (1,769,429)
Other comprehensive income 89,062
Accumulated deficit (48,392,001) (10,890,098)
--------------- ---------------
Total stockholders' equity 137,315,853 21,692,979
--------------- ---------------
Total liabilities and stockholders' equity $153,974,982 $ 26,196,867
=============== ===============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
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INTERLIANT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
1999 1998 1999 1998
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
Service revenues $ 12,030,164 $ 1,733,394 $ 28,110,067 $ 2,591,198
Costs and expenses:
Cost of service revenues 6,532,726 951,112 15,871,868 1,461,945
Sales and marketing 5,224,106 886,152 11,193,242 1,419,876
General and administrative 8,454,096 1,821,780 19,956,063 3,534,734
Depreciation 2,058,494 259,665 4,157,420 333,252
Amortization of intangibles 6,055,064 876,854 14,841,358 1,250,733
------------ ----------- ------------ -----------
28,324,486 4,795,563 66,019,951 8,000,540
------------ ----------- ------------ -----------
Operating loss (16,294,322) (3,062,169) (37,909,884) (5,409,342)
Interest income, net 536,377 48,643 423,861 92,245
Other income (expense) 96,308 (15,880)
------------ ----------- ------------ -----------
Net loss $(15,661,637) $(3,013,526) $(37,501,903) $(5,317,097)
============ =========== ============ ===========
Net loss per share - basic and diluted $ (0.37) $ (0.28) $ (1.13) $ (0.84)
============ =========== ============ ===========
Weighted average shares
outstanding - basic and diluted 42,552,296 10,586,601 33,097,059 6,322,407
============ =========== ============ ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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INTERLIANT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Operating activities
Net loss $(37,501,903) $ (5,317,097)
Adjustments to reconcile net loss to net cash used in
operating activities:
Provision for uncollectible accounts 1,055,545 112,500
Depreciation and amortization 18,998,778 1,583,985
Amortization of deferred compensation 1,702,688 265,260
Other non-cash charges 189,062
Changes in operating assets and liabilities:
Accounts receivable (1,250,048) (673,501)
Prepaid expenses and other current assets (1,143,250) (554,411)
Other assets (12,540)
Accounts payable 168,384 549,624
Accrued expenses 1,693,365 526,484
Deferred revenue 698,113 (129,236)
------------ ------------
Net cash used in operating activities (15,401,806) (3,636,392)
------------ ------------
Investing activities
Purchases of furniture, fixtures and equipment (7,894,496) (2,494,495)
Payments issued in connection with non-compete agreements (1,000,000)
Investments in restricted securities (952,969)
Transfers to restricted cash (1,259,122)
Acquisitions of businesses, net of cash acquired (20,499,664) (12,786,454)
------------ ------------
Net cash used in investing activities (31,606,251) (15,280,949)
------------ ------------
Financing activities
Proceeds from sale of common stock 91,500,000 22,540,000
Proceeds from issuance of Series A redeemable convertible preferred stock 13,000,000
Proceeds from exercise of options and warrants 5,196,032
Proceeds from capital lease financing 1,277,255
Repayment of debt (10,965,826)
Offering costs (7,197,996)
------------ ------------
Net cash provided by financing activities 92,809,465 22,540,000
------------ ------------
Net increase in cash and cash equivalents 45,801,408 3,622,659
Cash and cash equivalents at beginning of period 6,813,360 912,085
------------ ------------
Cash and cash equivalents at end of period $ 52,614,768 $ 4,534,744
============ ============
Supplemental Disclosures of Noncash Investing and
Financing Activities
Stock issued and options granted for acquisitions $ 49,609,991 $ 3,310,201
Stock issued for compensation agreements $ 2,605,500
Debt assumed or issued in acquisitions $ 17,449,357
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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Interliant, Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 1999 (unaudited)
1. BUSINESS
Interliant, Inc. (formerly Sage Networks, Inc. "the Company") is a provider
of a wide range of Internet hosting and enhanced Internet services that enable
customers to deploy and manage their Web sites and network-based applications
more effectively than internally developed solutions. The Company's hosting
services store customers' Web sites, software applications, and data on servers
typically housed in the Company's data centers so that others on the Internet
can access and interact with the customer's Web sites and network-based
applications. The Company's consulting services provide customers with
Internet-based solutions, internal networking implementations, and application
development solutions. The Company has grown rapidly through the acquisition of
19 hosting and related Internet service businesses.
The Company was organized under the laws of the State of Delaware on
December 8, 1997. Web Hosting Organization, LLC (WEB), a Delaware Limited
Liability Company, is the majority and controlling shareholder of the Company.
WEB's investors are comprised of Charterhouse Equity Partners III, L.P. and Chef
Nominees Limited (collectively, CEP Members) and WHO Management LLC (WHO).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
Condensed Interim Financial Information
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the regulations of the Securities and Exchange
Commission (SEC), but omit certain information and footnote disclosure necessary
to present the statements in accordance with generally accepted accounting
principles. The interim financial information as of September 30, 1999 and for
the three months and nine months ended September 30, 1999 and 1998 is unaudited
and has been prepared on the same basis as the audited financial statements. In
the opinion of management, such unaudited information includes all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of the interim information.
The balance sheet at December 31, 1998 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
For further information, refer to the Financial Statements and Notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations included in the Company's Registration Statement on Form
S-1(Registration No. 333-74403) (the Registration Statement). Operating results
for the three months and nine months ended September 30, 1999 and 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999.
4
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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 amounts of assets and liabilities, and
disclosure of contingent 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.
Net Loss Per Share
Net loss per share is presented in accordance with the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share".
Basic net loss per share is computed based on the weighted average number of
shares of common stock outstanding during the period. Diluted loss per share
does not differ from basic loss per share since potential common shares to be
issued upon the exercise of stock options are anti-dilutive for the periods
presented.
3. INTANGIBLE ASSETS
The Company has allocated the purchase price of acquired companies to
identifiable tangible assets and liabilities and intangible assets based on the
nature and the terms of the various purchase agreements and evaluation of the
acquired businesses. Covenants not to compete are amortized over periods not to
exceed the term of the respective covenant. Values are assigned to covenants
not to compete in accordance with Accounting Principles Board Opinion No. 16
(APB 16), using the Company's estimate of fair value of the covenant. Amounts
not allocated to tangible assets and liabilities and identifiable intangible
assets have been recorded as goodwill.
4. ACQUISITIONS
During the three months ended September 30, 1999, the Company consummated
the following acquisitions, each of which has been accounted for using the
purchase method of accounting.
In August 1999, the Company purchased substantially all of the assets of
The Daily-e Corporation, a provider of business process re-engineering and Web
development services. The purchase price consisted of 70,000 shares of the
Company's common stock (Common Stock), valued at $11.13 per share. The
agreement also provides for contingent purchase consideration of up to $3.9
million, payable in cash, Common Stock, or any combination thereof at the
Company's option, if specified net revenue and EBITDA targets are achieved for
the twelve-month period ending July 31, 2000. The payment of contingent
consideration, if any, will be recorded as additional purchase price.
In September 1999, the Company, through its wholly-owned subsidiary,
Interliant International, Inc., a Delaware corporation, acquired all of the
outstanding stock of Sales Technology Limited, a United Kingdom-based systems
integrator of Customer Relationship Management (CRM) software products. The
total consideration consisted of cash of $0.4 million, 235,410 shares of Common
Stock valued at $11.23 per share, and assumed debt of $0.3 million. In
addition, contingent consideration of up to $3.6 million is payable in Common
Stock, the issuance of unsecured notes, or any combination thereof at the
Company's option, to certain sellers if specified revenue and earnings targets
are achieved during specified periods. The payment of contingent consideration,
if any, will be recorded as additional purchase price.
5
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The allocation of purchase price for the acquisitions completed in 1999 as
reflected in the September 30, 1999 condensed consolidated balance sheet is
preliminary based on the Company's initial assessment of the fair value of
assets acquired. The allocations may be modified between components of
intangible assets as the Company finalizes the purchase accounting for such
acquisitions.
The following unaudited condensed pro forma information presents the unaudited
results of operations of the Company as if the acquisitions completed in 1999
and 1998 had occurred on January 1, 1998:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Service revenues $ 35,281,115 $ 32,599,671
Net loss (43,142,217) (28,230,465)
Net loss per share - basic and diluted $ (1.24) $ (2.02)
</TABLE>
5. STOCKHOLDERS' EQUITY
Common Stock
In July 1999, the Company sold 8,050,000 shares of Common Stock, including
shares sold through the exercise of the underwriters' over-allotment option, in
an underwritten initial public offering (IPO) of the Company's Common Stock for
net proceeds of approximately $72.9 million, after deducting underwriters'
discounts and commissions and estimated offering costs paid by the Company.
Upon the consummation of the IPO, all of the 2,647,658 outstanding shares of
Series A Redeemable Convertible Preferred Stock were converted into an equal
number of shares of Common Stock.
Stock Option Plan
During the nine months ended September 30, 1999, the Company granted
options to purchase 1,042,505 shares of Common Stock, at exercise prices ranging
from $6.67 to $14.00 per share. The weighted-average exercise price of the
options granted was $7.84 per share. In addition, in connection with the March
1999 acquisition of Interliant, Inc., a Texas corporation (Interliant Texas),
the Company granted options to purchase 2,322,139 shares of Common Stock at
$0.13 per share in substitution for existing Interliant Texas vested options, of
which 1,523,461 were vested as of the acquisition date. Pursuant to the terms
of the acquisition of Interliant Texas, the remaining options to purchase
798,678 shares of Common Stock were forfeited upon the closing of the IPO since
the Company's pre-IPO value, based on the public offering price per share, was
greater than $300 million. The difference between the fair value of the vested
options at the date of grant ($6.67 per share) and the exercise price has been
included in the purchase price allocation.
During the nine months ended September 30, 1999, options to purchase
644,300 shares of Common Stock were exercised. As of September 30, 1999,
options to purchase 2,214,441 shares of Common Stock were outstanding, of which
983,761 options were vested.
6
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SEGMENT INFORMATION
The Company currently has three reportable segments: Web hosting,
application hosting, and consulting. For the year ended December 31, 1998, the
Company operated only in the Web hosting segment. The summary unaudited results
of operations for the nine months ended September 30, 1999 for each of the
segments is shown below.
<TABLE>
<CAPTION>
Web Application
Hosting Hosting Consulting Other Total
------- ------- ---------- ----- -----
<S> <C> <C> <C> <C> <C>
Revenues $ 11,297,766 $10,596,962 $4,130,966 $ 2,084,373 $ 28,110,067
Operating income (loss) $(10,217,687) $(3,610,587) $ 524,743 $(24,606,353) $(37,909,884)
Segment assets $ 9,977,289 $12,770,210 $2,822,439 $128,405,047 $153,974,985
</TABLE>
The Company's management generally reviews the results of operations of
each segment exclusive of depreciation and amortization (aggregating $19.0
million) and interest related to each segment. Accordingly, such expenses are
excluded from the segment operating loss and are shown under the Other caption.
In addition, all intangible assets and corporate expenses of the Company are
included in the Other caption.
The Company believes that the reportable segments may change in future
periods as management continues to integrate acquisitions.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following description of our financial condition and results
of operations in conjunction with the Unaudited Condensed Consolidated Financial
Statements and the Notes thereto. This discussion contains forward-looking
statements based upon current expectations that involve risks and uncertainties.
FORWARD LOOKING STATEMENTS AND ASSOCIATED RISKS
This Form 10-Q 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. Certain forward-looking statements
relate to, among other things, future results of operations, profitability,
growth plans, sales, expense trends, capital requirements and general industry
and business conditions applicable to our business. Any statements contained
herein that are not statements of historical fact may be deemed to be forward-
looking statements. Our actual results and the timing of certain events may
differ significantly from the results discussed in the forward-looking
statements. These forward-looking statements are based largely on our current
expectations and are subject to a number of risks and uncertainties. The words
"anticipate," "believe," "estimate" and similar expressions used herein are
generally intended to identify forward-looking statements. In addition to the
other risks described elsewhere in this report and in other filings by the
Company with the Securities and Exchange Commission and in the Company's
Registration Statement, important factors to consider in evaluating such
forward-looking statements include but are not limited to: changes in external
competitive market factors; changes in our business strategy; an inability to
execute our strategy due to unanticipated changes in the emerging hosting and
Internet services industries or the economy in general; difficulties in the
timely expansion of our network and data centers or in the acquisition and
integration of new businesses; difficulties in retaining and attracting new
employees or customers; difficulties in developing or deploying new services;
risks associated with rapidly changing technology, including but not limited to
Year 2000 compliance; and various other competitive factors that may prevent us
from competing successfully in existing or future markets. In light of these
risks and uncertainties, there can be no assurance that the forward-looking
statements contained herein will in fact be realized and we assume no obligation
to update this information.
OVERVIEW
We are a provider of a wide range of Internet hosting and enhanced Internet
services that enable our customers to deploy and manage their Web sites and
network-based applications more effectively than internally developed solutions.
Our hosting services store customers' Web sites, software applications, and data
on servers typically housed in our data centers so that others on the Internet
can access and interact with the customer's Web sites and network-based
applications. Our Web hosting services provide virtual, dedicated and co-
located hosting solutions to meet the needs of businesses of all sizes. We
offer various levels of services for our customers' Web sites as they develop
from low-end marketing brochures to more complex, interactive Web sites and
finally to Web sites that are integral to the operating, marketing and sales and
customer support functions, or mission-critical, of a business. Our application
hosting services consist of groupware hosting and application outsourcing
solutions that can provide our customers with 24 hours a day, seven days a week,
remote access to mission-critical applications and data required by their
businesses. Our consulting services provide our customers with Internet-based
and application hosting solutions, as well as internal networking
implementations and Web development solutions.
During 1998 and 1999, our strategy has been to rapidly acquire operating
companies in the Web hosting, application hosting and consulting services
businesses, to build or acquire data centers, and to integrate the acquired
hosting operations into those data centers. We acquired 19
8
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operating businesses during 1998 and 1999 for total consideration of
approximately $91.6 million, including transaction costs. We have accounted for
all acquisitions using the purchase method of accounting which has resulted in
the inclusion of substantial intangible assets on our balance sheet. Of the
total consideration, we paid $8.2 million of assumed seller debt and have
allocated approximately $(9.7) million to tangible net assets and $93.1 million
to intangible assets which are comprised of covenants not to compete, customer
lists, assembled work force, trade names and goodwill. In accordance with APB
16, an allocation methodology was applied to each acquisition to determine the
value to be assigned to each type of intangible asset where appropriate. Amounts
not allocated to specific intangible assets have been recorded as goodwill.
Recoverability of our investment in intangible assets is dependent on our
ability to operate our businesses successfully and generate positive cash flows
from operations. Annual charges for amortization of intangible assets with
respect to acquisitions completed to date will be approximately $24.7 million
which will result in increased losses or reduced net income. Additionally,
during 1998 we issued stock valued at approximately $2.6 million as compensation
in connection with agreements entered into with sellers of acquired operating
businesses of which $2.5 million has been charged to operations through
September 30, 1999. The purchase consideration for the acquisitions was in the
form of cash, stock or a combination of cash and stock.
Since our inception in December 1997, we have experienced operating losses
and negative cash flows from operating activities for each quarterly and annual
period. As of September 30, 1999, we had an accumulated deficit of
approximately $48.4 million. Had the companies acquired to date been included
since January 1, 1998, our accumulated deficit would have been approximately
$71.4 million. The revenue and income potential of our business is unproven and
our limited operating history makes an evaluation of us and our prospects
difficult. We anticipate increased operating expenses as we:
- expand our sales and marketing initiatives to continue to grow our brands;
- fund greater levels of product development;
- continue to complete and equip our data centers;
- implement centralized billing, accounting and customer service systems;
and
- continue our acquisition program.
Although we have experienced revenue growth, primarily attributable to
acquisitions, we do not believe that this growth is necessarily indicative of
future operating results. Future acquisitions are expected to increase
operating expenses and operating losses and as a result, we expect to continue
to incur operating losses for the foreseeable future. We cannot assure you that
we will ever achieve profitability on a quarterly or annual basis, or, if
achieved, that we will sustain profitability.
RESULTS OF OPERATIONS
We derive our revenues from Web hosting, application hosting, consulting
and other services. Revenues for our Web hosting business consist primarily of
hosting fees and setup fees, which cover costs incurred by us to establish a
customer's Web site. We provide virtual, dedicated and co-located hosting. We
charge our Web hosting customers a fixed amount for bandwidth availability and
incremental fees if those fixed amounts are exceeded. In addition, our virtual
Web hosting customers are also charged for disk space on a server, dedicated
hosting customers are charged for use of one or more dedicated servers and our
co-located customers are charged for the amount of physical space such co-
located customers' servers occupy. We charge flat rates for our enhanced
Internet services. For application hosting, our revenues are comprised
primarily of monthly usage fees per number of end users, including bandwidth
fees. For our consulting services, charges are generally fee-based on time and
materials basis.
Our contracts with our Web hosting customers typically range in length from
month-to-month to one year, a large proportion of which are cancelable by either
party with 30 days' notice.
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Our contracts with our application hosting customers range in length from month-
to-month to three years. Revenues derived from hosting are recognized ratably
over the applicable contractual period. Payments received and billings in
advance of providing services are deferred until such services are provided.
Revenues from consulting services are recognized as the services are rendered.
Substantially all of our consulting contracts call for billings on a time and
materials basis. We are aware that the Staff of the Securities and Exchange
Commission is developing a Staff Accounting Bulletin on the topic of revenue
recognition. There can be no assurance as to what revenue recognition policies
will be required by the Staff when that Bulletin is released. If that Bulletin
requires revenue recognition policies different from those we are currently
using, our results of operations may be affected.
Cost of revenues consists primarily of salaries and related expenses
associated with consulting and network operations personnel as well as data
communications expenses, including one-time fees for circuit installation and
variable recurring circuit payments to network providers. Monthly circuit
charges vary based upon circuit type, distance and usage, as well as the term of
the contract with the carrier.
Sales and marketing expense consists of personnel costs associated with the
direct sales force, the internal telesales group and product marketing
employees, as well as costs associated with marketing programs, product
literature, external telemarketing costs and corporate marketing activities,
including public relations.
General and administrative expense includes the cost of customer service
functions and also includes finance and accounting, human resources, and legal
and executive salaries, corporate overhead, acquisition integration costs, and
fees paid for professional services.
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Service revenues
Service revenues were $12.0 million for the three months ended September
30, 1999, representing an increase of $10.3 million from the comparable 1998
period. The increase in service revenues was due primarily to the 7
acquisitions consummated during the first nine months of 1999.
Cost of Revenues
Cost of revenues increased by $5.6 million to $6.5 million for the three
months ended September 30, 1999. This increase was due primarily to the 7
acquisitions consummated during the first nine months of 1999. In the future,
cost of revenues may fluctuate due to capacity utilization, the timing of
investments in data centers, changes in the mix of services, fluctuations in
bandwidth costs and increased levels of staffing to support anticipated revenue
growth.
Sales and Marketing
Sales and marketing expense increased by $4.3 million to $5.2 million for
the three months ended September 30, 1999. This increase was due primarily to
the 7 acquisitions consummated during the first nine months of 1999. A key
component of our strategy is to significantly increase our sales and marketing
activities. This will include the expansion of our sales force, development of
reseller and referral partner channels and increased marketing efforts to grow
recognition of our brands. As a result, sales and marketing expenses are
expected to increase substantially in future periods to support anticipated
revenue growth.
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General and Administrative
General and administrative expense increased by $6.6 million to $8.5
million for the three months ended September 30, 1999. This increase in general
and administrative expense was attributable to the 7 acquisitions consummated
during the first nine months of 1999, and increased investments in
infrastructure and levels of staffing to implement billing, accounting, human
resources and customer service systems to integrate the operations of acquired
companies. Substantial staffing and related increases are expected to continue
in future periods in order to support anticipated revenue growth.
Depreciation
Depreciation expense increased by $1.8 million to $2.1 million for the
three months ended September 30, 1999. This increase in depreciation expense was
attributable to the 7 acquisitions consummated during the first nine months of
1999, and our investment in equipment, furniture and construction to complete
our data centers in Atlanta, Georgia and Vienna, Virginia. We expect
depreciation expense to increase in the future as we continue to invest in data
centers and systems to integrate future acquisitions and support future growth.
Amortization
Amortization expense increased by $5.2 million to $6.1 million for the
three months ended September 30, 1999. This increase in amortization expense
was attributable to the 7 acquisitions consummated during the first nine months
of 1999. We expect amortization expense to increase in future periods as we
continue to make additional acquisitions as well as reflect amortization of
intangibles associated with acquisitions consummated to date.
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Service revenues
Service revenues were $28.1 million for the nine months ended September 30,
1999, representing an increase of $25.5 million from the comparable 1998 period.
The increase in revenues was due primarily to the 18 acquisitions consummated
during the last three quarters of 1998 and the first nine months of 1999.
On a pro forma basis, giving effect to acquisitions completed to date,
revenues for the nine months ended September 30, 1999 and 1998 were $35.3
million and $32.6 million, respectively. Excluding a one-time sale of
internally developed intellectual property in the amount of $2.0 million in the
1998 period, revenues increased by $4.7 million, or 14.4%. Pro forma revenues
for the Web hosting segment increased approximately $2.8 million, primarily as a
result of increased marketing and advertising efforts. Pro forma revenues for
the consulting segment increased by approximately $1.8 million, driven by higher
professional services headcount due to an increase in the number and size of
client engagements.
For the nine months ended September 30, 1999, on a pro forma basis and
giving effect to acquisitions completed to date:
. Application hosting revenues comprised 40.0% of our revenues;
. Web hosting revenues comprised 34.9% of our revenues;
. Consulting services revenues comprised 18.3% of our revenues; and
. Other services revenues comprised 6.8% of our revenues.
11
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Cost of Revenues
Cost of revenues increased by $14.4 million to $15.9 million for the nine
months ended September 30, 1999. This increase was due primarily to the 18
acquisitions consummated during the last three quarters of 1998 and the first
nine months of 1999. In the future, cost of revenues may fluctuate due to
capacity utilization, the timing of investments in data centers, changes in the
mix of services, fluctuations in bandwidth costs and increased levels of
staffing to support anticipated revenue growth.
On a pro forma basis, giving effect to acquisitions completed to date, cost
of revenues for the nine months ended September 30, 1999 increased by $4.4
million to $19.4 million. The increase is primarily the result of higher
staffing levels and operating costs to support increased revenues.
Sales and Marketing
Sales and marketing expense increased by $9.8 million to $11.2 million for
the nine months ended September 30, 1999. This increase was attributable to the
18 acquisitions consummated during the last three quarters of 1998 and the first
nine months of 1999. A key component of our strategy is to significantly
increase our sales and marketing activities. This will include the expansion of
our sales force, development of reseller and referral partner channels and
increased marketing efforts to grow recognition of our brands. As a result,
sales and marketing expenses will increase substantially in future periods to
support anticipated revenue growth.
On a pro forma basis, giving effect to acquisitions completed to date,
sales and marketing expense for the nine months ended September 30, 1999 and
1998 was $12.9 million and $6.5 million, respectively. Sales and marketing
costs increased by approximately $6.4 million, reflecting higher staffing levels
and increased marketing and advertising activities related to our efforts to
generate service revenue growth.
General and Administrative
General and administrative expense increased by $16.4 million to $20.0
million for the nine months ended September 30, 1999. This increase in general
and administrative expense was attributable to the 18 acquisitions consummated
during the last three quarters of 1998 and the first nine months of 1999, and
increased investments in infrastructure and levels of staffing to implement
centralized billing, accounting, human resources and customer service systems to
integrate the operations of acquired companies. Substantial staffing and
related increases are expected to continue in future periods in order to support
anticipated revenue growth.
On a pro forma basis, giving effect to acquisitions completed to date,
general and administrative expense for the nine months ended September 30, 1999
and 1998 was $23.1 million and $17.4 million, respectively. General and
administrative costs increased by $5.7 million, mainly from increased
investments in infrastructure and levels of staffing to implement billing,
accounting, human resources and customer service systems to integrate the
operations of acquired companies.
Depreciation
Depreciation expense increased by $3.8 million to $4.2 million for the nine
months ended September 30, 1999. The increase in depreciation expense was
attributable to the 18 acquisitions consummated during the last three quarters
of 1998 and the first nine months of 1999 and our investment in equipment,
furniture and construction to complete our data centers in Atlanta, Georgia and
Vienna, Virginia. We expect depreciation expense to increase in the future as
we
12
<PAGE>
continue to invest in data centers and systems to integrate future acquisitions
and support future growth.
On a pro forma basis, giving effect to acquisitions completed to date,
depreciation expense for the nine months ended September 30, 1999 and 1998 was
$4.8 million and $2.6 million, respectively. Depreciation expense increased by
$2.2 million primarily as a result of increased capital expenditures during the
last quarter of 1998 and the first nine months of 1999.
Amortization
Amortization expense increased by $13.6 million to $14.8 million for the
nine months ended September 30, 1999. This increase in amortization expense was
attributable to the 18 acquisitions consummated during the last three quarters
of 1998 and the first nine months of 1999. We expect amortization expense to
increase in future periods as we continue to make additional acquisitions as
well as reflect amortization of intangibles associated with acquisitions
consummated to date.
On a pro forma basis, giving effect to acquisitions completed to date,
amortization expense for the nine months ended September 30, 1999 and 1998 was
$18.5 million for each period.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations and acquisitions primarily from private
placements of equity and our initial public offering of common stock (IPO). We
had $52.6 million in cash and cash equivalents at September 30, 1999. Net cash
used in operations for the nine months ended September 30, 1999 was $15.4
million. This reflects primarily the net loss for the period of $37.5 million
along with changes in operating assets and liabilities, offset by $4.2 million
of depreciation expense and $14.8 million of amortization of goodwill and other
intangible assets and $2.9 million of other non-cash items including provisions
for bad debts and deferred compensation charges. Net cash used for investing
activities for the nine month period ended September 30, 1999 was $31.6 million,
of which $7.9 million was for purchases of furniture, fixtures and equipment,
and $20.5 million was for acquisitions of businesses. Net cash from financing
activities for the nine month period ended September 30, 1999 was $92.8 million,
reflecting $102.5 million of net proceeds from the issuance of common stock and
Series A preferred stock and $1.3 million of proceeds from equipment financing
transactions, less repayment of acquisition-related and other debt of $11.0
million.
In addition to funding ongoing operations and capital expenditures, our
principal commitments consist of non-cancelable operating leases and contingent
payments of earnouts to certain sellers of operating companies acquired by us.
If all earnout targets are achieved in full, total consideration pursuant to all
earnouts will be $1.6 million in cash in 1999 and $5.8 million in cash in 2000.
Certain agreements provide for issuance to stock in lieu of cash at the
Company's option.
During 1998, we constructed a data center in Atlanta into which the
majority of the Web hosting businesses we acquired have been or are being
integrated. We believe that this facility has the capacity to service a larger
number of Web hosting customers than are currently serviced there. The cost of
constructing and equipping this facility was approximately $2.0 million. In
September 1999, we commenced the operations of our Vienna, Virginia data center,
which was designed to provide high-end application hosting services. We expect
the total costs to construct and equip the Vienna, Virginia facility to be
approximately $3.2 million, of which $2.3 million was incurred as of September
30, 1999. We intend to continue investing to construct and equip our data
centers as more operating businesses are acquired and integrated into these
facilities, and as sales and marketing efforts generate internal revenue growth,
requiring additional servers, routers and related equipment. For the nine
months ended September 30, 1999, our capital expenditures totaled $7.9 million.
13
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In June 1999, prior to the completion of our IPO, we entered into a
sale/leaseback transaction whereby certain network and office equipment was
financed under equipment leases payable over thirty-six months, with an
effective interest rate of approximately 14%. As of September 30, 1999 the total
proceeds received by us under this arrangement were approximately $1.3 million.
We anticipate that we can finance future equipment purchases under similar
arrangements, however no assurances can be given that such financing will
continue to be available to us.
At September 30, 1999, restricted cash totaled $1.3 million. In connection
with our acquisition of Interliant Texas, we entered into an Assignment and
Assumption Agreement, dated March 10, 1999, pursuant to which we were assigned
all right, title and interest in and to, and assumed all obligations under, the
lease for one of our primary data centers located in Houston, Texas. In
connection with receiving the landlord's consent to assignment of the lease, we
were required to issue letters of credit in favor of the landlord totaling
approximately $0.6 million to replace the letters of credit previously issued by
Interliant Texas. The aggregate dollar amount which may be drawn upon by the
landlord under these letters of credit shall be reduced at specified dates in
specified amounts such that by August 8, 2000 all of the letters of credit shall
have lapsed. In addition, restricted cash includes approximately $0.5 million
held in escrow in connection with one of our acquisitions and approximately $0.2
million held to secure outstanding letters of credit used as security deposits
on our facilities.
We believe that our existing cash and cash equivalents will be adequate to
meet operating needs through the middle of 2000 and will provide enough funds to
continue our acquisition program through 1999 and into 2000. We are currently
seeking additional financing to provide funds through the end of 2000. We may
also seek to raise additional capital to take advantage of favorable conditions
in the capital markets, however no assurance can be given that we will be
successful in obtaining such financings. We have no credit line under which we
may borrow funds for working capital or other general corporate purposes.
Interest Rate Risk
We have limited exposure to financial market risks, including changes in
interest rates. At September 30, 1999, we had short-term investments of
approximately $49.3 million. These short-term investments consist of highly
liquid investments in debt obligations of highly rated entities with maturities
of between one and 90 days. These investments are subject to interest rate risk
and will fall in value if market interest rates increase. We expect to hold
these investments until maturity, and therefore expect to realize the full value
of these investments, even though changes in interest rates may affect their
value prior to maturity. If interest rates decline over time, this will result
in a reduction of our interest income as our cash is reinvested at lower rates.
YEAR 2000 RISKS
Currently, many computer and software products are coded to accept two-digit
entries in the date code field. These date code fields will need to accept four-
digit entries to distinguish 21st century dates from 20th century dates. As a
result, many companies' software and computer systems, including our own, need
to be upgraded or replaced to a certain extent in order to comply with Year 2000
requirements. We rely on both information technology ("IT") systems and non-IT
systems to conduct our business. Our IT systems include the hardware and
software that enable us to provide and deliver our solutions to customers, as
well as to operate our internal infrastructure systems. Our non-IT systems
include, without limitation, electric power, uninterruptable power supplies and
generators, telecommunications services and equipment, and office equipment used
in the operations of our business. Non-IT systems often include embedded
technology such as microcontrollers. If either our IT systems or our non-IT
systems experience Year 2000-related problems or failures, our operations could
be materially adversely impacted.
14
<PAGE>
Consequently, we have taken and are continuing to take steps designed to ensure
that our systems will be Year 2000 compliant in order to mitigate or materially
decrease the risks associated with Year 2000-related problems and failures.
Our on-going plan to address Year 2000 compliance includes: (i) identifying
all material IT and non-IT systems, (ii) contacting third-party suppliers,
vendors, and licensors of material hardware, software, and services that are
both directly and indirectly related to the delivery of our solutions to
customers, (iii) assessing the significance of those systems and suppliers, and
the risk of a Year 2000-related failure,(iv) remediating, upgrading or replacing
material IT and non-IT systems as needed, (v) quality assurance testing, and
(vi) creating a contingency plan in the event of Year 2000 failures.
As part of our plan, we commissioned a comprehensive independent, third-
party assessment of our IT and non-IT readiness processes. That assessment was
completed in September 1999. The assessment identified numerous problems with
our historical approach and pointed out areas where additional focus and work
were needed. The assessment concluded, in part, that if our continued efforts
were properly conducted during the remainder of the year, then a reasonable Year
2000 state of compliance could be achieved. The assessment also contained a
detailed plan laying out a course of action for the remainder of 1999 and early
2000, which, according to the assesment should, if followed, materially
decrease the potential risks associated with the date change. We are currently
implementing the plan and have no reason to believe that we will not be able to
complete it. However, given the possibility of unforeseen developments or
complications, there is no assurance that we will complete remediation of all
our systems prior to year-end, or that a Year 2000-related failure, if it were
to occur, could not materially adversely affect us.
We have performed and are continuing to perform assessments of the Year
2000 readiness of our information technology systems and our non-IT systems. We
have been informed by our vendors of material hardware and software components
comprising our IT systems that such hardware and software is either currently
Year 2000 compliant, or may be upgraded or remediated to render it compliant.
Our general Year 2000 compliance plan includes upgrading or remediating this
second category of hardware and software. We have sought or are seeking
assurances of Year 2000 compliance from vendors and other providers of our
material non-IT systems. While our assessment is not yet complete, and while we
may not receive responses with respect to all such systems, we have yet to
identify any material non-compliance that we feel can not be rectified by
upgrade or remediation efforts. However, unless and until the assessment and
compilations of responses is complete and unless and until we receive and
compile a full set of responses from such vendors and providers, we will not be
able to make a complete determination as to whether, and to what extent, our IT
and non-IT systems will need to be upgraded or replaced in order to render them
Year 2000 compliant. Accordingly, we may need to revise or replace third party
software, hardware or services incorporated into our material IT and non-IT
systems which could be time consuming and expensive and otherwise materially
affect us. Our failure to fix or replace our software, hardware or services on a
timely basis could result in lost revenues, increased operating costs and the
loss of customers and other business interruptions, any of which could have a
material adverse effect on our business. Moreover, the failure to adequately
address Year 2000 compliance issues relating to our IT and non-IT systems could
result in claims of mismanagement, misrepresentation or breach of contract and
related litigation, which could be costly and time-consuming to defend.
We have also assessed or, in some cases, are currently assessing the
Year 2000 readiness of the hardware and software used to deliver hosting and
Internet services to our customers, including the Web servers and operating
systems on which customer Web sites are hosted. This includes examining the
extent to which such servers and systems may require remediation to be Year 2000
compliant. The information gathered to date has not revealed any material non-
compliant hardware or software that we feel cannot be replaced or remediated.
However, until the assessment is complete, we cannot, with any certainty, make a
determination
15
<PAGE>
as to the full extent of the Year 2000 non-compliance of such Web servers and
systems or the cost of remediating such non-compliance.
Also, there can be no assurance that governmental agencies, utility
companies, telecommunication companies, other Internet service providers, third
party service providers, hardware and software manufacturers and others outside
of our control will be Year 2000 compliant. The failure by such entities and
other third parties to be Year 2000 compliant could result in a systemic failure
beyond our control, such as a prolonged Internet, telecommunications or
electrical failure, which could also prevent us from delivering services to our
customers, decrease the use of the Internet or prevent users from accessing the
Web sites of our customers. Any of these occurrences could have a material
adverse effect on our business.
To date we have incurred approximately $0.3 million in connection with
identifying, evaluating and remediating Year 2000 issues. Most of the expenses
we have incurred thus far relate to the internal staffing costs associated with
the evaluation process and Year 2000 compliance matters generally. We currently
estimate that the total cost of our efforts including additional staffing,
revisions to our software and systems to the extent such revisions are required,
and the cost of upgrading or replacing third party software, hardware or
services that are ultimately determined not to be Year 2000 compliant will be
approximately $1.5 million. This is a forward-looking statement, however, and
is based on the results to date of our assessment and remediation program. As
we continue, or if unexpected problems are discovered or the costs involved in
our process exceed our current estimates, we may have to incur additional
expenses, which, if material could have a material adverse effect on our
business.
We have undertaken and substantially completed a business continuity
contingency plan for material business processes. The plan documents critical
business processes, and the sequence of events that initiate implementation of a
continuity plan. The completed plan is in the process of being implemented
across the Company. When implemented, the plan is designed to significantly
decrease the likelihood that we suffer material interruptions in our business
operations or the provision of services to our customers, however, there is no
assurance that the plan will be effective or properly implemented.
Despite our efforts to implement and manage an appropriate Year 2000
readiness program there can be no assurances that we will timely identify and
remedy all Year 2000 issues, and accordingly that business will not be
materially adversely affected by Year 2000 problems.
16
<PAGE>
PART II. OTHER INFORMATION
INTERLIANT, INC.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(c) In the nine months ended September 30, 1999, options to purchase 644,300
shares of Common Stock were exercised at a weighted average exercise price of
$0.24 per share.
(d) Use of Proceeds from Sales of Registered Securities.
On July 13, 1999, we completed an IPO of our common stock pursuant to the
Registration Statement whereby we sold all of the 8,050,000 shares of common
stock, including 1,050,000 shares sold pursuant to the underwriters' over-
allotment option. The offering price was $10.00 per share for an aggregate price
of $80.5 million, before underwriters' discounts and commissions and offering
costs payable by us. From the effective date of the Registration Statement to
November 1, 1999, we paid an aggregate of $5.6 million in underwriting discounts
and commissions, and approximately $2.0 million of IPO expenses. After deducting
the underwriting discounts and commissions and the IPO expenses payable directly
by us, net proceeds from the IPO were approximately $72.9 million.
As of September 30, 1999, we used net proceeds of the IPO as follows:
. $8.0 million for repayment in full of a 9% promissory note issued in
connection with the acquisition of Interliant Texas.
. $2.4 million for repayment in full of a promissory note, bearing
interest at the prime rate, issued in connection with the acquisition
of Advanced Web Creations, Inc.
. $0.7 million in connection with the acquisition of Sales Technology
Limited.
. $4.7 million for capital expenditures, including data centers; and
. $4.5 million for working capital.
The balance of the net proceeds of the IPO will be used for acquisitions,
capital expenditures, including completing and equipping our data centers, and
working capital and general corporate purposes.
ITEM 5. OTHER INFORMATION.
For information concerning acquisitions refer to Footnote 4 to the
Condensed Consolidated Financial Statements for the nine months ended
September 30, 1999, included in Part I of this Form 10-Q and incorporated
herein by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a.) Exhibits -
Exhibit 27 - Financial Data Schedule (for SEC Use Only)
(b.) Reports on Form 8-K
Current Report on Form 8-K dated September 14, 1999, which
reported the acquisition of Sales Technology Limited.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Interliant, Inc.
Date: November 11, 1999 /s/ James M. Lidestri
----------------------------------
James M. Lidestri
President
Date: November 11, 1999 /s/ William A. Wilson
----------------------------------
William A. Wilson
Chief Financial Officer
Date: November 11, 1999 /s/ Paul E. Chollett
----------------------------------
Paul E. Chollett
Senior Vice President, Finance and
Chief Accounting Officer
18
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<PAGE>
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
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</LEGEND>
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
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