<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] 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: 000-27269
BREAKAWAY SOLUTIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 04-3285165
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION )
50 ROWES WHARF
BOSTON, MASSACHUSETTS 02110
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(617) 960-3400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
There were 46,154,015 shares of the Registrant's common stock, $0.000125 par
value per share, outstanding on October 31, 2000.
<PAGE>
BREAKAWAY SOLUTIONS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS FORM 10-Q
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at December 31, 1999
and September 30, 2000 3
Consolidated Statements of Operations for the three months and nine months
ended September 30, 1999 and September 30, 2000 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and September 30, 2000 5
Consolidated Statements of Comprehensive Income for the
three months and nine months ended September 30, 1999 and September 30, 2000 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities and Use of Proceeds 24
Item 3. Defaults upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURE 25
</TABLE>
<PAGE>
Form 10Q Page 3 of 26
BREAKAWAY SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE-RELATED AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1999 2000
---------------- -----------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $3,920 $38,125
Short-term investments 28,227 2,092
Accounts receivable, net of allowance for doubtful accounts of $357 in
1999 and $2,189 in 2000, respectively 7,559 17,998
Accounts receivable from related parties 3,991 10,224
Unbilled revenues on contracts 725 1,450
Prepaid expenses and other current assets 2,548 4,208
------------------ -------------------
Total current assets 46,970 74,097
Investments 9,705 6,543
Restricted cash -- 2,777
Property and equipment, net 7,541 36,459
Intangible assets, net of accumulated amortization 6,170 228,141
Deferred costs, net of accumulated amortization 6,011 87,001
Loan to officer -- 1,041
Loans to employees 568 602
Other assets 496 2,320
------------------ -------------------
Total assets $77,461 $438,981
================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit -- $10,000
Due to stockholders - current portion $625 1,625
Capital lease obligations - current portion 533 1,282
Accounts payable 2,955 7,346
Accrued compensation and related benefits 1,477 2,100
Accrued expenses 1,306 4,445
Deferred revenue 224 618
------------------ -------------------
Total current liabilities 7,120 27,416
------------------ -------------------
Due to stockholders - long-term portion 1,625 892
Due to investors -- 1,050
Capital lease obligations - long-term portion 376 1,801
Deferred income tax liabilities -- 27,676
------------------ -------------------
Total long-term liabilities 2,001 31,419
------------------ -------------------
Total liabilities 9,121 58,835
------------------ -------------------
Commitments and Contingencies
Stockholders' Equity:
Common stock, $0.000125 par value, 80,000,000 shares authorized; 37,889,084
shares and 49,143,047 shares issued in 1999 and 2000, respectively, and
34,778,684 shares and 46,032,647 shares outstanding in 1999 and
2000, respectively 4 6
Additional paid-in capital 78,868 430,492
Less: deferred compensation (253) (199)
Less: treasury stock, at cost -- --
Accumulated deficit (10,367) (50,448)
Accumulated other comprehensive income 88 295
------------------ -------------------
Total stockholders' equity 68,340 380,146
------------------ -------------------
Total liabilities and stockholders' equity $77,461 $438,981
================== ===================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Form 10Q Page 4 of 26
BREAKAWAY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(UNAUDITED) (UNAUDITED)
1999 2000 1999 2000
--------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Revenue, including revenue from related parties $7,181 $34,601 $14,786 $87,927
of $1,296 for both the three months and nine
months ended September 30, 1999, and $14,431
and $33,730 for the three months and nine
months ended September 30, 2000,
respectively
Operating expenses:
Project personnel costs 3,421 17,791 7,080 41,835
Selling, general and administrative 7,375 22,130 13,516 55,764
Amortization of deferred costs 443 6,115 570 14,149
Amortization of goodwill and intangible
assets 443 12,506 637 23,941
--------------- --------------- ---------------- ----------------
Total operating expenses 11,682 58,542 21,803 135,689
--------------- --------------- ---------------- ----------------
Operating loss (4,501) (23,941) (7,017) (47,762)
Other income (expense):
Other income 7 501 1 501
Interest income 129 567 188 1,471
Interest expense (101) (132) (155) (356)
Gain on disposal of equipment -- -- -- 16
--------------- --------------- ---------------- ----------------
Total other income 35 936 34 1,632
--------------- --------------- ---------------- ----------------
Loss before benefit for income taxes (4,466) (23,005) (6,983) (46,130)
Deferred income tax benefit -- 3,050 -- 6,050
--------------- --------------- ---------------- ----------------
Net loss $ (4,466) $(19,955) $ (6,983) $(40,080)
=============== =============== =============== ================
Net loss per share:
Basic and diluted $ (0.33) $(0.48) $ (0.65) $ (1.01)
=============== =============== ================ ================
Weighted average shares outstanding:
Basic and diluted 13,698 41,946 10,699 39,689
=============== =============== ================ ================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Form 10Q Page 5 of 26
BREAKAWAY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1999 2000
-------------- ---------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,983) $ (40,080)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 1,882 43,712
Deferred tax benefit -- (6,050)
Compensation expense for issuance of common stock options 223 54
Change in operating assets and liabilities:
Accounts receivable (2,090) (7,641)
Accounts receivable from related parties (323) (5,501)
Unbilled revenue on contracts (3,116) (632)
Prepaid expenses and other current assets (1,977) (3,371)
Accounts payable 2,519 3,533
Accrued compensation and related benefits 1,287 585
Accrued expenses 3,222 (2,600)
Deferred revenue (79) 394
-------------- ---------------
Net cash used in operating activities (5,435) (17,597)
-------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash acquired in acquisition of businesses -- 3,822
Cash paid for acquired businesses net of cash acquired (2,103) --
Sale of investments -- 26,700
Purchases of property and equipment (3,939) (28,059)
Increase in due to investors -- 1,050
-------------- ---------------
Net cash (used in) provided by investing activities (6,042) 3,513
-------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock 23,289 --
Proceeds from issuance of common stock -- 39,000
Payments to stockholders (2,769) (1,733)
Proceeds from exercise of stock options 507 2,853
Borrowings (repayments) on credit line (426) 10,000
Issuance of note payable to stockholder 4,000 --
Repurchase and retirement of common stock (4,469) --
Loans to officer and employees (553) (1,073)
Payments of note payable (38) (180)
Payments on current portion of long-term debt (142) --
Payments of capital lease obligation (192) (606)
-------------- ---------------
Net cash provided by financing activities 19,207 48,261
-------------- ---------------
EFFECT OF EXCHANGE RATE ON CASH AND CASH EQUIVALENTS -- 28
-------------- ---------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 7,730 34,205
CASH AND CASH EQUIVALENTS, AT BEGINNING OF PERIOD 17 3,920
-------------- ---------------
CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 7,747 $ 38,125
============== ===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 99 $ 371
============== ===============
Conversion of notes payable and accrued interest to
stockholder for common stock $ 4,053 --
============== ===============
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock and stock options in connection with acquisition of
businesses $ 9,193 $ 309,772
============== ===============
Capital lease obligations $ 100 $ 2,772
============== ===============
ACQUISITION OF BUSINESSES:
Cash acquired $ -- $3,822
Other assets acquired 16,358 348,694
Liabilities assumed (4,299) (42,744)
Common stock and stock options issued (9,956) (309,772)
-------------- ---------------
Net cash paid in acquisition of businesses (2,103) $ --
============== ===============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Form 10Q Page 6 of 26
BREAKAWAY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(UNAUDITED) (UNAUDITED)
1999 2000 1999 2000
------------- -------------- ------------ ------------
<S> <C> <C> <C> <C>
Net loss $(4,466) $(19,955) $(6,983) $(40,080)
Other comprehensive income:
Change in unrealized gain on investments -- (2) -- 179
Foreign currency translation adjustment -- 28 28
------------- -------------- ------------ -----------
Comprehensive income $(4,466) $(19,929) $(6,983) $(39,873)
============= ============== ============ ============
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance, beginning of period -- $ 269 -- $ 88
Change in period -- 26 -- 207
------------- -------------- ------------ -----------
Balance, end of period -- $ 295 -- $ 295
============= ============== ============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Form 10Q Page 7 of 26
BREAKAWAY SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
by Breakaway Solutions, Inc. (the "Company") pursuant to the rules and
regulations of the Securities and Exchange Commission regarding interim
financial reporting. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements and should be read in conjunction with the consolidated
financial statements and notes thereto for the year ended December 31, 1999, and
the Company's 1999 Annual Report on Form 10-K filed with the Securities and
Exchange Commission. The accompanying financial statements include all
adjustments (consisting of normal, recurring adjustments) which are, in the
opinion of management, necessary for a fair presentation of results for the
interim periods presented. The results of operations for the three month and
nine month periods ended September 30, 2000 are not necessarily indicative of
the results to be expected for any future period or the full fiscal year.
On March 6, 2000, the Board of Directors approved a two-for-one stock dividend
distributed on March 23, 2000 to shareholders of record as of March 7, 2000. All
share data shown in the accompanying consolidated financial statements have been
retroactively restated to reflect this stock split.
In December 1999, the Company formed Breakaway Capital I LLC ("Breakaway
Capital") a wholly owned venture capital fund, for the primary purpose of
making minority interest investments in clients. The Company intends to make
total investments of approximately $5.0 million through Breakaway Capital.
The Company intends to distribute approximately 50% of the profits earned by
Breakaway Capital to certain employees who are not executive officers of the
Company. As of September 30, 2000, Breakaway Capital had invested
approximately $3.6 million.
In March 2000, the Company formed Breakaway Friends I LLC ("Breakaway Friends"),
to allow executive officers of the Company to invest their own personal funds in
the same clients as Breakaway Capital. The Company intends to distribute all the
profits earned by Breakaway Friends to its individual investors.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NET INCOME (LOSS) PER SHARE
The provisions of Statement of Financial Accounting Standards No. 128, "Earnings
per Share" ("SFAS 128") require the presentation of basic and diluted net income
(loss) per share for all periods presented. The Company was in a net loss
position for the three months and nine months ended September 30, 1999 and
September 30, 2000. Therefore, common stock equivalents of 15,008,773 and
13,745,806 for the three months and nine months ended September 30, 1999,
respectively, and 21,409,855 and 18,864,135 for the three months and nine months
ended September 30, 2000, respectively, were excluded from the diluted loss per
share calculation as they would have been antidilutive. As a result, diluted
loss per share is the same as basic loss per share, and has not been presented
separately.
NOTE 3 - NEW ACCOUNTING STANDARDS
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101, "Revenue Recognition" ("SAB 101"). This bulletin,
as amended, established guidelines for revenue recognition and originally was
effective for periods beginning after March 15, 2000. In June 2000, the SEC
announced that the effective date of SAB 101 was being delayed until no later
than the quarter ending December 31, 2000. The Company does not expect that the
adoption of the guidance required by SAB 101 will have a material impact on its
financial condition or results of operations.
<PAGE>
Form 10Q Page 8 of 26
BREAKAWAY SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2000
(UNAUDITED)
On July 1, 2000, the Company adopted Financial Accounting Standards Board
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation", an interpretation of APB Opinion No. 25, "Accounting for Stock
Issued to Employees". This interpretation clarified, among other issues: (a) the
definition of an employee for purposes of applying Opinion 25, (b) the criteria
for determining whether a stock ownership plan qualifies as noncompensatory, (c)
the accounting implications of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for the exchange
of stock compensation awards in a business combination. The effects of applying
the Interpretation are recognized on a prospective basis. The adoption did not
have a material impact on the Company's financial condition or results of
operations.
In September 2000, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, a
replacement of FASB Statement No. 125". ("FAS No. 140"). This pronouncement
is effective for all reporting periods beginning after March 31, 2001. The
Company does not believe that the adoption of FAS No. 140 will have a
material impact on its financial condition or results of operations.
NOTE 4 - ACQUISITIONS
Effective February 18, 2000, the Company acquired DataCyr Corporation
("DataCyr"), a software development company for 110,000 shares of Breakaway
common stock. Of these shares, approximately 85% are owned by individuals who
are now employed by Breakaway. These shares are subject to Breakaway's right,
which lapses incrementally over a four-year period, to repurchase the shares
from the applicable employees for a nominal amount upon the resignation of
such employee or on Breakaway's termination of the employee for cause. The
acquisition was accounted for using the purchase method of accounting.
Effective April 1, 2000, the Company acquired Eggrock Partners, Inc., a full
service consulting and systems integration firm that focuses on delivering
customer-centered business solutions to emerging enterprises. The total
consideration for this acquisition was 7,272,000 shares of Breakaway common
stock. Of these shares, 6,176,331 shares were issued to Eggrock stockholders
and 1,095,669 shares were reserved for issuance to Eggrock option holders.
Eggrock options were converted into options to acquire Breakaway common stock
on the same basis as Eggrock stock was converted into the right to receive
Breakaway common stock. Of the shares of common stock issued to former
Eggrock stockholders at closing, who are now employees of the Company,
approximately 30.5% of these shares are subject to Breakaway's right, which
lapses incrementally over a four year period, to repurchase the shares from
the employees for a nominal amount upon the resignation of such employee or
on the Company's termination of the employee for cause. The Company accounted
for this acquisition using the purchase method of accounting, which resulted
in approximately $305 million of intangible assets and deferred costs, which
will be amortized over a three to five year period, and $30 million of
deferred tax liability.
The following unaudited pro forma consolidated results of operations gives
effect to the acquisition of Eggrock as if it occurred at the beginning of 2000.
Such pro forma consolidated financial information reflects certain adjustments,
including amortization of goodwill and deferred costs, income tax effects and an
increase in the weighted average shares. This pro forma information does not
necessarily reflect the results of operations that would have occurred had the
acquisition taken place at the beginning of 2000 and is not necessarily
indicative of results that may be obtained in the future (in thousands except
per share amounts):
<TABLE>
<S> <C>
Revenue $ 93,773
Net loss $(43,087)
Net loss per share $ (1.09)
Weighted average common shares outstanding 41,109
</TABLE>
Effective July 28, 2000, the Company acquired all of the issued and
outstanding share capital of Zartis.com Limited ("Zartis"), a Dublin,
Ireland-based e-business consultancy. Zartis is a full service consulting and
systems integration firm that focuses on delivering customer-centered
e-business solutions to emerging enterprises. As consideration for the share
purchase, the Company issued 430,456 shares of common stock, assumed 64,441
outstanding options and issued a note payable of $2 million to the former
Zartis shareholders. Of the shares
<PAGE>
Form 10Q Page 9 of 26
BREAKAWAY SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2000
(UNAUDITED)
of the common stock issued to the former Zartis shareholders, who are now
employees of the Company, approximately 75% are subject to Breakaway's right,
which lapses incrementally over a four year period, to repurchase the shares
from the employees for a nominal amount upon the resignation of such employee
or on the Company's termination of the employee for cause. The Company
accounted for this acquisition using the purchase method of accounting, which
resulted in approximately $19.5 million of intangible assets and deferred
costs, which will be amortized over a three to five year period, and $1.5
million of deferred tax liability.
Effective August 11, 2000, the Company acquired all of the issued and
outstanding share capital of Norsec, Inc. ("Norsec"), a Massachusetts based
e-business security consultancy. The Company believes that this acquisition
will allow it to enhance and expand its service offerings in the Application
and Web Hosting business. As consideration for the share purchase, the
Company issued 273,019 shares of our common stock to the former Norsec
shareholders and assumed 30,299 outstanding options. Of the shares of the
common stock issued to the former Norsec shareholders, who are now employees
of the Company, approximately 75% are subject to Breakaway's right, which
lapses incrementally over a four year period, to repurchase the shares from
the employees for a nominal amount upon the resignation of such employee or
on the Company's termination of the employee for cause. The Company accounted
for this acquisition using the purchase method of accounting, which resulted
in approximately $7.8 million of intangible assets and deferred costs, which
will be amortized over a three to five year period, and $2.3 million of
deferred tax liability.
NOTE 5 - RELATED PARTY TRANSACTIONS
INTERNET CAPITAL GROUP
As of September 30, 2000, Internet Capital Group beneficially owned
approximately 32.8% of the outstanding shares of Breakaway common stock.
Subsequent to June 30, 1999, the Company began providing services to Internet
Capital Group and some of Internet Capital Group's affiliated entities.
During both the three months and nine months ended September 30, 1999,
revenues derived from engagements with Internet Capital Group and its
affiliates totaled $1.3 million. During the three months and nine months
ended September 30, 2000, total revenues derived from engagements with
Internet Capital Group and its affiliates were approximately $14.2 million
and $32.8 million, respectively. Accounts receivable from Internet Capital
Group and its affiliates totaled $4.0 million and $10.1 million at December
31, 1999 and September 30, 2000, respectively.
KATALYST LLC
During the fourth quarter of 1999, the Company made an investment in Katalyst
LLC of $3.0 million, and made a secured loan to Katalyst LLC of $0.8 million,
which has been recorded as a note receivable. During the three months and
nine months ended September 30, 2000, total revenues derived from engagements
with Katalyst LLC and its affiliates were approximately $34,000 and $0.4
million, respectively.
MEDIABRIDGE TECHNOLOGIES, INC
The Chief Executive Officer of the Company, Gordon Brooks, currently is a member
of the Board of Directors of MediaBridge Technologies, Inc. ("MediaBridge"), a
customer of the Company. The Chairman of the Board of Directors of the Company,
Christopher H. Greendale, also serves as the Chairman of the Board of Directors
of MediaBridge. In addition, in May 2000, Breakaway Capital purchased
approximately $500,000 of MediaBridge common stock, which represents less than
1% of the common stock outstanding. During the three months and nine months
ended September 30, 2000, total revenues derived from engagements with
MediaBridge were approximately $0.2 million and $0.5 million, respectively.
Accounts receivable from MediaBridge totaled $123,000 at September 30, 2000.
<PAGE>
Form 10Q Page 10 of 26
BREAKAWAY SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2000
(UNAUDITED)
NOTE 6 - OPERATING SEGMENTS
Historically, the Company has operated in a single segment: Strategy and
Internet Consulting Services. With the acquisitions of Applica and Web Yes,
Inc. in 1999, the Company expanded its operations to include a second
segment: Application and Web Hosting Services, whose operations were
immaterial prior to the third quarter of 1999. Revenues totaled $0.7 million
and $0.8 million for the three months and nine months ended September 30,
1999, respectively. Net loss was $0.9 million and $1.5 million for the three
months and nine months ended September 30, 1999, respectively.
The following tables sets forth certain components of the Application and Web
Hosting Services and the Strategy and Internet Consulting Services segments
as of and for the three months and nine months ended September 30, 2000 (in
thousands):
THREE MONTHS ENDED SEPTEMBER 30, 2000 (UNAUDITED):
<TABLE>
<CAPTION>
STRATEGY AND
APPLICATION AND INTERNET
WEB HOSTING CONSULTING
SERVICES SERVICE TOTAL
-------------- ------------ --------
<S> <C> <C> <C>
Revenue $7,594 $27,007 $34,601
Depreciation expense 1,398 1,320 2,718
Net loss (2,448) (17,507) (19,955)
Capital additions 4,822 6,771 11,593
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 2000 (UNAUDITED):
<TABLE>
<CAPTION>
STRATEGY AND
APPLICATION AND INTERNET
WEB HOSTING CONSULTING
SERVICES SERVICE TOTAL
-------------- ------------ --------
<S> <C> <C> <C>
Revenue $15,553 $72,374 $87,927
Depreciation expense 2,898 2,724 5,622
Net loss (4,230) (35,850) (40,080)
Capital additions 14,685 13,374 28,059
</TABLE>
Substantially all of the Company's assets are located within the United
States. At September 30, 1999, of the Company's total assets, $6.3 million
are specifically related to the Application and Web Hosting business, $7.5
million are specifically related to the Strategy and Internet Consulting
business, and the remaining $26.0 million are general corporate assets. At
September 30, 2000, $28.7 million are specifically related to the Application
and Web Hosting business, $91.5 million are specifically related to the
Strategy and Internet Consulting business, and the remaining $318.8 million
are general corporate assets.
During the three and nine months ended September 30, 1999, one customer
accounted for approximately 66% and 57%, respectively, of the Company's
Application and Web Hosting Business. During the three months ended September
30, 1999, one customer accounted for approximately 11% of the Company's
Strategy and Internet Consulting Services revenue. During the nine months
ended September 30, 1999, one customer accounted for approximately 11% of the
Company's Strategy and Internet Consulting Services revenue.
During the three months ended September 30, 2000, two customers accounted for
approximately 26% and 11% of the Company's Application and Web Hosting
Services revenue and no customer accounted for more than 10% of the Company's
Strategy and Internet Consulting Services revenue. During the nine months
ended September 30, 2000, one customer accounted for approximately 17% of the
Company's Application and Web Hosting Services.
<PAGE>
Form 10Q Page 11 of 26
BREAKAWAY SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2000
(UNAUDITED)
revenue and one customer accounted for approximately 15% of the Company's
Strategy and Internet Consulting Services revenue.
NOTE 7 - SUBSEQUENT EVENTS
In October 2000, the Company, along with ICG Asiaworks, an entity owned by
Internet Capital Group, Hutchinson Whampoa, and Li Ka-shing Foundation,
established Breakaway Asia Pacific. This new entity is expected to provide
services similar to those provided by the Company in the Asia Pacific market,
other than Japan. In exchange for use of the Company's intellectual property,
the Company received a 19.9% ownership interest in Breakaway Asia Pacific.
The Company will account for this investment using the equity method of
accounting, as the Company will be able to exert significant influence over
the operations of the investee.
In October 2000, the Company announced a restructuring, which included a
reduction in staff of approximately 9% of the total employees at September
30, 2000. The costs associated with this restructuring will be recorded as
period costs during the fourth quarter of 2000.
<PAGE>
Form 10Q Page 12 of 26
BREAKAWAY SOLUTIONS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
During the third quarter, we expanded our market presence geographically
through the acquisition of Zartis.com Limited, a Dublin, Ireland-based
professional services company. We also added depth to the features and
functionality of our application hosting business through the acquisition of
Norsec, Inc., an Internet security company.
In October 2000, the Company announced a restructuring, which included a
reduction in staff of approximately 9% of the total employees at September
30, 2000. The costs associated with this restructuring will be recorded as
period costs during the fourth quarter of 2000.
RESULTS OF OPERATIONS
REVENUES
REVENUES. Revenues for the three months ended September 30, 2000 increased by
$27.4 million, or 381.8%, to $34.6 million from $7.2 million for the third
quarter ended September 30, 1999. The increase was due to greater market demand
for Internet professional services, which generated $27.0 million, or 78.1%, of
our total revenues for the three months ended September 30, 2000, as compared to
$6.5 million, or 90.5%, of total revenues for the three months ended September
30, 1999. The increase was also due to increased demand for our application
hosting services, which generated $7.6 million, or 21.9%, of our total revenues
for the three months ended September 30, 2000, as compared to $0.7 million, or
9.5%, of total revenues for the three months ended September 30, 1999.
Revenues for the nine months ended September 30, 2000 increased by $73.1
million, or 494.7%, to $87.9 million from $14.8 million for the nine months
ended September 30, 1999. The increase was due primarily to our acquisition
of Eggrock Partners, as well as greater market demand for Internet
professional services, which generated $72.4 million, or 82.3%, of our total
revenues for the nine months ended September 30, 2000, as compared to $14.0
million, or 94.7%, of total revenues for the nine months ended September 30,
1999. The increase was also due to increased demand for our application
hosting services, which generated $15.6 million, or 17.7%, of our total
revenues for the nine months ended September 30, 2000, as compared to $0.8
million, or 5.3%, of total revenues for the nine months ended September 30,
1999.
OPERATING EXPENSES
PROJECT PERSONNEL COSTS. Project personnel costs for the three months ended
September 30, 2000 increased by $14.4 million, or 420.9%, to $17.8 million
from $3.4 million for the three months ended September 30, 1999. This
increase was primarily due to an increase in the number of employees hired
and subcontractor costs incurred to deliver client services. Project
personnel costs represented 51.4% of revenues for the three months ended
September 30, 2000, as compared to 47.6% of revenues for the three months
ended September 30, 1999. This percentage increase was primarily due to
the costs associated with our growing employee base, which grew at a higher
rate than our revenues.
Project personnel costs for the nine months ended September 30, 2000
increased by $34.7 million, or 490.9%, to $41.8 million from $7.1 million for
the nine months ended September 30, 1999. This increase was primarily due to
an increase in the number of employees hired and subcontractor costs incurred
to deliver client services. Project personnel costs represented 47.6% of
revenues for the nine months ended September 30, 2000, which approximates
47.9% of revenues for the nine months ended September 30, 1999.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses for the three months ended September 30, 2000 increased $14.7
million, or 200.1%, to $22.1 million from $7.4 million for the three months
ended September 30, 1999. This increase was primarily due to an increase in
salaries and related costs for new employees, depreciation expense on capital
equipment in connection with the growth in our application hosting business,
and rent and related costs associated with the growth in our facilities. As a
percentage of revenues, selling, general and administrative expenses
decreased from 102.7% for the three months ended September 30, 1999 to 64.0%
for the three months ended September 30, 2000. The decrease in 2000 was
primarily due to economies of scale associated with the growth of the
Company's operations. Selling, general and administrative expenses incurred
relating to our application hosting
<PAGE>
Form 10Q Page 13 of 26
BREAKAWAY SOLUTIONS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS-CONTINUED
service line were $5.5 million for the three months ended September 30, 2000
compared to $1.1 million for the three months ended September 30, 1999.
Selling, general and administrative expenses incurred relating to bad debt
expense were $0.1 million for the three months ended September 30, 2000.
There was no bad debt expense incurred for the three months ended September
30, 1999.
Selling, general and administrative expenses for the nine months ended
September 30, 2000 increased $42.3 million, or 312.6%, to $55.8 million from
$13.5 million for the nine months ended September 30, 1999. This increase was
primarily due to an increase in salaries and related costs for new employees,
depreciation expense on capital equipment in connection with the growth in
our application hosting business, and rent and related costs associated with
the growth in our facilities. As a percentage of revenues, selling, general
and administrative expenses decreased from 91.4% for the nine months ended
September 30, 1999 to 63.4% for the nine months ended September 30, 2000. The
decrease in 2000 was primarily due to economies of scale associated with the
growth of the Company's operations. Selling, general and administrative
expenses incurred relating to our application hosting service line were $11.5
million for the nine months ended September 30, 2000 and $1.6 million for
the nine months ended September 30, 1999. Selling, general and administrative
expenses incurred relating to bad debt expense were $2.3 million for the nine
months ended September 30, 2000 as compared to $0.1 million for the nine
months ended September 30, 1999. This increase was primarily due to increased
revenues.
NON-CASH CHARGES. Amortization of deferred costs, goodwill and intangible
assets for the three months ended September 30, 2000 increased $17.6 million
to $18.6 million from $0.9 million for the three months ended September 30,
1999. This increase was attributable to amortization related to intangible
assets recorded upon the acquisitions of DataCyr Corporation, Eggrock
Partners, Inc., Norsec, Inc., and Zartis.com, Limited. We amortize deferred
costs and intangible assets over their estimated useful lives, ranging from
three to five years. When combined, these expenses represented 53.8% of
revenues for the three months ended September 30, 2000.
Amortization of deferred costs, goodwill and intangible assets for the nine
months ended September 30, 2000 increased $36.9 million to $38.1 million for
the first nine months ended September 30, 2000 from $1.2 million for the nine
months ended September 30, 1999. This increase was attributable to
amortization related to intangible assets recorded upon the acquisitions of
Applica Corporation, WPL Laboratories, Inc., Web Yes, Inc., DataCyr
Corporation, Eggrock Partners, Inc., Norsec, Inc., and Zartis.com, Limited.
When combined, these expenses represented 43.3% of revenues for the nine
months ended September 30, 2000.
OTHER INCOME. Other income (expense) for the three months ended September 30,
2000 increased to $0.9 million from $35,000 for the three months ended
September 30, 1999. Other income (expense) for the nine months ended
September 30, 2000 increased to $1.6 million from $34,000 for the nine months
ended September 30, 1999. These increases were mainly attributable to
interest income earned on the proceeds from the Company's initial public
offering of Breakaway common stock in October 1999, interest income earned on
the proceeds from the Company's private placement of 1,500,000 shares of
common stock in May 2000, and $0.5 million of proceeds received for a legal
settlement in September 2000.
DEFERRED TAX BENEFIT. During the three months and nine months ended September
30, 2000, the Company recognized a deferred tax benefit of $3.1 million and
$6.1 million, respectively. This tax benefit is associated with the
amortization of deferred costs related to the acquisition of Eggrock
Partners, Inc., Norsec, Inc., and Zartis.com Limited.
<PAGE>
Form 10Q Page 14 of 26
BREAKAWAY SOLUTIONS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS-CONTINUED
LIQUIDITY AND CAPITAL RESOURCES
From inception through December 31, 1998, we funded our operations primarily
through cash provided by operations and through a line of credit with a bank.
In 1999, we funded our operations through the issuance of preferred and
common stock, and to a lesser extent, through a line of credit and equipment
leases with a bank. In October 1999, the Company issued and sold 6,900,000
shares of common stock in our initial public offering, the net proceeds of
which were approximately $42.0 million. In May 2000, the Company issued and
sold 1,500,000 shares of its common stock through a private placement to five
mutual funds managed by either Putnam Investment Management, Inc. or The
Putnam Advisory Company, Inc., the net proceeds of which were approximately
$39.0 million. The proceeds of these offerings are being used for general
corporate purposes.
In September 2000, we entered into an agreement with FleetBoston to increase our
working capital line of credit from $3 million to $10 million. At September 30,
2000, there was $10 million outstanding on this line of credit.
Our cash and cash equivalents, short-term investments and restricted cash
balance was $43.0 million as of September 30, 2000 and $32.2 million at December
31, 1999. Our working capital balance was $46.7 million as of September 30, 2000
and $39.9 million at December 31, 1999.
Cash used in operating activities was $17.6 million for the nine months
ending September 30, 2000 as compared to $5.4 million for the nine months
ended September 30, 1999. This cash was used primarily to support costs
associated with the Company's growth in personnel and facilities.
Cash provided by investing activities was $3.5 million for the nine months
ending September 30, 2000 as compared to cash used of $6.0 million for the
nine months ended September 30, 1999. This cash was primarily provided by the
sale of investments, offset by purchases of property and equipment.
Cash provided by financing activities was $48.3 million for the nine months
ending September 30, 2000 as compared to $19.2 million for the nine months
ended September 30, 1999. Cash provided was primarily attributable to the
private placement of the Company's common stock in May 2000 and $10.0 million
of borrowings on the Company's newly increased working capital line of credit.
We have various equipment lease financing facilities. The terms of these
equipment lease financings average two years. The annual interest rates on
borrowings range from 12.7% to 13.3%.
Our accounts receivable relative to our revenues has decreased from 115.7% for
the fourth quarter of 1999 to 85.8% for the third quarter of 2000. This decrease
was due primarily to improvements in our billing and collection process.
We believe that the proceeds from our private placement and cash flow from
operations, based upon our current business plan, will be sufficient to
finance our funding requirements for the foreseeable future. There can be no
assurance, however, that our actual needs will not exceed expectations or
that we will be able to fund our operations in the absence of other sources.
If additional funding is required, we may seek this through the debt or
equity markets. There can be no assurance that any additional required
financing will be available through additional bank borrowings, debt or
equity offerings or otherwise, or that if such financing is available, that
it will be available on terms acceptable to us.
<PAGE>
Form 10Q Page 15 of 26
BREAKAWAY SOLUTIONS, INC.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 that are subject to a number of risks and
uncertainties. All statements, other than statements of historical facts
included in this Quarterly Report on Form 10-Q, regarding our strategy, future
operations, financial position, estimated revenues, projected costs, prospects,
plans and objectives of management are forward-looking statements. When used in
this Quarterly Report on Form 10-Q, the words "will", "believe", "anticipate",
"intend", "estimate", "expect", "project" and similar expressions are intended
to identify forward-looking statements, although not all forward-looking
statements contain these identifying words. We cannot guarantee future results,
levels of activity, performance or achievements and you should not place undue
reliance on our forward-looking statements. Our forward-looking statements do
not reflect the potential impact of any future acquisitions, mergers,
dispositions, joint ventures or strategic alliances. Our actual results could
differ materially from those anticipated in these forward-looking statements as
a result of important factors, including the risks described in "Factors that
May Affect Future Results" and elsewhere in this Quarterly Report on Form 10-Q.
We do not assume any obligation to update any of the forward-looking statements
we make.
FACTORS THAT MAY AFFECT FUTURE RESULTS
We caution you that the following important factors, among others, in the future
could cause our actual results to differ materially from those expressed in
forward-looking statements made by or on behalf of Breakaway in filings with the
Securities and Exchange Commission, press releases, communications with
investors, and oral statements.
OUR BUSINESS WILL SUFFER IF GROWING ENTERPRISES DO NOT ADOPT AND ACCEPT
APPLICATION HOSTING SERVICES
Our ability to increase revenues and achieve profitability depends on the
adoption and acceptance of third-party application hosting services by our
target market of growing enterprises. Information technology service providers,
including Breakaway, only recently have begun to offer third-party application
hosting services. The market for these services has only recently begun to
develop and is evolving rapidly.
OUR BUSINESS WILL SUFFER IF GROWING ENTERPRISES DO NOT ACCEPT E-BUSINESS
SOLUTIONS
Our ability to increase revenues and achieve profitability depends on the
widespread acceptance of e-business solutions by commercial users, particularly
growing enterprises. The market for e-business solutions is relatively new and
is undergoing significant change. The acceptance and growth of e-business
solutions will be limited if the Internet does not prove to be a viable
commercial market.
WE HAVE A HISTORY OF OPERATING LOSSES, EXPECT TO INCUR LOSSES IN THE FUTURE AND
WILL NOT BE SUCCESSFUL UNLESS WE CAN REVERSE THIS TREND
We expect to continue to incur increasing sales and marketing, infrastructure
development and general and administrative expenses. As a result, we will need
to generate significant revenues to achieve profitability. We cannot be certain
whether or when this will occur because of the significant uncertainties with
respect to our business model and our ability to raise capital. We experienced
net losses of $0.6 million and $10.4 million for the fiscal years ended December
31, 1998 and 1999, respectively and a net loss of $40.1 million for the nine
months ended September 30, 2000. We expect to continue to incur significant
operating losses in the foreseeable future. If we do achieve profitability, we
may not be able to sustain or increase profitability on a quarterly or annual
basis in the future, or raise capital.
<PAGE>
Form 10Q Page 16 of 26
FACTORS THAT MAY AFFECT FUTURE RESULTS - CONTINUED
OUR QUARTERLY REVENUES AND OPERATING RESULTS HAVE VARIED IN THE PAST AND ARE
LIKELY TO VARY SIGNIFICANTLY FROM OUR OWN EXPECTATIONS AND THE EXPECTATIONS OF
EXTERNAL PARTIES. THESE VARIATIONS MAY CAUSE THE MARKET PRICE OF OUR COMMON
STOCK TO DECLINE
Our quarterly revenues and operating results are volatile and difficult to
predict. Our quarterly operating results have varied in the past and are likely
to vary significantly from quarter to quarter in the future. It is likely that
in some future quarter or quarters our operating results will be below the
expectations of public market analysts or investors. If so, the market price of
our common stock may decline significantly. Factors that may cause our results
to fluctuate include:
- the amount and timing of demand by our clients for application
hosting and e-business solution services;
- amortization charges for intangible assets attributable to
acquisitions;
- our ability to collect accounts receivable from some of our
growing enterprise clients who, as a result of their short
operating histories and emerging businesses, have not paid us,
may pay us only a portion of what we are owed, or may delay
paying us for an extended period;
- our ability to obtain new and follow-on client engagements;
- the number, size and scope of our projects;
- cancellations or reductions in the scope of major consulting
and systems integration projects;
- demand for our services and offerings by Internet Capital
Group and affiliated partner companies;
- our ability to enter into multi-year contracts with
application hosting clients;
- cancellations of month-to-month application hosting contracts;
- the length of the sales cycle associated with our service
offerings;
- the introduction of new services by us or our competitors;
- changes in our pricing policies or those of our competitors;
- gains recognized and related compensation expenses we incur as
a result of our venture capital investments and commitments to
employees based on the performance of those investments;
- the amount and timing of certain restructuring expenses that
we have taken previously and may take again in the future;
- our ability to attract, train and retain skilled personnel in
all areas of our business;
- our ability in a consistent and accurate manner to manage
costs, including personnel costs and support services costs;
and
- the timing and cost of anticipated openings or expansions of
new regional offices and new Solution Centers.
<PAGE>
Form 10Q Page 17 of 26
FACTORS THAT MAY AFFECT FUTURE RESULTS - CONTINUED
We derive a substantial portion of our revenues from providing professional
services. We generally recognize revenues as we provide services. Personnel and
related costs constitute a substantial portion of our operating expenses.
Because we establish the levels of these expenses in advance of any particular
quarter, underutilization of our professional services employees may cause
significant reductions in our operating results for a particular quarter.
WE PLAN TO EXPAND RAPIDLY; IF WE CANNOT MANAGE OUR GROWTH SUCCESSFULLY, OUR
GROWTH MAY SLOW OR STOP
We have rapidly and extensively expanded our operations. Our growth has
placed, and will continue to place, a significant strain on our management,
operating and financial systems, and sales, marketing and administrative
resources. If we cannot manage our expanding operations, we may not be able
to continue to grow or we may grow at a slower pace. Furthermore, our
operating costs may escalate faster than planned. In order to manage our
growth successfully we must:
- improve our management, financial and information systems and
controls;
- expand, train and manage our employee base effectively; and
- enlarge our infrastructure for application hosting services.
WE RELY ON A SMALL NUMBER OF CLIENTS FOR MOST OF OUR REVENUES; OUR REVENUES WILL
DECLINE SIGNIFICANTLY IF WE CANNOT KEEP OR REPLACE THESE CLIENTS
In 1998, revenues from a single client accounted for approximately 27.0% of our
total revenues, and revenues from our five largest clients accounted for 54.0%
of total revenues. In 1999, while no single client accounted for more than 10%
of our total revenues, Internet Capital Group, which is our largest shareholder
and has two representatives on our Board of Directors, and companies related
to or owned in part by Internet Capital Group accounted for 17.9% of total
revenues. Revenues from our five largest clients accounted for approximately 26%
and 30% of total revenues in 1999 and the first nine months of 2000,
respectively. If these clients do not need or want to engage us to perform
additional services for them and we are not able to sell our services to new
clients at comparable or greater levels, our revenues will decline.
OUR FUTURE SUCCESS IS UNCERTAIN BECAUSE WE HAVE SIGNIFICANTLY CHANGED OUR
BUSINESS
Prior to 1999, we primarily provided traditional systems integration services
along with limited strategic planning and Internet systems integration
services. In 1999, we added application hosting to our service offerings and
substantially increased our capacity to provide strategic planning and
Internet systems integration services through three acquisitions and
significant hiring of professionals. Through September 30, 2000, we have
further expanded our consulting and systems implementation services in
connection with our acquisition of Eggrock Partners, our European presence
through the acquisition of Zartis.com Limited in Dublin, Ireland, and our
acquisition of Norsec - a web security firm. In part, due to these recent
significant changes, we are subject to the risk that we will fail to
successfully implement our business model and strategy. This risk is
heightened because we are operating in the new and rapidly evolving
e-business solutions market. Our historical results of operations do not
reflect our new service offerings. Consequently, our historical operating
results and pro forma financial information may not give you an accurate
indication of how we will perform in the future.
OUR GROWTH COULD BE LIMITED IF WE ARE UNABLE TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL
We believe that our success depends largely on our ability to attract and
retain highly skilled technical, consulting, managerial, sales and marketing
personnel. We may not be able to hire or retain the necessary personnel to
implement our business strategy. Due to likely variations in the price of our
stock, a significant portion of our employees may not have vested stock
options which permit them to acquire stock on favorable terms, thus making
employee retention less likely. In addition, we may need to pay higher
compensation for employees than we currently expect. Individuals with
e-business solutions skills or prior histories of success in selling
complex e-
<PAGE>
Form 10Q Page 18 of 26
FACTORS THAT MAY AFFECT FUTURE RESULTS - CONTINUED
business solutions, particularly those with the significant experience which we
generally require, are in very short supply. Competition to hire from this
limited pool is intense.
WE MAY LOSE MONEY ON FIXED-FEE CONTRACTS AND PERFORMANCE-BASED CONTRACTS
We derive a portion of our revenues from fixed-fee contracts. We may, from time
to time, make a portion of our fees contingent on meeting performance
objectives. If we misjudge the time and resources necessary to complete a
project, or if a client does not achieve the agreed upon performance objectives,
we may incur a loss in connection with the project or experience a substantial
delay in getting paid. These risks are heightened because we work with complex
technologies in compressed time frames.
OUR RELATIONSHIP WITH INTERNET CAPITAL GROUP MAY LIMIT OUR ABILITY TO OFFER
CERTAIN SERVICES OR PROVIDE CERTAIN OFFERINGS
Our relationship with Internet Capital Group, which owns approximately 32.8%
of our outstanding common stock at September 30, 2000, may, as a practical
matter, limit or affect our ability to enter into strategic alliances or
otherwise offer services competitive with products or services offered by
Internet Capital Group or affiliated companies. In some instances, we may be
unable or unwilling to offer services or products requested by clients or
prospects, and our financial results and market share may suffer accordingly.
OUR GROWTH STRATEGY WILL FAIL IF WE ARE UNABLE TO OPEN NEW REGIONAL OFFICES
SUCCESSFULLY
A key component of our growth strategy is to open regional offices in new U.S.
and foreign locations. If we do not implement this strategy successfully, we
will not grow. We devote substantial financial and management resources to
launch these offices. We may not select appropriate locations for these regional
offices. We also may not be able to open these offices efficiently or manage
them profitably.
WE ARE LIKELY TO NEED ADDITIONAL CAPITAL, WHICH MAY NOT BE AVAILABLE TO US, AND
WHICH, IF RAISED, MAY DILUTE YOUR OWNERSHIP INTEREST IN US
We are likely to need to raise additional funds through public or private equity
or debt financings in order to:
- support additional capital expenditures;
- take advantage of acquisition or expansion opportunities;
- develop new services; or
- address additional working capital needs.
The recent decline in our stock price could negatively impact our ability to
raise capital through the equity markets. If we cannot obtain financing on
terms acceptable to us or at all, we may be forced to curtail some or all of
these activities or otherwise reduce significantly the scale of its
operations. As a result, we could grow more slowly or stop growing. Any
additional capital raised through the sale of equity will dilute your
ownership interest in us and may be on terms that are unfavorable to holders
of our common stock.
<PAGE>
Form 10Q Page 19 of 26
FACTORS THAT MAY AFFECT FUTURE RESULTS - CONTINUED
WE MAY UNDERTAKE ADDITIONAL ACQUISITIONS WHICH MAY LIMIT OUR ABILITY TO MANAGE
AND MAINTAIN OUR BUSINESS, MAY RESULT IN ADVERSE ACCOUNTING TREATMENT AND MAY BE
DIFFICULT TO INTEGRATE INTO OUR BUSINESS
From January 1, 1999 to date, we have acquired seven companies. We may undertake
additional acquisitions in the future. Acquisitions involve a number of risks,
including:
- diversion of management attention;
- amortization of substantial goodwill, adversely affecting our
reported results of operations;
- inability to retain the management, key personnel and other
employees of the acquired business;
- inability to establish uniform standards, controls, procedures
and policies;
- inability to retain the acquired company's customers; and
- exposure to legal claims for activities of the acquired
business prior to acquisition.
Integrating the operations of an acquired business can be a complex process that
requires integration of service personnel, sales and marketing groups, hosting
infrastructure and service offerings and coordination of our development
efforts. Client satisfaction or performance problems with an acquired business
also could affect our reputation as a whole. In addition, any acquired business
could significantly underperform relative to our expectations.
WE FACE INCREASED RISKS IN CONDUCTING BUSINESS ABROAD WHICH MAY DAMAGE OUR
BUSINESS RESULTS
One component of our growth strategy is to expand into international markets. We
recently opened an office in London, acquired Zartis.com Limited, a company
based in Dublin, Ireland, and anticipate opening other offices outside the
United States. We believe that we will face certain risks in doing business
abroad that we do not face domestically. Among the international risks we
believe are most likely to affect us are:
- costs and difficulties in staffing and managing international
operations;
- strains on our financial and other systems to properly
administer VAT and other taxes, and different cost structures;
- competitive markets for office space in various non-US
locales and the inability to lease space on favorable terms;
- unexpected changes in regulatory requirements;
- increased tariffs and other trade barriers;
- costs and delays of localizing products and offerings for
local market and the costs and difficulties in complying with
local business customs;
- difficulties in enforcing contractual and intellectual
property rights;
- heightened risks of political and economic instability and the
possibility of nationalization or expropriation of industries
or properties;
- potentially adverse tax consequences including restrictions on
repatriating earnings and the threat of "double taxation;"
<PAGE>
Form 10Q Page 20 of 26
FACTORS THAT MAY AFFECT FUTURE RESULTS - CONTINUED
- the burden of complying with a wide variety of foreign laws
and regulations, some of which may conflict with U.S. laws;
- currency issues, including fluctuations in current exchange
rates and the adoption of the Euro by many countries of the
European Union by 2003; and
- restrictions on the import and export of sensitive U.S.
technologies, such as data security and encryption software
and systems that we may wish to deliver to our customers.
Any of these factors or other factors not listed here could damage our business
results. There can be no assurance that one or more of these factors will not
have a material adverse effect on our foreign operations, and, consequentially,
our business, operating results and financial condition.
IF OUR EFFORTS TO DEVELOP BRAND AWARENESS ARE NOT SUCCESSFUL, WE WILL NOT
INCREASE REVENUES AS PLANNED
An important element of our business strategy is to develop and maintain
widespread awareness of the Breakaway name. To promote our name and brand
identity, we have expended considerable amounts and may increase our marketing
expenses. These expenses have caused and may likely cause our operating margins
to decline. If these efforts are not successful, we will not experience any
increase in revenues to offset these expenses. We may nonetheless continue to
incur these expenses, possibly at higher levels. Moreover, our name may be
closely associated with the business difficulties of some of our clients, many
of whom are pursuing unproven business models in competitive markets. As a
result, the difficulties or failure of one or more of our clients could damage
our name and brand identity.
OUR FAILURE TO MEET CLIENT EXPECTATIONS OR DELIVER ERROR-FREE SERVICES COULD
RESULT IN LOSSES AND NEGATIVE PUBLICITY
Many of our engagements involve information technology solutions that are
critical to our clients' businesses. Any defects or errors in these solutions or
failure to meet clients' specifications or expectations could result in:
- delayed or lost revenues due to adverse client reaction;
- requirements to provide additional services to a client at no
charge;
- refunds of monthly application hosting fees for failure to
meet service level obligations;
- negative publicity about Breakaway and our services, which
could adversely affect our ability to attract or retain
clients; or
- claims for substantial damages against us, regardless of our
responsibility for such failure, which may not be covered by
our insurance policies and which may not be limited by the
contractual terms of our engagement.
There can be no guarantee that the Company has or can obtain adequate insurance
coverage at acceptable rates for these risks.
WE MAY NOT BE ABLE TO PREVENT UNAUTHORIZED ACCESS TO OUR CUSTOMERS' NETWORKS
In August 2000, we acquired Norsec, Inc. to enhance our application hosting
product offerings and bolster our business model. Despite our focus on
Internet security, we may not be able to stop unauthorized attempts, whether
made unintentionally or by computer "hackers," to gain access to or disrupt
the network operations of our customers. Accordingly, our success is
substantially dependent on the continued confidence of our current and
potential customers that we provide superior network security protection. Any
failure by us to stop
<PAGE>
Form 10Q Page 21 of 26
FACTORS THAT MAY AFFECT FUTURE RESULTS - CONTINUED
unauthorized access from the Internet or disruptions to related Internet
operations of our customers could materially harm such customers and us.
Although we typically limit warranties and liabilities in our customer
contracts, our customers may seek to hold us responsible for any losses
suffered as a result of unauthorized access to customers' network systems
from the Internet. This could result in liability to us, which could have a
material adverse effect upon our business. Moreover, computer "hackers" from
the Internet could infiltrate our network and sabotage our network or
services by creating bugs or viruses. Any adverse publicity resulting from
unauthorized access could deter future customers from using our services and
could cause current customers to cease using our services, which could have a
material, adverse effect upon our business. There can be no guarantee that
the Company has or can obtain adequate insurance coverage at acceptable rates
for these risks.
WE GENERATE A SIGNIFICANT PORTION OF OUR REVENUES FROM SERVICES RELATED TO
PACKAGED SOFTWARE APPLICATIONS OF A LIMITED NUMBER OF VENDORS; WE WOULD
EXPERIENCE A REDUCTION IN REVENUES IF ANY OF THOSE VENDORS CEASED DOING BUSINESS
WITH US
We derive a significant portion of our revenues from projects in which we
customize, implement or host packaged software applications developed by third
parties. We do not have contractual arrangements with most of these software
vendors. As a result, those software vendors with whom we do not have
contractual arrangements can cease making their products available to us at
their discretion. Even in the case of software vendors with whom we do have
contractual arrangements, those arrangements are either terminable at will by
either party or are for short terms. In addition, these software vendors may
choose to compete against us in providing strategic consulting, systems
integration or application hosting services. Moreover, our success is dependent
upon the continued popularity of the product offerings of these vendors and on
our ability to establish relationships with new vendors in the future. If we are
unable to obtain packaged applications from these or comparable vendors or, if
our vendors choose to compete with us, or the popularity of our products
declines, our business and operating results may be adversely affected.
OUR MARKETS ARE HIGHLY COMPETITIVE AND OUR FAILURE TO COMPETE SUCCESSFULLY WILL
LIMIT OUR ABILITY TO RETAIN AND INCREASE OUR MARKET SHARE
Our markets are new, rapidly evolving and highly competitive. We expect this
competition to persist and intensify in the future. Our failure to maintain and
enhance our competitive position will limit our ability to maintain and increase
our market share, which would result in serious harm to our business. Many of
our competitors are substantially larger than we are and have substantially
greater financial, infrastructure and personnel resources than we have.
Furthermore, many of our competitors have well established, large and
experienced marketing and sales capabilities and greater name recognition than
we have. As a result, our competitors may be in a stronger position to respond
quickly to new or emerging technologies and changes in client requirements. They
may also develop and promote their services more effectively than we do.
Moreover, barriers to entry, particularly in the strategic consulting and
systems integration markets, are low. We therefore expect additional competitors
to enter these markets.
IF WE ARE UNABLE TO REUSE SOFTWARE CODE AND METHODOLOGIES, WE MAY NOT BE ABLE TO
DELIVER OUR SERVICES RAPIDLY AND COST-EFFECTIVELY
Our business model depends to a significant extent on our ability to reuse
software code and methodologies that we develop in the course of client
engagements. If we generally are unable to negotiate contracts to permit us to
reuse code and methodologies, we may be unable to provide services to our
growing enterprise clients at a cost and within time frames that these clients
find acceptable. Our clients may prohibit us from such reuse or may severely
limit or condition reuse.
<PAGE>
Form 10Q Page 22 of 26
FACTORS THAT MAY AFFECT FUTURE RESULTS - CONTINUED
WE DEPEND ON A LIMITED NUMBER OF KEY PERSONNEL WHO HAVE RECENTLY JOINED US AND
WHOM WE MAY NOT BE ABLE TO RETAIN
Many members of our senior management joined us in 1999 and 2000. Many of these
individuals have not previously worked together and are becoming integrated as a
management team. As a result, our senior managers may not work together
effectively as a team. In addition, due to the competitive nature of our
industry, we may not be able to retain all of our senior managers.
WE MAY NOT BE ABLE TO DELIVER OUR APPLICATION HOSTING SERVICES IF THIRD PARTIES
DO NOT PROVIDE US WITH KEY COMPONENTS OF OUR HOSTING INFRASTRUCTURE
We depend on other companies to supply key components of the computer and
telecommunications equipment and the telecommunications services which we use to
provide our application hosting services. Some of these components are available
only from sole or limited sources in the quantities and quality we demand.
Although we lease redundant capacity from multiple suppliers, a disruption in
our ability to provide hosting services could prevent us from maintaining the
required standards of service, which would cause us to incur contractual
penalties.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST US, EVEN WITHOUT MERIT, COULD
COST A SIGNIFICANT AMOUNT OF MONEY TO DEFEND AND MAY DIVERT MANAGEMENT'S
ATTENTION
As the number of e-business applications in our target market increases and
the functionality of these applications overlaps, we may become subject to
infringement claims. We cannot be certain that our services, the solutions
that we deliver or the software used in our solutions do not or will not
infringe valid patents, copyrights or other intellectual property rights held
by third parties. In addition, certain of our current and previous employees
who formerly worked for Eggrock Partners may not have signed assignment of
inventions/confidentiality agreements, and there is a risk that one or more
of these present or former employees could claim ownership in and to
intellectual property created for third parties or otherwise compromise
Breakaway Solutions' intellectual property rights or trade secrets. If there
is infringement, we could be liable for substantial damages. Any infringement
claim, even if without merit, can be time consuming and expensive to defend,
and may divert management's attention and resources and could cause service
implementation delays. They also could require us to enter into costly
royalty or licensing agreements.
WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
If third parties infringe or misappropriate our trade secrets, copyrights,
trademarks or other proprietary information, our business could be seriously
harmed. The steps that we have taken to protect our proprietary rights may not
be adequate to deter misappropriation of our intellectual property. In addition,
we may not be able to detect unauthorized use of our intellectual property and
take appropriate steps to enforce our rights. Also, protection of intellectual
property in many foreign countries is weaker and less reliable than in the
United States. Accordingly, as our business expands into foreign countries,
risks associated with protecting our intellectual property will increase.
<PAGE>
Form 10Q Page 23 of 26
FACTORS THAT MAY AFFECT FUTURE RESULTS - CONTINUED
OUR BUSINESS MAY SUFFER IF GROWTH IN THE USE OF THE INTERNET DECLINES
Our business is dependent upon continued growth in the use of the Internet by
our clients, prospective clients and their customers and suppliers. If the
number of users on the Internet does not increase and commerce over the Internet
does not become more accepted and widespread, demand for our services may
decrease and, as a result, our revenues would decline. Factors that may affect
Internet usage or electronic commerce adoption include:
- actual or perceived lack of security of information and the
actual or threatened threat of computer "viruses" or other
malicious code;
- lack of access and ease of use;
- congestion of Internet traffic;
- inconsistent quality of service;
- increases in access costs to the Internet;
- excessive governmental regulation or the imposition of
taxation on Internet transactions;
- uncertainty regarding intellectual property ownership;
- reluctance to adopt new business methods; and
- costs associated with the obsolescence of existing
infrastructure.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
To date, we have not utilized derivative financial instruments or derivative
commodity instruments. We do not expect to employ these or other strategies
to hedge market risk in the foreseeable future. We invest our cash primarily
in money market funds, which are subject to minimal credit and market risk.
We believe the market risks associated with these financial instruments are
immaterial.
<PAGE>
Form 10Q Page 24 of 26
BREAKAWAY SOLUTIONS, INC.
PART II - OTHER INFORMATION:
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
(c) Sales of Unregistered Securities
On July 28, 2000, Breakaway issued 430,456 shares of its common
stock to former stockholders of Zartis.com Limited as consideration for the
purchase of all of the outstanding capital stock of Zartis.com Limited.
On August 11, 2000, Breakaway issued 273,019 shares of its common stock
to former stockholders of Norsec, Inc. as consideration for the purchase of all
of the outstanding capital stock of Norsec, Inc.
(d) Use of Proceeds from Sales of Registered Securities
As of September 30, 2000, there were no proceeds remaining from our initial
public offering in October 1999.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.1 Technology Assignment and License Back Agreement between
the Registrant and Satori, Inc. dated September 29, 2000
10.2 Shareholders Agreement among the Registrant, ICG Asiaworks Limited,
and Breakaway Solutions Asia Pacific Limited dated October 24, 2000
10.3 License Agreement between the Registrant and Breakaway Solutions
Asia Pacific Limited, dated October 24, 2000
27.1 Financial Data Schedule.
(b) Reports on Form 8-K:
There were no reports filed by the Company on Form 8-K for the three months
ended September 30, 2000.
On November 13, 2000, the Company filed a report on Form 8-K for the purpose
of filing with the Securities and Exchange Commission: (1) a press release
dated October 3, 2000, announcing, among other things, preliminary third
quarter 2000 financial results and a 9% reduction in staff, (2) a press
release, dated October 26, 2000, announcing the third quarter 2000 financial
results, and (3) to announce the acquisition of a 19.9% interest in Breakaway
Solutions Asia Pacific Limited, a Bermuda company ("Breakaway Asia Pacific")
and the granting of a license to that company.
<PAGE>
Form 10Q Page 25 of 26
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BREAKAWAY SOLUTIONS, INC.
Date: November 14, 2000 /s/ Kevin Comerford
------------------------------
KEVIN COMERFORD
Vice President, Administration,
Chief Financial Officer,
Treasurer and Secretary
(Principal financial officer and
Chief accounting officer)
<PAGE>
Form 10Q Page 26 of 26
Exhibit 27.1
BREAKAWAY SOLUTIONS, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
10.1 Technology Assignment and License Back Agreement between
the Registrant and Satori, Inc. dated September 29, 2000
10.2 Shareholders Agreement among the Registrant, ICG Asiaworks Limited,
and Breakaway Solutions Asia Pacific Limited dated October 24, 2000
10.3 License Agreement between the Registrant and Breakaway Solutions
Asia Pacific Limited, dated October 24, 2000
27.1 Financial Data Schedule
</TABLE>
