<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
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
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 000-25467
---------
FLYCAST COMMUNICATIONS CORPORATION
----------------------------------
(Exact name of registrant as specified in its charter)
Delaware 77-0431028
-------- ----------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
181 Fremont Street, San Francisco, CA 94105
-------------------------------------------
(Address of principal executive offices including zip code)
(415) 977-1000
--------------
(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 report) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
There were 15,165,021 shares of the Registrant's Common Stock outstanding as of
September 30, 1999.
<PAGE>
FLYCAST COMMUNICATIONS CORPORATION
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
<S> <C> <C>
PART I. FINANCIAL INFORMATION Page
----
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 1998 and
September 30, 1999 (unaudited).............................................................3
Consolidated Statements of Operations for the three months and
nine months ended September 30, 1998 and 1999 (unaudited)..................................4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998 and 1999 (unaudited)....................................................5
Notes to Consolidated Financial Statements..................................................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................................................8
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
Signatures................................................................................................25
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item I. Financial Statements
FLYCAST COMMUNICATION CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
(unaudited)
<TABLE>
<CAPTION>
<S> <C> <C> <C>
DEC. 31, SEPT. 30,
ASSETS 1998 1999
------------ ------------
Current Assets:
Cash and cash equivalents $5,197 $14,221
Short-term investments 183 57,195
Accounts receivable, net 3,802 11,336
Prepaid expenses 267 2,002
------------ ------------
Total current assets 9,449 84,754
Property and equipment, net 1,945 9,606
Other assets 108 315
------------ ------------
TOTAL ASSETS $11,502 $94,675
============ ============
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Accounts payable $2,561 $10,270
Accrued liabilities 375 3,141
Accrued compensation and benefits 460 2,392
Short-term capital lease obligations 490 841
Short-term debt 1,045 1,817
------------ ------------
Total current liabilities 4,931 18,461
Long-term capital lease obligations 1,041 1,189
Long-term debt 3,682 2,224
------------ ------------
Total liabilities 9,654 21,874
------------ ------------
Mandatorily redeemable preferred stock, $0.0001
par value, 9,904,000 share authorized:
Series A, 920,000 designated, 918,295 shares issued and outstanding
at December 31, 1998; none at September 30, 1999 ....... 1,027
Series B, 5,500,000 designated, 5,324,532 shares issued and outstanding
at December 31, 1998; none at September 30, 1999 ....... 7,824
Series C, 3,484,000 designated, 497,785 shares issued and outstanding
at December 31, 1998; none at September 30, 1999 ....... 5,004
------------ ------------
13,855 -
------------ ------------
Stockholders' equity (deficit):
Common stock, $.001 par value: 20,000,000 shares
authorized; issued 2,690,787 shares - December 31,
1998; 15,165,021 shares - September 30, 1999 922 103,747
Common stock options 2,929 3,931
Deferred stock compensation (1,771) (1,556)
Notes receivable from stockholders (606) (404)
Accumulated deficit (13,481) (32,917)
------------ ------------
Total stockholders' equity (deficit) (12,007) 72,801
------------ ------------
TOTAL LIABILITIES, MANDATORILY REDEEMABLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) $11,502 $94,675
============ ============
See notes to consolidated financial statements
</TABLE>
3
<PAGE>
FLYCAST COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
<S> <C> <C>
THREE MONTHS NINE MONTHS
ENDED SEPT. 30, ENDED SEPT. 30,
------------------- -------------------
1998 1999 1998 1999
--------- --------- --------- ---------
Revenues $2,544 $12,531 $4,765 $24,066
Cost of revenues 1,630 8,592 3,066 16,811
--------- --------- --------- ---------
Gross profit 914 3,939 1,699 7,255
Operating expenses:
Sales and marketing 1,627 5,981 3,330 14,136
Research and development 655 2,576 1,574 5,623
General and administrative 490 2,481 1,389 4,922
Stock-based compensation 407 365 737 1,323
--------- --------- --------- ---------
Total operating expenses 3,179 11,403 7,030 26,004
Operating loss (2,265) (7,464) (5,331) (18,749)
Interest income (expense), net (63) (309) (71) 56
--------- --------- --------- ---------
Net loss ($2,328) ($7,773) ($5,402) ($18,693)
========= ========= ========= =========
Accretion of mandatorily redeemable preferred stock (165) - (491) (667)
========= ========= ========= =========
Loss attributable to common stockholders ($2,493) ($7,773) ($5,893) ($19,360)
========= ========= ========= =========
Basic and diluted loss per common share ($1.75) ($0.57) ($4.77) ($2.18)
========= ========= ========= =========
Shares used in computing basic and diluted loss per
common share 1,426 13,645 1,235 8,895
========= ========= ========= =========
Proforma basic and diluted loss per common share ($0.33) ($0.57) ($0.79) ($1.61)
========= ========= ========= =========
Shares used in computing proforma basic and
diluted loss per common share 7,662 13,645 7,471 12,027
========= ========= ========= =========
See notes to consolidated fianancial statements
</TABLE>
4
<PAGE>
FLYCAST COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------------------------
1998 1999
------------------- -----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss (5,402) ($18,693)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 388 1,590
Provision for doubtful accounts 107 735
Loss on sale of property and equipment 5
Stock and warrants issued for services 180 139
Non-cash interest expense 43
Stock-based compensation expense 736 1,323
Changes in operating assets and liabilities:
Accounts receivable (1,936) (8,269)
Prepaids and other assets (372) (1,942)
Accounts payable 1,212 7,710
Accrued liabilities 181 4,684
------------------- -----------------
Net cash used by operations (4,858) (12,723)
------------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (93) (8,197)
Proceeds from sales of property and equipment 3
Purchase of short term investments, net (180) (57,025)
------------------- -----------------
Net cash used by financing activities (270) (65,222)
------------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt 2,100
Payments on long-term debt (115) (673)
Payments on capital leases (163) (492)
Proceeds from payment of notes receivable from
stockholders 58
Payments on note payable to shareholders (49)
Shareholder distributions (79)
Proceeds from issuance of common stock 25 73,668
Proceeds from issuance of preferred stock 14,536
------------------- -----------------
Net cash provided by investing activities 1,847 86,969
------------------- -----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (3,281) 9,024
CASH AND CASH EQUIVALENTS-BEGINNING OF PERIOD 3,593 5,197
------------------- -----------------
CASH AND CASH EQUIVALENTS-END OF PERIOD $ 312 $ 14,221
=================== =================
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest $ 101 $ 575
=================== =================
Non-cash financing and investing activities:
Purchase of equipment under capital leases $ 1,612 $ 1,041
=================== =================
Issuance of common stock for notes receivable $ 446 $ 31
=================== =================
Repurchase of common stock for extinguishment
of debt $ 35 $ 175
=================== =================
Conversion of preferred stock to common stock $ - $ 28,856
=================== =================
See notes to consolidated financial statements
</TABLE>
5
<PAGE>
FLYCAST COMMUNICATIONS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The interim consolidated financial statements are unaudited and have been
prepared on the same basis as the audited financial statements. In the opinion
of management, such unaudited financial statement includes all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of the Company's financial position as of September 30, 1999 and
the results of operations for the three and nine months ended September 30, 1998
and 1999 and cash flows for the nine months ended September 30, 1998 and 1999.
The unaudited financial statements should be read in conjunction with Flycast's
audited financial statements and the notes thereto as included in Flycast's
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on May 4, 1999, and its periodic filings with the Securities and
Exchange Commission thereafter. The results of operations for the three and nine
months ended September 30, 1999 are not necessarily indicative of the results to
be expected for any subsequent quarter or the entire year ending December 31,
1999.
On August 30, 1999, Flycast acquired InterStep by issuing 480,337 shares
of common stock for all of the outstanding shares of InterStep, Inc. in a
transaction that was accounted for as a pooling-of-interests. As a result,
InterStep became a wholly owned subsidiary of Flycast. For purposes of
financial statement presentation, historical financial information for
InterStep has been consolidated into the statements presented herein.
Certain reclassifications have been made to prior period financial statements to
conform to the current period presentation.
2. INITIAL PUBLIC OFFERING
On May 4, 1999, Flycast completed an initial public offering of 3,000,000 shares
of the Flycast's common stock. In addition, on June 4, 1999, the Company sold an
additional 200,000 shares under the underwriters' overallotment option. Total
net proceeds were $74.4 million. Upon the closing of the initial public
offering, Flycast's mandatorily redeemable preferred stock converted into 6.9
million shares of common stock.
3. ACQUISITIONS
On August 30, 1999, we acquired InterStep by issuing 480,337 shares of
common stock for all of the outstanding shares of InterStep, Inc. Of the 480,337
shares of common stock, 47,558 shares are held by an escrow agent to serve as
security for the indemnity provided by some of the shareholders of InterStep.
The information presented in this Form 10-Q reflects the combination of Flycast
and InterStep accounted for as a pooling-of-interests.
On September 30, 1999, we announced that we had signed a definitive agreement to
be acquired by CMGI, Inc. in a stock-for-stock merger. Under the terms of the
agreement, CMGI will issue 0.4738 CMGI shares for every Flycast share held on
the closing date of the transaction. Closing of the merger is subject to
customary conditions, including formal approval by our shareholders. It is
anticipated that the transaction will close in January 2000. A significant
percentage of our shareholders have agreed to vote in favor of the merger. In
connection with the merger, we also entered into a Stock Option Agreement
dated as of September 29, 1999, whereby we granted CMGI an option to purchase
up to 19.9% of the outstanding shares of our common stock, which option may be
exercised in the event that the Merger Agreement is terminated under certain
circumstances. We incurred approximately $1.5 million in expenses related to the
acquisition which are reflected as general and administrative operating
expenses in this Form 10-Q for the quarter ended September 30, 1999. We expect
to incur additional financial advisory and legal fees estimated to be between
$6.0 million and $8.0 million contingent upon completion of the acquisition.
This range is a preliminary estimate only and is, therefore, subject to
change.
4. BASIC AND DILUTED LOSS PER SHARE
Basic net loss per share is computed by dividing the loss attributable to common
shareholders by the weighted
6
<PAGE>
average number of common shares outstanding for the period (excluding shares
subject to repurchase). Diluted loss per common share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. Common share equivalents are
excluded from the computation in loss periods, as their effect would be
antidilutive.
The following is a reconciliation of the denominators used in calculating basic
and diluted net loss per share (in thousands):
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
Shares (denominator) 1998 1999 1998 1999
-------- -------- -------- --------
Weighted average common shares
outstanding 2,677 14,980 2,744 10,310
Weighted average common shares
outstanding subject to repurchase (1,251) (1,335) (1,509) (1,415)
-------- -------- -------- --------
Shares used in computation, basic and diluted 1,426 13,645 1,235 8,895
======== ======== ======== ========
</TABLE>
5. PRO FORMA LOSS PER COMMON SHARE
Proforma basic and diluted loss per common share is computed by dividing loss
attributable to common shareholders by the weighted average number of common
shares outstanding for the period (excluding shares subject to repurchase) and
the weighted average number of common shares resulting from the assumed
conversion of outstanding mandatorily redeemable preferred stock.
6. COMBINING FINANCIAL INFORMATION
The acquisition of InterStep has been accounted for as a pooling-of-interests
and, accordingly, our historical consolidated financial statements have been
restated to include the accounts and results of operations of InterStep. The
results of operations previously reported by the separate businesses and the
combined amounts presented in the accompanying consolidated financial statements
are presented below.
Three months Nine months
ended September ended September
30, 1998 30, 1998
(unaudited) (unaudited)
Revenues
Flycast $ 2,126 $ 3,890
InterStep 418 875
------- -------
Combined $ 2,544 $ 4,765
Net income (loss)
Flycast $(2,321) $(5,775)
InterStep (7) 373
------- -------
Combined $(2,328) $(5,402)
We have restated our results of operations for the three and nine month periods
ended September 30, 1998 and 1999 by combining InterStep's financial statements
with our financial statements. We have restated the balance sheet as of December
31, 1998 to include our balance sheet and InterStep's balance sheet as of
December 31, 1998. The equity accounts of the separate entities were combined.
There were no significant transactions between our Company and InterStep prior
to the combination.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the financial condition and results of operations of
the Company contains 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. Such statements involve risks and uncertainties. The Company's actual
results and timing of certain events could differ materially from those
anticipated in these forward-looking statements as a result of certain factors
including, but not limited to, those set forth under "Risk Factors that May
Affect Future Results" and elsewhere in this report. In this report the words
"anticipates," "believes," "expects," "future," "intends" and similar
expressions indentify forward-looking statements which speak only as of the date
hereof.
OVERVIEW
Flycast delivers Web-based advertising solutions designed to maximize the return
on investment for response-oriented advertisers, direct marketers and electronic
commerce companies. By combining unsold advertising space from over 1400 Web
sites, the Flycast Network offers advertisers a large audience of Web users and
high-quality advertising space at favorable prices. Additionally, by selling
advertising space on an unnamed basis, Flycast creates a supplemental revenue
opportunity for Web sites that does not conflict with their other sales efforts.
We completed our initial public offering of 3,200,000 shares of Common Stock,
which includes 200,000 shares from the exercise of the underwriters'
over-allotment option, at a price of $25.00 per share on May 4, 1999. The net
proceeds of approximately $74.4 million from the initial public offering were
added to our working capital. Pending use of the net proceeds, we have
invested such funds in short-term, interest bearing investment grade
obligations.
We commenced operations in April 1996 as a California corporation. From April
1996 through May 1997, our operating activities related primarily to developing
our AdEx technology and the Flycast Network, identifying markets and recruiting
personnel.
Revenue from advertisements delivered on the Flycast Network began in the second
quarter of 1997. We generate revenue by delivering advertisements to Web sites
in the Flycast Network. Pricing of advertising is generally based on cost per
advertising impression and varies depending on whether the advertising is run
across the network, across specific categories or on individual Web sites. We
sell our services through our sales and marketing staff located in San
Francisco, Atlanta, Boston, Boulder, Chicago, Detroit, Los Angeles, New York,
Philadelphia, Sarasota, Seattle and Fairfax, VA. The advertisements we deliver
are typically sold under short-term agreements that are subject to
cancellation. Advertising revenue is recognized in the period that
advertisements are delivered. We pay each Web site in the Flycast Network an
agreed upon percentage of the revenue generated by advertisements run on its
site. That amount is included in cost of revenues. Generally, we bill and
collect for advertisements delivered on the Flycast Network and assume the
risk of non-payment from advertisers.
We expect to generate most of our revenue for the foreseeable future from
advertisements delivered to Web sites on the Flycast Network. Our ten largest
customers accounted for 40% of our revenue for the year ended December 31, 1998
and 31 % of our revenue for the quarter ended September 30, 1999. No single
customer accounted for more than 10% of our revenue for the quarter ended
September 30, 1999. No Web site contributed more than 5% of our advertising
views served, as measured based on the fees we paid to Web sites, during the
quarter ended September 30, 1999.
We have entered into value added reseller relationships with BellSouth, SBC
Communications and U S WEST. Under these agreements, we will deliver local Web
advertising inventory to BellSouth's, SBC's and U S WEST's sales forces that
they, in turn, will offer to local advertisers. To date, these agreements have
not accounted for a material percentage of revenue. However, we anticipate that
revenue from these agreements will account for an increasing percentage of our
revenue in the future.
We have incurred significant losses since inception and, as of September 30,
1999, had an accumulated deficit of $32.8 million. In addition, we have recorded
stock-based compensation, which represents the difference between the exercise
price and the fair market value of our common stock issuable upon the exercise
of stock options granted to employees. Stock-based compensation of $1.1 million
was amortized during the year ended December 31, 1998 and
8
<PAGE>
$1.3 million was amortized during the nine months ended September 30, 1999.
Stock-based compensation of $1.6 million will be amortized over the remaining
vesting periods of the related options, including $303,000 in the remainder of
the year ending December 31, 1999.
In light of the rapidly evolving nature of our business and our limited
operating history, we believe that period-to-period comparisons of our operating
results are not meaningful and that the results for any period should not be
relied upon as an indication of future performance. We currently expect to
increase significantly our operating expenses in order to expand our sales and
marketing operations, including our reseller network, to enhance our AdEx
technology platform and to expand internationally. As a result of these factors,
we expect to incur significant losses on a quarterly and annual basis for the
foreseeable future.
RESULTS OF OPERATIONS
REVENUE
Our revenue is derived primarily from the delivery of advertisements on Web
sites in the Flycast Network. Our revenue increased from $2.5 million for the
quarter ended September 30, 1998 to $12.5 million for the quarter ended
September 30, 1999. Revenue was $24.1 million for the nine months ended
September 30, 1999, up from $4.8 million for the same period in 1998. This
increase was primarily due to an increase in the number of advertisers
purchasing advertisements on the Flycast Network and an increase in purchases
made by existing advertisers.
COST OF REVENUES
Cost of revenues consists primarily of amounts we pay to Web sites on the
Flycast Network, which represent a percentage of the revenue generated by
delivering advertisements. Cost of revenues also includes costs of the
advertising delivery system and Internet access costs. Cost of revenues was $1.6
million for the quarter ended September 30, 1998 and $8.6 million for the
quarter ended September 30, 1999. Cost of revenues was $16.8 million for the
nine months ended September 30, 1999, up from $3.1 million for the same period
in 1998. The increase in cost of revenues was due to the related growth in
advertising revenue and associated amounts paid to Web sites, increased expenses
from third-party Internet service providers and increased capital investment in
infrastructure to increase our network serving capacity. This investment
resulted in a decline in our overall gross margin from the same quarter in the
prior year. These expenses increased in absolute dollars and increased as a
percentage of revenue due to investments in upgrading the advertising delivery
system.
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation (including commissions), travel, advertising, trade show costs and
marketing materials expenses. Sales and marketing expenses were $1.6 million or
64% of revenue for the quarter ended September 30, 1998 and $6.0 million, or 48%
of revenue, for the quarter ended September 30, 1999. Sales and marketing
expense was $14.1 million or 59% of revenue for the nine months ended September
30, 1999, up from $3.3 million or 70% of revenue for the same period in 1998.
The increase in absolute dollars was due primarily to the increase in sales
personnel and costs related to the continued development and implementation of
our marketing campaigns. We expect sales and marketing expenses to increase on
an absolute dollar basis in future periods as we hire additional personnel in
sales and marketing, expand into new markets and continue to promote our
advertising solutions.
Research and Development. Research and development expenses were $655,000, or
26% of revenue, for the quarter ended September 30, 1998 and $2.6 million, or
21% of revenue, for the quarter ended September 30, 1999. Research and
development costs were $5.6 million or 23% of revenues for the nine months ended
September 30, 1999 up from $1.6 million or 33% of revenues for the same period
in 1998. The increase in absolute dollars was due primarily to increased
personnel expenses. We believe that continued investment in research and
development is critical to attaining our strategic objectives and, as a result,
we expect research and development expenses to increase on an absolute dollar
basis in future periods.
General and Administrative. General and administrative expenses were $490,000,
or 19% of revenue, for the quarter ended September 30, 1998, and $2.5 million,
or 20% of revenue, for the quarter ended September 30, 1999. General and
administrative expenses increased from $1.4 million or 29% of revenues for the
nine months ended September
9
<PAGE>
30, 1998 to $4.9 million or 20% of revenues for the nine months ended September
30, 1999. The increase in absolute dollars was due to the growth in staffing,
internal administrative expenses related to the staffing growth and expenses
related to the pending merger with CMGI. Acquisition related expenses incurred
during the quarter ended September 30, 1999 were approximately $1.5 million.
We expect general and administrative expenses to increase on an absolute
dollar basis in future periods as we hire additional personnel and incur
additional costs related to the growth of our business, but decrease as a
percentage of revenue.
Stock-Based Compensation. Stock-based compensation of $407,000 and $365,000 was
amortized during the quarters ended September 30, 1998 and 1999 respectively.
Stock-based compensation of $737,000 and $1.3 million was amortized during the
nine months ended September 30, 1998 and 1999 respectively. Stock-based
compensation of $1.6 million will be amortized over the remaining vesting
periods of the related options, including $303,000 in the quarter ending
December 31, 1999.
Interest Income (Expense), Net. Interest income (expense), net consists of
interest paid on capital lease and debt obligations, offset in part by interest
earnings on our cash, cash equivalents and investments. Interest expense
consisted primarily of interest incurred in connection with debt and capital
lease financing and interest income consisted mostly of interest earned on the
proceeds from our public offering. Interest expense increased from $77,000 in
the quarter ended September 30, 1998 to $206,000 in the quarter ended September
30, 1999 and from $150,000 for the nine months ended September 30, 1998 to
$596,000 for the nine months ended September 30, 1999. Interest income
decreased from $14,000 in the quarter ended September 30, 1998 to $(102,000) in
the quarter ended September 30, 1999 and increased from $78,000 for the nine
months ended September 30, 1998 to $652,000 for the nine months ended
September 30, 1999.
Income Taxes. No income tax benefits have been recorded for any of the periods
presented due to our current loss position.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through the private
placement of equity and convertible debt securities, borrowings from a related
party and others and our initial public offering. As of September 30, 1999, we
had raised approximately $100.8 million from the issuance of common and
preferred stock. As of September 30, 1999 we had $14.2 million of cash and cash
equivalents and $57.2 million in short-term investments and had borrowings of
$6.1 million under credit and capital lease facilities.
Net cash used in operating activities was $12.7 million for the nine months
ended September 30, 1999. Cash used in operating activities for the nine months
ended September 30, 1999 resulted from net losses and increases in accounts
receivable, which were offset by increases in accounts payable and accrued
liabilities.
Net cash used in investing activities was $65.2 million for the nine months
ended September 30, 1999. Cash used in investing activities was primarily
related to the investment of IPO proceeds for the quarter ended September 30,
1999.
Net cash provided by financing activities was $87.0 million for the nine months
ended September 30 1999. Cash provided by financing activities resulted
primarily from the sale of common stock in our public offering .
While we do not have any material commitments for capital expenditures, we
anticipate that we will experience an increase in our capital expenditures
consistent with our anticipated growth in operations, infrastructure and
personnel. We plan to incur approximately $2.0 million to $4.0 million in
capital expenditures during the remainder of 1999. We currently anticipate
that we will continue to experience significant growth in our operating
expenses for the foreseeable future and that our operating expenses will be a
material use of our cash resources. We believe that our exsiting cash, cash
equivalents and short-term investments and available credit facilities will be
sufficient to meet our anticipated cash needs for working capital, repayment
of debt and capital expenditure for at least the next twelve months.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept or recognize only two digit entries in the date code field. These systems
and software products will need to accept four digit entries to
10
<PAGE>
distinguish 21st century dates from 20th century dates. As a result, computer
systems and software used by many companies and governmental agencies may need
to be upgraded to comply with Year 2000 requirements or risk system failure or
miscalculations causing disruptions of normal business activities.
State of Readiness. We have made an assessment of the Year 2000
readiness of our information technology ("IT") systems, including the hardware
and software that enable us to provide and deliver our solutions, and our non-IT
systems. Our assessment plan consisted of an audit, performed by a independent
third-party consulting company of our internally developed proprietary
software incorporated in our solutions ("AdEx Technology"); contacting third-
party vendors and licensors of material hardware, software and services that
are both directly and indirectly related to the delivery of our solutions to
advertisers and the Web sites on the Flycast Network; contacting third-party
vendors who provide important business services (non-IT systems); assessment
of repair or replacement requirements; repair or replacement; implementation;
and creation of contingency plans in the event of Year 2000 failures.
Based on the results of our independant audit, we revised the code of our AdEx
Technology as necessary to achieve Year 2000 compliance. The third-party
consulting company has verified the results of our Year 2000 remediation
efforts. We have contacted our hardware and software component vendors and
we have been informed by our hardware and software component vendors that the
products we use are currently Year 2000 compliant. As our AdEx Technology has
undergone changes due to maintenance and enhancement since the third-party
independent audit, we intend to re-test the current version of the AdEx
Technology before the end of 1999 to ensure that we have maintained full Year
2000 compliance.
We have assessed third party vendors that provide important business services
(non-IT systems) and are seeking assurance of Year 2000 compliance from these
providers.
Costs. To date, we have not incurred significant costs in connection with
identifying or evaluating Year 2000 compliance issues. Most of our expenses have
related to, and are expected to continue to relate to, the operating costs
associated with time spent by employees and consultants in the evaluation and
conversion process and Year 2000 compliance matters generally. At this time, we
estimate the potential costs of revisions to our AdEx Technology and the
replacement of some third-party software and hardware to be minimal. Although
we do not anticipate that these expenses will be material, these expenses, if
higher than anticipated, could have a material adverse effect on our business,
results of operations and financial condition.
Risks. We are not currently aware of any major Year 2000 compliance problems
relating to AdEx Technology or our IT or non-IT systems that would have a
material adverse effect on our business, results of operations or financial
condition, without taking into account our efforts to avoid or fix these
problems. We may discover additional Year 2000 compliance problems in our AdEx
Technology that will require substantial revisions. In addition, third-party
software, hardware or services incorporated into our material IT and non-IT
systems may need to be revised or replaced, all of which could be time consuming
and expensive. If we fail to fix our AdEx Technology or to fix or replace third-
party software, hardware or services on a timely basis, the result could be lost
revenues, increased operating costs, the loss of customers and other business
interruptions, any of which could have a material adverse effect on our
business, results of operations and financial condition. Moreover, the failure
to adequately address Year 2000 compliance issues in our AdEx Technology, and
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.
In addition, there is no assurance that governmental agencies, utility
companies, Internet access companies, third-party service providers and non-IT
systems providers outside our control will be Year 2000 compliant. The failure
by these entities to be Year 2000 compliant could result in a systemic failure
beyond our control, including 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 in the Flycast Network, which could have a material
adverse effect on our business, results of operations and financial condition.
Contingency Plan. As discussed above, we are engaged in an ongoing Year 2000
assessment. The results of our Year 2000 simulation testing and the responses
received from third-party vendors and service providers is being taken into
account in determining the nature and extent of our contingency plans.
11
<PAGE>
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
We have only a three-year operating history, making it difficult for you to
evaluate our business and your investment
We commenced operations in April 1996 (although InterStep began operations in
March, 1995). Thus, we have only a limited operating history upon which you can
evaluate our business. Our prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by early-stage companies in the
Web advertising market, which is new and rapidly evolving. We may not be
successful in addressing these risks and our business strategy may not be
successful. These risks include our ability to:
. maintain and increase our inventory of advertising space on Web sites;
. maintain and increase the number of advertisers that use our products and
services; and
. continue to expand the number of products and services we offer.
Please see "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for more detailed information.
We have a history of losses and anticipate continued losses
Our accumulated deficit as of September 30, 1999 was $32.8 million. Although we
have experienced revenue growth in recent periods, this growth may not be
sustained and is not necessarily indicative of our future revenue. We have not
achieved profitability and, given the level of planned operating and capital
expenditures, we expect to continue to incur losses for the foreseeable future.
Our future revenue and operating results will be affected by a number of
factors, including those set forth in this section. It is likely that our
internal projections for 1999 and 2000 will change throughout 1999 and 2000. In
addition, projections published by market analysts may differ from our internal
revenue projections. We do not believe that we will be required to provide any
updates or further information as to our internal revenue projections for 1999
and 2000 and it is not our present intention to do so.
We plan to increase our operating expenses to expand our infrastructure to
support our current business and new lines of businesses, including our reseller
network. The timing of this expansion and the rate at which our reseller network
generates revenue could cause material fluctuations in our results of
operations. We also plan to purchase additional capital equipment. Our losses
may increase in the future and we may not be able to achieve or sustain
profitability. Even if we do achieve profitability, we may not be able to
sustain or increase profitability on a quarterly or annual basis in the future.
If our revenue grows more slowly than we anticipate, or if our operating
expenses exceed our expectations and cannot be adjusted accordingly, our
business, results of operations and financial condition will be materially and
adversely affected. Please see "Management's Discussion and Analysis of
Financial Condition and Results of Operations" for more detailed information.
Our quarterly operating results are subject to fluctuations and seasonality that
make it difficult to predict our financial performance
Our revenue and operating results may vary significantly from quarter to quarter
due to a number of factors, some of which are outside of our control. Therefore,
you should not rely on period-to-period comparisons of results of operations as
an indication of our future performance. It is possible that in some future
periods our operating results may fall below the expectations of market analysts
and investors. In this event, the market price of our common stock would likely
fall.
The factors that affect our quarterly operating results include:
. demand for our advertising solutions;
. the number of available advertising views on Web sites in the Flycast
Network;
. the mix of types of advertising we sell, including the amount of advertising
sold at higher rates;
. changes in our pricing policies, the pricing policies of our competitors or
the pricing policies for advertising on the Web generally; and
. costs related to acquisitions of technology or businesses.
We believe that our revenue will be subject to seasonal fluctuations because
advertisers generally place fewer
12
<PAGE>
advertisements during the first and third calendar quarters of each year. In
addition, expenditures by advertisers tend to be cyclical, reflecting overall
economic conditions as well as budgeting and buying patterns. A decline in the
economic prospects of advertisers or the economy generally, which could alter
current or prospective advertisers' spending priorities or the time periods in
which they determine their budgets, or increase the time it takes to close a
sale with our advertisers, could cause our business to be materially and
adversely affected.
Revenue and operating results for the foreseeable future are difficult to
forecast. Our current and future expense estimates are based, in large part, on
our estimates of future revenue and on our investment plans. In particular, we
plan to increase our operating expenses significantly in order to expand our
sales and marketing operations, including our reseller network, to enhance AdEx,
our advertising management platform, and to expand internationally. To the
extent that these expenses precede increased revenue, our business, results of
operations and financial condition would be materially and adversely affected.
We may be unable to, or may elect not to, adjust spending quickly enough to
offset any unexpected revenue shortfall. Therefore, any significant shortfall in
revenue in relation to our expectations would also have a material adverse
effect on our business, results of operations and financial condition. Please
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations" for more detailed information.
We may experience capacity constraints that could affect our advertising revenue
Our future success depends in part on the efficient performance of AdEx, as well
as the efficient performance of the systems of third parties such as our
Internet service providers. An increase in the volume of advertising delivered
through our servers could strain the capacity of the software or hardware that
we have deployed, which could lead to slower response times or system failures
and adversely affect the availability of advertisements, the number of
advertising views received by advertisers and our advertising revenues. Due to
unexpected growth in the number of advertising views that we served in 1998, we
experienced a slowdown, and in some cases an interruption, in delivering
advertisements to viewers over a three-week period that limited the number of
advertising views we were able to serve. As the numbers of Web pages and users
increase, our products, services and infrastructure may not be able to grow to
meet the demand. To the extent that we do not effectively address any capacity
constraints or system failures, our business, results of operations and
financial condition would be materially and adversely affected.
We run the risk of system failure that could adversely affect our business
The continuing and uninterrupted performance of our system is critical to our
success. Customers may become dissatisfied by any system failure that interrupts
our ability to provide our services to them, including failures affecting the
ability to deliver advertisements quickly and accurately to the targeted
audience. Sustained or repeated system failures would reduce significantly the
attractiveness of our solutions to advertisers and Web sites. Our business,
results of operations and financial condition could be materially and adversely
affected by any damage or failure that interrupts or delays our operations.
Our operations depend on our ability to protect our computer systems against
damage from a variety of sources, including telecommunications failures,
malicious human acts and natural disasters. In this regard, we lease server
space in the San Francisco Bay Area. Therefore, any of the above factors
affecting the San Francisco Bay Area would have a material adverse effect on
our business, results of operations and financial condition. Further, despite
network security measures, our servers are vulnerable to computer viruses and
disruptions from unauthorized tampering with our computer systems. We carry
business interruption insurance, but, it may not be enough to compensate for
losses that may occur as a result of any of these events. Despite precautions,
unanticipated problems affecting our systems could cause interruptions in the
delivery of our solutions in the future. Our data storage centers incorporate
redundant systems, consisting of additional servers, but the primary system does
not switch over to the backup system automatically.
We also depend upon Internet service providers that provide consumers with
access to our products and services. In the past, users have occasionally
experienced difficulties due to system failures unrelated to our systems. Any
disruption in the Internet access provided by third-party providers or any
failure of third-party providers to handle higher volumes of user traffic could
have a material adverse effect on our business, results of operations and
financial condition.
We have a limited number of customers upon whom we rely, and the loss of a major
customer could adversely affect our revenue
13
<PAGE>
We expect that a limited number of customers will account for a significant
portion of our revenue for the foreseeable future. As a result, if we lose a
major customer, our revenue could be adversely affected. In addition, we cannot
be certain that customers that have accounted for significant revenue in past
periods, individually or as a group, will continue to generate revenue in any
future period. In particular, advertisers may not achieve desired results from
the use of our products and may therefore choose not to continue to use our
products. We also target small advertisers that have limited advertising budgets
and/or are interested in reaching small and limited target audiences. We may not
be able to generate sufficient revenue from these advertisers to lessen our
dependence on our largest customers. We typically enter into short-term
contracts with Web sites for their supply of advertising views. The loss of a
significant number of these advertising views might result in the loss of
customers, which could have a material adverse effect on our business, results
of operations and financial condition. For more detailed information, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
We depend on the evolution of Web advertising for our future success
We expect to derive substantially all of our revenue in the foreseeable future
from Web advertising. Therefore, our future success depends on increased use of
the Web as an advertising medium. If the market for Web advertising fails to
develop or develops more slowly than we expect, then our business, results of
operations and financial condition would be materially and adversely affected.
The Web has not existed long enough as an advertising medium to demonstrate its
effectiveness relative to traditional advertising media. Customers that have
relied on traditional media for advertising may be reluctant to use Web
advertising. Many customers have limited or no experience using the Web as an
advertising medium, have allocated only a limited portion of their advertising
budgets to Web advertising or may find Web advertising to be less effective for
promoting their products and services than advertising using traditional media.
In addition, advertisers and advertising agencies that have invested substantial
resources in traditional methods of advertising may be reluctant to reallocate
their media buying resources to Web advertising. We cannot assure you that the
market for Web advertising will continue to develop or be sustainable.
Substantially all of our revenue is derived from the delivery of banner
advertisements. If advertisers determine that banner advertising is not
effective or attractive as an advertising medium, we may not be able to shift to
any other form of Web advertising. Also, users can install "filter" software
programs that limit or prevent advertising from being delivered to a Web site.
The widespread adoption of filter software by Web users or the failure to
develop successful alternative forms of Web advertising could have a material
and adverse effect on the Web advertising market and our business, results of
operations and financial condition.
Our business model has a limited history, is different from other Web
advertising networks and may not succeed
Our business model is to generate revenue primarily by providing Web advertising
solutions to response-oriented advertisers. We cannot assure you that Web
advertising, response-oriented marketing or our model for providing solutions
based upon providing an improved return on investment for advertisers will
achieve broad market acceptance or generate significant revenue. Other Web
advertising companies' business models focus on selling advertising space on
premium Web sites. Many of these other Web advertising companies have a longer
history than we do. Our ability to generate significant revenue from advertisers
will depend, in part, on our ability to:
. demonstrate to advertisers the effectiveness of direct response advertising
on the Web;
. demonstrate to advertisers that they do not need to pay higher rates for
advertisements on premium Web sites in order to conduct an effective
advertising campaign on the Web;
. attract advertisers and Web sites to the Flycast Network;
. retain advertisers by differentiating the technology and services we provide
to them;
. obtain adequate available advertising space from a large base of Web sites,
whether they are small Web sites or large, premium Web sites; and
. obtain adequate advertising space from large, premium Web sites that either
have direct sales forces or are represented by Web advertising companies that
focus on selling advertising space on premium Web sites.
Further, the Web sites in the Flycast Network must continue to generate
sufficient user traffic characteristics attractive to advertisers. The intense
competition among Web sites has led to the creation of a number of pricing
14
<PAGE>
alternatives for Web advertising. These alternatives make it difficult for us to
project future levels of advertising revenue and applicable gross margins that
can be sustained either by us or the Web advertising industry in general. A key
component of our strategy is to enhance return on investment and other
performance measurements for the advertisers using the Flycast Network. We have
limited experience in implementing and following this strategy and we cannot
assure you that this strategy will succeed or that we will be able to achieve or
maintain adequate gross margins.
We face intense competition from more established Web advertising companies and
potential new competitors that could adversely affect our business
We face intense competition from Web advertising networks and providers of
advertising inventory management products and services. We expect this
competition to increase because there are no substantial barriers to entry. Many
of our existing competitors, as well as a number of potential new competitors,
have longer operating histories, greater name recognition, larger customer bases
and significantly greater financial, technical and marketing resources than it
does. This may allow them to respond more quickly than we can to new or emerging
technologies and changes in customer requirements. It may also allow them to
devote greater resources than we can to the development, promotion and sale of
their products and services. These competitors may also engage in more extensive
research and development, undertake more far-reaching marketing campaigns, adopt
more aggressive pricing policies and make more attractive offers to existing and
potential employees, strategic partners, advertisers, and Web sites. Our
competitors may develop products or services that are equal or superior to our
solutions or that achieve greater market acceptance than its solutions. In
addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase the
ability of their products or services to address the needs of our prospective
advertisers, advertising agency customers and Web sites. As a result, it is
possible that new competitors may emerge and rapidly acquire significant market
share. Increased competition is likely to result in price reductions, reduced
gross margins and loss of market share. We may not be able to compete
successfully, and competitive pressures may materially and adversely affect its
business, results of operations and financial condition.
We will depend on distribution relationships to increase our revenue
We believe that our future success will depend in part on our relationships with
companies that distribute or resell our Web advertising solutions. These
relationships have not generated significant revenue to date, and, in order for
us to be successful, revenue generated by our resellers must increase. Our
inability to enter into future distribution relationships might limit the number
and size of the markets that we serve. This could limit our revenue growth and
have a material adverse effect on our business, results of operations and
financial condition. We have recently initiated reseller relationships with
BellSouth, SBC Communications and U S WEST. Our agreements with them provide
that we will deliver a wholesale supply of local Web advertising that their
Yellow Pages sales forces will resell to local advertisers. These resellers have
no obligation to resell our inventory of advertising space on Web sites and can
terminate their relationships with us with limited or no penalty with as little
as 120 days' notice. The loss of any reseller, the failure of any reseller to
perform under its agreement with us or our inability to attract and retain new
resellers could have a material adverse effect on our business, results of
operations and financial condition.
Intensive marketing and sales efforts may be necessary to educate prospective
local advertisers about the uses and benefits of our products and services in
order to generate demand for our services in the local advertiser market
segment. These companies may not have adequate resources available to advertise
their products and services and may not be willing to devote the staff necessary
to educate themselves on the uses and benefits of our advertising solutions for
localized or otherwise limited target customers. We will depend on our
distributors to sell our Web advertising solutions. If these distributors do not
sell our solutions in an effective manner, our business, results of operations
and financial condition may be materially adversely affected.
We need to manage our available advertising space and to establish relationships
with diverse Web sites to attract customers
We need to make available a consistent supply of attractive advertising space to
attract customers. Our failure to do so could have a material and adverse effect
on our business, results of operations and financial condition. The Web sites
that list their unsold advertising space with us are not bound by contracts that
ensure us a consistent supply of inventory. In addition, Web sites can change
the number of advertising views they make available to us at any time, subject
to monthly minimums. If a Web site publisher decides not to make advertising
space from its Web sites available to the Flycast Network, we may not be able to
replace this advertising space with advertising space from other Web sites that
have comparable traffic patterns and user demographics in time to fulfill a
buyer's request. We expect our customers' requirements to become more
sophisticated as the Web matures as an advertising medium. For example, we
expect our customers to become more precise in their requirements for
geographically-targeted advertising that we sell through our reseller network.
We cannot assure you that the amount or type of advertising space listed or the
number of Web sites listing their advertising space on the Flycast Network will
increase or even remain constant in the future.
15
<PAGE>
We need to manage our growth effectively in a rapidly growing Web advertising
market where the requirements for success change frequently
As we continue to increase the scope of our operations, we will need an
effective planning and management process to implement our business plan
successfully in the rapidly evolving market for Web advertising. Our business,
results of operations and financial condition will be materially and adversely
affected if we are unable to manage our expanding operations effectively. We
have grown from 86 employees on March 31, 1999 to 153 employees on September 30,
1999. We plan to continue to expand our sales and marketing, customer support
and research and development organizations. Past growth has placed, and any
future growth will continue to place, a significant strain on our management
systems and resources. We have recently implemented a new financial reporting
system and expect that we will need to continue to improve our financial and
managerial controls and our reporting systems and procedures.
We depend on key personnel for our future success
Our future success depends to a significant extent on the continued service of
our key senior management, technical and sales personnel. We do not have long-
term employment agreements with any of our key personnel nor do we have key-
person insurance on any of our employees. The loss of the services of any member
of our management team, or of any other key employees, would have a material
adverse effect on our business, results of operations and financial condition.
Our future success also depends on our continuing ability to attract, retain and
motivate highly skilled employees. Competition for employees in the industry is
intense. We may be unable to retain our key employees or attract, assimilate or
retain other highly qualified employees in the future. We have experienced
difficulty from time to time in attracting the personnel necessary to support
the growth of our business, and we may experience similar difficulty in the
future.
We depend on the continued growth of Internet usage and infrastructure for our
business
Our market is new and rapidly evolving. Our business would be adversely affected
if Web usage does not continue to grow. Web usage may be inhibited for a number
of reasons, such as:
. inadequate network infrastructure;
. security concerns;
. inconsistent quality of service; and
. unavailability of cost-effective, high-speed service.
If Web usage grows, the Internet infrastructure may not be able to support the
demands placed on it by this growth or its performance and reliability may
decline. In addition, Web sites have experienced interruptions in their service
as a result of outages and other delays occurring throughout the Internet
network infrastructure. If use of the Internet does not continue to grow, or if
the Internet infrastructure does not effectively support growth that may occur,
our business, results of operations and financial condition would be materially
and adversely affected.
We must keep pace with rapidly changing technologies to be successful
The Web and Web advertising markets are characterized by rapidly changing
technologies, evolving industry standards, frequent new product and service
introductions and changing customer demands. The introduction of new products
and services embodying new technologies and the emergence of new industry
standards and practices can render existing products and services obsolete and
unmarketable or require unanticipated investments in research and development.
Our future success will depend on our ability to adapt to rapidly changing
technologies, to enhance existing solutions and to develop and introduce a
variety of new solutions to address our customers' changing demands. For
example, advertisers may require the ability to deliver advertisements utilizing
new formats that go beyond stationary images and incorporate video, audio and
interactivity, and more precise consumer targeting techniques. In addition,
increased availability of Internet access that delivers greater amounts of data
faster is expected to enable the development of new products and services that
take advantage of this expansion in delivery capability. Our failure to adapt
successfully to these changes could adversely affect our business, results of
operations and financial condition. We may also experience difficulties that
could delay or prevent the successful design, development, introduction or
16
<PAGE>
marketing of our solutions. In addition, any new solutions or enhancements that
we develop must meet the requirements of our current and prospective customers
and must achieve significant market acceptance. Material delays in introducing
new solutions and enhancements may cause customers to forego purchases of our
solutions and purchase those of our competitors.
Our patent status is uncertain
We have filed two regular patent applications and one provisional patent
application in the United States, but we do not have any issued patents. A
provisional patent application is a type of patent application under which a
patent will not issue. A provisional patent application only provides a priority
date for a regular patent application that is filed within a one-year period
following the filing of the provisional patent application. In September 1998,
we mistakenly announced that we had been issued one United States patent. At the
time of our announcement, that patent had been allowed by the United States
Patent and Trademark Office. Subsequently, the United States Patent and
Trademark Office informed us that the patent application had been withdrawn from
issue. A Patent Cooperation Treaty application covering this invention has been
filed and an application has also been filed in the European Patent Office. The
application relates to our AdEx technology, specifically the ability to serve
Web advertisements targeted to yield a viewer response. In January 1999, the
United States Patent and Trademark Office suggested a claim for interference
purposes with respect to this application. In March 1999, the United States
Patent and Trademark Office informed us that all claims were allowable but that
ex parte prosecution was suspended for a period of nine months due to a
potential interference. Therefore, we cannot take any action relative to this
application during the nine-month period. The purpose of an interference
proceeding is to determine the relative priority between two or more applicants,
and which of the applicants, if any, will ultimately be issued the patent. The
United States Patent and Trademark Office has not informed us of the identity of
the other patent applicant(s) involved. If an interference is declared, we may
not obtain a patent with respect to the application that is the subject of the
interference or may obtain a patent only for some subset of our original claims.
Regardless of the outcome of any interference, it may take years to resolve and
it might result in substantial expense to us. Patents may not be issued with
respect to our pending or future patent applications. Even if patents are
issued, the patents may not be upheld as valid or prevent the development of
competitive solutions. Third parties may have or may in the future be granted
patents that cover our technology. In September 1999, we became aware of a
patent that was granted to DoubleClick entitled "Method of Delivery, Targeting
and Measuring Advertising Over Networks." In an article published in the Wall
Street Journal on September 13, 1999, the Company, along with other companies,
was identified as a potential infringer of the DoubleClick patent. We are
reviewing our intellectual property with regard to the DoubleClick patent for
any possible patent infringement claims. We may be limited in our ability to use
our technology, whether or not patented, without licenses, which may not be
available on commercially reasonable terms.
We depend on our intellectual property rights and are subject to the risk of
infringement.
Our success and ability to compete are substantially dependent on our
internally-developed technologies, including AdEx, our advertising management
platform, and applications that use the AdEx platform, and our trademarks
AdAgent, AdEx, AdExchange, AdReporter, Category Select, Flycast, Run of
Category, Run of Network, SiteRegistry, SiteReporter and SiteSelect, which we
protect through a combination of patent, copyright, trade secret and trademark
law. We have applied for patents and applied to register trademarks in the
United States and have registered the trademark Flycast. We cannot guarantee
that any of our patent applications or trademark registrations will be approved.
Even if they are approved, these patents or trademarks might be successfully
challenged by others or invalidated. If our trademark registrations are not
approved because third parties own these trademarks, our use of these trademarks
will be restricted unless it enters into arrangements with these third parties,
which may be unavailable on commercially reasonable terms.
We generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and generally controls access to
and distribution of AdEx, tools and documentation and other information. Despite
these efforts, unauthorized parties may attempt to disclose, obtain or use our
solutions or technologies. Our precautions may not prevent misappropriation of
our solutions or technologies, particularly in foreign countries where laws or
law enforcement practices may not protect our rights as fully as in the United
States.
Our customized advertiser, affiliate and sales applications collect and utilize
data derived from user activity on the Flycast Network and the Web sites of Web
advertisers and sites using our solutions. This information is used for
targeting advertising and predicting advertising performance. Although we
believe we have the right to use this information and the compilation of this
information in our database, trade secret, copyright or other protection may not
be available for this information. In addition, others may claim rights to this
information. We have licensed, and may license in the future, elements of its
trademarks and similar intellectual property rights to third parties. Although
we attempt to ensure that the quality of our brand is maintained by these third
parties, they may take actions that could materially and adversely affect the
value of our intellectual property rights or its reputation.
We cannot guarantee that any of our intellectual property rights will be viable
or valuable in the future since the validity, enforceability and scope of
protection of intellectual property rights in Internet-related industries is
uncertain and still evolving. Furthermore, third parties may assert infringement
claims against us or the Web publishers with Web sites in the Flycast network.
Any claims could subject us to significant liability for damages and could
result in the invalidation of our intellectual property rights. In addition, any
claims could result in litigation, which would be time-consuming and expensive
to defend, and divert our time and attention. Even if we prevail, this
litigation could materially and adversely affect our business, results of
operations and financial condition. Any claims or litigation from third parties
may also result in limitations on our ability to use the intellectual property
subject to these claims or litigation unless we enter into arrangements with the
third parties responsible for these claims or litigation, which may be
unavailable on commercially reasonable terms.
We are subject to privacy concerns that may limit our success
Our technology collects and utilizes data derived from user activity on the Web
sites in the Flycast Network. AdEx enables the use of personal profiles, in
addition to other mechanisms, to deliver targeted advertising, to help compile
demographic information and to limit the frequency with which an advertisement
is shown to the user. The effectiveness of our technology and the success of our
business could be limited by any reduction or limitation in the
17
<PAGE>
use of personal profiles. These personal profiles contain bits of information
keyed to a specific server, file pathway or directory location that are stored
in the Internet user's hard drive and passed to a Web site's server through the
user's browser software. Personal profiles are placed on the user's hard drive
without the user's knowledge or consent, but can be removed by the user at any
time through the modification of the user's browser settings. In addition,
currently available Web browsers can be configured to prevent personal profiles
from being stored on their hard drive. Some commentators, privacy advocates and
governmental bodies have suggested limiting or eliminating the use of personal
profiles.
The European Union has recently adopted a directive addressing data privacy that
may result in limitations on the collection and use of information regarding
Internet users. These limitations may limit our ability to target
advertising or collect and use information in most European countries.
We are subject to government regulation and legal uncertainties of doing
business on the Web
Laws and regulations that apply to Internet communications, commerce and
advertising are becoming more prevalent. These regulations could affect the
costs of communicating on the Web and adversely affect the demand for our
advertising solutions or otherwise have a material and adverse effect on our
business, results of operations and financial condition. Recently, the United
States Congress enacted Internet legislation regarding children's privacy,
copyrights and taxation. A number of other laws and regulations may be adopted
covering issues such as user privacy, pricing, acceptable content, taxation and
quality of products and services. This legislation could hinder growth in the
use of the Web generally and decrease the acceptance of the Web as a
communications, commercial and advertising medium. In addition, the growing use
of the Web has burdened the existing telecommunications infrastructure and has
caused interruptions in telephone service. Telephone carriers have petitioned
the government to regulate and impose fees on Internet service providers and
online service providers in a manner similar to long distance carriers.
Due to the global nature of the Web, it is possible that, while our
transmissions originate in California, the governments of other states or
foreign countries might attempt to regulate our transmissions or levy sales or
other taxes relating to our activities. Furthermore, the European Union recently
adopted a directive addressing data privacy that may result in limits on the
collection and use of user information. The laws governing the Internet
remain largely unsettled, even in areas where there has been some legislative
action. It may take years to determine whether and how existing laws including
those governing intellectual property, privacy, libel and taxation apply to the
Internet and Internet advertising. In addition, the growth and development of
the market for Internet commerce may prompt calls for more stringent consumer
protection laws, both in the United States and abroad, that may impose
additional burdens on companies conducting business over the Internet. Our
business, results of operations and financial condition could be adversely
affected by the adoption or modification of laws or regulations relating to the
Internet, or the application of existing laws to the Internet.
We face an unknown number of Year 2000 risks
Many currently installed computer systems and software products are coded to
accept or recognize only two digit entries in the date code field. These systems
and software products will need to accept four digit entries to distinguish 21st
century dates from 20th century dates. As a result, computer systems and/or
software used by many companies and governmental agencies may need to be
upgraded to comply with these Year 2000 requirements or risk system failure or
miscalculations causing disruptions of normal business activities.
We have made an assessment of our Year 2000 readiness. We performed a Year 2000
simulation on our software. We have also contacted third-party vendors,
licensors and providers of software, hardware and services regarding their Year
2000 readiness.
Please see "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for more detailed information.
We expect to experience volatility in our stock price that could affect your
investment
The price at which our common stock will trade at is likely to be highly
volatile and may fluctuate substantially due to factors such as:
. actual or anticipated fluctuations in our results of operations;
18
<PAGE>
. changes in or failure by us to meet securities analysts' expectations;
. announcements of technological innovations;
. introduction of new services by us or our competitors;
. developments with respect to intellectual property rights;
. conditions and trends in the Internet and other technology industries; and
. general market conditions.
In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have affected the market prices for the
common stocks of technology companies, particularly Internet companies. In the
past, these broad market fluctuations have been unrelated or disproportionate to
the operating performance of these companies. Any significant fluctuations in
the future might result in a material decline in the market price of our
common stock. In the past, following periods of volatility in the market price
of a particular company's securities, securities class action litigation has
often been brought against that company. We may become involved in this type of
litigation in the future. Litigation is often expensive and diverts management's
attention and resources, which could have a material adverse effect upon our
business and results of operations and financial condition.
19
<PAGE>
We may not achieve the benefits from our acquisition of InterStep, Inc
On August 30, 1999, we acquired InterStep, Inc. by issuing 480,337 shares of
common stock for all of the outstanding shares of InterStep. Of the 480,337
shares of common stock, 47,558 shares are held by an escrow agent to serve as
security for the indemnity provided by some of the shareholders of InterStep.
We accounted for the acquisition as a pooling-of-interests. The acquisition of
InterStep and any other company involve numerous risks, including difficulties
in the assimilation of the operations, technologies, products and personnel of
the acquired company, the diversion of management's attention from other
business concerns, risks of entering markets in which we have no or limited
direct prior experience and the potential loss of key employees of the acquired
company. Therefore, our business, results of operations, financial condition and
the trading price of our common stock may be materially and adversely affected
due to the factors described above.
Risks Related To The Proposed Merger Of Flycast With CMGI
CMGI's stock price is volatile and the value of the CMGI common stock issued in
the merger will depend on its market price at the time of the merger, and no
adjustment will be made as a result of changes in the market price of CMGI's
common stock.
At the closing of the merger, each share of Flycast common stock will be
exchanged for 0.4738 shares of CMGI common stock. This exchange ratio will not
be adjusted for changes in the market price of CMGI common stock. In addition,
neither CMGI nor Flycast may terminate or renegotiate the merger agreement, and
Flycast may not resolicit the vote of its stockholders solely because of changes
in the market price of CMGI common stock. Any reduction in CMGI's common stock
price will result in you receiving less value in the merger at closing. You
will probably not know the exact value of CMGI's common stock to be issued to
you in the merger at the time of the special meeting of Flycast stockholders.
The market price of CMGI's common stock, like that of the shares of many other
high technology and Internet companies, has been and may continue to be
volatile. For example, from October 1, 1998 to November 1, 1999, the CMGI
common stock traded as high as $148.906 per share and as low as $9.3438 per
share.
Recently, the stock market in general and the shares of Internet companies in
particular have experienced significant price fluctuations. The market price
may continue to fluctuate significantly in response to various factors,
including:
. quarterly variations in operating results or growth rates;
. the announcement of technological innovations;
. the introduction of new products;
. changes in estimates by securities analysts;
. market conditions in the industry;
. announcements and actions by competitors;
. regulatory and judicial actions; and
. general economic conditions.
20
<PAGE>
If CMGI does not manage the integration of other acquired companies
successfully, it may be unable to achieve desired results and as a result the
market price of CMGI may decline
CMGI has recently entered or announced additional business combinations and
acquisitions, such as the recently proposed acquisitions of AdForce Inc.,
AdKnowledge Inc. and AltaVista Company. CMGI may enter into further business
combinations and acquisitions. Acquisitions are typically accompanied by a
number of risks, including:
. the difficulty of integrating the operations and personnel of the acquired
companies;
. the potential disruption of its ongoing business and distraction of
management;
. the difficulty of incorporating acquired technology and rights into CMGI's
products and services;
. unanticipated expenses related to technology integration;
. the maintenance of uniform standards, controls, procedures and policies;
. the impairment of relationships with employees and customers as a result of
any integration of new management personnel; and
. potential unknown liabilities associated with acquired businesses.
CMGI may not succeed in addressing these risks or any other problems encountered
in connection with these potential business combinations and acquisitions, which
could disrupt CMGI's business and cause increased losses.
CMGI may face challenges in integrating CMGI and Flycast and, as a result, may
not realize the expected benefits of the anticipated merger
Integrating the operations and personnel of CMGI and Flycast will be a complex
process, and we are uncertain that the integration will be completed rapidly or
will achieve the anticipated benefits of the merger. The successful integration
of Flycast with other CMGI companies will require, among other things,
integration of sales and marketing groups and coordination of development
efforts. The diversion of the attention of CMGI's management and any
difficulties encountered in the process of combining the companies could cause
the disruption of, or a loss of momentum in, the activities of the combined
company's business. Further, the process of combining CMGI and Flycast could
negatively affect employee morale and the ability of the combined company to
retain some of its key employees after the merger.
If CMGI does not successfully integrate Flycast or the merger's benefits do not
meet the expectations of financial or industry analysts, the market price of
CMGI common stock may decline
The market price of CMGI common stock may decline as a result of the merger if:
. the integration of CMGI and Flycast is unsuccessful;
. CMGI does not achieve the perceived benefits of the merger as rapidly or to
the extent anticipated by financial or industry analysts; or
. the effect of the merger on CMGI's financial results is not consistent with
the expectations of financial or industry analysts.
21
<PAGE>
Failure to complete the merger could negatively impact the market price of
Flycast common stock and our operating results
If the merger is not completed for any reason, Flycast may be subject to a
number of material risks, including:
. we may be required to pay CMGI a termination fee of $20,000,000 and/or
reimburse CMGI for expenses of up to $500,000;
. Flycast stockholders may experience dilutive effects to their stock ownership
because an option to acquire up to 19.9% of the outstanding shares of Flycast
common stock granted to CMGI by Flycast may become exercisable;
. the market price of Flycast common stock may decline to the extent that the
current market price of Flycast common stock reflects a market assumption
that the merger will be completed; and
. costs related to the merger, such as legal and accounting fees, must be paid
even if the merger is not completed.
If the merger is terminated and Flycast's board of directors seeks another
merger or business combination, you cannot be certain that Flycast will be able
to find a partner willing to pay an equivalent or more attractive price than the
price to be paid by CMGI in the merger. In addition, CMGI's option to acquire
up to 19.9% of the outstanding shares of Flycast common stock, which may become
exercisable upon termination of the merger agreement, may impede an alternative
merger or business combination.
We may not be able to enter into a merger or business combination with another
party at a favorable price because of restrictions in the merger agreement
prohibiting us from entering into such transactions or soliciting such proposals
Under the merger agreement, we are is prohibited from entering into or
soliciting, initiating or encouraging any inquiries or proposals that may lead
to a proposal or offer for a merger, consolidation, business combination, sale
of substantial assets, tender offer, sale of shares of capital stock or other
similar transactions with any person other than CMGI. As a result of this
prohibition, we may not be able to enter into an alternative transaction at a
favorable price.
Our officers and directors have conflicts of interest that may influence them to
support or approve the merger
The directors and officers of Flycast participate in arrangements and have
continuing indemnification against liabilities that provide them with interests
in the merger that are different from, or in addition to, yours, including the
following:
. As of September 30, 1999, the executive officers and directors of Flycast
owned stock options to purchase an aggregate of 2 million shares of Flycast
common stock, of which 1.4 million are unvested. If the merger is completed,
550,000 of the unvested options will accelerate and become immediately
exercisable;
22
<PAGE>
. Directors and officers and their affiliates, representing a significant
percentage of Flycast shareholders, have agreed to vote in favor of the
merger;
. Certain officers of Flycast are entitled to certain benefits, including
substantial severance packages, under their employment agreements with
Flycast if their employment is terminated upon Flycast's change of control,
such as the merger;
. Upon completion of the merger, CMGI and Flycast may enter into employment
agreements with certain Flycast executive officers; and
. CMGI has agreed to cause the surviving corporation in the merger to indemnify
each present and former Flycast officer and director against liabilities
arising out of such person's services as an officer or director. CMGI will
cause the surviving corporation to maintain officers' and directors'
liability insurance to cover any such liabilities for the next six years.
The directors and officers of Flycast may therefore have been more likely to
vote to approve the merger agreement and the merger than if they did not have
these interests.
Uncertainties associated with the merger may cause us to lose key personnel
Current and prospective Flycast employees may experience uncertainty about their
future roles with CMGI. This uncertainty may adversely affect our ability to
attract and retain key management, sales, marketing and technical personnel.
Customers of CMGI and/or Flycast may delay or cancel orders as a result of
concerns over the merger
The announcement and closing of the merger could cause customers and potential
customers of CMGI and/or Flycast to delay or cancel orders for products as a
result of customer concerns and uncertainty over product evolution, integration
and support over the combined company's products. Such a delay or cancellation
of orders could have a material adverse effect on the business, operating
results and financial condition of CMGI or Flycast.
Failure Of The Merger To Receive Governmental Approvals In A Timely Manner Could
Slow The Progress Of The Transaction Which Could Negatively Impact the Value Of
Your Investment
The merger's consummation is conditioned upon the expiration or termination of
the applicable waiting period under the Hart-Scott-Rodino Act. In addition,
other filings with, notifications to and authorizations and approvals of various
governmental agencies relating primarily to antitrust and securities law issues
must be made and received prior to the consummation of the merger. There is no
assurance that the approvals or required clearances will be obtained. The
failure to obtain or delay of such approval or clearance could have a material
adverse effect on the business, operating results and financial condition of
CMGI or Flycast and could have a negative effect on CMGI's and Flycast's stock
prices and the value of your investment.
23
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
NONE
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Changes in Securities:
NONE
(b) Use of Proceeds
On May 4, 1999, the Securities and Exchange Commission declared effective
Flycast's Registration Statement on Form S-1. Pursuant to this Registration
Statement, and the Abbreviated Registration Statement filed on February 19, 1999
pursuant to Rule 462(b) promulgated under the Securities Act of 1933, as
amended, on May 4, 1999, Flycast completed the initial public offering of
3,000,000 shares of its Common Stock at an initial public offering price of
$25.00 per share (the "Offering"). The Offering was managed by BT Alex.Brown,
Hambreqt & Quist and Dain Rauscher Wessels. Proceeds to Flycast, after
calculation of the underwriters discount and commission, from the offering
totaled approximately $69.75 million net of offering costs of $5.25 million.
None of the expenses incurred in the offering were direct or indirect payments
to directors, officers, general partners of the issuer or their associates, to
persons owning ten percent or more of any class of equity securities of the
issuer or to affiliates of the issuer. Flycast expects to use the remaining
proceeds for all general corporate purposes.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
(a) The following exhibits are filed as part of this report:
27.1 Financial Data Schedule
(b) The Company filed reports on Form 8-K on September 9, 1999 and October 13,
1999.
24
<PAGE>
FLYCAST COMMUNICATIONS CORPORATION
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Flycast Communications Corporation
Date: November 12, 1999 By: /s/ Ralph J. Harms
---------------------------------- -------------------------------
Ralph J. Harms
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 14,221
<SECURITIES> 57,195
<RECEIVABLES> 12,236
<ALLOWANCES> (900)
<INVENTORY> 0
<CURRENT-ASSETS> 84,754
<PP&E> 11,998
<DEPRECIATION> (2,392)
<TOTAL-ASSETS> 94,675
<CURRENT-LIABILITIES> 18,461
<BONDS> 0
0
0
<COMMON> 103,768
<OTHER-SE> 1,874
<TOTAL-LIABILITY-AND-EQUITY> 94,675
<SALES> 24,066
<TOTAL-REVENUES> 24,066
<CGS> 16,811
<TOTAL-COSTS> 16,811
<OTHER-EXPENSES> 26,004
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 596
<INCOME-PRETAX> (18,693)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,693)
<EPS-BASIC> (2.18)
<EPS-DILUTED> (2.18)
</TABLE>
